Transformational Change in Diversified Corporations

Diversification remains a critical issue for diversified and multi-business companies today. The most important trends of diversified companies in the past two decades have been on transformational change activities including “refocusing on core businesses” and “splitting” to form separate companies-to resolve the strategic issues that will have a powerful effect on improving future business performance. Before the 1980s, most successful diversified companies operated in stable business environments. But the business environment at beginning of the 1980s started changing, leaving strategic managers unaware of this phenomenon. Diversification remains a strategic issue because it has destroyed more firm value in the past than creating it.

During the 20^th century, diversification by large corporations was driven by two basic goals: growth and risk reduction. Companies were able to achieve their revenue growths and profitability and operated with lower risks because the business environment was quite stable during that time. In determining a firm’s profitability, irrespective of the firm’s size, involves two issues: industry attractiveness (corporate strategy) and competitive advantage (business strategy). Due to the changing environment in the 1980s, multi-business firms started losing ground on these two important strategic factors, resulting in poor performance. As a result, corporate managers started changing their goals and objectives without knowing the cause of poor performance to sustain profitability and create shareholder value. The transformational trends in diversification began with changes in corporate goals, from growth to profitability to the creation of shareholder value to corporate advantage. But the pace of organizational transformation has been slow. For example, General (GE) lost half of its enterprise valve between the years 2000 and 2009 and continuously drained market value until 2018 when it realized the seriousness of the strategic issues that had surrounded the company. From the year 2000 onwards, GE failed to identify and analyze the impediments to its success due to not having a strategy to navigate the crosscurrents of a changing environment.

Most diversified companies in the past believed that corporate management does not need industry-specific experience, and the techniques of strategic and financial management could be applied to any business to remain successful. However, these beliefs and assumptions were not true. Most of the failures among diversified companies can be attributed to a lack of strategic and financial management. Additional causes of failures have been related to unsuitable acquisitions, over-optimism, divestment of assets at lower costs, and poor cash flow management.

However, in the past, for multi-business companies to prosper and survive in the long-run, many organizations required a rapid change or a revolutionary transformation within a short period of time. Most companies failed to deliver it or were unable to understand the difference between transformation and restructuring. Many organizations plan to deliver a revolution, but they end up delivering restructuring. To cope with the financial crises of 2008, most companies attempted restructuring and downsizing activities, but a transformational change was not thought of. For many companies, failing to timely transform resulted in a constant drain of cash for many years down the road until they finally realized the necessity of strategic change. GE constantly drained cash for 17 years when it realized the necessity of a transformational change in 2018. In practice, only a few organizations have been capable of delivering a revolution. The proponents of the continuous model of change argue that companies can also transform incrementally in the dimensions of time, achieving the same outcome as transformation. However, this approach, as we have seen, resulted in huge financial losses as described above for not timely transforming when needed. Revolutionary transformation involves redefining the vision and mission, and changes in goals and objectives, strategies, structure, management systems, and even top management personnel. When the business environment of the diversified firms started changing in the past, strategic managers identified and understood the causes of failures and began thinking about changing to create value and remain profitable.

Transformational Change Trends in Diversified Firms

The transformational trends in diversified companies started in the early 1980s when the external environment of the companies started changing, negatively affecting the multi-business firms. These market share growth-oriented firms’ declining financial performance forced them to strategically change but could not, due to a lack of perception and understanding in this area. Even if they were knowledgeable, the transformation was a risky undertaking and would have required resources and skills in achieving it. The transformational trends included changing corporate goals, unjustified acquisitions, and divestments of assets, restructuring, and refocusing on core businesses to restore the organization to its competitive position and profitability. These trends are described below in more detail.

Shifting Corporate Goals

Because of the declining financial performance of the diversified companies, after 198o, these companies began divesting their non-core business assets because they were generating low profits than their core businesses. The trend of changing goals in cost-cutting and buying and selling assets was seemingly an attempt to transform to return the corporation to profitability, but was not transformational, because transformation needed significant changes to corporate goals.

Restructuring

Restructuring differs from transformation. Diversified organizations have often engaged in a variety of restructuring efforts without recognizing that transformation was needed. Restructuring efforts typically fail to deliver the required fundamental transformation. This goes on and on for years until the corporation realizes it needs a fundamental shift in strategy, structure, and systems.

What we have seen is that in practice, for the last two decades, most of the multi-businesses have transformed gradually, consistent with the continuous model of change leading towards the same results as revolutionary change but fell short in recovering from the declined performance. Companies took a long time to complete a transformation and incurred heavy financial losses before achieving it. GE lost two-third of its valuation in the past twenty years, with several restructuring attempts before it started actual transformational initiatives in 2018. And Philips stayed in restructuring mode for the past three decades without achieving a significant transformation.

Refocusing

The focus of the transformation of diversified firms in the 1990s shifted from profitability to creating shareholder value, resulting in refocusing and splitting efforts. During that time, diversified firms realized that their core businesses were more profitable than their non-core businesses. A company’s core business is its center of gravity where its best expertise and capability lie. Refocusing creates the greatest shareholder value at a lower cost and higher stock-market valuation. Two decades ago, Philips was engaged in consumer electronics, home appliances, lighting, and medical system businesses. By 2018, Philips was refocused on medical systems.

Responding to External Change and Speeding the Pace of Organization Evolution

Disillusioned by the thirty years of restructuring efforts, diversified firms started to realize that transformation was needed to restore a firm’s competitive position. In the last decade, particularly after the 2008 recession, the focus of transformation has been shifted to enhance responsiveness to external change and speed up the pace of transformation. The focus of strategy has been shifted from shareholder value maximization to creating new sources of value. To achieve this, most diversified companies started to identify opportunities for innovation, including new product development and exploiting internal and external linkages. Corporate management of multi-business firms is now more concerned with creating value and less concerned with corporate control issues.

From the above discussion, we see that transformational trends in diversified and multi-business corporations have been incremental or gradual, reflecting a slow pace to achieve results because implementing revolutionary transformation requires transformation capabilities, particularly those that facilitate adaptation to change. Over the years, large multi-business companies have developed adaptive capabilities to facilitate corporate adaptation: these include counteracting organizational inertia, institutionalizing strategic change, developing new business and scale development capabilities.

Still, the greatest challenge of strategic management is in managing the strategic drift: the firm’s inability to keep pace with the changing environment. The only solution to manage strategic drift is through revolutionary transformation. Research indicates that organizations that have achieved revolutionary transformation restored their profitability and competitiveness, and outperformed organizations that followed a more gradual or incremental approach to transforming.

However, it is also possible to transform while winning or adapting to a more compromising transformational path, such as restructuring and evolution. The goal may be transformation, but the organization may lack the resources needed to achieve transformation, or it is running in losses and needs to stop bleeding money before a long-term change can be implemented. As a result, it may be essential to undertake a restructuring phase, as part of the turnaround first. Evolution is a transformational change that is implemented gradually or incrementally through stages. One variant of evolution and revolution is strategic transformation: a major strategic change while winning or without a financial crisis. The examples are rare. These companies are described as successful strategic transformers because they have continuously transformed themselves to remain successful.

In both types of transformers: strategic and evolution-based, companies are more proactive than reactive: transformation, in which change is implemented in response to the future needs of an organization. Transformation is achieved when an organization becomes ambidextrous: it exploits existing competencies and explores new opportunities at the same time. This can help the organization operate successfully and continue to transform it at the same time. Therefore, an ambidextrous organization can help to avoid the dangers of strategic drift and the destruction of value.

References and Further Reading

1. M. Grant, Contemporary Strategy Analysis (United Kingdom: John Wiley & Sons, Ltd., 2018), Chapters 8, 12, 13 and cases 17 & 20.
2. Balogun, V. Hope Hailey, and S. Gustafsson, Exploring Strategic Change (United Kingdom: Pearson Education Ltd., 2016), Chapters 1 and 2.
3. Romanelli and M. Tushman, Organizational Transformation as Punctuated Equilibrium: An Empirical Test, Academy of Management Journal (October 1994), 37 (5), pp. 1141-66.
4. Ashok N., Internal Sources of Strategic Transformation: Competitive Advantage through Innovation, A&N Strategy Consulting (August 7, 2018).
5. Brown and Eisenhardt K. (1997) “The art of continuous change: Linking Complexity Theory and time-paced evolution in relentlessly shifting organizations,” Administrative Society Quarterly, 42 (1), pp. 1-34.
6. L. Wheelen & J. D. Hunger, Strategic Management & Business Policy (New Jersey: Prentice-Hall, 2000), Chapters 1 and 4.
7. Ashok N., Organizational Barriers to Transformational Change, A&N Strategy Consulting (March 5, 2019).
8. Hensmans, G. Johnson, G. Yip, Strategic Transformation: Changing While Winning (Great Britain: Palgrave Macmillan, 2013), Chapters 1 and 2.