How to put your money where your strategy is PART II
1. Have a target corporate portfolio.
There’s a quote
attributed to author Lewis Carroll: “If you don’t know where you are going, any
road will take you there.” When it comes to developing an allocation agenda,
it’s helpful to have a target portfolio in mind. Most companies resist this,
for understandable reasons: it requires a lot of conviction to describe planned
portfolio changes in anything but the vaguest terms, and the right answers may
change if the broader business environment turns out to be different from the
expected one.
In our experience,
though, a target portfolio need not be slavish or mechanistic and can be a
powerful forcing device to move beyond generic strategy statements, such as
“strengthen in Asian markets” or “continue to migrate from products to
services.” Identifying business opportunities where your company wants to
increase its exposure can create a foundation for scrutinizing how it allocates
capital, talent, and other resources.
Setting targets is just
a starting point; companies also need mechanisms for revisiting and adjusting
them over time. For example, Google holds a quarterly review process that
examines the performance of all core product and engineering areas against
three measures: what each area did in the previous 90 days and forecasts for
the next 90 days, its medium-term financial trajectory, and its strategic
positioning. And the company has ensured that it can allocate resources in an
agile way by not having business units, which diminishes the impact of
corporate politics.
Evaluating reallocation
performance relative to peers also can help companies set targets. From 1990 to
2009, for example, Honeywell reallocated about 25 percent of its capital as it
shifted away from some existing business areas toward aerospace, air
conditioning, and controls. Honeywell’s competitor Danaher, which was in
similar businesses in 1990, moved 66 percent of its capital into new ones
during the same period. Both companies achieved returns above the industry
average in these years—TRS for Honeywell was 14 percent and for Danaher 25
percent. We’re not suggesting that companies adopt a mind-set of “more is
better, and if my competitor is making big moves, I should too.” But
differences in allocation levels among peer companies can serve as valuable
clues about contrasting business approaches—clues that prompt questions
yielding strategic insights.
2. Use all available resource reallocation
tools.
Talking about resource
allocation in broad terms oversimplifies the choices facing senior executives.
In reality, allocation comprises four fundamental activities: seeding,
nurturing, pruning, and harvesting. Seeding is entering new business areas,
whether through an acquisition or an organic start-up investment. Nurturing involves
building up an existing business through follow-on investments, including
bolt-on acquisitions. Pruning takes resources away from an
existing business, either by giving some of its annual capital allocation to
others or by putting a portion of the business up for sale. Finally, harvesting is
selling whole businesses that no longer fit a company’s portfolio or
undertaking equity spin-offs.
Our research found that
there’s little overall difference between the seeding and harvesting behavior
of low and high reallocators. This should come as little surprise: seeding
involves giving money to new business opportunities—something that’s rarely
resisted. And while harvesting is difficult, it most often occurs as a result
of a business unit’s sustained underperformance, which is difficult to ignore.
However, we found a 170
percent difference in activity levels between high and low reallocators when it
came to the combination of nurturing and pruning existing businesses. Together,
these two represent half of all corporate reallocation activity. Both are
difficult because they often involve taking resources from one business unit
and giving them to another. What’s more, the better a company is at encouraging
seeding, the more important nurturing and pruning become—nurturing to ensure
the success of new initiatives and pruning to eliminate flowers that won’t ever
bloom.
Consider, for example,
the efforts of Google CEO Larry Page, over the past 12 months, to cope with the
flowering of ideas brought forth by the company’s well-known “20 percent rule,”
which allows engineers to spend at least one-fifth of their time on personal
projects and has resulted in products such as AdSense, Gmail, and Google News.
These successes notwithstanding, the 20 percent rule also has yielded many
peripheral projects, which Page has recently been pruning.
3. Adopt simple rules to break the status
quo.
Simple decision rules
can help minimize political infighting because they change the burden of proof
from the typical default allocation (“what we did last year”) to one that makes
it impossible to maintain the status quo. For example, a simple harvesting rule
might involve putting a certain percentage of an organization’s portfolio up
for sale each year to maintain vibrancy and to cull dead wood.
When Lee Raymond was
CEO of Exxon Mobil, he required the corporate-planning team to identify 3 to 5
percent of the company’s assets for potential disposal every year. Exxon
Mobil’s divisions were allowed to retain assets placed in this group only if
they could demonstrate a tangible and compelling turnaround program. In
essence, the burden on the business units was to prove that an asset should be
retained, rather than the other way around. The net effect was accelerated
portfolio upgrading and healthy turnover in the face of executives’ natural
desire to hang on to underperforming assets. Another approach we’ve observed
involves placing existing businesses into different categories—such as “grow,” “maintain,”
and “dispose”—and then following clearly differentiated resource-investment
rules for each. The purpose of having clear investment rules for each category
of business is to remove as much politics as possible from the resource
allocation process.
Sometimes, the CEO may
want a way to shift resources directly, in parallel with regular corporate
processes. One natural-resources company, for example, gave its CEO sole
discretion to allocate 5 percent of the company’s capital outside of the
traditional bottom-up annual capital allocation process. This provided an
opportunity to move the organization more quickly toward what the CEO believed
were exciting growth opportunities, without first having to go through a
“pruning” fight with the company’s executive-leadership committee.
Of course, the CEO and
other senior leaders will need to reinforce discipline around such simple
allocation rules; it’s not easy to hold the line in the face of special
pleading from less-favored businesses. Developing that level of clarity—not to
mention the courage to fight tough battles that arise as a result—often
requires support in the form of a strong corporate center or a
strategic-planning group that’s independent of competing business interests and
can provide objective information.
4. Implement processes to mitigate inertia.
Systematic processes
can strengthen allocation activities. One approach, explored in detail by our
colleagues Sven Smit and Patrick Viguerie, is to create planning and management
processes that generate a granular view of product and market opportunities.6 The
overwhelming tendency is for corporate leaders to allocate resources at a level
that is too high—namely, by division or business unit. When senior management
doesn’t have a granular view, division leaders can use their information
advantage to average out allocations within their domains.
Another approach is to
revisit a company’s businesses periodically and engage in a process similar to
the due diligence conducted for investments. Executives at one energy
conglomerate annually ask whether they would choose to invest in a business if
they didn’t already own it. If the answer is no, a discussion about whether and
how to exit the business begins.
Executives can further
strengthen allocation decisions by creating objectivity through
re-anchoring—that is, giving the allocation an objective basis that is
independent of both the numbers the business units provide and the previous
year’s allocation. There are numerous ways to create such independent,
fact-based anchors, including deriving targets from market growth and market
share data or leveraging benchmarking analysis of competitors. The goal is to
create an objective way to ask business leaders this tough question: “If we
were to triangulate between these different approaches, we would expect your
investments and returns to lie within the following range. Why are your
estimates so much higher (or lower)?”
Finally, it’s worth
noting that technology is enabling strategy process innovations that stir the
pot through internal discussions and “crowdsourcing.” For example,
Rite-Solutions, a Rhode Island–based company that builds advanced software for
the US Navy, defense contractors, and first responders, derives 20 percent of
its revenue from businesses identified through a “stock exchange” where
employees can propose and invest in new ideas.
Much of our advice for
overcoming inertia within multibusiness companies assumes that a corporation’s
interests are not the same as the cumulative resource demands of the underlying
divisions and businesses. As they say, turkeys do not vote for Christmas. Putting
in place some combination of the targets, rules, and processes proposed here
may require rethinking the role and inner workings of a company’s strategic-
and financial-planning teams. Although we recognize that this is not a trivial
endeavor, the rewards make the effort worthwhile. A primary performance
imperative for corporate-level executives should be to escape the tyranny of
inertia and create more dynamic portfolios.
By Stephen Hall, Dan Lovallo, and Reinier Musters
https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/how-to-put-your-money-where-your-strategy-is?cid=other-eml-alt-mip-mck-oth-1810&hlkid=e93beb8ae7154445848633c5b7488822&hctky=1627601&hdpid=5d63fd64-7956-44d3-a067-59fe7255b8e9
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