Bob MacDonald on Business

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Breaking the Back of Bureaucracy at the VA

July 6th, 2014 · Business Management, Effective Leadership, Politics and Politicians Gone Awry

The real story behind the appointment of Bob McDonald to lead the VA

When word broke that President Obama had appointed “Bob McDonald” to take charge of the Department of Veterans Affairs (VA) my e-mail account and voice mail went crazy. Most of those who made contact wanted to either congratulate me or to inquire why I was dumb enough to take such an impossibly thankless job.

After all, attempting the cure the bureaucratic ills of the VA is not only an unenviable job; it is also an impossible job, especially in today’s polluted political climate. One would have a better chance of solving the Israeli-Palestinian AND the Shiite-Sunni conflicts than in breaking the back of the bureaucracy at the VA.

Of course, the truth is that I may be dumb, but not so dumb as to take the job heading up the VA. But it was a close call: here is a behind-the-scenes look at how things actually transpired.

First of all, the truth is that President Obama did call me and did his utmost to talk me into taking the job as head of the VA. Unfortunately, in a desire not to offend the President, I equivocated in my response and told him that “I would think about it.” The president must have McDonald_3 copymistaken that ambiguity as a “yes” and instructed his people make preparations for my appointment. Well, when I finally got back to “Barack” and respectfully rejected the offer, everything regarding my appointment had been set in motion, the press releases, the acceptance speech, the guest shot on Sixty Minutes. Naturally, the White House didn’t want to embarrass itself with yet another “oops, we made another mistake,” so they kept looking until they found another Bob McDonald who was willing to take the job. And that’s the rest of the story . . ..

Nevertheless, even though fixing the VA is not my job, the least I can do is offer my namesake some suggestions as to how he might slog his way through the VA’s formidable bureaucracy. Since that Bob McDonald is a lifelong Republican, the best place to start might be to explore outsourcing the problems at the VA to a large corporation in the private sector. After all, since the Republicans staunchly proclaim that the “private sector” is so much better at fighting bureaucracy, it seems logical to outsource the VA problems to a private company. The corporation that comes to mind might be General Motors. And lest we forget, the wars in Iraq and Afghanistan that are the reason for the current strain on VA resources were pretty much outsourced to Dick Cheney’s Halliburton and Blackwater Security.

Any chance for McDonald to be successful at the VA also calls for a heroic suspension of reality; stakeholders must come to believe that he will have the time, political support, power and, most important, the cooperation of those working at the VA. But that fantasy is as likely to happen as ordering a heart/lung transplant at a VA drive-thru. McDonald will not have any of those necessary tools or power to break the bureaucracy. Once a bureaucratic culture has become entrenched in either a large government or corporate organization, nothing short of an act of God will stamp it out; and even that may not be enough.

But— if we could suspend reality, here are a few steps that could be taken to thwart and even eradicate bureaucracy at the VA. Even though this is never going to happen at the VA, these concepts can be used by a leader to prevent bureaucracy from creeping in and crippling their organization.

  • Unambiguously define, communicate and reinforce a clear, concise vision and specific objectives of the organization in a way that everyone involved can understand and be held accountable for at least striving to achieve.
  • Push authority and decision making down through the organization, rather than vesting that power in a few at the top of the organization.
  • Eliminate the rules of performance that tell people how to do the job and institute rules of engagement that define what needs to be done and allows the people to decide how it should be done.
  • Always drive a sense of urgency within the organization. Encourage making a decision by defining failure as not making a decision.
  • Provide incentive and reward for success and accountability for failure.

Even a cursory overview would show that none of these bureaucracy-fighting concepts exists in the Department of Veterans Affairs. The “mission” of the VA is so all-encompassing and suitably nebulous – get this, it’s “responsible for providing vital services to America’s veterans” – it is impossible to focus activity and establish clear benchmarks of performance.

Combine this with exceedingly top-heavy management authority – it is estimated that out of more than 250,000 VA employees only about 200 managers have authority to make even limited decisions – and the confused lack of effective action is as understandable as it is predictable. Such a top-down management approach in any a large organization causes the creation of rules and regulations that document corporate process and procedure in such excruciating detail that it prevents any type of flexible response in dealing with individual needs.

The result? Those who deal directly with the “customer” (the veterans) are forced to spend more time straining to comply with rules than solving problems or meeting needs. With no clear-cut benchmarks or standards of performance – other than conforming to the rigid rules – waitlistthere is no sense of urgency to meet the needs of the veteran. (That is why some veterans can be forced to wait 9 months or more for a simple appointment.) In the VA failure is defined as “not following the rules,” not failing to provide needed services to veterans. As a result, there is little incentive to provide timely service and no reward for doing so; and accountability becomes virtually nonexistent. Despite what is acknowledged as a widespread “mess” at the VA, out of 250,000 employees, only three individuals have lost their jobs. But that is not surprising, because true accountability can only be enforced when authority has been bestowed and few if any have real authority at the VA. Considering all this, it is a wonder that the VA functions as well as it does!

But not all is lost. Any leader who seeks to resist the encroachment of stultifying bureaucracy in their organization can study the model of the VA for what should and should not be done.

The Bottom Line

Any organization must have a clear, consistent vision that is constantly communicated and is unambiguous enough to be converted into identifiable actions necessary to achieve the vision. Those within the organization – not just those at the top – must be empowered to identify the actions necessary and vested with the authority to complete them. Leaders may define “what” is to be done, but “rules of engagement” rather than “rules of procedure” must be in place in order to allow others to decide “how” it is to be done. When specific benchmarks and measures of performance are established a “sense of urgency” to complete the task is created. And without a continuing sense of urgency, ultimately nothing is accomplished. Reward for doing the right thing the right way is more important than accountability for failure, but you can’t have one without the other. Put all these together and you have the makings of a successful – bureaucracy-free – organization. Ignore these concepts and you have the makings of another VA.

Good luck Mr. McDonald! Better you than me!

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ESOP – The Fable and the Fraud

June 29th, 2014 · Business Management, Effective Leadership, Employee compensation

ESOP is a fanciful fairytale of sharing spun amidst the props of smoke and mirrors.

I have always been a believer in the motivational power of parallel interests that are created when employees share an ownership interest in the company they work for. It puts everyone on the same page and allows those who create value to share in the reward of success. And I know it really works.

After all, I helped create a very successful company – LifeUSA – that was founded on the premise that success is more likely to be achieved using a business model of direct employee ownership. But at the same time, I have also harbored the opinion that the employee stock ownership plan known as ESOP is not the best way to achieve that objective; it may, in fact, do more harm than good. The truth is that in many cases ESOP is an acronym for Employees See Only Promises.

My concerns about ESOPs emanate from the fact that they are a very complicated way to create parallel interests: they promise employee ESOPownership but fail to include rights of ownership. Plus, there is the potential for conflict of interest, which run counter to true parallel interests.

What ESOPs do is create a synthetic form of “group ownership” for employees as opposed to true, individual ownership that is enjoyed by company founders and management. Sure, using  ESOP “ownership” as a way to motivate employees  is better than no plan at all. But these plans are often more effective at demonstrating management’s desire to have their cake and eat it too, since they engender a feeling of false promises among the rank and file.

A Growing Concern

As ESOPs have grown to include almost 12,000 companies, the federal government has become concerned with the potential for abuse – if not fraud – that can occur in the structure and management of these plans. The Wall Street Journal recently reported that the federal government is currently the plaintiff in 15 lawsuits related to ESOPs. Virtually all of this litigation revolves around the potential abuse in the valuation of company shares (often sold by company founders or senior management) purchased by the ESOP “for the benefit of employees.” The Journal reported that since 2010 the Labor Department has recovered over $240 million from companies that had abused ESOP plans, all of which involved stock valuation.

The Nuts and Bolts of ESOPs

Technically, ESOPs are defined-contribution pension plans, regulated under the 1974 Employment Retirement Security Act (ERISA). As a qualified retirement plan, ESOPs offer favorable tax benefits for the company and employees. For example, contributions made by the company into the ESOP to purchase shares of the company are deductible and these contributions are not taxable income to the employee until they actually receive the benefits, usually at retirement.

Even though ESOPs are considered a retirement plan for the benefit of employees, the assets of these plans can be – and often are – used to enrich the management of the company, create liquidity for existing shareholders and serve as a lucrative “exit strategy” for company founders. This can result in a significant potential conflict of interest between existing shareholders and the employees who are “buying” the shares via an ESOP.

The vast majority of companies that have adopted ESOP plans are private; meaning there is no existing “market” for its stock. The result? Not only is there is no sure-fire way to determine the value of the stock, existing shareholders have little or no liquidity, that is, a ready-made market to sell shares. An ESOP remedies these problems for existing shareholders by creating a “captive” market for their shares and the liquidity they desire.

But, you ask, if there is no real “market” for shares, how can fair value for shares be determined? Simple. Outside consultants are be brought in (paid for by the company) to place a valuation on the stock, the price at which the employees (the ESOP trust) will purchase the stock from selling shareholders.

Now comes the tug-of-war. Existing shareholders seek the highest value possible, while employees seek share price as low as possible. This creates the potential for conflict of interest that ultimately has triggered the government lawsuits over valuation. And it raises an even more important question: If the stated idea of the ESOP is to motivate the employees with a feeling of ownership, just how much motivation and incentive will be engendered in employees who feel they are being forced to buy the stock at inflated prices?

The next important question is: Regardless of the price that is determined, where is the money going to come from for the ESOP trust to buy the stock from current owners? The company is obligated to make annual contributions to the ESOP and these funds are used to purchase the stock, but from the viewpoint of existing owners it could take years for them to receive the value for selling their shares. Not something they are likely to want to do.

To solve this problem (it is really only a problem for existing shareholders) about 70 percent of all established ESOPs “leverage” the purchase of the stock by taking a loan against the stock. This works well for existing shareholders because they can put cash in their pocket now, while the ESOP must use future contributions to re-pay the loan. There is nothing inherently wrong or immoral with this approach, but it does Pay-Daycreate a potential conflict of interest and the actual interests of the selling shareholders and employees participating in the ESOP are not truly in parallel going forward. One side has received their reward, while the other side has the promise of reward in the future.

Another potential conflict of interest arises when it comes to voting the shares of stock. Even though current shareholders have been paid for their stock, management of the company often controls the voting power of shares held by the ESOP but not yet allocated to participants, and that action that could take years. Again, there is nothing illegal in this type of structure, but when thinking of parallel interests and the motivation that real ownership provides, it leaves a lot to be desired.

If the existing owners of a company are seeking a way to cash out or create liquidity in the most tax-advantaged way, then an ESOP is the answer. But if management really believes that the way to enhance the total value of the company is by putting the interests of the employees in parallel with the interests of the company, then there are simpler, easier and more effective ways to accomplish that objective than using an ESOP.

So what are some of the ways to build real parallel interests between company founders, the company and employees?

First off, at LifeUSA, all employees and sales representatives as a condition of employment were required to use 10 percent of their gross pay to purchase new stock issued by the company. If someone was making $25,000 they were required to buy $2,500 of LifeUSA stock. Since the stock of LifeUSA was not publicly traded, the cost of this new stock was pegged at the same price the founders of the company paid for their stock.

Second, there was only one class of stock – common voting stock – for all shareholders. This meant the CEO of the company and the newest employee both owned the same class of voting stock, purchased at the same price. The CEO could not benefit from his stock unless everyone in the company could also benefit from owning their stock.

Thirdly, the happy outcome was that everyone working at LifeUSA was a real, direct, individual owner of the company. This may not have been the most tax-efficient way to spread ownership in the company, but it was simple, easy to understand and in pure parallel.

Just in case you might wonder, LifeUSA moved from being a start-up company in the life insurance industry to one of the fastest growing and most successful companies of the 1990s—a vivid testament that true employee ownership does, in fact, motivate employees to work harder and produce stunning results. In 1999 — 12 years after its founding — Allianz SE purchased LifeUSA for a value of $540 million and every single one of the 800 employees working at LifeUSA received a share of that purchase price. l

More times than I would like to count, I have been told that the LifeUSA model would not work for other companies. I agree that it would not work if you did not really believe in the concept of true shared parallel interests and didn’t want to work at it. But for the most part those comments come from the non-believers, the greedy and the lazy.

There are other ways a company can gain the benefits of parallel interests created by employee ownership without taking on the complexities, complications and potential problems of an ESOP. From my perspective and experience, the best way to motivate employees to work hard for the success of the company is to develop a plan that gives the employee both the feeling and the benefits of being an owner. And the best way to do that is make them real owners.

And the Moral of the Story …

I recognize that reading the ins-an-outs of an ESOP plan can be tedious and boring, but that’s the point. If you are an owner of a company and, deep in your heart, you really want to find a way to create liquidity for yourself and even create an exit strategy, then the path for you is to pretend that your motive is altruistic and that you want every employee to enjoy the benefits of ownership. And the best way to do that is to create an ESOP.

On the other hand, if you really believe that you will gain more value by sharing value; if you believe that building true parallel interests means creating a plan under which no one benefits unless all benefit, then you will eschew any thoughts of the fable called ESOP.




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Create an Incentive Plan That Delivers More Than it Promises

June 22nd, 2014 · Building Better Business Managers, Business Management, Employee compensation

Four Steps to Encourage Employees to be More Productive and the Company More Profitable

Last week’s blog reviewed the efficacy of compensation plans that are intended to incent employees to make the extra effort to add value to the company, by allowing them to share in a piece of the value created.  In theory, that makes sense because it aligns the interests of participating employees with those of the company. But the post also pointed out that many plans fail for a number of reasons:

  • They are often “cookie-cutter” plans developed by outside consultants who don’t understand the specific company’s value drivers;
  • Plans are often complicated, convoluted and difficult to understand;
  • Frequently they are structured for only the top executives;
  • The plans are based on targets that participants feel they have little power to influence;
  •  The “value drivers” that ultimately create increased value are not properly identified.

As mentioned in the previous post, years of experience has taught me that the concept of sharing value is by far the most effective way to motivate those who have the ability to add value to a company to actually do so. However, fair and effective compensation plans must be properly structured, implemented and supported. Here are the steps that I learned work best:

1.  Create, Don’t Copy

Management – with the approval of the board – must assume direct responsibility for developing the plan, because the foundation for any successful incentive compensation plan is that it is based on company-specific objectives, culture and value drivers. Only the management of a company has (or at least should have) intimate knowledge of these factors.

Admittedly, it is hard work to develop an effective company-specific incentive plan, so there is a tendency to abdicate this responsibility to outside compensation consultants. The rationale is that they have experience creating plans for other companies, and can give management numerous options from which to pick. The problem is that companies end up with cut-and-paste plans that are simply a copy-cat version of what other companies are doing, with very little sensitivity to the subtle nuances of their company’s culture and objectives. As such, they are significantly less effective.

2.  Design from the Bottom Up, Rather Than the Top Down

Unfortunately, most incentive compensation plans are predicated on the basis that only the CEO and senior management have the understanding and ability to add value to the company, so they are the only ones invited to participate.  However, to be truly effective, incentive plans should include all members of the organization, starting at the bottom and working up to the executive suite.Power

In reality, creating real value starts at the bottom of the organization, and is based on completing specific activities that, when taken together and multiplied, form the ultimate basis for increased value. That’s why the CEO and senior executives should be the last to receive the rewards of the plan, and their reward should be based on what others receive. A bottom-up structure provides incentives for everyone in the organization to make the extra effort that builds value.

Moreover, it incents management to support the efforts of those who have the power to increase value, because their own rewards are tied to what others receive.  An often-heard excuse for not including everyone is that “it would be too expensive.” This is such a lame (dishonest) excuse. If payouts are truly based on “new value created,” a plan that is inclusive and generates benefits from the bottom up may pay out more, but only if more value is created.

3.  Base Benefits on What Drives Value

Most employees don’t understand how macro values are created, and don’t believe they have the power to influence them. But most do understand their jobs, and if they are incented to do a better job, then ultimately increased value will be created.

The CEO and senior management must identify the specific activities that ultimately drive value. (If they don’t know what those value drivers are, they probably should not be in charge.) Management should also be able to calculate how much increased value is created when the performance of these specific activities is enhanced. For example, if “customer loyalty” is identified as a “value driver,” then those who have the power to positively influence customer loyalty should be rewarded for doing so.

The benefits for these specific activities should be identified and “pooled” during the course of the year, and then distributed among the various groups that created them. This provides a constant reminder and incentive, because individuals can see just how much value they are building for themselves.

These benefits are triggered when the company reports higher revenues, profits or equity. Benefits could be reduced or increased based on controlling expenses and higher than anticipated revenues or profits. Those in support positions, such as IT, legal and administrative, would be rewarded for supporting those charged with performing specific value driver tasks, by receiving a percentage of the benefit pool.

At the end of the year, the CEO and senior management would receive a factor of the total benefits paid to all others. For example, if the total “pool” for specific value driver activities is $3 million, management could receive an additional 50 percent of that amount as their benefit pool. This encourages management to focus on those who are creating the real value. The more others receive, the more management will receive.

At first glance, this approach to incentive compensation may seem complicated, but in reality it is very simple and easy to understand. That’s because the actions that drive value are broken down to simple, specific actions that all employees can understand and believe they have the power to influence.

4.  Make Incentive Payments Just Once

Of course, no benefits should be paid if value does not increase, but there also need to be benchmarks that trigger benefits. For example, profits must increase by 10 percent to trigger 50 percent of the benefits, and by 15 percent to trigger a full payout. This ensures that the cost of the incentives paid out is fully covered by the company’s increase in value.

The newly created value becomes the baseline for the next year’s incentive compensation plan. This prevents paying twice for the same value.

And the Moral of the Story …

Incentive compensation plans are a great idea and they work well when they are structured properly. To achieve this end, the plan must be developed by management and the value drivers must be company-specific. One size does not fit all.

The plan must be all-inclusive and benefits should be driven from the bottom up, where true value is created. Benefits should be determined by specific activities that drive value, and activated by the actual value created.

This approach is equitable, creates parallel interests and is easy for employees to identify with and understand. Most important of all, it provides real incentive for everyone to make the extra effort and add value for the company.

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