THE STORY
There’s an old science tricks kids love. First, you take a glass bottle and put a lit piece of paper in it. Then you place a peeled hard-boiled egg on top of the bottle.
Eventually, the flame will go out on the paper in the
bottle. Shortly thereafter, the egg will get sucked into the bottle.
The kids are amazed because the mouth of the bottle is so
much smaller than the egg. They can’t push the egg through the hole, so how did
it get in there?
The science experiment works on the principle of air pressure. The flame on the piece of paper uses up the oxygen in the bottle. This causes the air pressure in the bottle to be so low in comparison to the air pressure outside the bottle that the vacuum inside sucks the egg into bottle.
Businesses seem to be creating a vacuum as well. It is
caused by not spending enough time working on strategy. The lack of strategy
effort creates a “strategy vacuum” within the business. This vacuum then sucks
in strategic alternatives offered from the outside. Like the egg that doesn’t
fit but still finds a way in, alternative strategies from the outside often do
not fit the company, yet still find a way in.
And then you are stuck with a strategy that doesn’t belong
and hard to get rid of, like that egg in the bottle.
The principle here has to do with abdication. If you abdicate your responsibility for developing and implementing a strategy, someone from the outside will fill the vacuum and supply a strategy for you. Sometimes it will come from an activist investor like Carl Icahn, Bill Ackman or Nelson Peltz. Sometimes it will come from another company which starts a hostile acquisition of your firm. Other times, a big private equity firm will decide to step in and make a lot of changes. Or maybe your debt holders step in with a strategy if your strategy vacuum causes you to break your debt covenants.
Many times their strategic suggestions make about as much
sense to you as having an egg trapped in a bottle. But there it is…that egg is
in the bottle anyway. And with these outside strategists, once they start
filling your strategic vacuum, they are hard to get rid of—like that egg. And
now you suffer the consequences.
Narrow Perspective
So what’s wrong with getting strategic help from outsiders?
Isn’t help a good thing?
The problem is that these outsiders tend to be more interested
in what is best for them than what is best long-term for the business. Occasionally,
what they perceive as best for the outsider is also best for the company
long-term. But in most cases, it is not.
For example, activist investors and private equity funds are
usually looking for a very quick way to take a lot more money out of a business
than they put in. All that money they take out has to come from somewhere.
Often, it comes out of the balance sheet. They suck out the cash and fill the
balance sheet with tons of debt.
Then the outsiders leave with their cash and you are stuck
trying to move the company forward with all the debt. Rarely is a company’s
strategic position improved when overburdened with high risk debt.
Remember, all that cash the outsiders suck out had to come
from somewhere, and the cash they take out is cash no longer available to
invest in a strategy for the future (once the outsiders leave). Yes, the
company may temporarily get a bump in its stock price during the outside
intervention. But once the dust settles, the price usually falls back (and then
some).
And the debt holders tend to be even worse. They really don’t
want to run the business and don’t care that much if the business continues to
run. They are not even necessarily looking for a big profit. They just want to
find enough cash to settle what’s owed them. This can lead to selling off and
liquidating whatever is salable, no matter what the strategic implications. The
result is that the company is often left as a hollow shell of only the
properties that were difficult to sell because they aren’t worth much. How’s
that for a strategy?
Just ask TWA how that type of dismantling worked for them.
Oh, that’s right. You can’t ask them because they no longer exist.
Who is the
Customer?
These outsiders also have a different opinion about who the
customer is. For example, activist investors see themselves as the company’s
customer—the one the company should focus on pleasing.
Private equity funds tend to see the next investor in the
company (the one the private equity fund wants to eventually sell its equity to
when it leaves) as the customer. They dress the company up for resale rather
than invest in strategic projects with long paybacks. These private investors
are like the people who “flip” houses for a living. They buy distressed homes
and fix up only the cosmetic things most pleasing to the next one to buy the
home—their customer—and ignore the structural issues.
The bankers tend to see the customer as whoever will take an
asset off their hands and put money in their pocket.
As you can see, most outsiders never give much attention to
the customer of the on-going business strategy—the one buying the goods and
services being offered by the business model. I don’t see how ignoring or
downplaying this customer improves one’s strategy.
Solution
So what is the solution? How do we keep these bad eggs from
getting sucked into our bottle? How do we keep good strategies in place? There
are three things one can do.
First, don’t abdicate your responsibility for designing and
executing a great strategy. If you don’t create a strategy vacuum, then those
eggs can’t be sucked in. Make having a great strategy a high priority. That
way, you will be so successful that outsiders will be hard pressed to find
excuses for why your strategy should be replaced with theirs. Even if you don’t
like doing strategy, think of it as the lesser of two evils when compared to outside
intervention.
Second, target the right partners. Not all investors are
created equal. Some want a quick grab and run. Others want to be associated
with enduring companies over the long term. Seek out the second type and court
them. Make them your primary investor.
It can be done. There are people like Warren Buffett who
invest for the long term. Amazon has cultivated an investor base which is
willing to forego near-term profit bursts and instead prefer a longer-term
strategic perspective. If you surround yourself with partners who want your long-term
strategy to win, then they are less likely to try to replace your strategy.
Third, if you are a professional strategist, perhaps you
should consider spending more time working with these outside private equity
people. After all, if companies are willing to abdicate their responsibility
for strategy and let it fall into the hands of outsiders, then the best way to
influence strategy is by working with the outsiders.
One of the largest sources of income in my strategy
consulting practice comes from the private equity sector. They often seem more
interested in talking strategy than the companies. I try to help them see the
bigger picture better. My desire is to help them see that they are better off
if they help build enduring businesses rather than just grab and go.
If a company abdicates its responsibility for strategy then an outsider will step in and provide one. In most cases, you will not like the strategy imposed upon you. Therefore, keep them out by doing it right in first place.
There’s an old saying that “Nature Abhors a Vacuum.” You should, too, especially when it comes to strategy.
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