Finding Common Ground Between the CFO and COO–Part 2

[Continued from Part 1]

I do not believe there is any doubt about it. Cutting costs takes far less real and deep thinking than it takes to come to understand your marketplace better. Both the CFO and the COO can agree that cutting costs saved them money—even if the unspoken side-effect of the cost-cutting action was to also reduce revenues through lost sales, lost customers or both. (Of course, in really hard times, the CFO and COO can console themselves by saying, “Sales probably would be down anyway,” and thus ignore the damage done through cost-cutting.)

Making your move

Most firms—even with brilliant CFOs and COOs—are not going to make one giant step from “failing” to “leading.” It is far more likely that they will take incremental steps. So, let us now look at each of these quadrants in more detail.

Failing

The failing firms are those that are both ineffective at increasing Throughput and are also undifferentiated in the marketplace. These are the “also-ran” firms in which management has been unable to produce enough throughput to sustain profitability.

Throughput leads to profitability via this formula:

Profit = Throughput – Operating Expenses (OE)

Recalling the definition (see Part 1) of Throughput, and substituting, we get this:

Profit = Revenues – Truly Variable Costs (TVC) – Operating Expenses (OE)

Of course, the ineffectiveness in producing profits is also linked directly to management’s other failure: the failure to differentiate itself in the market. It is far more challenging to produce a profit when all you have to offer is a “commodity”—a product or service that is so generic as to make “price” the sole differentiator.

Risking

Risking firms are sometimes “bleeding-edge” companies. These firms have found ways to differentiate themselves, but have not yet discovered how to make a profit while doing so. Their differentiation leads to demand, but the demand just adds more risk because they are losing a bit on every unit while trying to make up the difference in volume.

Competing

The competing firms are also stuck dealing mostly with “commodities.” They find themselves competing based on price more than almost any other factor—due to their lack of differentiation in the marketplace. The good news is that their management has learned how to be effective at producing a profit, at least.

Some firms are very comfortable in this role. They do not seek market leadership. If they are, then all of their profit must be predicated on business volume. They are generally hurt by significant economic downturns that kill sales volume.

Leading

The largest rewards (on a per-unit basis) are reserved for “leading” firms. Companies in this quadrant have both differentiated themselves in their markets and their management has proven itself effective at producing and increasing throughput.

Even as overall markets shrink, it is possible for such leading firms to prevail by taking a larger and larger share of the shrinking market. While sinking or shrinking companies are giving up market share, prevailing or leading companies can grow by taking over what is surrendered by vanishing firms.

Increasing breadth of market

In 2006, Chris Anderson, a former journalist at The Economist and editor of Wired magazine, published a book entitled The Long Tail: Why the Future of Business is Selling Less of More. The term “the long tail” comes from the appearance of a sales graph where lots of products (x-axis) are sold in smaller quantities (y-axis) into lots of different market segments. This book talks about the why behind the product proliferation we are seeing in many, many markets.

Although I am not a smoker, when I was a young man a recall that there were only a couple dozen cigarette brands sold in the U.S. Today, the tobacco industry has proliferated cigarette branding to perhaps a hundred varieties or more. Similarly, when I was younger, there were a few dozen major soft drinks: Coke, Pepsi, Mountain Dew, and so forth. Today, that has exploded into almost a dozen varieties of Coca-cola, alone.

In the 1950s and into the early 1970s, automobile makers produced a fairly limited range of options available for U.S. made cars. Many cars were sold out of the showroom or out of dealer inventory simply because they had a model in stock with all the options a particular customer might want.

Today, however, the number and variety of options available for U.S. made cars has grown to the point that one automaker claims that “no two cars delivered” are identical—even if they are inventoried by the dealer and sold out of dealer stock. Choices in colors, sound systems, trim kits, accessory “packages,” engines, seating, and more have led to satisfying “markets of one.”

[To be continued…]

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

The New ERP – Part 34

What executives and managers need to know

It seems we must constantly return to fundamentals – to simplicity. Meredith Levinson , writing for CIO magazine, points all too clearly to the fact that executives and managers in far too many business enterprises do not understand clearly the three simple things necessary to improve an organization:

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

Levinson writes: "Part of the reason project managers don't know projects are strategic is because the projects are chosen in many organizations in an ad-hoc manner. Half of survey respondents said that projects are selected in their organizations on the basis of a stakeholder requiring it or some through some other informal process, or they indicated that they didn't know how projects were chosen.

"Since projects are often initiated through informal processes, organizations shift project priorities in an equally informal manner. This severely complicates project managers' work." (Levinson 2009)

It seems all too apparent from Levinson's findings that organizations spend far more time and energy trying to figure out how to assure that their selected projects are "successful" – i.e., they are on-time, on-budget, and delivered with some measure of quality – than they do deciding whether the projects should be done at all. Worse! Shifting priorities within the organization make even efforts on poorly selected projects less likely to produce the desired results.

Only one reason to select an improvement project

For-profit organizations (i.e., business enterprises) will find themselves in one of four classes based on two critical criteria:

• How effectively are they increasing Throughput?
  
• Are they significantly differentiated (in a positive way) from their competitors?
  

The four classes become:

1. Failing – firms that are neither effective at increasing Throughput nor differentiated from their competitors
   
2. Risking – firms that are differentiated from the competition, but ineffective at increasing Throughput (sometimes, "bleeding edge")
   
3. Competing – firms that are effective at increasing Throughput, but are not significantly differentiated from the competition ("commodity" firms)
   
4. Leading – firms that are both effective at increasing Throughput and successful at differentiating themselves from their competitors
   

Note: For readers unfamiliar with the definition of Throughput or other terms used in this section, see Part I in this series.

In the New ERP – Extended Readiness for Profit, we advise that executives and managers always seeking to maximize R.O.I. (return on investment) according to the following formula:

ROI = (delta-T – delta-OE) / delta-I

where T = Throughput,
OE = Operating Expenses, and
I = Investment

For executives and managers, the analysis becomes a simple matter of maximizing the change in T (delta-T), with the lowest possible change in OE and I. Doing so assures that the planned action will help the organization achieve more of its goal of making more money – both today and in the future.

Being rescued from cost-world thinking

Executives and managers looking at this simple formula are immediately rescued from cost-world thinking and are transported into the realm of guiding their organization toward achieving the potential for which they are already paying. Guided by new understandings brought to light through the application of the Thinking Processes executives and managers in companies of all sizes are exposing heretofore unrealized potential within their own organizations. As published in The World of the Theory of Constraints, Vicky Mabin and Steven Balderstone report the following astonishing results:

• Lead Times – 70% mean reduction in lead times
  
• Cycle Times – 65% mean reduction in cycle times
  
• Inventory Levels – 49% mean reduction in inventory
  
• Due Date Performance – 44% improvement in on-time delivery
  
• Combined Financial Variable – 63% improvement in combined financial results
  
• Revenue/Throughput – 73% mean increase
  
  (Mabin and Steven 1999)
  

Cost-world thinking causes management teams to shrink their organizations in an attempt to hold costs and expenses within present revenues. Unfortunately, this leads to diminishing returns in several ways. However, getting your management team to focus on increasing Throughput and helping them achieve breakthrough thinking on new ways to differentiate what you do, leading to increasing market segmentation and penetration, can help your firm unlock more and more of its potential for making money.

©2009 Richard D. Cushing

Works Cited

Levinson, Meridith. Business Strategy: The 'Best Determinant' of Project Success. Nov 17, 2009. http://www.cio.com/article/508018/Business_Strategy_The_Best_Determinant_of_Project_Success (accessed Nov 17, 2009).

Mabin, Vicky, and Balderston Steven. The World of the Theory of Constraints. Boca Raton, FL: St. Lucie Press, 1999.