The necessity of mastering the vital few
Most of us are familiar with the Pareto Principle, often referred to as the 80:20 rule. The idea, as captured in the graphic below is that a few activities are disproportionately responsible for a large majority of results. The implication, if we can identify the valuable few and take action to deliver them, is that we can achieve substantially better outcomes with less effort.
In the world of private equity investments, that principle could apply in various ways. Certain investments will strongly outperform the rest of a portfolio; particular sectors or strategies may be unusually productive (which may explain the current big focus on SaaS models and buy-and-build programmes); certain Chairs or CEOs may be seen as having golden fingers.
But there is another angle which is relevant to a wide range of investment situations and styles, namely giving special attention to decision-making related to a few key board processes. Consider the following activities:
buying other companies;
setting executable strategies;
making senior appointments;
creating high performance teams; and
building effective organisations.
What do those have in common?
They all involve high stakes – upwards and downwards – with major implications for value outcomes. However, those activities and their outcomes are rarely defined or monitored systematically and are instead mostly left to subjective judgement. Moreover, with the benefit of hindsight, we can see that many decisions in this area are made quickly and with limited process when compared with, say, major items of capex. The exception may be bolt-on acquisitions where some boards bring real rigour to the task.
The other thing which unites these activities is that decisions are unusually complex for a couple of reasons. Firstly, there are usually many dimensions which can influence success or failure. For example, the Catalysis model of team effectiveness includes nine factors – and is definitely not comprehensive. Likewise, constructing a complete and executable strategy involves bringing together many elements. That complexity means that multiple people usually need to be involved to wrestle with the issues and trade-offs involved. However, on-going accountability for team and organisational effectiveness (by definition, cross-functional in nature) is rarely assigned explicitly unlike classic functional responsibilities. The cross-functional profile explains in part why these activities are so high-stakes: good or bad decisions affect almost everything else in a business.
These complexities in causes and stakeholders explain why failure rates for these vital few activities can be so high. Research on acquisitions and senior appointments typically point to lower-than-expected results at least half the time. The quality of strategies, teams and organisations is harder to measure but does anyone with board experience really believe that more than half of outcomes are typically successful? Contrast that with expectations about processes lower down in the organisation, i.e., invoicing, deliveries, machine up-time, where failure rates at 10% would be seen as unacceptable.
Putting those last three paragraphs together suggests that these complex but vital board processes relate to value outcomes the way displayed in the graph below: the effort of getting the vital few activities right is high – but the potential benefits are even greater.
If that is true, what principles can guide us to better outcomes?
The first thing to observe is that none of these issues are fixable in an absolute sense – and there are no silver bullets. Consequently, a useful objective is not to expect the elimination of all mistakes – but to remove predictable sources of error which can more easily be avoided. If we can reduce own goals, that is already a major shift in the right direction.
Secondly, to systematically – and irreversibly - improve the ‘batting average’, we need guidelines or processes which can resist constant pressures to act opportunistically. That means simultaneously both committing rigidly to following certain principles while making their application intuitive and low pain. In the case of strategy, for example, that means defining what a complete strategy looks like and then double-checking process outputs. Regarding team and organisation issues, it means creating measures of how well things are working and then checking them periodically. In executive selection it means asking the right questions of candidates and ourselves to avoid systematic biases.
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