This is the 8th and last week of the AMP program. We have two days of cases - and the finale is a set of final lectures by each of the professors. It is amazing that almost two months we have been together here - each day is a new day of learning, reflecting, meeting and knowing people; knowing their extraordinary achievements, their career goals, about their companies and personal ambitions. I have never met so many highly successful leaders in my life - successful not in their professional careers - Rob Scott is the Managing Director of Wesfarmers Insurance in Sydney; what was fascinating to me was the fact that he is Olympic Medalist in rowing ! It is a humbling experience to meet such people.
Today, we discussed Barack Obama and the US fiscal crisis, the Bush tax cuts and the financial mess that the US economy is in today. The questions for the US Congress is simple: who will finance the US this year .... and the next year ? Current account deficit is US $640 billion/year and the budget deficit is US $1.5 trillion/year. Here is some historical perspective of the US economy and what different US Presidents did in the past.
- JFK was the first to consider deficit-financed tax cuts to eliminate output gap and push economy to its true potential; but he was assassinated before he could put this into action
- It was left to Lyndon Johnson to implement the tax cuts, but was quickly followed by the expansion of federal budget to finance Vietnam war; but pushed a significant tax hike in 1968 and the deficit was closed.
- Presidents Nixon, Ford and Carter oversaw a series of recessions in the context of ever increasing inflation, and hence the deficit expanded; High unemployment and inflation was the primary reason for Carter to lose to Reagan in 1980
- Reaganomics followed :implemented 25% across the board tax cuts and well as corporate tax reductions; he not only failed to cut federal spending, but increased military spending significantly and the deficits increased dramatically.
- Economic boom of the 1990's and the tax hikes passed by Bush Sr and Clinton generated budget surplus for the first time since the 1970's.
- George Bush wanted to reduce taxes, retire debt and reform social security and medicare at an expected cost of US $ 1.7 trillion; in spite of opposition by many economists , he went ahead with the tax cuts in June 2001; Made another set of tax cuts in 2003 and 2008.
- But all this was overshadowed by the sub prime crisis, which turned into a financial crisis and finally into an economic crisis in 2008
Given all the bailouts done by the Federal government in 2009, this years budget will be a difficult one - expected to have deficit of over $1.4 trillion. Obama has clearly inherited a tough situation. His stimulus package of $787 billion with focus on infrastructure, education, money for the states and tax cuts is crucial.
Today's session by Prof Fruhan was an excellent session on "Pressures for Corporate renewal" - which was almost like a summary session. It was a long one, but we need the time to put it all together. There are four reasons for pressure:
- Threat of early CEO replacement due to:
- Takeovers
- Activist shareholders not being happy with company progress
- Boardroom revolts
- Failure of the firm
- How to improve shareholder value in the tough economic scenario - more so in the developed economies
- Aggressive use of high management pay-off incentives
- Professional pride of a CEO to succeed
Shareholder activism has increased so much, at least in the US. In the old days, if an institutional shareholder is not happy with the progress made by the firm, they sold the stock and moved on. No longer true - in fact to quote a retirement fund manager, " we don't want to sell. If a company can be improved, why should we be the ones who leave?" This may not be true in developing economies as of now, but is not a question of whether but a question of when.
Some summary points:
- We have a big difference in corporate profitability in terms of ROE, through out the developed world; with US being in the 18%, Continental Europe at 12% and Japan at 8%
- The value of, and therefore the pressure to increase market share tends to make the strongest players even more aggressive
- Market share is much more valuable to a high profitability firm; such firms should be much more willing to fight for market share. Why ?
- the shareholder value creation flowing from a $10 million increase in incremental sales volume is about $0.5 million for a firm that earns 1% above the cost of equity
- for a firm that earns 10% above its cost of equity, the shareholder value creation is 10 times as much, or nearly $5.0 million
- Many governments are having a difficult time maintaining a social safety net against extraordinary pressure. More so in Japan and Continental Europe
- Developing world is providing a wonderful labor pool of educated people who are prepared to compete on cost - off shoring and outsourcing has become a necessity
- Sets up a nice contest between multinational managers and developing world workers on one side, and developed world workers and their governments on the other side
- Business is viewing national governments like a tenant views a landlord ; if they don't like the value proposition, they just move, or at least move the workforce
- In the middle are PE firms and activist hedge fund managers who are turbocharged and ruthless
- Question to all of us: how to emerge as winners, as the contest for survival and global competitiveness unfolds in the months and years to come.
The final session on Operations in the context of investors. How do organizations look at investors. We discussed two cases - Arrow Electronics and Merck. The CEO's of these organizations during the period under discussion were in class to give their perspectives.
Steve from Arrow Electronics - a distributor of electronics components had this challenges in 2000 of whether to invest in the ecommerce boom and put aside $100m to fund it. Under pressure from the board, competitors and some employees, he had to take a call. He did the following:
- Since he was not convinced of the business model of the Internet, he did not invest, beyond the basic to keep the website running
- Felt that there was a 10:1 probability that he was right; however since there was a finite possibility that he could be wrong, he wanted to take an insurance policy of sorts;
- As an insurance policy, just in case the Internet model takes of in a big way, he decided to invest some money in some VC funded start ups in the space - up to $30m in taking about 19% of ownership
- Why 19% - because the accounting rules allow you to take these costs in the balance sheet and not in the P&L
- Only one of the succeeded and all other investments were a write off.
- Lessons from him on the experience:
- Be sure before you do any investments; if required get the experts
- Don't help the guys who are trying to kill you ( here the dot-coms were trying to put him out of business)
- Communicate to stakeholders - employees, analysts, customers, etc
- Listen to all with an open mind
- Courage - knowing what you believe in and sticking to it
Merck was a similar case - but a different context. In the face of a reducing revenues and margins because of a withdrawal of drug, should Merck cut R&D costs to boost earnings in the short term. According to a survey, 68% of the CEO's said that they will sacrifice the long term to meet short term goals. Merck did the opposite, but packaged it well with appropriate communication to stakeholders. And the stock price actually went up.
Good day overall. Spent some time with other participants - with one to help in creating a blog, and with another discussing the challenges of implementing SAP in the organization.
Here is picture taken by a colleague of sunrise across Charles river overlooking Cambridge. Beautiful, isn't it ?
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| Photo by Dominic Cameron - Overlooking Cambridge across the River Charles |
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