Friday, February 24, 2012

Bill George Talks About True North Groups

Bill George, philanthropist, Harvard Business School Professor and former CEO of Medtronic, made a presentation last night with his partner Doug Baker of the True North Institute.  There were so many ideas to chew over, and it was a very candid presentation, which isn't easy to summarize.

The overarching problem, they said, was to reestablish public trust in business.  With tongue in cheek, George said that it's not possible to reestablish trust in politicians, and since there were no messiahs forthcoming from either party that business would have to continue to innovate and grow so that there would be a better economic future for all.  

George made a very important distinction: he believes in, and lived his career in stakeholder-based capitalism, which history shows is the most sustainable model for economic and social development.  He cannot abide what he rightly calls "crony capitalism," which is what ran rampant, especially in the global financial services sector. 

He also had little use for a public company governance model which drives every decision on shareholder value, or what he called "the shareholder for the last five minutes."  To paraphrase what I heard, the response of George and Baker is come up with a way to nurture, nourish and grow the current and future generation of leaders.  Executive education programs, like that of the Harvard Business School, have quite a good business doing just this: of the 5,500 executives who have come through HSB executive programs, 63% have been in leadership track programs.  So, the speakers were talking about another mechanism for achieving their goal.

Although George mentioned Enron, the parade of bad actors has continued and become even more toxic.  Think about Bear Stearns, Lehman Brothers, AIG, Countrywide Financial, Washington Mutual,, IndyMac Bank, and FannieMae, to name a few.  Speaking as a former CEO of a large global medical technology company, he believes that failed business leaders lose both self-awareness and a grounding to their core values. 

George himself has incorporated ideas from the work of Dan Goleman on emotional intelligence (EI) versus IQ.   Goleman, in turn, incorporates meditation techniques into some of his training for children and adults.  So, George has developed a personal practice of meditating twice a day.  He also keeps a daily journal.  Finally, both George and Baker believe that it is critical for leaders, but I would say for most of us, to have a small, trusted group of people who are trusted advisors and confidants, with whom we can openly discuss our most important issues.  These groups are called True North Groups, and the presenters talked about practical issues in forming, kicking off and maintaining a True North group, which would serve to nourish, sustain and ground its members according to shared values. 

Here's a list of some ideas George and Baker discussed:
  • The group should be composed of people whom you trust, like and are willing to learn from. This is an "HR issue" in the beginning, i.e. selecting members based on individual and team criteria;
  • Every member has to commit time to attend, prepare for meetings, be open, always maintain confidentiality, and be ready to offer support at any time;
  • All members sign a contract clearly stating required commitment and expectations and are held to it;
  • Ethical behavior is something that has to be modeled by all members of the group, both inside and outside.  A team can't have members who are excessively needy, because others will fall away over time.
  • Early groups met weekly, but this may not be possible.  Minimum commitment to have an effective group is 4-5 hours per month.  A meeting should be about 1 1/2 hours.
  • Have a prepared agenda set and circulated for every meeting; rotate this responsibility each meeting;
  • Never stop challenging your assumptions about the world and about yourself;
  • Everyone should initially tell the other members their life stories: where did you lose your way in your professional and personal lives?  what were some of the crucibles in your life? if you could find a sweet spot where your professional and personal goals were perfectly aligned, what would that look like? what do you do to empower others?
  • Stay away from newspaper issues.
  • A True North group is not a spiritual group or a book club, although some early groups came out of spiritual groups.
  • Active listening and the ability to give non-judgmental feedback are critical attributes of good team members.
The True North Institute offers books, articles and personal guidance in setting up groups, as well as a calendar of public events talking about the concept. 

I'm doing some research on the IndyMac Bank collapse as a possible business school case study, and in the research process I am really questioning something Bill George raised early in his talk.  What if we are permanently in a "crony capitalism" model?  If public figures can skim hundreds of millions in executive compensation based on bogus earnings and a share price which eventually collapses, without civil or criminal prosecution, by taking a plea and paying a fine/tax on your ill-gotten gains, why not do this as many times as you can?  If you read some of the written material and testimony from some of the worst actors in the subprime mortgage lending meltdown, they don't believe they did anything wrong.  Would having been in a True North group have changed Angelo Mozillo?  Who would he have chosen to be in the group with him?

I guess that we are back to self-awareness, or the lack of it.  But really, we are talking about the lack of a real moral foundation.  Such a foundation cannot, it seem to me, rest on business values alone.  There's the rub.

Thursday, February 23, 2012

Hot Air From HP

I  read the press on HP's quarter, and a quick six month comparison on Yahoo, using Cisco and Dell as peers, shows Cisco up about 30% and Dell and HP about dead even at some 17%.  HP was indeed a good trade at $25, where it showed strong support and an accumulation pattern.  The jury is still out on value creation.

From prior pronouncements, it seemed obvious that CEO Whitman was being counseled to tamp down expectations as low as possible; her characterization of HP as a GDP driven growth company may have been in that vein.  On the face of it, the current quarter is disappointing even against the dismal guidance.

The Wall Street Journal reported these comments from CEO Whitman:

"Ms. Whitman was named CEO in September after the board fired Leo Apotheker, in part because of his decision to pursue a spin out of H-P’s PC business. Ms. Whitman, who was already on H-P’s board at the time, approved Mr. Apotheker’s decision, but on Thursday sought to distance herself from it. The job of a board member, she said, is to decide “do you want to back the CEO or get a new CEO.”

The last sentence is really muddled thinking.  She is distancing herself from her own decision as a former board member, to go along with a proposed spin out of the PC business.  But, in revealing her rationale, she should make a shareholder reach for the Rolaids. 

The decision on whether or not to spin off the PC business should NEVER have been a referendum on the popularity of the CEO.  It should have been a strategic business decision, weighted on the best financial analysis available, tempered by the board's own broader business judgment.  Even going against a CEO recommendation says nothing about that executive's value.  Management proposes, but the board disposes. 

Let's say during the five year turnaround that has now been suggested by CEO Whitman, she were to decide to bite off another monster acquisition.  According to the logic of her statement, that decision would be an up or down vote on her staying on as CEO.  For a company with a history of CEO mis-steps, this comment makes me wonder how this board looks at things.  Would they agree with CEO Whitman's comments? 

Some bullish analysts talk about the company's ability to deliver end-to-end solutions for IT customers from PCs to servers, software, analytics and consulting.  So what?  IT purchasers want best in class performance at every system node and interoperability so that they don't have to go with a one vendor solution throughout.  IBM doesn't make PCs anymore, yet they have many of the same pieces.  They focus on what they do at a world class level. 

HPQ has lots of great assets and financial strength, but so did Digital Equipment Corporation, much beloved by analysts and academics; it of course lost its way and sunk into oblivion.  The board's job is not keep a CEO happy but to make sure that every major decision is made with the best interests of the company in mind and to make sure that it stays in business.

Wednesday, February 22, 2012

China 2030: World Bank Imprimatur for Reforms

The Wall Street Journal today previewed a report from the World Bank and a Chinese consulting company, entitled, "China 2030," in which it looks in the rearview mirror and says that Chinese growth is slowing.  It also brings up the issue of the dominant state owned enterprises and the inefficient use of capital.  Here's a chart from the Wall Street Journal:

It sounds like the nature, timing and presentation of this report all fit the goal of presenting useful and politically acceptable analysis for the next generation of leaders and policy makers.  In that sense, without having had a chance to read the report itself, it's a helpful step forward.

Economics and GDP are not everything, though; political economy and social issues will have to be part of a real discussion about the future of China's development. 

Tuesday, February 21, 2012

The Beautiful and the Damned: Fantasy and Facade

I just finished reading Siddhartha Deb's book, "The Beautiful and the Damned," and I was left imagining modern India like the fake Alamo, in which a visitor can have all the experience of the real thing, right down to the climactic battle.  In the end, however, it's just a facade.

Reviewers of the book have focused on a poignant story of a intelligent young woman named Esther who has made a success of herself, leaving her rural village behind to become a waitress in a "luxury restaurant." However, both socially and economically, she's hit a ceiling especially as a woman, and this story is melancholy and well drawn.

Deb points out that all of the call center and business outsourcing employees Western journalists harp on endlessly, amount to a little over 1 million workers.  By contrast, Indian farmers represent about 400 million people.Western journalists' fantasies sometimes portray budding entrepreneurs using modern technology and free markets to take their place in the sun, as American industrial farmers have done. Siddhartha Deb paints quite a different picture, in what I consider the best vignette in the book.

The author visits Andhra Pradesh developing a story about red sorghum, a versatile crop which is the subject of product development efforts to create new foods and food ingredients.  The U.S. is the world's number two producer behind Nigeria, and the number one exporter of the crop, mainly to Mexico.  Red sorghum is used also in animal feed for cattle and chickens. In the recent past, the Indian government has provided price supports to farmers to buffer them from droughts, floods and volatility of commodity prices.

A McKinsey report, which Deb notes has disappeared from circulation even on the Web, touted the need for India to abolish agricultural subsidies and move to "free markets" if the country wanted to modernize the agricultural sector.  Of course, in this extreme form, the idea is quite ludicrous given that every Western nation subsidizes its agriculture in chosen domestic or export sectors. 

Andhra farmers gave up their traditional production of millet in order to convert their cultivation to sorghum, in light of what they were told was rising demand.  Millet had the advantage of being relatively hardy and not requiring extensive irrigation or expensive seeds.  Switching to sorghum immediately forced the farmers to drill wells, for which they went into debt with unscrupulous operators who often failed to find water.  Next came the seed dealers, the new mafia, who were peddling GMO seeds, for which the farmers again had to go into debt.  Can you tell where this is leading?

Deb's story includes one Mahipal Reddy who offered to buy the farmers sorghum for what he considered a fair market price, taking into account some measure of adequate margin for the farmers.  Reddy went all in on offering to buy the area's sorghum crop, and he showed a bank guarantee for Rs. 40 crores, which should have given anyone comfort that he could perform against his bid, take delivery and pay. Reddy, like many personalities in rural India, is not a totally transparent character, to be fair.

Now, the timeless, traditional methods of Indian business kicked in.  A rival bidding group to Reddy went around to the bank, suggested that Reddy's bid was foolhardy and that he would be unable to repay any bank loans. As if by magic, the bank rescinded its credit guarantee and Reddy's bid collapsed, putting the farmers at risk.  In this case, the local government Collector in Nizamabad did step in to offer some degree of relief, against the prescriptions of McKinsey's rugged capitalism.  Farmer suicides, often by swallowing insecticide, have become a recurring feature of the new agricultural landscape, but it's an issue that has received far less attention that the call centers and their "new middle class" workers. 

Indian government agricultural policy has become very cozy with multinational giants by touting GMO seeds and other high cost inputs for farmers who are still a class without the benefit of good, reliable information on prices, market outlooks, alternative forms of credit, and without any enforceable property rights, as Deb outlines in his book. 

Prince Charles has called attention to the issue of Indian farmer suicides dating back to 2008, but his campaign was an easy target for corporate propaganda to discredit due to the Prince's own quirky private behavior. It's much more fun to read Tom Friedman's odes to globalization and bright Indians and Chinese subjects of  his books.

In the end, the failure is the failure of the Indian government.  Like a fake Western town, it has the facades of democracy: beautiful houses of Parliament built by those bad boy British colonizers, noisy but predicatable elections, and CEO's of public companies who run their businesses like family companies while pontificating about governance and foreign investment.   It doesn't have the vision or will to build a public health infrastructure with prosaic things like water treatment, rural power, housing and the rapid judicial enforcement of property rights and prosecution of abusive lending.

We are still living through our own scourge of  unfettered mortgage lending, especially with toxic instruments to unqualified populations: we have experienced the harm this kind of lending can inflict on an economy.  In the Indian agricultural sector, the government should start with a mission to create a viable future for Indian farmers, which would keep them on the land, being productive, and not migrating to the urban favelas to join the vast, informal work force.  In undertaking such a mission, a lot of oxes would have to be gored, but continuing on the current path will not yield a sustainable future. 

I give Siddhartha Deb credit for telling a small story about Indian agriculture in his book.  I'm only sorry that he didn't give us a punch line and get angry about what he has described in plain, but moving detail.

Tuesday, February 14, 2012

China Ascendant? US Declines? Maybe, Maybe Not.

Long term forecasts are always wrong, almost by definition.  So, when I read that Arvind Subramanian wrote in Foreign Affairs, "China's dominance is a sure thing," I can comfortably feel, "That must be wrong."  It's a clever assertion  because I'm not sure what it really means. Enough semantics, though.

Michael Beckley's article, "China's Century? Why America's Edge Will Endure," provides an interesting framework for discussing this question. He writes that the rise of China is the most read-about news story of the 21st century. 

The Global Language Monitor's survey of 50,000 publications worldwide shows that the China ascendancy story has surpassed 9/11 for total world readership.

U.S. "declinists" see the U.S. as turning benefits of the global reserve currency and globalization into economic hegemony which cannot be sustained.  These authorities believe  either though benevolence or impotence that the U.S. is unable or unwilling to maintain the future international order.  These discussions often use the term, "multi polar world" when producing their dire forecasts. 

The U.S., according to Beckley, spends 25% more in real dollars than it did in 1968 at the height of the Vietnam War.  However, as he rightly points out, the U.S. effectively guarantees the security of some 50 nations worldwide, and those countries, including the wealthy Japanese, get a very valuable free ride. 

Turning to historical comparisons, Beckley notes that spending 4% of GDP on defense is not in the realm that has financially undone hegemonists like the Roman Empire, which ultimately overextended itself and its legions with far flung outposts. 

Looking at GDP comparisons can be misleading, most of all because that number it itself inadequate as a measure of global political power and the ability to project that power.  In a chart, Beckley's article shows that the average Chinese citizen is $17,000 poorer relative to their American counterpart in 2010 compared to 1991. 

As a nation, our politicians and Wall Street are in love with numbers.  Unfortunately, government numbers are modern propaganda and should be treated with disbelief.  Wall Street's numbers are generated by promoters and should be treated wtih skepticism.  So, we are told that Chinese GDP has and will continue to grow at 8% per year. That means it doubles every nine years.

This growth has not come in a sustainable model.  Beckley points out that much of China's investment has been funneled through investment entities connected to local governments, which issue debt.  Taking this local government debt into account, China's debt to GDP ratio goes from the stated 19% to 75-150% . 

Trees don't grow to the sky.  The World Bank wrote in a 2006 study, "...most (80%) of a country’s wealth is captured by what we called intangible capital residual. ... By construction, the intangible capital variable captures all those assets that are unaccounted for in the wealth estimates. These are often intangible assets such as the skills and know-how embodied in the labor force. It also includes social capital, that is, the trust among people in a society and their ability to work together for a common purpose. The residual also includes all those governance elements that boost the productivity of labor. So, for example, if an economy has a very efficient judicial system, clear property rights, and an effective government,the effects will be demonstrated by a higher total wealth and thus a higher intangible capital residual"  

Jack Baranson has written about the experience of Cummins, an American company and worldwide leader in large diesel engines, producing the same engine in Japan and India.  Japanese workers learned quickly and produced the requisite quality product at the projected cost.  This was due to their intangible assets described above.  Indian workers, however, produced "second rate engines" at 3-4x the projected cost.   Indian workers do not have the benefit of their government and society having put those intangible assets into place.

 Our declinists often talk about our aging population.  Beckley writes that the "One Child" policy will leave China "with the most severe aging process in human history."  (that sounds like a long-term forecast to me) The reader will get the point.

Beckley writes that half of China's engineers are auto mechanics or graduates of two-year vocational programs.  The brain drain of the top scientific minds to Western institutions continues.  Even the Chinese government's intentions to create a network of "world class universities" attracting the top students from all over the world seems far fetched.  If money were the issue, every Ivy League university student would have graduated  in Saudi Arabia or Qatar. 

Talking economic statistics, many observers have pointed out a deficiency in current world trade statistics. Over 90% of China's high tech exports are produced by foreign firms from imported components assembled in China, which then records the final good export.

Beckley's conculsion is that the U.S. is "coercive and capable" of maintaining a world order consistent with rebalances of power, but which is not a sunsetting of U.S. hegemony.

Of course, we have no reason to be complacent.  Our society is being alternatively roiled by Wall Street's cycles of financial recklessness and by social engineers and their political enablers.  Our ship may be listing, but it has historically righted itself, and the collection of intangible assets we have don't seem to be duplicated anywhere else. 

Cause for optimism?  Maybe so.

Tuesday, February 7, 2012

Andrei Shleifer on Transitions From Communism

Professor Greg Mankiw's blog referred to an article by his Harvard economics colleague, Professor Andrei Shleifer, a Russian born, American trained economist.  Shleifer writes about things he learned about economies transitioning from Communism, with the benefit of twenty years of history, which is still a relatively short time period. 

A few of his point struck me as interesting and different from the mainstream American press narrative.  He writes,

"...economists have greatly exaggerated the benefits of incentives by themselves, without changes in people. Economic theory of socialism has put way too much weight on incentives, and way too little on human capital. Winners in the communist system turned out not to be so good in a market economy. Transition to markets is accomplished by new people, not by old people with better incentives. I realised this and wrote about it in the mid-1990s, but the lesson both in firms and in politics in profound: you cannot teach an old dog new tricks, even with incentives."

He concludes optimistically, "...middle-income countries (like Russia and Ukraine) eventually slouch towards democracy, but not nearly in as direct or consistent a way as they move toward capitalism."

Wellington's View on Microsoft

I just received a copy of the November 30, 2011 Annual Report for the Vanguard Wellington Fund (VWELX), a balanced fund with a long, consistent track record  Ed Bousa, manages the equity portfolio which was about 66% of net assets at fiscal year end.  The management team wrote this about  Microsoft (MSFT).

"We increased our position in Microsoft, as we see an extremely attractive risk-to-reward ratio at current valuations. The price of the stock suggests market participants do not have particularly high expectations, yet earnings growth at the company remains strong, driven in part by businesses' cyclical computer upgrades.  Cash-flow generation is solid and may be under appreciated by the market as well.  In our view, the upside potential of this stock more than adequately compensates investors for the downside risks they bear."

On the other side of the coin, the biggest detractor to the fund's performance, in absolute terms, for the year was their holding of Bank of America, which they reduced.  Wellington Management Company has always been populated by sharp, value-oriented investment managers, but they like every market participant didn't get the risk-reward ratio right for Bank of America.  

[Nothing in this post should be construed as investment advice or as a recommendation of any mutual fund or equity security.]

More Euro Agonistes

We've always believed that resolution of the euro crisis had to include a Greek exit from the currency union. Now, many the consensus-driven financial community are busy hedging towards a similar position.  For example, from the Wall Street Journal, we read:

"Citigroup on Monday raised its estimate of the likelihood of a Greek exit from the euro area over the next 18 months to 50% from a prior range of 25% to 30%, according to the bank’s latest “Global Economics View” analysis by economists Willem Buiter and Ebrahim Rahbari." (Wall Street Journal)

The Jerome A. Chazen Institute of International Business at the Columbia Business School recently sponsored a panel discussion on the euro crisis.  A video of the forum, along with pdfs of the presenters slides is available.

The foundational issues are good, old fashioned issues of international economics.  The European currency union was put together with members whose economies were too diverse in size and character.  The entire theoretical framework of the currency union  put together by Robert Mundell, Roland McKinnon and Peter Kenen required a basic assumption that inflation rates among the members were similar.  The entire model, like most international trade models, requires factor mobility (labor and capital), and no economic rigidities in labor markets, for example.  The creation of the customs union was a backdrop for the currency union.

However, the elephant in the room was always "harmonisation" of fiscal policies in the language I read in the economic literature when studying in Europe. That harmonisation was supposed to magically lead to integration of fiscal and political policies.  There never was a harmonisation of fiscal policies,  and there surely will never be an integration.  The geographical and politicial balkanization of Europe has settled that issue. 

The current situation has also introduced significant economic distortions in Europe, as Professor Beim's slides show. Germany was the first to rationally remove labor market rigidities, regulatory burdens, and to provide financial incentives for its export-oriented sectors.  Subsequently, German industrial output showed rapid growth, while those of large economies like Italy fell, from the date that the euro exchange rate was fixed.  Greece fared far worse. 

European politicians are skilled diplomats, unlike our own rough-and-tumble media brawlers, and so they will put a better face on the crisis.  More importantly, they will stretch out the meetings, summits, communiques and public lectures so that any exit will be relatively orderly.  Meanwhile, the economic and social  costs of the adjustment to the weaker EU members will be genuinely painful.