Is Uber Wall Street’s New ‘Great Vampire Squid’?

(As this article relates to an impending NYSE listing, please note the disclaimer at the foot of this article.)

In one of financial journalism’s most memorably descriptive pieces, Rolling Stone Magazine’s Matt Taibbi described Wall Street investment bank Goldman Sachs in these less-than-flattering terms…

The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.

Matt Tiabbi – Rolling Stone Magazine

I have no particular views on Goldman Sachs…then or now…but if ever I thought any business deserved to be described as a “great vampire quid”, it’s Uber, whose business practices appear to plumb the depths of an uniquely deep pool of poor conduct in the technology sector..

They’re not right at the bottom, admittedly. Facebook deserves that accolade all on its own, but Uber are certainly giving Menlo Park’s finest privacy invaders a run for their money.

And, of course, money is what it’s all about.

Stock Market listing ahead…

Uber have announced plans for a stock market listing which would value the business at $100 billion or more. However the “price” for this influx of cash from new investors is that the law says Uber now has to tell people at least a little bit about their business as a condition of being allowed to invite members of the public to buy their shares.

Everyone who’s anyone in the field of banking and finance is buzzing around the most eagerly-awaited flotation for years…including, it has to be said, the aforementioned Goldman Sachs, alongside another 28 banks and financial institutions.

Now, I’ve no problem with the basic concept behind Uber’s business.

Like a lot of traditional businesses at the dawn of the digital era, some long-established cab companies were not as responsive and customer-friendly as they might have been. In some cases, service was variable and passenger safety was not always guaranteed.

Even for those business which were at the upper end of the service and reliability spectrum, like London’s Black Cabs, for example, their initial reluctance to embrace new technology left the door open just far enough for an upstart like Uber to gain a foothold.

I also have no problem with people earning a bit of extra cash using their own vehicle to ferry people around outside their normal working hours, provided they are properly insured, trained and regulated.

So far, so good. Up to this point there was the potential that Uber might have become a service- and safety-focused personal transportation business which would provide a much-needed, safe, reliable service to a great many people, while providing an opportunity for part-time drivers to earn a bit more cash in their spare time.

There is a good business idea at the heart of this ‘great vampire squid’ of an organisation.

But it didn’t take long for Uber to show its true colours.

Away from the PR, reality bites…

Uber’s clashes with transportation regulators around the world became the stuff of legend…specifically, the legends that had law firms around the world salivating and rubbing their hands with glee.

Taking on City Hall, with their effectively unlimited legal resources, in a case funded by the deep pockets of venture capital investors with an eye on an eventual multi-billion dollar payout, is the stuff of dreams for the managing partners of sizeable law firms in every major city around the world.

And the personal conduct of Uber’s founder, Travis Kalanick, was less-than-commendable, leading to his ousting from his own business by a group of investors who felt his behaviour was in danger of getting in the way of their own financial returns.

For a short while after Kalanick’s departure, there was an air of optimism that some of Uber’s more questionable management practices would be reined in by their newly-appointed CEO, Dara Khosrowshahi.

It’s certainly fair to say that many of the personal excesses of the Kalanick era have been addressed and having the much more investable Khosrowshahi as the public face of a business heading for one of Wall Street’s biggest IPOs of the 2010s is almost certainly a plus for investors.

So everything is OK, right?

Well, not from where I’m standing.

Uber’s business model is no great shakes…I wonder if it even has a model…

Concerning though the behaviour of one of Uber’s co-founders might be, there’s worse to come. For that, you need to take a look at Uber’s business model.

All you need to do is read Uber’s Securities and Exchange Commission (SEC) Form S-1…the preliminary prospectus businesses are required to issue in advance of listing their shares on the New York Stock Exchange (NYSE).

The prospectus doesn’t start well. The very first page is proudly emblazoned with Uber’s mission statement – “We ignite opportunity by setting the world in motion”.

No doubt some swanky ad agency or strategy consulting boutique came up with this, but the only question that should be in your mind when you read statements like this is “whose benefit is this opportunity for?”.

It feels a bit like Alibaba Co-Founder Jack Ma’s description of his staff’s 996 workweek (9am to 9pm, 6 days a week) as a “blessing”. We can be fairly sure that most of the blessing from making his staff work those hours flows into Jack Ma’s bank account, rather than his employees’.

The “opportunity” that Uber claims to “ignite” is almost certainly less an opportunity for its staff and customers and more an opportunity for its early investors, the management team lucky enough to have picked up plenty of share options along the way, and the Wall Street investment banks, who have large fees riding on a successful NYSE listing.

As part of their S-1, Uber is legally required to disclose who owns 5% or more of its shares and there are some interesting names on that list who will do very well out of a successful IPO

  • First and foremost, Travis Kalanick…remember him?…who remains Uber’s largest individual shareholder with 8.6% of the business, worth a potential $7 billion
  • Garrett Camp…not a name you’re likely to have heard, but the original Uber app developer…has 6% of the business, worth just under $5 billion
  • Investment firm Softbank owns 222 million shares, worth potentially $13 billion on flotation
  • Ryan Graves, Uber’s first CEO but long-since departed from the business, has shares worth just shy of $2 billion
  • Benchmark Capital, who led the Series A funding round and participated in later rounds as well, has 150 million shares worth around $9 billion

And, of course, there are many other canny investors who kept their shareholding below the 5% level at which their interest has to be publicly disclosed. Even 5% of a $100 billion business is worth $5 billion, after all…that’s a pretty decent chunk of change.

What’s extraordinary though, at least since the go-go days of the 1999 dot-com boom, is that Uber has never made a penny from operating its business.

The business lost $3 billion in 2018 alone, and $10 billion in the last three years. The only reason it still exists in the face of operating losses of that scale is because its financial backers keep giving Uber cash to grow.

But don’t worry…there is a plan…(on second thoughts, start worrying – I’ve seen the plan…)

The basic plan is that Uber crowd out smaller, more local, operators in their chosen markets…at which point Uber can raise their rates and, having eliminated their competition through a combination of predatory pricing and slick marketing, make back the losses they incurred building the business many times over.

That’s for the long-term, though. There’s clearly still plenty of work to be done crowding existing operators out of their traditional markets first, as Uber’s prospectus makes clear… “We anticipate that we will continue to incur losses in the near term as a result of expected substantial increases in our operating expenses”.

Let that sink in for a moment. Not only has Uber lost $10 billion at the operating level in the last three years, losses, presumably the multi-billion dollar level as a result of Uber’s “substantial increase in operating costs”, will continue into the indefinite future.

Of course, fast-growing businesses with great potential can sell while still loss-making and do very well out of it. But in the long run a business valuation can only be sustained by the level of profits it makes…or, if you’re taking a purist approach to company valuation, the operating cash flow it generates.

If the future flow of profits is a number less than zero, no matter what discount factor you apply, the overall valuation of the business cannot be a number greater than zero…it’s mathematically impossible.

The only way you can sell a business which anticipates making losses into the indefinite future at a number greater than zero is by being fortunate enough to find another group of people who are prepared to keep funding the loss-making business instead of you.

Usually they do that because you…or your investment bankers or PR consultants… manage to convince those investors that immense riches will somehow be magically unlocked for the lucky people who take the shares off the early investors in the IPO. because the business will do so much better in the future than it has in the past.

In essence, that’s what Uber’s IPO is all about. We’ll return to the consequences of this in a moment…

The people who really know what’s going on are the debt-holders

Before we consider what’s in Uber’s plans for shareholders, first we need to consider the role of debt in the business.

Uber hasn’t just been bankrolled by over-excited venture capitalists. It’s been bankrolled to the tune of $7.5 billion in debt as well. And the SEC Form S-1 rightly makes potential investors aware that interest payments and capital returns to its lenders would have priority ahead of any payments to shareholders, and could take up a substantial portion of Uber’s future operating cash flow.

What’s worse, from Uber’s point of view…although undoubtedly better from their bankers’ perspective…the S-1 indicates that terms on which the $7.5 billion in debt has been provided largely prevent Uber from raising additional debt from other sources.

If you wondered why Uber are heading for an IPO right now, your answer is there.

And if you wondered why you should be concerned about Uber’s IPO, your answer is there too.

Uber’s providers of debt finance have been supporting that business, one way or another, for several years now. They have a level of access to the business’s financial information that no outside stock market investor will ever have.

Here’s why that matters…

If the people who know more about Uber’s finances than anyone else have capped their risk so tightly at $7.5 billion…an almost minuscule level of debt exposure in a business allegedly worth $100 billion, you can bet your bottom dollar that they are a whole lot less convinced about the soundness of Uber’s business model than the army of investment bankers and PR consultants walking the floors of the NYSE at the moment.

For any other business with a stock market valuation of $100 billion, a debt exposure of several times $7.5 billion wouldn’t be much of a problem.

But the providers of debt finance have not only capped their own risk, they’ve made sure that other providers don’t increase their risk through the back door by adding more debt on top of the debt the early financiers have already extended to Uber.

It’s quite normal for holders of senior debt to require that their approval is sought before, for example, additional security is lodged against assets over which the senior debt holders already have security.

But Uber’s S-1 says something subtly different to that… “Our existing debt instruments contain significant restrictions on our ability to incur additional secured indebtedness. We may not be able to obtain additional financing on favorable terms, if at all.”

That’s another way of saying that Uber’s debt financiers have wrapped their loans up in conditions so tight that using more debt to grow isn’t a practical option.

Which is odd…

There’s plenty of cash sloshing around the world’s banking system at the moment looking for a home. There’s a good economic argument that suggests loading some more debt into the business would increase returns to ordinary shareholders. And banks, usually, are generally prepared to finance…at the right rate, of course…rapid growth in a successful business with a good business model.

Yet Uber’s debt-holders seem to have lent almost inconsequential amounts of money for a $100 billion business, and done so on terms which prevent Uber raising other external debt either. It hardly speaks of confidence in the business model from a group of insiders with unparalleled access to Uber’s financial records.

Which brings us back to the IPO as a way of finding a group of people who can be hyped-up to such an extent that they’ll buy a story of the sunlit uplands of a few years into the future when Uber will be the dominant transportation business in the world and able to garner excess profits through its pre-eminent market position.

Uber’s own providers of debt finance don’t appear to believe this, and neither do I.

How big do you have to get before you work out how you’re going to make any money?

For a business going for a stock market listing, Uber doesn’t seem to have much of a business model.

In their prospectus, Uber talk a good game, but it remains murky how they ever expect to generate a level of revenue which would cover their operating costs and leave a profit for shareholders.

In my opinion, if you haven’t worked out a way of billing revenues higher than the costs of running your business by the time you’re trying to convince potential investors that business is worth $100 billion, you’ll probably never work out how to do it.

Another astounding feature of the Uber listing is that they’re not even making a secret of any of this. It’s all there in the S-1 Form.

Uber, and their investment bankers and PR consultants, are just presumably hoping nobody reads much past the first few pages full of shiny happy people and vacuous corporate mission statements.

One of the great weaknesses of Uber’s business model is that pretty much anyone can compete with it. In fact, it’s hard to imagine a business with fewer barriers to entry, which is also why it’s hard to imagine profitability is anywhere on the near-term horizon for Uber.

In highly competitive markets, like the ones Uber operates in, if a business increases its prices to cover their operating costs…as Uber desperately needs to do to achieve economic stability…other providers with lower operating costs simply undercut the “market leader” and steal their business away.

That’s why Warren Buffet talks about the “moat” he likes to see round businesses he owns, where the barriers for entry are so high that competitors flooding the markets he owns businesses in are a very unlikely prospect.

Here’s what Uber’s own S-1 says about their “moat”…

The personal mobility, meal delivery, and logistics industries are highly competitive, with well-established and low-cost alternatives that have been available for decades, low barriers to entry, low switching costs, and well-capitalized competitors in nearly every major geographic region. If we are unable to compete effectively in these industries, our business and financial prospects would be adversely impacted.

Uber Technologies Inc, SEC Form S-1

Low barriers to entry and low switching costs aren’t the sort of things that would make Warren Buffet feel very comfortable, and it shouldn’t make potential investors in Uber feel very comfortable either.

Realistically, sooner or later Uber need to increase their rates to generate profits, and positive cash flow. But the moment they do, according to Uber’s own prospectus, existing “well-established, low-cost alternatives” are likely to hoover up their business..

We can’t raise our prices, so how do we make a profit?

If you’re unlikely to be able to raise your prices, the only other lever you can pull to generate a profit…and don’t worry, Uber, being a potential ‘great vampire squid’ of a business, has already thought of this…is for Uber to take a greater share of the revenue currently earned by their drivers.

That way, they don’t need to charge customers any extra, so there’s limited risk a competitor will move in and take Uber’s business away. Instead the increased share of their drivers’ earnings can be deployed to plug any gaps in the balance sheet.

You might think this was a particularly scuzzy thing to do…and I wouldn’t disagree with you…it’s not as if driving for Uber is an already-lucrative profession.

In London, a recent Oxford University report found that Uber drivers earned around £11 per hour on average, or only slightly above the London Living Wage.

Around the word, the reaction from Uber drivers to the company’s attempts to take a greater share out of an already small pot is fairly predictable. For example, Uber drivers in Los Angeles have recently voiced their fury about a 25% reduction in their per-mile rates in an attempt to put Uber on a sounder financial footing.

No wonder Uber’s S-1 says this…

…we continue to experience dissatisfaction with our platform from a significant number of Drivers. In particular, as we aim to reduce Driver incentives to improve our financial performance, we expect Driver dissatisfaction will generally increase. 

Uber Technologies Inc, SEC Form S-1

So Uber’s business model is one where it can’t raise the prices it charges to customers due to the wide availability of competitors who will undercut any rate rises. And it can’t cut driver rates much more and still find people prepared to drive for them.

And all that is glossing over the continuing legal and regulatory disputes about whether Uber drivers are really independent contractors, as Uber claims, or employees who would be entitled to a much higher, legally-mandated, level of pay and benefits.

Were that to happen, Uber’s S-1 acknowledges their business model…such as it is…would suffer a severe and negative impact.

The ‘great vampire squid’ makes its move…

It doesn’t take a sophisticated financial analysis to see that a loss-making business, which can’t raise it’s prices or cut its costs…and which carries substantial risks that its costs will increase dramatically if various legal challenges go against Uber and lower-cost competitors step up the fight against them…isn’t a business model which inspires a huge amount of confidence.

As a CFO, if someone proposed that model to me in a business case, I’d be telling them to go away until they’d found an economic model that actually worked properly. I certainly wouldn’t be giving that business plan a penny.

With the cream of Wall Street financiers on their payroll, I’m sure Uber’s offering will get away in the markets. People will buy, the early shareholders will cash out and retreat to their idyllic Pacific islands without a care in the world.

Things might even appear fine on the surface for some time thereafter. The black arts of public relations can, in fact, defy gravity for quite a while.

But the laws of fundamental economics always wins in the end.

If a year or two from now Uber is still losing $3 billion a year, even as the business grows larger, investors might start to wonder if profitability was ever going to come to Uber.

At first nobody might sell, but people would stop buying.

Brokers would start having to mark the share price down to a level which attracted some buying interest.

As the share price fell, the more risk-averse investors would start selling their shares to make sure they don’t suffer an even greater loss.

Then short-sellers, who will be sniffing around Uber already as they can spot a shaky business case from several miles away, even in the dark, will load up on their positions.

In the history of the financial markets, we all know what’s going to happen next…even if the precise timing of the big swing downwards is harder to predict…days…weeks…months… a year or two…

The timing is uncertain. The direction isn’t.

Once a selling momentum gets behind a business which looks like it’s running out of cash due to its inability to generate a profit, the end is predictable…and usually not pretty.

Of course, even as the ship goes down, its cheerleaders will insist that everything is fine and investors’ money is safe.

But it won’t be.

It wasn’t in the sub-prime mortgage collapse of 2007 which led to the global financial crisis.

It wasn’t in the collapse of Long Term Credit Management in the late 1990s, which went belly-up despite having two Nobel Prize-winning economists on its board after it ran out of cash.

And it won’t be if Uber doesn’t convince ordinary investors that it’s got a business model from which investors can expect a solid financial return anytime in the near future.

As always, the people who suffer if Uber goes belly-up will be the small investors who buy now, not the early-stage funders who are cashing out in the IPO…and the drivers, given that Uber’s S-1 already makes clear that reducing payments to drivers will be one of the ways it’s going to balance the books in the future.

That’s why Uber might be Wall Street’s new ‘great vampire squid’…sucking the life savings out of legions of small investors, and sucking the hours out of their drivers’ lives in return for less and less cash per mile.

It might take a while for the markets to catch on. The IPO hullabaloo will carry Uber for a bit. And once the shareholders switch from well-connected insiders to ordinary members of the public, the likelihood is Uber will get a bit of breathing space while the new shareholders settle in (after all, the prospectus tells them it will be a long haul, so nobody’s expecting magic to happen overnight).

But in John Maynard Keynes’ immortal words. “the markets can remain irrational for longer than you can remain solvent”. Unless you’re a short-seller of unique bravery and deep pockets, now is almost certainly not the time to call Uber’s bluff.

But there are only two possible scenarios from here on in.

There are only two ways forward…neither of them good for Uber investors…

Either Uber will lose the confidence of its investors and fail.

Or it will change its business practices to be fairer to both investors and drivers.

The problem is, the way Uber is set up, either eventuality will be seriously prejudicial to its share price. Uber’s own SEC filing says so, which means thousands of small investors could lose out.

Until one or other of those events takes place, Uber’s continuing pressure to reduce payments to drivers might result in drivers sticking with the platform regardless in the short term, as they need to generate at least some cash to cover their car payments and running costs.

However, in the long run the many thousands of drivers working for Uber will have less money to spend on themselves and their families.

Their car leases will…for now…trap drivers into working for Uber, but ultimately thousands of private individuals are not going to keep subsidising the lifestyles of Silicon Valley billionaires by working for a level of economic return that doesn’t fully reflect the effort they put into the business. They’re all independent contractors. They can leave at a moment’s notice.

I don’t know if it was fair of Matt Taibbi to describe Goldman Sachs as as a ‘great vampire squid’ in his Rolling Stone article.

But I do believe that any business which is trying to unload itself onto an army small investors when it’s not in a position to say when, how or whether it will ever make a profit…

…while at the same time squeezing the payments to its drivers close to, if not below, Living Wage levels and planning to continue to squeeze them down still further after it’s “played nice” during the PR campaign in support of its NYSE listing…

…and indulging in predatory behaviour with the explicit intent of driving ‘mom and pop’ operators out of the towns and cities where they’ve made a decent, if unremarkable, living for many years…

…has the potential to directly affect the lives and financial futures of millions of ordinary people.

Maybe Uber will turn it all around and surprise us all.

But if they don’t, Uber has the potential to become Wall Street’s next ‘great vampire squid’, sucking the life out of millions of people even as they suck the cash out of their bank accounts.

Thankfully, Wall Street investment banks don’t spend their time making pitches to people like me. But if one of them brought along Uber’s prospectus and asked me in invest, I’d be laughing from now till Christmas.

Investing in Uber is one opportunity I certainly wouldn’t want igniting.

(Disclaimer: Just in case you’re stupid enough to act based on a blog post from someone you’ve never met, and wealthy enough to be able to afford a team of swanky lawyers, the foregoing is a personal opinion. I am not a regulated investment adviser in any jurisdiction and before making major investment decisions, you should consult someone who is. Unless they’re dumb enough to fall for Uber’s PR campaign, in which case you might want to reconsider your choice of investment advisor. And yes, that’s a personal opinion too, covered by the rights of free speech in every major jurisdiction.)

Picture credit: Rick Tap on Unsplash

Are you spending 50 quid to save a fiver?

When you’re a Finance Director or CFO people always expect you to “have a tight grip on costs”, “rigorously pursue cost-saving opportunities” and “implement tight procedures to ensure maximum efficiency”…or at least that’s how job advertisements for Finance Directors and CFOs usually describe the role.

Of course any good Finance Director or CFO will have a keen eye on the running costs of the business. The last thing they’ll want to do is make it harder than it needs to be to create the profit the business depends on to survive and thrive.

But sometimes the need to control what people are doing to make sure costs are properly managed can be carried too far. More often than you might think, the costs of control far outweigh any potential savings the control might bring you.

I call this “spending 50 quid to save a fiver”. That’s something no rational person would do, but it happens more often than you might think.

The best way I can illustrate this is by way of an example from somewhere I used to work (no, I’m not saying where…). Most people find it hard to believe this control process was ever allowed to see the light of day…but it did.

People I use this example with tend to chuckle and say something like “that would never happen in my business”. Which is true to a point…this is undoubtedly an extreme example…but versions of this, at a lower order of magnitude, can easily be found in just about every business I’ve ever worked in.

Here’s the logic which sets a business up for “spending 50 quid to save a fiver” – if a little bit of control is a good thing, surely more control has to be better…doesn’t it?

That’s not necessarily true. There is a diminishing return from every control system and there comes a point where dis-economies start to kick in – that is the business would run at a lower net cost if it took out the costs of the control process and just let people act in a sensible manner instead.

I’m not advocating anarchy…I’m a Finance Director and CFO, after all…

Simple procedures with a proportionate level of sign-off are essential in any organisation to create a sense of order and provide a sensible level of assurance about the business having an appropriate level of management control in place.

So here’s the example from my own career…just to be clear, I didn’t play a part in designing this system and spent most of my time in this business complaining about it, but the powers that be prioritised increasing control over reducing cost, for reasons I’ll leave to your own imagination.

In this business we had to send people overseas on a reasonably regular basis to work with partner organisations and customers spread around the world. Most people would never go overseas at all. A small number of people would go overseas three or four times a year.

To be allowed to travel overseas, a staff member had to complete seven different paper forms…yes, seven…yes, paper…

Each of those paper forms had 70 or 80% the same information on them as all the other paper forms, but each also had a small amount of information that wasn’t on any of the other forms.

The form that went to the Travel Office (yes, we had one of those) had the visa details on it, for example.

The form that went to the Finance Department had the costs on it, but not the visa information.

The form that went to the Head of International (yes, we had one of those too) had a risk assessment for whichever country the staff member was visiting, but didn’t have either the costing or visa information on it.

The form that went to the Group Chief Executive…yes, they all did…had an essay on it explaining why this particular trip was necessary, even though all our client agreements specified a certain number of visits each year on a relatively fixed timescale to dovetail with our own business planning cycle back home, so none of the trips should have been a huge surprise to the Chief Executive or anyone else..

And so on, and so on…

The original idea was sensible enough. No organisation wants people incurring costs on unnecessary overseas trips willy-nilly. I don’t think any fair-minded person…including the people who had to handle multiple 7-form overseas trip requests each year…would object to that principle.

There were some sensible concepts in there too…even though the execution was flawed. For example, final approval for all business trips was given by the Chief Executive in practice, even though there was a limit in the process which said if the trip was less than £1,000 it could be signed off by the divisional head instead.

The trouble with that was most of our business was in the Far East and it took at least a week or 10 days to travel out there, do the work required with the client or partner and return home again.

Once upon a time it might have been possible to do that for less than £1,000 but those days were long gone. So, although there was, sensibly enough, a limit in place to avoid involving the Chief Executive unnecessarily, that limit was set far too low to be meaningful and in practice he got to sign off everything.

From perhaps even a relatively reasonable starting point…if I give the maximum amount of credit to those involved initially…over the years, the whole process just got out of hand.

There was a sensible solution, of course. One electronic submission which went everywhere with all the information entered only once…which, ironically, we did with other decisions in the business requiring multiple sign-offs, just not with travel requests…combined with a sensible view on what the costs of a 10-day trip to the Far East might reasonably cost would have been a good start.

However, that’s not the only downside of this process. There were some significant cost penalties from this “tight system of control” too.

For starters, in general, air travel is cheaper the earlier it’s booked. And the nature of this business was that most trips could be predicted a couple of months in advance.

But it took between two and four weeks to get the necessary “live” signatures on all seven travel forms before a booking could be made. So it wasn’t unusual for air fares to have increased in the time between the trip being requested and sign-off being received, necessitating another “go round” of the process to get a higher budget signed off.

So let’s think about this process…designed to “ensure tight cost control” and “ensure robust processes are implemented”…

We had a Travel Office to coordinate many, but not all, elements of this process. They didn’t do the travel bookings, for example…that was subcontracted to a travel agent…they just handled the paperwork.

Including salaries and on-costs, there was probably the thick end of £100,000 per year just in the costs of this department…even before a single flight or hotel was booked.

The dozen or so signatures required on the various bits of paper…some required more than one signature on them…meant that a whole range of pretty senior people were spending time scrutinising the travel arrangements for someone who, in practice, they didn’t know and had no way of fully appreciating (despite the essay-style forms in some cases) precisely why someone was wanting to arrange the trip they were being asked to sanction.

Because all travel requests ultimately went to the Chief Executive, you can bet your bottom dollar that everyone whose hands touched one of those seven forms made absolutely sure they knew as much as they could in case the Chief Exec asked a question about their particular part of the process.

In practice, there was a flurry of emails and phone calls from different senior managers to the person proposing to travel overseas just on the off-chance the Chief Executive asked that particular senior manager about the trip. He rarely did, in practice, but still…just in case…

So to “save money on travel” we had a system which required a department costing £100,000 to administer.

Taking account of all the preparation time for the seven paper forms and the multiple sign-offs by senior people, up to and including the Chief Executive, that must have cost at least another £100,000…with an opportunity cost probably a lot higher than that.

And because we tended to end up paying more for air travel than we needed to, due to the delays in making bookings which this convoluted system forced upon us, we probably dropped another £100,000 there.

This was in an organisation which, whilst by most business’s standards did “a lot of international travel” but spent less than £1 million each year on it.

When the “overhead” of running a supposedly robust process is one-third of the cost of doing the activity in the first place, that’s a sure sign the admin burden has got completely out of hand.

Metaphorically, that business spent 50 quid to try to save a fiver.

There’s always a better way than that. All it takes is an outbreak of common sense.

(Photo by Alexander Mils on Unsplash )

Is “How cheap can we make it?” always the right question?

A couple of years ago I helped judge a Dragon’s Den-type competition in a local school (you might know this as Shark Tank if you’re outside the UK).

Groups of students each had to create a gift which they could “sell” to students who wanted to say “thank you” to their teachers for being so helpful and supportive that school year (which I’ve always thought was a great use of the power of hypnotic suggestion on the teachers’ behalf…but that’s not entirely the point of this article).

On the appointed day, each group presented their suggestions to the panel of “Dragons”, of which I was one.

There were some super ideas in there, but the one I remember most was the group which proposed, in essence, using a free web design service to produce a quick design, which could be printed off on a piece of flimsy card, thin enough to fit through a home inkjet printer, and handed to the teacher at the end of the school year at a cost of just a pound or so each..

All the students took turns to present different elements of the idea to the panel, but I still remember the boy who led the pricing section of his group’s pitch beginning his remarks with “Obviously, we wanted to make this as cheap as possible…”

Whilst I didn’t interrupt the presentation or try to derail their ideas…I might be a Finance Director and CFO, but I’m not an ogre…I did seek out this group afterwards to give them some feedback.

“Why, ” I asked, “would you want to go out of your way to make something as cheap as possible when it’s intended as a heartfelt thank you to someone who has been extra-nice to you? When your parents give you their heartfelt congratulations on your exam results or passing your driving test, do they think “how can we make this as cheap as possible?” or do they try to get you the very best of whatever they can afford to show their appreciation for your hard work?”

Bear in mind, this was a school which caters to a pretty well-off group of parents. I lived close enough to know kids who went there were often treated to exotic holidays for doing well in their exams and new cars when they passed their driving tests.

I don’t begrudge them any of that…after all, who among us wouldn’t do the very best for our own children?…but it was an interesting perspective.

The boy who’d done the pricing section spoke up. “Well, we’re in business, so we have to make everything as cheap as possible.”

I agreed that no business would last for long if it over-paid for the products it buys. But I asked him what car his dad drove…and wasn’t too surprised to hear it was a swanky BMW towards the top end of their model range as that seemed to be about the running average when I saw parents dropping their children off at this school each morning.

Why is that, I asked…I’m sure your dad knows there are plenty of cars cheaper than his BMW. Any one of them would get him to work pretty reliably. Or he could catch a bus.

And BMW are a business, yet they sell products which both they and their customers know for sure aren’t the cheapest way of getting to work.

So how cheap they can make their transportation doesn’t seem to be the most significant factor for people who buy BMWs, at least. We know that for sure because, if lowest-cost transportation was their overriding consideration, they wouldn’t buy a BMW in the first place.

I ended up having a nice conversation with this group about how things like branding can make a big difference to what people are prepared to pay, and how, in the eyes of the receiver, an expensive gift might be viewed very differently from a cheap one.

I don’t know if I helped this group of students see the world in a different light. I’d like to think so but, as I recall from being that age myself, 16 and 17 year-olds have plenty of other things going on inside their minds, so I’m not banking on it.

Now, don’t think I’m being too hard on a group of well-meaning 16 and 17 year-olds. We were all young and foolish once…yes, even future Finance Directors and CFOs.

But I find it a lot harder when this conversation comes up in a business context. While, of course, having an eye on costs and margins matters, too often middle and senior managers in sizeable organisations spend their time focused on how cheap they can make something when that’s just about the worst question anybody in business can ask.

The question they should ask instead is how they could build in significant amounts of extra perceived value for customers, provided the business can deliver it for an additional cost which is less than their customers’ perception of what those extra features and services are worth.

This is Economics 101.

If a business makes a 10% margin on its £100 product, that’s a tenner in its bank account.

If someone finds a way to increase the price to £200 by packing in more value…in the eyes of their customers…but it only costs an extra £50 to build in those features, the business goes from making £10 per unit to making £60 per unit.

The margin has gone from 10% on a £100 product to 30% on a £200 product.

What’s more, your customers are happy to pay double compared to what they paid before.

I fully accept if you’re in the commodity business…mining for coal, perhaps, manufacturing paper or smelting aluminium…market forces mean you’ll only get the same price per tonne as everyone else who can deliver to the same technical standards.

But a lot more businesses behave as if they were commodity producers, competing purely on price, than actually are commodity producers. More often than not, that’s just down to the business’s lack of imagination.

Sometimes the £100 product is very little different to the £200 version, but at the higher price point it comes bundled with a range of extra services which justifies the higher price point in the eyes of customers.

There really is no excuse for businesses not to try to improve the value they offer to customers.

That doesn’t mean overpaying. You have to make sure the commercial terms work in your favour. But, strange as this may sound, it means businesses should be actively seeking to increase their costs, because…unless they’re staggeringly inefficient now…that’s how they’ll deliver greater value to customers.

To illustrate, let’s flip that around…very few businesses have customers who are likely to allow it to make more profit by providing a worse service or poorer-quality products.

If a business focuses on cutting costs, its £100 product with a 10% margin might…if it’s diligent with the cost-cutting and lucky enough that its customers don’t notice or don’t care too much about the corners it’s cut along the way…become a £90 product with its original 10% margin maintained.

Except now you’re making £9 per unit instead of the £60 you could have made. And making £60 per unit isn’t going to be six times harder than making £9.

If you’re doing it right, it’s likely to be no harder…perhaps even easier as you’ll have the budget for a slick, well-managed operation rather than running the business on a shoe-string which needs regular urgent intervention to keep its under-resourced people and services on track.

Perversely, it’s often a lot harder to run a business when you fire the expensive, long-serving staff who know all about your products and your customers and replace them with casual workers hired only when you’ve got something for them to do. Often businesses end up using a lot more labour as a “blunt force” solution to a problem when a much smaller number of highly-paid people might have crafted a more elegant and effective solution at a lower overall net cost.

Or when you replace the top-quality German computer-controlled machines which some pale imitation from goodness knows where at half the upfront cost…but which extract a much higher price in maintenance, repairs and additional downtime across the lifetime of the machine itself.

Not only is it a lot harder to run a business supposedly “on the cheap”…it’s usually more expensive in the end too.

That’s not what the business case for making the changes will say, of course, but it’s what people will gradually realise six or nine months down the line when holes start appearing in its product or service delivery and the business moves firmly into “recovery mode”.

That’s when the customer complaints department has to take on more staff. The quality inspections have to go up. The refunds to customers when the products don’t last out their guarantee period goes up. And the business will spend a lot more on marketing to attract a constant stream of new customers prepared to give a poor quality service a try than it would have to spend if the brand and reputation did more of the heavy lifting on the sales front.

If you doubt this, just think to yourself…when did you last see an advertisement for a Rolls Royce?

I’m not sure I’ve ever seen one. Yet everyone knows that “the Rolls Royce of the XYZ industry” is the byword for a product of unimpeachable style and reassuringly good quality.

Which is why I’ve always been mystified that supposedly intelligent people, often with fancy MBAs, spend so much time reducing costs…often to the detriment of their staff, their customers and ultimately their business…when they should instead be actively seeking ways to make their products more expensive by offering additional value to their customers and standing out from the crowd rather than becoming just another bland price-based operation.

Don’t blame your customers for choosing the cheapest deal if price is the only thing you’re competing on. Some customers will always choose the cheapest option because that’s just the way they’re wired.

But more customers…maybe even most customers…are only deciding on price grounds because you haven’t given them any reason to make a different choice.

Were businesses to work on improving their branding, their reputation, their customer service, the marketing, their customer loyalty, their staff motivation, their product development, their design and any one of the dozens of other aspects that define the customer’s perception of the product or service they’re buying…then they might be surprised how many customers will happily pay for the extra value they receive.

That’s why, whether you’re a 16 year-old student or a 45 year-old middle manager with an MBA, “how cheap can we make it?” is rarely a good question to ask.

A better question would be “how much additional value can we build into our products and services such that customers will happily pay more than any extra costs we incur?”

Perhaps we shouldn’t ask “how cheap can we make it?”.

Maybe we should ask “how expensive can we make it?”.

(Photo by Manuel Cosentino on Unsplash)

Why thorough processes delivered to a high standard might account for all the problems in your business

The world is becoming increasingly process-orientated. There are positive aspects to that – if you’re the pilot of a 747, the Operations Director of a nuclear power plant or a surgeon carrying out microsurgery on a vital organ, I’d feel a lot more comfortable knowing that what you do, and the order you do them in, has been designed in a reliable, dependable way.

Even though most of our daily work activities aren’t anything like as mission-critical as those examples, the business world seems determined to introduce ever-greater numbers of processes and procedures to govern every aspect of what they do.

I’m not sure that’s a good thing for a number of reasons, but in my capacity as a Finance Director and CFO what bothers me most about our process-heavy world is that this approach often turns into a really expensive way to do something simple, and can easily lead to a range of less-than-wise decisions.

There is a better way…which we’ll get there in a moment…

But first, the inspiration

This article was inspired by a tweet from the always-interesting Mark Pollard (@MarkPollard on Twitter) reporting on a conversation with Phil Adams (@Phil_Adams). Here it is:

Their conversation was specifically in the context of producing good creative work, but I’d argue this concept matters for just about everything a business does.

The maths is unarguable.

Phil Adams points out, correctly, that even with just a 5-step process, where each step is done right 90% of the time, the likelihood of getting to a perfect answer each time is less than 60% (59.049% to be exact), assuming we’re dealing with a sequence of independent events (quick statistics primer here if you would like a refresher)..

Yet the holy grail for most large corporations is a detailed process with dozens of precisely crafted steps, each done right at least 95% of the time.

For a business process with even just 12 steps, however, each done right 95% f the time, the likelihood of everything happening exactly as planned is even less than Phil Adam’s example above. In fact, that process will only work as intended 54.04% of the time on average for a 12-step process, or not much over half.

Think about this. With a 12-step process where each step is done right 95% of the time, nearly half the time this process will go wrong somewhere along the line.

With a more complicated process, say one with twice that number of steps, you’re down to things going right less than 30% of of the time (29.2%). More than two-thirds of the time, your customers will be disappointed or something will be going wrong in your business. This will inevitably, one way or another, increase your costs.

I’ve worked for some large multinationals in my time and it was never much of a challenge to find processes 24 steps (or more) long. But even in relatively small businesses activities such as manufacturing products, responding to customer enquiries and tendering for new contracts can quite easily have two dozen steps or more to follow before reaching the right answer.

So this is a real problem for many businesses. Especially in large businesses which don’t often realise how often the end-to-end process goes wrong because each department involved in the process trumpets their 95% success rates on the individual elements.

That goes double when the process involves several different departments within the business and everyone tries to claim their share of the credit for doing their bit well, while doing their best to deflect the blame for customer dissatisfaction, or manufacturing inefficiencies, onto some other part of the process for which they are not responsible.

But it gets worse…

After a while, let’s say someone notices that the customer service department has ballooned to 20 people because of the volume of customer service incidents generated. Each of these customer service people costs £30,000 a year with on-costs.

Someone who feels they have a point to prove about how good their thrusting entrepreneurialism is for the business turns up at a management meeting and says something like “over half a million quid a year on the call centre – we need to save some of that cost”.

Strategies what what happens next vary, but common solutions are one or more of the following…

First, starting salaries get pared back. In a high labour-turnover environment like a call centre, there are always people leaving. So, thinks some aspiring company superstar, when one of our £30,000 a year people leave, we’ll replace them with someone on minimum wage so that, over time, we’ll only spend half as much. The Finance Director and the CEO will be delighted, they imagine.

I’m all for saving money and for giving entry-level people an opportunity to embark on a meaningful career. The part of the equation that’s often overlooked is that junior, inexperienced people are very unlikely to carry out the assigned tasks as well as the more experienced person who has just left.

Our 95% success rate for each step in the process goes down to 90%, let’s say. So our 12-step process with each step done right 90% of the time means only 28.24% of transactions will go through properly. And for a 24-step process at 90%, only 7.97% of transactions will go through right first time.

What looks superficially like a smart cost-saving move is often one of the least smart decisions a business can take, for reasons we’ll cover in a moment.

Another popular option is to look at a £600,000 cost and try to outsource the work. Although the outsourced customer service industry doesn’t enjoy the best of press, there are good businesses in there (I know, I used to run one of them).

But the first thing any self-respecting customer service outsourcer will do is ask you to be really explicit on what steps there are in the process, how you want their agent to respond in a number of different scenarios, how the interface to the client’s IT systems will work and so on.

It’s almost nailed on that your 12-step process will have just increased to, let’s say, an 18-step process. However your 95% success rate for each step is unlikely to change. After all, you’ve told the outsourcer exactly what to do, haven’t you, which you’ve naturally based on what your current staff do now.

An 18-step process performed as intended 95% of the time will have a 39.72% rate of successful completion. A similar 50% uplift on a 24 stage process means it’s right just 15.8% of the time.

I won’t even calculate the 90% options – let’s just say they’re almost never right.

These scenarios are not the fault of either the new, junior member of staff or the outsourcer. They’re only working with the material you’ve given them, and frankly they were never likely to result in a positive outcome, although both are common “budget saving” strategies.

The final common approach is to decide that everything is going to be self-service through your website which means you don’t need a customer service department at all.

There are two major problems with this.

Firstly, it is literally impossible to do everything through a self-service website. Even the kings of web self-service, Amazon, have telephone based support for particularly thorny issues…which is, perhaps surprisingly, very good, in my own experience.

If Amazon can’t make an entirely web-based service work, let’s just operate under the assumption that your business is unlikely to achieve a goal Amazon hasn’t any time soon.

The second issue is that developing web self-service options to cover every eventuality is expensive. An external firm will charge a high six-figure sum to develop one for you, or you can do it yourself but you’ll need to beef up your IT department to do it. At least over time, you’re likely to spend as much in IT resources, internal and external, as you’ve been spending in customer service costs.

Oh no, it’s even worse than that…

Sorry to say, we haven’t finished with things getting worse.

All the common solutions lead to an increase in costs.

Hire much less-experienced labour who get things wrong more often and you’ll have to beef up your management resources to deal with queries, handle dissatisfied customers and authorise refunds, special deliveries and whatever it takes to try and put things right again for the customer.

You have fewer £30,000 a year call centre agents, but a lot more £50,000 a year managers to look after the new minimum wage staff. (Again, this is not the staff’s fault, the deck has been unwittingly stacked against them.)

Outsourcing can be a good idea, but if you’ve got a £600,000 a year outsourcing contract which is your main interface with all your customers, unless you’re an extreme risk-taker (which I don’t recommend if you still want to have a business to run in a couple of years) you’ll need a relatively senior manager to make sure the outsourcer keeps on their toes and delivers what they say they will.

So you can probably add £70-80,000 back into whatever savings you make…perhaps even more than that if you deal with complex processes or work in an industry where there’s regulatory oversight to contend with.

And as for the web self-service option, there’s a real danger that you’ll just swap 20 customer service agents on £30,000 a year for 10 software engineers in the IT department, each on £60,000 a year.

The simple, low-cost solution

The biggest, fastest, lowest risk way to reduce your costs (outside the flight deck of a 747 or the control room of a nuclear power station) is to look at the process and take some of the steps out.

If you reduce the steps by only 25%, what was a 12-step process becomes a 9-step process. At a 95% success rate for each step. a 9-step process goes right first time 63% of the time.

That’s getting on for a 20% improvement over the 12-step process, even though the average success rate for each individual step has not improved. In my experience, they often do, just because there’s less going on in a customer service agent’s mind and they’re likely to make fewer errors. But let’s not even factor that very pleasant surprise on the upside into the equation.

If we consider the 24-step process with the same success rates as above, a similar 25% reduction in the number of steps makes it into an 18-step process. End-to-end, that’s likely to work as intended 39.7% of the time. That might not sound like much to write home about, but it’s about 30% better than the old 24-step process.

The changes are even more dramatic when the percentage going right is 90% instead of 95%.

The old 12-step process, now a 9-step process, is now right 38.7% of the time, and the old 24-step process, now 18 steps, is right 15% of the time. That’s a 30% improvement and a near-doubling, respectively, compared to the original success rates.

So next time you want to save money, don’t just work with the numbers, think about the underlying processes. Simplify those and you’re well on the way to a low-risk way to save a lot of your budget.

And maybe ease back on the need to have detailed processes at all.

Years ago, I heard the CEO or Ritz-Carlton speak at an event and they had absolutely minimal procedures for their staff. Instead they told their staff to focus on the customers needs and deliver whatever they, in their best judgement, thought best-served the customer’s needs.

My memory is a little hazy on the detail, but I seem to remember that any staff member could, on their own authority spend a significant amount of money on the spot to satisfy a customer need. It might even have been as much as $5.000, but don’t quote me on that. It was certainly a number in the thousands of dollars.

I remember most of the audience wincing at this approach, but it’s actually one of the smartest ideas I ever heard.

How many complaints did Ritz-Carlton get into their call centre? Almost none as all their customers were satisfied at the point the problem arose. They spent a bit more on the front end, but they saved a fortune in their call centre.

How much did Ritz-Carlton need to spend in IT resources to develop a self-service model? Nothing at all. The staff member they first spoke to sorted out whatever the problem was and they never had to go onto the website to try to find a way to resolve their issues.

And how much did this really cost Ritz-Carlton? The CEO was a little coy on that point, but he did say that firstly they worked hard to make sure very few customers were dissatisfied, so complaints were relatively few anyway. Secondly, he hinted that the average charge was a lot less than the $5,000 (or whatever the number was).

Of course, some did cost the full allowance, and some went over that limit at which point a manager did need to get involved. The impetus was still centred around making the customer happy, so there were still no calls to the call centre and so on, but a manager had to authorise the budget in light of the amounts involved.

More often, I’m sure the guest’s problems would be rectified with some express dry cleaning or the cost of an extra cab to send on the glasses someone had left in the hotel. Minimal costs against a top-dollar five-star hotel room.

And that, for me, is the secret to cost saving.

To people who hadn’t thought this through, giving every member of staff $5,000 they could spend if they had to sounded like a needless extravagance.

It was actually the cheapest way to run their business. There was just a single step in the process “do whatever it takes to satisfy the customer, up to a limit of $5,000”.

In practice only tiny amounts were spent by staff members and Ritz-Carlton saved a fortune on call centre and IT resources.

I’m not suggesting this is the right approach for every business in every set of circumstances, but there’s definitely something worth thinking about in there.

So next time you want to do things differently in your business, or you’re under pressure to save costs, why not experiment with having fewer steps in your processes, or even just fewer processes, full stop.

Perhaps try giving your people a little more discretion. Even allowing for the fact that they’ll get it wrong some of the time, this is likely to be a much cheaper way of running your business than adding an extra half-dozen steps to your current processes in an ultimately futile attempt to “engineer out” things that go wrong.

It might seem a little counter-intuitive for a Finance Director or CFO to recommend a lighter touch on the process front, but even after allowing for the fact that things will still go wrong from time to time, that may very well reduce the overall costs in your business. And isn’t that what a good Finance Director or CFO is supposed to be concentrating on?

(Photo by Campaign Creators on Unsplash)

Too much love can kill you, sang Freddie Mercury. So can bad statistics…

Freddie Mercury sang “too much love will kill you”. That might be true, but as an accountant, I’ve got to say that love isn’t usually on anybody’s mind when they come to see me.

So I’m not qualified in the love department, but I do have stronger views on how businesses can end up doing crazy things just because people don’t understand basic statistics.

Now, I know what you’re thinking… “it’s easy for you, you play around with numbers every day so you’re used to them”. But I always struggled with statistics while doing my accounting exams, until, mercifully, something “clicked” shortly before my statistics exam and I managed to pass.

The problem I had with statistics was that, like most people, I was taught statistics as a series of techniques – how to do such-and-such a calculation – without being taught the broader concepts and underlying principles which made a particular technique work.

It wasn’t until I realised that the trick to making statistics easy was to do the thinking bit first, and only after sorting that out, getting your calculator out to crunch the numbers.

Don’t get me wrong, there are still some complications in getting the correct answer, but the way statistics is usually taught, emphasising techniques over thinking, accounts for many people struggling to understand what it’s all about.

In just the last couple of weeks I’ve come across these three examples which hopefully illustrate the point.

“Consistently high quality”

A recent article on tes.com suggesting that leadership teams in further education colleges were consistently better than leadership teams in schools caught my eye at the weekend.

I’ve worked extensively with schools, colleges and universities and encountered lots of leadership teams across the education sector. And while it;s almost certainly is true that a good leadership team in a college is better than an average leadership team in a school, this isn’t comparing like with like.

I’ve encountered appalling leadership teams in colleges and brilliant leadership teams in schools, and indeed vice versa. But on the average a good leadership team pretty much anywhere, inside or outside education, looks pretty much like every other good leadership team in the world.

There’s nothing “consistently” good about leadership in colleges, although Further Education does have some exceptional leaders, including some I’ve been privileged to work with.

However the sector also has its share of leaders who have led their colleges to disaster.

The TES article is only one person’s perspective, admittedly, and the writer makes that clear. I’ve no reason to suppose it isn’t an accurate reflection of his time working in both schools and further education colleges.

But one person’s perspective, however valuable it might be for them, isn’t necessarily reflective of an entire sector with hundreds of schools and colleges and thousands of people in leadership teams across the country.

So don’t make the mistake of scaling up one person’s experience and imagine it’s reflective of some bigger sector or market. It’s very unlikely to be anything of the sort.

Using outliers to prove a point

An “outlier” is a out-of-the-ordinary result that’s so far away from the “average” that relying on it might not be wise.

You see this in marketing a lot – “Apple do this and it works, so we should do it too”. Apple…or indeed any other business darling…does a lot of things that nobody else makes work. Just because Apple makes a premium price offering work like gangbusters doesn’t mean you can 10x your prices and still expect to win any business.

HR people like this line of argument too – “Google organise their teams this way, so we should too.”

Some people even wrote a book about how Indian managers are unusually good, due to, according to the authors, a combination of the Indian education system and the competitive upbringing for children there. They even cite half-a-dozen or so global CEOs who do, in fact, happen to have an Indian background.

But it’s also true that most global CEOs do not have an Indian upbringing, and it’s also true that there are many non-Indian CEOs who achieve the same or better results than the Indian superstar managers used as case-studies in the book.

India has approximately 17% of the world’s population, but considerably less than 17% of superstar global CEOs. India does admittedly have some business leaders who successfully steered global companies to considerable success. But, statistically speaking, you can’t infer that Indian managers are exclusively excellent, just because a handful of them clearly are.

Here’s the simple truth. Hard-working, smart, competitive people in just about every country of the world are more likely to end up as global CEOs than their countryfolk who prefer an easier life. This is true whether you’re American British, Bulgarian, German, French or any other nationality.

I’ve been to India several times and worked with Indian managers both there and outside India. My experience is that there are undoubtedly some exceptional managers amongst them, but average managers there are about the same as average managers in every other country, and a similar proportion to any other country in the world are truly appalling.

The percentages in each category are not materially different from any other nationality of ethnic grouping between India and any other place on the planet. Intelligence, a capacity for hard work, a competitive nature and many of the other personal qualities the book cites as evidence for Indian managers being so good are approximately normally distributed across every single human being on the planet as far as I can tell.

Nobody would write a book about smart, hardworking kids who went to Eton and Oxford ended up in a top job somewhere. A book about a Harvard graduate running a global business probably wouldn’t be a best-seller either. In both cases, that’s pretty much what we’d expect to happen – both are non-stories.

So it should be no surprise that, statistically, at least some of the population of India are world-beating international business executives. I’d be a lot more surprised if there weren’t any Indian executives leading global multinationals, given that 17% of all the people on the planet, 1.4 billion of them, live in India.

So don’t use outliers…management practices from Apple, Google, India or anywhere else for that matter…to evidence your arguments.

Outliers exist in every field, and I’ve no problem celebrating them where they exist. But be clear that the results of exceptional businesses or individuals are unlikely to be repeated if you try the same thing elsewhere.

By all means use outliers to inspire you to make improvements, but don’t imagine for a moment that the results outliers deliver are likely to be reproduced somewhere else by entirely different people, because you’ll almost certainly be disappointed.

Small groups


“Research shows…” is one of the most-overused expressions in management.

It’s often the magic key that someone hopes will unlock a budget or a strategic decision of some sort, but I always want to know exactly what sort of research has been carried out, and how rigorous it really was.

The tweet above is a great example. Even if you do research which is decent enough in itself, the results from any small group are, at best, no more than mildly comforting in terms of how an entire target market might view your business.

Sometimes people feel the need to draw statistical conclusions where none exist. Everybody likes to see some numbers and. as an accountant, I get to see more than most, to be fair.

However I also see enough numbers to get a feel for when I’m being fed a line.

If you’ve called together a focus group of 20 people and 58% of them say they like (or don’t like) something, in my book that means almost nothing.

58% of 20 people means 12 people in the whole universe like what you’re doing. All it takes is a couple fewer saying “yes” and it’s a 50:50 deadlock.

Even if those 12 are theoretically representative of your entire customer base, which has about the same odds as looking out your window and seeing unicorns dancing on top of rainbows, the realities of everyday life means just about no meaningful conclusions can be drawn from those 12 people’s responses.

Yet I’ve seen many a business case constructed on a similar premise. You might be surprised how few people seem able to explain their “research” in statistical terms.

Never take statistics at face value. Always find out how they did the research and if the answer isn’t “we ran a statistically-valid survey across a representative sample of couple of thousand people”, the level of reliance you can place on the numbers meaning anything sensible is probably close to zero.

Even professional polling businesses know their 2000-people surveys have an error rate of a few percentage points one way or the other. Your 20 person focus group will have an error rate many times that so you’d be unwise to make significant business decisions based on conclusions that could be out by 20-30% or more.

That doesn’t mean small group research hasn’t got any value. It most definitely does.

Individuals and small groups are ideal ways to get qualitative feedback about your business and its operations, or how people feel and experience your services.

Good qualitative research is under-appreciated in businesses because people are mostly looking to use numbers to support the case they’re making.

But most business cases which come my way have not been constructed using research methods rigorous enough to support the conclusion they propose.

Business cases tend to draw conclusions using quantitative research methods – that is, just using the numbers drawn from their research as if they were statistically valid – even though there was no statistical validity to the data at all.

That doesn’t meant heavy-duty quantitative research is necessary for every single business case, though.

If there isn’t a statistical basis for the conclusions, just say so, give me the verbatim feedback from a focus group to read through and let me understand what you’re proposing based on that.

Don’t present statistically-meaningless tables of numbers, graphs and charts to support your case when the underlying research isn’t rigorous enough to justify any conclusion, much less the one you’re putting forward.

Summary

The world would probably be a better place if we stopped allowing politicians to quote highly selective “statistics” (which is what they call their numbers…they’re nearly always a completely partisan interpretation of numeric information which was not been collected using valid statistical methods, just because it happens to suit their case).

But much as we rail against politicians’ misuse of numbers and statistics, something very similar goes on in every business in the country on a more or less daily basis.

And a large proportion of those end up on my desk “because we have to show the Finance Director some numbers to get his buy-in”.

I’d rather they didn’t bother. Either do the job properly and show me something that’s statistically-valid or stop pretending that some random numbers which were chosen because they happen to support your preferred outcome have any statistical meaning.

No Finance Director or CFO should be close-minded enough to rule out every initiative which doesn’t come accompanied by a bevy of numbers, charts and data tables.

We just want to know that you know your stats, because if you don’t, we’re unlikely to believe that anything else in your business case is going to be a solid foundation for decision-making either.

Next time someone presents you with a plethora of numbers to support a business case, try a quick “sense check” against the experiences above. You might be surprised by the insights you get from questioning people about how they’ve approached their research, and hopefully you’ll make better business decisions as a result.

(Photo by Stephen Dawson on Unsplash )

From Zero to Hero: How to a Zero-Based Budgeting hero instead of a Zero-Based Budgeting villain

Zero-Based Budgeting has been in the news for all the wrong reasons lately. Kraft Heinz have reported a $15billion write-down after a focus on cost cutting, primarily using the Zero-Based Budgeting technique, resulted in the business taking its attention away from their customers.

Kraft Heinz investor, 3G Capital, is well-known for deploying Zero-Based Budgeting as a way of driving costs down. Their work at Burger King and HJ Heinz, pre-merger, encouraged them to try to repeat the same trick with Heinz Kraft.

This time they ended up writing off over $15billion.

Analysts believe too much energy within the business went towards reducing costs, leaving too little energy to focus on customer needs. That was unfortunate, to say the least, as the nature of Heinz Kraft’s traditional product lines meant that many of their products were precisely the products today’s more health-conscious, environmentally-minded customers were starting to move away from.

By the time Heinz Kraft caught on to the change in their marketplace, it was too late and $15.4 billion had to be written off the value of well-established brands like Oscar Mayer hot dogs and Kraft macaroni and cheese.

As a Finance Director and CFO, I always get concerned when businesses adopt a “paint by numbers” approach to anything. It’s a sure route to trouble.

At the very least, the business ends up falling short of its potential for transformation. At the very worst, it completely messes up a useful technique and ultimately puts the whole business at risk.

Now, I’ve no idea how Heinz Kraft approached their Zero-Based Budgeting exercise, and with deep-pocketed shareholders I don’t imagine their business is at risk any time soon.

But, from the outside, given their $15bn write-down and the accompanying analyst commentary, it’s at least possible that some of the common errors of a Zero-Based Budgeting programme were part of the experience at Heinz Kraft. Let’s explore where they might have gone adrift.

What is Zero-Based Budgeting?

Before we get into the details, perhaps first we need to explore what Zero-Based Budgeting really is, as it’s one of the most frequently misunderstood business models, in my experience.

I’m not sure if the term Zero-Based Budgeting was arrived at by an accountant trying to jazz something up with a bit of marketing hype, or by a marketer trying to over-dramatise what might have sounded to them like an otherwise fairly dull financial technique.

Either way, the biggest problem Zero-Based Budgeting has is that the term lends itself to an overly-simplistic interpretation, as this brilliant cartoon from Tom Fishburne illustrates…

That overly-simplistic interpretation is usually something along the lines of “every department has all their budgets taken away from them and they have to justify, line by line, every single item that gets put back in”.

Someone, usually the Finance Director or CFO (sorry…), is tasked with saying “no” to a lot of the budget lines that are requested with the net result that the business’s operating costs reduce substantially.

Expenses that look “optional” – pesky things like marketing, training and employee engagement – which perhaps lack the robust business cases which can be applied to, say, re-engineering a product to take a pound of aluminium out of each unit produced, tend to fall by the wayside.

Frankly any idiot can say “no” to a proposal for supporting customers better or training staff to be more effective, especially if the payoff is uncertain (in conventional business modelling terms, that is, they’re a nailed-on cert for anyone who has even a superficial knowledge of the role of human behaviour in decision-making).

So if this is what you think Zero-Based Budgeting is all about, the good news is that you don’t need to go to the expense of having a Finance Director or CFO go round saying “no” to people. Someone like Dilbert’s Pointy-Haired Boss is more than up to the task of making moronic short-term decisions.

But this interpretation of Zero-Based Budgeting is a gross over-simplification of quite a nuanced technique.

Zero-Based Budgeting was developed by Peter Pyhrr, then a manager at Texas Instruments. His objective was to break the historical way of compiling budgets which, back in the 1960s and 70s, generally involved taking the actual spend from the previous year and increasing it by some inflationary increment to arrive at the new year’s budget.

You don’t need to think about cost management for very long to realise that the “annual inflationary increase” method of budgeting was unlikely to be the most sensible way to run a business over anything other than the short term.

In the very short term in a stable business environment, it might be a reasonable enough approximation to reality. But at times of high inflation, as in the 1970s and 80s, or great technological change, such as the move to digital in the last 20 years, the likelihood is that “the way we’ve always done things around here”, supplemented by an annual inflationary increase is probably not going to cut it any more.

That’s why the original concept behind Zero-Based Budgeting was to re-imagine the best way to run a business on a reasonably regular basis to reflect changing economic and technological times.

Why Zero-Based Budgeting is a good thing, when applied properly

I’ve used Zero-Based Budgeting extensively throughout my career as a Finance Director and CFO, more often than not informally.

Of course, you can mobilise the entire workforce, employ gangs of consultants and spend millions of dollars to come up with some whizzy new plan if you want to, but that’s often unnecessary, especially in small-to-medium sized businesses.

For a Finance Director or CFO who knows what they are doing, a conversation, usually as part of the normal budget review process, with department heads, and an afternoon with a spreadsheet can usually get you the results you need without creating a ruckus within the organisation.

Whether you’re running a Zero-Based Budgeting project with teams of accountants, or just your CFO and departmental managers working together in a less formal way, any approach which doesn’t start with a thorough understanding of the results the business needs is doomed to failure.

And those results are much more than reducing costs just for the sake of reducing costs. In the short-term, earnings might mathematically increase as revenues hold constant against a background of reducing costs, but this is generally only true in the short-term.

That’s because of a significant assumption – one you rarely see in business plans, but it’s always there in the customers’ minds.

You see, businesses often think they “own” their customers. Many of the craziest decisions taken by large businesses were predicated on the belief that their customers were a constant and would never go elsewhere.

Thinking about that for just a second, of course every one of us would at least consider taking our business elsewhere sooner or later if we felt we were paying ever-higher prices for what we perceived as ever-poorer value. Yet this dynamic always seems to catch large companies like Heinz Kraft by surprise.

In the short term, businesses can be suckered into thinking they got away with it as revenues hold up after dramatic cost-cutting. What they’re forgetting is that brand loyalty is a lagging indicator, not a leading indicator.

In the short term, loyal customers will cut you some slack and hope you realise the folly of your decisions, inertia means that hordes of customers won’t head for the exits the minute you make a change, and in markets like those Heinz Kraft serve, considerations such as how much shelf space you get in Walmart and what promotions you run might take the edge off a little for a while.

But in the end, you will be found out. And businesses whose customers don’t perceive them as offering good value will, sooner or later, start to decline.

In fairness to Heinz Kraft, the value they offered or didn’t offer was probably secondary to the fact they’d taken their eyes off a grocery market which was moving against the products they had traditionally sold while they focused on a massive internal project to reduce costs.

But the same principle applies – if you stop listening to your customers, whether that’s about the value you deliver or the products you supply and their position in your customers’ order of priorities, you’re putting your business at risk, sooner or later.

It doesn’t have to be this way. Here’s how to run a Zero-Based Budgeting process with a minimum of disruption, while keeping your eyes where they should be, on serving your customers.

A simple Zero-Based Budgeting approach that works

To run a sensible Zero-Based Budgeting project, here’s what you need to ask your budget-responsible managers: “Knowing what we know now, would we do things the way we’ve always done them…and if not, what would we do instead?”

This needs to work within the context of your business model, so if you don’t have a clear idea of how that works, make sure you develop a well thought-through business model first.

But assuming the business model is clear, those questions are all your Finance Director or CFO needs to ask at budget time (and perhaps, depending on how fast-moving your sector is, a couple of other times during the year too) to run a sensible, low-hassle Zero-Based Budgeting project.

Let’s make this into a practical example…

If your business needs 1,000 customer leads every year to generate the sales income the business requires, ask your marketing manager whether there is a better way (by, for example, accelerating the sales cycle) or cheaper way to deliver 1,000 suitably-qualified leads in the coming year.

To keep this simple, let’s assume the rest of the business model stays the same – your sales team converts leads into customers in the same ratio as before, customers spend the same amounts they did previously over the same customer lifetime, and so on.

In recent years, lead generation activity for most businesses is likely to have moved away from printed materials, outbound sales calls and personal visits from sales representatives to more digitally-based solutions. Perhaps Google Ads or LinkedIn sponsored posts play more of a role now, depending on your business.

The key aspect to consider is that, despite the name of the technique, the objective isn’t to get the Marketing Manager’s budget to zero. It’s to determine how much of a budget he or she needs to generate 1,000 suitably-qualified leads now the business has decided to take more of a digitally-based approach to lead generation.

What you’re doing is rethinking the business approach, without any preconditions or assumptions that things will continue into the future they way they’ve always worked in the past.

Done properly, a Zero-Based Budgeting project should also force you to consider the knock-on consequences of any changes. You’ve got to take these into account too before taking action.

Maybe you can halve the print advertising budget, but only if you invest in an upgrade to the website to enable a digital-only solution.

Maybe you can save a bit on the costs of the outbound telesales team that you need less of in the digital world. But you need to hire some digital marketing executives instead with the skills to fine tune your Google Ads campaigns and manage your social media presence.

Business leaders who apply a “paint by numbers” approach to Zero-Based Budgeting, without really understanding the subtleties of the technique, tend not to think about the knock-on implications. And that’s usually the basis of their undoing.

Any idiot can suggest cutting out print advertising completely and using social media exclusively to generate leads because social media is “free”. (And, to be fair, plenty of idiots have done exactly that…)

But without the expertise and staffing the business needs, that strategy is the route to disaster. “Free” social media is actually quite expensive in terms of staffing requirement…those tweets and Facebook updates don’t write themselves, after all.

So any Finance Director or CFO worth the title should be considering the results in the round.

In addition, although “cheaper”, social media campaigns tend to have vastly poorer response rates compared to, say, traditional direct mail. You need to do the maths before deciding which approach is best, and perhaps selectively pilot some new strategies to make sure you’re on the right track before flipping the switch and doing things completely differently.

That’s why, when used intelligently and holistically, Zero-Based Budgeting is a great system for continually reinventing your business, making sure you keep up with customer and market trends and giving you insights which allow you to service your customers better.

Problems with Zero-Based Budgeting

In my experience, the biggest problem with Zero-Based Budgeting is not the technique itself. All the problems come from those people who half-remember it from some management training programme and don’t take the time to understand it properly.

They inevitably end up applying Zero-Based Budgeting in a “painting by numbers” approach which is insufficiently customer-orientated.

This article from McKinsey highlights five common myths about Zero-Based Budgeting, and explains why those myths really don’t hold any water. But, in essence, the problems McKinsey highlights don’t come from the technique, or its underpinning philosophy, but in how people apply it when they don’t take the time to understand it properly.

Whilst Zero-Based Budgeting can realise substantial cost-savings – when done right – its more mindless proponents forget that one of the main reasons to make cost savings is to reinvest those savings, or at least a proportion of them, in making the business better.

As Accenture put it:

Strategic cost reduction [which includes Zero-Based Budgeting] can only be successful if the savings are reinvested in areas of the company to drive growth, innovation, improved productivity, better customer experiences and so on.

(Source: https://www.accenture.com/gb-en/insight-getting-ahead-cutting-back)

Accenture’s own research shows that only 51% of businesses are able to sustain their cost savings for 1-2 years. That’s because:

Piecemeal approaches that focus on overhead and cost of goods sold is a common mistake that occurs during cost-cutting. These efforts only scratch the surface and risk causing the company to lose valuable, differentiating capabilities.

(Source: https://www.accenture.com/gb-en/insight-getting-ahead-cutting-back)

But, for most people, their experience of Zero-Based Budgeting is exactly what Accenture say it shouldn’t be – a mindless cost-cutting approach which destroys the business’s operating model (if not in the short run, certainly in the long run) and doesn’t reinvest any of the savings to re-position the business for a more successful future.

Frankly there’s not a business technique in the world that will deliver something worthwhile in the face of that level of misunderstanding about what the process is supposed to be.

I’d also agree with Bain & Co that one of the primary reasons Zero-Based Budgeting, or ZBB, doesn’t work is this:

When ZBB fails, it’s usually because leadership is neither engaged nor aligned, cost-cutting is indiscriminate, cost control is the primary message, and execution is inadequate, prioritizing pace, tools and benchmarking over capability building.

(Source: https://www.bain.com/insights/why-zero-based-budgeting-goes-wrong/)

People complain about Zero-Based Budgeting and say it doesn’t work. I’d respectfully suggest they only think it doesn’t work because they’ve never seen it applied properly.

If you want a high-level understanding of the potential of Zero-Based Budgeting, Bain & Co have produced a very helpful infographic which explains the underlying concepts succinctly.

Summary

Zero-Based Budgeting, in the right hands, can be a powerful technique to ensure your business is running in a cost effective way.

By getting your managers to consider periodically “knowing what we know now would we do this the way we always have done, and if not, what would we do instead?” you have the luxury of starting with a blank sheet of paper on a regular basis.

Zero-Based Budgeting put you in the fortunate position of being able to redesign your business as the world around you changes, at a time when most of your competitors won’t be.

Used by an astute leadership team, Zero-Based Budgeting is a wonderful tool for keeping at the forefront of your industry.

Used by a management team who don’t understand the subtleties of the concept and just use Zero-Based Budgeting to “slash and burn” their cost base without reinvesting the proceeds to position the business for the future, disaster isn’t usually far away.

For your sake, I hope your leadership team is an astute one.

(Photo by Eric Ward on Unsplash )

How sweary chefs, innuendo-fuelled bakers and exasperated hoteliers guarantee great customer service

Most businesses nowadays at least pay lip service to the importance of customer service. Yet many customers remain dissatisfied.

Astute businesses pick up on that sentiment and try to do something about it. And that’s where the problem starts…

Don’t mistake activity for making improvements

One of my favourite Ronald Reagan quips is “Don’t just do something, Stand there!” It always reminds me that we shouldn’t mistake activity for making improvements. Sometimes “doing something” is worse than doing nothing at all.

And in the pursuit of great customer service, there are nearly always better, simpler and more cost-effective ways of making improvements than introducing new procedures. (In fact I’d argue that I’ve never seen a new formalised procedure, beyond a threshold level, adding any value from a customer’s perspective at all.)

It’s not just new procedures for your customer service reps, of course. Especially in our busy, tech-centred world, it’s tempting to think whatever problem we’ve got, customer service or otherwise, can be addressed by introducing more technology…a revamp for the website, allowing online purchases, optimising for mobile or getting that Shopify store up and running.

Too many businesses think improving service is only about revising their procedures or implementing new technology. Almost nobody spends time thinking about what they should stop doing to improve customer service.

But if you’re serious about creating a world-class customer experience for customers, your first question…to real customers, not a software vendor or consulting firm…should be “what specifically do we do now that irritates or annoys you?”.

Then, whatever they say, stop doing that as quickly as you can unless there’s some legal reason you can’t. And here I mean a real legal reason, not the sort of thing people say when they don’t want to do something. If in doubt, ask to see the precise clause in an Act of Parliament that stops you, Unless someone can show you that, just politely press on regardless.

Of course, you should always seek appropriate professional advice if there’s any doubt, but even where laws and regulations do exist, they’re usually far less all-encompassing than people inside your business, or external parties with an angle to push, like software vendors and consultants, would have you believe.

And in a sense it shouldn’t be too surprising that you can improve customer service by taking things away.

Sweary chefs, bawdy bakers and exasperated hoteliers…

Watch just about any Gordon Ramsay programme when he works to turn around an under-performing restaurant. Part of his turnaround plan is nearly always paring down a hugely ambitious menu with 77 different choices across 8 different styles of cuisine into a dozen or fewer meal options.

Seemingly overnight, the business becomes easier to run, quality tends to be better, service happens as it should and customers leave at the end of the evening, well-fed and happy, intending to recommend the revamped restaurant to all their friends.

Same for The Great British Bake Off. Hugely talented people try to squeeze too much into their recipes and crash out the competition on a weekly basis. A simpler approach would have produced something they could be proud of, not a “soggy bottom” with the standard of decorative icing a 4 year-old might have been ashamed to bring in for “cake day” at their primary school.

And you see it in just about any edition of my favourite reality show… “The Hotel Inspector”. You can really sense Alex Polizzi’s intense frustration as, for seemingly the umpteenth time, she summons every last ounce of her sorely-tested patience to explain to a hotel owner that their extensive Lego collection has no place in the hotel bar, or that having their pet lizards running free around the hotel might be putting guests off a little, or that “tasteful” Victorian prints shouldn’t be hanging up in a motel tacked onto the motorway services.

What’s fascinating is that all these would-be hoteliers say the same thing… “none of our guests have ever complained about our Lego (or lizards or whatever) so we thought people liked them”.

That’s not completely untrue. If you want to run your hotel as a specialist retreat for lizard-fanciers, there might well be a good business in that. But don’t expect to become the world’s largest hotel group with a lizard-friendly approach to overnight accommodation.

But it’s also true that while few guests have complained, the hotel owner never asked them either. They just presumed that “no complaints” meant “good news”.

It might be astonishing to all these would-be restauranteurs, bakers and hoteliers that their personal eccentricities might not be valued quite as highly valued by their target market as they do, but hopefully it’s not news to you.

So before you try to improve your customer service by adding in more things, have a really good think about what you’re already doing and see if you can remove elements that annoy, irritate or frustrate your customers first.

Your business will be easier to run, your running costs will be lower and your customers will be happier.

The hidden knack to great customer relationships

But there’s a hidden knack to this.

Normally people like me, Finance Directors and CFOs, are happy to do fewer things because they quickly work out if you fire half the call centre then the wage bill halves as well. Usually, not doing things is a popular choice for a red pen-wielding Finance Director or CFO.

However life isn’t as simple as they teach you at bookkeeping school.

Although our sweary chefs, innuendo-fuelled bakers and exasperated hoteliers do cut down the menu choices and remove hotel owners’ personal garbage from their guest rooms, that’s only to get the business to “ground zero”.

It’s what they do next that is the ultimate secret of their success.

Yes, they do fewer things. But they do them so much better than they used to.

Instead of frozen steaks of questionable provenance, Gordon Ramsay brings in fresh, grass-fed Aberdeen Angus steak from an artisan butcher at perhaps twice the price of the restaurant’s more dubious historic choices. Sometimes the prices go up a bit too, but as the value to the customer increases exponentially, even after the price increase, they’re happy to pay the new prices.

Out go elaborate moulds for the finishing touches on a Bake Off cake, but much more effort goes into getting the taste of the icing absolutely perfect which is then just simply piped onto the cake.

Alex Polizzi gets rid of all the pet lizards, but she also does a stylish refurbishment of a previously tatty bar to attract guests and locals alike. They’re now happy to spend their hard-earned cash at the hotel bar in a way they weren’t before.

Building a reputation for great customer service is hard.

In the short term, you can make dramatic improvements in service just by cutting out all the things that annoy or frustrate your customers. To really cement the relationship, you take what’s left and dramatically improve the quality of your solution so that customers see a massive benefit from dealing with your organisation.

Do that well, and you’ll be a world-class service provider in no time at all.

And don’t just take my word for it…sweary chefs, innuendo-filled baking programmes and exasperated hoteliers find this everywhere they go. So you will too.

What could your business stop doing today that would make your customers happier? Ask them…their answers might surprise you…