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Value creation by the holding company: a delicate balance

October 19, 2015 – by Rob van de Blaak &samhoud consultancy

As consultants, we have worked extensively for holding companies and witnessed how they unfortunately fail to attain many of their goals (greater coherence, synergy and cooperation) in practice. The recent collapse of the Dutch engineering firm Imtech was indicative of how a holding company can also grant its subsidiaries too much freedom. Where does the balance between creating and destroying value lie within a holding company?

artikelRob2Large holding companies

Often, these holding companies have come about through a process of mergers and takeovers. And out of the desire to capitalise on the potential synergy offered by different companies, the holding company is expanded even further. All kinds of functions are executed within the individual companies. It then seems logical to group all of these people together (in Facilities, HR, Finance, IT, communications, compliance, marketing, etc.) in order to work more efficiently and effectively.

An own dynamic is also often created within a holding company, and sometimes even an own reality. The Executive Board of the holding company must be served. Working in the holding company often has a higher status than working in an operating company. The holding company should be subservient to operating companies, but in reality the holding company is the boss. The holding company is far removed from the business and customers, and lives within its own world.

And that is how the gap between operating companies and the holding company grows ever greater. Does this sound familiar? This is also how business units/divisions/subsidiaries grow increasingly annoyed with the holding company. And the other way round, by the way. We frequently encounter the following responses:

  • Why don’t those people in our subsidiaries understand that they have to work together with other subsidiaries?
  • Why are they only concerned about their own company, and not the business and not the entire entity?
  • They clearly do not understand what it is about and lack the overall view that we in the holding company have.

Small holding companies

But it doesn’t have to be like this. Warren Buffet manages his conglomerate Berkshire Hathaway (340,000 employees) from a holding company with merely 25 members of staff. There is considerable confidence in entrepreneurship within the individual companies. Another example is a large construction company in the Netherlands, with around 7,000 employees across 22 different companies. Its holding company is staffed by 30 people. Or look at Buurtzorg, the Dutch home-care provider, with over 3,500 employees and only 20 individuals in its head office.

The number of people working in the holding does not tell the whole tale about value creation or destruction by the holding company. It is primarily about what they do, and whether they do that better than those within the individual companies could. 

Value creation and destruction by the holding company

There are activities that the holding company can use to create value for companies, and likewise activities with which they can destroy it. The skill lies in ensuring that more value is created than that which is destroyed. In that sense, life is simple. Five activities that can be used to create value:

  • Financing – the total is greater, which means there is better access to the capital market, external funding is possible, funding benefits can exist internally, and fiscal optimisation can be implemented;
  • Strategy development – there is a better complete overview of market development, the portfolio of businesses can be managed via active mergers and acquisitions;
  • Centralised tools and functions – headquarter assets (including brands) and centralised functions such as IT and Finance, and HR benefits such as labour market communication and employer branding;
  • Operational involvement; budgeting and monitoring, centralised initiatives and encouraging cooperation;
  • Creating synergy in the business – for example, in sales, processes or operations.

Five activities that can be used to destroy value:

  • Insufficient expertise and skills – caused by a poor understanding of business-imposed requirements, why would a holding manager who spends 10% of his time on a particular business make better decisions than a manager in an operating company who devotes 100% of his time;
  • Inefficient processes – due to complex and costly corporate processes;
  • Complexity costs – excessive waste of resources and time due to internal coordination problems;
  • Lack of resources; subsidiaries receive too little capital or too little management focus;
  • Conflicting goals – differing agendas, opinions or incentives. For example, synergy can also be an ‘enlightened self-interest’ of the holding company.

holdingcompaniesThe six holding company roles

Six possible strategies for creating value for holding companies:

Hands-off ownership: these holdings manage the portfolio of companies, but do not aspire to influence strategic or centralised functions. They manage their companies as financial assets and only specify global financial targets. They have a small corporate centre and are highly cautious even when setting up centralised shared services.

Financial sponsorship: these holding companies offer financial benefits in particular. Cheaper and more flexible funding, fiscal optimisation, protection against external capital markets (reporting or interfering stakeholders). These holding companies are also equally careful about interfering as the first group, and only do so if performance deteriorates, but then often only temporarily.

Synergy creation: these holding companies seek synergy in sales, marketing or operations. Together they compose a portfolio of companies that are a natural fit and can benefit fully from internal cooperation. The subsidiaries, however, remain fully responsible for their performance. This simultaneously creates the risk of complexity costs, slow decision-making and costly internal processes.

Strategic guidance: these holding companies seek strategic advantages and create value through superior strategic insight and by defining a clear strategic direction for subsidiaries. Such holding companies are very active in mergers and acquisitions. Large centralised functions are not needed to this end. They do, however, require a certain skill set within the holding company (investment appraisal, joint venture management and productivity improvement). If these skills are absent, such a strategy is risky.

Functional leadership: a more active strategy whereby these holding companies endeavour to create value through functional excellence, shared corporate resources and centralised services. As a result, they build strong centralised functions that combine expertise in areas that add value to the companies, such as strategy development and innovation. Occasionally, they also combine functions as IT, accounting and procurement to obtain cost advantages. This strategy is chosen by many leading, globally integrated companies.

Hands-on management: the holding company goes further than merely defining objectives, strategic guidelines or functional leadership. It becomes deeply involved in the management of subsidiaries by influencing operational decisions in individual companies. These companies often have a detailed and comprehensive process for budgeting and strategic planning, with the decision-making process occurring within the holding company. They also have stringent investment criteria, and holding managers sometimes take improvement-related initiatives between or within subsidiaries. The risk of destroying value is greatest here. If the holding company adds considerable insight and skills, this can offset the cost of complexity and inefficient processes.

Choosing on the basis of value creation

The greater the level of involvement from the holding company, the greater the likelihood of creating value. But the likelihood of value destruction is also greater. What is the optimal choice? This differs for every organisation, and can also differ for various sectors. The diversity of the portfolio also plays a role.

Questions you must ask to determine the correct ‘parental’ strategy:

  1. How do we now add value to companies in our portfolio? Are there ways in which we destroy value?
  2. Who monitors and challenges the holding company with regard to its added value? Who keeps the holding company on its toes and has countervailing power?
  3. How would we describe our current ‘parental strategy’? How is it compared to our key competitors?
  4. What are the ‘parental strategy’ needs and opportunities in the business? What corporate activities can support our overall strategy?
  5. What should our ‘parental strategy’ goal be, and which ‘parental strategy’ activities should we focus on?
  6. What are the biggest gaps we must bridge to achieve our desired ‘parental strategy’? What we should be doing more of, and what should we stop doing?

Make a deliberate choice before others choose

Many holding companies fail to address these questions in a deliberate manner. The holding company often assumes greater influence during an organisation’s life cycle. The deliberately chosen and gradual path, on the other hand, is encountered less often. This usually occurs in a heavy-handed manner. The company comes under shareholder pressure and is acquired, subsidiaries are spun off and sold separately, or listed on the stock exchange. And what do we see? When added together individually, they are worth more compared to when they were in the holding company.

A deliberately chosen balance, integrating neither too quickly nor too much , but also neither too slowly nor too little, can help avoid a great deal of misery .

 

Sources:
The Value of the Parent Company, Campbell, Goold and Alexander, California Management Review, 1995
First, Do No Harm. How to be a Good Corporate Parent, BCG March 2012

 

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