Corporate Finance: November 2008 Archives

I recently blogged about a presentation the 2008 Communications Policy Research Forum in Sydney on disruptive innovation in the music industry.

You can now download an Adobe PDF version of the PowerPoint slides here.

The refereed paper has been published in the Proceedings of the Communications Policy Research Forum 2008 (pp. 155-175 or PDF file pp. 179-199).  You can also download a local copy of the paper here.

The paper's case study examines why Radiohead and Nine Inch Nails released their new albums as digital downloads.  I suggest a major reason why, and one that was overlooked by Web 2.0 pundits, is that each artist was in the 'label shopping phase' of a new contract and defected after negotiation problems with their major labels.  This fits a pattern in mergers and acquisitions: the major labels lost artists due to integration problems in a merger or acquisition.  Terra Firma Capital Partners has since partially confirmed this hypothesis: the private equity firm endures more post-acquisition integration problems with EMI and is fighting against government regulation of Great Britain's financial services sector.

The paper's data appendices contrast the artists' strategies with signficant events and innovations in music industry contracts, conglomerate mergers and deal structures.  Somehow I missed U2's March 2008 deal with Live Nation: I found out about it in an October 2008 announcement.  Guns n' Roses also finally released Chinese Democracy (MySpace audio stream): a new album that has taken 15 years, a rumoured US$14 million budget and 14 recording studios in New York, Los Angeles, Las Vegas and London.  I may write a paper on it . . .

Recently I posed two questions about Foresight in Organisations: What are are the intervention points?  After five or six years, who are the teachable case studies for successful implementation of the foresight function?

I've only read the Los Angeles Times and New York Times reviews but Charles D. Ellis's The Partnership: The Making of Goldman Sachs (Penguin Press HC, New York, 2008) has some answers to both questions.

Ellis suggests Goldman Sachs has three intervention points to cultivate a foresight function: (1) a human resources function staffed by A+ people who recruit "A+++ people" usually in computational finance, financial engineering and statistical arbitrage; (2) an organisational culture tolerant of the "longer-term view" that is linked to the "[operational] details" necessary for strategic execution; and (3) a creative tension between past excellence and new frontiers.  Intriguingly, the "longer-term view" or "forward view" in Foresight parlance, emerges from people in a supportive culture who are faced with challenge at the boundary of the firm and the external competitive environment.

Two other biographies partially validate Ellis's insights.

Perry Mehrling's biography Fischer Black and the Revolutionary Idea of Finance (New York: John Wiley & Sons, 2005) and his working paper 'Understanding Fischer Black' describe why Goldman Sachs recruited the economist Black: to tap his academic knowledge to design new financial instruments, and use his influence as coauthor of the Black-Scholes equation in finance to impress clients.

Emanuel Derman describes his Goldman Sachs collaboration with Black in My Life As A Quant: Reflections on Physics and Finance (New York: John Wiley & Sons, 2004) and how the firm benefited from the influx of PhD graduates in the 1980s.  Derman was bored at AT&T Bell Labs which had a reactive culture of research management.  He transitioned into Goldman Sachs' fixed income division in 1985 and then moved to equities in 1990 where he thrived for the next decade in a culture that appreciated how conceptual expertise can underpin a firm's competitive advantage in new growth markets.

The contrast was so different that I pointed Derman's experience out in a private submission to Australia's National Innovation System Review (aka Cutler Innovation Review) in comments about the institutional design and research management culture of Cooperative Research Centre consortia.  Maybe given the subprime fallout CRCs can also learn something from Goldman Sachs and Berkshire Hathaway's Warren Buffett who has now taken a $US5 billion equity stake in Sachs' foresight culture.

A few years ago I took a Masters unit of study about Foresight in Organisations.  In its early iteration the unit covered several topics:

∙ Conceptual theories of strategic planning: Alfred Chandler's structure and strategy, Michael Porter's 5 Forces model and contributions to industrial economics, Gary Hamel & C.K. Prahalad's early work on core competencies and industry whitespaces, and Henry Mintzberg's eloquent critique of the strategic planning function.

∙ The operational span of strategic planning including an overview of business units, corporate level strategy, and multi-national conglomerates.

∙ Good practices in change management and organisational interventions such as Elliott Jacques' requisite organisation, Ralph Stacey's shadow or informal networks in organisations, Richard Hames' strategic navigation, and Peter Senge's view on learning organisations.

∙ Practitioner reflections and post-implementation case studies on creating a foresight function in organisations from Andy Hines, Sohail Inayatullah, Peter Hayward and Joe Voros.

The most fun part was a lunch with Hines around the launch of the Association of Professional Futurists.

The student cohort grasped several hypotheses from these topics: (a) the limits of traditional strategic planning in a complex environment, (b) the emergence of anticipatory management and strategic foresight as two new paradigms, and (c) how the foresight function may be embedded in organisational culture.

In retrospect three broad trends may have influenced the topics and hypotheses:

(1) Hamel & Prahalad's view led a new wave of practitioners to frame the foresight function as a managerial core competence in pragmatic strategic thinking (thanks to Mike McAllum for his practitioner insights on Hamel's influence).  In the contract phase of a consulting engagement this meant the practitioners often linked foresight to growth options, visioning and corporate strategy.  Clients were receptive, partly due to Hamel & Prahalad's solutions at the firm and competition levels.  More broadly, exogenous factors played a major role in creating the macroeconomic climate for client demand: the 10-year Juglar business cycle, the late 1990s Internet bubble and the M&A wave of European industry consolidation.

(2) Hamel & Prahalad's work coincided with the diffusion of new frameworks for organisational interventions from management theorists into consulting firms.  Senge's systems modelling at MIT's Society for Organisational Learning and Arie de Geus's scenarios work at Royal Dutch Shell were two such frameworks.  If Hamel & Prahalad provided the strategic rationale, then Senge, de Geus and others suggested the intervention points: how a forward view and systems awareness could enhance managerial decisions about corporate strategy.  However this alignment of the foresight function with strategic thinking did not explore other potential intervention points: cost management systems, project hurdle rates for risk-return, and operations management.  Attention to these would bridge the strategy|operations divide in organisations that demand quantifiable results.

(3) An alternative route for contract phase buy-in was to connect the foresight function with a hot topic that interested the client.  On the upside, this was a way to raise awareness of dynamics, forces, trends and challenges beyond the firm or market.  On the downside, the buy-in now depended on the currency of the hot topic, the differential diagnosis skills of the practitioner, and the value created by the solutions.  If the hot topic waned, so might the buy-in for the foresight function.

With the benefit of five years hindsight I now see how some barriers to Foresight in Organisations might be avoided.

Foresight in Organisations gives students a grounding philosophy that informs their consulting approach.  However its philosophy is also a relatively young discipline with multiple schools of thought and stances, and in competition from other frameworks, methodologies and stances for client dollars.  This poses translation challenges between the Foresight practitioner and their client that arise in the contract, data collection and implementation phases of a consulting engagement.  Clarity on how philosophy informs rationale may help the engagement go smoothly.

The Foresight practitioner also faces cognitive biases and judgments that can affect their consulting decisions during an organisational intervention.  The Foresight practitioner's enthusiasm for Foresight as a normative stance and silver bullet solution can set them up to fail or give their solutions a shorter half-life.  Specific cognitive biases that the Foresight practitioner may be prone to include positive illusions about their implementation competencies, illusion of control over others, and unrealistic optimism about the likelihood of organisational transformation.  The client may also have a shadow agenda about power and the direction of organisational change which can blindside any intervention.  Finally, as the Foresight practitioner is not embedded in the organisation their enthusiasm for change can trigger defensive routines from others that may delegitimate the practitioner, block the microprocesses for change, or derail the organisational intervention.

I learnt the most from the war stories of other Foresight practitioners: what worked, what didn't, how and why interventions failed, and what was done the next time.  You may mess up as others have messed up before you.  Now I have my own war stories to add . . .