Before being seduced by the bright lights and glamour of the accounting profession, I did a Law degree. That taught me the single most important thing I’ve ever learned, and I’m going to tell you what that is in just a moment.
It’s how I’ve been able to create great businesses as a CFO and in other C-Suite roles.
As a CFO, I know that keeping your accounting records straight is an important, and legally-required, activity. It keeps you out of jail, but it’s rare this adds a lot of value to any business.
There is, however, one thing I do which always adds value. And you’re about to discover how to do it too, making you smarter than a Nobel Prize winner if you do it right.
It’s something I learned it in the second year of my Law Degree.
The wise old professor who took our Company Law class looked at us over the rim of his glasses one morning, mid-lecture, and told the class-full of aspiring young lawyers… “Never forget there are always two sides to every legal argument…there’s often more than two, but there’s always at least two. It’s your job to work out the other side’s perspective and why that might be different from your client’s so you can develop a way of counteracting their claims.”
There’s always at least two sides.
Especially when you think there isn’t.
To run a great business you don’t need the smartest people in the room. In fact, sometimes that’s a hindrance rather than an asset, as we’ll see shortly.
What you need are different experiences and different perspectives. Someone exploring the side of the story nobody else is.
And in case you think that’s an unnecessary luxury or a waste of time, here are three quick stories of how some of the smartest people on the planet got things spectacularly wrong because that’s exactly what they thought…followed by the steps you can take to make sure your business doesn’t suffer a similar fate…
To screw things up really badly, you need a Nobel Prize winner
To screw things up really badly, you need a Nobel Prize winner. But to bring the financial world to its knees, you need two.
Improbable, you might think, but in 1998 that’s exactly what happened, largely behind closed doors and with the minimum of publicity. For a time, unknown to most of us, the international financial system was only a heartbeat or two away from collapse.
And we got there thanks to two Nobel prize-winners and a room full of PhDs in Greenwich, Connecticut. Some of the smartest people on the planet.
Robert C. Merton and Myron Scholes won the Nobel Prize in economics for developing a financial model which untangled the arcane world of pricing options on financial markets.
So when Merton and Scholes became partners in Long Term Capital Management (LTCM), a hedge fund set up by some of Wall Street’s biggest names of the mid-1990s, surely nothing could go wrong?.
LTCM used the principles developed by Merton and Scholes (and Scholes’ co-developer Fischer Black…together, creators of the Black-Scholes Option Pricing Model which is still used in financial markets today) to devise an unusual investment strategy using highly-leveraged financial derivatives.
LTCM’s approach was hugely successful for a time, returning unprecedented 40%-plus annual gains on its portfolio.
But, soon after, this secretive, closely-held hedge fund controlling highly-leveraged off-balance sheet derivatives worth an estimated $1.25 trillion…roughly the GDP of an economy like Australia or Spain…came crashing down in spectacular fashion as their models stopped working and their luck ran out.
The reason for this collapse? Insiders at LTCM were so wedded to their “magic formula” that they couldn’t see any other possible strategy. People who didn’t “get” their genius were shunned or ignored. They were the smartest people on the planet, after all, so everyone who didn’t see things their way must be suckers or idiots…right?
LTCM stuck by their strategy even as the markets moved sharply against them because they were so convinced the market was wrong and their formulas were right.
As we know now, it turned out the market knew exactly what it was doing after all and LTCM disappeared in a cloud of dust as quickly as it had arrived on the scene just a couple of years earlier.
The Federal Reserve twisted the arms of the big Wall Street banks to bail out LTCM at a cost of $4 billion or so and save the international financial system from potential ruin.
But, to the very end, some of the partners at LTCM believed so firmly in the models the firm had developed and the strategies their data had led them to believe were “true” that they almost went down with their ship.
And nearly took all of us with them.
History doesn’t repeat, but it rhymes
10 years after LTCM went belly-up the financial crisis hit.
The rot started when sub-prime mortgage specialist New Century Financial Corporation went into Chapter 11 protection in April 2007. 18 months later Lehman Brothers spectacularly imploded and nearly took the global banking system down with it.
The Federal Reserve and governments around the world pumped billions into their economies to prevent the global banking system collapsing altogether.
While there were many contributory factors, at the heart of the financial crisis were the “Quants”, or Quantitative Analysts…Wall Street’s developers of complex spreadsheets and financial models.
These backroom specialists thought they’d developed a way of taking sub-prime mortgages…essentially the dodgiest loans in any lender’s portfolio…and converting them into AAA investments.
In fairness, the maths is quite interesting and the broad concept is not without entirely without merit but, as we now know, those loans were not as attractive as the Wall Street sales teams would have us believe. It turned out they were largely worthless.
Even at the time, some investors held the view that, to put it as politely as possible, no amount of effluent could be endlessly repackaged with a range of other sources of effluent without it remaining anything other than 100% effluent.
But the Quants had their models and their spreadsheets showing just how valuable their securities were.
There was plenty of “proof”, plenty of data, plenty of financial models developed by top-end PhDs from the very best Ivy League schools. These were smart people. And the numbers never lie…right?
On the way up, everyone did very nicely out of this financial alchemy. Few people asked awkward questions while they were busy filling their own bank accounts.
Like Long Term Capital Management, the strategy worked absolutely fine until…virtually overnight…it didn’t, and the biggest financial crisis the world has ever known got fully into its stride.
I’d like to buy the world a Coke
Sometimes called the “hilltop ad”, the mighty Coca-Cola Company shifted plenty of their products on the back of one of the classic TV ads of all time.
Even the jingle was adored, a rare event in the tough world of TV advertising. It was so popular The New Seekers took a re-worked version, which they re-titled “I’d Like To Teach The World To Sing (In Perfect Harmony)”, to the UK Number One spot in 1971.
The Coca-Cola Company had long been one of the world’s most profitable and most successful businesses. Until one day in the early 1980s, when they had an idea which has since been used as a case study of corporate failure in probably thousands of MBA classes.
Coke was concerned about their main rival, Pepsi. They’d been making ever-greater inroads into Coke’s dominant market share since the end of the Second World War.
The pressure ramped up in 1975 when, with the warm feelings of the “I’d like to buy the world a Coke” commercial still fresh in soft drink buyers’ minds, Pepsi launched their hugely successful “Pepsi Challenge” campaign.
Consumers were invited, on camera, to sip Pepsi and Coke side-by-side in a blind taste test and choose their favourite. When the big reveal came, their preferred drink was almost always Pepsi, even among people who described themselves as long-term Coke drinkers.
Perhaps understandably, this caused consternation in Coke’s headquarters.
The New Product Development team was whipped into action. Make us a drink that performs better in blind taste tests than Pepsi, they said.
After spending a rumoured $4 million in new product development costs (Coca-Cola has never confirmed the actual number) that’s exactly what they got.
Almost 200,000 blind taste tests were carried out to reformulate Coca-Cola’s century-old recipe. As many as half of the testers preferred New Coke to both Classic Coke and to Pepsi. It was just what the top brass had been hoping for.
Certain of their strategy after analysing the data from those 200,000 taste tests, overnight Coca-Cola retired the recipe they’d been serving for 100 years and introduced New Coke in a blaze of publicity.
There was just one problem.
Despite the extensive pre-launch testing, in practice consumers didn’t buy New Coke in the shops…or at least not more than once.
There was plenty of speculation about why, but that hardly matters. When it came to voting with their wallets, consumers didn’t buy New Coke at the tills. The 100-year old Coca-Cola Company was on the brink of a meltdown.
Only 77 days after withdrawing what was now called Classic Coke from the shelves, the Coca-Cola Company re-introduced it and consumers started buying their products again. New Coke’s market share dwindled to almost nothing and it was quietly withdrawn, and an estimated $30 million of unsold concentrate written off in the process.
At the press conference to announce the hurried back-tracking on their strategy Coca-Cola’s then-President, Don Keough, uttered probably the most honest assessment of an internally-created disaster any business leader has ever given…
Some critics will say Coca-Cola made a marketing mistake. Some cynics will say that we planned the whole thing. The truth is we’re not that dumb and we’re not that smart.Don Keough, Coca-Cola President, 1985
Where did it all go wrong?
These three business disasters…and there have been plenty more…share one common characteristic.
Nobody in the business was taking a different perspective to everyone else.
The same Kool-Aid was being quaffed by everyone involved in the decision-making and, if there were any dissenting voices, they quickly got the message that their input was unwelcome to a career-threatening degree.
In every case, there was nothing wrong with the mathematical calculation of the numbers all these businesses relied on. The basic premise was flawed, but the maths just faithfully reflected that initial premise.
Put enough scientific-sounding formulas together and throw in some huge computers churning through terabytes or petabytes of information and very few people are going to challenge the answer the magic box throws out.
None of these ultimately fatal decisions lacked data. But data alone wasn’t enough to protect those businesses from disaster.
In every case, each business allowed itself to be seduced by their own brilliance, convinced of their invincibility, secure in their position at the top of the world.
Because of their brilliance…those Nobel Prize winners, rooms-full of top PhDs, expert new product development teams…those businesses suckered themselves into believing they had an edge they didn’t really have.
The more data they had, the more they believed everyone else in the world…Wall Street, the Federal Reserve, soft drink buyers…were completely wrong.
Those businesses forgot their data was just a model…an estimation, an approximation, a best guess at a point in time.
Data was elevated from the status of “potentially helpful aide to decision-making” to the status of “nobody dare question the all-knowing, all-seeing Oracle”.
Strong opinions, loosely held
If you can’t rely on your data what do you do?
When his fund makes investments, he thinks in terms of “strong opinions, loosely held”.
What he means by that is the firm is completely committed to whatever strategy they’ve decided, but they’re always testing out other options, considering where their initial model may be off-base to some extent, and they don’t shy away from having to completely re-invent the business model if that seems the right thing to do.
In the 10 years since the firm was founded, Andreessen-Horowitz has grown from nothing to having $10 billion under management. So it’s probably fair to say there’s something in that approach.
If you’re not lucky enough to have a top Silicon Valley VC on board, what do you do?
No matter how well you’re doing, you need to be able to take a completely different perspective on your business.
Just as the darkest hour is just before dawn, the biggest risk to your business comes when things have never been better.
LTCM enjoyed a succession of stellar years before going belly-up in the matter of a few months.
Wall Street was buzzing, bonuses were flowing, markets were booming…right up until the point where the sub-prime crisis hit and a succession of major financial institutions imploded overnight.
The Coca-Cola Company was still the world’s number one soft drink maker when it decided that it needed to be more like its less-successful competitor even though the race was Coke’s to lose.
Taking a very different perspective sounds easy, but it’s really hard. The odds are stacked against it to a large extent.
If you ask one of your managers for a report on something, odds are they’re not going to put something forward that shows them in a bad light. Even if they have to stay up all night to find a glimmer of positivity, they’ll include some data to suggest they’re doing at least an OK job, even as their world collapses around them.
That goes double if the report relates to a part of the business where the CEO or the Board has been quite specific about how they want it to run.
How the business interacts with customers, both its current customers and its future potential ones, is a common area for CEOs and Boards to take a particular interest. Ditto how it interacts with employees. And, occasionally, how the technology that underpins the business works.
That doesn’t mean any of those strategies are wrong. But over time, the market might move in a different way. To give a current example, the Daily Telegraph reported at the weekend that Facebook usage is down by one-third in the UK due to concerns about their data privacy policies.
Money-making machine though Facebook is, it’s in real danger of being caught on the wrong side of a sudden market move away from sophisticated, some might say manipulative, advertising-funded income strategies and towards a world where there are greater concerns about protecting privacy.
Their strategy worked until it didn’t. Just like LTCM’s. Just like Lehman Brothers’. Just like the Coca-Cola Company’s.
That’s why a different perspective is so important.
And, in a lot of businesses, that’s the job of your CFO. Even though they will be just as committed to your business succeeding as you are, the worst thing you can expect them to do is drink the same Kool-Aid as everyone else.
A good CFO should be good with numbers, without being a slave to them…especially when those numbers come from somewhere other than the Finance Department.
They should be supportive of the company’s mission, but challenging about the best way to get there.
They should help make sure any major decision…even one taken for the best of reasons with more data than you can shake a stick at…doesn’t bankrupt your business if it should turn out, with the benefit of hindsight, to have been a move in the wrong direction.
One of the best ways to make sure your plans don’t go awry is to have the right Finance Director or CFO in your business, someone who’s going to bring a perspective nobody else is bringing..
When the rest of the business is zigging, you want your CFO to be zagging. Not necessarily because they’re right, but just because that’s how you bring a different perspective to bear. That’s how you end up considering some issues you might not have considered otherwise.
And remember, there’s always at least two sides to everything. You need to give someone the job of finding the perspective everyone else has missed.
Your CFO is usually a great choice.