The Long-Term Value of Internet Companies

From New York Times Deal Book:

A decade after the last technology bubble burst, the signs are everywhere that it is happening again.

Look at what’s happened to the highly publicized initial public offerings: Facebook’s value has declined $30 billion since its I.P.O., costing investors nearly half their investment. Zynga shares have plummeted. Groupon shares trade at such an extreme discount that there should be a Groupon for them. Pandora’s stock, once $17, has touched $7. Companies like Friendster and MySpace, meanwhile, toil in oblivion.

These declines didn’t have to occur. Creating new markets is a messy, fast-moving process in which many companies will collapse. Instead of mourning Facebook’s inability to surpass the market capitalization of General Electric, we should be celebrating the success of companies that have navigated early-stage minefields.

An aggressive approach to early-stage venture investing has led to a bubble in start-up financing. Financial analysts of these growth companies make a host of assumptions to project performance to justify outsize valuations.

As a consequence, promising young companies like Groupon and Zynga get overvalued. To support its I.P.O. valuation of nearly 100 times its earnings, Facebook would have to sustain an unrealistic growth rate. Even at its lower valuation, Facebook’s market capitalization is 12 times its revenue. Last week, Facebook reported respectable growth across all its important metrics: new users, active users, total advertising revenue and operating income. Yet, the vicissitudes of volatile markets caused its stock to decline 12 percent after its earnings announcement.

In a prudent financing environment, investors would be banking on Facebook’s future instead of wondering why it had lost so much of its I.P.O. value. Critics have argued that Facebook’s backers increased value for the company’s original investors by aiming for the highest valuation during the I.P.O. Did they lose sight of the importance of creating long-term value by having a base of stable committed shareholders who understand the business and are focused on its long-term success?

As we learned during the financial crisis, speculative traders looking for outsize returns can increase the volatility of company valuations. In turn, management gets trapped into trying to justify excessive valuations by focusing on short-term results. These huge swings in valuation have consequences. They jeopardize acquisitions. They demoralize employees who are compensated with stock. Most important, they distract senior leaders from their real job: creating great products that serve their customers.

Entrepreneurs who want to build for the long term should avoid going public until they have positioned themselves as market leaders with diverse and stable revenue streams. Even then, they shouldn’t strive to notch 80 times price-to-earnings ratios or a 100 percent pop in its shares on the first day of trading. Google is a classic example of the right way to go public. It delayed going public until six years after its founding. Since its I.P.O. in 2004, Google stock has moved steadily upward, rewarding its investors with a 500 percent return. Google’s $200 billion market capitalization is justified by $40 billion in revenue and $10 billion of net earnings.

Rather than trying to maximize the value of their I.P.O.’s, start-ups should align themselves with capital partners who are builders themselves, interested in sustainable growth and wary of unrealistic valuations. They should select board members committed to the long-term success of the company, compensating their directors with restricted stock. Founders should accept lower valuations in order to attract the right investors – financial partners who will invest in the brand, research and development and operational engine to create sustainable competitive advantage.

The striking example of Warren E. Buffett contrasts markedly with what we observe happening with the social media start-ups. Mr. Buffett cautions his investors about overpaying for assets and often talks down expectations for Berkshire Hathaway stock. He has taken the high road in treating his shareholders like long-term business partners. While shareholders don’t get one-time pops, they have compounded earnings at more than 20 percent a year for 50 years.

These days, the scrutiny of public company leaders is intense, and public markets are unforgiving. The high turnover in hedge fund portfolios makes Wall Street a place where fortunes are made, not where businesses are built.

In contrast, the best entrepreneurs are business builders. They should keep a laserlike focus on precisely that and never deviate to please short-term traders.

Penn State Lesson: Today's Cover-Up was Yesterday's Opportunity

The most damaging portion of former FBI Director Louis Freeh's comprehensive report on the Pennsylvania State pedophilia scandal is his conclusion that four senior university officials concealed football coach Jerry Sandusky's child abuse from 1998 to 2011, even from its board of trustees, because they wanted "to avoid the consequences of bad publicity."

In so doing, these officials—including legendary head football coach Joe Paterno and President Graham Spanier—placed their own reputations ahead of the harm that Sandusky did to young boys for the next 14 years.

Ironically, had Penn State turned Sandusky over to legal authorities in 1998, the public would have viewed its actions as protecting the victims, thereby enhancing the University's reputation. Instead, these men caused grave damage to a great university while allowing Sandusky free reign to destroy lives.

Sadly, the Penn State situation is not unique. Consider these other cases:

  1. Had President Richard Nixon acknowledged his role in the Watergate scandals, he could have saved his presidency and his legacy.
  2. Had the hierarchy of the Roman Catholic Church acknowledged its pedophilia scandals, it would have protected victims and its moral authority.
  3. Had President Bill Clinton admitted his relationship with Monica Lewinsky, the scandal would have subsided, enabling him to focus on his pro-growth policies to balance the budget and create jobs; instead, he had to fend off impeachment.
  4. Had Martha Stewart and Rajat Gupta admitted their roles in insider trading, they could have plea bargained, moved past their ethical lapses, and possibly avoided prison time.
  5. Had Best Buy founder Richard Schulze not covered up CEO Brian Dunn's improprieties, he could have retained Best Buy's reputation for sound values (and his own).

Contrast these actions with JPMorgan CEO Jamie Dimon, who took immediate responsibility for his firm's recent trading losses, calling them "stupid and egregious." While Dimon has taken considerable heat during the past month, his reputation as a "truth teller" remains intact. Eventually, JPMorgan will be restored and corrective actions put in place to mitigate future risks.

The deeper question raised by these examples is this: What causes leaders to cover up inappropriate actions instead of acknowledging them immediately?

Many leaders strive for such a high degree of perfection that they are unwilling to admit mistakes. They feel tremendous external pressure to be perfect, but in reality they are far more successful when they areauthentic. Were they to think rationally and consult with others about what to do, they would see it is better to acknowledge the truth, no matter how painful, because the truth will surface eventually. More importantly, they can prevent further harm to the victims. While leaders may rationalize that a cover-up protects the interests of their organizations, the damage of one typically harms their institutions far more than the direct admission of a mistake.

The Greatest Generation, venerated for placing stewardship and institutional trust ahead of self-interest, contrasts starkly with those in this generation of leaders who believe that putting self-interest first is acceptable. The cardinal responsibility of leaders is to always put their organizations first. As leaders become increasingly successful, their reputations soar and they begin to think they have to be perfect, contributing to their inability to acknowledge mistakes. Or they conflate their interests with the institution, thinking "I am the institution."

In doing so, they head for a fall—often taking their organizations down with them. Meanwhile, the public loses trust in them, and everyone associated with the organization gets hurt. This problem is compounded when many leaders fail, further alienating the public.

Reversing this loss of trust will require a concerted effort to develop a new generation of responsible leaders. No longer can leaders be chosen strictly for their abilities. In the future they must also be selected for their sense of institutional responsibility, based on their performance under stressful conditions. They must be bound by a sound governance system and constraints that require them to acknowledge their responsibilities to their organizations.

Developing this new leadership generation will require programs that focus on their inner sense of responsibility, their integrity and purpose in leading, and accepting themselves as imperfect human beings striving to do their best to help their organizations. An integral part of their development is gaining the self-confidence to acknowledge mistakes and make their actions transparent. Many leaders fear showing their vulnerabilities, but actually gain power and respect in being authentic.

Improving leadership development and selection won't prevent all failures, but it will go a long way toward minimizing them and restoring trust in our leaders.

Authentic Leadership Revisited

Nine years ago today the New York Times favorably reviewed Authentic Leadership, my first book. At the time "authenticity" in leadership was not a well-established idea. Many people asked, "What is an authentic leader?" although the concept seemed self-evident to me as being genuine, real and true to who you are. In those years authenticity has been popularized by Oprah Winfrey and others, as people search for the real thing.

With repeated leadership failures, many people today are eager to find authentic leaders, and the ideas have gradually become widely accepted, even among academics. More and more students are studying authentic leadership and striving to lead in this way. In spite of several well-publicized leadership failures, the new generation of corporate CEOs, many of whom I know personally, are highly authentic and doing an excellent job of leading, in spite of the economic headwinds. I find these trends very encouraging and feel that they bode well for the future of corporate leadership.

For those of you interested in Authentic Leadership and its successor, True North, here are two excellent blogs summarizing its ideas: and If you haven't read either or both, of course would be happy to send them to you.

As always, your feedback on these ideas is greatly appreciated.

Finding a Cure for "CEO-itis"

By: Joann S. Lublin for The Wall Street Journal

Warning: You could be at risk of contracting "CEO-itis."

An affliction of arrogance that plagues many people picked for powerful posts, its symptoms include a tendency toward isolation, belief that you're smarter than others, preference for loyalists, aversion to changing course even in the face of failure -- and love of royal treatment.

It appears to occur when promising managers reach the corner office or other C-suite spots. Once infected, once-successful executives often underperform and put themselves at great risk of early exits, experts say.

In June, John Figueroa quit after 17 months as chief executive of Omnicare Inc. "He believed he accomplished the goals established by the board,'' the nursing-home pharmacy operator announced.

But Mr. Figueroa also acted imperiously, ignored suggestions from colleagues, and made extensive personal use of the corporate aircraft, according to people familiar with the situation.

In short, the CEO title went to his head, one informed individual says. McKesson Corp., Mr. Figueroa's prior employer, had recommended him as a collaborative team player, another person remembers. Omnicare declined to comment.

Mr. Figueroa says he's "very proud of all the great things we accomplished" during his Omnicare stint, though he concedes he wasn't a warm and fuzzy boss. "I certainly did not make friends with everyone as tough decisions had to be made," he says. "We changed things very quickly, and looking back, I could have been better" at communicating with the board and managers.

Similarly, while Mr. Figueroa denies abusing perks, he confirms that a friend of his daughter flew with him, his wife and daughter on the corporate aircraft during a business trip.

Every top executive once was a rising star, building a base of influence. What changes them along the way?

David Kirchhoff, head of Weight Watchers International Inc., admits that he's had bouts of CEO-itis since assuming command in 2007. "It's almost impossible to avoid completely," he explains. "People treat you differently" when you become chief executive. He says he keeps his ego in check by working closely with people who enjoy teasing him.

Senior managers with an inflated sense of their superiority repeat actions long after they stop working because they overlook "information that has changed," says Carol S. Dweck, a Stanford University psychology professor and author of "Mindset: The New Psychology of Success." The rapid pace of change in most businesses requires more questioning, not less, she notes.

The problem, also called CEO disease, "is beyond epidemic," in part because executives today are so stressed that they fail to open themselves to new ideas and see themselves as "God's gift to the world," says Richard Boyatzis, an organizational behavior, psychology and cognitive science professor at Case Western University. He co-wrote "Primal Leadership,'' a 2002 book that discusses CEO disease.

Still, it is possible to get ahead without getting a swelled head. The remedy, leadership specialists say, involves the often painful process of reattaching an executive's feet to the ground.

Here are suggestions, gathered from ten present and former CEOs, for how to maintain equilibrium after you land a top job:

Surround yourself with highly capable lieutenants. 

"You have to have enough self-confidence to know you'll do well if you have a bunch of smart people doing well," Mr. Kirchhoff observes.

Strong, talented associates "make it easy to acknowledge I don't always – or even often – have the best idea in the room," concurs Scott Wine, CEO of Polaris Industries Inc., a maker of off-road vehicles, motorcycles and snowmobiles. That's why "I cannot be arrogant or expect unwarranted privileges," he adds.

Encourage dissent, discourage sycophants.

Help subordinates overcome their fear of offering frank feedback – but resist their seductive accolades.

"Reward people who challenge you," recommends William George, a former CEO of Medtronic Inc. "I didn't promote people who didn't take me on."

Mr. George says he especially disliked associates who frequently flattered him or showed up uninvited at meetings in order to gain face time with the CEO. For the worst sycophants, "I actually had to move them out," recollects Mr. George, now a management practice professor at Harvard Business School.

Regularly admit and fix your mistakes. 

Taking responsibility for your errors "is a very powerful way to keep yourself humble,'' Mr. Kirchhoff says. He recently took his own advice.

Weight Watchers' first-quarter profit fell more than expected on virtually flat revenue growth. During a May earnings call, Mr. Kirchhoff blamed the disappointing performance on execution issues. "I bear responsibility for those misses," he said.

Treat every employee with respect. 

Carin Stutz, hired to lead Cosi Inc. in January, is trying to revive the struggling fast-casual dining chain. Her predecessor resigned shortly after Nasdaq warned that it might delist the company. 

"There is definitely a lot more attention and visibility in this (CEO) role," says Ms. Stutz, previously a Brinker International Inc. executive. "I feel more responsible than ever to respect and support people."

Ms. Stutz chose a highly visible way to demonstrate respect for Cosi workers. She spent ten hours a day during her initial five weeks as CEO going through store-manager training. Among other things, she baked bread, prepared food and ran the cash register at restaurants in three cities.

Find an objective sounding board outside the office. 

A spouse, executive coach or informal group of advisors can alert you about looming signs of CEO-itis.

Mr. George, for instance, has attended a men's support group every Wednesday morning for nearly 35 years. "You're losing it (humility),'' some members warned while he ran Medtronic.

He says he was being too direct with his employees because he thought he had all the answers. Thanks to such reality checks, Mr. George adds, "you pay attention to your behavior.''

A rising pharma star's Executive Dream Team

Our son Jeff names his executive "Dream Team" for Fortune Magazine along with the rationale of his top picks. Who would be on your dream team? It’s nice to see Fortune featuring some of our great leaders, not just exposing poor leaders. We have many exceptional leaders these days who deserve some positive kudos for the amazing leadership they provide great organizations.

Supreme Court Ruling on the Accountable Care Act

Here is my Op-Ed on Supreme Court ruling on the Accountable Care Act, published on HBS' website ( I believe it is time to focus on living healthy lives, not just disease care with a national "Healthy Living" campaign. This is the only way to bring health care costs in line and make America a nation of healthy people. Your feedback is welcome!

Harvard's prescription for a broken American political system

Last week Harvard Business School Dean Nitin Nohria and a group of senior faculty members led by University Professor Michael Porter and Professor Jan Rivkin, co-chairs of HBS' U.S. Competitiveness Project, led a seminar for 400 leaders and policy makers at the Newseum in Washington DC on the subject of U.S. competitiveness. Fortune magazine did the following article on the session.

Leaders' Character Must Take Precedence over their Resumes

By Bill George for the Star Tribune, published June 23, 2012.

The tragic fall of Rajat Gupta, a man who helped so many organizations, is a vivid reminder of the frailties of human character. Convicted of insider trading, Gupta, who once headed global consulting firm McKinsey & Co., joins a lineup of failed leaders that includes ex-HP CEO Mark Hurd, investor Bernie Madoff, Berkshire's David Sokol, ex-Best Buy CEO Brian Dunn, and Chesapeake Energy's Aubrey McClendon.

Will the parade of leaders who fail to fulfill their leadership responsibilities ever end?

CEOs are public figures. Their actions are constantly being scrutinized inside and outside their organizations. For this reason their actions must be beyond reproach. The greatest failure for any leader is putting self-interest ahead of the organization's interests, which is precisely what these leaders did.

A year ago, I wrote an article titled "Why Leaders Lose Their Way" that analyzed ways in which high-profile leaders get seduced. What I learned in researching that article is that leaders who focus on external gratification -- money, fame and power -- instead of inner satisfaction, tend to abandon their roots and lose their grounding. That makes them vulnerable to small unethical violations that gradually build into unfathomable actions.

In choosing leaders, people place their trust in them, believing they will always do their best to build the organization and ensure their organizations can navigate difficult times. Leaders who put their self-interests ahead of their organizations violate this most basic responsibility of leadership.

Why? It's not because they don't understand their responsibilities. Rather, too much credit is given to leaders, who are applauded when things go well as if they were one-person bands. Eventually, they start believing their press clippings.

As Novartis Chairman Daniel Vasella told Fortune magazine: "The idea of being a successful manager is an intoxicating one. It is a pattern of celebration leading to belief, leading to distortion. When you achieve good results, you are typically celebrated, and you begin to believe that the figure at the center of all that champagne-toasting is yourself."

At this juncture, failed leaders start to believe they are above rules that govern others, and even above the law. Fueled by hubris, they violate the most basic principles, rationalizing that they won't get caught. When confronted, they try to talk their way out of it, rather than admitting their mistakes. This only compounds their problems by creating a trail of distortions that eventually brings them down.

It's easy to feel angry toward these leaders, but that misses the larger point. Violating the inherent trust their organizations place in them doesn't just harm the leader, it hurts everyone associated with the organization as well as its reputation. Their actions cause employees, investors and customers to lose confidence in their organizations. It can even put their organizations in play. That's what happened at Chesapeake Energy as Carl Icahn gained four board seats in a proxy contest. Best Buy could be next, due to Brian Dunn's misconduct and former Chairman Richard Schulze's failure to address it.

Gupta's actions tarnished the reputations of many organizations, among them McKinsey, Goldman Sachs, and Procter & Gamble. In the case of HP's Hurd, his termination left the company without a CEO or a viable strategy, leading to a decline in HP's market valuation of $60 billion, or 55 percent.

Each of us is fallible. To minimize the likelihood of leaders losing their way, it is essential to screen them carefully for their values and character. Leaders should be recognized for who they are, not just what they are, as character takes precedence over their résumés. Authentic leadership development opportunities enable them to integrate their life stories and crucibles into their thinking and understand their weaknesses, shortcomings and failures as well as their strengths. Ultimately, great leaders must be comfortable with their vulnerabilities. This requires years of careful preparation to ensure they are ready for the responsibilities of leadership.

Perhaps because of these well-publicized leadership failures, there has been a marked shift in recent years from hiring external candidates to the promotion of insiders whose character and values have been carefully tested. Recently-appointed CEOs seem to have a deep understanding of their personal responsibilities and the importance of staying grounded as leaders and human beings.

Bill George is professor of management practice at Harvard Business School, author of True North, and former chair and CEO of Medtronic, Inc.

Speaking Against the Marriage Amendment

The Minneapolis Star-Tribune published this piece on Sunday, May 20, 2012.

Now that the debate over the Vikings stadium is settled, taking center stage is an issue that has far graver consequences for Minnesota's future: the marriage amendment.

President Obama's unqualified support for same-sex marriage came on the heels of North Carolina's overwhelming vote to pass a constitutional amendment banning it. In Minnesota, the actual ballot question is whether to prohibit same-sex marriage in Minnesota's Constitution.

But even if the amendment fails, same-sex marriage will remain illegal in Minnesota by statute.

This is not a religious issue, because churches, synagogues and mosques have the right in any case to determine whom they will marry.

My interest in this issue is twofold. First, I believe in freedom of association for all Minnesotans. Second, as a former CEO of Medtronic, I know firsthand how important and challenging it is to recruit and retain talented people. Doing so requires a culture that accepts people as they are -- not in spite of differences, but because of them.

Defeating this amendment is essential not only to provide civil rights, but also to ensure that Minnesota is open and welcoming to everyone -- regardless of religion, gender, race, national origin or sexual orientation. Would Medtronic's new CEO, who is a Muslim born in Bangladesh, have left General Electric had he not believed that Minnesota was open to people with diverse life experiences?

To sustain their growth, local companies like Target, General Mills, 3M, U.S. Bancorp, Best Buy and Cargill must attract creative professionals from around the world. In his 2003 book, "Rise of the Creative Class," Richard Florida found that tolerance -- openness to diversity regardless of race, religion, ethnicity and sexual orientation -- is one of two key factors in recruiting creative people. He ranked Minneapolis No. 29 on diversity, well below competing cities like Seattle, San Francisco, Portland, New York and Boston.

Local business leaders have been remarkably progressive within their companies, enabling them to sustain their growth and diversify their leadership teams. Passage of this amendment would make it increasingly difficult for Minnesota companies to recruit and retain the talented people required to build global companies -- not just gays, but anyone whose choice is to be part of an open society that rewards performance over social issues.

Our corporate leaders need to speak out forcefully against this amendment, because their companies have the most to lose if it passes. To date, only former CEOs Wheelock Whitney and Marilyn Carlson Nelson have done so, while other corporate leaders have been notably silent.

In North Carolina, the business community failed to speak out against its amendment. CEOs and bank chiefs like Brian Moynihan of Bank of America remained silent, while only Duke Energy CEO Jim Rogers warned about the amendment's consequences. Rogers didn't mince words:

"We're going to look back 10 or 20 years from now and think about that amendment [like] the Jim Crow laws [legalizing racial discrimination]. We're competing with people around the world. We've got to be inclusive and open."

In the late 1940s, African-Americans faced discrimination when Minneapolis Mayor Hubert Humphrey spoke in defense of racial freedom. In retrospect, how would that era's leaders have felt had they not opposed racial discrimination?

Until the 1967 Supreme Court decision, many states banned interracial marriage. Imagine how families would be affected were those laws still in effect.

In my final years at Medtronic we faced a difficult situation when the Supreme Court ruled that the Boy Scouts could reject gay males as scoutmasters. Since Medtronic Foundation policy prohibited grants to organizations that discriminate, it withheld funds to the Boy Scouts until its policy was changed, causing significant controversy inside the company. As a result, the local Boy Scout chapter amended its policies to be open to all leaders, and our community is better off for that.

Do Minnesotans want to become a parochial haven, or will we be a role model of diversity and quality of life for everyone? Minnesota corporations are leaders on jobs, family-friendly cultures, education, health care and the arts.

Now their leaders need to speak out against the marriage amendment to ensure that Minnesota will continue to be one of the most progressive workplaces in the nation.

Facing Reality, Starting with Yourself

In my 2009 book, 7 Lessons for Leading in Crisis, the first lesson when encountering a crisis is to "face reality, starting with yourself." This week we have contrasting examples of leaders confronting crises who took sharply different paths: JP Morgan's Jamie Dimon and Best Buy's Richard Schultz.

Schultz founded Best Buy in 1966 with a single store called "Sound of Music." He has built his company into an international chain with 1,250 stores, 170,000 employees, and $50 billion in revenues. Although he twice turned the CEO role over to long-standing colleagues, Brad Anderson in 2002 and Brian Dunn in 2009, he never relinquished control.  As Best Buy's board chair, Schultz dominated both the board and the company, with few board members or executives who dared challenge his power.

Without question, Schultz is a brilliant entrepreneur who built a great organization. He was named one of the Twin Cities top five executives of the decade in the 1990s. In 2004 Best Buy was named "company of the year" by Forbes magazine.  He amassed a personal fortune, retained 20 percent of Best Buy's voting shares, and endowed the Schultz School of Entrepreneurship at St. Thomas University.

In the last three years Best Buy's model of selling all forms of electronic hardware has lost ground to on-line retailers like Amazon, and its sales have slipped. Schultz and Dunn have been slow to react, resisted making fundamental changes in Best Buy's business model. Last December Schultz got some very disturbing news from a reliable source in the company: CEO Dunn was having "an extremely close personal relationship" in Best Buy's headquarters with a 29-year-old female employee. Schultz confronted Dunn with the allegations, which he denied.

What did Schultz do next? Nothing. He buried the issue, not mentioning it to Best Buy's board, its general counsel or head of human resources. Nor did he launch an internal investigation to see whether the allegations were true. Not surprisingly, the issue surfaced again in March, this time directly to members of the board. The board took immediate action, terminating Dunn that day and hiring two experienced investigators, William McLucas and Tom Strickland, to determine the veracity of the charges. Their report led to Schultz's forced resignation as board chair on May 14 and caused further turmoil at the company.

The lesson: Schultz failed to face reality and acknowledge his role in supporting, and perhaps dominating, CEO Dunn. As a result, he was forced to resign in disgrace, a sad end to a brilliant career.

In contrast, Jamie Dimon of JP Morgan, upon learning of the firm's $2 billion loss in a hedging transaction, took full responsibility for the problems. He didn't hide from the media, as he talked openly about what happened. He went on Meet the Press the next day, telling David Gregory, "We made a terrible egregious mistake. We were stupid. There’s almost no excuse for it.” The following day he accepted the resignation of the trader responsible for the losses. He acknowledged that the losses came at an extremely awkward time in the finalization of the regulation of the Dodd-Frank law in defining proprietary trades and hedging, but didn't blame others.

The lesson: While the losses at JP Morgan are not insignificant, they represent less than 10 percent of the firm's annual profits and can be absorbed without basic harm to the bank. While the crisis was front-page news for the past week and has triggered several investigations, Dimon will be able to put it behind him in due course and continue to build his bank. All because he faced reality and took full responsibility for the problems.