Ahead of the Curve (12 page)

The second example concerned a time when Quentin had brought his family, including two young children, to Paris and I had put them up at the
Telegraph
apartment. I had no idea if any of this would ever help me leverage my reflected best self or work maximally from a position of strength. But it was good to wallow in the flattery for a moment after the insecurities of those first few weeks at HBS, to be reminded of one’s qualities rather than one’s inadequacies. And that, I believe, was the point.

The fifth and final course of the first semester was finance, which did not start until the fourth week. Despite my dunking in the subject during Analytics, I was still feeling woefully unprepared. I had gone over the cases from Analytics several times, drafting and redrafting summaries, but it had become apparent during Accounting and TOM how facile many in the class were with numbers, and of course Excel, and how far behind I was. I had overheard students sharing jokes about Excel shortcuts and “macros,” a way of programming certain buttons on your computer to perform calculations that come up again and again. I was a million miles from macros, a Luddite still, with a stubby pencil and calluses forming on my index finger from pounding away at my calculator.

I was further unnerved by the fact that I had only the vaguest of ideas what exactly finance was. I knew it was about buying and selling and numbers, and that lots of people I knew claimed to be “in finance.” I knew that there were financial services companies who gouged me every time I used an ATM, and financiers who wore well-cut suits and frameless spectacles and sat in places like the City of London and Geneva packaging debt and floating stock and taking a cut of everything they touched. These people were higher in the pecking order than accountants; there or thereabouts with corporate lawyers; as powerful, on occasion, as politicians; and regarded with suspicion, bordering on contempt, by the owners of businesses. It turned out that finance is really about one thing: valuation. How do you put a price on an asset? From that basic question flows everything else. How much should I pay for it? What will the owner accept? How should I pay for it? Cash or credit? How can I increase the value of an asset I already own? Would now be a good time to sell? What risks may jeopardize the value of my asset? What can I do to mitigate them? Only once you have a clear sense of something’s value can you move on to everything else.

Teaching us finance, or FIN 1, was none other than Rick Ruback, the wisecracking head of the RC program. Our first case dealt with the Butler Lumber Company. The case was just three pages long, with two exhibits: a balance sheet and an income statement. Butler Lumber was a small business in the Pacific Northwest that sold lumber products. It was growing and making good profits but kept experiencing cash shortages. The first question Ruback asked was “do you like this business?” The cold call went to Shelly, a woman in her mid-twenties who had worked at Home Depot. She had been staring down into her notes, clearly hoping that she would not be dragged into this. But of course she was. Professors would scour the class cards to find a fitting student to cold-call for each case. If the case was about lumber, it was the Home Depot employee. If the case protagonist had graduated from Brown, the Brown alumnus would be called. If the case dealt with a newspaper company, I knew I would be picked on.

“Yes,” Shelly said, gathering herself. “It seems like a good business. The bank says the owner has good judgment, and it seems the business is growing.”

“So if you were its bank, would you let it borrow more money?”

“Ummmm, yes, I think so.”

“Why?”

Shelly winced and rested her arms on her desk. “Looking at the income statement, its profits are growing. Its operating expenses seem to be under control. There seems to be a stable set of customers.” She paused, and Ruback began asking for numbers and ratios. Shelly held her own for nearly ten minutes, and when she ran dry, Ruback called on others in the room. It turned out that Butler Lumber was making a mistake common to small businesses as they grow. It was mismanaging its cash. In order to grow, it was buying more and more wood from its suppliers. It would then store the wood in its warehouses until a customer bought it, giving its customers thirty days to pay their bills. In the meantime, of course, it had to pay its suppliers either in cash or on credit regardless of whether the wood was sold or the customer paid on time. In order to cover the time between buying the wood and selling it, it was borrowing from the bank and from its suppliers. And as the company grew, so did its dependence on credit. It was also losing out on discounts offered by suppliers for prompt cash payment.

It turned out that Butler Lumber was not such a good business after all. Its cash conversion cycle—the period between when it paid for goods and when it was paid for them—was a disgrace, which only grew as the company grew. It had, we learned, a “funding gap.” Instead of borrowing yet more from the bank, it needed to stop being so generous to its customers and pay its suppliers in cash earlier.

I learned my own lesson about cash as an undergraduate, when I was perennially short of funds. In order to buy food once my bank account had run dry, I would cash checks at a local pub, which would charge me one pound for every check I cashed. Not only was I being charged a usurious fee, but I always ended up writing a check for more than I actually needed and then spent it. Eventually, the bank would call me in, and I would have to plead for a further line of credit. And so it went. The worst thing was that no matter how I tried to right the situation, it deteriorated. Each semester, the portion of my allowance that went toward paying off the previous semester’s debt increased, until by my final year, my first act was to sign over my entire allowance to the bank and begin the year with absolutely no money. It required sackcloth, ashes, and prolonged groveling to Mr. Lester of the Midland Bank to salvage my university career. I had let my cash conversion cycle get away from me.

One company that had mastered the cash conversion cycle was Dell. In fact, in the period we studied, 1996, it had managed to turn its mastery of cash management into an advantage over its competitors. Whereas other computer makers built computers, warehoused them, and sent them into stores where customers might or might not buy them, Dell waited until it had an order and payment in hand before making a computer. While its rivals risked making computers that might be obsolete by the time they reached stores, Dell never made a computer no one had expressly ordered. To do this, it needed a far slicker production system than its competitors, which it built. It needed to have the parts and capacity at hand when the orders came through, which it did. It needed to have accurate forecasts of customer demands, which it obtained through its sales force. As Michael Dell himself explained, “what we’re all about is shrinking the time and the resources it takes to meet customers’ needs.”

Inventory,
as we would learn again and again, is a dirty word in business, and the less you have of it, the better. For a company that made computers, complicated-seeming products, and promised to deliver them within a day or two of receiving an order, Dell, staggeringly, had almost no inventory. If only Butler Lumber had been so lucky. The cash effect of this was that while Dell’s competitors sank money into product they weren’t sure people wanted, Dell earned interest on the money it was not spending on inventory. This added millions of dollars to its bottom line, increasing its value.

If finance, then, is really only about valuation, the only serious means to establishing an asset’s value is understanding how much cash it generates. People will occasionally try to obscure the issue with all kinds of curious terms like
intangible value
and
synergy value,
but really all that matters is cash. Because without cash, you could find yourself like Butler Lumber, thinking you are growing but becoming a credit junkie for lack of short-term cash. With cash, you could become Dell, leapfrogging your opposition on a trampoline of greenbacks.

But just knowing how much cash your asset produced now was not enough. You wanted to know how much it would produce in the years to come. If I put in a hundred dollars today, how much cash would be returned to me in the next ten years? Would I be better off investing in something else? The rest of the semester’s finance course would be devoted to this one task: forecasting cash flows. It was the root of valuation, and though it sounded simple enough, it turned out to be a beast.

The word
leadership
lurked in every corner of HBS. When the student clubs requested new candidates for “events organizer” or “speakers coordinator,” they emphasized that these were more than mere jobs. They were “leadership opportunities.” Every club position, no matter how menial, carried the title of vice president. One day we, too, might be part of corporate America’s bulging vice-presidential class, so we may as well get used to the weightlessness of the title. Within our section, we held elections for posts ranging from president to sports rep, alumni rep to international rep, with ten or eleven more in between. It was part of what the school called “making the section our own.” Everyone at HBS, it seemed, could be a leader of one sort or another.

In the run-up to our section elections, Ben Esty, our section chair, told us that we should run the section however we wanted. He then passed around a case concerning a section in which two members had taped up a poster of Britney Spears. Some in the section had found it offensive. Others said their right to put up the poster was a free speech issue. They ended up holding a vote in which more than half chose to leave the poster up. After a vigorous case discussion within our own section, we decided that our main duty was to create a positive learning environment.

Each candidate for the section’s leadership posts had to make a stump speech to the class. These candidates varied wildly in quality, from the aspiring Martin Luther Kings to one poor man who was so nervous he stood behind the desk fumbling with his notes and lost his chance for the presidency there and then. One student composed his own rap song to tell us why he wanted to be admissions rep, a job that involved arranging for applicants and recently admitted students to sit in on classes. Of the two leading candidates for section president, one spoke of the section as a family.The eventual winner, Brian, promised to get to know each and every one of us and keep us together over our lifetimes.

Dean Clark came to speak to us one lunchtime, and it was immediately apparent where HBS had derived its present image. He was focused and talked repeatedly about the HBS mission to educate leaders who would make a difference in the world. He spoke of the “transformational experience” of HBS as if it were a form of religious conversion. He must have given this talk dozens of times a month, but he managed to make it sound fresh and important. Several other university officials had accompanied him, and they sat in their seats like Politburo members while the party chief spoke. The Mormons in the class came to know Clark better than most of us because of their shared faith. One of them told me that at a meeting of the Mormon Club, Clark explained the secret of his success. He had whittled his life down to just four things: work, family, faith, and golf. As an academic, he used to arrive at his office at dawn and work in silence until lunchtime. Only then would he engage with the world, returning telephone calls, answering letters. On Saturdays he played golf, and on Sundays he spent the day at church with his family. Such discipline had propelled him to the leadership of the school.

When he invited questions, several hands went up. The first question was about HBS’s place in the media’s ranking of business schools. A
Wall Street Journal
poll had just come out ranking Harvard number thirteen. Numbers one and two were the business schools at the University of Michigan and Carnegie Mellon, respectively. Harvard’s low rank was in large part due to the negative opinions of recruiters, who had told the newspaper that HBS MBAs were “arrogant,” with a “sense of entitlement” and “ego problems.” Clark said he took these rankings seriously, but not too seriously. He said he didn’t want to talk about them too much as he could go on forever, but then spoke about them for fifteen minutes. If you looked at all the polls over ten years or so and averaged them out, he said, HBS came out decisively on top. Of this particular poll, “you’ve got to ask yourself, what are the questions to which this list is the answer.” The
Wall Street Journal
poll was taken among recruiters, many of whom find it hard to recruit HBS graduates. Harvard MBAs, he said, often chose between several job offers, so left many companies disappointed and complaining to newspapers.

Clark said that two of his biggest challenges were trying to change the image of HBS alumni as stuck-up jerks, though not quite in those terms, and encouraging a more diverse group of applicants by making clear to prospective students how nice and comfortable the HBS environment was. One of the most common reactions among students after their first month or so at HBS, Clark said, was how different the people were from how they had imagined they’d be. Once I had recovered from Crimson Greetings, I agreed with him. HBS was a civil place. Occasional horror stories would leak out from other sections—of sharks seeking to humiliate their classmates and fights over section norms. I had taken a dislike to Misty, who now bellowed, “Hello troops!” when she arrived in class each morning. But she was the exception. The rest of our section could not have been nicer. If I did not understand a concept discussed in class, there was always someone there to explain it. But I was quite removed. My days consisted of nothing more than attending class, studying, returning home to see Margret and Augie, and then studying before going to bed.

Those who lived more intimately in the bosom of the section had noticed darker rumblings. The skydecks had quickly become quite vicious, targeting the same few people in class who either spoke too much or made fools of themselves at section events. It was hard for them to complain, given the peer pressure to see the funny side. One man, an Indian, who was mocked again and again for his rambling contributions to discussions, now packed up and left before the skydecks began. “I don’t need to take that shit,” he told me later, when we bumped into each other in the cafeteria. “I don’t see why we have to be stuck with the same people day after day. One guy in the skydecks came up to me this week and told me if I talk again, they’d nail me in the skydecks. I don’t need this.”