Column 15 - Characteristics of Companies Compatible with the Holding Company System

General Manager, Change Management Consulting Dept., Mitsubishi UFJ Research and Consulting Co., Ltd.

What is a successful holding company system?

When providing consulting services to client companies on the subject of group-wide management, I am almost always asked what sort of companies are fit to adopt the holding company system or have proven successful under such a management structure. It is surprisingly difficult to answer this question because it depends on whose success we are talking about and how we define success.

Intrinsically, we should be talking about success for a broadly defined set of stakeholders including shareholders, customers, and employees. However, since the board of administration primarily propose to adopt the holding company system, it would be appropriate to define success or failure from the management viewpoint, i.e., whether or not its intended objectives have been achieved.

It may be interesting to learn that improving business performance is rarely cited as a reason for adopting the holding company structure, but it should not be surprising. The holding company system is just a change in the organizational structure of a company, but business performance does not necessarily improve simply by changing the organizational structure.

Twelve reasons behind adopting the holding company system

What are the goals or objectives cited by companies pursuing the holding company structure? Reasons vary among companies and they are often abstract. Typical descriptions such as "for the enhancement of group-wide value" make it difficult to grasp the substance of companies' true intent. Some of the reasons given by my clients include the following:

(1) A step toward comprehensive business integration
In recent years, the formation of a pure holding company rather than an outright merger or consolidation seems to have become an increasingly popular way of integrating companies belonging to different corporate groups. One reason behind this tendency is the relatively short time it takes to form a pure holding company, which provides extra time for the integrating companies, which may be unfamiliar with each other's corporate culture, to get to know one another before pursuing an outright merger or consolidation. Indeed, it is often the case that these companies are initially temporarily held in parallel under a pure holding company before moving on to further reorganization steps.

(2) As a means of enhancing the independence of business units
This idea, often described by such wording as "achieving independent and self-sustaining management," is typically cited by companies that are trying to shift from the multi-divisional or division-company system to the holding company system by means of a spin-off. Business divisions and division companies are, by definition, internal units, but they are nevertheless held accountable for their respective business performance, i.e., costs, revenues, and profits. Moving from either of these systems to the holding company system is meant to be an attempt to ensure that each and every member, from managers to rank-and-file employees in operating business units, fully understand the idea of profitability. Indeed, companies that have followed such an incremental reorganization path typically cite "increased attention to cash-flow management" and "enhanced awareness of responsibility toward management" as positive effects of adopting the holding company system.

(3) Increasing the pace of decision making
As an organization grows in size, the number of management layers increases as does the number of approval signatures required before decisions can be made. A pure holding company may be formed as a vehicle to reorganize such a large organization into multiple smaller organizations, thereby improving the responsiveness of decision making by bringing it and authority closer to the market. To be successful, however, meticulous care must be taken in planning the division of responsibility and authority between the holding company and individual operating companies. Otherwise, a holding company could easily end up being just another layer of management and causing further delays in decision making, exactly contrary to the intended results.

(4) Paving the way for growth through M&A
It is well known that the use of a pure holding company makes it easier to carry out mergers and acquisitions (M&A), whether as a seller or buyer. A corporate group employing the holding company system can withdraw from a certain business simply by selling shares in the relevant operating company. Meanwhile, compared to an acquisition by another operating company, an acquisition by a pure holding company would arouse less psychological resistance on the part of the company being acquired. In the extreme sense, shifting to the holding company system to become a "corporation dedicated solely to realigning its business portfolio" effectively sends out a message that the company is pro-M&A.

(5) Streamlining a complex capital structure
When a company under the management or strong influence of its founding owner comes to a major turning point, it is often necessary to untangle and streamline a complex capital structure within its corporate group. When faced with such a situation, some companies choose to form a pure holding company and convert all group companies to wholly-owned subsidiaries in a transitional step before proceeding with full-fledged capital reorganization.

(6) Redefining the scope of business
When a company needs to redefine its scope of business with its traditional mainstream business reaching maturity, one typical response is to spin off the mainstream business as an operating company placed under a pure holding company. This reorganization scheme aims to achieve two goals: stimulate the traditional business and motivate development in the new growth business.

(7) Enhancing the functionality of group headquarters
This is an attempt to expand headquarters' functions, such as planning, management, and support services, to cover the needs of group companies (including subsidiaries in Japan and abroad) in addition to those of the parent company. Apart from corporate groups with diversified business portfolios, those focused on a single business domain sometimes opt for this scheme when they operate in diverse markets and/or through diverse channels.

(8) Preparing the successor
In a company that is controlled by its founding family, the current head of the family typically serves as the top manager of the holding company and supervises the business operations of the entire group with his or her heir-apparent placed in charge of the top manager of a group subsidiary to gain management experience. Should the heir turn out to be ineffective as a business manager or found to be better fit at serving in an administrative role, the heir can still be appointed to head the holding company in a largely ceremonial role, leaving the management of operating companies to their respective top managers chosen from internally promoted senior officers.

(9) As a defense against hostile takeover bids
Listed companies with strong brands often choose to adopt the holding company system as a means of defending against hostile takeover bids. Takeover threats can be neutralized by spinning off a specific division holding such key brands, thus paving the way for the liberated division to seek, on a stand-alone basis, a capital tie-up with a friendly external partner. However, since spinning off such a division alone would demonstrate intent a bit too obviously, many companies spin off multiple divisions simultaneously while shifting to the holding company system as a sort of camouflage technique.

(10) As a tool for promoting and motivating employees
When a company has a disproportionately large number of employees belonging to a certain layer of the hierarchy or in a certain age group, many of them would inevitably hit a promotion plateau at a relatively early stage of their careers due to the mismatch between personnel composition and organizational structure. In this situation, the company may choose to shift to the holding company system using spinoffs as a means of creating senior management positions to accommodate some of its future leaders, thereby enhancing the motivation of middle-management level employees.

(11) Facilitating management practices more close to the type and nature of the business
Companies adopting the holding company system for this purpose typically do so as a means of establishing different personnel systems for different business segments in accordance to the particular characteristics of each business. Even though it is not impossible to adopt different personnel management systems for different business divisions within a single company, it is obviously easier to accomplish this system by converting these divisions to separate companies.

(12) As a vehicle for shifting to a team management structure
When a company that has been managed in a top-down style by its owner-manager shifts to a next-generation management system, the process often involves significant changes in management styles that leave the company with no choice but to follow a team management approach. Decision making under a holding company structure requires decisions and judgments for the different companies, which would necessitate the establishment of a new decision-making process appropriate for that purpose.

As demonstrated by these examples extracted from actual cases that I have handled, there are a variety of reasons why companies reorganize into a holding company structure. Knowledge about management and organizational structure is not all that is required in shifting to the holding company system, which needs to have diverse practical knowledge and expertise on legal, accounting, tax, and labor matters. In addition, it takes a great deal of effort. The aforementioned expected gains should be weighed against the cost and effort involved. If a company determines that the former definitely exceeds the latter, it is fit to adopt the holding company system.

May 18, 2009

May 18, 2009

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