01 July 2010 Issue 7 Christian Mustad

Getting real

Christian Mustad explains his approach to direct investment management.

In the wake of the financial and economic crisis, important academic and business publications1 proclaim the dawn of a new age of transparency in all things related to decision making and communication, and surveys of ultra high net worth individuals2 show that in every aspect of the management of their estate, they now expect a much better quality of information and intend to be more involved than in the past.

What does this mean for direct investments? The companies that beneficial owners invest in without the intermediation of dedicated investment professionals – and we are talking here mostly about private companies – are in general soon left to the care of the family officers and trustees that manage the beneficial owner’s estate. It is then up to them to exercise their fiduciary responsibility, and the quality of the information they get from the companies involved soon becomes the key issue.

Financial statements and management reports are, in most cases, poor guides to understanding what constitutes the value of a company over time. Acting to protect the value of the investment made by the beneficial owner on the basis of such information is nearly impossible. At the very least, it places those that have such responsibility in a risky position.

My belief is that no information of relevance can be gathered about a company’s value without gaining insight into how that company actually works. Using a formula that sounds radical and has significant consequences when deciding how to monitor direct investments, I believe it makes sense to think about companies in this way: the value of a company is the sum of its productive activities.

With that in mind, meaningful supervision of direct investments does not centre only on financial statements and management reports. Such supervision must be based upon a comprehensive list of activities that any company must perform in order to function properly and it must be supported by generally accepted best practices that cover each area. Of course, things can get unwieldy if too much detail is brought to the attention of those in charge of making decisions, so findings must be grouped and prioritised to provide a view that is comprehensive, while highly usable. Assessing and monitoring companies in this way constitutes quite a change of habits when that type of approach is first implemented.

Deeply seated assumptions

When it comes to explaining successes or failures, two words stand out: strategy and management. Adding ‘good’ or ‘bad’ to these two words pretty much sums up the explanation given to any situation or outcome in direct investments. That is a problem. Viewing investments in private companies in terms of right or wrong strategy and good or bad management boils down to admitting that exercising oversight as a member of the board is vain, equivalent to scrutinising a black box.

But that kind of fatalistic view of things only works if we forget a couple basic truths. First, the key problem with business strategies is very rarely their definition; most strategies make sense on paper… The key problem is in their execution. Second, company managers are not all either perfect or dismal; they are, like the rest of us, fallible human beings working under pressure. This being the case, there is ample space for insightful and relevant monitoring of companies by board members.

Even with that in mind, some readers will still be sceptical about the real usefulness for board members of basing their decision making on that type of information. How can a collection of data that is essentially ‘operational’, no matter how comprehensive and well presented, really make a difference? The answer is that it can and it does because it goes to the actual source of failure of companies.

The process is the problem

There is no better way of demonstrating this than to explore concrete examples of such failures. To do this, let us consider some of the key components on which companies build their value over time.

The first and most obvious component to mention is the relevance of any company’s offering to its market. This cornerstone of company value is developed and consolidated over time by a series of important activities that could or should be deployed internally in order to ensure that what ever is offered to the market is and remains in line with customers’ needs and expectations. Of all management disciplines, this is the one where notions like vision and drive are the most essential. However, leaving the development of a company’s offering to the sole vision of its management means transforming what should be a considered approach into a mere bet.

To illustrate this point, we can refer to two real-life cases. The first is a company that develops and sells innovative sports footwear, and the second has used the web and information technology to propose a new platform for the import/export industry. Each company was in great difficulty and the following is what was discovered when looking at how their offering had been developed. First, the definition of what the actual market opportunity is for the new product or service. One would expect that in addition to the initial idea, some research would have been performed and facts gathered about where exactly the market opportunity was. For the footwear company it turned out that the most basic prioritisation of target markets – performance vs wellness – had never been settled, severely damaging the coherence of all ensuing product development efforts. For the import/export services company, initial enthusiasm had led to huge investments in the development of a technological platform, but with no clarity on whom the target users were, and no research on what potential competition might already be out there on the market.

Second, securing the relevance of product development by seeking potential customers’ feedback; investing early on in getting actual customers’ feedback prevents much larger misguided investments down the line. For our footwear company, a wide and, at least from the outside, impressive looking product range had been developed without once seeking the advice of potential customers’ focus groups or active involvement of the relevant sports federations or associations. As for the import/export services company, very expensive additional features – or functionalities – had been added to the initial platform in order to support additional services which actual use to potential customers had never been tested. Here again, there were plenty of industry bodies or potential customers that could have been contacted to provide a reality check on ideas floated inside the company.

These few examples of ‘best practices’ that should be looked for in the way that a company develops its offering may sound obvious in the sense that every one would expect that they naturally take place. The fact of the matter is that they often do not, needlessly exposing shareholders to risks they are unaware of.

Another important cornerstone of company value has to do with how the various relationships that a company has with its market are actually managed. There is a lot that any company can or should do to maximise its influence over its market, and therefore the robustness of its revenues. Most of what shareholders get in terms of information on what a company does to develop its market is sales figures, usually split between actuals and forecasts. The same set of figures can, however, hide very different realities and very different prospects for the future.

The way that distribution channels are managed is one key factor in determining how solid the top line of a company’s P&L is. Going back to our examples above, the footwear company had initially scrambled to find distributors without clarifying what criteria they should be selected on, and what a good distributor agreement should really look like given the specificity of the products. That resulted in a pool of distributors that was changing every year, preventing any kind of sales momentum to develop.

Initial sales success is also often ruined because companies understandably focus all efforts on sales and omit to set up even the most basic capabilities in terms of after sales services, thus scuppering repeat sales, affecting brand reputation, and driving sales volume into irreversible decline. The import/export service company cited above is a case in point: only invoicing and delivery had been planned for. The assumption that the information provided to customers via the web-based platform was enough for the clients to know what was happening with their goods. But a lot of things can happen between product order to a factory in country A and its delivery to the customer’s warehouse in country B, and the complete lack of a customer care unit to tackle customers calls on unexpected delays was fatal to the company’s growth prospects.

And so on… Relevance of the offering; market ‘stickiness’; operational efficiency; competencies; and management of book assets: five key components of company value. For each of these, time and professional practice have identified key activities that make them a reality, and have established generally accepted best practices. A well-organised effort to describe the way in which the various key activities are executed within a company will thus yield spectacular results in terms of transparency and support to decision-making by shareholders. It will reveal information that, although not intrinsically difficult to gather, is almost never made available to those who need it most.


As these few examples demonstrate, acting in order to protect the value of a company requires access to information about the real potential causes of value destruction, and these causes are to be found in the company’s activities. Fate, under the guise of ‘strategy’ or ‘management’, is by a long way not the sole cause of failure. The tell-tale signs are there for all to see: it is just a matter of looking.

  • 1See the latest issue of the Harvard Business Review
  • 2

    See the survey issued by the Economist Intelligence Unit on the matter in April


Christian Mustad