Monday, June 8, 2015

Strategic Planning Analogy #552: Dead By 45


THE STORY
A few years ago, I went to a conference on Big Data put on by IBM. The first thing I noticed was that almost everyone attending (other than myself) looked younger than my children (who were in their early 30s).

After a particular seminar session at this conference, one of these young attenders asked the speaker a question that went something like this:

“What do I do about these old people in my company (old defined as over 40) who don’t get it and are don’t want to get things accomplished our way?”

The speaker answered the question something like this:

“I used to tell people like you to be patient. Those old people will be irrelevant soon enough and then you can proceed. But now I see that they are already irrelevant, so just ignore them and move on. Treat them as if they were dead.”

That was not very assuring to people like me, who still think 40 is young.


THE ANALOGY
If you read the literature about the new economy, it is common to find references to the idea that anyone over 45 should be treated as dead. The idea is that if you haven’t made your millions by 45, you never will, so anyone over 45 who hasn’t already made it is irrelevant…they may as well just give up.

You may not buy into this philosophy, but it is common among the many of the key players in the new economy. And since people act based upon what they believe, this belief system is impacting the way the new economy acts.

All strategies work within the context of the environment around them. If you want your strategy to succeed in the new economy, you should consider how the “death at 45” philosophy impacts the context in which you are trying to succeed. If you don’t, death of your business is a very real possibility. You really will become irrelevant.


THE PRINCIPLE
The principle here is that even if you do not want to play by the rules of “Death at 45,” many of your competitors may be. This may cause them to take actions which seem irrational to you and your rules. But it will be very rational based on THEIR rules. And their actions will disrupt your business in ways that will be nearly impossible to deal with unless you get a grip on their mindset.

Therefore, we will first look at how the “death at 45” system works. Then we will see how it impacts the status quo and what the status quo can do strategically in this new world.

The Rules of “Death at 45”
The rules of “Death at 45” are as follows:

  1. The only way to (legally) make it big by 45 is to cash out. You have to transfer the ownership of your concept to someone else who is willing to pay you big dollars for it. That would be to one of three choices: private equity, going public, or selling the business to another, larger business (like selling to Google).
  2. Since there is really only one meaningful transaction (when you cash out), there is really only one meaningful customer (the one you sell out to). All the other transactions related to running your business pale by comparison. They are little more than “proof of concept” examples to show to your one meaningful customer.
  3. The only income statement that matters is the personal income statement (how well did I do when I cashed out). It really isn’t all that relevant if your business model is profitable or even if there is not a clear path to profitability in the future. If you play the game well, even poor business models can cash out at a high price.
  4. Given the weak ties between financial performance and cash out potential, the game is played a lot like the lottery. Both the buyers and the sellers do a lot of transactions because they don’t know which venture will be the big one. Since the best way to win the lottery is by purchasing a lot of tickets, the best way to win by 45 is to pursue a lot of potential cash out ventures. If it looks like the current business model isn’t leading to a quick cash out, either radically change the model or dump it and move on to the next one.
Competing Against Death at 45 Businesses
So let’s say you are an older, status quo company trying to compete against an upstart playing by these rules. They can make your life very difficult, because their rules allow them to play differently than your rules allow you play.

  1. The large, established firm has pretty much already cashed out a long time ago. Without another strong cash out option, the established firm has fewer ways to make it big. It is stuck in the old, slow process of trying to increase sales and decrease costs with a relatively mature model. The new firms don’t concern themselves as much with this, because they have better options.
  2. The potential owners of the “Death at 45” companies aren’t necessarily looking for profits, especially not in the near term. By contrast, the established companies have owners who want to see increasing profits on a quarterly basis. It is very difficult to increase profits quarterly when your competitor isn’t all that interested in making any profit at all.
  3. Even if the established company tries to instill some of the culture of a business start-up into their system, it won’t be the same, because employees in the established firm won’t see as clear a path to their personal cash out potential. Since the big company they work for isn’t on a full cash out path, all that entrepreneurism effort will not reward them as well as it would in working for the right “Death at 45” company.
  4. When you are a tiny start-up, it is easy to radically flip the business model or shut down and start over again if things aren’t leading to a quick cash out. It is much more difficult for a large, established firm to be as flexible.
The increased flexibility and lack of a need to make immediate profits gives the “Death by 45” companies an apparent “unfair” advantage. But fair or not, that is reality.

What to Do?
So what should the established players consider doing to better compete in this environment?

  1. Structure your firm to be more like a holding company. Rather than defining yourself as being in a particular singular business (working in a singular manner), define yourself as a flexible holder of many types of business models and structures which can come and go as needed to be in the right place at the right time. For example, GE has used a holding company approach to effectively flex over many decades. It is now flexing away from lending and flexing towards the Internet of Things. Taking the holding company route will cause you to act more like a private equity firm. It will give you more opportunities to cash out.
  2. Work on changing the profile of your equity holders. Amazon can cause a lot of problems for its competition because its shareholders are less interested in near-term profit than the shareholders of its competitors. Just think of what you could do if you had Amazon-like shareholders behind you.
  3. Play YOUR game. Just as the little guys can do things you can’t do, you can do cool things they can’t do. You have economies of scale, distribution, a brand name, business synergies, people who have a lot of experience, and so on. Play a game that puts THEM on the defensive.

SUMMARY
Although we only scratched the surface of this topic, we have seen that different mindsets will cause you to operate your business differently. Someone operating under the “Death by 45” mentality will have strategies very different from people in older, larger, established firms. The problem occurs when these two types of firms compete against each other in the marketplace. Their different approaches create an unlevel playing field. For example, the “Death by 45” company is less encumbered with a need to make money versus the establishment counterpart.

To win in such a world, it helps to first understand the thinking behind all the players you are competing with. That will help you understand the rules they play by. Second, one needs to find a strategic path that neutralizes the advantages of other mental models while taking advantage of what your position offers.


FINAL THOUGHTS
It is important to remember that nearly all the attempts to make it big by 45 fail. For every successful Google, there are millions of attempts that never make it to the cash out stage. The odds of personally winning with this strategy are extremely low. By comparison, the established firm has much better odds of carrying on.

Wednesday, May 27, 2015

Strategic Planning Analogy #551: You Only Sell it Once


THE STORY
Let’s assume that Bob sells his house for $100,000. A few days later, the person Bob sold it to resells the house for $200,000. Then, a few days after that, the newest buyer resells Bob’s former house for $300,000.

Bob gets excited and thinks, “Wow! That house is more valuable than I thought.” So he re-buys his former house for $400,000.

So, in the end, he’s back in his same house as before, but $300,000 poorer. Yet he is happy because now he feels like he is living in a more valuable house than before.


THE ANALOGY
In the story, Bob is happy when the price of his former house keeps going up. But why is he happy? After all, he did not gain any benefits from the price rising. He still only had his $100,000.

In fact, he should have been angry, because he sold out too low and should have asked for a higher price when he sold it. The resellers got the money which could have been his.

And then he re-buys the house and is happy to pay $400,000 for it. Buy why is he happy to be where he started only poorer?

Buying and selling houses is a lot like buying and selling stock. Let’s change the story so that Bob is a company doing an initial public offering (IPO) rather than selling a house. Let’s say the company plans to issue 1 million shares at $100 per share. So, on the day of the IPO (when the stock is first issued to the public), the company earns $100 million.

A few days later, the people who bought that stock for $100 a share resell it for $200 a share. Then, the people who bought it at $200 a share resell it a few days later for $300 a share. The company is so excited that it buys back the shares at $400 per share.

So now, the company is right back where it started, except that it has $300 million less than it did before the IPO. But it is happy, because the company is valued higher than before.

Although not as dramatic as in the story, this type of behavior goes on all the time in business. The company is happy if the stock price goes way up after an IPO, even though the company never sees any of that gain (and missed out on pocketing some of that gain for the company). And then later, the company is happy to do a share buyback, paying more for the shares than their original price.

What’s going on here?


THE PRINCIPLE
The principle here is that once a company sells its stock, most of the benefits/risks of the future price fluctuations go to someone other than the company. In general, the company’s cash flow is not impacted much by what happens to the stock price after it leaves the company’s hands.

When the stock price goes up, the company may feel wealthier, but where is the immediate impact on cash flow? It hasn’t changed. The only one who gained was the second party selling to the third party.

Therefore, strategy should be more concerned with actions that meaningfully impact the cash flow than merely focusing on every little tick of the stock market price.

One Way Relationship
In general, if you pursue a strategy which raises the company’s cash flow with costs below the cost of capital, the company is stronger for the long term and the stock price goes up. But the reverse is not always true. If you play games and tricks to boost the stock price, cash flow does not necessarily increase and the company’s long-term prospects may be worse.

Take, for example, the idea of borrowing money to buy back stock. This typically results in less cash flow, a weaker balance sheet, and less freedom to pursue long-term growth strategies. That doesn’t sound good for the company.

So, why do them? Who benefits from those types of buybacks? It’s the people who bought the stock many transactions past the IPO and did not contribute anything directly to the company in terms of cash flow. Just as Bob got no benefit from the second and third buyer of his house, companies get no benefit from the second and third buyers of their stock. So why pursue strategies that hurt the company and only benefit these people who contributed nothing to funding the business?

The IPO Swindle
And then there is the IPO. Companies set them artificially low and get excited when the stock jumps in the following days. Why are the companies so excited? Just as Bob got no financial benefit when his house kept reselling for higher and higher prices, companies get no cash when subsequent trades raise the stock price.

In fact, the company has a greater justification to be upset when the price jumps a lot after an IPO, because that means they didn’t get as much cash from selling the stock as they could have in the original IPO. The only ones who benefit from the rapid post-IPO rise are the investment bankers and the stock re-sellers. The company is no wealthier.

Years ago, I worked on an IPO. When the investment bankers showed me their suggested IPO price, I almost choked on the numbers. It was far, far, lower than the value produced by my fancy spreadsheets. I told them we could go a lot higher and still leave room for the initial investors to have gains.

The investment bankers tried to intimidate me with academic papers full of arcane words and long formulas which they said “proved” that the price needed to be so low. But those papers had nothing to do with the issue at hand and they did not intimidate me, so I kept fighting for a higher price. I lost the argument.

After the IPO, the price jumped a lot. If the company had listened to me and used my suggested price, they would have gotten a lot more money and the initial investors would still have seen a gain.

We all know that the primary reason the investment bankers wanted a low price had nothing to do with those academic papers. It was because the investment bankers (and their investing clients) personally had more to gain if the price started out low. If the investment banker can get a company to do an IPO at a lower price, then they pocket some of that gap rather than the company.

Excuse me, but don’t the investment bankers work for the company? The company does not work for the investment bankers. The company needs to look out for its own interests first, not those of the investment banker.

I was so happy when Mark Zuckerberg fought to get such a high price for the Facebook IPO. Zuckerberg made sure that Facebook got the highest benefit from the IPO, not the subsequent traders or the investment bankers.

Where to Point the Strategy
So given all that was said above, it appears that strategic efforts should not be laser focused only on stock prices. Your business mission should not be “to create the highest possible stock price.” Yes, higher stock prices may benefit someone, but it is not always the company which benefits. Why focus on a strategy which primarily benefits people who contributed nothing to the cash position of the company?

Instead, the strategy should be looking at ways to improve the performance of the business model. If you do that, then pretty much all stakeholders benefit, including (and especially) the company.

This is consistent with the thinking of Warren Buffett and his company Berkshire Hathaway. They don’t try to make their money on constant trading and stock price manipulations. They just try to run good businesses for the long haul. The businesses benefit, and because the businesses are better, the shareholders benefit.

Yes, this is a rather simplistic argument. There are many nuances which go deeper than allowed in the space of a blog. But I still stand by the primary direction of this line of reasoning.


SUMMARY
When a company’s stock goes up and down, the primary loser/gainer is not the company. After all, the company got its money when the stock was first issued at the IPO. That amount does not change based on subsequent trading. Consequently, strategies which only seek to raise stock prices (at any cost) may not necessarily benefit the company (and its long-term viability in producing a cash flow). Therefore, the preferred approach would be to create a strategy which seeks to improve that long-term viability to create a cash flow. That would provide a greater likelihood that not only does the stock go up, but the company benefits as well.


FINAL THOUGHTS
The biggest risk to putting the company first is that there are activist investors out there who want to put themselves first and will intervene to do so. To keep the activist investors at bay, you may need to give a little. Just don’t give in. Better yet, if you focus on running your businesses as well as Berkshire Hathaway, then the activists will have little opportunity to intervene.

Friday, May 15, 2015

Strategic Planning Analogy #550: Adapt Our Strategy


THE STORY
I knew an executive who got a big bonus because he hit all his numbers. Unfortunately, he hit his numbers by totally ignoring the strategy.

His strategic mandate was to spend a lot of money converting his division to a radically different position—one more suited to the future. Instead, he did not spend that money, so it fell down to his bottom line, making his profits far higher than the goal.

Unfortunately, because he did not reposition the division, it was no longer able to succeed in the marketplace. In the following year, losses were huge and the division was sold at a huge loss. The division was destroyed, but the executive got to keep his big bonus from the prior year.


THE ANALOGY
Execution is important in business. But not just any execution, just execution which leads to strategic success.

In the story, the executive executed in a way which maximized his bonus. However, that execution also destroyed the business.

Although this example may be extreme, it is common for corporate strategies to not get properly executed, even though there are mechanisms in place to encourage right behavior.

Hence, it is not enough to just focus on getting the strategy right. One must also make sure the strategy is executed properly.


THE PRINCIPLE
The principle here is twofold. First, without proper execution, a strategy is fairly worthless. Second, the traditional business tools of execution are not working. As a result, strategies are failing.

These findings were discussed in the March 2015 issue of the Harvard Business Review. The article, by Donald Sull, Rebecca Homkes, and Charles Sull, was titled “Why Strategy Execution Unravels—and What to Do AboutIt.” They started by looking at a study of 400 CEOs who said that their number one challenge was “executional excellence.”

The authors then did their own research and found out that most companies were doing a pretty good job of implementing the standard tools of execution. These included things like translating strategy into objectives, cascading those objectives down the hierarchy, measuring progress, and rewarding performance. More than 80% of managers surveyed said that their goals were limited in number, specific, and measurable and that they had the funds needed to achieve them. Yet, in spite of this, good strategic execution eluded them.

The authors then did further research to figure out what was going wrong. Here’s where the article started to get a bit murky and meandering. As a result, I took their findings and repackaged them into something I feel is more actionable and easier to understand.

Wrong Definition of Execution
First of all, the authors found that businesses had the wrong definition for execution. In its simplest form, I would say that the definition used by businesses to define execution would be “Hit My Numbers.” The idea was that if the strategy was successfully cascaded down into individual numerical objectives, then if everyone did their part and hit their numbers, everything would be okay.


Unfortunately, that is the wrong definition of execution. I think a better definition would be “Adapt Our Strategy.” As will be seen below, by changing these three words, we get closer to the root of the problems in execution and pointed in the direction of how to fix it.

1. Priortization
There is only so much a person can do on top of their everyday responsibilities in order to execute a strategy. Therefore, one needs to be clear on what is most important to focus on for execution. Priorities must be made. In the old definition, the priorities would focus would be on specific numbers (hit the NUMBERS). Instead, the definition should be focused on specific strategic outcomes (adapt out STRATEGY).

The article (and my experience) find several problems with the numbers focus, such as:

  • There are usually way too many numbers to hit, coming from too many different sources, including the everyday non-strategic numeric goals, all jumbled together.
  • People usually do not understand the linkage between the numbers and the strategic intent, so they aren’t sure how to achieve the numbers in a way that advances the strategy. Hence, they could find ways to achieve the numbers without achieving the strategy (as we saw in our story). In fact, effort to achieve the numbers can become effort taken away from execution of the greater strategy.
  • Numeric goals tend to get frozen in time and not get adjusted to changing conditions in the marketplace. Hence, they eventually become out of step with what you really need to accomplish.
  • Too much focus on numbers can lead to micromanaging and locking down on the minutia rather than trying to achieve the big picture.
By contrast, if you focus your priorities more on the strategy and strategic outcomes, you are more likely to properly execute the strategy. This is a focus on what the company is supposed to look like in the future—what it stands for, how it is perceived, what products it delivers, what its position is, and what are the right trade-offs to make with limited resources. These should be the priorities, and they can be measured. This moves the management from number chasing to building a winning formula for success.

2. Agility
In an ever-changing and dynamic world, a rigid process is your enemy. Unfortunately, the current state of execution principles tends to be rather rigid. Budgets get locked down; personnel get locked down; numeric goals get locked down. People are rewarded with promotions and bonuses based on their ability to hit what is locked down rather than their ability to adapt to the environment.

In fact, being agile and adapting is practically punished, because it upsets the rules of execution. You are no longer sticking to the script; you are changing the rules of engagement. It is risky for your career to be agile, because you are no longer in lock step towards hitting the numbers.

Yet, without agility, it is impossible to effectively execute a strategy in today’s environment. Therefore, it should not surprise us that our rigid process is hindering our execution.

The HBR article found two main problems with the rigid process. First, it caused adjustments and adapting to come way too slowly. Slow reaction can lead to strategic death today. Second, because there was no mechanism for incorporating change into the system, there was no way to ensure that the changes moved in the direction of the strategy.

Shockingly, the authors’ studies found that 51% of the executives said they could find financing for projects outside the scope of the overall strategy. In other words, change was not linked to strategic objectives. Over time, hundreds of these little exceptions to the “official” strategy become the de facto strategy. After all, your strategy is the result of what you do, not what you say. So if your change mechanism allows you to do anything, you strategy becomes “do anything.” No wonder execution of the stated strategy is so hard to come by.

The solution is to first build agility into the process. Encourage it; reward it. Second, keep agility from turning into anarchy and randomness by building mechanisms into your execution process to ensure that the changes bring you closer to your desired strategic outcomes rather than further away.
In other words, instead of focusing on “HITTING a number,” which implies attacking a fixed location, focus on “ADAPTING our strategy,” which implies agility in order to get closer to achieving one’s desired strategic outcome.

3. Cooperation
The authors found out that the current state of execution processes are pretty good at getting activities to work properly within a particular bureaucratic silo (the vertical dimension). Unfortunately, they tended to fail at getting cooperation between silos (the horizontal dimension).

Unfortunately, excellence in strategy execution requires horizontal cooperation. This issue needs to be fixed. Part of the problem is that we have done such a good job of targeting the numeric goals at what the individual silo can control, that we have frozen out cross-functional accountability.

People get rewarded for hitting THEIR numbers. Since they are not collectively OUR numbers, we tend to ignore the issues of other silos. Some experts may argue that you shouldn’t hold people accountable for things not totally under their control. My counter to that argument is that there is no better way to foster cooperation than to make it impossible to hit a goal unless you cooperate with others. We have to move the mindset from reaching MY goals to reaching OUR company’s desired outcome.

When you broaden the prioritization from individual numbers to corporate outcomes, you get people focused on the big picture—the overall strategy. Is it no wonder that we get poor execution on the overall strategy when all the individuals are working on optimizing something else? Hold people accountable (at least in part) for the big picture. You’d be amazed how much influence people have on other silos when their personal success is dependent upon it.


SUMMARY
Poor execution can make strategic planning useless. Therefore, we need to focus more effort on getting the execution right. The problem with the current state of the art in execution is that it:

  1. Doesn’t get the proper priorities understood or adapted out in the field;
  2. Doesn’t allow for the flexibility to adapt to the changing environment in order to meet the strategy; and
  3. Doesn’t sufficiently encourage cross-silo (horizontal) coordination.
To rectify these problems we need to redefine execution from “Hitting My Numbers” to “Adapting Our Strategy.”


FINAL THOUGHTS
Next time you see someone get a fat bonus check, look to see if the company’s strategy was also rewarded.

Thursday, May 14, 2015

Another Free Book

I just got my 8th book converted to the EPUB format, so it can be read on multiple ebook devices. Actually, its my first book, called Fast Forward. I've updated some of the content for this edition. You can find it here.

You can find all 8 of my books in the new format here.

Wednesday, May 13, 2015

Free Strategy Books




I recently updated the content of seven of my books on strategy. In addition, I converted them into an EPUB format so that they can be easily read on a variety of electronic devices.

You can find these ebooks to download at lulu.com: http://www.lulu.com/spotlight/geraldnanninga

And the best news is that I am offering them for FREE (At least for now).