Managing in Turbulent Times

Nobody knows how serious this recession will be or how long it will run.  For some, the hang over at the end may be more painful and longer lasting than the initial headache.  So a topical question is: ‘what are the principle strategies for small and medium sized enterprises (SMEs), to not only survive a recessionary cycle but also to thrive in the recovery stage’.

Seven Management Tactics

After reflecting on my own business experience and scanning other sources of advice I offer seven strategic actions that may help you to get through.  As with many of these lists, they work best in concert, i.e. one on its own does not have much power, but when you get them working together the real benefits become apparent.

Focus on the core business & divest non-core assets

There is always a scarcity of productive resources (time, people, cash and other assets).  In good times the business can tolerate some indulgent use of these resources, but in tight times you do not have the luxury to carry any excess.  Investment of time, people and physical assets that are not essential to the core business may have to stop.

Increase the marketing activity

Your products and services must provide a real, or more importantly, a perceived value.  Market perception is a powerful force that needs feeding with continuous advertising and promotion. Don’t cut back on advertising. Take action to shape and direct the perceptions of your brand and its products. Turn up the volume on promotion.

Increased R&D activity (product innovation and market innovation)

If you are standing still, you WILL be overtaken.  Develop a culture of ‘pushing the boundary’.   Make it a performance requirement that a certain percentage of sales, say 20%, is coming from products or services you didn’t have last year.  Build a time-based process for new product or new market development that ensures continuous innovation – then feed the winners and starve the losers.

Build dedicated attention to customer relationships

In tough times, the attention can easily drift away from maintaining the personal connections with customers – customers become account numbers instead of people.  If you break the emotional bond between a customer and your business, you can lose them to the competition.  Strong relationships are based on trust, empathy, recognition, respect and responsiveness. Systemise these service elements into the culture and technology of your company.

Increase process speed and convenience

The need for innovation is not restricted to only products and markets.  The internet and the use of digital process methods has created a new landscape of business efficiency and customer satisfaction based on speed, connectivity and intangible assets (knowledge, systems and processes).  Now is the time to engage in business process redesign for an eCommerce world.

Assemble excellent cost knowledge, and cost management systems

You need to have detailed knowledge of what makes up the cost structure in your business.  Direct cost details are often hidden behind general headings such as ‘direct labour’ and ‘direct materials’ without any explanation of what makes up the total – and you WILL be carrying waste costs hidden in the aggregated totals.  Also many businesses do not know the true profit (or loss!) profiles of the products and services they sell.  ABC analysis of gross profit dollars and activity based costing systems are required to give you true cost management information.

Investigate ‘Acquisitions’ as part of your recession strategy

In tough times the poor operators tend to hit the wall first.  If you have good business systems and a depth of management skills, you can apply those to a distressed business and turn it around.  You may be able to acquire such businesses at a low price, strip overhead costs out of them and turn them into winners.  By building your market share and capacity you are then positioning yourself well for the lift after the recession.

Within this set of recommendations I think there are two that warrant further expansion – financial management and business process design.

Understanding the Five Basic Financial Nuts and Bolts in Your Business Model

Accountants sometime joke about the SME business owner who shows up sometime between November and January each year with a cardboard box of invoices, receipts, some cheque butts and a couple of bank statements – asking the accountant to do the tax return for the previous year.  The joke is that the cardboard box and the annual tax return represent the total financial management system for the business!

This is a serious abdication of management responsibility.  Today’s small business accounting software packages enable any SME to have accurate and up-to-date financial information, which can be easily managed by an internal or outsourced bookkeeping resource.  However my point is that while someone else can do the bookkeeping, there are key financial factors which are the owner’s responsibility to monitor and manage.

Figure 1. below represents a business model and shows how the main functions in any business feed through to financial results and financial reports.  The owners initially invest money (some borrowed and some of their own) into assets on the balance sheet.  These assets are applied, along with inputs from marketing, operations and people, to creating products and services that will generate sales income.  Direct costs are deducted from the sales income to give gross profit, and expenses are deducted from that, to give net profit.  Surpluses after tax can be allocated to dividends or retained earnings for the shareholders.

Within this system of activities and financial flows there is a small set of five key financial measures that represent the performance of the system, and are in fact, the financial nuts and bolts that hold the whole system together.  These measures are clearly the responsibility of the owner to monitor and manage, and not the job of a bookkeeper or accountant.  One way of seeing this set of measures is in the Ratio Chart shown in Figure 2.

Figure 1. The Business Model

  • Abbreviations on the Profit &Loss Account: COS = Cost of Sales; NPAT = Net Profit After Tax
  • Abbreviations on the Balance Sheet: CA = Current Assets; Non-CA = Non-Current Assets; CL= Current Liabilities; EQ = Equity; TL = Term Liabilities

Figure 2. Key Financial Ratios

Ref: Leith Oliver & Jack English, (2006), “The Small Business Book – A NZ Guide for the 21st Century”,  Allen & Unwin

Five key Measures

The chart flows from right to left, starting with the top four lines from the P&L Account, while the rest of the right hand column is from the Balance Sheet.  The rest of the chart emphasises the five key measures as follows:

Cash Flow

The first concern always is cash flow and a quick test of that is to check the relationship between current assets and current liabilities (a healthy 2:1 ratio in this example).  Cash and other ‘near cash’ assets like stock and debtors must be enough to cover the short term liabilities.

Profitability

The second issue is profitability (both gross profit and net profit).  In the example case the gross profit is $400,000 (40%) and the net profit is $90,000 (9%).  The percentages should be equal to, or better than comparable industry benchmarks.  Gross profit is the first place you can create profit and must be maximised by careful control of the direct costs (direct labour and materials).  Indirect expenses (fixed costs like rent, utilities and administration costs) also need careful control to avoid your gross profit being eaten away by blowouts in overhead costs and leaving little in the way of any net profit.

Asset Productivity

The third ratio to manage is the asset turns, which is a measure of how effectively the assets are being used to generate sales. (1.666 in the example).  Aim for high asset turns.  The asset side of the balance sheet needs to be funded so obviously the lower the value of assets needed to reach your annual sales potential, the better. You can achieve this by (a) using effective stock control and debtor control systems, (b) avoiding unnecessary and unproductive cash surpluses, and (c) lifting the capacity utilisation of the non-current assets (land, buildings, plant and machinery).

Ownership

Number four is the ownership ratio which shows how much of the balance sheet is being funded by shareholder funds compared to debt funding.  Equity funds carry a much higher required rate of return than debt funds, and this explains  the attraction of higher leverage (low equity/high debt), but this must be balanced by a need to carry a safety cushion of reserves in shareholder funds.

Return on Equity

Number five is the return on equity (shareholder funds) for the shareholders.  The example shows a 30% ROE which is considered to be a general benchmark target for SMEs because of the risk the equity money is subject to in a privately held business.

So leave the bookkeeping to your bookkeeper, leave the tax returns to your accountant, but take control of these five key measures and make sure your financial reporting system gives you the numbers in a timely and accurate fashion.

Business Processes Design – Mapping and Redesign

I recently ran a one-day seminar in which one of the key subjects was business process efficiency.  I based most of that seminar around the new process opportunities that are available in the digital and internet age we live in, and new tools that give us the ability to map and run live business process simulations in order to find new models of process efficiency.

The Competitive Landscape has Changed

With the development of the web and information technologies through the 90’s, the business world has had the opportunity to rethink their process designs.  New business model possibilities, freedom in goods movements and money controls have been harnessed by many countries to develop new competitive advantages in global markets.  However my observation of many SMEs and some larger businesses in New Zealand is that there is a general malady in the area of business process design.  The World Economic Forum’s annual analysis of our global competitiveness (www.weforum.org) shows a slow uptake of business technology by New Zealand firms in comparison to our competitors, and that we have in fact a competitive disadvantage arising from a lack of business process sophistication.

Ten Principles of Business Process Redesign for e-Business

The following ten principles form a great set of steps towards competing on speed, cost and customer satisfaction by upgrading your process designs.

  1. Streamline (remove waste, simplify, and consolidate similar activities)
  2. Lose wait (eliminate waiting time between process stages)
  3. Orchestrate (outsource/insource to the most efficient enterprise or operator)
  4. Mass customise (any time, any place, any way)
  5. Synchronise (run physical and electronic processes side by side)
  6. Digitise and propagate (capture information once at the source and spread it throughout the process)
  7. Vitrify (make process information available in real time with full data visibility)
  8. Sensitise (build in automated sensors for monitoring and feedback on the process performance)
  9. Connect, collect and analyse (leverage process data and information into valuable business knowledge, and apply it to the design of superior products and services)
  10. Personalise (design the process to discover the preferences and habits of users, and then enable the process to automatically adjust itself to add value to the users)

(see El Sawy, O. A., “Redesigning Enterprise Processes for e-Business” McGraw-Hill, 2001)

The First Step – Process Mapping

To understand how the human body works you have to see all of its parts, systems and functions; and how they are all connected together in one integrated system that allows the biology of the body to function as a ‘whole’.  Understanding how a business functions requires the same holistic view of all the parts and their interconnectivity.  The problem in many businesses is that there is often no understanding of the whole business process picture.  Each person or work group might understand the part that they do, but no one has a whole-company/whole-process view.

The answer is to use process mapping software to create diagrams of each process and its connection to others.  Common products that do this are Aris (IDS Scheer), Sharepoint Designer and Visual Studio (Microsoft), and iGrafx  (Corel Inc.)  The diagram below (Figure 3.) shows an iGrafx process map for a simple Order Fulfilment Process that involves the customer, three process stages and four company departments.

Figure 3.  Example Process map using iGrafx Software

Redesigning the Process

Static diagrams are of limited use, so mapping software products that include simulation capability are what I’m referring to here.  In iGrafx, each activity in the process is loaded with properties that allow live simulations to be run from the diagram.  The simulation can be run over any time period from minutes to years, and will generates reports on process cycle time, resource utilisation rates, business value added and cost.  You can then experiment with ‘what if’ scenarios by changing the process diagram and activity characteristics and running the simulation again. By a brief trial and error method you can find the optimal design in terms of efficiency, productivity, value and cost.  By applying some of the 10 principles listed above you could add significant value in the process at a lower cost and create new competitive advantage for your company. The significance of these kinds of redesign possibilities is undeniable.  However notice that it is not so much about change of processes but more about re-invention of the business model itself.  The idea is not to look only for improvement in the current processes but to ask why some things are being done at all, and to consider re-designing the whole process from a zero base. Think about what’s happened already in banking, music distribution, consumer goods retailing, billing and classified advertising.  Most process mapping sites allow temporary downloads for you to trial, so don’t hold back.  Get with it and try a dose of business process redesign.  You might like it!

Summary

Turbulent business environments can represent a major survival challenge to businesses with existing gaps in their management skills or flaws in the operational systems.  The tough trading conditions expose these weaknesses very quickly.  However, the upside is that if you are ready to react quickly to a more difficult environment you can turn adversity into advantage and threats into opportunities. The three fundamentals of success are (a) an intense focus on customer relationship management and connectivity with the market; (b) transparent financial information and the understanding of how to use it; and (c) business process redesign to take advantage of the digital web-enabled world we now live and work in.  Survival in turbulent times requires a combination of defensive and offensive actions taken at the same time. It is a time for creative problem solving – shore up your weaknesses, leverage your strengths and take advantage where and whenever it presents itself.


Dr Leith Oliver

ICEHOUSE Executive in Residence

University of Auckland Business School

This article originally appeared in Survey Quarterly Sep 2009 Iss59, p9