Wednesday, August 20, 2008

Analogy #200: Stakeholders as Customers


THE STORY
I can pretty much determine the beginning of my total disenchantment with government. It was 1991. The Senate Ethics Committee was investigating the “Keating Five,” five senators who were under suspicion of ethics violations. These five senators were accused of corruption by improperly interfering with an investigation by the Federal Home Loan Bank Board (FHLBB) into the demise of Lincoln Savings and Loan.

Charles Keating, CEO of Lincoln Savings and Loan, had given large campaign contributions to these five senators, only one of which represented the state of California (where the S&L was located). When his savings and loan got into trouble, he asked these senators to intervene to get the FHLBB to stop investigating him. Three of the five Senators did actively try to interfere with the investigation and improperly protect Mr. Keating.

In the Ethics Committee investigations, the five senators were asked why they had gone to such extreme levels to protect someone with such questionable behavior. The five senators all tended to answer in a similar manner, saying that they were “only trying to help one of their constituents.”

Constituents?? The dictionary defines a constituent as “a resident of a district represented by an elected official.” When did the CEO of a California Savings and Loan become the constituent of a Senator from Ohio? I thought the constituents of a US Senator from Ohio would be voters in Ohio.

Yes, Mr. Keating helped fund the election of a number of politicians, including an Ohio Senator, but I thought that made him a source of capital—an important partner, not a constituent.

So, I guess I live in a nation of representative government, but the government does not represent the people of the voting district, but the suppliers of money, wherever they come from.

THE ANALOGY
It seemed to me that the senators had crossed the line. They had forgotten who their true customers were. I believed they were elected to serve the region that elected them. These senators in essence said that they were elected to serve the interests of the ones that funded them.

They showed no shame or embarrassment about this. They just thought of funders as constituents.

While I agree that politics runs on money, I draw a line between funding and electing. Those that fund the politicians may be important partners in the process of government, but they are not the customers.

Others would say this is a naïve approach, and that good politicians must balance their ability to serve two masters—the ones who elect them and the ones that fund them. Both are constituents (or customers).

A similar situation occurs in business. Businesses need outside funding to effectively achieve their strategy. Some of that funding is in the form of debt and some is in the form of equity. Although your shareholders and creditors are important partners in the game, they are traditionally not seen as customers. The customers are the ones who buy things from you.

But now there is a school of thought that businesses should treat the people who fund them as customers, too. To think otherwise may be naïve.

THE PRINCIPLE
The principle here is that in today’s modern world of business funding, we may need to make room for two customers—the ones who buy from us and the ones who fund us.

Wait a minute! Isn’t that what got us into trouble during the dotcom bubble? All the dotcom entrepreneurs at that time were so busy courting the venture capital money sources that they forgot to create a compelling business model for an ultimate consumer. Instead, the capital sources became the “customer” that got all the sales pitches. When they got funding, that was treated like making a “sale.” Ultimately, that model blew up, because you eventually have to earn your keep by selling something to a real customer at a profit.

Well, according to an article by the folks from Booz & Co., times have changed. The article, entitled “First Capital, Then Strategy,” claims that supply and demand are what have changed. Authors Seamus McMahon and Michael McKeon, both Booz executives, say that sources of capital (debt and equity) have become scarce, whereas great strategic ideas are fairly common.

The scarce capital sources have become more demanding. Rather than passively investing and waiting, they are demanding—with a very short-term time horizon. It’s a “deliver results now, or I’ll take my money elsewhere” environment. In addition, these sources of capital are taking more active roles in the companies where they invest.

Hence, the article concludes that if you want some of their money, you have to do two things:

1) Woo them like you would any other customer in order to get them interested in you.


2) Satisfy their desires, just as you would satisfy the desires of any other customer. In this case, that means giving into at least some of their demands for short-term gains.

Of course, here is the dilemma (with business and with that article). Many of the tactics these sources of capital want to you to do are in direct conflict with your long range strategy. Case in point: One of the pillars in the success of Southwest Airlines has been its aggressive activity in locking up long-term jet fuel contracts at favorable prices. This has protected them from the recent rapid rise jet fuel prices.

Well, now some of those short term thinkers wanted Southwest to make a killing by reselling those contracts at a fat profit. Of course, Southwest’s response was that if they sell off the contracts, they will have destroyed their successful long-term business model. Sure, they could make a great near-term profit once by selling off those contracts, but it would destroy the ability for Southwest to be a profitable airline into the future. Destroying an entire business forever just to get one “great” transaction looked like a bad bet to Southwest.

But the sources of funds often don’t care about long-term prospects. As long as they can find a long continual string of short-term gains, they are okay. The trick for the funders is to keep shifting the funding from one short-term gain company to another.

So you see, the strategy of the funders is not always in sync with the strategy of the businesses. Business strategies typically look for longevity of prosperity for the company. Funders often look for one-time boosts regardless of long-term prospects. Their long-term prosperity comes from finding a continuous stream of different companies to get a boost from.

So the trick here is balance—a balance between your needs and their needs. The goal is to find a way to give into the funders just enough to get that funding. In other words, if you give them a little bit of a short-term boost, they may be more willing to support some long-term initiatives.

So, instead of thinking of your funders as the primary customer (as in the dotcom bubble), or thinking of them as a silent partner (when sources of capital were abundant), we need to think of them as another customer along side of the customers who buy our goods and services.

Think of it like traditional consumer segmentation. Different consumer segments want different things, so you build a portfolio of solutions to cater to the diverse needs. Your sources of funds are just another consumer segment for your company. Add a solution for them to your mix.

It may dilute your long-term strategy a little bit, but it allows you to get at least some funding for your strategy, so that you can live to fight another day. And it may be a little bit distasteful, like my feelings about how politics get funded, but it may be the price we need to pay until the supply and demand equation changes.

SUMMARY
It appears more important than before that a long-term strategy needs to include a strategy for how to obtain funding. Since these sources of funding have different needs, you need to create a strategy which incorporates a way to satisfy at least some of those needs. The trick is to build a strategy where you satisfy their needs without completely sacrificing your own needs.

If you don’t think all of this through in advance, you may end up caving into all of the wishes of the capital sources. This may make them rich but leave you with a bankrupt future.

FINAL THOUGHTS

Just as all customers are not alike, not all sources of capital are alike. There are some sources of capital which are more long-term oriented and may have desires more in sync with your long-term strategy. It may be worth your while to spend more time looking for (and courting) these types of sources.

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