Business Lessons From "Good To Great"
For entrepreneurs thinking about purchasing an entire business or investors thinking about backing a company, an important question is: "Does this business have any value beyond the value of its assets? Should the business be valued only upon assets? Or, can the business be valued on earnings?
The hope is that an ongoing enterprise should have a higher worth than just that of its assets. Yet, too often, businesses are acquired which appear to have sustainable and growing earnings. Then quickly the company's earnings fall and the company unravels.
Imagine a company as a collection of particles spinning around each other to make the company work. What force or glue holds them together? If the business is sold, will the glue keep the particles together? Or, is the owner desperately juggling the particles until a sale can be made before the particles fall apart? Is there any glue at all? Or just the illusion of glue?
As an entrepreneur, how can you create a great company that can be passed on to your heirs and still retain its value and grow its earnings?
Jim Collins, author of the bestselling book, Good To Great: Why Some Companies Make The Leap...and Others Don't, says that short-term success is often due to 'genius with a thousand helpers' leadership.
When the 'genius' departs the company, the company falters. Rather than being a tribute to the management ability of the 'genius,' failure after the leader's departure shows the leader wasn't able to create a lasting culture of disciplined business thought and action.
In every great company studied, Collins found a 'culture of discipline' which began with the question of "Who's on the bus?" and, just as importantly, "Who needs to get off the bus?"
Collins points out that bureaucracy and hierarchy develop as compensation to manage people who lack discipline. And, like a swamp to mosquitos, a bureaucracy is a breeding ground for people who just get by without really contributing.
Collins writes: "The old adage 'People are your most important asset' is wrong. People are not your most important asset. The right people are."
Collins offers valuable insight into knowing when you should get someone off the bus. Suppose the employee came to you and told you he just took another job. Would you feel bad about losing the person? Or would you be relieved? If relieved, it's probably time for that person to go. In a family business, this also applies to family members.
If you start with the right people, management not only becomes easier, but the likelihood of success becomes greater. A great leader values honest input from others and doesn't try to hand down a plan of action from the top. Collins says the question of 'who?' must precede the question of 'what?'
That's a radical notion given that nearly every business plan starts with 'what' and then tries to add people with strong resumes to create the 'who.' But, first plans usually aren't the key to a company's lasting profitability.
Collins says that it took the great companies studied an average of four years to find a strategy or a concept that made sense for the company. And, the concept usually resulted from much honest give-and-take discussion among management and employees. Success wasn't the result of a 'breakthrough' thought or action. It resulted from focused work based upon disciplined thought by the right people.
In the other not-so-great companies studied, Collins found leadership which was very much concerned with self-aggrandizement. In great companies, the ego of the founder and the key people is channeled into desire for the company's success, not their personal agendas.
Perhaps, surprisingly, the leaders of companies that made the transition from good to great were not only disciplined, but they were rather reserved. They weren't personal publicity seekers. They didn't take credit for their companies' successes attributing every success to "I" and blaming every defeat to 'bad luck.'
If the CEO is more ambitious for himself than for the company, why will other employees divert their ego's energy into building the company? They won't. They'll stake out their own turf. Collins describes great companies as 'plow horse,' not 'show horse.'
If the CEO tries to had down a plan of action and wants only 'helpers' to institute it, why should employees care about providing valuable front-line feedback and meaningful contributions? They won't. The employees who want to contribute will probably leave the company, as will the best employees if they sense that blind nepotism runs amuck in a family business.
Collins argues that people today are 'to do' list obsessed. Collins says companies would be better off making "stop doing" lists. In particular, Collins tells us that a company’s strategy must be focused. If your company is doing something that isn't part of that focused strategy, stop doing it. If a juicy acquisition appears that doesn't fit into your strategy, Collins says it's best to pass on the acquisition.
Most significantly, Collins says that we must stop doing things at which we are only competent. He goes so far as to call this 'the curse of competency.' For very often we are competent but lack the potential to be the best in the world at the thing.
Collins tells us that we can never build a world class company (or a world class life) doing things at which we are only just competent. Someone who is just competent at mathematics won't make a great mathematician. Just as being 'competent' at something isn't the basis for a great career, being experienced at something isn't the basis for company greatness. Maybe your potential for greatness isn't something you're currently doing. And, maybe, your company can't be great at what it does well.
It addition to world class potential, Collins tells us that all great companies tend to be passionate about what they do. Potential for greatness without passion means little. That said, Collins doesn't give us any hints for creating passion. Rather, Collins argues that a company's passion must be discovered, not mandated.
Collins says great companies tend to be effective at discovering a key factor of profitability in their industry and staying focused upon improving that one profitability factor.
Collins writes: "If you could pick one and only one ratio—profit per x ...—to systematically increase over time, what x would have the greatest and most sustainable impact on your economic engine?"
While many stock analysts thought that, as the provider of home mortgages, Fannie Mae's success would be completely determined by the spread in changing interest rates, Collins tells us that Fannie Mae realized that the key to Fannie Mae's market-independent success was not in the ratio of profitability per mortgage. Rather, Fannie Mae could become the world leader in understanding mortgage risk levels and profit by insuring that risk. Fannie Mae's key ratio became profitability per mortgage risk level.
In other cases, the key ratio for a great company was much more obvious. Faced with bank deregulation, Wells Fargo realized that banking was a commodity and that profitability per employee could capture the need for commodity-like efficiency.
In his studies, Collins found that less-than-great companies lacked such a key ratio insight into their business, but that seeking such a single ratio led to meaningful discussion that helped management better understand its business.
So, if we're contemplating buying a company or investing in one, Good To Great: Why Some Companies Make The Leap...and Others Don't by Jim Collins helps us by getting us to ask some very important questions:
-- Did the company begin with "Who?" putting the right people on the team and then giving them the freedom to discover the best "What?" Or, is the company only the playground for the CEO's ego?
-- Does disciplined thought based upon reality lead to disciplined action? Or, does the company lack a culture of discipline?
--Does the company try to define a business concept or strategy that encompasses both a real passion and the potential to be world class? Or is there passion with little real potential to be the best? Or is the CEO the only passionate one?
--Has the company understood a key ratio driving its economic performance? Has the management tried to discover such a ratio? If the company has a ratio, is it based upon reality or only upon speculation?
One last key insight from Collins: The purpose of budgeting and financial planning shouldn't be to determine how much each business endeavor is allocated. Rather, the purpose of analysis is to determine which endeavors should be fully funded and which endeavors shouldn't be funded at all. Of course, that's something many angel investors have always known.
The same is true for evaluating the qualitative aspects of a company. Before valuation, the first question is: "Is this a company I want to be a part of?" If the answer is "No," valuation is irrelevant.