The where, why and how of enterprise value creation.

The where, why and how of enterprise value creation.

Dec 17, 2018 | Governance, Management, Strategy

 

The balance sheet of an enterprise is a snapshot in time of the financial value of an enterprise. The comparison of balance sheets over time delivers a picture of the value creation, or destruction, of the enterprise over time.
The ‘Financial trio’ Balance sheet, Profit & Loss, and cash flow, together generate a picture of the performance of an enterprise, and are the foundations of performance management.
However, these are not enough for a thoughtful management.
To build a clear picture of the intrinsic value of a business, we need to look beyond the financial accounts, to the ability of the business to create sustainable value for customers. In other words, provide solutions to problems that cost less than the amount customers are prepared to pay for those solutions.
Therefore a closer look at the parameters of value may be useful.

Value cycles.
When the return on capital exceeds the cost of that capital in a given period, value has been created. Looking at the cycles in isolation can give a distorted picture, driven by seasonal sales mix, competitive activity, operational changes, product launches, and many other factors. These cycles always have in them a mixture of the short term challenges faced, and the longer term factors almost always driven by trends external to the business, such as technology adoption, regulatory changes, and the emergence of new competitive business models. Understanding the cycles of value creation and consumption can assist not only in smoothing them out, but doubling down on the good times, hunkering down in the bad, and ensuring that your strategic thinking is tuned to the evolution of the external environment.

Where is value created or consumed.
This can be pretty granular to geographies, product lines, market segments, brands, and so on. Understanding the variations, and applying pressure to them can dramatically increase the average value creation by isolating areas where it is routinely being destroyed, and fixing them. In many instances, the value destruction in the short term is deliberate in an effort to build value for the future. However, often the destruction is unseen in the mix of activities in every business. Innovation is in the short term generally a value destroying activity, but essential to the long term value creation, and this is a delicate balance that requires a strategic framework to be consistently applied to the allocation of resources.

Why is value created.
Linking the creation or destruction of value to specific assets and capabilities, again delivers the opportunity to optimise the investments you make. What makes you sufficiently different that you can create value? Is it short term or is it longer term, and how do you maintain the momentum, as superior value creation always attracts competitive capital in time.

How is value created.
Very simple to say, but hard to do. Value creation always comes down to solving a problem, or creating an advantage, for an individual, group, or enterprise.

Market position and long term decision-making obviously play a key role in value creation, and none of this happens by accident or over a short term. It is tangled up in your relative market position, the evolution of the market you are in over the lifespan of the market, and your competitive position in that market.
This sort of analysis enables a complete picture to be put together. If you have enough information to make judgement about your major competitors, those that might emerge from the pack, and those from the sidelines which are usually missed, this will inform the decisions you make that will impact on future value creation.

The root of all this is strategy.

The golden rule of marketing in regulated markets.

The golden rule of marketing in regulated markets.

Dec 13, 2018 | Governance, Management, Strategy

‘He who has the gold makes the rules’

I had to go to Sydney airport last week, and needed to park for a while, the plane was late.
It almost required an extension of the limit on my credit card.

It was just another brush with the cost of doing business with someone who has the inside running in a regulated market that I have had the misfortune to tangle with over the last few months. In this case, the airport is a monopoly, that was privatised. Governments seem to think that when they sell off a public asset to the private sector, the buyer will continue to price it at ‘social’ levels. They then act all surprised when the new owner with the regulated monopoly suddenly starts pricing at monopoly levels.

Consider what has happened to your power bills since the ‘privatisation’ process kicked in. Pretty obvious that the sale process included some sort of ring-fencing of competition to beef up the price so the press release looked better, as in the case of the sale of Port Botany and Port Kembla now being brought to court by the ACCC.

Pretty much all markets are regulated to some degree, from a very little to a whole lot, on top of the basics of incorporation, and paying taxes (which seems to be increasingly optional for MNC’s). Adding to the complication, there are three levels of government in this country all regulating different things in different ways creating an alphabet soup of bodies that have to be navigated before you can trade.

In highly regulated markets, it is reasonable to assume that most if not all incumbents will move aggressively and creatively to protect what they have. Claims of public interest, safety, loss of employment, are common, and are generally the reason the monopolies are there in the first place. However, what they have is a position that enables them to charge rent, rather than achieve success through a superior value proposition.

Understanding the structure of the rent seekers business model will help to see ways to invigorate or disrupt it.
The taxi industry is a classic. Around the world it was a regulated market that delivered regulated profits to the few who owned the licences, which therefore accrued a capital value, until Uber came along. Similarly, the milk industry in NSW was regulated until it became unmanageable to continue, and then there was a decade long 10 cents/litre levy to pay down the capital value of the regulated milk runs.

Having an understanding of who has the power in any market, the basis of that power, and the means by which it can be wielded, is vital to the construction of a viable business model and value proposition.

Header Photo credit: courtesy Jason Heller.

Focus delivers productivity

Focus delivers productivity

Dec 10, 2018 | Governance, Management, Uncategorized

When you fail to focus, you are scattering your capital.

Most importantly,  you scatter the vital Intellectual Capital it takes to succeed, as well as the financial capital that is a vital enabler of success.

Limited resources need to be focused on the point where they will do the most good, generate the most leverage.

The familiar investment advice to spread your investments, ‘do not put all your eggs in one basket’ holds when you are a passive financial investor.

However, when you are an active investor, not just of your financial resources, but of your limited time and energy, it is better to follow Andrew Carnegie’s advice to ‘Put all your eggs in the one basket, then do not take your eyes off the basket’

This advice holds equally as you consider your long term plans, what outcome do you truly want, to planning your day today. Ask yourself ‘What is the one thing I really need to get done today that will take me one step closer to the goal’

As Confucius is reported to have said somewhere around 500 BC, ‘Every journey starts with a single step’. That advice is as valid in today’s world as it was then, so make sure you take that step every day, and that it is one step closer to the goal.

 

 

What is the single source of competitive advantage in the 21st century?

What is the single source of competitive advantage in the 21st century?

Nov 26, 2018 | Governance, Strategy

Competitive advantage used to be about the sum of scale and the efficiencies that could be applied. Businesses like GM, GE, Exon Mobil, Wal-Mart all built scale and efficiency as the core of their success.

Our economies and institutions ran on the basis of scale and efficiency. Our political systems were fuelled by  the notion that those in charge accepted a moral obligation to be honest, tell us the truth, and act in our collective best interests for the long term.

Now things have changed.

Competitive advantage is now more about connections that deliver the scale. The planets biggest businesses, Apple, Amazon, Alphabet, Microsoft, Facebook and Alibaba, now have connections as the common element of their competitive advantage.

Over the weekend I heard Donald Trump in an interview propose that he had a ‘Platform’ in his followers on Twitter, Instagram and social platforms generally, that removed the need to rely on the institutions that had built the US. His platform was the people, he argued, with whom he now had a direct connection, independent of the institutions.

Love him or hate him, it is hard to disagree.

Equally, the Liberal wipeout in Saturdays Victorian elections will I suspect be sheeted back to the absolute lack of trust in the Liberal party generally, fuelled by the shambles in Canberra over the last decade. The Labor party should also be very careful, rather than crowing their success, as we trust them no more than the Libs.

It seems the foundation of the 21st century will be trust.

Hard won trust is easily lost, and very hard to win back.

As businesses and institutions build scale based on connections, those connections will be fuelled by trust. The absence of Trust will come to mean that your ability to build competitive advantage will be compromised. The strategic and marketing task of both public and private institutions, can be boiled down to the simple proposition that they need to be trusted, and that we, the great unwashed who vote with our feet, money and loyalty, require that they earn that trust, it will no longer be just given.

To reach that point, they need to build up the real evidence that they can be trusted, that they will act in our common interests before theirs, as distinct from the fluff and bullshit currently churned out by their publicity lackies.

As I look forward, I can see no driver of success more important than outlining a goal, articulating the route toward the achievement, then being held accountable for the actions that take us towards the goal.

In a word, trust.

Header photo: Christmas 1914 on the Western Front.

How much should I spend on that winning that tender?

How much should I spend on that winning that tender?

Oct 2, 2018 | Customers, Governance, Strategy

 

That is a common question, which requires some rephrasing to be answered with anything other than ‘It depends’

‘How much should I invest to increase my chances of winning that tender’ is a better question.

Would you spend 20k to have a 50/50 chance of a $5 million contract?

How about if your chances of success were only 20%. Would you still spend the 20k?

There is a continuum here, one that should change with your circumstances, and your judgement of your chances in the tender process. The management challenge is quantifying the level of risk tolerance that exists at that time.

‘How much should I spend’ is a form of question that implies a short term is involved, ‘How much should I invest’ implies a longer term. It may only be a semantic difference, but  there is a great difference in the manner in which you approach the tenders preparation.

Quoting on tenders has two elements, the first is that now it is a tender, the implication is always that you are just one of several to tender, so it is an auction, of sorts.

The second is that there is never a sure fire thing, even when you have the inside running for any one of a large number of reasons, the most usual being incumbency of some sort. The fact that there has been a tender made public is an indication that the tenderer is not only looking for a price, they are looking for ideas.

To some questions you should be asking yourself:

  • How valuable is the tender to me? If the tenderer is your biggest customer, and you are an incumbent for this sort of job, the answer would probably be very valuable, not just for the job being tendered, but for the ongoing relationship and flow of further work.
  • What is the strategic value of the customer? This will often be a similar answer to the previous question, but your largest customers always started as a new, much smaller customer, and grew, so considering how ‘strategic’ they may be is important. An acquaintance of mine has what he calls a ‘green-keeping’ business that specialises in public spaces. He will do everything possible to win tenders put out by public bodies, councils, schools, and the like, as each one he wins is strategically important not just to the current cash flow, but to the position he holds in the competitive field.
  • How unique is my solution? When you can do something none of your tender competitors can do, price becomes less important. Following the above example of the green-keeping business, he owns a tractor towed machine that ‘cores’ a surface, an important factor for vigorous grass growth on areas like football fields. All of his competitors need to hire such a machine (sometimes from him) as the need arises which adds a significant cost to maintenance and a resulting reluctance, which often enables him to get a superior outcome.
  • How close is the strategic fit of the tenderer to the profile of my ideal customer? Every successful business has an idea of what their ideal customers look like, and the closer to the ideal profile a tenderer is, the more important it will be to win a tender that arises from them.
  • How does the job fit into the existing workflow? When you have a ‘hole’ in your work flow, filling it becomes more urgent, the alternative being to cover the overhead costs from reserves or remove them. When the latter course is taken, it can be hard to resource back up when the work flows in again.
  • How does the job fit my capability mix? A key part of having a profile of the ideal customer is that the mix of capabilities you can deliver exactly matches what is required by the tenderer. Having to buy in a capability you do not have is a strategic decision, and should be made carefully.
  • What is the net cash flow from the project over the life of the project? To do any sort of financial calculation, this forecast is an absolute necessity. It should be done in any case, as you are bidding for the contract, and therefore should have calculated your costs and the financial benefits and risks. This is all that is needed for a financial calculation.

 

Having determined how important the job may be to win, the task is to increase your chances and decide how much to invest in winning.

There are two variables, the amount you invest, and the chances of winning the tender. To do a financial calculation on the options, you could use a function called  ‘Net Present Value’  or NPV. We all recognise that a dollar today is worth more than a projected dollar tomorrow. The value of tomorrows dollar being reduced by  the amount of inflation, and the certainty of the projected cash flow from the project.

To do an NPV calculation, you need to have projected the cash flows to which you are applying the formula.

The NPV formula is simple in principal: Assume an amount of $20,000 is outlaid with the projection that in the following 3 years the project will deliver 100k/year positive cash flow in current dollars, and the discount rate is 5% to allow for 5% inflation.

The cash flow looks like:

$20,000 initial investment, followed by year 1 net cash flow of $100,000, plus year2  100,000 X .95 = $95,000 plus discounted year 3 of $90,250.

The net cash flow from the project is therefore $285,250.

Therefore the net present value of the initial investment at the end of the project is $285,525 – $20,000, or $265,525. In this case, it would seem that the investment of 20k in winning the tender would be a very good investment indeed.

The discount rate can be changed to reflect not just the future value of current dollars, but to also  reflect the risk of not winning. This can be a more complex calculation, but relatively easily done with a formula called Internal Rate of Return (IRR) available in every spreadsheet package.

These two calculations, NPV and IRR are routinely done in tandem by accountants to calculate a risk adjusted return from an investment.

When considering the question ‘how much should I spend on this tender‘ they will together be very handy tools.

Cartoon credit: Scott Adams and Dilbert.

A marketers explanation of Free Cash Flow.

A marketers explanation of Free Cash Flow.

Sep 3, 2018 | Governance, Management

The net flow of cash into and out of a business is to my mind the most vital measure of the success or otherwise of that business, captured in the cash flow statement.

The P&L, and Balance sheet, vital as they are as performance measures, can be susceptible to ‘management’. The flow of cash is less able to be similarly ‘managed’

It is however, like all numbers, subject to the context.

Free cash flow is the cash generated by a business less its Capital expenditure.

The summary formula is: Net operating cash flow – Capital Expenditure. (Capex)

It is a very simple calculation once you have the cash flow statement in hand.

Free Cash Flow can vary dramatically over periods of time, so the trends are a vital part of the consideration. A business might invest a lot today in capital that is expected to deliver profits in the future, and should not be penalised for doing so, rather it should be supported, so long as the investments are sensible, which is another whole set of considerations. Every business needs to invest in the productivity of existing assets by way of renovation and replacement, as well as supporting innovation and maintaining regulatory compliance.

The trends in free cash flow and Capex expenditure are key measures of commercial sustainability.

I have seen businesses being tarted up for sale that display impressive increases in free cash flow over a few years, but as always, the numbers can lie. When you go behind them, the Capex has been restrained to the long term detriment of the business, to make it more attractive in the short term.

As an antidote to the rosy picture that can be generated by reducing Capex, I like to see the free cash flow and capital expenditure trends on the same sheet of paper, and being a marketer, as a graph. You can go one step further and break up  the Capex into three categories:

Capex spent for regulatory and compliance reasons

Capex spent for productivity and capacity reasons

Capex spent on new products and processes.

The nature of the Capex can tell you a lot about the health of the business, and its prospects.

Cartoon credit to Scott Adams and Dilbert.