LEAN SERVICES & ORGANIZATION THE CONSISTENT SEPARATION OF SERVICE AND MANAGEMENT

LEAN SERVICES & ORGANIZATION THE CONSISTENT SEPARATION OF SERVICE AND MANAGEMENT

LEAN SERVICES & ORGANIZATION THE CONSISTENT SEPARATION OF SERVICE AND MANAGEMENT Stern Stewart Research // Volume 55 Gerhard Nenning, Stefan Heppelmann Management Summary Originating with Toyota, the term lean management has become synonymous with efficiently organized production processes in all industries. With respect to the services of an organization, however, this approach is not widespread. Wrongly so. For while lean in the area of manufacturing has increased both productivity and the quality of the output, even in well-established organizations, the service functions are frequently only a third as productive, at best. The reason is often the incorrect definition of roles and responsibilities inherent in the functions producing a negative effect on dimensioning and output. Take Accounting and Finance for instance: It is not uncommon today to have most of their functions positioned as a shared service. Regardless of how effectively the shared service center actually is (capacity management, process design, quality, etc.); everything that typically remains in the holding company is not adequately scrutinized. Probably only a small share of 10-20% is actually officially handled, while the rest consists of expert services that have no place in a Corporate Center with its claim to leadership. On the contrary: this combination ensures that the function neither serves nor manages properly thus not playing its role effectively. Three rules should be adhered to in order to establish organizations and services that are lean, in the best sense of the term, i.e., highly productive: 1. The holding company should focus on supervisory functions thereby becoming sleeker (and at the same time stronger) 2. Based on this, the relationship between the holding company and the strategic business units should be designed to enable the latter to assume entrepreneurial responsibility with top down delegation of supervisory processes. 3. Expertise-driven functions should be bundled across all levels and converted into a critical mass with specialized know-how through the creation of so-called Centers of Excellence.

On the Do s and Don ts of organizational design First of all: There is no right or wrong organization even the discussion of whether it is a financial, strategic, management or operational holding company falls short. Instead, the following key questions must be addressed when designing the organization: What tasks are to be performed by the holding company? Basically, the following applies: A variety of functions or a large workforce are not synonymous with a productive, efficient holding company. On the contrary: policemen often work as waiters, as a sideline. How is the entrepreneurial role of businesses divisions strengthened? Please note: strong business divisions require functioning corporate governance as well as a clearly defined allocation of responsibilities among the holding company and business division. How is expertise specifically acquired and a culture of service promoted? Important: It is only when the right management signals are triggered on the demand side and on the service side that waiters become waiters with heart and soul. In the lean organization, enabling a thorough absorption of specialized resources into selected areas ensures not only a powerful holding company, but also the creation of latitude for entrepreneurial business divisions and high service quality. Thereby, three design rules apply: 1. Focusing the holding company on supervisory functions CONCEPTUAL OBJECTIVE OF THE LEAN ORGANIZATION HOLDING 3. Development and expansion of service functions CENTER OF E XCEL- LENCE S H A R E D S E R V I C E CENTER BUSINESS DIVISIONS 2. Strengthening the entrepreneurial responsibility 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH 3

Rule 1: Lean and strong Reducing the holding company to supervisory functions There is no room for service functions in the holding company of a lean organization. Therefore, the strict separation of supervisory and service-oriented tasks is the basis for a holding company that is as lean as it is mean. Three criteria characterize supervisory tasks / responsibilities: 1. The task is necessary for the achievement of corporate goals and strategy 2. The task is necessary in order to channel conflicts of interest in terms of corporate governance 3. The task is required from a regulatory perspective, or used for monitoring purposes. TASK TYPES AND ORGANIZATIONAL INTEGRATION KEY ISSUES DECISION CRITERIA 1. Supervisory tasks Strategy Governance Monitoring 2. Expertise-driven tasks Expertise Synergy potential Option of bundling 3. Transaction-driven tasks Scalability Synergy potential Option of bundling 4. Business-specific tasks Market and customer proximity Interface to operational processes Relevance for only one business division KEY QUESTIONS GC CoE SSC OpCo HOLDING BUSINESS DIVISION 4 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH

STRATEGY GOVERNANCE MONITORING SUPERVISORY TASKS OF THE HOLDING COMPANY Defining the group s objectives and fund allocation Standardization and harmonization in consideration of various interests Fulfillment of the governance function and monitoring the operational business Does the task involve strategic decisions? Does the task affect the business model? Does the task involve the basic allocation of funds? Does the task represent a central governance instrument from a Group perspective? Does the centralization of the task support the resolution of conflicts of interest? Does the task support the Group-wide standardization? Does the task serve performance measurement? Are guidelines developed, refined or their implementation reviewed? Does the task reflect the legal requirements? Typically, the task analysis and the subsequent analysis-based activity split will result, on one hand, in holding company functions that were previously, and to a large extent, will continue to be supervisory (e.g., Corporate Development). On the other hand, it also identifies departments that have no real supervisory function and therefore should not reside in the holding company (e.g., Legal). Furthermore, when considering individual tasks, potential for merging individual departments often becomes apparent. CEO CFO CHRO B O A R D O F COMPLIANCE TYPICAL RESULTS OF THE TASK ANALYSIS Corporate Development Controlling & Risk Human Resources Corporate Affairs Group Standards Corporate Finance Sustainability / Environment / Polit. Innovation & Quality Investor Relations Compliance Information Technology Materials Management Corporate Programs Executive Management Mergers & Acquisitions Legal Internal Auditing Accounting & Financial Reporting Corporate Communications Taxes & Customs Supervisory Outsourcing into CoE 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH 5

Based on this, the following is important for structuring the future organization: blueprints for deemotionalizing the decision among various design options. Otherwise, the discussion will become highly perspective-specific, especially in terms of structure, roles, areas of responsibility and function interfaces. By streamlining the holding company, savings in the mid-double-digit percent range are generally possible. In order to simultaneously increase the impact rate, focusing on value-creating activities is essential. Even well-designed companies currently apply this no more than 40% of the time. A first lever for avoiding waste is to review the performance spectrum. For example, the finance function: What level of granularity and which reports are actually necessary? Other starting points may be found in the processes within departments, e.g., in the form of a reduction of the coordination / monitoring by strengthening the individual s responsibility for quality. Additional potential that can be tapped through regular, institutionalized exchange is typically found in the area of cooperation across departments of the holding company and between the holding company and other units. In summary, the design of the lean group management model represents a new, more powerful layout of the holding company and the optimization of the structural costs. In general, the number of truly supervisory departments can be substantially reduced. The holding unit no longer executes tasks of a service or consultative nature. In short, the holding unit is no longer defined by requests, but rather by announcements. Rule 2: The Rediscovery of Subsidiarity Empowerment of Business Units to Become global entrepreneurs These are the business units that expand and secure the company s position as a global group. In the lean organization, the units play a major role of course within the framework of the reinforced functional governance of the holding company. Therefore, the business units must be equipped in a manner that allows them to always act flexibly and entrepreneurially as global groups. Accordingly, the lean organization is designed in terms of the concept of subsidiarity: Tasks, actions, and problem solving should be undertaken independently and autonomously within the business units to the extent possible. Selected supervisory functions should thus be moved out of the holding company; in this process the basic condition applies that there cannot be any substantive duplication or identical tasks on different levels. 6 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH

HOLDING CCs BUSINESS DIVISIONS AS GLOBAL ENTREPRENEUR 1. Relocation of individual supervisory CCs tasks from the holding company into the GEs (prerequisite: strengthening the functional governance of the holding company) LEVER FOR STRENGTH- ENING THE BUSINESS DIVISIONS CEO Business Development Accounting CFO Controlling CHRO 2. Selective lifting up supervisory functions from downstream units HR IT Compliance PL 1 PL 2 PL 3 PL 4 PL 5 PL 6 3. Analysis: added value by bundling in CoE? 4. Revision of Approval Regulations Another approach to the development of the role of business units consists in lifting up supervisory functions from downstream units. If there are knowledge-based tasks that cannot add value by their aggregation in the Center of Excellence, then their continued performance within the business units is an option. Not only the tasks, but also the organizational structure of the business units should be aligned to the entrepreneurial role. In this context, the CEO principle in particular, has proven to be effective. According to this principle, a CFO supports the CEO in theory complemented by a CHRO. Typically, the overhead of the business division is completed through the Business Development, Controlling, HR, Accounting and IT divisions. However, according to the leitmotif of a lean organization, the majority of the operational resources resides in the Shared Service Center or in the Center of Excellence. An example of the strengthening of corporate responsibility in the business units is the financial organization with strong functional and disciplinary guidance and reporting line. Formerly, an investment proposal was first assessed in the business division and subsequently a second time in the holding company. Not only are the redundancies obvious the practice also promoted mistrust and absolved the controlling of the business of ultimate responsibility. Well-designed companies solve the problem this way: The CFO of the division reports in both discipline-related and business terms directly to the Group CFO. Therefore, the latter has direct control over the investment controlling the business division and thus requires no separate department for this. 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH 7

Rule 3: The aggregation of expertise implementation of lean in expert Divisions The dominant guidelines for lean services are synergies and functional excellence and thus the counterpart of impact and efficiency, which are paramount at the holding company. The guidelines are initially implemented with the expansion of shared service centers around the transactional tasks that have been outsourced from the holding company and the business units. In the expertise-driven service functions, however, a change in philosophy occurs: Instead of offering the services from the holding company as previously, the lean organization now aggregates the tasks in a Center of Excellence. The aim is the commitment and creation of highly specialized expertise through sharing of resources and expertise. In addition, achieving a critical mass of demand ensures the efficient use of expert knowledge. CONTRACT MODEL FOR SERVICE FEATURES HOLDING No transfer anticipated No potential SSC GE HR Reporting IT SSC receives Business Serv IT Services Real Estate Market model / Business agreement SERVE PRINCIPLE HOLDING GE Legal Market Research Legal Market Research Tax Tax CoE receives C o E Inhouse C. Tax Risk & Insurance Compliance Market Research Accounting Legal Commissioning model However, it is only the appropriate management and contract models that set the course for an optimal interaction of service providers, holding company and business units. In this regards, the solution latitude of management models is far more sophisticated than [merely] the professional and disciplinary characteristics. That notwithstanding, in the lean organization the scope of action is clearly defined: At least in terms of clear functional governance, the manager of the Center of Excellence reports to the holding company via a solid line. Moreover, in the management of the Center of Excellence the cost-efficient quality within the given budget is paramount as opposed to the Shared Service Center, whose objectives are maximum process efficiency and low list price. 8 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH

Functional Functional and personal Disciplinary EXAMPLE: STANDARDIZED MANAGEMENT MODELS Accountability / Form of Management AND DESIGN OPTIONS No Right of Codecision Limited Commercial Comprehensive participation proposal veto power Partnership decision management hearing hearing 1. Resource Management 2. Personnel & Performance Management 3. Content Focus 4. Cost Management 5. Quality Management & Organization 6. Statutory requirements and guidelines TRANSFER PRICES PERFORMANCE INDICATORS AND KPIS No clearing Market price-based Other 15% 15% 10% 20% 40% Cost-based Other Employee-related 4% 19% 33% 20% Customer-related 24% Financial Negotiations-based Process-related SERVICE LEVEL AGREEMENTS CONTRACTING MODEL Price / Clearing Process aspects Financial aspects Customer aspects Conflict aspects CIP 33% 20% 18% 11% 11% 7% Compulsory contracting Competition solution Last call provision Others 66% 20% 6% 8% The transition to the Center of Excellence is a key step towards achieving significant cost reductions and quality improvements in overhead functions. These go hand in hand with a mental paradigm shift: The waiters become waiters with their heart and soul and are no longer police officers as a sideline. 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH 9

Summary Lean Services, lean organization in simple terms: The consistent separation of service and management. To truly enhance productivity and output quality, the following levers must be applied along the three design principles, when configuring the lean organization: First, the holding company must be strengthened by focusing squarely on supervisory tasks. The business units must be clearly distinguished from the holding company; they must be structurally empowered to fill their role as global entrepreneurs. In supporting functions, the building of centers of excellence enhances the quality of service and strengthens the consolidation of expert knowledge. At the same time, the extension / roll-out of shared services promotes a rise in process efficiency. Finally, appropriate management and governance systems must be developed to ensure the optimum interaction of holding company, business units and service functions. MODEL ROLES OF THE LEAN ORGANIZATION Strengthening the holding company by focusing on its supervisory function HOLDING Clear management model for each function with corresponding responsibilities Service quality and expert knowledge through Centers of Excellence Functional process efficiency through Shared Service Centers CENTER OF EXCEL- LENCE S H A R E D S E R V I C E CENTER Appropriate commissioning and market model for each function Strong entrepreneurial business divisions with reduced overhead Consistently implemented, the following features characterize a lean organization: 1. The holding company is no longer defined by requests but rather by announcements. 2. The business units can act as global entrepreneurs. 3. The support functions turn into service providers, dedicated with heart and soul. 10 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH

Stern Stewart & Co. Stern Stewart & Co. is an independent strategy consulting boutique. Our consulting focus is on the key management issues. This includes strategy and corporate finance, as well as organization and performance management. We see the company s management as a strategic investor in the business and support them to increase the value of their company. The authors Gerhard Nenning, Partner, gnenning@sternstewart.com Stefan Heppelmann, Partner, sheppelmann@sternstewart.com 12 2013 // ALL RIGHTS RESERVED FOR STERN STEWART & CO. GMBH

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