I’m Looking Backwards to Christmas, across the ICA

(with apologies to the late Spike Milligan)

The Institute of Chartered Accountants is running an advertisement intended to recruit new entrants which states that

80% of FTSE 100 Companies have an ICA member on their Board.

How does this look from the Comparative Competitive Strength point of view? Do ICA members actively contribute to performance that consistently exceeds expectations and generates world beating performance? Do they strengthen and reinforce outstanding business success and wealth generation? Or have they helped handicap the pursuit of excellence and been a contributory factor in potentially avoidable failures? Have they, perhaps, helped erode Capitalism by obscuring Common Sense?

Only a very few companies achieve the highest level, Free, of Comparative Competitive Strength (i.e. are the Very Best in the World in their field). A high proportion of these businesses are privately owned by shareholders or proprietors who are focused on the future, who know how to take decisions about long term risks, who are not scrabbling around for short term “prizes” without heed for the consequences, and who have the operational flexibility and sustainability to continue to prosper in hard times. It may be no coincidence that this is also the profile that seems to attract Warren Buffet. These are the companies that generate real wealth – solid sustainable human, intellectual, technological, physical, market, and financial assets and resources that deliver benefit to the future of the whole community. One of the keys to their success is their relentless focus on the future – what we call “Forward Facing Thinking”.

As we all can see, there is a continuing avalanche of business failures, of companies that are falling from the lowest level, Constrained, of Comparative Competitive Strength down into The Abyss. Do there really have to be so many? Have ICA members contributed, perhaps unwittingly, to the scale and severity of this bloodbath?

We have commented before in our “Excellence Quartet” blogs about the pernicious antics of the M&A “pirates” who, sometimes without permission, use their valuation of the assets of the purchased as collateral for the loans they need to complete their, often unwelcome, acquisition. A significant proportion of the continuing flood into The Abyss are companies that have been critically weakened by the debts incurred by such financial engineering. Many of these businesses were generators of real wealth and reservoirs of skills and knowledge vital to the future sustainability of our Nation State (such as nuclear power station design and manufacture). Far too many, especially in manufacturing and science based sectors, have been eviscerated by the decades of under-investment imposed by the muddled short term thinking and self-serving manipulation of numbers by their financial “experts” and bankers (now there’s a basis for comparison that might give the ICA serious pause for thought).

The ICA may trumpet the influence of their members. However, in the spectrum of real wealth generation (solid sustainable human, intellectual, technological, physical, market, and financial assets and resources that deliver benefit to the future of the whole community) they qualify to evaluate only one of those assets, the financial. Worse still the majority of their disciplines, and the primary basis upon which they seek to exercise influence on others, are based on looking backwards, “Backward Facing Reaction”. Sadly, too often they have been perceived “to know the price of everything and the value of nothing”.

The tragic and scandalous question is whether, in too many circumstances, that narrowness of view and understanding has been all prevailing and used (or abused) for the acquisition of personal power? Has that in turn led to over active collaboration in the City’s desperate “games culture” of financial engineering, reckless M&A, and the overall collapse of intellectual rigour in financial and business thinking that has brought us all to the brink through the Credit Crunch?

Sir John Rose of Rolls Royce, talking about the future needs of our economy in early November 2009, said there should be “less emphasis on social engineering and more on wealth creation”. We find ourselves “having a Heated Agreement” (to use the treasured words of the late Bill Carpenter, also of Rolls Royce) and paraphrasing those words as

“less emphasis on financial engineering and more on wealth creation”

Is ICA membership only about “What’s In It for Me?” Is, as the advert implies, the ICA focused only on dangling the prospect of power and authority for its members? Is this the moral and ethical leadership we look for and expect from our professional classes? Are the ICA really aligning themselves only with politicians, lawyers, bankers, financial advisors, estate agents and other perceived “professional” victims of public opprobrium? Or do the ICA want to be seen as professionals who are more vocational in flavour, like the engineers, the scientists, and the medics, most of whom seek to add to the overall well being of the nation, not just to find out the best way to grab more for themselves?

Wealth creation is driven by a focus on the future, not the past. It is centred in Forward Facing Thinking, not Backward Facing Reaction. We hope that ICA members might want to competently add real value by helping to generate real wealth, and not just manipulate numbers and words to serve either their own interests or those of close colleagues. If so, they will need to develop the ability to evaluate the future as rationally as the past and to articulate their understanding on a broader business basis than the judgement laden and perilously temporal fabrications of financial analysis. There has not been any truly objective tool to do this until recently. More often than not, the chosen solution has been a massive and time consuming investment in strategy management consultancy – perhaps even by a major accountancy company (more ICA members?) and, by definition, never truly objective!.

So how would it be if ICA members had access to a powerful and genuinely objective evaluation of how a leadership and management culture compares with the very best performers in the world, where its main constraints lie and what choices it must make to secure the future? Would it be better still if that assessment delivers these outcomes better, faster and cheaper than any other route?

• Cheaper? – now there’s a word with nasty ambiguities – we mean something that takes much less of business leaders’ valuable time, as well also as being comparatively inexpensive.

Wouldn’t that just be an opportunity to help create wealth, instead of risking being seen to be party to its dissipation? Could it be their chance to strengthen Capitalism with Common Sense.

You can find out more about the Comparative Competitive Strength point of view on our website here or contact us here.

Capitalism or .... Common Sense is brought to you by Steve Goodman & Tony Ericson, partners in ChangeWORLD & Achievement Coaching International. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. We publish a new article on one of these blogs every month or so using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at - Exceeding Expectations - You're having a laugh ... seriously - Business Bloop of the Month Award .

Loan to Lenders ratio

The big finance and business story on the Lloyds/RBS bailout and its consequences has rather overshadowed the intriguing story about Yell’s planned £500m rights issue.

Yell, the publisher of Yellow Pages and yell.com is heavily indebted, to the tune of £3.8bn. It urgently needed the rights issue and an extension of debt maturities to avoid the risk of a covenant breach.

However what really caught our attention is that Yell’s debt involves over 1,000 lending commitments! Can you believe that, over 1,000 for a business with current market capitalisation of just £390m! However when you consider how the sum per lender looks so much smaller than the total indebtedness perhaps the rest of us are missing a trick here.

There are a number of financial ratios used in the lending to assess the viability of a lending proposition, loan to valuation, multiples of earnings etc. Yell seem to have come up with a new one here, loan to lenders ratio. For example if you could achieve the same number of lenders as Yell on a mortgage of £100,000 you would only owe £100 per lender, hardly worth any of them asking you repay it!

Or, taking the average unsecured loan figure (credit cards, overdraft etc) in the UK of £3,000 this same ratio means you would only owe £3 per lender. However carrying around 1,000 credit cards each with a credit limit of £3 would be a challenge.

What also surprised us is that there was very little comment on the number of lenders, other than to give the figure of 1,000, in any of the articles we have read on this story. Are we only ones to think this is all a bit odd, that it doesn’t make sense? Did the lenders themselves not notice how the room was getting a bit crowded and was this such a good idea?

What about Yell itself. Did they wake up to just how many there were when they started the negotiations on the rights issue? If they actually deliberately accumulated this number of different loan commitments what possible rational reason was there for doing so? It not only complicated the rights issue process. - “ …. collecting their acceptances has been a huge logistical exercise” (John Davis Yell Financial Director) – it threatened to derail the issue completely and with it the company.

So this may be an example of capitalism at work, but does it make sense? Simple is always better but of course complicated demonstrates how clever you are. A final thought though.

Amazingly Yell have managed to gain 95% acceptance from their lenders of the terms they needed to allow the rights issue to proceed. Whoever achieved this is wasted in a publisher of directories and should be transferred immediately to sort out the Israeli/Palestinian problem. Move over Tony and let someone who really knows how to negotiate the impossible from the improbable take over!

Capitalism or .... Common Sense is brought to you by Steve Goodman & Tony Ericson, partners in ChangeWORLD &Achievement Coaching International. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. We publish a new article on one of these blogs every month or so using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at -Exceeding Expectations - You're having a laugh ... seriously - Business Bloop of the Month Award .

Cracking the Bonus Culture - Why Regulation cannot be the answer

Yesterday Lord Turner, Chairman of the Financial Services Authority proposed a tax on financial services transactions as a means of curbing excessive pay in the sector. He said that the financial sector had grown “beyond a reasonable size” and accounted for too much of British output. "I think some of it is socially useless activity," said Lord Turner, referring to the complex financial instruments that have largely been blamed for triggering the biggest global financial crisis in decades.

Whilst a relatively radical set of ideas, especially compared to Alistair Darling who is still “considering legislation”, this is just the latest utterance on the subject. The general opinion is that one way or the other the financial sector globally is going to be more tightly regulated. What is less certain is what form this regulation should take and how it can be applied and policed globally.

However our view is that if Capitalism, whether in the City or elsewhere is to prosper again, it will not be through Regulation. Wherever there are rules, there will be opportunities for the unscrupulous to explore the fringes of definition, structure and enforcement. Wherever there is wealth, you will find the unscrupulous “lingering with intent”, as they used to say.

They lingered long enough and close enough to take over much of the management of wealth and to wrap it all up in a bedazzling miasma of complexity and mis-direction. The Magic Circle should have been reeling in envy of these conjurors. They cannot be regulated; they must be eliminated, made unable to function.

The potential for Capitalism to return to its former strength in the future will depend on Ethics – on the development and maintenance of Trust between individual stakeholders. And, trust is the outcome of inter-personal relationships and transactions – it is earned by doing, not by promising nor, least of all, by certification or regulation. And here we have the essence of the new future – a return to people dealing with people and trading based solely on tangible assets, and credit based on the lenders’ personal guarantees - the Restoration of Trust. And nowhere is this needed more than in the Banking sector and The City.

The Restoration of Trust

In order for this to be possible, much will have to change. Will monolithic centralised organisations be unable to do business this way and be required to change how they operate? Will decision making only between principals with local responsibility, local accountability and local authority become the norm? Will large organisations be able to bring themselves to expect and allow local individuals to take risks? Will financiers and lenders be able to adapt to the idea of actually holding personal title to the commodities and assets with which they seek to trade? Will the principles of mutuality become much more widespread and overlap into the business to business commercial arrangements and relationships? Will performance related rewards reflect both gains and losses over extended time spans, or is this just trivial tinkering with a symptom?

How might we reflect this change in the “Global Marketplace”? How might we inhibit or constrain the adverse effects of short term betting that have been so vividly demonstrated? Should short term performance measurement be banned from all performance related reward schemes – and from business accounting public reporting? Should all periodic reporting be required to be historically smoothed? Or will we, again, be putting salve on the symptoms and ignoring the disease?

Control Theory – the solution that has never been considered?

Or should we recognise that these international financial marketplaces are just an enormous collection of massively complex closed loop control systems that are intrinsically unstable? Should we perhaps think about other such mechanisms, such as “Galloping Gertie” the Tacoma Narrows Bridge that collapsed spectacularly in 1940, or a motor car rendered uncontrollable by failed shock absorbers, or the ear piercing shriek of microphone feedback in a public address system? All engineers know that undamped reactions can cause resonance, massive instability leading to self destruction, in all such mechanisms, or systems. Experienced control engineers know too that relatively tiny energy inputs are enough to stimulate such systems beyond control.

The financial world is full of such potentially resonating systems, both human based (“market sentiment” - what a phrase) and technological (from Fund Trackers onwards) – and they are all undamped. In 1969, an early experiment in Canada using computer based share trading decisions generated extraordinary returns compared to the “normal” market. A cursory analysis showed that, once more than 2% to 3% of the total market trades became based on such technology, then the overall rate of returns would then converge to that new rate. That was 40 years ago, and the financial world has learned nothing.

If unstable mechanisms and systems are to made stable, they need to be damped – they need to have some of their energy “destroyed” to limit their intrinsic resonant feedback. In mechanical devices, this is often achieved by friction, either mechanical or hydraulic. In electronic systems energy absorption or time delay (e.g. “phase shifting”) commonly perform the role. In human systems, e.g. “market sentiment”, historically the most common source of damping was the elapsed time it took news to travel – even so, this delay was not always enough e.g. the Tulip Boom and the South Sea Bubble. In today’s electronic world, there is no delay at all, everybody knows everything while it is happening. In today’s logical world of semi-automatic systems, there is no systematic damping at all – it is all virtually instantaneous. Market prices swoop and dive, leap and tumble, in reaction to the tiniest of traded volumes and rumours. And, in response, the surrounding human systems cease to be able to cope – there is an almost total loss of confidence - the markets and the economy collapses.

The solution is obvious

Almost certainly too obvious for comfort. The answer to the problem of resonant instability is - Damping. But how might this be achieved practically? Certainly, there is no realistic prospect of converting all the world’s financial market control and analysis systems (even if we knew where they all were) to “add damping”. Nor would “News Management” to delay all news be practicable (bad luck, Gordon). What might happen if we look beyond the systems to the events that are being reported – trading transactions?

What would be the effect of creating a Deal Transaction Completion Delay into all stock, fund and loan deals, everywhere? Since, by our already stipulated requirement that only tangible or personally underwritten, assets might be traded (thus eliminating all derivative trading), only tangible trades would be possible. Perhaps, all such trades would require an elapsed time of 24 hours – instantaneous reaction would become impossible.

This would dampen markets – massively. Additionally, thousands of financial intermediaries would become surplus to requirement removing the distorting effects of their expectations for “compensation”. Enormously complex and opaque financial arrangements would become infinitely more difficult to “engineer”; even fraud might become more difficult, although the pool of less than scrupulous potentially credulous victims will not diminish, nor will the predators disappear.

Local Leadership for World Recovery

Superficially, it appears that total International agreement would be needed for this to be possible – suggesting that the probable feasibility is minimal – although the “opportunities to strut” might appeal to our politicians. Experienced deliverers of effective change know that major transformation of massive and complex systems is not achieved in a single stroke. Effective transformation comes from demonstrated change leadership – and that is best achieved by local, concentrated, and different, actions, behaviours and values that produce different results.

On this basis, we can ask what might happen if just some of the world’s largest markets went this way – e.g. London, New York, Frankfurt and Tokyo? Would they become recognised fairly rapidly as the best places for solid, long term, wealth development? Would that leave the get-rich-quick-regardless-sharks to have their feeding frenzies elsewhere in other, smaller, markets? Would those central stock values be able to resist pricing ripple effects from the shark pools? Would enough “investors” be able to recognise the difference in their risk-to-reward ratios to become more likely to invest in the damped and stable markets rather than the frothing shark pools?

Can we return to the generation of Real Wealth?

Will the stability of a damped market restore the capacity for consistent, long term, wealth increasing, business development by responsible business leaderships? This is a result that would deliver the greatest possible value for all stakeholders, the same form of genuine generation of wealth upon which our Industrial Revolution was first founded. This real wealth generation can be still be seen in many of those innovative market leaders, exhibitors of high Comparative Competitive Strength, that have eschewed public ownership whether through participative proprietors, private shareholders, or through employee ownership. Maybe all our financial markets could become driven by true wealth creation and not by just a tiny incentive reward driven minority of data manipulators. And then, but my hopes are not high, possibly even our Government may focus on actual wealth creation before it is too late.

Capitalism or .... Common Sense is brought to you by Steve Goodman & Tony Ericson, partners in ChangeWORLD & Achievement Coaching International. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. We publish a new article on one of these blogs every month or so using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at - Exceeding Expectations - You're having a laugh ... seriously - Business Bloop of the Month Award .

HSBC and The Case of the Wrong Viewfinder

The news from the retail sector has been a little better recently. However the story is still one of winners and losers. One retailer that has been losing steadily, even when most others were winning, is Jessops. We have highlighted their dismal prospects before in our Exceeding Expectations blog.

Apparently now they are fighting back. They were back in the news a few weeks ago with an interview with their Executive Chairman David Adams in the Telegraph, triggered by a reported £300,000 refit of their New Oxford Street store described as:

“… likely to be a blueprint for Jessops. The uncluttered store – sleek and black – has been designed to be a "house of brands" for all things camera-related”.

However, what really caught our attention were their reported negotiations with their bankers HSBC. As stated by the Telegraph -

“Jessops are now "in a process" which is likely to end with a positive outcome. HSBC has appointed consultants to look at restructuring options, and is deciding – with the company's help – on the best capital structure and the level of debt.

Mr. Adams is coy about the options, but a debt-for-equity swap is an obvious, some say likely, option.”

All our alarm bells rang. Are HSBC seriously considering the possibility of debt-for-equity swap? That would mean making their own shareholders and stakeholders investors by proxy in Jessops!

Why would those investors and stakeholders want this? Every Competitive Strength signal is, and has been for some considerable time, that Jessops is in a Constrained condition, headed for The Abyss. What has changed that could possibly justify throwing good money after bad in this manner? What are HSBC looking at, what level of understanding do they have of the risks they could be taking with other peoples’ wealth?

Apparently, the report continues, it is all OK really - Jessops have a plan. First their offer is going to be as described by David Adams "… all about price, choice and service. On price, we will not be price leaders – we can't with our structure. But we can be competitive. Service is our big differentiator.” That is quite a challenge, considering that right now all the anecdotal evidence is that they are perceived as not being about any of those things, especially service. That's not just our opinion, just what Mary Portas had to say about them. (Link to article)

Then they are going to re-model their stores! This is the same “cunning plan” that is being pursued by the Abyss bound DSG, also a regular subject within these blogs. After the briefest of Hawthorne effect rallies, Jessops is likely to exhibit the same slither back to doom. Furthermore, even at half the cost of the Oxford Street store it would cost over £30 million to refit all their 211 stores.

So whilst HSBC and their consultants deploy their undoubted expertise in the use of the resources and processes of capitalism to find “… the best capital structure and the level of debt” for Jessops, we believe that what has been missing all along in the Jessops saga is “Common Sense”. And for a retailer, one particular bit of Common Sense.

Let us explain.

Once upon a time, if you wanted a good photographic print service you could choose from many options, ranging from the cheap but slow postal services to speedy but expensive retailers – and of course, very expensive specialist processors. Jessops had a special edge, their staff were really knowledgeable photographic enthusiasts, their quality and service compared very well with other retailers, and their prices were competitive. So they had footfall and they had customer relationships - the first and best opportunity to sell other products and services; that was sharpened because the main drivers in the business were brilliant buying coupled with systems and financial policies that were totally focused on service. Based on this, we customers upgraded cameras, bought accessories and sought advice. This all “made sense” and at this point in its history, Jessops was exhibiting many aspects of the high Competitive Strength condition of Excellence, with trading results to match.

By the time the Digital revolution arrived, Jessops had passed into other hands and “professional management”. The logic for the venture capitalists that bought the business was simple. Buy the market leader and then open more stores. This would deliver sales and profit growth to ensure a successful flotation within a few years and a handsome profit to the investors.

As was usual, it was a geared deal where the “lucky” subject of the purchase effectively financed much of the cost of its own change of “ownership”. Stocks were cut thus removing one of the key enablers of the previous exceptional customer service. Payment times to suppliers were lengthened thus seriously weakening their ability to negotiate the low purchase prices that previously had enabled them to offer their customers outstanding value and still make good margins. This converted the business almost instantaneously into a Competitive Strength level of Constrained.

As they had paid the people who knew the secrets of Jessops’ success large amounts of money to go away there was no one to tell them that, whilst this might be conventional business practice, it “didn’t make sense”. As the profits began to dwindle together with the prospects for flotation they set out to “cut costs” further by downgrading their quality of shop staff amongst other changes and further diluting their buying competence. It was not long before Jessops ceased to be a reliable source of advice (customer relationships, remember?) – or anything much else. One attempted flotation was pulled and then at the height of the bull market they managed to float at a deep discount and the shares have hardly been in sight of the flotation price since.

Now all this may be Capitalism but where is the Common Sense? Still nowhere it seems.

The only maintained standard (which kept me as a customer) was the in-shop Print Service with its excellent link to Hewlett Packard’s online Snapfish ordering process which provided collection in the local store (equals footfall, remember?).

Jessops had been visibly slow to react to the Digital revolution – an inevitable consequence of their Competitive Strength weakness. And so the spiral to today’s sad condition accelerated. Now, we suspect driven by their desperation to cut costs, this business has achieved another large step to destroy itself. They have replaced their own On-Line Photo-Print service linked with Snapfish, by a third party “partnership”. It is slower, not noticeably cheaper, and the nearest collection point for me is now 20 miles further away in another town – and worse still, a retail area that no one around here would ever choose to shop in. So now I am not a customer any more – me and the other 125,000 people in this borough. So, at one unthinking stroke, Jessops’ management have succeeded in reducing footfall. We wonder in how many other areas this pattern of folly is repeated?

So we ask HSBC – just what are you looking at – or peering through? How much of all this have you understood before taking a potentially absurd risk with other people’s wealth? We suspect that Bankers’ can get fascinated by the technicalities of financial engineering and can forget that other peoples’ shareholdings, savings, pension funds, insurances and security are at risk.

If there is one constantly trumpeted factor for the avoidance of failure in Retail, we are told that it is footfall. In other words, if you have it, whilst other shortcomings might eventually cause you to fail – if you don’t have footfall then you are doomed to fail regardless, it’s just "Common Sense". As a fact, Jessops have reduced their footfall and their operational management have shown that they are either so unaware or so arrogant that they have ignored this. This seems to us to be basic – basic, basic, basic! Unless there is a substantial hidden agenda, HSBC is starting to appear incompetent or desperate or possiby both!

We return to our constant cry – Bankers need to learn how to assess not just the accounts that their business customers’ provide (those can be sooooo creative!) but also the Comparative Competitive Strength of the enterprise. They need to learn how to look forwards and not just backwards, it’s just common sense!

This means that they need to learn the language of Competitive Strength and the enormous differences (over 100%) in financial potential (that means future performance, folks) that exist between the Constrained level and the Excellence or Free conditions. They need, perhaps, to consider using our Competitive Strength Report and process to provide a more robust and structured approach to their assessment of the future prospects of potential investment and banking decisions. And, since there seems to be so much that they can overlook in these matters, we suspect that they also need to transform their inter-personal communication skills to be able to conduct the level of penetrating conversation that would reveal key facts – e.g. in this case the footfall question. We wonder if due Diligence would be much better executed if accompanied by much more due Intelligence? We think that they need to get much smarter at Finding Out.

You can find out more about all of this by looking at the ChangeWORLD web site here, and the Competitive Strength page here – and the Finding Out page too!

Capitalism or .... Common Sense is brought to you by Steve Goodman and Tony Ericson. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. Each blog has a new article each month using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at “Exceeding Expectations", "You're having a laugh ... Seriously?", "Business Bloop of the Month Award".

M&A thinking may still be common, but does it make sense?

One of the principles of free market Capitalism is that the strong will devour the weak. And, in many cases this happens with a solid underlying financial and commercial logic. However, although the strong may devour the weak, this is no logical basis to infer that the mere act of devouring creates strength. Consequently, and all too often, Merger & Acquisition has been used by weak businesses to shore up or disguise their own lack of genuine strength.

Let us look at the mega M&A deals in the pharmaceutical sector announced in early March.

From The Times March 10, 2009

Takeovers rarely a tonic for pharmaceutical groups
Ian King: Business Commentary

Faced with some unpleasant ailments, the pharmaceutical industry's biggest players are reaching for a familiar old remedy in the medicine cabinet — M&A. In January Pfizer splashed out $68 billion for Wyeth, yesterday Merck agreed to pay $41.1 billion for Schering-Plough and last night Roche looked set to buy the 44 per cent of Genentech, the biotech giant, that it does not already own for $46.7 billion. ………

………….. The question is what happens next in the industry. With company values depressed, because of recent market falls, the big fear for executives is that they miss out on a wave of industry consolidation and, as a result, are pushed down the global pecking order.

This is why shares in GlaxoSmithKline fell yesterday. As the industry's second-biggest player, it is under more pressure than most to do a big deal, despite the protests of Andrew Witty, its chief executive, that he is not interested in M&A. It is also why shares in AstraZeneca and Shire Pharmaceuticals rose sharply. They, with Bristol-Myers Squibb, are all possible targets in any round of deals taking place soon.

Yet the scepticism of Mr Witty and others who are constantly being told that they need to do a deal, such as Novartis and Sanofi-Aventis, looks well-founded. The majority of mergers and takeovers destroy value and, in the case of the drugs industry, M&A activity has conspicuously failed to deliver the promised returns. This is because, more than most, pharmaceuticals is a “people” business, with scientists at its heart. Cost-cutting after a big merger or takeover, although giving earnings a short-term boost, is not compatible with research and development programmes stretching out over decades.

In any case, many big drug companies are already incredibly bureaucratic. Making them even bigger will not solve this problem. For that reason, it is to be hoped that Mr Witty will stick to his guns, concentrating not on delivering a small number of highly profitable blockbusters but on a larger number of less profitable new products. In doing so, Mr Witty will, rather like users of GSK's Nicorette quit-smoking gum, need formidable powers of willpower. He will face intense pressure to do a deal from investment banking advisers in the next few months.

Our emphasis in bold.

Ian King's inciteful article highlights once again how “investment banking advisers” are seen to be trying to steer company policies in directions for which the only certain benefit is to themselves. And, once again, some executives are described as being in fear of them, this time of being “pushed down the global pecking order”.

GSK, under Andrew Witty’s predecessor, the gifted and radical leader Jean-Pierre Garnier, was transformed from a monolithic, over-centralised, bureaucratic, under-responsive battleship into its current form as a well co-ordinated fleet of highly responsive, flexible, agile, and enterprising, commercially acute, gun-boats. J P Garnier left GSK able to generate a consistent and sustained stream of new products and consequent profits – no longer gambling on occasional massive windfalls. His legacy, so well understood by Witty, is substantial Comparative Competitive Strength, with very high changeability embedded in both depth and spread. This is Common Sense – but anathema to the “me-first-get-rich-quick” mentality of the “investment banking advisers” – what a surprise.

Why does anybody spend any time at all listening to people whose advice will deliver virtually guaranteed benefits to themselves but highly uncertain prospects for those acting on their advice?

Suppose a smartly dressed person turns up at your front door and tells you that they have an amazing and exclusive deal for you? They say that they are an Estate Agent (let’s forget any prejudices, please) and that because of their special and privileged relationship with a Mortgage Provider they can enable you to become wealthier by buying a bigger house whilst remaining within your current means – just like that!

And you, like an idiot, agree.

It seems reasonable that the house deals and the mortgage deal will be handled by the Estate Agent; that you pay some “arrangement fees”, and even that your payments although unchanged are now guaranteed only for a fixed period. And now you have a property that is “worth” 25% more than your previous home – you have become more wealthy!

However, it may have escaped your attention that you now own only 20% of the apparent equity in your new house compared to the 35% you held in your old home. The good news is that should property values rise, your equity level will increase disproportionately – you have “leverage”. The bad news is should property prices fall, then you could end up right where you started, or worse. The very bad news is should interest rates rise, then after your fixed term expires, you may face payment levels you cannot sustain and disaster.

The only certain winners in this scenario are the instigators, the Estate Agent, and their financial backers, the Mortgage Providers. The instigators take a slice of your money whilst ensuring that you take all the increased risk.

Wouldn’t you have to be an idiot to fall for such a deal?
Can you imagine that anyone might be stupid enough to do that?
That cannot be Common Sense – can it?

Now if we substitute “Investment Banking Adviser” for the words “Estate Agent” and “Investment Funds” for “Mortgage Provider” we might recognize the story on a larger scale – and if we swap “executive” for “you”, we complete the match. The instigators take a slice of the Shareholder’s money whilst ensuring that the Shareholders take all the increased risk.

Wouldn’t the executives have to be idiots to fall for such a deal?
Can you imagine that any shareholders might be stupid enough to support that?
That cannot be Common Sense – can it?

Well – hundreds of them did – tens of thousands of you did.

It was not Common Sense – commonality did not make it sensible – it never does.

The only way out from this madness is to return to a solid focus on tangible wealth creation – to get back to Common Sense. The only reliable indicator of tangible wealth is deep underlying sustained long term profitability – the investment criteria upon which Warren Buffet patiently, steadily and lengthily, built his own and many other’s fortunes. But, because history takes too long, you cannot spot the tangible wealth creators in advance – or can you?

The most reliable determinant of massive financial strength, potentially solid wealth, is Excellence. Robust academic research has proved beyond reasonable doubt that the very best businesses in the world can deliver financial returns that are 50% to 100% better than the average. Take care here about which is the chicken and which is the egg – it is being the very best in every aspect of what they do that delivers the exceptional financial results of these businesses – it is not the money that makes them the very best, that is simply an outcome of being the very best.

Whilst Excellence is a well researched concept its connection to superior financial performance and long-term business growth and sustainability is not widely understood, especially in the financial sector. Consequently the application of the thinking and disciplines needed for Excellence is patchy at best and far too many business leaders think that being Better than Average is good enough. Furthermore, many cannot tell the difference between Big and Excellent – maybe psychologists can help us understand whether these sad souls confuse “global pecking order” with “pecker order”?

If you want to know more about all this, how you can spot the tangible wealth creators in advance and why Common Sense pays off handsomely, please have a look at our website where you will find out about - Competitive Strength, what this is and why it is crucial to financial performance – and about Changeability, the essential attribute for Excellence.

Capitalism or .... Common Sense is brought to you by Steve Goodman and Tony Ericson. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. Each blog has a new article each month using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at “Exceeding Expectations", "You're having a laugh ... Seriously?", "Business Bloop of the Month Award".

It's so obvious

From The Times February 19, 2009
Toyota to seek voluntary redundancies in Britain
Christine Buckley, Industrial Editor

Toyota's British operations are to shed jobs and may implement a pay cut, a reduced working week and a temporary suspension of workers, the company said yesterday after meeting unions.

Toyota said that it would put no target figure on job cuts from a voluntary redundancy programme and that the scheme had been suggested by employee representatives rather than by the company. It said: “Our philosophy is to make every possible effort to secure permanent employment. However, our employee representatives requested that we consider the introduction of a voluntary release programme. We have taken this into consideration and provided this opportunity.”

Toyota said that it had been hit in Europe last year by the wind-down of some models and few launches. The company said that it would not mount heavy discounts to try to win back customers, as some of its competitors have done, especially in the fleet market. It said: “This is not Toyota's strategy, as we want to develop our business in a profitable and sustainable way, with a long-term perspective.”

Now think about it, "develop our business in a profitable and sustainable way, with a long term perspective". Isn't this obvious, does it not make sense? The automotive sector has been one of the hardest hit by the recession. No company can be immune from the effects but let us contrast the prospects for Toyota with its competitors

In 2008 all vehicle manufacturers suffered a significant drop in sales but GM sales fell by nearly three times that of Toyota's. Toyota has said it will make a loss this year, the first time for 70 years! GM, along with Ford and Chrysler has been losing money for so long we can't remember when they last made a profit. They are only held together now by massive government bailouts and they want more! Now ask yourself, in a down turn where would you rather be? The answer is obvious.

That this would happen to the GMs of this world has been obvious for over 20 years, but apparently not to the Directors of GM, nor for that matter at Ford, Chrysler and now many others. Neither was it obvious apparently to their shareholders, investment analysts, bankers (well, what do we now expect of these?), rating agencies (well, what do we now expect of these?), HM Treasury (well, what do we now expect of this?), and, with a few honourable exceptions, financial journalists. All have bamboozled themselves by their specious fixation with sales volumes – “big is good” has been their idiotic mantra. Even now they continue to highlight the main benefit for the Lloyds TSB and HBOS merger as being the massive market share of the combined group in UK retail banking!

And whilst their attention has been so misdirected, the executives of these companies, with the connivance of the banking and financial community have whisked the lack of profitability, the failures in investment, the profligate waste of resources, the poverty of innovation and the cynical manipulation of the communities upon which they leach, back up their sleeves with another slice of complex financial engineering (was there ever such a slur on the word engineering?). And why have they done this? In order to continue to award themselves handsomely for the “brilliant results” that emerge from the financial manipulations that they themselves control.

None of this makes sense. Have they created genuine wealth? Probably not for 20 years or more, in most cases. Not for their shareholders nor their communities. What they have done is build an ever increasing sponge designed to soak up extra debt, more numbers to feed into their “financial engineering” to bamboozle more credulous Financial Industry “experts”. Where does this warped thinking come from when it is so obvious that it doesn't work? Here in the UK, we have to ask just how many of these experts are the result of the Scottish Education establishment – and given the moral intellectual and ethical quality of what we now see, HBOS, RBS, Numbers 10 and 11 Downing Street (both current and previous tenants) – what is wrong with it?

Toyota, where is their place in all this? We know that they have never pursued the goal of being “Number One”. They have concentrated on building the best quality vehicles in the world, straining to match them to each of the market sectors in which they trade, innovating where it makes a difference- new technologies that enable new levels of performance (e.g. the hybrid vehicles) and not for the sake of change. They have pursued excellence in every aspect of their business – operational superiority – elimination of waste – flexible resources. Every major managerial innovation that becomes fashionable – be it TQM, Lean, Green Practice – is something that Toyota will be found to have been doing for some considerable time. When asked why, they will respond “Because it is obvious, it makes sense”.

Toyota's strategy "to develop our business in a profitable and sustainable way, with a long term perspective" is more than a strategy, it is a philosophy. It this philosophy that drives the deep seated managerial values and behaviours throughout the company that have resulted in Toyota's superior Comparative Competitive Strength. Isn't it is obvious? The ability to beat seven bells out of your competition and to withstand setbacks better than anyone else are obvious indicators for long term financial prosperity - all without a single piece of "financial engineering" needed to achieve it.

To achieve the highest level of this brings considerable freedom of strategic choice. The route to this does not always allow for short term unrealistic financial results, it may require tough disciplines on margins, rewards and profit distribution – and that is why so many otherwise potentially strong businesses become undermined by the hysterical betting shop mentality of the Financial Industry. The City of London used to be a byword for financial probity, soberness and integrity – is there anyone left in the square mile that could even spell those words?

We need to get back to the basics of good business and wise investment – seek only excellence in every aspect of our operations, do the right things in the right way, love our customers to death, nurture our people, report our results honestly, borrow only the very minimum that we need, reward ourselves modestly and fairly, protect tomorrow and not just today and so much more. This is still Capitalism but it is also Common Sense. We need to concentrate on Comparative Competitive Strength because our competition is out there in the rest of the world and it will have different economic dynamics which we can outperform rather than seek to imitate. We can outperform the competition, there are examples here in the UK. What may be curious is how many of them are privately owned or led by majority shareholders – not a lot of The City here perhaps?

The Competitive Strength Report will tell you how your business compares with the very best in the world. It will help you decide what you need to do to match that standard and how you will handle your major threats. It does this better, faster and cheaper than any other analytical process in the world – your management team will need 2 hours of homework and up to a day of decision workshop – all can be completed within 4 weeks.

And, a message for all of the Financial Experts. Your credibility is at an all time low. The tools, techniques, values and processes that you have used have been found wanting – all look backwards. To be frank, you appear to have been judging the quality of the ship and its crew by looking at the wake – with no forward radar. The Competitive Strength Report is a forward looking tool - it will tell you whether or not your client, prospective borrower, potential merger partner, acquisition target is going to be a good bet.

What is more, it will enable the understanding of how Capitalism founded on Common Sense will deliver greater financial success and long term value.

If you would like to know more, please have a look at our website here.

Capitalism or .... Common Sense is brought to you by Steve Goodman & Tony Ericson. It is one of a quartet of blogs promoting the cause of Excellence as the key to prosperity. Each blog has a new article each month using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs at Exceeding Expectations, You're having a laugh ... Seriously? and Business Bloop of the Month Award.