Tag: management

How do you avoid a crisis?

I have been tracking the Coronavirus for about a month and a half, my first email on the subject was back on February 14th.  At that time, it looked like it was going to fizzle. It hasn’t.

“How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly.” – Ernest Hemingway

Firms fail all the time.  They survive when the sun is out and the environment is consistent, but when change comes, even if expected, they can’t adapt and failure results. During a bankruptcy meeting at the court I overheard the case before ours.  The owner had lost a significant portion of his business but failed to downsize staff, equipment and space and in a couple of years was in bankruptcy court.  I commented to our attorney that if the owner had just recognized and taken some action he wouldn’t be in this mess.  The attorney commented that was true for everyone in bankruptcy.  The challenge is recognizing the need for change and the development and execution of actions to solve the problem.

Start-ups are generally dealing with crisis every day and they good at solving the problem. What used to work, doesn’t. Procedures and processes are revamped shortly after development.  The management team is having strategic planning sessions every month laying out a new course.  As a firm grows, it becomes less flexible and processes are written, reviewed and put into a book.  The firm achieves a level of effectiveness, so efficiency becomes more important and redundant staff which provided flexibility is removed from the company.  This process works great in a static market. Unfortunately we are not in a static environment. Here are my four steps to keeping the start-up mindset going as you grow.

Keep your head up. Too many management teams are inward focused.  They care about what goes on in the next office more than the next building and even less about what is happening across the world.  When I started out we had a news service curated by the company librarian.  We would receive via a buck slip (names of the relevant executives to be checked off as read) a package of the most relevant articles that affected our firm, our competitors and market. Today that may be your RSS feeds.  Management meetings would include time to discuss what we learned.  Understanding and wisdom was shared through the team.  Black swan events happen all the time, especially if you are not paying attention.  Cut down on surprises, make sure your team is looking outside the firm.

Build multiple redundant plans. A plan is a decision on what you are going to do to achieve some goal.  If you have only one plan, any change will mean you have no plan.  All plans are about an uncertain and possibly unfriendly future.  Good plans think through contingencies and outline potential options. Bad plans reflect the present circumstances.  Charlie Munger talks a lot about decision trees and thinking about options and choices.  Most schools don’t do a good job of teaching this skill. Learn it.  Thinking through what could happen along with what actions could be taken will make your plan more robust. 

Build a diverse team. “None of us is as smart as all of us” – Ken Blanchard.  Recent research talks about the decision-making advantage of a diverse team.  History proves this true.  Good teams work together but also bring experience and perspective.  We’ve all worked with the executive who has 10 years’ experience which is really 1 years’ experience 10 times. Different perspectives help make everyone smarter. Seven people you went to grad school will be a great party, but your shared viewpoints hide rather than illuminate options. I’ve worked with a lot of executives: both great ones and a few not-so-great.  Great ones don’t always fit, but they always add value.   Organizations are quick to exit the “poor fit” team members who don’t share similar viewpoints.  Fit works great when the environment is static.  When the environment changes “fit” drops in relevance and competence rises. 

Only the Paranoid Survive is more than a book by Andy Grove. I don’t wish you to be truly paranoid.  Paranoia is a symptom of illness.  But I’ve now worked with too many businesses which when successful consider themselves brilliant and special, and when difficult times come they shatter. In the stock market we used to say, don’t confuse brains with a bull market.  It is easy to make money when everything is up and to the right.  Don’t drink the lemonade, keep humble.  This section is likely wasted at this time.  By now you‘ve figured out that the tide has gone out as Warren Buffet says, and who is naked.  This crisis will pass but don’t forget – there will always be crises. 

5 Customer Perspective Questions for CFO’s

Great CEO’s and CFO’s see both the inside and outside of the firm.  The inside perspective is natural, it is the default mode in corporate life. The outside viewpoint is harder but it offers a wealth of insights. Although there are many outside perspectives, a crucial one is the customer’s viewpoint. When I work with a company I am vitally interested on how customers perceive the product and the company. Here are five questions you can ask yourself about the customer’s perspective.

1)    Do you respect the customer? The customer perspective doesn’t come easy to finance executives. I’ve heard senior executives refer to their customer base as stupid and cheap, and similar to cows. Although you don’t have to use your company’s products to be a good executive, it helps.

2)    Do you get customer feedback? There is a saying “the best fertilizer is a farmers’ footsteps.”   Great executives get in the field and see how customers react to the product. I hate business travel, but there is no substitution for getting great customer feedback.  Although CFO’s can’t spend the same amount of time the CEO spends talking to customers it is an important part of the executive role. I know a lot of marketing execs swear by big data analytics. I love big data but stories drive passion and illuminate the data.

3)    Are your customers thrilled or merely satisfied?  Are we promising one thing and delivering another? Often the internal “story” we tell in the office is not connected to the reality in the field. My rule of thumb is to never give a customer something they don’t want and won’t pay for.  Additional features increase price without increasing value. Engineering teams will design the ultimate product, management egos get wrapped up in featurism, and pretty soon that great little software tool bloats up. Be clear about what you are promising, make sure it is what the customer wants and then deliver on that commitment.

4)    Are your operations streamlined to deliver on the promise you’ve made to the customer? The CFO has a key role in identifying where efforts (and costs) should be placed. Sometimes you centralize (and sometimes decentralize) but figuring out the best tradeoff in location, cost and service can increase profits significantly.

5)    Is your business model congruent with what you’ve learned? Although the CEO owns the business model, the CFO is key in developing the strategic plan. I’ve always drafted the agenda for strategic planning sessions, including identifying the key strategic questions. Having a handle on the customer allows a CFO to ask the right questions, and shape the strategy so that the intersection between your company and the customer results in profits.

Alan Kay said that “A change in perspective is worth 80 IQ points.” The fastest way to be smarter about a problem is to change your perspective.

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.

CFO thoughts on Business Models

Fortune magazine reports that Warren Buffett stated in 1988, “With few exceptions, when a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.”  Bad business models often result in poor fundamental economics.  Business models are hard to get right, and often very hard to change.

A 2014 survey of CFO’s asked about reporting and earnings quality.  The Financial Analyst Journal reported the (Dichev, Graham, Harvey and Rajgopal) study in their Jan/Feb 2016 edition.  The survey results are full of interesting details including the estimate of 1 in 5 financial statements being “cooked” with material (10% or better) adjustments.  That information is worthwhile and it is bolstered by a list of ways CFO’s can tell there is a disconnect between reality and the financial statements.   The survey also identified that a goal of financial reporting was about “conveying the long-run view of the profitability…of a bundle of assets”.  As interesting as this is, I’d like to focus on another aspect of the article, the sense by the CFO’s of what drives earnings quality.

The survey inquired about factors that determine earnings quality – both internal and external.  The top factor was the business model of the company.  The other inputs included external factors such as the industry, accounting standards and macroeconomic conditions.  Internal factors included internal controls and the aforementioned business model.  Clearly, management teams are accountable for internal controls, but the argument for business model is not as certain.

Management teams are hired- they don’t create the business.  They are brought in for their leadership, management, talent, knowledge and skills.  Consequently, much of the business model is defined before the management team starts.  Good business models require a good design in the beginning and careful nurturing.  As markets change, business models grow obsolete and no longer fit their markets.  Watching video has increased steadily in the last 20 years and yet the local Blockbuster is now a Dollar Tree.

I once joined a company that was earning <1% operating profits, and had no growth.  In one year sales were up 10+%, and operating margins increased to 4%.  In the next several years, we were never able to get operating profits much above 7%.  In the years after I left, operating margins averaged less than 1%, until finally it went bankrupt.

The managers who followed me were a mix, some weak, some strong, some were tactical, some were strategic.  When they took the position, they were confident about generating great results, but in the end none were able to solve the business model puzzle.  Earnings were invested in a series of new initiatives which never resolved the core problem.  Eventually weak profitability and lousy returns on capital resulted in a steady turnover in CEO’s and eventually it was sold to private equity who split out the good assets and bankrupted the rest.

This firm clearly had a business model issue.  Flat market share, low returns on capital, little ability to innovate or compete in new segments.   Low earnings quality is an outcome of the business model, and tinkering is not going fix it.  So what do you do with a business that has poor fundamental economic performance?  Here are a couple of strategies that can work.

One way is to get a break, either a technological change, industry change or strategic option which creates an opportunity that allows the firm to innovate.  Richard Rummelt discusses this approach in his book “Good Strategy / Bad Strategy”.   Blockbuster knew that digital streaming would hurt their business, but couldn’t come up with a strategy that was effective.  Netflix, which was in the mail order DVD business, however, did.  Searching, selecting and creating this opportunity takes time, resources and patience.

Another option is to pare the business down to the profitable core, and then build up from there.  The focus here is on increasing the return on invested capital.  A good business invests in projects that deliver a better than market return and prunes functions and divisions that do not.   Will the business get smaller?  Yes, it will, but the remaining business will provide a foundation for growth.

Both of these strategies have significant downsides for management.  Few business leaders are strong enough or are far-sighted enough to risk the company on a technological change.  Boards don’t like risk taking and the bigger the business the bigger the inertia.  Paring down a business can often mean several years of declining sales. Even if you are adding to profits by subtracting a poorly performing operations, there will be concern by the Board, by investors and even by the management team.  CEO and senior executive compensation is highly correlated with company size and declining company size means declining compensation.   This is a lot of headwind, which explains why there are so many firms stuck in this state.

The bottom line is that it is a whole lot easier to keep a business model working well, then to fix it after it is broken.

Dichev, I., Graham, J., Harvey, C. R., & Rajgopal, S. (2016). The misrepresentation of earnings. Financial Analysts Journal, 72(1), 22-35. Retrieved from http://0-search.proquest.com.library.ggu.edu/docview/1762049797?accountid=25283

Risk Mitigation for CFO’s

In my earlier post, I noted that converting uncertainty to known-unknowns requires thinking hard about the potential things that can go wrong and having a good risk identification search process.  I broke risk down into true risks, which are insurable at some level (known frequency and severity) and uncertainty, which could be hard uncertainty (can’t be known at a reasonable cost) and soft uncertainty (can be known relatively cost effectively).

Many firms do a poor job of searching for problems.  I have found several styles of management teams that struggle dealing with risk.

  • Insular management teams are prone to very large areas of soft uncertainty. Home grown executives are often dealing with problems for the first time.  Unaware of problems at other firms they repeat mistakes long solved elsewhere.  A diverse management team of backgrounds, industry and experience is just a better management team.
  • Management teams that are dominated by a single executive also tend to underestimate risks. Although I’ve worked with some great CEO’s, no one executive can reasonably see or know all the questions.  If the CEO calls all the shots, over time, management teams will let the CEO handle all the thinking too.
  • Firms with long term winning track records can begin to ignore risks as success begets complacency in the company culture. Company culture can be a great strength, but when the culture becomes too dominate, it blinds management to problems.  Andy Grove suggested that only the paranoid survive, which is good advice.  However, when you win a lot, it is tough to remain paranoid.
  • An executive team that is highly incentivized by the stock price (usually with options) tends to stay focused only on the positive news, and to only invest in strategies that appear to have a direct correlation with option value (usually growth initiatives). Stock options skew management priorities because the risk is one-sided.  If the stock price fails to increase or the company goes bankrupt the options are worthless.  So for the option holder, ignoring the risk of a blow-up makes sense, they only get paid if the stock goes up.  In these firms, it can be hard to get management focus on the known issues, much less invest in searching for unknown potential problems.

CFO’s have to assess risk.  To do this, we must examine the business, the environment and the management team.