Pkf Presentation V 4

Editor's Notes

• #18: Minting Money for Shareholders: Management Practices that Matter McKinsey recently completed a 2-1/2-year study to identify the management practices that differentiate companies that dramatically outperform their peers over a 5- to 10-year horizon. This question has been addressed by countless books and articles, each of which offered case studies, frameworks, and theories. Never before, to our knowledge, has such a large-scale, statistically rigorous study attempted to identify the management practices that have real impact. Strategy researchers assert that strategy is what really matters. Organization researchers assert that talent, processes, and alignment are what really matter. Marketing researchers say that marketing made the real difference. New economy pundits assert that nothing in the past really matters. In fact, a rigorous review of prior work found a wealth of contradictory answers. That review also found a tendency to project as truth findings gleaned from small samples of a-priori non-representative samples. Our research deeply examined companies and practices from the mid 1980s to late 1990s. Findings and conclusions are consistent with the challenges and opportunities facing senior management teams today. We do not assert that companies that follow our prescriptions will win forever or be eternally great. Nor do we assert that ours is the only prescription. But, we do believe that following these practices stacks the odds in favor of 5- to 10-year outperformance. Most CEOs would relish those odds.
• #19: DCO-ZXG923/000601DschPP1 By the end of the 10-year period the Winners had not only outperformed the Losers in shareholder return (945 percent increase versus 62 percent), but also across a range of traditional financial measures. The differences in performance were stark – while sales for Losers almost doubled over the 10 years (+83 percent), Winners increased their sales by 415 percent. Median Sharpbender assets grew by 358 percent while Losers’ assets grew by only 97 percent. Over the same period, the Winners improved their operating income and increased ROIC by over 5 points, compared to an 8.5 point drop in ROIC for Losers. The Winners systematically outperformed the Losers across a wide range of measures. An separate analytic conducted by Dr. Harvey Wagner verified that the operating performance, as measured by commonly used financial reporting metrics, was significantly better in our Evergreen versus our losers. Put differently, while we initially classified companies based on measures of their total return to shareholders, those classifications would have been almost identical had we used reported financial statement performance metrics instead.
• #20: DCO-ZXG923/000601DschPP1 A fairly straightforward answer emerged from this work. Eight management practices differentiate Winners from Losers. These eight practices, all measured relative to industry peers rather than against a universal standard, are highly predictive of five and ten year success. The four practices that have to do with strategy, execution, culture, and organization are foundational. The four that deal with talent, leadership, innovation, and M&A growth are complementary. A company must outperform on the foundational practices. Winners were not necessarily spikey positive on all four (although Winners were on average spikey positive on 3.2 out of the 4 practices), but they were not spikey negative on any of the four either (only 7 percent of Winners had any negative foundational spikes). Conversely, Losers tended to have negative foundational spikes: 86 percent had one or more negative spike, and averaged just 0.5 positive spikes. Change-on-change further confirms this, with Tumblers becoming weaker and Climbers stronger. Having earned the right to outperform, a company then outperforms by excelling in some combination of the four complementary practices. There are a large number of different winning profiles, defined by the specific combination of complementary practices. On average, Winners excelled in 1.7 of the complementary practices and were spikey negative in only 0.5. Conversely, Losers excelled in only 0.2 of the complementary practices, but were spikey negative in 1.5. Again, the change-on-change story holds, with Tumblers becoming weaker and Climbers becoming stronger.
• #22: For other Winners, customer understanding at all levels of the organization proved crucial to developing products that the market desired. For example, Bill Parker, President of Kroger’s North Texas stores, had customers call him directly with complaints and compliments. 7 7 Kroger Factbook
• #23: In-depth research on the effects of diversification showed that the strong growth of winning companies came from massive business growth in areas relatively close to their core business. Winners on average more than quadrupled the size of their core businesses and built new related business essentially equal to the size of the entire company at the start of the 10-year period. The Losers, on the other hand, did not come close to this rapid growth pace, performing poorly with both the core and related businesses. Ask yourself, do you have a credible plan to build over the coming ten years a profitable new business larger than the entire company is today? Most do not, and if the answer is no, maybe you should not expect to be a shareholder value winner!
• #25: 2. Execution: operational excellence and quality, branded, customer-focused products. The Evergreen study clearly showed that the basics of products and operations do matter – 81 percent of Winners showed excellence, and 56 percent of Losers struggled in these practices. The engine room of business, operations, is an important determinant on whether a business can compete successfully. Efficient operators like Duke Power and Shell continually demonstrate this core functionality. Duke’s coal-fired power plants ranked most efficient by Electric Light and Power Magazine 1 for 17 consecutive years and Shell demonstrated upstream efficiency by the numbers – its average oil and gas exploration costs were less than $2 per barrel, compared with an industry average of $4. 2 Another good example of operating efficiency is the paint and coatings manufacturer Valspar. Valspar was committed to being a low cost producer, distributor, and marketer of coatings by maximizing the productivity of all of its resources - employees, capital, raw material, energy, and information. Valspar had a number of strategies to ensure the competitiveness of their products (i.e., produced resins and colorants for internal use as well as for sale to other coatings manufacturers, maintained corporate overhead (< 2 percent of sales) less than one-half the industry average which enabled them to devote more resources to satisfying the needs of their customers). Another significant contributor to Valspar’s competitive position was their program of rehabilitating and re-equipping older facilities which could be accomplished at a cost of approximately two-thirds that of a new facility. 3 1 Bemis Annual Report 1991 2 Lon Wagner, “Smithfield will Eat One Competitor,” The Virginian-Pilot , October 7, 1995
• #27: 3. Culture: aggressive, exciting, value-driven culture with high expectations and rewards. Companies with a performance-oriented culture not only expected superior performance from their employees at all levels, they also rewarded that performance with extraordinary incentives. These incentives were often in the form of at-risk pay, but they also included promotions, bonuses, trips, cars, and even the possibility of punitive action for under-performers. Top-performing companies tended to have very strong cultures with successfully disseminated core beliefs and principles, and they strongly believed that buy-in to these values contributed to their overall success. Many high-performing companies, such as Home Depot, further incented their employees with an exciting, fun, action-packed, and stimulating work environment. Although the e-economy now abounds with examples of large incentives, in the early 1990s Oracle was well know for its aggressive incentive plans. Gary Kennedy explains, “We had two purposes, of course: recruit the best and we needed incentives to do that; and motivate them to heretofore unknown levels of productivity.” Unlike most companies Oracle’s sales commission was not capped. In one instance, a new saleswoman from Washington closed a $22 million all cash deal. Not only did did Oracle pay her the full $1.2 million in commission (even though, legally it could have capped it at far less), but Oracle’s president flew to Washington to personally deliver the check.
• #29: 4. Organization: fast and flat organization. Winners were not only able to see market changes before Losers saw them, more important, they were able to quickly adapt to the changes through faster, flatter, more bureaucracy-free organizational structures. Micron did this by bringing subsidiaries back into Micron Technologies, with the CEO envisioning the organizational structure as a circle with Micron Technologies in the middle and Micron Communications, Micron Display, and other groups evolving from it. Subsidiaries that were not naturally part of this structure were dissolved or pulled in. Micron’s corporate culture also helped minimize bureaucracy. “With the diversity of technologies we encompass, there’s no way I can second-guess the guy closest to any given technology.” 1 Analysts attributed Schering-Plough’s improved operating performance and enhanced long-term outlook to Robert Luciano’s (Chairman and CEO) and Richard Kogan’s (President and COO) restructuring of the organization. Luciano and Kogan fixed responsibilities throughout the corporation, delegated increased authority to operating managers, and increased managerial accountability. These changes resulted in an organization that was efficient at spotting new opportunities and, more important, quick to adapt . 2 Bemis made major changes to create a lean and efficient management structure. They decentralized their management, did away with their large corporate staff, and redirected profit responsibilities to the respective sectors. The resulting tight management organization enabled Bemis to more quickly reach major decisions. The entire management team was kept well informed about the company’s goals and focused on the path to those goals. 3 1 Dwight Davis, “Micron’s Formula: Be the First to Make Money,” Electronic Business, March 1993, Vol. 19, No. 3, p. 59 2 R. Benezra, Schering-Plough Corporation Company Report, Alex Brown & Sons, August 18, 1986 3 E. Schollmeyer, Bemis Company Report, Paine Webber, May 23, 1989
• #30: Four complementary practices To win, companies also require a mix of the four complementary practices. In addition to strong foundational practices, a healthy mix of the four complementary practices – 1) superior talent management; 2) insightful, involved CEO with knowledgeable, financially incented board; 3) innovation machine with industry transformational intent; and 4) merger, acqiusition, and alliance intensive growth– can dramatically increase a company’s probability of outperformance. While the complementary practices provided less sharp differentiation between Winners and Losers than the foundational practices, they were still highly predictive of company performance. Many Losers performed well in some complementary practices, only to be brought down by their weak foundational practices. Conversely, the Winners, with strong foundational practices, did not necessarily perform well across all the complementary practices, but concentrated instead upon only those that fit their modus operandi. The average number of spikey positive complementary practices per Sharpbender was 1.7, a drop from 3.2 for the foundational practices. Similarly, the average Never had It performed only 0.2 of these practices at a spikey positive level, and 1.5 at a spikey negative level. Last we will show later, the “change on change” story also holds up on the complementary practices.
• #32: 1. Talent: superior talent management. Companies with talent spikes were winning the war for talent. They placed a strong emphasis on attracting, developing, and retaining top talent, leading to better overall management “bench strength.” Winners had an average five year executive turnover rate of 35. That is, on average, 35 members of a Sharpbender’s executive team left during each five year period, whereas, Losers averaged nearly 56 turnovers in the same period. Additionally, Winners went outside for CEOs only half as frequently as Losers. Nearly half the Winners excelled, while nearly half the Losers were demonstrably poor, at talent management. Faced with a talent shortage, down-market retailer Dollar General relocated their headquarters, which enabled them to poach top managers from the likes of Viacom, Zale, and Kroger. 1 In a similar move, Schering-Plough Healthcare Products moved its Memphis-based sales and marketing staff to New Jersey. “We did it first of all because that is where the industry is concentrated, and for us to recruit the kind of folks to make us competitive, we felt we had to be at the heart of the action,” claimed President David E. Collins. 2 Software house Oracle had a very focused recruiting strategy to select the brightest people they could find. “. . . the people, in general, in the company were one of Oracle’s greatest strengths – they went out and very aggressively recruited the top engineering graduates from the best universities.” In fact, they didn’t just want people that were bright, they wanted people who boasted about how bright they were. Oracle was known to ask candidates; “who is the smartest person you know.” If the candidate answered other than himself, the interview would end and Oracle would then pursue the named person. Oracle also infused core values and engrained its culture and performance expectations through 3-week boot camp and all-day training and evangelism sessions where new hires were pitted against one another. 1 R.C. Saponar, “Analysts Give High Marks to Dollar General,” Nashville Business Journal , May 29, 1989 2 R.B. Hetherington, “Schering-Plough Approaches ‘Steady State,” The Commercial Appeal , September 8, 1991
• #34: 4. M&A Growth: merger, acquistition, and alliance intensive growth. Companies that excelled at M&A growth were successful at creating or taking over new businesses. They were able to focus on the correct new businesses because they had meaningful customer relationships and understood market opportunities. They were careful to enter businesses that worked to complement their strengths (i.e., in a line of business close to their existing lines, that leveraged existing skills, and/or used internal entrepreneurial leaders). Additionally, we found that winning companies did smaller, more frequent, and high value deals than losing companies Valspar, a paint coating manufacturer, had a successful strategy of buying and raising the efficiency of factories in the specialty chemical business. Their objective was to be among the top three participants within each new market. 1 Historically, Valspar conducted an active yet selective acquisition program and was quick to assimilate acquisition targets into the mold of its own operating structure characterized by excellent gross margins and operating efficiencies. 2 WorldCom, with its doctrine of “eat or be eaten” is a great example of successful business building. Even in the early days as LDDS, WorldCom employed a highly successful growth strategy focused on the acquisition and integration of neighboring companies. From 1984 to 1989 LDDS acquired 19 resellers, most of which were small companies with operations in only one or two cities. In 12 months during 1988 to 1989 the company doubled its customer base. In 1990, sales grew by 41 percent, with approximately 80 percent of that growth from acquisitions. 3 Finally, there is Cisco and whose staggering track record of successfully acquiring and absorbing new businesses exemplifies the practice of M&A growth via purchase. 4 1 Jay P. Pederson, “The Valspar Corporation,” International Directory of Company Histories 2 Yaari, S., Valspar Corporation - Company Report, Piper, Jaffray & Hopwood Inc., Oct. 14, 1986 3 LDDS Communications Company Report, The Robert-Humphrey Company, Inc., October 27, 1989 4 Alice LaPlante, “The Man behind Cisco; Cisco Systems President and CEO John Chambers,” Electronic Business, December 1997
• #35: It’s obvious from the Evergreen research that simple M&A activity isn’t enough. It’s the number and manner in which those businesses are acquired and alliances formed. Evergreen do 1.2 JVs and half an M&A deal more each period than losers. It is equally important that deals are chosen wisely. There is a drastic difference in value creation between Evergreen and losers. Based on the market-adjusted stock price reaction of the new entity, 93 percent of the Evergreen’ deals created value, while only 9 percent of the losers’ deals created value in the 25 deals that were analyzed by Evergreen. Conversely, none of the Evergreen’ deals destroyed value, while 27 percent of the losers’ deals were value destroying. The payoffs for strong acquisition-based business building practices were huge; the median 5 year TRS for companies that were spikey positive in the M&A growth practice was 204 percent compared to 95 percent for spikey negative companies.