Documente Academic
Documente Profesional
Documente Cultură
trategy
S
&
usiness
lanning
B
P
rivately
of
eld
H C
ompanies
Peter McCann
McCann Corporate Consulting Associates
2000
Peter McCann. All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording, or otherwise, without the written permission of the author. However, the
purchaser of this publication may make copies of worksheets and checklists for his or her personal use
in the preparation of a strategic, business or financing plan for his or her company or employer; and,
reviewers of publications and academics may quote, with full attribution to the author and publisher,
sections of 500 words or less.
TABLE OF CONTENTS
TABLE OF CONTENTS................................................................................................................3
ACKNOWLEDGEMENTS..........................................................................................................11
CHAPTER 1: PLANNING THE PLAN ......................................................................................13
Getting The Most Benefit
The Eight Step Planning Process
13
13
16
17
18
19
21
22
22
23
23
24
24
25
26
28
29
30
31
32
33
34
34
35
35
36
37
Frugality
Urgency
The Paradigms
38
39
39
40
41
41
42
43
44
45
47
47
48
48
51
53
57
58
60
62
64
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67
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69
69
70
70
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71
71
72
72
72
73
74
74
74
75
75
75
Building Consensus
Who To Build A Consensus With
The Consensus Traps
76
76
78
80
80
80
82
83
83
84
85
85
86
87
87
87
88
88
89
90
91
92
94
95
96
96
97
97
98
99
99
100
DIAGRAM 5.2: REVENUE & COST STRATEGY, & POSITIONS ...................................... 101
Determining A Revenue Or Cost Focus
Getting To Know Your Costs
Costs By Year, Per Cent & Daily Rate
Fixed & Variable Costs
Conversion Of Fixed & Variable Expenses
Breakeven
Sales, Cost Of Sales & Gross Margin
102
102
102
103
104
105
105
Contribution Margin
Contribution Margin Return On Investment
106
107
108
108
109
110
110
112
113
114
114
115
116
118
118
118
118
118
119
119
119
119
120
120
120
120
121
121
123
123
124
124
125
125
126
127
127
130
133
135
136
137
138
138
138
139
140
140
141
141
142
143
144
145
146
147
148
149
150
150
151
151
152
153
154
154
155
156
157
159
160
161
162
162
162
163
163
163
164
165
167
167
169
169
170
171
172
Speculation
Ownership & Governance
Legal Form Of Business
Classes Of Shares
Ownership
173
174
174
174
175
177
179
179
180
182
182
184
185
186
187
188
190
190
191
192
199
200
201
201
201
Quantity Of Management
Managerial Time
Mapping Management
202
203
204
206
206
209
210
212
212
212
213
214
215
216
216
217
217
218
219
219
219
221
221
224
225
226
229
231
231
233
240
242
242
243
243
244
244
245
245
245
246
246
10
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250
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252
253
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257
262
263
265
265
266
11
ACKNOWLEDGEMENTS
I am responsible for any errors in this book; however, some special people are responsible for most of
the good ideas. I dedicate this book to these special people, and especially to an enduring friend,
Graham Parsons.
Graham Parsons, a senior bank executive, has a laser-like focus on major priorities and a finely honed
people sense. Rob Alloway, a retired printing executive, has a mastery of business logic and a
commitment to religion and creative writing. Warren Kettlewell, an industrialist and venture capitalist,
is the coolest negotiator that I know. Peter George, President of McMaster University, possesses wit,
charm and vision.
companies. He probably inspired the phrase tough as nails. Brian Decker, who has built two leading
international medical publishing companies, is focused, urbane and witty. Stan Dermer is a client,
psychiatrist, student of business and friend.
capabilities and limitations. They set clearly articulated priorities. They have superb people skills
appropriate to their industry. They are vigorously healthy, highly intelligent and aggressive. They also
work very hard.
We enjoy a high standard of living because generations of men and women have worked for years to
grow and ensure the survival of their businesses.
12
Students at the Kazak-American College of Business & the Humanities, Ust-Kamenogorsk, Kazakstan
have been a forum for the expression of ideas that evolved into this book. I owe thanks to many
outstanding teachers, notably Gerry Kirby at Algonquin College and Randy Kudar, Mike Leenders and
Jim Erskine of the Richard Ivey School of Business, University of Western Ontario.
13
Apply managerial
experience, vision and insight to make well-informed decisions. Discuss legal, tax and other technical
issues with the companys professional advisors.
14
urgency or immediacy, and the company's capacity or potential capacity to influence or control the
issues. Later in the planning process, reduce the issues to three mega priorities.
Research Key Issues
Research can be as simple as collecting information already in corporate accounting records and asking
customers and suppliers for comments and insights. More sophisticated research may involve detailed
assessment of cost accounting, identification of 'best practices' in the industry and psychological
assessments of the abilities and aptitudes of the senior management team.
Analyze
Analyze the information gained through research. Avoid premature conclusions; instead, think of
analysis as cracking an oyster to find the pearl of wisdom inside. The point of the analysis (and the
previous research) is to gain new knowledge, not to support pre-existing opinions.
Diagram 1.1: The Planning Process
Build A Consensus
Involve as many people as practical in the planning process. When someone is part of the planning,
the person will usually be an enthusiastic part of the implementing. Keep shareholders and the Board
Of Directors informed.
15
Plan
Remember the children's riddle: How do you eat an elephant? The answer is: One bite at a time.
Write the first draft of the plan 'one bite at a time.' Write detailed draft notes as each chapter is
completed, while issues and ideas are still fresh. Don't worry about perfection; the draft notes will be
thoroughly edited. Keep notes, information and analysis in clearly marked files. Good notes in
convenient files and folders will save hours of work during the final assembly of the written plan.
Act
Planning without implementation is self-indulgent. Action is not the tag end of the process: action is
the reason for the process. If a consensus is built and maintained during the planning process, action
can be dramatic and immediate.
implementation might be lengthy, but it should be relentless. If implementation cannot be planned, the
plan probably cannot be implemented. Plan the implementation.
Measure Results
The company's people, culture and policies (especially unwritten policies) may take years to transform;
therefore, old patterns may re-assert themselves.
reporting of key results compared to plan are essential to ensure that all personnel are aware of the
financial and non-financial goals and that all personnel work consistently to achieve the goals. Of
course, what is measured must be important, and must be controllable or influence-able by
management.
And Then, Start Over
Strategic plans will be relevant for two or three years in the broad corporate policy sense. After two or
three years, the competitive environment and the company's internal capabilities and cost structure will
have changed, and a new strategic plan should be written starting with the Survey step, in order to
minimize pre-conceived ideas. Business plans should be updated annually.
16
REASONS TO PLAN
Executives have a responsibility to create their company's success, one day at a time. Whether the
company is doing well or poorly, executives plan to do better. Effective executives plan to win.
Competition is win-lose, and the losers do not receive a consolation prize in bankruptcy court.
Effective planning increases the probability of victory.
A small shift in odds can produce large long-term gains. Assume a business has an annual after-tax
income of $100,000, a growth rate of 1%, and a risk of failure (due to industry dynamics or any other
reason) of 3% in any given year. The expected value of Retained Earnings after 20 years will be
$1,209,000. If effective planning raises the growth rate from 1% to 3% and decreases the risk of
failure from 3% to 1%, then the expected value of Retained Earnings rises from $1,209,000 to
$2,263,000. $1,000,000 more, just by shifting the odds a little!
Table: Expected Value Of Retained Earnings After 20 Years
Annual Growth Rate of 1%
Annual Growth Rate of 2%
Annual Growth Rate of 3%
Failure Rate of 3%
$1,209,355
$1,347,703
$1,505,032
Failure Rate of 2%
$1,484,706
$1,654,554
$1,847,704
Failure Rate of 1%
$1,818,959
$2,027,045
$2,263,679
Executives of privately held companies plan to control the agenda. Without planning and a coherent
corporate agenda, the availability of capital will control the company access to capital will drive
marketing and product development decisions. A company without a plan is a ship without a rudder.
Emerging industry trends and shifting customer preferences will overwhelm and sink the rudderless
company. The world is changing, for a hundred reasons and in a thousand ways. There is no longer
stability in the external environment. Businesses are hamsters on the treadmill of change, and the
treadmill is getting faster and faster. Only the nimble will prosper. Nonetheless, the world still
revolves around its axis - individual human beings who eat, drink, work, walk, sleep, love and want to
be loved, and die. Human needs and personalities are not different, only the manifestations influenced
by culture, technology and economic conditions are different.
adoption of technology is still slow enough that companies can respond. Attentive executives can spot
emerging trends and industries. Privately held companies can plan to survive, grow and prosper.
17
Executives plan to avoid decision errors. One of the causes of decision errors is knee-jerk decisionmaking, usually explained as 'we've always done it this way', or 'it looked like a good opportunity at
the time'. Good planning requires good data and good analysis, which reduce decision errors.
Although strategic planning is ultimately the responsibility of the Board Of Directors, it is commonly
delegated to senior management.
management in strategic and business planning to develop their thinking to encompass a longer time
horizon and a broader appreciation of aspects and disciplines of modern business. (In a family
business, involving second generation family members in a vigorous business planning exercise can be
especially beneficial.) The completed plan can and should be used as an accountability tool: the Board
Of Directors should hold the President accountable for the results, and the President should hold the
marketing, operations, finance and administration managers or Vice-Presidents accountable for their
results compared to the plan.
ROADBLOCKS
Privately held companies may not prepare comprehensive strategic or business plans for many reasons.
The most common reason is that planning is too time consuming for people already overloaded with
duties and tasks that have more immediate benefit to their companies. Unfortunately, planning is
demanding work. Fortunately, planning may be divided into successive, manageable stages and some
of the work may be delegated to managers of the accounting, marketing and operations departments.
The busy executive must make the effort to plan now to harvest the future benefits of sharper focus,
higher profits and a more tolerable workload.
Executives may believe that they do not need to write what they know already. However, the process
of writing a formal plan may produce startling benefits. The process should involve the examination
of implicit assumptions, an identification of gaps in information and erroneous information, and a
review of commercial logic as currently applied by the company. In addition, written plans effectively
communicate corporate direction and expected results to staff, Boards Of Directors and lenders.
18
Executives of financially distressed companies may assert that they do not need a plan, they need more
money. Failing businesses need a plan to use the available resources more effectively, or a plan that
shows that additional financing will be used more effectively than past funding.
There are four 'paralysis' roadblocks to successful completion of strategic and business plans.
Paralysis by analysis, paralysis by pursuit of perfection and paralysis by indecision are closely related:
they are based on a fear of mistakes leading to endless analysis in the search for the incontestable
answer. The antidote is the recognition that life must be lived and that decisions must be made on the
best available information analyzed most correctly within a reasonable time. The fourth 'paralysis'
roadblock is paralysis by procrastination. Years ago a man said, "Never do today what you can put off
to tomorrow." Put off planning long enough, and the company will be left behind by its customers and
competitors. Make a decision to complete a strategic or business plan in a defined time, and do each
component, using the following chapters, in an orderly, disciplined manner.
SPEED BUMPS
The first speed bump that prevents planning well is the mistaken belief that the company's industry is
unique. It is not unique. The fur industry, envelope manufacturing, retail building supplies, wholesale
office products, charities, construction companies and high and mid technology manufacturing
companies have far more commonalties than differences. Each is competitive, faces changes in
government regulation and is challenged by technology. It is far better to learn from other industries
(cross-pollination of managerial approaches) than to deny the opportunities to learn.
The second speed bump is the belief that the company itself is unique. Companies, like people, are
different but have immense similarities.
19
large, single purpose, irreversible investments such as an oil refinery or a pulp and paper mill.
Companies with dissimilar divisions (example: a retail division and a manufacturing division) should
do plans for each division, and then tie the divisional plans and projections together in a summary.
20
In privately held companies, there may not be the time, staff or need to prepare multi-layered plans.
The goal should be to create actions with high impact on important business dimensions. Planning
should stop when what is being planned will not have a significant impact on customers, products, staff
and profits. For many privately held companies, one integrated plan, covering strategic, business and
major functional issues is better than multi-layered plans. Companies preparing their first formal plan
should remember the K.I.S.S. acronym (Keep It Simple, Silly!).
Congruence And Harmony
The functional components should support and be congruent with the business plan, which should
support and be congruent with the strategic plan. Congruence includes agreement across functional
areas. For example, if Operations wants a $4,500,000 plant expansion in the second year and Finance
wants a redemption of $3,000,000 of Preferred Shares in the third year, there may not be enough
money or borrowing capacity to do both. Achieving congruence amongst the strategic, business and
21
functional components of the overall plan and across the functional components is a back and forth
process of reconciling the desirable with the practical.
Congruence does not, necessarily, mean harmony amongst functional managers; in fact, achieving
harmony amongst functional managers through negotiation between senior or departmental managers,
who may have conflicting priorities, may produce sub-optimal decisions. Although the perspectives of
different managers should be considered, the company's best interests should inarguably dominate all
decision-making - and the arbitrator of what is in the company's best interests is the company's Board
Of Directors (if a well functioning Board exists) and its President.
FINANCING PLANS
Financing plans or financing proposals (the terms are interchangeable) are written to attract loans and
equity investment. Therefore, the financing plan is not really a plan; it is a selling tool. It is to spark
lenders' and investors' interests. Lenders and investors who are interested will then do their review and
investigation (called due diligence) before committing funds. The final editing of the financing plan
should reflect a sales orientation.
Of course, every statement and representation should be true and verifiable.
An independent
consultant or auditor should review the document thoroughly. Each jurisdiction has its own laws, but
generally a solicitation of investment cannot be widely distributed without approval by the local
securities authorities. Discuss the scope of distribution of the financing plan with the company's
lawyer. This book emphasizes strategic and business plans.
Good strategic and tactical plans, with editing, make superb financing plans.
contains an outline of typical strategic, business and financing plans. To quickly prepare a financing
plan, review the outline in the final chapter and then resume reading this chapter.
Table: Strategic, Business, Functional & Financing Plans
Why
Strategic Plans
Sets long term
objectives.
Business Plans
Sets annual goals and
actions; supports the
strategic plan.
Functional Plans
Financing Plan
Describes departmental To attract lender or
actions to implement the investor interest.
business plan.
Horizon
Scope
What
5 - 10 years or longer,
with detailed analysis
covering 1 - 3 years.
Status & trends of
market, competition,
technology and
company capabilities.
Big picture; how to deal
successfully with the
internal and external
environment.
The President.
22
Usually 1 - 3 years.
Usually 6 - 12 months.
Products or markets to
be developed, projected
investments and returns.
Specific departments:
Operations, Purchasing,
Marketing, etc.
Yes
No
23
24
Characteristics*
History
becomes the collective mentality of the business. One business may have been quite successful due to
an expansion program, and the collective mentality may be ''we'll take whatever risks and make
whatever investments needed to grow." Corporate history should be described in three parts: start up,
25
early operations, recent operations. If the business was established ten or more years previously, the
descriptions of the start up and early operations should be brief.
Worksheet: History
Start-Up
Who - Give the names and describe the roles of the people and the organizations actively involved in establishing this
business. Give some brief details about each founding person or organization.
Why - Why did the founding persons or organizations want to start a) a business and b) this particular business?
What - What was the original name of the business? Describe the original goals of the business. Include products to
be made or sold, markets to be served, growth objectives, and philosophy regarding employees, customers and quality.
When - Year and month that the business was formed, and when it started operations.
Where - Describe briefly the original premises and equipment.
How How was the business established (proprietorship, partnership, corporation, limited partnership, joint venture)?
How Much - How much was invested by each founding person and in what form (cash, bank guarantees, etc.)?
How Many - How many employees were there in the beginning?
Early Operations
Incorporation - If the business was incorporated after its start-up, when, by whom, what jurisdiction?
Name Changes - If the name was changed, why and the new name?
Original and early products:
Original and early suppliers:
Original and early customers:
Original and early competition:
Sales & Profits in the first two or three years:
Changes in business, social or economic conditions during the early years, and the companys response:
Recent Five Years Of Operations
Product changes:
Customer changes:
Operational changes:
Technology changes:
Competition changes:
Premises and equipment changes:
Management changes:
Personnel changes:
Organizational changes:
Union events:
Shareholder changes:
Regulatory changes:
What was done right?
What big mistakes were made?
What big mistakes were avoided?
What was not done which, with hindsight, should have been done?
What major problems or crises were successfully faced?
What key opportunities were taken advantage of? Not taken advantage of? Why?
Non-Financial Progress
Financial information is important, but incomplete.
corporate performance may provide stronger insights than historical financial performance.
26
No
27
WYN Most chapters end with 'WYN' (Write Your Notes). Detailed notes will capture the
Write
Your invaluable first impressions and most creative ideas. This will simplify the later task of
Notes preparing a detailed, intelligent plan. Record what type of plan is to be prepared, why, the
intended readers, the companys history and what lessons have been correctly or
incorrectly learned.
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THE POSITIONS
The five basic Positions of corporate vitality may be compared to an individual's athletic condition,
which is a summation of cardiovascular condition, muscular development, flexibility, co-ordination
and balance. An individual should know his or her condition before starting an exercise program and a
company should know its Position before launching a strategic initiative. Each Position describes a
cluster of interrelated characteristics. Characteristics include a company's financial and non-financial
resources and capacity to grow, adapt and compete.
characteristics has more attractive choices than a company with negative characteristics.
Table: Comparison Of Positions & Athletic Conditions
Position
Go For Gold
Status Quo
Tune Up
Turnaround
Get Out
Athletic Condition
Ready for the Olympics.
Once superb, but no longer competitive at an Olympic level.
Not ill but not athletic; may be overweight and under exercised.
Smokes; eats and drinks to excess.
Severe health problems.
Low
U
R
G
E
N
C
Y
High
Many Problems
Strong Performance
Note: the size of each Position suggests the estimated proportion of companies in each Position. Overlaps indicate that
differences between adjoining Positions may be blurred at the margin.
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GET OUT
The obvious Get Out companies have large operating losses, negative working capital and equity,
obsolete products, weak staff and inadequate management. In short, these companies are a waste of
scarce economic resources and speedy closure will minimize losses to suppliers, lenders and owners.
Closure may be by voluntary liquidation or by bankruptcy.
There is another category of Get Out companies: profitable companies in a declining industry or
companies without the financial or managerial resources to compete in a rapidly growing or changing
industry. These companies can be distinguished from Status Quo, Tune Up or Turnaround companies
by the severity of the medium to long term challenges posed by the external environment relative to
their internal financial and managerial resources. These Get Out companies may be sold to stronger
competitors, suppliers or customers or they may be phased out over many months.
Of the five Positions, the Get Out position is the hardest for shareholders and executives to accept
intellectually and emotionally. Procrastination concerning an exit decision when a company is, truly,
in the Get Out position may result in large operating losses and less recovery of equity when the exit
decision is finally made and implemented. Procrastination can result in the shareholders retiring with
less and perhaps much less retirement wealth. An exit decision is not a negative choice. For Get Out
companies, an exit strategy is a positive strategic option to re-deploy equity from a high risk, single
company (the classic 'all the eggs in one basket' problem) to lower risk, diversified investments such as
a balanced equity portfolio.
Shareholders of Get Out companies should be cautious of advice from staff that 'the business will
improve.' Staff may have a myopic vision and a conflict of interest in that their jobs may be threatened
by an exit decision.
considerations such as providing on-going employment for family members: if the company is truly in
the Get Out Position, the family members will become unemployed sooner or later.
Finally, diagnosing Get Out companies requires professional insight and objectivity.
Call an
independent professional (not the companys current accountancy or legal firm) to discuss and review
30
the diagnosis. Then, prepare scenarios and projections to determine the optimum exit strategy. Do not
finalize an exit diagnosis without a professional opinion. Do not implement an exit strategy without
professional assistance.
TURNAROUND
Turnaround companies are on a collision course with bankruptcy. Turnaround companies may have
operating losses, decreasing equity and weak working capital. Suppliers and especially the bank may
be nervous and may try to reduce their exposure. In severe cases, paying the payroll may be a
problem. Turnaround companies in healthy, growing industries can often be saved. Companies in
declining industries may face the double obstacles of internal problems and intensifying competitive
pressures on pricing and margins. Companies in rapidly growing industries may face the double
obstacles of internal problems and intensifying competitive pressures to achieve technological and
quality leadership. Conversely, turnaround companies which are fundamentally sound but which have
incurred substantial loses due to an unsuccessful technological leap, an acquisition or a major
expansion ('bet the company and lost') may be saved by the simple expedients of ending the mistake
('cutting the losses') and, perhaps, attracting additional equity investment.
Shareholders and management may be overwhelmed by the problems, dispirited by past errors and
failures and paralyzed by fear that further mistakes might cause irreparable damage. Accordingly,
some Turnaround companies sink into the Get Out Position and drift into oblivion. In other cases,
management may panic and make radical changes in products or customer and supplier relationships in
order to gain temporary cash flow improvements at the sacrifice of medium and longer-term viability.
31
profitability or competitiveness. Product quality may rank near the bottom of the industry and may be
produced by outmoded and expensive processes.
managerial indifference may have caused excessive overheads, and overheads become onerous as
revenues stagnate or fall.
Due to the typical creditor pressures, the planning and implementation process should be compressed.
Company management should not attempt a turnaround without experienced professional assistance.
TUNE UP
Tune Up companies are too healthy to die, too sick to prosper. Financial results are mediocre and
slipping. Cash flow may be insufficient for investment in new technology. Overheads are probably
high. Management may not have kept pace with accelerating requirements for sophisticated business
acumen, product quality and productivity. Tune Up companies may be in industries that are growing
or stable; however, Tune Up companies may rapidly reach a crisis if a new industry player or
technology intensifies competition.
Tune Up companies may not know their customers and likely use a stale marketing strategy; but they
may still have some customer loyalty or brand awareness. Products may have been surpassed by the
32
products of several competitors. Research & Development and marketing may be spread over too
many products, with the result that no product has been adequately rejuvenated.
The shareholders, Boards Of Directors, management and staff may be similar to those of Status Quo
companies, with the important exception that in Tune Up companies there may be a widespread but
possibly undefined sense that some change is required. Accordingly, a meaningful, permanent attitude
shift may be easier to achieve in Tune Up companies than in Status Quo companies.
Overall, Tune Up companies may have many moderate weaknesses, but they also have some building
blocks of success, such as an established customer base, adequate products and management and staff
with the potential to be re-energized and re-focused.
STATUS QUO
Status Quo companies are characterized by stability, and stability is the state immediately preceding
decline. They are living on the benefits of past achievements, harvesting yesterday's efforts and
investments. Status Quo companies were probably at one time Go For Gold companies that became
self-satisfied and lost a sense of Urgency. Status Quo companies may be good at either Marketing or
Operations, and adequate at the other. They may be in mature industries that have not yet been
ravaged by an innovative player. They may not have kept pace with industry gains in quality and
productivity, but the lag may be moderate and thus not a major disadvantage at the moment. Status
Quo companies are not, almost by definition, in embryonic or rapidly growing industries.
Status Quo companies may be owned and managed by a President who worked many years to build the
company and is now worn-out, risk adverse and out-of-touch with current competitive conditions. Or,
Status Quo companies may be owned by a family with management vested in the second or third
generation, which may attempt to perpetuate antiquated business practices, or a hired administrator
who may seek the illusion of stability by risk avoidance (instead of risk management).
33
Shareholders are complacent and undemanding. Good performance is considered to be the avoidance
of losses and, perhaps, the payment of token dividends. The Board Of Directors may be old family
friends or family members, and everyone has grown old and tired together.
Financial results are mediocre and management and shareholders are satisfied. Revenues and earnings
may have been stable or slightly declining (especially on an inflation-adjusted basis) for several years.
However, working capital and debt / equity ratios may be strong as earnings are accumulated as cash
or applied as reductions of debt rather than used for expansion or dividends. Capital expenditures may
be for replacement of assets rather than improvement of the company's products or cost structure.
Overheads may be excessive due to reluctance to deal with under-performing products, divisions and
individuals.
Status Quo companies may honor all the Principles, except Urgency. Status Quo companies distrust
Urgency because it is not safe: Urgency disrupts established practices and relationships. Frugality may
dominate because it is a safe principle: there is little risk in saving money.
Overall, Status Quo companies are not in bad shape; there is time to make the right changes the right
way. A meaningful, permanent attitude shift in management will be the major challenge and may take
at least a year (in a family business, change may take two or three years).
GO FOR GOLD
Go For Gold companies are ready to compete for the gold medal of the business Olympics (which is
held every day, not just once every four years). Go For Gold companies are not perfect companies:
they do not do everything superbly well; but, they do know what's important and they do all the
important things well and some important things superbly.
operations, and are good at the other. They know what they do well and they focus on doing it better.
They focus on their strengths. Their industries may be embryonic, growing or mature; but their
industries are not dying.
34
Shareholders demand performance appropriate to the maturity of the company and industry. A strong
Board Of Directors represents shareholders. Management may be a single entrepreneur or a team of
dynamic, seasoned professionals who think like entrepreneurs. Management has a vision of excellence
and market domination. Management accepts risk as being inherent in progress and growth but has a
clear sense of the acceptable level of risk. Staff know that people who share the vision and contribute
to their companies' success are appreciated and rewarded with money, challenges and security. Staff
know that the only job security is the security of doing good work for a competitive, successful
company.
Financial results are strong. Earnings are re-invested in planned growth. Rapidly growing companies
may sell equity to outside investors in order to maintain working capital and debt / equity ratios within
prudent limits. Cost control systems are up-to-date and are used by management. Productivity and
performance measurements are tracked and monitored. Overheads are appropriate to company needs.
Strategic goals determine capital expenditures.
35
THE PRINCIPLES
The fundamental Principles are Ethics, Focus, Excellence, Frugality and Urgency. Go For Gold
companies live and breathe these principles.
proclaiming tired slogans.
ETHICS
Ethics are not in short supply.
There are ten cases of quiet ethical behavior for every single
questionable act. Many ethical errors are not due to malice or greed; the errors are due to executives
swamped by activities and demands on their time and so rushed that they do not take the time to think
through issues and implications. Some supposed ethical errors are, on closer examination, not ethical
failures but rather an honestly held difference in opinion concerning, for example, environmental
issues and investments in countries governed by repressive regimes. Of course, ethical lapses and
violations do occur, but the fact that violations of ethics are disturbing indicates that the business
community does have a deep sense of ethics.
Do not confuse ethics with mushiness. Executives must have the guts to make difficult and even
unpopular decisions. Occasionally, executives wrap themselves in the cloak of self-righteousness,
masking procrastination and befuddlement. Bankrupt companies contribute to the world by their
demise, which frees up badly used resources; good companies contribute by their success. Have the
courage to be a leader, ethically.
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FOCUS
Focus recognizes that we cannot satisfy all the world's customers, we cannot make all the world's
products and we cannot seize all the world's opportunities. Large companies grew larger in the 1960s
and 1970s by buying unrelated businesses. The rationale was to achieve diversification of risk for
shareholders by income smoothing across cyclical industries and to increase Return On Equity by
maximizing managerial and financial economies of scale. In the 1980s, corporate raiders used hostile
takeovers to seize control of diversified companies with the intent to 'maximize shareholder value',
usually by selling non-core divisions and subsidiaries. In the 1990s, many mergers and acquisitions
were intended to strengthen the acquiring companys core.
In a highly competitive world, a company must focus on its core customers and core products, or its
customers will be lured away by aggressive competitors with newer products and superior marketing.
It takes managerial talent and money to compete, and diversification dilutes both.
As a simple rule-of-thumb, drop at least one product line, division or activity for every five years in
operations. The reason is fairly simple: over the years new products, divisions and activities were, no
doubt, added in response to the changing competitive environment. In almost all cases, the changed
environment rendered some products, divisions or activities uncompetitive and unprofitable or
marginally profitable.
Example - Focus & Managerial Time
In 1979 the President and co-founder of a rapidly growing high technology company started to
devote at least some of his time and prodigious talent to personal investments in unrelated
industries. In a few years his company lost its research leadership, then its product leadership
and then its market share. The company was eventually sold and has since failed to rekindle
the dynamics of the late 1970s.
Example - Focus & Financial Resources
In the 1980s a successful multi-location retailer invested heavily in property development,
diverting managerial time and cash flow. During the recession of the early 1990s, the company
did not have sufficient financial resources and management depth to exploit acquisition
opportunities or to refurbish and re-market either its retail operations or its property
developments. The company's growth stalled while its retail competitors gained market share.
The company has not regained its former glory.
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EXCELLENCE
Excellence is exceeding customers' expectations. Excellence is an attitude and a personal value
system.
Companies expect excellence from their suppliers, although they themselves may not
especially strive to give excellence. If companies do not achieve excellence, they will lose their
customers and may even contribute to their customers demise.
If the company does not know what standards of excellence are preferred or required by its customers,
ask the customers. Presidents of manufacturing and distribution companies, managing partners of
legal and accountancy firms and managers of bank commercial lending centers should be meeting with
at least one client a week. They should ask what that customer wants, what that customer views as
excellence, what the company, firm or bank could do less or more or better or faster. Organize
luncheons, inviting customers and staff to discuss how to provide excellence (as defined by the
customers). If the company thinks that it knows its customers expectations, ask the customers in order
to validate (or, invalidate) its assumptions.
Excellence and quality are, in many instances, used interchangeably but they are subtly different.
Excellence looks outward to customers' expectations (although the 'customer' may be another
department or assembly plant of the same company). Quality looks inward to the company's products
and processes. Quality initiatives should be used to serve excellence; quality is not a substitute for
excellence.
Quality can be measured, precisely and reliably. Improved methods of doing things right the first time
reduce the cost of rework and end-of-line inspection in the factory, the cost of post-sales service and
the real but intangible cost of dissatisfied customers. Savings of 5% to 12% are often attributed to
intelligent efforts to improve quality. Statistical Process Control is widely used in manufacturing and
SPC can be applied to white collar jobs too. It is possible to measure the contribution margin of bank
credit personnel, the efficiency of telemarketers and the effectiveness of surgeons.
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Excellence, on the other hand, is less easily measured; but measurement of excellence is essential.
Informally and formally survey customers, potential customers and, perhaps most importantly, past
customers on their perceptions of the value of their total experience with the company. Develop and
use systems to measure what customers like or dislike.
FRUGALITY
To be frugal, a company must know its costs, and most executives do not really know their costs.
Business people rely on their financial statements without realizing the basis on which their financial
statements are prepared. The basis for the preparation of financial statements has evolved and
broadened over the last one hundred years from a purely stewardship reporting basis. Nonetheless,
financial statements remain largely a report to legitimately interested parties, such as shareholders,
lenders and governments.
Management, on the other hand, needs information to make rational decisions. Getting the information
is management's responsibility, not the auditors. Using total transportation costs as an example,
financial statements do not report: "The cost of moving stuff around." The component costs are
reported, and the frugal company will look to a systemic solution.
$ 67,125.
$ 12,008.
$ 9,438.
$ 22,736.
$ 97,019.
$ 50,673.
The frugal company will assess capital expenditures on the basis of net purchase costs plus operating
costs over the assets estimated time of use. It will use linear programming to improve the routing
efficiency of vehicles, possibly leading to a reduction in the number of vehicles and drivers required to
give excellence service. It will ask why products or components have to be moved within a factory or
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warehouse. It will always ask if there is a different total expenditure that will produce both excellence
and greater financial returns.
Example - Frugality In Action
One furniture manufacturer moves its products directly from the end of the production line onto
tractor trailers, which reduces to almost zero the interest, insurance, space, security and
warehouse logistics costs associated with finished goods. That's frugality in action.
URGENCY
Businesses with a sense of urgency almost always are more successful. They identify and seize
opportunities. When they make mistakes, they act quickly and decisively to correct their mistakes.
Urgency is being aware that the hostile environment will probably worsen. Urgency is knowing that
the light at the end of the tunnel is a train coming. Urgency is Ready! Aim! Fire! Getting ready is
important, but does not justify paralysis by analysis. Taking aim is important, but executives should
not become too contemplative: executives are not academics or reclusive philosophers. Executives
must manage within a hostile, intensely competitive environment. Someone who shoots from the hip
may blow away three toes, but leaders do not freeze in the face of challenge.
Urgency may be the most dangerous principle if used in isolation from the other principles. Urgency is
not an excuse for reliance on intuition at the expense of sound research and analysis or shoddy
preparation leading to flawed implementation. Urgency should not be confused with vigorous pursuit
of a wrong, hastily identified objective. Urgency is acting decisively on the best available information.
Example - Asleep At The Wheel
In 1976, a business had been in default for several months. The banker went to the company's
offices with a demand for immediate payment in full. What was the President doing? He was
working on the fifth draft of the next year's business plan. No sense of urgency, no sense of
reality.
THE PARADIGMS
A paradigm is a pattern or intellectual framework. Paradigms are important because they affect our
perceptions and actions. A capitalist and a socialist have different paradigms and will, therefore, draw
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different conclusions from the same economic data about employment, government deficits and gross
domestic product. Reliance on a single Paradigm may be simplistic but the six Paradigms together
provide a holistic approach to management.
Diagram 2.4: Paradigms
MICROECONOMIC PARADIGM
This paradigm states that industry structure, technology and company specific knowledge drive
conduct which drives performance. It is a powerful tool for examining performance and strategic
options.
Clich To Live By - The Microeconomic Paradigm
You need to know where the other cars on the freeway are going.
Example - Microeconomic Paradigm - Machine Shop
In 1989, a machine shop's profits were marginal. The industry structure was divided into
segments: manufacturers without machining capability, manufacturers with machining
capability sufficient for all their needs, manufacturers with machining needs sufficient for their
normal, but not peak, needs, and independent machine shops. It was expected that in a
recession industry demand for machining would decrease, and manufacturers with machining
capability would use their own staff and equipment and stop using independent machine shops.
Therefore, a small decline in total demand could result in a large decline for independent
machine shops - meaning that operating losses were possible or likely. The companys bank
requested that the company move its account to a different bank. The company did not address
its operating problems. In 1991, a recession started and profits turned to losses. The new bank
called its loan and liquidated the company. The first bank understood the implications of the
Microeconomic Paradigm. The second bank and company management did not. The second
bank and the shareholders of the company lost a great deal of money.
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ACCOUNTANTS' PARADIGM
The Accountants' Paradigm states that understanding financial statements is mandatory to
understanding business. Common techniques include analysis of revenues, expenses, profits, assets,
liabilities and asset and expense ratios. It is a practical tool to identify many symptoms and some
causes of corporate performance. Over reliance on the Accountants' Paradigm can lead to treating the
symptoms and not the causes of performance. Nonetheless, neglect of the Accountants' Paradigm is a
far more common problem than over reliance on it. In fact, failure to understand the numbers is an
early warning sign of a possible business failure. One revealing comment is "We're losing money
now, but we'll make it up on volume." For many privately held companies, sophisticated financial
techniques are rarely required; but understanding the basic numbers is always essential.
Example - Accountants' Paradigm - An Absentee Shareholder
In 1987, an absentee (i.e. not involved in running the company) majority shareholder of a
medium sized service business did not understand why sales were high and profits were low.
Key information, presented in two pages of narrative and two graphs, showed that hired
managers were taking excessive money from the company and the payments were 'buried' in
fragments in several line items on the Income Statement. Management changes were made and
profits increased.
Example - Accountants' Paradigm - A Commodity Metals Broker
In 1988, a commodity metals broker established a manufacturing division. In the next eight
months the company recorded large losses. A little research revealed that product costing was
wrong. The company thought it had a positive margin on its product, but in fact its direct
expenses were 109% of product sales. Therefore, as sales grew, losses grew. Brokerage
activities were profitable but slipping in volume because key managerial talent was
concentrating on manufacturing. The company increased its product price by 25%, which its
major customer accepted, a management change was made, and the President devoted more
time to commodity brokerage. The company recovered.
Clich To Live By - Accountants' Paradigm
Know your numbers; accounting is too important to leave to the accountants.
MARKETING PARADIGM
The Marketing Paradigm is about satisfying customers profitably. It is about the basics: product, price,
promotion, place, customer, channel of distribution, contribution margin and, definitely, profit. It is a
useful tool to identify some of the causes of under performance and to indicate possible remedial
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actions. Some companies have suffered due to marketing thinking and methods that may have been
productive at one time but that became stale and unproductive over the years.
Example - Neglect Of The Marketing Paradigm
In the five years to 1991, a Niagara Falls hotel incurred moderate losses. It had high fixed
costs; therefore, it was sensitive to sales fluctuations. Its product was seasonal, with 70% of its
sales between May 1st and September 30th. In late November, the President expected to repeat
the following year the same marketing program, with minor variations, that he had used for the
previous five years. The company's accountants recommended cost cutting. The President cut
costs and did not change marketing. Cost cutting was not sufficient to restore profitability.
The bank called its loan in June, 1992.
Clich To Live By - Marketing Paradigm
Yesterday's marketing won't sell tomorrow.
OPERATIONS PARADIGM
The Operations Paradigm creates value. It is about making and delivering customer satisfaction through purchasing, manufacturing, logistics, research and development, products, processes, quality
and cost effectiveness. The study of Operations as a distinct discipline started with manufacturing.
The tools of modern operations management are now applied to distributors (vehicle utilization
planning), banks (efficient credit card processing), restaurants (food flow in kitchens), hospitals
(purchasing and inventory management) and accounting firms (audit scheduling).
Misuse of the operations paradigm may lead to capital investments that strain a company's financial or
marketing resources or to over-engineering of products. Under-performing companies may turn to big,
expensive technological solutions, such as the introduction of robotics or computer-integrated
manufacturing.
These solutions are sometimes called quick fixes, moon-shots or 'let's bet the
company projects. Alternatively, companies may turn to the panacea currently in vogue, such as justin-time inventory management, quality circles, statistical process control, time based management or
re-engineering. Companies that are owned or operated by stereotypical engineers or research scientists
may fail to match the investment in technology with market conditions and corporate resources.
Neglect or ignorance is a more common problem than the over enthusiastic embrace of the Operations
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Paradigm. Marketing and finance executives may emphasize their specialty and ignore the importance
of operations, to the long-term detriment of their companies.
Generally, companies should progress by incrementalism, making a steady stream of small,
inexpensive process improvements that are consistent with corporate resources and supportive of
corporate strategy. Incrementalism will not overwhelm managerial or financial resources and may
yield better returns on investment than expensive and complex solutions.
Example - Disdain For Operations
The President of a manufacturing company was an MBA from a prominent business school.
His offices were at the front of the plant. He referred to the company's manufacturing
derisively as "...behind the wall...", as if it was on a different planet and populated by different
and lesser beings. He neglected manufacturing despite the fact that the company's products
were labor intensive, that total manufacturing costs were 75% of sales, that foreign competitors
were taking market share based on price, and that the company had not significantly improved
either its manufacturing technology or processes in the last thirty years. The company was
seriously under-performing.
Clich To Live By - Operations
Operations is where we create or destroy customer satisfaction and our competitive advantage
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sensitivity training and too few customer service evaluations, warranty claims analysis and product
defect reduction programs.
Neglect of the Organizational Behavior Paradigm is a more common problem. Senior executives may
prefer a tax audit or a dental appointment to an afternoon assessing corporate training needs or an
employee performance appraisal. Organizational issues are important and need to be addressed in
every strategic and business plan - and during every working day of every executive. Even obviously
simple issues may have an underlying Organizational Behavior dimension that may furnish the
solution (or part of the solution).
Example - Organizational Behavior Paradigm
In 1990, a manufacturer had sales of $14,000,000. 45% of its total assets were accounts
receivable. Bad debts were $150,000 per year during the economic boom of 1985-1990.
Credit was more or less granted by the salespeople who were paid a commission when the
order was invoiced. Credit collection was the responsibility of the same salespeople who
booked the original order and who were at times trying to make a repeat sale to an overdue
account. The President made some changes: the Controller became responsible for all credit
arrangements and, after a phase in period, commissions became payable on collected sales.
This matched the right organization chart, the right person (the controller who was very
competent) and the right task, and matched the reward system (payment of commissions when
sales collected) with corporate goals (collect accounts receivable).
Clich To Live By - Organizational Behavior
Organizational behavior affects profits, so pay attention.
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The positive power of a manager's vision and values can inspire creativity, unparalleled constructive
effort, new heights of personal and corporate achievement and breakthrough innovations in products,
processes and services. The vision may be as simple as being the best lead pencil manufacturer in the
world or as grand as designing the first long term space habitat. The Managerial Preference drives the
choice of objectives and the pace and nature of efforts to achieve the objectives. The Managerial
Preference can be very basic: we are in the car rental business, gladiola farming or astrophysics book
publishing.
Managerial Preferences unchecked by reality and ethics can lead to disaster. Managerial Preferences
must be consistent with the external environment and with corporate capabilities.
The external
environment includes market demand, available technology, competition and regulation. Corporate
capabilities include financial resources, staff skills and managerial talent.
Example - Managerial Preferences Conflicting With Capabilities
Two specialists owned a thriving distribution business, which had been built on their product
knowledge and sales professionalism. The specialists decided that they wanted to grow into a
larger distribution business with a broad product range and a more diverse customer base.
However, neither shareholder wanted to become a 'manager', neither wanted to delegate
managerial control, and neither wanted to devote the considerable time required to become
expert in the expanded product line. In short, they wanted to operate as they had in past but
on a much larger scale. In two years, they doubled staff and sales dropped 30%.
Example - Managerial Preferences Conflicting With Shareholder Interests
In 1989 the President and Vice-President Finance of the American subsidiary of a German
food processor wanted the subsidiary to buy another, unrelated company. They admitted that
the reason was that 'running a bigger company would be fun.' They told the consultant that
his report on the proposed acquisition would need to be sufficiently positive in order to get
approval of the acquisition by the parent company. (The consultant declined the
engagement.)
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Marketing over Operations can lead to overspending on marketing and a neglect of product and
process improvements. The most striking imbalance is seen in cases of the Managerial Preferences
Paradigm dominating all other considerations.
Clich To Live By Managerial Preferences
A strong ego unsupported by objective data makes noise and sheds no light.
If hard data and intuition are contradictory, get more data.
Example - Decisions Dominated By Managerial Preferences
In 1977 the owner of a logging operation set up a mini-pulp plant. He borrowed heavily,
compared to his equity base, to build a ramshackle plant with second and third hand
equipment. He did not have and did not hire qualified technical people. After three years of
losses, he faced bankruptcy. Luckily a major corporation needed extra pulp capacity to meet
surge demand and bought everything except the logging operation, and the owner recovered
his investment. In 1986 he set up another mini-pulp mill, again borrowing heavily, again
building a ramshackle plant with appalling safety hazards and again not hiring qualified
technical people. By 1988, he had incurred huge losses and was again facing bankruptcy.
When asked why he had set up another plant, he replied in a wistful, little boy voice "I
always wanted to be a forestry executive." This man's biases were so strong that he refused
to look at reality objectively (not enough money, did not know the technology, inflated view
of his personal capabilities).
Example - Strategic Decision Without Financial Resources To Implement
In 1993, a company embarked on a strategic change of direction and incurred major capital
expenditures to produce a new product for a new market. 1996 sales and profits were
disappointing. Management asked the bank to lend and the absentee shareholder to invest
more money to sustain the company until the forecast sales and profits materialized. The bank
refused. A review commissioned by the shareholder indicated a possibility of losing both the
existing and the proposed investment. The shareholder sold the company.
WYN
Write
Your
Notes
If the Position Quiz (in the Appendices) has not been completed, do it now. Identify the
companys Position. List issues that indicate its Position. Record all ideas, observations,
questions, potential choices and strategies. What principles are applied? Not applied?
What paradigms dominate? Are neglected?
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Strategy is about long term, wide impact corporate decisions. Tactics are about short term, narrow
impact decisions. In practice, the distinction between strategy and tactics is blurred. An immense
variety of topics are described as strategic: strategic financial management, strategic corporate
intelligence gathering, strategic information technology and so on.
described as tactics influenced by strategy or strategy with tactical implications or, simply, tactical
strategy.
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Dominant Paradigms
Managerial Preferences, Accountants'.
Microeconomic, Managerial Preferences.
Accountants'.
Marketing.
Operations.
Organizational Behavior.
Organizational Behavior, Marketing, Operations, Accountants', Microeconomic,
Managerial Preferences, depending on what is being changed and why.
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Prudent executives identify potential shareholders with goals congruent with the company's goals. A
company with a long term commitment to developing a regional chain of nursing homes may have
needs and goals congruent with a pension fund but not congruent with a venture capital fund with a
three to five year investment holding horizon.
A vexing problem arises when current shareholders have conflicting needs and goals. A majority
shareholder may have a long term orientation and may direct the corporation to re-invest all or
substantially all income in expansion; if a minority shareholder's preference is for a dependable stream
of dividend income, conflict is inevitable and the potential exists for shareholder lawsuits and
corporate paralysis.
alternative to the purchase of the dissident shareholder's shares by the dominant shareholder, the
company itself or a new, compatible shareholder.
Another vexing problem is shareholder / executives who view the company as a lifestyle vehicle rather
than a profit-maximizing enterprise. These shareholder / executives may be unsophisticated in modern
business precepts and their companies invariably are dominated by Managerial Preferences. These
shareholder / executives spend company resources on extravagant personal benefits, they do not work
hard enough (they are too busy with toys and prestige), they do not provide strong leadership and, in
family businesses, they subsidize unproductive family members. The phenomenon of a moderate
consumption of wealth by inadequate or wasteful job performance by shareholder / executives may be
seen in Status Quo and some Tune Up companies. Severe consumption of wealth by inadequate or
wasteful job performance may be seen in some Turnaround and Get Out companies.
Management
Another pervasive assumption is that current management is a constant for the duration of the planning
horizon.
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become dissatisfied with a cautious, risk adverse President. A maintenance mentality to corporate
leadership may be entirely suitable for companies in declining industries whereas a drive to excel and
dominate may be better for companies in turbulent industries.
The imperatives of the external environment and shareholder expectations should determine a
company's strategic direction and will indicate the appropriateness of the retention or replacement of
senior management. An assessment of management's capabilities in relation to corporate needs and
goals may be painful; however, avoidance of a frank assessment can lead to strategic choices
unsupported by managerial resources. In some cases, where the demands of the external environment
are beyond management's abilities or inclinations, a change of management probably should be made
promptly. In other instances, skills upgrading may be considered. Keeping management and moving
the company into customer / product niches compatible with management's skills and inclinations
might be considered (especially if the President owns the majority of shares). The worst scenario is
keeping entrenched management that is unsuited to the company's challenges; the shareholders,
employees, suppliers and customers deserve good management.
Risk Tolerance
Risk tolerance is rarely explicitly considered in privately held companies. It should be. Risk tolerance
is fundamental to shareholder and management expectations and decision-making. Risk tolerance is a
strategic choice and a determinant of other choices. A company may identify uncertainty in the
external environment, due to government regulations or new technology, and may decide that
consolidation of marketing gains should replace a previous pattern of rapid expansion. A moderate
variance in risk tolerance in a senior management team and Board Of Directors may be desirable, in
order to access a balanced perspective of corporate decisions.
Executives may assess risk intuitively or quantitatively. Intuitive assessment of risk means that the
assessment is made on experience, guesses and hunches, without the benefit of any appreciable amount
of research and analysis. Quantitative assessment of risk means that the assessment is formulated as
the total risk created by the risks of the components, with component and total risk measured if
possible and estimated if necessary. A quantitative assessment of the risks of a new manufacturing
facility would be based on the risks of new manufacturing technology, the risks of future product
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demand, the risks of new competition and the risks of increased financial leverage. Occasionally, an
apparently intuitive assessment of risk will be, in fact, a very cerebral, quantitative assessment
expressed in summary form without explicit reference to numerical values. The distinctions between
intuitive and quantitative risk assessments are the amount of research and analysis underlying the
assessment and the objectivity of judgment exercised.
Synergistic risk is the risk of two or more factors occurring simultaneously. A company considering
an acquisition of a competitor may consider the risks of a subsequent economic downturn, a labor
union strike and a revenue decline due to customers diversifying their purchases away from the merged
firm. The greater risk (lesser probability and greater impact) might be the negative synergies created
by concurrent adverse events.
Once risk is assessed, risk tolerance will drive decision-making. Cautious shareholders and executives
have a very low tolerance of risk, preferring safety and stability. Others may accept moderate risk in
exchange for moderate rewards.
dangerously high tolerances for risk, leading to acceptance of inordinate risks and 'betting the
company' strategies.
Company Self-Image & Attitudes Issues
Orientation
Companies should unequivocally state what they are (not 'who they are', except in companies totally
dominated by the Managerial Preferences Paradigm). The external environment and the company's
assets and capabilities should determine orientation. The classic orientation dichotomy is between
Operations and Marketing, with the preponderance of authors strongly advocating that companies
become marketing oriented. Obviously, all companies need to be marketing oriented, but not all
companies should be marketing dominant.
Generally, the more specialized a company's assets and personnel, the more dominant operations
should be. A manufacturer of glass bottles should focus its managerial and financial resources on
being an exceptionally efficient producer of glass bottles; and, its manufacturing prowess in terms of
cost and quality then becomes its marketing advantage.
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The
construction industry would imply cyclical sales and particular channels of distribution and the plant
maintenance industry may suggest less cyclical sales and different channels of distribution, marketing
and promotion.
The company's attitude to its industry will be shaped by its industry's competitiveness and will
concurrently shape its industry. A company may be in a relatively mature, stable industry and may
make a decision to become aggressive, either by acquiring competitors or by pricing to gain market
share. Another company might adopt defensive tactics, by trying to create barriers to entry in its
product or geographic niches. A third company may adopt a conciliatory stance, by establishing joint
ventures or technology sharing alliances. A less common response to competition is avoidance, which
means that customer or product niches are abandoned to stronger or more aggressive competitors. The
avoidance strategy carried to extremes means that a company shrinks to nothing. Avoidance can be an
intelligent choice if the financial and human resources freed by the abandoned niche are used
effectively to strengthen the remaining customer / product niches.
Focus, Diversification & Integration
Another dimension of a company's industry orientation is the question of focus versus diversification.
Focus means an exclusive or near exclusive marshaling of financial and human resources on one or a
few product or customer categories. Diversification means spreading company resources over several
or even many product or customer categories. Diversification can be generated internally (developing
new customers and products) and externally (buying companies).
Vertical integration means moving up or down the industry chain. It is growth by acquisition of
customers or suppliers, by development of the capacity to produce previously purchased inputs or by
development of the next step closer to the end user of the company's products or services. Horizontal
integration means moving across the industry chain. It is the acquisition of competitors or companies
serving the same customer category or making the same product category but in a different geographic
area.
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Focus exposes a company to the reliance on a narrow group of customers and products, with the
danger that a change in demand could render the company obsolete. Diversification offers the promise
of risk spread across multiple categories of customers and products. Unfortunately, excellence without
focus is rare. Few privately held companies have the managerial depth and money to be competitive in
multiple categories of customers and products. A few illustrious corporations with immense resources
have achieved diversification and excellence because their large subsidiaries are both focused and
excellent.
Growth issues are linked to focus / diversification / integration issues and risk tolerance issues. If
growth is a priority, a company must choose either internally generated growth or acquisitions to
achieve vertical or horizontal integration. Growth by sales of new, unrelated products to new, unrelated
customers dilutes focus and causes vulnerability to focused, aggressive competitors.
Controlled
growth of sales of existing products to new customers, new products to existing customers or, best of
all, more existing and closely related products to existing and closely related customers minimizes
dilution of focus. Generally, companies should seek growth through focus. The obvious exception to
the focus imperative is a company in a declining niche; the company must either re-invent itself or
wither away. A possible exception is Go For Gold companies; they might possibly pursue successfully
a growth through diversification strategy if the diversified activities are contained within distinct
divisions.
Companies struggle to survive in a hostile economy. They work hard to be excellent in focused
niches, and are unlikely to be more successful by spreading their resources more thinly over broader
customer and product categories. Many companies are too diversified and should delete customer and
product categories to liberate capital and human resources and to re-direct resources to high potential
customer and product niches.
Financial Performance Issues
Setting The Goal Line
An important question is what constitutes superior corporate financial performance.
The most
common answer is sales and especially annual increases in sales. An emphasis on sales may indicate a
54
company dominated by the Marketing Paradigm, which may be positive, or dominated by the
Managerial Preferences Paradigm, which may be seriously negative. Net Income is probably the
second most commonly used measurement of performance. Net Income captures sales, which is the
value established by customers' purchases and the expenses to make and sell those goods and services.
Net Income links customers and the company's internal productivity. Net Income also links customers
and shareholders as Net Income increases equity. Return On Equity captures sales, expenses and
equity; therefore, it links customers, the company's internal productivity and the shareholders.
Strategy, as approved by the shareholders, should determine the key measurements of financial
performance. If a company is in an expanding industry and is committed to long term growth and
market leadership, then Sales and Market Share would be primary measurements. If a company is in a
stable industry and is committed to internal efficiency and payment of regular dividends, then Return
On Equity and Return On Assets would be primary measurements. A later chapter comments on
techniques to measure financial performance.
A note of caution must be made: financial measurements should be used in conjunction with
measurements of customer retention and satisfaction, product excellence, employee training and
satisfaction, and adherence to environmental, health and safety and employment standards.
Revenue Or Cost Driven
Companies may be either revenue driven and cost aware or cost driven and revenue aware. Companies
cannot be revenue driven and cost driven simultaneously (with a few exceptions such as Bear Sterns
under the legendary Ace Greenberg). The decision to be revenue driven or cost driven has many
implications for capital expenditures, marketing programs, staff recruitment and training and even
administrative controls. The decision to be revenue driven or cost driven is discussed in a later
chapter.
Pace Of Growth
Explosive growth has appeal and dangers.
expenses, higher investments in inventories and accounts receivable and additional equipment and
factory space. Unless a company is well financed or the sales growth is very profitable, there can be
55
months and years of greater cash outflows than inflows, leading to a liquidity crisis. Explosive growth
places tremendous strain on management and staff: the skills, policies and procedures suitable
previously may be stretched to inadequacy. Therefore, a strategy aimed at achieving explosive growth
should be implemented concurrently with a carefully formulated Debt / Equity strategy and a program
to upgrade management through training and hiring.
Moderate growth may stretch but not fracture a company's current and available human and financial
resources. Detailed financial projections should indicate the maximum, safe pace of finance-able
growth.
management of successful companies 50 - 100% larger may suggest management's ability to handle
growth. Intuitively, it would seem that Go For Gold companies might handle growth of 20 - 30% plus
inflation per year. Status Quo and Tune Up companies, once energized, might handle growth of 10 20% plus inflation per year.
problems before embarking on a growth strategy. Growth rates of 5%, 10% or even 20% may seem
low in comparison to certain high technology companies; but moderate growth rates compounded
annually for five years will transform companies.
Table: Sales Projected On Various Growth Rates
Sales
Year 1
Year 2
Year 3
Year 4
Year 5
Growth of 5.0%
$50,000,000
$52,500,000
$55,125,000
$57,881,250
$60,775,313
$63,814,078
Growth of 10.0%
$50,000,000
$55,000,000
$60,500,000
$66,550,000
$73,205,000
$80,525,500
Growth of 15.0%
$50,000,000
$57,500,000
$66,125,000
$76,043,750
$87,450,313
$100,567,859
Growth of 20.0%
$50,000,000
$60,000,000
$72,000,000
$86,400,000
$103,680,000
$124,416,000
Despite its allure, growth may not be the best strategy. Companies in stable or declining industries
might choose a harvest strategy whereby re-investment is minimized and dividends to shareholders are
maximized. Some companies in rapidly changing industries may require major investments in new
technology or plant capacity in order to remain competitive. If shareholders are opposed to the risks
associated with major technology or plant investments, then either a harvest strategy or an exit strategy
is appropriate. Shareholders may wish to recoup their investment through a sale of the company; a
harvest strategy should be adopted temporarily until new shareholders approve a new strategy.
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Negative growth - shrinking the company - may happen by default, but it can be a legitimate strategy
for some companies. Get Out companies may shrink operations by closures of divisions and activities
and sell the remaining parts. Turnaround companies may close divisions, drop product lines and
abandon customer niches in order to stop losses and to concentrate financial resources on fewer, more
profitable and higher potential areas. For Tune Up and Status Quo companies negative growth,
consciously planned and methodically implemented, is like a farmer removing weeds so that valued
plants (products and customers) have the space and nutrients to grow.
Asset Issues
Strategies relating to growth, risk, customers and products should determine the selection of the type
and quantity of assets.
assessment of the current and projected Return On Equity compared to the Target Return On Equity.
Unfortunately, asset strategy is sometimes determined by the availability of capital: if bank loans are
available, more inventory and more equipment are purchased. Conversely, assets may drive strategy in
those cases where assets cannot be readily re-directed to new products or customers, transformed to
new uses or sold at a price which would be more profitable than continued use. A hotel cannot become
a manufacturing plant; however, it might renovate and re-market itself to serve more affluent or less
affluent customers or specialized niches attracted by in-house kosher kitchens, bowling alleys or
cultural or lifestyle motifs.
Liabilities & Equity Issues
The degree of financial risk inherent in a company's proportionate mix of debt and equity is a strategic
choice: higher debt increases the volatility of Net Income and Return On Equity and, in cases of very
high debt or significant operating losses, can cause bankruptcy. The types of equity can be a choice,
with patient capital from pension funds supporting a long term build strategy and venture capital
supporting rapid growth and a stock market offering within five years. The mix of short and long term
debt can be another strategic choice, with short term debt supporting fluctuating accounts receivable
and inventories and long term debt supporting equipment and real estate. Furthermore, floating and
fixed interest rate debt denominated in two or more currencies offer opportunities to cushion the
company from interest rate increases and, perhaps, against fluctuations of exchange rates.
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Customer Issues
A company's view of customers is fundamental to its customer strategy. The worst view is that
customers are unreasonable, disruptive or burdensome. A better view is that customers are demanding
masters whose favor and patronage must be continually cultivated and earned: the customer is king,
queen and emperor. The best view of customers is that customers are one third of a transaction chain
extending from the company's suppliers through the company itself to the customer. This view
suggests that none of the participants could exist without the other two, that there is an economic value
created for each of the three participants in the chain, that gains can accrue to the company by
economically creating value for customers, and that the company - customer relationship is about
creating value and allocating the value through the price of the goods and services transferred forward
from the company. This third view suggests that even a small company, lacking the power of a multinational corporation, must add value and manage its customer relationships. A company can pursue a
mass market or a niche market, and can seek sales and market share growth or prune the customer base
to eliminate low or negative margin customers.
Diagram 3.2: Selection Of Tactical Strategy Options
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Product Issues
Low Cost / High Differentiation
The classic product choice is between low cost products and high differentiation products. Companies
may reasonably choose either low cost or high differentiation; however, to be successful, companies
must align all facets of operations, marketing and administration to the strategy.
Companies following a low cost strategy usually aim to satisfy a mass market or, at least, a large niche
market and will direct marketing expenditures accordingly. They will also invest in engineering,
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product design and capital expenditures to achieve economies in manufacturing and logistics. The
ultimate low cost company would be a coal mine.
Companies following a differentiation strategy usually aim for sophisticated, affluent or quality
sensitive consumers.
They will invest in Research & Development, product design and capital
manufacturing companies with tremendous sensitivity to customer needs or marketing companies with
very good manufacturing capabilities, either in-house or sub-contracted.
Roger W. Schmenner, Production/Operations Management, second edition (Chicago, USA: Science Research
Associates, Inc., 1984), page 457.
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Privately held companies may not have the financial resources to fund big premises and equipment and
may not have the managerial sophistication to organize flexible manufacturing.
Therefore, they
become half big, meaning that they incur substantial costs without the benefits of scale. Or, they
become half flexible, meaning they suffer from somewhat inflexible manufacturing equipment and
processes without the benefits of scope. Capital expenditure budgets and training programs should be
consistent with the economies of scale / scope decision in order to move Operations gradually closer
and closer to its optimum configuration.
Innovation
Companies must innovate or become obsolete.
companies; but thousands of small innovations might be within the budgets of smaller companies.
New advertising media, alternate employee reward systems and benefits, continuous improvement of
manufacturing processes and new products and product features may be considered.
The real innovation issue for privately held companies is leadership. Leading can create a competitive
advantage in terms of products, brand awareness and even recruitment; leading can also expose a
company to mistakes and losses. Following allows a company to learn from others, selecting and
adopting the best proven; following can also expose a company to decreased relative competitiveness.
Late adoption of innovation (by which time the innovation is no longer innovative) may be inadequate
to restore competitiveness.
People Issues
The Company Ranks First
The President's personal values may determine if people are viewed as replaceable and expendable or
as essential and valuable corporate assets. Instead, strategy should determine employees. Employees
who do not fit the strategy need to be retrained or fired (in a humane manner). Selecting a corporate
strategy to 'keep our people busy' shows a lack of knowledge of the demands of the competitive
environment, a managerial aversion to tough choices and a mushiness of leadership.
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In a few cases, employees skills and preferences define an organization's nature and strategic thrust.
Symphonic musicians define their organization as a symphonic orchestra. Seventy-five lawyers and
support staff define their organization as a legal firm. In these cases, the organizations' products are
essentially intellectual and personal in the sense of reflecting the people who play the music or litigate.
Replacing symphonic musicians with jazz musicians would totally change the nature and strategy of a
'music organization'. On the other hand, if the demand for symphonic music will not support an
orchestra, then changing the players and re-inventing the organization is the only alternative to the
demise of the orchestra (or, to government subsidies, which are a tax on fans of other types of music).
Nonetheless, symphonic orchestras are not typical businesses; few businesses employ people of rare
skills. Generally, employees have important but identifiable skills that are replaceable (with training)
in the labor market. A less obvious point is that employees do not make a sacrifice of previously
acquired skills if they are retrained. Still less obvious are the observations that employees often have
company-specific and industry-specific skills, customer and product knowledge, and familiarity with
the corporate culture. Their skills, knowledge and familiarity are what make employees valuable - if
there is congruence with the external environment and corporate strategy.
In cases of incongruence, a company must work to create congruence. The company may replace
employees (expensive and disruptive if on a large scale), retrain employees (less expensive and
preserves company-specific and industry-specific skills), train customers to accept employees' skills
(rarely successful) or seek to change the external environment (possibly by lobbying to change the
regulatory environment).
A company cannot build excellence with employee skills that are inadequate for the task of delivering
or creating excellence.
productivity, motivate employees to contribute the maximum and provide training to enable employees
to make excellent contributions. The downside is that training is expensive and may simply create
mobile, marketable employees who subsequently leave. Companies that invest in training should also
invest in retaining employees.
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Nonetheless, fluidity is not right for all companies under all circumstances.
Rigidity may be entirely appropriate when the consequences of mistakes are high (hospital operating
rooms and bank commercial lending departments) and in highly regulated industries (abattoirs) and
repetitive work environments (brick laying).
Of course, a totally rigid organization would suffocate creativity and individual initiative and a totally
fluid organization would consume itself with self-regulating activities, group bonding and team
building exercises. The correct choice along the continuum between total rigidity and total fluidity
should be based on the company's strategic decisions concerning customers, products, risk tolerance
and need for innovation and the choice may be nudged a bit towards either rigidity or fluidity by
Managerial Preferences.
Change Issues
Scope Of Change
The corporate challenge is to change the things that must be changed to remain congruent with the
evolving world. There are four basic choices about the scope of change.
The first choice is If It Ain't Broke, Don't Fix It! This may be an intelligent, short-term choice for Go
For Gold companies; however, there must be a continual re-assessment of the external and internal
environment in order to identify meaningful external changes to which the company must adapt. It
would be a rare company - even in the Go For Gold echelon - which did not face some problems or
opportunities that require a constructive corporate response. Fortunately, Go For Gold companies
normally have a great sense of urgency and respond quickly to new information (but, are not panicked
by new information).
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The second choice is Bingo On The Titanic: ignore warning signs and continue on course. This is the
unspoken choice that permeates Status Quo and Tune Up companies and it may have contributed to the
descent of Turnaround and Get Out companies.
The third choice is Tinkering: adjusting in small increments. This can be highly effective. Only
changes directly affecting truly important issues are made. Management is selective and focused.
Tinkering in marketing and operations may be a great choice for Go For Gold companies. Tinkering in
organization, culture, personnel, motivation and reward systems may be an essential first choice for
Status Quo and Tune Up companies in order to get their people ready to accept and implement
subsequent changes in marketing and operations. Tinkering is too little for Turnaround companies and
too late for Get Out companies.
The fourth choice is Transforming.
enormous, too. Radical, widespread change may destroy employee self-confidence, loyalty to the
company and trust in management, may confuse or alienate existing customers faster than new
customers are attracted, and may overextend management's capability to manage. The end result could
be the destruction of the company's core strengths. Transforming may pose an unacceptably high risk
for Go For Gold companies and may be too difficult for the management of Status Quo and Tune Up
companies. On the other hand, radical, widespread change may be the only feasible choice for
Turnaround companies.
Speed Of Change
Speed of change should be distinguished from speed of decision-making. After identifying the scope
of change, management should select the speed of change on the basis of urgency and the capacity of
management and employees to successfully make the changes. Some decisions might be made after
months of analysis and implemented immediately (ex.: pension plans). Other decisions may be made
quickly but implemented relatively slowly (ex.: training programs).
The first choice is the Tortoise And The Hare approach where small changes are followed by more
small changes until the accumulated effect over several months or years is an overhaul of how the
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company functions and relates to its environment. This approach is manageable, may not over stress
the adaptability of customers or staff and may not create excessive financial risk.
Nonetheless,
protracted, unremitting change can be wearying and stressing for employees. Employees should
receive regular explanations of the changes and of the grand vision that the changes are meant to
support. Go For Gold companies may have mastered this pace of change by continuously adapting to a
continuously changing world. Status Quo and Tune Up companies might opt for this approach,
although there is the danger that resistance to change will sabotage the implementation of any
meaningful change.
A second choice is Fast Is Better. A fast approach driven by committed management may shock Status
Quo and Tune Up companies out of their self-satisfied lethargy. Speed may be the only appropriate
choice for Turnaround companies. If great speed is selected, the scope of change should probably be
narrowed.
The third choice is Nuke' Em - making all changes Monday morning of Week One. This choice can be
a shattering experience for employees and customers.
especially large-scale change, eliminates the chance to adjust later changes to reflect lessons learned
from earlier changes. In other words, extremely fast, sweeping change is high risk and should be
avoided. The exception would be Get Out companies; generally, exit decisions should be implemented
very fast to preserve equity. Fast change in Turnaround companies is usually required, but the scope
should be focused.
combinations are not feasible for any company. The remaining options may be divided into groups
that are feasible for the different Positions.
companys Position are identified, the company may focus its subsequent research and analysis on the
most germane issues.
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competitive position, an exit strategy might be implemented over a year in order to maximize
recoveries of equity.
An exit strategy is irreversible: once a company is gone, it is gone forever. Never finalize a Get Out
diagnosis without an independent assessment. Never implement an exit strategy without professional
assistance.
Bankruptcy
Bankruptcy is a formal and often expensive process defined by legislation whereby assets are sold and
creditors are paid according to the creditors' legal rights, with the process being subject to court review
and approval. Bankruptcy is subject to complex legislation and expert legal advice is essential. In
addition, a bankruptcy will, usually, decrease net proceeds to the shareholders: potential buyers may
offer to buy operating assets at a substantial discount and offer nominal amounts for trademarks,
patents and other intangibles.
Orderly Liquidation
Orderly liquidation is the gradual winding down of operations and the sale, over a few months, of
operating assets. Because an orderly liquidation avoids the haste and publicity of bankruptcy, it has
the potential to produce greater recoveries (than bankruptcy) for creditors and shareholders. If demand
for the assets weakens or if there are significant operating losses during the liquidation, an orderly
liquidation may produce lesser recoveries (than bankruptcy).
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Company executives may conduct an orderly liquidation, either with legal and accounting guidance
and creditor consent or under the direct monitoring or supervision of independent professionals
appointed by creditors. Expert legal advice is essential.
calculated as the present value of the companys projected contribution margin over three to five years.
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TURNAROUND STRATEGIES
Turnaround companies, by definition, have serious problems that must be dealt with promptly.
Typically, there are seven turnaround essentials and four phases. The following description is not a
guide to a self-administered turnaround.
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be blinded by historical viewpoints, may have psychological inhibitions against making tough decisions or be
overwhelmed by the difficulties and complexities. However, management that has made one or a few bad mistakes
but is otherwise capable may do a successful turnaround, with professional assistance. Management, due to an excess
of repentance or eagerness, may attempt an unassisted turnaround and the consequences can be unsatisfactory.
Shareholders who are assured by entrenched management that a turnaround is imminent should be skeptical.
Urgency
Speed is essential. Get the facts. Make the best possible decisions on the available information. Implement fast.
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expenses and to create a direct relationship with customers. Instead, the change severed customer /
external sales force relationships faster than new customer / in-house sales force relationships could be
created and sales dropped sharply. The Bet The Company option may be doomed to failure if the
acquisition or change is targeted at only one of the company's issues and avoids interconnected issues
or if there are inadequate managerial and financial resources to complete the change.
Turnarounds By Management
Turnarounds are done by management - either existing management with or without professional
assistance and guidance, or replacement management. If a company does not have the managerial
ability, energy and gritty determination and the financial resources to successfully complete a
turnaround, it may be in a Get Out Position. Turnarounds by existing management unassisted by
outside consultants are problematic.
yourself-brain-surgery.
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turnaround consultants are hardy, tough individuals who thrive on the adrenaline rush.
These
turnaround consultants are seasoned by prior turnarounds and can remain objective and focused on the
ultimate goal of future prosperity and not simply survival during the darkest moments of credit and
cash flow crises. The objectivity is especially important: company personnel may be reluctant to
accept that divisions must be closed, that product lines must be dropped, that R & D programs must be
abandoned and that people must be fired.
experienced turnaround consultants know that decisions must balance the consideration of immediate
survival with the imperatives of preserving whatever are the company's competitive strengths and
assembling the resources required for a recovery.
TUNE UP STRATEGIES
Tune Up companies should consider combining an Attitude Transplant & Cultural Transformation
with a specific paradigm emphasis. The combination can be very effective because each part of the
combination can reinforce and support the other part.
compete and to win. Tune Up companies, their management and their employees lack intensity of
energy, commitment and competitiveness.
transplant, starting with the President.
wholeheartedly (within one or two months) and must manifest new behaviors (within two or three
months) or be replaced. A President may change personally and transplant a winners mentality to the
management team. A management consultant or a consulting psychologist may provide regular, ongoing coaching. The cultural transformation of the entire company may take one or two years, but
some early signs of progress should be discernible within two or three months (although there may be
instances of 'two steps forward and one step back').
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Unfortunately, the President or other member of senior management may not be up to the task, due to
age, health, temperament or lack of belief that a better way is possible. If so, the President should
retire or be retired and an aggressive, committed, competitive person should be promoted or hired.
The cost of procrastination in dealing with a President who is not suited to the task of vitalizing a Tune
Up company may be calculated as the lost income due to corporate under performance. A simple
formula is: Equity per the financial statements, multiplied by difference between the Target Return On
Equity and forecast Return On Equity, multiplied by the years or months of delay before dealing with
the issue, minus the cost of severance payments.
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problems or product failures. Fraud sinks an indeterminable number of privately held companies.
Stop Unproductivity
Terminate activities, branches, product lines and people who no longer make a meaningful contribution to the
business and which cannot be improved within six months. Use the money saved to invest in products and services
that are profitable. The company's accountants or management consultants should review the research methodology,
analysis and reasoning before implementation of closures and terminations. Nonetheless, implement closures and
terminations within six months of starting the tune up.
Asset Utilization
Better asset utilization means fewer assets, fewer debts and higher profits. Conserve cash by extending trade payables
to the maximum limit acceptable to suppliers, bearing in mind the cost of lost prompt payment discounts. Monitor
receivables; one bad receivable will typically wipe out the profit on sales of four to ten times that amount. Reduce
inventory to the minimum level consistent with excellent customer service. Sell all unproductive and non-core assets;
use the proceeds to reduce debt. Restrict capital expenditures to items that strongly support the company's strategic
direction.
Build Relationships
Decisions and changes should be evaluated, in part, on the basis of the likely impact on customers, staff, suppliers,
lenders and shareholders. Communications to each group should be carefully crafted. Once good relations are
fostered with each group, start to build excellent relations.
Prepare For Growth
Tune ups do not last forever: companies move up or down and out. Prepare to move into the Go For Gold Position.
Start accumulating the financial, human and technological resources that will be required for excellence and growth.
Cut costs that do not create customer and product value. Organize regular customer research and overviews of the
external environment, including demographic, social and competitive conditions. If the company's equity level is low,
seek additional investment from current shareholders, senior employees, suppliers, customers or venture capital firms.
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the event that corporate performance declines (a fairly safe bet in the case of Status Quo companies).
A family business in a Status Quo position should be sold, or the patriarch (or, occasionally, the
matriarch) should retire with dignity, cash and speed in favor of qualified management.
The
entrepreneur / bureaucrat must relinquish control, perhaps during an eighteen month transition period,
over everything except major capital expenditures so that the successor has the managerial space to
make changes.
The entrepreneur / bureaucrat must support the successor while the successor
implements the tough decisions previously avoided. The entrepreneur / bureaucrat may be forced to
watch the dismantling of yesterday's pet projects and the forced departure of old friends and cronies.
This can be painful. It can also be deeply satisfying to see a company climb to new heights and a
protg achieve managerial distinction.
Organizational Behavior theorists postulate that the prerequisite to successful change is the recognition
that change is required. The problem for Status Quo companies is that their continued success, by
internal standards although not by comparative external standards, means that management and staff
may refuse to see the need to change. This makes the Attitude Transplant & Cultural Transformation
in Status Quo companies more challenging than in Tune Up companies, where the problems are
obvious to at least some managers and employees. In other words, Status Quo companies' continued
success is a sedative.
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A moderate amount of humility will save Go For Gold companies from the worst
excesses. Complacency is rarely fatal in small doses temporarily taken. Go For Gold companies
should be highly conscious of the benefits of Focus and Excellence: no strategy should dilute either.
Steady State
It is tempting to dismiss the Steady State option as a decision to deteriorate into the Status Quo
Position; however, a Steady State option may be an intelligent choice if the external environment is
stable or if the company's current competitive position is improving. Go For Gold companies that
choose the Steady State option should continually survey the external environment and measure
financial and non-financial performance. Any slippage from being the best in key attributes such as
quarterly tracking of customer satisfaction, quality compared to competitors, cost to manufacture and
order to shipment time should jolt executives into vigorous responses.
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Growth By Acquisition
Growth by acquisition can produce explosive growth or just an explosion. The key may be a series of
small acquisitions, each of which stretch corporate resources within acceptable tolerances and with
each acquisition paced far enough apart to allow the Go For Gold company to absorb the previous
acquisition managerially, culturally and financially.
Internal Growth
Internal growth is usually safer growth: markets and products are understood, management operates
within its field of knowledge and experience, and financial resources are predictable and controllable.
Unfortunately, the upper limits on growth may be reached when a company becomes dominant in its
markets. Then, new customer and product niches must be targeted. Go For Gold companies should
select new targets based on their potential profitability and risk and the companies capabilities. Not
all attractive customer and product opportunities are within the grasp of even Go For Gold companies.
Selling should be
considered for two reasons. One, some companies may outgrow their shareholders: the companies
may require large additional investments or long investment horizons in order to grow into national or
international competitors. Second, the shareholders may wish to convert illiquid shares in a privately
held company into cash when the company is performing well and salable at a premium. It may make
more sense to sell a Go For Gold company at a premium than risk a decline in performance and value
over time.
Worksheet: Tactical Strategy Options
Clusters
Shareholders &
Management
Company Orientation
Financial Performance
Customers
Comments
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Products
People
Change
BUILDING CONSENSUS
There are three reasons to build a consensus now. First, the broad outline of the company's most
important issues has probably been identified and the range of strategic choices has undoubtedly been
narrowed to a handful. Therefore, the most important issues and the range of strategic choices
appropriate to the company can be communicated to the stakeholders (in the detail suitable to each). If
a consensus is reached now on the issues and range of choices, subsequent research and analysis can be
focused. Second, other people may have special insights that will contribute to a better formulation of
the issues and choices.
It is difficult to predict who will have good ideas and insights about
opportunities, problems, strengths and weaknesses. Therefore, to get the most and the best ideas,
involve as many people in the consensus stage as possible and prudent.
Third, implementation
requires co-operation and support of shareholders, the Board Of Directors, management personnel and
staff. Consensus now on the issues and choices will facilitate approval and implementation of the final
plan. People need time to adjust their thinking. Conversely, a failure to build a consensus now may
make approval of the final plan problematic and may indicate future behind-the-scenes opposition or
even sabotage of implementation.
Build the consensus on the overview - what has been the historical financial performance, what
Position is the company in, what Paradigms and Principles are strongest in the company. Try to
achieve agreement on the most important issues to research and analyze.
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Comments
Definitely; give details.
List the people to involve in consensus building, the level of detail to share (detailed information in the
case of the Board Of Directors versus some highlights in the cases of a key supplier or employees) and
the method of communication (written versus conversational).
Worksheet: Who To Involve In Consensus Building
Who
Level Of Detail
Method Of Communication
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'get on the team'. As a rough guideline, invest as much time and effort in selling the ideas and issues as
invested in studying them: other people may need a similar amount of time to come to similar
conclusions. Do not rush to a forced conclusion but be prepared to force a conclusion.
Describe the company's options. Summarize conclusions and start building the consensus.
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GOVERNMENTS
The myriad actions of governments affect business operations. Land zoning affects plant location
decisions, labor policy affects labor availability, defense expenditures affect retail sales near major
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installations, fiscal policy affects interest and exchange rates and multi-lateral trade agreements affect
opportunities to export, incursions by foreign competitors and the availability of foreign investment
capital. Even the least intrusive national government has thousands of subtle and glaring impacts on
business. Still worse, changes in government policy may upset an environment to which business has
adapted. The changes may be positive in the long term but there are inevitably some disruptions. In
theory, privately held companies should continually scan the legislative and regulatory horizons. In
practice, companies are unable to dedicate significant resources to scanning prospective government
actions. Industry associations and broad business coalitions have the resources to monitor and lobby
government and the resources to educate and alert members. Join these organizations and read their
periodicals and newsletters.
Table: Scanning The External Environment
Read A Lot Of Quality Material
Read trade magazines, more sophisticated periodicals such as The Economist (which is not just for economists),
management journals produced by leading universities and at least one high quality daily newspaper. Cut out
interesting articles, keep them in a folder and re-read the articles every six months; within two years the accumulated
articles will form a customized, personal textbook.
Get The Opposite View
There is a common tendency to associate with like-minded people and to read magazines that re-enforce entrenched
opinions. The result is a lack of intellectual fresh air. Instead, invite intellectually diverse people (an academic, union
leader, clergy, big company executive, local politician) to be golf, tennis and skiing partners. Read two alternative
political or social magazines, monthly.
Attend Industry Seminars
Managers expect their accountants, lawyers, lab technicians and auto mechanics to stay up-to-date in their specialties.
Managers should stay up-to-date in their industry and the art and science of management.
Build A Bridge To The University
There is an awesome amount of brainpower in our universities and the universities are trying to interact with the
business world. Ask to be added to the mailing list of the nearest universitys business school. Depending on the
company's needs, invite a professor of Physics, Applied Engineering, Nursing or Sociology to lunch, describe the
company and listen to their opinions.
Adopt A Politician
Adopt a politician in a positive sense of being a mentor and advisor to the politician. Offer observations about local
and national issues - and, listen to the politician's thinking. This will contribute to informed, responsible government
and be a source of insights about the nuances and pressures of political life.
Hire A Consultant
Hiring a consultant to prepare a report on trends in the external environment could be expensive but a good report
could help catch an exciting opportunity or avoid an expensive mistake. The greater benefit might be the personal
interaction with someone with knowledge of many different industries.
Arrow-Dot-Square Analysis & W5 + 3H it!
This involves the senior management team working for three or four hours. The results can be dynamite. Arrow-DotSquare analysis is listing any and all possible factors that might affect the business. Assign arrows at various angles
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to indicate the direction of the factors, attach big, medium and small dots to indicate the potential impact on the
company, and add big, medium and small squares to indicate the company's capacity to influence or handle the
factors. W5 + 3H means taking a topic or issue and working through every remotely possible aspect of the eight big
questions: who, what, when, where, why, how, how much and how many?
In countries with governments that are less transparent to scrutiny, businesses may face the choice of
influencing government officials (as opposed to influencing government) or being denied access to
capital and markets. Obviously, businesses will adapt to the legislative and regulatory environment but
competitive advantages bestowed, rather than earned, may not survive a change in government,
whether by election or revolution. Businesses should be wary of complacency and a false sense of
security engendered by tariff and non-tariff trade protection or other forms of favoritism.
TECHNOLOGY
Technology may be a revolutionary better tool to produce, sell or administer. More commonly, it is an
evolutionary better tool. In either case, astute business people can spot emerging technological trends.
The challenge is the optimum timing of adoption. Go For Gold companies may have the sophisticated
human resources to be technological innovators in areas carefully selected to maximize product quality
and customer attraction, retention and satisfaction. Go For Gold companies may have a technology
strategy. Other privately held companies probably should select their customer, product, people and
cost strategies and develop technology tactics to enhance those strategies. In other words, for most
privately held companies, technology may influence strategy and should definitely serve strategy. Fear
of technology should not retard efforts to progress. Technology should not overwhelm good, well
informed managerial judgment concerning customers, products, people and costs. The mantra of
technology should not subsume intelligent thought.
Example - The Rot Of A Technology Fixation
A Vice-President of a Go For Gold, internationally respected bank said during lunch in mid1998 that technology was the driving force in her bank's future - everything depended on
acquiring and deploying the best technology. About three months previously, two middle
managers of the same bank told me that '... we've spoiled our customers. They expect too
much, and it has to stop." These two incidents suggest that this wonderful bank is developing a
technology fixation and disdain for its customers. If the rot spreads, this will not be a Go For
Gold bank in five years.
83
84
85
the owners would work very hard until the computer withered into obsolescence, keep costs
down, make a lot of money and retire at the age of forty. The Re-invest strategy meant that
they would work very hard, invest in retraining, overheads and marketing initiatives with the
intent to 'catch the next wave' of technology and retire at sixty. They selected the Harvest
strategy and later switched to the Re-invest strategy when the manufacturer refurbished and
upgraded the platform.
Industry Stereotypes
A simple approach to identifying industry participants is to use stereotypes.
Worksheet: Industry Stereotypes
Companies
The Giants: Big companies, possibly serving many markets, or dominating a few markets.
The Pigmies: Small companies, struggling in many markets or focused in a few markets.
The Healthy: Companies racing ahead.
The Hamstrung: Companies that are losing the race.
The Ultimate Source Of The Dollar: Customers who buy from your customers.
The Industry That Creates Demand: Ex.: The tobacco industry creates demand for hospitals.
The Industry That Supplies Your Industry: Ex.: Government supplies roads to trucking companies
and trucking companies sell movement of goods over those roads.
The Industry That Will Put Your Industry Out Of Business: An emerging industry that might satisfy
customers' needs differently: internet cars might replace car dealerships.
The Industry That Will Eat Your Industry: An established industry moving into your product or
customer area (banks moving into insurance).
The Force That Will Energize Your Industry: Demand for computer expertise energized the
Engineering and Business schools / departments of universities and colleges.
The Emerging Customer: The little niche or the new and still infrequent use or application of the
companys product, with potential to grow.
The Emerging Industry: May be a mutation of the companys industry.
Suppliers
Your
Customers
Customers
Suppliers
86
Industry
Customers
87
knowing when to get out; in fact, otherwise good companies can be in the Get Out Position because
their industry is excessively turbulent or sick. However, exiting an industry or a niche has two big
drawbacks. One, once the company exits, it will never likely get back into the abandoned industry.
Two, exiting or even retreating can establish a defeatist mentality in the company, as it can in an army.
Therefore, do not waste money in a terrible industry but do not exit prematurely. Investigate every
possible means of achieving cost reductions, product differentiation, creative marketing, excellent
customer service or new concepts of product-service. There is a famous quote attributed to the great
boxer, Joe Louis, who was referring to Billy Cohn: "You can run, but you can't hide."
Industry Consolidation
During the 1980s farm implement manufacturers consolidated. During the 1990s the number of gas
stations in some areas of North America decreased by more than 35%. During the second half of the
1990s, automobile manufacturers started to consolidate their dealer networks. The implications are
enormous. If demand shrinks, the survivors of the consolidation may survive. If demand is stable or
expands, the survivors enjoy greater unit sales. Competitors may start price wars to capture or retain
market share - either to ensure their own survival or to hasten the exit of weaker industry players. If
profits are volume driven (almost a given during a period of industry consolidation), then every exit of
a weak player strengths the industry leaders. The middle tier is then squeezed down to the bottom tier
and another round of price warfare kills off a few more competitors.
COMPETITION
Monopolies may be unsustainable product monopolies: existing products may substitute for the
monopoly product and technological progress can generate products that replace monopoly products.
Market dominance in an unfettered economy is rarely maintained for two generations.
Market
dominance is transitory. Early technology pioneers stumble and are surpassed by later entrants.
88
Successful firms become arrogant and disdainful of customers or complacent about product
development and quality. New technology, new customer expectations and new delivery of customer
satisfaction by firms unencumbered by old ways of doing business redefine value as perceived by
customers. Yesterday's competition may not be tomorrow's competition.
Future Competitors
Future competitors may include similar companies in different geographic areas and suppliers and
customers who may adopt a vertical integration strategy. A company's best defense against attacks by
new competitors is to be so excellent and cost-effective that potential competitors avoid a frontal attack
on the company's market. However, future competitors might still launch a flanking attack. In the
89
1970s Japanese car manufacturers attacked with small cars aimed directly at a poorly served North
American niche.
Annual
Sales
$30,000
Growth
Trends
Steady
$105,000 5% per
annum
$5,000
5% per
annum.
$20,000 Potential
is 15%.
Specialty paint
stores
Convenience,
perceived
expertise.
Perceived
expertise.
Other urban
hardware stores
Convenience,
advertising.
Convenience,
advertising.
Painting
contractors
May buy from or
through painting
contractors.
Appeals to retired
homeowners.
Rural hardware
stores
Buys on weekend
when at cottage.
Have contractors'
desk and early
opening hours.
Advertise our
actual expertise,
train staff.
Location if near
office, product &
service quality.
Increase
advertising of our
paint department.
Add a phone-in
order service;
early morning
pick-up.
Competitor has
little impact on us.
Do nothing.
90
to estimate relative cost advantages. Review industry magazines. Look for appointment notices, new plant openings
(which may indicate looming over capacity and a possible price war) and new product launches. Check sources such
as suppliers' salespeople who also call on competitors.
Lost Sales and Lost Customer Reports
Prepare Lost Sales and Lost Customer Reports. Branch or Divisional Managers should interview lost customers what did the company do wrong, what did the specific competitor do right, what could / should the company do to
regain that customer?
Credit Checks
Do credit checks on competitors. (Some jurisdictions have laws and regulations concerning business credit files;
therefore, discuss with the companys lawyer or a credit-reporting agency.)
sophisticated marketing indicate power. Go For Gold companies and some Status Quo companies may
have power.
Aggressiveness means the willingness to use power. The addition of production capacity or innovative
products, price wars and the acquisitions of suppliers, customers or competitors indicate
aggressiveness. Difficulty in exiting an industry may increase aggression because players may decide
that it is cheaper in the short run to start a price war or absorb operating losses than to quit. Go For
Gold companies may be aggressive. Turnaround or even Get Out companies may be spurred by
desperation to become foolishly aggressive. Almost by definition, Status Quo and Tune Up companies
are not aggressive.
Vulnerability means the potential to suffer from competitors power and aggressiveness. Marginal
profitability, dependency on few suppliers or customers, aging product lines, obsolete technology, old
91
marketing programs, declining customer bases and weak management teams indicate vulnerability.
Easy entry to an industry may mean that there is or will be new players within an industry, which may
mean constant downward pressure on prices and profits.
Example - Defensive Actions That Hurt Too Much
One distributor with seven locations kept a small, unprofitable branch open in order to dissuade
a national chain from opening in that area. Losses in the unprofitable store were about 30% of
the profits in the other six stores. Of course, the national chain did not open in the area of the
unprofitable store - not because it feared the competition but because it could see that the
demand in that store's area was inadequate. The national chain did open a store near the
distributor's flagship location.
Clich To Live By - Hurts Too Much
Maintaining unprofitable operations or product lines to keep competition out of the marketplace
hurts too much.
niche
and
few
Low
Cost
Competitor A has a
Cost
strategy,
sophisticated
which
requires
manufacturing
A and J
Mass-Market
AJ
K
High
Cost
Mass Market
J
Custom
92
H and I.
Summarize Competitors
Assemble and summarize the information on current and potential competitors. Identify the potential
impact on the company and possible responses. Options might include selling to a strong competitor,
buying a weak competitor, adding a new product to exploit a competitor's weakness and dropping a
product that cannot be made competitive and profitable.
Vulnerability
Impact On Our
Business
Able Acme
Cash rich due to recent sale of unrelated
division.
Pen holders.
Agents in Mexico; sells direct in US; small
retailers are house accounts.
Tensile strength is less. Better matte finishes.
Ships in 2 days. Price: 5% - 8% higher
Strong.
Very aggressive in product development and
marketing. Does not cut prices.
Not vulnerable.
Able Acme is a major threat. We need to
improve products and marketing.
Blackball Basics
Reported to be slow paying.
Pen holders, pencil holders.
Sells to novelty & stationery stores by
catalogue and telemarketing.
Lower quality in strength and finish. Ships in
1 day. Price: 10% - 15% lower.
Low and weakening.
Family business; founder seems to have lost
interest.
Could cut prices to reduce
inventories.
Vulnerable.
We might consider buying BB, cheaply.
93
WYN Record your observations and analysis of the trends in the industry chain and the power,
Write
Your aggressiveness and vulnerability of competitors. Describe the implications for the
Notes company.
94
95
operating losses. Negative cash flows may be offset by additional loans and equity investments if
lenders and shareholders are confident that cash flows will become positive within a foreseeable
future. Planning should consider operating results and the timing and amounts of capital expenditures,
debt repayment, new loans, dividends and new equity issues. Shareholders may postpone dividends
with the expectation that there will be a large enough stream of future dividends and resale value of
their shares to compensate for the investment risk. Lenders are less likely to postpone debt payments.
The time horizon will vary by industry and by shareholder expectations but privately held companies
should generate satisfactory (relative to risk) average returns over an economic cycle of five to eight
years.
Clich To Live By Cash & Cash Flow
The company with cash survives to fight and win another day.
The company that generates enough cash has suppliers, lenders and shareholders that let it keep
playing the game.
Year 1
968,932
131,754
Year 2
996,188
154,345
Year 3
1,380,072
174,476
Year 4
1,156,150
196,176
377,652
1,478,338
515,075
523,135
440,128
1,478,338
96
532,101
1,682,634
553,055
604,058
525,521
1,682,634
759,496
2,314,044
815,676
954,335
544,033
2,314,044
815,988
2,168,314
686,636
951,160
530,518
2,168,314
Year 1
Year 2
Year 3
Year 4
$ 2,034,982 $ 1,945,587 100.0% $ 2,464,007 100.0% $ 2,815,527 100.0%
587,907
645,745 33.2%
718,649 29.2%
835,467 29.7%
570,147
586,936
30%
757,954
31%
834,132 29.6%
4,780
12,665
21,126
21,361
32,388
23,161
10,617
3,922
17,669
2,564
5,187
18,618
86,193
4.4%
2,418
0.1%
28,126
1.0%
FINANCIAL RATIOS
Financial ratios provide clear, concise measurements of financial performance. Executives should
monitor the ratios that highlight activities and achievements essential to their companies' success.
Non-financial measurements (ex.: customer retention, manufacturing scrap rates, quality defects per
million parts) should also be tracked.
comparative reports of key financial and non-financial performance measurements - and make every
effort to continually improve. Common financial ratios may be grouped into four main categories.
Growth
Executives and the media focus on Sales and Net Income because these measurements are widely
understood. There is an assumption that bigger is better, which is not always true. Sales is an
imperfect measurement of performance because it does not capture the relationship between the value
established by customers' purchases and the company's costs to make and sell those goods and
services.
unsustainable price discounting or extended credit terms. Some companies consider that market share
creates economies of scale in both operations and marketing and leads to long term profitability.
97
Market share should be viewed only as an indicator of future profitability. Net Income growth is an
important measurement for all companies.
Efficiency
Efficiency measurements show how effectively company assets are used and how productive company
activities are. Gross Margin / Sales, Net Income / Sales and Sales / Total Assets are common
measurements. Sales / Accounts Receivable, Sales / Inventory and Sales / Equity show the relationship
between Sales and resources.
Solvency
Solvency ratios show the capacity of a business to pay its debts. The common measurement is
Working Capital. Working Capital is Current Assets minus Current Liabilities; the Working Capital
ratio is Current Assets divided by Current Liabilities; and, Working Capital / Sales is Working Capital
in dollars divided by Sales. Since the scheduled annual principal payments on term debt may fluctuate
due to maturity dates of mortgages and debentures, exclude the current portion of term debt from
Current Liabilities when calculating and comparing monthly and annual working capital ratios. The
rule-of-thumb is that a Working Capital ratio of 2:1 is good and 2.5:1 is excellent; however, a working
capital ratio of 1:1 is acceptable in a few industries and in companies that manage their accounts
receivable and inventories very effectively.
Equity / Total Assets shows the level of equity which protects creditors from a decline in asset values.
Inversely, Debt / Total Assets shows the exposure of creditors to loss.
EBIT or Earnings Before Interest & Taxes is calculated as Net Income plus Interest plus Income
Taxes. EBIT shows the ability of the company to generate sufficient cash to pay interest. EBIT /
Interest is sometimes called Interest Coverage, meaning the amount of funds generated as a multiple of
interest expense. This ratio is an important measurement of lenders safety. EBITDA is Earnings
Before Interest & Taxes & Depreciation & Amortization. EBITDA / (Interest + Principal Payments) is
sometimes called Debt Payment (or Servicing) Coverage. This ratio is a more complete measurement
98
of the risk of default on payment of interest and principal. (There are more technical calculations but
for most companies these simple calculations of Interest Coverage and Debt Payment Coverage are
satisfactory.)
Return On Equity
Return On Equity is a very important ratio for long term business management. It should be calculated
on every analysis of monthly, quarterly and annual financial statements. Every important business
decision should be assessed, at least in part, on the basis of the impact on Return On Equity. Return On
Equity is Net Income divided by Equity. Privately held companies should make adjustments in order
to convert accounting information into economic information - to discover the reality of shareholder
returns. Since the tax rates applied to dividends, interest and salaries vary, Return On Equity should be
calculated (by the companys accountants) on an net of notional tax basis if the composition of
payments to shareholders varies significantly year-to-year.
(a)
Year 3
$
+
+
$
Year 2
$
+
+
$
Year 1
$
+
+
$
$
+
-
$
+
-
$
+
-
$
+
-
$
+
-
$
+
-
(b)
(c)
d=(b+c)/2
a/d
$
%
$
%
99
It should be used and it is not too theoretical. There is a simple, practical method of
estimating a 'correct' Target Return On Equity. Recognize that the company could be shut down or
sold and the equity could be invested at about Bank Prime in a variety of government long-term bonds.
Therefore, equity in the company should earn at least Bank Prime. Privately held companies are
riskier than governments and should earn extra to compensate their shareholders. Equity in privately
held companies are illiquid, meaning that the shares cannot be readily sold. Companies should earn
extra to compensate shareholders for illiquidity. Therefore, Target Rate Of Return may be estimated
as Bank Prime multiplied by a factor representing industry, company and illiquidity risks. Since Bank
Prime changes periodically, calculate Target Return On Equity for each year.
Worksheet: Target Return On Equity
Industry Multipliers (chose one of the three descriptions, & circle the multipliers on the right)
Industry is very stable (very few bankruptcies in last five years)
Industry is volatile (several or many bankruptcies in the previous five years)
Industry is rapidly changing, highly competitive or experiencing rapid technological change
Company Multipliers (chose one of the three descriptions, & circle the multipliers on the right)
Company equity is 50% or more of total assets
Company equity is 40% - 50% of total assets
Company equity is under 40% of total assets
Provision For Illiquidity (shares not readily sale-able)
Multiplier (Industry Multiplier + Company Multiplier + Provision For Illiquidity)
Bank Prime, start of year (available from the company's bank)
Target Return On Equity (multiplier x bank prime, start of year)
Low
1.25
2.0
3.0
High
1.5
2.5
3.5
1.25
1.5
2.0
2.5
3.0
3.5
1.0
1.25
____
____
___%
___%
___%
___%
Year 1
Year 2
Year 3
Inventory
Current Assets
Current Liabilities
Total Assets
Total Debt
Equity (Shares + retained earnings)
Principal payments due next year
Growth
Sales Increase
Net Income Increase
Assets Increase
Efficiency
Gross Margin / Sales
Net Income / Sales
Sales / Total Assets
Net Income / Total Assets
Sales / Accounts Receivable
Sales / Inventory
Sales / Equity
Solvency
Working Capital (Current assets current liabilities)
Working Capital Ratio (Current assets / current liabilities)
Working Capital / Sales
Equity / Total Assets
Debt / Total Assets
EBIT
EBIT / Interest
EBITDA
EBITDA / (Interest + Principal)
Return On Equity
Actual Return On Equity (see separate calculation)
Target Return On Equity (see separate calculation)
100
Year 1
Year 2
Year 3
Year 1
Year 2
Year 3
Year 1
Year 2
Year 3
Year 1
Year 2
Year 3
101
Few companies can simultaneously focus on both revenue increases and costs decreases. Increasing
revenues requires an external (customer) focus and decreasing costs requires an internal (product and
overhead) focus. These two orientations are too different for even Go For Gold companies to manage
well.
Companies with strength in market potential, financial performance and internal resources may adopt a
revenue strategy. Weaker companies should adopt a cost strategy, correct internal flaws and gradually
move to a revenue strategy.
Positions
Go For Gold
Status Quo
Tune Up
Turnaround
Get Out
Maintain orientation.
Be revenue driven (customer focus and product excellence).
Be cost aware, and gradually shift to being revenue driven.
Be cost driven. Later shift to revenue driven.
Extreme cost driven.
102
Additional Techniques
Category Costs
Product Costs
Customer Costs
Activities Costs
Zero-based budgeting; activity based costing.
103
Year 1: Amount Per Cent Daily Rate Year 2: Amount Per Cent Daily Rate
$2,464,007 100.0%
$6,751
$2,815,527 100.0%
$7,714
$718,649
29.2%
$1,969
$835,467
29.7%
$2,289
$330,230
13.4%
$905
$363,011
12.9%
$995
$52,605
2.1%
$144
$67,787
2.4%
$186
$67,913
2.8%
$186
$63,648
2.3%
$174
$39,747
1.6%
$109
$50,841
1.8%
$139
$26,462
1.1%
$72
$26,163
0.9%
$72
$18,649
0.8%
$51
$23,823
0.8%
$65
$14,105
0.6%
$39
$21,064
0.7%
$58
$42,189
1.7%
$116
$41,993
1.5%
$115
$139,816
5.7%
$383
$129,188
4.6%
$354
($54,167)
-2.2%
($148)
($51,229)
-1.8%
($140)
$18,055
0.7%
$49
$18,462
0.7%
$51
$62,350
2.5%
$171
$79,381
2.8%
$217
104
clerks were fixed costs within a reasonable sales range. Some retail clerks and delivery drivers were
variable costs. Interest costs were largely fixed, due to the large mortgage and equipment loan debts.
Some interest cost was linked to bank financing of accounts receivable and inventory, which would
fluctuate with sales. The company excluded from its calculations non-operating revenues (rental
income and the gain on the sale of fixed assets) and income taxes (which varies with income, not
sales).
Table: Fixed & Variable Costs
Sales
Cost of goods sold
Wages, benefits
Repairs & maintenance
Vehicle
Advertising
Insurance
Municipal & capital taxes
Light, heat & power
Office, telephone
Interest
Interest income
Bad debts
Depreciation
Total expenses
Year 1
$2,464,007
$1,745,358
$330,230
$52,605
$67,913
$39,747
$26,462
$18,649
$14,105
$42,189
$139,816
($54,167)
$18,055
$62,350
$2,503,312
Year 2
100% $2,815,527
71% $1,980,060
13%
$363,011
2%
$67,787
3%
$63,648
2%
$50,841
1%
$26,163
1%
$23,823
1%
$21,064
2%
$41,993
6%
$129,188
-2% ($51,229)
1%
$18,462
3%
$79,381
102% $2,814,192
Fixed
100%
70%
13%
2%
2%
2%
1%
1%
1%
1%
5%
-2%
1%
3%
100%
Variable
$2,815,527
$1,980,060
$217,511
$42,787
$33,648
$20,841
$145,500
$25,000
$30,000
$30,000
$26,163
$23,823
$18,000
$3,064
$40,000
$1,993
$110,000
$19,188
($45,000)
($6,229)
$15,000
$3,462
$79,831
($450)
$498,317 $2,315,875
17.7%
82.3%
105
month's notice). Buying a warehouse to replace a rented warehouse would convert a variable cost to a
fixed cost.
Breakeven
Breakeven analysis uses fixed and variable costs to estimate the level of sales at which a company
would have neither profits nor losses. The formula is: Sales at breakeven = Fixed Costs divided by (1Variable Cost as a per cent of Sales).
expenses as fixed and variable is approximate and not all variable expenses move exactly proportionate
to sales, detailed projections should be prepared before finalizing strategic and business plans and
major financial decisions.) Using data from the previous table, a breakeven table was calculated.
Table: Breakeven Table
Sales
$2,700,000
$2,900,000
$3,100,000
$3,300,000
statements and detailed internal financial statements. Separate sales of products and services and
revenue from miscellaneous activities. Adjust for aggressive revenue recognition treatments (i.e.
creative accounting). Cost Of Goods Sold includes the purchase price of the inventory that was sold,
in-bound freight, the wages and benefits of the workers who made the products and costs which made
it possible to make the product, such as utilities, foreman's wages and property taxes on the factory.
Gross Margin is Sales minus Cost Of Goods Sold. It is usually assumed that increases in Gross
Margin are good and decreases are bad; however, always investigate changes in Gross Margin.
Increases could be caused by selling at higher prices offset by costs (free delivery, higher sales
106
commissions or longer account receivable terms) reported elsewhere in the financial statements.
Decreases could be caused by lower prices, higher purchase costs or fraud. In the table below, Gross
Margin increased from 30% to 40% due to more sales absorbing the fixed cost of property taxes.
Table: Piano Parts Manufacturing Inc. - Gross Margin
Unit Costs
Total sales
Labor per unit
Raw materials per unit
Property taxes on the factory for the year
Total Cost Of Goods Sold
Gross Margin
$0.50
$0.25
2000
$150,000
$ 50,000
$ 25,000
$ 30,000
$ 105,000
$ 45,000
30%
2001
$300,000
$ 100,000
$ 50,000
$ 30,000
$ 180,000
$ 120,000
40%
Contribution Margin
Contribution Margin is sales minus all the variable costs that are tightly linked to buying, making,
selling, shipping and financing a sale of a product to a customer. Contribution Margin minus fixed
manufacturing and selling costs and overhead equals pre-tax profit. Contribution Margin can be used
to assess the relative profitability of customers, products and assets.
Fitness Hardware, Firmware & Software Inc. has two products. Product A is manufactured as orders
are received and is sold by commissioned salespeople. Product B has similar production costs, is sold
through a Mexico City representative, on a different commission structure, and is shipped from
inventory in the company's Texas warehouse. Product B is priced to reflect warehousing and selling
expenses. Product B produces twice the Gross Margin, and it is more than 50% more profitable as a
per cent of sales. Contribution Margin calculations confirm that Product B is more profitable in terms
of total dollars and about the same as a per cent of sales.
Table: Gross Margin & Contribution Margin
Costs
Total sales
Labor per unit
Raw materials per unit
Property taxes on the factory
Total Cost Of Goods Sold
Gross Margin
$0.50
$0.25
Product A
$150,000
$50,000
$25,000
$30,000
$105,000
$45,000
Gross Margin
Product B
$200,000
$50,000
$25,000
$30,000
$105,000
$95,000
Contribution Margin
Product A
Product B
$150,000
$200,000
$50,000
$50,000
$25,000
$25,000
107
30.0%
47.5%
$11,250
$7,500
$2,250
$1,973
$0
$1,100
$97,973
$52,027
34.7%
$40,000
$6,500
$5,000
$3,945
$986
$900
$131,432
$68,568
34.3%
(a)
(b)
(a/b)
Product A
$52,027
34.7%
$24,658
$0
$27,000
$51,658
101%
Product B
$68,568
34.3%
$49,315
$12,329
$31,000
$92,644
74%
108
Product Categories
A privately held company may have thousands of products and detailed inventory records showing
sales, purchases and gross margin by each of the thousands of items. If so, the companys current
method of grouping products may be based on arbitrary or simplistic past practices. For intelligent
analysis and decision-making, develop an intelligent categorization of products. If corporate records
will not allow sufficient data manipulation to generate meaningful revenue and costs figures for
product categories, use sampling of sales invoices to generate a sales report suitable for managerial
analysis. Ensure that the computerized base or sampled data spans a full twelve months, especially if
revenues or product mix are seasonal.
Table: Determine Product Categories
Any product or group of products that account for more than 5% of total sales is a single category.
Products with similar manufacturing processes may be grouped together.
109
A product category which represents more than 20% of total sales may include two or more distinctive groups of
products (example: animal feed could be segmented as chicken and turkey feed).
Combine a product category that represents less than 1% of sales with a similar category or a Miscellaneous category.
If the Miscellaneous category accounts for more than 10% of total sales, it may include two or more distinct categories.
One or two categories should be devoted to products that may be unimportant now but have potential for growth.
The minimum number of categories for many businesses might be five or six, including Miscellaneous. Fewer
categories indicate economic dependency on a few product categories, or inadequate effort to segment products.
The maximum number of categories may be nine or ten; more than ten may involve onerous work.
The Farm Feed, Seed & Equipment Store's preliminary and final product category lists are shown
below. The final list includes one small category that could have been combined into the Other
category; however, the President decided to keep Medicines, Vitamins as a separate category.
Table: Product Categories
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
Preliminary List
Dairy Feed
Chicken Feed
Turkey Feed
Fish Feed
Seed
Herbicides
Pesticides
Medicines, Vitamins
Fencing
Hardware
Paint
Pet Feed
Pet Supplies
Other
Total
$16,801
$4,500
$6,311
$978
$6,058
$2,600
$1,369
$1,001
$2,473
$1,175
$817
$264
$199
$1,030
$45,576
36.9%
9.9%
13.8%
2.1%
13.3%
5.7%
3.0%
2.2%
5.4%
2.6%
1.8%
0.6%
0.4%
2.3%
100.0%
1.
2.
3.
4.
5.
6.
7.
8.
Final List
Dairy Feed
Poultry Feed
Seed
Herbicides, Pesticides
Fencing
Hardware, Paint
Other
Medicines, Vitamins
Total
$16,801
$10,811
$6,058
$3,969
$2,473
$1,992
$2471
$1,001
$45,576
36.9%
23.7%
13.3%
8.7%
5.4%
4.4%
5.4%
2.2%
100.0%
110
purchase of raw materials or components for specific products. Product costs which cannot be
identified with or tightly linked to specific products are unallocated product costs and are usually fixed
costs such as property taxes on a factory, the salary of the plant manager and health and safety
programs. Unallocated Product Costs should be listed, totaled and compared to Product Contribution
Margin. (Note: the worksheet shows Product A and B; in practice use all 5 10 product categories.)
Worksheet: Contribution Margin On Products
Product Sales
Revenue - %
Variable Production Costs
Raw materials
Variable labor & benefits
Utilities, Freight In, Other
Total Variable Production Costs
Total Variable Production Costs - % of Product Sales
Variable Marketing & Sales Costs
Sales Discounts
Sales Commissions
Shipping & Delivery, Packaging, Other
Total Variable Marketing & Sales
Total Variable Marketing & Sales - % of Product Sales
Variable Administration Costs
Interest Cost Of Inventory
Other
Total Variable Administration Costs
Total Variable Administration Costs - % of Product Sales
Total Variable Product Costs (Production+Marketing+Admin.)
Total Variable Product Costs - % of Product Sales
Contribution Margin On Products (Revenue - Variable Costs)
Contribution Margin On Products- % of Product Sales
Total Contribution Margin On Products (Product A + B)
Total Unallocated Product Costs
Net Contribution Margin On Products
Financial
Statements
Product A
Product B
Unallocated
100%
111
customer categories is satisfactory for planning purposes. Sampling may be used to determine the
composition of annual sales for specific customers and customer categories.
Table: Determine Customer Categories
Any customer that generates more than 5% of total sales is a single category.
Customers with similar needs should be grouped together (example: school boards).
Customers with similar needs but different buying patterns should be in different categories (school boards and
industrial plants both need janitorial supplies).
Any category that represents more than 20% of total sales may include two or more distinctive groups of customers
(example: auto after-market distributors in Central Asia and India).
Combine a category that represents less than 1% of total sales into a similar category or the Miscellaneous category.
Devote one or two categories to customer niches that may be unimportant now but that may have potential for growth.
If the Miscellaneous category is more than 10% of total sales, it may include distinct groups that should be segregated.
The minimum number of categories for many businesses might be five or six, including the Miscellaneous.
The maximum number of categories may be nine or ten.
The Farm Feed, Seed & Equipment Store identified thirteen customer categories and sampled every
400th sales invoice. Then, the company combined some categories and selected a final list of nine
categories. The nine categories were extensively researched. Marketing and product selection plans
for each category were prepared. For Dairy, Poultry and Beef Farms, the product array was different
and the marketing plans were similar. Hospitals, Schools and Municipalities were identified as having
high sales growth potential and higher inventory and marketing investments were authorized.
Table: Revenues By Customer Categories
Sales, Per Sample
Dairy Farm
Poultry Farm
Cash Crop Farm
Beef Farm
Local Businesses
Hospitals, Schools
Municipalities
Landscaper
Construction
Homeowner
Other
Cottager
Fish Farm
Total
$19,658
$11,058
$7,748
$6,127
$3,025
$2,654
$2,191
$2,003
$1,836
$1,761
$1,173
$1,158
$931
$61,323
32%
18%
13%
10%
5%
4%
4%
3%
3%
3%
2%
2%
2%
100%
$19,658
$11,058
$7,748
$6,864
$6,127
$2,919
$2,654
$2,191
$2,104
32%
18%
13%
11%
10%
5%
4%
4%
4%
Total
$61,323
100%
112
100%
100%
100%
100%
(c)
Contribution Margin (b - c)
Total Contribution Margin (Customer A + B)
Total Unallocated Customer Costs
Net Contribution Margin On Customers
113
Variable marketing and administration costs should be calculated and included in the analysis, if those
costs were not included in the analysis of product costs and if they are tightly linked to customers.
Volume rebates, advertising allowances and similar discounts require careful analysis, as similar
customers may received different discounts.
calculated as Annual Interest Cost * [Account Receivable due from the customer / Total Assets]. Bad
debts and foreign exchange costs should be reviewed.
Contribution Margin On Customers should be calculated by subtracting Customer Costs from
Customer Revenues. Unallocated Customer Costs should be totaled and compared to Total Customer
Contribution. The Worksheet: Contribution Margin On Customers shows only two categories; in
practice use 5 10 categories. Also, as companies cost structures vary, adjustments to the worksheet
may be required.
The Farm Feed, Seed & Equipment Store did a sample of every
twentieth sales invoice to identify what products were sold to what customers in the previous year.
The data was entered into a large spreadsheet and summarized in a matrix. Only thirty-seven customer
/ product categories had recorded sales, per the sample. Of these active customer / product categories,
the top 40% accounted for 89.1% of total sales and the bottom 60% accounted for 10.9% of total sales.
The most important categories should be carefully analyzed to determine their contribution margins.
Table: Sales By Customer & Products
Feed
Dairy Farm
Poultry Farm
Cash Crop Farm
Bus.,Landscaper, Constr'n
Beef Farm
Home & Cottage
Hospitals, Schools
33.8%
21.5%
0.0%
0.0%
0.0%
0.0%
0.0%
Seed
0.0%
0.0%
9.8%
0.0%
2.5%
0.0%
0.0%
Herbicides Fencing
2.8%
0.0%
2.1%
1.9%
1.3%
0.6%
0.8%
0.2%
0.1%
0.4%
1.8%
1.2%
0.1%
0.6%
Hardware, Medicines,
Paint
Vitamins
0.2%
1.2%
0.2%
0.8%
0.1%
0.0%
1.8%
0.0%
0.4%
0.0%
0.0%
0.0%
0.9%
0.0%
Other
0.4%
0.0%
0.0%
1.3%
0.5%
0.8%
1.7%
Total
38.6%
22.5%
12.4%
6.9%
5.8%
1.6%
4.0%
Municipalities
Other
Total
0.0%
0.0%
55.3%
0.0%
0.0%
12.3%
0.5%
0.3%
10.3%
114
3.8%
0.4%
8.7%
1.8%
0.3%
5.7%
0.0%
0.0%
2.0%
0.0%
1.0%
5.8%
6.1%
2.0%
100.0%
COSTS BY ACTIVITIES
Analyzing costs by activities can produce significant insights. In the next table, a retail company
selected seven activities. The company was surprised to discover that Logistics accounted for 9.0% of
its total costs and that Selling Wages & Benefits was only 47% of total Wages & Benefits for this
retailer. The biggest surprise, though, was how little was spent on buying and the company resolved to
invest more resources in effective purchasing.
Table: Costs By Activities
Total
Sales
$ 2,815,527
Rental income
21,361
Sale of fixed assets
10,617
Total revenue
2,847,505
Cost of goods sold
1,980,060
Wages & benefits
363,011
Repairs & maintenance
67,787
Vehicle
63,648
Advertising
50,841
Insurance
26,163
Municipal & capital taxes
23,823
Light, heat & power
21,064
Office, telephone, other
41,993
Interest
129,188
Interest income
(51,229)
Bad debts
18,462
Amortization
79,381
Total expenses
$2,814,192
Pre-tax income
$33,313
Renting
Property
Buying
Selling
Logistics
Giving Owning
Credit Inventory
Other
2,815,527
21,361
21,361
2,000
3,785
2,815,527
1,980,060
19,500 170,000
10,617
10,617
62,300
42,000
63,648
25,000
25,000
59,211
22,002
1,750
3,950
5,900
27,000
(51,229)
18,462
1,500
36,000
20,463
19,058
6,689
34,593
24,350
50,841
4,765
14,375
16,625
7,000
34,175
1.2%
(12,814)
25,213
60,000
12,381
19,500 2,215,276 253,161
26,883
66,450 198,747
0.7%
78.7%
9.0%
1.0%
2.4%
7.1%
(19,500) 600,251 (253,161) (26,883) (66,450) (188,130)
COSTS BY CATEGORIES
Costs may be analyzed on any basis relevant to management's exploration of hidden or previously
ignored aspects of the business.
115
In the next table, a company selected six categories. The discovery that owning transportation and
other assets caused greater costs than employing people had a major impact on the subsequent
implementation of its cost strategy.
$2,815,527
21,361
10,617
2,847,505
1,980,060
363,011
67,787
63,648
50,841
26,163
23,823
21,064
41,993
129,188
(51,229)
18,462
79,381
$2,814,192
Rental
Property
People
Materials
Transport
Equipment
2,815,527
21,361
$21,361
10,617
$10,617
$2,815,527
1,980,060
363,011
3,785
42,000
63,648
22,002
50,841
4,765
16,625
7,000
$32,175 $363,011 $1,980,060
1.1%
12.9%
70.4%
25,213
60,000
$190,861
6.8%
26,163
19,058
21,064
39,893
87,350
(51,229)
18,462
12,381
$195,145
6.9%
2,100
$52,941
1.9%
OVERHEAD
Overhead is all the costs that are not tightly linked to the product or the customer. In a manufacturing
company, a CNC mill shapes metal (part of the product) and is not overhead equipment. A computer
used for production scheduling would be overhead equipment.
Good overhead adds value to the products, customer service, employee health and safety and
administrative control. A production scheduling department is good overhead because it facilitates
efficient production. Research & Development is good overhead because it creates the products and
116
processes that will make the company competitive tomorrow. Nonetheless, good overhead may be
inefficient
Yes
No
unallocated product, allocated and unallocated customer and overhead costs, the companys auditor
should review the methodology and the specific numbers. Spending money on getting a professional,
second opinion can be a lot less expensive than making a bad decision on wrong data!
117
Allocated
Customer
Costs
Unallocated
Product
Costs
Unallocated
Customer
Costs
Overhead
Costs
a)
b)
c)
d)
e)
Total Costs (a)
(a)
Total costs per financial statements should equal the total of allocated and unallocated customer and product costs
and overhead.
WYN State whether the company should be revenue or cost driven and the reasons. Evaluate in
Write
Your detail the company's revenue and cost structure. Note which costs merit greater
Notes management attention. Write commentaries on every cost item, noting those which seem
low or high. Identify which products and customers are most profitable. List overhead
costs that should be reduced or eliminated.
118
CUSTOMERS
There are sophisticated techniques to categorize customers according to psycho-socio-demographiceconomic parameters. However, privately held companies are better served by studying the basics.
Table: Questions For All Marketing Programs
Who is the customer?
What is the company - customer relationship?
What value does the company provide?
What value does the customer provide to the company?
CUSTOMER ARCHETYPES
There are eleven archetypes of customers and potential customers. Recognize and plan for them.
Who's Buying Dinner? - The Good Customers
These customers generate a positive contribution margin. Typically, 30% of customers generate about
70% of total contribution margin. Invest time to discover what needs these customers have that the
company is not currently satisfying. Lavish time, attention and marketing expenditures on these
customers.
Who'll Buy Lots Of Dinners? The High Potential Customers
Some customers start small and stay small. Other customers start small and grow into major accounts.
Track customer (or category of customer) buying patterns. Understand customer needs (and the
quantity of the needs). Target extra marketing efforts on growing accounts. High potential customers
may currently generate 5% of total sales and have the potential to grow either because of their own
growth trends or because focused marketing could generate more sales to them.
Who's Eating Dinner? - The Over-Served & Under-Priced Customers
About 20% of customers may pay too little for the total basket of products and services that they
consume. Some customers demand and get expensive extra features and services and consume pre-
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and post- sale management and service resources to the point that they are unprofitable. In other
words, the company is providing a subsidy or a charitable donation to those customers. If the customer
is particularly large, there can be a fear of losing the volume. Increase prices substantially. If the
customer accepts the price increase, corporate profits will increase. If the customer refuses to pay the
higher price and goes to another supplier, corporate profits will still go up (because the company will
no longer lose money on that customer). An unprofitable customer who has the potential to grow into
a larger customer is an opportunity to lose more and more money.
Who's Stealing Dinner? - The Bad Debts & Slow Payers
Occasionally a customer will consciously defraud the company by buying and not paying for products
and services. More commonly, customers are full of good intentions. In either case, the company
loses the money spent to create the product or service. Bad debts can consume an enormous amount of
managerial time, taking attention and focus away from good customers.
We'll Buy Dinner This Time - The One-Time Discount Customers
There is merit in taking an order that will result in a loss, to demonstrate quality and delivery
capabilities or to satisfy a special need of a normally profitable customer. However, if money-losing
orders become frequent, company profits will suffer. Be selective in accepting unprofitable orders.
The Giant In The Sleeping Bag - The Dominant Customer
'Economic dependency' means that the loss of the annual sales to a single customer (or category of
customer) could bankrupt the company. Economic dependency exposes a company to a second
problem: being bullied into offering prices too low or services too expensive. The defense is to seek
additional good customers to diversify the customer base. In some industries, such as auto parts
manufacturing, economic dependency is almost unavoidable.
The Marginal Customers, Because Of Us & Them
Typically, about 40% of customers or categories of customers generate about 10% of sales. These may
not be 'bad' customers; they may simply generate too many low volume orders which are expensive to
satisfy. The answer may be to introduce streamlined service or volume discounts to encourage larger
120
impossible; try to make creative connections between newspapers' reports of government statistics and
science advances. Listen to customers' complaints. Complaints may indicate an emerging need.
Worksheet: Customers Archetypes
1.
2.
Archetypes
Who's Buying Dinner? - The Good Customers
Who'll Buy Lots Of Dinners? The High Potential Customers
Customers
3.
4.
5.
6.
7.
8.
9.
10.
11.
121
CUSTOMER PROFILES
Customer and customer category profiles may inspire fresh, creative marketing programs. List all
characteristics of each customer or customer category. For consumers, list the usual demographic
information (age, gender, marital status, language, religion, income, health, education, political and
social affiliations, and brand loyalty). For industrial customers, list corporate information (sales,
profitability, purchases of similar products, competitive position, specifying and purchasing patterns,
brand loyalty and payment patterns). For each customer or customer category, list how to ideally
satisfy needs (the selling process, delivery, packaging, product features, pricing, payment terms).
Then, list all possible actions that the company might take to satisfy each customer or customer
category.
Example - Ignoring The Emerging Customer
A prestigious tennis and racquetball club was stuffy and stodgy and had difficulty attracting
younger members. The club's older members were gradually retiring. The club refused to
allow half-year memberships for people who spent their winters in Florida or their summers in
northern cottages. At the same time, the club would not change its image or operations to
attract a younger membership. Consequently, the club lost the emerging post-retirement
market. Moral of the story: Existing customers can change and become an emerging category.
122
Customers are all treated with respect but should be priced and served appropriately. Marketing
companies are smart companies.
Marketing does not exist in many privately held companies. Advertising does, and selling, too. The
most important, single marketing initiative for most companies is an attitude adjustment, starting at the
top. Companies must become obsessively committed to a focus on satisfying customers profitably.
Too many companies just do not seem to care about customers.
Example Dumb Marketing
An eastern retailer was completing renovations of its flagship store. The changes were
patterned on stores the President had seen in California, about three thousand miles away.
There had been no analysis of local customers, buying patterns or product profitability. The
store had a supervised play area, where parents could leave their children while browsing and
discussing high ticket purchases. The play area was being eliminated. The President
commented "It's too bad, the customers really loved it."
123
124
Market Research
Old marketing programs cause the decline of companies. Retail customers grow old, die and move.
Industrial customers expand, downsize, re-organize and re-locate. Therefore, yesterday's marketing
programs may target yesterday's customers.
Government statistical
publications and trade associations are sources of statistical information on established buying patterns
and trends. Magazines aimed at narrow demographics (teen / female / salsa music; senior / male /
marathon) are sources of qualitative information on emerging niches. Of course, the cheapest and best
market research is often the careful analysis and survey of a companys current customers.
Example - Get The Marketing Data
A successful hardware and building supply store relied on small contractors and do-it-yourself
homeowners. Research data indicated that sales, in the store's market area, of cleaning supplies
such as mops, cleansers and paper products were much higher than the national average.
Further research showed that the higher sales were due to the presence of numerous small
janitorial firms that served the nearby urban core. A distinct marketing program was designed
to attract janitorial firms: a salaried sales representative who worked afternoons and nights, a
direct mail campaign and an expanded section of mops, cleansers and paper cleaning supplies.
Moral of the story: Marketing data doesn't have to be glamorous, just useful.
Niche Marketing
Niche marketing means targeting a well-defined, often small group of customers.
For a large
corporation, a niche may be several millions of recreational, female runners with flat feet. For another
company, a niche may be North American manufacturers using multi-head blow molders. It is
possible to divide any group into half and divide the half into half and so on until there is a group of
one. A group of one is the ultimate niche.
Carefully chosen niches can be profitable if the niche places a high enough value on a product or
service. Categorize actual and potential customers according to logical attributes such as product
needs and customer characteristics (ex.: demand rapid response or price driven). Define the niche in
terms of actual and potential customers, their characteristics, the needs that the company can or might
satisfy, growth trends and competitive trends. Decide if the niche is likely to be sufficiently profitable
125
to justify the investment of time and money. Not all niches are profitable, either because the customers
are too few, poor or uninterested, or because the niche is crowded with competitors. (One company
lost $3,000,000 in a niche for all the reasons.)
Clich To Live By - Niche Marketing
Not all niches are profitable.
Never invade a crowded niche unless you attack with massive firepower.
distinguishable by quality, features and supplier. If the distinguishing physical or intangible features
are important to consumers, they will buy the product. Lumber is a commodity but pressure treated,
weather resistant lumber for exterior decking is a value-added product. Further value, to a consumer
building a deck, is added when the pressure treated, weather resistant lumber is pre-cut to particular
lengths and angles and packaged with instructions and hardware so that the consumer can erect a deck
in a weekend.
Value added can be taking something away. Auto repair garages diarize the probable date of a
customer's need for another oil change and then telephone the customer a week before the date. This
takes away the customer's need to diarize when to take in the family sedan.
Selling Commodities
Except in times of scarcity, commodities face downward price pressure from customers and upward
cost pressure from inputs such as labor and taxes.
126
preserve a company's position but commodity companies cannot normally achieve a sustainable
competitive advantage by cost cutting. The one exception may be cost savings due to patented
production technology.
differentiation from their competitors by extra fast delivery, engineering support or supply contracts.
Clich To Live By - Marketing Value Added
We get paid to increase pleasure or decrease pain.
Customers pay for value added valued by the customer; your cost is your problem.
127
Channel Of Distribution
Channel of distribution means the path a product takes from manufacturer to consumer. Each step of
the channel of distribution adds cost. Of course, each channel member is supposed to add more value
than cost. Companies that are in the early parts of the industry chain should ensure that financial and
non-financial value to customers greater than cost to customers are added by each step in the channel
of distribution of their products.
If a channel member, such as a distributor, adds more value than cost, suppliers and customers will
become dependent on that channel member. If a channel adds more cost than value, either suppliers or
customers will attempt to take over the functions of the uneconomic channel member. Strong value
added compared to cost added may be a sustainable competitive advantage and the basis of the
company's future direction.
vulnerability to competition from other channel members or invasion of the territory by suppliers or
customers. Vulnerability indicates a Turnaround or a deteriorating Tune -Up position; in either case,
increasing value added features and services and stabilizing or decreasing costs should be priorities.
Companies, whether profitable or not, that cannot add within the planning time horizon greater value
to the customer than cost to the customer may be in the Get Out position.
Pricing
Price & Volume Sensitivity
A classic approach to pricing is to measure elasticity of demand - which means the amount that
demand changes when prices change. Consider the case of a business that sells 100,000 units of one
product at $60.00 each and generates pre-tax profit of $300,000. If customers are insensitive to minor
price increases, the business could increase the unit price by 1.0% and generate $360,000 of pre-tax
profit. If the customers of the product are sensitive to minor price increases, the business could
increase the unit price by 1.0% and lose about 2.5% of its unit volume and generate $301,000 of pretax profit. Of course, price sensitivity may be asymmetrical, meaning that if unit volume decreases
2.5% due to a 1.0% price increase, volume may not increase 2.5% if the price is cut 1.0%.
128
Price and volume sensitivity of demand should be estimated for each customer - product category and
not uniformly to all customers and products. Estimate the change in unit volume if the unit price is
changed by -3.0%, -2.0%, -1.0%, +1.0%, +2.0% and +3.0%, and calculate pre-tax profit using a
breakeven table. Revise the estimates of unit volume at each price point until confident that the future
unit volume would be at least as favorable as projected. The estimates of future unit volumes may be
based on managerial experience and insight. Later, the results of a series of observed, measured price
adjustments will enable more precise forecasts.
Table: Price & Volume Sensitivity
Price Increase:
Unit Volume Change:
Unit Price
Unit Costs
Units
Revenue
Total unit costs
Overhead
Pre-tax Profit
Price Sensitive
1.00%
-2.50%
$60.60
$37.00
97,500
$5,908,500
$3,607,500
$2,000,000
$301,000
Price Sensitive
-1.00%
2.50%
$59.40
$37.00
102,500
$6,088,500
$3,792,500
$2,000,000
$296,000
Price Increases
Privately held companies view themselves as price-takers, not price-setters - meaning that they believe
that they do not have the market clout to raise prices. (General Motors' pricing is restricted by
competition, too.) Surprisingly, some privately held companies may raise on a one-time basis prices
by 1% - 5% more than inflation without imperiling unit sales. Overcoming a fear of customer price
resistance may enable some companies to double pre-tax income.
There is a natural reluctance to raise prices and to risk losing customers; however, pricing to marginal
customers and on marginal products should be increased (or, the costs should be decreased). A 10%
price increase may restore a customer category or product to profitability. In rare cases, pricing may
need to be raised 20% or more. Widespread price increases of 1% - 5% more than inflation may be
appropriate for Turnaround and Tune Up companies. Status Quo companies may hold prices steady
while concentrating on customer service and product quality issues. Go For Gold companies are
probably pricing intelligently.
129
Price Cuts
Frequent price cuts may cheapen the corporate image or brand name, may train customers to delay
purchases until the next sale and may signal financial instability to the business community. Price cuts
help sell off end-of-season fashion merchandise, overstocks of any product and products in danger of
becoming obsolete. A high volume, low cost strategy for innovative products may include regularly
paced price cuts, to stimulate volume and economies of scale, to broaden the appeal from early
adapters to the mass market and to discourage the introduction of competitive products.
Incremental Pricing
Incremental pricing offers unique opportunities in unique circumstances. Incremental pricing means
pricing one order to cover its costs plus some overhead. A business might bid on a large order of 8,000
units from a new customer at $47.00. If the unit cost is $37.00, the business should increase its pre-tax
profit by $80,000 ($47.00 - $37.00, x 8,000 units). Maybe. Maybe not. Incremental pricing has merit
in cases of a unique order which will not expose a business to a perceived betrayal of existing
customers or to the corporate disease of frequent discounting.
Price Wars
Price wars are an opportunity to ruin a viable industry. Price wars are bleeding contests. Price wars
are expensive, train customers to delay purchases until the next price cut or the next sale and only
convey a temporary advantage (except in cases where one or more competitors exit the industry). A
multinational corporation might gain a permanent advantage through initiating a price war; however,
privately held companies may not have the financial resources to withstand a price war and should
rarely start a price war. The one possible exception might be using below market pricing to make a
breakthrough into a new customer / product niche, if competitors in the niche are unlikely to retaliate.
If confronted by a competitor's price cut, there are three basic responses. Maintaining prices may have
no impact on unit sales if the competitor's price cut is minor or if product differentiation is great. If
neither condition applies, unit volumes may fall and profits may decrease. Matching the competitor's
price cut may maintain unit volumes, result in lower profits and even losses and signal the competitor
that any further price reductions will be matched and that a price war will not gain the competitor
130
market share. Exceeding the competitor's price cut may provoke a further spiral of price cuts, leading
to industry-wide losses and little re-allocation of unit volumes and market share.
Clich To Live By - Pricing
Undercharging is a self-inflicted injury.
The buyer - seller relationship is about dividing up the benefit of the relationship; and, if you don't
get your share of the benefit, you shouldn't be in the relationship.
Marketing Ideas
Listen To Your Current & Past Customers
Listen to your customers. Ask your customers. Use telephone surveys, mail questionnaires, focus
groups, stratified random samples and in-store intercepts.
customer satisfaction and to compare and graph responses on a monthly basis. Customer surveys take
the pulse of the marketplace. The survey can be a mail or telephone survey if it is short, easy for the
respondents and designed to get meaningful information. Focus groups are small groups of customers
invited to discuss the business or an aspect of the business. The most important point about surveys
and focus groups is that listening creates the benefit. The second most important point is to do it well.
Read a book on surveys or focus groups or hire a specialist.
Executive Interaction
The President and the financial, engineering, purchasing, manufacturing and marketing executives
should meet with current and past customers. Surveys and focus groups are valuable. Real life
feedback is invaluable.
Remove Irritants
Remove irritants no matter how small. If one customer complains about shipping damage, review
shipping procedures, packaging and freight carriers to solve the problem. Make it easy for customers
to want to buy. Remove irritants. Immediately.
131
manufacturing and logistics. Few have computerized marketing. Databases can facilitate customer
132
segmentation, telemarketing, highly targeted niche advertising and customer specific selling. Database
information management has been a competitive weapon; soon it will be a requirement of survival.
Direct Mail
Direct mail should be well done. Select industrial targets by using Chamber Of Commerce directories,
industrial directories, wholesaler directories and purchased lists. Select consumer targets by postal or
zip code or buy a mailing list of people suitable to the product or service. Have a clear message: a
product, a new line of products, a new location or a new service. Hire a specialist consultant until the
company acquires direct mail competency. Measure the contribution margin of direct mail.
Telemarketing
Consider taking the cars and airline tickets from traveling salespeople and giving them desks, chairs,
telephones, computers and databases. Telemarketing can reach small or distant customers who cannot
be served economically by traveling salespeople. Telemarketing requires a disciplined commitment,
some investment in communications technology, a good database of customers and their buying
preferences and trained people. Telemarketing can be used for prospecting new customers, soliciting
follow-up orders and surveying customers. Telephone companies may provide information about
telemarketing. Consider hiring a telemarketing consultant.
Open Houses & Trade Shows
Open Houses and Trade Shows can be expensive and time consuming. They are also wonderful
opportunities to meet potential customers, to do some reverse marketing to suppliers and to gather
industrial intelligence. Attend a number of Open Houses and Trade Shows as an observer in order to
assess the costs of making a positive impression and potential benefits. Also, an Open House tells staff
that they and what they do are important to the company and to customers.
Product Demonstrations
Product demonstrations are easy to do, cheap and sell product. Product demonstrations on a retailer's
sales floor can be highly effective for both the manufacturer and the retailer. Industrial demonstrations
may be more expensive, due to transportation and more skilled personnel, but demonstrations may be
essential for expensive, technical or innovative products.
133
Internet Commerce
Companies serving industrial and commercial customers should investigate internet catalogue and
ordering systems. Discuss with current and potential customers how they prefer to manage their
purchasing function. Large companies are moving to internet commerce and privately held companies
must keep pace. Companies serving individual consumers might consider attractive web pages.
Marketing Expenditures
Marketing expenditures include travel and promotion, advertising, sales discounts, sales commissions,
shipping and printing of brochures and packaging. Total marketing expenditures can be significant.
Marketing expenditures may be repeated year after year due to inertia, tradition and a copycat
mentality, leading to substantial wasted money if customers needs and preferences have changed.
Marketing expenditures should not be targeted at shrinking customer niches (unless the niche is
expected to remain profitable).
profitable customers and products (improve, re-price or de-cost instead). Status Quo and Tune Up
companies may tend to continue marketing programs in support of 'the product that built our company'.
Yesterday's products should be allowed to die a dignified, honorable death. Products in decline should
be analyzed to determine if they are in decline due to marketing neglect, demographics or
obsolescence.
Marketing expenditures should support of the company's priority customers and products. The money
saved from canceling marketing expenditures in support of unprofitable or marginally profitable
customers and products should be spent on high potential customers and high growth products. Go For
Gold companies are sophisticated in their marketing and marketing expenditures. Status Quo and
Tune Up companies might consider increasing total marketing expenditures by 50% - 100%.
Turnaround companies should finance new marketing by saving money on old marketing programs.
Get Out companies should direct marketing expenditures to selling existing assets, not to building
future customer relationships.
134
WYN Describe the company's customers. Review customer profitability. What customers
Write
Your should be dropped? What high potential customers should be targeted with special
Notes programs? What special programs? What should the company do more, less or better?
What should be implemented within 12 months? What issues should be researched and
analyzed? What marketing expenditures should the company make, and to sell what
products to what customers? How much should the company spend on marketing?
135
comparative attractiveness of company products on the basis of their competitiveness, market potential
and estimated future contribution compared to future investment. (A more detailed approach would be
to use the forecast net discounted cash flows of each product.)
Worksheet: Comparative Attractiveness Of Products
If a commodity, what value added could be added?
If a value-added product, what is the value added?
What is the closest competing product or service?
What are the quality, pricing and service of the closest competing product or service?
Who is our direct customer?
What benefits does this customer receive by buying this product?
What additional benefits might the customer pay for?
What problems does the customer experience with this product?
Can our customer use a different product to get the same or more benefits?
What are our specific marketing efforts to support sales of this product?
What marketing would be required to increase sales 20% in 12 months?
What could impact demand for this product (economic, technologic, legal, social
changes)?
What are the key components or raw materials required for this product?
What are the key staff and managerial skills required to make and sell this product?
What was the most recent quality improvement? And, when?
What was the most recent cost reduction program? And, the results?
What research and development is required? Why?
Revenue in the most recent business year.
Contribution Margin in the most recent business year.
Projected growth of demand for this product, over the next 5 years?
Will product price change, due to shortages, surpluses or competition?
Will the cost to make this product increase / decrease?
Projected Contribution Margin, next 5 years, estimated.
Investment Required To Achieve Contribution Margin, Over Next 5 Years (Inventory,
accounts receivable, fixed assets, research and development, other)
Contribution / Investment, next five years (b / c = d).
Competitiveness of this product, next 5 years (High = 5, Medium = 3, Low = 1).
Estimated Overall Attractiveness (a * d * e)
Product A
Product B
$
$
$
$
(a)
(b)
(c)
(d)
(e)
$
$
$
$
%
136
attractiveness of the companys crystals. The Low Profit / High Growth crystal is a danger: increased
sales will drag down corporate profits. The company should re-price, de-cost or drop it. The Low
Profit / Low Growth crystal consumes management attention and marketing resources and has nominal
profit and nominal potential. The remaining two crystals appear to be the company's future and should
be supported by current resources plus resources liberated from the first two products. The obvious
gap in the companys products is, of course, the absence of a High Profit / High Growth crystal.
Research and development should aim at creating a premium priced, innovative crystal.
Diagram 7.1: Map Of Comparative Attractiveness Of Products
137
Product Strategy
The analysis and mapping of products should indicate a product strategy. Current products may be
deleted, improved, augmented by additional features or services or stripped of costly features unvalued
by customers. The prices of some products may be increased. The prices of High Profit / Low Growth
products may be decreased to stimulate growth of unit sales and contribution margin. (Estimate the
price and volume sensitivity first.) Acquisitions or research and development may fill product gaps.
The company may aim to have differentiated products or to offer fewer, low-cost products.
Government regulations that may affect product strategy, as with pharmaceuticals, should influence
and may determine product strategy.
The worst product strategy is attempting to revive yesterdays product. Any product that no longer
meets a definable customer need is yesterdays product.
yesterdays product is that management feels a nostalgic attachment to it. This is the product that
built our company. Another strong clue is a sales decline over several years or steady sales in a
rapidly growing market.
The neglected product may appear to be yesterdays product or a failed product on the basis of sales.
The neglected product is characterized by low marketing support and little research and development
support for several years. A failed product has received good marketing and research and development
support and has not generated satisfactory sales or sales growth.
Privately held companies may expand their product line, incrementally, year after year. In time, they
may spread valuable managerial focus and manufacturing expenditures across too many products.
Companies should focus on the best products (Medium Profit / Medium Growth, Medium Profit / High
Growth, High Profit / Medium Growth and High Profit / High Growth). Managerial time, marketing
expenditures, process improvements, capital expenditures and research and development should be
devoted to the best products. Drop or gracefully phase out yesterdays products and failed products.
Gracefully phasing out products means raising prices, decreasing marketing support, stopping further
investments in research and development and reducing inventories over time. Reprice or de-cost
products with marginal or negative contribution margins. Medium Profit / Low Growth products
might be re-engineered to add or improve features valued by customers.
138
Operations is purchasing,
manufacturing, logistics and research and development. Operations represents 70 80% of many
companies costs and almost 100% of what customers value. Go For Gold companies are excellent at
Operations or Marketing, good at the other, and at least adequate in Administration. Go For Gold
companies are never bad at operations or bad at marketing. Never.
OPERATIONS
All successful businesses manufacture customer satisfaction. Operations is not limited to traditional
metal-bashing manufacturing companies. The concepts and techniques of Operations Management
have been applied to food preparation in restaurants, baggage handling at airports, mail sorting in the
Post Office, on-site lens grinding by opticians, equipment capacity and utilization by municipal
garbage collection contractors and audit work flows by auditing and accounting firms. Operations
must be analyzed in order to determine what the real, current operations and business strategies are,
versus what management thinks they are.
research and development, process refinements and employee training may not be congruent with
management's stated or future strategy.
Operations Data
Operations involve actions (stamping and drilling), documents (time dockets), time (action time and
waiting time), people costs (including benefits), purchases (raw materials and utilities) and time costs
(interest on inventories, business taxes and supervisors' salaries and benefits). Getting and analyzing
the operations data may be a daunting task; however, a thorough analysis will show where time and
costs occur and will indicate opportunities for accelerating the order received to order shipped cycle
and for incremental savings in people, purchases and time costs.
139
Time Is Money
Some costs are activity driven. If production doubles, the costs of raw materials and direct labor
double (more-or-less). Other costs are time driven: if production ceases for a week, salaries of
supervisory personnel, business taxes and interest on money borrowed to finance inventories continue
to accrue on an hourly, daily and monthly basis. Therefore, if the time from receipt of raw materials to
shipment of finished goods is four months, then the finished goods accumulate four months of timebased costs. If time from materials receipt to goods shipment is reduced to three months, then finished
goods accumulate 25% less time-based costs. A 25% reduction in time and time-based costs may
increase pre-tax income 5% and may reduce capital expenditures required to support growth. Savings
can be achieved by speeding information flows, co-ordination with suppliers and within the factory or
warehouse and reducing in-house waiting time.
Clich To Live By Time Is Money
You don't have to be smart to be slow.
No
140
Has the company reduced by 50% the order to shipping cycle (i.e. number of days)?
Has the company reduced by 50% materials handling?
Have preventive maintenance programs reduced downtime and disruptions by 50%?
Have packaging and in-bound and out-bound freight been reduced by 25%?
What new sales were generated last year, as a result of the previous year's R & D?
Should R & D expenditures be eliminated? Increased?
Does R & D have a focus or goal? If yes, state it in 30 words or less.
Has a capital expenditure budget been prepared for the next five years?
Small
improvements are affordable, manageable and prove-able. Many gradual improvements to every facet
of operations means that a business can shift and adjust to changing markets and technologies while
avoiding over stretching their people's ability to adapt and management's ability to manage.
Clich To Live By - Major Changes To Operations
A thousand steps covers more distance than a hundred jumps.
141
invited to participate in a task force to examine in-bound and out-bound freight. Scheduling, common
carriers and packaging alternatives should be considered.
equipment and processes and to prepare a three to five year capital expenditure and staff training plan
to achieve the ideal configuration.
Example - Control The Critical
Not everything is critical. Control the critical, relentlessly. And, know what is critical. One
manufacturer planned a multi-million dollar expansion; however, after analyzing operations,
two steps in the manufacturing process were identified as being proprietary, confidential and
critical to the company's distinctive competitive advantage. The company decided to subcontract the forecast overload on non-critical manufacturing operations, reduced its capital
expenditure budget by about 60% and devoted its remaining capital expenditure budget to the
two critical operations.
SUPPLIERS
Suppliers include sources of all purchased inputs, except personnel, depreciation and taxes. Purchased
inputs during the previous two years should be analyzed. (If corporate records cannot readily generate
a detailed report, use the last 24 months' Aged List Of Accounts Payable and consider the amounts
shown as 'Current' as the previous month's purchases.) Categorize suppliers as Suppliers Of Materials
and Suppliers Of Non-Materials and sort in descending order of volume.
Table: Summary Of Suppliers
Able Acme Widgets
48%
56%
$3,850
$16,050
$7,000
$1,400
$900
$9,300
$25,350
142
15%
63%
27%
6%
3%
37%
100%
$2,075
$17,025
$7,000
$1,600
$1,000
$9,600
$26,625
8%
64%
26%
6%
4%
36%
100%
$2,542,676
$565,730
$297,265
$3,405,671
74.7%
16.6%
8.7%
100.0%
It is possible to maintain a basic level of good relations with all suppliers by non-adversarial
negotiations and by paying as agreed. Relationships with key suppliers merit active senior management
attention.
appraisals. Almost none do supplier performance appraisals. Total purchased inputs may account for
60% - 70% of every sales dollar and key suppliers may account for 60% - 70% of purchased inputs;
therefore, key suppliers may represent 40% - 50% of total costs and greatly affect product and service
quality. Managing and measuring these key suppliers is managing and measuring a vital determinant
of corporate success. Performance appraisals of suppliers are a great management discipline and a
discipline of suppliers.
Worksheet: Supplier Performance Appraisals
Supplier Name: ________________ Annual Purchases: $_____________
The Supplier
Yes
No
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
143
Date
encourage suppliers to make sincere efforts to 'partner' in a mutually beneficial relationship. The idea
of a supplier linkage is that there must be mutual benefit and a relationship based on trust. Both the
customer and the supplier need to identify what each should gain and, thus, what the other should
provide in terms of market intelligence, marketing, production planning and research and development.
Trust requires similar values about quality, cost control, service, people and ethics. Supplier linkages
are time consuming. Communication and co-operation require co-ordination. Problems must be
openly addressed, possibly through semi-annual supplier appraisals. Therefore, focus on linkages with
key suppliers, not all suppliers.
144
PURCHASING
Every company has a purchasing function, ranging from one person who also handles inventory
counting and control to a distinct department reporting to the President, the Vice-President of
Manufacturing or the Vice-President of Finance. The purchasing function should be appropriate to the
company's needs. For auditing and legal firms, research labs, and creative advertising boutiques,
purchasing is not a key success factor; nonetheless, purchasing may become a key function when
unusual purchases are being considered, such as a major expenditure on lab equipment or the
negotiation with a landlord for new premises.
purchasing make to our success? The answer for many businesses is 'A great deal.'
Example - Purchasing By Amateurs
A firm of medical professionals bought $1,200,000 of equipment and furnishings. The senior
doctor and a medical secretary handled everything and saved the cost of a competent, per diem
purchasing professional. They paid too much for more equipment than they needed and
diverted time from their professional competencies.
Clich To Live By - Purchasing
Smart buyers buy smart; hire a professional.
The cost of purchasing minor, routine or inexpensive items includes the transaction costs associated
with surveying the market and paying numerous invoices. Corporate credit cards enable savings in
transaction costs. Internet-based distributors may be efficient sources of supply. Retailers' buying
groups can be a cost-effective choice for some companies, because the buying group employs
professional purchasers. For larger and more expensive purchases or higher volumes of purchases,
privately held companies should consider hiring a purchasing professional. The cost of competency is
less than the cost of incompetency. A decision to invest in a dedicated, professional purchasing
function can be based on a comparison of projected savings and projected costs.
Table: Savings Due To Professional Purchasing
Sales
Purchased Inputs, at 70% of sales
Personnel
Interest
Depreciation + Bad Debts
Pre-tax profit
Savings due to professional purchasing at 2.0%
$5,000,000
$3,500,000
$1,000,000
$125,000
$150,000
$225,000
$70,000
$7,500,000
$5,250,000
$1,500,000
$187,500
$225,000
$337,500
$105,000
$10,000,000
$7,000,000
$2,000,000
$250,000
$300,000
$450,000
$140,000
145
$140,000
$210,000
$280,000
WYN Review the previous analysis of product revenues, costs and contribution margins. Assess
Write
Your and map products and product categories. Describe the product strategy. Decide what
Notes products to drop, phase out, re-price or de-cost.
Select high potential products to support with increased marketing expenditures. Project unit product
volumes, prices, costs and contribution margins.
Note the competitive strengths and weaknesses created by Operations, as currently managed. Describe
the Operations strategy (economies of scale / scope, innovation, differentiation). State what actions
and expenditures are required to make Operations a source of sustainable competitive strength.
Evaluate suppliers and linkages, noting key suppliers in tabular form.
146
Debt
Equity
LOW
Return On Equity
Risk Of Loss
HIGH
HIGH
147
Consider the case of a High Debt Company and a Low Debt Company. They have the same level of
assets, sales and expenses, excluding interest and income taxes. In the first year, the High Debt
Company has lower profits (due to higher interest expense) and a higher Return On Equity (due to
lower equity). If sales decline $1,000,000, the High Debt Company loses money, has a negative
Return On Equity and can only pay part of its interest expense. Conversely, the Low Debt Company is
still profitable, has a positive Return On Equity and can comfortably pay its interest expense.
Table: Debt / Equity Trade-Off
Sales Are Steady
High Debt
Low debt
Company
Company
$4,000,000
$4,000,000
$3,000,000
$1,000,000
$1,000,000
$3,000,000
3.00
0.33
$7,000,000
$7,000,000
$1,680,000
$1,680,000
$1,200,000
$1,200,000
$300,000
$100,000
$59,940
$126,540
$120,060
$253,460
12%
8%
Total Assets
Liabilities
Equity
Debt / Equity Ratio
Sales
Contribution Margin
Fixed Expenses
Interest
Income Tax
Net Income
Return On Equity
Sales Decline
High Debt
Low debt
Company
Company
$4,000,000
$4,000,000
$3,000,000
$1,000,000
$1,000,000
$3,000,000
3.00
0.33
$6,000,000
$6,000,000
$1,440,000
$1,440,000
$1,200,000
$1,200,000
$300,000
$100,000
($19,980)
$46,620
($40,020)
$93,380
-4%
3%
define
and
the
affect
Assets define the company. A wholesaler that buys a building to lease to an unrelated company shows
that it is not focused on wholesaling, that management is not confident that the best use of company
money is wholesaling or that management is bored with wholesaling. Assets consume management
148
and staff time. Buying a building to lease to an unrelated company, leasing it, collecting rent and
supervising maintenance consume management time, which means less time to devote to wholesaling.
Conversely, a wholesaler that invests in advanced logistics shows focus, confidence and managerial
commitment.
The wise selection, purchase and use of assets enables companies to manufacture, wholesale or retail
goods and services to its customers and to generate revenue, cash flow, profits and dividends. On the
other hand, every asset causes an expense.
Clich To Live By - Assets
What we buy defines what we value.
We are what we eat; a business is what it owns.
All assets increase expenses, including interest expense, no matter how we pay for the assets.
Scenario A
Steady
Steady
$ 550,000
$ 335,000
$ 215,000
$ 550,000
Scenario B
Decreased
Steady
$ 490,000
$ 275,000
$ 215,000
$ 490,000
Scenario C
Decreased
Down
$ 490,000
$ 275,000
$ 215,000
$ 490,000
Scenario D
Increased
Up
$ 640,000
$ 425,000
$ 215,000
$ 640,000
Scenario E
Increased
Steady
$ 640,000
$ 425,000
$ 215,000
$ 640,000
$ 85,000
$ 26,800
$ 17,460
$ 40,740
12.1%
18.9%
$ 85,000
$ 22,000
$ 18,900
$ 44,100
16.0%
20.5 %
149
$ 45,000
$ 22,000
$ 6,900
$ 16,100
5.9%
7.5%
$105,000
$ 34,000
$ 21,300
$ 49,700
11.7%
23.1%
$ 85,000
$ 34,000
$ 15,300
$ 35,700
8.4%
16.6%
CASH
Cash is, invariably, a company's biggest asset, even if there is no cash reported on the balance sheet.
Cash moves in and out of corporate coffers with astonishing rapidity and the giant sponge of debt
absorbs the flow.
Cash management
includes fraud prevention, prompt deposits of all cash, checks and credit card slips, consolidation of
bank account balances and acceleration of accounts receivable collections. Fraud prevention applies to
all assets, not just cash, but protecting cash is a good place to start. Control of the disbursement of
cash is a treasury responsibility, usually handled by the Chief Financial Officer of privately held
companies. Controlling cash disbursements ensures that cash is available and used for corporate
requirements. The calculation of the cash flowing annually through a company is shown below. (Cash
flowing through a business is a different concept than Cash Flow, which is annual net income plus
depreciation, amortization and other non-cash expenses.)
Worksheet: Corporate Cash Flowing Annually
Accounts receivable, beginning of year
Annual sales
Less: accounts receivable, end of year
Cash that flowed through the business during the year.
New Company
$ 135,000
$ 1,050,000
- $ 145,000
$ 1,040,000
The Company
Conduct Unbecoming, The Rise and Ruin of Finley, Kumble; Steven J. Kumble and Kevin J. Lahart, Carroll &
Graf Publishers, Inc., New York, 1990
150
Cash Budget
Privately held companies should prepare and use a rolling six-month cash budget. The cash budget
should list all assured cash receipts plus a provision based on estimated probabilities for cash receipts
that are not assured in terms of amount or timing, such as accounts receivable. The budget should list
all non-discretionary cash disbursements, such as payroll, government remittances and debt payments.
Next, the budget should list provisions to pay accounts payable and non-recurring expenses, such as
new or seasonal marketing programs.
Turnaround
ACCOUNTS RECEIVABLE
Accounts receivable are the unpaid goods and services sold to customers. Accounts receivable may be
the largest asset on the corporate balance sheet. They represent significant tied-up cash and require
significant funding from debt or equity. This means either higher interest expense on additional debt
or a lower Return On Equity due to higher equity. In addition, receivables expose the company to the
risk of non-collection (bad debts expense) and cause administrative costs to record, invoice and collect.
Accounts receivable are composed of three parts: the expenses incurred to produce a particular order,
the administrative expenses of being in business and a provision for profits. If an account receivable is
not collected, there is an accounting loss equal to the uncollected receivable and a cash loss equal to
the cash paid to produce and deliver the order. One bad account receivable may negate the profit on 5
to 20 good customers.
Accordingly, the
151
$43,283
$742
By Customer Category
Account #
Type
139
Dairy Farm
211
Dairy Farm
Amount
$147,285
100.0%
$3,071
$175
YTD Sales
$43,283
$1,373
0-30 Days
$103,218
70.1%
$2,964
$3
Amount
$3,071
$576
Accounts
Receivable
$231,799
$259,218
31-60 Days
$17,723
12.0%
$102
$3
0-30 Days
$2,964
$211
31-60 Days
$102
$365
61 - 90 Days
$17,008
11.5%
$4
91 - 120 Days
$9,336
6.3%
$169
152
collection becomes) and amount (a big loss hurts more than a small loss). The standard aged list of
accounts receivable report generated by the corporate accounting system's account receivable module
should be reformatted or exported to a spreadsheet. Add a column for the Risk Weighting Number.
The Risk Weighting Number for each account is: [(Amount 0 - 30 Days * 30) + (Amount 31 - 60
Days * 60) + (Amount 61 - 90 Days * 90) + (Amount 91 - 120 Days * 120)] divided by 100,000. (The
reason for dividing by 100,000 is to get a small number.) The multipliers may be adjusted to
emphasize older accounts. Sort the accounts in descending order by Risk Weighting Number. Senior
management would then focus its attention on the top 10% of accounts ranked by risk.
Table: Accounts Receivable By Risk Weighting
Account
Number
Total
328
348
219
469
Customer
Type
Risk
Weight
Landscaper
Dairy Farm
Dairy Farm
Beef Farm
158.5
110.2
57.8
3.9
YTD
Sales
$780,517
$97,258
$44,703
$131,580
$1,289
61 - 90
Days
$17,008
$7,703
$4,049
91 - 120
Days
$9,336
$2,308
INVENTORY
Effective inventory management supports marketing and cash management. The common prescription
of management consultants, accountants / auditors, bankers and company controllers is 'Reduce
inventory!
Executives
commonly like large inventories; they can see and touch inventory and feel successful and capable of
satisfying customer needs, if and when a customer needs something. The ultimate inventory policy
would be to have everything that everyone could want every time, and that policy would bankrupt
every business. Inventory may increase until bank lines of credit are consumed and suppliers' patience
is exhausted. In effect, inventory investment decisions are abdicated to bankers and suppliers.
153
High inventories and mismatched inventories (too much of some items and too few of other items)
may be blamed on random or fickle consumer buying behavior. The alternative explanations are that
consumer buying behavior was not correctly analyzed and predicted by the company, or corporate
purchasing was ineffective in controlling the quantity and timing of materials received.
Example - Inventory Management - Let's Play Stupid
A company made a product for a declining market. The company offset the general market
decline by capturing sales as competitors went bankrupt. Over several years, the company
added a wider and wider range of gauges and quality of steel, no matter how small or
infrequent demand might be. There was no attempt to forecast if an order for a particular
variant would be repeated. Ballooning inventory tied up cash, so the company borrowed more.
Inventory clogged the warehouse and overflowed into the factory, so the company built a large
addition to its warehouse, and borrowed more. Tracking inventory became onerous, so the
company relied on visual inspection, and, at times, steel was ordered when sufficient quantities
were in stock. The inevitable cash crisis was resolved by effective inventory management.
Clich To Live By - Inventory
How smart do you have to be to buy stuff (or make stuff) you can't sell?
Inventory defines what business we are in and what customers we serve.
154
dissatisfaction leading to a loss of customers leading in time to lower sales and lower Sales / Inventory
ratios. Therefore, the causes of a Sales / Inventory ratio may be more important than the ratio.
$211,000
$265,000
$135,000
$145,000
$43,000
$60,000
$49,000
$33,000
$51,000
$992,000
Sales
Average
Sales /
Gross Gross
GMRI Season
Growth Inventory Inventory
Margin Margin
13%
$65,000
324.6%
30% $63,300
97% Spring
14%
$45,000
588.9%
40% $106,000 236% Fall
2%
$25,000
540.0%
31% $41,850 167% Spring
-1%
$35,000
414.3%
38% $55,100 157% Spring
2%
$19,000
226.3%
27% $11,610
61% Fall
2%
$20,000
300.0%
22% $13,200
66% Fall
2%
$10,000
490.0%
27% $13,230 132% Spring
106%
$17,000
194.1%
21%
$6,930
41% Fall
89%
$11,000
463.6%
41% $20,910 190% Fall
11% $247,000
401.6%
33% $332,130 134%
Customers
All ages.
All ages.
All ages.
Mid-Older
Schools
Youth, males
Youth, Adult
Gyms
Mid-Older
WORKING CAPITAL
Working capital is not an asset. It is the difference between current assets (mostly cash, accounts
receivable and inventory) and current liabilities. Generally, it is assumed that more working capital is
better, because greater current assets can be used to pay current liabilities. The implicit assumption is
that accounts receivable and inventory are effectively managed.
increase working capital is to increase long term debt and shareholder investment which are used to
reduce current liabilities, which increases working capital.
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management of accounts receivable and inventory may be neglected. Some companies work very hard
to reduce working capital to zero, meaning that current assets equal current liabilities.
They
aggressively collect accounts receivable and tightly control inventories. They use the freed up money
to reduce liabilities, pay dividends and invest in product development, new equipment and new
marketing programs. They may retain some of the freed up money as cash or short-term investments,
which increases working capital and provides a buffer from adverse events. The quality of working
capital is at least as important as the amount of working capital. Effective working capital planning
and control should strongly emphasize planning and control of accounts receivable and inventory.
FIXED ASSETS
Fixed assets are assets used for more than a year in the normal conduct of business. A factory and a
forklift in the warehouse are fixed assets. A vacation condo used by the President of a manufacturing
company is not a fixed asset because it is not used in the normal conduct of business (for planning
purposes, classify the condo as Other Assets). Fixed assets influence what customers are served, what
products are made and what cost structure is endured.
Table: Fixed Assets
Reasons
To store, move and deliver inventory
To 'shelter' administration
To do administration
To manufacture
To help manufacture
To earn investment income
To be used someday
To be an employee benefit
To decrease costs
To increase safety
To increase customer satisfaction
To enhance the owner's ego
Example
Warehouse, forklift and trucks licensed for highway use
Office building
Accounting department computer
CNC lathe
MRP II computer system
A building leased to others
Raw land for a future factory
Company cars
Anti-shoplifting and other security systems
'Two hand' controls on shears
Showers and change rooms in an exercise club
Many expensive offices, holiday condo or ski chalet
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Owners'
Calculations
$21,500
12,625
4,625
17,250
4,250
$1,275
$2,975
4,625
7,600
Revised
Calculations
$21,500
12,625
7,000
4,625
1,300
25,550
-4,050
1,215
-2,835
4,625
1,790
-2,500
-$710
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(a)
(b)
(c)
Capital Expenditures
After surplus fixed assets are identified and their sales are scheduled, capital expenditures to support
corporate strategy may be considered. One very practical approach is to allocate a budget to major
corporate objectives, which will help ensure that expenditures are wisely incurred. Include in the
preliminary budget all reasonably possible or reasonably attractive capital expenditures.
Group
smaller capital expenditures into categories (ex: delivery trucks or factory material handling
equipment).
Review the capital expenditure budget. Is health and safety adequately funded? Is there enough
money targeted at new products or new customers? Too much money targeted at new products or new
customers, possibly at the danger of neglecting existing products or customers? Do capital expenditure
plans indicate a bias towards administrative issues or to production?
frugality? Do capital expenditures reflect whether the company is revenue driven or expense driven
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(i.e. are expenditures intended to increase revenues or decrease costs)? Is the preliminary budget
affordable and finance-able? If not affordable, delete the lowest priority items.
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Year 2
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Year 3
Benefits
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
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OTHER ASSETS
Patents, Trademarks & Capitalized Research & Development Expense
Patents, Trademarks and Capitalized Research & Development Expense may have economic value if
they enable or will likely enable the company to generate profits greater than available from tangible
assets only. However, the future income stream is often uncertain. In addition, the resale market for
intangible assets is usually small or non-existent. Therefore, the choice concerning existing intangible
assets may be simply the rate at which the asset is amortized in order to reduce income taxes. The
decision to purchase intangible assets such as patent rights is the same as the decision to purchase
equipment: on the balance of probabilities, well researched and analyzed, will the acquisition generate
income sufficient to justify the financial risks and is the acquisition consistent with corporate strategy?
Loans To Shareholders & Directors
Loans To Shareholders & Directors are treated as assets for accounting purposes. The economic
reality is that they are a decrease in effective shareholder support for the firm. Generally, Loans To
Shareholders & Directors should be paid and the funds used by the company for growth. The plan
should state to whom the money has been lent, the interest rate and the terms of repayment. Financial
projections should show the expected repayment.
Mortgage Receivable
Occasionally, a company will sell a building and provide some financing to complete the sale. The
plan should state to whom the money has been lent, the interest rate and the terms of repayment.
Financial projections should show the expected repayment.
Inter-Company Loans and Receivables, Stocks and Bonds Of Related Companies
Companies may have shares in subsidiaries and loans to or from the subsidiaries. Subsidiaries of the
same parent company may have loans to and from one another. Companies and their subsidiaries, and
the subsidiaries amongst them, may have accounts receivable and accounts payable owing to one
another. Subject to professional auditing and tax advice, any tangled series of advances to various
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subsidiaries should be simplified, to achieve a rational financial structure that management, lenders
and shareholders can understand.
segregated on the balance sheets. Loans To should be deducted from Equity and Loans From should
be added to Equity for analysis purposes. The plan should state the amounts, terms and conditions of
each loan, receivable, stock and bond.
Stocks and Bonds Of Unrelated Companies
Consistently strong profits, a seasonal or cyclical fluctuation in operations, a sale of a building or the
proceeds of fire or life insurance may generate surplus cash. Until surplus cash is used (to fund a
seasonal demand, to buy another building or to redeem the shares of a deceased shareholder), it should
be invested in low risk instruments, such as short-term government securities.
Privately held
companies should avoid stocks, long term bonds (which are interest rate sensitive) and deposits with
organizations and institutions that are not undoubtedly solvent. Prudence, safety of capital and focus
suggest that investments in stocks and bonds in unrelated companies should be sold and the proceeds
used to retire debt or pay dividends. Notes to explain the rationale for holding stocks and bonds in
unrelated companies (as opposed to retiring debt, paying dividends or owning short-term government
securities) should be included in the company's plan.
LIABILITIES
Liabilities are classified as Current Liabilities (due within a year), Term Liabilities (not due within a
year), Deferred Liabilities (not due within a year, but the precise timing is undetermined), Contingent
Liabilities (payable if something happens, such as losing a lawsuit) and Contractual Liabilities
(payable upon completion of a contractual commitment). Current Liabilities, Term Liabilities and
Deferred Liabilities are shown on the company's Balance Sheet.
Contractual Liabilities are reported in The Notes To The Financial Statements, if the liabilities are
known to the auditors and are large enough to merit disclosure. Notes to the plan should list any nonarms length relationships, name of the creditor, interest rates, security, repayment terms, guarantees
and covenants. Large liabilities should be explained in detail.
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CURRENT LIABILITIES
Bank Lines Of Credit
Bank lines of credit are the lifeblood of privately held companies. Lines of credit are intended to
finance normal day-to-day operations and smooth cash fluctuations caused by accounts receivable,
inventory, accounts payable and periodic payments such as payroll and loan installments. Use of lines
of credit to finance capital expenditures reduces the capacity to finance day-to-day operations.
Generally, term loans should finance capital expenditures. Companies with limited line of credit
capacity may consider a term loan secured by fixed assets, if not currently pledged as security, and
with the proceeds used to reduce their lines of credit. The higher interest rate on term debt may be
justified by the advantages of minimizing bank borrowings and supplier credit.
Accounts Payable
Accounts Payable include normal payables to suppliers, relatively small amounts owing to
governments, such as income tax or property tax, and accruals such as employee wages for the last few
days of a month. Government payables and accruals may be reported separately on the balance sheet.
Companies hoarding cash and companies in financial difficulty usually delay paying accounts payable
beyond normal terms. A better accounts payable strategy, if funds are available, is paying faster than
normal terms. Paying suppliers fast creates suppliers that are anxious to serve.
Current Portion Of Term Debt
Term debt is debt that is not payable within twelve months of the date of the financial statements or
projections. Term debt includes equipment loans and leases and real estate mortgages. The Current
Portion Of Term Debt is the monthly principal payments scheduled for next twelve months.
Other Current Liabilities
Other Current Liabilities may include uncommon items such as customer deposits and the amount of
Deferred Taxes expected to be come due within a year. Estimate amounts in the draft projections and
have the company's auditor review the estimate.
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TERM LIABILITIES
Term liabilities (or long term liabilities) are debts due more than twelve months from the date of the
financial statements or projections. Term loans may have either fixed or floating interest rates. Large
term loans can be divided into components, with different maturities and interest rates, in order to
diversify interest rate and cash flow risks. If capital expenditures are not funded by income or equity
injections, they should be financed by term loans, leases and mortgages. Depending on economic
conditions, the financial strength of the company and the nature of the security, lenders may provide
60% to 100% financing of capital expenditures.
Table: Term Loan With Different Maturities & Rates
Tranche One
Tranche Two
Tranche Three
Total
Interest Rate
Bank Prime + 1.25%
8.75%, fixed
9.875%, fixed
Repayment Schedule
$50,000/month until paid.
$50,000/month until paid, starting after Tranche One is paid.
$100,000/month; payments start after Tranche Two is paid.
Amount
$1,000,000
$2,500,000
$1,500,000
$5,000,000
Amount
Interest
Rate, Source Of Payment Year 1:
Conditions,
(earnings, sale of Principal
Security
assets, new equity)
Year 1:
Interest
Year 1:
Total
Total
Deferred Taxes
Deferred taxes are created by differences in the timing of deduction of depreciation for income tax
purposes and for financial statement presentation purposes. If capital expenditures cease, depreciation
would taper down, as assets became fully depreciated, and Deferred Taxes would become payable.
Conversely, capital expenditures may defer Deferred Taxes indefinitely. The company's auditors
should assist in calculating Deferred Taxes in the projections.
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EQUITY
Equity is the shareholders' investment in shares plus accumulated earnings less accumulated dividends
plus unusual contributions due to government programs or accounting values adjusted to reflect
'goodwill' created by a merger. In practical terms, equity is money that doesn't have to be paid back.
Since shareholders' loans are obligations which must be repaid eventually, shareholders' loans are not
considered equity for accounting purposes; however, for analytical and managerial decision-making
purposes, shareholders' loans are equity if they are permanently invested and if repayment (and
possibly payment of interest) is postponed. In privately held companies, equity may represent 25%
(which is dangerously low) to 50% (which is usually comfortably high) of total assets.
Shareholder Loans
Shareholder loans are usually unsecured. If the company becomes insolvent secured liabilities, such as
the bank and mortgage holders, get paid first and unsecured creditors, including unsecured
shareholders loans, share on a proportionate basis any residual cash. If, on the other hand, shareholder
loans are secured, they are paid on the basis of the security ranking. Generally, the ideal time to take
security is when the shareholder loans are made. If shareholder loans are not secured by a charge on
all company assets (probably ranking after bank loans and mortgages), shareholders should take
security, subject to legal advice.
New Equity
The best source of equity is earnings retained in the business. If the company needs additional equity,
the shareholders may be the most reliable, available and cheapest source - they know the business and
the potential risks and rewards. Also, lenders and potential investors may expect current shareholders
to support their companies to the maximum extent possible.
investment of substantially all personal wealth in a single privately held company is very high risk and
should be avoided.
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A company may require equity from exterior sources to fund a turnaround, to launch a new product or
division, to reduce an over reliance on debt or to finance rapid expansion. Generally, investors will be
very cautious about turnaround companies, start-up companies and companies launching major new
products / divisions. Equity investors will be less cautious, but cautious nonetheless, about investing to
fund a reduction in debt or rapid expansion.
The first hurdle in attracting an equity investor is convincing the investor that the company has good
management, good products and good markets. The second hurdle is negotiation of the percentage
ownership to be exchanged for the investment.
individual investors receiving minority ownership for large amounts invested; however, stories of
investors supplying 95% of the cash and getting 5% of the equity are the stuff of legends, not normal
experience. Generally, investors supplying 60% of a company's equity at book value will want 60% of
the shares, with adjustments up or down based on the perceived risks of business failure and the
perceived rewards of rapid growth and future profitability.
Example - Supplier Investment
One manufacturer over expanded in 1990. By 1992, working capital was strained, and the
company's bank requested that $500,000 of equity be invested. No single customer accounted
for more than 4% of sales. The three largest suppliers were multi-million dollar companies.
The company approached its fourth largest supplier, ranked by its purchases; the company had
estimated that its purchases represented about 60% of the supplier's sales and that the supplier
had a 25-30% contribution margin; therefore, maintaining the manufacturer as a viable
customer was in the supplier's best long term interest. After some negotiations, the supplier
invested $400,000 in preferred shares in the manufacturer.
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Equity Budget
Prepare an equity budget. Include planned dividends on preferred and common shares and any
planned sale or redemption of shares at a reasonably estimated price. Include as a redemption the
purchase of shares held by employees expected to retire within five years and shares held by
shareholders who wish to re-direct their investments or who object to the strategic direction of the
company.
Include the conversion to equity of debt, if the company has convertible bonds or
debentures (which are not common among privately held businesses). Later, when the financial
projections are prepared, retained earnings will be forecast and any gaps in the adequacy of equity will
be identified.
Worksheet: Equity Budget
Year 1
Year 2
Preferred shares, start of year
(a)
Plus: Sale of additional shares
Plus: Conversion of existing debt to shares*
Less: Dividends
Less: Payment of arrears of cumulative dividends
Less: Redemptions, required by contract
Less: Redemptions, at company's discretion
Preferred shares, end of year
(b)
Common shares, beginning of year
(c)
Plus: Sale of additional shares:
Plus: Conversion of existing debt to shares*
Less: Annual dividends
Less: Redemptions, required by contract
Less: Redemptions, at company's discretion
Common shares, end of year
(d)
Shareholder loans, start of year
(e)
Plus: Investment of new shareholder loans
Less: Repayment of shareholder loans
Shareholder loans, end of year
(f)
Shareholder Investment, before retained earnings, start of year(a + c + e)
Shareholder Investment, before retained earnings, end of year (b + d + f)
* Note: Conversion of debt to equity increases equity and reduces debt, but does not increase cash.
Year 3
WYN Describe the alignment of assets, liabilities and equity with corporate strategy. Confirm
Write
Your that the capital expenditure budget supports the product and customer strategies and
Notes revenue or cost driven strategy. Evaluate the management of accounts receivable and
166
167
ADMINISTRATION
There is a pervasive bias in favor of overhead people and against people who make and sell company
products and services.
course, the accounting department. Accounting department lunchrooms are much nicer than factory
lunchrooms. Production workers are timed, clocked and metered to determine their productivity but
the army of administrators does not measure its contribution to customer satisfaction or company
profits. Go For Gold companies know that administration in all its forms must make real, measurable,
demonstrable contributions to corporate success.
Clich To Live By Good Administration
Good administration costs money; but bad administration may cost the business.
Accounting
Modern business management needs good data. The accounting department is the single best trained
and equipped source of data - if it has senior management instructions and support. Accounting in a
modern business is a staff function that gathers, analyzes and reports financial and operational data in a
managerially useful manner (and reports to shareholders and taxation authorities).
Go For Gold companies have good financial controls and reporting systems.
Their accounting
Their accounting
departments support and advise operations and marketing. Other privately held companies receive less
accurate and less useful information in a less timely fashion. Status Quo and Tune Up companies may
have adequate financial accounting but weak accounting department support for operations and
marketing.
Their accounting departments may not have progressed beyond record keeping.
Turnaround and Get Out companies often have weak accounting departments that produce inaccurate,
inadequate and late information. Managerial Preferences skewed heavily to Marketing may starve the
accounting department of the financial and human resources required to develop and implement strong
168
accounting systems. Weak accounting is a symptom and cause of the Turnaround and Get Out
Positions.
The accounting department should be judged on its quality of service.
department's customers (the marketing department, the factory and warehouse people and the
company's bank) if they receive precise, useful, timely data. The feedback from these 'customers' will
indicate actions required to revitalize and strengthen the accounting department's contribution to
corporate success.
Example - Bad Accounting
One eight year old company was in financial difficulty. Record keeping was questionable. At
the bank's insistence, inventory was counted and compared to computer reports and a large
sample of invoices was compared to costs on the computer reports. Almost every active
inventory line item was wrong: either the quantity on hand, the landed cost or both were wrong.
The total error was about 14.6% of total inventory and about 115% of the previous year's net
income. The problem was caused by a seeping, creeping disease of inattention to details.
The accounting departments of rapidly growing companies may become over-stretched and additional
people and funding should be allocated. If the Controller or Vice-President Finance has been in the job
for more than ten years, he or she may be stale. The accounting profession has not been stagnant; and,
its practitioners need to progress. Annual training sessions should be arranged, at the company's
expense. If training is refused or avoided, consider a change of personnel.
Senior management should have a good intuitive sense of the accuracy of financial information. If
there are any misgivings about the accuracy of financial statement information, the company's auditors
should be involved immediately. A strong indication of errant accounting is significant differences
between the month-end financial statements for the eleventh month of the fiscal year and the auditorapproved year-end financial statements. Another indication of errant accounting is the existence of
parallel or duplicate systems maintained by Operations or Marketing because they do not have
confidence in the formal accounting system.
There is another problem uncommon, but occurring frequently enough to merit comment. Company
accountants may come to believe that they know best and may skew data or present data to the
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Cost Accounting
Financial accounting is preparing financial statements and reports such as fixed asset and depreciation
schedules and aged accounts receivable.
products and activities so that senior management has the information to make sound decisions about
products, customers, people and capital expenditures.
Virtually every Turnaround company, most Get Out companies, and many Tune Up and Status Quo
companies have out-of-date or grossly wrong cost accounting. They do not know how much things
really cost and, therefore, their decisions are either wrong or accidentally correct. The causes of faulty
cost accounting may include accountants trained in financial accounting and not cost accounting,
systems of cost allocation that were established several years previously and subsequently invalidated
by changes in processes, and cost allocations based on nonsensical factors.
If there are misgivings about the cost accounting system or data, the planning process should proceed
in two concurrent paths.
management should proceed while the cost accounting system and its output is reviewed by an
independent accountant or management consultant.
strategic decisions on products, customers, people and expenditures may be finalized. If the cost
accounting data is found to be flawed, the data should be corrected and the previous analysis of
product and customer contribution margins should be redone.
finalized.
Computer Operations
Computer security is a boring topic that executives ignore at their companies peril. Security threats
are not just from hackers and contaminated data. Security threats include disgruntled employees and
fired employees who have not left the premises or surrendered their remote access. A computer
170
consulting firm should evaluate corporate vulnerability, design safeguards and monitor compliance. At
an absolute minimum, companies should limit access to sensitive areas of their system to a small
number of authorized personnel, make back-up copies daily and store the back-up copies off-premises.
Computer security may be a risk with a small probability and a potentially disastrous consequence.
Some very large corporations have sub-contracted computer operations to specialized providers;
privately held companies might explore similar out-sourcing.
Example - Computer Crash
A distributor did not back-up its computer records. Its computer system crashed five months
into the fiscal year and reconstruction of its records took two months. Sales and customer
service suffered due to disruption in inventory records. Cash flow suffered due to disrupted
sales and delays in sending monthly invoices and monitoring overdue accounts receivable. The
company was unable to pay its suppliers on time. Fortunately, the company's bank increased
the line of credit by about 45% (with security on the two shareholders' homes) and the business
survived.
Fraud
No executive likes to think that his or her company is vulnerable to fraud or that a trusted, long-term
employee has been stealing. But, it happens far too often for any executive to dismiss the possibility as
being farfetched. Fraud is committed by people who are trusted: people who are not trusted are
supervised closely and so do not have the opportunity to steal. Incidentally, fraud does happen in
family businesses and sometimes by family members.
Some companies have suffered frauds spanning multiple years without their auditors noticing. The
annual audit is not fraud prevention or assurance of the absence of fraud. The specialized search for
fraud is called a forensic audit and is performed by specialized auditors. Forensic auditors should be
engaged at the first suspicion of fraud and, subject to legal advice, before the suspected employee is
questioned by management or dismissed. If there is no suspicion of fraud, there is merit in senior
executives attending workshops on fraud and fraud prevention. There is also merit in a forensic review
of corporate vulnerability to fraud.
There is another way to catch some fraud: encourage ethical behavior and open communication.
Ethical behavior sets the moral tone of the workplace and discourages the good employee from
171
succumbing to temptation. Open communication is important. While some frauds are cleverly hidden,
other frauds are thinly disguised and the defrauding employee leaves potential clues such as deviations
from standard administrative practices, odd working hours, deferred holidays and expensive lifestyles.
Often another employee has unvoiced suspicions. The silent employee needs to feel that he or she may
confidentially raise suspicions.
Example Fraud
In the late 1980s a company reported Net Income of $1,100,000, due to a new contract that was
three times larger than any contract the company had previously handled. The President
believed that profits should have been much higher. An employee confided to the companys
consultant that a senior employee had about $100,000 of renovations done to his house by
'grateful' suppliers. An investigation confirmed the allegation and indicated that the company
had been over billed by $400,000. And, how did the consultant find out? By listening. Many
honest employees who suspect fraud are willing to tell a sympathetic, confidential listener.
Clich To Live By - Fraud
Show some guts and face up to the fact that your people may be stealing.
Insurance
As privately held companies grow, their insurance needs become more complex and they become more
tempting targets for vexatious lawsuits. Executives resent insurance premiums, until their companies
suffer a loss. Adequate insurance is management of risk. Sophisticated executives segment business
risk into insurable and non-insurable risk. They insure and manage insurable risk and they manage and
mitigate uninsurable risk. Insurable risk includes fire, theft, product liability and death or disability of
key personnel. Insurable risks are managed through safety, security, product testing and grooming of
successors. Uninsurable risks include economic cycles, product obsolescence and foreign government
repudiation of national debts. Uninsurable risks are managed through economic forecasting, research
and development, hedging and discounting.
Professional insurance agents should be members of a corporate advisory team. There is, of course, an
inherent conflict-of-interest within the agent - company relationship. The agent is paid for selling
insurance and has a vested short-term interest in selling expensive insurance.
knowledgeable, honorable agents who make a long-term commitment to their clients and place their
172
clients' interests first. Select agents and brokers based on their technical knowledge, integrity and
references. Companies should not change agents or brokers for minor savings offered by competitors.
Agents and brokers lacking technical expertise or integrity should be replaced.
Worksheet: Insurance
Yes
No
Have all asset insurance policies been reviewed for completeness within the last three years (two years if
the business is growing rapidly)?
Have all liability insurance policies been reviewed within the last three years (one or two years if the
company is growing rapidly or adding new products)?
Has business interruption insurance been reviewed within the last three years (two years if the company
is growing rapidly)?
Has the company informed the insurance broker and / or insurance company of every major change in
operations and major capital expenditures since the last insurance policy review?
Has 'key executive' insurance been updated in the last three years, to reflect changes in the company's
dependency on one or more executives?
Has life insurance supporting buy-sell provisions of a shareholders' agreement been updated within the
last three years to reflect changes in share values?
Has the Directors' Liability insurance been reviewed in the last three years?
Has the company invited an insurance company inspector or an independent inspector to inspect all
premises and operations within the last three years (or, more recently if there have been major changes in
operations or assets), in order to identify insurable risks and prudent risk management / reduction
actions?
Has an independent consultant conducted an environmental risk assessment within the last three years?
Does the company have complete records, stored off-premises, to support and verify a claim promptly?
Is each insurance agent / broker knowledgeable about insurance and about the company, and fully and
ethically committed to the company's long term best interests?
eventuality (not a certainty as key executives may retire before they die and shareholders may sell their
shares).
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Manufacturing companies may use an offset strategy, meaning that raw materials and components are
purchased in the foreign countries in which the manufacturers sell: collections of foreign accounts
receivable are used to pay foreign accounts payable. A variation on the offset strategy is mixed
currency borrowing: an American hotel with large Japanese tour volumes might arrange a mortgage
with all or a portion of the mortgage in yen. A hedging strategy may be used: a contract to buy or sell
a foreign currency may be arranged through many financial institutions. Hedging should always be in
amounts and maturities to match future, specific payments or collections. An imperfect variation on a
hedging strategy is to quote sales or estimate product costs based on forward foreign exchange contract
rates quoted by major banks and investment dealers. This hypothetical hedge does not eliminate risk
but it does allow an intelligent forecast to be built into pricing and costing decisions.
Speculation
Speculation in currencies, interest rates, commodities, securities, real estate and other assets are the
core business of hedge funds and commodity and securities traders. For privately held companies
speculation is terrible mismanagement.
speculation should be fired. Privately held companies should not speculate because they lack the
expertise and the financial resources to absorb losses.
Speculation in financial products is an act of desperation or greed, and neither motive is consistent
with prudent, modern business management.
Turnaround and even Tune Up companies and greed may drive executives in Go For Gold companies.
Status Quo companies, being sleepy, may be less likely to speculate, except in cases of unsupervised,
rogue financial executives.
Speculation in real estate is more common and may be marginally less foolish. Operating companies
may build premises far in excess of reasonably probable future requirements in anticipation that a
rising real estate market will generate attractive leasing revenue or a long-term gain on a later sale of
the premises. Speculation in real estate creates a number of risks, including interest rate fluctuations,
higher fixed costs due to debt repayment, reduced demand for premises due to economic swings and a
loss of focus on the core business.
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Classes Of Shares
Corporate shares are subject to the Corporations Act of the jurisdiction in which the company was
incorporated and the company's Articles Of Incorporation. Shares may have different characteristics
than this description. The types of shares issued by a business are usually described in the Notes To
The Financial Statements; if not, ask the company's auditor or lawyer. Companies may have more than
one class of shares and each class should be listed and described. Common shares are voting shares
and may be paid dividends if the company is financially healthy. Preferred Shares cannot usually vote
but are entitled to an annual dividend, either cumulative or non-cumulative. Shares may be voting,
non-voting or non-voting except under certain circumstances. At least one class of shares must be
voting shares, to elect the Board Of Directors.
Worksheet: Classes Of Shares
Class of share
Preferred A
Number
authorized (1)
Number
outstanding (1)
175
Preferred B
Common A
Common B
Partnership Units
Other
(1) A business may by its original incorporation documents or later amendments be authorized to issue, for example, 1,000
common shares but may have issued only 600 shares.
Ownership
Privately held companies usually have one to ten shareholders.
Differences in shareholder
expectations can lead to serious and even debilitating disagreements among the shareholders about
corporate strategy. Some destructive shareholder disputes may be attributed to the simple fact that the
shareholders have different goals and expectations. Does one shareholder want rapid growth and is,
therefore, prepared to accept an aggressive or slightly risky strategy while another shareholder wants a
steady rate of return on a safe investment? Does one shareholder want to sell his / her shares within
the planning time frame, while another wants to retain shares for many years and to reap long term
capital appreciation? Expectations should influence the choice of growth strategy, amounts to be
invested in capital expenditures and Research & Development, and what additional shareholders or
venture capital firms are 'right' for the business. Differences in expectations may suggest a need to
acquire the shares of a dissident shareholder.
List and describe the company's shareholders by class of share. Give the shareholder's name and
describe the shareholder (President, an employee who is expected to retire in 4 years, a venture capital
firm). State the number of shares of that class owned and what per cent ownership those shares
represent of the total number of shares in that class. Describe the expectations of each shareholder.
Worksheet: Ownership & Shareholder Expectations
Shareholder
Description Of
Shareholder
# Owned
%
Ownership
Total (1, 3)
(1)
(1)
The total should equal the total shares outstanding.
(2)
Delete this column when editing the final version of the plan.
(3)
If there are more than one class of shares, use more than one worksheet.
176
Harry Jones
60%
Jones Holding Co. Ltd.
40%
Bill Jones
70%
20%
Helium Corp.
Nitrogen Corp.
No
177
Shareholder Agreements
Every privately held company with more than one shareholder should have a Shareholder Agreement.
A Shareholder Agreement typically describes the limits on the shareholders who operate the business
(ex.: no capital expenditures over a specified amount unless approved by a shareholder vote), provides
a mechanism by which one shareholder may purchase the shares of other shareholders (ex.: an option
to buy, at the price first offered, the shares of a shareholder who offers to acquire the shares of other
shareholders), and establishes the method of valuing and buying the shares of a deceased shareholder
(ex.: a professional business valuation and life insurance on all or major shareholders). These standard
provisions protect the company from the worst cases of shareholder dissension and protect minority
shareholders from oppressive behavior by a majority shareholder.
Agreement prepared and signed within the preceding three years, the preparation and signing of a
Shareholders Agreement should be added to the list of important decisions to be implemented within a
short time after completion of the plan.
BOARD OF DIRECTORS
Boards Of Directors are elected by voting shareholders to govern the company. Boards and the
individual Directors have legal obligations to ensure that the company observes all laws and some
contractual agreements, that the interests of all shareholders are observed equitably and that the
company is operated in a responsible manner at all times. Directors have significant legal
responsibilities and they should receive legal advice on their responsibilities and potential liabilities.
Boards Of Directors of privately held companies are commonly ineffective. Many Boards do not
formally meet annually. The corporate lawyer may write up the Minutes Of The Annual Board Of
Directors & Shareholders Meeting even if no formal meeting occurred.
composed of shareholder / executives only or the shareholder / executives, family friends and old
professional advisors. There may be no independent persons on the Board, because the shareholder /
178
executives do not want interfering outsiders and qualified outsiders do not want the exposure to
potential Directors' liabilities and the aggravation of being ignored by the shareholders. Therefore,
most Boards Of Directors of privately held companies cannot and do not provide independent
overview, guidance and governance.
Fixing Boards Of Directors of privately held companies requires a commitment by the majority
shareholder to excellence in corporate governance and a frank assessment of quality of the current
Board. Directors should not be relatives, employees, professionals employed by the company (such as
its accountant and lawyer) or shareholders' spouses or relatives. Directors might include the largest
shareholders, the President and three or four non-shareholder, non-employee (i.e. independent)
Directors. Independent directors might include two business persons from a non-competing industry, a
retired executive from a large company, a retired commercial banking manager, a professor from a
local university (professors of business, engineering, political science and other disciplines are highly
trained and have special insights) or an Executive Director of a Not-For-Profit organization (some
charities have larger annual revenues and more employees than many privately held businesses). Two
or three Directors should be a different gender, race and age bracket than the company President. Two
or three Directors should have skills that are very pertinent to the companys Position and strategic
direction. The leadership and governance issues associated, for example, with the Turnaround Position
are much different than those associated with the Go For Gold Position. Also, a strategy of rapid
growth through exporting requires different skills than a strategy of defensive growth through
consolidation of the domestic industry. Directors should be paid an annual honorarium of $5,000 $25,000, which is money well spent to access top quality expertise.
Record the composition of the current Board Of Directors. Rate each Director as Good, Average or
Poor. Plan to replace any Director who does not make a meaningful contribution to the company.
Worksheet: Board Of Directors
Name
Shares
Owned
Principal Occupation
(Pres. of ABC Co., etc.)
Residence
(City only)
Rating *
Overall:* Does this Board have the mix of skills and personalities to provide governance consistent with the
companys Position and its strategic direction?
*
During the editing stage, delete the Main Contribution and Rating columns,
179
Board Of Advisors
Rather than trying to fix an ineffective Board Of Directors, establish and use a Board Of Advisors. As
its name implies, a Board Of Advisors advises, it does not decide or direct the business or management
or incur the legal liabilities that Directors may incur. The ideal composition of a Board Of Advisors is
similar to that of a Board Of Directors. The Board Of Advisors should be consulted on major
financial, marketing, operational and personnel policies and issues before binding decisions are made
and implemented. Quarterly meetings should be conducted in a business-like manner and a light lunch
or supper may be served. Seven to ten days before each scheduled meeting, the company should
provide to Board members memos or reports covering issues to be discussed and management's
proposals. Board members should offer advice and guidance but there does not need to be a consensus
amongst Board members. Votes are not normally held.
Record the composition of the current Board Of Advisors. Rate each Advisor as Good, Average or
Poor. Plan to replace any Advisor who does not make a meaningful contribution.
Principal Occupation
(Pres. of ABC Co., etc.)
Residence
(City only)
Rating *
During the editing stage, delete the Main Contribution and Rating columns.
180
unsuccessful business executive is like learning to drive from someone who just had an accident. In
practice effective and durable Roundtables are difficult: members must have a strong commitment to
sharing of ideas, openness, confidentiality of all discussions and regular attendance. A coordinator,
paid by the group, is desirable. A professionally organized roundtable is advantageous.
Table: Boards Of Directors & Advisors, & Peer Group Roundtables
Required by law
Liabilities
Represents
Qualifications
Cost
Member's time
Possible problems
Board Of Directors
Yes
Numerous
Equity
Elected by shareholders
Nominal
40 - 80 hours / year (or more)
to prepare for and participate
in the meetings
Directors may lack fresh
insights or independence
Board Of Advisors
No
Probably not (1)
Expertise
Expertise, commitment,
management's respect
$10,000 - $75,000 / year.
40 - 80 hours / year to prepare
for and participate in the
meetings
May not give practical advice;
or, management may not listen
PROFESSIONAL ADVISORS
Public accountants, lawyers, insurance agents, management consultants and other professionals can
become stale, complacent or simply tired; not all do, but it is worthwhile to frankly ask if the company
should change professional advisors. The fact that an individual was excellent twenty years ago is not
sufficient reason to keep that person or firm. The question should be: "Does this person or firm have
the ability and commitment to significantly help the company?" Also, buy professional services on
quality, not price: a cheap cost never compensates for bad advice.
Worksheet: Professional Advisors
Person, Firm, Address,
Years Time & nature of Rating
Telephone, Fax & Email used last major work
Quality*
Accounting & auditing
Legal
Insurance
Engineering & technology
Environmental
Rating
Cost*
Time to
change?*
181
WYN This chapter covered a variety of administration and governance topics and it may be
Write
Your tempting to do the research and analysis in a superficial manner. Instead, be thorough.
Notes Corporate governance is important.
182
LEGAL MINEFIELD
Do not rush into changes affecting the company's people. Take the time to think through any possible
changes. If employee relations policies, procedures and practices have not been reviewed within two
or three years by a lawyer specializing in employment law, spend the money and do it now. There are
laws and regulations on virtually every aspect of employer / employee and employee / employee
relationships. The laws and relationships are becoming more restrictive as politicians and the courts
find or invent new rights and responsibilities. The company and its executives and directors may be
responsible for what happens to employees. If there is any doubt about an employee issue, check with
a lawyer specializing in employment law. If there is no doubt, check anyway. If a question must be
decided without the benefit of legal advice, rely on the highest ethics.
ORGANIZATION
Business is an organized effort to achieve customer satisfaction profitably. Although good people may
achieve adequacy in a badly organized company, good people in a well organized company can
achieve consistent excellence. There are three common organizational models. The first two models
may be appropriate in particular circumstances and third model is inappropriate in all circumstances.
The Formal Organization
In
formal
organization,
there
are
clear
managerial roles
and
responsibilities.
183
Jobs are shown on a chart by boxes connected by straight lines representing lines of authority and
reporting responsibilities. The Board Of Directors governs the company and directs the President.
The President directs managers of major functional areas. Managers direct staff. This is the classic
model for mid-sized and large companies and stable companies. The potential disadvantage may be
rigidity and a loss of dynamism.
The Centralized Organization
In centralized organizations,
the
token
Board
Of
The President
Board of Directors
Controller
Six Salespeople
Purchasing
Manager
Truck Drivers
Warehouse
Manager
Sales
Manager
Manufacturing
Manager
by the President.
This model works well for very small businesses. For larger privately held companies, the centralized
organization may be appropriate during a crisis, the launch of a major project, or if the company does
not have a depth of talent and many tasks must be coordinated simultaneously. The disadvantages are a
184
crushing Presidential workload and a limitation on the contributions of other personnel. This model
may be found in companies that have grown faster than the Presidents ability or inclination to delegate
authority and responsibility.
The Chaotic Organization
Chaotic organizations may not have chaotic organization charts; instead, the behaviors of the President
and senior managers constitute the chaotic, disorganized management structure. In a small business,
key tasks, such as purchasing and approval of accounts receivable, are everybody's job and, hence, no
one's responsibility. In larger privately held companies, the President intervenes in many functional
areas and bypasses senior managers and even middle managers to direct sporadically supervisors and
workers. People may have multiple bosses who give conflicting orders. Managers have little authority
and a justifiable fear of making decisions.
Chaotic organizations
produce weak financial
results, weak managers
and dispirited staff.
Chaotic
organization
may be common in
Turnaround companies
and,
frequently,
in
family
businesses.
Early signs of chaos
may be found in Tune
Up companies.
185
may report to the President. For a high tech manufacturing company, Research and Development,
Manufacturing, Marketing and Finance & Administration may report to the President. It should
always be crystal clear who is responsible for achieving specific, measurable company objectives.
Keep it simple. People should understand who does what in the company.
After the senior echelon organization is designed, the secondary level should be designed on the basis
of a logical grouping of tasks and outcomes. A distributor that has identified product availability as
being a competitive advantage might assign inventory responsibility to Branch Management, while a
distributor that has identified low cost as a competitive advantage might assign inventory control,
central warehousing and purchasing to a Vice-President of Inventory & Logistics. The rank and file
echelon should be designed to achieve clarity, simplicity and specialization of labor (which does not
preclude cross training).
Avoiding The Sub-Optimum Organization Traps
There are two traps to avoid when designing the organization. First, do not design a position to absorb
someone who would otherwise not have a job or a senior enough job. The organization should be
designed to meet the company's high priority objectives, not to avoid the unpleasantness of a demotion
or outplacement.
practice. Focus resolutely on the company's current and future high priorities.
COMPANY CULTURE
Company culture is the attitudes, values and ingrained behavior that shape and guide how well or
poorly people work and, like a societal culture, it is the product of evolutionary changes over many
years.
A strong company culture binds people together, gives a shared vision and facilitates
communication. People know what is expected of them and every new person is gradually inoculated
with the corporate culture, attitudes and vision. Conversely, a strong company culture may, in some
circumstances, be negative: a strong culture may blind people to changes in the external environment.
Tune Up and Status Quo companies with deeply ingrained cultures may encounter passive resistance to
revitalization programs. A weak company culture means that people are not bound together by shared
186
values and vision. Weak company cultures may be advantageous for Turnaround, Tune Up and Status
Quo companies as revitalization and transformation programs may encounter less passive resistance.
The simplest way to estimate company culture is to ask a representative sample of managers and staff
to complete the Worksheet: Company Culture by circling the words that they believe best describe the
company. The results will be an unscientific indication of employees' perceptions of the company's
culture (and suggest the positive and negative behaviors that might occur).
Worksheet: Company Culture
aggressive
expansionistic
achieving
high freedom of expression
people are important
people care about doing a good job
concern for the future
shall meet or exceed employment standards
be the best
earning
departments co-operate
committed to excellence
rewards special achievements
revenue driven
dynamic
defensive
stable
maintaining
speak up if asked, maybe
people are necessary
people care about having a good job
concern for tradition
meets minimum employment standards
be no worse than the rest
entitlement
departments fight
meeting requirements
rewards following orders
expense driven
slow, unresponsive
187
Company culture must be judged by a simple criterion: does it make the company more or less
successful? Summarize the values, attitudes and behaviors circled in the previous worksheet. Are
these attitudes, values and perceptions good for the company? Do they help people to do good work?
Do they motivate people to improve company products, processes and services? Do they help or
hinder good customer service?
Position, the impact of the issues and the employees' capabilities. Insights into the appropriateness of
leadership and teams may be gained by comparing other organizations with the company. Using the
worksheet below, identify companies and organizations in each category and rate their leadership and
teams and describe their competitive environment.
Worksheet: Leadership & Teams
Strong Leader
Weak Team
The company's two best suppliers:
1.
2.
Two successful customers:
1.
2.
Two successful organizations (1)
1.
Strong Leader
Strong Team
Weak Leader
Strong Team
Weak Leader
Weak Team
Competitive
environment
188
2.
The company's two worst suppliers:
1.
2.
The two worst customers:
1.
2.
Two unsuccessful organizations. (1)
1.
2.
This company
(1)
Accounting firm, car dealership, police department, agricultural co-operative, bank, or manufacturer.
Forewarn
managers and staff of impending changes and the compelling reasons for change. If the company
culture is cost driven and the goal is to be revenue driven, explain the reasons and the impact on staff
and their expected behavioral changes. Give staff the relevant data, such as industry growth rates
compared to the company's growth, comparative product quality, customer satisfaction survey scores
and, possibly, actual versus Target Return On Equity over the previous five years. Slogans and posters
may have a minor benefit but hard data intelligently explained is better. Since people tend to believe
office gossip more than company newsletters, feed the rumor mill with true messages concerning the
need for change and the benefits.
189
Enlist employees in defining the solutions and designing the implementation, or announce the solutions
and implementation design. Employee involvement may be most suited to Go For Gold, Status Quo
and Tune Up companies: employees may be well trained and well attuned to the issues and may have
already devoted considerable mental energy to constructive ideas. For Turnaround and Get Out
companies, announcement of the solutions and implementation design may be more practical, due to
greater time pressures.
Give employees the information and training required by the new culture and the leadership and vision
to sustain them during the transition. Information and training are relatively easy. Leadership and
vision can only be provided by steady, unremitting re-enforcement by management living the new
truths. Slogans, pep rallies and company newsletters can help but they cannot replace managing the
company in ways that are consistent with the desired new culture.
Change the objective reality. If the company was lax on health, safety and diversity issues, force
improvements. If the company was mediocre in customer service, change the reward system and
institute measurements and tracking reports. If behaviors do not change, withhold rewards and inflict
punishments (demotions and firings in cases of serious, repeated failures to adjust behaviors).
Diagram 10.4: A Culture That Wasn't Broke
Sales & Estimated Industry
Demand
105.0%
100.0%
Demand
1993
1992
1991
90.0%
1990
95.0%
1989
Sales
190
Take inventory of the company's highly paid and key people, assess each person's current and potential
contribution, and identify gaps between contributions and corporate requirements. Use the information
and insights to plan training programs, recruitment of new talent and involuntary departures.
List the highly paid people and key people. The definition of key person is: there would be a
significant disruption if the person died, was incapacitated or quit. Limit the number of 'key people' to
two or three people plus one person per $3 - 5,000,000 in annual sales (i.e. a company with sales of
$20,000,000 might have six to ten 'key people'). Include any occupational group, such as polymer
scientists or tool and die makers, that is crucial to corporate success.
191
Yes__No__
Yes__No__
Yes__No__
Yes__No__
Yes__No__
Yes__No__
Yes__No__
Yes__No__
Yes__No__
Yes__No__
Yes__No__
192
1)
2)
The people who are actively championing corporate improvement and competitiveness:
1)
2)
The people who are most promotable next week:
1)
2)
The people who could run the company next week:
1)
2)
The people who are being actively mentored by senior management:
1)
2)
Title
Cost (1)
Yrs. To Actual
Retire
Contribution
Potential
Contribution
Comments (2)
1.
2.
3.
4.
5.
(1) Salary, benefits, perks & other allowances or payments.
(2) Actions to be taken, and by whom, to train, reward, motivate, promote or dismiss individuals.
(3) Delete Actual Contribution, Potential Contribution and Comments during the final editing stage.
COMMENTS ON PEOPLE
All decisions affecting the companys people must be consistent with ethics, labor laws and common
sense. Nonetheless, there is considerable scope for attitudes and policies that specifically support
corporate goals. Evaluate the following ideas on the basis of whether or not they would help the
company be more successful.
Example Insensitivity To People
During the recession of the early 1990s a company reduced all wage rates by 15%. After the
recession, the President invited all employees and their spouses to a meeting at his golf and
country club. A light lunch and beverages, including alcohol, were served. He gave a short
speech, saying that he cut wages to save the company and their jobs, and that he would do it
again if need be. Comments: Do not invite spouses to a function where possible future wage
cuts are mentioned. Do not serve alcohol at most company functions, and especially at
meetings dealing with sensitive issues such as wages and job security. Do not invite employees
to the Presidents golf and country club to discuss wages and job security.
Rise To Meet Expectations
Generally, people strive to meet explicit, reasonable, achievable expectations. Expectations must be
explicit: staff must be clearly told what goals are to be met and what behavior is appropriate.
193
Expectations must be reasonable: staff will respect targets based on fairly objective data, such as
revenue growth. Expectations must be achievable: staff will rise to the challenge of achievable (with
strong effort) targets. Unrealistic targets demoralize people. Having set explicit, reasonable and
achievable expectations, measure performance and reward good performance.
Measure What's Important
'Become customer focused' or 'Quality in every wire brush we make' are slogans, not goals. Goals
need to be specific and results need to be measured. If customer service is important, do a monthly or
quarterly customer survey, structured by customer and product segments. If quality is imperative,
measure quality, defined as meets specifications, on a per shift, weekly and monthly basis. If service is
strategic, track the number of orders 100% filled by the warehouse each day.
Performance
194
blamed for slowing upward and downward internal communication, resisting change and bloating
payrolls. On the other hand, middle management provides continuity of institutional experience and
wisdom, facilitates smooth implementation of standard operating policies, guides junior staff who may
lack experience in either the company or the marketplace and is the source of future corporate
leadership.
Hiring - This Is Important Stuff!
Some companies make hiring decisions quickly, with little real thought about long term needs, often
not thoroughly checking references, not using an industrial psychologist's testing service and with no
planning of the post-hiring training, orientation and guidance, either through mentoring or a 'buddy
system.' Then, companies wonder why they have a bunch of duds. It's not the employees' fault.
A hiring decision is a spending decision, just as a capital expenditure decision is a spending decision.
The present value of the cost of a new employee to be paid $35,000 per year plus benefits is $158,000
(assuming a corporate tax rate of 40% and a present value rate of 8%). How much management time
goes into purchasing a piece of equipment costing $158,000 compared to a hiring decision costing
$158,000? Companies may justify a cavalier approach to hiring by the simplistic belief that a bad hire
can be fired, but a faulty piece of equipment can be sold and yet companies still try to make wise
capital expenditure decisions. The money at stake in a hiring decision is the person's salary plus
benefits multiplied by the after-tax corporate rate and multiplied by the present value of the future
payments.
Table: Present Value Of Employee Cost
Interest Rates
2
4
6
8
10
6%
1.8
3.4
4.9
6.2
7.4
8%
1.8
3.3
4.6
5.7
6.7
10%
1.7
3.2
4.4
5.3
6.1
195
salary are payments for attendance and foster an attitude of entitlement. Salespeople, garment factory
workers and rock musicians are paid for performance, although their pay may be labeled as
commissions, piece work and royalties, respectively. Some jobs can be rated by results and the
workers can be paid for results. Many jobs involve co-operation and inter-dependency; therefore,
group, divisional and even company-wide incentive programs and profit sharing may be more
equitable than individual incentives.
Reward All Achievers
Few achievements are truly individual achievements; most are the result of many contributions. Even
Olympic athletes who blaze to glory are the product of national sporting associations and coaches who
have nurtured them over years of grueling training. Rewards should recognize diverse contributions
and encourage co-operation appropriate to the company's objectives. A bonus to a divisional sales
manager may be less effective and less equitable than a bonus system that includes the entire field
sales force proportionate to individual contributions. Avoid reward systems that deliberately or
accidentally create many losers and few winners.
Example - A Hasty Reward System
A company introduced an incentive plan based on X% of sales over its current sales level, with
the caveat that the bonuses would only be payable if the company was profitable. A rapid
expansion of inventory was seen as the quickest way to boost sales. Inventory skyrocketed,
putting severe pressure on available bank financing. The bonus system was 'temporally
suspended', pending re-formulation of the bonus system to achieve a balance in terms of
employees, working capital needs and shareholder expectations.
No More Annual Raises
Annual raises mean that payroll costs always rise. Instead, pay bonuses. In bad times, eliminate
bonuses, not people.
Substituting bonuses for annual salary increases may, over five years and depending on inflation, mean
that 10 25% of the company's personnel costs becomes a variable expense. A company with ten
branches might decide to pay a bonus to the top nine branches; the ninth branch would get one point,
the eighth branch would get 50% more points, and so on. Then the bonus would be allocated
according to the points. One third of the bonus could be awarded on the basis of sales growth, one
third on the basis of contribution margin and one third on Return On Assets. Bonus programs should
196
align incentives with the company's goals, enable most people to participate and keep pressure on top
people and top branches to stay on top.
Table: Bonuses Based On Comparative Performance
Branches
Best branch
2
3
4
5
6
7
8
9
10
Total
Points
25.6
17.1
11.4
7.6
5.1
3.4
2.3
1.5
1.0
0.0
74.9
Bonus
$37,737
$25,158
$16,772
$11,181
$7,454
$4,969
$3,313
$2,209
$1,472
$0
$110,266
197
reward what's important - over and over, again and again. Deadwood should be coached, retrained and
re-potted.
Coach in terms of the right attitude, the correct job behaviors and the company's
expectations. Retrain, because the person may not have been trained properly in the first place. Re-pot
to a new job, a job that more closely matches the person's skills.
Semi-Annual Appraisals
All organizations should do semi-annual appraisals: the world is changing rapidly, and demands on
employees are changing, too. The appraisal should state what the person should be contributing to the
company, the measurable results achieved in the past six months and expected in the next six months,
the skills to be developed, and what the person's superior is expected to do to help that person achieve
the targeted results. Semi-annual appraisals, coaching reports and training records should be given to
the employee, with copies placed in the person's personnel file.
Quick Written Employee Appraisals
Each time someone does something right or wrong or needs guidance, do a five to ten line note
(handwritten note using three-part carbon memo forms or a typed memo). Give one copy to the
person, place a second copy in the personnel file, and place a third copy in a 'Staff Appraisal File.'
Over six months the person will have received many units of feedback and will have developed a clear
understanding of performance expectations. There will be sufficient accumulated material to form the
foundation of an intelligent semi-annual appraisal. Once a month, count the positive and negative
messages given to all staff: the positive messages probably should outnumber the negative messages
by 5:1 to 10:1.
Let's Fire People
Sometimes people should be fired for the good of the company. Generally, it is appropriate to fire
someone who has not shown satisfactory improvement after receiving the benefit of every reasonable
effort to train, develop, coach and motivate, or if it is not practical to shift the person to alternate work
important to the company. Immediate (after consulting with a lawyer specializing in employment law)
firing is appropriate in four instances:
Table: Lets Fire People (Almost) Immediately
198
Health and safety violations (one or two written warnings for minor violations).
Violations of employee law or regulations, such as racial discriminations or sexual harassment (one or two
explicit, written warnings for minor violations).
Abuse of customers or suppliers (one or two written warnings for minor violations).
$_____
$_____
$_____
(a)
(b)
(c)
(d)
$_____
__ Yrs.
$_____
$_____
$_____
Consider making computer back-ups, having a locksmith change all locks and hiring a
security guard if there are any potential dangers or risks to the company or its staff. But, do not
procrastinate: it is important that the company not tolerate deadwood.
199
Exit Interviews
The departure of good people is a loss to the company and may signal future departures. Since good
people are the most attractive to other employers, the companys good people may be more likely to
leave than mediocre staff. A series of departures may lessen the average staff quality and cause a siege
mentality amongst remaining staff. Therefore, interview each person who resigns probe gently for
the reasons for the departure. Be aware that remuneration may be part of the reason why the person
has accepted a particular job, but remuneration is probably not the only reason why the person is
leaving. Some people leave companies because they are silently offended by the work environment.
Ask explicitly about sexual harassment, workplace safety, fraud and ethical standards. The person
conducting the exit interview should be two levels more senior than the departing employee. If a
member of the senior management team resigns, an independent (i.e. non-employee) member of the
Board Of Directors should conduct the exit interview.
Diagram 10.6: Internal & External Congruence
Personnel
President
Senior
Management
Company
Culture
P
O
S
I
T
I
O
N
S
200
company must have a powerful web of practices and attitudes that foster the pursuit of excellence.
Internally, the President, senior managers and personnel must share a clear corporate culture and
collectively they must support the company's strategic and tactical choices. The Paradigms affect
people. A company dominated by Operations has different hiring and training requirements than a
company dominated by Marketing.
WYN Prepare two organization charts: one showing the current organization and a second
Write
Your showing the ideal organization. Describe the company's culture and its congruence with
Notes the external environment. Confidential notes on specific individuals may be discussed with
a well functioning Board Of Directors or Board Of Advisors.
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MANAGEMENT IS IMPORTANT
Management of privately held companies must continuously improve to keep pace with national and
international competition. The good news is that a small improvement in managerial effectiveness
produces big benefits: a shift in effectiveness (as indicated by higher profits and lower business risk)
will double many companies equity over the next fifteen years.
Management
Quality
Management
Quantity
RESULTS
The quality of management is the right knowledge, skills, characteristics and application. The quantity
of management is the number of managers multiplied by the number of managerial hours. Therefore,
the expanded Management Formula is:
Diagram 11.2: The Expanded Management Formula
Quality Of Management
Quality of management, like the quality of anything else, is 'meeting or exceeding the customer's
expectations.' Quality of management is judged by customers based on the quality of results received
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and perceived by the customers. The customers, for management, are the senior executives, the Board
Of Directors, shareholders, lenders, regulatory bodies, employees, suppliers and the companys
customers or clients. Quality of management is determined by knowledge (scientific, technological or
business), skills (inter-personal skills, group dynamics), characteristics (detail orientation, ethics,
integrity) and the application of the knowledge, skills and characteristics appropriate to the company,
its industry and its Position.
No single management style is appropriate to every industry. Managing a chain of muffler shops is
different than managing a resort hotel: the customers, product, people and assets are different. Highly
developed administrative skills would be very appropriate for an executive in a large company in a
mature industry or in a government department; however, administrative skills may not be as valued in
a company during a turnaround or in a company in a turbulent industry.
Example - Being Better Than One Thought
The President and majority shareholder of a retailer with sales of $10,000,000 spoke about his
problems and potential opportunities. In a moment of candor, he said that he felt inadequate, as
he did not have a university degree, as his children did. The objective reality was that his
company was profitable at a time when many of its competitors were struggling to breakeven.
His listener suggested that he take an inventory of his skills and weaknesses, just as he
regularly inventoried his merchandise. He soon realized that he had been understating his
accomplishments and his ability to continue to lead the company to above industry average
performance.
Quantity Of Management
The right number of managers is a range. Too few managers means that the organization saves
managerial payroll costs, incurs waste, inefficiencies and fraud and loses long term commitment,
insights and wisdom. Too many managers are expensive, create a cumbersome bureaucracy and stifle
creativity and responsiveness.
A simple way to estimate the right number of managers is to visualize deducting one manager, and
then another and another, until there is a barely perceptible decrease in corporate effectiveness; then
add back one manager: that is the right number. Another equally unscientific method is to compare the
five year trend in profits and the five year trend in the ratio of total employees to employees who touch
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the products (factory labor, researchers actually doing research, truck drivers) or the customers (sales
people, accounts receivable collection personnel).
company could grow without adding any managers. If the company could grow 0% - 10%, it probably
is understaffed with managers. If it could grow 10% -20%, there are probably sufficient managers to
ensure control and continuity. If it could grow 20% or more, there may be excessive management.
Clich To Live By - Management
The leading cause of business success (and failure) is the quality and quantity of management.
Managerial Time
Go For Gold companies have hardworking executives. Status Quo and Tune Up companies may have
managers who attend work for long hours but devote many hours to community service and
maintenance activities rather than fewer hours clearly focused on growth and excellence. Amazingly,
almost all Turnaround and Get Out companies have a common characteristic (in addition to not
knowing their costs): their shareholder / executives do not work hard enough.
The best managers are, usually, good to excellent time managers.
effectiveness (doing the right things) and efficiency (doing things right) but they emphasize
effectiveness. Unfortunately, some essential tasks, such as strategic planning and staff motivation,
take great amounts of time and are not readily controllable in the way that annual supplier assessments
can be scheduled. Therefore, to be effective, there must be the right amount of time effectively used.
Depending on the size, complexity, rate of change and current and prospective financial performance
of the organization, the correct range of hours per manager is probably about 2,500 hours per year.
Longer hours may weaken mental alertness, creativity, work quality of life and their families' quality
of life. Exceptionally hardy individuals may work longer. Truly gifted executives may run successful
companies with fewer hours, if they have built a superlative senior management team.
There are several managerial delusions concerning time. One delusion is that the best managers work
the longest hours. In fact, the best managers work the number of hours required to achieve corporate
objectives and maintain personal effectiveness and health. A second delusion is that the person is
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working longer or more intensely than he or she actually is. An analysis of time often shows that the
amount of time is less than thought and that excessive time is devoted to small tasks or details which
should be handled by a less senior person. A Senior Vice-President with a major bank, who is an
impressive time manager, refers to this as 'micro-managing.' Clearly, details are very important when
formulating strategy, tactics and policies; however, when the strategy, tactics and policies are set, then
the senior executive should focus on the process (motivate and coach staff), on the results (customer
satisfaction, Return On Equity) and on the future (competitive opportunities, external threats).
Time Management Principles
An executive working an optimum number of hours must use the time as effectively as possible. There
are three principles that give awesome results.
Table: Time Management Principles
Mega Priorities
Select the two or three specific issues that are critical to the company's success (ex.: decrease scrap rate by 12% by
January 31). Do something every day to achieve the mega priorities (ex.: instruct the controller to prepare an update
on the inventory status every Friday). Make someone do something every day on the mega priorities. Ask staff what
they have done today to reduce inventory or to cut scrap rates. Pay bonuses based on achievement of objectives.
Just Say No
Say no to requests to sit in on non-essential committees. Say no to micro-managing; but say yes to coaching and
training staff. Say no to involvement in more than one community service organization or cause. If the company is in
the Turnaround or Get Out position, say no to all community service organizations. Say no to everything that does not
have a meaningful impact on long-term corporate success. Saying no will delete many unimportant activities and
enable a laser-like focus on the mega priorities.
Use The Tools
Buy a top quality, two pages per day desk diary to record appointments and tasks on one page and actual activities and
time on the opposite page. Analyze the time devoted to mega priorities compared to non-critical tasks. At the end of
every day compare the two pages to see if time was invested or squandered. Use a computer spreadsheet to prepare
and update a To Accomplish list of items and tasks, and sort by Mega Priorities or by Urgency. Print and use the list.
There are numerous time management seminars and cassettes available.
MAPPING MANAGEMENT
The intuitive link between managerial quality and company strength (good management makes a
company stronger) and the intuitive link between company strength and competitiveness (strong
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companies compete successfully) can be combined into a graph to identify any gaps in company-wide
and personal managerial quality. Assume that five years ago there were 100 units of managerial
quality, 100 units of company strength (product and service quality, customer and supplier
relationships and financial performance) and 100 units of competition. Assume also that management
and the company have remained stable at 100 units, and competition has increased to 150 units (or,
become 50% more intense), and that the forecast is that competition is expected to reach 200 units in
the next five years. In short, a gap exists now, and the gap may widen in the next five years.
Diagram 11.3: Mapping Management
200
150
Company
100
Company
Now
Map managerial quality, company strength and competition, using the worksheet below. Assume that
five years ago they were all at 100 units. Plot the current and projected status of each consideration. If
there is a gap - especially a widening gap - write a detailed explanation of the causes of the gap, the
strategic implications and the tactical responses.
Worksheet: Mapping Management
200
150
100
Company
50
Now
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REMUNERATION
Assessing the reasonableness of the remuneration of non-shareholder / executives is straightforward.
There are surveys published by leading personnel consulting firms and industry associations, there is
industry scuttlebutt and there is negotiation between the company and the non-shareholder executive.
The reasonableness of the remuneration of shareholder / executives is more difficult to assess and may
be a point of serious contention with other shareholders and, sometimes, lenders. If the shareholder /
executive is the majority shareholder, minority shareholders may feel aggrieved by the majority
shareholder's remuneration. On a practical level, the amount of shareholder / executive remuneration
is often based on personal consumption expectations and (usually) limited by the company's ability to
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pay and sometimes limited by prohibitions in banking agreements. A more satisfactory approach is set
shareholder / executive remuneration based on the theoretical components.
Return On Labor
The shareholder / executive is entitled to a salary and benefits, with the salary reflecting the skills and
achievements of the job, just like any other employee. If relevant salary surveys are not available, the
'fair' salary and benefits would be what the company would pay to hire an equally experienced and
qualified person for the same duties and responsibilities - the market wage for the job. The Board Of
Directors might estimate the market wage or a compensation specialist might be asked.
Return On Investment
The shareholder / executive is entitled to receive dividends, redemptions of shares and distribution of
cash proportionate to shares owned. (The maximum allowable payment to shareholders is limited by
solvency requirements in most jurisdictions' corporations' acts.)
companies pay nominal dividends and retain profits to fund capital expenditures and working capital.
The annual increase or decrease in the notional value of the company is not unique to the shareholder /
executive as all shareholders share proportionately and, therefore, the increase or decrease should not
be included in the calculation of remuneration.
Return On Money Lent
Shareholder loans are legitimate debts. Principal payments and interest comparable to rates payable to
other lenders should not be included in remuneration. The difference, if any, between the actual
interest paid and an amount based on a market rate should be included in remuneration.
Other Payments
Non-standard payments such as bonuses, perks and loans to shareholder / executives are sometimes
made. Bonuses may reflect outstanding managerial performance, or be a misnomer for a personal
income tax strategy. In either case, bonuses are part of the total remuneration. Perks such as a motor
boat purchased by a company for its President's use should be included as part of the total
remuneration, either on the basis of the cost in the year of purchase or on the basis of an amount equal
to the total operating expenses plus interest and depreciation charges. Loans to a shareholder should
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be added to the shareholder's remuneration. Stock options are rare in privately held companies. The
value of stock options in privately held companies when awarded is extremely theoretical and should
not be included in the calculation of remuneration. The value of stock options when converted to
shares is not theoretical and should be included in remuneration in that year.
Table: Analysis Of Shareholder / Executive's Income
Amount
Salary
Benefits
Perks
Bonus
Interest on shareholder loans
Principal repayment of shareholder loans
Dividends
Advances to shareholder
Total
$75,000
$9,000
$5,000
$30,000
$20,000
$10,000
$20,000
$10,000
$179,000
Return On
Labor
$75,000
$9,000
$5,000
$30,000
Return On
Loans
Return On
Equity
$20,000
$10,000
$20,000
$10,000
$129,000
$30,000
$20,000
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executive development program should be considered after the initial phase of a successful turnaround.
All managers should resign from all community service organizations. The President should closely
observe senior personnel during the turnaround to identify managers with long term, high potential.
Remuneration of senior executives, even if fair, may be cut in order to show leadership to staff and
lenders.
Being in the Get Out Position is demoralizing for all staff, including managers, even if the causes are
entirely external. Shareholder / executives of Get Out companies might take a few days early in the
exit process to consult with an industrial psychologist and a qualified financial planner to plan their
post-exit future. They should consult with a corporate lawyer to identify any possible issues with
personal impact. They should not resign from community organizations (take a leave of absence,
instead) or make other major life style changes until the personal post-exit environment is clearer.
Having resolved issues relating to the inevitable personal impact, managers should focus on
implementing with professional assistance the best exit strategy. Get Out companies may commit to
bonuses (called retention bonuses or stay pay) to key managers and staff who stay until the exit
strategy is fully implemented.
WYN Writing candid and complete comments may be difficult and time consuming, but it is
Write
Your essential. A high performing company needs a high performing President and senior
Notes management team. Plan to correct gaps in skills, knowledge and time effectiveness.
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Analyze the fairness of remuneration over the last two or three years. Later, during the editing of the
plan, delete confidential, sensitive or embarrassing comments.
212
BUILDING CONSENSUS
At this stage of the planning process key decision-makers such as the senior management team and the
Board Of Directors should be aware of the main observations and likely conclusions.
Key
implementaters, principally middle management and staff, should be aware of the competitive
environment and the product development and customer service issues confronting the company. If
earlier efforts to build a consensus were not entirely successful, make further efforts now. Avoid the
previously described Consensus Traps.
THE CORE
The concept of core is extremely important: excellence and frugality can only be achieved by focusing
on the core. The company must have focus. Urgency directed at non-core issues or activities is
dissipated energy. The core is what cannot be taken away and still have this business, or still achieve
the transformation into tomorrow's company. A bank could not delete deposit taking or lending money
and still be a bank; therefore, for a bank, deposit taking and lending are core functions. If a federated
fundraiser deleted fund raising or deleted all but one of its associated charities it would no longer be a
federated fundraiser.
Go For Gold companies know their cores and they focus on achieving excellence in their cores. Status
Quo and Tune Up companies may have drifted from their cores, as evidenced by diffuse products,
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214
Gap
Bridging Actions
Assets
Customers
Products
Revenues
Technology
Expenses
Overheads
Personnel
Financial
Results
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Mission Statement
The mission statement is a statement of the company's mission. It's that simple. The mission might be
to become the biggest, most profitable envelope manufacturer in the American Mid-West. It might be
to be the most reliable, most respected distributor of air conditioning products in Scotland. The
Mission Statement is more specific, action oriented and expressive than the Vision Statement; but it
should flow from and support the Vision Statement. Leadership demands that leaders define the
mission.
Worksheet: Mission Statement
GOALS
To convert the Vision and Mission Statements into reality, goals must be articulated. A goal is not a
goal unless it explicitly answers all or most of the W5 + 3H questions (who, what, when, where, why,
how, how much, and how many). If few of the questions are answered, the quasi-goal is probably
inarticulate dreaming.
Financial
Revenues
Expenses
Contribution Margin
Net Income
Cash Flow
Return On Equity
Return On Assets
Goals will reflect the company's current situation and its Vision and Mission Statements. There may
be several goals for certain topics, and possibly only one goal for other topics. The top line of the
Worksheet should be a clear and complete statement. The middle lines provide space to answer the
W5 + 3H questions. The bottom line is important; the definition of success will determine the actions
to be taken. Write one or more specific goals for each topic.
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OPPORTUNITIES
During the preceding research and analysis, many large and small opportunities will have been
identified. Some opportunities may have been deletion or avoidance opportunities, such as dropping
products or customers. Other opportunities may have been addition opportunities, such as entering a
new market niche. Some opportunities may be implemented immediately. Others may be beyond the
company's immediate grasp due to financial, technical or human resource limitations. Describe each
opportunity, using the Worksheet: Opportunity Statement.
VULNERABILITIES
Vulnerabilities are external and may be industry specific. Every company has some vulnerabilities.
Generally, companies cannot prevent external vulnerabilities but they may be able to cushion the
potential impact. Book publishers may be vulnerable to reduced public library acquisition budgets and
the publishers' association might sponsor a public relations campaign in support of public libraries.
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WEAKNESSES
Weaknesses are internal and company specific. A weakness might be a senior management team that
is much the same age and nearing retirement age. Every business has weaknesses. Go For Gold
companies have fewer and less critical weaknesses. On the other hand, Get Out companies may have
several major weaknesses or a single huge weakness. Describe each weakness.
POTENTIAL DISASTERS
A potential disaster is an event that could destroy the company. Potential disasters include the loss of a
key customer, a major corporation entering the company's customer / product niche, death or
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incapacitation of a key executive, major fraud, an unrecoverable computer crash and an environmental,
product liability or a personal injury lawsuit. Describe each potential disaster.
Worksheet: Potential Disaster Statement
Potential disaster:
Who:
What:
When:
Where:
Why:
How:
How much:
How many:
What must be done, when and by whom to avoid this disaster?
STRENGTHS
All companies, except the most pathetic Get Out companies, have strengths. Go For Gold companies
have either numerous strengths or a few huge strengths. Of course, a strength must be relevant to The
Core Today and The Core Tomorrow. Any gaps between current strengths and strengths essential for
future success must be bridged. List the current strengths and required strengths. Note gaps. Describe
bridging actions.
Strengths Tomorrow
Gaps
Bridging Actions
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220
million dollars in equipment and marketing costs for a new product line, and the plan may be based on
reports from the field sales force about customer buying intentions. Is the data relevant? Is it true? Is
the correct data, if relevant and true, indicative of buyer behavior twelve months from now? Are there
alternative data and data sources which should be checked?
Decisions with minor potential impacts on profits, customers, products and staff have been, no doubt,
adequately researched, analyzed and considered. The benefit of additional information and delays in
completion of the plan is likely negligible. Decisions with major potential impacts, on the other hand,
may merit additional work. The point should not be analysis for the sake of analysis. The point should
be to improve the probability of corporate success.
Before doing further research or analysis, calculate a rough estimate of the value of addition
information. The Worksheet: Potential Value Of Addition Information relies on a series of estimates;
therefore, the potential value of additional information is an estimate. If there is a significant potential
benefit of additional information, delay completion of the plan and get more data. If there is a strong
managerial intuition that important data or assumptions may be incomplete or erroneous, get more
data. Otherwise, prepare the second draft of the plan.
Worksheet: Potential Value Of Additional Information
To Avoid Losses
Amount of investment being considered in the plan
Amount of recovery if the project is shut down and the assets sold
Direct potential loss on investment (a - b)
Potential operating loss, including interest, before the investment is shut down.
Costs to shut down, including severance payments
Cost if unsuccessful (c + d + e)
Probability that additional information would help avoid a loss
Estimated Value Of Additional Information (f * g)
Estimated Cost To Get And Analyze Additional Information
Potential Benefit Of Additional Information (h - i)
To Increase Profits
Probability that additional information would help increase profits
Potential increased profits due to additional information
Estimated Value Of Additional Information (k * l)
Estimated Cost To Get And Analyze Additional Information
Potential Benefit Of Additional Information (m - n)
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
$
$
$
$
$
$
(k)
(l)
(m)
(n)
(o)
%
$
$
%
$
$
$
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offered this product') or community service ('our customers really deserve this product / service') or
loyalty ('we cannot let the widget department down / fire the broom staff'). Any argument that does
not persuasively state the benefit to the company is probably a special pleading. Reject special
pleadings.
Screen # 3: Life Support For Yesterday's Failures
Many managers will not accept that apparently good ideas failed. Managers may be reluctant to admit
a mistake. They may delude themselves into believing that more time and more money will make an
unprofitable activity or program worthwhile. Yesterdays bad decision or unsuccessful experiment
should not be compounded by a bad decision today. Never continue something in the hope of
justifying or recovering a past investment. The plan is about the future and should be based on the
future. The pertinent question is: knowing what we know now, would we now invest in this product,
service or activity? If no, reject the product, service or activity.
Screen # 4: The Simplification Principle
The Simplification Principle is sometimes called the K.I.S.S (Keep It Simple, Silly!) formula. Some
ideas may be valid but overly complex as formulated. Overly complex activities or programs are
invitations for disasters: errors in one segment or stage can cascade through successive segments or
stages until correcting the errors or repairing the damage costs more than the originally anticipated
benefit. Break down the overly complex into clear, complete components. Assess each idea, activity
or program on the basis of the company's future ability to implement successfully.
Screen # 5: The Non-Core
The Core dominates. The non-core drains money and talent. Delete old and new initiatives that do not
directly relate to the Core. Stop non-core activities. Sell non-core assets. State in the plan what
actions are to be taken to end non-core activities and to sell non-core assets.
Screen #6: The Power Of The Collective
There may be ideas that individually have little impact but which collectively have the power to
transform the company.
Reductions: Reduce courier expense by 15%; re-negotiate lawn maintenance contracts to save $8,500
per annum and so on. Thus, small ideas may be knitted into a meaningful benefit.
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expenditures; costs such as recruitment and training, marketing programs and even divisional and
corporate operating losses should be considered. These total costs are especially important when
considering a turnaround or a major strategic change in either marketing or operations.
The
availability of government funding, additional shareholder investment and venture capital should be
considered. Delete ideas that are too expensive under any reasonably feasible conditions.
Screen #9: The Adequacy Of Human Resources
Ideas that require new employees or new skills should be carefully considered in light of the company's
ability to hire the people or develop the skills. The acquisition of people or skills should be an
immediate, high priority step for many projects.
Screen #10: Unacceptably High Risk
Every company is exposed to some risk to some degree. However, good strategic planning should
screen out risk that is unacceptably high, compared to the potential benefits and compared to the risk
tolerance of the company's shareholders and Board Of Directors. The point of this screen is to reject
the truly bad ideas but to keep ideas with potential merit and moderate risk, subject to further analysis.
Risks include financial risk (decreased profits or capital expenditures significantly greater than a
company's equity), market acceptance risk (will customers buy a new product), customer risk (will a
new activity or change in existing products or services alienate customers), dependence risk (will there
be a severe dependence on one or very few customers or suppliers who might themselves not be
financially or competitively strong, or who might abuse their power over the company), staff risk (will
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changes in a bonus or commission system result in the loss of the most productive people), and
technology risk (will adopting new technology mean that the company becomes tied to the 'wrong'
technology).
Screen #11: Unintended consequences
Unintended consequences happen when the natural linkages of financial flows and relations between
people, suppliers and customers are forgotten. A classic example is a manufacturer that laid off tool
and die makers during a recession and was unable to attract this skilled labor post-recession, which had
the unintended consequence of limiting the company's recovery.
'management by accounting' whereby decisions are made on the basis of immediate impact on
profitability and the short-term savings are far less than the long term cost of dissatisfied customers or
disgruntled employees. There are times when a company's financial situation is so desperate that a
scorched earth policy is appropriate but one should not destroy a company when trying to save it. A
useful technique for searching for unintended consequences is to ask what the mid and long term
impact would be on each of the Paradigms.
PRIORITIES
Screening may have removed 30% or more of the original ideas. The remaining ideas are truly
important and potentially feasible. Unfortunately, there may not be enough time or resources to
implement all the important ideas. Therefore, establish priorities. Executives may be tempted to use
the trade-for-trade approach: one person 'trades' his support for an issue or action in exchange for
another person's support for her preferred issue or pet project. This trade-for-trade approach is a
disguised version of the 'special pleading' phenomenon. A far better approach is to determine the
relative importance of actions or issues.
Subjective criteria are relevant. Managerial Preferences will assert themselves, legitimately. The
Vision and Mission Statements, the progeny of Managerial Preferences, will influence priorities. As
well, a commitment to the Principles, including Ethics, will be persuasive. Finally, certain judgments
are unavoidably subjective: the adaptability of corporate culture, the capacity of senior management to
grow in sophistication as the business grows, the vulnerability of current products to technical
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obsolescence. Objective criteria are relevant: Return On Equity, working capital, cash flow, debt
servicing coverage, cyclicality of demand, manufacturing defect rates and environmental protection
costs. Sequencing is important: some actions must precede other actions.
The company's Position should influence priorities. Go For Gold companies may attach near equal
importance to profits, customers, people, products, capacity to implement and sequencing because Go
For Gold companies have a balance of resources and the desire to progress in equilibrium. Get Out
companies, due to their imminent sale or closure, may attach almost no weight to customers and
products and a low weight to people given the short employment horizon. Also, different companies in
the same Position may attach different weights to profits, customers, people, products, capacity to
implement and sequencing because their strategies and tactics are different. The next table shows
possibly appropriate weights of the decision criteria for each of the Positions.
Table: Possible Weights Of The Decision Criteria
Impact On Our Profits
Impact On Our Customers
Impact On Our People
Impact On Our Products
Capacity To Respond Effectively
Sequence Ranking
Overall Importance (total points)
Go For Gold
2
2
2
2
1
1
10
Status Quo
1
1
4
1
1
2
10
Tune Up
2
1
2
1
2
2
10
Turnaround
3
1
1
1
2
2
10
Get Out
2
0
1
0
2
5
10
Ranking Priorities
Ranking priorities may be by intuition or a numeric method. A numeric method forces greater
rationality and may build consensus in the senior management team. Use the Worksheet: Ranking
Priorities for each issue or idea. A criterion specific weight is applied uniformly to all issues or ideas,
and the total weight must equal 10. An impact number for each decision criteria is assigned. Then, the
weight number is multiplied by the impact number. The scores are added, to give a total score for that
issue or idea. The issues and ideas may then be sorted by total score, in descending order. The bottom
20% - 40% might be saved for future consideration. The top 60% - 80% are the most important and
implementable issues and ideas and should be included in the plan.
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Weight
Impact On Our Profits: If the forecast impact of profits is 10%, use 1; if the
forecast impact is 20%, use 2, etc. If the forecast impact is 10%, use 1, etc.
Impact On Our Customers: If potential impact is increased customer loyalty or
satisfaction, use 1 to 9. If negative, use 1 to -9, depending on severity.
Impact On Our People: If the potential impact is increased skills and overall
performance, use 1 to 9. If negative, use -1 to -9, depending on severity.
Impact On Our Products: If the potential impact on quality and price
competitiveness is positive, use 1 to 9. If negative, use -1 to -9, depending on
severity.
Capacity To Respond Effectively: If the company has the resources and
determination to respond effectively within the planning time frame, use 9. If not,
use 1.
Sequence Ranking: What must be done first is 9, what must be done last is 1.
Total Score
10
Impact
Total
(W * I)
N/A
IMPLEMENTATION
Implementation is the real test of a successful plan. Therefore, it is worthwhile to consider before
finalizing the plan - the managerial effort that will be required to successfully implement the plan.
The Path Of Minimal Effort
The Path Of Minimal Effort means giving a few pep talks to senior managers and putting up some silly
posters in the staff lunchroom. The Path Of Minimal Effort is tokenism. It is assuming that the point
of the planning exercise was the exercise itself, not the gain in corporate achievement that should
result. It is the belief that superior corporate performance will just happen. It is being satisfied with
small victories over insignificant obstacles.
decline, because hostile factors (competition, aging technology, dispirited employees) will drag down
the company. This is the path of Status Quo companies destined to decline.
The Path Of Minimal Resistance
The Path Of Minimal Resistance means abandoning efforts to change when entrenched attitudes
oppose progress.
The Path Of Minimal Resistance means using the plan at weekly or monthly
management meetings for a few months and then giving up when inventory levels do not decrease,
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when performance measurement reports are not prepared or when attitudes towards unionized workers
do not become more constructive. The Path Of Minimal Resistance is not getting red-hot angry when
sloppy deliveries or indifferent customer service occurs. The Path Of Minimal Resistance leads to
stagnation. This is the path of Tune Up companies destined to decline.
The Path Of Frustration
The Path Of Frustration is attacking every blocker in one brutal rush. The Path Of Frustration looks
heroic, like The Charge Of The Light Brigade but it may only be a failure to adequately prioritize the
truly important and to identify the truly tough obstacles. The Path Of Frustration may be caused by
pursuit of an elusive ideal, an underestimation of the difficulties in implementing change or an
overestimation of the company's ability to change and renew itself within an unreasonably brief time.
This is the path of Turnaround companies destined to not turn.
The Path Of Progress
The Path Of Progress is courage, wisdom and perseverance. It is the courage to confront blockers that
can be overcome, wisdom to circumvent the blockers that cannot be changed within the near term and
perseverance to keep working to build a better company despite complainers, apathy, passive
resistance and even sabotage. The Path Of Progress starts with a firm belief that progress is possible
and that the management and staff of the company can and will grow a better company. The Path Of
Progress is gentle when gentleness is appropriate but the gentleness is not weakness of resolve or
conviction. The Path Of Progress is the willingness to fight for excellence, focus and frugality. The
Path Of Progress coaches and motivates staff and fires those who do not perform. The Path Of
Progress is unrelenting and it ultimately works. This is the path of Go For Gold companies and of
Status Quo, Tune Up and Turnaround companies that are destined for greatness.
228
The Blockers
There are external blockers, such as a scarcity of investment capital or of people with essential
technical skills. The most frustrating blockers are internal. The internal blockers include arrogance,
ignorance, apathy, defeatism and disagreement. People must be convinced that change is required, that
they can do more and better and that intelligently selected change will create a more secure and
positive future for them. Communication is required to explain the competitive factors that make
change essential.
competitive, more responsive, more focused and more profitable. Time, appropriate to the companys
Position, is required, because people need time to adapt. People who do not respond to leadership,
communication and time should be fired.
Decisions Don't Get Implemented
A company may not improve despite the best possible intentions in a strategic or business plan because
of deterioration of economic conditions, emergence of new competitors or shifts in demand.
Sometimes companies do not improve because behavior and attitudes become fixed over many years.
229
Executives and shareholder / managers may agree intellectually with a business plan but still not agree
emotionally. The refusal to agree with, or the emotional inability to accept, change is perhaps most
common in companies in the Status Quo or emerging Get Out Positions. Resistance to making and
implementing decisions in cases of emerging Get Out companies may be patient waiting for
confirmation that industry trends, for example, are in fact too adverse. On the other hand, resistance
may be denial of harsh realities. Resistance to making and implementing decisions in Status Quo
companies may be satisfaction with mediocrity and a comfortable assumption either that business
conditions will not change or that the company will be able to respond as and when required. In family
businesses, resistance may be resignation to the inevitability of current performance or a perverse
pleasure in inter-personal conflict.
Getting Action
In all cases, people must be given the information, training, tools and time (appropriate to the
companys Position) in order to achieve successful change.
230
After Implementation
At some point the plan will be implemented as completely as possible. People will recognize their
achievement and victory. The vigor of the planning process and its successful implementation may
have lifted a company into the Go For Gold Position. Complacency and lethargy may seep into the
culture. The company may regress to previous behavior patterns and attitudes. Prevention is daily rededication to the Principles and measurement and communication of progress and achievement,
compared to past performance and industry standards. The price of excellence is unremitting effort, a
constant striving for better products and greater customer satisfaction. The price of excellence is
always hearing the roar of the racing engines of competitors. The price of excellence is asking what
more should be done.
Table: Abbreviated Implementation Table
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Marketing
Do quarterly customer satisfaction survey.
Use remaining brochures for Product B19;
do nor order any more.
Develop new brochures and catalogues for
Products A1 - A15.
Buy, start to use new brochures.
Review costs / benefits of attendance at four
trade shows. Decide on future shows.
Administration
Present draft shareholder agreement to
shareholders by May 1.
Finalize and have all shareholders sign the
shareholders' agreement by Sept. 15.
Instruct auditors to combine their year-end
audit with a preliminary study on any
vulnerability in our systems to fraud.
Analysis of cost accounting system,
including overhead allocations - after new
production equipment. Use a consultant.
Management
President to take a 2 wk. Executive
Development course at City U.
Decide if we have a successor for J.R.K.,
who retires in 18 months? If yes, start
training. If not, start talent search.
Production
Use remaining raw materials and
components to produce Product B-19.
Sell the de-burring equipment which is only
used to make Product B-19
Who
Financial
Impact
Jan. Mar.
Yr. 1
X
Apr. Jun.
Yr. 1
X
Jul. Sep.
Yr. 1
X
Oct. Dec.
Yr. 1
X
J.R.K.
J.R.K.
Cost: $2k
/yr.
Cost: Nil
J.R.K.
Cost: $3.5k X
J.R.K.
J.R.K.
Cost: $9k
Cost: $9k
X
X
S.D.G.
Cost: $3k
S.D.G.
S.D.G.
Cost: $2k
S.D.G.
Cost: $11k
P.L.H.
Cost: $3.5k
P.L.H.
n/a
E.D.J.
Savings:
$60k
E.D.J.
Cash:
$215k
Periodic
Report On
Progress
231
IMPLEMENTATION TABLE
Implementation may be described in a narrative or in a table format. An implementation table may
communicate most effectively to senior managers and the Board Of Directors. The table may be used
to double-check the feasibility of implementation and later to monitor progress. The table should
include actions, responsibilities, benefits, start dates, completion dates and space for periodic reports
on progress. Later, senior management and the Board Of Directors should closely monitor progress on
each of the planned actions.
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
No _
No _
No _
No _
No _
No _
No _
8
9
10
11
Company Operations
Are projected unit sales by product identified? Reasonable?
Are annual growth rates in unit sales identified? Reasonable?
Are sales discounts identified? Reasonable?
Are projected unit selling prices by product identified? Reasonable?
Yes _
Yes _
Yes _
Yes _
No _
No _
No _
No _
232
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
Does raw materials & work-in-progress inventory reflect sales in the following month?
Does work-in-progress inventory reflect plans, if any, to accelerate order-to-shipment times?
Does finished goods inventory reflect seasonal patterns? Historical trends?
Does finished goods inventory reflect plans, if any, to change order-to-shipment times?
Does finished goods inventory reflect plans, if any, to change channels of distribution?
Capital expenditure budget attached? Incorporated in projection?
Are patents, trademarks and copyrights recorded at cost, less reasonable amortization?
Are reasonable provisions made for depreciation, amortization and depletion of assets?
Are accounts payable calculated in accordance with normal trade terms?
Are taxes accrued? Projected payments in accordance with regulations?
Are scheduled payments on term debts deducted?
Are loans to / from affiliated or subsidiary companies paid?
Equity budget attached? Incorporated in projection?
Does equity (retained earnings) reflect the net income / loss in the month / year?
Do current bank borrowings reflect the changes in assets, liabilities and equity?
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
46
47
48
49
50
51
52
53
Completeness
Is there a projected Balance Sheet? Consistent with historical format?
Is there a projected Income Statement? Consistent with historical format?
Is there a projected Statement Of Financial Position? Consistent with historical format?
Is there a projected Ratio Analysis Schedule? Is it complete and thorough?
Is there a projected Breakeven Table?
Is there a Sensitivity Analysis to test the impact unit sales, prices and cost of materials, etc.?
Are there detailed Notes & Assumptions?
Is each page marked with the date of issue & "Projections - see Notes & Assumptions"?
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
No _
No _
No _
No _
No _
No _
No _
No _
54
55
56
57
58
59
60
61
62
63
64
65
233
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
Yes _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
No _
Strategic
Business
Cover Page
Notification Page
Table Of Contents
Executive Summary
Request For Financing
Vision & Mission Statement
Corporate Strategy & Tactics - Summary
Ownership & Board Of Directors
Professional Advisers
History & Historical Financial Results
External Environment
Industry
Competition
Customers
Marketing
Products
Suppliers
Operations
Administration
Asset & Liability Management
Revenue & Expense Management
Personnel & Management
XXX
X
XXX
XXX
XXX
X
XXX
XXX
X
XXX
XXX
X
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XX
XXX
XX
XX
XXX
XX
X
XXX
XXX
X
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XX
XXX
XX
XX
XXX
XX
Financ
ing
XXX
XXX
XXX
XXX
X
X
XX
XXX
X
XXX
XX
XX
XX
XXX
XXX
XXX
XX
XXX
XX
XXX
XXX
XX
Go For
Gold
Status
Quo
Tune
Up
Turnaround
Get
Out
Resource Gaps
Implementation Table
Financial Projections - Summary
Appendices
XX
XX
XXX
Strategic
XXX
XXX
XXX
Business
XXX
XXX
XX
XXX
X
XXX
X
X
X
X
X
XX
XX
XX
X
X
234
X
X
XXX
Financ
ing
XXX
XXX
XXX
XXX
XX
X
XXX
XXX
XXX
XX
XX
X
Go For
Gold
Status
Quo
Tune
Up
Turnaround
Get
Out
Cover Page
One page: company name, key management contact person, address, telephone and fax numbers and
email address, the name of the document (strategic plan, business plan, financing plan) and the date of
the document. Corporate logos are fine, if normally used in company documents.
Notification Page
The Notification Page can be entitled 'Notification', 'or Important Information'. It notifies readers of
certain basic facts and invokes the company's proprietary ownership of the plan. The President should
sign and date the Notification Page. If the plan is a financing plan, the Notification Page is very
important and should be reviewed by the company's lawyer to ensure that local laws are observed.
Notification Page
This Business Plan of Kaustic Organizer Associates Inc. ('the company') summarizes
management's knowledge, plans and intents for the establishment of a new manufacturing plant
and the growth of its business. This Business Plan is not intended as an offer of securities in
the public domain or as a solicitation of investment. Financial projections are included in this
Plan. Financial projections by their nature are subject to future events and may vary from
actual, future outcomes, and the variances between the projections and actual results may be
minor or significant. The company's projected revenue and profits are dependent on numerous
factors, some of which are beyond management's capacity to control or influence. Over time,
additional information will validate or contradict management's projections and assumptions.
Management's assumptions are noted in Notes To The Financial Projections. Additional
information, new opportunities or unexpected challenges may require revisions to
management's current plans. Reproduction, distribution or redistribution, in whole or part, and
235
by any means, of this Business Plan without the prior, express approval of the company is
prohibited. This Plan is only for the use and reading of the company's senior management, its
bankers, accountants, lawyers and management consultants. All other parties are prohibited
from reading, using or possessing this document and are expressly requested to return it.
Readers who require additional information are invited to contact the company.
Kirkby Kaustic, President
Date
Table Of Contents
Include a Table Of Contents for any document longer than ten pages. List each section and the page
number, plus the appendices and schedules.
Executive Summary
Write the Executive Summary last. It should answer the W5 and 3H (who, what, when, where, why,
how, how much, how many) questions about the company. Clearly state in the first sentence what this
plan is about (This Business Plan documents our intent to build a manufacturing plant in Iowa to
make automatic de-tasselers for the domestic and South American markets'). One or two pages.
Request For Financing
Include in financing plans. Start with this statement: 'Our company's financing needs are described in
Section XX; however, we welcome alternative insights and approaches from lenders (or investors)'.
State how much money the company needs, what the money will be used for, and how and when the
money will be repaid or how and when the equity investment will be redeemed. Include a table to
summarize the sources and uses of the requested funds. Some plans include the security which would
be available to a lender or the level of share ownership available to an investor; however, there is the
possibility that the lender or investor will disagree with the proposed arrangement and, hence, reject
the entire financing plan. One page.
Vision & Mission Statement
Vision and mission statements are optional. One page.
Corporate Strategy & Tactics - Summary
Summarize the company's major themes or initiatives under the headings of the major priorities. A
clear summary will help the reader quickly grasp the plan. One or two pages.
236
237
Marketing
Describe current marketing practices. Provide a brief marketing budget and schedule for any new
marketing efforts to support planned customer or product changes. If the company has lacked a
Marketing focus, describe the employee training and motivation programs that will create excitement
and commitment. One to three pages.
Products
Describe the company's products, annual sales by product or product category, profitability and growth
prospects.
Note any actions planned that will affect product quality, cost or technological
competitiveness, and the likely impact on customers and profitability. If there are no actions planned
that would affect products, explain why. Two to five pages.
Suppliers
List key suppliers by annual volume of purchases. Explain if the company is dependent on one or a
few suppliers. Describe delivery and payment terms and relations with the key suppliers. Describe the
company's program of supplier evaluation and review. One or two pages.
Operations
Describe in non-technical language manufacturing, warehousing, logistics and research &
development. Describe any competitive, operational strength or weakness, the significance in terms of
costs, quality or service, and the company's planned actions to either build on strength or correct its
weakness. One to three pages.
Administration
Describe the company's financial controls, cost accounting, fraud prevention, and insurance and
foreign exchange policies. One or two pages.
Asset & Liability Management
In strategic plans, divide into Asset Management and Liabilities Management sub-sections.
In
business and financing plans, divide into sub-sections, such as Accounts Receivable, Inventories, Fixed
Assets, Bank Debt and Deferred Taxes. Each sub-section should describe the asset or liability and how
238
it supports or detracts from the company's priorities. Two or three pages in a strategic plan. Five or
more pages in a business or financing plan.
Revenue & Expense Management
Describe the revenue or expense orientation of the company and the specific policies to be adopted and
actions to be implemented. One to three pages in a strategic plan. Two to five pages in a business or
financing plan.
Personnel & Management
Include an organization chart as the company now operates and, if changes are planned, a projected
organization chart. Describe briefly the senior management team. Identify current skills, future
demands for specific skills and recruiting or training programs to fill the human resource gaps.
Describe non-management employees in terms of functions, departments, wage and benefit rates,
working conditions, incentive programs and current and required skills. Describe the company's
employment equity, health and safety track record. If unionized, describe past and current union
relations. Two or three pages.
Resource Gaps
Discuss major gaps between current resources and resources needed to achieve projected results.
Discuss technological, managerial, personnel, fixed asset and financial resources. One or two pages.
Implementation Table
Describe the company's pace and scope of implementation. Include an implementation table. One to
three pages.
Financial Projections - Summary
Give highlights of the balance sheet and income statement projections.
historical and projected results, especially Net Income, Working Capital and Return On Equity.
Include projections for the parent and subsidiary companies, if any.
239
240
EDIT, EDIT
Re-read the document for errors or inconsistencies. Delete highly sensitive or personal comments.
The companys accountant, lawyer and management consultant should read the document to ensure
completeness and accuracy.
Use the word processor's spell-check and grammar check, plus have a second person read the plan
specifically for spelling and grammar. Charts, graphs and illustrations can add visual power and can
assist in 'selling' the plan in some circumstances; however, review the analysis of the intended readers
before deciding. Use consistent margins, spacing and type fonts. Avoid cute or flashy formatting
(although polish and style are desirable). Margins should be .75 inches for the top, bottom and right
side, and 1 inch on the left side (to allow for binding). Spacing of the narrative should be one and a
half spacing; tables may be single-spaced. Fonts should be common fonts such as Times, Geneva or
241
Palatino. Font size should be 18 for section or chapter headings, 14 point for major topics within a
section or chapter and 12 for sub-topics and narrative. Headings should be in boldface. The narrative
and tables should usually be in plain type.
Most companies should format and bind their plans in their normal corporate manner or style. Tune
Up and Status Quo companies should format and bind strategic and business plans in a manner
distinctively different than their typical corporate document in order to subtly confirm that old patterns
will be changed. Distribute the plan to all intended readers, in person or by courier.
242
243
FAMILY BUSINESS
A family business is a business controlled and operated by two or more family members, and in which
business decisions are contaminated by family considerations and family relationships are
contaminated by business decisions. By this definition, family businesses are dysfunctional.
shareholder / partners should sign a solemn declaration that they will not hire more than one child in
total. The child that is hired must be well qualified, before hiring.
Table: Indicators Of A Family Business
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
244
Key management tasks such as supplier relations and purchasing are neglected because nobody in the
family wants to do those tasks.
Family members do the jobs that they like, even if they do not do the jobs well and even if the jobs are not
really important.
Urgent, critical decisions are postponed because a family consensus cannot be formed.
The company does not have a clear organization chart with strict responsibilities and accountabilities,
because responsibilities and accountabilities would expose incompetencies.
245
246
If the family member is unqualified for his or her job responsibilities, provide training and coaching
and an explicit timetable for improvement. Or, transfer the under-performing family member to duties
appropriate to his or her skills.
If the family member is under-performing due to laziness or a cavalier attitude, provide frank,
constructive annual and semi-annual performance reviews. Under performance should be clearly
noted. Failure to improve to an acceptable level within three to twelve months should result in
dismissal. Under performance should not be tolerated or allowed to ruin the business. If the parents
have lots of money, the parents should buy a petting zoo and let their lazy, immature or dysfunctional
adult children feed the animals.
If the adult children are really rotten, their continued employment can damage or even destroy the
business, which may destroy the parents retirement income, throw good employees out of their jobs
and cause suppliers and lenders to lose money. Tolerating or indulging aberrant behavior sustains the
aberrant behavior. Suspend the offending family member and provide professional counseling for
personality or substance abuse problems. Aberrant adult children should be paid to stay away (so the
cost is limited to the cash payments).
247
improve because the entrepreneurs and the adult childrens behavior patterns are too deeply ingrained.
Even if the fathers announce their retirement, they will typically come in to the office every day 'to
keep informed'. The reality is that the old codgers come in to meddle and interfere.
Sometimes a shareholder / manager decides to pass ownership to his children in equal amounts. This
seems like equality when in fact it is a formula for dissension and disaster. When each adult child has
an equal share, each wants an equal voice - and some will be unqualified. When each has an equal
share, each will want equal pay - some may not be worth as much as their siblings. The inevitable
family dissension and resentment simmers at a slow boil as long as the patriarch is alive; when he dies,
the knives are unsheathed.
An alternative is giving voting shares to one child and non-voting shares to the others. This alternative
is an invitation to one child to exploit his / her siblings. The children should not be forced into
partnership.
The better approach is to distinguish between economic equality and ownership. One adult child
should be designated as the Presidential successor. The choice should be announced to all family
members while the entrepreneur is alive, so he can handle any dissension. If none of the children are
ready, a key employee may be designated as Interim President. The designated adult child should
receive a few shares. A formal professional business valuation should be prepared every five years
(every two or three years if the business is growing rapidly). The business should buy sufficient life
insurance on the entrepreneur to buy his shares from his estate. When the entrepreneur dies, the
company receives life insurance which funds the purchase of all shares owned by the deceased
entrepreneur, leaving the designated adult child with the remaining shares which at that point
constitute 100% ownership. The cash from the life insurance and received by the estate in exchange
for the deceased entrepreneur's shares may be distributed equally to all the children. (Note: Estate and
succession planning is subject to numerous tax, corporation and family law considerations. Always get
independent, professional tax and legal advice.)
248
Gender Bias
Entrepreneurs should beware of potential gender bias in favor of sons. Daughters are 50% of the talent
pool. Give daughters better training than sons usually get (and, give sons better training, too). Most
family businesses involve fathers and sons; however, the world is changing: in time, daughters will
come to share equally in the trauma of working in family businesses.
Clich To Live By - Family Businesses
Water must find its own level. Sons and daughters, too.
If you have a family business, sell it.
249
hire, fire and discipline and if that person has guts, vision and ability. Possibly, coaching, guiding and
mentoring by an outside consultant might be fruitful. Selling the business should be considered.
Turnarounds of family businesses are brutal. One or more family members may have to be demoted or
fired. Family members may have to take significant pay cuts, especially if they were being paid more
than they are worth. One way to externalize the family shock is to blame firings, disciplining and pay
cuts on the turnaround consultant.
Family businesses in the Get Out Position must be sold or closed promptly. There may be a tendency
to keep operating a family business that is losing money because the business at least provides
employment to the adult children who would otherwise be forced to get a real job. Postponing closing
the family business means postponing the day when the adult children have to grow up and allows
operating losses to dissipate family wealth.
patriarchal authority and change the family members performance expectations and rewards.
Dissension and hostility are possible. Previously submerged negative family dynamics may surface.
250
WHAT BANKS DO
In the capitalist system banks are primary allocators of capital. Therefore, judged by the success of the
capitalist system, banks have largely allocated capital wisely. Depositors lend money to banks as an
act of faith in banks' integrity and ability to safeguard their money; therefore, the safety of depositors'
money is the highest priority of every consistently successful bank. Shareholders buy bank shares with
a view to moderate capital appreciation and moderate risk. Therefore, income and appreciation in bank
shares is the next highest banking priority. Depositors benefit from professional management of their
money and a spreading of risk among many borrowers. Borrowers gain efficiencies. Accessing the
banks' pool of money for a $10,000,000 capital expenditure is far easier than attracting $10,000 each
from 1,000 individuals. Banks are suppliers of money. The most attractive customers are high volume
users that pay a price that makes a profit possible and that cause low marketing and after sales costs
(including default or nonpayment costs).
associates and fellow members of the local Chamber Of Commerce may have recommendations.
Table: The Borrower's Lender Risk
Lenders may cease operations, merge with rivals or stop lending to certain industries or in geographic areas. Those
events may force borrowers to scramble for replacement financing, possibly during periods of restricted credit.
Therefore, deal with strong financial institutions.
Funding working capital and fixed assets with the same lender may concentrate the risk of loss of lender confidence.
Consider diversification, by using different lenders for different financing needs.
Some lenders have excellent reputations for understanding their borrowers' industries and working with borrowers
through temporary difficulties. Check the lenders' reputations.
Some lenders are more aggressive - faster to make decisions, more flexible in their lending criteria. Lenders that lend
in haste may terminate the relationship in haste. In the longer term, prudent lenders are good suppliers.
251
252
253
APPENDIX 3: CONSULTANTS
CONSULTANTS
There are as many types of consultants as there are plants in a meadow, and some are flowers and
some are weeds. A consultant consults, whereas agents, per diem employees, contract employees, subcontractors and suppliers sell goods and services.
Table: Characteristics Of A Professional Consultant
Specialized expertise.
Independence (not sell any product or service, except his / her expertise).
Be hired on a periodic or non-recurring basis and on a project or time limited basis.
Function in an advisory role.
sensitivity training, wilderness excursions, mind games, emotional manipulation and stark terrorism of
managers and employees. There are some superb, professional, ethical people in this field: only hire
the best. Check references very thoroughly. Never let charlatans and clowns near the company.
Management Consultants
Management consultants advise on strategy, business planning, general management issues and,
increasingly, implementation of strategic and tactical plans. They have a much less well-defined body
of knowledge and are, therefore, more difficult to evaluate than technical consultants.
254
Disadvantages
Money
Good consultants cost a lot of money. The benefits may
not be quantifiable, either before or after the engagement.
Subjectivity
Consultants have been accused of gross simplification,
self-serving complexity, and being soft on hard data and
hard on soft data.
Chaos Transfer
Consultants have been accused of 'Shooting Ducks In A
Barrel' consulting, meaning aiming at easy targets, and
picking scapegoats. Others have been accused of being
like auditors and 'going onto the battlefield after the battle
and bayoneting the wounded.' Those approaches cause
dissension and recriminations and damage morale.
Consuming Scarce Staff Resources
Consultants to be effective need staff time, and senior
management consultants need senior management time.
Use the time wisely.
Creating Divisions
In a few cases, consultants may cause polarization of
opinion, leading to increased opposition to change.
255
Soft data is by its nature subjective and may be provided by staff with
incomplete data, weak analytical skills or personal goals that conflict with the shareholders' goals of
safety of capital and return on capital. A management consultant may assist in gathering and assessing
hard and soft data and may assist management in the formulation of effective decisions.
A consultant's' knowledge, skills, experience and insights may help executives, shareholders, investors
and lenders make good decisions but a consultant is not a tool to make decisions infallible. Of course,
companies do not always get the benefits promised by consultants. Companies may engage the wrong
consultants, have unreasonable expectations or devote insufficient company resources to enable the
consultants to complete their engagements professionally. Consultants may rush their work, overload
their junior staff, disregard the insights of the clients' staff or simply be unqualified.
diagnostic and involve defining issues, usually with input from company personnel. Be open to new
ideas and viewpoints offered by the consultant. Do not tell the consultant how to consult: any
management consultant who lets the company tell him / her how to consult will tell the company what
it wants to hear (and not what it needs to hear).
Worksheet: Rating Consultants
Rating Consultants Before The Engagement
1.
Does the consulting firm understand our problem?
2.
Does the consulting firm understand our industry?
3.
Does the consulting firm understand the task or issue?
4.
Do we understand the consulting firm's approach or methodology?
5.
Have we checked the consulting firm's references?
6.
Does this firm offer any unique capabilities that we need, as opposed to other consulting firms?
7.
Has the consulting firm confirmed that it does not have any conflicts of interest?
8.
Do we know how the engagement will be conducted?
9.
Do we know what will be excluded from the engagement?
Yes
No
10.
11.
12.
13.
14.
15.
16.
17.
256
Yes
No
257
1
2
3
4
5
6
7
Industry
The industry is labor intensive.
Technical advances are being introduced in the industry fast, or primarily offshore.
Transportation costs to and from low wage countries are less than potential labor savings.
The industry has many small companies, lacking purchasing or marketing power or
advanced inventory and information systems.
Big companies have started buying or squeezing out small companies.
The industry has production capacity surplus to normal demand.
A major customer or supplier is in receivership or bankruptcy or has a lengthy strike.
Decline in a product's social acceptability (ex. cigarettes, animal testing of cosmetics).
Government changes or plans to change the industry (includes regulation / deregulation,
nationalization / privatization, removal of tariff / non-tariff barriers).
A major supplier or customer to the industry faces regulatory or international trade
pressures.
Current or likely political turmoil may disrupt marketing, operations, key customers or key
suppliers.
Commodity price fluctuations or currency fluctuations, which are not hedged.
A price war has started or is threatened.
Markets are volatile, or very cyclical.
Strategy
An expansion is a quantum leap forward, rather than an incremental advance.
The company has started a major strategic change without the human, technical, marketing
and financial resources required.
An acquisition, capital expenditure, turnaround or strategic change is not working, and the
answer appears to be spending more money.
The company plans to buy a business or to sell a division, and has not had professional
advice.
The company has bought another business and does not really understand its strengths and
weaknesses.
The company uses technology that is 2 yrs. older than its most aggressive competitor.
The company invests in technology for technology's sake, rather than to benefit customers,
products or cost savings.
B.
B.
B.
B.
Yes
Yes
Yes
Yes
B.
B.
B.
B.
No
No
No
No
B.
B.
B.
B.
B.
Yes
Yes
Yes
Yes
Yes
B.
B.
B.
B.
B.
No
No
No
No
No
B. Yes
B. No
B. Yes
B. No
B. Yes
B. Yes
B. Yes
B. No
B. No
B. No
B. Yes
B. Yes
B. No
B. No
B. Yes
B. No
B. Yes
B. No
B. Yes
B. No
B. Yes
B. Yes
B. No
B. No
1
2
3
4
5
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7
1
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19
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21
22
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25
26
The company buys 'break-through' technology that its people are not trained thoroughly to
use effectively.
Shareholders
There is a Shareholders' Agreement that was prepared and signed within 3 years.
Shareholders agree on all major aspects of the company's strategy and performance.
There is an effective Board Of Advisors or a Board Of Directors.
Wages to shareholders equal their market wages (what they would earn elsewhere).
The corporate owner or parent company is financially healthy.
Shareholders who work in the company are competent.
The company or shareholders have life insurance to buy a deceased shareholder's shares.
Operations
Purchasing is a senior management responsibility.
There is an on-going preventative maintenance program.
The plant / warehouse is very clean and orderly.
Movement of materials in the plant has been reduced by 25% within the last 2 yrs.
In-bound & out-bound freight was reduced as a per cent of sales by 20% within the last 2
yrs.
The order receipt / shipping cycle has been reduced by 25% within the last 2 years.
The company's key competitive strength is Operations.
Product quality, features and pricing have steadily improved.
Products lead or closely follow industry innovations.
Processes lead or closely follow the best industry practices.
The company earns a premium for its quality and service, either in pricing or volume of
sales.
There has been a gradual shift from commodity products to value added products and
services.
The company deleted, within the last 2 years, products or product categories based on their
inadequate contribution to profits and growth potential.
The company has developed or acquired new products in the last two years.
Products introduced within the last five years account for more than 25% of total sales.
Scrap or rework costs are monitored and have decreased by 25% within the last 2 years.
Product costs, adjusted for quality and inflation, was steady or decreased within the last 2
yrs.
The company uses the most modern environmental standards in its manufacturing,
warehousing, distribution and logistics.
The loss of a single supplier or class of supplier (ex. computer chips) would cause a severe
drop in sales, profits or cash flow.
Production schedules are revised sporadically by marketing staff.
Increased order-to-shipment time.
The company is reluctant to adopt new technology.
The person who manages the R & D function approves the R & budget (common in
companies established by an inventor or engineer).
The loss of a permit, license or certification (ex. to handle uranium) would cause a severe
drop in sales, profits or cash flow.
The company makes, uses or emits toxic or environmentally dangerous chemicals.
A key customer complains about quality or delivery.
258
B. Yes
B. No
A.
A.
A.
A.
A.
A.
A.
Yes
Yes
Yes
Yes
Yes
Yes
Yes
A.
A.
A.
A.
A.
A.
A.
No
No
No
No
No
No
No
A.
A.
A.
A.
A.
Yes
Yes
Yes
Yes
Yes
A.
A.
A.
A.
A.
No
No
No
No
No
A.
A.
A.
A.
A.
A.
Yes
Yes
Yes
Yes
Yes
Yes
A.
A.
A.
A.
A.
A.
No
No
No
No
No
No
A. Yes
A. No
A. Yes
A. No
A.
A.
A.
A.
A.
A.
A.
A.
Yes
Yes
Yes
Yes
No
No
No
No
A. Yes
A. No
B. Yes
B. No
B.
B.
B.
B.
B.
B.
B.
B.
Yes
Yes
Yes
Yes
No
No
No
No
B. Yes
B. No
B. Yes
B. Yes
B. No
B. No
1
2
3
4
5
6
7
8
9
10
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12
13
14
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1
2
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7
8
9
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12
13
14
15
Marketing
The company promptly responds to customer complaints.
The company tracks and analyzes patterns of customer complaints.
Marketing expenditures are based on contribution margins, not sales.
Marketing programs are adjusted annually, building on the strongest past practices and
deleting unproductive historical expenditures.
The largest customer category represents less than 40% of total sales.
The largest customer represents less than 20% of total sales.
The company de-emphasizes or re-prices customers or classes of customers as a result of a
thorough evaluation of their contribution to profits and their growth potential.
The company has a specific program to increase sales to high profit customers.
The company has targeted specific categories of new customers within the last two years.
The sales force is paid on contribution margin (not sales).
The company has developed a 'brand name' or high name recognition amongst its current
and potential customers.
Contribution margin of each product or product group is calculated and used in marketing,
production and inventory decisions.
Contribution margin of each customer or customer group is calculated and used in
marketing, production and inventory decisions.
Company sales are growing faster than the total industry's sales.
Marketing is computerized (customer analysis, databases, telemarketing).
Sales are steady or declining slightly this fiscal year.
Sales decreased during the most recent two years.
Gross margin decreased this fiscal year.
Gross margin decreased during the most recent two years.
The sales force talks a lot about a competitor's new product or lower price.
Finance
Accounts receivable are steady or decreasing as a per cent of sales.
Accounts receivable in dispute and credit vouchers are steady or decreasing as a per cent of
sales.
The cost accounting methodology has been thoroughly updated within 2 years.
The company uses cost accounting.
Accounting controls are strong and protect the company from fraud.
Management makes consistent efforts to prevent fraud.
Insurance policies have been reviewed and updated within 2 years.
Month-end statements are accurately completed within 25 days of month-end.
Year-end financial statements are completed within 45 days of year-end.
Bank covenants (ex. margining of receivables) are consistently met.
Reports to the bank are complete, accurate and on time.
Management uses a rolling 4 - 6 months cash forecast to plan & control daily & monthly
actions.
After-tax profits are at least twice dividends and reductions in shareholder loans.
Corporate goals determine what capital expenditures are approved.
Loans, receivables and payables with the company's subsidiaries or affiliates are paid /
259
A.
A.
A.
A.
Yes
Yes
Yes
Yes
A.
A.
A.
A.
No
No
No
No
A. Yes
A. Yes
A. Yes
A. No
A. No
A. No
A.
A.
A.
A.
A.
A.
A.
A.
Yes
Yes
Yes
Yes
No
No
No
No
A. Yes
A. No
A. Yes
A. No
A.
A.
B.
B.
B.
B.
B.
A.
A.
B.
B.
B.
B.
B.
Yes
Yes
Yes
Yes
Yes
Yes
Yes
No
No
No
No
No
No
No
A. Yes
A. Yes
A. No
A. No
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
A.
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
A. Yes
A. Yes
A. Yes
No
No
No
No
No
No
No
No
No
No
A. No
A. No
A. No
16
17
18
19
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A.
A.
A.
A.
Yes
Yes
Yes
Yes
A.
A.
A.
A.
No
No
No
No
20
41
There is a monthly cycle count of inventory and comparison of units & costs to computer
records.
Work-in-process inventories are valued accurately and consistently every month.
Sales have increased faster than inventory.
Sales taxes and payroll deductions are paid as required by legislation.
Property and business taxes are paid as required by legislation.
Payables are paid in accordance with suppliers' terms.
Year-end financial statements vary significantly from statements for the eleventh month.
The bank asks for more frequent reports.
The bank asks for additional security, especially supported personal guarantees.
Bank borrowings increased (except normal seasonal fluctuations) during the past year.
Shareholders invest (or, need to invest) more equity, by buying shares, increasing
shareholder loans, or pledging personal assets.
Management was surprised within the last 12 months by a cash shortage.
High fixed costs in a cyclical business.
Overheads not readily linked to customer satisfaction or productivity.
Overheads increased in the most recent two years.
Investment in non-core activities, such as commercial real estate.
Profits before sales of fixed assets and extraordinary items decreased this fiscal year.
Profits before sales of fixed assets and extraordinary items decreased during the last two
years.
Subsidiaries in industries or activities that are not closely related to the company's core
business.
Inventory decisions are based on financial pressures or to increase financial ratios, not
based primarily on customer needs and customer satisfaction analysis.
There are frequent (in the opinion of customers) stock-outs of high demand or critical
items.
Suppliers restrict credit, or will only ship C.O.D.
1
2
3
4
5
6
7
8
9
10
11
People
The company spends at least one week's pay per employee on training.
The company does semi-annual employee performance appraisals for all staff.
In a family business, the 'next generation' has worked three to five years elsewhere.
Employee absenteeism is low.
Employees are responsible, committed to excellence and have appropriate tools & training.
Poor performance is dealt with promptly - through training and coaching, or dismissal.
The company knows who the best employees are.
Key employees leave for reasons of job security or greater opportunities.
Increased staff and / or management turnover (typically the best leave first).
A unionized labor force strikes or threatens to strike.
A non-unionized labor force starts the certification process (happy people do not unionize).
21
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27
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29
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31
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33
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261
A. Yes
A. No
A.
A.
A.
A.
A.
B.
B.
B.
B.
B.
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
A.
A.
A.
A.
A.
B.
B.
B.
B.
B.
No
No
No
No
No
No
No
No
No
No
B.
B.
B.
B.
B.
B.
B.
Yes
Yes
Yes
Yes
Yes
Yes
Yes
B.
B.
B.
B.
B.
B.
B.
No
No
No
No
No
No
No
B. Yes
B. No
B. Yes
B. No
B. Yes
B. No
B. Yes
B. No
A.
A.
A.
A.
A.
A.
A.
B.
B.
B.
B.
A.
A.
A.
A.
A.
A.
A.
B.
B.
B.
B.
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
No
No
No
No
No
No
No
No
No
No
No
1
2
3
4
5
6
7
8
9
10
11
12
13
262
Management
There is a strong management team to handle growth, or the death of a key person.
Management receives and uses every month a one page financial summary of the key
monthly trends that must be managed.
There is a clear organization chart, with identified responsibilities and authority.
Management has a sense of urgency appropriate to the issues.
Management has a sense of personal responsibility for the company's success (i.e. not
relying on hope and good luck).
The company has a plan to recruit / train / promote people to replace senior management
who may retire within 5 years.
There are weekly, focused, productive management meetings.
Senior management has noticeably increased its skills and sophistication within the last 2
years.
There is life and disability insurance on key executives.
There is a comprehensive, actionable business plan, prepared within 24 months, reviewed
at quarterly Board Of Directors / Advisors meetings.
The President develops a major non-business interest or activity, or dies.
The President undergoes a significant change, such as substance abuse, marital disruption
or health problems.
The President focuses on his specialty, neglecting operations, marketing or finance.
A. Yes
A. Yes
A. No
A. No
A. Yes
A. Yes
A. Yes
A. No
A. No
A. No
A. Yes
A. No
A. Yes
A. Yes
A. No
A. No
A. Yes
A. Yes
A. No
A. No
B. Yes
B. Yes
B. No
B. No
B. Yes
B. No
Number
Industry
Strategy
Shareholders
Operations
Marketing
Finance
People
Management
Total
14
8
7
26
20
41
11
13
140
# of A. No
# of B. Yes
Total: A. No + B. Yes
Total
%
Descriptions
of
263
On the schematic below, mark the total number of A. No and B. Yes that were circled. Join the
numbers with a line. Draw lines, on either side of the first line, to show the possible range of Position.
70
70
60
50
40
30
20
10
Overlapping Positions
Companies may straddle two or even three Positions. The difference between any two adjoining
Positions (Go For Gold and Status Quo, Status Quo and Tune Up, Tune Up and Turnaround) of the top
four Positions may be as simple as the trend. The simplest way to distinguish between two adjoining
Positions is to ask, "Is my company getting better? If the answer is yes, choose the higher Position.
If the answer is no, choose the lower Position. Distinguishing between one of the top four Positions
and the Get Out Position should be influenced by the severity of the medium to long term challenges
compared to the adequacy of corporate resources.
264
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Peter McCann
Peter McCann has consulted with privately held companies, large corporations, banks, not-for-profit
organizations and Aboriginal businesses and he has been a Director of privately held companies. His
professional experience includes eleven years as a commercial lender with two of Canada's largest
business lenders and, then, twelve years as a management consultant. He holds a Diploma in Applied
Arts and Technology (Honors Business Administration) from Algonquin College, Ottawa and a Master
of Business Administration from the Richard Ivey School of Business, University of Western Ontario,
London, Canada.
College of Business and The Humanities, at the East Kazakstan State University, Kazakstan; he
teaches at the College on a periodic basis. He has spoken to industry associations, service clubs and
business and academic audiences. He has written business cases for the Ivey School of Business and
the Kazak-American College and articles for industry magazines.
McCann Corporate Consulting Associates
MCCA is a management consulting firm established in 1989 to serve companies and organizations.
Strategic & Business Planning
MCCA works with company executives on the preparation of their strategic & business plans. In some
cases, long-distance feedback on mailed, faxed or emailed draft plans may be provided.
Management Consultation
Management consultations normally involve either the President or the President and the senior
management team. On a selective basis, Peter McCann provides management coaching.
Seminars & Speeches
Seminars for the senior management team of a company starting the strategic and business planning
process and speeches to company conferences and industry association meetings may be arranged.
266
Tel: 1-905-574-5400
Email: pmccann@globalserve.net
267
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