Thursday, February 13, 2014

Strategic Planning Analogy #521: Abdication

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.

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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