Friday, April 19, 2013

Corporate Strategy? You Shouldn’t Even Try

Most corporations consist of multiple divisions. These divisions, which set their own strategy (what we generally refer to as “business strategy”), more often than not have very little to do with one another. Take Philips Electronics with its lighting, medical equipment, and consumer electronics; ThyssenKrupp with steel, elevators, and engineering services; or smaller companies such as Trinity Mirror with newspapers, printing, and digital services. They may not be like the conglomerates of the 1960s – you can see how their portfolio of somewhat related business came about – but, in reality, the various divisions and business units do operate completely independently from one another.

Yet, corporate top management invariably tries hard to formulate an overarching strategy. It endeavors to stimulate cooperation across divisions (by repeatedly shouting really loudly that this should happen), sets up corporate shared services (which invariably are seen as a mere cost and nuisance by its divisional heads), and have some abstract talk about creating “cross-divisional synergies”.

And I say, don’t even go there; don’t even try.

It’s not worth it; it’s artificial; it won’t work (because it never does); and, most of all, there’s just no need for it. Just forget about it.

“But, what then could possibly be the rationale and justification for these various business to be together in one corporation?!” I hear a cacophony of voices – of analysts, investors, board members, and business school professors – shout. “There must be something; otherwise the corporation should be broken up, because shareholders can do the diversification themselves”. It is firmly rooted in our minds that there must be some sort of a rationale for why these various businesses are grouped together into one firm.

And that’s right; there is a rationale. But seeing it requires a significant change of mindset of what a corporation is and does, and should do.

Once companies grow they often start moving into adjacent business areas. For example, a company may have moved from steel into engineering products because they require steel, then moved into engineering services, and became big in elevators causing them to set up a separate division for that too. These four divisions set their own strategy – e.g. the business strategy for engineering services, the strategy for elevators, etcetera – and have their own management teams and P&L.

Any corporate finance course will then tell you – probably on day one – that somehow these four divisions must create extra value by being grouped together; otherwise they should be split up into four separate companies, because you then save the costs of an expensive corporate head office, and investors themselves can easily do the diversification across different businesses – including these four – better, cheaper, and more customized to their own needs.

And therefore corporate top management teams come up with some contrived idea of a joint strategy to suggest synergies and justify their own existence.

But what the real value of a corporate top management is – or can be – is very different from all these things, but it requires these people to see their task and themselves in a different light: corporations are not there to set strategy, but they simply exist as investment vehicles, with the senior executives as its managers. Overall, I see three related roles for them:

1) First, corporate C-suite executives are portfolio managers. But they differ from fund managers and alike in a significant way; they actually know the business. Fund managers, equity analysts, hedge fund managers, and so on can analyze the numbers perfectly well and listen to the powerpoint presentation of the CEO on its roadshow. But corporate executives, who may have grown up in the business, work on it every day, and have an authoritative relationship with their divisional managers are better able to really grasp the in-depth and tacit aspects of the business’ strategy and competitive advantage. This makes them better portfolio managers, in the sense that they see things that external investors miss. Analysts are easily fooled by nice numbers and charismatic CEOs; the Goldman Sachs analysts who wrote “Enron is still the best of the best. We recently spoke with most of top management; our confidence level is high” a mere six weeks before it filed for bankruptcy still come to mind.

2) From this also follows their second role: they can play the role of a board of directors – but then better informed. In reality, boards are severely limited in terms of their knowledge of the corporation they are governing – not the least because external directors are of course no more than a collection of part-timers and amateurs. It is nearly impossible to really grasp the inner workings of a multinational, diversified corporation for an outsider who spends a couple of days per year on it. The top management of the corporation can really conduct this task; hence, they are probably the company’s real governance mechanism, assuring that shareholders’ money is spent wisely, strategies are genuinely set, and the numbers justified. Moreover, unlike boards, they can staff the divisional management teams with people they actually know and select.

3) Finally, a corporation’s head office can provide funds, much like an in-house bank. This might sound trivial, because lots of parties can provide money, but the advantage is again the superior insider knowledge and accompanying speed of operation. For example, where it is well-known that the majority of public acquisitions destroy value, research by professor Laurence Capron from INSEAD shows that private deals, on average, do create value. Most companies in the world are private but, unlike public firms, there is not a lot of information about them available. Therefore, it requires someone knowledgeable of the business to identify attractive targets, and be able to make the funds swiftly available. The top management of corporations can provide such insight, funds, and speed of allocation. Which gives a business that is part of larger, well-endowed corporation a potential advantage. Hence, a corporation’s top management team is a way to internalize portfolio management, governance, and resource allocation.

I often attend yearly conferences of corporations in which they bring together their top 50 or 100 executives to discuss the corporation’s strategy (which invariably is a mixture of amorphous capability statements and financial goals, i.e. not really a strategy), proclaim once more the need for cross-divisional synergies and cooperation, and listen to some keynote speaker (such as yours truly) in an attempt to provoke ideas on how to achieve this. Stop doing this I’d say (including the keynote speaker). There is no need for an overarching corporate strategy. It is invariably contrived, never creates any real value, and is simply not necessary.

Corporations comprising different businesses in separate divisions can exist for good reason. Creating corporate strategy is not needed for such corporations to rightfully exist. It does require a fundamental rethink of what your corporation is for, and what you – as corporate manager – are for. Understanding the real advantage of corporations is paramount to making them work. It usually means getting out of the way of divisional strategy, rather than trying to set it.