Nasdaq Faces Eroding Share, End of Boom
Wall Street Journal, December 24, 2003
“Unbeknownst to all but a handful of insiders and industry players, Nasdaq is fighting for its life… Will Nasdaq survive as a thriving market for tech stocks? It’s under assault from all sides.”1
Thus began a splashy Businessweek cover story from August 2003, titled “Nasdaq: The Fight of Its Life.” The story was hard-hitting but not incorrect. Nasdaq’s situation was dire. We needed to act right away. But more important, we needed to act on the right things, and as Nasdaq’s new CEO, it was up to me to figure out what those were.
Why do some CEOs succeed and others fail? After all, most people who make it to the corner office are talented, smart, and experienced. That’s why they were hired. Generally, they work incredibly hard. But I’m convinced that one key factor that distinguishes those who thrive at the top from those who only struggle and strive is how they leverage their time. They work on the right things—those that will give them the greatest advantage. “Give me a long enough lever… and I’ll move the world,” said the ancient Greek mathematician Archimedes. Great executives feel the same way about their business. They are constantly seeking ways to increase their leverage—to have maximum impact without maximum expenditure of time or resources.
A common trait of those who fail, I believe, is that they end up working on the wrong things. Time is finite but the CEO’s to-do list is infinite, and every item may seem highly relevant at any given moment. Prioritizing the endless tasks is part of the great challenge of leadership at any stage in the growth of a business. During a turnaround, it becomes particularly critical. For a master-of-the-universe CEO type who naturally wants to do everything—and do everything perfectly—this can be a difficult reality to accept. People sometimes think the key to success is doing your job well, but for a leader it is equally important to know what you’re not going to do well and what you’re not going to do at all. It’s all too easy to spend time working on things that don’t provide high enough leverage to really impact the business. Don’t get pulled off course by the seemingly endless priorities and time-wasting task lists. Believe me, you can fix all kinds of problems in a big organization, win plenty of battles, and still lose the war.
I knew I couldn’t fix every problem at once. It was time for triage. In the midst of a turnaround, an organizational leader must be prepared to function like an emergency medic in a disaster zone—making quick decisions about which projects, business lines, and initiatives deserve further investment of energy and resources, and which do not. To ensure I was using my own time to maximum advantage, I would need to take stock of our numerous problems, understand the various business lines, figure out which most urgently needed care, and look for the most efficient ways to cut costs and increase revenue.
Bob vs. the Blob
Before I took the helm, I had requested that the existing Nasdaq leadership put together a daily accounting of profit and loss. I always want to be able to demonstrate the economic benefit or cost of every major activity. The report was on my desk on day one. I was pleased with the team’s responsiveness, and I wondered if the systems in place were better than I had initially thought. Then I found out we had fifty people working on it. This was clearly an example of an unsustainable business model. Over time, we would develop robust financial planning and analysis systems for internal cost accounting and, more important, a company culture that kept a closer eye on such matters.
What the report told me was that Nasdaq was losing $250,000 every single day. What it didn’t tell me was why—which specific business lines or projects were draining our resources. In other words, our cost structure wasn’t clear—there was a great big blob of corporate spending that was not being clearly allocated to the appropriate areas of the organization.
Every business has a blob. To some extent it’s legitimate—corporate overheads and resources that are used by every department. For example, IT resources, HR resources, or lawyers’ time—even the CEO’s time. What tends to happen is that because the departments don’t have robust tracking systems to know what percentage of these general resources they are actually using, these costs don’t get allocated. Sometimes they get allocated by formula, divided up by number of employees or by percentage of revenue. That’s better than not allocating at all, but it’s rough justice and doesn’t really help give you an accurate picture of how the organization’s resources are being used. It also doesn’t promote accountability throughout the organization. Big companies get into trouble this way, because everyone thinks their project has high profit margins, even while the organization as a whole may be bleeding out.
You can never completely eliminate the blob, but if you can minimize it, you will take a big step toward fiscal clarity and fiscal discipline. When you accurately allocate costs to the place they’re being consumed, you promote accountability among the leaders of various business lines and projects. For example, let’s say an organization is spending $50 million on data centers. You divide that cost up among the business lines that are making use of that resource, and one of them suddenly finds a big chunk of that $50 million flowing through its particular Profit and Loss Statement. The P&L of that business line doesn’t look so good anymore, and that leader has a new incentive to think creatively about using resources. He probably never voted for those data centers, but he’s getting billed for them. And so he now has a reason to try to reduce that cost. “Hey, why don’t we put everything in the cloud?” he suggests. When people are forced to take ownership of the actual costs associated with their projects, it starts critical new conversations. Seemingly fixed costs might be revisited. As Nasdaq’s then CFO David Warren used to say, “All fixed costs are variable over time.”
In the leader’s quest for leverage, tackling the blob is essential. Until you can clearly see where the money is going, you won’t know how to best focus your time and attention. You can’t have a functional organization without cost clarity. And the way you get to clarity is by focusing in on those areas where allocating expenses proves to be difficult. When David began presenting the report to the executive team, I requested that he skip straight to the problem areas. “I don’t need to start on page one. I don’t need the whole story. Start with the friction points. In what areas have you had trouble allocating expenses?”
Although I think of myself as a fairly positive person, as a leader I consider it my job to focus on what’s not working. It’s always a balancing act. Optimism is essential if you’re to take risks and succeed; indeed, it’s probably true that the only people who really accomplish things are the optimists. But that optimism must be tempered by a disciplined and critical perspective. Just as Marines are trained to run toward gunfire, overriding the fundamental human instinct for self-preservation, leaders need to run toward problems and not avoid them. Face reality relentlessly. Override the natural propensity to turn away from trouble or procrastinate. Unlike a fine wine, most problems do not improve with age. Shine the light into areas of vagueness, confusion, or conflict, knowing that there is leverage to be found in creating clarity, alignment, and resolution.
When I asked David to show me the problems, he didn’t hesitate. He quickly flipped halfway into his binder. As we allocated expenses, turning vagueness into granularity, our fiscal situation began to get clear. Some of his findings were information I’d anticipated; others were surprises. The meeting went quickly, and I made the final decisions where needed. I think the executive team was a bit surprised how fast things got resolved. The message sent was subtle but crystal clear: We’re not going to waste time in turf battles. We’re not going to spend precious hours arguing over details that sap our energy and reduce our focus. We have an enormous challenge ahead of us. We need to be decisive and move fast.
A Leader’s Instinct
How does a leader make decisions, especially big and consequential ones, under pressure? There are many factors, but it often comes down to instinct. By instinct, I don’t just mean a shoot-from-the-hip reaction or a mysterious intuition. Instinct, as I see it, is the accumulated result of a lifetime of learning that empowers your ability to assess and respond to a situation. Your life experiences, your education, your business acumen, your successes and your failures, your breakthroughs and your missteps—all of it comes together as an internal compass that calibrates to the issue at hand. You find out what you really know in those moments.
Instinct is more than just knowledge. I’m a runner, and I have a wealth of knowledge about my favorite sport, track. When my daughter was racing, I thought I could come up with a data-based training plan for her, a formula for success drawn from the experts in the field. But then I took her to a great coach, Frank Gagliano. I watched, each day, as he would talk to Katie before her workout, and then choose exactly the best training session for her on that particular day. While sometimes his suggestion was straight out of the training manual, at other times it was clear he was pivoting and innovating in real time. It was obvious that his ability to tailor her training regimen far exceeded my own. While he and I had access to the same technical knowledge, he had something I didn’t have in that field: instinct. In the virtuous overlap between trustworthy instinct and learned knowledge, effective leadership is born.
In business, I trusted my hard-earned instincts, but I also was a great believer in using all the data available. There were rare times when I had to make an on-the-spot call, but wherever possible I liked to allow time to let the decisions crystallize. The data needed time to settle and integrate with my instinctual algorithms so that eventually a clear direction or decision would emerge. Indeed, I was decisive, but not always in the moment. Often I’d try to sleep on an important issue, letting the information I’d gathered soak through the layers of my mental processes, knowing I would wake up with more clarity. Another of my favorite strategies in the early years was to go for a run—as my feet pounded the pavement, my mind cleared, focused on nothing but the miles ahead. But afterward, in the shower or eating a meal, deeper insight would come. The ability to work with your instinct—knowing when to trust it, when to act quickly, when to take more time, when to seek input or data—is one of the hallmarks of successful leadership. There’s no perfect formula for developing this other than time and experience.
During my first summer at Nasdaq, there was no shortage of consequential decisions to be made. We spent an enormous amount of time cutting programs, projects, and expenses. I shuttled back and forth between Chris’s and David’s offices, as we questioned everything. Some projects were failing; others were flailing. Even many initiatives that showed promise just didn’t make sense at that moment, given Nasdaq’s financial priorities. It was hard work, and I spent significant time each morning combing through financial reports. But in other respects, it was simple. We needed to cut costs and there were plenty of worthy candidates for the ax.
Here are some of the questions one should ask when evaluating business lines, projects, and initiatives in the midst of a turnaround:
• Where can I stop the bleeding? Which business lines are failing so dramatically that they need to be shut down before they waste any more resources?
• Which business lines are in decent health and can survive for now without significant new investment?
• Where might immediate care and attention make the biggest difference in helping the business survive and grow?
• Is any given project or initiative essential to our core business at this moment, or is it peripheral?
• Which proposed projects would be crazy to even start, with low odds of succeeding?
It’s easy to shut down projects or initiatives that are failing outright. The tricky ones are those that limp along, with a handful of loyal customers that embrace the product or service. As I often like to say, the only thing worse than no customers is one customer. You’ll upset them if you shut it down. Plus, over time, certain people within a company will get invested in those projects and protect them, despite their unprofitability. It’s important to be clear-eyed about what constitutes a success and what doesn’t.
Some of the most challenging decisions I faced involved projects that were promising but peripheral. A case in point was a project that Adena Friedman was leading: Nasdaq’s first exchange for smaller, “micro cap” companies, known as BBX. It had real potential; it was a valid concept that would serve investors. It was also going to take years to come to fruition, consuming resources and time in the process—most notably, the time of one of my most talented executives. But she was committed to it, and she argued passionately against my suggestion that we shut it down. I respected her all the more for this position, but that didn’t change my ultimate decision. It was simply the wrong time for that kind of project.
Six weeks after my arrival, Nasdaq wrote off $100 million in underperforming assets. This was a consequence of cutting through the confusion and analyzing the actual performance of the business. Nasdaq’s money pits were no longer buried, vague, or unknown. Thanks to Chris, David, Adena, and others’ hard work, we’d identified the problem areas and already taken major steps toward their resolution. My plan was beginning to take effect. I’d focused on people first because the right people leverage everything else in a business. I’d begun the essential process of reducing bureaucracy. Now we were embracing fiscal discipline.
How Healthy Is Your Core Business?
In a turnaround, fiscal discipline is critical. You need to weigh, measure, and count everything that can possibly be weighed, measured, and counted. But it’s important to understand that you can’t save your way to success. Cutting costs and becoming a leaner operation helps slow cash burn, but there is a lot more to getting your fiscal house in order than reducing head count or closing unprofitable lines of business. You can’t cut your way to prosperity.
At some point, you have to find a way to increase revenue and start bringing more customers in through the proverbial door. A new leader needs to quickly wrap his or her head around the company’s various sources of revenue and ask the question: How healthy is my core business?
Nasdaq revenue in 2003 was derived from three main pipelines. First, the data and indexing business. That includes, for example, the data that everyone sees scrolling across the screen on financial networks such as CNBC, Yahoo Finance, and Bloomberg. We also licensed financial products derived from Nasdaq listings, like the Nasdaq 100 index. As Exchange Traded Funds (ETFs) and index funds became more and more popular in the overall markets, this business was robust and growing—a godsend during the turbulent period from 2003 to 2005. It wasn’t our core business, but it was important. Without this revenue, Nasdaq wouldn’t have made it. I quickly ascertained that this business was healthy and didn’t require too much time and attention. I was free to focus on more urgent matters.
Nasdaq’s second source of revenue was its listings business. Companies pay to be publicly listed on Nasdaq. In addition to their yearly fees, there is also a onetime fee associated with the initial public offering (IPO) of shares in the company. It was not the largest source of revenue, but those yearly fees were steady and predictable, and investors loved that consistency. It was also our public face, our flagship business. Indeed, from a branding perspective, the listings business is Nasdaq. It wasn’t just about money; it was critical for our global brand. Stop anyone on the street and ask them what they know about Nasdaq, and they are not going to wax poetic about trading volume or exchange technology. They are going to talk about Google and Facebook and Microsoft. They are going to tell you about tech companies, opening bells, CNBC’s Squawk Box, or the latest, greatest tech IPO. Nasdaq is an attractive brand. And part of that was winning the best new IPOs every year, and keeping our existing companies happy with Nasdaq’s service and image.
Unfortunately, following the dot-com bust, the listings business was seriously impaired. There were very few IPOs in 2003. Moreover, our longtime rival, NYSE, was competing aggressively for our existing listings. I had confidence that given time, this business line would naturally recover its former health, but time was something we didn’t have. The listings business demanded immediate attention; in fact, it felt like an infinite consumer of resources, and I chafed against spending my time on it. It was the very opposite of the type of high-leverage activity that is critical during a turnaround. Listings is a good business, but it doesn’t have a very high ratio of revenue output to degree of energy input. A listings victory represents a single account. It doesn’t scale well, and it’s people intensive. It’s what I call an “arms and legs business.” In time, however, I would gain a deeper appreciation for the importance of listings to our global brand, but for now, I had more pressing priorities.
The third revenue stream, and the one that was truly our core business, was transactions. Nasdaq charges a transaction rate per share of stock traded on its systems. From an income perspective, this is the most important revenue stream, representing 40 percent of our overall revenue at the time. And it was in trouble. Our revenue from transactions dropped by 20 percent in 2003.
This business was on life support, but I knew what medicine was needed. I knew the industry intimately, and a significant part of the reason I’d been hired was to change Nasdaq’s fortunes in this mission-critical area. I arrived with a clear mandate: Invest in technology, focus on the future. While I couldn’t control trading trends in the overall market, I certainly intended to regain our footing in the battle for market share in electronic trading. We needed to innovate, compete, and serve our customers better. Transactions was the area where I could get the greatest leverage.
Every business is in a relationship with its competitors but also with the market as a whole. When assessing why a business line is struggling, it’s important to consider:
• Is the market as a whole depressed?
• Is the business struggling because we’re failing to compete?
• Is the market going through a significant transition?
In the case of Nasdaq’s transactions business, the answer to these questions was yes, yes, and yes. There was no doubt that the market as a whole was still struggling to recover from the dot-com bust. In 2003, industry-wide trading volume was down, and revenue along with it. Adding insult to injury, we were rapidly losing market share to competing ECNs, so we were also receiving a decreasing portion of that shrinking industry revenue. But by far the most important thing we were up against was a significant market transition: a sea change in equities trading. In the end, our success or failure would depend on how we met that challenge. As John Chambers, former CEO of Cisco and a longtime Nasdaq customer, reflects, ultimately “you compete against market transitions, not against other companies. If you don’t stay focused on figuring out what’s happening in the market, it doesn’t matter if you win a few battles here or there… Disruption can quickly lead to self-destruction if you misread the market and end up fighting the current.”2 Of course, as any leader of a public company who has to report quarterly earnings knows, you have to compete effectively in the short term as well. But from a macro perspective Chambers is right: Market trends can make or break a business. And when they involve technological innovation, there’s no sense in pretending it’s all going to go away and things will go back to how they were.
A Market in Transition
As in many industries, technology was radically disrupting how trading was done on Wall Street. Every exchange was impacted, or would be soon enough. Like many businesses that find themselves under the unexpected assault of a marketplace in technological transition, Nasdaq had been slow to respond to its changing environment. It had initially been cautious in embracing the emerging world of electronic trading, trying to keep one foot in the old dealer-dominated universe while cautiously embracing the digital future. The company had tried to listen to its customers, and that’s important, but sometimes, your existing customers want you to stay the same. In a market that is being disrupted, your customer base can be in flux, and it’s all too easy to follow your legacy customers off a cliff. Sometimes it’s necessary to forge a more independent path. As Henry Ford allegedly said, “If I had asked people what they wanted, they would have said faster horses.” With my arrival, the time had come for a different approach.
In order to contextualize the steps I took to get Nasdaq on track, and the lessons I learned in the process, let me briefly explain the market transition that was occurring, and the changing customer demands that were driving it. A few years before my arrival, Nasdaq essentially had 100 percent market share in Nasdaq-listed stocks, which meant that trades in Nasdaq-listed stocks were entirely controlled by Nasdaq-sanctioned dealers and processed through Nasdaq systems. By the time I arrived, Nasdaq’s market share for matching buys and sells in our listed stocks had fallen to 13 or 14 percent. That was how profoundly the electronic revolution was impacting our business. ECNs offered customers alternative venues for trading Nasdaq stocks. So although these stocks were still listed on the Nasdaq marketplace, we had less and less influence over the trading that was happening in that marketplace.
Why was Nasdaq falling short? It was failing to provide two of the critical things any stock market needs—speed and liquidity. Liquidity, simply put, is the ability to buy and sell relatively easily, usually due to the high volume of shares being traded. Liquidity is the lifeblood of any stock market. In trading stock, price is important, but so is the certainty that you can get the deal done. It’s Human Nature 101. When we make a decision that we want something, we demand instant gratification. Imagine that you, as a consumer, have spent hours agonizing over the decision to buy Microsoft—weighing up the pros and cons; poring over the research, the business model, the track record, the market conditions, the management team. Finally, you make up your mind: I’m going to do it. Getting a good price matters, but it’s not your only concern. The last thing you want, at that moment, is to wait for that order to get filled. You want it now! So you will tend to process your order with a trading firm that can assure you it has sufficient order flow to get the deal done fast. It’s just like buying produce at the grocery store. You are more likely to go to a busy market that consistently has ample supply, offering you the certainty that you can get what you want.
In the trading business, the phrase that describes this dynamic is “liquidity attracts liquidity.” If a particular firm has enough buying and selling activity, then there is usually going to be someone on the other side of any given trade in any particular stock. Naturally, that creates a network effect that attracts more people to want to trade stocks with that firm.
Waiting brings uncertainty. A delay in getting orders filled can cost money as the market continues to fluctuate. Customers were looking for speed, which means certainty, so they were increasingly choosing ECNs. We were losing market share and liquidity, and that was, in turn, causing us to lose more of both. If liquidity attracts liquidity, the opposite is true as well. Compared to NYSE, we might have been faster and more electronically oriented, but when it came to what all our customers wanted, we were slow-footed and a generation behind.
Remember, Nasdaq had pioneered the electronic market all the way back in 1971, providing a central, up-to-date quotation system for stocks of small companies. However, it didn’t eliminate the human element altogether. You could see the quotes on the computer screen—close enough to kiss—but you still had to pick up the phone and call a Nasdaq-sanctioned dealer in order to consummate the trade. ECNs automated that final step. They could match your bid with an offer in the blink of an eye. The traditional role of the middleman, the market maker, the broker-dealer, was being bypassed.* ECNs harnessed the latest technology to meet customer demands for speed and certainty. Nasdaq tried to compete with ECNs by building its own version of an electronic order-matching system, known as SuperMontage. It was a step forward, but by trying to include features both for dealers and for new electronic players, the final product ended up pleasing neither. It was a horse designed by committee, and the resulting camel didn’t help Nasdaq’s position in the market. By the time it was released, in 2002, the market had already moved on. As in any established business being disrupted by innovation, Nasdaq struggled to balance the interests of its legacy dealer network and its customers’ new demands for the latest technologies.
By the time I arrived in 2003, the dramatic loss of market share had created more than a decline in revenue—it also contained an existential risk. Some on Wall Street were beginning to openly question whether Nasdaq would survive. Without liquidity, the exchange couldn’t perform one of its critical functions accurately: price discovery.* The more buyers and sellers come together in any one trading venue, the more accurate will be the price of the stock that is being bought or sold. Without volume, all kinds of distortions are possible.
If other venues with more activity were providing the function of price discovery in Nasdaq-listed stocks more accurately than Nasdaq, what advantage did we have in the listings business? After all, wouldn’t it be more appropriate for those stocks to be listed on the exchange where price discovery was actually happening? If Nasdaq just became a sort of electronic posting service, showing the “last sale” prices of stock primarily being traded in other electronic venues, the fundamental relevance of the business would start to be called into question. I was deeply concerned that the decline in market share, if steep enough, could become a slippery slope that accelerated our troubles in the listings business—at least that was the scenario that occasionally woke me up in the middle of the night. In my mind, I could hear CEOs of would-be public companies asking, Why would I list with you, if you are not trading my stock?
Overhauling our transactions business was a major task, and I knew I couldn’t do it overnight. I also knew that I needed to move immediately to increase our market share and stop the bleeding. We did have some competitive advantages, including our size, our talent, our lack of any real debt, and a reasonable amount of cash on our balance sheet. That cash certainly wasn’t doing us any favors by slowly burning up in unprofitable operations. The short-term solution, I decided, was to employ these assets and buy some market share, in the form of an ECN. And so it was that approximately one year after my first day at Nasdaq, we purchased BRUT ECN from SunGard Data Systems, my former employer.
I have no doubt that several eyebrows were raised at a new CEO proposing to acquire the technology he’d built at a previous company. One very significant Board member, however, was more outspoken in his reservations. Pat Healy had replaced Warren Hellman, of the private equity firm Hellman and Friedman, who owned a fairly large percentage of Nasdaq at the time. Over time, Healy would become a highly valued advisor and someone with whom I would often consult on Nasdaq’s strategy. But for the moment, we were on opposite sides of this critical decision. I listened to his reasonable strategic concerns, but decided to proceed anyway. Overriding his objections regarding my first major acquisition was an early test of my leadership mettle.
BRUT was the first major acquisition on my watch. It wouldn’t be the last. We needed its market share—it was that simple. Our trading platforms needed it. Our listings business needed it. Our IPO business needed it. Our brand needed it. And frankly, our mojo needed it.
With the acquisition, Nasdaq also received an infusion of new technology, though it still wasn’t adequate to address the IT challenges we faced. BRUT was a good system, and it allowed us to level up on the technology front, but it wasn’t a foundation upon which we could build Nasdaq’s future. Like many ECNs, it was a bit rickety. But it was a step. A small step, perhaps, but my strategy was just getting going, and I knew the next one would be bigger.
From Defense to Offense
As I grappled with how to upgrade our technology and get Nasdaq on the right side of an industry in transition, our fortunes were helped somewhat by an improving economy. In 2004, the IPO market began to pick up. We launched a number of new public companies, twenty-five of which were international, including ten from China. Most notably, Google successfully launched their landmark IPO, trading 22 million shares on the first day. Few knew at the time just how massive an impact Google would have on the global economy, but already it was a tech company with a $27 billion valuation and extraordinary potential. Moreover, it was the first big IPO in the post-dot-com era, and the competition for Google’s favor had been intense.
Our victory in winning the listing was a group effort. Bruce, Adena, and I were the team that spent time courting Google’s young founders, Sergey Brin and Larry Page, and its CEO, Eric Schmidt. I was excited and more than a bit relieved when we got the good news that they’d chosen Nasdaq.
The Google IPO was a milestone, not just for Nasdaq but for the technology sector as a whole. After the dot-com bust, Silicon Valley had suffered through a particularly grueling period of retrenchment. But it felt like winter was finally receding, and the green shoots of spring were all around. As Larry Page led us on a tour of the Googleplex in Mountain View, California, the troubles of just a few years ago seemed to be fading into memory. A new generation of innovators, unencumbered by the failures of the past, was showing the way forward.
But we still had work to do. As the economic headwinds of 2000–2003 slowly shifted to tailwinds, I knew it was more important than ever to prepare Nasdaq to thrive as the economy picked up speed. It was time to make a move that was not about getting slimmer, smarter, leaner, or even meaner, but was about positioning ourselves for future growth. In a narrow, cost-cutting context, it’s not easy to innovate and think long-term. When a culture is focused entirely on thrift, the next big thing is usually invented somewhere else. In other words, we couldn’t just play defense; we had to get our offense on the field as well.
LEADERSHIP LESSONS
• Prioritize Your Time to Get the Greatest Leverage. The CEO’s task list is endless, but time is not, so choose those activities that give maximum return on time spent.
• You Can’t Do Everything Well. People sometimes think the key to success is doing your job well, but for a leader, it is equally important to know what you’re not going to do well and what you’re not going to do at all.
• Run to Problems. Face reality relentlessly. Override the natural instinct to turn away from the things that are not working.
• Develop Your Leadership Instinct. Find the right balance of experience, knowledge, data, and advice that works best for your decision-making process.
• Don’t Underestimate Market Transitions. To win in the short term, you need to compete well against other players in your market, but to win in the long term, you have to get out ahead of major shifts in the market itself.