1. Finally, evidence that managing for the long term pays off

    February 26, 2017 by ahmed

     

    Originally posted on HBR by Dominic Barton, James Manyika, and Sarah Keohane Williamson

    Companies deliver superior results when executives manage for long-term value creation and resist pressure from analysts and investors to focus excessively on meeting Wall Street’s quarterly earnings expectations. This has long seemed intuitively true to us. We’ve seen companies such as Unilever, AT&T, and Amazon succeed by sticking resolutely to a long-term view. And yet we have not had the comprehensive data needed to quantify the payoff from managing for the long term – until now.New research, led by a team from McKinsey Global Institute in cooperation with FCLT Global, found that companies that operate with a true long-term mindset have consistently outperformed their industry peers since 2001 across almost every financial measure that matters.

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    The differences were dramatic. Among the firms we identified as focused on the long term, average revenue and earnings growth were 47% and 36% higher, respectively, by 2014, and market capitalization grew faster as well. The returns to society and the overall economy were equally impressive. By our measures, companies that were managed for the long term added nearly 12,000 more jobs on average than their peers from 2001 to 2015. We calculate that U.S. GDP over the past decade might well have grown by an additional $1 trillion if the whole economy had performed at the level our long-term stalwarts delivered — and generated more than five million additional jobs over this period.

    Who are these overachievers and how did we identify them? We’ll dive into those answers shortly. But first, it’s worth pausing to consider why finding conclusive data that establishes the rewards from long-term management has been so hard — and just how tangled the debate over this issue has been as a result.

    In recent years we have learned a lot about the causes of short-termism and its intensifying power. We know from FCLT surveys, for example, that 61% of executives and directors say that they would cut discretionary spending to avoid risking an earnings miss, and a further 47% would delay starting a new project in such a situation, even if doing so led to a potential sacrifice in value. We also know that most executives feel the balance between short-term accountability and long-term success has fallen out of whack; 65% say the short-term pressure they face has increased in the past five years. We can all see what appear to be the results of excessive short-termism in the form of record levels of stock buybacks in the U.S. and historic lows in new capital investment.

    But while measuring the increase in short-term pressures and identifying perverse incentives is fairly straightforward, assessing the ultimate impact of corporate short-termism on company performance and macroeconomic growth is highly complex. After all, “short-termism” does not correspond to any single quantifiable metric. It is a confluence of so many complex factors it can be nearly impossible to pin down. As a result, despite persistent calls for more long-term behavior from us and from CEOs who share our views, such as Larry Fink of BlackRock and Mark Wiseman, the former head of the Canada Pension Plan Investment Board, a genuine debate has continued to rage among economists and analysts over whether short-termism really destroys value.

    Academic studies have linked the possible effects of short-termism to lower investment rates among publicly traded firms and decreased returns over a multiyear time horizon. Ambitious work has even attempted to quantify economic growth foregone due to cuts in R&D expenditure driven by short-termism, putting it in the range of about 0.1% per year. Other researchers, however, remain skeptical. How, they ask, could corporate profits in the U.S. remain so high for so long if short-termism were such a drag on performance? And isn’t the focus on quarterly results a natural outgrowth of the rigorous corporate governance that keeps executives accountable?

    What We Actually Measured — and the Limits of Our Knowledge

    To help provide a better factual base for this debate, MGI, working with McKinsey colleagues from our Strategy & Corporate Finance practice as well as the team at FCLT Global, began last fall to devise a way to systemically measure short-termism and long-termism at the company level. It started with developing a proprietary Corporate Horizon Index. The data for this index was drawn from 615 nonfinance companies that had reported continuous results from 2001 to 2015 and whose market capitalization in that period had exceeded $5 billion in at least one year. (We wanted to focus on companies large enough to feel the potential short-term pressures exerted by shareholders, boards, activists, and others.) Collectively, our sample accounts for about 60%–65% of total U.S. public market capitalization over this period. To further ensure valid results and to avoid bias in our sample, we evaluated all companies in our index only relative to their industry peers with similar opportunity sets and market conditions and tracked them over several years. We also looked at the proportional composition of the long-term and short-term groups to ensure they are approximately equivalent, so that the differential performance of individual industries cannot bias the overall results, and conducted other tests and controls to ensure statistical robustness. (For more on our methodology download the full report.)

    One final caveat: While we firmly believe our index enables us to classify companies as “long-term” in an unbiased manner, our findings are descriptive only. We aren’t saying that a long-term orientation causes better performance, nor have we controlled for every factor that could impact the relationship between those two. All we can say is that companies with a long-term orientation tend to perform better than similar but short-term-focused firms. Even so, the correlation we uncovered between behaviors that typify a longer-term approach and superior historical performance deliver a message that’s hard to ignore.

    To construct our Corporate Horizon Index, we identified five financial indicators, selected because they matched up with five hypotheses we had developed about the ways in which long- and short-term companies might differ. These indicators and hypotheses were:

    • Investment. The ratio of capex to depreciation. We assume long-term companies will invest more and more-consistently than other companies.
    • Earnings quality. Accruals as a share of revenue. Our belief is that the earnings of long-term companies will rely less on accounting decisions and more on underlying cash flow than other companies.
    • Margin growth. Difference between earnings growth and revenue growth. We assume that long-term companies are less likely to grow their margins unsustainably in order to hit near-term targets.
    • Earnings growth. Difference between earnings-per-share (EPS) growth and true earnings growth. We hypothesize that long-term companies will focus less on things like Wall Street’s obsession with earnings-per-share, which can be influenced by actions such as share repurchases, and more on the absolute rise or fall of reported earnings.
    • Quarterly targeting. Incidence of beating or missing EPS targets by less than two cents. We assume long-term companies are more likely to miss earnings targets by small amounts (when they easily could have taken action to hit them) and less likely to hit earnings targets by small amounts (where doing so would divert resources from other business needs).

    After running the numbers on these indicators, two broad groups emerged among those 615 large and midcap U.S. publicly listed companies: a “long-term” group of 164 companies (about 27% of the sample), which were either long-term relative to their industry peers over the entire sample or clearly became more long-term between the first half of the sample period and the second half, and a baseline group of the 451 remaining companies (about 73% of the sample). The performance gap that subsequently opened between these two groups of companies offers the most compelling evidence to date of the relative cost of short-termism — and the real payoff that arises from managing for the long term.

    Trillions of Dollars of Value Creation at Stake

    To recap, from 2001 to 2014, the long-term companies identified by our Corporate Horizons Index increased their revenue by 47% more than others in their industry groups and their earnings by 36% more, on average. Their revenue growth was less volatile over this period, with a standard deviation of growth of 5.6%, versus 7.6% for all other companies. Our long-term firms also appeared more willing to maintain their strategies during times of economic stress. During the 2008–2009 global financial crisis, they not only saw smaller declines in revenue and earnings but also continued to increase investments in research and development while others cut back. From 2007 to 2014, their R&D spending grew at an annualized rate of 8.5%, greater than the 3.7% rate for other companies.

    Another way to measure the value creation of long-term companies is to look through the lens of what is known as “economic profit.” Economic profit represents a company’s profit after subtracting a charge for the capital that the firm has invested (working capital, fixed assets, goodwill). The capital charge equals the amount of invested capital times the opportunity cost of capital — that is, the return that shareholders expect to earn from investing in companies with similar risk. Consider, for example, Company A, which earns $100 of after-tax operating profit, has an 8% cost of capital and $800 of invested capital. In this case its capital charge is $800 times 8%, or $64. Subtracting the capital charge from profits gives $36 of economic profit. A company is creating value when its economic profit is positive, and destroying value if its economic profit is negative.

    With this metric, the gap between long-term companies and the rest is even bigger. From 2001 to 2014 those managing for the long term cumulatively increased their economic profit by 63% more than the other companies. By 2014 their annual economic profit was 81% larger than their peers, a tribute to superior capital allocation that led to fundamental value creation.

    No path goes straight up, of course, and the long-term companies in our sample still faced plenty of character-testing times. During the last financial crisis, for example, they saw their share prices take greater hits than their short-term counterparts. Afterward, however, the long-term firms significantly outperformed, adding an average of $7 billion more to their companies’ market capitalization from 2009 and 2014 than their short-term peers did.

    While we can’t directly measure the cost of short-termism, our analysis gives an indication of just how large the value of what’s being left on the table might be. As noted earlier, if all public U.S. companies had created jobs at the scale of the long-term-focused organizations in our sample, the country would have generated at least five million more jobs from 2001 and 2015 — and an additional $1 trillion in GDP growth (equivalent to an average of 0.8 percentage points of GDP growth per year). Projecting forward, if nothing changes to close the gap between the long-term group and the others, then the U.S. economy could be giving up another $3 trillion in foregone GDP and job growth by 2025. Clearly, addressing persistent short-termism should be an urgent issue not just for investors and boards but also for policy makers.

    Where Do We Go from Here?

    Our research is just a first step toward understanding the scope and magnitude of corporate short-termism. For instance, our initial dataset was limited to the U.S., but we know the problem is a global one. How do the costs and drivers differ by regions? Our sample set consists only of publicly listed companies. How do the effects we discovered differ among private companies or among public companies with varying types of ownership structures? Are there metrics that can help predict when a company is becoming too short-term — and how do they differ among industries? Most important, what are the interventions that will prove most effective in shifting organizations onto a more productive long-term path?

    On this last point, we and many others have identified steps that executives, boards, and institutional investors can take to achieve a better balance between hitting targets in the short term and operating with a persistent long-term vision and strategy. These range from creating investment mandates that reward long-term value creation, to techniques for “de-biasing” corporate capital allocation, to rethinking traditional approaches to investor relations and board composition. We will return to HBR in coming months with more data and insights into how companies can strengthen their long-term muscles.

    The key message from this research is not only that the rewards from managing for the long term are enormous; it’s also that, despite strong countervailing pressures, real change is possible. The proof lies in a small but significant subset of our long-term outperformers — 14%, to be precise — that didn’t start out in that category. Initially, these companies scored on the short-term end of our index. But over the course of the 15-year period we measured, leaders at the companies in this cohort managed to shift their corporations’ behavior sufficiently to move into the long-term category. What were the practical actions these companies took? Exploring that question will be a major focus for our research in the coming year. For now, the simple fact of their success is an inspiration.


  2. A systems perspective to leadership and strategy

    November 25, 2016 by ahmed

    Originally posted on Blogrige by Harry Hertz

    I recently read a summary of an interview with Wharton Professors Harbir Singh and Mike Useem. The interview relates to their new book, The strategic leaders roadmap. In the book they contend that successful senior executives must be capable of integrating strategic thinking with strong leadership skills.Leaders who adopt the Baldrige excellence framework have already successfully addressed this integrative need because of the questions in the Leadership and Strategy categories of the Baldrige criteria. Indeed, the key considerations that Singh and Useem outline are contained in item 1.1 on Senior Leadership and item 2.1 on Strategy Development and are systemically interrelated in the criteria.

    Here are the key points I gleaned from the interview and how they relate to the relevant Baldrige criteria:

    • Leaders must inspire the workforce, and must also deliver strategic inspiration and discipline: The Baldrige criteria (item 1.1) ask how senior leaders create a focus on action that will achieve innovation and intelligent risk taking, and attain the organization’s vision. Item 2.1 asks how the organization seeks out potential blind spots in its strategy to avoid a senior leader’s bias or potential lack of realization that there is a changing external or competitive environment. Such bias may cause a disciplined approach to a poor strategy.
    • Leaders may be good at strategic thinking, but thin on making things happen, driving strategy and change through the organization: This is the very reason that starting with the Baldrige excellence builder, the criteria ask (item 1.1) how senior leaders set an overall focus on action and, in specific, in item 2.1 ask about the ability to execute the strategic plan and to achieve transformational change.
    • Leaders must realize that execution is not just about the workforce following orders, but that it is about creating and enhancing the value proposition to the client and getting ideas from the entire workforce: In item 1.1, customers and the workforce receive significant attention. At the Excellence builder level the criteria ask: “How do senior leaders communicate with and engage the entire workforce and key customers?” In the more detailed Baldrige criteria there are questions about senior leaders’ two-way communication with the workforce, and their actions to reinforce a customer focus, foster customer engagement, and create customer value.
    • Leaders must balance quarterly results with setting the tone of an ethical climate and a policy of integrity first: Here too, item 1.1 of the Baldrige criteria sends a clear message by asking how senior leaders’ actions demonstrate their commitment to ethical behavior and how they promote an organizational environment that requires it.
    • Leaders must create agility and adaptability in the organization: Item 2.1 specifically asks how the strategic planning process addresses the potential need for organizational agility and operational flexibility.

    While I have given some very specific examples from the Baldrige criteria, these are just examples. The systems perspective of Baldrige means these topics are addressed at appropriate places throughout all seven categories of the criteria to cause linkages wherever valuable.

    Professors Singh and Useem summarize their treatise by saying that senior leaders must be strategic in thought and lead well. I would assert that you can simply operationalize this unified concept (and more) by following the advice given in items 1.1 and 2.1 of the Baldrige criteria. And in the process, gain a systems perspective of all that is important in leadership and strategy.


  3. The Importance of Leadership and the “Best Kept Secret” for using a Baldrige application

    April 2, 2016 by ahmed

     

    Originally posted on Blogrige by Dawn Marie Bailey

    Dr. Katherine Gottlieb, president/CEO of Baldrige Award recipient Southcentral Foundation (SF) and recipient of the 2015 Harry S. Hertz Leadership Award, knows a thing or two about leadership. During her tenure, she and her organization have not only racked up corporate, program, and individual awards, but Gottlieb has received quite a few leadership awards, too, including the Bridge Builders of Anchorage “Excellence in Community Service Award,” the Alaska Public Health Association’s Alaska Meritorious Health Service Award, and an Alaska Pacific University honorary doctorate in public service.

    In preparation for her presentation on leadership at the 28th annual Quest for Excellence Conference, I asked her all about leadership.

    Why has leadership been important to you, your organization?

    The importance of leadership has been demonstrated in multiple ways:

    • first, in creating an organization that has an environment of trust and transparency, where customers and employees feel like they own the successes of the system;
    • second, leadership has guided the organization through systematic changes quickly, without causing fatigue;
    • third, the successful buy-in of leadership for the adoption of change, and the use of the Baldrige tools to drive systematic change and innovation; and
    • last, by leadership honoring customer and employee beliefs, values, and traditions.

    Can you share a story of leadership that has shaped your current success?

    There are so many stories to share. Trust can be earned through building relationships and creating an environment of trust by building an infrastructure based on a Vision and Mission, which is built on goals, objectives, and operational principles; this is what ties together all of SCF. And this includes governance, executive leadership, and all employees.

    What are your top tips for using Baldrige tools to support leadership?

    The Baldrige Excellence Framework as a tool doesn’t tell an organization what to do—it asks questions that drive systematic improvement and change that may be adapted to the culture of an organization.

    When an organization believes it has reached the top of successful change, Baldrige encourages the people to take even more steps through suggested opportunities for improvements. By following these steps to improvement, an organization may develop a means for delegation of authority, leading to higher employee and customer satisfaction.

    Baldrige is a journey, a tool that may be used for years after an award is won. It is universal and may be used for all types of businesses to reach for best practices and succeed.

    What else might participants learn at your conference session?

    We are choosing to attend the Quest for Excellence® conference to continue to grow and keep up with the latest innovative ways for improvement. We continue to interact with and visit other organizations that have won the Baldrige Award.

    We have hired and placed people on our organizational development team to continue to remind us of those things learned while instructing and teaching others.

    And I believe SF has found the best kept secret on how to utilize the Baldrige application—we plan to share this at the workshop.

    What are a few key reasons that organization in your sector can benefit from using the Baldrige Excellence Framework?

    It is all about the strengths of the tool and putting it to work:

    • Systematic change with innovation equals sustainability for the organization.
    • Utilizing a tool that is more than “words”; Baldrige drives innovation.
    • Baldrige ensures that all staff members use the same language and continue to grow one with another toward best practices.

  4. The Baldrige Guide to Overcoming Poor Leadership

    November 29, 2015 by ahmed

     

    Originally posted on Blogrige by Jacqueline Calhoun and Dawn Bailey

    Much has been written recently on the cost of poor quality that leads to recalls, loss of customer confidence, and of course much worse scenarios where customers’ lives and health are at risk. For example, recent recalls in the automotive, food, electronics, and pharmaceutical industries have led to plummeting stocks and even government investigations. And if you search for “corporate greed,” you can find editorials from all industries across the U.S. economy, including in the health care and nonprofit worlds.

    In many of these cases, it’s brand-name businesses behind the scandals/recalls. Are these simply cases of the corporate greed of senior leaders and their questionable ethical decisions? Could leadership itself be at fault?

    Leadership is paramount in the Baldrige Excellence Framework and its Criteria; the leadership category can be summarized as asking how senior leaders’ personal actions and the governance system guide and sustain the organization. The Baldrige core values also have a distinct focus on leadership, especially in the core values of visionary leadership, ethics and transparency, focus on success, societal responsibility, valuing people, management by fact, and managing for innovation. These core values are the beliefs and behaviors embedded in high-performing organizations.

    In the concept of an organization’s ongoing success, taking intelligent risks is also included in the Leadership category. Intelligent risks are opportunities for which the potential gain outweighs the potential harm or loss to an organization’s future success. One might wonder if some of the decisions made by leaders come out of thoughtful and measured intelligent risk, guidance for which can also be found in the Baldrige framework, but others might wonder if some decisions are made purely for the potential profits.

    When it comes to our leaders, Jeffrey Pfeffer, a professor at Stanford Graduate School of Business, writes in his book, Leadership B.S.: Fixing Workplaces and Careers One Truth at a Time, that although many of us would like our leaders to exhibit attributes such as authenticity, modesty, transparency, truthfulness, and benevolence, the reality is that some of the most successful business leaders actually exhibit other characteristics: narcissism/dominance, self-promotion/energy, self-aggrandizement/confidence, and self-confidence/charisma–traits that have often proven to be instrumental in building and promoting a brand.

    However, these latter traits often lead to decisions that don’t last–or recalls and costly decisions both for the business and the people it impacts. When there are questionable values of visionary leadership, ethics and transparency, societal responsibility, and the valuing of people, among other core values, can leaders really lead their organizations into a sustainable future?

    Of course, no business path is guaranteed, but the Baldrige Excellence Framework does provide a guide. Think about some of the leaders and the alleged examples of corporate greed in the news. Now consider the thoughtful questions in the framework, for example, for the following categories:

    Category 3 asks how you engage customers for long?term marketplace success, including how you listen to the voice of the customer, build customer relationships, and use customer information to improve and to identify opportunities for innovation.

    Do some of the leaders that we read about really listen to their customers and build relationships? How? (These leaders might learn something from reading about the innovative ways that Baldrige Award recipients accomplish these tasks.)

    Category 4, the “brain center” of the Criteria, covers the alignment of operations with strategic objectives. It is the main point within the Criteria for all key information on effectively measuring, analyzing, and improving performance and managing organizational knowledge to drive improvement, innovation, and organizational competitiveness. Knowledge of such data and information would be instrumental in making intelligent risks.

    Category 6 asks how you focus on your organization’s work, product design and delivery, innovation, and operational effectiveness to achieve organizational success now and in the future.

    Could leaders learn from considering the questions in these categories, as well as the other Criteria categories? Of course! The Baldrige Excellence Framework provides a road map. Now leaders, with all of their traits (the traits of narcissism/dominance, self-promotion/energy, self-aggrandizement/confidence, and self-confidence/charisma may be good or bad depending on your perspective) just need to consider the answers to the Criteria questions to ensure that their leadership is appropriate for their industries, their challenges, and their people (the Criteria are not prescriptive).

    With the Criteria as a guide, they can then move their organizations forward toward sustainability–and hopefully regain some of the customer confidence that can so easily be lost.


  5. How Do We Acquire Contagious Leaders?

    August 9, 2015 by ahmed

     

    Originally posted on Work Force by Alan Preston

    Q:

    How do we recruit (or groom) “contagious” leaders – people who spread their skills and develop more leaders? I know it won’t be easy, but give me some idea how to go about establishing this type of leadership culture.

    A:

    Recruiting and grooming people who will perpetuate a contagious leadership culture must start with support from the C-suite. First and foremost, senior leadership will need to prioritize this effort and supply the financial resources necessary. But money isn’t the only driving factor: What’s most important is providing leadership by example.

    To spread the types of leadership behaviors you desire, there must be a visible demonstration of this commitment at all levels. A mentoring program, for example, is a great way to demonstrate what you value, so that’s where you should begin.

    Start by selecting a small group of leaders who exemplify the behaviors you want to replicate, along with a member of your senior management team to serve as the sponsor. Generally speaking, you’re looking for extroverts with strong communication skills and genuine enthusiasm for leadership development in themselves and others.

    Be specific when you tell this team what their mission is, how they can contribute, and what the payoff will be. Everyone is doing more with less these days, so it’s important to remember that even the most dedicated among us are not likely to carve out time for activities that bring no reward. But for many, the reward is simply the recognition for doing something important and the opportunity to contribute at a higher level.

    Mentoring can be formal and structured or informal and loose, but it must happen with regularity. Leaders who volunteer to be mentors should be responsible for making it happen and for talking up their efforts around the company. Additionally, your corporate communications team or HR should publicize your mentoring program and include supportive comments from senior leadership. What’s important to the C-suite will become important to everyone else.

    Mentoring that fits your company culture and is publicized properly will go a long way toward demonstrating what you value. But even a strong program is not enough by itself to transform your organizational culture. In addition, you’ll want to build leadership performance, evangelism and the development of others into performance appraisals. Nothing gets attention more than objectives that have an impact on salary at review time.

    After institutionalizing expectations around contagious leadership, you’ll want to recognize and reward it. It can be quite inspiring for leaders and individual contributors alike to see others get recognized for their successful contributions to company culture. We tend to emulate those who are successful, and often people will look to those who are recognized as the examples they should follow.

    As we know, actions speak louder than words. By dedicating time, resources, recognition and senior leadership involvement, you will create a contagious leadership culture and propel your organization toward higher performance all around.