Archive for December, 2010|Monthly archive page

Is it time for professional boards?

Existing approaches to corporate governance are being questioned as a result of recent developments.  The 2008 financial meltdown plus some famous corporate implosions over the past decade – WorldCom, Tyco and Enron to name three – has focused government and academic attention on how shareholders and the public are being safeguarded.  Secondly, senior management is being challenged by growing business complexity arising from increasing globalization, the impact of new technologies and growing consumer activism.     

The Sarbanes-Oxley Act was supposed to improve governance by bringing greater financial transparency and management & director accountability to public corporations.  Despite its promise, SOX by itself was insufficient to prevent the financial crisis and loss of public confidence.  In reality, all of the troubled Banks were more than compliant with SOX’s stringent regulations.  Clearly, regulatory compliance is not a substitute for prudent financial, strategic and risk management.

One way to improve corporate governance is by professionalizing the Board of Directors, says Robert Pozen in a recent article published in the Harvard Business Review. Pozen,  a senior financial services insider and Harvard Business School lecturer, believes that governance failures arise from a lack of director expertise as well as the behavioural dynamics that influence their actions.

Pozen asserts that many Boards suffer from three basic weaknesses:

  1. Lack of expertise – Many Boards are populated with independent and “generalist” directors who do not possess the necessary skills and industry experience to effectively execute their role.  This skills gap can be especially problematic for Boards in complex, risk-laden sectors like energy, financial services and pharmaceuticals.
  2. Lack of time – Many Board members do not devote enough time to deal with the complex demands of their organizations. According to Pozen, a typical Board member in Financial Services might put in only 200 hours of part-time effort per year spread across Board meetings, telephone calls and prep time.  Moreover, generalist directors, especially those engaged in other pursuits, are often challenged to maintain the required knowledge of the business and industry.
  3. Lack of manageability – With an average size of 10-20 members, many Boards are too big and unwieldy to be effective decision making and oversight bodies. Within groups of this size, individuals often engage in what psychologists call “social loafing”: Members resist taking personal responsibility for the group’s actions and rely on others to take the lead. Furthermore, large groups are challenged with consensus building and open communication, both vital requirements for effective Board governance. In general, the more members there are, the harder it is to reach agreement.  As a result, fewer decisive actions are taken.

To address these challenges, Pozen recommends that Boards become “professionalized” through the following changes:

Reduce the size of the Board

Effective deliberation and decision making can be achieved by making Boards smaller or by creating a more focused sub-group within a larger Board, tasked with specific oversight or strategic responsibility. 

Research on group dynamics suggests that a team of six or seven individuals is the ideal size for effective decision making.  Smaller groups enable all members to take personal responsibility for the group’s actions.  Additionally, small groups can often reach a consensus in a reasonably short time.

Require higher levels of expertise

Boards could be required periodically to undergo an external talent assessment to identify key skills gaps and develop plans to fill them.  Firms have a number of options to augment Board expertise including recruiting more senior industry experts (versus Generalists) as independent directors or periodically educating existing directors on key facets of the Company or industry.  Part of this effort could involve a new director “boot camp” so that additions are quickly brought up to speed on key business and industry issues.

Demand greater time commitment

Directors should be required to invest more time than they currently do understanding the business, meeting key stakeholders and executing their responsibilities. For example, companies could stipulate that independent directors, who are now allowed to serve on the boards of four or five public companies, should be restricted to just two.

The above recommendations could go a long way in creating a dedicated and expert class of professional directors who would strengthen the current governance model and help rebuild the public’s confidence.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

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Improving joint venture performance

Over the past 20 years, Joint Ventures (JV) have become a popular form of business structure.   There are many types of JVs but each share a basic premise: separate businesses agree to develop, for a finite time, a new entity and new assets through the contribution of equity and resources. The partners exercise control over the enterprise and consequently share revenues, expenses and assets.

Although difficult to get an accurate tally, there are likely more than 8,000 JVs in existence worldwide representing hundreds of billions of dollars in combined revenues. JVs have been the preferred strategy for North American and European companies to enter the rapidly growing BRIC (Brazil, Russia, India, China) markets.

When operating well, JVs deliver compelling benefits including simplifying entry into new markets, reducing business risk and conserving scarce capital. 

The operant phrase is, “when functioning well.”  JVs are not easy to form, operate and exit. A number of studies by KPMG, McKinsey and PWC have concluded that no more than 50% of all JVs were seen to be successful by their participants, with the average partnership lasting between 8 and 10 years. For those JVs that soldier on, they often suffer from strategic confusion, slow decision-making, and duplication of effort with the parents.

Two successful JVs provide some important lessons on creating and managing these unique relationships.  CIBC Mellon, a leader in the Canadian Asset Servicing industry, is a successful 14 year JV between the CIBC and Bank of New York Mellon.  Sony and Ericsson created a JV s in 2001 to manufacture mobile phones.  In 2009, Sony Ericsson was the 4th largest mobile phone manufacture in the World.

The following are some key lessons on creating and managing well-run JVs:

 Finding the right partner

  • Look for similar goal, and cultures – Not only must the firm’s culture and business practices be amenable to collaboration but it must have what Tom MacMillan, Chairman of CIBC Mellon, calls “the JV mindset…Some companies are good at working with others, some aren’t” 
  • Ensure a strategic fit – When prospective partners are identified, managers must evaluate the firm’s capabilities, management and financial health against the JV’s needs and their own gaps. In Sony Ericsson’s case, the JV combined Sony’s well-honed consumer electronics expertise with Ericsson’s leading technological knowledge in the communications sector.

 Reaching the right agreement

  • Get a strong business case – A winning JV combines a compelling business case with financially-strong partners.  “Two lousy businesses put together will not make one good business…they will give you one big lousy business.” Says Tom MacMillan.
  • Align around goals, commitments and mutual expectations – To avert conflict and ensure proper resource allocation, all parties must ensure their strategic and financial interests are in sync before commencing operations. To ensure strategic and financial alignment, both Sony and Ericsson agreed in the JV to stop making their own mobile phones.
  • Get the right equity and capital deal – Research says that a 50/50 equity split, with clear responsibilities and rights on both partners, has the greatest chance of success. 

Making the partnership flourish

  • Assign effective leaders – Senior management at both the parents and JV must be skilled at managing through differences in reward systems, cultures and organizational practices.   According to Tom MacMillan, strong Board-level leadership by the partners and day-to-day leadership in the JV may be the most critical factor in ensuring the JV’s success
  • Insist on mutual commitments –  Both partners must honour and maintain their financial and operational commitments even when results are less than ideal or the strategic circumstances of one party changes. This puts an onus on properly capitalizing the JV at the outset and dealing with future investment requirements.
  • Get the governance model right – The ideal governance structure provides sufficient controls to minimize risk without stifling operational flexibility and speed.
  • Anticipate and pre-empt conflict – According to a PWC study, the top 2 reasons why JVs fail are poor financial performance and a change in strategy.  To pre-empt surprises and illuminate important issues, JVs need regular strategic reviews and performance tracking.  Building in transparency and regular management communications will help foster trust and reinforce shared goals.

For more information on services and work, please visit the Quanta Consulting Inc. web site.

Will P&G clean up with two new businesses?

Having worked in P&G brand management on some of their biggest brands (Tide, Cascade, Ivory Snow), I must admit to being an admirer of almost everything the firm does. Well almost everything.  I was not a big fan of the Tide Basic introduction.  And, lending their reputation and strong brands to some consumer service industries may turn out to be another misstep. 

Over the past three years, P&G has been refining plans to enter two new markets – dry cleaning and car washes – by leveraging two of their strongest brands. In effect, P&G is applying the considerable technology and brand equity of Tide and Mr. Clean to launch two new franchised consumer services.  In particular, a pilot program of Tide Dry Cleaners is about to be introduced in selected markets across the United States.  Secondly, P&G is continuing to roll out Mr. Clean car washes in partnership with franchisers ready to fork over a $5 million initial investment. 

I am skeptical as to whether these initiatives will succeed: 

One would assume that years of testing and refinement were behind the concept development and delivery model.  Was this effort of value?  Thorough thinking and ample investment can not make up for a weak consumer proposition or bad timing.  During my tenure in the late 1980s, P&G Canada launched a family of Enviro-Paks – cleaning, detergent and dishwashing liquids – packaged in large Tetra Pak containers – based on European learnings.  The roll out flopped, not necessarily because of poor execution but because the timing was about 15 years too early (environmental awareness was very low at the time) and there was no compelling consumer benefit in switching to the new format.

My concerns with P&G’s new franchising strategy centers on the following areas:

The attainable market may be too small

The dry cleaning and car wash markets are fragmented, often driven by price and location considerations.  On the other hand, P&G has traditionally focused on share leadership in large and defined market segments with premium-performing products.  I am not sure the dry cleaning and car wash sectors contain segments large enough to support P&G’s premium business model and generate sufficient financial returns.  Furthermore, at $5 million per store, a Mr. Clean franchise will not appeal to any but the deepest pocket franchisers.

Challenges with the customer experience

Financial returns will depend heavily on the quality of the customer experience delivered every day.  Service businesses rise and fall on front line staff interactions with customers and delivering consistent quality.  Ensuring a fruitful and consistent customer experience is a challenge in consumer services given the heterogeneous nature of employees who are often unskilled and transient.  While having a bullet-proof set of policies and procedures will help, P&G will lack the control and immediacy to ensure day-to-day execution excellence on a national scale.

Franchising cheapens P&G brands

Given the above challenges, P&G runs a significant risk that an unsuccessful franchise strategy could hurt Mr. Clean and Tide’s strong brand equity and subsequently damage their market shares.  Together, these brands represent over a billion dollars in profit in the US alone.

Without analyzing the business case, its hard to really know whether the above issues are problematic.  However, one must wonder why P&G chose to expand to new markets with completely new business models that are well beyond their core consumer and customer franchise.  Time will tell.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

Chinese takeovers: A primer

The Chinese are coming to an industry near you. Flush with cash, confidence and heft Chinese firms are aggressively pursing takeover opportunities across the globe.  In 2010, Chinese firms accounted for about 10% of all global deals by value.  Given a strong growth trajectory and need for raw materials & technology, the Chinese are expected to increase their pace of foreign acquisitions in the coming years.  If your company is considering, a strategic transaction with a Chinese firm, you would be wise to consider the learnings of your Western peers.

A terrific article in The Economist magazine outlines the trials and tribulations of executives from 11 Western companies who have been acquired by or are in the process of selling to Chinese buyers.  Some of their key insights include:

  • Overall, the executives were impressed with the ambition and technical skill of their Chinese peers.  At the same time, there are doubts as to their ability to improve the acquisition’s performance and to operate an international business. 
  • Emotion and trust matter a lot to the Chinese and they will go to extremes to gage their counterpart’s integrity and intentions.  To break down barriers and attempt to secure a negotiating advantage, the Chinese will often embark on marathon negotiating sessions and ply their Western counterparts with copious amounts of liquor.
  • As most Chinese firms are state-controlled, there is a lingering suspicion that the Chinese engage in dirty-tricks tactics including bugging hotel rooms for information and supplying interpreters who are in fact corporate spies.
  • The Chinese favor large negotiating teams with opaque and fluid roles & structures.  It is often unclear who has authority and how decisions are arrived at.   Those interviewed felt that the ultimate arbiter was the government and not necessarily the people who were part of the negotiating team.
  • Given China’s size and complexity, there will probably be more than one government  voice in the transaction.  When competitive Chinese companies are interested in the same target, it is likely that the firm with the most political support will end up as the preferred bidder.  These dynamics are often hidden from the Western company until the last moment before an offer is submitted.
  • Once the “preferred bidder” has been anointed, it is not surprising for them to shower wads of cash on the deal, reflecting their very strong balance sheets and the amount of political capital committed to the transaction.  Again, it is common for a high-ranking government (or People’s Liberation Army) minister to directly change the terms of the transaction.

Integrating the acquisition is where most Chinese deals (and Western ones I may add) drop the ball. 

  • The interviewees reported that the Chinese usually did their integration homework and did not barge arrogantly into the acquisition – although they did gain control quickly.  Senior management was usually retained if only in well-paid honorific roles.  Firm names and legal status did not change – at the outset.
  • Not surprisingly, one area where the Chinese fall short in integration is their low supply of English-speaking managers who are experienced in international business. This tends to slow integration activities, push decision making back to China, and alienate existing management.  In the companies canvassed, most senior managers have or are considering leaving.
  • Over time, the business plans did change albeit slowly and indirectly as is the case of a natural resource company that switched its selling from the open market to a single  Chinese firm.  In another example, an acquired firm abruptly shifted its strategy from profit maximization to production maximization once the Chinese took over.
  • From a cultural and management perspective, Chinese and Western firms could not be more different. Core Chinese values include deference, opacity and consensus, which are often at odds with more individual-focused Western companies who prize frank discussion, rapid action and employee empowerment.  This tends to create misunderstanding, inertia and frustration on both sides.
  • Finally, most of the interviewees felt that the next generation of Chinese business leaders – those in their 30s and 40s with more business and language skills – would be more effective than the current cadre [sic].

For more information on our work and services, please visit the Quanta Consulting Inc. web site.