The Business Book

LIGHTING THE FIRE 99 are rarely brave enough, or Challenging the status quo confident and committed enough in their ideas, to stake their careers African-American businessman African-American history, and reputations on risky game- John H. Johnson had the acumen literature, arts, and culture. changing innovations. The heroic to recognize the untapped It was a rapid success, reaching leader’s strength lies not just in potential for publications aimed a circulation of 50,000 in only six their vision, but also in their at the African-American market. months. A second magazine, willingness to stand in the Excelling at high school despite Ebony, was founded in 1945, and spotlight when things go wrong. an impoverished upbringing, at its height reached a circulation Johnson won a scholarship to of more than 2 million. Thanks Corporate history is littered the University of Chicago and to his willingness to challenge with examples of failed products. supported himself with an office the status quo, Johnson built Most businesses are therefore, by job at an insurance company. It a publishing empire that nature, risk averse. Even Apple has was while at work that he came included radio, television, and made mistakes—and, again, its up with the idea for Negro Digest books. He was named in the example is instructive. Jobs may be (later renamed Black World), a Forbes 400 list of wealthy best remembered for transforming magazine that would feature Americans in 1982. the music, computer, and phone industries, but he’ll also be world; Walt Disney’s Laugh-O-Gram encourages long-term thinking. remembered as the poster boy for studio went bankrupt in 1923; Adopting such a strategy means embracing failure, and bouncing and Henry Ford had three failed that shareholders must be tolerant back from it. He has reigned over businesses before finding success. of risk and uncertainty, and patient a long list of failures. The Pippen Game changers such as Albert with regard to returns; payback games console, for example, was Einstein (labeled “slow” by his periods may be long, and rewards unable to compete with the likes teachers) and billionaire Oprah difficult to measure. But if allowed of Sony’s Playstation, and was Winfrey (told she was not “fit to to flourish, this longer-term approach quickly dropped. The Apple III be on screen”) seem to defy the enables a business to build a computer suffered major design future mapped out for them. stronger brand, invest in research faults, and the Lisa—a computer and development, create better that would eventually provide the Long-term thinking business processes, and avoid basis for the iMac—had poor sales. It is the ability to recover from taking (possibly damaging) actions The Apple Newton, a forerunner of failure, and maintain the courage to boost short-term profits. today’s smartphones, was a flop. and conviction to keep changing the game, that sets great leaders As Christensen’s The These failures led to Jobs being apart from the rest. From a Innovator’s Dilemma suggests, fired in 1985. In a speech to students strategic point of view, a focus game-changing leaders are not graduating from Stanford University on game-changing innovation bound by incremental change and in 2005, Jobs stated that the “me-too” thinking: they rewrite the dismissal triggered him to change You have to be willing terms of competition by embracing his own game: “The heaviness of to be misunderstood. unique ideas, and recognize that being successful was replaced by in a corporate world characterized the lightness of being a beginner Jeff Bezos by the mantra “change or die,” again, less sure about everything. disrupting the status quo in your It freed me to enter one of the most US entrepreneur (1964–) own favor puts you not just one creative periods of my life.” step, but several steps ahead of the competition. In today’s History is filled with examples hypercompetitive markets, game- of trailblazers who stumbled before changing leaders do not simply finding success. KFC chicken, outthink, outsmart, and invented by Harland David Sanders, outcompete their rivals—they was rejected by more than 1,000 move the goalposts and redefine restaurants; R. C. Macy opened and the rules of the game. ■ closed many stores before founding the largest department store in the

100 IN CONTEXT THE WORST FOCUS DISEASE THAT Success and failure AFFLICTS EXECUTIVES KEY DATES IS EGOTISM c.500 BCE The ancient Greeks coin the term “hubris” to HUBRIS AND NEMESIS describe a form of pride that loses touch with reality and leads to “nemesis”—a fatal retribution or downfall. 2001 Kenneth Lay, CEO of Enron, sends employees an email saying “our performance has never been stronger.” Four months later, Enron files for bankruptcy. 2002 US activist Herbert London claims that hubris is as great a danger in the 21st century as in ancient Greece. 2009 Jim Collins identifies five stages of corporate decline in How the Mighty Fall. E ven iconic companies can falter, fail, and become irrelevant. History repeatedly shows that successful corporate goliaths—such as Swissair, Enron, and Lehman Brothers—can fall from greatness. The list of possible causes is long and includes management complacency, poor marketing, poor products, strategic blindness, a weak economic environment, or simply bad luck. However, in many cases, paradoxically, success is the catalyst for failure. This is because success can lead to an overconfidence that blinds business owners and managers to the real state of affairs. Meanwhile, they also start to

LIGHTING THE FIRE 101 See also: Reinventing and adapting 52–57 ■ Beware the yes-men 74–75 ■ Good and bad strategy 184–85 ■ Avoiding complacency 194–201 Success breeds Great success can lead to confidence. overconfidence. Greedy for more success, This can make managers Jim Collins managers force the blind to changes that begin to affect the Business consultant, author, company to overreach. company. and self-titled “student of great companies” Jim Collins Problems and pitfalls By the time management was born in the US in 1958. are swept aside as realizes there is a major Collins holds degrees in irrelevant or mere blips. problem... business administration and mathematical sciences from The worst ...it may be too late Stanford University, and disease that to save the company. several honorary doctoral afflicts executives degrees. He has worked is egotism. alongside senior executives and CEOs at corporations of believe their own hype. Internal company’s directors and staff start all types—from health care, warning signs may be present long to become overconfident. In highly education, and the arts, to before management—buoyed by successful companies there is a religious organizations and seemingly unstoppable success— risk that staff members will government. His interest lies notices or chooses to do anything become arrogant, and will begin in the difference between about them. Hubris, a kind of blind to regard their success as a right good and great: how do pride, can shield people from or entitlement. Managers lose sight companies attain such seeing that a company is already on of the underlying factors that superior performance? the path to corporate catastrophe. created success in the first place, overestimating their own strengths In 1995 he founded a Five stages of decline and those of the business. management laboratory in Jim Collins identified five stages Boulder, Colorado, to do of corporate decline. In stage 1, the If stage 1 is a feeling that “we’re further research into business business is doing well, perhaps so great, we can do anything!” excellence. His books have exceptionally well. Press coverage stage 2 is characterized by the sold more than 10 million is positive, finances are good, and feeling that “we should do more!” copies globally and have been morale is high. However, as a result Collins calls this stage the translated into 35 languages. of such success, during stage 1 the “undisciplined pursuit of more”: first warning sign appears—the more sales, more stores, more Key works growth, more of everything. ❯❯ 1994 Built to Last  2001 Good to Great: Why Some Companies Make the Leap … And Others Don’t  2009 How the Mighty Fall: And Why Some Companies Never Give In 

102 HUBRIS AND NEMESIS Continued management arrogance markets pick up, their business The best leaders never breeds indiscipline; decisions are brilliance will ensure that the presume they’ve reached made out of greed and warning company regains market leadership. ultimate understanding signs are ignored. Companies at stage 2 make indisciplined leaps Now or never of all the factors that into areas where they have little Stage 3 represents the turning point. brought them success. competitive advantage; diversify Many companies reach this stage into areas in which they have no but manage to avert collapse. If Jim Collins expertise; or undertake ill-conceived management listens to the views of mergers and takeovers. The its staff (especially from the front bank and journalists asked complacency of stage 1 turns into lines, such as sales staff), heeds questions about its future, Fuld the overreaching of stage 2. shareholder concerns, and changes was reluctant to countenance any strategy in line with the changing capital infusion. Selling parts of the By stage 3, problems begin to reality, it is likely to recover. Andy bank was not an option he felt he mount, staff begins to question Grove famously pulled Intel back into could consider. Although Fuld management decisions, and profitability by pursuing this strategy. eventually revoked this decision, it disturbing data suggest things However, the same cannot be said was too late: the bank declared might not be all that they seem. for Lehman Brothers. In 2007, with bankruptcy on September 15, 2008. However, as Collins points out, it is its stock price at a record high, the possible to be in stage 3 of decline US investment bank ignored the The way in which management and not yet realize that it is early warning signs of collapse. Even responds to a crisis brought about happening. Anomalies in as cracks in the US housing market by success and accompanying performance at this stage tend to be became apparent, with subprime hubris is critical. Inevitably, “band- explained away; any problems are mortgage defaults rising to a seven- aid” solutions that do not address blamed on “difficult trading year high, Lehman continued to the underlying problems rarely conditions.” Management holds firm expose itself to mortgage-backed succeed. Quick fixes based on the in the view that the company is financial products. Management, same overconfidence that brought strong and nothing is fundamentally particularly the chief executive, crisis in the first place—such as a wrong. They believe that once the Richard Fuld, were blinded by hubris bold but risky strategy, a hoped for and deep in denial. They pressed on blockbuster product, or a “market- “Rogue trader” Jérôme Kerviel with ill-conceived strategies and changing” acquisition—usually claimed his company, Société Générale quickly found themselves in stage 4. result in the company moving bank, was aware of his dangerously to stage 5: capitulation to large trades, but turned a blind eye Dealing with disaster irrelevance, or death. because they were focused on profits. By stage 4 a company’s difficulties become undeniable—even the Capitulating to irrelevance most headstrong and arrogant In stage 5, reality finally hits home. manager has to acknowledge that Expensive failed strategies erode there are problems. The question financial strength and accumulated now is how to respond. Unfortunately, setbacks damage the individual as the Lehman example shows, spirits trying to repair the damage. acknowledgment does not always Key managers generally leave the result in appropriate action. company at this stage, and the few customers that remain migrate to As the global credit crisis erupted in August 2007, Lehman’s stock fell sharply. Having grown Lehman to become the fourth biggest bank on Wall Street, Fuld could not accept that it was time to adopt a new strategy. When uncertainty started to grip the

LIGHTING THE FIRE 103 US homeowners were prey to companies such as Lehman, which made big profits in mortgage-backed securities in the 2000s. Lehman’s managers ignored warnings of unrepayable mortgages. other brands. The once-mighty company has finally fallen. A management buy out, merger, or takeover may save the business and protect some jobs, but the company is unlikely to ever recapture its former glory. Most, having slipped this far, survive (if they survive at all) as niche brands trading on past history. Return to glory Group. By 1997, Apple was months simplified product line, sold through Decline is, of course, not inevitable from bankruptcy, as the business a limited number of outlets. He for all successful companies. Those continued to spiral out of control. stabilized Apple and allowed a that reach the later stages of A new board assembled and called return to its core values—a focus corporate decline do so because for the return of one of the on innovation and quality—that managers failed to heed the early cofounders—Steve Jobs—as CEO. later brought iconic products such warning signs of change or were Many expected him to respond as the iMac, iPod, iPhone, and iPad. irrationally sure of their ability to with a slew of new products, but “beat the odds.” However, it is he did the opposite. He shrank the The pursuit of less possible to reach stage 4 and company to a size that reflected Hubris is not the single cause of recover. According to Collins, its niche position, and cut back the business failure. Even the most this involves taking a calm, clear- desktop computer models from skilled management may fail when headed approach and reaching not 15 to one. He ended production of faced with turbulent markets, the for savior strategies, but for the printers, cut software development, collapse of a key supplier, or other basic core values and disciplines and moved production abroad. He factors beyond their control (the that made the organization great redesigned the company around a 2008 credit crunch, for example, in the first place. was the final blow for an already Success comprises in struggling Woolworths). Hubris Steve Jobs did just that at itself the seeds of its may occasionally be a factor in Apple. In the late 1980s and early corporate decline, but failure may 1990s, the company’s management own decline. also result from poor business perceived Apple as vastly superior, Pierre de Coubertin practice or simply from bad luck. ignored increasing competition from PC manufacturers, and French educator (1863–1937) However, if overconfidence expected customers to dismiss leads to an “undisciplined pursuit quality and compatibility issues as of more,” the remedy seems to be “quirks.” After the 1995 release of the disciplined pursuit of less—a Microsoft’s Windows 95 operating return to a company’s strategic system, Apple fell into decline. roots. Ego, though, is a powerful Sales, profits, and Apple’s image thing, and humility is too rarely tumbled. BusinessWeek called it the tool managers reach for when “the fall of an American icon.” The fighting for survival. ■ CEO, Gil Amelio, cut costs, reorganized the company, and added a new Internet Services

CULTURE IS THE WAY IN WHICH A GROUP OF PEOPLE SOLVES PROBLEMS ORGANIZATIONAL CULTURE



106 ORGANIZATIONAL CULTURE IN CONTEXT Culture is “the way we do things around here.” FOCUS Organizational structure Organizations Culture is Culture is are collections exemplified by a subject to KEY DATES variation. 1980 Geert Hofstede draws of different company’s attention to the importance of cultures. language, organizational culture in his routines, book Culture’s Consequences. and rituals. 1982 US business consultants Culture impacts every aspect Terrence Deal and Allan of business behavior. Kennedy argue that culture is the single most important Culture is a significant determinant factor in determining success. of organizational success or failure. 1992 Harvard professor John Kotter claims that in an 11-year period, organizations with rich cultures see net income growth of 756 per cent, compared to one per cent in those with less-defined cultures. 2002 Watson Wyatt develops the Human Capital Index, demonstrating the economic value of business cultures that maintain good practice in human resources. O rganizations build a 1940s, human relations experts overlaps with societal culture. He sense of identity through began to consider organizations from identified five dimensions of culture tradition, history, and a cultural point of view, drawing that influence business behavior: structure. This identity is kept alive inspiration from earlier sociological power distance, individualism vs. through the organization’s culture: and anthropological work associated collectivism, uncertainty avoidance, its rituals, beliefs, legends, values, with groups and societies. However, masculinity vs. femininity, and long- meanings, norms, and language. the term “organizational culture” vs. short-term orientation. Corporate culture determines how only became part of the business “things are done around here.” lexicon in the early 1980s, following Five cultural dimensions the publication of Culture’s The first of Hofstede’s dimensions— Culture provides a shared view Consequences by the Dutch cultural power distance—refers to the of what an organization is (the psychologist and management distance in authority between intangibles) and what it has (the expert Geert Hofstede. manager and subordinates. Business tangibles). It is the “story” of the cultures that have a high power organization: a narrative reinforced Looking closely at organizational distance tend to be rule-driven and through idiosyncratic languages and structure for the first time, Hofstede hierarchical (everyone “knows their business-specific symbols. In the observed that it is shaped by and

LIGHTING THE FIRE 107 See also: Creativity and invention 72–73 ■ Gods of management 76–77 ■ Hubris and nemesis 100–103 ■ Avoid groupthink 114 ■ Balancing long- versus short-termism 190–91 ■ The learning organization 202–07 ■ Creating an ethical culture 224–25 Hofstede’s five cultural traits can be measured 120 across companies in different countries. Hofstede’s research 100 allocated a score between 1 and 120 for each trait. For example, companies 80 in China received the highest score—118—for long-term orientation, 60 while companies in the USA had a much shorter-term focus, 40 receiving a score of 25 (in Russia, data for this trait was unavailable). 20 Brazil China 0 Russia USA Power Individualism Masculinity vs. Uncertainty Long-term vs. distance vs. collectivism femininity avoidance short-term orientation place”). In Russia, for example, Masculinity and femininity, more uncertain and ambiguous employees have little access to Hofstede’s third cultural dimension, situations. British organizations, for executives (power distance is high). are viewed differently from one example, are considered fairly at Conversely, in low power-distance organization to another. Some place ease with unstructured and cultures, such as many companies great emphasis on masculine traits unpredictable situations. in Australia, decision making is (such as status, assertiveness, and distributed more evenly throughout advancement), while others accord Hofstede’s fifth dimension, long- the organization. feminine traits (such as humanism, vs. short-term orientation, is the cooperation, collegiality, and extent to which organizations Anthropologists have long nurturance) greater value. Italian privilege the short-term (profit) over theorized that collectivist cultures organizations, for example, tend to the long-term (value generation). ❯❯ control members through external have assertive, competitive cultures. societal pressure (shame), whereas The thing I have learned individualistic cultures control their The fourth of Hofstede’s at IBM is that culture members more through internal dimensions is known as is everything. pressure (guilt). In his second uncertainty avoidance. This is the Louis V Gerstner Jr dimension, Hofstede proposed that extent to which workers feel this tendency toward collectivism threatened by ambiguous US businessman (1942–) or individualism can be most situations. The more uncomfortable clearly seen in the difference people are with “not knowing” how between Asian and US companies. to react in a certain scenario, the When problem-solving, US more rules and policies the businesses tend to look to the company will need to introduce to individual for a solution, whereas reduce that uncertainty. Companies Asian companies prefer to pose with a low degree of uncertainty the problem to a group. avoidance are likely to thrive in

108 ORGANIZATIONAL CULTURE Japanese businesses, for example, maintaining unified business decisions, big and small, then they think very much in the long-term: cultures, whether operating across start to feel unloved and removed Toyota Motor Corporation has a multiple national or international from the business and its success.” 100-year business plan. cultures. The challenge is to balance the promotion of “one culture” within Cultural benefits Why culture matters an organization against the Strong cultures give staff a sense Every organization’s culture has influences of local cultures in of belonging, which in turn brings varying degrees of these different the external world. benefits, such as job satisfaction and dimensions. The best leaders know staff retention. At Nike, staff are which cultures operate within Companies with strong considered rookies if they have been different parts of their organization cultures, such as Nike and India’s at the company for less than a (and within different parts of the Tata Motors, are intensely aware of decade. Moreover, culture defines world), and adjust their leadership their history and image. At Nike it “the rules of the game,” simplifying style to suit—valuing collective is not unusual for employees to priorities. Decision making is faster approaches, for example, when have the company’s “swoosh” logo and easier if everyone understands dealing with Asian subsidiaries. tattooed on their body. At these company values, beliefs, and vision. businesses, culture encompasses Deeply embedded cultures also Today, organizational culture is an internalized sense of “who we improve the customer experience; if more important than ever before. are” and “what we stand for” to staff believes in the product, they Increasingly competitive markets, such an extent that many of the will transfer this belief to customers. globalization, the prevalence of staff are able to recite corporate mergers, acquisitions, and alliances, maxims from memory. Similarly, Culture also protects an and new modes of working (such as the UK smoothie company Innocent organization from the whims of teleworking) require coordination has worked hard to create a charismatic leadership and the across vast numbers of staff and corporate culture based on fickleness of fashion. A leader may huge geographic distances. communication. Dan Germain, the influence corporate culture, but a Hofstede’s observations highlight brand’s Head of Creative, explains: successful culture should endure the difficulties that leaders face in “if people aren’t involved in all even when management changes. Visible aspects of culture, such as Features of culture an organization’s rituals, stories and Strong organizational cultures can symbols, are only the tip of the iceberg. suffer from problems of groupthink Its beliefs, values, attitudes, and basic (everyone is too like-minded), assumptions are hidden but definitive. insularity (too narrow a vision), and arrogance (a belief that everything Symbols the company does is right). Culture can become a source of power and Ceremonies resistance; necessary change may Stories be resisted simply because “that’s not the way we do things.” Behaviors Terrence Deal and Allan Values Kennedy’s 1982 publication Corporate Cultures outlined a range Assumptions of cultural phenomena. The authors suggested that culture is composed Attitudes of a framework of six interlocking elements: a company’s history; its Beliefs values and beliefs; its rituals and ceremonies; its stories; the heroic Feelings figures whose words and actions embody corporate values; and the cultural network.

secret sauce that made this place LIGHTING THE FIRE 109 great and allowed us to earn our clients’ trust for 143 years ... I look Geert Hofstede around today and see virtually no trace of [that] culture.” The letter Born in 1928 in Haarlem, the made headlines, and the company’s Netherlands, Geert Hofstede shares fell by 3.4 percent. went to technical college then gained an MSc in mechanical The cultural network, devised by Culture in practice engineering from Delft Deal and Kennedy, refers to the informal The desire by leaders for some sort Technical University. He channels in a company—storytellers, of standardized culture—one that spent two years in military gossipers, and whisperers—through is fixed, visible, and stable—is service with the Dutch army, which culture is formed and passed on. understandable, but it likely to before going into industrial operate only in the imaginations of management and beginning Deal and Kennedy also defined four leaders than in the experiences of a PhD. In 1965, while studying types of organizational culture, employees. Companies rarely have part-time, he joined IBM and which emerge from the interplay one culture; they are usually a founded a personnel research between a company’s attitude to combination of many, which department. His years at IBM risk, and the speed of feedback and overlap across departments, were to prove formative; the reward. In the tough-guy, “macho” countries, and business units. The data and insight gleaned there culture, rapid feedback and reward task for leaders is to ensure that formed his research base and are combined with a high tolerance these cultures do not diverge too his “bottom-up” view of of risk, as in the advertising industry. far from core organizational values. organizations. Hofstede In the work-hard, play-hard culture became a professor of —such as a sales company—risk is Organizational culture is not management in 1973, and was less prevalent, but rapid feedback static. Every type of culture is named one of the world’s most and reward produce a high-pressure dynamic and shifts, incrementally influential thinkers by the Wall environment. In the “bet-your- and constantly, in response to Street Journal in 2008. The company,” high-stakes culture, the internal and external pressure. ideas in his 1980 book Culture’s risk attached to decisions is high, Managing culture, especially Consequences continue to but feedback on success or failure is through periods of deliberate inform global debates on slow. The oil industry is typical of the change, is one of the most difficult organizational culture. high-stakes culture. In a process business tasks a leader can face. culture, such as an insurance Key works company or government agency, The advice for leaders seeking feedback is slow and risks are low. to change culture is start small. 1980 Culture’s Consequences Culture is slippery, and trying to 2010 Cultures and Leadership and culture are change everything at once often Organizations: Software interwoven and interdependent. If a results in failure. Bold new mission of the Mind leader does not protect or redefine statements, big office redesigns, or the core values that made a exhortations that “working here is Culture eats strategy company successful, culture can fun” rarely have the desired impact. for breakfast. erode. In 2012, a Goldman Sachs Cultural change requires long-term employee bemoaned the investment investment in employees, not in Peter Drucker bank’s “toxic culture” in an open buildings and branding. This is letter to The New York Times, because culture may be led from US management consultant claiming: “the culture was the the top, but it grows from the (1909–2005) bottom; it requires patient nurturing over time. Leaders must understand the dynamic of an organization’s culture so that they can usefully draw on its strengths, rather than be overcome by its constraints. ■

110 EMOTIONAL INTELLIGENCE IS THE INTERSECTION OF HEART AND HEAD DEVELOP EMOTIONAL INTELLIGENCE IN CONTEXT E motional intelligence your emotions; motivating yourself; (commonly abbreviated recognizing and understanding FOCUS as “EQ”, for emotional other people’s emotions; and Emotional intelligence quotient) is the ability to perceive, managing relationships. control, and evaluate emotions, KEY DATES both in oneself and in others. The Goleman pinpoints high EQ as c.400 BCE The philosopher concept emerged from research a common trait among effective Plato says that all learning into social intelligence in the 1930s, business leaders. Without emotional has an emotional base. and from work in the 1970s on intelligence, he argues, a leader can different forms of intelligence. In have limitless energy and ideas, a 1930s US psychologist the 1990s, US psychologist Daniel perceptive and logical mind, and Edward Thorndike describes Goleman published the highly impressive qualifications, but still be the concept of “social influential Emotional Intelligence: ineffective and uninspiring. intelligence”—the ability to Why it Can Matter More Than IQ. get along with other people. In the book he identified the five Goleman cites Bob Mulholland, “domains” of emotional intelligence: head of client relations at Merrill 1983 US psychologist Howard knowing your emotions; managing Lynch during the 9/11 attacks, as a Gardner suggests that people leader with high EQ. After his staff have multiple intelligences, The most effective saw a plane hit the twin building including interpersonal, leaders are alike in one opposite their own, they began to musical, spatial-visual, panic—some ran from window to and linguistic. crucial way: they all window, and others were paralyzed have a high degree of with fear. His first response was to 1990 US psychologists Peter emotional intelligence. “unfreeze” their panic by addressing Salovey and John Mayer Daniel Goleman each of their concerns individually. publish the first formal theory He then calmly told them that they of emotional intelligence. were all going to leave the building, via the stairs, and that they all had 1995 Daniel Goleman time to get out. He remained calm publishes Emotional and decisive, but did not minimize Intelligence: Why It Can people’s emotional responses. All Matter More Than IQ, which his staff escaped without injury. becomes a global best seller. This was a rare and unusual context, but Mulholland’s approach shows the value of EQ in managing staff in any form of volatile situation.

LIGHTING THE FIRE 111 See also: From entrepreneur to leader 46–47 ■ Effective leadership 78–79 ■ Organizing teams and talent 80–85 ■ Avoiding complacency 194–201 ■ The learning organization 202–07 ■ Kaizen 302–09 Emotional intelligence has five components: Self-awareness Self-regulation Motivation Empathy Social skills (the ability to (the ability (a desire to (the ability to (an ability to recognize and to control pursue goals understand find common understand with energy) other people’s ground and emotions) impulses and build rapport) emotions) emotions) Goleman suggests that high EQ that the answer is both: inherent trigger points might be. This facilitates other essential leadership personality traits are important in procedure seeks to increase traits. For example, the ability to leadership, but EQ—which grows emotional maturity. A 1999 study recognize accurately what another with age, experience, and self- showed that partners in a person is feeling (empathy) enables reflectiveness—is just as important. multinational consulting company one to manage that feeling and any who scored highly on EQ delivered behaviors that arise from it. Today, the development of EQ $1.2 million more profit than other lies at the heart of leadership partners. Other studies have shown What makes a good leader? coaching. New and aspiring leaders similar correlations between EQ One persistent debate within the are mentored by experienced ones; and effectiveness. Emotional business world is whether leaders together, they discuss past and balance, it seems, is a key factor are born or made. Goleman suggests future scenarios, various possible in commercial success. ■ responses, and what the emotional Daniel Goleman Psychologist Daniel Goleman was his PhD, he traveled widely in born in 1946 in California, US. India and Sri Lanka, studying His parents were both college meditation and mindfulness. professors, and Goleman was He taught briefly as a visiting president of his high school before lecturer at Harvard University receiving a scholarship to study before becoming a journalist at Amherst College, MA. During and author. His bestselling the course, he transferred to the book, Emotional Intelligence, University of California, Berkeley, has sold more than 5 million for a year, where he studied the copies in 40 languages. rituals of social interaction under sociologist Erving Goffman. Key works Goleman then took a doctorate 1995 Emotional Intelligence at Harvard University, where he 1998 What Makes a Leader? studied under David McClelland, 2011 Leadership: The Power best known for his theories on the of Emotional Intelligence drive to achieve. After completing

112 MANAGEMENT IS A PRACTICE WHERE ART, SCIENCE, AND CRAFT MEET MINTZBERG’S MANAGEMENT ROLES IN CONTEXT Managers perform a multitude of roles, which can be divided into three categories... FOCUS Management roles ...Informational: ...Interpersonal: ...Decisional: Monitor Figurehead Entrepreneur KEY DATES Leader Disturbance 1949 French engineer and Disseminator Liaison business theorist Henri Fayol Spokesperson handler develops what becomes Resource allocator known as “the classical theory of management.” This claims Negotiator that managers have five key functions: planning, Management is a blend of these often conflicting organizing, coordinating, roles, where art, science, and craft meet. commanding, and controlling. T he question “What do discontinuity.” He finds them to 1930s Australian psychologist managers do?” has vexed be strongly oriented to action, Elton Mayo publishes the experts, and many front- and disliking of reflection. Hawthorne Studies, which office staffs, since organizations ushers in an era of people- came into existence. In his 1975 Mintzberg suggests that there oriented management, rather paper “The Manager’s Job,” business are ten basic management roles, than managing according to guru Henry Mintzberg argues that which fall into three categories: business objectives alone. managers are not the reflective, informational roles (managing systematic planners that people through the use of information); 1973 In The Nature of assume; instead, “their activities are interpersonal (the management of Managerial Work, Henry characterized by brevity, variety, and people); and decisional (managing Mintzberg dismisses Fayol’s decisions and action). claims about the management process as “folklore.”

LIGHTING THE FIRE 113 See also: From entrepreneur to leader 46–47 ■ Leading well 68–69 ■ Gods of management 76–77 ■ Learning from failure 164–65 ■ Crisis management 188–89 ■ Simplify processes 296–99 ■ Kaizen 302–09 The informational role is possible personnel resources and decision Organizational effectiveness because, although managers do making (be a “resource allocator”), does not lie in that narrow- not know everything, they tend to encourage innovation (act as an know more than their subordinates. entrepreneur); and seek conciliation minded concept called “Scanning the environment” and or pacification when the company rationality. It lies in the blend processing information is a key part is unexpectedly upset or of the manager’s job. In this sense, transformed (be a “negotiator” of clearheaded logic and Mintzberg claims, they are “the and “disturbance handler”). powerful intuition. nerve center of the organizational Henry Mintzberg unit.” They monitor what is going None of these roles is exclusive on, disseminate it to others in or privileged. Mintzberg claims that Mintzberg argues that the answer the companies, and act as a effective managers shift seamlessly to the question “what do managers spokesperson for the business between these different functions do?” is not simple. He concludes in the world at large. and know when each role is most that management is complex and appropriate for the given context. contradictory in its demands, Information is easily available relying as much on intuition, to the manager because the role Fact and fiction judgment, and intellectual agility connects him or her to many The traditional view held that as on technical skill, planning, people. In this sense, the manager management was a science, where and scientific logic. All these come plays an interpersonal role, which managers controlled a company’s into play, he says, since a manager also involves acting as a figurehead constituent parts—people and designs, monitors, and develops the for the companies, providing machinery—both of which acted ways in which things are done. ■ leadership, and acting as a liaison in predictable and scientifically point between a large group of controllable ways. Mintzberg people. The group may include argues, however, that management subordinates, clients, business is a practice in which art, science, associates, suppliers and peers and craft meet. It involves sorting (managers of similar organizations). and processing of information, organization of systems and, The third role of management, most importantly, highly subjective, is decision making. Managers must nonscientific management of people. oversee financial, material, and Henry Mintzberg Mintzberg is the author or co- Although he has been teaching author of 15 books and more than since 1968, Mintzberg’s interest Born on September 2, 1939 in 150 articles, and is best known for in organizations and managers Montreal, Canada, Henry his work on management and emerged during his first degree, Mintzberg’s background was in managers. His Harvard Business when he spent time at the mechanical engineering. After Review paper “The Manager’s Canadian National Railway. graduating in 1968 from the Job: Folklore and Fact” won a His memoirs describe the Massachusetts Institute of McKinsey award in 1975. In 1997 catastrophic result of two Technology (MIT), US, he moved he was made an Officer of the boxcars colliding as an excellent to McGill University in Montreal, Order of Canada and of l’Ordre metaphor for corporate mergers. where he joined the faculty of national du Quebec; and in 2000 management. He later took a he was awarded Distinguished Key works joint appointment as professor of Scholar of the Year by the strategy and management at Academy of Management. In 2013, 1973 The Nature of Managerial both McGill in Montreal and he was awarded the first honorary Work INSEAD, in Singapore and degree ever given by the Institut 1975 “The Manager’s Job” Fontainebleu, France. Mines-Télécom in France. 2004 Managers not MBAs

114 A CAMEL IS A HORSE DESIGNED BY COMMITTEE AVOID GROUPTHINK IN CONTEXT T he desire to belong is a of assumptions, and ignores powerful human emotion. warnings. It begins to assume FOCUS We want to be accepted a position of moral superiority, Group dynamics and to be part of a group, which and fails to consider the ethical explains why individuals may set consequences of its actions. KEY DATES aside their opinions, remain silent 1948 US advertising guru in meetings, and nod in agreement The challenge for managers is Alex Osborn promotes the even when they disagree. This to recognize groupthink and take practice of “brainstorming”— deterioration of individual “mental action to prevent it. Encouraging generating ideas in groups, efficiency, reality testing, and moral dissent, assembling groups with without criticism. judgment” was outlined by US diverse demographics, and listening psychologist Irving Janis in 1972, to others’ opinions before airing 1972 US research psychologist and is known as “groupthink.” their views are means of doing so. ■ Irving Janis publishes Victims of Groupthink. Groupthink is the idea that Swissair went into liquidation in 2001. concurring with others is the sole Once labeled “the flying bank” due to 2003 An investigation into overriding priority. It can become its profitability, the airline’s executive the Columbia space-shuttle so strong that it precludes realistic structure displayed groupthink traits, explosion cites a culture where assessment and analysis. Insulated such as a sense of invulnerability. it was “difficult for dissenting from contrary perspectives, groups opinions to percolate up.” displaying groupthink self-justify their own conclusions. Irrational 2005 Robert Baron publishes decisions may be made based on the academic paper “So Right false or incomplete information. it’s Wrong,” claiming that groupthink tendencies may Irving noted that groups be confined to the early stages displayed a series of characteristics of the formation of a group. when groupthink gains hold. The group begins to feel invulnerable, 2006 Steve Wozniak, the which encourages extreme risk inventor of the first Apple taking. It collectively rationalizes computer, advises creative decisions, fails to check the reality thinkers: “Work alone. Not on a committee. Not on a team.” See also: The value of teams 70–71 ■ Beware the yes-men 74–75 ■ Hubris and nemesis 100–03 ■ Organizational culture 104–09

LIGHTING THE FIRE 115 THE ART OF THINKING INDEPENDENTLY, TOGETHER THE VALUE OF DIVERSITY IN CONTEXT A s with most clichés, Diversity management it is also a truism that isn’t merely nice to have, FOCUS managers often tend Work-force diversity to recruit in their own image— it’s a business must. males, for example, have a tendency KEY DATES to employ males. If left unchallenged, Daimler company statement 2005 Car maker Daimler such behavior can lead to companies (2005) targets 20 percent of staffed with homogenous clones— management roles be filled by people from the same backgrounds can stifle innovation and growth. women by 2020. It sets similar and with the same view of how In diverse teams, opinions are less targets for other diversity the business should be run. likely to go unchallenged. measures, such as age mix, socio-demographic mix, and In contrast, when organizations Diversity is not confined to nationality mix. actively pursue diversity—by employee demographics. It might employing people from different simply involve creating cross- 2009 A survey analyzing cultures and socio-economic functional teams that incorporate the value of female backgrounds, and of different the views of people from across representation on corporate genders and ages—the more a company—the marketing team, boards ranks companies dynamic and stimulating they for example, might benefit from the with more females higher are as places to work. insight of operations or finance. But than male-dominated rivals. whatever the context, monochrome The case for diversity recruitment can lead to stasis— 2012 A Harvard Business Greater diversity means greater diversity fights against it. ■ Review article by business scope for creativity—the more consultants Jack Zenger and varied are the sources of an Joseph Folkman finds that organization’s views, the more women are rated higher in 12 likely that out-of-the-box thinking of the 16 competencies that and problem solving will occur. define outstanding leadership. Studies have shown that diversity can also combat groupthink, a 2013 New Italian law requires malaise in group dynamics that a third of a company’s board members be women by 2015. See also: The value of teams 70–71 ■ Beware the yes-men 74–75 ■ Thinking outside the box 88–89 ■ Organizational culture 104–09

MAKING WORK MANAGING FINANCES

MONEY

118 INTRODUCTION F inance has always been finance, in other words, when business owners, particularly when seen as having two distinct they do not report loss-making the failing institution has been a functions: recording investments on the company’s bank. Some financial commentators what has happened (financial balance sheet, thereby appearing wonder whether the balance has accounting) and helping businesses to boost profits. This leads to an swung too far away from tradition. to make decisions about the future important question in relation to (management accounting). Today, modern business: who bears the Director involvement it has a third function: financial risk? Traditionally it was assumed When times are tough, directors strategy. This incorporates that the risk taker was the have to make difficult decisions judgments about risk, which some shareholder, because it is the about investment and dividends. companies (especially banks) shareholders who collectively own Usually the directors will have an have realized must play a larger the business. However, in Europe agreed policy in place—perhaps part in financial decision-making. and the US especially, the desire that half the after-tax profit will be to encourage entrepreneurship has paid as dividends to shareholders, Understanding risk led to generous rules that reduce the while the other half will be retained Fundamental to an understanding extent to which losses are borne by to invest in future growth. But of financial strategy are the business owners. Since 2008, many during recessions it is wise to keep concepts of leverage and excess business collapses have proved more cash within the business, so risk. “Leverage” is a measurement expensive for customers, staff, directors may decide that dividends of the extent to which a business and suppliers, but less so for the should be cut. If the business also is dependent upon borrowings. cuts its investment plans, it can The higher the leverage, the greater The bonus mania which keep more cash in its current the level of risk. In good times, caused the recession could account, providing the liquidity to directors come under pressure to never have happened without survive difficult trading conditions. produce impressive profit growth, corrupted accounting rules. and one easy way to achieve it So who is responsible when is to borrow money and invest Nicholas Jones things go wrong? This depends on in the most profitable parts of the the systems of accountability and business. However, if the economy UK film maker, ex-accountant governance within each company. turns downward, toward recession, Ideally, the directors of the business heavy borrowings turn into should be sufficiently involved to an overwhelming burden. know when things start to go wrong, Leverage becomes toxic. and call for discussion of a change in strategy. If the directors are too The risk level generated hands-off, they may feel unable by leverage is worsened when to hold the CEO fully accountable businesses use off-balance-sheet when things do go wrong. Alert,

MAKING MONEY WORK 119 hands-on directors should also understanding the huge potential For financial accountants, the spot when rewards for staff are of the mass market. When looking traditional stance has long been so out-of-control as to threaten the at China today, the most exciting “playing by the rules.” Integrity and profits being made for shareholders opportunities are for products that adhering to accounting principles and for the future financial health would appeal to the hundreds of such as prudence and consistency of the business. “Profit before millions of potential consumers were seen as most important. More perks” should be the mindset. who are workers, not managers. recently, career opportunities have arisen for accountants who are Important to good governance Using money wisely willing to be more creative. This is a willingness to ignore the herd. In management accounting, two way of thinking stems from the For example, if every US bank began factors are of particular importance: scope for “making money from to expand into South America, a cash and costs. A management money,” by lending the company’s smart South Korean bank would accountant works hard to provide cash deposits to other companies at refuse to copy. However, in practice, accurate data on production costs, high rates of interest, or speculating this proves hard to do. Directors so that managers can make on future trends in exchange rates meet each other in the same clubs informed decisions about pricing, or commodity markets. In a world and conferences, and like to be part on outsourcing, and on which where a quicker, bigger buck can of the same pack. Nevertheless, products to back with marketing be made from money than from US investment guru Warren Buffett spending. Activity-based costing, manufacturing, playing by the has become one of the world’s which provides the most complete rules may seem a poor choice. ■ wealthiest men by ignoring the data on costs per unit, is the best herd instinct among investors. way to do this. When trading I am incredibly nervous that is poor, however, management we will implode in a wave The mass market accountants place their tightest Some modern boards of directors focus not on costs but on cash of accounting scandals. accept that if there is wisdom flow, following the maxim that Sherron Watkins among crowds, there may be “cash is king.” This arises because even greater wisdom among staff. the worse the trading conditions, US executive, former vice president Henry Ford was one of the first the more that companies try to hold of Enron (1959–) to realize that your workers are onto the cash they have—making your customers, but it has taken it much harder to get paid if they a century for others to see the are your customers. The flow of potential in this phrase. Not only cash dries up, so an early focus on is there value in drawing ideas from cash flow makes sense: start your staff who care about the products own cash hoard before others they both produce and use, but begin trying to create their own. there is also strategic value in

120 IN CONTEXT DO NOT LET FOCUS YOURSELF BE Governance and ethics INVOLVED IN A FRAUDULENT KEY DATES BUSINESS 1978 US scholars Ross Watts and Jerold Zimmerman PLAY BY THE RULES write Towards a Positive Theory of the Determination of Accounting Standards. 1995 French professor Bernard Colasse claims that “there isn’t any true result, but a result arranged using creative accounting techniques.” 2001–02 Telecoms giant WorldCom overstates earnings by more than $3.8 billion. 2009 UK professor David Myddelton publishes Margins of Error in Accounting. 2012 Directors of US discount website Groupon identify a “weakness” in financial reporting, five months after becoming a public company. B usiness accountants have two roles: to record profits and cash flow and to provide tightly estimated data about costs to help make strategic decisions. The accountant’s instinct is to be cautious and prudent—costs and cash-outflow figures generally err on the high side, while revenues and cash inflows tend to be on the low side. Any surprises should be positive. For example, in January 2009, Honda Motor Company warned that dramatic falls in sales worldwide—due to the global downturn and the strong Yen— would force the company into a $3.7 billion loss in the fourth quarter of its financial year. However, the loss

MAKING MONEY WORK 121 See also: Hubris and nemesis 100–03 ■ Profit before perks 124–25 ■ Making money from money 128–29 ■ Accountability and governance 130–31 ■ Morality in business 222 ■ Creating an ethical culture 224–27 ■ The appeal of ethics 270 The rules set out ...but some rules The alternative to minimum standards... ignore morality— rules is a principled “playing by the rules” approach based on a may not be enough. “true and fair view” of a company’s accounts. Good companies and But without statutory accountants consider protection, individuals can rules plus morality. ignore principles and profit from immoral actions. turned out to be $3.3 billion, up with different figures, even UK’s newly formed Accounting demonstrating that the company though the underlying data that Standards Board, which in turn had erred on the side of caution. they are analyzing is the same. developed new accounting rules in an attempt to minimize the Accounting for profit In 1992, British banking analyst scope for “creative accounting.” An accountant who follows safe Terry Smith published a book practices sleeps well, but may called Accounting for Growth. Today, most countries around the struggle to climb the corporate This publication set out the world follow the rules laid down by ladder. When the stock market is remarkable array of opportunities the International Financial Reporting full of optimism (a “bull market”), for publicly traded companies to Standards (IFRS). As a consequence, there are intense pressures within provide an artificial boost to their the income statements and balance companies to push the stated profit stated profit levels. The book had a sheets of companies in most level to the highest feasible point. huge impact, and influenced the countries follow the same format. ❯❯ This could be considered an odd statement, since profit might seem to be a simple matter of fact. However, the calculation of profit (which is effectively an estimation) is underpinned by a series of assumptions, and a company’s stated profit is effectively a moveable figure. Different accounting teams may come Accountants must decide how cautious they are going to be when reporting a company’s financial status, since they may be under pressure to boost the stated level of profits.

122 PLAY BY THE RULES Mark-to-market accounting is a risky method of valuation, since it of rules in accounting. He believes values a company’s assets according to current market value. Historic in traditional accounting principles, cost valuation is a more reliable, and cautious, measure of value. because these supply the required flexibility for accountancy across During a stock-market If the stock market many different types of companies. boom, valuing a company’s falls, the value of the He claims that the idea that there balance sheet will is a “single correct answer” when assets and investments preparing a company’s accounts is according to their shrink, leaving the nonsense. Nevertheless, this idea company in a lies behind the call for increased current market value vulnerable regulation. “People want it to seem can lead to an position. as if we’re doing something about overinflated scandals,” he says; they think that balance sheet. greater regulation will make a difference, “but it never does.” Although the time frame for suggested that a more prudent Myddelton also believes that implementation is unclear, a widely approach would be to increase the directors should gain a “true and supported plan is in place to merge level of provision” against bad debts. fair view” of their accounts, instead the IFRSwith the US’s Generally Ultimately, the directors of HBOS of being forced to rely on a picture Accepted Accounting Principles had decided to take an optimistic produced by someone else’s idea (GAAP) to provide globally view of the bank’s lending. They of the accountancy rules. recognized accounting rules. chose to play beyond the rules. Some “creative accountancy” Although the rules are becoming Cautious accounting practices stretch the flexibility clearer, important areas for debate Professor David Myddelton, a within the rules so far that they remain. These might be raised UK management scholar, argues can produce potentially misleading internally, in arguments between strongly against the expansion accounts. “Mark to market” company accountants and directors; accounting, for example, values or the debate might be between Moral duty assets at their current market value. independent auditors and the This means that when the stock organization. When UK bank Halifax Julian Dunkerton is the founder market is booming, any investment Bank of Scotland (HBOS) collapsed and major shareholder in the (such as shares in another business) in 2008, the UK government bailed fashion business SuperGroup will also be booming. This boosts it with $32 (£20) billion, before the plc, whose leading brand is the value of the company’s balance bank was acquired by Lloyds Bank. the popular street-wear label In 2008 the gap between the bank’s Superdry. Based in Britain, profit to the tax authorities. Not loans and its deposits was $341 but with business and outlets that Dunkerton wants to claim (£213) billion. The bank’s auditor, worldwide, SuperGroup could the moral high ground—in its KPMG, was heavily criticized over easily follow the lead set annual report, SuperGroup plc the HBOS collapse, although KPMG by other organizations and explains that “We recognize the had consistently raised warnings manipulate accounts to commercial value, as well as over the risks involved. When the minimize its tax liabilities. the moral duty, of consistently UK’s regulator, the Financial operating with integrity, Services Authority, published a Instead, the business plays honesty, and a commitment to report on HBOS in 2012 it noted by the spirit of the tax rules, responsible and ethical business that KPMG had “consistently paying about 30 percent of its practices.” Dunkerton has the wisdom to appreciate that acting responsibly can yield financial benefits, particularly in the long term.

MAKING MONEY WORK 123 Major accounting misconduct was unearthed by US company Caterpillar Inc. in a Chinese business it purchased in 2012. Irregularities included overstated profits and falsified stocks. sheet and may encourage it to 2013 Caterpillar said it was writing countries in which it operates have expand beyond its means. All it off $580 million from the value of no legislated cap on interest rates, takes is a fall in the stock market for ERA, thereby virtually admitting so the directors are playing by the this valuable shareholding to that the purchase was a complete rules. However, a report by the UK become worth considerably less. waste of money. Caterpillar then Citizens’ Advice Bureau in 2013 Myddelton suggests that it is better accused the previous management stated that three out of four “payday to use “historic cost” accounting at Siwei of deliberately creating loan” customers struggle to repay. than “mark to market,” since this misleading accounts, but let the In contrast to the UK, countries provides a more stable set of figures; matter drop in May 2013 when a such as France and the US have it values assets at their cost at time financial settlement was reached. rules that set maximum interest of purchase, minus any depreciation levels for consumer credit loans. that has taken place, rather than at In other circumstances, directors their current market value. can find solace in the rules. Ultimately, no set of rules can Operating in South Africa, Canada, substitute for ethical behavior The argument of rigid rules and Europe, short-term money- nor safeguard the system from a vs. looser-based principles will be lender Wonga.com sets its annual determined attempt to manipulate heard repeatedly when the merger percentage rate (APR) on “payday accounting figures in a misleading talks between the US’s rules-based loans” as high as 5,800 percent. way. In the hands of principled GAAP system and the IFRS This is perfectly legal because the accountants, flexibility within the become serious. Even though the rules is useful; but if someone seeks IFRS is far more rule-based than Mark-to-market accounting to gain huge financial advantage its predecessors, it retains a greater is like crack. Don’t do it. no matter what, that flexibility will reliance on principles than the Andrew Fastow enable him or her to do so, even US’s GAAP system. if this entails acting immorally. US former Enron executive (1961–) Ethical conduct Rules help to ensure that Whether rules based or rooted in companies operate at an acceptable principles, no accounting methods minimum standard. The argument can prevent a deliberate attempt revolves around where this standard by directors to mislead. In June lies, balanced as it is between useful 2012, for example, US construction- standards and costly overregulation. equipment giant Caterpillar Inc. Rules also encourage those with completed a $650-million purchase ethical principles to go further of Chinese company ERA Mining than the minimum. ■ Machinery Ltd. and its wholly owned subsidiary Zhengzhou Siwei Mechanical and Electrical Equipment Manufacturing Co. This was part of Caterpillar’s long-standing strategy of growth in China. Unfortunately, a series of black holes in Siwei’s accounts soon emerged, including the discovery in November 2012 that the company did not hold the stock levels it had claimed. In January

124 EXECUTIVE OFFICERS MUST BE FREE FROM AVARICE PROFIT BEFORE PERKS IN CONTEXT In a public company, Multiple shareholders the shareholders cannot run a company, FOCUS are the owners of so they must employ Equity and performance executive officers to do the company. KEY DATES this for them. 1776 Adam Smith says that managers will not watch over ... so it is essential that It is not possible a business with the same managers can be trusted to oversee, in detail, vigilance as partners in a to act in the interests of everything that these private company would watch over their own. the company, not managers do… themselves. 1932 US professor Adolf Berle and US economist Executive officers must be free from avarice. Gardiner Means coin the phrase “the separation of I n an ideal business, directors Yet there is a risk that bosses can ownership and control.” pursue the company’s be dazzled by the wealth generated objectives without undue around them, and work toward 1967 Canadian-American consideration for personal gain. boosting personal gain instead economist J. K. Galbraith says Upon election to the board, they of the profits due to shareholders. that shareholders no longer negotiate their salary and standard control the organizations perks, and from then on, their focus This situation, known as “the they legally own. is on the success of the business. divorce of ownership and control,” first arose in the late 19th century, 2012 Larry Ellison of US computing corporation Oracle Inc. becomes the world’s highest-remunerated CEO, when he receives $96.5 million in pay, shares, and perks.

MAKING MONEY WORK 125 See also: Beware the yes-men 74–75 ■ Is money the motivator? 90–91 ■ Organizational culture 104–109 ■ Avoid groupthink 114 ■ Play by the rules 120–23 ■ Accountability and governance 130–31 question corporate governance Leadership is a privilege mechanisms and executive pay. The to better the lives of others. shareholders of Barclays Bank, for It is not an opportunity to example, were stirred into taking action just before the bank’s 2012 satisfy personal greed. AGM. They had discovered that in Mwai Kibaki the previous year, profits had fallen by 3 percent, shares had dropped by Former President of Kenya (1931–) 26 percent, but chief executive Bob Diamond was due to receive a bonus of $4.2 (£2.7) million and total pay in excess of $10 (£6.3) million. German mittelstand companies— Restricted ownership of family-owned and publicly owned such as Faber-Castell, a world-leading In private limited companies, the companies in Spain found that producer of pencils—are usually family- situation is simpler. Since share family-owned companies performed owned. Directors of such firms are more ownership is restricted (often within better, in terms of financial equity, likely to focus on long-term performance. a single family), the directors and than nonfamily companies of the the shareholders are usually the same size in the same industry. with the creation of large, public same people. In any case, it is Countries such as the UK and US, limited companies (plcs) that unusual for people to take advantage however, have a larger proportion allowed senior management more financially of those within their of plcs than many other countries. freedom to operate beyond effective own circle of family and friends. For After decades of noninterference, shareholder scrutiny. As long as the example, the problem of perks before shareholders are once again company profits were satisfactory, profits is rarely an issue in Germany, becoming interested in corporate directors were free to conduct their where the mittelstand (medium- governance and gain. ■ business functions as they saw fit. sized) companies—which are However, if a business enterprise mainly family companies—are the comes to reflect the aims of its dominant business model. A recent managers, will the business be study of the different performances focused on profit maximization (for its owners, the shareholders) or Fewer perks, more profits on increasing the status, financial rewards, and power of its managers? Several companies have taken were told that the choice was positive steps to eliminate perks between a reduction in travel Personal interests as part of a cost-cutting strategy. expenses, or a cut in their Some directors act opportunistically; At the German company annual bonuses. they seem to be more interested T-systems International, an ICT in personal gain than in the subsidiary of Deutsche Telekom Since the 2008 financial company’s financial well-being. AG, all workers must now fly in downturn, there has been an The banking crisis of 2008 led the coach class, regardless of the increase in the trend of shareholders of many companies to traveler’s position within the organizations tightening their company, or the distance and purse strings. Even the mighty duration of their journey. The entertainment company Walt change from business- to Disney is phasing out executive economy-class travel is thought car allowances. Cost cutting and to have saved T-systems $1.5 eliminating perks puts greater million annually. Executives pressure on managers to boost their company’s profitability.

126 IF WEALTH IS PLACED WHERE IT BEARS INTEREST, IT COMES BACK TO YOU REDOUBLED INVESTMENT AND DIVIDENDS IN CONTEXT A fter calculating the year’s to shareholders that most businesses profit, a company’s manage each year. It might amount FOCUS directors can choose to a 3 percent return on the sum Financial strategy whether to pay a dividend to invested, which would make it shareholders or reinvest the sum. comparable to the interest a saver KEY DATES A dividend is the annual payment might receive from a bank deposit. 1288 The first recorded share certificate is issued to the How much a company pays in dividends or Bishop of Vasteras in Sweden reinvests in the business is decided… by Stora Enso, a pulp and paper company. …according to growth prospects and the health of the balance sheet. 17th century The Dutch East India Company issues shares, When growth is high, or the When the balance sheet is heralding the emergence of balance sheet is weak, strong, or growth is slowing, organized share trading. companies should retain cash companies should pay 1940 Peter Drucker writes on for reinvestment. dividends the need for businesses to balance short-term dividends to shareholders. and long-term reinvestment. 1961 Modigliani and Miller claim that paying or retaining dividends does not affect a business’s long-term performance. Their seminal work is later disputed, with several studies showing that dividend increases boost a company’s share price. Directors must balance the need for reinvestment in the business with shareholder returns.

MAKING MONEY WORK 127 See also: Accountability and governance 130–31 ■ Who bears the risk? 138–45 John Kay ■ Ignoring the herd 146–49 ■ Profit versus cash flow 152–53 Professor John Kay is a British The Dutch East India Company the company for reinvestment? The economist born in 1948. Best was the first public company to offer higher the company’s growth known for his sceptical support shares. Investors put up money for prospects, the greater the incentive for free-market business voyages in return for a share of the to keep money within the business. behavior, he is a visiting profits made from successful trips. Slow-growing companies should professor at the London School therefore pay out a high proportion of Economics and regular In 2012, for example, Honda Motor of profits in dividends, whereas contributor to the Financial Company of Japan paid out just booming organizations are more Times. In 2012 he presented under half its $2.7 million profit in likely to keep the cash within the a detailed report to the UK dividends, leaving just over half to business. There is no safer source government on the stock reinvest in the company. of capital than retained profit: it does market, which emphasized not need to be repaid, nor does it that the normal purpose The first dividend payments require the payment of interest. of stock markets is not were made in the 17th century by Another factor to consider is the speculation, but to provide the Dutch East India Company, health of the company’s finances. companies with access to which was the world’s first company If they are weak, profits should be capital and to provide savers to issue shares in exchange for retained; only if the balance sheet with an opportunity to share capital. To encourage investors to is strong should generous dividends in economic growth. He also buy shares, a promise of an annual be paid to the shareholders. highlighted concern about payment (called a dividend) was excess dividend payouts. made. Between 1600 and 1800 the Dividend payouts must be Dutch East India Company paid considered carefully. In 2006, the Key works annual dividends worth around 18 Royal Bank of Scotland (RBS) percent of the value of the shares. declared a 25 percent increase in 1996 The Business of dividends to shareholders. Market Economics Invest or pay out? commentators praised the move, 2003 The Truth About Dividend payouts are entirely the gift with one team of analysts issuing Markets of the directors. Their decision is the note: “Thanks Fred [Goodwin, 2006 The Hare and the simple: what proportion of after-tax CEO of RBS], we love you.” The Tortoise profit should be paid in dividends, dividend increase put money directly and what should be retained inside into the hands of the shareholders. Just two years later RBS was forced to ask shareholders to buy shares at 200p ($3.13) each, in order to raise £12 ($18) billion. Six months later, those shares were worth only 65p ($1.03); three months after that, just 11p (¢17). The company’s generosity in 2006 cost its shareholders dearly. In contrast, Apple did not pay dividends from its formation in 1977 until 2013. The directors, led by Steve Jobs, argued that shareholders would benefit in the long term by allowing Apple to reinvest profits. Only in 2013, with its growth rate beginning to fall, did the company announce dividend payouts, which it projected would average $30 billion a year until 2015. ■

128 BORROW SHORT, LEND LONG MAKING MONEY FROM MONEY IN CONTEXT Companies with a good cash flow and liquidity can make money from money, by… FOCUS Financial products …investing in financial …borrowing short- products such as term and lending to KEY DATES derivatives and customers long-term, c.1650 A rice market in futures contracts. Osaka, Japan issues the first like a bank. standardized futures contract, agreeing to prices for goods But this can prove to be a not yet delivered. money-losing exercise if there is a crash in markets or the economy. 1970s and 80s Deregulation gives banks and companies Making money from money is a risky, more ways to use money to short-term strategy. make money. S ome companies opt to they can gain access to a new 1973 US economists Fischer “make money from money.” source of profit. The two terms that Black and Myron Scholes This means they use their exemplify the idea of making devise a mathematical formula cash assets not only to further the money from money are “treasury that appears to take the risk development of their products, but function” and ”shadow banks.” out of futures contracts. also to generate money through the financial markets. Some Hedge betting 1980s Large corporations companies believe that by making “Treasury function” is a term that begin to use derivatives to hedges (bets) on the fluctuations of emerged in the late 1970s in the make money from money. the currency markets, for example, wake of economic challenges, such 2007–08 Financial markets collapse around the world, threatening the continued existence of banks and banking-type ventures.

MAKING MONEY WORK 129 See also: Managing risk 40–41 ■ Hubris and nemesis 100–03 ■ Investment and Treasury in focus dividends 126–27 ■ Who bears the risk? 138–45 ■ Leverage and excess risk 150–51 For the decade prior to the to rise, but in fact it underwent a financial crisis of 2007–08, sharp devaluation and the company many companies began to use ended up losing $2.5 billion. short-term financing to fund As a result, some companies now long-term capital expenditure. spell out their opposition to making However, the financial crisis of money from money. Mining 2007–08 changed conditions multinational Rio Tinto, for example, dramatically, as banks stated in its 2013 annual report that collapsed or came close to its treasury “operates as a service doing so. CEOs demanded to to the businesses of the Rio Tinto know where their company’s group and not as a profit center.” cash was, and the real-time cash position. Not all Many manufacturing companies, Shadow banks treasurers were able to such as Brazilian paper company Aracruz Other companies, however, have provide immediate answers, (known as Fibria since 2009), used the extended the treasury function to since some of their treasury function to make money, not just become a major, or even majority, investments were in local, manage it, from the 1980s onward. profit center for the business. manually operated, less-than- Companies such as US transparent systems. as quadrupled oil prices and conglomerate General Electric (GE) “stagflation” (where inflation and have developed this function into As a result, the treasury unemployment are both high at the an effective “shadow bank.” In function has moved to the same time). The idea emerged that 2007, GE’s treasury function GE forefront for many companies, the goal of a company’s treasury Capital held over $550 billon of with an increased need for function (the department responsible assets, making it larger than some transparency and up-to-the- for stewarding its finances) should of America’s top ten banks. It minute accountability. Boards be to achieve the optimum balance contributed 55 percent of GE’s expect treasurers to be between liquidity and income from profits, mainly by borrowing money prepared for the unexpected— the company’s cash flows. short-term to lend to customers such as by increasing cash over the long-term (“borrowing reserves to reduce liquidity During the decades leading up short and lending long”). GE was risk. However, this brings up a to the 2007–08 financial crisis, able to flourish as a member of the new problem for the treasury large companies steadily added shadow banking system without function: if more cash is kept in greater responsibilities to the having to bear the regulatory reserve, how can this surplus treasury function. Often, these burdens of banks. By 2008, liquidity be used most began as ways to minimize risk, however, it was forced to ask to effectively to fund growth? but the opportunities for profitable participate in the US government’s trading became very tempting—to banking sector bail-out program. The line separating the point that some companies took investment and speculation out contracts on financial hedges Making money from money that were worth more than all their carries serious risks, whether the is never bright and clear. export earnings. For example, in bets go wrong or not. This is Warren Buffett 2008, the Brazilian paper and pulp because the more profits a company Aracruz used cash assets company’s treasury generates, the US investor (1930–) to make bets on currency futures less willing the board may be to (the value of currencies at a future invest in research and development date). Specifically, it bet that the for the future growth of the company. Brazilian currency would continue This way of making money from money is strongly correlated with short-termism in business. ■

130 THE INTERESTS OF THE SHAREHOLDERS ARE OUR OWN ACCOUNTABILITY AND GOVERNANCE IN CONTEXT Good governance relies on... FOCUS ...proactive, ethical, ...clear, traceable ...alert board Executive control well-informed lines of members. directors. KEY DATES responsibility. 1981 Australian-born US management consultant Peter A ccountability is the Following a series of business Drucker suggests that chief obligation of an individual disasters (from Enron through to executives “have not yet faced or organization to accept Lehman Brothers and numerous up to the fact that they responsibility (be accountable) banks), corporate governance has represent power—and power for their actions. In business, become a major issue worldwide. has to be accountable.” it is often used to trace chains To achieve effective accountability, of responsibility: staff may be directors need to make sure that 1991 The Cadbury Committee held to account for their actions roles and lines of authority are clear. is established in the UK to by those above them in the This makes it possible to trace the investigate scams, failures, organization’s hierarchy; or higher cause of a mistake to its source— and accountability in corporate tiers of management may be held and attribute responsibility to governance. Its influential accountable for those below them. the right person or group. For report, Financial Aspects of Ultimately, the way the company is governance to work well, board Corporate Governance, is governed is the responsibility of the members must be well-informed, published a year later. directors; their governance should fully independent, and should work therefore be proactive and ethical. together for the long-term interests 2002 The US government’s Sarbanes-Oxley Act sets out much stricter guidelines to govern accounting practices and the publication of previously confidential data (such as operational business risks).

MAKING MONEY WORK 131 See also: Profit before perks 124–25 ■ Who bears the risk? 138–45 ■ Profit versus Jamsetji Tata cash flow 152–53 ■ Balancing long- versus short-termism 190–91 Born on March 3, 1839 in Companies that bury their heads limited or no understanding of the South Gujarat, India, Jamsetji in the sand—like the proverbial ostrich— risks their company faced. This Tata might have appeared an may be reluctant to be held accountable suggested a flaw in the ability of the unlikely candidate to be the for actions and decisions, with damaging board to hold executives to account. founder of a business that consequences for business ethics. would grow to be one of the Most of the time, in most largest conglomerates in the of the business and its owners— companies, executives make sound world. Tata followed his the shareholders. Nonexecutive decisions that require minimum father—who had broken the directors have an important role scrutiny. However, good governance family tradition of being a to play in corporate governance: ensures that the board is always Brahmin priest—into business they are not company employees alert—so it will be fully aware of at 14 and soon showed and should be able to quiz what is happening when a mistake potential, graduating from executives with impunity. is made. Such a mistake might be Elphinstone College in related to strategy (an overpriced Mumbai in 1858. After Board-level scrutiny takeover bid, for example), or to working for his father, Tata In 2011, consultants McKinsey & the ethics of a particular situation. took on his first enterprise—a Company published findings from Independently minded nonexecutive cotton mill—in 1868. One of a survey of 1,597 board directors, directors should be in a prime his dreams was to found a providing fascinating insights into position to question, for example, steelworks, and although this the proceedings of board meetings. whether the company is right to business aim would not be The survey showed that in Asia, be using very low-cost suppliers, achieved in his lifetime, Tata no more than a third of a board’s or whether a contract has been Iron and Steel Company was meeting time was spent scrutinizing won using questionable means. set up in 1907 by his son management actions and decisions; Dorabji. The steel industry far longer was spent on strategic When things go wrong went on to be the foundation planning. Although this sounded The importance of good governance for Tata Group’s global success. sensible, it suggested that was made clear in the case of accountability and governance Japan’s mighty Olympus camera One of Jamsetji Tata’s received less time. By contrast, in business in 2011. Newly appointed overriding principles was North America nearly two-thirds of Chief Executive Michael Woodford fairness, which permeated board time was spent on scrutiny. found that a $1.7 billion cover-up his entire business approach. of losses had been made when In terms of accountability, his More surprisingly, the same acquiring other companies. The vision was simple: “We started sample showed a lack of satisfaction Olympus directors had hidden on sound and straightforward with fellow board members. these losses from the published business principles, considering Directors thought that more than accounts and therefore from public the interests of the 30 percent of their peers had scrutiny. The board responded shareholders as our own.” by firing Woodford. Only after a successful campaign by Woodford Accountability breeds did the Japanese authorities charge response-ability. key Olympus directors with fraud. Eventually the whole board Stephen R. Covey resigned. The case demonstrated how ineffective Olympus’s US management consultant (1932–2012) nonexecutive directors had been in holding the board to account, and how important good governance and accountability are to the well-being of every company. ■

MAKE THE BEST QUALITY OF GOODS AT THE LOWEST COST PAYING THE HIGHEST WAGES POSSIBLE YOUR WORKERS ARE YOUR CUSTOMERS



134 YOUR WORKERS ARE YOUR CUSTOMERS IN CONTEXT M ost economic models The Ford Motor Company quickly state that during the realized that its production line was FOCUS early stages of economic efficient but made workers unhappy. Market expansion development, low-wage workers By giving them a large pay rise, Ford find themselves making products created a market of staff-customers. KEY DATES that are bought by middle- and 1914 Henry Ford doubles his upper-class consumers. The Model T automobile was priced at employees’ wages to $5 a day. workers tend to eat simple food, $825 in 1908, at a time when Ford such as potatoes, rice, or corn, workers earned less than $2 a day. 1947 US psychologist Alfred J. and travel on foot or—if they are In 1913, Ford introduced a system Marrow finds that productivity lucky—use a bicycle as a means of conveyor-belt mass production, increases when employees are of transportation. Meanwhile, their reducing the time taken to make involved in decision making, employers eat expensive meat- a Model T from 750 to 93 minutes. and introduces the concept based meals, and travel in With this improvement in efficiency, of participative management. luxurious transportation—from the company could afford to cut the the fine horse carriages of the 17th price of one of its vehicles to $550. 1957 Douglas McGregor century to the sleek, “dream publishes The Human Side machine” automobiles of today. One problem remained, however. of Enterprise, claiming that The repetitive jobs required to run organizations thrive best by However, economic growth the Model T production line made trusting staff to apply their takes a huge step forward when creativity and ingenuity to the workers are able to buy the products enterprise in which they work. that they make; when they, too, can afford to eat meat and purchase 1993 Ricardo Semler of Brazil’s household and leisure goods. This Semco writes Maverick!. is now starting to happen rapidly in China, where the the sales of staple 2011 Google is revealed products—such as toilet paper and to have the highest job refrigerators—are growing quickly. satisfaction in the US high- tech sector; young “Googlers” Building a market are both employees and Workers were recognized as customers of the company. potential customers by US car- making pioneer Henry Ford. Ford’s Companies should focus on They should also reward This enables employees providing consumers with their employees with the to buy the company’s highest wages possible. products or services. good products and services at low prices. If your workers become They can then provide your customers, your management with business will thrive. valuable insights and ideas, as well as boosting sales.

MAKING MONEY WORK 135 See also: Changing the game 92–99 ■ Organizational culture 104–09 ■ Understanding the market 234–41 ■ Focus on the future market 244–49 ■ Make your customers love you 264–67 ■ Maximize customer benefits 288–89 workers dissatisfied, and pushed 60$ (US) PER CAPITA, 2011 Household spending labor turnover to higher than 370 data from 2011 shows percent—the average employee 50 that US spending on stayed for only three months before luxury goods (such as quitting. To counter this, Ford 40 chocolate) outstripped announced that wages at the spending on essentials company’s factories would be more 30 (like toilet paper). The than doubled, to $5 a day. His data from China shows actions made headlines around 20 that as an economy the world, and in the factory, labor develops, spending turnover fell to 16 percent annually, 10 on essential items helping the output per worker (a rises the most. measure of overall productivity) 0 to rise by around 40 percent. Toilet paper Chocolate USA By 1914, it took a Ford worker stumble upon an important fact: China just three months to save enough when your workers earn enough money to purchase a Model T. By to afford to be your customers, India 1924, the price of a Model T fell there can be huge benefits for the again to $260, making it possible business. Along with increases Fragrances to buy a brand new car with a in staff pride and commitment, month’s pay. By 1924, the Ford managers are likely to be given in helping to generate the 400,000 Motor Company sold more than valuable insights into the company’s work force suggestions per year 50 percent of the world’s cars. products and processes. on how the company might improve production efficiency and quality. Learning from employees In Toyota City, Japan, more than Although Henry Ford generated half the work force owns a Toyota Emerging markets excellent publicity by making his vehicle. This is a significant factor In 1924, the US government policy of paying high wages sound published a report titled Cost of like altruism, his practical need to Living in the USA. It showed that lower the labor turnover helped him the average family spent 38 percent of its $1,430 annual expenditure on food. This is interesting because, in the past five years, India’s family spending pattern has slipped below this level, to 36 percent, indicating that the average wealth of Indian families is increasing. When China’s proportion of spending on food fell toward 30 percent of income, households could afford to increase their wider spending on nonfood items, such as consumer goods. In the US today, just 7 percent of household income is spent on ❯❯ Farm wages in India increased by 17.5 percent annually from 2007 to 2012. Since farm labor is at the bottom of the economic pyramid in India, this signifies a very fast overall rise in wages.

136 YOUR WORKERS ARE YOUR CUSTOMERS CAR OWNERSHIP (%) 90 18 ANNUAL SALES (MILLION CARS) Car sales in China 80 16 and India grew steadily 70 14 from 2005 to 2012. The 60 12 potential for sales is 50 10 huge—percentage 40 8 ownership in both 30 6 countries is tiny 20 4 compared to the US, 10 2 where ownership 0 is high and sales 0 remained static. 2005 2006 2007 2008 2009 2010 2011 2012 China Car ownership Annual sales India Car ownership Annual sales USA Car ownership Annual sales food, leaving the average family five years, boosts its spending on disguise, to find out what the with a huge surplus with which toilet paper to China’s per-capita business looks like from that to buy nonessential items that spending, the market growth in perspective. The show clearly quickly become “necessities,” such India will be $8.4 billion ($6.72 x illustrates how those in charge of as cosmetics and gym membership. 1.25 billion population). For China a business are often unaware of the India is perhaps about to embark to catch up with the US would opinions, insights, and feelings of on this stage of economic imply market growth of $24.3 billion their customers and staff. Despite development. If so, this will have ($17.98 x 1.35 billion population). a world of online praise and blame, an impact on the sales of a huge And that’s just the increase in some companies are able to remain range of everyday items. market size—not the total market. in a bubble of self-delusion. The significance of this trend Exactly the same logic applies However, this is unlikely to be lies in the numbers of people across the market for ordinary true of an organization in which the involved. If India, over the next household goods throughout the worker is also the customer. These developing world. Already, China is employees care about the product I will build a car for the world’s biggest market for luxury or service because they experience the great multitude … items, such as Swiss watches, it themselves and realize that their [that] will be so low in jewelry, and cars. Over the coming job security relies on customer price that no man making decades, China is also likely to satisfaction and the company’s a good salary will be dominate sales of ordinary items commercial success. If a customer (such as toothpaste), and services waiting room becomes messy and unable to own one. (such as insurance). The potential dirty, for example, staff-customers Henry Ford sales volumes involved are huge. will quickly draw attention to it. Today, China is the world’s largest US industrialist (1863–1947) car market, even though fewer than In Europe, fashion retailer 10 percent of households own a car. Primark enjoys huge success in the mainstream market. The In touch with reality company turns runway fashion The television show Undercover speedily into low-priced garments Boss sends senior executives with a target market of 15–35-year- into low-level jobs in their own olds. However, its growth was companies, under alias and instigated by an unusually elderly senior management team. By

MAKING MONEY WORK 137 Clothing retailer Primark has built a reputation for low-cost fashion in the European ready-to-wear market. Its success is due in no small part to the opinions of its workers. the time Primark had reached its beyond empowerment toward his engineers to start a special new strongest phase of growth in the worker fulfilment, even delight. business division. This became the 2000s, its senior executives were Born in 1959, Semler took over the nucleus of a new Semco, developing in their 60s and 70s. It was critical, business from his father at the age new ideas that soon generated 66 therefore, for directors to listen to of 21. Between 1982 and 2003, he percent of the company’s business. the young work force, who could drove Semco’s sales turnover from give insights into customer views. $4 million to $200 million. On his Semler’s leadership approach first day in the office, he fired nearly is to encourage his work force to Democratic management two-thirds of the senior management manage themselves in terms of Ricardo Semler, head of Brazil’s team, who he believed were too time-keeping, work-scheduling, Semco Group, is perhaps the rooted in his father’s autocratic and career development. By doing world’s most radical employer. He management style. In the late 1980s, so, he believes that workers will believes that bosses need to move he backed a proposal by three of truly care about what they do; this means that they will inevitably be taking care of not just the business, but its customers too. Semler describes his methods in his book Maverick! (1993) and outlines how much companies can benefit from the staff engagement that results. This approach has become known as participative management. It holds that people are naturally capable of self-direction if they are committed to corporate goals. And when your workers are your customers, the two sets of goals become perfectly aligned. ■ Work should be a pleasure, Arthur Ryan the name to Primark for the not an obligation … business model that he was to Born in Ireland in 1935, Arthur use in the UK, the Netherlands, We believed that people Ryan is the founder of Primark. and Spain. From 1973 until his working with pleasure could After leaving school, Ryan retirement in 2009, Ryan built worked at a department store up the business to change it be much more productive. and then a fashion wholesaler from being a “bargain” store to Clóvis da Silva Bojikian in London before returning to an inexpensive, on-trend fashion Dublin, where he worked for retailer. In 2013, Primark Brazilian former HR officer of Semco retailer Dunnes Stores. In 1969, employed more than 43,000 staff Garfield Weston, CEO of in stores in Ireland, Spain, the (1934–) Associated British Foods (ABF), UK, Austria, Belgium, Portugal, hired Ryan to set up a discount Germany, and the Netherlands. clothing chain with a seed fund ABF is still its parent company. of $80,000 (£50,000). The first In the recessionary year of 2009, store, Penneys, opened later that Primark’s like-for-like sales grew year in Dublin, but Ryan changed by more than 7 percent.

UTILIZE OPM OTHER PEOPLE’S MONEY WHO BEARS THE RISK?



140 WHO BEARS THE RISK? IN CONTEXT When a business is ...a small investment financed with debt, in shares can yield FOCUS or with other people’s control of the company. Financial risk money... This increases KEY DATES the chances of huge 1950s US economist Harry ...while the costs of Markowitz advocates failure are largely borne profits for the gathering a portfolio of business owners... investments to protect against by the work force... losses due to financial risk. Heads I win; ...and the company’s tails you lose. 1990s Research on types of middle managers, who financial risk identifies ways of measuring and managing take the blame for different kinds of risk, including poor performance. market risk (changes in the value of equity, interest rates, currency, and commodities) and credit risk (the risk of nonpayment of debts). 1999 UK conglomerate General Electric Company (GEC) is renamed Marconi plc, and its traditional businesses are sold off. The directors’ gamble on this change in strategy fails—the business collapses in 2001 and shares are suspended. Nearly 25 percent of staff is laid off. T he degree of financial risk Greek shipping magnate Aristotle shareholders’ capital finances the borne by a company has Onassis built a business empire business start-up, and remains at profound implications for that stretched across the world and risk until it is repaid in full. If the the long-term viability and success incorporated dozens of industries, business liquidates, the holder of of the business, its employees, and was underpinned by complex “ordinary” shares (as opposed to and its shareholders. A business financial arrangements. Onassis “preferred” shares, which are higher structured in a traditional manner recommended utilizing “other in ranking and yield dividends would put the most risk on the people’s money,” and while this before ordinary shares) is the last shareholders, since they stand approach might yield financial in the line to be paid. The ordinary to lose their investment if the success, it may end with others shareholder is therefore the least venture fails. But the proliferation bearing the costs of failure. likely to recover his or her of increasingly complex financial investment. Because of the risks mechanisms and means of Traditional risk they take, entrepreneurs are held in accounting have, to a degree, In theory, the risk takers in a market high esteem. So are early-stage, insulated a business’s owners from economy are the shareholders, who venture-capital investors, who invest the worst effects of failure. effectively “own” the business. The in start-ups in return for equity.

MAKING MONEY WORK 141 See also: Managing risk 40–41 ■ Play by the rules 120–23 ■ Accountability and governance 130–31 ■ Leverage and excess risk 150–51 ■ Off-balance-sheet risk 154 ■ Balancing long- versus short-termism 190–91 ■ Morality in business 222 The burden of risk associated with a business is spread wider as its financial affairs grow more complex. Executives and staff stand to lose financially and perhaps even punitively—with prison sentences possible—if the company fails. Creditors and shareholders can lose financially, while in the worst-case scenario taxpayers may bear the heaviest burden of all—in the form of high taxation and low economic growth—if their government chooses to rescue the business. Shareholders Creditors Venture capitalists, such as Indian- Business born Vinod Khosla of Sun Microsystems, invest in companies at an early stage and risk bearing the brunt of failure. But returns can be high with success. Executives Staff The association of risk with the Taxpayers shareholder is beneficial in many respects. A risk-bearing shareholder Risk of financial in a large, multinational bank would loss be inclined to discourage senior management from taking large risks Risk of criminal with the bank’s capital or reputation. prosecution Calculated risks may be considered, but not risks that threaten the code gives a struggling business business’s assets are sold after it existence of the business. The substantial protection from those to has entered bankruptcy. The assets shareholder can play a significant whom it owes money (its creditors, and operating model are sold to part in the business process, acting such as suppliers of raw materials, new owners, leaving the original as a natural check on the company’s ingredients, or subsidiary services). business entity behind. Suppliers propensity to take risks. This view This protection is intended to allow and other creditors may receive no of business has been held since the a company to rethink its business more than a token payment, such foundations of modern capitalism plan and perhaps find a more as 10 percent of the value of their in the 18th century. profitable business model. claims on the business. The new shareholders then have a debt-free Suppliers and creditors In the UK, a struggling company business with all the assets of the The traditional view may be can choose to enter a phase of “pre- old company, but with none of the ❯❯ threatened due to effects of new pack administration,” in which the rules and practices. In an attempt to encourage entrepreneurship, Chapter 11 of the US bankruptcy

142 WHO BEARS THE RISK? Suppliers are among the last to receive compensation for their goods or services if a business goes bankrupt. If, in the UK, it enters “pre-pack administration,” suppliers might receive nothing at all. liabilities. This method can be protection, the creditors can find personal pension funds in Enron especially controversial, since it themselves in a riskier position shares. When the business was can allow the owners of the original than the shareholders. liquidated, employees not only lost business to sell the “pre-packaged” their jobs, but also their pensions. new entity and still be involved in Employees at risk When the collapse of the business the business. In August 2008 the Staff employed by a business is was becoming clear, Enron froze London-based restaurant business also at risk when a company fails. its pension fund, preventing of Michelin-starred chef Tom When US energy company Enron employees switching their pension Aikens went into administration. collapsed in 2001, an extraordinary holdings out of Enron shares. It was bought by TA Holdco Ltd., feature of the unfolding story was of which Aikens was appointed the plight of many employees. Employees can also be partner and shareholder. Around Unlike the senior executives, rank- vulnerable due to the predations of 160 suppliers were left nursing and-file staff had been part inspired the investment market. If a company losses that would never be and part browbeaten into “showing is bought through private equity, recovered. However, by early 2010 faith in Enron” by investing employees can find themselves Tom Aikens’ business achieved a worse off if the business fails. A financial turnaround, and opened “Tails you lose”—in bad private-equity purchase is when a three new ventures in London. times, the owner is protected publicly traded company is bought from losses, but the business by a “private-equity group,” often When pre-pack administration and its employees suffer. through a leveraged buy out, where is utilized, suppliers are revealed the assets of the purchased to be in a much more vulnerable Private-equity ownership company are used as security to position than might otherwise be is typically structured in an borrow funds with which to finance expected. The financial losses asymmetric way. If things go the purchase. In so doing, the burden incurred by Aikens’s restaurants well the private-equity owner of risk is on the business (and its were effectively absorbed by gains, and if things go badly employees), not on the owners. suppliers, not shareholders. In a the subsidiary business loses. world of pre-pack administration The UK franchise of Canadian and Chapter 11 bankruptcy underwear business La Senza collapsed in 2012, with 1,100 “Heads I win”—in good employees losing jobs. In cases like times, the business this, the staff has little to gain when owner stands to gain, things go well, but everything to whereas the position of lose when they go wrong. Suppliers employees changes little.

MAKING MONEY WORK 143 are in the same position. Only the They were investigated over a ten- There is a simple way of private-equity shareholders are year period—the six years leading avoiding excess risk taking protected—by limited liability. up to the buy out, and the four years after it. The researchers found by the managers of our When publicly traded soccer that in the year following the buy financial institutions. It is team Manchester United was out, 59 percent of the private-equity purchased by US businessman owned businesses cut their staffing to make it a crime. Malcolm Glazer and his family in levels, compared with 32 percent in Paul Collier 2005, the transaction was the control group. In the following effectively a private-equity deal. years, private-equity ownership UK economist (1949–) The Glazers followed standard was associated with falling average practice, buying the publicly-listed wage levels among staff. In the company Blackstone Group earns company for $ 1.3 billion, then put short term employees appear to $130 million a year. He is closely the debts onto the balance sheet of lose out—and in the medium to followed by the bosses of Carlyle the new Manchester United Ltd. long term their chances of losing Group, Apollo Global, and KKR— Private-equity owners suggest that their jobs are higher due to the who each earn in excess of $100 debt is an effective means of forcing greater level of debt of the million a year. Remarkably, all these employees to work efficiently to companies they work for. bosses enjoy favorable tax treatment make a profit and meet interest in both the US and the UK. This payments. More plausibly, though, Private-equity iniquity became an important issue in the it is a way of transferring risk from Not everyone loses out under 2012 US presidential election, when the private-equity owner to a limited private equity. In 2003 the British Republican candidate Mitt Romney liability subsidiary. If Manchester retailer Debenhams was purchased (a former private-equity boss) had United Ltd. were to enter financial by three private-equity companies. to admit that his income tax rate, at trouble, the liability of the Glazers The businesses paid themselves 14 percent, was lower than that of would be minimal due to the a dividend of $1.9 (£1.2) billion average, working Americans. protection of “limited liability,” before floating the publicly traded which limits the owners’ liability to Debenhams onto the stock market Executives on the hot seat the value of their investment, not in 2006—laden with debt. Years In the world of public limited the total debts of the business. later, in its 2012 annual accounts, companies and corporations, the the financial strain still showed. CEO might be in the riskiest Research published in 2013 The degree of “gearing” (debt as a position of all. They may have the compared the performance of 105 percentage of capital employed in most to gain from their business’s companies purchased through the business) at Debenhams was a success, but also the most to lose private equity and 105 “control” high 51.5 percent, and its liquidity from its failure. These risks may be companies in the same industries. (as measured by the “acid test partly financial, but even more they ratio,” which determines whether a are reputational. Richard Fuld, chief We have corporate company has enough short-term executive of Lehman Brothers at CEOs who raise their pay assets to cover its immediate the time of its 2008 bankruptcy, 20 percent or more in years liabilities) was a very weak 0.175. went from being an award-winning when they lay off thousands Yet for the private-equity owners, CEO to a nominee for a range of the deal was highly profitable— “worst ever...” awards. From being a of people. It’s obscene. they made $1.9 (£1.2) billion very director of the Federal Reserve Bank Charles Handy quickly and still retained shares in of New York, he became a pariah. ❯❯ Debenhams (a stake that was sold UK management expert (1932–) in the years that followed). Their overall profits exceeded 200 percent. For the bosses of private-equity companies, the rewards can also be impressive. Bernard Schwarzman of US private-equity investment

144 WHO BEARS THE RISK? Italian food giant Parmalat’s 2004 $1.6-billion accounting cover-up was primarily due to fraud. The effects were sharply felt by shareholders and the many employees who lost their jobs. In the UK, a similar fate awaited should, on this basis, lead to the term “too big to fail” illustrates that figures such as Fred Goodwin (CEO death of the business. Austrian- business risks have been transferred of Royal Bank of Scotland when it American economist Joseph to the taxpayer. Faced with the collapsed in 2008) and James Crosby Schumpeter, in his classic 1942 bankruptcy of General Motors and (CEO of Halifax Bank of Scotland book Capitalism, Socialism, and Chrysler in 2009, the US government until 2006). Both were blamed for Democracy, made the famous —in other words, US taxpayers— the dramatic collapses of their statement: “The process of Creative took on billions of dollars’ of debt to banks in 2008, and for their part in Destruction is the essential fact give the companies a fresh start. the subsequent economic turmoil. about capitalism.” Schumpeter, like In the UK and Europe, bank many others, viewed recessions as bailouts in 2008 and 2009 saved Is it fair that a company’s a cleansing mechanism, allowing the private sector from huge losses. bosses should have to take the the weak to fall back and new, In Europe, what was put forward as blame for failure so personally? stronger companies to emerge. a Eurozone government problem After all, it is inconceivable that the was in fact a private-sector problem, CEO is the only one to blame for the Yet modern governments seem as banks faced nonrepayment of failure of a business. Objectively, to see things differently, certainly loans to businesses within Greece, the answer is clear, because in relation to large businesses. The Portugal, or Italy. The bailouts business failure is certainly the were arranged and financed by responsibility of more than just the Risk comes from governments, meaning that CEO. Yet high-profile executives not knowing what taxpayers turned out to be the risk often strive to associate themselves takers, even though nobody asked so closely with the company— you are doing. their opinion. American economist making it seem as though they Warren Buffett Nouriel Roubini summed this up personally are the business—and by saying: “This is again a case are so eager to back this up with US investor (1930–) of privatizing the gains and massive remuneration packages, socializing the losses; a bailout that it can be no surprise when the and socialism for the rich, the public and the media turn on them. well-connected, and Wall Street.” Taxpayers to the rescue This issue has stretched far In mature, developed economies, wider than the US and Europe, businesses are supposed to take influencing the economic situation risks in pursuit of reward. Failure in both Japan and China in recent decades. From the start of its 20-year depression in 1990, land prices in Japan fell by more than 80 percent, and today remain far below the levels reached in 1988 before the recession began. In effect, almost every bank in Japan was insolvent as a result of vast portfolios of nonperforming loans—loans that were made to companies that could neither repay the debt, nor pay the interest on that debt. Only the support of the Japanese central

MAKING MONEY WORK 145 bank kept these commercial banks by only 37 percent. Government Richard Fuld alive. The taxpayer took on the bailouts for big business effectively risks that are supposed to be taken mean that taxpayers are providing Richard “Dick” Fuld was born by the private sector. Many support for those who benefit most in 1946 in New York City, NY. analysts suggest that the same is from today’s economic system. In He graduated from the true in China at present, although the long run, businesses may enjoy University of Colorado in 1969, the opacity of the Chinese banking substantial profits, and accept the and received an MBA from the system makes this hard to verify. rewards as recompense for the risks Stern School of Business in they take. But if the risks (and losses) 1973. He was CEO of Lehman Who bears the risk? are borne by the taxpayer, it is fair Brothers investment bank Roubini’s statement that losses to question why only shareholders from 1994 to the day of its are “socialized” (borne by the public) gain the profits in the good times. collapse in 2008, and during while profits remain in the private that time, he received more sector appears to be true. Income Often, employees and suppliers than $500 million. Known as inequality has widened considerably bear higher levels of risk than the “Gorilla of Wall Street,” around the world in recent decades, seems fair—shareholders, who Fuld was the domineering in countries including the US, enjoy the rewards of success, should boss who pushed the company UK, China, and India. For instance, bear the primary risk of failure. into the subprime mortgage between 1979 and 2007 in the US, Even trade-union protection for business. For many critics, the the income of the top 1 percent of workers has been eroded in recent decision that illustrated his earners rose by 266 percent, while decades—in the US and many hubris was his refusal of that of the bottom 20 percent rose countries around the world, unions bailout funds from investor account for no more than 10 percent Warren Buffett and the Korea Greek citizens protest in Athens of private-sector employees, which Development Bank, even against austerity measures in 2011. leaves workers unprotected when though Lehman Brothers was Rescue loans from the European Union things go wrong. Although labor in the throes of being toppled to Greek banks mean that the country flexibility has its merits, imbalance by the 2008 credit crunch. His faces years of economic hardship. between “my risk” and “your reasoning was that the offers reward” has perhaps gone too far. ■ of cash did not match his own valuation of Lehman Brothers. Following the company’s bankruptcy in September 2008, Time Magazine named Fuld as one of the “25 People to Blame for the Financial Crisis,” and Condé Nast Portfolio magazine ranked him number one on its list of “Worst American CEOs of All Time.”

146 IN CONTEXT SWIM UPSTREAM. FOCUS GO THE OTHER WAY. Business behavior IGNORE THE CONVENTIONAL KEY DATES WISDOM 1841 Scottish journalist Charles MacKay documents IGNORING THE HERD herd behavior in his book, Extraordinary Popular Delusions and the Madness of Crowds. 1992 Indian economist Abhijit V. Banerjee publishes A Simple Model of Herd Behaviour. 1995 In “Herd Behaviour, Bubbles and Crashes,” German professor Thomas Lux claims prices and sentiment affect one another, so feelings of the herd affect prices (for example, faith in the housing market pushes up prices). 2001–06 The housing bubble in the US and parts of Europe gathers pace before collapsing in the 2007–08 financial crisis. T he herd instinct is clear in nature and just as clear in business. Most people feel more comfortable following what others are doing than standing out as a “loner” or maverick. Ignoring the herd takes great psychological strength. When stock markets rise steeply, new—perhaps first-time— investors get sucked in by the apparently easy pickings. These latecomers to a booming “bull market” cause share prices to propel upward for a last time before they slump back toward their previous value. By following the herd in this way, most first timers invest when share prices are near the top and usually sell when they find that their

MAKING MONEY WORK 147 See also: Stand out in the market 28–31 ■ Gaining an edge 32–39 ■ Beware the yes-men 74–75 ■ Thinking outside the box 88–89 ■ Avoid groupthink 114 ■ Protect the core business 170–71 ■ Forecasting 278–79 Companies follow herd instincts when they… …stampede to buy …buy other businesses …develop “me too” shares in high-trend because of a current products rather than businesses, or buy them follow logical strategy. market trend in completely. diversification. These actions are unlikely to be financially beneficial. Swim upstream. Go the other way. Ignore the conventional wisdom. assets have dropped in value. They An example of the risks of following shares. And by February 2001, the often suffer serious losses. A the herd came with the dot-com share price had fallen to 9 cents. contrarian investor—or a savvy bubble, between 1998 and 1999. A little later the business was company that holds a portfolio of Among numerous examples of declared bankrupt. ❯❯ investments—does the opposite. extraordinary share-price gains When share prices rise and new followed by equally huge losses, The herd instinct among investors are attracted into the was the business eToys.com, forecasters makes sheep look market, they sell, and if the market which was opened in 1997. In May slumps, they buy. However, few 1999 it was launched onto the New like independent thinkers. investors show the foresight required York Stock Exchange at $20 per Edgar R. Fielder to know when a boom is turning to share, raising $166 million. Buyers bust. Warren Buffet, a legendary piled in, pushing the price up to US economist (1930–2003) investor, says: “We simply attempt $76 by the end of the first day. By to be fearful when others are greedy fall 1999, the share price was $84, and to be greedy only when others giving the business a higher are fearful.” Between 1965 and 2013, market value than the retail giant Buffet’s investment company gave Toys R Us. As the market turned investors a capital gain of more downward, the experts started to than 900,000 percent. sell, leaving the herd with the

148 IGNORING THE HERD Global market shares of smartphones in 2009–13 varied Nokia military spending. A worried BAe greatly: Apple stayed relatively stable; Nokia and RIM, who Samsung then approached the owner of had responded with herd instincts to the iPhone’s success, Apple Airbus, suggesting a merger and saw huge losses; Samsung’s shares soared, reflecting its RIM implying that a mix of civilian development of products that would stand the test of time. and military businesses was a preferable focus. Could things 40% really have changed that much between 2006 and 2013, or was 35% BAe responding to the trend for diversification? Strong business 30% leaders look to the long-term and ignore fads and fashions among 25% stock-market analysts and management consultants. 20% 15% 2010 2011 2012 2013 Following the leader The third herd behavior to avoid 10% is “followership.” This occurs when companies develop “me-too” 5% products to imitate market innovators. Of course, if a business 0% already has a genuinely 2009 differentiated offering, it is wise to follow a new trend. Often, though, It makes sense for the share-buying but little mention of long-standing businesses rush out copycat public not to follow mass trends, research, which suggests that 60 products to demonstrate that they but is the same true for business to 66 percent of all takeovers are staying competitive in a sector. leaders? In 2008, US mass-media destroy shareholder value for the When the iPhone was launched in corporation AOL, noticing the winning company. In other words, 2007, Nokia could boast more than growth in social network sites, most takeover bids prove to be 40 percent of the global smartphone bought the social-networking site a disappointment. market. Despite a series of new Bebo for $850 million. It joined the product launches by the company, herd and lost out badly. In 2013, it The second herd behavior to sold the same business back to its ignore is the strategic clash between Those entrapped by the founders for $1 million. focus and diversification, and the herd instinct are drowned way the market tends to concentrate in the deluges of history. Following trends on one of these two at any one time. But there are always the Business leaders, then, must be When “focus” is the market mantra, few who observe, reason, as cautious as anyone else about share prices rise in companies that treading the same path as the sell off peripheral assets or divisions and take precautions, majority. There are three main of the business. This is what and thus escape the flood. types of herd to ignore. The first, happened to British Aerospace as mentioned, is the occasional (BAe) when it sold its 20 percent Anthony C. Sutton stampede to make takeover bids. stake in the Airbus aircraft business In this case, business leaders worry in 2006. At the time, the stock UK economist (1925–2002) that if they do not buy a rival, market liked its $2.99 (£1.87) billion someone else will and perhaps sale of the largely civilian aircraft create a bigger, more difficult maker, since it focused BAe on the competitor. At such times, there is defense and military sector. By 2013, much talk of synergies (the sum this view looked absurd, as Airbus being worth more than the parts) powered ahead but governments— especially the US—cut back on