March April 2012

Roundtable: Private Equity How to forge a successful PE partnership

The Co-CEO Conundrum Are two leaders actually better than one?

CEO2CEO Summit

The challenge of sustaining long-term growth

Driving Data Collection

How to harness the power of advanced analytics

march/april 2012

Special Report: Mergers & AcquisitionSs Chief Executive’s guide to navigating potholes, detours and dead ends on your way to M&A success

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contents

March/April 2012 No. 257

Cover Story

43

Chief Executive Special Report: Mergers & Acquisitions • Secrets of Top Deal Makers • Making the Most of M&As • Measuring M&A Success • Preparing Your Company for Sale • Takeaways for Mid-Size Companies

by Russ Banham

18

06

08

Editor’s Note CEO Chronicles American Water’s Jeff Sterba makes waves. • Yum! Brands’ Dave Novak offers growth strategies. • CEO Watch: eBay’s John Donahue on harnessing transformational technology.

28

18

Leadership

Two for the Road Though still relatively rare, co-CEO arrangements are on the rise—and mounting evidence suggests messy split-ups are the exception rather than the rule.

by Russ Banham

26

Operations Why Wait for Healthcare Reform?

A doctor-turned-CEO offers moves that you can make today to save your company millions in annual insurance costs.

by Ralph de la Torre

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CEO2CEO Leadership Summit The Challenge of Sustaining Long-Term Growth Insights on issues, trends, opportunities and challenges shared by CEOs and thought leaders at Chief Executive’s annual CEO Summit.

by Jennifer Pellet and C.J. Princel truth is that most mergers fail to create market value. Here’s how to make sure yours works.

by Russ Banham

march/april 2012

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contents

54

features Technology Analyze This!

Small- and mid-size companies are getting help from big data.

by William J. Holstein

54 60

CEO Roundtable Making Private Equity Work CEOs of PE firms and portfolio companies offer five steps to a successful partnership.

by Jennifer PelletThe bruta

64

Essentials Should the Chief Sustainability Officer be Sustained?

Some see CSO posts as the managerial fad du jour—but when managed properly effective initiatives deliver value.

by Fran Hawthorne

67

Executive Life

Recharge Your Body and Soul Aching—literally—for a break? Consider these three resort spa getaways.

By Michael Gelfand

71

Flip Side

Citizen Fed Bring on the amateurs!

by Joe Queenan

60

final word 72

64

Two Cheers for Wealth Creation

CHIEF EXECUTIVE, USPS # 431-710 (ISSN 0160-4724) is published bimonthly by Chief Executive Group, LLC with executive and editorial offices at One Sound Shore Drive, Suite 100, Greenwich, CT 06830.

Wayne Cooper, president. Copyright 2012. Published and printed in the United States. All rights reserved.

Reproduction in whole or in part without permission is strictly prohibited. Annual subscriptions are $196.

U.S. single-copy price is $13.95. Periodicals postage paid at Greenwich, CT and additional mailing offices.

POSTMASTER: Please send change of address to Chief Executive, PO Box 15306, North Hollywood, CA 91615-5306. For subscription inquiries, call 818-286-3119. All reprint and permission requests should be made to Brian Cuthbert (Email: bcuthbert@chiefexecutive, net, Phone: 203-889-4974).

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ChiefExecutive.net | Chief Executive Magazine

CEO http://chiefexecutive.net/

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contents

March/April 2012

features

Five Reasons for Businesses to Go Mobile Now Customers inherently know how to use mobility devices, so it’s not much of a stretch for your business to integrate them into your operations.

“Gamification:” A Rapidly Growing Trend That Will Accelerate Learning for Both Business and Education Five elements of gamification that will transform business training.

by Larry Ritter

by Daniel Burrus

Innovation Underpins Corporate Reputation: The Lesson of Steve Jobs Not having an innovation strategy could pose reputational risks.

Mobilizing Sales Here’s how to integrate mobility with social media using cloud-based tools—without overwhelming sales people with technology.

by Andy Tannen

by John Hand

The Synergy Mirage: A Case Study Brand extensions and product expansions don’t always make sense. A razor-like focus on what one does exceptionally well can make all the difference.

by Michael Rosenbaum

First the Thought Police; Then the Lawyers Social media strategy can be tricky; here’s how to sort through the issues.

by Nick Balletta

In Turbulent Times, Women May Prove to Be Better Leaders than Men Do women leaders consult more with peers than men? Do they tend to motivate teams more easily? Recent research reveals a host of provocative findings, some counterintuitive, that suggest the answers are not always what one might think.

by Shabeer Ahmad

Connecting the Company to the CEO Chief executives who connect personally with the company earn the power to lead employees out of their comfort zones to tackle big challenges and drive performance.

by Eric Sass and Tom Varian

The Rise of the Home-Based Workforce: Lessons to Manage and Motivate Remotely The use of home-based workforces is on the rise, but they need to be managed in specific ways if they are to be effective.

always available Books in Review

The Future of Value How Sustainability Creates Value through Competitive Differentiation, by Eric Lowitt Reviewed by R.M. Donnelly

by Rick Owens

Using Self-Auditing Applications to Reduce Software Audits With technology now available to mitigate software piracy, companies using unlicensed software will be at greater risk.

by Joseph Noonan

Does Your Moral Intelligence Have Economic Consequences?

Every CEO likes to think that he or she displays complete integrity as a leader. When investors or employees think otherwise, there can be unwelcome valuation consequences.

by Fred Kiel, Ph.D. and Doug Lennick

Entrepreneurial CEO

Who Is Managing Your Marketing?

Is it inside-out or outside-in?

Why do Volatile CEOs Have Nine Lives?

The intense pressure for boards to hire the right leaders often blinds them to leadership gaps that ultimately result in a costly hiring mistake. Here’s how to avoid such missteps.

by Bob Donnelly

by Dave Brookmire

by Claudio Feser

The Limits of Monetary Incentives Money isn’t the great motivator people often suppose. In fact, excessive monetary rewards can lead to bad behaviors.

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editor’s note

Editor in Chief J.P. Donlon Editor at Large Jennifer Pellet Art Direction Fastlane Production Rose Sullivan Director

The PE Question It’s interesting how a previously semi-obscure corner of business, private equity (PE), has suddenly become center stage in the media due to one presidential hopeful’s pedigree and his seeming inability to explain what it is or how it works to average voters.

With public companies, it’s easy to invest. Just call your broker. With private companies, it’s a little more complicated. In 1984, Bain & Company, a consulting firm founded by the soft-spoken, Tennessee-born Bill Bain, wanted to participate in such investing by starting Bain Capital. (Full disclosure: Chief Executive partnered with the affable Bill Bain in 1987 to host several leadership-focused roundtables—the first featuring our second CEO of the year, Chuck Knight of Emerson Electric.)

In those days, most PE firms invested in existing businesses, leveraging their positions using debt in leveraged buyouts in the hope that the businesses would grow fast and become more successful. These tended to be companies long past their initial growth cycles. The PE professionals typically teamed up with management to get the process moving. Sometimes they replaced managers but only if they felt existing management couldn’t do the job, in which case, they inserted people they believed could accelerate the growth of the business. Intuitively, it makes little sense to buy a troubled company merely to strip it and shut it down. All other things being equal, there’s not much point in paying for a business and losing the inherent value unless one is, say, doing a roll-up and buying up multiple smaller firms in the same industry to consolidate and gain scale. Even then, in many cases, the other parts that don’t fit can be sold to other firms where the fit is perhaps better. Operations that no longer make economic sense are doomed in either case.

There is no point in investing in any particular company unless the PE investor can bring superior skills to the process. This is one of the underlying premises of our private equity roundtable discussion featured on page 60. As Len Tannenbaum, CEO of Fifth Street Finance, said during the exchange, “we have to bring meaningful skills and knowledge to this because money alone isn’t enough to make a business grow and thrive.” PE investors and operating CEOs exchanged ideas on what works best and how either side can get the most out of the partnership, because fundamental disagreements only undermine the purpose of the deal. Yes, it is true that the primary object of the exercise is to secure a favorable return to the investors. However, jobs are created along the way, just as some jobs are eliminated. But when done right, the former should outdo the latter. (Full disclosure: Since 2009, Chief Executive has been owned by a private equity company.) In the long run, value is created and the economy has healthier, more vibrant companies that can sustain more productive employees.

PE investing, however, is not for the faint of heart. There are risks. The economic situation can suddenly change. Top talent can leave or be lured away. When a company is bought, any number of things can go off the rails. In many cases, it takes five or more years before it can be sold in the public markets or more likely, to a larger firm looking for an asset to build upon for its own strategic goals.

Why Mitt Romney can’t get this concept across in terms that anyone can understand would seem to be a curious shortcoming, considering his 25 years experience in private equity. Why his rivals seem bent on distorting a simple truth is another matter for another day.

Copy Chief Rebecca M. Cooper Copyeditor Carl Levi Contributing Russ Banham Editors Michael Gelfand William Holstein John Kador C.J. Prince Joe Queenan Photographer Paul O. Colliton Online Associate Karin Moyer Editors Fayazuddin A. Shirazi CEO Entrepreneur Robert M. Donnelly Publisher Marshall Cooper VP, Associate Phillip G. Wren Publisher 203/930-2706 pwren@chiefexecutive.net VP, Sales Central Christopher J. Chalk 847/730-3662 cchalk@chiefexecutive.net VP, Sales West Brian Cuthbert 203/889-4974 bcuthbert@chiefexecutive.net Director, Business Cristina Vittoria Development 203/930-2707 cvittoria@chiefexecutivegroup.com

Director, Business Rick Groves Development 610/341-0630 rgroves@chiefexecutive.net

Director, Online Michael Bamberger 203/930-2709 mbamberger@chiefexecutive.net

Wayne Cooper Marshall Cooper Chairman & President Chief Executive One Sound Shore Drive, Suite 100 Greenwich, CT 06830, 203/930-2700

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ceo chronicles

Z

Yum! Brands’ David Novak

Four Ways to Win

Yum! Brands’ David Novak has a secret for staying on his leadership toes: the “hot-shot-replaces-me” scenario.

“I think, ‘If someone replaced me tomorrow, what would he or she do?’” explains the CEO of the world’s largest restaurant company, which encompasses the KFC, Pizza Hut and Taco Bell brands. “Since I like my job, why don’t I do it first?”

Results suggest his method is effective. During his tenure as CEO, the $11 billion company has flourished, reporting 13 percent-plus earnings per share growth for each of the last nine years. Novak has also spearheaded global growth; approximately 75 percent of the company’s profits now come from outside the U.S. versus 20 percent in 1997. The firm is one of a handful of U.S. companies that have taken China by storm, in its case by leveraging brand expertise—intellectual property that local competitors can’t reverse engineer as they might a physical product.

In a recent meeting with Chief Executive, Novak, who penned the recent book, Taking People With You: The Only Way to Make BIG Things Happen, offered four tips to delivering growth.

Be Humble. “Recognize that nothing big gets done by you alone,” he says. “So you need to know who’s on your team the same way a marketer knows its target audience. Know your people cold. What’s in their heads? What are they thinking?

And then you’ve got to say, ‘Okay, to take them with me to achieve this strategy, what perceptions or beliefs do I have to build, change or reinforce to get them to come along?”

Grow Yourself. “Never stop learning,” urges Novak, who points to John Wooden, legendary UCLA basketball coach, as an example. “When he was winning national championships he met with and studied extra tall people and coaches of extra tall people. He was still focusing on growing himself. I think when you do that you’ll end up growing your business because you’ll be sharpening your skills and be able to apply that personal growth to growing your business.”

Wipe out “Not Invented Here” Syndrome. “Often when you have success, you get so insular that you don’t go outside and look to see what other people are doing,” he says. “I tell people one of the ways you get promoted in our company is to be a know-how builder, to get knowledge from other people and make yourself [and the company] smarter.”

Make Your Culture a Hero. “When we started our company, I had a chance to do a gigantic do-over, because we had been part of PepsiCo,” he explains. “So we looked at some of the best companies in the world at that time—WalMart, Home Depot, Target and Southwest Airlines. Every one of them said the key to their success was their culture.

You want to make it clear what you value in your company and then recognize the people role-modeling that behavior.

Then make culture the hero of all the good things that happen in your company. As a CEO, you have to be the culture champion. —Jennifer Pellet

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ceo chronicles > ceo watch

John Donahoe’s Transformational Adventure Even trendy tech start-ups like eBay need to re-examine their value proposition to customers if they plan to endure.

by J.P. Donlon

Z

eBay’s John Donahoe

Eight years into her tenure as eBay CEO, Meg Whitman called her former Bain & Co. colleague, John Donahoe, to interest him in coming to the San Jose, California startup to learn the business and maybe take over after she completed her tenth year. She had no successor and the eBay board wanted her to name one.

In 2005, he joined the company as president of eBay Marketplace and three years later became president and CEO. It didn’t hurt that eBay founder Pierre Omidyar, who still owns 12 percent of the company, was in Donahoe’s camp. Today he leads a global ecommerce and payments powerhouse with 2011 revenues of $11.7 billion.

The company recently reported its biggest revenue increase in six years, as sales in Q4 2011 rose 35 percent from the same quarter in 2010. eBay has hundreds of millions of users in every country where Internet connections can be found; 62 percent of its revenues come from activities outside the U.S. (PayPal’s is about half.)

Prior to joining eBay, Donahoe spent 20 years at Bain & Co. in Boston, where he oversaw a number of businesses (and became acquainted with presidential hopeful Mitt Romney). So far during his tenure, he has transformed eBay’s core businesses with a strong focus on innovation and customer access. In addition to the retail site, eBay encompasses PayPal, GSI Commerce and now X.commerce, the company’s technology platform unit open to developers and merchants. PayPal now processes $125 billion in payments and is growing 30 percent a year.

Under Donahoe’s watch, the company has aggressively grown payments, making major strides in reinvigorating its core marketplace business. But none of this came easily. On his third day on the

job, Donahoe set off a firestorm of protest when he went public with his plan to transform the company. As he told Chief Executive’s J.P. Donlon at the magazine’s CEOtech event at Stanford Business School, the company faced a deteriorating position despite upbeat financials.

The market pounded the stock. Internal messages became vitriolic. Donahoe was even the subject of YouTube video, where he was compared to a German guard in the holocaust film, Schindler’s List. “I was going to face 10 years of decline, á la AOL or Yahoo! unless I made really aggressive change,” he says.

To make matters worse, the Great Recession ripped through the economy in the middle of the turnaround, forcing him to lay off 10 percent of the company.

“That first year was not fun,” Donahoe recalls, “but my leadership team realized that the alternative—slow, steady decline— was worse.” He also credits the board for invaluable counsel and support in making the transformation work, a lesson that might benefit neighboring HP. The experience prompted Donahoe to adopt throughout his organization a universal customer-focused measure when viewing performance—its Net Promoter Score (NPS). (Created by Bain consultant Fred Reichheld, the Net Promoter Score is a measure of customer satisfaction that asks: “On a scale of 1 to 10, would you recommend this company to a friend?” A score of 8 or better makes one a promoter, a score of 5 or less makes one a detractor. Ten percent of eBay senior management’s compensation is tied to NPS improvement.)

His long-term goal? “To build a great and enduring company,” he says. “Amazon has done it so far, which isn’t easy,

considering Silicon Valley loves the bright, shiny object and drinks the bathwater like nothing you’ve ever seen. Saying his successor will need to be a different kind of leader just as he is different from Meg Whitman, he adds, “As the second CEO, I would like to hand it off in better shape to the third CEO, who then can do so for the fourth and a fifth.”

How is technology changing your business?

Technology has accelerated the pace of change. When I joined eBay six years ago, I remember my first year or two feeling that I could not keep up with the pace of change of the Internet. In the world of commerce and payments, we expect to see more change in how consumers shop and pay in the next three years than we’ve experienced over the last 15. The reason for this is this device [holds up a smartphone].

Consider the iPad and how people consume media differently today because of it. I don’t know about you, but I was the last guy in the world who ever got rid of my physical newspaper, because I loved it. And now, with the iPad, it almost feels archaic at times to open up the physical newspaper. And the iPad’s less than three years old. We’ve been talking about [the evolution] of media for a decade, right?

Probably longer. Suddenly the emergence of this one device changed consumer behavior at a stunning pace.

Well, the same thing’s happening to shopping and paying. For example, RedLaser is a barcode scanning application that we bought a couple of years ago. It enables anyone with an iPhone to scan a barcode of any item inside a store, recognize the item within seconds and bring up that exact item at a range of prices all

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across the Internet. With another application from Milo, a company we bought, the device can bring up that same item in nearby local stores. So, if you bought something, it could be available to be picked up at the store or shipped home. Is this an offline or an online transaction? In reality, it’s both. The reality is that consumers are embracing these technologies. No one knows exactly how consumers will behave a year or two from now. It’s sounds trite to say they are in charge, but that’s what is really happening.

How will mobility evolve and what is your strategy for adapting to it?

I take a dynamic view. When the iPhone came out, we launched our eBay mobile app for it about two-and-a-half years ago. In its first year, it did $700 million. In the second year, it did $2 billion.

This year, we expect almost $5 billion of volume. Fifty million people have downloaded it to their Apple or Android. We’re one of the top 10 Apps and were lucky to grab this real estate early. But that’s just phase one of mobile devices.

The way we use these devices a year from now will be different from the way we use them today. Think about Siri, the personal intelligent assistant that responds to your verbal commands. It can be used to locate restaurants and summon contacts.

We’ll have an app where I can take a picture of your coat. J.P., I like your coat. I’ll take a snapshot. And, boom, it’ll show me coats that look just like yours [by] using visual recognition and visual search.

The other thing to keep in mind is while the iPhone has been very appbased, Android and others are likely to rely on HTML5, which is, if you think about it, how you search the Web and get lots of different results. This has been slow on a mobile device because it’s not optimized for it. But HTML5 technology allows you to search all across the Web and have an app-like interface.

So, if you and I were to sit together a year from now, I could stand in the hallway beforehand and send the command “look up JP’s recent background” and, boom, that information’s going to come up. It won’t be constrained by apps. The broader message is: just as no one ever would’ve predicted the impact the iPhone has had, no one can predict how smartphones are going to be used a year or three from now.

Facebook launched its app on Apple using HTML5 the day Steve died. Steve was probably the greatest visionary in the last 25 years. Even he couldn’t predict how consumers were going to use something. Believe me, Mark Zuckerberg or Larry and Sergey and Jeff Bezos—the best visionaries in this space—will all tell you that they can’t predict how consumers are going to respond. What I can do is put something out there that enables consumers to behave the way they want to behave and then pay attention to it and doubledown in how they’re doing it.

Technology has a way of upending competition. For example, not long ago Apple was considered an also-ran and Nokia the market leader. What might be the unintended consequences of new technology that may affect your business?

In technology, a lot of innovation comes from young, upstart companies. So, the biggest threat to my company is not anybody who exists today. It’s

someone who starts something new, with a completely different paradigm. And so, if the question is what keeps me up at night, it’s just this: What’s out there that we’re not seeing?

Think about this for a second. The Web came into existence 15 years ago, more or less. Netscape was the great, first, Web company, right? Mark Andreessen’s on our board. Netscape’s gone. AOL was the next phenomenon. AOL was the Facebook of its day. Today it is in a long, slow, steady decline. Yahoo! was the next phenomenon. It’s now facing challenges. eBay was a global phenomenon, the hottest thing on earth. Inside the company, people just kept hoping and wishing it would last indefinitely. Soon, people started innovating around eBay. And eBay woke up as an eight-year-old company, realizing, holy cow, we’re screwed! We’re getting cannibalized! We’re getting disrupted!

This meant we had to go through a brutal process of reinventing ourselves, which sounds strange for a 10-year-old company.

InBox: How Does Your R&D Spend Stack Up? Keeping pace with the rapid changes in product innovations and technological advances is a competitive imperative. Yet in today’s ruthlessly competitive marketplace and turbulent economy, companies must tread carefully when devoting resources to innovation. Data from a recent research report by IBISWorld offers a useful benchmark in the average R&D spend by industry.

Average R&D Spend by Industry Biotechnology

22%

Semiconductor & Circuit Manufacturing

20%

Brand-Name Pharmaceutical Manufacturing

19.5%

Vitamin & Supplement Manufacturing

16.3%

Alarm, Horn & Traffic Control Equipment Manufacturing

15%

Software Publishing

12%

Search Engines

12%

Medical Device Manufacturing

12%

Computer & Printer Leasing

12%

Glass & Contact Lens Manufacturing

12%

Source: IBISWorld, Inc., www.ibisworld.com

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ceo chronicles

What did you have to confront culturally to overcome internal resistance to change?

The trap we faced was that financial results were out of sync with the reality. Financial momentum continued even when the underlying customer realities were not what they needed to be. Over time, the user experience on eBay shifted.

In the early days, it was funky and cool.

The seller was a husband and wife [team] in Iowa selling stuff on eBay on nights and weekends. You bought something on a Tuesday and they got around to shipping it on Saturday. They put it into a shoebox, put some newspaper around it together with a nice piece of candy and a note on top. You got it the following week and thought, “How cool. It’s so personal.”

About four or five years ago, this became an unacceptable experience.

You wanted next-day shipping or twoday shipping or three-day shipping. You wanted the item professionally wrapped and packaged. You wanted to track it along the way. You wanted to be able to return it. We had 25 million sellers who didn’t know how to do that, and it was showing in our results. Our growth rate went from 70 percent to 50 to 30 to 10 to 5 to minus 5, because consumers were voting with their feet. I was forced to confront what everyone had sort of known, that eBay had not kept up. That involved changing almost everything about our whole ecosystem. It was brutal.

If people understood that the company had to catch up with user’s expectations, why were they not open to changing how eBay conducted its operations?

The trap of success is wishing the situation could return to the way it was.

Nokia’s still wishing it will go back to the way it was—and it ain’t. People would say, “boy, we’ve really changed. We’re 25 percent different than we were last year.” The problem is we needed to be 75 percent different. Deep down, when you’ve had such white-hot success that eBay enjoyed, everyone wished it would go back to that.

I had to replace 70 of the top 100 people because I realized very well-intentioned people couldn’t make that transition. Yet

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ironically, these same people could go to another company and make that transition because they didn’t have historical baggage at their new company. With new people, we embraced a three-year turnaround process that was pretty brutal. It meant upsetting some sellers who were making their livings on eBay who were unable to adapt to the revised rules and policies that our customers wanted.

Visit ChiefExecutive.com/eBay for an expanded version of this article.

Why John Chambers Paid It Forward to Donahoe As a new CEO, John Donahoe says the best advice he received was from Cisco’s John Chambers, whom he had never before met.

“Being the CEO is a lonely job.

And the longer you’re in it and the more successful you are, the lonelier it is. You will find fewer and fewer people you can talk to,” he remembers Chambers telling him. “The reason I will give you an hour is because the guys at HP, when I was a novice CEO, gave me more time than they should have on the condition I return the favor to younger CEOs. You are now one of those, and I will spend the time with you conditional upon your doing the same.

“Here’s how it will work. I have no agenda. The time is all yours. You talk about whatever you want. It will never leave this room. You will probably talk for some period of time about what your problems are. And then, I will probably throw out 10 ideas. You will find that five of the ideas you’ve already thought of. Three of the ideas are really stupid and don’t apply. One idea is moderately useful. And one idea is decently useful. If I knew which one was going to be decently useful upfront, I would tell you. But I don’t, so you get 10. You now have 57 minutes.”

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ceo chronicles

Making Waves at American Water Works

Z

American Water’s Jeff Sterba

The Challenge: You’re a huge water utility company providing millions of Americans with water. Like other utilities, your upside profitability is limited by the sector’s contract operations model—rates are set by regulators at state public utility commissions rather than by service providers. Meanwhile the nation’s water supply infrastructure is in abysmal shape.

In some states up to 40 percent of treated water is lost due to leakage and infrastructure issues. But your return on capital is just 3 percent—far too thin to justify investing in upgrades.

The Context: Based in Voorhees, New Jersey, $2.7 billion American Water Works Company is a publicly traded water and wastewater utility employing 7,000 and providing water to 15 million people across 30 states. CEO Jeff Sterba took the helm in August of 2010 after a former parent company steered the utility through a rash of acquisitions—and the accompanying debt—in an effort to build a utility behemoth and then exited stage left with an IPO. “Like any company that goes through an IPO, the company had gotten very focused on the IPO and not necessarily on operational efficiency,” explains Sterba.

“This is a utility that frankly wasn’t making anywhere near its fair return. The allowed return [or the profit public commissions must allow water utilities the opportunity to earn] is roughly 10 percent return on equity, and that’s generally what you see in [the industry]. This company was earning between 3 percent and 4 percent.” Factor in the need to boost investment in infrastructure and American

Water would soon be operating in the red.

The Resolution: To Sterba, the answer was simple: A relentless and meticulous focus on operational excellence. For example, by standardizing its supply chain across states, the company has seen up to a 14 percent reduction in the cost of pipes. On the larger end of the scale, American Water is testing new technology that reduces energy use in wastewater treatment facilities by 30 to 50 percent. “Taking operating costs out allows us to put in capital dollars that earn a return,” explains Sterba. “For every $1 of operating costs we take out, we can put $6 of capital into our systems without an impact on rates. Each $6 in capital then generates about $0.30 of earnings for our shareholders.”

Sterba also made the tough call of abandoning markets like Texas, Arizona and New Mexico, in which the company had long struggled to operate profitably.

“When you go 10 years in a market without being able to generate a return, it’s time to put that money to work somewhere else,” says Sterba, who also plans to exit Ohio for the same reason.

The Endgame: Sterba’s efforts are paying off. American Water improved its earned ROE from 4.7 percent in 2008 to approximately 7.2 percent in 2011, due to both operating efficiency initiatives as well as a string of rate case awards that allowed the utility to bump up its rates in certain states. What’s more, the company’s stock has risen by more 26 percent since Sterba took office.

The Lesson: A culture of seeking out incremental increases in efficiency adds up to big results over time. “We want every employee to be asking these questions every day,” says Sterba. “Is what you’re doing adding value to our customers? If it’s not adding value, why are we doing it? If it’s adding value, is the process efficient? If not, how can we fix it, change it.”

Once the process is streamlined to maximize efficiency, American Water focuses on reducing errors and reducing the cost of mitigating those errors that occur. “Every year, there are about 11,000 violations of safe drinking water in this country,” says Sterba. “Since we’re about 5 percent of the market that would suggest we have 550 violations a year. Last year, we had four. That demonstrates the kind of commitment that our folks have to the safety, the health and the quality of the product that they provide.”

—Jennifer Pellet

In Fact Compiled by John Kador

1 Percentage increase in total congressional net worth since 2008: 24 2 Number of members of Congress (out of 535) among the wealthiest 1 percent of Americans by net worth: 57 3 Percentage of all Americans who consider themselves part of the top 1 percent of U.S. earners: 13 4 Percentage of Hispanic Americans who do: 28 5 Number of companies in the S&P 500 whose stock value fell 20 percent or more in 2011 (compared to 11 in 2010): 85 6 The number of days the S&P 500 fluctuated by more than 3 percent, up or down, in 2011: 12 7 Number of times it did from 2004 to 2007: 0 8 Percentage change since 2006 in the value of U.S. residential land: -70 9 In the value of U.S. cropland: +18 10 Percentage of venture capital-backed firms that went public within five years of receiving funding from 2001 to 2010: 1 11 Percentage from 1991-2000: 18 12 Percentage of 600 CFOs who anticipate U.S. economic expansion in 2012, down from 56% who thought so in 2011: 38 13 Annual profit earned per average employee at privately held U.S. companies in 2012: $15,279 14 Rank of Dollar General, with 9,800 locations, among national retail chains by number of stores: 1 15 12-month moving average for revenue per hotel room in October, 2011, up 8.4% from a year earlier, the highest it’s been since March, 2009: $60.43 16 Number of companies in the S&P 500 that lowered their debt-to-cap ratio over the past 12 months: 244 17 Percentage of U.S. corporations organized as non taxable (pass-throughs) in 2008, up from 24% in 1986: 69 18 Of the 42 mainland Chinese corporations that appear on the Fortune 500 list of the world’s largest companies, the number owned by the Chinese government: 39 19 Percentage of Chinese and Americans, respectively, who struggled to pay for food in 2008: 16,9 20 In 2011: 6,19

Continued on p. 15

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Illustration: Pablo Lobato

In Fact

Chief Executive of the Year 2012 Selection Committee

Compiled by John Kador

21 Average number of words in the legal boilerplate of a typical software agreement in 2010, up 38% from 2003: 2,235 22 Percent of consumers who admit they don’t read all the terms of contracts before signing or agreeing: 61

Thorns & Roses Thorn In his speech in Osawatomie, Kansas, President Obama upped the class warfare rhetoric characterizing anyone who affirms free markets and economic liberty as a Gordon Gekko. And for good measure, the president also told his audience that capitalism doesn’t work and never did. And guess what he thinks the solution is?

Yes, more power to his office and to the government.

Rose In the Financial Times, former Fed Chairman Alan Greenspan recently wrote prophetically: “The welfare state has run up against a brick wall of economic reality and fiscal bookkeeping.

Congress, having enacted increases in entitlements without visible means of funding them, is on the brink of stalemate. As studies by the International Monetary Fund have demonstrated, trying to solve significant budget deficits predominantly by raising taxes has tended to foster decline.”

23 Percent who actually signed a contract that included clauses saying they’d do pushups on demand and give fellow participants electric shocks: 96 24 Number of cars BMW sold in the U.S. market in the first 11 months of 2011, a rise of 12.3 percent and slightly ahead of rival Mercedes Benz: 221,073 25 Chances that a top brand of imported olive oil labeled “extra-virgin” is not extra-virgin: 3 in 4 26 Number of tickets (at $200,000) that Virgin Galactic has sold for spaceflights it hopes to begin launching by the end of 2012: 460

Brian Duperreault President and Chief Executive, Marsh & McLennan Joseph Echevarria Chief Executive, Deloitte LLP Fred Hassan Chairman, Bausch & Lomb Senior Partner, Warburg Pincus William Hickey President and Chief Executive, Sealed Air Christine Jacobs Chairman, President and Chief Executive, Theragenics Alan Mulally President and Chief Executive, Ford Motor, 2011 Chief Executive of the Year William R. Nuti Chairman and Chief Executive, NCR Thomas J. Quinlan III

27 Percentage of consumers who lodge formal customer complaints and report ending up satisfied: 21

President and Chief Executive, RR Donnelley

28 Increment in the FICO score of consumers who are willing to delay a reward (e.g., if they would rather have $80 in a month rather than $70 now), relative to people who want it now: 30

The Chief Executive Leadership Institute,

29 The Institute of Supply Management’s Manufacturing index for December, 2011 (any reading over 50 indicates expansion in the U.S. manufacturing sector): 53.9 30 Number of working-age people in 1950 for every person over 65 worldwide: 11.7 31 Number in 2012: 8.6 32 The proportion of U.S. young adults (those between 25 and 34) who have never been married, a figure that for the first time in U.S. history exceeds those who are married: 44.9 33 Minimum number of U.S. colleges that offer courses in unmanned drone operation: 5 Sources 1 Roll Call, Washington D.C.; 2 Center for Responsive Politics; 3-4 Poll Position, Atlanta; 5-6 BusinessWeek; 7 Wall Street Journal; 8 Lincoln Institute of Land Policy, Cambridge, Mass.; 9 U.S. Department of Agriculture; 10-11 Rennassiancecapital.com, Scott Shane, Case Western University; 12 Bank of America Merrill CFO Outlook survey; 13 Sageworks; 14 National Retail Federation; 15 Smith Travel Research; 16 Capital IQ, Wall Street Journal; 17 IRS; 18 The Economist; 19-20 Gallup, Washington D.C.; 21-23 John Marshall Law School and DePaul University; 24 Wall Street Journal; 25 UC Davis Olive Center, Davis, Calif.; 26 Virgin Galactic; 27 WP Carey School of Business, Arizona State University; 28 Psychological Science, Association of Psychological Science; 29 Institute of Supply Management; 30-31 United Nations; 32 Population Reference Bureau; 33 Harpers Magazine.

Jeffrey Sonnenfeld President and Chief Executive, Yale School of Management James Turley Chairman and Chief Executive, Ernst & Young

c o n tact u s

Chief Executive Group, LLC One Sound Shore Drive, Ste. 100 Greenwich, CT 06830 www.chiefexecutive.net Letters to the Editor Address above or letters@chiefexecutive.net Advertising & Custom Publishing 847.730.3662 advertising@chiefexecutive.net Events, Roundtables & Conferences 847.730.3662 advertising@chiefexecutive.net Fax: 847.730.3666

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CEO Confidence Index

CEO Confidence Levels Show Optimism

Leaders say the media’s outlook is overly negative.

Some CEOs are ringing in 2012 with a greater sense of optimism, while some remain hesitant.

The CEO Confidence Index rose to 5.78 out of a possible 10, the highest the Index has been in seven months. The last time that confidence levels were so high was in May 2011. In January 2012, 56.3 percent of CEOs said they expect overall business conditions to be “good” or better over the next 12 months. Another 25 percent of CEOs, however, ranked overall business somewhere between “good” and “weak.”

Some leaders credited slowly improving business for their optimism, while others referenced the November election and hope for a new political climate.

The desire for a change in Washington has become a longstanding theme in the CEO Confidence Index. CEOs are frustrated with political leadership and regulations. Several CEOs participating in the survey commented to that effect: • “It’s imperative that we have a change in the President and in Congress, especially the Senate. I have a hard time understanding how a supposedly smart President can’t see [where] the track we’re on is headed when Europe is farther along that track and in deep trouble.”

• “ The regulatory climate is hostile and not conducive to a balanced approach to business needs and regulatory agency obligations. No oversight over regulatory bodies leads to uneven enforcement, or worse, operating in the dark.”

More than one CEO commented that business conditions seem to be better than the media is playing them out to be: • “ I believe the media tends to overplay the negative and underplay some of the positive movements in our economy.

Consumers are spending again;

CEO Confidence Index Confidence levels have not been this high since May of 2011.

10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00

Mar 2008

Jun 2008

Oct 2008

Feb 2009

Jun 2009

Oct 2009

Feb 2010

Jun 2010

Oct 2010

Feb 2011

Jun 2011

Oct 2011

CEO Confidence Index > Expectations for Overall Business Conditions 1 Year From Now Current Conditions Rating > 10 = Excellent | 8 = Very Good | 6 = Good | 4 = Weak | 2 = Poor

employment is growing, albeit not robustly, but consistently. The real estate market has clearly moved off its bottom and is trending upward. I’m personally very optimistic about 2012.”

• “ We are seeing a common thread of moderate growth in the basic material businesses that we supply equipment to. Although we saw a 20 percent drop in revenue 3 years ago, every year since has been better than the last. We have been able to give merit increases to our employees and also pay out performance bonuses. If the media did not keep telling everyone how bad the economy was, people would eventually realize that things are not bad.”

Almost 48 percent of CEOs (47.6 percent) reported expecting to increase their capital expenditures over the next 12 months. Only 16.8 percent expect to decrease their capital expenditures, a figure that suggests expectations have bounced back since July when only 39.9 percent expected to increase spending. As one CEO said, “Despite slower recovery in the construction and housing markets, we are now

expecting to hire more personnel across multiple disciplines within our company to attend to customers for added services. Our revenue resources are now more diversified than in the previous years and therefore demand greater management. This year we will continue to invest in new equipment and replace most of depreciated assets, allowing us to perform at a higher level.”

However, many CEOs are still hesitant to invest until the upcoming election, so it will be interesting to see what moves CEOs make in 2012.

Online Content Chief Executive’s Full Historical CEO Confidence Index Data (From October 2002 to present) is available at: www.ChiefExecutive.Net/ CEO-Confidence

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leadership

Though still relatively rare, co-CEO arrangements are on the rise—and mounting evidence suggests messy split-ups are the exception rather than the rule. by

Russ Banham

Key Takeaways

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Two for the Road

• A far-flung global enterprise may benefit from having two leaders on hand

• The most frequent cause of failure of a co-CEO structure is lack of clarity around the division of roles and responsibilities

• Da ta suggests the market responds favorably when public companies switch from a classic single CEO leadership structure to a co-CEO structure

18 chiefexecutive.net MARCH/APRIL 2012

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“ If a duo hasn’t walked through, mutually agreed upon and communicated their authority, roles and responsibilities, then the team is being led by an unequally yoked two-headed monster.”

Double the Pleasure Aspen Insurance Holdings Limited had been steered by co-CEOs for the past year and one-half; so when the time came for a change at the top of the ladder, the company opted for the same shared governance model.

The reason is simple—the model worked for the diversified provider of insurance and reinsurance products—with assets of $9.3 billion and more than 670 employees in eight countries. “We were becoming increasingly diverse by geography and products, and it was very hard for one person to cover all the time zones and still maintain the sort of control we wanted to see over the business,” explains Rupert Villers, co-CEO (formerly with John Cavoores). “John and I got along great, we’ve known each other a long time, we have different skill sets, and we’re both plain speakers. Sometimes people thought we were having a tremendous row, but we were just sorting things out.”

A tremendous row? Does this give pause to Mario Vitale, former CEO of insurance broker Willis North America and Villers’ new teammate? “I’ve been in shared positions before, though not as a co-CEO,” Vitale says. “If you don’t have a big ego, it can work. They key is to complement each other in terms of strengths. Rupert and I have some overlapping expertise, but a great deal of our experience is diverse—we bring different things to the table. He’ll lead on certain responsibilities and I will on others, which eases the decisionmaking process.”

Vitale believes two people may be required to run a farflung global enterprise. “The world of business is more global and complex, with more regulations and reporting requirements than ever before,” he notes. “That’s a lot of responsibility for one person.”

There is another reason why he is excited about sharing the helm. “For the first time in my career, I can go on a vacation and not take my BlackBerry,” he says. “I know Rupert can handle whatever comes up.”

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Are two heads better than one? When it comes to leading an organization, whether it’s a large, global enterprise or a small mom and pop shop, the answer seems to be yes. While some coCEO arrangements enjoy the brief bliss of a Kardashian wedding, most stand the test of time.

We’re not making this up, either. Studies by the University of Missouri (See sidebar, p. 20) suggest the stock market reacts more favorably to the announcement of a shared leadership role than one borne by a sole man or woman, despite the extra compensation two heads require. Sure, there are messy divorces like Citibank’s Sandy Weill and John Reed, but anyone who knows both fellows will readily admit they were classic opposites who charmed each other during the courtship before the marriage tore them apart.

How do companies arrive at a shared governance model? There are many different paths—a merger of corporate equals, the founding of a company by two people, a spinoff into two separate businesses, the twinning of a seasoned CEO on his way to retirement with a younger heir apparent and having two sharp senior leaders share the top spot for no other reason than they each deserve it.

As for the number of coCEO partnerships, it isn’t earth shattering. Forty-four U.S. companies within the Russell 3000 have currently positioned two people at the top of the pyramid, according to research compiled by GMI, an independent provider of global corporate governance ratings and research. They include such well-known businesses as Chipotle Mexican Grill, J.M. Smucker, Martha Stewart Living Omnimedia, Primerica, Whole Foods Market and Amway, the latter founded by two people who shared the spotlight before giving it up to their sons, who still share governance. Another 48 companies not headquartered in the U.S. also have co-CEOs in charge, the research indicates.

That’s less than 100 among 3,000 companies, but even that many opens the eyes. If you compare these figures to a couple decades ago, when co-CEO partnerships were few and far between, this is a thumping great leap. Moreover, these numbers fail to account for the thousands of smaller organizations thriving under two leaders—from family-owned enterprises to law firms. While there are no figures available on the incidence of co-CEOs at small to mid-size firms, studies like “It Takes Two: The Incidence and Effectiveness of co-CEOs” (Marquette University, University of Nebraska and the University of Missouri, 2011) report that the structure is significantly more common among smaller firms. Three companies we spoke with for this article—Automated Social Network, A Squared Entertainment and Kaye/Bassman International—are among the many small to mid-size firms with co-leadership structures.

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leadership Making It Work

To find out what it takes for a co-CEO arrangement to succeed, Chief Executive chatted with several successful leadership duos, and those who have studied these relationships or guided them. Not surprisingly, their responses sounded a bit like what a good marriage counselor might advise—a willingness to share the spotlight, divvy up the labor based on each partner’s strengths, communicate as a unit and leave the egos at the door.

As Bill McDermott, co-CEO of technology giant SAP ($13.1 billion in 2010 revenue), says, “One plus one can equal three.”

His partner, Denmark-born Jim Hagermann Snabe, does the math. “Bill and I have different backgrounds, experiences and perspectives,” Snabe says. “He has spent most of his career in the field with customers and running businesses for four global brands, and I’ve spent quite some time managing the development of our business software. We play to our strengths—not that we don’t get involved in each other’s area of expertise.”

When their arranged marriage was determined in 2008, New Yorker McDermott didn’t blanch. “Our chairman told me the other co-CEO would be Jim, and I said ‘Perfect,’” he recalls.

“The two of us had worked well together for years. Our core values are fundamentally aligned and we share the same vision and unified strategy.”

Their dialects may differ, but McDermott says both men speak with “one voice.”

Biting the Dust

If only all co-CEO arrangements worked as well. Mark Faust, principal at turnaround consultancy Echelon Management, says the most frequent cause of failure in a shared governance model is lack of clarity around authority. “If a duo hasn’t walked through, mutually agreed upon and communicated their authority, roles and responsibilities, then the team is being led by an unequally yoked two-headed monster,” Faust explains.

Few people who worked at Citibank during the two-year Weill-Reed era would disagree with this analogy—not even Weill.

“John Reed and I convinced ourselves that the people at Citi knew him and the people at Travelers knew me, and we were both hopefully old enough and mature enough to be able to work together to build something,” Weill says, reflecting on the experience. “I think we honestly believed that, but it didn’t end up that way at all. We were driving the people who worked for us crazy and not making decisions, or making decisions they didn’t understand. Eventually, one of our senior managers at a management meeting [said] something about this, and that became the cry that led to us having a board meeting to make the decistion that we needed one North Star. There had to be one North Star, and we had two North Stars.”

The takeaway? For a dual leadership structure to work, the two individuals need to hammer out their respective turfs. “John and Sandy each were equipped to do the job; but when they had to share power they tripped over each other,” says George Bradt, managing director at consultancy PrimeGenesis. “There was no agreed-upon division of labor in line with each leader’s complementary strengths, and employees found it hard to figure out who wanted what. It wasn’t an additive partnership.”

That’s a common pitfall for merger-inspired co-CEO arrangements, when talk of the new entity benefitting from the capabilities of two experienced leaders is a flimsy veil for the real goal—pushing a deal through. “Time Warner is a perfect of example of two companies that merge and then the respective leaders of each company share the CEO position,”

Z

SAP co-CEOs Bill McDermott and Jim Hagermann Snabe

The Market Values Co-CEO Structure Performance data for 30 companies that transitioned from a traditional single-CEO leadership to a co-CEO structure shows a positive reaction from the market.

Given the relative rarity of co-CEO leadership structures, one might expect the market to view them with suspicion.

Not so, says Professor Stephen Ferris of the University of Missouri, who has conducted extensive studies of the efficacy of the co-CEO model. “Our research shows that the market reacts positively and significantly to the announcement of a dual CEO appointment,” says Ferris, who crunched the numbers on 30 companies announcing such transitions to get a bead on the market’s response to a co-CEO structure.

“The average abnormal announcement return—or the return after adjusting for regular market movement and the firm’s expected return, given its level of risk—after such an announcement was 2.58 percent. If the market didn’t like these arrangements or was indifferent, then the announcement returns would be zero.”

The table below presents those findings, as well as the “abnormal announcement” returns for event windows before and after the announcement. “We wanted to look at what happened if the announcement was late in the day and the market couldn’t capture the impact on that first day, as well as what happened if there had been some leakage and people knew the announcement was coming,” explains Ferris. In all cases, the impact was both positive and significant—suggesting the market generally views a co-CEO arrangement as a positive development.

Market Performance after Announcement of a Co-CEO Structure Event Window

CAAR*

Day of Announcement

2.58%

Day of and Day After Announcement

2.81%

Day Before and Day of Announcement

6.19%

*CAAR = cumulative average abnormal return

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says Ana Dutra, CEO of Korn/Ferry Leadership and Talent Consulting. “The problem is that each CEO now is gunning for the other.”

More modern examples of failed co-leadership structures include Research in Motion, maker of the once-supreme BlackBerry smartphone. Headed by two chief executives, Mike Lazaridis and Jim Balsillie, a renowned technologist and businessman/philanthropist, since 1992, the company recently appointed an insider to take sole possession of the CEO role. The change followed a poorly managed leadership debacle in the wake of a major service outage. “When the problems were happening, you had one guy off doing his philanthropic work and the other guy working at corporate,” says Terry Jackson, Ph.D., managing partner at WEpiphany, an executive coaching firm. “There was no clear strategy to address the outage—no clear communication to the public— which resulted in it dragging on for more than a week. They weren’t in unison and lost their rhythm.”

Mastering the Marriage

However, there are plenty of examples where two heads are indeed better than one. “It seems contra-intuitive,” Paul Winum, senior partner and global practice leader at management consultancy RHR International. “but the single CEO, ‘bucks stops here’ model is not the only model that works.”

Take the case of Automated Social Networking, a $1 million provider of social networking services. Its two founding CEOs say they agree on strategy and more tactical decisions and speak with a single voice. They also have a way to resolve disagreements that do arise, says Len Schwartz, co-CEO (with Matt Loop).

“We conduct a ‘split test’ to see which produces the better result,” he explains.

“Recently, Matt and I disagreed about whether or not an audio piece should play immediately once someone logged onto our website. He wanted it; I wanted a little presentation instead. So we tested it, recording how long people listened to the audio before clicking onto something else. He won, and I supported him.”

The ability to resolve the inevitable conflicts that occur is essential to a healthy co-CEO structure, agrees Nicholas Turner, co-CEO (with Jeff Kaye) of online executive search firm Kaye/Bassman International, an executive search firm with $14 million in annual revenues. “We do disagree on occasion,” he says. “Since there are certain core components within the organization that are primarily my responsibility, such as recruiting and program creation, Jeff typically will defer to me in such instances. When it comes to his skills— he comes up with these amazing ideas on a cocktail napkin—I

“ We take pride that we don’t always have the same opinion and view. If we did, we’d lose the tremendous value that our diverse backgrounds and unique perspectives bring.”

Are Two Better than One? “Co-CEOs are ideal in many situations, especially when the executives provide oversight of each other’s actions and have complementary skill sets,” says Stephen Ferris, a finance professor and Rogers Chair of Money, Credit and Banking at the University of Missouri’s Trulaske College of Business. Ferris has studied the efficacy of the co-CEO model and argues that it is a highly effective way of running a business. “Co-CEOs are ideal in many situations, especially when the executives provide oversight of each other’s actions and have complementary skill sets,” he explains. “It’s actually a very successful model.” From his research on more than 100 shared-governance examples, Ferris offers the following highlights: “Job Complementarity.” Of more than 100 shared leadership structures examined in the study, Ferris found that 45 percent had what he calls “job complementarity,” while another 45 percent had “educational complementarity” (i.e. one CEO with a graduate degree in engineering and the other with an MBA or law degree). “Ninety percent of the sample had some complementarity in terms of duties and backgrounds, which allows for a much broader set of experience and ideas with which to chart a strategy or make a decision,” Ferris says.

Compensation Gap. Another interesting finding—co-CEOs earn a little less than twice what a single CEO would earn. This seems excessive, but Ferris says the expense may be worth it, given differences in the type of compensation. “Co-CEOs get a lot less incentive-type compensation, but equivalent amounts of cash compensation,” he says. “The median co-CEO team receives 35.7 percent of the options of a solitary CEO, which we interpret positively.”

The reason a single CEO’s compensation is geared to maximizing shareholder value is to incent the individual to perform.

However, with co-CEOs, “There is more of a self-policing aspect in play,” Ferris says. “Each ensures the other works as hard as he or she can to boost results—hence there is less need to link pay to performance.”

Tenure. A similarity in both leadership models is tenure—a median 4.5 years for co-CEOs and a bit more than a median five years for a sole CEO. Says Ferris, “This tells me that the co-CEO model is working just as well as the CEO model; otherwise we would see a bigger disparity.”

What Prompts Co-CEO Leadership?

According to a survey of 111 co-CEO partnerships, the circumstances break down as follows: Circumstance

% of Co-CEO partnerships

Merger or Acquisition

20%

Family Company

25%

Co-Founders of a Company

15%

Interim Leadership Transition Other

9% 31%

Source: University of Missouri’s Trulaske College of Business

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leadership tend to do the same.”

“Frankly, it’s like a marriage,” Kaye chimes in. “To resolve a problem in a marriage, it’s not a choice between right and wrong but a collaborative approach towards solving a problem. We’ve learned not to ‘bring old soldiers to new wars.’ Who won last time has no bearing on the current discussion.”

For Andy and Amy Heyward at A Squared Entertainment marriage was a primer for sharing leadership. The husband-and-wife team jointly lead a Los Angeles-based provider of children’s entertainment programs. A Squared has partnered with four high-profile people—Warren Buffett, Martha Stewart, Marvel Comics’ Stan Lee and model and United Nations Ambassador for Environmental Awareness Giselle Bundchen—to deliver video content on the Web. For kids fascinated with business, a cartoon Warren Buffett offers advice on the “Secret Millionaires Club.” Fashion-minded but environmentally sensitive kids can log onto GiselleandtheGreenteam.com. To learn a craft, try MarthaandFriends.com.

“We’re competing in the children’s entertainment market against Disney, Nickelodeon and others, so we pursued a different approach—forming partnerships with people who have established brand recognition,” says co-CEO Amy Heyward. “Kids three to seven years old aren’t watching TVs like we did as children; they’re going to online destinations, such as YouTube and Google. So we decided to produce three- to five-minute Webisodes, creating, producing and marketing the content ourselves.”

A Squared is only three years old, but it has already pumped out dozens of Webisodes and 26 half-hour episodes of the “Secret Millionaires Club.” It has 20 full-time employees and a contingent workforce of more than 100 designers, editors and composers.

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A United Front

When asked what makes their co-CEO arrangement work, Amy chalks it up to their different areas of expertise.

“He’s the creative force, yet he can also pick up a 50-page contract and distill its points,” she explains. Andy says, “She’s the marketing executive who really understands this very specialized consumer market.”

He adds, “Running the company is like parenting. People here understand they can’t go to one of us and if they don’t like the answer go to the other. There is no court of appeals.”

This direction is an important one, says Katrina Pugh, president of AlignConsulting and author of Sharing Hidden Know-How. “Employees in a co-CEO-led company could receive communications from two senders, a diffusion that could weaken their sense of stability and open the door to dysfunctional behaviors like ‘playing one parent against the other,’” she explains. “This could spread within the company and to customers. A plaintive customer might whine, ‘Is anyone in charge here?’”

There is no such whining at SAP today. “We take pride that we don’t always have the same opinion and view,” Snabe says. “If we did, we’d lose the tremendous value that our diverse backgrounds and unique perspectives bring.”

When the co-leaders do disagree, they respect each other’s point of view and move quickly to a decision they can stand behind before executing. “That’s the end of the debate,” says Snabe. “We then move forward as one.”

Too Many Cooks The single CEO model is the primary paradigm of corporate leadership, although co-CEO partnerships show promise. But five CEOs? Is it possible for five people to run a large, growing enterprise without shooting each other?

Mobi Wireless Management seems to think so.

Launched in 2008 with five CEOs who became friends in high school, the Indianapolis-based company manages mobile accounts for clients. The company is an offshoot of another business started 10 years ago by the fearsome five— Bluefish Wireless Management. So are they still friends?

“We’re still here,” replies Scott Kraege, one of both companies’ five managing partners. “We’ve been struggling together and succeeding together for a decade, not that we don’t trip over each other. If we’re not prepared for confrontation, dialogue and debate, we’re not going to make it.”

“Make it” is what they are doing. Since 2009, revenues at Mobi have skyrocketed 600 percent, and the number of managed wireless lines grew 78 percent. Both companies together employ 130 people. The leadership team meets to discuss all strategies and plans once a week at what the CEOs call the “roundtable.” “When we first got together, it was at the house of one of us, a bachelor at the time, and he had nothing but a small, round table, so that’s what we called it,” Kraege explains. “Now we’ve got a big round table.”

At these confabs, the CEOs draw upon each other’s respective skills, sidestepping the usual power struggles and finger pointing that doom many management-by-committee structures. “Each of us has our own department we’re in charge of,” says Kraege, who heads up new business marketing. Others are responsible for IT, finance, HR and business development, although there is overlap. Most discussions end with the five CEOs in agreement on whatever decision is on the table that day.

“We’ve had some heated, knock-down, dragged-out battles,” Kraege admits, “but that’s all healthy. Everything is out in the open, everyone gets his points across, and we all end up supporting whatever we agree on.”

CEO Online Exclusive Visit www.chiefexecutive.net/Co-CEOs For: • Co-CEO Prerequisites • What You Need to Make Shared Leadership Work

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WE SEE WHAT OTHERS DON’T. BRINGING A PSYCHOLOGICAL POINT OF VIEW

. . .

FOR OVER 65 YEARS IN THE AREAS OF:

CEO Succession Senior Team Development Executive Assessment and Development

WWW.RHRINTERNATIONAL.COM © 2011 RHR International LLP. All rights reserved.

Photography: www.charlesshotwell.com

operations

Why Wait for Healthcare Reform?

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A doctor-turned-CEO offers moves that you can make today to save your company big bucks in annual insurance costs.

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Five years ago, cardiac surgeon Ralph de la Torre gave up his surgical scrubs and turned his talents to saving a very different kind of patient—a group of Boston hospitals poised for bankruptcy. A former chief of cardiac surgery at Harvard University’s Beth Israel Deaconess Medical Center, de la Torre steered the Caritas Christi network—now known as Steward Health Care—from a $25 million loss to operating profits of $40 million in 2010.

Behind the effort was a fundamental shift away from the traditional fee-for-service model of healthcare to a managed care system that reduced healthcare costs by changing the way providers are paid. Such models have proven successful at Steward and a handful of other healthcare systems but have not been widely adopted by the healthcare industry. Given that it will be some time before companies can expect their widespread use to measurably reduce healthcare plan costs, Chief Executive asked Ralph de la Torre to offer an insider’s guidance on ways to bring down their ever-spiraling corporate healthcare plan costs in check.

by Ralph de la Torre, M.D.

CEO, Steward Health Care System

Any large employer has the ability to influence many details in a health benefits package. We no longer live in a world where an insurer comes to your company, presents a plan and tolerates your minor tweaks to the deductible or the co-pay.

First of all, you should be talking with more than one insurer and considering competing bids. Never order the soup du jour. Scrutinize each offering and make sure you understand the individual components. Small business owners, who pay more than 70 percent of the premiums themselves and typically work with insurance brokers, have to push back along exactly the same lines.

Once you have chosen an insurance partner, press the company to customize the plan so it fits your needs. Why, for example, are you paying for a no-smoking program if nobody in your company smokes? Next, you need a guarantee that the insurer will work with you to understand how your employees actually use health services. The insurer should help you monitor utilization and actively shape it. The right questions are: What is the price per unit of care? What’s driving that cost? How much care is actually consumed? You’ll want to know which pharmacies are participating, whether the formularies promote generic options, which specialists are under contract and where the procedures are performed.

The pattern, intensity and location of care have an immense impact on cost. Doctors may routinely request CAT scans when patients have headaches—and they may be funneling patients to hospitals when the scans could be performed just as well, at lower cost, in a physician’s office. The insurer has influence over these choices. It’s your role to request detail. Deconstruct the black box.

Your mission is to keep employees healthy, while receiving superior medical care at reduced costs. To help achieve this goal, you should ask insurers if they are able to make their

reimbursements contingent on quality. Suppose, for example, the insurer typically pays $1,000 for a standard test or medical procedure. Could they instead offer $950, with a clause that provides an additional $100 if quality standards are met? The insurer may have to swallow that cost for a period of time, as the hospital strives for higher standards. But you’ll see dramatic costsavings—plus improvements in employee health—if the quality boost means fewer hospital re-admissions from infections or other complications.

The Wellness Riddle

The goal of corporate wellness programs is to keep people healthy and, as a result, to lower healthcare costs. In an ideological sense, nothing is more important than preventive care. But from a business standpoint, wellness efforts fall on a spectrum.

At one end, you are keeping a 40-year-old person trim and free of diabetes.

Further down the spectrum, you’re helping a diabetic person stave off chronic heart disease. At the far end, you’re keeping a patient with diabetesrelated congestive heart failure out of the hospital.

From the position of the employer or the payer, you get the most bang for your buck by intervening early and preventing the advent of diabetes. The problem is that at some point, you are double-paying: You’re investing in the current health of employees in order to hold down costs that are 15 or 20 years down the road and at the same time, you’re paying to treat an employee with a chronic illness because nobody made a smarter investment in his or her

Small business owners, who pay more than 70 percent of premiums themselves and typically work with insurance brokers, have to push back.

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operations health 15 years ago.

This dilemma calls for some unconventional business thinking. It asks society to make a down payment that may pinch a little right now, so that our children won’t be even worse off 15 or 20 years in the future.

Making the Most of Your Choices

Finding the best healthcare plan for your company is no easy feat, but there are ways to tailor a plan to your needs, as well as pitfalls to avoid in navigating the healthcare marketplace. Following the do’s and don’ts below can help you raise the quality of care your employees receive while also lowering costs.

The Do’s: • Analyze the details in the plan or delegate to somebody who will. You may uncover features you don’t want to pay for, such as access to expensive teaching hospitals in a neighboring city for routine care.

• Request the insurer’s help in monitoring your employees’ use of health services. Utilization is one of the primary drivers of total medical expenses, but there’s no way to grasp what you need without scrutinizing what you consume.

• Seek the insurer’s aid in analyzing per-unit costs of healthcare to find out what is behind the high premiums you’re paying. It could be tests or procedures doctors in your plan are promoting that don’t improve health but do bring in revenues for providers.

• See if the insurer offers incentives for good behavior. If there are a lot of smokers at the company, see if the payer will experiment with higher premiums for those who indulge or discounts for non-smokers or for those who quit.

• Ask if the insurer has a “capitated” plan (see sidebar, “The Steward System: Capitated Care,” p. 29). This means doctors

in a narrow provider network are paid a fixed annual amount to manage each patient’s health, and the medical team retains a portion of whatever remains at the end of the year. If they go over budget, they must return money to the insurer. The employee enjoys lower premiums when staying in network. Not all capitated plans are full-risk, populationbased payments. As a matter of fact, most are not. Understand the differences.

• If capitated plans don’t exist in your area, see if there are other incentives to persuade employees to use local, lowercost medical facilities—as long as there are no gaps in quality.

• Ask if any offerings cover sustained consultations with doctors or nurses for employees with chronic illnesses.

The extra attention can save you money by encouraging lifestyle or behavior modification to keep the ill employee out of the hospital.

The Don’ts: • Never automatically renew a contract with your current insurer. Meet with at least two different companies and compare details and costs of each plan.

• Never take the untailored “soup du jour” offering. Insurers expect to customize plans for clients who take the time to study the details and analyze their own needs.

• Don’t pay for features that aren’t relevant to your situation. If there are no smokers in your company, why should you pay for a no-smoking program?

• Don’t go with a capitated insurance plan (see sidebar) unless it contains so-called quality overrides. These provisions reward doctors who actively keep patients healthy by following quality standards. The goal is to discourage doctors in capitated plans from reducing the total spend cost by withholding care.

Lessons from Massachusetts Massachusetts provides coverage to approximately 98 percent of residents, including 100 percent of children. The trouble is, Massachusetts is 15 percent above the national average in health expenditures, and annual increases in the state far outstrip increases in other parts of the country.

Local culture plays a role in those figures. Academic research centers, teaching hospitals and biotech companies are iconic fixtures in Massachusetts, probably inspiring higher per capita consumption of health services. However, it’s also true that when you expand access to medical care, you expand costs.

But I would assert that all Americans have a right to healthcare. This is simply axiomatic. Once we accept it, the whole discussion becomes an exercise in public finance. The next leg of healthcare reform has to be understanding and tackling the core contributors to cost.

That’s what a community-based approach is designed to achieve. The policies in Massachusetts created a burning platform for change. But the lessons we’ve learned operating in Massachusetts are broadly applicable. And none of them is contingent on how—or whether—the Affordable Care Act is implemented nationally. —Ralph de la Torre

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The Steward System: Capitated Care

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A state-of-the-art linear accelerator (left) and new imaging technology (right) at the St. Elizabeth Medical Center’s radiation oncology center enable physicians to deliver more customized cancer care.

Based in Boston, Steward owns and operates 10 hospitals serving 85 communities in Massachusetts. The second-largest health system in New England after Partners HealthCare, Steward has an integrated, community-based model caring for more than one million patients. We run the hospitals, manage insurance contracts and connect all the parts with an advanced Electronic Medical Record (EMR).

We offer a unique insurance plan to our 17,000 employees and their families, a low-premium product that is also available to many physicians and their staffs throughout the network. In January 2012, we rolled out a similar offering for small businesses in a partnership with Tufts Health Plan. It is approximately 20 percent less expensive than other insurance plans currently available in Massachusetts.

Our system is designed to address structural flaws in the way healthcare is delivered and paid for in the U.S., starting with the fee-for-service model. Today, Medicare and private insurers pay physicians for each test or procedure they call up. They have an incentive to increase the volume of care, indirectly encouraging patients to consume more of it. Apply this model to manufacturing and you’ll see the absurdity. The government turns to you and says: “We’ll pay you X dollars for every widget— oh, and by the way, you get to place all the orders, and you can order widgets forever.”

In 2009, we re-tooled our approach. First, we revived a system called capitated payments—famously misused

by HMOs in the 1980s. In this model, insurers pay doctors a fixed sum to manage each patient’s health over the course of a year. If the medical team spends less than this amount, they pocket the difference. If they over-spend, they have to repay the insurer. The danger here is that doctors, in their zeal to cut costs, will under-treat their patients. That’s why quality overrides that actively reward good practices, such as careful patient monitoring, attention to diet and lifestyle, and zero-tolerance for hospitalborne infections needed to be a key component of any plan moving forward. Blue Cross Blue Shield of Massachusetts first presented this model and helped create the catalyst to work collaboratively with them as the insurer.

Other steps Steward took to cut costs and improve care include:

•G oing local: Wherever possible, tests and procedures in the Steward system are performed within a narrow network of local hospitals, rather than at the famous Boston teaching hospitals, where routine care is more expensive with no demonstrable quality difference. Moreover, the best, most cost-effective care is often delivered in physicians’ offices, or in the patients’ homes. Of course, patients needing highly specialized treatment are referred to appropriate medical centers.

• Going digital: To wean doctors from the fee-forservice model, we had to provide data as well as incentives. We invested $100 million in developing an integrated electronic medical record system, which we support in the physicians’ offices. Combined with a unique call center, this system frees doctors from the red tape of billing, scheduling and referring patients. They can run their practices with fewer full-time staff, reducing their overhead and boosting the bottom line.

• Unit costs and utilization: We analyze patterns of care that drive per-unit costs and total medical expenses, such as doctors overusing MRI scans, discretionary heart procedures or preference for branded drugs over generics. Studies show that constant diagnostic scans and biopsies, for example, can lead to unnecessary surgeries and a catalogue of complications. We have fixed this problem by changing the incentives and carefully monitoring outcomes.

• Preventive care: We try to educate patients and employees on the importance of complying with drug prescriptions, staying healthy and staying out of the hospital. Our integrated records and information systems enable us to monitor how well patients are taking care of themselves and to step in when appropriate.

Editor’s Note: The Steward network’s total medical costs are now below the median for all providers in the state of Massachusetts, according to the 2011 Massachusetts Attorney General’s Cost Trends Report. Ninety percent of patients treated in the network receive care under the capitated payment model. Over the next three years, this approach is expected to produce upwards of $100 million in cost savings.

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CEO2CEO summit

CEO2CEO Summit: The Challenge of Sustaining Long-Term Growth At this time of economic uncertainty and political upheaval, the demands on top business leaders have never been greater. CEOs are called upon to generate earnings while pursuing innovation, to support new initiatives while protecting core businesses and to embrace new technology while trimming costs. These demands come during a time of both great economic uncertainty and tremendous change. Once impregnable-seeming business models and institutions are crumbling, while new giants are being born.

In December, Chief Executive magazine gathered more than 100 CEOs at The New York Stock Exchange to explore these challenges. The pages to follow capture some of the insights, opportunities and concerns shared during the presentations and discussions.

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CEO2CEO summit > CEO roundtable

A Strategy Map: Competing Through Culture A strong culture can leverage hidden potential and differentiate one’s competitive edge in a lowgrowth environment.

That tone at the top can begin to unify even the largest companies, particularly when the CEO is able to transform a culture of management into a culture of leadership, noted Mike Ullman, chairman and CEO of JCPenney. By the time Ullman took the helm seven years ago, the 109-year-old retailer had become so decentralized, each of the 11,000 store managers made his or her own decisions regarding hiring, merchandise purchasing and even store design. The company was rapidly losing market share.

“They got outfoxed by people that had large, centralized organizations that were much more efficient and productive,” he said.

by C.J. Prince

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Roundtable session at the New York Stock Exchange

With the economy rebounding at a snail’s pace and companies already operating as lean and mean as they can, CEOs have to get creative about achieving growth. Those hoping to increase share of market in the current environment need to find ways to exploit their company’s hidden potential and find that unique edge to propel them ahead of competitors. A company’s culture and values can be that secret weapon, enabling it to delight customers and inspire loyalty, and ultimately differentiate itself in a competitive field.

The trick is finding and then honing that unique culture and uniting the organization, with all its far-flung, siloed units, around a common set of values and principles. That magic act can only start with the company’s chief, said Tom Saporito, chairman and CEO of RHR International, speaking to participants gathered for a discussion on Competing Through Culture, held in partnership with global business services company, FedEx. “Culture is a byproduct of philosophy, it’s a byproduct of passion, and it really does start at the top. If you have someone at the top who is thoughtful and passionate and concerned about culture, that’s an essential ingredient.”

Cary Pappas, president and COO of FedEx TechConnect, the company’s customer service organization, pointed to his chairman and CEO as a prime example. “Fred Smith is an employee zealot; he’s a customer zealot. He leads in a manner that our customers and our employees come first and he operates with the highest level of integrity, which I believe makes a huge difference and it just resonates throughout the company,” he said.

RHR’s Tom Saporito, FedEx’s Cary Pappas, New World Van Lines’ David Marx

Ullman launched a training program to help managers construct an inspiring vision for their teams as part of the larger entity, and to develop their own communication and leadership skills so that their teams would follow and deliver. “Engendering trust is all about character of a leader, competence of a leader, all the various components of leadership. People work for people, not for companies, and no one wants to work for somebody they don’t respect,” he said.

Six years into Ullman’s tenure, employee survey numbers revealed people were starting to believe. In 2010, 93 percent of employees participated in the poll, compared with 60 percent the year Ullman started. “That means they know that whatever we learn in the survey, we’re going to do something about it.”

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Arise Virtual’s Angela Seldin, The Bradbury Co.’s David Cox, The Lee Company’s Bill Lee, Covanta’s Tony Orlando

No culture change can take root without buy-in from employees, who need to feel like they’re a part of something bigger, says Angela Selden, co-chairman of Arise Virtual Solutions, a virtual business services firm. That wasn’t easy for Arise, which employs 18,000 telecommuters. To keep people feeling part of a team, the company has invested heavily in social networking, using virtual town halls to bring people together. “People are still people, and they need that connection,” says Selden. Six years ago, Selden and her leadership team began to build a common culture and direction by establishing a set of four values—competence, confidence, consideration and innovation—transparently

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CEO2CEO summit > CEO roundtable sharing both the goals and the results of the company, and rewarding innovation with a monthly award. “If you can actually set the vision and then establish the corporate values, and you live them every day and your whole strategy is oriented around those, it can really mobilize and rally your team around where you want to take the company,” she said. “And if you can get them energized about where you’re taking the company, they’ll follow along.”

Ken Howard recalled facing the challenge of bringing employees along when his photography company, Splendid Portraits, embarked on the major transition from film to digital. In order to keep folks on track during a tumultuous time, Howard spelled out the company’s top five priorities for the next 90 days and then each employee had a copy of those goals along with three specific tasks he or she would complete in order to help meet them.

“I started to actually codify what my expectations were, because sometimes they literally don’t know what you’re expecting. You think they know, but they don’t,” he said.

Clear, simple language and compensation that’s aligned with goals can speed up culture adoption, noted Tony Orlando, president and CEO of Covanta Energy, which converts ordinary household trash into electricity at 50 facilities around the world.

“We know that safe and superior performance at our facilities translates into more efficiency,” he said. “If we can squeeze an extra one percent out of our facilities, that drives top line growth for us.” So the company laid out its goals for dramatic improvement in safety and environmental performance. “And then oh, by the way, half of your bonus is tied to safety and environmental [goals]. It’s not just about financial results,” he noted.

The company’s leadership must be ready to walk that talk, noted Ron Alvestetter, president of Service Express, who recalled a recent situation in which a top-performing sales rep was sabotaging the performance of another rep. The saboteur was fired. “The message that sends to the company is that culture is non-negotiable,” he said.

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FedEx’s Cary Pappas

Having a hard line on culture also can help acclimate newcomers to the organization, who may not have seen good behavior values at previous employers, said Pappas. “It’s like adopting a kid from a family that’s been abusive. You try to show them love and they’re not used to it and they resist at first,” he said. “You’ve got to sit down and have lots of conversation, understand where they’re coming from and what baggage they’re bringing. But if they’re the right person and they have the right beliefs underneath, you can bring that out.”

The Leadership Agenda What do CEOs need to know to succeed today?

by Jennifer Pellet Turmoil in the CEO world has been on the rise in recent years. In 2008, three Fortune 500 CEOs were replaced by members of their respective company boards. Each year since then has seen a threefold increase in that figure. Why are so many CEOs being shown the door? The market’s upheaval is a big piece of the equation—rattling boards and directors and coloring their expectations and perceptions around CEO performance. But while turbulence surely contributed to the bump in CEO oustings, the underlying cause is more likely a longer-standing issue, agreed participants gathered for a Chief Executive roundtable discussion on leadership held in partnership with Heidrick & Struggles.

“The No. 1 reason we get called for replacement of a CEO is a lack of strategic alignment with the board,” asserted John Wood, vice chairman of the executive search firm Heidrick & Struggles, who notes that the choice of a board member as a successor is only fitting in such cases. “If you’ve been sitting in a room with someone for the last few years, discussing the state of the business and where it’s evolving, you probably have a pretty good idea where their head is on strategy. When you reach out to one of your own and put him in the CEO seat you’re automatically getting someone who aligns with you strategically.”

But the idea of boards making a practice of replacing CEOs who don’t embrace their strategic directions with one of their own—as evidenced by recent successions at HP, The Gap and Denny’s—begs the question: Who is charged with forging a corporate strategy, the company’s board or its CEO? Are CEOs merely hired guns charged with executing to the collective vision of the board?

Joe Herring, CEO of the pharmaceutical development company Covance, expressed doubt about that concept. “Let’s say you’re brilliant leader with a lot of energy,” he said. “Would you rather the board paint its strategy and say, ‘This is the playbook.

Go do it’? Or would you rather be part of developing and then implementing the strategy? In my experience, the more I engage the team in developing the strategy, the more fired up they are about executing on it; and when things don’t go well they take ownership to fix it.”

Even a collegial environment might be something of a stretch for some CEOs, many of whom are accustomed to a higher degree of control over strategic direction “It’s the CEO’s job to do the vision and the execution,” noted Gayle Estabrooks, CEO of the Canadian optical store chain Greiche and Scaff. “You are immersed in the business, not your board. The board is not there all the time. They’re there for feedback, conversation and support.”

Complication Demands Collaboration Generally, however, board involvement is on the rise—and rightly so. “Today, every operating blueprint is so complicated; and without an execution strategy it doesn’t mean anything,” asserted Faisal Hoque, founder and CEO of the management solutions provider BTM Corporation. “So unless you have a collaborative way

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of coming up with a strategy and also the operational executions, the company will fail. You have to create a collaborative management structure and way to execute the operational plan.”

The issue of strategy-setting aside, the days of board members simply showing up quarterly to rubber stamp a CEO’s direction are long gone. At a minimum, both companies and CEOs expect counsel and input from their directors, noted Joe Herring, who overhauled Covance’s board when he took the CEO spot in 2005. “I had a troubled board,” he said. “I had one [director] who was sleeping, one who wanted my job and one who didn’t read the board book. So I said, ‘For this company to go forward we need a board that acts as a business partner—that will actively engage and ask hard questions—but in a respectful, constructive way.’ We changed out 75 percent of the board and the impact to our company was huge.”

At BTM, board members are expected to contribute directly to the company’s growth, said Hoque. “We want our board to be a working board,” he noted. “So we give assignments to our board members to make sure that they can actually help the company to get to the next level and to know who can help if something were to happen to the CEO.” At the same time, over-involvement of a board can lead to disaster.

Sandy Climan, president of media investment firm Entertainment Media Ventures, points to Panavision as an example of a board that brought in a new CEO who controlling investor Ron Perelman hailed as “a visionary,” only to undermine him at every turn. “That vision clashed with what the owners—it was an inside board—wanted and creditors ended up owning the company,” said Climan.

Achieving Alignment Communication around roles can stave off that sort of implosion, noted Bob Darbee, CEO of the venture capital company Omni Capital. “The relative roles of the CEO and the board have to be defined,” he said. “Nominally, the schoolbook rule is that the board members represent shareholders and are largely overseers, while management is [charged with] execution for the benefit of the shareholders. If the board gets involved with management, you can’t have mixed messages.”

In fact, ultimately, successful strategic leadership may depend more on CEO, board and management team alignment around strategy than exactly who sets strategy. “Whatever the system is, there needs to be alignment,” said Ken Makovsky, CEO of the public relations firm Makovsky & Company. “Whether the board sets strategy or the CEO decides it, there has to be consensus among that entire group in order for it to work.”

However, turbulent times can knock alignment off-track.

When CEOs and board members are under pressure to address a disruption and to do so swiftly, a disagreement about the best course of action can all too easily erupt into a crisis of leadership.

But CEOs can generally avoid that unhappy fate by changing their approach to conducting board meetings. The management guru and best-selling business author Ram Charan urges business leaders to focus on building board engagement by using meetings as an opportunity to educate board members on the competitive landscape in their respective industries. “Unless you have somebody who has industry knowledge—and even then that knowledge may be obsolete—your board does not really know the external side of the business,” he points out. “You need to educate them by succinctly presenting the external movement taking place—not what the competition has done, but what you see your competition likely to do. That’s how you’ll get partnership with your board.”

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1. Roundtable participants; 2. Yale School of Management’s Jeff Sonnenfeld, Huntington Bancshares’ Sumeet Kapoor, Excelsior College’s John Ebersole; 3. Hibbert Group’s Timothy Moonan, Entertainment Media Ventures’ Sandy Climan, Hay Group’s Michael Ippolito, Chief Executive Group’s Marshall Cooper, Omni Capital’s Bob Darbee, Heidrick & Struggles’ Anne Lim O’Brien; 4.

Service Express’s Ron Alvesteffer, Stuart Dean Co.’s Mark Parrish

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CEO2CEO summit

New Growth Drivers Hunkering down is the natural reaction to mitigate risk in recessionary times. Yet sidelining the pursuit of growth can be even more risky. “Companies really render themselves irrelevant when they don’t continue to improve,” panelist Lynn Tilton, CEO of Patriarch Partners, told CEOs gathered for Chief Executive’s CEO2CEO Leadership Summit.

“When you start cutting R&D—the lifeblood of future product innovations—you’re really damaging the business,” agreed Bob Nardelli, CEO of Cerberus Operations & Advisory Company. “From an integrity standpoint, you’re not doing what the shareholders and the board of directors have asked you to do.”

At the same time, spurring growth in a troubled economic environment is no easy feat. Chief Executive’s J.P. Donlon asked investment company panelists to recount how they overcame that challenge at one of their own portfolio companies. Here are brief recaps of the stories they shared.

>> L ynn Tilton CEO, Patriarch Partners The Company: Rand McNally, a $500 million Skokie, Ill.based publisher of maps, atlases and textbooks.

The Challenge: “In 2009, Rand McNally was a manufacturer of paper maps that had been left behind as paper maps became irrelevant. It let Garmin take the navigation device market, MapQuest take the directional market; and Google go into the digital/ satellite arena. People almost didn’t care if they had Rand McNally on their shelves anymore. So we faced this challenge of how do we get back into the game of innovation when everybody else has moved forward?”

The Philosophy: “In these situations, you need short-term, mid-term and long-term plans for innovation. You need ‘quick hits’ so people see that you’re back, that you’re innovating and there’s a reason to keep you where you are. Then you need that middle plan where you’re really starting the research and development, getting into new markets. And then [you need] that long-term plan of who you will be in the future that you’re pushing forward. You might change that as you run into obstacles and changes in the global environment, but you at least have to be moving in a trajectory between two points.”

The Solution: “The first thing we did was get into the electronic market. Rand McNally already did a lot of atlases and work for the trucking industry so we created a truck navigation device, Rand McNally’s TND, something that really wasn’t out there. We brought that to market, and it has been No. 1 in the market, and it was a very big hit. We also created an RV navigation device for people who travel

by RV. And we brought out a [new line] of Best of the Road paper maps, which Walmart featured at their checkout stands.”

The Outcome: “All of a sudden, all those people who didn’t care about having our paper maps and atlases anymore wanted them, because Rand McNally was relevant again. It wasn’t any huge innovation that changed the world, but it wasn’t going away. Because if you’re innovating, you’re not going away. That is the perception. And frankly, it’s the truth.”

The Future: Our long-term goal is to become a virtual-travel company, to take people who can no longer spend the money to go to Europe to shop the streets of Bellagio through sort of virtual travel. We brought the COO from our videogame company into this business as the CEO because we’re moving in the direction of virtual-reality travel.

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>> Fred Hassan Chairman, Bausch & Lomb Senior Partner, Warburg Pincus The Company: Bausch & Lomb. An innovator of contact lenses in 1971, the $2.5 billion Rochester, N.Y.-based company had grown stale and stagnant by the time Hassan came aboard in 2009.

The Philosophy: “Engagement with the customer is very, very important. One of the most important things is to measure the trust index by asking customers and employees, would you recommend this company or not? If you get those two numbers right, going in the right direction, that company is headed for stronger health.”

The Challenge: “The company was in the doldrums; it had gotten into some flat patterns and something had to be done to bring this older company back to a more vibrant culture.”

The Solution: “We worked on changing in several ways. First, customer engagement, getting customers to view Bausch & Lomb more as a partner. Second, innovation, because that improves customer engagement. Third, extending the business to overseas markets. Those were the three strategies, but the three priorities on the inside were a triangle of people, products and processes, with people at the base. Because if you can get the people part right, the products and the processes will fall into place. The best way to approach that strategy is on the two ends of the spectrum: the team at the top and the frontline managers. If you can get them to understand the approach in simple sentences, and internalize it and really focus on execution, it’s amazing how much power can be unleashed.”

The Outcome: “Our internal calculations indicate that our value has gone up 60 percent in less than two years. The top line is growing very nicely with all the businesses. Overall, it’s a case of a company that was too old and getting too stale that’s suddenly now become the new Bausch & Lomb.”

The Future: “We have been able to put very strong people on the ground in all the countries to serve as role models for the country operations. That’s creating a virtuous cycle, because as the company’s credibility increases, one can then attract better products from other partners and also better support from the key doctors who are very important in that business. And we’ve extended the business to overseas markets, which is now a big opportunity. In fact, Bausch & Lomb’s largest growth rates are overseas.”

>> Robert Nardelli CEO, Cerberus Operations & Advisory Company The Company: Talecris Biotherapeutics, a Research Triangle Park, N.C.-based company with $1.6 billion in revenues. Formed through a carve-out from Bayer, Talecris processes blood into plasma for specialized applications.

The Challenge: “One of the biggest issues we had was ensuring the quantity and quality of input material—blood.”

The Philosophy: “I tend to believe there’s an infinite capacity to improve upon everything that you do, so you enhance the core and then you extend the business and expand the markets.”

The Solution: “The company undertook reverse integration, taking control of the input material with the establishment of Talecris Plasma Resource, [a network of] 65 collection centers. We took control over the quality and the price of the input material.”

The Outcome: “It had a huge impact on our ability to control the quality and the volume of the product coming out and, ultimately, to meet demand. After we ran the business for a few years, we were able to sell it for 24 times the investment.”

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Growth Strategies recognize what is required and figure not what they know they like to do, but what needs to be done.”

Work from the Outside In In retrenching into the mainstream marketplace, Hoffman realized that Lord & Taylor would once again be going head to head with department stores like Macy’s. So he trolled the competition. “I realized that a traditional department store is overwhelming,” he said.

“It’s big, it’s loud and it’s tough to get service.”

With its more intimate feel and higher level of service, Lord & Taylor was well positioned to capture a customer whose needs were changing. “There were a lot of people in the world who either could no longer afford to shop Neiman Marcus or maybe should never have been there in the first place,” Hoffman recounted. “I thought this customer segment could find a soft landing at Lord & Taylor.”

Focusing on the external environment—consumer needs— enabled Hoffman to identify an opportunity, noted Charan. “The rearview mirror is a major problem in companies,” he noted.

“Instead of [looking back], start from the need and work backwards.”

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Author Ram Charan with Bon-Ton Stores CEO Brendan Hoffman, former CEO of Lord & Taylor

With steadily eroding sales, department store operator BonTon Stores last month named Brendan Hoffman CEO and president. Hoffman had served as CEO of Lord & Taylor since 2008, having taken the helm there when the company and its markets were in flux. “It had undergone a lot of management changes, and for the previous few years, sought to be more of a luxury player,” said Hoffman, recounting his experience at Chief Executive’s CEO2CEO Summit. “I was hired to accelerate that.”

But when the market went into freefall, Hoffman, who had been steeped in the luxury marketplace during a 10-year tenure at Neiman Marcus, had to rethink that strategy. “We recognized very quickly that we would have to reposition the brand—the luxury path wasn’t really working, and it certainly wasn’t going to work in this new world,” he said.

Back to the Basics Instead, Hoffman opted to return to Lord & Taylor’s foundation by bringing back mainstream department store brands it had jettisoned in its pursuit of the luxury market—brands like Jockey underwear, Liz Claiborne apparel and Nine West shoes.

It was the right call, noted fellow panelist Ram Charan, a business author and strategy consultant, who pointed out that Hoffman’s ability to recognize external changes that demand a shift in strategy is essential in achieving growth. “People like Brendan

Driving Differentiation For Hoffman, the shift in department store customers’ circumstances crystallized into a strategy for differentiation. “The answer became clear,” he said. “We were going to create an environment that was a little bit more upscale than where you traditionally find the same brands and offer a level of service that would cater to a customer that expected a little bit more. From there we really took off because nobody else was doing exactly that.”

Hoffman had found a way to stand out from the competition, pointed out Charan. “You need the acuity to see the point of differentiation that is sustainable—how you can connect to the ground floor of the customers.” The effort paid off. Lord & Taylor, which retail industry experts had predicted might disappear, began to show growth in late 2009, and has seen sales climb by an average of 10 percent a year over the last two years.

The lesson? Even in troubled times, perhaps especially in troubled times, opportunity exists. “You hear a lot about how the U.S. economy will only grow by 1.6 percent annually,” said Charan. “But aggregates are not a good indicator. There are segments that will grow and those segments are large.”

Charan urged CEOs to actively engage their teams to focus on finding those opportunities. “Stop commiserating that the U.S. is going to have no growth and Europe is going to hell and say, ‘Let’s find the growth,’” he said. “We have a $15 trillion economy and some of the segments are changing. Find out where the opportunity is and go after it.”

“Aggregates are not a good indicator.

There are segments [of the U.S. economy] that will grow and those segments are large.”

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Aligning People with Business Strategy Dick Finnegan

Lars Bjork

CEO, C-Suite Analytics Founder and President, The Retention Institute

CEO, Qlik Tech

“How important is retaining and engaging your teams?

On a one-to-ten scale most of you would probably say ten.

But while managers are held really accountable for [sales or revenue] metrics, they’re not held so accountable for retention and engagement. Yet 70 percent of how engaged your people are and whether or not they stay is about their boss— not about HR or employee programs. If you want to change your company to make retention and engagement metrics important, to drive them down to the first-line supervisor level, enforce them with reports that have names and tie outcomes to bonuses. Convert turnover percentages and engagement scores to the language we all know—dollars— so that now they’re really meaningful in your company.”

Emmet Keeffe CEO and Co-Founder, iRise

“The single biggest challenge for CEOs around alignment is how do you get business and technology people aligned and communicating and marching in this direction of automating business process and generating new things that will affect the top line? That’s huge because you have a fundamental communication problem between business and IT stakeholders; and as a CEO, if you’re going to really automate the business, drive it forward, make it more profitable, make the top line better, somehow you have to get the IT and business folks aligned.”

“What it all comes down to is you’ve got to motivate people. Why do they come to work? How can you assure yourself that they will come back to work the next day?

Payment is not the No. 1 driver for young people today.

It is feeling motivated, being engaged, making sure that they can contribute to the overall cause of the company, doing something that’s meaningful to them—which could well be financial success, but I don’t think that’s the sole driver.”

M. Christine Jacobs CEO, Theragenics

“If I’d say anything based on my experience [maintaining alignment though a massive strategic shift that involved reorganizing and downsizing], it would be don’t you dare delegate this. Don’t let the HR people say, ‘I can do it for you, Chris.’ No, they can’t. You have to sit with the folks. You have to not delegate away your messaging to your people, because they are going to need you at that moment. I followed Maslow’s hierarchy of needs, and I said, I’m going to change the company; this is how I’m going to change it; and here’s how it affects you. I spent the majority of my time on the employees, because I felt these folks were the most important to the long-term success in transforming the company into a diversified medical device company.”

Dick Flanagan, Emmet Keefe, Lars Bjork, Christine Jacobs

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CEO2CEO summit

1

2

3

4

5

6

7

8

1. Bausch & Lomb’s Fred Hassan, Covance’s Joe Herring; 2. Hassan, Patriarch Partners’ Lynn Tilton, Cerberus Capital’s Bob Nardelli; 3. Yale’s School of Management’s Jeff Sonnenfeld, Nardelli and Bumble Bee Foods’ Prasa Rangappa; 4. Tilton holds court with Stuart Dean Co.’s Mark Parrish, Enviro-Guard’s Roy Serpa, Receivable Exchange’s Justin Brownhill and Great Numbers’ Drew Morris; 5. Freudenberg-NOK Sealing Technologies’ Brad Norton; 6. Mate1.com’s Elizabeth Wasserman, Minyanville’s Todd Harrison and Arbor Energy’s Luke Williams; 7. Author strategy advisor Ram Charan and Entertainment Media Ventures’ Sandy Climan; 8. Participants brainstorming in the idea exchange roundtable session

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Five Execution Strategies That Work Panelists offered up strategies that work—and how to execute them effectively.

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Ingersoll Rand’s Larry Wash

2. Broaden Your Base “As a market leader in HVAC Systems, we were concerned about what would happen if the product commercialized or the market slowed,” recounted Larry Wash, who serves as president of Trane Global Services, a part of Ingersoll Rand’s Climate Solutions business. “So we looked at how to leverage our capability into doing something broader for our customers. In mature markets, we adopted a deliberate strategy of moving from equipment sales to system sales to solutions and then to services. We found that the journey of having a broader dialogue with your customers around systems and solutions inherently involves asking them about their broader business problems. As our understanding of those real problems accelerated, it allowed us to introduce many innovative service offerings so that now, when you fast-forward seven years, 40 percent of our revenue comes from services and solutions as opposed to equipment in mature markets.”

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Covance’s Joe Herring

1. Operational and Service Excellence “It’s the corniest, easiest to articulate strategy, but I think a very difficult strategy to actually execute against,” said Joe Herring, CEO of Covance, who explained that it’s been the execution model for the drug-testing and safety company for 10 years. “If you think about running a four-year clinical trial or drug safety testing for what could be a billion dollar drug for a sophisticated client, the data better be accurate and on time, and you better build a trust-based relationship. To put that strategy in a way that we could execute on it every day, we broke it down into people process and clients. And I can tell you, the effort we put into targeted selection, behavior-based interviewing, how we on-board, train, motivate, career path and terminate employees is fundamental to our strategy, absolutely fundamental. And since 1997, we’ve grown from about roughly $300 million in revenue to about $2.2 billion in revenue and from about 2,500 employees to 11,600 employees in 60 countries.”

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General Atlantic Partners’ Frank Brown

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CEO2CEO summit 3. Blue Ocean Strategy “‘Blue Ocean strategy’ is simply changing the rules of the game, eliminating competition through a completely different construct of the way a business or market is attacked,” explained Frank Brown, a former dean of the leading business school INSEAD, who pointed to Cirque du Soleil as an example. “They did away with the competition of traditional circuses like Ringling Brothers by eliminating animals and turning it into performance art, a phenomenal success.”

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Wolters Kluwer Health Medical Research’s Karen Abramson

5. Leverage Your Core Assets

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Mike Ullman, former executive chairman of JCPenney

4. Deliver on Customer Experience “To dramatically transform JCPenney, we had to build a differentiated experience that people would remember,” noted Mike Ullman, former executive chairman of the $17.8 billion retail chain. “We looked at the best of the best—companies like Wegmans, Southwest Airlines, Starbucks and The Container Store—that deliver the best customer experience in their respective industries. Then we identified our best 25 store managers and our best 25 sales people and looked at the characteristics that make them stand out. We found out there were some pretty simple principles. So we did several things at the same time.

We used a modeling program that actually maps when the customers are in the store by hour and the hours of customer service against that. Using that model we picked up a 16 percent savings in salaries by actually putting people there when the customer is there—a novel concept.

Then we essentially taught people that it was their responsibility to be themselves with a program called GREAT—Greet, Respect, Engage, Assist and Thank—and most of all, be yourself. We also adopted Southwest Airlines’ employee empowerment policy, which is that you only have to ask for permission to say no to a customer. Our customer service scores have soared. They’ve gone from 47 percent to around 66 percent. That’s key because in retail, highly satisfied customers come to your store 20 percent more often and spend 16 percent more.”

“Our job for 200 years has been to print articles about medical research, bind them in a magazine, and send it out once a month on behalf of societies like the American Heart Association,” explained Karen Abramson of Lippincott Williams & Wilkins, the division of Wolters Kluwer she runs. “I came on board during a time of contraction in the pharmaceutical market and falling print subscriptions, when the entire industry is under enormous pressure. But at the same time 92 percent of physicians said their medical journal is the No. 1 resource they go to when treating a patient, so the content—the information— was very, very valuable.

“Right around that time the iPad came into the market and we realized we had a disruptive technology that was going to be a real solution for us. This year we turned eight of our largest medical journals into iPad applications. By doing this, we’ve been able to deliver a much more interactive experience for our physicians.

There’s video. There are interactive conversations. You can have social media discussions with other physicians. If something changes, we can send out an alert.

“These were all wonderful things, but when we were scenario planning we had to question our revenue model, because our biggest revenue model was print advertising. Once we delivered this wonderful electronic system that everybody loved and wanted to convert to, what happens to the print revenue model? We decided that we would need to take the risk of telling our advertisers, ‘You’re buying an audience, you’re not buying circulation.

So effective now, if we have an iPad ad out, we will not break the price between the digital pricing and the print pricing, we will make you buy that audience.’

I’m happy to report that in January, which was our first bundled sale for advertising, we have not had a single advertiser refuse to pay for this new bundle, which in some cases comes at a 30 percent to 50 percent premium.”

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fedex.com

chief executive special report: mergers & acquisitions

Making the Most of M&A Deals There’s no denying the allure of growth through acquisition. At the same time, the M&A road is riddled with potholes, treacherous curves, detours and dead ends—and once deals do come together it can be hard to assess whether the value created justified the chaos they entailed.

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In this special report we offer tips from successful dealmakers on smoothing the acquisition and integration processes. We also present two methods of quantifying the outcome of a deal, demonstrate the application of those metrics to six recent transactions and identify the takeaway for would-be acquirers. And finally, for those on the selling side of the equation, we explore the preparatory steps necessary to garner an optimum price.

Secrets of the Great Deal Makers Top dealmarkers identify four imperatives for M&A sucess.

by Russ Banham

What is it that separates winners from losers in M&A transactions? To get a grip on the answer, Chief Executive turned to some of the world’s top dealmakers.

By and large, they all agreed the more deals you do, the better you become at it. A few clunkers along the way and a humble assessment of why they failed also sharpen one’s acumen to avoid similar pitfalls in future. Not to mention the acute need for

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mergers & acquisitions both parties to leave the negotiating table feeling good about the transaction; otherwise one of the companies will feel like the victor’s spoils.

To divine other secrets of the great dealmakers, we sought the imparted wisdom of two former CEOs of the Year and two others leading formerly small to midsize organizations that are fastgrowing, thanks to their leaders’ M&A acumen. To follow are a few highlights from the insights they offered. For more wisdom from the M&A mavens, visit ChiefExecutive.net/M&AReport.

Secret #1: Know Thy Target It should go without saying that knowing the target company inside out is the most vital consideration before phoning the other CEO, yet many dealmakers merely kick the tires and hope. “It’s the most strategic question one must ask—‘Is this the right company for us to buy?’” says A.G. Lafley, former CEO and chairman of Procter & Gamble, who ran herd on 10 to 20 acquisitions and divestitures per year over his nineyear tenure at the top of P&G. During that period, the multinational manufacturer more than doubled its sales, as its portfolio of billion-dollar brands expanded from 10 to 22. Driving the deals was a strategic imperative to expand in the beauty, health and personal care market and exit the food and beverage, and commodity segments of household cleaning products.

Lafley says during his time at the company (he retired in 2010), P&G maintained a list of strategic acquisition targets. One of those targets was Richardson-Vicks, on the defense from a hostile bid by Unilever.

“We were always interested in acquiring the Vicks brand, which fit our strategy,” he notes. “The company also was in the overthe-counter consumer health care market, which was important to us. Yet, it was the other prizes that we didn’t at first appreciate that put it over the top.”

He’s referring to Pantene and Oil of Olay, two little-known beauty brands in the U.S. at the time. P&G turned Pantene into the No. 1 haircare product in the world, taking it from under $50 million in sales at deal closing to approximately $3 billion today.

“ Dealmaking is akin to dating and falling in love. If you don’t think the behavior of the other party is something you can live with from a cultural point of view, you have to grit your teeth and simply say ‘No. We’re done.’”

—Sandy Weill, former CEO of Citibank

Oil of Olay fared equally well, rising from less than $100 million in annual sales to more than $2 billion, at present. “The secret was knowing what we wanted strategically, which in this case was to be in the consumer health and beauty care market and having an over-the-counter business,” Lafley says. “We were the ‘white knight,’ but it wasn’t like we hadn’t been thinking about Richardson-Vicks many years before.”

Secret #2: Have a “Walk-Away” Price From the Get-Go Knowing when to get out of the game is a critical consideration, says Sandy Weill, former CEO of Citibank. “I’ve been in situations where we’ve got an agreement, and as time goes by the other side sees you getting anxious and raises the price,” he says.

“You have to be disciplined at that point, and it isn’t easy. Dealmaking is akin to dating and falling in love. If you don’t think the behavior of the other party is something you can live with from a cultural point of view, you have to grit your teeth and simply say ‘No. We’re done.’”

To draw this line in the sand, Jerre Stead, CEO and chairman of IHS Inc., a global provider of market intelligence that Stead has beefed up via more than 25 acquisitions in five years, offers this advice—“Have a walk-away price from the start.” Following this counsel prevents “a potential acquisition from becoming an emotional decision,” he explains. “Set a fair and full value upfront that you know you can stand behind, and stick to it. If it’s not acceptable to all parties, be comfortable walking away from the deal.”

Secret #3: Summing Up the Other Side On paper the numbers may add up, but how do savvy dealmakers evaluate the target’s products and services, processes, intellectual property, technology, and most importantly its leadership and senior executives?

“You’re essentially agreeing to go into business together, yet you still have to ascertain the substance of the other leader—‘Is this person someone I trust, respect, and has attributes that are consistent with my own?’” says Dave Eslick, chairman and CEO of Marsh and McLennan Agency LLC. I always ask myself, would I feel comfortable inviting this person to my house?”

Eslick has had lots of houseguests in his 30 years in the insurance business. He’s presided over more than 100 acquisitions, 50 creating what is now USI Holdings, the country’s ninth largest insurance brokerage, where he served as president and CEO. His track record enticed giant broker Marsh, Marsh and McLennan Agency’s parent company, to hire him to launch and run its start-up brokerage serving the middle market. Since coming on board three years ago, Eslick has snapped up 17 small to midsize agencies worth some $300 million in annual revenue today.

Prior to signing off on these deals, Eslick toured their facilities. “I look to see how management interacts with the leader because this is likely how they would interact with me,” he explains. “I’m also trying to assess which talent drove business in past. Organic revenue growth is a great barometer of what to expect post-acquisition.”

Secret #4: Deciding Who Gets the Job It’s during the pre-closing planning for post-merger integration that the decision is made who will stay and who will go. “You don’t want to take a long time figuring out which person is better for a particular job,” says Sandy Weill. “Quicker decisions after

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“It’s the most strategic question one must ask—‘Is this the right company for us to buy?’” says A.G. Lafley, former CEO and chairman of Procter & Gamble

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the deal closes are much better than taking a long time, and making a few mistakes is better than appearing to be indecisive.”

A.G. Lafley addresses the difficult situation through a series of peer assessments. “I interviewed Gillette’s top 15 people, as did our head of HR, to determine if they fit our culture and management philosophy,” he says. “Half of them did. I did the same thing with Richardson-Vicks, and only about two executives made the cut.”

How did he make such a Solomon-like decision? “P&G is a company of principles, values and process—you either buy into them or you don’t,” he says. “Respect is a two-way street.”

M&A: Adding Up the Numbers New methodologies offer ways to quantify merger success.

by Russ Banham How does one define M&A success? Chief Executive reached out to two respected corporate performance consultancies—EVA Dimensions and Applied Finance Group—and put the question to them. Each came up with what they consider to be the truest test of a flourishing or regretful M&A transaction. The firms applied their metrics to six M&A deals, analyzed in full on the following pages.

Measurement Methodology

Before we get to the results, let’s look at each firm’s quantitative methodology: As the table on page 46 illustrates, Applied Finance Group (AFG) scrutinized each of the six deals through the lens of Total Shareholder Return (TSR), which combines share price appreciation and paid dividends to reveal the total return to the shareholder. While the absolute size of TSR varies because of stock market movements, the relative position reflects the market perception of overall performance as compared to a reference group, such as an industry or market.

This evaluation methodology considers the TSR over a fiveyear period because most companies tend to develop five-year strategic plans, and presumably this is a long enough period for the synergies and integration benefits to shine. It further includes EM or economic margin, a company’s spread or return above its cost of capital. As a way to help readers understand the

expectations of an acquisition, AFG developed two EM add-ons— Invested Capital and Productive Capital. The difference between them is that EM-Invested Capital considers the cost of intangible assets, whereas EM-Productive Capital does not.

Why is this important? “When the EM Differential between the two ratios is high, it indicates that the company paid an excessive amount for future growth and cash flows that have not yet materialized,” explained Michael Burdi, AFG portfolio consultant. By contrast, an EM Differential that is low indicates the company got a good deal at the time, not that this alone promises success. That’s why we’ve provided the expectations reflecting the EM Differential (high or low) along with the execution (good or bad).

EVA Dimensions, on the other hand, measured the acquirer’s stock price return from two weeks before the deal announcement to two weeks after, and then compared this to the S&P 500 return over the same period. It also calculated how much the acquirer’s shareholders as a group were ahead, or behind, compared to investing in the S&P 500 (labeled as “MVA Impact Test” in the table on page 47). MVA, for market value added, is the difference between the capital invested in a company and its market value, or to put it more bluntly, the measure of how much wealth a company has created or destroyed. “The initial MVA reaction tells us whether investors think the buyer is getting more value or less than what it’s paying,” says Bennett Stewart, CEO of EVA Dimensions.

Another method of establishing success or failure is following profit performance in the wake of a deal. To do that, EVA Dimensions computed how much EVA (economic value added) profit the buyer had earned when the deal was announced, versus five years later. EVA is a measurement of profit minus the cost of invested capital, including both equity and debt. As Stewart sees it, “It asks, ‘Did management earn a decent return

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mergers & acquisitions on the total capital it paid, or did it pay too much for the benefits that were achieved?’”

To delineate this, EVA Dimensions computed “EVA Momentum,” a measurement of the five-year change in each buyer’s EVA, divided by its sales in the period leading up to the deal. It then subtracted the EVA Momentum generated by the S&P 500 over the same five-year interval. What’s left is the “Alpha,” an indication if the buyer generated more or less EVA profit growth than other large companies.

Still with us? The purpose of the metrics is to lend financial credence to calling a deal a success or a failure. As for the tales told within, we turned to a group of M&A specialists. Their comments are useful to companies of all sizes plotting an acquisition strategy.

Procter & Gamble/Gillette While the metrics indicate P&G set high expectations in acquiring Gillette—represented by the high price it was willing to pay—the deal ultimately paid off for shareholders.

“It’s a story of pretty good timing and synergy,” says Burdi.

“Even though they didn’t steal the company, they had complementary products that eventually created revenue and cost synergies.”

Sharing this view is Robert Bruner, dean of the Darden Graduate School of Business at the University of Virginia, where he teaches business administration. “P&G could bundle Gillette’s products with its own products, resulting in

significant distribution savings,” says Bruner, author of the M&A book Deals from Hell. “Since they each distributed to drugstores, supermarkets and the like, they would now only need one distributor, providing economies of scale and possibly even a volume-based discount.”

Another academic and author, Mitchell Marks, professor of business at San Francisco State University and author of Joining Forces—Making One Plus One Equal Three in Mergers and Acquisitions, chalked up the transaction’s success to P&G’s vaunted strategic deal capabilities. “Like Cisco and Google, they’ve built an internal competency in M&A management,” Marks explains.

“They don’t pick up the phone and call McKinsey when they want to make a deal; they’ve got their own SWAT team inhouse. At most companies, they turn to someone who has a fulltime job in finance or legal and toss M&A integration at them.

The problem is there are only so many hours in a day.”

Stewart has a different take: “It’s a story of great management overcoming an overpriced acquisition. Still, this was an awfully expensive way to get there.”

Key Takeaway: Paying a high price won’t kill a deal, unless there is no strategy for integration.

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Bob Bruner

The Total Return Test

Conoco-Phillips netted the best outcome in an outcome measurement based on total shareholder return and economic margin.

P&G/Gillette

HP/Compaq

Conoco/Phillips

AOL/Time Warner

Sprint/Nextel

Boston Scientific/ Guidant to Lane via Insite

Year

2005

2002

2002

2001

2005

2006

EM -Productive Capital

20.9

4.8

5.1

13.1

6.4

13

EM - Invested Capital

6.5

-2.1

3.4

-54.6

-2.5

-26.2

EM Differential

14.3

6.9

1.7

67.7

9

39.6

5-Year Net TSR

19%

83%

135%

-61%

-84%

-81%

High Expectations/ Good Execution

Low Expectations/ Good Execution

Low Expectations/ Good Execution

High Expectations/ Bad Execution

High Expectations/ Bad Execution

High Expectations/ Bad Execution

Summary

A high EM differential indicates a company paid an excessive amount for future growth and cash flows that have not materialized.

EM = Economic Margin, or return above cost of capital; TSR = Total Shareholder Return Source: Applied Finance Group

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The MVA Impact Test

The metrics below bring in various factors such as market value added (MVA) and economic value added (EVA) to establish a method of comparing an acquirer’s shareholder value versus the S&P 500 over a particular duration.

For instance, the Conoco/Phillips merger generated 25.6% more economic value than the S&P 500 over five years, while the AOL/Time Warner merger lost a comparative 101.28% in value. Procter & Gamble’s acquisition of Gillette exceeded the S&P 500, but the other deals—Sprint/Nextel, Boston Scientific/Guidant and Hewlett-Packard/ Compaq—all lost economic value.

HP/

Conoco/

AOL/Time

Sprint/

Compact

Philips

Warner

Nextel

Boston Scientific/ Guidant

Acquisition

Merger

Merger

Merger

Merger

Acquisition

1/28/2005

9/3/2001

10/19/2001

1/10/2000

12/16/2004

1/12/2006

Stock Price 2 Weeks Before

$46.76

$21.80

$20.17

$152.38

$20.77

$24.74

Stock Price 2 Weeks After

$43.83

$14.18

$20.09

$120.06

$22.08

$23.15

S&500 Price 2 Weeks Earlier

$1,184.52

$1,171.41

$1,071.38

$1,328.92

$1,190.33

$1,254.42

S&500 Price 2 Weeks After

$1,205.30

$1,038.77

$1,087.20

$1,364.30

$1,213.55

$1,273.83

Stock Performance

-6.27%

-34.95%

-0.40%

-21.21%

6.31%

-6.43%

S&P 500 Performance

1.75%

-11.32%

1.48%

2.66%

1.95%

1.55%

-8.02%

-23.63%

-1.87%

-23.87%

4.36%

-7.97%

-$9.54 Billion

-$9.99 Billion

-$0.29 Billion

-$26.7 Billion

$1.33 Billion

-$1.62 Billion

10/1/05

3/3/02

8/30/02

1/11/01

8/12/05

4/12/06

$55,445

$45,226

$30,449

$6,886

$25,024

$6,288

TFQ EVA 3 in Quarter Deal was Closed

$4,013

$1,121

$(435)

$(62)

$(892)

$769

TFQ EVA 5 Years Later

$3,973

$2,704

$9,628

$ (6,799)

$(6,595)

$(1,434)

Buyer’s 5 Yr EVA Momentum 4

-0.07%

3.50%

33.05%

-97.84%

-22.79%

-35.04%

P&G/Gillette

Date Announced

Alpha 1 $ MVA 2 Impact Date Closed TFQ Sales in Quarter Deal was Closed

EVA Momentum for S&P 500: Aggregate Results for S&P 500 Companies, as of deal-close dates TFQ Sales in Quarter Deal was Closed

$5,672,875

$4,273,644

$4,136,326

$3,438,032

$5,840,504

$6,381,602

TFQ EVA in Quarter Deal was Closed

$148,267

$9,478

$(31,455)

$99,411

$164,477

$221,829

TFQ EVA 5 Years Later

$132,358

$261,856

$276,137

$217,539

$175,100

$264,064

S&P 500 5-Year EVA Momentum

-0.28%

5.91%

7.44%

3.44%

0.18%

$0.66%

Excess EVA Momentum 5

0.21%

-2.40%

25.61%

-101.28%

-22.97%

-35.71%

1. Alpha = an indicator of whether a buyer generated more or less EVA profit growth relative to its peer companies; 2. MVA = Market Value Added, the difference between capital invested and current market value; 3. EVA = Economic Value Added; 4. EVA Momentum = delta EVA/base period sales; 5. EVA Momentum = Company’s EVA momentum minus the S&P 500 company momentum Source: EVA Dimensions

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mergers & acquisitions

Time Warner/AOL Ask most anyone for the worst M&A deal in history and invariably they will respond “AOL/Time Warner.” The metrics indicate high hopes for the transaction to rain dollars on shareholders. Instead, it just rained.

What went wrong? “AOL at the time of the announcement had a stupendous market value of about $123 billion and had invested capital of just around $8 billion, so it was trading for an MVA premium of $115 billion, which is incredible,” says Stewart.

Why? “Because MVA has to come from the present value of the EVA profit a company can earn in the future,” he explains. “As a result, AOL would have had to increase its EVA profit, at the time running at $66 million, by over $1 billion each and every year, for the next 20 years, to justify that kind of MVA. A little math and economic logic would have shown the utter folly in taking AOL stock as currency for the sale of Time Warner.”

Burdi concurs: “Time Warner shareholders paid an astronomically high price for AOL, setting them up for failure from the beginning. Plus, they bought an unproven business with unproven cash flows—a veritable recipe for disaster.”

Key Takeaway: Theories are not a replacement for strategy, timing and stiff price negotiations.

Hewlett Packard/Compaq By contrast, HP’s acquisition of Compaq came at a good price and performed admirably over the five-year span, even though HP’s board initially expressed reluctance. “Hewlett’s son, who sat on the board, was dubious, at best, and a big battle ensued,” says Marks. “But, in the long run, they had very good execution, a consequence of HP’s sharp transition teams. Both companies also agreed to build one new company with one new culture, as opposed of pockets of this and that, and it worked.”

Bruner agrees. “Carly Fiorina (HP’s CEO at the time) touted the cost savings and revenue growth synergies, even though the board at first demurred, and she made good on them within three years,” he says. “Over the five-year horizon, Compaq strengthened HP’s franchise with a strong offering in the server market, not to mention the consulting services that HP was moving into.”

“It was the longest running soap opera in business when it was announced,” Stewart says, “but the good news is that both companies happen to be in a great business and they were able to ride the next wave up, even though the initial stock price reaction was horrible. HP surprised people by how well they were able to integrate Compaq and make it a pretty successful PC business, at least for a while. They saw the PC becoming a commodity and captured a strong niche at the lower end.”

Key Takeaway: A well-executed post-merger integration of two companies will overcome critics’ initial skepticism.

Sprint/Nextel There are good integrations and then there are truly terrible ones—the case with Sprint’s acquisition of Nextel. Making matters worse was that the telecom paid too much and, as Stewart comments, “still didn’t build the scale it would need to battle the giants—AT&T and Verizon.”

Faisal Hoque, founder and CEO of management solutions provider BTM Corporation, is equally critical. “It exemplifies poor integration from a product, cultural, infrastructure and organizational standpoint,” he charges. “The end result was a nosedive for shareholders. The deal was a disaster—the company wrote down nearly $30 billion of the $36 billion it paid for Nextel, wiping out 80 percent of Nextel’s value at the time of the acquisition.”

The integration was made especially difficult by the companies’ technological incompatibilities. “Nextel’s ‘push-totalk’ network, which runs on a unique technology called iDEN, was unsuited to Sprint’s, and this limited its selection for smartphones,” explains Hoque, author of The Power of Convergence.

Marks agrees. “They had serious network incompatibilities, which should have been considered in the due diligence,” he says. “But, they overlooked it, probably because of the ego of the CEO and senior team. They got so caught up in closing the deal because walking away would’ve been viewed as a failure by shareholders and the business press. Of course, losing billions of dollars in shareholder value is a much larger failure.”

Key Takeaway: One apple plus one apple equals two apples; one apple plus one orange makes one apple plus one orange. Make sure the pieces fit.

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Faisal Hoque

Conoco/Phillips Timing is everything. Just ask Conoco and Phillips Petroleum, two integrated oil and gas companies that merged as oil prices began rising. Not only did the deal carry a fair price, the partners pulled off a quick and commendable execution.

“Most of what is called M&A today is a behemoth scooping up a much smaller rival, but this was a real merger of equals or as close to that as possible,” says Hoque. “Phillips shareholders would own 56.6 percent of ConocoPhillips, with Conoco shareholders coming away with 43.4 percent. That’s still pretty close to equal.”

Burdi agrees. “As the EM differential (1.7) indicates,

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mergers & acquisitions Conoco didn’t pay a premium when the companies merged—it was a true merger of equals,” he says. “The deal was very carefully set up so all the synergies were identified and in place once the ink was dry.”

Marks, who worked on the integration in a consulting capacity, confirms that “both companies’ leaders and managers were prepared for the rigors of the M&A process,” he says. “It took about six months for the deal to get approved, but nobody sat around navel-gazing. They conducted a series of workshops for managers to understand what would be needed once they gained approval. Legally, they can’t open the kimono too much to the other side, but they could do things like address the types of data they would need to collect for the integration. These were real team-building sessions that established a high level of collaboration.”

After the merger got the nod from the government, oil prices began their stratospheric rise. As Stewart puts it, “Both companies were the lucky recipient of an appreciating asset, but there was still real value to be had through cost synergies and consolidation.”

Key Takeaway: Get the integration process ready to go the day the deal closes.

Z

Mitch Marks

Boston Scientific/Guidant Our last example also comprises high expectations (high price) with a bad execution. “The EM differential was very high, not surprising as Boston Scientific was in a bidding war with Johnson & Johnson and topped its bid, paying a whopping $27 billion,” says Burdi.

In retrospect, it should have sat on the sidelines. “J&J had uncovered some issues with Guidant’s main products (defibrillators and pacemakers) and lowered its bid,” says Marks. “This didn’t stop Boston Scientific, which paid 80 times Guidant’s earnings to buy it.”

“Then bad things happened,” Burdi notes. Boston Scientific had to fork over $296 million to the federal government after Guidant pleaded guilty to criminal charges for selling defective defibrillators, followed by another $22 million to settle charges that Guidant’s sales reps gave kickbacks to doctors who bought the defibrillators, and another $234 million to settle more than 8,000 claims by patients using the device.

What else? How about more than $2 billion to settle patent infringement lawsuits brought by J&J. “Obviously, Boston Scientific had to adjust its profits downward and write-off the deal (an eye-opening $4.4 billion),” says Bruner.

“The buyer hadn’t done the careful due diligence so necessary in M&A.” Boston Scientific “was guided by price, not strategy,” says Marks. “It jumped at the chance to buy Guidant, rather than do the slower and safer work of studying its options, setting a strategy and finding a target that fits it.”

He adds, “Doing a deal to get back at a competitor (J&J) just isn’t a smart move.”

Key Takeaway: Bagging a target may bring some early accolades, but your legacy will be determined by the eventual results.

M&A Takeaways for Midsize Companies Just because a company is smaller than an M&A-eating behemoth the size of Procter & Gamble doesn’t mean it can’t pick up a few morsels of wisdom from its experience.

That’s the word from Mitchell L. Marks, professor of business at San Francisco State University, and an M&A consultant on the side.

The same lessons apply, whether the deal steals headlines or not. “Many CEOs of midsize and smaller businesses deny or think they are immune to the perils of M&A difficulties,” says Marks, author of Joining Forces—Making One Plus One Equal Three in Mergers and Acquisitions. “They’re not, and in some cases there’s more to be concerned about.”

He explains that small and midsize company “lack the luxury of a large corporation’s corporate staff and the ‘bench strength’ of upand-coming, high-potential junior executives to manage the merger while keeping the business running.” In such cases, “the acquiring entity can be overwhelmed by the rigors and requirements of M&A integration,” Marks says. “Don’t delude yourself that doing the deal is the hardest part of a transaction. It isn’t. As one of my CEO clients said, buying a company is fun; integrating it is hell.”

What’s the secret then in adding up two companies’ strengths and synergies and not ending up with a negative number? “A CEO of a midsize company needs to understand first the synergies and cost savings represented by the deal, and then not overpay for this value,” says Michael Burdi, portfolio consultant at corporate performance advisory firm Applied Finance Group.

“If you pay a great price and have great synergies, you will likely succeed at adding value. If you pay a fair price and have great synergies you will likely get an average return. Valuation is the closest thing to the law of gravity that we have in finance. It is the primary determinant of longterm returns.”

Practice makes perfect, Marks chimes in.

“The best and smartest players in the M&A game have done multiple deals—they learn from their mistakes, and know what they can do on their own and what they need from external consultants,” he says. “The CEOs of large companies with great M&A track records also leave their egos at the door, knowing they can’t possibly bat 1,000 in this game, given the challenges of integration. That doesn’t stop them from trying, however.”

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mergers & acquisitions

Preparing Your Company for Sale As a managing director at FMV Capital Markets, an Irvine, California-based investment bank, Allan Siposs has advised dozens of companies on how best to prep for sale. He calls his process a pre-transaction “Due Diligence Dress Rehearsal.”

Here are a few of his thoughts on what to do well before opening night: • Confirm that formation documents, meeting minutes, summary of rights of each class of stock and stock ledger are all up to date and in good order, and address any potential shareholder issues or pending litigation that might derail the company’s sale.

• Prepare audited financial statements for at least three historic years, as well as detailed revenue and margin analyses by customer, product, region, etc., and a summary of all outstanding credit facilities.

• Prepare a complete set of financial projections.

• Create a detailed organization chart and job descriptions for each position, listing key managers and their specific responsibilities.

• Provide a list of sales by customer and annual revenue trends for the top twenty customers.

• Address all existing or potential regulatory issues, and all potential past and current tax issues.

• List all owned facilities and real estate, and summarize the operations, capacity and equipment related to each facility.

• Summarize all current and past company trade secrets and intellectual property, including ownership and expiration date of relevant patents.

CEO ONLINE EXCLUSIVE Visit www.ChiefExecutive. net/PreparingtoSell for a one-year plan for preparing your company for sale

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Technology

Analyze This

Small- and mid-size companies are getting help from big data.

William J. Holstein

ISTOCKPHOTO

by

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“ One of the errors that a C-level person can quickly make is not giving enough executive support or attention to the process.”

Key Takeaways istockphoto

Companies considering adopting advanced business analytics should: • Determine precisely what analytical tools the company needs

Doug Twiddy isn’t the sort of fellow you would expect to find using advanced business analytics. Based in the Outer Banks of North Carolina, in a small town named Corolla, Twiddy, 66, runs Twiddy & Co., an eponymous real estate company that rents out beach homes to vacationers. It’s a good business, with annual sales of more than $50 million, but it’s hardly high-tech.

It turns out, however, that the family-owned company must handle an astounding amount of data. It manages 906 properties owned by other people and must stay on top of the comings and goings of renters each weekend during the season. It schedules cleaning and repair services involving some 1,100 plumbing, heating, carpeting, pool and spa, and extermination vendors. It tracks how much of the rent it collects goes to the owners of the homes versus how much it keeps. Traditionally, the company has handled all of this information manually, using spreadsheets among other tools.

But after Twiddy’s son Clark, now 36, came home from serving as an intelligence officer in the U.S. Navy, Twiddy & Co. started working with SAS, the software company based in Cary, North Carolina, to capture all the data electronically. It took time and effort to implement a SAS system, but along the way the company reduced errors by 15 percent and also cut labor costs. More than just collecting data, it also can predict how much rent can be charged at a particular time of year—it can differentiate between a six-bedroom home on the ocean versus a

• Weigh the advantages of buying versus building • Assess your ability to commit the necessary time and resources

four-bedroom home located four blocks inland—and evaluate which vendors are the most cost-effective and reliable. “I’m tickled to death with the system,” says Twiddy Sr. It turns out that small- and medium-sized brick and mortar companies can use analytical tools just as the largest corporations can—or the hottest Web-based social media startups or the biggest intelligence agencies with three-letter names. They can use those tools to eke out real competitive advantages against rivals that haven’t embraced the new capabilities. Even the most advanced tools, such as those IBM developed to such powerful effect with its Watson competitor on the Jeopardy game show, are within reach of companies with $10 million, $50 million or $100 million in annual sales. It’s happening across the landscape in all industries, says Andy Monshaw, general manager of IBM’s Midmarket Business, based in Somers, New York. “The only thing that is a barrier to adoption right now is the knowledge of the mid-market customers themselves,” Monshaw says. “They don’t

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Technology yet all know that they can leverage this.”

In fact, the business of selling business analytical systems to small and medium-sized enterprises (SMEs) is one of the hottest segments in the information technology (IT) industry. IBM has purchased 25 companies in the area, including Cognos, which specializes in business intelligence systems. Hewlett-Packard’s $11 billion purchase of Autonomy was intended to help it secure a position in the business of analyzing “unstructured data,” one of the hottest niches in the data business. SAS, which argues that it is a leader in the SME market, said in December that its sales of business analytics to those companies were up 42 percent over the prior year. All of the giants—including Google, Microsoft and Oracle—are in the game, as are many smaller, specialized outfits.

As the field has rapidly evolved thanks to increasingly sophisticated algorithms and raw computing power, the vocabulary appears to have shifted. The phrase “business analytics” now encompasses many sub-disciplines—databases, data mining and historical pattern recognition, dashboards, online collaboration and predictive tools. Increasingly, customer relationship management (CRM) overlaps with business analytics because tracking what customers buy and whether they liked what they bought is essential in understanding the customer. More and more companies are combining the management functions that oversee customer relations and IT systems because the two have become so intertwined.

There seem to be at least four stages in adopting an analytical system: STAGE 1: What Will We Analyze?

STAGE 2: Do We Buy or Build?

One of the debates in the field is whether small- and mid-size enterprise CEOs should try to develop their own business analytics in cooperation with vendors or simply rely on the outsiders to install systems that essentially “plug in” to what they already have. The big vendors argue that they have already built hundreds of industry-specific models and can tweak those systems for a particular SME. They can even deliver the services via the cloud, meaning the customer pays for use as he or she downloads or utilizes software and other services. That raises a corollary issue: do you want to take a big plunge on a major expense or do you want to proceed with a step-by-step implementation with a long-term partner?

istockphoto

It’s important to go through a considered thought process before any decisions are made about what type of systems to purchase or develop, says Paul Magnone, co-author of Drinking From the Fire Hose and a 21-year veteran of IBM. There are specialist companies and there are integrators who bring various specializations together under one roof, “but the step before that is to get a grasp of your business and ask the right questions,” says Magnone. “It’s all about the framework you take going into it and about the culture within the company and within your

own self. The tooling comes later.” Those questions include: What is most important to the business? What matters most to your customers?

Most companies embarking on their first push into business analytics have been gathering data on multiple systems that don’t communicate with each other. “Before embarking on data mining or analytics, one of the biggest things the company has to tackle is the variety of data sources,” says Tapan Patel, global product marketing manager for predictive analytics and data mining at SAS. “How can I integrate those data sources?”

The planning stage may require real introspection. Ken LaVan, co-founder of Fort Lauderdale, Florida law firm LaVan & Neidenberg, which represents disabled veterans in dealing with the Veterans Administration and Social Security disability programs, started out by examining every step of its processes. “We documented everything we did in the office,” says LaVan, who had prior experience as a computer consultant. “Anything that anyone did manually, we put that on paper.”

It’s only at that point that a CEO can know precisely what analytical tools he or she needs. “If your needs are for accurate forecasting of car sales or pricing, then the analytics should focus more on forecasting,” says Patel. “If you’re trying to determine which customer segments you should pursue and what offers should you put before the customer, that’s more like data mining.”

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Oberweis: Milking Data

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Oberweis Dairy has come a long way in a very traditional business. Just a few years ago, the company didn’t have a solid understanding of how the buyers of its milk, ice cream and yogurt products were behaving. Some bought milk from traditional milkmen on their routes, some made purchases at Oberweis dairy stores and others shopped at grocery stores that carried Oberweis products. There was no way to get a complete picture of who was buying what and why, because there was no centralized analytical system. “Two years ago,” says CEO Joe Oberweis, “you’d walk into a room with file cabinets with paper stacked all over the place, completely disheveled.”

Unhappy, Oberweis started working with IT consultant Bruce Bedford to improve his analytical systems. After taking a series of relatively modest steps, Oberweis decided to take the plunge by implementing a SAS business analytics system and hiring Bedford to manage it. “Bruce pushed me over the cliff,” recalls Oberweis. “The first major step was getting the data organized in a fashion we could use it.”

As a result of the implementation, the company can now match up the data from the two sales channels it completely controls, traditional delivery and its own dairy stores. “We can look at customers across channels,” says Oberweis.

It also can segment its customers and experiment with different ways of marketing to them. It sends promotional offers to some customers, working with Valpak, a direct marketing company owned by Cox Communications. “We use SAS to analyze those results and modify the solicitations,” says Oberweis. Those tools work both for maximizing the number of home customers and driving traffic into the company’s stores.

The company also works with Groupon, the Internetbased company that promotes special offers from retailers to targeted online audiences, and it has become much more sophisticated in using its Moola loyalty cards. “We wanted to know if loyalty card customers behave differently in our stores than customer who don’t have loyalty cards. SAS helped us understand the difference in behavior,” Oberweis says. “We get more frequent visits from loyalty card holders with Groupon offers than from non-loyalty cardholders.

We drove increased traffic and we increased the size of the spend per visit.”

So the power of data and the ability to extract lessons from it has given Oberweis a powerful boost. Says the CEO: “It’s not just more sales, it’s more profitable sales.”

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Technology

STAGE 3: Are We Ready to Invest?

If a CEO decides to co-develop a business analytics system, odds are that he or she will need internal talent to help. Twiddy, in North Carolina, could not have gone down that path without his son, the former naval intelligence officer, and LaVan was able to rely on his experience as a computing consultant. Similarly, Joe Oberweis ended up hiring Bruce Bedford as his vice president of marketing analytics and consumer insights; Bedford had been an external IT consultant.

Other people also will probably need to be trained. “The process of merging SAS capabilities with my company was more intensive than I expected—it fooled me,” says Doug Twiddy. He had three to five people working on developing “cubes,” or storage mechanisms, for weeks and had to send some of them off for training at SAS headquarters. “I’d go check on the people in the room and ask, ‘How are you doing?’” he recalls. “They’d say, ‘We’re building a cube.’ I was waiting for results and they were

laying the foundations of merging our stuff with SAS.” SAS’s Patel says the challenge is more than just building a piece of software; it’s about knowledge transfer. “One of the errors that a C-level person can quickly make is not giving enough executive support or attention to the process,” he says. “They have to provide leadership. They have to make sure they have the appropriate skills in-house to understand the technology.”

STAGE 4: Do We Understand the Impact?

The reality is that reaching a certain point of sophistication with business analytics changes the way the company is run and challenges the traditional culture. “The sophistication of the platform is scary to a lot of people,” says Oberweis.

He says he can sense in his company that there is a divide between people who understand the business but not the software versus those who understand the software but not the business. He wishes that 30 people would be anxious to access the business insights coming from the data, not just five or six. All of which explains why going down the path of business analytics can be so profound. “It’s not just a software purchase,” Oberweis says. “It’s a strategic decision.”

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Ross, Doug and Clark Twiddy

The ROI of Analytics

Whatever complexities may exist, the payoffs from the successful implementation of an analytical system are clear. LaVan invested $1.5 million, but he says, “The return on investment has been tremendous. We’ve captured five times that much in new business.”

His firm has been able to reduce advertising costs and to quadruple the number of clients over three years. The firm has gone from having 40 employees and 5,000 clients to 120 employees with 20,000 clients, reflecting clear gains in per-employee productivity. “We have a pretty significant competitive advantage over competitors,” he boasts. “What our system does is manage the claims and organizes the millions of documents. It does the analysis and then cues it up to the employee to review.”

Improving a company’s entire decision-making process, and thus giving it a leg-up in the marketplace, is, of course, the ultimate goal of going down the path toward business analytics. Concludes Oberweis, “We wanted to make decisions with really clear information rather than just guessing what reality is.”

The bottom line? Even very small companies can benefit from business analytical tools that may literally transform their businesses.

istockphoto

The reality on the ground seems to be that most small company CEOs want to have a hand in developing their analytical capabilities gradually, not in a single big-bang moment. LaVan had six different computer systems, which made it difficult for his firm to manage millions of documents associated with winning benefits and disability payments for veterans. Starting three years ago, he examined off-the-shelf software solutions as well as the offerings of large developers. “I didn’t think any of them could be converted to run our business,” he recalls.

Partly because his previous database was based on Lotus Approach, he gravitated in the direction of IBM, which owns Lotus. He ended up working at an IBM partner company, Georgia-based Group Business Software, that was able to bridge the gap between a relatively small law firm and Big Blue to create a custom solution that combined the firm’s email and instantmail systems, collaboration tools and client data base. “We were extremely hands-on during the process,” LaVan says. “Internally, we spent 3,000 hours on developing the software.” Combining internal and external costs, he figures the total tab was $1.5 million.

Likewise, Oberweis Dairy, a fourth-generation family ice cream and milk company based in North Aurora, Illinois, had a mish-mash of systems. Even though sales are in the $50 million to $100 million range, the company faced surprising complexity. The reason is that it had two main products—ice cream and milk—and three distribution channels: a chain of 46 retail ice cream stores, a home delivery system for milk in glass bottles and wholesale distribution through 1,000 grocery stores in five states.

The company’s different databases didn’t talk to each other, plus it had custom applications to manage its milk routes, as well as other point-of-sale systems in its stores to manage Moola, its loyalty card program for customers. “If we wanted to ask ‘how many bottles of milk did we sell yesterday?’ we would have to go to a couple of different systems to get the answers,” recalls Joe Oberweis, whose great-grandfather started the business in the 1920s. “It was cumbersome and complex.”

So the company took all its databases and recreated them in SAS “tables,” or common formats, so that they could communicate, and created what are called SAS “views” of the data. Oberweis now knows whether a customer who receives milk on a home delivery route also buys ice cream at a store and what sort of special offers can be made to lure that customer into other purchases. It took time and effort to transfer its systems into SAS tools, but it was more practical than simply buying a completely new system. (See sidebar, “Oberweis: Milking Data, p. 58.)

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ceo roundtable

Making Private Equity Work CEOs of PE firms and portfolio companies offer five steps to a successful partnership. by

Jennifer Pellet

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You need an influx of operating cash to tap into a growth opportunity for your business. Private equity firms flush with the green stuff need to invest it. The concept has all the makings of the perfect symbiotic relationship. But in the private equity sphere things are rarely so simple, agreed CEOs representing both private equity firms and portfolio companies, who gathered recently for a roundtable discussion held in partnership with Fifth Street Finance and Rutan & Tucker, LLP. Take the case of Brian Coll, CEO of Nicos. A few years back, Coll was about to lock down a deal to trade equity in a plastics recycling firm for the capital he needed to make an acquisition— or so he thought. “They led me right to the water,” he recounted.

“I’m thinking they’re investing a certain amount so I can execute my growth strategy, and I’m giving them a certain amount of shares in my business. Then the term sheet came out and they were getting the equity stake but the investment was a loan. It was nothing like what we expected.”

The good news? Despite bumps along the way, many private equity deals play out to a successful endgame. In fact, Coll walked away from that deal and forged a successful one with his current equity partner, Fifth Street Finance. In discussing their collective deal-making experience, roundtable participants homed in on steps that can help CEOs and their private equity partners work together effectively.

Choose With Care Since the relationship between the CEO and his private equity firm factors heavily in the deal’s ultimate success or failure, mutual trust is crucial, noted Len Tannenbaum, CEO of Fifth Street Finance, who urged CEOs to look for PE firms with a track record. “There are firms that are honest and straightforward and as a result the companies they work with tend to go back to them again and again,” he pointed out. “The reason some private equity firms are on their third, fourth or fifth fund is because they’re trustworthy.”

It’s mutual faith that will carry a partnership over the hurdles that inevitably arise. “I look for somebody who’s going to be fair and reasonable to the management team, and who will understand the challenges,” says Larry Nusbaum, president of Leeb Group. “It’s always easy to be friendly to management when times are good, but what happens when you hit a bump in the road? Do you have the kind of comfort level where you can tell your equity partner that you lost the Walmart account without wondering, ‘Am I going to get shot?’”

Due diligence runs both ways, noted Paul Murphy, a partner at Sentinel Capital Partners. “Before we buy a company we do very extensive psychodiagnostic testing on the CEO and every member of the management team,” he said. “Anybody can run the model for the right market prices, but we’ve walked away from a deals we could have had on price, because we didn’t think that the relationship with the CEO was going to work.”

Pick Partners With Partners Ideally, a private equity partner will be willing and able to step up to the plate as problems arise. “When you lose a customer, are they going to say, ‘I’ve got a friend who’s the head of such-andsuch. Let’s put the product in there?’” asked Nusbaum. “That’s the kind of value-add that goes beyond board level financial analysis.”

“They need to have both connections and the willingness to use them,” cautioned John Garbarino, CEO of Epic MedStaff.

“I’ve worked with guys who said, ‘I don’t really want to call that guy about this,’ and I’ve also worked with others who have said, ‘Whatever it takes. Any relationship of mine is a relationship of yours.’”

Seek Industry Expertise Experience in the specific marketplace or business can be helpful—as is awareness of a lack of understanding. “It’s helpful if your backers have some knowledge of your business,” added Garbarino. “It’s also really important that people know what they don’t know.”

Installing an experienced operating partner can act as a bridge between management and a private equity board member who lacks an industry background. “I once had an investor who was great but would come up with all kinds of crazy schemes,” recalled Garbarino. “I would do my best to dissuade him but at a certain point, I’d look over at the operator and he’d step in and explain, ‘Well, that won’t work because…’ That perspective can be [huge].”

“Looking back, if you can find a managing director who has operating experience other than in investment banking or private equity, that would be invaluable,” summed up Traver Hutchins, chairman of Remedy Health Media.

Hammer Out a Plan The more clearly roles can be delineated, the better, said several participants. “We spend our first 90 days living with a company, not to watch what they’re doing, but to build the relationship,” said Rich Latto, managing director of Longroad Investment Capital. “In a turnaround, you often need to put more money in to restructure the business, so you really need to define your plan. The CEO needs to know what his roles and responsibilities are, and we need to know what ours are. That is paramount to a good relationship.”

At the same time, it helps to have a partner who can roll with the punches, noted Smith Yewell, CEO of Welocalize, a provider of translation services. “Anybody is a good partner when the times are good,” he said. “Six months after LLR Partners invested in us in 1999, I had clients go bankrupt and it was the end of the world. But they stuck by us and 10 years later, they got 10 times on their money.”

Keep Communicating

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Sentinel Partners’ Paul Murphy, Leeb Group’s Larry Nusbaum, Fifth Street Finance’s Len Tannenbaum

Open lines of communication can help CEOs and their private equity partners survive such a maelstrom. “One of the best CEOs in our portfolio saw his business decline 15 percent the first year

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ceo roundtable out of the box,” said Murphy. “We were way off our plan, but we stuck by the CEO because of the communication we had with him.

He made some cuts, deferred some things and tried some less capital-intensive ways to grow the business. Because of the way he handled the situation it never even occurred to us that we would fire that CEO. A few years later, we’re at an all-time high in EBITDA.” Ultimately, such happy endings are the result of management

and private equity alignment. But since partnerships invariably involve a certain amount of conflict, it’s a good idea to have a policy on how to handle an impasse, noted Murphy. “We have a pretty firm rule that everybody has veto rights,” he said. “If we can’t convince the CEO that something is the right thing to do, we’re not going to do it because trying to shove something down somebody’s throat is a recipe for disaster.”

1

2 1. Remedy Healthcare’s Traver Hutchins and Marwood Group’s Ted Kennedy, Jr.; 2. Beecken Petty & O’Keefe’s Peter Magas, Welocalize’s Smith Yewell, Beecken Petty & O’Keefe’s Kenneth O’Keefe

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3 4

4 3. Rutan & Tucker’s Bill Meehan, Rutan & Tucker’s Derek Dundas, Fifth Street Finance’s Alexander Frank; 4. Epic MedStaff’s John Garbarino, Baird Capital’s Randy Mehl, Nicos’ Brian Coll, Longroad Investment Capital’s Richard Latto

Private Equity Roundtable Participants Juan Alva, Partner, Fifth Street Finance Brian Coll, CEO, Nicos Wayne Cooper, Chairman, Greenhaven Partners J.P. Donlon, Editor, Chief Executive Derek Dundas, Partner, Rutan & Tucker Alexander Frank, CFO, Fifth Street Finance John Garbarino, CEO, Epic MedStaff Traver Hutchins, Chairman, Remedy Health Media Ted Kennedy Jr., President, Marwood Group

Rich Latto, Managing Director, Longroad Investment Capital Peter Magas, Principal, Beecken Petty & O’Keefe William Meehan, Partner, Rutan & Tucker Randy Mehl, Partner, Baird Capital Partners Paul Murphy, Partner, Sentinel Partners Larry Nusbaum, President, Leeb Group Kenneth O’Keefe, Managing Partner, Beecken Petty & O’Keefe Leonard Tannenbaum, CEO, Fifth Street Finance Smith Yewell, CEO, Welocalize

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ceo essentials

Should the Chief Sustainability Officer be Sustained?

Some see CSO posts as the managerial fad du jour— but when managed properly effective initiatives deliver value.

by Fran Hawthorne

Key Takeaways • To be effective the CSO must interface with all corporate departments

• The post is not appropriate for all companies

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• Sustainable practices can reduce risk in nontraditional ways

• PR is a component of the role, but ultimately CSOs must deliver value

Two years ago, the director of sustainability at a $1 billion consumer-products company suggested that the corporate budget committee add a new criterion in deciding which capital projects to approve: the project’s environmental impact.

The director devised a metric for measuring the impact in categories such as water usage, waste reduction, packaging and carbon emissions. The chief financial officer and other committee members were so impressed, according to Kyle Tanger, a director at Deloitte Consulting, that they adopted the idea, put the sustainability director on the committee and saved $20 million the first year.

Take away terms like “sustainability,” and isn’t this just a case of old-fashioned efficiency? If using less water or fuel saves $20 million, any smart business will do that. “CEOs would say, ‘We’ve been doing this since our great-great-great-grandfather started the company in 1896,’ ” concedes Jonas Kron, deputy director

of shareholder advocacy at Trillium Asset Management, a Boston-based investment firm that manages $1 billion for nonprofit institutions based on sustainability and other so-called socially responsible principles.

But many business experts say that with increasing naturalresource costs, regulation and public scrutiny, companies today need to go beyond traditional efficiency, and that requires a highranking manager with a specific mandate—a chief sustainability officer. Sure, part of the job is image. In this world of activist consumers and shareholders like Trillium, a socially responsible image is also a crucial business asset. But image-building— or guarding—alone won’t justify establishing a CSO spot; there must be more than just a warm fuzzy feeling to be gained.

“If we thought it was idealism, a nice reputation, we could never do it,” says André Veneman, the corporate director for sustainability at Netherlands-based AkzoNobel, a $19 billion

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manufacturer of paints, coatings and specialty chemicals. Noting that sustainability-related ideas not only save AksoNobel more than $270 million per year but have also spurred the development of new products that account for one-fourth of annual sales, Veneman adds, “It drives the sustainable economic success of our company.”

Apparently many CEOs agree. According to Knut Haanaes, the Geneva-based partner who heads the global sustainability practice at Boston Consulting Group, most Fortune 500 companies have hired chief sustainability officers, usually at a C-suite level with direct (though perhaps infrequent) access to the chief executive. Veneman, for instance, meets with CEO Hans Wijers at least once a week. The two men also sit on an executive sustainability council that meets quarterly to set and review goals.

“These are not things traditional business people are trained to pay attention to,” says Adam Kanzer, general counsel at Domini Social Investments, another major player in socially responsible investing. “There are opportunities all over the place, and you need somebody who is tasked to find them.”

Going Beyond Green

Even advocates admit that the CSO concept is still fuzzy, having taken root in corporate America only in the last two or three years. While it sometimes applies solely to environmental issues, usually it also encompasses areas such as overseas sweatshops, work force diversity, pay equity and community service.

Not surprisingly, CSOs are particularly common in industries that are heavy users of natural resources, like AkzoNobel, including mining, oil, pulp and paper, chemicals and construction materials. Their goal is reducing both the cost of the resources and the environmental operating risks. Ever since BP’s oil drilling disaster in the Gulf of Mexico nearly two years ago, “there’s no resource company that I know of that’s willing to take the risk of delegating this to a lower level,” says Jay Millen, a senior partner at executive recruiter Korn/Ferry who specializes in these sectors.

Companies with a well-known consumer brand—especially in apparel, electronics and food—are also likely to hire sustainability officers. Nike, Gap and Apple have already been pummeled by bad headlines over onerous working conditions in overseas factories.

Pressure from all sides

YRC Worldwide, the $5 billion, Kansas-based transportation and logistics-services company, faced both sorts of pressure, plus the looming threat of increased environmental regulation, when it named J. Michael Kelley—then the vice president of external affairs—as its first CSO three years ago. Major retail and manufacturing shippers wanted to know what YRC was doing to save fuel, in order to answer their own customers’ supply-chain questions, Kelley says.

YRC was already aggregating shipments and packing its trucks tight to save costs, but under Kelley it has dug deeper. For instance, it now puts truckers up in hotel rooms rather than running the engines while they sleep in their cabs overnight. CEO James Welch says that the cost of bulk-purchased hotel rooms is roughly the same as a night of diesel fuel, and in any case, “this helps with driver safety and retention.”

Kelley also says the “C” in his title “gives me credibility to talk to our equipment maintenance people” about fuel efficiency.

The authority to schmooze across departments may in fact be

the most important part of the job. Wood Turner, the vice president of sustainability innovation at Stonyfield Farm, oversees nine teams totaling 70 people drawn from every part of the $400 million organic-yogurt maker. While working at their day jobs, these employees also look for ways to reduce greenhouse-gas emissions, water use, waste, packaging and other environmental impacts. In addition to selecting the team members—in conjunction with their direct supervisors—Turner says, “I’m responsible for keeping those teams motivated and making sure it all ties back to business priorities.”

Acquisition Advice But the responsibility goes beyond bean- (or carbon-) counting. “The CEO should also ask the CSO, ‘In which areas should we create growth? Where should we invest more? Which areas should we exit?’” notes Hannaes of Boston Consulting. Obviously, such strategic decisions won’t be based solely on sustainability factors, but the CSO can contribute insight into resource costs, future regulation and potential markets. At AkzoNobel, Veneman says his department is called into M&A discussions “at a very early stage,” and the company typically nixes three or four possibilities each year for sustainability reasons.

Public relations (PR) is also a key part of the sustainability function, to ensure that demanding consumers and investors appreciate what the company is doing. These activists are increasingly alert to phony PR, or “greenwashing,” so they look for clues like whether the CSO reports to the CEO or merely to the head of marketing, and whether the title is listed in the 10k as one of the top corporate executives.

“The bottom line is to control risk,” says Laura Berry, executive director of the New York-based Interfaith Center on Corporate Responsibility, which represents about 300 religious institutions that invest according to social responsibility principles. “CEOs who are sufficiently visionary recognize that a chief sustainability officer is an important part of the risk assessment, management, and prevention architecture of the firm.”

But maybe not forever, says Haanaes.

“In very sophisticated companies that manage to embed sustainability into the culture and make the line management take it seriously,” he predicts, “the CSO will be obsolete in five or 10 years.”

Fran Hawthorne is the author of Ethical Chic: The Inside Story of the Companies We Think We Love.

CEO Online Exclusive Visit www.chiefexecutive.net/Essentials for more on CSOs and sustainability initiatives, including:

• The CSO Payoff for Small to Mid-Size Companies • Steering Sustainability Without a CSO

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executive life

Recharge Your Body and Soul Aching—literally—for a break? Consider these three resort spa getaways.

You know the feeling. Your body starts to sag like a wet paper bag and ache in all the usual places. Even your brain feels sluggish, not snapping into gear quite as quickly— and we’re not just talking about on the occasional jet-lagged Monday morning; we’re talking every day. When you hit that proverbial wall, there’s no better way to restore your body and rejuvenate your mind than a resort spa getaway.

Any spa worth its salt can deliver the de rigueur “mani-pedi-ina-terrycloth robe” spa experience. But we’ve ferreted out exclusive escapes that elevate luxurious relaxation and mind-body renewal to an exquisite art form, pampering you with a highly customized and ultra-sophisticated experience that goes well beyond mere creature comforts. All three of these destinations integrate their spas into top-notch resort environments, allowing you to reap the rewards of highly trained therapists focusing on your wellness, while enjoying amenities and activities that help you further relax and refresh yourself during your brief respite from the rat race.

spa lunch at the reflecting pool, finished off with—you guessed it—a signature manicure and pedicure.

If you would prefer to begin your five hours of therapy on the resort’s 18-hole, 6,361-yard, par-70 golf course, check in at the spa later for an individual massage treatment (they typically last between 25-80 minutes) or hit the barber and salon to get you looking and feeling tip-top in time to enjoy fine dining, tennis, croquet and breathtaking views of Castle Harbour, Harrington Sound and the Atlantic Ocean from Bermuda’s longest private pink-sand beach.

Rosewood Tucker’s Point Only a 90-minute plane ride away from most major East Coast airports, this 88-room luxury residential and resort community in Bermuda boasts a 12,000-square-foot spa with an astonishing array of à la carte exotic massage, body and water therapies, along with traditional treatments designed to satisfy your every want and need. With so many choices on the menu, you might want to kick your stay off with one of the four Day Journey packages, such as the Bermuda Day Journey. For $700, you receive five hours of bliss, including an aloe massage, a seaweed-algae skin cleanser and detoxification treatment, a citrus facial and a

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ceo life > extreme ceos

Calistoga Ranch

Ritz-Carlton Spa, New Orleans If you’re looking for an extravagant spa experience that rouses all of your senses, you need go no further than the Ritz-Carlton Spa. Located on the fringes of NOLA’s timeless French Quarter, the Ritz-Carlton’s 25,000-square-foot day spa and fitness center recently received the top slot on Travel & Leisure’s hotel spas in the U.S. and Canada list—and for good reason. Its staff of expert technicians offers nearly 100 state-of-the-art therapies, ranging from the synchronized Royal Four-Hands massage ($295 for 50 minutes) to the quick pick-me-up Café Au Lait Massage ($140 for 50 minutes, $200 for 80 minutes), that will alleviate stress and reinvigorate you from head to toe.

Even the stodgiest traditionalist will enjoy the relaxation lounges, steam and sauna rooms, whirlpool baths and resistance pools, but the spa is most well-known for its collection of massage therapies, hydrotherapies, aesthetic and exfoliation treatments, and salon services. Each of the 22 treatment rooms is lavishly appointed with chandeliers, fountains and the perfume of magnolia blossoms in the air, elements that have the effect of slowing down time so that you can properly unwind. And then, of course, there’s everything the Big Easy has to offer…

California’s Napa Valley has long been an area nationally regarded for its spa culture, and Calistoga Ranch remains its standard bearer of excellence. Rated the second best spa in the U.S.

by Condé Nast Traveler readers, Calistoga’s commitment to working with nature is evident in all of its spa treatments and across every inch of its lush 157-acre Upper Napa Valley property. The luxuriously appointed outdoor-themed interiors of its lodges complement their wooded surroundings, enhancing the experience for guests by keeping them connected with nature at all times.

Calistoga offers an impressive array of highly customized, individualized services, ranging from massages and body wraps to detoxification and exfoliation. There’s something here for everyone—even “personalized yoga”—but the spa takes great pride in using products made from its own bee colonies, which factor in many of its seasonal specials, including honey and shea butter massages ($230 for 90 minutes) or lavender honey milk or milk and honey body wraps. If you’re looking for something more invigorating, try a hike over some of the 140 acres of natural trails, followed by an Immune Boost Bath Therapy of essential oils and mineral salts to accelerate your natural immune responses ($85 for 30 minutes) at the secluded Bathhouse at the top of the property. Then take a seat in The Lakehouse, the spa’s private dining facility overlooking Lake Lommel, to enjoy Napa’s renowned foods, wines and artist products under the starlit sky.

Z Z

Calistoga Ranch offers Napa Valley views and 140 acres dedicated to active pursuits.

The lavishly appointed Ritz-Carlton spa offers 100 therapies.

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The Essentials

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Best rooms: Nestled near the banks of Lake Lommel, the Estate Lodge (seasonal from $2,300-$4,200) is a perfectly appointed creek-side haven set against a bucolic mountain backdrop.

With 2,400 square feet of indoor-outdoor living space, the lodge features two spacious master bedrooms, a fully equipped gourmet kitchen and dining area to accommodate four adults and two children under 18 years of age, plus private entry, butler service and exclusive use of a Mercedes S Class car throughout your stay. Conveniently located near all resort amenities but wholly private and sheltered from outside distractions, it’s ideal for a family or romantic retreat.

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flip side

Citizen Fed Bring on the amateurs!

by Joe Queenan

Internet for pertinent material written by non-professionals, quasi-professionals, gifted amateurs, self-starting neophytes and perhaps even enthusiastic hobbyists.

This is a practice that has already been used with considerable success by airline magazines, which discovered ages ago that nobody reads those stories about 112 places to eat in suburban Budapest anyway. Cynics might suggest that the Journal’s new policy is a cunning ploy to trim editorial costs by soliciting material from rank amateurs and just plain folks, sometimes referred to as “citizen journalists.”

But cynics are always being cynical.

The truth is, no matter how badly the material is written, no matter how poorly it is organized, and no matter how many times the author cites the canny wisdom of dear old Aunty Miranda, even the most incoherent or fatuous writing can be whipped into shape by experienced editors, provided the material itself is informative, enlightening, groundbreaking or amusing. The magazine itself is on record as saying that its new editorial policy will further empower women, in part by allowing the voices of ordinary people to be heard.

As a professional journalist, I should be expected to deplore this development, seeing as it sends even more of my colleagues to the sidelines. Nonetheless, I do not deplore this development; in fact, I welcome it. This is a harsh, Darwinian world we live in, and we must all get used to it. The Internet has changed the way the press does business and that change is incontrovertible, so there is no use crying over spilt milk.

The long and the short of it is: If amateurs can do a better job than professionals, then the professionals had better start doing a better job themselves. Otherwise,

Illustration: juliana alia

The venerable Ladies Home Journal has just announced that, starting with its March issue, the majority of the 128-year-old magazine’s content will be supplied by readers. Seemingly, the Journal will trawl the

they’re all going to be out of work. To which I say: Good riddance!

Many, perhaps most, contributors to general interest magazines are slothful hacks, and this will either light a fire under them or force them into another line of work. Gardening, perhaps. The same goes for sportswriters, an oxymoron if there ever was one; anybody armed with a television can do what most of them do for a living. In fact, I am so enthralled by the idea of citizen journalists that I would like to see the concept expanded to various other fields.

Am I the only one who thinks that citizen economists might be able to do a better job than the jaded professionals who’ve missed the last two stock market bubbles and the recent housing market meltdown?

Take a gander at these ding-dongs’ predictions for the last couple of economic cycles and tell me that citizen econometricians couldn’t do a better job. To their ranks might readily be added citizen interestrate forecasters, citizen technical analysts and citizen pension-fund managers.

You only need to take a peek at what’s been going on in Greece, Iceland, Ireland, Spain and Portugal to realize that professional economists, stock market analysts and rating agencies have persistently missed the mark in the past few years— and it’s cost investors plenty. That’s why I think we should all take a page from Ladies Home Journal and try something bold, iconoclastic and new. Out with the pros! In with the amateurs! The worst that can happen is that they fail. Big deal. Join the club.

Are there any other areas where

amateurs could bring greater energy, more vim and vigor, and a welcome, new perspective to the table? Sure. Citizen alternative fuels experts can’t do any worse than the pros who brought you ethanol. Citizen computer manual writers couldn’t possibly be any less helpful or less communicative than the guys who write PC user manuals today. For similar reasons, I am also in favor of citizen attorneys, citizen mortgage bankers, citizen landscape designers, citizen wine critics and even citizen tribute bands.

Not all human activities lend themselves to this dynamic, of course. Citizen heart surgeons? Not so sure about that one; it could get messy. For similar reasons, any attempt to replace seasoned root-canal engineers with citizen orthodontists must be viewed with trepidation, if not outright horror. I’m also not so sure about citizen proctologists, citizen airplane pilots, citizen nuclear power plant monitors and citizen SWAT teams. I’m just not convinced we want amateurs handling AK-47s.

On the other hand, citizen veterinarians doesn’t seem like such a bad idea; only Fido and Fifi are going to be any the wiser, should things take an unpleasant turn. Same deal with citizen chefs. Last but not least, I think we should all give serious thought to establishing a Citizens Federal Reserve.

Greenspan and Bernanke messed up big time with the subprime housing mess, so; let’s give Mr. John Q. Public a shot at it. Actually, I think that’s what Rick Perry was proposing all along.

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final word

ISTOCKPHOTO

Two Cheers for Wealth Creation The Republicans seem to want to talk about taxes and opportunity. The Democrats are obsessed with income inequality and a notion they like to call “fairness.” The President hammered his doctrine of “fairness” relentlessly during his State of the Union speech. Even independents, when polled, seem to favor the “rich,” loosely defined, “paying their fair share.” However, here’s the central question no one seems to be asking. Do we want people to create wealth or not? Do we even understand how wealth is created? When most politicians talk about spreading the wealth around, as Obama did with Joe the Plumber during the 2008 campaign, their understanding of wealth creation is a bit like the medieval notion of phlogiston, a substance that miraculously comes into being during combustion. Politicians, naturally, feel called upon to ensure that it is distributed “fairly,” a euphemism for taking it by force through taxation and regulation from one group and giving it to another.

In the real world most of us inhabit, wealth is created when someone—an entrepreneur—takes risks and creates something people value. Profit, if it is realized at all, is nothing more than the surplus generated after the entrepreneur covers his costs and effort. Most entrepreneurs don’t even get to see much of that because failure rates in new business creation are steep. Many of our political leaders are oblivious of the risks involved and simply assume people will start businesses and create jobs regardless of the impediments put in their way by government. Steve Jobs did not create the iPod and iPhone for money alone, but he clearly expected to reap the financial rewards from his efforts.

Could a similar venture get funded today? Could a 20-year-old college dropout, fresh from some ashram in India, attract funding for a capital-intensive venture based on the manufacture and sale of a $2,500 product for which the market is exactly zero? There is a reason why the tax rate on invested capital is lower than for the rate on income. Even Warren Buffett knows the difference despite his canard about paying at a lower rate than his secretary.

Barack Obama has made certain never to repeat the phrase “spreading the wealth around,” but he continues to bang on about “economic justice”—the immorality of income inequality. The notion did not begin with him. It’s been a central tenet of socialist thinking since Karl Marx. It’s the animating idea of an entire class of elites in academia, Hollywood, the media and the lumpen intelligentsia of Georgetown and the Upper West Side of Manhattan. They believe inequality does not result from inequalities of merit, ability or effort, but from discrimination, exploitation and systemic unfairness. A world defined by economic equality, the argument goes, will be a fairer and happier one.

Bringing the top down, whatever its consequences is as good as bringing the bottom up.

This is how statists—those willing to place economic control and planning in a consolidated state government—understand the path to greater enlightenment and well being for the rest of

us. It also explains why they are willing to sacrifice entrepreneurship for higher taxes, greater regulation and federally managed corporations like government motors. It is the equality of misery, which is all you get when you punish economic liberty. Punitive taxation dismantles the link between effort and reward. Everyone appreciates the need to pay for important services that only government can provide, but raising taxes for the sole purpose of income redistribution raises no one’s well-being because it raises virtually no revenues. In fact, revenues actually decline in the long run because of the negative incentives. As a result, there is less to redistribute.

A Small Business Administration study found that a reduction in the marginal rate of one percentage point increases the rate of startup formation by 1.5 percent and reduces the chance of startup failure by more than 8 percent. Furthermore, a 2008 World Bank study found that a 10 percent increase in the effective rate reduces the investment-to-GDP ratio by 2.2 percent and foreign direct investment by 2.3 percent. Tax rates don’t just influence how much investment, growth and job creation will take place in America. In a global economy, they will profoundly affect where a business will chose to invest or expand. Since 1986, all the OECD countries, except Japan, have lowered their statutory and marginal rates, while the U.S. has not. As a result, we cannot assume that the next Apple will emerge from the U.S. at all.

The irony is that President Obama is uniquely positioned to revive our economy through lowering the rates necessary to boost expansion and attract the nearly $2 trillion in potential investment sitting on the sidelines. Any Republican candidate advocating this will be demagogued by the left for being “unfair,” but it could be a Nixon-goes-to-China moment for the President—if only he would see the opportunity for himself—and for the rest of us.

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