investiledysfunction

I had dinner with a good friend who works at a hedge fund this past week, and after we discussed the markets and our views on where things are going (sorry we didn’t come up with an answer), he made an interesting comment that struck me.  He felt that this downturn may be a good thing for the US economy for the long-term.  His logic was pretty simple.

• A lot of very smart people over the last many many years moved into careers in finance because it was lucrative and was seen as a path to quick riches.
• Back in the day, there was a similar belief about becoming a doctor for instance but it was not a “quick path” but one that existed for the best and brightest after many years of hard work.
• With this being a potentially protracted downturn, some of the current and many more from the next generation of smart people may go back to pursuing careers which in his words “are not just about trading paper”.  This means more innovation, entrepreneurship, etc from smart people trying to solve real problems.

I found this perspective quite interesting coming from someone in the hedge fund world - especially someone who is successful at it.  I also agree with him. Finance companies (banks, hedge funds, etc) have had a voracious appetite for PhDs and smart people in general who’ve helped them build complex derivatives and the like.  This downturn/recession may mean less of these people are inclined to go into or stay in finance and if this happens, they may look elsewhere, e.g., in science and math disciplines either with employers or in research organizations (mainly universities).  This is a good thing as it can lead to ideas and innovations that drive the next great wave.

I’ve seen this migration to finance firsthand.  I graduated from the Jerome Fisher Program in Management & Technology (M&T) at the University of Pennsylvania which is a dual degree program between Wharton and Penn’s Engineering school.  As I’ve met alumni from the program over the years, it has become apparent that fewer and fewer of us went down the engineering route in our careers (I’m guilty on this count).  The early graduates of the program were more likely to have worked in engineering fields for at least some time while with the more recent grads, most have sought to go down the business (especially finance) with a belief that their training from engineering would always be valuable.

It’s obvious that these types of attitudinal and structural shifts don’t happen overnight, but if some small segment of the smart people who previously pursued careers in the world of finance move towards entrepreneurship and innovation, this is a good thing for us in America as well as globally.

This doesn’t mean the finance types go away nor should they.  Someone will have to extend credit and funding to these entrepreneurs, right?

I remember when I was younger (much younger), I’d wake up on Sunday morning excited to watch WWF wrestling (now WWE) only to find my dad parked in front of the TV watching Meet the Press or something that I found utterly mundane.  But it seems that I’ve outgrown my fascination with the figure-four-leglock and the camel clutch (former WWF fans will understand those references) and now I’m watching the boring stuff on Sunday mornings.  This morning, I was watching “This Week With George Stephanopoulos” (herein referred to as GS) with many guests including Robert Rubin and Newt Gingrich.  (Please note: as is fashionable these days, this is a ‘bipartisan’ post)

Newt Gingrich and Robert Reich were guests on GS’ show and these two agreed (shocking) that the US government needs to differentiate between expenses and investment.  They argued that investment occurs in improving infrastructure, education, alternative energy, etc while there are expenses which keep the machine running.

They were discussing investments vs expenses in the context of the government.  Yes - you read that right.  So let me explain why this is important.

Brilliont did an analysis of the 800 large and mid-cap companies which found that those who increase investment (expenditures in marketing, R&D, innovation, sales, etc) and minimize expense (general & administrative, IT infrastructure, etc) outperform their peers.  Basically, investing in those things that help the organization attract and retain customers and compete more effectively/efficiently is a good thing.

The key point here is that not every dollar that goes out the door is the same.  Some are strategic and create value and some are non-strategic.  It really is that simple.  Unfortunately, our accounting and treatment of these dollars is all too often not nuanced enough, and every dollar is the same.  This lack of understanding of expenses continues today in corporations which generally have more enlightened or progressive practices than government bodies given the short-term accountability they generally have and their inability to print new money.  So as you can imagine, this type of understanding within the government based on our experience with the public sector is quite rare.

Although Reich and Gingrich’s discussion was only on a talk show, I can only hope that the government (as well as corporations) starts to understand the difference between investments and expenses.  Investments may take some time to pay dividends but when thinking about the long-term, they are very important.  They’re the thing that ensure you have a long-term.  Investments (strategic expenses) need to be maximized and expenses minimized.  This is where the public sector at all levels can take a portfolio approach to its expenses and really improve decision-making and the outcomes they achieve for the constituencies they represent.

Hopefully, this type of understanding can move past talk and begin to impact decision-making within the government.

With technology development becoming cheap, it seems everyone is churning out a new web application (or app for the cooler amongst you).  And to be honest, most of them are cr^p.  Beyond the web app, it is now requisite soon thereafter to develop a Facebook and iPhone app as well.  The underlying premise behind this is I presume is that if you make a cr^ppy application ubiquitous, people will somehow like it.  This is from the same school of thought as a startup I once worked for called Kozmo.com which lost money on every order but figured they’d make it up in volume.  The logic is warped but who needs logic?  I certainly didn’t when I was at Kozmo.

So what’s wrong with this?

In some instances, nothing is wrong with the lack of logic.  When it’s a couple of guys in their dorm room or garage who are putting things together, this is fine because the opportunity cost to them of spending time on this is probably a few less games on their X-box.  These guys are tinkerers, and this is actually a great thing which should be encouraged.  My money is on the fact that they’ll learn some stuff and keep rolling it into bigger and better ideas down the road.

The problem is with those ideas that raise some money or that a founder or two go “all in” on which have no business model and/or where they are addressing a problem that is just way too small, e.g., the market opportunity is not that big or already way too crowded.  Any number of social networks, iPhone or Facebook apps or software as a service/cloud computing, etc upstarts today fall into one or multiple of these traps.

And then sometimes, you come across an idea that is exceedingly simple but which captures your attention and might even have an outside chance of becoming something of some scale (even though the business model may be a bit uncertain today).    In this camp is a new company called Sidetaker.

1. A husband or wife (or boyfriend/girlfriend) posts a complaint they have with their significant other
2. An email goes to the significant other for them to respond
3. After they have responded, the public weighs in with advice, commentary, etc.

So for example, wife puts up a post about how husband fails to put down the toilet seat.  Husband responds and then the public weighs in with advice or commentary.  It can range from ideas that have worked for others in similar situations to making fun of the neanderthal husband.

At this point, the site is focused on getting people to put up their sides, but they do offer some digital ebooks on marrying millionaires, relationships, etc which those coming to the site might enjoy and which might make some money for the Sidetaker team.  It seems they’ve thought of some ideas to monetize (remember that word) the traffic they’re getting but of course, the first goal will be to generate a community of SideTakers.

This taps into a need people have that will never end and which uses technology intelligently and elegantly to solve.

• People have problem in their relationships
• Others love to give advice
• Being a voyeur into someone else’s life is very popular (especially on the web)

The one deficiency is that this concept is not too hard to replicate, but people said the same for Craig’s List and they’ve doing well despite efforts by eBay, Google, Yahoo, etc to unseat them.

At some point, Sidetaker can take all their user-generated advice and become the WebMD of relationships or the goto place for online marriage counseling (a multi-billion industry based on the # of relationship self-help books and marriage counseling providers out there).  Of course, the site might just be a fun diversion for its founders, but here is one web app that I think could go somewhere with the right focus.  Time will tell.

I’ve previously talked about Kraft, P&G, Wells Fargo, Pernod and others whose CEOs have jumped onto the organic growth bandwagon.  Add to the list private equity companies.  Yes, those soulless, blood sucking private equity types who supposedly want to fire everyone in the name of the almighty dollar (or Euro or whatever) actually do care about company performance, and many are actually quite good at driving it according to a new study.  And the centerpiece to their work is good old organic growth.

The September 2008 issue of CFO Magazine has an article entitled, “Let Us Now Praise Private Equity” by Kate O’Sullivan which discusses a new study by Ernst & Young.  Ms. O’Sullivan writes:

“Often viewed as hard-hearted financial engineers who pile up profits by slashing expenses, P-E kingpins are criticized for their lack of transparency, their much-debated tax status, and, of course, their lavish lifestyles. But a new report offers support for the same case that P-E bosses often make for themselves — namely, that they are not only shrewd investors but also talented managers.”

John O’Neill, Americas director of private equity at E&Y, goes onto comment that “We found that probably only a third of that growth is from cost-cutting.  More than 50 percent is organic growth, and the rest is acquisition-related.”

Let’s do the math on that 50+% from organic growth, 33% from cost cutting and less than 12% from acquisitions.  It seems from the numbers that private equity managers know what the heck they are doing and understand that driving efficient organic growth is key to driving value.  And the numbers prove out their reliance on organic growth is well-placed.

“Private-equity-backed businesses outperform public companies in productivity gains, in employment growth, and in business expansion, measured both in terms of enterprise value — the company’s market value plus net debt — and earnings before interest, taxes, depreciation, and amortization” (quoted from the article)

It seems some of the savviest buyers of companies know that organic growth is the way to go.  When will others see the light as well?

When working with clients and helping them set up their innovation efforts, there is invariably a checkpoint with the in-house counsel (lawyers) especially in the largest firms.  And when the innovation efforts involve, as they should, getting ideas from around the organization, the legal teams often put together legalese which effectively says that anything that people within the organization come up with (ideas, prototypes, etc) is the intellectual property of the firm - no ifs, ands or buts.  Most of the times, people might not even read these terms & conditions before submitting so the company may think it’s not a big deal, but people who really have good ideas will read these because they’re smart.

And so while we sympathize with and understand the need for protecting oneself, the simple fact is that this legalese often goes too far and so becomes counterproductive to fostering innovation.  I’ll explain first what we’ve seen and then share examples of how Cisco and P&G handle this and the results.

The logic for not putting these legal shackles on idea generators is pretty simple.  In its worst form, people with really good ideas will not submit them.  Or another troubling consequence is they’ll be demotivated after they do.  Or perhaps they’ll leave.

In one instance at a client, we knew a very smart mid-level executive with a great idea (and awesome potential) who didn’t submit his idea.  His response when asked why:

“Why would I?  The odds are that the company is not going to select it, but because the intellectual property is owned by the company, I can’t do anything with it down the road.  And even if they do and make a lot of money off of it, I won’t get credit because I may not get to work on it or some senior person will own it.  And I’m not giving a multi-million dollar idea for a pathetic extra $10k in my bonus.”

This sentence may make someone in the General Counsel’s office smile.  For those who are corporate drones, you may also feel that this person is being selfish and not doing what is in the best interest of the organization.  But for managers and executives living in reality and seeking innovation, this should make you cringe.  Why?

• You lost out on a potentially good idea
• The organization’s ability to select good ideas is being questioned
• You’ll likely lose this entrepreneur (intrapreneur as we’ve heard them called) at some point because they’re demotivated
• You’re rewards (recognition and financial in this case) are not aligned with self-interest of individuals submitting ideas

None of the above is good.  Sure you may have lots of other ideas that did get submitted, but you’re not interested in the volume of ideas.  You’re interested in the “goodness” of a few ideas in most cases.

So how do you try to solve this innovation trap?  It requires being open first and foremost.  With all the talk these days of open innovation and collaboration, this type of legal heavy-handedness is counter to such efforts.  It also requires you to consider what will make your best people develop and submit their best ideas.  This comes down to “enlightened self-interest”.  Your best innovators want something in return.  There is NOTHING wrong with this.  You scratch my back and I’ll scratch yours is what this is about.  Anyone who is just doing things out of the kindness of their hearts is not someone capable of coming up with good ideas - they’re just fools most likely.  The best people are interested in recognition, money, status, power, flexibility, freedom, access or any combination of these - and sometimes they want all of them.

So how do you appeal to people’s enlightened self-interest?  Let’s explore how three very innovative companies have done this - P&G, Cisco and Google.  Interestingly, they all do this in different ways.

P&G lets idea submitters take ownership in the ideas they submit.  This means they not only can work on the ideas but if the idea does very well, they can be rewarded for it as owners.  This lets you be an entrepreneur within a large company setting.  This is something that people with the entrepreneurial itch find difficult in large organizations but P&G’s program helps foster this.

Cisco lets some of its best people get absurdly rich to keep them by developing “spin-ins”.  To keep his star salespeople and engineers after some mass layoffs, John Chambers, CEO, did the following according to Forbes Magazine.  “Soon after the mass layoffs a few star Cisco players, who might otherwise have left, were given $84 million to start a data storage firm called Andiamo.  The company grew to about 300 employees in a year, at which point Cisco, its only customer, agreed to buy the company for $750 million.”

They did this again in August 2006 when they backed Nuova with $50 million and then bought them in April ‘08 for $678 million.

This isn’t to say spin-ins are without their perils as former Cisco employee Jayshree Ullal alludes to. “Spin-ins are a creative model to accelerate innovation and bring in engineers you couldn’t normally recruit - and financial gains go to entrepreneurs, not venture capitalists.  It’s a nightmare when the guy in the next cubicle is a multimillionaire and you aren’t, because you weren’t chosen.”  (quote from Forbes)

Like any effort in the corporate world, not everyone will be happy.  But if such efforts can foster innovation and push the company in new growth areas they weren’t in before, these hurt feelings may just be a natural and required consequence to achieve an end-goal.

Yet another way to foster entrepreneurship within an organization is Google’s Founders Awards.  Per the New York Times, “The first two Founders’ Awards consisted of restricted stock that was worth $12 million stock when it was awarded last November to two teams of a dozen or so employees each.”

So even when there may not be as much upside in Google’s stock, employees can get paid handsomely for making innovation and entrepreneurship happen.

Moral of the story:  Control your lawyers and ensure you’re appealing to your employees enlightened self-interests.

In this recent interview from Business Finance Magazine’s Sept 2009 issue entitled, “The Serial Transformer“, Gary Crittenden, CFO of Citigroup, talks about his efforts to transform the finance organization at Citi.

He touches on many critical points about Finance Transformation which we help organizations with including corporate portfolio management (Investment Optimization), reengineering and driver-based planning.  Some relevant excerpts are below, but I recommend reading the entire article for those interested in creating a strategic finance organization and who are looking for ideas and a high-level gameplan from somebody who has successfully done this before in other organizations.

Gary led such a transformation for American Express Finance which transformed the organization into one of the most respected and strategic finance groups in a large organization.  American Express Finance has been discussed and chronicled by the Harvard Business Review, CFO Magazine, and the CFO Executive Board to name a few.

(shameless plug: Gary also wrote the foreword to my book - more info here)

Here are a couple of noteworthy excerpts:

On Selecting the Best Projects and Investments Using Investment Optimization

“…We think very carefully about every dollar that gets added back that offsets the reengineering.

This process is called investment optimization. We go through and look at the expense dollar optimization and ensure that we have a common definition for expenses across the company. I’m talking about the end-state now — not where we are, but where we’re headed.

In a company that is this large and this complex, even getting the definitions common is important so that somebody who is making an investment in a fixed income trader in, say, Brazil has the same financial metrics, terminal value, and present value calculations.

This is a big part of what has to happen as part of this process. But once you have this, you can then align those opportunities and say which one you prefer. You also know what’s on the margin — what the 20 last things were that I approved that would have the least impact if I had to cut them. You also know what the 20 next things are that you would approve if you had some dollars. And if you’re constantly updating and reforecasting, then you’re always able to ask yourself the question, “Do I need to cut or can I have the opportunity to add?”

On Driver-Based and Rolling Forecasting

“It ties back into this primary thing, which is that we’re trying to drive the performance of the business. There are several different elements to it.

One is to have a rolling forecasting process so that you’re always looking further ahead than you normally would. The way this starts for us is with a strategic plan that looks at a couple of years. This then turns into an annual plan, and then the annual plan gets refreshed each quarter, out for that quarter plus then the additional six months on the end of that, and then we update this twice a month as part of our normal process.

We’re always looking forward and doing a normal update to this. Now, if you’re going to be updating this frequently, you can’t do it from a bottom-up basis. You quickly conclude that you have to use the primary drivers of the business as opposed to the detailed, kind of bottom-up forecasting. It turns out, paradoxically, that doing this is just as accurate as the bottom-up forecasting. In fact, you probably get more accurate data because you’re doing it a lot more frequently.”

A good friend of mine runs a large distribution company, and they’re approaching that stage of going from a mid-market company to large-market company.  And with this growth comes some fun moments that he and I joke about.  Two recent gems he mentioned to me included:

• The company was paying interns overtime so they could analyze their overtime expense
• A mass meeting tomorrow to let people know that they’re no longer going to have mass meetings in favor of smaller ones

While this might make you think of Michael Scott of The Office, the interesting thing in this case is that unlike most companies, my friend’s company is doing things to understand and ultimately reduce unproductive complexity.  In the vast majority of instances, things like meetings or overtime expense become part of corporate culture with little questioning as they become considered “business as usual”.  When you hear or think those three little terms, you know there may be a problem.

Of course, just having a meeting or analyzing overtime isn’t enough.  Ultimately, you’ll have to take steps to improve the situation.  But diagnosing the problem is important, of course, before prescribing a solution.

I’ll leave you with one of Michael Scott’s greatest quotes - “You may look around and see two groups here; white collar, blue collar. But I don’t see it that way, and you know why not? Because I am collar-blind.”

We’ve seen Kraft, P&G, Pernod and many other companies in the recent past get on the organic growth bandwagon as they’ve also realized it is the least risky and most coveted by investors.  Our analysis of organic growth efficiency of the S&P 500 over the period from 2002-2007 actually reveals that companies with higher organic growth efficiencies also are rewarded with better shareholder returns.

To that list of the enlightened, let’s add Wells Fargo.  John Stumpf, Wells Fargo’s CEO, states this in no uncertain terms in the August 25th issue of the Financial Times when questioned about doing a mega-deal.  He states, “We don’t need to do a deal.  Organic growth is the core growth engine in this company.”

He later added, “We come from a culture where bigger is not better.  You get bigger by being better, you don’t get better by being bigger.”

Mr. Stumpf hits on organic growth in a practical way and also rightfully disparages the size matters credo which has especially infested financial services.  That said, Wells Fargo is no stranger to acquisitions, but it has tended to do smaller, regional deals which it can fold in to existing operations.

The increasing push and discussion around organic growth is one that we find heartening.  If companies invest in measures to improve their organic growth capabilities, we’ve seen that the numbers paint a very good story.

I’d previously written a post about liking the actions of Kimberly Clark’s CIO Ramon Baez who was trying to take jargon out of the IT culture at the company.

Well, Mr. Baez continues to push things as detailed in a recent blurb in BusinessWeek entitled, Techie Charm School.  The brief article describes some of the actions he’s taking:

“The day of the nerdy tech guy may be past at Kimberly-Clark, which recently ran a finishing school of sorts to teach its IT team the finer points of corporate interaction. The two-day seminar was the culmination of an IT reshuffle that started about a year ago in which the company outsourced 80% of its tech needs. The 800 or so surviving code crunchers and software specialists were handed a new job description: Bring IT knowhow to business problems. There were pitfalls aplenty. The techies had to learn to think strategically and speak a foreign language: jargon-free English.

At first, “attrition was high,” says CIO Ramon Baez, but most made the transition. The July seminar, including tips on relationship building, topped off the training. Baez says his newly burnished tech team is solving shipping problems and forging ties with retailers. And dressing better. “Some days they even wear sport jackets,” he says.”

The attitude shift Mr. Baez is promoting is refreshing.  If the dress code changes signify that attitude shift is occurring, good for Kimberly Clark.