Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Welcome, dear listeners, to this episode on primary research methods. In previous episodes, we've discussed submitting fieldwork projects to networks and how to work with networks effectively, along with a range of ideas on our own fieldwork process and how we approach fieldwork as part of our investment research process. This week, we're discussing how we vet executives, with particular attention to how we've done this in and around our study of the business of TransDigm. Will, I think some context on your interest in this business would be useful to set the scene.

I had been studying the commercial aerospace market, initially through the lens of the engine OEMs, like GE and the CFM engine, and their shift to aftermarket-focused, power-by-the-hour type agreements. I was aware of TransDigm and HEICO, and I was always interested in how the aftermarket was structured the way it is. An average 787 might have a couple of million parts, and assembling those, along with the whole supply chain for that plane, is incredible, complicated, and difficult to organize. This complexity means there are various niches and different product categories that can create quite interesting businesses.

When studying TransDigm, I found it interesting that it was mainly focused on the aftermarket in terms of buying assets. I think it was back when Citron published a short report on it, maybe in 2017 or a bit later, that I explored it. There was always this discussion about them hiking prices and price gouging. They had issues with defense contracts and testified in Congress. There was a sentiment that they were buying assets and hiking prices, similar to Constellation, where some people think they do the same thing in VMS.

Part of the project was to understand how TransDigm operates, how it's structured, and how it buys and operates its assets post-acquisition. The hypothesis was to prove or disprove if there was any additional value being created beyond just price increases. My intuition was that it's not just price increases. For a business to be around for that long with a sustainable margin profile and free cash flow, it's typically not just huge price increases, which was what Citron originally argued. That was a bit of the context.

As you prepared to source for this business and look at the profiles that seemed attractive to you, let's discuss how we actually vet people and assess their ability to make a contribution. You've clearly laid out the context there. Who, in particular, did you think you needed to speak to?

TransDigm is interesting because it's fairly decentralized. If you consider the organizational structure, at the top, you had Howley, who was the executive chair and former CEO. Kevin Stein was the CEO, and Bob Henderson was a vice chair. There was also a COO, a CFO, and Bernie handling M&A. Below them, there were about five to six EVPs, each responsible for managing five to seven operating company units, or subsidiaries.

The turnover at the COO and EVP level is very low. In the history of TransDigm, there have probably been only 10 or maybe 12 EVPs. It's unlikely you'll find someone very senior there willing to talk, as they've likely made a significant amount of money and aren't interested in this type of outreach. They're often not even on LinkedIn. The focus was really on the subsidiary level.

In this decentralized structure, the five to seven EVPs act like mini-CEOs, managing five to seven subsidiaries. Each subsidiary has a president, akin to a CEO of that operating company. For example, one subsidiary might make cargo handling systems for freighters, generating $50 million. These EVPs manage several such businesses.

I focused on the subsidiary level. At the subsidiary level, you have a president, which is like the CEO of the opco. Then where I was focused is where you have this role of the head director and sales and marketing, which is underneath them. This role is effectively a sales position, reporting to Howley and Kevin during their famous quarterly meetings in Cleveland or around the US. They report on their numbers and performance using the 3Ps methodology.

Below them, the structure is split by product line. Each product line has a business unit manager who manages sales, marketing, and the three Ps. So new business development, pricing and productivity cost for that product line. So these people are effectively like kind of mini-CEOs of product line but they touch manufacturing, engineering, quality, pricing, sales, new business for their specific one product line and opco. They do that because they kind of prime them to be promoted to director then president and hopefully VP over time.

The hypothesis was that these individuals, who touch all parts of TransDigm's model, are key to understanding how the company operates. They pull the levers at the ground level for pricing, productivity, and new business. I focused on two roles, which was the president of the opco, the CEO running that kind of cargo handling business and/or those business unit managers which were effectively implementing on a day-to-day basis the 3Ps and understand how TransDigm operates.

They can explain where EBITDA accretion comes from post-acquisition, typically seeing a 10 to 20 percentage point increase in EBITDA margin in the three to five years post-acquisition. The idea was to gather multiple case studies from these individuals across different TransDigm subsidiaries to understand the changes pre- and post-acquisition, how they pulled the three levers, and the outcomes. These roles proved insightful in explaining how TransDigm operates.

Were you aware of much of this before the first call? When we talk about vetting, we're discussing identifying people who can add value to a line of questioning. What you've described is the depth of knowledge, and there's a beauty in understanding how the business is structured. By definition, it gives you a bearing. If you find someone with a specific job title who has been in the role for several years, you've found something interesting, right?

It's no secret how TransDigm is structured. They've shown this in the capital markets day since they were listed. You have a decade of investor days that reveal the structure. That's where I discovered it. You can go through their historical subsidiaries and find the CEOs of those subsidiaries. It's not rocket science. The tricky part is below that level. For example, if you go on LinkedIn to find the CEO of Adel Wiggins, which is an opco, you'll find a president there, the person running Adel Wiggins. Most of these people don't leave TransDigm. If you're a president of an opco, which could be a $100 million business, you have a chance of becoming an EVP, so turnover is low. The people underneath are the ones implementing the 3Ps, and their titles aren't always clear. Part of the vetting process is understanding what the person really does on a day-to-day basis.

Let's pause for context. You've done the background work on the business and the organizational structure through filings. This could be months of work as you read up on the business, learn how it functions, and understand its structure. You then identify profiles of seemingly relevant people. Let's say a few people with relevant titles respond, and you get one on the phone.

Part of it is understanding what they do daily. The challenge in the expert network industry is that those conducting introductory calls, vetting the executives, don't typically understand TransDigm or the company. Part of our work at IP is to empower and foster that knowledge in the people doing the vetting so they can have great conversations and effectively vet these individuals. But that's always on a spectrum.

Yes, but every network claims they do that.

True, but they're not structured to do it effectively. That's the other challenge with them.

That's it. Could you elaborate on that?

As I mentioned, part of our structure involves analysts and recruiters working together to bridge the significant information asymmetry between the client, the hedge fund, and the network. In our industry, we are incentivized to find the best people because our competitors can leverage their scale as their product. We need to add value and produce a quality library, which requires finding good people. It's a different game we're playing.

Even if I know TransDigm, vetting someone is still challenging. People often try to deceive you. The first step is understanding where they fit into the organization and having a mental structure of how TransDigm is organized and where this person fits in. For example, what are they responsible for on a day-to-day basis?

My focus was to understand if you're selling a cargo handling machine to a freighter airline, were you responsible for pricing this product? Explain that to me. How often did you handle pricing? Did you sign off on the contract? What was the typical system cost? How much business do you sign on your product line per year? You can then determine if that person is signing off on a contract.

We can use that as a specific case study to explore, even if it's one product among the hundreds or thousands TransDigm sells. It's a specific case study that may reflect the broader principles on which TransDigm operates. Part of it is understanding exactly what that person does daily. You'd be surprised how putting your ego aside and asking very simple questions can go a long way.

It's important to articulate that when you've identified someone relevant and persuaded them to get on the phone, these are busy people. You've got them on a call. Discuss what leads someone to be responsive to this kind of detailed questioning. The pushback from people who know this business is, why would executives take the time? What you're describing is a conversation that takes more than five minutes. To get the information you're talking about, this could be 30 minutes on the phone. Why are these people taking 30 minutes on the phone with you?

Most people want to talk about how great they are. Part of it involves massaging egos a bit.

I don't know if that's the biggest part, though. I think at some point you'll say it, but maybe I'll go there, which is showing respect. You've done your homework, you have a sense of what they do, and you've shown basic respect for their life and career. Is it more than that?

If you walk through the process, most of the time there's an outbound email or call. At that point, you're not showing respect yet. You have the first few minutes to build respect and capture their imagination. Everyone starts on the same footing. We often send materials to executives, tweaking emails to suggest a different angle.

I might share an insight I've explored or found through our work, or even public information about the company, to show we're different from most people reaching out. Initially, without a brand, it was different. Now, they can see what we're about. Once you get them on the phone, it's about the art of conversation. How do you make people feel good, show respect, and help them learn?

Many people don't do this just for the money. Getting paid is a nice bonus, but the best people are interested in great conversations, learning, and sense-checking their views. They follow the market even after retirement, so they're always interested in engaging discussions. If you can help them learn while making them feel good, you're also vetting them.

It's not as simple as calling and asking direct questions like, "Did you sign the contract?" It's a more subtle process involving helping them learn and sharing what we're exploring and why it matters. We provide perspectives on what investors may be interested in regarding their sector and companies they've been involved with.

You weave in a vetting process to understand exactly what they've done on the ground. It's not a survey format; it's more subtle and quite an art rather than a science.

It is an art, and there are nuances that arise on a case-by-case basis. I think that's what makes the work enjoyable. It's almost easier to define what vetting is not. From our perspective, vetting is not simply sending an executive a list of five questions and asking them over email if they can discuss a particular topic, or getting them on the phone and asking if they can talk about something else.

What we've described is a comprehensive process of preparation even before getting on a call, to truly understand the person you're dealing with. Once that's done, you can delve into the actual substance of the introductory call process. As you've mentioned, you're trying to understand what someone did.

You personally have likely conducted over one and a half thousand interviews. My guess is you've probably managed more than 400 or 500 introductory calls yourself over the last five years, possibly more. What insights can we draw from these hundreds of vetting calls that might be on a deeper level?

One of my most common mistakes historically, and perhaps still today, is sourcing people who are good and involved at the company but are too far removed from accountability. This is where accountability and responsibility come in. For example, if I'm exploring pricing at TransDigm, the operational philosophy should translate well back to the organizational structure. At the operating company level, you have the president, direct sales and marketing, business unit managers, a director of engineering, a controller, and a plant manager.

If you find a plant manager, they can tell you how they price and operate, and discuss the 3Ps. However, they're not truly accountable for executing those moves; they're responsible for manufacturing and moving widgets in and out of the plant. This mistake can relate to any project where someone is involved in decision-making but not accountable for it. They're not the ones going through the real decision-making process on the levers we think matter or are trying to test.

In my experience, some mistakes arise from miscalculating the organizational structure. You might not realize they're the wrong person because you don't understand how the business is organized. People can persuade you, and if you don't know anything about it—like if you've never sold aerospace parts or worked at TransDigm—you might not know there's a business unit manager role accountable for it. They report numbers to Howley and Kevin, not the plant manager.

This mistake typically happens because I don't know the organizational structure well enough or I'm not vetting correctly. I'm not going through the integral process of understanding what they're accountable for. It's an art and a dance; you have to be direct to avoid fuzzy responses. When speaking to them, you need to vet them while making them feel comfortable. If you ask if they were involved in contract negotiations or signed off on something, it's rare they'll say yes if they didn't. You can sense their involvement by their body language and tone of voice.

The biggest mistake I make in this process is finding someone involved but too far removed. When you interview them, you can't reach the true depth required. This happens mainly due to two things; it's not doing the vetting properly or I just don't understand the org structure and the company enough.

How much emphasis have you placed over time on establishing what people can't discuss or defining the limits of what they're capable of?

Yes, that's often an easier first question to delve into. It's about understanding what they're truly responsible for and exploring what they can't talk about. If you give people an inch, they might take a mile. It won't necessarily be pure nonsense, but their responses might become a bit fluffy.

I think we should acknowledge that people are well-intentioned and want to please, which can create a dangerous setup that isn't discussed enough in our line of work.

My point is that the structure and dynamic of the conversation typically involve calling someone to chat and paying them for their time as a sign of respect, which is important. Therefore, you have to set the tone through the vetting call, which communicates the level of depth and understanding expected. For example, if I call a plant manager at TransDigm, he will confidently say he can discuss the 3Ps and knows about pricing. However, he's not negotiating contracts; he's a plant manager. Unless someone vets them and understands this, it can be misleading, especially when looking at their titles on LinkedIn or other companies. When you ask them if they can discuss something, they'll say yes, but that's not good enough for the interview. Finding someone accountable is crucial.

This is great because it highlights an important shift in our work over the years. We're now in our 12th year, and overcoming the temptation to fit an executive into a pre-existing box is key. What you've articulated here is important. Could you expand on what it means to give someone the space to reveal what they can do without pushing them into giving certain responses they're primed for because of the financial incentive? People genuinely want to be helpful and have an inclination to be useful.

The plant manager thinks he understands how TransDigm approaches pricing because he hears it from his friends at lunch and dinner. He believes he knows, but there's a difference between knowing, feeling it, living it, pricing it, and being accountable for it. There's a level of accountability required.

You raise an interesting point because when I was sourcing my interviews, about 50% to 60% of the time, I had a hypothesis about what I was looking for. I would find someone, onboard them, and end up interviewing them on a completely different topic. I was trying to find someone for a specific topic, but they were actually more interested in another area.

If I was just focused on one thing, I would have missed that. Part of the vetting process is understanding their competence, what they do all day, what they're good at, and what's interesting about their role. We're in a position to mold interviews around them when it makes sense. That was the case for 50% to 60% of my calls years ago.

Well, and still today to some extent, because our process has evolved to reflect that. This is where the fun is.

Yes, and Adrian or the team will send me an executive, and I'll decide I want to speak to them about a different topic.

What's clear to me is that the real art in the vetting process is understanding not just what someone can address, but what they're accountable for. What are they uniquely qualified to do?

Building calls at the scale we operate, considering many don't have million-dollar fieldwork budgets, has been a revelation over the years. This process of building calls around people's expertise, provided it contributes, is important. It's not about calling someone just because they can talk about something unique; it has to be relevant.

It has to be relevant, but it's not as simple as that. In some of the best calls, people often don't know why they're unique or the unique perspective they have. Sometimes, those who think they have the most unique perspective actually don't. If they've shared it with millions, by definition, it's no longer unique.

Some of the most interesting calls I've had, for example, involve people reaching out about our book. This isn't meant to be a plug, but the most popular interview, based on feedback, has been about the spirits industry. It's a prime example. Before I reached out, I was sure he hadn't done one of these interviews before because he didn't know the format. I had to explain it to him. I didn't plan on it until I realized his history and involvement in reformulating distribution agreements in the US. This is an example of how an interview centered on an executive's expertise led to a specific outcome.

We can discuss this another time, but during these interviews, when you talk about a circle of competence, people don't always know the edge of their competence or their unique expertise. Part of the art of these calls is pushing people to the edge of that competence, helping them stress test, explore, and validate what they've learned over 20 or 30 years. Some of the best calls I've done have restructured an interview around someone's expertise, pushing the limits of their circle of competence. During the call, you can see their mind working, questioning what they know, and coming up with new ideas or strategies. That's when executives really enjoy these conversations and learn as well.

Two things I want to highlight. First, when you enter a vetting call and the executive senses you can push them to the limits of their knowledge, it's extremely appealing. This allows you to access people you might not otherwise reach. Second, one of the largest pitfalls in our vetting careers is forcing someone to fit into assumptions we've made about what they know.

I believe that's partly due to how rigid the customer is. Typically, what happens is, if we consider what drives the behavior of those running expert networks, it plays out on a day-to-day basis. The majority of the industry consists of consulting customers like McKinsey, Bain, etc. They can be quite rigid in selecting whom they want to speak to and what questions they want to ask. This is because they are effectively ticking boxes for their private equity client or corporate customer. They have a checklist and requirements to fulfill, so they are stringent about whom they want to speak to. As a result, the expert network tries to find these people and mold them into ticking those boxes. This creates a situation where someone is incentivized to fit into a box they might not belong in. We've tried to approach it differently by considering what this person could be genuinely interested in and good at.

Just ask them what they do and be extremely cautious about the industry's imperative to fit people into boxes to maximize volume and the number of interactions through the network.

The challenge in the industry is that this becomes a self-fulfilling or negative feedback loop. Expert networks try to fit people into boxes, executives know this and hold back information, and then try to fit themselves into the box. This results in an ineffective mechanism of operation. It can be refreshing when someone calls and asks what you've actually been doing on a day-to-day basis. Many executives appreciate that we're not interested in wasting their time. Remember, we used to tell people we wanted a 20-minute call because we didn't want to waste their time by putting them in front of people who wouldn't interview them. It's better to know exactly what you're competent at so we can have a meaningful conversation.

There could be many more things to address, but for now, this wraps up this episode. We'll be here next week to talk about preparing for interviews. Thanks for listening.

As always. This is for informational purposes only and should not be relied upon for investment decisions. Please do your own research.