Is your company’s annual bonus expense in line with its recent financial performance? Do top performers receive a larger bonus than their lower-performing peers? The current economic climate is the perfect reason to review your company’s bonus and incentive plans.
During prosperous times, employees come to expect bonuses, and the company has less trouble justifying the expense. So bonuses lose their meaning and become automatic or entitlements. If there’s little to no growth in your company’s 2009 forecast, now’s the time to revisit those incentive plan fundamentals and make the necessary adjustments.
“Now that executive compensation is subject to new SEC disclosure rules, CEOs are realizing that the same philosophies around executive bonus and incentives must cascade down through the organization,” says Ann Costelloe, San Francisco office practice leader of executive compensation for Watson Wyatt Worldwide. “They’re wondering how they can justify paying employees profit sharing or incentives if the company’s financial results are lower than the prior year, yet still incent employees to achieve stretch goals.”
Smart Business spoke with Costelloe about how executives can calibrate employee bonuses and incentives to mesh with 2009 forecasts and still maintain motivation.
What’s the first step to calibrate annual bonus and incentive plans with results?
Executives should start at the macro level by revisiting the philosophy behind the plan to make certain it’s still appropriate. Next, make certain the plan is motivating employees toward the main business drivers. At all times, a plan should be self-funding in that the incremental gain to the company should more than pay for the bonuses to employees. If it’s a profit-sharing plan, where all employees share in the overall company results, should you pay employees the same percentage if the company doesn’t achieve a profit increase? Or is the percent of profit shared appropriate and affordable given the financial performance of the company?
The questions are: What results should we be rewarding? Are there specific business drivers and return (e.g. return to shareholders) that we must achieve and exceed before we can afford to pay a bonus? Should employees still have an opportunity to earn the same bonus if they meet individual goals, but the company misses its broader target?
What’s the next step?
Establish companywide financial goals that include the appropriate amount of growth that is both achievable and affordable but by no means a given. This is the first step to assuring that the employees’ collective performance will fund the bonus expense. Then cascade the goals down through management to each division, group and individual. Understanding the extent to which company performance versus individual performance will impact an employee’s personal reward is critical. I advocate giving employees no more than three goals, so that an individual isn’t juggling too many targets. A goal that impacts only a small fraction of an employee’s ultimate reward (e.g. 10 to 15 percent) will likely receive no attention versus goals that impact a significant portion of the reward. Bonuses and incentives should be earned for achieving results, not completing activities, and if it’s a true incentive plan, those who achieve at higher levels should earn larger bonuses than their lower-performing counterparts.
When determining the bonus amount that will motivate employees, there’s no one-size-fits-all number. Instead, the percentage must coincide with the company’s philosophy, the industry, the maturity level of the company and the targeted return to shareholders.
How should plan changes be communicated?
Initially, the CEO should communicate the plan change, including the reasons behind it, because employees are much more likely to embrace change if they understand why it’s necessary. Employees need to understand how bonuses payments are calibrated to company-expected results and to what extent the bar for performance measurement has changed. CEOs should then provide periodic updates, detailing how the company is tracking toward those goals. This strategy creates line of sight between the employees and the company’s mission, and it also keeps the employees focused and motivated, especially if they’re working toward stretch goals.
Which plan structures are the most effective?
I don’t favor all-or-nothing plans because they can be a little scary, and they often fail to motivate employees. A scaled system, which financially rewards employees at a level that’s commensurate with their performance, is fair and the expense is calibrated to the achievement. The key here is to ensure that employees at all levels know what performance, outcomes and results are expected and how they will be measured so that rewards line up with results delivered.
I also encourage employers to set aside a pool of funds to reward and retain top performers. It’s best if the opportunity is embedded within the plan structure because you don’t always want to be managing by exception. If your company is hitting or exceeding its bonus plan targets every year, there’s a good chance the plan isn’t working properly because the bar is set too low. When a plan is structured correctly, you won’t hit the goal every year, nor will you consistently miss or overachieve.
ANN COSTELLOE is the San Francisco office practice leader of executive compensation for Watson Wyatt Worldwide. Reach her at (415) 733-4244 or email@example.com.
Back pain is big business.
Annually in the U.S., people miss nearly 93 million work-days because of back problems and spend $4 billion on spinal products. With so much need, it would seem that an emerging medical device company like NuVasive Inc., which develops products and techniques for minimally disruptive spinal surgery, could grab a foothold in the marketplace with ease. But when Alex Lukianov assumed the CEO role in 1999, the company was struggling against its larger, entrenched competitors. Armed only with his vision for building a swift company culture as a slingshot, Lukianov took on the challenge of slaying the industry Goliaths.
“To compete against Medtronic and (Johnson & Johnson), you have to take on an offensive posture,” Lukianov says. “And that offense has to have a clear mission and a purpose, because to be a dragon slayer, you have to attract like-minded personalities and expect outstanding results.”
Lukianov had an extensive background in the orthopedic industry, including a stint as division president for direct competitor Medtronic Sofamor Danek, before coming to NuVasive. He says he thought carefully about the depth of the challenge before committing to the assignment. For example, at a large company like Medtronic, Lukianov says he could always pick up the phone and secure resources to tackle a problem, at the much smaller and struggling NuVasive, there’d be no one on the other end of the line to help. And the new position would entail uprooting his family from New York and moving to the West Coast. Still the idea of building a major league company from the ground up was an opportunity he just couldn’t pass up.
Shortly after arriving, Lukianov may have had second thoughts about his decision, when the company was down to having only enough cash in the bank to cover two weeks of expenses. But Lukianov is an optimist, so he rolled up his sleeves, started raising money and began installing a new secret weapon a swift response corporate culture. Since that time, he’s led the company through an initial public offering in 2004, which earned him a promotion to chairman and CEO, and then on to record-setting revenue, including $154 million in 2007.
The need for speed
Lukianov’s passion for swift response was partly influenced by his previous work experience. It’s not that his prior companies were unresponsive to the needs of the marketplace, the culture just didn’t go far enough to create a true competitive advantage. In his first CEO role, Lukianov says he finally had the chance to create a more complete culture, and given the circumstances, speed was the best cure for the company’s problems.
Surgeons buy NuVasive’s products, and Lukianov says that instinctively, surgeons want everything yesterday, so building a culture that would appeal to them was vital. Also, the pace of innovation at larger, more bureaucratic organizations can be slow. Greater speed in the design, implementation and sales of new products would enable Lukianov to drive productivity and greater output with a smaller staff and capture market share quickly. The business case for speed was clear, but to implement a culture built on swift response, Lukianov says CEOs need to start by letting the staff know why speed is important.
“To create an environment predicated on high standards and excellence, you have to let everyone know why it’s important, so they become emotionally invested in the outcome,” Lukianov says. “Investing in a culture really isn’t important if the plan is to build up the company and then flip it, because in that case, management is really not all that concerned about what happens to the people. There’s an emotional investment that leaders make when they build a culture, and you can’t really make the investment unless you’re committed for the long haul.”
Although Lukianov has named his cultural initiative “Absolute Responsiveness,” and he uses the cheetah as the culture’s symbol, he’s gone beyond rhetoric and T-shirts by putting some teeth into his cultural vision. Lukianov refers to NuVasive employees as shareowners, and almost every employee has a stake in the outcome.
“I just can’t imagine attracting the kind of people you need to drive 50-percent-plus growth rates unless they have a stake in the outcome,” Lukianov says. “I don’t think the equity has to be a lot, but it can be very effective if it’s done systematically.”
He opened a distribution center in Memphis adjacent to FedEx, so surgeons are assured of receiving their product orders overnight his stated goal is to never miss a surgery. He also reviews dashboards each month that track the company’s responsiveness on all its deliverables, and he uses a balanced scorecard for measuring performance and holding people accountable to his high achievement standards.
Each dashboard measures the company’s progress in specific functional areas, from the 40 products currently under development and their anticipated release dates, to the degree of sales force penetration for each product the company sells in every market. So far Lukianov’s plan is working because the company has been granted 48 U.S. patents and has another 134 pending, most of them coming under his leadership, and revenue is growing more than 50 percent.
“We measure four key areas on the scorecard including financial results, adherence to internal processes, customer knowledge, and personal growth and development,” Lukianov says. “There’s a progress review, and every employee is graded each quarter, but what really makes our scorecard different is that it not only measures achievement of short-term financial goals but progress toward the company’s long-term objectives. We have a goal of reaching $500 million in revenue and to be GAAP profitable, and every person in the organization can tell you how we’re going to get there and what their part is in reaching the goal. In many organizations, senior management is well-versed on the long-term objectives, but it’s critical for everyone to understand their role.”
Customers are second
There aren’t many CEOs who could drive their company’s stock price to more than $40 a share when the bottom line isn’t yet in the black and investors are third on the chief executive’s priority list. But under the Lukianov philosophy of prioritization, things are just as they should be.
“I think everything I’ve been taught over the years about putting the needs of the customer first really isn’t the best way to do things,” Lukianov says. “We do not put the customer first at NuVasive. The first priority is your internal staff, your second priority should be the customers, and your third priority is your investors. If you take care of No. 1 and No. 2, No. 3 (the investor) gets everything they want.”
Lukianov’s group of No. 1 priorities has been growing. When annual revenue reached $60 million, Lukianov approached the board with the idea of moving away from the company’s contracted sales force and hiring an internal team. Lukianov says he believed he could achieve faster growth through dedicated sales representatives who were trained in the culture of Absolute Responsiveness, possessed greater knowledge of the company’s product line and unique surgical approach, and could serve as the face of the organization to the surgical community.
“Our product allows the surgeon to approach the spine from the side, not from the back or the front, so it’s less invasive for the patient,” Lukianov says. “We train surgeons on cadavers here in our operating rooms, but it takes in-depth knowledge to explain the technique to surgeons and convince them to attend the training. You need commitment and dedication to be successful, and I just didn’t see any way to sustain 50 percent growth rates when we couldn’t retain business because of the churn in the sales force.”
Despite laying out the business case for taking on the fixed expense, Lukianov says that it took him three months to convince the board and other members of senior management about the soundness of his plan, and while he eventually got the green light in June 2006 and has since hired more than 220 sales reps, with so much at stake, he spends a great deal of his time monitoring the team’s performance and ROI.
“I think before you go forward and ask for this kind of commitment and investment, the company has to have achieved a certain level of success, so it’s all about the timing of the request,” Lukianov says. “We had been through the IPO, the restart was well on its way, and we had just passed $60 million in revenue, so I thought this investment would take the company to the next level and beyond.”
In addition to holding reps accountable for their individual performance via scorecards, Lukianov holds quarterly webcasts where he reviews the entire sales team’s dashboard and its progress toward reaching the company’s revenue goals. He is also personally involved in the hiring process for each sales rep.
He insists that only A players will fit NuVasive’s culture of Absolute Responsiveness and reach his high productivity standards. He uses 10 criteria to evaluate prospective new hires but finds that the genuine A players think of themselves as lucky. Lukianov says he is a lucky man, and since he believes that success is perpetuated by like-minded individuals, being lucky is the litmus test for prospective sales representatives at NuVasive.
“I ask during the interview if the applicant considers themselves to be lucky,” Lukianov says. “Then I watch for their body language in response to the question. I think when a person feels lucky and has an attitude of gratitude they will fit in to the culture and be successful with our high standards.”
Building an in-house sales team has also enabled the company’s growth plan. Lukianov has been able to leverage the group’s marketing expertise and their expense through several acquisitions of new products and technology that were poised for market, only requiring the addition of a ready, willing and able marketing team. Two of the most recent acquisitions include the January 2007 acquisition of technology and assets from Radius Medical LLC, a privately owned company that makes bone graph strips, and in May 2008, NuVasive announced the intent to purchase the Osteocel Biologics business from Osiris Therapeutics Inc.
Sustain the culture
As a company grows, it can be a challenge to sustain the corporate culture, especially one that fosters speed and innovation. But Lukianov anticipated the problem, and installed a number of processes to assure that the culture endures beyond any growth pains.
“I work extensively with our management team to make certain the culture is perpetuated, especially for all the new employees who are joining what has become a much larger organization,” Lukianov says. “So we’ve developed a cultural immersion program for new employees. For starters, every single person we hire goes through a training program on our products, anatomy and surgical techniques, then they must pass a knowledge test as a condition of employment. We want every person in the organization to be a subject matter expert, understand how our products and techniques differ, and can interface with a surgeon.”
In keeping with Lukianov’s high-performance philosophy, and as an introduction to the company culture, employees must pass the exam with a score of 90 percent or better, if they fail to do so, they must retake the exam. The motivation for high achievers includes $500 for a perfect score and $250 for those who score 95 percent.
“It’s a very difficult test, and people are petrified to go through it, but it brings new people together and teaches them about the company and our values,” Lukianov says. “We also perpetuate the culture, continue the educational experience and have a little fun, by playing a game we call spinal jeopardy at meetings and by giving annual cheetah awards and spot awards like ‘cheetah in the wild,’ where we recognize an employee who goes above and beyond in exemplifying the culture. When you constantly reinforce the culture, it doesn’t just become the flavor of the month, and there’s no way the culture won’t endure through growth.”
HOW TO REACH: NuVasive Inc., www.nuvasive.com
There’s a belief among business leaders that change is just a part of growth. That might explain the history of Garden Fresh Restaurant Corp., where there’s been no shortage of change or long-term growth since Michael Mack and a partner purchased two Souplantation restaurants in 1983.
The company operates a chain of casual dining restaurants that go by the name Souplantation in Southern California and Sweet Tomatoes elsewhere. Mack, the company’s co-founder and CEO, has expanded the company to 109 locations in 15 states during that time (the company doesn’t disclose revenue, but online estimates put it at more than $100 million), but it was not without navigating through a few twists and turns along the way.
In order to sustain growth over a quarter century, Mack’s list of successful change management feats includes guiding the company through an initial public offering and then returning it back to private status.
“At the time, going public was a viable option because it served as a financing vehicle to support growth,” Mack says. “It worked well for the first five years, but we expanded too rapidly, and we compounded our problems by some missteps in pricing and menu selection, and soon, our quarter-over-quarter performance was uneven. At the same time, the public environment changed with the advent of Sarbanes-Oxley. Very few businesses actually function well quarter over quarter, so the next logical move for us was a return to private status, which was a decision that also made our shareholders and board very happy.”
While the road to sustained growth is never straight, Mack insists that CEOs can navigate change successfully, by keeping everyone on the team aligned with the CEO’s goals.
So what’s a guy with an undergraduate degree from Brown University and an MBA from Harvard doing in the salad business?
“Originally, my partner and I got into the restaurant business because we wanted to become entrepreneurs in an industry where the competitive barrier was not technology,” Mack says. “We wanted to be in a business where the competitive advantage came from people.”
It’s important to understand Mack’s motivation because it’s an integral part to his change-management philosophy. Mack says that during his consulting days, he noticed that when leaders failed to guide their organizations successfully through a change process, it was generally because their employees no longer felt aligned with the personal goals of the CEO and the organization’s mission and vision.
Providing clarity in direction and gaining support from employees about proposed changes keeps everyone’s efforts unified toward the goal and prevents uncertainty, which can lead to execution failure.
The scope of Mack’s communications challenge has grown along with the company as it now employs more than 5,000 workers, but his personal goals have not wavered during his tenure. Much of his motivation for change has been to adapt to changing conditions in order to sustain growth.
As an example, Mack says that after expanding to 33 locations, he opted to take Garden Fresh public in 1995. At the time, his goal was to use the public offering as a way to finance expansion. He says that a common misconception shared by employees is that a public offering is the ultimate financial prize sought by founders,and it’s often part of a founder’s exit strategy. In fact, there are numerous restrictions that prevent management from exercising large blocks of stock after going public, and exiting the company wasn’t his plan. So he communicated his goals, intentions and vision for the company with employees and got his team on board with the change.
“As they go through the change process, people will draw strength from knowing that everyone on the team shares the same priorities and reasons for being here,” Mack says. “As the CEO, you should ask yourself a few questions to clarify your intentions before beginning the change process, such as, ‘What is it I personally want from the change, and what are the business goals that will result from the change?’ Then clarify your intentions with the employees. Without clarity of intentions, everyone will just flounder and flop around.”
Then in 2004, after adding 44 additional units in 10 states, Mack engineered Garden Fresh’s return to private status because the company was having difficulty generating revenue and earnings to match Wall Street’s expectations, and the costs and complexities of Sarbanes-Oxley compliance were diverting funds that could be better used for growth. He informed the staff of his decision six months prior to his return-to-private-status goal date, which gave them ample time to ask questions and digest the change.
“The next step is to articulate your plan to the executive team and let them communicate it down through the organization,” Mack says. “Many leaders think once they’ve communicated their intentions, that’s it. In fact, you have to communicate your intentions and goals over a long period of time because if you graph the way people actually jump on board with change, you’d see the adoption rate is actually shaped like a bell curve. Some people get on board right away and contribute to the change process, some come along as they hear more and start to understand, and then at the other extreme, you have the dissenters.”
Mack says he welcomes open dissenters and says it’s important for CEOs to listen to them and understand their concerns because silent dissenters can become plan saboteurs, unless they are heard. And if saboteurs emerge, Mack favors firing them.
As employees gain comfort with the proposed change, Mack’s next step is to move to the planning and implementation stage.
“Once the strategy is set, you move forward and let people know how they’ll contribute toward the change,” Mack says. “To execute change effectively, you have to be clear about the outcomes you want to achieve.”
He says that effective implementation plans are fluid and tweaked along the way because, invariably, CEOs must adapt their plans for unanticipated circumstances. He first sets macro-level business goals with his executive team and then creates microlevel outcome expectations, such as same-store EBITDA growth targets that need to be achieved by managers in the next 12 months. He keeps a pulse on the change process by reviewing his team’s progress toward the specific milestones during weekly executive meetings. Mack says he doesn’t get overly involved with the plan details, unless the implementation course starts to deviate from the main business strategy or the milestone check reveals a lack of progress.
“I’m always involved in decisions involving the critical business profitability drivers like pricing, menus and advertising, but more
often, I’m not involved in all the details, I’m more of a facilitator,” Mack says. “It’s more important to spend time getting clear about where we’re going and be a little less hung up about how we’re going to get there because that’s what creates alignment. I want to make sure what I’m doing is consistent with my values and the values of the organization.”
As an example, Mack says he’s supportive of a restaurant manager’s decision to offer menu items that appeal to local diners, but he says he’d want to know if the manager chose to make a major change from the restaurant’s primary fare, like diverting from salad as the main item on the menu.
Mack’s final change-management lesson is this: Before embarking on any major change initiative, CEOs should ask themselves if they are willing to be accountable, vulnerable and authentic to the people around them no matter the outcome.
“It’s important for CEOs to take accountability no matter what happens because that kind of openness and honesty with the organization creates alignment toward the mission and vision, and no matter how involved you are, on some level, when something goes wrong, you’re responsible,” Mack says. “When you ask yourself what you could have done differently when something doesn’t go well, it’s part of an iterative process that causes you to ask what was the outcome you intended and where it got off track.”
Accordingly, Mack admits to making a few mistakes along the way.
Besides accepting responsibility for the company’s early difficulties with large-scale expansion, Mack says he was the major architect of an ill-fated discount program designed to bring more guests into the restaurants. While guest traffic did increase, only half the goal was achieved because the meal price was too low and the program wasn’t profitable. Afterward, he took responsibility and asked his staff for input about how discount programs might work better going forward.
Creating a culture that embraces change without blame has helped Garden Fresh accelerate growth. After opening a few new locations in 2006 and 2007, the company plans to open nine new restaurants in 2008 and at least four in 2009. The new growth plan is the result of Mack negotiating through even more major changes at Garden Fresh, including the private sale of the company to investment group Sun Capital in 2005 and the creation of a new restaurant prototype in 2006.
An in-house team took on the task of creating a new concept for the restaurants that would reinvigorate expansion by reducing the barriers to entrance and profitability thresholds. The newly configured restaurant will allow more guests to dine in less space and require fewer workers.
“Most of the recommendations came from an in-house team because we’ve created a culture where people see the value in change,” Mack says. “There were no sacred cows. Everything was up for review, including how the restaurant was laid out and the way the food is merchandised.”
Mack says that on occasion, conflict erupted within the group as it debated prospective designs. In this case, he says, conflict was a good thing because there’s benefit in considering numerous options as part of a major change initiative. Ultimately, the team had to justify its creative concepts through financial models, and it also had to weigh customer feedback in making its recommendations.
For Mack, the success of the redesign initiative was indicative of the reasons he initially chose the industry because people, not technology, will dictate the difference between success and failure with the new restaurant model. All in all, that alone is proof-positive that his team remains aligned with his personal goals.
“It always comes down to this: Are we all here for the same reasons, and are we all drawn to the same goals?” Mack says. “It was a passion for people that originally drove me to this business, and creating great returns is all about having the right people doing the right things with the same set of priorities.”
HOW TO REACH: Garden Fresh Restaurant Corp., www.souplantation.com
Acquisitions can be good for business. They provide buyers with immediate revenue growth, new markets and intellectual capital while sellers have the opportunity to be financially rewarded for their efforts. But the deal’s attractiveness can quickly wane when the transaction results in a double layer of taxes for the seller or a lack of step-up in basis for the buyer. Advance planning along with knowledge of the tax implications and possible alternatives are the best ways to make acquisitions advantageous for both parties.
“In some cases, there will be no immediate taxes generated by a tax-free stock exchange or only a capital gains rate may apply, and in other cases, you could be looking at double taxation under an asset sale,” says Gary Curtis, corporate tax partner for Haskell & White LLP. “Since the transaction often puts buyers and sellers at odds, it’s important to have enough time to look at all the alternatives and structure the deal in a way that’s best for everyone.”
Smart Business spoke with Curtis about how to avoid excessive taxation from acquisition transactions.
What determines the tax liabilities in an acquisition?
Usually buyers and sellers benefit from different acquisition transaction structures. In a taxable acquisition transaction, two of the influencing factors include:
- Whether the buyer is purchasing assets versus stock
- The entity structure of the seller
Sellers usually want a stock sale because the gain will be taxed only once at the relatively low capital gains tax rate. Buyers usually prefer an asset sale because they can purchase known assets and liabilities, as opposed to a stock transaction where they take on liabilities for all previous actions of the company, and the ‘step-up’ in basis to fair market value can be depreciated or amortized, which improves cash flow. Generally, the seller offers more warranties and guarantees to offset the unknown liabilities resulting from a stock sale, but they may get a lower sale price, as well.
How does the seller’s legal entity impact taxation?
If the selling company is set up as a C corporation, the principals may be hit by two rounds of taxation during an asset sale: income tax at the corporate level and again at the shareholder level when the proceeds of the sale are distributed. You can avoid double taxation resulting from an asset sale if the selling firm is structured as an S corporation. An S corporation or a business set up as a pass-through entity, such as a limited liability company (LLC), will generally only pay one level of tax, which will be at the capital gains rate. There may be some taxes at ordinary income rates, but these amounts are often insignificant in relation to the overall taxes.
What are the tax alternatives?
S corporations and LLC legal structures produce the least amount of tax liability during acquisition events. So if your company is currently structured as a C corporation, and you plan to keep the company for 10 years or longer before selling it, consider converting to an S corporation status.
A tax-free merger is another alternative. It occurs when one company acquires a controlling interest in the other company in exchange for its stock. The sellers don’t report taxable gain until the new stock is sold. This method is advantageous if the shareholders of the acquired company don’t want to cash out in the near future, but even if the seller wants to receive some cash from the transaction, the merger will still work as long as the seller doesn’t require more than 50 percent of the sale price in cash.
Is a 338 election a viable tax alternative?
Section 338 allows the purchasing corporation to buy the stock of another company and treat the purchase as an asset acquisition under a set of specific conditions. On the surface this sounds favorable, but there are still a few things to consider. While the transaction may not result in double taxation, the seller may still be liable for some additional taxes. While an entity change may be a solution when time allows, there are other potential alternatives to the tax implications resulting from acquisitions. Each situation requires its own unique solution that will work best for both parties.
GARY CURTIS is a corporate tax partner with Haskell & White LLP. Reach him at (949) 450-6311 or firstname.lastname@example.org.
The business case for going green is rapidly growing. Not only is the green movement good news for the environment, but it’s even better news for the bottom line as customers, suppliers and job seekers are showing a clear preference for companies that demonstrate green work-place practices. But the pressure to go green is beginning to migrate beyond the voluntary, as legislators gear up to tackle green building, sustainability and renewable energy issues. These efforts will lead to new policies and new laws. The choice for CEOs might come down to this: Go green and save now or pay later.
“No one knows for sure how far the legislation will go, but I’ve never seen as much momentum behind environmental issues as there is around the issues of going green, climate change and global warming,” says John Lormon, partner and leader of the Environmental, Land Use and Governmental Affairs Practice Group at Procopio, Cory, Hargreaves & Savitch LLP. “There are currently six bills before Congress and another 15 to 20 in front of the California Legislature, many relating to sustainability of the environment, climate change, renewable energy and carbon footprint concerns. Going green is the way to do business.”
Smart Business spoke with Lormon about how companies can meet the green challenge.
What are the benefits of going green?
Going green speaks to our core values as a society, and it is a way for businesses to demonstrate social responsibility through preservation of our natural capital in the way they conduct business. There’s plenty of evidence to show that companies can enhance their brand in the marketplace by employing sustainable practices. Today, recycling and reduced energy consumption and greenhouse gas emissions (GGEs) are part of the green movement in the workplace, but I think we’ll see an even broader definition in the future.
How far will future legislation go?
It’s hard to say how far the penalties and reporting requirements will go or what might be just encouraged behavior through incentives or mandated by law, but already we’re seeing some impact from recently adopted legislation. A city of San Diego recycling ordinance that took effect in January of this year imposes sanctions including criminal penalties for non-compliance, and new building construction and tenant build-outs are being impacted by Leadership in Energy and Environmental Design (LEED) standards as well as the U.S. Green Building Council’s benchmarks for building design, construction and operation.
California’s landmark Global Warming Solutions Act of 2006 (AB 32) is a comprehensive program of regulatory and market mechanisms to achieve 1990 GGE levels by 2020 starting in 2012. The California Environmental Quality Act (CEQA), which requires public decision makers to submit documentation of a project’s potential environmental impact, will soon require an assessment of GGE. Companies may face third-party lawsuits related to their emissions, and companies will have to report to the investors if material financial liabilities arise out of GGEs.
How should companies prepare for the new legislation?
Be sure to keep good records, especially concerning voluntary and mandatory emission reductions, since you might need that data for compliance and defense purposes under these new laws and regulations. Look at everything you can do to reduce GGE, including the possibility of buying more local products so they do not cause excess impact to the environment when they are transported. You want to identify your company’s carbon footprint as soon as possible to establish a baseline, then initiate and document your efforts to use renewable energy and to reduce and offset your emissions. Try to use renewable energy sources, such as solar or wind energy, and consider acquisition of carbon cap and trade credits. I think CEOs will benefit greatly if they take steps not just to protect their business but to enhance it by developing a green strategic plan.
What other steps can CEOs take?
CEOs can take on a leadership position in the community by gaining a better understanding of the issues. When making purchasing decisions, look at the carbon life cycle of the products that the company purchases. Recycle, allow your employees to telecommute, and develop and follow a green plan that sends a signal to your customers and employees that your company is taking steps to minimize the depletion of our natural capital and to make for a more sustainable planet.
Here in San Diego, working through Scripps Institution of Oceanography, I started a Climate Club, and we meet for informal dinners where local business leaders can connect with Scripps scientists in an interactive forum to better understand the state of the science concerning GGE and their impact on global warming. A program such as this is an excellent way for CEOs to develop strategic thinking about what is best for their corporate programs.
JOHN J. LORMON is a partner and leader of the Environmental, Land Use and Governmental Affairs Practice Group at Procopio, Cory, Hargreaves and Savitch LLP. Reach him at email@example.com or (619) 515-3217.
Asalesperson quits, goes to a competing firm with your customer list and begins soliciting your customers. A competitor falsely advertises that your product causes injury to children. Must you sit back and wait months for your day in court while your company suffers irreparable harm? The answer to that question is a resounding “no,” according to Spencer Skeen, litigation partner for Procopio, Cory, Hargreaves & Savitch LLP. Skeen says that under these types of circumstances, executives should contact their attorneys about the potential for emergency injunctive relief.
“Injunctive relief is sometimes the only way to prevent irreparable injury to your business,” Skeen says. “It’s an effective option when a claim for monetary damages just won’t be good enough and when you need to stop someone from infringing on your rights pending trial.”
Smart Business spoke with Skeen about when CEOs should seek injunctive relief.
What is preliminary injunctive relief, and why is it beneficial?
Preliminary injunctive relief is frequently referred to as extraordinary relief because it is sudden and powerful. Traditionally, a preliminary injunction is a court order that preserves the status quo and requires one of the parties to refrain from doing certain acts pending trial. An injunction is extremely useful when there’s really no way to calculate or recover the full value of the damages suffered by your business at trial. Also, preliminary injunctions often save companies litigation costs by encouraging settlement talks. To get a preliminary injunction, the moving party must show it is likely to prevail at trial. As a result, injunction motions provide the parties with a preview of the court’s thinking. A party may want to avoid the expense of a full-blown trial if it knows the court is leaning in favor of the other party.
When should CEOs seek preliminary injunctive relief?
It’s commonly requested in cases of unfair competition, trademark, copyright or patent infringement. It is also requested in real estate and certain employment law cases. For example, if an ex-employee starts a competing firm using your company’s trade secrets, such as a customer list, it may be impossible to determine the revenue loss your company has suffered due to misappropriation of the trade secret. Preliminary injunctive relief would be appropriate in that case. You should seek an order from the court to stop the former employee from using the customer list. You can also seek an order requiring the former employee to return or destroy all copies of the list. You will have to prove the customer list was confidential and that the list had economic value due to its secret nature. In other words, you must show the list is not ordinary, publicly available information, but rather information that gives you a competitive advantage over others who do not have it.
Alternatively, let’s say a competitor falsely advertises that taste tests show its product is definitely superior to your company’s product. Obviously, this would hurt your company’s brand and trademark value, but it would be hard to quantify the amount of harm. Preliminary injunctive relief would be appropriate here as well.
Is preliminary injunctive relief an option in real estate disputes?
Absolutely. Suppose your company receives a foreclosure notice, and the trustee is alleging that your company defaulted on its mortgage payments. It may be that the lender’s payment history is incorrect, or perhaps the underlying loan agreement is subject to legal challenge. You can seek an immediate injunction to halt the foreclosure process and preserve your company’s rights in the property.
Even if your business is in fact behind on its mortgage payments, injunctive relief may still be appropriate if the trustee did not follow all procedures for a foreclosure sale. Getting the injunction to prevent the foreclosure sale may allow your company time to refinance the loan or negotiate a settlement with the lender.
What steps should CEOs take to seek preliminary injunctive relief?
First, determine the pros and cons of seeking injunctive relief. If you decide to move forward with a request for preliminary injunction, an attorney will need to file a lawsuit on your behalf. Next, the attorney will file either an application for a temporary restraining order or a motion for a preliminary injunction. A preliminary injunction can only be issued after notice to the other side and a full hearing. A temporary restraining order may be issued more quickly and without notice to the other side in some instances. However, a temporary restraining order only lasts for a brief time. Courts will often deny a request for injunctive relief if there is excessive delay in bringing the motion. So, if you think your company may need injunctive relief, you should act now.
SPENCER SKEEN is a litigation partner for Procopio, Cory, Hargreaves & Savitch LLP. Reach him at SCS@procopio.com or (619) 525-3844.
Silicon Valley is known as the birthplace of new business ideas and the home of the entrepreneurial spirit. The challenge is that even tech companies with entrepreneurial roots can struggle to maintain a competitive edge and a penchant for innovation as they grow.
Several times, one of the most famous, colorful and outspoken founders in the Silicon Valley, T.J. Rodgers, faced these same challenges.
“What’s important to sustaining growth is that you have to continue to learn as a CEO and as a company, you have to continue to drive things forward,” Rodgers says. “We started as an SRAM company, and we had a single-minded focus, which caused us not to diversify. That made us very vulnerable in 2001. What I’ve learned is that as a company, you exist to serve your customers, and you can evolve and change or simply disappear.”
Rodgers, president and CEO of Cypress Semiconductor Corp., has become famous for his business success and his expert opinions since founding the company in 1982. He testified before a senate committee in 1997, a senate judiciary committee in 1998 and, later that same year, he spoke to the Annual Cato Institute-Forbes ASAP Conference on Technology and Society about why the Silicon Valley should not normalize relations with Washington D.C. In addition, somewhere along the way, he’s grown a billion-dollar business with more than 6,000 employees, invented and patented new technologies, written a few books, and received numerous recognitions.
Given that Cypress’ core business was originally built in the ultracompetitive semiconductor industry, achieving revenue of $1.56 billion in 2007 up from $1.09 billion in 2006 is proof of Rodgers’ innovative tenacity.
At Cypress, the incubator switch is always in the on position and the company has become famous for its continual quest for new ideas. In addition to product diversification, Rodgers has sustained growth by creating and sustaining a visionary culture within the organization.
Building the incubator
Being open to new ideas always helps maintain your competitive edge.
“Start-ups have a lot of energy, and they keep you looking toward the future, so we always have two or three new companies incubating here at Cypress,” Rodgers says.
“We’re known within the Silicon Valley community as having an open door to new ideas, so sometimes we’re approached by external entrepreneurs who have an idea for a new business or internal employees who present an idea for a new product that further leverages our existing technology. Our openness to new ideas is also a powerful recruiting tool. Sometimes prospective employees approach us with an idea, and they come in as sort of a package deal. We get a new employee and a new idea; they get the chance to be entrepreneurs.”
When someone from the outside approaches Cypress with an idea for a new product, they write a business plan that defines the market the product will appeal to and the team that will be responsible for developing the product and executing the business plan.
“Our management team decides if this is something we should fund, and then we take the idea to our board for approval,” Rodgers says.
What makes the incubator structure so unique at Cypress is not only the number of internal employees who are spending their days working on new products but the flexibility of the support relationship between Cypress and the incubating company.
“Part of what gets decided before we agree to move forward is how the new company will be supported through Cypress’ infrastructure and what support they’ll provide themselves,” Rodgers says. “If they use Cypress support services, such as accounting and HR for example, we’ll bill them back for the time and materials. Since Cypress is providing the funding, if the new venture runs short of cash, it will sell Cypress additional shares to raise cash.
“Like any start-up, not everything succeeds, and you don’t always know exactly what the customer wants. I would say that maybe six out of 10 new ideas will fail.”
But Cypress has had two really big winners. One was the creation of SunPower, which got the company into the solar energy business, and the other was the creation of Cypress Microsystems Inc., which was an employee start-up that is now doing $160 million per year in revenue.
“Both of these businesses helped diversify our offerings, counterbalanced our cycles, improved our profitability, and they keep us on the leading edge of innovation,” Rodgers says.
“Creating these entrepreneurial start-up subsidiaries has allowed us to really do two things at once. Many companies have a hard time driving innovation, but with this structure, our main line managers can continue to drive our existing business, and they don’t have to worry about the fear of failure with new product development.”
Maintain a unified culture
While one of Cypress’ strengths is its entrepreneurial culture and its structure of multiple subsidiaries, Rodgers is the first to acknowledge that it’s been hard to find the balance between maintaining a culture that’s open to innovation and achieving consistency.
As the company grew, Rodgers says there have been times when not only innovation lagged but, at one point during the downturn of 1992, business results were extremely poor, partly because the company was having an identity crisis. To remedy the situation, Rodgers relied on the teachings of Jim Collins and Jerry Porras in their book, “Built to Last: Successful Habits of Visionary Companies.”
“One thing that I’ve learned is that in order to continue to drive growth and maintain innovation, the main thing is that you have to keep everybody on the same page philosophically,” Rodgers says. “It doesn’t matter that you have different structures or businesses, what matters is that everyone maintains the same set of values. That’s what holds everyone together.
“As you get larger and start acquiring other companies, it’s important to continue to think about who you are as a company because you can become a crazy quilt of different cultures. Once you achieve philosophical continuity, the technical work product flows from there.”
When Rodgers accepted the fact that his company was in the midst of a crisis seemingly from a lack of a singular vision, he traveled to each location, sat down with employees and talked to each group about what makes Cypress different. Their answers would be the key to reclaiming the company’s universal philosophy and values, a critical step to putting Cypress back on a growth track.
“I essentially put my butt in an airplane seat for six months and traveled around to 25 different locations asking each group of employees what makes Cypress different,” Rodgers says. “I was using them to write a new corporate vision, and what I found is that they frequently mentioned the same things. All I did was repeat back to them the things that they already believed about the company.
“For six months, I gathered this data, and then I reviewed it for commonalities and divided it into five categories. From there, I put the data in front of the VPs and managers for discussion, and then we rolled it out. Going through the process helped to get everybody on the same page because people who thought they were in an identity crisis, suddenly felt like they had a great deal in common with their co-workers.”
The results of the effort helped unify the company. “Now, we have a statement of core values, a unified statement of purpose, a mission statement, and we’ve stated specifically how we were going to take each business component and move it from its old position to a new posture that continues to drive revenue and profit growth,” Rodgers says. “We have one page of information that ties everyone together, and we’re out fighting the enemy not each other.”
Since the crisis, Rodgers says that he has learned his lesson. To keep the situation from repeating, he frequently meets with employees, gathers feedback and has rewritten the company’s statement of purpose 40 times. It’s the single tool that he relies on to keep everyone on the same page.
Learning from mistakes
Rodgers says a company needs to never lose sight of quality. “If I had it to do all over again and I was building a new company, from day zero, I’d hire a VP of quality,” Rodgers says. “Anyone can make a product more cheaply than the next guy. Where they fail is working quality into the process. Every company needs someone who gets up in the morning and thinks about quality, and they need to have real authority to get things done.
“You need to approach quality from a holistic standpoint, and as a CEO, you need to demand quality in every aspect of your organization, and then it will wrap itself around the manufacturing process. I was never trained in the mathematics of quality, and it took me awhile to understand it and embed it in all of our processes. Quality is the main reason that Toyota has been beating Detroit because they are perfectionists in design, and they have never given up on their quality focus.”
And if a lack of quality or any other reason leads to a mistake, don’t be afraid to admit that a mistake was made.
“That’s another thing I’ve learned through my experience as a CEO, always admit your mistakes and never stop learning,” Rodgers says. “There have been times in the history of this company when we’ve had a stellar ride and management took credit for it, so when there’s a problem, management needs to take responsibility for that, as well. People will judge you not by what you say but by your actions, so if you make mistakes, admit it.”
HOW TO REACH: Cypress Semiconductor Corp., www.cypress.com
Nothing sets a business apart from the competition like a stable of product or service names or logos. It is imperative to protect those trademarks by appropriate management and registration. In today’s global market, businesses must lay a foundation for protection in every country of interest to their business. Starting this process early provides maximum security.
Careful trademark/brand management not only builds brand loyalty, but, when used effectively, trademarks can become their own entities, symbolic of the total consumer experience when purchasing a product or service. This phenomenon makes the trademark one of the most valuable forms of intellectual property.
“There are several trademark management best practices that will protect a company’s investment in its brands,” says Kathleen Pasulka-Brown, partner and co-leader of the Trademarks & Copyrights Practice Group at Procopio, Cory, Hargreaves & Savitch LLP. “They include: methodical brand-name selection, managed registration of all existing and prospective brand names and logos, and a carefully prepared trademark strategy with an ongoing review process that maintains the effectiveness of the brands. Mistakes in any of these areas can be costly in terms of monetary value as well as a reduction in brand value.”
Smart Business spoke with Pasulka-Brown about how to register and protect your company’s trademarks.
What is the impact of the length of the trademark registration process?
It has always taken more than a year to obtain a trademark registration. It is important to note that while a trademark can be used during the approval process, it can ultimately be declined, causing losses in marketing investment and any good will developed under the trademark. This, in turn, may translate into a costly endeavor of relabeling products and packaging. Initially, in the United States, trademark registration requests are scrutinized by an examining trademark attorney who checks to confirm whether the new mark is capable of trademark significance and whether a conflict exists between the new mark and any existing trademark applications or registered marks.
Why is the trademark selection process so important?
In the United States and many other countries, marks do not have to be identical and the goods or services do not have to be the same in order for the trademark examining attorney to find that a conflict exists. It may be enough that the marks are similar and the goods or services are related. To make certain a particular trademark is approved, a thorough search should be conducted before filing the application. However, because the confusion criteria are subjective, marketing departments may miss some of the nuances in this search. For this reason, it is preferable to have a trademark attorney perform and evaluate the search because they have access to more comprehensive databases and will evaluate the choices on a different level, looking for nuances that may create a likelihood of confusion. Last, marketing departments should select several names. This will prevent them from becoming enamored with just one, in case the more prudent decision is to move forward with another selection. It is vital to request a search in each country of interest by an attorney if you are planning to use the brand during the approval process and in order to protect the investment in the application.
What are the other benefits of trademark registration?
Besides the enhanced marketing capabilities, benefits of registering a trademark in the United States include: notice to the public of the claim of ownership of the mark by the registrant, legal presumption of ownership by the registrant, increased rights in court, use of the symbol ® and the ability to obtain enforcement action by U.S. Customs. The benefits in other countries are similar.
How can CEOs maximize the value of the company trademarks?
In order to maintain the validity and enforceability of a trademark registration or the enforceability of a nonregistered trademark, owners must police their mark, meaning that if they become aware of an infringement which happens when another party uses a similar mark they must take appropriate action. Trademark owners should also protect their mark by obtaining a domain name that is the same as their trademark. Companies should also engage watch services that will assist in the policing process. The watch service results should be reviewed by trademark counsel, which is a good way to keep an eye on competitors.
KATHLEEN PASULKA-BROWN is a partner and co-leader of the Trademarks & Copyrights Practice Group at Procopio, Cory, Hargreaves & Savitch LLP. Reach her at (619) 525-3827 or firstname.lastname@example.org.
George DeVries faced the classic entrepreneur’s conundrum: How do you add enough structure to support a growing company without killing innovation?
His solution was part process, part culture.
DeVries, co-founder, chairman and CEO of American Specialty Health, relies on structure for both.
“I think that one of the things that fostered our growth is the continued evolution of our new product delivery process,” DeVries says. “We now develop new products and then deliver them to market in a very structured way. That delivery structure has helped us manage our risk, which meant that we didn’t always have to succeed with a new product in 90 days. We’ve been able to be patient waiting for new products to catch on, but in spite of that advantage, success has taken a lot of perseverance. I think, originally, one of the hardest things was selling the concept of complementary health care to customers before the customers knew the need even existed. Our success hasn’t been about risk avoidance; it has been about managing risk. We never bet the future of the company on just one product.”
DeVries founded American Specialty Health in 1987, after he had been laid off from his job. Needing employment, he listened to a friend’s idea and formed a chiropractic network while working from the spare bedroom in his condo. At the time, the notion of organizing chiropractic providers and providing insurance coverage for chiropractic visits was unheard of. As it turned out, that germ of an idea was the beginning of American Specialty Health.
Today, the company provides complementary health care coverage and services to 13.4 million members for clinical needs, such as chiropractic care, dietary services, acupuncture and massage therapy, as well as health education programs for everything from tobacco cessation to weight management and disease prevention. DeVries says that the key to growing the company to $128 million in annual revenue and 600 employees has been the creation and installation of a structured system that minimizes the risk of bringing new products to market while continuing to foster and support innovation.
While all new products start with a concept, idea generation is truly the vital component for new product development at American Specialty Health, simply because DeVries has been the industry’s trailblazer. He originated the concept for the company’s insurance coverages and educational services because it wasn’t possible to emulate the competition.
He says that he gets ideas for new products from a variety of places, and then develops them with the company’s senior management team into a working document.
“Many of our new product ideas come from the senior-management level in the company, but we also get a number of good ideas from talking to clients,” DeVries says. “I’ll be out talking with a client, and they know we’re an entrepreneurial company, so they’ll offer ideas to me. To get ideas from customers, you have to spend time with them, and you have to listen. Then, I’ll get together with one or two senior company leaders, and we’ll flush out the idea and create a detailed white paper. We drill down into the detail in the white paper, looking at every aspect of the product including the financial implications.
“We’ll look at the consumer trends and the clinical trends to see if we think there’s a market for the product, although sometimes because the idea is a new concept, there’s no data to support it, so you just have to go on intuition.”
Even though the data to support his ideas doesn’t always exist, DeVries says that the team rarely disagrees about bringing a new product to market. However, from time to time, disagreement occurs within the ranks, and getting to the next step requires DeVries to use his consensus-building skills.
“You can create consensus among the team by helping everyone understand how the product will benefit the market and why it makes sense to bring it forward,” DeVries says. “I’ve had to develop those skills because I had to sell new concepts to customers. One of our more hotly contested ideas was around development of our health coaching program. We had a lot of people scratching their heads with that one, but now the program is successful, and it’s generating millions in annual revenue.
“That program is an example of why it’s vital to have an entrepreneurial culture. We don’t work in silos, and as a management team, we can make difficult decisions come together because everyone knows that our company is all about innovation.”
While the senior management team and customers generate many new product ideas, the entrepreneurial roots of the organization inspire front-line employees to offer up new ideas, as well.
“In the case of our Silver&Fit program, which is a fitness program for seniors, that idea came from some of the folks in our marketing department,” DeVries says. “The culture is what creates that type of innovation.”
DeVries credits detailed and structured new product implementation with few launch failures and measured risk reduction. As a first step in the process, he turns the white paper over to the chief operating officer, who then builds a key process team composed of midlevel company managers. The goal of the key process team is to detail everything that will be necessary to bring the product to market.
“The key process team looks at all of the deliverables and what tools and resources it will take to make the product successful,” DeVries says. “This includes everything from the impact on customer service to the creation of marketing materials. We want to understand all of the resources and tools that will be required to support the product and the impact the service delivery requirements will have on our internal team and our customers.”
He says that this detailed look by the key process team helps to refine costs and avoid financial surprises. His next step assures that the marketplace will accept the product before the company makes a huge investment of time and resources.
“We sell all of our new products to a few early adopters who are current clients,” DeVries says. “This is an absolutely critical step before we go live. You can’t risk testing a product with new customer relationships, so you go to your existing customers. We want to see how the product is going to perform before we offer it to everyone. This step reduces our risk, and by staging the implementation, we’re able to postpone the larger costs associated with a wide-scale launch until later on.”
DeVries says that while research and development costs are fairly low in the complementary health coverage business, staging the implementation further enhances the cost effectiveness of delivering the product to customers. Also, he can refine the service delivery process for the product, which helps to assure quality for customers once the product moves beyond the beta test stage.
“I’m engaged on the sales side when we make the visit to the client requesting the trial because it shows the commitment of the organization to the new product,” he says. “Once the product is established, it’s much easier for the sales team to secure additional customers.”
Regardless of processes, successful new products are the result of having people that believe in a culture of innovation.
“One of the ways that CEOs can foster growth and create a culture that supports innovation is by hiring people who are committed to the vision and mission of the organization, especially at the senior-management level,” DeVries says. “It’s different managing and creating new products when you’re a company of three people because you can keep your hand in everything. But as you grow, whom you add to the team is vital because no one person can carry a team of 600, so your ability to assess people for a cultural fit is vital. We hire for character, enthusiasm and a positive attitude because everything else you can train. I always say, ‘Hire for character first and what’s on the resume second.’”
He says that he has no special formula for assessing character because hiring is not an exact science. However, he favors conducting multiple interviews with a candidate as a way to assess their character, and he also encourages employee referrals because current employees will refer friends who are also a good cultural fit for the organization.
DeVries says that he favors promoting from within and offering upward mobility to employees as another way to nurture the culture. Internal promotions help the staff feel engaged with the outcome and more like business owners.
“Creating promotional opportunities for the staff generates enthusiasm,” DeVries says. “Most of the entrepreneurial ideas are driven at a very high level in the company, but we wouldn’t be able to execute if not for the staff that administers the products and supports the innovation.
“One way that I check in with the staff and get a barometer on the culture is through our annual employee satisfaction survey and also by monitoring the number of referral bonuses we are paying to employees for referring their friends for employment opportunities here at American Specialty Health. I really regard employee referrals as the true litmus test of whether our culture is working. When the employees take the annual survey, they are asked to rank the attributes of the company, and I go through and read each survey along with their comments. It’s important for CEOs to listen, and we’ve made some adjustments based upon the comments and feedback we’ve received, such as increasing staff benefits. Listening to the feedback and making adjustments is an important part of maintaining the culture through the process of growing the company.”
While the culture has remained the same, the structure that supports innovation has changed and evolved over time and that evolution has been the secret to achieving growth and success for DeVries.
“We have continued to innovate, but now we handle the process of innovation in a very structured way,” DeVries says. “We’ve continued to evolve and create new products, but we wouldn’t have been able to accomplish any of it without a structured process for implementing new ideas.” <<
HOW TO REACH: American Specialty Health, www.ashcompanies.com
When Bob Calderoni was hired as the chief financial officer of Ariba Inc. in 2000, he thought he was leaving the world of restructurings and repositionings behind him.
He had seen such action throughout his career in financial management roles with companies such as Avery Dennison, Apple and IBM’s storage division, and he had tutored under accounting giant Arthur Andersen before entering the corporate arena.
But the Ariba job was supposed to be different. It was supposed to be tackling the relatively small challenge of dealing with growth at a small company.
It didn’t work out that way. “The tech bubble was literally bursting just as I was walking through the door,” says Calderoni, now chairman and CEO. “I had always worked for large companies, and I thought I was being hired to be part of a small, fast-growing company. I didn’t think I was being hired to reposition the company. It came as a surprise to all of us in the company, and I just had to deal with it.”
Six months later he was the CEO, leading the efforts to keep the lights on and blazing a new trail toward the future.
Originally founded in 1996 as a provider of software for large-scale corporate procurement functions, Ariba rose to the top by riding the late 1990s’ wave of technology investment by Fortune 500 companies.
Within the sector, the company had already achieved significant market penetration among the initially targeted client base of Fortune 500 firms. In fact, Ariba counted seven of the top 10 Fortune 500 firms as clients. No single competitor supplied a total solution to customers, and while there were battles yet to be won on the customer front, Ariba was better positioned to win big wars not smaller battles.
Calderoni says that although he previously held CFO titles, he was trained in the early days of his career at IBM to act as more of a chief operating officer than what was traditionally expected from CFOs of the era. It would take all of that experience and more to reposition Ariba for financial soundness and a new breed of midtier technology customers who required deeper solutions than software in a box and an end to technology installations that resulted in huge cost overruns.
Saving the company
As the technology boom turned into a bust, Ariba wasn’t much different than many of the other tech firms that were crumbling around it.
“The organization was in a lot of trouble,” Calderoni says. “It was a typical early stage Silicon Valley entrepreneurial firm burning through lots of cash, saddled with a lot of cost and facing a crumbling market.
“I had to stop the bleeding or nothing else was going to matter, so I was forced to eliminate 70 percent of the organization just to survive. As a CEO, you really can’t worry about the future if you aren’t even going to be there.”
To achieve the necessary cost reductions that eventually took the firm down from 2,500 employees to 700, Calderoni initially reviewed readily available competitive benchmarks for every function in the company. He compared Ariba’s operating budgets to the standard expenditure level for each function, which is usually expressed as a specific spend level as a percentage of revenue. From there, he decreased some of the planned cuts, such as in the research and development function, because he says he knew that when the tech market rebounded, he would need a new suite of client deliverables to tackle the midtier client space and to generate sales of additional services to pre-existing customers. Both moves would require additional R&D and cash investments.
“I really don’t think that you can cut too much from a company,” Calderoni says. “I’ve been hearing that for 20 years, and now that I have the benefit of hindsight, I never remember a time when I said afterward that I thought we cut too far. You have to make your cuts quickly and decisively because there are lots of ramifications within the organization when you are making cost reductions. You can’t move forward again until the veil of uncertainty is lifted.
“As we were making the cuts, I needed to listen to my staff because a CEO can’t make all of the decisions. In every organization when you are making cuts, you have to make some trade-offs and some portfolio decisions. We looked at every cut and how those functions related to our vision of building a whole e-spend, e-commerce solution and eliminated those areas that were not going to take us where we wanted to go.”
Winning on demand
Despite having to make cuts to save the company, Calderoni never lost site of innovation.
“I really worked on stabilizing the company, making us profitable and repositioning us for growth all at once it was simultaneous,” Calderoni says. “I know that a lot of people were thinking, ‘Oh here comes the bean counter, taking over and making cuts,’ but we really stepped on the gas in terms of innovation. We went from one product to 11 products within 24 months.”
The software industry was built on hefty upfront costs, long implementation schedules and big price tags. Customers wanted scalable solutions, and they wanted them now. Even behemoth Microsoft has announced plans to position that firm for the on-demand marketplace. Essentially changing the software investment platform to a pay-as-you-go enterprise for customers would mean that Ariba would need to make significant changes.
“Many people said that it couldn’t be done, they had never seen a software company reposition for the on-demand marketplace and survive the transition,” Calderoni says. “We had to redevelop all of our products, but the subscription model helped reduce cost and headaches for our customers, and that has resulted in a net gain of new customers.”
Calderoni says that he considers Ariba’s growing backlog of work and addition of new midtier customers to be further validation that the transition was exactly what the customers wanted all along. More than 75 percent of the new customers Ariba added during the fourth quarter of fiscal 2006 were small and medium-sized businesses.
“Procurement as a function needed a lot of investment,” Calderoni says. “They didn’t necessarily have the skills to maximize the efficiencies from the software. I think that many firms had learned through ERP installations that software alone would-n’t solve the problems, and we were a company that had just been pushing software.”
In answer to the need, Calderoni added a consulting division and hired more than 300 consultants who would bring solutions expertise to the customers. Seeing an opportunity for greater margin and the ability to cross-sell both subscriptions and solutions, Calderoni also says that he was filling the need for knowledge and technology among the firm’s procurement customers.
“Subscription revenue in the industry was inconsequential when I started, but everyone we competed against doesn’t exist today, and we had 15 percent growth in our subscription revenues in the second quarter of 2007,” Calderoni says. “Today, consulting is 50 percent of our revenue because customers are buying a solution.
“I knew it would be a challenge, but that’s what motivates me. I think now, consciously, overinvesting in R&D has been recognized as the right move and that we’ve proven that cost reduction and growth are not mutually exclusive.”
As Calderoni began examining what constituted the next level of growth for Ariba, it soon became clear that despite all of the initial repositioning efforts, providing a total solution to customers would require acquiring some capabilities that Ariba didn’t have in-house. From the predominately founder-led company cultures that are commonplace within Silicon Valley, Calderoni’s business acquisition view that, “it’s not important whether you build it or buy it,” may startle some.
“I am unemotionally biased when I look at acquisition targets,” Calderoni says. “My criteria for decision centers around gaps in capabilities, and those can be technical or nontechnical. That led to our biggest move, which was the acquisition of Free Markets. Free Markets brought commodity expertise and sourcing capabilities, and we provided the technology capabilities that they didn’t have.”
The acquisition also added another 400 commodity category specialist consultants to Ariba’s growing stable of experts. Each firm had its own technology platform, and Calderoni says that he used the best of both to achieve technology integration. The people side of post-acquisition assimilation plans requires a different strategy in his view.
“Only at the senior-most levels of organizations is it difficult to merge firms,” Calderoni says. “At the lower levels of the organization, people ended up in a better place so it’s usually the management teams that feel the brunt of acquisitions. I looked at who would fit best into Ariba going forward when deciding who to retain from the Free Markets management team, and there were certainly some tough calls to be made, especially early on. In some cases, the decision of who to keep and who to let go was very close.
“I leave emotions aside when I’m making decisions and just try to hire the stronger of the two individuals, but people make hiring mistakes all the time. I also act swiftly because uncertainty is bad for organizations. The staff will fill the void left by distracted leadership with ambiguity, and I think you are better off as a CEO making your decisions quickly and firmly and not worrying so much about making mistakes.”
Calderoni says that his background as a CFO causes him to lead with financial conservatism. His philosophy is that expenditure levels should match up to the corresponding stage of the organization’s development, and until firms achieve consistent cash flows, they should not take on additional debt. He says that he is also cognizant that many customers have well-deserved concerns about the stability of technology companies, and he believes that being fiscally conservative will attract new customers and increase revenue.
“In early stage firms, cash provides you with an appropriate safety net, and that’s what customers want,” Calderoni says. “We would not have been able to fund $170 million of our $300 million investment into the on-demand marketplace in cash, without having made all of those expenditure reductions early on.”
Calderoni says that it’s always about balance, and that goes for investment and debt loads. Once companies hit an emerging marketplace, only then is it appropriate to break away from a more conservative investment posture.
While Calderoni has repositioned Ariba and the firm generated revenue of $301 million in 2007 the expense level does not equal the pre-bust days. Ariba has 1,700 employees, down from the late 1990s high of 2,500, and a greater percentage of expansion costs are financed by cash from operations.
“Growth shouldn’t come by mortgaging the future of the company,” Calderoni says. “You can’t spend like a drunken sailor hoping for a better day.”
HOW TO REACH: Ariba Inc., www.ariba.com