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Thursday, February 1, 2007
The problem of narrowly defining what you manage in your corporate portfolio. What is a discretionary investment?
Most companies consider their operating expenses as business as usual, and they look to minimize them instead of managing them. And they often 'manage' them cavalierly with proclamations that operating expenses should only go up by x% this year or demanding they go down by y% over some period. And, unfortunately, this is a very poor way to manage these 'expenses'. Because in reality, a huge portion of what constitutes operating expenses would be better described as "operating investments". Investments because they generate returns, financial or strategic, for the firm and are vital to the long term success of the organization. Missteps in the allocation of operating expenses can put you at a competitive disadvantage and ultimately out of business. If where you invest your money is, by default, your strategy, then isn't not actively managing your operating expenses an indication of poor strategic planning? And from a shareholder perspective, if company managers are stewards of shareholder money, isn't it incumbent on them to actively manage ALL of their discretionary investment resources to maximize shareholder value?
Operating investments include areas like advertising & promotion, IT, salesforce, R&D, and even some operating initiatives. And these investments should be optimized as part of your CPM efforts. And most striking is the portion of operating expenses which are discretionary. Benchmarking several industries and organizations revealed that that 20-35% of operating expenses are discretionary meaning they can be turned on/off, reallocated, and ultimately managed. In fact, at American Express, the amount of discretionary operating investment dollars managed as part of our CPM efforts is squarely in this range and is several billion dollars on a per annum basis.
Of course, there is a portion of operating expenses that are not discretionary, i.e. those things that keep the lights on and keep you in business. For an internet company, it's ensuring that their website is up and available. For an automobile company, it's ensuring their manufacturing assembly line is producing cars. For us at American Express, it's making sure that when someone wants to use their card, the transactions works seamlessly for the consumer and the merchant. But, ultimately, not managing these operating expenses as investments does your firm, the people who run these investments and shareholders a disservice. From a behavior perspective, framing these expenses as investments serves to demonstrate to people that these are not simply areas to be re-engineered and minimized.
In fact, minimizing operating expenses can have very real and very deleterious impacts on share price performance. For discretionary branded consumer goods companies, cutting marketing expenses actually has been shown to lower total shareholder returns in subsequent periods.
Changing your organizational mindset about operating expenses will have major positive implications for your organization so I'd encourage you to begin this transformation asap. I welcome comments from those of you have managed to transform your organization's thinking towards operating expenses to a view that they are operating investments. What did you do in order to enable this behavioral change? For organizations struggling with this, what are the main roadblocks you are facing?
Monday, January 15, 2007
Ultimately, what organizations must realize as they put together their cost benefit analyses (CBAs) is that benefits are not strictly financial. There are strategic and risk benefits that can be quantified but which may not fit neatly into an ROI construct. That said, merely saying you need to do an investment because it is "strategic" is not enough and actually a cop out. You should be able to articulate and measure this strategic or risk impact even if it doesn't translate into direct bottom line impact.
The February 2007 issue of FastCompany magazine contains an interesting article which looks at how Whirlpool has begun to measure the impact of good product design. Like brand advertising, loyalty/retention investments, many IT investments, etc, investments in product design can be difficult to ROI-ize. As the article states, Whirlpool and the design world in general "lack objective financial metrics to help them calculate whether increased investment in design will generate increased profits."
Chuck Jones, Whirlpool's design chief, realized the need to quantify the impact of better design when "the company's resource allocation team asked him to estimate the return on investment, but Jones couldn't produce the numbers to make such a forecast. As a result, he was forced to fall back on a rationale that was simultaneously elitist and lame: Trust me. I'm a designer."
Jones didn't give up and instead of trying to force ROIs on design investments, his team "created a standardized company wide process that puts design prototypes in front of customer focus groups and then takes detailed measurements of their preferences about aesthetics, craftmanship, technical performance, ergonomics and usability."
Jones believes that "this metrics based approach is also transforming Whirlpool's culture." The process has actually yielded its first product and the first product is showing profits up 30% over the previous model.
The done by Whirlpool highlights several different key items worth learning:
- Benefits are not strictly financial. It is important that you think of benefits holistically and develop a way to measure the impact of investments even if those benefits are not financial.
- It is important that the measurement of these metrics & benefits be constructed in a robust and rigorous way so that they can defend against attacks that will invariably come in most organizations from the introduction of a metric or process that is not widely known.
- Development of a credible new metrics-based approach or any type of corporate portfolio management effort takes time. In the case of Whirlpool, Jones' team has worked on the development of their methodology for two years before the first product was launched.
- Build a repeatable capability and competency. Whirlpool has built their consumer-generated measurements into a database so they can continue to leverage this data on an ongoing basis to make design decisions. Data underlies good decisions and ensuring this data is captured and available is very important.
- Make sure the metrics you capture don't always point to a decision to undertake an investment. Your new process will be more credible if certain projects get killed along the way as well.
If your organization has developed innovative ways to demonstrate the value of and scrutinize investments which don't fit neatly into an ROI construct or which don't have measurable financial benefit, I'd love to learn more. Please drop me a note or leave a comment on this post.
Friday, January 12, 2007
There is an interesting contention made in a recent article in the Sarbanes-Oxley Compliance Journal. (Note: I read that sentence over and realized I used the word interesting in a sentence mentioning SOX compliance. That is a first. I apologize to any of you who are riveted by SOX compliance). The author, Jan Sondergaard (VP of Products, HP) correctly asserts that many IT organizations are viewed as "black holes" or "bottlenecks" but takes it one step further and say that this is reflective of the inability of many IT organizations to "automatically capture, view, and report on all of the work IT is doing." And as a result, this deficiency creates real corporate risk making "sustainable Sarbanes-Oxley compliance impossible."
The author further contends that the "best way to implement standards across an organization is to take a top-down project and portfolio management approach that allows you to define and enforce 'control points' throughout the processes" and to "take project and portfolio management solutions that offer real-time alerts and indicators."
So a couple of interesting points/questions this raises:
- I'd love to hear from any organizations who are using their portfolio management discipline as a source of SOX compliance. In general, I don't think I've seen that as the purpose behind a corporate portfolio management effort, but if the CPM discipline can aid in SOX compliance, it's an obvious benefit. Please leave a comment and let me know if you are doing this, and perhaps we can get a dialogue going.
- Of course, those of you with opinions on this topic of any kind should also leave your comments.
- Regarding the article itself, I like and am intrigued by the idea as I do feel that the rigor that a CPM effort would instill around IT investments can definitely help mitigate risk and offer insights into the behavior/nature of IT spending.
- That said, the article does come from the "portfolio tool as savior" school of thought with dashboards, workflows and real-time alerts all being highlighted as the means to get at "accurate, reliable information that IT professionals at all levels can more effectively respond to the demands of the business while creating a culture of accountability that can support current and future regulatory requirements." This I disagree with on multiple levels:
- Technology solutions are not a panacea to any type of problem - regulatory or not. You must understand what your objectives are, what process you are trying to enable, etc and then think of how technology might aid in this effort.
- Portfolio management solutions do not magically create accurate, reliable information nor do they force accountability. They create rules (good or bad) which people, if not properly educated and incentivized can circumvent and/or ignore.
- If building a portfolio management process, you should aim to build it as a capability -- not as a process to enable just support of regulatory requirements. CPM is a powerful discipline which has widespread organizational uses and so building it in a sufficiently robust way will enable it to offer insights into SOX compliance but will also give it significantly more ability to contribute to the organization on other pressing fronts including ensuring achieving financial, strategic and risk-oriented goals.
I am glad that Mr. Sondegaard raises this idea around CPM and SOX as it is quite interesting and has some merit. I think the means to achieve what he is talking about maybe enabled by a technology solution, but that is not the first priority.