The Challenge Dividend

Private Equity Challenges Public

Every few years there is a shift, innovation or minor revolution in the world of business and investments.  In the recent past, these have included leveraged buy-outs, hostile takeovers, IPO mania, and commercial paper.  Today the hot trend is the rise in importance of Private Equity - a choice to buy, sell and grow companies that are not available for ownership and analysis in the public market.  With both Fortune and the Wall Street Journal covering the emergence of Private Equity last week, we seem to have an official trend.  For me, this brings up an interesting question: How does Private Equity meet The Challenge Dividend?

First, let's recognize that the growth of the Private Equity market is undeniable.  According to the WSJ, 20% of the M&A activity and $300 billion in investor activity in the U.S. and Europe went to Private Equity.  In the last year, returns on Private Equity investments averaged 22.5% versus 6.6% for the S&P 500.  Brands like Dunkin' Donuts, Sears, and Kmart are now privately held.  And private equity firms are snapping up top management talent like GE superstar David Calhoun.

At first blush, it might seem that the growth of Private Equity means a weakness in the Challenge Dividend.  After all, public markets bring the pressure of government regulations like Sarbanes-Oxley that are meant to ensure open and honest financials.  And they bring a living market of buyers and sellers, who instantly reward or punish results and decisions in the open.

But further examination shows that Private Equity (PE) is an alternative with its own added pressures and Challenge Dividends.  In comparison to public firms, private companies:

• Have fewer, focused, consistent owners, who have more of their personal dollars at stake, and thus exert more pressure than a mass of faceless millions.
• Top business leadership is typically personally invested as well, as PE firms often insist that they put skin into the game.
• Typically PE investments are in turn-around or launch mode, so they are literally fighting for existence.  It is a sense of urgency that many large public companies lack.
• These companies are often freed from being lost in large public corporations where they are too small to make a difference and lack attention.
• Finally, PE firms lack some of the distractions that public companies can face and which are not totally consistent with successful business management.  This includes quarterly analyst coverage, investors with social causes, and Sarbanes-Oxley compliance.

At the end of the day, I believe that is the competitive, open economy itself, not private or public investors, that drives the Challenge Dividend.  Public or private financing are simply different strategies that companies can choose to win.  Each works better in different situations, and you can see several companies alternate from private to public and back again, and again.  Over time, the winners will advance and we businesses people, investors and consumers will reap the net benefits of a vibrant and competitive economy.

The News You Can Use

Last week I spoke at Ad:Tech, the world’s largest interactive marketing convention, in New York City. In addition to some great sessions and discussions related to my day job, I discovered an interesting example of The Challenge Dividend upending and improving yet another market.

The example came from Kevin Ryan, CEO and co-founder of ShopWiki, an online comparative shopping tool and one of about five interactive companies he has, or is still, leading. Kevin spoke about the evolution of news brands like CBS, CNN, ABC, and The New York Times, which at one point seemed poised to dominate the online world as much as they have in television and newspapers. These companies were overconfident entering the online marketplace, and assumed that their “trusted brands” would win over consumers in this new space, especially due to the amount of questionable content and questionable people posting online.

But Ryan pointed out that it was not brand loyalty or trust that gave the big news brands their power in the first place. Instead, it was their control of the distribution channels. Due to cost and licensing barriers, consumers were forced to get their news from a few TV channels and one city newspaper. Their semi-monopoly power locked viewers in, rather than consumers' loyalty to Dan Rather or Dear Abby.

The Internet has effectively chopped down the barriers to distribution and unleashed a wave of competing news sources. We can get our news from global channels like the BBC or Al Jazeera. And we can tap into millions of individual bloggers who are journalists and distributors in their own right. 

The plethora of competing news options means an explosion of innovation and improvement for we readers and viewers.  For example, niches are popping up which give us the stories and angles we desire; RSS technology feeds us information to our desktops; and “crowd sourcing” through sites like digg.com elevates the stories that other people find most interesting. Just last week, digg.com readers broke news of Donald Rumsfeld’s resignation faster than any other news source on the planet.

Ironically, blogs often score higher on trust than the traditional “trusted brands” like ABC and CNN. That’s because they are mainly “real” people, on the ground, reporting for their own pleasure rather than a paycheck.

One lesson for organizations and individuals is to be careful not to assume that loyalty is unending or always based on brand trust. Consumers, clients, shareholders, and employers are constantly in the market for improvement, and we must keep ourselves motivated to meet new challengers in particular.

Zune Out

Last week Microsoft released its answer to the MP3 Player market, the Zune player.  After watching Apple ride the iPod to dominance, Microsoft obviously felt compelled to get in the game.  Unfortunately for Microsoft and consumers, the Zune does not seem distinctive enough to win (see great analysis by Gary Stein here).  While the Zune might not last long, it serves as an interesting chapter in technology competition and innovation at Microsoft.

Microsoft has never been the most innovative company in the world.  Rather, they have made a long-term living out of co-opting others' innovations.  Successful followership has happened in operating systems (DOS, Windows), browsers (Internet Explorer), word processing (Word), spreadsheets (Excel), and calendar/email (Outlook).  However other efforts have been less successful for Microsoft.  For example, e-books, tablet PCs, and e-wristwatches have all failed on Microsoft's watch.  In Internet portals (MSN) and gaming (Xbox), the company is still struggling win leadership after billions of dollars invested.

The big difference between Microsoft's winners and losers?  First, Microsoft success occur where it is able to use its monopoly power in software - and specifically operating systems - to create an unfair advantage over competitors.  But this is bad for consumers, as its software has seen little improvement in value or innovation.  The functions are essentially the same, prices have increased, and crashes are still too frequent.  The only innovation is coming  recently due to free, open source options like Linux, Google (spreadsheets/documents) and Firefox (my browser).

Second, its failures by and large occur where Microsoft has tried to innovate, but failed to design for the consumer.  Bill Gates famously led the charge on tablet PCs and the Internet wristwatch because he personally had a need.  They worked well for the richest man, but not for the everyman.

In gaming and music players, the market is much more open to competitors and attractive to consumers.  Operating systems are meaningless, consumers are free to own many games or songs on multiple systems (including their PCs), and thousands of programmers and musicians large and small are writing new content.

I believe the Zune will land somewhere near the Xbox in terms of success and share for Microsoft.  On one hand, there is a huge, growing market and Microsoft will use its vast resources to carve off a decent piece.  On the other hand, the Zune is not unique enough to overcome the leader, iPod, and it gains little leverage from its operating system supremacy. 

But at the end of the day, the news is pretty good for the consumer.  Microsoft will re-direct some of its monopoly software money to drive innovation and value in MP3 players, and Apple now feels more pressure to provide even better products and services.  It is good to see two huge players battling it out.

I will stick with my iPod 60G and Xbox 360 for now, but am ready to jump to a new winner as soon as it comes along.

Good for GM, Good for America?

One of the most fundamental dilemmas of our modern, global economy is what to do when big, domestic companies hang on the verge of failure.  On one hand, thousands of jobs and national pride hang in the balance.  On the other, the free market and its need to reward winners and punish losers so that net total improvement can result.  The plight of American auto companies is just the latest chapter.  And while President Bush met with Detroit automakers last week and pledged "continuing dialogue", a new study shows that its failure may be best for America.

Often it seems that our democratically elected government sides with big business.  Examples include the Chrysler bailout in the early 1980s, the S&L bailout in the late 1980s, and the bailout of the airlines in the wake of 9/11.  These bailouts happen both because of the will of the voters and the pocket-lining of congress members by special interests.  In all three cases, the support helped some in the short term, but did little to drive a true turnaround or long-term success.  Chrysler was purchased by a Daimler-Benz and still struggles, the S&Ls basically went away, and most domestic airlines continue on a failing flight plan.  Most of these "saved" jobs have gone away, seen reduced salaries & benefits, or are still threatened.

A new piece of research by professors Kathy Fogel (Northern Kentucky), Randall Morck (University of Alberta), and Benard Yeung (NYU/Stern) suggests that Big Business failure actually causes rising income, productivity, and rapid capital accumulation.   Their data shows that strong economies are more driven by the failure of behemoths than by rising upstarts.  Finally, the failure of Big Business, and resulting greater economic success, happens in nations with high incomes, small governments, strong courts, small banking systems, strong shareholder rights and more open economies.

This research essentially proves economist Joseph Schumpeter's theory of "Creative Destruction", which suggests that innovation by entrepreneurs builds the national and global economy even as it destroys the industry leaders (and millions of jobs) in the process.  More specifically, the innovation that causes Creative Destruction removes the temporary monopoly power of the previous leaders, thus reducing waste and encouraging improvement.

To link this research and Schumpeter to this blog, I believe that economic market pressure has two results: First, the "negative," Creative Destruction of an old leader and its followers falling victim to a new entrepreneur.  Second, the "positive," Challenge Dividend of innovation and improvement, represents the fruits of the pressure.  The old order is destroyed while the new and improved rises from its ashes. 

Of course, Creative Destruction is a "theory" that can be very painful in our realities - as lost jobs, financial stress and fractured families can result.  But just as we hate but accept the natural process of death in our own lives, we must accept the death of old companies and business models.  For in both cases, the new brings the promise of a better tomorrow.

(Thanks to Marginal Revolution for the find.)

Milton Friedman, 1912-2006

Legendary economist Milton Friedman passed away yesterday at the age of 94.   He lived a long life, was a tremendous influence on modern economic and business thinking, and is a model hero for The Challenge Dividend.  He will be missed and remembered well by many of us.

His eulogy articles, probably written and stored years ago, are popping up all over newspapers and websites today.  But instead of the standard stuff, I thought I would honor Friedman by delving into my 750-plus pages of collected research for The Challenge Dividend and share some of my favorite Friedman quotes:

On Banking:

"A major sector of the economy in which no enterprise ever fails, no one ever goes broke.  The banking industry has been a highly protected, sheltered industry."

On Health Care:

"Nobody spends someone else's money as wisely as he spends his own."

On School Choice, in 1955:

"What is needed in America is a voucher of substantial size available to all students, and free of excessive regulations."

While Milton will no longer be with us in this world, his impact will be felt for generations to come.  I will certainly keep doing my share to spread his wisdom.

(On a side note, see my post on the passing of another legend, John Kenneth Galbraith, this past April.)

Challenging Doctors to Wash Their Hands

UPDATE: Freakonomics' Blog now links to another study that shows hand washing can reduce catheter infections (talk about insult to injury...).

I will never forget my first Marketing MBA professor warning we future brand managers that "changing consumer behavior is very hard".  I found out the truth of this the hard way in my first job at P&G working on Fit Fruit & Vegetable Wash - a natural soap for cleaning fruit & vegetables.  But in matters of life and death, the challenge of habit change is too important to ignore.  At least one hospital has found success and probably changed lives by challenging the thinking of doctors and convincing them to wash their hands.

The full story comes from the Freakonomics blog and full article in the New York Times.  Authors Dubner and Levitt tell the story of Cedars-Sinai Medical Center and its former Chief of Staff, Leon Bender.  While Cedars-Sinai is an excellent hospital, Bender became determined to improve physician hygiene based on the fact that there are up to 100,000 American deaths per year due to hospital error, and the spread of bacteria due to unwashed hands is one of the biggest causes.

Bender found several reasons for doctors' failure to take this small step.  For starters, they are very busy and often sinks are far away.  But efforts to put hand sanitizer within easy grasp didn't work either.  So they dug deeper, and found that most doctors do not know that they are often forgetting to wash.  Some are arrogant and simply assume that they are not the ones carrying bad bugs.

Bender responded with various tactics aimed to challenge doctors' thinking and drive habit change - even for those with 25 to 40 years of practice experience, including:

• Passed out hand sanitizer and spoke with doctors in their parking lot where they were more accessible and less busy.
• Gave $10 Starbucks cards to doctors they saw washing up, to encourage and highlight the good behavior.
• Took hand samples of top doctors which showed a high rate of bacteria, then posted the photos throughout the hospital and turned them into screen savers.  (see the example here)

The results of the effort seem very strong so far.  Hand hygiene jumped from 65% to 100% and has stayed strong over time, as these new, good habits are now hard to break.

The moral of this story is that habit change is very hard, but clever techniques to challenge people's thinking can be very effective.  Especially when their are thousands of lives on the line.

Bring Da Noise

For more proof that humans are programmed to embrace and improve upon challenge, the book Noise, by Bart Kosko, suggests that annoying sounds can actually be beneficial.

According to Kosko, as quoted in a Wired interview:

• The more you can concentrate with background noise, the more it strengthens the brain. 
• Adding small amounts of electrical noise helps a nanotube antenna detect faint binary signals.
• Injecting a little bit of random pixel noise helps digital photographers see hidden details in an overexposed image.

Kosko goes on to the tell the story of sci-fi author, Isaac Asimov, who used to set up his typewriter in stores and other loud places to work.

I think there is probably some truth to this theory.  Noise and distractions of any kind force us to better focus our attention.  I also find it interesting that most people "escape" noise on the street or in their offices by plugging into their iPods, which bring even more, direct noise.

Focus group of one: I am writing this entry from New York City where the sound of constant honking, alarms, and sirens is not stopping me from perfecting my craft.  Now if I can only learn to ignore the ping of an email hitting my inbox and I would be a champ...

Burning for Standards

Sometimes it takes the challenge of tragedy for improvement to occur in our society.  An airplane crash caused by poor wiring leads to upgrades via lawsuits and new regulations.  The devastation wreaked by Hiroshima and Nagasaki serve as proof of the danger of nuclear war.  Tragedy is never good, but it can prevent it from happening again.  Even the recent spate of laptop battery fires shows that in challenge, improvement is born.

Luckily no serious injuries have come out of millions of faulty laptop batteries from Sony.  But with a major recall of nearly ten million batteries and an earnings hit of $429 million, Sony and its shareholders might argue that the results have been tragic.  But USAToday reported this week that improvement might rise like the phoenix from lithium-ion ashes.

Underwriters Laboratories is rapidly working with the IPC, a computer component trade group, to align on battery manufacturing standards by June.  The groups hope that better standards will eliminate the guesswork from battery-making and buying, which in part drove the fire hazard and failure to move quicker. 

According to John Grosso, a quality engineer for Dell, these standards could additionally help lower costs, since manufacturers would no longer have to customize products for each buyer.  "Out of fire comes rebirth," said Grosso.  And prices come down for all of us.

What I especially love about this story is that it is rapid improvement among cooperating competitors that is happening with zero government involvement.  The IPC represents manufacturers, and Underwriters Labs is a non-profit organization paid to set safety and testing standards.  They recognized the need to improve and spent their time solving the problem rather than ignoring it or waiting for the government to weigh in.

THAT's an idea I would like to see catch fire elsewhere!

CEOs Can Lose By Winning

More and more data and examples suggest that nothing spoils winners like success.  Just when people or organizations reach greatness, they lose the pressure of challenge and can end up falling back down.  The Greeks called it "hubris".  I call it more evidence for The Challenge Dividend.

Back in May I wrote about research that suggested baseball players work harder right before going into the free agent market.  Later, I presented a series of posts about how success has spoiled organizations (Google, Republicans, China, Starbucks, Apple and the Gates Foundation).  Last weekend I discovered evidence that CEOs consistently fall victim to the curse of success as well. 

In a fascinating piece of research, Ulrike Malmendier (Stanford) and Geoffrey Tate (Wharton) found that CEOs who achieve "Superstar Status" after winning prestigious awards from the business press then lead their firms to worse performance both in real results and in comparison to non-award-winning peers.  Meanwhile, these knighted Superstars go on to demand much higher wages and take on more distractions like joining the Boards of other firms, thus worsening their impact further.

The data is surprising, but at the same time makes perfect sense.  Consistent with the examples above, success can spoil any kind of organization or individual.  Once at the level of greatness, they take their eye off the ball and pursue other interests or goals.  It is human nature to want to "finally" relax or celebrate our own successes.  But the negative consequences serve as a warning to the rest of us.

The challenge for successful people and individuals is to figure out how to keep the motivation high even after summits have been climbed and champagne uncorked.  The first step is recognizing that this risk exists.  Next, we must find a new challenge or challenger to keep ourselves motivated. 

The Challenge Dividend would suggest that maybe there is something to The Sports Illustrated curse.  Here's hoping you (or your CEO) don't fall victim!

The Talent of Hard Work

(This is my 100th Post! - I didn't anticipate putting this much effort into this project, but it is addictive.  Thanks to all my readers and visitors for the daily motivation.)

Conventional wisdom has it that the great ones in art, music, sports or business succeed because of a natural talent.  We assume that something in their genes or brains has them "unfairly" wired on another level, and we sometimes wonder whether we have unused natural talents.  But a recent article in Fortune quotes scientific and anecdotal evidence that show deliberate practice is the source of great performance.  It is a great motivator for those of us who are driven to succeed, and promises that any one of us can improve by taking on the challenge of hard work.

Examples of great ones who got there through hard work include Tiger Woods, who was introduced to golf at age 1.5 and essentially had 15 years of practice by the time he won the U.S. Amateur Championship at age 18.  Bobby Fischer became a chess grandmaster at age 16, but only after intense study for nine years. 

Fortune suggests the following tips for any of us to perfect our chosen craft:

• Approach each critical task with an explicit goal of getting much better at it.
• As you do the task, focus on what's happening and why you're doing it the way you are.
• After the task, get feedback on your performance from multiple sources.  Make changes in your behavior as necessary.
• Continually build mental models of your situation - your industry, your company, your career.  Enlarge the models to encompass more factors.
• Do these steps regularly, not sporadically.  Occasional practice does not work.

The challenge to achieve pushes the great ones to put in the hard work required to master their fields.  This challenge and hard work begets improvement, and these individuals reach success.  Consistent with one of my key messages in The Challenge Dividend, more often than not, their success leads to improvement for the rest of us as well - whether in the form of entertainment or invention.

But the question this raises is: "Is dedication and hard work itself a 'talent' some are born with?"