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Profit Is Less About Good Management than You Think

Jos Antonio Marco-Izquierdo

Benjamin Graham, the father of value investing, seldom met the managers of the

companies he invested in because he felt they would tell him only what they

wished him to hear and because he didn t want to be influenced by impressions

of personality. His talented student, the legendary Warren Buffet, thought the

same: when management with a reputation for brilliance tackles a business with

a reputation for bad economics, it is the reputation of the business that

remains intact.

Value investors like Graham and Buffett believe that the sources of sustainable

returns on capital are not a company s human assets but their so-called

economic moats, structural, durable competitive advantages around revenues or

costs. Revenue moats are usually linked to intangible assets (including brands

and patents), high switching costs, and network economies. Cost moats are

linked to the ownership of cheaper or faster processes, favorable locations,

unique assets, or firm size. In some cases, companies moats have enabled them

to survive multiple technology disruptions and industry shifts over time,

making their founders some of richest people in the world: think Bill Gates,

Carlos Slim, Amancio Ortega, and Larry Ellison.

There s an interesting fact about companies with these kinds of moats or

competitive advantages that often gets overlooked: the turnover rate of CEOs

among the S&P as a whole is between ten and twenty times higher than in the big

entrepreneurial successes of the past few decades. A case in point is Inditex,

founded in 1963 and now the biggest fashion group in the world, which has only

had two CEOs succeed founder Amancio Ortega. By contrast, Germany s Deutsche

Bank, which has suffered from years of poor performance, has had three CEOs in

the last five years, none of whom has done much to improve performance despite

their glittering CVs in the sector.

This raises a basic question: can a CEO with the best track record imaginable

turn around a poorly performing company? According to MIT economist Antoinette

Schoar the answer is yes roughly 60% of the time, which is not that much better

than the odds of getting heads on a coin toss.

Chicago s Steve Kaplan s findings on the difference that managers can make are

even more sobering. He studied the relative importance of management teams in

106 venture capital-financed firms from early business plan to IPO. He found

that although 50% of venture capital investors described the management team as

the most important factor at the business plan stage, this emphasis had dropped

markedly by the IPO stage. He concluded that non-human assets i.e., their

moats were ultimately more important to firms than human assets, with their

relative importance increasing over time. The implications are clear: first

choose the right industry and company, then pick the right management. If the

managers don t perform, they can be swapped out much more easily than the basic

business idea or industry.

Of course, in a highly competitive world, even a slim advantage is better than

a coin-toss. So is there something different about the managers who do succeed?

Let s go back to Steve Kaplan, who has also studied how and why CEOs matter,

relating their features to hiring and firm performance.

His detailed assessments of over 300 CEO candidates in private equity-funded

companies suggest that CEOs with execution strengths ( efficiency ,

organization and planning , attention to detail , persistence , proactive ,

sets high standards , etc.) perform better than CEOs whose softer skills such

as team building or listening dominate. This finding is a ringing modern

confirmation of what Peter Drucker was telling us in 1967 about what makes

executives effective.

If all this is true, then the high CEO turnover you see at many public

companies is not a symptom of poor management. It suggests a deeper problem,

which is that the companies in question simply don t have a competitive

advantage and are simply engaged in a lottery, hoping to find a CEO who can

find one. The odds aren t favorable.

Jos Antonio Marco-Izquierdo is a partner at Magnum Industrial Partners, a

private equity firm focusing on investments in Spain and Portugal.