Hierarchy + Homogeneity = Stupidity

I used to make up bedtime stories for my kids. One of them was about a young lion that liked to hang out with an elephant and a giraffe. Like Simba in Disney’s Lion King the other lions could not understand this, but when drought hit the region this trio mastered the problem by having different strenghts.  The giraffe could reach fruits from the top of the trees, the elephant could stomp a hole in the scorched ground to reveal the water below, and the lion could scare some hunters away. lion giraffe elephant

Obviously, the story contains some weak spots that I don’t think my kids would accept today, but I think they got the idea that heterogeneity is good.  I also  suspect the management of Volkswagen was told  no such story when they were kids.

Now Volkswagen is trying to understand how respected engineers failed to see what a monumentally bad idea it would be to systematically cheat with the exhaust tests.

Pressure must have played a part. The pressure of a successful past combined with a non forgiving leadership….and not having the solutions available to deliver what is expected.

But above all, this looks like a perfekt example of “GroupThink”, the syndrome where a whole Group of people think as one. For those of you who don’t know: This is bad.  Groups Think better than individuals. Above all, groups make fewer mistakes.

Hierarchy
Volkswagen is a strictly hierarchical Company.  An engineer does not say “no” to something that was decided several layers up in the organization.

Homogeneity
One of the key complaints from employees in the Volkswagen group is that only Germans get promoted. Indeed, the top management Group consists of eight middle aged men. One of them was born in spain but moved to Germany as a teenager. The rest are Germans.

Stupidity
For at least a decade, Toyota hade been investing heavily in R&D with the goal of cutting carbon dioxide emissions by 90 percent. Everybody else saw the stiffening legal requirements, but this Group of middle aged germans did not invest to meet those demands.  Only a homogenous Group can be this stupid.  Only a hierarchical organization can accept such stupidity from their top people.

Lea Dunand-Chatellet, fund manager at Mirova, explains how she could ask about innovations to cut carbondioxide emissions only to be told about inventions to open the hatch without using the hands. That’s when she decided to divest in Volkswagen.

So, in the end the engineers were probably under pressure from two sides:pressure

  • A decade of non investments from the one side
  • Legal requirements and competition on the other

Cheating may have looked like their only way out: either that or failing to sell the cars that kept not only themselves, but pretty much everyone in Volfsburg employed.

Let’s stop asking ”who is to blame” and start looking at how such an important decision making Group could be allowed to be so homogenous (=stupid).  Above all, let’s not make that same mistake.

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How being different beats being smart

Check out the graph below. My portfolio (green line) is outperforming the OMX30* by 45 to 22 percent in the last year.  That is not a surprise.  This is the pattern I expect, based on my Analysis of thirty listed Corporations over ten years.

My portfolio (green) vs the OMX30 (yellow)

My portfolio (green) vs the OMX30 (yellow)

My strategy is the simplest one imaginable. I buy stock in Corporations where people are getting what they need to do a great job.  When that improves, the value of the stock improves as the result of people doing great stuff. It’s as if I sat in a bar every friday listening to the Groups of people coming in for an after work beer. Where people feel their Company is better than ever I buy. That would probably work, but I look at the data from engagement surveys instead. Wherever my “What I need to do a great job” index is growing, the stock will outperform stock in companies where this index is shrinking by 2,5 times.  Not the first year, but the second, when this higher level of “macro flow” at work has resulted in better Products, higher sales and other conventional numbers that analysts appreciate.Escalators

Now, I’m not looking at those conventional numbers. I find it useless because there are hundreds of thousands of very intelligent people out there buying stock based on them. These people have degrees from places like Harvard, Stanford and Yale and they have access to this information before I have it.  In the conventional game I would be a looser. Less intelligent, less knowledgable and slower to access this information my chances are those of an overweight, middle age man trying to win New York Marathon.   My opportunity is this: They have all read the same books at the same universities and they are making their calls based on the same traditional information from places like Bloombergs. The price of any stock is likely to reflect the value based on this information. That’s why I don’t need to look at any of that information. I buy stock ONLY on the basis of the engagement survey results.

Sometimes being different beats being smart:-)

Me and the financial analysts

 

 

*the OMX30 is the index based of the 30 main shares in the Nasdaq OMX Stockholm stock market.

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Beating the market can be quite easy

It’s friday night and two groups come into the bar where you are sitting. They turn out to be from competing companies. One team is happy. You can hear them talk about how well everything is working. They believe in what they do and they have great contact with their managers. Work is flowing in a great way. The other group talks about much better it was a few years ago.

At this point you may be making a mental note to yourself to buy from the first group. It would be more fun working with them. Also, chances are they come up with better things. Everything is easier when you’re enjoying a nice tailwind forty hours a week. Then you realize both companies are listed. Which of these companies would you invest in?

That is how simple my investment strategy is. I followed 30 publicly listed companies for ten years in order to find the proper method, and I used engagement survey data to operationalize it. but the basic idea is as simple as listening in on whether people are working in a tailwind or a headwind.

Still the financial market finds this idea quite alien.

So, to prove my point, I’m investing in companies like the happy gang in the bar above.  My analyses indicate that in two years the stock of these companies rise in value about 2,5 times better than where the flow at work is decreasing. In one year there is no significant change.

So far my portfolio is performing exactly along that pattern. It started off following the relevant stock market index (the OMX30) but now the improved flow is starting to make a difference in terms of innovation, sales, productivity and other numbers that the market likes. That lifts the value of my portfolio.

My portfolio (green) vs the OMX30 (yellow)

My portfolio (green) vs the OMX30 (yellow)

My low risk portfolio

I expect to keep beating the stock market for as long as nobody else is doing the same thing.

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The Expansionist Disease

Djingis Khan had it. Peter the Great had it. As did Julius Ceasar, Asuka the Great and Napoleon Bonaparte; the disease called Expansionism. It brings glory to the ruler and misery to the people on both sides of his deeds.  Many of us thought this disease was something we left behind us in a less civilized past, but just as Measles, Mumps and Ebola it pops up from nowhere when we thought it was gone forever. Today the most obviously cases of the Expansionist disease are Russia and Israel.  Outright wars are combined with sneakier methods of engulfing territory that simply isn’t theirs. The west tries to cure these outbreaks of expansionism by diplomatic and economic sanctions, but so far probably has not gone far enough. The disease is picking up speed and in the long run that is bad for everyone involved, whether it leads to outright war or not.

Expansionism is even more rampant in business. Here it is completely accepted and even demanded by shareholders across the globe. Sadly, corporate expansionism is also a source of misery. The sum of all corporate Mergers and Acquisitions (M&Ss) has always been negative. 2+2 usually sums up to three rather than four or five.  The news of a merger between Nokia and Alcatel/Lucent makes analysts expect improved sales from Ericsson. Employees, meanwhile, worry about which ones of them will be the “cost cuts” that presidents talk about in press conferences. Headquarters will be based in Finland but the Finnish/French row on R&D jobs is sure to go on for many years.

Once in a long while a corporate acquisition is successful, and we read about those cases in business journals because the executives involved are eager to speak about their feat. Volvo Trucks purchase of Renault Trucks and Mack Trucks long seemed to be one of these few successful ones. Failed acquisitions however are mentioned as often as failed sports bets. A search on “lottery” will generate loads of information about wins, and none about losses. The same is true on M&As.

One good way to predict failing M&As is to look for a strong president reporting to a weak board with many owners.  In these cases, boards should consider possible side interests such as the opportunity to travel to a trendier city.  Insurance company Trygg-Hansa SPP had that situation when deciding to buy Home Insurance Company in New York; a deal that nearly took a highly profitable company down. Was the idea of owning a company on Manhattan part of what clouded the judgement of these bright men? The American Vivendi/Universal deal may be an even better example. This deal was reputedly driven by a president’s desire to get into a “funner” business than supplying water and energy.  The prospect of fraternizing with Beyoncé, Lady Gaga and Justin Bieber may have clouded the judgement of CEO, Jean-Marie Messier, leading to a corporate loss of a staggering €23.3 billion in its 2002.

Expansionism in publicly held corporations is almost always a really sad story. Citizens of one nation rarely have reasonable interest in buying service providers abroad. Yet it happens, and the results are often appalling, as in Vattenfall´s long list of failed M&As in Germany, Poland and the Netherlands.

 

Per Weidenman, Senior Analyst at Bisnode, points out that companies maintaining long term profitable growth are rarely involved in M&As.  These companies build their success on innovation leading to product and service excellence.  This is not always fancy.  Swedish trading stars JulaIKEA and H&M are good examples. All three are led by a strong entrepreneur’s family keeping CEO Megalomania away. The companies grow by consistently coming up with better stuff at lower prices than the competition.  That way these companies are like the ruler that focuses on peace and prosperity. A list of famous Kings and Queens of the world contains few such examples. Historians overlook them, or just find it boring to study rulers like Akbar the Great, the Indian ruler who tripled the wealth of his empire by means of an taxation system, land reclamation and huge agricultural outputs of cash crops.

 

Ikaros

As an investor I try to favor these companies, and stay away from expansionist follies.

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Long Surveys + Short Analysis = Waste

Your company beckons 10 000 customers to fill out 30 survey issues. Since 10 issues took about 30 seconds to fill out you figure the 30 survey issues take about a minute and a half of your customers precious time.

Wrong! 

If you average five survey issues in one minute a correct formula may look something along the lines of time=(n2)/5 where n is the number of survey issues.  30 survey issues takes three minutes and 50 issues take well over eight minutes as survey fatigue sets in. An engagement survey of 100 issues really tries your engagement by subjecting you to half an hour of very intensive work.  That is not counting the coffee break you have to take afterwards to recouperate from the ordeal.

Let’s say your company is subjecting 10 000 key customers to 30 survey issues. That is about three months of your customers’ time. That investment pales with the investment of having 50 000 employees fill out 100 issues. That engagement survey takes about 13 years to fill out, and hopefully twice that time in post survey process.

Based on Survey Web Stats

Based on Survey Web Stats

I am just trying to point out the real costs of surveys. Long surveys are far larger investments than most people realize.  A 100 issue engagement survey that is used primarily to inform top management of the overall working climate is very unlikely to be a good investment. Most of the value comes in local processing of the survey results. 50 000 employees discussing how to improve their local results. That is where the investment pays off.

Unfortunately the result feedback usually comes some three months after the survey was run. At that time the information is old. The frustrated talent who filled out the survey in August has probably moved on in November. This process needs to be reversed, as we did in a large telecoms/it company 20 years ago.  Everyone got their work group results the morning after the survey closed. Top management got theirs a month later. By then we could include information about what the groups had done.

A second problem is that the consulting companies focus on productivity. An analyst can run the same standard analyses on every company and come up with a predictable set of impressive looking slides in hours.  Running a real analysis where this rich data is turned upside down for different angles takes weeks.  Guess what happens?

Suboptimal Chain

13 years of survey material is analyzed for half a day to maintain productivity.  That’s a good example of how the difference between visible cost and invisible cost leads makes us suboptimize.

If an average engagement score was all you wanted, a sample of 1000 employees would have done fine at 2% of the cost.   

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