Corporate ParentingDesigning the corporate HQ MGT 214 Corp

Corporate Parenting
Designing the corporate HQ
MGT 214 Corporate Strategy
Spring 2021
Dr. Paul Kirwan
1
Recurring theme…
The goal of the corporate strategist is to exploit synergies
through administrative control that cannot be replicated by mere
investors.
Corporate advantage comes broadly from either portfolio
assembly (“selection”) or portfolio modification (“synergy”).
2
Recurring theme…
“Synergy” is an umbrella term to describe the various ways in
which the cash flows and discount rates of businesses in a
portfolio can be modified through administrative influence.
Synergy is the means through which corporate advantage is
created relative to a typical investor who can assemble the same
portfolio of investments (without exercising administrative

influence over them, as she lacks the decision rights to do so).
3
Introduction
This chapter explores how the appropriate influence model for
HQ is contingent on the choice of how corporate advantage is
being pursued.
The appropriate influence model is defined as the way HQ
influences individual businesses in the portfolio
4
Introduction
The HQ, where the corporate strategists reside, is ultimately the
custodian of corporate advantage.
Its goal is to ask (and help answer) the question of why the
collection of businesses they administer is worth more than
what they would be worth if operated independently.
5
Understanding HQ

“HQ” refers to:
the corporate HQ in a multi-divisional corporation
any administrative unit making strategic decisions that cut
across multiple businesses
Including regional, national, or divisional HQ
the holding company of a portfolio of companies (as in a
business group)
the organizational or physical location of shared service units.
6
Holding Company Structure, simple example
7
Heineken’s Premium Brand Portfolio, simple example
8
Basic facts about the corporate HQ
Studies decompose the variance in profitability to:
(1)business unit,
(2)corporate parent, and
(3)industry level factors

Found that the corporate parent factor represents around 10 to
20 percent of total variance (and 20 to 25 percent of explained
variance), using the most recent techniques (McGahan and
Porter, 2002).
This is in between that for industry and that for business unit.
9
This may be a significant under-estimate of the impact of the
corporate HQ because of data limitations and the methodology,
which mainly has to do with the fact that many business unit
specific factors actually originate through HQ decisions.
The size of the corporate HQ relative to the total size of the
corporation varies enormously across sectors and geographies.
Primary drivers of differences in HQ size are the scale of shared
service functions provided to the businesses in the portfolio, as
well as the extent of linkage influence exercised by the HQ.
10
The cost of the corporate HQ in large multi-business
corporations can range from 2 percent to 7 percent of sales
(Roland Berger, 2013) but may be much higher in terms of
operating profit.
Holding company HQs are relatively cheaper than other kinds of

HQs.
11
Most multi-business companies use some form of corporate
portfolio management frameworks.
However, their use in actual capital allocation decisions seems
limited, and the missing role of portfolio levels effects (i.e.,
synergies and dis-synergies between businesses) in most
existing frameworks is recognized.
12
HQ influence in portfolio assembly (selection)
A corporate strategy based on pure portfolio assembly (without
any modification of businesses in the portfolio) requires:
being able to systematically spot and access under-valued
opportunities,
being able to exit businesses when good opportunities to do so
arise.
13
The strategic capabilities needed for such an approach include:
Environment scanning for new opportunities

Expertise at M&A and alliances
Expertise at refocusing
14
Corporate Management Functions (CMF) exist in a multi-
business corporation (especially publicly listed ones) regardless
of whether modification of businesses were required after entry.
CMF include tasks such as treasury, risk management, taxation,
financial reporting, company secretary and legal counsel,
government relations, and investor relations.
15
If there are any benefits in consolidating and combining these
functions across businesses, then there may be some (almost
inadvertent) synergy effects.
In a holding company structure:
these CMFs are not strictly necessary at the HQ
they mostly exist at the individual company level (especially
with listed companies)
one could in principle have a very lean corporate HQ.
16

HQ influence in business modification (synergy)
Everything we have said above about the influence of the HQ in
pure portfolio assembly models is also applicable to cases
where corporate advantage is being pursued through business
modification (synergy).
Furthermore, there is a whole variety of additional means of
influence to consider when the HQ is pursuing a synergy
approach to corporate advantage.
17
Figure 10.1 HQ influence has two dimensions
(Goold, Campbell, Alexander, 1994)
18
Horizontal dimension: standalone influence
The HQ does not encourage any meaningful B2B relationships.
The HQ influence is felt solely through a vertical HQ-to-
business relationship.
The businesses independently benefit from, or use a valuable
resource or capability that is located at, the HQ.

19
The HQ is the locus of intangible resources and capabiliti es that
have Connection/Customization synergies with the business
value chains.
E.g. corporate brand; management expertise; functional
expertise in finance, HR, M&A, strategic alliances; and other
best practices.
These synergies could also be viewed as Consolidation or
Combination effects arising from creating these intangibles
once at the HQ instead of several times in the portfolio (i.e., for
each business).
20
Standalone influence models tend to involve portfolios of
businesses that look quite distinct from each other to the
external observer (prompting the label “conglomerate”) because
the synergies across them mostly occur at the back end of the
value chains and possibly in corporate management functions.
21
Horizontal dimension: linkage influence
The HQ encourages businesses to work together in alliance-like
fashion.

The HQ influence is felt through the B2B relationship fostered
and administered under the supervision of the HQ (in addition
to any vertical influence that the HQ may employ).
22
Horizontal dimension: linkage influence
The HQ exerts authority to enable the extraction of synergies of
all kinds (Consolidation, Combination, Customization, and
Connection) between businesses.
The portfolio is such that it supports active management of
inter-business synergies by the HQ (e.g., shared manufacturing,
R&D, or sales and distribution), are seen as being more
“related.”
23
Horizontal dimension: standalone vs. linkage
When the HQ is also the organizational or physical location of
centralized functions (e.g., to extract Consolidation and
Combination synergies across businesses through shared
services units) whose use requires some coordination between
businesses, then the influence lies somewhere between pure
standalone and pure linkage influences. For example,
IT procurement and real estate management functions across
different businesses may be centralized at HQ
In all other matters, the businesses may operate independently
from each other.

24
Vertical dimension: directive influence
The control that the HQ exerts on businesses by directly
influencing their strategic decisions and actions through
approving, vetoing, or ordering them.
Resource allocation (e.g., capital budgeting) tends to be a
rigorous process with a lot of scrutiny and vetting by the HQ
before budget approvals.
25
Capital budgeting becomes the key process through which the
strategic decisions at the business level are overseen and
controlled by the HQ
Close monitoring of the implementation of decisions via
operational targets.
The locus of strategy-making and implementation in each
business is at HQ.
26

Directive influence models tend to rely on strategic planning
capabilities concentrated at the HQ.
Directive approaches can more easily pursue one-sided
synergies (in which one business gains more than the other
loses, leaving the aggregate portfolio better off).
27
Vertical dimension: evaluative influence
Evaluative influence refers to control by the HQ of businesses,
primarily through setting financial performance targets and
evaluating outcomes;
The business units may, however, have a high degree of
autonomy in terms of their decisions.
Locus of strategy-making and implementation is at the business
level.
28
Vertical dimension: evaluative influence
Relies more on financial control and performance management,
with high degrees of delegation and autonomy on strategic
decision-making.
One-sided synergies may be harder to achieve in such settings,
and the focus may be mostly on two-sided synergies.

29
Vertical dimension: directive vs. evaluative
These are, of course, extreme cases, with intermediate points
possibly being much more common (e.g., the HQ decides,
business leadership implements, the HQ evaluates outcomes as a
measure of implementation success).
The HQ, for instance, may be actively involved both in guiding
and approving business unit strategy as well as managing
performance through targets and incentives.
For example, GE under Jack Welch was famous for a rigorous
capital budgeting and performance evaluation process.
30
Table 10.1 Prototypes of HQ influence
31
Standalone, evaluative
The standalone, evaluative (SE) influence model comes closest
to the pure portfolio assembly model, yet differs from it in the
sense that there is some attempt at indirect modification of
businesses through evaluative control.
Financial target setting and performance management are key
activities in the HQ in this case, besides any CMF that are
necessary to meet regulatory requirements.

32
Standalone, evaluative
The management capabilities that underlie evaluative control
constitute the intangible assets that generate
Connection/Customization synergies with the businesses
The cost of creating and hosting these are economized by
hosting them once at the HQ (rather than replicating them
across businesses).
33
Standalone, directive
The standalone, directive (SD) influence model is associated
with a restructuring orientation.
Like pure portfolio assembly, the selection of businesses is an
important part of HQ activity
Unlike pure portfolio assembly there is an active attempt at
modifying businesses through directive control.
34
The directive attempts can include changes in:
the business model,
business strategy,

staffing, and
compensation.
Key HR activities include:
Strategic planning
Turnaround management
Any CMF that are necessary to meet regulatory requirements.
35
The management capabilities that underlie directive control
constitute the intangible assets that generate
Connection/Customization synergies with the businesses
The cost of creating and hosting these are economized by
hosting them once at the HQ (rather than replicating them
across businesses).
36
The HQ may also be the physical or organizational location of
tangible assets in the form of shared services functions that
create Consolidation/Combination synergies across businesses
in back office and IT functions.
Conglomerates such as Hanson and Tyco were formerly famous
for following this model.
Danaher Corporation, the US equipment manufacturer, is a
contemporary example, though its scope is less broad than what
one would consider a typical conglomerate.

37
Linkage, directive
The linkage, directive (LD) influence model explicitly focuses
on actively managing operational synergies through linkages
between businesses by directive control.
Besides the CMF, the HQ in organizations following this model
is likely to have:
strategic planning teams,
corporate development functions (M&A and/or alliance teams),
and
centers of expertise (in areas like best practices, procurement,
etc.).
HQ also the physical or organizational location of shared
services functions that create Consolidation/Combination
synergies across businesses in back office and IT functions.
38
Linkage, evaluative
The linkage, evaluative (LE) influence model explicitly focuses
on managing operational synergies through linkages between
businesses, but does so passively rather than actively.
The goal instead is to create a context that allows businesses to
collaborate on synergy realization.
The use of corporate development functions at HQ are more
elective than imposed.
A strong corporate HR function with an emphasis on building
the informal organization that glues the businesses together may
be prominent.

39
Resource allocation by the HQ
The influence of the HQ is ultimately exerted on the basis of its
resource allocation decisions
This holds regardless of which HQ influence model is adopted
The HQ has the power to allocate resources to the businesses,
not the other way round.
Resource allocation in directive control takes the form that
major capital expenditure commitments (and therefore strategic
investments) cannot be made without approval and rigorous
screening, regardless of the need for capital rationing.
40
In evaluative control, capital expenditure requests are granted
semi-automatically if they clear hurdles, but individual
performance related incentives depend on past performance.
Resource allocation by the HQ may do better or worse than
resource allocation by individual investors via the capital
markets.
The HQ has access to better information about each business
and the decisions rights to enforce actions by their subordinates
that enhance the value of these investments.
At the same time, it has access to a smaller set of alternatives
and is prone to conflicts of interest between the HQ and

shareholders.
41
The authors focus on providing guidelines for HQ decision-
making about resource allocation under the assumption that the
decisions are motivated by a desire to enhance the value of the
firm.
Resource allocation in multi-business organizations involves
decisions about:
How to spread investment across a portfolio of businesses,
Whether or not to invest in a particular business.
42
Which raises two challenges.
1. The challenge of synergy
Businesses in a multi-business organization are not independent
of each other
There are interactions between them.
These could be in the form of synergies or dis-synergies.
How should one take these into account when allocating
resources across the portfolio?

43
2. The challenge of uncertainty
Well developed theories from finance for resource allocation
under risk:
Assume that the future is uncertain but we can describe the
possible outcomes and the probability of each of these outcomes
occurring.
These produce heuristics such as investing in projects only if
their internal rate of return (IRR) exceeds their weighted
average cost of capital (WACC), or to only invest in positive
NPV projects.
44
Under fundamental uncertainty:
The future is uncertain and we do not know all the possible
outcomes nor their probabilities of occurring
Researchers have recognized that the problem is one of
managing the exploration–exploitation trade-off:
how to balance investment in businesses likely to do well
(exploitation) vs. investment in businesses with uncertain
outcomes (exploration)
If the only way in which one can learn about the value of a
business opportunity is by trying it, then some degree of
exploratory investment is optimal. But how much?
45

The synergistic portfolio framework
To assess the how much question, we use the following
framework:
The synergistic portfolio framework tackles both synergies and
uncertainty in resource allocation decisions (see Figure 10.2).
The two axes correspond respectively to:
Horizontal axis: Incoming benefit – how much does this
business gain or lose in value from belonging to this portfolio?
Vertical axis: Outgoing benefit – how much value do the other
businesses gain or lose from the presence of this business in the
portfolio?
Figure 10.2 Synergistic portfolio framework
47
The total value created by a business being in the portfolio is
the sum of the scores on the horizontal and vertical axes.
A proxy for incoming benefit could be a comparison of the NPV
of this business when operating within the portfolio, with the
expected enterprise value when it is spun-off.
A proxy for outgoing benefit could be the comparison of the

sum of the NPVs of other businesses in the portfolio with the
expected enterprise value of the corporation after the focal
business has been spun-off.
The total value created by a business being in the portfolio is
the sum of the scores on the horizontal and vertical axes.
A proxy for incoming benefit could be a comparison of the NPV
of this business when operating within the portfolio, with the
expected enterprise value when it is spun-off.
A proxy for outgoing benefit could be the comparison of the
sum of the NPVs of other businesses in the portfolio with the
expected enterprise value of the corporation after the focal
business has been spun-off.
When both incoming and outgoing benefits are positive, the
business is two-sided synergistic and we call these fits (top
right quadrant).
However, one could still want businesses in the portfolio even
when they are not in this quadrant.

The 45 degree line through the origin, sloping downwards from
left to right, shows the threshold of acceptance for investment
opportunities in the portfolio;
If they are above it to the right, it is worth investing in them.
Because both improve the overall value of the portfolio:
givers (high outgoing benefit, low but negative incoming
benefit)
takers (high incoming benefit, low but negative outgoing
benefit)
However the following do not, and should receive little
investment or consideration for divestment:
altruists (high and negative incoming benefit, low and positive
outgoing benefit)
misfits (negative incoming and outgoing benefit)
parasites (high and negative outgoing benefit, low and positive
incoming benefit)
The goal of resource allocation in the portfolio is thus to push
businesses further away from the origin toward the top and
right, away from the investment threshold.
The movement of each business in the portfolio over time can
be traced through this diagram.
We must still account for the uncertainty of investment
opportunities.
53

We classify each business as best as we can but because such
classification depends on assumptions about an uncertain future
and we are bound to make errors.
A tractable way to think about this involves distinguishing
errors of:
omission (believing an opportunity was below the threshold
when in fact it was above) from those of
commission (believing an opportunity was above the threshold
when in fact it was not).
54
Resource allocation by the HQ: minimizing errors
Minimize both errors by obtaining good information, making
sensible assumptions, and following a structured decision
process.
To further avoid Commission errors:
Invest only if you were fully convinced that the business would
do well but that would imply plenty of omission errors (i.e.,
missing out investments in businesses that would have been
worthy of investments).
To further avoid Omission errors:
Invest even if you were unsure about the viability of a business
but that would imply plenty of commission errors (i.e., money
wasted on businesses that turn out to go nowhere).

55
Resource allocation by the HQ: minimizing errors
You should try to minimize the more costly of the two errors.
Omission costs increase relative to commission costs if there is
a unique opportunity to acquire, a decline in the availability of
alternatives, a temporary regulatory loophole, or a technology
with increasing returns or network externalities.
Higher costs of omission (relative to costs of commission)
stimulate exploration.
Figure 10.3 shows how the threshold of acceptance should
change location as the costs of omission and commission rise.
Figure 10.3 The cost of omission and commission errors
influences the threshold of acceptance
57
1- Directive and Evaluative Influence of HQ
The HQ of an organization consists of the place where a
company is run and its operations are directed. There are 4
different ways by which HQ can influence the underlying
businesses, divided in 2 dimensions: One dimension represents
the relationship between HQ and its underlying businesses. The
second dimension represents the relationship that HQ
encourages between those underlying businesses itselves. The

first dimension is divided into Directive or Evaluative. In a
directive control relationship, HQ is closely involved in all the
businesses' strategic decisions. Whereas, in a evaluative control
environment, HQ gives its businesses the autonomy to make
their own strategic decisions. HQ just evaluates their decisions
from time to time to make sure the business stays in line with
their values and financial goals. We found this concept to be
important because knowing which relationship an HQ wants to
follow can dictate how involved they are in the processes and
activities of their underlying businesses. This in turn will allow
for better decision making due to the clear cut mission and
vision of the HQ.
2- Standalone and Linkage Influence of HQ
The second dimension of influence that HQ can have consists of
the relationship it encourages between its businesses. These
relationships can be either Standalone and Linkage. A
standalone style of HQ does not promote any linkage between
the different businesses. This happens when the underlying
businesses independently benefit from the relationship with HQ.
Much of the synergies that exist between these underlying
businesses occur towards the origin of the value chains and are
therefore difficult to observe from an outside perspective. One
example is P&G. Being a house of brands, P&G serves solely as
an umbrella for many different and independent companies. On
the other hand, a Linkage style of HQ encourages the
underlying businesses to connect with each other. In this case,
HQ is just a supervisor overseeing their businesses and i ts
influence is felt through the relationship between these
businesses. One example is Gillete. Even though it has many
different brands and products, Gillete still encourages the

interactions between its underlying businesses. Similar to
before, we found it important for firms to understand the
different type of relationships in horizontal influences so that
they may better allocate energy and resources to their
underlying businesses; knowing whether a firm’s underlying
businesses are thoroughly linked together, or if they simply
share synergies early on in their respective value chains can
prove useful when allocating resources amongst them.
3 - Challenges in Resource Allocation by the HQ
There are two challenges that HQ’s encounter when allocating
their resources, which are the challenges of synergy and
uncertainty. The challenge of synergy can be best described as
businesses in a multi-business organization who are not
independent of each other, but still interact with each other.
Therefore, a firm must understand these interrelationships and
how they might affect resource allocation: will giving one
business extra resources take away value from the second
business as is the case when dis-synergies exist, or will
providing resources to one business help uplift the second one
as well? The challenge of uncertainty is arguably more complex
due to the existence of fundamental uncertainty (when one is
unaware of both the future or the possibility of potential
outcomes) and uncertainty derived from financial theories when
one does not know the future but is in fact aware of the
possibility of potential outcomes. This duality of theories quite
accurately mimics the duality of man in which there exists both
a state of good and bad simultaneously in every individual,
constantly at war with each other. Thus, businesses face the
obstacle of assessing the synergies that exist between
businesses as well as determining which businesses make the

best investments for the risk that they pose (aka exploration-
exploitation trade off). This is important because recognizing
and addressing these challenges will guide resource allocation
and decision on how to spread investment across a portfolio of
businesses as well as whether or not to invest in a particular
business.

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