Pt. 4: Managing for Shareholder Value - Getting Serious

So far in this series of blogs I’ve been pretty lippy.  Frankly, I just wanted to get your attention.  At this point, however, I either have it or I don’t, and it is time to get on with the real work.  So, no more smart remarks.  Just one man’s attempt to prescribe a set of leadership behaviors that he believes will create 100%+ changes in stock price within a timeframe relevant to the current management team. 

In this post we are going to look at the challenge of prioritization.  Recall that in the last post I claimed the only way to create a net new earnings engine and grow it to a material size within a timeframe relevant to the current management team was to make it the exclusive focus of the entire corporation for the duration of the transition.  How in the world could you actually do that?

The first thing you have to do is select, and more importantly align around the selection of, the new earnings engine you will accelerate.  There is both a time and a method for this.  The time is the second quarter of your fiscal year.  This is the only quarter in which you have the bandwidth to devote to really strategic decisions.  By contrast, every other quarter is in one way or another in service to an annual plan.  That is, the first quarter is all about getting out of the gate fast on the current plan, the fourth quarter is all about doing whatever it takes to make that plan, and the third quarter is all about positioning for the next round of budgeting for the following year’s annual plan.  Only in the second quarter is there no immediate competition for executive mindshare.

This is key because the single biggest enemy of breakout growth initiatives is the annual plan.  The former are all about optimism and entrepreneurial risk and great expectations, the latter about skepticism, risk hedging, and no excuses commitments.  Both are core to the long term success of any enterprise.  They just don’t play well together. 

OK, so say you’re in Q2 and you are ready to give this your full attention.  Now what?  To tee up the right dialog you need to put all the potential net new earnings engines on the table and categorize them into one of three ROI horizons. 

• Horizon 1 means that resources invested this year will create a payback in this same year. 
• By contrast, at the other end of the spectrum, Horizon 3 ROI means that resources are being invested to create future options, things too early to call in terms of when, or even if, they will create a payback. 
• Between the two of these, Horizon 2 ROI options require that resources be invested this year in order to create a payback next year and a much bigger payback the year following with one bigger still in the third year out. 

Horizon 2 is the “escape velocity” initiative horizon, the one that can be occupied by one, and only one, earnings engine for the duration of the journey to materiality.  Everyone gets the logic of investing here, but it is highly dilutive to the current annual plan—hence the need to choose wisely and on a restricted basis.

Now, suppose you are, say, a $10 billion enterprise with two major earnings engines in your core, and a number of candidates looking to become the next big thing.  Some of these will hail from within the divisions running your core business, others will have been incubated outside, and there may even be a recent acquisition or two that nominates itself for this role as well.  The point is, there is likely to be serious competition for this one slot, so much so that most executive teams cave in and launch two or more in parallel.  Per my last post, however, this is a 100% failure mode and must not be allowed.

So what to do?  Well, first you have to agree as a management team on which of the options in play—if any—is worth the all-in effort it takes to birth a net new earnings engine and get it to material size.  You want champions for each candidate to advocate like crazy, but at the end of the day, you have to stack hands around one and only one.  What criteria you use will likely be business specific, but the most obvious generic one is growth potential factored by risk.  When you factor in the opportunity cost—you only get two or three bites at the apple in any given decade—it should be a high bar, and there is no shame in deciding that this year we have no Horizon 2 horse in the race.

But let’s say you do clear the bar.  Let’s say you have picked the horse you will ride and are genuinely aligned around that choice.  What are your options with respect to all the other candidate businesses?  I think there are three that are both realistic and recurrent:

1. You can keep them on hold in Horizon 3, nurturing the technology, doing advanced projects with flagship customers, but not impinging on your primary go-to-market resources.  In short, it does not cost you much to keep spending R&D in the factory; you just cannot afford to distract the field.  Your intent is to ready one or more of these to be the next “next big thing,” ensuring for the present that they do not compete with the current candidate.
2. Alternatively, you can fold them into one or another of your current Horizon 1 earnings engines.  This will inevitably involve some dumbing down of their ultimate possibilities—they will never become net new earnings engines this way—but they may be able to make considerable contributions to your current earnings engines.  Said another way, they won’t ever change the P in your P/E ratio, but they can change the E, often quite appreciably.
3. Finally, if the candidate business really is in a “now or never” state, and for you it is a “not now” alternative, you can—and should—spin it out.  The key here is that you really do have to let go.  Yes, you will keep an equity stake, and yes you can dream of bringing it back into the fold at a later date, but the truth is, to raise the capital it will need to succeed, it will have to dilute your stake considerably, and if it succeeds in the end, it will be very pricey to buy back.  Nonetheless, this is far better choice than letting it die on the vine inside the firm, thereby creating a boatload of ill will and bad morale.

So much for prioritization per se.  I’ll have more to say about the ways and means of managing the rest of the Horizon 2 initiative workload in later posts.  But for now, that’s what I think—what do you think?

Geoffrey Moore

Escape Velocity

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