Who will win the battle of the numbers at your company?

Have you ever found yourself in a meeting, whose primary purpose was to make some key decisions about your business, and yet you find yourself in a heated debate about what numbers to use to make the decisions?  Believe it or not, it happens more than you might think.  Over the past couple of weeks you might have seen my posts on pricing.  A meeting about pricing strategy is usually, if you’re doing it the way you’re supposed to, a meeting where you will have participants from sales, marketing, finance and operations…so pretty much the key members of your leadership team.   Why?  It’s mainly because pricing requires input (read numbers) from all of those organizations to provide a complete picture from which you can make an intelligent decision, especially if you’re using it as a competitive weapon.

So, what’s the problem?  Unless your company is a surprisingly rare phenomenon and you’ve got all that data in a centralized data warehouse, the data’s structured in a manner that makes this kind of analytics possible and, this is the most important one, every one of these organizations is using that same warehouse you’re probably all working from a different set of numbers.  Worse, none of these numbers are likely to reconcile with one another.  Instead of having a productive discussion about how you’re going to take it to your competition, you’re arguing over whose numbers are correct.  Everyone’s jockeying for position to establish their version of the numbers as THE set of numbers.  It’s amazing how emotionally attached people can get to a set of numbers.  Needless to say, it’s not going to be a very productive meeting.

The real issue is that at some point, you really do need a set of numbers that does accurately reflect what’s going on in your business from every perspective.  It’s not an easy problem to solve.  If you read enough business intelligence software collateral, you’ll be led to believe that it’s just a simple matter of aggregating all the data from your line of business applications into a data warehouse using their software.  What they’re not telling you is that you have to provide a different perspective to each of the organizations for their day-to-day activities.  These perspectives usually require some level of analysis unique to that particular target audience that only they will be interested in.

 

Silos of Information

Many companies have addressed these requirements by creating separate data marts, one for each target audience.  And now you have disconnects because, while some of the numbers are the same, many others are not and it’s very difficult to reconstruct the links in a manner that would allow you to see how they fit together.  Having worked with databases in some form or another for the past 25 years, I could probably come up with a solution, but it’s not going to happen in a meeting.

One of our clients, Elkay Manufacturing, faced a similar issue.  Their senior finance executive, John Hrudicka hadn’t even made it through his job interview at the company when he was told, “Your numbers suck!”  Like many of you reading this, I might have thought twice about signing on, but John had a plan for A Total Remodel.  He started with his vision for a Discreet Product Costing (DPC) system as the centerpiece for their executive management system.  DPC, for Elkay, represents the single version of the truth upon which they base many of their decisions at tactical and strategic levels.  The rest of the executive management system, which is loosely based on Robert Kaplan and David Norton’s version they describe in their most recent book The Execution Premium, is rounded out with components such as their strategy framework, their business performance management component (for planning) and their CRM component.  Each of these will be integrated with DPC in a manner that provides transparency and guided knowledge in real-time.   What’s even more remarkable is that he’s decided to build this system with components from different vendors because he (and the rest of the Elkay Management Team) believe that “technology has matured to the point where you don’t need to buy a fully integrated suite that possibly forces you to sacrifice functionality that’s necessary to meet a business need. “  Elkay is seeing results, too.  They are arguably in one of the hardest hit industries in the past recession, yet they’ve been able to improve profitability and gain market share.  As Adam Sandler would say, “not to shabby.”

The key to their success has been the level of transparency John’s been able to bring to the table with his DPC system.  They are no longer arguing about which numbers are correct because everyone’s using the same set of numbers.  Even more important is the fact that everyone’s actually bought into the numbers in a way that makes you think they actually own the numbers.   They’ve achieved all of this in less time than you might think.  So, the next time you’re in one of those meetings that loses its focus and turns into the battle of the numbers, remember what John Hrudicka did.  It’ll dramatically change the way your company does business, I guarantee it!

Beating the competition with price, but not always how you think

Last time I wrote about one of the risks associated with price strategy, specifically on an internal analysis that aligns customers with your sweet spot with respect to margins.   It may seem obvious that pricing decisions factor in a deep understanding of how you make money, but as our founder Steve Anderson likes to say, the devil is always in the details.  In this case, it’s the variability cost-to-serve that presents opportunities to drive more revenue from existing relationships (using higher prices) to improve your bottom line.  This is great news times like these where finding new sources of revenue seems all but impossible.  However, that’s not the only thing you should be worried about. What about external pressures?

It turns out that there is plenty to worry about, too.  According to CEB’s James Fitzmaurice, competitor infringement on a company’s core market was cited in 13% of the cases as the root cause of the decline for the Fortune 1000’s top 200 companies whose market value declined more than 50% between 1998 and 2009.  That trumps both compliance issues and financial mismanagement!  What’s worse is that most companies have no way of determining this risk exposure.  That’s pretty scary stuff.

How does this happen and what can you make sure it doesn’t happen to you?  Let’s assume you’re a reasonably sized company who’s got four different revenue categories of customers: small, medium, large and national accounts.  Given that differences in volume for customers in each of the categories, it seems reasonable that you might provide more favorable price concessions to those that represent higher volume and greater revenue, so you’ve established a segmented pricing strategy for your various products, each with their own target price for that particular segment.  It’s a simple strategy that’s worked for many years at most companies.  So, what’s the problem?

 

Now let’s take a look at what actually happens during the course of most competitive situations.  Your sales team may need a special concession to win a deal over the competition or meet their sales goals for the period.  If you’re like most companies, you have a price desk, whose responsibility it is to review these concessions and make sure that these concessions don’t fall below the floor price for that particular product and segment combination.  This probably happens many more times than you imagine.  If you were to examine the products purchased by your customers using a band graph (see above), you’d probably expect to find tightly grouped bands with perhaps a few outliers.  In reality, you probably have fairly wide bands for a variety of reasons.  In many cases, you’ll find customers who are paying more than the average price so they represent a very lucrative relationship to your company.  In other cases, you’ll find customers who are paying far less than the average price so it stands to reason that these customers are probably not the best fit because you may actually be losing money on them. How much is anyone’s guess.  So, how much can what you don’t know actually hurt you?

The answer is plenty.  Here’s what’s likely to happen.  The companies who are paying more than the average price are significantly at risk of going elsewhere and one of your competitors would be more than happy to let them know how much their overpaying to earn their business.  The worst part is that you may never know its happening until it’s too late.  The further they are away from the average, the greater the risk. It gets worse.  Armed with a detailed analysis, such as the one above, that same competitor may actually steer customers on the lower end of the band to your company.  That’s right; they are willingly conceding their most undesirable customers to you in hopes that it will accelerate your demise.  The worst part is that you don’t even know about its happening until it’s too late.

I can’t tell you how many times I’ve had conversations with our clients who have shared a story where they actually referred an undesirable customer to one of their competitors because they were confident that eventually they would be able to win back that business on much more favorable terms.  Pricing is a powerful competitive weapon, especially in these times.  However, you have to know how to use it effectively to gain the edge over your competition.  Knowledge is the key to success.  How much do you really know about yourself and your relationship with your customers?  Can you really afford to wait any longer? 

Is your price strategy putting you at risk?

As I was writing about risk management practices I ran across an interesting blog post by CEB’s James Fitzmaurice on why you should audit your corporate strategy.  In it he cites a destructive price war (6% of the time) as one of the reasons that led to a market cap decline of over 50% in top 20 fortune 1000 companies, so it represents a strategic risk.  Other key factors include:

• Decline in core product demand (16% of the time)
• Competitor infringement on core market (13% of the time)

What does this have to do with pricing?  Plenty.  According to Frank Cespedes, Elliot Ross and Benson Shapiro’s recent article Raise Your Prices, many companies look to price as a demand lever in tough economic times, mistakenly believing you have to cut prices to gain volume.  As they point out, if you’re not the cost leader, it rarely works.  Instead they recommend competing on performance and pricing on value, where customers willingly pay higher prices for that value.  I highly recommend reading the article as well as Sean Silverthorne’s follow-up Q&A on the topic, Yes, You Can Raise Prices in a Downturn.

There’s no Easy Button for finding the value customers are willing to pay for.  It takes discipline, hard work and collaboration across many functional areas of your company.  So, now you’re probably wondering is it really worth it?  The answer is absolutely.  Pricing decisions can build or destroy value faster than any other decisions you can make.   On average, a 1% increase in price translates to a 12% increase to your bottom line and this isn’t just some future earnings potential with a payback measured in months or years.  It’s usually in the form cash that drops to the bottom line immediately and, now more than ever before, cash flow is extremely important.  Still not convinced?

Let’s look at a recent client example.  This particular client supplies a variety of high quality products to distributors and retailers across the country.  One of their largest customers was a major discount retailer.  They had determined that they were losing money on the account and the amount was rather significant.  They decided to investigate further.  They found that their products included a high value (and costly) custom finishing, yet they were being positioned against commodity products at a much lower price point.  In this case, neither the retailer nor their clientele had placed any value on the custom finishing being provided with the product.   Instead of firing the customer, they offered to substitute a product that didn’t include the custom finishing because they had determined their customer had not assigned any value to it.  This one decision alone more than paid for the investment they had made in the analytics that provided them with the necessary information to identify the problem and place a value on process applied to the product.  In addition, they did a little market research by visiting the retailer to see how their products were being sold.  Finally, they communicated their findings to the sales team, who then worked with the customer on a more appropriate product mix.  They used this as a learning opportunity to educate their sales team.  The results have been remarkable.  They’ve managed to gain market share and achieved record profits even though their overall revenue dropped by almost a third.  Not bad for a company in an industry that was hit the hardest by the recent downturn.    

So, where do you start?  One of the best things you can do is get a better understanding of gap between your customer value and your cost (and cost in this case is all costs, not just gross margin) because, as Benson Shapiro points out, you want to maximize this gap.    There are often dramatic differences in the customers’ perception of value and a detailed cost analysis will help you identify what those are.  One of the best ways to analyze these differences is by using a price waterfall analysis, where you identify the differences between the list price and what’s called your pocket price, which includes all discounts and the cost of value-add services you’re providing the customer.  

 

The results may surprise you, but it’s the first step towards understanding the potential price segments each of your customers belongs to.  As markets change, you’ll need to adjust these segments or even develop an entirely new segmentation strategy.  However, without this detailed analysis, you’re essentially flying blind and that’s exactly why your pricing strategy presents such a huge risk to your company.  It’s what you don’t know that can often kill you because you won’t find out until it’s too late.  

I realize this is an oversimplification and there’s a lot more to it than I just outlined, so I encourage you to download a white paper I wrote on the subject: Effective Pricing Using Profitability Insight – A Best Practices Guide.  You have more pricing power than you may think, even in this downturn.  You just have to find the right levers.  You will have to work at it a bit, but with the right tools, you can accomplish results that will surprise you even if you don’t opt for the total remodel  our client did.  Your biggest risk is not doing anything.

The Value Integrator and Enterprise Risk Management

In my last post, I wrote about the CFO as a Value Integrator and the need for CFOs to start thinking about how they can help their peers in other parts of the organization by focusing on helping them solve problems by mapping their own unique expertise to the challenges these other business executives face.  Earlier, while doing some other research on Risk Management I ran across a rather interesting Corporate Executive Board (CEB) blog post on the Six Myths of Risk Management and, as you might suspect, one of these myths crossed my mind as I was writing the Value Integrator post.

Myth 1: The Biggest Risk My Firm Faces is Financial Risk

Neither the myth nor the recommendations offered by the author, Srikanth Seshadri, were particularly surprising (see my posts How Well Do You Manage Your Risks and Award-winning Risk and Performance Management).  

I already knew risk management was more than evaluating Value at Risk (VaR) for financial risk management, which is really more about loss management and mitigation than anything else.   What really shocked me was how inconsequential financial risk was when compared to the other root causes of market capitalization declines based on a CEB study of the top 20% of Fortune 1000 companies whose market capitalization declined 50% or more from 1998 thru 2009.

 

Operational risks (13%) and strategic risks (68%) easily topped both financial risks (12%) and legal/compliance risks (6%) as causes of market cap decline.  If you’re a shareholder, these are scary numbers because no amount of auditing will mitigate these risks and most risk managers probably aren’t thinking about operations or strategy, at all.

So, how can the CFO, as a value integrator, help solve some of these challenges?  The first thing they need to do is to think about the problem from a holistic point of view.  Back in 2004, COSO created a framework for Enterprise Risk Management (ERM) as a way of extending the work they had done on internal controls, which was largely adopted by the SEC for the implementation to meet the requirements of the Sarbanes-Oxley Act.  Let’s look at how COSO defines ERM:

“…a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risks to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.”

So, ERM is a process.  That means there’s probably not going to be a magic formula or silver bullet software solution to the problem (see Myth 3: We are good at sensing risk because of our investment in ERM systems).  In fact, risk management cuts across all aspects of corporate management, especially strategic, operational and financial.  At Carnival Corporation, risk management is everyone’s job.  It’s also not something you do once in a while (see Myth 2 & 4). 

Now it’s starting to sound like a crusade, or worse, an ERP implementation, right?  Not necessarily.  In their book, The Execution Premium, Robert Kaplan and David Norton describe a multi-stage executive management system that takes you from strategy formulation to execution and periodic reassessment of both operational and strategic plans so that adjustments can be made when underlying assumptions change or are no longer valid, thus closing the loop and starting another loop around the system.  The continuous monitoring and testing is the key determining whether or not a strategy is working, in other words, evaluating whether or not the strategy is at risk of failing.  Kaplan reiterates this in his article Risk Management and the Strategy Execution System, where he outlines a method for creating a risk heat map for mitigating risk that incorporates not only a risk probability analysis, but also an impact analysis for global, strategic, operation, financial and compliance risks.  In it, he advocates the use of scenario planning as a way of helping managers consider the correlated consequences of future events.  Using Time-Driven Activity-Based Costing models of the entity or business provide a critical tool for managers to determine the future outcome in financial, strategic and operational terms.  This sounds a lot like the ABC war gaming I described in my post on forecasting and one of our customer’s mentioned at a recent user conference.

While risk analysis involves both probability assessment and impact (or scenario) analysis, one of the panelists in the roundtable on risk management that the recent CFO Core Concerns Conference reiterated that CFOs should focus less on determining probability and more on determining impact of even the most unlikely (or worst case) scenarios.  The volatility of today’s economic conditions mandate that companies improve their ability to do this type of scenario analysis because they’ll need to do them ever more rapidly.  A robust performance management solution can easily be leveraged to provide this capability.  The CFO can extend his skills as a value integrator by expanding the scope of these tools into the arena of strategy management, thus providing a valuable risk mitigation solution within the framework of the executive management system as the process for Enterprise Risk Management. 

I know I’ve covered a lot of ground here, but there’s something that I’d like you to consider.  Given the dire results of CEB’s study, can you really afford not to become a value integrator?  The reality is that if you don’t, you’ll believe many of the myths about risk management and they all have one thing in common: they all remind me of that ostrich who sticks his head in the sand in the face of danger.

Are You a Value Integrator?

I ran into Gary Cokins at the most recent CFO Core Concerns conference, which I highly recommend if you’re a financial executive.  I’d read his book on Activity-Based Management years ago so I introduced myself and found out he’d wanted to get to know me a little as well.  Gary and I are peers in the CPM market, yet we work for competing companies.  We spent most of the time getting to know one another, but I’ll spare you all the personal stuff.  What’s most interesting is that neither he nor I came from the finance world.  His background is in industrial engineering.  My background is quite different.  I spent most of my working time developing software products at a number of companies prior to coming to Acorn Systems, most recently BMC Software.  While at BMC I had an opportunity to work in a small group tasked with helping BMC find new product opportunities.  I’d already spent a fair amount of time working on automated systems and application management products under their PATROL brand.  One of these opportunities was an automated root cause analysis product line that was a critical component of a self healing system.  BMC already had the then market-leading automated recovery capabilities.  This was in the latter half of the 1990s.  About the same time you saw a massive adoption of ERP systems with SAP leading the way.  Of course, we immediately focused on managing the mission critical business applications that were essentially running the business.  Add self-healing diagnostics and you begin to see how a service level management approach would be extremely valuable to the business that had essentially turned over their processes to SAP, Oracle or Microsoft’s business applications. 

Yet, in the back of my mind, I’d always wondered what if you could actually manage the business itself?  I’m not referring to systems or applications here.  I’m referring to the actual performance of the business.  However, I could never quite figure out how you could manage the people that ran the business the way we were managing the systems that ran the business.  That’s when I met Steve Anderson who introduced me to this concept called Time-Driven Activity-Based Costing.  At the time I was somewhat familiar with ABC, but it had lacked adequate capabilities for measuring and managing the people that ran the business in an automated fashion.   Specifically, it couldn’t account for the variability that creates the biggest challenges in managing any business.   The critical thing that TDABC offered was an ability to account for peoples activities without asking them where they spent their time.  Instead, it relied upon transactional events available from any ERP system to create an extremely accurate simulation of where they spent their time using a number of different events and a model that translated what that meant in terms of resource consumption by business processes.  In other words, it’s root cause analysis for CPM, that missing link I was looking for.   I was so intrigued; I joined the company and began working on driving automated applications management principles into a solution platform that automated CPM.

So, what does this have to do with my conversation with Gary?  Gary and I are both pretty passionate about Corporate Performance Management.   With such innovative capabilities, why hadn’t more companies exploited them?   I wondered about this as I was sitting in the remaining sessions of the conference. Gary’s gave his opinion in his blog here. I think it’s a bit more complicated.  Like many other senior executives, the finance executive has been busy dealing with compliance issues, changing accounting standards, process efficiency and an increasingly complicated business environment.  Everyone has an opinion on what their issues are and how to solve their problems, so, where do they start?  The most recent IBM Global CFO Study (2010)groups CFOs into four finance profiles: Scorekeepers, Disciplined Operators, Constrained Advisors and Value Integrators.

It’s pretty consistent with what I’ve seen out in the market place and it sounds like Gary’s experiencing the same thing.  The study identifies several examples of what other CFOs have done and identifies some suggestions for CFOs wanting to become Value Integrators.  They’re all valid recommendations, but I think something’s missing.

In this respect, CFOs share some of the same challenges IT and many software development executives have been struggling with for years.  They need to make their contributions relevant to the business.  IT and software development executives have consistently tried to manage their relationship with the business at arm’s length.  I’m sure you’ve all experienced very detailed requirements documents that almost border on legal contracts and include everything but the proverbial kitchen sink because everyone’s convinced they have one shot to influence the outcome.  In response, these projects attempt to design the ultimate Swiss Army Knife solution that can do everything, but, in the end, nothing very well.  It takes a long time and no one is very satisfied in the end.  It’s enough to make your head spin, especially if you’re an agile practitioner like me.  But agile development practices can only help you so much and they’ll expose the real problem rather quickly.  If you don’t spend time understanding the perspective of your customers and collaborate with them on a solution, you’ll invariably miss the mark.  The best way to do this is to educate yourself on the nature of their challenges and needs in such a way that you can begin to frame a solution using their language.  That doesn’t mean you have to become an expert.  Instead, you simply have to learn enough to be able to map your expertise to their problems.  It’s one of the biggest challenges in IT Financial Management, as I have previously mentioned here.

The nature of our business here at Acorn Systems has forced me to become a value integrator.  Along the way I’ve had to move beyond my comfort zone as a software and IT professional in order to learn about what the business needs.  We’ve managed to build leading solutions that have enabled our customers to become value integrators with amazing results.  So, if you’re a finance executive and your peers are looking for a forecasting or risk management solution, take a moment to look at the world through their eyes.  Don’t be afraid to collaborate.  You’ll be surprised at what you will learn.  Value integrators, like Elkay’s John Hrudicka, consistently achieve remarkable results.  The road won’t always be easy, but your efforts will translate into a winning strategy.

Maximizing Value from the Balanced Scorecard

High-level business intelligence initiatives such as the balanced scorecard and lean management are alluring. Companies can quickly assemble a team of executives, revalidate corporate strategies / missions, define a "new" set of targets or metrics, begin tracking progress, and communicate success across the organization. This is not just exciting; it is "sexy." A high profile role, working with cutting-edge solutions, surrounded by the executive elite, with a ton of press and exposure - who wouldn't want to be on this glory team?

This endeavor reminds us of a recent fishing trip we had ‘hunting' for tarpon in the Gulf of Mexico. Like the balanced scorecard (BSC), tarpon fishing is a pedigree endeavor reserved for the most senior practitioners. It requires significant teamwork among the members of your boat, and also with the dozens of million-dollar boats surrounding you. Similar to the BSC, information needs to flow freely and in a timely manner between different boats since the tarpon move quickly and in irrational patterns. Like an elk hunt, teams can work together to drive the tarpon. This is similar to interrelated departments working together to drive company. As with the BSC, tarpon pursuits are most visibly executed on the surface - boats race along the surface in the quest to spot schools of tarpon breaking the surface.

But there are other, more subtle commonalities that companies need to recognize. Like business intelligence, real success at tarpon fishing requires tools that hunt the fish at lower depths. Fish are not caught on the surface, but at depths of 10 to 20 feet. That means using lures with weights, high-strength reels, depth meters, and sonar. The same is true of the balanced scorecard. Practitioners need tools like time-driven activity-based costing (TDABC) to not only identify, but also track opportunities. Having transactional details is critical for effective identification and measurement of opportunities, and is not necessarily achieved with high-level business intelligence. Transactional details help the practitioner to identify root cause and to be able to understand what the fix is. Many times you need to understand what is causing the problem. An example: two customers are both unprofitable. Do we fire them both? Do we try to fix a broken process with them? Is every transaction we do with them unprofitable or is it caused by one type of transaction? For these two, the answers may be different...how do we know without the details? The only way to know and take action with confidence is to get into the details. A second reason for having transaction information is for organizational buy-in. It is easier to get operational support when they can visualize the impact of actual transactions.

As colleagues Dr. Kaplan and Dr. Norton discuss in their new book The Execution Premium, good strategy tools (epitomized by BSC) require good operational tools (epitomized by TDABC).

Another parallel between tarpon fishing and business intelligence: spotting, or even hooking a tarpon is vastly different than landing one. And identifying value is not the same as capturing it. For the past 10 years, we have heard dozens of companies praise their efforts with business intelligence. They uniformly identify opportunities. For example, at a recent conference in Korea, we heard all four presenters share their satisfaction with BSC. The process did align corporate strategy with key performance measures and operational goals. But what surprised us was that companies were having difficulty quantifying the bottom line impact the company had actually achieved. In other words, ‘landing the tarpon.' To accomplish this, you need a whole lot more than "alignment"; you need great information, tools, and experience. This is why we were excited to see that Dr. Kaplan and Dr. Norton are recommending that a company lay the foundation of great information and tools by implement time driven activity-based costing before embarking on strategic initiatives. Don't do like we did when you fish for tarpon - make sure you do your research, have the proper equipment, and get an expert guide on your boat.

Is Virtualization Clouding Your IT Cost Transparency?

Getting a handle on the true costs for IT services continues to plague companies even though many have implemented server virtualization and cloud technology as a cost reduction strategy.  While companies may have been able to consolidate physical resources to reduce cost and increase resource flexibility, these same efforts have only made it more complicated to determine the true costs of the services provided to the business.  In his recent CFO Magazine article The New Star of IT Cost Allocation, David McCann discusses the challenges with IT cost allocation methodologies and their utility for managing consumption of IT resources.   He cites a CIO Executive Board study that shows 72% of organizations surveyed who use a lump sum allocation method for IT related costs, which provides little or no connection to the amount of services consumed.  This provides consumers of these resources absolutely no incentive manage and consume fewer IT resources.  Only a small percentage of respondents indicated that they used a granular chargeback method based on actual resource consumption and a unit price for these services. 

There are 5 critical aspects of a successful management system for shared services such as IT:

• Streamlined Processes - the level of effort required to track and report usage charges needs to be automated
• Transparency - the allocation methodology must traceable by the consumers or they will assume it's a lump sum (or arbitrary) allocation
• Accountability - it's important to hold the service provider accountable for keeping costs low
• Empowerment - it's important for consumers to understand how their activities affect their utilization of services that are provided to them
• Capacity - understanding capacity utilization is the key to operational efficiency

 

The prevailing method of chargeback can at most only accomplishes 2 out of the 5 key objectives: Streamline Operations and provide insight into Capacity.  What's missing are the 3 most important elements: Cost Transparency, Accountability and Empowerment.  Without these, the IT will never be able to demonstrate the value they provide to the business.  The missing link here is that they fail to map the resources to the processes (or activities) that consume them.   For example, it's easy to understand how to manage your mobile phone plan because the units of cost are expressed in terms of minutes of talk time and number of text messages  What if your provider billed you based on CPU utilization, server storage and bandwidth utilization (both internal and external)?  Would you be able to manage your plan usage?  Probably not.  Only by linking the resource consumption to business processes that consume them, blurring the lines as David refers to it, can you better align your IT organization to the business and empower the business to manage their utilization of IT effectively.

Don't underestimate the size of this divide.  It's enormous.  David McCann's article highlights the fact that any of the companies surveyed still had trouble linking the resources to the actual business processes that consumed them, so they didn't really understand how they could manage their consumption.  However, the solution he highlights addresses only one aspect of a successful shared services management process, namely empowerment.  That's because you've only linked the drivers of consumption to the business processes and determined the cost using a price based on actual expenses. So you can successfully charge out your services using unit costs that your customers understand, but they have no assurances that this is really the best price for that particular service?  Would it be more cost effective to outsource that particular service?  Can you even determine the true unit cost of this service using this methodology?  Unfortunately, the answer is no.

This is why accountability is also important because without it, most companies will never achieve their desired efficiencies in IT I&O.  The best way to determine the actual unit cost is detailed in Brendan Fox's white paper, Using Activity-Based Costing to Improve Shared Services Allocations, where he describes how to use Time-Driven Activity-Based Costing (TDABC) to identify capacity rates to establish pricing as well as a cost recovery methodology that holds the service provider accountable for the actual costs and the charged out costs.  This best-practice approach is currently in use at several leading financial services organizations.

The key to enabling both empowerment and accountability requires transparency or no one will believe the numbers.   This turns out to be much more complex than you might imagine because the service provider organizations (inside and outside of IT) often have reciprocal consumer and provider relationships with one another.  Finding a solution that can perform reciprocal allocations can be difficult (hint: Excel is not one of them).  Finding a solution that can demonstrate how costs got allocated at every step of the way across these complex relationships narrows down your choices even further.  The cost of not providing this level of transparency is enormous because without it, it is nearly impossible to drive the kind of operational change management that leads to meaningful efficiency gains. 

So, if you really want to do more with less, don't overlook empowerment, accountability and transparency.  A key enabler for these is linking the drivers of consumption to your business processes.  IT and the business will need to reach out to one another to bridge this gap or these three most important elements of a chargeback system will never be realized.  This is even more critical in organizations that have embraced virtualization and other forms of cloud computing that obscure visibility into IT infrastructure and operations.

Award-winning Risk (and Performance) Management

The Open Compliance and Ethics Group (OCEG) presented its GRC Achievement Awards to six leading companies last week.   Among the winners was Carnival Corporation, which was highlighted in Eric Krell's case study Inside Carnival Corp: A GRC Case Study last year for Business Finance Magazine.  Carnival's approach is worth considering because they have clearly integrated governance, risk and compliance (GRC) into their overall performance management framework.   Like the company I referred to in my blog post, How Well Do You Manage Your Risk?, Carnival has applied GRC management at every applicable level within the organization, essentially making risk "everyone's job."  There are a lot of similarities between leading companies' approaches to performance management and GRC management.  Let's take a look at how Carnival tackled the problem.

Carnival is a highly decentralized company whose individual cruise line businesses operate in a highly autonomous way.  They adopted a holistic approach to GRC management across all these businesses in such a way that best practices and results can be shared among them.  Along the way they identified some key enablers for their GRC objectives that will sound very familiar:

• Executive and board support for a proactive (internal) audit function - this program went beyond just reviewing financial controls by focusing on operational controls and ways to facilitate business improvements
• A process approach to managing the business - they analyzed their companies in terms of the business processes and identified the risks associated with each of these processes using the COSO risk classification framework, which allowed them to better evaluate the financial reporting, operational and compliance risks associated with each of these processes
• A process approach to Sarbanes-Oxley compliance - they used their process classification model to link processes, risk and financial accounts to identify the financial reporting risks existed within the company and what controls existed to mitigate these risks
• Strategic risk questions from the board - the board pushed to get the company to consider the exposure to external and strategic risks, which in turn led them to examine the business processes associated with these risks; ultimately, this led them to implement an enterprise risk management system (ERM)

This same operational and process focus are also key enablers to successful corporate performance management (CPM).

Carnival's approach is not unlike the approach I wrote about in one of my white papers, Sarbanes-Oxley Act Compliance: Reconciling Transactional Data with Financial Reports.  At the time I wrote it the SEC had not yet adopted its compliance rules and, while the SEC has yet to extend the compliance requirements into the broader area of effectiveness and operational efficiency (as recommended by the COSO framework), Carnival's success as well as that of many of our customers shows that this is an approach worth considering.  I identified three key ways profitability modeling and optimization (PMO) solutions can benefit Sarbanes-Oxley compliance:

• Documentation - the process-based approach for PMO is one of the key enablers identified by Carnival's award winning implementation of GRC
• Internal Controls - the 3-way validation process that's a key part of any leading PMO implementation acts as a natural monitoring system for the effectiveness of internal controls and can help eliminate exposure to compliance risks
• Material event analysis - I show how a business activity monitoring solution can be extended to perform automated material event analysis using the KPIs already monitored

In addition, a customer pro forma analysis process and external/strategic scenario modeling (see How Well Do You Manage Your Risk?) are other examples of how a PMO solution might benefit ERM.

I'm not the only one to make this connection.  In his recent article The Future: Enterprise risk-based performance management, Gary Cokins elaborates how companies can use many of the same principles of performance management to systematically manage their risks by using operational risk as a key lever to link their risk exposure to their risk appetite with a series of key risk indicators (KRIs).  Robert Kaplan also highlights the need to use predictive analysis to model the potential impact of key operational and strategic risks as part of the strategy execution system in his recent article, Risk Management and the Strategy Execution System.   

Like GRC, performance management needs to be everyone's job.  Both share a common enabler: a process-based approach.  Successful companies implement powerful measurement systems that link their processes to their results so that they can more effectively manage them.  Pro-active companies extend these capabilities with predictive modeling to that they can better manage even the most unthinkable situations that might occur.  Volatility is the new normal.  How well are you equipped to adapt and flourish? Spreadsheets are probably not the answer.

When Going Green Means More Green

As the saga in the Gulf of Mexico continues to unfold we're all reminded of our collective responsibility as stewards of the environment.  The impact the oil spill is having can be easily seen and will likely have a long term negative impact on the fragile ecosystem in the Gulf of Mexico.  The environmental impacts of many other decisions we make on a day-to-day basis aren't always so easy to see and, even if you are aware of them, making a more sustainable choice will often cost you more.  The complexity and costs involved with sustainability have made it easy for many companies reprioritize its importance lower or ignore it altogether.  However, consumer sentiment is changing and more and more companies are beginning to realize that going green doesn't always translate into red.  In fact, the world's largest company has found ways to make green by going green.  I am, of course, referring to Wal-Mart.

For decades, Wal-Mart achieved incredible growth by driving cost out of its supply chain network while providing consumers with value at the lowest possible price.  Wal-Mart recognized early on that collaborating with their suppliers through increased visibility across their supplier network was the key to a more efficient and lower cost supply chain.  In 2005, Wal-Mart launched their new sustainability strategy with some pretty ambitious goals.  Once again, they extended their initiative across their entire network of suppliers by creating a metrics system by which they could evaluate their suppliers based on their strategic goals.  It also created a sustainable value network to support these initiatives and invited its suppliers to participate in return for a closer, more stable relationship with Wal-Mart.  In order for these programs to be sustainable, they had to provide both an economic benefit as well as an ecological benefit.  For example, increasing fuel efficiency in a truck fleet not only reduces CO2 emissions, but it also reduces costs.  Other examples include reduction in energy use at facilities, reduction in solid waste and the use of electric power units that don't require the engine to be running in refrigerated vehicles.  The sustainable value network allowed it to pursue these goals across the other 90% of the end-to-end network represented by its suppliers.

But, Wal-Mart isn't alone.  Andrew Winston recently highlighted Pepsi's efforts to reduce its environmental impacts across the value chain in his blog post, Greening Pepsi, from Fertilizer to Bottles.  On the one hand, they collaborated with the GreenOps division of Waste Management to implement a reverse vending machine for recycling called Dream Machine that rewards consumers for their participation.  This program has already increased the recycling rate of their beverage containers from 34% to over 50%.  On the other hand, they performed a full life-cycle analysis of their Tropicana orange juice product line to identify opportunities for carbon footprint reduction.  To their surprise, the biggest contribution came during the agricultural stage, namely the process for making fertilizer.  They began to work with suppliers and farmers to find different ways to make and apply fertilizer with a lower carbon footprint.  While they're still in the process of testing the results of these improvements, they are hoping for a 15% overall reduction in CO2 emissions with no additional costs for their suppliers.  Like Wal-Mart, they took a holistic approach with their initiatives and were able to achieve more meaningful results.

How are these companies able to do this?  They've linked the consumption of resources with the processes that consume them, either directly or indirectly, for each product across the entire supply chain.  They were already tracking the key drivers of CO2 emissions, such as energy consumption and fuel consumption.  The challenge is linking these drivers to the processes required to produce and deliver products to customers.  What's required is a resource demand-based process analysis model that can not only identify the demand for these drivers, but also produce the carbon footprint (cost) for each process in the value chain.  Sound familiar?  It should.  The same methodology is also used to determine the actual costs associated for each process in the value chain.  Companies with capable profitability modeling and optimization systems should be able to extend these to help them better identify and manage their carbon footprint as well.  Those that take the extra step by holistically examining their entire value chain will be rewarded with opportunities to not only save money, but also reduce their environmental impact as well.

Innovative companies will find new ways to incorporate social responsibility into their business in ways that will set them apart from their competition.  Leading companies will formulate a balanced strategy that satisfies both shareholders and customers.  A critical success factor will be their ability to create transparency around their value chain because it fosters trust among consumers and collaboration among the supplier network.    The good news is that you can address sustainability using the same means as effective cost management with capable profitability modeling and optimization solution.  Who wouldn't choose to make a more responsible decision if it didn't cost you anything more, or better yet, made you more money?  Perhaps it's time to take a deeper look at your company's impact.  The solutions may be simpler than you think, but only if you can accurately measure it first.

How Well Do You Manage Your Risk?

Or, more important, do you even know your risk exposure?  After reading Michael Lewis' book, The Big Short, it's clear to me that relying on others to evaluate your risk as the bond rating companies did is a bad idea, especially if you're being asked to risk assess their offerings.  It's as if you were to go to the bank, ask for a loan telling them they have nothing to worry about because you're going to tell them how credit worthy you are and the unthinkable, that is you not being able to pay it back, could never happen.  Yet, this is the position many companies find themselves in when they try to assess their exposure to changing market conditions.  They generally have a Plan A, the budget, which is effectively their best guess at some point back in time.  So what happens when things change?  Is there a Plan B and, more important, how well will Plan B work?  Is anyone even asking the question, what is the worst that can happen and what do intend to do then (Plan C)?

The problem with most risk assessment is that it's based on history, which can be a poor indicator of future conditions, especially when they are as volatile as those we are experiencing today.  We've all read about the tragedy that continues to unfold in the Gulf of Mexico following the sinking of that BP oil rig.  I doubt anyone can really estimate the true impact this event will have because of the many variables in play and our ability to control them.  Coincidently, BP executives were visiting this particular rig to recognize its exemplary safety record.  Things were going so well that apparent warning signs were ignored.  Several unsuccessful fixes have been attempted, each promising a resolution to the issue so no backup plan was really needed. Now the government is stepping in.  Sound familiar?  How the mighty have fallen all because the unthinkable happened.  There are many people angry right now and rightly so.  Most are probably more upset by how BP handled the situation than they are about the fact that it happened in the first place.  You can never really afford to eliminate all risk, but if you know your exposure and its impact, you may be able to manage the situations better when they occur, possibly even picking up on early warning signs and preventing the worst case from happening altogether.

It all sounds pretty dire. But, there is hope.  I had the good fortune to meet with one of our long standing customers earlier this month and they had a rather creative strategy.  On the one hand they had implemented a process whereby they evaluated the profitability of any significant new or changing customer relationship before they were accepted.  It included an escalating approval workflow that was commensurate with the revenue associated with the relationship.  I found this fascinating for two reasons.  First, they had leveraged the drivers of profitability from profitability model to do Pro Forma profitability modeling of this customer's relationship to their company.  Second, they are a public company and they had a repeatable process for determining materiality which should serve as an excellent example for other public companies that face regulatory requirements around disclosure.

This customer was also using several rolling forecast (or should I say projection) models to predict future financial and operational outcomes using multiple horizons.  These were updated periodically.  I was equally impressed by the fact that they were not quite satisfied with either the frequency or the accuracy with which they were able to accomplish this, so they were always interested in exploring new ways to improve.  No wonder they have been so successful and more than doubled in size since we first started working with them.  Knowing your drivers of profitability is a critical enabler for this type of risk management and this company as a very deep understanding.  According to one Gartner analyst, companies with this type of measurement capability outperform their peers by more than 30%.

Risk can manifest itself in a variety of ways.  It's how well you're able to manage this risk that will set you apart from your competitors.  Recognizing your risk exposure and establishing the right plans are critical success factors for navigating your company through these situations.  Wouldn't it make sense to model these scenarios and your action plans before they occur so you can choose the path with the greatest chance of success when the unthinkable happens?  So, if Plan A doesn't work, how do you rate the likelihood that your Plan B and Plan C will succeed?  Are you comfortable with those odds?

It's worth thinking about because the rate of change is accelerating and it's survival of those who can adapt the fastest.  Let me know what you think by joining the conversation.