The huge sums that private equity firms make on their investments evoke admiration and envy. Typically, these returns are attributed to the firms' aggressive use of debt, concentration on cash flow and margins, freedom from public company regulations, and hefty incentives for operating managers. But the fundamental reason for private equity's success is the strategy of buying to sell-one rarely employed by public companies, which, in pursuit of synergies, usually buy to keep. The chief advantage of buying to sell is simple but often overlooked, explain Barber and Goold, directors of the Ashridge Strategic Management Centre. Private equity's sweet spot is acquisitions that have been undermanaged or undervalued, where there's a onetime opportunity to increase a business's value. Once that gain has been realized, private equity firms sell for a maximum return. A corporate acquirer, in contrast, will dilute its return by hanging on to the business after the growth in value tapers off. Public companies that compete in this space can offer investors better returns than private equity firms do. (After all, a public company wouldn't deduct the 30% that funds take out of gross profits.) Corporations have two options: (1) to copy private equity's model, as investment companies Wendel and Eurazeo have done with dramatic success, or (2) to take a flexible approach, holding businesses for as long as they can add value as owners. The latter would give companies an advantage over funds, which must liquidate within a preset time-potentially leaving money on the table. Both options present public companies with challenges, including U.S. capital-gains taxes and a dearth of investment management skills. But the greatest barrier may be public companies' aversion to exiting a healthy business and their inability to see it the way private equity firms do-as the culmination of a successful transformation, not a strategic error.
For most companies, organization design is neither a science nor an art; it's an oxymoron. Organizational structures evolve in fits and starts, shaped more by politics than by policies. Although most executives can sense when their organization designs are not working well, few take meaningful action, partly because they lack a practical framework to guide them. The authors of this article provide just such a framework; they present nine tests that can be used either to evaluate an existing organization design or create a new one. Four "fit" tests offer an initial screen: The market advantage test asks whether a design directs sufficient management attention to the company's sources of competitive advantage; the parenting advantage test determines whether the design gives enough attention to the corporate-level activities that provide real value to the company; the people test shows whether the design reflects the employees' strengths; and the feasibility test looks at constraints that may impede implementation. Five "good design" tests can help a company refine its prospective design. The specialist cultures test ensures that there's sufficient insulation for units that need to be different from the prevailing culture; the difficult-links test determines whether a design offers solutions for potentially problematic unit-to-unit links; the redundant-hierarchy test asks whether the design has too many parent levels; the accountability test looks at whether every unit has suitable controls; and the flexibility test ensures that the design lets the company adapt to change. Once a design is altered, the tests should be repeated. Organizational decisions are inevitably complex, and tweaking one part of the design may produce unanticipated consequences elsewhere.
Managers can separate the real opportunities for synergy from the mirages, say Michael Goold and Andrew Campbell of the Ashridge Strategic Management Centre, by taking a more disciplined approach to synergy. Corporate executives have strong biases in favor of synergy, and those biases can lead them into ill-advised attempts to force business units to cooperate--even when the ultimate benefits are unclear. These biases take four forms: 1) the synergy bias, which leads executives to overestimate the benefits and underestimate the costs of synergy; 2) the parenting bias, a belief that synergy will be captured only by cajoling or compelling business units to cooperate; 3) the skills bias--the assumption that whatever know-how is required to achieve synergy will be available within the organization; and 4) the upside bias, which causes executives to concentrate so hard on the potential benefits of synergy that they overlook the possible downside risks. In combination, these four biases make synergy seem more attractive and more easily achievable than it truly is. As a result, corporate executives often launch initiatives that ultimately waste time and money and sometimes even severely damage their businesses. To avoid such failures, executives need to subject all synergy opportunities to a clear-eyed analysis that clarifies the benefits to be gained, examines the potential for corporate involvement, and takes into account the possible downsides. Such a disciplined approach will inevitably mean that fewer initiatives will be launched. But those that are pursued will be far more likely to deliver.
Perhaps no other article published in the management literature has had the impact of Richard Pascale's piece on the "Honda Effect" that was published in the Spring 1984 issue of the California Management Review. This now classic article has stimulated considerable debate over the role and value of corporate strategy in business decision making--which is the subject of this forum. This special collection of essays includes an abridged version of Pascale's original article ("Perspectives on Strategy: The Real Story Behind Honda's Success"), an exchange of correspondence between Henry Mintzberg and Michael Goold, and new essays by Richard Rumlet, Michael Goold, and Richard Pascale, who revisits his own original article as well as this whole debate.
While the core competence concept appealed powerfully to companies disillusioned with diversification, it did not offer any practical guidelines for developing corporate-level strategy. To fill the gap, the authors propose the parenting framework, with tools for answering two questions: Which business should a company own? What parenting approach will get the best performance from those businesses? To determine the fit between a parent and its businesses, corporate strategists should look at four areas: the critical success factors of the business, the parenting opportunities in the business, the characteristics of the parent, and the financial results. Next, to determine which businesses to keep and which to divest, they should rank them into five categories: those that fit well; those that fit in some ways; those that fit but have little potential; those with a possibility of value destruction; and those that fit in parenting opportunities but not in critical success factors.
Almost every company wants to develop its businesses over time and earn high profits immediately, to respond quickly to market changes and make careful decisions, to coordinate business units and make unit managers accountable. But these goals are contradictory. They cannot all be achieved, no matter what the strategy decisions. Senior managers can decide, however, which goals are most important and choose a management style that works toward them. Success depends on choosing an approach that maximizes one's strengths and goals.