Growth Strategy

November 3, 2015 By Don Springer Leave a Comment

Overcoming Bad Compensation Standards

Is ISS, and other governance watchdogs, leading us to mediocrity and sub-par shareholder returns?

Speaking at a recent NACD North Texas event, Marc Hodak, noted compensation advisor, teacher at NYU Stern School of Business, and CEO Trust member, promised we would hear something we had never heard and he completely fulfilled that promise.

Co-sponsored by CEO Trust and UT Dallas’ Institute for Excellence in Board Governance, the well attended event provided board directors an opportunity to hear the latest compensation research set in a context of expert and candid advice.

Marc organized extensive research in the field by asking and answering the following questions:

What is the value of equity to managers?
What is the value of management equity to investors?
What to do about “underwater options”?
How should incentives be awarded?

The research findings for each were startling, especially in the context of most board room compensation discussions today. Boards predominantly “benchmark” their compensation plans asking questions about their peers and ISS guidelines rather than asking key questions about how a plan would truly motivate revenue growth and cost improvements over the shareholders’ investment horizon.

Among the findings, companies with uncapped bonuses significantly outperform their industry peers and no research study has contradicted this. On the other end of the “incentive curve”, thresholds have stimulated extreme behavior to cross the line at best and scandals like Enron and WorldCom at worst. Additional research findings contradicted the standard practices of “non-performance” pay, handling underwater options, budget-based management incentive plans, and others.

Once the empirical data was established, Marc continued by providing a general framework for compensation plans that do, in fact, increase shareholder value and properly incentivize management, as well as the entire workforce. They hinge on single metrics such as net income, earnings, or EVA, and support longevity to reinforce profit building behavior.

Marc has elsewhere written, “In a world where every dollar denied to management is thought to be a dollar more in the shareholders’ pockets, the accumulated public company compensation requirements and standards make perfect sense. But in the real world, where costs must be intelligently traded off with retention risk and alignment, SEC requirements and ISS standards get in the way of well-intentioned boards.”

Focusing on standards at the exclusion of research data and market dynamics can lead to unproductive compensation plans. Marc also candidly added that focusing on proxy approval can create continuing engagements with many compensation consultants as the standards ebb and flow.

As directors in attendance, we recognized a need for incentives that truly promise rewards to drive behavior for the benefit of the shareholders. Now armed with new information, we will be wary of an advisor who merely monitors an ISS checklist for proxy support. Instead, we will prefer a research based compensation advisor to help guide the development of a value based plan.

October 20, 2015 By Don Springer Leave a Comment

Can Entrepreneurship be Taught?

There are many approaches to entrepreneurship including the psychological approach that focuses on the personality of the entrepreneur, the environmental approach that focuses on the social and organizational aspects, and a combination that looks for systemic elements.

Saras Sarasvathy, Darden School research professor at the University of Virginia, has researched the approach from the context of a domain of expertise and has found that serial expert entrepreneurs use a distinct logic in their decision making that she refers to as “Effectual Logic”. As a method for design, it can be taught like other methods of thought.

A Psychological Approach

A psychological approach to entrepreneurship would consider questions of personality. Does one have a high need for achievement, a high locus for control, a high tolerance for risk, and perhaps, suffer from overconfidence bias? Based on these and similar assessments, one could conclude that an entrepreneur is born and bred.

An Environmental Approach

The environmental approach would ask if the entrepreneurial candidate worked in an environment with supportive mentors who themselves had been entrepreneurs. Is the geographical area influenced and supported by multiple companies, skilled employees, venture investors, institutions of higher learning, etc., similar to a Silicon Valley or Cambridge? In essence, this approach assumes the environment to be a significant impact conducive to entrepreneurship or not.

Both of these approaches would assume that entrepreneurship is not taught, but born as personality or coaxed and supported as a socio-economic outcome.

Sarasvathy was interested in two primary questions: (1) What commonalities and differences exist in the decision making process of a group of expert entrepreneurs, and (2) in the face of a non-existent markets, what underlying beliefs about the predictability of the future influence decisions as they build a new venture?

Entrepreneurship: A Design Approach

This led her to research entrepreneurial thinking as a domain of expertise and, as such, she found it had a logic of its own. She found that entrepreneurs have learned how to build ventures in a market in which the future in not only unknown, but unknowable. Yet, entrepreneurs are able to shape this future by utilizing the following five principles:

Start with the Means – they started with their means: who I am, what I know, and whom I know
Affordable Loss – they limit risk by understanding what they can afford to lose
Leverage Contingencies – they invite surprise as a clue to new markets vs. managing for risk
Form Partnerships – they build partnerships with self-selecting stakeholders and change the goals and resources available by doing so
Control vs. Predict – they build the future rather than finding it or predicting it.

She refers to this approach as an “Effectual Logic” that can be contrasted with “Casual Logic”, the approach that predicts the probability of the future, manages the risk, assesses the competition, and moves a new venture forward on the basis of returns on assets.

Effectual logic is an approach to design and construction in contrast to casual logic’s approach to decision making. It is, however, simply another method of thinking along side deductive logic, Bayesian analysis, the experimental method, etc., and as such, can be taught just like other problem solving methods.

October 13, 2015 By Don Springer Leave a Comment

Innovation Management

Innovation can be managed similar to organizational processes like quality initiatives, safety programs, and mergers. Yet, when organizations desire to become more innovative, they seem to move forward in a haphazard way.

Rita McGrath, in The End of Competitive Advantage, argues that a proficiency in managing every aspect of an innovation system is required as part and parcel of the other aspects of operating a company.

Proficiency in innovation requires a management system for planning, monitoring, and budgeting. It also requires a way to manage the resources to be used and a guide of how the innovations will fit into the larger strategic direction.

Additionally, it is important that roles are identified so that the organization knows who is responsible for vision and resource enablement, specific initiative development, and internal launch or market commercialization. With systems and roles in place, the organization can progress innovation phases of ideation, testing, development, and commercialization.

With a strategic direction as guide, an ideation process must include a pipeline of ideas that are promising. McGrath says that this part of the process “encompasses the processes of analyzing trends, connecting innovations to the corporate strategy, scoping potential market opportunities, and eventually defining arenas in which a company may want to participate”.

With regard to focus, there are two schools of thought: (1) ideation must be directed with a clear focus and (2) ideation springs from organizational support of free thinking.

Google, 3M, and others have practiced the latter by providing people with time to work on what they want without restrictions. McGrath argues for the former, coined as “challenge driven” or “needs driven” innovation, because it supports the direction of the firm, even in its widest strategic sense.

Once ideas have been developed, those with promise are further developed, tested, and defined. It is here where customer needs and use cases are defined and a plan developed to test the assumptions. The primary objective is to test those assumptions as quickly and cheaply as possible.

Moving forward to commercialization is a process of continual testing, prototyping, costing, partnering, planning and launch. Whether this is accomplished in three phases, as McGrath delineates, or in a phase of product commercialization and marketing, the idea is to move the idea to launch in quick, small, inexpensive steps that have been tested and confirmed along the way.

Proficiency in innovation is derived by managing the innovation process as a system, from idea through development to commercialization and integration with the company.

Furthermore, in a continually changing marketplace, innovation is now part of strategic design and operations. It is not simply a separate initiative to be implemented one time.

October 6, 2015 By Don Springer Leave a Comment

Pruning Your Business

Strategically, it is just as important to formulate what to stop doing as it is to formulate what to start doing. In Rita McGrath’s book, The End of Competitive Advantage, she argues for healthy disengagements of businesses.

It is a case of recognizing decline as soon as you can and appropriately disengaging from the business in a way that conserves resources and supports your strategic direction.

Signs of decline can easily be spotted and usually long enough before it creates a crisis. But as McGrath identifies, the measurements for decline are not the usual routine operational measurements. She lists the categories of declines as:

Diminishing Returns to Innovation – next generation innovations start to be smaller and smaller improvements in the user’s experience
Increasing Commoditization – alternatives start to be increasingly acceptable to potential customers
Diminishing Returns to Capital Employment – growth rates in certain portfolio offerings begin to perform below an acceptable target

Once a portfolio business becomes a candidate for shifting resources or divestiture, you have to act quickly to conserve the value as it declines. McGrath identifies three reasons a business should be removed from the corporate portfolio:

Capability-Offering is core – the offering is heading for obsolescence, but customers, suppliers, and the organization need to be transitioned to a new platform or service offering
Capability-Offering has value, but not for us – divest for reasonable prices
Capability-Offering is in decline – optimum pay for customer support while decreasing investment

Of course, to complicate each of these reasons and actions is the element of time. If there is relatively little time pressure, then the delineated approach can work in a deliberate fashion, but if time pressure exists, the response becomes more urgent. A migration becomes a divestiture, divesting for reasonable prices become bargain prices, and continuing support becomes transitional in an end-game.

To equip your business to prune in a healthy manner, McGrath recommends that you identify the warning signs of decline, create metrics to highlight the import, and once the decision for disengagement has been made, pick the appropriate approach in accordance with value to the business, the reason for decline, and the pressure of time.

Pruning your business is an important on-going strategic action for businesses who desire to build and exploit transient competitive advantages.