Management Skills for Investment Managers Seminar

Foreword o. Whitfield Broome, Jr. Executive Director

The issue of management skills for investment managers is one of the most challenging that confronts our profession. As confident as we may be in our analytical and portfolio-related skills, most of us would admit to at least some lack of self-confidence when it comes to managing the people who manage the money. And, with good cause. While about two-thirds of the Institute's members hold advanced educational degrees (and, of these, the MBA predominates), most practitioners have not employed their educational training in business management applications. Instead, it has been utilized primarily in one or more financial management roles. As a result, practitioners all too often arrive at a point in their careers when-demonstrated investment capabilities aside-they need to possess and apply general management skills to continue to advance in their organizations or to take advantage of new opportunities, only to find that they are deficient in this respect. To address this important issue, the Institute sponsored a seminar in Washington, D.C on October 26-27, 1982 entitled Management Skills for Investment Managers. It brought 110 CF.A.s and other investment professionals into contact with a front-rank educator and five outstanding principals from investment management firms, three of whom are themselves members of the Institute. Together, they explored the problems and the opportunities that are present in this critical area, seeking to identify and understand the complex factors that impact our activities in a business management sense and to apply this knowledge to suggest organizational forms and practices that can assist practitioners to manage better. Presentations were followed by question/answer and discussion sessions to elaborate on themes developed by the speakers and to provide for a sharing of experience and ideas. As important as the seminar was in and of itself, it was designed to serve a second and equally-important educational objective. Members will recall that the I.CF.A. Trustees last year announced a new continuing education program, to become operational in

1982. The Washington seminar was the first to be presented in actualization of this commitment. Others will follow, addressing topics of similar relevance and substance. Whenever possible, seminar content will be shared with members - either by means of written materials, as in the present case, or by other dissemination methods. The following Proceedings have a special significance, as they mark the beginning of a new phase in the Institute's development, a phase that will bring significant new benefits to members in the form of increased availability of quality programs and materials specifically designed to meet their needs in the area of continuing education. The Institute wishes to extend special appreciation to the Washington speakers: Professor Richard A. Cosier, Professor of Management, Indiana University; Harold L. Arbit, President, Treynor-Arbit Associates; J. Richard Boylan, President, Provident National Corporation; Daniel J. Forrestal, III, CF.A., President, InterFirst Investment Management, Inc. (whose chapter on this topic in the recently published book Managing Investment Portfolios: A Dynamic Process, inspired this seminar); Paul F. Miller, Jr., CF.A., Partner, Miller, Anderson & Sherrerd; and Dave H. Williams, CF.A., Chairman of the Board, Alliance Capital Management Corporation. Each of them made extra efforts in preparation for their seminar appearances, importantly speeding the availability of these Proceedings. Thanks are also extended to the Institute's Council on Continuing Education, chaired by Charles D. Ellis, CF.A.; to John L. Maginn, Donald L. Tuttle and James R. Vertin, three CF.A.s who helped shape and stage the seminar; and to Harry A. Hansen of the staff of The Financial Analysts Federation for his valuable organizational assistance. Lastly, the Institute extends hearty congratulations to Darwin M. Bayston, CF.A., its Director of Continuing Education, for so successfully launching this important new activity, and to Barbara Smyth, Susan Shelton, and Mary Shelton of the Institute who contributed so much to its success.

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Proceedings: Management Skills for Investment Managers Seminar Sponsored by The Institute of Chartered Financial Analysts October 26-27,1982- Washington, D.C. OVERVIEW OF THE SEMINAR

James R. Vertin, C.F.A. Directing; planning; motivating; compensating; controlling...all of these are general managerial skills. They differ in content and concept from the technical skills that are the day-in, day-out province of the investment manager. They are, in a very real sense, noninvestment skills. Yet, managers of investment managers must possess these skills if they are to lead their organizations effectively and achieve investment-related growth and expansion beyond the confines of their technical backgrounds. It was observed in an early session that success in the investment management business does not automatically flow to those firms that assemble the best people or spend the most money on their support. Clearly, something else is at work that acts to differentiate one firm from another in terms of the attainment by which success is measured. The identification and description of this "something else" was one of the major themes explored at the just-concluded seminar whose Proceedings are enclosed. KEYS TO SUCCESS

What makes successful investment firms successful? A high order of investment-related skills is required, of course. But, as we have all seen, the presence of such skills-even in extraordinary amounts-is not sufficient by itself to either attain or sustain success. What about resources? Again, an adequate resource base is essential- but size and depth of resources do not appear to be critical factors in determining success or failure as an investment manager. Rather, it seems to be the presence and effective integration of general managerial skills that leverages the basic elements of investment capability and resources to make a firm successful. Put another way, full realization of the potential value of a firm's investment skills and support resources will not be achieved in the absence of accompanying managerial proficiency. General Managerial Skins In opening remarks designed to illustrate the broad sweep of general

managerial skills that apply in businesses of all kinds, Rick Cosier stresses the fact that even the most fundamental of these skills are applied against a constantly-changing environmental background. The investment management business is especially dynamic and particularly sensitive to external developments, suggesting that our management skills must operate within a dynamic organizational context if they are to be effective in coping with the demands of change. Rick presents and discusses such a model (dubbed "The Pac-Man Model" by participants), identifying three distinct phases of organizationallife and noting that each of these phases requires a separate and distinct mix of managerial skills. Thus "good management," while a constant when viewed as a success requirement, is not a fixed combination of managerial skills that, once in place within the organization and being applied effectively, is immune to change. Looking ahead, he suggests that conceptual skills will become more and more important as the future unfolds; that generalist managers who are creative and can evaluate the impact of external forces affecting the firm will also increase in importance; and that more emphasis will be placed on specialists skilled in research, in development of new products and services, and in implementing change. He concludes that all of us-since our firms are in constant motion along the change paths identified in his model- will need the capacity to capitalize on new opportunities by shedding many of our old ideas, products and services if we are to attain and sustain success. Focus on People: Number and Quality Paul Miller, who turns out to be something of a computer buff as well as an accomplished portfolio person, illustrates a number of paradoxes that apply to the investment management business and asks the pointed question "Can we really improve our products and profits through better business management?" He believes that some professionals have a money-making knack; that this knack is the "something else" at work in producing firm success; and that the business should be organized to surround such people with a "group dynamic" that enhances their productivity, focusing on the people

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rather than the investment process. He discusses his own experience in this respect and presents a set of conclusions in the form of insights into the common characteristics shared by successful investment management firms. In the fascinating question/answer period that followed his remarks, Paul elaborated on these and other matters, commenting on why smallness (or at least very closely-controlled size growth) is essential for success; on the importance of possessi.ng a "sense of relativities" and a knowledge of market history; and on the value of economic forecasts, Wall Street (and other) research, and personal computers. In his firm's model, each of six partners manages a piece of each portfolio and the same people that manage the portfolios do the firm's analytical work. Concerning this definitely non-standard approach, he remarks that it is "...a very complicated process (that) sounds as if it would never work, but it seems to...." Coping with Growth and Organizational Change

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Building on the content of Rick and Paul's remarks made earlier, Dan Forrestal presents a cohesive description of both the unique external factors that render management of investment management firms so difficult and the response mechanisms that successful firms appear to utilize effectively. The successful firms are divided into three groups-the "good posHioners," the "good reviewers," and the "good leaders" - and each is described in useful terms. He then examines some of the internally-generated factors that operate to destabilize investment management firms, with particular attention given to the special problems induced by success itself as manifested by growth in size and accompanying organizational change. Again, effective counter-measures are identified and described, and the discussion provides examples within several life-cycle contexts, differentiating among creative, mature and transitioning situations. Concluding, Dan presents an insight from his own experience that represents a common law of managerial success in our industry. "Winning firms," he says, "understand the power and productivity of superior investment professionals and the importance of remaining lean and efficient in the portfolio decision process."

Use of Lateral Thinking Processes Hal Arbit undertakes an examination of the strategic issues addressed by successful investment management firms and of their responses to these issues. In the context of his discussion, "strategic" is defined to mean "...the actions (that) successful firms take to increase their chances of ensuring a competitive edge." The strategic issues discussed include the external environment's impact on the firm; the firm's own internal environment (organization, culture and management); and the important difference between investment information and investment insight. Hal identifies a number of success criteria, including the firm's ability to generate effective feedback and self-appraisal; to be selective in the data that it works with; to measure its strengths against the consensus of investors rather than against specific competitors; and to define what the key insights are that represent its competitive advantage and to organize to exploit that advantage effectively. "Successful firms don't believe they are good at everything," he says. "They have identified their specific strengths." Observations on making market bets, on staffing and on creativity and its management are offered, followed by a discussion of analysis vs. insight and what firms can do to increase the number of insights they generate. Here, he provides a description of a Iflateral" thinking process and the advantages it offers when used to complement our usual, Ifvertical" thinking pattern in the search for good ideas and better investment decisions. A variety of Iflateral thinking" techniques are identified, with graphic supplements that assist in understanding. Hal closes with an enumeration of characteristics that successful investment management firms will have in common. Concerning one of these-effective client communications-it is observed that while a client may be disappointed by results produced from time to time, the client will never be disappointed and surprised if communications are effective, thereby improving the odds that the manager will get the time needed for his good ideas to work out. Transitioning to New Creative Phases In Rick Cosier's Pac-Man Model" of organizational development mentioned If

earlier, firms in the maintenance phase of their life cycle eventually reach a point where continued viability and survival requires that they transition into a new creative phase. Dick Boylan, the principal actor in one such transition drama, described the process by which his firm was launched into a new era of growth and profitability. Proceeding step by step through the re-birth of the firm and its subsequent redirection and expansion of activities, he provides many illustrations of how change and the firm's responses affect organizational structure, staffing, compensation, the decision process and, in this case, even the geographical location of certain types of functions. Dick's experience clearly shows that organizational maturity need not equate with organizational senility or somnambulance ifits leadership is able to see itself in nonstereotyped terms and is able to generate the decisions and follow-through that are required for pursuit of new directions. Interestingly, we see from his description that old skills need not be abandoned and may well retain an important place in the firm's new life, given a new packaging and, perhaps, a new delivery system. In Dick's case history, what was a firm with essentially one undifferentiated product was transformed into a multi-unit, multi-product firm with extraordinary growth behind it and, apparently, still ahead. It is a clear example of creativity and the effective use of general managerial skills. Effective Size and Organization Planning Dave Williams addresses a second major seminar theme, size and the effects of size on the ability of an investment management firm to remain effective in its decision-making and, hence, in its results production. It was brought forward by many participants and clearly recognized by the speakers that the elements of creativity and entrepreneurship that characterize a firm in the early stages of its life cycle are the very characteristics that are most threatened by the growth and development that success engenders. Dave speaks to this dilemma and describes how his firm has managed to grow large while "remaining small." Resolution of this contradiction of terms has required innovation and the application of highorder managerial skills. To compound

the problem, resolution has had to deal with multiple office locations, the existence of which was first seen as a weakness but later found to be a source of strength. He describes the application of a "matrix" organizational form as a crucial element in attaining managerial control and flexibility. In addition, he illustrates the importance of diversification in the mix of skills employed and products produced by the firm, and comments on the attractions and difficulties associated with international investment activities. Dave concludes with an important final observation: given enlightened management, excellence as an investment management firm need have nothing to do with its industryaffiliation. KEY PARTICIPANT POINTS

The above brief overview provides only a glimpse of th~ tenor of the seminar's content and the key points of inquiry and discussion. Multiple points of view were represented, both in the presentations and in the group discussions, and several contrasting styles were evident. It was agreed that no one path or managerial approach to success exists and it was evident that markedly different solutions to similar problems can be equally effective. Indeed, as presaged in Dave Williams' concluding remark, here are five investment management firms that are obviously dissimilar in size, scope and structure, represented by spokesmen whose own views and emphases are not the same, and whose ownership (a private partnership, a brokerage firm, a trust-oriented commercial bank, a private corporation and a single-purpose bank subsidiary) is diverse. What do these and other successful firms have in common? The following extracts from their presentations reveal several threads of agreement and comparability, and serve to point up some of the philosophical and business management convictions held by the speakers: Richard A. Cosier " While technical skills are necessary for success in managing organizations, they are not sufficient. Examples abound of the competent technician who fails miserably when promoted to a management position

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involving supervision of the work of others. • Many managerial decisions are novel, involve uncertainty, and cannot be programmed. These decisions are typically best made by a creative individual. • Organizations are not static. The changing nature of organizations suggests that management should also be a dynamic concept, and each phase in the organizational life cycle has implications for the proper mix of managerial skills. • It is uncommon to find a handbook of company rules or a formal organization chart for a company in the creative/entrepreneurial phase. In this phase, technical skills are usually going to be the most important elements of effective leadership. • It is a fallacy that you have to be consistent as a manager and leader. You can be flexible, but flexible in a precise sense. You've got to know what you are doing, either directing or nurturing, depending on how welldeveloped the people are.

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• In our system, we've viewed information as power for so long that we like to hold on to it. We must learn to share our information with others (i.e., to delegate or decentralize) if we are to improve as managers as we move up the responsibility ladder. Information tends to move only upward in our system; we need to pass it downward. • Managing appropriately in different life-cycle phases may require that some of the more maintenanceoriented activities in your set should be separated from the more creative ones, so that you don't mix them up. • People who are achievement-oriented need feedback, particularly if they are in a maintenance activity. You tell them, "You're doing a good job and here's the data." And you pay them well. • The state of the art, as far as a particular product or service is concerned, is changing all the time. At the least, you have to keep up on what and where it is. • The best manager is someone who can effect the needed changes in an organization at the proper time.

Paul F. Miller, Jr. • By many textbook criteria, investment management "is a lousy business". • Many academics steadfastly maintain that there is no necessity for our product and that the worth of investment management is zero. In fact, they are right in the important sense that onehalf of all the money under our collective management will be belowaverage in performance. We in the business just happen to believe that the above-average performers aren't accidents. • The similarities of investment management with the advertising business (one that is somehow manageable, although known for its individual stars and the impermanence of its leadership) is very striking, even including the doubts about the worth of the product and the fact that one half of the product is inferior. • Clearly, certain parts of our business are susceptible to management: • A firm can benefit immensely from a well-conceived formulation of business strategy; • Product differentiation can payoff handsomely; • Efficiency and profitability go hand in hand, but cost-effectiveness seems to elude many older, institutionally-rigid organizations; and • Research directed at new products and the improvement of old products is just as valid for our industry as for, say, the pharmaceutical industry, yet there is amazingly little done on this score by most organizations. • Maintenance and improvement of product quality and the management of product development are areas which seem to make this business very different from others and present the largest challenges. Why is this? • The money-makers in our business seem to gravitate to the right answers even though they have no specific knowledge of the facts. There is some innate difference not based on intelligence, education or experience. We are talking about an abstraction similar to artistic or musical talent.

• Such talent must, of course, be organized and orchestrated. While there is no best answer to how to do this, it is surprising how few people recognize it as a problem. • Information in the marketplace has proliferated beyond all ability to deal with it, but, it's still as grossly inadequate now as it was years and years ago. • Successful investment firms have recognized in some way that the business has a peculiar benefit to be gained from entrepreneurship. Daniel J. Forrestal, III • Portfolio management favors the disciplined individual who is comfortable in becoming detached from consensus thinking and who makes contrary bets based on informed thinking. In providing leadership to such a process, the leader must constantly remind himself that the elements for successful execution run in basic conflict with fundamental human tendencies to seek conformity and acceptance. • These are some of the unique environmental factors affecting our industry: • We have a daily report card on the quality of our judgments and the performance of our product line; • The quarter-to-quarter orientation of performance measurement is at odds with the long-term nature of our role in the capital formation/allocation process; • The potential magnitude and mobility of the cash flows and assets that can move to a favored manager have placed a huge premium on the ability to market effectively, a non-investment skill; and .. A disciplined, long-range management perspective is very difficult to maintain when the basic human response to rapid change and information overload is to react to shortterm events, not to long-term logic. • Under the strain of short-term pressures the temptation for portfolio managers to follow the crowd can be overwhelming. This tendency must be managed. • The illiquidity of large positions and physical inability to implement major

strategic changes are often cited as the major impediments to success as firms grow larger. There are enough exceptional larger firms around to make one think that the primary obstacles to success are located deeper in the fabric of an organization. .. A key managerial requirement is to anticipate the changes in managerial requirements that will occur as the firm grows and responds to growth. .. It is crucial for managers of managers to recognize that, in the absence of deliberate action, creative organizations have a natural tendency to transform into mature organizations. Even small firms can exhibit maturefirm symptoms if their leaders fail to recognize the need for effective managerial direction.

• Resistance to change developed during the maturing of an organization can become so intense that the staff may refuse to consider new strategies even in the face of potentially devastating consequences. • A common denominator of firms that

retain their creative status despite substantial growth and organizational change is that they recognize the threat imposed by inertia and take specific managerial steps to defeat it. They also seem to have extremely high standards for the selection of staff and a deliberate leanness to the organization's head count. • A different but effective approach can be seen in those organizations that have responded to change by leveraging new services upon a core of knowledge and expertise that has already been assembled, evidencing unusual conceptual skills in benefiting from the inertial tendencies of their competitors. Harold l. Arbit • The investment environment is dominated by noise and information overload. How the organization handles this environment is critical. Successful firms tend to limit the data they process and focus on the abnormal, on the signs of change.

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• Most investment professionals assume that an above-average ability to analyze common data will result, as happens in most other fields, in a large competitive advantage. In the investment management business this is not true. In investing you are not trying to beat a specific competitor but the consensus of all competitors-a higher standard of competition. • Most investment firms have quite similar structures. Either most firms have the same key insight (which, if true, makes it unlikely that the insight will produce profits), or most firms haven't defined their insight and created an appropriate structure to exploit it. • Our culture focuses much more on making analyses than on developing insights. Yet, because it is so difficult to "out-analyze" the consensus, insight is much more likely to produce profitable investment ideas. • Successful firms are prospective (i.e., focused on new events likely to occur) rather than reactive. They challenge assumptions and are wary of adopting the first adequate alternative offered or discovered. • Successful firms are able to simultaneously accommodate three distinct cultures (creative, guild, and technical); they diversify the characteristics and traits of the people they employ; and, they have an above-average capacity to tolerate discomfort. 6

• Successful firms realize how easy it is to dissipate their best investment bets; they concentrate the largest proportions of their portfolios in their strongest ideas; and, they have considered how much business risk they are willing to take to exploit their best ideas. The more aggressive a portfolio, the more risk is being taken. • Successful firms have a clearlyarticulated purchase rationale for every investment decision, both as to the decision itself and as to why it was superior to the alternatives examined. In addition, they have a high feedback level, since they want to know if they were right for the reasons on which they were relying.

J. Richard Boylan • We currently have $20-21 billion under management, which compares with $1-1/2 billion ten years ago. • The earnings produced by our investment management activities represent a significant portion of total corporate earnings and consequently the Provident can, to this extent, be distinguished from most banking companies. • We could not hope for market acceptance of new products without acceptable performance. • Market surveys convinced us that consumers did not differentiate among Trust Companies in terms of investmenf capabilities. As a result, the buy decision tends to be relationship- and price-driven. • We were prepared and did indeed agree to pay premium prices for superior (transfer and custodial) service. As our EOP friends have been known to say, however, it's best not to confuse the sale with the installation. • It seemed to us that each of the concerns raised by the Court (in holding that Citibank's approach to offering managing agency accounts was illegal) could be resolved and that we could serve as advisor to a registered investment company if all aspects of distribution were handled by a broker-dealer and if the fund's prospectus carried clear prohibitions against the activities which troubled the Court.

• Provident's senior management has made a willing and conscious effort to depart from the daily rigors of the portfolio process. • Most managers subconsciously lead their organizations into the business strategies in which they have the most intellectual interest. Dave H. Williams • Some operating imperatives of a multi-office firm include: • Promoting good communications is one of the main tasks of management;

• Each regional office must be an investment office, not a sales office, nearly self-sustaining as a small investment firm on a stand-alone basis; • People in regional offices must be entrepreneurial, self-starting and self-reliant; and • The compensation for each office must be related to the profits generated there. • Regional offices can help a large firm "look small", and being close to the client or prospect is an aid in marketing. • Entrepreneurial people attracted to a small-office set-up tend to be good salesmen. • The message on opening offices is: don't do it unless you are prepared to stick with it until it is successful. Closing offices implies failure. • Entrepreneurial people are by definition independent-minded. So are good portfolio managers. So, our decision-making is geared to giving portfolio managers relatively wide latitude on issue selection in their portfolios. To bring policy structure to our operations, we employ a "matrix" organization where every portfolio manager has a formal role in some aspect of policy formulation or enforcement. The idea is that if the manager influences policy, he is more likely to both adhere to it and aggressively implement it. And, it forces him into frequent communication with his peers. • In marketing, it is necessary to do some "wrong" things to appease or attract the marketplace. For example, some prospects want the firm explained in standard corporate, hierarchal terms. A good investment firm is not hierarchal and should be freeform ...yet we have to periodically produce that horror of horrors, an organization chart. • The role of the CEO in mflrketing is being there, no matter where or when. • Logic and history argue for product diversification within the investment firm. The future for any financial market is uncertain. The answer to uncertainty is a hedged position.

• Our industry's pricing structure is out of whack, particularly as to the tail end, or trailing, part of the fee structure. • The "size problem" for money managers is size of staff, not size of assets. You really run into trouble when you can't get everyone around the same table to talk with each other any more. The plague of bigness is staff-the trick is to do with as few people as possible. Slightly-edited texts of the prepared presentations are appended, together with an Addendum to Professor Cosier's text. The latter was developed from a tape of the actual presentation to expand on the portion of his material that deals in depth with his concept of managerial dynamics and the life-cycle of the firm. Also included in this Addendum are a number of participant's questions and Professor Cosier's responses, which serve to add dimension to the exposition.

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The Changing Nature of Management: Technical, Human, and Conceptual Skills Richard A. Cosier What will it take to be an effective manager in the decades ahead? This important question has puzzled management theorists and practitioners for many years. Although nobody has satisfactorily answered the question, one thing is certain-continuing past management practices is not the best response. What has worked in the past will not necessarily be effective in the future. Many diverse U.S. businesses are painfully learning the lesson that a changing environment requires changing management. The purpose of this paper is to relate the basic management skills to a dynamic model of organizational change. The skills and the model apply to most organizations; including financial, manufacturing, retail, and governmental institutions. MANAGEMENT SKILLS

Robert Katz (1974) offered a useful scheme for looking at the types of management skills. He suggested that the three basic management skHls are technical, human, and conceptual. This approach is appealing because it focuses on what people are (personal traits). Technical Skill Technical skill involves the ability to apply methods, processes, or techniques for solving problems. There is a decided quantitative and analytical flavor to technical skill. Clearly, there are many different types of technical skills. 8

Functional Technical Skills Functional technical skills are associated with disciplines. This type of technical skill exists in areas as diverse as medicine, law, woodworking, auto racing, and business. Functional technical skills within business include fields such as finance, accounting, marketing, production, and management. Of particular interest is the inclusion of management as a technical skill area. Management, while certainly including skills other than technical skills, involves planning, organizing, and controlling operations within the firm. Therefore, it seems reasonable to state that some aspects of management involve knowledge and application of functional technical skills. Techniques exist to assist in planning, organizing, and controlling activities central to the mission of the business enterprise.

While it is beyond the scope of this paper to list the myriad techniques in these areas, it will suffice to note that such skills do exist as part of managerial activities. Organizational Technical Skills Organizational technical skills are associated with techniques learned through experience. They are typically unique to an organization, industry, or product. For example, a jargon seems to exist in most industries. This jargon is critical for communicating and solving problems in most organizations. Yet, it is typically not taught in the classroom and may span several functional areas. Organizational technical skills can be thought of as the "missing ingredients" in the repertoire of technical skills possessed by the new college graduate. While both functional and organizational technical skills are necessary for success in managing organizations, they are not sufficient. As Katz noted, two other skills are important: human skills and conceptual skills. Human Skill One cannot argue that human skill, the ability to deal effectively with people, is not an important element of management. Examples abound of the competent technician who fails miserably when promoted to a management position that involves supervising the work of others. Some very intelligent, excellent technicians find it difficult to relate with other people. Human skills, therefore, must frequently be possessed by the manager in order to get technical ideas adopted and carried out by others. Human skills may be learned through formal education or organizational experience. In formal settings, topics such as motivation, leadership, and group dynamics can be taught and lead toward development of human skills. Within "real-life" settings we typically learn human skills, Le., the capacity for empathy, through trial-and-error. An advantage of formal education is that it may help to minimize the"error" component of trial-and-error learning on the job. Katz differentiates intra-group from inter-group human skills. The ability to work within a group as a functional team member is important at lower

levels of the organization. Being able to coordinate groups and integrate departmental activities (inter-group skills) gains importance as the manager moves up the hierarchy and assumes greater responsibility. There remains, however, a missing component of managerial success. This component, conceptual skill, may be the most crucial for the organization's survival and performance. Conceptual Skill Conceptual skill can be subdivided into two components; creativity and systems thinking. Both of these components, while more abstract than technical and human skills, are essential to insure organizational"fit" with the environment. Creativity Creativity is simply the ability to generate ideas and surface alternatives. An effective creative thinker is fluent, flexible and feasible. Fluency involves the ability to generate several ideas and alternatives when considering a novel or "ill-structured" problem. Equally important, flexibility reflects skill at utilizing a broad range of resources and the ability to generate unique ideas. Finally, feasibility involves the probability of success associated with each idea. A creative thinker typically considers feasibility after applying fluency and flexibility to generate a wide range of alternative solutions to a problem. Obviously, if a problem can be programmed and a "best" solution has been identified, creativity may not be an important dimension of management. However, many managerial decisions are novel, involve uncertainty, and cannot be programmed. These decisions typically are best made by a creative individual. Systems Thinking Systems thinking involves the ability to integrate diverse bits of information. A systems thinker can assess the impact that the environment has on the complex organization (see the "big picture"). An effective systems thinker is not likely to fall into the trap of myopic thinking. For example, a decision affecting the organizational structure may impact other "subsyst~ms"in the enterprise. A structural change is likely to affect people, production/service

methods, and even goals within the organization. What may appear to be a functional structural change could adversely impact the morale of the employees. Conceptual skill is very important for managers formulating the strategy of the business. Probably the most beneficial aspect of conceptual skill, however, is the ability to understand when change is needed. John Aplin and I (1980) developed a model of organizational change that suggests conceptual skill is going to become even more important for organizations in future years. THE APLIN/COSIER MODEL

Organizations are not static. The changing nature of organizations suggests management should also be a dynamic concept. The Aplin/Cosier (A/C) model shown in Figure 1 on page 10 identifies three distinct phases of organizational activities. Each of these phases has implications for the proper "mix" of Katz's three managerial skills. The Three Phases The A/C model suggests organizations begin in an "immature" creative/ entrepreneurial stage. Over time, a transition must take place into a "mature" maintenance organization. Furthermore, subsE:quent transition from a maintenance into a mature creative organization must take place. Following the logic of "open-systems" theory, the organization can remain indefinitely viable by cycling between maintenance and creative stages depending upon internal and external demands. A close look at the model will help to identify needed management activities within each phase. Creative/Entrepreneurial Phase The creative/entrepreneurial (C/E) phase represents the infancy and early development of the organization. This is typically a very exciting period for the limited number of employees. Risks may be significant, but the challenges and responsibilities inherent in this stage cause many managers to report an exhilarating experience. In addition to the exciting climate, there are discernable characteristics that are typical of the C/Ephase:

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figure 1 Cyclical Nature of Organizational Activity

,----------=----------------------,

Immature Organization

Mature Organization Maintenance Phase

Creativel Entrepreneurial Phase

···· ··• ··· •

Decline:

•

•

Transition Period_

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·• · ··

Decline·

• A small scale of operations • A new or novel product/service • Identification of an "untapped" market • Few organizational rules and procedures • A loose or poorly defined organizational structure • A relatively simple environment The small scale of operations is reflected by the common multiple roles assumed by management. The founder-technical expert-financier may be the dominant management force in the business. The characteristics of the product or service will usually be more important than managerial skills. Frequently, a unique product sells itseH in a limited geographical market. In addition, the informality of the C/E phase is reflected by few formal rules and an "assumed" organizational structure. It is uncommon to find a handbook of company rules and a formal organizational chart for a company in the C/E stage. Also, as could be expected, an elaborate computer system is not common in this type of business. Finally, the organization in the C/E phase typically enjoys limited competition and minimal attention from governmental agencies. In most instances, the non-managerial technical skills are going to be the most important elements of effective leadership. However, human skills and conceptual skills should not be absent. Human skills are important to help form the team that is necessary to translate ideas into final product. Conceptual skills are a helpful attribute in the creation of the new or novel product/service that serves as the organizational raison d'etre. Nevertheless, an organization doesn/t stay in the C/E phase forever. Consider what happens to the characteristics of the C/E phase as the organization creates a whole new set of problems. The business grows and the small scale of operations is no longer possible. The product-service becomes widely known and the market begins to saturate. By necessity, the organization begins to generate rules and requires a formal structure. Finally, competition and government attention become widespread. A transition, or change, into a new phase-the maintenance phase-takes place.

Maintenance Phase The maintenance phase represents an attempt to gain control and efficiency within the firm. Cost reduction programs, new formal information processing and computer systems, structure, and elaborate planning processes are all common in the maintenance phase. Basically, these attributes arise to foster competitiveness and profitability in the expanding business. In contrast to the exciting C/E phase, the maintenance phase can be boring, routine, and predictable. Employee morale problems may develop. Hence, human skills gain new importance in the maintenance phase. Also, the managerial technical skills become extremely useful. In essence, a professional management staff is needed in a mature maintenance organization. Non-managerial technical and conceptual skills maintain importance, but for different reasons than in the C/E phase. Technical skills are necessary in order to refine existing products and improve current services. Functional area technical skills, such as accounting, are helpful in order to consolidate and process the ever-increasing amount of information. Conceptual skills assist the manager in structuring the expanding business and planning future operations. The final period in a maintenance phase may reflect a lot of slack in terms of money, people, plant, and equipment. In addition, managers become very "set-in-their-ways." This resistance to change is understandable since the company has experienced success. However, eventually the environment will change and the organization must follow suit. Otherwise, the inevitable decline will occur and the business will fail. A new creative phase is needed to insure survival. Mature/Creative Phase The transition from a mature/maintenance phase to a mature/creative phase is probably the most difficult transition for the organization to accomplish. The new creative phase is likely to involve the wholesale scrapping of old products and services. Some employees may be fired, while new, more creative employees are hired. The focus is now on effectiveness-doing the right things (not doing the old things better). In

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many ways, the mature/creative phase shares characteristics with the C/E stage. The main difference is the company has progressed to a larger scale of operations than typifies the C/E organization. Conceptual skills and product-oriented technical skills will be at a premium in the mature/creative phase. Flexibility and change characterize the initial stages of the new creative phase. New products/services and new markets must be developed. The capacity to generate ideas and react to the corporate environment is mandatory for top managers. Importantly, these managers will need a sound understanding of the financial environment, including economic trends. At the same time, professional technicians skilled in research and development are needed to develop the new ideas necessary for success. Human skills are not highly necessary to instill employee motivation. Instead, human skills are needed to help employees cope with change and the associated stress. Communication channels must be open and effective. The need for change must be communicated and accepted. Many employees must be willing to re-tool and gain new skills. Eventually, as suggested in Figure I, this creative focus will again yield to a maintenance phase of organizational activity. In future years, the firm should alternate between maintenance and creative phases and deliberately plan for such alternations.

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IMPLICAnONS FOR THE FUTURE

Many U. S. companies have enjoyed many years of success in the maintenance phase. This success, however, is

beginning to evolve into a series of failures. Examples abound-Chrysler, Lockheed, International Harvester, W. T. Grant, Braniff, and many others. Most likely, the future will reflect a need for more frequent, longer creative phases for domestic businesses. Obviously, this suggests conceptual skills are going to gain in importance for effective managers. The generalist manager who is creative and can evaluate how external forces impact the business should be invaluable. Along with these generalists, organizations will need: professionals skilled in research and development of new products and services; and organizational development experts skilled in implementing change. Organizations, whether financial institutions, manufacturing concerns, or governmental agencies, will need the capacity to capitalize on new opportunities. This will most likely involve shedding many of our old management practices as well as old products/services. REFERENCES

John C. Aplin and Richard A. Cosier. "Managing Creative and Maintenance Organizations," Business Quarterly, 1980, Vol. 45, pp. 56-63. Robert L. Katz. "Skills of an Effective Administrator," Harvard Business Review, September/October, 1974, pp. 90-102.

Text Addendum - Professor Cosier (Derived from tape of seminar presentation)

THE CYCLES MODEL

Let's move on now and talk about a model of organizational activity developed by a colleague and myself at Indiana University. If we take a look at this and talk about it in a general sense, we can get some notion about organizational dynamics and organizational change that will help us see when certain management skills are of more or less importance, depending on the phase that the organization is in. At this point, I'm going to be quite general and just try to communicate some understanding about the cycles model, about the cyclical nature of organization activity. Looking at it in its diagrammatic form (Figure I), it does appear a little unusual, so maybe the "Pac-Man" label some seminar participants have given it is OK. There are a number of models of organizations and a lot of them look like a bell-shaped curve. The problem with these models is they suggest that at some time you're going to decline and go out of business for sure as indicated by the right "tail" of the curve. It may take a while, but by definition that's going to happen. There's another model developed by a guy at Harvard that kind of goes out into nowhere. This model overcomes both of those problems. It suggests basically that there are three phases of organizational evolution and activity - very distinct phases that have direct implications for businesses in our country today, especially in today's economy. Creative/Entrepreneurial Phase The first phase we call the creative/entrepreneurial phase of the organization - the immature, young organization, if you will. Some characteristics of the organization at this point are obvious. It's a fairly small scale of operations. You may have a dominant individual. It may be the person who's come up with a great new product or new service idea or who's identified an untapped market. This person typically runs the show. You've got a lean staff here. Many times they're technicians, and they pretty much run the organization based on this new or novel product or service. It's an exciting period of time in a creative/entrepreneurial organization.

Things are small, you can see your inputs directly, it's challenging. To be sure, there's some risk involved, but that's part of the fun of it. And this type of organization can be very rewarding for people to work in. It's dynamic, it's uncertain, but it's definitely challenging. There's typically limited competition at this point. You've carved out this niche for yourself. There's typically less government involvement in your company than you'll see later on because you're a smaller type of organization. So it's a simple type of an environment. It's a very exciting environment and can be a very nice place to work for people, especially the technician that has the idea that is associated with the company being in existence and gaining success. You can purposely keep an organization in this phase for a long period of time if you want to, just by limiting its growth. But, as the organization moves through this period, if it does grow and it does become successful, there's an interesting thing that happens. Everyone of these desirable traits, by virtue of the organization being successful, becomes a problem. And this is the key point of this model. Remember that we had a simple, fairly small scale of operations and an exciting environment: there's normally a very informal nature to this type of an organization and there may not be any formal structure. As the organization does a good job during this phase, every one of these dimensions starts to cause problems. Competitors start to move in. You need to add staff, because you're gaining more and more business. The excitement begins to dwindle a little because the place is getting a little bit bigger. The informality of the organization starts to cause a lot of cost problems, and this is especially difficult to handle because you can't just jack up the price of your service or product any more. So by virtue of being successful, eventually the company starts to create problems for itself. And this is kind of an interesting twist. You might think that problems only arise because you make errors. The model suggests otherwise - by being successful and doing the right things, you create problems for yourself at the end of this

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creative/entrepreneurial phase. The model suggest that at some point in time a transition needs to occur. The organization needs to change its nature a bit and move into what we call a mainte· nance phase. Maintenance Phase A maintenance organization is primarily oriented towards gaining control over the cost aspects of the company. Things start to fly apart at the end of thE' creative/entrepreneurial phase. People are moving in different directions. You need to pull them together. You need, as Peter Drucker said, efficiency in the business. And efficiency is cost control, basically, doing the things you've been doing, but doing them better. Doing them less expensively, possibly with more quality, but doing them better. Not changing what you've been doing, doing it better-in other words, you stay with the same products and services.

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Maintenance phases are associated with the advent of bureaucracy-you start to have a formal system and you need a professional management team now. The old owner-operator-boss, the technical expert, may not be such a good manager. So you start to need management professionals. People that can plan. People that can put a structure in place. Typically, you'll start out with a product- or service-oriented structure and maybe a functional structure will evolve, where you organize people based on marketing, based on personnel activities, based on functional activities. It becomes formalized. Your management information systems start to come on board here. These are all efficiencyoriented ideas. You start to build up a system, basically, with professional management, and this is changing the entire nature of the business now. It isn't the same old fun little place it used to be. It's a much different type of company now that you need to evolve into and manage differently. I mentioned the first phase as being quite exciting. The maintenance phase, on the other hand, can get very boring and routine, very dissatisfying for your entrepreneurial types of people, because things are so well-programmed now. You've got a bureaucracy, you've got rules, you've got procedures, and

you've got systems in place. Entrepreneurial people can be quite unhappy in a maintenance phase. That's one of the reasons why in the late '60s those behavioral scientists sprang up all over the place, running around, you know, the "touchy-feely" people, trying to address these really serious personal problems that people were having in the maintenance organizations developing after the first rush of the post-WW n boom. But the maintenance phase is not negative. If it's necessary, which it is, after a creative spurt, it can be associated with a lot of profits - you can make a lot of money here. You can become very competitive; in fact, you can drive some of your competitors out of business, if you're good at efficiency-oriented management in the maintenance phase. So it isn't a negative term at alL But sooner or later, as the model suggests, there's going to be another set of problems come up. And these are also caused, just as in the first phase, by success. You build up in the maintenance phase a dysfunctional rigidity or resistance to change in the organization. It's common to hear managers at the end of a maintenance phase saying, "Don't bother me with that, we've done it this way for many years. I know it works-get out of here with that idea." And it's understandable. If you've done it that way for years, and it has worked-and remembering that maintenance is associated with success-it's natural to have resistance to change. There are whopping examples out there now of companies that have done just what I've said here. Take Chrysler. Look at Townsend and Ricardo, some of the statements made by the former chairmen there were extremely changeresistant. "We're right, we're doing it right, we'll come out of it, don't worry about it." Well, some years later, they aren't coming out of it. One of the things that makes it even more tempting to be defensive or resistant to change is the fact that you build up a lot of slack in the maintenance phase and you have what looks like a nice cushion, with extra money and extra personneL What you really have is a number of people who are sleeping at their desks.

But, as we've seen in today's environment, it isn't that way any more. You can't allow that deadwood to continue, you can't keep doing what you've been doing and hope that things get better sometime. It just doesn't work. Chrysler, for instance, couldn't keep inventorying cars right off the production line and hoping that dealers would order them. They have a lot of New Yorkers sitting out there, with the public out here clamoring for little teeny cars, which is exactly what they had in 1974. They couldn't get rid of them. It was a pretty stupid thing to do, when you look back on it, but during the time, it's what they had been doing for years, making money on it for years and years and years. So there was resistance to change there. I think a lot of companies in this country right now, companies you may deal with, maybe your company, are facing this important decision point at the end of a maintenance phase, suggesting that maybe things aren't working out quite as well as they used to, maybe there's a problem here. And you need to transition - unless you are willing to go into a decline, like Chrysler, like Lockheed, like Braniff, and others-into a creative type of an organization again. In some ways, we're moving almost back into the first phase, except that we can never go all the way back there because of the momentum and the size of the company. Even so, there are some similarities between this new mature/creative phase and the initial creative/entrepreneurial phase. Mature/Creative Phase Again, you've got a dynamic, exciting environment, and it tends to be creative. You need to reassess your whole product and service line many times. Not throw all of the old things out, to be sure, but add some new services, some new products. Maybe some of the things you've been doing for years just don't cut it any more. You get rid of them. Maybe some of the people that have been around for years just aren't cutting it any more. You might have to get rid of them too. Add some new blood. There's a lot of change and turmoil to go through in this transition, and it's extremely difficult. One of the most important types of managers we have today is the organization develop-

ment person who can help make this change between maintenance and creative happen. It's extremely difficult because you've got this resistance to :hange, but it's extremely important. The new creative phase is going to focus on effectiveness, and that's different than efficiency. Efficiency is doing the same old things and doing them better; effectiveness is doing different things, doing the rightthings. And that may be a marked change. Doing the right things is not the same as doing things right; there's a difference that Peter Drucker, as I mentioned, pointed out years ago, that I think is quite important. You still have people problems, but they're not the same type of people problems you had in the maintenance phase. So you still need human skills here, but you need human skills to address the stress involved in a creative phase. The change, the whole kind of turmoil that's generated in moving from maintenance to creative causes people to be really under the gun, feel a lot of stress. There's a lot of ulceroriented behavior, if you will, that occurs during the creative phase. And you really need to counsel people, talk to people, communicate to pe?J?le, get their ideas, allow them to partICIpate in this whole process if you can, so that they can better adjust to this new phase of the organization's existence. Because, again, it can be very trying. You may be out identifying whole new markets again, just like you did in the first phase of the organization, throwing away some of your old focuses. New customers, new people out there that you can tap into for your businesses. So there's a whole different focus. Companies are doing this. Chrysler's trying to do it. You hear their statements today, and they're talking about the newChrysler Corporation, new products, cutting back on people, new plants, etc.-all creative-phase activities. Maintenance Phase Revisited But sooner or later, the model says, you're going to have to pull back again and move into another maintenance phase. And, theoretically, your company could cycle through these phase~ indefinitely. If you handle your environmental and internal demands properly, you can go through these phases over and over, smoothly and profitably. A

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block at any point, though, can cause difficulties. The biggest problem you run into at the end of a mature/creative phase involves people feeling that they've set up their own little domains, that their domain is the most important domain for the company and don't cut back on their budget because they're the most important part of that company. If you put everything together, and look at the whole picture, you've got a lot of excessive expenditures again and a lot of cost problems, just like you had at the end of the first creative phase. That's why you need to move into a new maintenance phase; you've got to cut those costs and expenses down and gain control again. Now it's our belief-this is certainly just a belief-that in the United States, a lot of organizations have spent many, many years in maintenance-oriented phases. The big companies are especially good examples. They're just starting to move toward creativity again.

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I think in the future we're going to see longer creative phases, more focus on creative-phase activities and less focus on the maintenance phase. We're going to cycle through more quickly. If that's true, the conceptual skills we talked about are of primary importance, in my opinion, in this creative phase, Why? Because that's where you need the new ideas, that's where you need the new viewpoints, and that's where you need the systems thinking most. You need these skills in all the other phases, certainly, but the payoff in the creative phase really is in the conceptual skill area. QUESTION/ANSWER SESSION

them up. And just manage them differently. Different locations, different sub-sections in the organization, so they're not mixed together. This can be a classic problem if they are. I think the key is the flexible leadership idea we talked about applied to this model here, where you just see those differences. You don't want to unduly restrain your entrepreneurial people, because they're not going to like that, they'll leave, they'll quit, they'll go somewhere else, they'll start their own operation many times, where they can be right back calling the shots. So I think you've got to give those people some freedom and flexibility and have possibly the professional management staff doing the maintenance activities and letting these people be creative. Question: In a maintenance environment in which you are generating large profits off a rather antiquated system, the creative people may be worth more to you, and require more rewards in order to maintain the services. And yet there's a clash in the rewards system between them and the maintenance people. Can you comment? Cosier: There are actually things you can do for your maintenance people and some of the things that have been done in the area of job enrichment, for instance, might help here. You do as much as you can in maintenance activities by adding variety, telling them in no uncertain terms about the significance of what they're doing, giving them some autonomy, giving them feedback-many times that's one of the linkages that bothers people. People who are achievement-oriented need feedback-you have to give them feedback on how well they're doing. Tell them, "You're doing a good job, here's the data." And pay them for that type of thing. That may keep some of the incentive operating in this maintenance wing of the organization.

Question: How would you address the issues that are typical of the kind of businesses that a lot of us are operating in? Many of us have to manage in a maintenance phase but some of our people and products and services exist in a highly competitive, entrepreneurial type of environment.

Question: You said you thought the cycle time was going to telescope. Why?

Cosier: You do have subsystems existing at different phases, certainly. I think you have to recognize that and manage appropriately. It may involve separating some of the more maintenance-oriented activities in your company from some of the more creative, so you don't mix

Cosier: Because of the environment we're in. As we deregulate, we're kind of turning things loose, and when we turn things loose, we're forcing the market system and the organizational model to operate. If you regulate an industry, you can essentially keep that

industry in a maintenance phase forever. You really don't need good management in those types of situations, because of the fact that management's not really making the decisions. You've got the regulatory body out here. They may be enormously lousy decisions that the regulating body is making, but they're still making them for you. The airlines are a prime example. They pulled away the regulation blanket, and all of a sudden all hell broke 100se-2 or 3 of them immediately started to go bankrupt. They didn't have the management team in place. On the other hand, Delta had a good management group in place, and is able to compete. It can be a real opportunity when that blanket is removed, but there can also be problems. And I think the external, foreign competitive thing is going to cause need for change here also, primarily a need to be more creative, Japanese products being a prime example in the automobile industry. I think the environment is going to become more and more complex as technology advances at an everincreasing rate, and that also is going to cause organizations to need to react appropriately. Question: Are there examples of organizations that have moved from the maintenance phase to the creative phase with the same people, pushing them into a creative phase rather than getting a lot of turnover followed by new hiring? Cosier: One thing you can certainly do is educate people into the need for the change and have them adapt accordingly. And hopefully not clean house as much as you might otherwise have to. People do need to change, though-if they won't change, they're problems. A related point is whether you have to change your nature, change your overall culture to get creative, to move from one phase to the other. Maybe not. AT&T seems to be changing its nature but I was talking to the CEO at Heinz, a guy named O'Reilly, who's a very competent manager, and I asked him that question. He said what they do is acquire through acquisition the creative input the organization needs. So, the overall company itself may be quite maintenance over a long period of time but when they see the need for creativity

they buy it, they acquire it. They buy a new product, they buy a new company, bring it on board, milk the creativity there, and then they already have the systems in place to take the new company into a maintenance phase eventually. And usually, eventually, the acquired company's management team is turned out if it doesn't adjust to the maintenance phase that comes up in the future. You just retire them or whatever. Other companies like Tenneco, largely a creative company, have made maintenance acquisitions to fund the overall operations. They had container companies, for instance, that used to be fairly good at making money and weren't very creative at all, but they could fund all the exploration activity in the energy field that Tenneco was doing. So there is a company that is largely creative and has maintenance holdings. The problem they're having now, with the economy like it is, is that the maintenance companies aren't generating the money any more, and they're having tremendous cash problems handling that. My viewpoint given this model is that their overall company philosophy is going to have to turn more toward maintenance, which is going to require a big change in perspective from the CEO there, who's a gogetter, dynamic, creative type of a leader. He's going to have to turn the screws a bit in the overall corporate structure, I think. Question: Can you speak to the Japanese management style and the problem of teamwork in the United States? We seem to be tremendously noncompetitive, especially in manufacturing. Cosier: I have talked about Japanese management a lot, but I don't tell everybody that I talk to that it works in U.S. companies. There's a lot of value-laden things to consider here. I think that you can manage without Japanese-style management and be quite competitive, but to do so you have to reward people for quali ty, you have to have standards of performance that reflect something other than just quantity of output, and you may have to keep a leaner organization. It kind of gets at the incentive system issue here. We've paid people for years with emphasis on the quantity of their output-why not pay

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them for the quality as well? Why not give them responsibility for that quality? You can do that without moving to a whole team-oriented system. Question: Can you give any example of companies that have successfully done one cycle and recreated? Cosier: I think AT&T's a good company to look at, because they get a lot of press. There was an article in Business Week about two years ago that laid out the transition that they're making, and it fit the model almost to a "T". New products, new people and a new leadership team came in at AT&T. Interesting company because they had innovations that they never used, they just set them on the shelf in the maintenance phase. Now they're having to pull those into actual operation and use them. And I think they're being fairly successful. They're restructuring. Typically what you'll see in a creative phase is a more flat, loose, project teamoriented structure in the organization. And you see that happening here. Question: What do you do when you realize you're at the end of a maintenance phase and need to transition back?

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ferent associations together. This buys them time at the end of a maintenance phase, and gives them more resources to play with. It puts them together. But they're still doing the same old things, and you still get a lot Df resistance to change in a lot of those associations. They're bigger, but they're still resistant to change. So what they've done, I think, is buy themselves a few years, and if they don't change in a few years, they're going to be faced with the same problems they had as smaller, more independent associations before they put themselves together. Usually the bottom line starts to give you indicators if you need to change. It's a question of how bad you let the picture get. Growth patterns, declining growth, typically suggest that there might be a need for change. You may still be growing, but not at the rate you used to grow. In fact, the whole economy, as you well know, has been declining in productivity as far as the growth rate is concerned. This has been a problem. That's why I think some of the general implications I mentioned are true. The big picture is that a lot of the businesses in this country need to make this transition, and declining productivity really points that out.

Cosier: Obviously, what you want to do is to make the transition before it's too late. Chrysler, again, getting back to that, they were really too late, they were out of business, for all intents and purposes. They were too slow. Their management refused to acknowledge some of the indicators there from the marketplace that dictated a need for change. It's pretty easy to avoid those indicators if you can point to the bottom line and say, "This year we made money again and we've got some bucks left." You've got to be careful not to do that. You look at your environment, and if you see something going on out there, you've got to move right quickly. Don't wait for two years hoping that things will get better doing the same old things. If the economy picks up, you might gain some years of survival, but that is not the point.

Question: Based on some of the examples that you've mentioned, it seems like it's a major external event which causes the transition from the maintenance phase to the new creative phase. For AT&T it was government deregulation. With the steel industry, it was Japan. For Chrysler, it was Japan and maybe the oil embargo. How do you overcome that? In those cases, they waited until the very end to do it. In effect, what you're asking companies to do is to take a good thing, where they're making good money and doing well, and change to meet the contingencies.

Take the savings and loan business. It's interesting to watch them. They're attacking this problem in a way that I think in the long term is not going to work. They're merging, basically, dif-

Question: If you as a manager have some specific ideas of what you would like to accomplish, and at the same time you want to involve other people in

Cosier: Yeah, and its tough to convince people that there's a need for that. But we can have hindsight here, which is usually 20120, and see that they should have changed, even though they didn't. That's what really good management is all about.

working toward that goal, have you got any thoughts on how one might proceed?

circles..Jollow these steps. You go right through and offer inputs based on this process.

Cosier: You hear the word "quality circle" talked about a lot, or employee circle, worker circle, management circle, whatever. Basically, I think that is an attempt to do just what you're talking about here. That idea came from us in the '50s and Japan managed to use it for about twenty years before we opened our eyes to what was going on over there.

This isn't a cure-all, however. I've seen companies treat this as kind of a suggestion system. I don't know whether you have those in your organizations, but companies for years have had suggestion boxes all over the walls that some behavioral scientists had suggested would be a good idea. And besides the bubble gum and the other things you get in those boxes, you do get some good ideas from time to time. But the way the whole structure was set up, it was in the best interest of management to turn those ideas down. It could be a problem here.

Take roughly 8 to 10 workers, as they have, and actually decentralize as much information as you can to this group, and let them address problems that they see as important. So you're having them participate, not only because they feel like they have to, but because they feel like they want to. They're actually identifying the problems that they think need to be addressed in the organizational setting. And you can do that at any level. Top management all the way down, middle, lower level, you can do the same process anywhere along the line. Basically what you want to do is give people the authority and responsibility to identify the problems they think are important-or, they could be opportunities, too. There're ways to help groups do this. I always suggest that you have a process leader and it might rotate from week to week or from month to month in the group, and help facilitate the process, but basically a brainstorming, openminded discussion here of problems that people who are involved with the day-to-day activities address. Have them select an actual problem to look at-and creativity's helpful here, by the way. They analyze it. To do this, as I mentioned, they have to have the information-you can't have them analyzing things they don't know anything about. That's a different tradition-we tend to keep information upward in companies in our country. We need to pull it downward so that we'll pull in the lowest level possible. They come up with a solution recommendation, they may implement it, or suggest how it should be implemented at a minimum, and then track the solution idea right through. People...as groups...in these

Why is that the case? Because it's a threat to you to have some guy way down the line come up with an idea you should have thought of. So your incentive as an evaluator is to turn that down, do whatever you can to make that suggestion fail. Think of all the reasons why not. You can have the same problem here with this kind of participative quality circle system. If people can consider a problem and come up with a solution, you have to be willing to give it at least a fair chance at working, give it a fair hearing, and maybe try it out on an experimental basis. If you just shoot it down all the time, you'll have the same old problem as with the suggestion-box system. You'll have big problems with resentment. Question: Suppose that the opportunity and the solution have already been supplied. Suppose that the circle starts here. Will it work if they are not participating from the beginning? Cosier: Sure it will. I think it probably works better if you allow people to surface the problem they want to address. But, with opportunities, its OK. If possible, present alternatives and let the group analyze them, generate solutions, and possibly improvement. However, if people don't see an opportunity you have presented as being legitimate, then this could short-circuit the circle's effort. Management would then have to recognize that the opportunity they presented really wasn't such a good idea after all, and go along with that, which again is something that needs to be

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done more than it may have been in the past. Question: What about rewards for individuals vs. the group? Cosier: I don't think that those two work against each other necessarily. For instance, if you do put people in groups and have them attack problems or analyze problems, you can reward the group for the product. And it may be a very creative endeavor that they undertake. They may come up with a whole new way of delivering a service or a product that you hadn't thought of. And it may work very well, in which case you could reward the group for doing it, all eight people get a chunk of the pie, so to speak. I think a grave error here would be, if you're trying to do a group decisionmaking process, to go in and say, "Well,

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who thought of that now? Which one of you really had that idea?" And isolate that person. That would be a definite mistake. So it depends on how you allocate whatever rewards you do have to offer, and I think you can allocate th~m to groups and teams. Maybe you don't want to, and there are some value issues here. The good old competitive individual ethic has worked for years for some companies. I'm not saying you necessarily want to throw that out. But it would be possible to reward groups and teams for their ideas. And if they want to chunk it up differently, I suppose they could. But they don't have to. I always wonder what players in the World Series do who sit on the bench. Do they behind the scenes give everybody $1,000 who started? I don't know, but it's kind of a similar issue there.

figure 1. Cyclical Nature of Organizational Activity ,----------=----------------------"

Immature Organization

Mature Organization Maintenance Phase

Creative! Entrepreneurial Phase

··• • ··• ·•

Decline:

Decline

Transition Period_

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How to Run a Lousy Business For Fun and Profit Paul F. Miller, Jr., C.F.A. There were many possible titles for this talk-such as "Own Your Own Business for Under $10,OOO,"-or-"How to Practice Investing Before You Take a Chance With Your Own Dough" - but I thought perhaps the clients might get the wrong idea, so I settled on "How to Run a Lousy Business for Fun and Profit." CHARACTERISTICS OF GOOD BUSINESS

I mean that title to be serious; by many textbook criteria it is a lousy business. Think about that for a minute. Good businesses - those with high and protected profitability-usually have several of the following characteristics: 1

Difficulty of entry because of some feature such as high capital investment, large share of market in a few hands, patent or some form of know-how protection. 2 Insulation from exogenous economic forces. 3 Real, rather than imagined, differentiation of product. 4

Widely-perceived necessity for the product, such that demand is relatively inelastic. 5 Large or dominant share of a growing market.

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6 Significant benefits of scale. 7 Susceptibility to modern management techniques, including planning, to improve growth and profitability and selfinfluence the future.

I'm sure you can think of some others, but let's look at the investment management business and see what characteristics it has. CHARACTERISTICS OF INVESTMENT MANAGEMENT

First, ranking close to the street vending business, investment management is one of the easiest of businesses to enter. Assuming you meet the very minimal requirements of the S.E.C. and have six

week's worth of working capital in your pocket, you can have your own firm. The proliferation of firms in recent years proves this point beyond all doubt. Second, although we do enjoy a relatively good growth rate of our market, gaining a share of market beyond some minimum level seems to be a detriment to product quality, evidently making a firm muscle-bound, so-to-speak, in dealing with dynamic markets. Consider what happenE;d to the insurance industry, which had by far the largest institutional share of the flow of invested savings only 20 years ago. It has experienced declining effectiveness in garnering a large share of the cash flow of pension funds. Or consider the growing dissatisfaction with the product of the large banks over the past 15 years, a dissatisfaction which has allowed dozens of smaller firms like ours to garner a significant share of new cash flow. Third, as indicated by some of the above points, diminishing returns from investments in larger scale seem to occur rather early. Fourth, if there is a business less insulated from exogenous forces I don't know what it is. However, the amazing fact is that the business has had its most prosperous and revolutionary years-the past decade and a half-while the markets for financial assets provided their most dismal returns since the Depression! What might happen if we got a lasting tailwind? Fifth, there are many talented academics who steadfastly maintain that there is no necessity for our product and that the worth of investment management is zero. In fact, they are right in the important sense that one-half of all the money under our collective management will be below average in performance. We in the business just happen to believe that the above-average performers aren't accidents. Susceptibility to Management Techniques Which brings us to the point of these meetings- the susceptibility of the business to management techniques. Can we really improve our products and our profits through management? Unlike other businesses where the answer is

clearly affirmative, there seem to be models in our business that indicate a lack of permanence to leadership, both in products and profits. We are all too aware of the superstars who blaze, meteor-like, and then disappear forever. The only thing that really bugs me about this is that such people often make themselves fortunes in the process. They can really enjoy the aftermath of their disappearance! It just makes it more difficult for those of us who choose to do it differently to convince the world that investment management deserves respect as a profession. Oops! There's a word that needs some exploration - profession. Lawyers don't often talk about management. Nor do doctors. Are we different? That is, is our business best when we look at it as a collective practice of talented individuals rather than as a group of people gathered together to produce a single product line? Or are we more similar to the advertising business, known for its individual stars, little permanence of leadership, but somehow manageable or moldable into cohesive units? In fact, I believe the similarities with the advertising industry are very striking, even including the doubts about the worth of the product and the fact that half of the product is clearly inferior. But I think I'll let someone else develop that thesis more fully. Clearly, there are certain parts of our business which are no different from other businesses in their management susceptibility. Here are a few examples: 1

A firm can benefit immensely from a well-conceived formulation of business strategy. Indeed it must understand its market segment to survive. That sounds obvious, but we all know of instances in large organizations, including banks, insurance companies, and mutual fund management companies, as well as in smaller, successful firms where bad definitions of markets and market segments cost them dearly. 2 Product differentiation can payoff handsomely, but is as difficult to achieve in our business as it is in other businesses.

3 Efficiency and profitability go handin-hand. Cost effectiveness, the production of a superior product at the lowest possible cost seems to elude many older, institutionally-rigid organizations. If some of our major institutions had the profit per dollar managed achieved by smaller, newer organizations, and paid their management people accordingly, firms like mine could be in real trouble. 4

Research directed at new products and improving old ones is just as valid a concept for our industry as for, say, the pharmaceutical industry. There is, however, amazingly Uttle done on this score by most organizations. New products seem to arise more from sheer opportunism than from serious research efforts. There are some firms doing some of these things I just mentioned rather welL Fortunately for the rest of us, these number only a few, rather amazing considering the huge resource base of the large institutions which still dominate the markets. But, at the heart of the problems of management, at least in the narrow definition considered at this seminar, are the improvement and maintenance of product quality and the management of product development. These are the areas which seem to make this business so very different and present the biggest challenges. Why is this? WINNING MONEY MANAGEMENT TRAITS

The foundation of the reason, I believe, is simply that some people have a knack for making money in financial markets and others don't. I don't care what the academics may say, thirty years of observing and participating in the investment process have convinced me it's true. I'm not saying that other people are unnecessary to a successful investment process. They clearly are, as long as the focus is on the money-making knack rather than on the process. I'm probably not making myself understood on this point, so let me elaborate.

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Superior Sense of Relativities

Role of Group Dynamics

First, I'm not at all sure what it is that the money-makers have that the others don't. But, they seem to have a superior understanding of what makes securities go up and down in price and some sort of superior sense of relativities. I've often wanted to design a test which would prove some of my hunches on this subject. For example (now don't laugh), I believe that a multiple-choice test of one's innate sense of relativities could be designed, containing such questions as, "What were Exxon's 1981 sales? A) $18 billion B) $40 billion C) $81 billion D) $108 billion" that would indicate that the money-makers gravitate to the right answer even though they have no specific knowledge of the facts. Other examples I've thought about are questions on such disconnected subjects as the distance from the earth to the sun, the ranking of states by geographical size, and even guessing the tonnage of the QE2.

Groups are very important. It is very important to create a "group dynamic" as long as the individual talents are given vent for action. But then those individual actions must somehow be orchestrated into the production of a single product, not a bunch of individual products.

Directing Creative Talent

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All this may seem rather flighty and irrelevant. At the very least I have to say that Psychology 101 in 1948 hardly qualifies me for this discussion. But, if I'm right and there is some innate difference which is not based upon intelligence, education, or experience, then we're talking about an abstraction similar to artistic or musical talent. To make my point-can you imagine a painting by Picasso if he had been directed by a committee? Or a composition by Beethoven if he had to work under supervision? I am exaggerating, of course, but the question is a real one: How do we allow creativity and innate talent to be both free and directed at the same time? Creativity and innate, abstract talent have to be organized in many parts of other businesses, but very seldom does such an organizational problem apply to the production process itself, as it does in our business. There is, obviously, no best answer to this but the surprising thing to me is how few people recognize it as a problem. Rather, they design processes which rely upon a hierarchical direction of committee-oriented thinking. They seem convinced that a group of "safe" people can do the job if only the process is right.

It should be obvious by now that I have

many deep-seated, pre-conceived notions and prejudices, such as "smallness is beautiful," "investment advisors tend to be superior to the rest of the industry in product quality," and "innate talent is rare and should be paid accordingly". You're right in these observations. Striving for Improvement Some years ago I had the fortunate experience of being exposed to the workings of a truly superior investment operation-one which has continuously disproved many of the things I've just said. I guess it would be in poor taste to name it here, but they had an answer to the problem of milking dry the talents of their money-makers. While they have undoubtedly kept on evolving their process, it was the beginning of my thinking on the subject. Over the years my partners have often been frustrated by my eternal dissatisfaction with our investment process. I think, however, that as a result we have evolved toward a more optimum organization. I warn them, however, that the evolution will never end. Overcoming Insufficient Information A great gentleman of the industry J had the privilege to know many years ago once defined his profession as "the art of making money by investing on the basis of grossly insufficient information". An "art," he called it. That was in the days before modern portfolio theory and when a $25,000 advisory account was highly prized at an annual fee of $500. Information in the marketplace has since proliferated beyond all ability to deal with it, but it's still as grossly inadequate as it was then. SUMMARY OF ETERNAL TRUTHS

Regardless of the immense changes which have occurred over the years, are

there some "eternal truths" about success in the business of managing money? Let's take a stab at a few: 1

Successful firms target their market segments and carefully control their growth. 2

Successful firms are under the leadership of people who don't buy either the opinions or the stories of others. They think for themselves. 3 Successful firms, regardless of their investment style, use some kind of disciplined valuation process. 4

Successful firms are managed by people who know there is no single, best answer to the investment problem, even though there seems to be from time to time.

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Successful firms contain one or more "money-makers" and have been able to surround them with a "group dynamic" which significantly enhances their productivity. 6 Successful firms have recognized in some way that the business has a peculiar benefit to be gained from entrepreneurship.

When Gertrude Stein was on her deathbed, Alice B. Toklas asked her, "Gertrude, what is the answer?" Gertrude replied, "My dear, what is the question?" That you are here tonight indicates you are conscious of the question. In conclusion, I'll give you one answer: Exxon's 1981 sales were $108 billion!

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Unique Factors Impacting Effective Administration of Investment Firms Daniel J. Forrestal, III, C.F.A. The management of investment management refers to activities and methods we all use to make investment resources productive; that is, to create an environment in which investment professionals interact to do useful work in achieving the objectives of our clients. History has shown that success in our profession does not automatically flow to those firms which assemble the best people or spend the most money. Something else seems to be at work in the good firms. The key appears to be an appropriate blending of investment and managerial skills to add value and make money for both the buyers and sellers of professional asset management. What makes our jobs so difficult is that managerial and investment skills must be applied against an unusual set of external factors which impacts our industry. The purpose of my remarks is to attempt to describe the external environment which is unique to investment management and to put special emphasis on the problems and challenges presented by growth and organizational change as a firm proceeds through its life cycle. I will also discuss some common managerial skills which seem to be practiced by a number of the winners in our industry in order to cope with the special external environment which surrounds us all. EXTERNAL ENVIRONMENT AWARENESS

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Effective management of any endeavor requires environmental awareness, or an understanding of the climate in which the business or activity combines resources to add value and satisfy customer needs. This matter of environmental awareness has unusual significance in the management of investment management due to the presence of environmental factors that can frustrate or even destroy the basic purpose of our activities unless they are understood and controlled properly. Required. Managerial Talents As we all know, the effectiveness of portfolio management rests on the quality of human judgments about future uncertain outcomes. This in turn depends directly on the ability of the practitioner to engage in independent, unemotional thinking...to apply his skill

and knowledge in a disciplined, consistent manner...to form judgments with conviction and long-term perspective. More specifically, portfolio management favors the disciplined individual who is comfortable in becoming detached from consensus thinking, who searches out undiscovered value, and who makes contrary bets based on sound, informed analysis. In providing direction to such a process, the investment leader must constantly remind himself that this desired facility for detached, unemotional judgment runs counter to a basic psychological human need for acceptance and recognition by one's peers and associates. Our business is quite unique among major disciplines in that the elements for successful execution of the process run in basic conflict with fundamental human tendencies to seek conformity and acceptance by other people. The External Factors Effective managerial response to this basic conflict in values is complicated by a series of external factors which impact investment people daily. I might add parenthetically that the recent frenzied activity in the stock markets is an excellent illustration of one such unique environmental factor. Other factors would include the following: 1

Ours is one of the rare businesses in which there is a daily report card on the quality of our judgments and the performance of our product line. Bob Kirby of Capital Guardian once said that one of the major problems of our industry was when they started pricing common stocks daily, and there is more than a grain of truth to this statement. The destabilizing effect of daily pricing of securities is compounded by the growing volatility of all investment markets which results from widening institutionalization. .2

Our industry is also impacted by a basic incompatabilitybetween the long-term capital formation perspective which one would logically associate with equity investment and the short-term performance orientation practiced by many of our industry/s participants. The price of securities is set by the marginal buyer and seller and, hence,

we are all affected by the short-term performance orientation of our competitors even if we honestly or officially say we are above such shenanigans. The quarter-to-quarter performance syndrome is indeed a monster which both we and our clients have created, and it very much complicates the managerial challenges of investment leaders. 3 Portfolio management is also characterized by a high ease of entry by new organizations and, unfortunately, a high ease of exit by disenchanted investment accounts. Of additional significance here is the fact that our industry is quite accomplished in a second major area of endeavor, namely marketing skills. The potential magnitude and mobility of cash flows and assets which can move to a favored asset manager has placed a huge premium on the ability to market effectively; our industry has done an outstanding job of picking up this challenge and exploiting it. 4

Finally, a disciplined long-term managerial perspective is also threatened by the high pace of change and instant communication of massive amounts of information which characterize our industry. Management must recognize that the basic human response when subjected to a constant barrage of new information is to react to short-term events rather than to long-term logic. Readion to the Environment Even in the best-managed investment entities, the dynamic of translating ideas to action within a specific longterm focus is constantly subjected to subtle but powerful threats of erosion due to the external factors just mentioned. The problem areas in the portfolio process which stem from this combination of pressures are basically two-fold. Gut-feel Decision-making First, investment staff will be tempted to engage in erratic, "gut feel" decisions which are at variance to the stated investment philosophy and style of the organization. Unfortunately, the tendency for such deviations will likely be strongest at precisely the wrong time, when short-term investment performance is faring poorly or when the firm's philosophy is "out of phase" with popular investment

concepts of the day. This tendency to react erratically due to the pull of normal human emotions is one of the major reasons why a remarkably few number in our industry actually do what they say they do despite good intentions and very crisp statements of intended investment philosophy. Group-based Emotional Excesses Second, the temptation to find the comfort of consensus judgments often leads to emotional excesses in periods of exaggerated trends in the valuation of securities or of entire market sectors. Under the strain of short-term pressure, the temptation for portfolio managers to follow the crowd can be overwhelming. Interestingly, the more closer-knit decision makers are within one organization and the more they are in tune with each other's thinking, the greater the danger seems to be that the independent judgment so necessary for investment success will be replaced by concurrenceseeking tendencies. This phenomenon of "group think," which was first described by Irving Janis in 1972, helps explain the recurring theme of seemingly irrational selling at market bottoms despite valuation methods which indicate prices are at very attractive levels. It may also explain why widely-sponsored institutional stocks usually do worse than the overall market and why, of major significance to management, a large percentage of professional portfolio firms seem unable to out-perform an index of unmanaged investments. Grouping Successful Companies Those firms able to cope successfully with this external environment seem to fall into three categories. Good Positioners First, there are the good positioners who seem quite adept at answering the first fundamental question in the formative stage of a firm: What part of the investment business do we want to be in and how can we truly add investment value? The good firms answer this question simply, precisely and honestly and, of equal importance, seem to be able to transmit the values in their answer very clearly to both employees and clients. They appear comfortable with broad, simple statements outlining the values they intend to offer and the position they intend to occupy relative to their competitors.

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Good Reviewers Another group of firms that cope well with their operating environment can be personified as good reviewers. Such firms insist upon periodic and fairly formal reassessments of direction and effectiveness in the execution of their specific investment styles. Good firms seem to consciously or unconsciously engage in a system of rigorous quality control, with particular attention to the question: Do we as a firm actually do what we say we do? Good reviewers recognize that establishing and maintaining a permanent investment philosophy can help prevent the adverse, shorter-term reactions which stem from basic competitive pressures and human emotions. Good Leaders In addition to good positioners and good reviewers a third group of successful copers with their environment may be characterized as good leaders. The good leaders begin with a strong personal conviction in a particular style of investing by the founder or group of senior professionals leading the profession. These firms transmit tremendous enthusiasm and selfconfidence in their philosophy which is contagious to those around them. The good leaders also understand the necessity of patience and staying power for their philosophy to succeed and they understand that opportunities for the success of a given style are often greatest when the Becker comparisons are acting poorly.

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Good leaders also understand that knowledge and hard work are excellent allies in the constant battle against the pressures of our environment. The more knowledge and fundamental analysis one applies to a portfolio process, the less likely one will be to rely on gut feel or intuitive judgments. In fact, many successful investors depend on the weakness of others, manifested in crowd behavior and exaggerated trends of security prices, to effectively and unemotionally apply their particular philosophy. Another good buffer against environmental pressures is for investment leaders to know their weaknesses as well as their strengths. The good firms are generally honest with themselves, their clients, and their associates. They know what they can and cannot do well and they are good at communicating these values to people both inside and ou tside their

organizations. To cope with their environment, the good firms are those that develop and stay with a particular style of investing, knowing beforehand that they will be periodically out of phase with investment markets and with the majority of their competitors. GROWTH AND ORGANIZAnONAl CHANGE

I would like to shift now to a different aspect of environmental awareness, namely the unique challenges that growth and organizational change impose on our business. This is a second, more subtle and, hence, more difficult layer of environmental awareness required for effective management of a dynamic portfolio process. Unlike the external pressures we have just discussed, it is important to note that the problems of growth and organizational change are born within the firm and can strike with unrelenting and unsuspected fury. I am sure we can all remember specific experiences, possibly involving our own firm, where funny things happened to the investment process as the firm grew larger. There are countless instances of investment organizations that have lost their momentum and effectiveness over time, often following a period of outstanding performance and impressive growth. Conversely, there are other firms, including several represented by our other seminar speakers, that have sustained their special market niche and creative energies despite increases, sometimes substantial increases, in their asset and employee bases. Problems from Growth Illiquidity of large positions or a physical inability to implement major strategic changes are often cited as the major hurdles to success as firms grow larger. While there is obviously some relevance to this, there are enough exceptional larger firms around to make one think that the primary obstacles to success are located deeper in the fabric of an organization. Specifically, two problems that accompany growth offer unique challenges to effective management of portfolio firms.

Investment Process Impediments First, successful investment management is a delicate balance of creative people anticipating and responding to opportunities, creating a flow of ideas through a cycle of awareness, analysis and execution of portfolio decisions. Growth can be disruptive to this process. Growth is normally associated with an increase of staff and accounts that impact the established and finelytuned order of the firm. The special dynamics and culture of the investment process are tested, sometimes overwhelmed, as internal procedures incorporate more people and more diffusion of important investment tasks. Outdating of Acquired Skills Secondly, the skills and behavior patterns that work in one phase of organizational growth may be of limited value in later periods. As an example, the job satisfaction of an innovative and creative portfolio manager may be penalized by his own success as aboveaverage investment performance leads to an above-average growth of assets under his management. A transition of needs and talents may not be detected, or worse may be actively resisted, by people in the organization, leading to deterioration in performance, morale and managerial effectiveness. The key managerial solution to this process is understanding and planning for organizational change as it relates to portfolio management. The effective manager can then enhance the quality and growth of the organization and begin to prepare for the future internal environment that will likely accompany success. Recognizing Maintenance vs. Creative Phases John Aplin and Rick Cosier wrote a very relevant piece in the Spring 1980 Business Quarterly called "Managing Creative and Maintenance Organizations" which has direct application to the investment process. They described two distinct phases of activity that can be identified in most organizations: a relatively stable, internally-oriented maintenance period and a dynamic, externally-oriented creative period that usually includes, but is not limited to, the start-up phase of an organization. A series of common behavior patterns was noticed as a firm

cycled from one phase to another, both in terms of the values, directions, and priorities of the firm and the change in managerial skills that must be implemented to sustain success. Aplin and Cosier also point out that transitions between phases cause special managerial problems due to, among other factors, the potential inability of managers to excel in the types of activities that are required in both of these distinct organizational stages. These concepts seem unusually relevant to effective management of investment managers. Our business seems to go through recurring/alternating cycles of what I define as creative and mature organizational phases. Given the pace of change within the industry, the frequency of transition between these two phases can be expected to be high but the length of the creative and mature periods varies considerably depending on the management philosophy and the investment style of the firm. H should come as no surprise that mature periods, with their generally greater sense of stability, usually last longer than creative periods. Creative Phase Characteristics An organization enters a creative phase at its formative stage, and on those occasions when management and outside forces combine to change the destiny of the firm by introducing new organizational strategies and, possibly, a different investment philosophy. Creative firms tend to exhibit a set of common characteristics: 1

The firm displays strong immunity to the external pressures on the business. Investment philosophy and direction are well understood internally and externally, leading to a high confidence level and staying power of investment style. 2

The thrust is externally-oriented and aggressive. There is a willingness and comfort in dealing with long-term concepts and uncertainty in setting investment strategy. The managerial emphasis is on growth and the creation of business through new services, as opposed to maximizing internal efficiencies in controlling costs.

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3

Employees are enthusiastic and motivated by the momentum of the firm and have a creative, growth-oriented job content. There seem to be few if any people problems. 4

Senior management generally retains a strong and active role in the investment management process. 5 The investment process is relatively simple and straightforward. The firm exhibits an action orientation and a willingness to experiment, implement and respond to change. As a result, new ideas seem to flow freely and are quickly translated into portfolio action. Maintenance Phase Characteristics An investment firm has a tendency to enter a relatively stable, mature phase after its direction and style have become established and formalized procedures have become routine. Characteristics of a mature organization would include: 1 The organization takes on a distinct internal focus with a primary interest in improving and refining existing services and methods. There is less inclination to change direction or consider new strategies, and an unusual interest in retaining the status quo.

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2 There is a more regimented, task-oriented environment which often leads to frustra· tions in job content and turnover of creative and younger people. In many instances, turnover accelerates despite the existence of very attractive compensation levels. 3 Due to the press of other duties, senior management relinquishes some or all involvementwith the daily investment process. 4 The portfolio process seems to become more complex, with more steps involved between idea awareness and execution of decisions. This is normally accompanied by a greater use of committees or group judgments in making important decisions as opposed to individual portfolio action.

5 The organization puts greater attention on efficiency and cost control. Long-term planning, budgets and written status reports become more commonplace. 6 With the expansion of staff, good communications become more difficult, both internally and externally. Confusion arises as to the true purpose and direction of the firm, leading to more frequent deviations from stated investment style. It should be obvious that the innovative and crisp behavior required for effective portfolio management finds a much more conducive home in a creative rather than a mature organizational setting. Our business requires an environment that encourages the expression of ideas, the discussion of contrary opinions, the seizing of opportunities, and the prompt execution of strategic decisions. It is crucial for investment leaders to recognize that, in the absence of deliberate managerial action, creative organizations have a natural tendency to transform into mature organizations. I should add also that our industry has a number of smaller firms exhibiting mature organizational symptoms due to a failure by their leaders to recognize the need for effective managerial direction. Phase Transition Problems Management should also be aware of the special problems which flow from transitions both from a creative to a mature state and, vice versa, from a mature to a creative state. The seemingly simple task of observing a firm's posture within an organizational cycle is truly difficult due to the dynamics of our profession, its rapid pace of change and the seemingly infinite set of little crises that continually occur which prevent us from seeing what is happening in the "big picture." In addition, a problem commonplace in portfolio management is the unwillingness of managers to be honest about where the firm is in its organizationallife cycle, since the skills required for investment success during one phase often contrast considerably with those needed for superior results in another phase.

Finally, effective management of o~ga­ nizational change is further complIcated by events unique to creative-t~-mature as opposed to mature-to-creatIve . transitions. Creative-to-mature tranSItions often creep up on organizations since these require no direct managerial action to materialize. Portfolio managers can easily get caught up in the momentum of their own success and not be conscious of changes in their internal work environment which make it considerably more difficult to sustain creativity and effective portfolio management. On the other hand, mature-to-creative transitions can prove even more disruptive and unpleasant for the firm and its management. In these cases, there is often a subconscious tendency to delay needed decisions due to reasons which could actually include job survival for the investment leader or some of his key associates. Resistance to change developed during the mature period can become so intense that the staff may refuse to consider new strategies even in the face of potentially devastating consequences. As a result, many . mature-to-creative transitions are set In motion only by intense external pressures brought to bear on the investment firm and its leaders. Successful Examples On a more positive note, our industry has a number of organizations which have been quite successful in coping with growth, absorbing significant i.ncreases in assets with no apparent ddution to their investment skills. Alliance Capital Management The more numerous exceptions to the general rule about gravitating to a mature state are firms like Alliance that seem to retain their creative status despite experiencing substantial growth and organizational change. A first common denominator of such firms is that they recognize the threat imposed by organizational inertia and take specific managerial steps to defeat it. The founder or leaders of such firms have a tremendous personal conviction and personal sense of involvement with their stated investment style. Of equal importance, they are extremely eff~cti.ve in transmitting their values and pnonties to others internally, leading to a

strong sense of creativity and staying power despite the potential distraction of organizational noise. These "creativity sustainers" also seem to have extremely high standards for the selection of staff. There also seems to be a deliberate leanness to the organization's head count, accompanied by very high productivity and profitability that results from the dynamics of a group of superior people doing a few things unusually well. Provident National Corporation A second type of'exception to the organizational aging process is personified by Provident, and that is the firm ~hich has deliberately developed the faclhty to respond to external chang~s in it.s competitive environment and In the investment needs of its clients and prospects. As opposed to resisting change, these organizations seem to relish the chall~nge and opportunities provided by ~e~sIng new client needs that can be satisfIed by leveraging new services upon a core of knowledge and expertise that have already been assembled. These firms are truly client-driven as opposed to . product-driven. Management bUllds o~ organizational spirit that responds pOSItively and quickly to environmental change and is expert in effecting mature-to-creative transitions whenever necessary. The leaders of such firms seem to have unusual conceptual skill in drawing back from the daily activities of the investment process and perceivi~g new services that draw upon the skIlls and talents of their people. Due to practice and familiarity, these organizations are particularly adept at resisting the inward orientation that burdens many larger investment firms, and, indeed, they use the organizational inertia of their larger competitors to creat~ ?ew profit and investment opportunities. SUMMARY

In summary, I have tried to identify some of the major factors impacting the external environment of portfolio management and the particular problems and challenges which accompany growth and organizational chan~e. I have also tried to put forth a few Ideas of effective managerial skills used by the good firms in our industry to cope with

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their environment. I would like to repeat a common law of managerial success practiced by the good firms that cuts across aU of the comments I have made. It is that the winning firms in our industry understand the power and productivity of superior investment professionals and the importance of remaining lean and efficient in the portfolio decision process. In many industries, smaller firms have an important advantage if they can avoid the costs and inertia embedded in the large overhead of their bigger competitors. This statement

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seems particularly appropriate to the dynamics of professional portfolio management. The good firms seem to recognize that there is no correlation between head count and success in our business. If anything, it is a reverse correlation. If we concentrate on quality rather than quantity of investment professionals, the firm benefits in higher profitability for itself, its clients, and its employees, creating a very positive and reinforcing circle for effective management of investment managers.

Management Strategies Used by Successful Firms Harold l. Arbit

This paper will examine the strategic issues successful investment management firms address and their responses to those issues. "Strategic" is defined as the actions firms take to increase their chances of ensuring themselves a competitive advantage. The strategic issues examined include: the external environment, the internal environment such as organization culture, and the difference between investment analysis and investment insight. COPING WITH THE INVESTMENT ENVIRONMENT

The organization's reaction to an environment where noise dominates will determine its capacity for accurate selfappraisal. The term "noise" refers to the tremendous amount of variability around an equity portfolio's excess rate of return. The S&P 500, a welldiversified equity portfolio, has (95% of the time) a range of returns of plus/minus about 40 percentage points around its annual return. Indeed, even if you were an equity manager attempting to document your performance relative to the S&P 500 you would find it quite difficult to show statistical evidence of skill. For example, a manager with the typical level of aggressiveness in his equity portfolio who had the skill to outperform the S&P 500 by an average 10% a year would have to do so over a period of about 240 years to prove to a statistician that he possessed that level of skill. The point is that with so much variability, past performance alone is a weak basis for evaluation. Thus in this type of environment it is tempting to see what one wants to see. Indeed the temptations are similar to those faced by compulsive gamblers. Even though the odds might be against a compulsive gambler it is difficult to convince him of that since he is randomly reinforced with an occasional lucky streak. And it is that lucky streak that he both remembers and for which he strives. Successful firms realize that in this type of environment effective feedback and selfappraisal are critical. The investment environment is also dominated by information overflow. When you consider that just about anything that happens anywhere in the world has some investment implications

you can see that how an investment firm responds to this plethora of information will influence its whole decision-making structure: how quality control is handled, what production quotas are required, how job functions are described, etc. Focusing on the Abnormal Most firms focus on processing all data and thus are forced to focus on what is normal. Successful firms tend to limit the data they work with and focus on the abnormal. That leads them to be more concerned with signs of change rather than speed in processing data. Beating the Consensus Every successful business looks at the nature of competition it faces and determines its own strengths and weaknesses in light of the competition. Successful investment firms are no exception. This issue however is a highly emotional one because there is a difference between the competitive situation facing investment firms and the situation facing most other firms. Most investment professionals assume that an above average ability to analyze common data will result, as in most other fields, in a large competitive advantage. In investing this is not true. The competition can be thought of as the institutional equity market as embodied in the S&P 500. Hundreds or thousands of professionals are making judgments about individual securities every day. It is the interplay of all those professionals that sets the price of a security. Thus in investing you are not trying to beat a specific competitor but the consensus of all competitors. Hence even though a particular analyst may be above average when compared to other individual analysts, it is much harder to be above average when compared to the consensus. This is the result of what statisticians call "the law of large numbers." In effect this tenet says that while an individual's estimate of value may be more accurate (a smaller error) than the vast majority of individual estimates, it is unlikely to be more accurate than the average (consensus) of all estimates. If there are enough estimates and they are unbiased estimates then the extreme optimists will offset the extreme pessimists, the moderate optimists will offset the moderate pessimists, and so on. The end

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result is that the average (consensus) estimate will tend to have a smaller error than any single above-average analyst. It's the statisticians' version of "None of us is as smart as all of us." There are different ways of trying to outperform the market consensus of investors, and each approach has associated with it its unique odds of success. Successful firms look long and hard at their strengths and the resulting odds of success. Achieving Insights

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In order to determine its strengths the successful firm must determine what its key insight is. Firms that can't define their insight in more than the usual ambiguous terms won't be able to offer alternatives or get effective feedback. Exhibit I gives a partial list of rationales that investment firms might focus on in defining their insight or competitive advantage. For example, one investment firm defined its insight as being the result of the systematic analysis offered by their use of a sophisticated stock valuation modeL All they had to do was input consensus forecasts into the model and the system would point out seeming inconsistencies in the current risk/return relationships of stocks and groups of stocks. The only problem was that they didn't produce an effective structure to implement that insight. The analysts were allowed to put in whatever input they wanted as long as it was generally consistent with the provided consensus macroeconomic forecast. The investment opportunities highlighted by the system turned out to be mirages caused by the analysts not inputting true consensus estimates.

Exhibit I Insight Rationales

• • • • • • •

consensus input with system out-analyzing common data trading at margin screens historical relationships forecasting market psychology exploiting biases

Different organizational decisionmaking structures are more effective with different insights. Yet most investment firms have quite similar structures. The conclusion that can be drawn is that either most firms have the same insight (which, if true, makes it unlikely that the insight will produce profits) or that most firms haven't defined their insight and created an appropriate structure to exploit that insight. SUCCESSFUL ORGANIZAnONAL CHARACTERISTICS

Whatever the specific decision-making structure, successful firms have certain organizational characteristics in common. First, they are able to accommodate three distinct cultures: creative, guild and technical. The creative culture values iconoclasts and atypical thinkers. The guild culture values professional experience. And the technical culture encourages specific expertise and quantitative skills. Not only do successful firms accommodate all three cultures but they are keenly aware of when one culture is beginning to dominate and when another culture needs special encouragement. Determining Strengths and Weaknesses Also, successful firms don't believe they are good at everything. They have identified their specific strengths. This is especially true for large organizations which tend to presume an ability in many areas, Le., venture capital, fixed income, real estate, international, aggressive equity, etc. Often in these organizations as long as one or two of the areas are performing well-even if only by chance- the organization believes it has confirmation that it can/should be good at everything. Their conclusion is that the only reason an area is not currently successful is personneL Therefore, replace the people and you've solved the problem. This generates a game of musical chairs as different areas randomly have good and poor performance. The organization never accepts responsibility for defining its strengths and weaknesses.

One way of highlighting this is to create a flow chart of all decisions outstanding in your current portfolio ("decisions" in this case can be defined as deviations from the market portfolio or from your appropriate benchmark portfolio) and why you made them. I think you will be surprised by the number of decisions, both conscious and unconscious. Unconscious bets are either by-products of conscious bets or else unthinking deviations from characteristics of the benchmark portfolio. Successful firms realize how easy it is to dissipate their best bets. Agreeing on Risk Assumed In addition, successful firms have considered how much business risk they are willing to take in exploiting their best investment ideas. The more aggressive a portfolio the more risk. The more risk, the more noise and the more noise, the greater the chances of being in the Becker bottom quartile in a given year. (Of course the better chances of being in the top quartile also, but a manager doesn't get fired for being in the top quartile.) Successful firms seem to concentrate larger portions of their portfolios in their strongest ideas. This seems to be confirmed by the tendency of suc-

firms will couple traditionalists with iconoclasts, renaissance thinkers with specialists, and analytical people with creative ones. It takes a conscious effort to accommodate different personality traits. Identifying Creative People For example, Exhibit II lists some of the characteristics of creative people. It is not easy to accommodate some of these personality traits. Creative people switch reference points quickly. Imagine a meeting where the creative person seems to be jumping from one irrelevant point to another. It can be very frustrating. Or imagine that you want the creative person to come up with a solution to a specific problem and the creative person spends a Exhibit II Characteristics of Creative People

Wide-Ranging Curiosity and Desire to Explain the WorId • enjoy complexity • skeptical of status quo • broad-based thinker

cessful firms to have a larger percentage of a portfolio contributing to the portfolio's excess performance than do less successful firms. In less successful firms it is common to have 10% of the portfolio account for 80% of the performance.

Great Ego Strength

Managing People Effectively

• sees self as creative • able to recognize creative people • enjoys being creative

The general topic of people management has already been addressed by others. However I would like to offer some specific observations about successful firms and their handling of people. Typically, the personality traits of a successful investor are antithetical to the characteristics needed to be a successful manager of people. Successful firms have addressed this issue head-on. If the chief operating officer is also the chief investment officer, they have adjusted to this by staffing with people who are self-starters and self-confident, people who don't need a lot of feedback or guidance. Successful firms also tend to insure a proper amount of diversi ty within the organization. Creativity needs a certain amount of intellectual tension. These

• belief in one's problem solving ability • high tolerance for uncertainty • tenacity Values Creativity

Values Humor, Spontaneity and Playfulness • favors metaphors and visualization • switches reference points quickly High Energy Level Intelligent Autonomous • sees self as different Different Approach to Problem Solving • will tend to choose problems least likely to be solved but with highest payoff • will spend most of allotted time in analysis phase and little time in synthesis phase

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"disproportionate" amount of time trying to redefine the problem. Enhancing Creative Effort Clearly, the attitude of an organization and its management can enhance or inhibit the creative effort. Exhibit HI lists some of those actions. As an example take the separation of idea generation from idea evaluation. In order to encourage creative thinking it is essential to separate the generation of ideas from their evaluation. If an individual believes he must defend an idea as soon as it is uttered he will be reluctant to offer ideas that might seem foolish or too different or difficult to defend. However, it is precisely such ideas that are most likely to generate the most creative suggestions. Yet how do most investment firms operate? They rely on the conflict or ad· versarial method of evaluation. There is nothing wrong with this if it is done at the right time. But to subject a fragile,

developing idea to that reaction too early in its life will inhibit the development of creativity. Our own experience has been that if we have meetings to generate ideas and later separate meetings to then evaluate them we are much more productive. DIFFERENTIATING ANALYSIS AND INSIGHT

The remainder of this paper addresses the difference between analysis and insight, and what successful firms do to increase the number of insights that they develop. Let us define analysis as the processing of common data through an existing perceptual framework. Contrast that with our definition of insight: a useful change in perception. Given the previous discussion of why it is so difficult for even an above-average analyst to "out-analyze" the consensus, it

Exhibit HI Attitude of Organization Can Enhance or Inhibit Creativity

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Attitude Toward

Enhance

Inhibit

Creativity

Crucial to survival

Allowable if not disruptive Administer successful people Must fit in

Risk

Accept as inherent Flexible timing Resource slack

Predictability and efficiency paramount Efficiency based on predictability

Staffing

Diversity provides stimulation Value iconoclasts Reject givens Tolerate irrelevancies

Seek homogeneity Value guild members Experience vs. knowledge Judgment process itself accepted

Management

Curiosity is the motivator Pose questions Non-productive need to prepare mind Freedom from administrative details

Quotas motivate Daily tasks are necessary Define duties & hours Distinction between work & leisure

Evaluation

Non-threatening Informed feedback (outside experts)

Conflict method: articulate premature commitment Reliance on external measures Reward short term results Problems deal with detail, not essence

Reward creativity Separate idea generation from idea evaluation

should be clear that insight is much more likely to produce profitable investment ideas. However, I would argue that our Western culture focuses much more on analysis than insight. In addition, the training and background of investment professionals exacerbates that emphasis. A general discussion of how the mind works is required to understand why a specific effort is necessary to enhance our ability to produce insight. This discussion relies especially on the work of two scholars, Edward DeBono of Cambridge and Morris Stein of New York University. I urge you to read their very perceptive books on the subject. How the Mind Works Most people, if they thought about it at all, would describe the brain's processing of data as being similar to a computer which receives data, stores it in raw form, and then independently decides when to process that data. However, that is not an accurate description of the brain's process. In reality, the brain acts more as an e.fficient machine that allows data to form itself into patterns. These patterns, if useful, are repeated and ever more firmly entrenched. In this way the mind is focused on creating order rather than being focused on disorder or chaos. Just think how natural it is for a person to gaze up at the stars and automatically trace images or patterns. This pattern-structuring system of the mind has developed because it permits us to function effectively. First it allows us to keep our perceptual sanity. If we were changing our perceptions continuously, or if we allowed uncontrolled amounts of raw data to bombard us, we couldn't cope. Our mind would go into overload and react with something like an epileptic seizure.

It also allows us to react quickly. Patterns that are recognizable can form a code-we can react as soon as the code is identified rather than wait for all the data to come in and form the complete pattern. It also permits us to produce such useful tools as language. In this context it can be seen that insight should be considered more of an aberration than the norm. Indeed the system's strengths are also its weaknesses when viewed in the context of producing

insight: patterns become rigid and more firmly entrenched the more they are used. It becomes quite difficult to transfer information that is locked in one pattern to another. Anything that resembles an existing pattern will become that pattern, since the mind tries to be efficient: the fewer the patterns it has to choose from, the more quickly it can respond. The mind tends to stop at the first adequate solution rather than go on to a possibly optimal solution. This is especially troublesome since the sequence of arrival of information becomes critical. If the mind attempts to make sense of the data at any given moment, then it will seize upon the first reasonable pattern that the data forms rather than the optimal pattern that would have emerged if the attempt at pattern creation had been suspended for a time. Also, over time it becomes even more difficult to change an existing pattern because one pattern tends to be added to another pattern to form larger patterns. Thus, changing one might lead to the disruption of a much larger pattern. While this discussion might seem esoteric, the implications can easily be seen in the daily life of an investment manager. For example, when evaluating an existing pattern the manager excludes everything that is "irrelevant." Yet the definition of what is relevant is determined by the existing pattern. Thus, it is difficult to change the existing pattern and see something new if most attempts at doing so are labeled "irrelevant" and dismissed from consideration. Relevance of Lateral versus Vertical Thinking

It is clear that if one is to increase the chances of seeing something the competition hasn't already factored into current prices, one is going to have to make a conscious effort to do so. It is this effort that DeBono describes as "lateral thinking." Most of our thinking is vertical. It deals with proving and developing an existing idea. Lateral thinking deals with restructuring existing patterns and provoking new ones. Lateral thinking is complementary to vertical thinking in that it is meant to provide a wider choice of options for vertical thinking to pursue.

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Exhibit IV lists some of the important differences between lateral and vertical thinking. One can think of vertical thinking as being rational. This logical thought process is the result of a selection routine that uses acceptancelrejection to pursue an idea or identify a pattern and move along the path of its development. The presumption is that unless one can show why an existing pattern is clearly wrong or can document that one has a better alternative, one should be satisfied with it. This results in an investment approach being used as long as it is successful and never having it questioned or abandoned unless forced to do so. On the other hand, lateral thinking attempts to generate alternatives for the sake of generating alternatives. It does not concern itself with an evaluation of those alternatives. Developing Lateral Thinking Exhibit V lists some of the techniques that DeBono suggests will increase one's ability to engage in lateral thinking. We have tried many of these and I'd like to share our experiences with you. Our goal, by the way, is to devote at least 10-15% of our effort to lateral thinking. Most organizations devote less than 2% of their efforts in this direction. Generating Numerous Alternatives The first technique is the most common one: a meeting with the objective of

generating as many alternatives as possible.

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No evaluation of the alternatives is made at that time. Indeed, suspending judgment is crucial to encouraging participants to offer ideas that might initially seem foolish or that their own judgment process might extinguish before the idea is allowed to stimulate others. Our experience has been that many, but obvious, alternatives are offered in the first stage of such a meeting. Then there is a pause when people are tempted to conclude they have exhausted all the possible alternatives. However, they more likely have exhausted only the obvious alternatives. Forcing the meeting to continue beyond this point is critical to the generation of less obvious alternatives. Perhaps an arbitrary quota is set to ensure that the meeting effort continues beyond this initial stage.

Challenging Assumptions Another technique is to challenge assumptions. We found that a continuous use of this technique helps develop our ability to identify the assumptions in operation. Ordinarily, many of these assumptions are unconscious ones-ones we assume to make analysis of the problem easier to deal with. Most assumptions are not continuously evaluated but rather accepted until a major disaster forces a re-examination. Defining Dominant Ideas The intention behind the technique of defining the dominant ideas in a discussion is that unless we are aware of the dominant idea and can define it, it will be difficult to escape it and offer alternatives. We have found that an effort to define the dominant ideas leads to an increased willingness to question those ideas. Exhibit IV Two Different Thought Processes

Vertical

Lateral

Selective Available direction

Generative Generates direction Provocative Can jump Can be incorrect No negative Chance intrusions Flexible labels Least likely Probabilistic

Analytical Sequential Correct Use of negative Excludes irrelevant Fixed labels Most likely paths Finite process

Exhibit V Techniques to Encourage Lateral Thinking

• • • • • • • • • • •

Generation of alternatives Challenging assumptions Suspended judgment Dominant ideas Fractionation Reversal Brainstorming Analogies Entry point Attention areas Random stimulation

Using fractionation The use of the technique of fractionation exploits the notion that breaking a pattern down into smaller components- not the "true" components, just smaller ones-increases one/s ability to play around with the components and reformulate them into alternative patterns. In doing this we have found that the output of a discussion is determined by the words used to define the issue. When we break down an issue into smaller components we find it much easier to offer different words which in turn leads to different perspectives. Reversing Norm Relationships The technique of reversal is the simplest and yet the one we have found most productive. It is easy to enumerate many commonly-accepted relationships about any current investment environment. This technique asks that one articulate the reverse of those accepted relationships; e.g., "higher fuel prices are bad for the airline industry" becomes "higher fuel prices are good for the airline industry." The purpose of this is not the presumption that contrary thinking per se is correct, but rather it gets one out of the existing pattern which is insulating the person from other alternatives. Generating Analogies The use of analogies is the most fun. While the technique itself forces movement from an existing pattern, the movement tends to soar with the imagination. When we describe a cherished investment idea in terms of an analogy, we find ourselves much more willing to see the flaws in it. When describing an investment idea in terms of the journey of a cigarette butt down a gutter and into the sewer system, you know you are more likely to generate atypical observations. This is only a partial discussion of techniques to encourage lateral thinking. Of course, with hindsight, a successful alternative becomes obvious and one can identify the logical path one followed to reach that alternative. However that doesn/t mean that this logical path would have been taken without the stimulation needed to conjure up the alternative in the first place.

SUCCESS CHARACTERISTICS

In conclusion, I offer the following characteristics as those that successful investment firms are most likely to have in common. First, they are prospective rather than reactive. Their emphasis is not on reacting to an obvious event, but rather one of focusing on what new events might occur. This emphasis means that they are likely to challenge assumptions and be skeptical of an alternative if it is simply the first l1dequate one offered. Second, they insure that they have a high level of feedback. For these firms it is not enough to know that they had a superior performance record - they want to know if they were right for the reasons on which they were relying. Having a successful performance record which is not the result of the fruits of your investment thinking is not likely to spur you to change. Yet successful firms have a clear idea of their strengths and weaknesses and how every investment bet relates to those strengths and weaknesses. That allows them to catch early signs of problems in the assumptions that underlie their bets. Related to feedback is a clearly articulated purchase rationale for every investment decision. They know why they bought an investment, what investment environment they were presuming, what trigger events they were looking for, what the alternative investment bets were and why this one was more attractive. Less successful firms have increasingly vague and ambiguous rationales for purchase decisions as more time elapses. Or worse, they unconsciously change their rationale to fit subsequent events. Next, successful firms have an above-

average capacity to tolerate discomfort. This discomfort can take the form of having diverse people in the firm, the intellectual discomfort of always questioning assumptions, or the discomfort of being different from the consensus. How many firms do you know that make a specific attempt to create a reward system that reinforces criticism from internal staff?

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Successful firms are especially willing to tolerate the discomfort of placing big investment bets. They know the quality of their different investment ideas and are willing to concentrate their portfolios in their best ideas. Finally, successful firms have effective client communications. The client knows what type of investment to expect from the manager; he knows why the current portfolio is structured the way it is; he knows what events the manager is looking for to confirm that his idea is work-

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ing out; and he knows what exposures are in the portfolio as the unwanted byproduct of the manager's bets. The client may be disappointed, but he is never disappointed and surprised. If a client is both disappointed and surprised, it is unlikely he will grant the time needed for an investment idea to work out. This is reasonable since he can only assume that if he was surprised, it must mean that the manager was also surprised-which may mean that the portfolio is out of control.

Managing Growth & Organizational Change J. Richard Boylan I have been asked to discuss the management of growth and organizational change in the light of my experience in the investment business, most of which has been spent with the Provident National Bank. Before approaching the topic, I hope you will allow me to acknowledge my debt to several individuals whose judgment, wisdom and character have had a profound effect on my personal development. The first is the fellow who gave me my first job. Entering the securities business in 1950 was not easy and I recall pounding the sidewalks for four months before John Murphy, the resident partner of Reynolds and Co. in Philadelphia, had the courage to hire me as an analyst-trainee, an individual who had thoughtfully prepared for a career in security analysis by majoring in medieval history. I would also like to acknowledge my debt to Francis Nicholson, Provident's Chief Investment Officer w hen I joined the bank, for his inspirational tutelage; to Richard Willis, his successor, for teaching me important lessons in portfolio management and particularly how not to lose one's conviction in a bear market; to William Foulke, particularly for lessons in gentleness and people skills, and to Frank Howard, my superior for many years, for his unselfishness, inspiration and support. GOALS OF THE PROVIDENT

Since banks are generally best known for their commercial lending activities, and since the Provident has the distinction of being the fifth largest bank in the fourth largest city in the United States, it would be presumptuous of me to anticipate that today's audience has any great familiarity with our activities. In terms of trust and investment activities, however, we currently have $20 to $21 billion under management, which compares with one and one-half billion or so 10 years ago. The earnings produced by our investment management activities represent a significant portion of total corporate earnings and consequently the Provident can, to this extent, be distinguished from most banking companies. During the years in which I served primarily as a portfolio manager, my associates can assure you that I was never

a threat to the top performers in the Becker Universe. I am convinced, however, that most managers subconsciously lead their organizations into business strategies in which they have the most intellectual interest. In our case, product development and structuring the organization to deliver investment products to the market place has seemed the most interesting challenge and hence the business objective upon which we have focused. Let me stress, nonetheless, that the Provident is fortunate in having on its staff many outstanding analysts and portfolio managers whose business lives are focused on performance and how to achieve it. I recognize the importance of performance and I believe that we work hard on creating an environment in which professionals can achieve good results. Clearly, we could not hope for market acceptance of new products without acceptable performance. What I am trying to say is that managing the business is my primary concern and I am delighted to leave portfolio management to others much better equipped than 1. ORGANIZAnON STRUCTURE AT PROVIDENT

The Chairman of Provident National Corp., Roger Hillas, is my immediate boss. In addition to worrying about me, he is responsible for the banking side of the house. My responsibilities are directed to those holding company subsidiaries and divisions of the bank which deal with securities as opposed to commercial and consumer lending. My discussion of growth and change management at Provident therefore is directed toward the following profit centers: 1

The Bank's Trust Division, with $4 billion under management. :2

Provident Capital Management Company, a bank subsidiary which competes for national and regional pension account management. Assets under management are about $800 million. 3 Provident Institutional Management Company, an investment advisor to 10 domestic and off-shore investment companies. Assets under management are $16 billion.

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4

Provident Processing Company, providing shareholder accounting and transfer agency services for those mutual funds which we advise, as well as to a number of non-affiliated funds. 5 Provident National Investment Corp., a holding company subsidiary which has taken equity positions in a number of regional banks. I)

The bank's own portfolio, and related activities such as asset/liability management, short-term funding for the bank and the holding company, and foreign exchange dealing. As we discuss these businesses, I hope you will find some symmetry in management philosophy. One of our predilections is to try to organize profit centers by markets and into the smallest groups of individuals possible. The businesses are different, however, have distinct opportunities and problems, can require distinct skills, serve markets with different growth opportunities and, therefore, can and frequently do require different organizational structures. Some are in their growth phase while others are mature.

Provident's Trust Division

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When we took stock of the Trust Division's market position almost 20 years ago, we found ourselves in fourth place in terms of trust assets in the Philadelphia market. Most of our competitors were well regarded in terms of administrative capability, taxation and estate planning. Market surveys convinced us that consumers did not differentiate among trust companies in terms of investment capability. As a result, the buy decision tended to be relationship- and price-driven. From this factual situation, we concluded that our best opportunity to build the business would be to maintain our administrative competence while making heavy investment in people to improve our investment capabilities and thereby attempt to differentiate our product i.n our essentially regional market. In the beginning most emphasis was placed on equity research; the staff was increased from 5 to 15 professionals and quality standards and compensation were ad-

justed commensurately. Analysts were required to publish and to be accessible to the financial press and to sell-side analysts. We hoped, of course, that the inclusion of our analysts' and the bank's name in the press would help us achieve a bit of brand identification. Once this program was well under way, we initiated the same type of program in our portfolio management group, expanding staff, trading up, decreasing account loads and aU the obvious things that go with such an effort. Although our development effort in the investment atea was working reasonably well, our additions to staff were putting pressure on our profit margins. Of greater importance to the successful execution of our program, non-investment professionals felt and expressed concern at the thrust of our resource allocation-a perfectly normal reaction. As to the margin problem, we had either already satisfactorily convinced senior management that this result was predictable and should be accepted for a reasonable period or they were unable to find others to replace us until the results changed. We attempted to deal with the friction developing between non-investment professionals and investment professionals by explaining the strategy openly and repeatedly to the entire staff. We simply argued that the strategy represented our best opportunity to grow the business and that profitable growth would be in everyone's best interest. We also concluded that it would be desirable to differentiate ourselves in terms of pricing and minimum account size, to take the initiative in terminating unpleasant or unprofitable account relationships, and we did these things. By the late 1960s we felt that our investment research had improved to the point of becoming commercially saleable to the bank trust department market. In addition, we sensed opportunities to become a second source supplier of research to regional brokers and to foreign banks. The product was placed under the control of the research department, a dedicated marketing group was formed and agreement was reached with an concerned that our business objective was to generate sufficient fee i.ncome to offset the cost of our research effort.

The year 1971 was a critical one for us-second only to the time almost a decade earlier when decisions were made about our basic strategy. In that year we concluded that we would attempt to enter the mutual fund business as an investment advisor. Before I turn to Provident Institutional Management Company, the firm we formed to carry out this activity, however, just a few more words about management issues associated with managing a trust business. Special Problems of Trustees An obvious problem is that many customers don't want to be doing business with a trustee for obviously, "if grandfather had had all his marbles, he would have left the capital to me outright." Trustees, unfortunately, have to play it the way grandfather wrote it. A second, and more substantive challenge is a pricing structure which was developed generations ago when it was contemplated by all concerned that uninvested cash would be held on deposit on the commercial side of the bank. The earnings on these balances, together with the rather modest fees charged to the trust itself were deemed adequate to compensate the trustee. Such balances have largely disappeared. The absence of any need for heavy staffing with professional investment personnel during the period when the pricing structure developed differs markedly from contemporary experience. Trust law was real estate-oriented, most trusts invested primarily in mortgages, and despite Harvard vs. A mary most jurisdictions made equity investing either difficult or impossible for trustees until after World War II. Lastly, I would add that balancing the distinct cultures, aspirations and motivations of the investment and noninvestment staffs calls for considerable artistry. The business is mature and there is some question about the product's acceptability in a changing society and in an era of tax-law changes. Hence, it seems to me that Ted Mygatt, who runs our Trust Division, has perhaps the toughest management job of all those who head our various businesses.

Provident Institutional Management Company As I indicated earlier, Provident Institutional Management Company (PIMC) is the company we formed to carry out our responsibilities as advisor to investment companies. It is by far the largest of our subsidiaries. For a variety of reasons we chose to locate the company in Wilmington, Delaware but more of that ina moment. Rewriting history is, of course, a popular indoor pastime, but even I would not have the chutzpah to suggest that when we formed PIMC, or rather the unit within the Trust Division which evolved into PIMC, we hadn't the slightest expectation that the company would grow from zero to $16 billion under management in 10 years. Nor did we anticipate that identification of sector swaps would be overwhelmed by old fashioned credit analysis, that EDP systems analysts would become as important to the firm as portfolio managers, or that at the end of 10 years our annual legal fees would far exceed all the revenues booked in the early years. So much for long term planning! Managing Mutual Funds In fact, we did believe that our investment skills equipped us to do a competent job of managing mutual fund portfolIos and thereby try to make the transition from a regional to a national money manager. Citibank had already formed a "managing agency account" which had been approved by the Comptroller of the Currency and which had been registered with and declared effective by the SEC. Citibank's managing agency account was essentially an open end mutual fund organized, sponsored, managed and, most significantly, distributed by Citibank. We had prepared a registration statement following the Citibank modeL The Investment Company Institute had predictably sued the Comptroller of the Currency, complaining that the structure of the fund violated the GlassSteagall Act and that the Comptroller had as a result exceeded his authority by granting his approvaL

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A Glass-Steagall Violation In a state of euphoria we dispatched a runner to Washington with the address of the SEC pinned to his lapel. Someone had the wit to realize that our historic day coincided with one of the Supreme Court's decision days and arranged to have the runner check in from Union Station before proceeding to the Commission. In fact the Court had ruled that noon, in a 6 to 2 decision, that Citibank's scheme was just awful and we had to ask our runner to take the next bus back to Philadelphia. After recovering from a world class hangover, we reached several conclusions. First, martinis are dangerous to your health. Second, while the Court had ruled that Citibank's approach was illegal, we concluded that in the decree the Justices had told us pre~ cisely how to get the job done. The Court's reading of Glass-Steagall was unequivocal on the distribution of securities by banks and the case was in effect decided on this single point. However, having decided the case, the Court went on to review other aspects of bank involvement with mutual funds which seemed to the Court, and I think to any impartial observer, to raise serious public policy questions.

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Operating Within Glass-Steagall It seemed to us that each of the concerns raised by the Court could be resolved and that we could serve as advisor to a registered investment company if a broker-dealer were to handle all aspects of the distribution of the fund's securities and if the fund's prospectus carried clear prohibitions against the activities which troubled the Court. After this basic strategy had been critically refined by outside counsel and we had received preliminary encouragement from the Fed and the Comptroller, we let it be known to the investment banking community that we had a working model and, if selected to manage an investment company, that we were prepared legally to act and to defend our position. Fortunately for us, Blythe Eastman Dillon and Loeb Rhoades had reached similar conclusions and believed that a closed-end bond fund advised by a bank would receive a good reception from retail investors. We were pleased to be selected by the lead underwriters to advise what came to be called Independence Square

Income Securities and to have a new $40 million account, our largest at the time. Leveraging the Investment Base Continuing our basic strategy of attempting to leverage off a strong investment base and achieve national distribution through investment bankers, the following year we became advisor to Temporary Investment Fund which I believe was the first money fund registered with the SEC and the second declared effective. The fund was an open-end, no load investment company designed to offer economies of scale to bank trust departments in connection with their cash management activities for individual accounts. The distributor was Loeb Rhoades (now, of course, ShearsonlAmerican Express). Technical and Conceptual Contributions Our contributions to the money fund industry were perhaps both technical and conceptuaL Technical in the sense that we made important contributions in developing accounting techniques which made possible the achievement of constant net asset value and in finding an acceptable way to provide compensation to broker-dealers for their efforts in connection with a noload fund. In a conceptual sense, I think that we were among the first to recognize the fact that the money fund business actually would be addressing at least three market segments differentiated by the distribution techniques necessary to reach each. These are today referred to as stockbroker funds, general purpose funds and institutional funds. In the years since 1973 we have sought to expand our line of offerings to the institutional money fund market by adding portfolios invested entirely in securities issued by the Federal Government and its agencies, a fund restricted to securities issued by the U.S. Treasury, a tax-exempt money market fund and a tax-exempt fund investing in intermediate term securities with a fluctuating net asset value. Hoping to further segment the tax-exempt money fund market, we have in registration a fund which is designed to invest primarily in California municipal securities and thereby achieve for the fund's shareholders exemption not only from Federal income tax but also from California's sharply-graduated personal income tax.

In terms of stockbroker-sponsored,

retail-oriented money funds we have acted as advisor and more recently subadvisor to Paine Webber's Cashfund. In our only overseas venture, we also serve as advisor to Shearson International Dollar Reserves, an off-shore, dollardenominated money fund having a Luxembourg situs. Our investment activities at PIMC are not entirely restricted to fixed income securities and in passing I should mention the Chestnut Street Exchange Fund. Chestnut Street is a $100 million limited partnership equity fund which was formed in 1976, underwritten by 30-40 investment banking firms and distributed by Johnson Lane Space & Co. As you will recall, the basic idea behind exchange or swap funds as they became known, was to make it possible for holders of appreciated securities to exchange those securities for shares of a registered investment company, thereby obtaining diversification without incurring capital gains tax liability. Exchange funds were quite popular in the 60's, so popular in fact that the Congress outlawed them. About 10 years later, however, a brilliant lawyer concluded that Congress in its statute referred only to exchange funds organized in corporate form. Hence, 8 or 9 funds were organized in limited partnership form and we were fortunate to be among those who succeeded, after intense activity, in closing their transactions before the Congress once again closed the door. PIMC is still in a creative stage, people are excited, and we have deliberately located the business in another city. We try to keep staff size small and pay well. Provident Capital Management Provident Capital Management (PCM), a bank subsidiary, is in the business of providing investment management services to national and regional pension accounts. Assets under management approximate $800 million. The business, as was the case with PIMC, was transferred to a separate company in an effort to create a distinct environment which we thought would be critical to the success of the enterprise. PIMC, PCM and the Trust Investment group, we believe, require professionals with different motivations, skills and psy-

chological profiles. Compensation levels and incentive plans also differ in the industries in which they compete. Drawing on the historical association of Francis Nicholson and the Provident with low-multiple investing, PCM pursues a studied investment policy of confining its investments to bottomquintile PIE companies. It goes without saying that the firm needs highly motivated professionals, many of whom must combine investment and marketing skills. Professionals must accept PCM's investment philosophy since in fact we are selling a product, or an investment style. PCM has developed more unevenly than our other profit centers and was troubled 3 years ago by very serious personnel turnover and staying true to its investment philosophy. While I have every confidence in our current president, Tony Hitschler, participating in this conference 4 or 5 years ago would have saved me a lot of grief! PCM is also in a creative stage and is also located away from the bank's location. Bank management's function is to provide support and encouragement and to stay out of the way. Provident Processing Company Strongly influenced by the securities processing problems which were so prevalent in the 1960s, when we entered the mutual fund business in 1972 as advisor to Independence Square Income Securities, every effort was made to select a quality transfer agent and custodian. We were prepared to and did indeed agree to pay premium prices for superior service. As our EDP friends have been known to say, however, it's best not to confuse the sale with the installation. In a very few months shareholder complaints about the transfer agent's performance began and regrettably most were entirely justified. We concluded with great reluctance that to achieve quality assurance and to control our own destiny it would be necessary to build our own stock transfer and shareholder accounting capability. EDP development to support these activities is an ongoing effort, driven by increased volume and, more importantly, by product innovation. For 4 or 5 years we pursued a policy of restricting the use of these resources to

45

our own products, declining several opportunities to serve as a supplier to other fund organizations. We believe that these decisions were appropriate at the time, given the absence on our part of excess capacity. Marketing Support Capabilities Eventually our manufacturing capacity reached a point where it became possible for us to market to fund sponsors the services we had developed for the funds which we advise ourselves. We are, therefore, actively peddling our shareholder accounting, transfer agency, mutual fund accounting and SEC reporting capabilities to nonaffiliated funds. Our most recent addition to this line of non-investment mutual fund support services is acting as a processor for broker-dealers who choose to develop integrated products to compete with Merrill Lynch's CMA Account. In this connection, we are helping to support various aspects of the products developed by Shearson/American Express, E. F. Hutton and Smith Barney. The non-investment mutual fund support activities I have described have evolved from a small group of individuals in Provident's Trust Operations Department to a subsidiary of our holding company known as Provident Processing Company. It is located in Wilmington, Delaware in close proximity to PIMe.

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The President of the company is a longterm Provident employee who combines to a remarkable degree broad management abilities, technical knowledge and superb marketing skills. The company also receives heavy systems development and marketing support from our Bank Operations management. Provident Processing is an independent profit center which operates with considerable autonomy. The product is not new, yet the company is creative. In dealing with the management of Provident Processing we seek for agreement on marketing objectives, the allocation of resources, and of course, profit contribution. Then we stay out of the way. Bank Portfolio and Asset/Liability Management Because I suspect that this audience is perhaps less interested in these activities than in other aspects of investment

management, my treatment will be brief. The central notion from our holding company's point of view is that while it seems most appropriate to deal with PCM, PIMC and the Processing Company at arms length, the business purpose of the bank's own portfolio and the implications of funding the holding company, the banks in our holding company and our non-bank subsidiaries are so critical and so interrelated to our deposit-taking and lending roles that a management structure which integrates these activities is critical. The profiie of the bank's portfolio and asset/liability management is closely coordinated with the activities and volume projections of our banking officers, the counsel of our Chief Tax Officer and the advice and consent of our Controllers Division. Our Chief Financial Officer is necessarily concerned with decisions in these areas as well in decisions with respect to short term funding policies. Provident Investment Company The last of our investment affiliates that I will comment on is Provident Investment Company, a holding company subsidiary. Five or six years ago we decided to sell three non-bank subsidiaries at prices which approached a PIE multiple of 20. We received about 70-75 million in American dollars. Having no immediate need for additional equity in our bank, thinking perhaps foolishly that we knew something about the banking business, wishing to position ourselves for intra- and interstate branch banking, and observing that many good regional banks could be bought for four times earnings, we purchased 4.9% of the stock of 15 to 20 banks. Both the Chairman and I started as analysts at the Provident and I think we found some real charm in a switch from 20 times earnings for nonmarketable securities to four times earnings for reasonably marketable regional bank stocks. This portfolio currently has a market value of $120 million and on a tax-equivalent basis produces an excellent return on assets. While we tried to think through analytically the strategic implications of the location and market penetration of our individual bank selections, I am sure we were influenced by subjective considerations as well.

As Dan Forrestal observed correctly in his paper, "the senior management of the Provident has made a willing and conscious effort to depart from the daily rigors of the portfolio process." However, as Oscar Wilde said, "Consistency is the hobgoblin of small minds." Whether in the management of our bank stock portfolio we are primarily driven by a desire to position our holding company for national banking or by a personal desire to get back in the action and pick a few shots is a good question. I wonder!

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Managing Growth & Organizational Change Dave H. Williams, C.P.A.

When the LC.F.A. asked me to discuss my management experiences at Alliance Capital, I was pleased to respond favorably. It's frequently helpful to stand back, and try to take an objective, distant look at an organization. This provided that opportunity for me. I hope that sharing these true-to-life, very real, business episodes of Alliance Capital will be instructive and provide insights that will be helpful to you, too. I'll tell aU, the good and bad, the victories and the defeats...in the spirit of learning from experience. MANAGEMENT VS. ENVIRONMENTAL INFLUENCES

Alliance belies the notion that a company is a reflection of its senior management. Rather, in some ways, Alliance is very much a reflection of its environment. For example, six years ago many people, including many Alliance employees, believed that Alliance was doomed to "no growth" because of its corporate ownership by an investment bankingbrokerage firm. And people- both in our parent corporation, Donaldson, Lufkin & Jenrette, and in Alliance-were agitating for the spin-off of Alliance, saying that this was the only salvation for growing the business. And at least one other brokerage firm, Goldman Sachs - not exactly a "follower" in the business, but a leader-was divesting its money management business. 48

Fortunately for the DLJ shareholders, Dick Jenrette was not totally convinced that brokerage was incompatible with money management. He dragged his feet on selling Alliance, and eventually developed the conviction that the popular opinion was wrong. Dick was right, as the numbers in Exhibit I attest. Today, being part of a brokerage firm is no disadvantage to Alliance. There may be 1 in 50 prospective clients who object to this. But at the same time, DLJ has been helpful in some cases to winning new business for Alliance...business that we'd not get if we were an independent firm. The behavior of the rest of the brokerage community confirms this. There's hardly a brokerage firm...Goldman Sachs and Salomon Brothers remain

notable exceptions...that's not in the investment management business. And Salomon seems to be edging into it. Alliance's origins began with DLJ's desire to be in this business, back in 1961. Let me review our history. ORIGINS OF THE FIRM

DLJ won its first investment management account in 1961, a triumph of salesmanship. The young management of Litton Industries was impressed by the young Bill Donaldson, Dan Lufkin, and Dick Jenrette. Miraculously, Litton is still a client. As you know, not every year has been "up" in the last 21! Moody's Investors Services, acquired in 1970, was merged with DLJ's money management division and a new corporate entity, Alliance Capital Management Corporation, was formed. DLJ brought a high-risk, equity-oriented, discretionary corporate pension account business to the new firm. Moody's was low-risk, bond-oriented and mostly managed non-discretionary public employee retirement funds. These strange bedfellows got along surprisingly welL It turned out to be a brilliant acquisition. Alliance's bond business, born out of Moody's, helped the firm greatly in the mid-70s when equity performance was mediocre and corporate clients suddenly wanted bonds and balanced accounts. Alliance was better equipped than many money managers to give the market the bonds and balanced accounts it wanted...never mind that these accounts would have been much better off sticking with all equities! Moody's also brought an unusual feature to Alliance: regional offices...in Los Angeles, San Francisco, and Chicago. Subsequently, other offices were opened: Boston... to recruit some particular people. Minneapolis...because a very talented person, Phil Von Blon, wanted to build the corporate business there, and the management of DLJI Alliance had the good sense to recognize his talents.

Exhibit I

1971

1976

1981

Revenues, $ millions

10"

9

30

Employees

137

126

181

Revenues per employee

$71,000

$70,000

$165,000

"Includes brokerage commissions

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Atlanta...a new business venture, much like Minneapolis, but unfortunately one that did not work out.

think, rivals Fayez Sarofim in Houston! Wish I could say that about all of our offices!

Cleveland...an acquired money management firm, with two very talented partners.

And finally, these entrepreneurial people who are attracted to a small office set-up tend to be very good salesmen.

And others, that I'll talk about later. MULTI-OFFICE FIRM NECESSITIES

There are, of course, some operating imperatives with a multi-office firm. First, good communications are a necessity. Communications for both investment decision-making and for running the business. A multi-office firm has to work especially hard at communications. Second, the regional office must be an investment office, not a sales office. For credibility with the clients, the regional office must be a small investment firm, nearly self-sustaining on a stand-alone basis. Third, people selection. People in regional offices must be entrepreneurial, selfstarting, and self-reliant. An advantage is that it's possible to attract the very high calibre person who absolutely refuses to live in New York City. And last, and perhaps most important, the compensation system must be profitrelated. People in the regional office must participate in the profits they themselves generate.

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Decentralization Projects Smallness I'll elaborate more on these points, but first, I want to talk about new business in a multi-office firm. As is well-known, big size is a terrible disadvantage in getting new business in our industry. But regional offices help Alliance "look small." Our office in Minneapolis can say, "True, Alliance manages $12 billion assets. But we in the Minneapolis office are five professionals managing only $900 million. We can be fast and flexible." A pension consultant can sell one of our offices as a "boutique," no small advantage given the mania for smallness. Obviously, being close to the customer, and potential customer, is an aid in marketing. Again using our Minneapolis office as an example, we have a market penetration in that area that, I

Importance of Internal Communication But no matter how good the people, internal communications are a problem for any investment organization. And the problem is compounded by the fact that some of the best investors are inarticulate about investing, and can't explain why they're doing what they're doing. As we all know, good investors act on instinct, and it's hard to explain an instinct. In a multi-office firm, promoting communications is one of the main tasks of management. Here's some of the things we do: • We publish a daily newspaper...an idea borrowed from Capital Research. • We hold a daily, hour-long morning phone conference for the entire staff. Our San Francisco people usually take the call in their homes. Our London office is just back from their typically British three-hour lunch. • Most of our investment meetings are by conference phone with all our offices...from our internal groups and committees to visits from broker analysts and corporate managements. • We print out and distribute our daily trading activity. • We have a quarterly, three-day meeting of all our staff, usually in New York, for discussion of investment issues. • We have a high-level professional whose job is "Research Communications." • We spend liberally for phones, DEX machines, overnight mail, airline tickets, hotel rooms, etc...we just don't question these costs. Profit-Based Compensation At the same time, though, we operate on the theory that the more profit centers the better, and that everyone's pay is linked to the profits of his profit

center. We want everyone to have maximum possible influence on his own financial destiny, and know how much he'll earn if his profit center performs at various levels of profits. This set-up is made convenient by Alliance's arrangement with its parent. All of Alliance, like all of DLJ's profit centers and subsidiaries, is on a "share of the profits" incentive compensation formula. We installed the Alliance system five years ago. The nay-sayers feared it would engender too much internal competition. But my thought was that it wouldn't hurt to have some internal competition for new business...that management can adjudicate some number of territorial disputes. But, fortunately, this competition doesn't show up in investing...our people are experienced enough, and mature enough, to know they need each other's help, and to know that to get help, you've got to give it. One more reason to cherish experience and maturity! Regional Office Closings A constant issue in a multi-office firm is the opening and closing of offices. One thing for sure: closings hurt. Employees' lives are disrupted, morale suffers. Closing implies failure, not exactly the headline you want the world to read in Pensions & Investments Age. And if you close in a town, don't plan on reopening soon. Credibility with the local people is obviously damaged. Shortly before I joined Alliance, two uneconomic offices were closed- Boston and Atlanta. Atlanta was the classic blunder...bad in conception, bad in implementation. We entered a territory already "overstored." We had no particular advantage: no existing "lighthouse" account in the territory, no outstanding, well-known hometown boy to run the office. We staffed the office with outlanders plus one just-hired Atlanta person. We really looked like carpet-baggers! And we were so treated! It hurt to suffer the negative PR that came with these office closings, and we lost aU the people in both offices, including some outstandingly good portfolio managers. But in truth, the firm was overstaffed at the

time, and our profitability was helped by the closings. We lost only one small account. The message on office openings is don't do it unless you're prepared to stick with it until it's successfuL Like generals say, don't fight a battle unless you're sure you're going to win. When Dan Forrestal knocked on our door two years ago, and said he wanted to open a Dallas office for us, our first consideration was how much money we were prepared to lose in starting-up in Dallas. We and Dan agreed we'd accept three years of red ink, but happily, Dan had us in the black in a year. I don't have to tell this group that our Dallas story took a strange twist...Dan got lured away by InterFirst. But we still love him...and we'd love to have him back! MDtTI-OFFICE FIRM INVESTING

Now I'll turn to investment decisionmaking in the multi-office firm. Entrepreneurial people are by definition independent-minded. So are good portfolio managers. So our decision-making is geared to giving portfolio managers relatively wide latitude on issue selection in their portfolios. Conversely,· we don't attempt much market timing. Imagine getting 33 portfolio managers in seven different offices to agree, swiftly, on major changes in the bond/equity ratio! So, our investment emphasis is on issue and sector selection. Exhibit II on page 52 shows the number and location of our portfolio managers. The Matrix Organization To bring policy structure to our operations, we employ what a management scientist calls a "matrix" organization. That is to say, each of our portfolio managers has a formal role in policy formulation or enforcement. Each portfolio manager staffs a functional group...stock selection, stock strategy, asset mix, etc...or has some collateral responsibility directly related to investment policy. He, therefore, is a policy formulator, a participant in defining strategy and policy. The idea is that if the manager influences policy, he's more likely to both adhere to it and aggressively implement it. This extra, collateral duty...such as being a member of the Stock Selection

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ExhibitU Portfolio Management Locations

52

Committee...also forces the portfolio manager into frequent communication with his peers, a positive benefit for all. Marketing Money Management I think marketing in money management is a much more challenging task than in the brokerage business. The portfolio managers are the best salesmen, because they've got the credibility. But they've got other things to do, such as managing the portfolios. And if that's not done well, you might as well forget about new business because a history of superior investment results is the foundation of successful marketing. So the balancing act is to do enough marketing, not using the portfolio managers, to get a steady flow of "live" prospects in for the portfolio manager to meet with, or present to, on a screened, selective basis. This requires raw selling...like cold calls...and also more subtle marketing methods. It's also necessary to do some of the "wrong" things. I'm reminded of the similarity of marketing oranges. Oranges are dyed orange, to make them prettier and more salable. The dye doesn't help the taste, and in fact many buyers of oranges would be offended if they knew what was going on. In our business, we have to dye our own oranges, to appease, or attract, the marketplace. For example, some pension consultants press for consistency of investment results between portfolio managers over short time periods...undue pressure for conformity obviously is harmful to long term investment results. Some pension consultants also want us to explain ourselves in standard corporate, hierarchal terms. A good investment organization is not hierarchal, and should be free-form...yet we have to produce- horrors of horrors-an organization chart periodically. The list goes on. Role of the CEO The Chief Executive Officer has an important role to play in marketing. The prospective client, understandably, wants to meet the man in charge. It's no accident that the CEO has the biggest airline bill. Let me give you an illustrative story. The University of Texas, a year ago, decided to hire outside managers for its Endowment Fund for the first time. Alli-

ance was asked to make a presentation to the Board of Regents at 2:00 P.M. on a certain day in, of all places, El Paso (the Regents rotate their meetings around the different campuses in the state). Being a native Texan, I knew that it was easier to get to SAMA in Riyadh than to the Texas campus in El Paso. A forever plane trip, taxi drivers who can't speak English and don't know the location of anyplace, burning sands and hot winds. But that's not where the Mid-East analogy ends. My associate and I arrive for our 2:00 P.M. appointment, and find three of our competitors...including Harold Erlich and Fayez Sarofim (for once Bob Kirby wasn'tthere) ...all arriving at the same time for the same 2:00 P.M. appointment. Confusion reigns, everyone waits, everybody missing his flight out (and you don't have many options or planes in El Paso) ...so, cancelled appointments the next day, lost sleep, anxiety, tension. That's the role of the CEO in marketing...being there, no matter where, or when. The Texas story had a real Mid-East finish...all four competitors got big chunks of money! Marketing Abroad. Now, a few words about international business. Americans in the money business have always found the lure of foreign markets, and foreign stocks, irresistible. We just love to spend time abroad; those long City lunches, replete with wine and port, are a great contrast to sandwich-at-the-desk Wall Street. And how things can drag on in, say, London. Another trip is necessary. We couldn't finalize, so we must go back. Meanwhile, they're coming here and we must entertain them. It goes on and on. I remarked to Bob Kirby (following a very expensive trip I'd made to Japan) that everywhere I turned in Tokyo I ran into someone from Capital Research. Bob said that Capital's main profit problem was that the employees preferred foreign travel to good financial results. I've learned what he meant. Alliance has embarked on a big international effort. We decided to go it alone, rather than create a joint venture with a foreign firm, because we didn't view the venture as having an attractive shortterm return. Rather, we thought it would take years to get established, so we might as well do it on our own. And, we didn't see the skills as special-we

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think we can learn foreign stock markets. So three years ago we opened a one-man London office to both get us into the business of investing internationally and to get foreign clients. A year ago we expanded that office to three people, and added a fourth "international man" in New York. And we've just added a fifth international man in Riyadh, and gritted our teeth, anticipating a flood of red ink. Believe me, we're not disappointed in that expectation...we're definitely meeting our budgeted losses! What will result from this? I'm convinced we'll help our investment results. More knowledge will help our U. S. investing. And I think foreign diversification can improve our portfolio results. We've gotten excellent investment results in the first year of operation of our pooled vehicle, Alliance International Fund.

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New business is still a question mark. I'm not sure we're much advantaged in marketing to the Mid-East by being in London-except that we'll market there more intensely. The real hope is the U. K.-European market. There are a few signs that the old school ties, and banking relations, are not holding as firm as they once did, and there's a gradually growing pressure for better investment results on pension assets. Pension consultants and performance measurers are moving in...in time, they'll make the market more performance-sensitive. This is the factor we're counting on, and there are a few encouraging signs. Meanwhile, we've been pleasantly surprised by winning some new business in other parts of the world. DIVERSIFYING INTO REAL ESTATE

Alliance is also attempting to diversify into other product areas. The most important of these is real estate. Contrary to our views on international investing, we did not think we could develop the needed expertise in-house. So we're attempting to joint-venture with an established real estate company. This has not been easy. First, our firm was divided on the issue. Conservatism says, "why do something we don't know anything about, when we're doing so well at our basic business?" And true, there are risks-particularly,

if it hurts the clients, it will hurt the firm. And it costs time and money - time taken away from the basic business. We suffered a defeat in the real estate field. We attempted, some two years ago, to take a publicly-owned real estate company private...by a staged, severalyear, programmed buy-out by a group of pension funds. The pension funds would have ended up owning a spread of high quality, fully rented office parks across the Sunbelt. A beautiful investment! Much more attractive, for a lot of reasons, then the traditional PRISA-Iook-alikes (and PRISA) that pension funds were hurtling into at the time. But we couldn't convince the marketplace. We were obviously "new" to the field, our deal was unique, unprecedented and complicated. Never mind that it was a terrific deal...that even in this horrible real estate recession, with hindsight the investment looks good. We hadn't done our market research...we designed a product for which there was no market! We built an SST! But logic and history argue for diversification, despite the risk of failure. If there's one thing that's certain, it's the

unpredictability of the future for any financial market. The answer to uncertainty is a hedged position. Furthermore, Alliance's diversification history has been outstandingly good. We were saved by the bond business in the mid-70s, and our venture into money market funds four years ago has not exactly been a financial disaster. We've gone into the business of managing separate accounts of venture capital pools. We're still intending to be in the real estate investment management business. We're on a long-term path of product diversification, trying to meet, or anticipate, changing needs of the asset management business. The present composition is shown in Exhibit III. MONITORING PRODUCT PRICING

At the same time, we're monitoring closely the pricing of our traditional businesses. It's said our business isn't fee sensitive. We can attest to that. Alliance has raised fees twice in four years, with a careful eye to positioning vis-

ExhibHHI Assets Under Management

55

a-vis the firms we define as our competition. True to predictions, we didn't lose an account. We think our industry's price structure is out of whack. The problem is not at the front end of the fee structure but instead at the tail end, or trailing, part of the structure where revenue per dollar of additional money managed drops off so steeply. There are costs to running more money. Both our price increases were greater on the trailing side than on the starting side. I'm surprised that there's so little fee increase activity in our business...or maybe I'm just unaware of what's going on. I think the marketplace is accepting the idea that higher fees are justified by better performance, and there are constant cost pressures in a peopleintensive business. INVESTING PUBLIC FUNDS

As you can see, public funds are important to us. They are a special Alliance problem and/or opportunity. The Moody's acquisition brought Alliance the largest market share in this field, and we think that's still the case today. The problems are well known. Low fees, political risks, and an inability to deliver the best product because of inefficient or archaic laws and restrictions that interfere with good investing.

S6

Our strategy has been, and continues to be, to stay in this business in the belief that it will change...and become more like the corporate pension business. There's still hope for a Public Funds ERISA, states' rights notwithstanding. And there are pressures within the local systems. In the past, investment performance could always be ignored-after all, taxes could be raised to pay the retiree. But awareness is growing that tax revenues aren't infinite. Madelon Talley and the New York State Pension Fund are a prime example of positive change. New York hired Madelon-a very competent and savvy investment person-to improve the Funds' performance. Madelon hired a group of new managers, paying competitive fees. And she started lobbying to change restrictive laws. Not surprisingly, the performance of the New York State Pension Funds has improved. This is becoming a less unique story.

Many public funds are under-funded. So asset growth via accelerated contributions may be especially fast. That, plus improving performance requirements and higher fees, offer the hope of a better business in the future. THE "BROKERAGE PROBLEM"

I'll finish my comments where I began...with the "brokerage problem." The world moves in cycles. In the 1960s, despite non-competitive commissions, there was ho problem being a broker and a money manager, and capturing commissions. In the mid-70s, a "reformist" SEC, ERISA, publicity about May Day, and the great stock market crash of 1974 combined to make brokerage and money management seem incompatible. As I said earlier, that's all changed now. For example, the new money managers hired by New York State last year were all broker-affiliated. Of course, these managers aren't capturing their own commissions on New York State transactions. But six years ago, that wouldn't have mattered-guilt was assumed by association. There's little doubt that being a broker, or being affiliated with one, has become respectable. With Sears Roebuck, American Express and Prudential Insurance paying multiples of book value for brokers, we no longer have to sit in the back of the bus. Would you rather have your money managed by a hard goods retailer or a financial conglomerate? My point: the question is irrelevant. Excellence can, and does, exist in many different places...and with enlightened management, need not have anything to do with the industry label of the owner.

QuestionlAnswer Session Highlights

PAUL F. MILLER, JR., C.F.A.

Question: What is "success" in investment management? How is it measured? Paul Miller: There are two ways to measure it. One is by the profitability of the enterprise; the other is by the quality of the product. The quality of the product determines the profitability of the enterprise in the long run. It does not necessarily determine it in the short run. There are people who let their product quality deteriorate, they grow much too rapidly, and that accounts for most of the deterioration. They go home rich, and the client suffers. As a profession, we have an obligation to maintain product quality in the same way that the surgeon does. My answer to this question, then, is that a firm is successful when it consistently produces a product of high quality and, therefore, grows in profitability over time. Question: Does "product quality" equate with "performance," with beating the S&P consistently? Paul Miller: Not necessarily. Product quality is achieving what the client wants. So, the client has something to say about whether you've produced the product he wants or not. He mayor may not see beating the S&P as what he wants from you as the product for him. Question: Please give your views on computers in investment management. Paul Miller: I've been sort of dragging my organization into the personal computer revolution, which I think is a very significant thing. My partners first thought that it was nothing more than a big calculator. Now they're finding it to be something very different-a way to extend their intellects. My desk is becoming paperless and much more efficient. Beyond that, the use of computers lends a whole new future to Modern Portfolio Theory in certain ways-different than we were brought to know in the last few years. The construction of samples, cohesive samples of stocks with high degrees of covariance that better represent economic sectors and industries than do traditional descriptive measures for reasons which only research can show-that whole kind of approach, it seems to me, is wide open for exploitation in the next few years.

Question: You spoke of the need to control growth. At what point does growth become a problem? Paul Miller: I think one's own personality has got to go into the answer, so please understand that there's a lot of my own personality in this answer. I'd much rather manage money than manage people. I think that most investment managers, when they get to managing people, find that it's very different and that they're frequently not very good at it. So, if you are going to control the number of people you have to manage you have to control the number of accounts. Say you have an average account size of $25 million, you have one person per account. And I don't mean one portfolio manager, I mean one person-counting computer people, secretaries, statisticians and alL I take it for granted that if we have 40 accounts, we'll have 40 people. That's one aspect of growth. The other is the markets you are dealing with. I have a bias in favor of medium- and smallsized capitalization companies. That puts another constraint on growth if you are looking to optimize performance. Question: You mentioned the importance of people with a knack for making money. Can you illustrate how they work? Paul Miller: It's in the interaction between them and others in the firm. The other people are not only there to support the money-maker-he can direct them, too. Economic research, the production of forecasts of the economy, is absolutely worthless for our business. Yet, there is more energy wasted on that subject in our industry than on any other that I know of. Same thing with the money supply figures. Yet, there are people in our industry who just can't wait to get the new number. Worthless. My own experience is that the moneymakers know this. They also know that there are ways to look at economic developments and make money out of them. They identify the dominant economic characteristics that are going to shape the financial markets. This past year, the dominant theme was disinflation. That's an overworked word on Wall Street now, but that's aU you had to know, or had to see ahead of time, to make money over the past year. You just had to see that disinflation would produce lower interest rates at

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some point. The money-maker both feeds out to and takes in from the group in such a way that his productivity is leveraged. The sense of relativities is very, very important, the sense of what is important and what isn't. Question: With the accounts to manage, the selling to do, clients to talk with, etc., how did you manage to introduce the computer to your firm? Paul Miller: I hired a relative into our business one time, a nice kid, and I said I would know that he was going to go somewhere in this industry when he turned to the financial page before he turned to the sports section. He never did, and he's not in the business any more. There are people who have a huge dedication to this business, it's everything to them - they eat it, breathe it, and sleep it. Every time I see one of my partners start jogging, I worry - because I think this business requires every ounce of energy you have. I don't mean that I don't have fun-I do, but a lot of my fun is just the business and I've had a lot of fun with the computer. I can't give you a better answer than that. You can do it. Anybody can go out and conquer Visi-calc in six hours. That's all it takes, but you've got to do it-it's already very important. DANIEL}. FORRESTAL, III, C.F.A.

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Question: Granted that success in investment management requires "something else" besides investment skills and resources, what are the two or three managerial things you see as being most important? Dan Forrestal: First, an appreciation of conceptual skills; that is, being adept at backing away from the day-to-day environment and having time hanging a little heavy on our hands as managers, and really trying to perceive just what we want to do. Second, an emphasis on procedural skills. We begin by the foundation of an investment style or philosophy-a tremendous buffer against this external noise that confronts us daily-and then think out how we are going to operate, working hard to be creative and to "stay small." And, finally" I think that this matter of leanness and of leveraging the productivity of good people is extremely important.

Question: What have been the key aspects of your own effort to be creative and "stay small"? Dan Forrestal: While we are very committed to quality research, we're very uncommitted to the "Research Department" business where a group of 8 or 10 analysts, each of whom is an expert on an eighth or tenth of the world, feeds ideas through a committee-or several committees-to portfolio managers. Our organization is portfolio-management dominated; good analysts can thrive in such an environment-we call it equity planning and strategy-and the analyst is part of a project team, not an industry person. They aren't in the stockfollowing business, they're in the money-making business. So, a different orientation toward security analysis and toward analysts is one means. Second, we do owe the client the best product of the firm, as opposed to the product of different individuals. The key to this, to blending structure and creativity, for us is by creating several key strategies around a central philosophy, and asking for a uniform compliance to these strategies by all our portfolio managers. But, the individual stock selections and timing are very much the product of the individual managers. We are very wary of committees and fight the committee orientation ruthlessly. Third is the communications process, where the key element is a tremendous emphasis on involvement and participation. We try to make it very easy for our professionals to exchange information, to listen to each other, and to put that wispy, faintly-glimmering idea or belief on the table. We might not agree with it, but we sure want to hear it and maybe be stimulated by it. We don't buy the notion that the best ideas or creativity flow from the senior people in the organization. We meet every morning, we forget title, we forget seniority, and we just exchange information. There's no agenda, no time-frame. We deal with what went on yesterday, what we as an organization want to do today, what experiences we've picked up in the last 24 hours, and so forth. It's a very responsive, informal kind of process where the informality definitely spurs the creativity.

Question: Your job includes both investment and business management responsibilities. How do you think of yourself in this dual role? Dan Forrestal: I think my primary job is two-fold. First, to put forth an organizational philosophy, an investment philosophy, and continuously reinforce that philosophy. When the market gets frenetic people have a tendency to wander, to over-manage, to deviate. They are wellintentioned, they know what is written in our brochures, but they have normal human reactions to uncertainty. My job is to make sure that we maintain a permanent long-term perspective, that we do what we say we do. Second, my job is to see that the bureaucracy stops with me, by providing a buffer from the outside so that the professionals can devote their entire energies to their own jobs. You have to work at that, you have to do it as a deliberate managerial action. It takes you away from the investment process but you should plan for that, and plan around it, see it coming. I think that the investment process can be delegated if you do both of the things I mentioned as being included in my primary job. HAROLD L ARBIT

Question: The kind of "insight process" you have talked about takes a lot of time, but markets won't necessarily wait for you. How do you rationalize these two things? What about performance? Hal Arbit: We've come to grips with this by the way we've defined our product: as a satellite manager that's designed to work around a core. We don't provide any diversification for the client, and we're coming up with, typically, only 3 or 4 ideas in the portfolio. These ideas generally have a life of 3 years or so. The client knows what our ideas are, what the timing on them is, and he's willing to wait. We've tried to get away from "performance" as a focus. We actually tell the clients what the signposts are that would indicate that an idea was working out. If the clients see some of those things happening in the short- or intermediate-term then, regardless of interim "performance", they have something that they can get their hands on, something that permits them to wait for the idea to mature.

Question: With creative people in the organization, do you have to operate differently? Hal Arbit: The people who come up with the ideas, the creative ideas, usually don't want to do the work that's required to follow up on them. The analytical person, on the other hand, doesn't want to be bothered by all those ideas that might or might not be relevant-they want to take an idea and see how it can be used. What we do is make up teams of different people where the people who come up with the creative ideas are not the same people who take those ideas and follow them through to fruition or application. By pairing the people, the work gets done. What we've found is that we have lots more good ideas than we have capacity to use. Question: You say you have regular meetings - brainstorming sessions - to generate ideas. Don't the creative people resent this, maybe feel that they are wasting time doing this somewhat formal process to end up with what they could produce without techniques? Hal Arbit: Actually, I think it's a myth that creative people are just automatically creative. Anyway, they love these brainstorming sessions where nothing "productive" is expected of them. It's the very bottom-line, investmentoriented people who pick stocks that are sitting there saying, "Boy, it's been an hour and we don't have an investment idea yet-let's speed this thing up." So, the problem we've had is the opposite-it's not the creative people who get frustrated! Question: How do you follow up on an idea? How do you pick the stocks you want to own to implement an idea? Hal Arbit: We might come up with a trend, for example. The trend has implications. These are researched. When the research is done - and this can take a very long time-and the team has convinced itself that their insight is a moneymaker, they have to take it to the one committee we have and convince the committee that the market hasn't already seen and incorporated the insight they think they have. It's pretty easy to get to the actual stocks to buy after you've got the insight. We define the universe of all stocks that will benefit from this insight, and there

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might be 40 or 400. Then we employ negative screens to get rid of those where some other event or events are going to swamp the characteristic that lets the stock respond to the insight. Typically, we aren't that concerned about the individual issues as long as we feel that the sub-group of stocks we've selected, based partly on liquidity and partly on the negative screen, is representative of all the important characteristics of the major universe. So, it's more of a sampling technique than in-depth, individual stock analysis. Question: Do you use Wall Street information or do you have different sources?

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Hal Arbit: We don't look at much from Wall Street, except to get some understanding of what the consensus is thinking in order to document whether we are really thinking something different. I don't know if you have ever heard of the Tarrytown Group, or The Futurist, or American Demography-there are lots of very provocative idea-generating periodicals that have nothing to do with investments. We spend a lot of time on these. One of our quota systems is that each person has to come up with 30 "variables" each month from their reading, and mostly they don't get these by reading Wall Street output. A "variable" is just some interesting thing that pops up-like half of the in-ground swimming pools in this country were built by doctors. Who knows what the investment implication is, if any? It's just an interesting variable tidbit. Question: What happens when you develop an idea that seems better than the ones you already own in the portfolio? Hal Arbit: With ideas, it's "king of the hill." If we like a new one a lot better than an existing one in the portfolio, there's no justification for not kicking an old one out. Also, we don't want all ideas to mature at the same time, so if we see one that might mature, say, in 2 years instead of 4 or 5, we might just add it in. The committee decides whether or not to include it and what weight to give it. Question: Suppose a firm just manages growth stocks - can they use the creative-person idea? Hal Arbit: Sure. You want to improve your insight, relative to other growth

stock managers. You have probably always looked at growth stocks in a certain way. Creative people can help you see them in new ways that would be helpful. Just their ability to stimulate the other people, their ability to spark ideas, is worth it whether or not they generate specific growth stock names. Question: Suppose you are in an organization where the people are not as creative as you would like. How do you get them to improve their creativity? Hal Arijit: I have very rarely found a person that was as uncreative as I initially thought he was. Most people have much greater capacity to be creative and insightful than you might think. The people who help the think-tanks develop the creativity of their people tell me there are techniques you can use to make people who aren't "geniuses" much more creative than they are now. Maybe 70% of the people you might label as "uncreative" can be helped. Part of it is structuring the process, like Intel did, to be sure that whatever people they had were forced to spend a lot of their time being creative. For whatever reasons, it's very easy for us in the investment business to focus on the analytical and say, "Well, since we can't see any immediate application of creativity, we'll just ignore it for now." The definition of creativity is almost that there isn't a clear, direct application. So, unless you as a manager are willing to create an environment where creativity is encouraged, even without advance knowledge of its form or substance, you shouldn't write any of your people off for appearing to be "uncreative." Question: You have outlined a number or techniques to foster creativity or to stimulate it in your meetings. Do you find that the process becomes selfstarting and self-sustaining through repetition? Hal Arbit: We haven't been able to make it so. It's an effort every time we do it, and we've been doing it rather intensively for the past two years. The reason is that we have two of these sessions a week, of about two hours each - but the other 50 hours are spent doing normal things, going back to the normal patterns of behavior. So, it's constantly necessary to reinforce this effort at creativity and make it worthwhile for people to contribute to it. Part of our

peoples' performance appraisal and their bonus comes from the ideas they generate. After a while, it comes easier than it did at first.

J. RICHARD BOYLAN Question: Was the morale of your Trust Department staff adversely affected by formation of your new subsidiaries and the possibility of outside hiring? Dick Boylan: Somewhat to my surprise, it was not. I think the reason is that long-time Trust Department professionals thoroughly enjoy the varied challenges of their normal work assignments and are contented with them. We encouraged them to apply if they wished to join a new team. About the only threatening thing that was connected with that was that if you made the team-it was a one-way trip-you couldn't return to the Trust organization later. Question: How are the people chosen to be in one rather than in another of your various activities, and how are they paid? Dick Boylan: Since the essence of managing a money market fund is, "Don't make your first mistake," the people we want there are careful, riskavoiding types. This group differs greatly from the type of folks at Provident Capital Management, who tend to have a free-wheeling, entrepreneurial style. Very few of these would put up with the degree of supervision and discipline that is basic to the money market fund process, so the people kind of choose themselves for one activity or another. As far as pay is concerned, we simply accept the fact that life is not always fair; it is a fact of the marketplace that there are discrete and disparate pay structures in the various types of businesses, so you pay the scale that the market requires. DAVB H. WILLIAMS, C.F.A.

Question: What are the special challenges of managing marketing people? Dave WiHiams: Our situation is different than most, I imagine, since our branch office people tend to be broadinterest, self-starters who are sales oriented and more or less manage themselves in the marketing role. So our

problem is more the general problem of managing entrepreneurial types. One can see a clear problem, however, sort of a "class clash," where-as in most investment organizations-the portfolio person is king, is courted, loved and made wealthy while everyone else is looked at as support for the investment function. My personal feeling is that the answer for the marketers is to overpay them, since that is their only incentive. Question: Please comment on how you structure and manage your investment process. Dave WiHiams: The most important element of management is communications, in any way one can stimulate it, to make sure that the professional staff is talking (and listening) to itself. The informal workings, the informal organization, of an investment organization is what determines whether or not the process works. The formal structure and the formal roles should mirror the way the organization works informally. Such informal structures are unique and special to the set of people involved. Mechanically, we have a Research Department and a Portfolio Management staff; all are charged with generating new ideas and all do. We also have these policy-forming groups like everybody else does. Because they are spontaneous, based on instinct and informal-that is why questions like the one you have asked are always impossible to fill out on a questionnaire. Question: While your process may be spontaneous and hard to write down in two sentences for the consultants' questionnaires, isn't it really something that the management of Alliance works at as part of its managerial role? An environment in which spontaneity can occur and recur would seem to be no accident. Isn't it something you work at? Dave Williams: Yes, we certainly do work at it. We acknowledge that our investment style is one of risk-taking, with high turnover and frequent changes ofnames in the portfolios, and one with great flexibility in terms of the types of stocks we'll invest in. So, part of the role of management is to encourage portfolio managers and analysts to act on their instincts, to make decisions before all of the information and data is known, to COme to conclusions swiftly,

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and to implement these conclusions swiftly. This type of behavior is praised and rewarded by management to make sure that it is seen as the model of how the professional staff should behave. Question: To what extent do you use Wall Street research as a supplement to our own Research Department? Dave Williams: We are very heavy users of Street research. We are a huge commission generator and deal with about 200 brokerage firms world-wide. We deliberately deal with a lot, want to deal with a lot, want a lot of information flow. We emphasize regional firms, and of course we've got the manpower that's capable of absorbing the information flow that this heavy involvement generates. Another aspect of our organization is that we don't specialize much in research; less than half of our 10person research staff does industry work and all of our staff are very used to working with the Street. We try very hard not to re-invent the wheel in our internal research. So, reliance on the Street is a big part of how we generate our investment ideas. Question: Please comment on the "matrix management" method you employ. What is the theory behind it and how do you control it?

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Dave Williams: Matrix Management is a name that came out of work at TRW about 15-20 years ago. People who had a very specialized job were given another responsibility that was related to their speciality but different from it. The idea was to try to tap intelligence, broaden horizons for the individual involved and, very importantly, to create communications between different segments of the organization that might not otherwise be interacting. We use this concept by having each portfolio manager have a position on one of our functional committees or groups or, if he is not on one of those, then he's our person in charge of monitoring technical analysis, or monitoring valuation analysis, or something else like that. The control aspect is really not difficult at all because these functional groups, be they stock selection or asset mix or whatever, are continuously deliberating, testing present standards or asking if guidelines should be changed. Since the functions are broken down into small groups with particular people involved in discrete sets of activities, control is not a problem.