I thought of the following story to illustrate the need for a centralized financial control.
Suppose you have a holding company named Acme Conglomerates, and it owns 2 subsidiaries- Acme Umbrellas and Acme Sun Screen, and the profit of the two subsidiaries depends on the number of sunny days.
Now let's suppose that the Chief Weatherman for Acme Umbrellas forecasts 60% rainy days for 2010, it's a bit higher than the historical 50%, but it's not a particularly egregious estimate. Likewise, the Chief Weatherman for Acme Sun Screen forecasts 60% sunny days for 2010, again, it's higher than the historical 50%, but it well with historical deviation.
Well, 2010 comes and goes, and as it happened, it was 50-50 sun and rain. Both Acme Umbrellas and Acme Sun Screen overestimated their expected revenues. What are you gonna do right?
This is where good central financial control at the enterprise level is necessary. Given that you cannot have a year that is both 60% sunny and 60% rainy, you already know from the outset that the aggregate revenue outlook for Acme Conglomerates is biased upwards. Furthermore, this bias is not because of some corporate malfeasance, but simply because that the different business units were not coordinated.
In order for you to have an unbiased estimate of your expected revenue, Acme Conglomerate has to get the two subsidiaries to agree on their projection assumptions. This is where you need to have enterprise level coordination.
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3 comments:
In life in general, incentives is a huge issue. Reading your example, I thought of them once again.
Each unit's chief might have an incentive to overestimate future earnings in their favor. But your incentives (when analyzing the conglomerate) are different. This basically means that you have to do your own analysis. If it's important enough to you, and if you realize that people's incentives do not match, and if you are able, you are forced to do your own analysis.
So there is that centralization consideration- which itself not costless- the human effort in breaking down the silos, as well as a very real danger of having various business units becoming too rigid because of over-centralization.
But there is one additional dimension to the example I used I wanted to highlight- part of the conglomerate strategy is to acquire business units in such a way that its annual cashflows are smoothed out because they are countercyclical to each other- sunscreens and umbrellas. With this consideration in mind, without a good centralized financial control over your subsidiary forecasts, it's hard to get a gauge as to what extent your cashflows are truly smoothed out.
Great point. Negative correlation can certainly be a good thing.
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