Strategy in the media

Citation

Henry, C. (2012), "Strategy in the media", Strategy & Leadership, Vol. 40 No. 5. https://doi.org/10.1108/sl.2012.26140eaa.002

Strategy in the media

Article Type: CEO advisory From: Strategy & Leadership, Volume 40, Issue 5

Is the Euro crisis a rerun of 1931?

It is often forgotten that the failure of Austria’s Creditanstalt in 1931 led to a wave of bank failures across the continent. That turned out to be the beginning of the end of the gold standard and caused a second downward leg of the Great Depression itself. The fear must now be that a wave of banking and sovereign failures might cause a similar meltdown inside the eurozone, the closest thing the world now has to the old gold standard. The failure of the eurozone would, in turn, generate further massive disruption in the European and even global financial systems, possibly even knocking over the walls now containing the depression …

Before now, I had never really understood how the 1930s could happen. Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events. Perhaps the panic will vanish. But investors who are buying bonds at current rates are indicating a deep aversion to the downside risks. Policy makers must eliminate this panic, not stoke it.

Martin Wolf, “Panic has become all too rational,” Financial Times, June 5, 2012.

JPMorgan and the future of risk management

JPMorgan Chase & Co.’s lost billions remind us that modern finance has changed the world, and not in ways that we should celebrate. Nothing demonstrates this more than the use of hedging …

When JPMorgan hedges, it doesn’t get rid of the risk. That only happens when the customer repays the loan or, say, improves its balance sheet. JPMorgan’s hedges didn’t make the risk disappear; they merely transferred it to someone else …

The plasticity of modern finance – the ease with which institutions can transfer risk – is a major cause of the heightened frequency of meltdowns and increased volatility. As with a saloon in which each gunslinger comes armed (and with the safety catch released), markets resemble a shooting gallery in which risk takers, each in the name of self-defense, put the group in peril.

Housing bubbleFaith in the ability to transfer risk (such as from mortgage bank to securitization firm to investors) was a major contributor to the housing bubble. In that case, transferring risk was a polite term for passing the hot potato. American International Group Inc., which famously sold credit-default swaps, was simply the firm holding the most potatoes.

Roger Lowenstein, “Banks’ hyper-hedging adds to risk of a market meltdown,” Bloomberg, May 28, 2012, www.bloomberg.com/news/2012-05-28/let-s-shut-down-bank-credit-default-swap-trading-pits.html

Banking, customers and shareholders

There has been an avalanche of press around JPMorgan Chase‘s $2 billion “hedging” loss. Yesterday morning a New York Times reporter quoted Jamie Dimon responding to a question about how they were going to deal with the multi-billion dollar bad trade sitting on their books by saying “We are going to manage it to maximize economic value for shareholders.”

Ah, the “maximizing shareholder value” mantra. It comes right out of the CEO handbook. But is maximizing shareholder value the best objective for a government-backed bank? I think it may be at the heart of what got JPMorgan Chase and our entire banking industry into trouble in the first place …

This may be one of the biggest problems with banking today. I would argue that the most successful companies in the world are not shareholder focused but rather customer focused. Did Steve Jobs ever obsess over shareholder value or Apple’s stock price? No, he obsessed over things like customer experience and over creating products that people would demand in droves.

Most banks – especially the too big to fail type – have lost sight of this. Wells Fargo may be one exception. It professes to live by the principles of customer first. Well’s customer-culture happens to be a Walter Wriston legacy that was imported into California by Dick Kovacevich. Like Reed, Kovacevich was a Wriston-trained banker. He was chairman of Wells Fargo’s until 2009 and is largely credited for shaping its culture. Wells Fargo, by the way, has intentionally avoided investment banking and Wall Street culture.

Eric Jackson, “Jamie Dimon’s folly: shareholders over customers,” Forbes, May 16, 2012.

Hayek and “too big to fail”

But treating the financial crisis like a malaria outbreak uses the wrong model. Better, say the authors of that Fed bank study, to view the meltdown as a different sort of noneconomic catastrophe: “Science has a theory of why earthquakes occur, but quakes strike without warning, and there is nothing we can do to prevent them. Even so, policymakers can mitigate their consequences.” Or as Hayek might have put it, not only is government unable to predict the future, the world is too complicated for it to really have much useful understanding of what’s going on right now. Regulators are always a day late and a dollar short. Indeed, despite Dodd-Frank, the biggest banks still have a sizable funding edge over their smaller rivals. Markets still perceive them as too big to fail …

Of course, some will argue that we need large, complex financial institutions and that their very existence is proof of that. Who are the know-it-all breaker-uppers to say we don’t? But that size and complexity is itself more a result of crony capitalism than of market forces. It’s little wonder, then, that the preponderance of the evidence is that all the supposed benefits from supersized banks and their economies of scale are outweighed by the risks of disaster they generate. Take this 2011 study from the University of Minnesota: “Our calculations indicate that the cost to the economy as a whole due to increased systemic risk is of an order of magnitude larger than the potential benefits due to any economies of scale when banks are allowed to be large … This suggests that the link between TBTF banks and financial crises needs to be broken. One way to achieve that is to break the largest banks into much smaller pieces.”

James Pethokoukis, “Too big for comfort: why we need to break up the banks.” The Weekly Standard, June 4, 2012, www.weeklystandard.com/articles/too-big-comfort645908.html

The danger in marginal cost thinking

Netflix was the quintessential David going up against the Goliath of the movie rental industry. Blockbuster had billions of dollars in assets, tens of thousands of employees, and 100 percent brand recognition. If Blockbuster decided it wanted to go after this nascent market, it would have the resources to make life very difficult for the little start-up. But it didn’t.

By 2002, the upstart was showing signs of potential. It had $150 million in revenues and a 36 percent profit margin. Blockbuster investors were starting to get nervous – there was clearly something to what Netflix was doing. Many pressured the incumbent to look more closely at the market. “Obviously, we pay attention to any way people are getting home entertainment. We always look at all those things,” is how a Blockbuster’s responded in a 2002 press release. “We have not seen a business model that is financially viable in the long term in this arena. Online rental services are ‘serving a niche market.’”

Netflix, on the other hand, thought this market was fantastic. It didn’t need to compare it to an existing and profitable business: its baseline was no profit and no business at all. This “niche” market seemed just fine. So, who was right?

By 2011, Netflix had almost 24 million customers. And Blockbuster? It declared bankruptcy the year before.

Blockbuster’s mistake? To follow a principle that is taught in every fundamental course in finance and economics. That is, in evaluating alternative investments, we should ignore sunk and fixed costs, and instead base decisions on the marginal costs and revenues that each alternative entails. But it’s a dangerous way of thinking. Almost always, such analysis shows that the marginal costs are lower, and marginal profits are higher, than the full cost.

This doctrine biases companies to leverage what they have put in place to succeed in the past, instead of guiding them to create the capabilities they’ll need in the future. If we knew the future would be exactly the same as the past that approach would be fine. But if the future’s different – and it almost always is – then it’s the wrong thing to do. As Blockbuster learned the hard way, we end up paying for the full cost of our decisions, not the marginal costs, whether we like it or not.

Case studies such as this one helped me resolve a paradox that has appeared repeatedly in my attempts to help established companies that are confronted by disruptive entrants – as was the case with Blockbuster. Once their executives understood the peril that the disruptive attackers posed, I would say, “Okay. Now the problem is that your sales force is not going to be able to sell these disruptive products. They need to be sold to different customers, for different purposes. You need to create a different sales force.” Inevitably they would respond, “Clay, you have no idea how much it costs to create a new sales force. We need to leverage our existing sales team.”

Clayton Christensen, How Will You Measure Your Life? (Harper Business, May, 2012).

Signals, noise, and stressors

In business and economic decision-making, data causes severe side effects – data is now plentiful thanks to connectivity; and the share of spuriousness in the data increases as one gets more immersed into it. A not well discussed property of data: it is toxic in large quantities – even in moderate quantities …

The more frequently you look at data, the more noise you are disproportionally likely to get (rather than the valuable part called the signal); hence the higher the noise to signal ratio. And there is a confusion that is not psychological at all, but inherent in the data itself. Say you look at information on a yearly basis, for stock prices or the fertilizer sales of your father-in-law’s factory, or inflation numbers in Vladivostok. Assume further that for what you are observing, at the yearly frequency the ratio of signal to noise is about one to one (say half noise, half signal) – it means that about half of changes are real improvements or degradations, the other half comes from randomness. This ratio is what you get from yearly observations. But if you look at the very same data on a daily basis, the composition would change to 95% noise, 5% signal. And if you observe data on an hourly basis, as people immersed in the news and markets price variations do, the split becomes 99.5% noise to .5% signal. That is two hundred times more noise than signal – which is why anyone who listens to news (except when very, very significant events take place) is one step below sucker.

Nassim Taleb, Antifragile, (Random House, November 2012).

Managing supply chain risks

A globally diversified pharma company faced daunting operational challenges: not only were upstream supply shortfalls causing downstream production delays (and headaches for customers) but the company was also about to initiate quality-related product recalls. Together, these problems threatened to damage its profits and reputation seriously. What’s more, as senior leaders began to address the problems, they concluded that the organization’s existing processes weren’t sufficient to identify – let alone mitigate – potential sources of supply chain risk.

In response, a small team of executives investigated a set of high-priority products – those with great potential to influence the company’s financial results and public-health outcomes. The team also catalogued the risks associated with these products at major points along the supply chain, from product development to distribution. This approach allowed the team to visualize more clearly what problems might occur and where: for example, the risk that raw materials from suppliers might be rejected for quality reasons early in the process or that process disruptions could, later on, delay production in plants operated by the pharma company or a supplier.

In parallel, the team assessed the impact of each of these risks on three of the company’s major supply chain objectives: meeting customer demand in a timely way, as well as achieving cost and quality targets. By creating a scoring system that converted the assessments into simple numerical scores, the team could compare risk exposures and discuss the company’s appetite for risk in an “apples to apples” way at the corporate level and across divisional and functional boundaries.

The results were eye opening. Products representing more than 20 percent of the company’s revenues depended, at some point in their lifecycles, entirely on a single manufacturing location. That was a much higher proportion than senior executives had assumed, given the company’s large global network of plants. Similarly, fully three-quarters of the several dozen products that one business division made contained materials or components from single suppliers – a finding that had big implications for public health and the health of the company’s reputation should a supplier have problems. The exercise also highlighted where the company was likely to miss sales because of factors such as poor demand forecasting or capacity constraints.

In addition to suggesting some immediate changes (measures to improve product quality, for instance), these findings helped executives create new risk thresholds to serve as operating “guardrails.” For example, the company no longer allows any particular plant to account for more than a certain percentage of corporate revenues. It also embarked on a far-reaching dual-sourcing program to increase its operating flexibility by guaranteeing better access to supply. Thus far, the company reckons it has lowered its risk exposure by more than 50 percent and almost completely eliminated the most catastrophic risks it faced, at a cost equivalent to less than 1 percent of annual revenues.

Mike Doheny, Venu Nagali, and Florian Weig, “Agile operations for volatile times,” McKinsey Quarterly, May 2012.

From ideas to action

As it turns out, individuals can apply several lessons from shaping strategies when trying to turn a grand idea (be it for social good or professional gain) into a reality.

1. 1.

   Create a Compelling Shaping View. In order to mobilize supporters, it helps to put forth a compelling view of what the future-state could look like …

2. 2.

   Make Sure the Benefit is Mutual. In defining a shaping view, it is important to make clear how the conditions you are trying to achieve will benefit many people beyond yourself. The more tangible you can make these benefits and the more explicitly you can define the types of people who may benefit, the more those people are likely to be motivated to support your efforts and help to make the shaping view a reality …

3. 3.

   Are you serious? Prove it. First of all, take some action that will demonstrate your conviction regarding the shaping view …

4. 4.

   Create a Platform. If your shaping vision is compelling enough, there are likely many people who want to help make it happen. Having a central shaping platform typically removes friction for these potential supporters, which can help grow a support base and encourage participation. The key is to find ways for people to connect with each other, work with each other and draw strength from each other …

5. 5.

   Gain Critical Mass. Margaret Meade once famously said, “Never doubt that a small group of thoughtful, committed, citizens can change the world. Indeed, it is the only thing that ever has.” While this is certainly true in the early stages of a shaping vision, a large support base can lend credibility to a cause.

John Hagel III and John Seely Brown, “How to make your big idea really happen,” HBR Blogs, May 9, 2012, http://blogs.hbr.org/bigshift/2012/05/how-to-reshape-your-world.html

Strategies for declining industries: Warren Buffet and the future of newspapers

There was the bad news on the front page of The New York Times last month, “New Orleans newspaper scales back in sign of print upheaval”: The Times-Picayune, a much beloved 175-year-old institution that memorably rallied the Crescent City after Hurricane Katrina, “had buckled under the pressures of the modern newspaper market.”

… Never mind the news that just the week before Warren Buffett had bought 25 daily newspapers in the South (and 38 weeklies), including the Richmond Times-Dispatch and the Winston Salem Journal, while seller Media General had kept its Tampa Tribune, struggling with the Tampa Bay Times in a two-newspaper metropolitan market. Buffett’s Berkshire Hathaway bought the Omaha World-Herald, his hometown paper, earlier this year. The company for many years has owned the Buffalo News and held a stake in The Washington Post. Buffett has said “we may buy more.”.

… If you believe, as I do (and Michael Bloomberg and Warren Buffett, too), that newsprint is a superior way to assimilate information (probably for many decades to come), and that density of cities will make it possible to distribute print editions efficiently, then Buffett is your dream investor – patient, deep-pocketed and emotionally committed to the business. “Berkshire buys for keeps,” he wrote in a letter to editors and publishers after his recent acquisition was announced. “Our only exception to permanent ownership is when a business faces unending losses, a remote possibility for virtually all of our dailies.”

Berkshire’s plan, he elaborated, is to focus on small and mid-sized papers in long-established communities. “American papers have only failed when one or more of the following factors was present: (1) The town or city had two or more competing dailies; (2) the paper lost its position as the primary source of information important to its readers or (3) the town or city did not have a pervasive self-identity.”

David Warsh, “You can’t tell the unhappy families without a scorecard,” Economic Principals, June 3, 2003, www.economicprincipals.com/issues/2012.06.03/1374.html

Strategies for declining industries: harvesting goodwill

In his 2004 book The Vanishing Newspaper: Saving Journalism in the Information Age, Philip Meyer imagined “the final stages” of a “squeeze scenario” by a newspaper owner who wanted to exit the business but didn’t want to actually sell the title: He would start charging more for his newspaper and delivering less, commencing the “slow liquidation” of his property. This slow liquidation would not be immediately apparent to observers, Meyer wrote, because the asset “being converted to cash” would be “goodwill” – the newspaper’s standing in the community and the habit of advertisers and subscribers of giving it money.

One reason an owner would want to extract a newspaper’s goodwill value before selling its physical assets – its real estate, presses, computers, trucks, paper, ink, etc. – is that traditionally, goodwill is where most of a newspaper’s value has resided. When Meyer asked two newspaper appraisers to estimate how much of a newspaper’s value was locked up in goodwill versus physical assets, both gave him the same answer: 80 percent goodwill, 20 percent physical assets.

Selling goodwill is a dangerous strategy because once sold, it’s difficult to reacquire. But a newspaper owner who feels trapped by losses and can’t find a new owner at what he considers a fair price may feel he has no alternative but to cheapen his newspaper bit-by-bit, month-by-month. He may explain the goodwill sell-off as temporary economizing to be reversed once business conditions improve, or even as the exploration of a new business model. Sellers of newspaper goodwill might protest that the financial losses they’re absorbing constitute a serious investment in the newspaper’s future, that they’re harvesting nothing. But don’t be fooled. If you’re winding your company down with no strategy to wind it up, you’re burning goodwill even if you don’t acknowledge it …

In exchange for less and less, owners are charging readers more and more … Publishers can rightly claim that falling display and classified revenues give them no other choice but to make readers pay more. But that doesn’t erase the fact that most readers are paying more for less now, one of the hallmarks of liquidation.

Jack Shafer, “The great newspaper liquidation,” Reuters, June 4, 2012.

The changing face of the C-suite

The C-suite is getting crowded, with top management teams doubling in size since the mid-1980s. And it’s not just the size that’s changed, says Professor Maria Guadalupe – the composition of top management has changed as well, with some important considerations for organizations to heed.

Working with Hongyi Li of MIT and Julie Wulf of Harvard, Guadalupe has shown that the growth of the C-suite is largely the result of a disproportionate move away from general managers and toward specialized functional managers.

“Most positions reporting to the CEO used to play a general management role. But in recent years most of the increases in the number of positions reporting to the CEO are the result of the addition of functional managers to the roster,” Guadalupe notes.

“Instead of general managers who carried out many different functions for the specialized units they ran, there are now marketing officers, finance officers, legal counsel, chief information officers – positions that specialize in one particular function that applies across the organization.”

“Whenever we see centralization in a firm, we think: what are the synergies a firm wants to exploit?” Guadalupe explains. “Why does a firm now have a chief marketing officer at the top of an organization when the position previously did not exist? Probably because there are some marketing activities that are relevant to the different business units the firm wants to coordinate, with synergies to exploit.”

The researchers identified two specific forces at work behind the expansion and specialization of the top management teams:

• •

  Diversification. Firms are becoming less diversified and more focused. “Firms have been shedding noncore businesses and focusing on fewer lines of business,” says Guadalupe. “To the extent that shedding businesses means that the remaining businesses are more related, the potential for synergies increases.”

• •

  Information technology. Since the mid-1980s, firms have adopted IT in multiple waves of innovation. IT has improved the ability to communicate, share, and classify information within organizations in a way that was previously impossible, and that increases the ability to better coordinate activities across business units and hence realize synergies …

In light of these shifts, the implications for CEOs and firm strategy are clear, says Guadalupe. “Firms need to be very careful about how they centralize positions, especially in conjunction with the other strategic choices the firm is making,” she says. “Our data suggests that centralizing product functions should go hand-in-hand with the focusing of activities. At firms that have many closely related business units, firms centralize and create specialized, functional positions. At firms that are increasing their investment in IT or already heavily rely on IT to enhance communication within the firm, administrative positions are more needed. Specialization and general administration are both important, but the firm’s strategy matters.”

“The shifting C-Suite,” Ideas@work, April 30, 2012, www4.gsb.columbia.edu/ideasatwork/feature/7228562/The+Shifting+C-Suite

Craig HenryStrategy & Leadership’s intrepid media explorer, collected these examples of novel strategic management concepts and practices and impending environmental discontinuity from various news media. A marketing and strategy consultant based in Carlisle, Pennsylvania, he welcomes your contributions and suggestions (Craighenry@aol.com).