Shareholder value creates a recession, passion creates revenues

The past week I’ve been in Silicon Valley to meet a lot of people and to launch a new service. I talked to people working at the big companies there, but also with guys that were literally starting a new business out of a garage (haven’t we heard that before 😉 ). The contrast could not have been bigger.

In the big companies the usual pattern appears. A recession is about to hit, revenues are dropping and the pressure on shareholder value is increasing fast. Shareholder value has quickly become the best excuse for companies to stop thinking ahead and stick their heads into the sand. Shareholders must be complete idiots if their short term value is maximized to a level that it endangers the long term sustainability of the company.  And yet we see this pattern recurring time after time. In order to maximize shareholder value companies stop innovation, cut down costs, maximize revenues and become financially driven organizations.

Managing finance becomes the most important asset. Excessive rewarding plans for top managers govern the direction of the company, and the devastating effect of that is something we can now see with the current financial crisis. Companies that once generated revenue and were able to innovate at the same time turn into a efficiency maximizing process killing off anything remotely creative as that negatively influences the short term bottom line. So we can prepare for lay offs and forget about exiting new stuff coming out of those companies for quite a while. Needless to say that in any business this is usually devastating in the long run.

With the exit of innovation comes the exodus of those that could start change. Don’t get me wrong on this. I think financials are important for a company. But they should be seen as a byproduct. Run the company with passion for your customers and in most cases revenues are generated as a side effect.  Rolf Skyberg has written an excellent post on a similar theme, called “Leadership doesn’t mean optimizing ROI”. Read the article, it’s excellent. Here is an excerpt.

Choosing projects based on projected ROI is a dangerously simplistic way of running your business.
If you take a look at the actual acronym: “ROI” return on investment, it seems like a perfectly logical way of directing your business activity. After all, who wouldn’t want to invest in the things that bring them the greatest returns?

The unfortunate simplification in action is that “return” is generally taken to mean revenue or cashflow, which is but one of the important aspects of running a business.

The problem here is that while revenue can be easily counted, recorded, multiplied and divided; other intangible dimensions cannot be. How do you quantify “trust”? How do you measure “excitement”?

What would an ROI of 20% on trust actually mean? Because the intangibles cannot easily be typed into Excel, they can’t be utilized on pivot charts, or factored into equations.

And because MBA’s live and die by Excel, anything you can’t count, doesn’t count.

A few miles away the world seems quite different. In Palo Alto the air is filled with creativity and entrepreneurship. Talented people get together, think out new ideas and start new companies on the fly. With or without funding, in small offices, homes or even garages. These people think and breath opportunity. They are passionate about an idea, and nothing is holding them back. Not even a recession in the makings. For them raising funding is a side effect for the fact that they are building a business.

If you think about it, Palo Alto seems in some ways a bit like Florence around 1500. Florence was a meeting place for the most talented people known. Michelangelo, Leonardo da Vinci, Machiavelli, Dante, Donatello, the list goes on and on. They were all there at one time or another, challenging each other, taking science, art, poetry,  and culture to an unprecedented level. Surrounding them were rich families, the Medici being the most important, that accelerated this cultural process by financing it, gaining both power and respect.

I don’t know if the Silicon valley of today contains the same brilliant people as Florence did then, time will have to tell.  The environment can trigger great things. But there may be differences too. Where the cultural revolution of Florence had huge impact on the world, it remains to be seen if the Valley can pull of something similar. And it seems to me that passion in Silicon valley is sometimes traded for shares, option plans and new gigs. I heard of several startups having to deal with experienced developers leaving at critical stages for something else. Experience is hard to find and those that have it can get a job anywhere. It results in less attachment and less passion in my opinion.

Why is it that when companies start they are full of entrepreneurial spirit, but when they reach their success it becomes “corporate” and quickly loses its entrepreneurial nature? At some point shareholder value becomes more important than passion. That’s when the company changes from a leader into a follower. At that time managers become more important than employees. Thousands of management books are written about how to get big companies more innovative and flexible. It really isn’t that hard. Make sure there are more passionate people on board than managers and you will do just fine. When that balance is disturbed shareholder value takes over and the financial manager seizes the company. Passion is replaced by predictability.

With the current financial crisis in the USA reaching a new high it will likely have effect on both large companies and small entrepreneurs. There will be less money to invest, less risks to be taken. But I think Howard Lindzon is right when he says:

Unlike Jason who started a bad business (Mahalo.ugh) at the top and now is scared and panicking to his e-mail list, use this recession to build the business of your dreams off the panicked and overleveraged. Don’t feel guilty. Don’t go to the mall and piss your money away. Buy a laptop, tune in to some great VC’s and stock market blogs, roll up your sleeves and take your best shot.

If you are thinking of building a new startup, be sure that you do it with passion. It will be the difference between a good and a great company.

Update: there is an interestin discussion going on at Techmeme now, kicked off by Erik Schonfeld and picked up by Rafe Needleman.