Breaking up is hard to do: Unlocking the value of corporate functions in a divestiture

Company executives have become quite good at releasing trapped value through the divestiture of noncore businesses, but they often overlook the significant value that can be had by correctly separating corporate functions shared by the parent and spin-off companies. Those that approach this undertaking with the right focus and intent can accomplish in short order what might have taken years to reengineer in the old support services organization. Not only can they recalibrate the parent’s functions to better support the refocused core business and its critical few capabilities, but they can also design the ideal corporate core for the spin-off from the ground up.

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Breaking up is hard to do Unlocking the value of corporate functions in a divestiture

Contacts

Chicago Vinay Couto Senior Partner +1-312-578-4617 vinay.couto @strategyand.pwc.com Gary Neilson Senior Partner +1-312-578-4727 gary.neilson @strategyand.pwc.com Deniz Caglar Partner +1-312-578-4863 deniz.caglar @strategyand.pwc.com Namit Kapoor Partner +1-312-578-4502 namit.kapoor @strategyand.pwc.com

DC Matt Mani Partner +1-703-682-5759 matt.mani @strategyand.pwc.com

Florham Park Thomas Ripsam Partner +1-973-410-7603 thomas.ripsam @strategyand.pwc.com

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About the authors

Vinay Couto is a senior partner with Strategy& based in Chicago. He leads the firm’s global organization and change leadership practice, and has worked with clients in the automotive, aerospace, pharmaceuticals, life sciences, media and broadcasting, packaged goods, banking, and insurance industries. Namit Kapoor is a partner with Strategy& based in Chicago. He specializes in formulating shared-services strategies and improving the effectiveness and efficiency of sales and marketing functions.

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Executive summary

There’s a growing contingent of company executives who have become quite good at releasing trapped value through the divestiture of noncore businesses. What’s usually overlooked, however, is the significant value that can be had by correctly separating corporate functions shared by the parent and spin-off companies. The task of disentangling this highly intertwined back-office infrastructure is complex and painstaking, and executives don’t have much time to accomplish it. Most companies fail to make the most of this perhaps once-in-a-lifetime opportunity, but those that approach this undertaking with the right focus and intent can accomplish in short order what might have taken years to reengineer in the old support services organization. Not only can they recalibrate the parent’s functions to better support the refocused core business and its critical few capabilities, but they can also design the ideal corporate core for the spin-off from the ground up. Executives need to keep three priorities in mind: 1. Design/restructure the operating model. 2. Capture the cost transformation opportunity. 3. Create new capabilities aligned to the business strategy. These three overarching priorities guide a pragmatic approach to systematically and strategically separating corporate functions in a divestiture.

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Divesting your way to greater value

Divestitures and spin-offs have become a familiar way for companies to achieve a number of strategic objectives, from raising funds to invest in core businesses to restructuring product portfolios. Yet many executives — so fluent in deal valuation and due diligence — are not well versed in the art of assessing and separating the corporate functions, such as finance, HR, IT, and legal. Corporate leaders are so focused on the necessary separation and stand-up activities that they don’t see the opportunity to also optimize their support services model, thus missing the chance to redesign these functions to support the parent and the spin-off businesses more effectively. Progressive companies unlock the value of corporate functions in a divestiture in three ways. First, they seize the opportunity to design and/or restructure the functional operating models of both the parent and spin-off. Second, they articulate and then optimize the cost structure of each. Finally, they arm their refreshed functional operating models with the critical capabilities required to meet the ongoing strategic needs of the separate businesses they will support . A robust and well-articulated business strategy drives each of these actions and creates a vision of how the separated entities will compete after the close (see Exhibit 1, next page).

Progressive companies design and/ or restructure the functional operating models of both the parent and the spin-off.

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Exhibit 1 Three ways to unlock the value of corporate functions in a divestiture

Operating model design
– Develop detailed corporate core baseline – Redefine corporate core by deploying functional operating model best practices

Cost transformation
– Rightsize corporate core – Engage in business partnering activities – Outsource shared services – Minimize stranded costs

Capability building
– Perform capability scoping and baseline analysis – Identify new functional capabilities – Invest in horizontal capabilities that can be leveraged across operating units

Source: Strategy& analysis

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Operating model design

The first step is to use the divestiture opportunity to develop a fit-forpurpose operating model. Start by assessing what already exists. Top managers of the parent and the spin-off should develop detailed cost and head count baselines to provide the C-suite with a clear breakdown of functional activities, service delivery models, organizational structures, workload drivers, employee time allocation, and cost levels. These will also serve as the key input for the new operating models. In our experience, world-class functional operating models are typically built around four key tenets: 1. A senior leadership team focused on oversight, governance, and fiduciary activities 2. A thin layer of functional specialists who are embedded in the business units and serve as trusted business partners on strategy, finance, and people-related matters 3. A center of excellence (CoE) to drive scalability and share best practices for expert-based activities such as tax planning or talent acquisition 4. A shared-services unit that delivers core processes across the enterprise more effectively and efficiently by leveraging outsource partners The spin-off, in most cases, will start from scratch and build a cleansheet corporate core. And the parent must recalibrate and rightsize these components, given its new and, most often, smaller size (see Exhibit 2, page 9). In many divestitures, we typically see the parent migrate from a holding company into an active management model. This shift presents three operating model alternatives for the support functions: pure-tone active management, active management for subscale business units, and shared capabilities provided by the largest business unit.

Start by assessing what already exists.

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1. Active management. In this model, corporate provides shared functional capabilities for all business units, allowing the parent to realize cost savings and maximize value across the enterprise, and to apply common standards and share best practices across all business units. However, the standardization that comes with active management can lead to a loss of business-unit-specific knowledge and inhibit the business unit’s ability to customize its functional capabilities. 2. Active management for subscale business units. In this model, only subscale business units share functional capabilities, and the largest business unit is self-sufficient. Granting big units autonomy allows for necessary customization and retention of localized knowledge, while applying common controls and standards for the subscale business units allows for cost cutting. However, this may lead to redundancy in roles and activities. 3. Shared capabilities provided by the largest business unit. The third model is one in which the largest business unit provides shared functional capabilities for all other business units. Here, corporate is limited to providing governance and oversight. This functional operating model results in cost savings for the subscale business units and a thin corporate layer, but corporate loses control over operations and delivery of shared services. Parents evaluating their choices must consider the need for customized functional capabilities, the target level of cost savings, and the amount of corporate control desired.

Consider the need for customized functional capabilities, the target level of cost savings, and the amount of corporate control desired.

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Exhibit 2 Separating corporate functions in a spin-off
Parent company before separation Parent and spin-off companies after separation

Parent company

Parent company
(Opportunity to recalibrate corporate core)

Corporate core and shared services Finance HR Legal Facilities

Corporate core and shared services Finance HR Legal Facilities

Business unit 1

Business unit 1

Business unit 2 Business unit 2

Business unit A

Spin-off company
(Opportunity for clean-sheet design)

Corporate core and shared services Finance HR Legal Facilities

Business unit A

Source: Strategy& analysis

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Cost transformation

The second step is to look for opportunities to cut costs. There are four principal areas that both the parent and the spin-off should target: 1. Recalibrating the corporate core. Parents often fail to recalibrate their corporate cores after separation, leading to disproportionately higher costs relative to lowered revenue. But there are a host of improvements they can make: aligning staffing levels to meet future business needs; streamlining corporate core processes (such as treasury and audit) to deliver more value to the front line; resetting grade levels and establishing more efficient spans of control; using third-party providers for select services typically performed internally (such as tax and audit); or engaging in demand management to eliminate activities that are low in added value. 2. Business partnering. There are also significant opportunities to reduce support costs through business partnering activities (such as embedding finance, HR, or IT personnel in the business units). Companies can use automation and self-service tools to change delivery models from high-touch to low-touch, consolidate expert activities into global or regional CoEs to serve several business units with the same resources, relocate global or regional support to lowercost locations, or outsource transactional support services. 3. Outsourcing shared services. For shared services, the best way to reduce costs is to move to a highly outsourced model. Rather than setting up two new shared-services units, the parent and the spin-off can hire a third-party provider to set up scalable, efficient, and costeffective transactional services for both entities. 4. Minimizing stranded costs. Even if the parent effectively and efficiently cuts costs, management must still tackle the problem of costs that are stranded after divestiture. Resources that are now significantly underutilized — leases for vacated facilities or human resources, for example — are considered stranded, and their costs don’t automatically adjust with the transaction. Some, like IT systems, cannot be readily reduced. Others are more variable and
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There are significant opportunities to reduce support costs through business partnering activities.

can contract with a lower head count (particularly in finance and HR), but they can still take a long time to adjust unless explicitly planned as part of the divestiture. Companies should reexamine their entire cost base and identify cost recovery opportunities for stranded resources before separation, using tools like benchmarking analysis and zero-based budgeting. After separation, the parent can further eliminate stranded activities by selling or disposing of idle IT systems or terminating leases with low occupancy rates.

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Capability building

The third step in separating corporate functions is to take a hard look at the critical capabilities that will be required to fulfill the strategic agendas of the two business entities. Parent companies should take stock of the capabilities that are most important to them and to the assets being put up for sale, and then identify where, when, and how corporate functions overlap between the two entities’ capability sets. Parents must also look for functional gaps that will exist after separation and develop a plan for replacing these missing capabilities. Focused parent companies should also identify any new functional capabilities that will help them compete more effectively. These new and critical capabilities will vary based on how the company as a whole chooses to create value for its customers. However, it’s important to note those capabilities that can be leveraged horizontally across operating units, such as strategic talent acquisition/management and big data analytics skills. 1. Strategic recruiting and development. At many companies, functional leaders have joined the CEO’s inner circle in helping run the enterprise as critical partners in the development of strategy and the delivery of results. Increasingly, CFOs, CIOs, and CHROs are bringing a wealth of experience and expertise to their positions, so the ability to attract and develop these individuals is critical to the success of not only the corporate functions but the entire company. This becomes particularly important in a divestiture, as the spin-off company will likely need to recruit a senior management team for its clean-sheet corporate functions. 2. Big data analytics. The ability to discover profound insights in terabytes of financial or customer data is an increasingly important capability for companies in every industry. Companies must put a data analytics capability at the top of their priority lists.

What can be leveraged across operating units, such as strategic talent management and big data analytics skills?

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Value-driven separation planning and stand-up

Parent companies and spin-off entities can play to win in divestitures by mapping functional capability value drivers onto their separation planning process — and preparing to fully unlock the value of a tighter corporate core at every step (see Exhibit 3, next page). Parents must also plan to overcome certain challenges in recalibrating their corporate cores. In the front-end planning phases, the parent should focus on capability scoping, a powerful value driver that can help maximize the potential value of a deal. By assessing the planned spin-off’s current capabilities and matching them with the needs of potential buyers, the parent can better target its deal-making activities, more accurately set the expectations of investors, and get a higher purchase price. Assessing the current-state operating model and designing a less complicated one can also amplify deal value. In spinning off a business, executives are being asked to unravel a highly complex overhead infrastructure that likely took years, if not decades, to consolidate, and then set up two new standalone entities. In performing this tricky balancing act, senior management has to contend with a number of competing challenges: 1. Allocating shared corporate resources across both entities. Once the lines are drawn in a divestiture, the internal competition for resources can become intense between the managers who are staying and those who are leaving. Accurately dividing up corporate support resources can be a painstaking process. 2. Retaining critical talent. In an environment of uncertainty, management needs to cultivate and energize top performers in the functions as well as the businesses. These individuals will be critical in leading the parent and spin-off organizations through the divestiture.

Management needs to energize top performers in the functions as well as the businesses.

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Exhibit 3 Value-driven separation planning
Front-end planning Process execution After close

Value drivers
Opportunities

Strategic intent

Readiness and planning

Transaction

Separation

Stand-alone operations

Capability scoping Operating model design Cost transformation

Challenges

Resource allocation Talent retention Leadership recruitment Business stabilization

TSA negotiations

Source: Strategy& analysis

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3. Recruiting leadership for the spin-off entity. An immediate priority is the identification and vetting of the CEO and other C-level executives for the spin-off. 4. Continuing business as usual. As senior leaders of both entities become preoccupied with the demands of the divestiture process, they also need to keep the existing business going. 5. Negotiating transition service agreements (TSAs). The spin-off will need time to build stand-alone capabilities, so the parent will need to make some provision for transitional support services. Following a separation, services like accounts payable or HR payroll are typically outsourced by the parent to a service provider, which then delivers the specified services to the spin-off. Defining, pricing, and negotiating these TSAs can be a complex and tedious task that requires focused due diligence. However, effective TSAs tailored to the requirements of a specific deal can enable value capture by reducing functional complexity and supporting stand-up activities. Before entering into TSA negotiations, both the parent and the buyer should develop an inventory of transition services and agree on TSA scope. Each function/service reviewed and approved by stakeholders should generate a comprehensive and detailed service agreement. There should also be an accompanying TSA governance model for ongoing management of services during the transition that addresses common processes such as issue escalation, service delivery, and invoicing. To manage all of the moving parts in a spin-off transaction, we strongly recommend that the corporate center dedicate and empower a program management structure to plan and manage the financial and physical separation. Indeed, such a structure can serve as a role model for the new operating model and should be set up as soon as possible after the decision to divest. A joint steering committee, composed of leadership from both the parent and the spin-off, should maintain oversight of overall separation planning and execution. This committee should also set clear, aggressive financial and other performance-based targets on the top-level operating vision. Leadership teams within each organization should guide all management and transition decisions, ensuring visible senior management sponsorship and encouraging involvement in a forum-based leadership process. A dedicated and strong program management office (PMO) should be established in each entity to drive the divestiture’s key activities, using
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A joint steering committee should maintain oversight of overall separation planning and execution.

rigorous project management processes and tools to monitor key financial and operating metrics as well as sustainability of changes. The PMOs should engage key organizational stakeholders as participants, assign them clear decision rights, and free them from business-as-usual activities to facilitate their engagement in the PMO effort.

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Case study: Global media and information provider
Consider the real-life example of a US$6 billion global information services provider that sought to split its existing portfolio of businesses into two distinct and powerful companies. This transaction realized the value of what, in effect, had long been the case — the company was in two distinct businesses, each of which comprised multiple smaller businesses and brands. The global financial crisis and increased regulation had stirred up shareholder demands to release trapped portfolio value. The company’s lack of programmatic focus on a clear cost or growth agenda only served to exacerbate the situation. So the company resolved to separate its media operations, enabling the creation of two focused and nimble firms with competitive infrastructures and capabilities, and cost structures that were at least $100 million lower. The divestiture unfolded in three distinct phases: (1) cost realignment, (2) separation and rightsizing, and (3) restructuring of the operating model and portfolio (see Exhibit A, next page). Global centers of excellence were established to deliver scalable and standardized expert-based finance and HR services, including financial planning, accounting, talent acquisition, and analytics. Shared services were largely outsourced in order to facilitate the separation of the two companies, variabilize their cost structures, and offset the scale disadvantages of creating two smaller companies. Because both entities selected world-class service providers, they were able not only to reduce infrastructure costs, but also to improve flexibility and quality. Management also streamlined and focused its business partnering activities and systematically eliminated stranded costs. Overall, it is estimated that these initiatives will generate cost savings of more than $200 million over three years, double the original objective.

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Exhibit A Case study
Phase 1
Parent company

Phase 2

Phase 3

Program setup and launch end-state model/savings

Cost transformation road map and separation plan – Define structure, processes, systems, and governance for new operating model – Put leadership in place – Identify stranded costs and disposition plans – Develop road map for IT and real estate transition – Develop transition plans to migrate to new operating model – Outsource transactional assets

New operating model stand-up and separation plan – Implement new operating model – Implement efficiency and effectiveness improvements – Institutionalize new performance management – Assess workforce planning and people transition requirements – Finalize investment plan for new capabilities

Spin-off company

Operating and financial model/separation planning and savings

Separation

– Near-term restructuring – Stand up separate company capabilities – Legal entity restructuring – Prepare form 10 – Define capital structure and financing – Draft private letter ruling

– Define structure, processes, systems, and governance for new operating model – Implement new operating model and strategy – Continuation of implementation of efficiency and effectiveness improvements – Separation

Opportunity waves

Wave 1: Quick hits and cost avoidance

Wave 2: Rightsizing and separation

Wave 3: New operating model

Source: Strategy& analysis

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Breaking up is hard to do — but worth it

Companies that successfully address the challenges of separating corporate functions in a divestiture stand to reap significant benefits on many levels. Dedicating time and energy to utilizing this framework not only generates substantial and continuing bottom-line savings, but also grows the top line in terms of enhanced business support. Companies can use this unlocked value to fund global growth, build capabilities, accelerate innovation, and ultimately achieve a significant competitive advantage.

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