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Chief Executive Magazine's CE 100 Index.

Raising Shareholder Returns and Business Performance -- Boards Should Assist CEOs to Expand Their Roles

Donald W. Mitchell
Chairman
Mitchell and Company
(781) 466-9500

Winter 1999/2000 Issue
Directors & Boards

Introduction

Boards are entrusted with looking after the interests of their shareholders. How does that responsibility translate today into best practices for evaluating and selecting CEOs? A major change is occurring in the ways that CEOs can add value for shareholders, and the consequence is that the standard of excellence has risen substantially. As evidence of this, every reader will have noticed that the lists of fastest growing stocks often include companies that were recently founded, and increasingly these companies are also found on the lists of the largest market capitalization companies in the world.

For the past eight years, Mitchell and Company has had the privilege to study how the most effective CEOs, as measured by their company's stock-price growth during the latest three years of their tenure (usually buttressed by great expansion in revenues and earnings per share), differ from all other CEOs. Not surprisingly, this research has provided insights into new and changing roles that CEOs can play that make a large difference for their companies and shareholders.

What are the lessons for a board in evaluating the current CEO and considering possible successors?

(1) CEOs need to take on several new roles that ensure the company's effectiveness in business model innovation, accessing and managing low-cost capital for strategic advantage, knowledge enhancement and application, improving white collar productivity, and reducing bureaucratic processes and costs. These added roles will greatly improve business performance and attractiveness to investors.

(2) No CEO will have the skill to be outstanding in improving the company's performance in all these roles when first appointed, so a CEO's "learning on the job" will be very important to the organization's success. Boards will need to monitor and encourage the CEO's learning and progress in becoming a more effective leader where skills and experience are initially lacking. In addition, with expanded roles, the CEO will more often need to be the company's facilitator and/or catalyst rather than the primary thinker and doer.

(3) The most successful CEOs will be those who spend the most time listening and communicating as broadly as possible to current and potential stakeholder groups, and constantly improve how well these messages are applied by the organization. This high time allocation for listening and communication will make it possible for key company roles to be understood and properly pursued. In listening and communicating, CEOs and their boards will find the greatest opportunity to create greater success.

In the remainder of this article, you will learn more about what the CEO's most important roles are and will be, plus how boards and CEOs should work together to help CEOs grow successfully into these roles.

Most Important Past Roles

Unfortunately for the time-pressed CEO, past roles remain important in many cases so the broadening set of roles this article discusses also increases time and attention demands on CEOs who may be struggling already just to meet the past roles. To find out which of those past roles are most important today, we recently spoke with many institutional portfolio managers and CEOs whose companies have performed extremely well.

We asked managers of many of the largest stock portfolios in North America what CEOs can do to help stock price grow, as well as what errors need to be avoided in order for stock prices not to drop. These answers were very revealing about places where influential investors see large differences in CEO effectiveness. From these thoughts, we can define important, continuing roles for CEOs.

Positive characteristics included:

(1) building a strong management team while establishing management depth in each position

(2) being credible and dependable because of having been candid in past communications about problems and risks, and delivering on promises, and

(3) having concern for shareholder interests.

We can summarize these characteristics as relating to the CEO being sure the organization is rich in people and effectively employs them, speaking at all times in balanced and candid ways that indicate to all an accurate understanding of problems and opportunities, and being an advocate for shareholders in making decisions. Jack Welch of General Electric and Lou Gerstner of IBM were cited as examples of these positive traits.

Negative characteristics most often cited were:

(1) hiding problems

(2) not being willing to make needed changes

(3) not understanding the company's businesses

(4) pursuing the wrong strategy, and

(5) not being credible because of past statements.

These downside issues combine personal character faults such as avoiding problems (rather than addressing them openly and effectively), and trying to curry favor by painting an overly rosy picture while lacking the knowledge and skills needed to direct the enterprise through an appropriate vision, strategy, and implementation. Many CEOs whose companies have faltered were cited as examples here, including past leaders of companies like Boston Chicken that experienced poor operating results, as well as leaders of companies whose executives or managers stand accused of accounting fraud.

Combining these perspectives, we see the paramount importance of the CEO being an effective leader who sees and understands what is happening, and transfers that understanding where it is needed the most. This process should emphasize communication and organization building to ensure that the organization's people are improving their focus on the appropriate directions for providing above average returns to shareholders.

Many top-performing CEOs tell us that they believe their job is to be sure that all of the company's constituencies and stakeholders are treated well, including (but not limited to) customers, employees, suppliers, partners, shareholders, and the communities that the organization serves. Interestingly, many portfolio managers strongly disagree with this perspective. Independent research by Mitchell and Company has shown that the CEOs are actually more right in this case than the portfolio managers. Trying to do more for all groups is a highly effective way to create greater results for each group. This occurs because providing valuable benefits for a group creates good will that expands effectiveness in many other directions. Do enough of this, and the reflected benefits substantially strengthen the company's effectiveness. If anything, the CEO's vision is too limited in this case. Those who extend the stakeholder concept to include potential customers, employees, suppliers, partners, and shareholders do even better.

New Roles in Combination

In the same way that world records continue to fall and average competitive performance improves in almost all fields of athletics, the standards of what CEOs must accomplish with their companies are also rising. Although many would argue solely from the latest week's headlines what CEO roles are being shortchanged at the moment, our look at those whose companies have accomplished the most in the last decade identified five new roles (with a continuation of the important past roles) which, in combination, should make all the difference in the decade ahead. Interestingly, few companies have combined these roles successfully so far, primarily because the roles are considered important by few CEOs and their boards.

Business Model Innovation

Most CEOs assume that they can continue to serve customers in pretty similar ways, and focus on improving quality, service, and costs to make this a profitable activity. Contrary to that belief, many of the most successful CEOs have led their companies to totally change the business model so that they serve customers in totally different and improved ways.

Michael Dell's Dell Computer provides one such example. Computers had always been produced in mass quantities with standard features and sold directly to customers by sales people or through retail stores. Dell saw that customers really wanted low-priced computers custom-made to their precise specifications, ordered over the telephone or Internet, delivered the next day, requiring little set-up, and having a service capability where the customers could solve almost all their own problems in a few minutes. Over a decade, Dell worked with his talented people to design just such a business process and quickly leapt past much larger and more highly regarded computer manufacturers.

Lowry Mays's Clear Channel Communications provides another example. The company started as a radio broadcaster, being good at providing a growing, high quality listening audience for advertisers. Mays soon realized that advertisers really wanted to get more customers at the lowest possible cost, and reorganized his company as government regulations were dropped to provide the best and lowest cost media buy for the largest local advertisers. In many cases, this meant taking radio stations and changing their format (say from rock and roll to country and western) to increase market coverage, acquiring television stations, and adding billboards. Then, with these media outlets available, Clear Channel custom designs media buys that make the most sense for local advertisers. Like Dell, Clear Channel went from being a small company ten years ago to being an industry leader today.

While these two companies' CEOs played a key role in developing the vision and the strategies and implementation to make that vision happen, in many other firms CEOs played an equally effective role in making business model innovation occur through questions and attention. For most CEOs, this role will be the right one.

Accessing and Managing Low-Cost Capital for Strategic Advantage

In the past, large companies felt safe from new competitors because of large established bases of business, good reputations, and great employees. Now, such companies can find themselves threatened very quickly by new competitors brandishing enormous stock-price multiples, and using the value of that stock to buy a preferred customer position quickly. When coupled with new technologies like the Internet to innovate in a business model as discussed above, the combination can be truly amazing from a shareholder perspective.

eBay, the Internet auction leader, is a case in point. The company became a large capitalization stock within a year of going public, selling at its peak in early 1999 for over 150 times projected 1999 revenues. While many would dismiss this as merely a whim of an overpriced market, the key point is how eBay used these stock-price riches. First, during its rapid growth in revenues and stock price, the firm needed to grow its management and staff very rapidly and with high quality people. Using stock and stock options, eBay has been able to actually upgrade its management team during a time when most would have seen management greatly weaken. For example, eBay was able to bring in a highly regarded CEO. eBay also acquired one of the world's largest and prestigious auction houses, Butterfield & Butterfield, to bolster the company's expertise and image. Second, the stock price action (often helped by on-line day traders) also helped to attract customers, which grew by 75 percent from the fourth quarter of 1998 to the first quarter of 1999.

A fellow Internet competitor, Amazon.com, provides an extended example of the power of large amounts of low-cost capital. Amazon.com has added to the eBay approach two other ideas: One, using a high stock price to raise capital that allows the company to grow faster by sustaining large, start-up marketing-cost-based losses. While eBay is consistently profitable, Amazon.com has a loss margin much higher than most company's profit margins. Yet the company has the cash on hand to sustain these losses for years. Two, using the stock to acquire what are believed to be complementary Internet-based businesses in order to grow faster by expanding into other categories. This approach allowed Amazon.com to leap into second place in on-line auctions after eBay in 1999 by acquisition, and to make key purchases in many other areas. As a result of these two additional uses for its low-cost capital, Amazon.com has a chance to become the Wal-Mart of the Internet with its ability to spend many billions on marketing over the next few years, something that established retailers with thousands of stores can only dream of doing in most cases.

Knowledge Enhancement and Application

This area is a hot subject for academics and business authors, but most of the good work focuses on sharing information internally. While very valuable for applying knowledge, much of the best knowledge comes from outside the organization. The CEO can set an example here and affect the agenda of where attention is placed.

When Mike Birck of Tellabs helped found the company, one of the guiding principles of the company was not to get into telecommunications switches. That business was considered too tricky and difficult for a new, small company to approach. A few years later it became clear that the company had no choice -- telecommunications switches were in its future. Since that decision was made, the company has added core knowledge of six technologies that it did not originally have. CEO Birck helped lead this push by working with others to identify the potential future impacts of these technologies, and then assisted in implementation through acquisitions, recruiting, and establishing academic and business partnerships. Tellabs has grown mightily as a result, and is a worldwide leader in its demanding market.

Jack Welch of General Electric provides another example for our consideration. Originally nicknamed "Neutron Jack" by some for his large layoffs as a new CEO, he has developed into a leader who emphasizes finding best practices outside the company, and sharing useful perspectives inside the company. To set the right example, he often teaches management classes for up-and-coming executives. He has also taken the opportunity to introduce key themes several times since becoming CEO that have enormously improve General Electric results. Beginning with his maxim to be number one or two in an industry or to get out as a new CEO, the latest theme is to reach the Six Sigma quality level espoused by Motorola. The idea for this successful change came from a presentation by former General Electric executive, Larry Bossidy, CEO of Allied Signal, to a group of GE people. The remarkable growth of GE Capital is another case in point, as Welch encouraged the business leaders to add experienced people and new knowledge to expand into ever increasing areas of poorly-served financial services and create innovative products and services to steal a march on the competition.

Improving White Collar Productivity

Whenever economists look at the U.S. economy, they report generally good things with two exceptions: Horrible trends in white collar productivity and a plunging savings rate. The former has occurred despite decades of enormous spending on Information Technology and other capital investments designed to make white collar workers more productive. Decades of work on improving manufacturing productivity have been highly effective, and the same tools are now starting to be applied to the white collar part of the company and to service firms.

One company that has shown what can be done is Cadence Design Systems, originally under the leadership of former CEO, Joe Costello. Cadence makes software that engineers use to design semiconductors. Because of technology trends, these chips become ever larger and more complex. The software to handle this moved in the same direction. Customers were finding it harder and harder to learn the new design software and apply it effectively. Cadence began offering design services for customers, as well as software. In one notable example, a well-regarded customer was spending 7 months to create custom chip designs. Cadence was able to lower this time to 7 days, and at a lower cost. The potential value to Cadence's customer and its customer's customer were worth billions in this case. Outsourcing to the most efficient companies will be a major tool of white collar productivity improvement, but only after more top-performing companies choose to provide their outstanding skills to other organizations. This will make productivity soar for both supplier and customer.

An interesting sidelight to this example is that if the customer had asked for this service earlier, the benefits could have been delivered many years earlier. So productivity enhancement works both ways: The effective and efficient need to provide services for others, and everyone else needs to seek out the effective and efficient as suppliers to replace low productivity white collar work.

Paychex is a well-developed model of how such outsourcing can work under Tom Golisano's leadership as founder and CEO. Paychex provides a wide range of payroll and human resources services for smaller employers. The company does this so well that its own revenues per white collar worker (pretty much the whole organization) soar annually while the costs for customers fall well below what it would cost to provide the services internally. Paychex has accomplished this by expanding its product line to leverage the time of its sales people and customers for choosing a supplier, and redesigning the ways it delivers its processes to constantly reduce costs and improve effectiveness. Golisano does this primarily by providing a stimulating environment to pursue his vision of expanding white collar productivity for customers and Paychex, but he plays little role in the day-to-day implementation of that vision. Golisano is a good model for what can be done by most CEOs.

Reducing Bureaucratic Processes and Costs

A common misconception is that only large and older organizations have bureaucracies. Actually, smaller and newer organizations often have more problems with bureaucratic processes and costs than larger and older ones do. The reason is that many "hands-on" CEOs insist on reviewing almost everything the company does before it can move. As a result, progress is stalled everywhere until the one overworked CEO gets around to reviewing the proposals. Months will pass. If new questions are raised by the CEO, it starts all over again.

Another example is that almost all CEOs love to ask questions to learn more about how the company is doing. What few CEOs do is check on what it costs to answer these questions. Some assistants to CEOs and CFOs estimate that 40-70 of corporate overhead costs could be removed if these questions were pared down appropriately. This is ironic because the purpose of many of the questions is to find ways to improve profits. For a typical company, dropping that much corporate overhead would increase profits by 40-100 percent. The legendary Warren Buffett provides a useful role model here. His Berkshire Hathaway is organized to have almost no corporate staff, yet the company is one of the world's largest. Dozens of different businesses all report directly to Buffett. His rules: Call me immediately when there is a problem or if you want help. Otherwise, don't call. And he doesn't call them, either, except for 3 businesses where he finds the issues interesting. On the other hand, he spends enormous time checking out the businesses and their CEOs before buying them. Then he keeps the same CEO in place, and trusts him or her to do the right thing. That trust has been rewarded, as the business CEOs scramble to justify Buffett's faith in them. Thus, the need for few questions and reports.

A third layer of the problem involves having complicated rules that inhibit people from doing their jobs. This area has been the source of much attention in companies with labor unions. What many CEOs do not realize is that their own rules hold back improvements across the company, even where there are no union agreements. Consider AT&T. Under new CEO Mike Armstrong, the company quickly concluded deal after deal to expand into the cable television business, as a way to expand access to customers for providing future local telephone and Internet services. After several deals closed, news reports began to speculate about what had changed at AT&T. Some reports indicated that under Armstrong's predecessor, many deal guidelines had been laid down. If the other side would not agree to the guideline, there was no deal. Armstrong encouraged his negotiators to be flexible and to bend on areas of small benefit to AT&T like who would control the rights to self-produced movies if larger benefits could be gained instead. Both parties could then quickly find a way where everyone came out ahead, a win-win agreement.

CEO-Board Collaboration Needed

With an existing CEO, a great place to begin is for a board member to share this article with the CEO and to get his or her reaction. This is best done away from a board meeting, and by someone who has a close relationship with and the respect of the CEO. A natural person to do this is the head of the Compensation Committee who is constantly thinking about how to evaluate the CEOs performance. It is important to portray this as an opportunity for further personal and company growth, rather than as an explicit or implicit criticism of the CEO. If the company has been performing well, this could be phrased in terms of continuing to be outstanding as competitors get better. If company performance has been disappointing at all, this could be termed as another perspective on getting back on track in light of tougher competition and business issues, or whatever the CEO sees the problem as having been.

The follow-up conversation should be a private one, in person, coupled with an offer to help. A good way to begin is to ask the CEO what barriers exist to expanding his or her role in the ways this article outlines. Some of these may relate to the way the company is organized, its culture, compensation arrangements, or other factors where the board can be a resource. You can then suggest good ways to work with the board to make these changes.

If the CEO sees no benefit in some of these areas, you might encourage the CEO to spend some time with CEOs who are known to be effective in these roles. If that doesn't work, you will probably have to work through the compensation process to change focus. In any case, compensation will probably have to be realigned to take into account these personal development opportunities. Although each area seems qualitative rather than quantitative, you will be pleased to know that measurements can be used to track progress and form the basis of compensation. Rather than just change the compensation, you should use that change to ensure that the board itself develops an understanding of and a consensus concerning the importance of these roles for the company.

Once the changes are in place, the board will also have to be a mentor, as well as an evaluator. To play this role, the CEO will have to provide some regular reports on results in these roles. This means that when the CEO stalls in making progress in some area or the other that the board encourages the CEO to try something different and to get more help. Examples might include recruiting board members who have successful experience in those roles, or introducing the CEO to people who can help.

The opportunities to make improvements in role coverage will be much greater with successors. You should start with the internal candidates for CEO successor, and work with the current CEO to be sure these people get the opportunity and encouragement to round out their experience in roles that will be new to them, or for which they may have less aptitude. This also helps the current CEO by providing some help with role areas where he or she may be weak or have limited time availability, and the company seriously needs to improve.

If you decide to have an external search, as most companies do, be sure that your search consultant is aware of the board's consensus concerning the roles it wants the CEO to play. Part of that explanation should be to benchmark the company's current performance and potential in each role area, so that the search consultant will know the degree and types of change that the new CEO will have to make.

During the evaluation process with the prospective CEOs, you should emphasize this expanded set of roles, and get ideas from the potential CEOs on how they see themselves filling those roles. Wherever possible, get examples from them of how they have treated these roles in the past, what they have learned from those experiences, and how they would approach the role in your company. Then link the person's evaluation and compensation to fulfilling the roles and results that the board has decided it needs. Because of the diversity and difficulty of these roles, you should look for open-minded learners who have a good track record of taking on new roles rather than those who already have all the roles down pat -- those latter people are too rare for you to have a realistic hope of finding one. Those who already love to listen and are effective communicators will be even better prospects.

Although you may find that whoever your CEO is, he or she is always at a big disadvantage in performance versus the all-stars cited in this article, you should be encouraged. Currently, these roles are not being well combined in more than a handful of companies. By simply becoming competent in each role, you will have the opportunity to make enormous improvements in company results and shareholder returns. As a result, you will have the satisfaction of knowing that you have played a very valuable role in serving the interests of your primary constituency, your shareholders.

Donald W. Mitchell is chairman and chief executive officer of Mitchell and Company, a strategy and financial consulting firm in Waltham, Massachusetts. He is the co-author of The 2,000 Percent Solution: Free Your Organization from "Stalled" Thinking to Achieve Exponential Success (AMACOM 1999). To read past research about outstanding CEOs in stock price improvement, visit Mitchell and Company's Web site (www.mitchellandco.com and click on the file folder for CEO 100 on the home page). To read about breakthrough business processes you can use to fulfill these new roles, visit the same Web site and click on the file folder for Management Processes on the home page.9

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