Leadership Capital Index

The lefthand circle is the investor, and the investor has a simple question, "How do I make money on my investment?" I assume we all worry about that. And the investors are learning that, making money on an investment, some of it comes because the company makes money and so, if a company makes money, I invest and I do better. But some of it comes in predicting will the company make money in the future? That's often called intangibles, and then we believe that the essence of intangibles is leadership – that leaders make decisions that build strategy brand and value that eventually makes money. So my lefthand circle moves to the right, focusing more on leadership, and investors are interested in that.

The second circle, the righthand circle, is leadership and people study leadership starting at the right of the righthand circle, and say, "Our leader's authentic." And everybody wants an authentic leader who says what he or she thinks and is living what their values are, but we've discovered that authenticity is not really effective leadership because leadership is creating value for somebody else, and the stakeholders that we create value for are not only inside the firm – leaders inspire their employees – but outside the firm, and so the righthand circle of leadership moves from authenticity to internal stakeholders to external, which are investors.

So the intersection of that circle is what we call leadership capital. Do investors, the lefthand circle, value leaders on the right? Do leaders do work that creates value for investors in the left? And when we can do that combination, investors win because they have confidence in leadership and leaders win because they're creating value for investors.

Rachel Salaman: Well, your Leadership Capital Index sets out to basically measure how well that system works. Is that right?

Dave Ulrich: Absolutely. We go to investors and we ask them a question. Divide 100 points, what do you invest in? A, 35 to 40 points of the 100 is does the company make money? And they can track that. They look at the income statement. Two, intangibles – does the company have a strategy, a brand, a global position, the right industry? And they can track that. And that gets 30 to 35 points. Three, leadership – does the company have good leadership? And it gets 25 to 30 points, but here's the problem – it's hard to track.

How do you know somebody's a good leader? We've all grown up with better or worse leaders in our homes, in our work settings, in our social settings, but we don't have a very rigorous way to get it and sometimes investors go on instinct. They say, "Oh this person's great. They dressed well, they wore a great suit, they had great temperament," but that's not real leadership and we wanted to come up with a way to more rigorously define what investors can look at in making an effective leader.

Rachel Salaman: Mm, and that's outlined in your book, "The Leadership Capital Index, Realizing the Market Value of Leadership." So who will benefit from reading the book?

Dave Ulrich: Actually it's always tricky. When you write a book, you think the whole world's going to be new and changed and that's not really true, but one audience is clearly investors – it will reduce their risk. If you have a great financial history, if you have a great strategy, and really lousy leaders, what happened in the 2008 period is a great example. A lot of banks did badly and they went broke and they had to bail them out. Bailout is a horrible metaphor because, when you a bail out a boat, there's a hole in the boat and you keep throwing water out of the boat but, if you don't fix the hole, you've not solved the problem.

We think the hole in some companies is leadership and investors will benefit by knowing what good leadership looks like. Boards of directors will benefit by saying, "One of our stewardship, a primary stewardship of many boards, is to build the leadership team within a company. Can we do that more rigorously?" Rating agencies, who rate companies, will be able to say, "When we rate a company we, it's like a movies index, the rate's financial credibility and financial discipline. We want to rate leadership," and then inside a company, "I'm a leader. How do I know that I'd been effective?"

I love your introduction – how do I know I'm good, becoming better? And if they can show that what they know and do builds value for the investment community, it's a stakeholder that they should care about.

Rachel Salaman: Now, you've been using this method. What relationship have you seen between the index assessment and the market value of a company?

Dave Ulrich: I just shared our research that I think is fascinating, that leadership is not the only thing that determines market value but two firms in the same industry with the same earnings may have dramatically different market value and it shows up in their price earnings ratio. How much does an investor value the earnings that you make? And what we found is that it's 25 to 30 percent. That quality of leadership can explain 25 to 30 percent of the market value of an enterprise.

Rachel Salaman: That's really interesting and very exciting that people might now be able to really measure this. How many of an organization's leaders should be assessed in this way?

Dave Ulrich: What a great question. When we talk to folks, what often happens is people look at the CEO. What does she do? What does he do? What are their behavioral characteristics? And we would agree with that but it's incomplete. It's like looking at the coach to judge whether a team is effective.

So we have to look at at least three levels. One is obviously the senior manager and his or her team. Second is their direct reports, and third is what we call the leadership cadre. It's often the square root of the number of employees. So if you have an organization with 100, it's 10. If you have an organization with 1,000, it's 30 to 35.

And that square root number gives me a kind of crude index of the kind of, what we call leadership cadre. So it's the CEO, their direct reports, and then the square root of the number of employees. That gives you a total number.

Rachel Salaman: Now, you touched on this a little earlier but to what extent should a distinction be made between the leaders and the leadership of an organization?

Dave Ulrich: It is such a great question again. Every organization has a leader. That's the individual, and he or she is exceptional. They have qualities. They have characteristics. They've got values. Leadership is the collection of individuals. Leaders matter but leadership is the pipeline – it's the capability of building the next generation of leaders. What happens is, if you have a great leader, when that individual leader leaves, is there a leadership team that will carry it to the next generation?

I think this is one of the things that you see firms like Apple have a transition. Steve Jobs was obviously a gifted and incredible leader but one of the roles of the leader is to build leadership, and he did that very nicely. Towards the end of his life when he knew he was tragically ill and unfortunately passing far before his time or anyone's time, he would go on stage to introduce a new product and he'd bring a team with him, and he'd say, "Ladies and gentlemen, I'm Steve Jobs. Obviously I'm proud of our new product but let me commend this team," and he would begin to transfer his personal leader equity to the leadership team.

And I think that's what good leaders do, is they build the next generation of leadership that helps a company survive longer term.

Rachel Salaman: And could you talk a bit more about the structure of the index in general terms now and why it's split in two, with the individual domain on one side and the organizational domain on the other? With five elements in each, isn't it.

Dave Ulrich: Let me tell you the dilemma I ran into and in one of the blessings. There are many curses of being old, which I hope people recognize, but there's a blessing as well – with age comes some experience.

The concept is really simple. How do investors evaluate better leadership? And people go, "Yes, that's easy." It's not easy, and having edited journals, and published books, and really played in this leadership field for many, many decades now, I struggled for 10 years to find a way to make this simple. There, a lot of people say, "Oh HR analytics or leadership analytics are new." They're not new. There are literally thousands of studies, and so my background is in taxonomy, which is the science of order and discipline. I struggled to say, "How do we make this instrument simple?"

Here's what I came up with. There's two dimensions of leadership. One is the individual – what personal traits do you as an individual have? And as we distill the leadership work, and my colleagues and I have written a book called "Leadership Code," we said (there's five and I'll do them real quick) personal proficiency, your character integrity; strategy, the ability to set direction; execution, the ability to make it happen; managing talent, the ability to work with people; and what we call leadership brand, the ability to adapt to the condition. Those are personal characteristics that we can see in a leader.

The second side is, do you build human capital? Do you build the systems?

We've just finished another research that's just for me breathtaking and hugely dramatic, and we just sent the book off this week. The individual side is the worth or talent. Do we have great people? Do we have great leaders? Do we win the individual battle? What we discovered is the quality of the organization has a four times impact on business performance. So what it means is you’ve got to have good people – that's fighting a war, but the victory of the war is through the organization and so our new book is going to be called, "Victory Through Organization." That's the second column.

One column is the individual traits of a leader. Does this leader has these traits? The second column is the organizational capabilities that they build and we distilled it into five: creating a culture. Do you have an identity? Do you have a culture? Managing the flow of talent. Managing performance and accountability. Managing information, and managing work.

Now here's my caveat. Are those two columns and five dimensions in each perfect? No, not even close. I see people and they say, "Oh you missed this," and I go, "OK, you know, I think we're now in the process of creating an index that moves us from zero to 30 to 40 percent confidence. It's much better than intuition but it's not yet rigorous science."

Rachel Salaman: Now, on the individual side, as you said, one of the assessment areas is personal proficiency and that looks at health among other things, including how much sleep a leader gets. Now, how reliable are self-reported measures like that?

Dave Ulrich: We, they're not perfect, which is why I think on the personal side we often use 360s. And they're not manipulative. I think one of the patterns we all face is we judge ourselves by our intent and so "I intend" at a personal level could be socially engaging but others judge me by my behavior. And that's why an instrument that doesn't just do self-report becomes really important because, again, I don't think self-report people are being delusional but they say, "Oh my intent is this, this and this," but other people don't see the intent. They see the behavior, and we need to be able to measure both of those.

By the way sleep, is one of those areas when people say at a personal level what you need in leaders. Obviously nutrition, fitness, exercise, all those good things. Sleep is the new one that everybody talks about and, when I talk, what a lot of executives say, and I'm not very good at this one obviously, is nutrition, eat healthy, get exercise, and they go, "Oh yes, I'm doing okay, I'm doing okay," but what about sleep? And everybody puts their head down and says, "Don't ask me about that." Because I think sleep is really difficult for folks who have really demanding and hectic lives. So that's one that is getting a lot of attention.

Rachel Salaman: Yes, and I suppose reliability comes into play as well, even on execution proficiency, because leaders tend to shy away from pessimistic projections of the future, don't they. So how do you get at the truth when you're assessing the likelihood of future execution proficiency?

Dave Ulrich: We have three things and it's always tricky to get. The first step is getting the framework in place. So what are the dimensions of leaders who will build value in investors? And the second is getting metrics. The first thing in metrics we try to do is interviews, surveys of leaders, getting the 360 data. The second is looking at organizational reports, for example in the leader, show us your last two years’ performance reviews. What goals did you set? How many of those goals did you meet? Trying to get organizational data that is not self-report, so the main one is interviews, observations of the leader domain. Two is organizational data, for example another source of organizational data would be an engagement survey. How well do your employees report you as a leader having the ability to execute? And the third source of data refine is really fascinating, is social media. And data in the cloud is never flawless but, when you look at patterns, leaders develop reputations and so we've got a really cool science, artificial intelligence group who says, "Here are the words that characterize execution. When this leader is discussed, at the individual level, in the media, how often do these words show up relative to other leaders?"

And we can begin to create a, and again it's not perfect because social media's always subjective, but we can begin to create on those three areas. One is the interview observations, two is the existing data, and three is the social media cloud data of a dimension like execution.

Rachel Salaman: If we could talk about people proficiency now. What are some ways to assess that? And in the book you talk about Google's project Oxygen – perhaps you could use that as an illustration.

Dave Ulrich: Sure. What Google did, and it's really fun, Google is a company based on analytics and they did a major study to identify the characteristics of leaders who manage people well and they came up with eight characteristics. Really nice for Google to do that.

Here's the reality. This has been studied before. Every one of their eight characteristics has got a stream of literature behind it and so, on the people side, those three dimensions. One, we want to go look at their, observe the leader in meetings. Do they involve people? At an intuitive level, as you interview the leader’s subordinates, "When I leave an interaction with this leader, do I feel better or worse about myself?" Again, these are somewhat subjective but it's not self-report from the leaders, it's report from those who work with the leaders."

Second column is engagement surveys and organizational data, for example one organizational indicator: does this, is this leader a leadership magnet who has a, what we look at is an import/export ratio. Does this leader take in other employees and never let them leave, kind of a black hole metaphor of leadership, or is he or she a producer of other leaders in the firm? Do they export leadership? It's kind of an import/export ratio of leadership. Good leaders build leadership in the rest of the organization. It's the same kind of thing on this indicator as money. A good leader takes in money but then creates money. So does this leader create other leaders? Are people moving?

And then social media. The same kind of test – what's the reputation of this leader in some of the blogosphere in terms of how he or she deals with people? And we can begin to get an indicator of people.

Rachel Salaman: Turning now to the organizational domain of the Index. You quote the management expert Peter Drucker, who supposedly said "culture eats strategy for lunch." Your Index assesses leaders’ ability to create an effective culture. What are some ways to do that?

Dave Ulrich: First, I have to confess that's probably misquoted in the book. I tried to find the citation where Peter Drucker said culture eats strategy for lunch or breakfast. I couldn't find it, so I've now concluded that if you have a great quote attributed to Peter Drucker and everybody will quote it, so we love to put a Peter Drucker name on it.

Culture is the buzzword. It is the hot topic right now in organizational thinking. There's a special issue of Talent Quarterly just came out with discussions of culture. Most definitions, and this is dangerous because I have a strong point of view about this with my colleagues, most definitions of culture look at culture as the embedded values in a company, and the metaphor is a tree and culture is the roots. This is the roots of the tree. They give us our values. They give us our sense of belonging, our sense of being. I think that's a bad definition, because I think the roots of the tree lock you into what's been. I think they anchor you.

We believe culture is the identity of the firm in the mind of your best customers made real to your people. That's a pretty complex concept. So culture is not the roots of the tree, it's the leaves, it's the sun, it's where the tree is growing towards. It's not the roots that anchor it in the past.

So an investor says, "Does this company have the right culture?" When I look, and here's an example, when I look at their brand statement or their promotions, what do they tell the outside world and social media or advertising or any other kind of external media positioning? Are those the same messages that show up in their leadership competency model? For example, we love to say, "Here's your external world. Here's what you're promising customers. Here's our model of what good leaders should be. Do those overlap at least 80 percent?" Because what often happens, I speak with companies and they say, "Our leadership team went to an offsite. They came up with our 10 competencies. Here they are." Good idea but incomplete. I think those competencies need to be connected with what we promise our customers, and when we get an overlap of 80 percent we win.

Second exercise to measure that. This is column two of my three columns. Here's what we promise our customers, our brand statements, our messages to the world. Look now at the leadership training your company has done. What's the content of those senior leadership programs? Do they overlap 80 percent with what we promise customers? A company may promise customers great service but then their leadership training focuses on efficiency.

By the way, when I say this, it just seems so simple and obvious, to me at least, but we still miss it. Most of those who design internal leadership training don't do that against the promises we've made our external market. That's the concept of culture from the outside in made real to our employees.

Rachel Salaman: Now, you say that investors want organizations to manage the flow of people well, and talent management is another category of your Index on the organizational side. But how much does the talent management of a company reflect the top leaders? Do they usually get involved in the human resources side of their businesses?

Dave Ulrich: In managing talent, there's three steps. Step one is bringing the right people in and all the steps of setting standards, securing people. The second step is moving people through the company, training them, career planning, motivating them, engaging them. And third is appropriately moving them out, which includes retaining really good people and then appropriately moving people.

The senior leaders, I don't think are responsible for the latest and greatest practice. So there's a practice about, from Beverly Kaye who's brilliant, retaining people through a stay interview and then asking people will they stay. But the senior leaders, I think, set a philosophy.

One of the discussions we're having, in fact I had the privilege with my colleagues of attending a board of directors association. In most companies, the compensation committee of the board looks at people only through the eyes of compensation. Bob Hallagan from Korn Ferry is proposing, and he's allowed me to join him, that we should change the definition of that committee from compensation to talent, because compensation is one piece of an overall talent puzzle. The rest of the puzzle is have we brought the right people in? Have we set standards for who we hire? Have we sourced people? Have we interviewed people? And senior leaders can set the philosophy of what kind of people do we bring in, how do we bring them in, how do we orient them? Moving people through the company, what's our philosophy about developing people? Who do we promote from within? Do we promote from outside? How do we manage that trend and when do we appropriately move people out?

And so we believe senior leaders set the correct principles and then executives throughout the organization – leadership – has the opportunity to make it happen.

Rachel Salaman: Now, you have a chapter on performance accountability and you note that it's very important, even though some leaders are doing away with accountability processes like appraisals. Could you expand on that?

Dave Ulrich: Every survey I've seen in the last three years, the most hated HR practice is performance appraisal. The people doing it don't like it because they don't like to tell people they're doing a bad job. The people receiving it don't like it, but here's, and so some companies say, as you say so appropriately, "We've done away with appraisal." And here's my comment – that's just stupid because, if there's no accountability, people don't improve. They don't get better. If I don't weigh myself, I gain weight. That's a personal insight – I've tested that many, many times. When I rent a car, I almost never wash it before I turn it in because there's no incentive to turn in a clean car, but I do fill it up with petrol or gas because I pay three times the price. Accountability does matter. There has to be accountability.

Now the question is, how do you build what we called in the book positive accountability? And here's the headline. Shift from a focus on process, which says appraisal is a set of forms. You rank people. You rate people. Whatever that system is is a process, and shift from that to a conversation. Help a business leader have a positive conversation with her or his employee about how they're doing.

Our sense is those conversations done well, any process you have can work. I can do management by objectives. I can do a nine box. Whatever the conversation, the process is, if you can have a productive and positive conversation, that works. If you can't have a good conversation, every process will fail and so we believe good performance management, that the investors should look at, is is there accountability in a company? If a company has employees or leaders who are not performing well, there has to be accountability but is that done in a way that affirms and builds a positive output? And that's what we're looking at.

Rachel Salaman: So how long does it take to complete a full assessment on a leader, on one leader or on a leadership team?

Dave Ulrich: That's a great question. We've got two or three levels of how detailed you want to go on that assessment. We have the three columns. The one column is simply looking at your individual leaders and the leadership. The organizational domain, that may take a couple of days but, if you go to the second column and the third column, that might be a month or a two-month project that you would look at.

Rachel Salaman: And who actually does the digging – the interviews and the surveys and so forth?

Dave Ulrich: At this point we have been doing that. We, my colleague Justin Allen and I, have a Leadership Capital Index group and one of the dangers is, it's kind of like financial auditing. You go to an onsite firm in order to have somebody do a statement that this is done well to get it. And we've been, Justin especially, my partner in this business, has been doing those audits and doing them very well.

Rachel Salaman: Now, as we touched on earlier, leaders do move on. So people might put in a lot of time and effort assessing a leader who's suddenly not there any more. Have you ever known this to be an issue?

Dave Ulrich: Oh of course. One of the big dilemmas is there are times when leaders, and I bet you've even met some and I hope I'm not one, have relatively, I hope I say this appropriately, healthy egos and they almost become the sun, the moon and the stars. They become almost a black hole that sucks all the energy and we've been in some companies where the leader says, "I'll be the only interface with the media. I'll be the one that presents." And one of the tests we have by the way of investors of that, in that first column of observation of leaders, how often do they use the word "I" versus "we?" We might have somebody who, even in Britain or France or Australia or America, is running for a political office and 95 percent of his sentences begin with "I," and you begin to say, "This is a leader who's more of a narcissist than building in others," and you want to try to contract some of that because good leaders build the next generation. They transfer their leadership equity to others.

A leader will stand up and say, "I have made a billion dollars. I'm a great leader." The real question is, have you made a thousand millionaires? Because a leader is about how great you've done, leadership is about how many other people you've made successful. And we think it's so critical for the successful leader to build leadership in sustainable organizations, and we see companies struggling with that and even great companies today.

Google, Apple, Amazon, Facebook are really great companies and nobody could in any way deny that, but have the leaders in those companies, who are often founders, created a pipeline that their successors will in some ways be different from them and better because they'll respond to a new world?

Rachel Salaman: So if you and your team undertake one of these assessments on behalf of, let's say, an investor, do you then share any tips for improvement with the company, anything like you've just described, like perhaps they don't have a particularly effective succession plan in place? Do you then share that with the company?

Dave Ulrich: We do. We are trying, and it's an interesting Chinese wall. If the people doing the assessment then do the development, it becomes almost a conflict of interest. Let us do an assessment in the five areas you're weak and then we will come train you in them. I go, in fact it's been a real dilemma because we do leadership development, we do coaching, we do training but what Justin and I have said is, we want to build the assessment and then, if there is a need for improvement, we will make recommendations to some of our colleagues that they may bring them in.

We are not trying to do, you know, let's do an assessment so we can build our business, that's, we want to do the assessment that gives investors confidence.

Rachel Salaman: So, finally, for anyone thinking of using this Index via your book, how would you sum up its usefulness?

Dave Ulrich: One of the issues in business that people keep looking at is risk. How do we manage risk? How do we reduce risk? I think one of the increasingly risky parts of a company is its leadership, and by leadership I'm putting under that the personal traits of the leader, the culture of the organization. This Index gives you a disciplined way to reduce that risk, and we think for investors it gives you confidence. We think for leadership development it gives you focus – where should I invest in leadership development to reduce the risk for investors? And we think it builds them together.

I tend to be an optimist. A lot of people who look at companies see what's wrong and tell people they're going to hell if they don't change. I like to see what's right and tell people how they can get to heaven, and I hope that what we've done in this work gives people that pathway of how they can go forward.

Rachel Salaman: Dave Ulrich, thank you very much for joining us today.

Dave Ulrich: Thank you Rachel. Thank you very much.

Rachel Salaman: The name of Dave's book again is "The Leadership Capital Index, Realizing the Market Value of Leadership."

I'll be back in a few weeks with another Expert Interview. Until then, goodbye.