Long Term Thinking Does Exist in Corporate America!

Harvard Business School Assistant Professor George Serafeim, HBS doctoral candidate Maria Loumioti, and Assistant Professor Francois Brochet have written a new paper titled, Short-termism, Investor Clientele, and Firm Risk.  They find that companies with a short-run orientation do have more volatile stock returns and a higher cost of capital.   On the other hand, they find that we may be over-estimating the amount of short term thinking out there in corporate America.   The scholars find plenty of firms who are taking a long term perspective.   Here's an excerpt from HBS Working Knowledge's interview with the authors:

Q: In general, what relationship did you find between companies you identified as short-term-oriented, their investors, and the behavior of their stocks?

Francois Brochet: Overall, we found a positive association between the horizon over which firms communicate and the investment horizon of their shareholders. In addition, short-term-oriented firms appear to have more volatile stock returns and higher estimated cost of equity capital—that is, greater risk. While the presence of long-term-oriented investors appears to mitigate the positive association between firms' short horizon and the volatility of their stock, this does not apply to the association between short-termism and cost of capital. We interpret this as evidence that our short-termism measure captures a dimension of non-diversifiable risk in the economy. 

Q: What is the big takeaway here for investors, especially those seeking to invest in companies with longer-term perspectives?

George Serafeim: One important takeaway is that firms with long-term horizons exist! We tend to make sweeping statements and overgeneralize. While significant short-termism exists, there are organizations that have developed a long-term-oriented approach through formal (e.g., incentive systems) or informal institutions (e.g., building the corporate culture over time and employee selection).
The finding that more long-term-oriented firms have lower volatility and cost of capital has implications for capital allocation. Investors who care about the volatility of their portfolio should factor in their decisions the time horizon of the corporation. That generates a need for more data that help investors separate companies that are short-term-oriented versus long-term-oriented. Developing a robust data infrastructure that separates companies could have profound implications and incentivize companies to become more long-term-oriented.

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Why Change is Hard

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Facebook and Instagram: Where was the Board?

The Wall Street Journal reports today that the Facebook Board of Directors was not involved until very late in the process with regard to the Instagram acquisition.  According to the article, "By the time Facebook's board was brought in, the deal was all but done. The board, according to one person familiar with the matter, 'Was told, not consulted.'"  Later in the article, it describes an amazing meeting that took place at Zuckerberg's home:

At around 6 p.m. that evening, Facebook board member Marc Andreessen showed up at Mr. Zuckerberg's house for a regular meeting. What he didn't know was that Mr. Systrom was in another room, getting his own board to sign off, people familiar with the matter said. Mr. Andreessen, whose venture-capital firm was the second to invest in Instagram, cutting a $250,000 check before the service launched, was surprised when Mr. Systrom walked into the room about an hour into his meeting with Mr. Zuckerberg, the people said.

You can imagine the reaction of corporate governance experts!    Most people have pointed to the fact that the Board and Mr. Zuckerberg will have to interact much differently when Facebook becomes public.  If not, minority shareholders will be quite concerned.  It's interesting, of course, because agency theory says that we ought to like it when CEOs own lots of shares of a company. In those cases, according to theory, there's less divergence of interests between shareholders and executives as opposed to publicly traded companies in which top executives own a tiny ownership stake.  The theory says that we like it when CEOs are playing with their own money, not other people's money.   While I generally agree with that theory, there are limits to the applicability in the real world.   In particular, the interests of minority shareholders need to be considered, particularly when a founder is CEO.   Good governance processes matter, even if we assume that the CEO generally is trying to do right by all shareholders.  Moreover, founder/CEOs rightfully should get held to a different standard when a company goes public.  

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Audi to Acquire Ducati

Honda makes automobiles and motorcycles.  BMW does as well.  Now, here comes Audi.  They appear to be on the verge of acquiring Italian upscale sport motorcycle brand Ducati.  More than a decade ago, Ducati had faltered badly.   Texas Pacific Group, a private equity firm, purchased a major stake in the firm in the mid-1990s.  TPG hired turnaround specialists Federico Minoli, who led Ducati in a very successful comeback. 

The deal provides a moment to reflect on the nature of the motorcycle industry.   In many markets, as Gary Hamel has noted, "strategies tend to cluster around some central tendency of industry orthodoxy. Strategies converge because success recipes get lavishly imitated."   Firms compete head-to-head in these situations, and overall industry profitability suffers as a result.  The motorcycle industry, thankfully, does not fall into that type of destructive rivalry.  Instead, firms have found a way to occupy different niches in the industry, and to avoid the type of vicious price rivalry that can damage margins irreparably.   Ducati, Harley, and Honda, as an example, all compete in different segments of the market for the most part.  That recipe has been very good for the key players in the industry.  We'll see if anything changes with the Audi acquisition. 

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Growth Lessons from Gilt Groupe Co-Founders

Alexis Maybank and Alexandra Wilkis-Wilson are the co-founders of Gilt Groupe, a company that specializes in online sales of luxury apparel at discount prices.  Maybank and Wilkis-Wilson described to Forbes why they have been so successful.  At first glance, they seem remarkably similar.  They even look alike!  However, the two co-founders argue that their differences make them stronger.  However, it's not just that they have different strengths, but that their abilities and personalities are quite complementary.  One plus one equals three, if you will.   Here's an excerpt from the Forbes article.  A short video is below as well.

“It’s very much like discovering your latter-day stunt double,” Maybank says of finding the right cofounder. Wilkis-Wilson is detail-oriented, a task-master who keeps everything running according to schedule, while Maybank is a self-described “big picture thinker” who is referred to throughout the new book, out in stores this week, as the “impulsive” one. “Our differences haven’t just made us a much stronger team but they’ve allowed us to see what we’re missing and who [else] we need to bring around us as part of our founding team.”

The story, though, is not as simple as selecting a partner who is different than you.  You definitely need someone who shares the same passion for a particular product, technology, or business model.  Both co-founders need to care deeply about what they are doing.   They have to be passionate about the broader purpose of the enterprise.  Moreover, they have be able to communicate well with one another.  In this case, the training at Harvard gave them a common language system that certainly facilitated their communications with one another.  Finally, both parties have to share a similar work ethic and willingness to carry their share of the load. Once you have those foundations in place, then the complementary strengths can become a huge asset. Without that foundation, though, simply finding someone with complementary skills won't lead to success.

 

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Separating Needs and Concepts: How to Develop Great New Products

Professor Laura Kornish of Leeds School of Business at CU Boulder has a great post about crowdsourcing over at Fast Company.   She reminds us that we have to be careful when identifying our objectives during consumer research or crowdsourcing initiatives.   We have to separate the determination of the customers' needs from the development of a new product concept.   Here's an excerpt:

In traditional product development practice, there is a separation between gathering data from customers about their needs--via interviews, observations, focus groups, and surveys--and proposing new product concepts. The classic example of this separation is, "People don’t want to buy a quarter-inch drill. They want a quarter-inch hole!" (Theodore Levitt’s example from Harvard Business Review, 1960). In that view, managers guiding innovation should consult the users for what needs to happen, not rely on the users themselves to dream big about how it can happen. Crowdsourcing in innovation allows us rethink this separation. We can ask the crowd directly to provide the solutions, then work backward to infer what is on their minds.

What wonderful advice!  Don't ask the customer to design the new product.   Seek to understand what the unmet need of the customer is!   We don't want the customer actually having to come up with the innovation.  In fact, often they will just offer incremental modifications of the existing product.  They usually won't be able to "think outside the box" in the midst of a focus group or interview.  Seek instead to understand their frustrations and their pain.  What makes them unhappy at the moment?  Then, work on alleviating that pain with a new product concept.  

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The Dollar Shave Club: Look Out Gillette?

The Wall Street Journal reports today about the rapid and surprising emergence of a new competitor to Gillette in the razor and blades business.   The Dollar Shave Club provides a subscription service, whereby customers can sign up to have blades shipped to them each month.  Customers choose from among three plans - a good/better/best set of options.  The prices range from $3 to $9 per month.   The company has garnered a great deal of attention, as a YouTube video went viral recently - surpassing 4.1 million views as of this morning. The company's motto might offend some, but it sure garners attention: "Our blades are f— great."

What's going on here?  With Gillette, we see a classic case of a company innovating constantly to try to upgrade its product quality.  The efforts result in a continuing "premiumization" of the product.  However, at some point, those enhancements "over-shoot" the needs of some customers.   The price point begins to exceed the willingness-to-pay of some consumers, as they don't necessarily see the value of the most recent product upgrades.  Is there some evidence that consumers were beginning to feel that the price did not match the value for Gillette's high-end razors?  Certainly.  As the Wall Street Journal indicates, the company had become the butt of jokes about the number of blades that they could stick on a tiny razor.  Moreover, customers have been reported to go to great lengths to try to get as many shaves as possible from a particular razor. 

The barriers to entry in the razor/blades business seemed insurmountable though.  Getting on the supermarket shelf was no mean feat.   Moreover, promoting a new line of razors could be very expensive.  However, the Dollar Shave Club has found a way around those traditional barriers to entry.   They've gone direct to consumers with a subscription service, avoiding the supermarket shelf entirely.  In addition, they've used social media to promote the product at virtually no expense. 

The question remains:  Is the Dollar Shave Club truly a better value than Gillette?  The answer: it depends.  As the Wall Street Journal reports in this complementary article, the true cost to the consumer depends on shaving habits. Those habits, in turn, depend partially upon the physical attributes of the customer.   Gillette, of course, has been trying to persuade customers that their blades last longer, making the true cost of ownership less expensive than competing blades.   That argument raises one final interesting point related to this story.   With industrial marketing efforts, customer willingness-to-pay is often something that a firm can quantify.  With B2B marketing, a company can persuade a customer of the superior economics of buying their product instead of a competitor's goods.   With consumer marketing, one can try to explain those economics to the user, but it's a bit more challenging.  You aren't sitting with a purchasing agent and walking through a spreadsheet.  You are trying to persuade someone in a 30 second commercial.  Therefore, Gillette will have to come up with a very clear and concise way to convince consumers that the total cost of shaving will be lower with their products, even though the price per blade is significantly higher. 

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