2014 May/June Chief Executive magazine by Chief Executive Group

Alternative Financing

A primer on crowdsourcing, BDCs and other options, p. 36

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Marketing Maven

Neil Rackham on what your sales team is doing wrong, p. 44

Social Media for B2B CEOs

What Twitter, Tumblr and Instagram can do for you, p. 54

Get Your Google On

How to make your digital reputation soar, p. 58

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QUAD RECOMENDATIONS

CONTENTS

May/June 2014 No. 270

COVER STORY 25 2014 Best and Worst States for Business States that reduce the burden of government and extend greater economic freedom tend to grow and expand more rapidly than those that do not. by J.P. Donlon and Dale Buss

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Editor’s Note

CEO Watch Pulte’s Richard Dugas on building financial discipline • Royal Caribbean’s Adam Goldstein on navigating the crisis-hungry media • POV: Walker Digital’s Jay Walker on fixing the patent process

Chief Concern The CEO as Growth Leader Changeable times call for leaders who are also able to change.

by Dr. Thomas J. Saporito

CEO Confidence Index CEO Confidence at Its Highest Level in Three Years

Mid-Market Report Healthcare a Top Focus

Raising Capital Off-Roading Your Way to Financing Crowdfunding and other alternative paths to capital are drawing in the crowds. Plus: Why CEOs should know about BDCs.

by Russ Banham

B2B Sales & Marketing Summit The New World of Sales Author Neil Rackham on what your sales team is doing wrong.

by Jennifer Pellet

Technology Making Tech Transfer Work How America’s idea factories can work with CEOs to commercialize more technology.

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by William J. Holstein

MAY/JUNE 2014

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CONTENTS

Corporate Governance Why Boards that Lead Succeed Recent history shows that directors who take more active roles— particularly in CEO selection—are fundamental to the long-term health of their companies.

by Ram Charan, Dennis Carey and Michael Useem

B2B Marketing Social Media & the B2B CEO What can the likes of Facebook, Twitter and Tumblr do for your company?

by Dale Buss

Reputation Management You Are Whoever Google Says You Are CEOs have a clear choice: Define yourself via social media tools—or let your detractors do it for you.

by C.J. Prince

Executive Life Why CEOs Buy Sports Teams—And What They Do With Them by George Nicholas

Flip Side To Bitcoin a Phrase by Joe Queenan

62 72

Final Word The Imperial City

Chief Executive (ISSN 0160-4724 & USPS # 431-710), Number 270, May/June 2014. Established in 1977, Chief Executive is published bimonthly by Chief Executive Group, LLC at One Sound Shore Drive, Suite 100, Greenwich, CT 06830-7251, USA, 203.930.2700. Wayne Cooper, Executive Chairman, Marshall Cooper, CEO. © Copyright 2013 by Chief Executive Group, LLC. All rights reserved. Published and printed in the United States. Reproduction in whole or in part without permission is strictly prohibited. Basic annual subscription rate is $198. U.S. single-copy price is $33. Back issues are $33 each. Periodicals postage paid at Greenwich, CT and additional mailing offices. POSTMASTER: Send all UAA to CFS. NON-POSTAL AND MILITARY FACILITIES: send address corrections to Chief Executive, P.O. Box 15306, North Hollywood, CA 91615-5306.

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The Best Tips, Tools, Insights & Practices for CEOs EXCLUSIVELY ONLINE NOW Lessons for CEOs on Barra’s Response to GM’s Crisis It’s not what she wants to be doing right now, but General Motors’ CEO Mary Barra is conducting a running case study in how to handle a corporate reputation crisis with the recall of 1.6 million old vehicles for a previously undisclosed problem with their ignition switches. Is it possible for a CEO to bear the brunt of responsibility for dealing with a crisis that festered before she was in charge without irreversibly sullying the rest of her tenure? Can a company with a poor track record in corporate integrity ever do enough with new transparency measures to acquire a good reputation? READ MORE ONLINE >

Eight CEOs with Staying Power The average tenure for a CEO in the U.S. is just over eight years, which makes the enduring careers of corporate chiefs, such as Reed Hastings, Rupert Murdoch and Larry Ellison all the more impressive. The chances of a company’s surviving 50 years are dauntingly slim. In fact, data from the U.S. Department of Labor shows that of all private-sector businesses started in 1994, only 24.6 percent were still in business 16 years later in 2010. In a report by MSN Money, Bruce Kennedy identified eight long-serving leaders. READ MORE ONLINE >

Six Steps To Ensure Nadella’s Success at Microsoft

www.chiefexecutive.net/ceobriefing

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With the appointment of Microsoft CEO Satya Nadella come expectations for him to make some quick changes, but is this wise? Rapid changes by a new boss almost always produce an unwanted backlash. A recent case is the relatively new boss at Yahoo!, Marissa Mayer, who ended her company’s work-fromhome policy and caused mostly unwanted international attention to herself and Yahoo!. In fact, the six steps offered here could help guide any freshly minted CEO. READ MORE ONLINE >

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Finding The Needle in the Haystack is Just The First Step The Mid-Market Talent Experts Executive Recruiting

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EDITORS NOTE

Editor in Chief J.P. Donlon Editor at Large Jennifer Pellet Art Director Raymond Palmer Production Director Rose Sullivan Chief Copyeditor Rebecca M. Cooper

States that Get It Right In a nonbinding referendum, Venice recently voted to secede from Italy. An 89 percent majority were in favor, a clear vote of “no confidence in Rome.” The separatist Parti Québécois (PQ) is expected shortly to take control of the provincial Québec legislature. The PQ’s mission, expressed sotto voce to be sure, is to establish Québec as a sovereign nation. In a 1995 referendum, they came within a hair of doing just that. This September, Scotland will vote on whether to disunite from the United Kingdom, leaving half of those in England and Wales in dismay and the other half muttering good riddance under their breath. Then, there is Catalonia, which proposes a November 9 vote to separate from Spain. Madrid considers this action illegal and has promised to quash the voting process. Yet, the proposal is an indicator of public disaffection with Madrid. In the U.S., 11 Colorado counties recently, narrowly voted down seceding to form a new state (a process requiring more Constitutional steps than were in evidence).The Washington Times reported a comparable movement to break the governance of New York State into two autonomous regions—one western and another northern. It will surprise no one that secessionist movements in California pre-date the Civil War. Not only do folks from northern and southern parts of the state irritate one another, but the Central Valley has always claimed it wishes to be part of neither. Most recently, in 2011, a Republican official in rural Riverside County called for 13 Southern California counties to band together to form “South California.” Notably absent from that group: Los Angeles. A Second Vermont Republic is the brainchild of former Duke University economics professor Thomas Naylor, author of several books on secession. Naylor advocates Vermont’s secession to escape the big government and multinational corporations that he says dominate the U.S. Second Vermont Republic even fielded a slate of candidates for statewide office in 2010, although they registered in the low single digits on Election Day. Notice I haven’t even mentioned Texas. What is going on here? While the nation-state is far from dead, more and more regions are feeling encumbered—if not suffocated—by centralized control. A large body of empirical research has examined the relationship between the size of government and economic outcomes; and based on that research, the U.S. has much room to scale back. “We are losing and may have lost, in many respects, the rule of law,” said Allen Meltzer, professor of political economy at Carnegie Mellon. “We are getting the rule of regulators. The rule of regulators is a rule which encourages corruption, crony capitalism and circumvention.” This negative effect is, in fact, what many individual states have been pushing against in order to boost their attractiveness as places to live and do business. Notice the strong five-year showings in our annual Best and Worst States Survey of states like Indiana, Wisconsin and Louisiana, not to mention Florida and Texas. In each case, they are expanding economic freedom as Washington seeks to go in the opposite direction. In addition, and close to home, Canada’s recent experience with government retrenchment is an example of a country shrinking government without a trade-off in economic and social consequences. The idea that smaller government can achieve better outcomes for the American people is being played out in America on a state-by-state stage every year.

Associate Copyeditor Carl Levi Contributing Editors Russ Banham Dale Buss William J. Holstein George Nicholas C.J. Prince Joe Queenan Online Editor Lynn Russo Whylly Associate Publisher Christopher J. Chalk 847/730-3662 cchalk@chiefexecutive.net

Director, Business Development Lisa Cooper 203/889-4983 lcooper@chiefexecutive.net

Director, Business Development Liz Irving 203/889-4976 lirving@chiefexecutive.net

Director, Business Development Sean Pesce 203/930-2708 spesce@chiefexecutive.net

Director, Business Development Dave Wallace 203/930-2705 dwallace@chiefexecutive.net

Marketing Director Michael Sherman 203/889-4978 msherman@chiefexecutive.net

Wayne Cooper Chairman & President

Marshall Cooper Chief Executive

One Sound Shore Drive, Suite 100 Greenwich, CT 06830, 203/930-2700

06 / CHIEFEXECUTIVE.NET / MAY/JUNE 2014

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CEO WATCH | CASE STUDY

Pulte’s Richard Dugas Builds a Better Mousetrap THE CHALLENGE You took the CEO spot at one of the nation’s largest building companies in 2003. In the runaway real estate market that follows, everything you do turns to gold. Then, the housing bubble pops and it all goes pear-shaped. Between 2008 and 2010, the company’s home-building revenue tumbles 60 percent and you find yourself laying off a whopping 80 percent of your employees. Perhaps worse yet, you’re holding a great deal of land now valued at far less than you paid for it and likely to stay that way for a decade or more. THE CONTEXT Atlanta-based Pulte Group builds a variety of home designs, from single-family homes to condos and townhouses, typically buying and developing large parcels of land, then marketing the new construction to home buyers. Like many building companies, historically, the company thrived by relying heavily on appreciating real estate values for its profits. “For a long, long time our focus had been about growth, growth, growth,” explains Richard Dugas, Jr., CEO of Pulte Group, recounting the humbling revelation he experienced in the wake of the downturn. “I remember pounding the table with investors saying land is the asset. The truth is land is an asset—but it’s also a liability if you have too much of it or it’s in the wrong location.” That epiphany prompted a re-evaluation of the business model. Dugas tapped an internal employee to take a hard look at the business. The result was a strategy shift for the future: Pulte Group would look to profit from what it actually does— building and selling homes. THE HURDLE To his consternation, Dugas soon discovered that Pulte, like many building companies, was actually not all that efficient at building. “We were leaving tens of thousands of dollars on the table per home in terms of inefficient construction, undisciplined pricing practices and simply not operating the day-to-day business as well as we could,” he recounts. For example, on a metric dubbed “throughput per floor plan”—or

the number of times a year any given floor plan was actually built and closed upon—Pulte averaged around three compared with a competitor’s range of 70-75. Dugas soon discovered the reason came down to simple math: Pulte offered thousands of floor plans but was only closing on 15,000 to 16,000 homes a year. To realize the efficiencies and benefits of scale, that would have to change. THE RESOLUTION “Having every location design their own floor plans was not a very efficient way to run a company making $5 billion worth of housing a year,” notes Dugas. Instead, Pulte began leveraging customer feedback on things like the need for more storage or “drop zone” entryways with a place to deposit boots, coats and bags. They needed to develop suites of floor plans suitable for specific areas of the country. Next, the company huddled with subcontractors to find ways to build those homes more efficiently. The result? In the regions where it practices this “commonly managed homes” approach, profitability per floor plan is significantly greater. THE ENDGAME Three years in, the strategy has made a big impact. “Over 24 months, we have taken our balance sheet down from a debt-to-capital ratio in the mid-to-high 50 percent—one of the highest in our industry—to 31 percent,” reports Dugas. “We paid down well over $1 billion of debt and reintroduced a dividend to our shareholders, one higher than we’ve ever paid before. Our profitability has mushroomed.” Perhaps most encouraging of all, the strategy is still playing out. As of last quarter, only 16 percent of Pulte’s homes were commonly managed, which means the company has a lot of runway before it maxes out in the 60-70 percent commonly managed. “I don’t think we have any idea yet how good we can become because we have not—not only as a company, but as an industry—ever operated this way,” says Dugas. “We don’t believe we’ll ever get to 100 percent commonly managed, but there’s an awful lot of efficiency and profitability to be gained just by migrating from 16 percent up to 70 or 80 percent.”

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THE LESSONS The biggest lesson Dugas drew from negotiating the company’s post-housing dip was one of humility. “If I had relied more on facts and data and less on my own opinions, we probably would not have bought as much land,” he says. “Frankly, I needed to be more humble. As a young CEO, I didn’t know what I didn’t know and the harsh lessons of a downturn taught me a lot. I wish I’d had that perspective 10 years ago.” —Jennifer Pellet

WHO: Richard Dugas, Jr., CEO of Pulte Group SIZE: $5.4 billion BUSINESS MOTTO: “We’re better together than apart” LEISURE INTEREST: Archery, bow hunting FAVORITE FICTION: Daniel Silva

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CEO WATCH | CEO PROFILE

Royal Caribbean: On Deck with Adam Goldstein Cruises—people either love them or they’ve never been on one. That, in a nutshell, captures the biggest challenge facing today’s cruise lines, says Adam Goldstein, who recently sailed into the president and COO role at Royal Caribbean Cruises, Ltd., from his former post as CEO of the company’s flagship brand, Royal Caribbean International. “As a former colleague of mine used to say, ‘We’re not in the kind of business where you can hand out samples on the street corner,’” he notes. “Almost everyone in America has friends or family who are fanatical about cruising and yet, for whatever reason, they don’t sign up.” Some non-cruisers fear seasickness; others shun the concept of being “stuck” on a boat teeming with partying twenty-somethings or swarming with tour-guidebook-toting geriatric folks. Many are mired in misperceptions born of the “Love Boat” era of cruise vacations, when passengers lounged on deck chairs by day and gorged themselves at all-you-can-eat buffets by night. Plus, recent events, including the grounding of Carnival’s Costa Concordia, a fire aboard Royal Caribbean’s Grandeur of the Seas and viral outbreaks aboard several ships, haven’t exactly helped convince ground-bound travelers to trade their spacious resort suites for staterooms on the Lido deck. “The issues of recent years have probably accentuated what was already our biggest challenge and will continue to be our biggest challenge for the foreseeable future,” concedes Goldstein, who is quick to note that the industry as a whole has banded together to address the reputational challenges passenger safety crises pose. Chief among those efforts was the rollup of some 10 regional industry associations into the Cruise Lines International Association (CLIA). CLIA members have since committed to a slew of safety-related policies, as well as the Cruise Industry Passenger Bill of Rights, which details specific measures members will take to ensure passenger health, safety and comfort. “CLIA has

become a truly global spokesperson for the industry, which has been very beneficial, particularly in advancing new policies that take an already enviable safety record the industry has had over the last 50 years and moved it even more forward,” says Goldstein, a cruise line veteran who joined Royal Caribbean in 1988. “There is no such thing as perfect safety; there is perfect dedication to safety, and we must remain committed to that. Over time, that [goal] will enable us to minimize the number of adverse incidents; and, when they do occur, make the handling of the event—and therefore coverage of the event—as benign as possible.”

‘We’re not in the kind of business where you can hand out samples on the street corner. Almost everyone in America has friends or family who are fanatical about cruising and yet, for whatever reason, they don’t sign up.” EXTREME CRUISING? As the industry’s second-largest cruise line, Royal Caribbean has also worked diligently to lure non-cruisers into the fold by adding activities that most wouldn’t associate with the quintessential cruise experience. The company’s newer, larger ships— its Oasis-class ships can carry 5,400 passengers—already offer a wide array of “experience” offerings, from surfing wave pools and rock-climbing walls to zip lines and bumper cars, and more fantastical features are on the way. “On Quantum of the Seas, which we’re bringing into service this year, you’ll be able to climb into a jewel-like capsule on a mechanical arm that extends 100 feet above the top deck—

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CEO WATCH | CEO PROFILE

where you’re already 200 feet above water,” says Goldstein. “So you’ll have a bird’s eye view as you’re swung around a full football field’s length above the water. That’s certainly never been attempted before.” Both Quantum and Anthem of the Seas will also feature a wind chamber where passengers can experience the sensation of skydiving above the ocean. “We do these things because guests love them and because having them tells people that the cruising experience is more active than you might have thought; it’s not just about eating in the dining room.” In fact, Quantum will forego the traditional two-seatingsat-6-and-8 in the main dining room entirely, instead featuring “Dynamic Dining,” or five themed dining rooms serving various cuisines. A new app will help its tech-savvy passenger population navigate their culinary options, letting them view real-time availability and make reservations that work with their other evening entertainment plans. “As people’s palates have become more sophisticated in terms of exposure to ethnic cuisines, we’ve branched into specialty restaurants to the point where on some of our ships there are more places to eat than there are nights of the cruise,” notes Goldstein. CRUNCHING COSTS Cost controls have also increasingly been a focus for Goldstein. As with many fuel-consumption-intensive businesses, energy efficiency has been a challenge for Royal Caribbean, which spends approximately 8 percent of its total revenue on fuel compared to 3-4 percent in 2003—despite the fact that the company’s ships are 20 percent more fuel-efficient. “If you had asked us whether we were dedicated to reducing fuel expenditures back in 2003, we would have said, ‘Absolutely!’ and pointed to several things we were doing,” says Goldstein. “Looking back, it feels like we were kindergartners then, and that we’re at least in college, if not grad school, now.” Part of the challenge is fleet-related. Fuel efficiency factors heavily into every facet of new cruise ships coming on line, from the shape of the hull and the heating and air conditioning systems to the software that guides the navigation. Retrofitting energy efficiency into existing ships—each of which typically represents a $1 billion-plus investment—is more challenging and will only become more so as new restrictions and regulations come into play. “[Mandates] on reducing sulfur emissions, in particular, have put the industry in a position where over

WHO: Adam Goldstein, CEO, Royal Caribbean Cruises SIZE: $7.96 billion LEISURE PASTIME: Shooting SERVES ON: Energy Security Leadership Council DOWNTIME PURSUIT: Running BUSINESS MOTTO: “A marathon without a finish line”

the next seven years we could be forced to spend considerably more on fuel than we have in the past,” says Goldstein, who reports that Royal Caribbean is exploring ways to scrub sulfur out of a ship’s exhaust. “If that doesn’t work, we’ll need to buy more expensive fuel types.” LESSONS FOR LEADERS With Goldstein now stepping into a strategic role at parent company Royal Caribbean Cruises, Chief Executive asked him to reflect on his 12 years as CEO of the nation’s second-largest cruise line to offer newly minted CEOs tips on coping with company and industry crises: Build a customer-centric culture. “You need to have this in place before a crisis develops, because when you’re managing a situation there is very little time and often incomplete information. If you haven’t made putting the customer at the center of the situation a natural tendency, it’s not something you will be able to institute on the fly.” Define situations that could occur and drill for them. “Every industry is different. Think about the situations you’re likely to face and practice how you would handle them on a regular basis. It may mean doing safety drills with your team or staging a mock press conference to practice handling questions.” Figure out how you can communicate proactively. “We decided to put out the photo of the blackened hull of Grandeur of the Seas that got the most coverage ourselves. It wasn’t a nice picture, but we decided it was better to put it out and try to control the flow of information—and that turned out to be for the best. Media coverage of different situations varies, but with social media and a 24/7 news environment, you need to be prepared to be visible. The more significant the situation, the more visible you need to be.” —Jennifer Pellet

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CEO WATCH | POINT OF VIEW

Patents’ Prince Charming There are 2.2 million U.S. patents in force and less than 10 percent of them are generating any licensing revenue. Jay Walker thinks his latest venture will awaken our economy’s “Sleeping Beauty” patents, which can be leveraged as springboards to innovation, business expansion and greater economic competitiveness. by J.P. Donlon Serial entrepreneur Jay Walker has founded a number of successful startup companies; the best known is Priceline.com, which brought a new level of value to the travel industry. Today, Priceline is a highly profitable, billion-dollar company with tens of millions of active customers. He also co-founded Synapse, a company that used the credit-card-processing network to revolutionize the magazine subscription business. Walker served as its marketing leader and created a customer database of 25 million active buyers. For his work, he won the Direct Marketer of the Year award in 1999. Synapse is now a unit of Time Warner. Walker is now chairman of Walker Digital, a privately held R&D lab founded in 1994 and based in Stamford, Connecticut. Walker Digital has invented hundreds of solutions for a wide variety of business problems. Since its founding, the company has funded an R&D budget well in excess of $100 million, specializing in creating innovative applications that work with large-scale networks, such as cell phones and the Internet. As an inventor, Walker is named on more than 719 issued and pending U.S. and international patents, making him one of the most prolific individual, living inventors. The company often partners with Fortune 500 firms to license its innovations or bring its inventions to market. Patent Properties, his latest venture, is a startup intending to create a voluntary, market-based alternative to the court system for the mass market of patent owners and users at disruptively low prices. By bundling related patents into discreet packages, the organization plans to create a marketplace and secure affordable licenses. Patent Properties says it creates a no-fault licensing system that will help inventors and businesses to stay clear of the courts, allowing companies to have access to desired patents they would never get without a no-fault system. Walker compares his no-fault system to the music industry, which faced many of the same intellectual-property problems 100 years ago with the advent of recorded music. At the time, individual owners of copyrighted music didn’t have the resources to monitor the marketplace and secure fair royalties for the use and performance of their protected music. Back then, big stars got paid, but most everyone else was left out. The no-fault system was inspired by the lessons from other industries that changed their procedures to stay voluntarily out of court, namely auto insurance and divorces. Walker says he made a point of learning from the insurance industry’s reliance on probability rather than certainty. Just as infringement is not clear when it comes to patents, almost nothing is clear about the future of an individual policyholder. He thinks a no-fault license can “unfreeze” 80 percent or more of the 2 million frozen patents in the U.S.

He sees the modernism in classic Clayton Christiansen terms of disruptive innovation... It not only circumvents the lawyers that grow rich off the current system, it mitigates the “litigation lottery” where one can either win a jackpot or—more likely—go broke in a patent lawsuit. Then, there is the fact that trying to negotiate a patent license in good faith can get you sued, or worse. It can get your patent invalidated—leaving you far worse off. In Walker’s scheme, operating companies get licenses they need at low prices—a warranty against lawsuit costs. Also, patent owners, particularly universities, which generate about 60 percent of patents in the U.S., get revenues they never had before. After teeing up a number of clients, he plans to launch Patent Properties officially later this year. An avid collector, Walker had architect Mark Finlay design a 3,600-square-foot wing in his Ridgefield, Connecticut, home for “The Library of the Human Imagination,” which was constructed in 2002 to house and showcase a collection of 30,000 books and artifacts that Walker had been assembling for 20 years. Items on display at the Library include an original 1957 Russian Sputnik, the world’s first space satellite; a page from an original Gutenberg Bible; and a White House cocktail napkin, circa March, 1942—upon which President Franklin D. Roosevelt, in his own handwriting, briefly outlined his three-point strategy for winning World War II. The president jotted down his thoughts on the napkin during a Rose Garden meeting with U.S. Army Air Corps General Hap Arnold, who took the napkin back to the Pentagon where it remained classified for many years. What problem was Patent Properties created to solve? There is a large problem in American business today, specifically in global [commerce]. The vast majority of inventions that are covered by intellectual property, specifically patents, generate little or no licensing revenue because the system for which licensing is conducted is completely broken. As a result, people have been investing in innovation and in new products, services and systems; but when they get patents on those things, they’ve been unable to license the patents. You can’t license these patents [because] the only mechanism for the licensing of a patent in America is a lawsuit. There is no voluntary licensing anymore in the U.S. All of it is tied to a lawsuit. The U.S. Patent office grants you a patent; but when it comes time to turn that patent into money, there are really only a couple of ways to do this. I can sell it to you like a piece of property and

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Chief Executive of the Year 2014 Selection Committee

David Cote Chairman and Chief Executive, Honeywell 2013 Chief Executive of the Year Dan Glaser President and Chief Executive, Marsh & McLennan Fred Hassan Chairman, Bausch & Lomb Senior Partner, Warburg Pincus Christine Jacobs Former Chief Executive, Theragenics Director, McKesson Tamara Lundgren President and Chief Executive, Schnitzer Steel Industries Robert Nardelli Chief Executive, XLR-8 William R. Nuti Chairman and Chief Executive, NCR Thomas J. Quinlan III President and Chief Executive, RR Donnelley Jeffrey Sonnenfeld President and Chief Executive, The Chief Executive Leadership Institute, Yale School of Management

you can pay me for it. That’s income. I can trade it. I’ll give you my patent; you give me yours. It’s a kind of income, or I can license it and say, “Look, why don’t you pay me a royalty of X dollars per product per year or X dollars per total per year?” You’ll use my intellectual property and you’ll license it like rental of an apartment. That system of licensing, which was a voluntary, commercial system—where one party owned an invention and licensed it to other parties who made, manufactured and distributed an invention—is completely frozen in ice. So, in American business, without a lawsuit, there is no licensing income for the vast majority of the patents. There are a little over 2.2 million active, U.S. patents and essentially, to a first-order approximation, few of them are generating any revenue. What about businesses that are based on one or more patented items? If you are the inventor and the manufacturer, then you’re generating revenue from the sale of your invention, but you’re not generating any money from the patent. You didn’t have to go get a patent to do that. It doesn’t protect anything. A patent is just the right to sue. A patent doesn’t give you any protection in America. Let’s say you spent half a million dollars inventing something; and then, you turn to your lawyers and say, “I want to you to get me a patent on this.” The lawyer says, “Okay. That’s going to cost you $20,000.” You say, “Okay. Spend that $20,000.” All you end up with from the U.S. government is a right to sue somebody else. Well, congratulations. If you have no licensing, then you undermine the entire reason for a vast majority of R&D in terms of capacity to create income. This [situation] results in forcing companies [to be] content using their own patents. But guess what happens to the American economy if you have inventions and the R&D spending is only for the companies that are using it themselves and they can never license? Half the drugs in America are licensed. They weren’t invented by the company that markets and sells

Mark Weinberger Chairman and Chief Executive, EY Maggie Wilderotter Chairman and Chief Executive, Frontier Communications Solutions

C ONTACT US Corporate Office Chief Executive Group, LLC One Sound Shore Drive, Suite 100 Greenwich, CT 06830 Phone: 203.930.2701 | Fax: 203.930.2700 www.chiefexecutive.net Letters to the Editor letters@chiefexecutive.net Advertising, Custom Publishing, Events, Roundtables & Conferences Phone: 847.730.3662 | Fax: 847.730.3666 advertising@chiefexecutive.net Reprints Phone: 203.930.2701 circulation@chiefexecutive.net Back Issues Back issues are $33 each. For back issue availability and additional order information, please contact us at: Phone: 203.930.2701 circulation@chiefexecutive.net Subscription Customer Service Chief Executive, P.O. Box 15306 North Hollywood, CA 91615-5306 Phone: 818.286.3119 | Fax: 800.869.0040 cexcs@magserv.com www.chiefexecutive.net

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CEO WATCH | POINT OF VIEW

them. When you buy a car or a computer, it’s filled with licensed inventions from other parties. These marketplaces used to work before the legal disaster we have today of a frozen court system and an endless set of arguments. Having a patent is really just an argument waiting to happen. What is your solution? Our company has been created to take the lawyers and the courts out of the system of licensing, not out of the system of creating patents, not out of the system of enforcing patents. Those things have to be done in the courts and the patent office. The patent office needs improvements. [There is] no question about that and there’s no question that our commercial, legal system is dysfunctional. Those things need fixing, but that’s not our business. Our business is unfreezing valuable assets that were frozen in the two million patents or more that are [locked] in the ice—generating no licensing revenue. There are hundreds of billions, and in some cases, more than a trillion dollars [that have] been spent in real R&D; and yet, the universities and government agencies that hold these patents and the small inventors and foreign companies that hold these patents get paid nothing. That’s crazy. How does your operation solve this deadlock? We address the licensing question by creating a new kind of license—a voluntary license that is good for both the inventor and the user. The way you do that is you take the biggest cost and uncertainty out of the system. The costs are the lawyers and the uncertainty is the courts. The concept is not unlike how no-fault has actually worked in traffic accidents and in divorces. It was clear in the divorce “industry” that having a lawsuit to dissolve a marriage enriched

lawyers, but [it] didn’t enrich anybody else. We’ve come up with a product called a no-fault package license. Instead of arguing about whether or not a given patent is infringing, we will bundle a bunch of patents that are statistically relevant but without taking ownership of them. We will find patent owners who want to collect some money and are willing to allow us, on a non-exclusive basis, to license their patents as part of bundles, for which they will get some money. It may be a relatively small amount of money from each licensee, but it will be substantially more than they would have gotten [without taking this approach]. We will distribute it to the patent owners. We will not take ownership of them. We will be a non-exclusive agent. It’s a way of creating a platform for which patent owners can list their patents with us; and patent users, for a very low fee per year, can license whole blocks of patents together. We will take that money and distribute it to patent owners, minus a piece for us. What’s the incentive for a user to draw from this bundle and pay the fee as opposed to using it anyway saying, “Sue me?” The user, the general counsel of this company, is in a position to say, “You know what? If I could get a license to use 250 patents for $1,000, that’s 250 people, one of whom might sue me.” Any one of those lawsuits is equal to 50 times what I’m spending here. Not only that, I also have a legal cost when other people outside might sue me and I want to demonstrate that I already license patents. So, this is a good tool to demonstrate that I do license patents—not for millions of dollars but for a small [and] reasonable amount of money. So, it gives one a good defense in court if one is sued for other things. Plus, in those 250 patents are probably ways to improve your products and services. For $1,000 a month, you suddenly, at least

16 / CHIEFEXECUTIVE.NET / MAY/JUNE 2014

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for the ones you’ve licensed in the package, go, “Wow! Let’s take a look at this stuff. There might be some good stuff in here that improves our competitiveness, reduces our costs or makes us more effective.” So, you’re opening up the world of opportunities of prior research that can come to help your products and services. For what? A thousand bucks a month? You can’t even call your lawyers for that amount. By pricing it disruptively low, you’re generating fair money because, in the aggregate, there’s fair money for the patent owners, who are getting nothing now. At the same time, you’re not pricing it so high that the person who is currently paying nothing now doesn’t realize, “Wait a second. I’m better off paying a little and getting real coverage than paying nothing and waiting for the inevitable lawsuit, the inevitable problems that follow.” [Paying something] reduces risk for a manufacturer or a seller. Also, it demonstrates that one is not a bad actor. What do you do when a disaffected actor claims his patent is worth more than what your bundling algorithm suggests? Here’s how that will work: Our inventors give us a non-exclusive license to try to generate revenue for them. We then go to a company and say, “Company, here’s the price we’re quoting you for the whole package.” We then go back to our inventors and say, “Here’s how much money you’re going to receive out of that total. If you want, you can drop out right now and get nothing. You can sue them yourself.” So, you’re never compelled to enter into a license [agreement] at a price you don’t want.

THORN & ROSES

You have an invention, a new system to monetize and create value for patent owners and patent users, so what stops somebody from ripping off your system? The short answer is maybe nothing other than the quality of our execution. I mean, you and I can form a competitor to Walmart tomorrow. Right? Walmart has very few patents that protect Walmart as a business. They simply out-execute their competitors. So, we would seek to out-execute our competitors, too. There’s a first-mover advantage in this kind of system. We learn faster. We’ll invest millions of dollars and take a risk, whether or not our computer’s algorithms are going to be good enough. But the second mover will have the easy advantage of copying us and that’s not abnormal in American business. On the other hand, if indeed we can get the elements within our system that are patentable—we know a little bit more than most people [about] how to get patents—and we would be more likely to take you to court for copying us, since we have taken more than 100 big companies to court who have copied some of my inventions. So, we’re an exception, ironically, to the rule. We can play the sport of kings because we have enough money to play the sport of kings. If you, on the other hand, invent something and somebody copies you, you’re unlikely to have the resources to play the sport of kings. That doesn’t mean they won’t compete with us. They’ll compete with us by designing solutions to the problem that we have designed a solution to that don’t infringe on our solution.

THORN ANDREW ROBERTS

Why put the open Internet at risk by ceding control over ICANN (Internet Corporation for Assigned Names and Numbers)? The U.S. role in protecting the open Internet is similar to its role in enforcing freedom of the seas. Relinquishing U.S. control paves the way for authoritarian regimes from Russia and China to ban access to inconvenient groups, not to mention muddling cross-border commerce. Internet guru Esther Dyson, the founding chairman of ICANN, has objected saying, “I’d rather pay a spurious tax to people who want my money than see [ICANN] controlled by entities who want my silence.”

ROSE More than a dozen news organizations want to see the emails of global warm-monger Michael Mann to see what the creator of the hockey stick graph has been saying in private. This is a noteworthy turn of events, reports Investor’s Business Daily, as “Mann is the Penn State climate scientist who, in the late 1990s, came up with the hockey stick-shaped graph that supposedly shows global temperatures rising sharply in recent decades. It’s been taken by many alarmists as incontrovertible, even holy, proof that humans cause global warming. “It’s rather remarkable, then, that so many news outlets want to see Mann’s emails,” notes IBD. “But what else could they do, given that temperatures in the last 17 years have been cooler than models predicted, while the weather and the climate have remained within the historic variability. It’s only natural for some skepticism to develop.”

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CHIEF CONCERN

The CEO as Growth Leader

Changeable times call for leaders who are also able to change. By Dr. Thomas J. Saporito “Growth is never by mere chance; it is the result of forces working together,” James Cash Penney, the American entrepreneur who founded JCPenney, once said. Evidence is mounting that the economy is moving towards a growth phase. The annual CEO survey presented by PwC at the Davos World Economic Forum stated that 39 percent of CEOs were “very confident about their companies’ growth prospects.” At the same time, in a recent poll by a financial service trade association, 59 percent of venture capitalists predicted an increase in U.S. venture capital investment dollars for 2014. Although still wary of the global economy and the effect government policies will have on profit margins, CEOs are clearly feeling confident enough to begin shifting their focuses from pure survival mode to looking for growth opportunities. Not surprisingly, the Davos study also revealed that talent management is high on the list of CEO concerns. Business leaders realize the extremely lean organizations of today are not conducive to accelerated growth. Half the CEOs surveyed want to hire more people in the current year, but two-thirds of them are worried about finding the right people. At best, CEOs have a limited line of sight into the future. To align their leadership talent with the unknown organizational needs of a growing enterprise, they should address three vital elements of success.

ENCOURAGE AGILITY Changeable times call for leaders who are also able to change. Assessment for intellectual agility should be a part of every company’s executive-development program. Rather than just looking for high IQs or demonstrations of pure mental horsepower, CEOs should select individuals who can bring an open-minded approach to problem solving and grasp the complexities of unfamiliar, ambiguous situations with a speed that truly sets them apart from their peers. On the top end of the spectrum are the executives who consistently demonstrate a high level of openness to data, feedback, ideas and learning. Developing a culture of agility is vital to an organization’s success. A 2009 study by MIT showed that agile organizations grow revenue 37 percent faster and are 30 percent more profitable.

IDENTIFY CHANGE AGENTS Jack Welch once said, “Change in the marketplace isn’t something to fear; it’s an opportunity to shuffle the deck.” In the beginning of any transformation phase, the entire organization must come to grips with adjusting to disruptions in the status quo. CEOs should make sure they select or promote agents of change to address growth issues, such as driving innovation and new-product development. The ability to initiate change, coupled with agility, allows organizations to correct their courses swiftly and keep on track, as growth complicates the communication flow. In the Davos study, 86 percent of CEOs surveyed recognized the need for change in areas including R&D and innovation capacity.

REMAIN RIVETED ON RETENTION A good selection process means little if the organization falls short on talent development and retention. According to PwC, a full 93 percent of CEOs polled recognize the need to change their strategies to attract and retain talent. Development programs accelerate the readiness of high-potential executives and prepare them to move more quickly through the pipeline. Besides the obvious need to develop internal candidates for the organization’s future needs, investment in the career growth of high-potential executives sends a signal that they are valued by the business and allows them to envision a future there. This is a particularly important method of protecting the organization’s talent assets, since executives advancing through the ranks are particularly attractive to outsiders.

THE FIRST STEPS Successfully managing the talent needs of an organization during a growth phase involves a variety of very complex issues. CEOs who rigorously seek out, develop and reward nimble thinkers and change agents while focusing on a retention process that encourages loyalty have taken the first important step towards leading their organizations into a period of growth that is both meaningful and sustainable.

18 / CHIEFEXECUTIVE.NET / MAY/JUNE 2014

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CEO CONFIDENCE

CEO Confidence Index Jumps 5.4% Highest in Three Years The CEO Confidence Index, Chief Executive’s monthly gauge of CEOs’ expectations for business conditions over the next 12 months, jumped more than 5 percent in March, landing at 6.2 out of a possible 10. This is the highest rating CEOs have given in the survey since April 2011. CEOs also rated current conditions more than 4 percent higher than in February. At 5.75 out of 10, this is the highest rating of current conditions since December. Despite the clear increase in optimism reflected in the Confidence Index ratings, comments received from the CEO respondents show a more cautious sentiment prevailing. “The feeling and talk about the economy is positive, but the ramification of the past few years keeps the enthusiasm in check,” said one CEO. “It will require quarter-over-quarter and year-over-year results before the conservative component becomes just a normal part of the deal and not a lingering thought.”

The expectations executives have for their own businesses have improved compared to last year, with more than 70 percent of CEOs now expecting their firm’s revenue to increase over the next 12 months. Last year at this time, only 66 percent of CEOs expected revenue growth. Despite this positive indicator, clearly some caution remains. Only 48 percent of CEOs expect an increase in capital expenditures over the coming year. This is a modest increase from the March 2013 survey, when 45 percent of CEOs had increased expectations for capex. Similarly, 46 percent of CEOs now expect an increase in their number of employees, which is a 5 percentage point increase from last year. A common sentiment from CEOs is regulatory uncertainty and dysfunction in Washington. “Until we can predict the costs of labor, capital expenditures, regulation and labor we cannot risk scarce cash reserves,” noted one business leader. “Does anyone trust laws, regulations, rules made in Washington?”

Revenue Growth Expectations Mar. 2013

9.5%

19.4%

66.3%

37.4%

Up over 20% Up 10 to 19.9%

Mar. 2014

9.7%

20.1%

71.2%

41.4%

Up less than 10%

Hiring Growth Expectations Mar. 2013

2.1%

5.9%

Up over 20%

41.2%

33.2%

Up 10 to 19.9%

Mar. 2014

3.6%

8.0%

46%

34.4%

Up less than 10%

Capital Expenditures Growth Expectations Mar. 2013

5.6%

10.8%

28.5%

44.9%

Up over 20% Up 10 to 19.9%

Mar. 2014

7.2%

9.0%

32%

48.2%

Up less than 10%

20 / CHIEFEXECUTIVE.NET / MAY/JUNE 2014

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Are you ready for proxy season? Read this first. By Ram Charan, Dennis Carey, and Michael Useem “Boards That Lead is a must for anyone who sits on a major corporate board—or wants to understand them.” – The Wall Street Journal, January 16, 2014

AVAILABLE GLOBALLY WHEREVER BOOKS AND EBOOKS ARE SOLD hbr.org/books

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2/7/14 1:01 PM

MID-MARKET REPORT

Healthcare a Top Focus

After years of absorbing double-digit price increases with declining benefits, mid-market companies now expect increased healthcare investments to yield positive returns on investment. A whopping 90 percent of mid-market executives name healthcare costs as their top challenge. Yet, despite concerns about the rising cost of providing care, most middle-market firms are committed to continuing to offer healthcare benefits, according to a new report. Eight out of ten mid-market executives reported viewing healthcare as a company’s responsibility to its employees, according to “The State of Healthcare in the U.S. Middle Market,” a report by the National Centre for the Middle Market at Ohio State University, which was based on a survey of 600 C-suite executives and HR or benefits decision makers at middle-market firms. The

majority also see healthcare as providing value to their firms and as a key driver of talent productivity and growth, with more than 90 percent recognizing healthcare as critical to attracting and retaining talent. In lieu of dropping coverage, middle-market firms are implementing other cost-management strategies, including wellness programs, on-site or remote healthcare access, sourcing lower-cost healthcare and analyzing healthcare data. “Mid-market companies expect that by implementing these programs they can increase growth and productivity by 25 percent, decrease absenteeism by 22 percent and reduce healthcare costs by 17 percent.

Why Offer Healthcare?

Healthcare Topped the List of Business Challenges

PERCENT AGREE

TOP IMPLEMENTED PROGRAMS

Middle Market Companies Expect High Returns on Investment with New Healthcare Programs Middle Market firms provide unique insight into the relative effectiveness of healthcare programs

62% 50% 49% 49%

WELLNESS PROGRAMS HEALTH CLINICS SOURCING LOWER COST HEALTHCARE ANALYSIS OF HEALTHCARE DATA

EXPECTED OUTCOMES

+25% +25% -22% -17%

GROWTH

PRODUCTIVITY

ABSENTEEISM

HEALTH COSTS

22 / CHIEFEXECUTIVE.NET / MAY/JUNE 2014

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IT TAKES EXPERTISE TO STAY AHEAD. To succeed today, you need industry expertise and transformative advice to drive your business forward. Find out what CohnReznick thinks at CohnReznick.com. Forward Thinking Creates Results.

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What makes Florida an economic super-state? We’ll give you 9 million reasons.

If you’re looking for one of the nation’s top talent pipelines, look no further than Florida. Our workforce of 9 million plus is educated, diverse and ambitious. Our nationally renowned universities are producing some of the brightest grads in the country — in the state famous for its sunshine. Companies can find the innovative talent they need to be competitive. And, yes, we even have rocket scientists. Consider Florida. The perfect climate for business.

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2014 BEST & WORST STATES FOR BUSINESS

States that reduce the burden of government and extend greater economic freedom tend to grow and expand more rapidly than those that do not. By J.P. Donlon

In the 10th annual survey of CEOs concerning their views at us. Business is comfortable that we’ll keep the tax base low of the best and worst states for business, over 500 CEOs and improve our workforce.” across the U.S. responded. Business leaders were asked to grade Tennessee edged out North Carolina to take third place states with which they were familiar on a variety of measures with North and South Carolina respectively capturing 4th that CEOs themselves have said are critical. These include the and 5th place. Indiana, Arizona and Nevada finished 6th tax and regulatory regime, the quality of the workforce and through 8th, respectively. Having jumped 31 positions from the quality of the living environment. For example, a state’s 40th in 2010 to No. 9 this year, Louisiana is the Cinderella state attitude toward business is viewed as a critical component of of Chief Executive’s ranking, proving that a concerted effort to its tax and regulatory regime, while employees’ attitude toward transform old habits and policies can truly pay off. Wisconsin management is considered a crucial factor in the perceived comes close with a meteoric thrust from 41st five years ago to quality of a region’s workforce. Public education and health 14th in 2014. Having survived a bitter recall last year, Wisconsin are also important factors in the living environment, as are Governor Scott Walker recently signed Senate Bill 1, legislation such things as cost of living and affordable housing. that provides $504 million in tax relief over the next two years Texas continues its 10-year historical position as the best to state taxpayers. The bill reduces income- and property-tax state overall; but Florida, which ranks No. 2, is edging up and rates, as well as eliminates income-tax rates for manufacturers, even overtaking Texas in its quality of living environment. making the Badger state even more competitive. Likewise, Ohio has seen dramatic improvement due, in part, “We’ve learned from Texas how to tell our story better and it helps that we’ve cut taxes 25 times—about $400 million,” to an energetic governor in former congressman John Kasich, Florida Governor Rick Scott told Chief Executive. Scott points who, like Walker, pushed a vigorous turnaround. During his to what he calls the Jim Collins “flywheel effect” where tenure, Ohio became the No. 5 job creator in the nation and No. momentum is generated as more big name companies invest 1 in the Midwest. Unemployment is now 6.5 percent, the lowest in his state. “When companies like Hertz, Amazon, Deutsche in Ohio since June of 2008. Likewise, Ohio has gone from an Bank and Verizon add jobs here, it causes more people to look $8 billion deficit to a $1.5 billion surplus over the same period. MAY/JUNE 2014

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2014 BEST/WORST STATES FOR BUSINESS 2014 RANK

BIGGEST GAINS FROM 2013 STATE

2013 RANK

CHANGE

2013 RANK

1-YEAR CHANGE

Texas

Florida

Tennessee

North Carolina

-1

South Carolina

Missouri

Indiana

-1

Iowa

Arizona

-1

Nevada

Louisiana

Georgia

Virginia

-4

North Dakota

Utah

-1

Wisconsin

South Dakota

Colorado

-3

Alabama

-1

Wyoming

Iowa

Oklahoma

-6

Nebraska

Missouri

Delaware

New Hampshire

Kentucky

Kansas

-7

Ohio

-5

Idaho

-7

Arkansas

-1

New Mexico

Montana

-7

Alaska

Washington

Minnesota

-4

West Virginia

-1

Maine

-1

Mississippi

Oregon

Vermont

Rhode Island

-3

Maryland

Pennsylvania

Hawaii

Connecticut

Michigan

-1

Massachusetts

New Jersey

-1

Nebraska

Delaware

Kentucky

California, New York and Illinois continue to rank among the worst three states in 2014, with virtually no change from previous years. California has gained breathing space since Governor Jerry Brown took office and is credited with a budget surplus. But despite the return of fiscal discipline, it has exchanged acute problems for merely chronic ones. It is a state that continues high personal income tax rates and regulates with a very heavy hand. Its top, marginal tax rate of 33 percent is the third-highest tax rate in the industrialized world, behind only Denmark and France. This situation creates a bias against savings, slows economic growth and harms competitiveness. The Economist reports that it takes two years to open a new restaurant in the Golden State compared to six to eight weeks in Texas. The task of unraveling the byzantine layers of regulations seems insurmountable. The jungle is too thick to be pruned. That’s why Carpinteria, California CKE Restaurants (owner of Carl’s Jr.), is committed to opening 300 restaurants in Texas, but has no plans for new restaurants in California. According to Dun & Bradstreet, 2,565 California businesses with three or more employees have relocated to other states between January 2007 and 2011, and 109,000 jobs left with those employers. As one CEO commented, “personal income tax rates and too much ‘big government’ regulation...public employee unions dominate California to its detriment.” The state is justly famed for its natural beauty, exceptional universities and high-tech clusters, but consider that one of its best-known tech firms, Palo Alto-based Tesla, is looking elsewhere to build its $5 billion “gigafactory” battery plant. California’s real estate is simply too expensive; and because its continued on page 33

BIGGEST LOSSES FROM 2013 2014 RANK

STATE

2013 RANK

CHANGE

Kansas

-7

Idaho

-7

Montana

-7

Illinois

Oklahoma

-6

New York

Ohio

-5

California

BOTTOM 5

TOP 10

2014 RANK

STATE

26 / CHIEFEXECUTIVE.NET / MAY/JUNE 2014

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Auto Manufacturing Redraws Its Map Every time a site consultant or state economic-development official turns around, some automaker or large supplier is expanding a plant, ordering tooling for a promising future model, domesticating production that occurred offshore or even plotting a whole new facility. It’s happening across America’s increasingly prosperous auto belt. In the first quarter alone, among other moves, Chrysler announced expansion of its Jeep plant in Toledo, Ohio. Ford said it would return output of medium-duty trucks from Mexico to Ohio. Volkswagen flirted with unionization of its Chattanooga, Tennessee, plant amid speculation that the company would double its footprint there via production of a new SUV. BMW revealed a major new investment at its Spartanburg, South Carolina, manufacturing complex. And, of course, Tesla dangled its multi-billion-dollar battery “gigafactory” in front of four Sun Belt states as potentially the biggest economic plum ever bestowed by a carmaker. Texas, Nevada, Arizona and New Mexico benefit just from being considered. Yet while American and foreign-based automakers are deciding in favor of more U.S. output than could have been imagined even a few years ago, opportunities remain limited for new states to get into the game. Because they have built advantages in transportation infrastructure, labor-force skills, utility rates and other important auto-manufacturing criteria over the course of decades, the Midwest and South are harvesting almost all of the stepped-up domestic output. “The states with the toughest business cases for making cars are all gone now,” note Sean McAlinden, executive vice president of research and chief economist for the Center for Automotive Research, based in Ann Arbor, Michigan. “New York, California, New Jersey—they all had the highest tax and health-insurance rates and were far from suppliers that have clustered in the Upper Midwest and South.” Now a few new states could make cases as virgin territory for auto production. Nebraska, for instance, has positioned itself for such a run with tax reform and workforce-education initiatives, argued Larry Gigerich, managing director of Ginovus, an Indianapolis-based site consultant. Pennsylvania

lurks on the fringes. Even Arizona and Nevada could join the auto belt someday because of favorable taxes and Sun Belt locations that are increasingly crucial markets for all auto companies. Landing the Tesla plant would make either an instant Tier 1 member of the car-state fraternity. If Texas gets the nod from Tesla, it could become an auto-making superpower, since General Motors and Toyota already have major operations there making their most profitable vehicles: pickup trucks. “No matter which state wins,” Gigerich says, “there also will be the opportunity to develop a research and technology park to leverage off Tesla’s impact, because of the sheer size of its facility.” But as a cautionary tale, states also must consider the case of Arkansas. Surrounded literally on every side and corner by a state that already was making cars, several years ago Arkansas “fell flat on its face in an attempt to launch an automotive platform because it just didn’t have the industrial labor force,” McAlinden says. Tennessee also provides reason to pause. The state granted Volkswagen $500 million in incentives to open its plant in 2008. But when VW cooperated with the United Auto Workers union in staging a unionization vote in the plant in February, some national and local politicians in the state threatened to close the spigot on any further financial breaks for Volkswagen if the union won. It didn’t. One trend is clear: Increasingly, the attractiveness of the Midwest and the South as auto-making regions is equalizing. Rising wage rates and even the threat of unionization of a Sun Belt plant make it more complicated for Japanese, Korean and German manufacturers to expand in those states. Meanwhile, favorable tax reforms and the spread of a right-to-work ethos in traditional car-manufacturing powerhouses Michigan, Indiana and Ohio impose dwindling penalties on the Detroit Three for sticking with the region they know best. “The only remaining big difference is that, for deal-closing tools, Southeastern states can bring more to the table than Midwestern states in terms of cash-equivalent incentives,” Gigerich says. “But we tell our clients not to make a decision on incentives. Everything else has to line up first.” —DB MAY/JUNE 2014

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RATINGS1

6 Indiana 19 26 25 9 36 41 46 45 34 37 22 31 21 8 24 47 30 49 4 12 27

Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio

20 Oklahoma 38 42 40 5 15 3 1 13 39 11 33 35 14 18

Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming

6.20 6.19 6.71 5.93 1.74 5.62 2.51 7.06 7.93 6.79 2.82 6.13 2.16

5.95 5.29 6.70 5.47 6.21 7.11 6.46 6.82 6.88 7.06 3.86 6.80 5.45

6.34 5.24 7.09 5.93 6.79 7.73 6.12 6.35 8.13 7.33 8.36 6.13 4.65

DIRECTION

LIVING ENVIRONMENT

Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois

WORKFORCE QUALITY

17 32 7 29 50 16 44 23 2 10 43 28 48

TAXATION AND REGULATION

RANK/STATE

DEVELOPMENT TREND INDICATOR

COMMENT

Flirts with minimum-wage increase while maintaining business tax-friendliness. Oil-tax reform helps competitiveness but minimum-wage hike is threatened. Despite coming new Apple factory, has trouble recovering from job losses. Reduces some business taxes and manages to climb in job-growth rankings. Shreds of hope in new laws in the margins, but just glad for Silicon Valley. Business-friendliness gets shaky as state deals with legal-marijuana fallout. Embrace of minimum-wage boost pushes business to lower rung in Dante’s inferno. Job growth booms; regulatory reform offsets modest minimum-wage increase. Machinery-tax exemption, housing boom rev up state’s job-growth engines. Legislature passes significant worker’s comp reform that cuts business costs. Workers’ paradise keeps losing ground on job growth and entrepreneurship. Exempts small business from some property taxes but jobs picture slides. Anti-growth hot mess can only coast on Chicago’s economic engine for so long.

7.57

7.74

7.10

Presses friendliness by trimming several taxes; right to work blossoms.

6.72 6.57 5.57 7.23 3.44 2.93 2.52 3.52 3.58 5.66 6.77 6.00 7.00 7.37 6.00 2.38 5.46 2.02 7.23 7.74 5.49

8.44 6.71 6.05 7.24 5.31 6.24 6.45 4.84 7.70 5.02 7.00 5.40 7.67 6.25 6.83 5.66 5.46 5.99 7.62 7.13 6.77

7.56 6.57 6.43 7.96 6.25 5.93 5.59 4.52 6.91 5.28 7.38 6.47 6.87 6.56 7.39 4.21 6.54 4.82 8.09 5.95 5.85

Enacts historic across-the-board property-tax cut though job growth lags. Historic tax cuts may help job growth that is wobbling in relative terms. Business interests on the defensive as job growth slides to bottom. Its high-tech side emerges by landing major IBM site for Baton Rouge. Fiscally tight Gov. LePage is battling tax-increase efforts by legislature. Push for minimum-wage boost and paid family leave unsettles businesses. At least state legislature is resisting Gov. Patrick push for highest minimum wage. With right to work, Gov. Snyder now goes after business personal-property taxes. Toxic environment grows with big boosts in taxes and minimum wage. Job growth rises and it exempts manufacturers from paying energy sales tax. Life-sciences victories help boost state to top half in job growth last year. Nibbled at tax rates last year but needs more reform to reignite growth. Sadly, Gov. Heineman punted on chance to eliminate personal income tax. Relative job growth slides as education-funding initiative threatens progress. Relies on lack of sales tax to keep burnishing its appeal to business. Gov. Christie has helped but legislature did end run for higher minimum wage. Enacts huge cut in corporate income-tax rate as attractiveness brightens. Startup NY makes media splash but favors only narrow niche of companies. Passes tax-reform package hailed as by some as any state’s best in two decades. Energy boom funds surprise $850-million property-tax reduction for residents. Movement on taxes is mixed by business size as right-to-work is tabled.

7.07

6.64

6.43

Trims some taxes but remains income-tax “sandwich” between neighbors.

3.70 3.61 2.33 7.37 8.58 7.81 8.45 7.71 2.69 6.71 5.08 4.63 5.86 8.45

6.19 5.63 5.00 7.22 7.58 7.23 8.02 7.94 5.13 8.21 6.73 4.50 7.43 6.82

6.96 5.38 4.50 8.16 7.08 7.89 7.73 8.09 6.31 8.02 6.95 4.13 6.82 7.05

Keeps loading on taxes and entitlements but job growth soars anyway. Natural gas fuels jobs boom while state keeps holding the line on taxes. High-tax, high-unemployment basket case now must bail out government pensioners. Manages to boost highway-infrastructure spending without penalizing business. Employment shows vigor as legislature enacts economic-development package. Rock-solid labor reputation takes a hit from VW dalliance with UAW. Job growth remains stellar though slips to No. 4 from No. 3 percentage-wise. Keeps knocking the lights out as it grows professional-services trade. State-led Obamacare revolution and now businesses are paying the price. Fades a bit in job growth and entrepreneurial fervor but keeps low taxes. Strong job growth defies nation’s highest minimum wage at $9.32 an hour. Cut in worker’s comp rates helps offset troubles besetting coal industry. Continues climb in tax-friendliness and now tackles regulatory reform. Libertarian streak keeps taxes sleek enough to rank No. 1 with Tax Foundation. Positive

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Negative

New

No No

Neutral

4/17/14 11:49 AM

Pe R Sou So

W W

STATE & LOCAL GOV’T EMPLOYEES PER 10,000 RESIDENTS

RATE (%)

COMPARED TO NAT’L AVG. (9.9%)

DOMESTIC NET MIGRATIONS IN 2013

STATE-LOCAL TAX BURDEN6

STATE DEBT PER RESIDENT 2013 ($)

STATE GOV’T5

RANK

Indiana

DOMESTIC MIGRATION4

COMPARISON W/ NAT’L RATE (6.70%)

1.2 1.1 2.6 1.3 3.5 2.1 -0.1 0.2 2.4 2.1 1.6 0.4 1.9

UNEMPLOYMENT3 UNEMPLOYMENT RATE DECEMBER 2013 %

Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois

6.1 6.4 7.6 7.4 8.3 6.2 7.4 6.2 6.2 7.4 4.5 5.7 8.6

-0.6 -0.3 0.9 0.7 1.6 -0.5 0.7 -0.5 -0.5 0.7 -2.2 -1.0 1.9

451 -4,006 26,417 -2,031 -49,259 36,284 -17,224 3,010 91,484 -6,347 -1,457 4,579 -67,313

21 35 6 29 48 4 43 18 2 36 27 16 49

1,967 9,294 2,080 1,169 3,915 3,111 8,500 6,932 2,381 1,301 5,839 2,399 5,569

615.3 766.0 473.1 585.3 504.6 541.9 537.4 598.8 489.5 545.7 559.8 538.6 503.1

8.2 7.0 8.4 10.0 11.2 9.1 12.3 9.2 9.3 9.0 10.1 9.4 10.2

-1.7 -2.9 -1.4 0.2 1.4 -0.8 2.4 -0.7 -0.6 -0.9 0.2 -0.5 0.3

6.9

0.2

-1,179

3,227

536.3

9.6

-0.3

4.2 4.9 8.0 5.7 6.2 6.1 7.0 8.4 4.6 8.0 5.9 5.2 3.6 8.8 5.1 7.3 6.4 7.1 6.9 2.6 7.2

-2.5 -1.8 1.3 -1.0 -0.5 -0.6 0.3 1.7 -2.1 1.3 -0.8 -1.5 -3.1 2.1 -1.6 0.6 -0.3 0.4 0.2 -4.1 0.5

671 -12,557 -2,290 -2,492 -1,423 -8,525 -2,833 -28,539 -1,147 -7,038 -7,612 5,467 -695 12,854 -2,355 -45,035 -10,526 -104,470 37,240 16,961 -23,094

20 42 30 32 26 40 33 45 24 37 38 14 23 10 31 47 41 50 3 8 44

2,657 2,648 3,520 4,345 4,363 4,543 11,790 3,097 2,712 2,453 3,609 4,521 1,306 1,434 6,743 7,659 3,525 7,366 2,005 3,213 2,873

611.2 676.7 582.7 605.1 580.7 535.2 517.5 491.0 541.8 647.7 557.3 585.2 642.0 431.9 550.0 593.0 680.4 634.5 599.7 649.5 534.6

9.6 9.7 9.4 7.8 10.3 10.2 10.4 9.8 10.8 8.7 9.0 8.6 9.7 8.2 8.1 12.4 8.4 12.8 9.9 8.9 9.7

-0.3 -0.2 -0.5 -2.1 0.4 0.3 0.6 0.0 0.9 -1.2 -0.9 -1.3 -0.2 -1.6 -1.8 2.6 -1.4 2.9 0.1 -1.0 -0.2

-0.4

5.4

-1.3

14,268

2,837

597.9

8.7

-1.1

1.4 -0.8 -1.1 0.2 -2.3 0.8 2.3 0.9 -1.3 -1.4 1.1 0.8 -1.0 -2.3

7.0 6.9 9.1 6.6 3.6 7.8 6.0 4.1 4.2 5.2 6.6 5.9 6.2 4.4

0.3 0.2 2.4 -0.1 -3.1 1.1 -0.7 -2.6 -2.5 -1.5 -0.1 -0.8 -0.5 -2.3

10,215 -30,718 -3,922 29,324 4,762 12,649 113,528 5,567 -653 3,099 17,027 -1,894 -8,158 2,616

12 46 34 5 15 11 1 13 22 17 7 28 39 19

3,913 3,667 8,471 3,271 4,551 911 1,344 2,939 5,787 3,417 4,213 4,375 4,292 1,958

509.2 478.4 510.8 577.2 545.7 527.8 563.9 494.9 641.0 574.0 527.3 558.5 503.0 918.3

10.0 10.2 10.9 8.4 7.6 7.7 7.9 9.3 10.1 9.3 9.3 9.7 11.1 7.8

0.1 0.4 1.0 -1.5 -2.3 -2.1 -1.9 -0.6 0.2 -0.6 -0.6 -0.1 1.2 -2.1

% GROWTH 2011-2012 VS. NAT’L AVG. (1.5%)

% GDP Growth 2011-2012

STATE GDP2

-1.3 -1.4 0.1 -1.2 1.0 -0.4 -2.6 -2.3 -0.1 -0.4 -0.9 -2.1 -0.6

3.3

0.8

2.4 1.4 1.4 1.5 0.5 2.4 2.2 2.2 3.5 2.4 2.0 2.1 1.5 1.5 0.5 1.3 0.2 1.3 2.7 13.4 2.2

-0.1 -1.1 -1.1 -1.0 -2.0 -0.1 -0.3 -0.3 1.0 -0.1 -0.5 -0.4 -1.0 -1.0 -2.0 -1.2 -2.3 -1.2 0.2 10.9 -0.3

Oklahoma

2.1

Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming

3.9 1.7 1.4 2.7 0.2 3.3 4.8 3.4 1.2 1.1 3.6 3.3 1.5 0.2

Sources: 1Chief Executive Magazine, 2Bureau of Economic Analysis, 3Bureau of Labor Statistics, 4NewGeography.com & U.S. Census Bureau,

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5,6

The Tax Foundation

4/17/14 11:49 AM

2014 BEST/WORST STATES FOR BUSINESS

States Leading the Crowdfunding Surge By Dale Buss

For more than two years, plans to build and open Tecumseh Brewing in Tecumseh, Michigan, were frozen by inadequate funding. Co-founders Kyle DeWitt and Tim Schmidt had raised about $150,000 from family and friends to start a microbrewery, but they couldn’t find a bank with the courage to lend them the matching amount they still needed. Then last winter, the Michigan legislature created an intrastate exemption for equity crowdfunding that allowed companies based in the state to sell shares and other forms of investment over the Internet to non-accredited investors. And practically overnight, DeWitt became convinced that Tecumseh Brewing would open after all. “Crowdfunding is everything for us right now,” says the 32-year-old DeWitt, an experienced microbrewer. A lot of his new investors also will rank among his best customers. “We’re the first company in Michigan to go through it; and now, we hope to be open by October.” Popular sites like Kickstarter created a cultural buzz around crowdfunding with successes, such as providing financing for the Veronica Mars movie. However, Kickstarter is donation-based and therefore not a potent enough fund-raising engine for most ambitious startups. It also doesn’t tap into states’ economicdevelopment powers or into local pride that can attract smalltime investors to companies they can see and visit. Enter state-sponsored equity crowdfunding initiatives. Georgia created the Invest Georgia Exemption program.

Kansas came up with one, too, and Wisconsin’s crowdfunding law took effect in the spring. Washington State, North Carolina, Indiana and Maine are now advancing efforts. The MILE (Michigan Invests Locally Exemption) program sailed through the state’s normally combative legislature in two months with only one nay vote. It allows a maximum of $2 million in crowdfunding, depending on the level of financial documentation of the issuer. Furthermore, companies can’t accept more than $10,000 from a single non-accredited investor. To get around objections that higher-level investors might have to dealing with equity positions held by dozens of individuals before they fund a company, MILE gives startups a choice of issuing equity- or of using debt-based and revenuesharing mechanisms to pay back investors. With funding caps and continued uncertainties about how the Securities and Exchange Commission ultimately will regard such programs, some doubt state equity-crowdfunding programs can actually generate much traction. But such concerns aren’t stopping Christopher Miller, director of economic development for Adrian, Michigan, from touting MILE to every expansion-minded, small-business owner he knows. “A lot of entrepreneurs were imagining what could happen if it [were] possible to access capital in their own communities that previously was unavailable,” Miller says. “Now, they’ll be able to find out.”

30 / CHIEFEXECUTIVE.NET / MAY/JUNE 2014

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Selected CEO Comments on States

5 Great States for Biotech Companies A decade ago, every state and metro area with an economic-development team was pitching itself as a potential locus for burgeoning biotechnologies. Even if they came late to the Internet revolution, they weren’t going to miss the boom in genomics and bioengineering. The target was spot on: The bioscience industry has become one of the most innovative and important economic drivers in the U.S., now accounting for more than 1.6 million jobs, nurturing a well-paid and highly skilled workforce and maintaining an American edge in a cluster of technologies that likely will be as important to this century as computerization was to the last. The sector also has managed to emerge newly vibrant from the Great Recession and has adjusted to dramatic dislocations in the traditional pharmaceutical industry. Fully 34 states gained bioscience-industry jobs during the last decade, meaning that the gains have been distributed widely. “We have people from the coasts who got burned out on the big-city mentality,” says Brian Williamson, president and CEO of JCB Laboratories, a Wichita, Kansas, startup that now employs about 30 people making sterile products and drugs for dialysis and other uses. “When people visit our facility, they see the Midwest work ethic, and they appreciate it.” Some states have been big winners. Here are snapshots of five of them:

decade ago created 25,000 of the jobs.

California:

Rapid growth from a small base is the hallmark of a bioscience sector in Utah that expanded by 26 percent since 2001 to more than 23,000 employees. Landmarks in 2013 included budding success in specialty pharma through companies, such as Navigen and Tolero, and the creation of the first industry association, BioUtah. —DB

It’s more than computer chips: The state boasts the largest state bioscience employment base with more than 228,000 jobs and nearly 7,500 establishments, maintaining research and lab-employment growth of 36 percent since 2001. A $3-billion stem-cell-funding measure launched a

Indiana: The Hoosier State is one of only two with a concentration in four of the industry’s five major sectors, employing 60,000 workers at more than 2,000 bioscience establishments. The plan now is to catch up with rival states in areas including capital formation, research commercialization and science, technology, engineering and math education.

Maryland: The state counts more than 33,000 bioscience jobs and more than 1,800 enterprises specializing in research and pharmaceuticals. In fact, Maryland’s drugs and pharma sector has grown by 37 percent since 2001. Industry interests got the state legislature last year to increase the annual R&D tax-credit cap to $8 million from $6 million, among other accomplishments.

North Carolina: The state maintains one of the most varied biotech sectors in the U.S. and employs more than 62,000 people at more than 2,500 locations. Creatively, the state used $60 million from tobacco-settlement trust funds to form a statewide training program for biomanufacturing workers, which provided North Carolina State University with the money to create a training center.

Utah:

MAY/JUNE 2014

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“Illinois’ worst-in-thecountry, unfunded pension issues; unfriendly business environment; high tax rates; union-controlled government; secondhighest real estate tax rate; last-place credit rating; and fiscal uncertainty have caused substantial harm to the residents, as well as the businesses in Illinois!” “Business [in Illinois] is viewed as the enemy in a state where the liberals and unions control.” “California and New York are absolutely terrible for taxation and regulation. If it [weren’t] for California’s environment and the millions born in New York, both states would see a mass exodus of small and medium business from the state. I continue to be amazed that New York can hold onto the financial community. Perhaps the new Mayor will change that.” “Expanding in California is subjecting yourself to future bribery approved by law.” “Gov. Walker has turned around Wisconsin’s tax and business climate—a significant improvement

CHIEFEXECUTIVE.NET

4/17/14 11:49 AM

2014 BEST/WORST STATES FOR BUSINESS

Selected CEO Comments on States over previous administrations.” “I have plants in Kentucky, Indiana and Ohio. Indiana is by far the best of the three for business climate. Ohio is gaining in recent years. But Kentucky remains mired in the past in terms of education and labor relations. And the state treasury’s own fiscal condition is ominous. At some point in the future, that will make things even worse for business in Kentucky.”

7 BEST STATES FOR STARTUPS

Even states with laws and government attitudes hostile to business can be great places to grow a company in spite of them. That’s the case with nearly half of our “7 Best States for Entrepreneurs.” Blending qualitative and quantitative criteria, Chief Executive selected Alaska, California, Colorado, Florida, Kansas, Massachusetts and Texas as the best places for new and fledgling companies. While Texas and Florida also rate as No. 1 and No. 2 in the magazine’s 2014 Best State/Worst State rankings, three of these states are in the bottom half of the magazine’s overall rankings of business climate. Four of the seven were rated in the top 10 in the Kauffman Index of Entrepreneurial Activity for 2010 through 2012, a leading gauge of startup fervor and staying power. In these places, robust entrepreneurism persists and even grows despite a climate that may erect barriers to business overall. California, for instance, is “a place where dreamers and innovators are—you get to see things happening long before they ever make it to the rest of the U.S.,” says Chris Reed, founder and CEO of Reed’s, a $40-million brand of all-natural soft drinks based in Los Angeles. “And you simply can’t discount the pleasure of living here, even if the regulatory environment is a little rough.” Hard criteria also exist to characterize places friendly to starting up and growing companies. These states tend to have reasonable property-tax rates and low or non-existent income taxes, because those types of levies bite all entrepreneurs even before they make a profit, says Yasuyuki Motoyama, senior scholar at the Kansas City-based Kauffman Foundation, which studies and supports entrepreneurship nationwide. Startup-friendly states also have solid secondary- and higher-education systems—regardless of whether they boast the massive, renowned research universities that are so often incorrectly correlated with a vibrant entrepreneurial culture. They tend to have strong formal and informal networks for mentoring of new entrepreneurs by established ones. And, perhaps tautologically, they often have several urban areas that provide strong environments for startups. On the other hand, Motoyama says, contrary to conventional wisdom, high levels of government research investment and strong venture-capital communities don’t necessarily correlate with robust entrepreneurial cultures and neither do low corporate-tax rates. Here are snapshots of the seven states, in alphabetical order: Alaska: More entrepreneurs are burning the long, midnight oil in the land of the midnight sun. Alaska has no individual income or state-level sales taxes to burden startups. That qualified it for the No. 4 overall ranking in the Tax Foundation’s latest State Business Tax Climate Index. Last year, the

“Texas is the best state for business, and I don’t see anything to slow it down. The education and quality of eligible employees is excellent right now. Business is booming and growing quicker and more rapidly in 2014 than any other year. It’s an exciting time in Texas.” “Corruption and union pensions have made Illinois a poor alternative for business. Continually avoiding, addressing and fixing the problems have only exacerbated the situation.” “New York and—in particular NYC—needs to be more supportive of businesses or all the jobs will leave with the businesses.”

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BIGGEST GAINS FROM 2010 2014 RANK

STATE

2010 RANK

CHANGE

Louisiana

Wisconsin

Ohio

North Dakota

Indiana

A Warning for Texas

BIGGEST LOSSES FROM 2010 2014 RANK

STATE

2010 RANK

CHANGE

Idaho

-15

Alaska

-11

Delaware

-11

Pennsylvania

-10

Maryland

-8

taxes are higher, general costs of living are higher. As a result, wages have to be higher, as well. The state is also known for policing companies more heavily than just about any other state—and sometimes more than the federal government. “California likes to say that Texas can have all those low-wage jobs,” says Richard Fisher, CEO of the Dallas Federal Reserve, “but from 2000 to 2012, job growth percentage change by wage quartile was better in Texas.” Texas won another bragging right last February when Site Selection magazine reported that it surpassed California in global technology exports in 2012. If there is a pattern in the survey, it is that states have diverged in recent years in their experimentation with economic freedom. Those lightening the burden of government have generally improved economic growth over those insisting that state-directed spending and governance is best. Apart from their geographic locations, many states are similar; and thus, they offer a natural experiment in economic policy. John Hood, president of the John Locke Foundation, a state policy think tank in North Carolina, points to numerous academic research studies that compare such policies over time. Writing in Reason, he cites 112 studies that examined high, overall state and local tax burdens and found that 72 of them—64 percent—showed a negative association with economic performance. Some analysts counter that isolating variables, such as high taxes, misses the point. States are better served, they argue, when they increase tax burdens to “invest” in education, infrastructure or other government programs. Hood counters that this may seem plausible in theory but almost never works out this way. Of 43 studies testing the relationship between total state and local spending and economic growth, he says only five concluded it was positive.

The relatively low-tax and limited-regulation policies adopted by the state of Texas have provided it with many economic and commercial advantages over other states, but policymakers and elected officials must be careful not to overlook potential problems in those areas where the state has failed to restrain the size and scope of government. While not always readily observed, these faults have the potential to blossom into something much larger if left unattended— especially as the nation’s economic situation improves in the coming years and other states follow Texas’ lead in their efforts to attract investors and entrepreneurs. One problem area for Texas is the revised franchise tax or “margin tax.” Mounting evidence suggests that the four-year-old margin tax, the state’s primary business tax, has harmed Texas’ economic competitiveness because of its costly and complicated nature, its imposition irrespective of an employer’s profitability and its contribution to an overall increase in the total business tax burden. Collectively, these factors are putting downward pressure on the state’s economy and weakening its economic competitiveness among the states. Sixteen found a negative correlation and the rest were inconclusive. The problem is that states don’t invest effectively. States like Texas, Florida, Tennessee, North and South Carolina, Indiana and others have figured out that economic freedom works. Economists who create the Fraser Institute’s Economic Freedom of North America index examined state economic growth from 1981 to 2009. They found that if a state adopts fiscal and regulatory policies sufficient to improve its economic freedom score by one point, it can expect unemployment to drop by 1.3 percentage points and laborforce participation to rise by 1.9 percentage points. The question is why have states nearer the bottom of the ranking not acted on this insight? The answer is likely complicated, but it has much to do with power and control. There will always be leaders who have convinced themselves that they act from superior knowledge and wisdom. And such figures have their adherents. However, business leaders are not bound to indulge such delusions and neither do citizens who continue to vote with their feet and abandon such states for friendlier places. MAY/JUNE 2014

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2014 BEST/WORST STATES FOR BUSINESS

Selected CEO Comments on States

“We relocated from Los Angeles to Atlanta in 2006 largely because of the regulatory and unfriendly tax environment in California. We considered Dallas but settled on Atlanta. I would make the same decision if I had to do it all over again.” “Stay away from California. I am a sixth generation Californian [and] I know how the state has declined.” “Texas enables doing business, and Austin is an attractive city to many young, high-tech workers.” “Virginia has a significant level of local taxes, particularly in jurisdictions in Northern Virginia. While the state tax structure is low, the business property taxes on gross business income and other related taxes of the local jurisdictions eat away at profitability.” “Wisconsin and Indiana are headed in the right direction. California and New York are headed in the wrong one. Illinois has no heading at all.”

continued from page 32 state cut taxes for small businesses earning $222,000 or less, and oil-tax simplification will give Alaska a greater economic edge. The state tied for No. 4 in the three-year Kauffman Index. California: Entrepreneurship is a stubbornly strong feature of the Golden State, as California ranked No. 2 in the Kauffman Index. The self-perpetuating startup cultures of the Silicon Valley—and of lesser renown in Southern California—account for much of California’s reputation despite a blatantly hostile state government and regulators. The state’s unchallenged status as a cultural bellwether also gives new companies an advantage. New laws that cut the pre-startup filing periods and security deposits required for new businesses are glimmers of hopeful change. Colorado: Pot legalization is stoking many—but not all—of the startups in the Rocky Mountain State lately. Colorado ranked No. 6 in the Kauffman Index with its legacy of technology and new-age food companies. The state also enjoyed four—No. 1, Boulder; No. 2, Fort Collins-Loveland; No. 6, Denver; and No. 9, Colorado Springs—of Kauffman’s top 10 U.S. metro areas for high-tech startup density. A No. 15 ranking for individual income taxes helped Colorado rank No. 19 overall in the Tax Foundation index. Florida: Retiree heaven has been jolting to life as an unlikely startup haven. It was No. 11 in the Kauffman Index. Lack of an income tax and low unemployment-insurance taxes helped Florida to a No. 5 ranking by the Tax Foundation. Strong population growth tends to yield an inordinate number of new businesses, so that’s a factor as well. Some believe Florida’s renascent housing industry—in a state where it had slumped so badly—is a big contributor as well by creating new contracting companies. Kansas: The Great Plains leader isn’t a chart-topper for entrepreneurs statistically, ranking only No. 20 in the Tax Foundation index and in the middle of the pack for the Kauffman Index. But small business won hopeful legislative victories last year in areas including individual income taxes, paycheck protection from automatic deduction of union dues and worker’s compensation. Unusually strong entrepreneurial networks, particularly in metro Kansas City, have created ways to propagate success lessons. And Google Fiber’s new high-speed Internet service there is accelerating technology-startup growth. Massachusetts: This favorite foil of big-company CEOs because of its high labor and utility rates and hyper-regulatory regime remains a hotbed of knowledge-based startups, despite its middling ranking in the Kauffman Index. Cambridge, including Harvard and MIT, ranked as Kauffman’s No. 4 metro area for high-tech-startup density, and entrepreneurs brewed by those institutions love staying around Boston. Also, Massachusetts ranks a surprisingly palatable No. 25 overall by the Tax Foundation. And the hometown Suffolk University index ranks the state business climate No. 1 in the country. Texas: The business-rich Lone Star State is only getting richer as its entrepreneurial culture spreads from Austin to Texas’s bigger cities, and its unbridled pro-growth stance continues to fuel growth for small businesses as well as large. Texas still specializes in stealing small companies from California. The state tied for No. 5 in the Kauffman Index and ranked No. 11 in the Tax Foundation list, including No. 7 in the crucial individual-income-tax category. Last session, the legislature passed a $1-million tax deduction for Texas businesses. —DB

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RAISING CAPITAL

Off-Roading Your Way to Financing Crowdfunding and other alternative paths to capital are drawing in the crowds. Russ Banham

Despite significant easing of the credit constraints and continuing near-record interest rates in the post-financial crisis era, many midsize companies and startups are funding their growth and expansion through alternative-financing strategies. Among these novel, capital raising methods is crowdfunding—less so the Kickstarter “please donate” concept and more the newer debt and equity models similarly drawing in crowds of online investors. These newer platforms share some DNA with Kickstarter, but they provide an actual return on investments. The concept has also rapidly gained momentum as a funding method, reportedly growing between 60 and 80 percent in 2012. By 2014, the crowdlending market is projected to be $6.7 billion, according to Lending Memo, which is the largest periodical on the crowdlending space. Other alternative-financing strategies like capital-equipment purchase and lease schemes and atypical debt and equity models also are thriving. Given the easy credit and low rates, the obvious question is, why bother with such alternatives? The answer seems to be speed. Both startups and growing, midsize companies sense a rare opportunity that must be seized now. “The companies that come to us are fed up with banks,” says Alex Tonelli, co-founder and managing director of Funding Circle, a crowdfunding marketplace. “The banks require so much documentation and have so many restrictions that literally months can slip by before any money is handed over.”

Many midsize businesses and startups also perceive drawbacks with traditional, private equity; chief among them is the concern of the firms’ sticking their noses where they don’t belong. “We sold our business to a private equity group and were quickly dissatisfied with the relationship,” says John “Jay” Ripley, co-founder and co-chairman of Sequel Youth and Family Services, a Round Hill, Virginia-based operator in 18 states of academic programs for young people experiencing behavioral problems. “We’d been in this business for 25 years, and they wanted to get in our shorts and run it themselves.” When Ripley had enough, he bought them out via a unique, alternative-financing concept. (See sidebar, “Four Paths to Unconventional Capital,” p. 39.)

Needing Money Now Other companies like Mixt Greens, Ayla LLC, Sustain Condoms and Sonoma Cider were similarly fed up with traditional funding methods, and turned on the crowdfunding spigot instead. Had they not, they might still be waiting for investor interest and bank capital. Sonoma Cider is the brainchild of David Cordtz, co-founder and CEO of the Healdsburg, California-based maker of hard cider. Cordtz has worked in the beverage industry for more than 25 years and previously was the national sales manager for another hard cider manufacturer. In 2012, he happened to glance at the market growth for the beverage and nearly fell over. “The growth was ridiculous,” he says.

SONOMA CIDER

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SONOMA CIDER

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RAISING CAPITAL

“A PE firm managing $500 million is not going to invest $500,000 in a startup” —Ryan Caldbeck, CEO of CircleUp Indeed, the hard cider category had shot up from an annual 5 percent to 6 percent average growth rate over the past 25 years to more than 100 percent in 2012, the fastest growth rate for any beverage category. Even better, this rate was expected to rise further. Drinking-age Millennials had apparently taken to hard cider like their great-great-grandparents once enjoyed the drink. “Prior to Prohibition, hard cider was the leading alcoholic beverage in the U.S.,” says Cordtz. “Young people like that it’s a craft alcohol like some beers, but [it] is much lighter, organic and does not have any gluten in it. It hits the happy spot.” Cordtz did the math and it added up to a $2 billion market in four years. With his son Robert and longtime business associate Fred Einstein, Cordtz incorporated Sonoma Cider in December 2012. They successfully reached out to Novus—a small, private lending institution—for the startup money, as well as to a small group of angel investors, mostly friends and family. One of them mentioned CircleUp, an equity-based crowdfunding site. CircleUp’s investors are comprised of hundreds of investment firms looking to park their money with companies in the consumer and retail spaces. The distinction between it and the typical private equity firm is that these investors are willing to write smaller checks. “A PE firm managing $500 million is not going to invest $500,000 in a startup or midsize company,” explains CircleUp founder and CEO Ryan Caldbeck. CircleUp’s investors, who typically put their money into technology businesses, gain portfolio diversification and significant returns. “According to the Kaufman Foundation, the consumer and retail space averages a return of 3.5 times the investment in 4.5 years,” Caldbeck notes. Not too shabby at all. For clients, the attraction is the speed of the investment. Caldbeck claims it takes 12 months for the average consumer or retail company to attract funding up to $10 million, the site’s cut-off point. “Our average is 61 days,” he says. That swiftness was important to Cordtz, who wanted his cider business up and running in less than a year in order to

Jeffrey Hollender, co-founder and CEO, Sustain Condoms take advantage of the market opportunity. “It seemed like the best way to reduce the time required to do this,” he says. “We took a nice chunk of investment capital from them to build our plant. We’re up and running now and on track to hit $4 million in sales our first year.” Sustain Condoms also found an angel in CircleUp. Jeffrey Hollender, co-founder and CEO [of Hollender Sustainable Brands, which introduced Sustain Condoms], which he calls the “world’s first sustainable condom” (Not what you think; the product is made of fair-trade latex sourced from rubber trees), had previously launched the highly successful Seventh Generation line of environmentally safe household products, selling the company in 2010. He positioned Sustain Condoms the same green way, with a twist. “Only 19 percent of women use condoms as a form of birth control, and we wanted to dramatically increase this volume by marketing a condom specifically to them,” Hollender explains.

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Four Paths to Unconventional Capital While crowdsourcing gets all the ink, alternative-financing models also include less sexy BDC (Business Development Company) investment funds, equipment buybacks and other debt and equity strategies ranging from the slightly unconventional to the quirkily obscure. Still, their availability testifies to the buyer’s store of options out there for companies needing cash. Take the BDC option, for instance. This was the money path taken by Blurb, an online maker of hardcover, softcover and/or digital books, thanks to its cost-effective design software. Two and a half years ago, founder and CEO Eileen Gittens sought an infusion of capital to “accelerate the business,” as she puts it. “We went to the VC market to raise about $8 million and lo and behold, we were too big to be small and too small to be big—we were a tweener,” Gittens laughs. “Venture capital folks had no interest in investing that little a sum; they wanted to fork over $40 million. I had no plan for an infusion of that size and it would have seriously diluted the equity in the company anyway.” Instead, she dove into the world of debt equity—the interesting combo play offered by Hercules Technology Growth Capital, a business development company providing specialty-finance solutions in technology-related companies. “They took a bit of risk on the equity side in return for giving us really good terms on the debt side,” Gittens explains. “We took a $7 million line of credit at a rate that is lower than what a bank would charge. We can easily service this debt and have been paying it off pretty quickly.” Equity dilution is not an issue either, given the small amount of stock provided to Hercules Technology. “Besides, they see it as a way to get some upside, since we all firmly believe the stock will be worth far more down the line,” Gittens adds. Callidus Software, a fast-growing provider of cloud-based sales and marketing automation solutions, went a different route for its capital infusion—a unique convertible debt instrument. Making a traditional secondary offering to raise the capital was not desirable, as it would have been immediately dilutive, and the company believed its share price was undervalued. “The convertible was a way to raise capital and maintain shareholder value,” explains Callidus CEO Leslie Stretch. Stretch devised a unique hitch to the $80 million convertible debt—an early call option at an additional .75 percent or 75 basis points of the debt rate. “After three years of the fiveyear convertible term, we can call the bonds if our shares are selling for over $10.02 per share for 20 consecutive days,” says Stretch. Having now pulled this trigger, Callidus now has only

$14 million of the $80 million debt outstanding. “Convertibles were not really in vogue for Software-as-a-Service (SaaS) companies back in 2011, but since then a number of other SaaS companies have followed our lead,” the CEO notes. Sequel Youth and Family Services got money by selling partial ownership of the company as passive non-voting preferred equity, capped at 6 percent, a much lower level of share dilution than in an IPO. Seeking to buy back the company from its private equity owners, co-founder and co-chairman John “Jay” Ripley turned to Alaris Royalty, a Canadian-based provider of cash financing to companies at an agreed-upon valuation, in exchange for predetermined distributions akin to a dividend. Although Alaris participates in the business, “They’re in there for the long term, not at all like private equity,” says Ripley. “My partner and I finally regained voting control of the company.” Another plus is that the distributions to Alaris come out of pre-tax income, making the financing highly tax-efficient for Sequel Youth. “The bottom line is we are sharing a small percentage of our incremental operating profit with them as we organically grow,” Ripley says. “Therefore, the common shareholders get to keep most of [the profit], which encourages our continued growth. We see them more like ‘silent’ equity partners, not at all like what we had before.” Once Alaris invested $66 million in Sequel, the company’s banks re-upped for another $60 million to extend the franchise of youth-oriented behavioral schools to 18 states and 24 brick and mortar facilities. Channel M got its nice chunk of capital by selling capital equipment—in this case, its television monitors—to Fountain Partners and then leasing them back. The company produces much of the televised content one sees in retail stores like Nordstrom and the old Blockbuster, tallying more than 20,000 retail stores as customers. Former CEO and co-founder David Teichner had raised capital through the years through the traditional debt and equity sources, but he was on the hunt for a better financing option. He found it in Fountain Partners. What was interesting and unique in the partners’ approach is that Channel M did not yet own the television monitors it planned to sell to Fountain and then lease back. “They gave us a meaningful line of credit to buy the necessary equipment, which we then sold back to them and now lease,” Teichner says. Why not simply go to the bank for financing? “Are you kidding—it took two weeks to get the capital and install the equipment in 200 stores,” he explains. “Our revenue went up immediately. With a bank, we’d still be filling out the documents.” MAY/JUNE 2014

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RAISING CAPITAL

Weighing Your Needs Traditional financing is tested, tried and true—a financial lifesaver for many companies. But, traditional financing can often be slow to materialize and onerous to obtain— not the best recipe for a business sensing a need to pounce on an opportunity now. Hence, the appeal of alternative-financing methods, which arguably are a bit esoteric and not exactly tested, tried and true. Time will tell, of course. So how does one sift through the alternatives to find the right one for the right growth strategy? Here are some decisions to ponder: Do you want to retain as much equity as possible with the current owners to prevent share dilution and maintain management control? If so, one of the many debt instruments like convertible debt, a capital equipment sale and lease back model, or a crowdsourcing site like Funding

He sought to raise at least $3 million to get the company to market as quickly as possible, but [he] had no stomach for debt, private equity or venture capital, preferring instead to reach out to individual angel investors. Several former investors ponied up and CircleUp rounded up the rest. While he won’t divulge the percentage of capital these investors represented, Hollender says he could not have funded the company without them. “One of them even joined my board,” he adds. “It was an efficient process that didn’t eat up any time, which was critical. Best of all, they got me to people who really understood both the value and the risks [of] what I was trying to do.” The product hits the market in June 2014.

Circle offer decent rates without an ownership stake. Are you comfortable with a capital infusion for a small equity interest, but you don’t want to go the private-equity route because they like to run things their way? A Business Development Company (BDC) and a passive non-preferred equity arrangement both offer the means to give away a bit of the company for cash, without giving away the store or its control. (For more on BDCs, see p. 42.) If you have no problem with a more robust equity-for-capital strategy, a crowdfunding site like CircleUp presents a way to tap seasoned investors in your industry that believe in your company’s value proposition and simply want to see it flourish. They may even have some good advice to offer, without making you feel that they’re the ones in charge.

Can You Spare a Few Million? Mixt Greens is a multi-unit, quick-serve restaurant company with five locations in San Francisco and two in Los Angeles, making tossed-to-order salads and sandwiches. The six-yearold company also turned to crowdfunding for capital, but not in equity form, as the company’s owners did not want to dilute their ownership stakes. Like Sequel Youth and Family Services, Mixt Greens previously was owned by private equity and reacquired by its founders (in early 2012). “We didn’t want to go the equity route again, and banks hate restaurants,” explains David Silverglide, CEO

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and co-founder of the San Francisco-based, casual dining chain. Despite promising unit economics and scalability, banks were unimpressed with Mixt Greens’ potential. “Even the banks with which we’d had longstanding relationships and did tens of millions of dollars a year in business with wanted so much paperwork that the whole process became too cumbersome to continue,” Silverglide says. “Valuable time kept slipping away.” Silverglide had heard about Funding Circle from a friend and enquired about a $250,000 capital loan to build a new restaurant in San Francisco. Within weeks, the money was forthcoming. “It was a bit more expensive than what we would have had to pay a bank, but they at least understood our unit economics and profit,” he explains. Funding Circle’s mission is to connect businesses needing up to $500,000 with an investor base that includes family offices, wealth advisors, high-net-worth individuals, fixed income funds and alternative-asset managers. “Our cash flow makes it easy for us to service the debt, and the timing alone makes up for the [loan rate] difference,” Silverglide says. He points out that the biggest limiting factor in a restaurant chain’s growth is real estate. “When an opportunity beckons for a prime location, we now have the financial flexibility to seize it,” he says. Mixt Greens has since gone back two more times to Funding Circle to raise an additional $500,000 for two more restaurants, each opening in mid-2014. Ayla LLC also went the Funding Circle route. The company sold high-end skin-care products like serums, cleansers and moisturizers online and wanted to branch out into its first brick and mortar store. “We were about to expand into makeup lines; and since most of our customers are women with challenging complexions and adult acne sensitivity, that’s a tough combination to market online,” says Dara Kennedy, founder and CEO of the San Francisco-based business. Opening an actual store required more capital than she had, and Kennedy did not have a network of wealthy friends and family from which to draw. She visited her bank, but it imposed “too many restrictions,” she says. “They wanted to lend us hundreds of thousands of dollars when we only needed $50,000. I had built this business with as little money as possible, focusing on the bottom line, and that was not the route I wanted to go.” Funding Circle provided the $50,000 and the store opened in October 2013. The week after, the San Francisco Chronicle featured Ayla in an article and customers swarmed the counter. Kennedy again is reaching out to Funding Circle to open two more outlets.

“I’m a big fan of crowdsourcing, but if you can get your money from a bank, you should be doing that.”

The Maddening Crowd

more attractive equity arrangements for investors than traditional capital sources. The concept also is so new that other downsides may eventually surface, says Daren Brabham, an assistant professor at the Annenberg School for Communications and Journalism, and author of the book Crowdsourcing. “I’m a big fan of crowdsourcing; but if you can get money from a bank, you should be doing that,” he counsels. “It may be great for startups; but for midsize companies, there are a lot of gray areas here that will take time to become clearer.” Among these gray areas is the JOBS (Jumpstart Our Business Startups) Act, easing some securities regulations and signed by President Obama in 2012. Certain provisions of the act have yet to be implemented. “It’s just not fully clear yet how the SEC (Securities and Exchange Commission) or FINRA (Financial Industry Regulatory Authority) will implement the remaining sections,” says James Walbom, CFO of Tiempo Development, a Tempe, Arizona-based software development company, who has similar reservations. “What if the way things are presented to investors now fail to go the way the investors’ expected? What implications might that have? To me, it’s casino stakes, a little too undefined for the moment. Consequently, we prefer more traditional means of capital financing.” Among these means, of course, is the “go-it-yourself” route—building a business without borrowing a dime or giving anyone a piece. That’s what Kim Overton did, launching Overton Enterprises with a single product, the Spibelt. It’s the classic American business story, by way of Horatio Alger. A personal trainer at the time, Overton was jogging and saw other women running with their house keys secured in their bra tops or in a bulky belt pouch. “I thought, why not a one-inch wide slender pocket made of elastic like when a snake swallows a mouse,” she says. That day in early 2011, she sewed her first Spibelt (the first three letters stand for small personal item). Today, Overton Enterprises sells Spibelts and related items directly and through intermediaries, its 15 employees sewing them in a 5,900 square foot warehouse. 2013 sales were $5.5 million. “I’m building this business on cash flow,” says Overton. “No way I’m sharing any of it with banks or investors.”

All this sounds too good to be true, of course. But, crowdfunding does have its drawbacks, chiefly higher loan rates and

Russ Banham can be reached at www.russbanham.com MAY/JUNE 2014

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RAISING CAPITAL

Why CEOs Should Know About BDCs By Christian L. Oberbeck

When a multi-location provider of end-of-life care with $38 million in revenues needed $13 million in financing for a dividend, it did not find the funds at a bank. Rather, it used a Business Development Company (BDC). Ditto for a nationwide distributor of office equipment with $11 million in annual revenues looking for $5.4 million to recapitalize the company. And when an industrial-controls corporation needed $9.5 million to roll several sales-representative firms up into a larger company, it found the financing at a BDC. Banks, under tougher regulations than ever, either would not or could not meet the financing needs for these representative, middle-market businesses. Congress enacted legislation creating BDCs in 1980 as an amendment to the Investment Company Act of 1940. The idea was to create a regulated entity to focus on the capital needs of smaller, middle-market companies. Few investors or CEOs have known what BDCs are and why they are advantageous to growing businesses, but that situation is changing. Since January 2007, BDCs have grown from 16 to 41 companies. They serve an estimated 65,000 businesses in the U.S. with revenues in the range of $20 million to $200 million; the overwhelming majority of these businesses are privately held and family owned. Such companies have significant capital needs; but, because they work in a fragmented marketplace, they are underserved by banks. Here, then, are six reasons why BDCs are thriving and will continue to grow as a source of capital for smaller, middle-market companies and why CEOs should understand how valuable they are as a source of financing. 1. Evaluation as a growing concern, not just a credit risk. A BDC looks at the entire business and its prospects for growth rather than just its credit history. Banks under tighter scrutiny as a result of recent law and regulation, such as the Dodd-Frank Act, now have less freedom in accepting risk. A BDC working with a bank can structure deals that otherwise might not be acceptable. 2. Focus on relationships, not just transactions. A BDC typically takes on an investment that is higher risk than most bank portfolios can tolerate. This opportunity means the BDC needs to truly understand a companyâ&#x20AC;&#x2122;s business and to form an ongoing relationship with it, so it can help the

company to expand. BDCs grow by doing their homework and maintaining investment discipline. 3. Certainty of closing. Once a BDC approves a company, there is a high certainty of closing a deal without wasting time. Often those who arrange a deal are on the investment committee approving it, unlike other financial institutions, where there are multiple levels of approval and fewer people who fully understand a company and its marketplace. 4. Shrinking capital market. There are fewer banks with lower market shares and their capital structures have become more conservative. This contraction has narrowed the capital window for many smaller, middle-market companies, even stable and conservative ones. 5. Customized financial engineering. BDCs take on more financial engineering than just term loans. It is common for a BDC to fund a shareholder buyout or a dividend recap, allowing owners to take money from a business. BDCs with extensive experience in the lower, middle market create customized, financing solutions for clients. As solutions-oriented lenders, they partner with business owners, equity sponsors, fundless sponsors, family-owned businesses and management teams to craft capital structures that enable them to pursue their business plans. 6. Experienced professionals. BDCs are staffed by professionals with deep experience, both in the private-equity side and the mezzanine and senior lending side of businesses. They have closely examined thousands of companies and can understand more extensively and quickly how to customize a financing solution for a client. BDCs are beginning to emerge as a significant force in lending to smaller, middle-market businesses, but there still is limited understanding of what they are and how they work. CEOs who havenâ&#x20AC;&#x2122;t encountered them will find them not only to be alternative sources of capital but easier to work with than traditional lenders and conclude that they should be a regular part of their financing tools. Christian L. Oberbeck is chairman of the board and CEO of Saratoga Investment, a business development company traded on the NYSE (SAR).

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B2B SALES & MARKETING SUMMIT

Neil Rackham

The New World of Sales Author Neil Rackham on what your sales team is doing wrong. By Jennifer Pellet “The average company has twice as many competitors as it did five years ago,” Neil Rackham, author of Spin Selling, told CEOs gathered for Chief Executive’s recent B2B Sales and Marketing Summit. “Statistically, that means your market share is cut in half.” That less-than-cheery thought, of course, underscores the importance of having effective salespeople—the kind who can not only accomplish the increasingly difficult feat of winning entrée to potential customers, but who can also effectively communicate the value of your products and services. In fact, ideally, your sales team will be capable of actually adding to that value proposition themselves. Traditionally, salespeople have been charged with explaining the value of a given product, essentially enumerating all the ways that it’s better than competing products. However, intense competition has led to a commoditizing world, one where fewer and fewer products and services are viewed as unique. That new reality renders the “we have a better mousetrap” approach to sales virtually obsolete.

The Value Imperative “Instead of the old role of explaining the products and services and why they’re good—information customers can find themselves on the Internet—sales, done well, is becoming a

value-creation channel,” noted Rackham. “What the salesperson is doing becomes the reason why the customer buys from you. They don’t sell a mousetrap, they say, ‘Let me show you the kind of cheese to put in your mousetrap. Let me show you where you should place it to catch the most mice.’” Ye’t, the way the business world—from CEOs to sales representatives—tends to view the sales role remains mired in that traditional idea of, essentially, a walking, talking sales brochure. Unfortunately, not only is that method of sales no longer effective, it’s downright detrimental. “The reaction to the salesperson who says, ‘Let me tell you about our mousetrap’ is actually now negative,’” explained Rackham. “In our study of 1,100 buyers, it was the No. 1 complaint they made about the people who pitch them.” Instead, buyers want to hear information they can’t find elsewhere—information about market trends, about what competitors are doing, about industry developments—and they want help understanding and preventing or solving their business problems. “One of the people I interviewed told me, ‘If I fall in hole, there are 50 salespeople who can sell me a ladder to let me climb out,’” said Rackham. “But there aren’t a lot of salespeople who can prevent me from falling into the hole in the first place.” Buyers also value a salesperson who acts on their behalf,

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Customers are getting tougher to deal with; even before the economic meltdown

They treat you more like a commodity

NEIL RACKHAM

Most Sales Executives Agree . . .

But they also demand more expertise and support than ever before

Customers expect more value than ever before % = percent of Sales VP’s who agree with each statement The contents of this article were drawn from Neil Rackham presentation at Chief Executive’s B2B Sales & Marketing Summit. For information about upcoming events, visit www.chiefexecutive.net

advocating for a rush delivery or actively sorting out any problems that arise. “Maybe that’s why the best salespeople are always a pain in the ass to manage, because they’re client advocates fighting their companies all the time,” suggested Rackham.

Transactional vs. Consultative Customers According to Rackham, another fundamental shift has changed the reality of the way selling relationships play out in today’s market. Historically, customers have fallen somewhere on a range between transactional customers, who are motivated by price and ease of doing business, and consultative customers, who are looking to benefit from the expertise their vendors can offer. “Five years ago, you probably had a few transactional customers and a few who were very consultative; but most were probably somewhere in the middle,” says Rackham. “Now both extremes are growing and the middle ground is going away.” For the majority of companies, which generally have sales forces trained and accustomed to selling to the middle of that range, this situation is problematic. Obviously, sending your most talented salespeople to pursue opportunities where price is the only determining factor is wasteful. Yet, given a mix of transactional and consultative sales prospects, a salesperson will inevitably place too much focus on the transactional relationships. “They’re quick and easy and the fact that it’s a zero-margin business doesn’t worry them,” noted Rackham. “They’ll still get their commission check at the end of the month.” The solution? Companies should explore every possible way of shifting those transactional relationships to cheaper channels, such as telesales or the Web, said Rackham, who acknowledges that salespeople will not look kindly on this concept and referenced his own experience justifying such a change at Oracle. “I thought I was going to be assassinated because to salespeople, taking away anything is taking bread from their mouths and starving their children,” he recounts. “The argument went

all the way up to Larry Ellison, who said, essentially, ‘You know what’s wrong with my sales force? They’re so busy knocking off gas stations, they never get to rob the bank.’ That really communicates it.” Ultimately, taking transactional business away from salespeople both frees and motivates them to focus on deeper, consultative relationships. However, companies need to go further, helping their sale forces develop the skills to build value-creation relationships with their customers. “Very few salespeople look beyond the immediate, possible contract,” pointed out Rackham. “You have to help them develop a sense of looking forward.”

Ditch the Pitch One proven approach, covered in detail by Rackham’s book, is for salespeople to engage customers with questions designed to understand the problems and challenges they struggle to overcome. “The best people ask the kind of questions we call implication questions, taking a problem and saying, ‘What’s that really costing you? Could it lead to this? What’s the impact on other products? On customers?’” explains Rackham. “These questions get the customer to tell you the benefits you offer, which is more powerful than saying, ‘Let me tell you why we’re better.’ That’s because customers believe their own words.” At the same time, too many of the wrong questions can backfire. Salespeople who go in asking questions they could have gotten the answers to on their own risk earning the ire of their customers. To avoid this problem, Rackham urges companies to school salespeople on boosting their pre-call research and preparation, which he says is more important than ever. However, the big change is one of mindset. “Salespeople need to stop jumping in to talk about products and services—about the mousetrap. They really have to up their game,” says Rackham. “Ultimately, questioning skills are going to make or break their success. Interestingly, most salespeople are quite good at making pitches. They find questioning a lot harder.” MAY/JUNE 2014

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TECHNOLOGY

Making Tech Transfer Work How America’s idea factories can work with CEOs to commercialize more technology. By William J. Holstein

Laura Kilcrease has founded or helped to found dozens of companies on the basis of technology created inside the University of Texas at Austin. The technologies have ranged from three-dimensional printing devices to nano-ink for solar energy panels. In creating so many companies with names such as Exterprise, Hart Intercivic and LNNi over a quarter of a century, she has emerged as something of a legend in Austin entrepreneurial circles, having also founded the Austin Technology Incubator, worked at the renowned IC2 Institute and founded an early stage venture capital company called Triton Ventures, where she is managing director. But as entrepreneurial as she is, Kilcrease is frustrated that more technologies developed inside the university do not make it into the commercial marketplace. “There is a vast investment going into the research, but we’re getting only a small amount of that research commercialized,” says Kilcrease. “Most technology institutions end up commercializing very little of what they have because their people are phenomenally good at solving their problems, but they are not necessarily thinking about how it applies to someone else’s problems in the marketplace.” Kilcrease’s frustrations are part of a national conundrum— various arms of the U.S. government in 2012 spent $138.9 billion for research and development (R&D) at the Department of Energy’s 17 national labs, at research institutes, at universities and elsewhere, according to the Congressional Research Service. That spending over the years has helped make the U.S. arguably the most innovative nation in the world. Federally funded research has spurred the creation of the Internet, the

Laura Kilcrease

KEY TAKEAWAYS If you wish to obtain access to a technology inside a university or federal lab: • Recognize that you are trying to establish a relationship with scientists, not just sign a licensing agreement • Recognize that scientists will defend their technologies but do not grasp the commercial applications—only you can judge whether there is a market • Assemble adequate, long-term financing for what could be a multiple-year engagement

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biotech and genomics industries, GPS satellites and other fresh ideas. However, at a time when the U.S. is still crying out for jobs, has all the spending fueled the growth of enough smalland medium-sized technology companies; and therefore, has it created millions of needed jobs? That answer, it seems, is overwhelmingly, no. Different “idea factories”—labs, institutes and universities—face slightly different issues. Of the DoE’s energy labs, only three have been set up to facilitate the flow of technology to the private sector; but the other 14 remain focused on defense-related research, much of it classified. Research institutes, often situated in the medical and biotech arenas because of billions of dollars in support from the National Institutes of Health (NIH), are under greater pressure from Congress to commercialize technology; and hence, they have opened more “translational” institutes—but only with limited success. Universities, aside from a relative handful, including the Massachusetts Institute of Technology (MIT) and Stanford University, tend to focus on publishing their findings in research journals and do not invest enough in technology commercialization. Most do not allow faculty to spend 20 percent of their time on outside projects, as MIT does. The core problems of identifying great new ideas, patenting them, nurturing them through different stages of development and allowing them to bear fruit in the marketplace are similar. “Fundamentally,” says Kilcrease, “it is the same set of issues.” Part of the problem starts at the very top, in terms of how the U.S. government allocates its billions of R&D dollars.

“There’s a deep bias toward pure science,” says Mark Moro, senior fellow and policy director for the Metropolitan Policy Program at the Brookings Institution in Washington. “There’s an overvaluing of the life sciences by comparison with the physical sciences; and then, there is a kind of denigration of applied or commercially relevant work. Those are big problems.”

The Politics of Innovation There are hints that the issue could gain ground at the national level. Likely Republican presidential candidate in 2016, Sen. Marco Rubio of Florida, for example, is proposing to exploit research breakthroughs to create more jobs. Unfortunately, at least for now, ideological gridlock is likely to prevent much action at the federal level. On the opposite side of the policy debate from Moro are basic R&D proponents who argue that any shifting of increasingly scarce federal dollars toward commercialization would reduce spending on basic research and therefore destroy the “seed corn” of future breakthroughs. It’s at the regional/state level that the issue has generated the greatest attention because cities and states are trying to use technology from universities and national labs to create “clusters” of technology companies, as San Diego has done in biotech, genomics and wireless communications; the Denver area has with “clean” environmental technologies; and Orlando, Florida, has with computer simulation programs. “This is a crucial, huge issue in the regions,” says Moro. “Regions are on their own now. The fact that Washington is gridlocked and that adjustments to federal programs won’t be forthcoming means

Impediments to Tech Transfer—and Solutions The Impediments

Possible Solutions

1. Universities, federal labs and research institutes do not have adequate incentives to commercialize ideas. 2. These “idea factories” have an incentive to charge large, up-front royalties rather than accept shares in successful start-ups that may not yield gains for several years. 3. Ph.D. inventors inside these idea factories do not have enough personal connections with business-minded people with MBAs. 4. Tech institutions do not know how to build teams with the right combination of skills to commercialize an idea. 5. Would-be entrepreneurs emerging from a lab lack access to seed-stage capital to test their ideas in the market. 6. Established businesses looking for new ideas may want to strike quick deals that secure control of a technology.

1. Alter federal funding methods to encourage not just basic research but also encourage commercialization efforts. Allocate funding, for example, to technology-transfer offices, including the writing of patents. 2. Persuade idea factory leaders that they will achieve greater, long-term financial gains by making it easier and cheaper for technologies to be spun out. No longer require tech-transfer offices to fund their own operations from licensing fees. 3. Create social-networking events where technologists meet with potential CEOs, as well as marketers, financial mavens and manufacturing experts. Break down rigid, vertical siloes in universities between engineering and business schools. 4. Create more incubators just outside the idea factory’s walls to serve as crossroads for different types of talent. 5. Encourage early-stage investors and venture capitalists to go to events inside technology institutions to meet people with the best ideas. 6. Business leaders must recognize that successful technology transfer requires more than just licensing a patent. MAY/JUNE 2014

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TECHNOLOGY

they are taking ownership of regional, economic development with increasing sophistication. Regions are taking stock of their assets; and at the top of list are their research universities and their national laboratories—along with their community colleges and other entities.” One of the states taking the subject very seriously is Colorado, which is home to 10 federal laboratories, including the National Renewable Energy Laboratory (NREL) in Golden, just west of Denver. NREL is one of three Department of Energy labs dedicated to tech transfer to the private sector, and it is one reason that Colorado boasts 300 companies in the clean-energy field with 30,000 employees. Companies from many other states also have licensed its technology. But commercialization of NREL’s technologies “doesn’t happen as easily as people think it ought to happen,” says Bill Farris, NREL’s associate laboratory director for innovation, partnering and outreach. Part of the problem is simply informing the business world what ideas exist in the lab. The DoE came up with an Energy Innovation Portal (techportal.eere.energy.gov) where it posts 18,000 patents in the energy field and provides summaries of how about 1,000 of those ideas work. However, there is still a huge gap in the mentality and operating style of scientists on the inside and business leaders on the outside. To help bridge this breach, NREL created an Innovation and Entrepreneurship Center, a kind of half-way house. Nevertheless, putting together the entire “ecosystem” to support the commercialization of ideas has been challenging, particularly as it relates to capital. “I can provide some funding to help prove the technology,” says Farris. “But I’m not going to help capitalize the company. I wouldn’t make the best investor. Investors are pure of heart, in the sense that they are interested in making money. They don’t get emotionally attached to a technology; but left [on] our own, we get enamored with the technology.”

Chuck Provini

One entrepreneurial company that benefitted from NREL’s research is Natcore Technology. Natcore’s Chairman, Brien Lundin, and CEO, Chuck Provini, met three scientists whose

work with solar energy fascinated them. They raised some funds from family and friends. Then, they avoided taking on large amounts of debt or selling a large piece of the company to venture capitalists by listing on the Toronto Stock Exchange, through a platform called the TSX Venture Exchange, in 2009. The company’s first promising technology for possible commercialization came from Rice University in Houston, a process called liquid phase deposition. This technology held out the prospect that solar wafers, the building blocks of a solar panel, could be made by immersing them in a liquid bath that created various layers of receptors. That approach was simpler and cheaper than using a furnace that burns at temperatures as high as 1,200 degrees Centigrade and generates toxic waste. Next, Provini heard about a black silicon material that NREL had invented. Using black silicon was intriguing because the creators of wafers would not have to figure out how to make them non-reflective. After all, the whole purpose of a solar wafer is to absorb the sun’s light, not reflect it. NREL licensed the black silicon technology to Natcore in December 2011. Putting the two technologies together using nanotechnology techniques, Provini figures his company can reduce the cost of making solar wafers by 20 percent. He anticipates reaching his first commercial licensing or joint venture deals this year. “The biggest key with Rice and NREL,” says Provini, “was that their primary motivation was not to just get revenue. They wanted to try to commercialize their technology and do good things and help the world. For new companies like us, that’s key. We can’t write the big check.” He argues that idea factories that do not charge large up-front royalties for their technology will reap larger gains over the long run if the companies they spawn become successful. A basic issue in dealing with scientists was building trust that his company would not simply steal their ideas. “You’ve got to establish a relationship through face time,” Provini says. “You can’t do it with lawyers. You have to go there and persuade them that you are a good company. Then, they will back off on some of the restrictions” on the use of their technology. He recommends that a company should take a series of small, concrete steps to establish a relationship in which ideas can flow back and forth across the table. “In R&D, you never end up where you think you are going initially,” Provini adds. “There has to be a little bit of good faith. Not all the T’s have to be crossed and [not] all the I’s get dotted. A lot of times, you’ll sit down and can’t get through the contract negotiation if the business and the university or lab don’t have the right confidence in each other.” Provini’s case is slightly unusual in that he combined technology from two different technology institutions in different geographies and founded the company in yet another state. But Provini threaded the eye of the needle by adopting a collegial style

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with researchers over a period of years and carefully nurturing technologies with promise. It was not a case of one-stop shopping. One of the figures who has spent 50 years in technology transfer, and who may have derived some of the keenest insights, is Lita L. Nelsen, director of the technology licensing office at MIT, which has licensed technology to hundreds of companies. Tech transfer is about much more than mere licensing, in her view. It requires the transfer of skills, as well. “Start-up companies don’t happen very often without the active participation of the inventors, either as founders or as consultants,” Nelsen says. An MIT professor can spend 20 percent of his or her time on a venture and graduate students and post-grads can join the company, taking with them many of the lessons derived from having helped invent a new idea. In so doing, “the vision and the championship and the know-how can be transferred to the start-up company,” she says. This process can rarely blossom in the same way at a federal lab, where scientists may not be allowed to work on outside projects, or at research institutes funded by NIH, which imposes conflict-of-interest policies against scientists seeking to commercialize their ideas. Universities also will grant exclusive licenses to companies for a technology, whereas the federal labs and institutes will rarely grant that, another deterrent to successful tech transfer. “If we give you an exclusive license, you will be more willing to try to invest to bring this risky stuff to market because you’ll have protection from competitors,” says Nelsen. The hardest part of successful tech transfer is not finding or licensing an idea or even raising the money. “The hard part is finding someone who can set up a structure where the vision and participation of the inventors can be accommodated,” she explains. “The scarcest resource is not money but rather the experienced technology entrepreneurs who can both raise money and also manage early-stage development.” Nelsen argues that companies of all sizes are shooting themselves in the foot if they fire their own internal R&D executives and managers, assuming they can simply rely on ideas from a university. “If CEOs in some industries are firing the guys in R&D to make their earnings look better, that’s not going to help,” she says. “You need the receptors for early-stage technology in the company, the engineers and development scientists who can receive the technology.” There’s a debate in the economic-development field about whether large companies or small to medium-sized ones do a better job of commercializing technology. Nelsen says smaller companies are the stars, but Brookings’ Moro thinks the deck is stacked in favor of the big guys. “The large corporations are characterized by greater capacity to drive and structure long-term research partnerships, which allows them to work more smoothly with large research universities,” says Moro.

“The scarcest resource is not money but rather the experienced technology entrepreneurs who can both raise money and also manage earlystage development.” “Smaller- and medium-sized firms may not have a chief research or innovation officer. They may not have the standard, professional player who can spend the time to develop a research contract or partnership.”

Size May Matter Actually, it takes both large companies and small startups to create the robust, regional ecosystem necessary to commercialize ideas, according to other experts. Sometimes large companies license a technology but spin it off into a captive company to develop it. Many times, large companies will simply acquire small firms that have already “baked” a technology and proven its commercial value. “Small companies innovate, big companies acquire,” says Waymon Armstrong, co-founder and president of a $12 million a year company in crisis simulation software called Engineering and Computer Simulations, in Orlando. The technology originated at a research park that the U.S. Army uses to develop simulation training for soldiers. Rick Weddle, president and chief executive of the Metro Orlando Economic Development Commission, says one key to creating a regional climate where commercialization can flourish is breaking down the siloes between tech-transfer officials, entrepreneurs, large companies, economic development officials and other constituencies to allow them to better communicate and align their interests. “If you are in your silo, and another person is in another silo, there’s no way you can help each other,” says Weddle, who also managed North Carolina’s vaunted Research Park for seven years. CEOs cannot create the ideal ecosystems for successful tech transfer by themselves, but they can work with different constituencies, including state and local political leaders, to eke out progress. Weddle says many states are now enacting new laws to remove legal barriers to tech transfer from public universities and are studying how to improve their climates for innovation. That’s good news for CEOs looking for new ideas. The Bottom Line: Technology transfer from the nation’s idea laboratories could be greatly improved if CEOs invest in developing relationships with scientists and help create ecosystems that foster commercialization. William J. Holstein is the author of, most recently, The Next American Economy: Blueprint for a Real Recovery. MAY/JUNE 2014

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GOVERNANCE

Why Boards that Lead Succeed Recent history shows that directors who take more active roles—particularly in CEO selection—are fundamental to the long-term health of their companies. By Ram Charan with Dennis Carey and Michael Useem

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hen Microsoft CEO Steve Ballmer announced last August that he would be stepping down within one year’s time, the board began a six-month-long search for his replacement. Directors reportedly identified more than 100 potential CEO candidates to fill the top spot before choosing Satya Nadella, who had headed up the Redmond company’s cloud-computing and enterprise-engineering group. As an outsider peering in, it seems clear that the search, headed by an independent director, was exhaustive and methodical. The choice likely came down to—as it frequently does—either a) the CEO of another company, who has the broader general experience, but not the deep knowledge of the specific industry; or b) a candidate who has the DNA of the company and deep expertise, and who may have leadership experience at a lower level within the organization, but is not yet battle-tested as CEO. Microsoft’s board decided that the latter was the best bet. Nadella clearly has the deep understanding of where Microsoft’s future lies as a technology-driven company, how the industry is shifting and in what direction it is headed. Did the board make the right choice? Choosing a CEO is never risk free, but the conscientiousness and high level of deliberation that went on in the Microsoft boardroom gives us high hopes. The Microsoft search is a fine example of how far U.S. corporate boards have come in the U.S. Gone are the days of the ceremonial, rubber-stamp board serving at the pleasure of an imperial CEO who made all the big decisions, including when to leave and whom to anoint as the successor. Company performance is now transparent, and investors, activist shareholders and other stakeholders don’t shy away from taking passive boards to task. A growing number of boards are reinventing their role in keeping with this new governance climate. Successful boards are beginning to make sharp distinctions about when they should partner with the CEO, when they should get of his or her way and when they must have a firm grip on the reins. When it comes to succession—selecting a leader, coaching and developing a leader, and when necessary, dismissing a leader—boards must take the lead and do all they can to get it right. Nothing can overcome a wrong leader in the top job. Some boards, like DuPont and Apple, have done well in choosing their chief executive and, as a result, their companies have flourished. Others, like Sears, Kmart and more recently, Yahoo!, with its cavalcade of CEO departures, have not been so fortunate. When a CEO fails, the consequences are weighty, not only for the company and its ecosystem but also for the nation. Here are some of the key things successful boards do to manage CEO succession—and what can happen when they fail in that role.

10 Principles for Finding the Right CEO 1. People set strategy. Directors and executives who know where the company should be going will be best equipped to get it there. 2. Make the criteria for the CEO job specific and up-to-date. Link it to the company’s central idea and its competitive landscape, not just to personal traits such as integrity and personal gravitas. Include team building, execution excellence and ability to work with the board. 3. Include in the CEO’s evaluation an assessment of how well the company is building a succession plan for the next generation of company leaders. Companies should have a coherent system in place to evaluate and compensate the CEO’s succession performance. 4. Assign the board leader or head of the governance committee to work with the CEO to make succession planning part of the company’s management development processes. That will help ensure succession is not an event-driven crisis. 5. Retain a high-performing chief executive, but also work to keep capable successors. Make sure you incent CEOs-in-waiting sufficiently to keep them on if a well-performing chief executive still has ample energy in the battery. 6. Seek candid comparative data on inside CEO candidates from those who have worked with all of them. 7. Make direct contact with both sources and candidates and drill deep to verify information—even when engaging third parties to vet. 8. Review outside consultants carefully to prevent conflicts of interest. Make sure you’re getting an unbiased view of the candidates. 9. Maintain confidentiality. Many a stellar CEO candidate has dropped out of consideration when his or her identity is inadvertently revealed. 10. Embed succession-planning in corporate culture. Creating a culture of executive succession entails many steps, including performance incentives for executives to build the system, a development capability that repeatedly reaches large numbers of managers, coaching and mentoring by both directors and executives, and an openness to both inside and outside candidates. Above all, it requires an active partnering between the directors and the chief executive to ensure that their pipeline is full and its occupants are developing in the upward direction. MAY/JUNE 2014

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GOVERNANCE

Ford: A Lesson in Taking the Wheel In 2006, Ford Motor was facing a bleak future. It had never quite recovered from the massive recall of Firestone Tires in 1998-2001 and the economic downturn following 9/11. While William Clay Ford, Jr. temporarily restored confidence when he stepped up to the CEO position after Jacques Nasser’s ouster in 2001, the company’s financial condition and market share had steadily deteriorated. There were numerous problems: Ford’s manufacturing costs were outpacing its rivals; its acquisitions of Jaguar and Volvo had sidetracked management; market share was slipping to Volkswagen, Toyota, and even Hyundai; and operations were badly balkanized. Ford’s earnings skidded more than $12 billion into the red. To be sure, some of the problems were a direct result of a larger declining American auto industry. But whatever the cause of the ailments, it was up to the company’s leadership to find a way to stop the bleeding before it was too late. The old governance model would have kept Ford’s directors mostly on the sidelines, leaving management to do the triage. But when Bill Ford warned the board that he would not be able to save the company on his own, the seasoned board, led by lead director Irvine O. Hockaday, Jr., former CEO of Hallmark Cards, stepped up to find a CEO who could. The search had to be both thorough and discreet. Hockaday turned to Robert Rubin, former co-chairman of Goldman Sachs and former secretary of the U.S. Treasury, and John L. Thornton, former co-COO of Goldman, to help. As Bill Ford told Hockaday, “You guys must have the best Rolodexes on the planet. You should be able to get anybody to come to the phone.” The three carefully identified what the company needed: a CEO who would bring strong vision for the company’s future; an executional ability to strategize and execute an appreciation for the power of current and future technologies; and an experienced hand in harnessing complexity. He or she would also have to be CEO-battled-tested, and ready to take the reins firmly from Day One. It was Thornton who identified Alan Mulally, who had been with Boeing for three decades and was currently overseeing manufacturing. After a series of discreet meetings with Mulally, during which time

Hockaday updated both the board and Bill Ford in real time, the decision was made and Mulally was named chief executive of Ford in September 2006. He went on to successfully steer the company through the collapse of the U.S. auto market in 2008, the bankruptcy and bailout of Ford’s two archrivals in 2009 and the restoration of Ford’s reputation and earnings by the end of the decade. In 2011, Ford’s income had soared to $20 billion, earning him the title of Chief Executive’s CEO of the Year. Ultimately, Ford’s directors were able to change the company’s trajectory by installing the right person to run the show. They did three things that are particularly instructive to other boards tackling the task of CEO transition: 1. The governing board actively directed the process. Three highly experienced directors took charge, but all board members pitched in to help. They didn’t wait for Bill Ford to come up with a solution; they took charge themselves. 2. The board’s leadership did not follow a formally designated process, nor was its foundation visible to the outside world, including the rating agencies. As Hockaday noted, “Effective leadership at the board level will relate to the particular state of the company and the dynamics of the board at a given point in time. A written-in-stone template about board governance is a distraction and maybe even risky.” 3. The recruitment process used in 2006 has provided a foundation for the board’s search for a replacement of Alan Mulally, who is expected to retire in 2014. The directors pioneered a leadership process of trust and transparency among themselves and with the executive team that will serve the company well as it searches for Ford’s next chief executive. Good succession habits begin well before the CEO plans to depart—a good five years before, ideally. It can take that long to groom inside talent, research external candidates; and, if necessary, bring in an external candidate at a level reporting to the current CEO to be readied for the job. When Michael B. McCallister, CEO of Humana, announced in 2011 plans to retire in 2013, William J. McDonald, an executive at Capital One Financial Corporation and chair of Humana’s organization and compensation board committee, wasted no time working on a long-term plan. Succession is all about “lead time,

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lead time, lead time,” he observed. “The board is accountable for the succession process and must stay out in front rather than waiting to hear from the CEO. If the board waits for the CEO, it is too late.” That’s why the board brought in Bruce Broussard as president and COO in 2011, in anticipation that he would take over when McCallister retired, which is just what happened. Similarly, Johnson & Johnson brought back Alex Gorsky, who began his career with J&J, several years before CEO Bill Weldon was expected to retire, giving him a range of roles with significant responsibility, including group chairman and worldwide franchise chairman for Ethicon in the medical devices business; worldwide chairman of the surgical care group; and vice chairman of the executive committee. He was then a natural replacement for Weldon in 2012 when the longtime CEO stepped down.

The Risks of a Wrong Choice When the board selects the wrong person for the job, consequences abound. All too often, these failures can be traced to inadequate due diligence on part of the board when vetting candidates. Take Yahoo!, which by 2012, had appointed six CEOs in 11 years, leading hedge fund activist Daniel Loeb, manager of the $9 billion Third Point fund, to mount a proxy challenge to the Yahoo! board. Loeb argued that the company’s directors did not have the talent to help the firm grow its revenue from advertising or even really to understand the market challenges faced by management. While performing its due diligence on Yahoo!, Third Point discovered, shockingly, that the current CEO, Scott Thompson, had claimed two college degrees from Stonehill College, when in fact, he had only earned one. To make matters worse, it was revealed that the director who led that CEO search, Patti Hart, had herself incorrectly stated college credentials. In the wake of that news, Thompson resigned and Hart announced that she would not stand for reelection. Yahoo! agreed to bring three Third Point director nominees onto the board and two months later, that board recruited Marissa Mayer, a former Google star. By March 2014, it was reported that the stock price of Yahoo! had doubled over the 14 months since Mayer’s appointment. College degree verification is one of the most basic of due diligence requirements—yet Yahoo!’s board missed it. Preventing human capital shortfall by ensuring the selection of the right CEO—one whose capabilities and skills properly align with the job to be done—is among the board’s most fundamental risk-management responsibilities. Nothing can fully make up for the choice of the wrong CEO. Boards that lead in making this important judgment are careful not to overrely on their search partner, as the HP board seems to have done in hiring Louis Apotheker, who was then replaced by Meg Whitman, one of their own directors. In some cases, the board simply fails to match the right person to the job. That was clearly evident when Sandy Weill and the

Citigroup board chose to hand the CEO baton to Charles Prince, passing over the more experienced operations manager, Robert Willumstad, who was given the role of COO. But the plan only worked as long as Willumstad stayed. When he left less than two years later, and Prince assumed the COO responsibilities in addition to his role as CEO, it soon became clear that the CEO did not bring the entire range of capabilities required to fully lead the complex firm on both the inside and the outside in a more unpredictable climate and volatile markets. After surprisingly poor company performance, the board forced Prince out in 2007.

Early Detection is Key Even the best of boards can misfire on CEO selection. That’s why another critical skill is the ability to catch a falling CEO before he or she hits the ground with a thud. True leadership at the top requires directors to trust their instincts and act quickly on troubling news even if their concerns ultimately prove to be false warnings. A candid, data-seeking, and truth-telling role is critical for the board to meet its own leadership responsibilities. To ensure that the board catches problems early, it is useful for directors to keep a weather eye on early signs of executive deficits, such as: 1. Lack of clear strategy. Chief executives who do not return straight answers to the board when questioned on strategic direction—or who release bad news only at the eleventh hour—are among the more telling signs of strategic ambiguity. 2. Failure to execute. The fault is usually the result of a combination of several troublesome habits: a) a lack of clear focus on a few dominant priorities, favoring instead an idea du jour or a long menu of initiatives that distracts from what really needs to be done; b) a dislike of follow-through, characterized by the CEO’s failure to ensure a change in strategy is carried out by direct reports and; c) underanticipation of unintended consequences, which essentially means the CEO is too often caught off guard. 3. Wrong people calls. When a CEO seems to be overly reliant on the decision-making of a senior officer, or becomes captive to one or more special advisers who filter the upward flow of diverse views, that’s a sign of weakness in this area. Another red flag is when a CEO decides to elevate a functional executive with little line experience into a major line position. A board that leads, in a proactive, thoughtful way, will have a chance to act before the company flies too far off course—whether that means helping the CEO to right the ship, or replacing him or her. And that same board is far more likely to select the right person for the job to begin with. The author of several books, including Execution and Global Tilt, Ram Charan taught at Harvard Business School and the Kellogg School at Northwestern University before becoming a consultant, strategic advisor and executive coach. MAY/JUNE 2014

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LEVERAGING SOCIAL MEDIA

Social Media & the B2B CEO What can the likes of Facebook, Twitter and Tumblr do for your company? By Dale Buss

To sell more textbooks, Wiley Publishing horns its way into social-media conversations among delegates to upcoming professional conferences. Transplace provides eye-popping graphics about industry issues that customers can lift out of the logistics consultant’s blog and plop right into their own Powerpoint presentations. IBM has created one of the world’s most-admired B2B, social-media programs by encouraging all of its employees to participate individually. Kraft operates an Internet “talent community” to help it acquire the best employees. And Adobe, the maker of graphics software, set up a social-media “war room” during the last Super Bowl for B2B communications—much like Oreo, Coca-Cola and other brands did to talk with consumers—as it launched an online-video ad to remind the marketing community of the importance of “screens” other than the TV. “We wanted to encourage marketers to accelerate their digital-marketing strategies,” said Ann Lewnes, Adobe’s CMO. “And we wanted to be the company that helps them do it.” Social media has moved robustly beyond the consumer marketplace into the business-to-business realm. Consumer brands still invest far more in communicating with their customer base via Facebook, LinkedIn, Twitter, Tumblr, Instagram and their own websites and blogs. But arguably B2B companies have been getting more bang for their bucks by leveraging the business-building capabilities of real-time, personal digital networking through social media.

KEY TAKEAWAYS • Leading-edge practitioners use social media to stake out thought leadership, more intimately manage customer relationships and find new customers • Societal and cultural familiarity with social media in personal settings serves as a gateway to B2B applications • Some companies are taking the risk of allowing all their employees to use social-media accounts—on behalf of the operation—with internal and external audiences “What’s unique about social media is that it allows you to have continuous engagement with a customer that’s bidirectional,” says Clay Stobaugh, senior vice president and CMO of Wiley. “It’s not like e-mail once was, where you’re just blasting something once, or [like] traditional media. You’re actually having a conversation. “However, there’s no silver bullet,” he warns. “It’s fairly heavy lifting. It’s still the old challenge of getting engaged with customers and knowing what their needs are. Social media just helps you do it in a whole new way.” One reason this works is the ubiquity of social media in the lives of practically every global citizen these days. They rely on dozens or hundreds of blogs for an endless variety of information and entertainment. And they’re familiar with the power of Facebook and other platforms for networking their

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personal lives. Many also share and commingle their private and occupational lives in those venues. Especially for younger generations, that ability creates a certain comfort with the use of social media for business purposes. Another enabler is that, while brands sponsor Facebook pages and Twitter accounts, their social-media efforts still break down to individual human beings’ sitting or standing somewhere and communicating with one another electronically, in real time. So, effective harnessing of social media by B2B brands involves using outlets to exploit this one-to-one aspect. “Within a certain area, who is the decision-maker?” as Stobaugh puts it. “The end game is pretty much the same: to find that individual and have a conversation with them.” There are skeptics. “I don’t know how much value there really is in B2B social media,” says Peter Heffring, CEO of Expion, a Raleigh, North Carolina-based digital-marketing agency. “For them, it’s sort of like checking the box. You need to be on social with whatever brand you’ve got, but the return on investment in social media is much higher in B2C than B2B.” IBM execs would argue vociferously with that point, as the company systematically and culturally encourages its more than 400,000 employees in more than 200 countries to talk about the company, as well as its products and services, on as many social-media platforms as they can. It has more than 300,000 employees on LinkedIn alone, for instance, and about 1.5 million individuals at its customers and elsewhere follow the company on Facebook. For example, IBM encourages its salespeople “to use social media as a way to understand customers better, to anticipate their needs, to create more provocative proposals,” says Ethan McCarty, director of marketing and communications labs for IBM. “It’s been very successful, particularly as IBMers have used Twitter and LinkedIn to connect with their clients and get value out of that.” The company also maintains what it calls an IBM Select, social-media platform around its “Smarter Planet” positioning in which more than 400 experts of various sorts open themselves to interaction with customers as “guests hosts” for a day on Facebook and other social-media platforms, sharing their expertise—and, again, building connections of interaction and understanding with customers. IBM understands that, for customers, the explosion of potential modes of communication with company representatives via social media is “uncomfortable at times, if they’re used to getting all of their information about our company through something narrow and controlled,” McCarty says. “But we think there’s real richness in that. It’s good business for IBM. There’s a good rationale for using social media’s complexity and trying to tease value out of that for IBM and our customers.” IBM executives count on safeguards to mitigate the risk of false or downright embarrassing information or opinions leaching from millions of interactions between its employees and customer employees into public information, as often happens to brands that partake in social media. It stresses company values

“I don’t know how much value there really is in B2B social media; it’s sort of like checking the box. You need to be on social [media] with whatever brand you’ve got, but the return on investment in social media is much higher in B2C than B2B.” —Peter Heffring, CEO of Expion and heritage that it expects social-media practitioners to respect. The company also has a strict social-computing policy with key tenets, including a ban on IBMers’ misrepresenting themselves or obfuscating their identities. And each social-media participant must complete company cybersecurity training. Besides, McCarty says, “It’s become clear that the risk of not participating in social media is much greater than the risk of participating.” Other B2B marketers also are concluding that social media works for them, both as an educational tool for their customers, as well as in support of marketing efforts. Transplace, for instance, is a Dallas-based manager of freight-transportation services for retailers and manufacturers, ranging from AutoZone to Del Monte Foods. CEO Tom Sanderson personally writes a blog about the many issues that impact the logistics industry, ranging from economic growth to gasoline prices to regulatory pressures. Transplace also uses the blog to lend out handy graphics about many of these topics. “Our customers are free to take any chart we have online and use it in one of their own internal presentations,” Sanderson says. “If the vice president of logistics is meeting with his CFO, he can take one of our graphs and tell an accurate and informed story inside his own organization. And when I speak at industry conferences, people come up to me [every time] and say how much they love the blog and graphs.” Meanwhile, American Express is relying heavily on social media to expand its Open online platform for helping its small-business cardholders with a wide range of advice. Open really started getting traction after the company used a Facebook page to launch “Small Business Saturday” in 2009. It designates the Saturday after Black Friday as an annual rallying point for consumers to support local merchants. MAY/JUNE 2014

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LEVERAGING SOCIAL MEDIA

Caterpillar: Courting Customers Caterpillar is one of the most far-flung companies in the world, with thousands of its high-priced excavators and earth movers digging holes and cleaning up debris for hundreds of public and private customers in dozens of countries at any given moment. So the Peoria, Illinois-based heavy-equipment giant is turning to social media in a variety of ways to tie that vast and sprawling community more tightly to its brand. “We try to connect the dots with whatever content we do on social media,” says Kevin Espinosa, social media manager. “At the end of the day, we’re trying to sell a piece of machinery—a product, a service or some training. We try to generate leads for our dealers and get them to dealers as fast as we can, so they have a relationship with the customer.” Caterpillar starts with using social media to “create a relationship with our customers that we’ve never had before,” Espinosa explains. For example, at the top of the sales funnel, Caterpillar is adding to its chops as a “thought leader” in its industry with blog posts that share with B2B customers “how to be a better landscaper, a better miner or how to get the most out of that skid steer.” The company also uses Facebook, Twitter and other social media to direct customers to stories about “how some piece of Caterpillar equipment is being used at a tornado or hurricane site or a hydraulic excavator that is really efficient,” he explains.

Caterpillar also has turned to social media to help dig up smaller customers in verticals, such as construction and landscaping that may have been using Caterpillar equipment for decades without much contact from the company. “There are so many customers we don’t even know, where their pieces of equipment might be in the second or third generation of ownership,” Espinosa says. “And we need to get that customer back because our annuity and our business is parts and service. It’s a big deal.” The company stalks “that customer” by going to small Cat owners’ own Facebook pages, Twitter accounts and other external, social-media nodes, looking for relevant hints in their profiles, posts, “likes” (such as the Facebook pages of Caterpillar competitors) and so on. Caterpillar also uses “social listening” in which its social-media personnel track what “key industry influencers” are saying about important topics in the industry. “We want to develop relationships with them, so they can help us spread the message about our brand,” Espinosa said. To assess the impact of all this activity, Caterpillar also is putting metrics in place “so that when we do post about a new hydraulic excavator and tweet it and put something [about it on] Facebook, we can figure out how it turns into sales,” explains Espinosa, “by tracking how visitors respond to the ‘call to action’ that typically accompanies online content.”

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The brand has used social media continually as a way to expand this B2B event. American Express uses the Open platform to publish case studies of Small Business Saturday success stories and to spread the word about effective business tools of all sorts. And Open members can get a $10 credit on their American Express cards by participating. “We do Small Business Saturday to inspire consumers and help business owners leverage that day to get the message out to them,” says Scott Roen, until recently the vice president of digital marketing for American Express. “It would be extraordinarily difficult to get out that message without social media.” Toyota has launched a “social syndication hub” that allows its individual dealers to access pieces of the company’s “branded content”—ranging from think pieces on environmental affairs to results for Toyota-sponsored teams in NASCAR races—and to appropriate it for the dealers’ own social media. The company posts a handful of articles and video clips each day to participating dealers’ Facebook and Twitter accounts, and it appears to online shoppers that the material is coming from the dealership itself. “It’s important to us on the dealership level because we can use these tools to get consumers engaged in product knowledge,” explains Brent Wofford, Internet sales manager at Alexander Toyota, in Yuma, Arizona. “And they believe that they can go to Alexander Toyota for answers about products.” Wofford can schedule as seldom as once a week what content appears, and when, each day. “It doesn’t look like an automated system,” he says. “Nothing is getting posted at 3 a.m. It looks like someone is at the dealership and posting them every once in a while.” Domino’s Pizza has come to rely heavily on an ever-burgeoning social-media network as a key nexus of communications with its 1,000 U.S. franchisees, who own most of its stores. The company’s “discussion boards” provide a means for franchisees and their managers to communicate continuously and securely with one another and with Domino’s to address just about whatever topic they want. “Domino’s can’t be successful unless we communicate effectively with franchisees,” says CEO J. Patrick Doyle. “And it’s critical that we reach them through avenues that are both modern and simple to execute.” Crucial to the success of this effort is ensuring that Domino’s provides a contextually and culturally relevant experience to franchisees who, of course, typically are using social media in many other facets of their business and personal lives. For instance, franchisees on an internal Domino’s network can “microblog” a message that can be accessed only by managers and employees at their stores—a function that Facebook, Twitter and LinkedIn make available to users in the “outside world.” Domino’s is developing ways for its own employees to share photos and videos internally as they already do in their personal lives on Instagram. At the same time, the speed of change in social media—many youths already are abandoning Facebook, for instance and one of the hottest new things has been Snapchat, in which messages disappear after a while—requires B2B marketers constantly to be evaluating potential new platforms.

BlueGrace’s Social Media Ambassadors More companies are turning to the true last frontier of social-media use in business: allowing employees to leverage social media on behalf of the company. BlueGrace Logistics, for instance, encourages all 160 staffers at its $150-million Riverview, Florida-based company to use LinkedIn, Facebook, Twitter and other social media to talk about the company and its services and to mingle such communications with personal news and observations with fellow employees, as well as with clients and potential customers. “We treat adults like adults,” says Bobby Harris, CEO of the transportation and logistics consulting company. “They can tweet or get on LinkedIn or whatever while they’re here. It keeps them connected with the outside world; but more important, it’s the best way to communicate inside the organization and you can’t place a big enough value on that.” Plus, Harris said, many of the highest-quality employees these days “want to have access to social media while they’re at work. It helps us recruit these people. That’s one reason we do social media so heavily.” Harris himself tweets continually. “I get to know my people,” he says. “People ask how you can have a personal relationship with a whole company as a CEO and that’s how.” Do customers mind, given that they occasionally will get to see BlueGrace’s dirty laundry? “They’re not only happy with us, but they remain our customers,” Harris reports. “There’s no way to get stickier with a customer than to get them communicating with you on social media.” “Social media gives us ideas and concepts we can use to better connect with our internal base, so we can utilize what exists today, as well as constantly [keeping] our eyes open to what’s next and [to] be ready to evolve,” Doyle says. In similar ways, thousands of B2B companies are plunging deeply into social media, says Paul Rand, CEO of marketing agency Ketchum, “because they’re seeing phenomenal success from lead generation to product development to customer service to flat-out marketing. If it isn’t part of the arsenal of any B2B company, it will have to become so very quickly, or they’ll find themselves at a real disadvantage.” MAY/JUNE 2014

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REPUTATION MANAGEMENT IN THE DIGITAL AGE

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You Are Whoever Google Says You Are CEOS HAVE A CLEAR CHOICE:

Define yourself via social media tools— or let your detractors do it for you. By C.J. Prince

Have you Googled yourself lately? You might be surprised by what you find. An online search of your name can unearth any number of unfortunate results, including, but not limited to: 1. The news article from six years ago in which you were misquoted as saying, “Profits are not a priority.” 2. The blog of a disgruntled shareholder who isn’t above name-calling. 3. An online, bulletin-board discussion in which you engaged in a very colorful debate with a dissatisfied customer. 4. The arrest sheet of a convicted felon who shares your name. 5. The resumé of an adult film star who also shares your name. The list goes on. Although the Internet offers both companies and individuals a cost-efficient, ubiquitous tool to distribute information, it has also become a repository of personal photos, data, emails, blogs and news items dating back decades—some of which can haunt individuals and companies for years. Unfortunately, once things are on the Net, they’re there to stay, much to the chagrin of some executives who wish they weren’t. “One of the most common mistakes CEOs make about managing their online presence is the idea that they can ‘delete’ items from Google,” says Julie Murphy, senior vice president and partner with Sage Communications. As Google’s own CEO, Eric Schmidt, admitted last year during an appearance at New York University. “The lack of a delete button on the Internet is a significant issue,” he said.

Key Takeaways • Search engines like Google have become a central tool for due diligence • Negative data cannot be “deleted” from the Internet, but generating positive content can “bury” it • 68 percent of Fortune 500 CEOs have no presence on any major social network; use the tools available to creative a positive presence online

It’s an issue on a variety of fronts. Often, the first thing that potential customers, employers, employees, business partners and media will do when researching you or your company is to Google you. “At the end of the day, your online impression—or in some cases, lack thereof—does reflect on who you are. It may not be the deciding factor, but it matters,” says Nels Olson, vice chairman and co-leader of the CEO and Board Practice for Korn/Ferry International. A standard part of Korn/Ferry’s vetting process for executive candidates is to do online searches and to look beyond just the first page of Google. “We’ll go a number of pages back.” Olson points out that since the hiring company will inevitably do the same searches on the candidate, some negative material can put an otherwise outstanding candidate on the back burner. The most common culprit? Photos taken at industry events showing no small amount of celebratory imbibing. “Mostly it’s around unprofessional behavior,” he says. MAY/JUNE 2014

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REPUTATION MANAGEMENT IN THE DIGITAL AGE

While there is no way to delete items, there are proactive ways to deal with the debris of previous gaffes and to clean up your online media profile—or prevent it from becoming tarnished in the first place. Here are some tips from the experts for putting your best virtual foot forward.

Google yourself. Like any problem, you can’t fix it until you know what it is. Google your own name and be sure to look at the first three pages, minimum. Use a variety of search terms—with your company’s name, with the city or cities where you’ve lived, with a board you sit on or a charitable organization you involved with. Make sure to get an objective picture of your online presence, suggests Lorrie Ross, CEO of Web Marketing Therapy, a marketing agency and training company. To do that, you may need to delete the “cookies” file from your browser. This file, which stores your personal web site travels and preferences, can cause your Google search to bring up more favorable results when searching your own name. “The search engines give a biased view based on what you like,” says Ross. “Do a clean search and see what others are seeing.” If you have a LinkedIn account (and you should), log out of it and then search for yourself to see which information is publicly available. Do the same with Facebook and Google Plus. Keep in mind that finding very little about yourself can be as problematic as finding negative information. “Not participating is no longer a solution in today’s environment,” says Tripp Donnelly, founder and CEO of RepEquity, an online reputation-management company specializing in search engine optimization, or SEO.

Search and destroy. While there will be a lot of content you can’t delete, there will also be a lot over which you do have control. The photo you posted to Facebook of your family on a lavish vacation may not play well during a period of stock

volatility or market recession; delete it to keep it from popping up in Google’s photo results. Change all of your personal-profile privacy settings to the strictest possible to keep them from appearing in online search results. When the negative content appears as defamatory content on another person’s blog or on a media outlet’s website, your options are more limited. You can pursue legal action, but it’s often difficult to get the resolution you’d ideally like, explains Richard Lee, a founder and co-managing partner with the law firm Salisian Lee in Los Angeles. First, if the defendant can prove he or she, or the organization, had a good faith belief in the truth of the material, libel will be very difficult to prove. “Even a successful resolution to these types of lawsuits— which are costly and often a waste of time, as there are a number of defenses to defamation—will typically result only in monetary damages for the harm caused,” says Lee. “The suits won’t eliminate those negative web hits, unless one can obtain a court order or injunction to take down the offending website.”

Push the dirt to the bottom. While you can’t delete negative information that appears on external websites, you can bury it beneath a deluge of positive content. That will, over time, force the negative data to drop lower in the ranking of Google hits. Over 90 percent of all search traffic is on the first page of Google results, with 99.3 percent in the top two pages, says Donnelly. To crudely summarize the search process: a Google program called “Googlebot” uses a method called “crawling” to search billions of web pages and create an ever-growing and changing index. When a user enters a query, the Googlebot machines search the index for matching pages and return the results deemed most relevant, based on more than 200 factors. The more content you create that can be easily searched and indexed by the Googlebot, the lower

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“Ninety-plus percent of Internet users instinctively ‘trust’ Google’s page one content, shaping purchasing decisions and corporate perceptions around what is presented on the first page of a search.” you’ll push the unsavory items. “Ninety-plus percent of Internet users instinctively ‘trust’ Google page one content, shaping purchasing decisions and corporate perceptions around what is presented on the first page of a search,” says Donnelly.

Fill out your virtual profile. One of the easiest ways to create positive content is to use the tools already available to publicize your professional profile. A recent survey by business-intelligence software company Domo and CEO.com found that 68 percent of Fortune 500 CEOs have no presence whatsoever on any of the major social networks—Twitter, Facebook, LinkedIn or Google Plus. LinkedIn is the most popular network for CEOs; but even then, only 140 of the 500 have LinkedIn profiles. Adoption of Twitter is growing, but still just 5.6 percent of Fortune 500 CEOs are users of the tool. Those are missed opportunities, particularly given that LinkedIn profiles often come up on Google’s page one. If you have no profile, or your profile is missing a photo or lists your current job as the position you held five years ago, you’re not getting the benefits you could be. “LinkedIn is a sleeping giant,” says Murphy, noting that while Facebook has garnered more attention, LinkedIn is the professional niche tool. “It does need to be more real-time engagement, but it’s going to get there.” She suggests taking full advantage of the section that allows you to describe who you are. Add your philanthropic activity, passionate pursuits and any other positive material that puts a more personal face on your corporate image.

Write your own story. Consider creating a web page for yourself, says Donnelly. “It’s not intended to be self-promotional or self-congratulatory. But the best person to tell your story is you,” he says, adding that CEOs should purchase their personal domain names and those of their family members as added protection, “even when you don’t want to launch personal content.” Ross notes that it takes little time to post content that already exists, such as positive news releases and articles in which you are quoted, as well as YouTube videos of speeches and photos of your participation in community activities. “Make sure they are tagged with your full name,” she says. The next level is to publish new, positive content that not only pushes down the negative, but establishes you as a thought leader in your industry, so that when a potential client, partner or employer searches for experts on a topic, your name will come up in the list. “We’re seeing a lot more executive blogs for that reason,” says Murphy. The more “hits” that content

receives, the higher up it will climb in Google searches for your name. That said, blogs are challenging to maintain for busy CEOs. “They’re a huge time-sink; and if you’re going to put content out there, it really needs to be good,” she says. Often, creating and managing this content for senior executives is the purview of the company’s media-relations team. Increasingly, managing social media content for the company is becoming distributed across departments, rather than having one social media manager on the case.

Use caution with social media. Powerful tools for both good and ill, online platforms have invited no small number of gaffes on the part of executives and companies over the past several years. John Mackey, co-founder and co-CEO of Whole Foods, first went through the wringer in 2007 after it was discovered that he had, over a seven-year period, masqueraded as an anonymous Whole Foods fan on Yahoo’s financial bulletin boards, praising his own company’s products and criticizing those of competitor Wild Oats. (The two companies have since merged.) He apologized, but even now, seven years later, a search of John Mackey on Google will still pull up a 2010 New Yorker article that talks about the embarrassing gaffe. “Today, with social media, people are less tolerant of not having full transparency,” notes Murphy. “And good companies make mistakes.” Another case in point: JPMorgan’s lesson that the best-laid social media plans can go terribly awry. The same day Twitter went public—with underwriting help from JPMorgan—the investment bank initiated a live Twitter Q&A about leadership and career advice with one of its senior executives, Vice Chairman Jimmy Lee. The firm’s tweet asked followers to submit questions with the hashtag “#AskJPM.” The request was quickly met with a deluge of sarcastic jokes and comments—18,669 tweets in the first 24 hours—lampooning the firm for a lack of ethics. The Q&A session was canceled, but the damage had already been done. “They had good intentions, but they should have realized that wasn’t the right forum,” says Murphy.

Build the ark before the flood. If Google doesn’t bring up any negative information associated with your name, now is the perfect time to get proactive about managing your online reputation, says Donnelly. “Launching new content, putting thought leadership out there, actively monitoring what’s out there—that’s a lot less painful and a lot less costly than coping with a crisis. It’s very difficult to get torpedoes back in the boat.” MAY/JUNE 2014

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EXECUTIVE LIFE

Andrew Murstein celebrating after a win by Marcos Ambrose, driving for Richard Petty Motor Sports, at Watkins Glen in 2012.

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WHY CEOS BUY SPORTS TEAMS— AND WHAT THEY DO WITH THEM Some CEOs buy a team to fulfill a life-long fantasy. Others do it to run a different kind of business. Some want to bring a team to their city and others to keep one from moving away. Meet some of the business chiefs who have become team owners. / By George Nicholas

To “Revolutionize” Major League Lacrosse Andrew Murstein is president of New York’s Medallion Financial, which lends to the taxicab industry and other niche markets. He’s also the majority owner of Richard Petty Motorsports, which fields two NASCAR teams. His acquisition of the team in 2010 for $120 million in debt “started out purely as a business decision, but I have come to love and appreciate NASCAR,” he says. He feels “tremendous pleasure when we win or perform well and aggravation when we don’t.” He recently acquired the New York Lizards “because lacrosse is one of the fastest-growing sports in the U.S.” In what he calls a move that will revolutionize the sport, he drafted goalie Devon Wills, the first-ever female player in Major League Lacrosse, in the supplemental draft opening the 2014 season. “I don’t believe team owners should go into the dressing room and travel with the team,” he comments. “There should be a clear separation between the athletes’ world and the owner’s world. I wouldn’t want them stepping in and parading people around my office or my bathroom. We treat this as a business and them as professionals.” However, that philosophy didn’t protect him from getting doused with champagne after a recent NASCAR victory.

rose, 2012.

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THE SPORTING ACQUISITION

Vivek Ranadivé (center right) and Shaquille O’Neal cheer the Sacramento Kings during a 90-88 win against the Denver Nuggets in Sacramento last October.

Can a Silicon Valley CEO fix the Sacramento Kings? To the dismay of its fans, the NBA’s Sacramento Kings finished dead last in ESPN’s ranking of the 122 teams in the NBA, NFL, MLB and NHL last September. But that didn’t discourage Vivek Ranadivé, CEO/founder of TIBCO, the $1 billion software infrastructure company. He bought majority interest in the team for $535 million last year, one day after the league rejected a bid by Steve Ballmer and hedge fund manager Chris Hansen to buy and move the Kings to Seattle. “I’m a huge basketball fan,” Ranadivé says. “I really felt I owed it to the region and the team’s fans to keep the Kings in the area.” The owner group is building the league’s first indoor-outdoor arena, set to open next year in Sacramento’s Downtown Plaza. TIBCO-powered technology will make the entire facility ticketless and cashless and provide fans with personalized, real-time offers on their smart phones. Ranadivé told Commissioner David Stern’s group he wants to make the Kings an “NBA 3.0 team.” Going against convention, Ranadivé hired a coach before he hired his general manager. He re-signed the team’s young star, DeMarcus Cousins, despite his well-publicized troubles and persuaded Shaquille O’Neal, a 15-times All-Star Center, to become a minority owner and to mentor Cousins. Ranadivé hopes to make the Kings a global brand with a big presence in India and China. “I think basketball will become the sport of the 21st century, like soccer was in the 20th,” he says. Before buying the Kings, Ranadivé led a group that outbid Larry Ellison to buy the NBA’s Golden State Warriors. He used technology to analyze online ticket sales patterns and identify the best combinations of players. The team’s valuation increased from $324 million to $555 million in two years. (Ranadivé had to divest to buy the Kings.) Ranadivé, who left Bombay at age 16 with $50 in his pocket to earn master’s and bachelor’s degrees in electrical engineering at MIT, grew up with cricket and soccer. In fact, he had never

even held a basketball when he began coaching his daughter’s middle-school team so he could spend more time with her. The team lacked size and athleticism; but, using analytics from his business, Ranadive decided to deploy an unconventional fullcourt press and took the team all the way to the National Junior League championships. Author Malcolm Gladwell recounted the story in his book, David and Goliath: Underdogs, Misfits, and the Art of Battling Giants.

Andrew Berlin in the dugout of the Silver Hawks, the Midwest League’s Eastern Division champs last year.

Doubling Fan Attendance Baseball can be profitable if it’s operated “like a business rather than a vanity investment,” asserts Andrew Berlin, who became sole owner of the South Bend Silver Hawks of the Class A Midwest League three years ago. He says he manages both the team and his company with a single philosophy: Thrill the customer. The CEO of Chicago-based Berlin Packaging, which provides containers and dispensing systems, doubled fan attendance since he bought the team. He redesigned the park to make it more family-friendly, with a kids’ splash-pad playground among its many features. “We re-imagined the fan experience,” says Berlin, who also applies his thrill-the-customer philosophy at his $800 million company with extras like interest-free financing. “We have a truly sustainable business at this point. I’ve

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focused my involvement on the business fundamentals of the Silver Hawks. We want to sell tickets, engage sponsors, provide a great experience and connect with the media and community audiences. All of these require skills that are not unique to baseball, so I’ve been glad to dive in. There are other areas where I am learning and listening. I’m fortunate to have a great front-office staff that knows how to run a team.” An affiliate of the Arizona Diamondbacks, South Bend’s Silver Hawks finished first in the Midwest League’s Eastern Division last year. Its name is a tribute to the Studebaker Silver Hawk automobile that once was manufactured across the street from the stadium. Berlin is also a limited partner of the Chicago White Sox.

Michael Alter on court at the Allstate Arena, home of the Chicago Sky.

High on the Sky “I am not a major sports nut,” says Michael J. Alter, president of The Alter Group, a leading office developer based in Skokie, Illinois. “I had no notion of owning a professional sports team.” But in 2005 he bought the franchise for Chicago Sky, one of the six teams in the WNBA’s Eastern Conference, for $10 million because “it did not make sense to me that the third-largest city in the country and frankly, in my opinion, the best sports town in the country, did not have a WNBA team.” “I treat the Sky not as an avocation but as a business,” he says. “We’ve come a long way since 2005, when we marched our new coach—NBA Hall-of-Famer Dave Cowens—and new mascot, the Sky Guy, through the streets of downtown Chicago while trying to drum up interest.” Last year, the team made the playoffs for the first time in franchise history. This helped increase sponsorship and attendance by 20 and 30 percent, respectively. One of the team’s games on ESPN 2 garnered the highest audience for a WNBA game in nine years. Alter is impressed “not only by the WNBA players’ prowess as athletes but their intelligence, their passion, their dignity and their power to inspire.”

Michael Schwartz with members of the 2013 Team SmartStop bicycle racing team.

Should You Buy a Team? Over the past decade, owners who have sold teams saw their values increase by between 7 and 11 percent annually, depending on the league, according to Scott Milleisen, head of JPMorgan Chase’s Private Bank Sports Finance Unit. Much of the growth resulted from richer media-rights agreements in recent years, he adds. What sports franchises should return-oriented CEOs consider? Minor League Baseball teams that are affiliated with an MLB team have been a good choice, according to Anthony DiSanti, managing director of Citi Private Bank Sports Finance and Advisory team. One of the reasons for this is that they share costs with their MLB affiliate. With any sports investment, he adds, “the most successful clubs today are supported by a talented team of individuals with diverse experience surrounding key revenue drivers like media, real estate, retail and sponsorship.” Local owners have the best chance at creating value due to their knowledge and relationships with civic and business leaders, adds JPMorgan’s Milleisen. “Owners are typically very involved in management of sports franchises,” he comments. “It is not always apparent to the public, but sports organizations often adopt the personality of the controlling owner. Owners make the most important hiring decisions, set the direction for the brand and generally guide the culture.” George Steinbrenner’s personality continues to permeate the Yankees organization even today, he says. Rising team prices have attracted more investment groups, but individuals are continuing to buy teams. Witness the recent activity in the NFL. A Triple A baseball team will cost $20-25 million, while a team in the low minors can be had for as little as $100,000. There is an active debt market for sports teams. On the lower end of the range, CEOs can buy a share of the Green Bay Packers for a few hundred dollars. Another alternative is to sponsor a team’s events rather than buy ownership. This is the route taken by H. Michael Schwartz, CEO of Strategic Storage Trust, a publicly registered non-traded REIT owner of self-storage facilities with the SmartStop Self Storage brand name. His company is the lead sponsor of the Team SmartStop bicycle race team and its 15 members wear the brand’s logo on their uniforms. Schwartz says sponsorship provides three kinds of benefits: “Positive brand awareness, cross-promotional opportunities and increased engagement in our social media outlets.” Like the other CEOs profiled here, he is an enthusiastic fan. “When I attend a race,” he says, “I make sure to talk to each member of the team and its manager with the goal of offering encouragement and support.”

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Stephen Ross cheers the Dolphins at their home field, Sun Life Stadium, during the fourth quarter of Miami’s 27-23 win over the Atlanta Falcons on September 23, 2013.

Owning the Dolphins, Living the Dream “When I read the paper, the first section I go to is the sports section,” says Stephen M. Ross, chairman and majority owner of Related Companies, whose global real estate holdings are valued at over $15 billion. “Since I wasn’t going to make it as a player, it was a dream to become an owner.” Ross became 50 percent owner of the Miami Dolphins and its stadium for $550 million in 2008. He bought an additional 45 percent the following year for another $550 million. Since then, he has brought in Gloria Estefan, Marc Anthony and Venus and Serena Williams as minority owners. Ross says he intends to keep the team in Miami despite having failed to secure Florida and Miami-Dade funding to renovate Sun Life Stadium. Ross, who has a net worth estimated at $4.8 billion, is a former minority partner of the New York Islanders and was part of a group in 1990 that tried to bring Major League baseball to Miami before the Marlins were founded. He also tried to buy the New York Jets in 1999 and was on the executive committee that hoped to bring the Summer Olympics to New York in 2012. An active philanthropist, Ross ranks second only to Michael Bloomberg in gifts for higher education. He lives and works at one of his properties, the Time Warner Center in New York. His current projects include the 26-acre Hudson Yards development on Manhattan’s West Side. ========================================================= George Nicholas (georgenicholas@mindspring.com) is a journalist and communications consultant in New York.

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FLIP SIDE

To Bitcoin a Phrase Is cash really no longer king? The future of bitcoins is very much up in the air. Scant months ago, bitcoins and other “altcoins” seemed poised to take over the world. You couldn’t open a newspaper or run a Google search or walk through an airport or have a quiet cocktail without hearing somebody ranting about this exotic virtual currency. Bitcoins were The Blair Witch Project of finance; they were going to make the existing infrastructure of commerce disappear overnight. Cash? Stupid. Credit cards? Dumb. Gold? A crude, metallic substance designed to be hoarded by idiots. Bitcoins were different. Bitcoins were going to usher in the Iron Age of imaginary currencies and usher out the pathetic Bronze Age of dollars, pounds, euros, Swiss francs and the yuan. Bitcoins, we were ceaselessly told by bitcoin aficionados, were going to revolutionize the world of commerce, replacing cash with an online currency derived entirely from algorithms. The great appeal of bitcoins was that they could be moved directly from one account to the next, bypassing government regulation and cutting out the middleman. Much like peer-to-peer file-sharing, bitcoins could seamlessly move from one owner to the next without any persnickety authorities getting in the way. Then all hell broke loose. First a number of governments became suspicious of altcoins, arguing that they might be used to launder money. Next, hundreds of millions of dollars’ worth of bitcoins—750,000 bitcoins, all told—disappeared from the prestigious bitcoin exchange, Mt. Gox. Now no one knows where the future of bitcoins lies. The insane hype of a few months back, hysteria aided and abetted by the media, is now making some people look very, very foolish. But if people think alternative currencies are likely to go the way of Milli Vanilli, the DeLorean and the Newton, they had better think again. What the public does not realize is that the horse has already left the barn, that it is too late for Katy to bar the doo, for bitcoins are just the tip of the virtual-currency iceberg. Operating far below the radar, many other exotic financial instruments derived from powerful algorithms are being stored in server farms anchored off the coast of Iceland. Just as soon as the bitcoin furor quiets down, these instruments will rise to the surface and have their day in the sun. Here are two examples: Bitmunis are an exotic type of municipal bond that exists only in the abstract. They are derived from insanely complicated algorithms incorporating the Kondratieff Cycle, Fibonacci Numbers, Fermat’s Last Theorem and the annual rate of return on investment-grade bonds issued by the cities of Cleveland, Philadelphia, Detroit and Baltimore. Bitmunis can be traded

directly among investors and need never be evaluated by ratings agencies because bitmunis are self-rating. Powerful sensors concealed in the bitmunis themselves instantaneously recalibrate the current price and yield on the units, making it unnecessary to ever consult Moody’s or Standard & Poor’s to find out what they are worth. “You stash away bitmunis for widows and orphans and they never have to worry about money for the rest of their lives,” says Gisele-Aphrodite Saberhagen of the Reno-based Bitmuni Foundation. “It’s electronic coupon-clipping at its most abstract.” BitReverseCollateralizedMortgageObligations are another exciting new instrument. These securities can be cut into alt-tranches marketed by virtual brokerage firms that only exist on server farms hidden away in the forests of southern Romania. “BitReverseCMOs are going to make junk bonds go the way of the dodo,” says Lee Kunstler, executive director of the Federal Virtual Deposit Insurance Corporation. “No one knows what they are, what they do, where they come from, what they look like or where they can be found. Other than that, they’re exactly like treasuries.” One final note: In recent weeks, there has been much speculation about who invented bitcoins in the first place. Some say it is Dorian Nakamoto, a 64-year-old engineer who lives in Southern California. Other insist that it is Eastern European gangsters associated with a shadowy organization called SPECTRE. But the latest evidence points to a rogue avatar in a popular video game who possesses extraordinary programming skills. “Gangulon Moonterror, Wraith of Slikl, is smart, he’s funny, he’s daring and he’s unstoppable,” says Kuntsler. “He doesn’t exist, true. But in the world of virtual currencies, that’s generally viewed as a positive.” MAY/JUNE 2014

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FINAL WORD

THE IMPERIAL CITY Columnist Peggy Noonan recently opined that Americans feel less like citizens and more like subjects. We are dictated to, not consulted. We are told to get in line or feel the wrath of the state. One is reminded of the scene in Ridley Scott’s 2000 film Gladiator when Russell Crowe’s Maximus Decimus Meridius and his fellow gladiator-slaves are brought to Rome from the provinces. Upon entering the imperial capital, they behold the enormity of the Coliseum itself in all its imposing majesty. Haken, the German gladiator, is overcome saying, “Who could build such a thing?” Washington has that effect. Power seekers and power mongers are thick on the ground. Maybe it always has been. The difference now is the size of the machine. The Leviathan has grown in such size and power that—unlike in past generations—it can’t be ignored. Like imperial Rome, it dominates life. A report from MSN Money illustrates how the political elite are getting rich by exacting tribute from ordinary Americans. America has 3,033 counties, and they identified the 15 richest jurisdictions from that list. Of those 15 super-elite counties (the top 1/2 of one percent), 10 are in the Washington, D.C. metropolitan area. One may wonder about the location of the other counties in the top 15. Four of them are suburbs of New York City: Nassau County on Long Island, as well as Morris, Somerset and Hunterdon counties in New Jersey, meaning that many are home to well-off, Wall Street people. Douglas County, Colorado is the only one of the 15 west of the Mississippi. It’s no secret that Washington, D.C. has become—in every sense—the imperial capital. When asked about his opinion of

living there, President Kennedy used to joke that Washington had the best of both worlds: Southern efficiency and Northern charm. But that was then. In Kennedy’s day, Washington was a backwater town. Most Fortune 500 companies were headquartered in New York, Chicago and greater Boston. At last count, at least 18 and as many as 24 F500 companies are centered in and around the capital, depending on how broadly one defines greater, metro D.C. And defense contractors no longer dominate their ranks. There may not be as many F500 firms near D.C. as Texas’s 64, but it tells you something: It makes sense to be near the center of power. The march toward the all-encompassing state seems relentless, but it need not be, argues columnist Nick Sorrentino. “Thankfully, we have new technologies which can counter the snowball of statism, but we must use this technology vigorously and protect its free and open access. A renaissance of classical, liberal thought is possible, but it won’t be easy, “he argues. In his book, The Road to Freedom, American Enterprise Institute president Arthur C. Brooks argued that there are two contradictory and irreconcilable strategies for achieving prosperity, and Americans must choose which one they want to pursue. According to one view, the key to prosperity is the state. The policy prescription is, therefore, higher levels of government—more stimulus, more taxes and more borrowing. In line with the second strategy, the source of economic growth is free enterprise. At the least, the policy prescription is for the government not to interfere with entrepreneurs and allow them to succeed. As economist, statistician and writer Milton Freeman, once said in a different context, “we are free to choose.”

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