Managing Family-Entrepreneur Companies : Challenges of a Professional CEO

With the increasing emphasis on corporate governance and an enlightened interest in business development, many family and entrepreneur led firms are hiring professional Chief Executive Officers (CEOs) to run their businesses. This is opening up new exciting career opportunities for capable professional managers. However, pitfalls are as many as the opportunities are. This paper summarizes four critical facets of this transition.

Coping with the family / entrepreneur

Typically, a family tends to be conservative while an entrepreneur tends to overreach. A family member or an entrepreneur, continuing as an executive head of the board, could therefore be a major constraint on a professional CEO’s style. The answer to this from a CEO does not lie in attempting to change the family member’s or entrepreneur’s business DNA. It lies in the CEO’s ability to offer a framework by which unreasonable aspirations and reasonable resources are harmonized to develop a workable blue-print for the future.

An organization in transition (from family-promoter control to professional management) needs intensive and structured interfaces at all levels, more so at the top to smoothen the transition. An entrepreneur-CEO and a professional CEO would most likely have dissimilar aspirations, managerial styles and personalities. The professional CEO would need to constantly evaluate how his relationship develops with the family / entrepreneur on one hand and the organization on the other hand. Only frequent and direct communication with the family and entrepreneur can help usher in the transition smoothly.

In an organization controlled or co-promoted by more than one family member or entrepreneur, the inter-se dynamics between the family members or co-promoters are not always visible. The apparently passive member(s) may have invisible influencing power, which needs to be understood. Similarly, an existing organization may have persons of influence who do not operate in the open. Molding all these relations in his favor is a challenge for the professional CEO.

A family or entrepreneur run organization is likely to have many informal channels of communication between various employees and the family member or entrepreneur,
which operate as a result of the micro-management of the company by the family or the entrepreneur. The informal channels could often distort information and even use the
information for ends which are not necessarily aligned to business goals. The CEO would need to establish structured strategic planning and budgeting processes, visible performance management systems and open communication channels as a formal means that renders the informal operations increasingly irrelevant.

Keeping up the growth momentum

As one moves into a CEO’s position of a hitherto family run or entrepreneur driven company, the challenges would be significant in the areas of project execution, operations management, strategic planning, business development, peer-relationships and communication with investors and employees. The focus and spirit of the role would need to be on managing for the future with the speed of an entrepreneur and the caution of a family. The CEO would need to innovate constantly on business, technical and operational models to achieve this. The knowledge, assets and execution capabilities of the past and present, though belonging to different businesses and products, often serve as the levers for new business development. These must be exploited on a proactive basis. At the same time, old business models and past experiences of established companies need not necessarily succeed in a family / entrepreneur company. The CEO has to be, therefore, dynamic, contextual and differentiated in respect of strategy as well as execution.

While the very reason for bringing in a CEO in a family firm is to do things differently, yet when it comes to systemic changes, the entrepreneur or the family would more likely baulk rather than support the changes ostensibly for fear of losing business momentum or stability as the case may be. Yet, as a CEO, one has to live with apparent contradictions; closing down manufacturing lines while investing in new facilities, slashing jobs while creating new knowledge positions, phasing out products while innovating new ones, eliminating today’s expenses while adding costs for the future and so on. Building long term value, without compromise to current revenue and profit growth is the essence of the CEO task.

Fusion of strategic intuition with operational excellence and balancing of the short term with the long term are the ultimate challenges for a CEO. A family or entrepreneur-led company would have achieved growth due to an opportunistic mix of operational and business strategies. This may not meet a professional CEO’s litmus test in all cases. Practically viewed, neither time nor resources will be on the CEO’s side to attempt a total structural, systemic and value-chain upgrade of a hitherto family or promoter run firm. The CEO is likely to succeed if he keeps the degree of revamp to a minimum even as he judiciously pursues newer options that comply with professional norms, both in technical and business arenas.

The responsibilities of a CEO would typically follow a normal distribution. About seventy percent of the focus would need to be on the core aspects of driving revenue and profitability. There would be two outlying areas of say, fifteen percent each, related to turnaround (extreme cost and efficiency management) and family or promoter inspired value-gaming (extreme futuristic investment bets). A focus on the outlying areas beyond the limits indicated could expose a CEO to the threat of weakened performance on the core.

In today’s competitive world, investors (including the promoters) have a relentless focus on continued growth in revenues and profits. Unless there is a need for a radical restructuring, ways and means have to be found by the CEO to keep growing, even while rectifying errant operations. If any part of the business requires radical restructuring with organizational implications or large investments with long lead times, the plan must be clearly articulated to the stakeholders so that there are no misunderstandings.

The domain of business development is almost always imprecise. As strategic business development is a key responsibility of a CEO, he would need an organizational infrastructure for a structured yet entrepreneurial business development. In business development, by definition and practice, the entrepreneur tends to over-commit. The family member, on the other hand, tends to be conservative and cash-conscious. The professional CEO, however, has to balance these trends by arranging resources and ensuring execution.

Reshaping the organization

The effectiveness of a CEO lies in the smartness of delegation, notwithstanding the possibility that the informal or unstructured nature of the organization requires his close attention. The CEO cannot afford to have all “pupils” and no “masters”, if he wishes to succeed fast. A CEO has also to make sure that the persons to whom responsibilities are being delegated are good enough for the job. For delegation to be effective, the overall level of competence (both individually and collectively) has to meet stringent standards. Effective delegation also requires that various departments at all levels interact meaningfully without ‘upward delegation’ which is characteristic of organizations functioning as vertical silos requiring sanctions from the top for everything. Cross-functional teams will need to be encouraged at all levels to enable executives broaden their horizons, without the day-to-day involvement of the CEO or even the next tier. While speed of execution is important, issues have to be prioritized. A smart CEO would use multiple levers differently, to blend delegation with accountability.

When a new chief takes over a family or entrepreneur run firm, people who have been wayward or powerful hitherto in the organization tend to be defensive or manipulative. There can be no implicit belief in anyone until his or her professional competencies and managerial approaches are established. Setting uniformly clear goals would be one way to isolate performers from non-performers. The concept of a long grace period could be as detrimental as bundling all the old guard as being irrelevant. An objective judgement on each executive and checking out with the entrepreneur or family would be a quick and effective route to aligning the organization to the CEO’s thoughts.

While the board deliberations in general tend to be a matter of form than substance, the boards of some family or promoter companies may have an even greater issue with regard to the independence. With Clause 49 coming into force, one has to hope that such boards will reflect objective and strategic oversight on corporate matters. The professional CEO will need to add his inputs specifically to enliven and spark the discussions, even though he may be constrained by what the family member or entrepreneur has been disclosing so far to the board.

Though in an organization the buck certainly stops at the CEO, all onus cannot be on the CEO alone. For the organization to really reap the value from a professional CEO, the family member or the entrepreneur would also need to fulfill certain responsibilities. For example, he has to respect the mandate given to the CEO, explain the past and integrate his experience with the new CEO’s perspective, follow the CEO’s advice in matters of strategic plan and operational execution, eliminate invisible or whimsical checks on the CEO’s style and create forums for free flow of information.

Dealing with oneself

A CEO who is new to the job would need to ensure that his time gets channeled to activities which are most productive for his physical and financial performance. Even though teaching and coaching are an integral part of a good CEO’s profile, the CEO cannot allow them to erode his ability to focus on other key factors relevant to his new position. Consolidation of his own position should be as important as coaching others at least until he gets a solid grip on the company affairs.

The hallmark of a true CEO is that he outgrows his functional core competence. In several respects, he demonstrates that he is “equi-distant” with all functions and all professionals. Similarly he “owns” all the functions, whether or not they work for him, against him or with him. This is easier said than done. It requires a constant work-out on oneself to achieve this state of mind. A CEO, in the event he is from a technical background, will definitely need to become financially savvy as well. Similarly, a non-technical CEO has to demonstrate certain grasp of the technical nuances of the business to gain an overall organizational command. In addition, any CEO would benefit from tracking the successes and failures of other CEOs. Such readings would help him raise the bar of performance on one hand and develop a sense of equanimity about the limits of performance on the other.

Ultimately, all stakeholders, the family or the entrepreneur and the board need assurance that things are moving fine. Regardless of the past track record of the CEO and his current level of confidence in the new job, the CEO needs to periodically assure his stakeholders regarding corporate performance and investor returns. The longer the gestation period of a project or the more traumatic the nature of a change, the greater would be the need for such assurance. Often written reports, value-added by face-to-face discussions reinforce such confidence all-round. The CEO will also need to significantly work on his presentation skills as well as his diplomatic approaches which are as important as the raw results of operations. The CEO is also a dependent member of the organization, in some respects. He cannot be a silent sufferer for the corporate mission when resources are not available. He has as much responsibility for demanding (or generating / deploying) capital as he has for delivering on achievements. It is not infra dig for a CEO to demand the due resource inputs for the business from the board, the family or the promoters.

The CEO’s role in creating a positive organizational culture, conceptualizing a growth-oriented business model, developing a new corporate plan and driving a tight execution program would be vital in determining his impact on the hitherto family or entrepreneur run organization. If a CEO desires to make a lasting impact beyond the level of his past achievements, he would also need to do something that rivets attention. Given India’s niche in the knowledge-led activities and the several business opportunities waiting to be tapped in these areas, fundamental innovation would be a key driver. It certainly calls for resources, skills and equally importantly, time. However, unless the seed is sown one day and carefully nourished every day, the professional CEO and his company (in transition from the hitherto family or promoter led status) will not have the comfort of lasting shade in the future.

Posted by Dr CB Rao on February 22, 2009

Indian IT/ITES:Reducing Windows or Expanding Vistas?

Over the last two decades, the information technology (IT) and information technology enabled services (ITES) industry has contributed significantly to the Indian economic growth. The industry contributes to over 5% of India’s GDP, earns over US$ 40 billion in foreign exchange and provides direct employment to over 2 million professionals. No less significant has been the ripple effect of prosperity that it has created in various sectors of the economy. Nearly 50% of its revenue of US$ 40 billion is spent in the domestic economy in a host /of sectors and services, covering infrastructure to consumption goods. This spend of about US$ 16 million is estimated in turn to generate US$ 32 billion as output impact across the economy.

In more ways than one, the IT/ITES industry has been the icon of India’s foray into the global economic league, with major growth aspirations. The industry hoped to double its turnover to US$ 80 billion in 5 years and contribute further to the shaping of India as a truly global economic powerhouse. Against this background, the unprecedented global economic meltdown has raised concerns of adverse impact on this vital industry. Although the IT/ITES industry continues to be cautiously optimistic, the industry requires now, more than ever, a new vision and strategy to address the deteriorating economic environment.

Globally, all affected industries have begun to respond to the recessionary trends in certain classic, established ways; cutting down output, reducing inventories, controlling costs, postponing payables, advancing receivables and freezing investments. Though the IT/ITES industry may be tempted to follow this route, the industry has to look also for certain strategic approaches to weather the storm and in the process emerge in a fundamentally stronger frame.

Product Innovation

Typically, several Indian IT majors have comfortable cash positions and, in addition, enjoy good balance sheets to raise additional debt financing. They also have surplus operational capacity in terms of physical infrastructure, be it campus or office space and computing or connectivity capabilities. Such firms should respond to the slowdown by creating a much-needed focus for development of original software products. Redeploying its experienced professionals, inducting fresh manpower and releasing the purse strings, IT majors should aggressively create new product innovation laboratories that are dedicated to different domains and industries.

Success of the Indian IT products has been largely in the banking and retail space. Similar product success stories can be created in the domains of design and development, project engineering and erection, procurement and manufacture, sales and distribution and customer service and relationship management. The domain practice however varies with each industry vertical. For example, the design and development needs of an automobile maker would be quite different from those of a pharmaceutical producer. Customer management in hospitality sector would be vastly different from that in hospitals sector. Each of these five fundamental domain groups combined with industry specific needs would lead to a matrix of several IT products customized for industry-domain combinations. Product development opportunities for the Indian IT majors could be endless, if only they choose to focus on such innovation goals. Conservatively, the IT industry can dedicate a significant share of its current manpower on such innovation laboratories over the next two years.

Indian ERP

Platform software is for the IT industry what steel and automobiles are for the engineering industry. Indian has captured global attention with the highly ambitious yet famously successful attempt by Tata Motors to design and manufacture, on a commercial scale, a Rs 1 lakh Nano small car. Indian IT industry has to also stretch and reinvent itself to design and develop at least one software platform which can serve as the global symbol of India’s true software capabilities. An Indian Enterprise Resource Planning (Indian ERP) system could be one such flag bearer for the Indian IT industry.

Indian firms, and even global firms, are often forced to deploy certain ERP systems which are built around programming robustness rather than process flexibility. From structural nomenclature to business processes, these ERP systems represent a different nativity, when compared to either the US or Indian management structures and processes. On top of it, the need for additional user interfaces and/or the requirement to install additional analytical solutions for management information makes the available ERP solutions less than optimal.

Top-rung Indian IT majors could collaborate to form a special purpose vehicle (SPV) which can be entrusted with a national mission of designing, validating and commercializing an Indian ERP which is practical, flexible and robust and is customized to the Indian and US business processes and tax regulations. In contrast to a model of modular or “foundation now-superstructure later” ERP solution, the proposed Indian ERP solution could be developed as a cost-effective integrated suite that provides a comprehensive coverage from transactions to analytics. Also, instead of aggregating all industrial sectors into one straightjacket model of ERP, the Indian ERP could be developed as a set of customized solutions for individual or groups of industries which have unique or similar business processes as the case may be. Such an Indian ERP could do for the Indian IT industry what a Nano car did for the Indian automobile industry, in terms of global visibility and achievement.

Application software

It is not that only the larger IT majors can survive and grow in the downturn. Small and medium enterprises as well as individual IT entrepreneurs also have their respective niches.

A marvelous development of the recent years has been the proliferation of opportunities for writing application software for new electronic devices and services. This being a highly individualized and creative endeavor, small / medium IT enterprises and IT entrepreneurs are ideally positioned to participate in this space. The Linux Ecosystem has demonstrated how a global community of individual, motivated programmers could create a whole new software architecture that could compete with a massive, monolithic and established software organization. There is therefore tremendous scope for initiating and organizing mini-communities of application developers who could innovate to upgrade existing hardware and software as well as to add new dimensions to emerging products and services. In addition, applications which have significant consumer interface offer additional opportunities for continuous creativity. Mobile telephone applications, gaming applications and various web based internet applications lend themselves ideally to device-specific and consumer-centric application development by individual entrepreneurs.

Web Portals

The World Wide Web has converted the globe into a community of internet connectivity. Firms such as Google have re-defined the Net as the new ‘store, plug and play’ platform for a host of applications. Portal-based initiatives, such as Amazon, Wikipedia, Facebook, Netscape, Yahoo and YouTube, to name just a very few, have created a multi-billion dollar web-based industry. Though India has taken its initiatives in portal technology through web-based sites such as Sify, Rediff and Naukri (again to quote a very few), these have been India-centric than pan-global. India’s much acclaimed IT leadership and manpower pool needs to put its strengths to work to create truly innovative, world-class, pan-global Internet business, economic and social sites that appeal to all global citizens.

From arts to science and from engineering to management, Indian professionals have capabilities that can cater to universal needs and multifarious tastes. These, combined with contemporary telecommunication and information technologies can create sites which are pioneering and unique in their and service offerings. For example, there could be sites where amateurs and professionals can collaborate to learn, teach or experience a wide range of socially positive avocations and hobbies or utilitarian activities like music, education, yoga, self-help and alternative healing and so on.

Domestic Services

IT/ITES industry has grown phenomenally thanks to the international orientation and outsourcing advantage. The services that the IT/ITES industry has offered to its international consumers are equally relevant and required in the Indian setting too. Medium sized IT/ITES companies could have a major role in expanding the Indian market for IT/ITES offerings.

Indian ITES industry in particular can play a pioneering role in bringing industries and their consumers significantly closer. Although banking and telecommunication sectors have been quick to utilize call centres as a tool to stay connected with the customers on a 24X7 basis, a whole range of industries, including consumer oriented retail chains are yet to explore, even partially, the potential of 24X7 connectivity. ITES companies which may be experiencing a bit of downturn due to international recession could diversify into domestic services and even expand their business through vernacular offerings.

In a similar vein, there is an immense scope for the BPO and KPO industries to provide outsourcing services to the Indian industries. Product management, sales and distribution management, intellectual property management, human resources management and legal services management as well as development of knowledge repositories are some of the areas where Indian firms require more extensive and incisive BPO and KPO services.

Summary

The global economic meltdown could be an opportunity for the Indian IT/ITES industry to redefine its global business model in terms of certain new fundamentals of product innovation, platform software, application software, web portals and domestic focus. By redeploying some of its large talent pool, tapping into the streams of bright graduating professionals and allocating some of its financial resources for creative, even if experimental, initiatives, the Indian IT/ITES industry can emerge stronger with diversified capabilities encompassing innovative products as well as generic services. The NASSCOM leadership and the several visionaries that lead the IT/ITES industry today should actively collaborate to define such a new paradigm for the industry at the earliest.

Posted by Dr CB Rao on February 18, 2009

Like IAS, IES, IFS etc., Needed : Indian Directorial Service (IDS)

Corporate frauds wherever and whenever they occur, from Enron in US to Satyam in India, bring focus on the role of independent directors in the boards of companies. In India, Clause 49 of the Listing Agreement with the Stock Exchanges specifies the role and requirements of independent directors on the boards of listed companies. Clause 49 is positive and comprehensive. Unfortunately however, neither the Clause in its scope nor the concept of independent directors in practice has the teeth or enablement to deal with the detection, prevention and correction of deliberate, systematic corporate frauds undertaken by the managements of the companies and the systemic deficiencies that are perpetuated in organizations to facilitate such frauds, as exemplified by the Satyam episode.

Several white papers on the collapse of Enron pointed out that lax regulatory environment in the US and poor oversight by the Enron board contributed to the collapse of the company. Regulations have since been tightened up significantly; reporting requirements enhanced substantially and oversight expectations on boards escalated notably in the major economies of the world. In all this effort, major emphasis has been placed on having a higher proportion of independent directors in the boards. This focus on independent directors has not helped matters as evidenced by the successive corporate failures in the US and the shocking Satyam imbroglio in India.

Satyam, for example, had some of the most talented and respected names as the independent directors on its board, prior to the recent events. The list includes Mr V P Rama Rao, former Chief Secretary to the Government of Andhra Pradesh, Dr (Mrs) Mangalam Srinivasan, Adviser to Kennedy School of Government, Harvard, Professor Krishna Palepu of Harvard Business School, Mr Vinod Dham, the famous Intel chip discoverer, Professor M Rammohan Rao of Indian School of Business, Mr T R Prasad, a former cabinet secretary, Government of India and Professor V S Raju of Indian Institute of Technology. The number of independent directors at 7 is larger than the number of whole-time directors at 3. The company was listed on NYSE and therefore was subject to the most rigorous reporting requirements of Sarbanes-Oxley Act of the USA.

From an analysis of Satyam’s corporate governance report, the independent directors participated in the board meetings as well as in the governance committees such as audit committee in full compliance of corporate governance norms. The directors represented proven, distilled administrative, technological, management, governance and academic experience. The company had a full-fledged Code of Conduct and Ethics for Directors. None of the above has, however, helped the board or the independent directors of Satyam, individually or as a group, to detect the corporate fraud that happened under the board’s very nose. It is indeed ironic that one of the independent directors of Satyam, Professor Krishna Palepu had the distinction of co-authoring with Professor Paul Healy of Harvard Business School a landmark book titled “The Fall of Enron” in 2003! Obviously, there is more than individual expertise and integrity that is on test under the independent directors system.

The fault does not lie in the independent directors, per se. The very act of having professionals at the peak of their respective careers or at the launch of new careers post-retirement as independent directors brings with it the twin disadvantages of a non-aligned career focus and an enormous time constraint. In the few hours they have at their disposal for each board meeting, such directors can bring no more than a whiff of world’s best practices or a gentle advice of caution to the deliberations of the boards. They would have neither the time nor the capability to analyze projects, operations, plans and finances to detect systematic fraudulent activities. The problem of inadequate attention gets compounded as such reputed professionals are much sought after as outside directors in several companies.

India has several thousand joint stock companies out of which over 5000 are listed in India’s oldest stock exchange, Bombay Stock Exchange. Assuming that these board managed companies require 5 to 7 independent directors each (based on an average board size of 10, with 2 to 3 members being whole-time directors and 2 members representing investors) there is a gigantic requirement for 25000 to 35000 independent directors to guide and manage these listed companies. It would be self-defeating to try to source them from a professional pool which is otherwise engaged in fulltime work of its own. If one superimposes the need for such independent directors to contribute effectively to the affairs of the company through industry knowledge, strategic guidance, operational oversight and risk management and in addition in the post-Satyam situation by way of regulatory compliance, internal audit and management audit the job of independent directors becomes a fulltime job with specific skill sets. The problem is not confined to private sector alone; several public sector companies too face the problem.

If the Government of India and India, Inc are serious about making the boards truly perceptive and powerful bodies with independent directors making a distinctive knowledge cum practice based contribution to the functioning of the boards, major structural and systemic changes in the institution of independent directors are called for. There are three aspects to this: (a) creation of a dedicated all-India talent pool for independent directors (b) making the independent directors truly independent and empowered and (c) integrating the independent directors in the strategic functioning of the company. These objectives can be fulfilled by the creation of an Indian Directorial Service (IDS) on the lines of the famed Indian Administrative Service (IAS) which creditably runs the Indian government.

IDS will be a special, high profile corporate cadre selected, trained, placed and compensated by the Government of India through its entities. The selection to IDS will be made through an all-India selection process by a newly created Union Corporate Directors Commission (UCDC) akin to the Union Public Services Commission (UPSC). The training for the directors selected for IDS will be carried out by a newly created National Corporate Directors Academy (NCDA) akin to the National Defence Academy (NDA) in collaboration with the various Indian Institutes of Management, which will be encouraged to set up academic verticals for corporate directors. The placement of independent directors from the IDS in various companies will be made by a Standing Committee for Independent Directors (SCID) under the governance of SEBI. The compensation for the independent directors will be carved out of a share of tax earnings reported by the corporate entities and administered by the Ministry of Corporate Affairs(MCA) if necessary through Company Law Board (CLB).

Unlike the IAS and other public services, the minimum entry age for IDS will be 40 years of age with a minimum of post-graduate qualification and15 years of senior level industrial, business, academic or armed forces experience. Maximum age of entry will be 60 years. Superannuation age will be 70 years. Senior executives from private and public sector companies as well as universities will be encouraged to apply. Aptitude, intelligence and psychological tests appropriate to directorial responsibilities will be administered as part of the selection process. The selection will be national and conducted annually. The tenure will typically be for renewable terms of 5 years and subject to the usual shareholder approvals. The IDS pool will be typically rotated across companies and industries to promote cross-fertilization of ideas and avoid the development of vested interests.

The independent directors are expected to influence the boards to make bjective and ethical quarterly and annual reports to the shareholders, stock exchanges, SEBI, SCID and MCA on the state of affairs of the companies they manage. The reports will be strategic in nature and cover critical aspects such as business environment facing the company, competitiveness of the company, performance parameters and ratio analysis, regulatory compliance, SHE (safety, health and environmental) profile, risk and prudential management and human resource accounting. Each of the independent directors on the board is expected to take a lead role in each of the 7 areas. One of the independent directors is expected to be appointed as the Chairman or Vice-Chairman of the company.

It is expected that each independent director from IDS will not be on the boards of two or three companies and not be on the board of more than one company from the same industry. Each independent director will have a working office as well as a basic secretariat in the company and possess the freedom to operate fulltime in the company. The independent directors will be provided access to the management information system (MIS) of the company and will be afforded the freedom to interact with the senior tier of executives directly reporting to the CEO.

When IDS takes off on the lines suggested above, it may evolve from being a governance cadre to a becoming a total talent source for directorships in the companies. It may lead to a healthy competition between the home-grown whole-time directors and the externally-inducted independent directors. Companies would have the benefit of a knowledge driven, fully functional board contributing to all aspects of corporate management.

Obviously for a major structural initiative such as IDS to succeed, this new public service has to be provided with the necessary legal enablement. Necessary supportive institutions such as UCDC, NCDA, SCID discussed here should be established. MCA and CLB as well as SEBI should be expanded to be able to handle additional administrative responsibilities efficiently. Apex industry associations such as Confederation of Indian Industry (CII) should lend their full support to the concept. Indian Directorial Service could be a major structural and systemic reform that could be a pioneering one even globally.

Posted by Dr CB Rao on January 11, 2009.

Corporate Growth and Collapse:A Competence-Conscientiousness Interplay?

Enron, Tyco, Worldcom and Xerox of the recent years, the Wall Street of the recent months and Satyam of the recent days raise the question as to how just one or two top ranking leaders of a company can perpetuate gross operational mistakes and / or financial falsification of the magnitude reported in each case. The occurrence of such events in a public listed company is even more surprising given the size and scale of operations a large company has, the public visibility it receives and the innumerable transactions it has with thousands of its stakeholders.

One conclusion that emerges is that such adverse outcomes cannot be attributed to just one leader, however powerful he or she is in an organization but probably are the result of a number of individuals working collectively together, knowingly or unknowingly, towards such outcomes. However, even this conclusion is paradoxical in the context of such organizations being expected to have people with established backgrounds and appropriate perspectives. Are these adverse outcomes caused by an organizational behaviour dynamic that is not adequately researched?

The answer probably lies in the interplay between two critical dimensions that drive human behaviour. Competence and conscientiousness are the two dimensions which drive the behaviour of any personality, in an organizational context. Competence is the important skill (or skill-set) that is needed to do a job effectively. Such competencies are acquired through education and experience. Conscientiousness is the part of an individual’s thought process that judges the morality of the individual’s own actions.
Competence stems from knowledge and awareness. The more competent a person the more likely the person is likely to be able to contribute in his or her role to the organization. A competent person is likely to be aware of the various decisions he takes and the implications for business growth and propriety. More importantly, competence provides a unique sense of self-worth and the requisite confidence to an individual to operate as per the fair dictates of his or her profession. A competent person is thus likely to stand his ground against any undue pressures and conduct his activities in a performance oriented and ethical manner. As a corollary, an incompetent person is likely to be a pliant individual susceptible to various types of pressures besides being a poor contributor to corporate performance.

Conscientiousness provides the sense of right or wrong to an individual. It helps a person with the requisite sensitivity to analyse whether the decisions and actions he takes by himself or is asked to take by his superiors are consistent with professional and business ethics and practices of good governance. A conscientious person is more likely to exercise his competence in a positive manner for the good of the business and society. As a corollary, a person who is not conscientious is likely to be more amenable to undue pressures and questionable ways, and worse still may even put his competence to misuse in pursuit of short run gains.

A person’s contribution to and influence over the ethical performance of a company is thus an interplay of these two essential dimensions of a personality. The issues one encounters in various organisations are linked to the variability that is found in each of these the two dimensions. Like every attribute or outcome in the universe, competence and conscientiousness also follow stochastic distributions. In a well-run organisation, the talent pool is likely to reflect a normal distribution in terms of levels of competence and conscientiousness each.

One can, therefore view the human resource base of an organization, irrespective of the domain specialization or hierarchy level to which the talent pool belongs, in terms of a 2 X 2 matrix which classifies people in terms of high or low levels of competency or conscientiousness. Organizations being the sum-total of individual profiles, the aggregation of competency-conscientiousness profiles of the individuals also contributes to the organizational DNA. An interplay of these two dimensions of a collective human resource base results in organizations which are clearly differentiated, as shown by the 2 X 2 organizational grid below.

High in Competence and High in Conscientiousness: Virtuous and vibrant organizations
High in Competence and Low in Conscientiousness: Aggressive and mercenary organizations
Low in Competence and High in Conscientiousness: Ethical and static organizations
Low in Competence and Low in Conscientiousness: Opaque and shallow organizations

Organizations which have people with high levels of individual competence and conscientiousness turn out to be virtuous and vibrant organizations which demonstrate industry leading performance in business, ethics, governance and safety. These firms figure consistently as the top rankers in the blue chip league and often set the tone in all aspects of corporate behaviour. Companies such as Toyota fall in this category.

Organizations which have large pools of highly competent people but with low levels of conscientiousness typically post high business growth rates. However, the methods they deploy to achieve the performance could be questionable. These organizations are typically driven overwhelmingly by a performance criterion and are likely to choose the quantitative goals of performance over qualitative ideals of ethics, governance or safety if it were to come to a crunch ever. Most performance-centric companies which are loved by investors for the momentum of their earnings tend to fall in this category.

Organizations which have a preponderance of people who subscribe to high levels of ethics but have not bothered to equip themselves with the competencies required to handle the challenges of modern-day business would be virtuous organizations but with pedestrian performance. Though such organizations have the ability and intent to do good to the economy and the society they would be unable to do so for want of requisite technical and managerial bandwidth. Most traditional family-held businesses and NGOs run by individual champions fall in this category.

Organizations which are low in competence and conscientiousness are a drag to the economy as well as society for they represent a waste of public resource. In addition, if these companies desire to emulate the high performance companies without the inherent competence and conscientiousness they could pose a grave risk to the economy and society. Such companies could resort to questionable means to grow in business. Short term tactics deployed by such companies under the cover of opaque management processes result in hollow and risky business models that are susceptible to collapse at the first downturn. From Enron to Satyam, gigantic corporate failures take place in companies with such low levels of competence-conscientiousness mix that fail to support aspirations of high achievement.

Given the interplay discussed above, the top leadership in an organization has to aim at enlarging the human resource pool that is truly both competent and conscientious while shrinking the human resource base that is patently low in competence and conscientiousness. This is easier said than done for a couple of reasons. Competence is often measurable and visible as quantitative outcomes of performance while conscientiousness is qualitative and perceptional. It is a matter of further complication that high level of quantitative performance could itself be due to low levels of conscientiousness.

Organizations have to deploy 360 degree analysis during recruitment, training and performance appraisal phases of its human resource management so that each individual is analyzed in terms of not only the individual’s competence and conscientiousness levels but also how he or she integrates these two essential factors in terms of a performance work ethic. The top leadership of a company has to necessarily set the pace for processes which recognize and reward individuals only when their competencies are combined with conscientiousness. Such an approach will doubtless help create an organizational DNA that is virtuous and vibrant, leading to high performance with high ethics.

Posted by Dr CB Rao on January 9, 2009

The Sordid Satyam Saga : DAACS in the Dock?

The continuing Satyam saga has touched a new, horrendous low today with the resignation of the Chairman, B Ramalinga Raju and the shocking explanation tendered by him on the inflated accounts of the company. If the earlier episode of the aborted Satyam-Maytas merger brought into question the role, in corporate governcnce, of board of directors in the overall and that of the independent directors in particular, today’s episode brings into focus an errant axis that could exist amongst the promoters and directors, accountants, auditors and company secretaries (DAACS) in deviant corporations.

Viewed in a relevant perspective, DAACS as a group of corporate officers are trustees of public money that is created, transacted or held through corporate mechanisms. Each of these corporate officers has a specific purpose in an organization that serves corporate as well as public interest.

A director, whole time or part time, has an inviolable duty to provide the right vision, strategy and execution in an ethical climate to the affairs of the company. When a promoter is also a director or the CEO the responsibility becomes even greater. Whatever may be the seed capital with which an entrepreneur sets up a venture, sooner than later the capital structure gets expanded to include external equity and debt that is several, several times over the seed capital that is brought in by the promoter. It is to be therefore expected that the promoter-director acts as a trustee of the public money for public good rather than as a total owner of a corporation which has grown as much through public money as much through the founder’s passion and capital .

An accountant, or the chief financial officer, has the responsibility to ensure that the operations are conducted in a financially prudent and stable manner while fulfilling the corporate aspirations for growth and insulating the company from economic and business risks. Whatever be the IT and accounting systems deployed, it is ultimately the translation and interpretation of physical performance into the financial numbers and the performance certification that is provided by the CFO that determines the solidity and integrity of the financial status of the company.

Equally, significant emphasis is placed on the audit function, both internal and external, to ensure that a company’s operations and financial numbers are in compliance with all the statutory requirements and are reflective of the true state of affairs. Typically however, auditors are a highly pressured lot having to attend to multiple account closures in short windows of time on a quarterly and yearly basis. In any case it may be impossible to check the veracity of each transaction and consequently, reliance is placed on the self-certification by the operations and management teams. This however, does not absolve the auditors of their responsibility to ensure that a company’s systems and procedures are laid out and observed in practice in such a manner that the accounts represent a true and fair reflection of the business.

Last but no less important is the company secretary who is privy to all the agenda, deliberations and minutes of all board meetings. The secretary who in several companies acts also as the responsible officer for corporate governance and risk management has a special responsibility to ensure that the capabilities and competencies of the board are harnessed for the benefit of company operations. It also dwells on the secretary to ensure that the statute and prudential norms are followed in both letter and spirit and compliance as well as violation is reported diligently to the board.

Given the critical roles played by each of the DAACS officer group, a manipulative crisis of the magnitude that has hit Satyam could have been possible only when each member of the DAACS group collaborated, actively or passively, to abdicate the respective responsibilities and in fact acted in complete counter-direction to such requirements.

Obviously, the corporate and regulatory systems would need fundamental changes to avert these types of collusive behavior. Several measures are needed to ensure the needed robustness to the system. For example, the boards should reflect ownership interests in a truly proportionate manner. The independent directors should be appointed by ombudsman and regulatory institutions such as stock exchanges and SEBI. The two core corporate officers (the CFO and the company secretary) should be made accountable only to the board. Larger companies should be required to have two audit firms on a mandatory basis. Corporate compliance reports should be made a part of overall quarterly reporting as well as annual corporate reporting. Banks and financial institutions should have key client managers. The nexus between analysts and corporate managements should be discouraged. Media and industry associations should control their irrational exuberance and cease painting corporate leaders as demi-Gods. There could be several other logical measures.

If the Satyam episode serves as a clarion call for a fundamentally ethical transformation in the way companies are established, grown and managed; in the way corporate performance is compiled, reported and reviewed; and in the way responsible officers think, act and comply with reference to prudential norms, it would have served a purpose, albeit at a high cost.

Posted by Dr CB Rao on January 7, 2009

Entrepreneurs : A Breed Apart?

A dictionary definition of an entrepreneur is not very flattering, but shorn of the hype it is probably simply factual! According to Oxford, an entrepreneur is a person who makes money by starting new businesses.

In common business parlance, however, an entrepreneur is one who is not an employee and is more than a manager or a leader. Often, an entrepreneur starts with nothing but his or her idea or plan, hard-earned savings and of course passion to create a business.

There are managers and leaders who are routinely starting new businesses within companies, new companies within industries and new industries within economies. There are probably several thousands of them. What distinguishes an entrepreneur from such managers and leaders?

An analogy would probably explain well. An entrepreneur is like a mountaineer who relies on his guts, energy and passion as well as a few basic tools to reach a peak. A manager or a leader is perhaps one who analyses the path and weather and deploys a helicopter to get to the peak. There are applicable challenges and opportunities as well as costs and benefits in both the approaches.

Not every entrepreneur is probably the same. There are entrepreneurs like Henry Ford, Konosuke Matsushita, Akio Morita, Bill Gates, Steve Jobs, Larry Page and Sergey Brin who rewrote industrial history by creating new industries around novel technologies and products commercialized for the first time. There are also follow-on entrepreneurs who expanded and reshaped industries or competed with the pioneers, like William Durant did with General Motors. There are entrepreneurs who created industrial history in a hostile or fledgling environment like Jamshedji Tata or Larsen and Toubro. Entrepreneurs like Dhirubhai Ambani applied an inventive and aggressive mind to redefine what entrepreneurial initiative could deliver for business. Narayana Murthy and Infosys co-founders demonstrated how with little money and abundant skills one could create companies around global opportunities. And so does Raghavendra Rao of Orchid bring out his own story of entrepreneurial creativity, ardor and passion.

Is an entrepreneur for life? Probably not. Somewhere along the path of growth most entrepreneurs become all too adventurous, all too confident or simply all too obsolete. Microsoft, for example, failed to see the Web revolution. Sony failed to see the flat panel revolution. Yet these firms are mercifully surviving and growing because the entrepreneurs in good time created institutions with core strengths and which could reinvent themselves in the face of adversities.

An entrepreneur who ceases to be a good manager or a leader (or fails to recognize the need for good management and leadership) often fails to transform his company into a sustainable growth engine.

Should one have limits for claiming oneself to be an entrepreneur? Probably yes. The moment an entrepreneurial venture achieves a profitable full year of operations, logically the main defining elements of an entrepreneur (no money, no organization but only idea and passion) would have disappeared. The sooner an entrepreneur realizes that and transforms himself into a role model of balanced leadership, the better will it be for him and his company. This is because if he is a true entrepreneur, he will look for new challenges to undertake another resource-strapped, boundary-less quest. It is better for his company, because such a transformation substitutes the singular entrepreneurial zeal of the founder with the diffusion of entrepreneurial management across the company.

Is working as an entrepreneur exciting? Surely, because it is the attitude and personality that drives an entrepreneur. He or she typically likes to define his or her boundaries and rules of game. Yet, as mentioned above an entrepreneur needs also to know when his individual competence and satisfaction have to be subjugated to organizational capabilities and excitement.

Is it exciting to work with entrepreneurs? Yes, because they tend to be inspirational and energetic individuals fizzing with ideas and optimism. They believe in individuals and let people experiment. Yet, in their strengths lie their own weaknesses. They fail often in drawing the line between being truly inspirational and excessively rabble-rousing. They have too many ideas to get excited about, and in trying to implement all of them they tend to cross prudential norms. Their relentless optimism sometimes strays into dangerous territory which is characterized by foolish risk-taking, a denial of reality, and persistence beyond common sense. Many successful entrepreneurs fail to delegate. Some entrepreneurs who get surrounded by incompetent individuals remind one of lessons in history where successful emperors failed to retain their successes because when they overreached they had no one to bring them to their senses.

All things said, entrepreneurs are the inventors, the makers and the builders. The economies need them for the momentum of growth. The clever and sagacious ones who translate their singular entrepreneurial competence into organizational capability and who surround themselves with able supporters to balance out their imperfections will make a lasting mark on the history.

Posted by Dr CB Rao on December 30, 2008

Economic Meltdown: A Failure of Forecasting?

The severe global economic meltdown has taken the governments, corporations and public by surprise. It is even more surprising, however, that the meltdown has been preceded and accompanied by severe forecasting errors. For example, it was forecast that the crude oil will jump to USD 200 per barrel; now it is forecast that it would go as low as USD 20 per barrel. Similar gross variations between forecasts and actual levels have occurred in the currency exchange rates as well as in various economic parameters. Governments, central banks, economic agencies, consultants and experts have uniformly failed in generating forecasts that could have reasonably mirrored the likely actual levels.

Given the enormous progress made in archiving and analyzing data through information technology and the internet and the equally significant progress made in quantitative and stochastic modeling using mathematics, heuristics and simulations, the failure of forecasting is truly amazing. Perhaps one has to go back to the era of simpler models and their evolution into complex quantitative techniques to understand the reasons.

In the 1960s and 1970s, the forecasting models were based on mathematical models which analyzed a small set of past data to project a future trend. Within this, improvements were made to identify the impact of trends such as seasonality and cyclicality and smoothen the forecasts. As the quantitative capability enhanced thanks to information technology, the forecasting models became more sophisticated and moved into the domain of simulation. Eventually generic as well as domain specific simulation models, covering multiple sectors from FMCG to industrial equipment and from energy to economy, evolved.

Despite the increased sophistication, the failures of forecasting and simulation models have only increased. The reasons are many; some of which can be addressed and others which are difficult to address as discussed below.

Complexity of variables

A model is considered more sophisticated if it considers as many relevant variables as possible. Here lies the essential fallacy of complex models. Each variable is in itself dependent on a series of sub-variables and needs to be forecast based on its own simulation. As one would expect, any decrease in the forecasting efficiency of the primary variables will only decrease the accuracy of the final forecasting outcome in a multiplicative manner. And in several cases, as the variables and sub-variables arise from multiple sectors of the economy and/or multiple geographies, it is nearly impossible to achieve a uniform level of rigor in quantifying the variables and sub-variables. It is therefore necessary to limit the variables that are considered in modeling to only those that would have a significant impact on the outcomes, preferably by using ABC analysis.

Inflection Points

While identification of cyclicality and seasonality do help in generating a better model, the techniques do not help when inflection points emerge in respect of certain variables. For example, in today’s scenario purchasing power could have reached an inflection point with reference to the housing sector. The prices of commodities, especially of agricultural products could have a determining impact on the evolution of biofuel space.

Not all inflection points are economic in substance, however. Some inflection points are caused by technology. Ability to redefine the form factor of a device (whether a mobile phone or a laptop computer, or both) could substitute or combine the demand for such products each of which hitherto functioned as independent product-market segments. Ability to combine multiple functionalities in a single product could lead to generation of new product-market structures that are completely different and path-breaking. It is therefore necessary to conduct appropriate qualitative macro-economic evaluation and Delphi type technological analysis prior to embarking on detailed forecasting models.

Inflection points are hard to detect if organizations are mired in managerial dogmas. One is aware of the IBM chief’s observation made decades ago in the context of building of the first computing device that the world would not need more than a handful of computers. Cellular technology collaborators who introduced mobile telephony to India a few years ago felt that India could not support more than a few thousand cellular connections. In both these cases, separated by several decades, the dogmatic beliefs were beaten hollow by the new technology waves that these two products represented. In each case, sheer utility, affordability and proactive market segmentation led to levels of market expansion and penetration, which no forecasting models or leadership judgement could identify.

Cause-effect relationships

In today’s complex world where technological and economical factors generate lateral (and sometimes tectonic) shifts in supply side and consumption side factors, the cause-effect relationships are particularly complex to identify. These changing relationships impact the outcomes in several inexplicable ways.

The demand for oil, for example, is not determined merely by economic growth factors such as industrialization, or the infrastructure factors such as roads and automobiles but by the emergence of alternative cleaner energy sources such as biofuels, hydrogen energy, electric energy, solar energy or several combinations thereof. As seen earlier, each sector has its own variables and each variable is influenced by several sub-variables. The more pervasive, and the more multi-component a variable is, the more difficult would it be to define or quantify. Forecasting the overall demand for energy is not a sufficient solution in the alternative because, demand estimation for individual components is essential for sustainable economic and industrial planning.

Amongst all the intriguing aspects of forecasting and simulation, the cause-effect relationships are the most difficult to handle. It is important to aim at scenarios rather than specific outcomes to handle this issue.

Ignoring errors

The common perception is that forecasting is a statistically supported precise science. This has been a major contributor for the inadequate appreciation and incorrect application of this science. Forecasting is not an exact science. In fact, the subject of forecast errors is a fundamental part of the overall forecasting science. Identification of forecast errors and their sources helps the elimination of systematic deficiencies and refinement of the forecasting model.

Integration of the application domain and forecasting expertise would generate a feedback loop that helps the forecasters and users understand the benefits and limitations of forecasting with accuracy levels that should reasonably be expected. If forecasting through a model and its application in practice are treated as two different disciplines there would be no scope to study forecast errors in a real time framework. Modification of models based on a systematic study of forecast errors is essential to develop robust forecasting models.

Marketing of forecasts

Forecasts were seen in the past by the decision makers as well as lay public as guideposts for an uncertain future. Over time, these have come to be creatively positioned and eagerly lapped up by decision makers to make economic or business moves. Even lay men are increasingly basing their consumer purchase or retail investment decisions on slickly marketed forecasts.

Nowhere is this seen more evidently than in forecasts about corporate performance or stock movements. Over the last few years forecasting of corporate performance has become a “speculative science” built on the foundations of management projections and simple financial planning. The glaring absence of economic and business analysis in such forecasting is covered up under an excessive projection of the so called growth drivers and financial triggers.

At another level, analysts, institutions and agencies use forecasts as a tool to market themselves. It is a matter of concern that despite their apparent data orientation, these bodies rarely compare the forecasts with actual developments and seldom use them for effecting changes in their forecasting methodologies.

Value destroyers

In recent years, forecasting has moved into a new domain called derivatives. Based on an underlying transaction, be it related to exports or demand-supply match, calls are taken on the future course of current investments which are, indexed to forecast movements in variables such as currency exchange rates. Scores of companies have lost millions of dollars individually, and billions in the aggregate, in exotic derivative deals. It is with great wisdom and appropriate that Warren Buffet called the modern day derivatives as weapons of mass economic destruction.

Intrinsically, forecasting offers no guarantee in derivatives despite the element of “future projection” that is involved. Movements in foreign exchange rates are subject to unexpected substantial changes and volatility in macro and cross-border economic developments such as demand for dollars, foreign direct investments, balance of trade, industrial recession and so on. Even the most sophisticated experts failed to predict the drastic change in dollar-euro parity or the unrelenting strengthening of Japanese yen. No wonder then that the banks that sold exotic derivative products and the companies which bought them for attractive service fees and profit opportunities respectively are nursing huge losses.

Healing the physicians

Being in the forecasting business does not mean that the wisdom to ensure a future of certainty, and insure an uncertain future accrues through forecasting. We have the case of Goldman Sachs causing a tremor in the global economy with its dramatic forecast of USD 200 per barrel crude not so long ago. While crude is now in a rapid reverse trend towards a low that is just 15 per cent of the forecast, Goldman Sachs could not forecast the downfall of its own institution caused by its erroneous economic and asset forecasts, and related management decisions.

There appears to be a valid case for forecasters to appreciate the science of forecasting in a more temperate and holistic sense, carefully charting all the variable and sub-variable trees, understanding the inflection points and tectonic shifts, delineating cause-effect relationships and recognizing the science of forecast errors. Resisting the temptation to hyper-market forecasts or misusing them to destroy economic value, the forecasting experts have to introspect on the capabilities and the limitations of the science of forecasting, and function as reliable and sensitive guides to considered decision making by the governments, corporations and people at large.

Posted by Dr CB Rao on December 29, 2008