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.