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!

The Coming Shakeout

Saturday evening I had dinner with a young man I believe to be one of the most capable entrepreneurs that I have met in the Mid-Atlantic region of this United States. He has grown his company from three people to fourteen people over the last year and one half and has moved to bigger quarters. His revenues have increased rapidly and he has been profitable since the first month of his operations. He is in the Information Technology space and his specialty is in the area of search networks. He is very intelligent and a bundle of energy. He is also a great speaker and communicator.

We talked about the future and how he is positioned for the upcoming storm. If I were running a business right now I could not think of being in a better position than he is in. First of all, he knows who he is and what he stands for. This is a person that required his employees to give something back to the community right from day one they joined the firm…he himself is very active in community affairs. He believes so much in what he is doing and what his company has to offer that I have seen him turn down business when a potential customer has ask him to do something that he doesn’t believe equals up to the quality he demands in himself. He does not take on a customer just to build his customer base.

He stays focused and will not go into areas that he is not qualified to work in…he has a short list of other firms that are top performers in these other areas and easily shares them with potential customers.

He has done no marketing and does not need to do any for the near term because he is in such demand through follow up work or through word-of-mouth advertising that he needs little additional effort to grow his customer base. He has a full book but does not want to extend himself further at this time because he wants to maintain the quality of his work.

He has no debt! Furthermore, he has sufficient cash on hand and an adequate cash flow. He realizes that he may run into some months where cash flow might be negative over the next year or two, but with the liquid assets he has built up he seems to be prepared for some of these down months.

He has stayed focused. He has not branched out and diversified what he has to offer like many of his competitors. Thus he has not stretched his staff’s capabilities and has not created parts of his business that are now cash flow negative and drains resources from other, more crucial areas of the business.

As a case study, one could not pick a young firm and a young entrepreneur that is better positioned to weather out the coming shakeout.

To me, there are several important take-aways from this example. First of all, an entrepreneur, or for that matter, anyone who leads an organization, should know who he or she is and what their standards are. This is not something that comes after the fact, but is something that needs to be built into the leader before he or she commits to leading an organization. If you don’t know who you are, you will start to waver once you are faced with the decisions that will test you and your organization. And, once you begin to waver…

Second, an entrepreneur needs to maintain focus. When things are good and when pressure grows to take on more and diversify more it is very easy to lose focus and try and do all things for all people. The crucial thing in this age is to do something very well and continue to innovate in that field. Given the competition that is “out there” new products and services are constantly coming to the market and an entrepreneur cannot ‘blink’ or the competition will surpass him. Within this environment, diversification just enhances the competition’s changes to get in front of you.

Third, try and stay away from debt as much as you can. Taking on debt increases risk and the higher the risk is the greater the chance is that it will at some time divert one’s attention so that one loses focus. The business leader needs to create competitive advantage and sustainable competitive advantage comes developing some kind of market power relating to what his or her company produces.

If the business leader has to rely upon financial leverage to achieve exceptional returns, that business leader is just openly admitting that the firm does not have a market position of sustainable competitive advantage. The trouble with this is that when the business leader comes to rely on financial engineering to produce acceptable returns he or she has lost focus of the thing that has gotten the firm where it is and is betting on the financial markets to secure the future of the company. This is usually a bad bet.

My friend and I got to talking about my business activities. He knew that I had been in the process of starting up a private equity fund to work with young entrepreneurs in the urban environment. I believe very strongly that there are many exceptional opportunities to invest in young entrepreneurs within the inner city…investments in information technology and social networking. To me, this is important investment because the funds tend to stay in local communities, employment comes from local communities, and “give back” takes place in local communities. My plans also include the creation of a minority owned commercial bank and/or local credit unions.

Obviously this is not the time to build such a fund because the deployment of the monies would not take place in an efficient manner. This is a time to hold back, perfect plans, and get everything in place in order to be ready for when the time is right. One has to think of the future and be ready when opportunities rise to the surface.

So, I continue to write…my speaking engagements have increased (I have some open dates if anyone is interested…even some short courses are planned related to the subject of the financial crisis, Federal Reserve and government activity, and re-regulation for the future…and, of course, there is consulting on turn-arounds and restructurings and advising young entrepreneurs on how to prepare a start-up.

The coming shakeout is not going to be pleasant but we must continually work toward the future. My friend is an inspiration to me and a model for many other young individuals who would like to have their own company and who would also like to return something to their community. Everyone should be so lucky to have such a friend.