Chapter 1 - So You Want a High-Performing Business?
"... the answer is as simple today as it was in the industrial revolution, even back in ancient times: businesses and their leaders must be evaluated based on their ability to deliver financial returns to investors. We need to be unequivocal in asserting this viewpoint; it is the cornerstone of the insights, tips, and even philosophical outlook that you will read in this book."
"Interestingly, it is the proverbial mom-and-pop business that most readily recognizes cash profitability and the need to measure performance by it. The larger and more complex the business becomes, the more difficult it seems to become to understand the need for, and to determine, cash profits, particularly at any useful level."
"Market strategy also has much greater scope to make large, discrete changes in the business and its economics than do other areas of business strategy (such as operational strategy, financial strategy, or other internal viewpoints and planning perspectives). For example, it may bring the business into totally new areas, each bringing with them entirely new streams of cash flow, whereas other more internal and functional strategies are limited to dealing within existing business areas, and the scope of the cash flow that they can influence is limited to some portion of existing streams. The implications of the disproportionate relationship between future cash flow and market strategy are dramatic ..."
"Marketing professionals tend to focus [on competitive tactics], albeit with a very near-term lens; making incremental adjustments to some baseline position. By contrast, at the market strategy level we are interested in the strategic and long-term baseline positioning itself—concerned with differentiation and pricing at the highest level, and the associated economics."
"In fact, markets with the largest revenue opportunity very often do not offer the best long-term profit opportunity. Frequently, large-revenue markets have many players in them and profitability has declined; smaller markets become more attractive. Remember how Southwest’s equity capitalization is greater than all other U.S. airlines combined? Its focus on just positive-profit air routes has yielded huge returns. There is a lot to be said for a targeting and participation strategy that simply avoids market areas that drain value."
Chapter 2 - Profit Pools; Market Strategy on Steroids
"Market profit pools refer to the profit generated by each market segment; this profit is available to all competitors in those segments. Generally, market profit pools are considered in terms of a profit stream going into the future; that is, the profit expected from each market segment today and in the years ahead. Internal profit pools refer only to the profits your business receives from each segment. Internal profit pools can be defined to focus only on profit performance in a single period (such as this year) or on the profit stream your business is expected to receive over future years."
"The GAAP-based measures of profit exclude swaths of costs and expenses, and are subject to the inappropriate charges of poor allocation methods and distorted accounting. In one of these distortions, depreciation of capital investments for plant and other fixed assets is artificially charged against profit; investment capital is charged as an operating expense in small lumps over arbitrarily set time periods. In most cases, these time periods have very little to do with the life of the equipment they relate to, and their durations are actually guided by the tax code. Moreover, the approaches used by GAAP to allocate shared costs and expenses are, more often than not, simply unrelated to how those costs are consumed.
One thing GAAP does not do is charge profit for the capital that investors actually do have tied up in the business. This is a critical omission; investors sustain an opportunity cost for that capital (they could invest it elsewhere and get a return), and so the business needs to know what minimum profitability it must generate to justify its use of that capital. (Note: This charge for capital is only important in measuring profit performance in specific periods, such as a year; when looking across many periods, as in present value calculations, it is usually dealt with differently and is not charged against cash flow.)
With these issues, profit pool attractiveness cannot be determined by GAAP-based profit measures. Real profit pool attractiveness can only be figured out using cash-based profit (that is, after unwinding GAAP) and must include a charge for capital invested."
Chapter 3 - You Just Can’t See Them
"It seems incredible that with so much invested in information technology (IT) even in the smallest of businesses, management still does not have access to the most basic of business information: a value-oriented measure of profitability. Yet the simple fact is they don’t. Today’s information systems deliver three broad groups of information:
1. Day-to-day operational information (such as production planning, marketing logistics, etc.). 2. Accounting records and capital markets investment and profitability information. 3. Other regulatory information for tax, environment, and other mandates.
More or less, management tends to view these sets of information in this order of importance. Notice that tucked in the accounting line is a mention of profitability—but also notice how it is oriented to the needs of others, namely the capital markets. In fact, most businesses use that external reporting information system for business management purposes. And why not? It is precise (with audits and other mandated quality control measures), it comes mostly complete, and it is well developed (with billions of tested implementations over time).
Unfortunately, external reporting–based information systems do not give business leaders the information needed for them to see cash-based profit contributions and to properly manage the business for the purpose of maximizing long-term cash flow. So what do business leaders need? They need information that is granular enough to give meaningful insight and cash-based profit measures for all the good reasons set out in Chapter 1."
"Profit Measured in Real Money (Cash).
This is where the accounting profession comes in for some considerable criticism. While they are doing a great job of accounting for the comings and goings of money in the business and reporting it to external parties, they are not giving business leaders information that is useful for driving cash flow. To some extent they are just doing the bidding of Congress and various regulators, though it must also be said that their influence on those powers is quite considerable (as evident in the recent gains they secured as an industry, in terms of billable hours, from the enactment of Sarbanes-Oxley).
Generally accepted accounting principles (GAAP) and their cohorts, Financial Accounting Standards Board (FASB) statements are not geared to help business leaders track cash flow within their business; and in any case, both are entirely oriented around looking at the past. At best, we find that managers in today’s businesses have access to operating profit (OP), though in most cases they are only able to use gross profit (GP) or even revenue to make critical investment decisions and steer the business at any appreciable level of granularity.
The most egregious example that we have observed of this kind of flying blind was ..."
Chapter 4 - Know Your Own ACTUAL PERFORMANCE
"What is the fastest way to boost cash flow in the near term? Oddly enough, the answer to this Holy Grail of management questions is actually quite simple: Just neutralize losses.
What is the fastest way to boost cash flow in the medium term? Answer: Focus growth investments on the most highly profitable business segments now, and improve the profitability performance of underperforming ones.
While the premise underlying the profit pool approach is that business value is tied to long-term cash flow, driving cash flow in the nearer term has a useful role to play (discussed momentarily). With that in mind, there are three deliverables ..."
Chapter 5 - Get a STRATEGIC VIEW of Markets
"Any investor would pay handsomely to know today where pools of market profit will be over next 20 years, and what capabilities will be needed to compete effectively in those areas. In fact, investors try hard to create such insights to drive investment strategies, but have limited information and connections with markets.
Business leaders should create these insights too—at least those who want to prosper! After all, they are in direct contact with customer markets and have a much greater view of information. Yet few actually do this effectively. Why? Because ..."
"How far ahead must businesses forecast markets and plan their actions? This question is far from an intellectual curiosity; event certainties, the value of money, and many other factors diminish over time. Conversely, the cash flow your business will generate in the near term accounts for only a fraction of its business value. An unscientific, experientially based survey (a guesstimate based on past client work) indicates most businesses look at, and manage to, three-year time horizons. This might extend to five years in exceptional circumstances or markets. This is shockingly shortsighted! Just 15 percent of the value of the business (typically) is covered by the next three years’ cash flow. Figure 5.2 sets out a simple and easily calculated phenomenon: the proportion of business value captured in the next few years of cash flow.
Figure 5.2 Proportion of Intrinsic Business Value in Near-Term Cash Flows
It shouldn’t be controversial to assert that the key to maximizing business value is to manage to a time horizon where most of the value is! And that, in a typical business, means 15 to 20 years ahead. In this range, both the majority of value is captured and the accuracy of forecasts and predictable behaviors can be readily managed. Contrary to popular myth, it is not true that everything beyond three years is unpredictable and there should no attempt to forecast it. As we will see, …"
Chapter 6 - Define a Path That Exploits REAL OPPORTUNITIES
"In [this chapter], we explore a market strategy formulation process specifically designed around driving business value, and incorporating very powerful techniques and tools. In the past 20 years, particularly since 2000, the science of strategic decision making has made some insightful advances; we have included some of these, including “real options” valuation techniques that allow uncertainty to be easily incorporated into decision making. Sadly, these advances have been cloaked in an aura of complex mathematics to date, and presented primarily in technically oriented literature. This has seriously inhibited widespread adoption—although, to be fair, some of the tools have only recently reached usable levels of robustness and ease of use.
We use and illustrate these new techniques simply and clearly at an executive level, and have taken pains to avoid the underlying mathematics and theory. The idea is that you need to use these techniques for strategic understanding and action, but need to avoid getting mired in the mechanics of the tools. Let’s face it, as of the past five years, those skills can be bought; what can’t be substituted is your understanding of your market, your business, and the choices available—and, of course, you leading your business along a value-creating path."
Chapter 7 - Corporate Renewal and New Business Management
"The key difference between managing incumbent businesses and creating (and managing) new business can be summarized in one word: failure. While failure is simply not acceptable in an incumbent business, it is a hard fact of life in new business creation. It just needs to be properly managed. As one might expect, problems arise when incumbents try their hand at new business creation—as they must do for renewal and sustained value growth.
New Business Creation and Failure
The degree to which failure is a fact of life in new business creation is borne out by the fact that only 5 percent of formal new business ideas make it to market launch, and only 4 percent turn out to be value creators. This rate of failure is ..."
Chapter 8 - Value-Maximizing the Existing Business Business Specialization
"Where’s the Value Coming From?
What can be said about organizational value-add is that, by definition, it always has a dollar value associated with it. The trick is to figure out where the sources are, and what their dollar value-adds are too.
Introducing Value Centers
This is where a mapping of value centers and cost centers can contribute. Most business leaders and information systems take a vertical view of business performance, at best—reporting performance in terms of offerings or lines of business. An example of this might be performance reporting on the whiskeys, tequilas, and perhaps a couple of other product lines in a broad-based beverages business. In the value centers model, a combined vertical and horizontal view of the business is taken, specifically to localize and measure value creation within the organization. While it does not paint a complete picture of how the business creates value, or what that value is, it can certainly help pinpoint where it is coming from. To a large extent, that is as much about where value does not come from as it is about where it does ..."
