Leading Through Rough Times: An Interview with Novell’s Eric Schmidt
Few large companies have soared as high, sunk as low, Fand struggled as long as the 18-year-old networking software maker Novell. Not long after it was founded in Provo, Utah, in 1983, the company came to dominate the market for local area networks. But after several misguided acquisitions and product missteps in the mid-1990s, Novell seemed to be down for the count in April 1997. That’s when Eric Schmidt, the highly respected CTO at Sun Microsystems, surprised the business world by accepting an offer to become the beleaguered company’s third CEO as well as its chairman. His mandate: put Novell back onto a sound financial footing, refocus it on its core engineering strengths, and turn it into a leading player in Internet software and network services.
The situation Schmidt faced was daunting, to say the least. Microsoft, with its Windows NT operating system, was competing aggressively for the networking market. Novell was saddled with an outdated product line and large unsold inventories. Customers were getting nervous, and reporters were beginning to write the company’s obituary. With a deft combination of cost reductions, divestitures, and new product rollouts, Schmidt turned the company around. By 1998, it was back in the black. But the good times didn’t last long. Like most technology companies, Novell is now struggling with a slowdown in demand. And in March, the company announced its intentions to acquire Cambridge Technology Partners and to appoint Jack Messman, current CEO of CTP, as CEO of Novell. Now acting as Novell’s chief strategist, Schmidt is back in turnaround mode.
It’s a mode that seems to suit him. In February, when he sat down in Novell’s executive offices in San Jose, California, for this interview, he talked expansively about the challenges involved in bringing a once proud company back to life and then leading it through yet another tough stretch. When you enter a downturn, he said, you have to fight the instinct to be overly cautious. Rather, you have to encourage your most creative people to take chances, to follow their hunches. The alternative is to succumb to a “culture of fear,” in which a bleak vision of the future becomes a self-fulfilling prophecy.
In today’s unpredictable business world, with its ever shifting markets and competitors, the prospect of a sudden downturn haunts every executive. Eric Schmidt’s experience provides more than a cautionary tale; it suggests a path through the wilderness.
A lot of people were stunned when you left Sun for Novell in 1997. Why did you make the move? And what did you find when you arrived?
I had spent a long time—14 years—in a variety of executive positions at Sun, and I’d hit the top of my game as CTO. I was ready to try something new. Over time, I’d become fascinated by network technology, and Novell looked like a good fit with my interests. When I agreed to take the job, I’d done my homework. McKinsey had performed an audit and reported that the company had lots of cash. Novell’s main product, NetWare, was a solid brand. I knew that I was coming to an organization that needed help, but I certainly didn’t think it was hopeless.
Things were considerably worse than I expected. On my first day on the job, the president told me that it looked like our revenues would be up $20 million for the quarter. That was terrific news. But on day three, he caught me in the hallway. He was ashen.“We have a problem,” he said. “Remember what I told you about being up $20 million? Well, it turns out we’re actually down $20 million.” Our sales were tanking, and we had a lot of inventory backed up in the channel. It was a shock, to say the least.
A few days later, I found myself on a plane sitting next to Roel Pieper, the former CEO of Tandem Computers, which had recently been acquired by Compaq. I told Roel about my problem. He smiled at me and said,“Congratulations. You’re about to do a turnaround.”
“Are you kidding?”I said.“That’s not at all what I signed up for.”
“Nonetheless, that’s what you’re going to do,” Roel informed me.“And I can help you. First, you do a big layoff.”
“But I didn’t come here to fire people.”
“Second, you get rid of 80% of your executives.”
“You’ve got to be kidding.”
“And,” he said, “you do all this in the next three weeks.”
“I can’t possibly terminate people I haven’t met yet,” I said. And then I asked myself, “What on earth have I gotten into?”
In my third week on the job, we had to decide what to tell Wall Street regarding our revenue loss. The CFO told me that we had enough revenue reserves, despite high inventory in the distribution channel, to avoid pre-announcing the shortfall. But that strategy made me nervous. I knew that a lot of software companies had run into trouble with the SEC for questionable accounting tricks. I called the cochairman, John Young (the former CEO of Hewlett-Packard), to seek his advice, and he asked me, “What does your gut say?” I said that I felt we should be honest and announce the shortfall. And John said, “I approve.” Later, he told me that he knew then that he’d made the right decision in hiring me. But after that announcement, everyone really thought the company was dead as a doornail.
After Novell was founded in 1983, its flagship product, NetWare, quickly became the de facto standard in operating system software for local area networks (LANs). But in the 1990s, two epochal events combined to undermine the company’s leadership position. First, in late 1993, Microsoft entered the networking market with its Windows NT operating system. Second, the rise of the Internet created a powerful new standard for networking, rendering the old LAN architecture obsolete. Faced with an erosion of its core market, Novell launched an ill-fated diversification initiative, spending $1.5 billion to acquire packaged-software businesses such as WordPerfect Corporation to compete with Microsoft on the desktop. Thus distracted, Novell saw its grip on the networking market slip further, even as its new products failed to live up to the company’s overly optimistic expectations.
Since taking over as chairman and CEO in 1997, Eric Schmidt has pulled Novell back to its networking roots while also guiding the company into the booming market for Internet-based products and services. At the core of Schmidt’s strategy is a new product called eDirectory (founded on the Novell Directory Services platform). This software allows corporate IT departments to hold down the operational costs associated with locating and managing millions of “objects”—servers, PCs, notebooks, wireless devices, routers, application programs, files, and users—on ever expanding networks composed of complicated and diverse mini-networks. By developing and selling applications and services that take advantage of the eDirectory system and that operate across all computing platforms, Schmidt believes Novell can become a leader in the rapidly growing directory-services market.
The company’s fortunes initially rebounded in 1999 with the successful launch of NetWare 5.0, its new, industrial-strength network operating system. And customers appear to be embracing the eDirec-tory system, opening up many new opportunities for the company. Indeed, the fastest growing segment of its business is applications such as ZEN-works and GroupWise, built to run on eDirectory.
But Novell is not out of the woods yet. In 2000, corporate technology spending began to slow, and Novell’s revenues, like those of many high-tech companies, flattened. In March 2001, the company announced plans to acquire Cambridge Technology Partners, a global IT service provider, accelerating Novell’s shift into services. As part of the acquisition, CTP CEO Jack Messman will succeed Schmidt as CEO of Novell. Schmidt will continue as the company’s chairman and will also become its chief strategist.
After you got over the shock, how did you go about bringing Novell back to life?
First, of course, you have to stop the bleeding and stabilize the patient. And that requires exactly the kind of tough, fast action Roel Pieper had described. We had what I call a “kitchen sink”quarter, when you clean up the mess. We drained the excess inventory from the channel and cut costs drastically. We laid off more than 1,000 employees and replaced most of the executive management team, reducing seven layers of management to four. Those were painful steps, but they were necessary to save the company. At the same time, I met personally with our major customers to show them what we were doing and to convince them that we were still alive. And we launched an aggressive PR campaign, announcing new products or product upgrades every month. The trade press is crucial in our business, and we had to get the word out that we were moving forward.
While we were making these kinds of tactical moves, we were also repositioning the company strategically and refocusing on our core networking strengths. But neither the cost cutting nor the repositioning represented the biggest challenge we faced when I joined Novell. The biggest challenge was retaining our key talent—the ones I call the “smart people”—and keeping them motivated. A company can survive losing a lot of people, but if it loses its smart people, it’s done for.
Keeping your most talented employees must have been particularly difficult given the company’s precarious condition. What did you do?
The first thing I had to do was identify them. In a company like ours that is driven by innovation, you can’t just look at an org chart to find your most important employees. The key people here are our most creative engineers—they’re the smart people, the ones who control our future—and they can be very well hidden in the organization. They’re not necessarily at the top of any hierarchy.
I used a kind of algorithm to locate these people. A few days after I started, I was on the company shuttle from San Jose to Provo, where our engineering staff is centered, and I was sitting knee-to-knee with two engineers embroiled in a fascinating, heated argument. They were obviously two extremely bright people. I asked them to give me the names of the smartest people they knew in the company. They gave me a list, and over the next week I set up half-hour meetings with all of those other smart people, and I asked each of them to give me the names of the ten smartest people they knew. Because the smart people in an organization tend to know one another, I eventually found out who they were—about 100 in all.
I met and talked with each of them. It helped that, as an engineer myself, I understood their intellectual and technological needs and what their concerns were. I listened intently while they told me about their experiences and their frustrations. They were very demoralized; no one had listened to them for a long time, and they had basically decided to lie low and keep their mouths shut. As a result, lots of great ideas were being lost.
The more conversations I had, the more clear it became that Novell had a dysfunctional culture, a sick culture. Doctors will tell you that when you’re sick, having a diagnosis allows you to focus your energy on overcoming your disease. So my management team worked together to name Novell’s condition, and we ended up calling it the “culture of fear.” In a culture of fear, which I think is a common condition in companies going through rough times, people are always worried about getting laid off, and so they suppress their feelings. Instead of complaining to their bosses, whom they fear might fire them, they complain vociferously to their peers. That’s what was going on here. This situation created a kind of pervasive bellyaching, a corporate cynicism. A related condition, which we came to call the “Novell nod,” was ubiquitous. People would sit in a room, listening to someone talk and nodding in agreement. Then, as they left the room, they’d all say to one another,“That was the stupidest thing I’ve ever heard.” I’d see that kind of behavior constantly.
So exactly how do you overcome a culture of fear?
You begin by recognizing that you can’t change a culture by fiat. The problem lies deep within the organization, and you have to give everyone—not just the smart people—permission to correct it. In our case, that meant encouraging people to say what was really on their minds. I remember one instance of this, in a meeting with a group of engineers. There was something wrong with the meeting’s atmosphere: it was a little too controlled, a little too formal. I kept asking questions, pushing for an answer. And finally, one of the engineers exploded, saying, “I can’t take this!” We were all a little shocked. Then he looked at me and said, “Do I have permission to be passionate?” I said, “Yes, of course!” Then he stood up and gave this incredibly lucid proposal for a new product. He’d been so constrained by the culture that he’d been afraid to promote his idea for fear of being shot down by his boss.
I spent a lot of time trying to get people to open up in this way, to give voice to the ideas they’d buried inside themselves. Some of these ideas were brilliant, and I encouraged people to work on them. You know, it’s a natural reaction to turn cautious when your company’s in trouble, but that’s precisely the wrong tack to take. You have to give people freedom to pursue their passions. That’s the only way to keep them focused and inspired and to ensure you’ll have a flow of new products to regain, retain, or grow ground in the market. The new version of our flagship product, NetWare 5.0, emerged in this way. After we released it in September 1998,our revenues improved nicely, leading to after-tax profits of $192 million on revenues of $1.3 billion in 1999. This built on improvement from the preceding fiscal year when our after-tax profits were $102 million on revenues of $1.1 billion, compared with a loss of $78 million on $1 billion of revenue in 1997. The turnaround wouldn’t have been so dramatic if we’d told people to be careful.
It’s a natural reaction to turn cautious when your company’s in trouble, but that’s precisely the wrong tack to take.
Another way to overcome a culture of fear is to show employees that you understand what the cultural problems are and that you are committed to fixing them. Sales meetings, for example, offer opportunities not only to motivate people and get them excited about new products or directions but also to address cultural issues on a broad scale. At one meeting, I told the audience that we had discovered a secret weapon deep in the bowels of Provo. And I introduced this engineer in a Hawaiian shirt named Ron Tanner. Ron launched into a very funny story about how the management in California has never understood anything and how a few engineers in Utah pulled together as a team and developed this brilliant product for customers. Everything he said resonated with the audience, who were laughing and shouting, “Yeah!” Then he unveiled the product, ZENworks, the first new product developed under my leadership. This product had long been suppressed within the culture of fear, but Ron and his team succeeded in bringing it out. ZENworks now produces more than $100 million in revenues for us. That sales meeting was a wonderful public acknowledgment that there had been suppression—a kind of denial about things like the friction between the Utah people and the California people—but that now the era of suppression was over.
I’m not saying we’re completely cured, by the way. The cultural issues have been extremely difficult to eradicate. In fact, I’m less satisfied about this today than I was two years ago. When I first arrived here, I experienced an incredible outpouring of goodwill, as if I’d ridden in on a white horse. But cultural problems are like cancer. They keep coming back. So I still feel the remnants of the culture of fear, and I still sometimes see the Novell nod. The good news is that these problems don’t appear in gross forms the way they used to, and, when they do appear, we know how to address them.
Despite the cultural problems, you’ve had good luck in keeping employees from jumping ship. Novell’s turnover rate in 1998–99 hovered around 15%, which was significantly lower than the industry average of 22%. How have you kept people, particularly the smart people, from leaving?
A lot of it is Management 101: repeating the same message 20 times, training the trainers, getting in front of people, cheering them on. We’re also fortunate to have our engineering headquarters in Utah, where the competition for talent is much less fierce than in Silicon Valley. We do whatever it takes to hang on to our top talent. Sometimes that includes counteroffers. Most people will tell you that’s a bad idea, because extending a counter-offer leads to bidding wars. But when you lose a talented marketing person to the competition, it’s a huge cost to your business because great knowledge and skills go to a competitor. Usually, when we ask people why they’re leaving, they talk about money. But most of the time, it’s something else, like a project or a manager or their confidence in the company. We pay attention to compensation issues but then also work on the real issues of management and leadership.
In addition, you need some kind of early warning system so that you always have a chance to get to people before they’re out the door. In a company in difficulty, you can’t presume that people are happy. So I’ve told my staff to sit down every day with everyone who reports to them and ask overtly how they’re doing and if they’re happy. That forces people to discuss their concerns. Most of them will be honest if you give them the opportunity, I’ve found.
Retaining people is only one facet of the challenge, though. You also have to keep them motivated, and smart people are not as motivated by money as they are by recognition. At Novell, we have something called the President’s Award Program, an annual dinner at which we recognize individual accomplishments. We choose 20 of our top employees each year, and we invite them and their spouses to the dinner and give them plaques and stock option grants to recognize their accomplishments. These are simple gestures, but it’s amazing what they do for people. Recognition like this makes it much harder for them to leave the company, and it keeps them much more engaged in their work.
Smart people also need to feel that they are part of the solution. Most companies make the mistake of putting their most creative people in places where their contributions are limited or where they’re resented by others. If you put them in research, they’re ghettoized. If you put them in product groups, no one likes them because they work differently than everyone else. If you put them in strategy jobs, they write wonderful documents that no one uses. And in a hierarchical company, you have some managers who are not as smart as the people who work for them. These managers act like colonels. They tell the smart person,“Take the hill!,” and the smart person says, “But I’ve been thinking about this and—”And the colonel says,“No. Take the hill!” That kind of command and control does not work.
I’ve found that the best way to manage smart people is to let them self-organize so they can operate both inside and outside the management hierarchy. They report to a manager, but they also have the latitude to work on projects that interest them, regardless of whether they originate with their own manager. You tell them, “Look, I don’t know how to solve this problem, so why don’t you throw yourself at it and figure it out? Take the time and resources you need, and get it right.”If they get frustrated and need to blow off steam, you invite them to talk to you directly—no go-betweens. At the same time, you discuss this new component of the person’s work directly with his or her manager, and there are no reprisals when a smart person works outside a manager’s jurisdiction. It’s the complete opposite of the culture of fear.
I’ve found that the best way to manage smart people is to let them self-organize so they can operate both inside and outside the management hierarchy.
To win the hearts and minds of your key employees, you have to communicate directly and physically with them. Videoconferencing, telephone, e-mail, and other tools don’t cut it. Politicians use the handclasp, and so do the best industry leaders. Since I’ve been here, I’ve spent way too much time on our corporate jet. In the beginning, I routinely hit five cities a day. That lifestyle is grueling but utterly necessary. Eighty percent of winning is just showing up.
Rarely is a corporate culture embedded only in a company’s people; it also tends to be embedded in the processes and systems of the company. Was that the case at Novell?
Yes, and it was a big problem. For example, we had to change our reward systems to make sure people stayed focused on our key objectives, and we had to do it in a very short time frame. When I first came to Novell, our sales-people knew that they were spending too much time selling through the channel and not enough selling directly to corporate customers. This practice led to huge inventory problems, which were very costly to us. So we set up quarterly objectives for direct selling, and we also introduced a new incentive program based on 25 points: if you earned at least 20 points, based on the fulfillment of your objectives, you got a 100% bonus at the end of the quarter. When people would come to me and complain—which they always did—I would ask, “What are your objectives for this quarter?” If they didn’t know them, I’d call their bosses and make sure they knew that the objectives had to be clearly communicated down the line. Business as usual wasn’t going to cut it.
Incidentally, not all systemic changes work. I’ve also learned that certain management techniques can actually make things worse when applied to a distressed culture. For example, I had always worked in companies with yearly and quarterly employee ranking systems, in which people were divided into three groups: overperforming, performing, and underperforming. So not long after I came here, we started a ranking program that graded on a curve: 45% into the overperforming group, 50% into the performing group, and 5% into the underperforming group. I didn’t know—and certainly didn’t intend it this way—that if you got the lowest grade, it was presumed that you were about to be fired. We started getting hate mail from people who argued that there was no way to rank people who worked as a team. The ranking system exacerbated the culture of fear and proved to be such a huge retention and motivation issue that we were forced to stop it after a year. In its place, we introduced a modified ranking program that better reflected overall employee performance.
Novell had a resurgence through 1999, so your efforts obviously paid off. But like many companies, particularly in the tech sector, it’s now facing slackening demand, rapid technological change, and relentless competition. How do you keep the company buoyant through the ups and downs?
First of all, we take our cash position very, very seriously. I balance my personal checkbook to the penny every month, and we run the company in the same way—as if the cash were our personal money.My first rule of business is that when you run out of cash, you close the doors. Cash is the last bulwark.That’s a simple rule,but it’s one that executives too often forget. I was fortunate to learn it when Sun nearly ran out of cash in 1989. The CFO had to get a bank loan to keep the company afloat. So after we turned around Novell,I was careful to harvest assets.The goal was to collect cash, hoard it, manage it, and talk about it a lot.
Harvesting cash is particularly tricky for companies in distress, because that’s when customers don’t pay. We put in a set of objectives for the sales force based on cash collection, and we made it a point to get everybody thinking about saving money. That discipline is helping us in our current transition away from our packaged software and toward our new technology platform. Our sales are under pressure at the moment, but our balance sheet is in incredibly good shape. We have almost no inventory in the channel, more than $700 million in cash, strong positive cash flow from operations, and hundreds of millions in investments that, we hope, will generate more cash down the road. Our cash position allows us to go on as we are for a long, long time, but we expect revenues to grow again in 2002.
Reporters and stock analysts can be brutal on a CEO when a company goes through a downturn. What keeps you from getting discouraged? What gives you the perspective to keep leading Novell through difficult times?
Obviously, I have very good reasons for putting up with four years of turning around a business and struggling to make it successful in new markets. First, I actually like the network services space that Novell is in. We have an immense market opportunity in this area. As for those greatly exaggerated rumors of Novell’s death, I try to take them in stride while working hard to educate the market about our real situation. You know, it’s easy to sit on the outside and criticize the one who’s making the decisions. Taking harsh criticism is part of any top executive’s job.
Real leadership involves taking the heat and staying focused on the way to achieve the desired outcome. Look at Steve Case. In 1997, he decided to change AOL’s pricing to a flat $21 per month. He shouldered unbelievable criticism for that. I remember being on a panel with him at the time, and he was introduced as the “most hated CEO in America.” They played a busy signal as he walked on-stage. And he came out and said to the audience, “I’m sorry, I’m sorry. We’re doing everything we can to get this right. But this is the decision we’ve made, and this strategy is the right one.” Today, AOL is incredibly successful. No one doubts now that Steve was right, but everybody doubted him back then.
It helps that business leaders understand what their colleagues are experiencing and go out of their way to support one another. I’m fortunate to have lots of good relationships with the tech industry’s leaders, many of whom I met when I was Sun’s CTO. I recall a moment in May 2000 when Novell was forced to preannounce a bad quarter. That very afternoon, Steve Jobs called me and said,“I wanted you to know that I know what you’re going through, but I respect what you’re doing and I wish you the best of luck.” The next call was from Dave Wetherell of CMGI, which has had ups and downs, too. He told me, “These things are hard, but you have to stick with your principles, stay with your focus, and you will win.” I believe these people. In fact, I think people trust leaders who have toughed it out through crises more than those who’ve had easy sailing. In a way, the fact that Novell has gone through crises has made me a more credible leader. I’m still here, and I’m still fighting for the company.
When you fly a plane, as complicated as it is, there are only a few things that will kill you. You can run out of gas, fly too low, or go off course. In my world, it’s a good metaphor.
One thing that helps me a lot—that keeps things in perspective—is flying. I’m a commercial pilot, and during my most recent training, I was doing a difficult maneuver called “circle to land.” I was in a twin-engine plane, and I was wearing a kind of hood so that I couldn’t see out the windows. The instructor had shut down half the instruments and one engine, and I had to fly by the few remaining indicators. Then, at 900 feet, the control tower switched the runway on me. I had to turn around within a mile and come in on the other runway. I did the maneuver successfully. When you fly a plane, as complicated as it is, there are only a few things that will kill you. You can run out of gas, fly too low, or go off course. In my world, it’s a good metaphor. As long as we pay attention to the important things, we’ll survive.
Leading Through Rough Times: An Interview with Novell’s Eric Schmidt
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