Finance – Page 2 – Bates Creek Consulting

Retail Apocalypse or Just Another Cycle?

Bricks & Mortar retail is suffering. People are shifting their shopping habits from in person to on-line. The on-line selection is greater, the prices are better and the shopping experience is relatively easy (in comparison to parking at the mall). Peter Drucker said that “What customers – at least a good many of them – want is not shopping that is enjoyable, but shopping that is painless.”

Although e-commerce will continue to grow, I suspect that on-line shopping will top out in the 20-30% range of total retail sales. The drawbacks of e-commerce (freight, timeliness, inability to touch or try-on) will limit sales to only a portion (although a very significant portion) of total sales. However, just losing another 10-15% of market share to e-commerce will make bricks & mortar returns even less attractive. It doesn’t matter if your retail chain is cannibalizing itself with a web site or it is Amazon, stores will continue to generate worse returns on investment. With lower returns, there will be less capital invested, fewer stores and fewer malls. The New York Times calls them Zombie Malls, the escalators are running but no customers.

There have been many, many articles on how the US is overstored. In 1990 the ICSC reported (Billboard 6/2/90) shopping central growth was dropping due to the country being overstored. ICSC reports the millions of net square feet added to U.S. Shopping Center space in their report “America Marketplace”. You can easily see the post 1980 recession slow down and the post 2008 recession collapse of growth. The dot.com era of 1999-2001 didn’t appear to matter. One conclusion is that the overstored retail space has gotten less overstored in the last seven years.

I don’t know what the right amount of retail space is in the US, but given this trajectory we will eventually reach an equilibrium where demand closer matches supply. However, when equilibrium is reached, a lot of today’s retailers will be gone.

Life Cycle

The usual life cycle for retail bankruptcies is a recession which weakens the retailer, a recovery which allows some breathing room and then another recession which puts the retailer out of business. This is the retailers’ version of the Eldredge & Gould “punctuated equilibrium”, where a significant event creates the opportunity for species growth (or death) followed by a long period of relative calm. Eventually another significant event punctuates the equilibrium and the game changes. This cycle is only slightly different from the normal recession/recovery/recession, as the punctuation now is the on-going loss of market share to e-commerce. If we get another recession, then we should expect even greater industry turnover.

The total profit of a transaction is split between the manufacturers (the product), real estate (the space), staff (the labor) and the retailer (the operator & the capital). This is an uneasy relationship, as total profitability is limited by the market. Each player takes the steps that create the most long-term value for their portion. The losers in the movement online so far have been staff and retailers. Next the cycle will impact real estate prices.

Tim Harford, who wrote “The Undercover Economist” suggests that over time, the landlord obtains most the profits of the relationship due to lack of substitution. Retailers combat this by negotiating long leases with renewals to lock in the lease costs. If business slows, those long leases can burden the parent company enough to cause bankruptcy. When retailers stop making money, they close stores, vacancies rise, the real estate centers stop making money and the price of retail space falls. Stores are closing at a record pace, and rents are beginning to drop (see here). Lower rents allow retailers a chance to recover and begin growth. However, things are a little different this time as e-commerce will still gobble up market share and retailers have loaded up on debt.

Debt!

One factor that is worsening the crisis is debt. Low interest rates and high equity valuations have caused growth companies to borrow funds to drive growth. When I was a student, we were told that carrying debt would lower the cost of capital as interest on debt is deductible and interest rates are usually lower than the cost of equity. This is an accepted part of finance theory and is used extensively by CFO’s to generate equity returns. Whenever you can invest at a rate of return that is higher than borrowed funds, you create a return to equity (see WACC). So if you can open units that generate a 40% return and are limited to 3 outlets due to limited equity capital versus opening 6 outlets with a mix of equity and debt you generate almost twice as much cash return. The only drawback is a subtle increase in risk and interest costs that comes with additional debt.

The risks aren’t always apparent. Low interest rates are great, but they don’t always stay low. When interest rates normalize, payouts will squeeze profits and options. Most loan agreements are based on covenants that call for enough earnings to pay a multiple of the interest and principal payments. Earnings in a growth company can be volatile as expansion, even if investment oriented, is accounted as expenses by GAAP. Banks use GAAP, not “reported” earnings.

Theoretically financing should not matter. Modigliani-Miller came up with a concept of capital structure irrelevance. They believed outside the tax effects of interest (vs. dividends which are rare), how you financed the company shouldn’t affect the intrinsic value. M-M’s insight was that you could imagine an investment pool that is half debt and half equity buying a company with no debt. The total investment would be leveraged, 50/50. If you bought the stock of a company that was half debt/half equity with a fund that was all equity, the pool together will still be 50/50 leveraged. Whether debt is held at the company level or at the portfolio level is irrelevant. However, the relative amount of debt in the system remains.

CFO’s that leverage their firms (as I did) find themselves taking on risk that may be better placed at the portfolio level. If the investors want leverage, they should borrow to make their investments. I’ve come full circle and consider debt a serious problem for growth companies. Yes, there are some instances when it makes sense, but in general it should be avoided.

The other big debt factor that will grow is lease debt. The great lease debate is now settled for the next decade. The FASB agrees that leases are debt. The new rules further muddy the financials as the value of the liability won’t represent the true value of the asset, and it will put another confusing and inaccurate calculation on the balance sheet. Retailers are readying to put trillions of debt on their balance sheets, drawing further attention to the risk.

Fear is the mind killer – Frank Herbert. Debt is the company killer – The Market.

Conclusion

The future is clear, malls are going to struggle and they are not going to turn into apartments (sorry Sears). The e-commerce story is only half over. Further retail consolidation is likely and we should be looking for new concepts that will be able to use that (now lower cost) space to deliver a product/service package that will compete with the convenience and prices of e-commerce.

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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.

SaaS – Churn, Ansoff and Unit Economics

Unit economics is the name for the analyis of an investment at a detailed level based on the customer, store or unit. This is the analysis we do when we are approving a capital project. A good recap of unit economics by Cleverism is here. This article uses Ansoff’s matrix and SaaS metrics to compare different businesses to illuminate the gaps between current business metrics and what different sectors can learn from each other.

I’ve written about Ansoff before (see here). Ansoff says that there are two axis to growth, product and customers. Ansoff’s matrix splits the opportunities into four segments. Selling current products to current customers, finding new customers for current products, selling new products to current customers and finally, selling new products to new customers. For different kinds of businesses, each of these segments are tracked by different metrics.

Turnover or churn is the statistic that tracks how long customers use your services or purchase your product. Different concepts result in different levels of churn. Parents buy diapers only as long as their babies need them, a couple of years. Certain B2B services might stay with a company for the life of the business. Even this, however, is not forever.

You can classify consumer businesses by their lifecycle, basically the length the product remains relevant to the customer. Churn works along Ansoff’s customer axis, and begins with the square titled market penetration and moves towards product development. When a customer signs up a for a service, their potential to stay is not always apparent. Some will stay for a long time. Some will not. Some concepts have very wide age range (McDonald’s) others are much shorter (say Rue21).

I am on the board of a small company that teaches music to 1-4 year old children and their parents. Every year a new cohort of 1 year old’s join and four years later they graduate out of the program. Annual customer turnover is over 25% based on the business model. Real turnover is higher because some families move and some families quit, and some children join at age 2 or later. I’ve calculate the churn by individual children, but if you saw the basic unit as the family, then churn would be lower, as some families have two or more children.

Defining the unit in different ways offers new ways to thinking about your business. For example, retailers usually define the unit as a store, while Wal-Mart saw the primary unit as the distribution center and the related regional stores. They wouldn’t open one store in a market, but would open one distribution hub, and many stores.

Subscription businesses like SaaS track churn as a way of monitoring customer lifecycle, see here for a great outline of SaaS metrics by David Skok. Selling only current product to current customers results in a slow decline in sales, because customers will eventually leave for one reason or another. Corporations have unlimited lifespans in theory, but in actuality they don’t. Innosight suggests the average S&P 500 company listing lasts about 18 years now (see here). Although a lot of firms last 100 years, even then firms aren’t immune to change, Radio Shack was over 115 years old when it declared bankruptcy.

Defining the implicit natural churn rate helps define the business model and SaaS firms should use that data to better identify add-on products or additional services to be offered. As client firms move through their lifecycle, SaaS can be a responsive force, focusing the solution so that software, service or solution remains relevant. This is moving across to the product development side of Ansoff’s model, offering different product to the current customer . In the case of the pre-school company, we are working on programs that extend our reach to 5-6-7 year olds. Adding additional years means that the churn rate will decline, but it will never get to zero.

If you can convince your current customer to buy more, typically subscribing additional services or purchasing more products, you increase the value of the customer relationship. Ansoff would call this selling current customers new products. Sales growth for a cohort of customers could grow, rather than decline. SaaS businesses call this negative churn. If churn is low enough and the service supports a rising price (either it was underpriced or continues to add value) then you can achieve negative churn without selling additional goods or services. Negative churn is very profitable because no additional selling costs are required, yet sales and margin increase.

Retailers would call negative churn an increasing “share of wallet”. Increasing your share of wallet was about selling more stuff to the same customers. Retailers have a concept called “same store sales”, which tracks the change in y/y sales through the same number of outlets. This is not the same as negative churn, but it is close. Same store sales could increase due to increasing customer count (new customers for current goods) or sell more new goods to the same customer (share of wallet) or higher prices. Positive comp sales also have a very strong impact on profits, as store location costs and location overhead are leveraged. Retailers focus extensively on the store as the unit, and would benefit from seeing customers as a unit also as SaaS businesses do. Recognizing that some segment of a population is aging out of your sweet spot gives direction to marketing and customer acquisition efforts.

In the wholesale business we track sales by dollar churn and by customer wins. Dollar churn is the similar to churn but instead of using number of clients, we use dollars of sales. That way big customers are more relevant. Wins relate to obtaining business from new customers. If it is a technology solution, a win would imply agreement by an organization to use a specific tool or platform, which as adopted through the business will result in additional seats and sales growth. Sometimes a win is just an initial “test” order from a customer which uses many suppliers. Either way this can be a significant step to increasing sales.

SaaS businesses offer fremiums or lower cost options, which like wholesale’s initial test order, start the customer getting familiar with the product or service. Given the value of a customer it seems obvious that most wholesalers/retailers should consider this strategy.

Investment and Life Time Value

The average selling price (ASP or average transaction size) and annual volume (also known as Annual Recurring Revenue – ARR – for SaaS) define a business model. If ASP is low, then the amount of service given at the transaction must be low. McDonald’s has an average transaction in the $5 range. This is why there is no service. The ASP for a Mercedes is $50,000, which means you get service at the point of sale.

The lifetime value of the customer (LTV) is a calculation of the total operating margin of all the sales to the customer. Obviously the higher ARR, the longer the customer remains, the higher the margin, all result in a higher LTV. If the LTV is low, then the amount you can spend obtaining a customer is low. A higher LTV allows for more investment in the customer. Obtaining a business customer that pays $20,000 a year in service fees could result in a typical SaaS LTV of $150,000 or more. That allows for a number of sales calls and demonstrations. If you are selling a $100 annual subscription, pretty much it has to be handled via email and on-line, with automated responses.

SaaS firms often use margin for the LTV calculation while “four wall” profits are used for retailers. Having the LTV can help you define how much money you can spend to obtain a customer (normally, cost of acquiring customers, CAC or CoCA). The CAC is the total investment required to acquire a new customer. In a retailer it would be the cost of a new store, in a catalog firm, the cost of a new catalog. Four wall profits are the variable costs driven by the addition of a new unit and typically don’t include any headquarters or regional management costs.

Although margin is a good proxy for profitability, it isn’t perfect. Skok recommends (see here) deducting the cost of the retention and expansion teams and the cost of service from margin. This would make the net margin SaaS calculation the achievement of the steady state of the business. Normally I’d have the cost of expansion in the cost of customer acquisition calculation, and leave it out of the net margin calculation. Theoretically it should only be in one place because the cost of service and cost of retention (the account managers) are variable costs driven by customers, while the cost of expansion (sales team) is discretionary. This isn’t unusual and it treats the account managers the same as the sales team. A lot of retail new store models also include some costs on both the investment side and the operating expense side. As long as you are consistent in assessing projects, it is fine.

The rule of thumb for SaaS is a 3x return on CAC. This is similar to the typical unit economic model of a retail store, which over it’s first ten years should generate 3.5x-4x the investment cost of the unit. SaaS companies ideally should discount the long term cash flows (DCF) of the expected life of the relationship to better reflect the LTV to CAC comparison. Most of the SaaS business models have been developed in a low interest rate environment, with relatively cheap capital so this hasn’t been an issue. As SaaS relationships extend out, a DCF makes a lot more sense. If you do use a DCF, the rule of thumb isn’t valid, and LTV/CAC ratios less than 3x can be profitable.

Retail is a little different because it fulfilled a demand for a product line in a geographic area. So if you are selling car parts, you cared about the vehicles owned in the area, not so much who owned them. As long as cars were owned, they will need parts. The CAC for retail is the cost of opening the store and stocking it. Unit economic slides for years boasted 40% ROI’s on stores by hiding inventory investment and other relevant costs. Sales forecasts were often suspect too. Hiding costs may look good in the short term, but overall ROI is driven by the accumulation of unit ROI’s, and smart analysts generally ignore unit economics that don’t aggregate to company economics.

The aggregation of LTV minus overhead costs should approximate the economic value of the business (debt + market priced equity). Usually there is an additional “option value” for the on-going business and the opportunity to enter new markets and develop new products. Standard DCF calculations that Wall Street analysts use attempt to convert the stream of profits over 10 years to an economic value. Unfortunately, usually 50% + of the value is wrapped up in the “in perpetuity” assumption, which is dropped in the 11th year to cover for the expected future stream of income. A good LTV model with realistic assumptions will help a CEO/CFO better plan for the long term value of the business, and communicate that value to investors.

Winning a loyal customer is valuable, but understanding the math is even more valuable. Returning to the diaper business, when you can calculate the number of diapers a child will use you can calculate the lifetime value of obtaining the parent’s diaper business. This gives a place to begin budgeting marketing expenditures, planning sales efforts and valuing the business. You can do this while still knowing that one day the parent will no longer purchase diapers and you will need to find a new customer. Thankfully people keep having babies.

There is a lot of similarity in unit economic calculations and enough differences to create some interesting ways of analyzing, displaying and investing in new operations.

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Dr. John Zott is the principal consultant at Bates Creek Consulting and works as a CFO for growth oriented businesses. 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/SaaS/retail/consumer company, or are a former student, colleague or would just like to connect – reach out.

Overconfidence and You

There is a psychological phenomena called the Dunning-Kruger effect. It states that unskilled people may not know enough to figure out that they are below average. Dunning et al recently wrote in Why People Fail to Recognize their Own Incompetence (Current Directions in Psychological Science, 6/23/16):

…people tend to be blissfully unaware of their incompetence. This lack of awareness arises because poor performers are doubly cursed: Their lack of skill deprives them not only of the ability to produce correct responses, but also of the expertise necessary to surmise that they are not producing them.

It may feel good to think about all those “unskilled people” who go through their lives blissfully confident and unaware that they are unskilled, but to do so misses the point. By definition, half of us are below average and all of us are unskilled at some tasks.

The Dunning-Kruger effect is closely related to the overconfidence bias and self-serving bias. The overconfidence bias is the tendency for humans to be over confident about their skills, abilities and choices. Self-serving bias is when we attribute success to our skills, and failures to external factors or other people.

Unfortunately, overconfidence can be the most destructive bias and is one of the most pervasive. Everybody is overconfident, even you and me. Daniel Kahneman who wrote the book about overconfidence said he believes he is still overconfident. Self-service bias helps protect our self-esteem. Frank Knight stated that sometimes it is the belief in our own luck, and this bias dates back to the bible when Adam blames Eve for his mistake in eating the apple. Self-serving bias can be witnessed daily in the Wall Street conference call.

I cover these biases in my class on Behavioral Finance at Golden Gate University. Given a stack of behavioral finance books and some time on the internet you will find that humans aren’t the rational beings we think we are and are frequently biased in certain directions. The increasingly detailed definitions of biases seem to be primarily about generating academic papers, but the Dunning-Kruger effect is worth thinking about because it happens a lot in business.

Business leaders want to appear upbeat, positive and confident, and acting this way (see here) tends to make us confident. This isn’t the same as “fake it to you make it” (which I recommend to my students) as you know when you are faking it. Kahneman stated in his book Thinking, Fast and Slow that “An unbiased appreciation of uncertainty is a cornerstone of rationality— but it is not what people and organizations want.” We want certainty in our leaders, not complexity. There are no clear tests of business ability so it is easy for executives to be overconfident of their skills.

Ignorance more frequently begets confidence than does knowledge: it is those who know little, not those who know much, who so positively assert that this or that problem will never be solved by science. Charles Darwin

Hiring

I used to think I was a good picker of executive talent. Of the five controllers I’ve hired, the majority have gone on to be CFO’s, and I’ve had successful hires for CIO’s, President, VP Human Resources amongst others. I recently talked to Dave Arnold, a recruiter who has hired hundreds of CFO’s with success. Dave interviews 20-30 candidates a week and used to teach interviewing skills to management teams. My confidence in my interviewing skill was based on a small sample size and a comparison to other executives who may not have been great interviewers either. There is a lot of evidence that interviews aren’t that helpful for many jobs, due to interviewer incompetence and candidate dishonesty (see here and here).

I once worked with a leading recruiter for a COO position who kept sending us candidates who lacked analytical skills. Eventually after a long search the CEO hired someone. Within a year I was walking the new hire through their termination paperwork. Conversations with the recruiter revealed that the CEO had been very specific and the “weak” candidates were exactly what was requested. The recruiter knew that the CEO was wrong but eventually caved in. CEO’s who express confident answers even while they lack knowledge is known in Silicon Valley as “Founderitis” or Founder’s Syndrome (see here and here) another form of overconfidence.

With a small sample size, you are especially prone to be overconfident about hiring skill. All failures are blamed on the candidate, all success is attributed to management competence. Hiring a competent recruiting partner lowers risk and makes you smarter.

Investing

Private Equity fund managers are quite confident at investing in growth companies, even when evidence doesn’t support their confidence or skill. As a hedge fund analyst, I followed firms who kept growing even as signs of declining productivity and performance became overwhelming. Rue21 in 2012 boasted that they were opening units in Paris (Texas), London (Kentucky), even while average volumes in new units were down double digits. Apax Partners then paid $1.1b to buy this 877 unit chain in early 2013 and grew it to over 1,200 stores by the end of 2016. Associated Press reports that Rue 21 is closing 1/3 of their units in 2017 to end back at ~800 stores. To spend four years to end up where you started is a bad outcome. The trends in the industry (e-commerce!) and in Rue’s numbers (declining ROI) have continued to the surprise of their investors. And unfortunately, there is a significant chance this isn’t the last bad news out of Rue.

During the 1980s there were a group of auditors out of Texas that used to celebrate the completion of a savings & loan audit with a party which featured drinking champagne out of their boots. (I didn’t witness this, darn! I heard the story from an audit partner who’d paid a sizeable sum of money to settle the claims.)

A couple of things you should know. First, you ruin good champagne by pouring it in footwear, and secondly, wine is not particularly good for leather. Auditors who think this is a good idea probably aren’t appropriately risk and control oriented. And investors in businesses that need risk management (like a S&L) shouldn’t hire champagne swilling auditors who can’t afford stemware. The person who told the story considered himself a savvy businessman. He put the blame for the eventual failure of the S&L and expensive legal claim down to bad management, the economy and regulators and none to the audit team or the firms’ lack of risk management.

Elizabeth Holmes dropped out of college to start Theranos at 19 with $6m in venture money. This ballooned into an eventual $700m of private equity/mutual fund financing. Ms. Holmes reportedly used to keep the office in the mid-60s so she could wear her signature outfit: black mock turtleneck, black pants and puffy black vest. In January 2017, Theranos laid of 40% of the staff and in April 2017 agreed to leave the blood testing business for two years to avoid further sanctions by the Centers for Medicare & Medicaid Services.

Who invests in a company with a CEO who can’t figure out how to take off her vest? Although Ms. Holmes wanted to be Steve Jobs, she didn’t get that even Steve Jobs wasn’t always Steve Jobs.

Nassim Taleb talks about Black Swan’s as unpredictable or unforeseeable events. I’ve commented in the past (here) that “black swan” events decline as learning increases. In this case, it appears that Silicon Valley VC’s didn’t participate in the funding of Theranos and most of the money was private equity and east coast VC funds. Vanity Fair reported that Google Ventures staff had attempted to get a blood test using the proprietary Theranos Edison machine, and found instead of taking a pin prick, the test used the same samples used at any clinic. Google Ventures passed on the investment. What did they know that $700m in capital and a board full of luminaries did not? Why no medical expertise on the Board? Why was there no CFO?

Theranos was intensely secretive about its Edison technology which, based on the latest disclosures by the company, never really worked. Probably smart keeping it a secret. Every investment mistake isn’t due to overconfidence, of course, but these examples show that sometimes even the experienced are unaware of how unskilled they are.

Human Resources

There has been a litany of “bad behavior” stories in the paper recently with Uber, Snapchat, GitHub all being hit for sexual harassment and not following basic human resource standards (see here). These companies have sufficient money to hire a senior HR executive but they didn’t think they needed one. That was a bad choice. Between the bad publicity, the lawsuits and the costs to correct the problems, these firms and executives are learning the cost of ignorance.

Scaling a rapidly growing business isn’t easy. Not all of it is renting space and hiring. Being really good at technology or raising money or even having a terrific idea is helpful but it isn’t enough. It takes a team of executives. We shouldn’t be surprised however when we hear of these problems, Uber won’t admit that it has a CFO (see here) and Tesla and Github are both going through relatively rapid CFO changes (see here and here). The CEO’s including Travis Kalanick (Uber), Elizabeth Holmes (Theranos) and Chris Wanstrath (Github) had no experience running any successful business prior to their startup.

Learning is at least partially about reducing unforeseen, unexpected and negative events. There are techniques for overcoming our overconfidence and Dunning-Kruger (see here, here and here) and if practiced, can help. We also can be amused at the unskilled and how they don’t realize how incompetent they are. But we shouldn’t be amused without realizing that sometimes we are the unaware and unskilled.

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Zombies reach a Dead End

Sandeep Shroff recently wrote about burn rate zombie companies. I’ve worked with Sandeep and he is a very sharp guy. He defines a #burnratezombie as a firm that lacks the cash to go through the process of raising capital. A firm reaches this point when the burn rate is so high and the time left is so short that the company will have to sell itself or go bust. These companies are dead but don’t know it yet.

A zombie company is normally known as one that can pay interest, but doesn’t generate enough cash to pay off the loan balance. Their loans don’t go away and they survive by holding off the debtors. These firms aren’t dead yet, and they aren’t really alive.

The Economist in January 2017, wrote about the productivity slowdown due to zombie companies which have large amounts of invested capital, but don’t generate much profits. The invested assets should probably be liquidated and the business recapitalized, but instead they limp along, making enough to keep the doors open but not enough to upgrade the equipment. A company that is just covering marginal costs can price lower than a company that is seeking to make a profit. That competition lowers return on capital and limits new entries into the market. These zombies don’t eat people – they slime the market.

I think there is another class of zombie firms that isn’t spoken about often. I call these Dead End Zombies.

Dead End Zombies consist of firms that are stuck. Like a driver lost in suburbia they’ve turned into a cul-de-sac, and they can’t continue forward. Their returns are under the cost of capital so they can’t attract investment and grow their way out of the problem. The only good strategic direction is backwards. The invested capital in the business has to be restructured and the business has to be pared back to the profitable core.

Austrian business cycle theory says that low interest rates increase borrowing and investment. Too low of rate, too much borrowing and too much investment or “mal-investment”. Easy capital is invested too quickly and there is a correction because the resulting profits are just too low. The correction causes firms to restructure and reallocate the cash to better investments. If the capital isn’t reallocated and stays stuck in these underperformers it becomes “dead” money and a Dead End Zombie.

When I think about businesses that have low profitability I apply Seldon & Colvin’s approach from “Angel Customers & Demon Customers” and split the business into customer deciles. Some segment of the customer base generates good return – the top 10%. This implies there is some segment that is at low and perhaps negative profitability. These are Seldon & Colvin’s devil customers and one cause of the poor returns. For a CFO, marginal operations that don’t add to profits end up just driving down the return on capital. Recognizing this, cutting overhead and trimming marginal operations isn’t easy and it isn’t popular. For management, a shrinking operation means a less staff, lower pay and less power. Sales declines also upset boards and shareholders.

Private Zombies

Dead end zombies can be public or private, both have challenges. A private firm that is at a dead end stage has to conserve capital to execute the transition out of non-performing assets. Selling assets can be an option. However, cutting overhead may not be possible. A recent client had half of their assets invested in low return operations with weak profits. However, even minor profits helped since they helped cover overhead. The incentive was to “extend and pretend” rather than fix, since the fix basically meant lower paychecks for the CEO and the management team.

Public Zombies

Public Dead End Zombies are usually small caps and are under followed. There is a discount due to liquidity (ability for larger investors to buy and sell shares), so they suffer a low stock price too. Small stocks without a following are called “orphans”.

As I have noted before here, G. Bennett Stewart classified firms by ROIC and growth options. Low ROIC firms, that return less than the cost of capital, Stewart titled “X-Minus” firms. The proper valuation for a firm that earns its’ cost of capital is 1x book value (or a market/book ratio of 1.00). If the firm is an X-Minus, then they are valued at less than book value. Each additional $1 the management team invests in the business is discounted in the market. So the company invests $1 and the shareholder receives 80¢.

In a public dead end zombie, the shareholders and management aren’t on the same team. As long as there is cash in the business the management team will hold on and continue to re-invest hoping for better results. Public Dead End Zombies can’t grow out of their predicament, they can’t buy back their shares, and often they can’t decrease the sales or the management team would be fired. They are stuck.

There are a lot of these firms. I looked on the Mergent database and found that there are ~2,650 public firms (not including finance, insurance, real estate) with sales of $10m or more, and 38% earn less than 4% return on equity. The smaller the market cap, the greater the odds it has low return on equity, with more than half of the firms with less than $75m market cap have sub 4% ROE’s.

The direction forward for a lot of these firms is restructuring. In a different time we’d have seen investors buying these companies with borrowed money. Unfortunately, after the banking meltdown and the beating the bankers received, there isn’t much money chasing these opportunities. This is a very big opportunity for the right investor, and the LBO will come back as value is discovered lurking in these dead end firms.

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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, ora former student, colleague or would just like to connect – reach out.

The Better Way to Define Growth vs Value

I often read arguments about which is better, investing in growth or value stocks. Unfortunately much of what is written on the subject is simply wrong. By definition, value stocks have low market to book ratios and growth stocks often have high market to book ratios.

However, there isn’t a lot of difference in the sales growth rates between growth and value because sales growth isn’t what defines them.

The defining factor is in their return on invested capital (see here by Jiang Koller 2007). The process is simple, firms with great opportunities to invest at above average rates of return (high ROIC), receive capital, invest and grow. So why don’t growth companies have more sales growth than value companies? Because many high ROIC firms don’t have attractive places to invest capital and many low ROIC firms don’t need outside capital to continue to grow.

Bennett Stewart in his book “The Quest for Value” defined firms into three basic categories, X firms had returns near the cost of capital, Y firms had returns above the cost of capital but had limited options for investing capital, Z firms also had returns above the cost of capital but had many options for investing capital and grew quickly. Stewart also said there were X-minus firms that didn’t earn the cost of capital and pre-Z firms that grew quickly on outside capital with the thought they’d have a Z level of ROIC later. I like this approach to classifying firms – it is clearer about the status of the business and adds clarity to strategy.

	Return on Capital	Opportunities
X-Minus	Below Cost	N/A
X	Near Cost	N/A
Y	Above Cost	Limited
Pre-Z	Below Cost	Many
Z	Above Cost	Many

X and X-minus, Low ROIC

Firms with returns equal to the cost of capital (and even less than the cost of capital) or “X and X-minus“ can still have sales growth, but they won’t get the high valuations (market to book ratio) of the high ROIC firms. These firms grow because they retain earnings, which even if low, they can reinvest in the company. With low interest rates, firms can borrow to continue to grow. A CFO I once met said that as long as he could borrow at 4% and invest at 7% he was going to continue. The market cost of capital is higher than the bank cost of capital and consequently the firms stock price took a nose dive (although the bankers LOVED him).

Theoretically the right choice for these firms would be to return capital to the investors so that it could be invested at higher rates of return. However, CEO’s and CFO’s rarely think that they should return capital, and it is often the board or an activist that pushes the issue. This is the agency problem, where management and shareholders aren’t always on the same page. Management incentive programs have to be carefully drawn to balance growth and return to shareholders. Too much on sales or profit growth, then the capital becomes “stuck” in low performing investments. Too much on return to shareholders and the management team underinvests and damages the firm long term.

X and X-minus firms shouldn’t grow, but they do by retaining cash and investing in projects that generate weak returns.

“Y” Firms – High ROIC, Constrained by Operations

Most firms with good ROICs that are constrained by other the factors are called Y” firms by Stewart. The firms have good returns on capital but are limited in how fast they can invest. My rule of thumb on retailers was that sustained unit growth rates above 25% always and everywhere resulted in a blowout. Over a 15 year period every retailer who grew at this rate, blew up. Eventually the growth retailer I was with that grew at over 25% a year for 7 years blew up too. The causes of the blow ups vary, but usually it was a lack of talented staff, poor controls or the firm continued to grow after returns declined. All problems that could be foreseen.

Growing at 25% a year for a retailer means opening a lot of new locations, and you need to locate, hire and train a staff. Growing during a downturn when good talent was being laid off helped ease some of the hiring pressure. Although central office and distribution staff grew at a fraction of the sales growth rate, every year staff count would need to grow at 15% or better to keep up.

Growing fast also stresses controls. Ebay used to reorganize 3-4 times a year because as the company grows, the management challenges, controls and processes have to be updated. Nothing is static. What you could get by with at $100m in sales won’t work at $200m in sales.

If you are successful managing the growth, the best markets will eventually be addressed and you reach the point of diminishing returns where further investment turns the above average returns to average returns. (See here for a recent discussion of this same phenomena by Fisher, Gaur and Kleinberger). Niche retailers run into this but also big firms such as Wal-Mart, Home Depot and Best Buy. (This was a great source of short ideas, as there is nothing like a management team with their foot mashed on the growth gas pedal while new store returns are tanking.)

A great deal of consumer product firms are constrained by opportunity. They cannot further invest at similar ROIC levels. New strategies (panini’s at Starbucks?) often decrease profit rate and require large investments in process and product that don’t generate a solid return.

A lot of auditing and consulting firms are extremely profitable, but as long as they can capture new clients at full rates. You can follow a low price strategy, but in the end, you end up with low priced customers and low returns of capital.

Growth can destroy shareholder value – that is what I call dumb growth. Capital allocation requires discipline and a set of metrics and standards that are appropriate to the strategy. Investments must earn their cost of capital. But there are often strategies that offer lower (but still above average) ROIC’s, that should be explored. The Ansoff Matrix I mentioned earlier can be of help looking for opportunities.

“Z” Firms Grow Fast

A great deal of internet software and services qualifies as “Z”, above average returns, with lots of above average places to invest capital. Sales growth is a function of reinvesting profits and raising outside capital. This was perhaps captured best by the HBR article in 1996 by W. Brian Arthur “Increasing Returns and the New World of Business”, where he outlines the shift from decreasing returns on capital (like a retail chain that over expands) and increasing return on capital (the internet) where more users increase the value of the product.

A firm with attractive places to invest capital and is unconstrained will grow quickly. Ebay grew over 60% for a dozen years, although they’ve grown 5% over the past five years. Eventually that happens to every “Z” firm, they reach diminishing returns (yes, even Facebook) and growth slows.

“Pre-Z” Fast Growth and Low ROIC

There are a few pre-Z’s that have gone public, Snapchat lost $520m in 2016, and $380m in 2015. Revenue in 2016 was less than “cost of revenue”, so the customers paid actually less than it cost to deliver the service. They are growing fast, and losing money fast. Maybe Snapchat’s numbers improve although usually great growth companies make money right away.

Amazon has survived for years where the return on capital has been paltry, with the thought at some time it will turn for the better (and perhaps it has). Amazon’s operating profit from 2011-2015 totaled to $3.8b (no interest, no taxes) but the asset investment has grown $35.7b. In 2016 operating profits were $4.2b, more than previous four years added together. Amazon continues to invest to grow market share, and as long as they’ve got the cash and a 185x p/e they can continue.

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Dr. John Zott is the CFO for Carlson Wireless Technologies, and 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 a former student, colleague or would just like to connect – reach out.

Sales Forecasting, Budgeting and Igor’s model

As a CFO I have struggled with sales forecasts and budgets. Either I am presented with a list of sales initiatives that add up to a multiple of the sales plan (I call it the “whatever sticks” method) or I get a sales plan that lacks any detail at all besides a growth rate which is similar to previous years rates (the same as last year method). Both outcomes leave me unsatisfied.

The “whatever sticks” method usually is a brainstormed list of ideas that haven’t been resourced or have an effective plan of action. Because the total ideas add up to a big number everyone goes into the new year excited for results, only to be surprised by the end of the first quarter when the numbers don’t turn out. The estimates for sales were often the “seven sunny days” types, which counted on a lot of luck.

I used to call this the church potluck dinner problem. Every one brings a wonderful dish to the potluck. When you begin loading up the cheap paper plate, the salad gets mushed in with the beans and the jello ends up leaking into your chicken. As the line goes on, you realize you’ve run out of room for other attractive dishes and you build a second level of food. And the plate bends as it gets wet creating more unattractive mashups and nothing tastes right.

The “same as last year” method does a better job of focusing on the current business but it generated few new ideas. Projects that needed resources weren’t identified and budgeting was based on history. If any portion of the current business was changing the plan wouldn’t be accurate and we’d be playing catch up. The sales plan should include a list of action items that are assigned, have deadlines and are likely to increase sales. Otherwise the “same as last year” plan is based on hope and not action.

I used to teach a class where we’d use a linear regression equation to forecast sales of public companies. It works. The CFO/CEO should have a separate statistical model for sales. Sometimes it is more accurate than budgeting and it always provides insights when reviewing the plans.

Sales and profits are a function of taking a chance. Risk-less profits don’t exist and all sales efforts entail investment with an expectation of a return. I’ve written before about Frank Knight’s comments about risk and uncertainty (see here). Sales efforts are generally uncertain – we don’t know what will work and what won’t, but we need a method to organize and prioritize actions. If we develop a list of sales initiatives, how are we to sort through and assign probabilities or guesstimates of effectiveness? When will we know we have enough quality, resourced initiatives? I’ve found a simple insight by Igor Ansoff that can provide some help overcoming this problem. Igor Ansoff was a management theorist who laid out a simple 2×2 matrix, on one axis markets on the other products.

I usually draw this using the axis: Same/New Customers and Same/New Products. The list of sales initiatives are assigned to one of the four boxes. For example, opening new units for a retailer is New Customers : Same Products and is shown as “Market Development” on the chart. Obtaining more of a key customers business is Current Customers/Current Products or Market Penetration as titled on the chart. Line extension or Product Development is adding additional product or services to the offering to our current customers. In the chart the Diversification strategy is in red, and that’s a good color for this approach. New Products/New Customer strategies are startups.

Using the Ansoff Matrix helps identify the uncertainties and the holes in your plans. The holes are identified as you assort the strategies into the boxes. The uncertainties can be estimated by box. Market Penetration strategies will tend to be cheaper, more numerous with small payoffs and high chance of success. Market and Product Development will have worse chance of success then Market Penetration but will have a high payoff. Diversification will have the lowest chance of success. As a CFO, I rarely include in a sales budget a diversification strategy, mostly because I’ve been burned. Many (most) diversification strategies fail and all should be tested thoroughly before counting on them for sales.

With the Ansoff Matrix you can assign a standard deviation and mean result to success for each of the initiatives and then simulate a 1000 trials of the expected strategies. Many strategies are one-tailed or are options, which can result in a positive payoff, but only if certain conditions occur. Summing the range of results for the strategies selected gives a more accurate representation of potential sales and can set expectations realistically.

Taking these extra steps focuses the management team on strategies that generate a difference, while still staying within the level of resources the company possesses. Realistically if you are a star and finish your sales objectives by mid-year, you can just generate a new set and begin again (or get back in line for seconds!)

The way to solve the church potluck problem is to focus on a few things to eat and to leave some room on your plate for later in the line. The way to solve sales budgeting conundrum is similar. Being picky is good for management teams and good for a potluck.

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Four thoughts on how to deal with Hedge Fund Investors

After being a public company CFO, I spent some time as hedge fund analyst. During that twelve years I spoke with a lot of management teams, watched hundreds of investor presentations and read a
roomful of disclosure documents.

The most interesting change in perspective was 1:1 meetings, when we’d be in a room with the CEO and CFO and we’d have an hour to ask questions. Sitting in those meetings on investor side of the table was a lot easier than being a CFO. However, the biggest difference in the two positions is time span.

When you run a company you are thinking about time differently than a hedge fund portfolio manager. Projects take years and to turn the ship is hard. Profitable business investments have to be identified, planned and implemented. If you are a hedge fund manager, you can reshape your portfolio in an afternoon, and exit your positions within a week.

Elliot Jacques wrote about the “time span of discretion” which dealt with the time frame where the executive was focused. Most senior managers are focused on the coming 6-12 months. Most fund managers are focused on the next 2-3 months. I’ve argued before that senior management needs to raise its focus from making this year to a process of making every years’ numbers. Thinking further out will not help your discussions with a short term investor. I’ve come up with four ideas for you to think about when dealing with professional investors and the hedgies.

1) Prepare your company presentation as a story.

Most stock analysts are intense, smart, educated and inexperienced. When they make mistakes it is usually based on relying too much on book learning and too much reliance on models. Most risk isn’t covered in an excel spreadsheet, and at best they generate a couple of point estimates for EPS based on simplistic assumptions. Their lack of experience makes them open to a good story. A well constructed narrative will sway an analyst, even if the story is simplistic and inaccurate. Good stories have a beginning, a middle and an end. There are characters. A good story has a coherent theme and is easy to remember.

2) Keep your messaging consistent.

Because analysts often lack the experience to tell if a management team can deliver, they simplify and judge on message consistency. If you separate a CFO and CEO at a stock conference and quiz them individually about recent events at the company, you will often hear two stories, which is a problem. If the words in the 10k don’t align with the slide deck then there is another inconsistency. Hedge fund analysts are a little more savvy, they are paid more and they have been burned a few times. They are less swayed by a story and are more tuned in to the results.

Off the cuff remarks and meetings at the bar are a danger to management teams. I once heard a senior executive announce that they had to work the weekend on the budget. It was April. What does “having to work the weekend on the budget” mean in April? It means you are off plan. Analysts are not your friends and there are no “off the record” conversations.

3) Be prepared.

A management team presents the strategy to the board, to executive management, to senior management, to the employees and to the investors. If the investor presentation doesn’t sound practiced, then how much has management communicated to the company? If your presentation isn’t crystal clear, clear enough that a person with a high school education can understand, then you probably haven’t presented it the 20+ times you need to if you are going to convince the employees. Repetition equals retention. Management teams that are not practiced fail. After valuation, this was my most reliable source of ideas. If I heard a management team stumble through the presentation of a complicated new strategy that would require thousands of employees to do something different (say make panini’s at Starbucks), I knew I had a winner short idea.

4) Don’t take it personally.

A hedge fund trades in and out of stocks a lot. Selling your stock doesn’t mean they hate your company. It just means that they’ve found something that will move more or sooner than your company. We shorted a lot of good companies because we have to hedge our other positions, that is what we are being paid to do. I went to a lot of meetings without a preconceived notion of whether a stock was a long or a short. We’d be short for an event or a tough quarter, and then would go long. Management teams that obsessed with whether the analyst is a “long” or a “short” wasted their efforts. Keep your ego out of it, manage what you can manage and make the company better.

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Retrospective Thinking and You!

*Santa Cruz Small Boat Harbor Lighthouse*

McKinsey recently published a survey about whether CFO’s are ready for tomorrow’s demands on finance. For the most part it is not terribly helpful. The additional roles include the “new” fields of risk management and compliance. These tasks have been with us for decades, but today there is a department with the title. My experience with big consulting firms is that they offer good input at a high price. (However, I read everything Tim Koller writes for McKinsey and you should too. I’d classify his insights as great ideas.)

The CFO survey had one question about capital expenditures which caught my attention. Only 30% of the CFO’s agreed that their company “has a formal process to review investments made 3-5 years ago.” This is a big problem as firms that don’t check on their performance don’t learn from their mistakes. Retrospection is hard and I get why you don’t want to do it. Ben Franklin said “Experience keeps a dear school, but fools will learn in no other”. When a management team makes a mistake and doesn’t learn from it then we even less smart than the fools.

I know that everyone cares about the stock price. Stock prices are driven by the return on investment in the projects the management team selects. Poor project selection means poor investment returns and poor stock price performance. Measuring returns informs future investments and identifies opportunities. It creates accountability. It is the difference between taking a class in investing and trading in the stock market for a living. Great investors track their wins and losses and try to learn from both, although the losses are always the most informative.

After being a CFO I took a turn as a hedge fund analyst. About 10 years ago I went to a stock presentation where Coldwater Creek was touting their secondary offering. The plan was to open new units that would generate great returns, earnings and a high stock price. The management team offered up very compelling ROI’s over their first three years of investment in a new unit. I got to ask one question: “how many of these stores have reached their three year anniversary and did they perform similarly to the forecast?” The answer was they had no units that had yet reached the three year life. I wanted a follow up question but the CEO wisely picked on another analyst. Simply put a pro-forma financial model is not the same as actual results. Coldwater Creek never achieved those planned returns and the $32 stock is now worth 2¢.

I worked with a major US bank and was told that the way to promotion was to make a lot of loans fast. When inquired about what happens when they inevitably go bad, I was told that the rotations typically lasted 24 months, and the problems didn’t show up until after you’d left the department. Credit problems were never tracked back to the initial bank officer, just assigned to the executive that then held the portfolio. The difficult job at the bank was in following one of these “fast-trackers” and constantly dealing with a crappy portfolio. This strategy worked until there was a slow down in growth and executives were stuck in the job for 48 months. As Warren Buffett says “ Only when the tide goes out do you discover who’s been swimming naked”.

Recently I heard that the average Silicon Valley CFO lasts 28 months in a job. I’ve never seen a financial analysis on a public company that didn’t go back at least three years if the data is available. The analysis usually go back at least five years and I’ve seen some that go back ten years. We do that to get a sense of how capital has been deployed though the firm’s history. I’ve written here about how hard it is for senior executives to change a business model. Returns on investment are persistent with companies generally moving towards the mean return for the industry. Some of reversion is due to luck evening out, and some of the reversion is due to management teams responding to incentives, both bad and good. If the management team knows that they will be held accountable for capital investments, they have a big incentive to do a better job.

I get that everyone wants to focus on the future and no one wants to poke through past errors. As investors, we are relying on CEO’s and CFO’s to invest the assets of the company wisely. As executives, that means taking a hard look at how capital has been invested, what we did wrong, what we did right and what that teaches us.

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How Financial Metrics Change when Firms Grow

Ichak Adizes consults with firms about managing corporate lifecycles. He states that there are 10 stages of the corporate lifecycle, one pre-start, four growth, four declining stages, and one for organizational death. There is a lot of good material here for a senior executive to consider, but I am just going to focus on the growth side.

Adizes breaks the 4 growth stages into Infancy, Go-Go, Adolescence and Prime. The problems that growth firms face are all the same. It’s always: people, time and money. However, in a growth environment there are different priorities for financial metrics at different times in the cycle.

Firms in Infancy are focused on cash flow. You’ve only got so much cash and so much research and development to do. We define in months our “runway” left by the amount of cash you have divided by burn rate. When you are out of runway, the firm has to be aloft or you are out of business. In Infancy, it is spending on the right things that must be managed by the senior management team. Treat every spending priority as if you had 6 months of cash left. Good employees believe in the vision and are committed. Budgets are check book oriented. Don’t forget the balance sheet because stretching vendors isn’t generating free cash flow!

Go-Go firms are focused on sales growth. That is what makes them fast growers. In this phase the key financial metric is sales. The company wants as much sales as it can get at a good margin. The focus is on selling to firms that pay on time and offer a good margin. Selling a big order to a distributor who is known for slow payment and low margin isn’t as important as selling to five smaller customers for cash up front and a decent gross margin rate. The best hires are able to step in at any level and take care of the customer. Accountability is diffused and procedures are changed on the spot.

Firms that reach Adolescence struggle with balancing the entrepreneurial spirit with professional management. The key people that could do every job in the department now become assigned to one job and they chafe about the lack of “make it happen” attitude. Profits become more important to the company. I’ve had meetings with CEO’s who complain about the lack of expense discipline after hearing story after story from them about how they’d shipped product timely without any thought of costs. Instilling discipline, procedures and process isn’t easy and it has to be balanced against the flexibility that helped the company grow sales quickly. Adizes says this is the most difficult stage for firms and for founders. Budgeting can become a battle rather than a collaboration. Good executives focus on steady process improvements and increasing accountability.

As firms mature into the Prime stage the company balances profit growth, controls and cash flow. Return on investment and risk management become important for the CEO/CFO to manage. The strategy is working, profits and sales are increasing and there is a good balance between entrepreneurial spirit and control. The locus of effort is in longer term planning rather than on day to day operations. Watch for signs of creeping bureaucracy and procedures that kill initiative. New initiatives require taking risk and too much risk management means that the business will stop investing in the future. The senior management team should be setting stretch goals and pushing the company to think outside itself. The focus has to be on the future and maintaining performance.

Eventually if the company is unable to balance return on investment with sales growth and risk management efforts result in too few initiatives taken, the company begins to decline. I’ve followed dozens of mature firms that talk a lot about growth in sales and earnings but don’t grow consistently. Plans are all short term in nature which contribute to the choppy results and don’t create a long term competitive advantage. Often there is increased turnover in the executive ranks, rather than solve the problems we choose to change the players. The focus of the firm is inward, rather than outward. Often sales increases are driven by large increases in invested capital as growth is forced, rather than planned. Discussions about how mergers will help the management team achieve the bonus plan become relevant.

It is easier to stay in the Prime phase than to recover from a fall. To get back to Prime requires leadership by the CEO/senior management team and commitment by the Board to focusing on the profitable core of the business. Firms that fail to face previous mistakes and poor capital allocations can struggle for years.

Dr. John Zott is the CFO for Carlson Wireless Technologies, and 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 andcomments regularly on issues that affect consumer businesses. If you are a former student, colleague or would just like to connect – reach out.

Managing Risks

When I try to manage risks, I start with a good scan of what could go wrong. Some of these we insure, some of these we cannot. Frank Knight broke risk into two categories, uncertainty and real risk. Real risk is calculable, it has a frequency and a severity. Uncertainty has neither.

Donald Rumsfield’s comments on knowledge can be related to risks. Rumsfield stated that there are known knowns or things we know we know. These risks have a known frequency and severity and are generally insurable and controllable.

There are known unknowns, which are questions which we have, but which we don’t have an answer. These are complicated risks that can’t fully be insured because the frequency is low, or the severity is incalculable. These risks can still be managed.

Finally, there are unknown-unknowns, where we are not aware of the questions or the answers. Risks that are unknown can’t be managed or insured. This category is the same as Knightian uncertainty.

The risks that make business crack up are generally unknown-unknowns and are often a surprise to management and investors. Risk management for the CFO becomes a process of handling the various real risks and trying to better understand Knightian uncertainty.

Bad and unusual events that we were not aware of are sometimes referred to as black swan events. Nassim Taleb defined black swan events as a surprise with a major impact. The thing about black swan events is that it may be a surprise to you, but it doesn’t mean mean that the event wasn’t known by others. That is true also for Knightian uncertainty. A larger knowledge base decreases uncertainty and unknown unknowns can be reduced by learning.

I therefore break uncertainty into two slices, hard and soft. Soft uncertainty are issues that could be learned with a reasonable investment in diligence and research. Hard uncertainty can’t be. The trick is to convert soft uncertainty into complicated risks, where management, insurance and reporting processes can be brought to limit losses. Hard uncertainty remains retained risk.

“Risk comes from not knowing what you’re doing.” – Warren Buffett

Converting uncertainty into something that can be managed requires an open mind and a sense of paranoia. CFO’s who think risk management is an annual lunch with the broker are going to find themselves surprised by events.