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The CEO’s Balancing Act

May 21, 2013

Most of us have one ultimate goal in our work. For those with a Lean bent, it might be to increase customer value. For Operations it could be to achieve the perfect order or in Payroll, deliver the perfect paycheck. The CEO however, has the objective of achieving two goals. The first is success in their customer markets. The second is success in capital markets. What makes these two goals particularly difficult is that to be judged successful, they must achieve both goals simultaneously. To achieve the first goal, the CEO must deliver more customer value than their competitors through better products, services and effective use of their channels. As a measuring stick, most of us would gauge success in the customer market by a company’s revenue or profit. For CEO’s however, they must compete in a second simultaneous competition; the capital market. This market is comprised of investors that make up hedge funds, pension funds, mutual funds, private equity and banks. These investors only interest is determining the correct valuation of a company to ensure they make wise investment.

For the capital market, absolute profits are very important, but that’s not enough. Investors want to understand how a company earned that profit. That’s because the size of the profit doesn’t provide any indication about how much effort it took to earn. For example, two companies may be generating the same amount of profit at the end of the year on the same revenue. These two companies earn the same profit, but are valued very differently. The reason for this may be that one is competing through low-cost production and has high levels of debt due to automated factories. The second may be competing on high levels of service. It has no debt but high labor costs. Even though the revenues and profits are the same, investors will value these companies differently which in turn influences the behavior of their respective CEO’s.

Fortunately for the CEO, they receive lots of help figuring out how to balance the company’s performance in each market. The CFO offers recommendations on how to make the many financial ratios, which investors use in part to judge a company’s value, look better. To improve these ratios, companies can sometimes make decisions that are hard to understand. For example, it is not uncommon to see a manufacturer spin-off a slow growth but reasonably profitable plant because it is asset intensive. Simultaneously it enters into a contract to buy the exact same materials from the new owner. One likely explanation is that the company is trying to continue making the products it needs for its customer market while increasing its return on assets (ROA) ratio to increase its valuation in the capital market. Changing how a company operates to improve its valuation is extremely difficult. While the Return on Assets ratio might improve, it could easily impact the customer market: Operations must now incorporate a longer supply chain or absorb higher costs with increased SG&A costs from its new “supplier”.

Finding the right balance between these markets is where there are often spicy debates between Finance and Engineering, Production, Services, and Sales & Marketing. These operational groups can often find themselves at odds with the CFO as they help the CEO determine what is important in customer markets by understanding how external influences such as competition and regulation are affecting the customer market.

It’s obvious that with interdependent pressures acting upon a CEO as he or she tries to increase value in both markets that a continuous stream of really good ideas is required. This observation is supported by the CEO’s polled in the Council on Competitiveness’ latest Global Manufacturing Competitiveness Index: For the second time in a row, over 400 CEO’s around the world ranked an innovative workforce as the most important competitive driver to their company.

What’s surprising though is that with all the metrics a company puts in place to measure the fiscal and operational health of a company, very few are able to overtly measure and improve their employees’ innovative ability.

Fortunately, there are lots of great examples of an engaged groups of people exhibiting exactly the type of innovative behavior that CEO’s value. The example I’ll share is of magazine subscribers. I subscribe to Cook’s Illustrated and Fine Homebuilding. Both of which provide articles to improve their subscribers’ skills and knowledge. One feature both publications have is a reader’s tips and tricks section. Every issue, each magazine publishes dozens of ideas that its subscribers submit. These ideas are exactly the kinds of ideas a business needs:

  • How to use common materials to replace expensive materials.
  • How to use leftover materials rather than discarding them.
  • Creating simple techniques that turn a hard job into an easy job.

I don’t believe cooking and building homes attract individuals with an above average ability to innovate. Rather the cross-section of individuals tells me that under the right conditions all employees have the potential to be a part of an innovative workforce. The trick is to harness that same innovative and productive energy at work that they display about their personal interests.

To achieve this for my clients, I start with organizational behavior 101, but with a twist. Using Maslow’s hierarchy of needs as a framework, I simplify it into three stages: Security, Productivity, and Engagement.

maslow's hierarchy

Secure Employee

If individuals are insecure about their jobs or feel unsafe at work, they are not likely thinking about ways to incrementally improve the company’s use of an injection molding machine. Creating security has many common themes but is different for everyone. It doesn’t mean every job has to have the same level of security. Instead it means that the employee understands and is comfortable with their environment. Most employees would feel secure in the following environment:

  • Employees are paid in accordance to their agreement with the company (presumably risk adjusted)
  • Employees receive regular communications from leadership that provides transparency as to how the company is doing and where it’s going
  • Employees understand the rules within the company
  • Employees are treated fairly and equitably relative to fellow employees
  • Employees feel safe in their work environment

Productive Employee

With security complete, individuals can be productive. Secure employees want to contribute and add value to a company. They didn’t sign up to fail. Their ability to be productive is dependent on a workplace that creates an environment and situations where they can be successful.

  • Employees know what to do to be effective in their jobs
  • Employees can measure their individual and collective contributions
  • The workplace environment and processes work with them to be productive rather than introducing obstacles.
  • The company values an employee’s personal time as much as it values work time.

Engaged Employee

When employees are secure and productive, they become engaged. Companies who have engaged employees are receiving much more value from their employees than the wages paid. Similar to magazines’ tips and tricks sections, companies have the ability to harvest the ideas created by their engaged employees. To activate this potential, companies need to create an environment where:

  • Individuals are encouraged to contribute ideas and are recognized for their work and ideas
  • Individuals can map their contributions to the success of the company
  • Reasonable failure is tolerated and even encouraged

Similar to developing the process to create a new service or product, an engaged employee can be developed. Companies that have achieved an engaged workforce have figured out how to balance the constraints of the customer, the money, and their employees. For the CEO in the middle of a balancing act, their success hinges on creating an innovative workforce and improving their ROHC – Return on Human Capital.

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One Comment leave one →
  1. May 30, 2013 6:42 am

    Spot on! Having been around a lot of different companies and management styles, those that recognize this will outperform those that do not.

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