Corporate centre - Discovering the value of the corporate centre

Chris Frost, a partner in the global risk management solutions practice at PricewaterhouseCoopers.
By focusing too much energy on cutting costs and not enough on activities that add value, company executives risk damaging vital functions, explains Chris Frost.

For most companies, the role of the corporate centre is to build value, to provide compliance and governance for the business, and to deliver centralised transaction processing. The corporate centre can become a cost-intensive part of the business and, consequently, is often at the sharp end of any planned cost-cutting programme. Experience has shown that unless considerable care is taken, unfocused cost reduction exercises applied wholesale to the corporate centre can be very damaging.

Sustainable corporate growth depends on the strategic management of volatility - cutting costs with an eye to the future, instead of embarking on knee-jerk slash and burn cost reduction. However, some companies are still confusing short-term shareholder appeasement with effective strategic cost management, and, in the process, risk being under-resourced in key areas. During downturns, companies should be prepared to invest in activities that add long-term value - and on cutting costs in areas that do not damage the business. Achieving the right balance is a real challenge.

Smart cost reduction is all about trimming fat and building muscle. And doing that means understanding which of the activities performed within the corporate centre functions add value - and which do not. A model developed by David Pettifer, a PricewaterhouseCoopers partner, in conjunction with the Ashridge Strategic Management Centre, helps management to analyse the value of key corporate centre functions before taking steps to reduce headcount or costs. The model groups these activities into the following:

•   Compliance-based activities - that add no inherent value to the business, but must nevertheless be performed for a regulatory or compliance purpose (eg, health and safety, environmental, financial reporting).

•   Value-adding activities - that add value to the business and ensure that the value of sum of the organisation as a whole is greater than its constituent parts (eg, managing the company's portfolio of businesses, brand management, training, R&D, marketing, etc).

•   Transactional processing activities - that are a fact of life for any business (eg, invoicing, bill processing, procurement, IT, payroll processing, etc.).

Viewed as a pyramid, many manufacturing and retail-sector companies will have compliance at the apex, value-added in the centre and transactional at the base (see Figure 1).

This structure would, however, be inverted for financial sector organisations which are necessarily heavily compliance-oriented. Although common to all businesses, the relative importance of these three functions will vary substantially, according to individual corporate cultures and industry sector pressures. Some corporate models involve decentralising many corporate activities away from a minimal corporate centre. On the other hand, there are businesses with a very substantial corporate centre - because that is the right model for that kind of business. There is no 'one size fits all' - the nature of each corporate function must be tailored to the needs of the business as a whole.

But whatever the sector, and whatever the challenges, constructively rethinking a company's corporate centre can involve benchmarking compliance and transaction processing activities against industry sector norms (we use Ashridge's own data with data from our global best practices database).

This is a straightforward, quantifiable process that can help highlight those corporate centre functions that should not be included in a cost reduction exercise - as well as those that should be targeted.

Management's role

The role of management is to understand where cuts can be made (depending on which activities do, and which do not, add value) - and equally importantly, where cuts should not be made. This self-assessment entails breaking down corporate centre departments into key activity areas, and quantifying how much effort and cost is invested in each one - and for what return.

There is a need to have a clear definition of the role that the corporate centre is to play in the running of the business. What are the value-adding activities? Do they add as much value as required? How much effort should be expended in value adding activities? The answers to these questions may also lead to executives finding that they need to question their own role - should they be focused on directing and controlling the business?

Or should they spend more time energising it?

The results are usually sobering. Many executives discover that the time they devote to adding value to the business is eclipsed by the hours spent on managing the day-to-day needs of the business. Command/control structure organisations set great store by budgeting processes, resource allocation and financial planning - and management is responsible for ensuring that these are adhered to. Instead of the corporate centre serving the business - the business begins to serve the corporate centre. Visionary decision-making gets forced out and competitiveness is dangerously undermined.

Change in these organisations is usually reactive and so, when their executives come under pressure to initiate cost-cutting, the understandable reaction is to reduce corporate centre headcount - across the board and immediately. A key message to anyone in that unenviable position is that before they start this process, they should spend time working out what they want from their corporate centre. They should understand what is being done within the corporate centre and have a view of those areas that are really over-staffed (some companies we encounter have finance function headcounts three to four times higher than the best practice benchmark), and where they need to make additional investment for the future to generate additional value for the business. How much time is wasted overseeing the generation of interminable financial management statistics when that could be better spent on added value activities?

Each company will have its own priorities and its own agenda. There is no 'one size fits all' approach to cost-cutting, and there is no generic value-creation formula. Our role is, put simply, to facilitate the process by which executives challenge their own assumptions. We steer them slightly to keep them on course - or put them back on a safe heading. We also encourage them to be counter-intuitive - cost reduction programmes frequently throw up an urgent need for investment in long-term value.

From that point, they can manage the process themselves, revisiting the value proposition regularly to take account of changes inside, and outside, the organisation, while keeping a weather eye on corporate centre administration.

Corporate self-awareness is beneficial at any time - but in a volatile business environment, it is basic survival.

Bad parenting

So, in re-evaluating and restructuring their corporate centres, what should organisations be striving towards? A helpful analogy, especially for large organisations with multiple operating units, is to view the corporate centre as the 'corporate parent'. Its role is to help the business grow - achieving a balance between control and self-determination. Like bad parents, far too many corporate centres tend either to be overbearing, limiting essential freedoms and killing initiative, or to be too hands-off, failing to provide any real framework for growth and development.

By extension, instead of maintaining close control over transaction processing, executives might be better advised to move this function into a separate service division, achieving efficiencies through a combination of shared service and outsourcing. The boundaries of control will vary according to the nature of the business - there may be some aspects that require close monitoring, while others can be moved out.

The winners in today's market are low-cost, agile organisations - but cost reduction must streamline the business without hurting future revenue potential. In Strange Days, a 2002 PwC survey, we asked over 590 businesses worldwide how they were addressing cost management in an uncertain environment.

The findings were disturbing (but probably predictable). Notably, companies are not practising what they preach - 86% of respondents agreed that short-term cost reduction programmes can be strongly detrimental to corporate cultures, and 55% agreed that obvious cost-cutting is more about impressing analysts and shareholders than improving the business. But knowing this did not stop most of them from making exactly those same short-term cuts.

Sustainable corporate centre cost reduction is not blue-sky management theory. It is simply good business sense. Just as the human body has a highly-developed survival technique for dealing with famine (eating up blood sugar, fat and non-essential muscle, leaving the key parts of the body strong enough to continue to forage for food and water), so companies need to ensure that their planned cost-cutting is not, in fact, suicidal.

Effective corporate centres manage to hit the right balance between compliance, administration, and adding value. So do effective managers.

CASE STUDY: the Co-Operative Group

With 3,000 retail outlets, 70,000 employees and 7.7bn annual revenues, the Co-Operative Group is, in effect, a major conglomerate. Rethinking its corporate centre would be a challenging process.

Neil Fletcher, the group's general manager, internal audit, explains: 'Our ongoing cost reduction programme initially prompted the corporate centre review. Our first task was to launch a discovery phase, in order to redefine the purpose of the corporate centre. We were clear that cost reduction should not be a short-term exercise - but part of an overall strategic focus on building and adding value to the whole business and clearly the corporate centre had an important part to play in that.' PricewaterhouseCoopers was selected to steer the group through the discovery phase and into the review process (taking three months in all). A project team was assembled combining, at various stages, five PwC advisers and four Co-Operative employees. It was important, says Fletcher, that detailed knowledge of the process and techniques should be retained internally when PwC left. An early-stage priority was for management to define, identify, and agree on, the key activities that the corporate centre should be fulfilling.

Group-level compliance and governance was one; value-adding/parenting activity was another, and the third was shared services (there were additional Co-Operative-specific angles where compliance and value-added were concerned).

The review process involved creating detailed spreadsheets recording the time and costs on each of the key activities (some individuals spread their time over all three). Where value-added activities were concerned, Fletcher stresses that it was essential to be strict in keeping within the definition - 'activities that only the group could create (that could not be created by a single business itself)'. During the analysis the project team had to be careful to explain what added value/parenting is, as all employees add value and there would inevitably be employee sensitivities around this issue. The activities that add, in the words of one PwC adviser, 'super value', for example, by creating synergies across all the businesses.

Also, it became clear that some corporate centre activities if misdirected could potentially destroy value!

The results of the review provided useful background information on the corporate activities for the new chief executive. One action has been to commence a review of business service functions.

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