Marina Gorbis's Blog, page 1379

Corn Ethanol Helps Create Boom Times for Midwestern Farmland

After bottoming out in the late 1980s, the value of farmland in the Midwestern U.S. has risen dramatically. For example, the value of high-quality Iowa farmland has increased 12.5% annually, on average, since 2000. The increase has been driven in part by higher world demand for grain, say Jeffrey R. Stokes and Arthur T. Cox of the University of Northern Iowa; past research has found that farmland values are highest near plants that convert corn into ethanol for fuel.

An Insider’s Account of the Yahoo-Alibaba Deal

Editor’s note: When the Chinese e-commerce giant Alibaba goes public, as it will soon, Yahoo will earn many times its significant original stake in the company — a surprising ending to a tale of experimentation and discovery. Sue Decker, Yahoo’s former president, describes how the deal came about and what Yahoo learned from doing business in China.

In May of 2005, Yahoo CEO Terry Semel, cofounder Jerry Yang, corporate development executive Toby Coppel, and I — I was then chief financial officer of the Silicon Valley internet company — went on what would turn out to be a fateful trip to China. Less than a decade later, the ownership stake that resulted from that trip has been the saving grace for the company that had dominated the early internet. The value of the shares bought then, in fact, makes up a big chunk of Yahoo’s value today, and the windfall from that purchase is what many hope will allow the company to remake its future.

At the time, though, we were just in search of a new approach to building a sustainable business in that critical but often difficult market. Things hadn’t gone well up until that point. In fact, you could say (and many did) that our previous attempts had failed, in that we hadn’t established a sustained market position. And then we found Alibaba — and it found us — and that connection led to the partnership that ultimately proved to be remarkably successful. This success was built on what we learned from our prior efforts, as well as a resolve to take new risks to do what was necessary to succeed.

In some ways, the lessons ring with greater clarity nearly a decade on and might shorten the pathway to success for other business leaders seeking growth in China.

Build, Buy, Partner

Yahoo’s forays into China started with a build strategy, which later became a buy strategy and ultimately morphed into a partnership strategy. In each iteration, we spent a lot of time thinking about what might make the best use of our existing product. In hindsight, this thinking turned out to be far less important than what we learned about leadership, control, and trust, which ultimately were reflected in how each of the businesses was created, capitalized, and staffed.

Yahoo China was launched in 1999 as a platform for email and instant messaging, translation of U.S. content (news, finance, weather) into two Chinese languages, and directory access to 20,000 web sites, an approach that the company had adopted elsewhere.

The number of internet users in China stood at roughly 5 million in 1999 but grew to 40 million in 2002, by which time it was clear that Yahoo was not getting the traction that local Chinese internet companies were seeing. Revenue was only a few million dollars, and we were drawing just 5 million to 10 million users each month. With the ad market under $70 million, many of our local competitors were rapidly experimenting with new types of revenue and business models and were far ahead of us. As a result, they amassed much larger user bases and were collectively generating close to $100 million.

The solution, we decided, was to acquire a local company that had already gained traction in the market and that could provide us with proven local management as well as help us with web search, which had become a priority after we bought U.S. search engine company Inktomi in 2002.

In November 2003, after due diligence, we announced our agreement to purchase 3721 for $120 million. The company had five years of growth experience and nearly 200 employees; most important, it was run by an aggressive local internet entrepreneur, Zhou Hongyi.

3721’s core product was essentially an early form of search: a browser download that helped users in China go directly to destination web sites. The company generated revenue from selling hundreds of thousands of Chinese language keywords for Latin alphabet domain names.

The idea was simple: Combine the best of both companies into the new Yahoo China, which was projected to generate more than $25 million in revenue in 2004. We had 300 people — mostly local talent — and together we were reaching more than 50 million users each month. We were optimistic about Yahoo’s future in China as the deal closed in January 2004.

By mid-2004, however, the operation was mired in conflict over control and differences in management style. Zhou reportedly felt that the original Yahoos were overpaid and lazy, whereas the Yahoo team felt bullied and believed Zhou wasn’t focused on the Yahoo operations. We insisted that the local team follow Yahoo reporting, systems, and governance requirements. Not surprisingly, this didn’t sit well with the local team. Zhou departed in 2005 and went on to found Qihoo 360 Technology, a $12 billion company that now trades on NASDAQ.

Although Zhou had outperformed the financial plan, the gap between 3721’s market position and the local competition was widening.

During the first half of 2005, Yahoo’s executive team studied the landscape carefully, looking at companies to acquire or partner with. And so began that auspicious trip in May of 2005, in which Semel, Yang, Coppel, and I set out to meet dozens of business leaders and government officials over the course of a whirlwind week.

Most of the companies we met with were publicly held, but Alibaba was still private. The company was owned by management, venture capitalists, and SoftBank. We met with founder Jack Ma and his chief financial officer at the time, Joe Tsai, and we immediately felt a strong cultural alignment.

Alibaba was based in the south, in Hangzhou, and had about 2,400 employees. The previous year the company had generated more than $4 billion in gross merchandise sales through its platform, yielding about $50 million in revenue. It also had two start-up business lines, Alipay, a new payment system designed to work like Paypal; and Taobao, an auctions site. Both were offered free to consumers and merchants.

We were impressed with Ma’s visionary and principled management philosophy, and we liked how our two companies might fit together. We also had the financial resources to help Alibaba weather the days of offering auctions for free as it attempted to compete against eBay.

We thought there might be a window of opportunity to build a leadership position in search and commerce in China to complement our portal offerings. We returned in late May to Sunnyvale, California, and began an intense two-month period of negotiation to craft what became the joint venture with Alibaba.

Yang had struck up a good relationship with Ma, which greatly facilitated the negotiations. On the finance and deal side, we also felt a strong kinship with Tsai. The deal was complicated to structure, but we eventually decided that Yahoo would own 40%, SoftBank would hold 30%, and existing management would keep 30%. Ma and the Alibaba leadership team would retain management control.

The deal was valued at just over $4 billion, with Yahoo putting in $1 billion in cash and our Yahoo China assets, which were then valued at $700 million. It was an attractive offer and a step-up in value for us, considering the value of what we had contributed to 3721 and its $120 million purchase price two years earlier.

While Yahoo China was tracking toward about $40 million in revenue in 2005, Alibaba’s consumer business alone was poised to do more than double that for the year, so it was valued at close to double our operation. At the time this seemed like a big leap of faith: More than half the value of the venture — more than $2 billion — was attributed to Taobao and Alipay, both of which were losing money and had announced that their services would be free for at least the next few years.

Still, we announced the deal by early August, less than three months after the trip that gave birth to the venture.

Key Lessons Learned

Looking back now, it is clear that there were three primary factors that ultimately led to the Alibaba deal’s creating value in the Chinese market.

Probably the most important element of Yahoo’s ultimate success was “failing fast”: recognizing mistakes early and being persistent about trying new and different ways to approach the market.

Continuous learning and a willingness to experiment are crucial for companies exploring new markets. I serve on two boards — Costco’s and Berkshire Hathaway’s — with Charlie Munger, a legendary business leader with an abundance of wisdom. He says he has constantly seen people rise who are not the smartest but who are “learning machines.” “They go to bed every night a little wiser than they were when they got up,” he says. He also has a broader view, which I really love: “If civilization can progress only with an advanced method of invention, you can progress only when you learn the method of learning. Nothing has served me better in my long life than continuous learning.”

A second critical principle that contributed to our success in China was the realization that we had to be willing to loosen the reins of control. This runs counter to the behavior of most corporations and counter to our earlier attempts. In the media and internet industries, it turns out to be very important when operating in China.

The most “controlled” approach we took was in our initial build strategy: Yahoo controlled the product and the team and centralized the compliance functions, such as finance and legal. To do that, we relied on talent hired by Yahoo employees and recruited managerial talent from within Yahoo. This facilitated communication to headquarters and know-how on the ground, and it seemed a comfortable way to access a new market, considering the great distances, both geographic and cultural.

But the local hires in China felt that our Sunnyvale leaders did not understand the market — they viewed them as outsiders. This created tension from the get-go. But there were bigger problems. Headquarters took too long to approve locally generated ideas, and as a consequence, Chinese competitors were beating us with rapidly-turned-out products that were tuned for the local market.

We were ready to do things differently when we purchased 3721. We gave up a lot of the product control to an aggressive and experienced Chinese leader and allowed the local unit much greater latitude for decision-making. We also empowered 3721’s top team to manage the combined operations, including those of the former Yahoo China. Only legal, finance, and human resources still reported back to headquarters.

But 3721 got bogged down dealing with the people issues that emerged from two different cultures and business practices. Those issues slowed us down on the product side as well.

So with Alibaba, we realized we needed to be willing to give up all operating control. Practically speaking, this meant forgoing our previous desire to own more than 50% of the local operations. It also meant we would leave all employee issues to our partner and allow our code to be used by people with no previous connection to the company. Scary.

But the real key to our ultimate success in China was the match with Alibaba’s leadership team. We had seen hierarchical, top-down management systems in place in many Chinese companies. Ma, by contrast, displayed a distinctive humility and openness. Although he didn’t have a U.S. education, he was an avid student of U.S. management and leadership practices, as he told us in our earliest meetings.

Unlike other Chinese leaders we had met with, Ma was willing and eager to hire executives who had more skills and experience than he did in areas where he was less strong. Tsai, for example, clearly understood U.S. business practices and had strengths that complemented Ma’s in strategy and setting the vision.

A 2010 Harvard Business School case by Julie M. Wulf noted that Ma studied Jack Welch’s approach and was inspired by GE’s decentralized decision-making. Like Welch, Ma wanted his executives to be free to do whatever was needed to make their units the best businesses in their fields.

This felt like the change we needed. We were ready to give Ma the keys to Yahoo’s operations in China.

Beyond the Yahoo Experience

Many other U.S. companies were either entering China or making plans to do so around the same time that Yahoo was making its early moves. All entrants faced a similar set of circumstances and conditions, including unfamiliar laws and customs as well as an array of business challenges – for example, non-Chinese social-media sites are blocked to a greater extent than local ones. According to GreatFire, a Chinese web-traffic monitor, more than 2,600 websites are blocked by China’s censorship policies. This extends to any non-Chinese user-generated-content sites such as Facebook, Twitter, and YouTube. Whether they are blocked because of political concerns or to promote local competitors, the impact is the same.

Most would-be entrants made the same mistakes Yahoo did, and many left the market after early disappointments.

The most interesting attempt at a buy strategy was eBay’s 2003 purchase of Eachnet, which had a nearly 80% share in the auction market. By 2005, eBay was already being locally outmatched — by none other than Jack Ma’s Taobao. Ma had launched Taobao to defend Alibaba’s business-to-consumer business and therefore decided not to charge listing fees, as Eachnet did. He also offered live chat so users could make deals together and build trust, a feature eBay rejected out of fear that users would transact directly and avoid Eachnet’s listing fees. Taobao’s service was faster than Eachnet’s, because its servers were located inside China. At the end of 2006, eBay pulled out of the market.

By contrast, Google primarily pursued a build strategy that was similar to Yahoo’s first foray. Google rolled out a translated version of Google.com in 2000, running on U.S. servers. The site was slow and often censored or shut down, causing it to lose market share over time to Baidu. Even after Google launched a local version of its code, using servers in China, it garnered only about one-third of the market to Baidu’s two-thirds. Ultimately, after Google moved its business to Hong Kong and China banned access, Google’s attempt to compete in China came to an end. But how much of the decision was due to the political climate and how much to being outgunned operationally is unclear.

AOL approached China through partnerships and investments, none of which appear to have borne fruit. Amazon purchased Chinese local firm Joyo in 2004 but has not kept up with local competitors such as Taobao Mall and Jingdong Mall. Amazon has launched a cloud service and an app store but claims only about 1% of the e-commerce market in China.

Social sites such as Facebook and Twitter have been unable to make inroads because of government blocking and competition from strong local sites.

The bottom line: Yahoo is the only example of meaningful value creation by a U.S. internet company in China.

Yahoo had failed at first too, of course. The difference was that it kept going back, building on knowledge from prior attempts. In the early days, we invested a lot of energy in analyzing which businesses would fit best with Yahoo. But I can see in hindsight that what mattered most was finding the right team, including a leader who was a good cultural fit with the company and whom we trusted, and structuring the deal so that the local unit was free to make operational decisions.

Nine years later, the venture has gone through a number of changes. For example, Alibaba was listed on the Hong Kong stock exchange in November of 2007, raising $1.5 billion — the world’s biggest internet offering since Google’s IPO in 2004. The company subsequently went private in early 2012. There have also been changes in the framework agreement around the ownership of Alipay in both 2011 and 2012, as well as a buyback of almost half of the Yahoo stake in May of 2012 for $7 billion.

These changes would have been hampered by a layer of operating control from the U.S. parent. For example, Alibaba never really emphasized the products of Yahoo China in the market; Alibaba’s interest in the Yahoo deal was largely to secure cash to help fund operating losses at Alipay and Taobao and to leverage the Yahoo brand for Alibaba’s global business. The core structure of the transaction empowered Ma and his team to make the decisions to drive long-term value. Yahoo felt it could live with this arrangement. But Yahoo never would have structured a deal this way on its own.

Today Alibaba is ranked beside Google, Facebook, Twitter, and TenCent as among the titans of the internet. With the filing of Alibaba’s registration statement in early May of 2014, the company is set to tap the U.S. capital markets in what is estimated to be one of the largest IPOs ever. Analysts estimate that the company will be valued at more than $200 billion.

That works out to 40 times the value of the deal we struck in 2005. Had Yahoo held its entire 40% stake from the time of the deal, the value of its pretax share in Alibaba would be worth $80 billion, or more than $78 per Yahoo share. Even though Yahoo has sold close to half that position and currently holds a 23% stake at lower valuations, the company will be reaping a huge return.

Looking back, it’s clear to me that this windfall is the result of talents we didn’t even know we possessed: It turned out we were good at identifying the right partner in China and good at acknowledging our errors early on. We also kept getting up, after we were knocked down, and trying again. We did this over and over until we found a workable approach. We also learned how to relinquish control and go wherever the market took us. And where it took was to a business relationship that proved more fruitful than we could have imagined.

Venture Capitalists Get Paid Well to Lose Money

2013 had all the signs of being a comeback year for venture capital. Booming public equities and a recovered IPO market generated record portfolio company exits and distributions from VC funds. The industry realized its highest returns since the Internet boom.

Yet 2013 annual industry performance data from Cambridge Associates shows that venture capital continues to underperform the S&P 500, NASDAQ and Russell 2000.

The industry’s persistent inability to outperform public equities is a disappointment to investors, and a very real threat to the sustainability of the VC industry as we know it. A VC firm is, first and foremost, an investment vehicle created to generate returns for investors that exceed those available in the fully liquid, low cost public equity markets. If that objective is persistently left unaccomplished, investors will allocate their capital elsewhere.

The ongoing poor performance of venture capital firms should be an obvious problem for institutional investors. The public pension funds, endowments, and foundations (called limited partners, or LPs) that foot the bill for the industry through their investments in VC funds do so to realize the outsized returns that VC claims to provide. LPs expect to be paid well to assume the high fees (2% annual fees on committed capital) and long illiquidity (minimum 10 years) of investing in private equities. A minimally viable venture rate of return is 300-500 basis points of outperformance above the public markets, a level of returns that investors haven’t consistently seen since the late 1990s, despite optimists’ predictions of promising technology trends, a smaller “right-sized” VC industry, improving exit markets, and incredible investment opportunities.

There are, of course, individual firms that succeed in generating venture rates of return. But they are too small in size and too few in number to make up for the vast majority of funds that fail to generate attractive returns (or any returns) for investors. They are also inaccessible to institutional investors looking to make either new or large commitments in hopes of generating above-market performance in their portfolio.

But the bigger problem – and the real problem for investors – is how little of a problem this persistent underperformance is for VCs themselves. LPs have created and perpetuate an industry of such structural economic misalignment that VCs can underperform and not only survive, but thrive.

To understand how we got here, we need to understand four major issues:

VCs aren’t paid to generate great returns. LPs pay VCs like asset managers, not investors. LPs generally pay VCs a 2% annual fee on committed capital (which may step down nominally after the end of a 4- or 5-year investment period), and 20% carry on any investment profits. The 2% fee is cash compensation, paid annually, regardless of VC firm investment activity or performance. This fixed 2% fee structure creates the incentive to accumulate and manage more assets. The larger the fund, the larger the fee stream. Raising bigger subsequent funds allows VCs to lock in larger, and cumulative, fixed cash compensation. The 20% carry, in contrast, is paid sporadically (if there’s any generated), not until several years after the fund is raised, and is directly tied to investment performance (or lack thereof).

Given the persistent poor performance of the industry, there are many VCs who haven’t received a carry check in a decade, or if they are newer to the industry, ever. These VCs live entirely on the fee stream. Fees, it turns out, are the lifeblood of the VC industry, not the blockbuster returns and carry that the traditional VC narrative suggests.

VCs are paid very well when they underperform. VCs have a great gig. They raise a fund, and lock in a minimum of 10 years of fixed, fee-based compensation. Three or four years later they raise a second fund, based largely on unrealized returns of the existing fund. Usually the subsequent fund is larger, so the VC locks in another 10 years of larger, fixed, fee-based compensation in addition to the remaining fees from the current fund. And so on. Assume it takes three or four funds for poor returns to start catching up with a VC firm. By then, investors have already paid for nearly two decades of high levels of fixed, fee-based compensation, regardless of investment returns. And the fee-based compensation isn’t trivial – in all but the smallest funds, the partners make high six, and more often seven, figures in fixed cash compensation.

Investors have perpetuated a compensation structure where VCs can generate significant personal income over their career, even when they make no money for their LPs. This payment structure perpetuates the economic misalignment between VCs and LPs, fails to create strong incentives to generate outsized returns, and, most importantly, insulates VCs economically from their own investment underperformance. A recent article quoted several VCs supporting the idea that entrepreneurs should be paid $100k (or less) per year until their companies are profitable. What if LPs structured VC compensation that way? Investors would see lower fees and would stop paying well for underperformance, and VCs would rely on their investment performance and carry to generate high compensation. LPs would pay VCs well, through carry, when they do what they say they will: generate great returns in excess of the public markets.

VCs barely invest in their own funds. The “market standard” is for VCs to personally invest 1% of the fund size, and for investors to contribute the remaining 99%. It’s an interesting split, considering that, to hear VCs tell it in a pitch meeting, there is no better place to invest your money than in their fund. Pick up any pitch deck, slide presentation or private placement memorandum and read about the optimistic projections about the VC industry, the fund’s unique strategy, the incredible market and technology trends that support the strategy, and the impressive team of investors that generates “top quartile” returns. The future has really never looked better! Yet, when it comes time to close the fund, there’s hardly a VC checkbook in sight. In fact, many VCs don’t even invest in their fund from their personal assets, instead contributing their investment via their share of the management fees.

Last year I spoke at a conference to an audience of VCs. During our discussion about VC commitment levels, one frustrated VC raised his hand and asked “how much do I have to commit to make my investors happy?” That question reveals the most common attitude I encounter among VCs; they don’t ask how much they can invest, but rather, how little. They seek a minimum, not a maximum. When it comes time to put their own money where their mouth is, there’s a surprising lack of both interest and capital. Investors are well served to pay greater attention to this phenomenon, and watch what VCs do, rather than listen only to what they say.

What is the optimum level of VC commit? Well, it depends. It depends on the partners in the fund, their prior levels of success, their personal balance sheets, and their stage in life. The point of the VC commit is to ensure that each of the partners has a meaningful (to them) investment in the fund. One percent is rarely meaningful. I’ve argued previously that it makes sense to start (and preferably end) the conversation at a 5-10% commitment level, modifying the range, either up or down, to take into account personal asset levels and circumstances of the team. If the partners aren’t enthusiastically committing meaningful capital to their own fund, LPs should assume that the fund is too big, the investment strategy is too risky or unproven, or that the VCs do not have confidence in their own ability to generate the returns they promise. Investors should run, not walk away, from such funds.

The VC industry has failed to innovate. The business model and economic structure of the VC partnership has remained stagnant for the past two decades. Despite enormous changes in the industry — more funds, more capital, bigger funds, lower costs to start companies, poor returns – investors have failed to change the basic economic structure of the VC fund, even when it’s clearly in their economic interest. VCs have hardly taken the lead on “creative destruction” in the industry either, but as we’ve seen, the high levels of asset management style fees and the continuous gush of capital into ever-larger VC funds provides little economic incentive for them to do so.

VCs’ behavior may not be laudable, but it’s understandable. Any changes, then, must come from investors. The good news – and there is some – is that change is starting to occur. The increasing prevalence of small VC funds significantly reduces, and can even eliminate, the misaligning effect of the fat fees that dominate the large funds. It’s very hard to be a $100m fund and coast off the economics of underperformance. Not so for a $1 billion fund. The online investment platform AngelList and its emerging group of syndicates forgo fees in favor of carry, such that the investment upside and downside are shared by VCs and LPs alike. (Disclosure: the Kauffman Foundation, where I am a Fellow, is an investor in AngelList). The absence of fees puts VCs and angels on the same footing as their investors and more perfectly aligns interests.

We’re also seeing some evidence that VCs aren’t entirely insulated from their own underperformance. The latest National Venture Capital Association yearbook (2013) indicates that the number of VC funds has fallen 25% in the last decade, and the number of VC firms has declined 8%. Even more dramatically, the number of VC professionals has fallen 60%. But these are small numbers relative to the size of the underperformance problem.

LPs can certainly do a better job of paying VCs to act less like asset managers and more like investors. We can cut fees dramatically, structure compensation so salaries are small and carry checks matter, and stop paying VCs to raise larger funds. LPs can pay VCs to do what they say they will: generate returns well in excess of the public markets. Until we do that, the enemy of better performance is us.

Assess Your Cultural Profile

When people talk about cultures, they often paint with a broad brush: He is so American, so French, or so Japanese. But individuals within a culture vary enormously in their behaviors and attitudes, and many societies have distinct subcultures. Even a small country like Switzerland (which has four national languages) is far from homogenous.

Erin Meyer, author of The Culture Map and “Navigating the Cultural Minefield” (HBR May 2014), has identified eight dimensions that together capture most of the differences within and among cultures — a much more nuanced approach than focusing on just one or two elements, as people usually do.

Using her method, Meyer has developed a new assessment tool for hbr.org. It allows you to see where you fall on the eight scales. She also offers insights about where people in countries other than your own typically land on the scales.

So have some fun trying out the self-assessment. After your results are tabulated, you’ll receive a personal profile that can help you identify where cultural or personal differences may be enhancing or limiting your potential as you interact in a diverse world. Maybe, for example, you identify strongly as Swiss, but you don’t necessarily communicate in the same way many of your Swiss colleagues do.

Whether you’re from Switzerland or South Dakota, the trap is in assuming that you “know” people because you have identified their cultural pedigree. Without understanding all the dimensions of their behavior and your own, you probably won’t figure out what’s behind the harmony — and the friction — you encounter with them. Meyer’s test will help you deepen and broaden your perspective.

Just be careful about comparing yourself with people across international boundaries. For example, you may be a Swiss who, when it comes to scheduling, is very laid back compared with your national average — but don’t then assume that you’ll be comfortable living in, say, India, where people often do take a relaxed approach on this dimension. Meyer’s scale on scheduling might suggest you’d be happier in Lausanne or Geneva than in Zurich, but Indians occupy a whole other range on this scale — so you still may not adjust well to life in Mumbai.

Managers can also use the tool to learn a bit more about variations within countries they’re unfamiliar with. Suppose you’re French but managing a team in India. Chances are you don’t distinguish carefully enough among the people on your team (and the various subcultures they hail from). Have each team member take Meyer’s test so that you can paint a more complete picture of what they’re like, and compare everyone’s results with those from your self-assessment.

The Rebirth of the CMO

The CMO role is undergoing a renaissance. Overly simplistic notions – “the people who do the advertising”– were based on stereotypes that never accurately reflected the range of responsibilities that many CMOs had. Those notions are even more outdated now.

Instead, the last few years have seen a proliferation of C-suite titles that include a component of marketing. Some are chief customer officers, chief experience officers, chief client officers, or chief digital officers. This diversity reflects not only a deepening understanding of the connection between growth and customer satisfaction, but a much greater awareness of what marketing can do to help forge that bond.

Digital disruption has driven much of this shift. Digitally enabled tools and processes have altered what and how a business sells, flipped the tables on the typical customer relationship, introduced a glut of new channels and competitors, and made it harder for organizations to break through the “noise.”

That shift has created an increasingly commoditized product and service environment. Digital has removed barriers across sectors, even in old-line businesses known for “sticky” products, such as telecom and insurance. And that same transparency has radically shortened the shelf life of any new competitive advantage. “We’ll spend a lot of time bringing product to market, but we need to plan for the fact that a launch gives us a six-month head start and no more,” says Gary Booker, CMO of Dixons Retail. “While our competitors catch up, we have to get into the mindset of already moving onto the next thing.

All that has elevated – and complicated – the role of CMO. Delivering above-market growth increasingly hinges on differentiating the customer experience and building tighter customer relationships . That in turn relies on not only having excellent marketing capabilities, but also connecting marketing with the entire organization. That isn’t easy, but the payoff is worth it: Our most recent research shows that companies with excellent marketing capabilities outperform the market with 2-3X greater revenue growth.

While the CMO role necessarily varies across sectors, we see three activities that are now required of all CMOs.

1. Discover data-driven insights that drive growth.

Clear, meaningful insight into the market and the consumer decision journey is job one for today’s CMO. “When it comes to who asks the provocative questions [and] who agitates for customer-led change,” says Tariq Shaukat, the CMO of Caesars Entertainment, “it is the group closest to the customer and the group with the data. And that really is on the backs of marketing.” McKinsey’s DataMatics 2013 survey shows that companies that use customer analytics extensively are more than twice as likely to generate above-average profits as those that don’t. They also outperform their peers across the entire customer lifecycle, are nine times more likely to enjoy superior customer loyalty, and a remarkable 23 times more likely to outperform less analytical peers on new-customer acquisition. That means churning through data to find insights that others haven’t seen and then developing the organizational capability to act on them faster and better to drive above-market growth.

At a large hospitality company, for instance, the CMO can use analytics to find out not only which property or category was up or down over the weekend, but how key customer segments moved as well. If data shows the lucrative “weekend tripster” segment cut back on the average length of their stays, marketers can respond with offers or other perks, such as late checkout or complimentary upgrades, to drive changes in behavior and protect revenue.

Better analysis of those insights can improve marketing return on investment (MROI) by 10-20 percent and drive average profit growth of 14 percent. Yet, only 30 percent of companies believe they understand their customers’ needs well enough to identify what initiatives will drive growth. That’s a major missed opportunity according to Ian Ewart, Head of Products, Services & Marketing at Coutts. “I see far too many data that don’t go anywhere and that’s just a cost.”

To have the influence to help set business strategy for the company, CMOs need to translate customer insights into terms meaningful to senior leadership. Deborah DiSanzo, the CEO of Philips Healthcare, was once a CMO. She knew that to have a role in steering strategy, she had to earn the trust of her CEO and board. “To get that trust,” she says, “you have to speak with authority, you have to speak with empowerment, and you have to speak with the facts—and your marketing plans had better have a return on investment.” Data-driven customer insights give the CMO the power to do all that.

2. Design the right strategies and processes to carry out the vision in a multichannel world.

Talk about how complex marketing has become is very much in vogue, but there’s much less discussion about the operational (and diplomatic) muscle CMOs need in order to get things done. Customer journeys are complex and crisscross the organization. Even simple-seeming tasks, such as browsing or buying, often involve several steps, each touching a different part of the business. A customer may go online, compare products, scan a bar code, search, and call an agent. Designing a consistently positive, rewarding experience across all those touchpoints takes system-wide thinking and an integrated service-delivery approach. Point solutions, such as focusing on the call center, the store, or the website, no longer cut it in a multichannel environment, not when delivering excellent customer journeys can increase revenues up to 15 percent and cut costs by up to 20 percent.

Any well-designed interaction starts with a clear understanding of customer needs and the capabilities of front-line employees. That means plotting and, in many cases, reformulating processes to create a smooth and satisfying customer experience. To stitch it all together meaningfully, CMOs are increasingly expected to act as general managers with P&L or shared/shadow P&L responsibility that drive revenue growth. That bottom line sensibility is crucial. Says Abi Comber, Head of Marketing for British Airways: “Having P&L responsibility is incredibly powerful. CMOs need to show the ROI of every pound spent on marketing and how it delivers against the bottom line.”

CMOs are also now often judged on how well they can design and run an organization that reaches across the entire business. We’re seeing marketers develop centers of excellence, particularly around digital, to advise and support business units and functions in serving the right information to the right person at the right place and time.

To hit P&L targets, for instance, the CMO at one technology company focused on shortening the sales cycle. Data revealed the initial sales meeting and RFP were especially influential in shaping buying outcomes. So marketers collaborated with IT to design an iPad application that allowed salespeople to enter their book of business and receive detailed customer profiles with background on important customer decision-makers and priorities, as well as status updates and other useful information. That helped account managers focus their pitch on the client’s business issues and build rapport. The CMO also worked with the finance office and product managers to link pricing and benchmark data into the RFP process, which improved quality and response times.

Similarly, when web analytics revealed a spike in the number of unique visitors at a student loan site, the CMO helped orchestrate the responses. To woo high-value, low risk customers, the CMO worked with the risk team to fast-track the credit approval process. They also worked with the call center and IT to create a “chat live” button to make it easier for customers to complete forms online before they drifted off to a competing site. And when customer data showed that first-time applicants were more likely to move forward when there was a human touch to the process, marketing helped assign a sales person to individual customers. Those steps helped the bank drive up loan volumes, a tangible bump the CMO could point to in discussions with other leaders.

3. Become the organizational “glue” to deliver change.

“If marketing is not driving the change agenda then either the agenda is wrong or marketing is not being effective,” says Ewart.

Companies across the spectrum are grappling with change as new technologies, innovations, and customer behaviors disrupt old business models. When it comes to transforming an organization, clearly leaders across the C-suite, starting with the CEO, have critical roles to play. But the CMO has a unique and critical role to play to deliver the change. Deep insights into customer behaviors and market trends mean that the CMO needs to identify what changes are necessary. More importantly, the CMO then needs to motivate and help drive the required changes through the organization.

“You have to be able to command the pace of change in your organization in order to keep up with what consumers are looking for and the ways in which they’re interacting with you,” says Comber.

The most obvious changes are often the ones affecting the customer experience. Providing a consistent customer journey across all the touchpoints of an organization is critical because customers today punish companies that don’t deliver a consistent experience. Banks, for example, have a very strong correlation between consistency on key customer journeys and overall performance in customer experience. When we sent an undercover-shopping team to visit 50 bank branches and contact 50 bank call centers, the analysis showed that for lower-performing banks, the variability in experience was much higher among a typical bank’s branches than it was among different banks themselves.

Improving a customer journey is not something, however, that CMOs can do on their own. It requires that the CMO work with other leaders in the company who have responsibility over various touchpoints along the journey. The CMO needs to sit down with the head of sales, the COO, the customer service center leader and others to map out what exactly customers do on a given journey, which function has responsibility for which interaction, and what each then needs to do to ensure a consistent and excellent customer experience. With so many parts of the organization needing to come together to deliver on a customer journey, the CMO has to operate as the “glue” across the organization.

That bonding role extends to other aspects of the business as well, such as delivering on products and services. “Marketing is the integrator in the end-to-end chain,” says DiSanzo. “If you don’t have a world-class marketing enterprise, your solutions won’t meet the market.”

At Philips Healthcare, that integration takes the form of a “Great Marketing Plan.” The core of that plan is a 15-page blueprint detailing what various parts of the organization need to do and how different functions need to work together in order to bring something to market. Marketing plays an oversight and coordinating role in this process.

Erwin van Laethem, CEO of the Dutch energy company, Essent, highlighted that connecting talent when describing what he was looking for in a CMO: “We were looking for somebody who had a track record in fact-based marketing and someone who was also very engaging for the whole organization – what we call an ‘attractor’ for other people who would then follow the vision and the aspiration that we set out.”

In delivering on change, the CMO is increasingly being asked to go beyond providing an orchestrating role across the organization to deliver products, services, and experiences. We see CMOs, with their strong communications and creative skills, increasingly move into a position to drive changes in the culture itself. At British Airways, for example, the CMO was a leading force in using social media to transform the organization into a much more transparent, customer-oriented business. Interactions with customers went from a “tell” to a “conversation.”

“This is a far more open version of British Airways than we may have had ten years ago,” says Comber.

To affect changes in culture, some CMOs are partnering more closely with human resources. Says Peter Markey, CMO of Post Office (and former CMO of the RSA Insurance Group), “The HR director is a vital relationship for me because a lot of what we’re trying to do through marketing and brand is drive culture change in an organization. So the HR director has to be my best friend.”

Such a partnership is also helpful in establishing the right performance incentives. For example, a large conglomerate needed to mobilize 500,000 employees around a new customer-focused initiative. To do so, it linked customer and operational performance metrics, and then prioritized them based on their ability to lift customer satisfaction and market performance. That approach to linked metrics served as the basis for developing employee incentives, such as bonuses.

The truth is that for all the hard skills needed to master the operations of marketing, CMOs really need to excel at the soft skills to succeed. Forging strong working relationships with leaders in the C-suite, building bridges across functions, being transparent, demonstrating the value of marketing, and helping other leaders succeed is becoming the core factor in a CMO’s ability to succeed.

The need to deliver on organization-wide imperatives creates lots of pressure for CMOs. But it’s also raising the CMO’s profile, a fact that explains in part why Fortune 100 CMO tenures are growing to an average of 45 months (Russell Reynolds data), nearly double the 23-month average formerly considered the norm. CMOs who bring data-driven insights to all decisions, build effective bridges across the organization and use their experience and acumen to drive above-market growth will see their profile and influence grow significantly.

Beware Big Data’s Easy Answers

The rise of powerful and easy-to-use software (e.g., software as a service) and analytic programming languages (e.g., R) have made it possible for people across the entire organization — not just the database trolls — to ask questions of business performance. Suddenly everyone(-ish) can see just about anything about the business.

This transparency allows more people to engage on important business problems, making success more likely. But there is one notable downside: Just because you got an answer, even a “significant” one, doesn’t mean you got a real answer, or an important one.

Many people have called this the “button effect”: The ghost in the machine gives the correct answer, every time, and I don’t need to think about it. In the messy real world, though, there are some bits of knowledge you should have so that you can interpret the button’s offering.

In big data analysis, you need to know, among other things, about “data distributions.” Many statistical tests — and almost all that are taught in statistics classes — require that the data to which the test is being applied be “normally distributed.”  There is a mathematical description of this distribution, but everyone knows it as the “bell curve,” where the number of observations is plotted on the y axis; the high point is the mean, the distribution is perfectly symmetrical on both sides of the mean, and the number of observations drops off fairly rapidly on both sides of the mean.  As a result of this particular structure, 66% of all observations lie within one standard deviation above and below the mean, with 95% occurring within 2 standard deviations above and below the mean.  These facts allow us to use simple math to determine whether two groups differ on some set of measures to a “significant” degree. That’s a lot of words. The key element is that most of us want to know the answer to some question like “are sales up month on month?” or “do people spend more time on our new site than our old one?”

Answering these questions often involves a simple statistical test called a “z-test.” The details don’t matter, except that it’s important to realize that the z-test depends on the normal distribution and, more specifically, on symmetric standard deviation values.

Let’s work through an example of how statistics can get messed up by non-normal distributions: Are men taller than women? In the US, men are, at about 5’10” median height, about 9% taller than women, so the answer should be yes.  I set out to confirm this statistic by measuring the height of about 20 women at my company and comparing them to an equivalent number of men.  As expected, the statistics showed that men were taller.  Then I pretended to hire another man: Dylan Postl, a professional wrestler measuring in at about 4.5 feet.  With the addition of the immortal Hornswoggle, the statistics show that men and women are the same height.  Oops.  Then I “hired” Sandy Allen, a 7.5’ tall woman.  Now the statistics show that women are significantly taller than men. What happened? The addition of Dylan and Sandy were “outliers,” values that shouldn’t really exist in the normal distribution.  The simple tests I used are very sensitive to outliers, making incorrect results quite common.

It’s pretty easy to tell that Dylan and Sandy are outliers, because we all have been observing for decades how tall the people around us are. With lots of the other statistics we rely on, though, that isn’t the case. Large public policy issues are argued using statistics; if the stats can be so wrong about something trivial like height, they might be wrong in, say, health care reform or gun control. The same issue arises in business.

Doing an A/B test comparing whether people like a new product design more than an old one? The person who runs that test might come back providing average ratings for each design showing that B’s average rating is significantly better than A’s. All done, right? Well, “average” usually implies testing based on means. Ratings are ordinal numbers that don’t have means or symmetric standard deviations. How can they? On a scale of 1 to 5, 4 is not twice 2. Thus, that “significant difference” is … well… not. Yup, that number you are using to reform your entire product mix? It might be right. It also might be random.

I’m not trying to say that means and standard deviations aren’t useful.  However, there is knowledge that users of powerful big data buttons need to know in order to understand the output. Some of this knowledge is simple, although often ignored even by researchers. Other bits of the knowledge are art, only gained through experience.

Regardless, the most important thing, with all due respect to Lewis Carroll, is: Beware the button, my son, the assumptions that bite, the findings that catch!

Children Get Educational Benefits from Having a Parent at Home

A Norwegian cash-incentive program to encourage parents to stay at home with their toddlers had a long-term beneficial effect on older children’s educational attainment, according to a team led by Eric Bettinger of Stanford. By 10th grade, children whose mothers didn’t work outside the home because of the program had grade-point averages that were up to 1.2 points higher than would have been expected otherwise (in this study, the average GPA was 4.1 on a 6-point scale). Parents who stayed at home may have been more available to help their children with their schoolwork, the researchers say.

The Supreme Court Is Wising Up on Digital Privacy

While much of Washington grapples with a handful of newly-minted Supreme Court decisions focused on social and campaign finance reform, three largely overlooked court decisions signal a much larger tidal wave of change ahead for the tech community. Taken together, these cases shed light on the court’s views of how the Fourth Amendment’s protections of searches and seizures are complicated when much of our personal information is now digital.

The turning point for tech began in 2012 with United States v. Jones, in which the court ruled that attaching a GPS device to a car and monitoring its movements constitutes a search under the Fourth Amendment. This year, the court issued a single opinion on two more cases, Riley v. California and United States v. Wurie, finding that police enforcement must obtain a warrant in order to search digital information on a cell phone seized from an individual at the time of the arrest.

In delivering the court’s unanimous opinion in Riley, Chief Justice John G. Roberts Jr. noted that for many Americans, today’s smartphones hold the “privacies of life,” adding that the American Revolution itself was predicated on opposition to illegal searches. Chief Justice Roberts also highlighted the difficulty of setting legal precedent on technologies that won’t be outstripped by innovation. “A smart phone of the sort taken from Riley was unheard of ten years ago,” he wrote. Technology is evolving too quickly for a single case to concretely set precedents that will still be relevant 30 years from now. Imagine attempting to apply a court ruling on cassette tapes or mini disks (remember those?) from twenty-years ago to a case today involving digitally downloaded songs. These technologies are no more applicable today than digital downloads will be in 30 years.

As we enter an increasingly digital world, a period in which the Internet of Things is poised for explosive growth, it’s reassuring to see that today’s court is equipped to handle cases related to digital privacy. These cases are more than just ruling on a singular issue like digital privacy. They are about how courts should approach aspects of our daily lives that are impacted by and through the use of technology. These cases – and the hundreds that are sure to follow them – foreshadow how our digital lifestyles will put to the test long-held values and social norms.

We now live in both a physical and digital realm. The strict parameters we once used to define privacy aren’t sustainable in a world increasingly defined by this dual existence. Our new paradigm will be much more fluid – and require a more fluid approach. That is precisely where the Supreme Court is leading us.

This year, privacy lives on your cellphone. Next it will be wearables, which offer even greater capture, recognition and recording functionality, deepening the digital well. Sometimes the lasting legacy of landmark court opinions isn’t immediately apparent, but technological innovation evolves along a continuum.

The Supreme Court’s opinions in this recent spate of tech cases confirm the justices recognize how quickly the technological landscape is evolving. It’s impossible to draw hard lines in the sand, knowing that these hard lines – even though they’re digitally drawn – may not apply to future technologies.

VC Funding Can Be Bad For Your Start-Up

More than two generations ago, the venture capital community — VCs, business angels, incubators, and others — convinced the entrepreneurial world that writing business plans and raising venture capital constituted the twin centerpieces of entrepreneurial endeavor. They did so for good reasons: the sometimes astonishing returns they’ve delivered and the incredibly large and valuable companies that their ecosystem has created.

But the vast majority of successful entrepreneurs never take any venture capital.

Take Claus Moseholm, co-founder of GoViral, a Danish company created in 2005 to harness the then-emerging power of the Internet to deliver advertisers’ video content in viral fashion. Funding his company’s steady growth with the proceeds of one successful viral video campaign after another, Moseholm and his partners built GoViral into Europe’s leading platform to host and distribute such content. In 2011, GoViral was sold for $97 million, having never taken a single krone or dollar of investment capital. The business had been funded and grown entirely by its customers’ cash.

In fact, venture capital financing may even be detrimental to your start-up’s health. As venture capital investor Fred Wilson of Union Square Ventures puts it, “The fact is that the amount of money start-ups raise in their seed and Series A rounds is inversely correlated with success. Yes, I mean that. Less money raised leads to more success. That is the data I stare at all the time.”

Wilson’s observation reflects the fact that there are a number of serious drawbacks entailed in raising capital too early, drawbacks that have profound implications at all stages of the investment cycle:

1. Pandering to VCs is a distraction. Trying to get a fledgling venture off the ground is a full time job, and then some. But so is raising capital, which demands a lot of time and energy on its own. It will distract the entrepreneur from doing the more important work of getting the venture onto a productive path. As Connect Ventures founder Bill Earner argues, “Finding the right customers and getting them to fund your business [constitute] a great step-by-step guide to raising venture capital — build the business first and the investments will follow.”

Why spend your time trying to convince investors to invest, when you could spend the same time convincing prospective customers to buy — or perhaps learning why they won’t — before you burn somebody else’s money! Besides, as customer-funded entrepreneur and investor Erick Mueller recalls, “It’s a lot more fun dealing with customer needs than pandering to investors.”

2. Term sheets and shareholders’ agreements can burden you. Investors don’t like risk any better than you do. If you’re raising money before traction is in hand, so-called “market risk” is higher than if demand has already been proven. To protect their downside, investors will require what are often seen by entrepreneurs as onerous terms. And when the concise prose of the term sheet is fleshed out into the fine print of the shareholders’ agreement, the terms get even worse.

3. The advice VCs give isn’t always that good. According to an analysis of venture fund returns by Harvard Business School’s Josh Lerner, more than half of all VC funds delivered no better than low single-digit returns on investment. Worse, only 20 per cent of funds achieved 20 per cent returns (or better), a figure that they might be expected to deliver. Incredibly, nearly one in five funds actually delivered below-zero returns.  Given this performance, you would be forgiven if you wondered just how helpful most VCs’ support or “value-add” is likely to be! Unfortunately, you will very likely to be obliged to follow their sage “advice.”

4. The stake you keep is small — and tends to get smaller. When you raise angel or venture capital early, as Jobs did to fund Apple, you start giving away a portion the company — often a substantial portion — in exchange for the capital you are given. And that portion grows over time, as additional rounds of capital are raised. Dell, on the other hand, used his customers’ pre-payments for their PCs to fund his start-up and its early growth. Claus Moseholm and his partners, who managed to go the distance at GoViral without ever raising outside investment, retained their stakes in the business (bar one co-founder, who sold his stake to a growth capital investor) until they eventually sold.

But the best news is this. If you raise money at a somewhat later stage of your entrepreneurial journey, you’ll find that many of the drawbacks have largely disappeared. Why? Because with customer traction in hand, you’ll be in the driver’s seat, and the queue of investors outside your door will have to compete for your deal.

5. The odds are against you. Even worse, perhaps, than the difficult terms, the questionable advice you may get, and the dilution you will incur if you raise capital too early, are the difficult odds faced by companies that do win VC backing. In the typical successful fund, on average only 1 or 2 in 10 of the portfolio companies — the Googles, Facebooks, and Twitters of the world — will actually have delivered attractive, and occasionally stunning, returns. Facebook alone accounted for more than 35 per cent of the total VC exit value in the United States in 2012. A few more portfolio companies may have paid back the capital that was invested in them, but most of the rest are wipeouts. In the VC game the very few winners pay for the losers, so most VCs are playing a high-stakes all-or-nothing game. Are these the kind of odds with which you’d like to put your new venture into play?

VC Funding Can Be Bad For Your Start Up

More than two generations ago, the venture capital community — VCs, business angels, incubators, and others — convinced the entrepreneurial world that writing business plans and raising venture capital constituted the twin centerpieces of entrepreneurial endeavor. They did so for good reasons: the sometimes astonishing returns they’ve delivered and the incredibly large and valuable companies that their ecosystem has created.

But the vast majority of successful entrepreneurs never take any venture capital.

Take Claus Moseholm, co-founder of GoViral, a Danish company created in 2005 to harness the then-emerging power of the Internet to deliver advertisers’ video content in viral fashion. Funding his company’s steady growth with the proceeds of one successful viral video campaign after another, Moseholm and his partners built GoViral into Europe’s leading platform to host and distribute such content. In 2011, GoViral was sold for $97 million, having never taken a single krone or dollar of investment capital. The business had been funded and grown entirely by its customers’ cash.

In fact, venture capital financing may even be detrimental to your startup’s health. As venture capital investor Fred Wilson of Union Square Ventures puts it, “The fact is that the amount of money startups raise in their seed and Series A rounds is inversely correlated with success. Yes, I mean that. Less money raised leads to more success. That is the data I stare at all the time.”

Wilson’s observation reflects the fact that there are a number of serious drawbacks entailed in raising capital too early, drawbacks that have profound implications at all stages of the investment cycle:

1. Pandering to VCs is a distraction. Trying to get a fledgling venture off the ground is a full time job, and then some. But so is raising capital, which demands a lot of time and energy on its own. It will distract the entrepreneur from doing the more important work of getting the venture onto a productive path. As Connect Ventures founder Bill Earner argues, “Finding the right customers and getting them to fund your business [constitute] a great step-by-step guide to raising venture capital — build the business first and the investments will follow.”

Why spend your time trying to convince investors to invest, when you could spend the same time convincing prospective customers to buy — or perhaps learning why they won’t — before you burn somebody else’s money! Besides, as customer-funded entrepreneur and investor Erick Mueller recalls, “It’s a lot more fun dealing with customer needs than pandering to investors.”

2. Term sheets and shareholders’ agreements can burden you. Investors don’t like risk any better than you do. If you’re raising money before traction is in hand, so-called “market risk” is higher than if demand has already been proven. To protect their downside, investors will require what are often seen by entrepreneurs as onerous terms. And when the concise prose of the term sheet is fleshed out into the fine print of the shareholders’ agreement, the terms get even worse.

3. The advice VCs give isn’t always that good. According to an analysis of venture fund returns by Harvard Business School’s Josh Lerner, more than half of all VC funds delivered no better than low single-digit returns on investment. Worse, only 20 per cent of funds achieved 20 per cent returns (or better), a figure that they might be expected to deliver. Incredibly, nearly one in five funds actually delivered below-zero returns.  Given this performance, you would be forgiven if you wondered just how helpful most VCs’ support or “value-add” is likely to be! Unfortunately, you will very likely to be obliged to follow their sage “advice.”

4. The stake you keep is small — and tends to get smaller. When you raise angel or venture capital early, as Jobs did to fund Apple, you start giving away a portion the company — often a substantial portion — in exchange for the capital you are given. And that portion grows over time, as additional rounds of capital are raised. Dell, on the other hand, used his customers’ pre-payments for their PCs to fund his startup and its early growth. Claus Moseholm and his partners, who managed to go the distance at GoViral without ever raising outside investment, retained their stakes in the business (bar one co-founder, who sold his stake to a growth capital investor) until they eventually sold.

But the best news is this. If you raise money at a somewhat later stage of your entrepreneurial journey, you’ll find that many of the drawbacks have largely disappeared. Why? Because with customer traction in hand, you’ll be in the driver’s seat, and the queue of investors outside your door will have to compete for your deal.

5. The odds are against you. Even worse, perhaps, than the difficult terms, the questionable advice you may get, and the dilution you will incur if you raise capital too early, are the difficult odds faced by companies that do win VC backing. In the typical successful fund, on average only 1 or 2 in 10 of the portfolio companies — the Googles, Facebooks, and Twitters of the world — will actually have delivered attractive, and occasionally stunning, returns. Facebook alone accounted for more than 35 per cent of the total VC exit value in the United States in 2012. A few more portfolio companies may have paid back the capital that was invested in them, but most of the rest are wipeouts. In the VC game the very few winners pay for the losers, so most VCs are playing a high-stakes all-or-nothing game. Are these the kind of odds with which you’d like to put your new venture into play?