Your new book talks about leadership in the face of the global financial crisis. Doesn't the turmoil point to the failure of leadership in general?

In the context of the crisis, we need to look at leadership in the two segments of the economy. Segment one is the leadership at the financial institutions on Wall Street, and segment two is the leadership at some of the regulatory institutions.

Now, coming to your question, in a period of roughly eight years, the global financial system became such that it could not absorb the risks that became inherent in the toxic wastes of derivatives, SIVs [structured investment vehicles] and so on.

Most people who look at the risks, they do it from the viewpoint of a company, industry, general interest rates or lack of liquidity. But perhaps no one since the depression days of 1929 has asked the question how the global financial system was itself at risk.

Nobody can see that until you start learning how to analyse those risks. That's the reason for this tsunami, and people are now learning how to do that. So that is one kind of leadership issue.

The regulators, particularly former Federal Reserve chairman Alan Greenspan, went on a certain ideological basis - that is, the markets will correct themselves. This is now proven to be incorrect. The markets are correcting themselves, but the human cost is very high. And then, in between, the regulatory agencies, SEC, rating agencies, Fannie Mae and so on failed and the Congressional people pushed. So it is more to do with a failure of commission in the different parts of managing the global financial system.

This affected a large number of companies and people because the most devastating effect is that when liquidity dries up, and it can go over the cliff in no time. That's what this generation has not experienced for 30-40 years, that's what it is.

One expects leaders to be people with insight, with vision, but hardly anyone saw what was coming...

You need to be very careful here. One is the domino effect of companies failing, but most of that began with the financial institutions. The failure of leadership is that of the people who were regulating and managing the financial system, that's where it started.

The other part of the failure of leadership is that certain changes were made where the risk used to be assumed by the lending institutions. But in this period, the risk shifted to be assumed by investors -- who didn't have enough mechanisms, enough expertise. Then there was this failure of leadership in the way they evaluated the securities which were downright incorrect. Those were the failures in leadership.

How should leaders function in these difficult times? What are some of the points you are making in your book?

The first one is look at the human side. A leader is ineffective if he does not take his people with him. He first needs to develop a viewpoint of what the reality is. The key word here is reality. Then he needs to be humble enough to tell his people that he does not know everything, and is willing to listen to others' viewpoint.

No wishful thinking, no rear-view mirror looking at history, but he needs to look at what lies ahead and what is the reality. And then communicate, communicate and communicate. Listen to others' viewpoints but at the same time have your own.

Two, for most companies, cash is the blood in the body. You must know what are your sources of cash and how these  sources can be tapped.

Three, in many cases, the demand for your offerings. The demand for what your company offers, your products, will not be as high as it has been before. In many cases, it will be low. So confront this reality.

Four, reduce your break-even point.

And five, don't ever forget the storm will fly out at some point. Are you building your company for the future? Are you investing in innovations so that after the storm you will be better than you were before, having something to offer that will keep you ahead? Protect your talent, make sure it is engaged and an engaged mind will bring new ideas. These sound very simple but are very hard to do --  they require discipline and self-confidence.

What do you mean by reducing the break-even point?

Reducing your break-even point means that you make your costs more variable and less fixed. Say, your demand was 100 crore and you had a fixed cost on that 100 crore of 50 crore, and 20 crore was your variable cost. Now, if your demand went down, your fixed costs are still very high, and your break-even point will be higher. If you change the proportions of the variable and fixed costs by reducing the fixed cost, you will have less cash problems and less margin problems. With break-even point, what's happening is that companies are moving very fast to take the fixed cost out, or outsourcing a number of costs, or shutting the plants very fast.

You've been emphasising on investing in the future even in these difficult times. Can you explain with an example?

In the US, Procter & Gamble has just announced a huge expansion programme to put its plants in the emerging markets. It had been planning for it by changing logistics, and saying it is going to take advantage of the external change in this crisis. P&G looks at the world as a whole. It sees the declining demand in the US and parts of western Europe, but increasing demand in emerging markets. And it thinks by putting the plants close to those markets is a competitive advantage.

Does the financial crisis call for a change in the way leaders are mentored?

Leaders need to be more externally-oriented. They need to learn the financial system and understand what factors caused change in the macro conditions. Earlier they were too operationally-oriented, internally-oriented. They need to learn how the general economic conditions change, how the global financial system actually works, what causes liquidity problems, they've got to understand this part of the business. One key thing that never changes is confronting reality -- define reality, confront it, and have a steady hand on the tiller.  

What is the advice most company heads are now seeking from you?

Most of it is getting them to see what the reality is. The most critical thing they have been asking is that what is that I see changing in the macro-economic conditions. The second question they are asking is what early signals they should be looking for to see the conditions changing. And third, what are some of the best practices emerging.

And your answers...

I will have to tell you in the American context, the first is that the macro-economic conditions are still resulting in an increase in unemployment, that is common knowledge. The key here is to see which industries that have not yet felt it are going to feel it, for instance, the healthcare industry.

The early positive signals, the most important ones are which segment of the economy is beginning to see that the demand has stopped declining. Consumption is very crucial for this thing to turn around. The second signal is what is happening to the velocity of flow of short-term papers among the banks, if that begins to improve you will see a turnaround in the economy.

What best practices do you recommend?

First, focus your business very sharply. If your total demand is on a decline, and you are carrying 50 variety of products -- the simple rule that most businesses have is that 80 per cent of the revenue or profit comes from 20 per cent of the products -- so you prune some of the products fast and sharpen your focus. That way you simplify your business.

Second, you watch your cash, as I mentioned to you earlier. Third, is your company really building something, investing in innovation, that will prepare it after the storm to do better.

Investing in innovation at a time when companies are cash-strapped and the demand is uncertain is not easy. Should companies go ahead with R&D now?

The key here is that the world has changed. If you believe in developing products that will be different when they are out in a year or two -- that's innovation. If you are not doing it, you may survive in the short term, but you may not survive the long term. The risk you are talking about is a risk you've got to take, but not doing it is a more bigger risk.

You have authored a book on "game changing" along with former P&G chairman A G Lafely. How relevant is game-changing in the current scenario?

The Game-Changer is a book on how to go about innovation, and innovation changes the game. P&G, in this time, is again changing its game. As I mentioned, they have a very good expansion plan in the emerging market. And that's what makes it a great company.

What about companies that are under a lot of financial stress...

Those who are under financial stress, they got to go after the same things that I mentioned to you before -- focus on their cash sources, sharpen the focus, be a smaller company, but in doing that cut deep and save some resources to develop new products that they are going to need. That is not negotiable.

You've recently said good leaders are those who are able to connect to change in the face of the crisis. Can you explain?

Connecting is most important, it is what I call "ground intelligence". That is, the need to really connect directly with the consumer, and get unfiltered information. Visit, observe and talk directly to the consumer. If you are targeting, say, a rural market in India, you better take the time to personally visit and observe this market. Get out and be a common person.

Companies rely on a lot of research data to base their decisions on...

I think the company head or CEO needs to have that first-hand observation. That will cause him to redesign the research, to test new hypothesis. Even if you are a CEO of a $100-billion company and it's in one business, you must get yourself in touch with some consumers. Take some samples, and you've got to devote at least a month in do this; if you do it, your people, too, will do it.

What's your take on corporate governance in Indian companies? What are the biggest challenges?

The family-run companies need to make corporate governance very transparent. They need to have directors who are truly independent and make the functioning world-class. Directors at the family companies will have to share information to the fullest, they need to see what's happening internally in the company. Look at the Satyam situation today, the board here was not effective, it failed completely.   

You mentor leaders, guide companies, but do you also learn from them?

My work is daily learning, you can learn from anybody and I hope I learn every day. This is what shapes you. In fact, you learn from your students all the time. My teaching teaches me a lot.