Tuesday, October 14, 2008

Good Management Never Goes Out Of Style!

I recently asked a group I was speaking to what was the difference between responding to incentives and “greed”. “Greed” is, of course, one of those loaded words that can immediately draw a visceral reaction when mentioned. The basic answer of the group was that greed was like pornography…greed is what an individual sees it to be. Responding to incentives is how the world goes about its daily living and for the response to incentives to become greed is just a matter of degree…it is an “excessive” response to incentives.

A concept like greed, to me, is like the concept of ego. All successful people have an ego…and that ego can be quite large for people who are very, very successful. But, it is not the fact that successful people can have extremely large egos that gets to me…it is how those people with extremely large egos use their egos. Let me give you three people with extremely large egos whose egos do not both me: Tiger Woods, Michael Jordon, and Bill Russell. (Yes, these are all sports figures, but they serve my purpose in this post.) Yes, these individuals have very large egos but…these people tend to make other people around them at least as good, if not better, than they would be otherwise. That is, they raise other people to levels they would not be able to achieve individually and this produces teams that win and win and win!

The point I am trying to make is that responding to incentives, in and of itself, is not “bad” but how this response is applied that makes all the difference in the world. “Greed” in building a management team and creating an exceptional company is definitely good and a benefit to the society and culture in which it resides while “greed” aims at self glory tends to be destructive and short-lived.

The difference to me is focus, with an emphasis on the longer term, on sustainability. To me, this is what ultimately defines “good management” and it is something that one should look for because good management, even in the face of fads and frenzies, never goes out of style. “Good management” builds winners…sustainable winners. “Good management” is what one should look for to invest in at all times.

Good management must first create an organization that has some kind of competitive advantage, something that differentiates it from other organizations, within the marketplace. This competitive advantage is generally built upon something the firm has, some core competencies that others don’t possess. And, these core competencies are enhanced by the team that management builds to enhance and sustain these core competencies.

In judging a company, I have gotten away from just looking at the head of the organization, the top dog. What has become crucial in my appraisal of any organization is the people the head person brings in to support and enhance the firm. If a leader surrounds him- or her-self with very talented people, people that will challenge and question the leader, people that will push others, including the leader, to do their very best, then I believe that such a company will have a fair chance to build up a competitive advantage over other companies and sustain that competitive advantage over time. A “leader” that cannot stand to have other “stars” around his heavenly presence may be able to create a competitive advantage for his company to start with, but generally he will not be able to sustain that competitive advantage over time.

A company in which the leader facilitates the very capable people around them is better able to “keep focus” on what is important much better than the leader that must generate all the ideas himself. It is important in the modern environment to constantly be bringing new or better products to market on a regular basis, but someone must keep the focus of the company. “Good management” encourages, supports, and promotes the team to keep up this “time pacing” of new products and services while, at the same time, maintaining focus on what created the competitive advantage of the company and what factors will sustain this competitive advantage.

Alternatively, a leader that does not build a strong team to surround him finds that the competitive advantage that the company initially boasted slips away over time. This is because creating a competitive advantage produces exceptional returns. (In the book “Competition Demystified” by Bruce Greenwald and Judd Kahn, exceptional returns are defined as a 15% to 25 % return on capital after taxes.) However, here is where the longer run is important. Others see this exceptional return and capital is drawn into this space to attempt to get some of the action. This additional competition works to break down the competitive advantage and reduce the returns that are earned by those in this specific industry.

One should note that the competitive advantage may come about only because the firm happens to be in the right spot at the right time; it has nothing to do with talent. Being in the right place at the start of a “bubble”, for example, can make someone look like a genius when there is nothing to back up the performance. (See Taleb’s first book “Fooled by Randomness” for a discussion of this phenomenon.)

In either case, as returns are being threatened by greater competition, the “leader” that has little talented support staff and limited new ideas begins to lose focus on what got them the initial competitive advantage and starts to focus on other factors that can enhance returns and have nothing to do with core competencies. Financial engineering is one such diversion that can bring continued returns. Increased leverage and mismatching maturities, as we have seen, are two such types of financial engineering that bring positive results…at least in the short run.

Less than stellar management, therefore, tends to lose focus on what initially brought them attention and eventually puts greater and greater reliance on other factors, like financial engineering, to keep attention. As is often the case, however, one cannot always tell the wheat from the chaff as the economy experiences “good times.” Only with the bust do we really find out who the good managers/leaders are.

Or are their clues we can observe earlier on that can give us some insight into which companies have “good management”? I, of course, believe that you can identify good managements early on. I have emphasized the word “sustainable”…which of course has to do with long term performance. Greenwald and Kahn argue that good managements are able to sustain the 15% to 25% returns for an extended period of time while still focusing on core competencies. Sustainable competitive advantage is also connected with relatively stable market shares within the core industry of the company.

Sustainable competitive advantage is connected with “how” the firm is able to achieve the high returns and the stable market share. Where do the earnings come from? Have they come from the core competencies of the company? Does the company attract and build up the talent that continually enhances these core competencies? Or, does the company have to go outside these core competencies to keep up performance? Or, do these companies rely upon financial leverage or strategies connected with mismatching durations to maintain performance?

Good management does not go out of style! I don’t believe that one has to argue for “conservative” management practices across the board. I do believe, however, that one should insist that the management of a company keep its focus on what it is strong in and build from that foundation and not depend upon extraordinary means to “puff up” its performance. In this, I believe that good management will build a good team and act “conservatively” because it doesn’t need to rely solely on its “super star leader” or “gimmicks” to create a winner…a team that continues to win over time. Therefore, I would argue that the concept of “Greed” is connected with FORCED performance…not with true achievement!

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