Converting internal departments/divisions into free standing businesses

08 Jun

This is a specific issues that I have been dealing with over the last 3 months with 2 different clients. Client A converted an internal division into a stand alone company a good 6 years ago – with the view that as a stand alone company they could also sell their services to other companies in similar industries.

Client B is now just about thinking of converting an internal division into a stand alone company – for the exact same reason as Client A, that is the services can be sold to other companies.

Somehow for those people who are running service departments – often referred to as cost centers, there is a seductive logic to becoming independent and it is quite easy to understand why. After all it cannot be to much fun constantly being referred to as a “Cost Center” and the fastest way to change that is to be a “Profit Center.” Then there is the lure of potentially better salaries and bonuses as well as upward mobility and recognition just like all the other “Profit Centers.”

Equally for management, if a Cost Center can be spun off to become a profit center – why not?

The move to create shared service organizations in large global companies is an example – however the motivation for such shared service organizations is not be a profit center but to deliver a service at the lowest possible cost.

Some organizations have found that they have strong and deep internal competencies that there is an outside market for such competencies, but this is more the exception than the rule. Having said that, some companies have successfully spun off internal departments into profit centers and those profit centers have gone on to take a whole new life of their own.

What makes the difference then between the internal department that gets spun off into a profit center and becomes successful and another internal department that goes down the same route only to flounder around?

The answer is “business acumen.” In most cases, the people who run the internal department do not realize that the competencies required to manage a departments are significantly different from that off a profit center. It is just like the person who enjoys cooking then opens a restaurant, only to find running a restaurant has nothing to do with enjoying to cook. Which is, by the way, why so many mom and pop restaurants fail.

As an internal department – one’s focus in on delivering services internally and if possible at the lowest possible cost – the prime concern here is all about service delivery. Whereas as a profit center – it is how to build a business, generate positive cash flows and make profit. The new competencies are all about product development, pricing, going to market, negotiations etc. There are a whole set of external and internal competencies required for success.

My advise for any company that is planning to go down this route is:
1. take a hard look at the business case, just like you would for any other investment.
2. put in a “CEO” with a proven track record for successfully growing businesses
3. put the business under the same level of Board scrutiny and standards of performance as one would do with any other business

Somewhere along the line there has to be a balance between “promoting entrepreneurship” hence giving
space to people to try out new things and pandering to internal whims and fancies.

The last thing one ones is the huge mistake IBM made in not listening to Ross Perot (who was an employee of IBM) ideas and Ross Perot left IBM to start up EDS and the rest is history. But I woudl strongly suggest EDS is more the exception rather than the rule.

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Posted by on June 8, 2008 in Business, General


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