Do you believe in dragons?
That’s the question in a children’s book I used to read with my kids. A young boy finds a dragon and brings it home. His mother says, “There’s no such thing as a dragon.” As long as she denies that it’s real, the dragon gets bigger and bigger, eventually carrying the house on its back. Finally, when she asks what the dragon is doing with their home, it shrinks back to a manageable size. “He just wanted to be noticed,” the boy concludes.
Companies seem to be recognizing the dragons in their corporate structure. HP is splitting into a business-services division and a hardware company. Yum brands is spinning off its Yum-China division and everything else. Their Chinese franchises have been plagued by several food-safety scandals and increased local competition. A good bank / bad bank structure was used several times during the Financial Crisis to get poorly performing assets off of bank balance sheets. And in an inverted variation, several years ago Phillip Morris separated its fast-growing international division from its US-based enterprise.
Isolating a problem can be a good way to focus and make sure it isn’t avoided or concealed. When the sole purpose of your business is to manage your way out of a hole, it’s less likely that you’ll forget about the hole. At the same time, it’s important not to ignore the rest of the business, which still needs attention. Businesses don’t just manage themselves. There are decisions to be made about personnel, marketing, operations, finances—the list goes on and on. But senior managers only have so much attention.
By spinning off the problem child, companies can make sure their issues get addressed. Problems often require their own specific processes. But it’s important to start out right. If the new organization doesn’t assert control quickly, it can devolve into a downward spiral, where good people leave, the business declines, causing more people to leave.
So it’s important to get started. Because the surest way to make a problem worse—or a dragon to grow—is to deny that it’s there.
Douglas R. Tengdin, CFA
Chief Investment Officer