Starbucks and Licensing

We have recently learned that activist investor Nelson Peltz has taken a stake in Starbucks. Peltz, of course, has taken stakes in companies such as Heinz, Wendy's, Kraft, and Cadbury Schweppes in recent years, and he's pushed for strategic changes to bolster shareholder value. In a Wall Street Journal story about Peltz's investment, we see some conjecture about the types of changes that he might propose:

"John Glass, an analyst at Morgan Stanley, said Mr. Peltz could urge Starbucks to cut spending and use more licensing or franchising in opening locations. The money saved from that could go to buying back shares or a larger dividend for shareholders."

I can see why Mr. Glass has come to this conclusion. There is no question that licensing or franchising would reduce the capital investment required to continue to expand the Starbucks footprint around the globe, and it would free up cash to be returned to shareholders. However, Starbucks has relied on owning a majority of its locations for good reason (it does use some licensing in locations such as airports, as well as in other countries).

There's an important lesson about vertical integration here. Many firms rightfully employ franchising, because it gives local entrepreneurs great incentive as they run their own businesses. Moreover, it conserves capital. However, a company tends to own its own retail locations when they have concerns about controlling the experience, atmosphere, and customer interaction that takes place. Starbucks sells much more than coffee.

Some firms with premium differentiated strategies face challenges when they try to write into contracts the specific behaviors and atmosphere that they want to create and stimulate in their stores. Thus, one can see why these firms tilt toward owning their retail locations. Take Apple, for example, which operates its own retail stores; the retail location is about the entire Apple experience, not just selling computers and iPods. Apple doesn't want to leave that responsibility for guarding the brand, the relationship, and the experience to a licensee. Similarly, a Starbucks location is supposed to be about much more than selling coffee. It entrusts that relationship and experience to others at some peril.

If you examine what Schultz has done since returning as CEO, he's focused extensively on the Starbucks experience within their stores. He has always talked about the importance of Starbucks as a "third place" - outside of home and office. Shifting dramatically in the direction of franchising and licensing would seem to be at odds with his strategic direction. Starbucks would not have full control over the quality and the experience if they don't own these retail locations.

A Great Board of Directors

A recent article on Business Week's website discusses how a firm can create an excellent board of directors. The article makes a key point, namely that while a board can meet all of the structural requirements advocated by governance experts, that does not mean it is an effective board. In other words, one can have the correct percentage of outsiders, a nonexecutive chairman, and the like, and yet still not provide effective goverance. I have always believed that far too much attention is paid to structural dimensions of the board, and far too little attention is paid to process. Great boards of directors have highly effective group processes for dialogue and deliberation. Their process distinguishes them from less effective boards, not their structural characteristics.

Credit Rating Agencies

Roger Lowenstein has a great new article in this week's NYT magazine about the role that the credit rating agencies played in the mortgage meltdown. He speaks at length about the conflict of interest that the credit rating agencies face, since they collect fees from the very clients that they are evaluating. Of course, these conflicts have always existed, but Lowenstein explains why the conflicts are most pronounced and worrisome when it comes to mortgage-backed securities, as opposed to corporate bonds:

The evidence on whether rating agencies bend to the bankers’ will is mixed. The agencies do not deny that a conflict exists, but they assert that they are keen to the dangers and minimize them. For instance, they do not reward analysts on the basis of whether they approve deals. No smoking gun, no conspiratorial e-mail message, has surfaced to suggest that they are lying. But in structured finance, the agencies face pressures that did not exist when John Moody was rating railroads. On the traditional side of the business, Moody’s has thousands of clients (virtually every corporation and municipality that sells bonds). No one of them has much clout. But in structured finance, a handful of banks return again and again, paying much bigger fees. A deal the size of XYZ can bring Moody’s $200,000 and more for complicated deals. And the banks pay only if Moody’s delivers the desired rating. Tom McGuire, the Jesuit theologian who ran Moody’s through the mid-’90s, says this arrangement is unhealthy. If Moody’s and a client bank don’t see eye to eye, the bank can either tweak the numbers or try its luck with a competitor like S.&P., a process known as “ratings shopping.”

Oil Bubble?

I'm not an expert on the crude oil market, but naturally, we are all very interested observers. I was struck by this recent article in the Wall Street Journal, in which a number of people express the argument that we are in the midst of a massive bubble in the oil market. It will be interesting to watch this play out over the coming months and years.

Inside-Outsiders

One of my mentors, Joe Bower, has published new research on the very important topic of CEO succession. In his new work, Bower argues that firms should aspire to elevate "inside-outsiders" to the CEO post. Here is Bower's explanation:

The answer to problems with CEO succession is what I call inside-outsiders. These are men and women who have performed well and risen high, but have maintained their objectivity. They are aware ofhow much change is needed to sustain success or turn around a failure, but they also know the organization, its culture, and its people. They can do more than bring in consultants or make across-the-board cuts. Beyond getting short-term profits, they can build for future growth. These unusual people are often found at the periphery of the organization, managing new businesses or new markets.

The idea is that companies should try to find someone who combines the experience and knowledge of a typical insider with the fresh perspective and divergent thinking typical of an outside hire. I think it's good advice, and it's particularly interesting to note that these people often may have spent a great deal of time at the periphery of the organization, forging into new markets, launching new products, or coming up with entirely new business models. Those experiences at the periphery expose executives to new ways of thinking and give them a fresh perspective on deeply held assumptions and mental models to which many insiders perhaps become overly wedded over the years.

Capitalizing on a Recession?

Can companies actually grow stronger during a recession? What can they do to capitalize on the problems that their rivals encounter during tough economic times? Suppose you have a sturdy balance sheet, low debt, and plentiful amounts of cash. How can you employ these strengths to take on rivals who have been weakened considerably?

First, invest heavily in research and development now so that new products and services are ready for launch as the economy begins to grow again. Your competitors may be inclined to cut R&D, particularly if they face high interest payments, substantial drops in revenue, and the like. If so, your acceleration of investment now will yield a strong product advantage in the coming years.

Second, spend some time learning about the customers of your weakest competitors. You might be inclined to go after their largest and most attractive clients. However, be aware that your rivals are probably working desperately to save those customers. They might not, however, have the time and resources to focus on smaller clients. Focus your attention on these potential new customers, particularly those with attractive growth prospects and strong balance sheets.

Third, identify your most critical suppliers and distributors, and determine if any face the possibility of severe impairment to their business due to the economic downturn. Assess the risk to your business if they should falter badly or even fail completely. Then, examine ways in which you might help those supplies and distributors weather the downturn. Even the smallest gesture can sometimes build an enduring loyalty that will pay off for years to come.

Finally, think carefully about your talent needs. As weak companies lay off employees, many good people will find themselves searching for work. Other skilled workers may still have a job, but they may be disenchanted with their struggling firms. Capitalize on this opportunity to identify and attract talented employees, while slack exists in the labor market.

I'm reminded of the importance of considering these questions when I read Steven Jobs' recent quotes about Apple's strategy in the days and months ahead. Jobs promises to expand the firm's research and development efforts this year, even if economic growth does turn negative. Here is what he told Fortune magazine a few weeks ago, reflecting on the last recession as well as the current economic climate: "In fact we were going to up our R&D budget so that we would be ahead of our competitors when the downturn was over. And that's exactly what we did. And it worked. And that's exactly what we'll do this time." Of course, Apple sits in an enviable position. They have an impressive balance sheet, mountains of cash, and no debt. If your firm also finds itself in such a position of strength, remember that it too can use the recession to become even stronger relative to the competition.

Deciding how to Decide

Noted political scientist and former Assistant Secretary of Defense Joseph Nye applies my framework on decision-making in the opening to a commentary in yesterday's Financial Times. It's an interesting read, regardless of where you stand on the political spectrum.

Guest Post: Leadership Training Through Virtual Worlds

The rise of virtual worlds like Second Life and World of Warcraft has led to innovative new ways to train corporate leaders. In a virtual world, people are represented by avatars and can practice their skills in a variety of settings with other professionals. This is a cost-effective way to train a large amount of people in various situations. In short, this is business training of the future.

While many video game aficionados were always told that their hobbies were pointless, even the youngest players are gaining leadership training without realizing it. John Seely Brown and Douglas Thomas of Wired magazine write:

When role-playing gamers team up to undertake a quest, they often need to attempt particularly difficult challenges repeatedly until they find a blend of skills, talents, and actions that allows them to succeed. This process brings about a profound shift in how they perceive and react to the world around them.

They become more flexible in their thinking and more sensitive to social cues. The fact that they don't think of gameplay as training is crucial. Once the experience is explicitly educational, it becomes about developing compartmentalized skills and loses its power to permeate the player's behavior patterns and worldview.

It isn't just the "accidental" training that companies are interested in, however. The aforementioned Second Life serves as a training ground and collaboration tool for many different industries. The Coalition Connection, for example, is a University of Maryland project that provides virtual training for a group of emergency responders.

Is this new age in leadership training free of problems? Certainly not, as there are cultural and technical obstacles people must overcome. Not everyone is Web-savvy and trained in PC gaming, after all. However, more companies are relating virtual world training to their bottom line. It is extremely cost effective to undergo this sort of widespread training, especially when remote workers must be brought together.

Elastic Collision is one of many consulting firms that helps businesses to develop their own virtual world presence. As the company states, corporate training sessions can "leverage the educational potential of virtual worlds." Will every company adopt this new technology? Perhaps not, but the most innovative companies already have.


Susan Jacobs is a freelance writer as well as a regular contributor for CollegeDegree.com, a site helping students select an online college degree. Susan invites your questions, comments and freelancing job inquiries at her email address susan.jacobs45@gmail.com.

Harvard Business School's 100th Anniversary

Geoff Colvin of Fortune has written a very interesting piece about my alma mater's 100th anniversary. Colvin sets out to ask some very succcesful alumni what they learned at HBS. After listening to their answers, he concluded, "All their answers are different, but they're all the same: none are about the content of the courses; all are about the experience." He goes on to say, "It makes sense that the content of the classes isn't what it's all about. That's constantly being commoditized."

At HBS, students learn to think, both individually and collectively, through the case method. It's active learning each and every day. At one point, Colvin quotes Yale Professor (and former HBS student and faculty member) Jeff Sonnenfeld, who says, ""I learned that yellowed lecture notes and blackboards filled with algorithms don't teach professionals how to think."

As a graduate and former faculty member of the school, I can attest to what Colvin and Sonnenfeld have concluded. We do easily forget the frameworks and theories that we learned at HBS, but we never forget the learning experience. As former Dean John McArthur once said, "How we teach is what we teach." In other words, the faculty member leads a process of collective inquiry, using the Socratic method, that can and should be emulated by leaders in any business. What do students learn at HBS? They learn the process of asking tough questions, stimulating debate, questioning assumptions, and generating alternatives. They learn to work as a group to identify and solve tough problems. These are the skills any aspiring business leader must master.

The Collapse of Bear Stearns

The collapse of Bear Stearns brings to mind a fascinating quote by a very accomplished CEO: "I am well aware that humans will always make errors. My irritation comes from the fact that these errors are not caught immediately." That quote is from Alan “Ace” Greenberg, former Chairman and CEO of Bear Stearns, in a book titled Memos from the Chairman, which was published in 1996.

Steve Jobs on Apple's Strategy

This Steve Jobs' quote in the current issue of Fortune magazine (Most Admired Companies) exemplifies Michael Porter's idea that business strategy is as much about choosing what NOT to do as it is about determining what a company will do. Here is the quote:

"Apple is a $30 billion company, yet we've got less than 30 major products. I don't know if that's ever been done before. Certainly the great consumer electronics companies of the past had thousands of products. We tend to focus much more. People think focus means saying yes to the thing you've got to focus on. But that's not what it means at all. It means saying no to the hundred other good ideas that there are. You have to pick carefully (italics added). I'm actually as proud of many of the things we haven't done as the things we have done. The clearest example was when we were pressured for years to do a PDA, and I realized one day that 90% of the people who use a PDA only take information out of it on the road. They don't put information into it. Pretty soon cellphones are going to do that, so the PDA market's going to get reduced to a fraction of its current size, and it won't really be sustainable. So we decided not to get into it. If we had gotten into it, we wouldn't have had the resources to do the iPod. We probably wouldn't have seen it coming."

The Isolated Executive

Far too many senior executives at large companies become isolated in the corner office. Their professional lives involve a series of handlers - people who take their calls, screen their email, drive them places, run errands for them, etc. They live in gated communities, travel in first class, and stay at five-star hotels. They have worked hard for these privileges; few would suggest that they don't deserve them. However, executives often find themselves living and working in a bubble. They lose touch with their front-line employees, their customers, and their suppliers.

Yes, many senior executives conduct town-hall meetings with employees, and they go on customer visits periodically. They tour the company factories or stores, and they visit supplier locations. However, these events are often highly orchestrated and quite predictable. People typically know that they are coming... which clearly alters the dynamic a great deal. Often, executives simply witness a nice show, put on by lower level managers to impress them. They don't actually come to understand the needs and concerns of people who work in their factories or consume their goods. Such isolation breeds complacency and an inability to see new threats or opportunities.

How can executives protect against becoming isolated at the top? First, engage your consumers and employees in authentic, unscripted conversations. At Xerox, CEO Anne Mulcahy and fellow corporate officers rotate serving as "Customer Officer of the Day" at the company's headquarters (one day per month for each executive). In that role, they must deal personally with all customer complaints that come to the headquarters that day. As Mulcahy says, "it keeps us in touch with the real world. It grounds us."

Second, go watch how consumers behave, rather than simply relying on the data summarized after marketing research folks have conducted surveys or focus groups. People call this "ethnographic marketing" because the researcher acts as an anthropologist watching people in their natural environment. At Proctor and Gamble, CEO A.G. Lafley engages in such direct consumer observation. A 2003 Forbes article describes Lafley making visits to consumer homes "incognito" so that he can learn directly from watching how people live and use his firm's products.

Third, go put yourself in your front-line employee's shoes for a day. Go work on the line - whether that be at the cash register in a supermarket or at a station along an assembly line. When I began working at Staples in the mid-1990s, after completing my MBA, my first assignment was to spend several days stocking shelves and running a cash register in a store. You learn a great deal about the business in this manner. Executives too need to periodically go to the front lines.

Finally, executives must interact with young people. Time spent with young people exposes executives directly to new societal and technological trends, as well as a different perspective on the world. They should visit college campuses, spend time learning about social networking sites, as well as listen to and watch some of the multimedia (music, books, television) that young people enjoy. Within their own firms, executives might even take up Gary Hamel's suggestion that they set up a "shadow executive committee" consisting of employees 20 years younger than the actual top team (2003 Harvard Business Review article). Seeking feedback from these young workers can provide a fresh perspective on the firm's strategies and initiatives.

In sum, executives must work hard to break out of the bubble that often forms around them as they rise to the top of large organizations. It takes a concerted effort, but the payoff is great. They will keep themselves grounded, as Mulcahy notes, and they will create bountiful opportunities for learning. That learning can drive innovation and improvement in their organizations.

The Powerpoint Doldrums

We've all been in meetings where a presenter slogs through a seemingly endless Powerpoint presentation. The graphics are wonderful; the fonts are just right. Still, it's boring. People are multi-tasking right and left. The Blackberries are all in hand. The questions are few and far between. Thus, I found it interesting when I read the following quote in a recent Business Week article:

Stephen Pratt, chief executive of Infosys Consulting, understands the power of the pen; he rarely walks into a meeting with a formal presentation. "People tend to fall asleep when they see very long PowerPoint presentations full of text," Pratt says. "But if you start drawing on the board, people sit up in their chairs."

I found this particularly interesting, because as a professor, I know that many faculty members rely on Powerpoint heavily. It can easily become a snoozefest. I do use Powerpoint, but for most of my classes, I use the chalkboard or the whiteboard much more often. My drycleaning bill can attest to the fact that I love chalk! I find that students are much more engaged when you use the chalkboard to communicate an idea and to trigger a conversation with them. That's why I think Infosys CEO Stephen Pratt is correct. If the chalkboard or whiteboard works more effectively in the classroom, then I think there's no question that it can have a powerful impact during management meetings as well.

Recessions and Differentiation Strategies

Eac day brings news of slowing economic growth. Moroever, we see many retailers reporting disappointing earnings and/or slicing their outlook for the year ahead. These reports raise an interesting question. How should retailers with a differentiation strategy react during a recession? By differentiation, I mean retailers who try to create better-than-average willingness to pay on the part of their customers, thus enabling them to charge premium prices. Limited Brands, for instance, employs a differentiation strategy in its businesses such as Victoria's Secret. Meanwhile, TJX tends to employ a low cost strategy in its businesses such as Marshall's.

The challenge during a recession is that many differentiated players may suffer larger declines in sales than low cost players, as budget-conscious shoppers flock to outlets that offer rock-bottom prices. My view is that differentiated retailers must be very careful during recessionary periods. The natural inclination might be to slash prices to retain customers during sluggish economic times. However, lower prices means lower margins, unless the retailer can also reduce costs. Herein lies the problem. If differentiated players are not careful in their cost reduction efforts, they may damage their brand, quality, and market reputation - thus compromising their position in the market and their ability to return to premium pricing in the future. Thus, the differentiated players in the retail sector have to be very careful, as efforts to shore up their financials during a recession can have long term detrimental effects that persist long after robust economic growth resumes.

New Strategies for the TV Networks

The Wall Street Journal reports today that the major broadcast networks are considering doing away with some age-old conventions of the television business in an attempt to entice viewers and advertisers back after the lengthy writers' strike. Well, it's about time!!! I've wondered for many years now why the broadcast networks have adhered to certain conventions, while their ratings have deteriorated. It's seems a classic case of a business being caught in a particular mental model, and not able to shake those basic assumptions while the world around them is changing dramatically.

Here are some questions that all the networks should consider: Why should most new shows premiere in September? Why must the season run from September to May for most shows? Why should nearly every series air episodes once per week? Why not have some series that run episodes in a more condensed fashion, perhaps with 2-3 episodes per week for a few months? Why not create an event, some hoopla, out of the testing of new pilots, perhaps creating a 2-3 day block several times per year filled with a whole array of pilots? Why not couple that with a huge web-based effort to collect feedback about those pilots? We could go on and on... this is clearly a business that needs to be re-tooled, and that begins with shaking the old conventions. I'm glad to hear some executives are beginning to question the conventional wisdom in the business.

Selling the Chicago Cubs

The Wall Street Journal has a story today on page B1 about Sam Zell's attempt to sell the Chicago Cubs. Apparently, Zell would like to sell the Cubs and Wrigley Field separately to different buyers. The paper reports that Zell is exploring the sale of the ballpark to a state agency in Illinois, while seeking a private buyer for the team. The paper also reports that "most observers believe he will make more money" by selling the two entities separately.

I wonder about this conclusion. Strong arguments can be made that, in fact, it makes more sense for the Cubs to remain a vertically integrated organization - with both the team and the ballpark sitting under one corporate umbrella. When we think about vertical integration, scholars tend to think about transaction costs, i.e. the costs associated with contracting and coordination between two parties. Some would argue that the transaction costs associated with the team and the ballpark trying to cooperate as separate entities exceed the transaction costs associated with that same cooperation if the two entities were part of the same corporation, with the same owner.

What drives transaction costs? Well, scholars like to think about what they call "transaction-specific assets." An example of a transaction-specific asset would be if a supplier had to invest in specialized technology in order to manufacture components for one of its customers. In that scenario, the two parties can become beholden to one another. The opportunity exists for what economists call "holdup" i.e. one party can try to renege on obligations and perhaps try to extract additional value from the other party. In that type of situation, we tend to see vertical integration arise, i.e. the customer merges with the supplier.

In this case, I think that there may be a high degree of asset specificity... to put it simply, the Cubs are closely linked to Wrigley; it's highly unlikely that the Cubs will have the option to play anywhere else in the foreseeable future. Thus, I think the potential for holdup and opportunitistic behavior exists if the two entities are owned separately and trying to negotiate contracts to cooperate with one another. I think that transaction costs associated with coordination and cooperation might be lower if the team and ballpark are owned by the same corporate parent.

Save the planet AND make money

Gary Hirshberg, CEO and founder of Stonyfield Farms, has a great new book about how his company has managed to become very profitable, while adhering to "green" environmental practices and principles. Stonyfield is quite a company; they generate $300 million in annual revenue, and have become the world's largest organic yogurt producer. Hirshberg's book offers practical advice for managers by detailing the specific ways in which his firm has managed to increase revenue and profits, while also promoting sustainable environmental practices. I'm looking forward to hear Hirshberg talk about his book when he visits our campus here at Bryant University on March 19th.

Yahoo in Play

With Microsoft's unsolicited bid for Yahoo, it's now clear that Yahoo is in play. It's likely that other offers will follow, particularly with Google now poised to perhaps help Yahoo find a white knight. My guess is that Yahoo's board and management will try to raise the selling price by attracting other bidders, recognizing that shareholders will not accept a rejection of the bid and maintenance of the status quo.

One key question is: Can Yahoo find a bidder whose culture represents a better fit than Microsoft? Cultural mismatch represents a key hurdle in many acquisition integration efforts, and it surely would be an obstacle if Microsoft purchases Yahoo. Perhaps another company could provide a better match.

Alternatively, we could see a bid by a firm such as News Corporation. Murdoch has a reputation for allowing each of his businesses to run fairly autonomously, though he intervenes selectively on key strategic choices. Perhaps Yahoo's board and management would conclude that they can live with a takeover by News Corporation, because those top managers who remain would maintain some autonomy, rather than facing full integration with other News Corp businesses.

The Financial Meltdown: From Blame Game to Collaborative Problem-Solving

The WSJ's Davos Blog has some interesting comments from Charles Dallara, managing director of the Institute of International Finance. Dallara argues that people around the world need to stop pointing fingers at the US for the current crisis, and instead, begin thinking about how central banks and governments can work collaboratively to improve economic conditions. He points out that the financial system is a global one, with many interconnections. All problems can't be solved at the national level.

I think Dallara makes a good point about the need to shift from the blame game to some collaborative problem-solving. Yes, the US regulatory system may need some fixing, but I'm sure that no nation has a perfect system. It's time to work together to iron out some of these issues that led to the current situation.

I find the finger-pointing so interesting because employees in companies do this all the time. Too often, managers spend far too much time assigning blame when a problem occurs, or trying to dodge blame, rather than confronting the issues openly and fixing them collaboratively.

Developing the Leadership Capabilities of Your Children

Michael McKinney of The Leading Blog points parents to a great article by Tim Elmore of GrowingLeaders.com about the attributes that we should be nurturing in our children. I especially liked the points about humility, gratitude, and being teachable - i.e. being willing to seek advice and wisdom from others, and being a good listener in those situations. We can all work on being more teachable - children as well as adults. As a faculty member, I think this list is useful to think about in terms of how we can nurture the development of our students personally as well as professionally.

Challenging the Tipping Point

Great article in Fast Company about Columbia sociologist Duncan Watts and his research that challenges a key assertion in Malcolm Gladwell's book - The Tipping Point. Watts studies social networks. He has done a number of studies, using computer simulations, to examine Gladwell's assertion that a small group of influential and connected people tend to trigger social trends. He concludes from his work that these influencers don't have nearly as much influence as Gladwell believes. It's a fascinating debate about how social trends emerge, and not surprisingly, many marketers are deeply skeptical about Watts' research findings.

Evaluating Companies...Lessons from the Jim Rice Debate

This week, Jim Rice, a famous Boston Red Sox slugger of the 70s and 80s, was denied entry into the Hall of Fame once again. To explain this, many sportswriters point out that he "only" hit 386 career home runs. Yet, he played when hitting thirty home runs in a season actually meant something. Many others have played during a more recent era in which balls have flown over the fences at an unprecedented rate. Rice was one of the game’s most feared hitters for a decade. How should we measure his performance? For starters, we should not focus on raw numbers alone, because today’s offensive numbers are grossly inflated relative to the 1970s (thank you, steroids and HGH). Instead, we ought to see how a player fared relative to others who competed during the same era.

Let’s see how Rice stacks up . One good measure of preeminence in a particular era is the Most Valuable Player award voting. Right away, we see a stark contrast between Rice and many other great ballplayers. Jim Rice earned one MVP award, but he also finished in the top five in the MVP voting on six separate occasions - a remarkable feat. To put this in perspective, Rice finished in the top five more often than many Hall of Famers including Reggie Jackson, Willie McCovey, Willie Stargell, Dave Winfield, George Brett, Tony Perez, and Boston's own Carl Yastremski!

Why do I bring up the example of Jim Rice? For one, I'm a Red Sox fan who believes that it is wrong for him to have been repeatedly denied entry into the Hall of Fame :-) However, I also bring up Rice's case because, too often, journalists, students, and practicing managers make the mistake of looking at company's financial results in isolation, rather than thinking about how they are doing relative to their competitors. They make the same mistake that sportswriters have made with regard to Rice.

With the economy slipping perhaps into recession, many firms are experiencing a deterioration in their financial results. The key question, however, is this: Are some firms able to weather the storm more effectively than others? The headlines shouldn't be: XYZ retailer experiences downturn in comparable store sales growth. Why is that newsworthy these days? Almost all retailers are experiencing softness in their numbers. What we really want to know, particularly as investors, is this: Is XYZ retailer experiencing more or less of a downturn in performance relative to its rivals? Too often, articles fail to explore this very important comparative data.

Entrepreneurship Myths

On Guy Kawasaki's blog, Professor Scott Shane of Case Western has a phenomenal post on the ten biggest myths about entrepreneurship. It's a must-read.

Schultz Returns as CEO of Starbucks

Breaking news this afternoon that Howard Schultz has returned to the role of CEO at Starbucks. The news comes on the heels of a front page article in the Wall Street Journal today, which focuses on how McDonald's is expanding its direct competition with Starbucks in terms of coffee sales. That article proved very interesting, because it is clear that the strategies and product offerings of Starbucks, Dunkin' Donuts, and now even McDonald's have been converging over time. Strategy convergence generally isn't a good thing in industries; it tends to enhance direct and intense rivalry among firms and diminish overall industry profitability.

Kudos to Schultz for finally recognizing that Starbucks needed to re-think its strategy. They had drifted from their core strengths in recent years, and ultimately, it began to affect financial performance. In the letter Schultz posted on the Starbucks website, he notes that the company will scale back the growth of domestic locations and even close some underperforming stores. Moreover, Schultz states that Starbucks will seek to reconnect emotionally with their customers, enhance differentiation relative to rivals, and launch new products.

Here are some issues that should definitely be on the table as Starbucks considers its strategy moving forward:

• Should the company continue to serve breakfast sandwiches? Does this really fit with the Starbucks experience? Do the sandwiches take away from the atmosphere in the store, and from the focus on coffee?
• Should the company continue to build drive-thrus? Do these fit with Schultz' initial vision of Starbucks as a "third place" where people gather and enjoy coffee together?
• Should the company take some products off of the menu? Is the product proliferation diluting both product quality and the quality/speed of the service by the baristas?
• Should the company consider offering free wireless, as competitors such as Panera Bread do, so that customers may come and spend more time in the stores?

Naturally, the list goes well beyond these questions. Schultz' return provides a tremendous opportunity for Starbucks to confront key strategy issues such as these and rekindle the magic that drew in so many customers over the past twenty years.

Training Generation Y

Fortune magazine had an article last month about how UPS transformed its training practices to address the unique ways that Generation Y tends to gather information, communicate, and learn. The story is fascinating for me as a professor because it shows the power of active learning.

Let me explain. Lectures invite passive learning; the student sits and listens quietly as the professor drones on and on... The student isn't involved in the creation of knowledge; they are an empty vessel hoping to be filled up with knowledge. Active learning involves participation by the student in the educational process. It involves discussion, hands-on projects, simulations, experiential exercises, etc. Ideas and knowledge emerge from the process of trying to apply concepts to real problems.

UPS recognized that Generation Y tends to react in a particularly negative way to passive learning techniques. Thus, they shifted to an approach that emphasizes hands-on training - very much an active learning orientation. Here is one great example from the article:

The final kinetic-learning module - or for non-academicians, hands-on learning tool - is the crowd-favorite slip-and-fall simulator. UPS incurs significant costs every year from slips and falls, and it is first-year drivers who succumb the most. Lucky for first-years then that Thurmon Lockhart, director of the Locomotion Research Laboratory at Virginia Tech, has devoted his entire life to the issue. In his studies Lockhart has found that the only way to help people avoid falling is to "perturb" them - i.e., to put them through the motions of falling - which causes their bodies to adjust during subsequent encounters with falling hazards.
To that end, Lockhart's lab houses a falling machine - a nine-foot-high metal frame with a body harness attached to it. A subject puts on the harness and gets comfortable walking back and forth, and then someone sneaks up behind her and spills soapy water, causing the subject to slip, scream, and flail around before getting caught by the harness. It sounds funny - until you wipe out. For the record, having experienced this first-hand, I was perturbed, and my gait remains adjusted. "This type of research has been going on since the 1920s," Lockhart says, "but UPS is going to be the first to apply it. And when their guys get out of the program, they'll almost be ergonomists. The training is that good." Now there's a shiny new brown version of the simulator at the training center.

The article reports that UPS has experienced much success with these new training methods. My belief is that active learning always trumps passive learning, though perhaps that is even more true with Generation Y. The lesson of this UPS story applies in a range of settings... from the classroom at business schools, to corporate training programs such as the driver training at UPS, and even to corporate leadership development programs populated by senior executives. Let the lectures cease!

Develop Teams, Not Just Individuals

Fortune recently published an article on how great companies develop future leaders. While the article did not provide any earth-shattering new insights, it did point out some key practices that are often discussed, but not always put into practice. One technique that warrants a great deal of attention has to to with team development. The article suggests that companies should "develop teams, not just individuals." They point out that General Electric now sends entire management teams to Crotonville, and each team goes through a developmental experience in which they apply what they are learning to their business. Given that many leadership development programs seek to address topics such as team dynamics, communication, decision-making, and the like, it makes sense for intact teams to experience these programs together.

Of course, organizations must not allow the intact teams to isolate themselves in these types of leadership development experiences. One key benefit of leadership development programs is that emerging leaders have the time to network with their peers in other parts of the organization. Often, these peers work in far-flung parts of the world, and they don't know one another quite well at all. The leadership development program offers them time to get to know one another, share best practices, and explore collaboration opportunities to advance the business. If intact teams attend these leadership development programs, one has to be careful that managers don't spend all their time with their own team, thus spending far too little time networking, sharing, and learning from their peers in other parts of the business.

Apple Video Rentals

Yesterday, Apple made major headlines with news of a possible deal with Fox to offer video rentals via iTunes. The fundamental question, in my view, is how Apple will leverage a movie rental business into the sale of more hardware. It's hard to imagine a dramatic new surge in iPod sales because of the movie rental launch. Moreover, it's easy to imagine price battles among the major players, such as NetFlix, who compete in the movie rental business . On the other hand, perhaps Apple is poised to build upon its early Apple TV product, or launch an altogether new product designed for consumers to easily view movies downloaded via iTunes. If Apple can couple the on-line movie rentals from iTunes with an easy-to-use piece of hardware, then they can generate substantial profits. Once again, they will have executed a successful blades and razors strategy, i.e. selling inexpensive blades (movie rentals) to generate high profits from hardware sold at a price premium (Apple TV or some other product used to view the movies, transfer them easily from PC to TV, etc.).

Moneyball & The Lessons for Business Leaders

Several months ago, I was interviewed by Bret Dougherty, author of The IronDog Chronicles, a very interesting blog about sports, media, and entertainment. Bret co-hosts WXYC’s ‘Sports Rap’ on Sunday nights in Chapel Hill, North Carolina, while also pursuing his MBA at UNC-Chapel Hill. Here is the link to the recorded interview, which focused on my case study about the rise of sabermetrics in baseball, and some of the lessons for business decision-makers.

Dsylexics as Entrepreneurs

Business Week had a fascinating article about new research suggesting that dyslexics may tend to become successful entrepreneurs, particularly in the United States. Here is a brief excerpt from the article:

That kind of rejection, along with a penchant for creativity, may help explain why so many dyslexics are inclined to become entrepreneurs. Julie Logan, a professor of entrepreneurship at Cass Business School in London, believes strongly in the connection.

In a study to be published in January, Logan found that 35% of entrepreneurs in the U.S. show signs of dyslexia, compared to 20% in Britain. Logan attributes the gap to a more flexible education system in the U.S., vs. rigid tracking in British schools, and better identification and remediation methods. "Most of the people in our study talked about the role of the mentor and how important that had been," Logan says. "The difference seems to be somebody who believes in you in school."

The broader implication, she says, is that many of the coping skills dyslexics learn in their formative years become best practices for the successful entrepreneur. A child who chronically fails standardized tests must become comfortable with failure. Being a slow reader forces you to extract only vital information, so that you're constantly getting right to the point. Dyslexics are also forced to trust and rely on others to get things done—an essential skill for anyone working to build a business.

The article raises some interesting points regarding dyslexics as entrepreneurs, but I think it also should cause us to consider some more fundamental questions about our entire education system . In the era of self-esteem promotion during the 1990s, our schools often heaped praise on children. They sought to bolster each child's self-image. For me, this article suggests that we should make sure that we also focus on building our children's capabilities with regard to coping with failure. All of us fail many times in life, and entrepreneurs, in particular, must be able to deal with failure. They must be able to experiment, learn from those experiments, and then adjust or adapt their strategies.

Back to the Blog

Sorry to those readers who have been wondering where I have been for the past two months. Well, it's been a busy time in the Roberto household, as we have welcomed a third child into the family. Baby Luke Roberto was born in November, and he's doing very well. I'll be posting again on a regular basis going forward.

Amazon vs. Apple

Amazon made big news lately when they launched a new digital music service to compete with iTunes. Some news reports suggested that Amazon would pose a threat to iTunes' dominance. Perhaps that may prove to be true, but there is one important way in which Amazon may actually HELP Apple. How is that?

iTunes songs and iPods are complementary goods. If consumption of digital music rises, it will fuel more demand for digital music players - and iPod is the dominant player in that market. Where does Apple make their money? They appear to make far more profit from selling iPods than from selling songs on the iTunes stores.

Think of it the way that Harvard Professor David Yoffie explains it in his classic case study about Apple. Yoffie draws on several sources that describe the Apple business model as razors-and-blades in reverse. He quotes Steve Jobs stating that Apple makes very little profit on a song sold through iTunes. Yet, the profit margins on iPods are very healthy. They essentially provide the blades (songs) at a low price as a means of driving demand for the razors (the very profitable iPods).

If this is indeed the business model, then Amazon's latest move in digital music may actually HELP Apple... by fueling further demand for iPods, iPhones, and iPod accessories.

The Ethics of Guerilla Marketing

This article, about a singer named Marié Digby, caught my attention. It appeared in the Wall Street Journal last week. One has to wonder about the ethics of such marketing tactics, in which a young woman presents herself on YouTube as a complete amateur, while in fact, she has been working with a large media company for some time. The record company helps create quite a stir on the web about this supposed amateur sensation. Then, the firm announces the signing of this young YouTube phenom, without making it clear that they had been supporting her rise in on-line popularity all along.

Selling Home Depot Supply

This article describes critics who think Home Depot should not be selling its Supply unit, which serves contractors. The critics argue that the firm is forsaking the potential growth in that segment simply because it wants to "exorcise Nardelli's ghosts." The critics argue that the private equity firms will make a great deal of money on the Supply unit.

The critics are missing a crucial point. The issue is NOT whether the Supply unit is an attractive and potentially quite profitable business. This issue is whether the Supply unit is BETTER OFF as an independent company vs. within Home Depot. Moreover, the issue is whether Home Depot's retail business is better off on its own or when combined with the Supply unit.

This example demonstrates a larger point. When firms consider diversification, they must not only look at whether a new business unit will provide higher growth and profits... they must also consider whether that new unit will perform optimally as part of the diversified firm, or whether it will be better off on its own or as part of some other corporation. Shareholders benefit most when a business unit is located in an organizational situation in which it can perform best.

Mike Watkins on The Mistakes New Executives Make

Michael Watkins has a wonderful new post on his blog about the mistakes executives make when they join a new firm. He points out that many executives stumble because they try to recreate the organizations from which they came. There is no question that this is true. I have seen this so many times in my research and consulting.

I can recall one remarkable incident in my class several years ago, when Emerson Electric's former Chairman and CEO, Chuck Knight, visited my class. We discussed Emerson's highly regarded strategic planning process. I told the class that there is no one best way to conduct strategic planning; instead, a firm must match its strategic planning approach to the industry dynamics, firm strategy, organizational culture, and leadership style of the CEO. To bolster this point, I shared a quote from Charlie Peters, one of Knight's top executives at Emerson. Peters once said, "

• "Many companies come to Emerson wanting to find out what we are doing and why it works. But often, the trip is wasted. Our process works for us because of the type of impact we are trying to have on our businesses and because of our CEO, Chuck Knight – how he likes to operate and his relationship and status with the divisions. Other companies can’t duplicate that."

Interestingly, a student then asked Chuck Knight if he would have tried to replicate the Emerson strategic planning process if he had gone on to another firm, rather than retiring after he stepped down as CEO of Emerson. Knight offered a fascinating answer. He said that it probably would have been the wrong thing to do, in that the new situation most likely would have called for a substantial adaptation of the Emerson process to fit the needs of that particular company. However, he said that he would have been tempted to simply transport what he done at Emerson to the new firm. He said that this is what CEOs do...they rely on what made them successful. It's easy to convince oneself that this approach will work anywhere.

Knight's remarkably thoughtful comments reinforce the point that Mike Watkins makes in his blog. It is incredibly tempting for executives to want to replicate the the methods and techniques that worked for them in other organizations in the past. However, in business, there is often not "one best way" to do things. Success in business is so often about fit or alignment. The methods and practices must be adapted to fit the current situation and context.

China, Outsourcing, and Transaction Costs

Each day seems to bring new headlines regarding tainted products from China. Mattel has been hit especially hard, with the discovery of many toys containing lead paint. For me, the news about tainted Chinese products offers an opportunity to remind students and executives how to think strategically about outsourcing, rather than focusing singlemindedly on manufacturing cost reductions.

Let's go back to the fundamental strategic choice regarding vertical integration. What should drive the decision by a firm to produce its own inputs (or to conduct its own manufacturing in-house) versus outsourcing these activities to external vendors? Firms need to consider more than simply the direct manufacturing costs of performing these activities in-house vs. outsourcing them. They must consider the transaction costs associated with outsourcing production. In other words, how expensive is it to write contracts with external vendors, to monitor vendor behavior, enforce contractual provisions, control quality, etc.? Many firms underestimate these "costs" associated with using the market (i.e. outsourcing to an external vendor) versus keeping certain activities within the firm.

Quality control can be a very important reason why production is kept in-house instead of outsourcing it. We are learning from the tainted Chinese products situation that the transaction costs associated with quality control of outside vendors can be very high. The transaction costs come not only in the form of expenses associated with monitoring external vendors, but also in the form of a damaged brand in the event of a major recall.

Let's take a simple example of how control can be a key reason for keeping certain activities in-house. Why does Apple choose to operate its own retail stores? One reason is that they want to control the customer experience and the quality of the customer service that people receive. Of course, there are other reasons as well, but control is a critical one. Similarly, Disney owns some hotels in and around its theme parks because it wants to control the quality of the customer experience. Consider the risks and costs associated with having external parties in charge of the experience that families have at a Disney resort.

My argument is not that outsourcing should never occur. I simply aim to remind managers that they must consider the nature of transaction costs when making the outsourcing decision. Of course, there are transaction costs associated with keeping production in-house. The key is to compare the transaction costs of using the market (outsourcing) vs. keeping production in-house.

Finally, firms have to remember these strategic decisions are dynamic in nature. It may make sense to keep certain activities in-house at this point in time, but then outsourcing may become more attractive down the road. For instance, Disney used to own its retail store chain. One can see why they might want to control that customer retail experience. However, once they had operated this chain for some 15 years, they made the decision that they now could establish a licensing agreement, and allow an experienced retailer (Children's Place) to run the chain. Think of it this way. In the 1980s, when they launched the retail chain, they might have felt it was quite difficult, costly, and risky to establish a contract with an outside firm to operate Disney stores. However, now that Disney has run the stores for many years, they may feel more comfortable that they can write an enforceable contract that allows them to maintain quality control without running the store themselves.

Merck & Sunk Costs

The sunk cost effect refers to the tendency for people to escalate commitment to a course of action in which they have made substantial prior investments of time, money, or other resources. If people behaved rationally, they would make choices based on the marginal costs and benefits of their actions. The amount of any previous unrecoverable investment is a sunk cost and should not affect the current decision. However, research demonstrates that people often do consider past investment decisions when choosing future courses of action. In particular, individuals tend to pursue activities in which they have made prior investments. Often, they become overly committed to certain activities despite consistently poor results. They “throw good money after bad”, and the situation continues to escalate.

Many companies face the problem of the sunk cost effect. In fact, it's particularly problematic for firms involved in extremely expensive and lengthy product development projects. In those situations, the sunk costs can be enormous, and it can be very difficult for managers, scientists, and/or engineers to walk away from a project in which they have not only invested a great deal of money, but also much time, energy, and personal reputation.

A recent Business Week article suggests that Merck has found a way to try to combat this problem. Here's a snippet from the article (for the entire article, click here):

Merck is rewarding scientists for failure. One of the hardest decisions any scientist has to make is when to abandon an experimental drug that's not working. An inability to admit failure leads to inefficiencies. A scientist may spend months and tens of thousands of dollars studying a compound, hoping for a result he or she knows likely won't come, rather than pitching in on a project with a better chance of turning into a viable drug. So Kim (Merck R&D head Peter Kim) is promising stock options to scientists who bail out on losing projects. It's not the loss per se that's being rewarded but the decision to accept failure and move on. "You can't change the truth. You can only delay how long it takes to find it out," Kim says. "If you're a good scientist, you want to spend your time and the company's money on something that's going to lead to success."

Jensen vs. Langone

Business Week has a good wrap-up of an interesting exchange about private equity between Harvard Professor Emeritus Michael Jensen and Home Depot founding investor Ken Langone. These kinds of spirited discussions aren't typical for the Academy of Management meetings. I wish that we could find more ways to infuse the meetings with these kinds of exchanges between practitioners and academics.

Private Equity IPOs

Private equity seems to be all over the headlines these days, with a range of issues coming to the fore. I'd like to focus here on the issue of private equity shops going public. To me, the rationale is very weak. One of the fundamental reasons why private equity firms add value is their superior model of governance and control. As I have written previously, private equity firms have expanded rapidly, in part because they solve some of the governance problems posed by the large publicly traded corporation, with its separation of ownership and control. In short, I believe the ownership and governance structure of a private equity firm has the potential to dramatically reduce agency costs relative to a publicly traded firm.

Going public changes things significantly. For years, strategic management scholars and consultants have argued (and shown empirically) that conglomerates (unrelated diversified firms) trade at a discount, that they are worth less than the sum of their parts. You all know the reasons - they have been well-articulated over many years. Well, if a private equity firm goes public, then precisely what is the difference between it and the typical conglomerate? The private equity firm begins to look much more like the usual unrelated diversified firm. A private equity firm no longer can argue that its governance structure poses a substantial advantage over the old style publicly traded conglomerate.

I have heard many of the reasons why private equity firms are going public, beyond the fact that it offers an opportunity for enhancing personal wealth. Access to capital, ability to recruit and retain talent, management successsion... none of these seems like a persuasive argument. These firms have been wildly successful raising capital and attracting talent, while remaining privately held. Even if there were some advantages to going public, they must be weighed against the substantial disadvantage outlined here with respect to agency costs and corporate governance. To me, those disadvantages clearly outweigh the possible benefits of conducting an initial public offering.

Why More People Don't Buy Hybrids

Forbes.com has a very good article about how and why many hybrid automobiles have not become big sellers. Many people buy the Prius because they have a personal desire to reduce their energy use, and perhaps because they would like to make a social statement about environmental protection. However, hybrid technology comes at quite a cost. For many consumers, a hybrid's price premium proves far too substantial; affordability becomes a major concern. Let's do the math. According to the EPA, a Prius averages 46 miles per gallon. A Toyota Corolla averages 29 miles per gallon. Suppose that the typical person drives 12,000 miles per year, with gas at $3 per gallon. The Prius owner saves $459 per year in gasoline expenses over the course of one year. However, the sticker price for a Prius exceeds that of a Corolla by approximately $7,000. In other words, it would take roughly 15 years for the Prius owner to recoup his or her extra investment ($7000 divided by $459 per year), and that doesn't even take into account the present value of money. In conclusion, I think hybrid technology is very promising, with great potential to help us reduce gasoline consumption and carbon emissions. However, the automakers have quite a way to go before they can make hybrid technology affordable for many consumers.

Nintendo vs. Sony vs. Microsoft

The remarkable success of the Nintendo Wii offers a very important lesson for business leaders. It shows that the most sophisticated technological solution doesn't always win in the marketplace. Recall that, in the prior generation of video game consoles, Sony's Playstation 2 and Microsoft's Xbox outsold Nintendo's GameCube by a wide margin. The GameCube tried to compete with the technology of their rivals, and they failed. In this generation, the Playstation 3 and Xbox 360 became even more technologically advanced. They offer far more speed and graphic capability than the Nintendo Wii. However, the Wii has outsold its rivals and has become a smashing commercial success. The lower-tech Wii does not target the hard-core gamer who favors the technological superiority of the PS3 or Xbox 360. Instead, the Wii offers a unique new approach to gaming with its wireless motion-sensor controller. It has sought to appeal to a much broader audience of consumers who are more casual gamers, or who have never played video games. Even senior citizens have taken to playing the Wii games. With less technological wizardry, but a novel idea, the Wii has gained the upper hand against its rivals. Nintendo shows us that companies can succeed without getting into a technological arms race against rivals with deep pockets. The key is to take an indirect approach to competing against those rivals. Rather than confronting Sony and Microsoft head-on, Nintendo created a different kind of console that appealed to different customers than those typically interested in Sony and Microsoft products.

Diversification vs. Focus at Limited Brands

Limited Brands announced yesterday that it had agreed to sell a 75% stake in The Limited chain of apparel stores to a private equity firm. That announcement comes on the heels of the sale of a 75% ownership stake in the Express chain to a private equity firm. The company will focus on the two business units that have delivered far better growth and profits in recent years - Victoria's Secret and Bath and Body Works. With these divestitures, the company looks far different than it did twenty years ago, when it was one of the leading specialty apparel retailers in the nation.

The transformation of Limited Brands mirrors the situation that many diversified firms encounter. As firms operate multiple businesses, the corporate office finds itself trying to manage a complex internal capital market. Senior executives typically allocate resources to the business units that show more promise in terms of revenue and profit growth. After all, higher growth and profitability makes additional capital investments appear much more attractive. Executives understandably want the best return on their investment, and they do not have unlimited funds; they must make tradeoffs. Perhaps just as importantly, senior executives allocate more of their time and attention to the more promising business units as well. That, in turn, can lead to a downward spiral at the less successful businesses in the portfolio - weak results lead to a decrease in capital allocated to the business, as well as a decrease in management attention, which together further diminish the prospects for enhanced revenue and earnings growth. Moreover, slower growth and lower rates of capital investment make the businesses less attractive to talented current and potential employees, causing a drain in the quality of human capital in those businesses. That, in turn, further weakens the financial results in those units.

This scenario, which we see unfold in many diversified firms, points out the dangers associated with trying to manage a portfolio of businesses with differing levels of growth and profitability. Moreover, it demonstrates why focused firms often are able to capitalize on the distractions faced by executive teams who are trying to oversee a wide range of business units.

Limited Brands deserves credit for ultimately recognizing that its apparel chains could be better off under management whose sole focus is on that particular brand. Moreover, Victoria's Secret and Bath and Body Works are likely to benefit too. Now senior management can completely focus on these businesses, which face increasing competition as new entrants chase the high profits in those sectors.

Generational Differences

Carol Hymowitz has a good article in today's Wall Street Journal entitled, "Managers Find Ways To Get Generations To Close Culture Gaps." Hymowitz is correct when she argues that managers must find ways to tailor their approach to meet the needs of different generations of employees. I find the point about learning and development particularly interesting.

As a professor, I can see these generational learning differences very clearly. Young people gather and process information, develop new skills, and discover new things in very different ways than many people from prior generations. My younger students, for instance, love studying for exams by listening to and reviewing my weekly podcasts, which discuss key points from the case studies that we examined. They also tend to embrace active learning, i.e. classroom experiences in which they are engaged participants, as opposed to passive listeners to faculty lectures. Just as orofessors must adapt to this newer generation's distinct learning style inside and outside the classroom, so too must managers find ways to tailor the way that they monitor, motivate, and train employees of various generations.

The challenge, however, becomes one of fairness. While I believe tailoring approaches for different employees makes some sense, I worry that managers may end up creating perceptions of inequity. People often don't like to feel as though their peers are not playing by the same rules. Thus, as managers try to adapt their approaches to meet the needs of a multigenerational staff, they must be particularly careful that employees do not begin to perceive that they are being treated unfairly in comparison to peers of another generation.

How much is a reputation worth?

Business Week has a very interesting article on corporate reputation. The authors describe efforts by companies and consulting firms to determine the impact that a positive reputation can have on a firm's stock price, and then to develop programs aimed at juicing a firm's shares. What is especially interesting to me about this article is the reaction by investors. The article points out that, "Many investment pros scoff at suggestions they can be influenced by image manipulation." When it is suggested that reputation-building efforts can have a direct impact on a firm's stock price, one investment analyst responds, "The markets are smarter than that." In general, I believe that U.S. capital markets are reasonably efficient. However, I would not be as quick to dismiss the notion that reputation-enhancing initiatives can have a near-term impact on investor perceptions and share prices. Scholars in the field of behavioral finance have shown that investors can be affected by biases, thus demonstrating that markets aren't perfectly efficient.

Having said that, I think that sustainable long-term changes in stock price require substantive improvements on the part of a firm, not just image-oriented campaigns. Companies, in fact, can find themselves in deeper trouble if they try to build a reputation through advertisements and public relations, while consumers, journalists, and investors later learn that the reputation is not consistent with the underlying realities of the business. Take BP, for instance. It spent a great deal of money on its "green" campaign under former CEO John Browne. When it then encountered several accidents and mishaps at its facilities, the company faced a serious disconnect between what it was saying in its image campaigns and what it was revealed to be doing in its own operations. BP's market value fell by nearly $40 billion from mid-2006 until the announcement of the resignation of Lord Browne in early 2007.

The Power of Integrative Thinking

Roger Martin, Dean of University of Toronto's business school, has a wonderful article in the June issue of Harvard Business Review. He argues that successful leaders are integrative thinkers. By that, he means that they attack problems in the following manner:

• They examine problems as a whole, with careful consideration of how different parts of a situation fit together, rather than analyzing different elements in isolation.
• They consider multiple avenues of causation for a problem, as well as possible nonlinear relationships between cause and effect, rather than thinking of terms of simple linear relationships between a single cause and effect.
• They embrace the tension between opposing ideas, and they use that conflict to generate creative new alternatives, rather than making simple either-or decisions.

In short, Martin argues that successful leaders think holistically and embrace the power of conflict. In my work, I have argued that constructive conflict within a management team leads to better decisions. Martin stresses that successful leaders also have to embrace conflict within their own mind. They must "hold two conflict ideas in constructive, amost dialectic tension." Martin points out that many people find this internal tension uncomfortable, and thus they shy away from it.

While I would agree with Martin in general, I am reminded of the challenges associated with this type of integrative thinking, as described by Karl Weick in a famous 1984 article entitled "Small Wins." Weick argued that large, complex problems can sometimes be cognitively overwhelming. Thus, he argued that decision-makers should break complex problems into parts, and seek a series of "small wins" as a means of generating solutions to complicated issues. Martin explicitly argues against breaking problems into pieces. He says that holistic thinkers view problems as a whole. Here, I disagree slightly with Martin. I think one can approach a problem holistically, yet still follow Weick's advice to seek small wins while working through the organizational decision-making process required to solve the problem. Trying to achieve small wins in attacking a problem does not mean that a leader fails to think about how various elements of a problem fit together.

Supermarkets vs. Wal-Mart

Today's Wall Street Journal has an interesting article about how many supermarkets have learned to compete more effectively with Wal-Mart. The answer is straightforward: don't try to imitate Wal-Mart's low cost strategy. Instead, supermarkets have tried to create some differentiation by offering unique upscale products and high quality prepared meals along with the usual staples. They also have redesigned their stores to create an enhanced shopping experience for the consumer. Not all supermarkets took this path. Some tried to imitate Wal-Mart's low costs and low prices, and many of them found their way to bankruptcy.

The competitive dynamics in the supermarket industry remind me of what took place in the mass merchandising sector. Many chains went bankrupt trying to match Wal-Mart's low costs and low prices. Target took a different path. It chose a differentiation strategy, with higher quality products, better service, and a bright, clean store with easy-to-navigate aisles in which consumers love to shop. It didn't go head-to-head with the behemoth. Instead, it chose a form of indirect competition, moving slightly upmarket. In so doing, Target has prospered while many chains became extinct.

Firms in all industries would be well-served to consider the fate of those that have competed with Wal-Mart. Imitating the market leader often does not lead to bountiful profits. Finding a different path proves much more economically rewarding.

Supply Chain Risk

CNN reports today on a study by Deloitte Consulting regarding supply chain risk. The title of the Deloitte report is "Supply chain's last straw: A vicious cycle of risk." The consulting firm studied how many firms have prepared (or not prepared) for major supply chain disruptions. They concluded that, "The search for cheaper labor, cheaper raw materials, and cheaper transportation - the quest for efficiency - has forced the focus of companies to switch from revenue growth to cost reduction...Individually, these forces have changed the world in which we live and conduct business. But when combined, these forces can create a perfect storm of risk not seen before in the history of commerce or humankind."

Charles Perrow's theory of complex systems, I believe, can be applied to think about the enhanced risk that firms are assuming with the leaner, more efficient global supply chains of today. According to Perrow, the risk of catastrophic incidents increases when systems are characterized by what he calls "tight coupling." By tight coupling, he means systems that have the following characteristics: time dependent processes, a fairly rigid sequence of activities, one dominant path to achieving the goal, and very little slack. His classic example is that of a nuclear power plant. Its subsystems are tightly coupled (or highly rigid, if you will). One could argue that the efforts to build leaner, more efficient global supply chains have enhanced the level of tight coupling in those systems, and thereby enhanced the risk of a catastrophic failure of some kind.

Take, for example, the issue of slack. Years ago, supply chains tended to have a fair amount of slack - for instance, many firms maintained a fair amount of buffer inventory between various stages of the value chain. Of course, carrying all that inventory proved quite costly. Today, firms have been driving slack out of their supply chains in order to reduce costs. The unfortunate downside of that slack reduction may be an increase in tight coupling - and thus, in systemic risk. Naturally, the solution to the enhanced risk does not lie in adding back tons of waste to the supply chain. Instead, firms must find ways to reduce the rigidity of the system, so that one small error cannot easily cascade into a series of problems that lead to major catastrophe.

Does Six Sigma Inhibit Breakthrough Innovation?

Business Week has a thought-provoking article about the tension between innovation and efficiency at 3M. When Jim McNerney came over to 3M from General Electric, he brought with him many GE processes and systems, including Six Sigma. During McNerney's tenure at 3M, profitability soared. Operating margins increased from 17% to 23%, and earnings grew 22% per year on average. However, some people wonder whether the Six Sigma process, as well as the emphasis on improving efficiency, harmed the creative culture at 3M and dampened the likelihood of breakthrough innovation. Drawing on 3M's experiences as well as the work of several academics, the article suggests that Six Sigma may drive a large amount of incremental improvement and innovation, but perhaps makes it difficult for employees to pursue discontinuous/disruptive innnovations. Simply put, one cannot completely systemize the process of innovation.

It will be interesting to watch how new CEO George Buckley's efforts to stimulate creativity play out in the years ahead. Can the company stimulate more breakthrough innovation without compromising its efforts to continuously improve quality and efficiency? The 3M story takes us back to a very interesting issue that academics have been studying for years, namely the tension between exploitation activities and exploration activities. Exploitation refers to the systematic refinement and improvement of existing processes and products, while exploration involves more open-ended experimentation and discovery. Can firms simultaneously perform both sets of activities well? Often, a firm's resource allocation process exhibits a strong bias toward one form of activity or the other. Senior management teams often have skills and capabilities that are well-suited for exploitation, but not exploration, or vice versa. The incentive system also often leans one way or the other. Some managers and academics believe that the best firms can strike a balance between exploration and exploitation, but it has not been easy identifying how to achieve this balancing act. It strikes me that we will learn a great deal about this issue by watching how events unfold at 3M in the years ahead.

Predicting Hit Products

Seth Godin has an interesting new post on his blog entitled "Pundits are (nearly) always wrong." He examines why many so-called experts are wrong in predicting the next big hit in technology, books, music, etc. Godin argues that the experts often "measure the wrong thing." They focus on the presentation more so than the substance of the idea. To some extent, a slick and clever pitch can overcome many flaws of logic.

Moreover, Godin suggests that experts often judge a pitch based on their existing worldview. Their mental model becomes the filter through which they judge whether something will become a hit. Of course, that mental model is largely shaped by past successes and failures. However, as Godin rightly points out, "The problem is that hits change worldviews. Hits change our senses. Hits appeal to people other than the gatekeepers and then the word spreads."

Godin's argument reminds me of the famous quote by legendary screenwriter William Goldman, who once remarked that “nobody knows nothing” in Hollywood, meaning that picking hits remained a formidable challenge even for industry veterans like him.

The Eclipse of the Public Corporation

Nearly two decades ago, Michael Jensen was criticized by many people, including many of his academic colleagues, for his thought-provoking article, The Eclipse of the Public Corporation, published in Harvard Business Review. People dismissed him when the LBO boom of the 1980s faded. They laughed when he wrote, "By the turn of the century, the primacy of public stock ownership in the United States may have all but disappeared." Well, in January 2000, with the dot com bubble raging, Jensen's far-reaching prognostications did seem completely off base. What about today? The dramatic expansion of private equity has validated Jensen's predictions from 18 years ago. Private equity has expanded rapidly, in part because it does solve some of the governance problems posed by the large publicly traded corporation, with its separation of ownership and control.

It's worth revisiting Jensen's arguments for a moment. At the time, Jensen argued that the public corporation's "decline is real, enduring, and highly productive." He explained the benefits of private equity and leveraged buyouts using agency theory, of which he was one of the founding fathers. Jensen wrote, "By solving the central weakness of the public corporation - the conflict between owners and managers over the control and use of corporate resources - these new organizations are making remarkable gains in operating efficiency, employee productivity, and shareholder value."

I can recall being one of Michael Jensen's students back in the early 1990s, long before I became his colleague on the HBS faculty. His class was the most popular elective at HBS back then. Not everyone agreed with him, but he offered thought-provoking theories, and he sparked some wonderful debates. This article, in particular, resonated with me and many of my peers back then, and it sure does seem quite prescient looking back today.

Back to Retail for Dell

Dell announced today that they will be selling several PC models in Wal-Mart stores. It's a very interesting development, not only because Dell is so well-known for its direct business model, but also because Dell did not succeed when it tried to sell PCs in the retail channel back in the early 1990s. What's the challenge for Dell as it tries to sell through retailers? It goes back to why many traditional PC makers had difficulty imitating Dell's direct business model. The two ways of doing business (selling through retail and selling direct) are somewhat incompatible with one another. Selling through retailers means producing and distributing large volumes of standardized products. Selling direct means producing customized PCs on demand. The processes and activities required for each business model are quite different. It's easier for a firm to completely optimize on one business model, rather than trying to operate two models simultaneously in the same corporation. That's one reason why Dell did so well in the 1990s, while IBM, Compaq, and others struggled to launch their direct businesses while still selling through value-added resellers and retailers. Dell was a "pure play" - those often trump firms that find themselves "straddling" between two somewhat incompatible business models. Hewlett-Packard ultimately figured out how to make the two models work together - now Dell must learn the same if they wish to succeed in the retail channel.

Sir James Dyson on Failure

Very interesting to read the current issue of Fast Company, given my recent post regarding managerial attitudes toward failure. Writer Chuck Salter interviews Sir James Dyson, the inventor of the best-selling vacuum cleaner in the U.S. - the famous Dyson bagless vacuum. Dyson points out that he made more than 5,000 prototypes before he discovered the model that became a commercial success. He notes, "There were 5, 126 failures, but I learned from each one. So I don't mind failure. I've always thought htat schoolchildren should be marked by the number of failures they've had. The child who tries strange things and experiences lots of failures to get there is probably more creative. " Of course, that sentence struck me because I had just written about Build-A-Bear CEO Maxine Clark's admiration for her schoolteacher who did precisely what Dyson suggests! Dyson goes on to say: "We're taught to do things the right way. But if you want to discover something that other people haven't, you need to do things the wrong way. Initiate a failure by doing something that's very silly, unthinkable, naughty, dangerous. Watching why that fails can take you on a completely different path."

Tuition Assistance and Employee Retention

Today's Wall Street Journal reports on research by Stanford graduate student Colleen Flaherty and Wharton professor Peter Cappelli indicating that employees are less likely to leave a firm if they have been enrolled in a tuition assistance program. The finding proves quite interesting, because many firms have worried in the past that employees would jump ship after taking advantage of a tuition assistance program. Economists too have questioned whether tuition reimbursement programs increase turnover among talented employees. After all, most MBA programs enhance an employees' general human capital, rather than firm-specific human capital; thus, they become more attractive to outside employers. Investments in firm-specific human capital, in contrast, would increase an employees' prospects within the firm, but not on the outside market. The findings from Flahery and Cappelli suggest that employees may stick around despite the increase in marketable skills. Perhaps employees feel a sense of loyalty to their employers, or they might find that the advanced degree offers numerous opportunities for internal promotion. Of course, the finding may also suggest that the kinds of firms offering generous tuition reimbursement programs also are quite likely to have other attributes that are highly attractive to talented, highly educated employees. Those other attributes may explain, in part, why turnover is lower for those enrolled in tuition reimbursement programs.

Attitudes about Failure

Tom Kelley, the co-founder of IDEO - one of the world's leading design firms, has a great saying about how to learn and innovate effectively: "Fail early and often to succeed sooner." At IDEO, a great deal of experimentation and prototyping occurs in the design process. People try lots of new things in search of progress toward a great design. Unfortunately, most organizations have the wrong attitude toward failure. They treat all failures in the same manner -harshly. Managers often create environments where people live in fear of making the smallest of mistakes, and thus, employees become highly risk averse. Yet, without risk-taking, innovation will not take place.

Maxine Clark, founder and CEO of Build-a-Bear Workshop, has a refreshing take on how to encourage risk-taking and use mistakes to drive innovation. She has built an incredibly successful company, growing it to over $350 milllion in sales over the past decade. She has done so by delivering a world-class customer experience in her stores. In her book, Clark tells us the story of her first grade teacher, Mrs. Grace. Like many elementary school teachers, Mrs. Grace graded papers using a red pencil. However, unlike most of her colleagues, Mrs. Grace gave out a rather unorthodox award at the end of each week. She awarded a red pencil prize to the student who had made the most mistakes! Why? Mrs. Grace wanted her students engaged in the class discussion, trying to answer every question - no matter how challenging. As Clark writes, "She didn't want the fear of being wrong to keep us from taking chances. Her only rule was that we couldn't be rewarded for making the same mistake twice." That is the key - making sure that you emphasize the importance of learning from each mistake, so that they do not happen again.

Clark has applied her first grade teacher's approach at Build-a-Bear by creating a Red Pencil Award. She gives this prize to people who have made a mistake, but who have discovered a better way of doing business as a result of reflecting upon and learning from that mistake. Clark has it right when she says that managers should encourage their people to "experiment freely, and view every so-called mistake as one step closer to getting things just right." Of course, her first grade teacher had it right as well when she stressed that people would be held accountable if they made the same mistake repeatedly. Failing to learn is the bad behavior that managers should deem unacceptable.

Chrysler Sold to Cerberus

DaimlerChrysler announced today that they would sell 80% of Chrysler to a private equity firm (Cerberus Capital Management) for $7.4 billion. Of course, Daimler bought Chrysler back in 1998 for $36 billion. Is it any wonder that Newsweek once called the merger, "the worst-executed big takeover since God invented corporations." If you want to learn more about how this merger took place back in the late 1990s, I would highly recommend reading Taken for a Ride: How Daimler Drove Off with Chrysler. Veteran auto industry journalists Bill Vlasic and Brad Stertz wrote this definitive account of how the deal unfolded. I had the pleasure of hosting the two gentlemen at a seminar at Harvard Business School several years ago. They impressed us with the thoroughness of their research, and the incredible access that they had secured with many of the key figures involved in the deal.

Breaking up General Electric?

The Wall Street Journal has an article today about the calls by some investors to break up GE. Some shareholders have clamored for a break-up, largely because GE shares have performed poorly since Immelt became CEO in 2001. The article points out that GE shares are down 7% since Immelt took charge, while the DJIA is up 35%. This discussion reminds us of the arguments surrounding the conglomerate discount. For years, studies have shown that unrelated diversifiers trade at a discount to their break-up value. (Note that this is true in the United States, where markets are relatively efficient, and many information intermediaries exist to facilitate the flow of products, capital, and labor. According to research by Harvard Professor Tarun Khanna, unrelated diversifiers tend to perform better in developing economies, where markets are less efficient).

The explanation for the conglomerate discount is that, in the presence of efficient capital markets, investors can diversify more effectively and inexpensively than the executives of the firm. In short, we don't need senior managers at the conglomerate to spread risk by being in a wide range of unrelated businesses; we can achieve risk mitigation much more effectively by buying a portfolio of stocks of more focused firms. Similarly, in the presence of efficient external labor markets, we would question whether a conglomerate could operate its internal labor market more effectively than the external market.

However, GE has been a famous exception to the general tendency regarding the conglomerate discount. It has performed quite well for decades, with its business units outperforming most focused competitors. Could this no longer be true? If the stock price performance continues to lag the overall market, more investors will be taking a look at the age-old question: is the whole worth more than the sum of the parts? Given GE's track record, I would tend to be cautious about breaking up the firm, but it will be interesting to watch what happens if the stock continues to lag the market.

Low Risk Innovation

Business Week has an interesting article about how Pixar's John Lasseter is re-invigorating innovation and creativity at Disney's animation studios. Lasseter has come up with a relatively low risk, low cost strategy for doing so. He's funding the development of a series of five minute shorts, and he's asking young talent at the studio to direct them. The budget for a short represents less 2% of the money required to fund a major animated film. Therefore, he's deploying a relatively small amount of capital, yet providing talented up-and-comers an opportunity to try their hand at directing their first animated film. Interestingly, Walt Disney built his studio back in the 1930s based on a series of popular shorts. Now, it seems that Lasseter is returning Disney animation to its roots in hopes of rekindling the creativity that, once upon a time, made the Disney animators the envy of the entertainment world. Other firms should take notice, and they should look for their own low risk, low cost opportunities to spark innovation and creativity, while simultaneously developing and evaluating young talented employees.

Have Boards of Directors Really Changed?

In the April 2007 issue of the Academy of Management Journal, Jim Westphal and Ithai Stern published a thought-provoking study of the labor market for directors of U.S. corporations. They found that directors are more likely to be appointed to other boards if they provide advice to the CEO frequently. That is the good news. The bad news is that directors are more likely to gain new appointments to other boards if they engage in a low level of monitoring and control activity with regard to strategic decision-making by the CEO and his/her management team. After the corporate scandals of Enron, Worldcom, and others, we saw the implementation of many corporate governance reforms intended to strengthen the monitoring and control activities of boards of directors. Yet, Westphal and Stern discovered that their findings hold even in the post-Enron era. The bad news does not end there. The scholars also find that women and minorities "are punished more for engaging in monitoring and control behavior." Those findings also hold in the post-Enron era. What do I conclude from this finding? We have focused far too much effort on structural reforms at the board level, rather than focusing on board process. Board chairmen and lead directors need to develop processes that stimulate open dialogue and induce constructive debate in the boardroom. We cannot simply expect a vigorous exchange of views because we have appointed a certain percentage of outside directors. Pressures for conformity will arise, even among a highly capable group of directors who are properly nominated and selected.

Chasing the Story

In the New York Times yesterday, Hal Varian wrote about a new study conducted by three finance professors at the University of Richmond (Thomas Arnold, John Earl Jr., and David North). These scholars published a paper entitled, "Are Cover Stories Effective Contrarian Investors?" They examined how a company's stock price changed after the appearance of a cover story published in one of the leading business magazines. Arnold, Earl, and North discovered that journalists tended to write cover stories after a period of unusually good or bad performance on the part of a company - positive stories about high performing firms and negative stories about poor performers. However, after the stories are published, the companies about which positive stories were written do not perform much differently than the firms about which negative stories were published. What's the lesson for investors? Do not try to time the purchase or sale of securities based on what you read in glossy cover stories. Of course, those of us who believe that the American capital markets are relatively efficient should not be surprised by this result. The cover stories often do not constitute breaking news to the investor community. They already know much of what is being written in these pieces, and thus, the stock price has adjusted to that information prior to the publication of the magazine.

Learning vs. Performance

Harvard Professor Amy Edmondson, with whom I have co-authored several articles and case studies, has an interesting new paper about the tensions between organizational learning and performance. This paper is especially interesting because it synthesizes her outstanding work over the past decade. In this article, she argues that firms must engage in learning if they are to improve performance over time. However, efforts to enhance learning often appear at odds with an organization's performance orientation. For instance, she points out that many of her past studies have shown that learning requires a willingness to surface and discuss problems and mistakes. However, detecting and discussing errors makes organizations appear to be performing poorly. That makes managers and employees uncomfortable. Learning also creates another type of discomfort. When people learn, it typically involves a transition period, during which performance may lag as individuals and teams develop new capabilities. Therefore, Edmondson suggests that managers need to confront and assuage the discomfort that is created by a healthy learning process. If they do not, then the performance orientation of most organizations will stifle opportunities for improvement and innovation. For more on this interesting work, see http://hbswk.hbs.edu/item/5588.html