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Why 'SMART" Companies Never Fail

By Sydney Finkelstein, Professor, Dartmouth College's Tuck School of Business and Eric M. Jackson, Vice President, Jackson Leadership Systems

Building Smart Leadership How paying attention to the kind of leadership you are encouraging and developing at the senior ranks and board-level can help successful software organizations build immunities that prevent failure later on?

At the beginning of 2005, Morgan Stanley Lead Director, Miles Marsh, thought that the performance of the white shoe investment bank was on-track. "Performance had turned up," he said, as earnings per share rose 18% in 2004 and the firm was #1 in stock underwriting.i He and his fellow directors would no doubt have been surprised to learn that, just 6 months later, Chief Executive Philip Purcell would be ignominiously forced to resign his post after an unprecedented number of complaints from employees, ex-employees, and shareholders, putting a cloud over the entire board.

It turned out that - despite several positive financial indicators - there were many warning signs that Morgan Stanley was headed for trouble. These signs went unheeded. The public and private battles, high-level executive turnover, and demoralized culture were not inevitable; it was through lack of attention that they became so.

In our research we have found that Morgan Stanley is not the first - nor likely will it be the last - highly successful organization that sowed the seeds of its own demise. Based on six years of research that went into the writing of the 2003 book "Why Smart Executives Fail", as well as more recent research, we have identified the key organizational patterns that differentiate between high-performance organizations (like Morgan Stanley) that later fail in large part because of their success (what we call "Not-so-Smart Organizations") and other successful companies that have been able to maintain and grow their market dominance. We call the latter, "SMART Organizations," and, in this article, we outline the key factors that can help you determine whether or not you are building a software organization with "SMART Leadership."

The "SMART Organization" Defined
We have all seen successful software organizations that have their day in the sun. Earnings are up, maybe there's a hot new space that's attracting a lot of VC money, or there's a category-killer technology that is generating a lot of buzz. The CEOs in these organizations are typically splashed across the covers of major business magazines, and are given ample opportunities to outline in Inc., Red Herring, Fast Company, and CNET the reasons why they have been successful. Alas, in many of these situations, the excitement does not endure. A couple of missed quarters. New competitors emerge with an even more interesting gizmo. Larry Ellison said famously that over two-thirds of software companies will be out of business or consolidated within the next 5 years. Where is the Second Act for these organizations?

For other one-time successful organizations, their Second Act is more of a slow bleed. They don't immediately head into bankruptcy. Rather these one-time giants quietly fade into market irrelevance or cannot raise further venture money and, instead, pull in their horns while they try to outlast their competitors, ceding market share and often profitability. Some of these firms are able to shake off the rust (look at Motorola's comeback under Ed Zander's leadership), while others must accept being acquired by competitors they used to rival in prestige and profits (think of Siebel's acquisition by Oracle). We call these organizations that struggle to maintain their market pre-eminence "Not-so-Smart Organizations," as their failures are almost always within their control. "Why Smart Executives Fail", outlines these major causes of corporate failure.

However, in our research leading up to and since the publication of the book, we noticed that there appeared to be other successful organizations (in software and other industries) that were able to keep churning out steady and consistent growth, quarter after quarter and year after year. Why? As we began to look closer at what was going on in these two types of organizations at the board level, at the top management team level, and across the entire organization, we noticed some compelling differences. For example, while the "Not-so-Smart Organizations" seemed almost consumed by their financial performance to the exclusion of other organizational factors (Founder and CEO An Wang of Wang Labs, used to carry a note card displaying Wang Labs" stock performance versus IBM's), other organizations not only paid close attention to their own financial indicators, they were also carefully attuned to several organizational factors as well. Because these organizations all maintained and grew their market dominance, we refer to them as "Smart Organizations."

Again and again, the same kinds of organizational factors appeared across these firms. They cluster into three groups, so we call them the Three Pillars of a "Smart Organization:" Smart Leadership, Smart Strategy, and Smart Process. Examples of "Smart Organizations" in our study included Google under Eric Schmidt, Sergey Brin and Larry Page, Dell under Michael Dell and now Kevin Rollins, Four Seasons Hotels & Resorts under Isadore Sharp, Gucci Group under new head Robert Polet, and the world's largest retailer Wal-Mart Stores under Lee Scott. According to our research, it's only through paying attention to each of these "Three Pillars" that an organization can help ensure that it will continue to execute the necessary high-performance financial indicators that all boards, top management team, investors, and analysts want to see. In the remainder of this article, we describe the role of the first of these pillars: Smart Leadership.

The Three Pillars of a "Smart Organization"
Smart Leadership
The first commonality we found across Smart Organizations was that they possessed "Smart Leadership" at the Executive Team and Board levels. The "smart" label doesn't reflect their collective IQ (although all would have scored highly). Instead, what made their teams and boards "smart" was a combination of certain individual skill-sets that each officer and director possessed, none of these organizations had "Imperial CEOs" with thousands of faceless followers. Instead, they had teams, boards, and leaders throughout the organization who were the stars of the show. These officers and directors had skill-sets, knowledge, attitudes and behaviors that were in place in "Smart Organizations" but were conspicuously absent in successful companies who later headed towards failure.

Skill-set #1: Breeding "Proactive Paranoia"
Several years ago, Andy Grove popularized the notion that "only the paranoid survive." While this phrase is now almost a Business School cliché, it is truly an embedded value we found in our sample of "Smart Organizations." Executives and directors from these firms believed that their market leadership was truly only a quarter away from slipping from their grasp. They maintained a healthy respect for all their competitors and never got too caught up in their success. Wal-Mart execs religiously track Target's and other retailers" moves, often visiting their stores at least once a month.

By contrast, "Not-so-Smart Organizations" cavalierly disregarded the potential threat of competitors. Instead, they saw their market leadership as permanent and, perhaps because of this, often began spending lavishly on themselves and their corporate offices. Wal-Mart still requires all of its senior executives to share hotel rooms on corporate trips. And, if you have been to their Bentonville Home Office, you know that they don't waste an inch of space, stuffing cubicles together as tightly as they stuff product on Wal-Mart floor space. Sam Walton would be proud.


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