The decision of centralization vs decentralization of functional resources has been a regular evaluation by small and large businesses for decades. No company is fully centralized or decentralized, instead there are varying degrees of both.
The amount of centralization that’s right for a company depends on its size, culture and strategy. If a company is wrong about the timing and fit for centralization, it can suppress responsiveness, limit the ability to locally customize products and services, and burden business units with higher costs. On the other hand, insufficient centralization can deny business units the lower cost structure or coordinated strategies needed to win global customers. So, how do you know the time is right for a change?
As with any business change, there are several variables that need to be understood before moving forward. This article will briefly provide some background on the case for centralization, when is the right (and wrong) time, and an implementation methodology. Let’s first level set with a few definitions that will be utilized throughout this article.
The term centralization refers to the process in which activities involving planning, decision-making and transaction entry within an organization are consolidated to a specific leader and/or location. The term functional resources refers to the areas of the company generally outside the business units that are serving all business in a similar fashion such as finance, HR, procurement, and IT – and potentially the supply chain or manufacturing depending on the scope of the business. And lastly, the term shared services (SS) is an operating model that consolidates multiple functions such as HR, IT and finance, to act as a single organization that delivers services in a standardized fashion across a company, resulting in lower costs with agreed-upon customer-service levels. The majority of the article will be focused on the centralization decision using the SS model. The decision-making and implementation process are conceptually the same, whether you are centralizing one or two functions, but clearly the complexity increases as the number of functions to be centralized increases.
The origins of the centralization approach can be traced back to the early 20th century by Henry Ford on the Model T assembly lines in the 1920s.
Ford’s approach to dealing with ‘variation’ is famously summed up by his (centralization-type) comment,
The customer can have any colour, as long as it’s black.Henry Ford, founder of Ford Motor Company
Fast-forward about 50 years later and GE (General Electric) and DEC (Digital Equipment Company, now part of HP) are acknowledged to be the first companies to create what would be recognized currently as SS organizations. GE implemented shared financial and accounting services in 1984, while DEC created shared financial services in 1985, and both claimed reported annual savings of greater than $30m.
The Hackett Group and Deloitte are two of the many management consultancies that have tracked the centralization of functional resources, across a variety of industries on a global basis. In the late 1990s and early 2000s, companies followed GE’s lead in centralizing functions. Table1 containing information from the Hackett Group shows the progression of the SS model.
In 2003, of the companies who had completed centralization activities, 73% of them had centralized a single function (which was typically finance), and the balance (27%) centralized two or more functions (typically finance, HR and IT). Over the next 15 years, more and more companies moved to centralizing multiple functions into an SS environment. By 2016, companies who had centralized two or more functions in an SS had risen to 77%. Linde, Air Liquide and Air Products have all implemented SS over the
last 10+ years, covering multiple functions and geographies. So, if the big guys are doing it, is it something I should consider?
The right time
Let’s first take a look at some of the major pros and cons of the centralization of functional resources. Table 2 (above) could be much longer but generally speaking, shows that the centralization vs decentralization decision is often driven by the trade- off between cost and what is needed to improve a company’s customer focus.
Centralization often makes sense when scale or standardization is
a deciding factor. Alternatively, decentralization is more appropriate when different products/services for individual markets are needed or when the company must respond quickly to changing or regionally differentiated customer needs. So, it seems that the first question is how do you know when the time is right to consider centralization or a move to SS? Below are some indicators that point to taking a closer look:
• Cost challenges – If G&A as a percent of sales is rising and it is
not being solely driven by customer requirements. Functions that are not ranked in the first quartile (top 25%) are candidates
• Global customer requirements – As customers grow regionally or globally, they demand the same level of service, no matter where they receive your products and services. If you’re not able to meet those requirements consistently, centralization in a SS structure may be part of the solution
• Mergers & acquisitions (M&A) – As a company grows through M&A, the need for a fast and efficient process of bringing in the functional elements of an acquisition can be handled most efficiently by an SS structure
• ERP implementation completion – After a company has completed an ERP implementation and the associated process work, that
is the perfect time to consider centralization via a SS model, if it agrees with your business strategy.
Tom Ward, President of 4-WARD Consulting, LLC and former vice- president of Global Business Services for Air Products states, “While many of the above indicators point to ‘when’ to move to SS, both Work Process Standardization and converging to a Single Instance ERP Implementation are not only enabling but essential to a successful transition to a SS Model.”
The centralization decision is also clearly driven by ROI or payback. In Deloitte’s 2019 biennial Shared Services survey, the results stated 80% of respondents recovered their investment within the first three years of SS implementation and 50% achieved break-even within first two years.
As with any major transformation, it should be sponsored and led by the executive(s) who will receive the majority of the programmer’s benefits when the new structure is in place and operational. If the company is considering centralization of multiple functions in an SS framework, the CEO/COO should sponsor this. If it is only one function (say, finance) the CFO along with the company’s largest business unit should be co-sponsors. Below are a few best practices that should be employed:
• Vision/strategy – This needs to encompass how the organization and customers will benefit in the future, and articulate how they will get there
• Take the time to benchmark (learn from others) before agreeing on
• End-to-end process mindset – Understanding and documenting enterprise processes is critical
• Technology enablement – While technology is not necessarily the most critical success factor, it can
be a significant enabler. Having a standard ERP in place before the launch of SS would be the ‘holy grail’
• Talent management – A rigorous, disciplined, but flexible selection and management process is critical
• Change management – As with any significant transformation, this is an absolute requirement. It involves all impacted organizations, customers and vendors. The plan should be communicated early and often, and help/coaching with change given.
As mentioned, the decision of centralizing functional resources and/ or moving to a SS structure has been around for a long time.
A recent Deloitte study stated that greater than 80% of Fortune 500 companies have been through this process, and estimated that 20% of companies of less than $1bn in revenue have done so as well.
One thing to remember, is that centralization is not a permanent
or ‘final’ decision. It is often driven by a change in leadership or market conditions, often resulting in a change in strategy/direction of the company. Whatever the driver, don’t wait too long to make the decision, and miss out on the benefits that can be reaped in the short/medium-term from this transformation.
ABOUT THE AUTHOR
Art Anderson is a Senior Business Management Executive with 20+ years of experience in the industrial and specialty chemical industries. He has specific expertise in optimizing commercial operations, implementing shared business services, leveraging process excellence tools and processes, and improving both internal and external customer focus. Previously, Art was a Director for a Fortune 300 company, and member of the executive team leading the transformation from SS to a GBS framework. Learn more at www.linkedin.com/in/artandersonjr. Art can be reached directly at email@example.com.