FEI Competition

Apparently, our final round presentation for the Financial Executives International Case Competition is now available online. Unfortunately, I can't embed it into the blog, but I can include the link below:

http://www.feicanada.org/cfo-tv.php?vid=22&page=2

Enjoy!

KKR at LBS - Socially Responsible Private Equity

Just now, we had the inaugural talk for the Socially Responsible Private Equity talk given by Ken Mehlman, KKR's Global Head of Public Affairs. He was the Chairman of the United States Republican Party, campaign manager for President George W. Bush's re-election campaign, and White House Political Director. He was also a classmate of Barack Obama at Harvard Law.

He gave a great talk on how social responsibility is integral to sustainability of a business, especially one with patient capital in PE. One point he made which I thought was particularly poignant seemed to echo the ideas of Integrative Thinking. He said that there are generally two common models with regards to social responsibility:

1. Corporate CSR – Where a company makes contributions to organizations outside of its operations that show it cares.
2. It focuses solely on strong operations and generating business returns to the bottom line without much consideration for social responsibility.

He mentioned that KKR takes a third approach, and that it integrates social responsibility not just at some abstract corporate or portfolio level, but right down to the alignment of its operations to produce. Examples of this would include involving a broader definition of stakeholders versus shareholders such as environmental agencies and unions in determining the best course of action for a company’s future operations and how it should be run.

Besides some of the insightful deal war stories, future PE trends and industry knowledge he shared, he also gave great advice on what he thought it took to be successful which was well received by the crowd.

There were a host of excellent questions asked by the crowd in the Q&A session as well as the cocktail reception following. I’m looking forward to the next event hosted by the PEVC club.

Financial Executives International – 5th Best in Class Competition

On Saturday, a Rotman team composed of myself, Shree, Fei and Matt Literovich competed in the Financial Executives International 5th annual Best in Class Competition. The case company was HudBay Minerals. Unfortunately, we placed second, behind Alberta School of Business.

The competition was intense, as many of the teams worked late into the night on Friday to put together our decks and get a few rehearsals in before scrambling to get a few hours of shut eye. The next morning, our names were drawn for presentation order and we found ourselves in the seventh spot.

Matt Literovich was phenomenal understanding potential legal issues related to mining and commanded the attention of the room when he spoke of precedent case law.

Fei gave a detailed account of all the organizational issues we could expect as HudBay Minerals grew and followed our acquisition strategy.

And Shree’s knowledge of mining and dissection of potential target companies gave us an exceptionally high level of credibility.

All three were exceptionally strong in both the presentation and the question and answer period and this short description does not do justice to the quality of our presentation.

While we were very disappointed that we didn’t take the top spot, the event itself was challenging and very entertaining. Judges from the competition included top executives from HudBay Minerals, USGold, OTPP, Mercator, a justice and many other top professionals. Definitely a great experience, I would recommend any MBA student to attend this competition.

Nextel Institute

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

The Nextel Institute is a NGO which provides additional training for at risk and vulnerable youth aged 16 to 24. They are funded by Nextel and work in partnerships with companies like Agencia Click.

They have had explosive growth, placing 70% of their 124 participants in 2008 and 60% of 390 in 2009, more than doubling their success rate.

This tremendous growth has caused this foundation to look at developing new locations and partnering with additional companies to absorb the additional youth looking for employment.

Gol de Letra

[LAIST Tour Begins, Fazenda Tozan, Churrascaria – Nova Pampa, Port of Santos, Deloitte, Embraer, Natura, Gol de Letra, Bom Bril, Agencia Click, Nextel Institute, May 6, Rio, Rio Weekend, Petrobras, PREVI]

[Delayed from yesterday, photos and video forth coming]

The Gol de Letra Foundation is a non-for-profit organization founded by Rai Souza Vieira de Oliveira, former Captain of the National Brazilian football team, and Lenardo Nascimento de Araujo, midfielder for Brazil and current manager of the Italian A.C. Milan FC.

The project reaches 1200 youth and has been running for 10 years in Sao Paulo and Rio de Janeiro and has received recognition from international organizations such as UNESCO in 2001 as the world model for helping underprivileged children. Their core values are dignity, fraternity, perseverance, solidarity.

They find the most vulnerable children in the community and provide a place for them to play and learn. Typical school programs only last half a day, with school access not nearly as prevalent as in countries such as Canada, so programs such as Gol de Letra fill the gap to provide opportunities not necessarily available otherwise.

Their programs promote literacy, physical education, music and social interaction with peers. We were treated to an impromptu Brazilian musical performance by some of the children.

Certainly one of our more fun visits, we also participated in a game of “chain tag” running around with the kids. It was absolutely moving when the adorable little kids were giving us hugs goodbye.

Ethanol Fuel – Is Sustainable Fuel Socially Responsible?

In our Business Ethics class, I had done a presentation on the Ethics of Ethanol Fuel and now that I am in Brazil, the topic of ethanol fuel and its relationship to sugar cane and other staple food commodities has been emphasized. And even if global trade increases and creates wealth it does not make any guarantees with regards to how that wealth is distributed as explained by our GMP Prof. Blum.

I proposed this question: “Is it ethical for rich countries to drive cars if it causes poor countries to starve?”

This problem was exacerbated in the World Food crisis in 2007 and 2008, when oil prices hit all time highs and the arbitrage relationship between oil and food was exploited.

Here is the relationship:

1. The US and Brazil are the largest producers (89%) of ethanol fuel using corn and sugar cane (respectively).
2. When oil prices increase, people have a tendency to switch to ethanol based fuels.
3. When the demand for ethanol increases (as a substitute) the demand on the inputs for ethanol (corn, sugar cane, potatoes) also increases.
4. There are real arbitrage opportunities by hedgers, speculators and even farmers as they shift the use of arable land to produce more valuable crops. However, even with arbitrage there are limits as arable land is limited (to create more arable land, there is often deforestation which creates its own sustainability issues).
5. Also poor countries have a much higher sensitivity to fluctuations in the price of raw commodities whereas rich countries are insulated from food costs because they only represent a small percentage of the final costs (including value added costs such as manufacturing, distribution and retail costs). It’s the difference between eating a bowl of rice versus a bowl of Rice Krispies.

The consultants at Deloitte confirmed this relationship in very concrete terms using the Brazilian gas pumps as an example (where prices for ethanol based fuel versus gasoline are explicitly posted in the same way gas prices are at the pump). Currently, the cost of Ethanol fuel is 50% the price of gasoline (although it only provides 70% of the performance). However, in the “off season” when sugar cane is more expensive, it can even reach a price of 80% of gasoline (which is clearly not as cost effective). There is a direct relationship between the price of sugar cane and the price of ethanol fuel.

Legacy: The Million Dollar Question

I look at my classmates, what rock stars they will be in the future and I ask them: "What do you want your legacy to be? 10 years from now, when you make heaps of money and your tax accountant suggests you need to make a million dollar contribution to a charity, where will you put your money? Would you want your name on a junior highschool? A cancer ward in a hospital? A park bench?"

I used to ask my friends at McMaster Engineering to remember McMaster in their donations (Mac Lab Endowment comes to mine) in a half joking attempt to "keep DeGroote out of McMaster" (Micheal DeGroote has been buying up parts of McMaster including the business school and life sciences department... We've been wondering when they'd rename the school DeGroote University).

Joking aside, the question is intended to provoke introspection. Most people will give to something they feel is a worthy cause or something which helped define them as a person. When presented with the prospect of where to make a significant contribution (the amount itself is trivial, whether people feel their ambition would be better accomplished with 10k or a billion dollars is not important - increasing the fictitious sum of money is an easy enough task) people think a little harder about what's important to them and you get some surprisingly personal answers. I'd also like to think that people learn a little bit more about themselves when confronted with the altruistic challenge.

Mubadala

[MEIST - Dubai -Abu Dhabi 1, 2, 3, 4 - Jordan]

One company which was paritcularly impressive on this trip was Mubadala (arabic for "Exchange"). They are owned by (and intimately related to) the government of Abu Dhabi (the directors on the board are also the same ministers in government), yet operate seperately in many important respects which makes them a good proxy for what is happening the Emirate in general. While related to the Abu Dhabi Investment Authority (ADIA) and the Abu Dhabi Investment Council (ADIC) as a government owned entity, Mubadala has a different mandate to undertake long term, capital intensive projects with the intent of making competitive market level returns while diversifying Abu Dhabi's economy.

It was best explained on our trip as a "PE firm with a soul" where they have what they call a double bottom line: Financial returns and social / strategic improvement (will the project increase jobs, generate intellectual property etc). They try to balance their projects on "the curve" - a production possibility curve where the axes are financial return of the project and social and systematic improvements in the economy (shown above).

Another interesting characteristic is that Mubadalah recently (this year) released it's financial statements publically which is surprising considering it's size, the fact that it is essentially a sovereign entity. Our speakers made a point to emphasize Mubadala's focus on three guiding principles: Transparency, Accountability and Corporate Governance.



Some of their projects include Masdar city, an ambitious project attempting to build the first carbon neutral city in the world. They also have partnerships with the Ferarri Group which has a strong investment team and partners up in ownership of companies such as Piaggio Aero. We were told Mubadala has a particular investing style in bringing in partners. In order to ensure that they behave in a manner that is "best in class" (not being complacent with it's wealth - they have the funds to wholy own companies, but bring in partners anyways), they bring in parters for a variety of reasons:

• To "test" projects as if they were capital constrained and to get an affirmation that their project is financially sound by bringing in external institutions
• Gain additional expertise of partners who participate in principal co-investing on projects
• Lay off risk - balance risk and reward
• Find the sweet spot between 'optimal' versus 'maximum' leverage

Because of the nature of Abu Dhabi (in a similar nature as Dubai) a large proportion of the workers are Expats (we have constantly heard about the 80/20 split, 80% expats and 20% locals). This creates an interesting challenge. How can you create industries, business models, infrastructure and (eventually) jobs to benefit the local Emirates while attracting the international talent to help develop the human capital to support it? As a result, some of their projects have a high degree of automation since there is relatively low population numbers and the locals are actually in "minority".


These two sisters, Dubai and Abu Dhabi, have been exceptional at putting up the infrastructure and buildings required as shown by the Burg Dubai / Khalifa (above). However, developing human capital takes longer with training, experience and opportunity. As a result, Mubadala has emphasized what they called the "C's": CA, CFA etc as education beyond the MBA which are required to succeed. They believe in this philosophy so much that they have a special CFA training program for their local Emirates which acts as an accelerated training program as a fast track to management positions. The locals write the CFA level I exam and those that pass advance in the program.

CEO Compensation - Using Complex Derivatives

In our FIT class, our group presentation project was to look at CEO compensation (with deliberately vague instructions to give the teams flexibility to take the initiative on how to approach the topic: allowing us to think about our thinking). Our group was one of the teams that presented today (and we got generous feedback from our peers), however, it's another group's presentation I wanted to discuss in more detail.

Nick Kerhoulas' team, composed of Amanda, Nik, Mark and Nick K, mentioned in their presentation the unique idea of compensating a CEO with stock options against a benchmark. I thought this was a brilliant (yet generally overlooked) idea and I wanted to explore it further.

First, you will probably notice a trend (and skeptics and critics in the market have always highlighted this) that when a company has done well, it is touted as because of good management (alpha). However, when the company is doing poorly, it is pitched as being because the market (beta) is in recession.

In using Kerhoulas' idea which he presented in class, I think it would be interesting to see if CEO compensation could be restructured to include more complex derivatives rather than just stock options. Although stock options are a form of derivatives, deriving their value based on the underlying stock (in this case the firm's equity), I think Kerhoulas' idea can be adopted with more complex derivatives. My proposal is to use a sort of net neutral strategy similar to the market leader growth strategy I mentioned at the end of this previous post. The assumption here is that you believe your company should outperform competitors.

How would this work? Well rather than compensate your CEO with either pure equity or call options to buy the equity at a given exercise price, the CEO should be compensated with a mix of these options as well as a short position against an industry index. What does this mean?

The short position against the industry index means that if the industry as a whole succeeds because the market rises (beta), the compensation of the CEO goes down (the firm is succeeding because of the industry). However, if the CEO's decision making allows his/her firm to outperform the industry, then (s)he will be compensated based on the performance in excess of what the market is providing (alpha).

Similarly, if a market is in recession (beta), the short position gains value as the market declines, but if the CEO can manage the company to outperform (or 'do less bad' than the market as a whole), (s)he gets compensation accordingly (based on alpha).

How about poorly performing CEOs? If management ability (alpha) ever underperforms the market (beta), the CEO's compensation will always be negative. Now rather than qualitatively make statements against the causes of your firm's performance, you can use the market index as a benchmark to have a context in which to describe management (CEO) performance as suggested by Nick.

I think another interesting result is what happens if this compensation structure is adopted in a system (say, the industry at large) versus in isolation (at one company). I intuitively believe that the game theory grid that would represent this scenario describing a system would resemble the prisoner's dilemma, in that as CEO's are incented to "outperform" the market becomes more competitive and the market index rises (which reduces overall compensation within the system due to all the short positions) because each of its individual components rise. It could even potentially be framed as a zero-sum game (as shown below) if the CEOs are forced to trade stocks with each other to create the required short positions in the market index.

This actually even acts as a natural cap for CEO compensation, but still motivates CEO's to fight over the same pool of compensation. The maximum compensation available will be determined by the increase in the short position of the market (how the market moves as a whole), but CEO's can essentially earn more compensation against their competitors.

Example:
Assume 3 CEO's managing equal companies. Each company's stock is valued at $100.
Market index is composed of one of each stock and the compensation derivative is described as:

• Long three shares of the company's stock
• Short one unit of the market index

Assuming that companies 2 and 3 have stable performance (no change in stock price), but company 1's performs and stock price goes up by $10.

Total compensation would be:

• Long three shares: Increase in value $30
• Short Market: Decrease in value $10
• Total compensation change:+ $20

Now try a new (industry wide / systems based) scenario:

Firm 1's stock: +$50

Firm 2's stock: +$20

Firm 3's stock: -$10

Market index: +$60

CEO 1's compensation: 3*(+$50) - (+$60) = +$90

CEO 2's compensation: 3*(+$20) - (+$60) = $0

CEO 3's compensation: 3*(-$10) - (+$60) = -$30

Note that the sum of the CEO's compensation is $60 (CEO compensation 1 + 2 + 3 which is the Market index). This is because the market index compensates 3 CEO's with 3 shares of each company, and the CEO's each hold three shares of their own company. It's as if each CEO shorts competitors' stocks to the other CEOs respectively. In this way, there is a natural cap on the CEO compensation (which is directly reflected to the value they bring to the market) yet, CEO's are still incented to overperform because they can capture the bonuses of their competitors if they outperform them.

Would this work in practice? Well the only people who would actually adopt this form of compensation are the executives who actually believe they can outperform the market. Once this gains legitimacy as a compensation structure by those who want their performance bonuses to have high credibility, it provides companies with a quantitative answer (and a nearly indisputable answer) to the question: Is your company performing well because of you or the market you are in?

Meet the Dean - Roger Martin and Integrative Thinking

I figure I'll take a short CFA study break to write about an encounter I had at the Meet the Dean session at Rotman early last week. I thought it was an invitational event for those of us who were accepted, but it turns out there were some people who were still applying, waiting for acceptances or deciding.

Dean Martin spoke about how Rotman is different from other MBA programs and for once, I was actually impressed with the Rotman presentation. This may seem kind of odd, coming from someone who has already "sampled" the proverbial kool-aid so to speak by accepting my offer letter to start in September, but the truth of the matter is that I was more sold on Rotman by my colleagues and friends currently enrolled (or graduated) than I was from the Faculty administration. I'm quite embarrassed to say that the admin simply made it seem like just an MBA program whereas my friends were raving about their experiences.

The reason I bring up this point is that Dean Roger Martin brought it up and addressed it as well. Now from ANY MBA program, you would expect some pomp and circumstance regarding why their program is so fantastic. One of the major issues facing MBA programs today is their incremental value add. For instance, there are some top schools for which recruiting companies have stated they would rather hire students who were accepted, rather than students that had graduated. The reason? Top schools who accept good candidates are simply validating their position as top performers, whereas the marginal benefit of attending a top school doesn't necessarily justify the exorbitant increase in salary.

Dean Martin reframed this postulate as top schools resting on their laurels and not affecting the changes required by society in light of the financial crisis in the markets. He put up a rather simple diagram of a three dimensional box with the dimensions described as depth, breadth and flexibility. He called the current state of MBA education, shallow, narrow and static where it should be deep, broad and dynamic. I can't remember who he was quoting off hand, but he mentioned: "There aren't marketing or finance problems. Only business problems" (reflecting the interdisciplinary relationships).

He used the example of the Blacks-Scholes models for derivatives valuation and that stated limitations in the model made it inappropriate for use in many circumstances. However, this model is widely used in ALL derivatives valuations and therefore leaves models with large vulnerabilities in their assumptions.

The punch line?

Integrative thinking is a framework which systematically creates people who ask the right questions to make the right decisions.

Using Oligopolies and Monopolies to Model Union Behaviour

Imagine there are a limited number of organizations which control the supply of a valuable resource. This small group of organizations collude with each other to deliberately regulate and restrict the supply of this resource in such a way as to maximize profit (acting in a similar manner as a monopoly). I'm not talking about OPEC and oil, I'm talking about unions and labour.

While it should hardly be a surprise that organizations and individuals look out for their own best interests, why is it permissible for some to exhibit behaviours that would be considered illegal by others?

What do I mean? Unions are essentially collaborating (colluding) with each other in order to capture as much of the labour market as possible across different industries. Whatever sectors they have influence over will usually experience inflated costs. If any business ever did that, they would be struck with anti-trust and anti-competition legislation.

Now any intelligent person will immediately point out that people should not be treated in the same way as oil. Of course not. However, the fruits of their labour can be quantified as a wage and to stray too far from that natural intrinsic value is poor practice.

Don't get me wrong. I don't think labour should be under paid. That scenario is just as unstable (and disastrous). But please don't act surprised or insulted when there is an inevitable reckoning when a scenario demanding more competitive practices force dramatic changes. Inefficient and unfair practices, whatever form they take, are inherently unstable. This is currently the scenario with Fiat purchasing Chrysler but incredibly weary of union wages inflated above the industry norm.

The difference between a union and good management is that good management should adjust wages as close as possible to their intrinsic value (up or down). Bad management will always try to under cut and unions will always try to get more. Its ironic (and extremely unfortunate) that in unions often start (and perpetually persist) in companies that at one time or another exhibit bad management practices regarding labour. Resulting in extravagant tug-of-wars in which no one really wins.

The best way to keep a union out? Be a responsive, flat and flexible management. Pay your staff well, respect them and be sensitive to their needs so they don't feel like they need an "additional management layer / political structure" to take membership dues in order to insulate them from poor management. A scenario where you regularly pay dues requires you to regularly justify your use of those fees (as any accountable organization should) and the situation naturally becomes resistant to change as unions are required by their mandates to always fight for higher wages even if the situation does not permit it (this is due to the zero-sum non-efficient use of membership fees to capture labour "demand surpluses" of businesses).

Regarding my previous model of profit per employee, I think that there should also be a risk / reward model when applied to wages for jobs. This is in direct response to critics who see CEO's with large compensation packages who leave sinking ships. I firmly believe (as do our capital markets) that if you want higher rewards, you must take more risks. The golden parachutes provided to CEO's seem to defy this logic. Certainly another example of an unstable scenario that doesn't "feel right".

Story of Stuff - Sustainability and Statistics

I was recently introduced to this interesting video on the history of stuff (~21 min) and thought it might be helpful to do a quick review. I think there are some brilliant messages here, but at the same time, I think this is a prime example of having to look more closely at statistics and question what's presented. First let's look at some of the key points:

• Linear systems are not sustainable (and certainly cannot support exponential growth). You need a cyclic system in order even have a chance.
  
• Externalizing costs is a model which offsets the factors of production to keep costs low (and like over utilizing any resource is itself unsustainable).
• The three R's are Reduce, Reuse, Recycle (in that order). Recycling should actually be a last resort from a sustainable consumption perspective.

While I like the overall message, I find some of the points and use of statistics questionable. Or as xkcd puts it:


For instance, Anne Leonard states that 99% of everything we consume is disposed of in 6 months. That's a lot. I have a general heuristic for these types of scenarios. If your statistic produces a result of more than 90%, that generally means there is some selective data mining going on. To reach a number like 99%, it suddenly becomes more interesting as to define what is the 1% that we keep beyond 6 months. It seems pretty astronomical, yet something about this doesn't seem right. What could possibly justify this number?

• Why six months? Why not look at a quarter? A year?
  
• Is it measured by income dollars spent? Mass of goods? Volume occupied in a landfill versus in storage?
  
• What's included? Housing, food, gasoline, seasonal clothes, books, text books per semester, garbage?
• What would be a more appropriate number given the same metrics? What should we aim for?
  

Next, Anne mentions that the US has 5% of the worlds population but they are consuming 30% of the resources (implying a footprint of 6x of what is should be). She also mentions that we are consuming 2x as much as 50 years ago which I feel is like comparing our peek consumption with our valley (which upon further analysis is almost meaningless). 50 years ago is very close to the depression and WWII which are the lowest consumption rates in recent history.

I am very opposed to peak to trough comparisons in behavioural studies because they represent extremes. I'd be more impressed with a normalized study over time with standard deviations rather than an opportunistic snapshot of a scenario 50 years earlier. This is because I'd expect that despite the growth of consumption, there is a corresponding diminishing utility that Anne hints at as a cause of decreased happiness since the 50s.

Her point on computers and planned obsolescence is both correct in many respects yet highly oversimplified and as a result (I would suggest) misleading. She implies that a computer upgrade is simply a CPU replacement and that companies intentionally design chips so that they cannot be easily substituted.

Upgrading a computer can *sometimes* be as simple as replacing a chip, but often with increases processing power come increases in bus speed and memory. A computer system is a much more complicated than simply replacing an old chip with a newer, better one. It's not just a matter of "shape" as suggested. Actually, the change in shape is deliberate to prevent people who don't understand how computers work from blindly substituting in parts (and destroying both).

Despite my negative tone regarding her use of statistics, I really think Anne has done something phenomenal. Her attempts to reach a broad audience are successful, but she does sacrifice a bit of credibility for accessibility. Some of her broad and extreme claims leave her work more vulnerable to criticism than it should be. I do like her proposed solutions, but I think the corresponding required change in consumer behaviour will be quite a challenge. I think that everyone should spend the just 21 minutes and watch this video.

Selfish Sustainability - Save or Starve pt 2

Selfish Sustainability - Save or Starve Series [ 1 - 2 - 3 ]

Now that we had a "new" mission, e were forced to help change. Not by governments nor regulations, but our own self interest as a profit loving entity. We had to take a new perspective on our goals and extended the scope. Now we were a force of change.

New Problem: Depletion of natural resources
We can't call ourselves a top luxury hotel with pristine nature if the sea bed has been bombed to smithereens. Our natural resources are being depleted in a decidedly unnatural rate. As mentioned in my previous post, we had to understand why.

Salience:
We need to increase the awareness of the damage that's being done to our natural resources with the public. Issues arise that quickly become apparent. This is an illegal activity. You can't just advertise a class for fish bombers and hope you get good attendance.

We also need to address the poverty and danger associated with this negative short term thinking and the negative economic externalities they impose on the local community.

Causality:
Fish bombing is driven by a combination of poverty which is a result of a lack of opportunity, education and awareness in the general local public. It also thrives because of lack of policing due to difficulty to coordinate naval operations with the community.

Architecture:
How should we model our action plan to solve these challenges?

• There is a need to work closely and communicate with the community to educate them and start a community dialogue. We need to educate our society to understand the value of this natural resource for everyone.
• We need to fight the root causes of this destruction and poverty by creating better, higher paying jobs and opportunities for local members of the community. Suddenly, instead of selling a pile of dead fish for a few RM each, you can have wealthy tourists pay you the same amount just to look at them. One of these you can do forever. The other guarantees your children a worse future than what you have now.
  
• The community needs to be connected to the relevant policing agencies to actively protect our natural resources.

Resolution:
A higher quality resort demanded higher quality service. We had to introduce language classes, service training to give our staff an opportunity to develop into new more fulfilling roles. It was nice to see local hires who saw the resort as a family. No longer simply "changing sheets", they became part of the hotel experience and fellow nature lovers.

Our staff numbers more than doubled from the previous management (which excludes the second island resort), wages and benefits also increased (caused by the increased demand for labour). In one of the arguably best applications of supply side economic theory working in the real world, we demanded more from our team, compensated them better to keep them and they stepped up to the task.


Also, we developed incredible programs such as the Marine Ecology Research Center (MERC) based on leading edge research to restore marine life in the water. We increased the number of PADI certified divers in our resort, making diving equipment and training accessible to our locally based general employees so that they could experience and understand what they were protecting.

We started our own sustainable fish farms and water treatment and recycling systems. As an island resort, we couldn't just hook up to the city mains. Plus our treatment systems were more advanced that those provided by the city. We made an effort to have our values and behaviours reflect our over arching philosophy. We are profiting from nature, so we have to protect our interests.

Long Term Outlook and Lessons Learned:
If you want to use capitalism as a force for good, how can you redirect 'greed and the drive for profits' into a solution for sustainability? Align the corporation with the values of society. Our situation was unique. There was a direct correlation between the health of our environment and our profits. Our environment: Save or starve.

Anyone who is a cynic of corporations will immediately raise their hand and ask "Uh... Shouldn't governments be looking after the natural resources and interests?" Absolutely. But some governments are not as wealthy as others. The unfortunate truth is that many wealthy countries have exploited their natural resources. The remaining ones that are naturally beautiful usually remain that way because they haven't been industrialized (and tend to be poorer). While this isn't strictly always the case, often governments often can't afford to police and protect their resources. Malaysia is hardly unique in this area. They know they have a valuable resource and are working hard to try to find more effective ways of protecting it.


This was a topic of the Asia Pacific Ecotourism Conference (APECO). While corporations may not be the best solution in all cases, it certainly beats the solution of no awareness and no responsibility. There were countless examples of beautiful areas that were ruined because they were neglected. These areas were notorious for exploitation by seemingly less scrupulous individuals who (it turns out) were just looking to feed their families.

There are certainly a lot more issues and complexity that arise from the discussions and further study regarding ecotourism policies, corporate social responsibility and sustainability. This series of posts is intended only as a starting point to illuminate another path for more enlightened discussion:

1. Corporations, if used appropriately, can actually be a force for good rather than stereotypical greed,
   
2. Corporations can contribute funds to develop positive programs, real opportunities and supply good jobs, rather than simply act as a source of tax shelter based charitable donations, and that
   
3. Integrative thinking can help you find the surprising nugget of gold in a case where there is a lot of chaotic data and relationships

Selfish Sustainability - Save or Starve Series [ 1 - 2 - 3 ]

Selfish Sustainability - Save or Starve pt 1

Selfish Sustainability - Save or Starve Series [ 1 - 2 - 3 ]

Corporations are based on greed right? Is there any way to use the drive for profits to enforce ecological sustainability? Turns out there is. One of the reasons I love this case (derived from my experience in Malaysia) was that it started out as a standard vanilla business problem and evolved into something wonderful. Suddenly, evil corporations could be on the side of angels.

If there was ever a case where integrative thinking would lead a corporation to pursue success while preserving the environment, my work with hotel developers in Malaysia would certainly fit the bill. It's a great case study for looking at a problem through the framework, coming up with more interesting questions and reaching a surprising conclusion. Another reason why I like this case is that when you use integrative thinking to look at the broad perspective of what's going on, you can often find surprising answers to your original questions.

Let's look at what happened:

*Initial* Problem Definition: Let's Make Money
Our holding company held several properties. Two key properties were beautiful island resort properties which had unfortunately been left in disrepair. Our Managing Director had seen some great potential for these new island properties to be acquired and developed into boutique luxury hotels to service the affluent Asian and Australian market.

Salience:
Metrics of a hotel are pretty standard. You want to charge good rates and have lots of people come. As I mentioned in my previous post about hotel capacity management, the raw math for making money in a hotel is pretty straight forward.

Causality:
As I also alluded in my previous post, average room rate (ARR) is dramatically effected by quality (real and perceived). Also occupancy (OCC) was greatly affected by market presence. Both of these qualities are strongly correlated to brand equity. Certainly no surprises here.

Architecture:
(Where new problems and interesting challenges start to surface)
One of the reasons I was brought on the team was to bring in an international perspective. Most of the senior staff was composed of local managers who (although talented) had trouble perceiving (and therefore developing and selling) the differences in the international market. Many of our sales agents had a legacy two-star rating of our old services and facilities. So we set up a framework for dealing with those issues:

• Upgrade facilities to match a 5+ star boutique quality with a luxury brand network (such as Small Luxury Hotels or Prestige)
• Leverage network to attract high quality clientele (from outside of local markets - average spend of a visitor to our part of the world was RM2000 (Ringgit Malaysia) or ~$700USD for an entire week long vacation. We were charging $300 USD per night). Relying on the average and status quo wasn't going to work.
  
• Renew brand equity and highlight natural beauty and proximity to nature as inimitable point of differentiation against other leading international hotels in the luxury space (in the luxury space you have to be exceptionally unique to attract guests)
• Have world class operations to support your brand equity promise of a peaceful, serene resort experience

While all of this may seem rather obvious (even those of us who haven't yet finished our fancy MBA school degrees), I deliberately emphasize the importance of natural beauty *and* proximity to nature because without it, we were a resort like any other.


While services like jungle trekking and scuba diving were available in beautiful places like Sipadan (World class diving site) or jungle trekking in the depths of the Sabah's jungles, we were the only location that was located only a 15 minute boat ride from main ferry terminal in the heart of the capital city and offered both.

Every other hot destination required a minimum 3 hour bus ride. Sipadan also required a flight to Tawau on the other side of Sabah followed by a lengthy boat ride. While they are worth it for those who are "hardcore" (I myself have done these trips) they are hardly easily accessible and require additional days travel. We were isolated, pristine and accessible.

Resolution:
Exploit natural resources, build hotel, make money. Right? Well that would seem to be the natural answer. But if you're livelihood depends on the pristine condition of your surroundings you have to make sure that you look after your natural resources.

There was a problem in Sabah. While rich in natural beauty, like many developing nations, the majority of the population was poor. By Malaysian standards. This resulted in some extremely negative short term behaviour.

New problem: Destructive Fishing
One such example is fish bombing. As an outsider, I thought it was an over exaggerated myth until I experienced it on a trip during a day off.

I was taking some time off with the diving staff so we decided to scuba dive in a reclusive area of the island. With our proximity to the city, we often see fishing vessels of locals. Pump boats, notorious for being illegal vessels (because they can outrun police boats in shallow shoals), are still incredibly common. On our search for a dive site, we passed by one and in my good natured naivety, I waved as we passed by. Unamused, the two fishermen, sharing what is essentially a canoe with a lawnmower engine, eyed me suspiciously before returning to their work. I though nothing of it at the time (whereas my two diving companions apparently knew better).


Our dive was nice, but fairly uneventful, until towards the end, just before we decided to surface, I heard a rather forceful explosion and felt as if someone has punched me in the chest. It was incredibly unsettling. At first I thought someone's tank exploded, looking at my two companions they were fine. I checked my equipment and everything seemed to be in order. When we returned to the surface I was shaken: "Did you hear that? What was that?"

"Fish bombing" came the reply, "probably from those guys we passed earlier." Although the explosion was a good distance away (judging by the position we last left the two fishermen in the pump boat) I had temporarily forgotten the physics of propagating waves in water (water is an exceptionally good transmitter of waves and pressure). The force felt so close, I thought it had to be nearby.

It turns out this "urban myth" is all too real. What happens is that poor fish farmers will create homemade grenades, toss them in the water and cause large vibrations which immediately kill the fish in a large area by rupturing their organs and they immediately float up to the top for a catch which will supply the fisher man with as much as a reported RM4000 for a days work (average salary for Malaysian workers ranges from RM300 to RM1000 per month for skilled or semi-skilled labourers) so that translates into a great deal of money.


The obvious problem is that this indiscriminate form of destruction also destroys corals that took years to grow. Besides being beautiful in it's own right, coral also acts as a home and food supply for many forms of aquatic life and is therefore a critical part of the ecosystem in the water. In recursively applying the integrative thinking framework (Salience, Causality, Architecture and Resolution) the less obvious "secondary" problem that surfaces becomes the primary one. Fishermen are poor and have an good financial incentive to take more aggressive measures to ensure their livelihood (exploiting their future for the present).

Suddenly, not only is a matter of developing the resort facilities, but also the society that the resort exists in. Our problem definition has suddenly become more complicated (and enriching) than "build hotel, make money".

[cont'd on pt 2]

Selfish Sustainability - Save or Starve Series [ 1 - 2 - 3 ]

Is Globalization and Outsourcing "The Devil"?

Often we hear cries that globalization and outsourcing are the demons of capitalism and create unfair playing fields for local business while oppressing the poor of foreign countries for the benefit of the rich. Unfortunately, often many activists have reason to complain.

Many altruistic people are comfortable drawing parallels between our lifestyle versus those of developing nations, akin to: "You should be happy with what you have compared to what poor people in other countries have." I would propose that responsibly exporting components of success that lead to a shared and similar lifestyle is the first step towards achieving that dream.

While good intentions are the motivations at the start of the journey, it is necessary to have the engine to drive you there which I propose is the idea of fair trade and responsible globalization.

I think that if you are aiming for the noble goal of global equity (as the aforementioned statement assumes) than you will have to rely on some degree of globalization to happen. And as with anything, a good idea can be poorly applied if the implementation is not well planned.

I do believe that globalization is inevitable (for better or worse). Furthermore, I perceive the inequities in terms of purchasing power and lifestyle as inherently unstable scenarios that free trade should theoretically begin to remedy. However, I can understand an activists concern at the potential (or rather, historical) of exploitation of poor foreign workers (or even "opportunistic disaster capitalists" as Naomi Klein describes them in her book Shock Doctrine) which subsequently also results in lost jobs in home countries. While the opposite strategy would be considered protectionist, this strategy certainly seems reckless, benefiting only a select few based on morally weaker ground and attracts negative attention.

The focus should not only be on exporting the engine of capitalism, but also the standards that come from more developed countries in terms of workers rights and democratic process that should go with it. This is to bring a more broader definition of success and prosperity into an economically (and potentially politically) less developed country.

Any company that attempts to outsource without taking these issues into consideration will certainly struggle as consumers and workers demand more corporate responsibility from their leadership and insist that company's stick to their stated core values.

Assuming a more optimistic tone, a corporation that is sensitive to these issues will not abandon globalization, but will rather do it in a more responsible fashion. The economic assumption from free market and supply side advocates is that a company opening a new factory in an area should be increasing the labour demand curve and as a result raise the wages of the local populace. While a rise in real wages is a great metric for describing success, what is more important for the population at large in this case is that the entrant companies are providing options for local workers.

That is to say, if current workers are unhappy with their working conditions in their current jobs, this new opening will need to provide them with incrementally better opportunities in order to attract them from their current positions or to fill a vacuum of unemployment. This is the opportunity that foreign companies can and should offer to locales where they open new operations.

For companies who are constantly looking for differentiation, this leads to the obvious marketing and PR component. In this day and age, it is simply not enough to do social good without having an open and frank discussion about it in public (in a closed loop communication system). Corporate communications should proclaim their messages of good faith coupled with their good deeds so that the public can transparently judge them based on their actions.

Sustainability and a Green Focus

The top issue with MBAs and other business leaders today is the idea of sustainability (Wikipedia article authored Jan 8, 2009) coupled with corporate responsibility. Although, MBAs are currently highlighting this area as important, it lacks a definition which is meaningful as actionable advice.

I would propose that the most base definition of sustainability should relate directly to energy capture and consumption. However, since products cannot simply be arbitraged nor modeled directly as energy consumption, there are many other aspects which must be considered: carbon emissions, land use, natural resource extraction rates etc.

It is quite obvious that anything which is consumed and not replaced is in an inherently unstable relationship. Currently, companies such as Monsanto are working "diligently" in order to increase the yields of products we consume (in Monsanto's case, GMO food products) as a solution to assuage the strain and diminishing return of our resources. However, even the most cynical and fastidious capitalists must recognize that there exists some natural limit of efficiency (even with technological augmentation).

Biotechnology growth has recently spiked up as a result and its now up to companies to find out what that means for them. How should companies incorporate business practices so that they can benefit from this inevitable trend. While some companies are contributing at the forefront with new innovations in resource management, other companies will have to find which services they can provide or will demand in the future. Whether these companies are innovating to create substitutes or trying to increase the efficiency of how we use our resources, sustainability management will likely become an increasingly popular (and necessary) field.