Friday, April 25, 2008

Pilgrimage Part IV: What if Bob Nardelli Had Done This Once in a While?

Originally published May 14, 2007
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The contrast to most annual meetings couldn’t be greater.

Whereas except during times of crisis, the average large company annual meeting—and Berkshire-Hathaway is a large company, with almost $100 billion in revenue last year, almost three-fifths the size of GE and four-times the size of Coke—gets modest shareholder attendance and gadfly-dominated questions from the floor, the Berkshire annual meeting draws shareholders from, quite literally, around the world.

German, Australian, Swiss, Canadian and Japanese investors—not to mention those from California, New York, Connecticut, Kentucky and elsewhere—have lined up early to ask Buffett their questions.

And it’s impossible to say how many other states and countries are represented, given the fact that only slightly more than one tenth of one tenth of one percent of all those in attendance will get to ask a question before the five-and-a-half hours are up.

What we do know is that so many international shareholders have come that Warren and Charlie will host a meet-and-great with them later in the day, for more than an hour. Buffett explains that he feels if so many shareholders have come all that way to be in Omaha, he just feels he ought to thank them.

Why is it that, hearing Buffett talk this way about his shareholders, I begin thinking about Bob Nardelli?

Nardelli is, of course, the infamous ex-GE Power Systems star whose stormy tenure as CEO of Home Depot—during which time sales doubled, earnings rose almost 150%, and yet the stock price languished—ended not long after a Nixonian shareholder’s meeting at which the public company CEO did not respond to a single question from the Home Depot shareholders who dared ask one, aside from saying “Thank you.”

In true “Final Days” style, Nardelli’s Board of Directors—the folks nominally in charge of the company—did not witness the mockery of corporate governance for the simple reason that not one of them attended the meeting.

Nevertheless, after the shareholders finally revolted, that same Board of Directors later gave Nardelli a fine send-off—$210 million worth—for what, to the stock market, looked very much like failure. (See “The Tragedie of Home Depot,” January 6, 2007.)

Still, you might well ask if it is fair that the increased sales and earnings which occurred under Nardelli should be considered “failure” merely because Home Depot’s share price flat-lined during his reign of errors?

The answer, I think, is: yes, absolutely.

While stock prices in the short run are, as Buffett repeatedly tells shareholders, quite irrelevant, and one should be comfortable owning a stock without regard to near-term fluctuations, stocks can also be quite accurate leading indicators of the business itself.

And in this case, the stock market knew what Bob Nardelli did not: it knew that his militaristic, top-down, numbers-obsessed operating style—which worked quite well at GE Power Systems—was destroying what had been an egalitarian, bottoms-up, customer-obsessed culture that, prior to his tenure, had transformed a sleepy, cyclical, low-margin industry and created one of the great retail success-stories of all-time.

The failure wasn’t hard to spot: all you had to do was visit stores and ask. But Nardelli did not even listen to his own shareholders, so why should he listen to ex-store managers?

Now, I don’t particularly like thinking about Bob Nardelli, so this is unfortunate, having him come to mind right now. The shareholder questions are moving along and I want to pay attention.

But the next question is about the seemingly outrageous compensation packages offered like candy by today’s corporate Boards desperate to get the next Jack Welch, even if he turns out to be—you guessed where I was going—Bob Nardelli.

Buffett flat out does not care much for meticulously crafted compensation systems in the first place, and he states something at once obvious and profound:

“There are more problems with having the wrong manager than having the wrong compensation system.”

It is a lesson the Home Depot Board of Directors learned the hard way. Buffett riffs further on the topic, noting that despite serving on 19 corporate boards he has only been nominated to a single compensation committee:

“They’re looking for Cocker Spaniels to go on comp committees, not Dobermans.”

As for what’s to blame for outsized compensation packages, Buffett and his partner place it squarely on the public disclosure rules which, well intentioned though they might be, have the unintended consequence of fueling compensation inflation because everybody knows what everybody else earns.

The “envy” which drives the ensuing compensation one-upmanship is hard for Buffett to grasp:

“Envy—where the hell is the upside?” he asks rhetorically. “You feel miserable…but the other guy has no idea how you’re feeling.”

Noting that envy is one of the original “seven deadly sins,” Buffett picks up a chocolate candy from the See’s box on the table before him—something he will do frequently throughout the meeting, both before the lunch break and after—and declares gluttony to be a far more worthwhile sin.

While there’s no upside to envy, “there’s upside to gluttony,” he declares, happily popping the See’s in his mouth, to laughter.



One of the less-well known aspects of Buffett’s career is that he ran a hedge fund before turning Berkshire-Hathaway into his own personal investment vehicle.

And it is no wonder the model attracted him, for Buffett is a pay-for-performance kind of guy. Following the discourse on gluttony, Buffett is asked by a Swiss investor about how to cure the executive compensation arms race, and he uses the example of an oil company that benefits from a sudden rise in the price of crude oil:

“If oil goes from $30 (a barrel) to $60, it’s crazy to pay more” to the executive management team. “But if their finding costs (for oil) were lower (than the industry finding costs), I’d pay ‘em like crazy.”

It is simple, concise and clear, and hard to argue with.

I begin to wonder how Nardelli’s tenure at Home Depot—and his impact on the company itself—might have ended differently if Nardelli, and his Board of Directors, had allowed themselves to be subjected to just such an annual session in which everything was on the table?

How many ex-store managers might have given the military-obsessed Nardelli a piece of their mind—and a real-life view from the trenches—about what was happening to the stores and their customers when his efficiency experts replaced the plumbers, carpenters and electricians with junior military officers and self-checkout stands?

How many former Home Depot customers and long-suffering shareholders might have educated Nardelli, who by then was no longer eating lunch with the masses, having created an executive dining room for himself and his Team, on the distinction between running a time-and-materials factory line and a flesh-and-blood store, if they’d been allowed to ask him a question before his fellow Directors?

Is it just the GE culture that created such an out-of-touch CEO?

Or have Wall Street’s financial innovations—Mutual Funds, Exchange-Traded Funds, Hedge Funds, Funds-of-Funds—so removed the shareholders and their money from the companies they fund that management and their handpicked Boards of Directors no longer have to answer to the shareholders in the flesh and articulate why they do what they do?

Buffett, who sets his own example of a CEO’s accountability—and willingness to hear dissenting views directly—during the five-plus hours of Q&A at his meeting, doesn’t even think the CEO should let somebody else write the CEO letter for the annual report.

“If the CEO isn’t willing to talk [through a letter] directly to the people who gave him the money…I’ve got a problem with that.”


I wonder how many other CEOs even think that way?


To be continued…

Jeff Matthews
I Am Not Making This Up

© 2007, 2008 NotMakingThisUp LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

5 comments:

arpapale said...

Jeff,
Great posts from Omaha. May I copy your writings and send them to some friends? Thanking you in advance, Art Papale

Aaron said...

"Still, you might well ask if it is fair that the increased sales and earnings which occurred under Nardelli should be considered “failure” merely because Home Depot’s share price flat-lined during his reign of errors?

The answer, I think, is: yes, absolutely."


I couldn't agree with you more, Jeff. This is one of your best posts ever! Keep up the great work, and I look forward to your next installment.

pondering said...

Thanks for peaking behind the curtain in Omaha and reporting it. Many years ago I was driven out of the HD to Lowes by the shear chaos 100k square feet of roofed hardware-homegoods can create not mentioning the wasted time looking for what I need. Now I've noticing Lowe's is slowly morphing into the HD of old where the floor space is cluttered with items. By chance I returned to the old HD and am surprised to see its vitality. Two guys who earned their stripes in retail are running it. They committed to weeding out the lazy customer service types. All the stocking equipment MUST be off the sales floor during retail hours and the floors spit shined each day. They have cleared the clutter and the store is rebounding. He rolled his eyes when I asked if he had his MBA. That was the extent of his public comment on Nardelli. Another example of hardware boxstore competition can be found in the story of Curry Hardware. Curry, a mom and pop hardware in West Quincy went mano e mano with the first HD in eastern MA in October 1992. The stores are a quarter mile apart door to door and Curry won hands down and expanded as well entirely on fair prices and quality customer service. Name me a guy who wants to browse 100k square feet of hardware on a Saturday morning when he really would rather be on the 9th green by 10 am. If your that guy, Curry has you driving home by the time you’ve found the right HD associate who knows where to find replacement rake handles.

David said...

Jeff,

I'm an investment manager myself, and while I agree with a ton of your stuff, I disagree partially on Nardelli. While Mr. Nardelli can, and should, be faulted for sucking out some of the life from HD stores and their "associates" (employees), his militaristic background from GE did indeed help him and the company as a whole. EBITDA and EBIT margins as a whole increased by 25% (from ~11% to ~14%) over Nardelli's tenure, and Nardelli was the one who introduced 21st century supply chain management and distribution techniques to the company and also introduced better IT in general, which led to better margins through more efficiency. Granted, he could have done all of this while NOT sucking the life out of the stores. In fact, Frank Blake, if you listen closely to all the conference calls (of which I read every single one carefully), is in essence continuing the improvement of HD's "militaristic" efficiency. He just understands that it doesn't have to be at the expense of customer service and lifelessness. I would think that Nardelli understood this at one time as well, but alas, Wall Street had gotten to him by the time his tenure was close to over. Indeed, Blake was Nardelli's right-hand man, and thus far has continued everything that Nardelli was doing, but he's adding the human element. Just pointing out that while Nardelli is always criticized for the lifelessness of his mgmt approach, he has to be given credit for the vast margin and efficiency improvements. They are indeed separate from the issues that HD is experiencing, as Blake has made clear many times over since his tenure started.

Hatch said...

Or maybe Jeff the stock was stupidly priced when he started and it rationalized.