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Borrow — in Moderation

Optimism is on the rise. This year, almost every conversation with our clients, major corporations, has begun with sentiments like, “We’ve spent several years now focusing on cutting costs and making our operations as efficient as possible. We need to make a transition. We need to focus on growth now.” That’s wonderful news. Several of our clients are thinking about the rapid growth attainable only by venturing outside of the boundaries of their existing operations.

Optimism is on the rise. This year, almost every conversation with our clients, major corporations, has begun with sentiments like, “We’ve spent several years now focusing on cutting costs and making our operations as efficient as possible. We need to make a transition. We need to focus on growth now.” That’s wonderful news. Several of our clients are thinking about the rapid growth attainable only by venturing outside of the boundaries of their existing operations.

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But established organizations have a less-than-impressive track record when it comes to building breakthrough businesses. In some ways, that’s a bit of a mystery. After all, large organizations have tremendous assets that independent startups envy — established brands, networks of sales contacts, manufacturing facilities, and technical expertise. Sometimes, such advantages are so mammoth that they put attractive opportunities completely out of reach for startups, or at least put them at the mercy of industry giants. Consider the helplessness of a semiconductor startup without access to one of the industry’s multi-billion dollar fabrication facilities.

The fact is, however, that startups within established companies can face the same difficulty. Though it is easy to identify the advantages available to a startup within an existing organization, it is much harder to actually achieve them. How can a new company (NewCo) borrow from its parent (CoreCo)?

This is exactly the question facing one startup that we are working with, a major bank building a new business offering back-office processing to other banks. The bank is resource rich. There is no shortage of assets that it could borrow. But borrowing isn’t easy. As our client put it, “Opportunities to step on toes are plentiful.” Potential relationships within the bank have been complicated by competing priorities, leadership changes, and reorganizations.

When companies decide to stretch outside of their core businesses to achieve growth, they face a number of crucial organizational challenges. How should NewCo be designed differently from CoreCo? How should the two interact?

Most companies approach these questions with one of two mindsets. Some will be very keen to create different behaviors within NewCo. After all, it is a startup, and its business model is fundamentally different from CoreCo’s. As such, they will alter hiring practices, change metrics and incentives, and create a new culture. They often will find a separate building and even consider how the architecture can be used to shape different behaviors. All wise choices. But it is easy to go a step too far and completely isolate NewCo from CoreCo. This makes it exceedingly difficult to borrow.

Companies that recognize as a first premise that their existing assets promise great advantages over independent startups take the opposite approach. They want NewCo to be able to borrow as much as possible from CoreCo. Access to core operations? Absolutely. The ability to leverage existing relationships with customers, suppliers, and partners? You bet. Eagerness to have NewCo adopt CoreCo’s information systems? Of course. Insistence that NewCo adopt CoreCo’s policies for hiring, promotion, and compensation. Yep.

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All of this saves NewCo a great deal of time, effort, and money. But it creates a different kind of problem. When NewCo is so closely integrated with CoreCo, it acts just like CoreCo. It may be able to talk about how its business model is different, but CoreCo’s mindsets and assumptions about success will be reinforced in so many ways that they will dominate NewCo’s thinking, and NewCo will fail as a result.

Thus, the solution: Borrow in moderation. NewCo must ask: What is the one asset that I can borrow from CoreCo that gives a make-or-break competitive advantage? Is it a brand? A facility? A group of experts? Could be any of the above. Is it CoreCo’s planning infrastructure? Hiring policies? Compensation norms? Almost never. It may seem painful to build such infrastructure from scratch, but that is what NewCo must do.

If our banking client wants to outsource foreign exchange processing services, then it had better have access to the bank’s currency exchange operations center. That is where economies of scale can be achieved, and that will ultimately be the source of the cost advantage that makes their services attractive to other banks. Is there another link that is nearly as important? Probably not.

Once the crucial links have been identified, NewCo must recognize that drawing a line on the organization chart will not be sufficient to make the link effective. Senior executives help NewCo most when they ensure that the relationship between NewCo and CoreCo is productive and healthy. As we will explain in a future, numerous sources of tension are likely, and there are a variety of ways to overcome those tensions.

Companies will achieve growth outside the core this year and next — but only if they carefully select and carefully manage the links between the old business and the new.