What’s the measure of an outstanding business leader? Is it their managerial abilities? Their company’s share price? Their charisma, or even name recognition? In short, how do you know when you’re looking at a great CEO?
William Thorndike says it’s none of the above. In his book The Outsiders, he explores eight exemplary CEOs and examines the nature of their success.
Named as one of the most important business books by Forbes, The Outsiders features business leaders you’ve probably never heard of—nonetheless, they have substantially out-performed the best-known leaders. Their leadership characteristics differ remarkably from the typical archetypes, and their methodologies are divergent from their peers.
When the dust settles, Thorndike finds that the success of these leaders can be attributed to one hyper-focused practice: capital allocation.
What Is Capital Allocation?
Most people assume the primary role of the CEO is to efficiently manage the organization. The public glorifies this aspect of the job, but this is merely the baseline requirement for a company’s survival. Capital allocation is more important, because it can distinguish your company’s growth from your peers. But what exactly is capital allocation?
Capital allocation is all about what you do with your cash and how you generate it. Options include:
- Investing in operations
- Buying businesses
- Paying dividends
- Paying off debt
- Buying back share in the business
As a CEO, you can make perfect decisions on the managerial side, but what really multiplies your success is your ability to allocate capital. Your job as the head of the company is to evaluate all of your alternatives to spending capital and to choose the one that produces the greatest long-term impact—and doing it at appropriate risk levels.
As logical as it sounds, this kind of thinking isn’t very common. It requires great discipline to master. And because the skills for allocating capital aren’t required for most jobs, they simply aren’t picked up along the way. Most organizations that grow leaders from within are missing this critical skill set.
As a result, there’s a skill set deficit across industries. And since most leaders look to their peers to make decisions, they all make the same mistakes.
By contrast, successful capital allocators think independently and develop these skills on their own. Very few people understand capital allocation, and fewer still are experts at it. But the good news is, it’s that much easier to compete when there’s no one in the ballpark.
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Becoming a Capital Allocator
As the head of your company, your time is valuable, because you control the resources. Shouldn’t you spend the majority of this time evaluating the distribution of these resources?
Thorndike says to focus on building long-term value, not on organizational sprawl. Your cash-flow creates opportunities. Find a way to increase it and focus on using cash to make investments that do the same. These investments should target the best option available at the time (read: cheap compared to value).
If no investment meets your conservative predetermined criteria, Thorndike says to be prepared to sit on cash (or pay a dividend). Sometimes your organization is the cheapest available opportunity—can you buy it back? Other times, a division is more valuable by selling it, and you can use the cash to buy better investments. When your company is overvalued, consider issuing equity to buy other businesses. Is your money better spent paying down loans or applying leverage?
Don’t repurchase when your price is high—the investment’s price must be attractive. Don’t acquire because your competition did. Focus internally, and wait for value. Welcome a big bet when the numbers are on your side. Don’t be afraid to walk away from a negotiation above your price.
You must have the discipline to run the numbers. It’s your most important role, that’s why they pay you.
Don’t be afraid to go against the grain and be a contrarian. Have the confidence to make logic-based decisions instead of emotional ones. Think about your peers’ actions that you might be tempted to copy and ask if they make sense with the principles of The Outsiders in mind.
As Thorndike says, a dollar-in must produce more than a dollar-out. In fact, if you can’t reliably produce above market rates, you’re obligated to pay the dividend so that your organization’s owners can allocate this capital instead. Never destroy value.
An owner-operator thinks like an investor, and ideally, all employees develop this skill set as well. Any money spent in the organization, at any level, is an investment. Next time you’re making a tough decision on an investment on behalf of your company consider the lessons of The Outsiders, and as we say in our core values at Traction Tools, find a way to win!
Ready to be a capital allocator? Check out The Outsiders!
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