Lean Case: Hearst Corporation

 

Hearst Corporation

Founded 1887, Hearst Corporation weathered the advent of movies, television, and the Internet and emerged as a prototypical multimedia conglomerate with interests in newspapers (15 daily and 36 weekly papers), magazines (Cosmopolitan, Esquire, and O, The Oprah Magazine), cable networks (A&E, ESPN, Lifetime, History), and broadcast television  (29 stations).

George Kliavkoff joined Hearst in 2009 to run digital operations. As executive VP of business at Major League Baseball and chief digital officer at NBC Universal, Kliavkoff had scored high-profile successes including Hulu, a joint venture between archcompetitors NBC Universal, News Corp, and Disney-ABC that helped pioneer commercial online television distribution. Currently, he oversees Hearst Ventures and is copresident of Hearst Entertainment, comprising television production and cable network joint ventures. He spoke with us about the incentives that drive enterprise innovation.

 

What’s your personal approach to innovation?

 

I’ve had an unusual approach because I’ve always done it within large, traditional organizations. Major League Baseball, NBC Universal, and Hearst are traditional media businesses that have needed to innovate to protect their existing businesses and grow into new ones. Most disruption comes from outside large organizations, so it’s unusual to be a disruptor within large organizations.

 

Do you find that entrepreneurs and employees are motivated by different things?

 

Great entrepreneurs and great employees are similar in that they both want to win, solve real problems, and work on projects that make a difference. But they differ in their thinking about compensation. That’s one of the big challenges.

 

How important is it to provide special incentives for entrepreneurially minded employees?

 

Well, you have to, or you aren’t going to attract and retain competitive folks. People who are entrepreneurial in nature want to participate in the value they create. There are so many opportunities for them to do that outside a large corporate structure that you have to be competitive. While compensation is very important to attract and retain the right people, though, other things need to be in place before you get to the point of hiring the first person.

 

What kinds of things do you mean?

 

I have a list of five. First, in any large organization, you need support from the very top. The CEO and board have to be behind what you’re doing, or it will be doomed to failure. Second, you must have the ability and organizational support needed to build unique structures, say, to start a new company or form a joint venture with one of your biggest competitors. You have to be willing to embrace structures that don’t feel right within the corporate environment. Third, it’s important to have physical separation. If a corporate startup is to be successful, it can’t be in the same physical location and building as the thing it’s trying to disrupt. Major League Baseball is on Park Avenue; Major League Baseball Advanced Media was in a cramped space downtown in the Chelsea Market. I’ve gone so far as to set up companies in other cities to create that separation. Fourth, you need patient capital. You need to understand that these things aren’t immediately accretive and that you have to invest to get a return. This is much easier to do in a private company. If you have shareholders who are thinking about quarterly returns, you’re probably limited in the amount of forward investing you can do in new ventures. And fifth, you have to take a portfolio approach with the understanding that some projects will fail. You have to be okay with that. You can’t penalize executives who work on failed initiatives. If they did a good job, you have to embrace it and move on.

 

Getting back to compensation, how can enterprises organize their startups to give employees a piece of the upside?

 

There are a few things they can do, mostly around the startup’s structure. Hulu began as a joint venture between NBC Universal and News Corp. Then we sold a piece of the venture to private equity and created an option pool, so the employees were treated much more like traditional digital entrepreneurs than executives within large organizations. In fact, we brought in outside investors partly because we knew they would demand that the management team be properly incentivized for a digital startup, including equity. That allowed us to attract a great CEO and team. At Major League Baseball, we set up a separate company. Each of the 30 teams received a portion of the equity, and a portion was set aside to be earned by the executives who were working on that venture.

 

Can you build the same kinds of structures within a private company like Hearst?

 

At Hearst, we don’t have equity plans for anyone because there’s no equity to share in any of our business lines. So we have to create incentives that are as good as, if not better than, those being offered by the folks we’re competing with for engineers. For instance, we’ve created profit-sharing plans that acted like phantom equity. Portions of the profits for every year the new venture was profitable were set aside to be shared among the employees, and all the employees had points in the plan. In some respects, that’s more attractive to employees than a straight equity option plan, because it didn’t require an exit to be monetized, and it wasn’t a one-time occurrence. Basically it’s a special bonus pool that’s tied directly to the profitability to the business so that the interests of the company and the employees of the startup are aligned. It also has interesting knock-on effects. If you’re the manager of that business, every time you hire a new employee and give that employee points in the bonus pool, you’re diluting your own share and that of all the other employees. So you only hire someone if you think they’re going to increase the pie enough to offset the dilution incurred by granting them points.

 

Does offering different compensation schemes to innovation teams and other workers create issues around employee morale?

 

Of course. You have well established, profitable lines of business that are throwing off cash, so you’ve been able to attract great talent without giving equity. Meanwhile, the people in the new venture are getting a 10 percent share. You can open that door, but it’s difficult. You’re going to hear from the heads of salaried business units: “Wait, I work hard for the company, I run a big P&L, why don’t I get 10 percent?” You have to be ready for that. Many enterprise CEOs are bound to resist spinning off internal startups and giving equity to employees on the basis that these practices reduce the value of the enterprise’s own stock.

 

How would you answer them?

 

Hulu was set up as a joint venture. NBC Universal and News Corp owned 50 percent each. Then we sold 10 percent to private equity. So, yes, you could say we diluted the initial partners’ equity by 10 percent. But I would argue that bringing in an outside investor established a high valuation for a company that had not yet launched. It added legitimacy that attracted and retained amazing talent to build that business. It put investors on the board who had Hulu’s long-term interests in mind, as opposed to milking it for the benefit of the media equity stakeholders. So bringing in the outside investor more than made up for the dilution. When Major League Baseball created its digital wing, Major League Baseball Advanced Media, it gave 90 percent to the 30 baseball teams and retained 10 percent as a stake to be earned by the executives. If it had given 100 percent for the 30 baseball teams, the level of executive talent would have been lower and the growth of that business would have stagnated. Instead, it made the pie so much bigger that it offset the 10 percent dilution. If you give away equity without getting a benefit in exchange, sure, you’re diluting yourself. But if the equity is being used to accelerate the growth of the startup and ensure that you have great talent running it then the dilution is worth taking every day of the week.

 

Founders of startups typically take a 50 percent pay cut in exchange for a portion of equity. Is this an appropriate model for corporate innovation?

 

It may be better to attract more risk-averse people or more risk-tolerant people depending on the nature of the business you’re trying to build. If you’re building a highly secure personal finance site, you probably want to attract risk-averse people, which means you’d lean toward market-based compensation on the salary side with a lower upside on the equity or profit-sharing piece. If you’re building something incredibly disruptive that requires someone who is quite tolerant of risk, you probably want to attract someone who’s willing to take a lower salary and willing to engage in a little bit of roulette with you on the equity upside and the profit-sharing. People coming from the startup world are already accustomed to that model. Folks who are going through their first entrepreneurial experience may be looking for that kind of gamble. But the vast majority of entrepreneurial experiences don’t work out. The Facebooks and Twitters of the world are the exception, not the rule. Most people who go to work for venture-backed companies never get a payout on the equity piece of their compensation. So, more often than not, folks who are doing an entrepreneurial venture for the second or third time appreciate mitigating that risk while retaining some upside and variable compensation based on performance. They can be great entrepreneurs even if they’ve been through a few unsuccessful companies.

 

Why don’t corporations tend to trade off salary against equity or profit sharing?

 

It’s really, really difficult. It’s heavy lifting and it’s painful. And it includes embracing failure, which most executives avoid at all cost. Part of being an entrepreneur is understanding that in a portfolio, most things don’t work out; that if you start 10 things, six or seven will fail. You have to be willing to suffer the lashes of failure to see some successes. Most executives spend their career trying to avoid failure, not embrace it. It’s a different mentality.

 

George Kliavkoff, co-president

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