Relationships and Shifting Contexts

One of the benefits of my work is the opportunity to work with some outstanding people throughout the country. And as diverse as any population segment in America is, there are some common, not universal, traits. One of those is small and medium sized enterprise operators (SME’s) tend to make decisions based on more social reasons than business reasons.

A client is currently unraveling some decisions made over the years and as we are working through these, a distinct pattern began to emerge. The client had business and social relationships who were shifting the context of the interactions and the client was not quickly “putting on the business hat” to make better decisions.

This is a simple box graph illustrating the Relationships and the context of the interactions. Business relationships with business oriented interactions as well as the social/social interactions are straightforward. Where I have seen missteps is where a social relationship begins to shift the interaction to a business context and before the SME realizes it, they are making a decision based on the social relationship and not necessarily the best business decision.

I have been using this with those clients simply to illustrate to them the segments and provide “tools” for them to use when they find themselves in a shift.

What’s up with that Yellow Dot?

Prahalad and Hamel wrote about monkeys in a cage undergoing operant conditioning as a lesson to the development of corporate culture in the book Competing for the Future. Researching this on the internet for factual basis led to several articles and blogs denying the events ever took place. It is a fascinating story and if the reader has not read it, it is worth a few minutes. Whether the Prahalad and Hamel monkey experiment is indeed factual, I do not know. But I have seen this played out in real time on consulting engagements with clients.

There is a particular occurrence to note. One day while touring one of the plants with a new client. He was proudly showing me the machinery, the dedication to continuous improvement processes and really showing off his people. Bragging wherever he could. And let me say, this client had a lot to brag about. This plant was one of the most productive plants, with engaged employees. I was encouraged to stop and ask randomly about important financial results of the company and what they meant. The employees seeing the pride in the client were only too happy to oblige in this play.

While reviewing one of the production lines I stopped and asked an employee who was placing yellow dots on completed units “What is the purpose of placing those yellow dots on the units?” He didn’t know. His response was “When I started here three years ago, I was trained to place them there.” The client sensing the visiting consultant had stumbled on one of those precious veins of opportunity quickly jumped in. He asked “Where do you get these dots?” “From the shift supervisor.” Good, the shift supervisor was someone we were going to see soon. Meanwhile, we asked downstream in packaging and shipping, “What is the purpose of those yellow dots?” No one seemed to know. What was more, the yellow dots did not serve a purpose or contribute to meaning of anything to anyone. So off we went to the shift supervisor. Hopefully going upstream back to the headwaters of the issue we would find answers.

The shift supervisor did not know the purpose of the dots. But added that when he was trained here seven years ago, it was pressed on him to make certain the front office supplied him with enough of them. He even commented that the front office held on to them as if they were vital raw material inventory. The plant manager did not know the purpose of those dots. As you can imagine now we had a retinue of employees all asking the question “What’s up with those dots?” Back to the shift supervisor “Who supplies those dots to you?” It turned out one of the front office employees was the supplier.

We all walked to her station all curious looking for the source of those dots. She, sensing possibly a village revolt was nervously answering “I don’t know how the dots get used, or what their purpose is.” She only knew from the lady who trained her in her role twelve years ago that she better never run out of those yellow dots. So each week she would open this large metal cabinet drawer dedicated to warehousing these seemingly important yellow dots and count them. Further, if they ran low, her mission was to run out to the office supply depot and purchase more on her lunch break. Sometimes as the plant seemed to use up some colors more than others, she found herself in fire drill emergencies rushing out to resupply dwindling supplies of dots. She commented about the constant struggle with the plant consuming the dots without her knowledge and the vital stock running low jeopardizing the entire enterprise.

By now we are all laughing with tears running! Some of us had trouble talking and breathing! She was aghast and didn’t appreciate this, I’m sure. It was after all an important duty for her. The retinue of the yellow dot curious were otherwise entertained with the idea that for a minimum of twelve years the company had dedicated resources to processes that no one can remember how they were begun nor why. Further, no one ever questioned “why are we doing this?”

The client walked around the rest of the day with a dot on his glasses hoping others would ask “What’s up with the dot?” His response “YOU TELL ME WHAT”S UP WITH THE DOTS?”

So, I do not know if the monkey cage experiment is true, but I have seen what Prahalad and Hamel were referring to the development of corporate culture.

Jobs! Jobs! Jobs!

My daughter has a part time job in Savannah where she is attending college. The owner announced he was closing the store this quarter. Skype’ing with her this weekend and I asked “What would you do differently if you owned the store?” Her response was “The location is terrible, clear out inventory that has been sitting for a year or more, bring in offerings that tourists will buy and don’t let family members come in and take the top-selling products home.”

What makes this so notable to me is that she is an art history major never having expressed a business idea in her life! You don’t have to have an MBA or a business degree to offer some good insight. The point is there are now five jobs that will be eliminated soon unnecessarily!

Right now the National Debate is how to stimulate the economy to create jobs. Can the Nation afford it? If small and medium sized business owners and managers can not make better decisions than the ones my art history daughter identified, then maybe we are focused on the wrong question.Is it possible that the economy and easy credit policy prior to the recession allowed business owners to operate longer than they would otherwise? Are we seeing an unwinding of the excess of marginal businesses that will exacerbate the employment trends in the U.S.?

If there was a job plan today creating 100,000 jobs per month, yet 20,000 businesses go under with an average of 5 employees, then we have made no progress. Twenty thousand businesses going under each month sounds unbelievable. Think about it this way. That means 400 businesses per State going under each month. In the State of Florida, that is an average of a little more than 6 per county each month. Does that sound so unbelievable now?

Should we be focused more on creating opportunities for new and existing businesses, educating business owners and providing credit to those who will seize the opportunities? And less on the current debate?

Management Does Matter!

Early this morning as I opened my email, there were a few unhappy comments from former colleagues at UBS. It seems there has been a rogue trader who lost and covered up (all allegedly at this point) $2 billion in trading losses. Besides the fact there will be consequences throughout the company for those employees who had nothing to do with the trades (stock options, awards and bonuses not being paid this year, etc), there is a general sense of “Aw man! When are we going to get it right?”

As I thought about the question, it occurs to me “What does ‘get it right’ mean? As a management consultant our goal is to increase the economic value added to the enterprise with whom we are consulting. Meaning, we want our efforts and implementation to add value above and beyond the value the enterprise would have gained without our involvement. For those quantitatively minded out there, this means adding alpha. Senior Managers of publicly traded are expected to add value by making good decisions.

Another way of looking at this is through the lens of the mutual fund industry. The first mutual funds were actively managed. Professionals were paid to invest because they had knowledge, access and abilities not available to everyone. So they were paid well for it. The fund industry grew through to the 70’s when a certain Mr Bogle at Vanguard realized professionals weren’t providing value by outperforming the market, so why pay for it through high fees to the professionals? Thus the index mutual fund industry was born. Passive returns at a low fee to get near-market returns consistently.

Take this concept to the company level. Assume a hypothetical investor has the choice of buying but one company completely or putting the money into a market index representing a basket of managers of companies. Will the managers of the one business make decisions that will lead the company’s results to outperform the index representing a basket of other professional managers? And how do we measure the impact of their decision making? I recommend using the principles of economic value analysis.

Using UBS’s Annual Reports for the years 2006 to 2010, calculating the increases or decreases in market value and comparing it to the returns for the Dow Jones Industrials during the same period a couple of interesting items pop out; 1) UBS had a market valuation of $127 billion at the end of FY 2006. By the end of FY 2008 the market valuation was $42 billion. A drop of $85 billion. Remember UBS had to write down $50 billion in equity due to toxic assets. The extra $35 billion resulted from investors bidding the shares down in price as a result of the write downs (read: senior management decisions adding negative alpha). 2) Since the end of FY 2008 UBS has added a little more than $12 billion in market valuation through the end of 2010. That same equivalent investment in the Dow would have gained just under $14 billion (read: new management making decisions adding positive alpha).

Lessons to learn from this, management does make a difference! An area that does not receive enough attention is an analysis of the senior management team to the same level as all the spreadsheets analysts use to analyze companies. Another lesson, there is a way to measure the effectiveness of senior managers, I recommend Economic Value Analysis for measuring that impact.

DJIA Coppock Curve Update 8.31.11

Coppock Curve 1970 to Today

As expected the Coppock Curve declined ever so more slightly again this past month. Momentum is really being drained from the market. This does not rule out rallies, we expect them. With the economic backdrop and news expect more volatility. We are working on calculating Coppock Curve data for other markets since there is a proliferation of data. Stay tuned for more.

* The information here is for informational purposes only. Consult your Advisor *

Financial Services meet Porter’s Five Forces

Porter’s Five Competitive Forces meets the Financial Services Industry.

(If you would like more on Porter’s Five Competitive Forces, please join the conversation on LinkedIn under groups Porter’s Five Competitive Forces)

According to Michael Porter the Five Forces at work within an industry can be evaluated to explain that industry’s potential profitability. As an industry creates industry profits the participants of each of  the five forces will ‘conspire’ to siphon profitability from that industry. Blue Ocean Strategy is a related body of this work and is used to relocate a company from a red ocean (intense rivalries) to a business strategy where the five forces have not matured or may not mature. I want to introduce a new concept, brown ocean. One where the business level differentiation is not based on price, but marginally on the value side (i.e. small and marginal differences in company policy, costs, fees, relationships at the point of consumption, locations, recruiting of talented employees to gain their clients etc.). The perfect industry to illustrate a brown ocean is the financial services industry.

A quick review of those five forces:
1.Threat of new entrants. If there are not enough barriers to restrain entrants, enough new entrants may emerge to lower the profitability from the incumbents.
2.Bargaining power of suppliers. If the suppliers are powerful enough, they may raise their prices, decreasing their customer’s (industry in question) profitability.
3.Bargaining power of buyers. If the buyers are powerful enough they will demand lower prices from the industry and thereby lowering profitability.
4.Threat of substitution. If the industry is not just competing against products and services of their direct competitors, but also industries where the customers can meet their needs.
5.Intensity of rivalry. If there are enough players who are equally resourced for a fight, it could move to cutthroat competition.

Now let’s overlay the five forces on the financial services industry. The players are well known as Bank of America, Morgan Stanley, Wells Fargo, Citigroup and UBS on the mass-market side. On the niche player side, there are regional companies like Ed Jones, Stifel Financial and Morgan Keegan to name but a few and there are the independent broker dealers, discounters, insurance companies, private banks and trust companies competing for many of the same investors. The five forces look like this:

1.Threat of new entrants. There will not be any new large mass-market players or niche players bursting on the scene, but there will be new independent broker dealer players as well as discounters, banks, insurance companies and credit unions. Count as well the independent shops where a broker can set up shop literally overnight. The costs of self clearing, recruiting, staffing, technology etc. prevent any new mass-market or niche players from coming on the scene. The number of sub-industries developing within the financial services industry has seen dramatic growth over the last couple of decades. With the fall of Glass-Steagall, the barriers to entry fell impressively. Within each sub-industry, there are few barriers to entry to prevent rapid growth. For instance, almost anyone can get a job with an insurance company selling insurance. They can then get licensed to sell securities (mutual funds and variable annuities). Within the banking system, many client facing employees have at least a Series 6. Then within the independent/regional and warehouse industries, the only barrier is the ability to pass the securities exams. Not a barrier really, more like a speed bump.
2.Bargaining power of suppliers. Who are the suppliers to a business based on intangibles? Mutual fund companies, hedge funds, other broker dealers in structured deals, separate account managers, life insurance companies and companies looking to go public, and believe it or not, Advisors fit in this category. Their bargaining power has grown over the last 20 years from not being paid to move, to deals of up to 300% of their trailing 12 months production as well as commission and fee payouts and benefits. Today these mass-market firms must pay their Advisors to stay at work on top of salary, bonuses and benefits. They are called retention bonuses. Mutual funds, insurance companies, money managers can gain access to the various firms, but to be in a preferred list, these entities have to pay a little extra. This is to gain a good spot on the shelf, eye level. Here the heft of the wirehouses can gain the firms more credibility when demanding the shelf space fee (update:WSJ article of firms raising fees to fund companies).
3.Bargaining power of buyers. Shifted dramatically toward the favor of the buyers. Gone are the days when the industry had all the information. I remember in the 80’s the phone would ring at night and the weekends with investors looking for an explanation for the drop in AT&T’s stock. The newspaper was the only place to get a quote then and if AT&T went ex-dividend it used to be enough to create a call. Along comes the internet and now the buyers have access to faster, better and more clear analysis and information than the industry itself provides to Advisors. As if that were enough, now there are multiple sources of information the investor can access. While their Advisor is stuck with being able to only supply the firm’s individual-investor-digestible research.
4.Threat of substitution. What is it the firms in the wealth management industry provide? Wealth transfer, wealth preservation and wealth creation. Wealth Transfer can be handled by insurance companies, and they do a lot! Wealth Preservation by banks, trust companies, life insurance companies. Wealth Creation in this country has always been through the creation of businesses; long, slow disciplined investing; luck with corporate stock options; real estate and other non-financial markets; all of these not the domain of diversified financial services companies. Financial Services firms are not the place where investors go to become wealthier. It is the place wealthy people go in hopes of maintaining their wealth.
5.Intensity of rivalry. These companies raid each other’s local shops offering checks ranging from 200% to 300% of the financial advisor’s trailing 12-month production. One company I worked for had about 6500 Advisors in the 90’s. Recruiting wars were heating up then. Fast forward 13 years, they still have about 6500 Advisors despite 3 acquisitions and 13 years of recruiting. The industry has been completely neutered in the equity research departments since 2003; there was a time when the quality of research was a differentiator and the competition to offer the best advice was furious. There is no competition to be the lowest cost provider, competition on prices is left up the advisor sitting in front of the client for the most part. At the firm level, there is almost no way to distinguish the client experience from one to the other on the mass-market side, other than brand.

Just as you would expect from behaviors predicted by the Sheth Model, the large mass-market participants compete for market share at the expense of financial performance following and sometimes leap-frogging the leader. The niche players, those whose plan is to play for a small niche can do so far more profitably. Compare the stock performance, ROE, ROA, etc. of UBS (UBS), Wells Fargo (WFC), Morgan Stanley (MS), Bank of America (BAC), and Citigroup (C) to Stifel Financial Group (SF).

Between these two industry participant groups lies the “ditch.” This is the place where the companies who are too big to be a niche player and too small to take on the mass-market find themselves sliding. “The Ditch” is a place where many never return. A question to ask, will the market reward innovation? A review of an article and the associated research from an MIT Sloan Review, The Business Models Investors Prefer provides insight. Also, those firms who have not built strategy and executed it to combat the 5 competitive forces, will be found in the ditch.

The only real differentiator for investors to choose firms is the individual advisor. Any investor can go into a single branch office and find a different experience for every Advisor in that particular branch. The choice for investors is not based on the capabilities of the firms, yet really and almost always based on the relationship with their Advisor. The time has come for the financial services firms to innovate. The last real game changing innovation was Merrill Lynch’s rollout of the CMA account. Since then the ‘innovations’ have been self serving to the firms. The names on the tombstones of offerings and product failures stretches back past the recent real estate bubble. With the differentiation coming down to each individual Advisor, all competing against each other (also within the same branches and firms) without the ability to compete on a unique product or service offering, the ocean is a brown hue through and through.

From this brown ocean who is poised to break out into a bluer ocean? Again, look to the Sheth Model to predict who is the best positioned to make the innovative move? It would be the one closest to the ditch (for fear of slipping into it) with the most resources. In this case it’s UBS. If there is a chance to innovate profitably it is their’s for the taking. But it will require a competitive strategy built to combat the competitive forces and innovation. WIthout those, the future is certain it is only a matter of when.

I have a client who has over 30 years experience in the construction industry. Very competitive and not a very profitable industry. This client moved to a blue ocean. Needless to say, his results have been outstanding versus his peers for the last 18 years. Here is a chart of the differences in the five forces in the two industries, the one he created and the financial services industry. The wider one is the more profitable one.

The financial services industry will need to make decisions like this client. The only thing lacking is a clear strategy.