Harvard's Gentleman's C

Much of the press coverage of the recent resignation of Harvard’s president has focused on Larry Summers’ rough edges. But as a non-profit board member and author of a book on corporate governance, I see a problem with Harvard’s board whose governance I’d grade a gentleman’s C.

The Harvard Corporation’s seven-person board should never have appointed Larry Summers in the first place. Although he was a brilliant scholar Summers felt the need to prove his intellectual superiority in his interactions with others. He had a reputation for aggressiveness which the Board may have thought would contrast nicely with his predecessor, the genial Neil Rudenstine, who took a leave of absence in 1994 due to the stress of the job.

Famously, his former boss at Treasury, Robert Rubin had encouraged Harvard’s board to overlook Summers’ rough edges. This turned out to be an important mistake in the board’s exercise of its governance responsibilities. Since Harvard, with its 12 separate schools, operates under the principle “Every Tub on its Own Bottom”, its president must be able to lead while gaining sufficient consensus to overcome the natural inertia of these highly decentralized, and innately competing Tubs. Perhaps the board should have considered more deeply whether Summers’ combatitiveness was compatable with this leadership requirement.

To its credit, it appears that Harvard’s board took action when it became clear that his loss of support among parts of the faculty threatened Summers’ ability to lead. Moreover, Summers can cite some important accomplishments during his tenure such as setting the groundwork for a stem cell research facility in Allston and earning significant support from Harvard undergraduates.

Now that Summers has resigned, it begs the question: “What kind of leader does Harvard need?” Probably someone more like Rubin. As Boston Magazine described him, Rubin “is slender, elegantly tailored… a polished veteran of the New York financial world and a graduate of Harvard College -- suave, sophisticated, mannered, charming.” Rubin rose to the top of Goldman Sachs, a company where intellectual brilliance and teamwork are highly prized. This contrasts with other Wall Street firms, where the rewards go to individual superstars who outcompete their peers.

Harvard’s board can show that it’s learned from the Summers experience by choosing a leader who combines intellectual horsepower with deft tiger herding skills – someone not unlike Robert Rubin.

What Color is Your Ocean?

This semester I’m teaching Competitive Environment and Strategy to 37 MBA candidates at Babson College -- which US News and World Report ranked #1 for entrepreneurship for the tenth year in a row. A few weeks ago, one of my students asked me whether I had heard of Blue Ocean Strategy (BOS). A couple of days later, an executive at another company asked me to propose how I could help the company implement BOS.

Now I am asking myself “Could BOS be the next management fad?” To explore this question, I’ll address some others:

• What is BOS?
• Why does it interest managers?
• What are BOS’s strengths and weaknesses?
• How can it be implemented?

BOS is an idea described in a book of the same name by two professors at INSEAD. According to the professors, most companies participate in red oceans – highly competitive markets in which it is difficult to earn good profits because companies benchmark each others’ performance and ultimately end up with the same strategies – many of which involve intense price competition. By contrast, a few companies have created blue oceans – entirely new industries whose creators enjoy profitable growth with no competition due to the unique value they provide to a large swath of previously underserved customers.

To bolster their case, the authors cite their study of 108 companies’ business launches. 86% of the launches were incremental improvements within red oceans; whereas 14% were aimed at creating blue ones. While the red ocean line extensions delivered 62% of the total revenues, they only produced 39% of the total profits. By contrast, the BOSs generated a mere 14% of the revenues but a whopping 61% of the total profits.

The authors cite Casella Wines, an Australian winery whose new product sold 11.2 million cases in the US two years after it was introduced, as an example of BOS’s benefits. With its fun, easy-to-enjoy, everyday wine, Casella Wines’ BOS captured consumers of beer, spirits, and ready-to-drink cocktails – alcohol markets which are three times larger than the US wine industry. By looking to these wine alternatives, Casella learned that most Americans viewed wine as intimidating and pretentious and that wine’s complex taste – a dimension along which winemakers competed -- made it difficult for most Americans to drink regularly.

Using this insight, Casella introduced [yellow tail] in 2002, a brand which by August 2003 was the top selling US red wine. Casella’s BOS made [yellow tail] social and accessible to drinkers of beer and other wine alternatives. [yellow tail] tasted fruity and sweet, rather than complex, and the brand consisted of only two wines – a white Chardonnay and a red Shiraz -- whose packaging was simple and eye-catching. Moreover, Casella gave Australian outback clothing to retail employees which inspired them to recommend [yellow tail] to customers.

Meanwhile Casella chose not to perform activities which other wine companies viewed as essential. For example, [yellow tail] was not aged so Casella did not require the working capital associated with storing wine in wooden barrels for long periods of time. Furthermore, unlike its wine industry competitors, Casella chose not to spend money on promotional campaigns, mass media, or consumer advertising. In addition, since it only had two kinds of wine, it had higher stock turnover and minimal investment in warehouses and inventory.

My theory on why BOS interests managers is simple. After years of cutting costs since the economic contraction which began in 2001, many companies have realized that future earnings growth will need to come from revenue increases. And since many managers these days are risk averse, they would prefer to invest in growth opportunities which they perceive as having the greatest profit potential. BOS seems to answer that managerial call -- offering the promise of highly profitable revenue growth. And as the Casella Wine case suggests, BOS’s payback can happen very fast.

However, to gain widespread adoption, established companies will need to find a way to profit from BOS. This may not be so easy because many established companies have a very difficult time changing the way they think about their businesses. Moreover, this resistance to change is not simply a matter of psychology – it is also a result of managers’ incentives which are often based on exceeding quarterly profit targets. But implementing BOS can involve a radical change in business strategy which may undermine existing strategy – hence requiring a big investment with a payoff which managers may perceive as uncertain and of indeterminate size. Managers will be reluctant to take such risks unless senior executives give more than a lip service commitment to supporting them.

Since BOS is a new management concept, it has not been widely adopted by large corporations – and it may never be. Many large corporations will wait to see whether BOS enables their more adventurous peers to achieve measurable and dramatic success. If so, large companies may feel compelled to remedy their BOS envy by adopting it aggressively. Veterans of previous management fads will need to see whether management is sufficiently committed to BOS to alter corporate incentives and investment criteria in order to capture BOS’s potential payoff.

In my view, companies that decide to move forward with BOS should take the following six steps:

• Build the BOS Team. Establish a project team and a steering committee of senior executives that reviews the work of the project team to assure that its recommendations will be implemented. This first step results in agreement on objectives, methodology, and business scope. And it trains the team members in the BOS tools they will need to conduct the project;
• Develop a strategy canvas for the selected business. A strategy canvas maps how an industry’s providers perform on key competitive factors from the customer’s perspective. For example, the strategy canvas for the wine industry illustrates how well wineries’ perform in terms of criteria such as price, use of wine industry terminology in marketing, aging, quality, and vineyard prestige. For a company implementing BOS, this step would identify these key competitive factors and map out how customers perceive that the company and its competitors perform vis-à-vis these factors;
• Evaluate the alternatives to the selected business. Alternatives are the different products that customers may buy instead of the ones that the company sells. By analyzing the key competitive factors in these alternative industries, a company can identify blue oceans by imagining a new positioning that draws in customers from the alternative products. Casella’s analysis of the key competitive factors in alternative industries – such as beer and spirits – revealed that many of these beer and spirits customers were put off by wine’s complex taste and its snobby positioning. As with Casella, this step is intended to provide the basis for a company to identify the unique positioning that will drive its BOS;
• Define the company’s BOS. Using the Four Actions Framework (FAF), this phase defines a company’s BOS. The FAF leads a company to identify (1) which industry factors it can eliminate, (2) which ones it can reduce, (3) which new sources of buyer value it should create, and (4) which existing industry factors it should raise. For example, Casella’s [yellow tail] eliminated wine terminology in marketing and the wine industry’s focus on aging and quality; it reduced vineyard prestige and wine complexity; it created easy drinking, ease of selection, and fun and adventure; and it raised price. In this phase, a company defines a memorable tag line for its BOS, and makes specific choices regarding target customers, product/service positioning vis-à-vis key customer purchase criteria, and functional policies in activities such as manufacturing, marketing, distribution, and research;
• Perform a BOS financial evaluation. This phase estimates the BOS’s future cash flows. It develops a base case scenario and identifies the assumptions that lead to the biggest variations in the BOS’s base case net present value. It also provides a company with optimistic and pessimistic scenarios which help the steering committee decide on the magnitude and timing of the capital and managerial investments required to implement the BOS; and
• Plan the BOS’s implementation. In this final phase, the project team develops a sequence of strategic initiatives that will be required to implement the BOS. For each strategic initiative, the project team defines the key action steps, accountable manager(s), deliverables, deadlines, and additional resources required.

If it helps companies grow more profitably, then BOS deserves to be the next management fad. Your company should decide whether it wants to be among the first to find out.

Barron's Alan Abelson on Car Race

In a Januuary 24th post, Car Race, this blog commented on the US auto industry. Editor Alan Abelson picked up on this post in his column in the February 6th Barron's. Here's an excerpt.

Kibitzers on what the companies should do to drag themselves up from the morass are a dime a dozen, and that's about what most of the advice is worth. GM is being pressured to unload its profitable financing unit, GMAC, and a truly helpful suggestion is that the two fallen giants build cars that consumers like and build them more cheaply. That's like telling drowning people they should learn to swim.

Peter Cohan of Peter S. Cohan & Associates, who offers some interesting observations on the economy and kindred hair-raising subjects, weighs in with a different idea. He says the fundamental question facing GM and Ford is: Are they car companies or finance companies that happen to sell cars?

The U.S. auto producers are being eaten alive by the likes of Toyota, Honda and Nissan because finance, he contends, "has become the tail that wags the dog." By way of proof, he cites the fact that Ford earned $2 billion last year because it generated $6 billion in operating profits from its financing arm, while losing $4 billion turning out cars, SUVs, etc. GM limited a humongous loss to a merely eye-popping one by virtue of its financing activities.

GM and Ford, Peter goes on, "can't cut their way to success in the car business." Both are operating at roughly 80% of capacity and although the pitiable pair are busily shrinking their physical plant, he reckons that "at the rate they're losing market share," they'll find those capacity cuts simply won't do the trick.

Peter ticks off the usual culprits that have thrust Ford and GM into the abyss: Quality enables Toyota, for example, to charge higher prices, while efficiency enables it to build cars 7% faster and $300 to $500 cheaper. Moreover, the Japanese government picks up most of the sizable tab for health care that heavily burdens U.S. automakers.

To Peter, the answer is clear. He would like to think that "GM and Ford can transform themselves into makers of the world's highest quality vehicles." But, he sighs, that seems unrealistic. A more likely survival strategy, he proposes, "would be for GM and Ford to outsource vehicle manufacturing to China and India and focus exclusively on financing."

Man, would that ever get the natives howling. Somehow, we don't think it's going to happen anytime soon. But it could be an interesting bargaining ploy when the Detroit moguls next sit down with the UAW to hammer out a contract, provided, of course, there's still a Detroit.

Bernanke's conundrum

With his retirement yesterday, former Fed Chairman Alan Greenspan leaves his successor, Ben Bernanke, with a conundrum of his own.

In the last quarter of 2005, the economy slowed dramatically. Greenspan contributed significantly to the artificial economic expansion of the last several years. And now the risks of that artifice will be left for his successor to manage.

Greenspan’s artifice stands on two wobbly legs – tax cuts and cheap money. Greenspan supported the $1.6 trillion in tax cuts – 36.7% of whose benefits went to the top 1% of earners -- pushed by the President. And he lowered interest rates to encourage borrowing.

The economy responded to the artificial stimulus. Housing prices increased 50% and consumer spending – fueled by credit cards and home equity loans -- kept the economy from imploding.

Unfortunately, this artificial expansion has a dark side. The Federal government went from a roughly $200 billion surplus to at least a $400 billion deficit (forecast for this year). The savings rate -- at negative 0.5% -- has not been so low since the Great Depression. Personal bankruptcies are at a record and home foreclosures are spiking.

But this dark side is not a concern for the White House. Its financial supporters – the oil industry and Wall Street – have never had it better. Exxon Mobil just reported a corporate record quarterly profit and Wall Street bonuses have never been higher – despite a flat stock market.

This does not help the 60,000 auto workers whose jobs GM and Ford executives intend to eliminate over the next five years. But they are probably Democratic voters anyway.

With interest rates rising, fewer consumers will be able to afford to keep paying the debt service costs required to keep up with exorbitant housing costs, high heating bills, record gas prices, and spiking health care bills. This could result in decreased demand for many consumer products -- leading corporations to cut staff to preserve their margins.

So Bernanke faces a conundrum: How can the Fed control inflation in a world where consumer prices are rising rapidly without exacerbating an economic slowdown being fueled by Greenspan’s wobbly economic legacy? The answer is of more than academic significance for this former Princeton professor – and for the rest of the world.