Why we believe in extreme decentralization

Earlier this year, we gathered 215 of our top leaders for a summit in Austin, Texas. During our Q&A session, one of our leaders asked us a great question: “why does Evergreen believe so deeply in decentralization?”

We could do a better job of publicly articulating why we believe in decentralization – hence the great question at our summit. We wrote this post to elaborate on what it means to be decentralized, the advantages of an empowered operating model and what’s at stake for small businesses.

What is decentralization?

In a decentralized operating model, most decisions are made by local operating companies instead of by the corporate headquarters. A highly decentralized company is characterized by dozens or even hundreds of separate offices and brands, empowered CEOs who manage their own profit & loss statements (P&Ls) and a razor thin corporate team. Most decisions that impact an employee or customer are made locally at the operating company level without corporate involvement.

A centralized company, on the other hand, is characterized by a robust corporate team with highly empowered functional leaders. Local offices work at the direction of corporate, following strict brand guidelines and standard operating procedures. Decisions that fall outside of standard operating procedures must be approved by corporate.

Evergreen’s operating model

Evergreen’s model is simple. We are on a mission to be the best home for businesses and their leaders. To achieve our mission, we are deeply committed to (1) creating a permanent home for businesses and (2) empowering our leaders through our decentralized operating model.

For business owners, our mission means that Evergreen is the best acquisition partner to take care of your employees, customers and brand.

For leaders, our mission means that Evergreen is the best partner to support your entrepreneurial operating experience. We offer a level of empowerment that leaders cannot find elsewhere in the corporate or private equity landscape and a business system that drives market leading growth.

Extreme decentralization is central to our value proposition for business owners and leaders. It enables us to preserve the soul of the companies we acquire and empower our leaders to live into their potential as entrepreneurs.

Advantages of decentralization

We believe that decentralization leads to higher growth and returns on capital over time because:

  1. The best people want to be empowered – the most talented operating leaders want to be entrepreneurial CEOs with wide decision-making authority and aligned incentives, not branch managers executing corporate’s plan. Our view is that the best and most energized team wins and that team wants to work in an empowered environment.
  2. It’s easier to grow a small P&L – It is easier to grow a $5 million revenue business 20% by adding $1 million of revenue than it is to grow a $100 million revenue business 20% by adding $20 million of revenue. It is widely accepted that percentage growth rates tend to decelerate as businesses grow in scale. We have a simple solution: keep our P&Ls as small as possible and our growth rates as high as possible.
  3. Business owners prefer decentralization – business owners prefer selling to an acquirer that will retain their brand and provide maximum continuity to employees and customers. We of course evolve, grow and improve the businesses that we acquire over time, but we don’t disrupt and dislocate them in the way that centralized acquirers do. 80% of business owners who partner with Evergreen highlight our decentralized model as a key consideration in their decision to partner with us.
  4. There is crystal clear accountability – in a decentralized structure, each operating company CEO has a straightforward scorecard, which is their P&L and KPIs. If a business is not growing sufficiently or has below average margins, it is crystal clear who is responsible for improving the business. Decentralization does not mean unconditional empowerment. Empowerment is earned through strong performance and is lost when the company underperforms. Centralized companies have murkier accountability. They often fall victim to the matrix structure where the functional leaders blame local offices for subpar metrics while the local offices point their finger back at corporate.
  5. Bureaucracy is minimized, margins are maximized – a large corporate team inevitably leads to bureaucracy in many forms: requests for information, approval processes, meetings, standard operating procedures, company-wide mandates and policies, etc. As a corporate team grows, coordination costs and organizational friction build up. That friction holds back the growth of underlying operating companies and the pace at which new acquisitions are on-boarded. And it drags on margins. Leading decentralized companies operate at significantly higher margins than their centralized competitors even though decentralization requires duplicating roles (e.g. accounting, sales) at each operating company. Bureaucracy is more expensive than duplicative local costs.

How do you measure decentralization?

You can measure the degree of decentralization of a company by comparing the size of the corporate or holding company team to the scale of the overall organization.

Will Thorndike, author of The Outsiders and an Evergreen Advisor, articulated our favorite measure of decentralization on his 50x podcast: the ratio of total employment of the company to corporate employees. This measure of leverage is a clear indicator of where decisions are being made and the level of bureaucracy in a company. The higher the ratio, the more decentralized a company is.

In a centralized company that ratio might be less than 25:1. Highly decentralized companies will have a ratio of 100:1 or higher. Hall of fame decentralized companies like Constellation Software and Berkshire Hathaway operate well in excess of 100:1 (Berkshire operates at ~15,000:1).

When centralization makes sense

There are situations where we think centralization makes sense:

  • Uniform product or service: if a company is selling a small handful of products or services that are uniform in nature, centralization is a better structure. It makes sense that Apple designs iPhones and AirPods at corporate instead of delegating product decisions to its retail stores.
  • Winner-take-most markets: in a winner-take-most market like a social network, a credit card network or a ratings agency it makes sense to take maximum advantage of scale by centralizing. These markets also tend to be characterized by a uniform product or service.
  • Certain low-cost producers: there are certain low-cost producers that benefit from a centralized structure. Walmart relies on a strong centralized purchasing function, though they empower their local store operators with certain decision rights.

At Evergreen, our industries generally do not exhibit these attributes. Our markets prioritize characteristics like customer intimacy, quick decisions, local presence, vertical expertise, employee retention and continuity. Centralization would lead to increased employee and client churn, slower innovation and increased bureaucracy. Further, we have managed to secure economies of scale with minimal coordination costs amongst our companies.

What’s at stake?

What’s at stake is the soul of small businesses. At least that is how we see it at Evergreen.

A decentralized operating model preserves the soul of a business, encouraging innovation, growth and continuous improvement. That is why decentralization is so central to our mission to be the best home for businesses and their leaders.

We pursue our work with tremendous energy every day, because we know that every company that we acquire at Evergreen is a company saved from a less empowered existence.

 

Jeff Totten

Founder & CEO

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