NZIM – INVESTING : Successful Companies – What they have in common

There is no single prescription for becoming “successful” company. But certain characteristics do, particularly when they are present together in an enterprise, increase the probability that company will be seen as “successful”. Conversely, and perhaps more importantly from an investor’s point of view, when these characteristics are missing alarm bells ring and I prefer to invest elsewhere.

Governance and communication
It starts with governance and senior management. Successful companies have experienced directors and senior management teams who openly seek to increase shareholder wealth. However, it is not just experience per se. It is the breadth and depth of relevant experience that is fundamental to long-term business success. In fact, few New Zealand boards lack accounting and legal expertise. But some jump out as having healthy mix of operational, technical and marketing experience. Such mix is essential for board to effectively evaluate and contribute to the strategies pursued by the chief executive and senior management team.
And I look for clear and open communication from board. Few things make me more nervous than chairman who responds to questions at an annual meeting with long-winded and irrelevant responses. I expect them from politician and not shareholders’ representative.
Similarly, I am wary of boards that seem unable to admit mistakes and take responsibility for their actions, or inaction, particularly if, when the going is good, those same boards are quick to take direct credit and the rewards.
We all want to be confident about our investments and board that communicates openly and constructively is more likely to engender confidence from investors and, just as importantly, from senior management and other employees.

Decision making
Successful companies make proactive decisions. These decisions are, in most cases, based on an awareness of their own and their competitors’ competitive marketplace position, and clear understanding of their customers’ needs. This approach results in the timely introduction of new or modified products and/or services, often the outcome of collaboration with key customers. On the other hand, poor performing companies are more reactive in decision making, whether responding to competitor behaviour, consumer/market demands or regulatory changes.
Poor performing companies are also likely to make important decisions without adequate research or evaluation of the potential consequences. Key senior executives are often not actively involved in the evaluation, relying instead on the advice of external consultants. The consultancy approach doesn’t doom every initiative to failure, but lack of rigorous internal analysis and debate, including at the board level where major expenditure and/or changes in strategic direction are involved, is not recipe for good or consistent decision-making.
Acquisitions provide an example of major transactions that successful and less successful companies tend to approach differently. Successful companies are generally unafraid of acquisitions. They do not, however, underestimate the difficulties associated with these transactions and are not afraid to walk away from deals that offer marginal returns or require bold assumptions around “turnaround potential”. In my experience, few successful companies rely on highly leveraged acquisitions of struggling companies to generate long-term growth.
Successful companies also recognise the risk involved when boards and management get wrapped up in “the thrill of the chase”. Instead, they retain focus on generating shareholder wealth. They are also aware of the potential divergence between shareholder and management interests and avoid policies that reward growth for growth’s sake.
Successful companies devote significant senior management resource to acquisition decisions and to the ongoing management of successful takeovers, in addition to financial resources. Large acquisitions and those that take firms into new territory, such as the purchase of an overseas company, will typically see the CEO and other key senior executives actively involved.

Avoiding complexity
Most successful companies have relatively simple organisational structures with only few layers of management and relatively small head offices. This delivers transparency and constructive communication as opposed to stifling bureaucracy.
Consistent with simple organisational structure is logical and transparent remuneration policy that is clearly linked to relevant drivers of individual and organisational performance. Successful companies seldom exhibit jaw-dropping discrepancies between remuneration packages at different levels of the organisation.
Conversely, less successful enterprises frequently have complicated organisational structures reinforced by many layers of management and large head office. Managers are often based in different location from those they are managing. The result is less regular communication, particularly informal and open communication. These organisations are likely to apply different “logic” to the way remuneration decisions are made and have larger pay differentials
Differences in structural characteristics and remuneration philosophy manifest themselves in number of key ways. For example, successful companies generally have lower staff turnover and they retain the “right” people.
Retaining top performers who, as rule are more engaged in their work, is crucial to the long-term development and leveraging of intellectual and human capital. This, in turn, builds competitive advantage and platform for ongoing success. Lower staff turnover also enhances the case for significant employee training and development, both of which strengthen the company. And the more training and personal development delivered, the longer the enterprise retains the best employees.

External consultants
Successful companies seem to make much less use of consultants. Less successful make what I perceive as excessive use of consultants for one or more of the following reasons:
•Management lacks the experience or confidence to carry out sound analysis and make genuinely informed decisions.
•A complicated organisational structure results in managers not having clear responsibilities and consequently preferring to avoid personal decision-making.
•Management is unable or unwilling to acknowledge poor performance and seeks “explanations” from theoretically impartial sources to divert attention from their own shortcomings.
•Weak boards seek external validation for questionable decisions, particularly on issues like CEO and senior executive remuneration.
This is not to say that consultants do not have place. But successful organisations use consultants where they can genuinely add value and where permanent resource cannot be justified. As an investor I am not enamoured of already top-heavy companies that make almost permanent use of external consultants to do the work of senior management, the CEO and even the board.

Des Hunt, FNZIM, FIOD, runs his own private investment company and is corporate liaison director of the New Zealand Shareholders’ Association.

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