6 essential questions from the devil

6 essential questions from the devil

May 4, 2018 | Governance, Leadership, Management

Having a ‘devils advocate’ around you is one of the most productive relationships you can have in a complicated enterprise. Such a relationship enables the stripping of any position held back to its core, removing the bias, preconceptions, and power of the status quo, but leaving room for intuition born of domain knowledge, experience, and most importantly, data.

You should seek out and nurture such relationships.

The most successful commercial relationship I have had was with a bloke to whom I reported for a long time, in two different businesses. Vigorous ‘conversations’ took place as a natural part of determining the best course of action to take, the best allocation of limited resources, with each testing the positions taken by the other.

The eventual outcome was more often than not, one that would not have emerged without such a process, although we both knew who held the power of veto, and from time to time, it was used.

I was reminded of this relationship recently in a conversation with a client who had reached a conclusion I thought was absolutely wrong. It was based on flimsy information, the opinion of someone whose opinion in this matter was in my view skewed by some unfortunate and irrelevant bias, and a reverence for the status quo which appears to me to be destructive.

I went through my standard list of  ‘Devils questions’ to no avail. Tell me what questions I should have asked on top of those below in an effort to help him consider the real merits of the decision he was about to make.

  • What is the source of the data you are quoting? Without a reliable, robust and repeatable data source that stands up to scrutiny, an ‘insight’ based on it is just another opinion.
  • How did you get from the ‘data’ quoted to the ‘insight’ you appear committed to? I like to see logic chains, definable cause and effect, when gathering insights from data, and am wary of leaps of faith that do not have the authority of logic and experience.
  • What biases have you have built in from your background and experience? Nobody is immune from some level of built in bias, a good devils advocate holds up a mirror to them.
  • What other options could there be based on the same data? In most situations, there is more than one way to interpret and leverage data, opinion, experience, and outside knowledge. Playing the ‘options game’ as a part of a conversation is a very useful tool.
  • How do we test the insight without betting the farm? These days the ability to test has been multiplied a thousand fold by the digitisation of everything, it is no longer wise (if it ever was) to bet the farm. The scientific method rules!
  • What will you do if you are wrong? Learning from mistakes, and applying the learning is the basis of improvement, and without an inclination to learn from mistakes, you will be destined to repeat  them, usually for  the same reason they were made in the first place.  In addition, answering this question almost inevitably opens up other options for consideration that may not have been adequately considered, or completely missed in the conversation.

Devils can be very helpful when used well, but they also have the power to be destructive, so be careful with whom you dance.

 

The two crucial leading indicators of business performance.

The two crucial leading indicators of business performance.

Apr 18, 2018 | Governance, Management, Small business

‘Simplicity is the ultimate sophistication’. So said Steve Jobs and he was not only right, but just one of a long line of people saying similar things.

Aristotle, Marcus Aurelius, Mark Twain, and my personal favourite, a marketing guru of great stature, although known for other things, who said ‘Everything should be as simple as possible, no simpler’. Albert Einstein.

It is also very useful to have a few simple but reliable forecast measures that give you a ‘heads-up’ about rough waters ahead.

Therefore when doing a StrategyAudit of a business, I try to distil everything down to its most simple form. That way not only can most (including me) understand it, but there is less room for error, misunderstanding, evasion, finger pointing, and all  the rest that goes on.

Two words capture the essence of a successful business, irrespective of size, structure, location and market. Having done many StrategyAudits, using a whole range of tools, some simple, some pretty sophisticated, there are just two words that underpin everything.

‘Cash’ and ‘Flow’.

Let me explain.

Cash.

Cash is the lifeblood of every business. Every activity, in one way or another is connected to the consumption or generation of cash. When you are doing something that is not contributing in a positive way to cash generation, even if it costs cash (such as advertising), stop. It does not matter how grand the vision, how well meaning the mission, how creative the advertising, how innovative the products, unless it generates cash in excess of its cost, stop.

So, I look at the cash. How it is managed, committed, deployed, forecast, leveraged, and disbursed.

The three fundamental parts of an accounting system are the cash flow statements, Profit and Loss statement, and Balance Sheet.  Both the P&L and Balance Sheet can be ‘managed,’ just look at Enron, Dick Smith, FAI insurance, State Bank of SA, One-Tel, and a host of others for proof. However, look closely at the Cash Flow, and without sophisticated fraud, it cannot be ‘managed’, and if there is fraud, a close look will reveal it fairly quickly to an experienced eye.

Probably the easiest way of judging the health of a business is to look at free cash flow. Cash coming in – cash going out, excluding capital expenditure. If positive, at least there is some hope, negative, start resuscitation immediately, or run for the lifeboats. This assumes a reasonable period of time. My recommendation to most clients is a rolling 13 weeks. Long enough to be somewhat immune from the day to day stuff, but short enough to give a fair indication of the overall health of the place quickly while giving enough time for any necessary corrective action.

Every business I work with is strongly encouraged to do a weekly rolling 13 week cash flow forecast. Those that resist strongly usually end up former clients for one reason or another. Once set up, the routine makes it easy, takes little time, and removes a whole lot of stress.

Flow.

This is probably a bit unexpected, but when you think about it, every business is made up of many processes, sub processes, and sub, sub processes. Draw a ‘map’ of your sale to cash process, and there are a number of steps, preparation and dispatch of the order, proof of delivery, invoicing, supporting book-keeping steps, and debt collection. Similarly, all the processes in your business have stages, points at which there are necessary interventions, potential changes, interruptions, delays, mistakes, rework, and a myriad of admin things and performance measures that need to be completed.

Keep drawing process maps and see how they become entangled, are dependent and interdependent, and can create uncertainty, opacity, and opportunity for error, as well as being necessary to get the work done.

I think about flow as you would a river. Water flows smoothly and predictably while there is no interference, but insert a rock, or bend, or shallow bits, and there is interruption to the flow. The greater the interruption, the more unpredictable the flow, and the more energy is required to move the water through. The velocity of the water through a part of the river is a measure of the productivity of that part, and again, the greater the interruption, the less the productivity.

I therefore look at the ‘flow’ of processes through the business, and seek to simplify, and accelerate all of them by removing the ‘rapids’. It is an incremental and never ending task, but one that delivers great financial and emotional rewards. In most cases, there has been little process mapping done, so that becomes a priority in any improvement project, but the current state of the ‘Flow’ is a very good indicator of the health of the business.

When you need a bit of help considering these two crucial performance indicators, give me a call.

Why Wesfarmers is taking Coles through the checkout

Why Wesfarmers is taking Coles through the checkout

Mar 21, 2018 | Governance, Management, Strategy

It is no great surprise to me that Wesfarmers are spinning off the Coles supermarket business, and associated liquor and variety businesses. It also makes sense that they are keeping Officeworks and Bunnings, both stunningly successful businesses in Australia. Bunnings However, has failed miserably in the UK expansion, consuming capital and morale like a starving gypsy. It seems ironic that Coles thought they could beat the odds in the UK, just as Woolworths thought they could beat the odds with Masters here at home.

I do not think it is just being smart with hindsight to have foreseen the spin-off. Wesfarmers always seemed to me to be an owner that had adopted a culturally different and troubled although talented child, and was not too sure what to do with it. Despite pumping a lot of capital (around 8 billion) into the business and successfully turning it around beating the incumbent FMCG thug, Woolworths at their own game for a number of years, it still seemed to be an odd adoption.

A new Managing Director will always be keen to take the opportunity to ‘clear the decks’ of underperforming assets freeing up capital to deploy elsewhere in the hope of better returns.

New Wesfarmers MD Rob Scott is no different. Coles was a weight on the Wesfarmers balance sheet, accounting for 60% of capital employed, but returning only 30% of EBIT. Coles while a strongly cash positive business, is also the second player in a very mature market that faces a volatile future. However, it has played a role in the impressive increase in Wesfarmers value despite the nightmares that must have engulfed then MD Richard Goyder when the 2008 market crash occurred just after the $22 billion Coles acquisition in July 2007.

The FMCG market is entering a volatile period.

The channels to the consumer continue to fragment and enable the entry of innovative business models, and cashed up innovators. Aldi continues to make significant market share headway, Costco while a minnow is continuing to invest, Kaufland appears committed, and the shadow over everything is what Amazon may, or may not do.   Meanwhile, online shopping is increasing, while at the extreme other end of the spectrum, farmers markets, and even ‘pick your own‘ schemes are growing like mushrooms after rain.

Sounds like a good time for Wesfarmers to sell out of what may become a ‘legacy’ business over the next 10 years, and to put shareholders capital to work elsewhere.

 

 

Header credit: David Rowe Via Australian Financial Review.

 

 

A marketers explanation of Internal Rate of Return.

A marketers explanation of Internal Rate of Return.

Mar 19, 2018 | Governance, Management

 

This post should be read by marketers in conjunction with the earlier one that explains Net Present Value.

IRR partners with NPV as another tool in the investment choice toolbox. Both use as their basis, the forecasting of cashflow to make choices between investment options. While there are potentially a whole menu of influences over making decisions about investment options, cash as we know is the lifeblood of any business, and the measure least open to ‘management manipulation’, so should be in the mix.

The Internal Rate of Return, is the discount rate that would result in the net present value of a project to be zero.  In effect, you are  ‘solving’ for the discount rate that is used in the Net present Value calculation.

The discount rate best used in the Net Present Value calculations can be uncertain, we live in volatile times, and IRR is a means of calculating the rate given a set of investment parameters.

Businesses should set out to understand the rate at which the project breaks even,  so the IRR is the interest rate at which the NPV of all cash flows from an investment equals zero. Your investment break even.

IRR enables a ranking of projects by their rates of return to be done, rather than just relying on the NPV of the cash required. However, relying on IRR in isolation has a downside: it does not measure the absolute size of the investment.  A small investment might deliver a very attractive IRR, but be not as strategically attractive as a larger one that positions the business for growth. These are judgements  made outside the straight financial calculations, which are just tools to compare.

As with any mathematical modelling tool, an IRR calculation it also suffers from the ‘garbage in garbage out’ syndrome. Therefore the the most important part of the investigation is to understand and critically analyse the assumptions made, rather than just relying on the numbers Excel spits out to make the decision for you.

 

How to apply logic to the development of KPI’s

How to apply logic to the development of KPI’s

Mar 12, 2018 | Governance, Leadership, Management

‘If it matters, measure it’

There are many variations in that old saying, but it holds true. How therefore do we end up with hundreds of measures that seem not to matter?

Fear.

Fear of missing a measure that does matter, so we create metrics for every-bloody-thing to ensure that we do not miss one.

That is crap management.

Let’s think about measuring stuff that does matter, and then measuring it at the point where the decisions and actions that influence the outcome are made. This is tying cause and effect together at the point where they intersect, not looking at a range of data and wondering what happened to cause that!

How do we define what matters?

To me it is simple, if it moves the performance indicator, it matters. Clearly, the converse is also true.

Ask yourself, does the number of Facebook likes you have impact your profitability? If it does not, and I would contend it never does, so why use it as a KPI? It is simply a readily available metric that has no relevance to performance. It is what those ‘likers’ do with your information that counts, much harder to define and measure, but if you understand that, and the cause/effect chains, it just might move the performance needle and become a KPI worth measuring.

In short, behaviour determines the outcomes, so set out to measure the behaviours you need to deliver the performance you are looking for, not the other way around.

How do we measure what matters?

A measure without a target is not of much value, as we cannot see if any movement is relevant to performance. A measure should articulate the performance against which we need to move the performance needle in a strategically significant manner. This setting of targets is challenging if we do it properly. Applying a 3% increase in last year’s performance is not doing it properly, it is just extrapolating, accepting that history will repeat itself.

To measure properly, we need to consider the factors at work that will influence performance, seeking the causes, and measuring them, not just glancing at the metrics and having no idea of whether or not any movement is significant. Holy cow Batman, we just got another 5,000 likes on the Facebook page. Wow! But so what?

A further caution. ‘Sandbagging’ so called KPI’s is common in situations where there is little strategic linkage, and analysis of flow on impact. Two examples. Sales people when incentivised only by a target will be tempted to keep the targets as low as possible in order to achieve their bonuses.  Who has not seen that? Purchasing people incentivised only by purchase price will not care too much about the performance of the cheaper version they opt for, which in the factory, may corrupt the efficiency numbers, and have a far greater financial impact than the saving of a few bob on the initial purchase price.

Do not focus on averages.

Too many times I see piles of measures, taken at a high level, so that they reflect the average of a whole lot of other factors. If I have one foot in an ice bucket, and the other in the fire, on average the temperature of my feet is about right.

Nonsense.

Measure the outliers, the things that are unseen in averages in order to better manage them. For a KPI to be meaningful, it has to influence the outcome. Removing one foot from the fire will influence the average, but if I have not realised that the effect is caused by the removal of the foot in fire, I will at some point put my foot back in the fire.

I do not remember much from the statistics I did 45 years ago at university, but one of the ideas I do remember is that of standard deviation.  I recall little of the mathematical gobbledy Gook and probably do not need to any longer, as the formula is in Excel, just fill in the boxes, but I do remember what it means. (Forgive the pun).

In the normal distribution curve we are all familiar with, 68% of outcomes are within one standard deviation of the mean. These can reasonably be classified as an ‘expected’ result, given that forecasting is not an exact science, it is just a best informed guess, and the level of ‘informed’ varies hugely, depending on who has their mouth open at any one time.  95% of outcomes fall in the range of 2 standard deviations, and 99.7% fall in the range of three standard deviations. This is commonly called the ‘Rule of 68’

A focus on the unexpected, the outliers, will give you far greater leverage on the outcomes than a focus on the averages, or expected. It might lead to taking one foot out of the fire, and understanding that this is what has caused the increase in the comfort level.

 

 

 

 

 

Defining the outliers, like most things in life, can be made easier by imagery. A core piece of process improvement is defining the levels of variability, and then seeking to understand the causes of that variability. A visual way of communicating this is a performance graph that includes what you define as the limits of the variability you would consider to be ‘normal’. Commonly this is called a ‘statistical control chart’, and includes the upper and lower limits of what can be expected. Anything outside these limits needs to be investigated.

Anything inside the control limits is by definition, ‘normal’ and therefore not necessary to spend a lot of time considering. What however is worth great consideration is determining what the control limits are, where the normal becomes abnormal, which is where action must be taken. Over time, in an improvement process, the control limits will be progressively tightened as the outliers are progressively understood, so they become part of the normal, or eliminated.

 Cascade the KPI responsibility

Having any more than 6 or 7 KPI’s to manage creates a situation where we skate over the top, not able to devote the time and energy to improving the things that matter, that move the performance needle. The things that really matter will be different at each level, and in each part of the enterprise.  Therefore, constructing KPI’s relevant to each role should be a core part of the process of managing the resources of the enterprise, and especially in encouraging the behaviour we want  that will collectively, move the performance needle. Within each functional area, there will be a cascade of KPI’s that together add up to the 6 or 7 KPI’s to which the functional manager is held accountable. This is not to forget that the processes we are measuring are very often cross functional, and ignoring those cause and effect chains leads to sub optimal performance as in the purchasing/operations example noted earlier. This can be addressed by ensuring that the purchasing manager has a KPI that involves operational efficiency in the measurement.

Use the narrative in reporting.

A dashboard of a few easily understood performance indicators is terrific, it tells you what has happened, but lacks two vital pieces of information: Why it is happening in this way, and what should be done about it.

Narrative is the best way to communicate these vital factors, the core of great management, indeed, leadership. Knowing clearly what is happening is step 1, steps 2 and 3 are what make the difference between the companies that struggle to survive and those that prosper and grow. Illustrating these narratives with graphical KPI movements over time is a powerful way to illustrate the impact of performance at any level.

 

Credit Wikipedia: Rule of 68-95-99.7.

Header credit: Hugh McLeod Gaping void

 

A marketers explanation of Internal Rate of Return.

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