Investile Dysfunction

Training IT people on the basics of finance

Earlier today, I spoke at the CFO Magazine Technology Summit about corporate portfolio management.  It has been a great session so far and opened with a highly entertaining and engaging address by James Dallas, CIO and SVP of Medtronic.

Mr Dallas spoke about the cultural change that he is hoping to make within the IT function at Medtronic and made a few key interesting points. 

• He highlighted that IT and Finance need to partner with each other and is working actively with his finance organization to ensure this occurs.
• Interestingly, Medtronic is having all 1100 IT staffers go through a finance training put together by the finance organization (which Mr Dallas' group has partnered with on this).  The training will help the IT staff understand basics of good business case development and relevant finance concepts.  In his view (which I agree with), finance is the language that people in the organization speak and understand (e.g. revenue, profit, ROI, etc) and so instead of fighting this, he is partnering with finance to ensure his people are able to talk this language.  Bits and bytes are interesting but not what the vast majority of people understand or need to understand. 
• He also highlighted that most organizations are implementing BI, ERP, etc solutions.  And that the mere installation of such tools does not confer competitive advantage on your firm especially when everyone else is doing the same thing.  It's the culture elements and the ability to use such tools to execute better that determines and delivers competitive advantage.

It was great to hear a CIO and especially one of such a great company point to the need for IT and Finance to work together.  More than the talk, however, is the actual actions that Mr Dallas and Medtronic are taking which are worthy of praise and should be emulated in some form.  It seems Medtronic is committed to and executing upon a vision of making IT more relevant, understandable and valuable to the entire organization. 

Transformational M&A doesn't work. Focus on organic growth.

I'm really beating a dead-horse here as readers of my blog know that I don't think highly of M&A especially the sexy, transformational deals which are generally all style and little substance, but here is another interesting nuggest for you all.  A research study by McKinsey consultants Janamitra Devan, Matthew Klusas and a professor at the McCombs School of Business, University of Texas at Austin, Timothy Ruefli, makes the point quite conclusively.

Methodology - They looked at "20,000 companies around the world, focusing on the 1,077 with revenues exceeding $5 billion in 2004.  The study examined their performance on two fundamental indicators of sustained competitive advantage—revenue growth and profitability—over the 11-year period from 1994 to 2004."

High-Level Findings - "Many executives focused on growth assume that companies can sustain strong top- and bottom-line performance over long periods of time. McKinsey research, however, confirms that this kind of success is exceedingly rare and suggests that its pursuit can lead executives to set unrealistic expectations. Indeed, a study of large global companies finds that less than 1 percent of them outperformed their competitors on both revenue growth and profitability over a decade."

Let's restate that.  Out of the 1077 firms, only 9 beat on revenue and net income growth over the decade.   How did they do this you might ask?

And the kicker - "The top nine performers strongly preferred organic growth: they made few acquisitions and divestitures when compared with other companies in their industries. Further, none of the deals these companies made were transformational; that is, no divestiture or acquisition had a value exceeding 30 percent of their market capitalization in the year before the deal. By contrast, 37 percent of the companies enjoying either strong revenue growth or profitability—but not both—attempted some type of transformational deal."

Let's repeat the lesson of this entry:  Organic growth WORKS!  Focus on optimizing resource allocation and you'll be in a better place.

Financial supermarket lunacy -- Attention shoppers - We have a problem in Aisle 3

Have you ever purchased a personal printer/fax/copier combo?  I have and here is what I've found.  When you try to smash all three of these together, you tend to get a gadget which is mediocre on all three counts.  And so I've decided that I'll go and find the best of breed and save myself a lot of frustration.

In the business world, the equivalent of the half-baked printer/fax/copier combo has been the oft-attempted but always failed financial supermarket or financial conglomerate idea.  It was attempted in the 80s and 90s and more recently by Sandy Weill of Citigroup or Ken Lewis at Bank of America (BofA).  The idea behind the financial conglomerate is that all financial services can be resident under one banner to offer customers the proverbial one-stop shop, e.g. consumer banking, wealth management, corporate and investment banking, commercial lending, mortgages, etc.  And this idea is predicated on some nebulous view of synergies amongst these businesses and some stated but highly dubious and yet unproven customer demand for the one-stop shop.

And while there are numerous examples of the travails of this strategy, a combination of hubris (empire-building), ego (I can make it work this time) and naivete (I can make it work this time) leads to it again and again.  The recent problems faced by Chuck Prince are proof again that he is having to deal with the messy string of loosely-tied together and poorly integrated acquisitions done by Weill in his pursuit of building a financial conglomerate.  The most recent issues came from BofA yesterday who axed their investment banking chief as well as 3000 employees, most coming from the corporate and investment banking unit.  When you look at the numbers, Citi and BofA trade at forward P/E ratios of 10.9 and 10.5 respectively while Wells Fargo trades at a P/E of 12.5 - a premium of nearly 20%.

What's the phrase?  Those who don't learn from the past are bound to repeat it.  Let's hope not.

So this underscores a few pitfalls which a more robust and rigorous review of resource allocation attempts to mitigate. 

1. M&A is a sketchy and highly uncertain way to grow.  Focusing on organic growth or select M&A growth where you stick to your knitting will have better results albeit not as sexy.
2. Decibel-driven decision making (bold statements of vision) is dangerous and at a minimum  should be balanced with rigorous data-driven decision-making to ensure the soundness of the analysis

Marketers are seeing the data and portfolio light

A recent interview courtesy of McKinsey with 4 senior marketing executives of Carlsberg, Nokia, Wal-Mart and Yahoo! revealed some promising trends and thoughts amongst marketers.  Progressive marketers are embracing many of the tenets of corporate portfolio management which is a very good sign.  I was particularly glad to see two comments in the interview by Alex Myers of Carlsberg who touches upon the need for data-driven decisions as well as the portfolio approach.  Excerpts below:

"

The Quarterly: What skills and traits do you think are particularly important for marketers today?

Alex Myers: The marketing function is developing along two extremes: the advertising guru, on the one hand, and what one might term the fact-based businessman, on the other. The trick is to find the right balance. The journey, which so far has been from advertising guru to communications guru, is entering a new phase that requires us to be businessmen and explain things clearly to management. It’s no longer enough to say, “Trust my campaign” or “It looks great.” You have to explain things internally in a much more relevant way. The marketing function is becoming much more accountable, with CEOs and CFOs saying, “Okay, since you’re spending all this money, we want to know if it’s effective or not. Is our business growing or is it just the budget?” The challenge is not to lose the passion and religion of brands or consumers but to do it in a fact-based way.

The Quarterly: A deep understanding of customers’ needs, of course, is a foundation for building strong brands. How are you managing your brands in today’s increasingly complex environment?

Alex Myers: We’re shifting from being a single-brand-driven business to becoming portfolio managers.⁷ And that’s a big transition. I would go so far as to say that the strength of a portfolio in the beer business is now much more important than the strength of individual brands. Five to ten years ago that wasn’t the case: the brand was everything.

"

Kudos to Alex and Carlsberg for seeing and embracing such discipline in the way they manage marketing.

Using Toyota's concept of kaizen with your corporate portfolio - oh what a feeling

In my book, I talk about worrying only about investment projections as one the 7.5 deadly sins of managing your corporate portfolio.  By this, I mean that making projections is easy.  Slap a sophisticated or even basic looking model in Excel together and with a reasonable amount of savvy, you can probably convince people your assumptions that drive to some outcome are reasonable.  In other words, projections are prone to error as they are a best, hopefully educated, guess.

And so making corporate portfolio management all about the projections is not enough.  You also need to close the loop and measure results.  Measuring results does two things. 

1. You can hold people accountable for results
2. More importantly, you can inform future year projections based on historical actual results

This is what I've referred to as "closing the loop" which is the act of getting the actual results.  The more important piece to emphasize is the kaizen or continuous improvement that this closing of the loop enables.  That is really the end goal of this effort - improving results going forward and learning from the past.

Kaizen is part of the famous Toyota Way.  The company is famous for measuring and monitoring everything with an aim to use such measures to improve processes, results and outcomes on a continuous basis.  This has led them to becoming probably the best carmaker in the world today.  They're highly rated on reliability, quality and durability and are projected to overtake GM as the world's biggest car manufacturer this year.

So as you embark on a corporate portfolio management discipline, ensure that you are always keeping an eye towards kaizen.

The myth of strategic planning

Saw a quote from Richard Rumelt, a professor at UCLA's Anderson School of Management, which I thought was pretty spot on. 

"Most corporations 'strategic plans' have little to do with strategy.  They are simply three-year or five-year rolling resource budgets and some sort of market share projection.  Calling it 'strategic planning' creates false expectations that the exercise will somehow produce a coherent strategy."

A McKinsey survey found that only 45% executives are, in fact, happy with their strategic planning process.  It's obvious the process is broken and this is due to the either non-strategic nature of the discussions (rolling budget exercise) or the fact that talking about strategy doesn't make it a reality.  Given this, the process by which resources get allocated and which ultimately determine and drive strategy is much more important.

Short-termism takes its toll on brand-building as well

When you talk about a portfolio of investments, whether it is your personal portfolio or the corporate portfolio of marketing, operations, innovation, etc investments, there has to be a time element considered.  By this, I mean a well-constructed portfolio has some things that are short-term oriented and some that are long-term oriented.  That makes for a healthy, diversified portfolio.  And so I read with interest a good article in the Harvard Business Review by Leonard Lodish and Carl Mela titled "If Brands are Built over Years, Why Are They Managed over Quarters?" where the authors argue that companies have damaged their brands by investing too heavily in short-term price promotions and too little in long-term brand building. 

This is due to the availability of near-term sales data and good ol' Wall Street quarterly expectations and pressures.  They argue for imbuing certain long-term measures into the evaluation of brand health into the company so that the short-term doesn't win out over the long-term always. 

Within a corporate portfolio management discipline, investments in areas like the brand can be difficult to deal with because their benefits are not always discernible especially if they are long-term oriented.  This is where and why traditional financial standards of NPV, ROI, etc need to and can be relaxed in favor of other metrics and measures.  It is important to still measure the efficacy of these long-term brand initiatives but in a way that is realistic and salient to these investments.  It is also important to realize as you examine your corporate portfolio that there must be investments which have a long-term payback or benefit and these help to provide balance in the portfolio. 

Some Microsoft-Facebook stats & new commentary

Some additional facts related to my prior post about the Microsoft invesment in Facebook. 

Facebook projected revenue of $150 million this year implying the valuation as calculated by Microsoft of $15 billion represents a price to sales ratio of 100.  High-flyers Google and Apple trade at a price to sales ratio of 14.3 and 7.3, respectively (source: Smartmoney).  Neither are in the same business as Facebook so the metrics are admittedly not apples to apples but in order for Facebook to come into line with Google's 14.3 P/S ratio, their revenues would have to goto over $1 billion.  That's 7x current revenue.

Microsoft has $20 billion in cash so this investment represents a bit over 1% of their cash horde.  Again, this investment is not a huge amount for them. 

CNBC commentary this morning had folks saying things like "I'm not sure if this is the right price but I think it's a good deal for Microsoft because of the cachet they'll get from this deal."  In essence, forget the price but do the deal because it makes you seem visionary, bold, etc.  Sounds like some folks are drinking (or chugging) the deal Kool-Aid.

We shall see.

Business Intelligence software - can it make you dumber?

Business intelligence is about leveraging data to monitor business programs and operations and utilizing that data to make decisions and forecast coming trends that could impact the business.  This makes sense.  I am a big fan of utilizing data to make better decisions - it is a central tenet of corporate portfolio management.

What amuses me are software or consulting providers who say they sell business intelligence software.  This usually means re-labeling reporting tools that do nice bubble charts and other seemingly cool reporting bells & whistles as Business Intelligence software.  The problem is not that these tools are bad but they are just that - tools.  Instead, the term Business Intelligence has become synonymous with the software tools.  Business intelligence is ultimately about doing something useful with data and so it is critical that people be trained on what to do with the data when they have it.  Just boiling it down to a software which is by itself completely unintelligent is stupid.  It's the same thing as telling any Joe off the street that we have a state-of-the-art garage setup for him and we want him to go there and rebuild a car's engine.  The tool is irrelevant without the skill and acceptance of data as a way to make better decisions.  Business intelligence software may keep you looking busy for hours and hours making pretty graphs and charts, but it may not actually make you more intelligent about your business.   

For another perspective on this, there was a recent article in the Wall Street Journal which features an interview with Tom Davenport, author of "Competing on Analytics: the New Science of Winning" (for more on book, you can click here).  An excerpt of the interview is below.

WSJ: What technology does a company need to go down this path?

Mr. Davenport: The most important thing is good data. Now organizations still have lots and lots of it.

The key task is integrating it and making sure it doesn't have a lot of errors, making sure it's common, that customer means the same thing across the entire organization so you are not comparing apples to oranges.

WSJ: Is it all about technology?

Mr. Davenport: No, not at all. That was one of the things that I think was an interesting outcome of my research. I'd say the number one factor is really a leadership dimension.

It's how committed are a company's senior executives to fact-based and analytical decision-making and the whole idea of experimentation as a way to learn rather than doing it out of gut feel or intuition.

Well said, Professor Davenport.  Get people on board with the idea of data-driven decisions and then make sure you have people who are comfortable with data and understand how to handle it.  At that point, a technology may help. 

Skeptical and cynical about Microsoft's investment in Facebook

I don't normally comment about deals in my blog most generally because I think (and many studies back me up on this) that M&A as a means to grow is a much dicier proposition than organic growth (which coincidentally is what corporate portfolio management focuses on :)  M&A growth is generally predicated on esoteric visions & ambiguous synergies and usually serves to make a company or a management team look bold and visionary.  Unfortunately, it tends to fall on its face and take down with it many senior executives.  In this process, your friendly neighborhood investment banker does well because he helps put the deal together and then when things sour, he gets to charge you to break it apart to "unlock value".  Companies, unfortunately, don't fare as well (except a few solid serial acquirers who are in a very small and exclusive minority).

In this case, we don't have an acquisition but a $240 million investment by Mister Softee in Facebook for a 1.6% stake.  This values Facebook at $15 billion.  Wow.  I think Facebook is a tremendous service/product and has the very real potential to live upto that valuation one day. 

My concern with the investment is centered not on Facebook's future prospects but around a few key questions:

• Was deal envy a driver? - Google had been winning many of the recent M&A deals and so it seems from press reports that Microsoft felt the need to do this deal to really put forward that they are serious about being a player in online advertising, social networking, etc (put in any hot growth area here).  If vision and bravado were part of the mix (and it'll never be admitted to but they were), we have a problem. 
• Is the price rational? - Will they be able to demonstrate an eventual ROI on the business relationship with Facebook?  I'm not talking about gains from an eventual Facebook IPO.  It is not Microsoft's job or business to diversify on behalf of its shareholder by investing in companies.  As a result, we really need to look at whether the value of the ongoing business relationship with Facebook will pay back.
• Is this the solution?  - From a search perspective, Microsoft is getting its proverbial a$$ handed to it by Google.  More generally, Microsoft has a relevance issue online.  By investing in Facebook, do they solve for those issues or do they just distract people from focusing on the issues in their online business?  Shock and awe and a desire to move to fast-growing, sexy segments seems to have won out over a substantive overhaul and rethinking of how to innovate.
• What would $240 million have done organically?  - Microsoft's cash horde is well documented, but that doesn't mean they want to give out money.  Was the alternative of looking at what internal investments this $240 million could have funded examined or was the company so intoxicated and hot to trot on Facebook that they had to do a deal - no matter what.
• What about the culture?  I am curious to see how this hot, raging startup will deal with big corporate Microsoft.  I hope they've given significant thought to this as it has the potential to derail their entire effort - quickly.

I am sure these questions were asked but in the excitement to do a deal, the projections (aka best guess) and even discussions on the softer stuff ("Yes, we'll put together a task force on culture integration after the deal is done") can definitely push you to the outcome you want.  I applaud Facebook for realizing the leverage they had with MSFT and really capitalizing on it.  Microsoft is up after hours so that may be an indication that The Street likes the deal.  I wouldn't pay any attention to this as The Street is wrong 1/2 the time.  Time will tell what happens with this deal.  I do hope it works out for both parties.  That said, I'm highly cynical/skeptical that it will.  I think Microsoft may make a killing on an eventual Facebook IPO but that was not the reason for this deal.  And for the strategic and business reasons this deal was done, it's now on the record that I don't see it working.  Thoughts anyone?