My agent just got me a publishing deal with CelebrityPress® to co-author a book with Brian Tracy called Masters of Success.
I have finished a chapter of the book, which I am posting below. It discusses the importance of using Principled Performance as a way to make better business decisions. I would encourage you to read through and provide me with comments and feedback.
I will send out another post when the book is ready for purchase, later in 2016.
Making Better Business Decisions as a Principled Performer
By – Jason Mefford
On the morning of Friday, 18 September 2015, I received an alert on my phone: “The [Environmental Protection Agency] EPA set to make an announcement about a major automaker at 12:00 PM EST today.” The gears in my mind started turning at high speed.
At the time, I was a shareholder in a major automaker and wondered how this announcement would affect me as an individual investor. Usually these sorts of announcements, especially from the EPA or another government regulator, were not a good sign for an organization’s stock value. It usually meant the organization had done something illegal and was about to be penalized. The news, and the penalty, usually lead to a significant decline in the stock price, at least for the short-term.
Was the company I was invested in the culprit? I monitored my phone closely that day until I heard the news.
The press conference was to announce the EPA issued a Notice of Violation (NOV) to Volkswagen, alleging that four-cylinder Volkswagen and Audi diesel cars from model years 2009-2015 included defeat device software that circumvented EPA emissions standards for certain air pollutants. The NOV alleged Volkswagen loaded a sophisticated software algorithm onto almost 500,000 vehicles in the United States. This defeat device software could detect when the car was undergoing official emissions testing, turning on controls to pass the test, but under normal driving situations the cars would emit nitrogen oxides up to forty times the standard allowed by law. Such devices, which provide false information about the actual pollutant levels in order to evade the clean air standards, are illegal.
The stock market and I were left to wonder what would this mean for Volkswagen. We all knew this was just the beginning of something much bigger, but how much bigger we did not know. How would this affect Volkswagen’s stock price? Over the course of the next few days more information became available.
When the stock market opened on Monday, 21 September 2015, Volkswagen’s stock started its decline by dropping almost 20% in one day.
On Tuesday, 22 September 2015, Volkswagen announced there were eleven million vehicles world-wide equipped with the defeat device software, 10.5 million more cars than the US EPA was alleging. They also set aside a provision of $7.3 billion “to cover the necessary service measures and other efforts to win back the trust of our customers.”1 The stock continued to drop.
Over the course of the two weeks following the announcement from the EPA, Volkswagen’s stock price plummeted almost 40%. That means, shareholders who invested in Volkswagen lost almost 40% of their wealth due to this particular event and the market’s reaction. An event that appears to have started all the way back in 2007 and was the result of a series of bad decisions. Decisions that did not take into account the full impact they would have on the value of Volkswagen.
The example of Volkswagen is become ever more common in the media. This begs the questions of why, what and how. Why are these sorts of events happening to large, sophisticated organizations? What can we learn from them to make sure our organizations don’t suffer similar events and losses? How can we make better decisions?
Running an organization is similar to being a juggler. There are several different balls an organization must continually juggle. Organizations have multiple objectives to achieve, but also have to be concerned with uncertainty and business risks they face, while complying with laws, regulations and promises has made to various stakeholders. The concept of Principled Performance2, is the reliable achievement of objectives, while addressing uncertainty and acting with integrity. The three “balls” an organization must juggle are: governance or performance, risk management, and compliance.
When organizations get into trouble, they effectively “drop” one or two of these balls, usually because they are so focused on the others. Successful organizations do a better job of juggling these three balls, keeping their eye on all three as they fly through the air. Organizations that practice Principled Performance have capabilities in place to ensure all three balls are juggled and monitored to ensure one of them does not get dropped.
Organizations are created to meet specific objectives or identified needs. For many organizations a major objective is to earn money and make a profit, or return, for its owners and investors. Even public sector (governmental) and non-profit entities are concerned about staying within financial budgets and providing a net contribution, that can be used to provide those public services. Other objectives often relate to strategic, operational, customer, or processes. Sometimes these objectives can compete with each other. For example, the objective of making a profit may take a backseat to increasing sales. Organizations may sacrifice profit by taking a strategy to lower prices to increase the volume of sales.
Regardless of the type of organization, a group of individuals came together seeing some opportunities or needs in the marketplace. For example, an opportunity to make money from providing a new or different product or service; or a need for some public services to help their community. They developed specific objectives and created a business model to meet those objectives. Business models include strategies, processes, technology and infrastructure that help organizations meet their objectives.
Governance or performance relates to how an organization is structured from the owners, board of directors, senior management, management, and on down to the employees. This is how the organization has developed strategies, processes, technology and infrastructure to help achieve its objectives.
Along the road to meeting objectives, uncertainty happens. Uncertainty that invariably has an impact on whether or not the organization will meet its objectives. This uncertainty comes in the form of certain opportunities and threats. This uncertainty creates obstacles the organization must navigate around on the way to meeting its objectives and is the reason for taking a risk management approach to business.
Organizations have to make decisions today about uncertain future events. They have to make decisions affecting investment of money, people, infrastructure, resources without knowing for sure if the investment will pay off. The process used for making the best decisions possible, based on this uncertainty, is called risk management.
In addition to navigating around the obstacles, an organization must also stay within certain mandatory and voluntary boundaries. Mandatory boundaries include those requirements imposed on an organization by an external party: for example, laws and regulations. Voluntary boundaries are values, policies, procedures, processes, contracts and promises the organization has voluntarily chosen to follow. Often these voluntary promises are made in public statements expressed to its stakeholders, or are in the form of agreements with its business partners.
In order for organizations to exist in today’s business environment, they are granted license to do business from a government entity. The legal structures organizations use, such as corporations, partnerships, limited-liability companies, come with certain expectations. The governments where these organizations are domiciled expect the organizations to follow the necessary laws and regulations. Other stakeholders who work with the organization also have expectations, usually in the form of promises and contracts. Maintaining the trust with these stakeholders, by following the laws, regulation, promises and contracts; and, being able to prove this trust is called compliance.
A stakeholder is a person, group, or organization that has direct or indirect stake in an organization because it can affect or be affected by the organization’s actions, objectives, and policies. This is a very broad definition, but in today’s inter-connected world it means almost anyone can be a stakeholder of your organization. Some of the most common stakeholders include: investors, employees, vendors, customers, communities, and government regulators.
The answer to our first question: Why are these sorts of events happening to large, sophisticated organizations? Organizations are dropping one of the three balls. In the case of Volkswagen, it appears decisions were made starting back in 2007 to help them sell cars that weren’t designed to meet the new environmental regulations. Including defeat device software on these cars would help them meet their objectives of selling more cars and making more profits, but at the expense of sacrificing compliance with laws and regulations. At the time the decision was made, I surmise someone thought it more important to meet the sales and profit objectives, than to comply with the law. They effectively allowed the compliance ball to come crashing to the ground while the focused on selling more automobiles in their effort to become the largest car company in the world.
What those individuals failed to realize is how the loss of trust, caused by non-compliance, would impact meeting their objectives. This is a common mistake made by managers: not anticipating the full impact our decisions may have on the organization. We already know they have taken a $7.3 billion write-off, and several experts are anticipating this event will cost Volkswagen at least $30 billion. The loss of trust has led to a significant decrease in sales in the 4th quarter of 2015, and the potential for lawsuits from various stakeholder groups.
In business school I was taught, like many other business students, that our key objective as managers of an organization was to “maximize shareholder value.” I don’t think that is an incorrect statement, but I believe many business managers misinterpret short-term profits as the key to shareholder value. Shareholder value is a long-term principle, and as we have seen with the Volkswagen example, shareholder value can be erased very quickly by dropping one of the balls. Managers need to be more concerned about what is right for the organization in the long-term, not the next quarterly earnings release, or even next year’s revenues.
It can take years for someone to notice when a ball drops. We see in the case of Volkswagen, and others like the penalties assessed on the US banks related to the sub-prime mortgage issue from 2008, when it is the compliance ball that drops, the government will eventually come knocking at the door demanding justice. In both of these examples it took the government seven or eight years before sanctions and penalties were assessed erasing much of the prior profits.
The answer to our second question: What can we learn from them to make sure our organizations don’t suffer similar events and losses? Organizations need to take a more Principled Performance approach to business, considering and integrating governance, risk management, and compliance processes to ensure the balls don’t drop. In large, complex organizations these functions are usually managed by different people who often do not communicate. Developing capabilities to ensure the organization makes decisions in a Principled Performance manner, considering the impact decisions have on governance, risk management and compliance, will help ensure one or more of the balls don’t get dropped.
So, how can we make better decisions? We can develop capabilities and decision-making models to help our managers make decisions that consider all three balls: governance, risk management and compliance. We can use frameworks and models, such as the OCEG GRC Capability Model (Learn to GRC Audit) to help us ensure we have the necessary components and elements built into our capabilities to ensure our managers are making decisions that consider the governance, risk management and compliance aspects of our business. We can encourage communication between the various functions in our organization that impact these three areas. We can develop decision-making models to help ensure our managers consider all of the impacts their decisions have on the organization, in the short-term and the long-term. We can align our performance, compensation, and incentive programs in such a way to ensure we encourage our managers to be vigilant in juggling all three balls, without damaging our reputation or failing to anticipate a risk.
In short, we can make better business decisions when we consider the concept of Principled Performance. We have to think, how can I reliably achieve my objectives, while addressing uncertainty and acting with integrity? What is the decision that make will allow me to achieve my objectives, manages the uncertainties and risks I face, but doesn’t sacrifice my integrity?
If we don’t make decisions considering all three areas in a principled way, we will find ourselves just like Volkswagen, and countless others, giving back more than a short-term gain when a ball drops.
1 http://www.volkswagenag.com/content/vwcorp/info_center/en/news/2015/09/Volkswagen_AG_has_issued_the_following_information.html
2 The term Principled Performance is a trademark of OCEG, used with permission (www.oceg.org).
