Discussion of the Week - Financial Pricing Assumptions

This past weekend, we covered a case on pricing equities in FinMgmt. The core of the case was to highlight the various "Cost of Capital" elements and assumptions can create variability in pricing between analysts. How to determine an appropriate Risk-Free rate? How to determine the Cost of Debt?

An interesting side discussion came up from a classmate that works in the financial service industry (one of the remaining banks). He talked about how some of the banks were starting to dissect the algorithms and assumptions that are embedded in the planning software used by other banks (from IT vendors, not proprietary software). They were beginning to use that knowledge to create prediction models for how they would reacted to market conditions and use that to influence their strategy.

It creates an interesting dilemma for financial services. Do you incur the costs to develop your own software and models but give up the time-to-market, or use 3rd-party tools and software in exchange for faster availability? Where can the competitive advantage be gained, or lost?

Positive NPV vs. "The Best use of Corporate Capital"..?

Fred Wilson's recent post about Google's VC business highlights a discussion we been having in our FinMgmt course, which overlapped discussions in both ITMgmt and StratMktg. It's one thing for Venture Capital firms to take on the risk associated with start-ups, but well does that risk-management and strategic-planning work for corporations that are trying to identify positive NPV projects to create value? Should you measure activities that attempt to drive Disruptive Technologies in the same way that you measure Sustaining Technologies?

One of the comments highlights an interesting paper from Michael Porter (HBS), who is frequently referenced in our FinMgmt readings:

"A study of the diversification records of 33 large U.S. companies from 1950 to 1986 shows that diversification--whether through acquisition, joint venture, or start-up--generally has not brought the competitive advantages or profitability expected. Portfolio management, restructuring, transferring skills, and sharing activities are four concepts of corporate strategy that companies most commonly use. Portfolio management no longer works very well in the United States because of its highly developed capital market. Restructuring is merely a stopgap measure that will not build shareholder value over the long term because it usually produces an unwieldy conglomerate. Companies have the best chance of being successful at diversification if they capitalize on the existing relationships between business units by having them transfer skills and share activities."

What an MBA program should be like!

We're about 8 months into the program, and we finally had a weekend that was what I had expected the program to be like. Don't get me wrong, the program so far has been very fun, and we've learned quite a bit from both professors and classmates. But this weekend was just a little more rich, a little more complete in terms of the entire experience.

Here's a few of the highlights:

Every class spend much of the time working through cases. I've stated my preference for case method learning before, and this weekend was an excellent example of the types of learning and discussion that can occur when it's focused around multi-facted cases. OpsMgm't focused on capacity planning (for manufacturing & service industries); ITMgm't focused on runaway projects and outsourcing; MgmtAcct focused on companies that are looking at techniques like Open Book Management and Beyond Budgeting; and FinMgm't focused on capital budgeting for multinational companies. Great discussions of the issues within the cases, intermixed with healthy arguments of opinions and personal experiences from classmates. The prep work and actual discussion can be exhausting, but I feel like we learn so much more from this method.

In our MgmtAcc't class, Dr.Beatty has been talking about Open Book Management (OBM) throughout the semester as a topic that student may want to consider evaluating for their work environments. In fact, our final exam is being dropped in favor of a OBM project to create a plan to introduce OBM into one of the companies without our group. Our project (Team 5) will be for General Parts International (Raleigh, NC), a $3-4Byr privately-held company, where teammate Matt Johnson is a Sr.VP. After sending us a recent WSJ article on OBM, Dr.Beatty realized that Kindermusik (referenced in the article) was a local company and arranged to have their EVP/GM (Brian Healy) visit class and give us an overview of how they implement OBM within their organization. Mr.Healy did a tremendous job of sharing experiences and taking Q&A about how OBM helped shape the culture of Kindermusik, and focus each individual in the company on the "critical number" necessary to make that portion of their business successful.

The evening before our FinMgm't class, the amount of discussion between teams in trying to pull together all the information and analysis of the Whirlpool case was excellent. We were literally walking back and forth between rooms in the hotel comparing notes, debating analysis, struggling with how to handle missing data or assumptions, and generally putting in a ton of time for a piece of homework that effects a very small portion of our overall grade. By 2am we were completely blurry eyed and exhausted. But the journey was well worth it. Not only did we each learn quite about about the concept (capital budgeting), but I think we broke down a couple of mental barriers between the teams.

A few weeks ago a few of us where out late, signing Bon Jovi's "Living on a Prayer" with the local cover-band, and started talking about some ways that we could have a little fun and bring the class together a little better. Sometimes we get too focused on school work. The first attempt fell short (sorry Matt Kirk!!), but this weekend's Pajama Saturday turned out to be a big success. I'll get into that more later.

The 1st annual EXFT Ping-Pong Singles tournament reached the finals. This is our unofficial break-time activity. Congrats to Gregg Lewis and Brian Turner for reaching the finals. We're looking forward to the match next weekend.

So all-in-all a really great weekend. Lots of variety, lots of interaction within the class and outside of class, and I think the group is continuing to come together quite a bit more. It's a great bunch of people and a program that I'm proud to be a part of.

Discussion of the Week - Prioritizing Shareholders vs. Stakeholders

Over the weekend, we had our first Financial Mgm't class, with Dr.Sandra Dow. One of the readings for the class was a piece by Michael Jensen (Harvard Business School), entitled Value Maximization, Stakeholder Theory, and the Corporate Objective Function.

[I'm paraphrasing & summarizing here, so my apologies to Dr.Jensen for butchering his theory]

The paper makes the argument that companies need to consistently put the maximization of Shareholder Wealth as their top priority, ahead of goals to enhance Stakeholder "value".

It was an interesting topic for a couple of reasons:

1 - Several other courses have brought up the Balanced Scorecard model as an example of how to manage the business, often showing that Balanced Scorecard provides management with balance across Financial, Customer, Internal Business Processes, and Learning & Growth. This was the first time the Balanced Scorecard was presented as the wrong approach for running the business, and that it led to too many internal conflicts to be able to manage simultaneously.

2 - It was the first class with Dr.Dow, and the first couple hours were spent going over the Pros and Cons of these different prioritizations. Needless to say, it was a healthy discussion as my classmates had very strong opinions (on both sides) about how well each approach worked in their experience, the morality issues, the conflicts of interest with employee/mgm't stock ownership, how much lower-level employees or managers could impact shareholder wealth (ie. stock price), etc.. Dr.Dow has been very generous with her time in extending this discussion with several of us via email since the class, and I expect it will be an on-going discussion throughout the semester, especially given the existing economy (how we got in, and how we might get out).

Overall, it was a good discussion to reflect on how this applies to each of our companies, our existing roles, and if we'd make any changes if we held higher roles within our organizations. I personally used it to contrast some existing thinking I've been having about 20th Century vs. 21st Century thinking that has been inspired by Dr.Umair Haque, and his recent talk at the Daytona Sessions in Sweden.

[UPDATE: An interesting article looking at how Amazon has created an 180* turnaround on their balance sheet (2002-2009) and how it used an unorthodox model of revenue growth vs. profit growth.]

Update on Financial Management Class

Today we received our syllabus for the Financial Management class.  On the surface, it looks like a fairly standard finance class.  Lots of Cash Flow analysis, Net Present Value, Capital Budgeting, Cost of Debt & Equity, etc...

The one thing that jumped out at me is the grading model for the course.  55% is based on a final exam, and only 20-30% is based on team projects or class interactions.  While this might be fine for a full-time program made up of students with less work experience, but it doesn't seem to be in line with an executive program made up of experienced students that have knowledge to share. This structure seems to facilitate memorization rather than long-term learning.  It almost seems ironic that a finance class wouldn't be focused on "leverage", in this case the students leveraging each other.

If there is one thing that frustrates me about the program is the lack of consistency of how the courses are structured (case model vs. exams vs. lecture).  I've mentioned this before, but it came up a couple times this past weekend in class.  Several people mentioned that they would prefer to see the excellent cases presented across classes, so we can examine them from the different course perspectives (Operations, Marketing, Accounting, etc..).

The 2nd Semester Approaches

I think I'm finally caught up with my summaries and impressions from the 1st semester, so it's now time to take a look at the upcoming (2nd) semester, which starts next weekend.  The course list looks like this:

Operations Management - Dr. Jack Meredith

Managerial Accounting - Dr. Bern Beatty

Strategic Marketing - Dr. James Narus

Financial Management - Dr. Sandra Dow

IT Management - Dr. Charles Iacovou

Commercializing Innovation - Dr. Tom Clarkson & Dr. Stan Mandel (Elective)

Based on some initial reading and syllabus review, both Strategic Marketing and Operations Management appear to be extremely interesting.  StratMktg includes an online simulation model, and OpsMgmt appears to be very much about active discussion and the case-study model.  As much as I like Dr. Beatty, I can't say that I'm really looking forward to another accounting course.  I know it's good for me, and so are certain vegetables, but that doesn't mean I have to like them.  Luckily I have a few teammates that seem to grasp it better than me, so I'll be leaning on them again this semester.  I'm interested to see what is covered in the ITMgmt course, since I've spent the past 15 years in the IT industry, although almost entirely on the side of the vendors selling products as opposed to the day-to-day management of those systems.  I'll be interested to see what ROI models and metrics are discussed...maybe it'll help me position and sell my vendor-side products better. The FinMgmt course doesn't have the syllabus released yet, but I suspect that will also be a favorite of mine, as I'm a closet finance junkie.  

I suspect this semester will be as challenging as any in the program, both in terms of the coursework (seems like quite a bit in several courses) and the navigation in the economy in early 2009.  I suspect that we'll all be learning alot from each other as we cope with additional layoffs, economic swings, a new government in place and the overall uncertainty in our connected world.  

The break for the past couple of weeks has been nice and much appreciated, but I'm looking forward to getting back in a routine next week.  I just need to keep reminding myself that 2009 is not 2008, and new thinking and optimism will rule the day.