Visions and Strategies, Finance Metrics, and the Execution Gap
Broad visions and grand strategies are a wonder to behold. Who hasn't felt like they were making a difference in their company by helping to develop a "strategic plan"? You might have felt the excitement after participating in the presentation or viewing a PowerPoint presentation that outlines your company's strategy, often by providing examples of what "worked" for a different company at a different time. It seems so simple: All you need to do is adopt those best practices or the strategies identified at the winning companies, and your company, too, can achieve sustainable growth in revenues and profits that will create value for your shareholders. What's not to like?
The problem is that vision statements and strategies are broad, sweeping generalizations. They are important, but at best they provide only a framework and the starting point for creating shareholder value. At worst, they become the standard reference point that people in a company use to support and justify almost anything. In fact, sometimes it seems that vision statements and strategies are like horoscopes, always offering advice that is general enough to apply to everyone, but not specific enough for anyone to really act on the advice.
At the other extreme from vision statements and strategies, finance-based metrics, like ROI, provide a proven methodology for allocating scarce corporate resources. The methodologies of finance are straightforward and logical: gather the data, do the analysis, get the answers, and make the decision. The analysis and results can be easily replicated, and the facts are on paper. The facts resulting from financial analysis appear to be black and white, and, therefore, some people argue that financial analysis and ROI are the way to allocate corporate resources.
If you have sought corporate resources for an investment in new plant and equipment or personnel, you probably have experienced the process, sometimes painful and always time consuming, of building the business case for the investment. (A business case is essentially a financial model showing that the financial returns to the company will exceed the cost of the investment.) Outside of a general reference, broad strategies and visions have no standing in the development of a business case: it is numbers pure and simple. Still, the finance department can, and usually does, say no.
Unfortunately, finance metrics, the key variables in business cases, often do not mean much once the investment is made. Consider the Quaker acquisition of Snapple. The deal was easily justified by financial projections. Unfortunately for Quaker share-holders, the projections did not take into account the fact that Snapple did not fit into Quaker's business model, which was focused on the supermarket distribution channel, rather than Snapple's target channels of small retail stores, restaurants, and delica tessens. In less than two years, the value of Snapple declined by more than 75 percent, based on the price paid by buyout firm Thomas Lee & Partners. A short time later, after rebuilding the value Quaker had inadvertently destroyed, Thomas Lee & Partners sold Snapple to Pepsi for a sizable profit. From the perspective of Thomas Lee & Partners, it was a tremendous deal. Needless to say, for Quaker shareholders it was anything but a good deal, and many senior managers left Quaker. Quaker is now a division of Pepsi, largely as a consequence of the failed Snapple deal.
More recently, AOL Time-Warner decided to drop AOL from its name. This decision was obviously more than a name change; it acknowledged the failure of the merger between two very different companies that was supported by extensive financial analysis. The stock price of AOL Time-Warner has fallen more than 70 percent from the time of the merger and, as of late 2003, was not worth much compared with the value of Time-Warner itself prior to the merger. These numbers are particularly astonishing when you consider the accolades that AOL and Time Warner managers received from institutional investors (the people who manage pension fund money) and the business press at the time of the deal. Statements like "deal of the century" and "merger of the new economy and the old economy" were bandied about, and Ted Turner, the largest single shareholder in Time-Warner, compared his enthusiasm for the transaction to his anticipation of losing his virginity in his youth. The failure of this deal has already been and will continue to be fodder for numerous business books and business magazine articles.1
A tremendous number of acquisitions fail to achieve their expected financial returns because management does not execute the investments within the overall context of their organizations, people, and strategies. They seem to ignore that the real issue is making the acquisitions work. The critical execution issues are related to the who, what, when, where, why, and how of the deal, particularly in relation to bridging the gap between the financial analysis and the grand statements made at the time of the deal.
The limits of financial metrics as decision tools are not just apparent with mergers and acquisitions. More often than not, information technology investments are supported by financial analysis framed in the context of the technology, rather than the more important and critical issues of how the investment will leverage the existing strengths and competitive advantages of the company. Consider the investments that many companies have made in customer relationship management (CRM) systems. Many of these CRM systems were implemented without sufficient input and participation by the primary users (the sales forces), a critical execution-related factor. Monster.com, for example, spent more than $1 million to acquire and implement CRM software. The resulting system was so slow and difficult to use that the Monster.com sales force simply stopped using it. Monster's experience is not a rarity. Many large banks have invested in CRM systems and received zero or only minimal returns, even excluding training time and costs for their staffs.
Even research and development (R&D) investments that are justified financially might not provide the expected returns to shareholders. Several researchers have found no relationship between a company's investment in R&D and positive returns to investors. Look at the returns to the respective shareholders of Dell Computer and Sun Microsystems as an example. As Figure 1.1 indicates, Dell spends much less on R&D as a percentage of revenues than Sun Microsystems. In the past 10 years, however, Dell shareholders have received more than 10 times the financial returns of Sun's shareholders, reflected in the market capitalization of the two companies, shown in Figure 1.2. A dollar invested in Dell in the early 1990s would have returned to its investor more than 10 times the amount of a dollar invested in Sun. As of late fall 2003, Sun was trading at less than $4.00 a share, significantly less than its highs of a few years ago. One indicator of the company's difficult position is that it has reported a tenth consecutive quarter in which revenues were lower than the comparable quarter for the previous year. The stock market has apparently decided that Sun has too far to go from its visions to the reality of growing revenue and profits.
Figure 1.2. Market Capitalization for Dell and Sun Corporations
Dell spends significantly less on R&D as a percentage of revenue compared to Sun, but Dell has a much higher market capitalization. Although spending on R&D tells only part of the story of the differences between Dell and Sun, there are many other examples that reinforce the point that investments in R&D do not necessarily result in increased company value. Consider IBM, which in the late 1980s was investing more in R&D than the rest of the computer industry combined. In fact, IBM's R&D spending was eclipsed only by that of the federal government. At the same time, the flow of products through IBM's pipeline was barely a trickle, compared to other technology sector companies, and the company's market capitalization suffered as a consequence. By the late 1990s, IBM had cut its investment in R&D as a percentage of revenue by more than a third; at the same time, it substantially increased its flow of new products, and returns to shareholders increased dramatically.
The limitations of financial analysis have been well documented by others. You might be familiar with the Balanced Scorecard, an analytical framework developed by Robert Kaplan and David Norton that provides an alternative approach to what they label the "traditional financial accounting model" for measuring and managing corporate performance.2 Kaplan and Norton advocate that financial measures are important, but that other factors drive corporate success as well. As evidenced by the great success of the Balanced Scorecard in the marketplace, they are absolutely correct and, indeed, financial analysis is necessary but not sufficient for achieving corporate strategies.