Base KPI’s on behaviour, not outcomes, for best results

Base KPI’s on behaviour, not outcomes, for best results

Feb 21, 2018 | Governance, Leadership

It is budget season, so amongst the detritus of everyday management, we have to make time for creating the budgets for the next 12 months, in Australia usually starting July 1. Hopefully, budget preparation is a normal part of the management ‘flow’ of your enterprise, where it follows naturally after a regular strategic review and preparation of operational plans. The budgets then become a financial expression of the operating plans, but sadly, it is most often not the case.

Irrespective of the procedures that dictate preparation, part of the budget process is the setting, or in most cases, the resetting of Key Performance Indicators, KPI’s.

In almost every case I see, KPI’s are all about outcomes, achievements that more often than not are recorded in the financial reports, which are an alarmingly one dimensional reflection of performance in today’s world.

Would  it not be better to set KPI’s based on the behaviours we want, which are after all the underpinning of outcomes. It is unlikely the outcomes will be favourable unless the behaviours that occur are constructive.

There are many challenges in  setting KPI’s  in this way:

It is hard to do, therefore we take the easier route

To be effective, behaviours, and specifically the behaviours we want, need to be made sustainable, part of the everyday routines,  not something that happens when the boss is watching.

Behaviors are a product of  the environment in which we exist, so the task of management is not just to mold behaviors, but too mold the context in which you want them to evolve. Commonly this gets called alignment, but almost always it implies financial alignment, rather than the broader definition that includes revenue generation activities, operations, process optimisation, and capability development I think appropriate

Behaviours are integrated into the processes of any enterprise, together they make up what is commonly called ‘Culture’. Again, these do not evolve without senior management taking control, and being seen to do so, thus enabling the processes to evolve in a direction consistent with the objectives of the enterprise.

Are the behaviours in your enterprise all contributing to the objectives, or are they disconnected, the KPI’s just a set of optimistic benchmarks dreamed up in the boardroom designed more to intimidate than motivate?

 

 

A marketers explanation of Net Present Value (NPV)

A marketers explanation of Net Present Value (NPV)

Feb 12, 2018 | Governance, Management

‘What the Hell is NPV?‘ the marketer cried

Accountants seem to love to baffle with jargon, but that is not, usually, what they set out to do.

Rather , they use terms as a shorthand to describe what to them makes absolute sense, but to the rest of us, mere marketing mortals, seems like gobbledygook.

One of the ones that commonly causes headaches is ‘Net Present Value’  or NPV.

Guaranteed to put most marketers to sleep.

However, you should not sleep, way better to understand the idea in simple  terms so you have an understanding of the conversation, and can contribute in a meaningful way.

NPV  is simply one of the common methods of calculating the relative value of a number of investment choices. It recognises that money you have today is worth more than money you may have tomorrow because it can be invested,   used now, while the ‘future money’ is subject to inflation and risk.

Often the term ‘time value of money’ will be used.

It is one of a suite of calculations that can be used when sorting out which projects to pursue from a range of possibilities. It provides an objective measure that enables you to make better choices, that management challenge in a world of subjectivity, conjecture and bullshit.

Marketers should understand the principal, if not necessarily the formula, which is readily available in just about every spreadsheet application since  Visicalc. Remember that? I do, it became a marketers best friend, years before excel emerged.

The formula is relatively simple, it just looks a bit complex.

The discount rate is the rate of inflation used, plus the amount you choose to add to allow for risk.

Most businesses use a consistent discount rate that reflects their return on investment hurdle rates. For example, if the current inflation rate is 1%, and the business requires an 8% ROI, the discount rate will be 9%

The great benefit of NPV to marketers is that it uses the cash flows derived from a proposal to sort out the priority, not just the quantum of the initial investment, so  it reflects the forecast cash success over time.

For example, you want to invest $3 million in gear to launch a new product, that is forecast to deliver a net profit of $1.3 million/year for 3 years, with a discount rate of 9%.

There are a number of sequential steps to take.

  • Calculate the present value of each years net profit by dividing the net profit by (1+discount rate). In year 1, that is 1,300,000/(1+.09) or 1,192,661. The ‘1’ in the formula being the current inflation rate
  • Repeat the exercise for each subsequent year, in year 2, it would be 1,192661/(1+.09) or 1,094,184.
  • In year 3 1094,184/(1+.09) 1,033,838
  • Add the present values calculated, 1,192,661 + 1,094,184 + 1,003,838 = 3,290,683 to give you the total forecast present value of your money in three years, then subtract the initial investment to give you the net present value of the investment.  $3290683 – 3,000,000 = $290,683.

The larger the positive number the better, a negative number would indicate that the project will drain cash from the business, a positive one adding cash.

To make the choice between investment options, repeat the exercise for  each, and pick the one with the highest positive value.

Clearly, the calculation is based on a series of assumptions and forecasts, so there is a lot of room for error, but when used in a consistent manner it is a good tool to assist making difficult choices, and offers the flexibility to do some informed scenario and ‘what if’ planning.

 

 

 

 

The easy way of course is just to go to excel, and look for NPV in the formulas tab, which will give you the numbers, but not the understanding of what they mean.

Photo Credit: Bentley Smith via Flikr

How does the Amazon innovation formula keep replicating?

How does the Amazon innovation formula keep replicating?

Feb 7, 2018 | Change, Governance, Innovation, Strategy

Amazon is an astonishing company for a whole lot of reasons, but there is one that is not front and centre in most conversations I have seen and in which I have been involved. This is the means by which Amazon just keeps on innovating, genuine, disruptive innovations, time after time, at astonishingly small intervals.

Note: This link is to an expanded version of this infographic from Visualcapitalist.com

 

Amazon must have the internal processes that enable it to punch out new businesses, and business models that way a factory stamping machine pumps out widgets.

The biggest impediment to efficiency on a widget machine is the changeover times between widget sizes and internal specifications.

Quick changeover is a hallmark capability sought by manufacturing companies employing Lean thinking, and is a challenging proposition, even in a small, tightly run factory. So how does Amazon achieve it at scale in businesses as complex as it routinely disrupts.

Amazon started by flogging books, or as CEO Jeff Bezos  (apparently) liked to say in the early days, ‘we do not sell books, we make books easy to buy’

The hallmark of a successful lean implementation in a factory is that there are processes that take a prospective order through the whole ‘sales funnel’ to production, delivery, and ongoing relationship building. Lean practitioners call it the ‘Value Stream,’ the set of activities required to deliver value to the customer. These are all done the same way, every time.

The paradox is that this process stability is the foundation of innovation, you need a stable base in order to trial ideas at speed, then scale the ones that work. This is an idea sometimes hard to communicate but as fundamental as it gets to successful innovation and continuous improvement.

Amazon appears to have achieved this at scale, in a service business, typically harder than a manufacturing business to get traction.

How?

Amazon is organised just like a whole collection of independent business units, all cross fertilising, and cross pollinating each other, using (I suspect) what Ray Dalio would term ‘Radical Transparency‘.

The secret seems twofold:

  • The internal technology that Amazon uses across all its activities, is modular and scaleable.  It is in effect the machine enabling the manufacturing of Amazon widgets. This enables new businesses to be added the way you would add another coloured widget to the sales inventory of a manufacturing business. I suspect the scalability will be the source of the next round of disruptions coming to the fast moving goods retailers.
  • Each part of the business multiplies the customer impact of the ones next door, a ‘flywheel’ effect. Digital technology enables the network or ‘Flywheel’ effect to build momentum. The more eyeballs you have on one side of the network equation, the greater the value to the other side. This effect builds scale very efficiently once you have reached a tipping point, reflecting Metcalf’s law which states that the value of a network increases with the number of nodes in the network.  Amazon has created their own version of Metcalfe’s law amongst their own offerings, one product or service leading to the one next door.

Bezos has achieved something that I think will be studied for decades, and it is clear he is not stopping any time soon. The only thing that appears likely to slow the momentum is regulatory intervention. Amazon has 44% of  on line retail sales in the US, 35% of global cloud services, a market growing at 40% a year,  where AWS is bigger than the next 5 biggest combined. The list goes on. The point is, Amazon is chewing up competition everywhere, yet pays very little tax, $1.4 billion since 2008, while Wal-Mart has paid $64 billion over the same period, so in effect, Wal-mart is subsidising its greatest threat to eat its lunch. Outcomes and numbers like that will have to prod regulators into some sort of action, before Amazon (and to be fair, Facebook and Google are very similar, even more dominating in their markets)  is in a position of power so dominant that regulators cannot stop them.

Amazon, a product of the 21st century is simply outrunning the capacity of the institutions and public mind set of the 20th century by reshaping our world around us, and with our consent by unthinking compliance. They are being joined in this exercise by Google, Facebook,  Alibaba Tencent, and a few other aspirants like Netfliks, to dominate the way we think, behave and work.

Header photo Jeff Bezos circa 1998

 

Update June 2018.

Amazon bought on line pharmacist ‘Pillpack’  last week for almost a billion dollars, saw its own share price jump double what they paid at the same time industry incumbents collectively lost 10% market valuation. Jeff Bezos has signalled his interest in pharmacy in various ways for years, so this should not come as a surprise, but it seems to have done so, as the threat of Amazon had clearly not been priced into the market valuations of the incumbents.

The Pharmacy guild in Australia, one of the most powerful lobby groups in the country, should be asking themselves if they are next for the chopper.

Update August 2022.Amazon last month paid $A5.6 billion for subscription health service One-Health, which gives them a network of doctors surgeries around the US. If ever there was a huge industry mired in its own importance, removed from the needs of those it is supposed to service, and ripe for disruption, it is the US health care industry. It will be a tough nut to crack, others have tried and failed, but Amazon has the street-cred to make it happen. The ‘flywheel’ at work again.

9 reasons why SME’s should invest in a governing board

9 reasons why SME’s should invest in a governing board

Jan 31, 2018 | Governance, Leadership, Small business

 

Very few of the small and medium sized businesses I interact with have a governing board of any real quality. Many have a ‘board’ required under the various regulatory regimes they must meet, but very few have a board that acts in the manner of a public company, as an independent oversight of strategy, financial and operational performance, culture, and of the senior management effectiveness.

This is something that should be remedied.

The short term costs are in my experience  heavily outweighed by the benefits over the medium to long term.

Some of the benefits I have seen can be summarised as:

  • Introduction of industry knowledge and networks.
  • Introduction of business management expertise and experience from a wide range of backgrounds.
  • Provides time and the catalyst for management to consider wider issues than the normal ‘urgent’ things that dominate the daily routines.
  • Provides diversity of views, values and ideas
  • Keeps management and particularly the CEO focussed on the issues that will impact long term commercial sustainability, as well as the short term financial outcomes.
  • Adds depth to the management functional capability by enabling mentoring and coaching
  • Thought starter and sounding board for management
  • Acts as a catalyst and guidance for longer term capability development of employees, and the manner in which the business captures and leverages those capabilities.
  • Oversight if not development of strategy, and oversight of strategy implementation, feedback and renewal.

 

There is an old saying that most of the smartest people in your industry work somewhere else. Therefore it makes sense to try and tap into that expertise in some way, and a well considered ‘board’ is a great method.

These bodies do not necessarily operate under the rules of  the Corporations Act, where there are enforceable fiduciary responsibilities. They are usually more of an advisory body, often meeting  formally only 4 times a year, but with significant interaction with management on an as needed basis.

 

What governments can learn from small business.

What governments can learn from small business.

Jan 29, 2018 | Governance, Leadership, rant

Apart from the obvious, of doing sufficient due diligence on the important detail, such as knowing your nationality, there are many other lessons to be learnt.

Amongst the key ones is the depth of consideration small business owners need to give to the deployment of their very limited financial and operational resources. In most cases, some level of financial and strategic consideration is applied, and trade-offs are always necessary and usually painful. Governments on the other hand are not similarly constrained, spending is welcome, and rewarded, whereas constraint and tough choices are avoided, and there is no bank to refuse an increase in the overdraft.

Those I work with are encouraged to consider their commitments from three buckets:

  • What is required to keep the business going, which includes operational and necessary capital expenditure.
  • What is required to build the resilience and agility of the current business, enabling it to grow and prosper at the rate, and in the manner necessary to be commercially sustainable.
  • What is required to move the business to the ‘next level,’ whatever that may be in the context of their competitive and strategic environment.

Those that give this sort of framework deep consideration generally come out on top.

By contrast, Governments seem to consider their expenditures only in two buckets.

  • Sustain operations and get elected. In other words, never take anything away, but find creative ways to rebadge it so that it seem you are always giving.
  • Who is entitled to what from the bottomless purse of money to be spent. Joe Hockey when delivering the 2014 budget referred to ‘The end of the age of entitlement’ and look where it got him, and the Abbot government. A bad dose of adversarial short term politics by the opposition, and marketing incompetence by the government ensured that the age of entitlement continues, to this day.

 

Let’s hope that in this new year we see some common sense and vision emanating from Canberra. A big ask, but after a year of utter and complete chaos, irresponsibility, and self-congratulatory bullshit in 2017, I think we all deserve more.

 

How do you measure the scalability of your business?

How do you measure the scalability of your business?

Jan 23, 2018 | Change, Governance, Management, Strategy

Almost every business I know  seeks to grow, as there is a recognition that growth brings benefits beyond simply the size of revenues and profits. It  brings credibility, attracts good employees, enables negotiation from a stronger position, and much more.

It seems to me that there are four macro measures that can be applied, each with a few key sub measures that can be used as appropriate.

‘Stickiness’.

This is a term I use to describe a combination of factors vital to the health of every business.

  • Customer retention rates. How much customer ‘churn’ do you get, how long is the average ‘ ‘lifetime’ of a customer, and what is the subsequent lifetime value of a customer. Associated with customer retention is the cost of customer acquisition. At some point, investment in further customer retention will start to deliver diminished returns. It is therefore sensible to have a parallel process in place that delivers a steady flow of new customers coming in to replace those that do move on, and build the spread of customers and the penetration of your preferred markets.
  • Share of Wallet. Regular readers will be aware of my attraction to this measure. In effect, how much of a customers purchases that you could service, do you actually attract. Calculation becomes an important strategic exercise as it forces you to consider which types of business you can and want to service, which markets you are able to compete in effectively, and the relative power of your value proposition in any market segment.

 

Referrals.

How likely are your customers to refer you to others? When an existing customer values the services you provide sufficiently to recommend you to their own networks, that is marketing gold. One of the formal measures that has gained a lot of traction is the Net Promoter Score. This is a very binary system, which has its merits, but I like to see some qualitative evidence as well, gained by customer stories, feedback, and various answers to the question ‘where did you hear about us’?

How likely are those in your value chain to recommend you, these referrals are as useful and relevant as those from your customers, as they have a commercial relationship with you, and are in a great position to judge.

Margins.

The simple word ‘Margin’ can have different meanings to different people, particularly accountants, but in its simplest form, is the profitability divided by revenue. However, you do not bank percentages, just dollars, so you also need to consider the absolute amounts of money that can be made from a market. Generally the higher the margin, the better, but generally, higher margins attract competition, so over time margins become eroded. The key is  to make the margins sustainable, which requires appropriate strategic investments to be made.  Measurement  of margin can take many forms:

  • Customer margins can be measured both individually and by group, depending on the nature of the business.
  • Product margins similarly can be measured by product and product group.
  • Both the customer and product margins can then be further measured by geography, market segment, and any other sensible parameter. The absence of margin management is a sign of poor or at least lacking management, and the mixing of marginal costs, particularly in the case of a manufacturing business, with overheads is a significant drain on management ability to make informed price and cost management decisions.

Investments.

Effective financial management captures all investments of cash irrespective of the nature of that investment. It makes no distinction between operational and regulatory investments necessary to keep a business functioning, and those that have some risk associated with shoring up future revenues and margins. Investment in marketing, innovation, staff capability, process optimisation and others do not routinely turn up in financial statements, but without them any business is doomed, so seek them out in any due diligence exercise.

Good businesses make the investments in line with their strategic priorities, and track the outcomes of those investments over time.

Need help thinking about these issues, give me a call.