Spurred by the need to find new cost gains in a waning recovery, corporate change is back on the agenda
Corporate transformation will not be a new phrase to most readers of these web pages. Indeed it is likely that more than one of you will have let a groan escape your lips when reading the headline. The unfortunate truth is that "corporate transformation" implies unsettling change caused by grand projects that commence amid much excitement, only to falter a few months later.
Yet despite this history, we've seen growing numbers of executives starting significant transformation of their corporate center functions. Interestingly, this wave of change comes after most companies have completed major restructuring within functions and across divisions. So why pursue more change now?
Notwithstanding the statements from the world's government officials that the recession is over, Corporate Executive Board research shows that executives are still pessimistic about their growth options, and many are resorting to a plan over which they have total control: wrenching more cost out of the system.
The Perpetual Search for Efficiency Gains
Onlookers were surprised when recession-era earnings reports showed many firms were able to expand margins despite huge sales drops. These results were taken as proof that cost cutting was successful. Unfortunately fewer people seemed to understand that extreme austerity measures, and the inflated margins they can create, are unsustainable over time. CEB research suggests that only about 10% of companies are able to maintain significant cost gains (often achieved after several painful years) over a three year period.
Yet as we look at current consensus expectations for revenue and earnings at large firms, market analysts project margins to improve by another 3-5% over the next five years. Given the limp economic recovery and increasing global competition, few firms are able to able to achieve their margin goals through price increases, leaving more cost cutting as the only option.
The challenge is that after two years of austerity, most firms have trimmed the fat, cut into muscle and risk cutting right to bone if they go any further. The days of slashing general and administrative costs (G&A) to hit targets are over: even if firms hadn't already squeezed their overhead structures dry, executives understand that G&A costs are quick to creep back into the system, providing little help to long-term margin improvement. There is a growing realization that the old tricks won't maintain or expand margins. And hence an increasing number of our clients are turning to corporate center transformations as part of the answer.
A Renewed Urgency for Corporate Center Change
What's particularly interesting about these new transformations is that they are far broader than past attempts. For years CEB has been advising clients on separate finance, HR, and IT transformation efforts. Now many are explicitly linking all three together to create leaner, more agile, and more productive corporate centers that produce synergies across functional silos. In a recent snap-poll of large company finance executives, over half say that more than two functions are involved in current or upcoming transformations; almost a quarter are taking on more than four functions at once.
As you might expect, we believe this is a step in the right direction. The most effective corporate centers are designed to ensure a firm executes on long-term strategic goals; they balance efficiency with value creation, and improve the speed and quality of support provided to operators. Unfortunately many executives who are championing this new round of transformations are still overly focused on cost cutting, and are missing important opportunities to create value from the center. Although cost control is important there are other significant barriers to success.
A Big Mountain to Climb
Though the well documented challenges of managing large scale projects are important to overcome, corporate center overhauls like these face other less frequently discussed issues. Firms must take power and influence away from some corporate center functions and give them to others, and keep a tight grip on execution and internal communication.
CEB research has revealed that sustainable costs gains will only come from pairing G&A more closely with cost of goods sold (COGS) so that overhead directly supports and reduces the much larger portion of the firm's expenses that are tied up in production. Establishing this relationship requires a clear design strategy aimed at shared goals. Some functions will have to operate on minimal resources, focusing on scale and efficiency, while other areas with more strategic importance will be given more funding to aid corporate value creation. This will create much antagonism, especially if the strategy isn't clear and the execution isn't tight.
Making these huge transformations work means engaging change-weary employees, concentrating on creating a competitive advantage despite ubiquitous (and expensive) technology providers, and overcoming the tendency of business unit managers to replicate central costs in their fiefdoms. Ultimately, it requires executives to think differently about the relationship between a firm's corporate functions; that isn't easy but it will be hugely rewarding for the world's firms.