A Balanced Buy

Business executives can no longer ignore technology these days, and they'd be dumb to even try. Technology provides unprecedented opportunities to build customer relationships, increase operational efficiencies and create new sales channels, to name just a few. But for all its promise, technology's complex nature has proven intimidating to business folks faced with purchasing decisions. After all, a big technology purchase is, in essence, an investment in the company itself.

How do you know which vendors have the most innovative products and are likely to survive long-term? Which company will increase in value? The best predictor of that ability, it turns out, is competitive advantage. The more competitive advantage a company has, the greater the probability that it can increase future returns (and thus remain a viable supplier).

So how do you measure a company's competitive advantage? It gets a little complicated, but it all boils down to how much effort a company puts in to innovation versus how much it uses to maintain operations. Consider this: A company's current competitive advantage is presumed to be factored into its stock price. However, competitive advantage is like a new car-it starts depreciating almost immediately, since the competition instantly seeks to neutralize that advantage. Thus, a certain amount of investment is needed just to maintain current differentiation. But that's not enough. Investment is supposed to be about increasing stockholder value, not maintaining the status quo. Companies must not only retain current competitive advantage, they must increase it.

Such increases in valuation can come from new sources of competitive advantage, such as new products and new markets. Companies can also boost valuation by expanding the power of existing advantages through such techniques as growing the sales force or opening a new plant. In either case, let's call the work that goes into creating these enhancements "core work," meaning it contributes directly to increasing shareholder value. By contrast, all the other work that is done in a company is known as "context work." Context work provides necessary support to the processes of the organization but does not increase competitive advantage. For most companies, context tasks include providing employee benefits, conducting accounting and managing employees.

Now the more energy that goes into core rather than context work, the better for the investment, provided that the processes that the context work supports do not suffer. After all, a certain amount of context work is the necessary glue that holds everything together. But management must also minimize context in order to maximize core. Hence investors, knowingly or not, have an inherent interest in the core/context ratio in each of their investments. And, therefore, so should management.

The core tasks that comprise a company's competitive advantage are the underpinning of its current valuation. Monitoring core/context ratios is an ongoing process, chiefly because the core tasks that comprise a company's competitive advantage are under constant attack by the competition. Once they neutralize that advantage it ceases to differentiate your company. Although the task still has value, it moves from being core to context. Over time, therefore, much of what has been a core task becomes context.

This does not mean they are neglected, however. Context tasks function as the minimum standard for competing at all in the marketplace. If you fail to execute them effectively, you will be punished. However, if you execute them brilliantly, you will not be rewarded. Context, in other words, has little to no upside but plenty of downside.

Now let us suppose that you are a manager in charge of a function that is, for the most part, context. What kind of management behavior will you exhibit? I will argue that risk-averse behavior is the rational response to being charged with not screwing up something that has no upside, only downside. So the more context tasks you have inside a corporation, the more risk-averse managers you will have incubated.

By contrast, what kind of executive excels at managing core tasks that create new competitive advantages? Here I would argue a natural selection for risk-taking behavior, modified by appropriate levels of prudence. It is virtually impossible to create new advantages without taking some level of risk.

Because core tasks are so crucial to the future of the corporation, they get top management attention and attract risk-taking managers. At the same time, context tasks get relegated lower and lower as they become less core, and that is where risk-averse managers migrate. Thus we get the fundamental dynamic of so much of corporate life: a frustrated interaction between a top management with visionary ideas and a middle management with risk-averse tendencies.

One can reach some pretty interesting conclusions by analyzing the ratio of core managers to context managers, as well as the interaction between the two types.

In a large corporation, for example, senior executives have historically looked down on middle managers for their inability to get behind new core initiatives, but this is disingenuous in the extreme. As long as midlevel managers are saddled with context tasks, there is no way they can both succeed with their current charter and support a new one. It is top management's responsibility to outsource old context tasks so that middle management can concentrate on new core tasks.

If the corporate leaders fail in this agenda, the company's core/context ratio will inevitably worsen as context builds up in-house. Companies that retain too many contextual tasks risk a major momentum stall out. Imagine, for instance, that the executive staff at a company decides on a new strategic agenda. They ask all the core managers to lead the charge and bring the context managers with them. Now these core managers are energetic folk, so if the core/context ratio is 1-to-1, this is not a problem. Indeed, these core task managers are so energetic that if the ratio is 1-to-2, they still can make it work. But as it becomes 1-to-4 or 1-to-8 or 1-to-20, even the most energetic people will throw up their hands and leave.

All talented risk-taking managers ask, really, is a chance to prove their ideas and energies. As long as a corporation can create such an environment, it will have no trouble attracting and keeping its talent. People assume that talent comes to Silicon Valley for the stock options, but I would argue it is just as likely the stock options come for the talent. That is, investors like putting money into companies that have great core/context ratios, and virtually every startup, regardless of its deficiencies, is spending the overwhelming bulk of its time, talent and management attention on core work.

For established corporations that have internalized a load of context tasks, the No. 1 imperative of top management is not to generate a new strategy but rather first to unload the baggage from the old ones. Mapping the core/context boundaries in the corporation and then finding creative ways to outsource context is the critical first step to rejuvenating the enterprise. Only then can it introduce new core with a chance of overcoming context inertia and gaining new competitive advantage and a rise in valuation.

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