Only this time around, only true and enduring cost reforms count. The Street and The City are today wise to bureaucrat shell games such as (1) double-counting expenses previously taken, (2) cutting allocated but presently unfilled phantom positions and (3) contraction by attrition, and the company that tolerates such deliberate deceit merely shoots itself in the foot, value wise.

In all three instances, ‘the number´ is already in the marketplace—that is, already included in the financial community´s perceptions set of future discounted cashflows. Thus by committing one of the three sins above, management accomplishes absolutely nothing in terms of the data upon which market valuations are formed (And you wondered why the announcement of phantom position cuts failed to budge the company´s stock price at all).

Correction. Flailing out with shell game cuts ISN´T entirely without impact. At best, such a ruse means that management´s reputation for straightforward communication is damaged, and future similar announcements are simply ignored. At worst, the financial community ascribes both deception intent and incompetence to incumbent (for now) management.

It is one thing to be caught for double-counting or pretend efficiencies. Something else again to raise suspicions that management doesn´t know the difference between actually dismissing a deadwood manager suppressing company value by 7-9x his total compensation and erasing a hollow box on an organizational chart.

And yet, sometimes Selling Out is the only available fallback strategy for pedestrian management in over their depth.

But one has to get the timing right-- otherwise even Selling Out can disappoint as a value-creating tactic.

During euphoric economic periods, a company with a recognized name toiling in an attractive segment might even manage to offset much of the value destruction caused by the soon-to-be-retired incumbent senior management group.

The key is timing. Seems that the best prices (measured by offer price as a percentage of market value) tend to occur at the high points bin economic cycles (VBM Consulting´s BEYOND THE DEAL, Clark, Harper Business (91), Ch. 1).

Seems that in such times, the overpaying acquirer who is highly vulerable to the ego-trap of a career-making acquisition observes his company´s inflated share price and price-to-cashflow ratio and concludes, in effect, that ´We´ve got to get solid something for this inflated corporate currency while the value is still inflated´ and goes on a spending spree.

(Never mind for now that the share prices (market values) of most quality targets have also increased in step with the too-eager acquiring company. That´s another source of value destruction by a different company.)

For beleaguered management Selling Out because internal value methods fail, timing is critical. Outside of cycliucal peaks even an obtuse hint of receptiveness to a sale shouts DAMAGED GOODS! to everyone, suppressing value to fire sale depressed levels.

One recent example: Marconi in the UK, formerly GEC. Another: Euronext Exchange. One might excuse operating company management from getting cyclical value timing right when it comes to Selling Out. Exchanges almost directly reflect value swings to the extend that for decades, the cost of a seat on the New York Stock Exchange has been one of the most reliable trailing cyclical indicators.

To maximize value on a consistent basis, the division of effort to be split between solid value content (including follow-through) and presentation window-dressing is about the same as the Corporate Key Contributor´s relative impact compared to journeyman lackeys in the company, as revealed in Clark & Neill´s The Value Mandate: about 95 to 5.

Don´t get us wrong. No one is arguing for an imprecise or cosmetically unattractive report, presentation or brief. The problem is at the other extreme: when fluff takes over, with massive value destructive consequences.

An example. We were recently asked to try to help salvage the business plan of a company which had digressed into unwise diversification into highly competitive fields where it had no real distinctive advantage as perceived by average customers themselves.

In such situations, the value resurrection imperatives are straightforward. First, move the amateurs who have no past ability and limited familiarity in the unknown field out of harm´s way, for the corporation´s sake and their own. A new, higher risk area of operation is no safe haven to park marginal performers held in low esteem by the rest of the organization.

Second, examine the separate, distinctive markets in terms of where the late entrant might eventually compete, profitably. “Might compete” is the operative phrase, not “dominate” as repeatedly heard within the large company which believes its own internal propaganda too much. An impressive brand name in Market A only means that customers might listen five seconds longer to your sales pitch than a completely unknown new provider. Nothing more.

Next, in those few markets where success is possible, establish an all-new basis of price/performance/quality that makes the entrenched providers sweat. Then advertise the critical advantage, never hesitating to cull overhead staff to pay for key ads and promotions.

Direct. But in this particular pre-mentioned company, something amazing occurred. Managers in the center of the problem spent far more time and focus on the cosmetics of periodic presentations to higher-ups that the clarity and correctness of the underlying strategy.

In one exclamation which has since become infamous, one such future unemployable denegrated the essence of any new value-- what we at VBM Consulting refer to as the Value Business Plan-- as “just the content part.”

With such massive misdirection, the result was inevitable. A year after the fact, no one cares at all whether the margins on Report 116 were one half inch or three quarters, or whether fuscia was used as the lead color rather than black.

What DOES remain stuck in the memory of the institutional value-setters who ultimately own the business is that here were managers who were (1) on the Titanic and (2) faced an iceberg ahead.

And Beyond the Deal warned that mergers between non-related companies face even higher failure prospects. The base message, backed by the facts, has been re-packaged as ‘new´ by someone every few years or so-- and yet the wave of marginal deals continues, depressing company shareholder value while terminating erring CEOs´ careers.

So with such massive evidence against hasty acquisitions in general and marriages of poorly related businesses specifically, why would any CEO persist with deal that is optimistically described as troubled-- such as Hewlett-Packard´s (strength: printers) proposed acquisition of fading Compaq, a leader in the fast-imploding commodity PC business?

Predictably, the acquiring company´s PR explanation is always ‘value´ creation, despite the massive weight of precedent and often Disneyesque financial projections, made even less plausible because of acquirers´ traditionally poor postmerger integration performance. Everyone knows the real reasons for failure to retreat from the faltering deal: (1) massive corporate egos and (2) persuasiveness of bankers and other intermediaries who have a vested interest in ensuring that the marriage proceeds—because they receive no 6-8 figure fees otherwise.

But there´s another important reason as well, what we refer to as the Point of No Return. In the case of Fiorina´s Folly and past value destructive propositions, the CEO finds him/herself in a no-win dilemma. Retreat from the fatally flawed deal, and some in the biz-press shout weakness. Some on the Board see the abandoned deal as a wasteful junket, especially since they had their hopes raised and then received nothing.

Peattie & Taylor´s Alex© comic was featured in VBM Consulting´s 2001 best-seller, Net Value: Valuing Dot-Com Companies Uncovering the Realities Behind the Hype (Clark & Neill, New York, Amacom).

In Chapter 1, we parodied the quasi-criminal practice of pretending that worthless e-businesses had any worth at all. The strip´s main character, Alex Masterly, instructs his junior lackies to access or ‘hit´ his Dot.Con client company´s website a thousand times or night or more.

With no legitimate, value-creating business model for 95-99% of these vapor businesses, investment bankers needed to create their own rules of mathematics to suspend disbelief, even temporarily. In this case, the laughable fiction was that the number of times that anyone visits that site is a basis for valuation. Such literally bankrupt logic is the equivalent of trying to value a store based on the number of cars passing by it on a highway a mile away.

But without this type of Criminal Math, the investment bank sharks would never have been able to steal their underwriting fees from taking WorthlessLoser.com public in an IPO. Alas, the anti-heroes of 1998-2001 have mostly been stripped of their stolen booty.

Most of the Alex strip´s ideas come from readers themselves, so there´s a biting truth associated with many of them. Including one of the most recent (May 4) where executives search the Internet, presumably for the best and most convenient short-haul airfares.

But these execs are not looking for the cheapest fare, or even the most convenient time of departure or arrival. These furiously-clicking executives are scrambling to find a flight in which the economy section is all filled, as they are the authorized by company rules to upgrade to a more expensive business fare, at greater cost to the company.

Spending other people´s money. That´s the same black motivation that inspires some second-tier‘value´ consultants to squander tens of millions of their clients´ funds on unnecessarily analysis of the obvious by novice MBAs. It is the dark side of top-up pensions for failed senior executives and treating value-destroying managers as royalty for their incompetence.

Managing for Maximum Value©* begins with every individual in the company thinking about whether the action being considered (or in some instances, inaction) is creating or destroying value for the corporation.

The gamesman who tries to find the loopholes in the company´s rules that permit value destruction to occur might be seen at the moment as clever by like-minded colleagues, who work to Beat the Rules rather to do the best by the owners of the business. Soon, they are all gone.

Certainly, there are a few bolt-on, closely related deals made during the early stages of the economic cycle which beat the 67 percent failure level somewhat. 1

But such relatively modest deals are not the type of transaction that are likely to set hearts at Dewey Cheatem & Howe Investment Bankers aflutter.

Unfortunately for the investment banker seeking to fill his deal quota regardless of the value canage inflicted, small bolt-on deals are relatively inexpensive, with corresponding low advisory fees. Even worse from Dewey Cheatem´s perspective, management of the target company are likely to already be well-known to the would-be acquirer, effectively eliminating any sizable role for the financial ferrets.

The mega-acquisition was once treated as the CEO´s right of passage, confirmation of the executive´s prowess as an astute industrialist. Crowning glory for a great career, the stuff of fawning biographies in later years.

No longer. Personal career and corporate value risks associated with the major deal massively outweigh the advantages, regardless of occasional exceptions such as Hewlett Packard´s acquisition of Compaq, expertly planned and navigated by H-P´s chief executive, Carly Fiorina. 2

When the CEO sticks her or his head above the parapet and announces pursuit of the large, high visibility target, others on the Board and across the company find themselves swept up in testosterone mania comparable to war-lust.

Woe to the CEO who loses that war, even if ‘losing´ happens because of his astute, value-maximizing decision to avoid overpayment. This chief executive quickly finds himself shunted aside, treated as a corporate embarrassment. The closest equivalent is the leader of a political party who just lost a presidential election in a landslide. The Board cannot act quickly enough to get rid of this embarrassment.

The penalties of ‘winning´ the war are often even worse, although the day of reckoning is delayed. Unless the deal begins to unravel quickly in the first three quarters after the close (such as Quaker Oats-Snapple, AT&T-NCR, Compaq-DEC or Vivendi-Universal), a CEO with an especially skillful internal spin-doctor might delay the extent of the value destruction for a couple of years at least. In all the forementioned transactions, the acquiring company chief executive was gone in a couple of years).

As Spring 2003 blooms, one cannot help but notice the proliferation of planted articles in the business and financial press about the coming resurgence of major merger activity, despite the fact that evidence points to the opposite conclusion.

Price-to-earnings multiples remain high today on a historical basis, particularly in technology and service sectors. Precedent suggests that until and unless those price-to-earnings multiples reach new lows and remain there for some time, the bottom-feeder acquirers who spark the beginning of any M&A resurgence remain on the sideline. Other factors strengthen the P/E case. Overcapacity is extensive today, which means that would-be acquirers can (and will) expand organically at far lower cost.

Given the solid facts stacked against the M&A resurgence argument, who then is paying the papers for the planted articles trying to make generate false momentum nothing. Those pumping the hallucinatory gas are the same ones who are in a position to benefit most from a return to M&A insanity, regardless of how many billions of shareholders´ dollars are destroyed. That´s right: your friends at Dewey Cheatem, or at least those still remaining after the Spitzer cleansing.

Notes:

1

The most widely accepted measure of acquisition success or failure is whether the returns over time (five years is usually the time period used) exceed the returns that providers of capital could alternatively achieve by putting the same funds in available very low risk investments such as US Treasury bonds. On this basis, about two-thirds of acquisitions fail. (Clark, Peter J., Beyond the Deal: Optimizing Merger and Acquisition Value, New York, Harper Business, 1991).

2

Today. Tomorrow. Possibly, for several tomorrows. But almost never beyond an 18-24 month time horizon. The smug corporate bluffer who boasts that he has secured maximum value approach for all time fools no one, except perhaps himself. Today’s optimal value solution is soon displaced by something else, something better.

Speed of change dictates such displacement. The evidence is all around. Mused to be good for six months, two years ago. Today, fresh data becomes stale in just three months.

And the competitive decision marketplace is compressed so that only the surest and swiftest prevail. Just a year ago or so, ´Venerable Corporation´s´ decision crawl mean loss of ´only´ one major value opportunity. And even this was invisible as committee members concentrated on decisions made, rather than those which they missed.

But then the pace of change quickened, and even the most introspective committee members begin to realize that two, three, four major opportunities capable of substantially improving company shareholder value are missed. Not because of poor analytical techniques, but rather, because the underperforming committee´s pace is not up to the challenge.

Even ´threshold´ value developments in research, assembly and production are subject to being succeeded by the next best value answer. In Chapter 5 of VBM Consulting´s newest book, THE VALUE MANDATE: Maximizing Shareholder Value Across the Corporation, authors Neill and Clark describe how platform assembly changed the rules of the automotive industry value game.

But even that development is now being upstaged by its value successor. Volkswagen was one of the platform-value pioneers, gaining efficiencies by using the same platform for up to four different nameplates.

But some customers got smart and realized that they could get the same performance for cheaper price by choosing the least prestigious nameplate of the group. Great for buyers, but lousy for car makers, who see their margins narrowed.

As a consequence, ´platform´ is now being displaced by cross-line and cross-platform massive sharing of components. But in two years (at most) this too will give way to ITS value successor. And so it goes.

Note:

Note: This is the second in VBM Consulting´s series on the interrelationship between business ethics and pursuit of maximum shareholder value. The initial column and article, “Setting the Record Straight” (© VBMCL 2003-4, all rights reserved) first appeared in September 2002 and can be viewed on the VBM Resource Ctr. Article Archives.

The examination of ethical issues related to MFV that follows is intended to provoke constructive discussion, and does not necessarily reflect the opinion of VBM Consulting or its staff, operators of this website, or anyone else associated with the firm. Other perspectives on the issue of business ethics and pursuit of maximum shareholder value are welcome. For consideration, submissions should be sent to: outperform@vbm-consulting.com including full contact details. 1

There are few sure things following the multiple shocks of corporate scandals such as those experienced in 2000-2, but one is that self-appointed protectors emerge to remind us the importance of business ethics. Or at least, their own highly individualistic interpretation of what “ethics” means to them.

While absolutely no one opposes the notion that Managing for Maximum Value (MFMV) must be pursued in an “ethical” manner, reasonable people have considerable differences of opinion about what the “e” word means in daily business practice.

One working definition for ethical business behavior is that the company does not partake of any action which is illegal, nor does it have any dealings with customers or suppliers who are known to be operating in such a manner (Admittedly, this is a very limited interpretation of the word. Your own interpretation is probably far more expansive, if you´re anything like us).

But starting with this narrow definition, we suggest that the imperative for “ethical” MFMV can be viewed as self-correcting. Stated another way, the company that violates “ethical behavior” is severely and almost immediately penalized in the financial marketplace in terms of valuation, assuming that full information is available.

Assume that management at hypothetical ‘Brinkmanship, Inc.´, a waste management company, decide that they want to grab the extra profits that appear to be available by selling used radioactive waste to North Korea, through middlemen.

Brinkmanship´s managers might try to pretend that they don´t know where the intermediaries are shipping the potentially hazardous materials. However, that is why management at Brinkmanship Inc. were interested in the maverick side deal in the first place.

Assuming full disclosure of the true situation (a very, very important assumption), Efficient Market Theory takes over and the borderline illegal company´s share price and valuation plunge. 2

Why? Because the Value-Setters adjust management´s future cash flow projections (upon which all valuations are based, See Clark & Neill´s Net Value, Figure 1.5a-b) for anticipated additional litigation costs and perhaps even the possible loss of an executive who could be by prosecutors to take up new residence in prison.

Think that such automatic market valuation adjustments are unlikely? Think again.

A similar situation (remove the illegality) occurs, say, when a company is found to have new liability for asbestos liability (Halliburton, ABB). Or when certain manufacturing processes that sometimes causes more than the average level of injuries become a favored targets of compensation-chasing attorneys eager to take advantage of today´s victim culture.

But one of the key problems associated with the word “ethical” is when it becomes an umbrella theme by various groups of unemployables as a cover for their resentful anti-business rantings. Let´s face it—losers whose best job ever will involve saying “Would you like fries with that order, sir” will rarely accept the notion that someone else earns a thousand times what they do because they create more value.

Instead of blaming themselves for their self-imposed underperformance, it is so much easier to label anyone and everyone doing better as “unethical”.

Understandably, Nike´s alleged employment of under aged Asian labor for a pittance has emerged as one of the recurring targets in recent years of activists rallying against alleged “unethical” behavior: both reasonable adults and the maggots referred to in the paragraph above.

The protesters tend to forget that the market mechanism referred to above severely penalized Nike directly and its shareholders indirectly.

Certainly, the prospect of taking advantage of child labor in countries where it is still allowed in order to reduce costs is an anathema, especially when one considers that the result of such possible exploitation is to produce sneakers for some rich couch-potato of a kid in East Armpit, New Jersey for $150 of Daddy´s money per pair.

But even with a case such as this, there are other considerations. Imposing new rules and restrictions to reduce child labor sometimes removes the only source of income for those families. Again, our point is only that the business ethics issue is far more complex than initially thought. Especially since the word ethics means something different to almost everyone.

When a company has an opportunity to Manage for Maximum Value but blows it, is that ethical business behavior? Some of the shareholders who believe they have had their pockets picked by leaders who have deliberately underperformed consider such neglect as “unethical”.

Notes:

1

All of the VBMC series on ethics and shareholder value (as well as all other materials on this website) are copyrighted property of VBM Consulting Limited, all rights reserved. No duplication, copying, printing or retention of any of these materials in any device whatsoever is permitted, under any circumstances.

The columns editor will have sole discretion on which articles may or may not be selected. There will be no payment and there is no assurance that by-lines will be used for any submitted article that is used, in whole or part. The article editor may select excerpts from any submission, or combine comments.

2

Those statements about “maximizing shareholder value--” you fell for them, huh?

Hollow words, nothing more. We have never even conducted an RTSR (Relative Total Shareholder Value) which means that we have no idea about what “maximum value” represents at all on the only enduring basis that really counts, owners´ expectations (Ed.: Also Covered in the new leading book on shareholder value, VBM Consulting´s THE VALUE MANDATE: Maximizing Shareholder Value Across the Corporation, by VBM Consulting Partners Peter J. Clark Clark and Stephen Neill, amazon.com and amazon.co.uk).

If WE don´t have a clue what 100% value represents, how in the world could we say we were achieving “maximum”? Exactly—we were just making it up as we go along. And how could you, dear reader, be vacant enough to believe our lies?

You see, our financial PR guys tell us to state “maximizing shareholder value” at least twice in every press statement, and we hope the gullible are awed and the rest can be bullied by hard stares through frameless glasses (Funny, though, when its just words and nothing else, the Street´s and the City´s knowledgeable tend to grade us down a notch each time we say “MSV” and don´t know how to achieve it—oh well).

And here´s the really good part: if we underperform in terms of executing our value plan (or worse, if we don´t have a credible maximum value plan at all) we then just BLAME THE SHAREHOLDERS. I know, I know, its like blaming a mirror for the image that you don´t want to see. But it USED to work, sort of.

Oh, we´ve gone through the faux-value motions and losers. First we shelled out seven figures for a statistical valuation formula that is 90 percent is extracted from the Capital Asset Pricing Model of the 60s, but hey, if Beancounter Valuation Statistics want to re-sell air that everyone else can breathe for free, then more power to them. And then we (once) brought in Darkstare, a junior consultant-staff intensive data-crunch sweat shop that transforms the simplest projects into massive (and largely superfluous) analyses because that maximizes THEIR value, albeit diminishing our own value.

Hey, know what? NOW I think I´m finally understanding what maximizing shareholder value means! It never had anything at all to do with OUR value!

On to expenses. Even though the world is slipping into turgid sideways markets that look like a recession (whether or not they are), we are going to emphasize ‘growth´ at all costs in our non-value plan. I mean literally, at any cost.

You see, it doesn´t matter that there are no enduring profits today or tomorrow in some of the click-n-eyeball pheeenoms—growth strategies permit some of our more influential executives with clout to pad their department staffs even more, based on the curious logic fat upon fat is required to meet support requirement (Ed: Chapter 8 in THE VALUE MANDATE is entitled, suitably, “Unwinding the Crony Bureaucracy”).

Shareholder value? It´s a PR fad only—at least that´s how we treat it. Either that, or a full-employment paralysis-by-analysis joke: study it for two years first before acting, assuming that the company is still around. The so-called ‘value´ staff certainly won´t be.

In its most malignant form, ‘shareholder value´ is contorted by those who should know better into efforts that actually DESTROY value by opening up the corporation´s door to worthless staff-intensive data fishing expeditions.