Rules – Success Needs A Playbook

This issue is my final installment devoted to business infrastructure.  In my experience people respond to rules in two very different ways – they rebel or they embrace.  Two opposing perspectives that imply rules function to consent or restrict a particular action.  The job of the business leader is to harmonize these two seemingly conflicting viewpoints so that the business’s fundamental objectives are satisfied.  To do so it is beneficial to have a context for rules.  That is my ambition with this issue of The Business Odyssey.

I use the term Rules to convey clear and unambiguous standards not a convenient excuse to impose autocratic, arbitrary, or oppressive authority.  Quite to the contrary, rules should serve as the foundation to thoughtfully empower people.  Rules do so with explicit interpretations or appropriate actions the business has adopted to guide the response warranted for a particular circumstance.  Rules enable the confident delegation of responsibilities as well as the preservation and routine replication of actions.

The discussion that follows focuses on business infrastructure’s dependency on rules.  Previous issues have described people and things; those responsible and the tools used to effect an action.  Rules are the explicit guidelines specifying what to do and when to do it.  When People, Things and Rules are properly designed and effectively functioning this infrastructure improves performance and protects assets.  So how I am going to define rules?

Business rules are the acceptable or approved actions expected to be applied to specific transactions, activities or decisions.

Business executives expect that certain routine activities will be handled consistently, correctly and timely.  Rules are an explicit statement, best in writing, expressing the allowable or acceptable treatment to be applied to a specific action.  Rules serve four distinct business needs: operations, reporting, compliance and protection.

Operational

The senior business executive’s primary concern is typically focused on making money.  Making money is obviously accomplished with operations that create customer satisfaction, do so efficiently and is adaptable to change.  The business’s operational activities convert the promise the company makes to its customers into the satisfaction the customer expects.  Managing the operations ensures that the fidelity of the product or service the customer receives is consistent with the customer’s expectations.  Moreover, doing so efficiently is required so that the business is profitable and capable of delivering the return expected by owners and providers of capital.  Nevertheless, the executive can’t subordinate other important responsibilities to a single-minded focus on making money.

Senior executives need a frequent barometer to monitor operational effectiveness.  The integrity of this barometer depends on the contributions of others and a common understanding of its meaning.  Monitoring operations requires a shared understanding of the rules and how those rules are applied.  A few examples of routine operational issues that require adherence to specific rules.

• Order processing
• Collecting money owed
• Scheduling production
• Manufacturing or production methods
• Product packaging
• Customer service
• Routine financial performance
• Selling

Reporting

Business executives depend on reliable and timely information.  This information may be diagnostic or strategic.  Regardless of the application the business executive depends on the veracity of the information relied upon to make decisions.  Business executives depend on knowing what it is that they are looking at.

A recent client had the accounting staff produce a weekly operating report for its senior executives.  Included as part of this operating report was the cash balance of each bank account.  Pretty simple right?  Well maybe not.  As it turns out the executives thought they were looking at a cash balance reported by the bank at the end of the banking day.  The accounting staff on-the-other hand was reporting the cash balance showing at the time (most often mid-day) and was adjusted by deducting outstanding disbursements.  Either one of these was legitimate.  In this case however, two different definitions of cash balance was used.  Executives thought cash balance meant one thing and the accounting staff was reporting something different.  This is not an example of accounting incompetence but rather an example of ambiguity arising from the absence of clearly defined rules.  And no one, that is until I looked at it, thought to consider the possibility that a discrepancy of meaning existed. A discrepancy that was compromising the reporting of cash balance.  This observation naturally led to suspicion towards other reported numbers.

Another example from the same client.  I was asked by the CEO to provide a comparison of current year billings to previous year billings.  Despite the CEO’s impatience and dismissive demeanor I had a pretty good idea of what he was looking for.  Nevertheless, my job was to advise him and the President of operational deficiencies and vulnerabilities, and I recognized that this simple request would allow me to expose just that.  So I decided to ask a few of the accounting staff, who, had I not been there, would have been the target of that question, what was meant by billings.  This was not a formal term the company used.  And as no surprise to me, I got as many definitions of billings as people I asked, all different I will add.

The point is clear, the absence of rules, in this case the measure of dollars committed to the company collected or promised, would produce misleading information.  The absence of rules dictating what things mean will result in people making-up their own definitions.  Some of these definitions will be approximately correct but there will be subtle and not so subtle differences.  One of the roles that rules play is to eliminate misunderstandings, ambiguities and misinterpretations.  Standardized definitions are but one form rules can be found.

But this application is critical especially when looking at financial reports.  Most of the accounting standards that exist are simply detailed statements of what a term or phrase means.  It is critical that all financial reports be free of ambiguity, errors and other misleading information.  Similarly estimates or projections are often required.  This should be clearly recognizable and qualified with the underlying assumptions.  For a report to be reliable it must be free of ambiguity and errors.  Rules establish the standards used when reports are prepared.  Without these standards the integrity of what is reported is severely compromised.

Compliance

Businesses are expected to comply with many different kinds of legal requirements.  This legal requirements include taxes, human resources, contracts, environmental and safety regulations as well as countless others.  Most of these legal requirements include reporting obligations together with an agency’s right to verify compliance.  When a failure to comply is discovered there are often serious fines and penalties.  Thus businesses are oftentimes required to verify that they operate in a lawful manner and have satisfied legal obligations.  Meaning a business needs to demonstrate convincingly to an outsider that is adhering to legal rules.

Protection

Rules also serve to protect the assets of the business from fraud, manipulation, or threat.  The following are examples of rules applied for purposes of protection.

• Segregation of duties – separating authorization, custody, and record keeping roles to prevent fraud or error by one person.
• Authorization of transactions – review of particular transactions by an appropriate person.
• Retention of records – maintaining documentation to substantiate transactions.
• Supervision or monitoring of operations – observation or review of ongoing operational activity.
• Physical safeguards – usage of cameras, locks, or physical barriers to protect property, such as merchandise inventory.
• Top-level reviews – analysis of actual results versus organizational goals or plans, periodic and regular operational reviews, metrics, and other routine diagnostic indicators.
• IT general controls – security, to ensure access to systems and data is restricted to authorized personnel, such as usage of passwords and review of access logs; and change management, to ensure program code is properly controlled, such as separation of production and test environments, system and user testing of changes prior to acceptance, and controls over migration of code into production.
• IT application controls – Controls over information processing enforced by IT applications, such as edit checks to validate data entry, accounting for transactions in numerical sequences, and comparing file totals with control accounts.

Rules take many forms and serve multiple purposes.  It is the responsibility of senior executives, owners and directors to ensure that the business infrastructure incorporates rules that are clear, unambiguous and properly conceived.

Things – The Levers of Business

 “Give me a place to stand, and a lever long enough, and I will move the world.” 
― Archimedes

This issue of The Business Odyssey continues my discussion of infrastructure by introducing business infrastructure’s second component, Things.  People act.  Rules influence how to act.  This however begs the question – act upon or with what?  Things are the levers producing or enabling action.  People use Things in specific ways (in accordance with Rules) to produce specific outcomes.

Business infrastructure uses many different levers taking on a variety of forms.  Some levers are obvious and some not so obvious.  I will share a few examples.

I recently advised a maker of precision machine parts on cash flow and capital structure.  Among other things I was instrumental in helping the company restructure their balance sheet and secure an institutional private equity investor.  This engagement required producing meaningful and reliable forecasts of future financial performance.  My client produced parts for Tier One and Tier Two defense and aerospace contractors.  These customers all maintained sophisticated ERP systems that scheduled the delivery of system components years in advance.  This provided my client with a predictable and enviable order backlog.  My client maintained its own ERP system that communicated electronically with its customers producing, in theory, an up-to-date backlog.

My client’s ERP system can serve as a powerful infrastructure lever capable of enhancing financial performance.  Focusing exclusively on order backlog, for purposes of this example, I’ll offer a few thoughts on the specific ways this infrastructure lever could benefit the company.  The obvious benefit is scheduling production.  However, this backlog data combined with a reliable production schedule, not available when I started working with the client, could be used to dramatically reduce inventory carrying costs.  In the case of this client, their inventory days were about 160 days.  That’s an inventory turnover of about twice per year.  Meaning that the company was devoting a significant amount of its working capital as inventory.  This meant that the cash the company needed to satisfy payroll, suppliers and capital providers was unavailable.  This required the company to pay more for its borrowed capital, subjected the company to penalties and made it impossible to take advantage of supplier discounts.  The cost of protracted inventory days produced elevated capital costs, forfeiture of discounts, inefficient use of production resources and most importantly, lost revenue opportunities.

The business needed to manage its inventory more efficiently.  A proper business infrastructure ensures that this happens and happens effectively.  The lever to improve inventory utilization already existed but was unused – customer backlog data.  The Company was failing to understand its infrastructure needs and cost it was incurring because its infrastructure was deficient.

I will point out that inventory efficiency is only one single example of the consequence of failing to understand the value of business infrastructure.  This lever, backlog data, could and should be put to use in many other ways including forecasting and managing cash flow; managing expected growth by identifying revenue gaps, as well as anticipating and evaluating appropriate capital expenditures to name a few.

I use this as an example of a software system (a business infrastructure “Thing”) that was adopted, at no minor expense, to comply with its customers’ requirements.  My client however failed to consider the other contributions this infrastructure could provide to improve competitive advantage, liquidity, and profitability.

This example is not unusual.  There are many business practices and systems that businesses employ to comply with regulatory, tax, human resources or customer requirements.  These systems are adopted mindlessly to comply without taking the time to think about how each might serve the business or in the context of an overall infrastructure architecture.  This commonly produces redundancy, inefficiency, lost opportunity and in some cases even conflicting outcomes.

I’ll offer another more common example – tax compliance.   Companies typically maintain voluminous records to ensure compliance with the morass of tax regulations.  Another recent client conducted business nationwide as well as internationally.  The business was required to comply with sales, use and income tax requirements from many different agencies.  This particular client was very profitable and was thus a target of frequent audits.  I need to digress for a moment to point out that being audited, while hardly a pleasant experience, is not necessarily caused by any misdeeds on the part of the company.  Tax authorities often target successful companies for audits because the likelihood of collecting something is higher than auditing a company in trouble.  I make this digression to emphasize that this client invested significantly to ensure tax compliance.  During my consulting tenure I personally oversaw two separate tax audits and this company ran a clean ship.

My client had invested significantly in accounting systems, record retention and outside advisors to ensure rigorous compliance.  However, tax compliance was considered a silo all to itself with no consideration of how that investment might be used to serve the business in other ways.  The implications of this compliance mentality infected the business’s perspective by distracting executive leadership’s ability to see the bigger picture.  An entire infrastructure, poorly architected I might add, had been established to ensure that the business was capable of responding to requests an auditor might make.  There was a wealth of information being maintained to ensure tax compliance.  Using some of this information I was able to identify the most profitable clients.  Other information was used more rigorously to understanding the flow of cash and ultimately revealed the single most important measure of financial performance and will add millions of dollars to the bottom line every year going forward.  The examples I’m using are meant to show the “ancillary” uses of data already maintained for the simple purpose of compliance.  Needless to say, this more detailed understanding of the systems used to ensure tax compliance could be dramatically improved to free up peoples’ time to do other things, reduce expenditures on outside tax advisors and reduce the anxiety executives experienced every time tax issues arose.

There are many occasions where companies have assets whether software systems, data, locations, vehicles, machines or other Things, that are acquired and employed with no thought towards how they can or should be used to serve the overall purposes of the business.

I’ve spent the last few issue of The Business Odyssey dwelling on the topic of business infrastructure.  My goal has been to address this seemingly nebulous concept by dissecting it into three component parts, People, Rules and Things.  I don’t pretend that my discussion is exhaustive or complete.  That was not my goal.  My goal is to encourage middle-market executives, owners and directors to adopt a broader appreciation of the role business infrastructure serves.  The middle-market business leader need not be an expert in business infrastructure.  Moreover, it is an impossible and undesirable expectation to expect a business leader to be expert in every facet of inner workings – that’s the role of specialists.  It is however the business leader’s responsibility to challenge infrastructure to serve the business and to know when exceptions to the routine require their decision.

THE BUSINESS ODYSSEY – Operational Planning

 “A goal without a plan is just a wish.”
― Antoine de Saint-Exupéry

  “You can always change your plan, but only if you have one.”
― Randy Pausch,  The Last Lecture

Operational planning differs from strategic planning. Strategic planning is the process that defines the business’s direction, overarching goals and competitive advantage. An effective strategic plan is the foundation executives use to make decisions allocating resources and choosing between alternatives. Operational plans on the other hand focus on specific outcomes and the initiatives necessary to advance the business’s goals and objectives (typically confined to a period of one year). The operating plan expresses accomplishments, action items, initiatives, budgets, scheduled milestones, and assignment of responsibilities expected over the coming year. Operational planning and the operating plan produced are most effective when delegated to individual revenue and cost centers. Plans prepared by individual operating units can be consolidated into a company-wide plan.  Doing so provides executives the information needed to ensure the business as a whole can achieve its strategic goals.  To be effective, operating plans need to be clear, actionable, temporal, assignable and measurable.

COPING WITH CHANGE, REDUCING UNCERTAINTY & MANAGING RISK

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

Planning is about confronting and managing uncertainty.  Operational planning is not a speculative folly trying to predict the future.  Thinking so exemplifies a common misconception of planning’s purpose and value. Meaningful operational planning is the tool required to mitigate the consequences of uncertain.   Mature and successful businesses can be distinguished by the presence of planning competencies.

The primary purpose of operational planning is to expose, understand and remedy uncertainty.  Thinking about planning in this regard requires developing the ability to distinguish between significant and insignificant uncertainty. To make this distinction it is useful to dissect uncertainty into two different components: likelihood and consequence. Taken together, likelihood and consequence, allows the planner to allocate precious time to resolving what is important and dismissing (or deferring) what is not.  Additionally, the discipline of operational planning, when performed effectively, provides a systematic framework to convert uncertainty into knowledge.

Let me illustrate with a look at revenues.  One of the common topics of operational planning is the development of a forward looking estimate of revenues.  It would be easy enough to project future revenues by multiplying last year’s revenues by the desired growth rate.  A method commonly used.  Projecting future revenues by simply escalating historical revenues may produce an attractive spreadsheet but it will yield limited useful knowledge.  Resorting to this simplified method often hides useful insights.  Alternatively, parsing future sales into what is known and what is not known reveals information that can be applied to allocating resources and time.

A recent engagement required determining the adequacy of a client’s deployable capital as well as an appropriate capital structure.  Quickly, it was determined that the company had inadequate access to deployable capital necessary to satisfy its demand for working capital.  Moreover, the existing capital structure was overly burdened with debt. This led to the conclusion that approximately $5 million in fresh equity was need (in addition to a restructuring of the existing debt capital).

In order to successfully re-capitalize a comprehensive business plan was required that included expressing the Company’s expectations for future revenues. The conventional approach to forecasting future revenues uses historical sales escalated with an assumed growth rate. The senior executives of our client expressed their belief that a 15% increase in revenues was a reasonable escalator. Using this escalation factor, together with other assumptions provided by the company’s executives, an estimate of capital requirements was derived.  These assumptions also indicated that cash flow and earnings would be adequate to provide an appropriate return to both debt providers and equity investors. However, when the senior executives reviewed the sales forecasts they reacted with disbelief. These executives could not imagine how they could produce the sales forecasted.

The executives reacted by dismissing planning as meaningless. This initial reaction however missed the point.  These executives were focused on a single number – projected sales. Rather than reacting with skepticism the executives would be (and eventually were) better served by asking where those future revenues might come from.  That question focuses on understanding uncertainty, rather than just impulsively dismissing the plan which is nothing more than just surrendering to ignorance.  Focusing on the source of projected sales led to thinking about future revenues as composed of three different categories; Confirmed, Anticipated and Gap.

Certain future sales can be anticipated with a high degree of confidence.  These future sales may currently exist as contracts or purchase orders for future deliveries.  These Confirmed sales can be identified as a line item labeled Confirmed.  Other sales may not yet be contractually confirmed but the company may know from history that a certain customer buys a certain number of units.  These future sales cannot yet be treated with the certainty of a Confirmed order but the volume and customer can be reasonably anticipated.  These are entered on a second line labeled Anticipated.  The third line “Gap” represents the sales whose origins are not yet known but required to satisfy the company’s revenue growth expectations.  It is the uncertainty of the Gap revenues that is significant. Parsing out Gap revenues in this way, expressed both quantitatively and in context, was what the executives needed to believe their own growth assumptions and more importantly to devise an action plan to achieve those expectations.  Revealing the scale of gap sales led executives to focus on how to acquire new customers or new sales to existing customers.

Presenting sales as Confirmed, Anticipated and Gap changes the nature of the revenue uncertainty.  The uncertainty is no longer how we generate total sales but rather how to ensure anticipated sales occur and where to find Gap sales. By narrowing scope of uncertainty from all sales to anticipated and gap sales executives can focus their attention and energy towards the real issue.

The essence of this approach is to divide the problem into two pieces: what’s known and what’s not.  Continuing to break down uncertain into known and unknown eventually leads to an uncertainty that is manageable.  Referring back to the previous example, where will the Gap sales come from.

The work we do for clients commonly includes preparing or clarifying business plans and financial forecasts.  Contrary to popular belief we don’t make up these numbers; we translate what our clients tell us about their business and their plans for the business into a concise narrative and a quantitative financial expression.  I cannot begin to guess how many times I have heard clients tell me, after reviewing these forecasts “I don’t believe these numbers.  We can’t predict what will happen in the future.”  In one sense these comments are absolutely true – none of us can predict the future.  This comment however exposes a dangerous naïveté – dismissing the importance of managing uncertainty and change.  I cannot predict the future, I am however confident that the future will be different than the present.  That simple sentence expresses two essential realities businesses confront; change and uncertainty.

Mature companies respect the importance of uncertainty and develop the ability to manage it; sometimes giving them powerful competitive advantages.  Managing uncertainty and change is essence of operational planning.

THE MECHANICS OF OPERATIONAL PLANNING

“If you don’t know where you are going, you’ll end up someplace else.”
― Yogi Berra

Mountains of books have been published offering guidance on the appropriate techniques for constructing an operational plan.  I have no intention of prescribing any particular planning methodology, rather to emphasize its critical importance and offer a few words of guidance.  Most importantly, is to adopt a corporate culture that explicitly acknowledges and confronts change and uncertainty.  Senior executives of mature and successful businesses embrace the idea that change and uncertainty is their primary responsibility.  The sophisticated executives use change and uncertainty as a source of competitive advantage devising the business infrastructure required to effectively and rapidly reveal change as well as to respond to uncertainty.

The mechanics of Operational Planning is composed of four components: 1) expected outcome; 2) planning premise; 3) thoroughness; and 4) ownership.  Planning is performed for the purpose of achieving an outcome.  In some cases the outcome is predictable and stable while on other occasions the ultimate outcome may evolve as a result of rigorous planning.  Understanding, at the onset, the nature of the outcome is critical.  In some cases the outcome may be as simple as knowing the scale and origins of future sales.  However, it is just as likely that a rigorous planning process may reveal that the real outcome should be confirming the specific satisfaction customers seek.  I don’t suggest that one kind of outcome is any better than the other, only that the quality and achievability of the operating plans depends on how well the outcome is understood.

There is a necessary mindset that needs to be in place to ensure that operational planning serves its purpose – the planning premise.  That premise is that the planning process can reveal and mitigate uncertainty only when the right questions are asked.

There is a need to be holistic when performing operational planning.  When an operational plan is designed to ensure that the company’s strategic objectives are satisfied it requires considering every possible influence.  Meaning it is not just top-line revenues but also includes considering cost structure, pricing, resources, people, competitors and outside business environment – thoroughness.

At the end-of-the-day achieving an expected outcome and producing superior performance is the result of effort applied by the individuals responsible for business execution.  The command and control approach, delegating goals and prescribing approaches, fails.  Harnessing the energy and imagination of the individuals that make-up an organization requires ownership.  A robust operational planning approach specifies the organizational goals and objectives then seeks individuals to “sign-up” (assume responsibility) for the specific goals that they are qualified and motivated to achieve.  This requires delegating the specifics of the operational plan to the individuals who will ultimately have responsibility for execution.  The responsibility of executive management is to ensure that the consolidation of business unit goals and initiatives satisfy the businesses overall objectives.  This oftentimes means pushing business unit leaders and other individuals to be aggressive and imaginative.  But this push is not prescriptive or threatening rather it is a challenge to individuals to push boundaries and discover new levels of achievement.  It is creating a culture and a working environment that encourages individuals to trade the comfort of routine for the rewards of accomplishment.  A noble goal and the secret to superior performance.

THE BUSINESS ODYSSEY – Competitive Strategy

“People in any organization are always attached to the obsolete – the things that should have worked but did not, the things that once were productive and no longer are.”
― Peter F. Drucker

“Any man who can drive safely while kissing a pretty girl is simply not giving the kiss the attention it deserves.”
― Albert Einstein

Competition exists to choose who gets the prize when the prize can’t be shared. To prevail requires strategy. Business requires creating customer satisfaction and return on invested capital. The business environment is about competition. Securing profitable customers, suitable capital and qualified employees is not a consequence of happenstance; it is a consequence of strategy. The competition for customers¹, capital or employees is typically a zero-sum game, there is only one winner. Every business employs a strategy though not necessarily explicit or successful. This issue of The Business Odyssey will share a few thoughts about competitive strategy.

Conceptions of competitive strategy stir up a muddy mix of meanings and expressions. Even the most casual reader of business literature cannot help but feel bombarded with theories about strategy touting success’s dependence on Big Data, Game Theory, Scenario Planning, Strategy Maps, Value Chains, Balanced Scorecards and a long list of other ideas. To be clear, all of these ideas as well as others can contribute significantly to a business’s efforts to achieve a competitive advantage. These advanced methods however, have limited value in the absence of a solid foundation of competitive strategy. My focus is limited to building that solid foundation.  I identify and explain the basics necessary to produce a sturdy foundation that can support a sustainable advantage and when appropriate apply more advanced tools and methods.

Middle-market companies rarely need overly complicated or sophisticated strategy methodologies. These companies do nonetheless, benefit from understanding strategy’s importance, how to develop strategy and how to incorporate strategy into operations efficiently and effectively. A sound competitive strategy, effectively integrated into the business’s modus operandi, is unmistakable evidence of a business taking its maturation seriously.

Our goal is to construct a conceptual foundation for competitive strategy that produces meaningful advantages. To construct this strategic foundation we have devised a simplified process consisting of three steps: characterization, integration and validation.

CHARACTERIZATION
Devising a healthy competitive strategy requires discipline, precision and attention to detail. The wisdom in the old saying – information is power – is revealed clearly in competitive strategy. I call the first step of strategy development characterization to reflect the initial emphasis on defining and clarifying specific aspects of the business. Characterization describes three things: 1) what the business does (outcome); 2) who the business does it for (customer); and 3) why the business is different (advantage).

What the Business Does (Outcome)
What the business does is a precise and accurate statement describing the customer satisfaction it creates.  Relying solely on a description of a product or service fails to provide adequate insight into a customer’s underlying decision to buy.

Customer satisfaction is the measure of the business outcome; not the features or benefits of a product or service. The following example illustrates the difference between customer satisfaction and product description. When Intuit developed its personal finance management software Quicken it could easily have conceived it as an accounting program for individuals. Most individuals maintain a checkbook and avoid anything remotely resembling accounting like the plague. Offering an individual an automated solution for personal accounting is trying to solve a problem that most individuals don’t have or want. Individuals want to pay bills, keep their accounts flush, and balance their checkbook. And about once a year they would like to eliminate some of the burden experienced preparing a tax return. Intuit, focusing on customer satisfaction and not a “product description” created the automated checkbook – Quicken.

The satisfaction customers seek can take many different forms. And it is important that the individuals devoted to crafting strategy recognize and suspend personal bias, stepping into the shoes of their customer. Some customers may seek economic satisfaction in the form of low price or cost of ownership. Other customers may put higher importance on the value of time and hence look for usability, convenience, or reliability. A different customer may place more importance on status or prestige looking for rarity or perceived quality. Or the customer may value social responsibility found with such attributes as sustainable materials, chemical free, living wages or contributions to worthy causes. All of these are forms of satisfaction customers seek and all are legitimate.

Who the Business Does it For (Customer)
Customers are people. Markets are abstractions. Relying on demographic characteristics parsed from a seemingly attractive market produces an abstract composite caricature of an “idealized” customer. To the best of my knowledge, I’ve never actually met one of these people. Alternatively, conceptualizing a specific individual together with requirements and expectations reveals information that can be used to create a competitive advantage. Generalizing from the individual oftentimes produces unexpected markets. It doesn’t matter whether the satisfaction is delivered via product or service; or the customer is a consumer or institution. Every decision to buy is made by an individual (or perhaps several).

Using Intuit again, the company produced an automated checkbook that conveniently also relied on double entry accounting. A conventional market analysis would categorize this as a consumer product. However, Intuit discovered that many businesses in need of accounting software were staffed with individuals with the ability to manage a checkbook but not necessarily the specialized knowledge of double-entry accounting. QuickBooks was introduced as an automated checkbook for business.

Why the Business is Different (Advantage)
To prevail in competition requires an advantage. Securing consequential competitive advantage requires an understanding of what the business does and for whom it does it that is meaningful, effective and clear. Competitive advantage is the customer’s perception of value that makes the business different. Customers have the choice to select a competitor, a substitute, or to do nothing. Any one of those three choices means your business loses. So why will a customer select your business’s offering rather than one of these other alternatives?

It is well beyond my scope to attempt to catalog, much less discuss, the different ways to create a difference.  Michael Porter² describes three general competitive strategies: cost leadership, differentiation and focus. As an unapologetic Porter devotee I will use these three strategies to describe differences.

Cost leadership: an advantage the business achieves by its ability to offer its products or services at a cost less than a competitors. Using cost leadership as a source of advantage requires the business to tailor its entire way of doing business in a manner that allows it to maintain an overall cost structure that competitors cannot match. Contrary to popular thinking this does not necessarily mean that all costs need to be minimized or that cost reduction is the panacea for success.

Differentiation: businesses create competitive advantage when a customer can clearly perceive and value a difference. The complicating factor in devising differentiation strategies is the variety of alternatives and the temptation to do things that conflict. To illustrate a successful form of differentiation is the appeal to a customer’s desire for exclusivity or status; luxury cars are an easy example. Some customers seek products seeking to enhance an image of success or superiority. These customers will pay a premium for that privilege. I’ve seen on more than one occasion a business seeking to appeal to the status buyer but holding the steadfast belief that prices needed to be discounted compared to competing products. Big mistake. The status buyer is only satisfied with a product no else has, a discounted price may imply that the product will be accessible to everyone, defeating the purpose. This is not to say that pricing and cost management become unimportant.  Quite to the contrary, pricing and cost management are always inextricably dependent on competitive strategy and require careful consideration. Premium pricing is not a license for frivolous spending.

Focus:  Business can achieve a distinguishing and profitable advantage by focusing on a specialized segment of a market. Successful defense contractors employ specialized know-how pertaining to procurement processes, contracting, accounts receivable collections, and the appropriations process their customer use for future procurements. These companies build organizations that are profitably optimized to satisfy contracting requirements in an environment that is highly sensitive to cost. An interesting corollary is the difficulties successful defense contractors encounter trying to diversify and service private sector clients.

INTEGRATION
The Characterization stages identify the components of competitive advantage. Successful competitive strategy and the advantages it creates require that these components be fully integrated into the way a business operates. Consider as an illustration of operational integration the recruiting function. The business seeking an advantage as a leader in technology innovation requires the ability to recruit and retain the most innovative and smartest people with recruiting becoming a critical competitive competency. Imagine yourself in a space capsule preparing to launch; you don’t want to be thinking that you’re sitting at the top of all the low-cost bidders – not a reassuring thought. I would much prefer to think that the smartest people in the world worked together to produce the rocket I’m sitting on. Customers have their own requirements and expectations of what they are paying for and want to believe that whatever that expectation, the business is structured to perform better than anyone else.

The strategy of low cost provider is a good example to look at with a little more detail. Offering the lowest price is only the tip of the iceberg. The business not only needs to offer the lowest price it needs to do so in a manner that is profitable. I’ll have more to say about this in a moment when I introduce the business purpose. For the moment, a business pursuing a low cost advantage requires executives to dissect each activity or function of the business to ascertain how it contributes to satisfying its customers with the lowest cost. These activities include purchasing, paying attention not only to the cost of materials but also the costs associated with purchasing. This careful analysis might possibly reveal that paying more for a component can reduce manufacturing costs. There are countless trade-offs that must be revealed, analyzed and made.

Developing a successful competitive strategy requires understanding how each component influences every activity the business needs to perform from the obvious examples such as pricing, developing products and advertising to the not so obvious like recruiting, purchasing and accounting. Meaningful competitive strategy affects everything. Thinking otherwise will result in second place in an environment that only rewards first.

APPLYING THE BUSINESS PURPOSE
In the third issue of The Business Odyssey I introduced the idea of the Fundamental Business Purpose. All businesses need to create customer satisfaction and a return on invested capital. The competitive business strategy is viable only when these two conditions are satisfied. Adopting a strategy to be the low cost provider is not a license to operate without profits. The fundamental business purpose is a critical diagnostic of the soundness of a competitive strategy.

This issue of The Business Odyssey has focused on competitive strategy. This discussion, by necessity and brevity has been restricted to a narrow focus on establishing a few foundational concepts. It is by no means complete. The foundational concepts presented are introspective with a focus directed inwardly at operations. Meaningful competitive strategy cannot ignore competitors, suppliers, or other external factors. A future issue of The Business Odyssey will discuss the external business environment and the influence on competitive strategy.

Notes

¹   The operational domains where competitive strategy has relevance are much broader than just customers. Throughout this article the term customer is oftentimes used, for the sake of brevity, to also include investors or prospective employees.

²   Michael Porter, Professor at the Harvard Business School, is in my opinion, the definitive author on business strategy. This does not demean the contributions of many other important writers however, I would advise anyone, with a reason to delve more deeply into business strategy, to start with Porter. As a consequence many of the thoughts presented in this issue of The Business Odyssey can be traced to Porter. Clayton Christensen, a Professor at the Harvard Business School, also deserves credit for his significant contributions to many of my views reflected in this article. Despite the appearance of blatant plagiarism my intention is to extract and apply sophisticated, complicated and proven ideas about competitive strategy to the middle-market businesses that have not fully embraced the importance of competitive strategy.

 

The Business Odyssey – An Introduction

“The journey is the thing.”
Homer

Homer’s Odyssey chronicles Odysseus’s (commonly known as Ulysses) ten year journey home to Ithaca following the Trojan War. The Odyssey describes Odysseus encountering and overcoming numerous dangers in the forms of pirates, seductresses, and monsters. Like Odysseus, businesses confront threats. These threats may resemble pirates co-opting products, technologies or strategies. On some occasions these pirates steal and defraud. The sounds of encouraging but vacuous compliments and promises from customers or investors are dangerously mistaken as commitments; possibly resulting in fatal consequences – not so different than the Sirens in Homer’s Odyssey. Ruthless competitors, customers, or investors are easily compared to Odysseus’s monster Charybdis who could destroy whole ships.

My partner, Chuck Moffitt and I each have more than twenty-years of experience advising and operating businesses. Though not exclusively, much of our experience has been working with struggling or distressed companies. I am launching The Business Odyssey as a periodic publication with each edition devoted to an individual topic appropriate for middle-market companies. The Business Odyssey is my vessel to bring to you a few of the lessons I have learned over the years.

Using odyssey in the masthead is a reminder that business is a journey. The business journey oftentimes demands overcoming crushing obstacles and navigating perilous uncertainties in order to claim the rewards of success. In this introduction I am probably overusing this literary metaphor, trying to escape the sterility of typical business writing; a practice we promise to restrain in the future.

Each issue of The Business Odyssey will be limited to an individual topic. Each article is designed to be informative but brief. I have no intention of writing an exhaustive analysis or prescriptive narrative preferring rather to highlight an idea, a concept or an issue that has meaningful value. The forthcoming articles will follow a loose logic by presenting first a more general overview followed by useful detail. The generality provides a conceptual rope that tethers specific issues together. Doing so clarifies the application of these ideas for achieving business success.

My focus is middle-market companies; those companies with annual revenues between $15 and $500 million. Upcoming editions of The Business Odyssey will address topics that range from planning to governance; financial analysis to managing uncertainty; decision making to capital structure as well as other pressing business challenges.

“Good judgment comes from experience, and experience – well, that comes from poor judgment.”

A.A. Milne

Failure is a valuable source of learning. Much of my work over the years has required me to evade the hazards that threaten businesses and jeopardize success. I hope that sharing my experience can help your businesses succeed while avoiding some of the many dangers that conspire against your success. And reassure others that the struggle need not be fatal.

#Business, #Strategy, #Management, #MiddleMarket, #Finance, #Turnaround