Ownership vs markets - Stumbling and Mumbling

Summary:
Chris Dillow argues that the traditional capitalist ownership structure is responsible for the credit crunch, not free markets as others have argued. Banks lost money on mortgage derivatives because of principal-agent failings, i.e. bosses (principals) don't know what the traders (agents) are doing. Traders have an incentive to take risk: life-changing bonus; gains exceeds benefits of prudence. Also, little pressure upon banks' executives to be prudent because when shareholding is dispersed, no individual shareholder has much incentive to rein in management. There has been more "bad" financial innovation that good ones. With good financial innovation it is very difficult for anyone to own its beneficial effects, it's a public good. Gains from “bad” financial innovation are more appropriable, hence we get more of it. Finally, banks' reluctance to lend to each other stems from the inability of management of such complex organisations to know everything. Banks should become more like venture capitalists, i.e. using an internal market, allocating capital to semi-independent divisions, which put in their own capital. (Published: 12/09/08)

Notes:

• Samuel Brittan and Anatole Kaletsky: credit crunch is undermining the case for free market capitalism
• but: crucial distinction between free markets and traditional capitalist ownership structures
• credit crunch does more to highlight the failing of the latter than of free markets
• Four reasons
• Banks lost money on mortgage derivatives because of principal-agent failings
• principals (banks’ bosses) didn’t understand what agents (traders) were doing,
  
• traders had incentives to take on excessive risk
• because the gains from doing so - a life-changing bonus - exceeded the benefits of prudence.
• Banks have been reluctant to lend to each other
  
• not so much because each bank fears its counterparty will not repay the money
• but: because they fear they’ll need the money themselves
• because banks just don’t know what sort of losses they are sitting on
• it’s impossible for managers of such complex organizations to know everything
• Banks are under-capitalized because chief executives have traditionally had incentives to maximize earnings by using leverage
• pressure upon them to be more prudent has been absent partly
  
• because when shareholding is dispersed, no individual shareholder has much incentive to rein in management
• [note: is shareholding too dispersed? 70% of all stock in America is now owned by financial institutions; as John Bogle said, in relation to Enron-type scandals, "the problem is that shareholders aren't owners anymore, they're agents of owners, and they do not actively engage in corporate governance, making sure that companies are managed for their shareholders etc.; instead they are more actively engaged in trading pieces of paper back and forth and they don't seem to care much about anything except whether the CEO meets the earnings expectations he's promised or doesn't; sometimes these expectations are met by fair means, but sometimes by foul ones" - like Dillow, Bogle also focuses on the ownership, but he blames it on the traditional owners capitalism having been replaced by managers capitalism]
  
• Good financial innovation has been lacking
  
• because it’s very difficult for anyone to own its beneficial effects;
  
• it’s a public good
• gains from “bad” financial innovation are more appropriable.
  
• so we get more of it
• e.g. overly complex mortgage derivatives
• solution
• not nationalization
  
• bad way of solving principal agent problems
• perhaps instead, banks should make more use of internal markets
• i.e. should become more like venture capitalists
• allocating capital to semi-independent divisions, which put in their own capital
• would restrain traders’ risk-taking
• as they can not so easily hide behind the fact that losses are spread over the whole firm
• would reduce the problem of asymmetric information between banks’ senior managers and trading desks
• as there’s a simpler test of how well the latter do: whether they can hand over enough hard cash to cover their required returns

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Back to bust? High technology on course for harder times - FT.com

Summary:
The IT industry may be about to face its toughest period since the dotcom bust due to the slowdown in the economy. Corporate demand, the IT industry's main source of prosperity, will fall significantly. Instability in the financial markets, declining new hires and weakening corporate profits will result in a lowering of capital expenditure and a premium being placed on operational efficiency. This is likely to play out over the next 9 months, with tech stock, already down 19% over the last 12 months, to fall further. Other recent trends that will compound the impact of the economic slowdown are the increase in choice leading to price deflation; the rise of software as a service and virtualisation. Consumer spending and spending on advertising, an important source of revenues for many Web 2.0 startups are also in decline. The downturn, however, may be less painful than the dotcom crash. There is less overcapacity in the industry, and increasing demand from the emerging world for IT services is compensating for the slowdown in the US and UK. (Published: 14/08/08)

Notes:

• information technology industry may be about to face its toughest period since the dotcom bust
• forgotten side of the technology world: industry's main source of prosperity is the corporate customer
  
• the engine that powers Silicon Valley and the rest of the technology industry
• "flashy gadgets such as Apple's iPhone and online consumer services such as Facebook may have captured the popular imagination and created new technology fortunes, but they are not the industry's main source of prosperity"
• companies account for 60-65 per cent of the end-market for technology
• consumer technology represents only about 20-25 per cent
• governments make up the rest
• with a pronounced economic slowdown in the US and the UK, this engine has started to sputter:
1. weakening corporate profits
2. decline in new hires
   
3. instability in the financial markets
   
• these have historically all been warning signs of lower capital spending ahead
• based on the usual lag, the turmoil in credit markets of the past year virtually guarantees that corporate spending on technology will fall over the next nine months or so
• technology demand, which has been growing recently at an annualised rate of 5-6 per cent, could decline by 10 per cent
• tech stock investors
  
• investors in tech stocks are invariably drawn by the promise of superior growth
• made the sector a stock market stand-out for much of last year, as a slowing US economy made growth stocks rarer
• industry's seemingly endless hype cycle feeds this optimism
• there's always a new computing architecture about to go mainstream, a new must-have gadget, and a Next Big Thing
• optimism is often justified given the big markets that new technologies can create
  
• but: investors frequently pay dearly for that potential
• "If it doesn't work, you get your neck broke"
  
• tech stocks have fallen 19 per cent over the 12 months to the end of July
• nearly double the rate of the overall market
• operational execution at a premium
  
• "I expect the slowdown to profoundly impact Silicon Valley internet, networking and technology companies over the next 12 to 18 months"
• "Technology start-ups should already be tightening their cost controls and turning their attention to the nuts and bolts of operational efficiency."
  
• "There are still numerous long-term growth opportunities across Silicon Valley, but operational execution is at a premium and much more of a differentiator than it has been in many years."
  
• Jim Breyer, partner in VC firm Accel Partners
• recent trends in the technology industry compounding the impact of the worsening economic environment
• availability of choice -> price deflation
  
• thanks to the rise of the internet and other standards-based technologies
• made it easier for buyers to shop around
  
• many corporate buyers have come to count on these to help them continually reduce the overall size of their tech budgets
• When the 1990s tech boom reached its peak, corporate buyers were often tied to proprietary systems from single suppliers
• that is no longer the case
• result: a severe price deflation has taken hold in some corners of corporate technology
• rise of "software as a service" and virtualisation
• two of the most powerful recent technology trends that exemplify this change
  
• software as a service (SAS)
• involves shifting corporate computing tasks to online services
• e.g. using a company such as Google to provide an e-mail service
• "I don't have to buy servers, I don't have to buy storage, I don't have to do back-ups"
• many of these service companies have priced their services at rock-bottom rates
• relying on attracting large volumes of customers to spread their large fixed costs
• "We're talking about products that are one tenth the cost of things that were hawked in the last recession"
• virtualisation
• makes it possible to run several computing workloads on a single server,
• greatly reducing the number of machines that companies need to buy and maintain
• trends like these have created new markets and supported the rise of new companies
• but 1: they have also exposed those whose technologies or business models are not suited to the changing times
• e.g. Sun Microsystems
• soared in the dotcom boom as its proprietary servers became the mainstay of Web 1.0
• but has struggled to adapt to the latest generation of low-cost, standards-based machines and open-source software
• but 2: even tech companies that have been better positioned to ride this wave are starting to feel the pinch.
• due to weaker corporate demand
• companies taking a more "pragmatic" approach to their tech budget
• putting off buying new services
• not just weaker corporate demand
• consumer spending on tech, though far less significant overall and traditionally less prone to big dips, could also be hit in a wider downturn
• another big source of growth, the rapid rise in online advertising, has slowed notably this year in the face of a wider softening in consumer advertising
• after growing nearly 26 per cent in 2007, online advertising in the US, is predicted to grow by only 17.5 per cent this year and 14.5 per cent in 2009, before growth eventually pushes back above 20 per cent in 2011
• search still dominates
• people are cutting back on typical display ads
  
• this slowdown in advertising could not have come at a worse time
• many of the consumer web companies created since the dotcom crash have been avidly building an audience in the expectation that they will cash in through advertising

• downturn will not be anywhere near as painful as the one that hit the industry at the start of this decade
• late-1990s tech binge was more than a bubble in stock market valuations:
  
• it also reflected a massive bubble in tech spending
• internet euphoria
• fear that many older IT systems would not be able to handle the date shift at the turn of the millennium
  
• combined to produce a boom in corporate spending
• we don't have the overcapacity in IT systems we had going into the last downturn
• capital spending in the US has been low by historical standards for the past four years
• will cushion the blow from any fall now
• demand from emerging world growing
  
• after many years of investment, these markets are finally on the brink of becoming significant money-earners for some of the industry's biggest players.
• at its current growth rates, these "growth markets" may account for nearly 30 per cent of its revenues in five years' time
• Silicon Valley is once again turning into a place of "haves" and "have-nots"
• those start-ups that raised a comfortable cushion of cash from investors to see them through this more uncertain period and those that risk being left high and dry if business turns down
  

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Entrepreneurs versus corporate managers - IMD

Summary:
An IMD study looks at the main differences between entrepreneurs and corporate managers. Key differences: 1) Long-term/short-term decision making. Contrary to expectations, entrepreneurs proved to be the group with the greatest focus on building a long-term business. Corporate executives operated far more from a monthly or quarterly framework. The reason behind this difference is that an entrepreneur ends up creating an end result – a product, market or firm – which looks very little like what they started out to accomplish in the first place. The big difference is in the goal of trying to create something big and enduring. 2) Marketing information. Entrepreneurs tend not see the point of such information. To them, market research lies in the principle of the proof of the pudding being in the eating. Under this line of thought, positive market feedback consists of trying to sell something and being successful – and negative feedback the opposite - being unsuccessful at selling something which therefore requires some re-thinking. 3) Money. Entrepreneurs showed themselves to be far more cost conscious than their corporate counterparts – who were much more willing to throw big budget at things with uncertain outcomes. 4) Competition. Where corporate executives were seen to be highly focused on the competition, entrepreneurs are far more concerned with whom they can establish solid partnerships - almost to the exclusion of worrying about competition. (Published: August 2008)

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Profit-maximization as the sole goal of a corporation - Creative Capitalism

Summary:
Martin Wolf on the nature of the firm. "What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy?" Important distinction between the role of the firm and its goal. Role is to provide valuable goods and services, whereas its goal is to maximize profit. Different views of the firm: as a bundle of contracts, as a social organism, as having culture and history, and as having/offering meaning. Big differences between Anglo-American capitalism and capitalism in rest of the world. Differences focus on the nature of ownership of the firm, the existence of a market for corporate control, and whether or not a firm can be bought and sold. Implications for relationship with employees, efficiency and creativity. Room for enduring divergence in the forms of capitalism is bigger than those working in the Anglo-American intellectual tradition appreciate. Evidence on the (in)effectiveness of takeovers and the recent sad experiences in financial markets rather suggests Anglo-American capitalism may be on the way out. (Published: 17/08/08)

Notes:

• What is the goal of the limited liability, joint-stock company, the core institution of the contemporary capitalist economy?

• distinction between goal of the firm and its role
• role of companies: to provide valuable goods and services
  
• i.e. outputs worth more than their inputs
• great insight of market economics is that they will do this job best if they are subject to competition
• goal of the firm: profit-maximization
• or shareholder value maximization
• its more sophisticated modern equivalent
• goal of profit-maximization drives the firm to fulfill its role

• market in corporate control
  
• competitive market for corporate control forces companies to maximize shareholder value
• or at least behave in ways that the market believes will lead them to do so
• if companies fail to oblige, the company will be put “into play."
  
• thus, in Anglo-American shareholder-driven capitalism, maximization of shareholder value (as perceived by the market) must perforce be the goal of the company
• not the case in countries where a market in corporate control does not exist
• in such countries, companies must earn a high enough return on capital to survive
• but this need not be a shareholder value-maximizing return

• views of the firm
  
• company as a bundle of contracts
• Anglo-American view of the company
• contracts between the company, its employees and, quite often, its suppliers and even distributors
• many contracts relational
• cannot be written down in any precise form
• companies are hierarchies in which people engage voluntarily
• they necessarily work on the basis of trust in what is often a very long-term relationship:
  
• "I work extra hard to meet a deadline now, in return for consideration when I need to look after my elderly mother later on."
  
• for many companies, trustworthiness is an essential ingredient in their long-term success.
• company as social organism
  
• companies are social organisms created by a highly gregarious mammalian species with a unique capacity for large-scale co-operation over time and space
• companies have cultures and histories
• companies have/offer meaning
• for many of those most closely associated with them
• committed workers in successful companies do not work in order to maximize shareholder value or even to earn the largest possible living
• indeed, it is impossible to direct most companies solely by the goal of profit-maximization
• they have to be aimed at the intermediate goal of producing and developing goods and services that people want to buy and are worth more in the market than they cost to produce
• company is an entity that can be freely bought and sold
• Anglo-Saxon view
• not shared by rest of the world
• for many cultures, a company is viewed as being an enduring social entity
• e.g. for many Japanese, one can no more sell a company over the heads of its workers than one can sell one’s grandmother
• in this view, goods and services can be bought and sold.
  
• companies, like countries (or, as we all now agree, people), must not be
• if companies can be freely bought and sold, relational contracts are hardly worth the paper they are (not) written on
• relational contracts depend on continuing interaction among specific people inside the business
• rational employees will act opportunistically
  
• because they will always expect their company to do the same
• the longer and more reliable relationships are expected to be, the less likely such opportunistic behaviour is to emerge
• not necessarily the case that companies which operate under the assumption that they can be bought and sold (like GM) will operate more successfully in terms of maximizing shareholder value than those which do not
• e.g. Toyota is a better car company than GM in almost all dimensions.
  
• the failure of Japanese capitalism to achieve the highest level of productivity and sustained dynamism may have far more to with
  
• repression of domestic competition in many markets for goods and,
  
• above all, services, rather than with the absence of an active market for corporate control.
• ownership of the firm
  
• Anglo-Saxon view: shareholders are the owners
  
• rest of the world: core workers are the owners
  
• shareholders are not genuine owners
• they are merely an (ever-shifting) group of people with a claim to the residual incomes
• contribute nothing of value to the competitive strengths of the firm
• enjoy the benefits of limited liability
• are well able to diversify the risks they run
• core workers have the biggest (undiversifiable) investment in the firm
• and thus the greatest exposure to firm-specific risks
• the interests of the core workers are, therefore, paramount
• capital-market arrangements (and associated views of the firm) that enforce shareholder value maximization may make companies work less efficiently than otherwise, in terms of their primary role, by precluding a range of potentially valuable relational contracts inside the firm
• such restrictions may have powerful effects on comparative advantage
• by shifting countries away from those activities in which companies that benefit from long-term relational contracts are likely to be most effective
• room for enduring divergence in the forms of capitalism is bigger than those working in the Anglo-American intellectual tradition appreciate
• without an active market for corporate control, managements rule companies
• they also acts as a trustee for a range of stakeholders, of which core workers are the most important
• Anglo-American capitalism gives primary direction of companies to capital markets
• because these companies cannot be forced to maximize shareholder value, they can indeed undertake a range of costly “charitable”activities
• provided they do not threaten the company’s ability to survive
• one of the most interesting questions over the next generation is whether the Anglo-American form of capitalism will flourish and expand, or not
• some of the evidence on the (in)effectiveness of takeovers and the recent sad experiences in financial markets rather suggests not
• but: active financial markets do bring big benefits
• particularly in financing new companies and enforcing greater discipline on badly run businesses
• the more “Anglo-American” capitalism becomes and so the more shareholder driven
• the less “creative” it is likely to be
• the less concerned with wider social results it is likely to be

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America’s Addiction and the New Economics of Strategy - HarvardBusiness.org

Summary:
Umair Haque we're not just addicted to oil, but to everything. We're not entering Peak Oil, but Peak Consumption. Current financial system is a house a cards that's in the process of collapsing. Consumption in developed world has been subsidised by developing countries: goods at low prices, and reinvestment of their revenues into our government and mortgage debt. Ignored costs like pollution, community fragmentation, and abusive labour standards. Our economy is built on firms whose very purpose is to sell, to relentlessly push people into endlessly consuming, without ever considering the long-run consequences. But we're entering a world where consumption must slow. Haque proposes that being able to break yesterday’s maladaptive consumption addiction is at the heart of next-generation advantage. Next global financial system will be powered by firms that can shift past nihilistic, meaningless industrial-era corporate purpose, beyond acting as mere pushers of an addiction. (Published: 29/07/08)

Notes:

• house of cards that is the global financial system
• emerging markets seek export-led growth
• they undervalue their currencies, so their exports are more competitive purely in terms of price
• amounts to essentially a subsidy to consumers on the other side of the table – those in the developed world
• emerging markets accumulate surpluses, and recycle them:
  
• lend them back to the US and UK in the form of government and mortgage debt, stabilizing their economies
• amplifies the existing consumption subsidy in developed countries through leverage
• artificial cheapness further amplified by simple fact the true costs of production haven't been factored in - until now
• very real costs like pollution, community fragmentation, and abusive labour standards
• we’ve been able to consume mercilessly and remorselessly – with no regard for the human, social, or environmental consequences, to us or to others
• not just cheap oil we’re addicted to: it’s cheap everything
• world we’re entering isn’t really of Peak Oil as it is one of Peak Consumption
• tentative economic history of the 21st century:
  
• Emerging markets – and the people that broke their backs in them – lent the developed world tremendous amounts. What did the developed world do with it? Instead of investing it in tomorrow, they spent it on McMansions, Hummers, and strip malls.
• could have chosen, instead, to invest
• anything would have been a more sensible choice than naïve consumption
• education, energy, healthcare, transportation, even a more sensible and rational kind of finance
• problem with strategy
• our economy is built on firms whose very purpose is to sell
  
• to relentlessly push people into endlessly consuming, without ever considering the long-run consequences
• tough choices for boardroom
• entering a world where consumption must slow
• Does it continue to hawk stuff that “satisfies” largely artificial needs?
  
• Or does it choose to do something authentic, meaningful, and purposive – something that makes us all radically better off than we were before?
• new strategy
  
• At the heart of next-generation advantage is, paradoxically, being able to break yesterday’s maladaptive consumption addiction – not fuel it
• It is firms who can shift past nihilistic, meaningless industrial-era corporate purpose – beyond acting as mere pushers of an addiction – who will power the next global financial system.

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Quote of the Day

"It's probably true that hard work never killed anyone, but why take the chance?" - Ronald Reagan

Notes:

• Buffett on how the management of large organizations is extremely hard work, which is why he has taken the "easy route": just sitting back and working through great managers who run their own shows. "My only task is to cheer them on, sculpt and harden our corporate culture, and make major capital-allocation decisions."

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Quote of the Day

"We shape our buildings, and afterwards our buildings shape us." - Churchill

Notes:

• Buffet uses this quote in reference to organizations apparently becoming slow-thinking, resistant to change, and smug as they grow bigger
  

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The Equity Equation - paulgraham.com

Summary:
When offering to trade stock for investment or the services of an employee, use the Equity Equation: i >= 1/(1-n), where i is the expected increase in value due to the contribution, and n the share of the company offered in exchange. Even though stock grants can not always be reduced to a formula (there are other factors to consider in a VC deal; it's never just a straight trade of money for stock) and ultimately you always have to guess, it is useful to run the trade through 1/(1-n) to see if it makes sense. You should always feel richer after trading equity. If the trade didn't increase the value of your remaining shares enough to put you net ahead, you shouldn't have done it.

Notes:

• Whenever you're trading stock in your company for anything, whether it's money or an employee or a deal with another company, the test for whether to do it is the same:
• You should give up n% of your company if what you trade it for improves your average outcome enough that the (100 - n)% you have left is worth more than the whole company was before.
• i >= 1/(1-n)
• where:
• i is the expected increase in value due to the contribution
• n is the share of the company offered in exchange
• (1-n) is the share of the company you have left
• i(1-n) >= 1
• i.e. the value of the remaining share in the company should be greater or equal to what it was before
• the trade has left you better of
  
• n <= (i-1)/i
• the share of the company a projected increase of i in value of the firm is worth
• e.g. determining the share value of a new employees contribution
• examples
• investor wants to buy half your company: how much does that investment have to improve you average outcome to break even?
• intuitively: has to double
• 1/(1-n) = 1/0.5 = 2
• if you trade half your company for something that more than doubles the company's average outcome, you're net ahead
  
• you have half as big a share of something worth twice as much
• investor offers to fund you in return for 6% of your company, when should you make the deal?
• you should make the deal if you believe the investment will improve your average outcome by more than 1/(1-n)
• i.e. 1/(1-n) = 1.064, or 6.4%
• if investor can improve your outcome by 10%, you're net ahead
• remaining 94% is worth 1.1 x 0.94 = 1.034
• you're just two founders and you want to hire an additional employee who's so good you feel he'll increase the average outcome of the company by 20%; how much is he worth in terms of a share in the company?
• n <= (i-1)/i = (1.2 - 1)1.2 = 0.167 = 16.7%
• suppose the company wants to make a "profit" of 50% on this new hire, how much stock is the employee worth after accounting for salary and overhead of $60k, if the company's valuation is $2m?
• most startups grow fast or die
• if you die you don't have to pay the guy; if you grow fast you'll be paying next year's salary out of next year's valuation
• next year's valuation should be 3x this year's
• if your valuation grows 3x a year, the total cost in stock options of a new hire's salary and overhead is 1.5 years' cost a the present valuation
• new hire could claim 16.7%, so in order to make 50% profit on the hire, subtract a third from 16.7%, i.e. 11.1%
• the total cost in stock of the new hire is 1.5 years' cost at present valuation
• $60k x 1.5 = $90k
• if the company's valuation is $2m, $90k is 4.5%
• the offer, therefore, should be 11.1% - 4.5% = 6.6%

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Four Reasons Most Startups Fail (And How Yours Can Succeed) - HBS Discussion Leaders

Summary:
Paul Graham (Y Combinator) says four principles determine which startups work and which fail: "Make something people want"; "Be willing to change your ideas" (cfr. Reddit); "Don't worry too much about the money" (probably only applies to web startups); and "Be benevolent." Being benevolent is particularly powerful: keeps morale and energy of employees high; people (customers) will rally around you with ideas, improvements, and word-of-mouth marketing; and it helps the founders to be more decisive: if you make every decision based on doing whatever is best for your users, it's that much easier to make decisions. (Published: 18/07/08)

Notes:

• Paul Graham
• Y Combinator
• Silicon Valley & Cambridge, Mass.
• Seed funding and hands-on advice to startups
• Invests a little money (<$20,000) and takes a small equity stake (~6%)
• Funds companies in batches
• Four principles that determine which startups work and which fail:
1. "Make something people want."
• entrepreneurs often fall in love with what technology can do as opposed to what customers need
• good question: "What are people forced to do now because what you plan to do doesn't exist yet?"
2. "Be willing to let your ideas change."
• a great idea isn't always the original idea
• successful startups often make dramatic changes not just in strategies and tactics, but in the very essence of what they do
• e.g. founders of Reddit originally wanted to help people order fast food on their cell phones
3. "Don't worry too much about the money."
• applies mostly to web startups
• it's become cheap to buy equipment, reach customers, and generate buzz on the Web
• power of investors and VCs is on the wane
• "It's so much easier to get the money you need than to make something great."
• "Unlike back in the mid-90s, you've got the MBAs working for the technologists, rather than the other way around."
4. "Be benevolent"
• in terms of how you do business
• act in the long-term best interest of customers, as opposed to the short-term best interests of yourselves
• most important rule for starting a company (the "Golden Rule")
• cfr. Google: "Don't be evil."
• benevolence is powerful for three reasons:
1. keeps morale and energy high
• in an age of constant disruption and realignment, employees want to be the "good guys" in their field
• makes sense for companies to act that way
2. people will rally around you with ideas, improvements, and word-of-mouth marketing
• more than ever companies require the active participation of customers, suppliers and industry enthusiasts
3. helps founders to be more decisive
• if you make every decision based on doing whatever is best for your users, it's that much easier to make decisions
  

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The nature of ownership - FT.com

Summary:
FSA's new short selling regulation raises questions about the nature of ownership of firms. Is it okay for investors to lend stocks to short-sellers? When shares are no longer an asset to be bought, held or sold, but also a handy device for high-speed financial engineering, it becomes harder for managers to focus on the job in hand. Business may have changed for good. More and more like Chelsea football team, assembly of talent, rarely stays together for long. Nature of ownership changing. Today very fragmented and confusing. How should managers respond? McKinsey advised companies to concentrate on what it called "intrinsic" shareholders, leaving traders and "mechanical" owners to the investor relations department. (Published: 24/06/08)

Notes:

• new FSA regulation
  
• from now on any investor holding short positions in more than 0.25 per cent of stock in a company conducting a rights issue would have to own up to it
• "no more lurking in the shadows, unloading shares in a cash-strapped business that you planned to buy back soon at a much lower price"
  
• hedge fund outcry
• FSA reforms have brought bigger questions into focus:
• Why are institutional investors so relaxed about lending stock to the hedge funds to allow this shorting to take place?
  
• It may be profitable, but is it proper - especially if you have any regard for that company's management and your relationship with them?
  
• What sort of ownership do shareholders now provide, and how should managers respond?
• owners of any asset can pass on all or any of their rights to someone else ("the rights of transmissibility")
• i.e. stock lending is not illegal, nor wrong in any strict moral sense
• but: when managers get the message that their companies' shares are not merely an asset to be bought, held or sold, but also a handy device for high-speed financial engineering, it becomes harder to focus on the job in hand.
  
• Building and improving a business takes time. You cannot be judged hour by hour on your performance.
• Richard Sennett (LSE):
• "we need to update our classic view of the way markets, companies and their employees interact."
  
• "It's not capital versus labour any more, it's the operation of the firm versus the investment in the firm."
• is familiar phenomenon in the world of start-ups and IPOs
• company founders have a business idea, get it up and running, bring in new sources of capital and then, quite frequently, leave
• but then employees no longer feel answerable to the people in the office and managers lose a sense of control.
• Richard Sennet:
  
• "this kind of evolutionary process, writ large, is what we see in public companies today. How can managers get back to being in control of the companies they manage?"
• may be futile question, based on a nostalgic view of what companies should be
• business may have changed for good
• companies are now barely even semi-permanent organisations, with their own ethos and identity
• "we are all financial engineers now"
• Anthony Hilton:
  
• "Tomorrow's company will be like the Chelsea or Arsenal football teams - an assembly of talent which comes together but rarely stays together for long. Managing businesses like that, and indeed choosing those in which you should invest, will require a range of skills which we have as yet barely begun to appreciate."
  
• Mark Goyder, director of Tomorrow's Company, a think-tank
• points out that the roots of the word "company" are Latin - con panis - the people you break bread with
• analysing the changing nature of ownership
  
• argues that today there are perhaps as many as seven different types of owners that businesses may have to reckon with, all of them laying claim to assets in different ways
• fragmented and confusing world
• How should managers respond?
• McKinsey advised companies to concentrate on what it called "intrinsic" shareholders
• leaving traders and "mechanical" owners to the investor relations department
• i.e., do not waste management time on people who do not really understand you and will never make the effort to get to know you properly.
  

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Manufacturers plan to outsource more R&D - Economist Intelligence Unit

Summary:
A survey reveals that an increasing number of manufacturers are keen to outsource R&D and innovation. The main motivation is skills shortage in design and engineering. To keep pace with the breathtaking pace of product innovation, outsourcing elements of research and development may be the only viable way forward. The biggest barrier to outsourcing innovation is trust, i.e. losing IP to partners or competitors. Better IT technology is needed to prevent this, as well as better communication and an open culture. (Published: 16/06/08)

Notes:

• new paper by EIU suggests manufacturers are increasingly keen to outsource R&D
• "Outsourcing innovation: A manufacturer's perspective"
• outsourcing was pioneered by manufacturing companies
• especially in automotive sector
• two top motives:
1. cut costs
2. focus on core competences
• survey:
• 22% of manufacturers use outsource-providers as a source of innovation
• product design or process improvement
• 41% admits that, in past three years, little or no innovation has been derived from external partners
• 37% says only about one quarter of innovation has been derived from external partners
• respondents clearly see a benefit in seeking innovation outside the organisation's R&D laboratory
• skills shortages in design and engineering
• 58% of the survey sample said that, in the past three years, it has become somewhat harder or much harder to hire talented employees who can deliver innovative ideas
• “With the war for talent intensifying, especially in the design and engineering arena, manufacturers can no longer rely on finding all the best ideas under their roof. To keep pace with the breathtaking pace of product innovation, outsourcing elements of research and development may be the only viable way forward.” (Robin Bew, EIU)
  
• biggest barrier to outsourcing innovation: trust
• companies fear losing IP to partners and competitors
• most physical products start life as a blueprint on a computer
• is when they are most vulnerable
• 5 years worth of R&D can be loaded onto a memory stick in seconds
• IT security can go some way to preventing this from happening
• 51% of respondents feel their firms need to invest more in technology in order to facilitate the outsourcing of innovation from external partners
• more openness needed
• most respondents believe that establishing better communication channels with partners—both face-to-face and virtual—would make capitalising on their ability to innovate easier
• majority of companies believe that having an open culture in which knowledge is shared is essential to capitalising on innovation from external partners.
• note on measuring innovation:
• counting the new products and businesses they launch (64%)
• calculate the proportion of revenue growth that is attributable to these new products and businesses (54%)
• counting the number of patents filed comes in a distant third (32%)
• not measuring innovation at all (8%)
• related links:
• In the Pipeline: More on Outsourcing
  

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Global CEO Study, 2008 - IBM

Summary:
IBM study on thoughts and views on the future of business (the "Enterprise of the Future"). Concludes that the Enterprise of the Future hungry for change, innovative beyond customer imagination, globally integrated, disruptive by nature and genuine, not just generous. CEOs are most concerned about the impact of three external forces: market factors, people skills and technology. Organisation should act like VCs to establishe processes and structures that promote innovation and transformation. Informed and collaborative customers are viewed as chance to differentiate. Views of globalization are shifting from labor arbitrage and riding the wave of economic growth in China and India to global integration. Majority sees M&A as part of their global integration strategies. Business model innovation more important because it is increasingly difficult to differentiate based on products and services alone. CSR increasingly important, impacting on both top and bottom lines. (Published: 30/05/08)

Notes:

Change

• In our 2006 Global CEO Study, we were surprised when two-thirds of the CEO s said their organizations were facing substantial or very substantial change over the next three years. But in 2008, even more CEOs — eight out of ten — are expecting such change.
  
• CEOs find themselves — as one CEO from Canada put it — in a “white-water world.”
• CEOs are most concerned about the impact of three external forces: market factors, people skills and technology.
  
• Market factors: Customer expectation shifts, competitive threats and industry consolidation continue to weigh on their minds.
  
• “ The market is so dynamic. Visibility is very low.”
  
• People skills: CEOs are also searching for industry, technical and particularly management skills to support geographic expansion and replace aging baby boomers who are exiting the workforce.
  
• They rated insufficient talent as the top barrier to global integration — even higher than regulatory and budgetary hurdles.
  
• “ We’re making acquisitions for the people, not the assets.”
  
• Technology: CEOs also described how technological advances are reshaping value chains, influencing products and services and changing how their companies interact with customers.
• “ Technology is driving huge changes in our industry landscape.”
• Change management
• In a 2008 study of change management practices, 75 percent of the companies surveyed said their approach to change management was usually informal, ad hoc or improvised.
• In contrast, the Enterprise of the Future defines and manages change as robust programs, structured around and driven to deliver defined business outcomes.
  
• It tracks the business benefits of change and change management effectiveness.
  
• Strong change management is a core competence at all levels and nurtured as a professional discipline, not an “art.”
  
• Operating like a venture capitalist
• The Enterprise of the Future establishes processes and structures that promote innovation and transformation.
  
• It actively manages a portfolio of investments, protecting and supporting the fledgling ideas, while systematically weeding out the weak ones.
• "Do you have robust processes in place to incubate new product, service and business model concepts — and redirect investment when required?"

Innovation

• investment in new markets
• In both developed and rapidly developing economies, rising prosperity is creating growth opportunities for many companies
  
• In rapidly developing economies worldwide, the middle class is growing and becoming progressively more prosperous. Greater disposable income brings new demand for more sophisticated, higher-value products and services.
• e.g. “In India, 400 million consumers will demand new housing in the next 20 years — that’s more real estate than the United States has built since the Second World War.”
• In established economies, significant wealth accumulation among aging baby boomers and a corresponding increase in young, affluent inheritors are boosting prosperity in what some might otherwise consider flat-growth markets.
• but: tapping into these new geographic and demographic segments will require a deeper understanding of these customers and a more tailored approach.
• informed and collaborative customers: chance to differentiate
• rising expectations from increasingly informed and collaborative customers
• in increasing numbers of industries, customers are swapping passive roles for much deeper involvement.
  
• “Consumers” are becoming “producers,” creating entertainment and advertising content for their peers and even generating their own electricity.
• serving the informed and collaborative customer as an opportunity to distinguish their organizations
  
• a chance to justify premium positioning and price.
• understanding timing and network effects
• Exceeding expectations: there is a fine line between “beyond” and “too far.”
  
• The Enterprise of the Future understands the need to introduce innovation that the market is ready to accept and works to perfect its market-entry
  timing.
  
• It exploits the network effects of early adoption to take a commanding early lead.
• Market insights are critical to the Enterprise of the Future.
  
• It recognizes the value of the information it collects through its many channels and actively mines it for insights.
  
• It uses emerging technologies to gain insights in new ways.
  
• e.g. virtual worlds
• It also puts systems in place that allow very fast feedback cycles.
  
• When customer preferences and demand start to shift, it knows before the competition.

Global integration

• Traditional views of globalization: labor arbitrage and riding the wave of economic growth in China and India
  
• replaced by a new focus: global integration
• i.e. new business designs that facilitate faster and more extensive collaboration on a worldwide scale and rapid reconfiguration when new opportunities appear
• more than half of CEOs plan to deeply change their organizations’ capabilities, knowledge and assets.
  
• New customer expectations are driving some of these shifts.
  
• “We need to move away from an operational focus to a client interface focus. This requires new skills and a new skill mix for the corporation.”
• found that outperformers are 20 percent more likely to partner extensively than underperformers
• reinforces what we discovered in our last CEO Study: extensive collaborators outperform their competitive peers
• Sixty-six percent of CEOs plan to use mergers and acquisitions (M&A) as part of their global integration strategies
• described M&A as a key way to rapidly expand global reach
  
• integrating new capabilities, knowledge and assets and gaining access to new customers.
• outperformers are 55 percent more likely to use M&A than underperformers
• challenging the preconception that M&A is a risky and often unsuccessful strategy.
• Prior research suggests that frequent acquirers often become extremely effective at M&A and can use it more successfully
• CEOs’ approaches to global integration and optimization are carefully tailored to their businesses
• e.g. global brands and products must have local relevance
• Social networking and realtime collaboration tools improve communication and close the distance between people in different locations.
  
• Good ideas develop and spread quicker, and problems are solved faster.

Disruptiveness

• outperformers are pursuing more disruptive business model innovations than their underperforming peers
• CEOs told us they are changing their business models because it is increasingly difficult to differentiate based on products and services alone
• also stressed another reason: they simply have more options now
• e.g. With the Internet, businesses can now find niche markets for rare, surplus or highly specialized goods
• a virtual “garage sale,” as it’s often called.
• Business processes, as well as some products and services, are becoming more virtual.
  
• New delivery channels and electronic methods of distribution are overturning traditional industry conventions.
  
• these advances are not just changing the way individual companies work: they’re creating entirely new industries.
• Types of business model innovation:
• Enterprise model innovation
  
• Specializing and reconfiguring the business to deliver greater value by rethinking what is done in-house and through collaboration
  
• as Cisco has done by focusing on brand and design while relying on partners for manufacturing, distribution and more.
• Revenue model innovation
  
• Changing how revenue is generated through new value propositions and new pricing models
  
• as Gillette did by switching the primary revenue stream from razors to blades
• Industry model innovation
  
• Redefining an existing industry, moving into a new industry, or creating an entirely new one
  
• think music industry and the Apple iPod and iTunes
• Among CEOs making extensive changes to their business models, enterprise model innovation is the dominant choice
• “For us, enterprise model innovation is primarily about having the right business model to enter other markets and secure new capabilities.”
  
• main message heard from proponents of enterprise model innovation is that going solo is increasingly difficult.
  
• “We’re very vertically challenged,” one electronics CEO said when describing the difficulty of owning the entire value chain.
• “We have to collaborate to survive; there are fewer things that will be cost effective to do on our own. We will continue to do less inside the organization and more with partners and even competitors.”
• pursuing industry model innovation: tough to do
• pharmaceutical CEO:
  
• “Our industry has an ‘innovation paradox.’ We are constantly driving for innovation on the one hand, while being risk averse on the other. Pharma companies still hope for the ‘blockbuster party,’ and they’re trapped in that model. The company that breaks through this will be the winner, and others will follow.”
• outperformers are very interested in enterprise model innovation.
  
• But they are also planning 40 percent more industry model innovation than underperformers.
• the question is:
  
• Are these outperformers pursuing more industry model innovation because they have the clout to do so?
  
• Or are they outperformers because of their insight and inclination to continuously question industry norms?
  
• it’s actually both: a reinforcing cycle.
  
• Innovation successes can provide the financial means and industry position to attempt bolder moves, which, in turn, can improve business performance
• thinking like an outsider
• The Enterprise of the Future does blue-sky, green-field thinking.
  
• Its goal is to spark innovation by thinking about “starting over from scratch.”
  
• It finds ways to work with people and organizations that are not part of the industry status quo to develop new models.
• It challenges every assumption of its business model
  
• just as an outsider would
• drawing breakthrough ideas from other industries
• The Enterprise of the Future is a student of other industries because it realizes that game-changing plays spread like wildfire.
  
• It scours customer and technology trends that are transforming other sectors and segments of the market and considers how they could beapplied to its own industry and business model.
• experimenting creatively in the market, not just in the lab
• The Enterprise of the Future often pilots models in the marketplace, obtaining realtime feedback and making iterative adjustments.
  

Corporate Social Responsibility

• “I see corporate responsibility going through three phases. People start to consider issues like the environment because they are compelled to do so. Then they realize that it actually makes business sense. Eventually they move beyond compulsion and selfish motives to become passionate becauseit is the right thing to do.” (Vinod Mittal)
  
• customer expectations of corporate social responsibility (CSR) are increasing
• environment is one obvious touchstone:
  
• climate change has become an urgent call to action for citizens and companies around the world.
  
• has sensitized both citizens and corporations to the wide array of environmental and social issues that they can do something about.
• from child labor to recycling to product safety
• only three external forces have consistently ranked higher than CSR in consecutive surveys:
  
• socioeconomic factors, environmental issues and people skills
• but: all three are linked to CSR.
• With talent in short supply, employers’ CSR reputations are an important tool to attract and retain employees.
  
• Companies are also recognizing that they are being held mutually accountable, along with the public sector, for the socioeconomic well-being of theregions in which they operate.
• Regulatory compliance is not CEOs’ chief concern
• “Environmental legislation is less of a problem. It is reasonably easy to be ISO 14000 certified. It is much harder to face media and political pressure from socially active environmental NGOs.”
• CSR is impacting top and bottom lines
• “Our organization is responding aggressively to green issues in the marketplace, which have become the focus of several of our key customer segments. We are introducing newgreen-based insurance products into the market.”
• “Consumers will increasingly make choices based on the sources of the products they buy, even the ingredients and processes used in making these products.”

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Quote of the Day

"Even if you're on the right track, you'll get run over if you just sit there." - Will Rogers

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Why Every Employee Needs a Global Mindset - The Globalist

Summary:
Second excerpt from "The Quest for Global Dominance," by Anil Gupta, Vijay Govindarajan and Haiyan Wang. Companies that want to be market leaders need to cultivate global mindset in all its employees. Importance of selection, demographic makeup, promotion decisions. (03/04/2008)


Notes:

• Global mindset obviously needed for employees managing activties that span borders (e.g. global product manager, employees facing foreign customers/suppliers/colleagues) Greatest value added by/highest return from global mindset at senior levels.
• However, even employees with purely local responsibilities need global mindset. Even assembly workers should develop own "global learning communities"
• Global mindset in every employee needed for creation of global learning organization. Does not need to equally strong across entire spectrum of employees.
• If company's goal is to capture and sustain global market leadership in its industry, necessary to regard development of global mindset as a goal encompassing all units and all employees.
• Global mindset needs to be cultivated, ceaseless journey. Cultivating curiosity and openness about the world.
• Company's greatest degree of freedom lies at the point of selection, managing its demographic makeup and promotion decisions.
• "Promotion decisions to senior executive levels that place high value on global experience and global mindsets also have a corollary effect in terms of sending strong signals regarding the increasing criticality of openness to and curiosity about diverse cultures and markets."
• Market opportunities, critical resources, cutting-edge ideas and competitors not just lurking around corner in home market, but increasingly in distant and often little-understood regions of the world. Cultivating global mindset essential for company to exploit these opportunities and tackle accompanying challenges.

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Cultivating a Global Mindset - The Globalist

Summary:
Excerpt from "The Quest for Global Dominance," by Anil Gupta, Vijay Govindarajan and Haiyan Wang. Not sure what the global dominance is about, but discusses some interesting concepts. Cultivating a global mindset (vs. parochial and diffuse mindsets). Update: global dominance refers to companies wanting to become global market leaders (02/04/2008)


Facts and figures:

• Mobile subscribers in China (2007): ~500m
• Internet users in China (2007): >200m

Notes:

• Global mindset: "combines an openness to and awareness of diversity across cultures and markets with a propensity and ability to synthesize across this diversity.
• Global manager: open-minded; respect how different countries do thing and understand why they do them that way; however, don't passively accept it, push the limits of culture; finding opportunities to innovate through "the debris of cultural excuses"
• Diffuse mindset: some people in firm may have global mindset, but is not philosophy of the whole firm; behaves parochial.
• Microsoft in Chinese market: example of global mindset
• China promises huge market but is accompanied by perils (e.g. software piracy, unpredictable public policy, local enterprises favoured)
• Sophistication level Chinese market in many respects lagging behind, but leading in some (e.g. 2007: mobile subscribers, 500m, and internet users, 200m)
• Global mindset enables company to outpace rivals in assessing market opportunities, establishing market presence necessary to pursue worthwhile opportunities, converting presence across multiple markets into global competitive advantage
• central value of global mindset: enabling the company to combine speed with accurate response; having an insight into the needs of the local market + being able to build cognitive bridges across these needs and between these needs and the company's own global experience and capabilities
• prisoner of diversity: intimidated by enormous differences across markets and staying back
• companies that stay local (eg. nursing homes, hospitals, radio stations, cleaning services, ...) may benefit from global mindset, too: 1) benchmarking and learning from product and process innovations outside domestic borders; 2) alertness to entry of foreign competitors in local market (eg. a global consolidator acquiring a local competitor and changing the rules of the game)
  

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