Strategic Alignment of Information Technologies – Part 3

The Income Statement

A company’s income statement[1] is a financial report that tells us what transpired over a range of dates that led to either profit or loss for the organization. Just like we have laid out balance sheet numbers side-by-side for easy comparison, we can do the same thing with income statement figures, as well.
By looking at ABC Widgets Manufacturing’s Income Statements spreadsheet, one might immediately note that year 2004 was a very good year for the company. The firm made PBIT (profit before income taxes) of $126,000 on sales of $8.1 million. Revenues for 2004 were nearly $850,000 more than the average in years 2005 through 2008.
Of course, one cannot help but notice that NPAT (Net Profits after Taxes) declined dramatically between 2004 and 2007, where it reached its nadir of only $2,000. Things were not much better in 2008 where it rebounded to only $9,000 on more than $7 million in revenues.
Once again, these are interesting observations, but it is still hard to tell – at a glance – the management implications of some of these numbers. What might help us would be looking at some of the working relationships (ratios) between various numbers supplied to us from this historical data.

Ratio Analysis

Ratio analysis allows us to look at a set of calculated values – calculated from the underlying data we have just reviewed – in order to assess more quickly our organization’s positions and trends relative to

1. Solvency
2. Safety
3. Working Capital
4. Profitability
5. Asset Management

Solvency Ratios

Current Ratio = Current Assets / Current Liabilities  Interpretation: Higher is better

This ratio simply tells you, at a glance, how many dollars your organization has available in “current assets” to meet the demands of “current liabilities.” As we can see, in 2004, ABC Widgets had a little over $2 ($2.05) in current assets to satisfy every dollar in current liabilities. However, by 2008, that number had dwindled to only $1.35 to cover every dollar in current liabilities.

Quick Ratio or “Acid Test” Ratio = (Cash + AR + Marketable Securities[2]) / Current Liabilities  Interpretation: Higher is better

The Quick Ratio is referred to as the “acid test” of solvency because it looks only to the firm’s most liquid assets to meet the requirements of current liabilities. In 2004 our sample company had nearly 80 cents to satisfy every dollar in current liabilities. By 2005 that number had fallen to only about 50 cents for every dollar in current liabilities and has remained almost unchanged since.

Safety Ratio

Debt-Equity Ratio = Total Liabilities / Equity  Interpretation: Lower is better

The intent of this metric is to indicate the ability of the firm to withstand adversity (from a financial perspective only, of course). It may be understood as the “risk” metric, so the higher the value, the higher the risk. Over the five years we are considering here, this firm allowed its Debt-Equity (D-E) ratio to drift well above 1.30 at times, but has recovered to the present 1.37. The “1.37” means that the firm owes $1.37 for every dollar it has in equity. Therefore, in the midst of adversity, even if the company could not meet its obligations from current assets, the firm’s equity could likely step up to help meet the challenges.

Working Capital

Working Capital = Current Assets – Current Liabilities  Interpretation: Lower is better
Working Capital is the spread (in dollars) between current assets and current liabilities. It measures how many dollars the firm has tied up in its supply chain. In general, it is better to reduce this number. Organizations with higher cash velocities tend to have less cash tied up in their supply chain.[3]
Cash Conversion Cycle = Inventory Days + AR Avg. Days – AP Avg. Days  Interpretation: Lower is better
An organization’s Cash Conversion Cycle measures how long – how many days – cash is tied up in the supply chain on average. Again, fewer days in a firm’s Cash Conversion Cycle is better because it is indicative of one or more of the following:

• More rapid inventory turnover
• Improved AR average days-to-pay
• Faster payment of AP vendors[4]

[To be continued]
©2010 Richard D. Cushing

---

[1] Sometimes referred to as a “Profit and Loss Statement”
[2] In our examples, the firms have no marketable securities.
[3] Some speed-demon companies even manage to have “negative” Working Capital through special supply chain arrangements.
[4] Only vendors that supply inventory or other product-related services should be included in calculating AP Average Days to Pay.

Strategic Alignment of Information Technologies – Part 2

Setting Strategic Goals

Leveraging Technologies for Sustained Competitive Advantage

What makes new technologies valuable to a business?

• Answer: In general, the ability of the technology to contribute to a sustained competitive advantage[1] is what makes it valuable to an enterprise.

What about a new technology allows it “to contribute to a sustained competitive advantage”?

• Answer: Scarcity – the less available it is to your competitors, the larger will be your advantage in leveraging it
• Answer: Innovation – the more innovatively your organization applies specific technologies, the less likely your competitors will be able to achieve the same results or benefits

Consider the example of steam engines. When steam engine technology became available, for those that had direct access (e.g., they could afford to buy steam powered equipment), steam engine technology gave them a significant advantage over competitors that could not pay the entry costs to gain access to that technology. Similarly, those that did not have or did not require direct access, but could benefit from indirect access (e.g., they could afford to ship goods faster on steam ships or by steam locomotive), also had a significant and sustained competitive advantage over their competitors that had no such access to the new technology.

Basic Information Technologies

Today, information technologies provide only the following basic services:

• Data capture
• Data storage
• Data processing
• Data retrieval
• Data transportation (communications)

Since none of these basic IT services is any longer scarce, simply applying the technology in a routine sort of way – as a “copy cat” – cannot provide any long term competitive advantage to your organization. In all likelihood, applying IT in typical fashion will provide no competitive advantage at all.
At best, applying non-scarce technologies in a way that simply matches your competition might help you take your firm from “failing” to “competing” (see accompanying diagram), but such an application of technologies could not, in itself, take your business from “failing” to “leading.”

Strategic Planning Begins with Understanding Where You are Today

Since most organizations begin planning their strategies based on where they have been and what they already know, they generally turn to their in-house history-keeping systems – that is, their accounting applications.[2] We, too, will begin our journey by looking at a sample company’s historical information and considering some of the implications of the data presented.

The Balance Sheet

As many of you already know, the Balance Sheet is a “snapshot” of a firm’s financial position with regard to three categories: 1) Assets – what the company owns, 2) Liabilities – what the company owes, and 3) Equity – the difference between the value of its assets and its liabilities or what it owes to its investors.

In preparing our strategies for fiscal year 2009, our company “ABC Widgets Manufacturing” is looking back over five years of history. The organization has a balance sheet with a little less than $3.7 million in assets, about $2.1 million in liabilities, and $1.55 million in equity. With a quick glance over the spreadsheet we’ve laid out, one might notice the following:

• While total assets have remained fairly steady over the last five years, cash has shrunk by about 15% (down from $102,000 to $85,000) and accounts receivable are also diminished slightly.
• The company has invested significantly in the following assets over the five years we’re reviewing:
  
  • $590,000 in land and buildings
  • $354,000 in equipment
  • $97,000 in furniture and fixtures
• Short-term bank notes payable have zoomed from $211,000 to $589,000, an increase of $378,000 or about $95,000 per year (average).
• Accounts payable have also increased about 34% between 2004 and 2008, moving from $558,000 in 2004 to $750,000 in 2008.

While these are interesting facts in themselves, they really tell us very little about what might be good or bad about operations in general. So, let us turn to the same company’s Income Statements between 2004 and 2008.

---

[1] “Sustained competitive advantage” is a relative term. In some rapidly evolving industries an advantage of six months or a year may be enough. In other industries, perhaps “sustained” would be an advantage lasting a year, two years, or even longer.
[2] We call accounting systems “history-keeping systems” simply because that is what accounting really is – it is the fiscal record of your organization’s historical transactions. While the historical data may be used to produce forecasts and budgets of various kinds based on purely historical data or upon a combination of history and “forecasting parameters,” the accounting system is useless in actually connecting “forecasts” with the actions required to achieve those forecast results.

[To be continued]

©2010 Richard D. Cushing

Strategic Alignment of Information Technologies – Part 1

The Changing Role of Information Technologies

Fewer than 50 years ago (in 1965), U.S. firms were investing less than five percent (5%) of their capital budgets in information technologies (IT). By the early 1980s, about 15% of capital expenditures in U.S. companies were going toward IT. A decade later (the 1990s), U.S. firms had doubled that number and were making capital investments in information technologies at a rate of about 30%. By 1999, in fear of significant failures due to the feared “Y2K problem,” U.S. firms were investing in IT at a rate approaching 50% of all capital expenditures. Even today, due to the challenges of competing in an unmistakably global economy, U.S. companies continue to invest huge dollars (about $2 trillion every year) in new information technologies.

By the mid-1980s, the increasing power of the (then) new Personal Computer (PC) was putting computing power within the reach of the pocketbook of even the smallest “mom-and-pop” operations. There seemed to be a growing consensus amongst managers of every ilk and in every trade and industry that, “If I could just get my computer systems to collect enough data about what my business is doing and how it’s doing it, I could manage flawlessly.” Some companies have been investing in information technologies, sometimes without much more thought about the investment than the underlying fear that if they did not invest in technology, they would somehow be left behind entirely.

Underlying Assumption

As the power and pervasive presence of information technologies have increased, many executives and managers have simply made the assumption that the strategic value of IT has increased right along with it. Some have made this assumption based more on what they see everyone else doing than upon any actual analysis within their own organization or upon any actual effort to align IT spending with strategic or tactical gains.

This willy-nilly approach to IT investment has been somewhat underwritten by the fact that many small businesses have no actual strategic planning mechanism in place anyway. The organization’s planning about the future or thoughts about how to attain certain future goals may still be contained wholly or in substantial part solely in the head of the owner (and maybe a handful of key managers).

Making the Leap from Entrepreneurial to Enterprise

One of the things that occurred in the late 1980s and through the 1990s was a relatively sustained period of economic growth in the United States. Fed directly or indirectly by the rapid opening of both domestic and global markets accessible via the Internet, there were thousands of new start-ups. Many of these new entrepreneurial organizations found rapid acceptance and grew at startling rates from miniscule one or two person operations to firms that employed hundreds or even thousands.

One of the challenges faced by owners and managers in organizations that find themselves forced to transition from entrepreneurial to enterprise is the discovery that what worked effectively when managing an organization with 15 or 20 employees in a single office may not be effective in an enterprise with 1,500 employees scattered geographically. Entrepreneurial managers were finding themselves forced to somehow capture the “tribal knowledge” resident in key personnel who still carried the vision that had led the organization to its initial success. Many times, the “tribal knowledge” was most easily captured and codified into “business rule” within new IT systems.

This series is intended to help executives and managers – whether or not your organization presently has a standard method for setting strategic goals – to establish some effective operational goals; to quantify the expected results as forecasts based on the goals; and in the final step, to offer some ideas about how budgets might be established and new technologies engaged to help achieve the firm’s goals.

[To be continued]

©2010 Richard D. Cushing

Are IT Vendors Driven by the Business Results of Their Customers?

Writing for CIO UK, David Henderson suggests several reasons “Why IT vendors must raise their game”. The second major point he mentions is that “IT vendors tend to be driven by their portfolios rather than business outcomes” for their customers. Henderson points out that IT vendors “continue to make significant investments in their portfolios but aren’t prepared to make the same investment in understanding how these apply to their customers’ businesses,” which can “lead to huge inefficiencies” once implemented at the customers’ sites.

As a result, Henderson continues, “vendors… tend to give poorly defined generic presentations that bear only passing relevance” to the challenges faced by the customer or prospect at hand. Henderson goes on to berate the ERP vendors for “me, too” solutions and their inability to “connect the dots” between their product offering real value for the firm that buys the technology.
I agree that IT vendors need to change. The economic picture is vastly different in 2010 than it was even three years ago.

Where I disagree with Henderson’s writing, however, is who should know what.

Starting off on the wrong foot

Computer-based technologies really were not available to any significant number of SMBs (small-to-mid-sized businesses) until after the introduction of the personal computer (PC) in 1981. Prior to that, computing power available from mainframe and mini-computers was available only to larger firms with significant capital for investment in such technologies.

So, in the early days of the computerization of the SMB market, almost every new prospect was anticipating moving off a system dominated entirely by paper and the necessary manpower to keep the paper flowing. As the price of PC-based technologies fell, more and more companies made the switch. This movement dramatically increased productivity and return on investment (ROI) for such a move was almost a certainty. As a result, many ERP salespeople came in the door talking about increasing productivity and providing rapid ROI for almost every SMB they approached. And, almost without exception, the implementation of that first round of technologies provided consistently rapid payback for the firms.

Unfortunately, as the market changed (i.e., SMBs’ next round of technology purchases were not taking them off paper-based systems but, more frequently, moving them into a comprehensive suite of application modules or moving some SMBs off the high cost of maintenance associated with mainframe and mini-computer systems), the sales approach of most technology vendors did not change. The technology vendors’ salespeople continued to make the same claims about productivity improvements associated with the first round of ERP implementations and the executives and managers at the customers’ sites continued to drink up the claims like Kool-Aid. In many cases, the SMB management was spurred on by the impending arrival of the year 2000 and the Y2K epidemic of fear. Many executives felt they needed to spend the money to upgrade their systems and took little thought as to the ROI of such an expenditure.

Nobody grew up and nothing changed

By the early 2000’s the ERP market had changed yet again. By 2005 or so, almost every CEO or CFO of every SMB had been through at least one – and usually two or three – implementations of new software (or other technologies) in their business environment. Add to that experience the fact that they now had easy access to the Internet by which to explore and make inquiry regarding almost any ERP software on the market, and the ERP-buyer had changed dramatically over a bit more than two decades.

When ERP was starting to be sold (20-plus years earlier), when the technology salesperson first met a prospect, the prospect was hungry for information about products and capabilities. Furthermore, these green-horn technology buyers were more than willing to make the salespeople their de facto “instructors” in the purchase and application of new technologies in their businesses.

In addition, as previously stated, ROI was pretty easy to achieve. Almost any SMB moving off labor-intensive paper-based processes or coming from costly mainframe or mini-computer technologies was bound to reap savings in operating expenses, and was almost equally likely to achieve increases in Throughput. However, by the middle of the first decade of the 21st century, all the easy ROI from traditional ERP – Everything Replacement Projects – was gone and not likely to return. Sadly, much of the technology salespersons’ product positioning remained unchanged and the sales rhetoric and promises from a good many ERP vendors still harkened back to days gone by – without, of course, actually mentioning that fact.

This unwillingness to face the change in the marketplace was not entirely one-sided. As the traditional ERP sales hype continued to make sweeping “rule-of-thumb” claims about delivering ROI for the ERP-buying executives and managers, these executives and managers proved themselves equally willing to accept the claims without taking the time and effort to discover for themselves what they really needed to know about their particular organization and its potential for reaping ROI from any particular foray into new or upgraded technologies.

What every executive and manager needs to know

As Eliyahu Goldratt has put it so well, there are three – and only three – things that every executive and manager needs to know to make effective decisions in every situation. These are they:

1. What needs to change
2. What the change should look like
3. How to effect the change

If, before making the leap to buy technologies based on “rules of thumb” and sales-speak, executives would just take the time to figure out the answers to these three questions, there would be far fewer stories about traditional ERP implementations failing to deliver expected business results.

IT vendors are not necessarily driven by business results for every client. And, as executives and managers, you should be aware that rules-of-thumb may not apply to you and your enterprise – and the ERP vendor or VAR is not responsible for your business’s not fitting the rule-of-thumb by which other enterprises may have achieved return on investment.

As executives and managers in your organization with your particular circumstances and requirements, you – not the technology vendor or reseller – need to know what needs to change in order for your firm to start making more money tomorrow than you are making today. You – not your vendor or reseller – need to know what the change should look like in your particular organization. (The vendor or VAR may help you understand how new technologies may be part of what that change should look like, but you need to understand the precise need in order to effect your desired ROI. (Read more in many articles found right here at GeeWhiz To R.O.I.)

And lastly, as executives and managers it is your responsibility to understand how to effect the change within your enterprise. (Here again, the technology vendor or reseller may help you understand the technology-related components of the change, but you and your team need to take full responsibility for creating a roadmap for change.)

Need help?

Contact me at rcushing(at)GeeWhiz2ROI(dot)com and I can show you a way to unlock your firm’s “tribal knowledge” to discover what needs to change so you can start making more money tomorrow than you are making today, and you won’t spend money needlessly on technologies that don’t bring almost immediate ROI.

©2010 Richard D. Cushing

ERP Vendors and Customers: The Blind Leading the Blind

Writing in CIO UK magazine online, David Henderson’s article entitled “Why IT vendors must raise their game” makes several salient points. Not least among the points raised is the fact that “too many IT vendor sales personnel don’t really understand my underlying business processes and investment criteria….”

For me, however, the issue is somewhat stood on its head. Far too many business enterprises with which I have been involved have precisely the same problem internally. CEOs, CFOs and CIOs in many businesses buy new technologies without understanding their own underlying business processes and by what criteria they should invest.

What executives and managers should know

Executives and managers seeking ways to improve their business enterprises (read: make more money tomorrow than they are making today) too often buy new technologies out of “hope” or “desperation,” rather than with a clear and concise understanding of

1. WHAT needs to change in order for the business to begin making more money tomorrow than it is making today;
   
2. What the change should LOOK LIKE; or
   
3. HOW to effect the change (including what role any new or upgraded technologies might play in delivering the improvement).

Since they do not have the tools to concisely analyze what needs to change in order to make more money tomorrow, then they cannot know what the change should look like or how to bring about the change effectively. So, in the absence of clarity, they grope about in their darkness hoping that some change – any change – will bring them their desired end of higher profits.

Blind leading the blind

Like the blind leading the blind, the technology vendors and resellers who do not fully understand their prospects’ underlying business processes or appropriate criteria for investment (in fact, they understand them less clearly than the executives and managers, in many cases), console the yearning executives with platitudes and “rules of thumb” about how their latest and greatest “gee-whiz” technology will “reduce costs by X percent” and “improve sales by Y percent.”

Of course, this is precisely what the executives want to hear. Like the Sirens of old, the vendors and resellers lead many to spend. Even if they don’t fully believe what they are hearing from the vendors and VARs, the executives and managers frequently do not take time to calculate with any precision just how or why the new technology should, could, or would produce a return on investment (ROI) in their particular organization and circumstances. Instead, they close their eyes and ears to any negative thinking and, In the absence of any better ideas, these executives take out their checkbook to purchase the latest and greatest of new technologies. Of course, the correct general ledger account to which this “investment” should be charged is “Hope and Earnest Expectation.”

Serendipity

Sometimes good things come of this method. According to the industry literature, we can say that about one out of three such “investments” lead to noticeable improvement. Many times, however, the measure of improvement cannot be known with certainty. A growing company that shows improvement after some implementation cannot know which results may have occurred even in the absence of the new technology. A far greater share of SMBs (small-to-mid-sized businesses) simply assume they are “better off” if they are not clearly “worse off” following the deployment of some new technology. Some merely breathe a sigh of relief after some trying implementation period and, like a good Calvinist, say, “I’m glad that’s over,” without ever looking back to measure their return on investment.

My argument, however, is that “hope” and “serendipity” are not strategies and, while a few companies come to excel and even to dominate some markets for a short period of time based on little more than serendipity, it is not a sound strategy for long-term growth in any enterprise. For executives and managers return on investment should be seen as a primary responsibility. This responsibility should not be handed over to the technology vendor or VAR (value-added reseller). Neither should it be left to chance.

As W. Edwards Deming said so clearly: “It is management’s job to know.”

It is management’s job to figure out WHAT needs to change in order to start making more money tomorrow than the firm is making today. It is management’s job to come to a clear understanding as what that change should look like when it occurs. And, it is management’s job to define an unambiguous roadmap to effecting the necessary change. Then, it should be management’s job to measure and report on the return on investment yielded by their own keen insight.

Need help with this? Contact me at rcushing(at)GeeWhiz2ROI(dot)com and let’s talk.

©2010 Richard D. Cushing

5 Things SMB Decision-Makers Aren't Getting Right Yet About ERP

5 Things SMB Decision-Makers Aren't Getting Right Yet About ERP

Despite more than a quarter-century since the arrival of 'ERP' on the scene, far too many executives and managers are still struggling to get things right.

Click the link above to read the article in full.

Two Peas in a Prison

Have a good laugh at the expense of “Big ERP.”

Watch “Two Peas in a Prison” and then remember that the New ERP – Extended Readiness for Profit is what you really want.

Learn more about the New ERP – Extended Readiness for Profit by reading right here at GeeWhiz to R.O.I.
Thanks.