The recent spate of spin-off announcements reveals the limits of diversification as well as some of the potential value-creating benefits of separations
Breakups aren’t just fodder for celebrity-gossip websites. Separations are back in the business pages, as large conglomerates in healthcare, consumer electronics, logistics, and other sectors announce their intentions to spin off business units or explore avenues for doing so.
Despite all the new ink being spilled on this trend, in many ways it’s just another chapter in the long-running story about diversification strategies: a company matures, prompting executives to look outside the core business for ways to grow. (A logistics company acquires a software company. A pharmaceutical company enters the consumer-health market.) As revenues increase, so do costs and complexity. Some operational and other synergies may materialize—but eventually executives and boards realize how difficult it is to add value to businesses that have little or no direct connection to the company’s core business.
The realization may come when a business unit’s performance is lagging behind that of its peers with no clear path to catch up. Or a review of the company’s portfolio may reveal that some business units’ cost structures are not comparable with peers. Or executives may recognize that the company lacks sufficient management capabilities to grow all the businesses in its portfolio.
When these signals appear, companies acknowledge that they are no longer the best owner of an asset, and spin-offs ensue—especially in an environment like the one we’re experiencing now, when business models are being tested by a crisis and new strategies are needed, market valuations are high, and financial engineers are hard at work.
There are fundamental reasons why we’re seeing more large companies pursuing spin-offs—specifically, because such deals can help to improve the operating model, management focus and strategy, and capital management for both the parent company and the divested business unit.
Operating model
A group structure often imposes operating requirements on all the business units in a company’s portfolio. A pharmaceutical and medical-device conglomerate, for instance, may require all business units to use a centralized compliance and regulatory process or common inventory-management and sales-reporting systems. But different drug and device divisions have different needs, so the teams managing these common compliance, procurement, and sales functions would likely struggle to cater to each unit’s unique circumstances and priorities. Indeed, when companies’ portfolios mix high-margin, high-growth businesses with lower-margin, mature businesses, there can be a clear operating-model mismatch.
A breakup would allow for a more tailored operating model. Consider the case of a global consumer company that owned both a high-margin branded business along with a lower-margin, private-label business: there were clear synergies in distribution and supply-chain processes. But razor-thin margins in the highly competitive private-label industry meant that the private-label business required a much leaner cost structure and a more focused operating model than the consumer company had. By selling off the private-label business to a better owner, the global consumer company was able to streamline its operating model and pursue growth in its branded business.
A group structure can make it difficult for executives to determine how to balance investments in high-risk, high-reward opportunities (or, “the most exciting initiatives”) versus low-risk, low-reward ones.
Management focus and strategy
Experience shows that senior leaders in conglomerates tend to overinvest attention and organizational resources in high-growth parts of their business and underinvest in lower-growth or more mature parts of the organization. The opposite can happen, too. Senior leaders may be overly focused on the success or failure of the biggest business unit and less so on overall growth. The result is often uneven development of businesses within the portfolio. Mature organizations fall further and further behind peers and struggle to find the resources to maintain or recapture their leadership positions, even when they represent most of the company’s total revenues. Even if management is appropriately tending to all parts of the business, analysts and investors with limited time to evaluate companies may struggle to understand what’s driving growth in disparate parts of a diversified business.
At one technology services provider that also owned and developed its own software, senior management struggled with resource-allocation decisions and at times missed out on some of the biggest trends in the industry—particularly in moving the provider’s software to a cloud infrastructure. It was only after divesting its services business that the company was able to position itself as a player in the market for software as a service.
SOURCE: McKinsey
Keyword: McKinsey: When bigger isn’t always better