Investile Dysfunction

Costco's CEO, Jim Sinegal, doesn't let the tail wag the dog - a true long-term outlook

I read an interview with the CEO of Costco, Jim Sinegal, and found myself impressed with what seems like Mr Sinegal's truly long-term outlook and his commitment to investing in his company with this mindset. 

Summarized excerpts of the Wall Street Journal interview are below and are indicative of Mr. Sinegal's refreshingly long-term outlook.  When asked about balancing the needs of customers, employees and shareholders in the face of some sentiment that shareholders eel they come third in that equation, he responded, "That's not the case.  We want to obey the law, take care of our customers, take care of our people and respect our suppliers.  And we think that if we do those things pretty much in that order, we're going to reward shareholders."  Well said!  Any underlying business is about serving a customer need and if that is done in an economically sound manner (meaning you don't give away the product), the value to shareholders should result from these efforts.  The tail should not wag the dog.

When questioned about whether giving customers great deals hurts profits, Mr Sinegal responded, "There are all sorts of opportunities where you can try to sneak in a little more margin here and little more profitability there, but that's not what we're about.  When you start suggesting that it's not important to save the customer money on this because they'll never know the difference, you start to fool yourself.  The customer trusts us.  You don't want to give up on that type of reputation."  Bravo.

What do we have here?  A truly customer-oriented and employee-oriented executive.  While customer-centrism and employee-centrism (yes I make up words) are often talked about, this type of true focus on these parameters is refreshing and rare. 

The ultimate question you may be wondering, however, is do all these nice ideas around business by Mr. Sinegal actually work?  Per SmartMoney, Costco trades at a forward P/E ratio of nearly 24 which is at a premium to its peers.  Additionally, over a 5 year period, it was up 80+% while competitor BJs was up 40+% and Walmart (owner of Sam's Clubs) was actually down over that period.  So it looks like shareholder value is being created by Mr. Sinegal and his team at Costco through their focus on the constituents that enable business success - customers, employees and suppliers/partners.

Wedding budgets and why you should just say no to metrics (the bad ones)

I'd talked about the metrics zeitgeist in a recent post (click here) and saw a great piece by Carl Bialik aka the Numbers Guy in today's Wall Street Journal.  In short, Bialik did some research to show that the oft-quoted $27,000 - $30,000 cost of an average wedding is probably wrong.  The culprit is simply that most of the studies use the mean instead of the median.  Of course, there are some additional issues with these surveys caused by self-selection, e.g., the people who tend to respond to these surveys may be the type more inclined to spend more on their weddings.

So why am I talking about wedding costs and budgets in a corporate portfolio management blog?  Because this wonderfully illustrates how metrics get used incorrectly.  Metrics & data are only useful in a portfolio management effort or in any setting if they are right, and oftentimes, companies get so wrapped up in the act of measuring that they forget about the quality of the information going in and the resulting outputs that are generated. 

Let's take the wedding example and apply it to a corporate setting.  Let's say the $27,000 mean represents the average sales per customer for a software company.  Based on this information, the company decides that the sales team should be incentivized in a way that encourages them to go after sales greater than $27,000.  And let's assume that the mean was artificially inflated because of a single $1 million sale and median sales were actually closer to $13,000.  Now you've created incentives that are impossible for the sales team to hit.  This will probably result in them going after customers they can't get which will result in them ultimately getting demotivated and quitting which will ultimately result in the company going bankrupt. 

Ok, that was a bit dramatic, but the purpose of this exaggerated example is that because something is measured doesn't imply it has any predictive or useful value.  Worse yet, using this poorly measured metrics data can actually result in the making of decisions which destroy value - in stark contrast to their objectives.  Remember to just say no to bad metrics. 

Anyone out there with any interesting, funny bad metrics examples you've seen?

Abolish unproductive complexity

McKinsey occassionally hits upon an insight that I like :) 

In issue #2 of McKinsey Quarterly, there is an article by Lowell L. Bryan and Claudia I. Joyce entitled "Better strategy through organizational design" which has some interesting take-aways for those considering or doing portfolio management.  Of course, the article does over-generalize and simplify the world and how organizations work in order to make a point, but nevertheless, let me give credit where it is due as the article does make some interesting points. 

My favorite point is about unproductive complexity which the authors appropriately explain is "the common enemy in today's corporations."  While there points are related to organizational design, unproductive complexity seems to carry through many facets of organizations I talk to about resource allocation.  Somehow the old K.I.S.S. acronym is completely out of fashion (K.I.S.S. = Keep it Simple Stupid). 

Instead of looking at the data and information to see which investments are performing and which are not and/or which teams are performing and which are not to make obvious go/no go investment decisions, organizations dress up the information using value maps, maturity models, linear curves, real options, regressions, myriad bubble charts, etc.  I'm not sure the purpose of this beyond making an obvious decision from simple data & information except to make it look more sophisticated and fancy needlessly (and maybe justify jobs).

There is a greatness to simplicity when looking at resource allocation.  Did the investment under- or over-deliver what it was supposed to?  If under, what is the problem?  Is it a fundamental issue due to the product, the competition, the team executing, etc?  If over-delivering, should we consider further investment in this type of product or think about innovating further to extend an advantage?  Or perhaps the team who made the prediction was low-balling and we need to hold them accountable?  These are the key questions.  And I'm not sure you need all sorts of high-brow academic and/or consultant-inspired jargon, frameworks and nonsense to understand these fundamental questions.

What removing this complexity also does is make decision-making discussion and power more available to people within the organization as it is not resident with a few elite geeks who control the keys to some unknown black box.  And this engagement of "the masses" is a good thing as it leads to greater engagement and accountability.  But allow me to let my astute friends at McKinsey say this in another way.  Bryan and Joyce argue that "to overcome unproductive complexity, a company must undertake a management initiative specifically to make itself operate as a single profit center that can allocate decisions among the employees best able to make them.  The workers closest to the the company's business opportunities must collaborate easily with one another, exchanging knowledge throughout the enterprise...And the company will have to become much better at measuring its performance if it is to motivate these people and hold them accountable."

To all the decision analysis, strategic finance, portfolio management groups out there, please remember that your ideas may appeal to the geek in you and us, but they're often tough to translate to everyone.  And so KISS (Keeping It Simple Stupid) is key. 

The 4 (Conflicting & Unclear) Principles of Enduring Success

Ah yes!  Another guru who has boiled down long-term success into 4 principles.  Everyone go home because all the work you were doing to figure out how to grow your organizations for the long-term is no longer needed.  The answer is here and has been put forward by Christian Stadler in the July-August 2007 Harvard Business Review in his article titled "The 4 Principles of Enduring Success."

So here are the proposed principles: (I've extracted these verbatim from the HBR article)

1. Exploit before you explore - Throughout their history, the great companies in our sample have all emphasized exploiting existing assets and capabilities over exploring for new ones.
2. Diversify your business portfolio - Good companies tend to stick to their knitting, but the great companies know when to diversify.  They are careful to also to maintain a wide range of suppliers and a broad base of customers.
3. Remember your mistakes - Great companies tell and retell stories of past failures to make sure they don't repeat them.
4. Be conservative about change - Great companies very seldom make radical changes - and take great care in their planning and implementation.

There are numerous leaps of faith that I feel have been made in the undertaking of this analysis but I won't go into detail on them.  Instead, let me take issue with the article from a bigger picture perspective.  This article is ultimately well-packaged common sense.  By talking about the reams of data and the 3.5 years it took to analyze it, I am awed by the effort but left disappointed with the stale conclusions.  It appears in Harvard Business Review and so perhaps the bar is set a bit higher in terms of expectations.  Let's look at the 4 main principles given above.

First of all, principles 1 and 4 are not that different.  Exploration is risky and exploiting current assets and capabilities is less so.  So by explioting, isn't a certain conservatism inherent?  So I'd collapse principles 1 and 4 into one principle - "Do what you know and do it well."

Then there is principle 2 which is quite different as this talks about diversification which is less conservative.  And the great companies "know when to diversify".  So in order to have enduring success, you should stick to what you know but diversify at the right moment.  If you do that, VOILA!  You will be enduringly successful.  Do I need to know to subscribe to the Harvard Business Review for this type of rocket-science insight?  If I either accidentally or purposefully diversify at the right time into the right thing and execute it well, I am likely to be successful.  Duh.

And there is principle 3 about remembering your mistakes.  So you are telling me if I don't repeat past mistakes and learn from them, I am more likely to be successful.  Wow. 

I don't disagree with the fact that organizations who do these things may well be successful but packaging them as "insights" and spending 10 pages in the HBR to discuss these doesn't quite fit.  Again, I'd recommend reading the Halo Effect by Phil Rosenzweig to learn about why many of these analyses/studies contain dubious conclusions. 

You've just been diagnosed with a potentially terminal case of Myopia

From the July-August 2007 issue of the Harvard Business Review, an article titled "The Cost of Myopic Management" provides a scary view into short-termism aka focusing on the short-term goals such as quarterly or even annual targets.  The authors, Natalie Mizik and Robert Jacobson, survey 401 top financial executives and "80% said they would decrease spending on 'discretionary' activities like marketing and R&D to meet short-term goals."  WHAT??  Let me say that again - 80% would cut discretionary spending to meet a short-term goal. 

This is straight from the 'cutting off one's nose to spite one's face' management strategy as it should seem obvious that these short-term cuts may create some short-term gain but ultimately result in long-term pain.  But what should seem obvious has been nicely proven with some good old number crunching by Mizik and Jacobson. 

They found the following after reviewing data for seasoned equity offerings over 1970-2001:

"In our study following the financial performance of 2,859 companies over five years, firms that appeared to make short-term expense adjustments to inflate earnings when they issued equity ended up losing profits in the long run, causing their market value to drop by more than 20% four years out."   

What happens when you cut back on investment and your competition is increasing investment? Hmmm...

A recent Duke University/CFO Business Outlook Survey found that only 26% of CFOs are optimistic about the economy than they were last quarter.  As a result, "they predict slower growth in capital spending, technology spending, and advertising spending."

While the optimism overall wasn't great, there were differences by region.  In Europe, finance executives were more optimistic than their US colleagues.  Asia's CFOs were the most confident with actual plans to increase hiring and capital spending in the next 12 months.

So there is a certain irony that evidences itself when you think about this.  Watch CNBC or even read the popular press, and you hear folks lamenting the loss of competitive advantage in many US and European industries.  And during this loss of 'advantage', these European/Western companies are spending less while their peers in Asia are increasing investment.  Does this foreshadow good things for the US and European companies when it comes to closing the gap?  I'd love to hear your thoughts on this and also get people's thoughts on whether the short-term expectations US and European companies are subject to is also impacting this.

A different spin on middle management

Geoffrey A. Moore of Crossing the Chasmfame has nicely articulated the need to focus on the often forgotten medium-term.  In his article "To Succeed in the Long Term, Focus on the Middle Term", Moore argues that it is the medium-term that bridges the gap between the short-term budget to the long-term plan. 

Moore refers to the short-, medium- and long-term as Horizon 1, 2 and 3.  "Horizon 1 corresponds to managing the current fiscal-reporting periodm with all its short-term concerns, Horizon 2 to onboarding the next generation of high-growth opportunities in the pipeline, and Horizon 3 to incubating the germs of new businesses that will sustain the franchise far into the future."

And so what occurs in the portfolio of businesses is that the 'cash cows' support Horizon 1 and obviously get a large amount of attention given the importance organizations and management put on the short-term.  And then given the need and desire to keep the franchise successful far into the future, there is focus paid to those sexy, big-bang ideas which may enable this, e.g. the Hortizon 3 timeline.  But in doing this, Horizon 2 opportunities are neglected and have difficulty getting sponsorship and resources. 

Identifying and ensuring Horizon 2 opportunities exist can be done as part of a corporate portfolio management effort.  Whether you call them Horizon 2 or adjacent/emerging opportunities, it is important to apportion some of your investment and your effort to these opportunities.  Given that they often get lost in the shuffle, utilizing a corporate portfolio management effort to identify, track and measure these opportunities will be hugely beneficial.  If any of you have figured out a way to ensure these types of investments happen within your organization, please share your insights & ideas.

Kimberly Clark's CMO, Anthony Palmer, understands the simple power of resource allocation

The 8/15/07 issue of the Wall Street Journal had an interview with Anthony Palmer, the recently appointed CMO of Kimberly Clark (the company behind brands such as Kleenex, Huggies, Scott toilet paper, etc).  Palmer and Kimberly Clark are duking it out with a much larger rival in Procter & Gamble which is one of the largest advertisers in the US.  When asked about how KC can beat a better-funded rival such as P&G, Palmer summed up the essence of optimizing resource allocation quite nicely stating, "You can take on a bigger, harder spending competitor if you spend more wisely."  Well said.

Governmental decision making and suboptimal resource allocation - perfect together?

In the aftermath of tragic events like that of the collapse of interstate 35W in Minneapolis into the Mississippi River, you can be sure that the politicians will come out of the woodwork crying for inquiries, funding, etc on whatever the topic du jour at the time is.  Of course, the media feeds this with their special reports and special investigations.  The Wall Street Journal's issue today had an article entitled Aging Infrastructure: How Bad is It? which serves up some ramped up decibels from the politicos voicing indigantion and concern. 

The article highlights Senate Majority Leader Harry Reid who comments, "I think we should look at this tragedy that occurred as a wake-up call for us.  We have - all over the country - crumbling infrastructure, highways, bridges, dams."

Before I go on , I want to emphasize that this is not a political entry advocating any viewpoint, e.g., Democratic/Republican or liberal/conservative.  What these events and the constant post-crisis second-guessing coupled with constant budgetary problems does highlight is that the governments at all levels (federal, state, local) are in need of a discipline like corporate portfolio management to optimize resource allocation decisions.

One of the 7.5 deadly sins of managing resource allocation that I talk about in my book is decibel vs data-driven decision making.  And probably nowhere is the propensity to make decibel-driven decisions more obvious than in the government.  Obviously, there is an inherent complexity in choosing between myriad, perhaps infinite, proposals/initiatives, but this highlights the need to use some degree of data to determine which initiatives are worthy of finite funding.  When I talk about data, I'm not talking about profit & loss either, but data could be community feedback, risk or loss mitigation measures, additional tax collections, etc.  The post-crisis (whether Minneapolis, unsafe Chinese goods, terrorism, etc) demagoguery used by talking heads is ultimately not healthy or useful to making better resource allocation decisions. 

I know that there are progressive governmental departments using IT portfolio management.  I chronicle the State of Oregon's Department of Human Services efforts in this regard in my book for example.  But I've not really heard of any governments adopting a more robust and rigorous resource allocation process to make more policy oriented decisions.  If anyone knows any governmental body using or adopting a corporate portfolio management or a similar discipline to make better resource allocation decisions, I'd love to hear from you.  I'm especially interested hearing success stories in this regard.