Wednesday, September 23, 2009
Let’s say I had some land I wanted to sell. I could put one of two “For Sale” signs on the land. The first option is a sign that says “Farm Acreage For Sale.” The second option is a sign that says “For Sale: Zoned for Future Luxury Condo-Golf Complex.”
I suspect that I would get different results depending on which sign I put out on the land. The “farm acreage” sign would draw in farmers as potential buyers, who would evaluate the land based on its ability to produce crops. The “Condo-Golf” sign would appeal to resort developers, who would evaluate the land based on its luxury appeal.
The selling process would be entirely different, the offering prices would be entirely different, and the resulting use of the land would be entirely different. In both cases, the land is the same. The only thing I changed is a few words on a sign.
Pretty powerful words.
A lot of people pooh-pooh the idea of Vision or Mission Statements. They say they are just a bunch of meaningless words on a piece of paper.
Yes, it may be true that there are some poorly written mission statements. But don’t blame the mission statement; blame the author of the mission statement.
As we saw in the story above, by changing a few words on a sign we can change the destiny of how land is developed. The words on the sign changed the way we looked at the property and how we envisioned its value. One sign caused us to look at the land as a place for growing crops. The other sign caused us to look at the land as a future resort complex. By changing our thinking about the land, each sign changed how people acted with the land.
Same land; different actions. All because of a few words on a sign.
The same is true with vision or mission statements. The words we use can frame the way we look at a situation. Depending upon the point of view those words evoke, we will act differently.
Same company; different actions. All because of a few words in a mission statement.
Some actions are far more profitable than others. As a result, it is important to choose the words in your mission statement carefully, so that they help us envision the right future.
The principle here is that how we think about a situation impacts how we act. If you want the right actions, you have to properly frame the way people think about the situation. The mission statement is one way to create the right common mindset among your people, in order to end up with the right actions.
To illustrate how important a mindset is in determining actions, we will look at the Walgreens company. Walgreens recently changed the mindset for management. As a result, the actions now are totally different from before.
In the past, Walgreens envisioned itself as being a convenience-driven drug store company. Today, it sees itself as a consumer-driven health-care professional. By changing those few words, Walgreens has started a significant transformation of the entire company. This transformation is not dissimilar from the difference from seeing a plot of land as a place to grow crops to seeing it as a place for luxury condos.
The Convenience-Driven Drug Store
If your vision is to be a convenient drug store, you look for ways to make your drug stores more convenient. How is that done? Primarily by building a lot of drug stores. The more stores you have, the more convenient you are. So store growth is the key action which came out of that vision.
At its peak in 2008, Walgreens was building stores so rapidly that it was opening roughly one store somewhere in the United States on an average of every 16 hours. Walgreens now has 7,000 drug stores. Now that’s what I call convenience. I have one within walking distance of my house (as do many others).
The second aspect of convenience took place inside the store. The idea was that once they got you in the store, Walgreens would bombard you with as many impulse items as they could. The stores were crammed from floor to ceiling with a hodge-podge of whatever high margin item they thought you might purchase out of convenience. Again, vision dictated action.
Seeing the company as “convenience driven” also meant that Walgreens did not see themselves as “price driven.” This worked reasonably well for years at the pharmacy, where those with pharmacy insurance paid the same out-of-pocket price no matter where they went. However, the rest of the store was relatively non-competitive on price; but when you view yourself as in the convenience business, that is not seen as so bad.
The problem with this strategy is that the marketplace has redefined convenience in a way that puts drug stores at a disadvantage. First, mail order operations like Medco, Caremark and Express Scripts put the pharmacy in your mailbox, which is more conveniently located than the drug store.
Second, supercenter operators like Wal-Mart have redefined convenience from “locational convenience” to “one-stop shopping convenience.” They have all the basic drug store needs plus food needs, plus general merchandise needs all conveniently under the same roof. And this type of convenience is not a tradeoff with price. These supercenters can offer both. In fact, they have started pricing some pharmaceuticals at a lower retail price than the co-pay associated with insurance programs.
Suddenly that vision for Walgreens doesn’t look as good. It’s time for new actions. To get new actions, Walgreens needs a new way to envision themselves.
The Consumer-Driven Healthcare Professional
As a result, the new Walgreens CEO (Jeff Rein) has envisioned a new way to think about Walgreens. Instead of the product being the store, the product is now healthcare. Instead of the key attribute being convenience, the key attribute is consumer advocacy. Once you take down the “convenience-driven drug store” sign off the headquarters and replace it with a “consumer-driven healthcare professional” sign, change happens. New visions dictate new actions.
Here are some of the major changes.
1. Building fewer stores
The store is no longer the star of the show. The idea now is to serve the customer better, no matter where that takes you. Through the Complete Care and Well-Being program, Walgreens is putting pharmacies and health clinics right on employer campuses and worksites.
2. Re-merchandising the stores
When the focus moves from convenience to professional health care, the way the store is merchandised changes. In the new Walgreens test stores, the clutter of convenience-based products that have nothing to do with health are significantly reduced. Areas where health is relevant are expanded, to create destination-based assortments. New health-based categories are added, like the Take Care in-store health clinics, which tackle many of the health care needs that you used to have to go to a doctor for.
Rather than pushing a lot of high-margin general merchandise, the goal is to find ways to reduce overall costs in health care by leveraging the Walgreens infrastructure.
3. Re-deploying the pharmacist
Instead of being primarily an order-filler, the new role of the pharmacist is to be a health care expert and advisor. Walgreens is pushing much of the order-filling tasks upstream to regional centers, so that the in-store pharmacist can do other activities, like consulting with customers, administering immunizations and vaccinations, perform medication therapy management services, and improve patient compliance.
In addition to pharmacists, the stores are adding nurse practitioners and infusion therapists to the service mix. Walgreens is using these face-to-face interactions as a competitive advantage over competing alternatives, which rely on just telephones or the internet.
The new Walgreens currently coming about is quite a departure from the old Walgreens. It took a new way of looking at themselves to get there. Don’t shortchange the process and avoid time in crafting your mission statement. Those few words can be the catalyst to making the change happen.
Mission statements are important, because they help frame how people look at a situation. People act based on how they view a situation. Therefore, if you want new actions, you need to first change the perspective. By changing a few words in a mission statement, you can change that perspective and accelerate a consensus around the new action.
If you don’t proactively put a stake in the ground and claim the vision for your company, someone else will. And if you let the competition or disgruntled employees/customers do it, you may not like the results.
Friday, September 18, 2009
This summer, I did something I have never done before—dance. I did not dance at my own wedding. I did not dance at my daughter’s wedding. But this summer, I danced at my niece’s wedding.
Okay, it was for less than one song, and it was more a kind of swaying on the dance floor than a real dance, but I did it (and it made my wife happy).
Don’t expect to see me on any time soon on any of those dance competition shows on TV.
Dancing well requires a lot of effort and preparation. It takes many hours (even months or years) of preparation beforehand in order to look good for just a few minutes on the dance floor.
On the TV show “Dancing With the Stars,” they show some of the grueling practices in order to prepare for the short performance. If you just get on the dance floor like I did, with no preparation, you are going to look awful.
In the business world, sometimes you have only a brief moment in which to convince consumers to vote for your brand. If they don’t like what they see, they will send you away. If you want your performance to shine, you need to prepare—just like in dancing.
This is the essence of strategy—to properly prepare your business to perform well when it’s show time.
The idea here is that strategic planning is a lot like dancing. Great dancing occurs when there is great coordination—coordination with the music and coordination with the dance partner. Strategic planning is a process to create that coordination.
1. Coordination With The Music
Music creates the environment in which you are dancing. If your dancing is out of step with the music, you will look bad, even if your athletic ability is sound. Dancing a fast cha-cha to slow, romantic music will appear inappropriate and will not get you the votes you want from your audience.
The same is true in business. Businesses do not operate in a vacuum. They operate within a business environment. This is the music of the business world. If you want to succeed in your business dance, you’d better be in sync with that business environment. Don’t have a cha-cha strategy when the world is playing a slow waltz.
Take Abercrombie and Finch, for example. During the recent economic collapse, they refused to alter their strategy of charging a top price for their top brand. Abercrombie and Finch were not listening to the music of their environment. The mood had shifted. Due to the economic environment, people were more willing to trade away certain brands in order to get a better price/value. Abercrombie and Fitch lost a ton of market share to firms like Aeropostale, whose pricing strategy was more in tune with the music of the day.
As another example, in many sectors today the music of the business environment now has a “green” rhythm to it. If you are not into environmental sustainability, you are out of step with the beat.
For strategy, this implies that an important function is to always have your ears listening to the music of your environment. Listen for when the song changes, and be ready to dance the appropriate dance that the new song requires. No environment lasts forever. Moods change and tempos change. Therefore, you must change.
a) Environmental Analysis Should Be an Ongoing Process
Therefore, I recommend that your strategy function do two things. First, do not treat environmental analysis as an infrequent event. Instead, treat it as an ongoing process. Never stop listening to the music of your world (or you may miss it when the song changes). Never stop trying to understand your environment better.
Even if the music does not change, one can benefit from getting more intimate with the music of your environment. When I was a teen, I spent a summer working at a public swimming pool. Every morning, all summer long, there was a group of synchronized swimmers practicing for a competition at the end of the summer. Every morning, I had to listen to that same song they were practicing to—over and over again.
The music drove me crazy, but the repetition made the synchronized swimmers better. The better you know the music, the easier it is to stay in sync. Dive deep in your environmental analysis so that you better understand what is going on. And make sure you “play the music” in the office everyday, so your employees do not forget the world in which business transactions are taking place out in the field.
b. Have a Repertoire of Dances
If you only know one way to dance, then you will be unprepared when the music changes. This is where scenario planning fits in. In scenario planning, you look at the environment and how it would play out under different scenarios. This is like looking at how the world could end up playing different songs. Then the job is to prepare a dance/strategy for each song/scenario. That way, you are ready when the song changes.
Procter and Gamble was performing a dance similar to Abercrombie and Finch—premium prices for premium brands. It took them a long time to adjust their dance to the new song, created by the harsher economic environment. They are finally taking some steps to appeal to the new tempo by introducing Tide Basic to the US and converting Cheer to a value brand.
However, the song changed a long time ago and many already abandoned P&G for those brands which were dancing more in step with the times. In fact, with a potential recovery coming, P&G may be getting in tune with this song just when the song may be about to change again. Without more flexibility in their repertoire, P&G could perpetually fall one song behind.
So you not only need a repertoire of dances, but flexibility in your strategic process, so that you can adapt quickly.
This is not to imply that core strategies should be continually changing. No, the core of one’s business should not change very often. However, the way you express that core business should adapt to the rhythm of the times.
For example, Wal-Mart’s core strategy is about being a low cost operator, so that it can offer lower prices. As the music shifted to a “greener” beat, they incorporated environmentalism into the strategy. But they did it in a way that reinforced the core. They used the elimination of environmental waste as a way to eliminate spending waste and thereby save even more money that can be passed on in lower prices.
2. Coordination With Your Partners
Dancing well also requires dancing well with your dance partner. If you are not in sync with each other, the dance will fail. You will step on each others’ feet and fall down. In business, you can have many dance partners—suppliers, distributors, venture partners, outsourcers, and so on. Your successful dancing requires that both of you are on the same page of the strategic dance.
a) Choose Partners Well
Strategy is about more than just choosing the right dance. Strategy has to include a path to performing the dance well. Part of the path involves choosing the right partners. Poor choices lead to poor dancing.
Before choosing a partner, ask yourself these questions: Does this partner have a similar philosophy/approach to business (are the trying to dance the same dance)? Are they an appropriate match in terms of size and capabilities (dancing rarely works if the partners are mismatched in size)? Will you be an important partner to them? How committed are they to making the dance a success?
b) Spend Time Together
It’s difficult to dance well with a partner if you don’t spend time with them. Coordinated dancing requires spending time together. How much time to you spend with your partners? How well do you know them?
Do you ever talk to your partners about strategic issues? Do you invite them to any of your strategy sessions? How can you expect them to dance in sync with you if you keep them in the dark about the type of dance you are trying to perform?
Many successful businesses have developed strong, long-term relationships with their partners, like the partnership between Intel and Microsoft. Frequent shifting of partners rarely leads to good dancing.
Business performance is a lot like dancing performance. If you want to perform well, you need the preparation of strategic planning to:
a) Get in tune with the music of the environment; and
b) Get in sync with the steps of your partners.
Great dancing is more than just coordinating motor skills and getting the mechanics right. People do not want to watch robots get the steps right, but in a cold and heartless manner. They want emotion, flair, élan—an artistic performance. Never forget the emotional elements in devising and executing a strategy.
Wednesday, September 16, 2009
Ford invented the minivan, but refused to build them. Why? First, Ford was #1 in the sales of station wagons at that time. Ford feared that the minivan would cannibalize the sales on all those station wagons. Second, the truck division thought it might cannibalize some truck sales, as well.
Ford saw little benefit in spending all the money needed to gear up production for a new vehicle (the minivan) if all it was going to is steal business from their other profitable lines. Therefore, they did not introduce the minivan. It seemed like a wise financial move at the time. Why needlessly spend all that extra capital to get sales you already had?
Of course, when Lee Iacocca left Ford and went to Chrysler, he found himself at a company that was weak in the station wagon and truck businesses. There wasn’t much at Chrysler to be cannibalized by the minivan. Therefore, Chrysler introduced the minivan. It was a huge success, mostly at Ford’s expense.
Ford was correct about one thing. The minivan did make the station wagon obsolete. Ford lost nearly all of its station wagon sales. Too bad Ford did not factor in a competitive introduction of the minivan into their business model. In the end, Ford did not save the expense of introducing a minivan (as they had hoped). They had to do it anyway, as a response to Chrysler. However, because they let Chrysler get a head start, Chrysler got most of the benefit of the minivan.
As this story illustrates, one can create logical arguments to kill a new project, as Ford did with the minivan. One can even back up that argument with solid financials. However, that does not always mean that the new project should be killed.
Logical arguments and financial models can be flawed. A natural bias to kill new initiatives can exist in an organization. This bias can cloud one’s judgment, leading to a flawed analysis.
Due to a bias towards past success, Ford failed to take into account the inevitability that station wagons would eventually become passé. By not proactively planning for their replacement, they allowed Chrysler to replace them.
Businesses need to be aware of the potential for this bias, so that they do not fall into the trap which hurt Ford.
In the last blog, we looked at how a bias to “go” on new ventures can hurt a company. In this blog, we will look at how a bias to “no go” on new ventures can also hurt a company. We will look at the causes of the “no go” bias, how it can distort our analysis, and questions to ask ourselves in order to keep the bias from causing us to make the wrong decision.
1. Bias Source #1: Avoiding the Hammer
The old saying is that the hammer hits the tallest nail. If you stand out too much, you are vulnerable to attack. New ventures have high visibility and stand out. If they fail, you run the risk of being attacked. Their failure becomes your failure. By contrast, it is easier to hide in the bureaucracy of the established businesses.
2. Bias Source #2: Avoiding Accountability
If you say “go” and the new business fails, there is hell to pay, because a highly visible loss is right there on the books for all to see. However, if you say “no go” and the business would have been great, there is less of a backlash, because it is all subjective. Hence, if you want to avoid accountability for your decision, it is easier if you say “no go.”
3. Bias Source #3: New Game Threatens My Game
You’ve been working yourself up the corporate ladder playing by the old rules associated with the old way of doing things. The new ways could make your “game” obsolete. To protect your personal future, you need to protect the ways of the past.
4. Bias Source #4: Short-Term Pressure
There tends to be more pressure on hitting the targets for the current month or current quarter than for long-term profits. Since new initiatives usually have a near-term drain on profits, there is a tendency to put them off, so they won’t hurt near-term earnings.
5. Bias Source #5: Not on My Watch
The remaining tenure for most CEOs is relatively short—shorter than the time for a new initiate to have a positive impact. The leaders may be retired or have moved on by the time the new initiative pans out. As one CEO put it, “Why should I invest in something that hurts earnings on my watch, but provides benefits for my successor that he will take credit for?”
6. Bias Source #5: Fear of Cannibalization
As we saw in the story, new projects often cannibalize older businesses. The thought is that by avoiding the new businesses, we can protect the old ones while at the same time avoiding all that new investment.
These factors can cause a bias to say “no go” to projects which should move forward. They can even distort the financial analysis, to make “no go” look better than it should.
1. Distortion #1: Old Cash Flow Will Go On Forever
New initiatives are often compared to the status quo. If you assume the status quo will always be strong and healthy, then it is hard to justify change. However, it is a fact of life that all strategic initiatives eventually fail. Customer desires change and innovations from others change demand. Product lifecycles eventually reach maturity and decline. The “next big thing” eventually becomes “that obsolete thing.” 8-Track players were once the rage in music. Now they are junk.
The cash flow on the old business will not go on forever. If you don’t replace it, another company will. Either way, there is inevitable decline. Make sure you put it in the model.
2. Distortion #2: Things Won’t Change if I Don’t Change
Ford thought that if they didn’t build the minivan, the minivan would not be built. This, as we saw, was not the case. Innovation is going on all over the place in your industry. If you can see the potential in the new venture, so can others. Just because you like the status quo and don’t want change (because right now you are the leader) does not mean that everyone likes the status quo (especially the non-leaders). Change is inevitable. Either you can take advantage of it (by action) or be hurt by it (through inaction). Therefore, your modeling should assume changing conditions caused by others.
3. Distortion #3: Old Beasts don’t Need to be Fed
To keep older businesses vital, one needs to reinvest in them. For example, I know of a retailer who built a lot of stores in the 1970s and 1980s and then hardly ever reinvested in those locations. Eventually the stores looked rather shabby. In addition, over the next 30 years, those neighborhoods changed and became less desirable locations for stores. People wanted to shop the newer, nicer stores of the competition which were closer to their new homes, rather than drive into the dangerous inner-city locations where these old shabby stores were. By not reinvesting in the old business and refusing to relocate those stores to better locations, the company eventually went bankrupt. In the near term, those relocations looked more expensive than staying in the older locations. Over time, however, the lack of reinvestment killed the old business. Does your business model include reinvestments in the status quo? The old beasts still need to be fed, or they will die.
So how can we avoid this bias and resulting distortions? If helps if we ask ourselves the following questions before making a decision.
1. If you were assured of a promotion regardless of the success or failure of the new initiative would you still want to kill it? (This unlinks your fate from the fate of the project, so that you can look at it more objectively)
2. If near-term pressures were eliminated, what would you do? (near-term is biased towards status quo) Keep in mind that astute investors value your firm based on future cash flow potential, not history. If you can convince them that these are good long term investments, they will support you. It helps if incentive programs de-emphasize near-term and also reward good long-term decisions.
3. What if another company says “go” to your “no go” decision? Can you survive the impact to your core businesses? (This provides a more realistic way to evaluate cannibalization)
4. In your model, are you adequately feeding the old beast to keep it relevant or are you choking it? Either the modeling needs to include lots of cash to invigorate the old, or the future prospects for the status quo need to be significantly reduced. Make sure the residual value on the status quo does not overstate its potential.
Since all current initiatives will eventually fail, there is a need to continually reinvent a firm with new initiatives. Otherwise, your company will fail when all the current initiatives fail. Unfortunately, it is often difficult to justify the cost of reinvention while the old initiatives are still cranking out healthy cash flows. This creates a bias to kill off new initiatives. The more we are aware of this bias, the more we can avoid its disastrous consequences.
Just as the station wagon did not live forever, it appears that the minivan is now in decline. Crossover vehicles are starting to take its place. And guess what? Ford has aggressively gone after the crossover business, because they do not have many minivan sales to cannibalize. By contrast, Chrysler has been slow to get into the crossover business, in large part due to not wanting to cannibalize the most profitable piece of their portfolio (the minivan). Times may change, but the mistaken logic appears to live on.
Tuesday, September 15, 2009
I worked with a company that desired to have a new corporate headquarters building. The company at the time was spread over several buildings around the city, making things inconvenient. Not only would a new headquarters get rid of that problem, but many thought it would be fun and a boost to the ego to work in a flashy new building.
The problem was that the new headquarters was difficult to justify based on financials. New headquarters can be very expensive, and the benefits to the rest of the business are difficult to quantify.
To make the financials more appealing, two assumptions for the model were changed. First, the resale value of the old headquarters was increased in the model. In other words, if we moved to a new building, it was assumed we would get more when we sold the old building (to help pay for the new building).
Second, it was assumed that the company’s unusually rapid growth rate would continue for awhile. This meant that the current infrastructure was even less adequate moving forward (we’d have to add more office space anyway). It also made the cost of the new headquarters more efficient, since a bigger headquarters costs less per square foot to build.
These changes gave the new headquarters scenario just enough of an edge so that it looked slightly better to build an impressive new corporate headquarters building than work with the current hodge-podge of buildings. So the decision was made to “go” with the flashy new headquarters.
Well it takes a year or two to get one of these headquarters built. Between the time of giving the go-ahead to build the new headquarters and the time it opened, two particular things occurred. First, the bottom dropped out of the real estate market, meaning that the old headquarters sold for a lot less than what was put in the model. Second, internal growth had stopped and the company had actually shrunk the headquarters staff. So the new headquarters opened up as about half empty. At this point, it would be difficult to justify that new building. But it was really cool and people still liked the prestige of being there.
At the end of the day, that huge new headquarters was not built because it was the wisest financial move. It was built because people wanted a cool new building to work in. That bias of desire overtook common sense. The financial model had been unjustly modified to make it look like a wise move, but in the end, reality told a different story.
In the business world, there are all sorts of similar types of business decisions. They are some variation of this question: Do we stick with the old and familiar or go with the new and different? This applies not only to headquarters, but to potential new product offerings, brand extensions, acquisitions, diversifications, and the like. The sexiness of the new initiative lures people in like the songs of the Sirens.
People seem to forget that most new initiatives fail. They think that this one is the exception to the rule. So they push forward on the new initiative and create one more disaster, confirming one again that most new initiatives fail.
The principle here is that when it comes to “go” vs. “no go” decisions on new initiatives, there are many internal biases towards “go.” If we don’t understand the impact of these biases, we can become blinded into making less than ideal decisions. Therefore, this blog will look at three things: Sources of a bias to “go,” distortions to the decision-making process which come from the biases, and the questions we need to ask ourselves to unmask the bias to “Go.”
In the next blog, we will do the same thing for the biases to “No Go.”
1. Bias Source #1: Fun Factor
Let’s face it. It’s fun to work on the “new” project. It sure beats working on the old routine stuff. You get to go to lots of committee meetings (and eat lots of yummy donuts). If you keep saying “yes” the fun continues. If you say “no” the fun ends.
2. Bias Source #2: Freedom
The old routine stuff has all sorts of tight budgets and short performance deadlines. There is a clear line of authority and accountability. It’s a hassle and you get yelled at a lot if budgets are missed. By contrast, the new stuff is usually more open-ended. There is a lot more freedom and less accountability as it is being set up.
3. Bias Source #3: Career Enrichment
The new stuff is highly visible. If you can make the new project a success, you can quickly become a hero in the organization. That can lead to all sorts of bigger titles, promotions, perks and money. Your rise in the organization tends to be faster if you work on the new stuff (and succeed), so you are biased to work on these projects and promote them so that you have a chance to succeed with them.
4. Bias Source #4: Linkage of Person and Project Image
Of course, this also works in the other direction. If the highly visible new project fails, your “failure” is very visible. The more a person sees their personal success as linked to the project success, the more likely they will push the project forward. After all, saying “no” to the project is viewed as being like saying “no” to the people working on it. This creates a strong bias to avoid shutting a project down, no matter how bad it looks.
5. Bias Source #5: The Panacea Phenomenon, or the Optimism of Ignorance
We all tend to know the shortcomings of our current businesses. However, when we venture into new territory, there are more unknowns. Given all of the other biases, we tend to take a more optimistic slant to those unknowns. After all, we have expectations to grow corporate sales and profitability. We know we cannot hit those aggressive goals with our current ventures. Therefore, the gap has to be filled by new ventures. If we say “yes” to the new ventures, we have a shot at filling the goal (our panacea for our problems). If we reject the new ventures, we run out of options for filling the gap.
So, given all of these biases, there is a tendency to create financial models which are biased towards moving the new ventures forward, even when they should be halted (whether we are aware of it or not). Some of the ways the models get distorted are as follows:
1. Distortion #1: Forget about Life Cycle Impacts
New ventures are often very profitable in the beginning. This is because it tends to be in an uncontested space with little competition. However, once we show that profits exist in the space, others will jump in. Competition will erupt and profits will go down. In addition, all that new business is probably coming to us at the expense of someone else’s old business. As soon as they see their business being attacked, they will fight back and get some of that business back. This is all part of the natural rhythm of the product life cycle. Eventually the industry matures and profitability drops to something near the cost of capital. If you only project the good, early times into your model, you will distort the model to be too optimistic. This is particularly true if there is a large residual value at the end of your model’s time frame.
2. Distortion #2: Forget about Transition Costs
The models for the new business often look at the venture once it is up and operating smoothly. That’s nice, but there is usually a costly transition to get there. For example, I’ve seen lots of people model out the benefits of an acquisition and only look at how the acquired company will perform once acquired. They leave out all sorts of very expensive costs associated with doing the acquisition, like investment banker fees, legal fees, PR fees, severance costs on the people let go, and so on. When you factor in all of these transition fees, a supposedly “good” deal can become a money loser. There are also substantial transition costs in new ventures. It takes a lot of time and money to get them up and running, which may not get into your model.
These two distortions can make your models biased more towards the new venture than they should be. They reinforce the bias to “go” which was already there, increasing the likelihood that you will vote to “go” when “no go” is the better response.
To help avoid the consequences of making poor decisions due to the bias to “go”, ask yourself these questions:
1. If it were your money, would you still do it? (We tend to have less of a bias to “go” when it is our own money at stake)
2. If you were assured of a promotion regardless of the success or failure of the project would you still want to go forward? (This unlinks your fate from the fate of the project, so that you can look at it more objectively)
3. Can the new venture overcome the competitive reactions and the copycats that will naturally occur as part of the life cycle? (Put it into the model and see)
4. Can the new venture absorb all of the transition costs and still work? (Put them in the model and see)
Since most new initiatives fail, there is reason to be skeptical when new initiatives are proposed. Double check to see if the new initiative is truly worthy of a “go” vote. Don’t just assume the analysis is telling the whole story, since the bias to “go” can distort the analysis (even if you are unaware of it at the time). And check out your own biases to be sure you are choosing based on reality not some irrational emotion.
According to the book Parkinson’s Law, “During a period of exciting discovery or progress, there is no time to plan the perfect headquarters. The time for that comes later, what all the important work has been done. Perfection, as we know is finality; and finality is death.” So when people are pushing for a luxurious new headquarters, it may be time to get out of there, before it is too late.
Wednesday, September 2, 2009
I used to live in a city where the citizens were upset with the ambulance service. The ambulance drivers were accused of being incompetent and dangerous, causing far too many accidents.
In response to citizen protests, the city suspended the license of this ambulance company and replaced them with a different ambulance company.
Unfortunately, this new ambulance company did not have any other operations in the immediate vicinity. Therefore, they needed to hire ambulance drivers in order to serve this city. As it turns out, pretty much the only people in the area who were qualified to drive an ambulance were the former drivers for the ambulance company which just lost its license. Consequently, most of the drivers for the new ambulance company were those same “incompetent and dangerous” drivers that worked for the old company.
So, other than a new name painted on the outside of the ambulance, we were pretty much back to where we started. So much for progress.
In the story, the city tried to improve the performance of the ambulances. To do so, it changed ambulance companies. Unfortunately, what didn’t change were the people driving the ambulances. Since the poor drivers were the cause of the problem, the change in ambulance companies did not solve the problem. The only thing that changed was the name painted on the ambulance.
Many businesses fall into the same trap as this city. They develop strategies intended to change things for the better. However, because the underlying people and processes stay essentially the same, the situation does not get any better. It’s business-as-usual under a different label. These company strategies are about as useless as the idea that painting a new name on the ambulance is going to make those drivers any safer.
The principle here is that significant changes in performance require significant changes in how things are performed. I know this sounds obvious, but actions like what happened with those ambulances seem to occur all the time. We put a new label on something and expect miracles. Concentrate more on labor (what they do) than labels (what they’re called).
This problem seems most acute under two situations: acquisitions and revitalization initiatives.
When you are acquiring a company, you typically have to pay a significant premium price (over current market value) in order to get the deal done. This leads to an important question: What is your company going to do with those assets that is going to make them so much more valuable in order to justify that premium price?
Let’s face it. The current owners probably know a lot more about the company than you do. They are typically already working very hard to extract as much value out of it as they can. And, except for maybe a few people at the top, you are going to keep the same basic people that worked there prior to the acquisition. So why do you, as an outsider, think that the same basic organization is going to perform so much better just because you painted your name on the building?
Sure, people talk about all the “synergies” of putting the acquired company together with their own. My experience is that one never gets as many synergies as hoped for. Either the cultures don’t mesh or fewer things can be eliminated than planned. As mentioned in an earlier blog, using common shared services across multiple divisions quite often causes more net costs than savings. Unless you are planning on running the company significantly differently than before (and I truly mean SIGNIFICANTLY different), you won’t get much of a significant improvement.
Take the recent acquisition of Marvel by Disney. Disney paid a ton of money to get the company (a 29% premium over current value). Will Disney run the company significantly differently than the prior owners? Well, Marvel already was exploiting the value of its characters in movies, merchandise and theme parks (the very things Disney would do). In fact, one could argue that those prior contractual arrangements could make it more difficult for Disney to exploit them under the Disney umbrella.
And is Disney going to get rid of all the Marvel people? Of course not! Disney wants their creativity.
So, other than perhaps executing the prior strategy a little bit better, has Disney done much more than just “paint their name on the ambulance”? Even if they make Marvel 29% better, all they will have done is break even on the deal.
Let’s assume for second that Marvel was horrible at exploiting their assets, leaving huge potential for Disney. Typically, when a company is not doing well in exploiting their assets, astute investors assume that potential acquiring companies will also recognize this potential. These investors assume that eventually one of these firms will acquire the company to better exploit those assets.
As a result, the investors will often bid up the current price of a company ripe for acquisition to include a “potential acquisition premium.” Hence, when the acquirer pays a premium over the current value, they may be paying a premium on top of a premium already embedded in the stock price.
Make sure that when you put an acquisition into your strategy, you specifically outline in that strategy enough changes to that company in order to create enough value to justify the price. Otherwise, all you are doing is painting your name on their ambulance. For more on this topic, see this prior blog.
2) Revitalization Initiatives
In addition to acquisitions, strategies also often deal with revitalizing problem areas in a company’s current portfolio. These revitalization programs are often given fancy names, like “Vision 2020” (If you don’t believe me, just Google “Vision 2020” and see how many firms use that label for their strategic initiative).
The goal is to revitalize performance. However, these initiatives often try to create this revitalization using the same basic people whose poor performance created the need for revitalization in the first place. As we saw in the ambulance story, often times the people are one of the main causes of the original problem. Unless the people (or the culture surrounding the people) are radically changed, why should one expect revitalization?
This reminds me of an interesting story. Years ago, I worked for a firm that was having a sales slump due to a recession. The president of the company asked every employee to send him suggestions on new ideas to improve sales. One person replied, “Do you really think I was holding back on good ideas to increase sales until you asked for them? I’m already doing everything I can to increase sales.”
The point is that most employees are not worthless bums. They are generally good people already trying to help the company do well. Putting a new label on what they do is not going to suddenly make them significantly better. They are already putting in the effort. Unless you significantly change the quality of the people or the nature of the work process, you will get only minimal, short-lived improvement. All you have done is paint a new slogan on an old ambulance.
Significant gains require significant change. If one has the same people doing essentially the same work, one should not expect much of an improvement. Just changing the label doesn’t change the results.
A pig is still a pig, not matter what you call it.