Selker Leadership

In a mid-January 2009 article in Business Week, L. Kevin Kelly, the CEO of Heidrick & Struggles said, “the business model for the executive search industry is broken.” In Heidrick’s most recent earnings call, he elaborated by stating that leadership advisory services represent “the evolution of the search business going forward.”

In their most recent earnings call, Gary Burnison, Korn Ferry’s CEO, outlined one of their key strategic imperatives to “create a more consultative solutions based workforce to drive integrated revenue growth.”

Welcome to my world, Kevin and Gary, and “better late than never”. But please don’t hold it against me if I listen to your pronouncements of a new model of search with a healthy dose of skepticism.

I founded Selker Leadership in 2002 because I knew then that the executive search model was broken, and it needed to be fundamentally altered to deliver actual value. This realization led to the development of our patent-pending PVA™ (Performance Values Assessment™) methodology. (see: Believe What We Say, Not What We Do; How Should I Know? I’m Just the Search Consultant!; What have you done for me lately and why it doesn’t matter, and Values Based Hiring as the Leverage to Building a High-Performance Organization).

I wanted to address the travesty that executives universally report that regardless of whether they’ve used retained or contingency search, internal recruiting, networking or Monster.com, their personal track record at hiring is 50/50. Translation: 50% of the money spent on executive search has resulted in a hiring mistake. (P.S. you will want to multiply your wasted money by a factor of 7X to include the intangible costs.) It really is crazy when you think about it. In your businesses, 50% failure would be unacceptable, so why would you accept it when you are dealing with the most important asset – the talent.

Some firms may augment executive search with leadership services, and change their overall mix of business. This will certainly allow them to maintain their earnings and price/share, and please their partners and shareholders, but it won’t alter the fact that their retained executive search processes are still a crap shoot. Bottom line, until executive search firms begin to seriously address the core processes and methodology of their business, hiring a great executive and leader will continue to be a coin toss.

What’s the solution? Well, first, stop spending your hard earned money on a process that fails at least 50% of the time. The economy is finally forcing many of you to come to this conclusion.

Then, find a search partner who delivers more than empty promises, but the onus is on you. You’ll have to pay greater attention in the selling process, become a discerning buyer who looks for firms that add qualitative value through their processes, and sees the proof by analyzing sample search deliverables and through your own reference checks.

Or, you can just call us. We’ve got a seven year jump on the rest of the crowd.

The recent fervor over the competing proposals from the White House and Congress to cap executive pay for firms who have received TARP assistance has everyone from Carly Forina to Donald Trump weighing in on whether or not this is a good idea. And while it appears the exact details of how compensation will be capped still need to be worked out in negotiations between the administration, Congress and the firms who have received money, on the surface I can say that there is a direct correlation between how executive compensation is structured, and a firm’s (and industry’s) ability to attract and retain their talent base.

As a career executive search professional with over 20 years of experience, I know that there are three main reasons why people ultimately accept or decline a job:

1. The Opportunity Quotient, meaning, the inherent challenge, the ability to have fun, impact a situation, have greater responsibility and work with great people are all compelling reasons to move forward.
2. The Compensation Package, both short-term and long-term allows greater wealth creation and accumulation.
3. There are Personal Reasons that come into play and force one’s decision either to accept or decline an offer. These could be life changing and unforeseen circumstances such as a family illness or a divorce that either does not allow relocation to a new geography, or forces geographic relocation.

Here’s the rules:

 1. The Opportunity Quotient needs to always be a factor. Even if the Compensation Package is astronomical, if the Opportunity Quotient is not there to some degree, a new executive won’t be long in the job.

And no matter how good the Opportunity Quotient is, if the Compensation Package is less than the executive’s current comp, they won’t be coming to your company. This will always be the case except if:

•  The executive has already acquired significant wealth, and the Opportunity Quotient is significant. Then the executive may accept an offer of employment even without a better Compensation Package. (I placed a CEO at an exciting technology company who took a $750,000 a year pay cut and put $1 million of his own money into the company to acquire an additional 10% equity stake. In this case, the executive saw that the long-term wealth creation opportunity outweighed the short-term compensation loss.)

2. People very rarely accept an offer of employment at a lower base salary than they currently have. This will always be the case except if:

• On a comparative basis the long-term wealth creation potential in the new opportunity is far greater than the difference in their new to current base salary.

3. In nearly all cases with most people, Personal Reasons trump everything and either force someone to not accept an offer regardless of how good the Opportunity Quotient or Compensation Package is; or accept an offer even if there isn’t a great Opportunity Quotient or Compensation Package.

Given this, what can we surmise about the compensation caps under consideration for those companies accessing TARP funds?

If $500,000 base salaries for executives are significantly below the median point in the industry, unless the long-term wealth creation opportunities are significantly better, it will be extremely difficult to attract and retain top talent.

Given the mandate that no restricted stock granted can be sold until all loans are paid back to the U.S. Government, unless the potential long-term wealth creation opportunity is better than what can be achieved at a company who has not taken TARP funds, it will be extremely difficult to attract and retain top talent.

Given these factors, on the surface I would conclude that the best bet to attract and retain top executives into these troubled firms is to attract new executives who:

• Look at turning around a high-profile player under intense scrutiny in the financial services sector as a “once in a lifetime” opportunity to transform a company an industry, and help right the U.S.A.’s and the world’s overall financial health and viability; and,
•  Have already achieved a sustained level of wealth creation in their lives; or,
• The executive is a “next step” candidate, e.g. the operations, revenue and/or role are all slightly larger than the executive’s current or past operations, revenue and role; and because of this, the Opportunity Quotient is highly attractive.

Come to think of it, given how badly our current crop of past and recently successful financial executives (measured by how much they’ve been paid) have so totally screwed things up, with their short-term thinking around profits and wealth creation which lined their own pockets, and led to the incredibly bad decisions and actions around risk mitigation that have resulted in the myriad toxic assets on their books, maybe going downstream to the “next step” candidates to lead our beleaguered financial firms isn’t such a bad idea after all!

Ken Goldman is an accomplished executive with extensive financial, operational and business management experience and a solid track record of success. He served as senior vice president, finance and administration, and CFO of Siebel Systems from August 2000 until the close of Oracle Corporation’s acquisition in January 2006. Prior to that, he held CFO positions at Excite@Home, Sybase, Inc., Cypress Semiconductor and VLSI Technology.

Ken’s experience additionally includes board director, audit committee chairman, and financial advisory roles at several leading public and private technology companies. Ken earned his bachelor’s degree in electrical engineering from Cornell University in 1971 and his master’s degree in business administration from Harvard Business School in 1974. He is a member and the former president of The Financial Executive Institute, Santa Clara chapter, and was formerly a member of the Financial Accounting Standards Board Advisory Council (FASAC) from 2000 to 2004.

Greg Selker: So first of all, Ken, thank you for taking the time to talk with me. I’ve come to know you off and on over the past few years, and so I’m just thrilled to have this opportunity to engage with you in this way.

Ken Goldman: Same here.

Greg Selker: I think the first area to talk about is the economy. Let me start out by saying that you’ve got a well deserved reputation for being one of the financial executives in the [Silicon]valley that runs the tightest ship. You’ve got great functional command over all of the areas of the financial organization – it’s your reputation and it’s well-deserved. So, from your perspective of someone who’s spent his lifetime building his career within financial organizations of large companies and for having a high degree of accountability, what’s your reaction in looking at some of the most aggrieves excesses that have occurred over the past six months in the collapse of the financial sector?

Ken Goldman:  Actually it’s very simple. There were two things that most amazed me. The first is the lack of really understanding and being concerned with the balance sheet. While I’m not an accountant, one of the things I was trained to do is to manage the balance sheet very well. So I’m amazed at how poorly these folks with a very sophisticated financial understanding did in terms of managing the balance sheet and balancing risk. The second thing is, if you look at some of these toxic assets held by many institutions, they never could and still can’t really measure their value and hence the impact on their balance sheets. The simple axiom is that if you can’t measure it – you can’t manage it. Since the value of these assets has turned out to be nebulous, they have not been able to manage the risk - and then take action accordingly.

As I watched this whole drama unfold it was clear that people played too aggressively toward the end. Clearly folks like Lehman Brothers and Bears Stearns had the opportunity to raise money. It’s like playing Russian roulette – you can hold out and hope to get a better deal, but at some point you have to know when to fold them up, take the money and live another day. It’s sort of amazing that the people who should have been very smart financiers – didn’t act like it. They didn’t add a little bit of conservatism to their plan and just take some money. Even if it would have been very “expensive money.” If they had done that, they would still be in business today.

Greg Selker: Right.

Ken Goldman: One of the things I’ve always told my staff is - focus on the balance sheet, and focus on cash. I remember at Siebel when we had $2B in cash on the balance sheet and we got all this flack about our lack of a stock buyback! More recently you’ve seen many other companies buyback their stock by going into debt, leaving them with no liquidity. And where are all the activist hedge funds that drove those companies to do that, and realized that was the wrong strategy? So, I think there was a lot of fast money – aggressive money, that played out as if the world only goes up and to the right. Well it’s good to plan that it could go the other way as well. This is fundamental training on what could go wrong, being prepared for that, and taking appropriate actions.

Greg Selker: Right.

Ken Goldman: You know, it’s no different than your personal balance sheet. I was just talking with some friends earlier today about the many folks that put all their money with Madoff. How can you put 100% of your assets with one guy!? The point is to diversify so if one investment goes south – it may make you very unhappy, but at least it’s only one of your assets – it’s not 100% or 90%. I’m amazed at how many folks basically put all their eggs in one basket. The last point I’ll make about this, which I’ve been saying and will continue to for years, is I really wish we would require good accounting financial literacy education – starting in high school and in college.

A friend of mine who used to be Juniper’s CFO, Marcel Gani, teaches an advanced accounting class at Santa Clara, after they have taken accounting 101. He’ll give a 10 question quiz, and these are simple questions, to the class ahead of time to gauge the level of their understanding of accounting, and they’ll consistently get seven or eight questions wrong.

Greg Selker: And this is an advanced accounting course?

Ken Goldman: Yes. It just validates that at basic educational levels we’re not spending enough time, and people are not taking seriously enough a goal to really understand accounting. I think that people need to take responsibility for their net worth. They need to understand how to manage their money. This all starts with having some rudimentary accounting and financial literacy skills.

Greg Selker: Certainly when you look at Wall Street and Madoff–and I think there’s a direct correlation between the inability to measure assets with the propagation of collateralized debt obligations, the lack of regulation surrounding them, and the irrefutable evidence that something was wrong with Madoff’s results. What’s in common with both is an acceptance of something that on the surface doesn’t jive with reality.

Ken Goldman: Definitely. In the instance with Madoff, here are people making money every month regardless of whether the market is down or up – they still make money. But at some point you have to think that this doesn’t make sense.

 Particularly people who did any study at all of what he was doing. They would have known it was impossible to consistently get those results. Whoever was auditing his accounts was a one man game and somebody that no one had ever heard of. So where were the hedge funds and fund of funds that were investing folks’ money with Madoff? The most rudimentary due diligence would have led to ask the question, “who is auditing these accounts?” My own sense is that the general regulatory bodies in the US spend too much time worrying about “after the fact” enforcement - as opposed to “before the fact” anticipating the investigation to prevent it.

Greg Selker: Have you read some of the articles that Michael Lewis has written? An article in the New York Times in early January chronicled Harry Markopolis, an investment officer in a fund somewhat competitive to Madoff who tried for years to get the SEC to investigate what he surmised was outright fraud?

Ken Goldman: I’ve read a number of Michael Lewis articles but I didn’t see that one – if you want to send me that – that would be great, because he is extremely lucid

Greg Selker: I’d love to. One of the main points he made in the article “The End of the Financial World as We Know It” was that the revolving door needs to close between the SEC and Wall Street. There needs to be a greater time lag that occurs from individuals leaving firms and then joining the SEC.

Ken Goldman: That’s true, but I don’t know if that’s the core issue. I think the issue frankly, is on emphasis. I think the emphasis has to be on compliance – ferreting out issues ahead of time – doing more checks ahead of time – and stopping things early. In other words, where was the SEC in terms of reviewing the accounts of Wall Street – giving them actions to do and preventing what would occur – as opposed to after the fact fault finding and going after enforcement? You can now punish Madoff all you want– that doesn’t help anybody who lost their money in the $50B wipeout. They should have found him in the first place and stopped the fraud before it got going.

Greg Selker: Ken, it sounds like you’re in favor of more rigorous regulation?

Ken Goldman: I think regulation is good, if it’s done right. It doesn’t have to stifle creativity or the drive to make money. Good regulation just means that information is reviewed, and you make sure people are adhering to certain rules. I don’t think there’s anything wrong with that.

Greg Selker: I agree.

Ken Goldman: The other analogy that I used in a discussion the other day was about internal audit. Look, you can either beef up internal audit capabilities in a company, or you can spend more time on making certain you have the right controls in place and that these are being adhered to. I want to spend more of my time and my people’s time on controls. Making certain we have the people and the systems to get it done right first.

Frankly, I think we’re in a centralized world and need to centralize finance as opposed to de-centralizing it. I want to get it done right and not assume that internal audit will find something wrong after the fact. Because I think it’s always much harder to find what the source of the problem really is after the fact. If you find it after the fact – by definition it’s after the fact. The real question is would you rather have quality up front, or do you want to fix it after it’s broken? If you do it right the first time – then you don’t have to worry about all these specialists. The Japanese have done this well for many years – build quality up front. It isn’t any different in building financial controls. If you build the right controls up front, instead of going around after the fact and then checking it to see if it’s right, you have the controls in place to make sure you’re doing it right.

Greg Selker: Measure your choices.

Ken Goldman: Yes. I’d rather have 80% of the regulatory bodies worried about making sure companies are doing it right first, and maybe 20% enforcement. As opposed to 80% enforcement – and 20% making sure they’re doing it right. Again, I don’t know if those numbers are right – I’m just giving you directionally where I’d like to see the emphasis.

Greg Selker:  What are your initial thoughts on the proposed salary cap on executive compensation in the financial sector, and what do you think Silicon Valley could teach Wall Street about executive compensation?

Ken Goldman: Well first of all let me say that the proposed compensation caps strike me as a little vindictive, but I can understand the feeling that something has to change. Wall Street has brought this upon themselves. They’ve acted short sighted and short-term oriented in their thinking, and even worse, they’ve been driven by an entitlement mentality as opposed to a performance driven mentality. I mean, how many businesses could survive if the rules of compensation were no matter how we perform as a company, we’re going to be paid our bonus regardless. This is not how we’ve paid our executives at companies I’ve been involved with.

Typically around technology companies, there’s a bonus pool that’s created that is dependent upon corporate performance. Once the pool’s created, participation is determined by individual achievement of personal goals along with other criteria. If the corporate performance isn’t there, then there’s no money to fund the pool, and there’s no cash bonus payouts. This has worked pretty well for us over the years. On Wall Street, for some of the firms, particularly for some of the largest ones, this has not been the case. It’s been a situation where people were paid bonuses regardless of corporate results. It’s the epitome of a culture of entitlement. Now I know that these practices have not necessarily existed at all firms, or that they have existed at all times over the years, but they seem to be more prevalent recently.

Maybe the answer is to move bonus payments more towards stock payments as opposed to cash, stock payments occurring in both options and restricted shares. In some firms, I know that the granting of stock has been an important component of their bonus structure. But even with these firms, given the horrific results reported, maybe the right thing to do would be to pay bonus awards in their entirety with stock. This also would have the effect of pushing long-term thinking and investment in the company as opposed to short-term thinking, short-term payout, and entitlement. I won’t pretend to have all the answers here, but I know that this entitlement mentality and culture with its focus on short-term rewards has to be replaced by a performance mentality and culture, and a reward system that incentivizes employees for longer-term results.

Greg Selker: I know we’ve talked in the past about the overall IPO market and how that affects your plans as a company in terms of your growth and expansion. With the current climate and the return of the IPO market being volatile, and most likely pushed out even further, how does this effect how you look at growing and developing your own employee base?

Ken Goldman: Well I think the good news is we are private. The expectations with Fortinet before I got here were to go public in ’06 – ’07; but we weren’t ready as a company to do that. In ’08 we probably were close to being ready. I honestly never felt the market in 2005 was conducive to taking a company public. Last year was a year in which we had more companies withdraw their filings than file to go public. My perspective is you that you only file for an IPO when you’re absolutely prepared to go out – come hell or high water. I never felt there was a time in ’08 where it looked like a good market for a public offering. 2008 was just way too volatile.

In terms of ’09, the conventional wisdom says it’s going to be a horrible year – but I never believe conventional wisdom. I think Q1 will be a horrible quarter – a really horrible quarter actually. But that could become a low point and therefore, from a very low base, things hopefully have got to improve. So I think there’s a chance the market could improve later this year as opposed to everybody’s perspective that it’s going to be horrible. The thing that I worry about is when things do start to improve, with all the money being put into the system inflation could come back. With inflation, interest rates would likely go up, and now you have the seeds of another downturn.

All of this has to be managed. But my own sense is that even though conventional wisdom says everybody has basically written off ’09 and maybe even ’10 – I mean everybody – it’s like when you watch sports, everyone says, “Team X is going to win.” Well maybe team X ends up winning, but maybe they lose. We’re in the space where I don’t think any of us know. But the point is, I’m not willing to give up on the year like a lot of other people have just because it’s obviously started off pretty ugly.

Greg Selker: Well I’m glad to hear that.

Ken Goldman: So there’s a little ray of hope. So maybe you’ll come back and quote me at the end of the year and find out I was wrong - and so be it.

Greg Selker: We feel the same way actually. From our perspective, even though there’s a lot of conflict going on, I think there are pockets of growth. Even in retrenchment people are looking more carefully at who they have on board, what they need to do to get the most out of their people, and what they need to do to bring people into their company who deliver even greater expectations.

Ken Goldman: Somebody had a good comment at a meeting I was at this morning. They said, “the worst thing you can do is waste a recession.” I think this is a very good way of saying it.

Greg Selker: Absolutely.

Ken Goldman: Don’t waste a recession. Use the time well to do things that need to be done, and force yourself to do things you might not have done otherwise.

Greg Selker: Exactly.

Ken Goldman: So if it’s upgrading your people – hiring in some very good people that are now available – rolling out some new products – and just doing certain things. Don’t just “give up.” Use the recession wisely, knowing that at some point things will come back and you’ll be more prepared for it. Don’t just hunker down and do nothing. “Don’t waste the recession.”

Greg Selker: So with that in mind what are the ways in which you see your company not wasting the recession?

Ken Goldman: Well in our case, in technology, I’ve always learned that it’s all about the products. Always remember that – technology is all about the products. So we’re going to continue to invest heavily in R&D. We’re going to continue to focus on bringing out our new products on a timely basis. Then we’re going to look at how we can price attractively, and how we can aggressively hire good sales people from other companies. I think it is a great time to hire sales people. So we’ll continue to do what we have been doing, which is to invest in people.

We will also set some high standards in terms of our quotas for this coming year. We’re setting a high bar for achievement and we’re aggressive. On the conservative side, we’re budgeting to keep our expenses under control. We’re going to make sure we’re running an efficient shop and not spending money in a nonsensical way. On the other hand, we intend to invest in areas that we think will pay dividends when we do have an upturn. We think we can grow through the tough times and gain market share.

Greg Selker: Right, beautiful.

Ken Goldman: So that’s what we are doing. Based on my prior experiences in the semiconductor industry, there will be an upturn, you just don’t know when. But you do know that it’s easier to gain market share in a downturn than in an upturn. Because in an upturn, the rising ocean lifts all ships. In a downturn, there’s always some that don’t have the cash resources, or the wherewithal to make significant gains. And our goal is to gain market share. So we’re going to drive what is necessary to produce that result. We have a strong balance sheet with a strong cash flow. We have a clean balance sheet. We’re well poised. It’s all about the “core” details of the balance sheet, when you come back to it. People get hung up on the P&L – and they forget about the balance sheet. The balance sheet is really very important. I can tell you that I know every account on our balance sheet. I review this in detail at least quarterly. I review all of our assets, prepaids, other assets and all the little stuff.

I love Finance. I love planning. But the accounting and your cash position are very important. This is where it all starts. And some things haven’t changed. I’m still a big fan of really getting into the details. If I get into the details and my people get into the details, that means we’re watching what’s important. To me, cash flow is very simple. How much did my cash go up? I don’t need a big cash flow statement. I do look at it, but the cash flow statements you see in these financial statements don’t often help you. The key is: what’s my actual balance sheet cash? How much did it increase? Then look at the key drivers of that. That is what I do.

Greg Selker: Ken, how many boards are you on now?

Ken Goldman: I’m on six boards now. Three public and three private.

Greg Selker: And of the public companies – are you on the audit committee for all three?

Ken Goldman: Yes. All the private ones too.

Greg Selker: Well that’s a significant time commitment.

Ken Goldman: Yes it is. It’s the reason why I get so many calls to join boards. You think they want me for my looks? The good news is I’m able to do some of the meetings from my office– so I’ll call in for the private companies. You know, I was reading something about Warren Buffet where he said that being an operating guy helps him invest, and being an investor helps him run an operating company. My involvement with boards follows the same principle. Being CFO with Fortinet helps my work on boards – and being on boards helps my CFO role. There was a period of time when for a few months after I left Seibel as their CFO I was just on boards, and frankly you start losing your edge.

Greg Selker: I see what you’re saying.

Ken Goldman: I think a company can have one or two professional board members, but I think a well balanced board needs to be composed of people that are still in the game and still actively working. Because, you’re just a lot sharper when you still have to make decisions and kick some butt yourself. So I think I’m actually a better board director, and a better financial executive for doing both than just one or the other. When I was only sitting on boards, I didn’t think I was accomplishing as much. Too many meetings. But now as the CFO of Fortinet, and sitting on several boards – I actually have been accomplishing more as a board director and as an operating executive.

Greg Selker: Very good. Well Ken, this has been great – so thank you for your time and insights.

Ken Goldman: You are welcome. Thank you as well.

Success is not a random event, according to Malcolm Gladwell author of the best seller Outliers: The Story of Success. In the opening pages of this excellent book, Malcolm Gladwell tells a story about Italian immigrants who settled in Pennsylvania. The culture and community they established, their values, their extended families and many other factors turned out to be the source of their longevity. This isolated community died almost exclusively of old age while neighboring towns had high death rates due to heart attacks and the long list of diseases in our modern society. The Italian community, with its habits of caring for each other, its 22 community organizations in a town of less than 2000, and it’s success in healthy living set them apart as outliers. Their success, as a medical study revealed, was not due to personal health habits (diet, exercise, yoga), or genes but rather from the community they had created. This community shielded them from the normal stresses and pressures of the greater society.

Gladwell has written a book about men and women who do extraordinary things. He has also discovered that there is something profoundly wrong about the ways we measure success. As he examines hockey players, pilots, lawyers, geniuses and many other highly successful outliers, he concludes that individual personal traits have little to do with grand success. Yet during the time it takes to read this, corporate executives are committing millions of dollars to executive recruiting projects where the primary focus of the assessments will be on the individual personal traits that has led people to success in business.

People are hiring, placing, promoting, and creating programs for development based on models of personal competency and personality traits. They then, through mysterious forms of success calculus, reach conclusions about a person and their success potential. However, hiring mistakes continue to plague companies. The wrong people get promoted, the right people leave unexpectedly. And everyone suspects, as Gladwell did, that there is something wrong with the way we make these decisions. A close reading of the Gladwell research will cause most of us to wonder how we ever get anything right when it comes to making these decisions.

As it turns out, it is more important where we came from, when we were born and the levels of parenting and patronage that we received along the way that leads us to success. The communities that surrounded us, with particular values and influences from our birth through the critical years of our development, shape how we see ourselves, others and the world. Ultimately, these factors play the biggest role in helping to determine the circumstances we find ourselves in and how we respond to them. They truly are the big predictors of success and potential.

Given Gladwell’s research into this area, it is useful to ask, how can it be applied to interviews to make certain the right hiring decisions a made? This might result in formulating the following questions:

• How would you describe the values, culture, influences, and experiences of your family and the community that surrounded you growing up, and how have these impacted your life?
• What are the most important lessons you learned from your parents and grandparents?
• Who are the most important people that influenced your life over many years and how have they impacted what you have attempted to do and accomplished?
• If you were to write a book with the aphorisms, philosophical statements and principles that are most important to you in your life, what would some of them be?

Engaging with a candidate by asking these questions will provide tremendous insight into the success potential of a person. However, you must know how to listen carefully, and then make sense of the answers to get to the right conclusions. Lastly, you then need to be able to ground your conclusions in details of a person’s behavior.

What we learn from Gladwell is that our approach to understanding the background factors that breed success should be a significant part of assessing leaders before we hire or promote them. Further, the assessment must also seek to discover how well people maintain their success and develop it to even higher levels. Those leaders, who are consistently successful, also thrive best in communities with strong values and representative behavior.

But, in Gladwell’s book, understanding real success is a never ending quest. Determining who is highly successful and who has the potential to sustain success at work and in life is not established in a one hour interview or by the recommendation of others. Success, once more, is not a random event. Finding successful people, getting them on your team and building a community of success is also not random or good luck. You must understand at a deep level what you are both looking for, and trying to build. And then you need to apply this understanding to your interviewing and selection processes.

Greg Selker: What are some of the best ways you see that companies can create a high-tolerance risk culture, where success as the result of risk is rewarded, and at the same time a culture is created that has the adaptability to embrace change and the willingness to operate with a variety of mental models?

Dick Foster: The best experience I’ve had in my life, which I’m very fortunate actually lasted for more than a decade, was a company that I’ll describe as a very large, highly respected healthcare company of several tens of billions of dollars in size. They had an ongoing dialogue with the CEO and the top management group of the executive committee. Now you could take an extreme view, the view that I rejected earlier in our conversation, that the company should be an operating vehicle.

In this extreme view the role of the executive committee is to review operating decisions, so the subdivision reviews the operating decision and passes it up to the division, the division passes it up to the group where it’s reviewed again, and finally the group takes it to the executive committee where it is passed or not passed.

The nature of all those presentations is what I would characterize as presentation and response. We want to build this plant here. Here’s what it’s going to do. Here’s how much it’s going to cost, and the next higher review group says okay or no, one or the other.

An entirely different kind of conversation might be, how is the world evolving? Which of our opportunities are getting more mature? Which opportunities are getting less mature? And rather than having the executive committee sit there and respond to questions or assertions put to it, have them instead actually engage in dialogue. Presumably the people on the executive committee, because they’re among the smartest people of the corporation, ought to be able to engage in dialogue and debate around a well-crafted set of issues. Discussing an issue and reaching a resolution on an issue over some period of time is a very different proposition than reviewing a capital expenditure budget. I think we ought to use the talent and intelligence of the executive committee and from time to time augment it by others in the corporation.

Let’s take the ten most outstanding people under 40 and have them do one or two retreats a year with the executive committee to talk about issues. Have them engage in a structured dialogue around an open-ended set of issues. There isn’t necessarily a “so what” at the end of these sessions, but these sessions change people’s perception, leading to new ideas and tradeoffs. Then somebody can say, if we’re going to do that new thing, that’s good, but what are we going to get rid of first? As opposed to making a decision on a new plant, a new marketing program, or a new hire in the next division, it becomes a problem solving exercise for the executive committee. They have to do both, of course, but I’d like to see more executive committees engage in this kind of structured and healthy dialogue.

Greg Selker: That’s a clear operational practice that if it was put in place where executive teams, executive committees, and boards had a structured amount of time devoted to these open dialogues, an environment of flexibility, malleability, adaptability, and creativity is created.

Dick Foster: I agree. My experience has been, by the way, that some people often ask, “So how often do you do this? Do you do this four times a year?” And I say, “You do it as often as the corporation can take.”

I’ve been involved with companies where we tried to run two of those dialogues in parallel and it worked just fine. I’ve been involved in other situations where we tried to run two and it was more than the corporation could take given the operating pressures of the day, so we had to cut back to one. I’ve been at occasions where we’ve been able to run three of these structured dialogues in parallel in one year. You don’t have a formula. It’s entirely dependent on how much change the corporation can take without losing control.

Greg Selker: It gets back to the three legged stool of introducing change, monitoring the stress that’s related to change, and maintaining operational excellence.

Dick Foster: Yes, and then bringing all those together with one question. At what pace do we do these things, how do we set that pace, and how do we decide? Every company should also have a dialogue about the definition of these terms. When I say, “change at the pace and scale of the market without losing control”, that presumes that somebody knows what that means. The only group that can give meaning to that question is the executive committee. At what pace should we change in this corporation and why do we think that’s the right pace? What’s the argument? What’s the rationale? Those discussions don’t go on very much and they are very healthy discussions to have.

Greg Selker: How involved should a board of directors be in that discussion?

Dick Foster: My answer is “not very” because I think that crosses the line from governance to management. Now you can push me both ways on this issue and I’ve personally just been involved with one at the board level but I felt quite uncomfortable because I felt quite unprepared.

I wasn’t as much of an expert as the people in the company so I’m thinking to myself, what am I doing here because I’m just guessing at these answers. I’m making things up.

Greg Selker: Well, perhaps a board’s involvement to maintain good governance processes should be to make certain that these specific kinds of conversations are taking place within the senior team and the executive team.

Dick Foster: I agree. There is nothing wrong with the board reviewing the results and acting as another sounding board on the results, but to get the board involved in the creative process I think is probably overstepping the bounds.

Greg Selker: I would also say that if we had more boards who took the responsibility to ensure that these kinds of conversations were taking place, that we would have far greater companies, getting back to the very beginning of our conversation, that looked like that they were going to continue to grow into the large trees in the forest.

Dick Foster: Yes. A process of this nature allows a company to engage in critical thinking over the long term and engage with questions that don’t have to be answered right away but that can and should be taken up by management and answered subsequently.

Greg Selker: Well, Dick, this has been, at least for me, a fascinating conversation.

Dick Foster: Thank you. You’ve asked great questions.

Greg Selker: And I can’t tell you how much I appreciate your time and also, again, the quality of the ideas that you’re forwarding. I find them to be both refreshing and incredibly fresh.

Dick Foster: Well, you’re kind to say that. I appreciate it. When I wrote my book, Creative Destruction, the economy was still whipping forward. It hadn’t kind of broken the tech back yet and then that happened. Ever since then, there has been no doubt that we are living in the age of creative destruction.

Greg Selker: I would agree with that 100 percent.

Dick Foster: And it’s not slowing down so we ought to master these skills.

What do Citibank’s CEO Vikram Pandit, the Christian Science Monitor and the Harvard Kennedy School have in common?

In late November 2008, just 2 days after Citibank reached a deal with the U.S. Treasury, the Federal Reserve, and the FDIC to inject $45 billion into Citi to increase the corporation’s liquidity, $20 billion provided by the Troubled Asset Relief Program (TARP) to purchase Citi preferred shares - insurance against the $306 billion face value of the high-risk loans owned by Citi - the bank’s CEO, Vikram Pandit, appeared for a 60 minute interview on PBS’ “The Charlie Rose Show”. Throughout the interview, Rose asked Pandit to comment on the past decisions Citibank made regarding the firm’s leverage of mortgage backed securities in their risk profile, and beyond offering an explanation of what happened, as the CEO of our 2nd largest banking institution, to convey some sense of responsibility for what has occurred.

While it is true that Pandit has been the CEO of Citibank for one year and was not at the helm when many of their high-risk portfolio decisions were made, his previous employment was leading the investment banking arm of Morgan Stanley. As such, he certainly is no stranger to the world of investing in high-risk derivatives typified by the relatively new instrument of collatorized debt obligations (CDOs) that are a major component of our financial collapse. To top it all off, the real value of the $306 billion in high-risk assets we have purchased and insured with our (the taxpayer’s) $45 billion investment into Citi is unknown. What we can surmise with a high degree of certainty is that it is certainly not $306 billion given that some percentage of the securities contained in Citi’s toxic waste heap have reduced in value to zero, and many have been reduced by 40% or more.

However, instead of delivering any palpable insight into our current situation, or straight talk about the value of the assets securitized, Pandit tip-toed his way through a maze of answers over the hour interview. Simply put, even though he wasn’t the top individual with his hand on the rudder of the bank when most of the high-risk investments were made by Citi, given that he is the CEO now, he shirked responsibility for what has occurred, and avoided any statement of accountability for the bank’s current situation. The closest he came to even acknowledging the gap between Wall Street and the rest of the country was the comment that he “can completely understand how people on Main Street, people who are not close to this industry would be furious at what’s happened and furious at kind of where we’ve gotten to.”

Now I know that a majority of Americans are not staying up to watch Charlie Rose, his show is broadcast at midnight on my local PBS station. But here we have the CEO of the 2nd largest US Bank being interviewed days after his institution accepts $45 billion in bail out money, and he cannot even offer a statement accepting responsibility for his bank’s actions. This is not to say that Vikram Pandit is a bad CEO, rather that he is not being held to a standard of accountability that reflects the best leadership.

What does this have to do with the Christian Science Monitor and the Harvard Kennedy School?

In October 22 of last year, the Monitor ran a story titled, “America’s Other Deficit: Leadership.” This article, written by David Gergen and Andy Zellke, chronicled the results of the Confidence In Leadership 2008 survey conducted by the Harvard Kennedy School and the Merriman River Group. Begun in 2005, this survey measures confidence in the leadership across seven sectors, business, the Executive Branch, Congress, religious, educational, the Supreme Court, and state government. Not surprisingly, this past year saw the steepest decline in the confidence level Americans have with their leadership and the largest decrease since the survey began. The survey’s results point to that 80% of Americans believe that we face a leadership crisis today. In fact, confidence in business leaders dropped more than did the confidence level in leadership of any other sector.

Given the steady stream of events leading to our financial crisis, and the gap in accountability by many of today’s leading business executives typified by Charlie Rose’s interview with Vikram Pandit, is it any wonder?

However, underneath this obvious connection between these two events there is another more subtle thread to be teased out. Accountability gaps with our leaders persist because we do not demand accountability from them. Accountability is the ability to account for “what has happened.” It is not blame or finger pointing. It is the recounting and telling of a story, owning the particulars of the circumstances and its results in their entirety.

In both of these instances, the news of the crisis of confidence in leadership and Citi’s CEO not demonstrating accountability for his bank’s status in the wake of accepting a $45 billion bailout, the general reaction by the media, the blogosphere and the public has been the same - virtual silence with an undertone of blame. Here is the nasty truth: the shareholders, and now as a tax-paying citizens of the United States we all are shareholders of Citibank, have been complicit in helping to create an overall environment in which our leaders are not held accountable for their actions, or the actions of their organizations.

This endemic culture lacking accountability has afflicted our institutions across the seven segments noted in Harvard’s Kennedy School and Center for Public Leadership, and is one of the dominant unspoken factors underneath our economic and leadership crisis.

While there are many structural issues that need to be addressed, from stopping the revolving door between Wall Street and the SEC, to striking a better balance between regulatory oversight and creativity, to stronger governance with many public company’s boards of directors, and to hiring and developing better leaders; like most cultural change, it begins at an individual level or it doesn’t begin at all.

So as we enter this New Year, I encourage all of us to look in our lives, our businesses and our organizations and ask, “Where are you not holding yourself or your leaders accountable? And what would change if you started to do that?”

In our third segment in the continuation of our latest Leadership Interview with Dick Foster, he discusses the role of a board of directors in ensuring a company and its leadership actively engages in the process of challenging their conceptions of themselves and their competitive markets; and in evaluating the CEO and senior team.

Greg Selker: What is the best way that a board of directors can participate in making certain that both their leadership is adept at changing their mental models, or if not, that the members of the leadership team change?

Dick Foster: The board has a very important role to play, but we need to be clear that I think boards only have a very few functions, and they are there to govern, not to manage. But one of the acts of governance is, “who is the top guy? What should they be doing? How adequate are they and when’s the right time to bring on a new one?”

I think boards need to be thinking about just the kinds of issues you and I have been talking about in terms of how they are evaluating their own CEOs. If their CEO is not changing in tune with the times, then the direction the company ends up heading is not going to be pretty. The board is the one with this responsibility, which means they have to understand the business. They have to really know the people that are running the business. They have to have a perception of these things.

They presumably should know what the alternatives are and should be. And if they don’t have a little list in their pocket of possible replacements, I’m not sure they’re doing the right job. Not that they need to look at that list all the time but they should think about it all the time.

Greg Selker: It sounds to me like boards of directors need a major re-education.

Dick Foster: I know some companies are better at it than others. This should definitely be on a board’s agenda and boards need to understand how they are going to do this. Judging the CEO and the team at the top only by their operating efficiency will turn out to be both narrow minded and costly. They have to think about the ensemble of abilities at the top to create, operate, and trade at the pace and scale of the market without losing control, to go back to my favorite sentence.

Greg Selker: I would think another factor that needs to be added to this is to evaluate the degree to which the CEO and senior team are adaptable and flexible in their thinking. What are their mental models and can they change and adapt with the changes that are occurring with the times?

Dick Foster: Yes, it’s essential because if they don’t adapt and change, someone’s going to come along who’s going to be more competitive and it’s over, so that’s absolutely correct. I’m willing to listen to all of the arguments about how the pace of change is slowing down. I just don’t see any evidence of it and I’ve looked pretty hard.

Greg Selker: Given that this is one of the critical priorities, perhaps maybe even THE critical priority for a board of directors, what have you discovered are some of the best ways for an individual board director and for a board of directors to get their arms around this level of insight and data about their CEO and the senior team?

Dick Foster: I think first of all they have to talk about it collectively as a board, then they have to decide who has got the monkey here, and I think of several key committees. There’s obviously the comp committee, which is a key place for doing all of this. The comp committee has to figure out how to operationalize these things. The first question is, how do we evaluate and compensate the CEO? My own personal belief is the comp committee should look at the CEO, and at most two, three or four others in the organization, and make sure that the perspective on these people, the ways of measuring them, and the information is correct.

The audit committee is obviously another key board group. Their role is different. It is to ensure that all the information necessary to evaluate the CEO and the entire business is accessible. That this information is provided without errors of omission, or commission, it is provided in a timely fashion, and is accurate and forthright. So while the audit committee plays an important role, it is a very different role than that of the comp committee.

The nominating and governance committee also has a very important role in making sure that the processes of the board itself are working correctly. If anybody’s going to judge the effectiveness of the compensation committee, it’s the nominating and governance committee. They’re the ones that should be and that generally have the monkey on their back to say when a member of the board should move off, when a member of the board should move on, and what, by the way, are we looking for in new members for the board? What are their job specifications, and how do we compensate and evaluate them? All of this falls to the nominating and governance committee, so I see them playing a very crucial role.

Greg Selker: You’ve described the mechanisms in which the evaluation can occur. Do you have any comments about the evaluation itself, and what you believe are perhaps some “best practices” of making that determination on the caliber and quality of the CEO and the senior team?

Dick Foster: There are two schools of thought on this and I’m probably in the middle. One view is, if you can only get one measure of performance, pick it. Mid-income growth, return on invested capital, whatever it is. Hold their feet to the fire on that, and anything else is unnecessarily complex. It just gets in the way, and by the way, allows people too many escape hatches to get out of it. So pick one measure and make it right.

The other extreme has been pursued by a number of academics. This is multidimensional evaluations, corporate scorecards, and that entire sort of thing. These can have a lot of value, particularly further down in the lower operational levels of a corporation where you have a large number of departments, with entirely different functions and different performance parameters, all of which need to roll up to the top. However, if you do that at the CEO level, you can easily end up with 20 or 30 measures of performance and your chances of getting a little bit twisted in your socks with this kind of mechanism is pretty high. So I’m not an advocate of extending this methodology that far.

For me, a third key measurement is margins. Is the company’s margins increasing or decreasing? With those three measures I can have a pretty good sense of how the company is growing and therefore what the CEO is doing. I tend to favor a limited set of measures, more than one but less than five, and apply it to the top three or four individuals.

Greg Selker: But how do these measurements give you insight into the adaptability and the flexibility of the CEO and his or her willingness to break apart their own mental models and take on new ways of looking at themselves, their company, their business, and the world?

Dick Foster: There’s a stunningly good question. I think what happens is “life”. As you put these measures into place, life never works out like you think it’s going to work out. You’re given challenges against what you intended, and the CEO has to make tradeoffs. For example, our margins have been growing, but this year it doesn’t look like it’s going to be the case. If I keep the prices high enough and even push for price increases to keep the margins up, my growth is going to fall. By the way, I know that I should be spending more on marketing but if I do, I’m going to take my fixed costs up. I want to keep my fixed costs down, but that won’t let me grow, and if I keep my prices high I’m going to get killed. These are all tradeoffs.

You watch the executive team during the year identify these tradeoffs. By the way, nobody ever implements their plan exactly as they put it down on paper. So you watch how they react to the challenges they confront. And as a board, you have to have your own idea of what the best approach is given the circumstances.

What is our objective here? What are we trying to present?

You don’t necessarily want to protect shareholder value every day, every week, every month at all other expenses. There’s a misperception out there that the job of the board is to represent the shareholders. That’s actually not true, at least according to the American Bar Association, and I take them as a pretty good guide. The ABA’s Committee on Corporate Law produces The Corporate Director’s Guidebook, which I’m looking at right now which is why I’m able to recite it. I keep it on my desk because it’s really a good book. And it says, “the duty of the director is to the company, to the best operation of the company.” There are many times when that is synonymous with the shareholders’ best interest, but not always. Particularly, when the company’s long-term best interest is not synonymous with the shareholders’ short-term best interest.

The responsibility of the board is to the long-term health of the corporation. In order to evaluate whether the CEO is making the right tradeoffs, the board has to have its own sense of what these tradeoffs ought to be and how they would react to these circumstances. And the board has an obligation, therefore, in their governance responsibility and duty of care, to have those dialogues with the CEO and work out what they think is right. If the CEO goes in another direction, they need to express that in the compensation and evaluation of the CEO. Eventually, if they feel strongly enough about it, they need to replace the CEO. That crosses over the line of governance into management, but I think that’s the one exception.

That’s the ultimate judgment the board has to make and if they’re not doing that, it’s up to them to determine the options and to move on those options. I think it’s the one management act that a board has.

Greg Selker: What can a board director or a board of directors can do to better equip themselves to deal with these issues, not only of evaluation, but also governance and management?

Dick Foster: First of all, they have to educate themselves on it and I think they have to be clear of their own purposes. I’m a big fan of charters for each of these three major committees, and maybe a charter for the board itself. Write these things down so that there can be no misunderstanding about what the purpose and role of the board is within the individual corporation. I think that’s a very important but hard thing to do. I think that more and more corporations should do this over time.

I think executive session is a very important way to do this so the board can talk without management being present. You get different answers in executive session than when you’re talking with management there. I’m all in favor of periodic board retreats with thoughtful people about these issues. There are some very good people around the country, and, as you know, there are many board trainings. I think some of them are quite good. These all represent good opportunities for the board to get away and to consider these alternatives.

Finally, I think turning over the board itself is very important. What are the policies for staggering and bringing new people on? This is a critical way to bring new ideas and insights onto a board.

In our second segment in the continuation of our latest Leadership Interview with Dick Foster, he discusses applying the market principles of create, operate and trade to individual corporations; and using McKinsey as an example, details how these principles apply to the ongoing development of leadership and evolutionary thinking within a company.

Greg Selker: In your book, Creative Destruction, you talk about striking the balance between introducing change, managing the stress resulting from this, and continuing to operationally execute at a high level. If we look at these three legs of the stool, what are the things you see that the field marshals who are down in the trenches in today’s companies need to pay attention to that they haven’t previously?

Dick Foster: That’s a central question. If we have a standard model of how a corporation works, and I’m not sure that we do, but if we have one, it’s a model based around improving operations. The work I’ve done says, well, that’s a very important key part and it’s sine qua non. You can’t do anything without that, but that isn’t enough. Markets actually do something more than that.

Merger and acquisitions clean out the detritus. Bankruptcy does this as well but merger and acquisition is by far the dominant force which takes out companies that have become relatively weaker over time. The creation of new companies acts as a dynamic balance to this that in general times, works very well. We eliminate companies. Think of the S&P 500. There are always mergers and acquisitions. Every time one of those happens a new company is brought into the S&P 500. To make a point, if we didn’t eliminate companies from the S&P 500, by definition we would have no new companies in the S&P 500. So the elimination of companies comes before the creation of companies, which is the opposite sequentially of the way most people think about this, but I believe this description more accurately describes what happens.

This whole system has worked economically, at least up until the last 12 months, where society itself has maintained control. Returns have been reasonable. There have been some fluctuations in that, but the whole system didn’t come to a grinding halt. Well, that’s a very important part. We have to be able to create, operate, and trade without losing control. Now the economy has been a very good model for this over the last 50 years, however, it’s not been a particularly good model over the last 50 months or 50 weeks. We have lost control and we see the penalty that’s being paid for that, but I fully believe we will get back in control, and we have to get back in control.

But I’d like to apply this same idea to an individual corporation. Individual corporations cannot hope to keep pace with the economy if all they do is operate.

They have to create, operate, and trade without losing control and that’s the big thing. Because the one thing that focusing on operations does for you is it makes it a lot simpler to control day-to-day activities. If you’re going to spin things off and shut down some of your businesses that you’ve had for a long period of time, which you will find to be incredibly difficult to do, then you’re going to shrink in size.

Acting in this way does not serve your shareholders interest. So, if you’re going to spin things off and shut down some of your businesses, at the same time you have to have an active acquisition program. I think that you have to do these three things just like the economy does. And you have to do these in a way that doesn’t jeopardize control so you don’t spin out of control, so your multiple doesn’t fall so low that somebody buys you out, or that you yourself go bankrupt. All those things are possible.

Most companies try to simplify it by focusing on operations. But in fact, to stay competitive in the economy, you’ve got to do all three. You’ve got to create, operate, and trade. The companies that say it’s only about creating and operating miss the point. Their operating management spends so much time trying to fix and keep alive old businesses which should be more properly sold, that they never have any time to give adequate attention to the creation side. And so creation is never as competitive in the organization as it is in the overall market. In the market, you’ve got a whole bunch of people that are ready to provide capital. Of course they want something in return called ownership. But the market is very good at sifting these opportunities out and determining which companies should be sold, merged or eventually killed. The markets ultimately get rid of companies that take up our time and don’t return anything to us.

Corporations don’t do that, by and large, and they’ve got to learn how to do that. Google is trying hard to do this. Microsoft tried very hard to do this, and I think the jury’s still out as to whether they’ve fully been able to pull this off because they’re kind of stuck in a corner. They really didn’t welcome open software, the internet, or all these things which they’re now trying to get into with their on-again/off-again deals with Yahoo. Even a company as innovative as Microsoft hasn’t done particularly well at this. The pharmaceutical companies that just ten years ago were viewed as the paragons of innovation and management excellence have also failed as a group at the whole creation process.

So this is a very difficult feat to accomplish. We’ll see whether Amazon or Google is able to pull it off. We’ll see whether any number of the green power companies are able to pull it off. If all you have to do is build and create a business, as hard as it is, it’s much simpler than running an existing business, spitting out old businesses and starting new ones that compete with the old ones, and doing this all without losing control. That’s a tough issue.

Greg Selker: When I look at many of the examples of companies who at one point represented the paragon, as you said, for that particular age, and now they have fallen on hard times, some of them have even disappeared, it appears that one of the things that these companies stopped doing is paying attention to the core set of values that were in operation that had them get to where they were, and began instead to focus on keeping their market share. We can take Microsoft as an example. One of their values has always been innovation. Yet we could say that at some point when being innovative challenged their position in the marketplace, they stopped innovating.

Dick Foster: Right. That’s the dilemma. When it came time to cannibalize their own product lines, no one would ever do that in the absence of any competitive threat, right? It makes no sense. If there is a competitive threat, then you have to do it. But at a certain point, people don’t recognize the future competitive threat, and then they deviate from their underlying values. In the case of Microsoft, they stopped innovating.

I think McKinsey is an example of a company, by the way, who has not lost sight of its values. The way they do it is through controlling their flow of people. I’ve been retired from McKinsey for four or five years, but it used to be that the bottom 12 to 15 percent of folks in McKinsey were asked to leave every year. That means one over that number is the average lifetime of a person in McKinsey, so 1 over 12 percent, for example, is about an 8-year life. So the average McKinsey employee spent 8 years of their career at McKinsey and not more. Now that number has probably dropped to 6 years.

Let me be clear about something. The weakest performers at McKinsey are still very strong outstanding people. But because McKinsey got rid of those lower performers, they could hire new employees, and some fraction of those new employees were the ones that became the future leaders, and you keep that process going. Because McKinsey embedded their values in a management system that allowed them to create, operate, and trade without losing control, they have come through down economic times pretty well. They’ve had their share of bumps and bruises, but they are still there and still doing quite well.

I think more companies need to figure this out for themselves, and I think that is exactly your point. If you don’t have management systems backing up your values, you may not really ever have to test your values. If your values give way when you decide to maintain your management system, well you really didn’t believe your values in the first place.

Greg Selker: That was beautifully said and that’s actually a perfect segue for the next area that I wanted to talk about. Ultimately, regardless of whether it’s a value system, or a management system, it all comes down to people who are executing and making it happen.

Dick Foster: It sure does.

Greg Selker: It sounds like one of the things that you’re pointing to is that McKinsey discovered a way to systematically make certain that they were always moving ahead and introducing innovation via bringing different people, thinking, intellects, and life experiences into the melting pot.

Dick Foster: Right,  and it’s very simple to say, but that system turns out to be quite elaborate. First of all, there are two parts to it: one is asking folks that have done well for you to leave, which is not an easy task. The second is bringing in the new people. Let me comment on each one of those.

In McKinsey, asking people to leave is a very elaborate and a very fair process. It starts in your first interview when you’re told, “this is the way McKinsey works. If this doesn’t sound appealing to you, if you’re looking for lifetime employment, don’t come here because it isn’t going to work that way.” McKinsey has the biggest alumni organization in the world and that’s because we have more people that have left on good terms than any other company. So McKinsey is not a good place to work if you really think you’re going to be here forever, or you are uncomfortable with the concept that you won’t work at McKinsey forever. This process starts before you even begin working at McKinsey.

Then at every level of McKinsey, there is an evaluation process that’s incredibly thorough, fact based and objective. This system allows people to move forward, and those that don’t move forward in the system don’t stay as employees. They’re asked to leave the company, and this is done in a fair and equitable way. This is absolutely essential and is one of the core values of the firm. When you first start at McKinsey, the evaluation system is in your office, your local environment. As you become more senior, it’s in your country or region. Then, as you become most senior, it’s on a global basis. So the sphere with which you’re being evaluated keeps increasing in size and the pressure keeps increasing over your career with the firm.

By the time you’re a senior partner and are evaluating other senior partners, you’re probably spending on the order of three to four weeks a year on this process. Out of the total senior complement – and again, I’ll make these numbers up. Maybe 1 out of 15 of the senior partners are asked to be on a committee that evaluates other senior partners. If you are one of these senior partners, you remain on this committee for six years. During this time, you’re evaluating your peers, not your subordinates. This is a very tricky proposition.

You’re spending about a month a year going out, understanding the programs of your colleagues, talking to their clients, trying to understand the quality of the work as seen by the clients, coming back and then rank-ordering everybody to figure out who’s in the top and who’s in the bottom.

This is a very elaborate process that has scaled very well when it comes to hiring new people and growing the firm. When I joined McKinsey we had approximately 15 offices. When I left, we had 85 offices. I was the first Ph.D. in the natural sciences, or among the first Ph.D’s, hired by the firm. Now, if you go into McKinsey, there are around 1,500 Ph.D.s and M.D.s in the firm. We added an enormous technical complement of people, some of whom have never been to business school. We added an enormous amount of Europeans, and then we added a lot of Japanese, Asians, Indians, and Middle Easterners to the system. And obviously, we added tons of women. A lot of our diversity came from hiring these different pools of people, and these different people brought us new ideas, different ways of doing things, and different ways of thinking. This process continually revitalized the firm.

So McKinsey has a very elaborate system of getting rid of things, in this case lower performing people. This gave us the ability to bring on new hires while increasing the pace of change without running the risk of losing control, or at least we tried very hard to maintain that control.

Greg Selker: How important is it that a non-professional services company, a product company, adopts a similar kind of methodology, with a similar goal in mind of rigorous internal evaluation of people, rotating people out and making way for the continual recruitment and expansion of top talent from the outside?

Dick Foster: I think it depends a lot on the firm. If you’re in a mature, slow-moving industry, you can’t do the same thing without fundamentally changing your strategy. McKinsey’s in a very rarefied environment for sure. However, regardless of what kind of company you’re in, you do have to create, operate, and trade at the pace and scale of the markets without losing control, or not meeting your shareholder goals, one of two things. So you’ve got to figure out how to do that and it’s hard for me to imagine that a crucial part of that isn’t going to be in selecting your leadership. If you’re not turning over your entire staff because that’s not the right thing to do or the skill base you have, the leadership at the top should be turning over in some way to allow that leadership to refresh themselves and to move the corporation ahead.

Greg Selker: Either from bringing people in from the outside or promoting from within?

Dick Foster: Yes, and you need to have that reasonable balance. The psychological phenomena that happens, and it is becoming increasingly important, as decision makers we’re all trained to believe that the more knowledge we have and the fewer assumptions we have around the decisions we make, the better off we are. But as the pace of change increases, we don’t have the luxury of increasing that knowledge to assumption ratio. In fact it more often than not decreases because we’re just moving too fast. I mean who knew a year ago we would be where we are right now? We may have thought we had knowledge, but in fact we had assumptions.

In these kinds of circumstances, most people fall back and rely on the mental models, the way they have seen the world up until then. Quite often, the more senior the executive, the more rigid those mental models become. These mental models not only determine what information is accepted and how that information is processed, they also determine what information is rejected. That information can be, “I think the markets are going to collapse.” “Oh, no, they’re not. They never have before.”

That mistake was made thousands of times over the past year because people were not able to change their fundamental framework and the fundamental way they look at the world. They weren’t able to change their mental models. I think in most corporations, people in general and leaders specifically have to learn to become more adept at changing their mental models. Or, you’ve got to change the leaders and people. I think for most people it’s very hard to change your mental model. In fact the whole concept of a “mental model” is so abstract a lot of people say, “well, that’s just for consultants, and that’s just a lot of nonsense”, and, “mental models, I don’t know about mental models.”

But they are very real. Psychologists have documented them for decades.

Greg Selker: Absolutely.

Dick Foster: They have huge practical impact on the way we see and solve problems. And in a world that is changing increasingly, rapidly, and with increasing volatility, and I hope no one doubts that right now, we just have to learn how to do this. We have to learn how to change and adapt our mental models. If we don’t learn how to do this, then we’re going to fall behind. So either we as individuals change our mental models or we change the individuals.

Our latest Leadership Interview is with Richard (Dick) N. Foster, the Managing Partner of the Millbrook Management Group, LLC. Prior to forming Millbrook, Mr. Foster was with McKinsey & Company for 30 years. While at McKinsey, he served as a Senior Partner and Director for 22 years and retired from the company in 2004.

Mr. Foster co-founded the firm’s high technology practice in the late ‘70s, the chemicals practice in the early ‘80s, the healthcare practice in the late ‘80s, and the private equity practice in the ’90s. He also led McKinsey’s worldwide knowledge development from 1995 to 1998. He served over fifty leading global companies primarily in healthcare, electronics, and chemicals as well as a number of nonprofit institutions.

Mr. Foster’s research interests are in the relationships between capital formation, innovation, and regulation. Mr. Foster has written two best selling business books: Innovation: The Attacker’s Advantage (1986) and Creative Destruction (2001), that focus specifically on the relationships between technological change, innovation and capital formation, and destruction. In 1999 – 2000, he led the Study Group for the Council on Foreign Relations on Innovation and Economic Power which led to the publication of, Technological Innovation and Economic Performance (Steil, Victor, and Nelson, editors, Princeton University Press, 2001).

Mr. Foster was elected a Fellow of the American Academy of Arts and Sciences and the President’s Circle of the National Academies. Mr. Foster is also member of the board of directors of: athenahealth (chairman of the Governance Committee); Trust Company of the West, a wholly owned subsidiary of Société Général (Audit Committee); Memorial Sloan Kettering Cancer Center (Member of the Executive and Finance); Yale School of Medicine Dean’s Advisory Board; W. M. Keck Foundation (Executive Committee); Council of Foreign Relations (Nominating and Membership Committees); Council for Aid to Education (chairman, Strategy Committee); and a member of the Chambers Street Executive Network of Goldman Sachs. Mr. Foster was director of the Santa Fe Institute from 1996 until 2004.

Mr. Foster received his BS, MS, and PhD from Yale University in Engineering and Applied Science.

In the first of this four part series, Dick discusses our current economic conditions and the types of leaders that need to emerge in the midst of these crises.

Greg Selker: Thank you for doing this interview. I appreciate it.

Dick Foster: You’re welcome. It’s a pleasure to do it. This is a good moment in our economic cycles to be discussing these matters.

Greg Selker: How do you see the current economic recession affecting the importance of a management team’s leadership in terms of their ability to balance the rate of change against the rate of stress that results from introducing change?

Dick Foster: During these periods we need more leadership and we probably need different kinds of leadership. There are so many firefighting exercises we have to go through today, and so we certainly need the field generals out there who have the ability to take us through all this. We probably also, by the way, need a few “conceptualizers” that analyze the deeper causes of how we got into our economic situation. And more particularly, of why it is that even the most knowledgeable people in the country who spend their whole lives thinking about these things have been so surprised that we are here now.

Almost none of them would have predicted this a year ago October, maybe half a year ago in April. But one year ago I think it would be very hard to find anybody that was quite as pessimistic as people are today. So we need these leaders to sort out the mess.

Greg Selker: Why do you think that is? Why do you think very few people saw this coming?

Dick Foster: First of all, we all know at some level that the system has globalized, but we don’t really know what that means, and we don’t understand how this level of globalization has resulted in these instabilities. This is a very complex system. Somebody was saying to me, “it’s like forecasting the weather”, and I think it’s actually quite a bit more difficult than forecasting the weather because the weather is relatively predictable based on strong scientific models. While there are also strong economic models, the outcomes can be manipulated because we think and act based on the forecasts of our economy and that induces further changes.

For example, someone says, “I think we may go in that direction” and that may trigger ten other people saying, “I think you’re right.” Then everything is amplified. Weather doesn’t respond to outside influences with the exception of seeding clouds. Weather is unbelievably complex, of course, but it doesn’t have that all-important feedback loop which is what has been driving a lot of economic uncertainty.

I think what’s happened in the current environment is that trust has gone away. There was a story I read the other day about scrap metal providers. The scrap metal market has totally dried up because people don’t trust each other. Somebody will say, “I’m going to pay you $10.00 a ton for that pile of scrap,” and nobody believes him so they won’t ship the goods. Actions and responses like this stop a market cold, and we have not integrated this kind of phenomenon into our current economic theories.

So the first kind of leadership we need is economic leadership. We need economic leaders to think deeply about our current situation, how we got into it, and how we can move forward. Obviously, the G20 is doing this. There’s also a group of economists called the G30 that has no official status, but they’re pretty good economists that include Paul Volcker, Roger Ferguson, and others. I hope they will start to look at this. But in spite of the current upheaval, we also need to remember that every time we lose one of our national forests to forest fires, six months later the little green shoots start coming up and start making the next forest.

And while this has been the worst and the most comprehensive pull back that I can ever remember, the little green shoots in our economy are coming up now. I look at 8,000 securities every day and it’s very hard to find any of those that are compelling. I look at ones that are mainly over half a billion dollars in size. Around the world it’s very hard to find anything that’s a compelling case for investment right now.

That being said, if I go a little bit smaller, if I look at securities that are $100 million to a half a billion, and I look for companies that have been growing at least 20 percent a year for the last three years and that have a forecast of at least 20 percent in earnings going forward, I can find several hundred of those around the world, many of which are here in the United States.

These companies are in the fields of healthcare, education, and interestingly, offshore drilling, and a variety of others. If this recession is like every other one, some of those will turn into really great companies going forward. This is the second kind of leadership we need now. Leadership that sees new opportunities and introduces new ways of operating that changes the fundamental rules of the game for their individual market segments.

When our economic downturn happened in the mid ‘70s, The Limited emerged. Nobody had ever heard of The Limited in the late ‘60s but it was really starting to move fast through the recession in 1974 and then produced an average annual rate of return for shareholders of 52 percent for the next 15 years. That’s not so bad. In addition to The Limited there was also The Gap, Home Depot and Wal-Mart. All these companies got started after the ’74 recession.

Then in ’86 when we went through it again, Microsoft really took off, Oracle ascended from the pack of database companies, and Amgen really started. Every time we’ve had a downturn, some of the little shoots grow into great trees. I’m pretty certain that will be the case now.

Greg Selker: Some of these “big trees” have fundamentally altered and transformed the businesses and markets in which they were in.

Dick Foster: All of them have that common characteristic, Greg. That’s absolutely correct. To do that and sustain this growth requires a special kind of leadership. By the way, there are some big companies doing this now, Amazon and Google to name a few. This is the third kind of leadership we need now: the leadership of the existing companies who represented the recent and past breakthroughs. We need these individual leaders within these companies to carry us forward now as well.

We may need a fourth kind of leadership, which again like the second group of leaders, is a little bit more abstract because it is emerging rather than existing. The next phase of the world’s growth, no matter how you calculate it in the next 15 to 25 years, is going to occur in China and India. Their growth will not occur because they’re going to leap ahead of the United States in advanced technology applications. Their growth is a look back in time, similar to the late 1800’s. China and India are now building the power plants and putting in place the basic infrastructure that we’ve been building for the last 100 years. They’re going to build their telecommunications networks, power grids, and physical transportation grids.

They’re going to have to build the hospitals, the schools, all these core infrastructure components which exist in our society, and they will be building these in numbers that are impossible for us to imagine. All of this is not really technology work. In China alone, the people moving into cities over the next 25 years will be the greatest human migration ever, if my colleagues at McKinsey are correct. And there’s a migration into cities of equal size which will occur in India.

This is just unprecedented in the history of humanity, so we’re going to need extraordinary leadership to pull all this together. You probably saw as I did recently, that the Chinese are saying they are going to build a battle group, and they have designs now they’re considering for an aircraft carrier. This will be the first time we’ve had a Chinese battle group floating around the world. We dominate this area right now. I think we have 13 naval battle groups in the United States. France has part of one. Nobody has anything remotely approaching what we have.

The Chinese say, “we’re not interested in whether you think we should have one or not. We are going to have one. We’re happy to talk about how it’s used.” We need to remember that it is 1 compared to 13, and maybe by the time the Chinese launch their naval battle group we’ll have 15. Maybe we’ll have 10. Who knows?

The point is that the next 25 years are not going to be a repeat at a larger scale of the last 25. Politically, we’re going to need plenty of leadership at the national and global level, and similar to the different kinds of economic and business leadership I’ve talked about; our political leadership will also have to think about themselves and what they’re doing differently than they have before, because we’ve never faced the kinds of issues we are facing now. This is the fourth kind of leadership we need now.

So I think in answer to your basic question, we need different kinds of leadership, and we need these different leaders to have the flexibility to lead differently dependent on the circumstances. Sometimes they will need to focus on planning and strategy. Sometimes they will need to be field marshals. But we need these different leaders now more than ever.

Let me elaborate a little bit more on the leadership needed to sort out our financial crisis right now. To do this will require operating leadership. We saw the other day that Circuit City is no longer. It’s not a circuit town or it’s not even a circuit village. Circuit City is going away. Neiman Marcus had the worst month on record in October. Christmas is shaping up to be absolutely awful. We need a lot of field marshals now to get us through this period of time with minimal damage. I think we’re vastly better positioned than we were in the ‘30s to do this. We know with the help of cost reduction, our productivity has been going up through this whole period of time. We shouldn’t forget about that.

Our guys that are down there in the trenches, the leadership of their current companies, non-financial companies, are doing quite a good job. Their leadership is incredibly important to us as well, and will help us move through this down period as quickly as possible.

I have been in the executive search industry for more than 20 years, and I have never seen more commitment to the status quo, regardless of the long term impact. But I can’t say I blame you. Given the odds and the growing reality that the state of economic uncertainty is here for a longer haul than any of us want, more of you are concluding that, “if it isn’t completely broke, we’re not going to fix it.” Bluntly, it makes more sense to stay with the “devil we know”, rather than hiring from outside only to find out that they’re the devil we don’t know.

Unless your organization is clearly in a bind where new leadership is needed from the outside, most of you have determined that the risk of failing with a search outweighs the probability of success. Again, I can’t really blame you.

I have always been a true “maverick” (with apologies to Senator McCain and Governor Palin) in this industry, pushing the boundaries and driving actual value to my clients, and I have a way to defy the status quo and mitigate that risk:

It is called a Benchmark Introduction and it is the new economic model of executive search.

Executive search is an expensive proposition when you have a 50/50 chance of coming out ahead. I know you are all familiar with the economics of traditional executive search: the commitment to pay 33% of an executive’s salary regardless of how long the search takes, not to mention the failsafe built into the contract that says the firm will be paid in full - even if the search is cancelled. Statistics show that with this model there is up to a 35% chance of a mishire even at the most senior level. Nobody wants to take a chance with those odds.

A Benchmark Introduction, on the other hand, starts with intensive research, narrowing desired candidates down to a highly selective group who are contacted to potentially engage in an extremely confidential discussion with a client. A typical executive search generally identifies around 100 people to contact, whereas a Benchmark Introduction narrows this group to the top 20 or so in terms of seniority, skills, experience and accomplishments. As opposed to recruiting someone for a particular position where the interest will either be a yes or a no, a Benchmark Introduction focuses on a strategic value proposition from which a number of option could occur.

This creative solution leverages the best elements of executive search, improving on them to a dramatic degree while significantly mitigating the risk. For a fraction of the cost of a full executive search, you realize these benefits:

A Benchmark Introduction allows you to meet the highest caliber talent in a tightly controlled environment that is also open-ended in terms of intended results.

This highly strategic conversation appeals to senior individuals not normally attracted to a standard recruiting call and search.
Given the lower number of people contacted and the confidential nature of the conversations, a Benchmark Introduction delivers maximum protection to both a company and candidates ensuring that no word will be leaked out either to the general marketplace, or internally within a company.

It may be that the result of the Benchmark Introduction is that a high-level relationship is initiated. It may result in the exploration of a business partnership. It may produce the identification of a specific opportunity, and it could possibly result in the identification of a senior leader who would be an exceptional match for a specific strategic, compelling role.

Our milestone fee structure and industry-leading Performance Values Assessment methodology ensures that you are only investing in the best talent for your organization. And with the placement of a Benchmark candidate, you are insured by our two-year performance guarantee.

What I am proposing is a new way of doing business when it comes to executive search and providing an economic model that removes the risk and provides a solution to the talent issues illuminated by the tough times we are facing. It makes a lot of sense.

The question is: can you afford to stick to the status quo, to this “devil you know” mentality or should you explore a new way of doing business that will bring top level talent into your organization today?