Archive for March 13th, 2010
How do you measure an organization’s wealth? Is it based on a company’s stock price or total return to shareholders? Is it in the organization’s book value – essentially what an organization’s physical assets are worth? Most will add in a component called “good will”, a concept that is notoriously difficult to measure as it is more or less the value of one’s reputation. Many organizations will say that its value resides within its people and from that their value springs. Interestingly while “good will” can actually show up in an organization’s valuation, employee valuation – or employee goodwill does not. I wonder if that is why phrases like “employees are our most important asset” ring hollow in some organizations.
What would it take to have a component of organizational culture, employee attitudes, become a concept so well entrenched and valued, so well recognized that it became standard practice to have it show up on a balance sheet or company valuation? Would a company be worth more in a merger situation if it could show its employee valuation to a potential acquirer? Would mergers and acquisitions proceed more smoothly if beyond financial calculations and “books of business” that organizational culture fit were taken into consideration?
What about organizational growth or a track record of success? While a track record may be taken into consideration by those buying shares, a track record of success does not often get into the measurement of value; rather it is earnings and expected earnings. But what if an organization had a procedure to more successfully expand its offerings and be more successful as it considered its expansion opportunities? A more scientific approach to deciding on product development and growth may be in the works and if utilized by organizations may lead to more reliable product and expansion outcomes increasing the wealth of the organization.
Poor or developing nations often depend on a single or small number of critical products to earn currency. Crops such as coffee or sugar or natural resources such as timber or diamonds or some other more limited resource are exploited to provide a source of income. Some countries depend on income sent home by workers based overseas or across borders in foreign lands. A common theme is that the economy of these poorer nations is not broadly based. This pattern has been well known, and countries have tried to break this pattern by attempting to branch out into other industries trying to diversify their sources of income. Most have not truly succeeded in this effort and the poverty stays stubbornly entrenched. A group of economist and physicists are trying to chart a path out of this poverty and have developed a technique and some lessons from which all organizations can learn. They have determined that a country’s prosperity can rise along well-define paths much as disease can spread along social networks (Science News, Sept. 1, 2007).
In more traditional work, economists look at what is called “factors of production”, infrastructure such as roads, airports, ports, and talent sources such as labor pools and educational institutions to determine the products and industry that a country could attempt to expand into. The notion was that if a country had a specific asset, such as good ports that other industries that also needed good ports could flourish there. When the actual record was looked at for attempted expansion using that method the most common finding was one of failed growth. What traditional theory and practice failed to take into consideration was the “distance” between the two products.
So for instance a country with a skilled group of engineers able to produce and export computer chips are not able to capitalize on that skilled group to produce and export cars, because the “distance”, the needed capacities to produce the two products, was too large. The country therefore that thought it was playing to its strengths was actually not. In order to improve this modeling and better predict economic expansion success, two researchers, Ricardo Hausman and Baily Klinger, attempted to map “distances” between products, suggesting that the closer a product is to one another the more likely it is for a country to successfully expand into that new product or market niche and increase the nation’s wealth. For instance one of their findings was that a country that was successful at exporting fresh fish would be more likely to succeed at exporting fresh produce, because both require ports, refrigerated storage, and agencies to monitor food safety, making the distance between the two products not too great. It is the large number of similar traits and characteristics between the two products that make them either similar or dissimilar not necessarily that they come from the same industry.
The two researchers mapped out the distance between 775 types of goods and each grouping of products became a node. When nodes where mathematically close, these represented products or industries that could more successfully branched into. Where the nodes were more distant the likelihood of successfully branching into those products or industries was lower. By examining 20 years of data using this approach the researchers came upon a pattern showing that the most successful countries are the ones that have expanded from one node to the next closest node. Less success is seen when a country tries to expand from industries clustered around a node into industries from a non-adjacent node.
At first this may sound like the traditional advice of “sticking to one’s knitting”, but it is much different. It is more akin to analyzing and utilizing the skill sets and capabilities of the organization in complementary products and services that need those similar skill sets, capabilities and infrastructure components. Expansion into new products, markets, geographies etc. using one lens, may seem eminently sensible, while under another lens somewhat questionable using this technique.
One question is the transportability of the technique from the country level to the smaller organizational level. One thing though that I have noticed is that when “truths” are finally defined that they tend to be very robust and transportable across a large variety of situations.
The credit market turmoil leading to the recession of 2008-2010 was partly causes by lending institutions expanding into marginal home mortgages. Under the traditional lens, the institutions saw the expansion as simply more of the same, increasing their portfolios to an expanded market, namely those with more marginal credit – the sub-prime market. They were already serving the home mortgage market, so an expansion to this more marginal group was a natural extension of current practices, fattening up market share and securing growth for the organizations. “Liar loans”, so called because they entailed no income verification became common. The banks and the borrowers were living in a dream world assuming that their economic circumstances would improve or at the very least not diminish. They failed to take into consideration that market conditions change, the housing bubble might burst removing equity, while at the same time interest rates could increase making paying off that higher loan much more difficult. Many trapped in this position can not even simply sell the house to pay off the debt as the amount of debt for many is higher than the current value of the house. Bankruptcies are on the rise.
The same business opportunity viewed through a non-traditional lens, the distance between their old products, the more traditional mortgage loans, vs. the new products, loans to the sub-prime market, can cause a different picture to emerge. One the face of it the distance between the two products would not seem too great, but you might find that differing standards and skills are needed to successfully lend to a sub-prime population. For instance, predicting the ability to repay a loan when the loan is made with a differing set of standards in place may require skills that were not necessarily available within the banks.
Did the banks examine their ability to function in this new space to successful serve it, or was the thinking much more simplistic – make more loans, expand the portfolio? Certainly one could criticize this logic for having the benefit of hindsight fairly easily. But this whole approach, of looking at the distances between new products and markets, prior to jumping into them, both at the country level and the organizational level would certainly seem worthy of more thought and study as it might prove powerful in helping organizations successfully expand and increase their wealth.
© 2010 by Jeffrey M. Saltzman. All rights reserved.