“If you look the right way, you can see that the whole world is a garden.”
Frances Hodgson Burnett, The Secret Garden
Several years ago Iwas asked to contribute to a course on board leadership. My instinct was to start by explaining how corporations work.
A minimum requirement for every company director is that they understand the logic that underpins the corporation they're directing. In fact, every member of the board should share the same understanding. It would be strange if boards made collective decisions on the basis of each director's differing opinion on how their corporation worked.
Could you imagine a team of surgeons performing an operation if none had studied the same basics in anatomy and physiology? Instead relying on their own personal opinion of how the body functioned and having their own language to describe the mechanism's that keep the body alive. Why would it be different for a board of directors making life and death decisions for their corporation?
How would a board achieve the same level of understanding when it came to their corporation? By using a model to graphically describe the key parts of their business and how they combined to keep things moving in the right direction.
Sadly, for this generation of directors, understanding how corporations work never made it into best practice.
To understand how a corporation works (and the the board's leadership role) see the corporation as a system designed to create enough business critical value to survive, grow and prosper in its own right.
Read on to see a general model of the corporation.
Why Modeling Has NEVER Mattered
The board's role is almost universally conceived as protecting and preserving shareholder value by ensuring things are done right.
Independent directors are expected to review management strategy proposals, reports and question the CEO. Directors tend to react to information presented rather than pro actively seek out the information they need to make their decisions. To the extent that an independent director understands how the corporations works, this is likely to be a personal opinion. But again, this understanding is used to test the CEO's assumptions and ask better questions rather than to come up with better solutions to the challenge of creating value.
Directors monitor management and that doesn't require an understanding of how things work - they only need the ability to challenge.
Or, do they?
Global thought leaders Ram Charan, Dennis Carey and Michael Useem argue that the role of the board is changing. Boards must evolve beyond their now traditional role as overseers. "Governing boards should take more active leadership of the enterprise, not just monitor it's management" they write in their latest book Boards That Lead.
If you're leading it helps to have a map.
To lead the board must understand the logic of value creation. Whether its called a canvas, map or blue print, understanding the business model is the foundation of great directorship.
Whereas directors mightn't need to understand the business model to govern, they can't successfully direct and innovate without it. Value creation doesn't happen by accident.
To build a corporation for the long haul, management and the board mustunderstand and "work" the logic of their business model to build strength, resilience and endurance.
To do any of the following a board must have a collective understanding of how their corporation keeps on going:
- choosing a CEO that can best "work" the business model
- deciding the information they need
- making key capital and other decisions knowing how these will impact on the strength, resilience and endurance of the company
- manipulating the elements of the business model to come up with better alternatives
- testing the logic of value creation and looking for where that logic is breaking down
This is not theory. It's been practiced for a decade.
I've successfully tested the idea that boards and executives perform better when they have a common language to describe the business model and have a shared understanding of how their corporation works. To be clear, not all were ready for directorship. Some board lack the time, ability or willingness to lead. But, without fail all improved their ability to govern. The reality is that a board that can read a business model makes for better governance and directorship.
Understanding How a Corporation Works
To help directors lead in the boardroom I'd teach them to draw.
To see their organization all at once boards need a diagram that shows their firm as a system of interconnected and interdependent "elements" or "building blocks".
Firms are sustained in the long term by a logic of value creation made up of building blocks. If all board members could see how those building blocks were arranged on a single page they'd know where they fit and realize there is more to the board than governance.
But to design the right tool, I'd need to get back to absolute basics.
Modelling tools are subjective. They're designed to allow you to see the corporation through the eyes of the person who created it. The choice of building blocks and how they're arranged reflect what the designer believes is the firm's purpose.
How Corporations Work Through the Eyes of Milton Friedman
Most business model tools are influenced by economist Milton Friedman who argued that businesses' sole purpose of business is to generate profit to satisfy the needs of shareholders.
Business Model Canvas by Alexander Osterwalder and co is perhaps the most popular tool on the market today.
The purpose of their tool is unequivocal:
"We believe a business model can best be described through nine basic building blocks that show the logic of how a company intends to make money."
And their template is designed to show how:
Business model canvas allows us to see how the corporation works through the eyes of Milton Friedman by tracing the logic of profit creation. More importantly, it's biased to the sell side of the firm. Most of the building blocks are directed towards revenue creation.
In what might seem an oxymoron, a model that only capture the creation of money is deeply un-commercial.
Money is only one type of value that a firm needs to survive, grow and prosper. As enterprise architect Tom Graves reminds us, money is not a synonym for value. He goes on:
It’s utterly crucial, in all business contexts, to understand that money is only one subset of value – and that whilst all forms of value may interact, and may often be convertible from one form to another, not all forms of business-critical value can be converted to monetary form.
For a corporation to create profits over the long term it needs a rich variety of value or capital. Put another way, corporations have a range of needs that must be satisfied if they are to continue to be.
Business Model Canvas only tells part of the story.
Don't get me wrong. Business Model Canvas is useful in different contexts. It's just the wrong map for directors wanting to understand how their firm creates value over the long term. Follow a map that just focuses on money and you'lleventually become lost.
How a Corporation Works Through the Eyes of Steve Jobs
To understand how a corporation works, we need to start thinking how corporations survive, grow and prosper by creating business critical value. But not for shareholders, customers or any other stakeholders. To understand how corporations work you need to put the corporation in the center.
My innovation is to flip convention and make the company, driven by its self interest properly understood, the customer and everyone else a supplier of cash, things or both.
Apple's chairman knew how corporations worked and didn't need a bunch of lawyers to tell him the rules. The self interest of Apple was the organizing principle for its board and the corporation. Through the eyes of Jobs, the only legitimate purpose of Apple was to create and sustain Apple. Everyone else was a means to that end.
Jobs treated Apple independently of shareholders, suppliers and even the customers it served so well (if he really wanted to delight Apple's customers he would have cut the price in half). Put Simply, Jobs prioritized stakeholders according to their value to Apple. If Apple didn't need a stakeholder to satisfy its needs, that stakeholder wasn't going to get its needs satisfied by Apple. This is hardcore capitalism.
This applied to everyone including shareholders. Apple ceased declaring dividends when Jobs returned to the Board. He also rejected calls to buy back Apple's shares. According to Warren Buffet "He didn't want to repurchase stock", he continued "although he absolutely felt his stock was significantly under priced at two-hundred and whatever it was then". What Buffet knew is that neither he nor Jobs would "buy dollar bills for 80 cents". What would Apple do with stock that had no value to it.
Is this innovation "nonsense."
Not if you believe Adam Smith. Steve Jobs played according to the founding rules of capitalism.
In a commercial society “everyman is a merchant” and self-interest should morally dictate their decisions. Smith argued that self-interest produces the greatest good. To Smith the “everyman merchant”:
is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. [...] Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.
The invisible hand is the original stakeholder theory of capitalism. Both shareholder and stakeholder activists alike have forgotten that their needs get satisfied only when the corporations needs are satisfied. More importantly, under the rules of capitalism no corporation would willingly sacrifice long term business critical value just to give it away out of a misplaced sense of duty.
Jobs treated Apple like Adam Smith's merchant. A free persons that owed nothing to anyone except what it promised in exchange for what it needed to survive, grow and prosper.
After all, why should there be two rules of capitalism. One for the butcher, baker and brewer that trades in their own name and another for the butcher, baker and brewer that trades through a company. One free to act out of self interest. The other bound, in a form servitude to act in the interest of a shareholder.
It's ironic that Smith gave us the invisible hand and then unwittingly tied it when he quipped about "other people's money". Thanks to the work of Lynn Stout and others we know that Smith and Milton Friedman made a mistake. Corporations are not owned by the their shareholders and have the right to be run to serve their own interests. Read more.
Everything looks different from the perspective of the corporation's self interest. What need of the corporation is satisfied by an exorbitant CEO salary, generous share buy backs or underpaying employees or suppliers?
If the board sees the corporation the right way the solution to these and other challenges is clear.
Building a NEW Model OF THE CORPORATION
The key to my model is the purpose of the corporation.
The purpose of a corporation is to be a corporation. Not for stakeholders but for the corporation in its own right.
My business modelling tool is designed to show directors how their corporation survives, grows and prospers by focusing on what the firm needs to be - now and into the future.
As far as I'm aware it's the first of its kind.
I invented my first model in 1999. Since then its been tested on for profits and non profits, airlines and insurance companies, start ups and public companies. What you see now is what I know about corporations not what I've been told.
Here's the 2014 version:
Working the map
- Start with culture. As Peter Drucker said, culture eats strategy for breakfast.
- Then the 3 P's - The corporation's processes, people and promises.
- Next put the corporation in the center of a two sided market. The trick is to see the corporation as the customer. From the corporation's perspective what it is doing is buying the customers cash and paying in products and services.
- On the left are suppliers of things - ideas, time, labor, data, products and services and everything else the company needs (other than cash).
- On the right are suppliers of cash. Customers, shareholders bankers, insurers.
- Connect each supplier to the corporation using the same sequence
- need of corporation>
- market for need>
- value proposition to market>
- channel to market>
- Value proposition to corporation>
- Store value at the top.
- Identify resources at the bottom.
It might take a while to see how these building blocks fit together to show the logic of value creation from the perspective of the corporation.
But keep trying. The future of your company legally, commercially and logically depends on getting all its needs satisfied. And, if all else fails, and you still believe Milton Friedman and the idea that corporations exist to maximize shareholder value read this before you make up your mind.
Taking MODELING TO THE NEXT LEVEL
How the corporation works is just the beginning.
The reason why modelling matters is that, along with senior management the board is at the heart of the logic of value creation. Not only is my model designed to show how corporations work, It's also designed to put the four forces of management at its core: directorship, leadership, management and governance.
For those unfamiliar with my work, I argue that governing and directing are different. In fact, I argue that governing is most likely a variety of managing and directing is a variety of leading. All four are needed for success.
Whereas Governance is focused on doing things right to preserve value. Directorship is focused on doing the right things to create value.
And at the core of Directorship is mechanics.
Mechanics is the logical plan that connects their work to value creation. For more on my model of leadership in the boardroom click here.
"The future is already here — it's just not very evenly distributed."
Last month the National Association of Company Directors (NACD) announced the formation of a Blue Ribbon Commission that will "focus on the board's role in recalibrating the enterprise's corporate strategy in response to market forces". The brief for more than 20 high profile corporate directors and governance professionals is to provide guidance to boards on "recognizing potential disruptors, assessing alternative approaches, and recalibrating the strategic plan".
The NACD will issue the Blue Ribbon Commission on Recalibrating Strategy later this year. My advice is not to make the same mistake as the organization that refused to include business modelling in their course on board leadership. Don't waste the head start you've been given. After all, you're holding the map.
*This is an updated version published 28 May 2014.