Sep 18, 2024 | Analytics, Governance
Economic Value Added, EVA, is another of those annoying acronyms accountants tend to use to confuse simple marketers. Therefore, it is a term marketers must understand if they are to hold their own in the boardroom.
EVA is a calculation used to measure the net cash flow from an asset, after taking into account the cost of the capital necessary to acquire that asset. It is often a part of a business case made to support a major investment or M&A proposition.
There are a couple of calculations that need to be made, all from the standard company accounts.
- The net cash flow is obvious, what comes in versus what goes out, as a result of deploying the asset.
- The cost of capital will be some combination of the cost of equity and the cost of necessary borrowings.
When the net cash flow is greater than the cost of capital, the asset is generating value. When it is less, it is destroying value.
The formula is simple: EVA = Net cash after tax – capital invested X the weighted cost of that capital.
The shortcomings of an EVA calculation are twofold:
- It is based on the past. The cost of capital yesterday is unlikely to be the same tomorrow. Interest rates bounce around, and the mix of debt and equity while not as volatile does change with circumstances.
- Increasingly business transactions are being done on the basis of intangibles. Costing the replacement value of intangibles, is a practise lacking discipline, consistency, and financial rigor.
Building a business case for an investment always requires deep consideration of the cash flow results of that investment. By definition, that requires a forecast of the future be done as the driver of that cash flow.
It is always easier to take the past and extrapolate, than to spend the time and energy building a strategic case for an investment. A strategic case requires that the relative costs and benefits of differing choices be articulated, in an environment of information scarcity. A much more demanding task than constructing a future that is the same as the past, and hoping that this time, it will be.
Header illustration by AI, in a few minutes.
Sep 9, 2024 | Governance, Leadership, Strategy
Amongst the tsunami of gratuitous advice on the web about how to manage remotely, whether you be the team leader, or a team member, there is a critical piece missing.
Depth of strategic thinking.
Regular and managed team video gatherings, as well as a range of individual catch ups for assistance, follow up, mentoring, and all the other things that go on, are tactical.
Particularly in times of crisis and high stress, it is sensible and natural to focus on tactical execution. However, tactical can only take you so far, and in the absence of a strategic framework, can lead you astray quickly.
Consider breaking out specific sessions for the discussion of the strategic issues and questions that emerge. They remain in place irrespective of the current crisis, whatever that may be.
Strategic depth is not something generated in a series of quick meetings. It requires data, forecasts, scenarios and deep discussion and contemplation by people who know the box from the outside, as well as from the inside.
These deeper questions of strategy usually reside in the ‘very important but not urgent‘ basket. In the absence of being addressed, they will be forgotten. Worse still, they will be over-ridden by short term tactical outcomes that would not have been allowed to evolve with sensible strategic oversight in place.
We are social animals, our best work is done when people get together, and together look to solve problems and pressure test assumptions. This takes time and human engagement. Verbalisation of ideas, questions, and explanations is only a small part of ‘Communication’. Face to face, there are a myriad of non-verbal nuances and contextual contributors to ‘communication’ that are lost over Zoom or Teams.
Failing to accommodate these human interactions will destroy your capacity to generate the insight necessary for deep and productive strategic thinking.
Header credit: Tom Fishburne at Marketoonist. Thanks again for encapsulating a difficult idea in a cartoon.
Sep 6, 2024 | Governance, Leadership, Strategy
Opportunity cost.
The mistakes you make of Commission are the ones by which performance is judged. They show up in a profit and loss and balance sheets of businesses. However, when you pass up a golden opportunity that turns out to be a winner, that ‘cost of potential profit’ does not show up anywhere.
It is a mistake of omission, not commission.
Those of us who failed to buy Apple shares when they were less than a dollar in 2003, and similarly, NVIDIA shares when they were $1.30, might see a missed opportunity. Both now trade at well over 100 times those prices.
However, such mistakes are acceptable when the opportunity is outside what Warren Buffett calls a ‘Circle of competence’. This is the area where you have the expertise to understand the opportunity being offered, but fail to accept it.
In the case of Apple and Nvidia, they are both outside my circle of competence. Therefore, I did not know enough to recognise the opportunity. Had I been immersed in the IT industry it might have been clearer.
Buffett’s seven rules for successful investing, summarised, are:
- Hire only intelligent people with integrity.
- Pay attention to facts, not emotions.
- Buy wonderful businesses, but not ‘cigar butts’
- Buy only stocks you understand.
- Seize the opportunity.
- Don’t sell because of price fluctuations.
- Buy stocks below what they are worth.
Passing up an opportunity that turns out to be something you should have grabbed, with the benefit of hindsight, means you have failed to give yourself an adequate answer to one, or more, of three simple questions.
- How much cash would the opportunity deliver to you?
- When are you going to get it?
- How sure are you?
Buffett and his late side-kick Charlie Munger are widely seen as geniuses. I suspect Mr Buffett would be embarrassed by that label. He might respond that all he did was follow the simple 7 rules, something most cannot do.
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.
Jul 15, 2024 | AI, Governance, Leadership
In a world dominated by discussions around AI, electrification to ‘save the planet’ and its impact on white collar and service jobs, the public seems to miss something fundamental.
All this scaling of electrification to replace fossil fuel, power the new world of AI, and maintain our standard of living, requires massive infrastructure renewal.
Construction of that essential electricity infrastructure requires many skilled people in many functions. From design through fabrication to installation, to operational management and maintenance, people are required. It also requires ‘satellite infrastructure’, the roads, bridges, drivers, trucks, and so on.
None of the benefits of economy wide electrification and AI can be delivered in the absence of investment in the hard assets.
Luckily, investment in infrastructure, hard as it may be to fund in the face of competing and increasing demands on public funds, is a gift we give to our descendants.
I have been highly critical of choices made over the last 35 years which have gutted our investment in infrastructure, science, education, and practical training. Much of what is left has been outsourced to profit making enterprises which ultimately charge more for less.
That is the way monopoly pricing works.
When governments outsource natural monopolies, fat profits to a few emerge very quickly at the long-term expense of the community.
Our investment in the technology to mitigate the impact of climate change is inherently in the interests of our descendants. Not just because we leave them a planet in better shape than it is heading currently, but because we leave them with the infrastructure that has enabled that climate technology to be deployed.
Why are we dancing around short-term partisan fairy tales, procrastinating, and ultimately, delivering sub-standard outcomes to our grandchildren?
Header illustration via Gemini.ai
