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Why the bottom line isn’t! How to build value through people and organization

Book cover

by Dave Ulrich and Norm Smallwood, Wiley, 2003.

Abstract

Intangible assets increasingly drive the market value of firms. Intangibles are not accounted for on a company’s financial statements but include leadership brand, corporate culture and the ability to attract talent. Building intangible value is the responsibility of leadership at all levels. The book provides an "Architecture for Intangibles" which leaders can use to build intangible value and "make intangibles tangible".

(Reviewed by Kevin Barham in December 2005)

(These book reviews offer a commentary on some aspects of the contribution the authors are making to management thinking. Neither Ashridge nor the reviewers necessarily agree with the authors’ views and the authors of the books are not responsible for any errors that may have crept in.

We aim to give enough information to enable readers to decide whether a book fits their particular concerns and, if so, to buy it. There is no substitute for reading the whole book and our reviews are no replacement for this. They can give only a broad indication of the value of a book and inevitably miss much of its richness and depth of argument. Nevertheless, we aim to open a window on to some of the benefits awaiting readers of management literature.)

Introduction

What is it that investors really value in a firm? According to this book, it is no longer just about the firm’s predicted earnings. What investors really value is the firm’s intangible assets. Intangibles are the factor that increasingly drives market value.

Intangibles, say Dave Ulrich and Norm Smallwood, are "the value of a company not accounted for by current earnings". Ulrich is a professor at the University of Michigan and has been called America’s "top guru" in management education. Smallwood is a leading consultant in leadership development, strategy and change management. The book began when they asked a simple question. How can two companies in the same industry with similar earnings have vastly different market values? They had assumed that two firms in the same industry with the same earnings should have the same market value. But they found this was not so. Firms with the same earnings had vastly different market valuations. In a rising market, some firms’ stock price rocketed while others did not.

The authors’ research led them to the conclusion that the bottom line today is about much more than earnings. It is about building long-term value through intangible assets not accounted for on a company’s financial statements, such as leadership brand, corporate culture and the ability to attract talent.

Intangibles now determine an increasingly sizeable portion of a firm’s market value. The "soft" people stuff is as important as the "hard" financial stuff because it builds customer, investor and employee confidence about the future. Companies with high intangible value have higher PE multiples than their competitors. Like coaches of successful sports teams, their leaders have earned the perception that they can be trusted to deliver on their promises about the future.

Because leaders want to build confidence about the future, they need to discover a new bottom line focused on creating value through intangible assets. When they consciously build intangible value through people and organisation, employees will be more committed, and customers and investors will be more satisfied, confident and numerous.

Intangibles are not random, they can and should be managed and are the responsibility of leadership at all levels.

[Throughout the book the authors provide references to online video clips which illustrate their ideas plus assessments and tools that they use with their clients. (These can also be completed online via the website of their consulting firm Results-Based Leadership, to gain access you need to register your details on the site.) The first assessment, for example, allows the reader to decide which part of the book will be of most interest based on their assessment of their organisation’s needs.]

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The new focus on organisational capabilities

The study of organisations has focused in the past on structure and processes. It is now shifting its focus to capabilities. Capabilities represent the ability of an organisation to use resources, get things done, and behave in ways that lead to accomplishment. They form the identity of the firm, govern the way that work gets done, and help managers create an organisation that succeeds. Capabilities are the skills, abilities and expertise of the organisation – how the people think and what they are able to do.

Individual competencies are widely spread throughout the firm but grow into organisational capabilities when they stop being tied to any one individual or programme. Organisational capabilities complement the technical core capabilities; they are the internal and external identity of the organisation. We should think of organisations as "bundles of capabilities", say the authors. The age-old adage "structure follows strategy" is being replaced with "strategy follows from capabilities". It is the job of leaders to turn capabilities within a firm into intangible value for the firm.

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Architecture for intangibles

Intangibles become tangible when they are understood and managed, allowing specific leadership actions and choices to define and deliver them on demand. The authors outline a way to build your own organisation’s intangibles. This "Architecture for Intangibles" consists of four "layers" in which leaders make choices that have an impact:

  • Layer 1. Delivering consistent and predictable earnings. This is the foundation of all the other layers and rests on a reputation for keeping promises about meeting current earnings projections. It is the most critical of all levels to achieve. Without it, there can be no success in building intangible value at any other level. Regularly meeting financial expectations implies that the leaders know their business, have made wise investments, and have the will to make difficult and innovative decisions to accomplish goals.
  • Layer 2. Articulating a future growth vision. Once leaders meet current numbers, they are expected to have a clear strategy for growing the business in the future, in terms of both revenue and cost. The critical elements of creating a strategy for growth include customer, innovation and geography. When investors have confidence that a leader’s strategy will produce a stream of future earnings, the current earnings are valued higher.
  • Layer 3. Aligning future competencies to strategy. The core competencies refer to the technical or functional requirements for a business to succeed and must be tied to specific strategies. They include product innovation, operating efficiency, customer intimacy, distribution and technology. When investors perceive that leaders have created core competencies, they have more confidence in future and current earnings.
  • Layer 4. Creating capabilities. Much of the book is taken up with discussion of this level which is about building a talent base. Here we are looking at shared mindset/culture, talent, speed, learning, accountability, collaboration and quality of leadership.

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Delivering constant and predictable earnings

There are five guidelines for delivering constant and predictable earnings:

  • Set realistic expectations – when expectations are too high they may lead to cynicism; when they are too low they create apathy.
  • Build credibility by degrees – change does not occur all at once or in a linear way. Instead, it builds on itself. A "tipping point" occurs when many little changes add up to substantive change. [For more information on how this works, see the book summary of The Tipping Point.]
  • Communicate frequently. Communication research indicates that the receiver of information needs to hear something ten times for it to make an impact. Consistent, redundant messages have more impact than bold, infrequent blasts.
  • Make bold decisions when necessary to adjust strategy – things will not always go as planned. Adjust the projection as soon as it is clear you are going to miss it; don’t wait and hope for a last-minute reprieve.
  • Legally level earnings, if possible – leaders with variable earnings try to manage risk by reducing earnings risk. They reduce variability by building a business mix that includes both short and long cycles. They also use "smoothing" – moving earnings backwards or forwards depending on business requirements. (The authors warn, however, that smoothing can go too far in eyes of regulators.)

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Articulating a future growth vision

Turning to the second level of intangible building, the authors say that growth rarely just happens. Leaders at all levels have a responsibility to build growth visions by urging their teams to focus on what is in their sphere of influence and by creating a sense of purpose for their team’s work.

Leaders who create a growth vision shape and capture the future. Because of the way they have often been used superficially, there is a lot of cynicism about visions and values. But visions focused on growth can engage employees by showing how their day-to-day work connects to a larger purpose. They help investors see that present investments will result in future opportunities for sustained profitability and help customers have confidence in a firm’s long-term viability.

There are three avenues to growth and increasing revenue. This is the "growth tripod":

  • Innovation – from new products, services and markets. There is no such thing as a mature business. Leaders who focus on innovation constantly ask: What’s next? The authors provide an "innovation protocol" to help leaders assess their unit’s performance on innovation. This sets standards for the different dimensions of innovation such as idea generation, impact assessment, incubation, investment and commercialisation, integration (sharing learning from the innovation), and improvement.
  • Geography – revenue per country. Not all countries are equal; some deserve more investment and attention than others. A three-step process is proposed for increasing global revenue growth: 1.) Select the targeted country. 2.) Develop a strategy to enter its markets. 3.) Use experience in that country as a base for expansion in the region or among similar countries elsewhere.
  • Customer – revenue per customer. Customer growth visions begin with a customer value proposition – defined more by the receiver than the giver. Customer-centric growth visions establish an identity in the minds of customers that becomes a future-focused brand equity that distinguishes the firm for customers and focuses employee attention. (e.g. Eli Lilly focuses on "answers that matter" as shorthand for its vision.)

In addition to the content of the growth strategy, the process of the strategy must also be designed to ensure it delivers value. The authors provide some "process tips". For example, a firm cannot be all things to all people. Its growth vision must focus on a few priorities at a time. Avoid "concept clutter" – trying to squeeze all good things into the strategy.

To communicate the vision, focus on a few key themes and messages. Simple messages, repeated constantly, will become accepted and be acted on.

Leaders who turn vision into commitment make sure that vision translates into employee behaviour. They should ask three questions when developing the vision: What will individual employees spend more or less time doing as a result of the growth vision? How would a customer or supplier know we behaved in a different way? If managers did a time log of who they spend time with and where they spend time, how would it be different with the new vision?

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Aligning future competencies to strategy

Once you have a growth vision, the third step in the architecture is to invest in technical know-how that is consistent with this direction. This means aligning the core competencies – the technical know-how embedded in functional areas – to the strategy.

Within an industry, leaders can choose one of five primary strategic foci to build core competence. Each of these implies different ways of competing, involves different means of tracking performance, and requires different core competencies:

  1. Product innovation – competing through new products. To measure performance, track the percentage of revenues created from new products in the last three years. The core competencies required are investment in R&D, winning new patents, and creating new sources of ideas.
  2. Operating efficiency – competing through reduced costs (via productivity, process and project improvements). Track ratios of operational costs versus competitors. The core competencies required are managing productivity, process improvement and project selection.
  3. Customer intimacy – competing through building customer bonds and relationships of value whereby employees have meaningful interaction with targeted customers. Track customer share from targeted customers. The core competencies required are target customer segmentation, service or connect with targeted customers, and building enduring brand.
  4. Distribution – competing through alternative market channels to customers (investing in multiple channels to serve targeted customers and allowing customers to pick the channels that work best for them). Track revenue from each channel to customer. The core competencies required are logistics management and customer channel creation.
  5. Technology – competing through investments in new technology. Track through access to and application of new technology. The core competencies required are developing unique technology, applying hardware and software for success, and product/service design.

Each business strategy requires its own set of core competencies. When the core competencies match the strategy, leaders can make functional investments to ensure their organisation has the know-how to deliver what is expected. The core competencies can then be tracked and measured as leading indicators of future financial performance. They can also be managed as leaders make choices about how to invest time, money and resources to ensure a continual stream of functional expertise in their organisation.

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Creating organisational capabilities

This is the fourth layer in the architecture. Organisation capabilities are the things an organisation knows how to do well; its ability to use resources, get things done, and behave in ways that lead to accomplishment. They form the identity of personality of the firm, govern the way work gets done, and help managers create an organisation that succeeds. Leaders use seven capabilities to build intangible value:

Building a talent base. Talent represents the ability of an organisation to attract, motivate and retain the employees it needs for peak performance. Talent implies that the organisation with the best, brightest and most diligent staff will be the one most likely to succeed over time.

Leaders need to build competence and commitment. They build competence through assessment and investment. Assessment involves identifying what results-driven competencies are required for the future and determining the competence gap between that and the present (the authors provide guidelines for this process). Investment means selecting from an array of activities those actions that will do most to enhance future talent levels. Five strategies include buying talent, building it by unleashing the latent potential of people already in the firm, borrowing talent through consulting or outsourcing, bouncing poor performers, and binding employees to keep talent on board.

Employee commitment consists of two factors; "cognitive identity" which means employees identify with the organisation, and discretionary energy which implies that employees work hard for the organisation and put its interests high on the list of claims on their attention. Commitment comes from defining a new employee value proposition based on seven practices that increase commitment. Summed up as "VOI2C2E", they consist of Vision, Opportunity, Incentives, Impact, Community, Communication, and Entrepreneurship.

VOI2C2E can be used by managers at all levels of the organisation. It reflects what talented people want from the firm. Vision means employees find meaning in their work. Opportunity gives them a chance to grow and learn new skills. Incentive involves financial rewards for good performance. Impact ensures they work on meaningful projects and participate in decisions that affect them. Community means they are proud to be part of their work team. Communication ensures they have knowledge about what is happening and why. Entrepreneurship gives employees personal ownership of their work through flexible work policies.

Creating a shared mindset. When a firm has a common identity or culture – which is created by a shared mindset – customers identify the firm as a brand and employees know what is expected of them. As an intangible, a shared mindset increases customer value by establishing confidence in the firm’s brand and increases employee productivity and commitment by reinforcing behaviour in accordance with customer expectations.

A shared mindset produces intangible value when it creates an identity or reputation in the minds of employees, customers and investors that is tied not to a person or product but to the firm itself. It becomes a self-fulfilling prophecy when it affects how each stakeholder behaves toward the firm. The authors propose a four-phase process:

  • Create the desired identity by asking: What are the top three things we want to be known for by our best customers in the future?
  • Make the identity real to customers – by specifying "touch points" – contact points between the firm and customer – and finding ways to make the desired identity real in each one.
  • Make the identity real to employees – through intellectual, behavioural and organisational "agendas". The intellectual agenda is based on simple messages that change how employees think about the firm. The behavioural agenda encourages and integrates employee behaviours consistent with the desired mindset. Through the organisational agenda, the principles of the new mindset become embedded in the organisation’s system and processes (e.g. rewards, and training and development).
  • Build an action plan for implementation – by planning for small steps of change and early successes. Leaders should focus two or three specific areas in which they could make the culture real to employees and customers. They should put a review of the mindset on the management team agenda and hold direct reports accountable for acting on it.

Speed. Being right is not enough when being first is critical. Speed not only allows for first mover advantage into new markets and products, it excites and engages employees.

Speed of change is more important than change itself. The author’s motto here is: "First beats best." Four practices increase speed:

  • High quality decision making – based on clarity, accountability, timeliness, attention to process, and follow up.
  • "Bureaucracy busting" – bringing employees and managers together in open dialogue to identify ways to remove barriers that prevent things being done quickly.
  • Speed profiling – making individual initiatives happen faster by profiling critical success factors to see how quickly they might be implemented, deciding where to focus attention, and investing in actions to master each critical success factor.
  • Eliminating viruses – working with your team to identify, understand and remove the "sacred cows" and patterns of thinking and behaving that impair financial health.

Learning. Learning becomes critical to an organisation when it attempts to generate and generalise ideas with impact. Leaders who build learning organisations encourage creativity and innovation of ideas within an organisation unit, and then build disciplined processes for sharing those ideas across units. Learning capacity becomes an intangible value when organisations have the ability to move ideas across vertical, horizontal, external and global boundaries.

Investors recognise intangible value in organisations with a learning reputation because these firms not only create new ideas, they share those ideas throughout the enterprise and build knowledge networks where experience is transferred from one setting to another.

Learning as an intangible requires three building blocks – generating ideas, generalising those ideas, and ensuring they have impact (i.e. that something substantial has changed and added value to the firm’s stakeholders over a long period of time). There are three target groups:

  • Individual learning – ensuring that people are creative and innovative and that they see patterns in behaviour and then do things in new ways. Train everyone to be a learner and to generate new ideas by helping them master the "choice-consequence-correction" learning cycle.
  • Team – ensuring that teams encourage creativity and approach problems in news ways, and ensuring they learn lessons from successes and failures. Team leaders must be role models here.
  • Organisation – ensuring that organisations find new ways to bring new ideas in from then outside and have the ability to share ideas across units. Encourage experimentation, competence acquisition, continuous learning and benchmarking. Frequently audit for internal best practices and find ways to export those ideas to other parts of the firm. Use the firm’s intranet to create chat rooms on important issues, making it easy to discuss important ideas across geographic boundaries.

Accountability. When organisations have individuals who are accountable for their behaviour and outcomes, they have the ability to execute and deliver what they propose. Leaders build organisations with accountability by setting clear goals and having consequences for meeting or missing goals.

Accountability is about making team work happen. When an organisation begins to tolerate excuses for poor results they start to mount and take on a life of their own. Accountability exists when leaders and employees deliver what they promise, on time and every time. It means when failure occurs, mistakes are acknowledged and lessons learned for the future. Accountability is a culture or way of work that shapes how employees behave. It sets a standard about what must be done that compels employees to do it. When accountability exists, high performance matters.

There are four phases of accountability with implications for both individuals and organisations:

  1. Strategy. What are we trying to accomplish? Where should an individual focus attention and energy? What are the goals or priorities of an organisation unit?
  2. Measures. How will we recognize success and what are our standards? What indicators will tell individuals how they are doing? What measures can organisations use to track performance and how can they be woven into performance appraisal process?
  3. Consequences. What are positive or negative consequences of meeting or missing measures? What happens if the individual does not meet goals? At the organisational level, what are the reward systems that deliver value?
  4. Feedback. How do we know how we are doing? How can we provide individuals with feedback on their performance? How can we build organisational feedback mechanisms to track results?

Collaboration. As organisations grow, leaders have to make the whole more than the sum of the parts. Larger, complex organisations need formal mechanisms to share information and create unity across the organisation. Collaboration refers to different parties (individuals, teams, plants, divisions, etc) working together toward a common purpose. It involves the capacity to manage efficiency (and its requirements for standardisation, control and consistency) simultaneously with effectiveness (and its focus on flexibility, customisation and responsiveness.)

There are some general principles and processes of collaboration that apply at different levels of the organisation as well as for the entire company. Ranging from the simplest to implement to the most complex these include:

  • Standards – Whereby leaders share a set of expectations and measures across boundaries about what is expected.
  • Information – Leaders share information through knowledge databases, case studies and site visits.
  • Expertise – Leaders share expertise and competence by moving people from one unit to another, either on full time or temporary assignment. They identify best practices and share those experiences with others.
  • Authority – Leaders share authority to solve problems with cross-functional teams or boards.
  • Business processes – Leaders collaborate on business processes to reduce costs and share knowledge about accomplishing work.
  • Innovation and design – leaders build collaborative ventures to create new products and services.

The authors look at how these processes apply in three common applications of collaboration: mergers and acquisitions, globalisation and shared services, They suggest these are the three areas that provide the most mileage for leaders seeking intangible value through collaboration.

Collaboration appeals to investors as an intangible because they want to know that leaders can work together and make the whole more than the sum of the parts. They want to see that when a firm grows through mergers or joint ventures or product innovation, the growth always makes the entire enterprise more successful, not just some individual part. Customers value collaboration because they get both personalised service from one part of the firm and institutionalised support from the larger parent firm.

Leadership brand. When there are effective leaders at all levels of the firm this becomes an intangible asset. "Captains everywhere," as the authors put it. Effective leaders demonstrate competencies (defined as knowledge, behaviours and motives) and deliver results. Investors who perceive a higher quality of leadership will have more confidence in a firm’s future earnings opportunities.

Leaders have two jobs relative to leadership intangibles: "be" and "build". First, they must be the leaders they expect others to become and must lead by example. Leaders send cues that others act on. Secondly, leaders must build other leaders. The ultimate test of a leader is what happens when he or she departs.

Building quality of leadership throughout an organisation rests on three activities:

  • Developing a leadership brand. Leadership is one of the most visible intangibles. Focusing on leadership as a brand creates value for investors, customers and employees. When the brand clearly, accurately and powerfully represents the intellectual capital of the firm, customers have greater confidence in branded products and services and are willing to pay a premium for them. The brand must be embodied in each leader throughout the firm. When they embody the firm’s brand in their actions and results, they convey that brand identity to employees who then convey it to customers.

Leadership brand lies at the heart of a firm’s identity. It occurs when a sufficiently large number of leaders exhibit distinct leadership practices over time.

Branded leadership, say the authors, requires a new definition of leadership that emphasises results as well as attributes. Leaders who demonstrate attributes and deliver results become branded leaders. They turn attributes into results by answering the "so that" query for each attribute they demonstrate (e.g. leaders at Disney have a vision so that guests will return home from a theme park with positive memories and stories).

Building a leadership brand may be done in five steps: 1.) Be clear about your strategy. 2.) Ensure the strategy leads to a shared mindset. 3.) Articulate desired attributes. 4.) Define desired results. 5.) Link results and attributes into a leadership brand statement.

  • Assessing quality of leadership against the leadership brand. A leadership brand without assessment will not endure. Assessment ensures that leaders throughout the firm are accountable for living the brand. Unfortunately, many leaders work well on either attributes or results, but often not on both. The authors present a simple matrix for assessing a company’s leaders dividing them into four groups depending on how they stand with regard to leadership attributes and results:
    1. Current and future stars (high attributes, high results). They should be nurtured.
    2. Unlikely to succeed (low attributes, low results). They should be removed.
    3. Hard workers who don’t deliver (high attributes, low results). They have good intent so deserve further investment.
    4. Make it happen, no matter how (low attributes, high results). This is the most difficult group. "Gung ho" managers get results but not by applying the firm’s values. They often grind people down and stifle them. General Electric took a "watershed" decision to remove such managers but a less draconian solution would be to give them a chance to try new behaviours.
  • Investing in future leaders. Leadership investment falls into three categories; training, development and supporting systems. Training programmes send messages about what matters in the organisation and must find innovative ways to deliver the leadership brand. Training has more impact when leaders accompany their work team through the programme. Customers should also attend workshops as team members as they validate the ideas taught and help to build commitment to acting on them.

Development will include coaching, assignments to task forces and project teams that expose people to new ideas and experiences that stretch them. Job assignments should give people experience in different business settings: growth versus turnarounds, line versus staff, small versus large, capital-intensive versus service-oriented, etc.

Through such development experiences, people begin to develop a learning mindset where they constantly go through a "choice-consequence-correction" cycle. Leaders should spend as much time thinking about shaping development experiences for emerging leaders as they spend on designing and delivering training programmes.

Investment in training and development must be coupled to supporting management systems to be effective. Leaders wanting to inculcate a leadership brand can use many levers to shape behaviour – reward systems, the performance appraisal system, promotions, etc. Communication by senior executives needs to be consistent with the leadership brand. Leaders need to have similar messages repeated over and over again. The informal messages leaders give in personal interactions with their subordinates often have the most impact.

Ultimately what employees see is how leaders spend their time. Leaders who spend time on the attributes and results of the leadership brand become congruent, have credibility and make more impact.

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Making intangibles tangible

One of the themes of the book is that there are no quick fixes to make change happen, but that the cumulative effect of many actions builds sustainable impact. The authors conclude by offering advice for building intangibles for senior executives, leaders at all levels, and HR professionals. Creating intangibles, they say, is a shared responsibility and leaders throughout a firm must focus on building intangible value:

  • Senior executives represent the organisation to outside stakeholders such as investors or customers. Those who interact with investors need to create ways of sharing intangibles that go beyond the balance sheet. They need to find a way to frame their investor conversations around intangibles.
  • Finance and accounting managers and specialists need to become more aware of intangible value and help define, improve and measure intangible factors.
  • Where HR is concerned, traditional measures of success (e.g. the percentage of managers who receive training per year) should be replaced with measures of the outcomes of HR activities – i.e. delivering intangibles such as learning, talent, speed, and shared mindset.

Finally, one of the biggest challenges is to provide investors with information about intangibles. Currently, most publicly required information focuses on financials and the intangibles are left to speculation and investor judgement. Investors need to look behind the numbers and make judgements about leadership intangibles. Firms need to consider how to help them make those judgements more easily.

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