The New Business Reality

With all the shock and uncertainty of September 11, it seems clear that on that morning there were very few, if any, corporate business plans that took into account the possibility of flying suicide bombers and the collapse of the World Trade Center.

In the weeks after the terrorist attacks, Wharton faculty began to meet and share ideas about what effect those events would have on business and the economy. As they talked, however, it became clear that even before September 11, major changes were underway that would alter the business landscape.

The U.S. economy was in recession, consumer spending behavior was confusing, financial markets were in flux following the collapse of the technology bubble and the global economy was fragile. “All of this has created a chaotic, uncertain new business environment,” said Wharton marketing professor Jerry Wind, who led the symposium with Robert E. Mittelstaedt, Jr. vice dean of executive education.

To help understand all that is going on, Wharton’s Aresty Institute of Executive Education held a three-day symposium in December called Wharton on the New Business Reality: Scenarios and Strategies for the Future. The symposium was designed to give executives a better sense of the new realities and to develop business plans that will help their companies not only survive in the current environment but grow as well.

Speakers at the symposium fell into two broad categories: those who described the new realities and forecast scenarios for the future, and others who offered advice on scenario planning and strategies to manage employees, fend off competitors and find new opportunities in unpredictable times.

Included in the lineup were Wharton professors of finance, information management, marketing, human resources, insurance, management and legal studies. Participants also heard from Victor Fung, chairman of Li & Fung Group, a Hong Kong trading company; Amir Barnea, dean of Israel’s Arison School of Business; Aharon Kacharginsky, head of the corporate banking division of the Israel Discount Bank; Israel Borowitz, chief executive of Arkia Airlines; a former chief technology officer at Citicorp and two Israeli apparel manufacturers.

“In the market there will be winners and losers; it’s the law of the jungle,” said Mittelstaedt. “Ultimately that’s what we’re trying to understand.” Companies, he noted, cannot afford to stand still until the uncertainty subsides or they will be overtaken by the competition. But the increased risk requires an even more careful approach to planning and disciplined, yet flexible, strategies.

There is, however, an upside. “Wealth is created during periods of uncertainty,” said Wind. “This is the time to take advantage of opportunities.”

A Country Caught By Surprise

Ian Lustick, a political science professor at the University of Pennsylvania and an expert on the Middle East, began the symposium with a geopolitical overview of U.S. foreign policy and the Middle East and an examination of how surprise is processed and converted to policy.

First, he discussed the notion that the world changed on September 11. Lustick pointed out that in 1993, during the first attack on the World Trade Center, a truck bomb was intended to set off a cloud of cyanide gas and kill thousands. But the terrorists made a miscalculation and the intense heat of the car bomb incinerated the cyanide before it could do any harm. The intent, said Lustik, was the same as on September 11. “It was only an accident that September 11 didn’t happen eight years ago. Yet the feeling is the world changed only this year.”

One result of the attacks has been an end to the American people’s ignorance of the anger some areas of the world feel against the United States and the extent to which global networks have developed out of that anger.

Lustick also discussed the nature of unintended consequences, which can frequently alter policy, particularly when the United States is involved. “For the U.S., as the largest player in the global environment, unintended consequences are magnified,” he said.

Some of the issues that Americans must come to terms with include the rise of global terror networks and how they come into play with an open society; poverty that has spawned Islamic fundamentalism, and past U.S. foreign-policy blunders that fed anger in the Muslim world.

“You put those things together and we suddenly realize, ‘My God, what is going on there? We are missing something,’” he said. “We may not be informed, but at least we now know we don’t know something. There is some big thing about the world that produced all these people willing to kill themselves just to hurt us.”

According to Lustick, Americans were caught by surprise by the anger, in part because most international news is absorbed in short television reports showing extreme behavior. On the television screen, it all seems very far away. “On 9/11 we learned we’re part of that world, in the same completely crazy, drastic and arbitrary ways it hits other countries.”

The attacks on September 11 and the subsequent global war on terrorism will have massive political implications, he added. “We are the 600-pound gorilla in this spider web. When we throw our weight around it has a disproportionate impact that ripples out and comes back to hit us.”

The main danger, he said, is not the task the U.S. is trying to accomplish, but its unintended consequences. He went back in history to the 1950s when the United States supported the return of the Shah of Iran over a democratically elected government that was about to nationalize oil. Hatred of the Shah, however, spawned Khomeini and the Iranian Islamic movement, he said.

The Taliban, he pointed out, grew out of U.S. support for anti-Soviet forces in Afghanistan in the 1980s. Osama bin Laden’s rage was in response to U.S. behavior in Saudi Arabia after the Gulf War against Saddam Hussein. “One has to stop and wonder, ‘What’s going to be the unintended consequence of the U.S. war in Afghanistan?’”

Problems abroad stem from the nation’s Madisonian political structure, said Lustick. In this system, everyone has a vote and power is splintered. In a conflict, the view with the most passionate, powerful or richest supporters prevails. When it comes to foreign policy, however, this system breaks down because many of those affected have no vote or no role in the decision. Vast American power has no counteracting force overseas. “Then, because we don’t feel the costs, we don’t get the information. We don’t get any feedback until 20 years later.”

Add to that the targeted political support within the United States for Israel, and foreign policy becomes more out of touch. “This has led to untenable positions throughout the Middle East,” where the U.S. condones a democracy-free zone in the Middle East and has come to be linked with the “hypocrisy and corruption” of some regimes in that region, Lustick said.

Another issue in U.S. reaction to the attacks is what he called the “fear factor.” People tend to associate with something they have experienced, Lustick noted. For millions of Americans who repeatedly viewed the terrorist attacks on television it was similar to actually being there. In a situation like that, negativity dominates. “It’s like it happened to you. So the World Trade Center or anthrax are set-ups to leave aside logic and [disregard] clear probability estimates.”

It’s Still Stocks for the Long Run

Wharton finance professor Jeremy J. Siegel, author of Stocks for the Long Run, said he remains optimistic about financial markets long-term, partly because of recent pessimism. “I get really worried when everyone is optimistic. When a lot of people are pessimistic, that marks a good opportunity in the market.”

He has compiled a pessimism index that indicates sentiment is moderately to highly optimistic, which he suggested is due at least in part to the rapid military success in Afghanistan. “People are getting very bullish again,” he said.

According to Siegel, research indicates there is reason to be optimistic about bear markets: They are good for long-term investors because during down periods companies tend to reinvest dividends and buy back outstanding shares. That increases a shareholder’s relative stake in the company, making the investment grow faster when stock prices rise again. Preliminary data, he added, suggests the long-term rate of return would be a percentage point lower if not for bear markets.

Siegel looked back into history for other insights into the current market. Total real returns over long periods were strikingly consistent at around 6.9%, while the average for long-term government bonds is 3.5%. Subtract the tech sector, he said, and the market has not done as poorly in the past two years as investors feel that it has. “The bubble was a tech bubble,” he said. “It was not a general market bubble by any means.”

One striking difference between the current downturn and others is that there is not much physical capital involved compared to the 1990-1991 recession that was induced by overbuilding in the real estate industry. While people who quit jobs to follow the tech boom are now scrambling, he said, they can be re-deployed: “That’s better than a building that stands empty for 10 years.”

The historic price-to-earnings ratio of 14.5% may be too low because of structural changes in the economy. His research indicates the correct value for today’s economy is in the low 20s.

Siegel pointed out that boom and bust production cycles have narrowed dramatically and policymakers have learned the importance of taming inflation, a driver of economic problems in the past. “Our cycles are just much less intense.” In addition, capital gains taxes are at an effective 60-year low, in part because of weak inflation and government policy. The government is unlikely to raise this tax because stocks are now so widely held that there would be strong political resistance.

Also, Siegel said, valuations have been permanently changed by companies passing along fewer taxable dividends and instead reinvesting in the company, or buying back shares. This allows shareholders to treat the subsequent gains as capital gains, not income, which is taxed at a higher rate. Shareholders also like the shift toward capital gains taxes because they can decide when to incur the tax.

In addition, lower transaction costs for stock trades are altering valuations. Increasingly liquid markets are taking out some of the risk and investors will be willing to pay an additional premium for that. However, he warned, this also dampens upside potential.

Siegel said he does not factor in productivity gains because they do not endure over the long term. “If you go through history, periods of technological change fall to the bottom line of corporations initially. But competition drives those margins down quickly and they turn into lower prices.”

As for global markets, he said international indices show there is less of a gap between the financial performance of countries even as the correlation of 10 industry sectors on a global basis is going down, indicating strong differences in the capability of industries in different countries. “What that means is forget about country diversity and do sector diversity. Pick the best firms in the sector wherever it is they are head-quartered.”

The current recession could end in February, Siegel suggested, noting that there is typically about five months between the trough in the stock market and the bottom of the business cycle. The February forecast would also coincide with the typical 11-month duration of post-war recessions.

But he cautioned that the end of the recession does not mean an instant boom. The market has already climbed since September. So with current earnings trending at $50 a share and a P/E ratio of 20 the S&P should be around 1100. “That’s about where we are,” said Siegel. “So it’s not an overpriced market, but it’s not cheap.”

He suggested investors might find it easier to beat the S&P 500 index in the future. While he still thinks index funds are good for investors, the rise of these funds have increased the price of companies that are included in the index funds because so many institutions are now required to own those stocks. “If they’re going to be overpriced I don’t want them,” he commented.

Finally, Siegel said that while he still expects stocks to outperform other investments over the long haul, the average annual increases will slip from 6.9% recorded for the period from 1802 to March 2001, to a range of 5-7%. “If there’s less of a risk premium in the market, then you’re not going to get those kinds of returns. The big gains,” he said, “have already been made.”

Hold the Tax Cuts

Richard Curtin, director of the Survey Research Center at the University of Michigan, told participants in the program that businesses, not consumers, hold the key to restoring economic growth.

Curtin said the University’s consumer-sentiment index had already dropped from 91.5 in August to 83.6 in September before the attacks. In the third week of September it bounced back to 88.3 as consumers said they were determined to defy the terrorists. But by the fourth week it fell to 72.2. “A 20-point decline gets me very worried,” said Curtin, who added that the entire range of the 50-year-old index is 50 points.

Consumers are more concerned about unemployment than the actual level of joblessness would imply, Curtin indicated. In October, the index reflected the same amount of anxiety over a 5.4% rate of unemployment as it did when unemployment stood at 10.7% in 1982. He pointed to demographics for an explanation: “An older workforce is more concerned about losing their jobs.”

Aside from unemployment, Curtin said consumers are optimistic about other parts of the economy, particularly inflation and interest rates, and they do not predict the economy will experience widespread deflation. Consumer expectations of real income growth are strong and increases in savings are likely to offset the drop in stock-market wealth. “The wealth effect is declining,” he said, “but it’s hardly disappearing.”

People were just as concerned about their jobs and income before the attacks, Curtin indicated, but the survey reflects that they now view their concerns as stemming from the terrorists’ actions. In fact, when consumers were asked if additional tax cuts would help, the response was ‘no.’ “This was a rather large surprise,” said Curtin.

Although government and businesses make up only a third of the total economy, he added, they hold more sway right now than consumers. “The question is how long will businesses wait before they make the right type of investment.”

Curtin forecast a slow-growth scenario that will last several years. GDP should bottom out in the first quarter, but will not turn up until business investment resumes. “That’s the key. When business investment turns around then we’ll see an improving economy,” he said, adding however, “I must admit I’m becoming more pessimistic about” that happening.

The High Costs of Managing Risk

The terrorist attacks and economic uncertainty have put a whole new emphasis on managing risk, from insurance to protection of data transmission to maintaining the ability to keep financial markets functioning in a crisis.

According to Wharton insurance professor Olivia Mitchell, executive director of the Pension Research Council, the first concern is protecting human assets. She pointed out that 60% of U.S. GDP comes from labor output. In the immediate crisis, she said, companies have responded with quick solutions such as hiring security guards or having employees carry airline tickets in case they need to flee a country quickly. “Security has crunched down across the board.”

In the medium-term, she added, companies should put systems in place to protect workplace security. These systems should include managers from all parts of the company to assure buy-in and should also come with backup systems.

Over the long term – and reflecting a trend that was evident before September 11 – employer-sponsored health insurance plans face sharp premium increases, with self-insured plans in the most trouble, Mitchell said. However, with renewed interest in life insurance, companies could make this a more important part of benefit packages for employee recruitment or retention.

Meanwhile, defined-benefit pension programs are suffering from funding problems and low interest rates. The drop in the stock market has hurt 401k plans and employers are cutting back on the amount they will match, she said, adding that other non-core benefits, such as sabbaticals, will also suffer.

Mitchell predicted there will be a push to bring government in to help with extended unemployment benefits or Medicaid coverage for those thrown out of work by September 11 or the underlying recession. “The problem is the government doesn’t have any money either.”

She said companies will become more involved in government policy affecting health and pension benefits. In addition, companies will increasingly hire outsourcing firms to manage benefit plans that are becoming too complex to do well in-house.

Program participants also heard from Wharton insurance professor Neil Doherty, who said the industry has not taken as great a hit as might be expected after September 11. The commercial insurance segment, he pointed out, is the hardest hit of the industry with losses from the terrorist attacks likely to reach $40-$70 billion and perhaps much higher, depending on whether courts award huge damages.

The industry, Doherty added, has under-performed for much of the past decade and prices were just beginning to rise prior to the attacks. In order to pay out the massive claims, the industry will now need to raise premiums dramatically. “It’s simple economics,” he said. “You can’t squeeze blood out of this stone.” In addition, premium prices are rising 50-100%.

Coverage for terrorism is difficult, according to Doherty, because reinsurance firms are not required to provide it. He said, however, that the global nature of reinsurance firms may spread the costs of terrorism around the world. In addition, insurers may be able to find creative financing and innovative capital structures to offload risk. Following Hurricane Andrew, for example, some companies were able to securitize the risk.

Doherty said he expects changes in the structure of the industry with continued concentration of the largest players. And rapid price increases could lead to a new political push for tort reform, he added, though he does not believe significant reforms are likely.

Technology Under Attack

The new business and security realities also have implications for information technology, according to speakers at the program. Colin Crook, former chief technology officer at Citicorp, expects continued pressure on spending for information technology as businesses now question whether technology has generated gains from 1995 to 2000. “There was a perception by a lot of people in business and technology that we were finally beginning to see the pay off from 30 to 35 years of information technology investment,” said Crook.

However, he pointed out, research is beginning to indicate that productivity gains in recent years may not have been as strong as previously thought. “A lot of businesses have come back and questioned the underlying validity and integrity of IT investments.”

He said much of the business investment in technology has been for generic products, such as desktop computers, rather than for focused technologies with the potential to add value to businesses.

Crook predicted the terrorist attacks will encourage more attention to security and a greater concern over the concentration of data in large servers. Customers these days also want to have more control over their information and communication systems. “Three or four years ago in business and the Internet the big issue was anonymity. Now I think [attention will be focused] on authentication.”

According to David Farber, Penn professor of telecommunications, the nation’s technology networks held up well after the terrorists attacks, in part, because of investing to head off Y2K problems. But he also raised the chilling possibility of a cyber attack that would knock out computer networks even as a physical attack was taking place. “So how good is our communications system?” he asked. “Unfortunately it’s not very good.”

He said economic concerns have led carriers to bundle equipment together, creating greater security risk. In addition, communications networks are not designed to be secure, the Internet itself was designed to be accessible, and the nation’s telephone infrastructure is fragile. “We know how to build security systems. The problem is they are costly. I think all we can do now is patch.”

Going forward, Farber predicted that major technology changes will be designed with security in mind. But he warned that if business does not pay for security in the nation’s communications networks, the government will require it. “Unless the private sector comes through with a real initiative, it’s going to be demanded by government … and it’s going to burdensome and slow.”

Ravi Aron, professor of Operations and Information management, said companies trying to make investment decisions about how to protect their data should be aware that recapturing initial transactions is the most critical part of the process. Data massaged for decision-makers, he said, is easier to replicate.

He recounted how a large bank once suffered a six-hour loss of data when communication between Singapore and Malaysia was cut. It took a year to reconstruct the information lost in that period of time.

Protection of the national hardware and telecom infrastructure needs to be done jointly by the private sector and government. “Since that network is a public good it will be under-invested in,” he said. And there is no good way to pin down the cost of necessary upgrades: “If you kill one demon another one pops up.”

When deciding whether to keep data protection in-house or outsource it, Aron said companies’ main concern should be cost. If they do outsource, companies should be aware of too much geographic concentration in data services. He described a single building in India that is a critical center for a bank’s corporate customer service.

Many companies, fearful of being overly concentrated by keeping data in-house, outsource the work without knowing that the data management equipment is highly concentrated: To do that, he said, “is to go from the frying pan into the fire.”

Financial Planning Takes On New Meaning

One important consequence of the terrorist attacks, said Wharton finance professor Franklin Allen, is that they revealed successful and unsuccessful strategies in dealing with financial services during an emergency.

“The attacks were in lower Manhattan which is the heart of the U.S. financial industry,” Allen said. The geographic proximity of the industry, in some ways, delayed its need to adopt new technologies as fast as might have been expected. “One of the most interesting aspects of 9/11 is it will potentially provide a catalyst to speed up a lot of those changes. The one communication method that seemed to be relatively robust in this sequence of events was the Internet.”

He said there are lessons to be learned in how different companies had prepared for the possibility of an attack. Morgan Stanley, for example, had started planning during the 1991 Gulf War, developing protocols for evacuation and alternate mirror sites, including a major center in Dallas. That center was handling much of the company’s business within an hour after the planes hit the World Trade Center. “Although it is extremely costly to have mirror sites,” he said, “when they’re needed, they’re absolutely critical.”

Ineffective planning at the Bank of New York left it unable to locate many of its employees and struggling to buy 4,000 cell phones in New York on the day of the attacks. The Federal Reserve helped with additional liquidity: “If that hadn’t happened there was systemic risk as a result of the Bank of New York’s poor planning.”

Allen raised the possibility of other shocks to the financial system, such as a suitcase nuclear device going off in midtown Manhattan or a widespread Anthrax attack through the mail that would disrupt the movement of checks to pay bills. “If we do have a shutdown in the payment system there are enormous ramifications.”

He also pointed out that using checks is expensive and the U.S. is more dependent on them than any other part of the world. Approximately 87% of transactions in Japan and 59% in Europe are done through an automated-clearinghouse. Allen also questioned whether the New York Stock Exchange needs to be a physical place. The Nasdaq is not, he pointed out, adding, however, that he recognizes the strong cultural forces that would make it difficult to break up the exchange.

Meanwhile, Allen said, the foreign-exchange markets have moved increasingly onto the Internet, but the bond market has not. Foreign-exchange portals have been established and half of foreign exchange sales are now done electronically, up from between 20% and 30% in 1998.

The bond market, however, has been resistant to improvement and remains dominated by brokers using telephones. A vacuum in the market created by the devastating loss of life on September 11 at the trading firm Cantor Fitzgerald could be a catalyst for change, Allen said, but predicted it would take another decade.

Developing Global Markets

The global economy will also undergo changes in the post-September 11 world, although it’s not exactly clear what those changes will be. Stephen J. Kobrin, a professor of multinational management at Wharton, said the world’s economy is too integrated now to return to isolation. However, the degree to which it grows could be at risk, depending on how policy makers move forward. “The real danger is not the end of globalization,” he said, “but that we screw it up badly.”

Kobrin described an earlier age of globalization – from 1870 to 1914 – that receded, then crashed, in the 1930s with a rise of protectionism.

Global markets, Kobrin pointed out, are different now, largely because of the internationalization of production. It is not so much the wholesale trading of goods and services that has increased, but trade among nations by multinational firms. Between 30% and 50% of cross-border business is made up of multinationals shipping components from one subsidiary to another.

Kobrin also said integration of the financial markets, and the information revolution that has impacted social and economic systems, will prevent the demise of global trade. The scale and complexity of today’s technology make it nearly impossible for a company to compete in a single national market. Kobrin pointed to pharmaceuticals, aerospace, defense and telecommunications as industries that need to amass global research to develop new products.

In the short-term, he said, countries might retrench from globalization, throwing up barriers to trade and other protections. However, he added, the cost of that, in prices, availability of goods and lost jobs, would be greater than most societies would be willing to accept. “I don’t think [that retrenchment] would last very long. The costs are just too high.”

But clearly, Kobrin noted, there has been some fallout from the September 11 attacks. Disruption in the flow of goods, people, information, technology and capital following those events and the subsequent U.S. war on terrorism has resulted in, and will continue to result in, a drag on global economic growth. Kobrin, however, described the magnitude of the drag as “sand in the gears” of the global economy.

The 1990s, he said, were unusual because after the end of the Cold War, business and economic concerns took the lead role on the world stage. Now, he said, geopolitics will have a greater impact on firms as they may increasingly face political constraints such as sanctions. “We’re in a world where which side you’re on matters,” Kobrin said. “It will affect where you do business and where you invest.”

As the world moves into recession Kobrin said business executives need to pay attention to popular opposition to globalization. “It’s a mistake to think it’s just a few demonstrators in the streets. People are concerned. They’re afraid control of their lives is moving to some big international organization they know nothing about, and they’re right.” He is encouraged by coalition-building in the international community, although it is difficult to tell how deep-seated it is.

And he said globalization must become more inclusive and address issues of poverty and equality. Poverty and destitution, he noted, breed terrorist movements.

Victor Fung, chairman of the Li & Fung Group, a $6 billion Hong Kong trading company that manages production in China and 35 countries around the world, said via live video link that his business has been little changed by the terrorist attacks.

Fung’s company, in effect, executes vertical production for its customers, many of them large U.S. retailers. For example, he said, if a customer orders a quantity of shirts, his (Fung’s) company might buy the yarn in Korea, dye it in Taiwan and sew the garments in Thailand, depending on production capacity and cost.

“What we are finding, of course, is there is now a bigger premium on fast response because people are tending to delay even further their placing of orders [due to increased] uncertainty in the market,” he said. For retailers, he added, the system saves on interest and inventory costs, but more important, it generates significant savings on markdowns of time-sensitive goods.

According to Fung, the terrorist attacks have accelerated the already fast-moving expansion into China in the wake of its entry into the World Trade Organization. “When you add that China is also a place where there is more security and higher reliability, people will want to relocate production in China even more.”

He also said that customers in the United States and Europe are turning to low-cost production areas in Mexico and Latin America (near the U.S.) and in Eastern Europe and the Mediterranean (near to Europe) for fast turn-around goods. “On the one-hand we have to develop better capability in China for the main-line production,” he said, “but for the fast turn-around or fill-in production we need to develop closer to the markets.”

Tensions between Beijing and Taiwan are fading, Fung noted, and he predicted the two could reunite within five to 10 years. “There really isn’t a major Taiwan company that is not extremely active in the Mainland,” he said. “The political integration has not yet taken place, but the human and economic integration has been substantially completed.”

Voices From the Trenches

For first-hand insight into running a company under constant uncertainty, Wharton faculty teamed up with businessmen from Israel and Ireland in a videoconference.

Amir Barnea, dean of Israel’s Arison School of Business, advised governments to act with caution when considering economic intervention after terrorists strike. He said it is appropriate for governments to provide liquidity to markets and beef up security, “but there is some danger here the government may overreact in order to fix solutions and may take steps that are harmful to the economy long-term.”

For example, “relaxing anti-trust laws and subsidizing industries may have a long-term negative effect on the economy,” he said.

According to Aharon Kacharginsky, head of the corporate banking division of the Israel Discount Bank, terrorism is just part of doing business in Israel. “We see the effect of terrorism in Israel, but we survived throughout our existence – 50 years – with terrorism and the economy in Israel is very much like the better economies in the western world.”

He said industries with an international orientation such as diamonds or data are not suffering. But others, such as tourism, are more susceptible.

According to Israel Borowitz, chief executive of Arkia Airlines, tourism in Israel has been reduced to zero. However, he said September 11 has become an excuse for some airlines to reduce their employees and solve problems with unions. His airline, he said, will survive because it has found new business with domestic travelers and tourists from Eastern Europe and Russia.

Two apparel manufacturers reported they have suffered from disruption in their labor supply from Palestine during the current Arab-Israeli hostility. But they have a diversified workforce in plants throughout the region, including Turkey and Jordan.

Yari Rotlevy, CEO of Argaman, Ltd., said buyers from other countries, particularly the United States, are not coming to Israel to see his products: “There is no atmosphere of buying, especially in the last month or so.” Since the escalation of the war in Israel, he added, his company’s biggest problem is the lack of confidence in the domestic U.S. market. “You (the U.S.) are the problem for us in this case. If there will be a peace, we are sure Israel’s economy will rise again and it will be as it was two years ago. If there is a world crisis, we are a part of the world crisis.”

Uri Dori, chief executive of Dori Engineering, a developer with projects in Israel, Europe and Africa, said his company copes with instability at home by emphasizing geographic diversity. When he travels abroad he finds media coverage of his country distorted: “It looks much worse from the other side of the ocean.”

The Israelis spoke just days after a deadly suicide bombing in a popular Jerusalem nightclub district and just as Israel was launching counterattacks against Palestinian leadership. The Wharton participants, who watched the speakers enter the room before the videoconference, were struck by the way the Israelis were laughing and smiling. “When you see us laughing you think we are crazy,” said Dori. “But [the terrorist attacks] are concentrated in very few places. It’s very bad and very sad, but at the end of the day life is going on.”

John McGuire, chief executive of Trintech Group, an Irish software company with global business revenues of more than $80 million, also urged Americans not to panic as a result of the terror attacks. “The effect of terrorism is to change behavior,” said McGuire. “The approach here is to get back to business as normal.” McGuire suggested managers use the current crisis internally to address fundamental restructuring issues that are always present.

Companies in an unstable country need to downplay the violence customers may be exposed to on television, he noted. While building Trintech in Ireland, McGuire said he found customers wary of coming to the company’s headquarters for a sales pitch or training. So he set up a network of “lighthouse” customers using Trintech services in Europe where potential customers could go to see the products without setting foot in Ireland. “Customers felt uncomfortable doing business with an Irish company they thought was steeped in war.”

McGuire also stressed the future importance of China and India where the impression of instability is frequently present among U.S. managers. “We see terrific partnership opportunities in China,” he said, adding that as an Irish company, experienced with instability, Trintech may have an advantage there.

“We have a workforce, especially in Ireland, that is willing to relocate to these regions and take advantage of opportunities that are present,” McGuire said. “U.S. companies are retrenching out of these locations. We see this as a vacuum and we’re moving in to take hold of that opportunity.”

Managing Human Assets

The new realities require managers to develop a culture within their organizations that encourage planning and strategies to capitalize on opportunity. Peter Cappelli, director of the center for Human Resources at Wharton said the confusing nature of the times is illustrated by a statistic from the American Management Association. The association found that 63% of firms were hiring and laying off at the same time. “This seems to be something quite different,” he said. “This kind of churning of the workforce could go on forever.”

Research is disproving the conventional wisdom that firing poor performers diminishes morale, he added. “If people tolerate poor performers, morale of the whole organization suffers dramatically.”

U.S. demographic patterns point to a trough in workers following the baby boom generation. But Cappelli said companies will not face a dire labor shortage if they utilize the aging boomers. “Maybe we ought to think about this huge pool of available workers. They’re not threatening to retire.”

The generation now entering the workforce has sharply different attitudes about work than prior generations, according to Cappelli. “The notion of a secure, long-term career is harder to imagine.” He cited a PricewaterhouseCoopers survey that asked MBA students what they hoped to get out of their first job. Forty-two percent wanted a good reference for their future careers. Only 20% said they could imagine working at their employer five years. “What they’re looking for is opportunity,” Cappelli said. “You could probably keep these folks in the same organization longer if you give them opportunity.”

What’s clear is that workers no longer feel there is any long-term contract with employers. To keep these employees, Cappelli suggested, managers need to be explicit about workers’ options and should think in two-year segments. “Then at the end of that two years they should say, ‘This is what we are going to do now, maybe for three years.’ I think that’s the way you can hold these people.”

Cappelli also said the rise of on-line recruiting has changed the nature of hiring by shifting information cheaply and easily to potential employees who can now “passively” job hunt. This makes employers increasingly vulnerable to raids from competitors.

About 15% of the U.S. workforce has used Monster.com and job searching is now the second-most popular pursuit on the Internet. “Talent remains in short supply,” Cappelli said, urging managers to think about the performance gap between their best employee and their worst, then consider whether the workers’ pay reflects that difference. “Open labor markets demand new skills from you as an organization. You’ve got to find people, figure out who’s good, then try to keep them.”

Managing Cultural Differences

Legal studies professor Stuart Diamond offered strategies to manage people with differences within an organization and across nations. “The ability to deal with people who are different is the single most important business skill of this century,” he said. Without this ability, all the management strategies will never translate into motivated employees or convert prospects to customers. “They won’t even hear you.”

Diamond said research indicates the substance of an argument only accounts for about 10% of a person’s ability to change another’s position. The rest has to do with how the people feel about each other and how they talk to each other. “The truth is only one argument. If they don’t like you, they won’t hear you. The first thing you have to do is get people ready to listen to you.”

He suggested negotiators begin by finding value in the position their opponent is taking and by establishing some kind of communal interest. In the 1970s, he said, the environmental movement was so controversial it used a photo of Earth from space to establish the most basic common ground.

“You begin with the people who are most friendly with you and you build out from there,” he said. In the Middle East, “I don’t have a clue why the U.S. government hasn’t used U.S. Muslims to build a power base.”

When negotiating across cultural lines, the tone must be subtle and tactful in order to gain the most accurate information about the other person’s sensibilities, said Diamond. “Anybody who comes in and says I want to talk turkey is a bad negotiator.” Negotiators instead need to recognize their own biases and understand how others see them. “Ask questions, try to argue their side, show them we understand their perceptions,” he said.

Diamond also suggested that negotiators should examine whether a problem is a true difference or a miscommunication. The goal is “to make the problem as small as I can.” And questions are better than statements, he said. Statements give opponents something to throw arguments at. Ask open-ended questions when you want to bond and closed-end questions when you are trying to establish common standards, he added.

According to Diamond, power breeds poor negotiators. “Adults are the worst negotiators. When people have a lot of power the baseball bat is the tool of choice.” Furthermore, arguments over who is right distracts from the purpose of a negotiation. “If you want to be right you can be right all day as long as I meet my goals,” he said.

When you have a problem, he added, try to turn it over to someone else. If a vendor raises prices, “You can say to the vendor ‘I like you, but other people are charging less. What do I do?’ And remember that emotion and anger cause negotiators to lose focus. When you feel yourself getting emotional, don’t take the bait. Think of it as losing focus on your goals.”

There are also questions of style. American businessmen need to learn more about relationships because they dominate business in much of the world, Diamond said. In Japan, business is conducted in the framework of golf, karaoke and drinks, not legalistic contracts and structured deals. “The problem is that a legal system that is fair, accessible and not corrupt is a luxury most of the world does not have. Most of the world just has each other and it changes the way people” behave.

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But that does not mean managers should act as if they are something they are not. Diamond said he never eats Chinese food when he is in Beijing. “They do not expect you to be like them. They expect you to understand them and value them.”

Above all, he said, U.S. managers need to acknowledge and capitalize on differences, not try to eradicate or ignore them. “Differences produce value; homogeneity does not.”

Leading From Below

Leadership is all the more essential in times of change, said Wharton management professor Michael Useem, author of the book Leading Up: How to Lead Your Boss So You Both Win. When analysts examine a company they not only want to know about the top leader, but also about the top leadership team.

The quality of the team is a better predictor of corporate performance than the quality of the chief executive alone. “We want leadership above us and below us because who knows what’s out there,” said Useem.

He examined several celebrated world leaders, including Nelson Mandela and Margaret Thatcher, and found a three-part formula. The leaders all had a strong vision and a strategy to reach it. But they also had the ability to engage other people in a struggle to build their dream. Martin Luther King was famous for electrifying a room when he spoke. “King was always on, he was never off,” said Useem.

Leaders capture small moments and use them to bring an audience around to their cause. When a leader has people’s attention for whatever reason, he or she asks, “What’s the main point I want to get across?”

Taking Advantage of Marketing Opportunities

Even with the right technical tools and management in place, companies still need to hammer out strategies to survive and find new opportunities as the environment shifts. Wharton marketing professor David J. Reibstein said the terrorist attacks and concurrent economic downturn have major implications for marketers. While some parts of the economy, such as travel, have suffered a shock, others – including security, health care and discount retailers – appear to be faring well.

Internet use has also seen positive growth since the attacks, Reibstein said. Approximately 11.7 million American now use the Internet daily compared to 6 million a day before September 11.

He offered some advice on how to create opportunities in a difficult environment. For those willing to carry inventory, or with well-developed just-in-time systems, there is the potential to gain over competitors by avoiding the loss of sales due to out-of-stock items. Some manufacturers are requiring suppliers to carry more inventory.

Reibstein suggested marketers stress the value of their brands, not necessarily dropping prices in a panic. He was struck when airlines dropped prices to gain business after September 11 because people truly afraid to fly would not get on a plane at any price. The people who did fly simply cut into airlines’ margins.

Financing deals can turn into opportunities to generate traffic, as has been seen in auto sales.

Globally, he said, the current environment will force companies to reevaluate the countries in which they conduct operations. Domestic business and ties to China and Russia are likely to grow while Middle East business will suffer.

According to Reibstein, this is a good time for managers to upgrade the quality of their staff by taking advantage of lay-offs throughout the economy and to introduce new systems while the business is not expanding rapidly.

If they can afford it, Reibstein urged companies to increase marketing expenditures while media prices are down and there is less noise from competitors. “This is the perfect time. If you increase expenditures while others are cutting you will have greater impact, much more than increasing expenditures during a boom period.”

‘Strategic Chunkification’

Eric Clemons, professor of operations and information systems, suggested companies look closely at what point in time new investments will have the greatest impact. “How do you make an investment in the future when you don’t know what the future is?” he asked.

If, for example, a company tries to aggressively attack customers with an Internet strategy before they are ready, the investment is wasted. The answer, he said, is to make different investments in a process he called “strategic chunkification.”

By developing alternative strategies a company can launch different attacks in stages as the environment gets ready. Going back to the Internet marketer, he suggested the company could first create a website and use it to build customer loyalty until customers appear ready to buy online. Then, the company would make the investment in Internet infrastructure. Using this strategy reduces risk in an uncertain environment and protects budgets from having to carry big investments over time, Clemons said.

Constantly Testing Assumptions

According to Ian MacMillan, Wharton professor of entrepreneurial management, entrepreneurs and the venture capitalists who back them value planning for uncertainty because they are always planning for the unknown.

They do not plan better than ongoing businesses, he said, but they plan differently. Their plans are based much more on assumptions than a conventional business with established platforms. “As you go into more and more uncertain environments, that platform erodes and you have to load in it more and more assumptions.”

Venture capitalists are constantly searching for ways to reduce the cost of failure so they can try again and again if they need to, he pointed out. With conventional platform planning, managers set a goal and work towards that. But if the situation changes in the meantime, a strict adherence to plan will lead to the wrong end result.

He said planning for uncertainty requires managers to constantly test assumptions and be ready to redirect. They should also plan to learn. A good example of this was the U.S. drive to land a man on the moon. Managers did not know how they were going to do it at first, but planned out various steps and developed the technology to achieve those steps along the way.

Once the target is framed, planners need to consider the competitors, MacMiillan said. For example, if the industry average for payment is 90 days, the plan should explain exactly why it assumes a 60-day payment cycle.

The plan should contain specific actions, not just financials on a spreadsheet. “I want to know all the physical activity you have to take that will cause somebody to write that check,” said MacMillan. As the plan evolves it should undergo constant testing. He suggested managers test for 30 assumptions against 30 milestones. The tests should be as simple as possible and geared toward the most relative issues. “The idea,” he said, “is we’re going to plan and we’re going to re-plan.”

Keeping It All in Perspective

Despite the drama of the past few months, managers need to maintain perspective, said Mittelstaedt. “The trick is to know what has changed and what has not changed.”

As he pointed to the day’s headlines showing once high-flying companies that are now struggling, he said a key lesson of the current times is: “You can’t violate the laws of economics. At some point in time, economics works.” He stressed the need for companies to keep watch on the whole business environment and not just on direct competitors. Years ago, he said, one would have thought Kodak’s undoing would have come from a competitor like Fuji, not electronics makers. “The problem is we spend all this time looking at people like us and eventually it’s the people we haven’t thought of who surprise us.”

The symposium laid out four broad scenarios based on a passive or an active, opportunistic response to shocks that were a surprise or expected. The active company working on a known action winds up the winner, while the passive company caught by surprise gasps for survival. “What are we doing to get it together and build a culture around being active and opportunistic?” Mittelstaedt asked.

High-performance organizations, he said, have a different sense of time. “It’s not that they do things capriciously, but they don’t take forever to figure it out.”

He said some companies that take a pro-active stance wind up shooting themselves in the foot if they act without information. Knowledge and the ability to prepare for different scenarios is the difference between using a “momentum strategy versus trying to understand the thing that can hurt you the most.”

According to Wind, companies need to strive for new opportunities and use new mental models to seek them out. The Internet will remain an important tool. He, too, said the tendency for companies to become risk adverse in today’s environment is worrisome. “This is the trend but I think we have to be careful.”

Wind said companies should think about competitive value when pricing. “The whole competitive value equation we have is changing because of the competitive nature of the Internet.” With massive amounts of information available there, the power balance in business has shifted to the consumer.

Companies should use this time to acquire cheap assets from troubled firms, including people. Discipline, however, is needed. “The challenge is to make sure you are not just attracted by the cheapness of the thing, but that it makes strategic sense,” he said.

As for new mental models, he said companies should look at various fundamental issues in the organization and question the way they think about them. For example, he said, managers might want to consider whether inventory, or people, are an asset or a liability.

Wind suggested executives imagine an ideal state, then plan backwards to reach that point, “Instead of saying, ‘Let’s aim for a 10% or 20% improvement, ask ‘Where is it that I want to be?’”

He encouraged managers to challenge all assumptions about their business. “If the environment is changing there is a pretty good likelihood that the assumptions that lead to your current vision, value proposition, strategies, and the like are not valid.”

Finally, he urged companies to experiment. “No one knows what the future will look like,” he said. “To know how effective you are is to continuously experiment.”

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