Plate Spinning

THE STORY
When I was a little boy, I used to enjoy watching the Ed Sullivan show on TV. Frequently on the show, he would have as one of his acts a “plate spinner.”

The plate spinner would have a number of long, thin wooden rods sticking straight up, all in a row. Starting at one end of the row, he would put a plate on top of the wooden rod and start spinning it until it was going fast enough to not fall off of the rod. Then he would move on to the next rod and get another plate spinning. He would continue this down the entire row of wooden rods.

Soon, the plates he began spinning earlier would slow down, start to wobble and almost fall off the wooden rod. The plate spinner would have to stop what he was doing and go back and very quickly get that plate spinning again. Eventually there would be so many spinning plates that the plate spinner would be frantically running from rod to rod trying to keep them all going.

Eventually, he would not be able to keep up with them all, and plates would start to fall and break. As a young boy, seeing someone breaking plates on TV seemed like fun.

THE ANALOGY
In the business world, leaders are confronted with a great number of tasks and responsibilities. Often times, it can feel like being one of those plate spinners. You are frantically moving from crisis to crisis just trying to keep things from breaking. There appears to be no time for quiet reflection or strategic concerns. All the effort is used just to keep the plates spinning.

It doesn’t need to be that way. In this blog we will look at how to stop being a plate spinner and how to become a more effective long-term leader. Plates were originally made to hold scrumptious meals. Let’s stop spinning plates and use them to feast on the fruits of successful planning.

THE PRINCIPLE
Back around the late 1980s, I read a book summary about how to be an effective manager. The author studied a number of executives who were noted for being effective leaders. He then wrote about the traits he saw in the effective leaders. I’ve forgotten the name of the book or the author and tried in vain to locate the book on the internet. If any of you know the name of the book, let me know.

What the author found was that there was no single way to be an effective leader, but rather several, although the methods did have something in common. As I’ve pondered what I read in the book summary so many years ago, I have modified the common principle of success to being “leveraged focus.” Using the analogy above (something the author did not do), when compared to plate spinning, the successful leader would not try to spin all of the plates by his/her self. Instead the leader would focus on only one of the plates. However, the leader would focus in such a way that the plate he was spinning would have an indirect impact on all of the other plates. His spinning of the one plate would leverage all of the other plates to keep them spinning without a need for the leader to focus on all of them.

The author mentioned several different types of “plates” to focus on and how they could leverage all of the others. I do not remember them all, but here are most of them:

1) Focus on People
2) Focus on Investment
3) Focus on Vision
4) Focus on Process

Each of these will now be described in greater detail.

1) Focus on People
This type of effective leader would focus on making sure that the right people were in the right part of the organization, pretty much to the exclusion of most other factors. This leader would get very involving in the hiring process for all executives, making sure to be part of the interviewing. This leader would spend a great deal of time making sure the skills of people matched their responsibilities and that there was a cultural fit.

The leverage works as follows: If you get great people properly aligned in the organization to take advantage of their strengths, and give them the right tools, they can do great things. In other words, if the “people focus” plate is spinning well, it will create an environment where great people on their own will find the right plates and spin them for you. Just get the right people in the right place and then get out of their way. By focusing on one plate, you get them all.

Dick Schulze, the founder of Best Buy is probably a good example of this type of leadership. He was always fond of saying “you win with people.”

2) Focus on Investment
This second type of effective leader would focus on making sure that the company was putting the resources behind the right projects. He or she would spend a lot of time focusing on capital investments—where and how the money is being spent. Returns on investment would be a key point of interest.

The leverage works as follows: If you can effectively control where the resources are placed in an organization, then you can effectively control what the organization does. In other words, you focus on determining which plates are the best ones to spin. Then you put enough resources behind those plates to ensure that they will keep on spinning without a need to constantly monitor them. The resources will get the work done, so you don’t need to be everywhere at once trying to spin the plates yourself.

3) Focus on Vision
This third type of effective leader spends a significant amount of his or her time on making sure the vision and mission is right. Then this type of leader spends most of the remaining time communicating the vision, to make sure that everybody understands it and is behind it.

The leverage works as follows: If you can get everyone focused in moving in the same direction, then you will end up moving the company in that direction. The details about which particular plates should be spun would occur naturally as people gravitate to the plates most in line with the vision and start spinning them. By focusing only on the direction, you can get all the proper action from others as a natural consequence.

Steve Jobs is probably a good example of this type of leader. He sets the tone for what Apple stands for, and because the people intimately know what he is looking for, they deliver.

4) Focus on Process
A lot of the failure in business comes from poor execution. Therefore, this fourth type of effective leader focuses a great deal of time on process—examining how things get done in the organization. This type of leader looks for ways to streamline a process, eliminate bottlenecks, and make handoffs more seamless. Process flow charts consume the interest of this leader.

The leverage works as follows: By focusing on the Process Plate, one is creating an environment where it is harder for things to fail. Therefore, one does not have to keep running from wobbly crisis plate to wobbly crisis plate, because the efficiencies of the process tend to make the plates keep spinning longer all on their own.

The point of all this is that leaders cannot do it all themselves. However, they still need to make sure that all the proper plates are spinning. So rather than be half-hearted at everything, pick a plate to really focus on. And then make sure that you leverage that effort so that the impact of that plate indirectly gets all the other proper plates to spin on their own. This then allows the leaders the freedom to be true leaders, rather than just frantic plate spinners.

SUMMARY
Even though a lot of things have to go right in order for a business to be successful, that does not mean that leaders need to spend time on every little thing that has to go right. In fact, if a leader gets spread that thin, they will end up being effective at nothing. Instead, leaders need to focus more narrowly to ensure that one particular aspect gets done supremely well, be it the people factor, the process factor, the resource factor or the vision factor. Then, the trick is to make sure the effectiveness in that one area ripples out to all the other areas, so that the consequence of the narrow focus causes everything else to naturally fall in line and get done without the need for constant leader attention.

FINAL THOUGHTS
Of course there are always exceptions. Great companies like GE tend to be able to do multiple things right. Regarding people focus, GE has one of the best executive development programs around. Regarding process, they have gotten their arms around processes like six sigma. Regarding resource allocation, they were leaders in no longer investing in businesses that were not #1 or #2 in their field. The mix of the GE portfolio has changed greatly over time, as investments changed with the environment. Regarding vision, people quickly start to understand “the GE way.”

However, even here there has been focus. They didn’t try to institute or perfect all of this at once. Instead, they would tend to focus on only one of these four areas at a time to get it right and then just rotate to the next focus. It has been more sequential plate spinning rather than simultaneous plate spinning.

Successful Retail is about making PAR (part 2)

THE STORY
Many, many years ago, I did some consumer research to try to understand the difference between a Wal-Mart customer and a Target customer.

The people who loved Wal-Mart thought that Target customers were stupid, because:

1) Target shoppers are were paying too much (and that’s wasteful—which is a bad thing). They could get the stuff cheaper at Wal-Mart.

2) Target shoppers were seduced by all the frills and glamour, which at the end of the day is worthless, because the only thing you get to take home is the product.

At the same time, the people who shopped Target thought that the Wal-Mart shoppers were stupid, because:

1) The Wal-Mart shoppers were putting up with a dirty, undesirable shopping experience when they did not have to.

2) Don’t the People who shop at Wal-Mart realize that by going into those stores they are associating with the undesirable people of society, so by association they would be considered an undesirable person?

So in the end, both sides thought that they were the smart shopper and that the other shopper was stupid.

THE ANALOGY
We tend to patronize those companies that reinforce the way we look at life. The Wal-Mart shopper tended to have a moral code which was against wastefulness. Many of them saw wastefulness as an indicator of being a bad parent, since money wasted at the store was less money they could spend on their family. Since Wal-Mart seemed to waste the least amount of money, that’s where these shoppers went.

Conversely, the Target shopper saw shopping as more than just a task to get a product as cheaply as possible. They also valued the shopping experience and how that experience would influence how others thought about them. Whereas the Wal-Mart shopper was more directed by an internal moral compass, the Target shopper was more influenced by external direction from the culture around them. Since the external culture thought more highly of Target, Target became the store of choice.

Therefore, when creating strategic direction for your brand, one must take into account how the customer integrates this purchase into their larger view of life and self worth. Otherwise, they will miss out on some of the key motivators of purchase and perhaps end up looking like the “stupid” choice for a large sector of people.

THE PRINCIPLE
This is the second of two blogs looking at how to be successful as a retailer. Once you get past mastering the basics of retailing (right product, right price), there are three more areas one must master. We called it mastering PAR, because this acronym spells out the three areas:

1) Personality
2) Advocacy
3) Respect

In the last blog, we looked at personality. In this blog, we will look at Advocacy and Respect.

2) Advocacy
If one assumes that most stores in a particular sector sell about the same stuff at roughly the same prices, then what becomes the tie-breaker to get you to choose one over the other? Often, it has to do with which store is doing a better job of being an advocate for your way of life.

One way a store can be an advocate is by helping its core customers get more of what they want and less of what they don’t want. Most people do not want to wade through acres of stuff they are not interested in so they can find the stuff they are interested in. An advocate store will know its customer type well enough to pre-select only those products important to their customer. This can be a great time-saving service.

Walgreen’s recently found out from its customers that they would enjoy the experience more if the selection was reduced, so that is what they are doing. In the area of food, Trader Joe’s and Aldi have been successful by narrowing the choice to just what their customer is looking for. In fashion, specialty stores tend to do well if they focus on a particular type of fashion statement rather than trying to be too many things in the same store (such as the successful focus of American Eagle Outfitters versus the muddle of the Gap).

For additional selection options to become meaningful choice, it needs to be relevant to the customer’s way of life. Otherwise, it no longer represents choice, but only clutter. Advocates get rid of the clutter on behalf of their customers.

Another way to become an advocate is by reinforcing the fact that you endorse the lifestyle of your customers. These retailers seem themselves as more than just sellers of goods, but also as outfitters of a lifestyle. Whole Foods is about more than just product. It is trying to advance an entire way of healthy living. Hot Topic makes the Goth teen feel like their lifestyle is welcomed, understood and appreciated. Christian bookstores are not just selling books, but endorsing and supporting a particular spiritual lifestyle.

A third way to be an advocate is to be a fighter for your customers. It is sort of like being a concierge for your customer, looking for special ways to help out your customer. This could include anything from special ordering product to lobbying for the rights of the customer. It’s going that extra step to make the customer’s experience special.

Finally a store can be an advocate by supporting the same causes which are important to their customer. More than ever, customers want to patronize stores which direct some of their profits to help make the world a better place. If the causes which are important to the customer are also important to the store (and the store puts their money where their mouth is) the store will tend to be patronized more. This could include environmental causes, neighborhood causes, or helping those less fortunate.

3) Respect
Closely associated with advocacy is respect. Customers do not want to be taken for granted. They want to be appreciated for their patronage. About a week ago, MSNBC ran a web page asking people to write in about how to improve Wal-Mart. One of the biggest complaints was the long lines at the store. People felt that those long lines showed no respect for the customer’s time. If you do not respect a customer’s time, then they will shop at a place where they get the respect. One of the reasons for the success of Carmax is the fact that they do a better job than the competition in respecting the time of their customers.

Customers want stores that respect the choices their customers make. Don’t be patronizing or judgmental. Believe in what you are selling and be proud of it.

Finally, show respect for the customer beyond the store experience. The relationship shouldn’t end at the cash register. If you sell poor quality junk that breaks down shortly after purchase, you have not shown respect for your customer. Stand behind what you sell and make sure the post purchase satisfaction is just as important as the in-store satisfaction. Repeat business creates profits. If you let down the customer after the transaction, you might not get another transaction from them.

SUMMARY
Customers have too many choices of where to spend their money. To get them to choose you, a retailer must go beyond just having the right goods at the right price. Instead, they must form deeper relationships which reinforce the lifestyles and moral codes of their customers. You must stand alongside your customer and become an advocate for the things most important to their way of life. In addition, you need to respect their time, their choices and their post-purchase experiences. Otherwise, you are seen as just a cold-hearted business. And it is difficult to excel high enough on the retailing basics in order to overcome this bad impression.

FINAL THOUGHTS
Sometimes, I think many retailers spend too much time defining themselves in terms of what they sell rather than who they serve. If a retailer were to focus more on pleasing a particular type of customer, they may find many more opportunities to profitably sell many more things which they would never dream of doing if they defined themselves by some narrow product category.

Successful Retail is about making PAR (part 1)

THE STORY
According to the Online Etymology Dictionary, the origins of the English word “par” comes from the Latin word par, meaning “equal” or “that which is equal.” In 1632, the word par in English still had this original meaning.

By 1767, the meaning of the word in English started to get modified. Par now was also used to mean “average or usual amount.” Its still similar, but not exactly the same meaning. Now, par was being limited to equality with normalcy.

The first reference to using par in reference to golf can be found in 1898. The idea here was that this was the normal amount of strokes it would take the average golfer to make the hole.

This golf usage then broke away from golf around 1947, when people started using the phrase, “that’s par for the course,” referring to that being normal behavior for someone.

Of course, nowadays professional golfers have gotten so skilled that to accommodate them golf courses have become ever more difficult to play in order to achieve “par.” As a result, par is no longer what a typical golfer achieves. Heck, even the great professionals of golf often have trouble achieving par these days.

So the meaning of par is morphing into more of an ideal state of performance, rather than an average performance. In other words, achieving par on the course makes one better than the masses. And so now, par is starting to imply that you are “unequal” and instead superior. So, in the span of less than 400 years, the term has moved from “equality” to “inequality.”

THE ANALOGY
In retailing, it used to be that if you did well on the basics, you would be successful. The basics of retailing are to have the right items in stock at the right price with enough efficiencies so that your cost of doing business was less than your markup from wholesale.

However, just as golfers have gotten better over time, so have retailers. Similarly, just as golf courses have become more difficult, so has the playing field for retailing. As a result, merely being good at the basics of retailing is no longer enough to win. Mastering the basics of retailing is merely the minimum level needed to make the cut and survive to play another day. It does not ensure success.

To get to the higher performance of the newer, more stringent retail par, one must add to the mastery of basics additional skills. It is the only way to achieve the superiority required to be a winner.

THE PRINCIPLE
What are the additional skills required to achieve this more stringent level of par? Well, I used the term “par”, because it is a useful acronym for the three skills one must add to basic retail mastery. Those three skills are:

1. Personality
2. Advocacy
3. Respect

In today’s blog, we will cover personality. In a subsequent blog, we will look at Advocacy and Respect.

1. Personality
When I first went to work for Best Buy in the late 1990s, I was given the results of some research that had been done a few years earlier. This research was asking consumers their opinions of various consumer electronics retailers. At that time, there were a large number of good-sized consumer electronics retailers in the US, including Circuit City, Best Buy, Highland, Silo, Fretter’s, and so on.

According to this research, most consumers saw these retailers as all pretty much the same. They felt they all had about the same variety of products at about the same price. There was very little to make anyone stand out from the crowd.

When asked to ascribe a personality to each of the retailers, most of the people surveyed drew a blank. The stores were viewed as so bland and similar, that they did not have any distinguishing characteristic on which to base a personality. The one exception was Best Buy. At the time, their advertising included a character dressed up in a costume to look like a giant Best Buy price tag. This character did some silly things interacting with customers which made Best Buy (the company) appear more human and more likeable.

As a result, Best Buy was the only retailer in the survey to get a meaningful number of positive personality responses. (Note: the survey comments showed that many respondents referred to the guy in the price tag as the reason for giving Best Buy the positive personality) So with everything else being relatively equal, Best Buy got an edge in “likeable personality” which became a sort of tie-breaker to shift business towards Best Buy.

I believe that this edge in personality was one of the key factors which started to shift the momentum towards Best Buy. Best Buy was able to take advantage of that momentum to build an even stronger business. Conversely, most of those other retailers (who were relatively competent at the basics, but had no positive personality) no longer exist.

Customers have a large number of choices of where to purchase products. All of these choices are fairly good at meeting the basics of retailing. The weak players have already been eliminated. To stand out from the crowd, a retailer needs to develop a positive personality which they can own to differentiate themselves from the crowd.

Target spent years refining its cheap chic personality. It’s the cool kid on the block when it comes to saving money, and people like hanging out with the cool kid. This has made Target very successful and helped it survive the shakeout when nearly all of the other discount store chains went away. At the teen level, American Eagle Outfitters has built a strong, positive personality which resonates with that age level. Whole Foods is another great retailer with a great personality.

Conversely, many of the retailers that are struggling today have poor or non-existent personalities. The Gap has tried to be too many things to too many people in too bland of a way. As a result, it really doesn’t have a strong, identifiable personality. And I’ve personally done some research on the personality attributes given to K Mart. Let me tell you, they describe the personality as being like a classless bum with bad breath (along with a lot of other negative attributes). This is the type of personality you do not want to be associated with (and their sales trends reflect this).

And this gets to the crux of the issue. People like to hang out with people who are similar to themselves or are like what they aspire to become. The same applies to the stores people want to hang out at.

The personality of the store reflects upon the people who patronize the store. If the store is cool, then my being there makes me appear more cool. If the store is considered wise and caring about the environment, then my shopping there will make me appear more wise and caring of the environment. If the store is considered rebellious, then I am more rebellious if I shop there.

The idea is that people prefer stores whose personality reflects their own personality.

We make a statement with our choices of where to spend our money. We want our peers to think better of us (and we want to think better of ourselves) based on these statements. The personality of the store impacts those statements. As mentioned in a previous blog, the personality of the name on the shopping bag you carry in public reflects on you and changes behavior as well (see "Pride of Bag").

Finally, if a store has a positive personality, it tends to create greater store loyalty. If you are seen as just a bland store selling what everyone else sells at about the same price, there is little reason for the customer to remain loyal. It is easier to walk away from a lifeless store than it is to walk away from a store that seems alive—like a friend—because it has a personality. There is more of an emotion bond when there is a personality. That bond helps keep people more emotionally attached to your store.

SUMMARY
In today’s world of retailing, the stakes are very high. Practically all the retailers who are left are pretty good at mastering the basics of retailing. Just being good at the basics is not enough. If you are a retailer, you have to elevate your game to a higher level in order to create the kind of superiority which makes one stand out and become a winner. That requires a mastery of PAR (personality, advocacy, and respect).

Regarding personality, the creation of a strong, positive personality for your store will give you an edge. People prefer shopping stores which have a personality which reflects well upon their own personality. The old saying is that you put your money where your mouth is. It is also true that you put your money where your personality is. Personalities also increase store loyalty, since emotional bonds are harder to break than rational ones.

FINAL THOUGHTS
One of the great things about personalities is that there are a variety of personalities to choose from. This variety allows you to choose a personality not already taken in the marketplace, so that you can stand out and be unique. This can be a lot easier than if there was only one desirable personality and you had to continually fight everyone else to gain temporary superiority in that same area (which, by the way, is a good reason not to pick the same personality as the leader when choosing your personality).

Building & Tearing Down Walls

THE STORY
In order to earn money while in college, I spent some time doing heavy labor. One time we had to tear down a sturdy brick wall inside of a building. The only tool we had was an incredibly large and incredibly heavy sledge hammer.

We took turns whacking at the wall with the sledge hammer. You would whack at the wall until you were exhausted, and then hand the hammer to the next guy. He would do the same, and so on. Eventually, the sledge hammer would get back to you and it would be your turn again to whack away at the wall. I have never been so exhausted and sore in my life as I was after that day was over. And after all that effort, we only made a small hole in the wall.

Another time, I was on a team helping to build a wall, although I did not get to have any of the fun part. My job was to haul the cement in buckets to the site where the wall was being built. The cement was outdoors. The wall was being built on the interior of the second story of a building. So I had to spend all day carrying these buckets up flights of stairs. Let me tell you, wet cement is very heavy. By the end of the day, I thought my arms and legs would never stop being in pain.

So the next time someone says that something is as solid as a brick wall, trust me—those walls are very solid.

THE ANALOGY
Strategy is like a journey. It is the art of finding a way to get from where we are today to where we want to be tomorrow. In business strategy, we tend to focus on creating the path we want to take. This is good, since blazing new trails can lead to great reward. However, as any trailblazer knows, after you do the hard work of creating a path where none existed before, others will start walking down that path you worked so hard at.

You may have invented a great new retail concept only to see someone else copy it and build out a successful chain faster than you. You may have worked hard to invent a new kind of drug and then see others make similar copycat formulations.

Studies have shown that being a “fast-follower” can be a very profitable way to go. For years, Coca Cola was successful by watching others experiment in the beverage space and then quickly copying what appeared to be catching on. Because Coke had superior distribution channels, it would win the battle. RC Cola invented cola in cans, diet cola, flavored cola, and so on. Coca Cola let RC do all the hard work of blazing the trails, and then swooped in to take all the profits.

Microsoft used a similar philosophy over the years. It would watch for developments in their space, like Netscape, and then be a strong fast follower with their own products, like MSN. The idea is to let someone else spend all the money and take all the risks on innovation, but out battle them on who ends up getting all the market share for that innovation.

So if you are an innovator, you need to do more than just focus on blazing the trail. You also need to spend some time building some walls. You need to build impediments to others so that they cannot just waltz down the path you built. As mentioned in the story, it is very difficult to tear down walls. It will slow down the competition as they try to chase you.

Yes, building walls can be difficult as well, but the effort can often produce great benefits by slowing down others who would want a piece of the fortune you are designing.

THE PRINCIPLE
The principle here is to incorporate into your strategy a comprehensive approach which not only makes it easier for yourself to get to the prize, but also makes it harder for others to do the same. We’ve touched on the need to concern one’s self with the competition in other blogs (see “Bombs Start Wars” and “If You Can Open the Door, So Can Others”). This time the focus is on designing ways to keep the competition from getting the upper hand in the race for market leadership.

Here are some ways to build those walls that will help your cause by not allowing others to catch up.

1) Speed to Capacity
It is usually not enough to just be good. In most cases, one also has to be fast. Speed is necessary, because of limited capacity, be it capacity in the supply chain or capacity in the mind of the customer. Take retailing, for example. If you have a great new retail concept, one cannot afford to be slow in rolling out the concept to multiple locations. Potential competitors may visit your store and copy it faster than you can roll it out yourself. There tends to be a relatively fixed capacity of how many stores a market will hold. The more you let a competitor build stores in a market, the less capacity there is for you.

Let’s say that a market can hold three stores. You build a single store in the market, thinking that will be very profitable. But what if the competition builds two stores in the market? Now, you may be locked into an inferior position in the marketplace. What if you own one city, but the competitor surrounds you by owning the rest of the state? Eventually, they will win the war of attrition. A similar situation occurs in packaged goods where the rush is to soak up the limited shelf capacity in the stores. If you own all of the shelf space, it is hard for others to attack you.

The customer’s mind has limited capacity as well. The first one to penetrate the mind as owning a position will get the credit for that position, whether they invented it or not. Everyone else will be seen as an impostor. Therefore, it is important to act quickly in order to be the first to claim the position in the mind of the customer.

Once you own the capacity in the field and the capacity in the mind, you have erected a difficult wall for others to tear down. The sooner you ramp up, the stronger your wall will be. Get out of test mode as quickly as possible and ramp up to outpace the competition in the growth mode.

2) Exclusivity
Competition has a tougher time attacking you and taking away your progress if you have created exclusivity for yourself. Maybe you can create exclusivity for yourself in obtaining some key manufacturing resources, like specialized computer chips. Perhaps you can create exclusive arrangements for yourself with key retailers. If you can create a strong, exclusive network with all of the other major players in the supply chain, then you force the competition to utilize an inferior network. When you “lock up” an exclusive arrangement, you have turned an open door into a locked wall. Exclusivity can be a huge wall.

3) Loyalty
The more you can lock in a customer to be loyal to you, the harder it is for a competitor to take them away. Loyalty programs which reward customers for increasing their business with you make it harder for them to leave, because they have to abandon not only you, but the rewards they were getting. The higher the wall you can build around “switching costs” the less likely a customer will switch to someone else.

4) One-Upmanship
If you can always stay one step ahead of the competition, then you are forcing the competition to always be one step behind. The Japanese automakers have been doing this to the Detroit automakers for years. Just when the Detroit firms think they have caught up the Japanese on some factor, like quality, the Japanese firms up the ante by moving on to the next improvement, like fuel efficiency or luxury.

The worst thing to do is to stay in the same place. If you don’t keep raising the bar for success, someone else will pass you by and create a new level of superiority. Reinvest some of the profits from being ahead into innovations that will make it even harder for others to catch you. This creates a situation so that when competition thinks they’ve finally torn down your wall, they will be disgusted to learn that behind that wall they just eliminated you built yet another wall for them to tear down.

Take time from your busy trail-blazing schedule to ponder ideas that can keep you one step ahead of the competition. For more on this, see the blog “Genius Sleep.”

SUMMARY
Sometimes, we can get so caught up in trying to move forward with our own company’s agenda that we forget to consider the ways in which competition can benefit from our strategy as much or more than we can. Unless we incorporate wall-building into our strategic process, we may be blazing trails which others use to get greater success than we do. Incorporate ways to increase your speed, suck up capacity, create exclusivity, increase loyalty, and stay a step ahead.

FINAL THOUGHTS
If you are not very good at building walls, then perhaps you should not have a strategy that is overly dependent upon innovation. Instead, you may want to become the fast follower by focusing on ways to tear down walls.

X-Ray the Balance Sheet

THE STORY
Imagine that you were asked to judge a beauty pageant. However, after you accepted, you were told that you would not be able to see any of the women in the pageant. Instead, all you would be able to see were X-rays of their skeletons.

Well, there’s a few things you can tell about beauty from looking at the X-rays. For example, you can check the spine for good posture. In addition, beauty pageant winners tend to be tall and have high cheek bones. You can check for those on the X-rays as well.

However, there are many things the X-rays cannot tell you, such as skin tone and the amount of fat on the contestant. Even more important, X-rays cannot tell you if the contestant has a winsome personality, poise, or a winning smile. You cannot hear them speak or see them walk. It is all of these subtleties which create a true pageant winner.

So the X-rays may be able to eliminate obvious losers, but by themselves are inadequate to determine who the best winner should be. At some point, you have to just narrow the choices and guess.

THE ANALOGY
A lot of business strategy these days revolves around buying and selling companies. In many ways, these courtings between buyers and sellers are a lot like beauty pageants. This has been especially true lately with all of the activity by private equity funds, hedge funds, and the like. These funds look at thousands of companies to find who they want to crown as that beauty they then try to purchase.

How do many of these firms find the time to look at so many different companies? In part, it is done by narrowing the focus to published financials. They pour over hundreds of thousands of numbers, looking for patterns that could lead to easy profits.

Finding the right takeover target just by looking at financials is similar to trying to determine who should win a beauty pageant by only looking at their X-rays. Sure, a balance sheet can tell you how strong an underlying business structure is, just as an examination of a skeleton can tell you how well a person is structured. But true beauty is more than just structure.

The subtleties of a smile, a personality and a walk can overcome a slightly less than perfect skeleton. Similarly, if a balance sheet is examined without looking at the subtleties of the business, you can miss a lot of the features which can truly make a company great (or truly ugly).

THE PRINCIPLE
The principle here is the risk of an over-reliance on numbers. Over the last year, I have had the opportunity to interact with some of those private equity funds and hedge funds. They all seem to have some of those quantitative geniuses in their organizations—people who are experts at dealing with numbers. It is scary how smart some of these people are, at least when it comes to looking at financials.

When they look at a set of numbers, they can see all sorts of business issues, just like a medical expert can see all sorts of things when looking at an X-Ray. Unfortunately, to many of these quantitative experts, the numbers are really nothing more than abstract concepts. They really do not understand the subtleties behind how the numbers are created. They can see a bad gross margin, but have no idea how to turn it into a good gross margin.

Because they look at so many different kinds of businesses, they often become experts in none of them. It’s all just a bunch of numbers and the trick is to find a combination of numbers which can be easily tweaked for profit, regardless of the industry.

After these firms get done looking at the numbers, some of them then go to management to get “comfort” with all of the subtleties behind the numbers. To me, this is a lot like asking a sleazy used car salesman to give you comfort that his promises about the car he is trying to sell you are true. There is a reason why my wife always takes a used car she is considering purchasing to an auto mechanic she has known and trusted for years. This mechanic has pointed out things the used car dealer was trying to hide, saving my wife from making several mistakes.

Why go to all the trouble to do your numerical homework and then drop the ball on the other aspects of success? This is like getting your act together on how to haggle over price on the used car without knowing whether the engine is in good shape.

In the beginning of the current rush to private equity, knowing just the numbers may have been enough. However, times have changed. There are many more firms bidding up the price and it has gotten a lot harder to find cheap money with which to do a deal. The margin for error has gotten less favorable. It is riskier. Now you cannot “manufacture” enough profits just through clever financials. You also have to “earn” them through superior execution of a sound operating plan.

There are many firms out there that “get it,” including firms like Cerberus. Cerberus employs a lot of operational experts full-time, people who in the past have been successful CEOs of large companies, or bring other types of operational expertise. This allows Cerberus to see beyond just the X-ray of the balance sheet and get to know the full personality of the beauty they are courting.

A similar problem exists in the firms which build those massive mathematical models for stock trading, typically referred to as quant funds. The reasoning was that if you churned through enough numbers quickly enough, you could beat the system. However, as the Wall Street Journal pointed out last Tuesday, these funds have done poorly in the volatility in the market of recent weeks.

According to the WSJ column Ahead of the Tape, the quant funds were playing with some of the same math as the private equity and LBO firms. This doubled the riskiness of what was going on, so that when the credit crunch squeezed the LBO gang, it also busted the math of the quant funds. What the columnist found particularly amazing was that the quant funds were so focused on just the numbers, that they missed the whole concept of how their fate was tied to the LBO boom, something easily seen by those with their heads out of the spreadsheets.

To quote Ahead of the Tape columnist Scott Patterson, “Many quant fund managers now seem to think that their models will start working again soon enough. But if the models proved flawed this time, who’s to say they won’t be proved flawed again?”

SUMMARY
Understanding numbers is critical to success in forming business strategy, particularly as it relates to buying and selling companies. However, if one only looks at numbers, one can be deceived about what is going on behind the numbers. A more balanced approach is needed which looks into the subtleties of success. Just as beauty queens are more than just a good skeleton, great strategic deals need to rely on more than just number manipulation.

FINAL THOUGHTS
Mergers typically do not fail because the number gathering was flawed. It isn’t because of a glitch in a formula on a spreadsheet. Instead, mergers typically fail due to people issues, cultural integration issues or an insufficient understanding of the nuances of business acquired. It is the very things that are hard to place on a spreadsheet which can make or break the deal. Why don’t we spend as much time on these other issues as we do on the number gathering?