Sep 30, 2022 | Governance, Leadership, Strategy
At a time when the market value of a business bears no relationship to the financial balance sheet, when PE ratios of market darlings are counted in geometric multiples, something is wrong.
Currently the PE ratio of stock market darlings: Apple at 33, Microsoft at 39, Alphabet (Google) at 34, Facebook at 30, and Amazon an eyewatering 68, are completely disconnected to the tangible assets of the businesses. By contrast, the PE ratio of some of the industrial stocks which built the economies we currently enjoy, GM 9, Ford 9, GE zero, (25 years ago the biggest company in the world is trading at a loss) still reflect tangible asset values.
The governance and operational reporting of business is often left in the hands of the CFO. They produce all the numbers and do most of the analysis of those numbers, as well as determining the investment choices other functional heads make by way of budgets, and the accounting for the spending of those budgets.
Several things have changed recently, on top of the rapid change that was proceeding up to 2020. The drivers of our economies took a dose of steroids from Covid, which not only accelerated the rate of change, but drove it in unpredicted directions.
- The accounting function deals with patterns and reporting that relies on history. This is a very poor guide to what happening around us now. The landscape has changed fundamentally, and that rate of change is not slowing down.
- Legacy systems now includes much of the stuff that was installed last year. Digital transformation has happened, redundancy is now counted in months, not years and decades.
- Business models have changed dramatically. Online ordering, and ‘no touch’ delivery of various types, previously struggling to get a foothold in many categories have taken off, while those that were already strong, have had their pedal to the metal. Legacy business models are dead. For accountants, trying to make sense of all of this while knee deep in the financial and governance accounting required, have run out of the gas necessary to accommodate it.
- Suddenly there are new power bases within an enterprise. All sorts of ‘Chiefs’ have emerged from hiding, and a few new ones have popped up. CDO (chief digital officer) CMO, CIO, and others that now have as much grunt at board level as the CFO, changing the nature of boardroom debates. ‘Traditional’ accounting is struggling, and largely failing, to keep up with the reporting and forecasting of increasingly fast cycle times and changing market and regulatory demands.
- How should the CFO deal with the accounting for innovation and change? The key for them is to learn much more quickly than they are used to doing, so they can recognise the demands, risks and costs of innovation, and think their way around the legacy accounting systems to deliver some sort of innovation and qualitative scorecard that fills the need for quantification.
- Sorting out Capex priorities, used to be done by business plans and discounted cash flow models driven by the often optimistic forecasts of marketing people. They usually relied on history to deliver an extrapolation, with allowances for the vagaries of new stuff. The time frames are now much shorter, the 10-year depreciation schedules allowed in financial accounting have become irrelevant when you are dealing with radically shorter equipment life and competitive needs.
- The significant move has been from a balance sheet that had little influence exerted by qualitative stuff, to a balance sheet structure that absolutely fails to reflect the real value of an enterprise, i.e.: what is in people’s heads. Those assets walk out the door every night and make choices about what to do tomorrow. This was previously a challenge, now it is a huge problem. The stock market calculations of start-ups with small if any revenues, but a few employees with a great idea can run to billions in the extreme case. They are backed by no hard, resalable assets at all, making valuation a nightmare for accountants.
What is a Strategic balance sheet?
Just as businesses undergo a regular financial audit, to ensure the appropriate governance and consumption of the enterprises resources, and account for the gains and losses of owners’ equity, so should it undergo a process of a Strategy Audit.
The financial balance sheet has a key role in articulating the ‘balance’ of assets and liabilities built up by the business, the difference between those totals is the owners’ equity, or what is left over to repay owners for the risks they have undertaken in lending the enterprise their money.
A standard balance sheet is a document assembled with historical data. It is subject to considerable ‘management’ by the valuation and classification methods employed in determining how an item will be treated.That is no longer even a fraction of what is requred to reflect the real competitive and strategic health of an enterprise.
Strategy drives the way resources will be deployed today in an effort to harness and maximise the potential for future returns.
This process of identifying the drivers of performance, and forecasting the optimised outcomes, is considerably harder than simply extrapolating the past. The only thing we know for sure about the future is that it will not be the same as the past, and even present.
Therefore, the strategy audit process is more qualitative. This does not mean that data and critical thinking should be thrown out the window as often happens, it makes it even more critically important.
Building a Strategic Balance Sheet is an iterative process. As you cycle through the expected costs and outcomes of strategy implementation, you will learn more and more about the relative weight, timing, cause and effect chains, and the trade-offs that exist between them. Being difficult to do means very few are doing it.
What an opportunity for those few who can get their heads around the drivers of strategic success and start to quantify them.
What do you think?
Send me your suggestions.
Sep 16, 2022 | Change, Governance, Strategy
In an economy desperate for productivity, how often does stupid, mindless bureaucracy get in the way?
This is not an argument against bureaucracy, rather it is an argument for strategic common sense. It is a nonsense to apply one standard across a myriad of differing circumstances, allowing no margin for reasonable error, then penalising tiny acts of reasonable noncompliance that do no harm.
A tale of woe.
One of my mates runs a small freight company based in a town in the central west of NSW with his two sons. He carries a range of agricultural goods, from grain to fertilisers to live animals, and has built a successful business by skilfully providing specialised services requiring investment in customised trailers designed to meet these specialised needs.
I spoke to him on the phone yesterday as he fumed at yet another example of bureaucratic stupidity making his life a misery.
One of his sons had been pulled up earlier in the day and fined $600 for being 40kg overweight in a 68,000 kg load of grain, loaded from a farm silo without a weighbridge. This is an error margin of .059%, hardly earth-shattering, presenting no danger to anyone, and absolutely understandable given the lack of expensive public infrastructure at the loading dock. The monitors on his axles, properly calibrated and checked, showed no overweight at the time of loading. His assumption is that one axle was in a very slight depression not visible to the naked eye in the loading area.
This is the second time in a few weeks this has happened.
His solution: get out. He can retire, remove the stress of running a small capital intensive business, and his sons will make more money doing something else. Meanwhile, the grain, and live animals he transports either stay where they are, or the costs of moving them go up dramatically as the haulage contractors either charge more to cover the risk of such tiny errors, or simply take less on board.
These standards are set and enforced by the ‘National Heavy Vehicle Regulator’ which has operations in each state. In NSW, there are 310 admin staff and 250+ compliance inspectors, according to their website. I wonder if any will jump in a truck to move the freight when my mate closes his business?
Who knows how the standards are set.
My assumption is that the big operators, Linfox, Toll, and perhaps a few others sit around with a few bureaucrats, agree some stuff, and go to lunch. The big operators go from weighbridge to weighbridge, they are unlikely to ever go up a muddy track to a paddock to take on a load of cattle or sheep to go to the abattoir, or a load of grain in an isolated silo going to a processor.
Is it any wonder it is getting harder to keep the supply chains moving, when the experienced owner-drivers are being driven from the chain by bureaucratic short sighted stupidity imposed for no good reason. The undertrained and inexperienced drivers being pushed in to fill in the gaps are a greater danger to themselves and everyone else on the road than a truck 0.059% overloaded, driven by an experienced driver with skin in the game.
Update: September 23, 2022. This ABC article dramatically underscores the point made in the post.
Sep 14, 2022 | Change, Management, Strategy
Scaling is the objective of every SME I have ever dealt with; they all want to get bigger. In every case they have the same three challenges.
Which activities do they Eliminate?
Which ones do they Delegate?
Which ones do they Automate?
EDA: the challenge of every SME.
The common challenge in them all is that they require change, and human beings, particularly busy ones, avoid change. This is the case even when they recognise that in the longer term, the change is necessary. The problem is finding the time to invest in figuring out what that the change must be, as that is an investment of time that is at a premium, without an immediate return. Besides, change makes us all uncomfortable.
Elimination.
This should be easy, but is often hard. The test is to define the value of the action, and if it is less than the cost, eliminate it. Before desktops, managers relied on regular printouts from mainframes to give us the information needed. Those under fifty may not remember the big dot matrix printed files that emerged in continuous sheets, often for further analysis by hand. These reports tended to multiply like rabbits on heat. One report responding to a once off information request resulted in that report being produced every time the report cycle ran, weather it was needed or not. In an effort to reduce this tree killing activity, I once put a line through most of the list of reports produced weekly for my department, not telling anyone, waiting for the screams. They did not come, nobody noticed. Eliminated. A simple example of what often needs to be done.
Delegation.
If it cannot be eliminated, can it be delegated? Someone who costs 150/hour doing a task that can be done by someone costing $50 is simply a non-productive use of resources. Again, delegating is easy to say but often hard to do. Everyone has established routines and delegating requires trust and change.
Automation.
When a task is necessary, cannot be delegated, and is done more than once or twice, it should be automated. The opportunity for automating tasks is limited only by imagination, the determination to do it, the time to specify it, and usually a modest investment of time and money. Automation of what used to come to me in huge printed blocks from a mainframe has been done by the advent of personal devices and ‘apps’. Information can easily be consolidated and tailored for the specific needs for which it is required. While the goalposts are continually moving as to what can be done, there is no task in an SME I have seen that cannot be at least partially automated.
EDA should be a standard item on every management improvement agenda.
Sep 2, 2022 | Marketing, Strategy
Some hard lessons will need to be learnt by the new crop of marketing managers who have never faced the evil of a recession, and even worse, one that has inflation as its bed-fellow.
Stagflation.
This is not supposed to happen, but it is, and we are seeing the first hints of it currently. Inflation growing rapidly, full employment, low interest rates lifting rapidly, we are facing an economic jigsaw that is defying conventional thinking.
Gone are the days when marketing could believe that failure was good, it was a learning opportunity for leveraging in the next round of potential failure. Increasingly the built in tolerance to failure will be tested, with an increased focus on pre experiment due diligence to reduce its incidence.
At last, we will revert to the core of business sustainability: Profit.
The absence of profit means that eventually, depending on the depth of your pockets, you will go broke. Nonetheless, marketing wankers for the last decade have been seduced by the comforting idea of ‘Purpose’. Often this seems to have overridden the old fashioned idea of delivering value to customers that leads to making a profit.
Every brand has a purpose they say. Heavens, I just want my washing soap to be an effective cleaner, my toothpaste to clean my teeth and leave a nice taste, my internet connection to work, and my car to start on cold mornings.
Having an explicit, relevant, and well understood Purpose is great. It provides a focus for the strategic choices that need to be made, and acts as an aligning ‘North Star’ for all stakeholders. However, purpose over profit is stupid, and the price of stupid is extinction.
Header cartoon credit: Thanks again to Scott Adams and Dilbert for clarifying and simplifying a complex question.
Aug 29, 2022 | Change, Innovation, Strategy
For some years academics have been mumbling to themselves about an observed phenomena they generally called ‘Flattening‘. The discussions have been centred around technology, but the impact can be seen in a much wider context.
The idea is that technology acts as the rising tide in the old saying that a rising tide lifts all boats. By rising the average level of the ‘water’ the differences between individual companies and industries are removed, that the offering becomes increasingly homogeneous until a new technology arrives, lifting the owner clear of the competitive debris.
There are numerous examples.
The emergence of the Internal combustion engine wiped out long established industries and companies in the horse drawn wagon, whip, and horse breeding and breaking industries of the time. As they disappeared the automobile industry and its supply chains emerged, now in the early stages of being ‘flattened’ in turn by electric vehicles.
Before the internet, information existed in small silos and did not move much, and then only slowly. Industries that relied on those characteristics were ‘flattened’ out of existence. Yellow pages, classified newspaper ads, and in their place emerged new industries. Google, Facebook, and the plethora of other communication and search platforms.
Let’s consider energy production.
For thousands of years people used wood or coal to heat their houses and water. In 1698 Thomas Savery patented a machine that drew water out of flooded mines by using steam pressure, then in 1784 James Watt patented the steam engine, which for the next 150 years powered most industrial development. In 1831 James Faraday created the first very simple electrical generator that converted mechanical energy to electrical energy.
So what you ask.
Look at the current environment with the concept of ‘Flattening’ in mind.
Internal combustion automobiles are in the early stages of being ‘flattened’. This has been initiated by Tesla, in parallel with the batteries required to run the cars, but which will have huge implications across the energy sector.
Coal, the dominant world source of energy has suddenly become a pariah. It is polluting the atmosphere with the attendant changes in climate, leading to rapid growth of renewables, both personal and commercial scale. New fossil fuel projects, especially coal, are now being locked out of capital markets as they see their investments being stranded. Only idiot governments with an eye to donors is keeping them alive via subsidy and barriers to entry of renewables.
The tide however is inexorable, and fossil fuel will be redundant soon. As Hemingway noted in the Sun also Rises, when one of his characters was asked how they went bankrupt: “Gradually, then suddenly’ was the response.
That is what is happening in power generation.
Renewables have been around for 25 years, slowly evolving as the technology improved. It seems to me we are at, or almost at, the ‘Suddenly’ point. In the absence of being in front of the wave of changes, we will be left behind in the technical race to build the new industries that will emerge, again.
Flattening is also happening in some way in your domain, it is the normal course of development. the challenge is to see the elephant and react to it in time.
Aug 15, 2022 | Leadership, Strategy
Strategy is an exercise of informed fortune telling.
What will happen if we do this? Is that better than if we do that? How will others react, do the ducks really all align the way they seem to?
A thousand questions we set out to answer to allocate our resources to best leverage the outcomes we plan/hope will emerge.
It is a messy business, full of uncertainty, mistakes, dead ends, and outright failures, most of which we hear little about. Instead, we hear a lot about the few successful exercises in strategy, the few that work as hoped, or as is usually the case, not as planned, but great outcomes.
We read about the success because people can analyse them with the benefit of hindsight, which delivers to those developing the strategy, some level of prescient certainty that they almost never deserve. Fact is, your strategy will never be spot on, the magic is in the ability to adjust on the run, while achieving the outcome for which you planned.
The strategic process benefits from being subjected to informed and critical thinking being applied to the inputs, both quantitative and qualitative. The greater the level of critical thought and diverse thinking that can be brought to bear on a strategic challenge the better.
The context of strategy implementation is always different to the context in which you do the planning, simply because it is the future, and things evolve in unpredictable ways.
I expect that in about 12 months there will be a rush of erudite papers and articles reporting on successful Corona instigated transformations. These will make the protagonists look like they had great foresight others lacked, when in fact, while they ended up with the lollies, they were as confused and muddled as the rest of us during the lolly fight.
They had the benefit of hindsight to clean up their bedrooms before anyone came along for a look.
Strategy is messy because it lacks hindsight
