Amid low oil prices and the subsequent struggle to maintain profitability, companies are looking for more drastic ways to cut costs. Specifically, lenders and analysts want to see companies reduce their general and administrative (G&A) expenses. One way to cut costs is to spin off unique assets.
The decision to spin off assets is complex and undertaken for reasons such as increasing profitability, refining product focus, or complying with regulatory requirements. The latter, regulatory compliance, has induced many energy industry spinoffs resulting from mega mergers.
In order for a spinoff to be successful, the new company must have a clearly defined and differentiated offering, the right people in the right organizational structure and fit-for-purpose technology.
In order for a parent company to spin off an efficient, high-functioning subsidiary, a clear product or service delineation must be present. Precise segregation provides the spinoff a singular focus on design and service delivery. For example, a company that produces pipeline and valves would have an easier time spinning off valve production in its entirety, rather than spinning off a company based on geographic location. The delineation comes from what drives complexity within an organization, and complexity is typically derived from the product offered and how it is delivered.
Similarly, an E&P company that operates both CO2 injection and high-pressure wells could potentially benefit from only spinning off their CO2 injection assets since operating CO2 wells requires a specific skill set and specialized technology. Spinning off would allow the company to eliminate entire systems and resources specific to CO2 activities. Spinning off unique assets allows both companies to focus on core functions with the intention of improving profitability, quality, and service.
The spinoff’s executive team is charged with the task of maximizing productivity with the most efficient organizational structure. From the number of employees to which departments or functions will be outsourced, these decisions are often based on capacity and risk management. For example, it is less risky to outsource payroll services than industry-specific accounting functions due to the universal nature of payroll opposed to the unique nature of land, joint interest billing, and revenue accounting. Outsourcing considerations depend on which functions are unique to the business and which are universal across industries. Strategic functions aren’t good candidates for outsourcing.
Organizations spinning off from parent companies will go through several iterations of change, allowing visibility into which positions are necessary and which can be combined. Once the organizational structure is finalized, invest in relocation and executive search services to ensure quality candidates and efficient hiring. Though it’s tempting to allow some employees to split time between companies, it is important to assign employees to only one organization and be willing to let employees leave with the company that is spinning off.
There will be a transition period as two separate entities are formed. It is tempting to assign transition activities to employees of the former parent company, since they’re knowledgeable regarding business functions and data. In our experience, it is better to include the new employees of the spinoff in the transition activities to familiarize them with new processes and help them become independent of the parent resources.
In most cases, the spinoff will be a smaller, more focused operation, which will significantly change business processes and data collection. Major technology, especially the ERP system used by the parent company, will likely be too robust or too specific to the requirements of the parent company’s structure. It is important to analyze the current system and capabilities in order to assess other available options. Smaller, more financially feasible systems are available for companies with less data and simpler processes.
During the transition period, the spinoff will most likely be under a Transition Service Agreement (TSA) for use of the parent company’s technology until the spinoff can function on its own. Commonly, TSAs are more expensive than licensing a new ERP, so it is beneficial to implement a new ERP as quickly as possible. Help from the system provider, outside consultants, and sufficient support from decision makers and internal resources will ensure a smooth and successful implementation.
Smaller systems outside of the ERP should be thoroughly assessed and consolidated based on business requirements and system functionality. For example, rather than using a robust document storage system, a new spinoff can use an internal server to share files. Rationalize the specific operations systems to decide which ones can be eliminated. A recent spinoff client was able to eliminate 35% of its operational systems and reduce G&A dramatically. As a result, the parent company discontinued all licenses associated with the new company and reduced its own recurring costs.
Spinoffs provide an unusual opportunity for a fresh start. A spinoff is most successful when the assets being spun off are unique, when organizational structure and business processes are optimized for the new company, and when systems are purchased or configured to fit the new organization.