Chapter 1-1

Chapter 1

THE NEED

There is a story told of a new CEO spending his first day at the office. The recently “retired” outgoing CEO stopped by and said to him, “I’ve put three envelopes in the top center drawer of your desk. If you ever get into trouble trying to do this job, open the first envelope and it will tell you what to do.”

Sure enough, after a few months in office, the new CEO, feeling some pressure, and knowing that things were not going well, looks in the desk drawer, takes out envelope #1, opens it and reads:

“Blame everything on me. Good luck. And if things don’t improve, open letter #2.”

The letter was signed by the previous CEO.

The new CEO blamed everything on his predecessor, and things seemed to settle down, with everyone saying, “Yes, if only so-and-so had done blah, blah, blah.” And morale appeared to lift, at least for a while…

After another few months, conditions worsened. Last quarter’s results missed forecast, and the next quarter looked equally dim. New product introductions had bogged down. There were serious channel conflicts. Warranty costs were up. And employee morale was back at rock bottom. The stock price had taken a series of hits. The few Wall Street analysts that covered the stock pegged it as a lukewarm “hold”.

This was happening despite the CEO working 75-80 hour weeks, meeting with all the business unit heads, getting everyone focused on increasing customer satisfaction, communicating incessantly with Wall Street analysts, appearing on business shows, flying the flag at industry events, working diligently to cut costs while trying to accelerate new initiatives.

So, the CEO opened his desk drawer, found the remaining two envelopes, and pulled out envelope #2. Quickly opening it he read,

“Blame everything on the poor economy, overseas competition and

the strong/weak (pick one) dollar. If things still don’t improve, then, as a

last resort only, open envelope #3.”

Letter #2 was also signed by the previous CEO.

The new CEO blames the economy, overseas competitors and the dollar. And the Board seems to be mollified. At least for a while…

Unfortunately, the situation does not improve. The quality improvement initiatives, the cost cutting, the downsizing, the new strategic plan, the new ad campaign, nothing seems to help the stock price. The Board is increasingly impatient and short-tempered. So the CEO goes to his desk drawer, pulls out envelope #3, tears it open, unfolds the letter, and reads the following message,

“Prepare three envelopes.”

This story, no doubt apocryphal, does serve to highlight the pressures that chief executive officers and other C-level executives are experiencing. And it’s not only C-level executives. These pressures are reverberating throughout companies, from executive suites down to local sales offices, to plant floors and call centers. No industry is immune, from foodservice to financial services, from media to pharmaceuticals, from retail to transportation. Succeeding in a company, large or small, public or private, is more challenging than ever before.

To Be, Or Not To Be

One sign of this “challenge” is fewer people want to be CEO. A survey by New York based global consultancy Burson-Marsteller found 64% of the most senior executives at North American Fortune 1,000 companies have no desire to be promoted to CEO. That’s more than twice the 27% who had no desire to be CEO in 2001, an incredible change in a short time. Seventy-three percent of 369 CEO’s answered yes to the question “Do you think about quitting your job?”

1,228 chief executives left their jobs in 2005, more than in any other year -doubling the level of departures experienced in 2004, and surpassing even the dotcom exodus of 2000; turnover among top management in general has picked up too, according to a study conducted by outplacement firm Challenger, Gray & Christmas.

The risk/reward ratio is not sufficient to help them decide to be CEO. The Sarbanes-Oxley law, passed in response to the Enron debacle, requires painful reporting for companies, and holds the CEO accountable for reported numbers, under the threat of prison. That increases the risk. “We believe the current (higher) annual rate of CEO turnover is the ‘new normal’,” notes Paul Kocourek, a Senior Vice President of Booz Allen Hamilton. “Today’s typical CEO knows that he will remain in office only as long as performance for investors is acceptable. The CEO’s insider allies are typically gone, or less powerful. No longer can a CEO expect to prolong his career by managing the board.”

"Due to shortened CEO tenure and intense media scrutiny, executives are more wary of the corner office," said Patrick Ford, chair of Burson-Marsteller's Corporate/Financial Practice. "Executives know that CEO decisions and actions are examined 24 hours-a-day."

Boards are judging CEO performance more harshly. CEO’s who were dismissed in 2000 generated median regionally-adjusted shareholder returns 13.5% lower than retiring CEO’s; in 2001 it took a 11.9% shortfall to prompt a firing, and in 2002 it took a 6.2% shortfall. In three short years the CEO’s margin for error was just about cut in half.

A study of 1,000 individual investors and 24 Wall Street analysts and portfolio managers showed that the typical individual investor, one who owns stock outside of a 401K or IRA portfolio, will give a new CEO about 17.5 months on average to make a difference. Wall Street professionals are less forgiving, with CEO’s having an average tenure of only 14 months to demonstrate results.

In Burson-Marsteller’s 2003 Building CEO Capital^TMsurvey, conducted with RoperASW, 1,040 “business influencers” shared their opinions on the leadership issues that determine CEO success. These business influencers now grant new CEO’s about 18 months to prove themselves – about two months longer than they gave CEO’s in 1999. The following is the timeline for other goals:

According to Booz Allen Hamilton, the frequency of CEO “succession events” (the departure of one CEO and the accession of another) nearly doubled, from 6% of the largest global 2,500 companies per year in 1995 to 15.3% in 2005. For many CEO’s, these are not “the good old days.”

The situation is summed up by this statement by Charles Lucier, Senior Vice President Emeritus of Booz Allen Hamilton, "Business leaders are enduring scrutiny and pressure unseen since the Great Depression. The CEO mystique has all but evaporated, and director activism has replaced crony capitalism in the boardroom."

Misery Loves Company

CEO’s and other C-level executives feeling the pressure for performance are energetically passing it on. Understandably, employees, key suppliers, channel partners and others feel the heat.

CRMGuru.com reports that within the high tech community marketing vice presidents experienced a 75% turnover rate between 2002 and 2003. Many organizations with revenues between $15 and $50 million have eliminated every single marketing position. Software Product Marketing, a volunteer group with a charter to help out-of-work software marketers find jobs, has more than 3,500 members.

This reflects an overall trend by business to get lean and mean. And that often entails gutting middle management. It’s simply marketing’s turn.

Executive recruiting firm Spencer Stuart reports the average CMO (Chief Marketing Officer) tenure only lasts 23 months. In the food industry tenure is only 12 months. By the time his business cards show up, the food industry CMO may already be gone.

Marketing management, in turn, are looking to their most trusted advisors and suppliers to help them show the worth of every investment made in marketing. This is impacting advertising, PR, design, naming and identity, research and other marketing service provider firms. The mantra of “If you can’t measure it, don’t do it” has never been more true. And, for many firms, more feared.

Ad agencies are receiving RFP’s (Requests For Proposals) from prospective client companies that contain strong requirements for credible information on how the ad agency will measure results and demonstrate a return on investment. Agencies are being asked to share case histories of how they’ve helped other clients measure ROI. Ad agencies and other key suppliers and vendors are being asked to justify their value, and their existence.

For these service provider firms, the questions of “What is the ROI from your activities and programs?” and “How do they contribute to an increase in shareholder value?” need to be urgently answered.

Measurement alone, however, is not the answer. As the late, great management guru Peter Drucker told us, "Efficiency is doing things right; effectiveness is doing the right things." Measurement of the “right things” gives us the best of both worlds. Measurement, therefore, must provide answers that are credible and germane to the firm’s value drivers.

Why Is This Happening?

Pressure for performance affects all businesses, but not all businesses fail to perform. Many businesses find ways to control costs, expand revenues and margins, and continue to grow profits. What’s the difference between those businesses and the ones that are in trouble?

Can it be explained by the type of industry they’re in? Not likely, since most industries contain a mix of leaders, “middle-of-the-roaders” and laggards – even though the industry may be ascending or declining in importance.

That also knocks out other reasons, like technological change. Seems some companies are better than others at adapting to technological and other types of change; whether it’s gradual or discontinuous doesn’t seem to matter. In fact, there’s a positive correlation between the pace of change and the appearance of new business units and start-ups trying to capitalize on change by applying technology to improve products or develop new products for current and new markets.

The investment community views innovation as a hallmark of companies that create shareholder value. So innovation, or lack thereof, or inability to translate innovation into shareholder value may be an area that can explain CEO and executive churn. This gives us another clue: innovation is an intangible asset.

However, the track record of innovation being converted into shareholder value is not very good. Let’s look at innovation via the application of new technology: Morgan Stanley estimates that between 2000-2002, U.S. companies wasted $130 billion on unneeded technology, according to its study of 25 years of tech spending. Separately, analysts at Gartner Group have estimated that $75 billion is wasted – annually – on “failed” technology initiatives in the U.S. alone. Using financial analysis to measure the total impact, this $75 billion translates into a staggering trillion-dollar figure in lost market value for US companies. What were the implications and outcomes of that loss of market value in terms of shareholders and boards demanding that CEO’s be held accountable – and for executive churn?

Baruch Lev, in his insightful book Intangibles – Management, Measurement and Reporting wrote, “Wealth and growth in today’s economy are driven primarily by intangible (intellectual) assets.” When you look at the stock market value of public-traded companies, the value of intangible assets represents well over 50% of overall firm value. This varies from a low in heavy industries like petro-chemicals to a high (over 90%) in some consumer and luxury goods.

Most corporations are run with standard cost-accounting systems that don’t measure and report on intangible assets in a way that gives executives useful insight into how value creation works in their enterprise. Leading and managing an enterprise by using standard cost accounting system provided data is like trying to drive a car by only looking in the rear view mirror. Sooner or later, you’re sure to encounter a nasty surprise.

This lack of forward-looking information, especially in the area of what creates brand value, results in under investment of resources in some parts of the organization and over investment in other parts, misalignment of processes designed to create loyal customers, and the attendant disappointing outcomes.

The National Institute of Standards and Technology estimates that not incorporating customer requirements costs U.S. corporations nearly $100 billion a year in failed projects. There’s another $1.25 trillion in potential market value that goes unrealized.

Adding to the need is the difference between what company leaders and managers think the brand asset and other value creators are, and the perception of investors, employees, suppliers and customers as to the most important sources of value. If there is a gap between the different perceptions, then company leaders and managers may think they are effectively communicating, when, in fact, they are not. They may be focused on the wrong “drivers,” and they may be communicating the wrong information, at the wrong time, in the wrong way. This may encourage employees to focus on the wrong issues. This may lead investors to incorrectly assess the value of intangible assets like brands, intellectual property, and other forms of innovation, thus leading them to either undervalue or overvalue firms, with the subsequent poor allocation of capital. This may also send the wrong signals to the company’s board and to the media and generate negative pressure, perhaps incorrectly and prematurely, on the company’s leadership.

PricewaterhouseCoopers surveyed hundreds of institutional investors and sell-side analysts in 14 countries – only 19 percent of the investors and 27 percent of the analysts found financial reports very useful in communicating the true value of companies. Only 38 percent of executives in the United States felt their reports were very useful. In high tech companies, the results are even worse.

Can the pressure on companies be explained by the transition to a service economy, using knowledge workers in flatter, less hierarchal organizations? Seems there are plenty of companies out there that are doing very well in this environment. However, one of the conditions associated with knowledge workers is often an inability to be effective. This may be another clue to poor company performance and CEO malaise.

Many companies are organized under a system that borrows liberally from the military’s old WWII ‘command and control’ model. This model worked well when people were relatively inexpensive cogs in an expensive machine (the factory) during the Industrial Age and needed to be carefully monitored and controlled.

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