As of this writing, no settlement of the dispute was in sight. A multinational partner of a Chinese firm should recognize Mao’s tactics and regard their use as an indication that the company is dealing with an authoritarian leader who tends to be secretive (secretiveness was a characteristic of many of the CEOs we studied) and who is likely to bypass formal decisionmaking processes. Such companies often have vague organizational structures and CEOs who can easily nullify any of the company’s agreements, hampering the JV’s attempts to implement official strategy. Recognizing a CEO’s penchant for Mao-style tactics isn’t easy, but the chief executive’s age is often revealing. Mao left an indelible imprint on the thinking of Chinese people who are now in their forties or older. Another indicator is a firm’s inability to select a second in command or successor (one analyst has wryly noted that Ren Zhengfei of the telecom equipment company Huawei has “more than 100 second in commands”). A multinational that chooses to work with a CEO who uses those tactics needs to have effective procedures – both formal and informal – in place for monitoring the Chinese leadership. A JV should create a standing executive committee with members from both companies that meets frequently and monitors the CEO and the decision-making process. At the same time, the foreign partner should take note of small details: For example, one way to anticipate management reshuffles is to pay attention to clues such as who sits where at receptions and who gets invited to play golf with whom. A former senior executive of Procter & Gamble in China described successfully following similar procedures during his P&G tenure. Additionally, a multinational should always be ready with a contingency plan to thwart the Chinese leader’s attempts to get around organizational procedures. Had Wahaha’s French managers anticipated Zong’s tactic, they might have been able to defuse it by providing rankand-file workers with objective information on the dispute.
Shaomin Li (
[email protected]), a professor of management and international business at Old Dominion University in Norfolk, Virginia, was the founding CEO of a Hong Kong– based IT firm with subsidiaries in China. Kuang S. Yeh (
[email protected]) is the chair of the Department of Business
Radical Shift The returns and relative rankings of the top 10 private equity performers (among 1,184 funds studied) change dramatically when fund performance is calculated according to the modified IRR rather than according to internal rate of return.
Management and EMBA director at Na-
Top 10 private equity performers
tional Sun Yat-Sen University in Kaohsiung, Taiwan.
Reprint F0712C
INVESTING
The Truth About Private Equity Performance by Oliver Gottschalg and Ludovic Phalippou
Rising credit costs have already taken the bloom off private equity’s rose, but some funds (and some investors) are due for another shock. Our research shows that the way PE fund performance is most often reported overstates the truth. Here’s the problem: Private equity returns are often reported as the internal rate of return (IRR) – the annual yield on an investment – of the underlying cash flows. This implicitly assumes that cash proceeds have been reinvested at the IRR over the entire investment period – that if, for example, a PE fund reports a 50% IRR and has returned cash early in its life, the cash was put to work again at a 50% annual return. In reality, investors are unlikely to find such an investment opportunity every time cash is distributed. Finance 101 teaches us a simple solution to this problem: the so-called modified IRR (M-IRR). This measure is similar to the regular IRR, but rather than assuming reinvestments at the IRR, it specifies a fixed rate of return for investing and borrowing. We looked at this measure in a study of 1,184 private equity funds raised from 1980 to 1995, considering all investments and corresponding cash flows through 2004. The highest IRR in our sample was an impressive 464% per year; when we applied the M-IRR measure to that fund and specified 12% per
Fund
Fund IRR %
Fund rank
Fund M-IRR %
Fund rank
A
464
1
31
9
B
313
2
42
4
C
248
3
30
10
D
244
4
41
6
E
190
5
43
3
F
166
6
41
5
G
155
7
33
8
H
153
8
28
15
I
147
9
23
21
J
143
10
29
13
annum for borrowing and investing, we got an M-IRR of 31%: a far cry from 464%, and certainly a better representation of the fund’s true return. Doing the same for all funds in our sample, we found that the top 25% as ranked by IRR had an average net-offees IRR of 35.32%. However, the top 25% as ranked by M-IRR (assuming borrowing and investing at 12%) had an average M-IRR of only 18.56% – much more in line with other investment opportunities. In addition to skewing the apparent performance of “star” funds, IRR calculations can mislead investors who are trying to compare the returns of different fund managers. We ranked the funds in our sample according to IRR and M-IRR and found immediately that the top two according to M-IRR don’t even appear in the list of the top 10 according to IRR. As the table shows, the top 10 IRR funds in our sample shift dramatically when ranked by M-IRR. What’s more, the astronomical returns suggested by IRR calculations plummet to earth when an M-IRR calculation is applied. Overstated private equity performance may partially explain why investors continue to allocate substantial capital continued on page 20
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Harvard Business Review 17
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Oliver Gottschalg (
[email protected]) is an assistant professor of strategy at HEC
Top Tools in 2006 The executives in our survey scored the tools below according to how frequently they were used and how much satisfaction they delivered. higher usage
to this asset class, despite our finding (forthcoming in the Review of Financial Studies) that PE funds have historically underperformed broad public market indexes by about 3% per year on average.
Blunt instruments
Knowledge Management Balanced Scorecard
at the University of Amsterdam Business School. The full paper describing this research is available at www.buyout
Shared Service Centers
Reprint F0712D
Loyalty Management TOOLS
lower usage
by Darrell Rigby and Barbara Bilodeau
Managers have a profusion of tools at their disposal – benchmarking, outsourcing, and customer segmentation to name a few – so it is a challenge to choose the right one for the job at hand. We set out to learn how (and how successfully) organizations are using tools, with the goal of helping executives make informed decisions about which ones to try. Every year or two since 1993, Bain & Company has culled the 25 most popular tools from a list of 50 to 100 by weighting and rating their mentions in academic and mainstream business articles. We have also asked thousands of executives worldwide how frequently and extensively they’ve used these tools, whether they’ve been satisfied with the results, and whether they intend to use the tools again. Now, with 8,504 survey responses in hand, we have a good sense of the tools’ performance today and over the past 15 years. After looking at the various ways managers use the tools and comparing levels of use and satisfaction, we have grouped them into four categories. (See the chart “Top Tools in 2006.”) Rudimentary implements – though they often generate buzz – are for a number of reasons underdeveloped. Sometimes, developing them would be overly complex; other times, the problems
20 Harvard Business Review
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Consumer Ethnography
Strategic Planning
Customer Segmentation Core Competencies
Outsourcing
uva.nl) is an assistant professor of finance
Selecting Management Tools Wisely
CRM
Mission and Vision Statements
Paris. Ludovic Phalippou (l.phalippou@
research.org.
Power tools
Benchmarking
BP Reengineering Growth Strategy
Scenario and Contingency Planning Strategic Alliances Supply Chain Management
TQM Lean Operations Collaborative Innovation
Mergers and Acquisitions
Six Sigma Offshoring
Corporate Blogs
Rudimentary implements
Specialty tools
RFID
lower satisfaction
higher satisfaction
Six Tools Over Time Management tools become more or less useful when their capabilities change or when there’s a shift in the business environment. Here’s how some of the most familiar ones have evolved since 1993.
December 2007
Knowledge Management
Cycle Time Reduction
2006 1993 2000 1996 Scenario and Contingency Planning
Customer Segmentation 2006
2006
1998
1993
Strategic Planning
CRM 2006
2006 1996
2000
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