Tuesday, September 30, 2008

Company cloning – how to change a winning formula

I am sure many of you know some of the ludicrous examples of when companies expanded into a foreign market and failed to adapt to the local circumstances.* It can be because they didn’t adapt their product, their way of doing business, or even their name.

For example, United Airlines famously handed out white flowers on flights from Hong Kong, where white flowers represent death and bad luck. India’s M.P. Been Products was used to printing a swastika on all their products (a symbol of good luck in many far eastern countries); it did not go down well when they launched “German Pilsner”, while also Japan’s “Kinki Nippon Tourist Company” noticed it attracted quite some unwelcome customers when they first expanded abroad.

And it’s a problem of all time. Coca Cola, when entering the Chinese market in the 1920s with less than moderate success, translated the sound of its name into Chinese characters, only to find out later that it, fairly unappealingly, translated into “bite the wax tadpole”. Even further back, England’s East India Company just might have lost control over India in 1857 when it continued to supply bullets encased in pigs wax to its Indian soldiers; the tops of which had to be bitten of before they could be fired. Since it was adamantly against their religion to eat pork, it seemed to have greatly whetted their appetite for pacifism.

The message that always comes with these examples is: “Adapt to local circumstances, stupid!” Don’t just implement what you’ve been doing somewhere else, but implement an altered form of it; adapted to the local context.

Well, in spite of these examples, I am not so sure…

Organisations and their business models are incredibly complex systems, consisting of many tangible and intangible elements. And often we don’t quite know what is causing their success – and, what’s more, often people from the company itself don’t quite know what is making it a success... Take the phenomenally successful Southwest Airlines. Is their success due to their swift logistics, the standardization of their procedures, materials and airplanes, their coherent corporate culture, leadership style, recruitment procedures, etc.? We don’t quite know; probably a combination of all of the above (and more).

Take Starbucks. Is it so successful because of the quality of their coffee, the training of their personnel, the lay-out of their bars, the logistics of the coffee-making processes, the ambiance, etc.? Well… probably all the elements interact, and create the competitive advantage in combination.

The problem of such a complex system is that when you change two or three elements of it, you don’t quite know what will happen… Because all the elements interact, you may be screwing the whole thing up in ways you hadn’t anticipated and won’t even be able to untangle and understand.

Therefore, Professors Gabriel Szulanski and Sid Winter – from INSEAD and the Wharton School – recommend: “replicate”. That is, before even thinking about making local adaptations, copy exactly what you have been doing before at some other locality. Only once you’ve got it working, adapt it, very slowly, one step at a time.

Consider again Starbucks. It was originally replicated by its founder, Howard Schultz, modelled perfectly on an Italian espresso bar. “But it doesn’t look at all like an Italian espresso bar!?” you might shout. Very true. But initially – the first one in Seattle – it did. There was standing room only, full fat milk, opera music, personnel with bow-ties, etc. Only when Howard got that to work, he slowly started to make some alterations, through trial-and-error, one step at a time. Had Howard tried to make all sorts of adaptations right from the outset, it may not have worked at all.

Thus, rather than trying to create local perfection from scratch, first be cautious and modest: replicate exactly, get it to work to an acceptable level, and only then think about very gradually introducing some alterations.

* See, for instance, the book “Blunders in International Business”

Thursday, September 25, 2008

"Selection bias"

During World War II, American military personnel noticed that some parts of planes seemed to be hit more often than other parts. They analysed the bullet holes in the returning planes, and set out a programme to have these areas reinforced, so that they would be able to withstand enemy fire better.

This may seem natural enough but it also contains a fundamental error. It’s called selection bias.

Assume, for the sake of the argument, that planes got hit in all sorts of places. If the areas which formed vital parts of the machine were hit (call it part A), the aeroplane was unlikely to make it back to base; it would crash. If the bullets hit the plane in parts which were not so vital (part B), the plane was much more likely to at least make it back home.

Then, military personnel would inspect the plane and conclude “darn, this plane also got hit in part B! We’d better strengthen those places…”

Of course, the military personnel were wrong. Planes got hit in part A just as often as in part B; it’s just that the first ones never made it back home. What’s worse, strengthening part B was exactly the wrong thing to do: those parts weren’t so vital; it is part A which needed strengthening!

This is why we call it “selection bias”; we only see a selection of the outcomes, and therefore draw false conclusions. And the world of business is full of it.

Consider, for example, the popular notion that innovation projects require diverse, cross-functional teams. This notion exists because if we analyse some very path-breaking innovation projects, they were often staffed by such teams. However, it has been suggested* that diverse, cross-functional teams also often created the biggest failures of all! However, such failures never resulted in any products... Therefore, if we (only) examine the projects which actually resulted in successful innovations, it seems the diverse cross-functional teams did much better. Yet, on average, the homogeneous teams – although not responsible for the few really big inventions – might have done better; always producing a reliable, good set of results.

Similarly, we applaud CEOs who are bold and risk-taking, using their intuition rather than careful analysis, such as Jack Welch. However, risk, by definition, leads some to succeed but it also leads quite a few of them to fail, and slip into oblivion. Those CEOs we never consider; it is the risk-takers that happen to come out on top that we admire and aspire to. Yet, if we’d be able to see the full picture, of all CEOs, innovation teams, and fighter planes, we just might have reached a very different conclusion.

* See the work of Professor Jerker Denrell from Stanford Business School: Some of the examples used in this text are partly based on his work.

Tuesday, September 23, 2008

Banks’ blurry categorisations – have your cake and eat it too

"Animals are divided into (a) those that belong to the Emperor, (b) embalmed ones, (c) those that are trained, (d) suckling pigs, (e) mermaids, (f) fabulous ones, (g) stray dogs, (h) those that are included in this classification, (i) those that tremble as if they were mad, (j) innumerable ones, (k) those drawn with a very fine camel's hair brush, (l) others, (m) those that have just broken a flower vase, and (n) those that from a long way off look like flies."

This categorisation was quoted by Jorge Borges in his book Other Inquisitions, from an ancient Chinese encyclopaedia. Glad that in the world of business, when it comes to analyst recommendations whether to buy, sell or hold the shares of certain companies, we use rather more unambiguous classifications, don’t we! Or do we…?

Analysts, as you likely know, often face a potential conflict of interest. In principle, they are expected to offer solid and impartial advice on whether they think it’s worth buying the shares of a particular company (because they forecast that the share price will go up) or whether they think it is time to offload any stock you bought in the past (because they forecast that its price will go down). However, their employer – the investment bank – quite often also serves this company as a client, for instance to advice them on their M&A, equity and debt deals. The tricky thing is, companies don’t quite like it (and this is a euphemism) when their own investment bank issues a negative (i.e. “sell”) recommendation for their shares…

How do investment banks deal with this? In the past, I guess, they often didn’t. As research indicates, they would shamelessly issue a “buy” recommendation for a company just to secure them as a client. However, this is a bit tricky – to say the least – because the truth can eventually come out (we’ve seen examples of informal e-mail exchanges between bank employees in which they mock clients who they formally recommended to “buy”), brokerage watchdogs have become quite focused on such behaviour and banks’ long-term reputation may suffer if they make recommendations (e.g. “buy”) which later turn out to be quite wrong, loss-making and plain stupid.

So, how do banks resolve this tricky dilemma…? Anne Fleischer – an assistant professor at the University of Toronto – undertook an intriguing piece of analysis. She looked at ambiguity in banks’ equity ratings systems and how it was related to such conflicts of interest.

You have to realise that banks use different classification schemes, in their advice regarding the attractiveness of certain stocks, and these vary in terms of how ambiguous they can be. For example, “buy; sell; hold” is simple enough isn’t it? But many firms use 5 categories, including a “strong buy” and “clear sell” or so. Still pretty unambiguous, right? But what about “buy/high risk” versus “buy/low risk”; a bit trickier, not? Or “buy; positive; hold; neutral; negative”? Or what about the difference between “buy” and “accumulate” (also found within one and the same classification scheme)?! Some banks have up to 16 different categories, advising us to buy or not. But why would they create such opaque, blurry schemes to advise us in the first place?!

Might it have anything to do with covering their back when they face a conflict of interest…? Could it perhaps enable them to get away with not offering an unambiguous “sell” advice on a client (risking to piss them off) while in reality their analysts are quite pessimistic about the company’s prospects…? After all, if they recommend an unambiguous “buy” but the share price plummets, they will look incompetent if not worse. However, what if they had recommended us a “speculative buy”…? Guess that might divert the blame a bit and get them off the hook... Perhaps such ambiguous schemes help banks make blurry recommendations that keep both angry investors and overbearing clients at bay? Would banks really be that devious…?

Anne didn’t just think; she looked at the facts: She had some financial specialists rate how ambiguous the rating schemes were of 207 brokerage firms. Then she computed to what extent these firms faced a potential conflict of interest, because they were both providing purchase advice and securing the same companies as clients underwriting their debt and equity offerings or supporting their M&A activity. The results were clear: Those investment banks that faced a conflict of interest developed more ambiguous classification schemes to “advise” us on the purchase and sale of company shares.

Evidently, these equity rating systems are not just created with the aims of unequivocal advice and clarity in mind; quite the contrary, sometimes banks don’t want to create clarity at all. Blurring the boundaries helps them cover their tracks, make money on both sides of the table, and thus have their cake and eat it too.

Wednesday, September 17, 2008

Binoculars in the mist

My good colleague at the London Business School, Professor Don Sull – master of the analogy – often shows his classroom a picture of a sailor looking through his binoculars, saying “this is our traditional view of how we regard making strategy”: someone who is able to look into the future, and make a detailed plan of how to proceed towards a chosen destination.

However, the reality of strategy-making is quite different; it is more – according to Don – like you’re driving a car in heavy fog, peering through the window, trying to navigate around unexpected things that suddenly appear in your way.

I like and agree with his analogy. In pretty much all businesses, although you may know where you’re headed, the route is fraught with uncertainties and unexpected events. Technological developments, market demand, competitor actions, entrants, changing consumer preferences, the macro economy, etc.; nobody can discern with any certainty what lies ahead of us.

I’d like to extend Don’s analogy, of driving in heavy fog. Because we’re likely not alone on this road. We have competitors. And what do most of us do, when we’re sharing the road with other users in heavy fog? We concentrate on the lights of the car ahead of us, because it gives us some guidance, and we can rely a bit on the faith of the fella in front of us.

But, although it may make us feel more secure, is that really such a good idea? It’s only human I guess, but it sometimes also seduces us to drive faster than we otherwise would have done, just to keep up with the advancing lights. And, if the fog is heavy enough, it seduces us to drive closer to the guy than we may deem wise if we’d think about it. Of course, a multiple collision in the mist is quite common; we’re following the car in front of us, but that doesn’t mean that we can brake in time if he goes of a cliff, smashes into a tree or another car on the road.

That’s often how it goes in business as well. Competition is a race, but it’s also a race in the mist. Often, everybody ends up following the quickest competitor, bidding for 3G licenses, entering China, merging with IT companies, etc. But sometimes, everybody ends up with a big bump on the head.

However, of course, if you slow down, you might lose the race. So, what do you do, confronted with fast-moving competition? Well, do what you do when you’re driving in the mist. First of all, keep a healthy distance between you and the car in front of you. If he crashes, you still want to have time to stop. Secondly, if that car is driving faster than you’re comfortable with; slow down. He may get there faster than you, but he may also not get there at all. And sometimes that’s just not worth the risk.

Finally, don’t use binoculars. They will blind you. Rigidly executing a detailed long-term strategy won’t allow you to see anything unexpected in your way. You won’t be able to navigate around – let alone take advantage of – the opportunities and obstacles that suddenly appear on the road ahead.

Friday, September 12, 2008

On the semantics of corporate blabla

One of the most annoying terminologies in Strategic Management blabla I find the words “core activities”. They’re the most easiest and flimsiest of excuses to do or not do something, without having to provide any logical rationale why.

“They are losing money because they are not focusing on their core activities”. Come on, cut the BS; why are you calling certain activities “non core” anyway? Yep, because they’re not making any money. That’s makes it a bit of tautology, doesn’t it? Had they been hugely profitable I am sure these activities would not be regarded so “non-core” after all.

“We decided to divest businesses X and Y because they weren’t our core activities”. Get real; you’re probably divesting them because they’re not making you any money (and therefore you call them “non-core”). And even if you did have some other reason for wanting to get rid of them – whether the reason is any good or not – the hollow “explanation” (“because they are not core”) tells us as much as doodly-squat.

If you give me a good logical explanation why certain activities or products do not mix, or at least do not give any advantage in terms of combining them in one organisation, I am with you, but the label “core” or “not core” itself doesn’t say a darn thing at all.

Often, fluffy terminologies seem to be used, making far-reaching strategic decisions, to provide some sense of semi-security by means of an apparent logic which in reality is nothing more than a semantic construction.

“Capabilities”; what are they anyway? Stuff you’re good at? “We have to build the capabilities necessary to execute our vision”. What do you mean: You have to become better at it in order to become good...?

But the most annoying discussion in management speak I find the long-standing debate on what are “capabilities” and what are “competencies”. Let me solve this debate for you: They are words!! And words mean what we say they mean. These things are not some objective reality, to be discovered through careful corporate archeology or so (“we have dug up some capabilities and some competencies, analysed them in a CT scanner and applied CO2 analysis and now have conclusive evidence that they are different things”). If you can tell me why it is necessary or at least useful to make a distinction between two different concepts – one which we can call “capabilities”; the other one we’ll name “competencies” (or “zoggers and zaggers”, “dinkies and donkies”; whatever), I am with you, but without such an explanation of why the distinction is useful, I cannot be interested in debating the semantics of some random words that happened to find their way into our business vocabulaire.

So leave me alone and go annoy someone else with your corporate word games.

Thursday, September 11, 2008

Conflicts of interest – do analysts rate their bank’s clients’ stock more favourably?

Heck yes.

Have you ever heard that you can see the Great Wall of China from outer space? Well, it’s a myth.

Have you ever heard of “Chinese Walls” inside professional organisations, such as management consultants or solicitors, who face a potential conflict of interest for instance because some of their employees are working on different clients that compete in the same line of business? They claim they have “Chinese Walls” inside their firms because their consultant or solicitors are not allowed to even talk to each other, let alone share information. Well, believe me, those are usually a myth as well.

Take investment banks. Investment banks often have a research department which employs analysts who provide recommendations whether we should buy or sell the shares of a particular company. A “sell” recommendation by such an analyst is quite a pain (in all sorts of body parts) for a company because their influence can be substantial in the sense that the firm’s share price will likely fall as a result of this recommendation. A recommendation to “buy” is obviously a much more cheerful event.

Such investments banks, however, often also have a Corporate Finance department which is trying to secure deals to advice companies on things like debt, equity or M&A transactions. The potential conflict of interest is clear: If a bank’s analyst would provide a “sell” recommendation for a (potential) client company, this is going to be one valued client who is “not amused”…!

Some companies are known to even explicitly select only those investments banks to represent them on their deals who have awarded them positive stock recommendations in the past. In any case, if a bank is chatting up a client on the left side but recommending “sell their shares; now!” on the right side, this client might just tell them to f-off.

So how do investment banks deal with such potential conflicts of interest? “Chinese Walls!” they’ll so firmly declare that you will almost believe it. “We have Chinese Walls in our firms, so that the Corporate Finance guys cannot pressure or even have lunch with the security analyst dudes”. Yeah right…

Professors Mathew Hayward and Warren Boeker – at the time based at the London Business School – investigated exactly this issue. They selected 70 companies from a variety of industries (e.g. biotech, oil and gas, restaurants, telecom), collected a total of 8,169 analyst ratings that had been issued for them, and analysed the investment banks that had been involved in their equity, debt and M&A deals. Then they statistically examined whether analysts made more positive recommendations for those firms who their banks were also serving as clients. The answer was a clear yes; in 80% of the cases, analysts would rate a company higher than their peers at other investment banks if this firm was also a client.

This was true when the rating was issued before the deal – at a time when the bank’s Corporate Finance department was likely bidding or at least eyeing up a potential client – but also after a deal had been awarded, when the company was now officially a customer, and apparently able to exercise power. However, the closer the issue date of the rating to the deal date, and the larger the client, the stronger this influence was.

While the Great Wall of China might have been helpful keeping the Hun tribes out of China, the mythical Chinese Walls inside our professional corporations are apparently much less apt at curtailing the influence of powerful stakeholders. Their presence can be measured and felt – at the end of the day all the way into their shareholders’ pockets.

Tuesday, September 9, 2008

Hang the hero

Remember the disaster with Union Carbide’s chemical plant in Bhopal, India, on the 3d of December 1984? One of the most dreadful industrial accidents in the history of mankind; thousands of people died terrible deaths on the horrid day itself; tens of thousands of people perished in the aftermath.

Strangely enough, the faith of Union Carbide’s CEO at the time, Warren Anderson, always reminds me of Tolstoy’s War & Peace.

In our world, CEOs often become celebrities, heroes and superstars. We place them on the cover of magazines such as Fortune and Business Week, we give them awards, honorary doctorates and multi-million salary packages, while they command dazzling fees for after-dinner speeches, at which they are drenched in the adoration of star-struck hopefuls, who quench their thirst for personal business success on the (expensive) words of the great leader.

The manager starts to personify his company and its success: Steve Jobs and Apple, Carlos Ghosn and Nissan and, of course, Jack Welch and GE. But do we really believe that organisations that consist of a 100,000 employees, located on various continents in all corners of the world, producing dozens of products in a multitude of industries and markets are controlled by the lunch-time decisions of one man? Can one man be that omni-potent?

Similarly, CEOs can become villains. They start to personify the misery that their organisation has brought us. We mock them, vilify them and, if we get the chance, put them in jail. Cees van der Hoeven – who got off with a suspended jail sentence – exemplified Ahold’s fall from glory; Enron’s Jeff Skilling is spending 24 years in a prison in Minnesota (of all places), while former media mogul Conrad Black is at least catching some rays of sunshine through the bars on his window of his cell in Florida.

I guess these attributions are not restricted to business leaders only. Tolstoy, reflecting on the eventual defeat of the Napoleon’s forces in Russia after the battle of Borodino, was explicitly sceptical of any attributions of omnipotence. He wrote: “Many historians contend that the French failed at Borodino because Napoleon had a cold in the head, and that if it had not been for this cold ... Russia would have been annihilated and the face of the world would have been changed”.

“If it had depended on Napoleon’s will whether to fight or not to fight the battle of Borodino, or had it depended on his will whether he gave this order or that, it is evident that a cold affecting the functioning of his will might have saved Russia, and consequently the valet who forgot to bring Napoleon his waterproof boots on the 24th would be the saviour of Russia”.

“But for minds which cannot admit that Russia was fashioned by the will of one man… such reasoning will seem not merely unsound and preposterous but contrary to the whole nature of human reality. The question, ‘what causes historic events?’ will suggest another answer, namely, that the course of earthly happenings … depends on the combined volition of all who participate in those events, and that the influence of a Napoleon on the course of those events is purely superficial and imaginary”.

Perhaps we also overdo it a bit when we bestow our adoration or vilification on the CEOs of multinational companies. The people from Bhopal viewed – and still view – Warren Anderson as the prime instigator of the evil that befell them. They still paint “Hang Anderson” on the city’s walls and burn puppets in his imagery. Was Warren Anderson responsible? I am sure he was; he played his part being in charge of the company that owned 51% of the dreadful factory. The personified anger of the people of Bhopal is understandable, just like the adoration of Jack Welch con suis seems due to some deep human inclination. But, in reality, both the success and the downfall of our organisations are, as Tolstoy put it, the result of “the combined volition of all who participate in those events”.

Friday, September 5, 2008

Down-town Calcutta firms

I'll admit it: I have a love-hate relationship with organisations. On the one hand, they’re fantastic, and they produce things that no individual could have produced by himself, such as airplanes, open-heart surgery and sky-scrapers. However, on the other hand, they can be incredibly stupid. British Gas who sends 28 letters and 3 bailiffs for a £100 bill despite having received evidence on multiple occasions that the meter is your neighbour’s (as you may gather, this is not a hypothetical example…), Firestone which continues to invest in bias tyres while the whole world (including their own employees) understands radial technology is the future, and Ahold which continues to make acquisitions although even the most junior HQ employee is starting to suspect things are getting out of hand.

Yet, the thing that I probably dislike most about large firms, is that so many of my (very well-educated and intrinsically motivated) friends seriously dislike going to work on a Monday morning – because, despite the façade, corporate life is rather dull, repetitive and unexciting. I also think this is probably the clearest symptom that organisations are not making sufficient use of the potential of what is likely to be their most valuable resource: people.

But many large organisations would like to be more entrepreneurial and vibrant. And therefore, they send their employees on training programmes and culture courses, in which they build sandcastles together, climb poles, play drums or go line-dancing, to develop some positive team-spirit, and provide them with entrepreneurial energy and creativity.

My favourite anecdote regarding this issue comes from my late and great colleague Sumantra Ghoshal, who used to say the following: He would tell executives that every year in August, during his children’s summer holiday, he would take them to his native Calcutta for a month. However, down-town Calcutta would be so humid and hot in August that he could not do anything else than lie on his bed and be sleepy all day. However, when he’d spend spring in Fontainebleau – where he lived for many years when he was on the faculty at INSEAD business school – which is located right in the middle of a protected forest in France, he could not help become cheerful seeing the flowers blossom, start to whistle a song, run through the forest and leap up to grab a branch!

"The problem with large organisations", he’d say, "is that most of them create down-town Calcutta in summer within them".

And then they send you on a training course to improve your creativity and entrepreneurial energy. "But the problem is not me!" he’d shout; "place me in the Fontainebleau forest in spring and you’ll see that I have all the energy and creativity you'll ever need". I don’t need a course; you need to change your organisation.

Wednesday, September 3, 2008

When to fire your M&A management consultant

Some time ago, I gave a presentation to a group of executives from a variety of companies on the topic of acquisitions. Much of the talk was about how vastly different acquisitions can be, in terms of the purpose they are intended to serve.

As often, I ended my talk urging the executives that, if they would ever come across a consultant who would tell them “this is how you should integrate acquisitions” (promoting one particular method), they should fire him. Because acquisitions can be so enormously different in purpose and nature that they really require quite fundamentally different approaches to integration, and if someone recommends a “one mould fits all” method, it is best to show that person the door.

Little did I know that the speaker coming after me was a consultant, armed with an impressive array of powerpoints on “this is how you should integrate acquisitions…” He looked a bit apologetic. They were also the main sponsor of the event.

Anyway, I sort of mean it. Because sometimes acquisitions are intended to lead to consolidation in an industry, and the reduction of overcapacity (think for instance of Daimler & Chrysler). Sometimes acquisitions enable a number of companies to join forces, and benefit from some shared operations while remaining relatively autonomous (think for instance of Johnston Press, buying scores of local newspapers). Other acquisitions are intended as some form of substitute R&D (e.g. Cisco buying scores of entrepreneurial companies in Silicon Valley). Some acquisitions enable a firm to gain access to a new product or geographical market (e.g. Heineken buying local breweries), while yet others have to do with blurring industry boundaries (e.g. the various industry conglomerates, such as Viacom).* Thinking that you could just all treat them the same way seems a tit naïve.

Now, it is of course true that, in all cases, you should “have a good communication plan”, “integrate carefully”, “make sure to not over-pay”, and so on. But this type of advice is also a bit of a motherhood; after all, the professional life of a consultant (or Strategy Professor) recommending to “integrate poorly”, “make sure you over-pay” and “have an appalling communication plan” would likely be swiftly truncated.

So what can you recommend? Well, first make sure that you understand what type of acquisition you’re engaged in or, put differently, exactly why you are considering buying the company. What is it that is supposed to create all this surplus value? Once you have figured that one out, you might be able to deduce what can or needs to be preserved in the company, what needs to be integrated and what can be left to its own devices. Dependent on the outcome of that exercise, you can start to device a further acquisition plan including, yes, “a good communication plan”, “a careful integration approach” and “a proportionate acquisition premium”. And perhaps even a consultant.

* Based on a well-known typology from Harvard Business School Professor Joe Bower.