The 3 terminal characteristics of 20th century accounting.

Dec 11, 2019 | Governance, Management

 

Accounting as generally taught at university, at least when I did it many years ago, and by observation since, does  not suit the 21st century.

It has served us well for centuries since the double entry system evolved from 15th century monk and mathematician Luca  Bartolomeo de Piccioli, and has not changed much since. Alfred Sloan who was CEO of General Motors for 23 years between 1923 and 1946, created what we would see as modern cost accounting, as he drove GM to be the biggest company in the world in his time. However, the context in which accounting is now used has again morphed into something completely different. Accounting practise has not followed quickly enough in 3 very fundamental ways.

It does not recognise a company’s most valuable assets.

The three fundamental parts of an accounting package are the Profit and Loss account, Balance Sheet and Cash flow statement. Together they offer what has been seen as the basis of analysis of the value of an enterprise, and forms the backbone of all management and reporting systems.

Why is it then that the value of many businesses as represented by their balance sheet, bears no resemblance at all to the valuations placed on them by the market?

Value in most enterprises now resides in ‘intangibles’, largely absent from the balance sheet because of the measurement difficulties. Intangible assets often walk out the door at 5.30, and have the confusing characteristic of being able to appreciate with use, unlike physical assets that depreciate.

A balance sheet, which records physical assets owned by an enterprise, is unable to adequately make this leap to intangible assets in preference to the easily measured physical assets, once the backbone of a valuation, but no longer. The occasional exception to this paradox is of course when a business is sold, or changed in some significant way, and an amount labelled ‘Goodwill’ can be added to the balance sheet. This amount rarely passes the ‘pub test’ and in any event, as the business has usually been sold, it is too late to be of any value to the now previous owners. 

Financial reports only the dollar outcome of asset deployment, not the value outcome.

I recall the zeal with which Michael Hammers book ‘Reengineering the corporation,’ published in 1993, was embraced by corporate management. They proceeded to outsource everything that was not  considered ‘strategic’ in the race to deliver ever increasing returns on net assets, a key measure for investors and analysts, driven by short term considerations. In the process of outsourcing, they failed to recognise the seemingly minor items that cumulatively delivered the value their customers were prepared to pay for.

The classic case is that of Dell Computer, who built a massive company quickly by redrawing the business model of PC sales, and then went public. This made Michael Dell a billionaire, but in the process of maintaining their impressive returns  upon which the IPO had been based, progressively outsourced their design, procurement, and manufacturing processes. Korean company ASUS became their primary supplier, then taking what they had learnt, turned around and became a competitor, leaving Dell without the operational capability to compete.

Listening to those working with the financial reports led them down this path, when they should have known better. After all, it was them that disrupted the previous manufacture/distributor model in order to maintain control of their own destiny, which they then gave away.

Accounting systems cannot tell the future

We are notoriously bad at telling the future, nor can it tell us what has not happened. About all we know is that it will be different to the past,  yet we accept an enterprise valuation that is a multiple of past cash flows. We also accept the numbers delivered as an unchangeable  fact, that gives us little scope to record the savings made by removing transaction costs and the hidden costs of waste in every system. Those deploying lean accounting systems are setting out to identify those cost savings, and recognise them, but the irony is that they need two sets of books. The traditional set, into which the lean accounting is back flushed to meet the accepted accounting standards, and the Lean books that identify the outcomes of actions taken to improve the processes that drive the costs of waste out.

The businesses that thrive in the 21st century will be assisted by the recognition of the paradox presented by the statutory accounts compared to ‘lean’ operational accounts, and effectively manage the inherent conflicts.

 

Cartoon Credit: Scott Adams and Dilbert, who bravely faces interrogation by accounting. Dilbert seems to be ever more common as the header to this blog, is it that I am getting older, or that Dilbert after 25 years is becoming even more relevant? 

 

 

 

How to think critically about your essential investments in marketing

Dec 9, 2019 | Governance, Marketing, Strategy

 

Marketing is almost always seen as an operating expense rather than an investment in the future.

This reality poses an absurd paradox.

We treat investments in capital equipment for our businesses, and various financial instruments for our own wealth generation,  as items on a balance sheet. By contrast, we treat marketing investments, and particularly those made in various forms of communication, as discretionary items recorded in the profit and loss account as an expense.

Why do we make this distinction?

Both forms of investment have as their motivator, the generation of future cash flow. Just because it is a bit harder to calculate the return on marketing investment than it is to calculate the return on an investment in capital equipment, or financial instruments, should not be a deterrent to the effort.

Nothing is more critical to the long term commercial health of an enterprise than the investment in marketing. What could be more important than identifying, communicating, creating transactions and building relationships with customers, that generate future revenue and cash flow?.

There are 3 basic strategies considered by financial investors

Index investment.

This is a passive, low cost, average but relatively safe return strategy, sticking to stocks that reflect the particular index against which the performance measures will be applied. The most usual are the S&P and ASX 200 indices.

Arbitrage investment.

Essentially this is a short term strategy that assumes the investor is smarter than the market, able to recognise mispricing before anyone else, and their IT programs. It involves a lot of buying and selling of stocks, and often commodity contracts, essentially bets on the short term movement of price. Over the long term, there is plenty of research around that indicates that the performance is around the major stock indices. This is also a high cost strategy, in that the constant trading incurs transaction fees, usually not included in the published performance metrics.

Value investment.

Investing for value is a strategy that involves taking a long term view of the businesses in which you invest. This means you engage deeply, not just with the numbers, but with the management and culture, as well as taking a view of the marketplace in which they compete. It is a ‘filtering’ strategy, one where a lot of research boils down the potential targets to a very few, in which you take a significant position. It is a focussing of resources at the specific points where you see there is long term returns available, and are prepared to accept the vagaries of the short term focussed market gyrations.

If you apply a similar frame to the manner in which businesses make investments in marketing, there is a remarkable similarity.

Index marketing.

Doing what everyone else is doing, being average, a follower, and risk minimiser. It also ensures you do not stand out from the crowd, which in a cut-throat marketing world means nobody notices or cares about you, so perhaps you should save your money.

Arbitrage marketing.

Those following this strategy are just applying tactical actions to situations they see, there is no underpinning strategy, just advertising and promotion, usually driven by a budget that has to be spent, and KPI’s that measure the activity, rather than the harder to measure  outcomes of the activity. The driving word is ‘campaign’. A string of tactical activities will be seen as a campaign, and usually there is little flow from one campaign to another. This tendency has been accelerated to stupid proportions by digital, where the cycle time of a campaign, limited as they have been, has reduced from months to days. No longer are we looking for the strategic ‘big idea’ that will engage and motivate customers over a long period, we are looking for 10 ideas for the Facebook and Instagram posts in the next 24 hours.

Value marketing.

Successful marketing requires a solid strategy, well executed with a long term perspective. Over time, you will fiddle with the details as you become more familiar with the minutiae involved, and you fine tune the application of funds as you learn, but it is a multi-year commitment, not a 6 month campaign, and certainly not a few ‘cat photos’ on Instagram. Such ‘cat photos’ may be a tiny part of the tactical execution, but are never a component of the strategy. This takes time, resources, and most importantly, a laser focus on what is important to  the selected group of primary customers. Over time, you communicate your value proposition that defines why they should do business with you, rather than someone else, and do so at a price that delivers you a premium return, while delivering them premium value.  Then you retain their business, increasing your share of wallet, innovating, reducing customer churn, all of which delivers sustainable cash flow.

If any of the above arguments holds true, then it must be that the measures we use to make decisions about our financial selves should be able to be adapted to the investments we make in marketing.

Step one is to see it as a long term investment in prosperity, and not a short term expense to be reported and forgotten, hidden in a monthly P&L.

Step two is to have a robust, well thought out strategy, that is able to optimise tactically in real time.

Step three is to implement and learn relentlessly, seeking the elusive cause and effect chains that must exist between marketing activity and cash flow.

 

Cartoon credit: Scott Adams and Dilbert reflecting on investment strategies.

 

 

 

Where to now for the bashed-up dairy industry?

Nov 12, 2019 | Governance, Strategy

 

There is an awful lot of hand-wringing going on amongst politicians, bureaucrats of various types, and industry pontificators about the state of the dairy industry. Sadly, it has been going on for as long as I have been an observer, which is a long time!

The current drought has been a disaster for the industry, but is not the cause of the long term decline. For 30 years, smaller family farms all over the place have been going to the wall, and those left are mostly just surviving as a result of the margin squeeze, caused by concurrent cost increases and downward price pressure, as well as short term thinking and often mismanagement throughout the supply chain.

This is not a recipe for long term industry health.

25 years ago I was booted out of a senior role in one of the largest businesses in the industry. I had consistently voiced disapproval of industry policy (this was before the inevitable de-regulation in NSW) and of some aspects of the management of my employer. They were as sick of me, as I was of them, so there I was, after a decade of delivering growth and profit, on the footpath with a young family.

After a frustrating search for another job, I emerged as a strategy consultant, never again to be required to act against my best instincts and experience.

Very recently I was asked to prepare a proposal for a body in the industry, and while I had little belief it would proceed, did some on the ground research to uncover the changes that had occurred in the 25 years since I had left active participation, upon which too base my recommendations.

Sadly, I could have almost written the list below 25 years ago.

The drivers of the industry have not changed much, nor has the lack of strategic response. Each factor has impacts on others, and the compounding impact has been significant, and probably terminal for most small operations in the absence of substantive and therefore unlikely change.  The reduction in numbers of family dairy  farm operations over the last 25 years leads to the conclusion that there will be very few, if any, left in another decade.

The list following is not weighted, or in any particular order.

Scale.

The big are getting bigger, sometimes vertically integrating through the chain, and the small are being squeezed out. This applies to all steps in the supply chain, farmers, processors, and retailers. In this environment, scale becomes the primary driver, delivering financial returns at the expense of other considerations. Product quality becomes ‘averaged’. The smaller operations cannot compete on price/cost, and do not attract a commercial reward for the higher quality they are able to deliver. A few have been able to find a niche that does value a superior product, but most have had no option other than to accept the price on offer, irrespective of costs incurred or quality delivered.

Capability.

Over a very long period we have hollowed out our scientific, management, and innovation capability in dairy, as well as allowing it to be taken into overseas ownership. The management focus of larger players is on international prices and commodity trading, rather than domestic demand responsiveness, market development and innovation. As a result, the whole industry has been commoditised. You can buy milk, a natural, nutritious product at your local supermarket for $1.10 a litre, while in the isle next door, water, virtually free from the taps sells for multiples of $1.10 a litre. A gross failure of industry and enterprise marketing, and not one that can be fixed with nonsensical regulation.

Financial depth.

Small farming operations do not have the financial capacity to expand beyond their dairy boundaries, and usually do not have the depth to even utilise existing technology to optimise current operations. This precludes both investing in potential productivity improvements on farm, and moving further into the supply chain to capture some of the value added margins that are potentially available.

Education.

The emerging generation of potential dairy farmers has nowhere to go to learn.  There is no longer any dairy education in Australia, which means that there will not only be a degradation of the management capability of existing industry participants, there will be no new blood coming in, and there will be no process or product innovation. This factor applies throughout the supply chain, but is particularly evident in dairying operations. There are a number of ‘cottage industry’ training courses around, such as cheese making courses. These only teach the ‘how,’ without any reference to the ‘why’ things happen. To a significant degree they also substitute for real education in the public mind, which makes it easier to close down the real education that has the potential to add long term industry value. Most of us would agree to the notion that education is a core foundation of long term success, and yet we have stood aside while it has been raped and thrown out into the street.

Scientific foundation.

The scientific base upon which all else is built has been discarded, not just degraded, discarded. Werribee, formerly the centre of dairy science is an uninhabited ghost-town, and as noted tertiary education in all its forms in dairy technology has been discontinued.  If I wanted my kids to do a degree in dairy technology, they would have to commute to New Zealand.

Food security.

Along with other parts of the food supply chain, Dairy has been sold off to international entities. We no longer control our own food supplies, the manufacturing capability is largely overseas, and local production increasingly in the hands of Multinationals who make decisions on their commercial needs, which are not necessarily aligned with the best interest of Australians.

Water security.

The current drought is a disaster but is not more than a nasty reminder that, in the driest continent on earth, we have allowed water security to diminish, and sub-optimal use to be made of the resource available. This impacts all aspects of primary production and has had a profound impact on the ecological and environmental management of the land.

‘Metro’ farming.

Dairy farming (and intensive farming generally) evolved close to population centres, often on the best land. That land is now more valuable as a short-term development opportunity than it is as a long-term producer of food, and so is largely sold off as ‘bedrooms’ to the population centres, pushing farming to more marginal and logistically costly areas.

Power.

Australia is a substantial net exporter of power, yet we have very high power prices by comparison to other developed economies. This is a failure of public policy over a long period. For dairy farmers, it has proved to be a real problem as they need a lot of power to drive refrigeration and their operational plant. Power costs alone are driving small operators out of the industry.

Survival mode.

Small farmers are in ‘survival mode’ working long hours for little financial return. This leaves little in the ‘kitty’, financial, time, or energy, to undertake the challenges of change on their own. They desperately need an infrastructure that supports and rewards their efforts. Rebuilding this infrastructure is not a short term ‘fix-it now’ press release response, it needs bipartisan political support across a number of  portfolios and geographies.

Demographics.

The average age of dairy farmers is now approaching retirement age (25 years ago it was 56 and it does not seem to have reversed). These people are retiring, selling the farms, and their children and grandchildren are not going to follow on. This loss of farming wisdom may seem minor in the scheme of things, but in the long term will diminish us all, as we try and address the increasing environmental challenges facing us.

 

The egg that is the dairy industry cannot be unscrambled, but there is some hope that a reasonable omelette can still be made. However the chefs seem to be out to lunch, and the apprentices do not know what to do, or how to do it. Only going right back to the basics, removing the politics of power and influence, of all types,  and rebuilding from the foundations up, has any hope of there being much more than a few corporate farms and the odd family with a couple of cows left in a few years.

13 Ideas to use analytics to improve the credibility of marketing investments.

Nov 10, 2019 | Governance, Marketing

 

Marketing is all about making assumptions about the future, and how your investment in marketing activity will enable you to deliver revenue and commercial sustainability.

Therefore, making informed assumptions then testing their validity as you implement, reassess and improve is a vital part of the exercise in investment optimisation.

CFO’s and CEO;s do not trust marketing: they are often seen as the makers of nice adds and suppliers of pens and mousepads to their children, they do not carry the credibility quotient of an analytical profession.

For a marketer, having credibility in the ‘c-suite’ is essential. You are seeking resource allocation decisions to be made on the basis of your best estimates of what the future holds, an imprecise exercise.

Therefore, tracking the performance of previous estimates, being transparent about those that did not work, while improving those that did,  is an essential part of building credibility.

Essential to continuous improvement of the returns from marketing investment is the ability to allocate scarce resources where they will deliver the most bang for the buck.

  • Shift revenue generating activity from low margin products to  those with higher margins. To do this you need to be able to segment revenues and margins by customers and product, as well as by actuals and percentages.
  • Focus investments in those larger opportunities at the expense of the smaller, maintenance ones. Unfortunately these are often the easier ones to ‘sell’ to the corner office, and it looks like useful activity so it is often the default. Explicitly dropping lower return projects in order to fund those with higher returns, and/or more strategically consistent outcomes builds credibility.
  • Increase investment in reducing customer churn, and increasing lifetime value. Recognising the costs of customer acquisition Vs the cost of retention explicitly, usually makes this an obvious strategy,  often ignored, particularly in commoditised markets.
  • Increase investment in attracting higher share of wallet for strategically important customers. Defining the depth and breadth of the ‘customer wallet’ usually leads to interesting debates that must be sheeted back to strategy, and where strategy is absent or thin, this debate throws a light on that situation.
  • Focus resources in the growing part of the portfolio where there is some level of product differentiation that customers value. As Warren Buffett has said often: ‘Price is what you pay, Value is what you remember’. Understanding the price/value trade-off your customers make is challenging, as there is so much inherent variation between customers and the context in which a purchase decision is made, but being able to articulate the quantitative parameters of those trade-offs builds great credibility.
  • Automate repetitive tasks while increasing the personal engagement at the close of the transaction cycle. The locus of power in the purchase decision has moved from the supplier to the customer by virtue of Dr Google. Potential customers no longer need sales reps, the most expensive part of the sales budget, to provide information, but customers still do often need the reassurance of another person to make the final conversion. Use your most expensive sales resource where you generate the best return from the investment.
  • Move into adjacent market areas, after demonstrating the risks and rewards of such a move.
  • Collaborations through the value chain to deliver leverage to your capabilities.
  • Increase investments in actionable marketing and market intelligence, and demonstrate the impact of good intelligence in the past.
  • Optimise high performing segments. Being explicit about the optimisation of current performance as a means to fund commercial sustainability builds credibility, and enables the more risky ventures to be supported by senior management.
  • Understand the customer journey and focus on the areas where conversion rates can be improved. Conversion rate dashboards are now relatively easy to set up and monitor in real time, and offer transparency and opportunities to improve by being tactically agile.
  • Increase investment in strategic account planning for strategically important customers. This may not always  be your biggest customers, it is those most aligned to your strategic aspirations, where a deepened relationship will deliver long term revenue sustainability.
  • Use the accountants tools, financial ratios, NPV and IRR, in your arguments, showing rolling results that give insights to the trends happening, and providing analysis that explains the trends.

 

Marketing will increasingly become the key  differentiator between success and failure in commoditising markets. Failure to build the credibility with the ‘c-suite’ necessary to make the long term investments in marketing required, will result in a shortened commercial lifespan.

 

Header cartoon courtesy of Tom Fishburne at www.marketoonist.com

 

 

6 ways leaders disrupt the ‘Lemming Effect’

Nov 4, 2019 | Governance, Innovation, Strategy

 

It is a confusing world.

On one hand, change is everywhere, and the pace of change is increasing as we watch. On the other, generating change in an organisation is really hard; we humans do not   like change, despite what we sometimes say. We are hard wired to resist it in the absence of a compelling reason, some set of circumstances that leaves us absolutely no option.

In the 50’s, psychologist Solomon Asch ran a series of ground-breaking experiments where he showed the power of conformity.

He shows a group of subjects two cards, one with three lines in it of different lengths, the second with a single line.  The question was, which of the three lines on card A was the same length as the line on card B?

He would go around the room, asking the question, and each person successively deliberately gave the wrong answer, until he got to the last person, the only real subject in the room. In an overwhelming majority of cases, the last person agreed with everyone else to the obviously wrong answer.

We are hard wired to conform, to agree with the group, to avoid being an outlier, even when the group is wrong; we still find it hard to do anything other than conform.

Evolutionary psychology at work.

Being outside the safety of the group, where cooperation added to the odds of survival, you conformed or you were expelled from the group, which meant you quickly ended up as sabre toothed tiger shit.

Not an attractive prospect.

There are not too many sabre toothed tigers left around, but the safety of the group is still a driving force in our behaviour, so we have to change the mind of the group.

  • Create a catalytic event. When confronted by a crisis, where the status quo has clearly failed to deliver, change is suddenly made easier to implement.
  • Identify the opinion leaders in the group; convince them, let them do your persuasion work for you. ‘Local’ networks and opinion leaders are very powerful as change agents. Conversely, they are in a position to block any change they do not like.
  • Identify a ‘keystone’ change, one that forces other changes, that that clearly demonstrates the value of wider improvements that can be achieved. Managing a manufacturing business as a contractor, we had an assumed  capacity problem, that necessitated long runs to inventory to service demand. The result was slow inventory turn, redundant stock that could not be sold, and excessive working capital, all problems stemming from the capacity limit. On analysis, the real problem was in the scheduling of the production process, which created a bottleneck at a key piece of machinery. This was solved by rejigging the timing and order of activities, changes that were strongly resisted by staff until a mandated trial clearly demonstrated the substantial productivity benefits that accrued.  This one  change led to significant improvement in almost all other productivity and financial KPI’s.
  • Create stories that the group members can relate to, that demonstrate the costs of no change are greater than the risk of change. The story related above took on a life of its own, as the staff involved rewrote history, by assuming the responsibility for suggesting and driving the ‘keystone’ change.
  • Have great clarity about the benefits of the outcome after the change, how it will be achieved, and the benefits it will deliver. Again, the story above had a knock-on effect through the business, as the results of the improvements were made very public, and credit given to the staff involved.
  • Embed the changes into the operating psyche of the organisation. Culture is elastic, and unless the binds of the past are comprehensively broken, they will spring back once the pressure is released.

Lemmings are persistent creatures, if not too bright. Put a barrier in place in front of the cliff, and they will climb it, unless there is an alternative path that is made to be more attractive in some way leads them in a different direction.

How are you disrupting the Lemming Effect in your enterprise?

 

Cartoon credit: Mike Keefe Denver Post.

 

 

The two things we have to achieve for our grandchildren

The two things we have to achieve for our grandchildren

Oct 31, 2019 | Governance, Leadership

Yesterday I listened to a hysterical condemnation of Woolworths, who had come clean to the Employment Ombudsman when they realised they had underpaid staff.

Another example of big business rorting workers, or more evidence of the impact of overwhelming complexity of a system causing self implosion?

Woolworths is the biggest private sector employer in the country, so it is reasonable to assume they have the will and resources to ensure employees are paid properly. On the other hand, with the complexity of the award systems, staggered and differing shifts, varied hours of operation, and the sheer number of people moving from one job classification to another, across locations, the complexity of the payroll must be staggering.  

Over the millennia, as we humans have become more ‘civilised’ and our social and commercial systems more sophisticated and complex, from the early Greeks through to today, there has been an increasingly delicate balance at play.

Varying supply systems and the bureaucracies that control them, deliver the means by which the surplus from our collective endeavours is distributed. While the cost of that complexity is less than the revenue generated, we continue to become more complex. Once we reach a tipping point, where the revenue generated is less than the cost of the management bureaucracies that enable it, we become pointed at shitters ditch.

Look at almost any part of the ‘management’ systems in a democracy. There are always competing priorities, with vocal advocates on all sides. The tax system, NDIS,  defence, social welfare, personal power Vs institutional power, and on, and on, and on. In Woolworths case, the responsibility to get employees pay correctly compliant with various agreements and regulations, while remaining in control of, and extracting maximum return from the biggest expense incurred in operating, is such a balancing act.

It seems to me we have reached if not passed the tipping point.

As Hemingway asks in the Sun Also Rises:

‘How did you go bankrupt?‘

‘Two ways:  Gradually, then suddenly”

Unless we find ways to address just two challenging items, we will continue to slide, as complexity increases, goals become more fluffy,  and accountability diffused .

Those two items:

Priorities.

Focus.

We have to identify and prioritise the few key things upon which the future of our children and grandchildren are based.

We then have to focus resources on their achievement. It will be long term, incremental, and politically difficult, but the alternative is ugly.

The challenge is the same for any enterprise as it is for the country, only the scale is different, along with the accountability. After all, politicians have 3 or 4 years to make a start, depending on the location, while public companies have  to make adjustments quarter by quarter or be castigated by the stock markets.

I wonder if we mere mortals have the grit and foresight to act?

A very rare few do, they are not mere mortals, they are true leaders.

Have you seen any recently?

 

Cartoon credit: Scott Adams and his mate Dilbert.