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Tuesday, June 29, 2004

forgetting to build the future

i’ve spent a considerable amount of my blog-space commenting on how things should not be done, and i guess that trend will continue today… of course, i have all the answers, that’s part of the geek paradigm, but what’s the fun in letting it all out of the box at once?

this began with a speech given by carly fiorina at the university of maryland (you can skip the rah-rah bits about the company).

carly fiorina, cio forum / inforum 2003, robert h. smith school of business, university of maryland, october 10, 2003

It was a great company. But in many ways, it had fallen so in love with its legacy and its past that it had forgotten to build its future.

as i started making notes, i ran into a piece on the “15% delusion” by carol loomis. it appeared in fortune magazine back in february of 2001, with the wounds of the burst bubble still fresh in many minds and mutual fund accounts. unfortunately, fortune only leaves the first few paragraphs of their archives available, so there’s no real point in linking to that.

the gist of the article, if i may be so bold as to boil it down to a sentence or two is this: don’t make predictions you know you can’t keep. and if you do, don’t keep doing it.

the context is the business environment – the big huge public companies, the big huge brokerage firms, and the constant barrage of data and news and opinions that drive the markets (that is, stock markets) up and down and sideways from second to second. it’s about the pressure to perform… no, actually, it’s about the pressure to out-perform, and it’s the same thing we see in so many interesting places in this society these days. it’s not good enough to be good enough anymore – you have to be better. you have set high (that is, unreasonable) expectations and then you have to exceed them (that is, impossible) or you are punished.

loomis mentions the 15% growth target, but her article is buried. fortunately (ahem), the guys over at the fool picked up on it and ran in their own direction with the 15% fallacy. that one’s linkable, so let’s go there for this adventure. i’ll leave the math homework to the fools. their perspective (investor perspective) is useful to explain the pressures on management, which is where i really want to go with this. investors want growth stocks, growth stocks grow at 15% per year, and that’s five times the historical average economic growth in the united states.

the problem is that not every company can outperform the average (i leave the math to back up that assertion to the reader). even if you’re in the company that is growing way beyond average, and for a good reason (perhaps a new company, or a new product, or something else meaningful), eventually with 15% compounded returns, that one company would suck up the entire market for everything, and that’s not a good thing. but in order to keep the stock price up, you have to promise those better-than-average returns, until the rug gets ripped out from under you and you either lower expectations or miss expectations, and the bottom falls out of your stock. and there’s the damage at the highest level – between the company and its investors.

so there’s a massive incentive to take the short-term gain at the expense of long-term results and to cheat – to fudge the numbers as much as possible for as long as possible and get out while the getting is good. hit those 15% targets long enough, and the stock price will grow even faster than 15% – for a while. then pile all the damage into one quarter (if possible) suck it up, run it through bankruptcy (if it’s that bad) and who really cares what comes out on the other side? there’s the real damage – the company rots from within as decisions accumulate that “work for now” but eventually expand like a cancer.

a favorite whipping-boy industry for this has got to be telecommunications. the problem is that once you’ve got a chunk of wire in the ground, there are only so many ways you can earn money with it, and several of those ways are disappearing with new technologies. there used to be a pretty solid bet that you could hook someone up to the wire, and keep them (or someone that moved into that house) hooked up to that wire indefinitely. all things being equal, just raise the price at 15% a year and you’re golden without even hiring enron’s accounting team. but all things are not equal, and now your wire has to compete with cell service and satellites and voip that’s going through the air, or down someone else’s chunk of wire. and the consumer is demanding things that your wire can’t physically deliver.

eventually, you get worldcom. to meet growth expectations, it had to suck up every company it could possibly leverage to buy, and when the bottom fell out, it found itself not only missing expectations, but leveraged so far out over the cliff that there was nothing to do but wait for the coyote to look down. depending on how you do the accounting (and that’s another issue), worldcom just made up something like $12 billion along the way – which promptly vanished, and then some.

the problem with this (and i’m sure i’ll catch some dissent on this point) is that it builds companies on these elaborate, diligent, fully-developed and amazing frameworks of vapor. it works (in as much as it does work) for a while because everyone who is in the game sucks up the same vapors. but with these goals, targets and short-term plans, these companies with all the accumulated resources spend so much energy planning to get bigger that they miss the opportunities to actually do something about it. the opportunities happen, randomly, but if they don’t fit the company plans or the division plans, or the preconceptions of the person who’s promised 15% growth in something, then they just slip right by. worse, the oppotunities are cannibalized for short-term returns to meet the next reporting period promises, rather than focusing the available resources on longer-term prospects.

a couple years after the fool picked up on this subject, jack trout came up with another version of the same story, which can be found in the economic times of india. he’s even got a nod in there back to loomis’ article, and a small bit of it got picked up by a blogger:

Why big brands fail [ryan’s hope]

I agree that growth (through innovation) often happens in spite of goals and forecasts, not because of them.

i hope i have the wisdom to assemble brilliant people that won’t forget to build the future with me. in the meantime, please don’t forget to put a cover sheet on those tps reports.

posted by roj at 2:04 pm