Misleading allocations and how to fix it–Part 2

[This is a continuation that will make very little sense to you if you don’t go back to read Part 1. Sorry.]

ACTIVITY-BASED COSTING ALLOCATIONS

Well, the partners were disappointed with these results, for sure. So, they decide to try Activity-Based Costing (or ABC) allocations. The administrative overhead is allocated based on their analysis of the amount of activity that the partners must undertake with each job type.

The ABC allocation of non-administrative overhead was done based on production-hours ($9,000 divided by 1,000 hours = $9.00 per production-hour).

The results of the partners’ new calculations (based on the historical product mix) are shown in below where you will note that company profit remains the same ($4,100 per month).

However, new priorities emerge: now the most profitable jobs appear to be landscaping (at $35 per job) and gutter guards (at $28 per job).

Based on these data, the partners rearrange priorities to allocate resources (i.e., the 1,000 hours or production time available) to capture the available markets for these job-types first. The results of this change in priorities may be seen in the following table:

Like the previous example, at first things look good: “calculated profits” boost to $7,924, but after subtracting overhead not absorbed (by abandoned job-types), the results are disappointing. Only $1,300 per month in net profits.

HOW TO FIX IT: THROUGHPUT ACCOUNTING VIEW

Throughput accounting eliminates all allocations except those that are truly variable with the changes in revenue. Typically, those costs are things like raw materials, commissions (maybe), outside processing costs, piece-rate labor—but not much else.

When you look at these Throughput Calculations, you will see two critical factors:

1. Throughput per Job (Revenues less Truly Variable Costs or TVCs)
2. Throughput per Constraint-Hour (Throughput divided by the time used on the constraint—in this case, the 1,000 hours of production time from the workers is the constraint to making more money)

So, looking at the Current Business and Profitability, you will see that another column as been added that represents the company as a whole or “the system.” Throughput is totaled across the enterprise into this column and then operating expenses are deducted from Throughput.

“Direct Labor” is not included in TVC and is included in Operating Expenses. Why?

Because in most organizations, so-called direct labor is not a TVC. Many times the payroll expense for labor will be the same whether the firm produces 10,000, 12,000, or 8,000 widgets in a month. Not to mention the fact that the payroll for “direct labor” (falsely so-called) sometimes includes payments for PTO, training or other non-productive time.

Note, again, that using Throughput Accounting, we still get the same net profit calculations ($4,100 per month).

Now, with this new information in-hand, the partners decide to prioritize sales and production to capture the market in order by T/C-Hr (Throughput per Constraint-Hour) until they run out of constraint-hours (i.e., the 1,000 hours available to them each month). The results of these new priorities are shown in the table below marked as Revised by Throughput per Constraint-Hour.

Wow! Profits are boosted 230 percent—to $9,410 per month or $112,920 annually—after fully covering all of “the system’s” overhead. In this case, they sought out and captured the 250 plumbing jobs available to them in the market as a top priority. Their second priority was to capture the 145 gutter guard jobs available to them. They had a few of the 1,000 hours left, so they were able to also do 16 window cleaning jobs.

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Hopefully, this helps you see two things:

1. The inherent dangers in believing data coming from an ERP manufacturing (or project accounting) system where the profit figures are clouded by allocations of overhead.
2. The simplicity and clarity provided by looking at your clients’ organizations as “a system” and helping them view their goal as optimizing the entire “system,” not trying to make decisions based on data that may imperfectly represent “system” performance.

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Let me know if this is valuable to you. Thanks.

Implementing CPM in small business on a limited budget

Eric Lundberg’s presentation at CFO Magazine’s 2011 Corporate Performance Management Conference today was refreshing. Lundberg brought things back down from the stratosphere for the large number of small-to-mid-sized business finance people in attendance.

My sense is that many of the presentations thus far have set forward concepts of such a broad scope and relative complexity that they are far, far beyond the pale of immediate consideration by many of the firms represented at the conference. Many of the attendees with whom I have spoken are mere “beginners” in corporate performance management (CPM).

Now, do not get me wrong: I have done no scientific—or even non-scientific—polling on this subject. I say what I say based solely on conversations I have had with a relatively small handful of conference attendees.

Nevertheless, I believe that many of the folks in attendance came here really trying to find out answers to pretty basic questions about CPM. And, given the fact that Julia Homer presented—that 63 percent of CFOs surveyed are more pessimistic about the coming year than they were about last year—I would further surmise that most of them are looking for ways to implement some kind of business analytics and CPM with the smallest possible drain on their corporate cash-flow.

That is precisely why I found Eric Lundberg’s presentation so very refreshing. Lundberg introduced his remarks by saying that he wanted to present “practical applications of tools” that he and his team put in place at ALM. He went on to tell the crowd that, as CFO in a firm held by private equity, he is not in a position to "go out and spend $100,000" or more on sophisticated analytics tools. Therefore, he and his team have implemented substantial business analytics built mostly around “home-grown” applications—not the kind purchased from analytics application vendors.

Lundberg went on to describe—in considerable detail—a number of the analytics in use at ALM. Using these effective but relatively low-cost tools, Lundberg and his team have gained considerable insight into what makes—and keeps—their company profitable. They have already implemented rolling forecasts and have the facility to re-forecast every month. They also do a complete bottom-up forecast fresh every quarter.

I really believe that Lundberg’s presentation put a light at the end of the tunnel for many CFOs struggling with the question: “How can we begin gaining the advantages of business intelligence and analytics without ‘big bucks’ to invest in making it a reality?”

This is real innovation, and it is clear that the analytics Lundberg and his team have put in place at ALM are already making the firm more successful, even in the midst of the present economic doldrums. Sixty-three percent of CFOs today may be more pessimistic about the coming year than the year just past, but Lundberg has leveraged limited resources in a way that will make his firm far more likely to survive and even thrive.

Congratulations, Eric Lundberg! And thanks for giving more small businesses hope for embracing new management metrics and analytics despite severely constricted funds.

Forecasting Mistake Number 1: Forecasting to the Wall

In today’s session at CFO Magazine’s 2011 Corporate Performance Management Conference, speaker and author Steve Player, of The Player Group and North American Director of the Beyond Budgeting Round Table, brought out lots of valuable information about the need for organizations to move from a once-a-year, top-down “budgeting” process and into an ongoing process of rolling forecasts.

In doing so, he employed a striking analogy.

Player asked the attendees: Would you be happy with a new car, if, when you first bought it, the headlights gave you a good view of the road ahead—shining out maybe a 600 feet ahead of you. But after three months, the headlights only gave you visibility for 450 feet; and after owning for six months, the headlights only showed you 300 feet of the road before you?

Of course not! No one wants a car like that.

Nevertheless, that is precisely the kind of performance being actively supported with the function of traditional methods of budgeting and forecasting. First the company is looking forward a full twelve months. Three months later, the company is looking only nine months into the future. And, after another three months, their view into the future—their forecast or their budget—gives them only six months of guidance.

What is worse is the fact that the one-year forecast was likely put together from statistics collected and judgments made three to six months earlier. So, by the time the firm’s forward-looking view is obscured beyond six months, the six months they are seeing in the forecast is now nine to twelve months old and out-of-date.

Is it any wonder that such a firm’s “budget” is considered little more than a well-intentioned joke—or perhaps just something to satisfy the executives—by the workers who are all too frequently being measured against the budget?

Steve Player calls this approach “forecasting to the wall,” where no one has a clear vision beyond the 12-month “wall.” He also calls it, “Forecasting Mistake Number One.”

Forecasts, when used, ought be updated as often as necessary; and certainly every time there is a significant change in the mathematical, statistical or intuitive elements underlying the existing forecasts. Forecasts should also be rolled into the future far enough and frequently enough to allow the management changes they are intended to guide to take effect for driving ongoing improvement.

“Mistake Number One” – Think about it.

CFO Magazine’s 2011 Conference on Corporate Performance Management (CPM)

I am pleased to announce that I have been selected by CFO publishing to officially blog on their Corporate Performance Management Conference to be held in Dallas, Texas, September 11-13, 2011. The focus of the conference will be improving business analysis and bottom-line performance. As you know, both topics are near and dear to my heart, so I look forward to hearing what the great line-up of speakers will have to say on the topic.

Speakers will include:

• Thomas Davenport, President’s Distinguished Professor of Information Technology, Babson College; author, Competing on Analytics and Analytics at Work
• Wayne Eckerson, Founder and President, BI Leadership Forum; author, Performance Dashboards: Measuring, Monitoring, and Managing Your Business
• Eric Lundberg, SVP & CFO, ALM
• Steve Player, North America Program Director, Beyond Budgeting Round Table (BBRT)
• Robin Washington, SVP & CFO, Gilead Sciences Inc.

If your business could benefit from better understanding the processes, structures, tools and people required to achieve the kinds of changes necessary to make you more profitable tomorrow than you are today, then this conference could be just the ticket for you or some members of your management team. By clicking here, on the picture above, or the CPM icon in the column to the right of this post you can register now. Better yet, by entering the code “BLOG” along with your registration, you can save $400 off the normal registration price! Don’t delay your registration. Do it today.

This is your opportunity to learn from real movers-and-shakers about how to leverage dashboards, budgeting, planning, and forecasting toward improving your firm’s bottom-line. Even assessing the performance of  your supply chain and the inherent risks you might face are covered.

See you there!

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

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[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.

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[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

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

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

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

ROI Is a Responsibility - Part 1

I have, of late, been challenged in my thinking from two quarters: first, in a LinkedIn discussion I had an entrepreneur tell me that entrepreneurs had to be too much "right-brained" and could not be cornered into decisions based on such things as calculated ROI (return on investment).

Next, I was going back through some old articles I had collected and discovered this excerpt from an May/June 2003 article by Jacob Varghese:

"Basing IT priorities on ROI rankings is a fool's game, a game in which the biggest liar wins. By relying solely on ROI figures to approve a project or decide between projects, managers are shirking their responsibility for understanding how technology will affect their businesses. ROI numbers do not ensure that technology initiatives will be in line with business strategy. The success of any technology initiative depends on whether the person responsible for implementation has the required incentives, authority, and credibility across the span of the organization that would be affected by that initiative. ROI figures should merely be used as a means to ensure that the planning is as comprehensive as possible and the totality of impact has been considered. And managers should avoid approving the entire funding up front. Rather, funding should be an ongoing contingent upon the project team meeting key milestones and realization of planned benefits." (Varghese 2003)

Now, I remain at two-minds regarding the Varghese article. On the one hand, I might agree with him on some matters, but I cannot be quite sure because there are other statements that run so outrageously against my inner sense that I cannot be certain of his meaning in the other statements. So, let me break this down sentence by sentence:

"Basing IT priorities on ROI rankings is a fool's game, a game in which the biggest liar wins."

Who is the "liar" here?

I suppose if the ROI figures are coming from a salesperson working for a software vendor or VAR (value-added reseller), then Varghese might have a point. However, it is the firm's executive team that is the "fool" in that case, for believing the ROI numbers provided by the very persons who stand to gain the most – and lose the least – by selling new technology to the firm.

However, if the executives and managers are doing their job properly and they have the right tool set, they should be the inventors of their own ROI figures. Furthermore, those figures should not be predicated on industry averages or "round-numbers" or rules-of-thumb. The executive team should figure out – for each proposed investment in IT – the following three factors (at a minimum):

	Factor	Description	Example
1	Change in Throughput or delta-T	How much will Throughput increase, where Throughput is defined as incremental revenues less truly variable costs (only those costs that will vary directly with the change in incremental revenue change)	Investing $85,000 in technology X should increase our sales of Product Lines A, B and C in the Y market segment by 15% over the next 12 months. We estimate that this will result in $215,000 per annum in additional Throughput when fully up-to-speed. We believe that minimal change in Operating Expenses will be necessary to support this increase it Throughput.
2	Change in Investment or delta-I	How much will total assets change	Of the $85,000 investment in technology X, we expect that $50,000 will be capitalized. We also expect that about $22,000 in additional inventory will be required to support the $215,000 per annum in additional Throughput. Therefore, total change in Investment (first year) is estimated to be $72,000 ($50,000 + $22,000).
3	Change in Operating Expenses or delta-OE	How much will day-to-day expenses increase or decrease	As previously stated, our estimates indicate that we will be able to support the $215,000 in additional Throughput with no additional staffing. However, the carrying costs for the additional $22,000 in inventory are estimated at 23.2% or $5,104 per annum. We also know that software maintenance costs will 18% of $20,000 or $3,600. Total estimated change in Operating Expenses are, therefore, $8,704 per annum. In the first year, we must add the non-capitalized part of the $85,000 IT project, or $35,000. First year delta-OE is, therefore, $8,704 + $35,000 = $43,704.

How, then, do we calculate the ROI for this "technology X" project? Quite simply using the following formula:

ROI = (delta-T – delta-OE) / delta-I

Or

First-year ROI = ($215,000 - $43,704) / $72,000 = $171,296 / $72,000 = 238%

Now, perhaps Mr. Varghese can explain to us all why comparing various IT projects on this basis is "a fool's game."

"By relying solely on ROI figures to approve a project or decide between projects, managers are shirking their responsibility for understanding how technology will affect their businesses."

Here, again, I guess we need to ask the question: Whose ROI figures? If the figures upon which the executive team is relying come from the vendor or the VAR or are otherwise based on non-specifics, then I would concur with Varghese.

However, if the ROI figures are coming from sound analyses as I just set forth in the examples above, then I would say that it would be managers who do not "rely solely on ROI figures to approve" IT projects, or to "decide between projects" that are "shirking their responsibility for understanding how technology will affect their businesses." In fact, by not preparing an ROI analysis with the kind of stringency suggested by my example above, then managers and executives are simply throwing in the towel and confessing outright that "We do not know how technology will affect our business. Instead, we just have hope that if we spend money on technology, that somehow our company will magically improve."

That, folks, is not a strategy.

[To be continued.]

©2010 Richard D. Cushing

Works Cited

Varghese, Jacob. "ROI Is Not a Formula, It is a Responsibility." Journal of Business Strategy, May/June 2003: 21-23.

Getting more of what you want - Part 5

How many things does an executive or a manager need to know to manage an organization -- a "system" -- effectively?

Answer: Exactly 3 things!

Here they are:

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

This sound easy and hard at the same time, doesn't it?

Well, I am a firm believer in a concept called inherent simplicity, although I cannot take credit for creating the concept. The concept was developed and articulated by Eliyahu Goldratt in his recent book The Choice. The basic thought of inherent simplicity is that underlying all complexity in systems is a concealed simplicity. If that simplicity can be made apparent, then any "problems" within the complex system will require only relatively simple solutions.

Consider a complex manufacturing machine with hundreds of moving and interrelated parts. No one would design such a machine so as to require that one touch every one of the hundreds of parts in order to effect an adjustment in the machine's operations and outcomes. A machine with hundreds -- or even thousands -- of interrelated, interdependent moving parts may often be adjusted to produce different results simply by making changes in a small handful of parts. These simple adjustments are made available because the inter-dependencies between the various moving parts are known and understood -- at least to the persons that designed the machine and wrote the instruction manual.

Similarly, if the entrepreneur can find a tool set that will help him or her decipher, document and understand the inter-dependencies in the organization (i.e., system) as it moves toward enterprise proportions and complexity, then the entrepreneur will also be able to discover the relatively small handful of places he or she needs to "adjust" the "system" in order to produce different results.

Is there such a tool set? Is it readily available? Is it of a nature that the entrepreneur can readily grasp the tools and make use of them effectively?

I firmly believe that there is.

[To be continued...]

Contact me!

...

Getting more of what you want - Part 3

Last time we talked about how a growing and expanding entrepreneurial organization can all too easily lose sight of a singular goal -- making more money tomorrow than its making today. When they do so, they also lose sight of the fact that, in serving its customers, the organization is a "system" -- not a collection of loosely connected departments or functions.

So, what are the symptoms exhibited by an organization that is not being measured and managed as a "system"?

• Lower than desired overall performance
  
• Challenges in achieving or maintaining a strategic advantage in the marketplace
  
• Ongoing or recurring financial difficulties
• Almost constant "fire-fighting"
• Frequent failure to meet customers' expectations
• "Bottlenecks" in the organization that move frequently from function to function or department to department
• An ongoing state of conflict between parties representing various functions or departments within the organization

If you can nod your head "Yes" to three or more of these symptoms being present in your firm, then chances are you need help getting a handle on once again seeing your organization as a "system" and turning the corner to measure and manage it in a proper way.

But what really keeps owners, executives and managers from tearing down these roadblocks to success? They aren't stupid. They've known for (perhaps) years about the constant "fire-fighting," the company politics, and conflicts between departments or functions.

What is blocking executives and owners from taking effective action against those things, of which they are well aware, that are keeping their firm from making more money tomorrow than they are making today?

[To be continued...]

Contact me!

Three Basic Rules for Business Suvival

Here are the Three Basic Rules for Business Survival in hard times (or any time):

1. Never run out of cash.
   
2. Never ever run out of cash.
3. Never, never ever run out of cash.

If you and your management team are not presently calculating and tracking important factors like:

• Your Throughput Cash Velocity
• Your Cash Consumption Rate
• Your Net Cash Rate

Then you just might run out of cash.

If you don't know how to calculate any of the following metrics:

• Cash-to-Cash Cycle
• Throughput Cash Velocity
• Cash Consumption Rate
• Net Cash Rate

Then contact me at for more information.

(c)2008, 2009 Richard D. Cushing

Government-Induced Economic Discontinuity

There is considerable upheaval in the U.S. economy right now, and your business could be in jeopardy if you do not have a framework and method by which to come to grips with the discontinuity that is likely to be introduced by federal government actions over the next several months.

Consider these facts:

1. Over the last 50 years, the federal government has controlled about 20% (+/- 2%) of our gross domestic product (GDP). They have done so through some direct controls as well as through the letting of government contracts for defense and so forth. However, with Congress pushing for a plethora of new programs, the drive toward a nationalized health care system, and the results of various so-called "economic recovery" actions being the virtual "nationalization" of some segments of some industries, we may see the federal government directly or indirectly involved in up to 50% of GDP in the near future.
   
   
2. Since about 1948, the federal deficit has hovered around 2% of GDP. Now, however, with so-called "recovery" bills pending and acts that have already been passed that run into the trillions of dollars, we could easily see the federal deficit leap to 15%, 18% or even 20% of GDP.
   
   
3. For nearly 30 years the Federal Reserve has grown the money supply at about 4% a year. That has changed dramatically! The Federal Reserve has doubled the money supply between October 2008 and January 2009 alone.

In essence, the U.S. may rapidly become "Europe" if politicians in Washington have their way -- and it is likely that this is largely unstoppable at this time. If we use for comparison Germany and France as "typical" Euro-zone nations, we find that in these countries the national government controls 40 to 60% of GDP and that these nations are dominated by massive social programs.

What are the results for business economics?

• Slower growth - the economies in these nations grows at a rate equal to about one-half or two-thirds that of the U.S. economy

• Higher inflation -Euro-zone inflation is about 10% higher than that of the U.S. over the last 20 or so years

What does all this mean for you and your business?

This government-induced economic discontinuity means that you and your business will find that "the rules have changed." You will discover that management tactics that may have worked before may no longer have the same positive effect.

In revolutionary times like these, my very best advice is for you to be sure that you and your management team have a sound framework of understanding by which to analyze and interpret the new reality in which you find your enterprise. I strongly recommend the application of the highly rational and easily understood "Thinking Process" tools as developed by Eliyahu Goldratt.

Contact me!

(c)2009, 2010

World Class Manufacturing -- Really?

I found this quote on a Web site which will remain unidentified in this article:

World Class Manufacturing - A definition
World Class Manufacturers are those that demonstrate industry best practice. To achieve this companies should attempt to be best in the field at each of the competitive priorities (quality, price, delivery speed, delivery reliability, flexibility and innovation). Organisations should therefore aim to maximise performance in these areas in order to maximise competitiveness. However, as resources are unlikely to allow improvement in all areas, organisations should concentrate on maintaining performance in 'qualifying' factors and improving 'competitive edge' factors.... The priorities will change over time and must therefore be reviewed.

The author here identifies six "priorities":

1. Quality
2. Price
3. Delivery speed
4. Delivery reliability
5. Flexibility
6. Innovation

I would contend, however, that none of these 6 priorities may be achieved without setting the organization's primary focus on making money -- making money both today and in the future. Without making profit the first priority, there is no money to spend on improving quality; there is no money to spend on improving the speed or reliability of delivery; and there is no money to spend on improving flexibility or innovation.

One might say, "Well, if we improve quality, we will make more money." But unless the framework for the planning and focus of the organization has demonstrated by a rational method that improving quality will lead to improved profits, then that statement remains only a "hope" and not a plan or a true "goal." The same may be said for the other five "focus" points in the article.

If the manufacturer has no sound framework by which to determine precisely what steps it must take beginning today to increase its profitability -- to make it more effective at making money -- there is a chance it may not survive long enough to work on any of the six "priorities" listed above.

"Without theory there is no knowing." -- W. Edwards Deming

Having a valid theory -- a consistent "framework" -- by which to evaluate all that transpires within your business is critical to constancy of purpose and effective leadership by management.

Contact me!

(c)2008 Richard D. Cushing

Increasing Your Cash Velocity

Cash velocity is related to cash flow and in tough economic times, nothing -- and I mean nothing -- is more important to the health of a business than cash flow. Most organizations cannot survive if they run out of cash. In essence, an organization with a good cash flow is a healthy organization and an organization with a bad or declining cash flow is at risk.

The Cash Velocity value measures how rapidly your business generates cash. The Cash Velocity of your organization is a good one-stop metric on your business' health because it includes so many important factors.

Here is the way we would recommend that you calculate your Cash Velocity (CV):

CV = Throughput / Cash-to-Cash Cycle Time

where:

• Throughput = Revenues minus TVC (truly variable costs)
• TVC or Truly Variable Costs are those costs that are directly proportional to your revenues and, in a manufacturing operation (for example), would typically include raw materials and outside processing costs, but would not include labor or overhead since labor and overhead do not vary directly with the number of units produced.
• Cash-to-Cash Cycle Time is the average number of days it takes from the time you pay out cash to a vendor or supplier for raw materials or outside processing until you collect from your customer for a resulting finished good. The chart below shows how this cycle may be understood.

The Cash Velocity metric is, as a result, stated in terms of "Throughput-dollars per day."
As stated above, this consolidated metric is influenced by a number of factors upon which management may take action for improvement:

1. Increasing Throughput - This may be done by either increasing revenues or reducing truly variable costs. Revenues may be increased in the aggregate (more sales) or by increasing prices (where the market will bear it and the net result will not actually be reduced aggregate revenues).
   
2. Decreasing the Cash-to-Cash Cycle Time - This, too, may be addressed in multiple ways:
   
   a) Reducing Inventories will mean that goods will sit a shorter period of time in either raw materials, WIP, or finished goods inventories before they are shipped to your customers.
   
   b) Changing the terms of your sales (reducing the days between shipment and receipt of payment from your customers where the market will bear such a change).
   
   c) Accelerating collections (if you have a significant number of customers that delay payment beyond your terms).
   
   d) Shortening your manufacturing cycle time (if possible).
   

This metric may be further refined so that you are not evaluating your organization as a whole. Instead, you may look at Cash Velocity by product line, for instance, if there are significant differences in how your product lines behave. There is a big difference between a product line that produces $1 million in Throughput on a 300-day cash-to-cash cycle ($3,333 Throughput per day) and another product line that produces $800,000 in Throughput with a 90-day cash-to-cash cycle ($8,889 Throughput per day). Clearly, the latter is "healthier" for your business even though the total revenues may be lower.

Email me.

©2008 Richard D. Cushing

Extending the Power of Your Information Technologies

In today’s exceedingly challenging business environment, it is becoming increasingly important for executive management to establish corporate strategies that include extending the reach and power of the organization's information technologies beyond the four walls of the firm. If your company is not building "communities" of customers or con-necting with your vendors and customers in real time up and down your supply chain, then it is likely that you are falling behind your competition.

No Technology for Technology's Sake

I am not advocating new "gee-whiz" connections beyond your enterprise just so the CEO can brag about them on the golf course or in the steam room at the club. Before embarking on a spending spree to extend your IT systems beyond the walls of your enterprise, it is important that you determine what you want to accomplish by moving forward with such efforts. Generally speaking, the valid reasons for investing in the extended enter-prise may be reduced to three fundamental categories:

1. Increasing throughput,

2. Reducing inventories or the need for new investment, and

3. Slashing or holding the line on operating expenses.


Let's consider some of the thinking that might go into such an analysis.

Increasing Throughput

When considering increasing throughput, your team should ask questions like these: Could a CRM (customer relationship management) system, a corporate blog or forum, or other enterprise extensions improve our ability to connect with our customers? Could such efforts improve our comprehension of our customers' needs enough that fresh new insights would result from understanding them better? Could the new insights lead to improved products, enhanced market segmentation, and the ability to create superior win-win offers?

If the answers to any or all of these questions are affirmative, then the next step would be to quantify the estimated impact and to set specific goals for any investments in new technologies. Each individual part of the IT investment plan should be directly correlated to expected quantifiable results. How many new customers will be added? How many additional sales to existing customers are to be expected? What additional market share are we likely to gain as a result of these efforts and investments?

Reducing Inventories or the Need for New Investment

The questions that should arise regarding inventories or investments should be along these lines: Will improved supply chain visibility with our customers allow us to better manage and reduce the volume of inventory lying between our manufacturing plants and our products' end users? Will linking our inventory systems with those of our suppliers allow us to reduce lead times and, as a result, reduce the amount of inventory we keep on-hand? Will improved end-to-end supply chain linkages reduce losses due to obsolescence and shrinkage?Again, if asking these questions leads to some "yes" answers, then the organization should take steps to quantify the benefits that are likely to accrue to the organization from reduced carrying costs, managing and handling less inventory, and (if true) the reduction in a potential investment in additional warehouse or production space, for example.

Slashing or Holding the Line on Operating Expenses

Generally, this area faces a two-fold battle: First, most organizations today have already done all the cost-cutting that they really can (or should) do. This is no longer the 1980’s – the heyday of cost-cutting as U.S. industry was struggling against the onslaught of Japanese products. Second, when you are talking about implementing new technologies, it is really difficult to get buy-in from your organization if the move is likely to lead to a significant reduction in the workforce.
However, results stemming from efforts to increase throughput (revenues) and reduce inventories are likely to drive growth, on the one hand, and internal improvements, on the other. Normally, then, a case can be made on the basis of these combined factors (i.e., growth and internal improvements) that your organization can support 30%, 60% or even 100% growth in the near future with little or no growth in operating expenses. The net result is often estimated and stated as savings in FTEs (full-time equivalents, i.e., the average cost of a full-time employee). In this way, the effect of “holding the line on operating expenses” may be properly factored in to the benefits accruing from investments in new technologies.

Conclusion

There is no longer a place for business as usual. In today’s highly competitive markets – driven to a significant degree by the international reach of the Internet and other technologies – every business owner, CEO, and CFO should be considering how extending their information technologies beyond the four walls of their enterprise might lead to in-creasing throughput and reducing inventories, while holding the line on operating expenses. However, every investment in technology should be carefully planned, be geared to achieving measurable goals, and fully aligned with the enterprise’s strategic and tactical objectives.

©2008 Richard D. Cushing

Information Is Not Knowledge

"Information is not knowledge. Knowledge comes from theory."
-- W. Edwards Deming

When Sir Isaac Newton was conked on his head by the falling apple (as the story goes), he had information. The information was, "apples fall from trees" or, put more generically, "things fall to the earth."

However, Newton still had no "knowledge."

Newton's comprehension of the facts did not provide "knowledge" that would be useful in any significant way. After all, people had known for centuries that things fall to the earth and, if one didn't want them falling to the earth, one must be certain that the objects are held securely in their present location.

Once, however, Newton began to construct "theory" around the fact that things fell to the earth, valuable "knowledge" began to spring from the "information" at hand.

For example, based on the "theory" that gravity was a force that always acted in precisely the same way, experiments could be set up to measure just how gravity functioned. From these experiments and calculations, we now know that the gravity of the earth accelerates objects at ~ 32.2 feet per second-squared.

This principle applies in business as well.

Having worked in the world of business management and computers since the time of the introduction of the personal computer (PC) in the early 1980s, I have found that many, many business people -- from owners, to CEOs, to CFOs, to middle managers, and on down the line -- confuse "information" with "knowledge". In fact, a very common fallacy is the belief that more "information" will lead to better management which will, in its turn, lead to better results.

Therefore, organization spend a considerable amount of some very limited resources (namely, time, energy, and money) acquiring or creating systems to give them more "information."

When all is said and done, however, these business folks often are not significantly better off than they were before they spent their precious time, energy and money, simply because, like the world before Newton, they have no "theory" by which to interpret the information they have. Without this theoretical "framework" in which to fit their body of information, many of their management actions are not much more than flailing at the wind. Some of their efforts work and some do not, but they generally cannot tell you (specifically or accurately) why one initiative worked and another similar one failed.

There are three required steps to gathering what one needs to take timely and effective action:

1. One must take the data (the raw, undigested facts -- perhaps line upon line of numbers) and convert the data into "information."

2. "Information" is data "digested" and put into a form (i.e., a chart, a graph, summed, analyzed statistically) that allows the user to quickly assess the essential implications of the underlying data.

3. The resulting "information" must be placed into a theoretical context -- a "framework" -- whereby the potential outcomes of any actions that might be indicated by the information may be fully comprehended.

Without these three steps, your organization may drown in data or become infatuated with "information" and, yet, never be able to move effectively when times are the most challenging.

©2008 Richard D. Cushing