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The Numbers on Open-book Management

Inc.'s editor looks at the effects open-book management can have on a company's bottom line; the mutual benefits of mentoring; and a photo lab that offers business workshops for photographers.
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FYI

It's been fascinating to watch the business phenomenon known as open-book management as it has spread in less than a decade from a handful of companies to thousands of businesses both in this country and abroad. That growth is particularly striking when you consider that, until recently, there has been only anecdotal evidence that open-book management really works.

I say "until recently" because the results are just in from a study that, for the first time, statistically evaluates and quantifies the effectiveness of open-book management. Conducted by the National Center for Employee Ownership (NCEO) and funded in part by a grant from Inc., the study looked at 50 companies for a period of time both before and after they began practicing their open-book disciplines and then compared their performance with that of a group of competitors. The conclusion: revenues of open-book companies grew, on average, 1.66% faster than those of their competitors, and 2.2% faster if the open-book company also had an employee stock ownership plan.

That may not sound like much, but academics will tell you that in the world of economic data, even a 1% difference is significant. I prefer to illustrate the effect using my own method: a story.

George and Bo are identical twins, except that George is handsomer and smarter. On their 20th birthday, they start identical software companies. After 10 years, they're both doing $10 million in sales, with after-tax earnings of 10%. At that point George starts wondering why, if he's smarter and handsomer than his brother, his company isn't performing any better. He decides to implement open-book management and install an ESOP. To no one's surprise, Bo does not.

Based on the NCEO's research, here's what's likely to happen: Ten years later George's company is doing $20 million in sales, with Bo's lagging behind at just over $16 million. They both decide to sell their companies to boyhood friend Bill, who has an even bigger software company based in the Pacific Northwest. He agrees to pay them each 30 times earnings. If we assume that their after-tax margins haven't changed, Bill cuts Bo a check for $48 million and George a check for $60 million.

Of course, the assumption about margins is a rather big one. Most open-book CEOs we know say their management approach has a greater effect on profits than on sales. If that were true in this case, George would have sold his company for even more money, demonstrating that open-book CEOs really are smarter (if not better looking) than their closed-book counterparts. For definitive proof on that score, however, we'll have to wait for the next study.


Exercising your, uh, ESOPs
These days everybody seems to be confused about the difference between ESOPs and stock options--even the big accounting firms. A recent issue of Growing Your Business, a newsletter published by Coopers & Lybrand, incorrectly defines an ESOP as an employee stock option plan. In fact, the letters stand for employee stock ownership plan, which has nothing to do with stock options. Hoping to relieve the confusion, the National Center for Employee Ownership has posted an essay on its Web site titled "An 'Employee Stock Option Plan' Is Not an ESOP." If you aren't sure of the difference, you might want to check it out.

Two-way streets
Mentoring, the subject of this month's cover package, is undergoing tremendous change. "Twenty years ago we defined mentoring as supporting the junior person's learning and development," says Kathy Kram, faculty director of the executive M.B.A. program at Boston University School of Management. "Today we know it's really colearning. That's important. Someone might assume he or she doesn't have time for mentoring, but in fact most mentors find these relationships to be critical to their own survival and growth." No wonder the smartest businesspeople we know are also mentors.


'If you don't know who the fool is in a deal, it's you.'
-- Journalist and entrepreneur Michael Wolff quoting anonymous bankers in Burn Rate: How I Survived the Gold Rush Years on the Internet (Simon & Schuster, 1998, $24), in which he recounts his experiences as the founder of an early digital-publishing company


Build it and they will come
You probably know about the dark side of Volkswagen's history--how Hitler built the original VW factory in the late 1930s to make Kraft-durch-Freude Wagens, "strength-through-joy cars," to be driven on Germany's new autobahns. But only 210 such volkswagens were produced before the factory was converted to wartime production. After the war, the plant was slated for dismantling by the Allies.

But then something happened that usually occurs only in movies--bad movies, starring Kevin Costner. As recounted by Jack Mingo in his book How the Cadillac Got Its Fins, a few former employees started drifting in to see what was left of the old production line. Scrounging some materials, they built a few cars by hand. What they produced they bartered with the Allies for food and raw materials. By the end of the year, more than 6,000 people were working at the plant, half of them making cars and the rest repairing the building and the machinery. Unmanaged and uncapitalized, the plant turned out 1,785 vehicles in 1945, and 10,020 the year after that.

When production dropped to 8,987 in 1947, the occupying British finally decided it was time to turn Volkswagen into a real business. They offered the plant to Henry Ford II--for free. Advised by his company's CEO that the factory wasn't "worth a damn," Ford turned down the offer. So the Brits appointed Heinrich Nordoff, a former executive with Opel, to serve as plant director, and he proceeded to make the Beetle the first serious import threat to Detroit.

And that's why you don't see billboards touting the new Ford Beetle everywhere you go these days.


A competitive edge you can count on
Ever get the feeling you're running out of sources of competitive advantage? That as fast as you introduce something new in the area of price or quality or service or time to market, others in your industry replicate it? Well, Frank Topinka has come up with an ingenious response to that problem, based on an observation he made 10 years ago. It was back then that he realized he had a skill his customers desperately needed to acquire: the ability to run a business. He's been teaching them how to do it ever since.

Topinka is the vice-president of operations for McKenna Professional Imaging in Waterloo, Iowa, a custom lab that does processing for portrait and wedding photographers. His customers typically do from $150,000 to $500,000 in sales annually and have two things in common. First, they see themselves as "artists," not businesspeople. Second, they're increasingly competing with companies that don't suffer the same confusion. "The competitors used to be other local photographers," says Topinka. "Now they're big national players like Wal-Mart and Sears, and they are fierce."

So Topinka runs workshops for McKenna customers, teaching them basic financial skills like budgeting, forecasting, increasing their average sale, and how to cut variable costs--including the cost of film and processing. Talk about building credibility. "We're helping them reduce costs associated with us," Topinka says. In return, participating customers pledge to send 80% of their processing work to McKenna.

Currently 45 of the company's 1,200 customers are enrolled in the MAPS (Management and Accounting for Portrait Studios) program, and Topinka expects to add 45 more by year's end. In addition, president Kelly McKenna has recently launched a new program, called PVP (Portrait Value Plan), to help customers market their services. Most small studios do little advertising, Topinka notes, but now they find themselves up against the massive campaigns of new competitors. So McKenna Professional Imaging has set up an in-house call center that makes outbound telemarketing calls for photographers. A customer can sign up for MAPS, PVP, or both.

What's in it for the company, aside from the additional volume? Asked if the payback comes from lowering the cost of acquiring a new customer, Topinka replies, "The payback comes from acquiring a new customer, period. Photographers just don't change labs. Think of the trust required to send a processor your only negatives of someone's wedding. We've got to give customers a very compelling reason to change. Showing them how to reduce costs by 15% and increase sales by 15% without expanding their customer base--for them, that could be the difference between profitability and extinction. That's compelling."


Feeling insecure yet?
If you're fed up with media accounts of downsizing that rely on anecdotal evidence and prove nothing, you might want to check out a first-rate article in Economic Perspectives, a quarterly journal published by the Federal Reserve Bank of Chicago. Titled "The Decline of Job Security in the 1990s," it examines the attempts by labor economists to add some substance to the debate. Then again, you may want to go straight to the handy formula economists have developed to estimate the rate at which people who have held their jobs for at least five years are being displaced. Here it is:

 d  t 5 r  t 5  =  ______n  t f t 5  

Any questions?


Faster than a speeding clichÉ
Blur: The Speed of Change in the Connected Economy (Addison-Wesley, 1998, $25) is the latest entry in the high-stakes field of books that attempt to identify and name the key characteristics of the New Economy. What sets this one apart is its authorship by two of the most insightful business observers around. Christopher Meyer is the director of the Ernst & Young Center for Business Innovation. Stan Davis wrote Future Perfect and 2020 Vision, both of which I loved--and I said so in this space.

Unfortunately, in writing Blur, the authors chose to be not merely observers of the phenomenon but practicing blur-sters. As they state in the acknowledgments, they took the concept from "brainstorm to bookstore in less than a year." It shows. Blur is economic junk food, a breathless survey of the landscape that's a mile wide and an inch deep.

If you want to learn something new about meeting the challenges of rapid change, read instead Competing on the Edge: Strategy as Structured Chaos (Harvard Business School Press, 1998, $27.95), by Shona L. Brown, a McKinsey & Co. consultant, and Kathleen M. Eisenhardt, a Stanford business-school professor. Chapter six, "Setting the Pace," is worth the price of admission all by itself. In that chapter, the authors describe how Intel uses "time pacing" to enter new markets and to create new products, services, and businesses according to the calendar rather than in response to competitive events.

Eisenhardt says that she and Brown needed three and a half years to produce Competing on the Edge. Which proves that, even in the New Economy, some things are still better done, and done better, slowly.


Contributors

John Case
Not only did editor-at-large John Case write one of the definitive books on open-book management, he also coined the term in the first place. In " Keeping Score," he explores the latest techniques for getting employees engaged in tracking the numbers.

Mike Hofman
We sent reporter Mike Hofman back to school--to report on the burgeoning trend of private companies' taking over public schools. It is, he discovered, a very lucrative business. His report, " Staking Out a Share of Public-School Gold," can be found in this issue.

Deborah L. Jacobs
There's nothing like an indecipherable legal bill to breed mistrust of lawyers. Check out Deborah L. Jacobs's advice (" What Your Lawyer May Not Tell You"). Her book, Small Business Legal Smarts, will be published by Bloomberg Press in August.

Edward O. Welles
Two articles by senior writer Edward O. Welles span the spectrum of entrepreneurship, from commercializing cutting-edge solar technology (" Going for Broke") to applying Sam Walton's advice to the lowest-tech businesses around (" The Mentors").

Last updated: Jun 1, 1998




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