Monday, March 27, 2006

Des Hunt: Rules for company success

What do successful companies have in common?

While there is no single prescription for becoming a successful company, I am a firm believer that certain characteristics do increase the probability that a company will be viewed as successful.

Conversely, and perhaps even more importantly given the importance of capital preservation to the average investor, when these characteristics are lacking I sense alarm bells and prefer to place my funds elsewhere.

Good governance and communication at board level:

In my experience, successful companies tend to have experienced directors and senior management teams who openly seek to increase shareholder wealth. However, it is not just experience as such, but the breadth and depth of relevant experience that I consider fundamental to long-term business success.

Few boards in New Zealand could be accused of lacking in accounting and legal expertise, but just as few jump out as having a healthy mix of operational, technical and marketing experience. I see such a mix as essential for a board to be able to effectively evaluate and contribute to the strategies being pursued by the CEO and senior management team.

I also look for clear and open communication from boards. Few things make me more nervous than a chairperson who responds to questions at an AGM with long-winded and irrelevant responses more reminiscent of a politician than a representative of shareholders.

Similarly, I am wary of boards that seem unable to admit mistakes and take responsibility for their actions (or inaction), especially if those same boards, when the going is good, have been quite capable of taking direct credit (and rewards).

Proactive and informed strategic decision-making:

Successful companies tend to make proactive decisions based on an awareness of their own and their competitors' position in the marketplace, combined with an understanding of their customers' needs.

This results in, for example, the timely introduction of new or modified products and or services, often involving collaboration with key customers.

On the other hand, poorly performing companies tend to be more reactive in their decision-making, whether responding to competitor behaviour, consumer and market demands, or regulatory changes.

Poorly performing companies are likely to make major decisions without adequate research and evaluation of potential consequences. Often key senior executives are not actively involved and the advice of external consultants is relied upon.

While not dooming every initiative to failure, a lack of rigorous internal analysis and debate, including at the board level where major expenditure and/or changes in strategic direction are involved, is not a recipe for consistently good decision-making.

Acquisitions provide a good example of major transactions that successful and less successful companies tend to approach differently.

Successful companies are not afraid of acquisitions but do not underestimate the difficulties associated with such transactions and are not afraid to walk away from deals that offer marginal returns or require bold assumptions about "turnaround potential".

Few successful companies rely on highly leveraged acquisitions of struggling companies to generate long-term growth.

Successful companies devote significant senior management resource to acquisition decisions and to the ongoing management of successful takeovers, in addition to financial resources.

Large acquisitions and those that take firms into new territory, eg, the purchase of an overseas company, will typically see the CEO and other key senior executives actively involved.

Organisational structures and remuneration strategies devoid of unnecessary complexity:

Most successful companies have relatively simple organisational structures with only a few layers of management and quite small head offices. This is more conducive to transparency and constructive communication as opposed to stifling bureaucracy.

Consistent with a simple organisational structure is a logical and transparent remuneration policy that is clearly linked to relevant drivers of individual and organisational performance.

Successful companies are also less likely to have jaw-dropping discrepancies between remuneration packages at different levels of the organisation.

Less successful companies are more likely to have complicated organisational structures with many layers and a large head office. Managers tend to be based in a different location than those they are managing, resulting in less regular communication, particularly of the informal and open kind.

Such organisations are likely to apply different "logic" to the way that remuneration decisions are made across the organisation and have larger pay differentials.

Successful companies generally have lower staff turnover and retain the right people.

This retention of top performers who also tend to be more engaged in their work is crucial to the development and leveraging of intellectual and human capital over the long-term, which builds competitive advantage and a platform for ongoing success.

Lower staff turnover also makes the case for significant employee training and development stronger as the company is likely to benefit more from such training the longer it retains the staff concerned.

Judicious use of external consultants:

Successful companies are likely to make much less use of consultants. Less successful companies make what I perceive as excessive use of consultants for one or more of the following reasons:

* Management does not have the experience or confidence to carry out sound analysis and make genuinely informed decisions. A complicated organisational structure results in managers not having clear responsibilities and preferring to avoid decision-making themselves.

* Management is unable or unwilling to simply acknowledge poor performance and seeks a variety of "explanations" from a theoretically impartial source to divert attention from their own shortcomings.

* A weak board seeks external validation for questionable decisions, often regarding CEO and senior executive remuneration.

This is not to say that consultants do not have their place. My point is that successful organisations use consultants where they can genuinely add value and where permanent resource cannot be justified.

As an investor I am simply not endeared to already top-heavy companies who make almost permanent use of external consultants to do what I perceive to be the work of senior management, the CEO, and the board.

* Des Hunt is the director of corporate liaison at the New Zealand Shareholders Association.

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