Stone Finch, Inc: Young Division, Old Division Analysis

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In January 2008, Jim Billings, president and CEO of Stone Finch, Inc. , sat back in his office chair, contemplating his next move. A crisis was brewing, as an email from Eli Saunders, senior vice president and head of the Water Products Division, confirmed. Water Products was the foundation of the company, and Saunders had been with the company more than 25 years. Billings read the email again: Jim, I must register my grave concerns with the way things are operating. In considering my perspective, bear in mind that I’ve supported you in the past.

When the firm purchased your company, Goldfinch Technologies, in 2000 and integrated it as a second division, focused on consulting “solutions,” I told R. L. Stone that I thought the decision was appropriate and that you looked like a talented, even inspiring leader. Then in 2004 you embraced the incubator concept of “strategic subsidiaries. ” I gave my support with a strong note of caution, fearing that the concept presented too many unanswered questions for our organization. My caution was well founded. Since 2004, you and I have had numerous discussions about the funding and basic tenets of the strategic subsidiaries.

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I agree with you that these subsidiaries do represent an engine of innovation, and they do create a buzz in the industry. But in the long term, using my manufacturing division as a cash cow to feed a proliferating number of subsidiaries is an unsustainable strategy for Stone Finch. I write this email because I am staring at the resignations of three of my top salespeople. Morale is plummeting because, as I’ve said for the past two years, the Water Products division is no longer a leader in any of our markets. Our brand, built over three decades of delivering superior products, lies in tatters.

The sales force is speaking with their feet. What should I tell those who remain? Saunders’s concerns were legitimate, Billings realized, and these latest departures from Water Products were worrisome. A-level talent was also leaving the Solutions Division, which Billings had run before taking the CEO’s job. Just that morning, he had seen a report indicating that eight people fast-tracked for advancement in Solutions had resigned in the past three months. HBS Professor Richard G. Hamermesh and writer Elizabeth Collins prepared this case solely as a basis for class iscussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental.

There are occasional references to actual companies in the narration. Copyright © 2008 Harvard Business School Publishing. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www. hbsp. arvard. edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business Publishing. Harvard Business Publishing is an affiliate of Harvard Business School. 3214 NOVEMBER 11, 2008 3214 | Stone Finch, Inc. : Young Division, Old Division Billings had always believed that the experimental subsidiaries were critical for Stone Finch’s future.

As Water Products passed through its maturity, the Solutions Division needed to be continuously nourished by new talent and fresh ideas. Billings had set up the subsidiaries partly to attract and retain star talent whose products, when fully developed, could be exploited by Solutions. Even though Stone Finch was a substantial firm, with decades under its belt and 20,000 employees in 12 countries, Billings wanted the kind of people who pursue daunting challenges in small companies, where almost every choice spells survival or death.

For Billings, “A-level” employees were like peregrine falcons, which fold their wings and drop through the air at 200 miles an hour to stun their prey. He, too, was a falcon, an entrepreneur at heart. In this way, Billings was very different from virtually the entire executive team in the Water Products Division, many of whom had been with the company 20 to 30 years, since the founder began fabricating products like piping, tanks, filters, and membrane systems for water and wastewater processing plants.

When the founder’s son stepped aside, the Board had wanted a leader with the vision to drive continued growth and expansion—and Billings had delivered. The company’s revenues, which topped $5 billion in 2007, had tripled in the four years since he had become CEO (see Exhibit 1 for a 2007 income statement). The second reason Billings had championed the subsidiaries, which were focused on bringing cutting-edge water purification, processing, and desalination technologies to market, was to build an innovation pipeline for the Solutions Division.

That division, added by acquisition in 2000, had a completely different business model: its mission was to develop biochemical solutions associated with water purification, seawater desalination, wastewater treatment, and industrial discharge. Billings believed steady profits from this division, which he had headed before becoming CEO, would lead the company through slow-growth periods and the now turbulent and crowded global marketplace for water and wastewater services. Despite Saunders’s latest expression of misgivings, Billings remained confident in his strategy.

Executing the strategy was the problem. Saunders’s email had raised many questions regarding Stone Finch’s growth model, tensions between the two divisions, and the best organizational structure for long-term employee retention. Billings searched his mind for a way to surface the feelings and attitudes of employees. Suddenly he remembered the idea of a corporate intranet “jam. ” In 2003 and 2004, IBM had invited all of its employees to participate in jams—freewheeling exchanges of ideas and opinions about corporate values—on the company intranet.

Thousands responded, and IBM used many of their ideas. Billings decided that later in 2008 he would invite Stone Finch employees to a similar jam to talk about culture, leadership, and attitudes toward the subsidiaries. Maybe the jam would generate ideas that could help him respond to the issues that Saunders had raised and identify answers to the questions he had posed himself. Building Stone Finch Stone Water Products, Inc. , was founded in 1975, when the Stone family launched the company to manufacture products for the water/wastewater industry.

Over the next 25 years, the company built its reputation on the quality of its products, the support embodied by its service agreements, and its sales people. Besides helping municipalities provide clean drinking water, Stone Water Products served a variety of markets that produced wastewater, including the automotive, chemical processing, microelectronics, mining, power, pharmaceuticals, and pulp paper industries. ?2 BRIEFCASES | HARVARD BUSINESS PUBLISHING Product innovation was not part of the company’s business model.

Stone Water Products’ economies of scale in production and distribution, along with well-established supply chain partnerships, made it possible to copy new products on the market and quickly undercut the competition. Though the company was publicly owned, the Stone family continued to hold a majority of the stock and controlled the Board of Directors. Richard Stone, son of the founder, served as CEO and chairman. Neither the family nor senior management, many of whom had spent their entire careers at Water Products, advocated for organizational change.

In 2000, the company employed the same standard functional organization, with a highly centralized chain of command, that had been put in place at the company’s founding. Later that same year, Richard Stone surprised his family, his employees, and his executive team by acquiring Goldfinch Technologies, a five-year-old biochemical firm in the water/wastewater processing market that was led by Jim Billings. At the stockholders’ annual meeting that year, Richard Stone explained his reasoning for acquiring the 75-person firm: Our water processing machinery business throws off excess capital.

By investing that capital in a biochemical research arm for the company, we will add additional streams of revenue that will be crucial for driving growth. That goal is worth working through the dramatic increase in business complexity that will naturally result from introducing a different business model. Stone continued, explaining that one of the primary reasons he had selected Goldfinch for acquisition was his high regard for Billings, whom he had met at a water processing plant construction site the previous year.

Jim Billings is energetic and far more of a risk taker than I ever was. He grew up on an Iowa farm, went to MIT, and then joined a large scientific equipment company in the Boston area. He rose through the ranks rapidly, moving from the research group to corporate planning to plant management. Jim was recognized as a high-potential leader throughout the company— and in fact, when some of the company’s research engineers left to create an research and development (R&D) company, they asked him to both head it up and to invest capital in it.

In the new company, branded Stone Finch, Inc. , Billings was tapped to head the newly created Solutions Division, which would continue to offer the same biochemical services and R&D that he had managed at Goldfinch. Over 80% of the Goldfinch Technologies’ employees—mostly biologists, chemists, scientific technicians, and chemical engineers—chose to stay with the new division. With the title of senior vice president, Billings was given full control of that division’s operations.

The company veteran Eli Saunders was given similar authority over the old Water Products manufacturing operations, now organized into a division of the same name (see Exhibit 2 for a 2003 organizational chart). Embracing Innovation: The Falcons Take Flight By mid-2003, Richard Stone was ready to step down as president and CEO of Stone Finch. After considering both internal and external candidates, the search committee made a surprise recommendation: Billings. Stone Finch, Inc. : Young Division, Old Division | 3214 ?HARVARD BUSINESS PUBLISHING | BRIEFCASES 3 3214 | Stone Finch, Inc. Young Division, Old Division According to the search committee’s report, Billings had played a key role in the “profitable growth and diversification” of the expanded company. The new CEO, said the committee, needed a “driving energy and vision” to continue the company’s upward trajectory. Above all, the new CEO could not be “complacent. ” Ultimately, the Board accepted the search committee’s recommendation, and on January 1, 2004, Jim Billings became president and CEO of Stone Finch. Billings expected to fulfill the Board’s mandate through further expansion of the Solutions Division.

He planned to use a variety of growth vehicles for this purpose, including acquisitions and joint ventures with startups. Funds would come from excess capital produced by the Water Products Division, as well as from Stone Finch’s rising stock price. His largest concern was how to build a culture of experimentation—energetic pursuit of opportunity. He wanted to attract “falcons” to Stone Finch instead of people who liked the comfort and security of large organizations. These “domestic fowl,” according to Billings, stolidly move up a company hierarchy by virtue of seniority, not drive.

Billings figured out a solution to this quandary one week after his appointment. The trigger was a meeting with three of his best people from the Solutions Division. They had developed a promising concept for a microorganism and disinfection system for nuclear power plants’ wastewater and were planning to leave the company to commercialize it. First, though, they wanted to ask Billings whether he would be willing to invest, either as an individual or as Stone Finch CEO. Here, Billings realized, was a way to build an innovation pipeline for the company.

He was particularly interested in positioning Stone Finch in two markets—servicing nuclear power plant wastewater and helping municipalities purify groundwater. Billings thought both of these markets were poised for enormous growth, and he wanted to build an early-mover leadership position in them. By some estimates, for example, the United States would need 1,000 new nuclear plants by the year 2020. Power-generating capacity was expected to grow by approximately 136,300 megawatts in North America by 2009, and by 2013 that number was expected to jump to 200,000 megawatts.

A similar surge in power plant construction could be identified all over the industrialized world. Billings wondered how to overcome the organizational hurdles to building a culture of innovation. The three engineers clearly wanted the high rewards they could reap from equity interest in a successful startup. Billings did not fault their motivation: indeed, he had followed a similar path himself. However, a fair offer to the group, if in salary, would require more than Billings could afford or could justify to the Board, given current pay scales across the two divisions.

After a night crunching numbers, Billings developed a concept of Stone Finch entrepreneurial subsidiaries that he felt he could sell to the Board. He would entertain applications to launch subsidiaries designed to bring innovative products in the power plant or ground water arenas to market. To be accepted, the product ideas needed to show promise of reaching the market in five years. Further, the proposals needed to come from Stone Finch employees, who were also expected to recruit from one to three star players from outside Stone Finch to join the subsidiary, if it were formed.

If Billings accepted a proposal, the employees would resign their regular Stone Finch jobs and become officers of the subsidiary. That subsidiary would issue stock in its name, 80% of which would be purchased by Stone Finch and 20% by the officers. Stone Finch’s initial capitalization of the subsidiary, along with sizable, direct loans for R&D, would come from retained earnings (mainly from Saunders’s Water Products Division) and funds raised in the form of long-term debt (see Exhibit 3 for details of the subsidiary plan).

Stone Finch would not, however, pay the salaries of subsidiary personnel. Stone Finch retained the right to merge a subsidiary back into the parent ?4 BRIEFCASES | HARVARD BUSINESS PUBLISHING organization after four years (through a one-to-one exchange of stock) or to stop supporting it at that time. At least initially, Billings expected to place the merged subsidiary capability in the Solutions Division. In February 2004, the Board had approved Billings’s subsidiary plan, and he signed a contract with the three engineers to create the first of these subsidiaries, named EnzaClean.

By February 2008, Billings had signed contracts for 12 of these organizations (see Exhibit 4 for a 2008 organizational chart showing the two divisions of Stone Finch). Virtually all of the subsidiaries were formed by “falcons” from the Solutions Division or from existing subsidiaries. By then, EnzaClean and three other subsidiaries had merged back into Stone Finch. The risk taken by the EnzaClean officers paid off: the three engineers who first approached Billings each received $2 million in Stone Finch stock.

Jamming on Company Culture and Innovation In March 2008—prompted in part by the angry e-mail Eli Saunders had sent in January—Stone Finch held its first “company jam. ” During the three days of the jam, 27% of the company’s employees posted comments on the intranet about culture, leadership, and attitudes toward the subsidiaries. To encourage employees to be honest, Billings himself posted several of the first comments in the different discussion areas. Billings devoted the first weekend in April to read through a printout of the different discussion threads.

He was hoping to find insight into the basis for Saunders’s January e-mail and for the retention issues that were cropping up in both the manufacturing and services divisions. Some comments—mostly from employees and officers of current or past subsidiaries—talked about the excitement of working full-tilt on new technologies and being part of close-knit entrepreneurial teams. For example: Max Chu, officer, EnzaClean: I have experienced such an amazing five years. First, I had the wild, exhausting ride of working 20-hour days on our product. We were all sleeping at the office, eating take-out.

Then, because of this astounding setup with the subsidiaries—which my co-workers and I’ve never heard of in any other place we’ve worked—we were able to leave our skunk works when we were ready and return to a division with the capabilities to bring our technology to fruition. Other comments, however, highlighted the stresses on the company culture resulting from the focus on the subsidiaries as the primary channel of innovation within Stone Finch. Reasons for the disgruntlement in the Water Products Division were outlined: Al Pearson, salesperson, Water Products Division: Our sales force was the best in the industry for years.

We prided ourselves on selling high-quality products, and we built deep relationships with our clients. Now, we are losing more relationships than we are winning. I’m tired of making excuses to clients about why we don’t stack up better against the competition. Everyone knows why, though: there have been no meaningful investments in Stone Water’s production facilities in 20 years. We lost one of our best salespeople to Calgon last year and I just heard that another one is going to Veolia Water.

Further, while the post-2004 organizational structure had worked out well for the officers of subsidiaries merged back into Stone Finch, the infusions of suddenly rich, intellectually energized people into the Solutions Division was driving down morale among those who had not been invited on a “wild ride. ” Stone Finch, Inc. : Young Division, Old Division | 3214 ?HARVARD BUSINESS PUBLISHING | BRIEFCASES 5 3214 | Stone Finch, Inc. : Young Division, Old Division Elias Masterson, Client Management Unit, Solutions Division: I’ve been with this company for five years—and next week, I start my new job.

I’m happy to leave, frankly. I was spending too much energy trying to get my work done, which is to propose the best solutions for the companies we handle operations for. We didn’t see much of the subsidiary officers after they spun off—until the subsidiaries merged back in and presto, we’d see them again in the cafeteria. We were the same, but they were different, much richer and more entitled. And they never really merged back in—subsidiary teams ate together, hung together, jogged together, and watched each other’s backs.

The rest of us were always on the outside. The process has become a little predictable: really interesting work starts, things go hush-hush, and presto, a new subsidiary is announced. Abe Pinker, Marketing, Solutions Division: The subsidiary people are always bringing in nonstandard platforms. At last count, I think we had three enterprise resource planning (ERP) platforms, three networks. Market forecasting takes forever because I can’t get the data I need, and I still can’t send files reliably to colleagues in the Water Products Division.

And without back-office ERP integration, we cannot leverage project synergies in communication, collaboration, and coordination. After EnzaClean merged back into Stone Finch in 2005, Billings had named Beth Suarez, one of the three founders of that subsidiary, as the vice president of the Solutions Division. He had placed total faith in Suarez, who had excelled with EnzaClean. But after reading the postings about the widening gulf between the “haves” and the “have-nots” in the division, as well as numerous commentaries about business and IT misalignment, Billings wondered whether that faith had been misplaced.

Before becoming division vice president, Suarez had led only groups of fewer than 100 people, but by 2008 the division had expanded to 4,000. At Suarez’s last performance review, Billings had asked her to prioritize an overhaul of the division’s information technology capability, and that had not happened. Nor had she addressed the souring of the culture or helped build social networks to the Water Products Division. Perhaps Suarez needed mentoring on scaling and delegation, he mused. Had her new-found wealth lessened her drive?

Billings swiveled in his chair to glance once more through Suarez’s most recent cost report, which indicated that the Solutions Division’s marketing, general and administrative (G&A), and project expenses were 15% over budget. One product, completing its first year on the market, had been forecasted by the subsidiary to achieve $20 million in sales in its first two years. Due to the high number of customer returns, the chances of breaking even now appeared bleak. Billings knew that the core Solutions Division had to be strong for the subsidiary organizational structure to work.

The subsidiaries were supposed to bring energy and focus into the division, not demoralize it and tear it apart. After all, the subsidiaries were still too new an idea for Billings to want to risk his entire future on their successes. So far, Stone Finch had spent $750 million to fund the new subsidiaries. The company stock Billings had used to capitalize the subsidiaries and pay bonuses to the entrepreneurs had had a diluting effect on Stone Finch shares. Billings didn’t expect all the subsidiaries to succeed; but if they did, that would mean a significant number of new Stone Finch shares would have to be rewarded to the subsidiary officers.

While Stone Finch had not had any difficulty raising the sizable amount of new funds it needed, the needs of the subsidiaries had left little new money for investment in the Water Products Division. ?6 BRIEFCASES | HARVARD BUSINESS PUBLISHING Pursuing Growth at Stone Finch Having read the Intranet jam comments, Billings suspected he needed better leadership in the Solutions Division. He wondered if he should develop it from within—or look for it outside the company . Billings returned to his mental checklist of top-priority questions.

How could he build the capabilities necessary to support continued growth, either organic or by acquisition? What did he need to do to manage the contradictions and tensions between the manufacturing and service divisions, while maintaining and improving the performance of the cash cow? How could he regain Eli Saunders’s support within the organization? Further, what kind of changes in the Stone Finch organizational structure and culture were necessary to retain his best people? Now was the time to find answers.

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