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managing for shareholder value in the  age of the internet
living on the fault line

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the weakness in strength

          This is the fourth and final thought.  This is for the non-dot.coms, non-startups, non-venture folks.  This is for a constituency of people who actually have real businesses that have been in existence for a while, and, God forbid, they have been successful.

          It turns out that the more successful you have been, the greater your challenge for meeting a disruptive technology.  It's not an accident that Xerox is struggling.  Xerox is a great company; Kodak is a great company; Digital was a great company, but those are the companies that have the most challenges.  A guy named Clayton Christensen has really nailed this in a book called The Innovator's Dilemma.  Clay and I are trying to collaborate because our two books are focused on the same problem.  I want to talk about this as a way of closing out the night.  What does this kind of company do to manage for shareholder value in the age of the Internet?

          As a going concern, you have to understand that when the disruptive technology comes in¾let’s say you’re George Fisher, the Chairman of Kodak and digital photography is announced¾all of a sudden the world looks at you and begins to say, "You might be on the wrong platform.  We understand that you have a great position in film, but film might be going away.  All of this ability you have¾this branding, these great little yellow boxes you have in stores¾they might not be what you need.  By the way, these new guys, they have some very cool things, like they can share on America Online.  You can't do that.”  All of a sudden, this great position of yours that you have spent decades building is challenged, but nothing has happened yet.


          “Time out,” you say.  “Have you looked at a digital photograph?  Don't you want to actually see the face of your child?  This technology is dog meat!”

          And they’re saying, “Well, it's dog meat today, but Moore's law, remember?  It's going to get bigger.”  You are sitting there thinking, “What am I supposed to do, abandon the best franchise on the planet for some pie-in-the-sky idea?”

          Remember, your shareholder value is based on your future unrealized potential.  You have to look at what the future unrealized potential is for the Kodak film business.  Most of it may have been realized.  There is an argument for saying, “Maybe we should divest and move forward.”  This is the challenge you have, and it's a nasty challenge because you don't know if the new category is going to succeed or not.  If you drop the Kodak business and digital never happens, people are going to . . . well . . . they are going to hang you.  They are not even going to bother to sue you, they are just going to string you up.

          It's a nasty, nasty problem.  In order to meet this problem you have to get your best and brightest people focused on it.  You have a window of time to act that's very limited.  If you don't act in that window of time, and somebody else does and gets the gorilla position in the tornado, you are out.  It's a nasty, nasty time problem.  Slowing down to make deliberate, well-researched decisions is not the success mode when you have a disruptive innovation.  You need to put your best talent on it, but the problem is that your talent is compromised because they are also managing this phenomenally large, successful business that you've already developed.  Management attention is equally compromised because this thing doesn't run by itself.  It's called work, right?  In the middle of doing work, you are supposed to suddenly put your best minds on some new thing that you are not even quite sure is going to happen.  The scarce resources in this situation are time, talent and management attention.

          The good news is that there are three corresponding resources that are relatively plentiful: capital, systems and outsource service providers.  I would argue that at this time in the history, they are the most plentiful that I have ever known them to be.  You can apply the plentiful resources to give you relief for the scarce ones.  You can use capital to buy time.  That's what Cisco does when it acquires a company—57 companies last year, I think.  Those companies didn't make something Cisco couldn't make; they made something Cisco couldn't make in time.  Cisco bought time in order to get into this life cycle that they would have missed otherwise.  If you are willing to invest in systems, and not customize them and modify them, you can actually use systems to free up your talent.  If you are willing to entrust a business process to a service provider in a way that you can both be accountable to the integrity of that trust, then you can free up your management attention to work elsewhere.

          In an era of disruption, investors want you to spend your scarce resources on core things that differentiate your company, that create GAP and that create CAP.  They want you to spend the plentiful resources on what they would call context.  Context is things you must do in order to fulfill your commitments to your customers, partners, investors and employees, but they do not differentiate your company.  The other companies in your category do the same context things that you are doing, so it can't affect stock price.  Only core can affect stock price.  Investors want you to put your scarce resources against the thing that reward the investor, which is core, and use the plentiful resources in a non-differentiated way where there is no advantage to differentiation; and that's context.

          Now here is the nasty part.  Core becomes context over time  It's like we are trying to climb up a down escalator.  We wake up in the morning and say, “We are going to create core.  We are going to do things that our competitors don't know how to do.”  Well, the competitors watch and say, “If we don't do that, too, these guys will get too far ahead of us.”  They start undermining your core and turning it back into context.  The person who benefits is the end customer because the bar gets raised every year, but the shareholder does not benefit.  I joined high-tech around 1978.  At that time, if you could get a timely report, it was like, “Whoa, I scored!”

Core Becomes Context

Copyright 2000, Chasm Group LLC

Sure, the report was a foot tall, but there might have been something in it.  Over the last 20 years we have added ad hoc queries, we got PC spreadsheets, we got the files down, we got OLAP (online analytical processing), we got better and better data warehouses, analytical applications, cached analytics; we are getting more and more.  Each time, as the new thing came in at the top, it shoved down the one below it.  I would argue that maybe the stuff in the middle, OLAP with data marts, that might give you a competitive advantage today.  Anything above it would, if you executed well, but anything below is out of the question.


          What's happening is that more and more and more of the processes in your organization are coming to the bottom of the escalator, as they eventually must.  You start out in a wonderful condition where most of life is core.  There is always a little bit of context, of course, but this is why it's so much fun to be in a startup.  Yes, the stock options are great, but I have to tell you, I was in three startups in the 1980s with no pay-out in any of them.  It was still a wonderful experience for me because you woke up every day and you did something that counted.  It's core.  It matters.  Whether you win or lose, it matters.

          Over time, however, if you are successful, you will start taking on a profile in which more and more of the things that used to be core get copied.  While your company still has a huge investment in core, on a percentage basis more and more of the management team is actually in charge of context functions, not core functions. 

End Result: Context Build-Up

Copyright 2000, Chasm Group LLC

Here are the consequences of that profile:

-     it wastes scarce resources

-     it alienates investors

-     it demotivates talent

-     it creates inertia that blocks change

-     the company misses next wave

-     the stock price decays

          The first thing that happens in a disruptive situation is that you need to get as much resource on the green curve stuff as you can, but you can't get that resource out of your company because it's locked into red context functions.  You are wasting scarce resources, and you can't compete effectively on the time, talent or management attention vectors.  That’s precisely why venture people back startups against established corporations.  With a startup, an investor looks at that first core/context pie chart and says, “Well, I understand that I'm investing in three rather young people, two of whom have pierced body parts in places I don't even want to discuss, but if I invest in that company, 90 cents of my dollar goes to the green stuff and only 10 cents goes to the red stuff.  I’ve got 90 cents working for me in that investment to raise my stock price.  If I invest in the pie chart on the right, I only have 10 cents working for me.  Ninety percent of my dollar goes to context functions.”  We agree that context functions cannot change the value of the stock price, “so I have only 10 cents working for me.  I don't want to do that.”  You alienate investors.  Now you are beginning to understand why established companies with great customer brands and great relationships get low price/earnings and price/sales ratios, while unestablished companies get very high ones.  This is part of where that’s coming from.

          It also affects the war for talent since you are playing with a liability.  Talented people want to work on core, but your company has most of its openings in context.  You can't win the talent war.  Who's left?  Middle management is left.  That whole red zone has all been put in the charge of middle managers, and this is why executives hate middle managers and middle managers hate and fear executives.  Executives are in the green zone.  They are not stupid.  They are looking out for the future and doing core work.  They come up with a great core idea, bring it to the troops and say, “Let's do it!” But everybody who has a context function is saying, “Hang on, I'm in charge of a context function.  Do you know what that means?  That means if I screw it up, I could really tank our stock, but, if I succeed brilliantly at it, I get no upside.”

          That's my job, right?  I'm in charge of the tires on the Ford Explorer.  There is no upside to that job, but there is significant downside, so what do you do?  What kind of behavior do you learn if you are in charge of a context function?  You learn risk-averse behavior because that's what Darwin selects for.  They fired the non-risk-averse guy at Ford and got a conservative one because that's what it takes to manage context.  Now you have a company in which, every year, more and more of the managers are risk averse, as selected by Darwin.  As a result, it gets to a point where the core/context ratio is so unfavorable that no matter what decision they make, they won't execute it because the risk-averse culture will kill it before it gets out.  That's the fault line problem for large companies.  They've missed the next wave and the stock price decays.

          What's the prescription?  The prescription is pretty simple, but it's kind of draconian¾outsource the context so you can insource the core.  It’s a pretty straightforward idea.  There are a bunch of reasons to worry about it¾we tried outsourcing before, it's mission-critical and a whole bunch of stuff I'm not going to go into now, but I think there's a very strong argument for this.  What's interesting is that in 1999, the Fortune 500 to a man, woman and child did precisely the opposite, right?  In the IT department we solved the Y2K problem in-house.  I will argue that getting your calendar right does not create competitive advantage.  Meanwhile, if we did want to work on an eCommerce site, we brought in a consultant to do it.  We insourced our context in order to outsource our core.  We need a head change here, okay?


          The drill is to rethink this core/context relationship.  The key idea here is that for every core there is a set of context, and quality is a function of both.  You cannot blow off context.  If it is a soggy bun, it is a bad hamburger.  The actor is core, the stage is context.  I have been married for 32 years¾gentlemen, if you do not wrap the gift, it does not work.  By the way, in the last two years, I also learned if you don't wrap the gift, it doesn't work.  This is a learning experience.

          So core and context are both important.  In no way can you de-prioritize or say context doesn't matter or we shouldn't pay attention to it.  You have to pay attention. Go back to the Ford Explorer.  You have to.

          The second issue is this, and it’s an incredible light at the end of the tunnel. Whatever your context, it can be somebody else's core.  The person who runs the copy center in your company probably cannot aspire to be CEO, but he or she can at IKON because that's what they do for a living.

          That leads to the third lesson, which is that context is really core in the wrong place.  What we ought to do, and the idea behind the New Economy, is that we should just rearrange things so that we have everything in the right place.  That's sort of the ideal vision of the New Economy. 

Final Thoughts

Copyright 2000, Chasm Group LLC

If you think about this New Economy, it's a network of cooperating companies creating end-to-end solutions in which nobody would do context and everybody would do core. Now, that's obviously an idealization, like body fat.  You don't want to go to zero body fat, but you do want to get lean, particularly if you are going to run a marathon.

          That's the model.  It has huge advantages over the Old Economy model.  We have seen it work in the tech sector and in the financial services sector.   We've even seen it get traction in the telco sector.  It has not yet gotten traction in the retail sector, but, I believe, it will. It creates higher returns for investors because every company is spending more of the investor's dollar on core.  It creates increased flexibility because you have multiple sources of support.  You don't have to carry everything with you, the way a vertically integrated company does.  It creates greater value for customers because you have more minds working on the problem.  Furthermore, better minds are working on it since you don't put your best minds on context, you put it on core.  That's the model.


          To recap this, just three key takeaways for everyone across all the sections.

          The first is: valuation is a measure of future unrealized potential.  That's what you have to change if you are going to manage for shareholder value.  It is a function, first of all, of what categories you are in, so one of the ways you can change value dramatically is by moving your company from one category to another, either by divesting things and buying into new ones, or by migrating the offer to the new category.  The next factor in valuation is your execution within category, and that's what the comparables are all about. There is a key component of execution here, but it comes after positioning.

          The second idea is: do not let the current financial markets confuse you.  The Internet is the greatest category that has ever hit the planet, and the fact that you are in an Internet-related business, if you are, is a very, very good thing.  This is a really, really powerful category.  The issue right now is that the planet is saying, “Until we see some proof in the pudding, we are not willing.  We over-invested in that thesis; we are going to under-invest until we see a change.”  I think the bellwether is the B2B exchanges.  The B2B exchanges have to get liquidity.  It's a chasm-crossing problem.  It's a known solution; I just want folks to get on with it.

          Finally, disruption, in large companies in particular, forces you to focus on core.  We are back to this issue that time, talent and management attention are the currency.  You need to outsource the context in order to focus on core.

With that, I want to say thank you very much.  I really enjoyed having a chance to address you.


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Statements made at Netpreneur events and recorded here reflect solely the views of the speakers and have not been reviewed or researched for accuracy or truthfulness. These statements in no way reflect the opinions or beliefs of the Morino Institute, or any of their affiliates, agents, officers or directors. The transcript is provided "as is" and your use is at your own risk.  

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