How can you stop short term choices from crippling long-term value?


As more bad news about Wells Fargo’s practices emerge,  the stain transcends CEO Stumpf’s  reputation. Warren Buffett opted to wait and comment knowing that he himself needs time to sort through his own internal review process.

It’s not just Stumpf who needs to believe that the “cancer “found in the retail bank was its source. The Gr8 prorgram setting very high bars for growth with 8 interconnected accounts per customer delivered results but discovery of the ill effects  proceeded much slower.  It took years and then the decision to remove the malignancy—firing of low level employees and managers—what made management believe this toxic behavior didn’t spread?

Well that’s naïve, if not ridiculous, isn’t it? Elizabeth Warren made clear that an organization must remain accountable to its customers more than its shareholders, no matter how large or successful it becomes. Somewhere along the line Wells Fargo, Samsung, Chipotle, VW, and GM all made similar high profile mistakes.

Speed to market may appear an appropriate competitive response but not if short-cutting quality results in shortchanging business value.

Bottom line the antenna in a business can’t be only tuned in for reward especially since it often means the business misses the risk signals. The obsession for rapid growth isn’t just blinding good judgment shows in ignorance of the environment and its complexity.

Interconnected digital networks absolutely create a speed advantage. But speed needs to be managed, and adjustments made to acknowledge the additional risk it creates. Ask the NASCAR drivers what precautions they take that are absent in other environments, or the Samsung engineers who knew they hadn’t done enough testing to properly advise the risk management team with information that prepared them for the inevitable fire.

Pull not push

The Internet made it easier than ever for consumers to find anything, anywhere, and at anytime. Businesses and sales people need to adjust and adapt to accommodate these more informed buyers. At the same time management goals or quotas must recognize changes in the environment, but looking more broadly at the inevitable interactions and the change in likelihood that they will occur.

It may be a cliché, but it isn’t true that what got you here will get you farther. What worked in the past works differently today and will work in another way in the future. The trick is to find the part that is essential and remains critical. Water does seep to the lowest level, but technology advances have created stronger more resilient and resistant containment mechanisms that alter the impact.  Don’t wait to understand them until it’s too late.

Start by answering these questions to the satisfaction of your leadership team and board.

  • How does your management team leveraging or limiting the new levers of change?
  • How does social media, sensor networks, big data and cloud computing alter the behavior of your customers?
  • What risks to your bottom line do they introduce?
  • What steps have you taken to mitigate and or adjust your targets to assimilate them?

Create value by sticking to principles and collaborating

I’ve been reading and writing a lot about creating value.  Value creation is what sustains our spirits as well as insuring us a livelihood. It preserves quality in our relationships as well as justifying our existence.

Does creating “shared value” accomplish the same thing?  creating value

A recent headline in the Financial Times challenged the premise of Michael Porter and Mark Kramer’s ideas on creating shared values caught my attention.  Corporate Shared Value, (CSV) conceptually seeks to align social impact and company success.  A very noble goal, akin to what John Mackey, the CEO of whole foods describes as Conscious Capitalism.  Andrew Crane’s Financial Times article merely wishes the CSV theory found its way into execution and not corporate report window dressing and lip service.

15 years ago, Frederick F. Reichheld  and Thomas Teal working for Bain Capital discovered that too few growth strategies successfully drove profits and explained competitive advantage. Since the traditional profit drivers failed to explain the discrepancy in performance, they turned to study costs.  Their research delved into a firm’s relationship between customer duration and its cash flow  and found the relationship also differentiated advantage. As they had eliminated one metric after another their discovery proved that value starts with building loyalty, growth follows and then profits result. Dual loyalty, they explained isn’t merely the reciprocal relationship between a firm’s leadership and its customers.  The duality extends to employees and includes relationships with investors.The Loyalty Effect: The Hidden Force Behind Growth, Profits, and Lasting Value published in 2001, detailed this research.  For businesses to focus and sustain this value creation process, the authors recognized would require fundamental changes in business practices including new ownership structures.

Porter and Kramer’s CSV theory in part recognizes a similar fundamental shift in business practices.  Their focus seeks to compensate for the historic failure of accounting balance sheets to report and record shared value as an asset.  Is it an output, or is Shared Value part of a  larger social movement?

Mark Cheng, Director of Ashoka UK and Ashoka’s senior advisor on social finance  explains the challenges in this article that appeared in Forbes, How Philanthropists And Investors Can Work Together To Create Social Change. He suggests, that trying to build a social innovation isn’t a company but a social movement and that’s why it requires very different investments.

To change consumer behavior whether you plan to build a new market or a social movement requires organizations to earn people’s loyalty to principles.  Reichhold and Teal explain these learnings as necessary to properly differentiate between creating measurable value and creating profits.  Porter and Kramer hope businesses will value social progress, but this alone won’t re-legitimize a business. A verbal commitment to value can’t create the cost-benefit advantages necessary to sustain the firm.

Social forces of loyalty can and often do bind customers, employees and investors. Indeed they serve as measures of  cash flow and indicate a company’s ability to deliver superior value. The interlocking set of a firm’s operating principles creates both a cause and effect which satisfies, inspires and engages all stakeholders to sustain the firm.

Alternatively, a collective solution and collaborative mindset that aligns around a broader set of principles or values clearly stated presents an opportunity to create shared value. Because the concept of shared value offers people the means to take part with the resources of a firm, these mechanisms also share in, and contribute to, the success of the wider social movement.

Cheng explains that different funders should rightly have different roles.  A social business partnership between a business enterprise and an NGO doesn’t have to compromise or tradeoff its economic goals for the benefit of social good.  Using philanthropic funds to cover start-up costs for the shared venture and utilizing the distribution prowess of the corporate entity is one way to make win-win social impact possible.

Social progress is difficult to achieve by a single player, however a shared operating model based on sound principles can be adopted and replicated to spread the changes more widely.  The goal for the business may be self-interest,  where self-preservation will be a result of its underlying value creation principles and relationships.

To win the game, we have to change the game

I can’t imagine the pressure on a CEOs when their organization misses the targets t120918053535-out24-shareholder-value-gallery-horizontalhey set for themselves.  How can they not take the failure personally?  More importantly, how do they turn the fail into opportunity?  Frequently, they publicly declare to the world renewed commitment to their strategy, reassure everyone that  management  knows what it’s doing and asks stakeholders to have a little faith.

A glorious future beats a glorious past.

This past week, Warren Buffet of Berkshire Hathaway released his annual shareholder letter and so did another hedge fund billionaire, Edward Lampert, the Chairman and now Chief executive of Sears Holdings comments.  2012 was tough on both companies.

Buffett reminded shareholders of his long-term management contribution:

“Over the last 48 years (that is, since present management took over), book value has grown from $19 to $114,214, a rate of 19.7% compounded annually.”

Lampert acknowledged his pride in the company associates for their resiliency in 2012 and then expressed the following:

“After reporting poor results for 2011, culminating in a very poor fourth quarter, we declared that we would take significant actions in 2012 to restore confidence in and financial stability to the company, while, at the same time, remaining focused on transforming Sears Holdings and creating long-term value for our shareholders.”

The vast differences between the diverse portfolio holdings of one  make comparisons to a single narrow industry portfolio holding company difficult, but it’s the philosophy of these two successful financiers that caught my attention.  Buffet’s reputation and success remains untarnished as he acknowledges sub par performance, meaning below the returns of the S&P 500.  Likewise, Lampert’s nod from his board to take the CEO reigns indicates their great faith in his judgment.

Both of these leaders inspire others to believe but how much do they expect shareholders to understand?  Rereading both of their letters, a wonderful clarity of mission and dedication to longstanding strategies can’t be missed.

Buffett draws readers attention to three elements that unlock the portfolio’s Intrinsic business value: one qualitative and two quantitative measures–per-share investments and per-share pre-tax earnings from businesses other than insurance and investment.

Lampert talks about creating long-term business value with an interesting description of EBITDA.  He shares an analysis of  value added by closing non-performing stores that reduced investment in non-performing stores but provided upside when the real estate sold.

An initial read shows just how similarly these two financial wizards think.  But who needs inspiration? How will sharing beliefs in these fundamental principles help hold the relative  position?

Which rubber and which road matter

Theory doesn’t always make for good practice and now matter what plans you make, until put into motion it’s impossible to know the results. The best predictors can’t incorporate every possible condition and inevitably some expectations go unrealized.

That’s where belief really counts. Funny, ever wonder why people believe what they believe?  It turns out that believing doesn’t require understanding; but it does color our interpretation.  Make believe, the imaginary is anything but real. Our beliefs and the way we interpret or make meaning of our reality is largely but not exclusively determined by the most recent experience and current context. This is the Halo effect at work which predisposes us to favor what we believe and what we first hear or see.  No experience? Ambiguity gets resolved unconsciously, consistent with context.

The more diverse  and numerous our experiences, the greater the number of differences or nuances in our understanding which results in unpredictable results.

Change the frame or limit the context of shareholder value to  financial expressions like EBITDA will reduce the variance in meaning. Formulas and standard accounting practices assure investors of an equivalence which makes EBITDA meaningful regardless of their depth of understanding, while also increasing the power of their belief in the financial measure to provide great meaning.

But accepting an idea doesn’t mean we believe it. Ever take a test that resulted in a wrong answer?  Perhaps, you asked why your answer was wrong, convinced you had it right.  Maybe your answer didn’t match the expected answer and so the first evaluation was incomplete.  Your answer didn’t make sense to the grader though it was still correct. An equilateral is both a square and a rectangle. Since different experiences lead to different beliefs both generate even greater diversity of understanding.

Big ambiguous ideas like shareholder value may be easy to believe but harder to understand and harder still to set clear, consistent actions into motion.Easy to measure share holder value at a point in time, but CEOs tasked to deliver it going forward need to provide greater clarity, less ambiguous and more specific associations and not risk letting recent experiences or context prove its meaning. What actions does the CEO wish to inspire, what associations does their message need to imply or offer guarantee?

Shares imply ownership and the value suggest material wealth.  For Berkshire Hathaway, a shareholder owns parts of lots of different companies with an assurance based on Buffets statements and reputation that their wealth will grow.  For Sears Holdings? Shareholders own a portion of physical tangible business components that are much harder to guarantee growth.

Align beliefs with understanding

If I yell Fire, everyone reacts almost immediately and reaches the same conclusion–flight.  There’s no visible delay between the declared message and the actions it produces.  The brain wastes no time finding the best match and cues our nervous system and muscles to respond.  No conscious awareness of decision or choice seems at play, move first,  think later. The instantaneous assessment of the environment places Fire in context, and fits a pattern in our memory, and a complete script presents itself making our next moves clear.  We are off following it without questioning its veracity, or applicability. We pay attention to what the script tells us not the ambient information surrounding us, unless of course that information boldly interferes with the expectation found in the script.

Simple question, which scenario came to mind for you?

1. I yell fire when the tinder in the hearth finally catches, and you left the fire pit at the campground to go find matches or more kindling nearby.

2. I’m cooking over a grill and yell Fire when the grease from the chicken has dripped off the foil, landing on the hot coals.

3. I yell fire when I smell something burning and see smoke in great quantities billow around the curtain on the stage in front of us.

I’m betting that your imagination took you to scenario three, the one that represents a scary, fearful situation. Especially since the idea was raised in a wider discussion of shareholder value or returns, a topic that triggers a similar set of automatic reactions depending on the experience or understanding of the listener.

The financial media pundits provide language that makes sense to their readers without appealing to the experience or context of employees or customers.  Our word choices even with the best of intentions don’t guarantee translation of similar expectations and in the case of shareholder value don’t make it easy to make a move without understanding more.

Leaders use of language creates expectations across a diverse set of audiences with vastly different understanding.  To get the people in your organization to produce the necessary EBITDA should the burden of understanding be drilled down to the lowest level of the organization?  Telling them about the challenge or demanding the performance may set the expectation, but leadership needs to do more.  They need to engage in the language and experiences that will trigger the scripts and make it possible for employees to believe their doings and their actions help. I have faith that Lampert is on the task.  It was his words that inspired this post.  His articulation of the convergence of new behaviors made possible by technology supported knowledge, a  complex transformation experience currently shared by many businesses.

Lampert isn’t the only one with an offensive strategy attempting to get out ahead of the curve.  JCPenney, Best Buy and now Barnes & Noble are all experiencing the loss of faith by shareholders that parallels the lost faith of their customers and employees.  As Buffet remarked in his letter, this is not a time for waiting.

“The risks of being out of the game are huge compared to the risks of being in it.”

Lampert’s plans?

“…we will use technology and training to encourage and embrace feedback to improve and make it much more transparent to everyone, thereby increasing accountability at the store and associate level.”

Both of these successful men know what can happen when you yell Fire.  Let’s just hope that the script that gets activated keeps their stakeholders on the same page.  Challenging but not impossible.


Can investment capital return a community?

Mutual funds pool funds collected from many investors to invest in a set of instruments in trying to produce capital gains and income for the fund’s investors. Typically, a professional money manager, whose job optimizes returns and minimizes risks, selects a group of specific instruments, stocks, bonds, REITS etc.  based on a set of key objectives.  Of course without risk there’s no reward. So high risk funds pay higher returns unless of course the risk gets realized.

Historically, private equity funds and merger and acquisition firms have been masterful at this game and consequently their earnings have been quite generous.  Among these firms Kohlberg Kravis and Roberts (KKR) and Goldman Sachs continued survival adds to their legend, so why are they dabbling in the mutual fund market?

FRANCESCO GUERRERA writing for the WSJ August 13, 2012 offered this explanation.

“KKR’s first two mutual funds will have much lower barriers to entry, probably in the $2,500 range. But they will invest in the likes of distressed debt and “junk” bonds, assets that can earn juicy returns and/or sleepless nights.”

No surprise, that to meet growth expectations , you have to assume some risks.  KKR choice of risks caught my attention as they plan to invest in distressed businesses and bolster assets expecting that the returns and  annuities generated will permit them additional investment options.

Goldman Sachs, like KKR , announced they will  create mutual funds to increase and diversify their funding base too.

“For Goldman, the goal is to curb its reliance on capital markets’ funding, thus reducing the risk of being caught short….”

I remember the 1980s well, when the junk bond kings reigned creating derivatives to swap debts and their subsequent fall when insolvency came to companies over leveraged.  Today’s landscape riddled with debt appears similar.  Unlike the 80s, today’s professional investors must temper investor risk a little differently.  Perhaps government should  sell EPA cleanup deals, why not, if you agree to pay to clean up a toxic site then you can have it.

Well, the straight swap of risk for assets doesn’t work that way does it.

So when a long neglected real estate situation came to my attention, I wondered why it has failed to prove golden.  The Rosenwald homes on the south side of Chicago, just north of Hyde Park where President Obama retains his private residence,  found a place on the historic registry and though once very beautiful, now sit vacant deteriorating for close to 20 years.   This full block, long abandoned residential building challenges the surrounding neighborhood’s  economic viability .

What if they succeed in cleaning up the site? What if the investment does restore it and the surrounding community?  Estimates of restoration costs greatly exceed any possible long-term payout. In other words, how long will investors wait to get some payback?  If property values rise, then the sale of the property would have to recover the investment in cleanup costs but also the debt service costs.  Today’s property valuations are close to zero, especially because the abandoned site serves as a crime magnet. The security costs and the demolition costs exceed the land value.

Hey Goldman Sachs, or KKR, you willing to buy in?

Prediction and Understanding

All things “new” fascinate us.  Of late,  the business world’s growing excitement about Big Data and its analytic modeling seems to turn up surprising results in interesting places. Predictions mesmerize us, they offer us control in the midst of uncertainty and fool us to believe we understand things more completely than is possible.  The models used to predict an outcome are often confused with underlying mechanisms responsible for the outcome.  Models fuel discovery and yet we get cocky when we rely wholeheartedly on a built model’s power and accuracy.  Risk doesn’t disappear and its infrequent appearance merely challenges our ability to prepare adequately and only in hindsight differentiate the early warning signs.  This is what int he trade we call differentiating signal from the noise and is the focus of Nate Silver’s book.

Power to Predict

In finance, or physics circles the fascination around models is anything but new. Isn’t the primary purpose of analysis and model building discovery or greater understanding of causal relationships and interactions? Observing physical properties of planets helps us make sense of their movements and  explain other observable phenomenon. The notation and models provide insights into other activities and data collected in other settings.  These scientific modeling techniques when introduced into social science formed the basis of understanding economic behavior and a framework for a series of policies governing the money supply to welfare.  Once operating in obscurity, the mathematically trained analysts and modelers impact on society continues to ripple into ever-widening arenas difficult to miss.

Michael Lewis earned his living as a quant on Wall Street. His dual talents manipulating numbers and words led to his successful book Liar’s Poker.  Complexity found a voice and Lewis continued to seek out and tell more stories about the quants in multiple settings. Perhaps it was the popular success of MoneyBall, that attracted the popular interest. I admit I’m an ardent fan.  Michael Lewis and his wonderful story telling ability around number problems, shared how the Oakland As made the playoffs using statistics for competitive advantage. Among the collected stats, the story revealed those overlooked by scouts the Oakland As valued, making it possible for them to compete effectively against baseball teams with much larger budgets.

In Presidential Elections, during 2008 the baseball stats model maven Nate Silver demonstrated how a command of statistics can improve the quality of a candidate’s campaign.  By 2012, his success garnered him personal attention as author of the New York Times 538 column while further upping the fascination with applied statistics in new arenas.

Leonard Mlodinow,  a trained physicist himself, in his sympathetic review of Silver’s new book, shares his frustration with statistical shysters.  “The Signal and the Noise,” Silver shares “… studies show[ing] that from the stock pickers on Wall Street to the political pundits on our news channels, predictions offered with great certainty and voluminous justification prove, when evaluated later, to have had no predictive power at all.”

Quality Thinking

Andrew Hacker’s review of Silver in The New York Review of Books caught my attention when he questions James Weatherall’s intention as author of The Physics of Wall Street and  exposing a different expectation.

“…the assumption that the quality of our thought can be enhanced by new methodologies.”

Certainly, Hacker’s impressive eloquence helps; but invoking quality in reference to thoughts struck a visceral chord.  Variety and range implied by differences in quality intrigue us.  They make the world more interesting.  At the most basic level, variety compels trade  and incites desire for around diversity.  Frequently, recombining ideas defines innovation but does either necessarily signify progress, reflect higher power thinking,  or even spread benefits more widely?

Variety in objects or tangible goods naturally reach their limits and so too does our tolerance for diverse ideas.  In products, declining sales makes the limit recognizable in hindsight.  In ideas, their displacement provides some evidence of their limited appeal as in the transition to capitalism in the communist bloc or the return of Islāmic fundamentalism in the middle east.

Does a valued quality suggest our preference associates with a higher ranking of an object or an idea? Naturally, higher ranking or rating indicates higher preference, especially when done consistently. For example, measuring liquid in litres vs. quarts does not enhance or detract from the quality of the liquid, the measure and the liquid’s qualities are independent of one another.  In the US, quarts are the culturally preferred volume measure and it persists for numerous reasons, some irrational, but few suggest higher power thinking.

Of late, I am reading Scott E. Page’s book entitled The Difference.  He provides a series of examples to  show the  added value produced when multiple perspectives and varying rule based approaches test a situation.  Page’s training draws on the work of social scientists in multiple disciplines and his examples, by design demand minimal mental arithmetic and can easily be scaled.  His fundamental premise challenges  higher order thinking as the ultimate value varying diversity, flexibility and adaptability as ultimately more useful.

Then again, utility or use as an idea in spite of its competitors continues to prove itself resilient over time and earthly situations.  I’m OK with some mystery, the unknowns that both Nate Silver finds challenging and James Weatherall believes his approach can resolve.  Big data regardless of the  measurement methods, analysis models and their possible recombination, I’m betting that diverse human preferences for truth will continue to prove self-limiting.  That’s what ultimately makes life and all its diversity interesting!