Value: A book review by Bob Morris

Value: The Four Cornerstones of Corporate Finance
Tim Koller, Richard Dobbs, and Bill Huyett
John Wiley & Sons (2011)

How executives can make much better decisions – “even as markets, economies, and industries change around them”

All organizations need a solid foundation on which their executives can base their most important decisions about strategy, mergers and acquisitions, budgets, financial policy, and performance measurement – “even as markets, economies, and industries change around them”

This book was co-authored by three McKinsey & Company partners — Tim Koller, Richard Dobbs, and Bill Huyett — who bring decades of experience and a diversity of perspectives to their rigorous consideration of what they characterize as “the immutable principles of value creation. ” These principles are in the best interests not only of shareholders but of everyone else directly and indirectly involved in the given enterprise. This is a key point because, more so today than ever before, value addition or reduction can occur at any level and in any area of an organization’s operations.

The focus in the book is on the four cornerstones of finance, best revealed within the narrative, in context. (They are introduced and discussed briefly on Pages 4 and 5, then delineated thoroughly through Part One, Chapters 1-5.). These are among the passages that I found most valuable:

o  Desegregating cash flow into revenue growth and ROIC (Pages 17-21)
o  The best-owner life cycle (55-57)
o  Summary of key points re five stock market eras, 1960-2009 (76-83)
o  Why accounting treatment won’t change underlying value (114-116)
o  Trends in return on capital (133-138)
o  The logic for systematic divestitures (158-162)
o  Why companies should retain at least some risks (189-195)

Most readers (I among them) agree with Koller, Dobbs, and Huyett that the most difficult part of creating value and, specifically, applying and then sustaining the four cornerstones “is getting the right balance between delivering near-term profits and return on capital, and, continuing to invest for long-term value creation. [Not just in fixed assets, but investments that are expensed right away, such as new product development, new geographic markets, and people.] Configuring the management approaches of the company to reflect this balance is the chief executive’s responsibility.”

Tim Koller, Richard Dobbs, and Bill Huyett provide a wealth of information, insights, and counsel that will serve as “a catalyst and guide for improving how executives plan strategy, make decisions, solve problems, and meanwhile create the next generation of leaders. Ultimately, we hope that the collective impact of more companies embracing these [four] principles creates a more stable and productive economy.”

Reverse Innovation; Abundance – Our 2 Books for the July 6 First Friday Book Synopsis

We had a wonderful gathering this morning for the June 1 First Friday Book Synopsis.  Karl Krayer presented his synopsis of All In: How the Best Managers Create a Culture of Belief and Drive Big Results by Adrian Gostick and Chester Elton.  I presented the best-selling and much-talked-about The Power of Habit: Why We Do What We Do in Life and Business by Charles Duhigg.  These are both genuinely useful books.

(Our synopses, with handouts + audio of our live presentations from this morning, will be available soon on our companion web site, 15minutebusinessbooks.com).

On July 6, Karl will present his synopsis Reverse Innovation: Create Far From Home, Win Everywhere by Vijay Govindarajan and Chris Trimble (foreword by Indra K. Nooyi).

I will present my synopsis of Abundance: The Future Is Better Than You Think by Peter H. Diamandis and Steven Kotler.  Peter Diamandis is the founder of the X Prize, and you can watch his TED talk, Abundance is Our Future, here.  So this book will give us a big hefty dose of optimism, which I suspect we could all use right about now.

Click on the flier below to read all the details. We begin at 7:00, and conclude right around 8:05.  And you eat a great buffet with made-to-order omelet bar breakfast, experience great visiting and table conversations, and receive a quick, substantive jolt of content.  Come join us.

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Why Managing Risks Means Managing Arguments

Here is an excerpt from an article written by Justin Fox for the Harvard Business Review blog. To read the complete article, check out the wealth of free resources, and sign up for a subscription to HBR email alerts, please click here.

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So it was Lyme disease that did it! The tick-borne illness kept JPMorgan Chase’s Ina Drew out of the office for extended periods in 2010 and 2011. And it was during Drew’s absences, according to a richly detailed account in The New York Times, that the bank’s chief investment office, which she ran, began to get into trouble:

The morning conference calls Ms. Drew had presided over devolved into shouting matches between her deputies in New York and London, the traders said. That discord in 2010 and 2011 contributed to the chief investment office’s losing trades in 2012, the current and former bankers said.

Whether this really was the main reason for JP Morgan’s $3 billion (and growing) trading loss or not, it does at least sound like it could be true. Managing risks — especially the hard-to-pin-down, moving-target risks that any financial trading operation has to cope with — inevitably involves arguing. Which is why managing those arguments, as Ina Drew appears to have done brilliantly during the financial crisis but wasn’t around to do for the past couple of years, is so important.

The words “risk management” usually evokes less subjective, more data-driven pursuits. But data and objectivity can only get you so far. Philosopher Karl Popper famously proposed that to be scientific, a theory had to be falsifiable: that is, it had to make predictions that could be tested and possibly shown to be wrong. Popper spent a lot of time thinking about this definition of science and the burgeoning science of probablility, which he called propensity. (This summary is from Wittgenstein’s Poker, a book I’ve been reading):

As far as falsification is concerned, he thought that statements involving stable propensities — such as, ‘The die has a one in six chance of landing on six’ — could be tested by looking at what happens in the long run. But isolated statements of propensity — such as ‘There is a propensity of 1/100 that there will be a nuclear holocaust before the year 2050′ may resist testing, and to that extent exclude themselves from science.

Routine risks like worker safety and even some day-to-day trading hazards can thus be managed successfully with a mechanistic, scientific approach. But the kind of big-picture bets that JP Morgan’s chief investment office made could never be tested, or managed, in that way. Decisions either worked out or they didn’t; given the small sample size it was impossible to test what the true probabilities were.

To navigate such unquantifiable hazards, then, you need to make judgment calls. And that’s where argument (or discussion, or conversation, if you prefer) comes in. You want diverse, even opposing viewpoints. You want to manage their interactions in a way that allows the quieter, less-senior, less-predictable voices to be heard. You probably do want to accord different weights to the arguments of different people, although deciding how to do so (past track record? clarity of argument?) is hard.

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To read the complete article, please click here.

Justin Fox is editorial director of the Harvard Business Review Group and author of The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street.

How and Why Strong Engagement Scores May Spell Trouble For Organizations

Here is a brief article featured by Talent Management magazine. It summarizes a few key points from on-going research conducted by Employee Engagement Consortium. To check out all the resources and sign up for a free subscription to the TM and/or Chief Learning Officer magazines published by MedfiaTec, please click here.

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High levels of engagement could actually be damaging for organizations and their employees if one-dimensional engagement surveys mask the types of engagement at play within an organization, according to a recent study.

The research, by the Chartered Institute of Personnel and Development (CIPD) and Kingston University Business School’s Centre for Research in Employment, Skills and Society (CRESS), found that employees that are engaged — i.e. engaged only with the task or job role at hand — may respond positively to engagement surveys and display the outward behaviors associated with engagement, but are less likely to perform well and will quickly leave for a better offer.

However, those that are emotionally engaged — i.e. engaged with the organization’s mission and values — are more likely to perform, have higher levels of wellbeing and are more likely to remain engaged through good times and bad, the study said.

The researchers identified transactional engagement as being shaped by employees’ concern to earn a living and to meet minimal expectations of the employer and their co-workers. In the majority of instances, people’s positive feelings about their work stemmed from the job or task itself; from the challenge, variety and autonomy that their role bestowed on them; and the gratifying ability to see the fruits of their labor.

Emotional engagement, meanwhile, is associated with different aspects of work that go beyond the job role itself — including colleagues, line managers, business unit, the organization and clients or customers. It’s driven by a desire on the part of employees to do more for the organization than is normally expected, the study said, and in return they receive more in terms of a greater and more fulfilling psychological contract.

High levels of transactional engagement were found to be potentially damaging for both individuals and the organizations they work for. Employees who are engaged from a transactional point of view report higher levels of stress and difficulties in achieving a work-life balance than those employees who are emotionally engaged, the study said.

What’s more, employees who display transactional engagement are more likely to indulge in behavior that might actually damage the organization than their emotionally engaged counterparts, according to the study.

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The Employee Engagement Consortium is a research partnership and networking group that brings together organisations actively working to better understand and drive engagement in the workplace.  Our key focus is on helping organisations to develop, manage and maintain effective engagement strategies with the aim of improving both individual and organisational performance.  The Consortium is sponsored by the CIPD and its member organisations.  We have run two successful phases of the Employee Engagement Consortium and are now entering a new phase.

This new phase of the consortium offers a more flexible membership package and goes beyond the topic of Engagement to examine other related HR areas such as well-being, employee voice, learning and development and so on.