CASE STUDY: A FOUNDING CEO LOOKS BACK

Leroy Jones is not, of course, the real name of the author of the piece that follows. He has, however, every credential to write about the company in question. Jones became CEO of the fledgling company in 1954. In less than 15 years the company had, by dominating its market niche, become a Fortune 500 company—one of the 500 biggest U.S. corporations. Much like Bill Gates at Microsoft, Leroy Jones had overseen everything from product development to company strategy to customer cultivation. As a founder of the company, his benefits were direct but so also were the benefits that accrued to everyone else who worked for and/or invested in the company.

In the late 1960’s, critical and chronic health problems forced Jones to step down as CEO. Resuming his position at a later date was out of the question. He thus chose to "get out of the way" of his successors. He did not, as the following attests, stop paying attention to what was going on at the company, and numerous confidantes, who had helped him birth and grow the company, kept him apprised of their insider view of developments.

This piece was generated in the early 1990’s, some twenty years after Jones had left the company. A friend had sent him a newspaper clipping about the company divesting itself of a subsidiary (representing 40% of the company) and getting back to its core business. The clipping featured a company spokesperson suggesting that the acquisition of this subsidiary some 15 years earlier had been a mistake, and that the company now had to get meaner and leaner. Not only was the subsidiary to go, but layoffs in the parent company were not out of the question. The friend’s question basically was "What happened to this wonderful company that you built?" Here is the answer, written under the persona of Leroy Jones, who gives a history of the decline and fall the author’s ("my friend") company.

My dear Johnny:

Thank you for sending along the clipping from the "Philadelphia Press."

You ask me why my friend’s old company is cutting back. I believe that the politically correct term these days is downsizing. I simply do not know.

When my friend retired some years ago (having had a heart attack and feeling desperately tired), the company had hired a very bright Harvard Business School graduate to take his place. But it is clear that, with this fellow’s wonderful business training, he knew ways to run the company that a naif like my friend had never dreamed of.

In the old days, the company just bumbled along, increasing its size by 50-100% per year by the ridiculous, outmoded procedure of developing new products or applications of the old products to new and better ways of producing and merchandising them. How could the management have been so simpleminded?

They also wasted a lot of time keeping overheads and operating costs down.

How silly of them! They missed the main chance which would have obvious to any properly trained manager.

Despite very substantial profits in the face of an all out effort by officers, directors and accountants to use any lawful method to reduce taxable reported income, the stock was still selling at over one hundred times earnings. (Editor's note: This is the price to earnings ratio. If a company has one hundred shares, and earns one hundred dollars in a year, the earnings per share is one dollar. If investors—who tend to look very carefully at a company’s condition--are willing to pay $100 for new shares, they are expressing a confidence that the earnings will continue and grow. In fact, those very stock purchases provide a successful company with money to do just that.)

And thus it was that the company (under my successors) was able to launch itself into a program of increasing sales by acquiring other companies . . . . by paying stock for them (Editor’s note: Paying with stock means paying with the investors’ bets on the original company, transferring some of the value of those bets to the stockholders of the acquired company. Everybody can end up better off or worse of depending on the stock market’s ultimate evaluation of the merged company.) Of course, the management could have paid cash for these companies if they had wanted to. The company had substantial cash reserves, owed not one penny to the banks, and accounts payable were current to one week or less. But the management appears to have had other uses for the cash.

This was a wise procedure, Johnny, because you could always run out of money, Johnny, because you could always run out of money, whereas there is no limit to how much stock you can print. This also takes the pressure off the question of how much to pay for companies because it doesn’t matter. Paper is cheap. (Editor’s note: In this context, "printing stock" means that the "buyer" company, asserting its great worth and value, does not pay for the new company with existing shares, but creates new shares. This may be nice for the seller company whose shareholders get paid with a piece of the buyer company. But the buyer company shareholders find that now, instead of, for instance, owning 1/1000^th of the parent, they own 1/2000^th of the parent and the newly acquired child. )

Was this program successful? You betcha! Adding on the sales of these acquired companies increased total sales remarkably. The company got much bigger in a hurry. But for some reason, which I have not figured out, the earnings per share went down. (Editor’s note: Double the shares and you better double the profit or else earnings per share go down. Jones knows this and is being sarcastic.)

So great was the enthusiasm for increasing sales by buying companies that, at one point, the corporation set up a subsidiary with its own generous bank account and the mission of finding such business opportunities.

The project was a success. It spent all the money without damaging the company by actually finding even one such opportunity.

Some of these acquired companies were purchased not for their present sales but for their potential. My favorite was the company which planned to develop a revolutionary series of human blood tests by examining the blood of horseshoe crabs. This company was notable also for the fact the head of the Corporate Aviation Department (about which more later) convinced management that this new company was so located that it would be best served by executive helicopters.

For some utterly unforseeable reason neither the company nor the helicopters worked out very well.

Now, my friend will be the first to admit that executive quarters were chaotic in those bad old days: Asphalt tile on the floors, exposed painted steelwork holding up the roof, and tacky stained pine boards for walls. It is true that two of the offices shared a one throne washroom, but everyone else had to mingle with the help.

Beyond that, while there were very competent young ladies to handle routine typing and filing, no one (not even the Chief Executive Officer) had a private secretary. As a result, if Joe wanted to communicate with Fred in the next office, he couldn’t do it in a civilized manner by dictating a nicely set up interoffice memo; Joe had to get off his arse and go see him face to face.

But even that was not the extent of the indignities suffered by management. If something didn’t work, say a toilet didn’t flush, an executive couldn’t call in the Chairman of the Maintenance Committee. There was no maintenance committee, never mind a Chairman. The people who did maintenance were busy keeping production machinery running right. Like as not the executive had to go and get the tools he was encouraged to keep in his bottom right hand drawer and fix the damned toilet himself.

Would you believe that there weren’t even any reserved parking spaces for the executives? This meant that if an executive came in late he had to walk. Of course this rarely happened because pretty generally the executives arrived first.

Naturally, (under the new management) such outrageous affronts to managerial propriety in such a very important company had to go, and so an Executive Office Building was built. The truth is that, including the various necessary amenities, it was nearly as large as the entire company had been before that company learned the advantages of doing things the right way.

"Go first class" they always say. And they (the new managers) did.

Gone was the shoddy pattern of dirt cheap rigid truss buildings which could be expanded as necessary by removing an outer wall and installing additional bays—after which you could bolt the original wall back into place.

Gone were the frightful steel desks with linoleum tops and the chairs with plastic seats. This was the age of fruitwood desks and real leather . . . . polished leather.

Gone was the clamor of busy people rushing about creating new and better products, new sales campaigns, new and improved production machinery, devising simpler and better methods, controlling costs and, yes, disgracefully having fun doing it.

Things were now much improved. Executive offices were properly expansive with rare wood paneling and subdued lighting. The offices themselves were served by broad corridors which provided each with appropriate secretarial stations. The tasteful gray broadloom carpet was backed by one inch foam padding so that everywhere there was a great hush. It was a place where a man or woman could really think . . . . or sleep.

Back in the olden days, the officers would set aside about ten percent of their time to join a group travelling about the world delivering lectures on the company’s products and their uses to astonishingly large audiences of customers and prospective customers. These expeditions may have been tiring, but they were great fun. They called them "dog and pony" shows. One wife was allowed to come as den mother to the group: arranging fresh laundry, finding out where to eat, what to do on a day off, and setting up all en route transportation. This is, she was allowed to come providing (1) no matter what, she kept smiling, and (2) her husband paid her transportation. My friend was amazed that these assignments were eagerly sought after. It must have been the other fellows who were so charming.

In the new and improved company, traveling to update customers was seen as a terrible waste of executive time. A suitable Customer Training Department was established and social science majors were hired to be lecturers on technical matters.

This policy had two outstanding advantages. First, since the customers generally knew more than the lecturers, the customers were actually training the lecturers. Second, the management was spared the crude rubbing of shoulders with the customers, so that their minds did not become clouded with petty detail concerning what, if anything, the company’s products were good for. I believe that the leading business school call this "avoidance of defocusing."

For some reason, attendance at these customer information sessions fell off.

Back in the early days, it was a company joke that you could always tell when a company was about to go down the drain: it bought an airplane. My friend had not been retired ninety days when, surprise, the company bought an airplane.

Well, I don’t want to give the wrong impression, Johnny. This was not a big and splashy airplane; it was only a customized executive transport version of a Beech Turboprop Super Kingair. The jets, the helicopters, the hangars and the full-fledged Aviation Department complete with mechanics, schedulers and clerks came later, but not much later. You know what Malcolm Forbes, the guy who inherited the publishing empire, said: "An airplane is just a business tool." The fellow who built the empire didn’t have one—but it would be rude of me to point that out.

These airplanes really worked! With appropriate added navigation, communication and long-range fuel tanks, they could carry officers, directors and their families to Paris and all the leading watering spots of Europe in pursuit of business opportunities.

In late fall, sluggish sales might prompt careful examination of the situation in Bermuda. In mid-winter, faithful attention to business would require extensive time to be passed at the finest resorts in Puerto Rico—no matter what the hardship. For all of these purposes the Corporate Aviation Department was essential.

Now, every schoolboy knows that company officers are selected by directors, but what every schoolboy knows is wrong. The directors are themselves selected by the officers and confirmed by the stockholders. Of course the stockholders don’t know one man from another and would eagerly approve Charles Keating—or even a US Senator--as head of the Audit Committee. (Editor’s note: Charles Keating was a Savings and Loan owner convicted of fraud in the early1990’s, some of his early defenders were US Senators, including John McCain.)

In this circular manner the truth is that, taken as a group the officers select themselves . . . . .set their own salaries, and then select all the other executives.

In my friend’s day, the directors were woefull underpaid. It was a typical board: two good men, two pretty fair men, two scoundrels, a greedy lawyer and a few others who never really understood what the company did. But each invested in the company at or near the outset and hoped to get rich through the increasing value of his stock. They did, even the two scoundrels, no thanks to the shenanigans that got them thrown out.

As these original directors dropped out, they were replaced by others who were, as we have seen, selected by the officers. Since getting rich on the stock was now out of the question (the stock only stayed pretty much the same or declined in value), it was necessary to increase the directors fees. This they did—by about 15 times. We do not know about other perquisites, only because the Securities and Exchange Commission does not require these to be revealed. (Editor’s note: Company directors are often extremely pampered by executives eager to have a favorably disposed Board.)

Of course, having been put in the way of such a good thing by the officers, it is only fair that the directors should do something nice for the officers themselves, and they did. On the average, they doubled the pay of the officers and then redoubled it, and again, and again. That’s right! They increased top executive pay by about sixteen (16) times.

Fortunately, they kept the perquisites under control; but the standard established was that of the Caliph of Baghdad at the peak of the empire.

I tell you, Johnny, good management does not come cheap.

Only one thing went askew. The grand and bountiful stock options issued to the officers were never worth a penny because on the whole the value of the stock only went down. Life is often unfair. ( Editor’s note: Stock options work like this. You give the executive the right to buy a share of stock—actually many, many shares of stock—in the future at today’s price. If today’s price is $30 and the stock goes up to $100 a year from now, the executive can exercise the option to buy at $30, and can then sell the stock the next day for $100, pocketing the $70 difference. Since options are often given in quantities of thousands or even tens of thousands of shares, millions can be made. If the stock price does not go up, however, the options are worthless and are never exercised.)

Still, such advanced management brings many benefits. Chief among those is the staff system. Whereas, before the guy running research would pretty much decide where the action (and the money) lay and would hire the people and buy the stuff required to make the company the world leader in that field (never mind if the field was not as important as perpetual motion). Usually he would get the product invented, in production and selling in a month.

Under the new management, the research director was spared the agony of thought and the despair of possible failure. There was bound to be a committee which dealt with the product area the research director thought had potential. After the research director made his proposal, within a year or so this committee would turn in a report.

There were further advantages of the company’s new modern management: any forward thinking corporation must give thought to the question of from where the managers of tomorrow will come—and get them into training early.

Where would you find a more outstanding genetic pool than the sons and daughters of the officers and executives? Most of them had been well trained in the most prestigious prep schools of America. Some of them had attended two or even three such schools—each in succession at the firm suggestion of the predecessor that he go elsewhere.

For a while, it was quite fashionable to spend one’s summer vacation working for the Paris subsidiary: at least to the extent that such work did not interfere with anyone’s social schedule.

Unfortunately, training sons and daughters for a career in the company did not work out. I am not aware of a single instance where such a child had permanently joined the company and put his shoulder to the wheel.

If I have left you with the impression that all of these organizational endeavors were disasters, then I am very sorry, Johnny. This is simply not the case.

For example, I have always felt that the term "Personnel Department" was downright common, haven’t you? So, you can imagine how pleased I was when the company set up a "Department of Human Resources."

This was a function which the Controller used to handle out of his top left hand drawer. I tell you, their Controller really controlled things. It was hard to get past him and the other executives to get hired: but once hired, the entire company would break its back to make that person a happy and constructive part of the team.

Of course, things were pretty simple-minded back then. Everyone got the same best available health plan for free. Everyone got the same $100 at Christmas. Everyone had the same fully paid life insurance policy and everyone got the same percent of his or her gross pay deposited tax free into a fully vested retirement fund. Except for the company’s first year, this amount was always every dollar the law would allow. This could have struck some as unfair because the president got bigger retirement contributions than the sweeper. But this was precisely what the law required, and the company had no choice. No one seemed to mind.

I suppose the sweeper figured out that one day he might be president—or at least a department head. If so, he was right. One of the department heads never got through high school, but the company paid full tuition for any employee who wanted to study any reasonable thing. At the risk of offending those who daily fight the good fight against Corporate Exploitation, that man worked both hard and smart to rise up in the company.

Oh, yes, I forgot to mention one trivial point. Having been very selective about who got hired, the company could operate with many fewer people than you would think and could therefore pay them very well, indeed. At one point, the company had an eight (8) year waiting list for employment.

Don’t tell me, Johnny, that these fancy departments are useless. It simply isn’t true. Not only did the Department of Human Resources successfully euchre the rank and file out of most of the above tiresome benefits, it also made certain that at any time the company had the right number of left handed Asian Islanders who were Branch Davidians . . . .or whatever the evershifting law required. (Editor’s note: Obviously Jones is not a fan of affirmative action but just as obviously he is not a fan of companies balancing their books by taking back the workers’ pension, health and other benefits—which has been all the rage for the last twenty years.)

Yet the real star has been the hugely augmented Advertising Department. Of course, the company had always had an advertising department; but it consisted of one talented guy who could write copy and knew such good things as where to get type set, where to get artwork done and how to place an ad or get something printed. It happens that he was also a first class mechanical engineer. So he not only understood what he was writing about (which set him apart from your usual advertising guru), but at the drop of a hat could find the errors in the Chief Executive’s tortured mathematics—or put on his old clothes to help design and build a new production machine.

But the new Advertising Department "explored options" and went far beyond that. One might say that its major assignment is the preparation of the Annual Report to stockholders. Wow, do they do a wonderful job.

The cover is always arresting, the artwork and illustrations spectacular, charts and graphs to the highest standard and the text—oh, my, the text.

The text is spirited, uplifting, enthusiastic and marvelously optimistic about the wonders which lie ahead for the fortunate stockholder.

This has been all the more difficult in recent years when, despite an ambitious program of raising prices, sales have actually declined. The stock has plunged so that it is no longer useful coinage for increasing sales by acquiring companies. Corrected for inflation, each share of stock is worth about a third of what it was when my friend cashed in his chips on retirement. And this, after so many years of advanced management. Nor can the company get more money from the banks—the banks are trying to get money back from the company.

To add to the problems of this brave and talented group, both operating costs and overheads continue to increase despite the undoubted skill and dedication of the executives.

I can hardly wait to read this year’s annual report . . . .though it may be late in coming out.

According to the newspaper report you sent me, the present Chief Executive Officer is now presumably becoming more "narrowly focused."

Well, Johnny, there you have it. Obviously, I have no idea why the company is in trouble.

Regards,

Leroy

N.B. I hope you understand that this is all in fun. Clearly I made it all up. No real company would actually behave this way.

. . . . would it?