In order to understand the reverse mortgage, one need to first understand what a regular mortgage is. In a regular mortgage, a borrower mortgages his immoveable assets with the lender in order to raise loan amount (which he/she may in turn use to buy the property proposed to be mortgaged); on the amount borrowed, the borrower pays interest at a particular rate for a particular period. The borrower then has to repay the loan amount in the form of EMIs (equated monthly installments), which comprise of both principal and interest amounts. The mortgaged property is utilised as a security to cover the risk of default on the borrower's part.
In the reverse mortgage, the person who own any immoveable property, and wants to create regular flow of money, can mortgage the same with the lender (a scheduled bank, NBFC or a housing finance company-HFC). In return, the lender makes periodic payment to the borrowers during their lifetime/or certain agreed period. Inspite of mortgaging the house property/immoveable assets, the borrower can continue to stay in it during his entire life span and continue to receive regular flows of money from the lender as well. Also, since the borrower doesn't have to repay the 'borrowed amount' to the lender, borrower is not bothered about the payment of EMIs.
The lender will recover the loan along with the accumulated interest by selling the house after the death of the borrower or earlier, if the borrower leaves the mortgaged residential property permanently. Any excess amount will be remitted back to the borrower or his heirs. However, before resorting to sale of the house, preference will be given to the owner or his heirs to repay or prepay the loan amount, along with the interest, and to get the mortgaged property released.
To summarise in one sentence, in normal loan secured by the mortgage of immoveable property the borrower taken loan in one go and repays in installment/EMIs, however in a reverse merger, the borrower takes loan in installment (monthly payment by bank to the borrower) but repays at once (may be after his/her death) by selling the mortgaged property.
The concept of reverse mortgage, although new in India, is very popular in the Western countries. Recently, National Housing Bank (NHB), a subsidiary of the Reserve Bank of India (RBI), released draft norms of reverse mortgage (the final guidelines are awaited). Following are some of the key features of the scheme from the draft norms.
1. As per the norms, a house owner who has crossed 60 years of age is eligible to seek a loan of upto 60% of the value of residential property by mortgaging the same (for the maximum period of 15 years) with a bank/HFC, while retaining the right to stay in the property. The borrower i.e. house owner is not required to pay back the loan amount.
2. In terms of receiving the loan amount, the borrower can opt for monthly, quarterly, annual or lump sum payments or payments at any other point in time as per his discretion. Also, a revaluation of the property has to be under taken by the bank/HFC once every 5 years. Consequent to the revaluation, necessary changes will be made to the loan amount. However, the bank/HFC will have the discretion to decide the mode of payment of loan and to determine the tenure of the loan, depending on factors like the state and market value of the property and age of the borrower, among others.
3. The borrower can use the loan amount for various purposes like renovation and extension of the residential property, maintenance/insurance of the residential property and family's medical or emergency expenditure, among others. However, the loan amount cannot be used for any speculative or trading purposes.
4. The interest rate on the reverse mortgage will be determined by the bank/HFC based on the risk perception and loan pricing policy, among others. Fixed and floating rate of interest may be offered, subject to a transparent disclosure of the terms and conditions to the borrower.
5. The lender will recover the loan along with the accumulated interest by selling the house after the death of the borrower or earlier, if the borrower leaves the mortgaged residential property permanently. Any excess amount will be remitted back to the borrower or his heirs. However, before resorting to sale of the house, preference will be given to the owner or his heirs to repay or prepay the loan amount, along with the interest, and to get the mortgaged property released.
6. The amount received through reverse mortgage is considered as loan and not income; hence the same will not attract any tax liability.
Following is the summary of guidelines issued by National Housing Bank with respect to Reverse Mortgages:
a. As per the guidelines, the maximum loan tenure can be 15 years. So, if the borrower outlives the loan tenure, he can continue to stay in the house. However he will no longer be eligible for any payments from the bank/HFC. The bank bears the risk that the outstanding will exceed the market value of property then and will not ask for the difference from the heirs.
b. The bank/HFC shall have the option to revise the periodic/lump sum amount at such frequency or intervals based on revaluation of property, or at least once every 5 years. The borrower will be provided the option to accept the revised terms and conditions to continue the loan. However, if he refuses to accept the revised terms and conditions, no further payments shall be made by the bank/HFC. Interest at the rate agreed before the review will continue to accrue on the outstanding loan amount.
c. Since the reverse mortgage can be either at fixed or floating rates, it will be prone to the interest rate movements. Hence, in the scenario when interest rates are moving northwards, a floating rate reverse mortgage would add to the borrower's liability.
d. Under the reverse mortgage, the legal heirs of the owner are not entitled to take control over the mortgaged property upto the extent of the outstanding loan. They are required to first repay the outstanding loan amount along with the interest to stake a claim on the property.
e. The banks/HFCs at their discretion may levy penalty or other charges on the prepayment of loan. So, if the borrower or his heirs wish to prepay the loan amount, they may have to bear an additional cost.
The most important advantage offered by the reverse mortgage scheme is that despite mortgaging the house, the house owner retains its ownership, is entitled to live in the same throughout his lifetime and also has access to a regular income stream, which can help meet his day-to-day needs. From the bank's/HFC's perspective, the mortgage on the property in its favour ensures that there is no scope for default.
EXTRACTS OF THE NHB GUIDELINES
REVERSE MORTGAGE LOAN (RML): OPERATIONAL GUIDELINES ISSUED BY NATIONAL HOUSING BANK
1. Reverse Mortgage Loans (RMLs) are to be extended by Primary Lending Institutions (PLIs) viz. Scheduled Banks and Housing Finance Companies (HFCs) registered with NHB. The PLIs reserve their discretion to offer Reverse Mortgage Loans. Prospective borrowers are advised to consult PLIs regarding the detailed terms of RML as may be applicable to them.
2. Eligible Borrowers:· Should be Senior Citizen of India above 60 years of age.
· Married couples will be eligible as joint borrowers for financial assistance. In such a case, the age criteria for the couple would be at the discretion of the PLI, subject to at least one of them being above 60 years of age. PLIs may put in place suitable safeguards keeping into view the inherent longevity risk.
· Should be the owner of a self- acquired, self occupied residential property (house or flat) located in India, with clear title indicating the prospective borrower’s ownership of the property.
· The residential property should be free from any encumbrances.
· The residual life of the property should be at least 20 years.
· The prospective borrowers should use that residential property as permanent primary residence. For the purpose of determining that the residential property is the permanent primary residence of the borrower, the PLIs may rely on documentary evidence, other sources supplemented by physical inspections.
3. Determination of Eligible Amount of Loan:
· The amount of loan will depend on market value of residential property, as assessed by the PLI, age of borrower(s), and prevalent interest rate.
· The table given hereunder may serve as an indicative guide for determining loan eligibility:
Age
Loan as proportion of Assessed Value of Property
60 – 65
40%
66 – 70
50%
71 – 75
55%
Above 75
60%
The above table is indicative and the PLIs will have the discretion to determine the eligible quantum of loan reckoning the ‘no negative equity guarantee’ being provided by the PLI. The methodology adopted for determining the quantum of loan including the detailed tables of calculations, the rate of interest and assumptions (if any), shall be clearly disclosed to the borrower.
· The PLI may consider ensuring that the equity of the borrower in the residential property (Equity to Value Ratio - EVR) does not at any time during the tenor of the loan fall below 10%.
· The PLIs will need to re-value the property mortgaged to them at intervals that may be fixed by the PLI depending upon the location of the property, its physical state etc. Such revaluation may be done at least once every five years, the quantum of loan may undergo revisions based on such re-valuation of property at the discretion of the lender.
4. Nature of Payment:
Any or a combination of the following:
· Periodic payments (monthly, quarterly, half-yearly, annual) to be decided mutually between the PLI and the borrower upfront
· Lump-sum payments in one or more tranches
· Committed Line of Credit, with an availability period agreed upon mutually, to be drawn down by the borrower
Lump-sum payments may be made conditional and limited to special requirements such as medical exigencies, home improvement, maintenance, up-gradation, renovation, extension of residential property etc. The PLIs may be selective in considering lump-sum payments option and may frame their internal policy guidelines, particularly the eligibility and end-use criteria. However, these conditions shall be fully disclosed to potential borrowers upfront.
It is important that nature of payments be decided in advance as part of the RML covenants. PLI at their discretion may consider providing for options to the borrower to change.
5. Eligible End use of funds
The loan amount can be used for the following purposes:
Up gradation, renovation and extension of residential property.
For uses associated with home improvement, maintenance/insurance of residential property
Medical, emergency expenditure for maintenance of family
For supplementing pension/other income
Repayment of an existing loan taken for the residential property to be mortgaged
Meeting any other genuine need
Use of RML for speculative, trading and business purposes shall not be permitted
6. Period of Loan: Maximum 15 years.
7. Interest Rate: The interest rate (including the periodic rest) to be charged on the RML to be extended to the borrower(s) may be fixed by PLI in the usual manner based on risk perception, the loan pricing policy etc. and specified to the prospective borrowers. Fixed and floating rate of interest may be offered by the PLIs subject to disclosure of the terms and conditions in a transparent manner, upfront to the borrower.
8. Security:
The RML shall be secured by way of mortgage of residential property, in a suitable form, in favour of PLI.
Commercial property will not be eligible for RML.
9. Valuation of Residential Property:
· The residential property should comply with the local residential land-use and building bye laws stipulated by local authorities, with duly approved lay-out and building plans.
· The PLI shall determine the Market Value of the residential property through their external approved valuer(s). In-house professional valuers may also be used subject to adequate disclosure of the methodology.
· The valuation of the residential property is required to be done at such frequency and intervals as decided by the PLI, which in any case shall be at least once every five years. The methodology of the revaluation process and the frequency/schedule of such revaluations shall be clearly specified to the borrowers upfront.
· PLIs are advised not to reckon expected future increase in property value in determining the amount of RML. Should the PLIs do so in their best commercial judgement, they may do so under a well defined Policy approved by their Board and based on professional advice regarding property prices.
10. Provision for Right to Rescission:
As a customer-friendly gesture and in keeping with international best practices, after the documents have been executed and loan transaction finalized, Senior Citizen borrowers may be given up to three business days to cancel the transaction, the “right of rescission,”. If the loan amount has been disbursed, the entire loan amount will need to be repaid by the Senior Citizen borrower within this three day period. However, interest for the period may be waived at the discretion of the PLI.
11. Loan Disbursement by Lender to Borrower:
· The PLI will pay all loan proceeds directly to the borrower, except in cases pertaining to retirement of existing debt, payments to contractor(s) for the repairs of borrower’s property, or payment of property taxes or hazard insurance premiums from the borrower’s account set aside for the purpose.
· In case the residential property is already mortgaged to any other institution, the PLI may, at its discretion, consider permitting use of part proceeds of RML to prepay/repay the existing housing loan. The loan amount will be paid directly to that institution to the extent of the loan outstanding with that institution with a view to release the mortgage.
· Periodicity: The loan will be extended as regular monthly, quarterly, half-yearly or annual periodic cash advances or as a line of credit to be drawn down in time of need or in lumpsum.
· The PLI will have the discretion to decide the mode of payment of the loan including fixation of loan tenor, depending on the state and market value of the property, age of the borrower and other factors. The rationale behind the decision of mode of payment and fixation of the loan tenor shall be clearly disclosed to the borrowers.
12. Closing:
The PLIs will provide in writing, a fair and complete package of reverse mortgage loan material and specimen documents, covering inter-alia, the benefits and obligations of the product. They may also consider making available a tool kit to illustrate the potential effect of future house values, interest rates and the capitalization of interest on the loan.
The closing costs may include the customary and reasonable fees and charges that may be collected by the PLIs from the borrower. The cost for any item charged to the borrower shall not normally exceed the cost paid by the lender or charged to the lender by the provider of such service(s). Such items may include:
· Origination, Appraisal and Inspection Fees. The borrower may be charged pro-rata origination, appraisal and inspection fees by the PLI /appraiser.
· Verification Charges of external firms
· Title Examination Fees
· Legal Charges/ Fees
· Stamp Duty and Registration Charges
· Property Survey and Valuation charges
A detailed schedule of all such costs will clearly be specified and provided to the prospective borrowers upfront by the PLIs.
13. Settlement of Loan
· The loan shall become due and payable only when the last surviving borrower dies or would like to sell the home, or permanently moves out of the home for aged care to an institution or to relatives. Typically, a "permanent move" may generally mean that neither the borrower nor any other co-borrower has lived in the house continuously for one year or do not intend to live continuously. PLIs may obtain such documentary evidence as may be deemed appropriate for the purpose.
· Settlement of loan along with accumulated interest is to be met by the proceeds received out of Sale of Residential Property.
· The borrower(s) or his/her/their estate shall be provided with the first right to settle the loan along with accumulated interest, without sale of property.
· A reasonable amount of time, say up to 2 months may be provided when RML repayment is triggered, for house to be sold.
· The balance surplus (if any) remaining after settlement of the loan with accrued interest, shall be passed on to the estate of the borrower.
14. Prepayment of Loan by Borrower(s)
· The borrower(s) will have option to prepay the loan at any time during the loan tenor.
· There will not be any prepayment levy/penalty/charge for such prepayments.
15. Loan Covenants:
· The borrower(s) will continue to use the residential property as his/her/their primary residence till he/she/they is/are alive, or permanently move out of the property, or cease to use the property as permanent primary residence.
· Non-Recourse Guarantee: The PLIs shall ensure that all reverse mortgage loan products carry a clear and transparent ‘no negative equity’ or ‘non-recourse’ guarantee. That is, the Borrower(s) will never owe more than the net realizable value of their property, provided the terms and conditions of the loan have been met.
· Loan Agreement: The PLIs shall enter into a detailed loan agreement setting out therein the salient features of the loan mortgage security and other terms and conditions, including disbursement and repayment of the loan, in addition to the usual provisions, which are ordinarily incorporated in a mortgage loan document.
· The loan agreement may also include a provision that the borrower shall not make any testamentary disposition of the property to be mortgaged and even if it does so, it would be subject to the mortgage created in favour of the lending institution. In such a case, the borrower shall make a testamentary disposition of the mortgaged property in favour of any of his/her relatives, subject to the discharge of the mortgage debt by such legatee and a statement that the heirs shall not be entitled to challenge the validity of the mortgage as also the right of the mortgagee to enforce the mortgage in the event of death of the borrower unless the legal representative is willing to undertake the responsibility for discharging in full the amount of loan and accrued interest thereof.
· In addition, the PLI may also consider obtaining a Registered Will from the borrower stating, inter-alia, that he/she has availed of RML from the PLI on security by way of mortgage of the residential property in favour of the PLI, meaning thereby that in the event of death of the borrower (and co-borrower, if any), the mortgagee is entitled to enforce the mortgage and recover the loan from the sale proceeds on enforcement of security of the mortgage. The surplus, if any, has to be returned to the heirs of the deceased borrower(s).
· The PLIs may consider taking an undertaking from the prospective borrower that the “Registered Will” given to the PLI is the last “Will”, prepared by him/her at the time of availment of RML facility as per which the property will vest in his/her spouse name after his/her demise. The borrower will also undertake not to make any other ‘Will’ during the currency of the loan which shall have any adverse impact on the rights created by the borrower in the PLI’s favour by way of creation of mortgage on the immoveable property mentioned under the loan documentation for covering loan to be allowed to his/her spouse and interest thereon, even after the borrower’s death.
· The PLI will ensure that the borrower(s) has insured the property against fire, earthquake, and other calamities.
· The PLI will ensure that borrower(s) pay all taxes, electricity charges, water charges and statutory payments.
· The PLIs will ensure that borrower(s) are maintaining the residential property in good and saleable condition.
· The PLI may reserve the option to pay for insurance premium, taxes or repairs by reducing the homeowner loan advances and using the difference to meet the obligations/expenditures.
· The PLI reserves the right to inspect the residential property/premises or arrange to have the residential property/premises inspected by its representatives any time before the loan is repaid and borrower(s) shall render his/her/their cooperation in respect of such inspections.
16. Title Indemnity/Insurance
· The PLI shall obtain legal opinion for ensuring clarity on the title of the residential property.
· The PLI shall also endeavour to obtain indemnity on title related risks, as and when such indemnity products are available in India.
17. FORECLOSURE:
· The loan shall be liable for foreclosure due to occurrence of the following events of default.
If the borrower has not stayed in the property for a continuous period of one year
If the borrower(s) fail(s) to pay property taxes or maintain and repair the residential property or fail(s) to keep the home insured, the PLI reserves the right to insist on repayment of loan by bringing the residential property to sale and utilizing the sale proceeds to meet the outstanding balance of principal and interest.
If borrower(s) declare himself/herself/themselves bankrupt.
If the residential property so mortgaged to the PLI is donated or abandoned by the borrower(s).
If the borrower(s) effect changes in the residential property that affect the security of the loan for the lender. For example: renting out part or all of the house; adding a new owner to the house's title; changing the house's zoning classification; or creating further encumbrance on the property either by way taking out new debt against the residential property or alienating the interest by way of a gift or will.
Due to perpetration of fraud or misrepresentation by the borrower(s).
If the government under statutory provisions, seeks to acquiring the residential property for public use.
If the government condemns the residential property (for example, for health or safety reasons).
18. Option for PLI to Adjust Payments:
· The PLI shall have the option to revise the periodic/lump-sum amount at such frequency or intervals based on revaluation of property, which in any case shall be at least once every five years.
· Borrower shall be provided with an option to accept such revised terms and conditions for furtherance of the loan.
· If the Borrower does not accept the revised terms, no further payments will be effected by the Lender. Interest at the rate agreed before the review will continue to accrue on the outstanding amount of the loan. The accumulated principal and interest shall become due and payable as mentioned in clauses (13) and (17).
19. Counseling and Information to Borrowers:
· The PLIs will observe and maintain high standards of conduct in dealing with the Senior Citizens and their families and treat them with special care.
· The PLIs shall clearly and accurately disclose the terms of the RML without any ambiguity.
· The PLIs should clearly explain to the prospective borrowers the terms and conditions of RML, the methodology followed for valuation of the residential property, the method of determination of eligible quantum of loan, the frequency of re-valuation and review of terms and all related aspects of the RML.
· The PLIs may suggest to the Senior Citizens to nominate their ‘personal representatives’ usually a close relative who the PLI can contact in the event of any potentialities.
· The PLIs may counsel the prospective borrowers about the possible impacts to the borrowers due to adverse movements in interest rates and property price fluctuations.
· The PLIs shall clearly specify all the costs to the Borrower(s) that are associated with the transaction.
· The PLIs shall in no way assert or imply to the borrower(s) that the borrower(s) is/are obligated to purchase any other product or service offered by the PLI or any other associated institution in order to obtain a reverse mortgage loan.
· Take reasonable steps to check out the background and procedures of third parties before accepting referrals of business from them, and refuse to accept referrals from those that are found unacceptable. Members shall disclose to clients any third party with a financial interest in the reverse mortgage transaction.
· Overall, the PLIs shall treat the Senior Citizen borrower fairly.
* * *
Thursday, May 8, 2008
Tuesday, May 6, 2008
Want to succeed? Avoid these traps
Want to succeed? Avoid these traps - Robert J Herbold
Success leads to the damaging behaviors of a lack of urgency, a proud and protective attitude, and entitlement thinking. This leads to the tendency to institutionalize legacy thinking and practices. Essentially, you believe that what enabled you to become successful will enable you to be successful forever.
After reviewing this problem in many companies, I believe there are dangerous traps into which successful people and organizations often stumble.
Trap 1: NEGLECT Sticking with Yesterday's Business ModelBy business model, I mean what you do and how you do it. It includes such issues as deciding what industry you will be competing in and what approaches you will use in carrying out all the processes necessary to compete in that industry. Will we manufacture something or contract it out? How will we sell our products or services?Do we go through retail channels? How should we organize our sales force? Which segments of the industry do we want to ignore, and which do we want to compete in? What is the structure of our support staff? Which parts of the organization do we out source? What are our approaches to distribution and inventory management? What are the cost targets of the various components of the organization, like information technology costs and human resources costs? Does our model leave us satisfied with our gross margins, profit margins, and other such figures?Organizations should be consistently reviewing all aspects of their business model, looking for areas that are weak and need to be overhauled. By weak, we mean out of date, too costly, too slow, or not flexible. In which areas of the business model are you at parity? In those areas, are there any bright ideas on how to achieve a competitive advantage?
TRAP 2: PRIDE. Allowing Your Products to Become Outdated. You may be super proud of your product or service today, but you have to assume that it is going to become inferior to the competition very soon. You need to hustle ad beat your competition to that better mousetrap, and you need to do it over and over. The amazing thing about success is that it leads to a subconscious entitlement mentality that cause you to believe that you no longer need to do all the dirty work of getting out and studying consumer behavior in details, analyzing different sales approaches, jumping on the latest technology to generate improved products, and everything else that is required to stay ahead. The attitude is often one of believing that you have done all of that and have figured it out, and now things are going to be fine.Until the early 1970s, typewriters were used to prepare documents. The IBM Selectric model was the standard. Then along came Wang Laboratories' word processor in 1976, providing a completely new approach. It displayed text on a cathode ray tube (CRT) screen that was connected to a central processing unit (CPU). In fact, you could connect many such screens to that CPU in order to handle many different users. Wang's device incorporated virtually every fundamental characteristic of word processors as we know them today, and the phrase word processor rapidly came to refer to CRT-based Wang machines. Then, in the early to mid-1980s, the personal computer emerged. Wang saw it coming but made no attempt to modify its software for a personal computer. PC-based word processors like WordPerfect and Microsoft Word became the rage, and Wang died. Wang fell into the trap of not updating its products, even though it basically invented the word processor industry.We saw this behavior very clearly with the General Motors example. Its cars, while highly distinctive back in the 1970s, were allowed over time to look more and more alike, and the excitement factor for the customer disappeared.
TRAP 3: BOREDOM Clinging to Your Once-Successful Branding after It Becomes Stale and DullConstantly achieving uniquencss and distinctiveness for a brand and also keeping it fresh and contemporary is hard work. Once a brand achieves some success, the tendency is to sit back and pat yourself on the back, allowing your brand to become dull and ordinary.The Plymouth automobile was introduced by Chrysler for the 1928 model year as a direct competitor to Ford and Chevrolet. It was a sturdy and durable car that attracted a legion of loyal owners. Plymouth became one of the low-priced three from Detroit and was usually number three in sales, just behind Ford and Chevrolet. For almost two decades, Plymouth sold almost 750,000 cars per year and had a solid brand reputation in the low price range of being reliable but having a bit more flair than Chevrolet or Ford. Older readers may remember the 1957 Plymouth with the huge fins, as well as its Road Runner (beep beep!) model. Plymouth had a very clear brand positioning. In the 1960s, the Plymouth brand began to lose its uniqueness. Chrysler decided to reposition the Dodge, reducing its price so that it was quite close to Plymouth's. Chrysler came out with low-priced compact and intermediate-size models under both the Plymouth trademark and the Dodge trademark. By 1982, Dodge, was outselling Plymouth. Throughout the late 1980s and the 1990s, Plymouth offered nothing unique. Sales continued to decline, while Dodge was quite healthy. In 1999 Chrysler announced that the Plymouth brand would be discontinued. The lesson is simple: when you allow brands to get stale, they die.
TRAP 4: COMPLEXITY. Ignoring Your Business Processes as They Become Cumbersome and Complicated Successful organizations often reward themselves by adding more and more people and allowing processes to become fragmented and nonstandardized. This is often done under banner of? refining the management of the business. It is also caused by business units and subsidiaries seeking more autonomy, which leads them to develop their own processes and staff resources. Before you know it, getting any kind of change made is very complicated.Over and over again you read stories about organizations experiencing weak financial results, then finally coming to grips with the problem, laying off thousands of people and simplifying the organization. We saw in our Toyota case study how aggressive that company is at constantly improving each and every process. Keeping that mindset of constant improvement is very difficult. Success usually leads to a decrease in the intensity with which you tackle such challenges. Also, success leads to a belief that since we are doing so well, we probably need to reward the people in the organization who are asking for their own building and lots of extra people to get them to the next level. Importunely, all those extra costs often lead to bloated processes and further fragmentation of how work gets done.
TRAP 5: BLOAT
Rationalizing Your Loss of Speed and AgilitySuccessful organisations and individuals tend to crate complexity. They hire a lot of extra people, since clearly things are going well, and those people find things to do, often creating layers of bureaucracy, duplicating capabilities that already exist in the organization, and making it very hard to react quickly to change.Getting an organization to constantly think about retaining simplicity and flexibility is not easy. The account given in the previous chapter of Toyota's Global Body Line is a good example of doing it right. Toyota thought about agility ahead of time, and when it came time to build a brand-new car, such as the Prius, it didn't have to build a new plant or a new line. This enabled Toyota to get to market fast and save tens of millions of dollars compared with traditional approaches.
TRAP 6: MEDIOCRITY Condoning Poor Performance and Letting Your Star Employees LanguishWhen organizations are successful, they have a tendency to stop doing the hard things, and dealing with poor performance is a really hard thing. It also becomes hard to move new people into existing jobs, because there is the burden of getting the new person up to speed and the perception that you are losing valuable expertise. Also, the really strong performers and to get ignored. Consequently, what happens in many successful organizations is that people are left in their jobs too long and poor performance is not dealt with as crisply as it should be. Unfortunately, this also leads to strong players not being constantly challenged.Successful organizations are especially vulnerable to this trap, since companies that achieve success often have high morale and pride. And who wants to spoil the fun by dealing with the tough personnel issues, which is an onerous task for most managers? Any excuse to put it aside will be embraced.
TRAP 7: LETHARGY Getting Lulled into a Culture of Comfort, Casualness, and ConfidenceSuccess, and the resulting tendency to become complacent, often leads organizations and individuals to believe that they are very talented, have figured things out, have the answers to all the questions, and no longer need to get their hands dirty in the trenches. They lose their sense of urgency ?feeling that trouble might be just around the corner.Considering our case studies on GM and Toyota, the contrast between their cultures is really striking. GM seems to exude pride? and an attitude of "we are the real pro in the industry," while Toyota has a more humble personality that is all about constant improvement.The leader of a group really sets the tone on this cultural complacency issue. The tendency is to become very proud of your success and protective of the approaches that got you there. It is those very tendencies that lead to an insular, confidence culture that makes people believe that they are on the wining team, while in reality, the world is probably passing them by.
TRAP 8: TIMIDITY Not Confronting Turf Wars, Infighting, and ObstructionistsSuccess often leads to the hiring of too many people and the fragmentation of the organization. Business units and subsidiaries work hard to be as independent as possible, often creating groups that duplicate central resources. Staff groups fragment as similar groups emerge in the different business units. Before long, turf wars and infighting emerge, as who is responsible for what becomes vague.Even worse, the culture gets very insular, with an excessive focus on things like who got promoted, why am I not getting rewarded properly, and a ton of other petty issues that sap the energy of the organization.Another source of turf wars and infighting is lack of a clear direction for the organization and slow decision making on critical issues. When these kinds of management deficiencies occur, people are left to drift and end up pulling in different directions. That often leads to tremendous amounts of wasted time as groups argue to have it their way.
TRAP 9: CONFUSION. Unwittingly Providing?Schizopherenic CommunicationsWhen an organization is success or stable, its managers often fall into the trap of not making it clear where the organization is going from there. Sometimes this is because they don't know, but they don't admit that, and they don't try to get the company's direction resolved. They do everything they can to keep all option open, with no clear effort to get decisions made and a plan developed. Such behaviors lead to speculation by the troops, based on comments that they pick up over time. Often those comments are offhand remarks that the leaders have not thought through. Or the troops hear conflicting statements coming form a variety of folks in leadership positions in the organization.When employees receive confusing and conflicting messages and don't have a clear picture of where the organization is gong or whether progress is being made, they feel vulnerable and get very protective of their current activities. In late 1991, IBM's CEO,John Akes, announced that in the future, IBM would look more like a holding company and that "clearly it's not to IBM's advantage to be 100?per cent owners of each of IBM's product lines." During the next 12 months, everybody was trying to figure out what he meant. And IBM made no attempt to start publishing separate financial information by product line in preparation for possible spin-offs. IBM also ignored Wall Street's suggestion that it create separate financial entries, with their own stock exchange symbols, for the products that were to be spun off. Employees and investors were confused. The IBM board of directors finally ended the drama in early 1993, announcing that Akers was leaving and a new CEO would be hired quickly. From 1987 to 1993, IBM shareholders lost $77 billion of market value.Communications from the head of the organization, be it a small group or an IBM, are critical. People want to know where they are headed and how things are going. When the words and actions don't match, confusion reigns.In the remaining parts of this book, I will discuss these traps in detail. In each part, I will give detailed examples of companies and individuals that in some cases have been hurt and in other cases have avoided these problems. My objective in each part is to provide specific actions that people can take to avoid the particular trap, or to rid themselves of the problem.
Success leads to the damaging behaviors of a lack of urgency, a proud and protective attitude, and entitlement thinking. This leads to the tendency to institutionalize legacy thinking and practices. Essentially, you believe that what enabled you to become successful will enable you to be successful forever.
After reviewing this problem in many companies, I believe there are dangerous traps into which successful people and organizations often stumble.
Trap 1: NEGLECT Sticking with Yesterday's Business ModelBy business model, I mean what you do and how you do it. It includes such issues as deciding what industry you will be competing in and what approaches you will use in carrying out all the processes necessary to compete in that industry. Will we manufacture something or contract it out? How will we sell our products or services?Do we go through retail channels? How should we organize our sales force? Which segments of the industry do we want to ignore, and which do we want to compete in? What is the structure of our support staff? Which parts of the organization do we out source? What are our approaches to distribution and inventory management? What are the cost targets of the various components of the organization, like information technology costs and human resources costs? Does our model leave us satisfied with our gross margins, profit margins, and other such figures?Organizations should be consistently reviewing all aspects of their business model, looking for areas that are weak and need to be overhauled. By weak, we mean out of date, too costly, too slow, or not flexible. In which areas of the business model are you at parity? In those areas, are there any bright ideas on how to achieve a competitive advantage?
TRAP 2: PRIDE. Allowing Your Products to Become Outdated. You may be super proud of your product or service today, but you have to assume that it is going to become inferior to the competition very soon. You need to hustle ad beat your competition to that better mousetrap, and you need to do it over and over. The amazing thing about success is that it leads to a subconscious entitlement mentality that cause you to believe that you no longer need to do all the dirty work of getting out and studying consumer behavior in details, analyzing different sales approaches, jumping on the latest technology to generate improved products, and everything else that is required to stay ahead. The attitude is often one of believing that you have done all of that and have figured it out, and now things are going to be fine.Until the early 1970s, typewriters were used to prepare documents. The IBM Selectric model was the standard. Then along came Wang Laboratories' word processor in 1976, providing a completely new approach. It displayed text on a cathode ray tube (CRT) screen that was connected to a central processing unit (CPU). In fact, you could connect many such screens to that CPU in order to handle many different users. Wang's device incorporated virtually every fundamental characteristic of word processors as we know them today, and the phrase word processor rapidly came to refer to CRT-based Wang machines. Then, in the early to mid-1980s, the personal computer emerged. Wang saw it coming but made no attempt to modify its software for a personal computer. PC-based word processors like WordPerfect and Microsoft Word became the rage, and Wang died. Wang fell into the trap of not updating its products, even though it basically invented the word processor industry.We saw this behavior very clearly with the General Motors example. Its cars, while highly distinctive back in the 1970s, were allowed over time to look more and more alike, and the excitement factor for the customer disappeared.
TRAP 3: BOREDOM Clinging to Your Once-Successful Branding after It Becomes Stale and DullConstantly achieving uniquencss and distinctiveness for a brand and also keeping it fresh and contemporary is hard work. Once a brand achieves some success, the tendency is to sit back and pat yourself on the back, allowing your brand to become dull and ordinary.The Plymouth automobile was introduced by Chrysler for the 1928 model year as a direct competitor to Ford and Chevrolet. It was a sturdy and durable car that attracted a legion of loyal owners. Plymouth became one of the low-priced three from Detroit and was usually number three in sales, just behind Ford and Chevrolet. For almost two decades, Plymouth sold almost 750,000 cars per year and had a solid brand reputation in the low price range of being reliable but having a bit more flair than Chevrolet or Ford. Older readers may remember the 1957 Plymouth with the huge fins, as well as its Road Runner (beep beep!) model. Plymouth had a very clear brand positioning. In the 1960s, the Plymouth brand began to lose its uniqueness. Chrysler decided to reposition the Dodge, reducing its price so that it was quite close to Plymouth's. Chrysler came out with low-priced compact and intermediate-size models under both the Plymouth trademark and the Dodge trademark. By 1982, Dodge, was outselling Plymouth. Throughout the late 1980s and the 1990s, Plymouth offered nothing unique. Sales continued to decline, while Dodge was quite healthy. In 1999 Chrysler announced that the Plymouth brand would be discontinued. The lesson is simple: when you allow brands to get stale, they die.
TRAP 4: COMPLEXITY. Ignoring Your Business Processes as They Become Cumbersome and Complicated Successful organizations often reward themselves by adding more and more people and allowing processes to become fragmented and nonstandardized. This is often done under banner of? refining the management of the business. It is also caused by business units and subsidiaries seeking more autonomy, which leads them to develop their own processes and staff resources. Before you know it, getting any kind of change made is very complicated.Over and over again you read stories about organizations experiencing weak financial results, then finally coming to grips with the problem, laying off thousands of people and simplifying the organization. We saw in our Toyota case study how aggressive that company is at constantly improving each and every process. Keeping that mindset of constant improvement is very difficult. Success usually leads to a decrease in the intensity with which you tackle such challenges. Also, success leads to a belief that since we are doing so well, we probably need to reward the people in the organization who are asking for their own building and lots of extra people to get them to the next level. Importunely, all those extra costs often lead to bloated processes and further fragmentation of how work gets done.
TRAP 5: BLOAT
Rationalizing Your Loss of Speed and AgilitySuccessful organisations and individuals tend to crate complexity. They hire a lot of extra people, since clearly things are going well, and those people find things to do, often creating layers of bureaucracy, duplicating capabilities that already exist in the organization, and making it very hard to react quickly to change.Getting an organization to constantly think about retaining simplicity and flexibility is not easy. The account given in the previous chapter of Toyota's Global Body Line is a good example of doing it right. Toyota thought about agility ahead of time, and when it came time to build a brand-new car, such as the Prius, it didn't have to build a new plant or a new line. This enabled Toyota to get to market fast and save tens of millions of dollars compared with traditional approaches.
TRAP 6: MEDIOCRITY Condoning Poor Performance and Letting Your Star Employees LanguishWhen organizations are successful, they have a tendency to stop doing the hard things, and dealing with poor performance is a really hard thing. It also becomes hard to move new people into existing jobs, because there is the burden of getting the new person up to speed and the perception that you are losing valuable expertise. Also, the really strong performers and to get ignored. Consequently, what happens in many successful organizations is that people are left in their jobs too long and poor performance is not dealt with as crisply as it should be. Unfortunately, this also leads to strong players not being constantly challenged.Successful organizations are especially vulnerable to this trap, since companies that achieve success often have high morale and pride. And who wants to spoil the fun by dealing with the tough personnel issues, which is an onerous task for most managers? Any excuse to put it aside will be embraced.
TRAP 7: LETHARGY Getting Lulled into a Culture of Comfort, Casualness, and ConfidenceSuccess, and the resulting tendency to become complacent, often leads organizations and individuals to believe that they are very talented, have figured things out, have the answers to all the questions, and no longer need to get their hands dirty in the trenches. They lose their sense of urgency ?feeling that trouble might be just around the corner.Considering our case studies on GM and Toyota, the contrast between their cultures is really striking. GM seems to exude pride? and an attitude of "we are the real pro in the industry," while Toyota has a more humble personality that is all about constant improvement.The leader of a group really sets the tone on this cultural complacency issue. The tendency is to become very proud of your success and protective of the approaches that got you there. It is those very tendencies that lead to an insular, confidence culture that makes people believe that they are on the wining team, while in reality, the world is probably passing them by.
TRAP 8: TIMIDITY Not Confronting Turf Wars, Infighting, and ObstructionistsSuccess often leads to the hiring of too many people and the fragmentation of the organization. Business units and subsidiaries work hard to be as independent as possible, often creating groups that duplicate central resources. Staff groups fragment as similar groups emerge in the different business units. Before long, turf wars and infighting emerge, as who is responsible for what becomes vague.Even worse, the culture gets very insular, with an excessive focus on things like who got promoted, why am I not getting rewarded properly, and a ton of other petty issues that sap the energy of the organization.Another source of turf wars and infighting is lack of a clear direction for the organization and slow decision making on critical issues. When these kinds of management deficiencies occur, people are left to drift and end up pulling in different directions. That often leads to tremendous amounts of wasted time as groups argue to have it their way.
TRAP 9: CONFUSION. Unwittingly Providing?Schizopherenic CommunicationsWhen an organization is success or stable, its managers often fall into the trap of not making it clear where the organization is going from there. Sometimes this is because they don't know, but they don't admit that, and they don't try to get the company's direction resolved. They do everything they can to keep all option open, with no clear effort to get decisions made and a plan developed. Such behaviors lead to speculation by the troops, based on comments that they pick up over time. Often those comments are offhand remarks that the leaders have not thought through. Or the troops hear conflicting statements coming form a variety of folks in leadership positions in the organization.When employees receive confusing and conflicting messages and don't have a clear picture of where the organization is gong or whether progress is being made, they feel vulnerable and get very protective of their current activities. In late 1991, IBM's CEO,John Akes, announced that in the future, IBM would look more like a holding company and that "clearly it's not to IBM's advantage to be 100?per cent owners of each of IBM's product lines." During the next 12 months, everybody was trying to figure out what he meant. And IBM made no attempt to start publishing separate financial information by product line in preparation for possible spin-offs. IBM also ignored Wall Street's suggestion that it create separate financial entries, with their own stock exchange symbols, for the products that were to be spun off. Employees and investors were confused. The IBM board of directors finally ended the drama in early 1993, announcing that Akers was leaving and a new CEO would be hired quickly. From 1987 to 1993, IBM shareholders lost $77 billion of market value.Communications from the head of the organization, be it a small group or an IBM, are critical. People want to know where they are headed and how things are going. When the words and actions don't match, confusion reigns.In the remaining parts of this book, I will discuss these traps in detail. In each part, I will give detailed examples of companies and individuals that in some cases have been hurt and in other cases have avoided these problems. My objective in each part is to provide specific actions that people can take to avoid the particular trap, or to rid themselves of the problem.
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