Decision-making about ROI and your technology spending

Dan Gilmore wrote in “The ‘Probability’ of Supply Chain ROI” propounds properly and rationally the fact that any “forecast,” including forecasts of ROI (return on investment) should not be a single number. Rather, as anyone properly trained in statistical methods will tell you, it should be a range of numbers. The range of numbers would generally be calculated based on a single calculated value plus and minus values that represent the confidence intervals or, simply put, how likely the statistician believes his estimates the calculates will approximate reality. A larger range indicates lower levels of confidence and a smaller range higher confidence levels.

Now, while Gilmore is mathematically correct, the fact remains that most small-to-mid-sized businesses (SMBs) simply do not have anyone trained in statistics on their payroll and they are not likely to go out and hire a statistician to produce ROI forecasts for their IT projects – since this would, by definition, automatically reduce the ROI of the enterprise as a whole in the short term.

Back on a growth trajectory

Gilmore makes another comment in his article with which I wholeheartedly agree: “[T]here is some evidence that companies are in fact looking at investments that can help them to get back on a growth trajectory (read: increasing Throughput) without having to add much in the way of head count (read: Operating Expenses) by achieving productivity gains.” Given the world-wide economic malaise that is showing some signs of lessening (for the moment, at least), Gilmore’s description probably suits the vast majority of SMBs across the U.S. and beyond.

Furthermore, many others besides me have written that a firm stand on return on investment will be the hallmark of technology spending in the 2010 and beyond. So, I can hardly fault Gilmore for suggesting that SMB executives and managers need to become increasingly sensitive to and realistic about ROI for every kind of investment in their firms’ futures.

Too much complexity already

Despite my agreement with Gilmore on theoretical grounds regarding forecasts – including ROI forecasts; and despite my agreement with him regarding the goal of companies to get back on a growth trajectory through wise investment of capital resources, I must disagree with him on the matter of adding useless complexity to the return on investment forecasting process.

Allow me to explain why I use the harsh term “useless” to describe such an effort in the development of a ROI forecast for an IT project.

First  of all, let me say that statistical methods ought to be applied where they make sense. Statisticians generally agree that a valid statistical sample must contain at least 30 members. This works great where you have 30 dogs, 30 cows, 30 houses, 30 automobile, 30 miles of roadway, and so forth for comparison. Then, of course, you need to factor for environmental differences. Thirty or more cows all in the same pasture, eating the same foods, and enjoying the same climate would make a pretty good statistical sample for some studies of cows. On the other hand, three Holstein cows in northern Minnesota, two long-horns in west Texas, 15 black whiteface cows in eastern South Dakota, and ten mixed-breed cows in central Florida are not likely to constitute a good “sample” for cow studies.

Why?

Simply because there are too many environmental dissimilarities surrounding the cattle. By the time these factors were accounted for, (generally speaking) any results would have such a large confidence interval as to make any prediction almost meaningless.

When considered as a whole, a typical SMB has tens of thousand of variable at work within the enterprise. Any number of those variables are likely to dramatically separate it any “sister” enterprises in a sample group used to forecast ROI outcomes.

Of course, the fact that traditional ERP – Everything Replacement Projects – are going to affect the whole enterprise is a big part of the problem of predicting ROI outcomes. With tens of thousands of variables at play, picking the winning number is far more challenging than winning the lottery.

Reducing the scope reduces the complexity

First of all, a good many SMBs today have a “pretty good” ERP system in place – regardless of its brand. Unless there is some pressing reason to undertake a traditional ERP – Everything Replacement Project, it is probably a far better idea to consider a New ERP – Extended Readiness for Profit project instead.

Narrowing the scope of the project reduces the complexity. And, reducing the complexity increases the likelihood that your ROI forecast will be more on-target. Allow me to give you a couple of examples:

• Warehouse automation – Suppose your Current Reality Tree (CRT) shows you that, in order to increase Throughput, you need to enable your warehouse to be able process 80 to 100 shipments per hour, rather than the present 30 to 40 per hour. Furthermore, you need to do this while holding the line on Operating Expenses.
  
• Business intelligence – After reviewing their Current Reality Tree and laying out a Transition Tree (TrT), your marketing and sales team has assured you that, if they are provided tools with which to better understand customers and markets, they will be able to segment the market and create UROs (un-refusable offers) and increase Throughput by 130% in two years. No additional staff or other increases in Operating Expenses would be required.

If your executive management team were to elect to pursue either of these projects – or both – the goals are specific and measurable – as would be the expected outcomes. ROI calculations become simple:

Where T = Throughput (Revenues less Truly Variable Costs), OE = Operating Expenses, and I = Investment.

Simple. Elegant. And ROI calculations are far more likely to be right than any calculation around traditional ERP – Everything Replacement Projects.

©2010 Richard D. Cushing

Making more money in the service business

If you’re a regular reader of my writings, you will know that I do not endorse many products. And, even if a product delivers many outstanding benefits, I will give you the straight scoop about delivering on R.O.I. (return on investment).


Well, I just finished reviewing an outstanding product for the SMB (small-to-mid-sized business) service industry. If your company sells, installs and/or services high-value technical or industrial products – or even if you service products sold and installed by others (such as swimming pools and hot-tub systems) – SM-Plus(tm) from Single Source Systems could help you start making more money.

A study done by Aberdeen Group indicates that service companies that adopted end-to-end solutions that aided managing their business as a “system,” rather than in silos, saw an average of 14.2% increase in revenues over a two-year period. Since, for many service companies, their service revenues carry very little in Truly Variable Costs (TVCs), that means that almost all the dollar increase in revenues drops directly to the company’s bottom-line.
 
So, how does an service management end-to-end solution create this increase in revenue – and profit?
Here are a few of the key factors:

• Elimination of inter-departmental silos increases visibility of “bottlenecks” and helps executives and managers take effective action to increase Throughput.
• Integration with mobile computing devices reduces time lost for data-entry or trips back to the job site or warehouse. This means more available service hours are actually used performing billable services.
• End-to-end solutions are able to handle complex contract-based billing calculations, thus virtually eliminating “islands of information,” manual calculations and redundant data entry. This, in turn, means the enterprise can grow revenues without adding to operating expenses.

So, how would you determine if Single Source Systems’ SM-Plus would be a good investment for your service-centric enterprise?

The formula return on investment remains the same:
You and your team need to calculate how much your Throughput (T) (i.e., Revenue less TVC) might increase (see average of 14.2% over two years above, but calculate your own numbers) and any net effect on Operating Expenses (OE). Then, figure out what your investment would be to get started with a product like SM-Plus. Put those numbers into the formula for ROI (see illustration), and you can calculate your ROI simply and easily.

Give it some thought.

Drop me and email at rcushing(at)GeeWhiz2ROI(dot)com if you have further questions.

©2010 Richard D. Cushing

Technorati Tags: service management,SM-Plus,Single Source Systems,ROI,return on investment,Throughput,bottleneck,TVC,Truly Variable Costs,mobile computing,operating expenses,SMB,SME,Aberdeen Group

Generating Business to IT Alignment for successful packaged software (COTS) implementations

You've decided on the software you need, the business side has bought into it, and you've even picked your integrator. Now the hard work begins: Making sure that your software deployment strategy sets your company up for success, and that means making sure Business, IT and the Implementation Partner are in alignment.

First, we need to understand that Business, IT and the Implementation Partner are coming from different perspectives. Every party has a knowledge gap to address. Business best understands their existing business model and the underlying success drivers. The Implementation Partner understands the packaged software and has multiple years of implementation experience. IT best understands how technology supports the existing business model as well as how best to utilize existing corporate IT technologies. Alignment is generated only when a common understanding of the business model, packaged software and technology capabilities are shared by all three parties. When this alignment occurs there is effective communications and faster decision-making. Decisions move implementations forward.

Following is a recommended set of steps to develop a common understanding for effective collaboration during the COTS implementation:

1. Document existing business processes

It is an area that I see many packaged software implementations lack. The typical challenge I get is "Why document my existing business processes if I know they are changing?" Here are my reasons:

• Business users may not have a consistent understanding of their existing business model. Going through the exercise of documenting business processes will highlight these differences and driver deeper understanding.
• Documenting the existing business model will enable you to highlight the EXACT organizational changes that will occur. How can you manage organizational change when you do not have a clear understanding of what's changing?
• Business process maps can be a key source of information to quickly educate IT and the Implementation Partner on the existing business process model.

2. Educate IT and the Implementation Partner on the existing business model

Business should take a formal, iterative process to educate IT and the Implementation Partner on the existing business model. The entire project team should be involved in this training and should progress from a solution-level overview to a detailed business-role level "day-in-the-life" review. Following is a suggested approach for conducting this training:

3. Complete packaged software training BEFORE the Implementation Partner arrives

Just as it is important for your Implementation Partner to understand your business model and your business language it is important that Business and IT have an understanding of the packaged software and its language. Effective communication is a two party effort. Taking the required packaged software training before the arrival of your Implementation Partner will enable you to more effectively work together.


4. Have the Implementation Partner conduct supplemental packaged software training

Education is an iterative process - you will never learn everything you need to know for supporting packaged software in a classroom. Packaged software providers provide foundational training. I always say that the Implementation Partner completes your packaged software training. Implementation Partners have hands-on experience with configuration and maintenance of packaged software solutions.

5. Implementation documentation should be more business-oriented

Nothing encourages alignment more than being able to think like your end customer. Too often we create project documentation that focuses more on technology than business reasoning and justification. There are times were I am guilty of moving too quickly from what needs to be done to how will it be done without completely understanding why does it need to be done. At the end of the day we build software to drive business results.

Summary

Business to IT alignment is a strategic goal that can only be reached by taking tactical steps to bring Business and IT closer together to generate mutual understanding and trust. Implementing packaged software is an opportunity to generate greater alignment by developing a common language for effective collaboration. When alignment is achieved then decision-making is effective.


Adapted from the book Maximize Your Investment: 10 Key Strategies for Successful Packaged Software Implementations by Brett Beaubouef.

Business Processes and Real Management – Part 3

Simply put: If there is no process, it – whatever “it” is – cannot be managed.

The key point here is to separate mere intuitive decision-making from the act of “management.”

Management implies the existence of “a process,” – that is, an understood cause-and-effect relationship in a sequence of dependent events leading to a predetermined goal. There are three critical elements to this definition of “management” and “a process”:

1. The “process” must have a goal or outcome. If there is no goal or outcome that can be stated in advance, then there is no point in attempting to “manage” it, for to manage it would be to somehow affect the outcome of the process (e.g., improvement). If the goal or outcome of the process is not understood or has not been articulated, then there is little need for the act of “management.”
2. The “process” must include more than one step or event, and the steps or events must be related by their sequential dependence. One cannot manage, for example, “the big bang.”
3. The “manager,” in order to manage effectively must understand both the goal of the process and the process itself.

If we return to the examples given, whenever an executive must deal with sales operations as mystical mojo that is carried out in some seemingly inexplicable way by certain persons who were hired because they have a demonstrated facility for working this “mojo,” then that executive cannot be said to be “managing” the “sales process.” He or she may be managing many things related to sales, like the expenses related to sales, the number of salespeople, the sales territory assignments, and more. But he or she cannot be managing “the sales process” any more than he or she would be said to be managing a group of witch doctors in the work they do.

Let me go further to say, that even though the executive may have a “prescribed sales process” that includes a number of “steps,” even if those “steps” are canonized in some CRM (customer relationships management) or other software application; and even if the salespeople are required to “check-off” against these prescribed “steps”; if such “steps” are subject to frequent manipulation by the salespeople or sales managers or if a near-constant series of concessions are being made to the demands of salespeople or sales managers in accommodation to their claims of “mojo,” (or something equally nebulous) then no real “sales process” exists in such an organization. Also, if management is repeatedly kowtowed by what amounts to little more than “threats” that “bad things will happen” if salespeople’s and sales managers’ demands are not met in this matter or that, then I would allege that no “sales process” exists.

Now, I hear you asking: “What difference does it make if we have a ‘sales process’ as long as we are making sales and surviving?”

To that question, too, there is a simple answer: If, as an executive, you do not have a real and manageable “sales process,” then you are at the mercy of the economic winds and the fickleness of fate. In the absence of a manageable process, you cannot know what actions will lead to improvement. Despite your title as “executive,” your only recourse is to try this or try that, because you have no comprehension of the actual cause-and-effect dependencies that lead to more sales or better sales.

Is that really how you want to run what is arguably the leading edge of your business enterprise?

Suggested Reading:

Reengineering the Sales Process

©2010 Richard D. Cushing

Business Processes and Real Management – Part 2

1. (continued) In the second scenario, the owner or chief executive is not in charge of the sales team. In fact, the firm has generally hired an experienced “sales manager” based on this persons history and background of producing sales at some other firm in the same or a similar industry. This person has then hand-selected a team of salespeople, the sales manager often doting over them making certain that each is uniquely satisfied with their particular arrangements. This is a variation on the same prima donna theme, but with a layer of middle management.
   
   In both of these cases, however, the general attitude of top management at the firm is that, while they may give lip-service to something they call their “sales process,” when one digs deeper, it becomes abundantly clear that the “sales department” is really surrounding by mystique. Each hand-picked salesperson has his or her own mystical mojo that is performed in a somewhat ritual-like fashion. This mojo, when properly carried out and when not too much interfered with management and administration produces a life-stream of sales to support the rest of the company.
   
   In these situations, the rest of the company’s executives and managers are under the implicit understanding that “I must not mess with the salespersons’ mystical mojo or things will go badly for the whole company.” Frequently, even top executives fear treading too much on the mojo, for fear there will be bad repercussions.
   
   
2. The second matter is that comes to mind is “sales commissions.” On numerous occasions I have asked executives, “How do you calculate and pay commissions?” A simple question?
   
   To this simple question, I am not infrequently given a simple answer: something along the lines of, “We pay commissions based on gross margins.”
   
   Simple enough, don’t you think? Until you begin to dig into the details. Then one starts hearing things like this: “Well, yes, we do pay commissions based on gross margins. But, if our buyers get a special deal on a purchase, we pay commissions on the ‘regular’ gross margins, not the actual gross margins of the sale of those special purchases.” Or, “Yes, we do pay commissions based on gross margins but, because the contract we signed with salesperson X is different from the deal we reached with salespersons Y and Z, the way we calculate ‘gross margins’ is different for each of salespersons X, Y and Z.”
   

So, I hear you ask, “What is the similarity between my daughter’s situation and the two examples I just mentioned?” The similarity is this: In each case the executive in charge called their decision-making a “process” (or, in the academic world, a “rubric”) or suggested that they were managing “a process” (i.e., “the sales process”). However, close inspection revealed that each decision was being made on a case-by-case basis without reliance upon a process or rubric, at all.
Note, my objection is not to the case-by-case decision-making – although I offer that this is likely not a sound approach to managing a growing SMB. Rather, my objection is to the managers’ beliefs that they are actually managing to a “process” or by “a process.”
(To be continued)
©2010 Richard D. Cushing

Business Processes and Real Management – Part 1

I had a conversation with one of my daughters on the way to the airport today. She was telling me about something that went on with regard to management decision-making at her work. (She works in the field of education, but the principle I wish to discuss applies everywhere, in every type of organization.)

The scenario is something like this: An executive (and here I use the term “executive” in the broadest sense, meaning any manager in a position to not only choose, but also to execute upon the decision made) states that he or she is going to make a management decision based upon a process (or, in this academic environment, a rubric – a process for scoring an otherwise subjective decision). However, upon further discovery and discussion, it becomes apparent to all involved that whatever “process” or “rubric” is ostensibly being applied is purely subjective and intuitive to the manager alone. That is to say, what is pretended to reduce an otherwise purely subject and intuitive decision to a “process” – a “rubric” – is merely that, a pretense. The decisions being made remain purely subjective and intuitive and are not correlated to a “process,” at all.

Now, let me be clear. I am a free-market guy. I believe that business owners and their executive agents should be able to hire, fire and make other management decisions at will. I am fully committed to the fact that they may do as they please so long as their actions do not include coercion or deceit. In this scenario, it is not the executives decision with which I take issue – which is why the decision itself is not discussed herein.

What I wish to discuss is how many times executives and managers are themselves deceived as to the presence of a “business process” or any kind of rubric by which they manage. From my experience, if I spent time cogitating, I’m certain that I could come up with a large number of examples. However, for brevity’s sake, let me just toss out a couple.

1. Foremost in my mind are the numerous discussions I have had with executives over the years regarding so-called “sales management.” I say, “so-called,” because I have too many times been faced with one of two variations on the same theme in this regard. The first is where the owner of the small-to-mid-sized business (SMB) was the companies first salesperson (which is quite natural, as the organization was likely an outgrowth of some entrepreneurial venture) and remains today as the firm’s sales manager. He or she has, over the years, created a sales team of hand-selected folks, and the executive is convinced that each of these salespeople is unique and each requires special handling – a sort of prima donna approach.
   

(To be continued)

©2010 Richard D. Cushing

Changing the game for ERP/COTS implementations

I think we've all learned that implementing ERP/COTS using a traditional approach of (1) focusing on custom software and (2) having a purely requirements-driven approach results in greater Total Cost of Ownership (TCO). ERP/COTS can make for an expensive custom solution. What is required to change this trend is to evolve our implementation approach. Following are my top strategies for changing the game for ERP/COTS implementations:

(1) Focus on Business Results. Too often we focus on software scope and not the entire business solution (People, Business Processes, Technology). A challenge I make to my project team is to focus on all three components that drive business results. Also, spend time/effort on gathering requirements that drive value-add business results. Not all of the customer's existing business results drive real business value.

(2) Ask customers to formalize knowledge transfer on their existing business model. Every customer's implementation is unique and it is important that every member on the project team has a common understanding of the customer's existing business model. This knowledge transfer will enable implementation partners (consultants, IT) to better align with the explicit and implicit expectations of their customer. Implementation partners need to speak the language of their customers. Being in the same meeting or having the latest chat technology does not guarantee alignment nor collaboration.

(3) Implementation partners need to enable customers to lead during the implementation. This requires us to have a formal knowledge transfer plan and a progressive leadership style: Directing, Coaching, Facilitating, and Supporting. A new measure for success: the implementation partner leavers before the go-live because the customer is self-sufficient.

(4) Perform business solution modeling. Use prototyping for defining requirements and modeling to validate requirements/configurations. Use multiple validation techniques (peer reviews, modeling, testing) to identify potential problems.

(5) Implement to the current business process maturity level. Technology alone does not mature a business process. Meeting the customer where they are at will (a) reduce the challenge of emerging requirements, (b) reduce implementation risk, and (c) put you in a better position for a quick win.

(6) Minimize customizations and maximize enhancements. Every customer will have unique requirements that must be addressed via software. Some of these requirements add no material value to desired business results (customizations) while other requirements have a material impact to desired business results (enhancements). This is not meant to be a negative commentary but it deals with the reality that a customer's existing business process is not 100% efficient nor 100% effective (Lean Six Sigma). A key strategy for the project team is to focus on the requirements that drive enhancements and eliminate non value add customizations as quickly as possible (before Fit/Gap).

(7) Negotiate for success. This requires changing the customer's expectation of business software. If the custom expects a custom software solution then the results will be additional gaps, costs, and disappointments. Implementation partners need to understand the potential areas in the ERP/COTS software where software changes can be cost-effective. Negotiation will be required to foster adoption and yet not eliminate the inherent advantages of ERP/COTS.

(8) Accelerate decisions by generating more knowledge and less information. At the end of the day, decisions (not documents) move implementations forward. Sometimes we get caught up in generating too many detailed documents without ensuring they generate value-add results (decisions).

In summary, the key to effective ERP/COTS implementations is to have an implementation approach that maximizes the advantages and minimizes the challenges associated with ERP/COTS software.

Adapted from the book "Maximize Your Investment: 10 Key Strategies for Effective Packaged Software Implementations" by Brett Beaubouef.

Fractured Planning Processes

In a report entitled Retail Merchandising: Buckling Down in a Tough Economy, authors Paula Rosenbaum and Steve Rowen of Retail Systems Research (RSR) tell us that nearly half (47% on average, but 55% of performing laggards in the survey) of respondents to their survey said that their leading business challenge was “fractured [inventory] planning processes.”

Unfortunately, in the published report to which I have access, Rosenbaum and Rowen do not elaborate on just what the respondents consider to be a “fractured planning process,” although the accompanying prose tends to suggest that this description relates to business processes tied to inventory planning that are not unified or even in good end-to-end communications across the enterprise and beyond.

A common problem

While this survey deals with retailers and inventory specifically, it does highlight a problem in small-to-mid-sized businesses (SMBs) that I have observed for nearly 30 years: that is, the lack of “planning” at all. For sure, most SMBs do develop plans for special projects. If they are going to purchase new or upgraded technologies, build a new or extend existing facilities, open a new location, or add a new product line, then they do prepare and plan in a more or less formal way.

What executives and managers do not do on a regular basis is develop a plan for making more money – both now and in the future. Most executives tend to get their business rolling and then set the “cruise control.” Then, with the vehicle barreling down the road, they spend their time fighting fires and trying to keep up the organization’s momentum with little or no thought about how the terrain (read: business environment) has changed until something big hits (like a recession or big competitor appears on the horizon).

So, what keeps executives from “planning” more frequently and more effectively for business improvement?

My experience suggests the some blend of following key components comprise the answer:

1. Many executives developed a business plan once, and now they have a business. It never occurred to them that planning for “improving” the business is required or would even help. Being entrepreneurs, they tend to manage by the seat of their pants and trust their “gut” for what will bring improvement.
2. You can’t drain the swamp when you’re up to your neck in alligators. Many executives spend the bulk of their time being reactive, rather than proactive. There time is spent taking care of things that others don’t get done or fighting fires so people can return to doing what they need to do to keep the business running.
3. Unless something big is happening, most executives don’t think time spent in “planning” – rather than “doing” – is a good investment.
4. Far too many executives do not know of – or know how to apply – a good “tool” for effective planning. In the absence of a good tool, most executives feel that time spent in planning is not going to be effective anyway.
5. Things are changing too fast. We just need to do the best we can to survive, right now. Of course, in good times, or when things were not “changing too fast,” these same executives used other excuses for not planning.

A POOGI: A Process Of On-Going Improvement

In times like these – challenging economic times – it is more important than ever for executives and managers in companies that hope to survive despite the economic upheaval to make a concerted effort at ongoing improvement. That is, to start a POOGI within their firm.

Why?

Because it is becoming increasingly difficult to compete for the consumers dollars.  If you are not improving your value proposition in a process of on-going improvement, then day-by-day your products and services are losing out. Dollars that used to come your way are now going to other businesses – and I don’t mean just businesses that you see as your competitors. I’m talking about dollars that consumers used to spend for your goods and services are now going, instead, to buy groceries, fuel, or pay off credit cards – anywhere but into your bank account. That’s why you need a plan to increase the value of your offerings in an on-going way.

How to begin

How should you begin a POOGI?

You should begin by figuring out your present situation. You need to unlock your organization’s “tribal knowledge” and understand your current reality. Naturally, the right tool for doing this is called the Current Reality Tree (CRT).

For more information on Current Reality Trees, including step-by-step information on how to begin constructing one, click here. If you would like to have help unlocking your firm’s “tribal knowledge” effectively and in constructing your CRT, then contact me directly.

Next steps

Once your CRT has given you and your management team a clearer view of what needs to change, the next step is to decide what should the change look like. In other words, if you and your team took steps to reduce or eliminate Un-Desirable Effects (UDEs – pronounced: YOU-dee-eez) revealed by your CRT, what would your organizational cause-and-effect flow look like? The Thinking Processes tool used to expose this future state is called the Future Reality Tree (FRT).

Other of the Thinking Processes may also be applied, including:

• Evaporating Cloud
• Prerequisite Tree
• Negative Branch Reservations

However, for your “planning roadmap,” the tool that will you and your team move from where you are today (your CRT) to your planned future state (FRT), you will want to build a Transition Tree (TrT).

Again, if you’d like to have assistance in effectively applying the Thinking Processes and in creating a POOGI in your organization, then feel free to contact me directly. But, whatever you do, do not sit and do nothing and let the recession drive one more enterprise out of business.

©2010 Richard D. Cushing

Collective Fixation on Short-Term Profits

Vivek Sehgal brings up an important point in the post Putting Your Money Where Your Mouth Is (3 March 2010) here at Supply Chain Expert Commnity. Even though, at GeeWhiz To R.O.I. I talk a lot about the the goal of business being to make more money, I generally add ...tomorrow than you are making today. Making more money "tomorrow," should not be predicated on actions that will diminish the long-term prospects for making more money. Nevertheless, a lot of companies -- especially publicly traded companies -- have a fixation on short-term profits that is damaging to the long-term health of the enterprise.

W. Edwards Deming diagnosed this issue early and brought it to our attention about 30 years ago. He called it "paper entrepreneurialism." The investing relationship of real entrepreneurs looks like this:

Entrepreneurs sitting in this relationship have a vested interest in the ability of the firm to produce profits over the long term. Such investor-entrepreneurs seldom intentionally make decisions to reap short-term profits at the expense of the long-term prospects for the business.

Speculative investors have a slightly different relationship with the firm(s) in which they take stock. That relationships looks like this:

The most connected investors are those that hold a relationship similar to that of the real entrepreneurs. They invest in shares directly with the company (or at least have an more intimate relationships with the firm and knowledge of its management, even if they must make their stock acquisitions through a broker). However, most of the investors agreed to buy stock in the specific firms based on the advice of their broker. They may know little or nothing about the firm or the firm's management directly. They trust the advice of their broker.

The intervention of the broker/brokerage house makes buying and selling of stocks easier, and the brokers are typically incented to produce results (return on investment) for their customers (the shareholders) over both the short-term and long-term. The focus of the broker and the guidance given to the investors will vary based on personal preferences. Nevertheless, it is easy to see that the investors are abstracted from their investments by the borkers and management at the publicly held companies must satisfy the short-term expectations of the brokers or, in the interest of their customers, the brokers are likely to shift investment away from companies performing poorly in the short-term in favor of those with better short-term returns on investment.

Paper entrepreneurs are even further abstracted from their holdings as shown in the following diagram:

With the introduction of mutual funds and government-incented retirement plans, more capital has moved into the markets, but at the price of having the investors abstracted from the companies in which their dollars are invested by three or four layers, which layers tend to be focused entirely on short-term performance and profitability. By a huge factor, a majority of the investors in today's capital markets do not even know the names of the companies in which they hold stock. How can they be anything but "paper entrepreneurs"?  They seek the highest return on their investments without any concern for the long-term viability of the companies providing the returns.


Consider that the mutual fund manager. He care not one whit for the companies in which the fund he manages invests beyond the companies' ability to provide solid growth for the mutual fund over the next reporting period. He will gladly shift millions from company A to company B at the hint that company B's short-term return will outstrip company A's performance.

Next in line come the brokers and the brokerage houses. They are willing to recommend mutual fund C over mutual fund D on the basis of their likelihood of producing short-term returns to the investors. The brokers and brokerage houses are incented to provide this kind of advice without consideration for the long-term survivability of the companies which their investments ultimately reside.

Then, of course, for the vast majority of investors, there are the corporate retirement and pension fund managers. They, too, have only one incentive: to see good performance in the funds they manage. They, like the investors themselves, quite often have no knowledge -- ultimately -- about the companies in which their investments ultimately are put to use.

All of this leads to the boards of directors in publicly-held companies providing incentives to their chief executives to provide short-term profitability so as to keep market capitalization up -- which is almost entirely based on stock prices. So, how do CEOs and CFOs react to all of this? They are willing to sacrifice the long-term prospects of their own organization for short-term performance during the particular CEO's or CFO's term in office -- and their successors will do the same.

This constitutes a grave danger to publicly-held companies in the U.S.  What is the answer?

Contact me!

The Right Cost-Cutting Formula

The formula above is the only real formula that should be considered by companies considering cost-cutting during this recession.

Here is what the formula means.

The upper-case Greek letter delta (the triangle-shaped character) is used in mathematics as a symbol meaning “the change” or “difference.” Therefore, we read this formula as follows:

The change in P = the change in T minus the change in OE,

where P = Profit, T = Throughput and OE = Operating Expenses.

Throughput (T) is defined as Revenue (R) less Truly Variable Costs (TVCs), and TVCs are further clarified as only those costs that vary directly with incremental changes in Revenues. For example, raw materials probably vary directly with changes in unit sales of a manufactured item. However, production payrolls do not vary directly with changes in Revenues. If your firm produces 1,000 widgets this week and only 850 next week, but 1,200 last week; chances are the production payroll was substantially the same for each of these weeks.  Therefore, production payroll cannot be classified as a TVC.

Substituting for T

Since T = R – OE, we can substitute into our formula and make it read like this:

The change in P = the change in R minus the change in TVC minus the change in OE

Thinking about cost-cutting

Based on this formula, we can safely state the following:

• An increase in R will result in an increase in P, provided there is no change in TVC or OE
• A decrease in TVC will result in an increase in P, provided there is no change in R or OE
• A decrease in OE will result in an increase in P, provided there is no change in R or TVC

Where executives get into trouble during recessions

Pay attention to the “no change” clauses in the three statement above. These are critical, but all too frequently overlooked by executives and managers in making cost-cutting decisions. We just saw a terrific example of this with Toyota.

Some executives at Toyota thought that they could increase P (profits) by reducing TVCs through the purchase of lower-priced components for their automobiles. For a while, it probably worked. However, in February 2010, Toyota’s year-over-year sales for the month were down 43%, and for the first time in several decades, Ford Motor Company sold more units than Toyota in a calendar month. This is not to mention the fact that some billions of dollars will be expensed by Toyota over the coming months and years due to the recall.

So, what were the affects of Toyota management’s decision to reduce TVCs in order to increase Profits?

1. Revenues down 43% year-over-year
2. Several billion dollars added to Operating Expenses (OE) due to recall effort
3. Lost customers, which will require additional expenditures in OE (marketing) to reclaim
4. Additional expenditures in OE (public relations, legal, etc.) for damage control

Think it through

It is a simple thing for executives in a firm facing recessionary pressures think, “We will cut our operating expenses (OE) by laying off some people,” without considering the long-term affects that the move may have on customer satisfaction, for example. How many customers will be lost due to the cut-back in staffing? How much more will need to be spent in OE (sales and marketing, for example) to maintain the same levels of revenue as a result?

Use the formula

If, as an executive, you are considering cost-cutting, then consider the whole formula. Go over it with your management team. Carefully consider any short-term and long-term impact on Revenues and Operating Expenses. Do not simply assume that you can change one factor and the others will remain unchanged.

Contact me!

©2010 Richard D. Cushing

The Business Plan (Podcast Series by LeasePlan)

LeasePlan is sponsoring "The Business Plan - Series 2" Business Plan Podcast. The series include:

• Episode 1: Data Security
• Episode 2: Opportunities for Business in Social Media
• Episode 3: Developing an Online Strategy for Your Organisation (the firm is from Australia, so the spelling is correct)

The series will run to ten parts over ten weeks.  It may be of value to your organization.

...

Maximize Your Investment with Packaged Software Implementations

Brett Beaubouef recently published a book entitled Maximize Your Investment: 10 Key Strategies for Effective Packaged Software Implementations. This book, published in December 2009, is a welcome addition to ERP literature if, for no other reason, than that there is a dearth of literature in the field regarding COTS (commercial off-the-shelf) or packaged ERP software implementations altogether. Beaubouef's work helps bring an end to that.

Beyond that, however, Beaubouef's writing is closely aligned with my thinking, as well. Plus, the vast majority of SMBs (small-to-mid-sized business) will end up implementing some form of COTS software. Most small businesses are simply not good candidates for "Big ERP," anyway.

Here are some salient quotations worth cogitating upon and that will, I trust, encourage you to go out and buy the book in order to gain more valuable insights:

• Customers are more concerned with implementing successful business solutions, not just installing software products and technologies.
• Flexibility in a business solution starts with a flexible implementation approach.
• The ideal COTS software implementation approach would focus on maximizing the “out of the box” value that packaged software can provide to a customer. The implementation approach would naturally filter out requirements that did not provide quantifiable business value, and keep the focus on the customer’s value-added strategic requirements.

As the preface says: “This book is aimed at enterprise architects, development leads, project managers, business systems analysts, business systems owners, and anyone who wants to implement packaged software effectively.”  That’s a great target audience because so many implementations lack real business-value effectiveness, even when the software is otherwise “successfully” deployed.

If you fit into any of the categories listed in the preceding paragraph, my advice is to buy the book.  I did!
Contact me at rcushing@geewhiz2roi.com.


Works Cited
Beaubouef, Grady Brett. Maximize Your Investment: 10 Key Strategies for Effective Packaged Software Implementations. Birmingham, UK: Packt Publishing Ltd., 2009.

Taking the Easy Way (Down and) Out

In a LinkedIn group discussion today, many people were offering advice regarding how to save a small business that has been struggling due to the recession.  There has been no shortage of advice.  However, one comment today really stuck out to me. Here is what the contributor had to say:

A company is making 1 million a year.
From that it makes 10,000 profit (1%).
Each sale yields 25% return - i.e. if you sell 1,000 250 is profit.
To double its profit it can:
1. Reduce costs by 10%
2. Increase sales by 40%
Do the math(s). Which is easier?

Now, perhaps this example was intended to demonstrate what a clearly bloated and, likely, wasteful company really looks like. After all, the firm is grossing $250,000 on $1 million in revenues, but net profits are only $10,000 (1%).  That means that the firm is spending $240,000 (99%) on “expenses.”

If this is true – that the company really is bloated and wasteful – then, by all means, the quick and easy way to making more money is to “reduce costs by 10%.” It may even be likely for a $1 million revenue company that is spending $240,000 in expenses that $24,000 could be cut out and not do a bit of damage to the firm’s ability to survive and thrive.

The real state of things

For better or for worse, most small businesses today do not have a profit-and-loss statement that looks anything like that – at least not in terms of being bloated and wasteful. Most of the SMBs (small-to-mid-sized businesses) that I encounter are already running a pretty tight ship. There is no extravagance left in the firm’s operating expenses and, typically, they have already cut back on staffing so that many of the folks in the organization are working long hours and have taken on multiple duties so that fewer people are needed to keep things running. These organizations do not have any “fat” left to trim away. If they seek to cut expenses by even five percent (5%), it would mean cutting away “muscle and bone” – the strength that has allowed the organization to survive until today.

Cost-cutting may have gotten here

If management in such organizations are trapped in cost-world thinking, it could be that cost-cutting is what helped bring them to the brink of destruction, as it is. Here is how cost-world thinking can take a executives and managers astray and lead them to make decisions that are damaging to the organization:

Misleading allocations of overhead expenses

Using the figures offered by the contributor to the discussion (above), this company believes it has a gross profit of 25% ($250 for every $1,000 in revenues). Let us say that this is being calculated in the following (traditional) manner:

Cost Classification	Cost Amount
Raw materials	$250.00
Direct Labor	$100.00
Allocation of indirect costs and overhead	$400.00
Total Calculated Cost of Product	$750.00

For the sake of simplicity, let us say that each “widget” sells for a price of $1,000, so we have the following:

	Amount
Unit Revenue	$1,000.00
Unit Cost (incl. allocations)	$750.00
Calculated Gross Profit per Unit	$250.00

Also, let us assume that, due to the recession, this company also has excess capacity at this time.  (Otherwise, how could their operating expenses possibly be $240,000 on revenues of $1 million?)

Opportunity knocks

Now, one of this firm’s salespeople comes back from a long discussion with a potential new customer in Europe. This firm wants to buy up all the remaining capacity at the firm. That means 1,200 units. However, they are only willing to pay $650 per unit.  What should the company do?

Far too many executives caught up in cost-world thinking would turn this offer down. They would say, “We can’t take a loss of $100 per unit and ‘make it up’ in volume! That’s crazy!”

But, let us look at what is really happening. The company already has excess capacity. It could produce the additional 1,200 units without investing in any new facilities or equipment. Furthermore, it would not add to operating expenses, because no additional back-office staff would be required and no overtime is expected to meet the new demand. So, here is a contrast between cost-world thinking and reality:

COST-WORLD THINKING	Amount
Unit Revenue	$650.00
Cost-world Cost	$(750.00)
Gross Margin per Unit	$(100.00)
Number of Units Sold	1,200
Gross Profit from Offer	$(120,000)
Gross Profit from Current Operations	$250,000
Total Gross Profit	$130,000
Operating Expenses	$(240,000)
Net Profit	$(110,000)

Throughput Thinking

THROUGHPUT THINKING	Amount
Unit Revenue	$650.00
Truly Variable Costs (TVCs) (Raw Materials)	$(250.00)
Throughput per Unit	$400.00
Number of Units Sold	1,200
Change in Throughput from Offer	$480,000
Throughput from Current Operations	$250,000
Total Throughput	$730,000
Operating Expenses	$(240,000)
Net Profit	$490,000

Escaping from cost-world thinking

Here is a simple formula to help rescue firms from making the error we have illustrated above:

Where ROI = Return on Investment,
delta-T = Change in Throughput, where T = Revenue less Truly Variable Costs (TVCs),
delta-OE = Change in Operating Expenses, and
delta-I = Change in Inventory or Investment

In this case, we have determined that the change in OE = zero, and for simplicity’s sake, we have also assumed that the change in Inventory or Investment is zero (or negligible).

Essentially, when looked at properly this offer to “sell below cost,” actually increases the firm’s net profit by $480,000 with virtually zero investment. (In a real situation, some change in inventory is likely, but the effects would still be small.)

I trust this sheds new light on your business situation. Contact me at rcushing@GeeWhiz2ROI.com if you’d like to have help getting a better view of your business and how to make more money.

©2010 Richard D. Cushing