Succession Planning: Preparing for the future

Episode #146 Succession Planning: Preparing for the future

Regardless of the size of business we’re in one of our objectives is to prepare for the future. This means making sure that we have the talent and capability in place so that if something happens to us or one of our key people, the business doesn’t skip a beat.

We had a question via a podcast review from one of our listeners, a small business owner in the UK. He asked how we can manage succession risk when resources are severely limited.

For example, at Your CEO Mentor, we have only four employees at present and we rely on a lot of outsourced services. So how do you actually ensure your talent is stable, and that you have confidence in the continuity of your business when options are so limited.

The concepts of talent identification and key person risk are critical to being able to survive in the long-term.

• I’m going to start with a look at one of the most famous examples of key person, risk Berkshire Hathaway, and its majority shareholder Warren Buffett.

• We’ll talk about how to identify key person risk in your organisation.

• I’ll finish with my eight top tips for avoiding the talent crunch now and into the future. So let’s get into it.

Before we start, there are a couple of older episodes I’m going to refer you to;

• Episode #144: The Skills Shortage – if you haven’t heard this episode yet, I think you’ll find it useful to get a better understanding of what you’re likely to face in the labour market at the moment. And when you’re thinking about protecting the capability and skill base of your business, that’s really important.

• Episode #76: The Family Affair – if you’re in a smaller or founder-led business, you’ll find this pretty useful. This is the episode where I look at the different types of businesses and, in particular, address the challenge of making a business more than a single generational blip on the radar. This is about longevity as much as anything else.

Having said that I’m going to help micro businesses understand talent management and succession planning, my first example is of a firm worth about USD $645 billion.

I recently came across an article in The Economist that examined the succession issues likely to emerge at Berkshire Hathaway, one of the most successful firms on the planet.

Berkshire Hathaway has long been the corporate vehicle of the storied investor, Warren Buffett. He’s known as the ‘Oracle of Omaha’ due to the mystique that surrounds him. He’s arguably the most successful investor on the planet. The $64,000 question is, “Who takes over Berkshire Hathaway when Buffett’s gone?” Buffett’s about to turn 91 in a couple of months.

If you think succession is coming from his vice chairman’s seat, think again. Berkshire Hathaway’s vice chairman and Buffet’s right-hand man is Charlie Munger, who is now 97. At a recent annual shareholder gathering, Munger slipped that the succession candidate for replacing Buffett is Greg Abel, who is a baby in relative terms at only 58 years old.

When we look at Berkshire Hathaway’s $645 billion market valuation, $300 billion of that is held through minority stakes in other stocks, and the remainder is in businesses that Berkshire Hathaway controls itself – and that’s everything from railways to ice cream. Over the course of the Buffett reign, Berkshire Hathaway has delivered shareholder returns at a compound annual growth rate of 20%. That’s double the S & P 500. How on earth do you replace that?

But Berkshire Hathaway’s performance relative to the S & P has also been falling for decades. In the last five years or so, they’ve made some sketchy investments in airlines… they’ve overpaid for businesses they’ve acquired… and they’ve seen other investments that they have significant stakes in underperform. But I do have to say great diversification, which is also a key to talent management. It gives you a lot of flexibility. In Berkshire’s case, coming out of COVID, tech stocks might be overvalued, but their railroad business, Burlington Northern Santa Fe will make an absolute killing.

Even though Buffett enjoys celebrity status and what amounts to almost a cult following, the Berkshire Hathaway subsidiaries are left almost wholly to their own devices. This huge corporate conglomerate has a head office staff of only 26 people. Each subsidiary business has its own legal HR, accounting, and so forth. Buffett trusts his management teams to get on with it.

Now, one might speculate that this is great when you’ve got the right people, but disastrous when you don’t. It is true that Berkshire is subject to the vagaries of its minority shareholdings, like the 26%-odd stake it has in Kraft Heinz. There are concerns that in the transition from Buffett to the next head, many proposals will come to break up Berkshire’s diverse assets into more logical divisions. Control of the business will be difficult because Buffett’s 30% stake will be spread to the four winds.

This article quotes James J. Hill, who once said that a company only has permanent value when it no longer depends on the life or labour of any single individual. What’s almost certain is the Berkshire Hathaway will look a lot different in five or 10 years from now.

The reason I took you down the path of the Warren Buffett story is that, on face value, it appears to be a very real succession planning risk. Surely without Buffett, the company will begin to decline, won’t it? Well, I don’t think so.

As a stock picker these days, Buffett’s halo has been a little tarnished and the majority of Berkshire Hathaway’s value is derived from businesses that are run with virtually no involvement or intervention from the Oracle of Omaha. Can someone like Greg Abel be successful when he has such a hard act to follow? I don’t see any reason why not, and I think Berkshire shareholders will be just fine.

how to identify key person risk in your organisation

Now for us in our much smaller businesses, how would we identify key person risk? Well, in a micro business, it’s easy. You can look around the room, see who’s doing what and work out what’s critical to your operations.

If you’re running the business well, almost everything should be. So you have to think about how to mitigate the risk of someone being here today and gone tomorrow. You might have some great people: people you depend upon; people who do the job the way you want it done. But they are a key person risk only if you can’t replace them readily.

Let’s think about this carefully.

Knowledge can be acquired, but if there are certain skills that are very difficult to obtain from the market that may well make the person very hard to replace and therefore a key person risk.

Let me give you an example of how to think through this. I want you to pay particular attention to my thought process, not just the story.

When I arrived at CS energy, I marvelled at the deep technical skills of some of the engineers. Many had over 30 years experience in their specialist area of coal-fired electricity generation. They had worked on the projects that had built the very plants that we owned and operated. They’d seen multiple overhaul and maintenance cycles and dealt with the problems the assets had exhibited as they aged. This accumulated experience and expertise surely posed key person risk to the company in a range of areas. Right? Well, at first I thought so, but as time went on, I actually changed my view.

Initially, we tried to find a way to grow new talent underneath these wise, experienced heads so that we could one day replace them. But that was easier said than done. It wasn’t like 30 or 40 years ago. The top engineering students coming out of our universities today, don’t want to specialise in coal-fired power generation. They’re specialising in robotics and artificial intelligence. So we didn’t have a good feedstock of talent coming into the business. Also, the fact that much of their knowledge remained undocumented, a ‘black art’ so to speak, made it even harder to substitute for their skill and experience. It dawned on me that it was unlikely, we’d be able to replace that capability that rested with only half a dozen key individuals.

Once I had this blinding realisation, my next question was, “How core is this to the competitive advantage that we’re trying to achieve in our market?” My answer to that was, “Not Very!”

At the end of the day, our competitiveness in the market relied much more on predetermined asset characteristics than the knowledge of these people. Things like: “What’s the cost of each tonne of coal that we feed into the power station boilers compared to our competitors?”… “Do we have control of our generation capacity to the extent we need to, to take advantage of the peaks and troughs in the dynamically-traded wholesale energy market?”… “What cost structures had been built into the business?” These things were much more likely to determine our success and competitiveness than the skills of our engineers.

The deep skills in the black art of power station engineering didn’t seem to be driving a competitive advantage for the company in commercial terms. In my view, the advantage was immaterial.

Now, don’t get me wrong. I’m not being disrespectful to the good people. Who’ve spent their lives, trying to get the best outcomes they could for the company. What I am saying is that to be brutally honest, it’s like any perceived advantage in business. If you can’t articulate it, if you can’t measure it, and if you can’t price that value into a market, it simply doesn’t exist.

To recap, we had some deep skills that were arguably pretty valuable. We didn’t have the ability to easily replace these skills and they may or may not have been core to the successful running of the business, although I had serious doubts about that.

So then I went to plan B – can I buy these skills out of the market when I need them? Let’s face it, in our company, we had experience ranging across maybe 10 or 12 power station units, but companies like General Electric, Toshiba, and Siemens had experience with thousands of similar power station units all over the world. If the skills in this technology were going to be maintained over time, that’s where we would find them. And let’s face it, coal-fired electricity generation is a declining market – in 20 or 30 years, the need for those skills will disappear almost entirely. It became blindingly obvious to me that, to solve this key person problem, we would have to completely change the way we looked at it and set up alliances with other companies to provide the skills (obviously at a premium) as and when they were required. Our succession planning risk wasn’t really a risk at all!

8 rules of thumb for talent and succession planning

Let’s finish with some rules of thumb, for talent and succession planning.

We’ve made a free PDF resource for this, which you can download here. I know that these will be incredibly valuable whether your business has one person or a hundred thousand people.

Tip #1: Know the difference between potential and performance.

When we talk about talent, there are two separate dimensions we have to consider – potential and performance. Performance is the starting point, because there’s no potential for growth without performance in the current role. Don’t get sucked in by the person who makes all the right noises, talks a great game, and is incredibly likeable.

Performance has to be established based on results. But equally, don’t be lulled into the misconception that just because someone is good in the role they’re currently in, they can easily adapt to another role at a higher level. Think carefully about what capabilities and skills someone would need to make the transition to a broader, more complex and more demanding role.

Tip #2: Know the difference between knowledge and capability

Knowledge can be easily acquired. Capability? Not so much! We tend to see people who know a lot of things as being indispensable, just because of what they know But culturally, they are vastly different things.

Peter Senge, in his classic book, ‘The Fifth Discipline’, drew the distinction between knowing and learning organisations. The “knowledge is power” culture makes for poor performance. Instead think about building capability. People who can adapt, understand new concepts easily and see patterns in data and events that most people can’t. They will be immeasurably more valuable to you in the long run.

Tip #3: Know what are core skills and what are commodity skills

The only types of skills and knowledge that you need to be concerned about are those that differentiate you from your competitors. Some skills are absolutely core to your business, but others are a dime a dozen. For example, you don’t have to worry about losing your accounts payable clerk.

Of course, no disrespect to accounts payable clerks, but you can hire any of a dozen firms to process your accounts for you almost immediately. But if you’re a hedge fund, you may need to worry about losing your chief investment officer. That would be a key person, risk.

Tip #4: Multi-skill your people

No matter how big or small your business, make sure you give people the opportunity to learn about as many facets of the business as possible. Give them experience across multiple parts of the business. Now in big businesses, this should be easy, but it doesn’t necessarily play that way all the time.

Whereas there are many more opportunities for moving people around to give them more experience, people tend to specialise in much narrow fields. In small business, let people acquire as much breadth of experience as they have an appetite for (of course, as long as you keep clear accountabilities in place). Try not to allow islands of knowledge or capability to form. That’s just increasing your key person risk.

Tip #5: You have good processes and procedures

The best antidote for knowledge hoarding is to ensure that people are compelled to document what they do. In our business, Em is absolutely fanatical about creating processes for everything we do to run the vital parts of the business. As new people join, they can be brought up to speed much faster, and there’s much greater consistency in how things are done.

Tip #6: Understand your market

I fleshed out the example about the deep engineering expertise at CS Energy to highlight this point. Know what skills are available in the market and know how to get them. Even if you determine that you want to retain a certain set of capabilities internally, you never know when you’ll need a stop gap measure. We tend to look internally and become comfortable with the fact that everything is working as we’d like it to. Always think about the risk of disruption and how you might solve that problem.

Tip #7: Make yourself and your key people redundant, not indispensable

When you look at the team below you, your main consideration should be to ensure that they can do their jobs, regardless of whether or not you choose to turn up. The people who we think are indispensable most often aren’t. But we can gain a lot more confidence that our risk is covered by having consistent experience of people stepping up and getting the job done when gaps emerge. In reality, no one is indispensable. Not me, not you, not anyone.

I once had a boss, give me a good yardstick for how to work this out. He said to me, “Mate, you’re starting to talk as if you think you’re indispensable. So tonight I want you to go home. Have you got one of those plastic household buckets? Well just half fill that with water, and roll your sleeve up, and make a fist with your right hand. And put your arm into the bucket so that it goes to the bottom and your fist touches the bottom of the bucket and the water is around your arm. Now, here’s what you have to do. Pull your arm out really quickly, and if you look at the water in the bucket and you can see where your arm was, that means you’re indispensable.”

Tip #8: Think about scaling

Now in our business at Your CEO Mentor, we’re incredibly dependent on me and Em to deliver. But we have a strategy for scaling, so that we don’t have to rely solely on ourselves going forward. As I said before, Em is incredibly fanatical about capturing her skills, capability and knowledge in processes. But for me, it’s even harder… Who records the weekly, No Bullsh!t Leadership podcast, if not me?! Well, that’s the dilemma for every business, and one we’ll certainly solve in the fullness of time.

Making sure your business is resilient to the risk of losing people is core to founders, CEOs and senior executives. So get the right perspective and keep this front of mind. You don’t need sophisticated talent management processes, but you do need to think critically about what skills you need to operate and grow your business, and how rare those skills truly are.