Aug 22, 2024 | Collaboration, Communication, Governance
Throughout history, humans have existed in small groups, tribes, and clans. We have worked together for the common good of the small tribe, and often, perhaps most often, been at odds with the tribe across the river.
British anthropologist Robin Dunbar introduced his theory that humans can maintain stable social relationships with no more than 150 people. This is a theory now so well accepted that ‘Dunbar’s number‘ has almost become a cliché.
The phrase ‘Stable Social Relationships’ has particular relevance in the age of social media platforms. How many friends do you have on Facebook, connections on LinkedIn, followers on Instagram?? For many, it is way beyond 150, often into the many hundreds, and often thousands.
How do you maintain Stable Social Relationships’ with that number of people?
Answer: you cannot.
Social media gets the blame for all sorts of things, rightly so, but it is not the fault of the platforms, it is the fault of evolution.
Our application of technology has run way ahead of our evolutionary capacity to manage it and retain the relationships that made us the most successful species ever.
It seems to me that the growth of private messaging, reversion to personalised even hand written notes, and emotional engagement of ‘Local’ things is a response to the ‘platformisation’ of our social relationships.
I think it is a trend that will continue and grow.
The power of social media platforms will slowly erode as more one to one enablers incrementally retake the ground lost. In the process, we humans will build up ‘evolutionary resistance’ to their power.
I do however see some hurdles in the way, the dark side of social media is as powerful as ever, and Dr Dunbar has little advice on that score.
Header cartoon credit. Lynch. (I have no idea where I found it)
Aug 16, 2024 | AI, Governance, Strategy
AI is the newest, shiniest thing we have seen since, well, perhaps ever, at least in the speed with which it has overtaken consciousness.
ChatGPT was released to the ‘wild’ in November 2022. In commercial terms, yesterday.
In that time, it has overtaken discussion, business planning, capability questions, and profoundly changed the face of stock markets.
An amazing outcome for a technology without a business model.
The committed AI infrastructure spending over the next year by the big 5 LLM builders, OpenAI, Amazon, Microsoft, Amazon and Google is over $200 billion. Depending on your sources, this might vary a bit, but may even be on the low side. It does not count the billions being spent by everybody else, largely on setting about leveraging the ‘infrastructure’ delivered by the LLM’s.
Again, depending on your sources, the revenues being generated over the next year by AI suppliers, both of the infrastructure and tools rapidly becoming available is probably $20 billion.
Nowhere in history has there been a tsunami of investment of this size and speed in the absence of a solid business model. There is no clear way forward to generating a return on that investment.
This is the equivalent to a goldrush, except, in a gold rush if you were the lucky one to find those elusive nuggets, you had some idea what they were worth, and an established way of monetising the metal.
Nothing of the sort exists with AI.
I have done plenty of capital proposals in my time, some with forecasts that bordered on the wildly optimistic because I believed a change of some sport would be generated by the object of that Capex. In my wildest dreams, I have never proposed anything like the ratio of capex to current revenue exhibited by this investment.
There is confusion around the term ‘Trillion’. Historically, the US and UK definitions differed, the UK version being 10^18, 1,000 times larger than the US trillion which is to the power of 12, or one million million. I explain this for clarity and comparative purposes.
On current stock market valuations (August 2024) Nvidia, a business few had heard of a year ago, is the most valuable company on earth with a valuation of US3.2Trillion. They trade places regularly with Apple for the No. 1 spot. Currently Apple is number 2, also at a rounded 3.2 trillion, but a few tens of millions behind Nvidia. Microsoft is third with 3.1 trillion, followed by Amazon at 1.9, and Meta at 1.3. The comparison I wanted to highlight is with the GDP of Australia, of US1.7 trillion. Australian GDP is just over half the market valuation of Nvidia and Apple, a sobering thought.
An investment of 200 billion against current revenues of 20 billion is simply the biggest financial gamble in the history, by a logarithmic amount.
The people running these massive businesses are not stupid. They see and are betting their companies (and they are ‘their’ companies, as control is in a very few hands) on massive returns, which means in turn that the fabric of everything we see and do must change, very quickly. The business models will change, and they will not be just everybody subscribing for modest monthly amounts to the latest LLM model. There will have to be whole new industries being ‘invented’ with successful business models in place for there to be a return on the capex being deployed.
The windows of opportunity that will open, and close just as quickly, over the next decade are immense.
No wonder there is a gold rush, it is just the location of the gold still in question.
Aug 14, 2024 | Analytics, Marketing, Sales
There is lots of talk, often sales-hype from digital urgers, about Lifetime Customer Value. When applied correctly, it is a vital measure, but when you look closely, it often means lifetime customer revenue.
Revenue is of little commercial value in the absence of margin, so the discussion can be completely misleading.
Understanding the margin generated by customer segments, or in some cases, individual customers is an immensely valuable metric that enables you to focus resources where there is the most benefit to the enterprise. You can make informed tactical choices with a great level of confidence based on the margin delivered.
Customer margin is also an enormously useful metric elsewhere.
Sales people are often rewarded on revenue, which can be gamed. Margin over time is much harder to game, and a far better measure of the effectiveness of a salesperson in delivering value to the enterprise while serving customers.
Similarly, calculating the cost of acquisition of a customer gains traction when measured against margin rather than revenue.
One of my clients businesses relies on referrals as a source of business. Increasingly they are moving towards margin on converted referrals as the single metric that best measures the impact of their marketing and product delivery efforts.
You cannot generate margin in the absence of revenue, but you are easily able to generate revenue without margin. Not a good idea!!
As an aside, also beware of the difference between margin and mark-up. They are similarly often used to mislead the unwary.
Aug 12, 2024 | Change, Strategy
2024 is very challenging for SME’s.
It is proving to be a time of an unusually high rate of SME mortality. This is driven by the problems that emerged with the Corona virus, followed by a period of historically low cost of capital, then a burst of inflation now being wrung out by aggressive rises in interest rates, the wars in Ukraine and Gaza, uncertainty of supply chains, and a host of other items.
It makes sense for every business owner to consider the value of their business. While having an exit plan is always a good idea, few are proactive in creating one.
While you may not be considering selling any time soon, (or going broke) it remains a valuable exercise to uncover the drivers of value, and double down on them.
Following is my list of value drivers, in a rough order, which will vary with circumstances and conditions in any specific market.
Cash flow.
Managing cash is the single most important thing every business can do to ensure survival, after looking after your customers. Cash is not subject to accounting rules, conventions, or differential tax treatment, as are the P&L and Balance sheet. You either have it or you do not.
Calculating free cash flow, the cash left over after capital expenditure over time, gives an extremely sensitive view of the health of a business.
Happy and committed customers.
You can make customers happy by giving discounts, but that is not a good measure of value. A committed customer will be prepared to pay at least the going rate for your products, and will not be moved by short term incentives from a competitor. Two of the best measures are Share of wallet and customer churn.
How much of a customer’s spend on a category you could supply, do you supply, and what is the ratio of customer loss and gain that is occurring. Committed customers will also be happy to refer you to others, simply the best form of marketing there is.
Customer & supply chain diversity.
‘Don’t have all your eggs in the one basket’ is a dictum that has proved true time and time again. Businesses that allow one customer to become more than about 25% of their revenue are dicing with trouble. In the event that customer goes broke, changes personnel at the top, gets taken over, or a myriad of other things that can happen in commercial life, you can find yourself out in the cold. This is the structural problem facing Australian suppliers to FMCG.
It is the same in your supply chains, but in reverse. Every business wants to be a dominating force in their supply chains, to be able to exercise some level of control. The pandemic has shown us how fragile our supply chains are, so resilience has become a key KPI for many who were previously reliant on single sourcing and JIT supply.
Differentiated in ways hard to duplicate that customers value.
Charlie Munger often spoke about building ‘Moats’ around his businesses. We all understand that a moat is a structure that repels invaders, in a commercial case, competitors. It is a lovely metaphor, and works irrespective of the scale and type of your business.
You build moats by being able to create customer value that competitors cannot or choose not to match, and if they try, their resources are consumed by the power of the Moat. This sort of protection is rarely a function of just one element, in the metaphor, the height of the moat wall and depth of the water. It is always a combination of many contributing strategic and tactical measures.
‘Tide’ detergent in the US retains 50% market share of the washing products market. Any quick look would indicate it to be a commodity market. Anyone with the right gear can make a detergent that does a good job, so how has P&G retained this share? It is a combination of time, disciplined brand building tactics, consistently very good advertising, continuous innovation, and an ability to ‘shape’ the market by being strategically smarter than everyone else. These have delivered first mover advantage continuously to P&G as the ways Tide delivers value to consumers have evolved.
Defined Process maps subjected to continuous improvement.
Imagine a potential buyer comes into your business with a serious intent to consider purchase. Anything you can do that reduces the level of uncertainty that they will feel about the value of your business to them is worth doing. If a buyer sees that business processes are mapped, consistently applied, and the subject of continuous improvement, it will be immensely reassuring. Such an environment will remove a significant source of uncertainty and risk.
Revenue Predictability
Revenue predictability is gold. Forecast accuracy drives not only sales up, but operational costs down, and revenue generation activity more directly connected to results, and therefore accountability.
Over the last 20 years, the nature of revenue has changed from one driven by sales, to one driven by subscription. Once you have a customer ‘signed up’ to some sort of process that delivers revenue automatically, they are both more likely to spend more, as they have a sunk cost to recover, and less likely to leave.
Amazon Prime is the most effective subscription model ever seen. Currently Amazon prime has 170 million subscribers in the US. For $14.99 monthly or annual subscription of $139, subscribers benefit from a range of ‘free’ services from across the Amazon ecosystem. Numbers vary, but solid research puts prime subscribers buying up to 4 times as much on Amazon as the average non subscribing Amazon buyer, up from around $500/year to over $4,000. Not bad when you can also manage the margins they are buying at, and have already banked $11 billion in advance.
My local coffee shop has a loyalty program, the 11th coffee free, so I tend to buy from them when it is convenient to do so. If the situation were reversed, and I had paid a membership up front in order to get a discount, the incentive to go there would be significantly stronger. Amazon Prime has harnessed this basic psychological driver to generate billions of dollars.
Having a clear set of robust leading indicators of revenues, margins and profit, offers certainty to any buyer of your business, as well as to you. They also offer the explicit platform for improvement.
Focus
To optimise your business, and thus enhance its value, it will pay to focus aggressively on the areas where you have some sort of competitive advantage that can be leveraged. This always come down to trimming product ranges, brands, geographies, technology bases, and market segments aggressively. While the analysis is tough, and the choices even tougher, you will inevitably find that the pareto rule applies, and aggressive application drives profitability. A mantra I use with clients is ‘Pareto the Pareto’, suggesting that this optimisation is a continuous process.
Clean books
Using the business as an ‘ATM’ for the owner is a danger sign for any buyer. When preparing your books for the inevitable Due Diligence examination by a potential purchasers accountant, the less items that are up for deeper examination the better. Ensure you have a ‘normalised‘ P&L available for scrutiny that identifies and explains or excludes all the items that may draw a question. Similarly, many SME’s claim to have some component of cash transaction in their business. Expect those claimed transactions and resultant cash to be completely discounted by a potential buyer as a source of value.
Steady growth history
Any potential purchaser is only looking at what you have done in the past, as an indicator of what might be possible in the future. They are only interested in understanding the future return on an investment they might make in your business. Therefore, a history of growth will be an indicator that all things being equal, there is evidence that the growth that will benefit them will continue. Growth that is relatively smooth is always better than growth experienced in fits and starts in the eyes of a buyer.
This applies equally to all financial and non-financial measures.
A strong management bench
Across functions, you need people willing and able to step up as you expand. A balanced and robust bench with solid succession planning through all levels is a hedge against the uncertainty that accompanies an acquisition, and benefits the value of the business.
An obvious culture.
Every business has some sort of culture, the ‘way we do things around here’. A consistent, explicit, and aligned culture that is aimed at delivering a well understood strategy is like cheese to a mouse: irresistible.
None of these are easy to address. If they were, the mortality rate of SME’s would be less than it is.
