This is a great post, “Why Market Leaders Don’t Listen to Investment Bankers,” by Charles Green at HuffPo.
The set-up for this story is why it isn’t so dumb for companies to keep a lot of supposedly unproductive cash on hand. You can make similar argument for why companies shouldn’t divest their cash cows. A lot of Big Pharma has sold various consumer goods companies (my pet peeve: Bristol Myers selling Clairol, a company that coins money) that provided steady cash flow which helped fund their long-time-horizon drug development business. I for one would not want to depend on the whims of the capital markets if I were in a business with high, ongoing needs for investment.
And towards the end, Green makes another point: that the slicing and dicing of activities into smaller and smaller, more specialized pieces (Adam Smith’s pin manufacture carried out as far as possible) has gone beyond the point of maximum advantage. The problem is twofold: as we have learned in structured finance, there is the risk of loss of vital information when projects through too many hands. And relying on a sequence of specialists means that the buyer/client has to integrate and provide the big picture overview, when he may lack the skill to do so.
I see this play out in my own field, where dissatisfaction with consultants is growing, and has been created by the industry. Consultants increasingly offer packaged products because they are easier to sell than custom work, and give the illusion of certainty. But to buy the right product, you have to have made the correct diagnosis. Clients often wind up unhappy because the consultant didn’t solve their problem, but they are partly culpable for having gone for the easy out of a slick-sounding solution rather than the tougher process of coming to grips with their issues.
From Green:
I spoke to the (non-American) former CEO of a large company–the profitability leader in its capital-intensive global industry…..
“I used to get calls from them–Morgan Sachs, Goldman Stanley, you know–the supposed crème de la crème of MBAs. Here’s how they went:
Bankers: Why do you keep so much cash? Your leverage ratio is half that of your industry. You’re earning nothing on it–it’s like keeping shareholders’ funds under a mattress. You’re destroying shareholder value….
CEO: Let me ask you–who’s the global market leader in software?
Bankers: Microsoft, of course.
CEO: And how much cash do they have on hand?
Bankers: Way more than the industry average; too much; they should return it to the shareholders.
CEO: Uh huh. And who’s the global market leader in semiconductors?
Bankers: Intel, of course.
CEO: How much cash on hand?
Bankers: Again, way too much, more than industry average, they’re destroying shareholder value.
CEO: Uh huh. I too am the market leader, and the profitability leader….
My industry–like every capital-intensive industry–has cycles. I buy my expensive assets at a huge discount–when the market is cold and my suppliers have no backlog. I get what I want, when I want it, pay less, and have grateful suppliers. My competitors buy when their profits are high–they overpay, wait years for delivery, and irritate their suppliers–as do their competitors.
I make strategic moves when I’m the only one who can do so. My competitors make their moves along with everyone else.
I can do all this because I have cash. My competitors all listened to your advice about copying the average. Not only am I the only one with funds to execute my strategy–I’m the only one thinking of a unique strategy….
Q. Who’s right?
A. The CEO–hands down, a no-brainer.
Q. How could the bankers so spectacularly miss something so obvious?
A. The blinding power of an unchallenged paradigm.
Q. And what paradigm would that be?
A. Ah, that’s the big question. Is it:
1. Youth is arrogant
2. Business has become overly quantitative and analytical
3. Finance has triumphed over marketing and production
4. Paris Hilton was somehow involved
5. We are killing off strategies and relationships for the sake of transactions.
I vote #5–death by transactions.
The history of capitalism is one of scale economies, enabled by parceling out pieces of work to others. Every time you do that, you gain scale–and you create a transaction.
This trend has accelerated: more chunks of business are being chopped up and parceled out–both in space and in time.
Examples:
* Modular software
* Mortgage (and other asset) collateralization
* HR competency models
* Outsourcing
* Globalized sourcingThis habit is reflected even in meta-patterns of business thinking–how to tackle a problem? Break it up, break it down. Analyze it. Measure it. Parcel it out. Track it. Install rewards. Repeat at one level of detail lower.
Every time you break up a function and parcel it out to more people over less time, two things happen. Greater efficiencies–and less relationships.
Repeat infinitely, and you get people who think about business like tinker-toys–models to be constantly assembled and re-assembled.
That way of thinking often fosters neither strategic nor relationship thinking.
It is also impossible to think ethically when there are no relationships to be harmed, and no timeframe in which to be held accountable.
But the biggest irony is: it may not be working anymore. The chop and parcel game has been played out. The returns are beyond diminishing; the cost of the transactional mindset is exceeding the savings of scale. The game has turned dysfunctional.
Death by transactions.
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Absolutely, every extra transaction is a bit more spliff for the financial wizards. The problem is that added logistical overhead is usually ignored. So was all the added shipping when oil was $10 a barrel. $100 oil will leave a mark!
The reductionism also happened in time as noted. It seems that every long term project (defined as over about one year) I’ve set my eyes on over the last 8-10 years has been royally messed up because people just don’t want to think over spans that long. Or they can’t resist the temptation to tinker with things which has the effect of reseting the project clock so that it never gets completed.
The whole game of “lend long and borrow short” is essentially suffering from the same problem. If you have a short range plan for a long term project, you’re doomed. Unless of course you’re lucky enough to be doing business in one of those occasional periods when every deal works. Then you convince yourself that you’re a genius and you bet the farm. Then you get whacked upside the wallet by the great clue stick.
Re-read the dialogue and see how ‘shareholder value’ has become a talisman, an idol, a graven image. It is THE trump card for any debate, any dialogue, any decision. And, it is played, like the race card in politics, by people without souls — people who are celebrated by an ignorant, celebrity besotted business media even as the celebrated and celebrators destroy the very thing they claim to defend and advance.
And, by the way, the faux, so-called ‘balanced scorecard’ is just another form of the same wolf in sheep’s clothing.
If we are to see sustainable and real shareholder value, we must first end shareholder value fundamentalism.
Like just in time inventory as a great gain for most companies. Nonsense. The first time you have a flood or earthquake you’ll see what happens. The consultants always have prepacked solutions. Like CPAs with internal control studies, sanctioned by SARBOX yet.
The balance sheet leverage has been the mantra of the Investment banks throughout the last several years, now the end result:
Corporations have overpaid for their acquisitions (will meet with cash flows problems )
The benefit for the investment banks was of two folds, higher commissions and artificially pumped equities markets having an official recognition through M&A transactions at equities market prices plus 20%.
The end results, the investment banks are plagued with 260 billion USD LT loans on their balance sheets and unsuccessfully try to off load at discount price, using the material adverse change clause (when any) in order to escape their contractual obligations (see several cases with Goldman Saks)
The Federal reserve will have to comply with the financial markets requirements as designed by the banks and lower the interest rates, low real interest rates begging for lower interest rates.
This one’s a jewel. The villain in the piece, however, is our friendly neighborhood computer! Its modus operandi is modularity at the expense of human relationship. I consider it the elephant in the room that no one dares mention. The implications of an indictment are unthinkable. It’s a machine that we really can’t turn off. The whole idea of thinking as a computation really derives from the computer model. We know better now but the cliche persists.
By the time a process is modelled to the extent that a computer can coordinate, monitor and control it, the process no longer has a human dimension. I’m not waving my hands here. I am specifically saying that the genius of two or more human brains mulling over a problem is that the result can be something quite new under the sun and is based on the life experiences of the participants bringing to light new and heretofore unconsidered solutions. These fragile but sometimes very creative ideas would not fit in any pre-existing procedural model – especially the brittle and canned varieties mediated by computers.
But even more disturbing is the fact that genetically we are still hunter gatherers who are best served individually by existing in small tribal units that derive and extend from the family unit. It’s not paradise but it’s certainly a far cry from working at McDonalds.
The slice and dice approach you chronicle above is the logical extreme of a system whose money muscled proponents have gone totally mad with hubris and golf.
The rich and powerful tend to trust computers far more than each other – and for good reason. The irony is that what they end up trusting is a half-baked cake of fuzzy notions produced by profit oriented consultants and software houses. The complexity of the systems precludes a “horse-sense” understanding. Their digital nature creates a crystalline structure that can appear rock solid but can fracture with the tap of a crow’s beak.
And so on and so on. We’re screwed.
Anon of 8:36 AM,
That’s an important aspect, and one often neglected. You might enjoy this article which discusses some related issues.
M$ *does* have too much cash.
Intel, and other competitors, must pay for genuine capital costs. M$ is more or less printing money and can’t figure out how to invest it. That says they don’t have certain qualities needed for the long term.
Dmitry Orlov wrote in a similar vein:
“(Post-Soviet Russian business enterprises) drove Western management consultants mad, with their endless kindergartens, retirement homes, laundries, and free clinics. These weren’t part of their core competency, you see. They needed to divest and to streamline their operations. The Western management gurus overlooked the most important thing: the core competency of these enterprises lay in their ability to survive economic collapse.”
Warren Buffet’s looking like the smartest guy in the room these days.
He didn’t invest in anything he didn’t understand.
A Wall Street analyst was criticizing WB a couple of years ago because he wasn’t beating the Street. How can you beat a rigged game? You can’t.
-A-
Yves,
Great post. Strategy is dead. Imagine if Countrywide had made it a goal to LOSE share in the past year. Imagine if a large public builder had made a firm-changing sale of land holdings. Imagine if a major bank had used retained earnings to build reserves rather than buy back shares. The fact that NONE did means that managements didn’t see it as their job: “You pay us to be banks/builders/lenders,” they would argue, “not economists.” So they were operational care-takers, and not risk-taking owner/managers of cyclical assets.
Around forty years ago Bruce Henderson started up BCG and his clients were hungry for advice on positional advantage. Today his firm would likely fail in its first year.
capitalism’s development is at the same time the development of increasingly complex, generally more efficient, technical and social divisions of labor. But, beyond an uneven point, this same process tends to generate overspecialized highly programatic individuals, in effect automatons, and negation of efficiencies in the name of greater efficiency.