(I’ve always been and still remain a fan of systems thinking. If you want to read more on the topic, these two books are a good start: Management f-Laws and Systems Thinking for Curious Managers. The points below are my reflections on having read these two books almost a decade ago and having a chance to grow a company while applying these truths.)
Let’s face it: most companies have an idea crisis: every new decision (be it product, strategy, marketing’s 4Ps or anything else, really) suspiciously resembles the past decisions with minor room for variation. There are many reasons why management avoids rocking the boat, like: compensation, future career prospects (in Russia we have a term “a downed pilot” meaning someone whose career has abruptly ended as a result of a severe mistake or their judgement lapse or the Board’s brief moment of sanity), preserving social capital (one’s career path must look smooth from the outside, and the best way to achieve this is not deviating too much from the Business As Usual, aka BAU, strategy). I must also add that one should be aware of the strange feature of the human brain, which forces its owner to take action in the times of uncertainty (and in the case of shareholders – to expect the management to actively reduce said uncertainty). Technically speaking, no one can be blamed for actively believing that every single day of a firm is navigating through uncertainty (not that it’s helpful, either). But more often than not the right response to uncertainty is actually sticking to the BAU strategy.
If this strategy works, of course. Unfortunately, some management teams stick to the strategy that looks like it’s working, but over time leaves shareholders scratching their heads in disbelief looking at the share price (for a public company) or the lack of good liquidity prospects (for a private company). I have a strong suspicion that this strategy is measured by KPIs, but this topic has its own dedicated place in hell, let’s leave it for later. A cautious management team’s capital allocation decision becomes predictable and a bit pathetic: put more money into the past strategy thus robbing shareholders twice – via the poor investment decision and by destroying long-term shareholder value. On a corporate governance level this is a huge red flag for (especially) Independent Directors who are not supposed to feed off the management’s hand and actually ask their own questions. This applies to mid- and large-size companies, which have a playbook of past strategies and a Board that is not fully controlled by the CEO.
While we’re on this topic (let’s not waste an opportunity to vent), the skill to ask uneasy questions without management’s retribution (the easiest way is to withhold important information) is the #1 major ability of a Director to master. There are two markedly different dynamics in discussing capital allocation decisions for BAU initiatives and for new initiatives. One fallacy to look out for is having a lower approval barrier for BAU initiatives, since the amount of uncertainty is much lower than when it comes to them. And it’s fair enough: there are fewer people risks (in the number and the impact), outcomes are more or less predictable (ignoring the market benchmarks or shareholder expectations), org structures and processes are already set up for this very kind of execution. New initiatives have to be bold enough to cut through the “more of the same” narrative as well as offer the ROI way higher than the BAU initiatives. Since the only way to prove to the Board that an idea has legs (and dollars) is making a detailed plan, said plan (revenue-wise) has to be very ambitious to ensure the capital allocation approval. There are two interesting observations at play here:
· The higher the investment is – the less time it takes to approve it, and
· The more detailed the plan is – the higher risk it can command. At the same time, the management becomes victims of highly detailed plans as they start believing in the numbers forecasted.
Directors (obviously) don’t have time to go through the entire model (neither they should), but it’s prudent to ask for the major assumptions and the rationale for them. To an experienced Director the choice of assumptions is a tell-tale indicator of the management thinking. It’s fair to assume that at least some of the assumptions of the current management will match the Directors’ understanding of the growth drivers for the business (hint: they change over time), and Directors can score more points by trying to understand the differences between their own picture of the world and the picture of the world of the firm they’re supposed to be the servants to.
The familiarity of the set of assumptions can play a negative role since it lowers the acceptance barriers of the model. If it’s somehow linked to the compensation, one can bet these assumptions will be the safest ones to defend and achieve. So while I personally don’t like unrealistically ambitious goals (and not because I’m a coward, but rather because I prefer nicely planned battles without the need for constant heroism), I have to admit that most successful financial outcomes (and failures) come out of high-risk initiatives (i.e. where the core assumptions need a leap of faith). Thus, technically it’s more prudent for the firm to choose high-risk initiatives (not stupid-assumptions initiatives!!!) than the safer, more predictable and toothless ones.
… to be continued.
That's why some companies have 2 budgets - Run-the-Business (BAU initiatives) & Change-the-Business (new initiatives). It helps to measure the company's performanse both in the ordinary course of business and innovations.