Renewing the Enterprise: Governance, Innovation and Performance in the New Normal

8/14/2019 Renewing the Enterprise: Governance, Innovation and Performance in the New Normal

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Renewing the Enterprise and Preparing for the New Normal

Adaptation, Resilience, Innovation and Leadership

By Dave Livingston, Managing Principal, Llinlithgow Associates (www.llinlithgow.com )

Dave is a management consultant primarily focused on improving enterprise performance by coupling strategy with execution thru the design and implementation of workable, integrated management systems.He blogs on this and related issues in Economics, Markets & Investments and specific industries and companies at www.llinlithwo.com/bizzx , his BizzXceleration blog.

Introduction

You would think being blindsided by the sudden eruption of a major worldwide downturn would teach businessesthat they need to both monitor environmental conditions and make themselves more responsive and agile.Unfortunately that doesn’t seem to be the case, based on a wide range of evidence. Here we want to define whatthe “New Normal” environment looks like now and what it will look like over the next decade, what the responses

of business are as best we can determine and why they are struggling to adopt alternative approaches and adaptto the more competitive and disruptive environment they will be competing in.

We want to specifically understand the major problem causing these struggles, which appears to be managementsystems and corporate governance that lend themselves to the accumulation of old rules, procedures andprocesses and rigidity – we term this organizational sclerosis, or organoscelrosis. To cure themselves andprepare for the new normal businesses must run more efficiently and effectively by improving governance by re-thinking and re-designing their management system. At the same time they must be preparing for the disruptionsby creating new sources of value in products, service, markets and capabilities which requires an entirely newand more effective approach to managing and operationalizing Innovation. And they must tie all this together bylearning to deal with the mental barriers and leadership challenges involved.

We start by laying out the current situation, framing the approach, illustrate the impact of the new normal usingthe Oil/Energy Industry and suggest a “dashboard design” for monitoring and management support. That’sfollowed and coupled with a discussion of mental attitudes and how they help and hinder dealing with a moreturbulent world. Then we discuss the widespread evidence for lack of preparation for the new normal and startdigging into specifics. The specifics include two major essays on the strategic management of Innovation followedby another on an operational management system for end-to-end Innovation, a detailed decision of themechanics of organosclerosis and why it leads to governance failures and performance problems and a detaileddiscussion of the design principles of an integrated enterprise management system that helps balance short vs.long-term decisions and operational vs. strategic ones in a common framework. We also include two key articleson learning to manage Human Resources strategically, a necessary support and enabler of an effectiveenterprise!

Finally, we finish up with a summary of the structural outlook for the next decade, the New Normal, and what themajor trends and characteristics are as well as the major risk factors and likely disruptions; at least for some ofthe factors. We are on the cusp point of major and far-reaching changes in the structural underpinnings of the

global economy where the trends of the last 30-40 years are going to cause tectonic shifts in many dimensions.Shifts that most enterprises do not see coming, are not prepared for and don’t appear to be preparing for.

Along the way we illustrate our points and arguments with examples drawn from Energy, Finance, Auto andTechnology Industry cases. We’ll also point out that these issues are urgent no matter what the size orgeographic location of the firm is. In fact, we’d even go so far as to argue that developing an effectivemanagement system that reflects necessary strategies for the new normal is more important for the smallerenterprises than for the larger. They have less cushion to fall back on and fewer resources and skills to devote tothese challenges.



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Strategy without execution is fantasy. Execution without strategy is thrashing.

Either without a management system is unlikely.

This is our best-effort attempt to sketch out workable blueprints for diagnosing, correcting and implementingcorrective measures that will create performing enterprises by improving governance and value creation. Wehope you find it valuable, useful and above all workable.

Table of Contents

1. More Tales From the Frontline: Econ/Mkts to Performance & Policy 3

2. Response vs. Performance: Walking Wounded & Mental Attitudes 6

3. Adaptation & Resilience: Looking for the Naked Swimmers 9

4. A Bit of Xmas Cheer: Innovation As The Future 12

5. Christmas Wishes: Peace, Prosperity and Performance 16

6. Dealing With the Brave New World: Resilience vs. Sclerosis 18

7. People & Performance: Assets or Fungible Commodities? 22

8. Aholes, Shirkers and Performance: a Draft People Principles Policy 23

9. Renewing the Enterprise 1: the Proper Management of Innovation 24

10. Pecora 2 Hearings, Malfeasances, Your Future & Cusp Points 28

11. Talking Business: the Outlook vs. the Preparations 32

12. Renewing the Enterprise 2: Governance, Measurement & Performance 34

13. Chaos, Turbulence, Fragilities: Defining the New Normal, Blueprinting Business Performance 39

About Llinlithgow Associates 43



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December 03, 2009

More Tales From the Frontline: Econ/Mkts to Performance & Policy

http://llinlithgow.com/bizzX/2009/12/more_tales_from_the_frontline.html

It's just about time to switch back to our bread and butter oflooking at business performance but the readings start withsome segues into the state of the Economy and Markets. Thelatter at this point, as we've hopefully made clear a time orthousand, cognitively detached from any linkages to the realityof the former. But not inseparable either, nor for that matter isbusiness performance. Nor are any of the three detached fromthe huge inventory of policy-driven fluctuations gyrating at day-trading speeds while deeply impacting the underlying structureof all. Or, as we put it, it's a policy-driven economy and, addingto that, a fantasy-driven market.

Accordingly the readings have update chunks on the economyand markets plus the business stories we want to point to, andend with a survey of all those policy gyrations. A set of inter-dependent interactions we try and conceptualize with thisgraphic. If business performance is the sine qua non, thatwithout which there is no other, it depends utterly on theEconomy, Politics & Policy and the state of the Markets. Whileenterprises cannot control most of these factors they MUSTdeal with them, which means understanding how the winds are blowing is essential.

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Let's pop way up the conceptualization stack for aminute to explain part of our approach. The world isfull of experts in their subject areas, whether it'sFinance, Economics, technical analysis, marketingor manufacturing. The problem is that no problemwe must address is driven by just one factor but byall of them together. That means that you need tounderstand each subject area to some extent, theirlinkages and relationships and how they fit into abigger context and need some sort of framework forunderstanding the "ecology". The best illustrationwe've ever seen of this argument is this graphic.

The problem comes when specialists in one areapontificate on all the others without investingsufficient time to become knowledgeable. Whichhappens over and over again to the point ofpredictability. In fact we'd even argue that specialistsreaching firm conclusions that are flatly contradictedby the facts and other domain frameworks is thegeneral rule. And have spent considerable time in trying to sidestep that by digging deep enough into each areato be grounded and, at the same time, linked into the bigger picture.



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There's a second implication here that's potentially profound - a lot of what you hear is going to be wrong when anexpert is outside their area and refuses to recognize it.

For example the Stimulus package in combination with other policy moves saved us from GD 2.0, a fact whichmost were in denial about but now, at least implicitly take for granted to the point of myopic complacency. Yet notknowing how the buzz saw works leaves them and us vulnerable to surprises. Dubai being the recent case inpoint, which we just used as the jump off point for reinforcing the idea of a fragile and vulnerable market ( Markets

in a Policy-Driven Economy: Turbulence, Data and Idiocies, Thanksgiving Surprises: GDP to Dubai to "Fragile" ). Theother big "surprise" in this environment is that while we won Stalingrad we may lose Kursk thru misinterpreting theknown and knowable data. Specifically the impacts of the stimulus will be fading and with all the political backlashpreventing further stimulus exposes us to a W-shaped downturn redux, because the Economy is a long....longway from being organically self-sustaining. But, to our basic point, nobody is preparing or positioning for thoselikelihood’s.

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In this environment, where EVERY asset class is movingup and down together in lock-step, you can keep on"trading" with the new pattern until it breaks. Or you canunderstand why that pattern's in place and what's likely tohappen as the ecology keeps changing; whether it's gold,currencies, stocks or bonds. So when we say "performanceis everything" we're talking about the Buffet-Grahammantra - understand the value, the margin of safety and thekey drivers.

In the case of businesses, in some ways the most complexand important, it is these five factors that driveperformance. And each of the stories in the readings, eachworthy of their own post and discussion, are chosen to bothrepresent one or the other of those factors and to serve asrepresentatives of the broader issues. (The dynamic linkages between the factors are also illustrated in this

graphic: BizzX Performance Requirements).

They start with the large cash balances companies are maintaining for security which some argue indicate asurge in business investment but, as regular readers know, is NOT likely since investment lags demand growth.They go onto to talk about fundamental changes in the economics of energy development - a huge structuralchange in the industry, the comparative performance in developed vs. emerging markets for the Auto Industry andthe recent ouster of GM's CEO, Sharp's double-down bet on a huge new plant in Japan using a wholetransformative view of manufacturing, supply chain operations and supplier management, how retailers arereacting to the continued weakness and frugality of consumers, and Subway's $5 Footlong as a case in market-driven innovation, coupled with an interesting take on Bill Bellichek's evidence-driven gamble in their Colts gameand a story on GE's pending sale of NBC to Comcast. All of which speak to adaptation, innovation and resiliencein one way or another.



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Structural Changes in Oil: a Case in Point

In the last few weeks there have been some hugedecision taken by major players in the oil and energy

markets to give up existing resources and focus onmore easily controlled and accessible ones. Thesedecisions are being driven by deep changes inexploration and development economics as well asby the on-going changes in control of oil resources.We've gone from a world where the "Seven Sisters"were the dominant players to one where national oilcompanies and governments control the under-developed oil reserves, which is limiting access andenormously raising the costs of development. For anenergy company to keep on for the next decadepouring investments into those potential fieldsrequires deep pockets, financing and some level of

trust and certainty. Most of which is missing.

Ideally new oil would be coming into the long-term pipeline faster than existing reserves are being depleted but just the opposite is happening. Worse, because of the downturn, both existing and new reserves and fields arenot getting the investment they need. The end result is a future of much lower affordable reserves, setting thestage for a new energy crisis if demand picks up. But will it? With a decade of slower than expected growthdemand in the developed world will continue dropping while demand in the developing world won't grow as fast aswas expected. We still think that D>>S but also think the gap won't be as big. Interesting times indeed - andperfectly illustrative of the complexities for investing in oil and energy. For example are oil sand or greenalternatives economically justified in this new regime? Not really...what does that say about a lot of potentialinvestments?

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When you translate all of those issues thatimpact performance into a set of key issuesthat MUST be monitored and acted upon youend up with a very complex "dashboard"indeed. Put them all together and you end upwith this little nightmare - yet it's inescapable.

The UL chart is its own little nightmare thattries to capture the geo-political andsocionomic issues that need to be monitored.The UR chart represents the state of theEconomy (we trust its clear, NOW, why that'scritical to understand and monitor even ifalmost all companies got blindsided). The LRchart summarizes the major waves ofinnovation and the outlook and tells us, ingeneral, what the prospects are for mostindustries. And the LL chart tries to capture thedynamics of business performance - what allthe piece parts are, how they link and why the whole is ALWAYS different than the sum of the parts. Though notnecessarily greater than, sadly and unfortunately!



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The last readings collection could be taken as the readings for the UL quadrant and provides updates onFinancial Reform, a huge change in the Fed's outlook on policy where it will start including bubble-popping as oneof its goals, the upcoming confirmation hearings for Uncle Ben (& implicitly the threat to an independent centralbank, which would be a disaster), a WSJ oped piece takedown by Paul Kasriel of Northen Trust pointing outwhere ideology triumphs analysis and how dangerous that is and another WSJ piece form Christina Romer onwhy a renewed focus on job creation is so critical.

If you don't think this will all, immediately and far into the future, impact your investments, jobs and well-beingyou're not paying close enough attention, we haven't been clear and convincing enough or your brain is full andit's time to go home. Just remember - the boogiemen can find you anywhere, anytime....enjoy your nightmares!

December 05, 2009

Response vs. Performance: Walking Wounded & Mental Attitudes

http://llinlithgow.com/bizzX/2009/12/response_vs_performance_walkin.html

Well if last week was a surprise downward revision to GDP thisweek was, ostensibly, a massive surprisingly good number onEmployment. Even more interesting the Markets should haveshot thru the roof. Instead they barely moved as the Dollar ralliedstrongly, Gold fell dramatically and Oil did poorly. Now if theMarkets were based on fundamentals you'd have expected theopposite. We're not going to dig into the detailed analysis andinterpretation of either the Economy or the Markets - almostentirely because everything that's been going on and justhappened were things we've been dissecting extensively. Wewill poke at both chartwise (the Market composite dashboardchart's in the readings) and there are some very good readingsyou should at least skim. Instead we're going to continue our

focus on Business Performance - in fact the intent is to continuethe theme of the last post thru the next several becauseadaptability, resilience, innovation and performance are going tobe the sine qua non of returns for the next decade and beyond.

We do our level best to be evidence-driven around here and focus most of our efforts to those ends, as hopefullyyou've noticed. In filtering all the myriads data points and shibboleths down to key findings we end up with prettygood dashboards on the economy, markets, assets, strategies and businesses but if we were to boil it down tofour key things we'd ask (plead?) with you to remember it would to four major things. First, this time it really isdifferent (the Reinhardt and Rogoff findings that this is a major downturn associated with a financial crisis whichtake forever to repair). Next, with a jobless recovery likely it's going to be a long, slow and painful process to re-build employment (est. 2019 before Unemployment reaches 2006/2007 levels!). Third, valuations are aberrationaland the markets are as divorced from those underlying realities as they have been and there is NO MARGIN of

SAFETY. Finally, and the reason for our focus on performance, businesses taken as a whole weren't prepared forthe downturn, reacted poorly, aren't prepared for the New Normal and ARE NOT preparing. At the end of the daythis is a failure of Leadership, Governance and a willingness to be evidence-driven in decision-making. Implyingthat the search for the performers is in reality a search for the clear-headed, simple and honest.



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Let's set the stage for that discussion as

well as picking up points #1 and #2 brieflywith this wonderfully convoluted chart(the argument being that, like a Chineseideogram a lot of background informationis implicit in such a construct - if youdecode it; and there are no surpriseshere if you've been here before). We dostrongly recommend enlarging thishowever!

The UL piece gives us four Employmentdata series which show us that a turningpoint has been crossed but things are stillin about as bad a shape as they havebeen (some more chart roundups are inthe readings, please check 'em out) whilethe middle left (ML) chart relatesEmployment to GDP x-trade impacts.Ditto on the findings.

The real showstopper is the LL where New Jobs and Net New (-450K/quarter for growth) both upticked sharply,are still quite negative and relatively improved and, most importantly, as still worse than at any other period inthese timeframes. Cumulative new jobs are now -12.2 million. In other words just to get back to breakeven weneed 12 million jobs! During the 60s we grew jobs at 2.6%, the 70s 2.4%, the 80s and 90s at 2.0% and thisdecade it was 0.2%! If you look at the R.H. chart set 4% GDP growth gets you 2.5% while 2.5% GDP growth getsyou about 1% or so. Tell me again we're in a position to create a prosperous 60s-like economy, please! Nowonder wages have been stagnant for three decades!!! Really stop and think about that for a minute, PLEASE?

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Do we really need to explain that? If businesses seegrowing demand they hire. Those hired spend moreso businesses, in a virtuous feedback loop hire moreand invest more, making their operations moreproductive and so on. Sadly of course it runs in theother direction. All else aside, ignoring all theshibboleths about social policy, etc. etc. if businessesdon't perform neither does the economy, nor do we.Period, end of story. We buried a couple of charts on

historical business performance and on key strategies,borrowed from from BCG, in the readings but ifyou're in hurry click to see 'em now. Just to reinforcethose key points. We think they're being too nicethough.

Performance is the result of operational efficiency,strategic effectiveness and innovation. A performingbusiness does all three. In fact a business executive



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MUST balance total company concerns with detailed functional concerns for both the long- and short-terms. Thequestion is are they doing that? Our assessment is represented in the accompanying graphic.

In our view a business that's controlling costs and improving operational performance gets a 3, a business that'staking strategic initiatives in product development, new markets, etc. a 4 and one that is Innovating a 5. One thatblindly cut costs after being blind-sided by a foreseeable downturn and doing a perfect imitation of a deer in theheadlights is in the Red/Yellow Zones, with a 1 or 2. Everything we've read, seen or heard is that the vast majorityfalls into the Danger Areas. Just to drive the point home we need 2.5% job growth to recovery a prosperouseconomy. To get that kind of growth depends utterly and finally on the majority of businesses being in theBlue/Green Zones. If you can counter that we really hope you're right!

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Let's be clear - we're facing at least another decade oftroubled times. And, in fact, we've lived thru three decades ofsuch times judged by the job creation evidence, living in adebt-fueled, profligate and misspent economy. Yet everyone

looks back on the 80s and 90s as "Golden Ages", despite theevidence we have now and despite the evidence adducedand presented by several folks (Krugman for example) then.Now that we really are deep in the doo doo what's theoutlook?

That depends on how we respond - how we evaluate thedata, what kind of decisions we take, how we act on thosedecisions and how effective we are implementing andsustaining them. The readings are, so to speak, bookendedby the comments of a distinguished British historian talkingabout the need to keep things simple and understandable onthe front. And by the executive brought in to clean up Enron

on the back talking about honesty, integrity, clear-sightednessand a high-performance culture.

Unfortunately, that's not the way our brains our built. They arebuilt by evolution for our forebrain (the modern) to be clever ingetting what the Monkey (the midbrain) and the Lizard (thehindbrain) want. Now we need the Lizard for its reflexes incrisis and the Monkey for its curiosity and drive. The questionis can we learn to train both to be evidence-driven? Instead ofimpulse controlled. There's been a revolution in the lasttwenty years in cognitive neuroscience showing that that's notonly possible but showing the brain circuits changing as it happens. Of course this is what the Buddhists havebeen working on for 2500 years. Clearly it's possible. Equally clearly there's a pretty good case to be made that it

hasn't happened for the majority of businesses.

And therein lies the tale! Just to close out, amuze you a bit and make our point (if you listen carefully to the wordsas well as watch the Performance [puns intended] we give you the Muppets Doing Bohemian Rhapsody! (http://www.youtube.com/watch?v=cGlTzt24Izw ).



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December 09, 2009

Adaptation & Resilience: Looking for the Naked Swimmers

http://llinlithgow.com/bizzX/2009/12/adaptation_resilience_looking.html

One of our constant themes around here is thatit's the age of the "New Normal". The last postreviewed some key arguments that we hope willstick in your mind, talked about some key findingsregarding the state of employment and theoutlook and linked that into market performance.(BtW - can we rest our case about over-valuationand market fragilities given week-to-date marketperformance?). We'll re-visit the new normal withregard to both the economy and the markets -and ask that you review the four points - but wantto focus some more here on business response.

Last time we talked about "deer in the headlights"syndrome among executives. Now we're going todig into that a little deeper, that is what do wemean by that? In particular we ended updiscussing the importance of business jobcreation and the mental agility and resilience ofexecutives. And make no mistake - it's a lot easier to sit on the sidelines and critique their responses.

On the other hand they've been very handsomely compensated for sitting in the hot seats. The questions becomehow to judge who's earning those salaries? And what to do about it? The last post worked its way to this chart,which summarizes our impressions of how companies are, on the whole, responding to the crisis and positioningfor the future. The answer is, not very well. As Warren says, and is now frequently quoted, we're finding out that

there are a lot of folks who floated with the tide and now that it's going out turn out to have been swimming naked.As an investor, employee, business partner or other stakeholder you need some way of judging the clothed fromthe unclothed.

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A couple of weeks ago the CEO of the Boston Consulting Group (BCG) hadsome interesting and revealing interviews with the Financial times. He's a tadcircumspect, to say the least, but if you listen carefully you'll here what wemean. Oftentimes the first thing to do with regard to dealing with a crisis is toadmit it exists. The "sudden" appearance of a major downturn that turnedinto a crisis last Fall caught almost all businesses by surprise, though

arguably it shouldn't have. At least not on the evidence we've been trottingout for almost three years here!

This is Part 1 of a three part interview. Part 2 and Part 3 are also online andwell worth listening IOHO, by clicking on thru or just letting the FT video site take you there. Herr Burckner lays itout nicely though. Including the argument that, having survived the crisis, a strong sense of complacency and thistoo shall pass has overtaken most management. In other words they aren't preparing for the future we think is alltoo clear! (http://www.ft.com/cms/8a38c684-2a26-11dc-9208-000b5df10621.html?_i_referralObject=10606516&fromSearch=n )



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The second biggest problem, after recognizing the situation,is figuring out what to do. Those that haven't frozen up at thefirst hurdle often freeze at the second, which is often moredifficult because the old built-in responses won't work. Justmeat-axing costs and laying off people while curtailingcapital investment and R&D spending will simply store uptrouble for the future. Resilient adaptation requires newthinking and new responses - and that's hard! Especially ifyou were caught by surprise and are still scrambling to catchup.

Lest you think we're making all this up we've borrowed somecharts from some other BCG studies (some of which we've

admittedly shown before) to back up our assertions. The topsub-chart is a conceptual view of good vs. bad response,though we'd add a truly class 1/2 company would alreadyhave been re-thinking their business model and strategies(as MCD and the other examples we discussed in the firstchart did).

The middle chart give you some strong indicators to assesswhere a company's response fall. Based on this survey workmost of them fall into the trim things up and hope for a returnto business as usual. Let's make that point really explicit -any company that's "just" trimming costs and managing it'sfinancials gets a 3 at best on our ranking scale; and that's

being generous. We'd even argue that continuing to invest inR&D, albeit at a reduced rate, to maintain longer termeffectiveness should be a requirement for a 3!

If you don't think all that's important we went to the trouble ofcollecting all our prior posts on the auto industry and onfinance where we repeatedly applied this sort of assessmentto their performance outlook. The Auto Industry study is here while one of several finance studies is here. In both casesthe bottomline is the same - complacent, business-as-usualresponse are a death knell!



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One of the most common complaints that you herefrom executive management is best put as, "they

made me do it". That is the quarterly performancenumbers and reported earnings per share numbersare so important that companies will go to any lengthto try and meet expectations, which they've donetheir best to lower anyway, including selling their ownchildren in effect. Their children in this case being thelong-term health and capabilities of their companies.

Now that's actually never been true. If you have acogent, defensible and credible story to tell aboutyour "Theory of the Case", that is how you're going tomanage for the short-, intermediate- and long-terms,Wall St. has always been prepared to listen. AsFedex and Expeditors International have beenproving for years. And as Carol Bartz at Yahoo isproving now.

But there's also evidence that there's a more generalchange underway in the Finance community. BCGhas obligingly provided us with this second chart setwhich is worth some careful study. The top shows PERatios vs. CDS spreads. Now a CDS spread tell youwhat a company has to pay for default (BK)insurance on its debt while the PE ratio tells you whatinvestors think of the long-term (well sorta) growthand earnings prospects. Interestingly the folks in theupper left corner, the good corner, would still only get

a 3/4 on our rating scale.

But even more interestingly BCG only found about 20% of companies qualify as Haves. Instead of interestingmaybe we should have said scary. The bottom chart is another form of verification coming from a survey ofinstitutional investors and the factors they'll be using to evaluate company performance. In both cases you havepretty independent confirmation of our arguments AND, this is important, a strong indicator of how performanceassessment translate into market judgment.

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As usual you'll find an extensive series of readings intended to provide moreammo for these lines of inquiries. It starts with another dissection of earnings

and selected company outlooks, the failures of forecasting and theconsequences of business failure. It then continues to look at the new rules forthe reset economy including those companies (Level 4's?) who are moving totake some strategic advantage of the crisis by going for market share and thespecific example of GE. The latter reading was collected before the NBCU salebtw.

It then takes you to the questions of agility and re-thinking your business modeland a discussion of why operational strategy is so critically important.



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Something most companies not only neglect but completely ignore but is fundamental to good performance. Itconcludes with some pointers on finding the next McDonald's. A question to which our answer is look for the Level4's and 5's!

But other than that survey we'll pass on a more pungent summary and instead appeal to yet another authority,Jim Collins, who's latest book is "How the Mighty Have Fallen". A book he started working on a long time beforelast Fall's disaster. He lay out five typical steps in how companies get themselves in trouble. If the link doesn'twork go to www.charlierose.com and search for Jim Collins in the new format.

We will tell you about one of the most fascinating conversations we've had in a long time about corporateperformance. An acquaintence and I were discussing why so many companies get themselves into so muchtrouble. His answer, which I consider deeply insightful is that because most companies are unwilling to hear thetruth they create an internal climate where the only way to survive is game the system. In other words we'veinstitutionalized mal-performance because executive management "can't handle the truth". But listen to Collinsand think about it! The companies you want to be working with or investing in are the ones who can face the truthand figure out what to do about it.

Hard, hard, hard. How many would rather stay in denial and simply go down with the ship they know? On the dataabove, whether they know it or not, it would appear to be most of them. And if you believe us that we're facing anextremely difficult decade they will not be among the survivors. Certainly not among the performers!

December 23, 2009

A Bit of Xmas Cheer: Innovation As The Future

http://llinlithgow.com/bizzX/2009/12/a_bit_of_xmas_cheer_innovation.html

The last several posts might have struck you as a bit depressing. The next in order might have been a year-endish survey and summary of the markets but given performance over the last decade we didn't really want tohead into Christmas Day with that on your or our minds. Instead we're going to pick up the thread of businessperformance and concentrate on the future and what we think are some reasons for optimism. At least guarded

optimism. Though we're going to start with a bit of a down note by adding one more chart to the chain of argumenton the long-term economic challenges we're facing. Our optimism rests on the notion of Innovation, which we'vecovered before. The challenges are indeed dauntingand long-standing but we've faced worse, on both theenterprise and total economy levels. So what rays oflight are there for this optimistic season?

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We'll let's start with one semi-final note of a darkerhue and compare GDP Potential with Actual over thepost-WW2 period. Potential GDP is the level of

growth that we could reasonably expect if theeconomy was efficiently and effectively operating sothat all resources were fully employed. The CBOmakes continuous estimates of this number and doesa pretty good job - it is if nothing else an excellentbenchmark to start with.

The top chart shows GDP Potential (dark blue) vs.Actual (light blue) since 1950, as well as thedifference between them. First off, in case you had



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any doubt as to the real depth of this Great Recession, this ought to put them totally to rest. We've never beenany farther below potential in six decades than now.

The bottom sub-chart shows the difference compared to the running total difference, the aggregate (in red). Asalways click to enlarge. Notice that the aggregate differences ran close to zero thru 1980 and then starteddropping away. As we know from the previous post on Debt, Savings and Investment, that was because of therise of over-consumption fueled by debt. Our grandmothers were right. Then in the mid- to late-80s it reallydropped until it started to recover a bit in the late 90s, due to an economy running above potential (as good asany working definition of a boom as there is).

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If it's not clear running companies efficientlyand effectively is a necessary condition forsurvival. But in this new economy, where thesins of several decades have caught up withus, it is NOT sufficient. Digging out of thishole will require the creation of new value(new products, new services, new paths tomarket). A main reason for a pronounced lackof Innovation, as opposed to "mere"inventiveness is confusion over whatInnovation is combined with poor execution.Let's start with this graphic showing how it's generally treated and what's wrong with that view.

First off invention is not innovation. All to often the coming up with an idea is mistaken for delivering it in usableform. Innovation IS the creation of new delivered value, not the exercise of cleverness. An academicacquaintance of mine was running a multi-year research project which we tried to shape by trying to expand hisframework. Unfortunately his sponsors (mostly corporate researchers) were only interested in tools andtechniques to help them with lab work, not in creating new things. You can see this in history - the greatinnovations that drove post-WW2 growth in the US were the result of investigations during the 20s and 30s,scaling up to industrial production levels during the war with government money and then the post-war

commercialization by private industry. If we're going to have another Golden Age like the 50s it'll takeinvestigations, big ideas and delivery of those ideas.

What happens now is that most organizations think they come up with an idea, sail it over the transom todevelopment and production who readily and straight-forwardly turn it into a product and then pass it on toMarketing and Sales who will have no problem wrapping a ribbon around this great idea and turning it into thenext blockbuster. Almost a year ago now we posted a question on LinkedIn to see what folks thought and gotsome substantive feedback, ALL centered on culture and responsiveness. That's a recipe for a resilient andadaptive enterprise within existing boundaries - not a way to create something new, meaningful and valuable.



Page 14 of 43



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So how should it work? There are two levels to the answer, one explicit and the other implicit, in this graphic.

First, start with a real problem whose solutionaddresses real wants and needs in themarketplace. A lot of VC-funded startups failright here because they go after "neat" stuff(which is also the typical problem with the as-isapproach). The really critical next step, thecentral engine, is to analyze the needs andtranslate those into the high-level design, froma business (or customer or user) perspective.All of the innovation projects that fail tend to failhere....and that's based on literally decades ofworking on such projects personally as well asobserving lots of others.

Then comes the very hard but somewhatstraight-forward processes of translating thevalue-driven design into engineering andmanufacturing. A key here though is feedback- what are the tradeoffs between boots on the ground reality and initial fantasies about what you want? When youhave a multi-functional team actively involved thruout the entire process it's possible to make sound judgmentsabout the pros and cons. When you manage the process thru transom-sailing, which is the typical approach, youget more Edsels.

The other big glitch is when you finally take your dream to market. Typically marketing and sales are brought inonly at the last to put lipstick on a pig. That leaves them with little or no choice but to, shall we say, present analtered reality. If M&S have had early involved, in fact if market-based business analysis was your starting point,then you know what the value is and can carry that message all the way to the go-to-market activities. A night and

day difference, in our experience.

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Business as a whole should be a team sport butespecially innovation. The approach where eachfunction works in its own little silo with no cross-linkages and no feedback or feed-forward will endup with a lowest common denominatorcompromise. Pleasing to no one and not likely tosatisfy the market or customers.

If you look at organizations and companies thatare effective and repeat innovators, like Pixar orApple or Boeing, what you see over and overagain is highly motivated teams with goodexecutive sponsorship sharing a commonendpoint vision, coordinating their work and ledby an executive who has the vision, the technicalcompetence and the human skills to make morethan the sum of its parts from a disparate and multi-function team.



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If you want to see this in action we know of no better example than Lord of the Rings - get/borrow/steal theextended edition DVD and watch all the special features. The level of commitment, sheer inventiveness andwillingness to both know their own specialty while serving the overall objectives of each of the specialists isamazing.

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A while back Business Week had the sheer audacity and gall totell us the truth - the Emperor has no clothes. In other words wewere and are suffering from a lack of Innovation. That's onereason that jobs, wages and economic growth have beenstagnant for so long, along with all the others we've beendeconstructing.

But at the end of the day the two biggest barriers to successfulinnovation are rooted in executive leadership. Most companiescan invent and deliver new products or services that areconsistent with their history and culture. Few, if any, can dosomething that's truly outside the box. For one particular bigexample consider IBM's work on e-Business, which IrvingWladawsky-Berger discusses in a recent blog post (The

Evolution of Collaborative Innovation). Irving tells a good storythat's true and accurate, but (IOHO) incomplete (read the comments). We also were involved in the teams thatcreated e-Business but on a whole different, and far less successful, side of the house than the technologists.

Aside from Culture the single biggest barrier to real Innovation is that almost all companies treat it as "business-as-usual". They establish the same set of performance criteria, insist that standard operations be used, apply thesame overhead rates and judge returns as if this were an existing business. Strangely, oddly and sadly enoughIBM scaled up the commercial PC business by breaking those rules and creating a stand-alone business unitoutside normal controls and management systems.

If organizations truly want to innovate they need to treat the investment as a separate and stand-alone project.Remember our saying that there was an implicit message in the Should-Be chart? Well here it is - Innovationshould be viewed as an inter-linked chain of activities with its own separate management systems based on aproject orientation, rather than as an on-going business.

And that's the magic ingredient in a nutshell. But in the coming turbulent decade of extended doldrums thecompanies that Innovate will be the ones that do well. Whether as employee, supplier, customer, investor or otherstakeholder those are the folks you want to look for.



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December 25, 2009

Christmas Wishes: Peace, Prosperity and Performance

http://llinlithgow.com/bizzX/2009/12/christmas_wishes_peace_prosper.html

Please consider the normal wishes and sentiments of the season extended, sincerely and well, to all my readers.Christmas is the day and season of renewal and hope, and has been for ages, even millennia. It, after all, is theSolstice which all Man's religions have recognized in some form or another for as long as we know.

As is our wont however we would like to put a little more substance and reflection around the surface. It is also aseason for reflection on the year and years passed and on what the future may hold. Hope is one thing but hopebased on substance something different. Based on previous posts it's clear that this next year, even this nextdecade will be challenging.

We exited the last decade and entered this one in a state of euphoria that went aground on many hard realities.While it would be "nice" to suppose that some cosmic scale would see us entering a decade with a distinct lack ofeuphoria to be one of progress and prosperity. Alas, all the signposts point to continued challenges. Yet there is

hope - not least that we recognize these realities and prepare to meet them. And in that, combined with action,lies the true hopes for a good decade.

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In a word we hope to see Performance this decade instead ofcontinued coasting along on leverage, failures to execute andstrategic mal-adjustment. At the end of the day, therefore, all ourhopes rest on the ability of business to do its job and perform.

For our inspiration we look to the great Japanese Zen sage andfounder of the Soto sect, Dogen. One of the greatest thinkers,

philosophers and poets who ever lived, and capable of putting themost profound truths in the most elegant and simple verse.

In Steve Heine's wonderful translation, "Verses from theMountain of Eternal Peace", Dogen says:

Attaining the heart

of the sutra,

Are not even the sounds

Of the bustling marketplace

The preaching of the Dharma?

As Adam Smith pointed out a long time ago, though almost a1,000 years more recently than Dogen, man has a naturalpropensity to truck, barter and trade. Economic relationships areas natural to man as any other and promise more increase in well-being than any.

The Dharma is the natural way of things, the ultimate truth(s), which we must strive to see by seeing andunderstanding things as they are. Without distortions or delusions. A sutra is a major teaching of the Buddha, a



Page 17 of 43



doctrinal bedrock akin to the Bible or the Quaran, in which he set down his lessons for all to read, study andadapt.

Thus, we take the poem to tell us that doing business is a natural activity of humankind and that in conducting itwell, with honesty and integrity, we pursue the path toward enlightenment (small e of course). And that conductingbusiness well is as much a natural activity of us all and can take us in positive and productive directions. IF WECHOOSE.

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Our great sage of business performance isPeter Drucker who seems to us isn't just amember of the Panteheon but defines it. Aposition he earned by focusing on those things abusiness needed to do to perform thruout along, exemplarly and constructive life whosecentral concern was making things better.

What is the purpose of Business? It is toprovide goods and services that create value inthe marketplace for the rest of society.

What is the measure of an effective andsuccessful business? It is Profit - but not profitas it is usually grossly mis-understood and mis-represented. Profit is not the "excess" returns tocapital (an accident as it were) but the cost ofdoing business that provides funding for jobsand job growth, insurance against ups anddowns, the funds for new capital spending andthe only way to invest in new ventures. Withoutreal Profits, well-earned and wisely spent,

business does not perform.

How should a business conduct itself? It should provide a valuable service that justifiably earns a profit, itshould create a productive working environment, for its employees sake and in its own self-interests inperformance and it should be socially responsible in the broadest sense. That is it should first do no harm andcorrect the ones it causes, it should collaborate to reduce the impacts of unavoidable harms and it should supportthe effective solution of broader social problems.

How should it meet those goals? By balancing the overall performance requirements of the business with thecapabilities and characteristics of the key operational functions and by making each decision for both theimmediate needs and long-term requirements for performance. Above all, when those basics are satisfied, it mustInnovate, and continuously re-invent itself.



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The problems we've chronicled that interfere with meeting those goalsare largely rooted in the decades prior to the Noughties. We coasted thruall these trials, tribulations and turbulences on the backs of financialengineering and shorttermerism, with the underlying structuralweaknesses disguised, as it were, by a high fever of money and paperprofits. This next decade will require facing the challenges of reality asthey are, not as we'd wish they were, determing the correct pathways toperformance, pursuing the necessary actions with dedication anddiscipline and delivering that performance thru sustained execution.

In other words, judged by Drucker's standards, business did not performwell this last decade.

The difference between survivors, prosperors and also-rans (or the dead

for that matter) lies in not deluding ourselves.

Ganesha is the Hindu deity of obstacles and wisdom and new ventures.In all his attributes therefore let him be the deity of this next decade forbusiness. This decade is a time of risk and opportunity. Where it falls, onbalance, is going to be up to us and doing the right thing.

December 28, 2009

Dealing With the Brave New World: Resilience vs. Sclerosis

http://llinlithgow.com/bizzX/2009/12/dealing_with_the_brave_new_wor.html

By this time we hope it's crystalline that the"Brave New World" is going to be tough,steep and rocky, that is no more liquidityfrom which we can all get high fevers andhave bubblicious ephorillusions (boy, don'tyou just love it when word coinage canreally get carried away). We won't revieweither the extensive de-mythologizing wespent so much time on, nor the equallyintensive review of the long-term structuraloutlook for the next decade. Hopefully, it's

not necessary, right? Instead we're goingto turn our attention to the critical fulcrum -how are businesses preparing for the thisupcoming decade? One where there ARENO mysteries about how tough it's going tobe.

We started this series by setting out amarker that summarized our bestimpression from our network, other



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contacts, and various readings and used the accompanying graphic to illustrate our main points. Sadly, ourfriends at BCG have just published another study (not available yet) on how businesses are responding andconfirm there own findings from earlier in the year as well as our own (you'll find a link to the WSJ's summary inthe readings). Let's repeat it - businesses are NOT prepared, preparing or anticipating. Instead they're all prayingfor a miracle - we won't retell the old joke about the believer who drowned after being given multiple chances tosave himself but it seems to apply.

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Let's make another key point briefly - aboutwhy your care. It doesn't matter whetheryou're an employee, a business partner, acustomer, an investor or otherwiseinvolved - just general citizens ought to beconcerned because it is businessperformance that drives how and when jobs are created and, ultimately, whetheror not the economy grows and at what rate. When we focus on the big abstractions this down-in-the-mud viewdisappears all too often but this really matters. We can't put it any more clearly than that (and the graphic is ourattempt to bring it home).

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Let's re-visit another previous BCG graphic (ourcompositing) that the recent findings confirm andamplify. The red line in the top chart is howexecutives should not have reacted to the downturnand the crisis but is emphatically how they did.They ignored the warning signs, waited far too lateand then were forced to make drastic, meat-axecuts in costs - often reaching beyond the bone. Andcertainly damaging morale and attitudes as well asmortgaging futures by truncating new projects andR&D. By our standards the worst thing they did wasdo their meat-axing arbitrarily and out of balance.That is they just went ripping thru rather thanweighing and weighting each of the functions,status, contribution, performance and opportunities.

On the bottom chart what you see is the actionsthat got the most attention. Which are the short-term and short-sighted ones. And what the recentBCG studies tell us is that this same blindness,willful neglect and wishful thinking is, by the

executives own admission still going on.

Only this time around - a consequence of all oureconomic analysis - there's not going to be anotherasset bubble to bail people out with artificiallystimulated demand and growth. Not Tech Bubble,not Housing ATM. In fact, just the opposite. Take acareful skim/read of the excerpts in the readingsection. You'll find a very carefully selected set of links that summarize the key characteristics of this brave new



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world and why/how businesses are struggling with coping. They range from deep changes in consumer attitudestoward frugality and value to the over-emphasis on financial engineering and short-term paper earnings displacingoperational and industry savvy to some of the ripple effect consequences. Including all the businesses that bit thedust this last decade, the growing public backlash that's leading to major regulatory changes mandating pay forperformance for ALL companies, not just financials, to perhaps the most important. That would be the attitudinaladjustment crisis and lack of confidence.

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We don't know how many of you havebeen involved in the decision makingprocesses inside any organization, letalone large ones. Obviously the biggeran organization the more complex it isand the more difficult to coordinate. Infact one possible problem is that asorganizations become ginormous that

the amount of nerve tissue required toconnect all the parts and coordinatethem starts to absorb to manyresources and slow down and distortdecisions. We've all seen that, at leastsymptomatically.

But there are two fundamentalproblems that you have to besomewhere near the insider toappreciate. Most people thinkbusinesses are run by the org chartwith steely-eyed killer analysts and

hardcore decision-making machinesas the executive making all the rightchoices based on a completecommand of the inner nature of theUniverse. (the reference here might beto E.E. "Doc" Smith's Grey Lensman scifi series). Well there are no Arisian super-beings here, unfortunately.

Let me give you two constructs that serve well. Once the formality is over think of the table in the boardroom as apoker table - if you've delivered before you get more chips and the House will hold your marker. The second andeven more important construct is political log-rolling - too many business decisions are made based on whatexists and the amount of sunk resources, thereby reinforcing history instead of investing in the future. Over timemore and more decisions become less and less about creating external value and more and more about internal

gerrymandering. We could give you explicit examples but then "they'd" come carry us away. Consider that yourintroduction to the real dirty little secrets of corporate politics.

So we'll give you this abstraction to think about. As companies grow and mature they build out their organizationsand accumulate investments in people, plants, equipment, etc. More importantly a lot of rice bowls get attached tothe the way things are - not the way they should. We know of one major telecom firm who made office phoneswitches using the old telephone circuitry who had a prototype of a new software-based VoIP platform that wouldhandle any service on any size from small-business to major phone company. They shut it down because theexisting business, more importantly its executives, found their positions threatened. That's the difference between



Page 21 of 43



rent-seeking vs. profit-creating, or between internal political agendii and external value generation. We call itorganosclerosis - organizational sclerosis.

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The cure is simple in practice and devilishly hard inexecution. It requires good people, courage andsound leadership, above all other things. If youbrowse back thru all the companies we've cited goodand bad you'll find two sets of characteristics that areconstant. ONE - the ones that got into trouble did sobecause they got sclerotic and they got scleroticbecause leadership refused to tackle the problemseven when they knew they were major problems. Two- the companies that avoided or dug out of troublebroke up the political plaque and did it with goodleadership. Whether we're talking WMT, MickeyD's,HPQ,.... and others that's it in a nutshell.

The third thing you'll find is that each of thesecompanies had crisp, well thought out answers thatthey committed to and executed on to the questionsin the chart. If you listen to their conference calls,read the annual report or analyst presentations, checkout the press or otherwise investigate you'll be able tofind out what those answers are. Even moreimportantly you can watch them in action - how arethe stores laid out, what products are there at whatprices, what kind of PCs do they make and are they any good .... and so on and so forth.

That brings us full circle to the original "investment mantra" from economy to performance to profits to earnings toreturns. Ask yourself what the answers to each of those questions are in each of the timeframes. If you can't find

out then think twice. Just consider - what if anybody had applied this test to, say, Enron or Worldcom last bubbleand bust? Or Lehman, Bear Stearns, Citi, et.al. this one? We doubt that any of them would have passed any ofthese screens. It turns out you might be able to be an Arisian in training after all (sorry for all the obscure old scifireferences but once you get rolling and it works...it's hard to just pun one).

March 20, 2007

People & Performance: Assets or Fungible Commodities?

http://llinlithgow.com/bizzX/2007/03/people_performanceassets_or_fu.html

It's long been a truism that 'people are our most important asset' but anybody with a little bit of real-worldexperience has plenty of ground to question that. If you want some interesting evidence follow an old colleague'sadvice and read a Dilbert book from cover-to-cover, if you can. Amusing one cartoon at a time but taken as aseries deadly depressing. Many things are embedded and embodied there but one of the keys is this fundamentalquestion:

Are people truly assets or are they consumables that're easily replaced?

Now if people were really and truly assets we'd apply the rigors of capital budgeting, discounted cash-flowanalysis and IRR assessments. Despite the unhappy reactions I've gotten to that suggestion stop and think about



Page 22 of 43



it for a while: we look at capital over it's total lifetime, understand that regular maintenance and upkeep is requiredand the total life-cycle costs and benefits do NOT happen with one fell swoop. Why can't we apply the same logicto people.With at least two fundamental differences:

1. People are appreciating assets - unlike others they accumulate experience, training,

contacts and knowledge. Their productivity and value should grow over time.2. People are the last thing between you and your customers - and your suppliers for that

matter. If you'd like to establish viable and effective long-term relationships it should pay

to treat them well.

If you stop and think about it for just a bit the widely shared tribal folk wisdom of business and organizations isthat in fact people are treated, depending, as anything but assets. Somebody who's made a major part of hiscareer in examing the characteristics and consequences of that 'strategy' is Prof. Bob Sutton of Stamford who hasan excellent blog up at Work Matters .Bob has recently published his latest book "The No Asshole Rule" which has gotten a huge jumpstart in the blogcommunity and is know a bestseller on Amazon before even hitting the mainstream. Highly recommended as ishis blog.

There's a recent entry on the blog on the "Waste of Talent" which reflects the huge outpouring of painful storiesthat indicate how widespread the problem is. I'm sure Bob's e-mail is getting swamped. You can read mycomment there but let me put it up here as well. In my earlier, first post on Nardelli's impact on Home Depotenterprise performance I tried to link external performance measures, market value, to the treatment ofemployees and customers. That approach is a top-down one that reflects Mr. Market figuring out something iswrong, rather badly wrong, and adapting valuations accordingly. The Efficient Market Hypothesis is all well andgood but it takes a while for the distinctiveness of new information to be absorbed by the collective. It's fairer todescribe the market, in the short-run, as Adaptive.

I'm not sure that Dark Minions actually do make money at all for themselves or their company.Rather it's a question of the measurement and management systems not capturing thedamage they do. One could take that top-down or bottom-up. For the latter consider - if anasshole is abusing their team then more and more of the team's efforts (as ALL your stories

show) goes into avoiding him/her and diverting their effort into other directions. And thatgeneralizes to a company-wide basis - can't tell you for example the number of folks at well-known large companies who've told me how bad things are.

If after several rounds of over-work, bad measurement, etc. etc. the bulk of the employees keepreducing their efforts while spending all their time watching their backs and looking foralternatives you get an original 80% effort reduced by, say, 20%, at several rounds of stupidity.

Well .8 x . 8 x .8 X .8 is 40% or so. In other words one gets 1/2 the effort from skilled employeesthat one is ostensibly paying for.

It doesn't take many iterations for this to destroy a company's capabilities. Yet becausepeople are treated as fungible commodities instead of (uniquely) appreciating assets they're

grossly mis-managed.

Turn it around - good service is a major requisite of good competitive position yet employeeabuse causes them to spend less and less on attending to customers and you get the externaldeath spiral going. For one perspective on how that played out and is "measurable' at HomeDepot see the prior post on Nardelli: Cheap at the Price ?

Interestingly enough there's reverse evidence when you look at how the military performs. Despite the reputationof top-down, rigid hierarchies the modern US military has gone, and continues to go, to great lenghts to push



Page 23 of 43



empowered decision-making as close to the frontline as possible. In some cases, for example, USMC doctrinecalls for local operating authority to devolve to the squad leader, a corporal. And the Corp expects all its' leadersto take care of the folks underneath them. Which makes perfect sense on several levels when you stop to thinkabout, and for many reasons.One of which is the joint benefit to all the team-members is pretty clear. Have you ever stopped to wonder whyeveryone who works for an effective startup is excited and works long hours at 120% efforts levels. Sure, some ofit is the wealth prospects and some of it's the challenge. But a lot of it's the fundamental satisfaction we all getfrom doing good work that is worth doing and makes a difference.The real question is why don't we manage our organizations to maximize total performance by managing peopleas assets?

July 23, 2007

Aholes, Shirkers and Performance: a Draft People Principles Policy

http://llinlithgow.com/bizzX/2007/07/aholes_shirkers_and_performanc.html

Several posts here have explored the relationship between enterprise performance and the human environment.The argument is that the better people are treated the better they will perform for the company by taking care of

customers and its' interests. Now my biases in this case are shaped by both my management experience and myearliest working experience at Fedex who's motto was/is "People, Service, Profit". And they backed it up - thethree policy manuals around which the company governed itself were the People, Service and Profit manuals.Compensation and promotability were determined by effectiveness in people management and they've foundsince their beginnings that people are the key to service which is their whole reason for existence (& pricing andprofit : ).That said, at the same time, people are definitely not all perfect. In fact my experience has been that out of anyten person team normally assembled you're lucky to get one star solid performer, three decent ones and a lot offolks who'd like to be more than they work or are capable of. And further everybody's in denial about this fromboth sides - both bad bosses and bad employees. With all due respect to HR's due processes they aren't takenvery seriously in general.

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UPDATE (8/1): Seth Godin has two interesting post on toxicities among bosses and employees that are short,sweet and to the point. To which I'd add, my point here, toxic behavior is not rational (this is a family blog soscruples prevent putting it more strongly).Bob Sutton over at his blog has covered his new book "The No Asshole Rule" and triggered an avalanched ofheartfelt outpourings on bad treatment. Some of the stories of aholes run amok and bad people policy are....what? Startling, heartrending, make you shake your head ? Well my triggerring was to start wondering about therationality of these choices and on several lines of inquiry I'd argue that we can make a very strong case (see thethree prior posts cited below for different perspectives on total enterprise performance and people management).Let me put that more directly and strongly.

1. Bad people policy makes no rational sense and damages corporate performance in the short- and long-runs.

2. Bad people policy has a measurable impact on both enterprise value and internal efficiency andeffectiveness. It is NOT judgemental though judgement as to consequences is required.

3. In other words the costs and benefits of strategic investment in investing in people can be thought of inthe same way as we do other strategic choices.



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In other words we've all known for a long-time that we don't like working in bad environments and our collectivetribal knowledge is that it's bad for us, for the company and for the stock. But we've also generally talked aboutthese issues in 'soft' terms. I would argue that's mis-guided when the problem is properly framed and thought thru.So how to bridge the gap between delusions and realities ? Well, it's not entirely clear that I've got an answer butbeing on a plane and in that wonderful state of sleep-deprivation, crampedness and caffeine over-dosing wheresometimes the gods speak to you what they suggested was this little manifesto. It's based on the principle ofrunning a company for adults. See what you think:

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1. You are an adult, worthy of respect, who has every right to be treated as such and so expect.2. But we also expect you to be and act as an adult who takes responsiblity for their actions and deals with

the good and bad times equally well.3. You are entitle to a fair day's pay for an honest day's work4. We expect you, in fair exchange, to put the organizations long-term best interests first in your priorities

but not to the unbalanced exclusion of others in your life.o The virtuous circle of priorities is Customer (take care of them), Organization (which results in

satisfaction and value) and You (so the Organization will take care of you).5. We will walk this walk together - not just talk about it while we walk to the bank and you walk to the door.6. Good work done well is worth doing and it's fun (or least satisfying). We intend to do good and do well

and have fun as best we can manage.

Taken all together the organization will perform better in the short- and long-runs. Which implies the pie (Pi as inprofits) will be bigger for all of us even if somebody's slice changes relative size.

The prior posts that make the case are:

• People & Performance:Assets or Fungible Commodities ? • Aaargh, Captain Ye Best Take Care of the Crew

and Bob's blog is here and one of my favorite posts dead on this is "Waste of Talent" .

December 31, 2009

Renewing the Enterprise 1: the Proper Management of Innovation

http://llinlithgow.com/bizzX/2009/12/renewing_the_enterprise_1_the.html

By this point it should be absolutely clear that we're facing manychallenges, collectively and individually, to recover from a brushwith near-death. It should be even clearer from out earlier

discussions that our present troubles are the accumulated resultof the last three decades of not-so-benign neglect, wishfulthinking and refusal to face facts. Equally clear should be thenotion that this next decade will a challenging one with nofinancial leverage to bubble us out of our troubles. We're goingto have fix this old fashioned way - by earning it. There are twofundamental directions we need to pursue.

One is making the enterprise perform as it ought, the subject ofthe last post (Dealing With the Brave New World: Resilience vs.



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Sclerosis).

The other is that we need to find, develop, create and deliver new sources of value, also discussed in a previouspost (A Bit of Xmas Cheer: Innovation As The Future). On reflection and discussion it occurred to us that we didn'tlay down enough detail to get specific and convincing so we're going to re-visit the subject of innovation in somedepth. And do so from the perspective of how to make it happen, not why it's such a good thing. The New Year istraditionally when we look ahead with some hope to a better future but what is faith without execution? Let ustherefore "Make It So". (Christmas Wishes: Peace, Prosperity and Performance).

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So what is Innovation? And how does itwork...or should it in our idealized fantasyworld? The last Innovation post wrestledwith the first - Innovation is NOT invention,nor is it clever people sitting around makingincremental improvements in existingproducts. It is the creation of new value.Two things happen in general regarding I-discussions.

First off the more trouble an organization isin the louder the arm-waving about.Followed by a lack of delivery - noresources, no commitments, too muchrules-as-usual. NB: Innovation is notmeasured by the size of the R&D budget.Those are inputs. What we're concernedwith it outcomes. The other thing thathappens is that everyone stands aroundand talks about changing the mindset -building a new culture. Well culture is

important but again it's not Innovation.

On the next level down Innovation is a set of replicable processes that start with scanning all possible sources ofideas - ideas which must answer one fundamental question. What's the problem? And who's got it, can we solve itand what's it worth to you. The first step in the process is picking up all the little bits and pieces floating aroundand experimenting with them, rigorously, to see what starts passing those tests.

The first test is the demographics and sociographics of demand and value, not leaping into development.Demographics is the analysis of standard customer data (otherwise segmentation) but what you really want toknow is not who they are but what they value. That would be sociographics and it tells you what features andfunctions satisfy which needs and wants, as well as the potential values and returns. Then you start doing Design- which should be the translation of market-based analysis into the high-level characteristics of your product,solution or service. Of course real men don't do analysis, they just start building. (My favorite tech cartoon is the

IT manager standing by the cubicle of his troops saying, "you guys start coding, I'll go see what the user wants").

Finally it has to be deliverable at an affordable price relative to value. Each of these steps defines a filteringprocess where possibles are winnowed to potentials and then down to probables - which you then get to test inthe marketplace. Notice that a) a lot of time, effort and resources are being dedicated here. Also notice thatthere's no guarantees BUT you can play the numbers game. If you're not willing to play for table stakes AND learnto play the game well don't bother kidding yourself or anyone else that you're serious about Innovation.



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Let's spin that overview down a leveland look at the activities within the bigprocesses and the links - which are asimportant as anything else. It's thefeed forwards and the feeds backwardfrom each activity to another, as part ofa synchronous whole that creates thereal magic. And where most effortstypically fail - no market analysis, nolinks to business-design (in fact nobusiness-design at all), and no designand build for delivery. It's an end-to-end view that's required.

What we've tried to capture in thisgraphic is the next level of detail, thelinks and the content that's carried

around the loop. Anytime you have aloop you have feedback. Anothertypical failure point is that things arethrown over organizational wallsinstead of being an integrated flow.

Typically, for example, all the knowledge of customer needs and values used in design would makedocumentation and training a snap but is lost and the poor schmoos at the final end start from scratch. On asubject the probably don't actually know. So the rounded rectangles are the activities while the squares are theintellectual capital that should be carried along and appreciate thruout the chain of activities. Do it right and youget a virtuous cycle that runs faster and faster and better and better. Break it anywhere and you create risks offailure. Break or weaken it at too many places and the whole "machine" simply shakes itself apart when it's put tothe tests of the real-world.

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Above we said that Innovation was aprocess - or more correctly a linked webof processes and activities. It's also aproject and that's perhaps one of themost important challenges to bear inmind. Most organizations most of thetime are great at dealing with things asthey are - that is in managing theexisting business. And attempt to

squeegee innovation within theboundaries of the pre-existingstructures. Which is a death sentence(the reason the IBM-PC took over theworld (briefly) was that it was set up asa stand-alone.

The reason so much innovation comesfrom startups is that they aregreenfields). The cure is to treat each



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opportunity as a project. The difference between an existing operating process and a new project is that theformer has a set schedule and performance metrics. The latter is built up out of a set of related steps where youMUST complete them in sequential order or pause until you do. You're not running on a metronome here - nor areyou managing against the normal cost, return or headcount measures.

Here we try to translate those ideas and the ones on the activities into the skeleton of an Innovation managementsystem that's both a pre-defined process and a performance-based project management blueprint. We talkedabout three levels of types of innovation. The incremental which should run in existing organizations but, perhaps,off to the side. The major which requires more dedicated and stand-alone resources. And the Significant whichMUST be managed as a separate business by different metrics and performance measures. How you evaluateeach varies of course.

But you can use the blueprint to assess the likely performance in each case. Typically innovationorganizations/efforts are strong on low-level engineering and development, which are not then well-linked intodelivery. Roughly the "1" index-line in our graphic. So the first thing to do is figure where the major bang for thebuck is, typically in improving the grasp on the marketspace and translating that into design as well as puttingmore beef into incorporating your improved understanding of value into the delivery tools and content. That wouldbe the "3" level. Where you should be shooting for is the "5" level where you start to create the virtuous cycle wespoke of, with the hope and anticipation, and committed investment plan, to eventually reach the "7" level.You can use this template to evaluate any innovation or investment effort, at least IOHO. Just because a

company is spending a lot on R&D doesn't mean that it's effective. Conversely they may not be spending anusually large amount but if it's well-managed, along these lines, it will be productive.

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Just to prove our points about innovation,translating that into "on-the-field" execution, thepower of doing things differently and the fact thatmagnitude of resources is no measure of likelysuccess we'll point you to this Sixty Minutes storyon the coach of the Texas Tech Red Raiders andhis success in creating footaball power with a

resource base completely out-of-line with that ofhis competitors.

Lots of lessons here, or so we think, but youdecide.

It's not just Leech's different, even confusing,mindset. It's his ability to translate that into training,drills, plays and playbooks and train his players ina whole new game.

Pay particular attention to the quarterback's view of a Leech-inspired view of the field in action. And ask yourself ifthat's business as usual?

URL: http://www.cbsnews.com/video/watch/?id=4697690n&tag=cbsnewsMainColumnArea.6%20%20



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January 13, 2010

Pecora 2 Hearings, Malfeasances, Your Future & Cusp Points

http://llinlithgow.com/bizzX/2010/01/pecora_2_hearings_malfeasancs.html

The Financial Crisis Inquiry Commission (FCIC), orPecora 2, kicked off its hearings this morning with quickstatements from the chair and vice, testimony from theheads of 4 of 5 of the big banks, a second panel fromseveral investment banker/analysts with strongcriticisms and an afternoon panel from fourbanking/economic/housing experts.Frankly the hearings so far are stunning - intelligent,polite, informed, limited axe-grinding by thecommissioners (with some exceptions), almost noideology and a strong bi-partisan spirit of inquiry,digging into the data and understanding. In just today's

hearings (which we intended to listen to only for thekickoff but ended up getting sucked into for the wholeday mostly) we heard the entire crisis reviewed, mostof the major root causes id'd and the last two years ofback and forth raised, reviewed and either put too bedor confirmed. By and large the preliminary indicatorsare that our assessments align with the Commission's and the witnesses.

Just to set the stage however we'll start you off with a recent show from Bill Moyer's Journal on PBS where aneditor and a report for Mother Jones discuss their findings for why there's been such a delay in moving forwardwith reform and how the Industry has influenced things. (http://video.pbs.org/video/1380851536 )If you find yourblood pressure rising that was and is the intent. Perhaps the most interesting thing was that all the big bankersstarted off, stayed with and finished up with Mea Culpas and fairly forthright discussions of what went wrong (the

most intransigent and argumentative being Blankfein of GS, who more than got into it with the Chair).



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Let's start with some charts takenfrom Mark Zandi, of Economy.com,testimony. Zandi by the way is wellrespected on both sides of the aisle,was an advisor to McCain and has areputation for even-handedness.Starting in the UL corner he tell usthat after a near-collapse thatgovernment intervention hasstabilized the financial markets(under questioning he stated that theStress Tests this last spring wereTHE major turning point). At thesame time he also said that the

markets are far from healthy, using(UR) the bond markets and the levelof debt issuance as the criticalindicator.

He then went on to point out that itwas almost entirely the stimuluspackage that saved the economy perse from greater collapse and thatmany of the programs had large andbeneficial effects, leading to an estimate of 4% GDP growth in Q4. Yet also worried that the as the impact fadesthe risks of a W-shaped outcome are serious and would recommend another $200B stimulus follow-on (again,this from a McCain advisor). He also pointed out that (LL) the labor markets were damaged and recovering poorly

and would remain in trouble for a long time. Since all that lines up with everything we've been saying for monthswe thought it was profoundly insightful :)!

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Interestingly, despite differences inperspective (and one commissioner withan ideological axe to grind) all of thewitnesses basically agreed to the sameset of problems and breakdowns. Since

one of them (Michael Mayo of CalyonSecurities) was kind enough to providecharts to back up his diagnosis weborrowed a subset to create thiscomposite. (all the exhibits can bedownloaded from the FCIC's web site atwww.fcic.gov).

Starting in the UL corner he first pointedout that there was an explosion of



Page 30 of 43



securities in the 00's AND that the Asset/Equity ratios of the Banks and Securities firms exploded;i.e. they gotthemselves leveraged to a fare-thee-well (really interesting despite the roots lying in the 80s this didn't explodeuntil this decade).

Moving down the left column that much of that issuance moved from secure instruments to structured productsand that this financial engineering drove a huge surge in fees. No self-interest here of course. Moving to therighthand column we see the concentration of this new issuance in real estate trading in one form or another, inwhich btw, consumers, et.al. were complicit as well - since consumer debt also exploded. The real money chart isthe last in the lower r.h. corner - which tells you what happened to compensation in the Finance industry vs. therest of the economy. So there you have it - graphic testimony to malfeasant greed run amok taking the innovativetechnology of securitization and metastasizing it this decade to drive fees, profits and bonuses. And, oh yeah,almost collapsing the world. Again - in so many words - everybody including Blankfein, Dimon, Mack andMoynihan (BAC), basically conceded all these points (and a good thing it was the new guy and not Lewistestifying).

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So what are the long-term consequences?Well if you read our year/decade outlook onthe economy, markets and business you'vegot one set of answers. But we'll go back toMr. Zandi for his take - remember this isunder oath btw.Well Mark sees it pretty much as we see it -though if anything he's even gloomier,though he put it more simply and clearlyperhaps; and talked more about long-termdebt and savings. Nonetheless coming fromvery different directions we ended up withidentical conclusions.First off (UL) Consumers took a huge shotto their Net Worth that they will likely never

recover and which will cause fundamentallong-term damage. Which you can see inthe Confidence charts (UR) for businessesand consumers - which despite improvement are still worse than at any time this data shows (NB: the spokesmanfor regional/community banks said something similar in his own words).

The two really sad, scary and critically important factors are the long-term structural impacts. In the LR you cansee the estimate of the long-term impact on GDP growth rates - we're going to be hamstrung for a long time. Andin the LL you can what kind of debt financing problem we got saddled with and will take a long time to work out of.In the readings below we have a very long accumulation of excerpts leading up to the hearings, setting out thebackground, some diagnosis and recommended resolutions and the impacts. The Commission is chartered totake the year to to reach its conclusions but this will indeed be the year of re-regulation in several forms or theother.



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The Hearings and the Assessment

There's been an enormous amount of criticism of theAdministration and Congress for not moving faster on allthis to quickly and magically fix it. Of course that's how we

got into these problems and the original PecoraCommission didn't reach its end and see new legislation foralmost four years. There was plenty else to do this yearwhich should have and did preclude starting hearings onthis matters. At the same time now people both have someperspectives and we've seen the Industry's true colors. Allin all we don't think things could be better positioned for asgood an investigation and re-think as we're ever likely tosee. CSpan is carrying the hearings live and also puttingthem up on its web site. It's at least worth some of yourtime to listen to the openings (if the Chairman and Vice'sstatements are on this) but we felt encouraged from the getgo, and more so as thing proceeded. This is as qualified a

group of public servants as you're likely to get, even considering the political process that brought them there.

During the course of the hearings Zandi summarized the "root causes" in three points:

1) a worldwide excess of savings which created a sloshing surfeit of liquidity that drove downreturns and caused people to go crazy looking for any advantage (something we remember sayinga few times going back to '03).

2) the over-use and over-exploitation of securitization combined with absolutely terrible under-writing and diligence

3) and a failure of regulation.

He and several others added a fourth multiple times thruout today's hearings as the real root of the root -HUBRIS!

But we'll add a fifth that is the Alpha and the Omega, the ultimate AUM (OM): the failure of corporate governanceand performance management. In legal doctrine there is the notion of last clear chance to avert a disaster - wellthe people who had the first and last chances and who had the fiduciary duty to do so were the executives incharge. And the man who stepped up to that admission was Jaime Dimon, strongly seconded by John Mack.There were lots of factors, lots of mechanical breakdowns, a triumph of greed and some really terrible regulatorydecisions.

But the ultimate failure was a management failure - opting for malfeasant choices, in both the private andpublic senses, in the service of greed. Synthetic derivatives were merely the enabler, or one among many.The results of these hearings are going to frame your life and those of you descendents for decades, just as theoriginals did. And just as the failures of Financial leadership already have. Like we keep trying to say - the

Industry as people keep trying to analyze it ain't coming back!



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January 15, 2010

Talking Business: the Outlook vs. the Preparations

http://llinlithgow.com/bizzX/2010/01/talking_business_the_outlook_v.html

Well with the second day of FCIC hearings behind us and theagita reactions we could easily pick up on that thread andcontinue the conversation. Especially because we think almostall commentators are misjudging what they're hearing. Ofcourse to better judge it you'd actually have to a) listen to thewhole thing, b) know what you're hearing and c) know some ofthe background.

We still think the three most important things we heard were 1)we really screwed up, 2) it was fundamentally badmanagement and leadership and we're responsible and 3) weapologize but we're not really sorry (especially Blankfein and

GS!). The Street's grasp on the tsunami that will build up overthe next two years is abysmal and they don't know how to dealwith it, but dealing with public responsibilities is as much a partof an executive's responsibilities as is day-to-day decisionmaking.

But, God being just, JPM's lackluster earnings which arebringing down the market as we speak for all the problemswe've been warning about for 18 months at least (literally) willdo for now (that'll do Donkey, that'll do). Blankfein's majordefense for drinking the koolaid was that nobody could haveseen it coming - which is just flat not true, and is beingrepeated. CalculatedRisk was warning about this problems in

2005 and we were warning about a slowing economy in early2006.

Here's where those all come together - our fundamentalquestion. Are businesses properly preparing for the nextdecade of slow growth? Just to put up some new charts on that point of forewarnings this one shows monthlyretail sales, quarterly back to 1960 compared to Consumption and GDP and the determinants of future demand.The sum of changes in Employment and real Wages continues to weaken. Now if you don't believe things aren'tvery rosy you're probably done here. If on the other hand you think business performance is a critical factor inhow things will go please continue on.

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In the readings you'll find another slew of stuff starting with starting with long-term fundamental changes inconsumer spending habits ('ol hat here we know but it always bears repeating apparently). All the rest of theexcerpts are specific company stories starting with Best Buy and Sony, which gives us consumers and the CPG's(of a sort), Alcoa (who had not so good results and tanked the markets themselves), and Exxon who's acquisitionof XTO Energy (a natural gas firm) tells us an enormous amount about deep structural change in the EnergySector. Then there's a slew of Auto articles followed by another chunk of Technomedia stories covering theoutlook, Intel (who's surprisingly good results did NOT result in any significant market pop), IBM, patents and(indirectly) innovation and Comcast-NBC. Need we mention that the Jay/Conan screwup is more symptomatic of



Page 33 of 43



NBC's struggles with the new age than of anything else. When the world is changing under you well... march ordie as they still say in La Legion Etranger!

The top chart pretty well speaks to the retail and consumeroutlook - whether the necessary steps are being takenwe're not sure (that's being polite btw. Actually we'rehighly suspicious that the overbuilt, over-stored and under-run Retail Industry is in deep dodo and about a 1 on theadaptation scale [1-5], and its suppliers along with it). Let'sturn to the Auto Industry as our exemplar then. (The Self-

Inflicted Collapse of the Auto Industry). The top chartshows Industry Sales and YoY changes - notice the bigbubble in Sales after things were already headed south.Instead of adapting and adopting they choose to usespecial incentives to move stuff nobody wanted to buy.Our judgment would be that the US going out sales figurewill be 13mil/year at best, probably take 2-3 years to crawlback that high, if it does and tells us the US industry is stillabout 40% over-capacity. Europe's in much worse shape.

Meanwhile the real growth opportunity is in Asia and LatinAmerica but the Chinese have 117 manufacturers whoneed to shake out but will continue to be subsidized intomore over-capacity by government spending to gooseemployment. And all that's before we raise the perennialbut really critical issues about re-thinking and re-engineering product development, manufacturing,distribution and marketing & sales. Over this next decadethe industry has merely survived so far though the jury's out. And, again, it's not like you couldn't see this comingas long as you didn't drink the koolaid and talked to somebody besides yourself.

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Well, what about it? Well obviously Tech will save theday, right? Let's try that again by refreshing ourselveson how business makes capex decisions - rather likewe did circa Jun08 when we said things were going tohit the rotary impeller real soon now and folks neededto prep right now. Needless to say nine months laterthere were lots of Tech execs wondering around withstartled looks and meataxed labor forces.

The top chart compares YoY changes in GDP andTech spending. Looks like an extraordinarily close fitto us. Which is born out in the bottom chart which

shows the relationship over time - notice how tight thefit is and how high the R2 is! About as good as we'veever seen for any economic data.

Now Forrester tells us that worldwide spending will goup about 8.1% while US spending will increase about6.6%. Who are we to argue with the guys who got itwrong the last time. Of course if you do the math anda 2.5% real GDP growth rate implies a 4.5% growth in real tech spending. Not bad all things considered but a 1/3under the analysts forecasts. That would required a sustained 3% GDP for the entire year - again not to far off



Page 34 of 43



and given how sharply the sector might rebound possible but, we think, unlikely. If you want some morebackground on far and fast the Industries are changing try: Technomediatainment Futures: Evolution, Barriers,

Structure and Opportunities of a New Industry.

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So, there you have it. Reality checks from fundamentalchanges in Consumer behavior and weak employment to slackdemand growth and the ripple effects across the spectrum ofIndustries from Retail to Manufacturing to Extraction to Autosto Tech and Entertainment.

In an interesting comment on the "perversity" of our times oneof the best places to get your news and substantive discussionof serious issues is Stewart's Daily Show. Here's interviewingPaul Ingrassia, ex-WSJ Detroit reporter and editor. Paul's got a new book out on the history and performance ofthe Industry, how it dug itself into these holes and dodges the "what next" questions. Of course he's also thesame guy who wrote a book in '94 about the recovery and bright future of the Industry. Here he admits theycompletely lost their way back then and took their fingers off the control levers.(http://www.thedailyshow.com/watch/tue-january-12-2010/paul-ingrassia )

How many other companies out there are in the same state today? We certainly know that the Finance Industryhasn't even repaired the balance sheets let alone started re-thinking its businesses. How many others are goingto be the next Auto Industry?

January 18, 2010

Renewing the Enterprise 2: Governance, Measurement & Performance

http://llinlithgow.com/bizzX/2010/01/renewing_the_enterprise_2_gove.html

The fundamental messages we've been trying to drive home are that the nextdecade will be one of the most challenging in at least four, if not since theGreat Depression, that the new realities have not sunk into investors,management and stakeholder consciousness and the single biggest challengewill be to improve enterprise performance. Performance improvement willeither be led by the enterprises or imposed from the outside, less effectively,by a high level of distrust and justified anger at near-disasters brought on bymalfeasance. And this is not just restricted to the Finance Industry. It is inenterprises own best interests to improve their governance, managementsystems and performance to make sure it's done well, adapted to their needsand, most importantly, they actually improve their performance.

Backing up those assertions you'll find an extensive readings collection on each of the major issues involved afterthe break; here we want to review the evidence and explore the core concepts of performance improvement andmanagement systems. But start with the BNN clip of Don Coxe both laying out the situation and the level of realitydenial currently prevelent in the markets. A reality, judging by the week's reactions to earnings in the markets, thatmight just be sinking in the general consciousness.(http://watch.bnn.ca/market-morning/january-2010/market-morning-january-12-2010/#clip254429 )



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If you look at the general cases, the industries or the specific

companies there is one redcurrant symptom of failure. Thesacrifice of long-term value creation for the appearance of short-term performance.That difference, often thought to be mere words and arm-waving,actually makes a substantive difference in enterpriseperformance and in long-term stock values. In other words itmakes a difference to every stakeholder.And it actually turns out to be measurable using market data -though only after performance has resulted in changes in marketvaluation.

The graphic lays it out nicely, both in general terms and using thespecific example of MickeyD's. In their case the fundamentalstrategy was add more stores without changing the old valueproposition and just grow, grow, grow. Well that kept up reportedoperating profits and earnings but the saturation led to adeterioration in total enterprise value because long-term valuetanked.

Then they slowed growth, reinvented the menu and the storesand created both a new core proposition and translated that intoexecution. The result was a surge in future enterprise valuedriving a surge in total value. The trick is to spot the change inthe value equation early but clearly you can also spot it while it'swell underway and hop on the gravy train as it plays out.

To spot it early and to know whether or not it is sustainable you have to analyze the business as a business -

think like an owner. Is the value creation sustainable, what is the strategy, can it be executed and, mostimportantly, are they walking the talk? That is, is what they say they intend to do what's built into plans,capabilities and compensation? If so value will be created.

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It's not just the Finance Industry but all enterprisesthat have lost trust thru, at best, non-performance or,at worst, malfeasant behaviors.

The argument for exorbitant executive compensationhas been that it results in outperformance. As the

result of the Financial crisis there have been severalmajor studies of that proposition and the "startling"result confirms what common wisdom would suspect.Not only has it NOT resulted in out-performance but just the opposite. In fact the performance deficit islarge and significant.

This ought to cause major pressures fromstockholders and stakeholders for performance-based



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compensation tied to long-term value creation. But, with all the sturm und drang in Washington the fundamentalregulatory change has already happened. The SEC has put forth new regulations requiring executivecompensation to be tied to long-term objectives.

The saddest thing about this is that a regulatory agency is having to put controls in place that should have beencommon business practice and taken for granted. That it felt it had to act, on the basis of good evidence that it isnot, is a major indictment of corporate governance. When the Auto Task Force went into Detroit what it found wasnot the bad situations it anticipated but abysmal conditions; Wagner should have been removed, years ago. Whenthe government is forced by your private and social failures to re-engineer executives and the Board have leteveryone down, including themselves.

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The question becomes what's broken andwhat should be done to fix it. Let's start withthe way things are and go to the way thingsshould be, and must be to cope with theNew Normal, not to mention the SEC!

At best what you here from most companiesis some rather vague strategic assessmentsof the state of the enterprise (and if youlisten to conference calls, all the questionsthat get asked). For that strategy to bedeliverable it must translate into operationalcapabilities that support each other and arealigned with the overall enterprise goals.What you get is a set of functional fiefdomsthat grew up by accident and are defendedpolitically on internal agendii, with the resultthat the realities of strategic implementationare dictated by inadvertent operational

strategies. Thereby making what you hearall fantasy. And it's easy to judge - whenBartiromo interviewed Sue Decker at Davos a while back the answers were beyond vague. Immediately tellingyou that Yahoo hadn't a clue. The contrast with Bartz is astounding. Which is one early and easy tell!

What you want and need is a clear, simple, straight-forward and crisp definition of current strategy and objectivesand evidence that it is operationally deliverable. WMT would be our example of best practices while Citi is aperfect example of an organization that, finally, articulated a clear strategy but doesn't have the managementsystem or operational capabilities to make it happen. BAC and Dell may be suffering similar breakdowns inperformance management. Ideally what you'd hear, less granularly and with more give in the boundaries, wouldbe a clear articulation of future value and strategy as well as deep changes in operational capability. Again theseare things you can dig into the analyst presentations.



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A favorite story is the Citi branch manager whoconfessed that the 30 corporate memos from

HQ he saw a month went into the round filecabinet and he focused on monthly branchperformance. That's sad but telling because ittells you how broke the management system is,that any notion of long-term value was non-existent and that incentives were on theappearance of short-term performance. Peoplewill do what you incent them to do, period,though that takes more than money.

What you need is set of operationalmeasurements and metrics that link theperformance of the individual functions andorganizations to the broader corporate goals.Fedex has been doing this for years and theheart of WMT's re-engineering was settingperformance goals for return and operationalperformance at the store and department level.Performance results from Efficiency (using whatyou've got given a level of economic activity),Utilization (using what you've got effectively asdemand rises and falls in the cycle) and Capacity (increasing capabilities in line with the strategy).

But what business units do is activities - they don't return profits per se. In other words the necessary, and nowmandated, revolution in management systems requires decisions about the principal activities for each unit, theappropriate metrics, and what should they be in three time frames (matched against the Efficiency, Utilization andCapacity adjustments). For a Fedex station manager it might be packages per stop, for a WMT store manager it

might be sales and profits per square foot, preferably by department.Most importantly compensation of all sorts, including who gets promoted, should be based on these sorts ofadjustmenable activity indicators. And you'll be able to tell that it's happening when you hear the executives talkabout it (see UTX's analyst reports for example) and it starts showing up in results.

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To return to our point about the comingchallenging decade take a look at this chart(PBS just put out an interactive graphic looking

at job creation from BLS stats for the decade,anticipating 10% job growth over the decade.Less than breakeven - this is going to be aVERY tough decade indeed). This chart giveus a start on the long-term market performanceof four exemplary firms, all of whom are on ourlist of very well-run organizations.

Recently they've had major runups followingthe market but, on the whole, nobody has



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returned to '04 peaks. You can see the Enterprise Value pressures at work on WMT in the middle of the decadeas their business model aged and withered, and the impacts of their re-invention, then and now. But INTC andBAC are indeed challenged (meant to include CSCO but...fat fingers).

If we're right about the decade profits and earnings will be challenged (not to mention the artificiality and poorquality of finance profits) and we're looking at a sideways market where PE's will compress. The bottomline ofbottomlines here is that long-term performance, and therefore management systems, performance, governanceand compensation practices, are really going to matter. More than ever! And it will be incumbent to find theenterprises walking the talk now and for the future.

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One organization with astounding espirt de corp that manages to do more withless again and again, maintain discipline but always be resilient under extremestress while also, simultaneously, adaptive to long-term requirements is theUSMC. And nobody summarized it better than Gen. David Petraeus (in aMarine birthday speech where he took a lot of heat for his USAF jokes whileeverybody missed or ignored the substance).(http://dodvclips.mil/?fr_story=FRdamp358972&rf=bm )

If you find this overall topic of organizational performance interesting westrongly suggest that you listen to the address, though it admittedly runs about 30 min. or so. But in that timethere's a lot of ground covered, besides the inside jokes of course.

Petraeus' fundamental theme is that what distinguishes Marines is their adherence to bedrock principles in theface of all opposition combined with a constant willingness to innovate and adapt. Examples in history include theinvention of amphibious warfare and Counter-Insurgency but more recently the application of COIN to supportingthe Anwar Awakening in Iraq.

We'd add that within the context of strategy, doctrine and operations every Marine corporal is empowered to makelocal decisions. Applied to business the lessons are that value is created on the frontline, not in the Boardroom.And what happens on the frontline needs to be decided based on the overall good of the enterprise, not on merely

local conditions, narrow incentives or short-term gains. To get from where we're at to where we need to be willchallenging but necessary and the heart of it lies in governance and performance.



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January 29, 2010

Chaos, Turbulence, Fragilities: Defining the New Normal, BlueprintingBusiness Performance

http://llinlithgow.com/bizzX/2010/01/chaos_turbulence_fragilities_d.html

A few interesting things happened in this last week that define the things we want to address here. In anexchange with a friend on business performance in the new normal, despite several months of back and forth,most of what we'd been saying about the next decade hadn't really sunk home but we finally managed to get theother shoe to drop. His reaction was somewhere between Wow and OMG! What that exchange makes clear to usis that, in line with our expectations, most businesses haven't a clue as to what's coming at them. So those issues(defining the New Normal benchmark and assessing business preparation and performance outlook) define ourendpoints. At the same time we had an amazing, in many senses State of the Union and Davos 2010 kicked off.This environment has moved from Chaos to Turbulence and is still very Fragile - and will remain both Turbulentand Fragile for the decade as deep structural adjustments in the global economy, governance (corporate andpublic) and geo-politics that will radically alter the deep foundations we've taken for granted for the last three

decades are changed in response to the crisis and governance and performance failures. Those changes are acentral theme of this year's conference.

Taken all together the economic outlook, the implications for investmentand asset performance and business governance define the touchpointsof our highly selected readings section after the break, including severalcritical vidclips from Davos as some from the FT on emerging markets.There's nothing there that we're putting up just for fun. But the centralquestions are what will the New Normal look like and how are businessesprepared for it? And how will public authorities deal with restoring a fragileworld economy. To set the stage you might want to listen to this briefround table from McKinsey.(https://www.mckinseyquarterly.com/ghost.aspx?ID=/Video?vid=702%20 )

But we'll let a much wiser man define the situation in words we hope you recognize and take to heart:

"The dogmas of the quiet past, are inadequate to the stormy present. The occasion is piled high with difficulty, and we must rise with the occasion. As our case is new, so we must think anew, and act anew. We must disenthrall our selves, and then we shall save our country. Fellow-citizens, we cannot escape history. We of this Congress and this administration, will be remembered in spite of ourselves. No personal significance, or insignificance, can spare one or another of us. The fiery trial through which we pass, will light us down, in honor or dishonor, to the latest generation."

Annual Message to Congress (1 December 1862) – A. Lincoln



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Despite all the political posturing thatwent with it it was governmentintervention that saved us from asecond Great Depression. The goodnews is that a recovery has begun butthat bad is that it's policy-dependent, stillfar from self-sustaining (meaninginterest rates are going to say low), willweaken as stimulus fades and be belowpotential for a long time. Which meansweak job growth when almost allindustries are already over-capacity.Just on these factors alone would meanwe'd be facing a weak decade with, letus emphasis, no clear back to long-term

potential growth and prosperity withoutfundamental changes in the deepstructure of the Economy. In the chart inother words that upward sloping curve isout of reach without major publicinvestments. NB: since we've coveredall these points are trying to provide acompressed blueprint our charts will becomposites and we'll leave theinterpretations up to you.

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At this point we hope it's clear thatwhat sustained the economy for thelast three decades was decreasingsavings, under-investment andover-consumption, fueled byfinancial de-regulation, leverage anddebt which hurt long-terminvestment and growth. Dealing withthe consequences of deleveragingand balance sheet reconstructionfor consumers and businesses willtake the rest of the decade,

presuming growth is adequate if notgood, but is primary reason why it'llbe lackluster and unlikely on currentcourse and speed to reach theupward sloping curve. Building offReinhardt and Rogoff's work theMcKinsey Global Institute did adetailed study of the outlook bycountry and sector for deleveraging



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over the next decade (links in the reading - you really need to read it).

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O.K. - so far we've got a weak

recovery with challenges reachingtakeoff speed, a sustained period oflow, below potential growth that willkeep job growth limited to breakevenor below and deleveraging that willfurther reduce consumer demand inthe developed world. We previouslydug into how the high growth eras inthe US economy were the result ofhigh savings, which led to highinvestment and created a virtuouscycle. Now we're on the wrong sideof a vicious cycle. The l.h. side of thiscomposite illustrates the technicalside of that argument while the r.h.side illustrates the conceptual side.There are two bottomlines here.Consumers, as they are alreadydoing, will be forced to do and arelikely to choose to do, will need tochange their fundamental behaviors.And collectively we need to rebasethe economy and find new sources ofgrowth while reducing or eliminatingmajor structural weaknesses that have been drags on economic performance: deteriorating infrastructure,exponentiating healthcare, poor education and a shortage of high-quality laborforces and a dearth of newinnovation. To get back to long-term potential we need to fix all that (and it's a great puzzlement to us why

businesses, investors and financial advisors don't see that but on the evidence to date they really....really....reallydon't get it).

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The rapidly emerging world grew on thedeveloped world's consumer bubble andthe recycling of their savings into ourdebt. Well in this brave new world thatequation is going away. The majorexporting countries are going to haveshift to more domestically based

economies instead of relying onexporting commodities or manufacturedgoods. In fact despite the BRICacronym lumping very disparatecountries together we're going to see agreat seperation driven by these factors.Brazil is well positioned by a balancedeconomy, India somewhat less so,China's basic model probably needs to



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adjust faster than it's capable off and Russia's in the deep dodo. All of this governed as much by geo-politicalfactors as much as anything else. In some ways this chart set almost speaks for itself - consumer debt is droppingdramatically in the US because of huge hits to net worth while China built its growth on exports and investmentand has a very unbalanced economy where forced savings have subsidized manufacturing and infrastructure.The Chinese have an immense challenge that could take the rest of the decade to deal with but have a sharplylimited horizon because of demographic problems, unlike Brazil and India plus constant and on-going risks ofsocial instability. They know all this but the various factions are debating how, when, where and even why. Maywe all live in interesting times indeed!

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We won't go back over the businessperformance problems in any depth sincewe've just spent the last several years goinginto it in excruciating detail over the last fewweeks. But what we hope is clear from thebenchmarks we've summarized above is thatbusinesses need to be constantly monitoringand adapting to the multi-dimensional factorsof a very fragile, turbulent and complex NewNormal. They need to understand the social,political and international factors, thestructural disruptions in their industries andeconomies and the business cycle and long-term economic trends.

But all those things are largely beyond theircontrol (the Supreme Court notwithstanding).What is in their control is how they respond -and the fundamental conclusion of all ourprevious analysis is that they need to performwell now and innovate for the future - and putin place the proper sets of metrics, incentivesand management systems to turn strategies into delivered realities. One of the themes that comes up over andover again in the Davos vidclips is that the public's trust in business has gone from bad to abysmal in the last fewyears - and we're not talking about just Finance but all business. As you'll find out from the last set of readings itwould appear that business is doing NONE of the things it should be doing to cope with these realities.

On that note we'll give you a quote from another wise and brilliant man:

"The costs of maintenance of an existing order are inversely related to the perceived legitimacy of the existing system. ... it is the successes and failures in human organization that account for the progress and retrogression of societies".

Prof. Douglas North, "Structure and Change in Economic History", 1981.

In other words either companies fix their performance and governance problems and start meeting their privateand public obligations effectively or they will be fixed for them (fix is used here the same way the vet talks about"fixing" your cat!).



About Llinlithgow Associates

Llinlithgow Assoc. is a management consultancyfocused on evaluating businesses to reduce risk,leverage under-developed opportunities inoperations and increase overall enterpriseperformance to improve investment return.

Our approach is based on BizzXceleration, aproprietary framework with 25 years ofdevelopment, to review and analyze BusinessModels and Strategy, key operating functions andsupporting infrastructure and managementsystems. From there we develop comprehensive,integrated operating plans that tie all thecomponents of the business into a high-

performance enterprise.

Several years ago Michael Lewis published an interesting book on how the Oakland A’s took a systematic look athow the game really works, and what investments in players, strategies and tactics were most likely to result inthe most wins for the lowest cost. Our approaches are similar in taking a systematic look at the whole business,each of the major components and the best way to tie everything together into a high-performance system.

We start by looking at the basic core value proposition and it’s translation into the Business Model and Strategy.Typically we next examine Marketing and Sales operations, where it is possible to reduce operating costs by30%, shorten the sales cycle by 30% and increase the closure rate by 30%. This is primarily the result ofestablishing good processes and discipline.

BizzXceleration is comprehensive but integrated across the total reach and range of business activities and

issues. And emphasizes a pragmatic, workable approach that results in a stepwise path to performanceimprovement. We believe that our approach mitigates business risks, improves operational performance and canlay the groundwork for 10-30% EBITDA improvements in post-deal execution.

If you would be interested in further discussions, more detailed descriptions or the review and testing of specificopportunities we would enjoy hearing from you. We can be reached at [email protected] .

Customer Problem

• Value Proposition

• Business Model

• Strategy

Core Operating

Functions

• Functional Efficiency

• Inter-function

Integration

•Value Alignment

Marketing, Sales &

Service

• Customer value focus

• Process Discipline

• Business-driven

Management System

•Budgeting system

•Management Controls

•Operating Plans

•Resource Development

Customer Problem

• Value Proposition

• Business Model

• Strategy

Core Operating

Functions

• Functional Efficiency

• Inter-function

Integration

•Value Alignment

Marketing, Sales &

Service

• Customer value focus

• Process Discipline

• Business-driven

Management System

•Budgeting system

•Management Controls

•Operating Plans

•Resource Development

Documents

Renewing the Enterprise: Governance, Innovation and Performance in the New Normal