by Bob Andelman

There isn't a supply and demand economic cycle driving our economy right now. What is driving it is innovation and upgrades.

Renting a video at Blockbuster isn't convenient enough; today's entertainment-obsessed consumer downloads movies for the same price via the Internet and digital cable TV set boxes without ever leaving their living room. And we order pizza and Cokes to enjoy during the movie from Pizza Hut's Web site.

Speaking of sodas, is there too much sugar in your Pepsi? Swig a Diet Pepsi instead. Not enough sugar? Down a Wild Cherry Pepsi. Too much caffeine in your drink? Caffeine-Free Pepsi is just what the doctor order. Actually, if it's doctor's orders, he probably meant Caffeine-Free Diet Pepsi.

Can slackening interest in emulsion film be compensated for at Kodak by digital camera sales? Do people really want immediate access to photographs that can be downloaded this very minute rather than rolls that took anywhere from an hour to a week to be processed and printed?

Don't believe that your kid is learning enough or rapidly enough at school? Slip an educational CD-ROM in your iBook and Junior can learn to read, write and type WYSIWG on the way to preschool this morning.

Never finished your bachelor's degree? Your university is probably offering classes online (or at remote, satellite locations via closed-circuit video). Get the class time and instruction you need at any time of the day or night.

Is the paint on your kitchen cabinets chipping but you don't remember where you bought that darling color originally? No problem. The Home Depot can match the color electronically and mix up a fresh batch while you nosh on a Big Mac and fries in the McDonalds Café.

Does your job require visual presentations before small and large groups? Forget overhead projectors; with Microsoft's PowerPoint software, you can create powerful charts and graphics on your laptop and plug into a compatible project almost anywhere.

Not satisfied with the selection of radio stations in your hometown or while on the road? If you're stationary, try Yahoo! Broadcast on the Web for access to thousands of worldwide broadcast or Internet-only stations. Or if you're in a late model luxury car, turn on the satellite-delivered, commercial-free digital radio.

Get the idea? Every time we turn around in our computer-fitted 501 jeans, the coolest gadgets and gizmos of the 20st Century get even cooler in the 21st. And smaller. And smarter.

Pick the right one of those and you can ride that profit driver on into retirement.

Blockbuster, Man

David Cook was a Dallas-based computer whiz who had an idea many years ago that, if you're a movie fan, still touches your life.

He slapped bar codes on the tape boxes as if they were boxes of cereal in a supermarket and developed a computer application that tracked video rentals so that stores in the then-nascent business always knew where their tapes were.

Even more important, he demonstrated that a business owner could learn a great deal about customer behavior ­ track it, even predict it ­ by following a videotape box. He recorded customer preferences and used the data for marketing related products to them. For in-house purposes, he also learned which tapes turned over frequently and which stiffed, as well as which should be kept in perpetual inventory and which you need 20 copies of to satisfy demand.

One day, he changed the name of his company from Cook Data Services to Blockbuster Video. Wayne Huizenga is the name generally connected with Blockbuster Video, but transforming it into a household brand was a function of capital. It was Cook's innovations that drove it into consumer history.

"Blockbuster was not the first outfit to rent videos," says Cook fan and Dallas-based business analyst David Johnson. "Everybody rents videos. But he was the first one to refine it."

Cook sold out to Huizenga, but he wasn't done yet. He subsequently developed Toll Tag/E-ZPass, introduced in 1993, which allows automobiles and trucks to keep moving through highway toll plazas without slowing down to chuck a few quarters in a well.

When it comes to innovation and intellectual property, what drives profitability is something that is hard to knock off, especially something that can create a market.

Innovation is incredibly important. It is probably one of the shortfalls for AT&T and WorldCom. AT&T and WorldCom both took the exact same sort of strategy, milking long-distance for all the cash they could, all the while knowing it was a declining business. Why didn't they come out with a 7-cent flat rate business? Why didn't it compete more effectively? Why didn't it come out with no monthly fees, 7 cents a minute, and defend its market share? They didn't. They just put their heads in the sand and gave up.

Companies that can innovate and beat their competitors to the punch have a significant advantage in the market.

Cox Communications was one of the first companies to roll out advanced, interactive digital video services via cable TV. This meant giving its customers the ability to order movies, see interactive ads and experience all kinds of other "gee whiz" concepts from the safety of their bedrooms. Being first means Cox will generate revenues from that service and have a leg up on the local phone companies and other cable companies that will eventually offer competitive services.

Likewise, one of the reasons that Cisco keeps buying new companies is because it's an efficient way of finding new products. Companies are bought because they are innovative in not just products but design and execution.

Eco-Tech

Look for companies with an ability to create, on an ongoing basis, differentiated technology that addresses ongoing customer requirements.

The best companies regularly introduce or update their technology. That is the kind of consideration that you rarely need to see in other sorts of industries where the pace of change is perhaps less compelling and it is less fundamental to the nature of what those companies do.

Other industries, such as the consumer products market, also have new product development issues. But what drives the successful technology company is different from what drives other industries, whether they deal in commodities or services. So first and foremost, in assessing a technology company's business model, you should understand the unique characteristics of a company's product, and what it is about its addressable marketplace that makes the company's strategy and approach viable or appealing.

One of the things that is so interesting about technology, particularly over the last 20 years, is how incredibly fragmented it is. That fragmented complexity makes technology unique, and yet those pieces all fit together. You can see parts of technology selling or relating to other parts of technology. So when PC company sales get better or worse, that affects disk drive companies, microprocessor companies and memory chip companies. It is all part of that same process or chain.

If the price of a commodity goes up, then the end product using that commodity will be affected. Fuel price increases, of course, severely impact the airline industry. But those are fairly limited connections confined to a couple of related variables. What makes technology so unique is how increasingly complex the whole ecosystem became.

Version 9.99.1b

It is truly incumbent upon technology companies to reinvent their products constantly. The minute they don't, a never-before-noticed competitor will. Adobe must produce version 5.1, 5.2, 5.3 and 6.0 of PhotoShop in rapid succession lest someone else come out with a better software solution, or, even worse, consumers get bored with the existing version. In this regard, software is no different from laundry detergent. How many times has Tide been "new and improved"? But do you use it any differently today than your mother did a generation ago?

Compare that with the expectation put upon office chair manufacturers. Constant innovation ­ as opposed to fashion tinkering ­ is not an ongoing issue for them. They come up with a comfortable, ergonomic chair in a neutral color and sell the same model for the next five years. There are only so many different ways you can plop your backside into a seat, right?

Adobe's revenues are heavily derived from the upgrade phenomenon. That is a characteristic of technology investing, and an explanation of why you can make money if you call a product cycle right as an investor or get it wrong if a product cycle is late or falls short in some way.

Innovation Keeps
Economies Steaming

Besides offering a product that is in demand, a forward thinking, aggressive company will also have a research and development budget that keeps it ahead of the competition by developing new products.

In our economy, the one thing that has kept our country kind of an island of prosperity has been the innovative part of our economy, where we are coming up with better airplanes or better hardware or better software, better pacemakers, better pharmaceuticals. And in a lot of cases, because they are better solutions, they create markets for themselves and, in a time when there is not much pricing power, they have pretty enhanced margins.

There are some common characteristics to be found in companies that consistently innovate. They have superior management, are leaders in their industries, have people who are visionary, and people who are positioned as owners of the company, so what is good for them is good for you.

Even more typically, you will find people who are really engaged in their companies and, in today's world, almost paranoid. This is in sharp contrast to the corporate walruses of yesteryear, the fat, happy and contented good ol' boy network.

A decade ago, when companies got together and colluded, it ended up meaning higher prices for is. In today's world, we see combinations like General Motors, Ford, DaimlerChrysler, Renault and Nissan forming a trade exchange called Covisint, a sort of heavy metal eBay, to extract the lowest possible price through their combined buying power. And that supposedly means is lower car prices for us. In today's world, collusion isn't necessarily bad.

A company with a solid growth record is one that may spend 90 percent of its time doing what it is already doing, with the last 10 percent devoted to isolating new products and new opportunities.

"A strong balance sheet is normally a characteristic of that kind of a company," Phil Dow says, "no more than 30 percent of their capitalization in debt. I hate to see companies that have to spend profits paying back interest. I would rather have them have that money to innovate."

Nothing Ventura'd,
Nothing Gained

Is Lucent going to be the next Xerox? Both are technology driven and boast fabled histories of innovations. The laser was invented at Lucent's antecedent, Bell Labs, but Nortel dominates the market in optical networking systems, with Cisco gaining fast via acquisitions. Lucent also pioneered cellular networks, but is now falling behind in winning contracts for next-generation wireless networks.

Lucent used to make everything AT&T needed. It wasn't there to be profitable. It got away with that because it had total control over the market. Some say Cisco now has similar control over the enterprise data networking market, with its Fortune 500 customers. Cisco forced everybody else out. It totally controls those markets, but it also enjoys high customer satisfaction. It continues to have high growth and extremely high margins. That is what created its huge cash engine.

The Cisco money situation compares with Microsoft's but Microsoft doesn't compare with Cisco for customer satisfaction.

People are generally satisfied with the Microsoft product. We don't like the crashing business that we have all had to endure with the unstable Windows operating environment, but Microsoft does rule both the consumer and business PC software markets. And that is the goal of the top high-tech companies, a No. 1 or a No. 2 market share position that is defendable long-term.

How does a company defend its place at the top? It could be done through a variety of barriers to entry such as R & D investment, long-term differentiation, core technology, core processes or established channel. But innovation and intellectual capital is still an old foundation that holds true for many companies.

How do you get it? Where does it come from? How do you keep it fresh?

The answer is a combination of internal R & D, also called organic R & D and an outsourced R & D model of venture investments and acquisitions. It is important not just that a company has announced or has a venture capital fund, it is how it manages it and how it uses the fund as part of its outsourced R & D, and as part of its core business strategy.

On one end of the spectrum is Cisco, which doesn't provide any visibility into its investment group. There is nothing called Cisco Ventures that has its own Web site, its own visible team that investors can see or that announces its investments and their returns. It is built directly into the middle of Cisco, and it is part of its strategic direction.

At the other extreme you will find Alcatel Ventures, acting largely as an independent firm that just happens to carry the name of its primary limited partner investor, Alcatel. Then you have the in-betweens, like Intel Capital. It only invests directly in companies that will promote the use of its chips. So it is important to look at a company and ask, "How does it do this? How does it use this mix of internal R & D, venture investments and actual acquisitions?" A smart company will master that.

That is an unusual aspect of IBM. It is about the only high-tech company that doesn't have its own venture capital arm. It still makes investments; it just doesn't do it as a dedicated function. What some companies do is pipe money into other venture firms. Nortel Networks is a limited partner or investor in other VC firms. The market drove many corporations to the excitement of forming a VC arm. If there were a downturn, many of these VC arms will no longer be profitable, so the ones that were there just chasing returns will fade away. But the ones that were there to make strategic investments, as part of their R & D effort, will continue on."

The new venture capital world for start-ups is tricky. Many companies were created for no reason other than to be acquired for their technology and engineering staff, so they were not built to be profitable. That should be clear up-front to potential investors. What is the strategy of the start-up? If it wants to be acquired early on by Cisco or Nortel or Lucent, it will not invest heavily in sales channels, and it will not create a complex marketing program except to promote itself to be acquired in its very early stages.

So the innovation is important, but profitability is about building innovation that will be used in a large company, versus building a company to deliver the innovation itself.

"Over the years," says Bill Lesieur, an equipment manufacturing industry analyst and director of Network Business Quarterly, part of Technology Business Research in Hampton, N.H., "many analysts accused Cisco of holding back innovation in the market, which, of course, a lot of people on the other side said, 'How could you ever say that?' I don't totally agree with the argument that Cisco is stifling innovation. The argument goes back to Cisco being a master of controlling the market. It always had a very high market capitalization, which allowed the company to use its stock as its currency, so it can constantly scan the market for acquisition targets. It invests in some companies to keep an eye on them, or just outright acquire them and sit on them until they are ready to deliver the product on their time line. I don't buy into that totally, but there are cases where a company clearly had an innovative product that would challenge the market leaders and Cisco bought it and it took them a long time to get it to market."

The issue goes back to controlling the market and controlling innovation. But the Cisco example suggests that with start-ups, the innovation will come. If you ask Cisco or even Nortel, "Who is your biggest competitive threat in the next five years?" they will say, "Start-ups." They will not say the other big guy.

Look for (Loose) Change

The metrics that the experts use for gauging a technology company's potential differs from spot to spot. But their general admonition is "look for change."

Change is not just about the technology or whatever the company is producing, but what is often overlooked in the investment process is the adoption cycle for those products.

What is changing ­ not just in terms of the technology, or from the vendor standpoint ­ but in terms of demand? What is changing in terms of adoption that will allow one technology or one particular change to hit the market right at the right time?

It is not enough to look at industry data, or read guesses that consultants might have about how big a certain market will be in 10 years. It is also important to gauge when something will catch fire, when you will find that perfect inflection point where adoption from the end user will allow an innovation to click.

"I try to analyze that change and determine when I think those things will all come together," says Pip Coburn, a global technology strategist for UBS Warburg in New York City. "As bare bones, I need to get my arms around the technology so I feel comfortable that if the product is going to happen, that the market will also be there at the same time. In technology, it is critically important. There are over 1,000 companies that I look at globally; not all of them are clicking. We are looking for ones that we think the odds are pretty good that they will click."

More than half the battle for innovation is getting the timing right. There are adoption cycles and inflection points, not to mention whether a technology company will be torn apart at the seams by impatient venture capitalists waiting for its hot new product or service to be born. A company can lose its entire sales force if timing is bad.

In the stressful, competitive environment in which technology companies live and die, management's willingness and ability to empower employees may be more important than in other industries. A commanding, controlled methodology that might have been successful 30 years ago won't fly with today's intellectual capital.

One of the challenges in technology is that companies in this category don't have wonderful management team track records that you can point to in other industries. Instead, you should dig in a bit more on the thought process. You might want to see a management that has a history of failure in its background, because it needs to learn the lessons from those challenges in order to possibly adapt in a world that is continually changing in and of itself. Look for balances of successes and failures. Cisco CEO John Chambers is one. He survived many experiences prior to joining Cisco that were not all that pretty and pleasant. That allowed him to learn and become the leader he is today at Cisco.

Anyone could have made a reasonably good guess at how big the market would be for PlayStation II. It is much harder to gauge what the market might be for gigabyte Ethernet as it rolls out. Nonetheless, analysts and potential investors must get their arms around that and other breathless concepts in order to know whether a company's business model makes sense. Is it spending too fast? Is it spending too slowly? Is it joining the right consortiums? Is it blocking the right consortiums from making progress?

"I want a sense of their model because I want a sense of where the company can shoot and whether it is making the right decisions along the way in terms of the pace of becoming a more mature operating model," Coburn explains.

There is no rule of thumb in all of this; that is the fun part. There is no rule that as soon as someone mentions "paperless office" and you start buying all the related stocks, 10 years later the timing will be right. Different technologies have different time spans.

There aren't absolute truisms about the adoption cycle that will lead you to specific answers on a case-by-case basis. You have to get your hands dirty and be willing to make a lot of mistakes.

Vapor Dare

How can you be sure that a company's purported innovations are real and, if real, address a real market?

Journalist Geoffrey James has made a career of being cautious about alleged technologies.

"I am very skeptical about a lot of repeating themes in the computer industry on which no one ever makes money but which everyone periodically gets excited about," he explains. "Any company that is involved in any of those, I am not interested in. These include the kinds of technology that demand for which never existed, or if it did exist, no one would care."

What would be an example of technology that will never exist? The paperless office.

"There never will be a paperless office," James says. "That will never happen. In fact, there is an exactly proportional growth of the paper industry and the printer industry and the computer industry. Printers are growing, if anything, faster than computers are growing, so there will never be a paperless office. It will never happen because the more computing power you have, the more people want to produce paper. And yet, you will hear people talk about their business plans that assume that at some point the paperless office will exist. It is foolishness."

Pip Coburn has heard it all before as well.

"We get someone who will come into our office, and in 45 minutes, they will talk about the revolution of the paperless office and how their company stands to benefit. What if the paperless office never happens? How does your company stand then? Are you fully dependent on the paperless office? Or is the paperless office just a marker in my mind to imagine and get what your company does that is really special? If someone talks about the paperless office, I go back and say, 'What is the demand for it? Why does the end user really, really want to do that?'"

"The paperless office, obviously, is a total joke," agrees Bill Lesieur. "It is all about creating options, and that is what these start-ups are doing, that is what the venture capitalists are doing. It is like an option fund. An ideal company is going after growth markets that are not known, are not defined. If it were, if the market forecast was known and the market was defined and there were research reports on it, then it is too late. You are too late for the market. It will not be a growth market. So what the companies do is create future options depending on a multiple of variables that will happen."

One of the differences between the way James and Wall Street analysts look at things, according to Coburn, is that the analysts are trying to see a complete picture of major societal trends and then apply them to the company selling something based on the paperless office. And though Coburn doesn't completely discount the paperless office the way James does, he agrees it will take "a lot, lot longer than anyone ever imagined."

There are many tech themes that haven't come true. They were created by strategic marketing people or groups and with a goal of promoting and selling products and services.

A man once worked a summer job laying and fixing railroad track. The rule of thumb was that if you were really good at this job, it took three really good hits of the spike to drill it into the ground. In the same vein, you don't just throw out a huge revolutionary phrase like paperless office and get it drilled down in one shot into all of society. It takes a few shots. The Newton (the original hand-held personal assistant developed by Apple Computer years before the Palm) is a great example. The Newton is not discernibly different from the Palm. The reality is that the market wasn't ready for the Newton when the Newton was ready, so the Newton provided the first shot at that spike. Subsequently, the Palm came around, and there was the second shot. More and more people are adopting, the manufacturer sold 6 million or so, and lo and behold, there will probably be a third shot into the ground that really nails it for the consumer base.

Another fool's gold is home networking, where people will live in houses with all their devices and gadgets neatly e-tied together and communicating with each other.

"I am familiar with the scenario, we have all heard them, and gee, that sounds neat," James says. "But the truth is that most of the VCRs in this world are still flashing '12:00.' The people who do things on computers other than play computer games and word processing are still not programmers. The last thing people are going to do is sit around and program their house. Most people, if the power goes off, they hate going around and resetting all the clocks in their house. That is about the level that most people are going to do and not much more."

One of James' favorite anti-technology stands is on artificial intelligence. It's a rant that goes back to his days as a college student in the 1970s. In 1973, he says, the big buzz was that in 20 years, computers will be just like people and we will have to worry about them taking over the world.

"Every year," James says, "the 20-year prediction comes out, and the truth is that everything that is done in artificial intelligence today, everything is all based on software technology that was developed in the late 70s. There have been no significant software breakthroughs in artificial intelligence in 30 years. None. What has happened is that computers have gotten faster, and they have refined the techniques that they had before, which is all pattern-recognition, the same stuff that is used in voice technology and OCR (optical character recognition). It is hard enough to get a computer to recognize a spoken sentence, to recognize what the words are, but we are centuries away, or we may never be able to come up with a computer program that will be able to understand what a sentence means in the context of the rest of the world. But people keep on talking about that as a (viable) technology because it is ingrained in the myths of the culture, the idea of robots running around a la Star Wars. People believe that it is going to happen."

Speaking of Star Wars, talk in political camps is once more growing of a sophisticated missile defense system that the U.S. could one day build.

Pshaw, says James.

"That is goofy for a whole lot of reasons," he says. "If you can smuggle a kilo of cocaine into the country, or a hundred kilos of cocaine into the country, why couldn't you smuggle an atomic bomb into the country? I think that the terrorists are smart enough to realize that, 'Gee, I have two choices: I could smuggle a nuclear device into the country with almost no effort, detonate it in some big city, and they would never know who did it. Or I could send a freaking missile that has a jet trail back to my home country.' Hmmm, which would you do? It's stupid."

One more example: Marketers and technologists talk about the advent of wearable computers. Not James.

"What are they going to use it for?" he asks. "People will carry tiny computers, yes, but I don't think anyone is going to be wearing them. They are stupid, and they will get caught on something. Most of them have wires all over the place. The marketers say, 'People out in the field or working in a factory will wear them.' I say, 'Yeah, that is just what I want in a factory, a bunch of wires hanging all over me.' That isn't smart. It is so ridiculous that it is unbelievable, and yet you see companies pursuing this and building business plans around it."

In general, James adds, any business plan that depends on "crossing the digital divide" ­ putting computers in the hands of people in the United States who don't already have them ­ is nonsense.

"It is not that computers are too expensive," he says. "It is that people are stupid and illiterate. Everyone who wants a computer in the United States now has one or two or three. People whose total interaction with technology is flipping the channels to find Jerry Springer are not going to get a computer. They are not going to want a computer, and they are not going to want to program their television. They are not going to want a television that is like a computer, either. They are going to want a television, period. Anything that depends upon the use of the Internet in such a way that appeals to people who essentially cannot read, I do not believe there will be any market for that."

If you look at a large company's portfolio, it should be creating options through R & D investments that certain markets will take off, certain markets won't, some companies will make it, and some won't. Investors hedge their bets the same way, depending on how much risk they want.

Desktop video conferencing failed miserably. It was forecast throughout the '90s to take off. "I actually worked at a start-up that did video communications, so I know firsthand," Lesieur says. "The models were totally wrong based on supply, meaning they looked at the number of PCs that were technically capable of supporting desktop video conferencing. Where it failed was on the people side. They didn't accurately understand demand." Or the lack thereof.

Lesieur has his own Jamesian vapor tech concerns. His focus is on the alleged potential of the "mobile Internet" market.

"Huge assumptions are being made about Web-enabled digital phones and PDAs supporting Internet access, but it makes huge assumptions that we actually understand what people will use on a daily basis," Lesieur complains. "I hate to use the term, but what is the killer app of the Internet? We don't know yet. All we have so far is voice. But that could become my premise. If the first rollouts of applications and services go badly, this market could get thrown off for years. I am obviously not going to surf the Web on my phone."

Here's one that James and Lesieur might arm-wrestle over: telematics, a quaint term coined to describe Web-enabled cars.

"I think it is a huge opportunity," Lesieur says, "but it is one of those you have to be careful about. What kind of company makes money off this? GM says, 'We will not be considered a car company long-term; we will be an 'application service provider.' If its plans go as it expects, GM will be the largest wireless carrier in the United States. It will Web-enable all it cars, and it will control the carrier part of it. It is an old company trying to reposition itself.

"We don't need full access to the Internet from any of these devices," he continues. "We need specific applications that will help me and you. It has to be beyond e-mail. E-mail was considered somewhat the killer app for the Internet. The Internet is not just PCs looking at World Wide Web service. If you step back, it is a communications infrastructure; it supports network connections."

Of course, if the auto manufacturers ­ Ford is credited with coining the term "telematics" ­ are committed to souping up new vehicles with Internet access, why don't they first design a car in which it is more comfortable to do desk work? Put in folding trays for traveling salesmen to set their laptops on after appointments. Let driver seats swivel to the right to access those trays. Make better lighting an option.

Talk about the need for innovation!

"What does the business car look like?" wonders Lesieur. "I am sure they are thinking about that to some degree, especially for rental cars. But they will do the basics first, like when your airbag explodes, your car will automatically call 911. Maybe that is free, but if you want to read your e-mail, maybe that will cost $10 a month."

The point here is that if it sounds ridiculous, maybe it is.

The problem is that when it comes to the potential for technology, most people are easily misled by hype. It trips up even literate, educated, experienced investors.

There is a real lack of cynicism in the computer industry, and it comes up regularly in business plans. Computers do not suspend the laws of economics. So when you look at companies to invest in, decide for yourself whether they address a real market for a product or service that people can really use.

Open Wide and Say "Ahhh":
Innovation and Corporate Culture

A CEO's job is all about enacting, supporting and spreading corporate culture. Their first responsibility is making two or three key strategic decisions and then making sure that the organization is aligned to accomplish what he or she is sets forth.

Sometimes a board of directors brings in an outsider to shake the cobwebs from a company's culture, to bring it out of the past, or, in more simple language, to get its collective head out of its collective ass.

Culture is a combination of values and behavior. Corporate behavior can be changed fairly quickly. The values part takes a little bit longer.

Commonwealth Bank in Australia was a stodgy, government-owned bank. In the mid-1990s, a new CEO came in, changed the bank's operating model design and stock prices trebled over six years. He successfully changed Commonwealth's culture and its profitability.

Companies such as IBM are known for its tight-ass culture. Does it make any difference to its profits and worth as a company?

Heinz is an example of a company that was once seeped in veteran managers. But those managers were seen as resistant to change and out of touch with the consumer. Recently, Heinz brought in younger managers who are evolving its culture. They eagerly react to challenges and roll out new products more quickly than their predecessors, taking chances on new product, behaviors that should translate into increased profits.

Sometimes a company's culture is hidden beneath a veil of smoke and mirrors. Philip Morris apparently believes the public bears an incomplete picture of its position as a corporate citizen in the wake of recent anti-tobacco court battles. It spent big on advertising that paints it as a compassionate corporate citizen. Part of that is spin control, of course, but part of it is a genuine effort at getting out word of its internal culture.

Philip Morris went through a rough period where it was slammed left and right on television with anti-smoking ads and "Look what they have done to children." That is the perception a lot of people have about the company. But the company is working hard to say, "Look what we really do for you and the community, look at what we give back; we are not all bad."

It's a campaign aimed at both rehabilitating Philip Morris' image and restoring employee pride in the company's culture.

Where there is highly motivated and sensitive management, you'll most often find broad innovation and risk-taking. Many people believe that in business, individuals can't accomplish as much as a team or as part of an organization in a supportive corporate environment. It takes an environment where people are motivated to be cooperative.

Good management gets information from its employees who are close to the customers. A corporate culture where sharing information is not encouraged and where the messengers might be punished stifles innovation. Management in a nurturing environment demonstrates that it genuinely cares about its employees and their well being. If it is trying to grow and prosper, it must want that for all of its employees.

Some companies have a culture you can visualize just by hearing their name called. And sometimes, successful companies within the same industries boast cultures completely at odds with one another. For example, Apple Computer is laid-back, a "California Dreamin'" atmosphere, whereas IBM brings forth visions of an army of faceless men and women fanning out across the countryside in blue blazers and stiff white shirts.

Cisco maintains its culture even through all its acquisitions because it generally buys small start-ups. Small start-ups in Cisco's industry are staffed by 20 or 30 engineers whose only culture is working 'round-the-clock like madmen. In fact, as part of its acquisitions process, Cisco actually sends people to meet with employees of its acquisition targets to assess the company's personality and to decide whether or not the culture of that company is a fit with Cisco. The technology might fit, but what about the people? Cisco must choose well; its retention rate is reportedly over 90 percent.

Costco is a company with an enviable culture. James D. Sinegal, president and CEO, will not allow pricing above 14 percent gross margins on any product without his permission, and he never gives it. Let's say everybody else is selling products at a 42 percent average gross margin; the nature of a competitive merchant is to sell at 25 percent and still show great value. But Sinegal's rule is that Costco provides day-in and day-out value to its customers, and even though the competitive environment is weaker in an area, Costco's culture prevents it from taking advantage of that from a pricing perspective. Hence the rock-solid 14 percent gross margin rule.

Costco also pays its employees more than its primary competitor, Sam's Club, does because it doesn't want the turnover. And Costco will take back anything. (The Home Depot takes a similar stance. When it was just a four-store, Atlanta-only company, a store manager accepted a customer's return of four automobile tires ­ even though Depot did not sell tires. The manager hung one of the tires over the customer service counter as a reminder to store associates that the customer is always right.) Occasionally, Costco gets taken advantage of, but overall, it assumes its customers will take undue advantage. That is how you build customer loyalty.

Truth, Culture or Consequences

Listen for management code words that indicate what its basic perception is of the business world and of its role in it. These have nothing to do with technology and everything to do with management's mindset, the way that it views its function as managers and the way the managers view their employees. Will the company be in the game, or will it self-destruct? You'll quickly know whether it will be in the game or not or whether it is a sustainable company or sustainable culture.

Next, study what the company is doing. Does it really make sense? Is it addressing a real market? Does it offer something that anyone really wants? How much money does it have to play the game?

The ones that have a discernible culture often take a longer-term view. They look down the road. They want to be something when they grow up; they don't just want to be showing up for work every day and throwing everything down. Culture defines them.

Be leery of cultures that have a heavy militaristic component. Once you hear people in a company talking about warfare, and using hyper-macho talk, then it starts having problems.

A militaristic view of the world creates Us versus Them thinking. It demonizes the competition to the point where, when a company needs a partner, it can't get one. Military babble causes management to treat employees like soldiers, which is not all that desirable. You don't want people who wait around to follow orders. You want people taking initiative on their own, and it is difficult to encapsulate that kind of behavior in an organization that awaits "marching orders" and where they talk gibberish about "chain of command."

These organizations frequently leave women feeling out of the decision-making process, because men don't naturally react favorably to the idea of a woman as a military officer or commander. Most women think it is a scream when guys start talking about their test marketing plans as if they were planning a World War II battle. They think it is stupid. So companies lose part of their internal audience before they even reach out to the external world. And people who have actually been in the military often become annoyed by the inappropriateness of this approach.

When Microsoft started talking about Windows and code-named it Normandy, it meant problems. Think of the problems it had with allegations of predatory practices, its difficulties in forcing things down the throats of its partners, its inability to buy in with certain segments of the industry, and the termination of anybody who disagreed with it.

In a small company; it can be absolutely devastating. At CompanyGreenhouse, the blood 'n' guts sales manager told a mixed audience that he wanted them to rape and pillage and leave no wounded. A woman raised her hand and said, "Did you want us to rape the customers or the competition?"

At Cabletron Systems, a holding company for four networking and telecommunications companies headquartered in Rochester, N.H., co-founder and former president Bob Levine was known to dress for work in battle fatigues. At one sales meeting, Levine ­ who owned his own tank ­ reportedly stabbed a basketball with a combat knife. He was also known for taking guests for rides in the tank, eventually totaling it in a collision with an enemy tree. Those antics helped the company build a certain image in the marketplace, one from which it never escaped.

Unfortunately, Cabletron's primary competition was Cisco, where John Chambers' reputation is that of one of the great gentlemen of the industry.

Cisco has almost no military paradigms; it is organic in the way it approaches things. Cisco basically beat the pants off of Cabletron because Cabletron couldn't do things like partner with other organizations for sales. It wanted its own sales force. It wanted control of everything. Many of the assets that Cabletron bought ended up being worthless because all the talent left. Cisco, by contrast, tolerates different but complementary cultures inside its organization. In the early 1990s, Cabletron was even up with Cisco, booking about a billion dollars in sales, and now Cabletron essentially doesn't exist. It was broken up into four separate companies, and Cisco dominates the market for network hardware.

Sometimes, small companies pose as large companies by imposing bureaucratic methodology that they think will make them appear as if they have everything under control. At one company with just eight employees, the travel policy was that it took five signatures to approve travel.

Look for cheap office furniture. A small company should not spend money on a bunch of fancy accessories. Or on employees who are not hired for their job skills. A senior manager at CompanyGreenhouse.com had a secretary who looked like she could have stepped off of a Paris runway. Gorgeous. Couldn't type, couldn't file, didn't know how to answer the phone and take a message. What do you think was going on there? The same guy had a reserved parking space right in front where he had a Lamborghini parked, and he had a desk that must have cost $10,000. This in a company with only 40 employees in it at the time. This manager wasted the company's money on garbage and boinked the staff. Might be a fun place to work, but not to invest in.

Before a larger company acquired CompanyGreenhouse, it put all of its money into technology. A visit to its office included sights such as a Home Depot door laid across cinder blocks ­ that was a desk ­ and a $10,000 PC sitting on top of it for a developer. When you walk into a company like that, it has its priorities straight. You want to see lots of engineers and lots of technology and a minimum of flashy paraphernalia. One analyst suggests a ratio of 10 engineers per manager, minimum. Whenever you see a small company situation where there is a project leader, a product manager, a supervisor, a manager, and two programmers ­ run. Run, run for the door. Don't put money in that company.

Also, if possible, it is nice to know how much the engineers are being paid. If the company employs 10 engineers and one manager, the manager should be the lowest or one of the lowest paid persons. The money should be spent on hiring great engineering talent, not fancy managers, because management in an engineering environment is less important than the engineering itself. Engineers know what they are doing. When IBM bought Lotus, someone at Lotus was asked, 'What should (IBM CEO) Lou Gerstner do to make Lotus successful?" The answer was "Learn to program."

Don't be impressed by big buildings and what's on the walls. Look around at how management is dressed. If they wear $4,000 suits, they are probably alienating their engineering staff. If there is a big level of perks that managers get above what the engineers get, they are probably alienating their staff.

The Vision Thing

Experts look for managements that have a long-term vision and who are not just focused on day-to-day short-term results. A company that will sustain that growth must have the ability to look beyond the day-to-day.

Charles Schwab is a perfect example. It is a hotbed of visionary leadership and management that re-invented itself several times since its founding in 1974 as a discount brokerage firm. Few people think of Charles Schwab today as merely a discount brokerage firm, but that was how it was founded. It expanded dramatically beyond that initial premise because of its management and vision, its ability to anticipate market trends and seize on opportunities.

Schwab never waited for the market to move and to change. It changed ahead of market gyrations. It recognized needs in the marketplace, and then crafted products and platforms that met or anticipated those needs in the marketplace.

By contrast, how many times has McDonald's been unable to put sizzle in a new hamburger without getting burned? The McDLT, McLean and Arch Deluxe were billed as revolutionary advancements but rapidly became devolutionary embarrassments.

Schwab, by contrast, introduces new concepts quietly. If its new products and programs flop ­ and few have ­ you won't hear much more about it. There are no "New Coke" moments in Schwab's portfolio.

Cultures Endure;
Managers Come and Go

Good management is universally proportional to size. Often there is a natural match between a company and a manager. Perhaps he grew up in that company, and when he became a part of the company, the company became part of him. Bill Gates and Steve Ballmer at Microsoft are indistinguishable from their company. And who knows where Larry Ellison begins and Oracle ends.

In a company where the founder has moved on, the leader is less important and the culture much more important. The culture will often chew up the leader and spit him out. CEOs come and go, but cultures generally endure. Because unless a new manager is given a mandate to replace almost all the senior staff and some of the lower levels beneath that, the enduring corporate culture will survive. It is difficult to change corporate culture. It is not unusual to hear CEOs of old-style big companies say, "I feel like I am riding in a gigantic boat and no matter how hard I turn the wheel, nothing happens."

Technology has never changed a culture; all it does is accelerate behavior. If the culture sucks, technology will make it suck faster. If you give a computer to a bureaucrat, do you get less bureaucracy? No. You get more bureaucracy. You get computer-powered bureaucracy. If a company gives email access to an employee who previously thought his job was handwriting 10 memos a day, he will write 50 memos a day by email, and he will copy everybody in the freakin' building.

Good cultures create superior places to work in, people are more effective there, and it shows to customers.

The first signal of a quality culture is in its financial execution. That is the easiest way to find out. It doesn't necessarily mean it is a good culture, but you will not find a healthy capitalistic culture that doesn't deliver that guidepost. It could be Adolf Hitler and Company delivering the results, and you wouldn't want to do business with it, but normally, most companies that deliver good financial results have good cultures.

Paychex is a distinct culture, reflecting from founder B. Thomas Golisano, an orderly, to the point kind of person. His business reflection can be seen in Paychex employees across the corporation.

A market-driven organization is fundamentally about three things:

1. The culture, a mindset and set of values that puts the customer first, that says the first thing you do is find out what the market is doing, not just your customers but prospective customers. Some cultures are very affirming of that; others say, "We know better than the customer."

2. Or they have a transaction mindset; each sale is a conquest rather than a relationship mindset in which the business partners with people. So that is all about values, beliefs and mindset, which is part of culture. Its capabilities, how good it is at certain things, that is, learning about its markets and developing new products; those are all capabilities.

3. The final sign of a market-driven organization is how good its systems and organization is.

Those three pieces, culture, capabilities, and how it is configured really make the difference. But they must all work together. It is all well and good to have good systems and a good organization, but a dysfunctional culture in which the sales force says, "We own the customer, and we will not share any information with the rest of the organization," will get in the way of performance.

If you visit MBNA's headquarters, signs on the walls repeat the same message over and over: "Think of yourself as the customer." It is not just on the walls of the customer service departments; it is over almost every doorway. That is the culture of MBNA. It is a customer service business. While attracting a credit card customer has to do with marketing and price, once MBNA attracts that customer, service is key to retaining him or her. So for every time the customer phones or MBNA phones the customer, the company emphasizes to every employee the importance of customer service. MBNA sustains a high level of customer service throughout its organization because of its culture.

Another indefatigable culture is Disney's. Go to any Disney property and you can't help but be amazed at how clean it is. Disney's extensive employee orientation stresses customer service in all of its dealings with customers and makes that "Disney experience" so much better when you are trying to cart kids around.

If you interact with 10 different people at a Disney property, nine out of 10 will impress you.

As companies expand globally, retaining a high level of customer service becomes a challenge. In most of the successful companies, there is a strong corporate culture that usually starts at the top. People know what the mission is, they know what is important, and they know that following through will be profitable for everyone.

How important is a manager's ability to change or adapt what he thinks are positive influences? When he hears about something working well elsewhere, thinking outside the box in terms of the way his business was traditionally run, is paramount in keeping a company moving forward.

Good companies with good leaders definitely show the ability to do that. GE didn't invent the Internet, but it is probably as passionate about it as any large company in the country today.

Maybe the answer is a better balance: pull back on the growth and focus more on improving productivity in the existing store base.