Podcast Summary
Lessons from industrial titans for tech businesses: Industrial giants' lessons on capital allocation and business strategy can help tech companies avoid pitfalls and deliver shareholder value long term
The lessons from industrial titans in business history can provide valuable insights for tech businesses navigating growth and maturity. Scott Davis and Rob Wertheimer, authors of "Lessons From the Titans," have seen a striking resemblance between the mistakes made by tech companies and those made by industrial giants in the past. They've found that the industrial world's standard lessons on capital allocation and business strategy can be applied to tech businesses. Watching the technology sector's recent drawdown, they've noticed that companies are making similar mistakes, such as overinvesting in R&D and neglecting shareholder value. The authors believe that learning from the experiences of industrial titans can help tech businesses avoid these pitfalls and deliver shareholder value over the long term. The intersection of these lessons and the tech sector is a fruitful area for exploration, as companies like Danaher, Roper, Honeywell, Boeing, and GE have valuable insights to offer.
Three pillars of a successful tech company: operational excellence, supportive culture, and wise capital allocation: Operational excellence, a supportive culture, and wise capital allocation are the keys to a successful tech company. Learn from past mistakes in the industrial sector to apply these principles effectively.
The success of a company, especially in the tech sector, hinges on three fundamental pillars: operational excellence, supportive culture, and wise capital allocation. Operational excellence is crucial for any industry, including tech, to thrive. The culture of a company should align with its mission for sustained success. Lastly, the way a company deploys its cash flow is a significant determinant of its long-term success or failure. The tech sector, with its cash flow generation, presents an exciting opportunity, but the challenge lies in how the cash is deployed. History has shown that even great businesses face challenging periods, and arrogance, often top-down, can creep into the culture, leading to paralysis or complacency. The first year of a CEO's tenure is typically a period of uncertainty and adjustment, while the last few years can be marked by arrogance and a tendency to rest on laurels. The industrial sector, with its long history, offers valuable lessons from the successes and failures of the past. Unfortunately, history seems to repeat itself, and every generation seems to make the same mistakes over and over again. It's essential to learn from these mistakes and apply the lessons to the tech sector's current challenges.
A company's culture can be easily destroyed despite long-term efforts: Arrogance can lead to cultural breakdowns, but resilience and adaptability can lead to successful turnarounds, as seen in Honeywell's transformation
Culture is a long-term build but can be easily destroyed, and failure is inevitable in business with an increasing pace of change and disruption. Arrogance in organizations can lead to cultural breakdowns, and most companies have a greater chance of becoming worse than better over time. Honeywell, a company that was effectively dead in 2003 due to negative cash flow, massive liabilities, cultural problems, and unhappy customers, serves as an example of successful turnaround. Despite being considered an unlikely choice, Dave Cody's leadership and determination led to Honeywell's transformation. Companies can learn from Honeywell's history and the importance of resilience and adaptability in the face of challenges.
Business systems like lean manufacturing help successful companies stay focused and efficient.: Successful businesses have well-defined systems at their core for focus and efficiency. Implementing a system takes time, but is crucial for younger tech companies aiming for longevity.
That successful businesses over time have a well-defined business system or operating process at their core. This system helps keep the company focused and efficient, ensuring that everyone knows what they need to accomplish daily. Lean manufacturing is an example of such a business system, and it has been instrumental in enabling bottoms-up turnarounds. However, implementing lean or any other business system requires a significant time investment, typically ranging from 7 to 10 years. In the case of a company undergoing a turnaround, the first few years can be particularly challenging as the focus is on keeping the company alive while making the necessary improvements. The Danaher Business System is another example of a successful business system, which is a collection of various tools and best practices adopted over time. For younger technology companies aiming to survive for a century like some industrial companies, establishing a robust business system is crucial. To do this, they should focus on adopting proven tools and best practices, continuously improving processes, and maintaining a culture of continuous learning and improvement.
Adopt a proven approach to unlock potential: Effective business systems prioritize visual management, common sense application, and productivity. They ensure transparency, accountability, and eliminate destructive employees, improving performance of the majority.
Effective business systems, as illustrated by Danner, prioritize visual management, common sense application, and a focus on productivity. Every organization should adopt a focusing tool to ensure transparency, accountability, and the elimination of destructive employees. The real power comes from improving the performance of the majority of employees, rather than relying solely on stars or exceptional individuals. By implementing a business system, organizations can gain a significant edge over competitors by making their employees more productive. It's not about inventing something new, but rather adopting a proven approach to unlock the potential of your workforce.
Evaluating a company's business system: Assess a company's business system by asking if they can identify and fix problems, measure performance, allow bad news to travel up, prune underperforming employees, and have a clear focus.
Having a business system is not the only answer to achieving success for a company. The appearance of a business system, or a movie set, is not enough. Instead, it's essential to deeply embed the system into the company's culture. This includes having mechanisms for identifying and fixing problems, measuring performance, and allowing bad news to travel up. Additionally, effective business systems enable the pruning of toxic employees and have a clear focus, such as ITW's 80/20 approach. As consultants or investors, it's crucial to ask questions to evaluate a company's business system, such as whether they can prune underperforming employees, measure performance, and if bad news can travel up. By assessing these aspects, one can determine the health and effectiveness of a company's business system.
Comparing Performance and Benchmarking Against Industry Leaders: Investors should ensure a company's financial performance aligns with its narrative and compare it to industry leaders for potential investment opportunities.
When evaluating a company's performance and potential, it's crucial to ensure that the numbers align with the narrative being presented. If a company claims success but lacks substantial evidence in the form of improved margins and cash flow, it may be a "movie set" rather than a legitimate investment opportunity. Another important consideration is benchmarking against industries outside of one's own. Companies should aim to compare themselves to the best performers in various sectors, as investors have numerous options and are not limited to investing in a particular industry. Additionally, it's essential to question whether a company is continuously striving for improvement or content with current performance levels. Organizations that fail to benchmark themselves against industry leaders and adopt a value-based pricing strategy may miss out on significant profit potential.
Operational Efficiency and Continuous Improvement: Companies prioritize operational efficiency and continuous improvement to create sustainable value, even in a lower growth environment. This stinginess with capital and focus on operational leverage leads to increased free cash flow and a culture of continuous improvement and benchmarking.
Successful companies, particularly those in a lower growth environment, prioritize operational efficiency and continuous improvement to create sustainable value. This is evident in their numbers and in the way they speak about their management practices. Companies like Honeywell and ITW have demonstrated this by maintaining flat headcount while revenues doubled and returns on capital grew substantially. This stinginess with capital and focus on operational leverage leads to increased free cash flow. Additionally, these companies maintain a culture of continuous improvement and benchmarking to identify areas for improvement and generate feedback loops. As growth rates decrease, it becomes even more important for companies to capture every bit of operating leverage possible to maintain and increase value.
Pivoting towards higher return opportunities: Successful companies generate free cash flow, use it effectively to pivot towards higher return, less cyclical, and more predictable opportunities, and exit underperforming businesses to maximize growth.
Successful companies generate free cash flow and use it effectively to pivot towards higher return, less cyclical, and more predictable opportunities. This was evident in the cases of Danaher, which pivoted from a building products company to a healthcare diagnostics and life sciences company through strategic spin-offs and exits, and Honeywell, which was actively managing its portfolio to exit businesses facing secular decline. An important aspect of this strategy is operating leverage, which allows companies to get a multiple on their growth and net income. The successful execution of these pivots often requires exiting businesses that still look good but face challenges not fully recognized by the marketplace. Companies like Facebook and Boeing are examples of those that have made significant investments in research and development to evolve and pivot their businesses, requiring substantial upfront costs but potentially leading to significant long-term growth.
Operational expertise leads to sustainable earned margins: Companies with deep knowledge of their assets can operate them more efficiently, leading to sustainable earned margins. For growth capital expenditures, a decentralized approach focused on solving today's problems is more effective.
Operational expertise and continuous improvement are key competitive advantages for companies, even if they are renting out equipment or operating in mature industries. Companies that have grown over time and have deep knowledge of their assets can operate them more efficiently than anyone else, leading to sustainable earned margins. However, when it comes to growth capital expenditures, such as investing in new products or research and development, a decentralized approach focused on solving today's problems rather than guessing at future needs is more effective. Centralized research and development efforts, like those seen at IBM and GE in the past, can result in wasted resources and a lack of growth. Instead, companies should focus on addressing their customers' current needs and investing in innovations that have clear applications. The history of industrial giants shows that successful companies have been those that invest in R&D but do so in a focused and practical way.
Focusing on solving today's problems: Successful companies adapt and innovate by recognizing opportunities to solve pressing problems, rather than solely focusing on discovering the future in a lab or through major transitions.
Successful companies, like Danaher and Roper Technologies, focus on solving today's problems rather than solely focusing on discovering the future in a lab or through major transitions. Danaher's accidental invention of the Post-it note serves as a reminder that innovation can come from unexpected places. During the COVID-19 pandemic, Danaher's scientists were focused on developing high-quality and predictive COVID tests and helping vaccine manufacturers get their products to market, rather than inventing something brand new. Roper Technologies, on the other hand, pivoted from a hardware business to a software business by acquiring mispriced software assets and leveraging the cash to invest in higher-return assets. Neither of these companies started with a vision of being a software or biotech company, but they recognized opportunities to solve pressing problems and capitalized on them. This focus on solving today's problems has been a common thread among successful companies, as highlighted in the discussion of Amazon's transition from a retail business to a dominant player in cloud computing.
Investing wisely and building strong shareholder relationships: Successful industrial companies invest wisely, make calculated bets, focus on long-term value creation, and communicate openly with key shareholders to build strong relationships and unlock greater opportunities.
Successful industrial companies make the right investment at the right time, and this often involves making smaller, calculated bets instead of taking big risks. This philosophy has been exemplified by companies like Roper Technologies and Danaher, which have built strong relationships with loyal shareholders through clear communication and consistent performance. For instance, Danaher has maintained a low-key public profile, but has consistently returned value to its large institutional investors like T. Rowe Price and Fidelity. The best managers in industry compete for great shareholders by focusing on long-term value creation and maintaining open communication. While it's impossible to cater to every shareholder, building a strong relationship with key investors can lead to bigger opportunities and greater success.
Danaher's commitment to investor relations: Danaher prioritized strong communication and connection with top shareholders, following up after annual analyst day with meetings, fostering open communication, and maintaining consistent and trustworthy messaging.
Danaher prioritized strong communication and connection with their top shareholders. After their annual analyst day, executives would quickly follow up with meetings with major investment firms, demonstrating a commitment to keeping investors informed and engaged. Additionally, Danaher's culture fostered open communication, allowing analysts and investors to reach out and meet with leaders from around the world. The consistency and integrity of Danaher's messaging were also notable, as was the personal investment executives made in building relationships with investors. A notable example of this was Danaher's efficient equity deal raising process during the 2008 Tektronix acquisition, which showcased their ability to execute effectively and build trust with investors despite market uncertainty. Overall, Danaher's approach to investor relations was marked by a focus on transparency, accessibility, and strong communication.
The importance of strong shareholder relationships during times of uncertainty and pivots: Maintaining close relationships with shareholders is vital for companies, especially during crises or major pivots. Being open to strategic shifts, even when it comes to business model transitions, can lead to success.
Having strong relationships with shareholders is crucial for a company, especially during times of uncertainty or when considering significant pivots. This was evident in the case of Danaher, where close relationships with shareholders enabled the company to pivot during the financial crisis in 2008. However, business model transitions can also be a challenge for mature companies, particularly those with non-recurring revenue. John Deere, for instance, faced this challenge as they sought to transition from selling equipment to a software-based business model. Despite their initial skepticism, Gerber and Brett saw potential in Deere's strategy to add value to farmers and save them resources, leading to a pivot in the company's approach. Overall, these case studies demonstrate the importance of staying close to shareholders and being open to strategic pivots, even when it comes to business model transitions.
Building trust is essential for business success: Deere built trust with farmers through tech investment, demonstration, and communication. Companies need to earn shareholder trust with sound bets and value delivery. The flywheel concept reinforces doing the right things for growth and talent retention.
Trust is crucial for businesses, especially when implementing new technologies or business models. Deere & Company's successful pivot into precision agriculture is a prime example. They built trust with their farmers by investing in technology, demonstrating its value, and communicating the ongoing benefits. Similarly, companies need to earn the trust of their shareholders by making sound bets and consistently delivering value. The flywheel concept, which reinforces doing the right things, is also essential for long-term success. Companies that get on the flywheel experience increased opportunities for growth and retention of talent. Ultimately, software companies should trade at a premium to industrial companies due to their potential for consistent alpha generation, but many investors fail to fully engage with this story.
Emphasizing continuous improvement and reinvestment for sustainable success: Focus on long-term growth, drive up margins, cash flow, and reinvest, adapt to disruptions, and foster a supportive work environment for repeatable success
Companies need to focus on sustainable success, not just momentary bursts of it. The flywheel concept, as discussed in the book, emphasizes the importance of continuous improvement, driving up margins and cash flow, and reinvesting that cash flow back into the business. This can lead to repeatable success that lasts for decades. Another important lesson is that disruption is often telegraphed and companies that fail to pivot or adapt risk being left behind. Lastly, having a supportive work environment and learning from colleagues can be crucial in developing the necessary skills to succeed in business. A kind act, such as Rosanna Lee's help to a struggling research analyst, can make a significant impact on someone's career.
The power of kindness and support in building a career: Kindness and support from mentors and colleagues are crucial for career growth. Seek out opportunities to learn and work hard to overcome challenges.
Learning from this conversation between Scott and Rob is the importance of kindness and support from mentors and colleagues in building a successful career. Both Scott and Rob shared stories of early career experiences where they felt incompetent but were given opportunities and guidance by individuals who believed in them. These moments of kindness and coaching were instrumental in shaping their careers and allowing them to reach their current positions. It's clear that the support and encouragement of others played a significant role in their success. Additionally, both speakers emphasized the importance of being willing to learn and work hard to overcome challenges. Overall, this conversation highlights the importance of building strong relationships and seeking out mentors and supporters in order to grow and succeed in one's career.
In today’s podcast, we’ll hear from Paul Galloway, Senior Director, Advisory Services at Strategic Treasurer on what Capital Management is, why the structure matters, and optimization. Listen in to learn more.