Tag: Phil Rosenzweig

Culture Eats Strategy: Nucor’s Ken Iverson on Building a Different Kind of Company

Much can be learned about the world by studying business.

***

The problem with most management, leadership, and business books is that many of them harp on the same self-evident points, overconfident in the usefulness of their prescriptions for would-be imitators. They tend to vastly underestimate the role of circumstance, luck, the nature of completion, and the effects of scale, among other things; falling prey to the many delusions described by Phil Rosenzweig in his incredibly important book, The Halo Effect.

The main problem Rosenzweig describes in the book is that attributes we tend to think cause great performance (culture, leadership, etc.) are often just things that are attributed to companies we already know are high-performing. There's a Halo around everything they do. (Reminding one of the fundamental attribution error.)

How many current high-fliers would ever be described as having a bad culture, or bad leadership? It would be nonsense to say it. Thus, we run into a recursiveness problem. High performing companies have great culture, and great culture is defined as the attributes that cause high performance.

In other words, when you ask someone if Apple has a great corporate culture, they will tell you it does. (And it's an extremely successful company, so of course it does.)

But when we try to pinpoint which aspects of Apple's culture make it more successful than its peers, and which would be predictive of success at other companies, we run into a difficult problem.

The Halo Effect tells us that we will find a lot of false positives. The attributes we think are causal of success are the same ones we often deem causal of failure when company performance deteriorates. This is the strategy paradox.

***

Plain Talk, by Ken Iverson, is a memoir of his time running the steel company Nucor. Despite the warning, above this book deserves your attention for a few reasons:

  • Nucor was extremely successful, for a long period, in an industry that provided huge headwinds. There are no magic pills to being successful in steel. It's generally an awful business.
  • The company did some very unusual things that we see in few other companies, even successful ones.
  • The book was recommended by a very smart friend who runs a very successful business of his own, using similar principles.
  • The author/CEO, Iverson, seems honest about the fact that many of his prescriptions are not new or different. The book is not presented as a panacea.
  • It's generally good to study outlier success or failure.

A Peculiar Kind of Success

Ken Iverson

Under Iverson, Nucor was an unusual sort of steel company compared to the Carnegie-esque behemoths of the past.

Some of its attributes remind us of companies like Berkshire Hathaway, but Nucor did it very differently. There were few acquisitions. The company was totally focused on steel. Iverson describes some of the peculiarities in the opening of the book (this was written in 1998):

  • Our 7,000 employees are the best paid workers in the industry, yet Nucor has the lowest labor cost per ton of steel produced
  • Nucor is a Fortune 500 company with sales in excess of 3.6 billion, yet we have a total of just 22 people working at our corporate headquarters, and just four layers of management from the CEO to the front-line workers.
  • Nucor operates in a “rust belt” industry that lost one out of two jobs over a 25-year time span, yet Nucor has never laid off an employee or shut down a facility for lack of work, nor have we lost money in any business quarter for more than thirty consecutive years.

That is, of course, a very interesting outcome. Most steel companies were struggling mightily when Nucor came up. Bethlehem Steel almost went bankrupt in the late 70s. (They eventually did.) Foreign competition, rising input costs, rising labor costs, commoditization…steel is about as bad a business as you could invent. Yet in Iverson's 30+ year reign, Nucor compounded its per-share earnings at a rate of about 17% per annum. There must have been something going on here — he sounds like an outsider.

Let's focus on a few things that were particularly unusual.

Extreme Decentralization

Nucor believed (and to my knowledge, still believes) strongly in decentralization. The only parallel for 22 people at headquarters in a $4 billion business is probably Berkshire itself. Capital Cities, now part of ABC, might have been another parallel.

In order to achieve that leanness at the top, power must have been pushed down pretty far into the organization. And of course, it was:

Each division operates its one or two plants as an independent enterprise. They procure their own raw materials; craft their own marketing strategies, find their own customers; set their own production quotas; hire, train, and manage their own work force; create and administer their own safety programs…In short, all the important decisions are made right there at the division. And the general manager of the division is accountable for those divisions.

This is scary for most companies. They are not willing to allow local general mangers that kind of control and responsibility. The allure of synergy and the allure of top-down controls are too strong. And once it's in place, headquarters culture has a way of taking on a life of its own. Take a look at PepsiCo, or General Electric, or any number of corporate beasts in the United States. There is huge, expensive bureaucracy at the top. It is always thus. (Of course, that keeps firms like 3G Capital in business.)

But Iverson was willing to take the tradeoffs:

“We are honest-to-god autonomous,” says Hamilton Lott, general manager of our Vulcraft Division in Florence, South Carolina. “That means we duplicate efforts made in other parts of Nucor. The company might develop the same computer program six times. But, the advantages of local autonomy are so great, we think it's worth it.”

Any of you who have worked in a modern corporation know how unusual this mentality is. Who would allow the same company to develop the same software six times? Why not increase knowledge sharing and synergies?

Part of the problem is that the tremendous benefits of local autonomy are less immediately tangible than the costs. Berkshire has dealt with this for years. Every time one of Buffett's subordinates acts up, and it happens pretty darn infrequently by our count, people pipe up and ask why he isn't imposing more rigid oversight on them. It's very simple: the long-term benefits of trust-giving have far outweighed the occasional cost of non-compliance.

Call this an “unrecognized simplicity.” Nucor's corporate overhead expense was so small they didn't even bother allocating corporate expenses to the divisions. That is rare.

The other under-appreciated value of decentralized control is that great ideas tend to rise from the bottom rather than being dictated by the executives. Iverson claims that many or even most of Nucor's great innovations came from down in the divisions. The company merely had to be smart enough to harness them.

This has happened elsewhere in Corporate America. Look at McDonald's. Do you think Ray Kroc invented the Chicken McNugget, the Big Mac, and the Filet ‘o Fish? Do you think he figured out how to keep millions of pounds of potatoes fresh and get them to customers tasting exactly the same every time? No. But franchisees and suppliers did. He just had to be smart enough to help the ideas spread. (Hamburger U, anyone?)

Simple and Precise Strategy

In the book Good Strategy, Bad Strategy by Richard Rumelt (highly recommended, and we've written about it before), the author is clear that what makes a good strategy is that it's clear and that it's precise, a real call to a specific action:

The kernel of a strategy contains three elements: a diagnosis, a guiding policy, and coherent action. The guiding policy specifies the approach to dealing with the obstacles called out in the diagnosis. It is like a signpost, marking the direction forward but not defining the details of the trip. Coherent actions are feasible coordinated policies, resource commitments, and actions designed to carry out the guiding policy.

This is precisely what Iverson did at Nucor:

We don't clutter the picture with lofty vision statements, ask employees to pursue vague, intermediate objectives like “excellence,” or burden them with complex business strategies. Our competitive strategy is to build manufacturing facilities economically, and to operate them efficiently. Period.

Simple but not easy.

Was the technology that went into developing and implementing this strategy simple? I'm not an expert in metallurgy, but I doubt it. The modern steel company is quite efficient and quite advanced. Nucor made major strides like the mini-mill and thin-slab casting of flat-rolled steel. Whether that kind of technology would have been given a chance to succeed in a different culture is hard to say.  We can't re-run history but Nucor's purposeful drive seems to have fostered the right environment.

 

Remove Unnecessary Hierarchy

Ultimately, it's hard to build a great, supportive, seamless web of deserved trust if the executives are consistently treated as “above the fray” – subject to a different level of treatment than the rank and file. This is the way it is in most organizations.

The results tend to be predictable. Envy, plus a violation of basic Kantian fairness tendency, will create a lot of hatred. You can't put the managers and the executives in first class and stick the associates in coach and expect anything but resentment. It's basic human nature, driven by biology. Nucor was smart enough to avoid this folly:

Our executives get the same group insurance, same holidays, and same vacations as everybody else. They eat lunch in the same cafeterias. They fly economy class on regular commercial flights (although we do allow the use of frequent flyer upgrades). We have no executive suites and no executive cars. At headquarters, our “corporate dining room” is the deli across the street.

Our executives wouldn't have it any other way. They see our egalitarian culture serving their interests as much as the interests of our employees. For one thing, our mangers don't have to waste time fretting over their chances to get the fancy corner office or arguing over who gets to use the company plane. We don't have those perks, and we imagine they would cause a lot more stress than fulfillment. What a bunch of nonsense! Chasing meaningless status symbols and tokens of power…

Nucor had essentially four promotions available: Supervisor, Department Manager, General Manger, and Chairman (Iverson himself). That's it. I can imagine that over all those years of growth, more than one consultant tried to get Iverson to create a whole lot of bureaucracy, but he wisely resisted. The costs (such as the mathematically unavoidable large spans of control due to fewer managers in the system) were once again greatly outweighed by the benefits. Another unrecognized simplicity.

And when it came time for pay cuts, everyone shared in the pain. What a simple, yet generally unused concept:

Why, then, would workers who had endured deep cuts in pay and who had every reason to fear for their futures reach out to share a laugh with a manager passing through a mill? Simple. No employee was being asked to carry more than his or her part of the burden.

You see, their department heads had taken pay cuts of up to 40 percent, and the general managers and other officers of the company were earning 50-60 percent less than we had made in preceding years. My own pay dropped that year to about $110,000, from about $450,000 the year before. We not only shared the pain, but doled out the lion's share to the people at the top.

Think about what an inversion that is of most organizations, where the CEO takes a minor cut in pay (or worse, no cut) and hundreds of low-level employees simply lose their jobs. Wouldn't most places work better with Nucor's ethos? The fact that they did this in the highly cyclical steel business gives some tailwind to the idea. It wasn't a story like Google, where constant success has allowed them to pamper employees financially and otherwise. Nucor managed to avoid layoffs and share in the pain in a business that, by necessity, is constantly offering pain to share.

A Postscript on the Post-Iverson Era; Implications for Investors 

In the final analysis, Nucor probably didn't have any core attributes that were unavailable to its competitors. It simply made better choices and was more fanatical about sticking to them. The resulting success was deserved. This is why culture eats strategy.

But the postscript to the Iverson era has been interesting, at least from the perspective of the passive investor. Nucor was a brilliant investment in Iverson's time as manager, but if you'd bought the stock in the early 90s when Iverson left the CEO post, your results would have been pretty mediocre since. Can we see why? Let's deduce a few reasons.

  • Partially, the stock was fairly rich at that time – trading for something like 40x price/earnings. That's high even for a good industrial company. It's not so high now. But their fundamental performance has not been nearly as impressive either, in the time since Iverson left, especially in the last five or six years.
  • Partially, the effects of compound interest have served to slow down an increasingly large corporation. Nucor is now a giant in the steel business. They started off as a tadpole. If the company's net earnings had continued to grow at 17% per annum, they would currently be earning $4 billion a year, versus a little over $120 million in 1993. There's only so much profit available in steel.
  • Is there a tinge of Halo Effect here, as described at the beginning of the piece? Perhaps. Iverson would be the first to say his prescriptions were not that ground-breaking. I tend to think some of the attributes above did contribute greatly to its unusual success, but more of the success may have been situational and strategy driven than Iverson recognized.
  • Even more important might be to recognize that the steel business always was a fundamentally hard one, and even the best ships might struggle on a stormy enough ocean. Iverson and his team rowed very hard and successfully for many years, and that has continued to this day. Bethlehem Steel went bankrupt in 2001 and Nucor made money that year. U.S. Steel has been bleeding red ink for years and Nucor, although less profitable than it once was, has still made money. But the ocean current is what it is.

So even if Nucor has been better than most of its competitors in the last ten or twenty years, and I suspect it has, an investor would have had to ask him or herself: Do I want to be in the steel business at all? As Buffett used to say, something not worth doing well is often not worth doing at all.

Regardless, the lessons from Plain Talk show that the roads less traveled can be worth exploring. They're not that complicated. But they work.

A Discussion on the Work of Daniel Kahneman

Edge.org asked the likes of Christopher Chabris, Nicholas Epley, Jason Zweig, William Poundstone, Cass Sunstein, Phil Rosenzweig, Richard Thaler & Sendhil Mullainathan, Nassim Nicholas Taleb, Steven Pinker, and Rory Sutherland among others: “How has Kahneman's work influenced your own? What step did it make possible?”

Kahneman's work is summarized in the international best-seller Thinking, Fast and Slow.

Here are some select excerpts that I found interesting.

Christopher Chabris (author of The Invisible Gorilla)

There's an overarching lesson I have learned from the work of Danny Kahneman, Amos Tversky, and their colleagues who collectively pioneered the modern study of judgment and decision-making: Don't trust your intuition.

Jennifer Jacquet

After what I see as years of hard work, experiments of admirable design, lucid writing, and quiet leadership, Kahneman, a man who spent the majority of his career in departments of psychology, earned the highest prize in economics. This was a reminder that some of the best insights into economic behavior could be (and had been) gleaned outside of the discipline

Jason Zweig (author of Your Money and Your Brain)

… nothing amazed me more about Danny than his ability to detonate what we had just done.

Anyone who has ever collaborated with him tells a version of this story: You go to sleep feeling that Danny and you had done important and incontestably good work that day. You wake up at a normal human hour, grab breakfast, and open your email. To your consternation, you see a string of emails from Danny, beginning around 2:30 a.m. The subject lines commence in worry, turn darker, and end around 5 a.m. expressing complete doubt about the previous day's work.

You send an email asking when he can talk; you assume Danny must be asleep after staying up all night trashing the chapter. Your cellphone rings a few seconds later. “I think I figured out the problem,” says Danny, sounding remarkably chipper. “What do you think of this approach instead?”

The next thing you know, he sends a version so utterly transformed that it is unrecognizable: It begins differently, it ends differently, it incorporates anecdotes and evidence you never would have thought of, it draws on research that you've never heard of. If the earlier version was close to gold, this one is hewn out of something like diamond: The raw materials have all changed, but the same ideas are somehow illuminated with a sharper shift of brilliance.

The first time this happened, I was thunderstruck. How did he do that? How could anybody do that? When I asked Danny how he could start again as if we had never written an earlier draft, he said the words I've never forgotten: “I have no sunk costs.”

William Poundstone (author of Are Your Smart Enough To Work At Google?)

As a writer of nonfiction I'm often in the position of trying to connect the dots—to draw grand conclusions from small samples. Do three events make a trend? Do three quoted sources justify a conclusion? Both are maxims of journalism. I try to keep in mind Kahneman and Tversky's Law of Small Numbers. It warns that small samples aren't nearly so informative, in our uncertain world, as intuition counsels.

Cass R. Sunstein (Author, Why Nudge?)

These ideas are hardly Kahneman’s most well-known, but they are full of implications, and we have only started to understand them.

1. The outrage heuristic. People’s judgments about punishment are a product of outrage, which operates as a shorthand for more complex inquiries that judges and lawyers often think relevant. When people decide about appropriate punishment, they tend to ask a simple question: How outrageous was the underlying conduct? It follows that people are intuitive retributivists, and also that utilitarian thinking will often seem uncongenial and even outrageous.

2. Scaling without a modulus. Remarkably, it turns out that people often agree on how outrageous certain misconduct is (on a scale of 1 to 8), but also remarkably, their monetary judgments are all over the map. The reason is that people do not have a good sense of how to translate their judgments of outrage onto the monetary scale. As Kahneman shows, some work in psychophysics explains the problem: People are asked to “scale without a modulus,” and that is an exceedingly challenging task. The result is uncertainty and unpredictability. These claims have implications for numerous questions in law and policy, including the award of damages for pain and suffering, administrative penalties, and criminal sentences.

3. Rhetorical asymmetry. In our work on jury awards, we found that deliberating juries typically produce monetary awards against corporate defendants that are higher, and indeed much higher, than the median award of the individual jurors before deliberation began. Kahneman’s hypothesis is that in at least a certain category of cases, those who argue for higher awards have a rhetoric advantage over those who argue for lower awards, leading to a rhetorical asymmetry. The basic idea is that in light of social norms, one side, in certain debates, has an inherent advantage – and group judgments will shift accordingly. A similar rhetorical asymmetry can be found in groups of many kinds, in both private and public sectors, and it helps to explain why groups move.

4. Predictably incoherent judgments. We found that when people make moral or legal judgments in isolation, they produce a pattern of outcomes that they would themselves reject, if only they could see that pattern as a whole. A major reason is that human thinking is category-bound. When people see a case in isolation, they spontaneously compare it to other cases that are mainly drawn from the same category of harms. When people are required to compare cases that involve different kinds of harms, judgments that appear sensible when the problems are considered separately often appear incoherent and arbitrary in the broader context. In my view, Kahneman’s idea of predictable coherence has yet to be adequately appreciated; it bears on both fiscal policy and on regulation.

Phil Rosenzweig

For years, there were (as the old saying has it) two kinds of people: those relatively few of us who were aware of the work of Danny Kahneman and Amos Tversky, and the much more numerous who were not. Happily, the balance is now shifting, and more of the general public has been able to hear directly a voice that is in equal measures wise and modest.

Sendhil Mullainathan (Author of Scarcity: Why Having Too Little Means So Much)

… Kahneman and Tversky's early work opened this door exactly because it was not what most people think it was. Many think of this work as an attack on rationality (often defined in some narrow technical sense). That misconception still exists among many, and it misses the entire point of their exercise. Attacks on rationality had been around well before Kahneman and Tversky—many people recognized that the simplifying assumptions of economics were grossly over-simplifying. Of course humans do not have infinite cognitive abilities. We are also not as strong as gorillas, as fast as cheetahs, and cannot swim like sea lions. But we do not therefore say that there is something wrong with humans. That we have limited cognitive abilities is both true and no more helpful to doing good social science that to acknowledge our weakness as swimmers. Pointing it out did it open any new doors.

Kahneman and Tversky's work did not just attack rationality, it offered a constructive alternative: a better description of how humans think. People, they argued, often use simple rules of thumb to make judgments, which incidentally is a pretty smart thing to do. But this is not the insight that left us one step from doing behavioral economics. The breakthrough idea was that these rules of thumb could be catalogued. And once understood they can be used to predict where people will make systematic errors. Those two words are what made behavioral economics possible.

Nassim Taleb (Author of Antifragile)

Here is an insight Danny K. triggered and changed the course of my work. I figured out a nontrivial problem in randomness and its underestimation a decade ago while reading the following sentence in a paper by Kahneman and Miller of 1986:

A spectator at a weight lifting event, for example, will find it easier to imagine the same athlete lifting a different weight than to keep the achievement constant and vary the athlete's physique.

This idea of varying one side, not the other also applies to mental simulations of future (random) events, when people engage in projections of different counterfactuals. Authors and managers have a tendency to take one variable for fixed, sort-of a numeraire, and perturbate the other, as a default in mental simulations. One side is going to be random, not the other.

It hit me that the mathematical consequence is vastly more severe than it appears. Kahneman and colleagues focused on the bias that variable of choice is not random. But the paper set off in my mind the following realization: now what if we were to go one step beyond and perturbate both? The response would be nonlinear. I had never considered the effect of such nonlinearity earlier nor seen it explicitly made in the literature on risk and counterfactuals. And you never encounter one single random variable in real life; there are many things moving together.

Increasing the number of random variables compounds the number of counterfactuals and causes more extremes—particularly in fat-tailed environments (i.e., Extremistan): imagine perturbating by producing a lot of scenarios and, in one of the scenarios, increasing the weights of the barbell and decreasing the bodyweight of the weightlifter. This compounding would produce an extreme event of sorts. Extreme, or tail events (Black Swans) are therefore more likely to be produced when both variables are random, that is real life. Simple.

Now, in the real world we never face one variable without something else with it. In academic experiments, we do. This sets the serious difference between laboratory (or the casino's “ludic” setup), and the difference between academia and real life. And such difference is, sort of, tractable.

… Say you are the manager of a fertilizer plant. You try to issue various projections of the sales of your product—like the weights in the weightlifter's story. But you also need to keep in mind that there is a second variable to perturbate: what happens to the competition—you do not want them to be lucky, invent better products, or cheaper technologies. So not only you need to predict your fate (with errors) but also that of the competition (also with errors). And the variance from these errors add arithmetically when one focuses on differences.

Rory Sutherland

When I met Danny in London in 2009 he diffidently said that the only hope he had for his work was that “it might lead to a better kind of gossip”—where people discuss each other's motivations and behaviour in slightly more intelligent terms. To someone from an industry where a new flavour-variant of toothpaste is presented as being an earth-changing event, this seemed an incredibly modest aspiration for such important work.

However, if this was his aim, he has surely succeeded. When I meet people, I now use what I call “the Kahneman heuristic”. You simply ask people “Have you read Danny Kahneman's book?” If the answer is yes, you know (p>0.95) that the conversation will be more interesting, wide-ranging and open-minded than otherwise.

And it then occurred to me that his aim—for better conversations—was perhaps not modest at all. Multiplied a millionfold it may very important indeed. In the social sciences, I think it is fair to say, the good ideas are not always influential and the influential ideas are not always good. Kahneman's work is now both good and influential.