The Mobile MBA: 112 Skills to Take You Further, Faster (Richard Stout's Library) (10 page)

2. Operations and business processes.
This answers the question, “What must we excel at, and are we excelling at it?” It covers the day-to-day performance of the business or department: are we executing on time, on quality, and efficiently?

3. Market facing information.
This tells you how you appear to customers and competitors. How well are you serving your customers? Are you gaining or losing share? Where are you relative to competition? This is a current indicator and a future predictor of performance.

4. Learning and growth.
This is your forward indicator of performance. Are you building new ideas, test marketing products, investing in change?

5. People and staff.
How is our team doing? Are we building the right skills? Where are people on their career trajectory? Are we on top of compensation and performance management? How is morale?

I encourage managers to fit all of this onto one page of paper, because that reduces the data to what is most important. You remove the noise from the
reporting detail. This is possible. P&G used to have a system where every brand had to produce a full report on the progress of its business on one side of paper. The type was small and filled the whole page, but if P&G can do it, most businesses should be able to.

The “true” balanced scorecard only has the first four categories outlined above. Bad managers focus only on the ideas and completely ignore the people (who sort of get covered in items 3 and 4 in their framework but are not explicitly headlined). Good managers realize that managing people is important.

Depending on the nature of your department or business, you will look for very different things in your one-page balanced scorecard. When you start, you will find that your existing reporting system gives you plenty of information which you do not need, and does not give you information you want. There will be blank space on your one-page balanced scorecard. You do not need all the information every day, week or month. For some things (such as staff morale) you might get a formal survey done just twice a year. Figure out what works for you, and slowly fill in the blanks.

If you are the CEO, cascade your one pager down through the organization. This tells the organization where your focus lies. And challenge your team to produce reports for their areas that are consistent with your one-page report: let them produce the detail which can roll up into your report. This can be done quickly and easily by you and the team without spending three months and $500,000 on consultants.

George Orwell wrote: “Seeing what is in front of your nose requires constant struggle.” The difference between cash and accruals accounting should be obvious, but it is regularly missed by some managers and routinely abused by others. So we need to explore the obvious and understand the impact that cash versus accruals accounting can have.

Cash accounting is simple: if I pay for something today I recognize the payment today. But what if I order something today, but I only have to pay for it next month or in the next financial year? In cash accounting, I would only recognize the payment when the cash left my hand next month or next year. But clearly, that does not give an accurate view of my position. I could run up huge debts on my credit card which, under cash accounting rules, I could ignore until the inevitable day of judgement arrived as the bill came through the mail box.

With accruals accounting, I recognize the debt as soon as I make the purchase, regardless of when payment falls due.

As with costs, so with revenues. Cash accounting will only recognize the revenue when the payment has been made. But if I have already done all the work and the client has agreed to pay 30 days after the bill is submitted, then cash accounting does not reflect my true position.

Accruals accounting gives a more honest picture of both revenues and costs than cash accounting. But inevitably, accruals accounting is subject to some discretion and judgement: at what point do we recognize revenues have been earned and will be paid? Just how big is our liability and what level of costs will we incur on all those extended warranties we sold last year?

Managers should treat accruals in the same way that auditors do: conservatively. Only recognize revenues when you are sure of them, and err on the side of safety in recognizing costs and liabilities. In the real world, surprises are rarely positive, so it makes sense for the accounting world to be cautious.

Not all managers see things this way. Many see accruals accounting as a chance to play games, especially near the year end. An easy way to make the year end target, when things are tight, is to be aggressive about recognizing revenues, and to defer recognition of costs until the start of the next year.

You have to decide which side of this game you are on. Accruals accounting gives you some scope to manage the appearance of your budget. But if you are monitoring the budget of other people, then it pays to dig hard and deep to understand just what has been recognized as costs and revenues, when they are being recognized and why.

Much management time is spent looking at variable costs. Managers control variable costs because they are easy to see and easy to manage. In this respect a manager is like the drunk at night who lost his house keys in the woods, and so starts looking for them beneath the lamp post, because that is where he can see most easily. Occasionally we have to look into the dense woods of fixed costs if we want to improve our performance.

To make things simple: variable costs vary broadly with volume of output. Raw materials, ingredients, parts all vary with volume. The sandwich shop needs to buy more bread to sell more sandwiches. Fixed costs are fixed regardless of volume (more or less). Property rentals, overheads such HR, IT, legal costs do not increase each time the sandwich shop sells another sandwich.

Of course, no costs are fixed forever. If the sandwich shop grows, then it may need to take on more staff or even expand the shop and pay more rent. So “fixed” and “variable” are not absolute terms, but relative.

A few examples will show how fixed costs drive economies of scale, which lead to competitive advantage:

•
Marketing fixed costs.
If it costs $10 million a year to advertise a product effectively, then the market leader will just keep on winning. Work the math. Two detergents compete and both spend $10 million a year on advertising, both are priced the same and have the same production costs which give a 20% margin before advertising costs. Brand A sells $50 million a year and breaks even after advertising. Brand B sells $100 million a year and makes $10 million a year after advertising. Brand B can now always win: it has the room to increase advertising or reduce prices and Brand A cannot follow without losing money.

•
M&A and the fixed cost game.
Retail banking has been the subject of massive consolidation for the past 20 years, and it is nearly all about three types of fixed costs: IT costs, property costs (you do not need two branches next door to each other), and people costs (remove some branch staff and remove one set of head office and regional overhead costs). Revenues do not decrease because customers are more likely to change their spouse than their bank, even after a bank merger. So you end up with the same revenues but much lower costs and much improved profits.

•
R&D fixed costs.
These follow exactly the same logic as marketing fixed costs. If it costs $2 billion to develop a new car, or a new generation of computer chips, then the highest volume producer will make the most profit. They can then reinvest that in the next generation of cars or chips and the cycle continues until incompetence and complacency overwhelm the market leader, or a disruptive technology arrives.

The logic of fixed costs always helps the market leader over challengers.

Fixed costs have a dark side. The first problem is leverage. Leverage looks very clever when things are going well, and looks pretty dumb when a recession or other setbacks hit. A typical example is an airline which has huge fixed costs that are not easy to turn off. A 747 that flies from London to New York costs nearly the same to run whether it is 5% full or 100% full. If the breakeven load is 75%, then each marginal passenger makes a huge difference, which means that yield management becomes a critical skill for all airlines. And if you own a fleet of 300 aircraft, then in boom times you may do well (provided other airlines do not add capacity to the market and spoil your party). In bad times, the fixed costs can sink the airline.

fixed costs have a dark side

The second problem of fixed costs is mis-pricing. Clearly, to make a profit the firm needs to cover both fixed and marginal costs. Together, these are the “fully loaded” costs of production. So the fully loaded cost of transporting a passenger from London to New York might be $1,000. But if you ignore the fixed costs of the airline, the marginal cost might only be $75 plus taxes: each extra passenger costs a tiny amount of fuel and some catering costs. All the flight attendants, for example, comprise a fixed cost which the airline is going to incur regardless of whether the extra passenger flies or not. So the temptation is to accept a passenger who only pays $100: the airline covers its marginal cost and makes a contribution to its overheads or fixed costs.

If it is only one passenger, it may make sense to charge only $100, even though the fully loaded cost is $1,000. But it rarely works out that way. Once each airline tries to fill its last few available seats at $100 each, the market becomes intensely price competitive and it becomes increasingly hard to charge the fully loaded costs of $1,000. The result is a massively unprofitable industry: globally, the airline industry has made a loss over the past 50 years. Blame it on the problem of fixed versus variable costs.

High fixed costs make a business very revenue sensitive: the good times become great times and the bad times become a nightmare.

Method changes are cost cuts as they should be: you find a different way of getting to the same outcome at lower costs. You change your method. Method changes may involve increased costs in the short term to deliver lower long-term costs. Investment in new technology, the costs of making people redundant and other short-term costs will lead to the notorious J-curve: you promise short-term pain (the downward part of the J-curve leading to lower profits) before costs go down and profits go up (the upward part of the J-curve). Managers are normally very good at delivering on the downward part of the J-curve: the upward part of the J-curve is less reliable.

Re-engineering is a classic form of method change. For example:

1. Eliminate waste.
Waste comes in the form of:

• Low quality leading to rework.

• Delays and downtime, not just on the production line but in offices (decision-making delays, for instance) and in the supply chain (deliveries, etc.).

• Unnecessary activities: duplication of work, re-entering data, activities which add no value. This is the rationale for much M&A activity: two firms together find that they do not need two sets of head office, HR, IT
infrastructure. Banks can eliminate overlapping branches and eliminate one set of IT costs; pharmaceutical companies can often eliminate one, very expensive, sales force.

2. Find someone else to do the work
cheaper and better, for instance:

• Change suppliers.

• Outsource work: shift production to low-cost countries, IT and business processes to outsourcing specialists, including security, catering, payroll, property management, etc. This would make Adam Smith proud: it is the triumph of specialization which makes capitalism work best.

• Change the profile of your team. All teams become more expensive over time as people become more senior, so the cost of production goes up. Good managers manage this by moving senior and expensive team members up, sideways or out and then replacing them with cheaper and more junior staff. This is basic housekeeping.

• Find a way of achieving the same result cheaper: for instance, changing the media mix in advertising to target customers better and reduce your cost of customer acquisition, or changing your product’s packaging.

• Make the customers do the work: call it self-service and “putting the customer in control” (e.g. self-checkout at supermarkets, online help for your software problems). True method changes should improve the customer experience: self-service rarely achieves this.

3. Automate tasks.
From the production line to office productivity and IT tools, an ever wider range of tasks can be automated. The problem is that they do not always lead to cost reductions. Automating an inefficient and ineffective process is simply paving the cow path: you need to change the underlying way you do things to make the most of technology. Within the office, most office productivity tools do not reduce costs: they raise expectations. For instance, presentations used to be short, simple, and straight to the point until PowerPoint came along. Now that anyone can produce a 300-page PowerPoint presentation, that is what is expected. Costs, if anything, have shot up dramatically as highly paid managers waste their time trying to be PowerPoint experts.

There are two main approaches to method changes. The Japanese have an expression, “Open the back door, close the front door”: slowly reduce staff levels through natural wastage as method changes take hold and productivity rises. This is fairly painless and is associated with
kaizen
and other continual improvement approaches.

The more traditional western method is the campaign approach, often led by the hero in a hurry to make their reputation. About every 18 months there is a new campaign: quality, putting customers first, service, and then eventually
costs. The campaign approach might lead to a 20% reduction in costs once every five years; the
kaizen
approach might reduce costs 5% steadily every year.
Kaizen
is more effective and less painful. Campaigns produce heroes. So expect to see many more campaigns.