SOPHISTICATED FINANCE

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A Competent Team

This morning I played hooky and joined a joint training exercise on search and rescue between the USCG Auxiliary and the Miami Fire Department. The fun part was that I got to see the MFD's new jet propelled rescue boat and all of its fantastic on board equipment. The interesting point, from a management perspective, was to meet the firemen that command and crew this boat and an equally impressive sister ship.

There are about eighteen officers and firemen assigned to the two rescue boats. Everyone of these individuals has the following qualifications:

1. Trained fire fighter
2. Trained marine firefighter
3. Trained rescue and salvage diver
4. Holder of a Six Pack license, which is a US Coast Guard license to operate a vessel with up to six passengers
5. Many specialized qualifications, such as HAZMAT, EMT, etc.

These are very competent people based on any system of measurement. With all of this experience MFD sought out further training in specialized areas, such as search and rescue, from the USCG and the Auxiliary.

Lessons to be learned from this little story:

1. Do not be afraid to set high standards for employees; they can be met
2. Train employees constantly to improve skills and performance
3. No matter how elite your organization, there is always somebody who you can learn from (and do not be afraid to ask)

As I have mentioned before, the more I learn about the U.S. military and the first responder community, the more impressed I am with their training methods and staff development programs.

A Common Mistake

When I was young I made the same mistake a few times. Yesterday a prospect made the same mistake, which prompts this post.

When you enlist the advice of an advisor or expert, such as an investment banker or a lawyer, do not present your solution and ask for confirmation. Present your problem and ask the expert for possible solutions. If he does not mention your idea for a solution, then you can raise it. The advantages of presenting the problem are several:

1. You will get a range of solutions, many of which are probably better than your idea
2. Your discussion will be more efficient because the expert will understand the real problem, which means that people who charge by the hour will need less time to really understand
3. You will learn more by letting the expert list all of the possible solutions

Yesterday's prospect said he had a marketing issue and he needed to do X or Y. His company has revenues of about $3 million. No company with such small revenues has a marketing problem. The company either has a sales problem or a strategy issue. I still don't know what the problem is because the prospect only talked about his proposed solutions. Also, bad sign that he used the M word, but let's see where it goes.

Layoffs are for Cowards

It seems like every day another large company in the U.S. announces layoffs of thousands of employees. Thousands of lives are totally disrupted (if not destroyed) by incompetent management.

There is considerable debate about whether the purpose of a corporation is to first serve the employees or the shareholders. Not surprisingly, Americans favor the shareholder and Europeans and Asians generally favor the employee. Good cases can be made for both positions, but what bothers me is that the two positions are not mutually exclusive.

If we look at most of the recent layoffs in the U.S., I do not believe they were caused by a drop in demand. Rather, senior management was lax in reviewing staffing requests during good times and when times got more difficult senior management did the easy thing and fired the excess staff. Simple, cowardly and incredibly painful to the workers who lose their jobs. I believe, in fact, most workers would opt for a pay cut if it allowed everybody to stay employed at a company (but at a lower salary). Of course, someone might criticize the U.S. company that it was being considerate of the employees--heaven forbid!

A better approach to staffing is as follows:

1. Rigorously review new staffing requests at all times--not just when times are tough
2. Challenge executives to justify why improved IT systems would not be a better alternative than hiring more people
3. Hire the best people--they need less staff
4. Outsource functions that are not part of core competencies
5. Train and develop staff constantly
6. Fire senior managers who do not have a successor in place or at least identified (managers who can not think about succession or backup are not qualified for their position)
7. Avoid prima donna executives because they create inefficiencies (especially in staffing)

My approach creates a very lean organization of competent people who have a heavier workload, but this kind of organization does not lay off people. First, this type of organization is more profitable and second, every person is critical to the operations of the company.

I hate layoffs and I think they are proof of poor and cowardly management.

Enough idealism for one day.

Photo credit

Another Way to look at Customer Focus

In June last year I did a post entitled Understanding the Customer. This post focused on Gerald Zeitman's use of seven metaphors to explain human behavior. As a refresher, the seven metaphors are shown below.

What this exhibit made me realize yesterday (as I was doing my webinar) is that great companies focus on a single metaphor. In other words, if great strategy is based on a profound understanding of the customer, then the ability to focus on a single metaphor is the key to a successful strategy.

Now this conclusion may just sound like a repeat of the mantra "focus, focus, focus" that is a key to any company's success. However, I think that if you evaluate each strategic or tactical decision in terms of whether it enhances the metaphor for the customer, then I think you have an easily understood tool that should lead to better decision making. Perhaps an example will help.

Let's look at AMEX, the credit card company. You are faced with two alternatives: 1) launch a black card for super high end customers or 2) acquire a brokerage business. The metaphor that explains AMEX's success with customers is transformation. AMEX is satisfying the need for people's change in status to be recognized. Therefore, AMEX should choose to issue a new black card and avoid entering the brokerage business. The brokerage business doe nothing to recognize status.

Now the key to using this concept is in properly understanding which metaphor the company is satisfying. Coming to the correct conclusion will be a process that will greatly enhance your understanding of the customer. And, in the end, that's the key to successfully growing a company.

Florida Awards Grant for Ethanol Plant

The government of the State of Florida does certain things well. One area where they consistently make good decisions is in environmental matters, whether it be in wet lands reclamation, state parks and marinas or support for clean tech. Yesterday's announcement may be another good example.

The Florida Farm to Fuel initiative has awarded $7 million to Verenium to build an ethanol plant in Florida using renewable grasses. Verenium Corporation (Nasdaq: VRNM) develops proprietary enzymes for biofuel applications.

Always encouraging to see tax dollars going for an apparently worthwhile project. Even better when the project is environmentally sound.

A Professional Finance Network--Finance 3.0

I meet a lot of start up executives in the course of a year. Many are involved in Web 2.0 businesses and unfortunately many do not have a clue about how to get a company off the ground or build a web following for their site. Every once in a while I meet someone who "gets it" and I track the development of their business. Such an executive is Daniel Chow. I have been impressed by the continuous improvement and feature expansion of his "Business & Finance Professional Education Network"--Finance 3.0. 

Daniel is a full-time executive based in Hong Kong who works for a leading international media company. He formerly held positions with Arthur D. Little, a world class consulting firm, and Deutsche Bank, where he worked in investment banking. His background is analysis and finance and that may explain why I find the content on the site of such good quality--especially in finance and modeling. I spend a lot of time on business and finance sites and Finance 3.0 is one of those rare sites that combines high quality, correct information with the distinct absence of a lot of self-promotion by the participants. In many ways Daniel has achieved what LinkedIn would like to be.

I had the occasion to interview Daniel by email and his responses to my questions are below.

1.  Are you the founder?

Answer.  Yes I am, along with my wife Retha and sister Michelle.  The 3 of us are all experienced finance professionals with several years of experience working with Wall Street firms, Big 4 CPA firms and multi-national businesses across the Asia Pacific region.  We feel fortunate to have the depth of talent and resources within the family, which allows us to make decisions and respond to customer requests quicker then others.
 
2.  When did it start?

Answer.  We started our sister site - Financial Modeling Guide - in June 2007.  A community element was added - Financial Modeling Community - in Feb 2008.  In Oct 2008, the community was rebranded Finance 3.0.  Finance 3.0 is now the "mother ship", with Financial Modeling Guide (and hopefully other finance & accounting sites, with time) forming part of the Finance 3.0 network.
 
3.  XXXXX is your full time job and Finance 3.0 is your night job?

Answer. Not just nights, but weekends and almost all holidays as well :) As much as I would love to work on Finance 3.0 full-time, it is only prudent for us to manage our cash flow as we evolve (and bootstrap) the business.  However my wife Retha, has recently left her job to work on Finance 3.0 full-time.  She spent 8 years with PricewaterhouseCoopers in Singapore and Jakarta, working across their M&A advisory and assurance practices.  She now helps to manage our new product development efforts.
 
4.  Future direction for the site?

Answer. Our vision is to build a financial education resource that every finance professional will turn to whenever they have questions and training needs.  We currently distribute professional finance products (spreadsheets, software, books, etc) and sell advertising.  We are developing a subscription based e-learning product for finance & accounting topics.  With time, we hope to evolve a business model with equal-part contribution from subscriptions, e-commerce and advertising.

This business model can only be successful with continued emphasis on quality and balanced editorial (no bias, no spam).  Our customers should associate Finance 3.0 as a premium, world-class resource completely focused on their continuing professional education needs. For this reason, I continue to invest a lot of time on the site as a writer and community moderator.
 
5.  What mix of readers / users do you have in terms of geography?

Answer. The United States and India were our 2 largest markets by far.  The United Kingdom, Australia and Pakistan follow closely.  In the year of 2008, our page views were in the millions, from 222 countries & territories, of which 75% were new visitors.  There continues to be a lot of growth potential from both existing and new visitors. We are excited by the opportunity to build a dominant position in this financial media niche, across both developed and developing markets.

Check out Finance 3.0. Well worth the time.

Webinar--How to Develop the Business Concept

I will be presenting my first webinar on Tuesday, January 20 from 11:00 am to 12:00 EST. The subject I will discuss is "How to Develop the Business Concept". This webinar is in part developed from the lectures in my Entrepreneurship course at FIU. I use a very practical 5 step approach. This is not a presentation on how to write a business plan, which would bore me and you to tears.

To join the webinar, go here. The nominal fee goes to the Pino Entrepreneurship Center at FIU.

Former students, hecklers and people trying to avoid doing their SEC filings are also welcome :)

Key Performance Indicators--III

This is the third and probably last post in the series on key performance indicators. Previous posts are here and here. This is the war stories post, but because I always develop KPIs for any company I am involved in, I do not have any near death examples. A positive example follows.

A few years ago I ran a telecom company offering voice and data services to businesses. One month I noticed a precipitous decline in gross margin. Turned out one of the owners had contracted for a new fiber ring to carry data traffic (part of cost of sales) at a cost of $65,000 per month. Since this made no sense to me I determined how many data customers we had at the time. Answer--18 customers (KPI-1) paying $20,000 in total per month (KPI-2). Great, we have now increased our negative cash flow by $65,000 per month (after I had spent a year to get us to cash flow break even). So what did I do.

I created an incentive scheme to highly motivate the sales force to sell data. Each sales person had a monthly quota of one data contract per month in order to be eligible for any bonus payments earned on new voice contracts. In other words, if you did not close one data contract each month, you got no bonus. Now the sales force was focused on selling data and the commission on data was one months revenue or an average of $1,000 (a very large commission for our sales force).

Next I developed the KPIs for the sales force. KPIs for the sales force (60) were tracked weekly by me. The KPIs were a simple addition to the existing KPIs. There were two. Data contracts closed and $ value of data contracts closed per sales person. We also had a KPI not related to sales. Data revenue on the fiber ring as a percentage of monthly fiber ring cost. Note: the fiber ring cost was fixed so the real management effort had to be in getting the sales force to sell data.

At the end of the first month we had sold one new data contract. Not a stellar start. Six weeks into the program we still had only one sold data contract (voice sales were on budget). So I started to investigate. Turned out that data sales were much more complicated than voice sales and the sales force needed training. We designed and implemented the training in a week. When I left two years later we had monthly data revenues of $670,000, more than ten times the monthly cost of the fiber ring. Along the way we started tracking data customer attrition as a KPI. This signaled to us that we need a dedicated customer service department for data.

I believe that 2 or 3 KPIs are all you need to track a major management objective, which is almost always revenue growth related. 40 or 50 KPIs and you lose track of the key objectives.

Another thing I believe is the Rule of Two. You only need two weeks or two months of a particular data to identify a problem. I could spot new sales people who were not going to make it after two weeks and they were gone at the end of the month. A proven sales person misses quota one month, I notice. After six weeks (4+2) if there is no upturn in performance I am investigating. Usually they got divorced, have a sick child or some other one of life's major challenges. Somebody counsels them about their performance. At the end of the second bad month they get a warning and they are gone with three bad months in a row. (If the selling cycle was longer, I would probably give a sales person a longer period. Maybe a new sales person would get two months to show real traction.)

In my experience managers frequently look for excuses to explain away a bad KPI, wait too long to admit a problem and then have an emergency to address. Remember the Rule of Two. Two bad periods of data and you have a problem situation. May take some experience to know whether to use two weeks or two months, but remember two points make a line and a line is a trend.

Photo Credit

Key Performance Indicators--II

In response to yesterday's post on key performance indicators, a long time reader of this blog wrote to me as follows:

Don’t think I need to tell you, but this is a very relevant post.
 
I’m not sure the average reader (one who may not have similar experiences to mine) will appreciate it as much as they should.  If you can give concrete examples of why KPI’s are important (where things went wrong without monitoring them, or they helped somebody “pull up on the stick” in time), you will have a couple of very good posts.
 
If you can explain the process of determining KPIs in a manner that can be understood and implemented by your readers, you will have an OUTSTANDING series.

I am going to follow the reader's advice and do a series of posts on key performance indicators (KPI). First I am going to talk about how to determine KPIs and then in a subsequent post I will tell some war stories about KPIs and how they saved the day or accurately predicted the demise of a company.

KPIs basically report on the growth drivers of revenue and the productivity related to key expenses to produce revenue. KPIs are not a rehash of the income statement and frequently rely on information not on the income statement. To determine the KPIs you first must understand the growth drivers for revenue in the business. To restate from a previous post on growing your business, there are five possible revenue growth drivers:

• New Accounts (manufacturing)
• New Locations (retail, restaurants)
• New Subscribers (websites, social media)
• New Distribution Outlets (consumer products, business equipment)
• Sales Force (business services)

Most businesses rely on only one of these drivers as the critical success factor for growth in revenue, although occasionally two factors may be important. In my experience many companies do not understand the real growth driver in their business or do not analyze the driver to a sufficiently granular level. Perhaps an example will illustrate.

Let's suppose we are starting a business services company and we are selling Xerox machines to busineses. The sales force is the key growth driver and what we need to understand is the productivity of the sales force. The KPIs I would use are shown below:

Weekly by Salesperson

1. Customers contacted last 30 days
2. Customer meetings
3. Customers sold
4. $ Value of machines sold
5. Average $ value of machines sold
6. $ Value service agreements sold
7. Average $ value of service agreements

I would also include the following month-to-date information by salesperson:

1. $ Value of machines sold and monthly budget
2. $ Value service agreements sold and monthly budget

These 11 pieces of data allow me to track each salesperson weekly. I can see their prospecting, their meetings and their close ratio. Looking at the dollar values allows me to determine if they are going to make budget and the averages allow me to see if they are selling inexpensive machines or working to make their budget. For a sales force you have to use weekly data because two weeks of bad performance is sufficient to identify a problem at the salesperson or sales manager level and by the third week you should be taking corrective action.

Each month I would also calculate the customer acquisition cost by adding up all the costs for each sales person (salary, commission, benefits, car, phone, support materials, etc.) and dividing that total by the number of customers sold. Comparing this number to the average gross margin per customer would show me the productivity of the salesperson and whether a salesperson was contributing to EBITDA.

If I were running a steel manufacturing plant, the growth driver would be accounts but I might also monitor the sales people. For the account KPIs, I would be looking to understand the trend in repeat orders (given that it is not common to get a one off order), as shown below:

Weekly by Account (or top 50 accounts individually)

1. Orders $ (and vs budget)
2. Average order $ last 4 weeks
3. Average order $ last 13 weeks
4. Tons (and vs budget)
5. Average tons last 4 weeks
6. Average tons last 13 weeks
7. $/ton (and vs budget)
8. $/ton average last 4 weeks
9. $/ton average last 13 weeks

In this analysis I am trying to see the trend in revenue in order to spot changes in the economy (or a sector--autos) and whether a particular type of client is a better customer (in order to re-direct the sales force). Given the high fixed costs in steel manufacturing, I am particularly concerned about any negative effects on sales (which would include possible changes in tactics by a competitor). For the same reason I want to monitor the trends in tonnage. Price per ton allows me to determine how my pricing may be affecting sales and whether any changes in sales mix are having a positive or negative effect on revenue.

The example from the steel factory also makes clear another important point. KPIs should help you to monitor key business risks, such as high fixed costs, customer acquisition cost (social media sites) and customer attrition (subscriber based businesses such as telecom). 

KPIs should also be used to monitor the performance of large, current assets. For example, in retailing you can not look just at inventory turnover. You need to monitor "open to buy", discounts and markdowns taken and expected delivery dates for additional merchandise. The KPIs, therefore, match up with all the tools you have to manage inventory (the critical current asset).

Next post I will dig up some war stories and discuss the Rule of Two.

                                                   
                                          
                                                   

                                                   
                       
                                                   

 

Key Performance Indicators

Key performance indicators run through the life of a business, from building the growth drivers in the business model, to creating a proper financial model and finally to monitoring the actual performance of the business. Key performance indicators, simple put, are the 5-10 critical items that need to be constantly monitored to grow the business and achieve the profit and cash flow performance that makes the business self-sustaining.

Many of the companies I see do not use key performance indicators, a few use a poorly thought out subset and nobody I deal with has performance indicators for all lines of business. One thing is always true--once the situation is grave, a look back at the key performance indicators always shows the problem early enough to have fixed it in time. Perhaps the following joke from Flowing Data will help you to remember to instill the concept of key performance indicators at startup.

 

Credit: Flowing Data

What is Sophisticated Finance?

During the holiday weekend some one wrote and asked me what I mean by "sophisticated finance", which I have never precisely defined in this blog. After 260 posts, here goes.

When I came back to the U.S. in 1999, I had just spent ten years building a company in Indonesia from $40 million in annual revenue to $1 billion. At every opportunity during those ten years I took the opportunity to reduce or eliminate risks in the company because the environment of Indonesia included significant political, social and economic risks. Not as bad as some African countries, but a place of dramatic and significant risks. To manage or reduce these risks I became an accomplished derivatives trader/manager in currencies, interest rates, equities and off balance sheet vehicles. Derivatives were an important tool, but I only used them to hedge risk and rarely speculated. At one point I thought that all finance would be based on derivatives and the last ten years may have proven me correct.

In Indonesia we ran the most sophisticated IT operations in the country, as evidenced in part by the fact that the top IT people were always getting job offers. We constantly upgraded IT largely to better manage the company's largest asset--merchandise inventory. Outside Japan, we were the first retailer in Asia to use computerized inventory management (80,000 SKUs), link all our store communications via satellite and to poll POS (point-of-sale) information daily. Building this IT infrastructure was where my interest in IT really grew and I began to understand its importance.

The third critical element in Indonesia was a constant strategic review process. We constantly tracked our customers through a variety of information sources, including what was probably the first use of market research in that dictatorship. As the customers income and social aspirations changed significantly over a ten year period, we reacted both tactically and strategically. Good strategy requires that you constantly be close to and informed about the customer.

Sophisticated finance is an integrated approach to thinking about strategic planning, IT and finance. Financing (and risk management) without good strategic planning is like building a shopping center without a set of blueprints. An in depth understanding of IT is required because modern business operations can not be understood properly without detailed knowledge of the IT infrastructure. (Of course, to implement sophisticated finance, a company needs reliable and timely accounting, good controls and access to capital.)

Another way to think about sophisticated finance is to think about what is critically important to a business--knowledge of the customer, access to capital to pursue the plan and the use of IT as a competitive advantage. Bring these three things together in your business and you are beginning to use sophisticated finance.

Best Blog Post--2009 Predictions

Everybody blogged about their predictions. The best post I have seen is here at This is going to be Big. It's a video collage of comments from some thoughtful and observant people. May have to start using video in this blog.

My thoughts on the future of the Internet are here.