Crimes Against Reality - Page 3

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On energy, one of my favorite quotations comes from one of his old economics professors at the University of Houston back in the 60’s, Henry Steele who remembered: “In addition to working days at Exxon, writing speeches for the Chairman, Mike Wright - among other things, Ken was taking a five course load in evening classes which he said was easy and jogging a number of miles after work too”. 

I was quite taken by his energy to say the least.  Incredible energy.  To make one extra phone call to get on a plane - Ken Lay always did that.  So Ken Lay was very ambitious but at some point, Ken wanted Enron to be much more than good and successful, Ken wanted Enron and himself to be great and legendary.  He wanted to be a great man of the energy industry   But more, a great man of American society and business.   And this explains the hugely ambitious visions at Enron.  The ink was barely dry in 1985 on the merger of Houston Natural Gas and Inter-North where H&G’s debt load went from 25% to almost 70% when Ken proclaimed the new combined company to be America’s premier energy company.  And this was at a very scary time in the industry’s history.  There was the success of Enron Visions to become the premier integrated natural gas company of North America.  To become the world’s first natural gas major; To become the world’s leading energy company and to become the world’s leading company.   Wow.  Some of these visions in retrospect were tragically beyond the business plan and the capabilities of the Enron management team and the rank and file employees. 


But not only did Lay’s ambitions for Enron change, he himself changed in a profound way in the mid 1990’s by the mid- 90’s - a change that led to a fateful decision to not retain Richard Kinder by making him CEO and to choose Jeff Skilling instead. 

This is Ken Lay in 1986 - his game face is on. There are real problems confronting Enron and the industry.  This is Ken Lay about 15 or 16 years later when he believed that Enron had unassailable competitive advantage.   And I think these are two very different people - very different people.  My working hypothesis is that Skilling was picked over Kinder because Richard Kinder was an incrementalist in terms of a business model and Jeff Skilling was a revolutionist.  And Lay’s vision was all about the later.

Let’s talk a little bit about Ken Lay’s business model.   There hasn’t been nearly as much emphasis on this as there should be.  You cannot understand Enron from the mid 90’s forward without understanding what Lay was trying to achieve.  Ken Lay had a business model.  That model was perpetual first mover advantage - a model of revolutionary change or revolution always over incremental improvement.  It’s baseball season now so the analogy would be to swing for the fences and don’t use the strategy of the small ball: the walk, the steal, the sacrifice, scoring runs that way - go for the fences.   And Ken’s years at Florida Gas Company, Transco and at the very beginning of Enron in the early 90’s, it was more small ball.  And this is Ken’s first annual report at Houston Natural Gas, “Getting Back To Basics”, we’re going to stay with our knitting and do what we do best.  And this quotation is Principle 6 of A from Tom Peters book, “In Search of Excellence” and this book is in the tradition of incremental improvement for business.  And parenthetically, this business philosophy - Peter’s business philosophy of staying close to the customer, hands on management is most certainly Rich Kinder’s business model at Kinder & Morgan today or Exxon-Mobil’s business model.  And now it is so common sensical and so engrained that you really don’t want to footnote it to anybody.  But Ken Lay was not a status quo person.   He had something else in mind rather than just incremental improvement.  

And the roots of Ken Lay’s business model can be traced back to the great and colorful economist Joseph Schumpter who famously said in the 1940’s, “Every piece of business strategy must be seen in its role in the perennial gale of creative destruction.  It cannot be understood irrespective of it or in fact on the hypothesis that there is a perennial lull”. 

The two parts of the sentence “business strategy” - it was the first time that business strategy had ever been used in a significant way - that was in 1942 by Joseph Schumpter.  He also used the term  “creative destruction” which next to the “invisible hand” is the most important concept in economics and business.  But Lay was not a direct student of Schumpter.  Lay was a student of Peter Drucker whose 1968 book - the ‘Age of Discontinuity’ influenced Lay greatly and Lay used it as a textbook in a graduate course he taught at George Washington University in the early 70’s in Washington DC while he was working for the Federal Power Commission - teaching at night.  He had way too much energy to go home after working during the day.

Drucker’s book spoke about a new economic reality where knowledge trumps experience and the managerial role was ceding ground to the entrepreneurial function.  The Age of Continuity Drucker explained, was being overthrown by rapidly improving knowledge, disruptive technology and the diffusion of new products.  Business value in the future, Drucker concluded - and this was back in 1968, would come from the disrupting value creating entrepreneur.   

Fast forward a quarter century and let me introduce you to the guru of Ken Lay and Enron’s business model - Gary Hamel.  Hamel was a Drucker disciple who brought the discontinuity revolution to new heights in his book, “Competing for the Future and Leading the Revolution”.  To Hamel, the Age of Incrementalism was over.   The idea of cutting costs a little bit, increasing revenue a little bit - if you are doing that, there is another competitor that’s reinventing the industry that is going to leave you behind.    Don’t transform your organization.  Transform your industry.  Don’t be a rule taker, be a rule maker - no more, be a rule breaker.  How many of us at Enron remember all the presentations: ‘rule taker, rule maker, rule breaker. “We’re the rule breaker”.  “We’re revolutionaries”. 

Speaking of revolutionaries, there is an Enron mouse pad: “What are you going to do to change the world today”.  And there are interviews with Andy Fastow during this period: “I’m a revolutionary”. Lots of things at Enron were going on because people saw themselves as revolutionary.  And the idea went to the very end.  There was a conference in New York City by Gary Hamel on revolution, “Revolt, Revolt” and Ken Lay was scheduled to appear and this was less than a month before Enron’s bankruptcy.  And here is the draft of the speech that never got given [displays papers].  And I look back on it and maybe in the Q & A we can talk about some of the strengths and weaknesses of it.  But try to get into Ken Lay and Enron’s mind on what’s going on here - the Age of Incrementalism is over. 

So Ken Lay’s business model put in practice is something like this - there are great pools of potential profits just awaiting entrepreneurial discovery and action - opportunities that the stodgy competition has not or cannot see.  By employing and empowering the best and brightest, potential profits can be turned into actual profits.  But to get the best and the brightest, you have to implement very aggressive compensation systems, very aggressive employee review systems to weed out the slow folks - to create a world class, fun corporate culture.  In the corporate culture at Enron the basketball games in the front of the building with Ken Lay guarding Clyde Drexler and uh we have a couple of old Enron PR people here and I’m trying to remember if we got out a press release where it said that Ken Lay dunked one on Clyde the Glide - but maybe we didn’t. 

Houston’s professional sports teams - Ken Lay’s determined efforts to keep professional sports in Houston was absolutely essential if Enron was going to hire the best and the brightest; if Enron was going to get the top MBA’s instead of New York, San Francisco or Chicago with their sports teams.   Think of Ken Lay in terms of Enron from the beginning to just about the end.

Now to create a lot of new competitive space for Enron’s revolutionaries to make money - something very important had to be done.   At this point, you have to understand that Enron was the foremost - not free market capitalist company - but the foremost political capitalism company - because a lot of the new competitive space came from rule changes in Washington DC.  So many of Enron’s profit centers had lots to do with new legislation and rule changes to create the competitive space where the first mover profits.  It was political capitalism over free market capitalism.  Revolution over Incrementalism and asset lite. 

If you can use everyone else’s interstate pipelines and interstate transmission grid through government regulation, mandatory open access, indeed you can be asset lite and indeed you can hire the best and brightest to buy and sell gas and electricity at Enron.  But the irony here that the interpretation when Enron fell was that capitalism got the blame for no company in the history of the United States lobbied for and received more government favors in more ways than Enron.  It’s very ironic that many have concluded that more regulation was the correction for the failure of prior regulation.  In fact, existing regulation allowed the gaming opportunities for Enron with the tax system, the accounting system and regulatory trading particularly out in California.   Many have failed to understand that in some if not many cases, the more you regulate, the more you need to regulate.  And Enron was a master at gaming the regulations.


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