The Big Idea: The Case for Professional Boards - Harvard Business Review

This question was posted at Linked In, at the following location:

http://tinyurl.com/2fbpeeu

The orignial HBR article is linked through this address as well. I have also posted my comments directly to the Linked In discussion thread.

From what I saw in the preview, and based on my personal experience, I would agree with the three main recommendations made by the author, specifically:

1) Smaller size: the author recommends six to seven members, with the CEO and the rest as outsiders.

I have been on boards of this size, as well as both much smaller and much larger boards. Where I felt the board was most effective was in just the size and composition that the author recommends. In the case of too small a board, I did not find enough difference of opinion on any subject to make a worthwhile dialogue. Additionally, with a very small board, there are risks that one or two will dominate the conversation, especially the CEO. On the boards that are too large, as the author indicates, no one feels terribly responsible. Because of this, the board meeting becomes an echo chamber for the CEO.

2) Most of the independent directors would be required to have extensive expertise in the company’s lines of business.

I would agree, given the qualifier “most.” I offer the following cautions:

a) Experience in the industry by the board members must be tempered with the realization that management has the charge to run the company, and it is management that best understands the customers, suppliers, and other competitive dynamics faced in the present time and in the company’s particular situation, and

b) Outside perspective is always needed. Candidates could include someone with:

i) Complementary background, perhaps from a supplier or customer of the subject company,

ii) Someone from an industry with similar labor or cultural dynamics, or

iii) Someone who has experience dealing with a particular management situation (perhaps a turnaround, etc.).

3) They would spend at least two days a month on company business beyond the regular board meetings.

Of the three recommendations, I find this the most critical. I find it inappropriate to believe that one person can sit on several boards and somehow provide real value to the management and shareholders of each of the companies. However, this expectation is reinforced by the typical compensation practice for a board member. Board members are paid as if they are expected to not be involved more than four board meetings per year, so that is what happens.

It is not possible to properly serve as a board member in more than a small handful of situations at a time. Time must be spent with management; interaction should be encouraged beyond that with the CEO. This relationship must be clearly understood and defined to ensure that lines are not crossed between oversight and execution, but certainly this can and should be done.

What are the Necessary Traits of a Successful "Turnaround CEO" ?

I took this question from a TMA forum at Linked In posted by Frank Feather, and my response is also posted there.

1) A good listener. My assumption is the CEO is coming from the outside, and perhaps even outside of the specific industry. It is not fair to assume that a) all members of existing management contributed to the failures, and certainly b) none of them know anything about the business otherwise why would they have failed.

The incoming CEO must learn many things quickly about the new company. Who are the key customers, what are the critical factors for success, what are some of the internal views about how the company fell from grace. Most importantly, the incoming CEO must learn the people. Who has his head on straight, who can get his head on straight with a little guidance, and who is hopeless?

These decisions cannot be made if the incoming CEO acts like he already knows it all before walking in. With the wrong attitude, he will get no cooperation.

2) Understand the numbers. I have found companies typically did not get into trouble because of manufacturing failures, engineering problems, and a bad contract here or there. Yes, these contribute, but every company has its share of these. Good companies have the cushion to overcome a setback on occasion.

Companies get into trouble because they don't focus on cash flow. They don't focus on the balance sheet. They don't understand how decisions made each day by the many managers with authority will affect the bottom line.

I do not suggest that the incoming CEO must be a finance guy, but he must understand how business decisions will affect the firm financially. He must understand which levers he should push to quickly start building a financial cushion for the company.

3) Focus. The ability to identify the high leverage items quickly. The incoming CEO cannot fix everything at once. Neither he nor management will have the bandwidth. What must be fixed early that provides the most relief to cash flow with the shortest time to implement? What must be fixed early to stop decisions that will only add new problems to the old?

4) Be aggressive on expectations. Once the high leverage items are identified be aggressive about implementing solutions. Ensure teams are focused on fixing and solving the causes of the failures. Get some quick wins. This builds the team up - remember they have been getting torn down for quite some time during the downfall.

5) Patience. This seems counter to 4) above. But both must work together. Remember the staff already had a full-time job before you walked in the door. You are requiring them to work on things that they weren't working on before. As they see that you are driving them to some key wins, and as they see results, 4) and 5) will be highly complementary.

6) Empathy. Demonstrate that you understand the importance of the success of the company to them. The turnaround CEO will be seen as here today, gone tomorrow. Failure, while perhaps a setback for the CEO's reputation, is not as damaging to the CEO as it will be for the employees whose livelihood is dependant on the success of the company long-term. Many employees have a lifetime invested (or hope to invest) in the company. Show them you understand this.

What do Controllers "Control"?

A consistent downfall I have seen is the idea, defended by many in the organization, that the controller is actually controlling something. Finance defends this idea because it makes them feel powerful. Other management defends this idea because it relieves them of great responsibility.

Certainly, if properly executing his duties, the controller will implement systems that help accomplish much of what his title proclaims. Absent such systems, he is basically left having to sign a check for some agreement made some time ago by some other member of management. I do not intend to go into the appropriate procedural systems, these can be explained by most controllers, even the ones not doing their job.

But to really be in control requires having a management team at all levels that are complete businessman. Every day, employees are making decisions that are binding the company to future payments. These happen whether or not anyone else is looking.

How to create such a management team? Create complete entrepreneurs. Do they understand cash? Do they understand the customer? Do they understand quality? Do they understand how the decisions they are responsible for making every day affect the outcomes for the company?

I go back to some earlier posts:

http://anthem-llc.blogspot.com/2010/04/communicate.html

http://anthem-llc.blogspot.com/2010/03/four-oclock-meeting.html

Communicate, train, teach. This takes the investment of time by the entire team. However look at the payoff. Every manager acts like a complete businessman. They think about the impact of their decisions on cash, quality, and the customer. By the time a document gets to the controller’s desk for approval or payment, most if not all questions have been answered, and the project has already been scrubbed and re-scrubbed to ensure good assumptions driving a good outcome.

With this, the controller’s job becomes much easier. And, he can truly say he is in control.

Adding New Customers or Products

For a company failing to grow the top line, or seeing margins reduced on the bottom line, one solution is certainly to develop new customers and products. This can be done in a systematic way, in a way that is likely to yield better results, or it can be done in a hap-hazard manner in which there are almost no noticeable improvements.

It should be obvious as to the approach I have seen when coming in to troubled situations.

Often, with good intentions, individual sales-people and engineers are all working toward some new "thing" -- gaining a new customer, developing a new application, identifying a new product -- without any real direction or focus. There is little if any analysis done regarding the company's strengths and weaknesses in the new area relative to the competitors. There is little analysis regarding the size of the potential market. By gut feeling, someone decided it was a good thing to work on, and so the go-ahead was given.

However, an alternative is one where such possibilities are reviewed systematically, with some idea of the competition, of the customer's willingness toward adapting a new innovation, of the likelihood of achieving a successful implementation. Simple questions can be developed and answered that will give some indication as to the relative merits of one opportunity vs. another.

Any company, no matter the size, has limited resources. No company can afford to chase every dream. Therefore -- in every company -- someone or some group of "someones" must decide on where and how to spend resources. This can bring its own dangers -- a bureaucracy is introduced, or decisions are made by a group of executives too far removed from the knowledge of technology and customer. These are real dangers.

However, this doesn't change the fact that someone or a group of someones is responsible to decide. To do so, there must be a process. The process can be ad-hoc -- "let's wait to ask the boss on a Wednesday afternoon right before he goes golfing -- he is always in a hurry and usually will say yes quickly in order to get out the door." Or it can be systemic.

For example, what is the product, who are the customers, what is the potential size of the opportunity, do we have the technology or is it otherwise related to our existing capabilities? These questions can all be asked and answered quite easily. With such answers, opportunities can be assessed as to the likelihood of success and thereafter to the value for the firm.

As to the risk of stagnation, or bureaucracy taking over -- shame on management if this happens. It is not so difficult to ensure that the right number and type of people are involved in the decision making process. It is also not so difficult to identify the sales and technical people who have earned the opportunity for much more leeway and freedom from the process if they feel that they have a good idea. Give such performers a discretionary budget to spend how and where they see such an opportunity. It doesn't take much money to fund such internal entrepreneurs.

But, certainly, you must put some process around this. This must be managed. It is a certain way to lose focus, and a certain way to spend resources on opportunities that either a) don't fit in the direction of where the company wants to go, or b) have little or no likelihood of success -- technically or commercially.

Non-controllable Costs

One consistent theme in each company I have gone into is the idea of non-controllable costs. "Well, property taxes are not controllable." "We can't do anything about IT." "Energy rates are going to be whatever they are." Such statements come out at all levels of the organization -- even top management.

Consider this for a minute. Executive management is admitting that they are willingly spending money that they cannot do anything about. Is this a sign of a team that is on the top of their game? Would someone dare make such a statement to their spouse regarding the household budget?

Certainly some costs might be easier to manage than others. Some costs are approved "above my pay grade." Every cost can be controlled. Every cost has drivers. Every cost has opportunities for improvement.

Every line item of cost can have an owner, if management wants to manage. The owner can learn the drivers of the cost. The owner can understand the factors that affect the cost. The owner can take action to improve the cost and manage this action through the organization.

This attitude of non-controllable cost is a disease. It is a disease of laziness. It is a disease of complacency. When you hear such statements, know that management is inadvertently admitting that they are not qualified to manage.

When challenged with this, most will come around. "Yes, we actually can do something, but X, or Y, or Z must happen, or so and so must get involved, or...." With this start, you can now begin taking steps to focus on every item, on every project, on every cost -- even the difficult ones. This is the first step toward getting management's mind around change -- a change in attitude toward the future of the company.

Profit Margin

Understanding how a firm defines "profit margin" often tells a lot about how the firm is managed and the potential long term viability of the firm. I have seen many types of margin used -- some I could not explain if my life depended on it.

Gross margin, net margin, contribution margin, variable margin, EBIT margin, EBITDA margin, etc. I am sure I am missing many other options. The ones I typically focus on are EBITDA, and to a lessor extent EBIT. I find these most conducive to the philosophy of focusing on cash and creating a return on investment.

What I would like to spend some time on are the problem "margins" -- the ones I find being used in companies that have gone south and have helped contribute to going south, companies that "somehow" can't seem to find any profit: contribution margin and variable margin.

What these have in common is a conscious choice to ignore some cost -- everyone's favorite to ignore, G&A; next on the list, fixed overhead, etc. The justifications include the desire to win a program that is marginal financially (in fact, to price below fully burdened cost), or the desire to focus on operations but not support, or a desire to look at costs that management can "control."

All of these reasons are just excuses to not manage costs. Every time a program or project is priced below cost, the company is introducing a new competitor to the market -- and one that the company can never beat...that new competitor is itself, but always a lighter version.

A desire to ignore G&A is exactly what is convenient for the guys in the office. This way the lack of discipline in corporate is not made visible, and in fact the message is sent that this cost is not very important or not anyone's business.

Setting aside fixed costs and looking at variable margin implies that recovering machinery, equipment, and building expenses is not necessary. Or that somehow parts will spontaneously appear from nowhere.

The most stunning is the idea of focusing on costs that management can "control." It is impossible to have any item of cost that someone in management is not responsible for. And whoever is responsible for it must be held accountable to manage it. This one always amazes me, and I have heard it too many times. Management actually stands up and "admits" that they cannot control some portion of cost. If this is true, what use is management?

The bad message is reinforced -- not all cost is important. As if some dollars being spent are less important than others, or have less impact to the bottom line. Management is taught that there are some costs worth worrying about, and some that are unimportant -- or beyond their pay grade.

Such a practice creates a crutch, and a self-reinforcing one. The company develops a culture of dependence on subsidy, as if some benevolent father is covering part of the tuition bill.

Whenever I come across such a situation -- contribution margin, variable margin, etc., I ask which costs are being excluded. At a minimum, it is G&A. I then ask the management if they are agreeing that on such programs they are willing to give up that portion of their own compensation -- after all, what they are suggesting is some portion of their own personal costs will not be born by the company but subsidized by the shareholder.

Even this could be acceptable if the practice was managed strategically relative to opportunities -- with offsetting higher expectations on other opportunities. However, what I have found is that the line has continuously moved, until every program, every opportunity is looked at on less than full cost. In some ways, this is inevitable -- once dependence sets in, it is difficult to create the discipline needed to keep this in control.

Do not allow someone in accounting to convince you that the company can grow itself into profit by selling product at a loss. Don't allow the taste of this drug to seep in. Once it does, it will be difficult to keep it contained -- in fact, it will consume you.

Communicate

One regular theme I have found when coming into a turnaround situation is the lack of communication between the top two or three people in management with the rest of the organization. "They never ask our opinion." "They don't understand the customer the way I do." "I have given many good ideas and nothing has been done."

It seems obvious in its face, but should be said: the wisdom in the organization is priceless, and any two or three people in the organization will know more on a given subject than the leadership will.

The best ways I have found to deal with this is to talk and listen. This can be done one-on-one, it can be done in meetings. I know meetings can be a taboo -- very bureaucratic and cumbersome, some would say. I would like to offer a different view.

It was my practice to set up meetings on various topics. I have previously discussed the four o'clock meeting. I would have meetings on business engagement, new customers / products, innovation, and others. I would ensure a very broad participation -- much broader than required for the specific agenda. I did this for a couple of reasons: 1) I wanted a wide range of opinions on a given subject (especially from people "outside" of the direct line of knowledge), 2) I wanted everyone to benefit from each other's knowledge, and 3) I wanted an opportunity to be able to convey my way of thinking through a subject to the entire team.

At first, I would get many complaints: " we have too many meetings, these meetings last too long, why do you let people talk on and on?" I would remind them of the earlier complaints -- management never listened to me, nobody asked what I thought, etc. I would ask them how they expected me to listen to them if we didn't have some forum to communicate. Or how could we properly question and discuss some new course without a brad array of opinions. Finally, as we are all affected by any such decisions, shouldn't more of us be in the discussion?

I am not sure my arguments won anyone over, however I believe time certainly did. After some time I would get comments from even the most vocal skeptics saying that they now see the benefits of such a process, that it helps bring the team together, that it makes everyone feel like they have a say, etc.

For me, I get the benefit of learning a lot about a new company, seeing management in action as to how they think and communicate, and conveying my sense to the group. I believe it is a win-win for everyone.