I once implemented SAP over the top of Quickbooks. We were on a fast growth trajectory and the venture funds wanted a solid system that we could use while we grew. The SAP ERP system was selected before I joined. The system wasn’t as mature as it is today and for our $1,000,000 check we received a lot of “Achtung” error screens. The one positive was that we used their system exactly as designed. Our processes didn’t exist, so there was no need for customization.
Managing growth is about managing the many changes that occur when you turn a small business into a big business. Start-ups lose money before they achieve scale. This is because costs aren’t perfectly variable. If you open a frozen yogurt shop, you’ve got to rent space, buy fixtures, yogurt machines and train a staff. All of this cost occurs before you bring in any revenue. These investments are a part of your fixed costs. Costs that vary with sales are called variable costs. A perfect variable business would not have any costs until revenue is achieved. Unfortunately, there are no perfectly variable businesses.
Costs grow in “steps” because the cost increases are not smooth, they increase in a bunch. For instance, you could start out renting a small space with a fixed rent, which is a step up from working on the kitchen table. A year later you pay the same rent but the staff has grown and people have to crawl under their desks to get to their chairs. A new space is located and rent increases, another step. Shared space operations like WeWork, Regus and Carr and hope to minimize the steps by allowing you to add space as needed.
A big change in business in the last 25 years has been the decline in the size of the steps and the ability to ramp a small business. We used to call the growth infrastructure problem “the tunnel”. Before you entered the tunnel you could make money – the business is small, not much investment in space or people, there was little structure and no overhead. You entered the tunnel when a step up in investment was required. Maybe you needed a larger office, or a new system or a warehouse. But whatever it was, until you grew sales sufficiently to cover the cost of investment, you had high costs and lower profits.
Years ago there were many, many large steps. Renting an office space used to mean a 5 or 10 year lease with guarantees by the founder. Not so anymore. You will pay a more per square foot for shared space, but you aren’t committed in the long term. Systems used to run six figures, while today I’ve worked with businesses with sales more than $40m a year running on a $400 copy of Quickbooks.
Financing can sometimes help make those steps smaller, too. You may only need to put down 10% on that frozen yogurt machine, so you pay the loan with money you’ve made selling frozen yogurt. The risk remains (after all you have to pay the loan), but you better match income with outflow.
These steps happen with staff, space, equipment and systems. Managing the growth is a lot about making the steps as small as possible while keeping your attention on the target. My SAP install turned out to be a bust. After losing $50m the company pivoted and we returned to Quickbooks.
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Dr. John Zott is the Principal consultant at Bates Creek Consulting and works as a CFO. John is a senior adjunct professor at Golden Gate University and comments regularly on issues that affect growth companies. If you are a former student, colleague or would just like to connect – reach out.
Good luck can be bad, and sometimes we are right for the wrong reasons.
I worked with a company putting in a small market strategy. The idea was to put units with a subset of product in smaller markets. The idea was a good one, the plans were fine, but the implementation was fumbled when the test units were all placed in large markets. Instead of testing a small market strategy, they tested a small unit strategy. The results exceeded expectations. The small units performed great and a major investment initiative was undertaken. Several years profits were dumped quickly into new units. Unfortunately, the investments were made in small markets where results were nothing like the test markets. The next management team (and there is always a next management team) spent over five years shuttering these units while the stock dropped 90%.
Investments are made incrementally: a decision is made, an action implemented, a result is achieved. We review our results and make the next decision. When we get a good result based on a bad process, we change our criteria and understanding of the investment cycle.
When a good result happens after a bad decision process, management is mislead. Now the bad decision process gains momentum. Further decisions follow the bad process and the odds of further problems increase. The factor that caused the good result (big competitor leaving the market, change in government policy, innovation) is also not examined or recognized. The management team attributes their success to something else, usually their own intuition or skill. Humility is an executive management teams best friend. Over confidence and hubris precede the fall. One portfolio manager I worked with was especially skilled at identifying overconfidence in management teams.
When you have a good decision process you can still get a bad result. After all, business is about taking on risk. If it isn’t risky, investing in a business would be like investing in a bond. It is not.
When you follow a good investment process and lose, you can second guess your process or implementation schemes, or you can identify some other relevant factor. Sometimes, as they say “crap happens”, the market, customer, technology. competition change and your results are bad. Of course, some firms don’t look too closely at the results of their decisions. No one wants to admit error, especially a CEO who has committed personal power to a particular course of action.
How do you avoid this? It’s not as easy as remaining humble. Good decision processes are defined by good results. Taking the long odds when the payoff is low is stupid. But in business, the odds are not apparent as they are in a book about poker or on the tote board at the horse race track. Risk is estimated and a good result tends to lower our assessment of the bad risks and increase the upside potential. Often a careful review will identify unknown variables that mitigated the risk. Sometimes a counterfactual is helpful as a tool to identify whether your risk assessment is accurate. For example, what if the competitor in this market hadn’t closed the month after our opening?
Often we just need to update our assumptions slowly and continue to gather information as we move through the process. Another couple of test units would have helped, or a second review of the market size after the units are open to see if they remained classified as “small markets”.
Luck can be bad or good. Both can mislead. And sometimes, when you have positive luck, and the sun shines seven days in a row, enjoy it.
My uncle moved his pharmacy about 50 years ago. He could only choose one location, and he mapped out where he thought the growth of the city would be. The first few years were hard, but as the city grew, his shopping center became the center of town and the store site turned out to be a very successful location. He balanced today’s customer against tomorrow’s. Too early, and you build in a corn field and are bankrupt by the time the community arrives, too late and you pay higher rent, or are completely shut out of the market.
CFO’s (and CEO’s) work in a particular time frame. Some think about next month, some about next year, some about 10 years from now. This is typically called the strategic time frame. My Uncle’s time frame was 20 years, the length the time he’d be committed to a lease. To make a positive difference in earnings you typically need at least 6-12 months. Strategies take time to develop, initiatives need to be planned, advertising ordered, product sourced or manufactured, distribution organized, and sales teams trained. Of course, you can make a negative impact on a quarter a lot quicker, simply run out of inventory. My friends in the Hispanic grocery business called that “throwing a party without having any beer”. Not a recipe for a good party.
A good strategic plan is about figuring out what to do. You generate positive initiatives, put them in a rational order, fund and staff them, and sequence them so performance targets are achieved. But when should these initiatives be focused? If too short term the projects will be small, too long term and the market may change and the opportunity disappear. Balancing the “when” becomes as important as picking the “what”.
Elliot Jacques was an organizational development consultant who felt most OD problems were organizational and not people problems (see here for his requisite organization page). He felt that people had a natural time frame and controversially believed it couldn’t be changed. I don’t know whether that is true, but I do know that there is too much short-termism in plans.
Short-term projects tend to push out long-term projects. Silicon Valley CFO’s stay about 3 years in a job. There really isn’t time to think long-term when you spend six months learning the company, two years working and six months planning your next gig.
I’ve worked with management teams that spend 100% of their time focused on hitting the weekly numbers. These management teams react fast when things go astray. They also tend to be inward, operationally focused. So intent on what is in front of them, they miss opportunities to grow the business.
This applies in your personal life. There are probably 2 or 3 things that will make a difference in your life in 10 years. Are those things being addressed now on your to-do list? I talk with people every month about retirement, and too many lack a plan. Be kind to your future self, think about the future and make those constructive changes you know you need to do. The earlier you start, the smaller the changes need to be.
A good project plan has steps to help you reach your goals. A good strategic plan has interim steps that support your long-term goals. Look at your strategic plan (or project plan or to-do list) and see if you have a good mix of short, medium and long-term items, and be kind to your future self.
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Dr. John Zott is the Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are looking for a CFO for your e-commerce/retail/consumer company, or are a former student, colleague or would just like to connect – reach out.
Although I prefer to help businesses grow, sometimes growth goes bad and the company becomes a turnaround. I worked with a firm that went through a very rapid growth phase, was hit with an unexpected event, and ended up declaring bankruptcy. I joined shortly before the bankruptcy and saw them through the money raise and bankruptcy exit. It is a valuable experience that is way under appreciated by hiring managers.
One day early on in the process, the outside corporate counsel (a close friend) and I were sitting in the back of the court room waiting for our turn. Several smaller cases were being heard by the judge. After listening to a few of the facts, I noted to my friend that if these firms made a few relatively small decisions six months earlier they could have avoided the whole bankruptcy proceeding. The lawyer turned to me and said “every case in bankruptcy court could have been avoided by making a few better decisions earlier.” Although this doesn’t sound that profound now, it did to me then.
Decisions have consequences, and bad decisions lead to bad outcomes. Although it can be personally satisfying to blame one person or one decision for a bad outcome, there are often multiple decision points and multiple people involved and plenty of opportunities to take another path. The downward spiral of performance is often accompanied by a closed mind. You can’t fix a problem you won’t see.
Management teams repeat their core message to the staff, which communicates strategies and values. This repetition helps solidify the culture and keep the company on track. Unfortunately, as circumstances change, sometimes the strategies must change. Repeating the company line when it is no longer relevant is like dancing for rain. The only winner is the guy getting paid to dance.
Worse yet management teams that don’t recognize change become further out of touch with the front-line staff that faces the market and the changes. Respect declines when your boss is telling you to focus on “a” when you can clearly see the problem is “b”.
The first rule of holes is “when you find yourself in one, stop digging.” Management teams need a method of tracking performance that tells you when you are in a hole, an open mind to recognize that circumstances have changed and the fortitude to go and fix the problem.
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Dr. John Zott is the Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are looking for a CFO for your e-commerce/retail/consumer company, or are a former student, colleague or would just like to connect – reach out.
I have been saying for many years that we are using the word ‘guru’ only because ‘charlatan’ is too long to fit into a headline. Peter F. Drucker.
There is comfort knowing that someone knows what is going on and can help us by giving us their opinions about politics, stocks, how to live better and what to wear. All we have to do is to find the right guru – the right advice. We think we are reducing risk by following a guru, but we aren’t. But, at least we won’t look foolish alone.
There are not many physics guru’s because one important part of guru-ness is that the subject matter should be indeterminate, that is that it cannot have a single right answer. The stock market is prone to guru’s. There are no simple answers and what works one day, won’t work another. Investment shows on TV are about entertainment, not education.
By now hopefully you know that there are no stock market guru’s. It is simply not possible to forecast where the stock market is going in the short term. Most of what passes as forecasts are 20/20 hindsight or deal with relative valuation of the market. I think relative valuation is useful, you can buy the market at a discount. I know you will pay less for Christmas/Holiday cards in January (11 months early) than November. However, buying something at a discount doesn’t stop the chance that there will be a bigger discount later.
“Those who have knowledge, don’t predict. Those who predict, don’t have knowledge. ” Lao Tzu
Politics is similar to the stock market. The guru’s in politics are no more accurate, and offer no more clarity than the stock market guru’s. Political forecast accuracy has been the subject of quite a few good books. Tetlock’s book “Expert Political Judgement” outlines his thoughts on why so many political forecasts go poorly. Philip Tetlock’s suggests that foxes are better than hedgehogs at forecasting. The fox knows many different things, hedgehogs know a few things well. His more recent book with Dan Gardner “SuperForecasting” offers examples of good and bad forecasts and includes some suggestions on how to do it better.
Forecasts are effected by circumstances and human behavior that in the short term can be identified, but in the long term (more than a year or so) have too many interactions to be of any use in forecasting. Like the weather forecasts which fall apart the further out you forecast, the longer the time frame the more human behavior and chance result in different outcomes.
“No matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers.” – J. Scott Armstrong
There are a lot of guru’s in the business world. Harvard seems to grow them like tomatoes. The history of management includes a lot of ideas that turned out to be stinkers. Scientific management wasn’t a very good idea even when it came out. Re-engineering turned out to be another way of saying lay-off. I’ve spent hours debating core competencies which in the end, couldn’t be defined or implemented. Theories that can’t be tested are especially prone to guru-ness.
Trying to implement guru’s advice can be frustrating. I loved “In Search of Excellence” but the advice was general like “stay close to the customer”, which is almost perfect guru advice since you can always say you weren’t close enough. I call it Zott’s Law of Business Books. The more general, the easier to read, the less useful the advice. Kahneman’s “Thinking Fast and Slow” was a top business book of 2015 and is interesting and a good read. Again, not much useful advice.
J. Scott Armstrong also said, “If you can’t convince them, confuse them.” A lot of business guru’s wrap pretty simple ideas in complicated language.
The Principal Agent problem states that there are differences between principals and agents (owners and managers) and that making agents more like owners will solve the problem. I like Agency Theory, it explains a lot of behavior. We sought to fix this problem by giving executives stock options. Since then we’ve spent millions on stock options and it doesn’t appear that management is any more aligned now than before. The cure I think is worse than the disease.
We listen to these guru’s because we want an answer. The answers given aren’t necessarily right nor particular useful, but they are confident and we value that certainty. Guru’s use our need for certainty to sell us their opinions (and via advertisements, dish soap). In today’s world of fake facts, alternative news, spin and TV personalities who are selected and paid for their ability to speak confidently (without knowledge), our main defense is a healthy skepticism . Skepticism and an understanding that we live in an uncertain world.
Quidquid latine dictum sit altum videtur – Anything said in Latin sounds profound.
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Dr. John Zott is the Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are looking for a CFO for your e-commerce/retail/consumer company, or are a former student, colleague or would just like to connect – reach out.
Accounting is a numerical history of a business. We summarize the millions of transactions into a cogent one page document that tells the status of the business. The financial statements however, are not the same as the business. Alfred Korzybski said that “the map is not the territory”, referring to the object and its’ representation. A financial statement summarizes, and a summary leaves out details. Tracking which data goes where is the job of the general ledger and chart of accounts.
The core of reporting is the chart of accounts. Financial statements summarize sales into one line. Accounting might have half a dozen sales accounts and hundreds of departments, which all roll up to one single number – sales. These accounts are used to better understand the summarized information. Sales are reported net of returns, but accounting departments track the returns in a separate account so that department heads can see if return rate is trending up or down. If your ERP or sales software tracks returns, you probably don’t need a separate account for tracking that information.
However, accounts seem to proliferate. Charts of accounts grow over time – someone wants to know some summary fact of the business and the systems that generate that data don’t supply the summarized data to management. Commonly at retailers it is a POS (Point of Sale) system that runs the cash registers and reports summary data to a sales data warehouse or general ledger. Usually they only report data to the general ledger, so operating data is sourced from accounting records.
In an e-commerce firm it is the order entry and fulfillment systems, which may not be connected with purchasing or payroll systems. In addition, management has come to rely on the controls put in place in a general ledger system. In the 1990s we used a lot of database query tools that would often give different answers based on query design, so one meeting might have three different set of numbers based on who’d written the query.
The use of data warehouses should decrease demand for general ledger detail. Sales splits can be done in more detail using a database with all the relevant sales data, rather than the general ledger which might contain only weekly summary data. However as the needs of the company change, often it is easier to just add an account number than reconfigure a reporting system. Data warehouses – an idea that dates back 20 years – still don’t function as well as they should. So the g/l becomes a stand in.
I’ve typically used a couple of hundred “natural” accounts for businesses from $5m to $500b in revenue. An account like “sales” or “payroll” are called natural accounts. These are modified by department code and sometimes other codes for cost accounting or for projects. This can result in thousands of combinations. In a typical retailer with 100 stores they would support 60-70 natural accounts, for 6-7,000 combinations. Add in district and regional codes you could reach another 1-2,000 combinations. Designed right that level of detail is easily handled by your accounting team. Designed wrong and you spend hours trying to reconcile the source systems to the general ledger. Which adds cost without benefit.
Manufacturers sometimes have additional codes for production cost allocations. If you are running the same line in two buildings, under one department, you might also use a location code. All these codes end up making a chart of accounts pretty complicated. This is worsened if you end up layering on the complexity as you go, rather than plan it in. Knowing going in you will likely need a location or a production line code and planning for it makes a big difference later.
Much of the complexity of the chart of accounts depends on what information you will want to retrieve. Simple natural accounts and department codes can get a business a long way. Accounting codes begin to change if you are running project-level or fund accounting. Sometimes you can keep the reporting structure out of the chart of accounts. For instance, if you have a district manager with 10 units, you likely don’t track the district code in each transaction, but roll up the district report by selecting which units are in a district when you summarize the data. This is the default mode for most firms who report with excel. Changing the unit roll-up when a district manager leaves the firm is not Excel’s strength. Excel’s data summarization and analytical tools have improved, but realistically, converting from a trial balance to report is an area ripe for errors.
If you have online reports, managing the access in an ERP system can be a hassle, unless you have some hierarchy built into the system. Imagine allocating 600 units amongst 60 district and 10 regional managers? If each of the units had an assigned district and regional code, the reporting would be much easier to manage and control. With the rise of reporting dashboards, this feature is almost always built in.
The general ledger and financial statements are summaries but useful ones, where similar data is grouped, analyzed and decisions can be made. Too big a chart of accounts and you will spend hours managing complexity rather than providing information. Too small a chart and you will your time breaking out the details you need. A map is a representation of a territory which can be held in your hand and used to navigate. Good design and a thought for the future of the business will help develop a solid organization for your accounting data so that it will supply you the information you need to navigate.
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Dr. John Zott is the Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are looking for a CFO for your e-commerce/retail/consumer company, or are a former student, colleague or would just like to connect – reach out.
Millennial in natural habitat – a craft beer garden
When I started my career we were debating theory “X” vs theory “Y”, baby boomers and the nature of people. Today we debate about what millennial’s want. Millennials are the people who became adults in the early 21st century, so basically they are 18 to 35 right now. The debate about how to manage them reminds me of the debates we used to have about working with the baby boomer generation.
A great bunch of the stuff written about how to manage millennials is so general it is useless. It is slightly more scientific than astrology. For instance, millennials want meaningful work and work life balance. They want to be listened to, they want to dress casually. I am not sure what workers don’t want those things. Fortune has noted that millennials are not all the same in their November 1st 2016 “Millennials are not Monolithic” edition (see here). Fortune says we are more alike than different but spends a whole magazine repeating the same generalizations.
Being treated as a part of the baby boomer generation never described me and I bet at least some of the millennials out there that are being managed via the latest and greatest theory dislike it too.
I never saw big advantages of being a baby boomer. The era of cheap college ended with advent of tuition inflation in the 1970s (1970-1985 12.4% annually). The era of large protests pretty much ended while I was still a boy scout. There were some small advantages to following the bulk of the baby boomers. By the time I came to high school, we could wear our hair past our collars and the assistant principal couldn’t hit us with a paddle.
One thing they used to say about baby boomers was that they lacked loyalty as employees. I graduated from college in Detroit with a shiny degree in accounting and an MBA (accounting graduate fellow) the same year GM laid off 70,000 workers with an estimated 15,000 people in finance. My main clients at KPMG were the city government and a series of weak and getting weaker manufacturers. I left for better climes after I put my time in for my CPA license. A couple of years after I’d moved to California, my father got laid off from a job he’d been at for 20 years. Lesson learned, loyalty was not a two way street.
Millennials are supposedly quick to quit a job. I think this is due to the confidence that they will find another, and realistically, most will find another. They don’t expect a lot of loyalty from an employer, and they show little.
Managing people via a theory has had a long history of failure. I have never been a huge fan of scientific management and Frederick Taylor. My dislike is how Taylor perceived workers. Treating the worker like a machine, transferring control from worker to management and a general sense of contempt of the work force were his key viewpoints . Yes, work flow improvement is important, and the quality initiatives such as six sigma can be traced back to his research, but for the most part, it is the idea of applying science to work, rather than his specific ideas that he is known for. He was virulently anti-union, while the way scientific management was implemented almost assuredly pushed more workers into joining a union.
Henri Fayol was a contemporary of Mr. Taylor. Unfortunately he wrote his book in 1916, in French in the midst of World War One. His book didn’t get translated until 1949, but if you read about his ideas today, they’d make a good primer on how to be a manager. Fayol had the advantage of actually working with people successfully. Something Frederick Taylor struggled with.
Millennials aren’t a different species of worker. They want what we all want, meaningful work, a laugh now and again, decent pay and a convivial office. We get that taken care of and we can stop worrying about what year our staff was born.
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Dr. John Zott is the principal consultant at Bates Creek Research & Consulting.
I am the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and I comment regularly on issues that affect growth businesses. If you are looking for a CFO for your consumer company, or are a former student, colleague or would just like to connect – reach out.
I believe there are two kinds of sales growth, good and bad. Bad sales growth is unsustainable, and in the end counterproductive. Bad growth maximizes sales growth over optimizing the factors which can lead to good sustainable growth.
Maximum sales growth seems great (who doesn’t want sales?) but it can lead to bad outcomes. A few examples, because the most instructive examples are the bad ones. I was working with a window covering manufacturing company that had a shot at landing a national big-box retailer. The CEO wanted the business and bid hard for the work. His company immediately increased by 50% but within 18 months went bankrupt. In his eagerness to get the business he bid below his fully loaded cost for the product and began to lose money quickly.
Under investing in systems and accounting kept the client from knowing their costs or how deeply they could cut prices. I met them about 8 months after the fateful bid, when I was brought in to purchase a high volume wood blind finisher to support their growth. While doing due diligence, I compared the costs for the target to the base company. Given that the target was specialized, 10x bigger and extensively automated, I was surprised that the target reported 15% higher costs than the base company. Digging into the internal cost data identified a problem in booking inventory that caused this discrepancy. The person in charge of inventory tracking (the owner’s sister) had no accounting training and wasn’t relieving inventory accurately. Her husband ran the manufacturing operation and he’d continually boasted about efficiency he’d gained. Those gains turned out to be spurious. It took only weeks to figure out that the base company inventory was overstated and that the new “big box” business had lost so much money that the equity was wiped out.
I once worked with an insurance company offering our customers the option of purchasing their product. The company was eager to grow the book of business quickly. They suffered adverse selection as the bad risks switched insurance to get the low introductory prices. Risk was significantly under-priced and profits, which were planned for year 2, ended up in year 4. Growing fast meant taking on unqualified and riskier clients. Bigness doesn’t overcome crappyness.
I was the lead auditor on a large auto company’s financing arm. At lunch one day, the top executive at the finance subsidiary said that the front office wanted more loans written and more cars sold. Since the financing division couldn’t access funds cheaply, the loans they offered had higher interest rates than average. Low risk borrowers weren’t interested in high cost loans as they had low cost options. Consequently the only way the company could increase loans was to take on riskier borrowers. Another example of adverse selection. I asked how this would play out. He said they’d write a lot of loans (and sell cars) but in a year a higher than average portion of the new loans would stop performing. Eventually the front office would ask that he clean up these delinquencies. He then would repossess enough cars to drop his delinquency rate to average. Repossessing cars is expensive and after the increase in losses due to the disposition of these vehicles he’d then be asked to limit these losses. If the scenario worked out as he’d foretold, he would likely obtain a bonus every year for achieving his objectives.
Creating growth like this is counter-productive. Yet lots of firms think it is as simple as the CEO ordering growth to happen. Smart growth is about balancing the factors of growth. People, resources, systems, processes, time and management must be balanced against sales growth. The factors must be optimized so that growth and profits continue. Optimization can be complicated, as there can be multiple successful solutions at varying levels of profitability. Some solutions are oriented to throwing bodies at the problem, other solutions might include implementing a computer system. Both ways will work, one way offers more flexibility and the other cheaper long term costs.
Most of the factors of growth can be quantified into costs, so there is a basic cost vs. profit model that needs to be managed, but time is the factor that determines the rate of growth. A firm that grows 10% and 9% in two years is roughly equal to a firm that grows 20% and 0%. The cost vs profit trade-off has to be seen over multiple years as costs often come as a steps. Investing in a new manufacturing facility or a new computer system is a step that will need to be cost justified over five or more years. Finding ways to minimize the height of the steps, planning on when to take the steps and grouping the steps into logical order are a big part of dealing with optimizing the growth rate.
It is easy to delay investment in these factors, but eventually the problem worsens which brings growth to a halt and sometimes worse. I am not suggesting that everything will be perfect before you can start growing – and growing fast. But as much as it is wanted or needed, when the car is doing 180 mph around Le Mans, you can’t change the tires. You can fix a foundation after the building is built, but it won’t be cheap or easy. Smart growth is about about balancing and managing these trade-offs.
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Dr. John Zott is the principal consultant at Bates Creek Research & Consulting.
I am the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and I comment regularly on issues that affect growth businesses. If you are looking for a CFO for your consumer company, or are a former student, colleague or would just like to connect – reach out.
We all want certainty. We want our investments to average 5% return a year (7.375% if you are in the state of California), our children to grow up strong and healthy and it to only rain at night. However, life is uncertain.
Insurance is about creating certainty. A small cost is paid, instead of a small chance at a large loss. Health insurance is part pre-paid services (check-ups) and part joining a purchasing cooperative (in-network pricing is a lot cheaper than out-of-network) and part real insurance. Car insurance doesn’t include oil changes, although they do control where certain repairs are made. Not just insurance companies make money on reducing uncertainty.
I once had a competitor that sold a tuning service for radios and electronics. This advantage was a significant part of his marketing and brand value. At some time in the past, there might have been some value in swapping out vacuum tubes but since the 1960s most marine electronics were solid state. By the 1990’s there was nothing to be done to a solid state radio, and if they didn’t work out of the box, they had to go back to the manufacturer. He sold fear, uncertainty and doubt or FUD.
FUD was made famous by IBM, who would meet every new competitor in the computer industry with comments about reliability, threats of the loss of warranty coverage, rumors of financial difficulty and vague hints about losing purchasing status. For the longest time I’d hear the comment “no one got fired for buying IBM”. FUD works.
People will pay for security – even if the math suggests it is a bad bet. My firm started selling extended warranties on our products. This was a big money maker for Circuit City as electronics extended warranties had a 90-95% margin. For a while the staff wouldn’t sell them, they thought the extended warranties were a rip-off of the customers, and we had a no-hassle money back guarantee. Buying an extended warranty is not a good bet, but people appreciated the certainty and paid for it.
Eating at McDonald’s is not normally a “treat”. We select fast food because of the consistent product, price and convenience. We know what we are getting – uncertainty is reduced. Retailers who reduce uncertainty increase sales. Zappo’s can sell you shoes because they agree to take all returns. I doubt Zappo’s makes much profit on its shoes, the freight has to be killing them (see here) but given that Amazon owns them and Amazon is the worlds largest capital destroyer it is ok.
I see the problems with seeking certainty as a function of information asymmetry, competition and add-ons. The retailer that offers a money back guarantee knows how often goods are returned and when they sell you an extended warranty, the likelihood of your using the warranty. You can’t judge if it is a good deal or not. Those situations are referred to as information asymmetry, where one side knows more than the other. Learning more about failure rates can give you confidence to skip paying an extra 15% for a product, knowing the chance of fault might be 0.02%. A phone with a one year warranty and a three year overall life doesn’t present much time for a failure.
Your car insurance company knows more than you do about the likeliness of an accident and they price the insurance so that they make a profit. The car insurance company is kept honest by a competitive market place and regulators. Competitors push prices towards an equilibrium, which is lower in price than an un-competitive market.
The least competitive market is one where you have little time and no access to competitive prices or data about risk. This happens while standing in line, or in the midst of a transaction when an add-on is offered. Rental car companies are good at offering you several levels of insurance-like services (one full priced for 100% coverage, a second with a deductible, a third with a collision damage waiver) while all levels of coverage are priced extremely high. It is not unusual to pay $5-6 a day for coverage for your new car, and $40 a day for insurance for a rental car. The extended warranty is pitched to you at the register without any time to calculate the costs, benefits or risks.
Seeking security isn’t a problem, and reducing uncertainty isn’t bad. One consequence of a population that doesn’t understand probability is that we will be taken advantage of by providers of certainty. Be a smart consumer, do your research before you buy.
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Dr. John Zott is the principal consultant at Bates Creek Research & Consulting.
I am the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and I comment regularly on issues that affect growth businesses. If you are looking for a CFO for your consumer company, or are a former student, colleague or would just like to connect – reach out.
Investor relations is broken. It isn’t the people, it is the process. Most senior executive see it as a department designed to help the company put their best foot forward. The skills needed are someone who is good with powerpoint, knows numbers and can talk to analysts all day long without going crazy. I think this definition misses six key challenges for Investor Relations.
Challenge #1 Investors have no time
Investors are limited by time and attention. Investing is based on financial reports which are both long and redundant, and the amounts of disclosure are not improving investor knowledge (read this). The SEC and the FASB have turned a simple financial statement into a career generating stack of paper. A typical 10k runs 100+ pages and is stuffed with disclosures, reconciliations and accruals.
A typical financial model will go back 10 years and ideally, all the 10k’s & q’s should be read from the entire history. Most are not. I bet that fewer than 50 people outside the company conceivably completely read any 10k document. Most analysts look at changed pages from the previous document, skim the management discussion and update the models with the key data. If you own 50 stocks, your reading load might be the same as knocking off three books a week in SEC filings alone, not including the other material you read to know what is going on in the economy.
Time pressure causes investors to look for shortcuts to the intellectual rigor of a complete and detailed review. Pattern recognition conserves time and brain power. Investments are selected that are similar to past successes. Investors classify stocks by lots of methods (growth, value, etc) to eliminate the time memorizing details about every company. The intellectual demands to obtaining, sorting and absorbing the material means that complicated stories are often ignored or missed. Complicated analysis, the use of a lot of jargon just make the analysts job harder, and therefore less likely to expend the energy to invest in your firm.
Clarity increases comprehension and makes the job of an investor easier. Easier means better analysis and better communication and a better stock price.
Investor relations has to recognize the time pressure and focus on a coherent set of facts that allow a potential investor to understand the business and make a prudent investment.
Challenge #2 It’s not just numbers
For the last fifty years we’ve been training executives in quantitative analysis, and today’s MBA’s know how to deconstruct a business. Because of our emphasis on numbers, today’s executives tend to manage rather than lead. CEO’s and CFO’s certify that the financial reports to the best of their knowledge do not include misstatements, or are misleading. Making both CEO’s and CFO’s more involved in the data and detail.
Investors do not have access to the details of the business, and realistically we can’t share them. Analysts are trying to make meaning out of disclosures, so they ask a lot of questions about management’s impressions or thoughts (or my least favorite “add some color to the numbers”). When analysts ask these questions, they are asking for help understanding the bigger picture and cannot tie in the numbers to a direction or theme.
Santa Cruz cows out standing in their field
They are looking for the story behind the numbers. When a senior management team that generates and lives on numbersis selling to someone who is looking for a story, there is a disconnect.
Humans like stories (see here for Paul Zak’s HBR article) and we remember them better than the numbers. The story provides structure to our understanding and helps add meaning and relevance.
Investor relations has to communicate a story that makes sense. It has to be reasonably based on history and explain a direction and purpose for the company. It is more than the just the numbers.
Challenge #3 An Outside Perspective
Investors have one huge advantage in valuing firms that senior managers lack. They have an outsider’s perspective. Working at a hedge fund meant sorting through 2-3 firms a week. You hear what the other firm’s have been saying, you can compare this quarters disclosure to the last 15 quarters, you aren’t sitting on half a million options that are underwater. The outside perspective is very valuable, I have written about it before (see here). Outsiders haven’t drunk the company Kool-aid, they aren’t convinced of the company’s invincibility and they aren’t incentivized to worship the company mission. This perspective is valuable to CEO’s and Boards, but the criticism is dismissed because the outside view often is working off of fewer facts and CEO’s reject criticism of their strategic plans.
In a capitalist system, the investment community is the owners of the business, and we should listen to the owner, even if they are sometimes wacky.
Investor relations needs to be a vital conduit about market perspectives on company strategy. That message has to come back to senior management the board and the CEO in actionable and understandable ways.
Challenge #4 It can’t be delegated.
Management gets a chance a couple of times a year to tell their stories to the investment audience. The simplest way to tell of a management team lacks a coherent strategy is if they can’t get the message across in the 25 minute talk they give before the break-out session. If in 25 minutes you can’t get the message across to the 40 or so MBA clones that make up the ranks of stock analysts, how did you get that message across to the 10,000 high school graduates that make up your workforce? Whenever I hear jargon and business-speak when a senior executive is discussing strategy, I know that strategy is dead on arrival when it gets to the front-line worker.
All presentations should be practiced prior to being given. If we work for the investors, what message do we send when we arrive at our meeting and our report is fumbled and ill prepared? I’ve never believed the stats about how much of meaning in a conversation is non-verbal, but I respect it is very high. Stumbling through a presentation reduces personal and firm credibility.
Investor relations is the responsibility of the CEO and CFO, and hiring a director or VP does not absolve you of the responsibility of being prepared, practiced and ready when reporting to the investors.
Challenge #5 – Authenticity = Credibility
George Burns was quoted “sincerity – if you can fake that you’ve got it made”. Senior executives think of IR as a something that can be faked. After reviewing 100+ companies a year for 12+ years, I’ve seen a lot of pitches. Figuring out what the management team does and doesn’t know is how we made money. If you state that you are #1 in something, you’d better be prepared for us to check.
Most Investor relations staff get the compliance problem. All the numbers are verified, everything is properly sourced. Then the CEO or CFO make an off-hand comment that will end up on a transcript and will be fact checked. I’ve written before about the average experience of stock analysts (see here). New analysts spend a lot of time reconciling cognitive dissonance, which is a fancy way of saying, does management “walk the talk”.
I’d rather a management team was perceived accurately, even if that perception was negative, for example as aloof or uncommunicative, rather than as something they are not.
Investor relations stands for authenticity and accuracy. Senior executives aren’t clones, and should be respected as individuals. Don’t write speeches full of bafflegab and resist the use of jargon.
Challenge #6 – Everyone is an Investor
Most companies incentivize with stock options and most stock option grants are small. Outside of a relatively small circle of high paid executives, most option grants hold little perceived value. They have a cost, but the perception is that they don’t have any value until they are vested and are deeply in the money. The staff needs to hear the story as much as the analysts do. Vendors may make million dollar commitments for a new product line and they need to hear your strategy. Customers, especially when they are making a commitment to a product, need to know whether the company is viable.
The reality of today’s connected society is that the number of people who “care” about what IR has to say is much greater than before, and those listeners have much more influence the firms success.
Investor relations material should be prepared for all the stakeholders, based on their needs. The delivery of employee oriented material may be through HR, but that disclosure should be focused on the key story and theme set by the strategic plan.
Conclusion
Investor Relations needs to play a bigger role within your firm. Helping develop the strategic plan, communicating a coherent story with numbers that provide clarity and understanding. It is time that IR is more than someone who talks to analysts and comes up with a quote.
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Dr. John Zott is the principal consultant at Bates Creek Research & Consulting. I am the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and I comment regularly on issues that affect growth businesses. If you are looking for a CFO for your consumer company, or are a former student, colleague or would just like to connect – reach out.
Good luck can be bad, and sometimes we are right for the wrong reasons.
I have been saying for many years that we are using the word ‘guru’ only because ‘charlatan’ is too long to fit into a headline. Peter F. Drucker.
Accounting is a numerical history of a business. We summarize the millions of transactions into a cogent one page document that tells the status of the business. The financial statements however, are not the same as the business. Alfred Korzybski said that “the map is not the territory”, referring to the object and its’ representation. A financial statement summarizes, and a summary leaves out details. Tracking which data goes where is the job of the general ledger and chart of accounts.
We all want certainty. We want our investments to average 5% return a year (7.375% if you are in the state of California), our children to grow up strong and healthy and it to only rain at night. However, life is uncertain.