RELEVANT BUSINESS KNOWLEDGE SECOND QUARTER 2014 • ISSUE 21 • ieseinsight.com/review
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
PRICE PER EDITION €18/$25
INSIDE DEEP INSIGHT
Why Goo Wh Good Governance Matters
MICROSOFT REBOOT
From software to services CONSTRUCTIVE FEEDBACK
To give it well, you have to learn how to take it FAST FASHION
How does it work, and can it work for you, too? SWIMMING AGAINST THE TIDE
Olympic tips for performing at world-class levels
GOVERNANCE: RECOMMENDATIONS TO MEET FUTURE CHALLENGES TRANSPARENCY: A TRANSPARENCY: A RISING RISIN G TREND IN I N LISTED LISTE D COMPANIES COMPA NIES PROXY ADVISORS: ARE ADVISORS: ARE VOTING VOTI NG GUIDELINE GUID ELINES S RULING RULI NG YOUR BUSINES B USINESS? S? RENEWING THE MISSION: 6 ITEMS FOR THE TOP OF EVERY BOARD’S AGENDA
Always thinking Always asking Always doing
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
At OMD we are fully dedicated to our clients’ growth. Discover what inspires the most awarded media agency network in the world and how more powerful insights, ideas and results can unlock greater success for your brand.
blog.omd.es
INSIGHTS · IDEAS · RESULTS MOST AWARDED MEDIA AGENCY IN THE SPANISH EFFICIENCY AWARDS GLOBAL MEDIA AGENCY OF THE YEAR 2013 - ADWEEK MOST AWARDED MEDIA AGENCY NETWORK 2013 - GUNN REPORT
Always thinking Always asking Always doing
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
At OMD we are fully dedicated to our clients’ growth. Discover what inspires the most awarded media agency network in the world and how more powerful insights, ideas and results can unlock greater success for your brand.
blog.omd.es
INSIGHTS · IDEAS · RESULTS MOST AWARDED MEDIA AGENCY IN THE SPANISH EFFICIENCY AWARDS GLOBAL MEDIA AGENCY OF THE YEAR 2013 - ADWEEK MOST AWARDED MEDIA AGENCY NETWORK 2013 - GUNN REPORT
ISSUE 21
SECOND QUARTER 2014 PERSONAL INSIGHT
EXPERT INSIGHT
Bringing Microsoft to the World
How Fast Fashion Works: Can It Work for You, Too?
César Cernuda, President
Felipe Caro and Víctor Martínez de Albéniz reveal reveal
of Microsoft Asia-Pacic, discusses the shift from PCs to devices and services. 45
EDITORIAL
4 Antonio Argandoñ a says it’s time we talk about the elephant in the boardroom. ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
MY INSIGHT Jaume Ribera finds salient lessons on project management from the construction and expansion of the Panama Canal. Paul Druckman wishes “integrated reporting” would be seen for what it is: the story of how your company creates value.
5 6
EARLY INSIGHT Most attractive markets for food and beverage exports; the New York Times publisher on embracing a mobile future; adaptability as a key leadership trait; at what point does an emerging country take off?
7
the operational keys behind the fast-fashion business model.. model..58 Are Voting Guidelines Ruling Your Business? Gaizka Ormazabal and Allan Alla n L. M cCall believe
proxy advisors’ voting recommendations need to be handled with care. 31
6 Items for the Top of Every Board’s Agenda Jordi Canals casts a clearer vision of the rm’s
purpose, calling for a drastic rethink of how the board can add long-term value. 37 EXPERT INSIGHT
50 Feedback Tips for Less Grumbling, More Growth
Sheila Heen gives practical tips for improving
the quality of feedback conversations between managers and subordinates.
DEEP INSIGHT DOSSIER DEEP
insight
Why Good Governance Matters
Illustrationsby RAULARIAS
Bopentochange,forthe long-termsuccessofbusiness. oards need to close the rifts left by the crisis and be
15 How 15 How Boardroom History Is Writing Its Future Recommendations to Meet Future GovernanceChallenges By Jay W. Lorsch
31 Proxy 31 Proxy Advisors AreVotingGuidelines RulingYourBusiness? By Gaizka Ormazabal & Allan L. McCall
24 The 24 The Age of Activism Transparency,aRisingTrend in Listed Companies By José M. Campa
37 Renewing 37 Renewing the Board’s Mission 6 Items for the Top of Every Board’s Agenda By Jordi Canals
insight
IESE
Boards need to close the rifts left by the crisis and be open to change, for the long-term success of business.
ISSUE21 SECONDQUART ER2014 13
Recommendations to Meet Future Governance Challenges Jay W. W. Lorsch admits that while there have been
positive changes in boardroom practices over the past 25 years, there is still work to do.15
Transparency, a Rising Trend in Listed Companies
BUSINESS INSIGHT
66 Sustainability at Any Price? How can Henkel achieve its bold targets without hurting operating profits? WIDER INSIGHT
71 Swimming Against the Tide knows there’s no room for Edward Sinclair knows negativity or complacency on the hard path to greatness in whatever your eld.
José M. Campa explains the
trend toward greater transparency and an expanded role for shareholders.
24
IESEinsight
LAST INSIGHT
76 Strategy That’s Off the Chart Massimo Maoret returns to the timeless
wisdom of Igor Ansoff, the father of strategic management.
ISSUE 21 SECOND QUARTER 2014
3
EDITORIAL SECOND QUARTER 2014 ISSUE 21 E-mail:
[email protected] ieseinsight.com/review PRICE PER EDITION €18/$25
editorial director emeritus
Antonio Argandoña editorial board
Prof. Antonio Dávila
Accounting and Control, Entrepreneurship
Prof. Fabrizio Ferraro Strategic Management
Prof. Philip Moscoso
Production, Technology and Operations Management
Prof. Javier Quintanilla
Managing People in Organizations
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Prof. Julián Villanueva Marketing
managing director
Gemma Golobardes managing editor
Jordi Navarrete editors
Jordi Navarrete Cintra Scott Philip Seager assistant editors
Ivie Edosomwan Marta Peret Enric Rodon
editorialcontributors
Nicholas Corbishley Carlos Milla Javier Moncayo David Oliver Lydia Smears Gemma Tonijuan Natasha Young design
Cases i Associats layout
Antonio Argandoña
The Elephant in the Room
R
eading this issue of IESE Insight magazine, I was reminded of the parable of the six blind men and the elephant. Each one felt a different part of the animal and came to his own conclusion. For the one who touched the tail, the elephant was like a rope; the leg, a tree; the tusk, a spear; the trunk, a snake; the side, a wall; the ear, a fan. All were partly right, but unless they put their distinctive perspectives together, they were also all partly wrong. Corporate governance is a similar beast. Since the onset of the global There is more financial crisis, various pundits have to governance proclaimed what the problems are and the solutions needed to fix them than meets – whether say-on-pay, shareholder activism, proxy advisors and so on. They the eye may be right, and the regulators seem to think so. But as our authors reveal, there is more to the story. Our dossier helps to fill out the picture of corporate governance, adding flesh to what is often a bare-boned treatment of the topic. They bring rich perspectives on mission and values, leadership development and transparency, urging caution on the outsourcing of proxy voting and warning of the unintended consequences of seemingly progressive actions. Elsewhere in the magazine, Sheila Heen tackles another beast – the dreaded annual performance review – explaining how each side approaches the process from different standpoints and suggesting how each can learn from the feedback of the other. We also present multiple perspectives on innovative business models: Felipe Caro and Víctor Martínez de Albéniz reveal the logistics secrets of Zara and other fast-fashion businesses; César Cernuda discusses Microsoft’s shift from products to services under its new CEO; and our case study on Henkel highlights another key piece of corporate governance today: sustainability strategies. Taken together, readers will be able to talk more knowledgably about the elephants in their boardrooms.
Javier M. León infographics
Alejandra Villar illustrations /photos
Raul Arias Giulio Bonasera Edu Ferrer Alcover Ana Yael Zareceansky audiovisuals
Marta Comín Oriol Gil Lydia Rodríguez
advertising
IESE Business School, University of Navarra
Av. Pearson, 21 08034 Barcelona, Spain Tel.: +34 93 253 4200 E-mail:
[email protected]
4
SECOND QUARTER 2014
© 2014 IESE Insight is published 4 times a year by IESE Business School, University of Navarra. ISSN 2013-3901. Legal Deposit No. B-14089-2010. The opinions expressed in this magazine and associated website ( ieseinsight.com/review ) are solely those of the authors. The contents and elements of this magazine and associated website are licensed for the individual use of authorized subscribers on a limited basis for noncommercial, personal purposes only; commercial use is prohibited. All rights reserved. No part of this publication may be reproduced, totally or partially, or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system, without prior written permission of IESE Bu siness School, Univers ity of Navarr a. For our latest subscription offers, visit ieseinsight.com/subscription For queries regarding the use of articles and related material, e-mail
[email protected]
Av. Pearson, 21 08034 Barcelona, Spain Tel.: +34 93 253 4200 Camino del Cerro del Águila, 3 Ctra. de Castilla (M-500) 28023 Madrid Tel: +34 91 211 3000 165 W. 57th St. New York, N.Y. 10019 U.S.A. Tel.: +1 646 346 8850 www.iese.edu IESEinsight
The historic construction of the inter-American waterway and its recent expansion offer salient lessons on project management.
MY INSIGHT
Panama Canal: Hits and Misses by Jaume Ribera
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
THIS SUMMER MARKS the 100th anniversary of the opening of the Panama Canal, considered the riskiest, most technologically complex project of its time. The effort now under way to expand this corridor, like the original plan to build an Atlantic/Pacific shortcut, provides salient lessons on managing grand-scale projects. One has to remember that in the late 1800s, the scientific management of projects was something new. The Frenchman Ferdinand de Lesseps, riding high on pulling off the Suez Canal, aimed to repeat this feat in Panama. In the end, it bankrupted him, and the United States had to step in and finish what he’d started. In 1879, a decade after Suez, an International Congress was organized in Paris to entertain proposals for the Study of an Interoceanic Canal at Panama. De Lesseps’ plan to construct another Suez-style, sea-level canal without locks won majority backing among the 136 delegates present – only 19 of whom were engineers. In 1880, de Lesseps estimated the project would cost 658 million francs and take eight years to complete – this was before any surveys had been done or any excavation work began. Within a few years, he had to admit defeat. With insufficient capital, the company was declared bankrupt in 1889. Apart from the technical difficulties – not to mention charges of financial corruption later leveled against de Lesseps – one of the biggest obstacles proved to be the wet tropical work conditions, causing tens of thousands of laborers to die from malaria and yellow fever. De Lesseps’ failure underscores the importance of careful planning and risk analysis prior to the start of any project. A gung-ho committee is no substitute for a proper study, with the technical aspects determined by experts. In U.S. hands, the Panama project had three chief engineers: John Findley Wallace, John Stevens and George Washington Goethals. Stevens was the foremost civil engineer of his day, having accomplished the Great Northern Railway across the Pacific Northwest of the United States. He immediately applied his expertise to build a railway to cart away the excavated materials. Crucially, it was Stevens who finally calculated that a sea-level canal without locks was impossible, and he shifted to an elevated series of locks and dams, which ultimately saved the project.
IESEinsight
Stevens was also the first to take the working conditions seriously, understanding that humanitarian concerns were as vital as scientific management to the project’s success. He enlisted specialized physicians to treat the malaria and yellow fever, while also introducing an entertainment and food space for the workers, which boosted their flagging morale. There are two takeaways here: first, the need to create safe work environments; second, the importance of breaking down complex projects into activities that can be delegated and understood by those in charge of executing them.
There’s no substitute for careful planning and risk analysis by experts.” A century later, these lessons appear not to have been learned, as evidenced by problems with the canal expansion planned to be completed for the centennial. A group of companies, led by Spain’s Sacyr, won the bid to construct new locks based on high technical credentials and a budget lower than expected. However, time has revealed the shortcomings of awarding projects to the lowest bidder, with cost overruns leading to a bitter dispute and a stoppage of works until Panama coughed up more funds. This highlights another key point: When risks are shared between the project tenderer and deliverer, their interests are better aligned and greater efforts are made on implementation and, when problems arise, joint resolution. There are fewer legal battles and less finger-pointing over who should pay for things that were either poorly defined or not properly costed out by one side or the other. In the case of the latest dispute, a temporary deal was struck, but the completion date has been put back to at least late 2015. When that day comes, the canal should be able to accommodate much larger and wider container vessels, doubling the traffic passing through the channel and with it world trade. Project management is not so much a miracle – as the naysayers once said it would take to complete the Panama Canal under de Lesseps – but rather a science for which executives need to make sure they are fully prepared. Jaume Ribera is a professor of Operations Management at IESE
and holder of the CEIBS Port of Barcelona Chair of Logistics.
ISSUE 21 SECOND QUARTER 2014
5
Far from being a mindless exercise, “integrated reporting” needs to be seen for what it is: the story of how your company creates value.
MY INSIGHT
Does Your Board Grasp Its Role? by Paul Druckman
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
MANY YEARS AGO, I found myself in a strange situation in which my company was growing dramatically yet at the same time we were running out of cash. I realized, probably too late, that the sales director was manipulating the terms of payment in order to get orders. That was because our Key Performance Indicators (KPIs) had been set around sales, but not around sales in the context of the overall viability of the business. We nearly went under. That taught me a valuable lesson I will never forget: Reporting does influence behavior. Too often we treat reporting as a mindless compliance exercise, rather than as something that actually does influence behavior, in positive or negative directions. Given its influential role, corporate reporting needs to be seen for what it is: a tool for creating a more financially stable, sustainable environment for our businesses, for our societies and for the world. It is not about piling another burden on business; it’s about reporting that integrates three key areas. The first area deals with the kind of information contained in traditional financial statements – the financials, infrastructure, fixed assets and so on. The second area encompasses environmental and social concerns. The third area includes intangibles, such as intellectual property, branding and all the softer aspects of a business that are harder but are no less crucial to quantify. These three areas cover the full breadth of what a company should be reporting and what investors and others should be most interested in knowing. Corporations need to put metrics, or at least attempt to clarify their performance, against these three areas. This is “integrated reporting.” It tells the story of how your company creates value. Unfortunately, for some companies, it’s just that: a story; a piece of marketing. I prefer to think of i ntegrated reporting as the doorway to the strategy of a company. An integrated report is a concise communication of how an organization’s strategy, governance, performance and prospects demonstrate the creation of value over the short, medium and long terms. Conceived this way, corporate governance serves not just as a check or oversight but as a proactive, structured mechanism that supports a company’s ability to create value in the short, medium
6
SECOND QUARTER 2014 ISSUE 21
and long terms. Boards need to grasp this. Moreover, good governance is about quality, not quantity. When I see reports of more than 100 pages, I start to struggle. What these companies are doing is simply bringing together a lot of compliance data – the sustainability report, the CSR report, the financials – and producing one massive document. Certainly “combined reporting” is a first step in the right direction, but as integrated reporting becomes more advanced, the communication should become more concise and relevant – no more than 20 pages. It’s better reporting, not more reporting.
Integrated reporting is the doorway to the strategy of a company.” The more corporate reporting is able to distill the breadth of a company’s value-generating activities, the more useful it becomes to investors. Indeed, it conditions the types of investors you attract. Recent r esearch among U.S. listed companies has found that those companies that reported broader than just the requisite compliance data attracted investors who were less fixated on quarterly earnings and who tended to take a longer term, stewardship perspective of the firm. Over the past 12 months, I have heard quite a lot of talk about stewardship coming from the investor communities in Canada, Japan, the Netherlands, South Africa and the United Kingdom. Even Google, I discovered, included this in its SEC filing before going public: “A management team distracted by a series of short-term targets is as pointless as a dieter stepping on a scale every half-hour.” This is significant. For me, this marks quite a staggering change from when I went to business school and first learned about corporate governance. I think this view of governance – which encompasses corporate citizenship, ethical responsibilities, accountability and fairness – is an idea whose time has come. Paul Druckman is the CEO of the International Integrated
Reporting Council (IIRC), a global coalition dedicated to seeing integrated reporting embedded into mainstream business practice as the corporate reporting norm. He gave the closing address at the 2nd Annual Board of Directors Forum organized by IESE Madrid in April 2014.
IESEinsight
EARLY
QUICK KNOWLEDGE. THINKING AHEAD.
insight
MOST ATTRACTIVE FOOD & BEVERAGE MARKETS The top 3 importers in each category, by $ value.
USA
18%
GERMANY -7% UK -6%
Year-over-year changes Rate at which imports grew Rate at which imports fell
USA
FRANCE 11%2 3 UK -10%
USA -8% US 19% 4%
GERMANY USA
34%
2 3 1
GERMANY-1%
2
SINGAPORE 0.3%
7%
3
Sugar & confectionery High alcohol drinks
1
17% USA SWEDEN -0.5%
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Beer
1
CHINA
JAPAN
Water & non-alcoholic 3 drinks 1
3%
TRADE TRENDS
The Ripest Markets
1
2
WHEN IT COMES TO BEVERAGES, the United States is the top importer, while Japan 5% USA imports the most food products, mainly meat, UK 0.5% fish, cereals and baked goods. Other Asian GERMANY-7% countries that are significant importers of GERMANY-9% food and beverage products are China, India ITALY -15% and Singapore, while demand in Europe NETHERLANDS -1% is highest in France, Germany, Italy, the JAPAN Netherlands, Russia, Sweden and the -8% 17% USA United Kingdom. These are some of 84% CHINA the findings of the latest Food and 19% INDIA Beverage Attractiveness Index, 0.6% CHINA a useful tool for businesses to 17% NETHERLANDS analyze evolving market condiJAPAN 0.5% tions and set their export 7% RUSSIA % 7 GERMANY strategies accordingly. With -11% 82 countries ranked, the index USA monitors consumption habits, GERMANY-12% FRANCE -7% demographic trends, short-6% ages or surpluses and other GERMANY USA -0.5% vital factors that companies NETHERLANDS -0.5% need to know as they seek to internationalize their trade in 14 12 10 8 6 4 this sector.
2 3
Fish products
1 2
Wine
3 1 2 3
Dairy products & eggs
1 2 3
Bakery & cereals
1 2 3
Fats & oils
1 2 3 1 2 3
Meat products Hot drinks & spices
1 2 3
2
Fruit & vegetables
0 $USB
The Vademecum on Food and Beverage Markets 2014 was overseen by IESE Prof. Jaume Llopis and coordinated by María Puig and Júlia Gifra of IESE’s Industry Meetings Department, in collaboration with a Del oitte team led by Fernando Pasamón. Read “A Practical Guide to Food and Beverage Exports” at ieseinsight.com.
“Just like success, happiness cannot be pursued; it is rather the consequence of our actions. Therefore, if we are capable of passion and commitment, of nurturing our entrepreneurial spirit, of working hard but humbly, and doing all of these things responsibly, we will have bought
ourselves our surest ticket to happiness, and by extension, to success.” Pablo Isla, chairman and CEO of the Inditex fashion retail group most famous for Zara, shares his secret for success during his keynote address at the graduation ceremony for the MBA Class of 2014 at IESE Barcelona. Read more about Inditex’s fast-fashion business on pages 58-65 of thi s magazine.
insight
IESE
ISSUE 21 SECOND QUARTER 2014
7
EARLY insight
Adaptability: A Vital Competency
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
CHANGING ROLES AROUND THREE TIMES DURING YOUR CAREER, with just over eight years in each role, seems to be the optimum for developing “adaptability.” So says a study of high-level general managers, nding that executives with more varied career histories tend to become more adaptable as a result. Being able to respond effectively to new contexts, learn new skills and rapidly deploy them to solve unfamiliar problems is becoming a vital competency in today’s everchanging marketplace. This is made easier if executives have been exposed to a variety of situations and individuals over the course of their careers. Several factors help to develop this. For one thing, working as an executive assistant early in one’s career gives early training in being more adaptable. By shadowing senior managers, assistants observe how these leaders deal with changing circumstances, and this in turn fosters their own learning as they rise through the ranks. Corporate programs aimed at growing high potentials also help, but they need to be managed carefully. For example, rotating managers around the organization may be helpful for exposing managers to a wide variety of situations – but not if the changes are too frequent. Executives need adequate time to settle into each new role – but not so much time that they become complacent. It’s a tricky balance to get right. In aiming for adaptable leaders, companies may need to adapt themselves, thinking twice about individuals changing job-type too often, as those who stay in each role for relatively short periods of time benet less from the experience. Read the abstract “Fostering Adaptability in Tomorrow’s Executives” at ieseinsight.com.
8
SECOND QUARTER 2014 ISSUE 21
WHERE BEST TO INVEST
When Does an Emerging Country Take Off?
HIGH RANK
INDONESIA, THE PHILIPPINES, MEXICO AND TURKEY show the highest potential for meaningfully increasing private equity (PE) activity in the near future, with Georgia standing at a critical juncture in the development of its investment infrastructure. So nds the latest Venture Capital and Private Equity Country Attractiveness Index prepared by IESE’s Center for International Finance, in conjunction with EMLYON Business School, to help investors identify the countries with the greatest potential for investment. Analyzing the socioeconomic data of 118 countries, the authors discover a strong link between their attractiveness scores and actual PE activity. They determine that a country with approximately 45 index points or more seems to mark the turning point when
LOW RANK
PE activity comes alive. Georgia, rising eight places and with an index score of 45.9, is considered “increasingly attractive, stay alert.” While the BRICs (Brazil, Russia, India and China) remain the darlings of investors, the index reveals several other countries whose medium-term prospects show just as much, if not more, promising development. Besides those mentioned, the authors highlight Chile, Colombia, Estonia, Finland, Lithuania, Malaysia, Morocco, Oman and Peru. This is not to say that all these countries boast ideal conditions for investors. Indeed, many of these countries still lack certain key drivers of the six identied by the authors as necessary for attracting and protecting investments. But what they do afford is a chance for early investors to gain a toehold before these markets take off.
Read more at ieseinsight.com and see the Venture Capital and Private Equity Country Attractiveness Index 2014 at http://blog.iese.edu/vcpeindex.
IESEinsight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
insight
EARLY
GERMANY
38%
NEW RETAIL STRATEGIES
Consumers Won’t
31%
Accept Returns
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
DESPITE THE GAINS THAT THE EUROPEAN RETAIL SECTOR has experienced over the past decade, companies need to adapt to deal with post-recession realities. Cautious consumers show no signs of going back to pre-crisis shopping patterns. The main retail channels in danger of extinction are small, independent stores located far from main shopping thoroughfares and malls in the city outskirts. There is a general shift away from sales channels that require a large investment in real estate. This is not to say that physical stores have no future. Rather, they need to be combined with a digital presence, integrating online, mobile and social channels. Click-and-collect stores, pop-up stores and “shoppable windows” are examples of how online and offline channels can work together profitably.
UNITED
33%
KINGDOM
18%
RUSSIA
30%
FRANCE SPAIN ITALY
17%
BARGAIN SHOPPING IN EUROPE
Low-cost (“value”) retailers’ sales as a percentage of total apparel-industry sales, in 2004 and 2012
20%
8%
2004
20%
22%
2012 6%
25%
Read the abstract “The Return of the Consumer,” based on a new book by IESE Prof. J.L. Nueno, at ieseinsight.com.
WORKING CROSS-CULTURALLY
How Stereotypes Affect Teamwork WORKING WITH COLLEAGUES FROM OTHER COUNTRIES is not always easy. A study of U.S., Mexican and Indian engineers working together on a common project found stereotypes led to misunderstandings and communication breakdowns that threatened the viability of the collaboration. The Mexican engineers, fearing that others regarded them as “not smart enough to come up with new
ways of doing things” and likely to “spend all day talking,” deliberately did the opposite, believing this would subvert the stereotype. Their plan backfired: the U.S. engineers complained that the Mexicans were always trying to come up with new procedures and were missing out on the expertise of others since they never spent any time talking with experienced colleagues.
The fact that the engineers relied on e-mail, phone calls and messaging may have contributed to everyone falling back on stereotypes. In the absence of face-to-face encounters, people invent their own reality. As such, managers of multinational companies should allocate time and budget for global partners to visit each other’s workplace, learning how it actually is rather than how they think it is.
“Occupational Stereotypes, Perceived Status Differences and Intercultural Communication in Global Organizations,” by IESE’s Carlos Rodriguez-Lluesma and Paul M. Leonardi of Northwestern University, was published in Communication Monographs. Read the abstract “Beware of Stereotypes When Working Cross-Culturally” at ieseinsight.com.
10
SECOND QUARTER 2014 ISSUE 21
insight
IESE
EARLY insight
Presentations Time to Walk the Talk That Deliver SALES NETWORKS
Your sales efforts are focused on…
83% 75%
Attracting customers Retaining customers Recovering lost customers
21% 0
100
Do you currently offer any incentives to encourage Yes your sales teams to bring in new customers? ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Do you have an established target for customer retention, loyalty or recovery?
65
%
36 Yes
35
%
No
64
No
ALTHOUGH 83 PERCENT of companies surveyed say they place a strong emphasis on attracting customers, 35 percent do not currently offer any incentives to encourage their sales teams to bring in new customers. Surprisingly, just 36 percent of the companies surveyed have an established target for customer retention, loyalty or recovery, despite three out of four claiming they make an effort to hold on to their existing customers. What’s more, almost half of them still do not gauge their level of customer loyalty, and only a third have some type of loyalty program in place. The survey was led by IESE’s Cosimo Chiesa and Julián Villanueva. Read the abstract “Sales Networks: A Little Planning Would Go a Long Way” at ieseinsight.com.
“We are going to produce a newspaper in print for as long as people want it. But the one thing we know is that we have got to
continue to adapt and change. Increasingly our traffic is coming to mobile. The question is: How do we adapt to these new formats in a way that does not diminish the quality journalistic
experience?”
Arthur O. Sulzberger, Jr., chairman and publisher of The New York Times, spoke on these themes during a Global Leadership Breakfast at IESE’s New York Center.
IESEinsight
TOO OFTEN, PRESENTATIONS FAIL IN THE DELIVERY because they don’t follow a clear path to a concrete call to action. Follow these tips for planning and delivering persuasive presentations that get results. KNOW WHAT YOU WANT. Before thinking
about content, start by thinking about the outcome you hope to achieve. WIN YOUR AUDIENCE. Make sure you understand both sides of the argument. Prepare ethical and emotional as well as logical appeals, and gather a variety of evidence to support your argument. BENEFITS & OBSTACLES. Consider the strategic, personal and business benets of the audience doing what you propose, and what might prevent them. Choose the top three benets and nd supporting evidence for each. BUILD YOUR ARGUMENT. Successful rhetoric is built on a tried-and-tested structure. The Grabber. Grab the audience’s attention with an anecdote, a question, a startling statistic or a thoughtprovoking quotation. The Message. Follow the grabber with a one-line statement that succinctly tells the audience what your presentation is about. Signposting. Signposting lays out the skeleton of the argument for the audience. Benefits 1-3. Remember to focus on benets rather than features. At least 75 percent of your presentation should be dedicated to developing your three main points. Closure. This section of your presentation is crucial. Sum up your main points in one sentence and give your call to action. DELIVERING LIKE A PRO. Public speaking is a performance. Having a clear structure and lots of practice beforehand will help to lighten the mental load. Read the abstract “How to Persuade Audiences to Action” at ieseinsight.com.
ISSUE 21 SECOND QUARTER 2014
11
BE THE KEY TO YOUR COMPANY’S GROWTH ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
JOIN IESE’S PLD. MOVE FORWARD IN YOUR CAREER.
IESE’s Program for Leadership Development (PLD) is an interactive learning experience designed to provide a solid foundation in business. Its unique holistic approach to enhancing business knowledge and leadership capabilities will improve your performance and shape you into a well-rounded executive ready to move forward in your career. You will collaborate with a pool of high-caliber participants and faculty members to develop a personalized Executive Challenge and a take-home agenda to ensure continued development. With editions in Barcelona, New York, Munich and Sao Paulo the PLD is the definitive step to your career development. ,
www.iese.edu/pld
[email protected]
BUSINESS SCHOOL IN THE WORLD FOR EXECUTIVE EDUCATION
2 Financial Times, May 2014
DOSSIER DEEP
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T Illustrations by RAUL ARIAS
B
IESEinsight
oards need to close the rifts left by the crisis and be open to change, for the long-term success of business.
15 How Boardroom History Is Writing Its Future Recommendations to Meet Future Governance Challenges By Jay W. Lorsch
31 Proxy Advisors Are Voting Guidelines Ruling Your Business? By Gaizka Ormazabal & Allan L. McCall
24 The Age of Activism Transparency, a Rising Trend in Listed Companies By José M. Campa
37 Renewing the Board’s Mission 6 Items for the Top of Every Board’s Agenda By Jordi Canals
ISSUE 21 SECOND QUARTER 2014
13
We need a deeper reflection on the conceptual framework of corporate governance.
Governance Matters By Fernando Peñalva
wisdom and experience; and until we stop believing that executives are incapable of doing anything without first being “bribed” for it, then debates over pay will remain just as vexed. Next, JOSÉ M. CAMPA elaborates on one of the hallmarks of good governance: transparency. The IESE professor and director of Investor and Analyst Relations at Santander Bank calls for more openness at three levels: between management, boards and society. Clear financial reporting is a given; companies need to focus on being just as clear about business risks, explaining decision-making processes, justifying executive compensation and coming clean on potential conflicts of interest, so that everyone can exercise their voting rights without hidden agendas. That said, my IESE colleague in the Department of Accounting and Control, GAIZKA ORMAZABAL, and ALLAN L. M CALL, of Stanford University’s Graduate School of Business, point to research they’ve done on proxy voting to question whether you can have too much of a good thing. No one doubts that disclosure, transparency and accountability are good things – but blindly trusting proxy advisor recommendations is not necessarily the neatest answer. As other nations look to the U.S. Securities and Exchange Commission’s regulatory choices as a benchmark, the debate raised by the authors on the U.S. proxy advisory industry is worth following. Rounding out this dossier, IESE professor and dean JORDI CANALS casts a clear vision of the firm’s overarching purpose, rooted in a strong sense of mission and values. With this in mind, he sets out six agenda items for the board that will add long-term value to the company it serves. For Canals it’s not just a question of getting a few errant companies back on track but of safeguarding the future of capitalism itself. There’s no one-size-fits-all solution. But hopefully after reading this dossier, you will be one step closer to resolving the particular governance challenges you face.
Corporate governance has come in for a bashing lately, ever since the global financial meltdown of 2007-08. Yet even before then, governance shortcomings were already painfully apparent during the dot-com boom-and-bust of 2000 and the accounting scandals of 2001-02. And that’s just talking recent history. If we go all the way back to the 1600s, the Dutch East India Company – considered the world’s first multinational corporation and the first to issue stock – also endured perhaps the world’s first governance crisis owing to corruption, and by 1800 the company went bust. As the saying goes, “Those who do not learn from history are destined to repeat it.” Lest we find ourselves having this same con versation in a few years’ time, I recommend you read this IESE Insight dossier and reflect on its lessons for your organization. To be fair, corporate governance today is better than it used be. Progress has been made. In line with wider social trends revolutionizing the business world, there is a growing sense of “people empowerment,” with shareholders having more of a say over company affairs. Boards are more conscious of their social responsibilities. Accountability is up; rubber-stamping whatever the great and mighty CEO says is down. True, some of these moves have been reactive. What’s needed now is a deeper reflection on the conceptual framework of corporate governance to make sure the changes stick. We need to step back and ask ourselves: What should regulators and firms address next, which goes to the very heart of corporate governance? Harvard’s JAY W. LORSCH opens the discussion by reflecting back on 25 years of governance history to make four recommendations that must be addressed for there to be any progress on meeting the corporate governance challenges of the future. He questions some of today’s categorical thinking: that it’s always better to have independent directors serving shorter terms, for example, or that we need to nix hefty pay. Lorsch reminds readers that the mere fact of in- Fernando Peñalva is IESE’s Secretary General and dependence counts for little without equal parts professor of Accounting and Control.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
C
14
SECOND QUARTER 2014 ISSUE 21
IESEinsight
DOSSIER DEEP
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
HOW BOARDROOM HISTORY IS WRITING ITS FUTURE
Recommendations to Meet Future Governance Challenges By JAY W. LORSCH
B
oardroom: the word alone conjures up grand visions of power, wealth and privilege. The boardroom’s core – the symbol of its power – is a massive, highly polished table around which the directors are supposed to make the decisions that govern corporations, impacting the livelihoods of many. It is the throne room of the corporate world’s potentates. At least, that’s what people think. A quarter century ago, in the book Pawns or Potentates:
IESEinsight
The Reality of America’s Corporate Boards , my
coauthor Elizabeth MacIver and I found that boards were acting more like pawns and not so much as the potentates they were legally intended to be. More often than not, real power over corporate affairs and major decisionmaking was being wielded by the CEOs, posing serious problems for the boards that were ostensibly meant to oversee them. There have been significant, positive changes over the past 25 years. In spite of and to ISSUE 21 SECOND QUARTER 2014
15
Recommendations to Meet Future Governance Challenges
In practice, boards can choose to delegate their authority to manage the company to its officers. But they need to retain enough power to question and oversee CEO decisions. some extent because of the periodic crises that have occurred during this time, boards are now more seriously engaged and working harder to fulfill their duties. That’s the good news. The other news is that there is still work to do. This article outlines the major problems that boards have faced over the past quarter century and solutions proposed to overcome them. I warn about the negative, unintended consequences of some of these “solutions.” And I offer my views on how to meet future governance challenges within the wider context of business.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
pany to its officers. In practice, boards always did, and still do, make such delegations. Fulltime employees with the time and knowledge to manage are the ones who run the company. That being said, boards need to retain enough power to question and oversee CEO decisions. Board solidarity and building a strong relationship with the CEO are two sources of board influence. However, these sources of power were limited by the culture and norms of the 1990s. In the United States, these limitations included: LIMITED TIME. Most board members had other
How We Got to Where We Are Today: The Norms of the 1990s To begin, I should note that in the United States – the geographic focus of my studies – it is the boards that have the legal authority, as enshrined in Delaware law. In other words, the boards are in charge. They can then choose to delegate their authority to manage the com-
full-time jobs and some served on several different boards at a time. LIMITED KNOWLEDGE & INFORMATION. To an im-
portant extent, boards’ limited knowledge and information was due to the sheer size and pace of the businesses under their charge, in addition to the limited time mentioned above. LIMITED EXPERIENCE. Independent
EXECUTIVE SUMMARY There have been significant, positive changes in boardroom practices over the past 25 years. However, there is still work to do, says the author, whose expertise in corporate governance matters was tapped for lawsuits involving the Tyco and Enron fiascos at the dawn of this new century. Drawing on decades of research and experience, the author outlines the major problems that boards have faced over the past quarter century and the solutions proposed to overcome them.
16
SECOND QUARTER 2014 ISSUE 21
directors usually had limited experience in the company’s specific line of business, which forced them to learn on the job.
He warns of the negative, unintended consequences of some of these solutions, INFORMATION ASYMMETRY. In most boardmany of which were not rooms, the management teams not only had thought through carefully greater knowledge of the issues but they also and may be based on false controlled the information that the directors premises. Finally, he offers received. four recommendations for directors, CEOs, shareholders LACK OF CLARITY ABOUT BOARD GOALS. Certain and other stakeholders directors believed that the primary purpose of on how to meet future a company was to create value for shareholdgovernance challenges within ers; others believed that companies should the wider context of business. have broader goals, serving not only sharePut simply, there needs to holders but also customers, employees and be open communication their communities. Because such important between all parties and a distinctions were never clarified, decisions consensus on the ultimate wound up being based on fundamentally dipurpose of the firm. vergent premises within the same board. IESEinsight
Recommendations to Meet Future Governance Challenges
The diagnoses of the boardroom problems of the ’90s led to a set of agreed best practices. Yet even adopting best practices did not solve all boardroom problems. Far from it. STRONG NORMS. The presence of a strong coali-
The CEO and the executives reporting to the CEO served as the board’s primary sources of information. Since the board chair and the CEO were normally one and the same, it was usually the CEO who set the agenda and controlled the discussions of board meetings.
that the company complied with applicable laws. Granted, not all boards adopted these practices simultaneously or quickly, and some in the United States did not do so until laws and regulations required them many years later. Conversely, in the United Kingdom, the adoption of recommendations made by the Cadbury Report – such as having a board chair who was not the CEO, adding independent and nonexecutive members, and establishing audit committees – was swift and dramatic. Yet even adopting best practices such as these did not solve all boardroom problems. Far from it.
A New Paradigm Is Born? The diagnoses of these boardroom problems of the ’90s found willing listeners, leading to calls for change. Among the changes developed in the United States and the United Kingdom were a set of agreed best practices, which included: Smaller boards to facilitate group discussion. A majority of independent directors. Meetings without the CEO present. Directors were encouraged to hold executive sessions. They also began to feel comfortable speaking to each other informally between meetings. Board leaders who were not also the CEO. Independents controlling the selection of new directors. Audit, compensation and corporate governance committees in which directors met without the CEO or the top management present. A sharpened focus: The board focused on the approval and oversight of corporate strategy, CEO performance and management development to assure a supply of future executives. Boards also evaluated their own performance and were supposed to ensure
Crises at the Dawn of the 21st Century At the beginning of the new century, two different governance-related crises struck. The first was the bursting of the dot-com bubble in 2000. Many early-stage, newly listed public companies had yet to prove they had sustainable business models. Although their subsequent failures were blamed mostly on reckless entrepreneurs and venture capitalists, in hindsight such failures were at least partially the fault of boards who wanted to attract public investors even before their companies had earnings. A second governance failure was the wave of fraud and misleading accounting that occurred at companies such as Enron, Tyco and WorldCom. While the specifics of each scandal were different, all featured improper or fraudulent accounting practices and inflation of the compensation packages of senior managers. In the case of Tyco, a so-called “independent” director was receiving questionable payments from the company. Notably, all these boards had a majority of independent directors, and they also had audit, compensation and corporate governance committees. So what went wrong?
tion of board members to counter the power of the CEO was not the norm at the time. Directors subscribed to the notion that it was inappropriate to criticize the CEO in board meetings or to have discussions without the CEO present.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
COUNTERVAILING POWER OF THE CEO.
n
n
n
n
n
n
n
IESEinsight
ISSUE 21 SECOND QUARTER 2014
17
Recommendations to Meet Future Governance Challenges
The belief that corporate boards were improving made the financial meltdown in 2008 particularly shocking. Many blamed “bankers” as responsible. But where were the boards of financial institutions at the time?
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
At the time, I had the dubious distinction law had improved accounting and financial of serving as a potential expert witness in law- reporting for their companies. They felt the suits involving both Tyco and Enron directors. law gave audit committees clear responsibil After reading hundreds of pages of documents ity for overseeing the public accounting firms on both these cases, what struck me as a com- that audited them, which in turn improved mon theme was that the directors remained in corporate governance. thrall to the CEO, regardless of the lip service Also in response to the scandals, the New being paid to the new boardroom paradigm York Stock Exchange and the Nasdaq revised emerging out of the ’90s. Clearly, the goal of their listing requirements. Essentially both increasing the power of the board to counter exchanges modified their rules to require that the CEO had fallen short of the mark in these listed companies implement most of the precompanies. viously mentioned best boardroom practices. These corporate scandals generated masThe combination of the changed listing sive outcry from the public, media, business requirements and Sarbanes-Oxley added moleaders and politicians alike. This led to the mentum to the improvement of boards. passage of the Sarbanes-Oxley Act in the United States in 2002, which imposed new re- The Financial Crisis of 2008 quirements on the audit committees of boards and Beyond and for the certification of financial reports by The belief that corporate boards were improvpublic-company CEOs and CFOs. ing made the financial meltdown in 2008 Despite complaints from senior manage- particularly shocking to those of us closely ment and board members that Sarbanes-Ox- following corporate governance issues. Since ley was too onerous, there were no serious at- the media, politicians and the public identitempts to change or repeal it. In fact, within fied those responsible as “bankers” or “Wall a few years, most directors and senior execu- Street,” there was little public criticism of tives with whom I spoke admitted that the boards. Yet where were the boards of financial institutions at the time? Directors were apparently dependent on top management for inABOUT THE AUTHOR formation about corporate lending practices. Jay W. Lorsch is the Louis Future of Boards: Meeting the An underlying problem was that because of the Governance Challenges of the E. Kirstein Professor of drive to find independent board members, t oo 21st Century . His business Human Relations at Harvard few directors of financial firms had any depth Business School, where classic Organization and of financial experience. Environment, coauthored he earned his doctorate in Although the Dodd-Frank Wall Street Business Administration. He with Paul R. Lawrence, won Reform and Consumer Protection Act in the is the author of more than Academy of Management and United States in 2010 focused on the regulaa dozen books, including James A. Hamilton book-oftion of banks and their officers in the wake of the-year awards. He recently Back to the Drawing Board: the financial crisis, the new law had two wider collaborated with IESE on Designing Corporate Boards ramifications for corporate governance. The the Short Focused Program first was to allow shareholders – under certai n for a Complex World and “Value Creation Through conditions – to place nominees for board seats Pawns or Potentates: The Reality of America’s Corporate Effective Boards” held at IESE on the proxy statement of the company. This Boards, and the editor of The Barcelona in May 2014. was intended to allow shareholders to have
18
SECOND QUARTER 2014 ISSUE 21
IESEinsight
Recommendations to Meet Future Governance Challenges
Boards are part of complex systems. Unfortunately those who propose a particular change, frequently in reaction to a sudden public outcry, often do not anticipate the potential downsides of their proposals. more of a voice in nominating directors for board seats, although its implementation was rather limited. The second aspect of Dodd-Frank that affected governance broadly in the United States was its say-on-pay provision, which gave shareholders the right to vote on the compensation of senior executives, although the results were non-binding. The idea was adapted from a British proposal that had existed for several years. One may wonder how say-on-pay found its way into a law whose purpose was financial regulation. One reason was the shareholder and media outcry over executive compensation being too large and unrelated to corporate performance, with the pay for top executives of financial institutions singled out as an egregious example.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
25 Years of Progress? This historical recap sets the stage for discussing the future steps for continued improvement. That boards are doing a better job of governance today than they were 25 years ago seems indisputable. For example, directors now report that they understand the role they are expected to play and that they are focusing on the economic performance of their companies over the next two years or more. They also report that they have a high level of comfort with the information they are receiving. What remains problematic is the erratic and relatively unpredictable manner by which such improvements have been brought about. Negative unintended consequences of reforms have threatened the progress of corporate governance on several fronts. The following examples stand out: SAY-ON-PAY. In 2006 the U.S. Securities and Ex-
change Commission introduced a requirement for public companies to report the compensation of their senior executives. The theory was that disclosure of such information would help IESEinsight
to curb excessive pay. It was not to be. Instead what has happened is that senior executives have used the knowledge of their peers’ compensation packages to argue for more pay for themselves. MAJORITY OR LARGER PROPORTION OF INDEPENDENT DIRECTORS. The intention of having more
independent directors was to reduce potential conflicts of interest. Outside directors were to act with complete loyalty to their companies. But independence has had the unintended consequence of creating more or a majority of board members lacking deep experience in a company’s industry or line of business. ELIMINATION OF STAGGERED BOARDS FOR SHORTER TERMS. The advocates of doing away with
staggered boards argued that shorter terms provided shareholders with a greater opportunity to replace directors whenever they believed it was desirable. To me what is more important is to have directors with knowledge and experience. Serving longer terms fosters this knowledge and experience, thereby strengthening the argument for retaining staggered boards. I believe there are two major reasons for such negative unintended consequences. First, boards are part of complex systems. U nfortunately those who propose a particular change, frequently in reaction to a sudden public outcry, often do not anticipate the potential downsides of their proposals. Moreover, they may only understand and care about one part of the system – as in the case of institutional shareholders who believe the best way to improve corporate governance is to grant themselves greater influence over corporate decision-making (see the sidebar The Rise of Shareholder Power ). These problems are compounded by mistrust between directors and shareholders. ISSUE 21 SECOND QUARTER 2014
19
Recommendations to Meet Future Governance Challenges
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Shareholders interpret resistance to their understand that governance is the result of huproposals as veiled attempts by boards to en- man relationships. Directors know firsthand trench their power, while directors believe why boards may have difficulty carrying out shareholders are only out to protect their own their responsibilities and they are well placed rights and interests. to come up with the solutions that eliminate or Meanwhile, some parties cling to the view at least minimize these constraints. that a corporation’s sole responsibility is to its shareholders, while others argue that the Four Recommendations corporation’s purpose must be broader, con- for the Future sidering its long-term health and the value it Going forward, I see four things that must adds to society as a whole. So long as disagr ee- be addressed for there to be any progress on ments persist over a business’s ultimate pur- meeting the corporate governance challenges pose, it will be hard to achieve consensus on of the future. future changes to corporate governance. Open discussions are required. 1. A BETTER PROCESS FOR OVERSEEING EXECUTIVE In my view, the most beneficial changes have COMPENSATION. Current problems related to exemanated from boards and their advisers who cessive executive compensation are to my mind
The Rise of Shareholder Power Pushes for changes to corporate governance practices are increasingly coming from institutional investors. n many cases, the impetus for adopting best practices in the boardroom have come from directors themselves, but institutional investors have also pressed for certain changes. They rallied for changes and limits to CEO power, seizing on the fact that l eaders of public companies do not want to be embarrassed. One of the earliest examples occurred in 1990, when two U.S. state pension funds wrote letters to the board of General Motors asking how the directors planned to handle the selection of a successor for then-CEO Roger Smith. When they did not receive a satisfactory response, the parties publicized the episode in The New York Times and The Wall Street Journal. Further, they exercised their right to sponsor shareholder proposals
I
and changed corporate bylaws. In the United States, there are four salient examples of how institutional investors have influenced boards in a decade’s time. SHORTER TERMS. In 2009, 68 per-
cent of directors served one-year terms, compared with 38 percent of directors in 1999. MAJORITY VOTING. In 2009, more
than half of all companies in the S&P 500 had a majority standard for uncontested board elections, up from the plurality voting of prior years. SEPARATION OF CEO & CHAIR ROLES.
In 2009, 37 percent of S&P 500 companies split the chair and CEO roles, compared with 20 percent in 1999. Despite moves toward splitting the jobs, particularly in
the United Kingdom, I find the reasons for doing so can be b ased on knee-jerk reactions rather than on compelling evidence that it is better than leaving the two positions combined. I would argue that a competent lead or presiding director should be capable of striking the right balance b etween effective governance and leadership. Simply separating the roles without understanding the complexities involved is hardly the answer. POISON PILL. The number of S&P
1500 companies that maintain a “poison pill” – a tactic that gives directors power to deter or prevent takeover bids – continues to decrease: 42.5 percent in 2007, 34.5 percent in 2008 and 27.5 percent in 2009.
SOURCE: Lorsch, J.W. “America’s Changing Corporate Boardrooms: The Last Twenty-Five Years.” Harvard Business Law Review 3, no. 1 (Spring 2013): 119-34.
20
SECOND QUARTER 2014 ISSUE 21
IESEinsight
Recommendations to Meet Future Governance Challenges
symptomatic of larger societal questions and cannot be fixed by mere disclosure or say-on-pay. I stand by what my coauthor Rakesh Khurana and I wrote in The Future of Boards a few years ago: “Rethinking the nature of executive pay within the context of our larger economic and social system and the challenges we face may enable us to create a new model of compensation rooted in a more realistic recognition of the social context within which firms operate. It should, and can, rest on valid assumptions and fundamental values that allow us to build a more inclusive and sustainable economic future – one in which we don’t have to bribe executives to do the duties we have entrusted to them.”
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
2. MORE DIRECTORS WHO ARE BOTH INDEPENDENT AND KNOWLEDGEABLE. Most boards, espe-
cially in North America but also in European countries, are now required to be made up of independent members. The problem is, most independent directors join boards with limited prior connection to the company and its industry. As such, to be effective, boards must be good at educating their members and getting their knowledge base up to speed. A simple thing to do is make sure that directors ar e sent vital information in advance of board meetings with the expectation that they will digest it and come to the meeting fully prepared. This will help ensure that board meetings are more productive.
are all too often an excuse for stock analysts to probe for hints about short-term results. Shareholder proposals usually involve some means of harassing boards and limiting their power. Neither of these common means of communication between companies and their shareholders is very helpful for improving governance, yet these battles are likely to continue unless other means are found to enable shareholders and directors to communicate in a more positive fashion. In sum, communicating in a more positive fashion and agreeing on corporate purpose will be key to meeting the governance challenges of the 21st century. There is the question of who could convene such discussions. There are numerous possibilities – from the stock exchanges, to members of the legal community, to business leaders, to academics. Improving corporate governance more rapidly requires not only a more precise agreement about the purposes of the corporation, but also that the major actors involved in governance have a forum in which these issues can be explored and agreed upon together.
TO KNOW MORE 3. A REEXAMINATION OF STAGGERED BOARDS.
Over the past several years, many companies have eliminated staggered boards to the point where most directors, in the United States at least, are now elected annually. Does this lead to better governance? Some institutional shareholders, especially union and pension funds, believe it does. From their perspective, it is especially helpful in not allowing boards to become entrenched and block takeover attempts. But many directors have indicated that it took them a year or more to understand their company’s business. Terms should be longer than just one year.
This article was adapted from “America’s Changing Corporate Boardrooms: The Last Twenty-Five Years,” originally published in Harvard Business Law Review 3, no. 1 (Spring 2013): 119-34, and is used with permission of Jay W. Lorsch. The following other works also informed this article: n
n
IESEinsight
Carter, C.B. and J.W. Lorsch. Back to the Drawing Board: Designing Corporate Boards for a Complex World. Boston: Harvard Business School Press,
2004.
4. IMPROVED COMMUNICATION BETWEEN COMPANIES AND LONG-TERM SHAREHOLDERS. Clearly
the present methods of communication and dialogue between boards and shareholders are not adequate. Quarterly earnings calls
Lorsch, J.W., ed. The Future of Boards: Meeting the Governance Challenges of the 21st Century . Boston: Harvard Business School Press, 2012.
n
Lorsch, J.W. and E. MacIver. Pawns or Potentates: The Reality of America’s Corporate Boards . Boston: Harvard Business School Press, 1989.
ISSUE 21 SECOND QUARTER 2014
21
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
KNOWING WHERE TO G O IN A FUTURE WITHOUT MAPS.
REG ISTE R NO W: WWW.IESE.EDU/GAR
Some of the confirmed speakers
René Aubertin
Ana Maiques
Kenneth Rogoff
HAIER EUROPE �CEO�
STARLAB �CO�FOUNDER & BUSINESS DEVELOPMENT�
HBS (PROFESSOR OF ECONOMICS�
David Mills
Francisco Javier Ruiz
RICOH EUROPE �CEO�
DELOITTE IBERIA �CEO�
Thomas Rabe
Juan Miguel Villar Mir
BERTELSMANN �CHAIRMAN & CEO�
GRUPO VILLAR MIR �CEO�
Nani Beccalli-Falco GENERAL ELECTRIC EUROPE �PRESIDENT AND CEO�
Luis Cantarell ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
NESTLÉ HE ALTH SCIENCE �PRESIDENT AND CEO�
Patricia Ithau L’ORÉAL EAST AFRICA �MANAGING DIRECTOR�
Julio Rodríguez SCHNEIDER ELECTRIC �EXECUTIVE VICE P RESIDENT GLOBAL OPERATIONS AND MEMBER OF THE EXECUTIVE COMMITTEE�
SHAPING EUROPE AS A GLOBAL REFERENCE GLOBAL ALUMNI REUNION OCTOBER 30�31, 2014 CENTRO DE CONGRESOS PRÍNCIPE FELIPE MADRID
DEEP
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
THE AGE OF ACTIVISM
Transparency, a Rising Trend in Listed Companies By JOSÉ M.CAMPA
C
orporate governance is essentially a system of rules and procedures for regulating the relationships among various participants in a company – from the executive management team and board of directors, to shareholders and other stakeholders. Many people erroneously make the company’s relationship with its shareholders the chief concern, when in fact corporate governance should encompass relationships with all groups affected by the company’s activities, whether directly (shareholders, employees, creditors, service providers and customers) or indirectly (government bodies and other social actors). The global financial crisis has revealed the inadequacies of many business practices,
24
SECOND QUARTER 2014 ISSUE 21
prompting many companies to rethink the role of corporate governance. Although the specific way in which corporate governance is practiced depends on the company itself, legislators, regulators, shareholders and societal stakeholders are exerting their influence in this post-crisis period, having realized the serious consequences of bad governance. As I will explain in this article, the trend is toward greater transparency and an expanded role for shareholders. Accounts Getting Clearer The first priority of corporate governance is to have clear accounts. This means having consistent, comparable reporting criteria in order to provide a relevant, reliable picture of the company’s financial activities, which can be IESEinsight
Transparency, a Rising Trend in Listed Companies
Good governance is not just about presenting clear accounts. To ensure the clarity and consistency of its future accounts, there must also be transparency in a company’s decision-making processes. confirmed by impartial third parties. Even though this seems pretty basic, many companies’ reporting standards fall short, with the following deficiencies being the most common: UNCLEAR. All too often, the accounts of large, listed companies are overly complex. UNREPRESENTATIVE. While the reports may be a faithful reflection of accounting activities during a fiscal year, they may reveal nothing about the risks taken to get there or the company’s likely future evolution. LITTLE STANDARDIZATION. Certain accounting items may be arbitrarily defined. INCONSISTENT. The accounting principles used may change over time as a result of a corporate decision or a new piece of legislation. INCOMPARABLE. One company’s accounting criteria may be significantly different from another’s. This is especially true at the international level. NO GUARANTEES. Although companies are obliged to have audits, no third-party audit can ever give full guarantees. In spite of these flaws, there is some cause for optimism, with substantial progress made in the following areas: ACCOUNTING & FINANCIAL CRITERIA. As noted previously, the application of certain accounting and financial criteria can vary widely from
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
EXECUTIVE SUMMARY Good corporate governance cannot guarantee that good decisions will always be made: running a business is fraught with risk and managers can – and often do – make mistakes. What good governance does do is ensure there is accountability and that decisions are taken in an appropriate manner. The IESEinsight
country to country, company to company. However, moves toward agreeing universal, global reporting standards are steps in the right direction. INTERNAL AUDITS. Internal audits are getting more rigorous and compliance requirements have been raised. EXTERNAL AUDITS. The penalties for negligence by external auditors have been raised significantly. Also, much greater attention is now being paid to potential conflicts of interest. The “independence” of auditors who also provide consulting services to the same firm is increasingly being questioned and clamped down on following the wave of high-profile accounting scandals since 2000. ADMINISTRATORS. Little by little, administrators are being required to present clearer accounts.
More Transparent Procedures Good governance is not just about presenting clear accounts that reflect the company’s financial activities. To ensure the clarity and consistency of its future accounts, there must also be transparency in a company’s decision-making processes. Admittedly, even with the best governance systems in place, there is no built-in assuran ce that good decisions will be made all the time: running a business is fraught with risk and managers can – and often do – make mistakes. Whether to relieve top managers or executives of their duties for a decision that results in a recent experience of publicly negative business outcome is an open questraded companies has shown tion for shareholders. But from a governance that good governance requires point of view, the key concern is whether that both transparency and uid decision was made in an appropriate manner, communication between the free from procedural bias. Governance enmajor interest groups – that is, sures there is at least accountability for those between top management and decisions. the board of directors; between Recent history underscores the need for the board and shareholders; much greater transparency as well as more fluid and between shareholders and communication between the major stakeholdsociety at large. ers at three levels: between top management ISSUE 21 SECOND QUARTER 2014
25
Transparency, a Rising Trend in Listed Companies
Companies have an undeniable impact on the societies in which they operate. As part of this, the concept of sustainability has assumed critical importance in all business activities. But what does it actually mean? and the board of directors; between the board of directors and shareholders; and between shareholders, or the company owners, and society at large. (See Exhibit 1.) 1. Transparency Between Management and the Board To ensure robust decision-making, there must be healthy levels of trust between the top management team and the board of directors, as well as between the individual members of the board. Some measures being taken to deepen this trust include: COMMITTEES FOR STRATEGIC ISSUES. In addition to compulsory audit committees and the usual committees for appointments and remuneration, companies are increasingly setting up specialized committees to oversee such areas as strategy, risk, investment and technology.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
A HEALTHY DISTRIBUTION OF FUNCTIONS & BALANCE OF POWERS. There is a trend toward sepa-
rating the chair and chief executive roles, so that the functions are not concentrated in the same individual. In the event that both roles are held by executives, the competencies called for in each position are being better defined. THE GROWING IMPORTANCE OF NON-EXECUTIVE ADVISERS. As the presence of non-executive
board members or external advisers becomes more common, their role is expanding be yond merely acting as an outside inspector or observer. In addition to evaluating risks, management biases and the suitability of decision-making processes, many are assuming the capacity to act and lead initiatives independent of the board chair. Some may also have the power to summon the board, introduce items onto the agenda and evaluate t he chair’s performance. HIRING, EVALUATION & REPLACEMENT OF THE CEO.
These functions – by far the most important responsibility of the board – are generally becoming more transparent, with more companies thinking about succession planning.
26
SECOND QUARTER 2014 ISSUE 21
2. Transparency Between the Board and Shareholders Transparency between the board and shareholders extends beyond the obligatory presentation of audited accounts to include reporting on corporate social responsibility, environmental impacts, remuneration, risks and other aspects of business activity. For some regulated sectors, like banking, the reporting requirements introduced in the wake of the global financial crisis have provoked a sharp rise in compliance costs, with JPMorgan Chase CEO Jamie Dimon recently stating in his annual letter to shareholders that the bank had spent billions and hired an additional 13,000 employees just to keep up with regulatory issues and compliance. Boards are attempting to improve their communication with shareholders in the following areas: BUSINESS RISKS. Shareholders increasingly expect to receive a risk-evaluation report from the board of directors. They want to know what could go wrong, why and which instruments the company has in place to manage those risks. Companies are also now openly discussing a much broader range of risks – not just financial or catastrophic risks but environmental or reputational ones as well. FUTURE PROSPECTS. Accounts are a reflection of past actions and operations, not a forecast of what the company intends to do in the future. Shareholders and potential investors also seek information about a company’s future activities, management reflections on the environment in which they’re operating and about their business priorities, and signs of any dark clouds gathering on the horizon. There is an inherent tension between this need for detailed information about the company’s future plans and the impossibility of being able to predict the future. As such, future plans need to be flexible enough to accommodate any sudden changes in the business environment, while still offering some certainties for the IESEinsight
Transparency, a Rising Trend in Listed Companies
course ahead to avoid too many nasty surprises for shareholders. DECISION-MAKING PROCESSES. Corporate governance is a form of delegated decision-making, with the board making decisions on behalf of the shareholders. For this reason, shareholders deserve to know who is taking what decisions based on which criteria. Even though those who hold formal decision-making power may be quite different from those who actually wield power and influence in an organization, shareholders must be able to know who needs to beheld responsible for decisions taken. Naturally, people make mistakes, and governance mechanisms should include some tolerance for mistakes, which are par for the course when it comes to risk taking and inno vation. But accepting that boards may make mistakes is not to tolerate a lack of analytical rigor. Decision-making must not be allowed to get hijacked by a small minority who may only be serving their own interests rather than the greater good of the organization.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
3. Transparency Between Company Owners and Society Companies have an undeniable impact on the societies in which they operate. This impact includes the generation of employment and economic activity, as well as the provision of goods and services to customers. It also includes indirect effects such as improvements – or deterioration – in the quality of life of citizens. As part of this, the concept of sustainability has assumed critical importance in all business activities. But what does it actually mean? ABOUT THE AUTHOR José M. Campa is a professor of economics and nance at IESE Business School as well as Director of Investor and Analyst Relations at Santander Bank. He holds a master’s and PhD in Economics from Harvard University, and is an expert on international nance and macroeconomics. He has taught at Harvard University, Columbia University, N.Y.U. IESEinsight
Stern School of Business and Complutense University of Madrid. He has also been a consultant to organizations such as the World Bank, the International Monetary Fund, the Federal Reserve Bank of New York and the European Commission. Between 2009 and 2011, he served as Secretary of State for Economic Affairs of the Spanish government.
First, it means having a solid business model aimed at generating stable, self-sustaining revenue streams that guarantee the firm’s longterm survival. Second, it means taking ethical, social and environmental considerations into account when making decisions, so as to support the long-term development of the communities in which a company operates. Both issues are interrelated, as consumers increasingly evaluate companies not only on what products or services they offer, but also on the methods they use to produce or sell them. Consequently, a growing number of companies have begun to report on their performance in the following areas: SOCIAL & ENVIRONMENTAL IMPACT. More annual reports feature sections dedicated to the firm’s impact on the communities in which it operates. A similar trend is happening in the environmental sphere, with firms highlighting the environmental impact of their activities and integrating these reports with the financial statements. RISKS. Transparency is a prerequisite of effective risk management, founded on explicit communication. VALUES & LABOR PRACTICES. Companies are coming under mounting pressure to make sure their supply chains are ethically managed, particularly with regard to external suppliers and labor practices in far-flung locations. Companies must be open and honest about the working conditions not only of their own premises but of their suppliers in all the markets in which they operate. Consumers and investors are now able to compare the performance of various companies using publicly available indices that rate businesses according to ethical criteria and social indicators. Certain investors even base their investment decisions on such indices. However, these indices are still in their infancy, making it difficult to track and compare data on ethical business practices across countries. No doubt we will see greater convergence over coming years. Conflict Management Organizational conflict, though inevitable, can be preempted and mitigated if companies are transparent about potential conflicts of interest and develop explicit procedures for dealing ISSUE 21 SECOND QUARTER 2014
27
Transparency, a Rising Trend in Listed Companies
with them. This means publicly disclosing situations in which such conflicts have arisen and suggesting how they will be tackled. There are three areas of conflict that, due to their prevalence in business, deserve special attention. CONFLICTS BETWEEN SHAREHOLDERS. The
existence of different types of shareholders raises the likelihood of them having different interests, views and priorities about the company’s future. Managing these differences is an essential aspect of good governance. The interests of large shareholders differ ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Beyond the Balance Sheet
EXHIBIT 1
IN ADDITION TO C LEAR FINANCIAL STATEMENTS, TRANSPARENCY IMPLIES MORE FLUID COMMUNICATION AT THREE LEVELS.
MANAGEMENT
Specialized committees for studying strategic issues A better balance of power between the CEO and chair roles A bigger role and remit for non-executive advisers Shared responsibility for CEO hiring, evaluations and succession planning BOARD OF DIRECTORS
Producing a risk evaluation report Providing information about the company’s future prospects Clarifying who is taking what decisions based on which criteria SHAREHOLDERS
Publishing social and environmental impact reports Explicit communication about how the company intends to manage the business risks it faces Open and honest information about how supply chains are managed, particularly with regard to working conditions and labor practices involving external suppliers
SOCIETY
28
SECOND QUARTER 2014 ISSUE 21
from those of small retail shareholders. Some may wish to exercise their voting rights; others may prefer not to participate in governance issues at all. For diluted shareholders who do not want to be active participants, they risk maintaining the status quo, simply rubber-stamping the opinions of management. In this case, governance mechanisms need to encourage them to become more actively involved and engaged. On the other hand, having too many activist majority shareholders may lead to lopsided agendas, especially if these shareholders are also board members or wield undue influence or sway over prominent board members. When this is the case, governance mechanisms need to disclose the existence of any alliances between large shareholders, as well as any financial, business or personal relationships between shareholders, board members or company executives. CONFLICTS BETWEEN EXECUTIVES & SHAREHOLDERS. When it comes to conflicts between ex-
ecutives and shareholders, the biggest sticking point concerns remuneration – a key motivational lever that has been shown to affect managerial decision-making in both positive and negative directions. The questions on executive compensation typically revolve around: how much senior managers should get paid; how that pay should be linked to performance; and the impact of pay on the risks that senior managers are prepared to take. It is not easy to determine before the fact the optimal level of executive pay, beyond resorting to generalized considerations such as appropriateness and level of competitiveness in the top talent markets. Viewed in retrospect, there are legitimate concerns about executive pay related to: its weak relationship with profitability or performance; the ever widening gap between top executive pay packages and average salaries in developed economies; and the growing acknowledgement that most remuneration systems tend to incentivize decisions and actions that favor short-term results. In response, the governance provision of say-on-pay invites shareholders to weigh in on the compensation being offered to top managers and board members, with remuneration policies and golden parachute arrangements IESEinsight
Transparency, a Rising Trend in Listed Companies
The global financial crisis delivered a damaging blow to public trust in business. Restoring trust and regaining stable economic footing demand that companies embrace good governance instead. having to be disclosed prior to their implementation. This transparency rule has become a source of much debate, with no clear consensus on whether this provision is a help or a hindrance, nor is there a harmonized approach to this issue across jurisdictions. The European Commission recently proposed an E.U.-wide directive to introduce say-on-pay for the 10,000 companies listed on Europe’s stock exchanges. According to a statement by the European Commission, the new measure would “oblige companies to disclose clear, comparable and comprehensive information on their remuneration policies and how they were put into practice. There would be no binding cap on remuneration at E.U. level but each company would have to put its remuneration policy to a binding shareholder vote. The policy would need to include a maximum level for executive pay. It would also need to explain how it contributes to the long-term interests and sustainability of the company. It would also need to explain how the pay and employment conditions of employees of the company were taken into account when setting the policy including explaining the ratio between average employees and executive pay.” Switzerland tried to tackle the issue of compensation with a regulation that would have limited executive pay to 12 times that of the lowest paid, but the proposal was defeated by referendum.
on quarterly performance, share price volatility and high turnover among fickle investors. There does not appear to be any easy way of changing this dynamic between shareholders and the companies in which they are invested – other than by perhaps giving long-term fund holders a greater voice in corporate governance affairs. More measures exist to help prevent an excessive short-term focus among managers. Some companies are stacking executive compensation to include a larger element of deferred compensation linked to pension schemes, for example, which only pay off in the long term, rather than allowing too many quick cash grabs in the form of yearly bonuses. Others have introduced clawback clauses, enabling compensation benefits to be taken back in the event of underwhelming performance by senior managers. The Financial Stability Board, the body that coordinates the work of national financial authorities at the international level, recommends several Principles for Sound Compensation Practices as well as their Implementation Standards. The FSB calls for “compensation practices … to align employees’ incentives with the long-term profitability of the firm,” and for “effective governance of compensation, and for compensation to be adjusted for all types of risk, to be symmetric with risk outcomes, and to be sensitive to the time horizon of risks.” It urges that “the total variable compensation pool” be linked to “the CONFLICTS BETWEEN THE SHORT TERM & TH E LONG overall performance of the firm and the need TERM. The final area of conflict arises when a to maintain a sound capital base.” company has too many short-term investors and/or uncommitted senior executives. The Legacy of the Crisis The inevitable result is an excessive focus on The global financial crisis delivered a damaging short-term goals, often at the expense of the blow to public trust in business. Bad corporate company’s long-term interests. governance practices left many crying foul. Yet how this short-term focus translates Restoring trust and regaining stable economic into policy is not so straightforward. At the in- footing demand that companies embrace good vestor level, it can lead to a single-minded focus governance instead.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
IESEinsight
ISSUE 21 SECOND QUARTER 2014
29
Transparency, a Rising Trend in Listed Companies
Since 2007-08, when the magnitude of corporate governance failings became apparent, there have been waves of new measures driven by a tide of public opinion demanding that businesses conduct themselves more responsibly, always mindful of the consequences of their actions on society and general economic sustainability.
A Larger Role for Shareholders ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
One of the most ambitious proposals to shake up the corporate governance of listed companies has been the adoption of measures aimed at encouraging, or even enforcing, a much larger role for shareholders. hareholder activism has always been around. But since the global economic crisis exposed the failings of corporate governance, a case has been made to empower shareholders even more so they can make their voices heard throughout the world’s boardrooms. This is especially true for small retail investors, who are often ignored due to their lack of financial clout and/or specialized knowledge. The rationale for giving shareholders greater say is primarily to ensure that transparency penetrates all areas of corporate activity, and to demand that the best possible governance practices get implemented. In particular:
S
More Active Participation in Shareholder Assemblies
Requirements that shareholders must hold a minimum number of shares to be able to attend
30
SECOND QUARTER 2014 ISSUE 21
assemblies or serve as advisers have been scrapped. Information must be freely available by request or via the company’s website. Shareholders should be able to cast their votes remotely as well as through proxy advisors. Procedures for introducing items onto the agenda have been made easier. Increasing the Number of Decisions Needing Shareholder Approval
Another means of expanding shareholder participation in decision-making has been to increase the number of decisions needing their approval. Examples abound in which shareholders are now legally obliged to vote on decisions related to remuneration, operations, the use of consultants and external advisers, redundancy and other measures that might affect the corporate transactions market.
These measures have made a difference. Companies have to be more transparent, open and honest about their activities and any potential conflicts of interest, not only in their external communications but also in their internal decision-making processes. There are tighter reins on executive pay, and compensation is being more closely linked to long-term performance. Moreover, the definition of those who qualify as stakeholders has been enlarged beyond the shareholders. Formal requirements are undeniably stricter today than before. Companies are now under much greater pressure to dedicate time and resources to comply with new corporate governance guidelines. However, the goal should not be limited to formal compliance, but rather to achieving real, lasting improvement in corporate governance practices. One hopes to see the greater involvement of shareholders in terms of both the number and scope of management decisions on which they are consulted. The company continues to be a fundamental institution for economic risk-taking in society. Thanks to sweeping changes in corporate governance, that risk-taking is now being calculated with more care. Any further regulatory changes must be aimed at assigning appropriate roles and responsibilities to the company’s disparate stakeholders and making sure that the mechanisms in place are appropriate to deal with the governance challenges ahead, for the long-term social and economic welfare of everyone. TO KNOW MORE n
Belcredi, M. and G. Ferrarini. Boards and Shareholders in European Listed Companies: Facts, Context and Post-Crisis Reforms. Cambridge:
Cambridge University Press, 2013. n
n
Mayer, C. Firm Commitment: Why the Corporation Is Failing Us and How to Restore Trust in It. Oxford: Oxford University Press, 2013. European Corporate Governance Forum. “Action Plan: E uropean Company Law and Corporate Governance, a Modern Legal Framework for More Engaged Shareholders and Sustainable Companies.” Strasbourg: European Commission, 2012. IESEinsight
DEEP
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
PROXY ADVISORS
Are Voting Guidelines Ruling Your Business? By GAIZKA ORMAZABAL & ALLAN L. McCALL
O
ver the past two decades, U.S. markets have seen corporate governance failures blamed for a series of crises, including the dot-com boom/bust, the accounting scandals at the beginning of the 21st century and the global financial crisis. In response, legislators drafted new laws such as Sarbanes-Oxley and Dodd-Frank, which aimed to improve internal controls and corporate governance. Less well known, at least outside the world of institutional investment, are the regulatory changes made in 2003 by the U.S. Securities and Exchange Commission (SEC) to require mutual funds to develop “unconflicted” policies and procedures in rela-
IESEinsight
tion to their proxy votes, as well as disclosing their voting on all shareholder proposals. The reasoning was simple: If conflicts of interest on boards were as widespread a problem as the corporate governance crises suggested, then investors – particularly institutional in vestors – needed to pay much closer attention to governance in the companies in which they invested. The intentions behind this new legislation were laudable. After all, what investor would not want better disclosure, transparency and accountability? Critics push back that these potential benefits need to be weighed against other ISSUE 21 SECOND QUARTER 2014
31
Are Voting Guidelines Ruling Your Business?
This article discusses the main controversies around the proxy advisory industry. We also call for a more thorough investigation of the impact of proxy advisory firms on company performance. possible drawbacks of the regulation. In a 2013 speech on the dangers of reactive legislation, Daniel M. Gallagher, a commissioner at the SEC, argued that “the resulting regulatory mandates are often based upon false narratives and in the end lead to the expansion of a universal law: the law of unintended consequences.” In the case of the SEC’s proxy voting legislation, the unintended consequences have been subtle but impactful for corporate boards and investors. One of the controversies is the increase in the influence of proxy advisors – firms specializing in corporate governance research to whom institutional investors frequently outsource part or all of the analysis of corporate governance matters that are put to a shareholder vote. This article draws upon research that we have conducted with David F. Larcker from
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Stanford University. We highlight one unintended consequence of this new regulatory framework and discuss the main controversies around the proxy advisory industry. We also call for a more thorough investigation of the impact of proxy advisory firms on company performance. This issue concerns firms and investors not just in the United States but worldwide, as other national and regional regulatory bodies use the SEC’s regulatory choices as a benchmark. The Rise of Proxy Advisory Firms The traditional view of corporate governance involves three main actors – shareholders, managers and boards of directors – whose interests are not always aligned. Shareholders provide corporations with capital, managers make use of that capital and boards supervise the managers to make sure
EXECUTIVESUMMARY Recent legislative and regulatory decisions giving shareholders more influence over the governance of U.S. listed companies has motivated corporate boards and management to engage with shareholders – with unintended consequences. There has been a dramatic rise in the number of proxy issues that have to be voted on by shareholders. Under SEC rules, many institutional investors have a duciary obligation to cast a vote on every item that comes before them, leading many to outsource their voting decisions to proxy advisors. The two largest proxy advisory rms – Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis) – control most of the proxy advisory market and have thousands of institutional clients, meaning that the corporate governance policies of these two companies affect a
32
SECOND QUARTER 2014 ISSUE 21
signicant proportion of shareholder votes. The authors studied proxy voting on 264 stock option repricings for 251 individual firms and found that those repricings that were more aligned with proxy advisory firm guidelines experienced lower stock returns, weaker operational performance and a higher likelihood of executive and employee turnover. This negative impact on shareholder value suggests tha t there is a need to better understand the role of proxy advisors’ recommendations on other more important voting issues such as executive compensation, director elections or equity compensation plans. The regulatory debate on the U.S. proxy advisory industry is important worldwide, as the SEC’s regulatory choices are a benchmar k for other national and regional regulatory bodies. IESEinsight
Are Voting Guidelines Ruling Your Business?
Doubts are being raised regarding the depth and quality of the research offered by proxy firms, and whether enough is being done to understand the economic consequences of their voting recommendations. they allocate the capital appropriately. Shareholders are also meant to oversee the board’s actions through periodic shareholder votes. In the wake of the last decade’s corporate governance failures, the U.S. government, financial regulators and major stock exchanges sought to rectify the balance of power between these three actors. Shareholders, they decided, needed greater input on corporate governance matters. In 2003, the New York Stock Exchange and the Nasdaq altered their listing conditions to require that any new equity compensation plan or material modification to an equity compensation plan had to receive shareholder approval. This was followed by the SEC’s requirements that many institutional investors disclose both their voting polices and actual votes in proxy voting matters, ostensibly to expose potential conflicts of interest between mutual fund management and the funds’ ultimate shareholders. The result has been a dramatic increase in the number of proxy issues that have to be voted on by shareholders, putting strain on institutional investors’ limited time and resources available to research these issues. To deal with this burden, the SEC allowed investment firms to use independent third parties to guide their proxy voting and thereby fulfill their proxy voting obligations. Specifically, the SEC issued guidance providing that if an in vestor’s votes followed the recommendations of an independent third party (i.e., a proxy advisor) then its voting would be considered “unconflicted.” Consequently, many institutional investors began relying more heavily – some even exclusively – on the recommendations of thirdparty proxy advisory firms in determining their proxy votes. This, in turn, led to a rise in influence of a small number of proxy advisors on the outcomes of corporate elections. A decade later, two firms – Institutional Shareholder
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
IESEinsight
Services (ISS) and Glass, Lewis & Co. (Glass Lewis) – control most of the entire sector. For institutional investors, hiring proxy advisors provides a mechanism for sharing the cost of research on proxy issues. What’s more, having a proxy advisor’s seal of approval on your proxy votes could help shield you against accusations of conflicted voting. Although it seems like a win-win arrangement, doubts are starting to be raised with regard to the depth and quality of the research offered by proxy firms, and whether enough is being done to understand the economic consequences of their voting recommendations. Does One Size Fit All? One concern is that public companies may follow the corporate governance policies of proxy advisors in order to gain a majority of favorable votes for management proposals, even though the policies may not be appropriate for the firm’s specific circumstances. Such actions have the potential to impose real costs on firms and their shareholders. As anyone with managerial or executive experience will know, few rules of corporate governance can be accurately assessed without deep knowledge of a company and its management. And herein lies the problem: The recommendations of proxy advisors tend to be based on best practices applied to all companies. Yet these general rules could be irrelevant and even detrimental to some companies in certain business situations. To help shed light on this issue, we examined the economic consequences of proxy ad visor guidance on “underwater” stock option repricings, whereby firms seek to replace stock options whose exercise price is higher than the current share price (i.e., “underwater”) with new awards of options (with lower strike prices), restricted stock and/or cash. Critics of repricings – including proxy ad visors – have argued that such moves are used ISSUE 21 SECOND QUARTER 2014
33
Are Voting Guidelines Ruling Your Business?
Compliance with proxy advisor guidelines on stock option repricing limited the recontracting benefits of these transactions and had a detrimental effect on shareholder value. by entrenched managers to extract rents from shareholders by reducing the downside risk of their compensation contracts. In other words, repricings end up insulating managers from the financial repercussions of their own bad performance. However, research has shown that allowing some exchange of underwater stock options could be preferable to refusing to adjust initial contracts after they have gone underwater, which risks leaving a company’s employees with little or no financial incentive to stay the course in their current role, or with incentives to take excessive risks. In our study, we analyzed a sample of 264 stock option repricings announced between 2004 and 2009. For each repricing, we measured the degree of conformity to proxy advisor guidelines. We then compared the conformity with subsequent firm performance and executive turnover and found that repricing programs that did not conform to proxy advisor policies were generally more beneficial for shareholders. Specifically we found that firms with repricing
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
ABOUT THE AUTHORS Gaizka Ormazabal is an assistant professor of Accounting and Control at IESE. He received a PhD in business from Stanford University and a PhD in construction engineering from the Polytechnic University of Catalonia, where he also earned a degree in civil engineering. His research focuses on executive compensation and corporate governance mechanisms, including managerial risk-taking incentives and corporate risk oversight.
34
SECOND QUARTER 2014 ISSUE 21
programs more aligned with proxy advisors’ policies had a smaller increase in stock price, weaker operational performance and a higher likelihood of executive and employee turnover. Put another way, compliance with proxy advisor guidelines on stock option repricing limited the recontracting benefits of these transactions and had a detrimental effect on shareholder value.
Proceed With Caution This is not to say that everything proxy advisors do is flawed or damaging to shareholder value. Admittedly, our study examined only one management proposal that affected 251 individual firms in our sample. For example, in the context of mergers and acquisitions, there is evidence suggesting that proxy advisory firms’ recommendations may be better tailored to each situation. In these settings, proxy advisors must typically conduct firm-specific research into each M&A transaction to determine their recommendation. Moreover, some large investment firms seem to make up their own minds regardless of the proxy advisor’s views. Michelle Edkins, head of governance for the New York-based asset manager BlackRock, told Reuters that Allan L. McCall is a reproxy advisors provide a valuable service by searcher in the Center for helping them cast votes in relation to thouLeadership and Development sands of company stocks, but added that reat Stanford’s Graduate School search from proxy advisory firms was just one of Business in the areas of of many inputs in their voting decisions. corporate governance and Advocates of the proxy advisory industry compensation. He holds a also argue that critics overstate the influence PhD from Stanford University. of proxy advisors because many shareholder Prior to that, he was a co votes are non-binding and thus can be disrefounder and principal at Com- garded by corporate executives and boards of pensia, and vice president of directors. compensation and benefits That being said, negative non-binding votfor Providian Financial. He ing outcomes could also introduce significant earned a degree in economics costs for the affected companies in the form of from Yale University. reputational damage and litigation. IESEinsight
Are Voting Guidelines Ruling Your Business?
While there is a clear case to be made for a certain amount of shareholder supervision of boards and management, we believe it should be done with both caution and moderation. However, critics’ main concern rather re- the questions about the proxy advisory induslates to the fact that proxy advisors’ incentives try that are currently on the desk of regulators. to produce high-quality voting recommenda- Should the SEC regulate the proxy advisory tions are unclear. industry? Would this regulation stifle a source First, proxy advisors owe no fiduciary du- of independent research and increase manageties to the shareholders of the companies on rial entrenchment? Is competition rather than which they are advising, nor have they any di- regulation the solution to the potential probrect stake in corporate performance. lems of the proxy advisory industry? Second, proxy advisors are deemed indeMoreover, the debate on the role of proxy pendent and thus protected by the current advisors cannot be decoupled from the reguregulatory framework. latory debate on shareholder voting. We agree Third, because the proxy advisory industry that investors should vote their shares if doing is highly concentrated (being controlled as so is expected to increase shareholder value. it is by only two main players), it is not clear However, should institutional investors be re whether proxy advisors are subject to substan- quired to vote in every election? tial competitive pressure. While there is a clear case to be made for a Fourth, to the extent that proxy advisors certain amount of shareholder supervision of provide services to both investors and corpo- boards and management, especially in light of rate issuers on the same governance issues, recent scandals, we believe it should be done proxy advisors could be subject to conflicts of with both caution and moderation. interest. For example, the largest proxy adviOtherwise, we risk solving one problem sor, ISS, not only sells proxy voting services t o only to create a potentially bigger one – nameinstitutional investors but also offers consult- ly the loss of independence of company boards ing services to corporations that are the sub- and management and, by extension, their abil ject of ISS recommendations to institutional ity to create value for both their institutional investors. and retail investors. For these reasons, it seems vital that both policy makers and regulators scrutinize the effects of proxy advisory firms’ recommendations on issues that could potentially have a very large impact on investor returns, such as equity compensation plans, executive bonus plans, director elections and say-on-pay. Time is of the essence given that countries and regions far and wide are contemplating adopting regulatory frameworks for proxy voting similar to the SEC’s, including proposals for self-regulation. Before such measures are exported beyond TO KNOW MORE U.S. borders, we need to establish a much Larcker, D.F., A.L. McCall and G. Ormazabal. broader and deeper understanding of how the “Proxy Advisory Firms and Stock Option recommendations of proxy advisors impact Repricing.” Journal of Accou nting and Economics shareholder value and the economy at large. 56 (2013): 149-69. This improved understanding will help answer
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
n
IESEinsight
ISSUE 21 SECOND QUARTER 2014
35
LEAD PROGRESS, BE A STEP AHEAD ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
JOIN IESE’S AMP AND RESHAPE YOUR BUSINESS.
IESE’s Advanced Management Program (AMP) focuses on the latest business trends and facilitates the sharing of insights between high-caliber General Managers and CEOs. The program is designed to inspire reflection on your leadership style and help drive the best strategic decision making. A combination of case studies, peer discussion and individual coaching guarantees a flow of practical and innovative ideas. By collaborating with peers on a personal Executive Challenge, you benefit from a wealth of collective leadership experiences. With editions in Barcelona, New York, Munich, Warsaw and Sao Paulo the AMP gives you the confidence needed to face new business horizons.
www.iese.edu/amp
[email protected]
2 BUSINESS SCHOOL IN THE WORLD FOR EXECUTIVE EDUCATION Financial Times, May 2014
DEEP
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
RENEWING THE BOARD’S MISSION
6 Items for the Top of Every Board’s Agenda By JORDI CANALS
G
overnance failures have led to corporate failures in recent years. There have been serious problems with ex ecut iv e compensa ti on, director-nomination processes, accountability and reporting, and boardroom decisionmaking. Granted, important changes have been made: Executive compensation seems to be under greater scrutiny, more independent directors have been nominated, boards are making clearer proposals to shareholders, and there are more open discussions between boards and investors. Yet, however welcome these changes may be, they are not enough to steady the ship. What is ultimately needed is a sea change in the way companies view their activities and responsibilities.
IESEinsight
Going Back to Basics to Rebuild Trust Part of this change means remembering that corporate success depends primarily on people and the relationships they build among themselves and with other stakeholders. It demands trust, which can only be nurtured over the long term. Boards of directors play an essential role in building trust, making sure that it pervades every corner of the firm and that every decision the organization makes conforms to the highest levels of professional excellence. Boards also need to have a crystal-clear idea of how the firm can create sustainable value over the long term and how it can get the right people, starting with the CEO. ISSUE 21 SECOND QUARTER 2014
37
6 Items for the Top of Every Board’s Agenda
We need to redefine the firm, addressing nonfinancial as well as financial aspects of governance. Although this increases boards’ responsibilities, the complexity of the real world demands it. Failure to do so has serious repercussions, including: confusion over strategy; inadequate reporting and accountability, leading to strained relations with shareholders; poor financial performance; executive compensation scandals; high levels of management turnover; and reputational damage. In the end, this lethal combination of factors poisons innovation and entrepreneurship, stirring up popular resentment and mistrust of business in general. The main purpose of this article is to remind readers that effective boards of directors are not just the CEO’s backstop but stewards of the firm’s survival. Making boards more effective requires a much clearer definition of their functions, responsibilities and agendas, based on a holistic view of the firm. Ultimately, to be effective, a board of directors needs to develop and share a long-term purpose for the company and think long and hard about how it can add value to the firm.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
A Broader Mission for the Board Over the past decades, corporations have been mostly shaped by CEOs, with shareholders and boards of directors taking the back seat. In many cases, boards have limited themselves to EXECUTIVE SUMMARY The role of boards of directors is in the spotlight. Can boards do a better job at protecting their companies? There’s certainly good reason to think so. Today, some experts are calling for tougher regulations on boards and a larger role for shareholders in key strategic decision-making. Others advocate for more professional board directors. Neither of these solutions
38
SECOND QUARTER 2014 ISSUE 21
is enough. What is needed is a clearer vision of the rm’s overarching purpose, as well as aligning and measuring its long-term success. Also required is a drastic rethink of how the board can add longterm value to the company it serves. Such changes will be necessary not only to shape up corporate governance practices, but also to safeguard the future of capitalism itself.
simply rubber-stamping the decisions made by top managers. Recently some boards have taken a firmer hand, regaining some of the decision-making power tacitly ceded to the CEO. In a sudden break from the past, some boards have even openly expressed their full disagreement with their respective CEOs. In extreme cases – such as with Mike Hurd at Hewlett-Packard, Bob Diamond at Barclays or Ken Lewis at Bank of America – the clashes culminated in the ousting of the CEO and a real shift of power back in favor of the boards of directors. But such cases are the exception to the norm. Many boards still take a back seat in governance matters. By limiting themselves to designing financial incentives for senior management, they forsake their responsibility to monitor the CEO. The inevitable result is a sharp decline in corporate governance. The path toward renewal should begin from two basic starting points: first, a more comprehensive view of the firm; and second, a mission of the board that is fully align ed with that view. We need to redefine the firm so that it is more in tune with the on-the-ground reality of today’s business world. This means addressing nonfinancial as well as financial aspects of governance. Although this increases boards’ responsibilities, the complexity of the real world demands it. Good governance is not just about fiduciary duties or defending certain areas of responsibility; it is also about improving performance and pursuing new opportunities to build long-term success. Practices may differ enormously among countries and industries, and good corporate governance does not follow a one-size-fits-all model – two companies may have completely different practices and yet both can be successful in the long run. Some firms’ recent practices help us to IESEinsight
6 Items for the Top of Every Board’s Agenda
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
identify key areas that are critical for improving corporate governance. These include: creating positive environments in which people can work and grow (related to corporate culture, mission and values); defining the company’s strategy and approving sound strategic decisions; monitoring performance and controlling risks; selecting, appraising and replacing CEOs; nurturing and developing leadership competencies; and managing the firm’s social responsibilities and risks. (See Exhibit 1.) As diverse as these areas are, they share one common denominator: They all help create a context for good decision-making to flourish. They also depart from the assumption that the board of directors can go it alone. Instead, they underscore that boards must forge strong, collaborative relationships with the CEO and the senior management team.
Quality of Corporate Governance
EXHIBIT 1
THESE AREAS HAVE EMERGED AS KEY FOR IMPROVING CORPORATE GOVERNANCE IN THE WAKE OF THE GLOBAL FINANCIAL CRISIS.
PROFESSIONAL CONTEXT Creating positive environments in which people can work and grow (related to corporate culture, mission and values)
STRATEGY
RECRUITMENT
Selecting, appraising and replacing CEOs
LEADERSHIP DEVELOPMENT
Dening the company’s strategy and approving sound strategic decisions
Nurturing and developing leadership competencies
CONTROL
SOCIAL IMPACT
Monitoring performance and controlling risks
Managing the rm’s social responsibilities and risks
IESEinsight
Boards’ Key Tasks Based on this understanding, boards must become stewards of the mission and values. They should work with the CEOs and senior management teams, while promoting leadership development across the organization. They must establish effective financial and control systems to monitor risks. Finally, they must foster their companies’ institutional development and their commitment toward the communities in which they operate. These functions might not guarantee longterm financial success, but they will help en sure that the principles followed by boards are consistent with a long-term view of the firm and the stated mission and values. MISSION & VALUES. Being profitable is a condi-
tion for a company but not the purpose of a company. A strong sense of mission and val ues is a key driver of good performance. Without having an explicit mission, it is all but impossible to improve the quality of governance. Pursuing a mission also offers the organization a broader focus that goes far beyond mere financial performance. The French food giant Danone is an interesting case in point. Since its early beginnings, it has had a strong passion for consumer health. Franck Riboud, its current CEO, has built upon the company’s mission – to provide consumers with healthy food products – and turned it into one of its main strategic drivers. Danone also espouses strong corporate values such as openness, enthusiasm, proximity and humanism, which in turn foster improved decisionmaking, closer attention to customer needs and a more fertile ground for innovation. The mission encourages the CEO to think long term – a task that is made much easier when the CEO shares the same values, as is the case with Paul Polman. On taking over as CEO of Unilever in 2009, one of the first things he did was to set out a clear mission for the firm, based on much longer term thinking. As he told me in an interview for the previous issue of IESE Insight , “We don’t and shouldn’t make decisions based on 90 days. We’re here for the long term, not to hit quick goals.” Companies with a clear sense of mission are not guaranteed to be successful. But by havi ng deeply engaged people, they certainly stand a better chance of having long-term success. ISSUE 21 SECOND QUARTER 2014
39
6 Items for the Top of Every Board’s Agenda
Companies with a clear sense of mission are not guaranteed to be successful. But by having deeply engaged people, they certainly stand a better chance of having long-term success. STRATEGY & STRATEGIC DECISIONS. Corporate
governance best practices consistently underscore the value of board involvement with strategy. Naturally, the CEO and his or her team are ultimately responsible for strategy formulation, but they should not do it alone. The board of directors should serve as a sounding board, weighing up management proposals and, whenever necessary, challenging the CEO’s views. To do that, the board must understand the industry structure, customers’ needs and preferences, and the company’s strengths and weaknesses. The multinational telecom Telefónica pro vides valuable lessons on how a board of directors can contribute to strategy. At the end of 2001, Telefónica, like many of its peers, was struggling from the dot-com crash. Its problems included excessive financial leverage, bad investments, too much diversification and overcapacity. With the help of the board, the company sold off its bad investments, stepped up efforts to increase market share and profitability in Spain and Latin America, reshuffled key management positions and improved its overall financial health. As the global economy improved, Telefónica began expanding its activities in its core markets. It also acquired firms in the United Kingdom and Germany and strengthened its presence in China through an alliance. Throughout this process, the board played an
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
ABOUT THE AUTHOR Jordi Canals is IESE’s Dean and Professor of Strategic Management and Economics. He is the author of numerous books and articles in the areas of corporate governance, leadership and globalization, including Building Respected Companies (Cambridge, 2010).
40
SECOND QUARTER 2014 ISSUE 21
active role, helping the firm to get back on its feet and rebuild strength. The Telefónica case underscores the importance of the board having deep, strategic knowledge of the company it serves and the industries in which it operates. This is not to say that the board’s role is to run the company; rather, it must engage in strategy development with the CEO and top management. And to do that, it must have a clear understanding of all the issues at hand. CONTROL & RISK MANAGEMENT SYSTEMS . Inad-
equate control systems played a major role in the buildup to the 2007-08 global financial crisis. In many cases, the systems were designed neither to prevent a crisis nor to steady the ship during a crisis. Indeed, for some boards, crisis management was not even viewed as part of their responsibilities. The banking industry provides instructive lessons on the importance of risk management in today’s business environment. For example, the banking group BBVA withstood the recent financial crisis better than many of its peers because it was particularly effective at risk management, identifying early warning signals of deterioration in some markets and reducing its exposure to them. It also managed its capital ratios better than many of its competitors. The design and implementation of efficient risk management and control systems are vital for a firm’s longevity, especially in times of turbulence. As such, each board must design its own set of performance indicators that reflects the realities facing both the company and its industry. Some indicators, such as cash balances, mean different things to different companies. The board must also carefully track the evolution of these indicators. Quality information is indispensable for effective corporate governance. However, even good boards of directors have a tendency to focus excessively on short-term financial IESEinsight
6 Items for the Top of Every Board’s Agenda
For the CEO, the board of directors must be more than just a supervisor. The board can help the CEO develop leadership capabilities and provide a testing ground for ideas and projects. information. While this information is valuable, it is not enough. To gain a rounded picture of the firm’s positioning and prospects, the board needs a comprehensive scorecard that includes not only financial indicators, but also indicators for competitive positioning, customer loyalty, employee retention and development, risk management, innovation, new product and service development, and operational efficiency.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
CEO SELECTION, ASSESSMENT & LEADERSHIP DEVELOPMENT. CEO selection is one of the board’s
most complex duties. The CEO must support the values of the firm, define the strategy, appoint senior managers and other key people, and shape the way the executive committee works. The CEO is also the direct link between the board of directors and the rest of the firm. For the CEO, the board of directors must be more than just a supervisor; it should be a sounding board and a mentor. The board can help the CEO develop his or her leadership capabilities and provide a testing ground for his or her ideas and projects. CEO selection is a key board decision. Ideally, the board should first identify a di verse pool of potential internal candidates to find the next CEO from within the company. Leadership development programs help nurture vital talent for the company’s future and enhance the firm’s attractiveness for young professionals. To reflect the global markets i n which most companies now operate, this talent pool should represent as broad a spectrum of backgrounds as possible. The CEO may have the final say in appointing senior management, but it is the board’s job to make sure that the right leadership de velopment practices are in place across the organization. This means regularly reviewing their implementation and progress, as well as identifying and supporting those people who exhibit the greatest potential to scale the IESEinsight
company’s ranks. How much time the board allocates to this area speaks volumes about the firm’s concern for people development. INSTITUTIONAL DEVELOPMENT & SOCIAL IMPACT.
Firms have a bigger impact on society today than ever before – and not always for the good. Corporate scandals have done untold harm to stakeholders and firms’ reputations. As such, social impact must be weighed and controlled. By developing a robust institutional strategy, companies minimize the danger posed by political and social risks. It is the board of directors’ task to assess those risks, reduce the company’s institutional footprint and make sure that it positively impacts the communities in which it operates. Companies’ growing concern for social issues represents a step in the right direction. But real progress means going beyond what is currently understood by corporate social responsibility. Nestlé offers a fitting example of how a successful business model can be forged from the sense of purpose shared by large stakeholders and the board of directors. The company is a leader in many of the markets in which it operates, focusing exclusively on tried and tested businesses and products and staying well clear of reckless diversification. Nestlé has also consistently demonstrated a strong commitment to the communities in which it operates by developing long-term relationships, embracing social challenges such as sustainability, following the advice of medical doctors and experts on nutritional issues, and designing new business models for cheaper products in emerging countries. The Indian IT multinational Infosys is another company that is committed to serve and improve the societies where it operates. It does this by helping governments and NGOs improve the quality of their IT services as well as offering some of the world’s poorest citizens the chance to connect to the Internet. By ISSUE 21 SECOND QUARTER 2014
41
6 Items for the Top of Every Board’s Agenda
The board’s role is to define long-term goals, monitor performance and develop a positive corporate identity. Boards need to view the company as an institution embedded within society.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
offering basic technology training in neglected communities, Infosys has shown how to use corporate resources to tackle fundamental social challenges. Institutional development encompasses a company’s strategies, policies and values in relation to certain stakeholders, including governments. These, in turn, shape a company’s institutional profile – i.e., the way in which it interacts with the broader society. The board’s role is to define long-term goals,
An Agenda for Boards of Directors
EXHIBIT 2
THESE 6 ITEMS NEED TO BE REGULARLY CONSIDERED BY THE BOARD.
SHORT TERM
Strategic positioning Implementation
1 STRATEGY
2 PEOPLE & LEADERSHIP DEVELOPMENT
3
FINANCIAL PERFORMANCE
5 CUSTOMERS & INNOVATION
6 INSTITUTIONAL DEVELOPMENT
42
New capabilities Business portfolio Strategic investments
Talent pool Recruitment and turnover Work atmosphere
Mission and values Leadership development Commitment
CEO assessment
Leadership development Succession planning
CE O
4
LONG TERM
Liquidity, ROE, ROI Risk management
Value creation Capital markets
Customer satisfaction Efcient resource allocation
Growth boosters Customer loyalty
Stakeholder relations
Becoming a respected institution
SECOND QUARTER 2014 ISSUE 21
approve new initiatives, define policies, monitor performance and develop a positive corporate identity. While it is true there can be no sustainable corporate reputation without good products, good products may not be enough to sustain a solid corporate reputation these days. An Agenda for Boards of Directors In their quest to support their company’s long-term success, boards should consider the following basic questions: How can we add value to the company? How should our work be organized so as to have the greatest possible impact? How can we assess our performance? Based on the functions and responsibilities described previously, there is a broad agenda that needs to be regularly considered by the board. Some issues need to be examined often – in particular those that have a strong shortterm dimension. Others need only be considered periodically, perhaps just once or twice a year. Let’s examine these issues, grouped into six broad areas. (See Exhibit 2.) 1. STRATEGY. The board has an important role
to play in the strategy agenda. This should start with a solid understanding of the company and its industry. In the long term, the board should focus on strengthening the business portfolio, resource allocation and investment, and supporting innovation and developing new capabilities. 2. PEOPLE & LEADERSHIP DEVELOPMENT. People
development is a key task for the board, especially when it comes to ensuring the quality of current and future leadership. The board should consider three main factors in this area: managers and employees’ sense of purpose; the quality and breadth of talent in the organization; and the effectiveness of the recruiting process and the level of employee turnover. IESEinsight
6 Items for the Top of Every Board’s Agenda
Corporate governance and management are social functions that can only be developed in the long term. Investors who are not committed to the long term should ideally not be given a place on the board. 3. CEO. The board should develop a functional, working relationship with the chief executive and senior management team. This relationship should go beyond the normal processes of exchanging information and upholding accountability, to include the development of leadership capabilities among the top management team as well as succession planning for both the chief executive and other key senior managers.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Finance is of critical importance for boards. In the short term, boards need to monitor the company’s return on equity, liquidity levels, return on investment and investor relations. With a view to the long term, boards should focus on value creation, risk management and solvency. Of particular importance is the alignment between the firm’s strategy and its financial strategy. 4. FINANCIAL PERFORMANCE.
5. CUSTOMERS & INNOVATION. The board should
keep a close eye on how to serve customers better. This means using certain indicators to measure customer loyalty and customer service, which may be influenced by the firm’s level of innovation.
certain shareholders. Corporate governance and management are social functions that can only be developed in the long term. As such, investors who are not committed to the long-term development of the firm should ideally not be given a place on the board of directors. As social institutions that must earn public trust, companies need to be represented by long-term owners, not short-term investors. As Polman said, “Businesses can’t be bystanders anymore. Yes, we need growth and job creation, but we need to do it in a more sustainable way. We need to become part of the solution that gave us life in the first place.” As one of the central institutions in modern society, the firm is not just an engine of wealth creation and jobs, but an agent of change, a driver of innovation and people development. Its long-term success requires good governance. There is still a gap between the kind of governance needed to run comple x organizations and the governance currently offered by many of today’s boards. Boards should realize how critical their role is for the companies they lead and the well-being of societies at large.
6. INSTITUTIONAL DEVELOPMENT. The
board needs to view the company as an institution embedded within society. As such, it has a num ber of nonfinancial functions and obligations to fulfill. The board’s long-term goal should be to bolster the company’s reputation, while in the short term setting basic guidelines to shape the firm’s relations with its stakeholders. Planting Seeds of Good Governance Good governance is essential for companies to survive and thrive. Boards must take a frontrow seat in monitoring their firms. Beyond overseeing financial and nonfinancial performance indicators, the board has a moral obligation to support the long-term success of the whole firm – and not only for IESEinsight
TO KNOW MORE n
n
Canals, J. Building Respected Companies. Cambridge: Cambridge University Press, 2010. Canals, J. “Rethinking the Firm’s Mission and Purpose.” European Management Review 7 (2010): 195-204.
ISSUE 21 SECOND QUARTER 2014
43
CHANGE TO MAKE AN IMPACT ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
WE BELIEVE IT’S TIME FOR YOU TO MAKE AN IMPACT. JOIN IESE’S MBAs AND EMBRACE THE OPPORTUNITY OF A LIFETIME.
FULL-TIME MBA
EXECUTIVE MBA
GLOBAL EXECUTIVE MBA
The program will help you change through a peoplecentered, cross-cultural global learning experience with modules in New York City, Sao Paulo, Shanghai and Nairobi that will sharpen and refresh your critical leadership skills to help you make a global impact.
For professionals and entrepreneurs who are ready to take on new career challenges and broaden their minds as leaders. Offered on IESE’s campuses in Barcelona, Madrid and Sao Paulo, on a part-time basis, this transformational program includes two intensive weeks in Shanghai and New York City.
For high potentials who are at a turning point in their careers. This program – with modules held in Barcelona, New York City, Sao Paulo, Shanghai and Silicon Valley – will strengthen your knowledge of new markets and your leadership skills while transforming your managerial perspective.
3
BUSINESS SCHOOL IN EUROPE FOR MBA Financial Times ,
2013
PERSONAL
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
INTERVIEW WITH CÉSAR CERNUDA, PRESIDENT, MICROSOFT ASIA-PACIFIC BY JAVIER ZAMORA Photos by EDU FERRER ALCOVER
“We need the
to harness
energy, innovation and
speed
of the start-up.” IESEinsight
ISSUE 21 SECOND QUARTER 2014
45
Bringing Microsoft to the World César Cernuda began his career in the banking industry before joining Software AG. In 1997, he joined Microsoft Spain. Once there, he quickly made a name for himself, launching bCentral, an online services portal, which was awarded best product of the year in Spain and best initiative worldwide at Microsoft. While at Microsoft, he at tended IESE’s Management Development Program (PDD). Over the past 17 years, Cernuda has gone on to perform a wide variety of managerial roles at Microsoft around the world: leading the merger of Navision; running Microsoft Business Solutions (MBS) Europe, Middle East and Africa; driving sales and marketing as Vice President of MBS Worldwide; and becoming Vice President of Sales, Marketing and Services for the Latin America region, which was recognized for its use of workplace exibility. In 2012, he joined the exclusive Microsoft Executive Bench. Now, as the President of Microsoft Asia-Pacic based in Singapore, Cernuda is responsible for more than 7,000 employees and 100,000 partners in 32 countries. He manages commercial and consumer products and services in the region’s fast-growing consumption of cloud, mobile, big data and social technologies. Though born in Mexico, Cernuda’s family hails from Asturias in Spain, and he maintains close links to the region. He is an honorary patron of the Plataforma Solidaria de Asturias, a foundation that helps children in Bolivia.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
46
SECOND QUARTER 2014 ISSUE 21
IESEinsight
PERSONAL insight
INTERVIEW WITH CÉSAR CERNUDA
Tech That Works for Users
W ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
hen César Cernuda joined In the Asia-Pacific region last year, there were Microsoft in 1997, a cell phone around 27 million new PCs on the market com without an antenna was pared with 24 million tablets and 90 million smartconsidered high-tech, Google phones. Rather than seeing all those smartphones was a student research project and the iPhone and tablets as a challenge, we see them as an was just a glimmer in Steve Jobs’ eye. At the time, opportunity for Microsoft to create a more holistic Microsoft was heading for world domination, experience around Windows. Our focus today as a with an estimated 90 percent market share of all company is very much on devices and services. popular applications and operating systems. In the intervening years, Cernuda has witJZ– How does Microsoft’s acquisition of Nokia’s Devices and Services business fit with nessed the dramatic changes that technology and that? Microsoft have undergone. Most recently Microsoft has been attracting media attention ever since CC– Nokia is a key part of our strategy to penetrate Satya Nadella was appointed as the new CEO, the mobile phone market. For us it is about having taking over from Steve Ballmer, in February 2014. first-party hardware manufacturing and mobile First came the announcement that the company phone expertise. would be releasing a touch version of Office for In the future, we are going to see more and Apple’s iPad even before such a version existed more devices coming onto the market, which for its own Windows. Then, Nadella announced will provide consumers with a wealth of differthat Windows would be free on all devices with ent experiences to choose from. We have already nine-inch screens or smaller. For a company whose seen the launch of Windows Surface, a two-in-one traditional business model has been based on tablet designed to be the one device you need for licensing its software, to now be giving its product everything. It combines the power and portability away signals a significant shift in direction toward of a tablet with the keyboard, ports and software getting people to pay less for products and more functionality of a PC. for services. By partnering with other companies, we see As the President of Microsoft Asia-Pacific, Cer- this as a huge opportunity for us to offer users the nuda has a unique insight into this ever-evolving chance to embrace the Windows experience across industry in one of the fastest growing regions of a range of platforms using the same apps. the world. IESE’s Javier Zamora caught up with JZ– Does the appointment of Satya Nadella, Cernuda when he came back to his alma mater with his background in cloud computing, to deliver a special session on “Leading Business signal an evolution in the strategy of Transformation” while he was in Barcelona to atMicrosoft? tend the Mobile World Congress. CC– Yes. It is an exciting time for our company. JAVIER ZAMORA– Microsoft’s vision under Bill Satya has great vision and extensive experience in Gates was to put a computer on every desk both devices and cloud computing. Innovation is and in every home. We are now living in an era key to his vision and he has been very clear about where tablets and smartphones are outselling that. Bill Gates, at Satya’s request, has also agreed PCs. In light of this, how is Microsoft to spend over 30 percent of his time on research redefining its strategy and business model? and development with Microsoft, which will CÉSAR CERNUDA– The world has changed, it’s true. This really help us to drive that innovation. As CEO, is a time of great transformation and it is affecting Satya will be leading the company through its how we all live, experience and communicate. transformation into a device and services focused Today we may be talking about smartphones and company. I am sure that we are going to see great tablets, but tomorrow we are going to see different things to come in the next few years. types of devices becoming part of our everyday JZ– There seems to have been a distinct shift lives. For us, this is a great opportunity.
IESEinsight
ISSUE 21 SECOND QUARTER 2014
47
PERSONAL insight
INTERVIEW WITH CÉSAR CERNUDA
For small and medium-sized businesses, cloud computing is not just a cost reduction, it is a breakthrough.” away from Microsoft installing licenses on computers to becoming the custodians of data. How is cloud computing changing the way we all work? CC– Cloud computing is going to be growing 25-35 percent in developing and emerging markets. That is a big opportunity for us to capture a new way of using technology. Years ago, we used to say, ‘Information is the power of organizations.’ Today, the key challenge is how to access that information. Which type of device are you going to use to access it? How do you structure the data there? For companies, both large and small, cloud computing means that the total cost of owning a business is going down. Businesses no longer have to invest large amounts in hardware, rent or buy real estate to house servers in the office, pay for server maintenance or waste a lot of money on upgrades. With cloud computing, companies can effectively outsource these services and pay only for what they need. For small and medium-sized businesses, this is not just a cost reduction, it is a breakthrough. In the past, SMBs didn’t have access to the best technology because they couldn’t afford it or didn’t have the space for it. Now a small business can have the same technology as a large organization. They are going to pay per use and per number of users, so a small business with five employees is going to be using the same technology as a business with 100,000.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
your information stays secure. I would encourage companies to think not just about the cloud, but also about ensuring that they have the right device that will keep their information protected.
Back in 1975, Microsoft was a start-up that nipped at the heels of big companies like IBM. Today, you have other start-ups trying to challenge the position of Microsoft. Do you think Microsoft will ever be able to regain the speed and agility common to start-ups? CC– When you say we are being challenged by new start-ups, I would say we have always been challenged. As we have moved into new markets, we have been challenged everywhere we have gone. With regard to our past, technology is different today from how it was 40 years ago. Today our kids are growing up with technology and using it in a different way from how we did. It is no surprise to see how much more agile start-ups are today. As a company with 100,000-plus employees, and with the market capitalization we have, we can’t very well say that we are a start-up – but that is definitely where we came from. So we understand it. In terms of transforming the company, we are striving to harness the energy, innovation and speed of the start-up movement within our own organization. We need to be nimble, we need to be innovative and we need to make sure that is the mind-set of all our employees. JZ–
There has been much debate in the industry JZ– How are you motivating employees to about privacy and the protection of data in the subscribe to this new strategy? CC– Ensuring that Microsoft employees understand cloud for companies and consumers. How is Microsoft dealing with these issues? and share in our strategy is a big part of my job. CC– I am frequently asked about the security of However, so often it is not about strategy, it is the cloud, but to be honest I think people often about having the right R&D to go and deliver: to fail to think about the security of the devices walk the talk. they use. The cloud is quite secure, provided you As a leader, this is not something that can be understand from your cloud suppliers where your achieved by enforcement. It has to be about motidata are kept and how they work. vation and inspiration. It is about really believing When it comes to devices, users’ smartphones that what we are doing is the best thing for our and tablets are full of information and yet these customers and our partners. It is about undercan easily be lost or stolen. This is something that standing that we have been part of the transforMicrosoft is very vocal about. For example, with mation of the world and that we continue to have a PCs and tablets, we use device encryption so that positive impact. JZ–
48
SECOND QUARTER 2014 ISSUE 21
IESEinsight
PERSONAL insight
INTERVIEW WITH CÉSAR CERNUDA
Technology is not something we should be dependent on. It should be there to make us better at communicating, to help us have better lives.”
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
For us, it is about practicing what we preach. It is all well and good for a company to talk about mobility, but we need to make that a reality for our employees. We have to be flexible enough to allow people to work from home or wherever they are. When we achieve this, as we did in Latin America, it makes people feel much more engaged. A good example of this is Yammer. This is a technology that we acquired and which is now integrated within our Office 365 package. It works as an internal social network for companies. There was a study that said more than 70 percent of employees are not really engaged with the companies for which they work. Social networks like Yammer are a great way of fostering that engagement and the willingness to share information. In the past, if you had a problem and rang a call center, it might take a week to get the answer you needed. With Yammer, you can post your problem to everyone within the company and somebody can get back to you right away with an answer on how to fix it. That’s agility, that’s speed, that’s engagement. Within Asia-Pacific, I have one Yammer net work for all our employees, another for my leadership team and another for managers. It is a great way to share experiences and ideas. I think Yammer will really help a lot of organizations become much more agile and communicative.
The theme of Barcelona’s Mobile World Congress this year was “What’s Next?” In your opinion, what does the future hold for the industry and for Microsoft? CC– First of all, I have to say that the Mobile World Congress is an amazing setup. We have had a lot of productive meetings here. It is a great place to share, learn and discuss our vision with the real movers and shakers in the industry. As for what’s next, I think technology is going to be everywhere in our lives but in a less intrusive way. Perhaps you are going to go into your kitchen and have your fridge tell you that you need to buy milk. You are going to be talking to your TV and asking it to find a program or r ecord something for you.
Over the next few years, technology is going to be embraced even more. Our job at Microsoft is to make sure that the technology works for us as users. Technology is not something we should be dependent on. It should be there to make us better at communicating with others. It should help us to have better lives.
César Cernuda was interviewed by Javier Zamora
JZ–
IESEinsight
Javier Zamora is Lecturer in the Department of Information Systems at IESE. His areas of interest include big data, cloud computing, digital media innovation and business transformation in the digital age. No stranger to devices and services himself, he is cofounder of InQBarna, a company specializing in the development of apps for smartphones and tablets. He is also the author of two international patents on Digital Home architecture and services.
ISSUE 21 SECOND QUARTER 2014
49
EXPERT
insight
A R E S A N O B O I L U I G y b n o i t a r t s u l l I
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
WHOEVER HAS EARS, LET THEM HEAR
Feedback Tips for Less Grumbling, More Growth By SHEILA HEEN
E
ach year around the world, an esti- Perhaps this is why a quarter of employees surmated 825 million work hours – a veyed said they dreaded their review more than cumulative 94,000 years – are spent anything else in their working lives. preparing for and engaging in perforManagers don’t seem to be enjoying the mance reviews. Afterwards we all certainly feel process either. According to a 2010 Report a thousand years older, but did anyone actually from WorldatWork, only 28 percent felt they learn anything? Will anyone improve as a result? focused on having effective performance conThe statistics aren’t encouraging. Accord- versations, rather than just completing forms. ing to a Summer 2013 Workforce Mood Tracker If feedback conversations aren’t working, Report by Globoforce, 51 percent of employees whose fault is it? Managers report that when felt their performance review was inaccurate they try to give honest feedback, employees get or unfair. defensive, argue or disengage. Even if they apH.R. managers seem to agree, since another pear to get through to the employee, little actuGloboforce survey with the Society of Human ally changes. Given how much time and energy Resource Management found that 45 percent it takes to give honest feedback, why bother? of people managers and H.R. professionals did Those on the receiving end claim that the not believe that performance reviews were feedback they get is off base and unfair, fails to an accurate appraisal of employees’ work. appreciate the constraints they are under or
50
SECOND QUARTER 2014 ISSUE 21
IESEinsight
FEEDBACK TIPS FOR LESS GRUMBLING, MORE GROWTH
EXPERT insight
This article addresses why feedback is so hard to get right, provides a new way to think about how to change the culture around learning and suggests some practical tips for jump-starting that change immediately. isn’t helpful. When the feedback is right and useful, they say it is great, but this seems to be the exception rather than the rule. Of all the organizations I have worked with – large and small, for profit and non-profit, across various industries and on six continents – I have yet to encounter anyone who believes that feedback is truly “working” in his or her organization or that the quality of feedback conversations is as good as it should be. And feedback needs to be good because we rely on it, not just to determine whom to promote and how to reward, but to provide coaching and mentoring, to retain and motivate key talent, to address performance problems and to maximize the value of collaboration. If feedback isn’t working, teams get stuck, morale sinks, business results are suboptimal and talent is lost. This article will address why feedback is so hard to get right, provide a new way to think about how to change the culture around learning in your organization and suggest some practical tips for jump-starting that change immediately. First, let’s look at two common diagnoses for why feedback isn’t working in your organization: Either the people are good but the
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
EXECUTIVE SUMMARY “That’s wrong.” “You don’t understand.” Do these performance review reactions sound familiar? Why is it that managers and subordinates alike nd feedback conversations so difcult? After 15 years of working with clients, the author believes that efforts to improve these conversations by teaching managers how to give feedback have been misdirected. The best way to achieve more productive feedback conversations is for IESEinsight
performance management system is broken or the system is good but the people are broken.
There Are No Perfect Feedback Systems Let’s be clear: there are no perfect performance management systems. Debates abound as to whether to force a curve, how much to centralize the process or how best to ensure mentoring. Anyone choosing a particular system must grapple with the inevitable tensions and tradeoffs associated with it. In any system you choose, many feedback givers will find that the costs outweigh the benefits. Lucinda, for example, who works in pharma research, is clear about this aspect of her firm’s performance system: “It takes time away from my primary tasks, and there is no reward or acknowledgment for doing it well.” Moreover, she is unsure how to assess her subordinates. She knows they are not all top performers, but she worries about the effect that giving negative evaluations will have on morale: “If I score my people on the rigorous scale that we have been given, many of them are going to be disheartened. In a tight labor market, I can’t afford to lose any of the talent I have or to erode the performance we have achieved.” Forcing a manager to make stark distinctions may be designed to make things fair across the organization as a whole and to make everyone to become more it easier to identify key talent or poor performactive and skilled receivers of ers. But for Lucinda and her team, she only sees the feedback they get. This the downsides. Worse, Lucinda hears that othrequires overcoming three er managers aren’t paying any attention to the challenges: understanding what scale, so if she were to apply it strictly, then “it is actually being said, being would be like penalizing people just for being able to separate the message on my team,” she says. from the messenger and, nally, Another manager at a mountain resort, Jim, knowing the triggers that will also feels caught by the performance system make you more or less receptive but for a different reason. As a team leader for to the advice being given. The search and rescue, he knows that performance aim is to change the feedback is critical to survival. “I’ve put in the time to reculture so that everyone can cruit and select the best people,” he explains. accelerate their ability to learn, “If I have the wrong person out there in a blizimprove and grow. zard, it’s dangerous for everyone. I only have ISSUE 21 SECOND QUARTER 2014
51
FEEDBACK TIPS FOR LESS GRUMBLING, MORE GROWTH
EXPERT insight
A players. Unlike some of my fellow managers, I’ve already done the work of having the hard conversations and making the tough calls. A forced curve punishes me for managing well.”
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
systems look pretty flawed. Giving fully honest reviews poses risks. If handled poorly by either the giver or the receiver, such conversations can be damaging to trust, work relationships, motivation and team cohesion. Can’t Live With It, Then again, not giving fully honest reviews Can’t Live Without It is equally risky. Problems fester, the manager From where Jim and Lucinda sit, their feedback and the system lose credibility, the team underperforms and high performers resent that low performers aren’t pulling their weight yet face no consequences. When managers feel stuck, their typical reThree Kinds of Feedback action is avoidance. In the 2010 WorldatWork survey of 750 senior H.R. professionals, 63 “Feedback” means different things to different percent said their biggest challenge to effecpeople. The challenge is knowing which kind you tive performance management was that their want and which kind you are getting. managers lacked the courage to have the difficult discussions. They gave artificially high Appreciation reviews to even mediocre employees, which This is the kind of feedback that says, “I see you,” “I get you” diluted the usefulness of reviews for addressand “You matter.” Appreciation is what keeps us motivated, ing performance or guiding decision-making. feeling that our efforts are valued. Sometimes when people Susan Heathfield, in her article “Performance say, “I wish I got more feedback at work,” what they really Appraisals Don’t Work,” reports that in one ormean is, “I wish someone noticed that I work here.” Studies ganization, 96 percent of employees received show that most organizations have a chronic appreciation the highest rating. decit – a key cause of losing talent. Although appreciation is This should not be taken lightly, given usually well-received, we may be suspicious if we think that it that a lack of meaningful feedback is the No. 1 isn’t sincere or that there might be a hidden agenda. reason cited by talented people for leaving an organization, as researcher Brené Brown has Coaching observed. It is easy to complain about the system and This feedback is aimed at helping you to get better at something; it is the engine of learning and development. the people who populate it. What’s hard is to Coaching is needed in real time and year round, but often figure out what would help, especially b ecause gets put off until the performance review, where it gets lost of the vast range of goals that performance in the shufe. We may resist coaching or mentoring because systems are supposed to accomplish, which it suggests that what we are doing now isn’t “right” or is no include: longer applicable. to provide consistent evaluation across roles, functions and regions; Evaluation to ensure fair compensation and distribution This tells you where you stand and what to expect. It is your of rewards; to incentivize positive behavior and disciperformance review, whether you do or don’t get the new pline negative behavior; position or land the account. Although we need evaluation to reassure us that we are on the right track, this feedback is also to communicate clear expectations; the “loudest” emotionally and can drown out coaching and to increase accountability; appreciation, which are at least as important. Evaluation has to align individuals with organizational goals profound consequences for pay, promotion and reputation, so and vision; no wonder we experience it as high risk. to coach and develop individual and team performance; Few organizations are good at helping givers and receivers to to help get and retain the right people in the be clear about which kind of feedback is needed and which right roles; kind they are currently offering. Even when managers say they to assist succession planning in key leaderwant to offer coaching, it comes across as evaluation. “Here’s ship positions; to promote job satisfaction and high morale; how you could do that better” is another way of saying, “You’re not doing it as well as you could.” The defensiveness that to get it done on time – in the moment, as well results short-circuits opportunities for learning. as quarterly and annually. Accomplishing all of these goals can’t be done n
n
n
n
n
n
n
n
n
n
n
52
SECOND QUARTER 2014 ISSUE 21
IESEinsight
EXPERT insight
FEEDBACK TIPS FOR LESS GRUMBLING, MORE GROWTH
The very fact of feedback suggests that how you are now is not quite okay. For this reason, advice like “don’t take it personally” or “don’t be defensive” doesn’t work. The challenges go deeper, and so must the answers. with a single system or even with a combination of systems. As such, the trend has been to centralize and standardize systems, collecting data across employees, functions, regions and markets. While this can be helpful, you can’t “metric” your way around the fact that feedback is a relationship-based, judgment-laced process. Or as Dick Grote put it in a Harvard Business Review article, “The Myth of Performance Metrics,” you can’t evaluate the performance of a language translator simply by counting the number of pages he translates; you have to make judgments about the quality of the translation – its success in capturing nuance, meaning and tone. Whether the feedback lives or dies depends on the trust, credibility, relationships and communications skills between the giver and receiver. Although there are no easy answers and no system will ever be perfect, we can still work to improve it. However, we need to be realistic and recognize the limits of what a feedback system can and cannot do. You can’t create the perfect family by building the perfect house.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
There Are No Perfect Feedback People Perhaps you need to work harder at perfecting the people. When trying to improve the human side of performance management, the focus is typically on teaching managers how to give feedback more skillfully and more often. Globally, organizations spend billions of dollars every year doing just that. Helping managers become better communicators is valuable, and yet it doesn’t seem to be solving the feed back problem in organizations. After spending 15 years working with clients on helping givers give feedback more skillfully, a thought eventually occurred to my coauthor, Douglas Stone, and me: What if we have been going about this backwards? Maybe instead of teaching managers how to give feedback, we should be teaching everyone how to receive feedback more skillfully. After all, if the receiver isn’t ready or able IESEinsight
to take in the feedback, there is only so far that skillfulness or even persistence can go. No matter how much power or authority the giver has, it is the receiver who decides what to let in, what sense to make of it, and whether and how to change. Helping us all to become better receivers turns out to be where the real leverage is. It also turns out to be a real challenge. Why Is It So Hard to Receive Feedback? You would think that learning from feedback wouldn’t be so difficult. After all, we couldn’t have made it to adulthood without some kind of learning capacity – from learning how to walk and talk, to mastering a myriad of sub jects during our school years, to developing skills specific to every job we have ever had. But this kind of learning is entirely different from learning about yourself. This is because receiving feedback sits at the junction of two core human desires. On the one hand, we all share a basic desire to learn and grow, beginning from when we doggedly pulled ourselves to standing as toddlers, and continuing as we take up new hob bies during retirement. Research shows that this human drive to keep growing or getting better at something is a key to enduring happiness and life satisfaction. Yet alongside this desire sits another: the need to be accepted, respected and loved just the way you are now . The very fact of feedback suggests that how you are now is not quite okay. This makes us feel conflicted. For all the feedback or coaching we have received during our professional lives that profoundly changed our thinking or improved our capabilities, we can also point to feedback that was brutally painful and disorienting, regardless of whether it was justified. There is no way to make this tension go away. It is baked into the human condition. For this reason, advice like “don’t take it personally” or “don’t be defensive” doesn’t work. The challenges go much deeper than that, and so must the answers. ISSUE 21 SECOND QUARTER 2014
53
FEEDBACK TIPS FOR LESS GRUMBLING, MORE GROWTH
EXPERT insight
Getting good at receiving feedback means you are able to sort, sift and understand what the giver is trying to tell you. You are willing to try out new things, even if at first they don’t seem to fit. It is worth noting that getting better at receiving feedback does not mean you have to accept it, even if it is wrong. Getting good at receiving feedback means you get better at understanding your own reactions triggered by the feedback you get. You are able to sort, sift and understand what the giver is trying to tell you. You are willing to try out new things, even if at first they don’t seem to fit. Ultimately, you can make decisions about what feedback to take on and what t o leave behind. Sometimes this even means knowing how to establish boundaries – redirecting or stopping unrelenting criticism, unhelpful, unsolicited coaching, or simply a kind of feedback that isn’t what you need right now. (See the sidebar Three Kinds of Feedback. ) Honing these core skills pays off in myriad ways. Research shows that people who solicit negative feedback at work – genuinely looking for what they can improve, rather than simply fishing for compliments – adapt more quickly to new roles, report higher satisfaction and receive higher performance reviews. Receiving feedback well doesn’t just enable you to take charge of and accelerate your own growth; it can also change how people see you.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
ABOUT THE AUTHOR Sheila Heen is a graduate of Occidental College and Harvard Law School, where she teaches negotiation and for the past 20 years has developed negotiation theory and practice as part of the Harvard Negotiation Project. She is also a founder of Triad Consulting Group in Cambridge, Massachusetts, helping executive teams work through conicts. Her corporate clients include everyone from BAE Systems to
54
SECOND QUARTER 2014 ISSUE 21
Unilever, and she has provided training in the public sector to the Singapore Supreme Court and the Obama White House. She is coauthor of the international business bestseller Difficult Conversations (Penguin, 1999) and Thanks for the Feedback (Penguin, 2014). She was a keynote speaker at IESE’s Fast Forward Executive Education Program for international executives and H.R. managers held at IESE Barcelona in June 2014.
Three Challenges to Receiving Feedback Well To get better at receiving feedback, you need to understand and navigate three challenges at the center of our triggered reactions to feed back. THE CHALLENGE TO SEE. To see what the feed back means and to see yourself accurately. THE CHALLENGE OF WE. All feedback comes wrapped in the relationship between giver and receiver. You can have a reaction to who is giving the feedback that colors your reaction to the feedback itself. THE CHALLENGE OF BEING ME. Differences in our wiring mean that individuals range from being very sensitive to feedback to being largely insensitive to feedback. Being upset can distort your sense of the feedback itself as well as your sense of self. Understanding these three challenges will help you to navigate your reactions to feed back more successfully and enable you to find value in even off base or unfair feedback. Let’s examine the components of each challenge in more depth. n
n
n
The Challenge to See: First, Understand the Feedback When feedback is incoming, we immediately ask ourselves, “Is this feedback right or is it wrong?” If it’s right, then we may need to do something about it. But if it’s wrong, then we can safely relax, set it aside and move on with our lives. As human s, we are ver y good at finding something wrong with the feedback, quickly honing in on any and all of the things that are wrong with what is being said. Do any of these examples of “wrong-spotting” sound familiar? “What they are saying is totally not true, or at least it is not true anymore.” “They don’t understand the constraints I was under.” “They have completely missed what I was trying to accomplish.” “When, where and how they delivered the n
n
n
n
IESEinsight
FEEDBACK TIPS FOR LESS GRUMBLING, MORE GROWTH
EXPERT insight
In focusing on the aspects of the feedback that are wrong, you ignore what might be true. Even when the feedback is 90 percent off base, that last 10 percent might be what you need to learn in order to grow. feedback (e.g., by text message or in front of customers) was incredibly unskilled and inappropriate.” “I am suspicious of their real reasons for giving me this feedback. I don’t trust them. They are jealous or controlling or projecting their own issues onto me.” The problem with wrong-spotting isn’t that you are wrong about what is wrong. Indeed, any of the above claims might well be valid. The problem is you can always find something wrong. In focusing on the aspects of the feedback that are problematic, you ignore what might also be true or helpful. And even when the feedback is 90 percent off base, that last 10 percent might be the very thing you need to learn in order to grow. Start by making two lists. First, go ahead and list everything that is wrong with the feedback. Making this list is emotionally satisfying. The goal is not to pretend that wrong feedback is anything but what it is – patently false, poorly delivered, driven by ignorance or a hidden agenda. n
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
EXHIBIT 1
Understand the Feedback
UNDERSTAND ITS PAST AND ITS FUTURE.
THE FEEDBACK COMING FROM?
n
n
n
n
Your feedback has a past and a future. In order to understand the feedback, you need to understand: WHERE THE FEEDBACK COMES FROM. What specific observations led the giver to give you this feedback? Did they see you doing something that caused concern or upset? Did you miss an opportunity? Have they seen others do it differently or did they expect you to handle it differently? WHERE THE FEEDBACK IS GOING. What, specifically, do they want you to do differently in the future? Asking these questions will raise the quality and richness of the conversation, helping both sides sort out what the givers are trying to describe and what they are suggesting. Regardless of whether you ultimately decide to accept or reject their advice, this conversat ion will serve to strengthen your relationship as both of you learn something new about the situation and each other. (See Exhibit 1.) n
WHEN FEEDBACK IS VAGUE, TAKE TIME TO
ASK: WHERE IS
Now make a second list next to the first one. This time ask yourself if there is anything that might be right about the feedback. Even if there is only one item on this list, it forces you to think about what might be worth considering and what you might have to learn. There is a second challenge here: to see what is meant by the feedback. Part of the reason feedback is often so easy to dismiss is that it frequently arrives in the form of vague, generic labels: “Show more confidence.” “Be more proactive.” “Take your game to the next level.” “Work on your people skills.” Before accepting or rejecting such labels, pause to see what the giver means by them. For example, the advice to “show more confidence” might mean standing up straighter, looking people in the eye or pretending to know the answer when you really don’t. Or the giver could mean the opposite: that you need to relax and admit you don’t know the answer when you don’t know.
LABELS
ASK: WHERE IS THE
USED
FEEDBACK GOING?
n
Observations, data or expectations that led the person to give you this feedback
IESEinsight
Examples: “Show more condence.” “Be more proactive.” “Take your game to the next level.” “Work on your people skills.”
Advice or coaching: what specically do they want you to do differently?
ISSUE 21 SECOND QUARTER 2014
55
FEEDBACK TIPS FOR LESS GRUMBLING, MORE GROWTH
EXPERT insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
The Challenge of We: Separate Who From What Our first response to feedback is often not so much a reaction to the advice itself, but to the person giving it. The advice was unsolicited (“Who asked them anyway?”), their timing was terrible (at the annual shareholders’ meeting!) and their so-called people skills were nowhere in evidence. If only you could find a proper mentor – someone with experience and credibility, someone you trust, who has your best interests at heart – then their feedback would come preapproved. Certainly, great mentors are invaluable, and you should cherish those you have. That said, the fact remains that most of us are stuck with colleagues and supervisors who do not embody this ideal. They may be bosses who don’t have time for us, colleagues who are
Train Your Leaders Want to give better feedback? Then learn how to take it. he most powerful thing you can do to improve the quality of feedback conversations in your organization is to teach your leaders how to receive feedback more skillfully.
T
When leaders become skillful receivers: They start to get honest feedback from tho se below them. The higher you get in any organization, the more
reluctant people are to give you candid feedback since they don’t want to jeopardize their relationship with you. If you don’t know what you need to work on as a leader, chances are that the people who work for you can tell you. They will likely have a list of all the things you do – or fail to do – that make their jobs harder. Ask them and persuade them that you really want to know. This will accelerate your own growth as a leader. They become better feedback givers. By understanding
what is so challenging about receiving feedback, you become a more empathetic giver. You can anticipate defensiveness, improve clarity and strengthen the relationship. They become role models for what is valued in the organization. Instead of just saying you want a culture
of learning, you actually live that attitude of continuous improvement, showing people the skills needed to turn even unfair, poorly delivered feedback into opportunities for growth.
56
SECOND QUARTER 2014 ISSUE 21
difficult themselves and clients who are just plain awkward or rude. Most feedback is going to come from people like these, so if you want to learn from the feedback you get, you need to be able to separate the people who are giving you the feedback from what it is they are saying. They may not be trustworthy. They may be dead wrong about how you could improve your sales. They may have poor communication skills and express themselves ineptly. You may be right about their personality defects. Even so, their suggestion for how to run the weekly meetings better might actually help. Interestingly, some of the most valuable feedback can come precisely from the people with whom you find it most difficult to work. When we ask colleagues for feedback, we tend to seek out the people we like and whom we know like us. But those people are less able to help us with our edges because they don’t see our edges – we work easily and happily together. The people whom we find difficult do see our edges, in part because they are so adept at provoking them. They see us under stress, frustrated and when we aren’t at our best. They bring out the worst in us – and it’s at our worst where we have the most room to grow. Go to those people whom you find challenging and ask for coaching. Don’t say, “Do you have any feedback for me?” That is too broad a question and it is not clear how honest you want them to be anyway. Instead ask: “What’s one thing you see me doing, or failing to do, that is getting in my own way?” Or ask: “What’s one thing I could change about how we are working together that would make a big difference?” Not only are you likely to get something concrete and specific, but by asking the question, you begin to change the relationship. (See the sidebar Train Your Leaders.) The Challenge of Being Me: Your Wiring Affects Your Feedback Neuroscience research by Richard Davidson, among others, has found that in terms of sensitivity to feedback – how far you swing emotionally in the wake of feedback and how long it takes for you to recover – individuals can differ by as much as 3,000 percent. Some people are relatively insensitive to feedback. When they are offered indirect coaching from a colleague, for example, they may not even realize it is feedback. It simply doesn’t get through. Others are highly IESEinsight
EXPERT insight
FEEDBACK TIPS FOR LESS GRUMBLING, MORE GROWTH
In any team, it is important to open up a discussion around how each person reacts to feedback and how we can best help each other to hear it, understand it, sort it and act upon it. sensitive to feedback, and an offhand correction from the boss during the opening of their presentation causes them to lose focus and stumble through what was otherwise a wellrehearsed talk. This leads the boss to give them additional feedback: to grow a thicker skin and not take things so personally. This advice isn’t very helpful because whether you swing wide emotionally in the wake of feedback or you remain even-keeled, this is the way you are built. This also means that the receivers are in the best position to guide any feedback conversation, since they are the ones who know what will be most helpful for them and how they learn best. This does not mean you can say, “I prefer solely positive feedback. No criticism, please.” It does mean you can say, “I would love your suggestions for how to make my presentations better, and I’ll be able to hear them best and learn the most if you give them to me afterwards, on a one-to-one basis rather than in front of the entire crowd.” Or alternatively: “If you have a suggestion, I really want to hear it, and don’t be afraid to be blunt. I actually appreciate that.” Your wiring affects not just your emotional reaction; it can distort your thinking and your sense of the feedback itself. It becomes supersized, where one thing becomes everything and it seems you can do nothing right. What began as a comment about correcting your typos is experienced as one more piece of evidence that you are hopeless. Dismantling these distortions begins by recognizing your patterns when you receive feedback. Do you argue back out loud or only in your head? Do you accept the feedback in the moment but later come to discount most of it? Do you feel ill for days and avoid the person indefinitely? Positive feedback has its own pattern. For some people, a positive e-mail from a customer will put a bounce in their step all day. For others, that positive feeling has disappeared by the time they open the next e-mail. The idea that a critical comment can be balanced
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
IESEinsight
by sandwiching it between positives may help some people but won’t do anything for others. In any team, it is important to open up a discussion around how each person reacts to feedback and how we can best help each other to hear it, understand it, sort it and act upon it. Team members can coach others on how best to help them learn and can actively solicit feed back on the “one thing” that drives their own learning. These conversations can change the feedback culture of the team almost instantaneously. As each of us works to become more skilled at receiving feedback, we no longer need perfect givers, perfect timing or perfect advice. We begin to be able to turn even unskilled or unfair feedback into learning and improvement. Soon, giving feedback on this team becomes easy, since we trust our colleagues to help us be clearer and we explore what it is we can learn and improve together.
TO KNOW MORE n
This article is adapted from Thanks for the Feedback: The Science and Art of Receiving Feedback Well (Even When It Is Off Base, Unfair, Poorly Delivered and, Frankly, You’re Not in the Mood) by Douglas
Stone and Sheila Heen (Penguin, 2014).
ISSUE 21 SECOND QUARTER 2014
57
EXPERT
insight
L E A Y A N A y b n o i t a r t s u l l I
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
OPERATIONAL INNOVATION
How Fast Fashion Works: Can It Work for You, Too? By FELIPE CARO and VÍCTOR MARTÍNEZ DE ALBÉNIZ
O
ver the past decade, two Eur oThe success of these retailers is attributed pean retailers have experienced to a business model known as “fast fashion” explosive growth, in spite of a re- – rapidly churning out fashionable designs cord-long recession that saw the at affordable prices. Though there are many retail sector hardest hit as consumer spending imitators, these two giants are considered nosedived due to the global economic crisis. the pioneers responsible for popularizing the Ironically, the retailer that has grown the model and for transforming the global apparel most is based in one of the countries that industry and consumer purchasing patterns has suffered the most: Spain. Inditex, with as a result. its eight brands – Zara, Zara Home, Massimo How they do it is of great interest to other Dutti, Pull & Bear, Bershka, Stradivarius, retailers, not only in the clothing business but Oysho and Uterqüe – has 6,300 stores in 87 also in electronics, food and entertainment. markets. It is the largest apparel retailer in What can we learn from the successful executhe world in terms of sales. In second place is tion of the fast-fashion business model? the Sweden-based Hennes & Mauritz with six We have been following fast fashion for brands – H&M, COS, Weekday, Cheap Mon- several years, writing numerous research day, Monki and Other Stories – sold through papers and studies that have led us to col3,200 stores in 54 markets. laborate with Zara and others in the field.
58
SECOND QUARTER 2014 ISSUE 21
IESEinsight
EXPERT insight
HOW FAST FASHION WORKS: CAN IT WORK FOR YOU, TOO?
In this article, we highlight the operational keys and basic attributes underpinning the fast-fashion model, which are applicable to many different industries. We also suggest some downsides.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
In this article, we highlight the operational – leaves out many apparel retailers who are keys underpinning the fast-fashion model, often erroneously lumped in with the fast which are summa rized in each of the four fashion crowd. Many retailers offer low-price graphics that you see in the following pages. clothing – Gap and Uniqlo, for example – but These basic attributes are applicable to many T-shirts, sweats, jeans and chinos are not catdifferent industries. walk-inspired. And if prices are too high, then We also suggest some downsi des. Busi- high fashion retailers don’t fit the definition nesses looking to exploit fast fashion would either. do well to consider the societal and ethical reMain-street apparel retailers that do fit percussions of the model, as consumers and the bill include: Topshop and New Look from businesses begin to express greater concern the United Kingdom; Wet Seal and Forever for sustainability in this post-crisis era. 21 from the United States; and C&A from the Netherlands. These companies use a fastThe Fast-Fashion fashion model for at least part of their retail Value Proposition businesses. Still, Inditex and H&M are the As with any business strategy, fast fash- epitomes of the model and dominate the secVALUE PROPOSITION ion starts with a value proposition. tor by far. Fashionable & Affordable That proposition is to benefit the The fast-fashion value proposition makes customer with fashionable cloth- companies compete on both price and proding at an accessible price point uct freshness. Neglecting either is costly. QUICK DYNAMIC RESPONSE ASSORTMENT (Value = benefit – cost). FastTeenagers, for example, are said to be turnfashion companies set up and ing their backs on logos or labels as important align their operations and man- criteria for purchases in favor of freshness. agement systems to best satisfy As such, rotating in new products each week their potential customers, keeping feeds demand for changing fads. Recognizing SUSTAINABILITY clothing styles up-to-date and prices this, brands that rely on the youth market, down. Notice that this two-pronged such as Esprit and Abercrombie & Fitch, are proposition – fashionable and affordable now adding a fast-fashion elemen t so as not to be left behind. Moreover, prices tend to start – and stay – relatively low, and there are fewer discounts at the end of a season. EXECUTIVE SUMMARY The fast-fashion value proposition is supWhen people hear “fast This article walks readers ported by two operational pillars: Quick Refashion,” the retail giants through a more precise, sponse (QR) production and dynamic assortZara or H&M usually spring illuminating denition of fast ment planning with frequent to mind. However, few really fashion as a business model. assortment changes. know what fast fashion is, No discussion of how this Let’s examine each VALUE PROPOSITION Fashionable & Affordable operationally speaking, model is able to create value in turn. and how it takes advantage would be complete without of Quick Response (QR) also mentioning the ethical Pillar 1: QUICK DYNAMIC Quick production and dynamic and environmental concerns RESPONSE ASSORTMENT assortment planning to reduce associated with it. The Response traditional design, production/ authors also suggest possible Quick Response purchasing and distribution applications of the fast-fashion (QR) was origiprocesses from years and model to other industries nally developed SUSTAINABILITY months to just a few short – from food to phones to in the textile and weeks. entertainment and more. apparel industry as a IESEinsight
ISSUE 21 SECOND QUARTER 2014
59
EXPERT insight
HOW FAST FASHION WORKS: CAN IT WORK FOR YOU, TOO?
The design phase of a fast-fashion operation behaves like a surfer catching a wave. Raw materials are ready and waiting for orders. Design iterations are limited. Authorizations happen quickly. set of standards for information exchange and supply chain management that allowed lead times to be shortened and increased supply chain efficiency. Over time, the use of the term QR has evolved into a broader interpretation, which is conceptually very simple: postpone all risky production decisions – e.g., commitments to purchases that may not be needed in case of low sales – until there is enough evidence that the market demand is there. QR thus allows a reduction of excess inventory, although perunit costs related to manufacturing and shipment may increase. To understand QR, let’s compare the process of releasing an apparel collection – from design to production/purchasing to distri bution – for a traditional versus fast-fashion business. (See Exhibit 1 .)
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
For a traditional firm wanting to release a collection in, say, January 2014, the process may need to start in November 2012 in order to have the full collection desi gned by May 2013. A product concept is first rendered digitally, before being made physically from fabric samples. One of the key determinants here is the fact that some apparel firms have a wholesale channel and need to show their wares early to sell to multibrand stores and department stores. This takes time. Right off the bat, the fast-fashion model is already different, in that it is not predicated on “releasing” a collection timed with seasons, as traditional retailers do. Instead, it works at the item level and eschews wholesale channels. The goal is to respond to nascent demand trends, so as to provide and capture more value from consumers. This makes the design phase of a fastfashion operation behave more like a surfer catching a wave. Raw materials are ready and waiting for orders. Design iterations are limited, and standard methods and materials are used, to speed up samples. Authorizations to move from sample stage to full production happen quickly. 1. DESIGN.
60
SECOND QUARTER 2014 ISSUE 21
2. PRODUCTION/PURCHASING. Once the design
phase is completed, a traditional apparel firm contacts suppliers and places orders with them. Then the production phase begins. First, the fabric is made from cotton thread or some other raw material. Second, the fabric undergoes a treatment, including dying, washing or printing, to improve its touch and feel. Third, the fabric is cut into pieces for the various products. Fourth, the product is assembled and sewn together into the finished product. Finally, the product is packed and shipped to the retailer’s warehouse. As this phase entails specific equipment and labor, economies of scale become important. These labor-intensive steps may have a steep learning curve, due to quality issues, and require sufficient volume to be costcompetitive. The timing of the traditional production phase varies depending on supplier leadtimes. For example, a firm making knit fabrics in China and transporting them by sea to be sold in Europe may need a lead-time of three to six months. Working item by item allows fast-fashion companies to accelerate lead times across the board. Also, because they better utilize their resources on a constant basis throughout the year, they avoid the peaks and troughs of traditional production processes. This enables them to keep costs low and reduce response times to a few weeks. One way that fast-fashion production schedules are sped up is through the use of near-shore suppliers, located close to the main target market, even though sales may be global. For U.S. companies, near-shore suppliers may be located in Mexico and various countries of Central America. For European companies, factories may be located in Portugal, Morocco, Romania, Bulgaria or Turkey. Inditex locates more than half of its supply chain in three countries: its home base of Spain as well as nearby Portugal and Morocco. n
n
n
n
n
IESEinsight
HOW FAST FASHION WORKS: CAN IT WORK FOR YOU, TOO?
EXPERT insight
Fast-Fashion Process 4 months
Traditional Process
21 months
2012 2013 months of work
1
N D
J
2014
F
M A M
J
J
A
S
O N D
J
F
M A M
J
J
DESIGN
Concept
Sample Presentation of collection
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
2
PRODUCTION/PURCHASING
Production order Fabric production Fabric treatment Cutting
Traditional vs. Fast Fashion
EXHIBIT EXHIBIT 12
WITH FAST FASHION, TRADITIONAL
Sewing Ship to warehouse
PROCESSES ARE REDUCED FROM YEARS AND MONTHS TO WEEKS.
3
DISTRIBUTION
Initial loading Replenishment Sales at full price Sales at a discount
3. DISTRIBUTION. Once the product is in the re-
tailer’s warehouse, it needs to be distributed to the stores. The transportation process itself is fairly quick – days if by air or within Europe by road. However, the types of shipments involved are what lengthen traditional distribution. Initially, stores are loaded with large quantities of inventory at the beginning of the season. They are then restocked during the season in smaller quantities, which is called replenishment. To make room for the new season, items go on sale after five or six months. Again, QR serves as a powerful source of competitive advantage for fast-fashion companies, as we have found in our research. By IESEinsight
deciding distribution at the last minute, in ventory can be sent to where it is needed most. To measure the effectiveness of QR, an appropriate metric is the gross margin return on inventory (GMROI), defined as the ratio between the gross margin and the average in ventory. Improving GMROI can be achieved by using early sales data to generate more reliable forecasts. Information is key. We are currently studying how demand forecasts can be improved over time. The models are sophisticated, and a company committed to getting QR right needs to employ specialists – mathematicians or statisticians – to work with big data. Competition also matters when deterISSUE 21 SECOND QUARTER 2014
61
EXPERT insight
HOW FAST FASHION WORKS: CAN IT WORK FOR YOU, TOO?
Store offerings are updated often – weekly, every third day or even daily. These inventory updates are attractive to acquisitive customers. These constant changes have been proven to increase store traffic.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
mining the scope of limited, time-sensitive are attractive to fashion-conscious, acquisiorders produced via QR. In our research, we tive customers. These constant changes have have found that QR is a no-brainer regardless been proven to increase store traffic. of the competitors’ business model, whether To best time the entry of new products, they also use QR or, on the contrary, they are managers employ “dynamic assortment planslower, even when this comes with a lower ning,” which is becoming more of a science cost structure. Indeed, the cost of keeping raw than an art. In our studies of the topic, we note materials ready and postponing decisions pay that demand for any new product will typicaloff with tighter inventory controls and higher ly decrease over time as newer products tend gross margins. to get better displays and generate more interest, all else remaining equal. Pillar 2: Dynamic This means that properly timing the reVALUE PROPOSITION Fashionable & Affordable Assortment lease of products has the potential to alleviThe second operational pil- ate competition between them and, at the lar supporting the fast-fashion same time, ensures that traffic remains high QUICK DYNAMIC RESPONSE ASSORTMENT value proposi tion is the use of throughout the entire season. frequent assortment changes Currently we are working on the best forthroughout the season. In oth- mula to locate the ideal moment to introduce er words, store offerings are a product and then introduce the next produpdated often – weekly, every uct. This is a similar optimization problem SUSTAINABILITY third day or even daily – not just that a film distributor faces when deciding the twice a year, as under the traditional ideal time to introduce movies to maximize seasonal model. These inventory updates box office sales. Our research yields some simple but interesting rules of thumb. For example, basic products with stable demand should be inABOUT THE AUTHORS troduced at the beginning of the season. In Felipe Caro is an associate Víctor Martínez de Albéniz contrast, fashionable products for which cusprofessor in Decisions, is an associate professor of tomer interest quickly drops should be spaced Operations and Technology Production, Technology and over the entire season and used to refresh the Management at UCLA Operations Management assortment. Anderson School of at IESE Business School. How to measure the success of dynamic Management. His research He earned his PhD from assortment is not as straightforward as it is interests include decisionMassachusetts Institute with QR. However, the use of certain models making under uncertainty, of Technology and an to time in-season introductions is yielding demand learning for dynamic engineering degree from École promising results. assortment, carbon allocation Polytechnique in France. His By allowing closed-loop controls with in supply chains, pricing and research focuses on supply real-time feedback between sales and assortinventory decisions, and chain management, especially ment decisions, we have found that revenues forecasting. Prior to earning in the retail and fashion can jump by up to 10 percent using dynamic his PhD from Massachusetts industries. His work has been assortment planning and frequent product Institute of Technology, he published in Management introductions. (In control theory, a “closed taught at the University of Science , Operations Research, loop” refers to decisions made with dynamic Chile. He has collaborated inputs, such as a car’s cruise control staying Manufacturing & Service with Zara and is the author of at a set speed by constantly measuring the Operations Management the case study, “Zara: Staying and Production & Operations current speed, as is especially important on Management. Fast and Fresh.” a hill.)
62
SECOND QUARTER 2014 ISSUE 21
IESEinsight
EXPERT insight
HOW FAST FASHION WORKS: CAN IT WORK FOR YOU, TOO?
A byproduct of this amped-up supply-and-demand is waste. In response to outcries over such waste, fast-fashion companies are now rolling out recycling programs to reuse garments. When production costs are not too high average pieces of clothing that each person nor too low, and when there is significant un- bought per year went from nine to 14 worldcertainty about the decay rate of products, wide; in the United Kingdom, the average as in fashion retailing contexts, the success climbed from 19 to 30. of new product introductions beats sticking A byproduct of this amped-up supply-and with basics as soon as a drop-off in demand demand is waste. According to a report from is detected. the University of Cambridge’s Institute for Frequent assortment changes work when Manufacturing, the average British person apparel makers control their own stores. throws away more than 66 pounds of clothing This does not work with a wholesale business and textiles a year. model in which preorders are key. As noted In response to outcries over such waste, before with QR, another advantage to fre- fast-fashion companies are now rolling out quent assortment changes is that they even recycling programs. out resource requirements over time, reducH&M, for example, now has in-store coling production bottlenecks. lection boxes for unwanted clothes. In 2013, As such, const antly changing inventory the company collected more than 3,000 seems to work best in combination with QR tons of unwanted garments – enough fabric production, controlling inventory and keep- to make 15 million T-shirts. In 2014, H&M ing margins healthy. Fast fashion becomes a launched a clothing line made partly from truly compelling business model when solidly recycled cotton derived from this recycling resting on both of these pillars. initiative. The company has pledged to continue to collect and reuse its garments to help Sustainable Grounds reduce waste. At the base of the fast-fashion model are people, communities and production eco- 2. PEOPLE AND THEIR WORKING CONDITIONS. Fast systems. For fast fashion to last as a business fashion creates a lot of employment opportumodel, a long-term view is required, an d this nities in many different countries. But regurequires corporate social responsibility and lating working conditions is another area of sustainability checks. great concern. Critics argue that until this longDeciding where to produce a term view is fully established, the garment usually depends on VALUE PROPOSITION fast-fashion business model economic aspects – namely, Fashionable & Affordable rests on shaky grounds. Specost competitiveness of cifically, they point to three the production site, takQUICK fundamental challenges. ing into account wages, DYNAMIC RESPONSE ASSORTMENT material costs, energy 1. DEALING WITH WASTE. costs and freight chargMore items sold means es. But offshoring based store revenues are piling on economic motives and SUSTAINABILITY up – but so are the articles of considerations may ignore clothing. Fashionable items disethical elements. appear as fast as they appear. But The consequences of turning where do they disappear to? a blind eye to working conditions can Between 2000 and 2012, sales in the global be deadly. The col lapse of the Rana Plaza apparel industry grew an average of 4.3 per- factory in Bangladesh in April 2013 shocked cent a year, reaching a market worth of $1.7 the world, leaving more than 1,100 dead and trillion in 2012. During the same period, the 2,500 injured. At Rana Plaza, workplace safety
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
IESEinsight
ISSUE 21 SECOND QUARTER 2014
63
EXPERT insight
HOW FAST FASHION WORKS: CAN IT WORK FOR YOU, TOO?
The general ideas and practices of the fast-fashion model are robust and can be applied to many industries where products rotate frequently and consumers are searching for novelty. standards were not being followed, with fast fashion blamed for driving factories into noncompliance. Since then, over 170 brands and retailers have signed the Accord on Fire and Building Safety in Bangladesh to improve conditions in the country’s garment factories. Though an important collective step, indi vidual companies should draft their own codes of conduct, if they haven’t already. Acceptab le working conditions need to be stipulated with suppliers and manufacturers, backed up with inspections to ensure compliance.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
3. GLOBAL INDUSTRY, LOCAL CONSEQUENCES.
Besides putting workers in other countries at risk, offshoring – or moving core business processes away from a particular region – poses other long-term challenges. For instance, we have worked with an Italian jeans manufacturer that can no longer source and treat denim fabrics in Italy because most of the suppliers disappeared during the offshoring waves of the 1990s and 2000s. Likewise, there are very few suppliers with QR capabilities left in Spain, after most retailers moved their QR operations to Portugal, North Africa and Eastern Europe. We would recommend that fast-fashion companies pay closer attention to the cost dynamics and longer term implications of their sourcing decisions, ever mindful of the fact that their business strategies may end up irrevocably shaping a particular region’s capabilities. Inditex’s “Working in Clusters” program may yield improvements in this regard. Working in cooperation with local unions, NGOs, trade associations, governments, international purchasers and members of civil society, Inditex states it is seeking to promote a “sustainable productive environment” around its supply chain in a given region. The company has clusters in Spain, Portugal, Morocco, Turkey, India, Bangladesh, China, Vietnam, Brazil and Argentina, representing more than 85 percent of Inditex’s total production.
64
SECOND QUARTER 2014 ISSUE 21
What Next? Regardless of whether these companies rise to the challenges, we believe the general ideas and practices of the fast-fashion model are robust and can be applied to many industries where products rotate frequently and consumers are searching for novelty.
The food sector – including convenience stores and restaurants – is a prime candidate for the fast-fashion formula. Constantly changing offers and menus, based on locally sourced ingredients combined at the last minute and prepared on the spot, satisfies customers’ appet ite for new tastes. Seven-Eleven Japan already has these capabilities. Thanks to a retail strategy that emphasizes freshness, combined with a sophisticated information system that forecasts future trends, Seven-Eleven Japan achieved the highest average sales per store per day in its category, according to a Stanford case study. To make sure customers did n ot get bored by its offerings, the convenience store rotated out old items – food, beverages and magazines – in favor of new ones as soon as demand dropped. For example, Seven-Eleven Japan caught a fresh-noodle fad early and developed a new product with a manufacturer, rotating out its dry ramen offerings in favor of its highermargin fresh noodles while the food fad lasted. At the same time, traditional Bento lunch boxes were introduced three times a day and color-coded by shelf life. Milk products were rearranged a few times a day to better suit customers’ evolving needs over the course of a single day: small containers of milk to bring to work in the morning; lunch-sized servings for students around midday; larger cartons for parents bringing milk home in the evening. Keeping up with changing customer preferences and always offering something new worked for Seven- Eleven Japan. Anal yzing hourly sales trends for individual items WHAT’S ON TODAY’S MENU?
IESEinsight
EXPERT insight
HOW FAST FASHION WORKS: CAN IT WORK FOR YOU, TOO?
The fast-fashion model suggests operational strategies that might apply to your own business. QR can keep your product line fresh; dynamic assortment planning can optimize the scheduling of new releases. helped the convenience store optimize you optimize the scheduling of new releases, delivery schedules and minimize waste. taking account of variables such as fluctuating market conditions. FAST PHONES? Another area with potential is Whatever you decide to do, make sure your consumer electronics. A fast-fashion-style model is built on strong, sustainable grounds electronics manufacturer or retailer would that prioritize people and communities. The have to significantly reduce the time between long-term viability of fast fashion as a businew product introductions, and be able to ness model depends on it. install flexible production capacity so as to respond quickly to demand, with low supplychain inventories. Interestingly, releases of smartphones and tablets have been more and more frequent, and product upgrades have less to do with technology breakthroughs and more to do with aesthetics. Consumer electronics companies that want to be fast will have to pay special attention to their sustainability efforts, reusing discarded products. TO KNOW MORE
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
WHAT’S PLAYING? In
many other industries – namely, books, music, movies and any digital content delivered online – novelty provides a big sales boost. Stores provide special, better displays for novel items. Movie theaters do something more drastic, removing movies from the bill after only a couple of weeks. It makes sense to apply dynamic assortment planning to these industries. This can help decide when to release new songs for radio play, for instance, or when a movie or museum exhibit should open and close. By detecting immediately when demand starts to wane, releases can be better timed to engage new customers.
n
n
Caro F., V. Martínez de Albéniz and P. Rusmevichientong. “The Assortment Packing Problem: Multiperiod Assortment Planning for Short-Lived Products.” Forthcoming in Management Science, 2014. Caro, F. and V. Martínez de Albéniz. “Fast Fashion: Business Model Overview and Research Opportunities.” Forthcoming in Retail Supply Chain Management: Quantitative Models and Empirical Studies . New York: Springer, 2014.
n
Caro, F. and V. Martínez de Albéniz. “Operations Management in Apparel Retailing: Processes, Frameworks and Optimization.” Boletín de Estadística e Investigación Operativa
The fast-fashion model suggests various operational strategies, like these, that might apply to your own business or industry. Start by analyzing the three main decision areas related to design, production/purchasing and distribution. Look for new ways to serve your customers better in each individual area. QR works best for keeping your product line fresh while minimizing excess inventory. Dynamic assortment planning can help IESEinsight
29, no. 2 (2013): 103-16. n
n
Caro, F. and V. Martínez de Albéniz. “Product and Price Competition With Satiation Effects.” Management Science 58, no. 7 (2012): 1,357-73. Caro, F. and V. Martínez de Albéniz. “The Impact of Quick Response in Inventory-Based Competition.” Manufacturing & Service Operations Management 12, no. 3 (2010): 409-29.
ISSUE 21 SECOND QUARTER 2014
65
BUSINESS
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
k c o t s k n i h T / k c o t S i / m a h g n a M t t o c S
HENKEL
Sustainability at Any
66
Price?
SECOND QUARTER 2014 ISSUE 21
IESEinsight
BUSINESS insight
HENKEL
HENKEL’S NEW SUSTAINABILITY STRATEGY aims to achieve a 30 percent increase in efficiency by 2015 and to triple its efficiency by 2030. Can this be achieved without hurting operating profits?
A ) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
s a leading producer of detergents, household cleaning products and adhesives, the German multinational, Henkel, has an even greater responsibility to demonstrate sustainability, given the potential impact of its products on the environment. Although sustainability always formed part ofHenkel’s business commitment – indeed, it set up an ecology department as long ago as 1953 to assess the environmental impact of its products – the relevance of sustainability to the development of Henkel’s business was getting more intense, due to the heightened global challenges, as well as competitors and customers stepping up their own efforts in this area. Charlotte Kuszewsky*, head of a Henkel subsidiary in the European Republic of Esperanto* (*both composites based on interviews with Henkel country managers of several different countries), was in charge of drawing up an action plan to advance Henkel’s sustainability agenda. One of the largest economies in the European Union, the Republic of Esperanto was suffering the effects of the global financial crisis, with high inflation and unemployment, and no growth. In this tough economic context, Kuszewsky had am bitious new sustainability targets to meet. She needed to come up with a clear strategy that would benefit the local business and meet corporate-level goals set by top management. And with Henkel reaching its 2012 targets two years ahead of schedule, the bar was already set high. Meanwhile, Henkel’s main competitors were just as busy reworking their own strategies: Procter & Gamble, Unilever, L’Oreal and 3M had boosted their efforts, ranging from tree planting, to eco-labeling, to campaigns such as P&G’s “Future Friendly” educational initiative to encourage consumers to reduce their waste as well as their water and energy consumption. Kuszewsky would have her work cut out trying to maintain Henkel’s reputation as a sustainability pioneer. Achieving More With Less In 2010, CEO Kasper Rorsted began to feel that Henkel was not progressing fast enough in the area of sustainability, so he requested a new approach. Henkel brought in external experts to offer fresh ideas, resulting in a new strategy covering six focal areas: water and wastewater; health and safety; social progress; energy and climate; materials and waste; and performance. Henkel’s new sustainability target was to increase the efficiency of its operations by a factor of three by 2030: This meant either creating three times more value for so-
IESEinsight
ciety using the same level of natural resources, or diminishing its environmental footprint to one third of today’s while delivering the same value. In many cases, that meant approaching its sustainability target from both sides, reducing input while at the same time improving output. This strategy of “achieving more with less” was a challenge that Kuszewsky felt keenly. While she understood how the Factor 3 target would further Henkel’s corporate sustainability strategy, she wondered whether the rest of her team would be so enthusiastic. After all, the economic downturn in her market wasn’t showing any signs of abatement, and introducing yet bolder targets on top of the tremendous efforts the company had already made could place even greater strains on its limited resources. Ready for the Challenge? So far, the production plants in the Republic of Esperanto had been working on lowering their wastewater output and improving their energy efficiency. In fact, they had offered monetary incentives to achieve this, and one of their plants had gained the latest ISO 50001 energy management certification. The marketing department made sure that consumers knew that Henkel’s products were not only green, but that they had excellent performance. The department also pro vided recommendations on how consumers themselves could contribute to protecting the environment. Henkel targeted not only the few consumers who were willing to pay more for products with a reduced environmental impact, but also the vast majority of consumers who expressed some environmental concern. In Kusze wsky’s experience, the company’s top customers regarded sustainability as extremely relevant. Yet, coming fresh from a corporate summit at which Henkel’s leaders had thrown down the gauntlet, Kuszewsky wondered how Factor 3 would go down with her team. How could it be positioned as a positive step forward, rather than as a potential drain on their resources? Worsening market conditions had already forced them to close one plant and lay off nearly a third of staff. How could she ask her team, who had already been through so much, to embrace yet another corporate initiative? What was the best way to leverage the knowledge and skills of the sustainability experts at corporate headquarters for the benefit of her business? The case study “Operational Sustainability: From Vision to Strategy at Henkel” (SM-1603-E), by IESE Prof. Mike Rosenberg and Victoria C. Moreno, is available from IESE Publishing at www.iesep.com.
ISSUE 21 SECOND QUARTER 2014
67
BUSINESS insight
HENKEL
Sustainability should be included in the strategic objectives of any company that intends to be viable in the medium and long term.
Educate Your Leaders Involving experienced leaders helps to identify objectives as well as ensuring they are met. This by Julio Rodríguez will strengthen the credibility of the program. Executive Vice President, Consider the initiative of optimizing energy Global Operations, resources. This has a direct impact on operating Schneider Electric costs while reducing the risks associated with the rising costs of energy and raw materials. It SUSTAINABILITY STRATEGIES AREN’T JUST also decreases CO2 emissions. In relatively little GOOD for the environment, they’re good for bu- time, improved energy management can translate siness. Shareholders and investors increasingly into a 15 percent reduction in consumption. For a focus on this variable, as do governments, which company with an annual energy bill of $2 mill ion, have ramped up regulatory pressure; employees, this would amount to savings of who want to work for companies that strive $300,000 a year. for sustainability; and customers, who are For any sustainability proincreasingly more demanding when it gram, there must be clear metrics comes to their purchasing choices. for measuring the benefits. Several In a few years’ time, sustainability platforms are readily availahas gone from being “added value” to ble for controlling, ma being a critical factor that should be naging and forecasting among the strategic objectives of any the main indicators related company aspiring to be viable in the to sustainability, providing medium and long term. secure access to data, reports and In reflecting on how Schneider management tools. Electric got to be named one of the This brings us to another critical suctop 10 most sustainable companies cess factor: making the data visibly available in the world, I recommend the foacross all levels of the organization llowing steps for Henkel: develop and sharing tangible results, such as a strategy; educate executives; how much you’ve reduced your carassess your carbon footprint; es bon footprint or how much energy tablish an optimization plan; and efficiency you’ve achieved. share the results. In a recent global survey of busiWringing Out A su cc es sf ul su st ai na bi liness executives titled “Long-Term ty program starts by educating Savings Growth, Short-Term Differentiacompany stakeholders about its tion and Profits From Sustainable Start by educating key strategic importance. It must company stakeholders about Products and Services,” Accenture have the commitment, from the the strategic importance of the found that 78 percent of responoutset, of the CEO and the enti- sustainability program. dents agreed that sustainability was re senior management team, as vital to the future growth of their bu Involve experienced leaders: well as a road map for setting new sinesses. This echoes Kuszewsky’s Let them identify objectives, goals and marking out the path own finding that Henkel’s top custowhich will increase the to achieve them. I use the word mers regard sustainability as extrelikelihood they are met and “program” deliberately since one mely relevant. As such, committing strengthen the credibility of of the biggest risks related to susoneself further to sustainability, the program. tainability is launching a number though it may bring some short Use clear metrics and share of initiatives without having any term pain, cannot be resisted but specific plan or overall manage- tangible results across all must be embraced as strategic for levels of the organization. ment system in place. the company’s future.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
68
SECOND QUARTER 2014 ISSUE 21
IESEinsight
BUSINESS
insight
HENKEL
In making this aspirational leap, Henkel must make sure its words are matched with deeds.
A Step Forward somehow represent a step backward. She needs to draw upon the full support of management to communicate a clear, consistent message. by Jaime Martín Global Director, Safety and Whe n com pan ies make announcement s of Environment, Repsol this nature, they need to make sure their words are matched with deeds. Workers will be watching to see if Henkel dedicates the necessary IN ESTABLISHING FACTOR 3, Henkel is mar- time and resources to realize its ambitious goals, king a paradigm shift and taking an aspirational and whether it invites their input. There should leap forward. This is not just another lofty envi- be a program, with financials included, that actironmental ambition. Instead, by linking the con- vely promotes activities related to Factor 3, with cept of sustainability with business performance the results communicated to all employees. There and results, Henkel is setting clear targets for needs to be transparency, and if there are failures, what the company wants to be in the future. they should be recognized and corrected. No longer can these concepts be treated In addition to employees, Henkel independently of one another. Henkel needs to convince consumers that its is effectively saying to its employees sustainability goals are genuine. Given and to the world that its financial goals that the competitive gains from cannot be understood without taking sustainability are realized over environmental goals into account. the long term, consistency beThis is a bold move that carries comes all the more important, and risks. First, it risks breaking up the Henkel must keep its eyes fixed on the team previously responsible for prize of what sustainability can deliver: health, safety and the environment. It drives innovation in the search for teIn declaring that sustainability is chnological solutions that increase energy not their job but all our jobs, comefficiency and reduce emissions. panies going down this path need It boosts creativity to find alterto make sure that those who have natives to reduce its environmental been carr ying this agenda are footprint. successfully integrated and that It promotes a radical rethinking Wringing Out their experience is not lost but leof how to produce in order to add Savings veraged. This transition has to be value to products. handled carefully at each local orIt measures success not only in Set up a special ganizational level, otherwise the terms of financial performance, but committee to monitor the global vision will get lost. by the value created for society. implementation of Factor It may help to set up a special To achieve these goals, Henkel 3, with members who have committee to monitor the imple wil l have to m odify factory procesdecision-making authority. mentation of Factor 3. The peopl e ses, convince suppliers to deliver Launch a program, on this committee not only need in a more ecologically friendly way, showing financials, that to represent key areas of the busiand teach its customers how to use actively promotes activities ness, but they must also have deits products with responsibility related to Factor 3 objectives, cision-making authority, so their and care. and communicate the results. recommendations carry weight. Perhaps the most compelling Don’t lose focus along the In delivering news of Factor 3 argument for Kuszewsky to make is way, as the competitive gains that successfully creating value for to her workers, Kuszewsky must are only realized over the try to avoid giving the false imsociety is what will ensure the suslong term. pression that this move might tainability of Henkel itself.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
insight
IESE
ISSUE 21 SECOND QUARTER 2014
69
BUSINESS insight
HENKEL
Real gains come by replacing the linear “take-make-waste” logic with the Circular Economy.
The Circular Advantage able energy, bio-based or fully recyclable input material (e.g., solar or bio-plastic). by Peter Lacy & 2. OUTPUT RECOVERY. Recover resources/energy out Alexander Holst of disposed products or byproducts (e.g., paper reSustainability Services, cycling or heat waste that powers the next process). Accenture Strategy 3. PRODUCT LIFE EXTENSION. Extend the life cycle of products/components by repairing, upgrading and reselling (e.g., remanufacturing auto parts). THE ERA OF ABUNDANT, ever cheaper resources 4. PLATFORM SHARING. Increase the utilization rate is over. Most commodity indices have risen sharp- of products by enabling shared use/access/ownerly and, crucially for business planning, become ship (e.g., ride sharing or home sharing). volatile and uncertain. Upward price pressure will 5. PRODUCT AS A SERVICE. Offer product access but continue as a global middle class of 2.4 billion con- retain ownership to internalize the benefits of cirsumers is expected to more than double by 2030. cular productivity (e.g., pay per use for cars). Businesses are waking up to the impact that Champions of the Circular Economy a “take-make-waste” consumption model prove that resource efficiencies are possiis having on the planet’s finite resources. ble without compromising on price, quality In this context, Henkel is right to foor availability, or forcing consumer/customer cus on resource efficiency, aspiring to trade-offs. Desso has developed deliver more with less. But simply optian innovative technique that uses mizing existing activities won’t go far old yarn to make new carpets. Canon enough. Henkel needs to consider a remanufactures printing equipment, two-pronged approach – optimizing reusing over 90 percent of raw materials by current systems to achieve efficiency weight. Ecovative produces biodegradable gains while at the same time piloting packaging from agricultural waste and mushand scaling fundamentally new aprooms instead of petrochemicalproaches that replace the prevail based foam. ing “take-make-waste” logic. The Ecovative is a salient example for Circular Economy – based on reHenkel. Petrochemical-based prodstorative product, component and Wringing Out ucts rely on a global supply of petromaterial loops – can deliver these leum, which is scarce. Meanwhile, Savings new approaches. agricultural waste is abundant and Adopt a two-pronged If delivered in a way that oriavailable anywhere. What’s more, it ents R&D and marketing to put approach: optimize current is cost-competitive today and likely consumers/customers at the systems while piloting new to undercut petrochemical-based center of the value proposition, business models that chalmaterial by as much as 30 percent lenge the prevailing “takesuch approaches can enhance the once produced at scale. brand experience and impact, in make-waste” logic. Besides helping the environment, addition to boosting the bottom circularity presents real opportuni Look for non-petrochemicalline. We find five business mod- based alternatives: The soluties for reaping attractive economic els that reduce resource needs tions may not be easy, obvious returns today while repositioning while creating economically at- or immediate, but when scaled business for tomorrow’s resource tractive opportunities, many of will reap rewards over time. scarcity. Even though getting there which translate into consumer/ may not be easy, we believe Henkel’s Put the consumer/customer customer-focused gains. Kuszewsky should apply and scale at the heart of disruptive in1. CIRCULAR INPUTS. Replace single the principles of the Circular Econolife-cycle inputs with renew- novation to enhance the value my to achieve breakthrough results.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
proposition/differentiation.
70
SECOND QUARTER 2014 ISSUE 21
IESEinsight
WIDER
insight
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
s e g a m I y t t e G / n i e t s n e s s a H r e d n a x e l A
Two-time Olympian Edward Sinclair knows what it takes to perform at world-class levels. Success is determined as much by the battles waged in teams and in your own mind as by the caliber of the competition.
SWIMMING Against the Tide
B
razil is playing host to two of the wor ld’s premi er showcases for sporting achievement and greatness: the FIFA World Cup in summer 2014 followed by the Rio 2016 Summer Olympics. World-class sporting events, like these, can be performed with such seeming ease that the spectator may sometimes forget the years of tireless dedication and long psychological battles that the athletes have waged to reach these pinnacles of their careers. Two-time Olympian Edward Sinclair understands the complex path to become the best in the world. This record-setting freestyle swimmer has won eight medals competing in World and European Championships, and he represented Britain in the Sydney 2000 and
IESEinsight
Athens 2004 Summer Olympic Games. He has had his fair share of challenges along the way. After Team Britain placed fifth in the men’s 4x200 meter freestyle relay in Sydney, Sinclair was diagnosed with chronic fatigue syndrome but fought his way back to form part of the men’s swimming squad in Athens. After retiring from professional swimming in 2005, Sinclair decided to give back to his sport through coaching and inspiring the next generation of athletes, starting at the Millfield prep school. He currently runs Maximum Performances (www.maximumperformances. com), is the head coach at Teddington Swimming Club and is part of the coaching team of the England National Talent Program, aimed at identifying high potentials and supporting
ISSUE 21 SECOND QUARTER 2014
71
WIDER insight
I’ve worked with some very talented people who didn’t have the right mentality. They didn’t want to put in the work, they didn’t want to sacrifice.” their development to achieve future success at senior international level. He has coached swimmers all the way to the British National Team, and one swimmer he used to coach at Millfield, James Disney-May, competed during the London 2012 Olympics. To the uninitiated, athletic training looks deceptively one-dimensional: you just see people swimming lengths in a pool. But dive deeper and you see that achieving greatness – whether in sport or in business – depends on managing expectations, group dynamics, mental stamina and maintaining priorities.
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
someone underperforms, I say, ‘Okay, let’s try something different and try to do better work next time.’ We’ll attack it over a month or six months or six years. With some people it’s a longer journey.” Natural ability is essential, but it counts for little if people quite simply don’t have the drive to go along with it. “I’ve worked with some very physically talented people who didn’t have the right mentality. They didn’t want to train, they didn’t want to put in the work, they didn’t want to sacrifice. With them it takes a lot of perseverance and extreme patience.” However, there is little point in pushing someone – even if they are supremely talented – to achieve success on a national or international scale if they are only doing it for fun. For the sake of the team, each person needs to agree on where he or she is heading and set clear goals from the outset. To show that they take their success seriously, Sinclair has the people he trains fill out and sign a goal sheet at the beginning of each term. Seeing the goals on paper and pledging to work toward the same objective together makes a big difference, he believes. Regardless of whether they end up going to the Olympics or not, the main thing is that they are expressing a commitment to being the best they possibly can be; they are endeavoring “to reach their full potential.”
Managing Ambition Without Labels Sinclair, who started training when he was 10, says it helps to start when you are young, so that you develop in the right way during each key stage of growth. While it can be good to find you have a talent for something early on, being labeled prematurely can be limiting and keep you from achieving your full potential, he warns. “You might do one good sprint event and everyone will say that you’re a sprinter. But you might be a distance swimmer and not know it yet.” Having too narrow a focus not only stops you from excelling in areas in which you might have a hidden talent, but it can also hold you back from the area you practice most. Variety will lead to a stronger overall performance, so it’s important to keep the spectrum as wide open as possible during Getting the Group Dynamics Right your early training years. Although swimmers compete as individuLabels can be put on you by other people als on the whole, they train and develop in – telling you to stick to what you know and never try to do anything different – or they can be self-imposed – the inner voice telling you that you don’t have what it takes to ever do anything else. Even the most talented people need to resist their own mental barriers, especially those concerning success. One of these false beliefs i s that success happens overnight. “People love instant gratification. But you can’t wake up one morning and suddenly be a champion. Success comes from putting a set of processes in place and staying with it over time. If
72
SECOND QUARTER 2014 ISSUE 21
IESEinsight
WIDER insight
If you get the group dynamics wrong, and the wrong people working together, together, then the younger ones will get influenced by people they shouldn’t.” groups. As such, getting the group dynamics right is vital. The group affects each person’s motivation, self-perception and performance. Though crucial for success, having good team chemistry is one of the trickiest formulas to get right. “You might have a couple of big personalities who will influence everyone else on the team. If you get the group dynamics wrong, and you have the wrong people working together, then the younger ones will get influenced by people they shouldn’t.” You have hav e to have the t he right rig ht balance bal ance of perp ersonalities. This applies to those managing the team as much as to the individual team members themselves. Putting two loud coaches together on the same team, for example, won’t work either. Achieving the right balance bala nce comes from fr om considerin consid eringg the individindi vidual abilities of each person and then playing to the strengths of each one. One of the strengths that top performers grapple with is confidence. “Believe it or not, a lot of athletes struggle with confidence, even at the top,” says Sinclair. To help build up those with less confidence, you simply start by giving praise. “Tell them they’re doing a good job. Obviously if they’re doing something wrong, pick them up on it, but by all means tell them they’re doing well.” You can also pair them with more naturally confident performers to help bring them up. Each athlete will be motivated by different things, so you have to tailor your coaching accordingly. This requires taking time to get to know each individual and finding out what makes each one tick. ti ck. “You might have athletes who love to be told they’re great and that they are going to do an amazing job. Or you might have someone who needs to be told, ‘That wasn’t good enough. You could have done better. You know you’re better than that.’ When they stand up on the blocks, they’re on their own, so you have to find things that work for them. It’s fundamental you get to know them, and this takes time as there are many different personalities.”
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
IESEinsight
The team captain has a key role to play in this effort. And the right captain isn’t necessarily the best athlete. Athletes can be quite selfish, given their extreme focus on their own individual performance. A great captain, on the other hand, is someone who is more interested in others. “Traditionally, the best player or the best performer gets chosen to be captain, but one of the best captains that we ever picked was one of our weakest swimmers. He would go to all the competitions, and he gave emotional, passionate speeches at the end of the season that inspired everyone. He was just an amazing motivator.” This is the kind of team leader and role model worth having in place. Analyze Yourself Yourself as a s Well as Others As acoach or manager, you need to keep a close eye on how personality placement affects the team. But you also need to equip individuals to assess their own performance. You need to “challenge them to question themselves: could I have done this or that better?” This applies just as much to the coach or manager, who is also part of the process. “I’m constantly testing them,” says Sinclair, “but I’m also constantly testing myself. I walk away from every training session asking myself if I could have done it better and if I approached things in the right way. It’s important to analyze other people – but it’s just as important to analyze your own relationship with them.” He adds, “If you’re the head, and you’ve got nowhere else to go, and no one else is analyzing you in terms of your performance, then it is crucial for you to develop this self-awareness and find ways to evaluate your own performance.” Diving In After Defeat In the Sydney Olympics, the U.S., Dutch, Italian and British men’s freestyle teams all touched at the same time of 7 minutes and 12 seconds. The final tally came down to fractions of a
ISSUE 21 SECOND QUARTER 2014
73
WIDER insight
“I Don’t Do Negativity” How do you ignore the naysayers and come back ghting when the t he chips are down?
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
n 2001, having won his first national title and competed at the Sydney Olympics, Edward Sinclair (pictured) was given the potentially career-ending diagnosis of chronic fatigue syndrome. Training for at least 20 hours a week, it’s normal to be constantly on the verge of getting ill . When his performance times started to drop, his coach pushed him to train harder. But there was a lingering sore throat and a tiredness he just couldn’t shake off. After seeing some medical specialists, the penny dropped. “It was a real setback. As a kid, I had always dreamed of winning an Olympic gold. It was everything to
I
me. After Sydney, I really thought I had a chance of fi nally getting a medal in the next Olympics. I felt capable of doing that.” He had to stop swimming altogether. To fill the sudden void in his life, he surrounded himself with friends and family. After six months, he attempted to start training again but it was no good. Another six months went by. One day he decided to call the trainer who had coached him through the first Olympics. “He knew me well and we connected. He knew what worked and said we could plan it.” It was 2003 and they had 12 months to get in shape for the Athens 2004 Olympics. His training was limited to
second, with the Americans getting the silver (7:12.64) and the bronze going to the Netherlands (7:12.70) with a slim margin between them and the Italians (7:12.91) and Team Britain (7:12.98). Think about it: in a third of the time it takes for you to say “one second” you’ve missed out on a medal. “After a disappointment like that, it’s easy to go into a slump and feel like you want to quit. I see this happening quite a lot with young people: They build buil d somethi s omething ng up and when they don’t get it, they just quit and an d leave it all behind, which is a real shame.” Instead of giving up after a setback, Sin-
74
SECOND QUARTER 2014 ISSUE 21
15 minutes a day to start with – much less than the typical five hours of his competitors. If that wasn’t disheartening enough, he found himself being overtaken by 13-year-old girls in the pool. And then there was the tide of public perception to deal with. “After I pulled out of the Commonwealth Games, people said I was finished. People said I was never going to make it. There were a lot of people doub ting me.” But he was determined to prove them wrong, even though the odds were stacked against him. Mentally he was desperate to train, but physically he couldn’t. While this mental energy meant he pushed himself too far at times, it was what got him to Athens. Where did he pull this selfbelief from? How did h e manage to ignore all the glo om, overcome the obstacles and represent Britain once again? “I don’t do negativity,” he says. “I don’t believe in it. I might not have had a good swim that day, but I look at what did go well: I had a good start or my tu rns were good. That is what has helped me most in my career. I always try to see the positive in every situati on.”
clair urges that you take stock of the positives and consider other sets of goals. Rather than focusing on the missed medal, he made a list of what had been achieved in that race: going to the Olympics at the age of 19; swimming an Olympic final; breaking the British record. “It’s probably taught me a lot more, missing that medal,” he says, speculating that winnin win ningg might mig ht have hav e made mad e him complac comp lacent ent or a bit lazy. Sometimes one of the biggest barrie bar riers rs to success suc cess can be feeli fee ling ng satisf sat isfied ied to be among the best and simply stop there. The visceral stab of disappointment that comes from failure can be a better stimulus
IESEinsight
WIDER insight
for pushing you forward. Sinclair believes “it’s important in life to always be chasing something because it keeps you strong.” strong .” If you’re satisfied satisfi ed with mediocrity, you won’t just stay where you are, you’ll go backward. You need to take the disappointment and use it to help you win the next race. “I’ve raced against some of the greatest people in history – Ian Thorpe and Pieter van den Hoogenband. And every time I stood on the blocks I believed I could beat them. People might have thought I was arrogant or deluded. But I truly believed that I could go on and beat those guys.” How often do you play at second best simply because you you don’t believe you’re you’re good enough? And might this defeatist attitude attitud e be limiting limiti ng your performance and keeping you from ever competing at the level of the big leagues? See the sidebar “I Don’t Do Negativity.”
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
Staying Afloat All heroic heroi c epics need an element eleme nt of toil and struggle – to a point. For your own sense of health and wellbeing, you need to keep things balanced bala nced and in perspectiv persp ective, e, otherwise other wise you k c o t S i / a l a b a l a h C
Sinclair: “I love getting up early on Christmas morning and going training. It’s training when other people aren’t training. Those sorts of things keep you one step ahead.”
IESEinsight
risk getting burned out. “You have to have a life and make time to go out and have fun,” admits Sinclair. As important as it is to combine your dedication to your profession with a life outside, you have hav e to learn to do it on your own terms, without with out compromis compr omising ing your devotion devo tion.. For example, if you’re going out with people who don’t share your same concerns, you have to be a bit more self-disciplined. self-disciplin ed. “When I was going out with friends who weren’t athletes, I would still make sure to eat well and look after myself as I knew k new my perp erformance was at stake. I once went to a party, had a ball, but then changed into my trainers (sneakers) and went for a run afterwards.” Working Workin g hard doesn’t doesn’ t mean you have to rule out a social life; you just need to adapt it to your own agenda. “I love getting up early on Christmas morning and going training. It’s training when other people aren’t training. Those sorts of things keep you one step ahead.” Technology No Substitute for the Basics Technology has revolutionized the world of competitive sport as much as any other field. Underwater camera technology, for example, has considerably increased the reach of coaches. As most of the stroke techniques take place underwater, the analysis is now able to be much more all-encompassing and precise. preci se. Yet while whil e techn t echnology ology has upped uppe d the t he posp ossibilities for analysis, it’s important not to exaggerate what it can do for you. “I love technology,” says Sinclair, “but you can’t depend on it. A bit of equipment comes out and you think thi nk you have ha ve to go out ou t and buy b uy it. But B ut if you haven’t got the basics bas ics right, no amount amoun t of technology will help you.” Sinclair likes to keep it simple, because being the best, b est, he argues, ar gues, is ultimat ul timately ely about ab out being the best b est at a t the th e basics. bas ics. “Michael “Micha el Phelps Ph elps does the simple things in swimming better than everyone else and that’s why he’s the best. It’s not because becau se he has the best equipequi pment; it’s because he’s amazing at the simple things like starts, turns and dolphin kicks. He has just perfected the essential things.” “Throughout my career, I pushed myself to the absolute limit. Until you go to that limit, you’re not n ot going to understand unde rstand things and be able to reach your potential.” Lydia Smears, Smears, former Assistant Editor of IESE Insight magazine, interviewed Edward Sinclair for this article.
ISSUE 21 SECOND QUARTER 2014
75
Need help with your business strategy? Time to return to the timeless wisdom of the founding father, H. Igor Ansoff (1918-2002).
LAST INSIGHT
Strategy That’s Off the Chart
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T
mathematical background, he sought to structure, model and formalize his business findings in a scientific manner. by Massimo Maoret He essentially opened a new field – strategic management – and as one of the founding editors of the Strategic Management Journal, he gave it an audience. Ansoff’s approach to strategy stands apart for two reaTHE MAN CONSIDERED TO BE the father of strategic sons. First, he focused on the needs of the end user – namemanagement, H. Igor Ansoff, who passed away 12 years ago ly, practicing managers. His theoretical models pulled off this July, left his mark with business research that was not the twin feat of being as general as possible – applicable only academically rigorous but also directly applicable to to for-profit and not-for-profit organizations alike – while managers. In this sense, he would have made a welcome also being practical, with his rigorous theories accompacontributor to IESE Insight magazine. nied by summary tables, flowcharts and Born in Russia in 1918, Ansoff trained checklists. He never lost sight of helping as an engineer and a mathematician. As managers navigate the relationships cona thinker, he introduced the world to necting his concepts, and then using that seminal management concepts such as understanding to take action. “competitive advantage,” “organizationSecond, Ansoff injected a strong orgaal capability” and the “Ansoff matrix” – nizational flavor into his views on strathis product/market matrix for mapping egy and its implementation. For instance, growth alternatives. He specialized in he studied how to overcome organizathe behavior of complex organizations tional resistance to strategic change and in turbulent environments, looking for analyzed the role of organizational power determinants of success – a specialty and politics in defining and implementH. Igor Ansoff (1918-2002) that would only grow in relevance over ing strategy. the years. He was a prolific author of books and Before becoming a professor at Carnarticles throughout the ’60s, ’70s and egie Mellon University in 1963, Ansoff worked as a general ’80s. Throughout that time, he never lost touch with manager at Lockheed, the U.S. aerospace company. This the real business world in all its complexity. And during practical experience had a deep impact on his later work those decades, there was plenty of complexity and indusin academia. trial change. Ansoff investigated whether the problems and chalHis 1976 book, From Strategic Planning to Strategic Manlenges that he faced at Lockheed were unique or general- agement , first outlined a “strategic success hypothesis,” izable, taking into account the business environment and which he elaborated on in subsequent works. The idea was functional inputs, such as marketing and R&D. By borrow- that success could be realized when “strategic aggressiveing the scientific method’s tools of theoretical generaliz- ness” and “general management capability responsiveability and empirical validation from his engineering and ness” were aligned with the prevailing “environmental turbulence” level – from 1 (“repetitive”) to 5 (“surpriseful”). Environmental Turbulence 1. Repetitive 2. Expanding 3. Changing 4.Discontinuous 5. Surpriseful No doubt, many industries Levels today are experiencing turbuEntrepreneurial: Anticipatory: lence level 5, and his call for creStable: Based on Reactive: Based Based on Creative: Based Strategic Based on Aggressiveness Precedents on Experience Expected on Creativity ative strategies coupled with Extrapolation Futures flexible management in such General an environment remains just Custodial: Production: Strategic: Flexible: Seeks Management Marketing: Precedent Efciency Environment to Create New as applicable to today’s generaCapability Market Driven Driven Driven Driven Environment Responsiveness tion of business leaders. Massimo Maoret is an assistant professor in the Strategic Management Department of IESE Business School.
76
SECOND QUARTER 2014 ISSUE 21
IESEinsight
ART WITHIN THE CAMPUS. MUSEUM UNIVERSITY OF NAVARRA www.museumuniversityofnavarra.com
) 4 1 0 2 ( A B M E S E I r o f y p o c l a n o i t o m o r p a s i s i h T