Why Wesfarmers is taking Coles through the checkout

Why Wesfarmers is taking Coles through the checkout

Mar 21, 2018 | Governance, Management, Strategy

It is no great surprise to me that Wesfarmers are spinning off the Coles supermarket business, and associated liquor and variety businesses. It also makes sense that they are keeping Officeworks and Bunnings, both stunningly successful businesses in Australia. Bunnings However, has failed miserably in the UK expansion, consuming capital and morale like a starving gypsy. It seems ironic that Coles thought they could beat the odds in the UK, just as Woolworths thought they could beat the odds with Masters here at home.

I do not think it is just being smart with hindsight to have foreseen the spin-off. Wesfarmers always seemed to me to be an owner that had adopted a culturally different and troubled although talented child, and was not too sure what to do with it. Despite pumping a lot of capital (around 8 billion) into the business and successfully turning it around beating the incumbent FMCG thug, Woolworths at their own game for a number of years, it still seemed to be an odd adoption.

A new Managing Director will always be keen to take the opportunity to ‘clear the decks’ of underperforming assets freeing up capital to deploy elsewhere in the hope of better returns.

New Wesfarmers MD Rob Scott is no different. Coles was a weight on the Wesfarmers balance sheet, accounting for 60% of capital employed, but returning only 30% of EBIT. Coles while a strongly cash positive business, is also the second player in a very mature market that faces a volatile future. However, it has played a role in the impressive increase in Wesfarmers value despite the nightmares that must have engulfed then MD Richard Goyder when the 2008 market crash occurred just after the $22 billion Coles acquisition in July 2007.

The FMCG market is entering a volatile period.

The channels to the consumer continue to fragment and enable the entry of innovative business models, and cashed up innovators. Aldi continues to make significant market share headway, Costco while a minnow is continuing to invest, Kaufland appears committed, and the shadow over everything is what Amazon may, or may not do.   Meanwhile, online shopping is increasing, while at the extreme other end of the spectrum, farmers markets, and even ‘pick your own‘ schemes are growing like mushrooms after rain.

Sounds like a good time for Wesfarmers to sell out of what may become a ‘legacy’ business over the next 10 years, and to put shareholders capital to work elsewhere.

 

 

Header credit: David Rowe Via Australian Financial Review.

 

 

A marketers explanation of Internal Rate of Return.

A marketers explanation of Internal Rate of Return.

Mar 19, 2018 | Governance, Management

 

This post should be read by marketers in conjunction with the earlier one that explains Net Present Value.

IRR partners with NPV as another tool in the investment choice toolbox. Both use as their basis, the forecasting of cashflow to make choices between investment options. While there are potentially a whole menu of influences over making decisions about investment options, cash as we know is the lifeblood of any business, and the measure least open to ‘management manipulation’, so should be in the mix.

The Internal Rate of Return, is the discount rate that would result in the net present value of a project to be zero.  In effect, you are  ‘solving’ for the discount rate that is used in the Net present Value calculation.

The discount rate best used in the Net Present Value calculations can be uncertain, we live in volatile times, and IRR is a means of calculating the rate given a set of investment parameters.

Businesses should set out to understand the rate at which the project breaks even,  so the IRR is the interest rate at which the NPV of all cash flows from an investment equals zero. Your investment break even.

IRR enables a ranking of projects by their rates of return to be done, rather than just relying on the NPV of the cash required. However, relying on IRR in isolation has a downside: it does not measure the absolute size of the investment.  A small investment might deliver a very attractive IRR, but be not as strategically attractive as a larger one that positions the business for growth. These are judgements  made outside the straight financial calculations, which are just tools to compare.

As with any mathematical modelling tool, an IRR calculation it also suffers from the ‘garbage in garbage out’ syndrome. Therefore the the most important part of the investigation is to understand and critically analyse the assumptions made, rather than just relying on the numbers Excel spits out to make the decision for you.

 

How to apply logic to the development of KPI’s

How to apply logic to the development of KPI’s

Mar 12, 2018 | Governance, Leadership, Management

‘If it matters, measure it’

There are many variations in that old saying, but it holds true. How therefore do we end up with hundreds of measures that seem not to matter?

Fear.

Fear of missing a measure that does matter, so we create metrics for every-bloody-thing to ensure that we do not miss one.

That is crap management.

Let’s think about measuring stuff that does matter, and then measuring it at the point where the decisions and actions that influence the outcome are made. This is tying cause and effect together at the point where they intersect, not looking at a range of data and wondering what happened to cause that!

How do we define what matters?

To me it is simple, if it moves the performance indicator, it matters. Clearly, the converse is also true.

Ask yourself, does the number of Facebook likes you have impact your profitability? If it does not, and I would contend it never does, so why use it as a KPI? It is simply a readily available metric that has no relevance to performance. It is what those ‘likers’ do with your information that counts, much harder to define and measure, but if you understand that, and the cause/effect chains, it just might move the performance needle and become a KPI worth measuring.

In short, behaviour determines the outcomes, so set out to measure the behaviours you need to deliver the performance you are looking for, not the other way around.

How do we measure what matters?

A measure without a target is not of much value, as we cannot see if any movement is relevant to performance. A measure should articulate the performance against which we need to move the performance needle in a strategically significant manner. This setting of targets is challenging if we do it properly. Applying a 3% increase in last year’s performance is not doing it properly, it is just extrapolating, accepting that history will repeat itself.

To measure properly, we need to consider the factors at work that will influence performance, seeking the causes, and measuring them, not just glancing at the metrics and having no idea of whether or not any movement is significant. Holy cow Batman, we just got another 5,000 likes on the Facebook page. Wow! But so what?

A further caution. ‘Sandbagging’ so called KPI’s is common in situations where there is little strategic linkage, and analysis of flow on impact. Two examples. Sales people when incentivised only by a target will be tempted to keep the targets as low as possible in order to achieve their bonuses.  Who has not seen that? Purchasing people incentivised only by purchase price will not care too much about the performance of the cheaper version they opt for, which in the factory, may corrupt the efficiency numbers, and have a far greater financial impact than the saving of a few bob on the initial purchase price.

Do not focus on averages.

Too many times I see piles of measures, taken at a high level, so that they reflect the average of a whole lot of other factors. If I have one foot in an ice bucket, and the other in the fire, on average the temperature of my feet is about right.

Nonsense.

Measure the outliers, the things that are unseen in averages in order to better manage them. For a KPI to be meaningful, it has to influence the outcome. Removing one foot from the fire will influence the average, but if I have not realised that the effect is caused by the removal of the foot in fire, I will at some point put my foot back in the fire.

I do not remember much from the statistics I did 45 years ago at university, but one of the ideas I do remember is that of standard deviation.  I recall little of the mathematical gobbledy Gook and probably do not need to any longer, as the formula is in Excel, just fill in the boxes, but I do remember what it means. (Forgive the pun).

In the normal distribution curve we are all familiar with, 68% of outcomes are within one standard deviation of the mean. These can reasonably be classified as an ‘expected’ result, given that forecasting is not an exact science, it is just a best informed guess, and the level of ‘informed’ varies hugely, depending on who has their mouth open at any one time.  95% of outcomes fall in the range of 2 standard deviations, and 99.7% fall in the range of three standard deviations. This is commonly called the ‘Rule of 68’

A focus on the unexpected, the outliers, will give you far greater leverage on the outcomes than a focus on the averages, or expected. It might lead to taking one foot out of the fire, and understanding that this is what has caused the increase in the comfort level.

 

 

 

 

 

Defining the outliers, like most things in life, can be made easier by imagery. A core piece of process improvement is defining the levels of variability, and then seeking to understand the causes of that variability. A visual way of communicating this is a performance graph that includes what you define as the limits of the variability you would consider to be ‘normal’. Commonly this is called a ‘statistical control chart’, and includes the upper and lower limits of what can be expected. Anything outside these limits needs to be investigated.

Anything inside the control limits is by definition, ‘normal’ and therefore not necessary to spend a lot of time considering. What however is worth great consideration is determining what the control limits are, where the normal becomes abnormal, which is where action must be taken. Over time, in an improvement process, the control limits will be progressively tightened as the outliers are progressively understood, so they become part of the normal, or eliminated.

 Cascade the KPI responsibility

Having any more than 6 or 7 KPI’s to manage creates a situation where we skate over the top, not able to devote the time and energy to improving the things that matter, that move the performance needle. The things that really matter will be different at each level, and in each part of the enterprise.  Therefore, constructing KPI’s relevant to each role should be a core part of the process of managing the resources of the enterprise, and especially in encouraging the behaviour we want  that will collectively, move the performance needle. Within each functional area, there will be a cascade of KPI’s that together add up to the 6 or 7 KPI’s to which the functional manager is held accountable. This is not to forget that the processes we are measuring are very often cross functional, and ignoring those cause and effect chains leads to sub optimal performance as in the purchasing/operations example noted earlier. This can be addressed by ensuring that the purchasing manager has a KPI that involves operational efficiency in the measurement.

Use the narrative in reporting.

A dashboard of a few easily understood performance indicators is terrific, it tells you what has happened, but lacks two vital pieces of information: Why it is happening in this way, and what should be done about it.

Narrative is the best way to communicate these vital factors, the core of great management, indeed, leadership. Knowing clearly what is happening is step 1, steps 2 and 3 are what make the difference between the companies that struggle to survive and those that prosper and grow. Illustrating these narratives with graphical KPI movements over time is a powerful way to illustrate the impact of performance at any level.

 

Credit Wikipedia: Rule of 68-95-99.7.

Header credit: Hugh McLeod Gaping void

 

A marketers explanation of Internal Rate of Return.

A marketers explanation of Net Present Value (NPV)

Feb 12, 2018 | Governance, Management

‘What the Hell is NPV?‘ the marketer cried

Accountants seem to love to baffle with jargon, but that is not, usually, what they set out to do.

Rather , they use terms as a shorthand to describe what to them makes absolute sense, but to the rest of us, mere marketing mortals, seems like gobbledygook.

One of the ones that commonly causes headaches is ‘Net Present Value’  or NPV.

Guaranteed to put most marketers to sleep.

However, you should not sleep, way better to understand the idea in simple  terms so you have an understanding of the conversation, and can contribute in a meaningful way.

NPV  is simply one of the common methods of calculating the relative value of a number of investment choices. It recognises that money you have today is worth more than money you may have tomorrow because it can be invested,   used now, while the ‘future money’ is subject to inflation and risk.

Often the term ‘time value of money’ will be used.

It is one of a suite of calculations that can be used when sorting out which projects to pursue from a range of possibilities. It provides an objective measure that enables you to make better choices, that management challenge in a world of subjectivity, conjecture and bullshit.

Marketers should understand the principal, if not necessarily the formula, which is readily available in just about every spreadsheet application since  Visicalc. Remember that? I do, it became a marketers best friend, years before excel emerged.

The formula is relatively simple, it just looks a bit complex.

The discount rate is the rate of inflation used, plus the amount you choose to add to allow for risk.

Most businesses use a consistent discount rate that reflects their return on investment hurdle rates. For example, if the current inflation rate is 1%, and the business requires an 8% ROI, the discount rate will be 9%

The great benefit of NPV to marketers is that it uses the cash flows derived from a proposal to sort out the priority, not just the quantum of the initial investment, so  it reflects the forecast cash success over time.

For example, you want to invest $3 million in gear to launch a new product, that is forecast to deliver a net profit of $1.3 million/year for 3 years, with a discount rate of 9%.

There are a number of sequential steps to take.

  • Calculate the present value of each years net profit by dividing the net profit by (1+discount rate). In year 1, that is 1,300,000/(1+.09) or 1,192,661. The ‘1’ in the formula being the current inflation rate
  • Repeat the exercise for each subsequent year, in year 2, it would be 1,192661/(1+.09) or 1,094,184.
  • In year 3 1094,184/(1+.09) 1,033,838
  • Add the present values calculated, 1,192,661 + 1,094,184 + 1,003,838 = 3,290,683 to give you the total forecast present value of your money in three years, then subtract the initial investment to give you the net present value of the investment.  $3290683 – 3,000,000 = $290,683.

The larger the positive number the better, a negative number would indicate that the project will drain cash from the business, a positive one adding cash.

To make the choice between investment options, repeat the exercise for  each, and pick the one with the highest positive value.

Clearly, the calculation is based on a series of assumptions and forecasts, so there is a lot of room for error, but when used in a consistent manner it is a good tool to assist making difficult choices, and offers the flexibility to do some informed scenario and ‘what if’ planning.

 

 

 

 

The easy way of course is just to go to excel, and look for NPV in the formulas tab, which will give you the numbers, but not the understanding of what they mean.

Photo Credit: Bentley Smith via Flikr

8 clichés every entrepreneur should consider

8 clichés every entrepreneur should consider

Feb 5, 2018 | Customers, Management, Small business

Clichés become clichés because they make sense, and are widely used, so they pass into the language. Unfortunately, common usage often makes them appear flippant, a throw-away line that means nothing.

That they take on that label does not make them any less valid, in fact, becoming a cliché is almost like getting an endorsement for wisdom.

Following are 8 that entrepreneurs embarking on an enterprise, whether it is the next Uber,  starting a cleaning business in your local area, taking on a franchise or a multi-level selling ‘opportunity’, that you should consider.

 

Cliché 1. Know where, and who, you are.

Irrespective of the starting point, starting a business is a journey. If you are going to start a business, recognise  that it will consume you if it is to be successful. It is not like being an employee, irrespective of results, at least for a while, you get paid to turn up.

Not so now.

Starting a business takes a heavy toll on not just your financial resources, but your resilience and personal relationships as well. Being prepared for the long hours, stress and uncertainty is a good start, you must know yourself well.

Cliché 2. Know where you want to go.

Many become tangled up in visions, missions, values, business purpose, their Why, and all the other ways that have become ‘popular’. All are valid, all have their place, but I ask my clients a simpler question; What does success look like? When you can answer that question, you have at least enough of an idea to start, but if the answer is purely financial, you need to do some more thinking.

Cliché 3. Have a plan.

There are lots of clichés about plans. Prominent amongst them are: ‘no plan ever survives first contact with the enemy‘, and  ‘failing to plan, is planning to fail‘ and both are right. Point is that unless you have a plan, you have no chance of understanding and managing your progress towards the goal, which tactics worked, and which ones did not. All crucial pieces of information. There are many planning models, each with their own emphasis, and I always recommend that you use several in the thinking part of the planning process as a way to ensure that things do not get missed.

Cliché 4. A journey of a thousand miles begins with a single step.

Planning is the easy part, the hard bit is to take action. Without action, nothing happens, nothing!

Taking the steps, getting outside your comfort zone is why you are going into business for yourself.  Curiosity, an idea, recognition of a need you can fill, a problem you can solve, all are great reasons to go into business. All it takes is the first step, and it is always the hardest.

To add another cliché to the list: ‘hope is not a strategy’

Cliché 5. To succeed, you must have something others want.

Success in business is dependent on being able to deliver superior value to customers, at a cost that delivers you a margin. If you cannot deliver value, almost always the solution to a problem, which can be anything from a more efficient power station, to a better tasting tub of yoghurt, to on time delivery, or something no-one else can do, at a price the customer is happy to pay, you will  not survive.

Tough but simple.

Cliché 6. People have to know you are there.

Even if you do have the next greatest thing, you cannot sell it without  others who may need or benefit from your gizmo knowing about it. Marketing is essential. The process of gaining understanding how you will deliver value to whom, while making a profit on the way is make or break for every business, particularly a new one as generally you cannot afford to make mistakes. Selling skills are as important. Not only do you need to sell to your potential customers, but to the banks, your suppliers, and often even your partner. If you cannot sell, and do not want to learn how, do not go into business for yourself.

Cliché 7. Watch the pennies and the pounds will take care of themselves.

There are two aspects to this cliché. Cash is the lifeblood of every business, and you need to watch your cash the way a mother bear looks after her litter.

The first is to do a regular, I strongly recommend weekly, cash flow forecast. Make it a part of the way things are done in your business. At first it may seem strange, but it pays off, as you will always know your cash position, which will be a huge stress reliever. As a side benefit, trading while insolvent is illegal, and the simplest measure of solvency is can you pay your bills as they fall due.

The second is the behaviours you are setting out to build. Results come from the way things are done, as well as ensuring the right things are done, and if you want your staff to be as frugal with your money as you are, you have to  build, that behaviour deliberately. A weekly cash flow forecast with the appropriate level of staff engagement and contribution is a very good way to start.

Cliché 8. Work on your business, not just in it.

The ability to see your business as others  see it, customers, potential customers, and competitors, is essential to success. To have that external perspective, you must be able to extricate yourself from the day to day pressures of getting stuff done. It leads on to what could have been an addition the list, ‘do what is important, but not necessarily urgent’. Knowing what is important to the long term health and prosperity of the business is more about how others see you than it is about responding to those unimportant but seemingly urgent  things that pop up every day.

So, remember, all that glitters is not gold, but good advice can be.

 

 

How do you measure the scalability of your business?

How do you measure the scalability of your business?

Jan 23, 2018 | Change, Governance, Management, Strategy

Almost every business I know  seeks to grow, as there is a recognition that growth brings benefits beyond simply the size of revenues and profits. It  brings credibility, attracts good employees, enables negotiation from a stronger position, and much more.

It seems to me that there are four macro measures that can be applied, each with a few key sub measures that can be used as appropriate.

‘Stickiness’.

This is a term I use to describe a combination of factors vital to the health of every business.

  • Customer retention rates. How much customer ‘churn’ do you get, how long is the average ‘ ‘lifetime’ of a customer, and what is the subsequent lifetime value of a customer. Associated with customer retention is the cost of customer acquisition. At some point, investment in further customer retention will start to deliver diminished returns. It is therefore sensible to have a parallel process in place that delivers a steady flow of new customers coming in to replace those that do move on, and build the spread of customers and the penetration of your preferred markets.
  • Share of Wallet. Regular readers will be aware of my attraction to this measure. In effect, how much of a customers purchases that you could service, do you actually attract. Calculation becomes an important strategic exercise as it forces you to consider which types of business you can and want to service, which markets you are able to compete in effectively, and the relative power of your value proposition in any market segment.

 

Referrals.

How likely are your customers to refer you to others? When an existing customer values the services you provide sufficiently to recommend you to their own networks, that is marketing gold. One of the formal measures that has gained a lot of traction is the Net Promoter Score. This is a very binary system, which has its merits, but I like to see some qualitative evidence as well, gained by customer stories, feedback, and various answers to the question ‘where did you hear about us’?

How likely are those in your value chain to recommend you, these referrals are as useful and relevant as those from your customers, as they have a commercial relationship with you, and are in a great position to judge.

Margins.

The simple word ‘Margin’ can have different meanings to different people, particularly accountants, but in its simplest form, is the profitability divided by revenue. However, you do not bank percentages, just dollars, so you also need to consider the absolute amounts of money that can be made from a market. Generally the higher the margin, the better, but generally, higher margins attract competition, so over time margins become eroded. The key is  to make the margins sustainable, which requires appropriate strategic investments to be made.  Measurement  of margin can take many forms:

  • Customer margins can be measured both individually and by group, depending on the nature of the business.
  • Product margins similarly can be measured by product and product group.
  • Both the customer and product margins can then be further measured by geography, market segment, and any other sensible parameter. The absence of margin management is a sign of poor or at least lacking management, and the mixing of marginal costs, particularly in the case of a manufacturing business, with overheads is a significant drain on management ability to make informed price and cost management decisions.

Investments.

Effective financial management captures all investments of cash irrespective of the nature of that investment. It makes no distinction between operational and regulatory investments necessary to keep a business functioning, and those that have some risk associated with shoring up future revenues and margins. Investment in marketing, innovation, staff capability, process optimisation and others do not routinely turn up in financial statements, but without them any business is doomed, so seek them out in any due diligence exercise.

Good businesses make the investments in line with their strategic priorities, and track the outcomes of those investments over time.

Need help thinking about these issues, give me a call.