CEO Logic: How to Think and Act Like a Chief Executive

Part 1

The Foundations

CEO Logic begins with clear thinking, based on the disciplined application of fundamental business principles. Part 1 : The Foundations teaches these fundamentals, the essential groundwork required for constructing success in any business: how to develop a valid business philosophy and how to apply that philosophy strategically.

Chapter 1 offers insights into fundamental business principles, catalysts for developing individual personal management philosophies, and guidance for preparing core operating values for a specific business. Chapter 2 addresses the critical and strategic issues of core competencies and competitive edge.

Together, these chapters lay the groundwork for the clear thinking that is the hallmark of CEO Logic. Begin here to build the foundation for your own success.

Chapter 1

Thinking Like a Chief Executive Officer

Out of intense complexities, intense simplicities emerge.

—Winston Churchill

CEOs are the proclaimed heroes of the business world. They make the big decisions, they make the big saves, they earn the million-dollar salaries. Everyone tries to learn their secrets in order to replicate their success in the game of business. But too often the focus is on what they are doing —how they are reengineering a company in trouble, leading a successful reinvention of a company's image or executing a daring acquisition. Doing, of course, is essential—the ability to take the right risks and follow through on strategy is part of what all successful top managers do. But something else is missing, the something that is the real secret to all those CEOs’ impressive accomplishments. That something is the thought that drives the action. No one leading an organization can do it well unless the fundamentals have been thought through—only then can he move ahead to implement them in creative, innovative, and effective ways.

This systematic clear thinking about the fundamentals is what CEO Logic is all about. Top managers, of course, immediately see the value in learning to think like a CEO. But ambitious businesspeople at all levels are also realizing that their own success depends on their ability to think strategically and incisively, the way the best CEOs do. For most of the past century, business success has been driven by manufacturing productivity. As a new century approaches, however, the business environment is rapidly and radically changing. In the future, business success will depend more and more on the capacity to acquire and leverage knowledge. And it is the clear thinking of the CEO that is defining the new standards of what we need to know to remain competitive in the world of business.

The Philosophical Foundations of CEO Logic

What, then, are the challenges facing CEOs that force them to a higher level of thinking? The key issues that CEOs and senior managers confront every day are often very different in scope and consequence from those they faced in lesser assignments. Instead of having the middle manager's responsibility for playing by established rules and meeting predetermined targets, the CEO has both the opportunity and the obligation to determine the nature of fundamental operating systems, company culture, parameters of the business, and the structure of the organization. This freedom to increase the scope and risk of decisions forces top management to think differently about business. Operating without the safeguards that come with lower positions and largely determining their own authority levels and operating parameters, CEOs have to develop for themselves the concepts and principles that will be reliable foundations for their management decisions. If they fail to do this, so will their businesses fail. But even those at different levels of responsibility in an organization will find that a well-thought-out philosophical foundation will guide their decisions and actions to new levels of success.

For anyone, at any level, a comprehensive and valid business philosophy begins with at least three primary elements:

Mastery of Fundamental Business Principles: Market realities regarding management, competition, and economics that determine the general business environment.

Personal Management Philosophy: Your own core ideology that reflects your beliefs and values regarding management style, organizational structure and goals, policy, people, character, and operating methodology.

Core Operating Values: A defined set of operating practices, consistent with your personal management philosophy and the fundamental business principles that you believe are necessary to be successful in a specific business in a specific industry.

The goal of developing a valid business philosophy is to take the theoretical and practical elements of fundamental business principles (inescapable market realities that govern and drive all businesses) and your personal management philosophy (your own core ideology) and apply them to a specific business opportunity in order to arrive at a set of core operating values (practical company guidelines). In effect, by establishing core operating values, you are developing a mini-business philosophy that applies to the opportunities, problems, resources, and competition in your specific business.

Articulating your business philosophy helps to clarify the road to success, regardless of your position. Experienced CEOs know there is no packaged best way to manage, and so should you. There are only valid operating principles that can serve as a foundation to guide a company and its management team. During these times of change and uncertainty, business is always complex, difficult, unpredictable, challenging, and competitive. A CEO soon learns that there are no secrets or shortcuts to effective management. The trendy management programs with catchy names developed by clever consultants are often good ideas, but they are developed for the specific circumstances of one company and cannot be converted into a general theory for all companies. Good management of any particular company must be based on clear thinking about the fundamentals of that business.

Developing a valid business philosophy is not a be-all and end-all guarantee of success in the face of all challenges, but it can provide the foundation for skill, talent, instinct, experience, training, education, and even luck to play their roles in developing a vision and strategy that will pay off in the long run. Michael Thornton*’s story provides a useful illustration of the role of the persistent and successful development and application of his business philosophy in running his $14-million retail appliance company.

Michael Thornton: A business philosophy in action

Michael began in 1974 with one appliance store in a strip shopping center in downtown Los Angeles. As the anchor tenant of the small development, he had the largest store and was therefore the primary draw for all the other stores in the center. He purchased his products at competitive costs, priced them fairly, and ran a low-overhead operation. He developed a selling system that moved products but also allowed his customers to feel comfortable during the process. Michael and his company became known for honesty, value, and hometown service.

When Michael expanded his operation, he attempted to duplicate his original concept. Eventually he opened 11 stores in mostly urban locations. Business was good for a while. But his success brought competitive challenges. First, other appliance chains expanded into his territory. That hurt margins. Then he faced competitive challenges from specialists who competed in only one or two facets of his business. That hurt volume. At this point, Michael realized that just being an honest, fair, and somewhat crafty businessman was not enough. He needed to improve his competitive strategy.

Michael's first competitive move was to increase his advertising in order to generate more and better-qualified store traffic. His competitors countered by increasing their own advertising or by moving to malls. His second move was to further improve his advertising by touting independent product tests and using celebrity testimonials. His competitors mirrored his actions. Then he relocated from urban strip centers to suburban malls and concentrated his locations to get the most out of his advertising efforts. His competitors followed him to suburban malls, eliminated their own advertising, and used their window and store displays to convert general mall traffic to appliance store traffic. The elimination of advertising costs actually gave them a cost advantage over Michael's stores, and his margins deteriorated further. Michael's next move—to narrow his focus by specializing in TVs and stereos—worked for a while, but soon a number of his competitors followed. He realized once again that something was missing from his operating strategy.

What had gone wrong? Michael Thornton was still honest, still gave value, still ran a low-overhead organization, and was working harder than ever. He blamed his problems primarily on his inability to accurately predict his competitors’ counter moves. To some degree, that was correct. But his main mistake was in failing to recognize that he was violating a fundamental business principle: Unique or distinctive customer benefits must be generated and supported by hard-to-copy core competencies.

Michael's original concept for his business worked until it was copied. His improved advertising had the potential to become a core competency, but it was never fully developed. In addition, his move to suburban mall locations was inconsistent with his increased advertising strategy. Higher square-footage costs of suburban mall store leases only make sense when the store can take full advantage of the mall-generated traffic. Michael's increased advertising probably helped his in-mall competitors as much as it helped his own stores. Concentrating on TVs and stereos, likewise, was not grounded in a core competency, and was therefore easily countered.

Michael finally realized that he needed to develop a valid business philosophy. To guide his business decisions, he needed a set of core operating values that was consistent with market-dictated fundamental business principles as well as his own personal management philosophy. His old strategy was consistent with his personal ideology and view of the industry, but violated certain undeniable business truths. Without core competencies and high entry barriers, his competitors could (and therefore would) easily copy his strategic moves.

After rethinking his core operating values, Michael's final move was to abandon his mall locations for large single-point destination stores. He kept his focus on TVs and stereos, as well as his hometown, friendly selling system and his strategy of concentrated locations. In addition, he put more effort into improving his advertising. These strategies worked. Because Michael had first pick of the few available sites for his large destination stores, it was difficult for his competitors to copy that move. The relocation from malls lowered his facility costs as a percent of sales, so he could use the additional margin to fund his increased advertising. Michael's in-mall competitors either could not find similar destination locations or could not afford to respond. His stores became known for large-store competitive prices with hometown friendly service. He had established a competitive strategy that would allow him to fully leverage his core competencies of hometown selling and advertising for cost-effective store traffic. His competitive moves were consistent with his valid business philosophy. And by creating high entry barriers for competitors, he was developing and leveraging his core competencies while protecting his strategic position.

The moral of Michael's story is not about a specific successful strategy. In fact, my guess is that Michael will face additional challenges from the superstore chains that compete in his product lines. The lesson to be learned is about the importance of developing a valid business philosophy to guide fundamental management decisions.

Element 1: Identifying fundamental business principles

There are certain inescapable market realities that dictate the parameters of both the general business environment and the particular competitive environment of your business. Learning to keep these always in your sights will be your starting task.

The seven steps that follow will guide you as you begin to apply the fundamental principles of business management to the particulars of your own business challenges. Clarify your thinking about these fundamentals and you will be on sound footing for the mastery of CEO Logic.

7 Steps to Thinking Like a CEO

In its most fundamental form, thinking like a CEO means having the perspective to step back, analyze, and understand the business you're in, your core competencies, the wise and selective use of resources, the critical issues you face, the ways you'll measure the performance of individuals and the organization, and the role of key managers. Using the seven steps that follow will guide you in thinking about these fundamentals of the management process in a way that will help you excel in your role and achieve the business results you desire.

Step 1: Have you selected the right business?

Your first responsibility as CEO or senior manager is to make sure you're in the right business. The right business:

Has a sustainable competitive edge supported by one or more core competencies in a stable or growing market.

Is in an industry that protects its participants from casual competition through high entry and exit barriers.

Neither concentrates too much business with any one customer nor is limited to too few suppliers for critical purchases.

Has built in defenses against competitive forces or has positioned itself in a niche where it is strong and competitors are vulnerable.

These elements allow a company to satisfy its customers at a price that creates an acceptable return on investment. In today's successful businesses, great people, good strategies, guaranteed customer satisfaction, and even some of the off-the-shelf management programs such as re-engineering, are important elements. But if you pick the wrong business, good companies and great people will fail. Select an industry in decline and even the best strategies will be meaningless. Target customers who cannot afford to buy, and customer satisfaction will be irrelevant. Pick a business where suppliers or buyers have too much power and your re-engineering effort will fail. Even teamwork and empowerment cannot overcome a bad business selection.

At one time, I worked with a very bright and enterprising CEO who was also the owner of a medium-sized business that was primarily involved in real estate development. At the time Renee Sebastian* inherited this business from her father, the company owned small developments in five states. They developed property and managed construction for single-family residences, multifamily housing, retail properties, and commercial office buildings.

Their business was marginally profitable, growing in revenue but declining in cash flow. Renee had worked in the business for many years and was highly skilled at construction management, but her problem seemed to be in knowing how to think about the business she was in. What should she be monitoring and controlling? Should she be growing or downsizing? Did she need to focus on increasing revenues or reducing costs? She came to me with these and many more questions.

Our first step in addressing her problems was to analyze the existing business, the available resources, and the markets in which she was operating. We found that she and her management team were particularly good at designing, developing, and marketing entry-level, single-family homes in California but had no special expertise in commercial real estate or in multifamily housing development. In addition, it became evident that the Southern California marketplace was a much stronger venue than her out-of-state markets and that her own management expertise—and that of her senior management team—was much more effective in that market than in remote locations in other states.

Through analyzing strengths and weaknesses in the company's core abilities to compete, available resources, past performance, and forecasted market conditions, we decided to:

Limit Renee's focus to the development of entry-level, single-family housing in Southern California.

Build-out or sell-out all other existing developments.

Support the entry-level decision by focusing on price-point and key selling features. If, for example, entry-level homes were selling at $129,000 in a given marketplace, the company would only develop a particular property if it could offer the key selling features (such as tile roofs, cathedral ceilings, or designer windows), make an acceptable return (based on a formula that considered the cost of the land purchase, development, building, marketing, and financing, plus a target profit), and still meet the $129,000 retail price-point. If it could not make its target costs and profit, it did not buy the property.

In addition to these early decisions, Renee later decided to offer more competitive retail financing, which she developed through alliances with local lenders. She even eventually established her own mortgage company. Renee's valid and focused business selection allowed her to stay ahead of the market with land options and purchases consistent with the selling trends.

In the long run, Renee's decisions not to develop multifamily housing, not to do business out of state, not to pursue commercial development, and not to offer high-end custom homes contributed to her success as much as did her decisions about what she would do. The process we went through in helping Renee define her business and focus her resources taught her much more about how to think like a CEO—and that became the key to her success.

Where's your sustainable competitive edge? The most critical element in selecting the right business is a sustainable competitive edge. No sustainable competitive edge, no sustainable profits. End of story. Many business experts feel that 75 percent of business results are directly related to industry selection and timing. If you entered the California real estate market in the 1970s or early 1980s, others are now probably addressing you as Ambassador. If you made that same decision in 1988, your mail is probably having a hard time finding you. Management and capital can do a lot, but they cannot make up for selecting the wrong business.

Competitive edge may come from your company's ability to offer its product at a lower price or to differentiate it in some compelling way. It may take the form of a unique design feature or a special service. But that advantage must above all grow out of what your company is especially good at—its core competency. Core competency may reside in a special capacity, a distinctive approach to the business, or a unique access to resources.

The CEO's task is to leverage one or more of these core competencies into an advantage in the marketplace. You have to lead the way by increasing investment in the capability, supporting it, nurturing it, and keeping the organization focused on it. You need to make sure, to whatever extent possible, that your competitors cannot easily duplicate that advantage. If, for example, your research and development group generates profitable, patented products that are central to your business, that R&D capability is at the heart of your core competency and is the key to your competitive advantage. As CEO or part of the senior management team, it is your responsibility to constantly measure the efficacy of the R&D department in an effort to continually find ways to enhance its capabilities so that you can gain an advantage over your competitors.

Competitive advantage may also be created by changing the way your company does business. Starbucks Coffee, for example, created a new sales and distribution channel for its coffee when it began selling out of its own cafes rather than through independent grocery stores. They also reconfigured the product from whole or ground beans to drinks, such as mocha or latte. Dell Computers and Gateway Computers modularized their products so that customers could custom design a computer to their specific needs and order it directly from them, thus bypassing the cost of computer resellers. The superstore concept of Home Depot, Office Depot, and Circuit City, among others, has also changed the way business is done in their respective industries. Their new concepts for distribution and their warehouse approach to retailing have spawned a whole new industry, appropriately known as category killers, so-called because no other store in their vicinity can compete with their product lines.

Specialization can also create competitive advantage. ADP and Paychex focus only on the narrow issue of processing payroll. The automotive service industry has also divided its approach to business by segments (for example, tune-up, oil change, transmission repair, windshield replacement). All of these businesses have used distinct competitive approaches to select the right foundation for growth and prosperity. In each case, the strategy has been to use a special competency to offer a unique or distinctive benefit to the customer while simultaneously setting up a barrier to competitors.

Consider these other factors when thinking about core competency and competitive advantage:

Entry and exit barriers. Industries, such as consulting, that encourage severe competition by virtue of low entry and/or exit barriers often produce low-return enterprises.

Changes in government regulation. Regulations, such as those affecting life insurance sales, nuclear power plants, or real estate syndication, may drastically reduce profit potential.

Market saturation. Too many players, as in the recreational vehicle or mobile home business, can create tough competition in flat markets, where all revenue increases must be generated at the expense of a competitor's market share.

Product obsolescence and competition. New technologies, such as typewriters faced from word processors, can not only limit or change demand but can also affect the inherent viability of a business.

Threats from substitution. New products, such as artificial sweeteners for sugar or aluminum for steel, can change an industry almost overnight.

Learning to select the right business is the first step to thinking like a CEO. It deserves careful consideration and analysis, because a mistake in the selection process could prove fatal to your business.

Have you selected the right business?

What are the opportunities and vulnerabilities of a business in your industry?

What are your plans to deal with these opportunities and vulnerabilities?

What barriers are in place to protect you from aggressive competitors?

What is affecting your core competency and competitive edge?

What do you do well that results in unique or distinctive benefits that your customers are willing to pay for?

What is your competitive edge? What are you doing to strengthen it?

What threats are likely to come from existing competitors, customers, employees, or suppliers?

What is the risk of new entries into the market?

What is the potential threat from substitute products?

How will the company be affected by likely or pending government regulations?

How will a change in financial markets or your cost of capital affect your plans?

What significant business or market conditions are likely to change in the foreseeable future?

Step 2: What elements drive results?

What are those few success factors that separate the winners from the losers in your industry? What disciplines or activities directly impact volume, margin, cash flow, and return on investment? What elements in your business determine customer or employee satisfaction? A direct marketing firm may be driven by its ability to generate cost-effective leads. A manufacturing concern may drive results by its capacity to design desirable products or its ability to react quickly to changes in the marketplace. A distribution firm may find its success in its inventory control capability, its ability to control margin, or its productive and cost-effective selling system. Issues such as low cost, high quality, timely shipments, ability to accurately read the market, inventory availability, or cost-effective sourcing of materials may drive results in your business. The key is to identify these drivers and turn them into core competencies. Failure to do so can prove very costly.

I once consulted with a successful chain of retail stores founded in the 1980s that had achieved impressive success by placing their outlets in large, upscale malls and catering to the needs of solid, middle-class customers. As they grew, Jeff Edwards*, the founder and CEO, had changed his vision of his business. He developed a strategy for moving out of the malls and creating what he called destination superstores that would attract a larger, more qualified, and less price-sensitive customer base. As Jeff began to implement that strategy, he also adopted a series of new management concepts designed to increase teamwork and empowerment among his staff. His primary strategy was going well, but other aspects of the business were not. It appeared that margins were falling as overall sales numbers weakened. Jeff called me in to discuss what he might do differently to get his company back on track.

As we analyzed this company and Jeff's efforts as CEO, two things became clear. First, his superstore strategy was fundamentally sound, but the organization itself had forgotten that it was first and foremost in the retail selling business. It was not in the business of expanding its stores or empowering employees—although those were important and admirable goals. Its primary business was selling products to retail customers, and the effectiveness of his retail selling effort determined the level of his success. Jeff had neglected to maintain focus on his selling system. Initial attention to customers as they entered the store was weak, salespeople were not qualifying the customer's needs and ability to pay, presentations were focused only on product knowledge, and no one was asking closing questions consistently enough to get the sales that would fuel the rest of his expansion strategy.

Second, Jeff misdirected his own efforts by dedicating 100 percent of his attention to implementing his strategy to move out of malls and into his superstores. This left no time to manage in-store sales and operations. His priorities were not aligned with the kinds of things that he had always done to create success. Since the selling system was the primary business element that needed attention, it was clear that Jeff could provide his own solution. For many years he had used a state-of-the-art selling system, which he personally developed to drive the success of his company. It was, according to my way of thinking, a case of lost focus. It was as if Jeff owned a race car and had been tweaking the body, upgrading his drivers, and buying new tires, but not focusing on how to make his engine more powerful. In