Creating Shareholder Wealth

Creating Shareholder Wealth Answering The Five Critical Questions ©

Copyright © Daniel Peter, 2002. All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without permission in writing from the publisher.

Published by American University & Colleges Press http://www.american-book.com Salt Lake City, Utah, Printed in the United States of America on acid-free paper.

Creating Shareholder Wealth Designed by Alyson Hill Plante, [email protected]

Publisher's Note:

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold or distributed with the understanding that the publisher and author is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person in a consultation capacity should be sought.

Library of Congress Cataloging-in-Publication Data is available upon request. ISBN 1-58982-019-3 Daniel Peter, Creating Shareholder Wealth

_________________________________________ Special Sales These books are available at special discounts for bulk purchases. Special editions, including personalized covers, excerpts of existing books, and corporate imprints, can be created in large quantities for special needs. For more information e-mail [email protected].

_________________________________________

Creating Shareholder Wealth Answering The Five Critical Questions ©

By

Daniel Peter

This page intentionally left blank.

Dedication This book is dedicated to the cause of all organizational leaders…to create wealth for their constituents. This is best accomplished through an awareness of economic profit benefits, what I refer to as Shareholder Value Created, and the absolute necessity to include an acute awareness of the criticality of human nature to successful implementation. The people in our organizations hold great power. They are the ones who decide whether we will succeed or fail. This book is also dedicated to all those who, with their hands and minds, create products and deliver services. Without them, there can be no wealth creation. This book is also dedicated to the memory of Professor John Lindemann of the University of Wisconsin—Milwaukee who provided me with the encouragement and confidence to embark on a long career of operations management and business leadership. He also gave me the opportunity to be a teaching assistant at the university. This led to my love and appreciation for teaching. Thank you, John!

This page intentionally left blank.

Preface The world of organizational leadership has changed in recent years. The successful leader must be more than someone who can push products through the stages of production and meet cost, quality, and delivery targets. Today, you must also train, coach, counsel, plan, strategize, lead, implement, mentor, manage projects, discipline, delegate, negotiate, communicate effectively, and have a working knowledge of a number of functional areas. Those include finance, accounting, human resources, value chain management, quality control, engineering, and, most importantly, customer service. You must also have an innate understanding of human nature. The successful leader must also be a proactive and successful change agent who is sensitive to social norms. This means being a true organizational leader rallying all resources toward a common cause: Creating Shareholder Wealth. Clearly, this requires knowledge and skills beyond the technical tasks of the position. In mastering the tools to accomplish this goal, you automatically lead your organization to a greater customer service position, profitability, and competitiveness. Simply managing your organization is inadequate in today’s world. This book presents a new and easier way of leading your organization. It will enable you to develop an integrated framework for strategy development and implementation, business process improvements, and performance measurement. The chapters of the book are written in a brief and easy to read manner. Part Three presents fictitious case studies to illustrate how this information can be applied in several different settings. In taking you on this journey to a better understanding of what is involved in Creating Shareholder Wealth, I have organized the book into the following primary parts. Part One—The Foundation provides the basic fundamental information and discusses The Five Critical Questions. It walks you through each question. You will see how easy this approach can be for your situation. Part Two—Supporting the Change to Creating Shareholder Wealth gives you information about each element of this simple approach Part Three—Case Study Applications detail different case studies that highlight different aspects of Creating Shareholder Wealth

Part Four—Questions and Answers My sincere hope is that much of the information provided in this book is familiar to you. It is great if you read this book and react, “I know this stuff!” My primary goal is to put this information together in a manner that provides an approach that is new, easy, and highly effective. It has been for me. Enjoy the trip!

Contents Part One: The Foundation .................................................................................. 11 Chapter 1)

Introduction ...................................................................... 13

Chapter 2)

What Is the Strategy Intent? ........................................... 27

Chapter 3)

What Are the Strategy Goals? ........................................ 35

Chapter 4)

What Is the Strategy Plan?.............................................. 41

Chapter 5)

How Is the Strategy Implemented?................................. 43

Chapter 6)

What Is the Best Performance Measure?....................... 77

Part Two: Supporting The Change To Creating Shareholder Wealth ........... 93 Chapter 7)

How to Help Employees Embrace Change..................... 95

Chapter 8)

Incentives ......................................................................... 111

Chapter 9)

Measurements.................................................................. 119

Chapter 10)

How Does It Work?......................................................... 125

Chapter 11)

Who Should Care? .......................................................... 135

Part Three: Case Study Applications................................................................ 139 Chapter 12)

“Peaceful Transitions”.................................................... 141

Chapter 13)

“Secure Future” .............................................................. 205

Part Four: Questions And Answers................................................................... 261 Index..................................................................................................................... 267 Bibliography ........................................................................................................ 271 Acknowledgments ............................................................................................... 273 About the Author ................................................................................................ 277 Endorsements……………………………………………………………………279

This page intentionally left blank.

Part One The Foundation “Nothing so conclusively proves a man’s ability to lead others as what he does from day to day to lead himself.” —Thomas J. Watson This part of the book will introduce the ideas involved in Creating Shareholder Wealth as well as the process of answering The Five Critical Questions. It gives the reader a firm foundation to help bring an organization to new levels of success. Part Outline: Introduction What Is the Strategy Intent? What Are the Strategy Goals? What Is the Strategy Plan? How Is the Strategy Implemented? What Is the Best Performance Measure?

This page intentionally left blank.

Chapter One Introduction “Experience is the worst teacher; it gives the test before presenting the lesson.” —Vernon Law “Raiders of the Lost Ark” In the movie Raiders of the Lost Ark, Indiana Jones finds himself running for his life out of a cave with a huge boulder rushing behind him. Along the way he faces numerous obstacles. Fortunately, our hero reaches safety and lives to fight another day. It is the same in any organization. As executives and managers, you are Indiana Jones, you face numerous obstacles daily, the boulder is your competition, and the walls of the cave are the rules, regulations, laws, and limitations within which you must operate. To avoid being crushed by your competition, like Indiana Jones you must work hard to stay in front of the onrushing boulder and navigate your way around the other hazards you face. The shareholders at the end of your tunnel who own the organization represent safety. Because they represent safety, your obligation is to them. Your entire focus must be on fulfilling their needs. It is irrelevant if your shares are privately owned or publicly traded, or if your organization is financed with taxpayer dollars, the obligation is the same. You fulfill that obligation by running your organization with a strong customer focus and as efficiently as possible—thereby Creating Shareholder Wealth. Surviving This book is about surviving! It provides an easy process that enables making changes to keep ahead of the boulder. The suggested changes involve taking a new and challenging approach—implementing a new strategy. Creating Shareholder Wealth will provide you with crucial tools to accomplish your goals and exceed shareholder expectations. It links concepts of strategy development, lean business, and economic profit into a single process to make your organization stronger than ever before. It is a common sense approach that does not reinvent the wheel.

Creating Shareholder Wealth

This material applies to any type or size of organization. It is best suited for smaller organizations and business units of larger organizations. The boulder of competition will crush a piece of the organization before it crushes the whole organization. Survival begins with protecting those pieces. It begins with leadership from the top of the organization. The Missing Link I have over thirty-two years of experience in implementing significant improvements in organizations. I used what we now refer to as Lean Manufacturing techniques to implement most of these changes. During that entire time, I consistently recognized the need for a single, effective, primary performance measurement tool to aid successful implementation. Over those years, I also recognized that a meaningful and effective motivator and incentive to implement the needed change was missing from the Lean Manufacturing process. As you study this book, you will read short application examples drawn from my experiences. You will see these examples referred to as “IN BRIEF.” The point of providing these examples is to illustrate various applications and show that considerable improvement can be made at any level in any organization with effective change management and leadership. What was missing in past methods was a single primary measure to determine the economic impact to the organization, and reliably predict the benefit to the organization ahead of time and also while making the improvements. Lean Manufacturing techniques made the physical improvements possible. In the earlier years, the lack of a meaningful economic measure was unimportant. However, in today’s highly competitive environment, it is essential to see the economic impact of different decisions. This process enables you to do that. Some experts in finance and business economics will suggest that you implement any project with a positive net present value (NPV). I believe this is wrong! You should implement some positive NPV projects as a management philosophy. However, implementing all available positive NPV projects is unwise and unrealistic. You should implement the most beneficial positive NPV projects as well as those negative NPV projects that enable the best positive NPV projects. I use what I refer to as Shareholder Value Created to determine which projects will be most beneficial based on their economic benefit. This value-based metric was the missing link during my earlier years in business management. As outstanding as the improvement results were, they could have been even more effective with the tools available today and those described in this book. Whether the operation is privately owned, publicly traded, or a public entity is irrelevant. In any case, the managers have a responsibility to add wealth for the shareholders— or taxpayers in the case of a public entity. In doing so, these same mangers also have a responsibility to other stakeholders in the organization. This book will guide you through the entire process. It will take commitment, hard work, and dedication to be successful. How does economic profit—Shareholder Value Created—provide that missing link? It provides information on the economic impact of any decision you need to make. It also

14

Introduction

enables you to take full advantage of human nature in the most positive and constructive way possible. This process helps provide performance feedback as well as a basis for incentive compensation. These are good to have in your leadership tool kit. Additionally, they are available from a single primary source. Why Do Value Based Systems Fail? Simply, they fail because they disregard the most essential ingredient for success— human nature. This answer is both simple and complex. It is simple because it summarizes the reason why most systems or processes fail. It is complex because human nature can be difficult to understand and take into account when implementing change. A typical mistake made by value-based system installers is making the process and resulting measures too accurate. Going all the way to an economic profit (value-based) system is often too difficult for an organization. It becomes especially problematic when new personnel enter the organization because they were not part of the initial implementation so they lack the vital enthusiasm level. The results will be temporary if too many accounting adjustments are required, or if a highly complex P&L statement is necessary to accommodate multiple divisions, or if transfer pricing between divisions is made complex, or if any number of other complexities are installed as part of the overall process. The natural resistance aspect of human nature takes over when any process or procedure becomes burdensome or overwhelming. This happens when individuals no longer see the value of what they do, how it directly contributes to the stated goals, and the level of time and energy required to accomplish something. Even those individuals who are natural leaders and are comfortable with change may become resistant (usually subconscious resistance), and performance results will decline. If the organization uses too many value drivers or the wrong drivers, the process has a greater chance of failure. Value drivers that are vaguely linked to the primary measure create confusion and frustration. Utilizing drivers that are not controlled by, or strongly influenced by, the individuals held responsible for their results is demotivating. Any and all of these conditions have a negative impact on morale and enthusiasm. The process is viewed as complex, difficult, frustrating, and mysterious rather than understandable. A lack of sustainability results and the next step is failure. Managers at any level of these organizations may presume that a negative perception exists. They only see the difficulties and complexities in the system and the increasing level of resistance around the organization. They hear complaints about how difficult it is now compared to several years ago to achieve “continuous improvement” and earn incentive compensation bonuses at previous levels. They hear complaints about how it is becoming impossible to meet higher and higher “continuous improvement” goals. These complaints are legitimate and predictable. This is human nature.

15

Creating Shareholder Wealth

I have seen this happen time after time, and the basic circumstances are always the same. For instance, the major consulting firms installing value based management systems are excellent firms staffed with highly qualified and capable people. However, they also consistently fail to recognize human nature as the critical element of the success equation. Then they wonder why many of their clients come back later and express various levels of dissatisfaction and even abandon their programs. In an attempt to address this question, much has been published during 2001 and in the early part of 2002. Nothing I have seen addresses the human nature element as well as the lack of sustainability of the processes. This is not a surprise. If any of the major consulting firms were to publicly address this reality, they would have to admit the shortcomings of their own processes. What is published tends to focus on two basic aspects of the process. One focus is on the lack of top-level support and/or talent. The other focus is on too much complexity. Both of these are valid and important considerations. Without absolute support from the top of the organization, any process is doomed to failure. If executive talent is mediocre, the process will also fail. If the process is seen as too complex, it will eventually die. Numerous reports have surfaced of companies that abandon their value-based systems because of difficulties that developed several years after implementation. These difficulties brought on numerous and significant operational changes within some organizations. These types of changes should never be driven by system difficulties. They should only be driven by business decisions focused on responsibility to shareholders. Several reports suggest that as many as half of all companies who implement valuebased metrics abandon them within five years. This is an appalling statistic, albeit predictable. It is consistent with my own observations and is the direct result of what I discussed before: the failure of these implementers to modify their processes to properly take into account human nature and the inevitable inability to sustain “continuous improvement.” Blended into all of this is the cultural aspect of any organization. Without a culture that is conducive to change, significant levels of resistance will be faced and the effort will fail. In summary, three reasons exist for why implementations fail. • A failure to recognize that today’s notion of “continuous improvement” is unsustainable • A failure to develop a process that properly recognizes and utilizes human nature • A failure to understand the culture of the organization So, how do we install value-based systems and minimize the potential for these conditions to develop? Creating Shareholder Wealth redefines “continuous improvement” as something that is more sustainable over the long-term. It recognizes the legitimate aspects of human nature in every step of the process. It helps develop an understanding of the state of the business and its culture.

16

Introduction

This book walks you through a workable and sustainable process to develop a strategy, implement that strategy, implement change and process improvement, and measure progress in a meaningful way. Human nature is at the core of Creating Shareholder Wealth. The Culture You See; The Culture You Don’t See Every entity has two cultures: the one you see and the one you don’t see. As easy as it often is to forget this, it is dangerous to do so. The reason is that the culture you don’t see, the informal organization and power structure in the organization, is the primary one that you need to address in your leadership activities. It is the informal organization that influences what the workforce does and how it responds to your leadership initiatives. Truly effective leadership brings the formal organization (the culture you see—the organizational chart) and informal organization (the culture you don’t see—real leadership chain) into significant alignment. Don’t expect them to ever fully align all the time. They shouldn’t align all the time. The informal organization is “owned” by the workforce. The formal organization is “owned” by management. You can, and should, bring them into close alignment so the atmosphere is conducive to change. Even the definition of what that means will fluctuate over time. A number of indicators can tell you if they are sufficiently aligned. Among these indicators are the number of grievances, absentee levels, turnover levels, the reasons for turnover, work quality, initiative taken, and housekeeping. The Goals The first goal of this book is to provide an easy process for developing and implementing business strategy. This is done through what I call The Five Critical Questions. The second goal of this book is to show how economic profit and lean manufacturing/business fit together. Lean manufacturing/business gives you the necessary tools to make required, or desired, improvements and to sustain them. Economic profit gives you the tools to prioritize implementation opportunities, the incentives to change behavior so that employees consistently exercise high levels of initiative and focus over the longterm, and the ability to objectively measure results. The requirement is to maximize the efficient utilization of limited resources and earn more than the cost of the capital used to deliver your product or service to the marketplace. This results in true economic profit and creation of shareholder wealth. The third goal is to show the role human nature plays in this process and how to best utilize human nature as an asset to the organization. Lean Business Creating Shareholder Wealth focuses on improving all aspects of the operation. In today’s world, Lean Manufacturing is a misnomer. It is not limited to manufacturing organizations. It applies to any type of organization. You need to think in terms of Lean Business. By answering The Five Critical Questions, you can produce an effective flow through your entire organization.

17

Creating Shareholder Wealth

The commitment to this process must begin at the top levels of the organization. Don’t think about implementing change without that commitment first. The new culture must begin with the leaders and flow throughout the organization in order to become a way of life. Executives set the example; as an executive, you cannot say one thing and do another. Once you make that commitment you can expect to receive commitment from others in the organization. Managers at every level need to commit to the same goal of creating wealth for the owners of the organization. Lean business is one of the critical tools for realizing that goal. Key Philosophies The Process Must Have A PULSE: • Must be Predictable • Must be Understandable • Must be Long-term • Must be Sustainable • Must have Energy Financial: There are two primary financial philosophies in managing your entity to achieve goals: 1. Cash is good 2. Inventory is bad Performance Measures: Performance measures must meet the following criteria: 1. They must directly relate to the individual’s function. 2. They must be controllable, or at least directly influenced, by the individual. 3. The drivers selected must directly relate to the organization’s primary measure. Incentive Compensation: The plan must meet one criterion to be viewed as equitable: 1. The same plan for everyone. Leadership: Success is unachievable without understanding that: 1. Leadership is essential to survival. 2. Look everywhere to find the best available leaders. 3. Leadership is having ability and credibility.

18

Introduction

Continuous Improvement The traditional notion of “continuous improvement” is literal—every period will have performance results better than the previous period. This is unsustainable over the longterm. No organization can sustain “continuous improvement” indefinitely. The stock market in the United States continuously grew for the longest period in its history until late 2000 and early 2001 when that continuous improvement came to an end and the NASDAQ lost over half its peak value in a few short months. Even during this growth period there were fluctuations. Most organizations can experience continuous improvement for several years before leveling out or experiencing some reversals. This is a natural cycle that occurs in every organization. It is important to anticipate and take advantage of rapid improvement opportunities and to accept a more normal environment when business opportunities are more infrequent. It is also important to recognize how we, as human beings, naturally respond to this condition. We need a process that takes this into account from the beginning. We need to redefine continuous improvement to be more consistent with the realities of life and organizations in order to achieve a sustainable process. We need to recognize that we are in an era of constant change. Technology changes can bring reorganization in the economic conditions of entire industries overnight. As a result, organizations are affected and people’s lives are impacted. So, what is the right definition of continuous improvement in today’s world—and in the foreseeable future? It is that every period will be the best we can make it under the conditions that exist. We can forecast into the future for several years and we know that the forecast will be wrong. We have always known this, yet we forecast anyway. Additionally, we think we failed when we do not meet our forecasts. This is counterproductive. Having said this, you do need to forecast outward for two to four years. This is needed to establish the long-term goals and plans necessary to answer The Five Critical Questions. You also need to revisit long-term goals and plans on a regular basis for reality checks. This is critical to achieving your goals. During this process, it will become apparent that the expectations we have today for the next several years will fail to become reality because the world will have changed. This usually happens while we were focused on today’s needs. Everyone who has been in a leadership position for a few years has experienced that the goals we set out today to be accomplished three years from today were unachieved. Usually we fell short—sometimes we exceeded our goals. Either way, we failed to meet them because conditions changed. The most meaningful forecasts are the ones put together today for the coming two quarters and then updated every month. As we go through this process we will see that there will be periods where financial and economic performance will be positive, but worse than the previous term. There may also be periods where negative results are seen. Several outside realities can lead to temporary negative results such as an overall economic slowdown, a regional disaster that negatively impacts the ability to deliver products or services, or a competitor moving into the marketplace.

19

Creating Shareholder Wealth

Does this mean that we have failed or that we are not achieving continuous improvement? No! Certainly these changing conditions cannot be used as an excuse to justify failing to do our best. However, the inability to surpass past results in a prior quarter is a situation we will always face. If we accept that continuous improvement means doing the best we can every period under the conditions that face our organization, we will sustain a “continuously positive” environment over the long-term. This is to everyone’s benefit. This new notion is much more consistent with basic human nature. It allows for flexibility to adjust to current realities. The old notion of continuous improvement traps us into a thought process and operating mode that is inflexible. We think in terms of the need to be better than we were before, no matter what it takes. This is dangerous. It causes a high stress level and affects business conduct, which is unhealthy, and is never sustainable over the long-term. The new notion of performance that is continuously positive keeps us focused on long-term goals while allowing flexibility. This allows us to deal more effectively with those negative periods without losing focus. This approach is consistent with human nature. It releases creativity with an open-minded process. It contributes to a sustainable process. After all, sustainability is the real goal. You do not want to be among the nearly 50 percent of organizations that abandon the best process available because it wasn’t implemented properly. Being continuously positive allows you to succeed. As you read through this process, you will see periodic references to how this new notion of continuously positive is applied and how it is consistent with human nature. You will also see how it better enables success than the traditional approaches taken to valuebased system implementation. It maintains the organization’s PULSE. The Five Critical Questions 1. 2. 3. 4. 5.

What is the Strategy Intent? What are the Strategy Goals that support this intent? What is the Strategy Plan to achieve the goals? How is the Strategy Implemented? What is the best Performance Measurement System?

All you need to do is answer these five questions, follow through, and be successful. Clearly, the answer to the first question rests with the individuals at the top of the organization. This is why the process must begin at the top. Without true commitment to aggressive Strategy Intent and doing what is required to achieve that intent, you will fail. Why only five questions? We only need five questions because simplicity is the essence of this program. Four questions are used to develop and implement the strategy and the final question focuses on measurement. The goal is to keep the process simple and effective.

20

Introduction

The following “Concept Model” depicts the overall process and provides some basic guidelines to ensure the stated goal is accomplished. This model overlays the “Action Model” that follows and gives details of what happens at each level. Note that the Functional Level managers are expected to share goal support plans. This accomplishes four things. 1. It simplifies the process. 2. It provides greater focus. 3. It forces groups to work together toward common goals and rewards. 4. It automatically means that the Implementation Action Outlines will become shared and those managers will tend to work together and support each other. Taken together, these four benefits will also break down barriers that often develop between functions within an organization. Breaking down barriers is part of aligning the two cultures that exist in every organization. Never underestimate the importance of accomplishing this alignment. The right side of the “Concept Model” shows how the levels within an organization align with each of The Five Critical Questions. Notice that corporate level Q1 means that the corporate level of the organization has primary responsibility for answering question one (Q1), the division level has responsibility for question two (Q2), and so forth. The left side shows what is expected at each level of the organization. Use the Action Model as a “fill in the blanks” format. The corporate level and division level should work together to develop the answer to question one. The division level and functional level work together to develop the answer to question two, and so forth. This approach is also essential to simplify the process, obtain adherence, and break down barriers. This process applies to any size or type of organization. A large company would typically consist of all the organizational levels depicted in the models. A business unit of a large organization might also have these levels within its structure. Many smaller organizations may lack these levels. Alternatively, one individual may be responsible for multiple levels. You need to adapt the model to your situation. For example, a company like Johnson & Johnson will have all these levels and its medical product business unit will as well. The president of the business unit would address the corporate level question for his unit from his perspective while the president/CEO of the corporation would address the corporate level question from his perspective. What is essential is that the business unit’s Strategy Intent be fully consistent with and support the corporate level Strategy Intent. These two presidents would work together in answering the Strategy Intent question at both levels of the organization. For a small manufacturing firm, the president would answer the Strategy Intent question with the general manager. However, the general manger might well answer questions two and three because he or she has responsibility for both levels within the organization. The key is to fit your organization’s structure to the models.

21

Operations Organization

Support Organization

Executive Offices

22

Implementation with Support

Functional Managers

CONCEPT MODEL

Functional Managers

Engineering Production Purchasing Finance One or Two Plan Statements Per Goal from Staff Human Inventory Quality Each Function Resources

One or Two Goals Per Organization

One Strategy Intent Statement

Manager Level - Q4

Functional Level - Q3

Division Level - Q2

Corporate Level Q1

Creating Shareholder Wealth

Performance Measures - Q5

Goal Statement(s)

Goal Statement(s)

Strategy Intent Statement Division Level - Q2

Corporate Level - Q1

23

Implementation With Support

One or Two Plan Statements Per Goal Plan(s)

Plan(s)

Plan(s)

Plan(s)

Implementation Action Outlines

Plan(s)

Plan(s)

ACTION MODEL

Implementation Action Outlines

Plan(s)

Plan(s)

Manager Level - Q4

Functional Level - Q3

These Two Levels Should Share Goal Support Plans As Much As Possible

One or Two Goals Per Organization

One Strategy Intent Statement

Introduction

Performance Measures - Q5

Creating Shareholder Wealth

Things to Keep in Mind In making the commitment to maximize shareholder wealth, you are also making the following primary commitments to all stakeholders: • A commitment to Excellence • A commitment to Continuously Positive Results • A commitment to Absolute Ethics • A commitment to Efficient Use of Capital • A commitment to Continuous, Open, and Honest Communication Answer each of The Five Critical Questions in sequence keeping these commitments in mind. Then go back and fill in the details. The following sections will guide you through that process. Following is an article that describes key considerations in developing your answers to the first three of The Five Critical Questions. The italic insertions relating questions in the article to the first three critical questions are my own and not part of the original article. These are the types of questions you must answer in order to develop the best possible answers to The Five Critical Questions. They represent a form of due diligence.

“Strategy Development Points” Strategy Intent “Customer Analysis Who are our customers? What are the market segments in which they operate? What motivates them? Do they have unmet needs? Competitor Analysis Who are our existing and potential competitors in the industry? What are their levels of sales, market share, and share growth profits? What are their strengths and weaknesses? What are their strategies? Who are our existing and potential competitors outside the industry? Market Analysis What industry trends are significant to our strategy? How attractive are the segments or sub-markets in which we operate? What forces in our market are reducing profitability? What are the projections for growth in our market? What are our channels of distribution/service delivery? What are their strengths and weaknesses? What are the alternate channels of distribution/service delivery? What are their strengths and weaknesses?

24

Introduction

Environmental Analysis Technology. What technological developments or trends affect or will affect our industry? What technologies outside the industry threaten us? Government. What regulatory changes are likely/possible? What will be their impact? What are the risks of operating in any given governmental jurisdiction? What tax or other incentives might affect our strategy? Economics. What are the overall economic prospects for our market area? What are current regional prime rates? What will they be? What is the lending climate? Demographics. What trends will affect our overall market potential? What trends will affect each of our key regions? What trends can be viewed as opportunities? As threats? Culture. What are the current/emerging trends in design, lifestyle, buying that might affect us? What are their implications? Self Analysis What are our strengths and weaknesses? What are our opportunities, and what threats do we face? What is our culture? What has been our performance? What are our key points of differentiation? What are our costs? Are there any key problems we may have overlooked?”

Strategy Goals and Strategy Plan “Strategy Development How can we add value for our customers by doing something better or differently than we presently do? How can we add value for our customers by doing something better or differently than our competitors do? How can perceived quality be enhanced? How can we differentiate what we offer? Can we gain any significant cost advantages that will improve our performance? What are the key assets we must develop or maintain? What are the key knowledge, skills, and abilities we must develop or maintain? What synergies are available to us? What are some of our alternatives for growth? Should we pursue them? If so, how? What investment level is most appropriate for each market/division/department?” Written by:

L. Douglas Mault—President Executive Advisory Institute Yakima, Washington

25

Published in: AWCI’s Construction dimensions December 2000

Creating Shareholder Wealth

Full Implementation Although full implementation is most effective, the initiatives do not have to be fully implemented to yield significant benefit to the organization. The risk in less than full implementation is that the onrushing boulder of competition will catch up to you and may overtake you. Your competition may have read this book and made the right decision to fully implement the process while you did not. If so, their boulder will likely overtake you. However far you choose to take this process, what is most important is to effectively implement whatever level is decided upon in order to begin the process of continuously positive results. Go after the low hanging fruit right away. This gives you the greatest and fastest return for the initial funds and effort expended. At the minimum, implement: • The relationship between process improvement and SVC performance measurement • 5S Workplace Organization • CLOSEDMITT Waste Elimination • The related Incentive Compensation Plan All of these are discussed in detail later in this book. Understand that the greatest results will come from full and complete implementation with a focus on continuously positive results over the long-term. The full process involves answering all Five Critical Questions to the fullest extent. This means the implementation action outlines will be comprehensive. Summary Up to this point, I have discussed how the process works from a high level. You have seen the Concept Model and Action Model and how they are used. I have also discussed the things to keep in mind and various questions that need to be addressed as part of developing the answers to The Five Critical Questions. I have also discussed the importance of breaking down barriers, achieving alignment in the organization, and executive commitment.

26

Chapter Two What Is the Strategy Intent? “Curiosity is one of the most permanent and certain characteristics of a vigorous intellect.” —Samuel Johnson Intent In defining Strategy Intent, the idea is to be aggressive. It is not good enough to have a Strategy Intent to be competitive in the market place or to catch up with your competition. The essence of strategy is in creating tomorrow’s competitive advantage faster than competitors duplicate the ones you possess today—staying ahead of the onrushing boulder. Strategy Intent gives everyone in the firm the only goal that is worthy of commitment: to unseat the best, become the best, or remain the best. That goal must be specific in its focus. The following article is an excellent example of what can go wrong when executives are not committed to the process and fail to follow an orderly plan and follow up on their own Strategy Intent goal implementation. I will use this article throughout this part of the book to illustrate key points in developing the answers to The Five Critical Questions. As printed below, it is in the format originally published. In subsequent sections the format is modified to help illustrate points being made and bring focus to the discussion.

“More than Hardware and Software” “Sometimes installing systems on the plant floor can be frustrating. A couple of years ago, my team spent a substantial amount of time putting in a stock room inventory control system for a client. The system included barcoding, radio frequency terminals, and portable printers—the works. And after nine months of effort, time, money, toil and energy, inventory accuracy and efficiency was no better than it was before we started.

Creating Shareholder Wealth

It’s not that our original goals and expectations were unrealistic or unachievable. It’s not that we didn’t know what to do. In fact, I spent three days in the customer’s plant trying to ascertain what was really happening. Being a system integrator, I braced myself for the worst: that we had missed the target and designed and implemented the wrong solution. Thank heaven this was not the case. What I discovered was that most of the soft, people oriented stuff had not been done. Here are a few of the most important examples: • Users had no documentation or instruction for system administration. For example, if a piece of hardware was damaged they didn’t know how to return it for repair. In some cases, they tried to fix it themselves, and this resulted in further damage to the devices. • There was no established training program or user/procedural documentation. The result: frustration and dissatisfaction leading to inappropriate and inconsistent procedures and system use. Users’ efficiency in doing their jobs was also being compromised. • In the event of a system problem (software, hardware or procedural), users had no one in the plant to turn to for help. They had to wait for IS to help them. IS did its absolute best, but when a user has a problem and has to receive, find or ship something immediately, minutes seem like hours. • There was no ongoing system champion or manager. If management doesn’t care, is unavailable or has lost interest, you can bet the users on the plant floor won’t care. The actual problems with this implementation were really avoidable and reasonably resolvable, but as an outsider, I felt almost powerless to help. These were operational and management issues, not technical issues. I could tell them what to do, but they had to commit to doing it themselves and following through. At the end of my visit, my client and I concluded that the people side of the system equation had been neglected and/or underestimated. To achieve the benefits the client wanted, substantially more work was needed. The shocking revelation for me was that these different yet related problems seemed to compound themselves exponentially, causing additional damage. It’s like a one-two punch in a boxing match. Either punch on its own is recoverable, but the combination is devastating. What’s the solution? Well, you’re probably waiting for me to say that we did x, y and z and everything got better—we wrote documentation, implemented administrative procedures, installed a manager, etc. But I think there is something more important to learn in situations like this one. It is common for a system not to deliver the expected results. In those situations, the overall remedy is to commit to the results that were originally anticipated. Go back, as a group, and reflect on why you wanted the system in the first place. Then reinvent the project with the resources you have at hand, and go about implementing the actions that will get the results you want.

28

What Is the Strategy Intent?

I know it sounds simple and it is. But at the same time, I have a genuine appreciation and respect for the work, commitment and follow through required. It definitely isn’t easy, but it isn’t optional if you really want the success you desire and deserve.” Written by: Mr. Rick Duris—President Business Technology Group Libertyville, Illinois

Published in: Midrange Enterprise December 2000

One of the inherent weaknesses of Mr. Duris’ client was that their apparent Strategy Intent was to become more competitive in the marketplace, and that is not sufficiently focused. Although this Strategy Intent is unspecified, it was implied by the goals. Please go back, read the article again, and see if you can identify the Strategy Intent, the Strategy Goals, and the Strategy Plan. Did you find the answers to the first three Critical Questions? If not, don’t be concerned. They will be addressed and discussed in the coming sections. This is also a good time to think about a possible situation in your organization that might be similar to what Mr. Duris describes. Simplicity Strategy Intent should be defined in a single statement. “Become the industry leader in private aircraft manufacturing.” “Be the global supplier of choice of commercial aircraft.” “Lead the industry in disc drive manufacturing.” “Be the first to map the human genome.” “Be the industry leader in computer operating systems.” “Be the global leader in all forms of wireless communications.” “Be the industry leader in issuing sustainable insurance policies.” “Remain the industry leader in approving home mortgages that do not default.” “Lead the industry in providing sheet metal components to the commercial construction industry.” “Remain the global leader in vacuum cleaner sales.” “Become the global leader in high definition television sales.” “Become the leader in my market in automobile sales and service.” “Double revenues in six months.” Is “double revenues in six months” an appropriate Strategy Intent statement? Normally it would not be. However, it is included here because it could be appropriate under certain circumstances. Take a moment and think about organizational conditions where this might apply. Could it apply to an organization in transition? To a turnaround situation? Note that some of the statement examples might apply to a business unit within a corporation rather than the corporation as a whole. Companies such as Boeing, General

29

Creating Shareholder Wealth

Electric, and Johnson & Johnson have multiple business units making diverse products for various industries and consumers. In cases like these, it is appropriate for each business unit to develop Strategy Intent, Goals, Plans, and Implementation. There will be a corporate level Strategy Intent at the same time. For example, Boeing has a commercial aircraft manufacturing business, a military aircraft manufacturing business, a space business, and several others. The Strategy Intent for commercial aircraft could be, “Beat Airbus.” The Strategy Intent for military aircraft could be, “Control all militarily strategic airspace.” The Strategy Intent for the space business might be, “Lead our world to the stars.” The corporate level Strategy Intent could well be, “Be the global leader in all products and services provided by our business units.” All business units would use the same performance measures at each level and the corporation would use the top-level measures on a consolidated basis. Become Obsessed Once you define your Strategy Intent, you must make it your obsession. This takes true leadership. Strategy Intent implies a sizable stretch for the organization. To meet the challenge you create for yourself requires total focus and commitment. An obsession to succeed is essential. Defining a single Strategy Intent, being obsessive about that intent, and having a single primary measure creates a focused and understandable business philosophy and practice. Everyone in the organization will be able to understand and relate how he or she fits into the process. Your methods of leadership and communication must create the atmosphere in which the workforce chooses to become motivated and obsessed. In reality, Strategy Intent can be developed at any level of an organization. Where subordinate levels within the organization develop a Strategy Intent, it must fully support, and be consistent with, the corporate level Strategy Intent. IN BRIEF Departmental Strategy Intent Shift Supervisor Level: Very early in my career, I was promoted to the position of second-shift foreman of the Specialty Battery Department at Globe Union, Inc. in Milwaukee, Wisconsin. I made several changes in how the personnel on my shift processed their work on machines and at individual workstations. The result was that with just over half as many people, the second shift was nearly as productive as the first shift. My Strategy Intent was to improve the departmental profitability and the job security of the people working on my shift. That intent was achieved.

30

What Is the Strategy Intent?

Department Manager Level: Two years later I was promoted to Manager of the Specialty Battery Department and extended the changes I had made on the second shift throughout the entire operation. I also changed the plant layout and product flow. Improvements were made at individual workstations to simplify assembly operations as well. The cumulative effect was that the operation became approximately twice as productive and quality improved considerably. In one full year, only one lot of standard product failed quality testing of thousands of lots manufactured. The specialty battery department was part of the Industrial Products Group. The other departments in the group were unprofitable. One operation was losing a great deal of money and had a nearly 90 percent return rate at one point. The people in my area made enough profit for Globe Union shareholders that the division became profitable. It was during this time period that I developed the term “Throughput Management.” I never heard anyone else use this term or read it anywhere over the years until I was at The University of Georgia—Athens in the early 1990s receiving training as a “Jonah” from university professors who were associated with the Goldratt Institute. The Strategy Intent was to make the Industrial Products Division profitable. That intent was achieved. Accomplishing the Strategy Intent was a function of focus, obsession with achievement, continual communication, trust in the people working in the department, and always showing respect. I gave the organization PULSE. PULSE was introduced in chapter one under Key Philosophies and will be discussed in greater detail later. The Essence of Winning President John Kennedy captured the essence of winning in his speech that defined the nation’s goal of landing a man on the moon and returning him safely to earth by the end of the decade. This became the Strategy Goal. Nothing before or since captured the nation’s imagination and spirit in the same way. The United States, and much of the world, became embroiled in the space age and ensuing competition between the United Sates and the Soviet Union. Beating the Soviet Union in the space race became the Strategy Intent. This essence of winning drove many changes and united many divergent aspects of the nation. Congress approved the budgets NASA required. Many high school and college students focused their energies on space-related education. Thousands of men and women joined the competition in numerous roles. The construction industry benefited all over the country. Other countless resources were brought to bear in this competition. This Strategy Intent became the scorecard for the technology race between the United States and Russia. It drove the development of smaller and faster computers, advances in programming, electronics, safety practices, propulsion technology, aerodynamics, and many other industries. Kennedy’s stated Strategy Intent and Strategy Goal were met when Neil Armstrong became the first human being to set foot on another celestial body on July 20, 1969.

31

Creating Shareholder Wealth

If defining a strong and clear Strategy Intent, and providing related leadership, can make a nation obsessed and focused on a winning goal, you can do it in your organization. Think about what your intent should be and how to articulate that intent. Cultural Alignment One of the primary requirements for successful strategy development and implementation is cultural alignment. Part of defining the Strategy Intent is to evaluate the condition of the firm in respect to alignment. In all probability, your organization is suffering from misalignment. What is critical is to objectively determine if the extent of misalignment is an obstacle to effective implementation. An outside neutral party normally does this analysis most effectively. Creating Shareholder Wealth can be a tool to create alignment by identifying areas of focus during the plan and implementation aspects of the process. The following depiction is referred to as the McKinsey 7-S Framework. It shows the primary elements of culture within an organization and how they encircle the need for shared values—alignment. It comes from an article by Robert H. Waterman entitled “The Seven Elements of Strategic Fit,” published by the Journal of Business Strategy, date unknown. I have used this in several projects. In one particular situation, this evaluation was helpful in developing the Strategy Intent statement and in making recommendations to the company president concerning implementation—especially his specific role in that aspect of the process.

Structure

Strategy

Shared Values

Systems

Skills

Style

Staff

32

What Is the Strategy Intent?

Strategy Intent Is Stable Over Time Depending on your beginning point, achieving your Strategy Intent could take a number of years. In the battle for survival and leadership in your industry and market, the task for executives is to lengthen their organizations’ attention spans. This is consistent with the goal of Creating Shareholder Wealth and measuring performance with Shareholder Value Created—a long-term focus utilizing a single primary measure making incremental progress toward a clearly defined objective. The Strategy Intent provides consistency of short-term actions toward achieving a long-term objective. Executives communicate in terms of Strategy Intent more than in terms of creating value for shareholders. This helps establish the needed stability over time, no matter how long or short the road is to achieving your Strategic Intent. The manned space program of the 1960s did this with incremental steps. From the Mercury program carrying one man in a small capsule on orbital flights, we learned how to launch missions with reliability and return safely. This aspect of the program developed computer technology, flight dynamics, launch procedures, recovery procedures, and testing of heat-resistant materials, and laid the foundation for the next step. The Gemini program taught us how to carry out missions with two-person crews, how to rendezvous two objects in space and connect them safely, how to safely perform tasks outside the safety of the capsule, and how to safely land a larger, heavier spacecraft. Finally, with the foundation in place, the Apollo program carried three-person crews, performed more complex rendezvous maneuvers and extra vehicular activities, and began progressive missions to the moon. This program ultimately landed two men on the moon on July 20, 1969. Your organization will also have a series of progressive steps to achieve its Strategy Intent. By maintaining the organization’s focus on the intent and an essence of winning, you maintain needed stability. Create a Sense of Urgency This is not a process that can be taken lightly. This is not simply another part of the job. It is the job. As such, treat it with a continual sense of urgency, but not with a sense of panic or undue stress. Be realistic with the goals. However, stretch the goals that people reach for and the resources of the organization. Encourage creativity and innovation. These traits must be nurtured or you will fail. At the same time, the atmosphere must be safe for people to make mistakes. Excuse an honest mistake made by a person who is focused on the Strategy Intent and is working to achieve it. Only penalize for failing to try, failing to be innovative, failing to point out where opportunities exist or a wrong path is being taken. Encourage open and honest dialogue in a professional atmosphere.

33

Creating Shareholder Wealth

Develop the Skills Needed to Work Effectively Training is an essential aspect of achieving Strategy Intent. The workforce needs to be proficient at problem identification and solving, team building, and, where applicable, statistical tools. Managers at all levels need to be trained in business management and leadership as general managers. Computer skills need to be developed and encouraged. Communication and negotiating skills are among the most important since virtually every interaction is a form of negotiation. Perhaps the most important skill, because it is so all encompassing, is to train people to be effective change agents. One Challenge at a Time This process replaces any others that may compete against the defined Strategy Intent. Evaluate all other initiatives in the organization and see how they can be melded into and support this process. Any initiatives that cannot be integrated should be terminated. Once the whole organization is focused on this single initiative, you will have numerous challenges going on at the same time. The key is to make sure the goals are achievable and all support the Strategy Intent. One challenge at a time does not mean that you ignore multiple situations—you cannot. It means that you focus first on the challenge having the greatest negative impact or on the one with the greatest potential gain. Keep in mind that you have an organization with a number of key people; each person and each team can address a different primary challenge at the same time. It is common for an organization to address a dozen challenges simultaneously. However, they are manageable and non-disruptive because they are spread across the organization. This gives focus to the issue while ensuring that a number of issues are being addressed. This is the essence of teamwork and goal achievement. Summary Strategy Intent must be clear, highly focused, and stable over time. It must summarize the only objective employees have and emphasize it as worth achieving.

34

Chapter Three What Are the Strategy Goals? “In order to succeed, we must first believe that we can.” —Michael Korda

Goals Life and business are filled with many types of goals. Here we focus on organizational goals that specifically support the defined Strategy Intent. Strategy Goals establish the criterion the organization will use to chart its progress. These criteria form the milestones to be achieved to fulfill the Strategy Intent. Here, and in the following two chapters, I will repeat a portion of Mr. Duris article to illustrate how he identifies his clients Strategy Goals, Strategy Plans, and Strategy Implementation. The key points will be in underlined italics, will identify the subject of the chapter, and will show how they flow from one critical question to the next. In the case of Mr. Duris’ client, the Strategy Goals were clearly defined and support the implied Strategy Intent of becoming more cost competitive.

“More than Hardware and Software” “Sometimes installing systems on the plant floor can be frustrating. A couple of years ago, my team spent a substantial amount of time putting in a stock room inventory control system for a client. The system included barcoding, radio frequency terminals, portable printers—the works. And after nine months of effort, time, money, toil and energy…”

Creating Shareholder Wealth

Strategy Goal “…inventory accuracy and efficiency was no better than it was before we started.” Establish Clear—Short-Term—Milestones The Strategy Goal statement(s) directly support the Strategy Intent and are generally broad in nature. Milestone goals must be established and are part of the Strategy Goal statement. In tracking progress toward goal achievement, milestone goals should be in short time intervals. Some might be weekly, others monthly, and none more than three months out. Any project that requires more time should have subordinate milestones that are short-term in nature. Provide formal feedback and rewards at these milestones. Provide informal feedback on a continuous basis. The challenges in achieving these milestones and Strategy Goals must be inescapable for everyone in the organization. The performance of everyone in the organization, at all levels, must be linked to the milestones. There is a reciprocal responsibility in achieving the milestones and Strategy Goals. Reciprocal responsibility means shared gain and shared pain. It is unproductive to create an environment where the primary responsibility, risk, and work effort required is placed on the direct labor workforce and lower levels of management, especially if the executives are receiving bonuses at the same time. It is the entire organization that survives or fails. Everyone shares in that responsibility and shares in the rewards. The only difference between people in an organization is the specific tasks they perform to ensure success in achieving the Strategy Goals and fulfilling the Strategy Intent. Understand this daily in your career. It will help your interactions. Understand What Is Involved The article “More than Hardware and Software” is an excellent example of a proper Strategy Goal intended to help meet a Strategy Intent—and of failure due to the lack of executive commitment. That commitment cannot be understated. In setting goals and tracking progress, several things need to be understood: • The culture in which these goals are to be met • The costs associated with achieving the goals • The skills needed in the workforce to achieve the goals • How you intend to communicate the importance of the goals and intent • How the chosen Strategy Goals support the Strategy Intent

36

What Are the Strategy Goals?

Examples The Strategy Goals for any organization will be a function of the selected Strategy Intent, the situation within the organization, and its situation within the industry. Some possible milestone goals are: “Be in production within ninety days.” “Achieve a net profit before taxes of 35 percent.” “Redesign the product within sixty days.” “Move into the new facility within seventy-five days.” “Successfully install the new computer software system within six months.” The possible goals are unlimited. It is essential to select the few goals that directly support the Strategy Intent. This can be difficult. It is easy to fall into the trap of identifying a wide range of goals. Strategy Goals can be defined at the plant operating level as well. IN BRIEF Plant Level Strategy Goals The Kendall Company (now Tyco Healthcare/Kendall) bought a company in the Los Angeles, California area and I transferred from Milwaukee to take over the acquired company as Director of Operations. In the first couple of months, I was able to implement changes that doubled productivity on the product assembly line while increasing personnel on the line from six to eight. This, along with other improvements, enabled the operation to make enough profit to recover most of the cost of acquiring the company in about two years. That was the Strategy Goal I defined. The corporate level Strategy Intent was to buy a company with a product line that enabled expansion of products and services in the company’s Hospital Products Division. Also, the intent was to increase the company profitability. My Strategy Goal supported that intent by increasing throughput, retaining all previous customers of the acquired firm while also enabling the parent company to offer the full product line, and exceeding corporate goals. What Is the Fit with Shareholder Value Created? In selecting the Strategy Goals that support the Strategy Intent, calculate how each goal impacts SVC results. Also keep in mind that it is possible to have a goal that is essential to the business but does not have a positive—or the most positive—impact on SVC. Certain research or engineering activities may fit into this category. Another common situation is the goal of redesigning an aspect of a product and how it is assembled. Even though this redesign is a pure cost item, it can open the door to other improvement opportunities. Another common situation is work resequencing where the process can become more costly at one operation and lay the foundation for greater savings in subsequent operations. You would still accept these due to their overall benefit to the organization and the longer-term SVC results.

37

Creating Shareholder Wealth

The following true example demonstrates the folly of being narrow-minded and thinking only in the short term. In late 1997, while working with a process improvement team at an aircraft manufacturing operation, we recommended a change in work sequencing for fuselage assembly operations on one of the aircraft models. The fuselage sections of the aircraft were manufactured in Europe and shipped to a United States company for joining. The recommendation involved moving a small portion of work from Europe to the United States. If implemented, it would save less than fifty hours work in Europe and add less than fifty hours work to the domestic operation. Keep in mind that it was taking the domestic operation well over 20,000 hours of work effort to complete an aircraft. Implementing the recommendation would lay a foundation where the domestic operation could implement other recommendations that would save hundreds of work hours. The related recommendations and total process improvement package were well researched by the team and the potential savings were well documented. The process change was performed on a simulated basis to further prove its viability. The European product management group and the functional organization members on the domestic process improvement team all supported the changes. The domestic Director of Manufacturing repeatedly refused to implement the recommendation, in spite of the total savings potential, because of the added cost to his operation in implementing the first recommended step. In addition, he could not see past the negative impact and he distrusted the organization as a whole to implement the entire savings package. This was sheer folly, but it was not entirely his fault. It was symptomatic of the disease that existed in the organization as a whole and why the boulder of competition eventually caught up with and crushed the company. The real fault lies with the atmosphere created by the firm’s executives. For a midlevel manager to refuse to implement something clearly to his benefit and to the benefit of the organization, and where he had the authority to do so, is always an executive leadership failure. Executives had the responsibility to set a Strategy Intent and Strategy Goal philosophy and atmosphere that encouraged the manufacturing director, and other directors in the organization, to move forward with implementing the recommendations that would have resulted in Creating Shareholder Wealth. This story is one example of leadership failures that create an atmosphere that is nonconducive to survival. Do not repeat this type of failure in your organization! Instead, begin by developing a list of all the goals you can think of that the organization should attempt to meet. Next, identify those goals that support another goal on your list and develop the subordinate listing that results. Next, pare the list down to those higher-level goals that directly support the Strategy Intent. When this has been accomplished, evaluate the impact to SVC should a particular goal be undertaken and implemented. The final step is to prioritize the goals as follows: • Those that absolutely must be done to run the organization—no matter the impact to Shareholder Value Created • Those that provide the greatest benefit to Shareholder Value Created—in order

38

What Are the Strategy Goals?

Understand the fit with Shareholder Value Created and how the owners benefit. Example Summary Let’s use Boeing as an example to summarize Strategy Goal statements. The company has a commercial aircraft manufacturing business that might have a Strategy Goal of “Being the global supplier of choice for commercial aircraft.” This statement would support a corporate level Strategy Goal statement that might be “Become the global supplier of choice for all products and services offered by our business units.” The commercial aircraft group needs milestone strategy goals to fulfill the top-level goal statement. Among them might be: “Install a fully functional moving assembly line for one aircraft model within in one year.” “Reduce overall operating costs by at least 1% per seat mile per year for the next three years.” “Reduce lead times by 10% within one year, with the first 4% within six months.” “Reduce inventory costs by 7% within four months.” “Reduce operating space requirements by 20% within two years.” These milestone goals directly support and enable the top level goal statement. Summary You have a critical role in this step of the process. The previous example, as well as Mr. Duris article, is unfortunate and all too common in any type of organization. So far you have read how important it is to create an atmosphere that is conducive to success and survival. You have responsibility for answering question one—the Strategy Intent. This is not done in a vacuum, but is done in concert with the Division Level. This is so the Strategy Intent and Strategy Goals are fully aligned. Your actions must be consistent with your words. You cannot tell lower level managers that you have a philosophy that encourages creativity and improvement and then create an atmosphere where any manager is afraid to implement what he or she knows to be a benefit because he or she fears repercussions and/or has a lack of trust in the organization. This was the atmosphere at the company in the above example to a great extent, even though that was probably not the intention of most individual executives.

39

This page intentionally left blank.

Chapter Four What Is the Strategy Plan? “You may be disappointed if you fail, but you are doomed if you do not try.” —Beverly Sills Plans The purpose of Strategy Plan statements is to create a link between the identified Strategy Goals in the previous question and the implementation process developed through answering the fourth, and next, question. Accordingly, the Strategy Plan statement is a transitional statement and will typically be brief. It should look like an extension of the goal statement. In the previous chapter we saw that Mr. Duris’ client had a Strategy Goal to increase inventory accuracy and efficiency. Now we will see what the Strategy Plan was for his client. See how the Strategy Plan statement is brief, is an extension of the goal statement, and links the goal of increased inventory accuracy and efficiency to the Strategy Implementation discussed in the next section.

“More than Hardware and Software” “Sometimes installing systems on the plant floor can be frustrating. A couple of years ago, my team spent a substantial amount of time…” Strategy Plan “…putting in a stock room inventory control system for a client. The system included barcoding, radio frequency terminals, portable printer—the works. And after nine months of effort, time, money, toil and energy…” Strategy Goal “…inventory accuracy and efficiency was no better than it was before we started.”

Creating Shareholder Wealth

Establish Clear and Understandable Plans The plan Mr. Duris’ client chose was clear and understandable—to achieve the Strategy Goal by implementing a comprehensive stock room inventory control system. It is important to define clear and understandable Strategy Plan statements. Doing so aids in enabling the workforce to focus on achieving the Strategy Goals and Strategy Intent. Understand What Is Involved Understand what is involved in making the linkage between Strategy Goals and Strategy Implementation. It is easy to blend plans with implementation. Avoid this temptation. In the earlier years of my career, I didn’t understand the importance of this separation and sometimes had difficulty implementing plans. I originally developed only four critical questions with this question missing. Once I recognized this shortcoming and inserted this question, the process became clearer and easier. I’ve found implementation at client organizations and in my own executive positions much easier. Understanding what is involved in the Strategy Plan statement means defining the Strategy Intent in the studious manner discussed earlier and in defining the few Strategy Goals needed to support that intent. Answering the first two questions methodically makes it easy, or at least much easier, to answer this question because you will have a solid understanding of the state of your organization and where you need to go. Examples In the article written by Mr. Duris, the Strategy Plan was to implement a stock room inventory control hardware and software system to meet the Strategy Goals. The rest of the plan statement might have been: “We will utilize IBM hardware and Peoplesoft software.” As good as these products are, these are not endorsements, only examples of an expanded plan statement. What Is the Fit with Shareholder Value Created? In developing the Strategy Plan statement it is important to calculate the expected impact to Shareholder Value Created. You have defined the Strategy Intent for the organization. You have identified the Strategy Goals to support that Strategy Intent. By identifying the Strategy Plan you have an idea of what the implementation costs might be. Put those costs along with the anticipated saving from achieving the goals into the calculation and look hard at the result. Summary You now have the answers to the first three questions and can see how they are linked together. Hopefully you also see how they lead to answering the next question, “How is the Strategy Implemented?” You also have an idea of what the costs and savings are and how the process might benefit Shareholder Value Created. You have made a great deal of progress. Now the real work begins.

42

Chapter Five How Is the Strategy Implemented? “To contrive is nothing! To construct is something! To produce is everything!” —Capt. Edward V. Rickenbacker Implementation Strategy implementation is the most difficult aspect of the process. This is where “the rubber meets the road.” What actions are taken to successfully implement a strategy is a function of the defined Strategy Intent and Strategy Goals. In some cases, acquisitions or divestitures may be appropriate. Moving pieces of the business, or whole components, to new locations may be required. It may be necessary to buy or modify equipment of various types. Plant and/or workplace reorganization may be in order. In other cases, improving communications may be all that is needed. Whatever the actions, they always require commitment, and they are always an element of lean business implementation. Mr. Duris’ article clearly describes what can easily happen when you are not committed to the entire process and fail to fully and properly answer the question, “How is the Strategy Implemented?” In the previous two chapters we saw the Strategy Goals and Strategy Plans for Mr. Duris. Client. Here we see how he has identified his client’s Strategy Implementation, which was to hire Mr. Duris’ firm to fulfill their Strategy Plan statement and meet their Strategy Goals.

Creating Shareholder Wealth

“More than Hardware and Software” “Sometimes installing systems on the plant floor can be frustrating…” Strategy Implementation “…A couple of years ago, my team spent a substantial amount of time…” Strategy Plan “…putting in a stock room inventory control system for a client. The system included barcoding, radio frequency terminals, portable printers—the works. And after nine months of effort, time, money, toil and energy…” Strategy Goal “…inventory accuracy and efficiency was no better than it was before we started.” Other Strategy Implementation statements might be: “Retain an engineering and industrial construction firm.” “Hire a design engineering firm with specialty Y.” “Retain a commercial real estate firm with industrial properties.” “Retain an industry experienced information technology firm.” Team Leaders and Structures Strategy Implementation requires concentrated effort from focused leadership and implementation teams. This focus is one element of establishing clear and understandable processes. The entire workforce needs to have a singular focus and each person needs to see how he or she fits into the process. These teams help create this environment. This will yield significant improvement in operating efficiencies that will lead directly to increasing Shareholder Value Created. What is most important is to decide what is appropriate for the organization. Identifying the best team leaders and members is critical. It is also important that the Creating Shareholder Wealth Leadership Team be focused on this effort and does not have this assignment in addition to normal responsibilities that conflict. This means that Creating Shareholder Wealth is part of the normal responsibilities individuals have. Normal job duties and Creating Shareholder Wealth are one and the same. In the case of the implementation teams, a small team of people (typically two or three) with a broad range of skills should be leading this effort on a focused basis as a part of their normal responsibilities. Here again, the normal job duties and Creating Shareholder Wealth are one and the same. The exception is the Lean Business Implementation Team since the duties are broad and varied. In a larger organization, it may be appropriate to have a separate group of individuals comprising this implementation team. An excellent example of this is Boeing. The company has an outstanding Lean Manufacturing organization with a group of indi-

44

How Is the Strategy Implemented?

viduals dedicated to leading the successful implementation process. Many individuals from various functional organizations work with this implementation group. Where the cutoff point is relating to establishing a focused team or a team with this as a part of their other duties is a judgment call that can be difficult. The answer lies in doing an SVC cost and benefit analysis to the organization. While doing this analysis, look closely at workloads from the perspective of successful implementation. At this point, it is appropriate to discuss the five teams charged with making this change process work and effectively implementing Creating Shareholder Wealth. Creating Shareholder Wealth Leadership Team (CSWLT) This team leads the entire process. Its members typically are as follows: • Company President (or equivalent) leads the team • Chief Financial Officer (or equivalent), also leads SVC Implementation Team • Human Resources Director (or equivalent), also leads Incentive Compensation Implementation Team and Communications Implementation Team • Operations Organization Vice President (or equivalent), also shares leadership of the Lean Business Implementation Team • Support Organization Vice President (or equivalent), also shares leadership of the Lean Business Implementation Team • Engineering Director (or equivalent), leads Determinant Assembly effort where applicable • Quality Assurance Director (or equivalent) if there is one • Director Purchasing and Inventory Control (or equivalent, if not one of the above) • Director Marketing/Sales (or equivalent) • Administrative person In the beginning of the process, this team should meet daily and then weekly while it gets organized and familiar with the process. As progress is made, the team may decide to gradually move to monthly status and decision-making sessions. This is a cross-functional team representing each critical area of the organization. Each person “owns” an element of the change process and has responsibility for that element. The Leadership Team is not a new level of management or bureaucracy, a place to put someone you do not have another job for, or a place for a fading executive. It is a place for highly qualified and capable people. It is also not a steering committee in the traditional sense. It is not a group that convenes from time to time to guide those who are actually doing the work. This team actively leads the implementation effort, communicates with the workforce, evaluates progress, makes decisions, allocates resources, provides training, and ensures that rewards are provided. The Leadership Team oversees the change management effort. It makes sure all the pieces of the change puzzle properly fit together. The Leadership Team has the eight primary responsibilities identified later. However, the team is not solely responsible or accountable for fulfilling these tasks. The Implementation Teams

45

Creating Shareholder Wealth

and the entire management group share in that responsibility. You have to make sure the atmosphere is consistent with that or the process will fail. If the Leadership Team is seen as unsupported by management and is not seen as the capable decision making group with authority, accountability, and responsibility for successfully implementing Creating Shareholder Wealth, the process will fail. The eight primary responsibilities of the Leadership Team, as identified in the article “Managing Change: The Art of Balancing,” written by Jeanie Daniel Duck and published in Harvard Business Review (November–December 1993), are: 1. Establish context for change and provide guidelines. 2. Stimulate conversation. 3. Provide appropriate resources. 4. Coordinate and align projects. 5. Ensure congruence of messages, activities, policies, and behaviors. 6. Provide opportunities for joint creation. 7. Anticipate, identify, and address people problems. 8. Prepare the critical mass. One of your primary roles as a leader in the company is to be a strong and visible advocate for the transformation taking place, articulating the reasons why change is essential and defining the new corporate direction. In setting up the team and its charter, it is important to make sure that everyone understands that costs associated with implementation of these initiatives will be closely monitored. The team has an obligation to increase shareholder value by an amount that is a minimum of some factor greater than the cost of implementation. That improvement factor should increase with the learning curve until it reaches a fixed level. As an example: Quarter:

1

2

3

4

5

6

7

8

Factor:

0

1

2

3

4

5

6

8

As you begin the process, focus on training, get the teams in place, and complete other logistical matters. As a result, your SVC calculation may look worse than before you began. Costs are going up and you have not started to see results. In the second quarter of the implementation plan, you should start seeing improvement that is reflected in SVC results. As time progresses and experience grows, the expectation should increase. You want the team to be aggressive and to have goals that are challenging to achieve. For the process to have continuously positive results, the benefits must be greater than the cost of implementation. It is important for the Leadership Team to understand that, with change, the task is to manage the dynamic, not the pieces. This means managing the overall process and not getting bogged down in the details.

46

How Is the Strategy Implemented?

Shareholder Value Created Implementation Team (SVCIT) This team is responsible for maintaining the financial information needed to calculate SVC and making period calculations. Since the SVCcalc software links the SVC calculation directly to the Incentive Compensation Plan results, it is essential that this team be in close coordination with the Incentive Compensation Implementation Team. The SVCIT is also responsible for ensuring that the software is protected and that no formulas or calculation relationships are improperly modified in any way. Once the decisions are formalized pertaining to how the calculations are going to be made and the software is tailored to your organization, it should be almost impossible to make a change. Predictability is essential. Team membership is typically as follows: Team Leader is the CFO (or equivalent) Individual assigned responsibility for the software and calculations Backup to the above person Director Human Resources (or equivalent) Note: SVCcalc is an Excel based program I wrote and have used for several years to make calculations from financial statement information. It automatically makes certain adjustments appropriate to the calculation and process. Incentive Compensation Implementation Team (ICIT) This team is responsible for maximizing the number of people who are eligible to receive benefits. The ICIT must work closely with the SVCIT to make adjustments in the amount of SVC that will be placed into the incentive pool and the percentage of base pay an employee is eligible to receive as a performance bonus. I recommend starting relatively low on both counts so upward movement can be made as progress is made. You may start out with 10 percent of SVC going into the pool and move up to 50 percent over time. You may start out with bonuses of 25 percent of base pay and move up to 50 percent over time. Those decisions are yours. I recommend making them on a quarterly basis. Clearly, where you begin is a function of what type of incentive plans you may have in place right now and what they pay out to employees. Remember that this plan replaces anything already in place. In some respects, that may be the most challenging aspect of this process. Convincing people who are receiving bonuses based on one system that it is appropriate to replace that system with another system is often difficult. That is also why it is essential to have early successes in implementation so payments can be made right from the beginning.

47

Creating Shareholder Wealth

Team membership is typically as follows: Team Leader is the Director Human Resources (or equivalent) Individual(s) assigned responsibility for: • Maintaining the list of eligible people for bonuses • Coordinating payment of bonuses earned • Maintaining a file of individual SVC Accounts Backup to the above persons Communication Implementation Team (CIT): This team is responsible for developing, publishing, and coordinating: • All training material • Training sessions • All news bulletins • Workforce meetings Team membership is typically as follows: Team Leader is the Director Human Resources (or equivalent) Individual(s) assigned responsibility for: • Developing and maintaining all training material • Coordinating training sessions • Developing and maintaining all news bulletins • Coordinating workforce meetings • Coordinating publishing and printing functions Backup to the above persons Lean Business Implementation Team (LBIT): This team will have the most challenges. They have to manage the various improvement projects and get most of the results that are measured by SVC. This is why the operations and support organizations lead this team together. They must work together toward a common goal and must never compete against each other. Team membership is typically as follows: Co-team leaders are the VP Operations and VP Support (or equivalent) CFO (or equivalent) Director Purchasing and Inventory Control (or equivalent) Director Engineering (or equivalent) Director Quality Assurance (or equivalent) Director Human Resource (or equivalent) Administrative person Person from CFO group to maintain project cost information Project team leaders

48

How Is the Strategy Implemented?

This team will provide most of the workforce training. This team will also consume most of the resources allocated to Creating Shareholder Wealth implementation. As you see by the makeup of the team, it has a broad and integrated range of responsibilities. Phases of Implementation: Implementation requires two phases. It is set up this way to further establish clear and understandable processes. Phase One—Analysis: 1. Executive management needs to be totally committed. This involves becoming educated on the basic concepts and processes involved in: • Shareholder Value Created (SVC) as a performance measure • The associated incentive compensation plan • Lean Business techniques 2. The change management process needs to be understood. 3. Plans for training the rest of the management group must be developed. 4. A process for ongoing communication needs to be identified. 5. Data needs to be gathered and put into software files: • SVCcalc software for performing SVC calculations • Income statements • Balance sheets • Statement of cash flows 6. The state of the business needs to be evaluated—this includes doing a due diligence evaluation on the organization from an outsider’s perspective. 7. The formal and informal organizations need to be analyzed and understood. 8. Team leaders and members need to be identified. Find the most capable people in the organization—wherever they might presently be assigned. 9. Put the leadership and implementation teams in place. These should be accomplished in the sequence described below. The following is a sample matrix. Yours may look different, in particular in the time frames involved. Your particular situation may take more or less time.

49

Creating Shareholder Wealth

ANALYSIS TIME LINE MATRIX ACTION ITEM Training Develop Communication Plan Data Gathering and Input Analyze the State of the Business Understand the Formal Organization Understand the Informal Organization Understand the Alignment Between These Two Organizations Understand Organization History Understand Phases of Organizational Growth Identify Adjustments to the Formal Organization Identify Team Leaders and Members Put Teams in Place

1 X

2 X X X X

3 X X X X X X

WEEK 4 5 X X X X X X X X X X X X X X X

6 X X

7 X X

8 X X

X X X X X

X X X

X

Phase Two—Implementation: 1. Make a strong public commitment to the process as a way of life in the company. 2. Put the communication plan into action. 3. Put the incentive compensation plan in place. 4. Make sure the software is fully structured to support the ongoing effort. 5. Prioritize implementation projects. 6. Go for it! How Do the Two Phases Link Together? The analysis phase lays the foundation for the implementation phase. Perhaps the easiest way to see this is with a matrix for each phase showing what is involved in each step along the way. The goal is to have a fully functional and ongoing process. Accomplishing this requires a total commitment by management. This includes being an active role model for the process, all day, every day. As you work your way through the steps, considerable improvement in SVC and business conditions can, and should, be achieved. I find it helpful to align the entire process with financial reporting periods. This helps make the management and control process clear and understandable. Reporting periods are often quarterly, so the time line might look like the following:

50

How Is the Strategy Implemented?

Analysis and Implementation Time Line Period: Q1 Q2 Q3 Q4 Phase 1: Step 1

X

Step 2

X

Step 3

X

Step 4

X

Phase 2: Step 1

X

Step 2

X

X

Step 3

This matrix does not mean that it will take your organization twelve months to go through the entire process. It may well be less time in a smaller organization, or more if your organization has a large and complex structure.

X

The phases and steps referred to in the matrix are discussed in detail later in this chapter. Earlier we looked at a week-by-week time line for the analysis phase. The implementation phase is easier to manage on a broader time line. However, it must be micromanaged on a daily basis. Keeping the time periods small makes it easier for people to follow progress, meet schedules, and stay motivated. This is especially true when the rewards are short term. Again, we are taking advantage of a basic element of human nature: our natural tendency and ability to think in short time frames and our need for short-term feedback. Understand What Is Involved A great deal is involved in effectively implementing a Strategy Plan to achieve stated Strategy Goals. They can be summarized in one word—obstacles. Four obstacles are associated with change and Strategy Implementation. They are: 1.

Lack of Executive Management Direction: There must be an absolute commitment on the part of executive management to the entire process from the beginning. This process must become a way of life in the business. 2.

Lack of Motivation Throughout The Organization: People motivate themselves. As an executive, you provide the inspiration and atmosphere that makes employees want to be motivated. I believe the primary motivator is a working environment that allows people to contribute, feel a sense of accomplishment, have a sense of ownership, where expectations are clearly defined and make sense, and

51

Creating Shareholder Wealth

where there is feedback on a regular basis. The secondary motivator is money. This process introduces an incentive compensation system that will provide financial motivation for employees to focus on the long-term business success. 3.

Lack of Ability within the Organization: The ability to effectively implement these initiatives is directly related to the level of knowledge and experience that exists within the organization. Continuous training is an integral part of the system. That training begins with executive management and flows through the entire organization. However, it is essential that the right people be identified as implementation team leaders. The current job function and position level these people hold in the company is irrelevant. What is relevant is their ability to effectively perform their roles in implementing this process and maintaining it over time. 4.

The Final Obstacle is Culture: Culture kills strategy every time! If the culture within an organization is misaligned and will not embrace change, the best strategy and implementation plan will fail. You get past this obstacle by getting past the first three and by ensuring you have the right people in all leadership positions. Implementation Details Before getting into the details of the implementation steps outlined earlier, I would like to link some of the examples from the previous sections for clarity and flow. This can be seen in the following matrix. Please look for the Strategy Intent statement(s) that require(s) additional Strategy Goal or Plan statements right now to be successful.

52

How Is the Strategy Implemented?

STRATEGY INTENT Beat Airbus Lead the industry in disc drive manufacturing Be the industry leader in wireless telephone communication

STRATEGY GOAL Install a prototype moving production line at location X

STRATEGY PLAN Retain a qualified engineering and industrial construction firm

Be in production within Implement lean ninety days on high manufacturing in business speed lines units A & B Hire a design engineering Redesign the product line firm with specialty Y to within sixty days supplement in house staffing

Lead the industry in providing Retain a commercial real Move into the new sheet metal components estate firm with industrial facility within to the commercial properties seventy-five days construction industry Become the global Successfully install the Retain an industry leader in high definition new computer software experienced information television sales system within six months technology firm The answer is that lines two, four, and five require additional statements right now in the form of “how many” and “what type.” Line one applies to one facility and aircraft assembly operation within a business unit. Line three would be revisited later when the initial statements have been fulfilled because there will be changes. Phase 1—Step 1: The purpose of this step is to begin laying the foundation for successful implementation. Management Training The material in this book can be used to put together an internally generated overview-training package for Shareholder Value Created, an incentive compensation plan, and Lean Manufacturing. You may also contact the author to receive training materials. Change Management Training The material on change management may be used to put together an internally generated overview-training package. You may also contact the author to receive basic training material.

53

Creating Shareholder Wealth

State of the Business Analyze the current state of your business consistent with the information discussed in this book. Understand the result of that analysis in terms of where you are and how you got there. This will help you understand who the right people are to manage the change process as members of the leadership and implementation teams. Doing this involves several steps: • Understanding the formal organization structure • Understanding the informal organization structure • Understanding the history of your company • Understanding the phase of organizational growth • Understand the due diligence results It will take time and energy to go through this process. Expect arguments, discussions, and debates along the way. You will be surprised as to what you discover. Critically evaluate the formal organizational structure. This is not limited to the organizational chart. This analysis includes the information and paper flow through the business. Do you have more managers or staff personnel than the operation requires? Are people bored and under producing? Are people working a lot of hours and having difficulty keeping up? Are organizations and individuals that work together located in close proximity? Once you have completed this analysis, start thinking about what must be done to improve operating efficiency and reduce costs. There are two aspects to this portion of the evaluation: • What is the current formal structure? • What should the formal structure be to implement Creating Shareholder Wealth? Evaluating the current formal organizational structure is straightforward. Put together a chart of the current structure with: • Organizations • Names • Titles • Job Descriptions Develop this chart all the way down the organization to the first level managers and possibly team leaders. Put together comprehensive descriptions of what each person is supposed to do in his or her position. Have each individual put together a comprehensive description of what they actually do in their position.

54

How Is the Strategy Implemented?

Once this evaluation is completed: • Compare the descriptions by putting them side-by-side on the same sheet of paper. • Job description vs. actual work performed. • Match up common tasks, duties, roles, and responsibilities. • Identify the differences. • Prepare to make changes that will improve operating efficiency. The Informal Organization Structure Critically evaluate the informal organization. You are looking for the information flow in the informal structure. It is valuable to see how that differs from what the formal structure requires. You are trying to identify the informal power base in the organization and who the leaders are within that informal organization. Some of these people must have critical positions on the implementation teams and possibly the leadership team. You also need to find out why the informal organization functions as it does. You want to align the formal organization to the informal structure to the extent possible. This direction is most effective since there will always be an informal organization at work and it will always have a strong influence and control over what happens in the organization. Where alignment in this direction is impossible for regulatory or process reasons, move the alignment of the informal organization toward the formal requirements. This takes open, honest, and consistent communication. Accomplishing this alignment is emotionally difficult, but it will improve operating efficiency and reduce costs. In the previous exercise on the formal organization you obtained information on the informal organization by identifying the differences in how jobs are supposed to be done and how they are actually done. However, that is not enough. You need to interpret those differences and obtain more information. Interview every manager in the firm and many direct employees. The interviews are designed to learn the following: • What drives the differences between the job descriptions? • Which organization is perceived to have the real power in the company under different circumstances? • Why does this organization have this power? • Who is perceived to have the real power in the company among the management group? Why? • Who is perceived to have strong influence and power among the non-managers? Why? • What is the makeup of the informal organization? It is certain that you will receive more than a few surprises from this exercise. Some of them may be difficult to accept. It is essential that you do accept that there is likely a strong informal organization at work within your organization.

55

Creating Shareholder Wealth

What is most important is: • To use this exercise to learn what that organization is • To learn who has influence and power in the informal organization • To learn how to utilize the informal organization as an asset On completing these exercises you will be in a position to modify the formal organization so that both the formal and the informal organization are more effective and closely aligned. As a result, both organizations are structured to effectively implement Creating Shareholder Wealth. You will experience less resistance to the required changes. One specific goal of this exercise is to help identify individuals who will have critical roles on the implementation teams. You are looking for key team members and project leaders. It is possible that the best person for these positions is not currently a manager in the formal organization. He or she might be someone who was identified as having strong influence and/or power in the informal organization. Although it may be difficult, it is important that you put the best people in key positions and stand behind those decisions as long as those individuals perform effectively. Do not limit your search to the formal organization or even within the company. Be open and objective. Understand Your Company History Spend time putting together a key events time line of the organization’s history. You want to put three pieces of information into each entry: • What happened? • Who did it in the formal and informal organizations? • How it impacted the organization. Do this exercise in enough detail to get a good appreciation of where the organization as a whole came from, how it got to where it is, and where it may be headed as a result. Understand the Phase of Organizational Growth In this exercise, use the next pages in the book. Take the following steps: • Think about the history exercise and what you learned in the formal and informal organization exercises. • Read each portion of “The Five Phases of Organizational Growth Chart.” • Put a check mark in each applicable block. You should have seven check marks.

56

How Is the Strategy Implemented?

The following two tables are adapted from material in the article: “Selecting Strategies That Create Shareholder Wealth” by Alfred Rappaport and published in Harvard Business Review (January–February 1981). Modified from the original format with permission. The first table describes the forms of crisis an organization encounters as it goes through the growth phases. The second table discusses in detail the growth phases and other relevant elements within the organization at each phase.

Phase 1

The Five Phases of Organizational Growth Phase 2 Phase 3 Phase 4

Growth Through Creativity

Growth Through Direction

Crisis of Leadership: Increased production and employees need more efficient manufacturing, organizational processes. Who will lead and who will create?

Crisis of Autonomy: Lower level managers have more knowledge than top managers in matters of markets and machinery, resent following procedures, would rather take initiative. Top management resistant to giving up control. Disenchantment.

Young

Growth Through Delegation Crisis of Control: Top executives sense they are losing control over highly diversified field operation. Autonomous field managers prefer freedom, may not coordinate with rest of company. Attempts by top management to regain control.

Age of Organization

Growth Through Coordination Crisis of Red Tape: The proliferation of systems and programs begin to exceed its utility. Line managers begin to resent heavy staff direction. Staff complains about uncooperative line managers. Us vs. them mentality. Both criticize rather than solve problems.

Phase 5 Growth Through Collaboration Crisis of ??: Burnout “psychological saturation” may lend to sabbaticals to rejuvenate and then innovate. Greater emphasis on partnering, integration, temporary job assignments to lower level position.

Mature

Phase 5 Crisis of ?? intentionally contains the question marks. At this phase the crisis in the organization can come in many forms depending on the impact to the organization of what is happening.

57

Phase 1

Creativity: Focus on product, technology, making, selling, entrepreneurial, individualistic. Frequent informal communication, roles, and structure. Control of activities impacted by immediate feedback

Make and Sell

Informal

Entrepreneurial

Market Results

Ownership

Phase

Description

Management Focus

58

Organization Structure

Management Style

Control System

Reward

Salary and Merit

Cost Centers

Directive

Centralized and Functional

Efficiency of Operations

Direction: Able, directive leadership, implements functional structure, i.e. accounting systems, manufacturing, marketing, job assignments, incentives, budgets, work standards. Communication more formal, impersonal. Hierarchy of titles and positions.

Phase 2

Bonus

Reports

Delegative

Decentralized

Expand Market

Delegation: Greater responsibility given to plant and market territory managers. Profit Centers, bonuses, new acquisitions. Management by exception based on reports from field. Communication from top infrequent

Phase 3

Profit Sharing and Options

Plans and Investment Centers

Watchdog

Line Staff and Product Groups

Coordination: Using formal systems for achieving greater coordination initiated by top management. Decentralized units merged into product groups, formal planning procedures established, increased staff hired at corporate to implement company wide control programs. Capital expenditures weighed and parceled out across organization. Product groups treated like investment centers where return on invested capital is important terminant in allocating funds. Manage through f l t d Consolidation of Organization

Phase 4

The Five Phases of Organizational Growth

Team Bonus

Mutual Goal Setting

Participative

Matrix of Teams

Collaboration: Strong focus on interpersonal relationships, spontaneity, and collaboration to overcome red tape crisis. Flexibility, behavioral approach includes team oriented problem solving, cross functional, corporate staff reduced or absorbed into cross functional teams to consult, not direct, field units. Matrix type structure, focus on employee development through training, rewards through performance. Formal systems now simplified via multipurpose systems. Communication between top management more frequent d bl l i E Problem Solving and Innovation

Phase 5

Creating Shareholder Wealth

How Is the Strategy Implemented?

You may feel a sense of conflict doing this exercise. You probability had difficulty identifying the predominant growth of crisis phase in the first table for your organization. You probably also feel you are in various phases on the other elements as well. These conflicts are normal; no organization is squarely in one phase. In spite of this, you need to identify the predominant phase for each element. Once you place your seven red check marks and determined overall where your organization is, relate that information to the previously determined information. You should now see a clearer picture of your organization. You probably were also surprised by some of the answers. Due Diligence Evaluation Perform a due diligence analysis of the organization from an outside perspective. This will help in understanding the true state of your business, where you need to take it, and how to get there. Obtain a due diligence template and assign which team should address each line item. These teams are summarized below and were discussed in detail earlier. • Creating Shareholder Wealth Leadership Team (CSWLT) • Shareholder Value Created Implementation Team (SVCIT) • Incentive Compensation Implementation Team (ICIT) • Communications Implementation Team (CIT) • Lean Business Implementation Team (LBIT) Performing this analysis can be tedious. However, it will yield valuable information about the state of the business and direction needed to survive the onrushing boulder. This is an area where the assistance of an outside consultant would likely prove beneficial. Phase 1—Step 2: The purpose of this step is to gather data, set up analysis and measurement capabilities, and perform initial analysis. It also is where you identify the improvement projects. Shareholder Value Created At a minimum, use the standard formula provided in this book. Determining your total capital for the calculation is a potential difficulty. I recommend you contact the author to purchase a copy of SVCcalc. This will simplify the process. Gather data for the calculations from your financial statements. Calculate SVC from the information available, or input the data into SVCcalc. Lean Manufacturing/Business This is the more complex and demanding aspect of the process. Implementing Lean Manufacturing/Business techniques will take perseverance, patience, and total commitment.

59

Creating Shareholder Wealth

Analyze your operations to identify forms of waste as described in the following discussion about workplace organization and CLOSEDMITT. Prioritize what you find in terms of how easy it will be to correct or improve. The easiest improvement to implement goes at the top of the list. Start addressing the problems at the top of the list that do not require significant expenditures, time, or energy. You will get the biggest returns for your money with this approach. In addition, you will show quick results and early successes. This helps reinforce the entire process and gives credibility. Many of the things you identify will require capital expenditures to improve or correct. Now begin the analysis process for the Operations and Support Organizations. What is identified below is discussed in greater detail in the case study in Chapter 12. The goal here is to help you understand what is involved in developing the answer to “How is the Strategy Implemented?” Remember there will be four functions in each organization. Although this can be modified where required, make every effort to keep the organizations small and lean. • The Operations Organization: Production, Engineering, Inventory Control, and Quality • The Support Organization: Human Resources, Purchasing, Finance, and Corporate Staff As you read through this material, think about how each item applies to the functions in your particular environment. Organization Improvement: • Workplace organization o Evaluate every workspace from the perspective of the “5Ss.” This process creates and maintains an orderly workplace environment. Sort items by what is needed at the workplace to perform function requirements. Simplify the workplace arrangement. Sweep and clean the workplace every day. Standardize workplace processes. Self-discipline is essential to sustaining improvement. • Visual controls enable you to know the status of an operation at any time. They involve status boards for performance measures and production needs, posted schedules, and financial results. • Standard work involves common and predictable work processes wherever practical. This enables employees to move readily from one task to another and maintain a higher level of productivity. However, this does not mean that you should increase the number of workplaces or make job tasks so unchallenging that they become boring and frustrating. • Point of use means providing the materials needed for a job at the job location. This does not mean setting up a bunch of supply cabinets at every workstation in the organization. It does mean having smaller supply cabinets close to a group of workstations.

60

How Is the Strategy Implemented?

•

Kitting means putting all materials, tools, and documents required for a particular job together and delivering them to the workplace when needed to support scheduling needs.

These concepts can be applied at any level and should be applied at every operation level. IN BRIEF Lean Applications After leaving the USAF and returning to a position as a setup man at Globe Union, Inc. Specialty Battery Department in Milwaukee, Wisconsin I developed faster methods for setting up machines. I also developed methods for setting up simultaneous multiple operations on a particular machine. In addition, I was able to develop machine-operating methods that kept a primary machine running and making good quality parts where it had previously been shut down on a frequent basis for adjustments. All of these improvements increased productivity and quality of throughput. The improvements were a direct result of applying the previous ideas. I applied workplace organization to the setup process and work area enabling faster setup times. The setups were also more accurate which improved product quality. I applied the standard work concept to enable multiple operation setups at the same time by looking for the common elements in each operation and integrating them. Applying point of use ideas also enabled faster setups and greater throughput as well. CLOSEDMITT The following matrix shows the material you need to analyze for CLOSEDMITT. This is used at Boeing in its ongoing efforts to create wealth for its shareholders and to satisfy the organization’s commitment to customer service. CLOSEDMITT is copyrighted material of The Boeing Company. Further distribution or use of the material may not be made without the prior express permission of The Boeing Company. I have provided two versions that are derived from Boeing’s version. One focuses on the Operations Organization and the other applies to the Support Organization functions. Although these two are nearly identical, both are presented to help emphasize the differences between the two organizations. Keep in mind that each organization and function delivers a “product” in some form to a “customer.”

61

Creating Shareholder Wealth

Operations Organization C

Complexity

Find simple solutions in place of complex ones. Complex solutions tend to produce more waste and are harder for people to manage. They are also more costly.

L

Labor

Eliminate all unnecessary movement and steps by people. Identify and eliminate all other unnecessary labor within the organization offices and factory.

O

OverProduction

S

Space

E

Energy

D M I

Produce only the exact amount of goods the customer wants, when the customer wants them. Eliminate any production beyond customer demand. Conserve space in the plant and office layout, including poor arrangement of machines, people, conveyors, or workstations. Minimize space required for storage of engineering drawings, excess raw materials, parts, work-in-progress, and finished goods inventory. When operating equipment, use person-power only for productive purposes. Avoid false scale efficiencies, excess power utilization, and unproductive operations.

Defective Goods and The goal of no rework—EVER. No rework, scrap, or defects. Errors Materials

Convert all materials into production. Avoid trim, scrap, excess, or bad raw materials. Do not own materials that do not directly support production.

Idle Materials

Make sure that nothing sits. Ensure there is a steady flow to the customer. Any kind of idle inventory represents waste, including raw materials in any form, information, WIP inventories, and finished goods.

T

Time

T

Transportation

Eliminate delays, long setups, and unplanned downtime of machines, processes, or people. These often result from poor specifications, missing parts or information, late deliveries, and inadequate training. Eliminate the movement of materials or information that does not add value to the product, such as double and triple handling of goods and the needless movement of information.

62

How Is the Strategy Implemented?

Support Organization C

Complexity

Find simple solutions in place of complex ones. Complex solutions tend to produce more waste and are harder for people to manage. They are also more costly.

L

Labor

Eliminate all unnecessary movement and steps by people. Identify and eliminate all other unnecessary labor within the organization’s offices.

O

Over-Production

Produce only the exact amount of goods the customer wants, when the customer wants them. Eliminate any production beyond customer demand.

S

Space

Conserve space in the office layout, including poor arrangement of people and workstations. Minimize space required for storage of excess materials, supplies, work-in-progress, and finished goods inventory.

E

Energy

When operating equipment, use person-power only for productive purposes. Avoid false scale efficiencies, excess power utilization, and unproductive operations.

D M I T T

Defective Goods and The goal of no rework—EVER. No rework, scrap, or defects. Errors Materials

Convert all materials into production. Avoid trim, scrap, excess, or bad raw materials. Do not own materials that do not directly support production.

Idle Materials

Make sure that nothing sits. Ensure there is a steady flow to the customer. Any kind of idle inventory represents waste, including materials in any form, information, WIP inventories, and finished goods.

Time

Eliminate delays, long setups, and unplanned downtime of machines, processes, or people. These often result from poor specifications, missing parts or information, late deliveries, and inadequate training.

Transportation

Eliminate the movement of materials or information that does not add value to the product, such as double and triple handling of goods and the needless movement of information.

63

Creating Shareholder Wealth

At this point you should have a list of improvements you can make immediately in operating efficiencies with little implementation cost. Phase 1—Step 3: The purpose of this step is to begin the application process on a trial basis, debug the system, and make appropriate adjustments. Shareholder Value Created Run the SVC analysis again from the updated data input into SVCcalc. If you have not purchased SVCcalc, perform the calculations manually or with another software program. Use at least three years of history plus all year-to-date information, by quarter. Project at least two years into the future using information gathered thus far in your analysis. Graph the results of the analysis to see trends. Incentive Compensation Plan Incentive compensation is discussed in detail in Chapter 8. Perform a trial run of the developed conceptual plan given the SVC analysis results. Did the conceptual plan work as anticipated? Did you run out of money in the pool? Was money left in the pool? At this point it is likely that adjustments will need to be made to the concept plan. If you ran out of money, reduce the percentage of base pay that a person can earn as a bonus. It can be increased in the future. If money was left in the pool, either lower the percent going into the pool or raise the percent of base pay that a person can receive. It is important to get as many people into the plan as possible—the entire workforce must be the goal. This will encourage greater initiative by rewarding individuals for working to meet the objective of increased shareholder wealth. The wealthier the employees make the shareholders, the wealthier they will become themselves. In the movie Wall Street, Michael Douglas said, “Greed is good!” As leaders, your role is to channel and control that greed so it is productive. Greed, in the sense of improving our life, is a natural human goal. This can be done by encouraging cooperation in achieving a common and focused Strategy Intent. Rewards need to be performance based for individuals as well as teams. Lean Manufacturing/Business You have evaluated your organization to identify improvement opportunities and areas of waste. Now, develop basic business cases for potential projects. This should be a rough-cut cost/benefit analysis. It should not be highly detailed but reasonable enough to be credible. Conflicts will arise as different people advocate different projects at this early stage. Earlier I emphasized the importance of addressing opportunities in order of the easiest to accomplish. You will see opportunities with large savings potential. A natural tendency to go after those opportunities exists at this point. Don’t! Not yet.

64

How Is the Strategy Implemented?

Training Now develop the plan for providing training to the rest of the company. Since this is a process that requires the full commitment of the leadership group, it is appropriate that the training process flow through the organization from top down. Put together a plan that is time phased and provides regularly scheduled sessions. Make attendance mandatory! I recommend doing overview training first. Follow up with on the job experience. Then follow that with more detailed training. For example: Monday

Tuesday

Wednesday

Thursday

Friday

Week #

Overview

SVC

Incentive Plan

Lean Business

Implementation

1

Group 1

2

Group 2

Group 1

Group 1

3

Group 3

Group 2

Group 2

Group 1

Group 1

4

Group 4

Group 3

Group 3

Group 2

Group 2

5

Group 5

Group 4

Group 4

Group 3

Group 3

Group 5

Group 5

Group 4

Group 4

Group 5

Group 5

6 7

Communication Developing the ongoing communication plan is an essential element of the continuously positive process. It is critical that progress and status reports be presented to the entire organization on a regular basis. Use a wide range of delivery methods including meetings, publications mailed to employees’ homes, postings on bulletin boards, and the organization’s intranet system. I recommend monthly reports with a consistent format. Part 1: Shareholder Value Created calculations for the most recent period Part 2: Incentive Plan status for the most recent period

65

Creating Shareholder Wealth

Part 3: Lean Manufacturing/Business • Project list • Project descriptions in brief • Projected SVC results • Current actual status • Target completions dates Team Leaders and Team Members Identifying Implementation Team leaders and members is critical. This is one of the primary objectives of Phase 1—Analysis. Identify each person and their role. Put the structure together conceptually and operationally. Make a decision as to who will be full time members of the team and who will have team responsibilities as a part of their normal duties. Make certain there is time in the workday for people to absorb team responsibilities into their normal duties. As soon as the team leaders are identified during Phase 1—Step 1, they must begin an aggressive training schedule. They need to understand the business analysis, the initial project list, the results of the workplace organization and CLOSEDMITT research, and the business direction based on the identified Strategy Intent, Strategy Goals, and Strategy Plan. During Phase 1—Step 2 of the process, the team leader’s staff and their teams perform the initial analysis. During this step, the analysis is fine-tuned and formatted for the SVC run previously discussed. Phase 1—Step 4: The purpose of this step is to compile all analysis findings and prepare the Management Report. I recommend the following format: SECTION 1: Executive Summary • What was the analysis goal? • Who performed the analysis? • Brief summary of findings • Brief summary of recommendations SECTION 2: Shareholder Value Created • Page with summary calculations matrix • Discussion of what the analysis tells you about the business • Recommendations SECTION 3: Incentive Plan • Page with plan goals • Page with plan guidelines • Sample of what results would have been were the plan in place

66

How Is the Strategy Implemented?

SECTION 4: Lean Manufacturing/Business • Summary of 5S Workplace Organization plans and expected benefits • Summary of CLOSEDMITT waste elimination plans and expected benefits • Summary of any other findings, plans, and expected benefits • Prioritized list of recommendations and reasons Present the report to the executive group/leadership team for comment, requests for further information, and approval to move into Phase 2—Implementation. Phase 2—Step 1: This step involves formalizing team assignments for the people identified during the Phase 1—Analysis process. If any changes are necessary in assignments, this is the time to make them. Once the final team makeup is set, meet with the entire team at once. Once the meetings are completed, announce the final team membership lists and functions to the entire workforce. This is a follow up to previous information provided earlier. • What the plan is • Who is on the team • How the process will work o Training o Performance measurement o Incentive compensation plan o Implementation • What you expect of the workforce • What the workforce can expect of you • What the ongoing communication process will be • Why this new plan is important The following matrix provides a sample schedule of the roll-out process.

ACTION

DAY:

1

2

3

4

5

Group meeting of team members

Announce workforce meeting schedule

Final preparations

Begin workforce meetings

Complete workforce meetings

Schedule workforce meetings

67

Creating Shareholder Wealth

At the workforce meetings, provide the following information verbally, visually, and with handouts: • A copy of the presentation • Shareholder Value Created calculations from Phase 1—Analysis • Goals for the next eight calculation periods • Description of the incentive compensation plan • Discussion of who is included in the plan • Discussion of how the plan might be expanded, as a function of performance results • Lean Manufacturing/Business projects identified and approved during Phase 1— Analysis • Why those projects are important to the business • Introduction of the Leadership and Implementation Teams • Discussion of the employees’ roles • Discussion of the communication plan • Question and answer period (record and publish) This session is sometimes overwhelming and can meet with a certain level of resistance and skepticism in spite of all the previous communication. That is because this is where the workforce realizes that you are serious about Creating Shareholder Wealth. This reaction is natural and consistent with human nature. This session lays the foundation for future sessions and the consistency and support you will demonstrate to the process. Phase 2—Step 2: This step begins the formal application of the systems and procedures. Shareholder Value Created Ensure that everything is in place to continue SVC calculations for each period. This includes some final training. Assign a primary and backup person to this task. Make sure they understand how the software operates. This includes updating formulas, as required. Incentive Compensation Plan Make sure that each person included in the plan understands: • How it operates • How calculations are made • How the SVC account works • When their accounts are credited • When payments are made • How the “at risk” portion works • What is expected of them to improve SVC

68

How Is the Strategy Implemented?

Lean Manufacturing/Business Spend the greatest part of your management time and energy supporting this Implementation Team. This is where the improvements are made. Implementing measurable and sustainable improvements quickly is essential to getting the process off to a good start. Success breeds more success—this is human nature. Begin with the projects that are the easiest to implement. This brings results and introduces people to the process at the same time. As more positive results are demonstrated, more people will want to be involved. Most people want to be part of the winning team. Again, this is human nature. Take full advantage. General Continue active and visible management support. Have a philosophy of continuous communication, both informal and formal. As important as the periodic formal communications will be, the informal talks you have with people throughout the organization will make the greatest impact. It is during these informal communications that you will earn a higher level of credibility. Phase 2—Step 3: This step finalizes formal implementation and application of the process. The following should now be accomplished: • The first formal SVC period calculations ready to publish • The first formal payments credited to SVC accounts and paid • Several Lean Manufacturing projects completed • The entire workforce trained on Creating Shareholder Wealth • Formal communications newsletter in printing • A number of bulletin board postings completed • Management preparing to meet with the entire workforce to present status and results • Informal communications commonplace • A solid understanding of what is happening throughout the company and the entire workforce—at every level The following matrixes detail implementation at each level within the organization. They take you through the levels of the organization for training and introduction of the process elements. By the time you complete Level 4, the program will be fully implemented.

69

Creating Shareholder Wealth

LEVEL 1 ELEMENT Training

Requirements

SVC • • • • • •

• • • • •

Spending Priorities

• • • What to Expect • •

How to Measure

• • •

How to Compensate What End Result Should Be

EXECUTIVES LEAN BUSINESS

Overview How it is used SVCcalc demo Incentive compensation Implementation levels Assigned focal points receive specific training o Internal trainers o Team leaders Full commitment from the executive group Assignment of SVCIT Begin workforce communications Establish initial budgets Training Software purchase Communications Mixed opinions as to cost and benefit relationship Debate on how deep into the organization to take concept Have all executives been trained? Are all executives participating in discussions and debates? Do all executives seem to be developing a common focus?

• No change to existing methods • Begin discussions on future methods • Executive group trained and familiar with the concepts • Timetable for moving to Level 2 • Level 2 Decisions made • Team assignments and training complete • Budget structure in place • Communications begun

70

• • • • •

Overview How to apply Link to compensation Implementation levels Assigned focal points receive specific training o Internal trainers o Team leaders

• Full commitment from the executive group • Assignment of LBIT • Decision concerning Determinant Assembly • Begin workforce communications • Establish initial budgets • Training • Communications • Mixed opinion on cost and benefit relationship • Debate on where to begin implementation projects • Have all executives been trained? • Are all executives participating in discussions and debates? • Do all executives seem to be developing a common focus? • No change to existing methods • Begin discussions on future methods • Executive group trained and familiar with the concepts • Timetable for Level 1 • Level 2 Decisions made • Team assignments and training complete • Budget structure in place • Communications begun

How Is the Strategy Implemented?

LEVEL 2 ELEMENT Training

Requirements

MIDDLE MANAGEMENT SVC LEAN BUSINESS • Overview • How it is used • SVCcalc demo • Incentive compensation • Implementation levels • Assigned focal points receive specific training • Executives sit in on these sessions to show support

• • • • •

• Full commitment from the management group • Incentive compensation conceptual decisions • Begin data gathering and input • Continue workforce communications • Initial funding provided

• Full commitment from the management group • Incentive compensation conceptual decisions • Begin identifying potential projects • Continue workforce communications • Initial funding provided • Training • Communications • Business case development for potential projects • A growing awareness throughout the organization that this is for real • Continued mixed opinions as to cost and benefit relationship • Have all middle managers been trained? • Are all executives and middle managers participating in discussions and debates? • Does management seem to be developing a common focus? • No change to existing methods • Discussions of future methods • A management group that is trained and familiar with the concepts • Timetable for Level 3 • Teams active in their roles

Spending Priorities

• • • • What to Expect • •

How to Measure

• • •

How to Compensate What End Result Should Be

• • • • •

Training Software purchase Communications Data gathering and inputs A growing awareness throughout the organization that this is for real Continued mixed opinions as to cost and benefit relationship Have all middle managers been trained? Are all executives and middle managers participating in discussions and debates? Does management seem to be developing a common focus? No change to existing methods Discussions of future methods A management group that is trained and familiar with the concepts Timetable for Level 3 Teams active in their roles

71

Overview How to apply Link to compensation Implementation levels Assigned focal points receive specific training • Executives sit in on these sessions to show support

Creating Shareholder Wealth

LEVEL 3 ELEMENT Training

Requirements

SUPERVISION and TEAM LEADERS SVC LEAN BUSINESS • • • • • • • • • •

• • • Spending • Priorities • What to Expect • • •

How to Measure

How to Compensate What End Result Should Be

• • • • • • • • • •

Overview How it is used SVCcalc demo Incentive compensation Implementation levels Continued specific training Executives and middle managers sit in to show support Full commitment from the group Data input complete and initial reports generated Continue workforce communications Adjust initial budgets Incentive plan finalized Training Compensation Plan Communications Stabilization of opinions as to cost and benefit relationship No more debate on how deep into the organization to take concept Workforce anticipation of pending involvement Have all management been trained? Full participation in discussions and debates? A common focus No change to existing methods Introduce incentive plan A management group that is trained and familiar with the concepts Timetable for Level 4 Team assignments and training complete Budget structure in place Continuing communication

72

• • • • • •

Overview How to apply Link to compensation Implementation levels Continued specific training Executives and middle managers sit in to show support

• Full commitment from the group • Determinant Assembly projects prioritized • Continue workforce communications • Adjust initial budgets • • • •

Training Initial projects implementation Communications Stabilization of opinions as to cost and benefit relationship • No more debate on where to begin implementation projects • Workforce anticipation of pending involvement • Have all management been trained? • Full participation in discussions and debates? • A common focus • No change to existing methods • Introduce incentive plan • A management group that is trained and familiar with the concepts • Timetable for Level 4 • Team assignments and training complete • Budget structure in place • Continuing communication

How Is the Strategy Implemented?

LEVEL 4 ELEMENT Training

Requirements

SVC • • • • • • • • • • • •

Spending Priorities What to Expect

• • • • •

• • How to Measure • • •

How to Compensate What End Result Should Be

• • • • • • • •

WORKFORCE LEAN BUSINESS

Overview How it is used SVCcalc demo Incentive compensation Implementation levels Complete specific training Management participation Full workforce participation Data input and report generation continuing Continue workforce communications Budget tracking and reporting Incentive compensation plan in place Training Compensation plan Communications Maintaining process General acceptance as to cost and benefit relationship Workforce participation Continuously positive results Has entire organization been trained? Does entire organization have a common focus? Improvements quantified and published Base pay SVC based incentive pay An organization that is trained and familiar with the concepts Workforce involvement and understanding A plan for continuity Active budget structure in place Regular communications Published value drivers

73

• • • • • •

Overview How to apply Link to compensation Implementation levels Complete specific training Management participation

• Full workforce participation • Projects being implemented • Continue workforce communications • Budget tracking and reporting

• • • • • • • • • • • • • • • • • •

Training Project implementation Communications Maintaining process General acceptance as to cost and benefit relationship Workforce participation Visible results Has entire organization been trained? Does entire organization have a common focus? Improvements quantified and published Base pay SVC based incentive pay An organization that is trained and familiar with the concepts Workforce involvement and understanding A plan for continuity Active budget structure in place Regular communications Published value drivers

Creating Shareholder Wealth

Matrixes The following sample matrix shows the typical levels of implementation as applied to question four in the process. It demonstrates the progressive steps that might be taken during Strategy Implementation. This is just one example of the type of matrix you could put together to establish clear and understandable processes as part of developing your Strategy Implementation.

Step 1

• •

Lean Manufacturing/Business Overview Training Identify Various Team Members

Step 2

• •

5S Workplace Organization CLOSEDMITT Waste Elimination

•

Determinant Assembly Overview Training Identify Implementation Team Analyze Opportunities

Step 3

• •

Standard Work Analysis Point of Use Analysis

•

Develop Business Cases

Step 4

• •

Standard Work Implementation Point of Use Implementation

•

Step 5

•

Kitting Analysis and Full Implementation

Make Engineering Changes New Supplier Contracts Full Implementation

• •

• •

Typically you will not be at the same implementation level at the same time for each area. In this example, it would be normal for Lean Manufacturing/Business implementation to be at Level 3 or 4 while Determinant Assembly implementation is at Level 2. This structure, along with a simple matrix and process flow, is essential to establishing a clear and understandable process. Fit with Shareholder Value Created Every analysis should determine the impact to Shareholder Value Created. This will tell you if taking action is in the best interest of the shareholders. Keep in mind that it may be necessary or appropriate to implement an action that has a negative impact on SVC in order to take other actions that will have positive impacts.

74

How Is the Strategy Implemented?

Summary This process may seem complex. It is not. We have learned that implementing Shareholder Value Created alone will provide useful information on how well the firm is doing and will aid in prioritizing investment decisions and establishing a compensation system that will modify behavior to motivate managers and employees to act more like owners. This can be accomplished using the basic SVC formula and building on that foundation. We have also learned how Lean Manufacturing/Business is a tool for making the improvements needed in businesses. I urge you to, at the very least, implement the first two elements of Lean Manufacturing/Business: 5S Workplace Organization and CLOSEDMITT waste reduction. In summary, the minimum level of implementation I recommend is as follows: SHAREHOLDER VALUE CREATED SVCcalc Basic Incentive Plan

LEAN BUSINESS 5S CLOSEDMITT

Keep in mind that the best results come with full implementation.

75

This page intentionally left blank.

Chapter Six What Is the Best Performance Measure? “Economy has frequently nothing whatever to do with the amount of money being spent, but with the wisdom used in spending it.” —Henry Ford A Single Measure The benefits of a single primary performance measure are twofold: simplicity and focus. Both of these are critical and are emphasized throughout this book. Achieving the requisite simplicity and focus for the organization as a whole cannot be accomplished without the use of a single primary measure. If you use multiple primary measures, conflict will arise. Functional managers’ primary focus will be on their own measures and they will lack the ability to see how those measures support the organization. The measures used by Mr. Duris’ client are appropriate as supporting measures, not as primary measures. In this case, the goals and measures were the same. The goals were to improve inventory accuracy and efficiency. The measures were the inventory accuracy and efficiency improvements. These are inappropriate primary measures for the business because they are too narrow in scope. They apply to the inventory control function within the Operations Organization and would be appropriate supporting measures.

“More than Hardware and Software” “Sometimes installing systems on the plant floor can be frustrating. A couple of years ago, my team spent a substantial amount of time putting in a stock room inventory control system for a client. The system included barcoding, radio frequency terminals, portable printers—the works. And after nine months of effort, time, money, toil and energy…”

Creating Shareholder Wealth

Strategy Goal and Performance Measure “…inventory accuracy and efficiency was no better than it was before we started.” Earlier I noted that, by implication, Mr. Duris’ client appeared to have Strategy Intent to become more competitive in the marketplace and possibly to provide a higher level of customer service. Although these are inappropriate Strategy Intent statements because they are too general, the identified performance measures do not fully support the identified intent. From any perspective, the identified measures are supporting measures. By using Shareholder Value Created as the single primary performance measure, Mr. Duris’ client, and any organization, could see how these important measures for the Inventory Control function fully support the Strategy Intent—even when that Strategy Intent statement is marginal. Executives would also be able to identify the best supporting measures for other functions within the Operations and Support Organizations. When Is a Company Profitable? An organization is profitable when it earns more than its cost of capital. This should be intuitive for us as organizational leaders. At home we have bills to pay and expenses to meet (mortgage, car payments, credit cards, etc.). We have “spendable” funds after fulfilling these obligations. The same thing applies to organizations. Traditional accounting practices lead us to Net Operating Profit After Taxes (NOPAT). However, this figure does not account for all of the costs incurred by the organization. A cost is associated with using the capital in the organization to produce goods and services. This cost of capital represents an obligation that has to be met. The concept of Economic Profit, creating wealth for business owners, has been in our financial management tool kit for over 200 years. It represents residual income, that is, the income investors require as compensation for risk. As Peter Drucker wrote in “Information Executives Truly Need,” a Harvard Business Review article published in January– February 1995, “Until a business returns a profit greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resources….Until then, it does not create wealth; it destroys it.” Is a company profitable when its accounting profit is $1,000,000? Maybe. Has it earned enough to exceed its cost of capital? If it has total capital of $10,000,000 and a cost of capital of 15 percent, is the company profitable? No! It would need to earn $1,500,000 ($10,000,000 x .15) to break even from an economic viewpoint. The shareholders do not “make money” until earnings exceed $1,500,000 in this case. How Is SVC Calculated? The basic formula for calculating Shareholder Value Created is: SVC = NOPAT – (WACC * Total Operating Capital). This calculation can be, and often is, used by itself in calculating SVC for the organization and will provide useful information. However, it is best to make several adjustments to traditional GAAP (Generally Accepted Accounting Principals) information for a

78

What Is the Best Performance Measure?

better and more useful calculation. Our SVCcalc software automatically makes the more important adjustments to income statement and balance sheet information to determine NOPAT and total capital for economic purposes. Those adjustments make the calculation more meaningful. If you choose to use SVCcalc, we will tailor the software structure to your organization. The goal in tailoring SVCcalc is not to arrive at some theoretically perfect profit calculation. It is to improve the calculation and enable behavior change throughout the organization to maximize shareholder wealth. To accomplish this, the SVC measure must be simple to understand. Flexibility and the ability to customize are strengths of SVC. Once the software is tailored for your firm, it must be maintained. It should be changed only when business conditions make it absolutely necessary. What you should be most concerned with is the progress your firm makes and the relationship in the performance measure calculation from one moment in time to another, not necessarily the absolute value of the calculation. However, it is also important to understand that SVC results are the basis for incentive compensation. The more meaningful the calculation, the more credible the compensation plan will be. Now let’s look closer at the calculation elements. Net Operating Profit After Taxes (NOPAT): This is derived from the Income Statement and Balance Sheet. From an economic perspective, it is appropriate to make several adjustments. For our purposes, NOPAT is determined as follows: NOPAT =

EBIT (Earnings Before Interest and Taxes) – Cash Taxes – Increase in Deferred Taxes

This makes the economic adjustments to convert NOPAT from a traditional accounting perspective to an economic perspective to make the calculation more meaningful. Earnings Before Interest and Taxes = Net Sales – Cost of Goods Sold – Selling, General and Administrative – Depreciation Cash Taxes = Income Tax provision + Net Interest Expense * Marginal Tax rate – Interest Income * Marginal Tax Rate – Non-operating Income * Marginal Tax Rate

79

Creating Shareholder Wealth

Increase in deferred tax liability is from the balance sheet and compares, for example, 2000 deferred tax liability – 1999 deferred tax liability The Weighted Average Cost of Capital: A critical element in successful utilization of Shareholder Value Created is the cost of capital calculation. The capital charge can be viewed as a “rental cost” on the capital used to produce and deliver goods and/or services to your customers. The interaction between capital charge and SVC is direct. When managers are able to reduce the amount of capital used to deliver goods or services, there is a lower capital cost and higher SVC. Keep in mind that new investments increase SVC only when they produce profits in excess of the capital charge. It is important for executives to understand the concept that you get what you pay for. For example, if the charge for capital is too small, it is likely that managers will pay too much for new investments. The same is true for incentives. Charge too little for the use of capital and there is no incentive to economize. Calculating the appropriate cost of capital is critical to the overall goal to change behavior. A single weighted average cost of capital (WACC) for the entire business is the best. It is consistent with the goal of clear and understandable process—and simple. The exception might be an international business, or business structure, where significant differences exist in capital costs between operating units. The weighted average cost of capital (WACC) includes a proportional cost for debt and equity capital. Debt capital costs less than equity capital. Using the cost of debt capital alone will result in a capital charge that is too low, and managers may lose sight of the impact capital cost has on the business. As a result, they could pay too much for new investments. Using the cost of equity capital alone will result in a capital charge that is too high and may become a disincentive. WACC balances these two possible conditions and results in the most appropriate cost of capital. The formula for calculating WACC is: WACC = (Cost of Debt Capital * % of Debt Capital) + (Cost of Equity Capital * % of Equity Capital) + (Unsystematic Risk) Cost of Debt Capital = (Average Debt Rate as a % * (1 – Marginal Tax Rate)) Cost of Equity Capital = (Risk Free Rate + (Equity Beta for the Firm * Market Risk Premium)) • •

The risk free rate is typically the ten-year government bond rate. The equity beta for the firm can be difficult to determine. A private company and many public companies can use the number 1.

80

What Is the Best Performance Measure?

•

• •

The market risk premium is an estimate for the industry in which the firm competes. It is nominally in the 6 to 8 percent range. It represents the added premium demanded by shareholders to invest in that business rather than an alternative investment. Debt and equity capital ratios should be based on market values if possible. The addition of a percentage for “unsystematic risk” is a case-by-case decision. This represents an additional risk premium for a firm that is operating under unusual conditions or in a market with unusual circumstances. It represents a risk factor outside normal operating conditions.

Total Operating Capital: This information is derived from the balance sheets. Again, it is helpful to make certain adjustments. The formula for calculating total capital for our purposes is: Total Operating Capital = Operating Current Assets + Net Property, Plant and Equipment – Other Operating Assets, net of other liabilities – Non-Interest Current Bearing Liabilities (Excluding Deferred Taxes) This makes the economic adjustments to convert total capital from an accounting perspective into an economic perspective to make the calculation more meaningful. An Alternative: There are some economics and finance experts, as well as CFOs, that feel Shareholder Value Created can more easily and accurately be determined by applying the cost of equity capital to total equity in the business and subtracting that result from NOPAT. This approach does simplify the calculation. If the only goal is to determine a number for reference purposes, this can work. I disagree that this approach results in the most meaningful calculation of SVC. As stated earlier, the cost of equity capital is higher than the cost of debt capital. Using WACC provides the best cost of capital. Total equity is different from the total capital that the business employs to produce goods or provide services. I argue against taking this alternative approach. Making the recommended adjustments described before and applying WACC against total capital provides the most correct SVC calculation for any organization. Adjustments Making the calculation the way I recommend will not be the “perfect” calculation. My approach using SVCcalc software I developed automatically makes these basic, yet important, adjustments. Some consultants and academics argue that a number of additional adjustments should be made. I oppose making them except in specific business cases. I

81

Creating Shareholder Wealth

do not find it worth the additional time and effort since the difference in the result is often small and has little meaning in practical application. I advocate keeping this whole process consistent with human nature, as organized and simple as possible, while realizing the maximum benefits. A company with unusually high R&D expenses would be a case where I would recommend making further adjustments. A start-up company or a company experiencing tremendous growth is another case where further adjustments might be appropriate. These are case-by-case situations that can be addressed. What Does It Tell You? It tells you how efficiently, or inefficiently, capital is utilized. Shareholder Value Created (Destroyed) tells you the true state of the business by looking past the weaknesses of traditional accounting measures. It provides a valid indicator of risk. If SVC has a consistent negative result or an increasingly negative trend, the organization is at risk. The onrushing boulder of competition is catching up with you. If the trend is positive, the organization is at reduced risk and is staying ahead of the onrushing boulder. If the results are mixed over time, you are stagnant in your industry and are holding your position relative to the onrushing boulder of competition. What Drives It? The Right Supporting Measures One thing that often goes wrong with implementing measurement systems, valuebased systems in particular, is that the correct value drivers are not selected. Many organizations have discontinued the use of value-based economic profit systems. My own observations indicate that more than one-third of all companies trying value-based metrics abandon them by the fifth year of implementation. This is tragic. It is a result of failing to design the process and system correctly in the first place. It is also a failure to have a system that reflects the business strategy. Therefore, The Five Critical Questions approach is the answer to these shortcomings. Most of the difficulties associated with implementing value-based systems stem from a failure to select the right value drivers that are directly related to SVC results and are controllable. Failing to make these correct choices, and a minimal number of choices, means failing to address the causes of value creation. This leads to confusion, complexity, and an atmosphere of mysticism. A direct linear relationship exists between choosing the right value drivers that employees directly control or influence, and the SVC results, to the incentive compensation payments. Everyone will see this correlation, or lack thereof. That is human nature. Again, using human nature as a leadership tool in a positive way is to everyone’s benefit. Make the right choices, keep the process simple by adapting it to your environment and make it part of the daily job, demonstrate the relationships, and enjoy the results.

82

What Is the Best Performance Measure?

SVC drivers are those areas which managers in the organization control. These are the measures that are most impacted by implementing lean business techniques. They lead directly to impacting the SVC calculation elements and support measures. In implementing Creating Shareholder Wealth, it is important to understand how a value-based system will help you. It is not enough to have enthusiasm and commitment. You need to understand how the process works, why it works, and what drives it. Recommended Supporting Performance Measures DIVISION LEVEL: Division level executives control, or strongly influence, the following measures through the business decisions made. Free Cash Flow to the Firm (FCFF): Maintaining and improving this metric will support aggressive growth. It not only directly supports SVC results, it impacts the true market value of the organization. Net Profit Before Taxes (NPBT): This is an important measure for the firm. Achieving strong performance growth in this metric will provide fuel to support aggressive growth—cash. Keep in mind the discussion at the end of this section about where to focus improvement efforts. Results here are directly related to the organization’s value drivers. Sales per Employee (Total Number of Employees in the Entity): This is a simple calculation and provides interesting trend information as the size of the organization changes over time. Whenever you see the result decreasing, that is the sales per employee figure going down. In that case, you need to immediately look at why this is happening. Are sales per employee decreasing due to predictable seasonal fluctuations? Do you have a policy of not making short-term layoffs during these periods? Is this condition unexpected and unpredicted? What, if any, action is needed? When sales per employee go down, the cost of doing business goes up. When sales per employee go up, improvements are being realized. Results here are directly related to the value drivers in the organizations. OPERATIONS ORGANIZATION: Operations executives and managers directly control the following measures in their daily activity. On-Time Delivery: This is the most important internal metric in terms of customer satisfaction. The operating requirement must be to deliver a “quality” product on time, every time. On-time delivery of unacceptable products results in returns and lost business reputation. The quest for quality cannot be used as an excuse for late deliveries. At the same time, delivery schedules must be realistic to manufacturing process requirements and capability. A late delivery trend indicates operating costs, and often the cost of goods sold, that are higher than they should be. This measure directly impacts NOPAT.

83

Creating Shareholder Wealth

Customer Returns: The dollar value of customer returns, in absolute terms and as a percent of sales, provides critical information on the customer service level you are providing and how your product or service is viewed in the marketplace. For a service company, customer returns are expressed as complaints about the provided service. Performance here impacts the cost of goods sold and can impact S,G,&A (sales, general, and administrative expenses) and, therefore, Net Operating Profit After Taxes. Inventory Turns: Increasing inventory turns means less inventory on hand at any given point in time. This reduces inventory levels and the related cost of capital. Included in this concept is a minimization of work in process and finished goods inventories. This will open floor space, enable smoother production flow, increase operating cash flow, and support the growth process. Sales per Employee (within the Organization): This is a simple calculation and provides trend information as the size of the organization changes over time. Whenever this result decreases, the sales per employee figure is going down, and you need to immediately look at why that is happening. Are sales per employee decreasing due to predictable seasonal fluctuations? Do you have a policy of not making short-term layoffs during these periods? Is this condition unexpected and unpredicted? What, if any, action is needed? When sales per employee go down, the cost of doing business goes up. SUPPORT ORGANIZATION: Support executives and managers directly control the following measures through their daily activities. On-Time Delivery: This metric applies to internal functions at least as much as to delivery to customers. If individuals within the firm fail to provide a high quality product or service to their internal customers on time, the cost of business increases and the quality of service decreases. Here again, the quest for quality cannot be used as an excuse for late deliveries. Accounts Receivable < 30 Days: Maintain a positive and healthy relationship with your customers. Also emphasize to customers that you expect to get paid on time all the time. Getting paid within the traditional thirty day time period is essential to maintaining a predictable cash flow through the business. This reduces the cost and amount of debt. Accounts Payable On Time: Always pay your bills on time. Your reputation is on the line in terms of your relationships with your suppliers. It is as important to meet your own obligations as it is for your customers to meet their obligations to you. This metric is also the flip side of the cash flow management equation. This can help minimize interest expenses. Sales per Employee (within the Organization): This is a simple calculation and provides trend information as the size of the organization changes over time. Whenever this result decreases, the sales per employee figure is going down, and you need to immediately look at why that is happening. Are sales per employee decreasing due to predictable seasonal fluctuations? Do you have a policy of not making short-term layoffs

84

What Is the Best Performance Measure?

during these periods? Is this condition unexpected and unpredicted? What, if any, action is needed? When sales per employee go down, the cost of doing business goes up. Each of the previous measures is a driver of SVC. As you improve the performance for these selected measures, you will see SVC improvement due to the impact on NOPAT, total capital, and/or the cost of capital. There are also other drivers within the functions, such as inventory accuracy and efficiency as in the case of Mr. Duris’ client. Do not ignore these measures that are also SVC drivers. They are the measures that drive the recommended supporting measures. Actions taken here are what yield improvements in the recommended measures. The first level managers have direct control and responsibility for these. You need to identify the ones that will work best for you. The recommended drivers are the ones I believe are most effective at the organizational levels. If you already use another measure that works as a strong SVC driver, you probably should stick with that measure. Doing so will make the process easier to accept and will be one less thing to change. Here again, we are taking advantage of human nature in a positive way. What’s Wrong with Traditional Accounting Measures? The goal of Shareholder Value Created as a performance measure is to get everyone looking in the same direction with a strong singular focus. Our hero, Indiana Jones, escaped the dangers in his cave because he was focused on the direction he had to go to reach safety and he avoided many hazards along the way. That same need exists in your organization. You will stay ahead of the onrushing boulder of competition and avoid many other hazards when everyone has a singular focus—fulfilling their responsibility to the owners. Here I will discuss several commonly used traditional measures and why they are not the best ones to use. I will also discuss what is wrong with traditional measures in general and how SVC addresses this condition. Among the many performance measures available, SVC is the most effective and meaningful for a number of reasons. One of the most important is that traditional incomebased accounting measures simply do not reflect the organization’s true performance. At best, they reflect an element of performance. Among the most extensively used traditional measures are: • Return on Assets (ROA) • Return on Net Assets (RONA) • Return on Equity (ROE) Each is a measure of determining financial performance from a limited perspective. None tell the story of how the organization is doing in a summary manner. That is their weakness.

85

Creating Shareholder Wealth

The following, through the discussion on myopia, is drawn from information provided by Professor Ken Merchant, Dean of the Levanthal School of Accounting, University of Southern California, Marshall School of Business, in a lecture presentation made in February 1999 entitled “Is EVA The Measurement Panacea?” (EVA is a registered trademark of Stern Stewart, Inc.). Theory says that accounting measures are poor surrogates for value changes because: 1. Accounting earnings focus on the past, not the future. 2. Accounting systems are transactions-oriented, not value oriented. 3. Accounting earnings are highly dependent on the measurement method choice. 4. Accounting rules have a conservative bias. 5. Changes in the values of intangible assets 6. The costs of making investments in working capital 7. The cost of equity capital 8. Risk, and the changes in risk Some empirical evidence supports this. One article, written by Alfred Rappaport, entitled, “Selecting Strategies that Create Shareholder Value,” published in Harvard Business Review (May–June 1981), pages 139–149, reporting on a study of 172 firms in the S&P 400 which had Earnings Per Share growth greater than 15 percent over a six-year period, showed that: • 15 percent had negative rates of return (dividends less capital losses) • 35 percent had negative real returns (i.e., less than inflation). Fully 50 percent of the firms used in this particular study reported that high Earnings Per Share growth actually destroyed value for shareholders. This also means that 50 percent of the companies created value for their shareholders. The stock market sends a clear message that long-term cash generation and expected cash flows are what drive long-term stock performance. Increasingly, analysts and investors recognize that economic profit (SVC for our purposes) is a better measure. So, why do companies use accounting earnings to measure performance and attempt to motivate managers? • Below the corporate level, market measures are uncontrollable. • Bonuses cannot effectively be based on future expectations. • Accounting measures traditionally are seen as positively correlated to value changes. • Accounting measures can be measured on a timely basis. • Accounting measures are seen as relatively precise, timely, objective, and understandable. • •

If this is true, what problems do the use of accounting measures create? Investment myopia! Operating decision myopia!

86

What Is the Best Performance Measure?

Both problems focus managers on the short term. This is at the expense of the longterm good of the business and shareholders. In deciding what performance measures are going to be used and how managers are going to be compensated, keep in mind that you get what you pay for. Managers will always work to maximize performance measures and their resulting compensation. This is human nature. I have discussed traditional accounting income-based measures at some length. We looked at eight problems associated with these measures. Let’s look at how well SVC addresses these problems: 1. Focus on the past, not the future: SVC draws information from past performance. However, it is also an excellent forecasting and decision-making tool for the future. 2. Transactions oriented, not value oriented: SVC is also transactions oriented. However, it calculates true value created in the organization. 3. Discretion in choice of measurement method: SVC eliminates this problem. It is a single measure with a focus on creation of wealth and takes into account the conditions and capital used to create wealth. 4. Conservative bias: SVC retains the conservative bias. However, with its calculation method and forecasting capability, any negative impact is minimized. 5. Ignoring intangible assets: This problem is eliminated since SVC is calculated utilizing total capital. 6. Ignoring cost of working capital: This problem is eliminated since Shareholder Value Created is calculated using the weighted average cost of capital. 7. Ignoring cost of equity capital: This problem is eliminated since Shareholder Value Created is calculated using the weighted average cost of capital. 8. Ignoring risk: This problem is eliminated since Shareholder Value Created is calculated using the weighted average cost of capital. This calculation includes a risk factor for the equity portion. It also takes into account systemic and non-systemic risk. These are discussed in greater detail later. We see that Shareholder Value Created fully addresses five of the eight concerns and eliminates them. It also addresses two remaining concerns. As a result, Shareholder Value Created is a better performance measure than any traditional accounting incomebased measure.

87

Creating Shareholder Wealth

Example: Let’s now spend some time looking at SVC and the three typical accounting incomebased measures mentioned earlier. Let’s look at an example of these three typical accounting based performance measures in action. Assume we have a company with the following accounting information: • Total assets of $468,000 • Total liabilities of $222,000 • Total common shareholders’ equity of $246,000 • Net income after taxes of $43,000 • Interest expense on debt of $21,840 • A marginal tax rate of 40 percent Based on this information, the three traditional accounting performance measures of our fictitious company are: Return on Assets 6.38% Return on Net Assets 12.15% Return on Equity 17.48% Which one of these is the most accurate indicator of how the organization is performing? I argue the answer is none of them. Now let’s determine the Shareholder Value Created. This baseline is calculated using the SVC formula. To do this we need to work our way through the calculations. NOPAT (Net Operating Profit After Taxes) is already given as $43,000; net income is after tax. The WACC (Weighted Average Cost of Capital) is derived from the formula given previously. For our fictitious company it is calculated as 11.11 percent. The total capital for this firm is $272,000 for our purposes. Accordingly, the SVC for this firm is: SVC = NOPAT – (WACC * TOTAL CAPITAL) SVC = $43,000 – (.1111 * $272,000) SVC = $43,000 – $30,219 SVC = $12,781 Congratulations to the managers of our fictitious firm! They returned wealth to the shareholders by generating earnings in excess of the cost of capital. Determining this was easy and took into account all capital required in generating those returns and the total cost of that capital. In doing so, we avoided the limitations and weaknesses of the traditional performance measures. This was done without making any adjustments. Is this a better indicator of the true performance of the enterprise? I argue that it is. Next we’ll look at the three more common measures in greater detail and see why they were not accurate indicators of performance.

88

What Is the Best Performance Measure?

Return on Assets (ROA) The formula to calculate ROA is: Net Income + Interest Expense (net of tax benefits)/ Average Total Assets during the period ROA measures a firm’s performance in using assets to generate earnings independent of how those assets are financed. The rate of return on assets excludes consideration of the particular financing mix used (debt vs. equity). Thus, ROA attempts to measure the firm’s success in creating and selling goods and services. As such, ROA is a good financial performance measure of a portion of the business. It does not measure overall corporate results and does little, if anything, to focus the entire corporation on a single objective. The fact that this measure does not take into account the mix of financing used to capitalize the business is its primary limitation. If that mix is not taken into account, then the cost of capital is also unknown or taken into account. This measure also fails to take into account the total capital. Therefore, as a business leader, you have no way of knowing if your rate of return on assets is above or below your cost of capital. In the absence of that information, you also do not know if you are earning true economic profit for shareholders, even if, or especially if, you are the sole shareholder. If you measure ROA that is what managers will focus on. Every effort will be made to minimize the assets required to deliver product and services to the market. In the short term this may be good. It will certainly look good! Your ROA ratio will improve. However, you will reach a point where the condition of the assets in use will deny the level of quality or productivity your customers require at a production cost you need to remain ahead of the onrushing boulder. Return on Net Assets (RONA) The formula to calculate RONA is: Net Income + Interest Expense (net of tax benefits)/ Average Total Net Assets during the period Net assets are the total business assets less the total business liabilities. This equals common shareholder equity in a structure where there are no preferred shares. Since RONA removes the firm’s liabilities from the analysis, some see it as avoiding complications resulting from the business capital mix. As a management tool, many business executives view it as more meaningful than ROA because it measures how well the organization is utilizing the assets they own after all else is taken into account. I believe that it is not a more meaningful measure in terms of practical application. This calculation method makes the resulting ratio look better by reducing the denominator in the equation. Since the numerator remains the same, the ratio will be higher.

89

Creating Shareholder Wealth

This measure has all the same weaknesses as ROA and can be more dangerous by making the ratio look better. Anything that makes you believe your organization is performing better than it is places you at greater risk. This, in turn, enables the boulder of competition to catch up with you and crush you more easily. Nevertheless, many corporations use it as a primary performance measure and feel that a focus on this measure has helped them to be successful in Creating Shareholder Wealth. The former McDonnell Douglas Corporation is an excellent example. The firm placed a near total emphasis on RONA for several years. For a period of time it made the company look great. Debt was reduced, share price significantly increased, and the stock split a couple of times. The company stock performance looked great right up to the time it was acquired by Boeing and began displacing thousands of employees. Not all shareholders benefited, especially not those who lost their jobs. As any of us who have followed the performance of Boeing since the acquisition on August 1, 1997 realize, Boeing has suffered significant destruction of shareholder value. Over four years later, the share price was still below the pre-acquisition value. This is likely to continue until company executives create the proper environment and recognize: • •

The necessity of assigning key positions to capable managers focused on the business success rather than their own individual situation Focus on a performance measure that reflects value creation rather than value destruction

Too many organizations assign the wrong people to critical positions, emphasize the wrong measures, fail to create the right environment for true success, and destroy shareholder value along the way. Return on Equity (ROE) In this performance measure, we are looking at the return on common shareholder equity only. Preferred shares are excluded. The formula for ROE is: Net Income – Dividends on Preferred Stock/ Average Common Shareholders’ Equity Unlike the return on assets ratios, the rate of return on shareholders’ equity considers financing costs. This is its one redeeming quality and reflects why this can be the most meaningful of the three performance measures discussed. However, it is still a limited and risky measure. It does not take into account the financing costs mix or the total business capital. Some academics and Chief Financial Officers argue that this measure can be used in a meaningful way. They suggest calculating the cost of equity capital and determining if the ROE is greater than the cost of equity capital. This approach does make the measure more meaningful. These well qualified experts further point out that most companies that rely on ROE as a performance measure experience increasing share prices. This is often true.

90

What Is the Best Performance Measure?

This does not, however, make it the best or most meaningful measure. Return on equity lacks the financing mix that provides the capital to the business, that is, the combination of debt and equity financing. As such, it does not make a relationship between a measure of return, the total business capital, and the cost of that total capital. In reality, the more a firm is equity financed rather than debt financed, the more meaningful this measure becomes for the company. The greater the proportion of debt financing to the total, the less meaningful this measure becomes. Having said all of this, I want to emphasize that if you decide to use a typical performance measure, ROE is the best one to use even with its weaknesses. The primary weakness is that it will drive managers to increase debt to make the ROE measure look as good as possible. Inevitably, this will lead to cash flow problems, as the income of the firm must be used to pay for that debt rather than grow the business. As stated earlier, our fictitious company realized the following income-based performance ratios: Return on Assets Return on Net Assets Return on Equity

6.38% 12.15% 17.48%

How well is this company actually performing? I maintain that it is unknown at this point. We have looked at profit in relation to the total capital used in the business —SVC. If we assume that the cost of equity capital is 14 percent, then the performance measure of ROE tells us that we are doing great because we are providing returns on shareholder investment in excess of the cost of equity capital. Where this condition exists, the company is probably creating wealth for the shareholders—but we can’t always be certain. We still have to be cautious about the relationship of shareholder contribution to the total capital of the business and the real cost of capital for the business taking debt into account. Without these considerations, the ratio may be misleading. How about ROA and RONA as performance measures? Is the company doing well? Again, it is unknown. Do these performance measures tell you if you are creating wealth for your shareholders? Not by themselves! At this point it is unknown what it is costing you to create that wealth. Is your cost of capital 9 percent, 11 percent, or what? In the example, the interest expense on debt is 12 percent. In determining SVC, we calculated the WACC at 11.11 percent The ROA measure tells us we are doing poorly, while the RONA measure tells us we are essentially breaking even against the cost of debt capital. Is this correct? Probably not! We still have to be cautious about the relationship between net income, total business capital, and the cost of total capital. The assets of the business, or net assets, are just portions of total capital. The cost of debt, like the cost of equity capital, is a portion of the total cost of capital. Hopefully you see the difficulty associated with traditional accounting measures and the benefit of using SVC as the single primary measure of performance. In the final analysis, we determined that the company is doing well—at least for the period calculated based on the SVC calculation.

91

Creating Shareholder Wealth

Where Should Improvement Focus? The tendency is to say that improvement should focus on those value drivers that have the most impact on the SVC result. This is generally true. However, keep in mind the earlier discussion concerning quick successes at the lowest cost. We can recognize that a focus on NOPAT improvement will result in the greatest SVC gain. This is because for every dollar increase in Net Profit Before Taxes (NPBT), SVC will increase by (1 – Marginal Tax Rate) when the organization is profitable and paying taxes. In the case of our fictitious company, this would mean an increase of $0.60 in SVC for every dollar increase in NPBT since that company has a marginal tax rate of 40 percent. The more direct correlation is that for every $1 increase in NOPAT, there is a corresponding $1 increase in SVC. Let’s see if this is true. The initial example looked like this: SVC = NOPAT – (WACC * TOTAL CAPITAL) SVC = $43,000 – (.1111 * $272,000) SVC = $43,000 – $30,219 SVC = $12,781 Now let’s increase NOPAT by $10,000 and see if SVC increases by $10000. SVC = $53,000 – (.1111 * $272,000) SVC = $53,000 – $30,219 SVC = $22,781 ($22,781 – $12,781 = $10,000) We also see that a $1 improvement in total capital will increase SVC by the WACC. In our example, this means that a $1 reduction in total capital will result in a $0.1111 increase in SVC. Let’s see if this is also true by reducing total capital by $5,000 and see if SVC increases $555. SVC = $43,000 – (.1111 * $267,000) SVC = $43,000 – $29,664 SVC = $13,336 ($13,336 – $12,781 = $555) Clearly, reducing the (WACC) will also improve SVC results. In improving operating conditions, it is important to focus on both NOPAT and total capital. A focus on NOPAT alone will improve economic profit but will not reduce debt service obligations, the cost of capital, or the total capital utilized. Accordingly, free cash flow to the firm improves less than it could. The ability to support growth is negatively impacted since the organization does not improve as much as possible. A focus on total capital alone will improve economic profit, reduce debt service costs, and improve free cash flow. But, the improvements will be less and come slower. Managing the WACC is a function of moving toward the right balance of debt and equity financing. A multiple focus is essential for the maximum benefit of the firm and its owners —the shareholders.

92

Part Two Supporting the Change to Creating Shareholder Wealth “There is nothing wrong with change, if it is in the right direction.” —Winston Churchill The goal of this part of the book is to provide the information necessary to enable and support the change to Creating Shareholder Wealth. Change is a constant process requiring new learning experiences. Here I address the various aspects of change, the incentive process, and recommended performance measures in detail. Part Outline: How to Help Employees Embrace Change Incentive Program Performance Measures How Does It Work? Who Should Care?

This page intentionally left blank.

Chapter Seven How to Help Employees Embrace Change “Part of human nature resents change, loves equilibrium, while another part welcomes novelty, loves the excitement of disequilibrium. There is no formula for the resolution of this tug-of-war, but it is obvious that the absolute surrender to either of them invites disaster.” —J. Bartlett Brebner Creating Shareholder Wealth is important in a number of respects. As you proceed, remember that this concept applies to any size or type of organization, whether public or private. Helping employees embrace change means communicating information that raises each individual’s desire to motivate themselves. Open and honest, as well as frequent, communication is the key. Let’s look at the most important factors that motivate change. Change: “Managing Change: The Art of Balancing” Above is the title of an article written by Jeanie Daniel Duck and published in Harvard Business Review (November–December 1993). The article provides valuable insights into critical aspects of the change process. The following discussion draws on this publication. All quotes in this section are from that article unless otherwise identified. “Change is intensely personal. For change to occur in any organization, each individual must think, feel, or do something different. Small wonder that corporate change is such a difficult and frustrating item on virtually every company’s agenda. The problem for most executives is that managing change is unlike any other managerial task they have ever confronted. When it comes to managing change, the model he uses for operational issues doesn’t work.”

Creating Shareholder Wealth

It is important to understand change and why mature leadership is required to successfully manage change. Management is task oriented, and that is why operational models do not apply to the change process. Change is a collection of processes that have to be integrated. They focus on influencing people and achieving goals that will make an organization different than it is today. This frightens many people. This is why it is so important to learn the leadership techniques discussed in this book. If you have not mastered these techniques, people will continue to be frightened by change and be resistant to it. You can minimize fears and resistance by demonstrating leadership, communicating effectively and openly, managing conflicts before they arise and remaining focused on the goals. As the article points out, “With change, the task is to manage the dynamic, not the pieces. The goal is to teach thousands of people how to think strategically, recognize patterns, and anticipate problems and opportunities before they occur.” That is what Creating Shareholder Wealth is all about. By effectively implementing change, you are getting everyone in the organization to think strategically and take greater initiative toward achieving success and creating wealth. You want everyone to recognize what is happening in the organization, the opportunities that are developing, and find ways to take maximum advantage of them. This is how you add value to the organization and wealth to the shareholders. It is necessary to recognize that, “the key to the change effort is not attending to each piece in isolation; it’s connecting and balancing all the pieces. In managing change, the critical task is understanding how pieces balance off one another, how changing one element changes the rest, how sequencing and pace affect the whole structure. Managing change means managing the conversation between the people leading the change effort and those who are expected to implement the new strategies, managing the organizational context in which change can occur, and managing the emotional connections that are essential for any transformation.” This is human nature. It is important to communicate effectively on a one-to-one basis as well as to the workforce as a whole. Effective and ongoing group communication is an important element in the total process. Making the announcement that change is on the way sends a message to the workforce. Depending on the organization’s history of dealing with change, there may be little reaction. The workforce may doubt any real change is going to occur because it has not in the past. However, the workforce may have a strong reaction because past efforts at change have caused considerable disruption and have been poorly managed or communicated. It is possible to have a positive reaction if past change efforts are viewed as having been successful. Once the announcement that change is on the way is made, ongoing communication is essential. As the article further observes, “….people abhor information vacuums; when there is no on going conversation as part of the change process, gossip fills the vacuum.” You need to control the information flow. Never allow the rumor mill to replace you.

96

How to Help Employees Embrace Change

“Everything managers say—or don’t say—delivers a message. In fact, communications must be a priority for every manager at every level of the organization. This is particularly true during a change effort, when rumors run rampant. It is important for the messages to be consistent, clear, and endlessly repeated. If there is a single rule of communications for leaders, it is this: when you are so sick of talking about something that you can hardly stand it, your message is finally starting to get through. From the point of view of the leaders, who have been working on the change program for months, the message is already stale. But what counts is the point of view of everyone else in the organization. Have they heard the message? Do they believe it? Do they know what it means? Have they interpreted it for themselves, and have they internalized it? Until managers have listened, watched, and talked enough to know that the answer to all these questions is yes, they haven’t communicated at all.” Change is a top-down process in any organization. In order for the workforce to accept that change is needed and the change will benefit them, they must see that it is taking place in the executive group. So, the first behavior change must be on the part of top management. From the moment you announce that you are making change and are going to implement Creating Shareholder Wealth, you must be visibly acting and talking like an owner of the organization. “Top management should start by requiring a change of behavior, and when that yields improved performance, the excitement and belief will follow. Setting the context for change means preparing the players, understanding what they do and don’t know, working with them, watching their performance, giving them feedback, and creating an on going dialogue with them. When it comes to change, people don’t believe in a new direction because they suspend their disbelief. They believe because they’re actually seeing behavior, action, and results that lead them to conclude that the program works.” More is involved in the change process than executives acting like owners, requiring change, or demonstrating some initial successes. You must also earn the trust of the workforce. Trust always seems hardest to earn when you need it the most. “Trust in a time of change is based on two things: predictability and capability. In any organization, people want to know what to expect; they want predictability. Predictability consists of intention and ground rules: what are our general goals and how will we make decisions? The more leaders clarify the company’s intentions and ground rules, the more people will be able to predict and influence what happens to them—even in the middle of a constantly shifting situation.”

97

Creating Shareholder Wealth

Establishing predictability is essential to effective leadership. This predictability enables the workforce to feel safer and more comfortable. It also increases employee willingness to follow your leadership into the change process, therefore enabling the Strategy Implementation. “The second part of the equation is capability. To trust an organization, both managers and their reports must define the capability that each is providing; and each side has to believe that the other is capable of playing the new role. When each side understands the needs, capabilities, and objectives of the other, trust can be built.” Establishing predictability and capability is why it is so important to select the best people to fill key positions in implementing Creating Shareholder Wealth. This is also why it is essential that you master the leadership and communication techniques described. With that accomplished, you will be seen as capable. Change happens one person at a time. Four types of people exist in every organization as it relates to the change process. • Those who embrace change and willingly take on new challenges • Those who are happy to support change • Those who are uncomfortable with change • Those who are resistant to change Look for your leaders in the first two types. Make a project of finding these individuals and put them into leadership positions. Let these change leaders support the change process for the third type. The fourth type will eventually follow along and adapt or they will choose to find work elsewhere. Communication and Conflict As your organization goes through the change process, continuous communication is needed in many forms. Much of that communication will be with groups in the form of meetings, internal newspaper publications, or information bulletins. The most critical communication will be in the form of one-to-one interactions. For our purposes, this should be interpreted as small groups, typically two to five people, usually interacting on an informal basis. The subject matter of the communication may be critical to rather casual. It is essential that managers and leaders develop effective interpersonal communication skills to be effective change leaders. In the final analysis, this skill more than any other will determine how successful you are in meeting your improvement goals. Conflict will arise during the implementation process. This is inevitable. Understanding communication and conflict is essential. Mr. John J. Gabarro writes in the article “Understanding Communications In One-ToOne Relationships,” President and Fellows of Harvard College, Harvard Business School Case 476-075, Copyright 1976, “The value of interpersonal effectiveness and communication seems fairly apparent. Not so obvious, however, is what a person can do to develop and maintain effective interpersonal relationships.”

98

How to Help Employees Embrace Change

Not all-interpersonal conflict is a result of communication problems. Conflict can arise as a result of other factors, such as: • Political in-fighting within the organization • Power struggles • Basic personality conflicts • Conflicting goals • Self interest ahead of the organizations interest These factors are in the nature of organizations, especially larger ones. Top-level executives are responsible for practicing mature leadership and minimizing the impact of political in fighting and power struggles that may occur. All of us have to deal with personality conflicts. Where we are unable to resolve them, we need to learn to put them aside in the best interest of the organization and stay focused on the business goals. Conflicting goals are a normal part of any business environment. Not only do we have our own needs and goals that we honestly believe to be in the best interest of the organization, so does every other individual in the organization. Leaders reconcile legitimate differences. Where interpersonal relationships do rely primarily on communication, Mr. Gabarro further writes, “It is important not to confuse “good” with “effective” communication, for the latter includes aspects of behavior such as persuasion, motivation, power, coercion and the like….In practice it is not easy to separate the communication process from other processes in effective communication.” Effective communication brings about desired results voluntarily. Misunderstandings frequently take place through interpersonal relationships. Each party has a responsibility to make a continual effort to minimize the potential for misunderstanding. As Mr. Gabarro further writes “One relatively simple but effective way of doing this is by thinking about what each person experienced in terms of important assumptions he brought to the interaction, what he perceived as taking place, and what his feelings were during this series of episodes. By assumptions, we mean the values, attitudes, and beliefs that a given person has about how things should be in a given situation. By perceptions, we mean what the person actually sees, hears. Or otherwise perceives as taking place in a given situation, as compared to what he or she might think should be occurring. By feelings, we mean the emotive and affective responses of a person in reaction to what happens in a given situation.” This is human nature. It takes practice and concentration to become aware of what the other person is assuming, feeling, and perceiving during communication. Everyone has a natural tendency to judge what he or she perceives to be taking place during the communication process. This sends signals to the other person who is also making judgments based on their own

99

Creating Shareholder Wealth

perceptions. Each person needs to be aware of this continual non-verbal interaction and make every effort to maintain an effective communication process and interaction. Doing so is essential to effective, rather than good, communication. Strategy Implementation cannot take place without it. Mr. Gabarro summarizes the process of managing interpersonal relationships as follows: “To anticipate and deal with communication problems, three things are necessary. First, a person must develop a sense of awareness of what the other person is experiencing, as well as an awareness that difficulties in communication arise more often than we assume. (This is a matter of attitude.) Secondly, a person needs a conceptual understanding of how and why people are apt to see the same thing differently. (This requires finding a useful framework.) The simple concepts of assumptions, perceptions, and feelings, and how they might differ for two people, can be very useful in gaining this understanding. Thirdly, a person needs a way of examining and acting upon what is taking place in the communication process. This requires an understanding of some of the process assumptions that obstruct good communication and understanding. (This is a matter of both attitude and behavior.)” Renato Tagiuri writes in “A Note on Communication,” Harvard Business School, 1972, that the following nine strategies and attitudes are useful guides in anticipating and preventing communication problems: • Suspend judgments of right and wrong—at least temporarily, until you have understood the other person’s point of view (attitude and behavior). • Assume the legitimacy of another person’s view (attitude). • Try to see the situation from the other’s point of view (behavior). • Define terms (behavior). • Deal with “facts” rather than with interpretations or inferences (behavior). • Take the other person’s and your own emotions and feelings into account as being important and, if appropriate, recognize them (behavior). • Reopen communication—the balance between telling and listening (behavior). • Restate issues as the other party sees them. This serves as feedback to the other person and a check on your own understanding (behavior). • Attend to and stimulate feedback in terms of the consequences of the communication (behavior). These are important and critical techniques to master. Doing so will enhance every aspect of anyone’s personal and professional life. Note that behavior is the primary element in the process. Understanding communication in one-to-one interpersonal relationships is one essential aspect of leadership. Another is managing interpersonal conflict. As James P. Ware and Louis B. Barnes write in their article entitled “Managing Interpersonal Conflict,” President and Fellows of Harvard College, Harvard Business School Case 479-004,

100

How to Help Employees Embrace Change

Copyright 1979, “…the ability to productively manage such conflict is clearly critical to managerial success. The problem for a concerned manager is to build upon human differences of opinion while not letting them jeopardize overall performance, satisfaction, and growth.” For our purposes, the term manager as used in the referenced article applies to any person in the organization who is in a management and/or leadership role. The article goes on to observe, “A manager often becomes concerned with conflict when it leads to negative outcomes in individual or organizational productivity, satisfaction, or growth. In analyzing conflict management, he or she might start with these consequences or outcomes, partly with the idea of looking at both the positive and negative sides of the coin. A second area of examination is the behavior patterns manifested by the involved parties. A third entails the different feelings and perceptions. And a fourth looks for the underlying and background conditions that help to initiate and perpetuate the conflict. It is important for a manager, either as a participant or third party, to appreciate that any of these four areas may be an appropriate action point for dealing with conflict. With regard to these four areas, a manager might pose the following questions: 1. What are the important personal and organizational outcomes or consequences of the conflict as they currently exist? What of future outcomes? 2. What are the behavior patterns that seem to characterize the conflict? How do these patterns highlight the substantive issues, perceptions, and underlying causes of the conflict? 3. What are the substantive issues involved? To what extent are they colored by onesided perceptions? To what extent are the perceptions further colored by feelings and involvement? Where in the organization is there potential for relative objectivity on the part of a third party? 4. What are the apparent underlying and background conditions leading to the conflict feelings, perceptions, behavior, and outcomes?” The purpose of this discussion on communication and managing conflict is to give you important tools to use in your change management process and in developing the answer to the question, “How is the Strategy Implemented?” Hopefully you see these techniques as basic common sense and feel you already apply them. If so, that is great! Keep it up. Also, make a concentrated effort to include these techniques in your ongoing workforce-training program. It is certainly a portion of the training program that is a part of Creating Shareholder Wealth.

101

Creating Shareholder Wealth

Human Nature The answer to the question, “Why does this process work?” is easier than it may seem. It works because it takes full advantage of human nature in the most positive and constructive ways possible. As human beings, we need several things in our work environments—PULSE: • Predictability • Understandable • Long-term with Challenging and Achievable Goals • Sustainable with Performance Feedback • Energy with Meaningful Rewards Predictability The entire workforce will become trained in this process. They will know what to expect, why it is necessary, and how to achieve success. They will also know what the potential rewards and risks are. The message is constant and comes from a focused Strategy Intent. Understandable The process is straightforward. There is a primary, highly focused, performance measure with directly related value drivers as supporting measures. Most people will easily understand how Shareholder Value Created is calculated. There is a single incentive compensation plan that is easily understood. How improvements will benefit the business, its owners, and its employees is easy to explain and demonstrate. Long-term with Challenging and Achievable Goals The work effort required to succeed will be challenging. The atmosphere in which these challenges are faced is a positive one filled with opportunity for self-fulfillment and reward. The Strategy Goals defined, which represent success, must be within reach and achievable. Basing future goals on past performance and business need does this. This provides higher levels of self-motivation for the majority of people. Sustainable with Performance Feedback This means recognizing the realities of your environment and how human nature works with this, and any, process. The Strategy Plan helps make it sustainable. Human nature also requires information in the form of performance feedback. In every relationship, all of us have a need to know how well we are doing. This process calls for regular performance feedback to the entire organization. This is done through various communication methods—formal and informal. In many ways, the informal communications and feedback process can be more important and effective than formal communications in providing sustainability.

102

How to Help Employees Embrace Change

Energy with Meaningful Rewards Here again, we take full advantage of basic human nature in a positive way. The Strategy Implementation can maintain the level of energy needed to be successful and provide rewards. These rewards help maintain the requisite level of energy. People receive rewards through the feedback process. Knowing that you are making contributions to the business success and exactly what that contribution is and how it benefits the organization is a strong reward and motivator. Seeing the results of my efforts in increased sales, profitability, enhanced quality of work life, and in my paycheck through a fair wage and incentive compensation are powerful rewards that will help motivate myself and remain energetic. Properly applied, Creating Shareholder Wealth provides all of these elements to the process. It links lean business techniques to human needs in an effective, closed loop, manner. Motivating Behavior I take the position that people choose to motivate themselves as a core element of human nature. Human nature is one of the most important assets in a manager’s tool kit. Leaders create the atmosphere in which others choose to motivate themselves to achieve high levels of performance. People make choices based on perceptions of their environment. This is why it is essential to understand both cultures in the organization and align them as much possible. In doing so, the environments that people experience are in harmony. Employees are much more able and willing to recognize that no environment is perfect. Complaints and grievances are reduced and productivity and quality increase. You create this motivating atmosphere by your practices and methods of communication more than by policies or procedures. Accordingly, motivators are those things that you do that make people feel good about their environment, themselves, and what they do. The best single motivator is expressing appreciation, both publicly and privately. The Seven Perception Factors: • • • • • • •

The perception of management and leadership quality The perception of honesty of communication quality The perception of policy application consistency The perception of how good the fit is between the individual and his/her assignment The perception of how much ownership the person has over his/her assignment The perception of how employees are treated and made to feel about themselves as individuals The perception of the value of contributions made to the business success

103

Creating Shareholder Wealth

Remember that perception often becomes reality! Utilizing Creating Shareholder Wealth is a positive step in creating this atmosphere. IN BRIEF Downsizing: A number of years ago, the company where I was director of manufacturing experienced a serious setback. Our executive group met with the executives of our largest customer to discuss expanding the volume of business we did together, or so we thought. They actually wanted to meet with us to advise that they were beginning in-house production of all the products we sold them and they were canceling all open orders effective immediately. This customer represented one-third of our sales. By the end of the lunch meeting we had convinced them that we needed three months to transition. As a result of this customer’s action, we were now in a position of having to lay off one-third of our total workforce—about 200 people. What did we do? We remembered our responsibility to our valued employees. We wanted them to have the correct perception that we recognized their contributions, that we were sincere in our efforts to minimize the impact to the company, and that we would make every effort to manage that impact with the least amount of damage. First, the company had no union. We had established policies for layoff procedures that followed seniority. We could have simply made an announcement and gone forward with layoffs. What we actually did was have lengthy and open employee meetings where we discussed what had happened, our efforts to minimize the impact, and how we would be proceeding relative to existing policies. We also answered every question asked. We asked for input and suggestions from everyone. Second, we identified what cutbacks had to be made and communicated that. Third, we established processes and outside relationships to help people find jobs. Fourth, we followed policies and implemented suggestions. Fifth, we kept the lines of communication completely open. What Was the Result? We were successful in creating the right atmosphere. Nearly all the employees found other jobs. Many did so on their own and others did so with our assistance. A small percentage went on unemployment compensation for a period of time. Others renewed their family relationships and were happier. Only one employee filed a grievance. The remaining workforce saw a lot of communication and a lot of effort on behalf of those leaving as well as those staying. The morale in the company had already been high, but increased even further. Was It Easy? Of course not. It also was not gut wrenching. It is never easy to tell someone they are losing their livelihood. There was upset and more than a few tears on the part of a number of people. But, you have to stay the course. Remember—PULSE.

104

How to Help Employees Embrace Change

How Do I Know It Worked? All meetings with affected employees and their supervisors were one-on-one, and all the employees I met with worked in my areas of responsibility—I also met with every employee before his/her layoff date. One employee, who was a single woman, was particularly upset about being laid off and losing her income. While I was meeting with her to discuss her situation, she expressed her fears and cried. She worked hard to be strong and accepted what was happening. She understood that policies were being followed and the situation was fair. I repeatedly assured her that she would end up better off once the dust settled. Those were not just words; I knew it would prove to be true because she was intelligent, capable, and had the right drive and personality to succeed. Several months later I went to my bank to make a deposit. She was the teller at the window and she looked happier than I had ever seen her. She had a big smile and said that my assurances to her that she would be better off helped keep her going and ended up being true. She enjoyed her job at the bank and felt she had growth opportunities that never existed for her before. She liked dressing up to go to work rather than wearing factory clothes. It was obvious that she was happy and had a high level of self-esteem. Hers was a common story Leadership and Change Management Leadership: Human nature is the best asset and ally a leader has in his or her arsenal. The ability to utilize human nature in a consistent, positive, and constructive manner is what separates leaders from managers. Developing an understanding of human nature and using that to benefit the organization and its individual employees is an art. This ability will make the role of managing easier. Change is perhaps the most difficult and challenging thing we face as human beings. Being flexible and adaptable in this era of constant change is essential to success. In business, successfully managing change requires true mature leadership. The three “categories” of people managing any enterprise are: 1. 2. 3.

Mature Leaders Leaders Managers

We all should aspire to the highest level. However, the reality is that few will reach the top level and remain there consistently. Because organizations only have limited space for this type of leader, less than a handful will exist in any one firm. Most organizations should have a majority of middle and upper level management positions filled by leaders who are also good managers. Among this group are a select few who posses the traits to become mature leaders.

105

Creating Shareholder Wealth

Managers First and second level positions should be filled with individuals who are good managers, have traits of leaders, and can move up in the organization as they demonstrate their skills as leaders. Managers perform a task-oriented function. It typically involves assigning jobs, scheduling and/or maintaining workflow, performing routine tasks within the workgroup, and related tasks. Managers think creatively and are willing to take initiative. They must also communicate with credibility. The leadership level required is that necessary to get subordinates to perform required tasks at an appropriate level of quality and within necessary time frames to control costs. You need to find managers who demonstrate natural leadership skills. Possible managerial candidates can sometimes be located from within the informal leaders. However, keep in mind that the people who have strong influence in the informal organization do not always make a successful transition to formal managerial roles. They are excellent candidates if they are recognized and properly nurtured. Leaders Leaders are a select few who positively influence those people they come in contact with and, as a result, those people perform at a higher level. These individuals have vision, energy, and the ability to inspire people to perform at higher levels. They consistently demonstrate that they: •

• • • •

• • • • •

Have an innate understanding of human nature and how to use it positively. They have outstanding intuition. They have an excellent ability to interpret what is happening around them and the “data” they receive. As a result, they know the right time to act and what actions to take. Set and maintain high standards. They engage in “tough empathy.” They are passionate and realistic in the setting of standards and in demonstrating empathy toward others. Apply rules consistently, but are able to make exceptions when conditions warrant in a manner that the workgroup accepts as reasonable and appropriate for the circumstances. Spend a great deal of their time training and nurturing others. They are vulnerable—not weak. They selectively show their own weaknesses. By doing so they reveal their approachability and humanity. They recognize that everyone is human and know that the entire workforce knows they are imperfect and does not want them to be perfect. Appreciate individual differences between people. They reveal their own differences and capitalize on their uniqueness. Understand the other person from his/her point of view and appeal to their selfinterest. Give credit where credit is due. They care intensely about the work employees do. Command a high level of respect throughout the organization. Most importantly, leaders know themselves.

106

How to Help Employees Embrace Change

Mature Leaders Mature leaders have all the attributes described before, but they are even better. They reach that pinnacle as much because other people want them to as anything they specifically do themselves. These individuals do not need to take credit for transforming the organization. If people know their accomplishments, that is fine, if they don’t, that is also okay. The important thing to these select few is that the company and, more importantly, the people in the company benefited and grew as a result of what they did. They often have large egos that are satisfied with seeing results and having influence and power. The atmosphere around these people is that the workforce is not only willing to follow them almost anywhere they want to go; they want to follow these individuals to “hell and back.” These individuals are followed as much on faith as anything. People “just know” that they will be led in the right direction. IN BRIEF Leadership and Change Together As director of manufacturing at a firm located in Milwaukee, Wisconsin, I had a number of leadership and change management opportunities. These opportunities began about a month after my arrival when management became aware that a union organizing campaign had been in process for several months. The Board of Directors assigned me the leadership role to maintain a non-union status. Obviously, one person cannot accomplish this alone. Virtually nothing in leadership can be accomplished alone. It takes a great team to change an entire business culture in a few months. Together, we moved from an environment where approximately 90 percent of the hourly workforce had signed union authorization cards (according to reports from hourly personnel after the election) to a situation where the non-union status was maintained by fifteen votes out of several hundred eligible employees. Two years later, some employees decided to try again to unionize and lost again—that time by a large margin. During this same time, I made changes that reduced absenteeism and turnover to less than 2 percent. Productivity on the assembly lines went from a normal range of 500 to 900 units per line per shift, depending on the product being run, to a range of 3600 to 4200 units per line per shift. We reduced the number of personnel assigned to the line as part of balancing work and redesigning workstations. This represents considerable throughput improvement and unit cost reduction. Product quality improved as well. These improvements enabled the firm to double its size. This represents an increase in throughput and sales of over 800 percent. Accomplishing this, and maintaining the results for another seven years before transferring, required applying all the techniques discussed in this book: not just by myself, but by the entire organization. Success requires teamwork in the truest sense, continual communication, and an innate awareness of human nature. The Milwaukee operation was a business unit within a division of the total corporate structure. We applied this material to our facility and supported the Strategy Intent and Goals of the corporation independent of other facilities.

107

Creating Shareholder Wealth

Leaders Send Messages Everything you do sends a message to the entire workforce. Whether you discipline a single person for some infraction or promote someone to a new position, you are sending a message. To varying degrees, the workforce, as well as the affected individual(s), forms a perception relating to each of the seven perception factors identified earlier. What you want is for your actions to reinforce existing perceptions. Of course, this assumes that those existing perceptions are positive and strong. If not, you have an opportunity to change perceptions. One thing to remember is that it is hard to build the right perceptions and to maintain that level. It is easy to create a negative perception. If that happens, you lose credibility and it becomes hard to recover. The informal organization may never let you recover. Keep the seven perception factors identified earlier in mind…always work to develop a positive perception…remember human nature. Managers develop perceptions just as anyone else in the workforce. Sometimes you will find that you have a manger on your staff that should not be there. There just isn’t a good fit between the individual and his or her assignment. What do you do? The easy answer is that you make a change. And that is the right answer. The real question is, “How do I make the best change?” The answer lies in employee and executive development. Creating Shareholder Wealth, and maintaining it requires every organization to have an active development program. What is the premise of the process? First, that change is a constant in any environment. Second, that virtually all of us will have changes in our assignments over our careers, including our careers within organizations. Third, that no management position is guaranteed…it must be earned every day. Fourth, both parties on a regular basis evaluate that fit—formally and informally. IN BRIEF Making a Change Sometimes fit is viewed in different ways by different people. This is a function of individual self-interest. All of us have to deal with the conflict between self-interest and the good of the organization. Not all promotions are successful, and not everyone we hire as managers works out. Once I hired an individual to be the manager of our maintenance organization. The employees were responsible for all equipment maintenance and installation as well as facility maintenance. They were a proud group of talented people. The incumbent had all the right education and credentials. He placed a great deal of importance on teamwork and fulfilling one’s role to the best of his or her ability for the benefit of the organization and everyone in it. At one time he was a professional football player in the NFL with one of the league’s most successful franchises. I was proud to hire him and was confident he would make significant contributions to the organization and the people in his area. The people he supervised warmed up to him quickly and developed a strong loyalty to him. He was a strong advocate for his people.

108

How to Help Employees Embrace Change

What Went Wrong? His idea of teamwork turned out to be different than what the organization needed and was inconsistent with the culture. The culture was that every group had a critical role in the success of the business and worked in concert as peers to satisfy customer needs. No one group was dominant. His charges developed a loyalty based on his philosophy that the maintenance group was elite and deserved a dominant role. As this atmosphere permeated throughout the group, their performance declined. It was taking longer to get machines fixed and they were not always being fixed in the right priority. Preventive maintenance programs were being ignored. The group started to feel that they were not responsible to their internal or external customer. Camps began to develop between this group and other technical groups who chose to ally with them and those who were impacted by the change. There clearly was a lack of fit. This person did not belong in a leadership position in our company until he adjusted his management style and approach. What Did We Do? I worked with him and his group in an effort to maintain the needed atmosphere and keep cultural alignment. It eventually reached a point where I had to tell him that he needed to adjust and I would help him in any way possible or a change would be made. Our personnel director and company president were involved in this process. It became clear that he was unable to make the adjustments and that he believed he was managing effectively. He could not see the impact he was having on the organization. This was a good man in the wrong job. I had to release him. What Was the Result? We helped him find an equivalent position with a company where the culture was more compatible with his style and philosophy. He also told me that he learned a few things about the importance of adjusting, not comprising, his beliefs as a result of our various conversations. My later conversations with his new employer confirmed this. He did well. Internally, we also did well. His group understood why he had been released and acknowledged that they saw it coming from his second day on the job. They appreciated his advocacy and encouraged an even stronger sense of this throughout the organization— while volunteering that the company was already excellent in this area. The group renewed their efforts at customer satisfaction with considerable energy and positive results. Other technical groups were less accepting. Some people were angry. This was a more difficult and sensitive situation. Their vice-president, the human resources director, and myself had group and individual communications with those people to discuss everything that had transpired. We never attacked or condemned the person who was released. Our emphasis was on the many qualities he had. We openly discussed fit, culture, and customer requirements. We discussed the impact of what had developed and the efforts made to bring about adjustment and change.

109

Creating Shareholder Wealth

How Do I Know It Worked? Within several weeks, things were back to normal throughout the organization. The other technical groups reduced their cycle time to complete most tasks—without being asked. The tension that had developed between functions was gone. In Brief Summary Helping employees embrace change also means helping them understand why and how change provides benefit. This includes communication about role, fit, value, security, and performance. Acting Like Owners This notion has become popular in the past few years. Some major consulting firms implementing value-based management as well as many outstanding business schools push this idea. Too bad, because it is a misnomer. Abandon this idea in its present day context. Employees are not paid to think and act like owners. Nor is it in their mindset. Only those who have owned a business in whole or in part can think and act this way. A few others can come close. When employees understand the financial concepts being applied and how they are responsible for those concepts in their area of the organization, they will act more responsibly and with higher levels of initiative and can then contribute most effectively to the creation of wealth. This is the best role and fit. In addition, if incentive bonus compensation is based on this measure, they are more inclined to improve this measure of Shareholder Value Created in the short and long-term. This is the desired behavior modification that leads to “continuously positive” results. I encourage taking steps that will move employees toward this behavior. Do this by including shares of the organization as part of the incentive compensation plan wherever possible.

110

Chapter Eight Incentives “Avarice, or the desire of gain, is a universal passion which operates at all times, at all places, and upon all persons.” —David Hume “Greed Is Good” That is probably the most famous line from the movie Wall Street. Michael Douglas made the statement at a shareholder meeting while challenging the Board of Directors. In the terms of Creating Shareholder Wealth, the letter “g” is always lower case. You want your entire workforce to develop a partnership based on greed in a positive, constructive, and motivating sense. Since all of us want to improve our lot in life, we all have a basic sense of greed. That is human nature. Properly channeled and controlled, this is a good thing—with a small “g.” Incentives in general, and the incentive compensation plan in particular, address this. Incentives One tool in creating an environment in which people choose to motivate themselves is through incentives. Most of us think of incentives as monetary in nature and most are. I advocate monetary incentives and discuss an example later in this chapter. However, incentives should not be limited to money alone. They can come in many forms. Public and private expressions of appreciation are important motivators that also act as incentives. They must be perceived as sincere—this is essential to their effectiveness. The motivating aspect is the verbal expression of appreciation—especially the personal one-on-one expressions. An incentive I have used that works well is gift certificates for dinners or shopping. I often like to send them to the families of employees expressing appreciation for their support. I have used this incentive primarily when someone has done something outside the normal course of his or her assignment. During or at the end of a grueling assignment

Creating Shareholder Wealth

that required a lot of overtime is a good application. Another is where a long period of travel has been required and the trip was successful beyond expectations, or when someone delivered an unusually high level of customer service under difficult conditions. A fourth application is where an above-normal level of quality of work has been performed. Another incentive that can work well in most cultures is the ability to earn additional paid time off. Although this can be effective, it has implications in relation to work scheduling, staffing levels, and customer service. So it has to be approached carefully. However, it may be the right thing for your culture and business environment. Deciding what incentives are most appropriate and effective requires understanding the two cultures in your organization. Multiple incentives are most effective. The primary one is the monetary incentive plan. That is surrounded by the additional incentives you provide. These additional incentives are not maintained for the long-term. You may choose to have gift certificates for dinner during one time frame and for shopping during another time frame. If you are in a city with a strong support for your “home team,” tickets to sporting events can be motivating incentives. I put these examples in the category of incentives, rather than things that motivate people, because they are a part of what makes up the environment in which people choose to motivate themselves. Incentives can be successful in any organization. Be creative. IN BRIEF The Military As an NCO in the United States Air Force stationed at Naha AFB, Okinawa, I recommended restructuring work assignments and process flow for performing corrosion control maintenance work on C-130 aircraft brought to the base. The changes involved establishing two teams of the most qualified Air Force personnel, one to support each maintenance hanger, to prepare an aircraft for entry into the hanger and, once the corrosion control maintenance work was completed, to prepare the aircraft for flight status again. This restructuring allowed approximately twice as many aircraft to be processed through the facility with the same number of total personnel. The incentive to the Air Force personnel was earning the opportunity to be on one of the teams. This was a powerful incentive that acted as a strong motivator. It significantly contributed to the throughput results and savings to the American taxpayers. Incentive Compensation There are obvious things on which individuals place value. One of those things is certainly how much money they can earn. Enhancing base pay with a meaningful incentive compensation plan that is linked directly to a manageable, consistent, and understandable performance measure is an effective approach. A primary key to the success of Creating Shareholder Wealth lies in using positive SVC results in an incentive compensation plan that fires the imagination and initiative of all employees.

112

Incentives

Shareholder Value Created is the basis for incentives that drive behavior. I advocate financial incentives as one tool to help drive desired outcomes. Without these incentives, SVC can become just another measure and there will probably be no sustained behavior change. With these incentives, employees are further inclined to take initiative and accomplish goals. The objective of any compensation plan is to pay people to perform consistent with the needs of the organization and in a satisfactory manner. The details of how compensation is administered and provided have a direct impact on morale and motivation. Linking bonus compensation directly to SVC results is an excellent way to help change behavior. An effective incentive system is one that aligns the employee financial interest with shareholders, improves motivation and morale, and creates an atmosphere in which everyone consistently maximizes the effort to create wealth under whatever conditions exist at the time. It is an incentive system that makes every individual take responsibility for the portions of the business they directly influence or control. Accordingly, it is important that everyone receiving incentive compensation be under the same plan. One of the biggest mistakes executives make is developing multiple plans. The worst thing you can do is have a plan for a manager that continues to make payments when a different plan for other personnel stops making payments. This inconsistency will negatively impact morale and breed contempt. Do not do this to yourself. Remember human nature. Since Creating Shareholder Wealth adopts the new notion of a “continuously positive” process, the system includes a built-in incentive to think in the long-term interest of the firm and shareholders. This means crediting the full amount earned to a person’s “SVC account” while paying out a substantial portion to the individual and retaining a portion in the account against future performance. Enough needs to be maintained in the account from each SVC reporting period to motivate the person to think in the long-term by facing a downside risk if performance declines. Another reason for maintaining an SVC account balance is to enable continued payments to individuals when SVC results decline as a direct result of business decisions that are enacted or uncontrollable conditions. Shareholders need managers to focus on continuously positive SVC results over the long-term. When executives, shareholders, consulting firms, or analysts focus on the old notion of “continuous improvement,” the result will eventually be failure. This incentive plan structure helps ensure that shareholder needs are met. To accomplish this, the SVC incentive formula should contain a percentage based both on total organization performance and specific and controllable SVC drivers. The total corporate performance aspect motivates people to think globally and work together in the organization’s best interest. The SVC driver aspect ensures that people are motivated to make focused process improvements in their business units. In the case of Creating Shareholder Wealth, an incentive compensation plan is put in place on top of the existing base salary plan. This incentive plan replaces all other existing plans. How this transition takes place is determined on a case-by-case basis. In some cases, it may be appropriate to make a total and immediate change. In other cases, it may

113

Creating Shareholder Wealth

be appropriate to overlap plans and make a gradual transition while the workforce adjusts. The primary reason for a gradual transition is to protect against a temporary loss of incentive compensation employees receive during the implementation process where that loss is beyond their control or influence. Doing anything that penalizes people for doing what you ask them to do is inappropriate. If an income disruption were to occur, it could have a disruptive effect. Our incentive plan is designed to provide a near-term as well as long-term focus. The danger in most plans is that they provide only near term focus based on performance measures that can be misleading. This is at the expense of the long-term. Each individual in the plan receives an “SVC Account” for administering the plan. As Shareholder Value Created is calculated, and is positive rather than negative, an incentive pool results. The pool can also result where the SVC condition is negative but improves from one period to the next. This condition can exist under a number of circumstances. From this pool, each person’s SVC account is credited based on highly publicized formulas. Again, based on formulas established for the plan, a substantial portion of the account is paid out to the employee each period. A portion of the account is held “at risk” against future performance. If performance improves, payments improve and the account balance increases. If performance declines, payments decline and the account balance declines. Part of what you must determine is how much of this pool is in cash and how much is in stock. I suggest that, where possible, the portion paid out to the employee each period is in the form of cash and the portion retained in their account is in the form of stock. Although there are an infinite number of variations that could be developed for an incentive compensation plan based on SVC results, I recommend using something similar to the example described below. The details of application will vary by situation. Sample Incentive Plan As an incentive system example, you may determine that the following is workable: • • • • • •

35 percent of SVC results, or improvement, will be placed in the incentive pool. 1/2 based on corporate performance 1/2 based on performance against specific SVC drivers Managers may earn deposits into their SVC account of up to 75 percent of base pay. 2/3 of the accumulated SVC account is paid out as the incentive bonus. The balance is held in their individual SVC account (as cash or stock) and is at risk.

This is a simplified example and does not go into the details of blending top-level performance along with value driver results. Paying 50 percent of manager “Jane S.” compensation based on SVC results and 50 percent on how well she did in meeting her specific value drivers would do that.

114

Incentives

In the following example, that would mean paying $30,000 into her account based on top-level results and the other $30,000 based on how well she achieved her value drivers. If she met them all, she would receive $30,000 in full. If she met 70 percent of them, she would receive $21,000. Example One: Assume this is the first year of the plan: • • • • • •

The company realizes positive SVC results of $10,000,000 (this could be a truly positive number or an improvement in a negative number from one period to the next). 35 percent, or $3,500,000, is placed in the SVC incentive pool. Manager “Jane S.” has base pay of $80,000 a year. $60,000, or 75 percent of her base pay, is deposited into her SVC account. She receives $40,000, 2/3 of the deposit, as incentive pay. $20,000, 1/3 of the deposit, is retained in her SVC account and is at risk. Now let’s move to year two of the plan:

• • • • • • •

The company achieves SVC results of $12,000,000. 35 percent, or $4,200,000, is placed in the incentive pool. Manager “Jane S.” now has base pay of $82,000 a year. $61,500, or 75 percent of her base pay, is deposited into her SVC account. Her SVC account now has $81,500 in it ($20,000 from last year plus this deposit). She receives $54,333, 2/3 of her account balance, as incentive pay. $27,167 remains in her SVC account and is at risk.

Example Two—Second Year of the Plan: • • • • • • • •

The company realizes significantly reduced SVC results of $6,000,000 due to considerable changes in business conditions and investments made in growth opportunities. 35 percent, or $2,100,000, is available for the incentive pool. Manager “Jane S.” now has $82,000 in base pay a year. This SVC result calculates to a bonus of $36,900 (The result is 60 percent of the first year so the calculation process adjusts accordingly to ensure everyone is treated the same). This amount, $36,900, is placed into her SVC account. Her account now totals $56,900 ($20,000 from last year plus this deposit). She receives $37,933, 2/3 of her account balance, as incentive pay. $18,967 remains in her SVC account and is at risk.

115

Creating Shareholder Wealth

As a result of the reduced performance of the business, and “Jane S.’s” area of responsibility is a part of the business, her bonus is less and her account balance is reduced. Everyone shares in the opportunities and the risks. Continuously positive results are being achieved and the investments in growth opportunities should yield higher future returns. You have little interest in keeping people who want automatic bonuses or bonuses that always increase. If they choose to leave, let them. You want people who are willing to take risk, responsibility, and initiative. Including shares in the incentive compensation plan helps accomplish this. One way to ensure that employees have reasonable amounts of SVC bonuses they have earned into their accounts at risk is to put a ceiling on the amount held in the account. One possibility is a ceiling that is equal to their present annual salary. If the account balance exceeds that amount, make a special bonus payment in cash or by vesting the excess shares. This ensures employees receive what they have earned while also keeping substantial sums at risk for underperformance. Since one primary goal of an effective incentive plan is retention of good people, it is essential to keep a substantial amount in the SVC account. If the person chooses to leave the firm or is terminated, they lose their SVC account balance. However, by establishing a ceiling on how large the account can become, they are not losing everything they earned over time that was held in the account at risk for underperformance. This is an effective motivator. This is only an example. You must determine the best formula for your business and industry. Compensation plans, including incentive payments, must accomplish four critical objectives: 1. 2. 3. 4.

Align management and shareholder interests Motivate people to perform successfully Retain the best performers in your organization Keep shareholder costs at reasonable levels

By creating the best working atmosphere possible, paying competitive base wages, and providing a meaningful incentive compensation plan, these objectives can be met in any public or private organization of any size. How are SVC targets set? They are not! One of the biggest problems with the value-based systems installed over the years by some consulting firms is setting ever-increasing targets. Some advocate that targets not only increase every period, but also are automatically set based on an inflexible formula. This is in conflict with the realities of the world and is unsustainable over the long-term. This is one reason why these systems fail over time. Our plan excludes automatically setting SVC improvement targets. The approach is simply basing incentive compensation on the achieved results. Individuals know they will be better off by creating more wealth for shareholders and they will share in the wealth they create.

116

Incentives

Extraordinary incentive payments will come with extraordinary results and correspondingly high returns to the shareholders. The only “target” is the near-term forecast. Another thing to keep in mind is that employees are often also shareholders. You can make them shareholders. As such, they will benefit in two ways: through the bonus payments they receive and through the improvement in share value and/or dividend payments that result from their performance. To continuously earn exceptional bonuses, people must achieve continuously positive SVC performance. The amount of bonus will fluctuate over time. If performance drops, previously earned incentives in SVC accounts are at risk of reduction. This concept helps ensure that employees will think in the long-term. No rational person will intentionally take incentive compensation away from him/herself by making decisions that will reduce his/her SVC account balance without knowing how he/she is protected and will benefit in the longer term. Although it certainly can be argued that SVC alone can be used as an effective performance measurement tool, Creating Shareholder Wealth is intended to include an incentive plan that shares financial results with those who enable those financial results to occur—today and tomorrow.

117

This page intentionally left blank.

Chapter Nine Measurements “If you don’t know where you are going, you’ll end up somewhere else.” —Yogi Berra Shareholder Value The primary goal of every organization must be to increase shareholder value. This does not mean simply increasing share price in a publicly traded company. Although that is one measure of shareholder wealth at a given point in time, it is not the only consideration. It can also be a false indicator of the true organization value. It is essential to understand what is happening within the organization in order to create shareholder wealth. This wealth growth, or change, needs to be measured in a meaningful way. Traditional accounting measures are widely used, such as Return on Assets (ROA), Return on Net Assets (RONA), and Return on Equity (ROE). Each has strengths and weaknesses associated with it, as previously discussed. The primary weakness of these metrics is that they only measure one aspect of the organization. None of them tells you what is happening as a result of what is occurring throughout the entire operation. The best measure is one that directly determines how much value was created, or destroyed, by the organization on behalf of the shareholders in any given time period. I call this measure Shareholder Value Created, which directly measures economic profit. Measures are used to identify where you are going. Economic Profit The concept of economic profit was developed over 200 years ago. Today, hundreds of large and powerful companies, as well as mid-size and small companies, operate with this philosophy and shareholder focus. This is a concept that every business manager is free to apply and should apply. Although some excellent consulting firms have registered trademark ownership of certain names or terms associated with the concept, and eco-

Creating Shareholder Wealth

nomic profit is taught in some of the best universities around the world, no one owns the philosophy or concepts themselves. It is critical to understand that economic profit is not directly controlled by anyone in the organization. It is the result of actions and decisions taken by those who control the economic profit value drivers. Shareholder Value Created is value created by the firm the way shareholders should want it measured. It is the profit earned by the executives of the organization on behalf of the shareholders. If shareholders expect a return of 16 percent on their investment, they don’t begin to “make money” until the economic profit rises above that level. For investors to be willing to place their money in the hands of management, they must be confident of earning an adequate return. The return must be large enough to compensate for the perceived risk. The greater the return is above the level of risk, the greater the economic profit or Shareholder Value Created. This is determined after applying a charge against NOPAT (Net Operating Profit After Taxes) for the full WACC (Weighted Average Cost of Capital) of utilizing the total capital required to deliver products and/or services to the market. Properly applied, Shareholder Value Created (SVC) tells you the true economic profit of the operation and the true increase, or decrease, in shareholder wealth. Since SVC measures the performance of the organization as a whole, there needs to be more emphasis on the relationship between what is happening throughout the organization and the economic impact on the organization. You can also apply SVC to individual projects or business units. Shareholder Value Created is a tool to prioritize implementation opportunities, provide incentive to change behavior so that all employees take initiative and focus on the long-term, and the ability to objectively measure results. It is important to understand the difference between accounting profit and economic profit. Let’s look at a real company that assembled computers. Following is a summary example: 1998 PERIOD Accounting Net Operating Profit Shareholder Value Created (Destroyed) Economic Difference

Q1

Q2

Q3

$204,766

$133,247

$123,569

($612,012)

($743,787)

($840,688)

$816,778

$877,034

$964,237

This company was reporting accounting profits while destroying substantial value from the shareholder perspective. This company met its demise in mid-1999. Unfortunately, this is a common story. The difference is that the accounting profit excludes the capital costs associated with running the business, other than that it does deduct interest expenses. Shareholder Value Created takes into account total capital costs associated with running the business.

120

Measurements

Depending on what adjustments are made, the SVC result may be more or less technically accurate. Even in the case where no adjustments are made, the result is more meaningful than simple accounting profit calculations. The concepts of adjustments, and other specifics of the calculation process, are discussed in further detail in a later section. Measurement Performance measures must be few and consistent. They must also be in direct line with creating economic profit as measured by the formula given earlier. I recommend the following:

PRIMARY PERFORMANCE MEASURE

Corporate Level Executives and possibly Division Level Executives.

Shareholder Value Created

VALUE DRIVERS

•

Possibly Corporate Level Executives as well, depending on the business structure.

Division Level Free Cash Flow to the Firm • Net Profit Before Taxes • Sales per Employee Operations Organization • On Time Delivery • Customer Returns • Inventory Turns • Sales per Employee

Functional Levels

Support Organization • On Time Delivery • Accounts Receivable < 30 days • Accounts Payable On Time • Sales per Employee

121

Creating Shareholder Wealth

An article in the Los Angeles Times Business Section Executive Roundtable on February 21, 2001 discussed key performance measures. The article was entitled “Every Business Should Track Key Performance Measures.” TEC Worldwide, an international organization of more than 7000 business owners, company presidents and CEOs, provides excellent information on a weekly basis and submitted this article. The format of the article was question and answer. The question was asked, “What are the most important financial indicators to track and how often should I track them?” In summary, the response was that fundamental performance measures fall into three basic categories. The article goes on to identify those three categories and the measures within each: Profit and Loss Indicators • • • • •

Net Income Gross Margin Net Operating Profit Net Profit Cash Flow

Balance Sheet Indicators • • • • •

Current Ratio Quick Ratio Working Capital Ratio Debt-to-Equity Ratio Days Receivable

Non-financial Indicators • • •

Market Share Product or Customer Mix Number of Customer Complaints and Dollars per Unit Produced, Sold, or Shipped

The article also recommends that results in all three measures should be tracked using a trailing twelve-month rolling chart. In this case I disagree with TEC. Note that the article recommends tracking thirteen different “key performance measures” in three primary categories. Also note that few of these measures are directly controlled or influenced by individuals in the organization. They are the result of indirect actions. This is a serious problem. I recommend one “primary performance measure” and several supporting value drivers for the business.

122

Measurements

A significant difference exists between the two approaches. TEC Worldwide is recommending tracking a large number of measures with no central focus. I recommend one primary measure that offers focus for the entire organization along with several additional measures that are compatible with and support the primary measure. I am not a member of TEC as of the time this book was written. To the extent that I have information on the organization, it appears to be an excellent group with qualified members. It is not my goal to say anything that should be construed as negative about TEC Worldwide. Quite the contrary, I suggest that all business leaders actively participate in this type of organization. My hope in referencing the above article is to point out that there is a broad focus in business on the wrong measures. A tendency exists to think that by improving several traditional accounting measures, the state of the business will automatically improve. This is generally untrue, although it can be true in individual cases. Business leaders must learn to focus on where they want to take the organization, how to get there, and how to properly measure performance along the way—The Five Critical Questions.

123

This page intentionally left blank.

Chapter Ten How Does It Work? "Ambition, confidence, enthusiasm and success are produced by courage, faith, pride and hard work.” —Harry F. Banks Implementation Overview It is important to understand that Creating Shareholder Wealth is a concept as much as it is a process. The concept is adding value through continuously positive results and measuring that performance in the most meaningful way (Shareholder Value Created). The process is making improvements (Lean Business) to increase shareholder value. As this is done, the goal is to ensure they are solidly linked.

Shareholder Value Created

Getting Lean With SVC

Lean Business

Creating Shareholder Wealth

State of Your Business Before beginning an implementation program, it is important to understand the current state of the organization. This will help develop the Strategy Intent as well as the Strategy Implementation. In this evaluation, determine the phase of growth, the type of organizational structure, the culture you see, and the culture you don’t see. This third item, the culture, is especially important. Cultural misalignment is the biggest enemy of effective change. Depending on your organization, other factors may also be relevant. This is essential in order to develop the most effective implementation plan. Understanding the growth phase helps identify how aggressively you can implement this initiative and how much gain you are likely to realize. If your firm is in the early growth phases, you may lack the capital to be aggressive. If your firm is mature, you are more likely to have the capital, but there may be limited opportunities. If an organization has a functional structure the implementation plan might be established differently than if the organization has a matrix structure. It is possible that some modifications in the organizational structure will enhance the ability to effectively implement change. Every organization has two cultures. The one you see from the executive office and the one you do not see. Understanding the culture that exists in the organization is essential. If the culture you don’t see from the executive office is aligned with the one you do see, the organization is likely to be well positioned to implement substantial and effective change. If the two cultures are misaligned, the organization may be unhealthy, depending on the extent of misalignment. If you find this misaligned condition, it must be addressed first or implementation efforts may be resisted and prove unsuccessful. It is important to know the state of the business so you can begin to develop the most effective implementation plan for the two aspects of this process—Shareholder Value Created and Lean Business. Shareholder Value Created (SVC) SVC is an extension of your existing accounting information. This extension can take place with some additional programming in your current system or by exporting data from your current system into a program designed to make the calculations. The formula for Shareholder Value Created is: SVC = NOPAT – (WACC * Total Operating Capital) Net operating profit after taxes (NOPAT) is determined from income statement information. Total capital is determined from balance sheet information. Depending on your financial report structure, some information may come from the statement of cash flows. Determining your weighted average cost of capital (WACC) requires an additional worksheet. Calculating SVC often includes making several adjustments to how certain information is treated to eliminate distortions resulting from generally accepted accounting principals and to ensure that all accounting line items are properly included. This can be criti-

126

How Does It Work?

cal to the success of implementing this process with maximum benefit depending on the type of business and the amount of expenditure on certain items. These potential adjustments are discussed in further detail later. Lean Business For two decades there has been considerable and increasing emphasis on the importance of becoming “lean.” Analysts have criticized companies like General Motors for not becoming lean enough fast enough to remain competitive and profitable. Other firms, such as Toyota, have received a great deal of praise for their lean implementation efforts. Toyota became one of the most cash rich companies in the world as a direct result of implementing lean manufacturing techniques. Their process was so effective it became known as the “Toyota Production System.” As the benefits of lean manufacturing became widely recognized, an ever-increasing number of companies began to adopt it with varying degrees of success. It can take a great deal of effort and requires a total commitment to be even partially successful. If your firm is a monopoly, or if you are fortunate enough to be offering a product or service which enjoys demand so high that consumers will pay whatever price you require, you may feel you don’t need to read any further. Few companies are in that position. It is also a condition that does not last. Look at McDonnell Douglas for an example of past managerial complacency and the impact of competitiveness. The reality is that every company needs to implement lean business, not just lean manufacturing. Remember, this is about survival! McDonnell Douglas perished and Boeing continues to struggle. Much to Boeing’s credit, on March 21, 2001, Mr. Phil Condit, CEO, announced a significant restructuring of the firm and a total commitment to “…run Boeing as a business that has the flexibility to move capital and talent to the opportunities that maximize shareholder value.” As belated as this action and commitment might be, it is welcome. Competition has become global in nature for almost all products and services we demand as consumers. Remaining ahead of the onrushing boulder of competition— surviving—requires innovative thinking, Lean Business, and a commitment to the new notion of continuously positive results. First, we will look at Lean Manufacturing and then expand the discussion into Lean Business. Lean Manufacturing/Business contains the tools to improve any type of operation, from manufacturing to service companies. The word “manufacturing” means a physical product, or something that becomes a product. This can be a motor, an airplane, a plastic part, a loan package, an insurance application, a plumber’s repair truck and tools, a carpet layer’s equipment, a furniture or electronics store, research and development, or anything else you can think of.

127

Creating Shareholder Wealth

Lean Manufacturing/Business focuses on two areas: Organization improvement is in the forms of: • • • • •

Workplace organization—often referred to as the “5Ss” Visual controls in the process (always know the status of the operation at a glance) Standard work (common and predictable work processes) Point of use (provide the materials needed for the job at the job location) Kitting (put all materials, tools, and documents required for the job together) It also includes flattening and simplifying the organizational structure. Waste elimination is in the form of CLOSEDMITT (the ten forms of waste):

• • • • • • • • • •

Complexity Labor Overproduction Space Energy Defective goods and errors Materials Idle materials Time Transportation

Lean Manufacturing often includes statistical data gathering to help identify areas of focus for improvement. The statistics aspect is called variation identification and control and helps identify and prioritize areas where implementation focus is appropriate. Although this applies primarily to manufacturing operations, it can have meaningful application in other operations. JMPin software, or a similar statistics package, helps with this analysis. This book does not delve into this area. The engineering aspect of Lean Manufacturing focuses on processes referred to as Determinant Assembly, which applies two basic and important concepts. First, the fewer number of parts in an assembly, the higher the level of quality and the lower the assembly and inventory costs. In its traditional form, an “assembly” is a manufactured product. In reality, Determinant Assembly techniques can be applied to anything. The idea of an assembly can be broad in its interpretation. It can also be the number of blocks that have to be completed on a form, or the number of steps in a service process. Second, to the greatest possible extent, parts should index to each other and tooling should not be used to control configuration.

128

How Does It Work?

The engineering costs associated with the application of this concept are recovered through: • • • • •

Lower manufacturing costs Lower costs of materials Lower overhead costs Lower inventory and inventory control costs Higher levels of quality

Now let’s expand the discussion to include the rest of the organization— Lean Business. Lean Business expands the concepts of lean manufacturing across the entire organization. If the concepts of lean manufacturing apply to any type of physical product, manufacturing, or service in nature, they also apply to every functional organization and every person in the organization. Each must learn to think and act “lean.” Doing this more effectively and sooner than your competition will keep you ahead of the onrushing boulder. Take a moment to think about how much more productive and competitive your organization could be with the implementation of some of the organization improvement and waste elimination ideas discussed earlier. Then think about possible determinant assembly applications for your organization. Operations Organization Now let’s begin to expand the discussion into specific organizations and functions. Four operational functions exist in an organization. They are Production, Engineering, Inventory Control, and Quality Assurance. If your organization chart shows more than four, an immediate opportunity exists for potential improvement. It is easy for managers to get caught in the trap of creating a monster over time. This happens slowly. It often is a result of recognizing and rewarding individual accomplishments of those who have made important contributions. If this condition sounds familiar, look at ways to flatten the structure and reduce the number of managers at all levels without sacrificing customer satisfaction requirements. Survival requires a common purpose, teamwork, and a total commitment. These four functions must operate as a single unit with one mindset. Anything less will result in reduced efficiency and increased cost. There is no need for more than three levels of management to exist in a geographic location or within a business unit.

129

Creating Shareholder Wealth

VP or Director of Operations

General Manager - Quality Assurance

General Manager - Production

General Manager - Engineering

General Manager - Inventory Control

Manager

Manager

Manager

Manager

The one critical task not discussed later is equipment and facility maintenance. This belongs in the operations organization, but where it fits is best decided by your specific situation. I recommend that the equipment maintenance function be placed inside production. This gives that function full ownership and responsibility over the machines. This is a proper focus. Facility maintenance could also be placed in production unless there is something special and critical about your facility that makes it more appropriate to be in the engineering organization. A nuclear power plant would be an example. Production For our purposes, production means typical manufacturing as well as producing a service. This function is at the heart of every organization since it is the one that delivers value directly to customers through finished product. However, production is not the center of the universe and cannot be allowed to feel that it is. This is a team effort. This process impacts the production function in numerous ways. Every aspect of lean manufacturing discussed before applies. Engineering (Includes Research and Development) Engineering provides direct support to production and is responsible for designing products and process flows that are efficient to produce and fulfill customer needs. Accordingly, the concept of Determinant Assembly should be applied. The partnership between production and engineering must be strong. The only reason they are separate functions is the difference in expertise and role. These two functions in particular must have a common goal and mindset. It is appropriate to measure their performance together.

130

How Does It Work?

Inventory Control This is an important function and is responsible for a great deal of value within the firm. Responsibilities include the following tasks: • • • • • • • • • •

Receive materials Store materials Control and secure materials Dispense materials Receive finished goods for shipment Ship finished goods to customers Receive returned merchandise Disposition returned merchandise Records maintenance Scrap disposition

This function is responsible for minimizing the inventory level in the organization. This must be done in partnership with production and purchasing. In summary, this is supply chain management. Quality Assurance This function only exists where special quality requirements and test processes exist. The production organization must take ownership of this responsibility and be held accountable for quality levels. This is an important philosophy. Quality is built into the product or service. It is NEVER inspected or tested into the product or service. By the time a quality assurance person sees the product it is too late. Quality assurance is a cost function—a policing action. It rarely creates direct value. Some would argue that quality engineering belongs in this function and adds value to the organization. That activity belongs in the production function and certainly can add value. Give serious consideration to eliminating your quality function where possible. Reduce its size. Make sure the production function is ready and able to accept responsibility for first time quality. Retain a minimal quality function where you have special requirements, such as Federal Drug Administration compliance considerations or other regulatory requirements.

131

Creating Shareholder Wealth

Support Organization The support functions are also limited to four areas and each is critical to the operation organization. These functions are: Human Resources, Purchasing, Finance/Accounting, and Corporate Staff. Here again, if you have more than four areas, change the organizational structure. Everything that applies to the operations organization also applies to the support organization.

VP or Director - Support General Manager –Human Resources

Manager

General Manager – Purchasing

Manager

General Manager – Finance

General Manager – Staff

Manager

Manager

Human Resources In most organizations, human resources is a cost function. This does not have to be and should not be. Clearly, this function has important record keeping responsibilities. Beyond that, human resources must always be viewed as a neutral party. Their primary role is to always tell the truth with full objectivity. Performing in this manner, the function can bring significant savings in cost reduction and cost avoidance. Just a few areas where this is accomplished are: • Proper wage structures • Support the hiring and retention of the best people for your company. • Ensure discipline exists in the firm. • Ensure consistent and, more importantly, fair discipline. • Streamlined policies and procedures • Training & Development • Compliance with regulatory agencies and applicable laws • Community relations Do not keep these people in the office. They belong everywhere in the company and must be highly visible. Communication and public relations (internal and external) are two of the critical activities of the people working in this function.

132

How Does It Work?

Purchasing This is another area where considerable savings can be created for the company. This does not mean buying the least expensive materials or equipment. Purchases must be efficient and effective at reducing unit cost while meeting or exceeding quality requirements for customer satisfaction. Keep in mind the two essential financial goals identified in the introduction: 1. CASH IS GOOD 2. INVENTORY IS BAD Throw away any old notions you might have pertaining to economic order quantity. Numerous opportunities exist to improve Shareholder Value Created, the free cash flow of the business, and reduce the cost of capital. Accordingly, purchasing decision-makers must function in partnership with engineering, inventory control, and production. They should understand the needs of these functions by spending time with them. They must also have effective supplier negotiation skills. They also need to purchase in terms of inventory control and cost of capital. It is possible to purchase in bulk quantities while also spreading out deliveries to maintain minimal inventory levels. These decision-makers should explore purchasing alliances where possible, which might include competitors. Alliances with competitors do not necessarily create a competitive advantage or disadvantage. Purchasing alliances can reduce the cost of business, increase profits, and create stronger companies. Finance/Accounting The responsibilities of this function include: accounting, bookkeeping, accounts receivable and payable, income tax information preparation, warranty records, and payroll. This function also is responsible for investor relations and the financial structure of the organization. This means maintaining a relationship between debt and equity that minimizes the weighted average cost of capital. This responsibility must be performed within the guidelines established by the owners of the firm (the shareholders) or their representatives (the board of directors). Microsoft has enormous market value and cash reserves and has earned every cent of it in the marketplace. The company also has no debt, at least none to speak of. From a pure economics and finance perspective, it can be argued that Microsoft should borrow billions of dollars and lower its weighted average cost of capital. From a business perspective, this would be a foolish thing for Bill Gates and the board of directors to do. Microsoft would have more working capital but would also have a considerable debt service burden. This would negatively impact the free cash flow of the firm and could eventually reduce its cash position. This could weaken the competitive position and strength of the company by reducing its flexibility. Microsoft, however, is the exception. Most organizations are not cash rich and must manage the balancing act between debt and equity to reduce the cost of capital. Increasingly, other firms are recognizing that cash is king and cash flow is the name of the game.

133

Creating Shareholder Wealth

Ask yourself: What is the right cash reserve level for this company? What is the right debt service obligation level? What is the right debt to equity relationship in the best interest of the shareholders? What is the best competitive position to be in for this aspect of the company? Structure your financial position accordingly. Corporate Staff Everything else fits here: customer service, administration, sales, marketing, and janitorial services are examples. Productivity and efficiency are important to minimize the cost of doing business since this is a cost function. The exception is that customer services must be viewed as a value adding function and must operate as such. This is critical to staying ahead of the onrushing boulder. I place sales and marketing functions here because they represent a small number of personnel in the vast majority of organizations. Where this is not the case, I recommend that sales and marketing, along with customer service, have a stand-alone block in the organization chart. Depending on the size of the organization, this may mean five blocks exist in the Support Organization. Examples where this might apply are the aircraft and automobile industries. The administration activities can become part of the human resources block. I urge you to make every effort to limit the organization to four blocks. Summary I advocate a focus on customer service through a flat organization with a primary measure and a few supporting measures that are easy to calculate and understand. A clear focus is in the best interest of the organization and its members. Ambiguity, conflicting measures or signals, and complexity are not in the interest of anyone—especially your customers. Structuring your organization this way makes life easier, makes problem solving easier, reduces the cost of doing business, increases Shareholder Value Created, and goes a long way toward ensuring survival. It also creates an atmosphere where the organization’s two cultures are more likely to be aligned and people will choose to motivate themselves. Your managers can do what they should, that is, inspire people—not only manage them. Everyone in the organization is more likely to take greater initiative and make the best decisions for the firm. They will also see the benefit to themselves. There will be continuously positive results.

134

Chapter Eleven Who Should Care? “Our lives are not determined by what happens to us, but how we react to what happens; not by what life brings to us, but by the attitude we bring to life. A positive attitude causes a chain reaction of positive thoughts, events and outcomes. It is a catalyst…a spark that creates extraordinary results.” —Author Unknown Every entity has a number of stakeholders who care about how the firm operates and its ultimate success or failure. Each of these stakeholders has placed what they consider to be personal value at risk in the hands of the organization’s executives. This places responsibility on you as an executive. You have an obligation to protect what is valuable to others and that which they have entrusted to your care. It is essential to think of it in these terms. Even if you are one of the stakeholders, you have a primary obligation to protect what is valuable to the other stakeholders. You have an equal obligation to create value for these other stakeholders. Who are they? Shareholders As equity investors, the shareholders are the most important stakeholders in the business. They have it all on the line in terms of their investment in share price at the time of purchase and they take the greatest risk. In turn, the shareholders expect an above average return on their investment. This group is dependent on your leadership expertise and has every right to hold executives accountable for creating wealth on their behalf. The board of directors should be a strong activist on behalf of this constituency—the shareholders. Shareholders, through the board, need to demand that employees be compensated based on results.

Creating Shareholder Wealth

Debt Investors This group is next in terms of risk level. They make investments in the organization based on representations made by the executives and their own due diligence process. Their return for taking risk is the market interest rate charged for the perceived risk level. If the executives cause the business to fail, the debtors have first claim on the assets. However, they may never get their money back just as the shareholders may not. Suppliers This group has the third risk level in the organization. Suppliers provide the materials, tools, and equipment required to deliver your product and/or service to the market. Most suppliers expect to be paid within thirty days of handing over “supplies,” and executives have an obligation to fulfill that expectation. The longer it takes to receive payment, the more they have at stake in your organization. It is not their role to finance your cash flow—as tempting as that might be. In the case of major equipment purchases, the supplier may have been paid and a lender or lessor is now the stakeholder. Where this is the case, they move up into the debt investor group. Employees This is a critical group of stakeholders who are at the “middle” risk level. Although they have little at risk financially since most members of this group can change jobs at will, they have a great deal at risk emotionally. They are impacted by the quality of your executive and management practices. Their productivity and quality of output is directly affected. Their feelings of security, fulfillment, comfort, loyalty, commitment, and the reputation of your firm are also impacted. As such, this stakeholder group is pivotal to the success of the organization. This group responds to executive conduct and the atmosphere created by executives. The firm and all other stakeholders benefit if that leads to a condition where this group chooses to motivate itself to high levels of performance. If the executive group fails to create that atmosphere, the organization and all other stakeholders suffer. If shares of stock are part of your incentive plan, this group becomes a double stakeholder and has more at risk. Depending on your product, this could be a triple stakeholder group in that they may also be customers. Treat them accordingly. Customers The direct customers of the organization are stakeholders who are at the next risk level and have considerable power. If you satisfy their needs, they will continue to do business with you. If their needs are unmet, they will cease to do business with you. This stakeholder group is also at risk on behalf of their customers as a result of how you conduct business. There are multiple stakeholder groups that can affect your business reputation as well as future business possibilities. The conduct of your business needs to be focused on this stakeholder group. This group and the next could be one and the same, depending on your product and your spot in the supply chain.

136

Who Should Care?

Consumers With some important exceptions, this is the stakeholder group at the lowest risk level as a result of executive conduct. The exceptions are businesses that impact what I’ll broadly refer to as “public safety.” Among them would be: 1. Aircraft manufacturers, maintenance groups, and air traffic control (the entire flight safety system) 2. Automobile manufacturers (gas tanks that blow up on minor impact, door latches that open easily where ejection might occur) 3. Food and water providers, processors, delivery systems, and preparation (public health conditions, poisoning, restaurant cleanliness) 4. Toy manufacturers (child choking hazards) Most consumers affected by executive conduct in these businesses have recourse in the court system. This is little consolation and cannot be a factor in making executive decisions. If anything, executives in these and similar businesses have a special responsibility toward this stakeholder group. In the majority of organizations, the consumer as a stakeholder will become dissatisfied with the quality of product or service and will vote with their dollars and take their purchasing power elsewhere. These stakeholder groups will care what happens in the organization for a number of reasons. Share Price A correlation exists between Shareholder Value Created and share price. Companies implementing this concept have consistently demonstrated this. There have been some exceptions and failures. Where this relationship has not been maintained, or where a company utilizing economic profit as its primary measure has failed, there have been management failures and/or extenuating circumstances. The key is behavior modification so that every manager, indeed every employee, in the organization acts with a singular focus on shareholder value. As you improve the SVC condition of the organization, the market will make adjustments over time if your shares are publicly traded. If your shares are privately held, you can still determine a price per share change based on the number of outstanding shares. If your organization is a public entity, there are also ways to determine a “share” price.

137

Creating Shareholder Wealth

Market Value As the price of your shares increase, the market capitalization and perceived market value of the organization increases. Obviously, the real market value would be determined between a willing buyer and a willing seller under existing market conditions. Share price can be a good indicator of market value at a given point in time. However, be cautious of this indicator. Share price and market capitalization can fluctuate. This does not mean that shareholder value fluctuates in the same manner. It will not in a wellmanaged entity. Risk Measure Shareholder Value Created can be used as an additional risk measurement tool. In fact, it can be used as the first or primary risk measurement tool. Shareholder Value Created, economic profit, is an excellent indicator of how efficiently or inefficiently management is utilizing capital. If the organization has a positive SVC, especially over time, the relationship between net operating profit and efficient utilization of capital is as it should be. The firm is earning more than its cost of capital, will have greater free cash flow, and is in a sound position to support growth. The firm is at minimal risk. It is probably doing well in staying ahead of the onrushing boulder of competition. There is greater security. If the relationship results in negative SVC, especially over time, the organization is at greater risk. It is under-utilizing its capital. It will have lower free cash flow and less ability to support growth. The organization is at risk and could be in serious trouble. Calculating the amount of Shareholder Value Created tells you if you are staying in front of the onrushing boulder of competition. If the firm is adding value, it is going to survive. If the firm is destroying value, it may perish. If the results are inconsistent, the boulder of competition is probably gaining. Performance Measure Shareholder Value Created is well suited to the concept of a single primary performance measure driving the organization’s decisions. At the top level it should serve as the primary measure. As you move down into the organization, various managers will have responsibility for specific value drivers that directly impact SVC results. These managers should be measured against both of these criteria, their specific value drivers and SVC at the firm level. The key is to measure those items for which individual managers have responsibility and over which they have control, as well as the end result.

138

Part Three Case Study Applications

This page intentionally left blank.

Chapter Twelve “Peaceful Transitions” A Hybrid Manufacturing and Service Organization This case study focuses on two critical aspects of Creating Shareholder Wealth: 1. 2.

How is lean business implementation approached? How are improvement opportunities analyzed for Shareholder Value Created?

Chapter Outline: Corporate • Introduction • Business Model • Initial Findings • Implementation Actions Operations Organization • Production • Engineering • Inventory Control • Quality Assurance Support Organization • Accounting and Finance • Purchasing • Human Resources • Corporate Staff Summary and Key Philosophies

Creating Shareholder Wealth

Corporate Introduction Here we will take a look at the process and its elements as it pertains to the broad corporate organizational level. The next sections will look at the implementation details within the two functional organizations—the Operations and Support Organization perspectives. We will go through the process utilizing the Concept Model and Action Model. We will develop answers to The Five Critical Questions. In the summary we will show the linkage to Shareholder Value Created. We will set up a fictitious company containing all functions. We will also make assumptions about the financial condition of this fictitious company. Studying this case will enable you to implement this process in your own organization. Let’s decide what kind of business our fictitious firm is in. It could be anything. I could make it a manufacturing firm of technical medical diagnostic devices, a company that mass produces a simple commodity product, a pharmeceutical company, a service firm, or a public entity such as a police department or county accounting and finance function. This process will fit anywhere. The name of our fictitious firm will be “Peaceful Transitions.” The firm provides funeral and cemetery services and manufactures related products. The three operating divisions are: • Real estate • Manufacturer of funeral service related products • Funeral parlors and cemeteries I choose this business and industry with a tremendous respect for its importance to society. Also, it represents a number of various business conditions and situations blended into a single entity. It is simultaneously a manufacturing and service company. It is vertically and horizontally integrated. To my knowledge, there is no such business currently in operation and this example is not intended in any way to be a reflection of any currently operating business. Hopefully, this case will give you an opportunity to relate this example to your own situation. The firm is vertically integrated in that it manufactures product internally. It is horizontally integrated in that it provides a full range of clientele services. The real estate division buys and manages properties for the funeral parlor and cemetery division. The manufacturing division is responsible for providing all necessary products to provide full clientele services. What is not internally manufactured is purchased outside the firm. What does the basic process flow of Peaceful Transitions look like?

142

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

Executive Offices & Functions Real Estate Division Identify Funeral Parlor Locations

Acquire Properties

Construction (As Req’d.)

Identify Qualified Tenants

Manage Properties

Identify Cemetery Locations

Acquire Properties

Construc-

Identify Qualified Tenants

Manage Properties

tion (As Req’d.)

Funeral Parlor & Cemetery Division

Marketing Activities Operate Funeral Parlors

Provide all Related Customer Services

Transport

Operate Cemeteries

Provide all Related Customer

Sales & Marketing Activities

Manufacturing Division Acquire and/or develop manufacturing facilities and capabilities

Caskets

Fabrics

Accessories

Purchasing

143

Purchased Items

Creating Shareholder Wealth

Now let’s see how the organization chart looks as a function of this process flow. The following are the two aspects of the fundamental organization chart from Part One of the book brought together into a single chart.

President VP or Director —Operations

VP or Director—Support

General Manager — Production

Manager

Manager

General Manager — Finance

General Manager — Engineering

Manager

Manager

General Manager — Purchasing

General Manager — Inventory Control

Manager

Manager

General Manager — Human Resources

General Manager — Quality Assurance

Manager

Manager

General Manager — Corporate Staff

144

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization Now let’s look at the actual organization chart as a function of the multi-divisional operations of this business.

President VP—Operations

General Manager —Manufacturing Division

VP—Support

Manager

Chief Financial Officer

Manager

General Manager — Purchasing

Manager

General Manager—Real Estate Division

Manager

General Manager — Funeral and Cemetery

Manager

Manager

General Manager — Engineering

Manager

General Manager — Inventory Control

Manager

General Manager — Quality Assurance

Manager

General Manager —Human Resources General Manager — Corporate Staff

Manager

The additional boxes are a function of the multi-divisional operations of the business.

145

Creating Shareholder Wealth

Business Model Peaceful Transitions commenced operations as a private company on January 1, 1998. It was capitalized with substantial investment from the founders as well as considerable debt financing. During the first several months, the executives purchased several existing funeral home and cemetery operations in various metropolitan areas around the continental United States. During the balance of 1998, expansion continued through a combination of acquisitions and new construction Since the executives’ business plan is to remain domestic and on the mainland, the corporate headquarters is located in the Midwest in a city with an excellent airport and airline connections. This reduces total travel costs and time while searching for new locations and managing the overall business operation. The Problem At fiscal year-end 2000, executives are pleased with the growth rate achieved since founding the company. However, both executives and their financers are concerned that the company has not yet become profitable. They are approximately two years behind their original business plan expectations. Everyone involved is optimistic about the future prospects and agrees that the current projections for the coming two years are realistic. At the same time, all parties wonder what can be done to improve the projections. Fiscal year 2001 is projected to be unprofitable and year-end 2002 will yield just over 1 percent sales profit as compared to an original business plan projection of 5 percent. A lender group executive read an article you recently published and contacted you to see what recommendations you might have for the company. You entered into a consulting agreement and are prepared to start your research. The next pages provide financial statement information. They are a combination of historical information for the past three years and projections for the next two years based on management’s expectations of their markets and growth. You begin by interviewing the parties.

146

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

PEACEFUL TRANSITIONS INCOME STATEMENTS MILLIONS $ ACCOUNT TITLE

Consolidated Sales Net Sales Growth % Cost of Goods Sold Selling, General and Administrative Operating Expenses Gross Profit Depreciation and Amortization Goodwill Amortization Other Expenses Operating Profit Interest Expense Total Other Expenses Income Before Taxes Statutory Tax Rate: Income Tax Provision Total Taxes Income After Taxes Income Available to Stockholders To Retained Earnings

PROJECTED 2002

% sls

2001

ACTUAL % sls

2000

1999

$1,563 100% $1,251 100% $1,001 $770 $1,563 100% $1,251 100% $1,001 $770 25.0% 25.0% 30.0% 38.7% $1,129 72.2% $923 73.8% $759 $680 $272

17.4%

$237

1998

$555 $555 $652

18.9%

$183

$145

$128

$1,401 89.6% $1,160 92.7% $162 10.4% $91 7.3%

$942 $59

$825 ($55)

$780 ($225)

$49

3.2%

$48

3.8%

$44

$33

$11

$49 $113 $84

0.0% 3.2% 7.2% 5.4%

$48 $43 $76

0.0% 3.8% 3.5% 6.1%

$44 $15 $74

$33 ($88) $68

$11 ($236) $68

$84

5.4%

$76

6.1%

$74

$68

$68

$29 35%

1.8% 0.0%

($33) 35%

-2.6% 0.0%

($59) 35%

($156) 35%

($304) 35%

$10 $10 $19.0

6.4% 0.4% 1.2%

$0.0 ($33)

0.0% 0.0% -2.6%

$0 ($59)

$0 ($156)

$0 ($304)

$19.0

1.2%

($33)

-2.6%

($59)

($156)

($304)

$19.0

1.2%

($33) -2.6%

($59)

($156)

($304)

147

Creating Shareholder Wealth

PEACEFUL TRANSITIONS PROJECTED BALANCE SHEET Millions $ ASSETS: ACCOUNT TITLE Operating Cash Accounts Receivable Bad Debt Allowance Net Accounts Receivable Net Inventory Total Other Assets Total Current Assets Property, Plant and Equipment – Field Property, Plant and Equipment – Corp. (Accumulated Depreciation) Net Property, Plant and Equipment Goodwill—Tax Deductible Total Other Assets Total Assets

YEAR Projected 2002 2001 $15.6 $12.5 $4.4 $3.5 ($0.1) ($0.1) $4.3 $3.4 $29.2 $23.4 $0.6 $0.5 $49.7 $39.8 $1291 $1242 $47.0 $47.0 ($186) ($136) $1152 $1153 $104 $104 $104 $104 $1306 $1297

LIABILITIES AND SHAREHOLDER EQUITY: Current Portion LTD $45.9 $49.2 Accounts Payable $143.5 $128.1 Accrued Expenses $11.9 $9.5 Construction Obligations $84.2 $76.3 Current Liabilities $5.5 $4.9 Total Current Liabilities $291.0 $268.0 Senior Long-Term Debt $917 $984 Total Other Liabilities $1.3 Non-Current Non-Interest Liabilities $3.7 $3.0 Total Liabilities $1213 $1255 $75 $75 Common Stock Retained Earnings $18 ($33) Common Equity $93 $42 $1306 $1297 Total Liabilities and Net Worth

148

2000 $10.0 $2.8 ($0.1) $2.7 $18.7 $0.4 $31.8 $1154 $47.0 ($89) $1112 $134 $134 $1278

Actual 1999 $8.0 $2.6 ($0.1) $2.5 $10.1 $0.6 $21.2 $844 $47.0 ($44) $847 $102 $102 $970

1998 $7.0 $2.4 ($0.0) $2.4 $7.5 $0.2 $17.1 $250 $47.0 ($11) $286 $34 $34 $337

$51.6 $102.5 $7.6 $61.1 $3.9 $226.7 $1032.9

$45.1 $25.6 $47.2 $30.0 $5.9 $4.2 $46.4 $2.8 $1.2 $147.4 $61.0 $901.8 $503.8

$2.4 $1262 $75 ($59) $16 $1278

$1.8 $1.2 $1051 $566 $75 $75 ($156) ($304) ($81) ($229) $970 $337

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization Initial Findings 1. The company has no specific Strategy Intent. It does have a mission statement expressing the importance of customer service and sensitivity toward clientele. 2. There are no specific Strategy Goals identified to support a Strategy Intent. The operating goals are to “make every effort to meet the business plan.” 3. There are no Strategy Plans. The “plan” is to “find acquisition opportunities anywhere and anyway we can.” The other “plan” is to find under-served markets and build operations. When asked how these “plans” are carried out, the response was that “we look in phone books” and “talk to commercial real estate agents.” 4. There is no Strategy Implementation. The executives are implementing their business plan in the manner described and feel they have been successful, while acknowledging that they are behind their business plan goals. 5. There are no performance measures beyond the bottom-line profit number and its percent of sales, consistent with the original business plan. 6. The executives and managers of the corporation are all experienced, have expertise in individual areas of responsibility, work well together, are committed to the success of the business and to a high level of customer service, expect a great deal from the organization, express recognition and appreciation regularly, and are well respected throughout the organization. 7. The individual location managers for all divisions are capable and competent. They are pleased with the business operation and feel they are doing the best they can. There is an underlying awareness that the business could be more successful. A major part of this awareness comes from the fact that bonuses are not forthcoming even though they were expected to start at the end of fiscal year 2000. There is an appreciation for the open and honest manner in which executives seem to communicate and the frequency of personal visits to the various locations. 8. There is a general lack of clarity of the business direction—other than to grow. 9. You note that operating expenses are over 94 percent in 2000 and feel that number should be less than 70 percent. You also note the high level of debt obligation and increasing interest expense. Does this sound familiar? I would imagine that at least some of it does. Take a few minutes and think about how similar this might be to conditions in your own organization. I’d suggest making some notes. Your Initial Recommendations • Implement Creating Shareholder Wealth. • Focus on reducing operating expenses to increase Net Profit Before Taxes. • Renegotiate the debt package to reduce interest expense. • Stop developing manufacturing capability and focus expansion in the funeral parlor and cemetery division for the purpose of rapid cash flow improvement with minimal increases in total capital.

149

Creating Shareholder Wealth

Implementation Actions Phase 1—Step 1: Management Training and Change Management Training You arrive at the company with basic training packages that you can adapt to this client. State of the Business Along with appropriate executives and managers, you perform an initial analysis of the state of the business. In this case you find that: • The formal organization structure appears streamlined and efficient. • Your observations and interviews show the informal organization is substantially aligned with the formal. This appears to be a function of the business operation and the laws and regulations that apply to this business. An above average level of education exists in the business. Since the organization is geographically spread out around the country, there are no strong leaders in the informal organization at present. There is a leader in the informal organization at corporate headquarters. This person is the general manager of the funeral home and cemetery division. • You determine that the business is in Phase 2 of Organizational Growth. There is “Growth Through Direction” and a “Crisis of Autonomy” taking place. Local managers have more knowledge than top executives in market conditions and operation details. As a function of the informal organization that is developing, you see that these local managers want to have more control and autonomy. The questions are, “Is this a bad thing?” and “How do we channel this energy?” • The due diligence analysis performed shows that the company is strong in its markets, has plenty of room to grow for years to come, is increasing in value, and is well respected and appreciated in all markets. • You work with the executive group to put the leadership and implementation teams in place.

150

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization Phase 1—Step 2: Shareholder Value Created Working with the Chief Financial Officer, you determine that the condition of the firm appears to be less than desirable in several key respects. The financial results calculated show a negative working capital condition, and its rate of decline does not match the business growth requirements. The traditional accounting value drivers calculated show that margins are improving but may not provide much confidence in the business’s future. You see that the valuations based on SVC and free cash flow to the firm show that the business has a positive value in the market. Details are shown on the following pages. The economic value drivers are Return On Invested Capital and Free Cash Flow. These are shown below. SVC margin is a measure I developed several years ago and have not seen elsewhere. We see that Return On Invested Capital declines and improves again. Free Cash Flow and SVC margin improve progressively, which is encouraging. SECURE FUTURE SUMMARY OF VALUE DRIVERS Projected

Actual

Year

2004

2003

2002

2001

2000

1999

1998

Return on Invested Capital Free Cash Flow SVC Margin

227%

924%

(121%)

(12.7%)

5.6%

45.6%

192%

$72

($24)

($13)

($93)

($348)

($712)

($5634)

8.8%

8.1%

4.92%

2.12%

0.6%

(11.5%)

(45.2%)

Economic profit—Shareholder Value Created—is a value driver for any organization. Since we advocate its use as the primary performance measure, it is treated separately.

151

Creating Shareholder Wealth

PEACEFUL TRANSITIONS SUMMARY OF FINANCIAL RESULTS Projected Actual Millions $ Year 2002 2001 2000 1999 1998 Cash Taxes = Income tax provision $10 $0 $0 $0 $0 $30 $27 $26 $24 $24 + Net Interest Expense * Tax Rate $0 $0 $0 $0 $0 - Interest Income * Tax Rate Non-Operating Income * Tax Rate $0 $0 $0 $0 $0 $40 $27 $26 $24 $24 EBIT = Net Sales $1,563 $1,251 $1,001 $770 $555 $1,129 $923 $759 $680 $652 - Cost of Goods Sold S, G&A $272 $237 $183 $145 $128 - Depreciation and Amortization $49 $48 $44 $33 $11 $113 $43 $15 ($88) ($236) NOPAT = EBIT $113 $43 $15 ($88) ($236) - Cash Taxes $40 $27 $26 $24 $24 - Increase in Deferred Taxes $1 $0 $0 $0 $0 $72 $16 ($11) ($112) ($260) Free Cash Flow = EBIT $113 $43 $15 ($88) ($236) - Cash Taxes $40 $27 $26 $24 $24 + Increase in Deferred Taxes $1 $0 $0 $0 $0 + Depreciation and Amortization $49 $48 $44 $33 $11 Increase in Working Capital ($16) ($36) ($62) ($63) ($18) $49 $89 $310 $594 $297 + Capital Expenditures - Increase in Net Other Assets ($1) ($1) ($1) ($1) ($1) - Investment in Goodwill $104 $104 $133 $102 $34 ($13) ($93) ($348) ($712) ($563) Working Capital = Operating Current Assets $50 $40 $32 $21 $17 - Current Non-Interest Liabilities ($245) ($219) ($175) ($102) ($35) + Short Term Debt $0 $0 $0 $0 $0 ($195) ($179) ($143) ($81) ($18) - Excess Cash $0 $0 $0 $0 $0 ($195) ($179) ($143) ($81) ($18)

152

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

SUMMARY OF FINANCIAL RESULTS (CONT’D.) Year 2002 2001 2000 1999 Debt Ratio = Market Debt/ Market Debt + Market Equity 91.14% 96.05% 98.57% 109.4% Equity Ratio = Market Equity / Market Debt + Market Equity 8.86% 3.95% 1.43% (9.36%) Debt to Capital Ratio = Total Debt / Invested Capital (29.72) (11.74) (6.12) (4.26) Interest Coverage = EBIT / Interest Expense 1.34 0.57 0.20 (1.30) Return on Assets = EBIT (1 - Tax Rate) / Assets 5.62% 3.34% 1.16% (9.11%) Return on Equity = Earnings After Taxes / Equity 19.85% (76.7%) (377%) 192.6% Asset Turnover Ratio = Sales / Assets 1.20 0.96 0.78 0.79 Leverage = Total Assets / Shareholder Equity 13.96 30.54 81.2 (11.97) Operating Margin 4.69% 3.47% 1.48% (11.5%) Profit Margin 1.19% (2.60%) (5.92%) (20.3%) Earnings per Share = Net Income / # Shares Outstanding $1.86 ($3.25) ($5.93) ($15.60)

1998 178.8%

(78.8%) (2.0) (3.48) (69.9%) 128.1% 1.64 (1.42) (42.5%) (56.3%) ($31.09)

What do these traditional accounting measures tell us about the condition of the company, especially the economic condition? Not Enough! At best, they tell us that the overall company condition is improving but struggling. They do not tell us if shareholder needs are being met. The trends indicate that the business is moving toward meeting shareholder needs. But, there is no specific primary indicator.

153

Creating Shareholder Wealth

PEACEFUL TRANSITIONS COST OF CAPITAL WORKSHEET Year:

2001

2000

1999

Cost of Debt Capital Marginal Debt Rate:

15.0%

16.0%

17.0%

Marginal Tax Rate: After Tax Cost of Debt: Cost of Preferred Equity Capital Cost of Preferred Stock: Cost of Common Equity Capital

0.3500

0.3500

0.3500

9.75%

10.40%

11.05%

0.00%

0.00%

0.00%

Risk Free Rate: Market Risk Premium:

6.00%

6.50%

7.00%

6.50%

6.50%

6.50%

1.00

1.00

1.00

Equity Risk Beta: Cost of Common Equity:

12.5% After Tax Cost

Capital Weight

Debt:

9.75

Preferred:

0.00

Common: Systematic Cost of Capital:

12.50

Capital Type

Unsystematic Risk Total Cost of Capital:

13.0% Weighted Cost

After Tax Cost

Capital Weight

0.960

9.36

10.40

0.00

0.00

0.00

0.040

0.49

13.00

1.00

9.86 %

13.5% Weighted Cost

After Tax Cost

Capital Weight

Weighted Cost

0.986

10.25

11.05

1.094

12.08

0.00

0.00

0.00

0.00

0.00

0.014

0.19

13.50 -0.094

1.00

10.44 %

1.00

-1.26 10.82 %

0%

0%

0%

9.86 %

10.44 %

10.82 %

154

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

PEACEFUL TRANSITIONS SVC RESULTS PROJECTED

ACTUAL

Year

2004

2003

2002

2001

2000

Period NOPAT:

$222

$160

$72

$16

($11)

Period Cost of Capital: 9.86% 9.86% 9.86% 9.86% 10.44% Period Total Capital: $128 $67 ($32) ($88) ($177) Two Period Average Total $97 $17 ($60) ($133) ($200) Capital: SVC (SVD): $212 $158 $78 $29 $10 Period Change:

$54

$80

$49

$19

$95

1999

1998

($112) ($260) 10.82% 9.89% ($222) ($270) ($246) ($135) ($85) ($246) $161

In the above table providing SVC results, you see that total capital is negative in some periods. From an operating perspective, this might seem counterintuitive, and it is. Certainly the organization has capital it uses to produce goods or deliver services. However, from an economic perspective, this negative condition is entirely possible. It is a function of the capital-related liabilities of the organization being greater than the capital-related assets of the organization. As capital is reduced and debt is not, this condition can become even more apparent. There are a number of reasons why debt must be managed and minimized; this is just one of them.

155

Creating Shareholder Wealth

PEACEFUL TRANSITIONS SVC VALUATION Millions $ Sales Growth Rate:

25.0%

Terminal Value Growth Rate: 2001 WACC: Est. SVC $78 $158 $212 $287 $396

6.50% 9.86% PV $71 $131 $160 $197 $247

YEAR 2002 2003 2004 2005 2006 Terminal Value: Present Value of SVC: + Invested Capital: = Value of Operations: + Non-operating assets:

$7,363 $8,170 ($88) $8,082 $104

= Total Entity Value: - Value of Debt:

$8,186 ($983)

= Equity Value of Firm: Value per Share: 10,000,000 Shares Outstanding

156

$7,203 $720.27

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

PEACEFUL TRANSITIONS FREE CASH FLOW TO THE FIRM (FCFF) VALUATION Millions $

Sales Growth Rate: 25.0% Terminal Value Growth Rate: 6.50% 2001 WACC: 9.86% YEAR Est. FCFF PV 2002 ($13) ($12) 2003 ($24) ($20) 2004 $72 $54 2005 $124 $85 2006 $198 $124 Terminal Value: $3,691 Present Value of Operations: $3,922 + Non-operating Assets: $104 = Total Entity Value: - Value of Debt:

$4,026 ($983)

= Equity Value of Firm: $3,043 Value per Share: 10,000,000 Shares Outstanding $304.31 It is apparent that improvements must be made to increase NOPAT and reduce total operating capital. In this analysis, the valuation disparity is $415.96 per share. Using a lower terminal growth rate would narrow the disparity. Ideally, the two valuation approaches would give the same result. A number of reasons exist as to why they do not. Among them is the approach to adjustments. Again, we are not trying to get to the “perfect” result. As we move forward and implement Creating Shareholder Wealth, the valuations will move closer together over time but will not become identical. Reaching that point is not the goal. It is too complex and burdensome. Lean Manufacturing/Business At this point you are making observations and preliminary recommendations. So your analysis is done without the full involvement of managers in the various organizations. They are not excluded, but they are also aware this is preliminary to get an understanding of the business operations and make initial observations. The managers are aware that they will soon become active participants in the process.

157

Creating Shareholder Wealth

From your own initial analysis of this business and industry you made four recommendations. One of them was to stop developing internal manufacturing capability. This was driven by the financial statement information and organizational structure. Now, with involvement from the functional managers, you see this recommendation is appropriate. You also find that some organizational changes might be appropriate. Operations Organization The internal manufacturing capability exists in four old facilities that were acquired from retiring founders and serve regions. Although this vertical integration appears to be an efficient and cost-effective operation method, that may not be the case. There are no efficiencies of scale and there is considerable effort duplication. Transportation costs are high and the firm is having difficulty competing on price with well-established manufacturers. The funeral parlor and cemetery division is buying products internally at prices that are competitive in a local environment. However, the organization structure does not allow for buying at the corporate level and taking advantage of potential price breaks. Accordingly, you begin to discuss alternatives with the manufacturing division general manager. Specifically, what can he manufacture competitive with “best pricing in the market” and what should he stop manufacturing and allow the funeral parlor and cemetery division to source through the purchasing department. In addition, should the company maintain four regional facilities or sell some of them under the new manufacturing concepts that will be developed? In discussions with the engineering general manager it becomes apparent that his small staff is under-occupied. He wants to retire and dissolve his organization, which he sees as unnecessary. The few people on his staff can be absorbed into the manufacturing division or find new jobs elsewhere. This appears to be an appropriate recommendation. You have similar discussions with the inventory control general manager. She sees little to control. Virtually everything that is purchased for the business is “pass through” and remains in inventory for only a few weeks. Most items are custom ordered by clientele to satisfy individual tastes. Items that remain in “inventory” are primarily fixtures and furniture. She wants to move on and suggests that the purchasing general manager in the Support Organization take over her responsibilities. Again, after considerable discussion and analysis, you conclude that she is correct. You meet with the quality assurance general manager. He is also unsure his function is needed since most issues pertaining to quality are a function of local laws and regulations. In addition, the manufacturing personnel are experienced “craftsmen” who take a great deal of pride in what they do. You point out that, in this business, quality takes on several forms. It is not limited to the quality with which the firm conforms to applicable laws regulating the industry or the quality of the manufactured products. There is also the quality of customer service in its various forms: grief counseling, amenities, general service, taking the extra step for clients, appearance and condition of properties and fixtures, professionalism of all staff personnel, and appearance of those personnel. He had not thought of his job in such a broad scope.

158

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization He also points out that there currently is no one in the organization with a focused responsibility for quality assurance. He is excited about the possibility of expanding his involvement in the overall business operations. Support Organization Feeling good about the results so far, you meet with the general manager of corporate staff. She has an MBA with a major in marketing and loves what she does. She also has no particular interest in supervising the general staff and other functions that are part of her organization. She wants to focus on sales and marketing and growing the business by working with the real estate division to make acquisition selections by formal market research rather than the current “casual” method. She wants all other functions to be moved elsewhere. Given the conversation with the quality assurance general manager, where he wants responsibility for all aspects of quality including appearance of the facilities, you feel he should take responsibility for that from the corporate staff. You recognize that the general staff consists of only a few people and is something of a distraction. The corporate staff general manager suggests that maybe they could report to the human resources function and that her function title could change to reflect what she actually does—General Manager Sales and Marketing. This sounds like it could work well for this business. You move on to the office of the human resources general manager who also has an MBA and likes his job. He is excited about how the business is growing and has fun bringing top-notch people into the organization. He is also frustrated about periodically having to go to the general manager of corporate staff for additional support when it is needed. You ask if he would be interested in taking those people into his organization and making the job for the corporate staff general manager easier. You also wonder if he knows how she feels about her marketing activities. He indicates that she has commented on how she loves that type of work and would like to focus on it. You suggest that he go meet with her to negotiate a change in structure that meets both individuals’ goals. You go have coffee with the vice president of the Support Organization and relate the creative thinking of these general managers and suggest she allow them to do whatever they agree to as long as they can show it will benefit the organization and its ability to serve customers both internally and externally. In the meantime, the general managers have lunch and agree on organizational changes that will work for them. They request meetings with their vice presidents and have the concepts approved. You meet with the purchasing general manager and learn that she is capable and competent. She has a focus on cost control and efficient operations. She comes from a background that has given her a wide range of experiences. She discusses her philosophies on purchasing and inventory control. She sees the need for separation in a larger manufacturing organization. She does not see the need for separation in this small environment where there is little inventory to control. Again, you suggest she meet with her counterpart and negotiate an arrangement in the best interests of the business. The purchasing general manager is also frustrated with her inability to take advantage of bulk purchasing and drop shipments from well-established manufacturers. She wonders what could be

159

Creating Shareholder Wealth

done about that. However, she sees little likelihood that the manufacturing organization will give up anything. She has no specific basis for that opinion, she just feels that way. You have another cup of coffee with the two organizational vice presidents and bring them up-to-date. The two general managers meet and agree that inventory control responsibilities should be moved. They get conceptual agreement from their respective vice presidents, and the inventory control GM prepares to move on. You have been working with the Operations and Support Organizations to prepare for detailed analysis. At this point you are ready to work with these organizations on 5S and CLOSEDMITT analysis. These will be addressed in detail in the individual sections for those organizations. Note: The scenarios I have described here are common. I have experienced them in various forms on many occasions. People are observant and aware. Human nature is the best asset a leader has. In this case, the various managers were given the freedom to create an environment that better fulfills their needs as well as the organization’s. That is what leadership is about. The organization structure I recommended in the beginning is a baseline. The best structure is the one that evolves naturally and supports the Strategy Intent. Phase 1—Step 3 Shareholder Value Created You run the SVC analysis with the business improvements you now believe are realistic based on the meetings held thus far: • A 5 percent reduction in cost of goods sold in 2001 • An additional 5 percent reduction in cost of goods sold beginning 2002 • S,G,&A reductions reflecting the organization changes agreed to which equals 5 percent savings beginning 2002 You notice the significant improvements that can be realized if these goals are met. This is before any attempt to renegotiate the debt package, and it does not yet achieve the 70 percent operating expenses goal you initially recommended. Yet, the original business plan goal of reaching profits greater than 5 percent of sales by year-end 2002 would be achieved. Those results are on the following pages. Year-end 2002 operating expenses are just over 81 percent and year-end 2002 profit is projected at 6.5 percent of sales with this analysis. This is encouraging. You also note the beneficial impact to operating cash on the balance sheet. You begin to think about the best uses for that excess. Pay down debt faster? Accelerate the rate of growth?

160

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization PEACEFUL TRANSITIONS INCOME STATEMENT #2 MILLIONS $ ACCOUNT TITLE Consolidated Sales Net Sales Growth % Cost of Goods Sold Selling, General and Administrative Operating Expenses Gross Profit Depreciation and Amortization Operating Profit Interest Expense Total Other Expenses Income Before Taxes Statutory Tax Rate: Income Tax Provision Income After Taxes Income Available to Stockholders To Retained Earnings

PROJECTED 2002 $1,563 $1,563 25.0% $1,016

% sls 2001 100% $1,251 100% $1,251 25.0% 65.0% $877

ACTUAL 2000 $1,001 $1,001 30.0% $759

1999 $770 $770 38.7% $680

1998 $555 $555

$258 16.5% $237 $1,274 81.5% $1,114 $289 18.5% $137

$183 $942 $59

$145 $825 ($55)

$128 $780 ($225)

$50 $48 $239 15.3% $89 $84 $76 $84 $76 $155 $13 35% 35% $54 $4 $101 6.5% $9

$44 $15 $74 $74 ($59) 35%

$33 $11 ($88) ($236) $68 $68 $68 $68 ($156) ($304) 35% 35%

($59)

($156) ($304)

$101

6.5%

$9

($59)

($156) ($304)

$101

6.5%

$9

($59)

($156) ($304)

161

$652

Creating Shareholder Wealth

PEACEFUL TRANSITIONS PROJECTED BALANCE SHEET #2 Millions $

YEAR

ASSETS: ACCOUNT TITLE

Projected 2002 2001

2000

Actual 1999

1998

Operating Cash Net Accounts Receivable Net Inventory Total Other Assets Total Current Assets P,P, & E – Field P,P, & E – Corporate Adjustments to net P, P, & E (Accumulated Depreciation) Net Property, Plant and Equipment Total Other Assets Total Assets

$97.6 $4.3 $29.2 $0.6 $131.7 $1291 $47

$54.5 $3.4 $23.4 $0.5 $81.8 $1242 $47

$10 $3.7 $18.7 $0.4 $32.8 $1154 $47

$8 $3.5 $10.1 $0.6 $22.2 $844 $47

$7 $3.4 $7.5 $0.2 $18.1 $250 $47

($186)

($136)

($89)

($44)

($11)

$1152 $104 $1388

$1153 $104 $1339

$1112 $134 $1279

$847 $102 $971

$286 $34 $338

$25.6 $30 $4.2

LIABILITIES AND SHAREHOLDER EQUITY: Short Term Debt Current Portion LTD Accounts Payable Accrued Expenses Construction Obligations Current Liabilities Total Current Liabilities Total Senior Liabilities Total Liabilities Non-Current Non-Interest Liabilities Retained Earnings Common Equity Total Liabilities and Net Worth

$45.9 $143.5 $16.4 $79.8 $5.5 $291 $917 $1208

$49.2 $128.1 $14.6 $71.3 $4.9 $268 $984 $1252

$51.6 $102.5 $11.7 $57 $3.9 $227 $1034 $1261

$45.1 $47.2 $7.3 $45 $2.8 $147 $903 $1050

$3.7 $100.9 $75

$3.1 $8.7 $75

$2.4 ($59.3) $75

$1.8 $1.2 ($156) ($312.2) $75 $75

$1388

$1339

$1279

162

$971

$1.2 $61 $513 $574

$338

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

PEACEFUL TRANSITIONS SUMMARY OF FINANCIAL RESULTS #2 Millions $ Projected Actual Year 2002 2001 2000 1999 1998 Cash Taxes = Income Tax Provision + Net Interest Expense * Tax Rate - Interest Income * Tax Rate - Non-Operating Income * Tax Rate

EBIT = Net Sales - Cost of Goods Sold - S, G&A - Depreciation and Amortization NOPAT = EBIT - Cash Taxes - Increase in Deferred Taxes Free Cash Flow = EBIT - Cash Taxes + Increase in Deferred Taxes + Depreciation and Amortization

Increase in working capital + Capital expenditures - Increase in Other Assets - Investment in Goodwill

Working Capital = Current assets - Non-Debt Current Liabilities + Short-Term Debt

- Excess Cash

$54

$5

$0

$0

$0

$30 $0

$27 $0

$26 $0

$24 $0

$24 $0

$0 $0 $0 $0 $0 $84 $32 $26 $24 $24 $1,563 $1,251 $1,001 $770 $555 $1,016 $877 $759 $680 $652 $258 $237 $183 $145 $128 $50 $48 $44 $33 $11 $239 $89 $15 ($88) ($236) $239 $89 $15 ($88) ($236) $84 $32 $26 $24 $24 $1 $0 $0 $0 $0 $155 $58 ($11) ($112) ($260) $239 $89 $15 ($88) ($236) $84 $32 $26 $24 $24 $1 $0 $0 $0 $0 $50 $48 $44 $33 $11 $24 $5 ($62) ($63) ($17) $48 $87 $309 $593 $297 ($1) ($1) ($1) ($1) ($1) $104 $104 $133 $102 $34 $29 ($92) ($348) ($712) ($564) $132 $82 $33 $22 $18 $245 $219 $175 $102 $35 $0 $0 $0 $0 $0 ($113) ($137) ($142) ($80) ($17) $0 $0 $0 ($113) ($137) ($142)

163

$0 ($80)

$0 ($17)

Creating Shareholder Wealth

Note that excess cash is not deducted from working capital in the financial results. We are not addressing adjustments in this case. Usually we would deduct any amount in excess of 3–5 percent of annual sales. This is a typical approach to identifying the excess cash available in a business. The highest and best use of that excess cash needs to be determined. As that use is accomplished, the financial statements and results are affected accordingly. We will look at this further as we proceed.

Traditional Accounting Measures: Year Debt Ratio = Market Debt/ Market Debt + Market Equity Equity Ratio = Market Equity / Market Debt + Market Equity Debt to Capital Ratio = Total Debt / Invested Capital Interest Coverage = EBIT / Interest Expense Return on Assets = EBIT (1 - Tax Rate) / Assets Return on Equity = Earnings After Taxes / Equity ROIC = NOPAT / Invested Capital Earnings per Share (Undiluted) = Net Income / # Shares Outstanding

Projected 2002 2001

2000

Actual 1999

1998

84.6%

92.5%

98.6%

109.4%

178.8%

15.4%

7.5%

1.4%

(9.4%)

(78.8%)

(29.7)

(11.7)

(6.1)

(4.3)

(2.0)

2.84

1.18

0.20

(1.30)

(3.48)

11.2%

4.34%

1.2%

(9.1%)

(69.8%)

57.4%

10.4%

(377%)

193%

128%

(257%)

(43.8%)

5.6%

45.5%

(193%)

$10.09

$0.87

($5.93)

($15.60)

($31.09)

164

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

PEACEFUL TRANSITIONS VALUE DRIVERS #2 Improve:

By: Impacts: Increasing EBIT and/or Reducing Operating the Marginal Tax Rate Margin NOPAT Profit Margin Increasing Net Income NOPAT Increasing Sales and/or Reducing SVC Margin Total Capital NOPAT Asset Turnover Increasing Sales and/or Reducing Ratio Total Capital NOPAT Debt to Equity Reducing Debt (WITHOUT Ratio INCREASING EQUITY) Increase EBIT, Lower tax rate, Return on Assets and/or Reduce Capital Assets NOPAT

CAPITAL CAPITAL CAPITAL CAPITAL

PEACEFUL TRANSITIONS VALUE DRIVERS #2 Year Operating Margin = EBIT * (1-t) / Sales Profit Margin = Net Income / Sales SVC Margin = SVC / Sales

2002

2001

2000

10%

4.7%

1.5%

1999

1998

(11.5%) (42.5%)

6.45% 0.70% (5.92%) (20.3%) (56.3%) 10.3% 5.7% 0.97% (11.09%) (44.4%)

PEACEFUL TRANSITIONS PROJECTED ANNUAL SVC #2 Millions $ Projected Actual Year 2002 Period NOPAT: $155 Period Cost of Capital: 9.96% Period Total Capital: ($32) Two Period Average Total Capital: ($60)

2001

2000

1999

1998

$58 9.96% ($88)

($11) 10.44% ($177)

($112) 10.82% ($222)

($2603) 9.89% ($270)

($133)

($200)

($246)

($135)

SVC (SVD):

$161

$71

$10

($85)

($246)

Period Change:

$90

$61

$95

$161

165

Creating Shareholder Wealth

PEACEFUL TRANSITIONS SVC VALUATION #2 Millions $

Sales Growth Rate:

25.0%

Terminal Growth Rate:

6.50%

2001 WACC:

9.96%

YEAR

Est. SVC

PV

2002

$161

$146

2003

$256

$212

2004

$334

$251

2005

$437

$299

2006

$580

$361

Terminal Value:

$10,440

Present Value of SVC:

$11,709

+ Invested Capital:

($88)

= Value of Operations:

$11,621

+ Non-Operating Assets:

$104

= Total Entity Value:

$11,725

- Value of Debt:

($983)

= Equity Value of Firm:

$10,742

Value per Share:

10,000,000 Shares Outstanding

166

$1,074

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

PEACEFUL TRANSITIONS FREE CASH FLOW TO THE FIRM (FCFF) VALUATION #2 Millions $

Sales Growth Rate: Terminal Value Growth Rate: 2001 WACC: Est. FCFF $29 $58 $170 $244 $349

YEAR 2002 2003 2004 2005 2006 Terminal Value: Present Value of Operations: + Non-operating Assets: = Total Entity Value: - Value of Debt: = Equity Value of Firm: Value per Share: 10,000,000 Shares Outstanding

25.0% 6.50% 9.96% PV $26 $48 $128 $167 $217 $6,282 $6,868 $104 $6,971 ($983) $5,988 $599

The valuation improvement is significant. Each valuation has improved by similar amounts—averaging $324 per share. The valuation disparity has increased to $475.35 due to the greater increase in SVC value than FCFF value. The executive and lending groups are encouraged by these results. This information gives greater momentum to the work being done in the Operations and Support Organizations working with you to develop the implementation details. You also utilize this information to develop the first cut of the new incentive compensation plan based on SVC results. Incentive Compensation Plan Working with the incentive compensation implementation team, you suggest that a beginning point for developing the compensation plan might be to pay out 30 percent of actual corporate level SVC in 2001 and 2002. This would be $21.3 million in 2001 and $48.3 million in 2002. You also suggest that every employee in the company participate in the plan. An analysis shows that 30 percent of operating expenses are employee salaries. This represents $334.2 million in 2001 and $382.2 million in 2002. This means that employees would be able to receive incentive compensation up to 6.4 percent of salary in 2001 and 12.6 percent in 2002. Payments are to be made on a quarterly basis to those who have been employed the entire quarter.

167

Creating Shareholder Wealth

The implementation team supports these recommendations and an analysis is completed of payment amounts to each individual if the targets are met.

Year 2001 2002

PROJECTED PAYOUT OPERATING SALARIES EXPENSES SVC (With (With Improvements) Improvements) $71 Million 30% = $21 $1,114 $334 Million Million Million $161 Million 30% = $48 $1,274 $382 Million Million Million

% OF SALARIES

6.3% 12.6%

The payout of corporate level SVC to all employees, rather than a combination of corporate level and locally controlled results on value drivers, is considered appropriate after considerable discussion. The reason is the anticipated costs and difficulties associated with setting up the individual financial statements to properly track those value drivers at the local level in a short time frame. You urge that every effort be made to accomplish this in a simple format by the beginning of year 2003 so that the blended approach can be applied to 2003 incentive compensation payments. The team agrees with the importance of the blended approach. You warn the team of the dangers in not taking the blended approach from the onset of the program. The primary dangers are that under-performers are seen as overcompensated based on the efforts of others. This situation will be recognized and can negatively impact morale in the organization. The team recognizes this danger but feels that there are no “problem” under-performers in the company. The final team decision is to commit to accomplish blending beginning in fiscal year 2003 and to make this commitment part of the announced plan. Next, the discussion turns to the longer term SVC expectations. If this projection is met, payouts will increase. The analysis with improvements shows the following. LONG-TERM SVC PROJECTIONS (Millions $) YEAR 2006 2005 2004 2003 SVC $580 $437 $334 $256 PAYOUT $174 $131 $100 $77

168

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization The expected rapid improvement level will cease in the future due to reduced opportunities for available improvement. The team needs to watch for this development as future projections are performed. You suggest that the percent of SVC placed in the incentive pool could be increased to adjust for this if projected SVC results are not met in the long-term. If the team sees that future year projections will result in declining payout, they should consider progressive increases from the currently agreed 30 percent up to a maximum of 50 percent. The team agrees that this is an appropriate and equitable way to address changing business conditions, help maintain the PULSE of the process, and address human nature. In the future, people will typically still be putting in essentially the same level of effort with potentially declining results due to circumstances beyond their control. In part, these changes will be a direct result of previous achievements. Employees cannot feel they are being penalized for these accomplishments. At the same time, there has to be a limit on the payout because the shareholders also cannot be penalized. After all, this whole process is about Creating Shareholder Wealth. Lean Manufacturing/Business You are continuing your work with the organizations. Training The executive and management groups have received training and you now assist in developing the training plan details for the rest of the company. Communication You turn your attention to the communication implementation team. You find this to be a creative group with a number of excellent approaches to information sharing. Members of this team developed and maintain the company Web site. The team has three approaches: • Expand the intranet site to include “near” real-time detailed information on the status of the entire process—weekly updates on the site. • Monthly meetings at each company location, led by an executive, to discuss progress and status. • Quarterly publications mailed to every employee. These would be formatted like a magazine and would show history, status, and projections. Each venue would include recent success stories with a focus on the people accomplishing whatever the result was. This seems like a good beginning, although you are unsure the quarterly magazine is necessary given that this information will be on the company intranet and this site is widely used by employees in the company according to a survey the communications team conducted. Any information individuals would like to print out and keep for themselves is available through the “printable format” capability of the site.

169

Creating Shareholder Wealth

You point this out to the team, but do not argue with their approach. You expect that they will abandon the quarterly magazine once they get a better idea of its cost and the effort required to put it together. Phase 1—Step 4 You work with the teams to develop the management report. This report draws from the next three sections where the details of implementation are developed and then summarized. MANAGEMENT REPORT SECTION 1: Executive Summary 1.

2. 3.

What was the analysis goal? Two primary goals exist for this analysis. The first was to determine what actions are required to achieve, or exceed, the original business plan profit goal. The second was to determine if the identified actions were realistic and could be accomplished. Who performed the analysis? Members of the Creating Shareholder Wealth Leadership and Implementation Teams performed the analysis with the assistance of a consultant. Findings Summary • There is no specific Strategy Intent. • There are no Strategy Goals to support the Strategy Intent. • There are no Strategy Plans to fulfill the Strategy Goals. • There is no Strategy Implementation process to enable the Strategy Plans. • There is no primary, focused performance measure with directly supporting drivers. • There are experienced executives and managers who work well together; express appreciation; are well respected. • Managers know the business could be more successful; they are concerned that no bonuses are forthcoming. • There is a lack of clarity in the business direction. • There is a need to reduce cost of goods sold, debt levels, and interest expense.

170

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization 4. Recommendations Summary • Implement the organizational changes agreed to by various managers and shown in the recommended organizational charts. • Redistribute certain functional responsibilities with organizational changes. • Restructure the manufacturing division by disposing of two facilities and focusing on specialty custom products for clientele while also manufacturing standard products with available excess capacity for internal use or outside sale. • Enter into bulk purchasing and Just In Time delivery agreements. • Sell manufactured product to others. It has been determined that the profit goals in the original business plan can be achieved with a combination of organization changes, process improvements, and waste elimination, these primarily being: • Reduce Cost of Goods Sold 5 percent in 2001 and another 5 percent in 2002 • Reduce S,G,&A by 5 percent in salary and operating expense reductions beginning in 2002 The savings projections are summarized as follows. 2002 TARGET SAVINGS: ITEM RE-ORGANIZATION CLOSE FACILITIES OFFICE 5S, CLOSEDMITT, MIS SOFTWARE UNIT COST REDUCTION EFFICIENCY GAINS BULK PURCHASE TOTALS:

$14,000,000 S,G,&A $480,000 $2,035,000 $11,484,000

$13,999,000

$113,000,000 COGS

$67,800,000 $11,300,000 $33,900,000 $113,000,000

SECTION 2: Shareholder Value Created The following matrix summarizes the SVC projections. (Millions $)

Year

2006

2005

2004

2003

2002

2001

Current Projections

$396

$287

$212

$158

$78

$29

Projections with Improvements #2

$580

$437

$334

$256

$161

$71

171

Creating Shareholder Wealth

The current projections confirm that the business is moving in the right direction, but is not yet close to accomplishing its goals. Implementing Creating Shareholder Wealth with a focus on process improvement and NPBT improvement is recommended. Accomplishing the earlier identified items will result in the Projections with Improvements. Further improvements are available through the new notion of continuously positive results, judicious use of the excess cash that will become available, and reducing the interest expense obligation of the business. It is noted that the 2001 results are partial year due to the implementation process taking place. Year 2002 will be the first full year under the Creating Shareholder Wealth process. SECTION 3: Incentive Plan The recommended plan goal is to pay a substantial portion of SVC to every employee in the company and to use this plan as one tool to create incentives to achieve desired levels of performance. The plan guidelines are as follows: • Include all employees in the same plan. • Increase period payments through: o SVC results o Progressive increases in the percent of SVC paid, if required • Transition to a blended plan in 2003 where payments are based on a combination of locally controlled SVC drivers and corporate level results. Following is a summary of the incentive plan payout expectations in the first two years based on the projections and guidelines above. Payments would be made to all eligible employees in the company on a quarterly basis. Year

PROJECTED SVC

PAYOUT

SALARIES

2001

$71 Million

$334 Million

2002

$161 Million

30% = $21 Million 30% = $48 Million

% OF SALARY 6.3%

$382 Million

12.6%

SECTION 4: Lean Manufacturing/Business The Operations and Support Organizations reached agreements that will result in achieving more than the indicated SVC projections. Increased profits, reduced total capital, and some of the efficiency improvements are excluded. As they are realized, they will be included in monthly updated projections.

172

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization 5S Summary: • Offices and workflows are being rearranged. • Office supplies are consolidated at work cell locations. • Office supply costs are expected to be reduced. • Work is being standardized to improve efficiency and simplify cross-training. CLOSEDMITT Summary • Two manufacturing plants will be closed. • Product flow is being improved. • Focus will be custom products with standard products also manufactured. • Unit cost is reduced considerably. • COGS will reduce more than the projected 5 percent in 2001 and another 5 percent in 2002. • S,G,&A will also be reduced approximately 5 percent beginning in 2002. • The cash receipts from selling land, buildings, and equipment will pay for the improvements. • The excess cash in the business will also pay for improvements, increased growth rate, and accelerated debt reduction. • Additional realized savings will be included in future SVC and financial projections. Other Findings • None List of Recommendations • Implement the organizational changes agreed to by the parties, as follows:

173

Creating Shareholder Wealth

CURRENT ORGANIZATION STRUCTURE

President

VP—Operations

VP—Support

General Manager — Manufacturing Division

Manager

General Manager— Real Estate Division

Manager

General Manager — Funeral and Cemetery Division

Manager Manager

General Manager — Engineering

Manager

General Manager — Inventory Control

Manager

General Manager — Quality Assurance

Manager

Manager

174

Manager

Manager

Chief Financial Officer

General Manager— Purchasing

General Manager Human Resources

General Manager— Corporate Staff

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization PROPOSED ORGANIZATIONAL STRUCTURE

President VP—Operations General Manager — Manufacturing and Engineering Division General Manager — Real Estate Division General Manager — Funeral and Cemetery Division

VP—Support

Manager

Manager

Chief Financial Officer General Manager — Purchasing and Inventory Control

Manager

Manager

Manager

Manager

General Manager — Human Resources

Manager

Manager

General Manager — Sales and Marketing

General Manager — Quality Assurance This new structure is expected to be more efficient and productive. • Dispose of two manufacturing facilities. • Consolidate operations into two facilities, one in the west and one in the east. • Have a primary manufacturing focus on custom products, with standard products as a secondary parallel focus. • Implement a new process flow that will reduce unit cost and cost of goods sold. • Implement work cell manufacturing. • Implement bulk purchasing. • Implement workflow improvements in offices.

END OF REPORT

175

Creating Shareholder Wealth

Operations Organization Introduction You began your work with the Operations Organization by meeting with the vice president and the various division managers. You provided initial training on the process, and the result has been meaningful agreements and decisions that impact the organization structure as follows. By definition, the organizational changes include the agreed upon changes in functional responsibilities discussed previously. CURRENT ORGANIZATION

Vice President—Operations General Manager — Manufacturing Division

Manager

General Manager— Real Estate Division

Manager

General Manager — Funeral and Cemetery

Manager

General Manager — Engineering

Manager

General Manager — Inventory Control

Manager

General Manager — Quality Assurance

Manager

176

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization NEW ORGANIZATION

Vice President—Operations

General Manager — Manufacturing and Engineering Division

Manager

General Manager — Real Estate Division

Manager

General Manager — Funeral and Cemetery

Manager

General Manager — Quality Assurance

Manager

These changes result in reductions in the salary and benefits expenses on the income statement. Those anticipated reductions were reflected in the analysis in the previous section. The organization is now flatter and leaner than it was originally. At the same time, it is seen by its members as more capable of serving internal and external custmers. This goes a long way to achieving “buy in” to ensure the desired results. This is also consistent with human nature and the need to align the formal and informal organizations by modifying the formal organization to the extent possible. S,G,&A is expected to be reduced by $14 million in 2002 from the original projections. This organizational change will contribute $315,000 annually by eliminating the salaries and benefits of the two general managers along with another $165,000 by eliminating their staff needs. This totals $480,000. Managers are aware of the goal to reduce cost of goods sold by 5 percent in 2001 and another 5 percent in 2002 and have seen the projected results from the SVC analysis. They support these goals and a restructuring of the manufacturing division. They are also aware of the potential savings associated with bulk purchase opportunities. The recommendation is developed to reduce production of all standard products that are available from large, well-established manufacturers. Doing so also means that the company does not need all four manufacturing facilities. It is further recommended that two facilities be sold, retaining one facility in the east and one in the west. These two facilities would primarily manufacture special order custom designed products for clients. They would also be able to produce standard products on short notice to fill an immediate

177

Creating Shareholder Wealth

need. Finished goods inventory levels will be reduced to nearly zero which will further contribute to reducing total capital in the business. Implementing these recommendations will reduce the salary portion of S,G,&A by another $2,035,000. It will also contribute to reductions in cost of goods sold through the direct unit cost reductions (projected to be approximately 6 percent or $67.8 million) and efficiency improvements (projected to be approximately one percent or $11.3 million) in the manufacturing division. These were reflected in the final analysis done in the corporate section. The sale or closure of two facilites also contributes to the increase in excess cash to the business. The question becomes, “Which two facilities?” An analysis is done that considers the following: • Market value and marketability of the facilities • Geographic proximities to enable efficient support The analysis results show that in the east, the two facilities are outside major metropolitan areas and have approximately the same market value of $575,000. However, one of the facilities is in a community with higher growth than the other and there is a current demand for that facility and its employees by a company wishing to move into the location. Both facilities are served by highway and rail transportation and can serve the business needs. The decision is to close the facility that has the current buyer to the benefit of the employees, most of whom will be rehired by the new owner, and to realize the immediate cash infusion. This cash infusion and reduction in total capital are not in the projections with improvements. They will be included in later projections when the sale is closed. The analysis shows that in the west, the two facilities have significantly different market values and marketability. One facility is located in a small community, has plently of empty space, has a low market value (approximately $310,000), is relatively unmarketable, and the employees (and community) would be negatively impacted by its closure. It is on a major highway but is not served by a rail line. The other facility is in a major metropolitan area geographically well suited to the region, has a high market value (approximately $950,000), is in demand due to its location in the community and region, is served by highway and rail transportation, and the employees could find new work. The Lean Business Implementation Team has an easy and a potentially difficult decision to make. In the east, it is decided which facility to sell. After a some deliberation, the team decides to close the facility in the major metropolitan area. Although it would be in the interest of the business from a pure operations perspective to close the more rural facility, this would be inconsistent with the spirit of the business or its personality. Service, empathy, and sensitivity are what this company is about. The decision turns out to be easy. Once the sales are closed and the proceeds included in future projections, cash will be increased and total capital decreased by approximately $1,525,000

178

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization The next question is how to realize the remaining cost savings goals without sacrificing customer service or operating efficiency. The answer lies in workplace organization and waste elimination. You work with all of the managers in the organization to identify opportunities. Remember that workplace organization comes in the form of the 5S’s, which are: • Sort items by what is needed at the workplace to perform the requirements of the function. • Simplify the workplace arangement . • Sweep and clean the workplace daily. • Standardize workplace processes as much as is practical. • Self-discipline is essential to sustaining improvement. The other ingredient to realizing the desired savings is the CLOSEDMITT analysis. We will apply this to the organization’s main offices and then to each function within the organization. Organization Level Workplace organization—5S means several things. It applies not only to the individual workplace, but also the general workplace and environment. Sort through all items at all workstations. Remove any items that are unnecessary to the tasks performed at that station. This does not pertain to personal items. However, no one should have personal items at their workpalce that interfere with providing the highest level of customer service. Items removed should be grouped together for redistribution to areas where they are needed. Unclaimed items should be put into inventory for future use where there is an anticipated need. Items that are unnecessary should be disposed of. This might mean giving them to charity. Predictably, you find that people have been hoarding office supply type items. There should be no more than what is immediately required at any station. Gather all excess items together and place them into an inventory cabinet central to three or four stations so that needed items are readily available. Simplify the arrangement of each workstation by placing the most used items within close reach and the least used items further away, but still within easy reach. This may mean providing new types of workstation equipment and/or fixtures. This could mean single level bookshelves at each desk or new style chairs. You need to be creative. This area of workplace improvement also applies to the entire environment and work flow. Most companies arrange workstations by grouping together similar tasks. This is wrong because it increases the time, energy, effort, and costs associated with flowing tasks through the organization. Simplifying the workplace also means simplifying the work flow through the workplace. Think about how “deliverables” flow through the process and arrange the workplace accordingly. Wherever possible, an individual performing a task should be able to see his or her customer.

179

Creating Shareholder Wealth

Sweep and clean the work area daily as frequently as necessary to maintain an orderly and efficient environment. Standardize the work process as much as is practical at every workstation. When a person moves from one workstation to another, he or she will be more productive and produce a higher level of quality through familiarity. Self-discipline is essential to success and it is your responsibility as a leader to set the example. The analysis shows that throughout the organization, a potential for reductions exist in S,G,&A totalling $7,807,000 at all of the companies locations. Your expereince tells you that about 70 percent of potential savings are realized, so the team agrees that $5,465,000 in savings will be projected for this aspect of the implementation. The team wants to beat that 70 percent level over time. CLOSEDMITT analysis leads to several changes in the work environment and process flow as described later. Applying these concepts to the Operations Organization at the organization level results in a rearrangement of the environment to open space where people can see each other but are not so close together that they feel a loss of privacy. Several cabinets are put in place to provide supplies to individuals when required. Considerable savings in office supply costs are expected as a result of this consolidation. In the short term, no supplies will need to be ordered for several months as a result of removing excess items from individual desks. Manufacturing The office area and related work flow concepts identified for the organization level are also applied to the manufacturing division. The division has identified the two facilities that will close. They are the ones with the fewest number of employees and, fortunately, are located in communities where displaced employees will be able to find other work. The company will provide outplacement services for up to twelve months for affected employees. As part of the analysis to close the facilities and convert to the manufacture of custom products as well as standard products, equipment in the facilities will be rearranged and some moved from one location to another. Identifying the required equipment and the rearrangement needs to accommodate the new philosophy. This is also an opportunity to implement process improvements more broadly than might otherwise be accomplished. This analysis is comprehensive and includes: • Administrative process flows • Manufacturing process flows • Inventory types and levels • Inventory locations relative to workstations • Resulting new plant layout • Associated costs and savings

180

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization The result is a new facility layout and process flow with reduced unit costs. Your work with the manufacturing managers and team members determines that the two remaining facilities will have excess capacity and can provide custom product to other customers as well as to the parent company. The question becomes who you sell to, competitive funeral parlors or other manufacturers. Since the concept of selling to others is in conflict with the owners’ original business plan, the team requests a meeting with the owners. You arrange a meeting between yourself, the Lean Business Implementation Team leaders, the purchasing manager, and the business owners to decide this issue. The recommendation from the team is to sell to other manufacturers. The rationale is that this would be easier administratively and probably is something many would have interest in since the company would also be buying standard products from those manufacturers. This is a win–win opportunity for everyone. The purchasing manager supports this approach and the owners approve the change in business philosophy. The expectation is that capacity will be fully utilized and profitability will increase as a result. This profit increase benefit is not in the SVC projections. The expected additional savings not included in unit cost or efficiency improvements are projected to be $2,970,000 at all locations. Again applying the 70 percent guideline, the team settles on $2,079,000 in realized savings. They want to beat this as well. The analyis was accomplished using CLOSEDMITT: Complexity: The team recognized that with equipment arrangement into work cells, the production process would be less complex. The work flow would be streamlined. This also applied to the administrative aspects. Labor: Unnecessary steps and movement were eliminated by setting up workcells, placing required inventory within the cells, and placing all personnel (including administrative) who support that cell within and adjacent to the cell. This also helps reduce process complexity. Overproduction: The team recognized that inventory is bad and determines that only a minimal amount of basic units will be held in between work cells. Analysis determines that six basic units exist that can become a wide range of custom finished units. Accordingly, one of each type will be maintained in flow. This amount is a function of throughput rate and customer satisfaction requirments. This establishes the basis for “single unit flow.” Space: The new layout and process flows will reduce space requirements. This is what enables additional equipment to be moved into the facility so that standard product can still be made by having excess capacity beyond the demand for custom product. The end result is that the two remaining facilities will have nearly the same output as the previous four facilities.

181

Creating Shareholder Wealth

Energy: The new layout and cell concept reduces the consumption of human energy and enables people to be more productive. Electrical upgrades in the facility and on equipment will also result in less energy consumption and will reduce utility costs per unit. Defective Goods and Materials: The division has an outstanding quality record. The goal of no rework, scrap, or defects is more acheivable with the improvements resulting from the new layout and process flow. In addition, the direct labor personnel will be held accountable for quality; the quality assurance division will do only a cursory inspection prior to shipment. This accountability focus will also contribute to the goal. Materials: Analysis determines that the company has been buying standard materials in bulk at a good price but has not been converting all materials into product. A great deal of “drop off” exists from the raw stock when it is cut to size. The analysis shows there can be significant overall material and labor savings by purchasing a number of specific items already cut to size. This also will contribute to the reduction in the space required since these items can now be taken directly to the appropriate work cell. The number of different items purchased will increase, but the overall level of inventory will reduce. Idle Materials: The steps above will help ensure that there are no idle materials. Single unit flow with minimal inventory levels and all inventory at the work cell requiring it will keep materials moving. The result is a daily shipment of products and a single unit is in the factory for two days: one day to build the basic unit to replace the one shipped and the second day to convert that basic unit into a custom product. Time: The work cell concept with the equipment needed to be efficient results in no setup changes except for tool maintenance. Machine downtime can be planned and there is backup equipment available so that production is uninterupted. Time delays are reduced by setting up direct communication links between office support personnel and factory work cells. In addition, lights are installed on all machines that the operator turns on whenever there is a problem requiring support. The operator also has a switch panel that is linked to the desk of each support function, and the operator turns on the switch for the function(s) needed. This switch turns on a light and activates a low decibal buzzer at the desk. These make it easy for everyone to know when there is a problem and to respond quickly. Transportation: Nothing is moved that does not have to be moved, and the transportation distances from one work cell to build the basic unit to the other for conversion into custom product is short. With inventory at the work cell, there is only a few feet of transportation. With all support personnel at the work cell, it is only a short distance for any information or documentation flow. Goods are handled only one time at each step in the new process.

182

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

Custom Conversion Cell With JIT Inventory

Support Personnel and Equipment Maintenance

Standard Basic Cell With JIT Inventory

Standard Conversion Cell With JIT Inventory

Shipping

Receiving Dock

Custom Basic Cell With JIT Inventory

Packaging (with Inventory)

Further analysis shows that each of the two facilities should be set up with four work cells. One will produce basic units for custom products and one will produce basic units for standard products. They will be adjacent to each other and utilize the same support personnel and supervision. The third will convert basic custom units into finished product and the adjacent fourth cell will perform similar work on standard products. Again, they will share the same support personnel and supervision. The third and fourth cells feed product directly to packaging. The basic process flow is as follows. Block sizes are not representative of space allocations. Inventory should be at the point of use as much as possible, not in storage locations.

Engineering Consistent with previous discussion, this division is being eliminated and the design and process engineers are moving into the manufacturing division. The process engineers are located in the work cells. The design engineers are in the support office and available to the cells. Fewer engineers will be required. Inventory Control There is already an agreement to eliminate this division and move the responsibilities into the purchasing function. Some members of the LBIT disagree that the proposed move is in the best interest of the company since inventory is at local facilities and the purchasing function is central to the corporation with a local purchasing agent helping to coordinate requirements. Some feel that the local purchasing agent lacks the necessary

183

Creating Shareholder Wealth

experience to manage inventory as well as coordinate purchasing needs. Inventory control is a physical task and requires material handlers, strict processes, and related equipment. The argument is that this function has existed inside the Operations Organization and this should continue. The local purchasing agent is party to these discussions and the tone is professional and focused on the best interests of the business. The purchasing agent at the eastern location agrees with this argument and the agent at the western location feels the change should be implemented as agreed. The purchasing general manager at corporate headquarters feels the change should be implemented as agreed, especially since the vice presidents also approved the change. Complicating the issue is that the vice president of operations and many team members have been influenced by the arguement and now think the previous agreement was premature. A conflict has developed that needs to be resolved. You identify several options for the team: • Impose the agreement already approved. • Set the agreement aside and implement the team recommendation. • Find an approach that works for each group. The two vice presidents are the Lean Business Implementation Team (LBIT) leaders and are responsible for finding a solution. You recommend that these two individuals, the purchasing general manager, and the managers of the two final manufacturing facilities, along with yourself, meet to find a solution. At that meeting, you suggest finding an approach that works for each group. You point out that all organizations need to be flexible. Maximizing efficiency, accuracy, and customer service is the primary responsibility. The Operations Organization has inventory control personnel at each location, one of whom is a supervisor. One possibility is that the inventory control supervisor and the purchasing agent work as a team to achieve the needed results. The responsibility for overall inventory control, including from a financial prespective, rests with the purchasing function while the physical control responsibility rests with the operations group. Since the company is spread geographically and there will be a reduction in inventory levels, it is appropriate that the functions are under single executive responsibility for this organization. Both people at both locations will be responsible for learning each other’s job as part of a cross-training program already being developed. After considerable discussion, it is decided to take this approach and make an honest effort to ensure that it works. One reason this agreement is reached is that it preserves the savings projections already identified. It also honors the principles of the agreements already reached.

184

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization Quality Assurance The agreements already reached will be put in place. The general manager is looking forward to his expanded responsibilities and is making every effort to learn what is involved and prepare his group. The transition of all janitorial services to this function is already taking place. Training of factory personnel to be responsible for their first time quality is being developed. The quality personnel feel this will be an easy transition since those personnel are experienced and already produce a high level of quality. The factory personnel consider themselves to be craftsmen and are proud of their work. Summary The plans agreed upon will result in achieving the identifed savings targets. They will also result in additional savings that can be put into future SVC and financial projections. Members of this organization are excited about the changes and the benefits to the business. They are also excited about the financial opportunities that will come from the incentive compensation plan. This was accomplished with the use of the workplace improvement 5S and CLOSEDMITT analyses. It was also accomplished by looking at the company from a global perspective and through the owners’ eyes. Following is a summary of the first year savings projections for the Operations Organization as agreed by the team. 2002 TARGET SAVINGS:

$14,000,000

$113,000,000 COGS

ITEM

S,G,&A

RE-ORGANIZATION

$480,000

CLOSE TWO FACILITIES

$2,035,000

5S OFFICE RE-ORGANIZATION UNIT COST REDUCTION

$5,465,000 $67,800,000

EFFICIENCY GAINS CLOSEDMITT (NOT IN UNIT COST OR EFFICIENCY)

$11,300,000 $2,079,000

TOTALS:

$10,059,000

$79,100,000

The LBIT consists of members from both the Operations and Support Organizations. They all see that the benefits to the company are coming primarily from the Operations Organization. This raises some concern about equity among some team members. Some operations personnel ask, “Why should the Support Organization personnel benefit from improvements they have not made?” Others ask, “Why shouldn’t they?”

185

Creating Shareholder Wealth

This issue comes up in almost every situation. You have to be prepared for it. Reconciling this is done through the training and the informal communications processes. The two organizations exist because of the different roles they play in customer satisfaction. At the same time, they are both part of one company with a singular goal and focus—by maximizing SVC the firm will also maximize customer service. Neither organization can do this alone. They need to work and think as a team. This message needs to be delivered clearly and consistently. The work cell approach at the factories and in the new office arrangement helps to reinforce this concept and put it into practice.

Step A Support

Step B Operations

Step C

Delivery

Support

Customer (Internal or External)

Note: The office work cells are not depicted because they are different at the corporate office and the various locations. The concept of straight-through flow, without regard to organizational structure, is applied to each situation. As an example, people are free to transfer from one organization to the other within the limitations of available open positions. Cross-training is encouraged and expected. Without each other, none of the goals will be met and everyone will suffer. This is the simple truth and everyone needs to understand that and conduct themselves accordingly. This issue also places more pressure on the SVCIT to accomplish blending in the time frame committed to—by 2003. At that point, members of the two organizations will receive incentive compensation based on their own SVC value driver performance as well as corporate level SVC results to which they contribute.

186

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

Support Organization “Effective management always means asking the right question.” — Robert Heller Introduction You have begun your work with the Support Organization by meeting with the vice president and the various division managers. You have provided initial training on the process and the result has been meaningful agreements and decisions that impact the organization structure. The organizational changes reflect the agreed upon changes in functional responsibilities discussed in the previous sections. CURRENT ORGANIZATION

Vice President—Support Manager

Chief Financial Officer

Manager

General Manager —Purchasing

Manager

General Manager — Human Resources

Manager

General Manager — Corporate Staff

187

Creating Shareholder Wealth

NEW ORGANIZATION

Vice President—Support Manager

Chief Financial Officer

Manager

General Manager —Purchasing and Inventory Control

Manager

General Manager — Human Resources

Manager

General Manager — Sales and Marketing

The Support Organization implements essentially the same workplace and CLOSEDMITT improvements that were identified previously, as they apply to their environment. They contribute to the goal reductions in S,G,&A. At the corporate offices, the LBIT has made rearrangement recommendations that will make the division between the two organizations almost invisible along the work cell concept. This is good because it brings them closer together and enables them to function more as a team. Accounting and Finance The CFO is an atypical “bean counter” and thinks from a total business perspective and an operational point of view. These are important qualities for this function. He also recognizes the benefits of information technology and likes to keep up to date with software that might benefit the company. As such, he sees himself as an MIS (Management Information Systems) person for the company. He is researching integrated software packages that can provide cost savings and efficiency improvements. He recognizes that most of these packages are modular and often cost much more to implement than originally budgeted. He also knows that they often do not work as advertised. Mr. Duris’ article is just one example of how these implementations often do not meet expectations, at least initially. The CFO is looking at low cost, easy to install packages. He is convinced that installing such a system and providing proper training and support throughout the company will result in more information accuracy on a real-time basis. This will reduce the cost of doing business by increasing operating efficiency. He also wants to find a package that is compatible with calculating SVC and the goal of implementing the blended incentive plan by 2003. This blending can only be accomplished with the ability to have financial statements at the local level to 188

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization be accomplished with the ability to have financial statements at the local level to track locally controlled SVC value drivers as well as consolidated statements for the corporation. It is essential that this be done in a manner that does not become confusing, frustrating, or burdensome. You support his ideas and advise him, along with corporate executives, that proceeding with this plan is a good idea but to be cautious as they move forward. They must focus on buying a reliable package that is user friendly where mistakes in data input or command usage can be easily corrected. A number of integrated software packages exist that are relatively low cost and function well. However, few are forgiving where mistakes are easily corrected. There are virtually none that can be easily used to directly calculate SVC. As a result, he accepts that he will need two software capabilities: one is the integrated package and the other calculates Shareholder Value Created. Purchasing This function will absorb the inventory control responsibility consistent with the final agreements. Bulk purchasing agreements will be negotiated along with agreements to sell custom products to others. The bulk purchasing and Just in Time delivery agreements are expected to result in a savings of $33.9 million in cost of goods sold. The JIT aspect also provides reductions in total capital. The general manager of sales and marketing is involved in these discussions. During these negotiations, it becomes apparent that your firm can help other firms improve their processes to the mutual benefit of each company. This leads to arrangements for your teams to visit other companies in the industry to help them accomplish many of the same goals. The focus of your teams is to enable them to understand the benefits to each party by doing business together. Human Resources This general manager is busy with his teams developing the incentive compensation plan and communications processes. He is also involved in his role as the primary person responsible for developing the training packages for Creating Shareholder Wealth. As part of his interactions with the LBIT, he sees a need to strengthen the regional human resources offices around the corporation. They need to have experienced trainers and they need to understand more about business operations than they currently do. He sees that the world of human resources is changing and he must keep up. The typical human resources person of the past was not much more than a clerk. Even today, in many companies and situations, human resources is seen as a clerical function and often as an obstacle. To some extent this has been true in this company. The general manager has a goal of changing this and moving his function into the business mainstream and making cost savings contributions while also strengthening the business. He asks himself how this can be done and asks for your help developing a plan. Cost savings from improved training and similar items are sometimes difficult to quantify. Savings from different insurance carriers and similar things are easy to quantify.

189

Creating Shareholder Wealth

Corporate Staff As a result of the agreements, this function is renamed the sales and marketing division. This general manager is happy with the ability to focus on her professional love. Summary The result of the agreements is a more efficient organization, a higher level of morale and productivity, reduced costs to the business, and a higher level of teamwork throughout the company. The reduced costs agreed to by the team are summarized below. 2002 TARGET SAVINGS: ITEM BULK PURCHASE and JIT 5S, CLOSEDMITT, MIS SOFTWARE TOTALS:

$14,000,000 S,G,&A $3,940,000 (After applying the 70% guideline) $3,940,000

190

$113,000,000 COGS $33,900,000

$33,900,000

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

Summary and Key Philosophies “Perpetual optimism is a force multiplier.” —Colin Powell Overview You have completed a successful engagement with a solid company that needed to perform at an even higher level to meet its projected business plan and satisfy its investors. Along the way, you brought the organization to a new level of teamwork and participation. The Five Critical Questions were answered using the Concept Model and Action Model with the analysis processes described earlier. Operational The company is now leaner with a flatter organizational structure. Two divisions, engineering and inventory control, were eliminated. Work was restructured to improve employee satisfaction and reduce the cost of business. This contributed to the S,G,&A benefit. Two manufacturing facilities are being sold. This contributed to the S,G,&A and COGS benefit. The cash received from the sale will pay for substantial changes in workflow. This will result in considerable reductions in unit cost and the cost of business. At all office levels there are rearrangements that will also result in improved operating efficiency, greater teamwork, and improved customer service. This will reduce operating expenses Financial The goal of realizing profits of at least 5 percent of sales will be achieved. This is projected without inputting all the savings and profit increases that appear to be available. The cost of goods sold will be reduced by 5 percent in 2001 and an additional 5 percent in 2002. Sales, general, and administrative expenses will be reduced by 5 percent in 2002. The sale of two manufacturing facilities will generate additional cash. Total capital in the business will be reduced and SVC will increase. This will be done while improving customer service. Where the projections originally showed negative Shareholder Value Created, they now show positive results and rapid growth in the condition. Where no incentive compensation payments were being made, there now will be payments to everyone in the company and significant growth in the payment amounts in future years.

191

Creating Shareholder Wealth

There is increased excess cash available in the business. This will pay for the costs associated with implementing Creating Shareholder Wealth. It will also support an increase in the business growth rate and rate at which debt is paid down. Both of these will further improve cash flow, NOPAT, and resulting SVC in the business. The savings projections are summarized as follows ($ rounded). 2002 TARGET SAVINGS: (Thousands $) ITEM

$14,000

$113,000

S,G,&A

COGS

RE-ORGANIZATION

ITEM SVC GAIN

CUM. SVC GAIN

$480

$480

$480

CLOSE FACILITIES

$2,035

$2,035

$2,515

CLOSEDMITT

$2,079

$2,079

$4,594

OFFICE 5S, CLOSEDMITT, MIS SOFTWARE UNIT COST REDUCTION EFFICIENCY GAINS

$9,405

$9,405

$13,999

$67,800

$67,800

$81,799

$11,300

$11,300

$93,099

$33,900

$33,900

$126,999

BULK PURCHASE TOTALS:

$13,999

$113,000

Fiscal year 2001 is projected to be unprofitable without the improvements. Individual smaller improvements do not make the projection profitable; some portion of the cumulative improvements enables this result. At that point, the earlier discussion about where to focus improvements can be seen. That is when the firm begins paying taxes and the concept that SVC is improved approximately by ($1—Marginal Tax Rate) for every $1 of NPBT is triggered. Although this relationship is imperfect for various technical reasons, it exists. Up to that point, the contributions to SVC are $1 for $1. This makes sense. Up until the time the firm realizes a profit and pays taxes on that profit, there is a one-dollar benefit to NPBT, and therefore NOPAT, for every dollar of improvement. The Five Critical Questions Please go back to Chapter 1 and look at the Concept and Action Models. Think about how they might be used in this case study. Let’s look at how these models are used, in conjunction with the preceding analysis process, to answer The Five Critical Questions.

192

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization Question 1: What Is the Strategy Intent? Concept Model: Executive Offices—One Strategy Intent Statement Action Model: Be the full service market leader in the Continental United States. Question 2: What Are the Strategy Goals? Concept Model: Operations Organization—One or Two Goal Statements Action Model: Reduce cost of goods sold by 5 percent in 2001 and another 5 percent in 2002. Reduce S,G,&A by 5 percent. Concept Model: Support Organization—One or Two Goal Statements Action Model: Reduce cost of goods sold by 5 percent in 2001 and another 5 percent in 2002. Reduce S,G,&A by 5 percent. Question 3: What Are the Strategy Plans? Concept Model: Operations Organization Action Model: Function

Goal Statement

Plan Statement

Engineering

Manufacturing

Reduce COGS by 10% over two years

Reduce unit costs and efficiency gains

Inventory Control

Reduce COGS by 10% over two years

Manage inventory more efficiently

Quality Assurance

Reduce COGS by 10% over two years

Provide training to operators for self inspection

193

Goal Statement

Plan Statement

Reduce S,G,&A by 5% in one year Reduce S,G,&A by 5% in one year Reduce S,G,&A by 5% in one year

Eliminate the function; transfer responsibilities into manufacturing Close two facilities

Reduce S,G,&A by 5% in one year

Eliminate the function; transfer responsibilities into purchasing (shared with manufacturing) Absorb certain responsibilities from corporate staff

Creating Shareholder Wealth

Concept Model: Support Organization Action Model: Function Purchasing

Goal Statement Reduce COGS by 10% over two years

Plan Statement Negotiate bulk purchasing agreements; Reduce inventory levels

Finance

Human Resources

Reduce COGS by 10% over two years

Institute training programs

Corporate Staff

194

Goal Statement Reduce S,G,&A by 5% in one year

Plan Statement Absorb inventory control function (shared with manufacturing)

Reduce S,G,&A by 5% in one year Reduce S,G,&A by 5% in one year Reduce S,G,&A by 5% in one year

Identify and install appropriate Integrated software system Institute training programs Transfer certain responsibilities to quality assurance

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization Question 4: How Is the Strategy Implemented? Concept Model: Specific actions to implement plan(s) for each function. Action Model: Operations Organization Plan Statement COGS

Implementation

Engineering

Function

Reduce inventory levels

Lean manufacturing; efficient product and process flow; cell concept; self inspection; improved training; scrap and rework elimination; focused products Lean manufacturing; place at work cells

Quality

Inventory Control

Manufacturing

Reduce unit costs

195

Plan Statement S,G,&A

Implementation

Eliminate the function; transfer responsibilities into Manufacturing

Negotiate transfer of personnel to manufacturing; notify personnel; coordinate with human resources

Close two facilities

Select facilities; community, human resources, out placement, personnel, supplier coordination; move equipment to be retained; sell excess equipment; sell facilities

Eliminate the function; transfer responsibilities into purchasing (shared with manufacturing) Absorb certain responsibilities from corporate staff

Negotiate transfer; personnel and human resources coordination Negotiate transfer; human resources and outside services coordination

Creating Shareholder Wealth

Concept Model: Specific actions to implement plan(s) for each function. Action Model: Support Organization Plan Statement COGS Negotiate bulk purchasing agreements; Reduce inventory levels

Plan Statement operating costs

Implementation Supplier contact and negotiation; JIT delivery; locate at work cells

Negotiate transfer; personnel and human resources coordination

Identify and install appropriate integrated software system

Seek out software providers; evaluate packages; determine compatibility with existing systems; determine costs; determine installation sequence of modules; identify training requirements; identify existing skill levels; develop installation schedule; develop cost benefit analysis; obtain funding; negotiate package terms Design programs; departmental coordination; scheduling

Human Resources

Design programs; departmental coordination; scheduling

Institute training programs

Transfer certain responsibilities to quality assurance

Corporate Staff

Institute training programs

Implementation

Absorb inventory control function (shared with manufacturing)

Finance

Purchasing

Function

196

Negotiate transfer; personnel and human resources coordination; outside services coordination

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization Question 5: What Is the Best Performance Measure? Concept Model and Action Model: •

Corporate Level: Primary—Shareholder Value Created

•

Division Level: o Operations Organization: Primary Free Cash Flow to The Firm • Net Profit Before Taxes • Sales per Employee Drivers On-Time Delivery Customer Returns Inventory Turns Sales per Employee o

•

Support Organization: Primary Free Cash Flow to The Firm Net Profit Before Taxes Sales per Employee Drivers On-Time Delivery Accounts Receivable < 30 Days Accounts Payable On Time Sales per Employee

Function Level: o Operations Organization: Manufacturing: Drivers o On-Time Delivery o Customer Returns o Inventory Turns o Sales per Employee Engineering: Drivers o On-Time Delivery o Sales per Employee

197

Creating Shareholder Wealth

•

Inventory: Drivers o On-Time Delivery o Inventory Turns o Sales per Employee Quality: Drivers o On-Time Delivery o Sales per Employee o Support Organization: Purchasing: Drivers o On-Time Delivery o Sales per Employee o Inventory Turns o (Due to duties transfer) Finance: Drivers o Accounts Receivable < 30 Days o Accounts Payable On Time Human Resources: Drivers o On-Time Delivery (Training) Sales & Marketing: Drivers o On-Time Delivery o Sales per Employee Manager Level o Operations Organization: Manufacturing: Drivers o On-Time Delivery o Customer Returns o Inventory Turns Engineering: Drivers o On-Time Delivery Inventory: Drivers o On-Time Delivery o Inventory Turns Quality: Drivers

198

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization

o

o On-Time Delivery Support Organization: Purchasing: Drivers o On-Time Delivery o Inventory Turns o (Due to duties transfer) Finance: Drivers o Accounts Receivable < 30 Days o Accounts Payable On Time Human Resources: Drivers o On-Time Delivery (Training) Sales and Marketing: Drivers o On-Time Delivery

All deliveries must be high quality and all required work must be properly completed. On-time delivery requirements are never satisfied if delivery is anything less than complete with proper quality. You see consistency in the application of value driver throughout the organization. This is very important. Each of the identified drivers directly impacts cost of goods sold and/or sales, general, and administrative expenses. They are controllable or are influenced by the individuals to which they are assigned. This is through the actions taken to affect these drivers. As an example, when the purchasing manager brings the right quantity of the right items into the facility on a leveled Just in Time basis (whatever that may mean for this environment), he or she is contributing to the reduction in total capital, reduced space required, operational efficiency, improved cash flow, on-time delivery through the value chain, and sales per employee. This flows up through the organization and the results in Shareholder Value Created. When the manufacturing manager accomplishes zero customer returns, she is maximizing customer satisfaction, increasing the probability of more sales from that customer, likely reducing or eliminating space required for rework, reducing operating costs, increasing throughput and operating efficiency, reducing total unit cost, and increasing sales per employee. This flows up through the organization and results in Shareholder Value Created. For each driver, we can see how the individual has control over that driver, its results, and the linkage to Shareholder Value Created. Keep in mind the earlier position that no one individual or group is directly responsible for Shareholder Value Created. It is the result of other decisions and actions taken within the organization. The executive group is responsible for the overall operation and

199

Creating Shareholder Wealth

is measured accordingly by the only available measure that really tells us how the overall organization is performing—SVC. Overall responsibility—overall measure. This group is not directly responsible for any of the value drivers and is not measured by any. The picture begins to change at the division level. This group directly impacts SVC results through high-level business decisions and actions relating to their primary measures. This is done by how they make decisions that enable the function and manager levels to meet their primary drivers, which are the supporting value drivers for the divisional executives. The detailed steps taken to accomplish specific value drivers directly impact not only the value driver, but also the next higher-level driver and, ultimately, the top level SVC result. This relationship and direct linkage can be demonstrated at all levels of the organization. This is why only the top-level executive group can be held accountable for SVC results. It is inappropriate and impractical to force it down into the organization. It is appropriate and practical to provide training all the way down through the organization and show the linkages, but you can only hold people accountable for what they can control. This direct flow through and linkage maintains process predictability and understandability. It is consistent with human nature. Also keep in mind how the top level of an organization held accountable for SVC results might be defined. That definition is different for a multi-divisional organization than for a single division organization. In a multi-divisional organization like Boeing, the president of the commercial aircraft business would be measured by SVC results, as would the presidents of the military and the space businesses. The CEO would be measured by the cumulative results. The same thing would be true of Johnson & Johnson, General Electric, or any similarly structured organization. It may also be practical to measure local operations of a single or multi-division organization by SVC results if the accounting system is set up to provide full P&L statements at that level. I discourage expenses to upgrade or replace an existing and functioning accounting system for the purpose of forcing the measure down into the organization. Your funds are better-spent making improvements than increasing the bureaucracy. Where a legacy system is in place and operational, make use of it. Where several different local operations exist in a single division organization, it may be worth the expense of an upgrade. Key Philosophies Now let’s look back and see if we have fulfilled all of the key philosophies essential to continuous improvement.

200

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization The Process Must Have a PULSE Must be Predictable Must be Understandable Must be Long-term Must be Sustainable Must have Energy

Yes Yes Yes Yes Yes

Financial You should have two primary financial philosophies in managing your entity to achieve goals: Cash is good—We increased the cash flow and excess cash in the business. Inventory is bad—We reduced inventory levels and locations and increased inventory turns. Performance Measures They must directly relate to the individual’s function—At each level, the measures directly relate to the individual’s function. They must be controllable, or at least influenced, by the individual—At each level, the measures are controllable or influenced by the individual. The drivers selected must directly relate to and impact the primary measure—At each level, the measures directly relate to and impact the primary measure. Shareholder Value Created is the right primary measure—Yes Incentive Compensation One plan for everyone—Yes Leadership It is essential to survival—The training and roll-out process helped everyone understand this and there were many volunteers to help lead and implement the process. Look everywhere to find the best available—In establishing the teams and evaluating the formal and informal organizations, we identified the best people to participate on the implementation teams and their sub-teams handling specific projects.

201

Creating Shareholder Wealth

Did We Effectively Address the Initial Findings? Yes! Initial Findings: 1. The company has no specific Strategy Intent. It does have a mission statement talking about the importance of customer service and the sensitivity that all employees have toward the clientele. The company now has a specific and appropriate Strategy Intent statement. 2. There are no specific Strategy Goals identified that would support a Strategy Intent. The operating goals are to “make every effort to meet the business plan.” There are now specific Strategy Goals that directly support the Strategy Intent. 3. There are no Strategy Plans at all. The “plan” is to “find acquisition opportunities anywhere and anyway we can.” The other “plan” is to find under-served markets and build operations. When asked how these “plans” are carried out, the response was that “we look in phone books” and “talk to commercial real estate agents.” There are now Strategy Plans that will fulfill the Strategy Goals; acquisition decisions will be done utilizing market research data. 4. There is no Strategy Implementation. The executives are implementing their business plan in the manner described and feel they have been quite successful, while acknowledging that they are behind their business plan goals. There is now a Strategy Implementation process that will enable the Strategy Plans. 5. There are no performance measures beyond the bottom line profit number and its percent of sales, consistent with the original business plan. There is now a primary performance measure with a few value drivers that directly impact the primary measure. 6. The executives and managers of the corporation are all experienced, have expertise in their individual areas of responsibility, work well together, are committed to the success of the business and to a high level of customer service, expect a great deal from everyone in the organization, express recognition and appreciation regularly, and are well respected throughout the organization. The process will enhance this condition. 7. The managers of individual locations for all divisions are capable and competent. They are pleased with the operation of the business and feel they are doing the best they can. There is an underlying awareness that the business could be more successful. A major part of this awareness comes from the fact that bonuses are not forthcoming even though they were expected to start at the fiscal year-end 2000. There is an appreciation for the open and honest manner in which executives seem to communicate and the frequency of personal visits to the various locations. The business will be more successful. Incentive compensation is forthcoming. Open honest communication will continue and be more frequent and directly related to performance and success stories. 8. There is a general lack of clarity of the business direction—other than to grow. There is now full clarity as to the direction of the business and how it will move forward.

202

“Peaceful Transitions” A Hybrid Manufacturing and Service Organization 9.

You note that the operating expenses are over 94 percent and feel it should be less than 70 percent. You also note the high level of debt obligation and increasing interest expense. Operating Expenses will be reduced toward the 70 percent goal while exceeding the fiscal year2002 profit goal. Executives will enter into negotiations to reduce the interest expense. The rate at which debt is reduced will be increased through utilization of portions of the excess cash.

Were Your Initial Recommendations Implemented? 1. Implement Creating Shareholder Wealth. Yes. 2. Focus on reducing the cost of goods sold to increase NPBT. Yes. 3. Renegotiate the debt package to reduce interest expense. Pending, part of the plan. 4. Stop developing manufacturing capability and focus expansion on the funeral parlor and cemetery division for the purpose of rapid cash flow improvement with minimal increases in total capital. Yes.

We Have Created Shareholder Wealth!

203

This page intentionally left blank.

Chapter Thirteen “Secure Future” A Financial Services Organization This case study focuses on two critical aspects of Creating Shareholder Wealth: 1. What, if any, adjustments are made in calculating SVC when the organization is holding substantial cash or the equivalent? 2. What are some of the approaches taken in a merger/acquisition scenario to minimize disruption and further the goal of Creating Shareholder Wealth? Chapter Outline: Corporate • Introduction • Business Model • Initial Findings • Implementation Actions Operations Organization Support Organization The Acquisition Summary and Key Philosophies

Creating Shareholder Wealth

Corporate Introduction Now we will take a close look at the process and its elements as it pertains to the broad corporate level of the organization. The next sections will look at the implementation details within the two functional organizations—the Operations and Support Organization perspectives. We will go through the process for the organization and its functions utilizing the Concept Model and Action Model. We will develop answers to The Five Critical Questions and show the linkage to Shareholder Value Created. How that was done will be shown in the summary section. We will set up a fictitious company containing all applicable functions. We will also make assumptions about the financial condition of this fictitious company keeping in mind the previously stated goals. Studying this section will enable you to implement this process in your own organization. Let’s decide what kind of business our fictitious firm is. It could be anything. We could make it a manufacturing firm of technical medical diagnostic devices, a company that mass produces a simple commodity product, a pharmaceutical company, a service firm of any type, or a public entity such as a police department or county accounting and finance function. This process will work anywhere. This example is not intended in any way to be a reflection of any currently operating business. The name of our fictitious firm is “Secure Future.” This is a full-service company offering a wide range of low to moderate risk financial products and services designed to provide long-term financial security to clients. The three operating divisions are: • • •

Pricing and Receipts Product Sales Investments

The pricing and receipts division establishes prices for every product on a quarterly basis and is responsible for collecting payments from clients. The product sales division is responsible for new product sales and for maintaining current clients. The investments division is responsible for putting receipts to work in a secure and high yield manner.

206

“Secure Future” A Financial Services Organization What does the basic process flow of Secure Future look like? Executive Offices and Functions Pricing and Receipts Division Gather Statistical Information

Establish Product Prices

Send Information to Product Sales

Receive Documents for Sold Products

Collect Receipts

Product Sales Division Receive Product Information

Manage Sales Offices and Train Personnel

Sales

Check Documentation Quality

Send Completed Documents to Pricing and Receipts Division

Sales and Marketing Activities

Investments Division

Identify Appropriate Investment Products

Receive Funds From Pricing and Receipts Division

207

Manage Invested Funds

Make Required Payments to Clients

Creating Shareholder Wealth

The following are the two aspects of the fundamental Creating Shareholder Wealth organization chart brought together into a single chart.

President VP or Director—Operations

VP or Director—Support

General Manager — Production

Manager

Manager

General Manager — Finance

General Manager — Engineering

Manager

Manager

General Manager — Purchasing

General Manager — Inventory Control

Manager

Manager

General Manager — Human Resources

General Manager — Quality Assurance

Manager

Manager

General Manager — Corporate Staff

208

“Secure Future” A Financial Services Organization Now let’s look at the actual organization chart as a function of the multi-divisional operations of this particular organization business.

President Operations Executive VP

Support Executive VP

Vice President— Pricing and Receipts

Gen. Mgr.

Chief Financial Officer

Gen. Mgr.

Vice President — Human Resources

Manager

General Manager — Engineering

Gen. Mgr. Vice President — Product Sales and Claims

Gen. Mgr.

Manager

Vice President — Investments

Manager Gen. Mgr.

Manager

209

General Manager — Corporate Staff General Manager — Purchasing General Manager — Quality Assurance

Creating Shareholder Wealth

The firm is structured with an operations side and a support side consistent with the recommendations of Creating Shareholder Wealth. Business Model Secure Future commenced operations as a private company in the spring of 1880 as a firm that sold business insurance for established companies in the eastern United States. It capitalized with substantial investment from five founders who made their fortunes in various business activities. At that time, the focus was providing services to businesses located in larger cities. Initially, coverage was for the loss of business income and inventory in the event of robbery or a natural disaster. In addition, the firm made investments in other businesses. This company became a venture capital firm as well as an insurance provider. By the turn of the century, the firm had expanded its product offerings to include import/export insurance and property loss coverage. Several years before the Great Depression, the firm began offering life insurance coverage to business owners and their key employees. After World War I, the firm expanded its offerings across the country, including rural areas. It also offered services to start-up businesses. In addition, services were expanded to private individuals. After World War II, the firm transitioned from privately owned to publicly traded. The investment banking side of the business was separated into a subsidiary company and expanded its service offerings. Secure Future began offering products and services internationally in late 1948. The company has experienced considerable success in this arena. Although the company experienced hard times during severe economic downturns, annual growth has averaged 7.5 percent over the life of the company. Historically, the firm’s employment philosophy has been informal, offering lifetime employment to anyone who wished to remain with the firm and who demonstrated positive job performance. This has been a key factor in the firms’ success due to the loyalty it has brought on the part of employees, their families, and from customers. Their historic policy renewal rate is over 92 percent. The business plan is to maintain domestic headquarters while continuing to be aggressive in the international markets. Corporate headquarters is solely owned and occupied by the firm and is located in a downtown area overlooking one of the Great Lakes. The city offers a high quality of life with an excellent infrastructure, airport, and airline connections. This reduces total travel costs and time while managing the overall operation of the business. The Problem: At the close of fiscal year 2000, executives and their shareholders are concerned that the company has not maintained profitability projections and growth rates in the previous several years. The company experienced a substantial drop in retained earnings in 2000. It was the largest decrease since World War II and projections show that it will take the rest of the decade to recover to 1999 levels. As a result, the share price and market capitalization have dropped and projections are poor. Growth has slowed to less than 5 percent and projections for the coming decade are bleak—much less than the probable inflation rate.

210

“Secure Future” A Financial Services Organization This condition is attributed to two things by the executives: (1) the liberalization of banking laws during the 1990s that allow banks to offer competing financial products along with the proliferation of mutual funds. Stock market growth during the 1990s led to a change in how funds were invested. Executives are unsure how the company might be impacted from the recent market declines and interest rate reductions along with possible shifting of investment patterns given the high competition level in the industry; and (2) to an acquisition made at the end of 1999 that has not proceeded smoothly. A member of the board of directors and several company managers and executives read a book you recently published and contacted you to see what recommendations you might have for the company. In the initial meeting you are provided with financial information and the basis for projections. You are told that the company is embarking on a plan to reduce operating expenses as a percent of sales. Executives recognize that this is essential to remaining competitive. In addition, the top executives, during a confidential lunch session, tell you about their interest in acquiring a small competitor named “Income Protection” that provides products focused on fixed income instruments. Some believe this acquisition may prove necessary to save the company if the reductions in operating expenses are not met. Some are concerned about the impact to the company given the experiences of the most recent acquisition. If accomplished, it would be the sixth acquisition in the company history. The 1999 acquisition drove the sudden and significant increases in operating expenses as a percent of sales and the related profit drop in 2000. Sales did not increase as expected with that acquisition, while expenses increased more then anticipated. Three primary goals identified by the board and company executives are: (1) can operating expenses as a percent of sales be reduced quicker; (2) should the contemplated acquisition take place; and (3) can you develop a framework for the future operation of the business. Within these goals is the question of how they are accomplished while maintaining the highest possible morale level throughout the company. There is an acute awareness that staff reductions are probably necessary, which would be in conflict with historic practice. You enter into a consulting agreement and are prepared to start your research. The next pages provide the basic financial statement information. They are a combination of historical information for the past three years and projections for the next four years based on management’s current expectations of their markets and growth. You review this information and begin interviewing the parties at length.

211

Creating Shareholder Wealth

SECURE FUTURE CONSOLIDATED INCOME STATEMENT PROJECTED

Millions $

Year ACCOUNT TITLE Net Sales Cost of Goods Sold Selling, General and Administrative

ACTUAL

2004

2003

2002

2001

2000

1999

1998

$16,418

$16,175

$15,936

$15,701

$15,469 $14,775

$14,098

$8,259

$8,380

$8,454

$8,684

$8,787

$7,451

$6,913

$4,940

$5,028

$5,034

$5,116

$5,273

$3,245

$3,116

Operating Expenses % of Sales Gross Profit Depreciation and Amortization Operating Profit Other Income Interest Expense Other Partner Losses Total Other Expenses Income Before Taxes Statutory Tax Rate: Income Tax Provision Income After Taxes Income Available to Stockholders Adjustments

$13,199

$13,408

$13,488

$13,800

$14,060 $10,696

$10,029

To Retained Earnings

80.4

82.9

84.6

87.9

90.9

72.4

71.1

$3,219

$2,767

$2,448

$1,901

$1,409

$4,079

$4,069

$67

$62

$57

$43

$46

$36

$30

$3,152

$2,705

$2,391

$1,858

$1,363

$4,042

$4,039

$237

$216

$201

$184

$179

$162

$141

$908

$1,098

$1,098

$1,060

$1,003

$187

$197

($500)

($1,000)

($1,307) ($1,396)

$908

$598

$98

($210)

($393)

$187

$197

$2,481

$2,323

$2,494

$2,252

$1,935

$4,017

$3,983

35%

35% $813

35% $873

35% $788

35% $677

35%

35%

$868

$1406

$1394

$1,613

$1,510

$1,621

$1,464

$1,258

$2,611

$2,589

$1,613

$1,510

$1,621

$1,464

$1,258

$2,611

$2,589

($2)

($1)

($2)

($2)

($38)

($1)

($8)

$1,611

$1,509

$1,619

$1,462

$1,220

$2,610

$2,581

212

“Secure Future” A Financial Services Organization

SECURE FUTURE CONSOLIDATED BALANCE SHEET Millions $ Liabilities and Net Worth: Current Portion LTD Accounts Payable Construction Obligations Accrued Expenses Accrued Taxes Payable Advance Billings Current Liabilities Total Current Liabilities Total Senior Liabilities Total Liabilities Deferred Income Taxes Other Liabilities Total Other Liabilities Benefit Obligations Redeemable Preferred Stock Non-Current Non-Interest Liabilities Total Liabilities Common Stock Class A Common Stock Capital in Excess of Par Parent Shares Subsidiary Shares Preferred Shares Retained Earnings (Treasury Shares) Accumulated Other Income Other Common Equity Total Liabilities and Net Worth

PROJECTED

ACTUAL

2004

2003

2002

2001

2000

1999

1998

$239 $2,803 $15

$289 $2,549 $14

$289 $2,317 $13

$627 $2,,069 $11

$247 $1,655 $9

$131 $1,100

$299 $1,027

$1,004

$912

$829

$741

$592

$673

$829

$745 $388 $2200

$677 $353 $2000

$616 $321 $1818

$550 $287 $1624

$440 $229 $1299

$271 $203 $699

$189 $200 $771

$7,395

$6,794

$6,203

$5,908

$4,471

$3,077

$3,314

$11942 $19337 $2,680 $739 $3,419 $4,527

$14442 $21237 $2,436 $672 $3,108 $3,627

$14442 $20645 $2,215 $611 $2,826 $4,986

$13942 $19850 $2,013 $555 $2,569 $1,881

$11942 $16414 $1,830 $505 $2,335 $1,064

$3749 $6825 $1,017 $370 $1,387 $1,036

$2982 $6296 $847 $359 $1,206 $920

$13532

$6,509

$8,731

$11,998

$5,697

$3,116

$4,197

$18059

$10136

$11717

$13879

$6761

$4152

$5117

$40815 $7,470 $216

$34481 $5,044 $216

$35188 $2,912 $216

$36298 $1,251 $216

$25510 $1,151 $216

$12364 $876 $216

$12618 $876 $216

$7,586

$7,586

$7,586

$7,586

$7,586

$4,458

$4,426

$707 $379 $249 $9,859

$705 $378 $248 $8,247

$704 $377 $248 $6,736

$702 $376 $247 $5,115

$701 $375 $247 $3,651

$3,693

$3,212

($426) $104

($426) $104

($426) $104

($426) $104

($426) $104

($293) $108

($262)

($5) $26139

($5) $22097

($5) $18452

($5) $15166

($5) $13599

($32) $9,025

$8,520

$66954

$56578

$53839

$51464

$39109

$21390

$21138

213

Creating Shareholder Wealth

SECURE FUTURE CONSOLIDATED BALANCE SHEET PROJECTED

Millions $

Year ASSETS: Operating Cash Accounts Receivable Bad Debt Allowance Net A/R Net Inventory Notes and Other Receivables Other Current Assets Prepaid Expenses Adjustments Total Other Current Assets Total Current Assets P,P&E, net— Corporate P,P&E, net Corporate Accumulated Depreciation Net P,P&E Operating Invested Assets Investment in Affiliates Goodwill Other Assets Other Intangible Assets Accumulated Amortization Total Other Assets Total Assets

ACTUAL

2004

2003

2002

2001

2000

1999

1998

$164 $3,053 ($61) $2,992 $82 $125

$162 $3,008 ($60) $2,948 $81 $124

$159 $2,964 ($59) $2,904 $79 $122

$157 $2,920 ($58) $2,861 $78 $120

$605 $2,877 ($86) $2,791 $77 $118

$102 $2,643 ($47) $2,596 $52 $465

$1,151 $2,464 ($64) $2,400 $75 $102

$251 $260

$248 $260

$244 $260

$240 $260

$237 $260

$200 $159

$332

$637

$631

$626

$620

$615

$823

$264 $697

$3,875 $656

$3,821 $531

$3,769 $406

$3,717 $281

$4,088 $156

$3,573 $124

$4,322 $110

$1,028 ($386)

$1,018 ($319)

$1,008 ($257)

$998 ($200)

$988 ($157)

$787 ($111)

$644 ($75)

$1,298 $53064

$1,231 $42812

$1,158 $39998

$1,079 $38520

$987 $26640

$800 $14303

$679 $14255

$645

$645

$645

$645

$645

$1,243

$1,527

$1,584 $5,621 $1,137 ($270)

$1,584 $5,561 $1,137 ($213)

$1,584 $5,504 $1,137 ($156)

$1,584 $4,881 $1,137 ($99)

$1,584 $4,070 $1,137 ($42)

$384 $1,067 $56 ($36)

$61781 $66954

$51526 $56578

$48712 $53639

$46668 $51464

$34034 $39109

$17017 $21390

$355

$16137 $21138

Receipts from product sales are held as operating invested assets on the balance sheet. The rationale is that the company routinely buys and sells investment instruments and considers almost all of its invested capital as marketable. The exception is investments in owned real estate properties. Holding invested assets as marketable securities would be inconsistent with historic practice. Supporting the argument is that these funds are derived from the business operations and are the general equivalent of equipment that a manufacturing company might own. The counter-argument is that the company only needs to hold sufficient cash and equivalents to pay off all potential claims. Anything in excess should be held as “other assets.” This broaches the concept of adjustments.

214

“Secure Future” A Financial Services Organization Initial Findings 1. The company has a Strategy Intent to be the best provider in the global market in its offerings. It also has a mission statement talking about the importance of customer service and the sensitivity that all employees should have toward clientele. 2. No specific Strategy Goals are identified that would support a Strategy Intent. The operating goals are to “maximize new sales and customer retention” and a new goal of reducing operating expenses as a percent of sales with a target of approximately 70 percent. 3. There are no Strategy Plans other than to maximize sales and investment returns. Consideration of another acquisition is also a possible Strategy Plan. 4. No Strategy Implementation exists as defined in this book. The executives are implementing their general business plan in the manner to which they have become accustomed. 5. No performance measures exist beyond the bottom line profit number and its percent of sales. Operating expenses as a percent of sales are being considered as well. 6. The executives and managers of the corporation are experienced, have expertise in individual areas of responsibility, generally work well together, are committed to the success of the business and to a high level of customer service, expect a great deal from everyone in the organization, express recognition and appreciation, and are generally respected throughout the organization. There is no apparent dissension, just normal healthy debate on the best direction for the company. 7. The managers of individual locations and divisions are capable and competent. They are pleased with the business operation and feel they are doing the best they can. The managers have an underlying awareness that the business is heading toward tough times. When the financial reports for year-end 2000 were released, there was a great deal of concern that the company profits declined significantly, in spite of the quarterly reports. There is an appreciation for the open and honest manner in which executives communicate and the frequency of personal visits to the various field office locations. 8. You agree with the operating expense goal of 70 percent and feel it should actually be less than 65 percent. 9. The financial results analysis shows a growing negative operating working capital condition. This condition is a result of the high level of non-interest bearing current liabilities. Although this improves the Shareholder Value Created results, it is a concern.

215

Creating Shareholder Wealth

Your Initial Recommendations • Implement Creating Shareholder Wealth. • Focus on reducing the operating expenses to increase Net Profit Before Taxes. • Perform a comprehensive SVC analysis of the company with and without the anticipated acquisition. • Evaluate the organizational structure for options to better align authority, responsibility, and accountability with the required goals and stated Strategy Intent. Implementation Actions Phase 1—Step 1: Management Training and Change Management Training You arrive at the company with basic training packages that you can adapt to this client. State of the Business Along with appropriate executives and managers, you perform an initial analysis of the state of the business. In this case you find that: • The formal organization structure appears streamlined and efficient. This seems to be as much a result of habit as plan. The entire organization is accustomed to the “same old way” of doing things. This brings efficiency to the operations. It also brings a lack of innovation and creativity. • Your observations and interviews show that the informal organization is substantially aligned with the formal. This appears to be a function of the business operation, and the laws and regulations that apply to this business. There is an aboveaverage education level in the business. A high percentage of the workforce has advanced degrees. Since the organization is geographically spread out, there are no strong leaders in the informal organization at field offices. Leaders do exist in the informal organization at corporate and regional headquarters. • You determine that the business is in Phase 4 of organizational growth. There is definitely “Growth Through Coordination” and a “Crisis of Red Tape” taking place. There are also indications of Phase 5 in the organization, “Growth Through Collaboration,” and an evolution of crisis. A number of people are showing signs of burnout and several are on leave. Many local managers have more knowledge than top executives in matters of market conditions and operation details. • The due diligence analysis performed shows that the company is strong in its markets. It also confirms that the level of competition is intense. • The historic practice of lifetime employment is an integral aspect of the company culture. The security it represents is ingrained in every operation element. Everyone recognizes that poor performance has consequences and positive performance ensures a job. • You work with the executive group to put the leadership and implementation teams in place.

216

“Secure Future” A Financial Services Organization Phase 1—Step 2: Shareholder Value Created The economic value drivers are return on invested capital and free cash flow. These are shown below. SVC margin is a measure I developed several years ago and have not seen elsewhere. We see that all three drivers are projected to decline from 2000 levels.

SECURE FUTURE SUMMARY OF VALUE DRIVERS Projected

Actual

Year

2004

2003

2002

2001

2000

1999

1998

Return on Invested Capital Free Cash Flow SVC Margin

5.9%

7.9%

9.1%

10.8%

7.9%

27.1%

27.5%

($6,682)

$2,768

$4,054

$4,396

$2,469

$5,237

($1,064)

(5.37%)

(1.14%)

0.50%

2.18%

(1.05%)

13.57%

14.20%

Economic profit—Shareholder Value Created—is also a value driver for any organization. Since we advocate its use as the primary performance measure, it is treated separately later. It is a disturbing trend that these results and projections are declining. Working with the chief financial officer you determine that the condition of the firm is less than desirable in several key respects. The financial results show that the operating working capital is negative and is projected to worsen. The margins and earnings before interest and taxes (EBIT) are essentially flat or declining.

217

Creating Shareholder Wealth

SECURE FUTURE SUMMARY OF FINANCIAL RESULTS Projected

Actual

Year

2004

2003

2002

2001

2000

1999

1998

Cash Taxes EBIT

$1,103

$1,122

$1,187

$1,095

$966

$563

$689

$3,152

$3,205

$3,391

$3,128

$2,759

$4,042

$4,039

Operating Working Capital Return on Assets % Operating Margin % Profit Margin % Leverage

($3281)

($2684)

($2145)

($1563)

($136)

$627

$1,307

3.06

3.68

4.11

3.95

4.59

16.29

15.90

12.48

12.88

13.83

12.95

11.59

23.59

23.83

9.81

9.33

10.16

9.31

7.89

23.43

23.44

2.56

2.56

2.91

3.39

2.88

2.37

2.48

Debt to Equity Ratio %

61.42

83.57

83.57

82.65

62.66

17.34

19.27

It is increasingly apparent that the company is suffering from its acquisition at the end of 1999 in virtually every financial and economic respect. When you calculated the WACC you saw that the cost of capital is low and declining. This indicates good management of this business aspect. To a small extent it also is a function of the recently declining interest rates. This control of WACC is making other results look better, specifically the Shareholder Value Created calculations. This is good since every operation should be attempting to lower its cost of capital.

218

“Secure Future” A Financial Services Organization

SECURE FUTURE COST OF CAPITAL WORKSHEET Year Cost of Debt Capital Marginal Debt Rate: Marginal Tax Rate: After Tax Cost of Debt:

2001

2000

1999

7.60%

8.40%

7.80%

0.3500

0.3500

0.3500

4.94%

5.46%

5.07%

8.00%

8.00%

Cost of Preferred Equity Capital Cost of Preferred Stock: 8.00% Cost of Common Equity Capital Risk Free Rate: 4.00% Market Risk 6.50% Premium: Equity Risk Beta: 0.97 Cost of Common Equity: 10.31% After Capital Tax Capital Weighted Type Cost Weight Cost Debt: 4.94 0.349 1.72 Preferred: 8.00 0.287 2.30 Common: 10.31 0.363 Systematic Cost of Capital: 1.00 Unsystematic Risk Total Cost of Capital:

3.74

4.65%

5.75%

6.50%

6.50%

0.97

1.00

10.96% 12.25% After After Tax Capital Weighted Tax Capital Weighted Cost Weight Cost Cost Weight Cost 5.46 0.387 2.11 5.07 0.242 1.23 8.00 0.181 1.45 8.00 0.194 1.56 10.96 0.432

7.77 %

1.00

4.73 8.29 %

12.25 0.563 1.00

6.90 9.68 %

1.00

1.00

1.00

8.77%

9.29%

10.68%

219

Creating Shareholder Wealth SECURE FUTURE COST OF CAPITAL WORKSHEET Year Cost of Debt Capital Marginal Debt Rate: Marginal Tax Rate: After Tax Cost of Debt: Cost of Preferred Equity Capital Cost of Preferred Stock: Cost of Common Equity Capital Risk Free Rate: Market Risk Premium: Equity Risk Beta: Cost of Common Equity: After Capital Tax Type Cost Debt: 5.20 Preferred: 8.00 Common: 12.93 Systematic Cost of Capital: Unsystematic Risk

1998

1997

8.00%

8.90%

0.3500 5.20%

0.3500 5.79%

8.00%

8.00%

6.43% 6.50% 1.00 12.93% Capital Weighted Weight Cost 0.205 0.262 0.533

1.07 2.10 6.89

1.00

10.05 1.00

Total Cost of Capital:

11.05%

220

After Tax Cost 5.79 8.00 12.08

5.58% 6.50% 1.00 12.08% Capital Weighted Weight Cost 0.548 0.003 0.448

3.17 0.03 5.42

1.00

8.61 1.00 9.61%

“Secure Future” A Financial Services Organization Now let’s take a look at the details of the Shareholder Value Created calculations. SECURE FUTURE PROJECTED ANNUAL SVC Millions $ Year

PROJECTED

ACTUAL

2004

2003

2002

2001

2000

$1,805

$1,862

$2,003

$1,850

$980

Period Cost of Capital: 8.77% Period Operating Total $36,746 Capital: Two Period Average $30,632 Total Operating Capital: SVC (SVD): ($881)

8.77% $24,518

8.77% $22,165

8.77% $21,686

9.29% $12,687

$23,342

$21,926

$17,186

$12,285

($185)

$80

$343

($162)

Period Change:

($265)

($263)

$505

($1,316)

Period NOPAT:

($696)

You note that NOPAT is projected to rise and then decline slightly and total capital is expected to increase significantly with the business on its present course. These directions are opposite of what we want to see happen. You also see that the valuations based on SVC and free cash flow show to the firm result in a negative market value. Details are shown on the following pages.

221

Creating Shareholder Wealth

SECURE FUTURE SVC VALUATION Millions $ Sales Growth Rate:

YEAR 2002 2003 2004 2005 2006

Terminal Value Growth Rate: 2001 WACC: Est. SVC $80 ($185) ($881) ($1,611) ($2,041)

1.50% 5.00% 8.77% PV $74 ($156) ($685) ($1,151) ($1,341)

Terminal Value: Present Value of SVC: + Invested Capital 2001: = Value of Operations: + Non-operating assets:

($35,565) ($38,824) $21,686 ($17,138) $2,721

= Total Entity Value: - Value of Debt:

($14,417) ($13,978)

= Equity Value of Firm: Value per Share: 2001 Shares Outstanding

222

($28,395) ($64.43)

“Secure Future” A Financial Services Organization

SECURE FUTURE FREE CASH FLOW TO THE FIRM VALUATION Millions $

YEAR 2002 2003 2004 2005 2006 Terminal Value: Present Value of Operations: + Non-operating Assets:

Sales Growth Rate: Terminal Value Growth Rate: 2000 WACC: Est. FCFF $4,054 $2,768 ($6,682) ($869) $230

= Total Entity Value: - Value of Debt:

1.5% 5.00% 8.77% PV $3,727 $2,339 ($5,193) ($621) $151 $4,006 $4,410 $2,721 $7,131 ($13,978)

= Equity Value of Firm: Value per Share: 2001 Shares Outstanding

($6,847) ($15.54)

Ideally, the two valuation approaches would give the same result. A number of reasons exist for why they do not. Among those reasons is the approach to adjustments. The discrepancy indicates that some additional adjustments related to this type of enterprise are in order. In addition, the firm is operating in a marginal condition from an economic perspective. Accounting profits are positive and projected to move back toward 1999 levels in the coming decade, while SVC and free cash flow are fluctuating and expected to decline in the coming years. These opposing directions of movement are red flags for executives and tell them that serious action needs to be taken. Again, we are not trying to get to the “perfect” match between the valuation results. However, they should be similar. As we move forward by implementing Creating Shareholder Wealth, the valuations will move closer together but will not become identical. Reaching that point is not the goal. It is too complex and burdensome to attempt. Keep in mind the discussion on where to focus improvement efforts. You get the greatest return from Net Profit Before Taxes improvements, but you want to address both sides of the equation: NOPAT and (WACC * Total Operating Capital). This type of business has a natural and built in conflict. It wants and needs to increase invested assets from operations. This is where it receives the funds needed to pay off claims and policies redeemed.

223

Creating Shareholder Wealth

The company also needs to look for opportunities to provide a high level of service with less physical capital in real estate and equipment. The key to reducing the physical asset aspect of the business is office closures and consolidations, especially in conjunction with an acquisition. However, any reductions made in this area will provide only modest results. The WACC is under control and low, so little can be accomplished in this area. The place to focus the primary efforts for improvement is on the NOPAT side of the equation. This will be in the areas of expense reductions and revenue increases. These will be addressed after appropriate adjustments are addressed. Adjustments Right now, all invested assets from operations are part of the operating total capital. Should this line item be adjusted? YES! In determining SVC, the concept to apply is that excess cash as well as the traditional idea of marketable securities are adjusted out of operating total capital. The rationale is that including these assets artificially penalizes the organization and calculation results by inflating the ongoing operating total capital needs. The same concept needs to be applied to this type of business, or any organization that has a great deal of cash or equivalents, when calculating SVC. The idea is to determine the Shareholder Value Created (or destroyed) through the efficient (or inefficient) utilization of the operating assets. That is why certain adjustments are made in the calculation. You work with the CFO to determine what the adjustments are. First, how much of the invested assets from operations are needed for the ongoing operations of the business and how much has become excess and should be adjusted out? The calculation is straightforward. What is the total potential liability of all property owned and financed and all outstanding policies, etc.? Any invested assets from operations in excess of that total amount should be adjusted out and considered non-operating or other assets. This is a critical concept. Never manipulate this type of adjustment. In actuality, this total potential liability will become a different adjustment amount for each period. For the purposes of this analysis, the adjustment is based on the long-term average calculated to be in excess, which is 40 percent. Therefore, 60 percent of the invested assets from operations are considered part of the total operating capital. For valuation purposes, the amount of invested assets from operations that is removed for SVC calculation purposes is put into non-operating assets. If that amount is not put in, it is effectively lost. That would be inappropriate. It is a “hard” asset in the business and is part of the business valuation. Second, is there operating cash on the balance sheet in excess of 3 percent of operating revenues on the income statement? If so, adjust out the excess. This adjustment is made to operating working capital and either increases or decreases that amount. An excess of operating cash results in a decrease in operating working capital. A shortfall in operating cash results in an increase in operating working capital. There are arguments

224

“Secure Future” A Financial Services Organization against this second approach because the funds do not actually exist. However, we use it because it normalizes the treatment of this item over the long term. In a typical manufacturing operation, the adjustment would be cash in excess of 3–5 percent depending on the situation. Here, we recommend 3 percent due to the nature of the business and the relative equivalency of these assets. This amount represents approximately two weeks of operating expenses. The results of analysis number two on SVC and valuations with these adjustments are as follows. SECURE FUTURE ANNUAL SVC PERFORMANCE WITH ADJUSTMENTS PROJECTED ACTUAL Year

Period NOPAT Period Cost of Capital Period Operating Total Capital Two Period Average Total Capital SVC (SVD) Period Change

2004 $1,805

2003 $1,862

2002 $2,003

2001 $1,850

2000 $980

1999 $3,310

1998 $3,346

8.77%

8.77%

8.77%

8.77%

9.29%

10.68%

11.05%

$15520

$7394

$6166

$6278

$2031

$6161

$6830

$11457

$6780

$6222

$4154

$4096

$6496

$6664

$800

$1,268

$1,457

$1,486

$599

$2,616

$2,610

($467)

($190)

($28)

$887

($2,017)

$6

($280)

Making these adjustments provides continuously positive results, at least for the duration of the analysis, and better reflects the economic condition of the organization. It is a serious concern that the trend is still declining.

225

Creating Shareholder Wealth

SECURE FUTURE SVC VALUATION WITH ADJUSTMENTS Millions $ Sales Growth Rate:

YEAR 2002 2003 2004 2005 2006

Terminal Value Growth Rate:

1.50% 5.00%

2001 WACC: Est. SVC $1,457 $1,268 $800 $322 $50

8.77% PV $1,340 $1,071 $622 $230 $33

Terminal Value: Present Value of SVC: + Invested Capital 2001: = Value of Operations: + Non-operating assets:

$872 $4,168 $6,278 $10,446 $18,129

= Total Entity Value: - Value of Debt:

$28,575 ($13,978)

= Equity Value of Firm: Value per Share: 2001 Shares Outstanding

$14,597 $33.12

Making these adjustments results in significant improvements in the valuations. This is expected and is appropriate. However, we note that the SVC condition is still moving in a negative direction. From a risk analysis perspective, this tells us that we are heading for trouble and must take action now! Making adjustments is often appropriate to better understand the true condition of the organization, but it does not fix operating problems. Making these adjustments also impacts the free cash flow valuation, so we need to look at the result. The valuation change is significant. The disparity between the valuations has narrowed somewhat ($48.89 per share in analysis number one and $45.74 per share in analysis number two). This is an indicator that the adjustments were appropriate to better reflect the organization’s true economic condition.

226

“Secure Future” A Financial Services Organization

SECURE FUTURE FREE CASH FLOW TO THE FIRM VALUATION—WITH ADJUSTMENTS Millions $

YEAR 2002 2003 2004 2005 2006 Terminal Value: Present Value of Operations: + Non-operating Assets:

Sales Growth Rate: Terminal Value Growth Rate: 2000 WACC: Est. FCFF $4,640 $3,889 ($2,586) $753 $2,208

= Total Entity Value: - Value of Debt: = Equity Value of Firm: Value per Share: 2001 Shares Outstanding

1.5% 5.00% 8.77% PV $4,266 $3,287 ($2,010) $538 $1,450 $38,479 $46,010 $2,721 $48,731 ($13,978) $34,753 $78.86

At this point you are still making observations and preliminary recommendations. So your analysis is done without the full involvement of managers in the various organizations and regional offices. They will soon become active participants in the process. From your initial analysis of this business and industry you made four recommendations. One was to focus on reducing operating expenses as a percent of sales, consistent with the intentions of the executives. Now, with involvement from the functional managers, you see that this recommendation is appropriate. It is also apparent that achieving positive SVC results in the future will not require improvement all the way to the 70 percent goal right away. The transition can be accomplished over time. You also find that some organization and operating changes might be appropriate to support this goal. It is apparent that debt needs should be reduced to increase the valuations and improve the operating cash flowing through the business. Non-interest bearing current liabilities should be reduced to a positive operating working capital condition, even though this will contribute negatively to the SVC results.

227

Creating Shareholder Wealth

Operations Organization The company has a streamlined organizational structure. An executive vice-president is located at corporate headquarters. Vice presidents for the three operating divisions are also located at the corporate headquarters. General managers are at regional offices with managers located at field offices. This structure is consistent with the basic philosophies of Creating Shareholder Wealth calling for no more than three levels of management at any geographic location or region. The question is how can the organization contribute to reducing physical capital requirements and operating expenses while maintaining a high level of customer service. The pricing and receipts division has personnel at corporate headquarters and in the regional offices. The belief is that this structure enables the company to respond more quickly to pricing needs in regional market competitive conditions as well as to provide a high level of customer service in billing and receipts. A strong feeling exists throughout the organization that this structure should continue. Presently, the physical structure for product sales and claims is set up in two different ways. There are offices in urban areas that are within approximately ten miles of each other. This results in a high number of office locations. The purpose is to provide a high level of customer service with convenient customer access with a short travel distance to customer locations. This structure has existed for over sixty years. In rural areas, personnel generally work out of their homes. There are widespread rural offices that serve as sub-regional office locations because they support a large geographic area. Rurally, the company attempts to have personnel necessary to service any customer need within twenty miles. This total structure results in a high number of personnel and a high level of customer service satisfaction. There is widespread agreement that this structure can, and should, change. The investments division has the bulk of its personnel at corporate headquarters with some personnel located in the financial centers around the world. Most investment decisions are made centrally. However, the company wants highly qualified key people in the financial centers to establish and maintain business relationships on a personal level. The local personnel at the financial centers have a tremendous amount of influence on investment decisions and are trusted people in the company. Here again a strong feeling exists that this structure needs to be maintained. You also note that the company lacks an extensive Web site. What does exist was developed over three years ago and is only informational. It is well done, user friendly, and contains good information on products, services, and office locations with contact information; however, it lacks any customer service capability.

228

“Secure Future” A Financial Services Organization After lengthy individual meetings as well as several group meetings, there is a conceptual recommendation to reduce operating costs and physical assets as follows: 1. Expand the Web site capability to include full customer service. • Complete product information • Price quotes • On-line product ordering, subject to passing a physical examination where applicable • On-line invoicing and payment • On-line claim submissions and processing • Customer profile and account maintenance • E-mail contact information for inquiries and suggestions • Multilingual capabilities • Investor relations • Newsletters 2. While the site is being developed, explore the ramifications of closing urban offices so that all urban offices are within approximately twenty miles of each other. 3. Evaluate the possible closure of some regional offices. 4. Evaluate staffing requirements as a function of various usage levels of the Web site by customers. 5. Develop options for reducing staff costs and/or staffing levels while maintaining the historic company practice of not laying-off personnel. • Develop a generous early retirement plan. • Develop a generous buyout plan. • Develop a job-sharing plan. • Evaluate flexible scheduling possibilities. With this framework in place, the executives recognize the need to fully involve the regional general managers and office managers. Everyone in the company needs to have an opportunity to be part of the solution and to be heard. You prepare to travel to the various regional locations with executives to meet with those managers to begin that process. Part of those preparations includes developing an initial time frame and schedule for the entire process. Support Organization Feeling good about the developments so far, you meet with the executive vicepresident of corporate staff. She was promoted to her position after spending almost ten years in the Operations Organizations, then transferring to the Support Organization as a general manager, and eventually moving into her current position. She understands every aspect of the business from direct work experience. She has two Master’s degrees, one in general management and the other in finance and business economics. She also has a

229

Creating Shareholder Wealth

strong background in marketing. She loves what she does and enjoys the wide range of responsibilities of her position. Many believe that she could become company president. She has been involved in several of the operations meetings and supports the developed process. She has been advocating expansion of the Web site since its initial development and believes it will enhance customer satisfaction and make the firm more efficient in the marketplace as well as more competitive. She feels there are things her organization can do to reduce costs in the business, but she wants to wait to hear what the general managers and mangers recommend. You meet with the quality assurance general manager. He is responsible for ensuring compliance with company processes and procedures as well as applicable laws and regulations. His group also approves the format of forms and documents used throughout the company from a compliance perspective. As a result, there is a wide range of capabilities in this group, including many people with multi-lingual skills. He likes what he does, but he would also like to experience more of the business. He lacks specific recommendations for cost and process improvements in his organization. He believes they operate efficiently and have the correct staffing levels. The corporate staff general manager suggests that with the Web site expansion, the staff structure will need to be modified. One question he raises is how the Web site database will be maintained, internally or outsourced. He advocates entirely outsourcing the Web site in its current format. He is unsure that it is a good idea to continue outsourcing with all of the information that the expanded site will have. Information technology services for the company reports in his area and he expects that to continue in the future. He sees a need to expand that group in size and capability to properly support the new Web site. You move on to the office of the human resources vice president. He likes his job but is also feeling unchallenged. He gets excited when an acquisition is taking place and has fun bringing top-notch people into the organization. He is concerned about what seems to lie ahead. He sees the need to re-evaluate the historic practice of not laying people off. He participated in the meeting with the Operations Organization and helped develop the staff reduction proposals. He is unsure they will yield the results the company needs, especially if there are acquisitions in the future. In meeting with the general manager of engineering you find that he is from the “old school” and has a great deal of technical knowledge. His function is responsible for maintaining all properties owned by the company. He advocates reducing the number of office locations and “getting people back to work.” He thinks the company is overstaffed by about “20–30 percent.” He is beginning to calculate the potential savings in energy use, janitorial services, maintenance, etc. by reducing the number of offices. He isn’t excited about his job, but he supports the success of the organization. He looks forward to retiring in seven years and is beginning to “count down.” You meet with the purchasing general manager and find her to be capable, detail oriented, and bored to death. She is frustrated with her job because it provides no challenge to her any more. She has negotiated long-term low cost contracts with drop shipments on demand for nearly everything the company needs everywhere in the world.

230

“Secure Future” A Financial Services Organization She likes the opportunity to travel as part of negotiating those contracts. She approaches these trips as additional vacation time with some business mixed in. In talking with her you find that she feels strongly about two things. First, she wants a different job in the company and would like to become the corporate controller. Second, she feels that the staffing level in her function should be reduced by about one-third. She recommends a staff of six people in the corporate office and one person in each regional office. You meet again with the CFO and she is starting to develop the modified financial statements based on the proposals so far. You have lunch with the executive vice president of the Support Organization and relate the thinking of the managers. In this session, she begins to discuss her concerns that purchasing is fragmented throughout the company. She relates how information technology has the responsibility to set company wide standards for software, but the functional organizations decide for themselves when to buy needed hardware and the standard software. They also decide what type of hardware to buy. This has led to a wide range of different types of computers, monitors, printers, and scanners. She sees this lack of equipment standardization as costly. There is a resulting inability to get better deals on equipment costs, installation costs, and support contracts. She wants IT to identify standards for all computer hardware and software. She also wants the purchasing general manager to buy these items with the same efficiency as she buys other items for the company. You also learn from her that IT standardization alone could reduce operating costs about 1 percent across the company based on calculations she has made with the CFO. She believes that all the recommendations for her organization combined could reduce total operating expenses about 1 percent for the remainder of 2001, 2 percent in 2002, and 4 percent in 2003. After that, she believes costs will level and then begin to increase again due to inflation. The CFO is at this lunch meeting with you and agrees. It becomes clear that these two executives have already given thought to these issues. You ask what plans they have to move forward and why they have not already taken some steps in that direction. The executive VP relates that she started to talk about standardization several months ago and was poorly received inside and outside her own organization. People had their personal preferences and did not want to give up control. She goes on to wonder if that might be different now given the circumstances. Suspecting that she has already started to do so, you suggest she put together a communication plan showing the benefits of IT standardization to the individuals and the company. Her response confirms that she has done a good deal of work on a plan and will complete it for presentation. You also discuss the need to reduce non-current non-interest bearing liabilities to improve the operating working capital position of the company. The individuals at the meeting with you are unsure they agree with this need since the free cash flow of the firm is healthy. They do agree to run the analysis. The accounts payable needs to be brought current. Doing so will reduce this line item by 40 percent. Some current liabilities can be paid reducing that line item by 10 percent. The same applies to accrued expenses. To maintain the firm’s cash position, the analysis will be done accomplishing these reductions at year-end 2001.

231

Creating Shareholder Wealth

As expected, this analysis negatively impacts SVC results in a manner that is unacceptable to the executives. They decide not to change the way the CFO manages this aspect of the business as long as the cash flow needs of the business are being met. They recognize that accounts payable will be reduced by the amount of monthly lease expenses on closed offices. You have been working with the Operations and Support Organizations to prepare a detailed analysis. At this point you are ready to work with these organizations on detailed waste elimination and CLOSEDMITT analysis. These will be addressed in detail in the individual sections for those organizations. Phase 1—Step 3 Shareholder Value Created Working with the CFO, you run the preliminary analysis with these initial projected costs and savings identified thus far. • Reductions in operating costs consistent with the estimates from the lunch meeting • Closing about one-half of the urban offices • Expanded Web site costs for development and support These anticipated savings do not result in meeting the target of operating expenses less than 70 percent, but the operating expenses would be reduced to 76.1 percent in 2004 in this analysis. There is agreement on the projected costs associated with the expanded Web site. The question is whether it can be fully operational by year-end. Shareholder Value Created and valuations are impacted as follows.

232

“Secure Future” A Financial Services Organization

SECURE FUTURE ANNUAL SVC WITH ADDITIONAL SAVINGS (Analysis #3) Year Period NOPAT Period Cost of Capital % Period Operating Total Capital Two Period Average Total Capital SVC (SVD) Period Change

2006 $2448

2005 $2397

2004 $2264

2003 $2416

2002 $2443

2001 $1726

2000 $980

8.77

8.77

8.77

8.77

8.77

8.77

9.27

$24040

$19304

$13907

$5735

$4466

$4161

($87)

$21672

$16606

$9821

$5100

$4313

$2037

$3037

$546

$940

$1403

$1969

$2065

$1548

$698

($394)

($463)

($566)

($96)

$517

$850

($1918)

Valuations Equity Value of Firm (Millions $) Value/Share @ 2001 # Shares

Free Cash Flow $34,239 $77.69

SVC $24,917 $56.54

It is noted that the SVC condition is projected to improve considerably and the valuations are moving closer together as the analysis becomes more detailed. The price per share spread is now narrowed to $21.15. These results make it apparent that the organizational improvements suggested should be implemented. However, the fact that NOPAT is flat and SVC resumes its decline causes concern in several respects. One is that an effective incentive compensation bonus plan probably still cannot be developed. Others disagree, noting that adjustments can be made in the payout percentages in subsequent years until the acquisition benefits are realized. Another concern is that ways must be found to increase the rate of sales growth independent of the contemplated acquisition. In addition, more savings need to be identified to reduce operating expenses to 70 percent or less by 2004.

233

Creating Shareholder Wealth

It is now apparent that an analysis needs to be done including the acquisition. This acquisition is expected to increase sales an average of 20 percent per year and operating costs by 15 percent a year based on information provided by the executives of Income Protection, the firm that would be acquired. It is agreed that additional analyses must be completed: • With additional savings even though they are not yet identified • With accelerated growth in sales of 1 percent per year beginning in 2003 • Combining these two conditions. • Combining this third analysis with the acquisition • The acquisition with the analysis shown above Those results are as follows.

SECURE FUTURE ANNUAL SVC ANALYSIS WITH OTHER SCENARIOS Millions $ Year 4) Analysis #3 with additional savings 5) Analysis #3 with accelerated growth 6) Analysis #3 with additional savings and accelerated growth 7) Combining the above analysis with the acquisition 8) Analysis #3 with the acquisition

2006 $873

2005 1,261

2004 $1,723

2003 $1,961

2002 $1,970

2001 $1,362

$1,338

$1,341

$1,512

$1,883

$1,880

$1,362

$1,511

$2,200

$3,072

$3,121

$3,217

$1,362

$1,687

$2,235

$3,170

$3,186

$3,250

$1,362

$730

$1,881

$3,099

$3,446

$3,397

$1,176

234

“Secure Future” A Financial Services Organization These analyses indicate that scenario #8 is the one to choose for the following reasons: • • • •

It maximizes SVC for the next several years. It is the most realistic in terms of achievable savings in the near term. It lays the foundation for identifying additional savings and growth opportunities in the actual environment that will exist rather than a projected environment. It offers the greatest potential for future valuation growth.

The valuation analyses also indicate that choosing analysis number three with the acquisition is the right choice. The acquisition provides immediate benefit to the organization and should be pursued. This is also the scenario with the lowest operating expenses as a percent of sales.

VALUATIONS FOR DIFFERENT SCENARIOS Millions $ (4)

(5)

(6)

(7) (8)

Analysis #3 with additional savings Analysis #3 with accelerated growth Analysis #3 with additional savings and accelerated growth Analysis #6 with the acquisition Analysis #3 with Acquisition

Free Cash Flow

FCFF per Share

SVC

SVC per Share

$39,242

$89.04

$35,218

$79.91

Spread $9.13

$28,584

$64.86

$43,385

$98.44

$33.58

73.9%

$30,685

$69.63

$50,632

$114.89

$45.26

63.5%

$30,705

$69.67

$54,079

$122.71

$53.04

62.6%

$34,150

$77.49

$38,781

$88.00

$10.51

60.3%

235

Share Price

Operating Expenses 2004 71.4%

Creating Shareholder Wealth

After considerable discussion, the board of directors and company executives agree to pursue analysis number eight as the scenario most likely to be successfully accomplished. The target date for completing the acquisition is set for year-end 2001. They also commit to pursuing additional savings and growth in revenue once the acquisition is completed and the “dust settles.” This is expected to mean that additional savings identified would be implemented in late 2002 and early 2003. It is hoped that the end of 2002 can realize accelerated growth beyond the acquisition. Two key factors in this decision are the level of operating expenses to sales percent and operating working capital becomes positive immediately and grows rapidly in the analysis. Incentive Compensation Plan With these decisions made, the incentive compensation implementation team suggests developing a compensation plan to pay out 20 percent of actual SVC in the period at the corporate level beginning year-end 2001. 2006 $146

Projected SVC Payout (Millions $) 2005 2004 2003 2002 $376.2 $619.8 $689.2 $679.4

2001 $235.2

It is expected that there will 17,582 on the payroll at the end of 2001, prior to the acquisition, based on analysis of the savings identified. Based on total and average payroll, each person would receive SVC payments of 14.1 percent of their compensation if the SVC projection is met. The team believes that there should be a cap of 20 percent of salary to avoid extreme fluctuations in payments that individuals receive in the next several years. This is in conflict with the concept of an uncapped bonus compensation plan. The rationale is that this proposal provides substantial bonus compensation right away and more than doubles the expected compensation in 2002. This approach also leaves considerable funds in the business to support further savings improvement implementation and to pursue additional acquisitions. The primary reason for this cap is that the team believes making payments that are the result of an acquisition made by the executive group, rather than the organization’s efforts, would be inconsistent with the desired culture and goals of the incentive plan. An agreement is reached to evaluate removing this cap after two years, depending on what additional savings and growth opportunities are identified. All other elements of the Creating Shareholder Wealth proposed incentive plan would apply. Training The executive and management groups have received training, and you now assist in developing the training plan details for the rest of the company.

236

“Secure Future” A Financial Services Organization Communication You turn your attention to the communication implementation team. This is a creative group with a number of excellent approaches to information sharing. Members of this team developed and maintain the company Web site. The team has three approaches: • Expand the intranet site to include “near” real-time detailed information on the status of the entire process via weekly updates on the site. • Monthly meetings at each company location, led by an executive, to discuss progress and status. Each venue would include recent success stories with a focus on the people accomplishing whatever the result was. Phase 1—Step 4 You work with the teams to develop the management report. MANAGEMENT REPORT SECTION 1: Executive Summary 1.

What was the analysis goal? There were three primary goals for this analysis. The first was to determine what actions are required to achieve, or exceed, the operating expense goal. The second was to determine if the identified actions were realistic and could be accomplished. The third was to evaluate the viability of the contemplated acquisition. 2. Who performed the analysis? Members of the Creating Shareholder Wealth Leadership and Implementation Teams performed the analysis with the assistance of a consultant. 3. Summary of findings • There is no specific Strategy Intent. • There are no Strategy Goals to support the Strategy Intent. • There are no Strategy Plans to fulfill the Strategy Goals. • There is no Strategy Implementation process to enable the Strategy Plans. • There is no primary, focused performance measure with directly supporting drivers. • There are experienced executives and managers who work well together; express appreciation; are well respected. • There is a wide concern across the organization about the declining financial trends. • There is a need to reduce operating expanses.

237

Creating Shareholder Wealth

4.

Summary of recommendations • Implement the operating expense reductions agreed to by various managers. • Pursue the contemplated acquisition.

It has been determined that the operating expense goals can be achieved with a combination of closing approximately one-half of the urban offices, selected staff reductions through voluntary early retirement or buyout, and the benefits of the acquisition. The projected benefits to operating expenses are summarized as follows. Savings % of Sales Benefit Year 2002 2003 2004 2005 2006

Acquisition % of Sales Benefit 10.9% 12.5% 15.1% 10.1% 4.9%

4.2% 5.3% 4.3% 4.4% 3.3%

Total Benefit 15.1% 17.8% 19.4% 14.5% 8.2%

SECTION 2: Shareholder Value Created The following matrix summarizes the SVC projections. The projections with savings also include adjustments to the Weighted Average Cost of Capital. Millions $

Year

2006

2005

2004

2003

2002

Adjusted Projections

$50

$322

$800

$1,268

$1,457

Adjusted With Savings

$546

$940

$1,403

$1,969

$2,065

Adjusted with Savings and Acquisition

$730

$1,881

$3,009

$3,446

$3,397

The current projections show that the business is not moving in the right direction. The agreed upon savings result in significant improvement but also demonstrate that further improvements will be required in the future. The acquisition will yield great benefit, but the need for future operational improvement is still indicated.

238

“Secure Future” A Financial Services Organization SECTION 3: Incentive Plan The goal of the recommended plan is to pay a substantial portion of SVC to every employee in the company and to use this plan as one tool to create incentives to achieve desired performance levels. The plan guidelines are as follows: • Include all employees in the same plan. • Pay out 20 percent SVC results. • Limit payments to 20 percent of salary, at least for the time being. SECTION 4: Lean Manufacturing/Business The Operations and Support Organizations have reached agreements that will contribute to improved SVC results as indicated above. 5S Summary: • Offices and workflows are being rearranged. • Office supplies are consolidated at work cell locations. • Office supply costs are expected to be reduced. CLOSEDMITT Summary • Approximately one-half of the urban offices will be closed. • Operating expenses will be reduced in both COGS and S,G,&A • The excess cash in the business will pay for improvements, increased growth rate, and accelerated debt reduction • Additional realized savings will be included in future SVC and financial projections •

Other Findings None

END OF REPORT

239

Creating Shareholder Wealth

Operations Organization Introduction You have begun your work with the Operations Organization by meeting with the executive vice president and the various division managers. You provided initial process training and the result has been meaningful agreements and decisions that impact the organization structure. These changes result in reductions in cost of goods sold and sales, general, and administrative expenses on the income statement. Those anticipated reductions were reflected in the previous analyses. Office Closures An agreement is reached to close approximately half the urban offices. Part of this decision is that closed offices would all be leased locations when possible. Offices in buildings owned by the company which include other tenants would be closed as a second-tier decision. These closures are to take place through the remainder of the year so that all closures are in place by the beginning of 2002. Regional managers are assigned the task to work with their office managers to identify all urban offices on maps and decide which ones to close based on the geographic goal of having offices approximately twenty miles apart. Consideration is given to local conditions, such as weather, amount of business done in the office as opposed to customer homes, local culture and habits, and road conditions. Staff Reductions Staff reductions required as a result of office closures are to be accomplished in the most positive manner possible. The steps in this process are: 1. 2. 3. 4. 5. 6. 7.

Identify the personnel at closed offices by job function. Identify the ongoing staffing requirements Establish out-placement services in each urban location. Offer early retirement, with full benefits, to anyone age sixty or older. Offer early retirement, with one-half benefits, to anyone age fifty-five or older. If the early retirement offer results in an excess number of volunteers, cut off the offer at the point where business needs are met using “first come—first serve” as the criteria. For those whose positions are eliminated as a result of the office closures and who are ineligible for early retirement, offer a six month buyout at full pay and benefits. If this results in an excess number of volunteers, cut off the offer at the point where business needs are met using “first come—first servce” as the criteria.

240

“Secure Future” A Financial Services Organization All of this must be done with great care. You do not want to lose too many senior expereinced people. Doing so could weaken the business, resulting in reduced efficiency and increased cost. There is nothing wrong with offering buyouts to younger people for the purpose of retaining more expereinced people. The people who respond the quickest to such offers are the ones in the best financial position to leave or are the most eager to leave. The slower the repsone, the more thought is being given to the decision. You want to retain those who are most interested in remaining with the organization. Lean Business The next question is how to realize cost savings goals without sacrificing customer service or operating efficiency. The answer lies in workplace organization and waste elimination. You work with all of the managers in the organization to identify opportunities. Remember that workplace organization comes in the form of the 5Ss, which are: • Sort items by what is needed at the workplace to perform the job function requirements. • Simplify the workplace arrangement. • Sweep and clean the workplace daily. • Standardize workplace processes as practical. • Self-discipline is essential to sustaining improvement. The other ingredient to realizing the desired savings is the CLOSEDMITT analysis. We will apply this to the organization’s main offices and then to each function within the organization. Organization Level Workplace organization—5S means several things. It applies not only to the individual workplace but also to the general workplace and environment. Sort through all items at all workstations. Remove any items that are unnecessary to the tasks performed at that station. This does not pertain to personal items. However, no one should have personal items at the workplace that interfere with providing good customer service. Items removed should be grouped together for redistribution to areas where they are needed. Unclaimed items should be put into inventory for future use where there is an anticipated need. Items that are unecessary should be disposed of. This might mean giving them to charity. Predictably, you find that people have been “hoarding” office supply items. There should be no more than what is immediately required at any station. All excess items are gathered together and placed into an inventory cabinet central to three or four stations so needed items are readily available.

241

Creating Shareholder Wealth

Simplify the arrangement of each workstation by placing the most used items within close reach and the least used items further away, but still within easy reach. This may mean providing new types of workstation equipment and/or fixtures. This could mean single level bookshelves at each desk or new style chairs. You need to be creative. This area of workplace improvement also applies to the entire environment and work flow. Most companies arrange workstations by grouping together similar tasks. This is the wrong thing to do because it increases the time, energy, effort, and costs associated with flowing tasks through the organization. Simplifying the workplace also means simplifying the work flow through the workplace. Think about how “deliverables” flow through the process and arrange the workplace accordingly. Wherever possible, an individual performing a task should be able to see his or her “customer.” Sweep and clean the work area daily and as frequently as necessary to maintain an orderly and efficient environment. Standardize the work process as much as practical at every workstation. When a person moves from one workstation to another, they will be more productive and produce a higher level of quality through this familiarity. Self-discipline is essential to success and it is your responsibility as a leader to set the example. The analysis shows that throughout the organization there is modest potential for reductions in operating expenses at all of the company’s locations. Your experience tells you that about 70 percent of potential savings are realized. The team recognizes that more savings will be required to beat the 70 percent target level. CLOSEDMITT analysis leads to several changes in the work environment and process flow after offices are closed. Applying these concepts to the Operations Organization at the organization level results in a rearrangement of the environment to open space where people can see each other but are not so close together that they feel a loss of privacy. Several cabinets are put in place to provide supplies when required. Considerable savings in office supply costs are expected as a result of this consolidation. In the short term, no supplies will need to be ordered for several months as a result of office closures and removing excess items from individual desks. Complexity: The team recognized that with the appropriate arrangement of equipment and people into work cells, the customer service process would be less complex. The work flow would be streamlined. This also applied to the administrative aspects.

242

“Secure Future” A Financial Services Organization Labor: Unnecessary steps and movement were eliminated by setting up work cells, placing required inventory within the cells, and placing all personnel (including administrative) who support that cell within and adjacent to the cell. This also helps reduce the process complexity. Overproduction: The team recognized that inventory is bad and detremines that only a minimal amount of units will be held in between work cells. In this case, the “units” are packages of paperwork for a customer whose order for products or services is in process. The goal is established that there will be no more than one package in queue at any station in the process flow. This establishes the basis for “single unit flow.” Space: The new layout and process flows will reduce space requirements. As a result, it is expected that the remaining offices will have more throughput capacity than existed prior to the closures. Energy: The new physical structure reduces the consumption of human energy and enables people to be more productive. There will be less energy consumption, and utility costs per unit of production are significantly reduced. This is a function of the office closures and the fact that more than twice as many sales personnel are working from their homes after the office closures. Defective Goods and Materials: There has always been an outstanding quality record. The goal of no rework, scrap, or defects is even more acheivable with the goal of single unit flow and the improvements resulting from the new layout and process flow. Materials: The analysis shows that there can be significant overall material and labor savings by purchasing a number of specific items through bulk purchasing agreements with major office supply companies and arranging for drop shipments as required. This also will contribute to the reduction in space required since these items can now be taken directly to the appropriate work cell. Idle Materials: The steps above will help ensure that there are no idle materials. Single unit flow with minimal inventory levels and all inventory at the work cell requiring it will keep materials moving. Time: These improvements will result in shorter processing times and increased customer service. Transportation: Nothing is moved that does not have to be moved, and the transportation distances through the work cell are short. With inventory at the work cell there is only a few feet of transportation. With all support personnel at the work cell there is only a short distance for any information or documentation to flow. Goods are handled only one time at each of the few steps in the new process.

243

Creating Shareholder Wealth

The basic process flow is as follows. Block sizes are unrepresentative of space allocations. Inventory should be at the point of use as much as possible, not in storage locations.

Sales Support Personnel and Equipment Maintenance Pricing and Receipts Division

Electronic Funds Transfers and Package Transmittal

Product Sales and Customer Support Personnel

Regional Receipts Division Personnel

Regional Pricing Division Personnel

Product Sales Division

Summary The plans agreed upon will result in substantial savings and improvements in customer service, but it does not achieve the total savings targets previously identifed. Members of this organization are excited about the changes and the benefits to the business. They are also excited about the financial opportunities that will come from the incentive compensation plan. This was accomplished with the use of the workplace improvement 5S and CLOSEDMITT analysis. It was also accomplished by looking at the company from a global perspective and through the eyes of the owners.

244

“Secure Future” A Financial Services Organization

Support Organization Introduction You have begun your work with the Support Organization by meeting with the executive vice president and the various functional managers. You provided initial training on the process and the result has been meaningful agreements and decisions that benefit operating expenses. The Support Organization implements the same workplace and CLOSEDMITT improvements that were identified previously, as they apply to their environment. They contribute to the goal reductions in S,G,&A. At the corporate offices, the Lean Business Implementation Team has made rearrangement recommendations that make the division between the two organizations almost invisible along the work cell concept. This is a good thing in that it brings them closer together and enables them to function as a team. Purchasing This function will absorb the inventory control responsibility consistent with the final agreements. Bulk purchasing agreements will be negotiated along with drop shipment agreements. The bulk purchasing and Just in Time delivery agreements will contribute to savings in cost of goods sold. The JIT drop shipment aspect also provides reductions in total capital by reducing space requirements at offices making it easier to close the desired number of offices. Human Resources This functional manager is busy with his teams developing the incentive compensation plan and communications processes. He is also involved in his role as the primary person responsible for developing the training packages for Creating Shareholder Wealth and the staff reduction packages. As part of his interactions with the LBIT, he sees a need to strengthen the regional human resources offices around the corporation. They need to have experienced trainers and they need to understand more about business operations. They also need to be a focal point for the identified staffing changes. He sees that the world of human resources is changing rapidly and he must keep up with those changes. The typical human resources person of the past was not much more than a clerk. Even today, in many companies and situations, human resources is seen as a clerical function and often an obstacle. To some extent that has been true in this company. The human resources manager has a goal of changing this and moving the function further into the business mainstream and of making cost savings contributions to the business while also strengthening the business. He asks how can this be done and asks for your help developing a plan. Summary The result of the agreements reached is a more efficient organization, a higher level of morale and productivity, reduced costs to the business, an improvement in customer service, and a higher level of teamwork throughout the company.

245

Creating Shareholder Wealth

The Acquisition The executives of Secure Future contact their counterparts at Income Protection to schedule a meeting to move forward with the acquisition. Since both parties have had extensive sessions already to establish the basis for this transaction, the meeting is scheduled for the following week. At that session, the terms and timing of the acquisition are conceptually agreed upon. The executives of both companies fully recognize that the assimilation process is a daunting task ahead. So, how is it best accomplished with minimum disruption? Remember the discussion concerning the rumor mill? Never let the informal organization or the rumor mill take control of the communication process. To keep control and minimize the impact of rumors and allay the natural fears that people may have, do the following three things: 1. 2.

3.

Set up an integration leadership team and functional integration teams staffed by key individuals from both companies. Set up an information hotline that anyone can call day or night to receive the most current information available on the acquisition. Have this hotline staffed at least twelve hours a day six days a week with knowledgeable people possessing excellent verbal skills. Take Sunday off. Communicate, communicate, communicate. • • •

Set up a dedicated section on the company’s Web site with all current information. Have regular information meetings from informal small group sessions to large formal meetings. Post bulletins with news flashes.

The names of these teams are important. The term “integration” is used rather than “acquisition” in the titles of these teams. Approach the process as a partnership for the ongoing success of both companies and their employees, not as one company having power over the other. This is a team effort from day one and no individual or group can be made to feel as a “second class citizen.” Integration Leadership Team This team manages every aspect of the process from the time an agreement is reached until all aspects of assimilation are complete. Its makeup is the same as the Creating Shareholder Wealth Leadership Team. Members are from both companies. This structure ensures that counterparts are in regular communication and the best decisions are made.

246

“Secure Future” A Financial Services Organization Within this team are the other Creating Shareholder Wealth equivalent teams: • • • •

Financial integration team Incentive compensation integration team Communications integration team Lean Business integration team

This leadership team makes all decisions relating to the acquisition and assimilation process. Prior to the actual acquisition date, there may be legal limitations on what information can be exchanged or publicly disclosed, especially if one or both companies are publicly traded. Be sure to obtain legal advice from a qualified attorney on this or any other issue during the process. Along the way, it is certain there will be disagreements as to the best approach for some decisions. Something is wrong if that does not happen. These disagreements can range from minor to serious. The subordinate teams must be chartered with resolving those disagreements themselves. The leadership team should resolve disputes as a last resort. These people must learn how to work together. The most critical role the leadership team has is to provide a Strategy Intent statement for the acquisition that is clear and inflexible. For example, the Strategy Intent statement might be: “To complete an orderly and effective acquisition for both organizations.” Once the subordinate teams are established, the answers to the other critical questions must be developed as they pertain to the acquisition process. What are the Strategy Goals? To complete the acquisition and assimilation: • • • •

On time Within budget With no lawsuits With an openly satisfied workforce

What are the Strategy Plans? These are summarized as follows: • • •

Develop a time line for the acquisition process. Develop budgets for every aspect of the process. Retain a public relations consultant to guide internal and external communications.

247

Creating Shareholder Wealth

How is the Strategy Implemented? Establish integration teams with full authority, responsibility, and accountability for every aspect of the process. These teams are: • • • •

Financial integration team Incentive compensation integration team Communications integration team Lean Business integration team

How is Performance Measured? Results are measured by the following: • • • •

Was the acquisition completed on time? Was the acquisition completed within budget? Were there any lawsuits that went forward to some form of resolution? Was the workforce satisfied based on feedback obtained from all sources?

The role of the integration leadership team has been defined. Now let’s look at the roles of the other teams. Financial Integration Team This team has the following responsibilities during the acquisition process: • • •

Develop and track required budgets. Develop integrated financial statements for the merged companies using the analyses done by the acquiring company as a foundation. Communicate all information to other teams for dissemination.

Incentive Compensation Integration Team This team has the following responsibilities during the acquisition process: • • •

Understand the incentive plan developed by the acquiring company. Understand any existing plans currently in use at the acquired company. Reconcile any conflicts.

Communications Integration Team This team has the following responsibilities during the acquisition process: • • •

Manage and staff the rumor control hot line. Develop a common communications plan for both companies. Implement that plan.

248

“Secure Future” A Financial Services Organization Lean Business Integration Team This team has the following responsibilities during the acquisition process: •

Develop a common approach to all pertinent issues, such as: o Office closures o Staff reductions o 5S implementation o CLOSEDMITT implementation

In this case, Secure Future is implementing Creating Shareholder Wealth and Income Protection is not. Since Secure Future is the acquiring company and has committed to implementing Creating Shareholder Wealth, and is well along the way in the process, Secure Future should take the leadership in introducing Creating Shareholder Wealth to Income Protection. Training of the integration teams will be required. Keep in mind that the acquisition is not yet completed so Secure Future cannot require Income Protection to adopt Creating Shareholder Wealth. From the beginning of this process, Secure Future executives should advise their counterparts about Creating Shareholder Wealth, its benefits, their own progress in implementation, and recommend its adoption in the acquisition process. This process will take as much commitment and effort as implementing Creating Shareholder Wealth in one organization. In some respects, it might take more given that there are two different organizational cultures involved. Secure Future is now in a position of implementing Creating Shareholder Wealth in its company, acquiring another company, assimilating that company, and meeting the expectations of the analyses performed and committed to by executives. This is a major task. Within any legal constraints that might apply, Secure Future should take all steps available to achieve Creating Shareholder Wealth implementation in Income Protection in parallel to its own implementation efforts. What Can Be Expected Along the Way? “Mixed reviews” would be the best summarization. If communications are presented openly, honestly, consistently, and factually, the majority of employees will be satisfied with the process. Respond quickly to any question or challenge. Those in fear of losing their job as a result of implementing Creating Shareholder Wealth and/or the acquisition will have varying degrees of fear and concern. You must give special attention to this group. Remember the IN BRIEF about downsizing earlier in the book. Have additional one-on-one communications with those people. Listen to them and support them. Go out of your way to do so. It is worth every minute you spend. Some, but not many, will challenge your fairness if you follow the process. Keep the processes that impact the workforce, and employment actions in particular, as simple and intuitive as possible. Remain visible in their application. Engage daily in informal communications with individuals and small groups.

249

Creating Shareholder Wealth

You can also expect to exceed your original budget expectations. Some aspects of the process may have expenses double the original budget. Be prepared ahead of time for this and make additional funds available. What Is the End Result? A successful acquisition and assimilation will be the result. The Strategy Intent will be met. Summary A successful acquisition means much more than buying a company, taking over its management, and realizing more profit. People’s lives are affected and this must be taken into account. By doing so, the acquisition will be successful because the assimilation will be successful. A poorly managed acquisition will become a burden financially and emotionally, resulting in a drain on the company. Productivity will decline and costs will increase. Shareholder needs will not be met. A properly managed acquisition will cost more money during the process and will require a higher level of energy and effort. It will be worth it in the final result. There will be a higher level of productivity and lower operating costs. Shareholder needs will be met.

250

“Secure Future” A Financial Services Organization

Summary and Key Philosophies Overview You have completed a successful engagement with a solid company that needed to perform at an even higher level to meet its goals and satisfy its investors. Along the way, you brought the organization to a new level of teamwork and participation. The Five Critical Questions were answered using the Concept Model and Action Model with the analysis processes described earlier. Operational The company is now leaner and more efficient. Work was restructured in a manner that improved employee satisfaction and reduced the cost of business. This contributed to reductions in operating expenses. At all offices, rearrangements are made that will result in improved operating efficiency, greater teamwork, and improved customer service. This will reduce operating expenses. Financial The goal of realizing operating expenses of less than 70 percent of sales will be realized. This is projected without inputting all the savings and profit increases that appear to be available. Total capital in the business will be reduced, NOPAT will be increased, and SVC will increase accordingly. This will be done while improving customer service. Where the projections originally showed negative Shareholder Value Created, they now show positive results and rapid growth for the next several years. Where there were no incentive compensation payments being made, there now will be payments to everyone in the company and with significant growth in the payment amounts in future years. There is increased excess cash available in the business. This will more than pay for the costs associated with implementing Creating Shareholder Wealth. It will also support an increase in the business growth rate and the rate at which debt is paid down. Both of these will further improve cash flow, NOPAT, and resulting SVC in the business in future years. The Five Critical Questions Let’s look closely at how the Concept and Action Models are used, in conjunction with the preceding analysis process, to answer The Five Critical Questions. Question 1: What Is the Strategy Intent? Concept Model: Executive Offices—One Strategy Intent Statement Action Model: Be the full service market leader in the world.

251

Creating Shareholder Wealth

Question 2: What Are the Strategy Goals? Concept Model: Operations Organization—One or Two Goal Statements Action Model: Reduce operating expenses to less than 70 percent of sales. Concept Model: Support Organization—One or Two Goal Statements Action Model: Reduce operating expenses to less than 70 percent of sales. Question 3: What Are the Strategy Plans? Concept Model: Operations Organization Action Model: Function Pricing and Receipts Product Sales and Claims Investments

Goal Statement Reduce operating expenses Reduce operating expenses Reduce operating expenses

Plan Statement Align personnel with work cell concept. Reduce staff as appropriate. Close approximately one-half of the urban offices. Reduce staff as appropriate. Manage investment activities more efficiently.

Concept Model: Support Organization Action Model: Function

Goal Statement

Plan Statement

Purchasing

Reduce operating expenses

Finance

Reduce operating expenses Reduce operating expenses Reduce operating expenses Reduce operating expenses Reduce operating expenses

Negotiate bulk-purchasing agreements with drop shipments. Reduce inventory levels. Reduce staff as a result of office closures.

Human Resources Corporate Staff Engineering Quality

Institute training programs. Support staff reductions. Reduce staff as a result of office closures. Reduce staff and outside contractors as a result of office closures. Reduce staff as a result of office closures.

252

“Secure Future” A Financial Services Organization Question 4: How Is the Strategy Implemented? Concept Model: Specific actions to implement plan(s) for each function. Action Model: Operations Organization Function

Plan Statement

Implementation

Pricing and Receipts

Align personnel with work cell concept. Reduce staff as appropriate.

Work with other functions to develop work cells and single unit flow.

Product Sales and Claims Investments

Close approximately one-half of the urban offices. Reduce staff as appropriate. Manage investment activities more efficiently.

Establish teams with the responsibility to identify offices to be closed and resulting staffing levels required to ensure customer support. Upgrade computer capabilities to real time information on all investment status; enable computerized trading of marketable securities.

253

Creating Shareholder Wealth

Concept Model: Specific actions to implement plan(s) for each function. Action Model: Support Organization Function Purchasing

Finance

Plan Statement Negotiate bulk-purchasing agreements with drop shipments. Reduce inventory levels. Reduce staff as a result of office closures.

Human Resources

Institute training programs. Support staff reductions.

Corporate Staff

Reduce staff as a result of office closures.

Engineering

Reduce staff and outside contractors as a result of office closures.

Quality

Reduce staff as a result of office closures.

Implementation Renegotiate existing supply contracts as appropriate to achieve Plan and Goal. Identify new requirements and work with appropriate functions to implement. Develop training programs specific to various functions. Develop staff reduction plans. Communicate those reduction plans. Work with functions to implement reduction plans. Identify new requirements and work with appropriate functions to implement Identify new requirements and work with appropriate functions to implement. Renegotiate outside service contracts as appropriate. Identify new requirements and work with appropriate functions to implement.

Question 5: What Is the Best Performance Measure? Concept Model and Action Model: • Corporate Level: Primary—Shareholder Value Created •

Division Level: o Operations Organization: Primary Free Cash Flow to The Firm • Net Profit Before Taxes • Sales per Employee Drivers On-Time Delivery Customer Returns Inventory Turns Sales per Employee

254

“Secure Future” A Financial Services Organization o

•

Support Organization: Primary Free Cash Flow to The Firm Net Profit Before Taxes Sales per Employee Drivers On-Time Delivery Accounts Receivable < 30 Days Accounts Payable On Time Sales per Employee

Function Level: o Operations Organization: Pricing and Receipts: Drivers o On-Time Delivery o Customer Payments On Time o Sales per Employee Product Sales and Claims: Drivers o On-Time Delivery o Sales per Employee o Claims as a Percent of Policies Investments: Drivers o Percent Return on Investments o Investment Value per Employee o Support Organization: Purchasing: Drivers o On-Time Delivery o Sales per Employee o Inventory Turns Finance: Drivers o Accounts Receivable < 30 Days o Accounts Payable On Time Human Resources: Drivers o On-Time Delivery (Training) o Sales per employee Engineering: Drivers

255

Creating Shareholder Wealth

o On-Time Delivery o Sales per Employee Corporate Staff: o On-Time Delivery o Sales per Employee Quality Assurance: o On-Time Delivery o Sales per Employee •

Manager Level o Operations Organization: Pricing and Receipts: Drivers o On-Time Delivery o Customer Payments on Time o Sales per Employee Product Sales and Claims: Drivers o On-Time Delivery o Sales per employee o Claims as a Percent of Policies Investments: Drivers o Percent Return on Investments o Investment Value per Employee o Support Organization: Purchasing: Drivers o On-Time Delivery o Sales per Employee o Inventory Turns Finance: Drivers o Accounts Receivable < 30 Days o Accounts Payable On Time Human Resources: Drivers o On-Time Delivery (Training) o Sales per employee Engineering: Drivers o On-Time Delivery o Sales per Employee

256

“Secure Future” A Financial Services Organization Corporate Staff: o On-Time Delivery o Sales per Employee Quality Assurance: o On-Time Delivery o Sales per Employee You see the consistency in the application of value drivers throughout the organization. This is very important. Each of the identified drivers directly impacts operating expenses. They are controllable or are strongly influenced by the individuals to which they are assigned. This is through the actions taken to affect these drivers. As an example, when the purchasing manager brings the right quantity of the right items into offices on a Just in Time basis, he or she is directly contributing to the reduction in total capital, reduced space required, operational efficiency, improved cash flow, on-time delivery through the value chain, and sales per employee. This flows up through the organization and the results in Shareholder Value Created. When the operations general managers accomplish work cell structure and single unit flow, they are maximizing customer satisfaction, increasing the probability of more sales from a customer, likely reducing or eliminating space required for rework, reducing operating costs, increasing throughput and operating efficiency, reducing total unit cost, and increasing sales per employee. This flows up through the organization and the Shareholder Value Created results. For each driver, we can see how the individual has control over that driver, its results, and the linkage to Shareholder Value Created. Keep in mind that no one individual or group is directly responsible for Shareholder Value Created. It is the result of other decisions and actions taken within the organization. The executive group is responsible for the overall operation of the organization and is measured accordingly by the only available measure that really tells us how the overall organization is performing—SVC. Overall responsibility—overall measure. This group is not directly responsible for any of the value drivers and is not measured by any. The picture begins to change at the division level. This group directly impacts SVC results through high-level business decisions and actions relating to their primary measures. This is done by the decisions the group makes that enable the function and manager levels to meet their primary drivers, which are the supporting value drivers for the divisional executives. The detailed steps taken to accomplish specific value drivers directly impact not only the value driver, but also the next higher-level driver and ultimately the top level SVC result. This relationship and direct linkage can be demonstrated at all levels of the organization.

257

Creating Shareholder Wealth

This is why only the top-level executive group can be held accountable for SVC results. It is inappropriate and impractical to force it down into the organization, depending on the structure of the organization. It is appropriate and practical to provide training all the way down the organization and show the linkages, but you can only hold people accountable for what they control. This direct flow-through and linkage maintains process predictability and understandability. It helps create PULSE in the organization. It is consistent with human nature. Also keep in mind how the top level of an organization held accountable for SVC results might be defined. It is different for a multi-divisional organization than a single division organization. In a multi-divisional organization like Boeing, the president of the commercial aircraft business would be measured by SVC results in his business unit, as would the presidents of the military and the space businesses. The CEO would be measured by the cumulative results. The same thing would be true of Johnson & Johnson, General Electric, or any similar organization of any size. It may also be practical to measure local operations of a multi- or single division organization by SVC results if the accounting system is set up to provide full P&L statements at that level. I discourage expenses to upgrade or replace an existing and functioning accounting system for the purpose of forcing the measure into the organization. Your funds are better-spent making improvements than increasing the level of bureaucracy. Where a legacy system is in place and operational, you may want to use it. KEY PHILOSOPHIES: Now let’s look back and see if we have fulfilled all of the key philosophies essential to continuous improvement. The Process Must Have a PULSE: Must be Must be Must be Must be Must have

Predictable Understandable Long-term Sustainable Energy

Yes Yes Yes Yes Yes

Financial: You should have two primary financial philosophies in managing your entity to achieve goals: Cash is good—We have increased the cash flow and excess cash in the business. Inventory is bad—We have reduced inventory levels and locations and increased inventory turns.

258

“Secure Future” A Financial Services Organization Performance Measures: They must directly relate to the individual’s function—At each level, the measures directly relate to the individual’s function. They must be controllable, or at least influenced, by the individual—At each level, the measures are controllable or influenced by the individual. The drivers selected must directly relate to and impact to the primary measure—At each level, the measures directly relate to and impact the primary measure. Shareholder Value Created is the right primary measure—Yes. Incentive Compensation: One plan for everyone - Yes Leadership: It is essential to survival—The training and roll-out process helped everyone understand this and there were many volunteers to help lead and implement the process. Look everywhere to find the best available—In establishing the teams and evaluating the formal and informal organizations, we identified the best people to participate on the implementation teams and their sub-teams handling specific projects. Did We Effectively Address the Initial Findings? Yes! INITIAL FINDINGS 1.

2.

3. 4. 5.

The company has a Strategy Intent to be the best provider in the global market in its offerings. It has a mission statement talking about the importance of customer service and the sensitivity that all employees should have toward the clientele. The company has a specific and appropriate Strategy Intent statement. There are no specific Strategy Goals identified that would support a Strategy Intent. The operating goals are to “maximize new sales and customer retention” and a new goal of reducing operating expenses as a percent of sales with a target of “approximately 70 percent.” There are now specific Strategy Goals that directly support the Strategy Intent. There are no Strategy Plans other than to maximize sales and investment returns. There is consideration of an acquisition. There are now Strategy Plans that will fulfill the Strategy Goals; acquisition decisions will be done utilizing SVC analysis. There is no Strategy Implementation in our sense. The executives are implementing their general plan in the manner to which they become accustomed. There is now a Strategy Implementation process that will enable the Strategy Plans. There are no performance measures beyond the bottom line profit number and its percent of sales. Reducing operating expenses as a percent of sales is being considered. There is now a primary performance measure with a few value drivers that directly impact the primary measure.

259

Creating Shareholder Wealth

6.

7.

8. 9.

The executives and managers of the corporation are all experienced, have expertise in their individual areas of responsibility, generally work well together, are committed to the success of the business and to a high level of customer service, expect a great deal from everyone in the organization, regularly express recognition and appreciation, and are well respected throughout the organization. There is no apparent dissent to speak of, just normal healthy debate about the best direction for the business. The process will enhance this condition. The managers of individual locations and divisions are capable and competent. They are pleased with the business operation and feel they are doing the best they can. There is an underlying awareness that the business is heading toward tough times. The business will be more successful. Incentive compensation is forthcoming. Open, honest communication will continue and will be more frequent and directly related to performance and success stories. You agree with the operating expense goal of 70 percent and feel it should actually be less than 65 percent. There is now full clarity as to the direction of the business and how it will move forward on its chosen path to achieve this goal. The financial results analysis shows a growing negative operating working capital condition. This condition becomes positive as a result of the decisions made.

Were Your Initial Recommendations Implemented? 1. 2. 3. 4.

Implement Creating Shareholder Wealth.—Yes. Focus on reducing operating to increase NPBT.—Yes. Perform a comprehensive SVC analysis of the company with, and without, the anticipated acquisition. —Yes. Evaluate the organizational structure for options to better align authority, responsibility, and accountability with the required goals and stated Strategy Intent. —Yes. No organization chart changes are anticipated or required. The Strategy Goals and Strategy Intent are met by implementing the decisions made.

We Have Created Shareholder Wealth!

260

Part Four Questions and Answers Over the last several years of various implementations and during the development of this book, I received a number of questions that have been interesting and helpful. It seems appropriate to address some here. 1. You talked about addressing both sides of the equation to realize improvement. In the first case study there are no improvements to total capital shown. Why is that? In this situation, total capital will reduce as a result of selling two manufacturing facilities and reducing inventory levels through bulk purchasing and JIT delivery. However, at the same time, the business is continuing to grow at a strong rate. This will result in an increase in the total capital and corporate level inventory. This is predictable. The reductions are a temporary blip and do not show up in the analysis. They are hidden in the overall results in the sense that they are no longer part of total capital or inventory as a result of the improvements made. If the company were stable and not growing in terms of acquiring additional facilities, this reduction would be reflected in the analysis. However, the reduction in inventory level may not show up as a function of the number of services provided to clientele. The business would realize the benefit of improvement, but the increased number of services provided may result in increased inventories. The benefit is still there, it is just hidden due to the business condition. Keep in mind that total capital is both absolute and relative. The goal is to reduce the amount of capital required to deliver product and/or service to the marketplace. It is absolute in the sense that it has a finite value. It is relative in terms of throughput. For SVC improvement, total capital reduces whenever a greater amount of quality throughput results from the amount of capital required to generate that throughput. Maintaining the

Creating Shareholder Wealth

current level of total capital while doubling throughput benefits SVC. Maintaining the same level of throughput with half the original capital also benefits SVC. 2.

How can an organization in this type of situation reduce total capital? Total capital is both absolute and relative. There is a finite value to the elements of the equation. This company happens to have a condition where its net property, plant and equipment, and the inventory aspect of operating current assets represent its total capital. The other elements of the equation are operating current assets as a whole, non-interest bearing current liabilities, and other operating assets net of other liabilities. Most organizations will have these on their balance sheets and can identify them to provide focus for improvement opportunities. 3. Why don’t the first case study projections go out for at least three years? The company has been in operation for only three years and is growing rapidly. That growth rate is expected to slow somewhat in the projected two-year period. In this example, there is little to be gained by extending the projection. What is most critical is to project a relatively short-term period that is substantially controllable. As I stated earlier, the most meaningful projections are short term. As each quarter passes and actual results are known, the projections are extended. Once the first year implementation period is over, the projections should extend out for three to five years. There will be reliable information as to how successful the implementation has been, how much excess cash is available for debt reduction and growth, and how any additional opportunities realized that were not part of the initial projections have benefited the firm. 4. You talk about deciding on the level of implementation and that it is best to do full implementation. How do executives decide this? There are several aspects to consider in making this determination. One is the culture. Are the two cultures sufficiently aligned and conducive to successful implementation at any level? To what level? What steps are necessary to further align the cultures? Second, what is the true level of executive and management commitment to measuring SVC down into the organization? In a company like Boeing that has divisions that can operate as though they were independent businesses, SVC should be taken to that level and consolidated at the corporate level. In a company with a strong accounting organization, SVC can be taken down to the plant operating level. Most organizations are not set up to do this effectively and consistent with human nature. So, in most cases, SVC will be determined at the corporate level and value drivers will be the measures at other levels. However, everyone needs to be trained on and understand what Creating Shareholder Wealth and Shareholder Value Created are about and how their efforts directly impact results. At least one major consulting firm implementing value-based management advocates matching the level at which economic profit is measured to the level at which the incentive plan is offered. I absolutely disagree with this. Everyone in the organization should share in the risks and benefits of the operation. Not everyone has to be measured by SVC results alone. The best approach is to base incentive compensation on blended results,

262

Questions & Answers

those directly controlled by the individual and by the corporate level results in SVC. This approach keeps people focused on their area of responsibility as well as on the operation as a whole. It pushes people into a situation of finding ways to work together to achieve results that benefit all. Another factor is the workforce as a whole. Beyond the question of culture, it needs to be determined if there are any policies or contracts that might be obstacles to implementation at certain levels in the organization. Policies can be changed to accommodate the process. Contracts can be renegotiated where the parties are willing to work together for mutual benefit. 5. How do you reconcile the conflict between making decisions that will benefit the organization and its people in the longer term but may cause a negative impact in SVC results and the related incentive plan payout in the shorter term? If Creating Shareholder Wealth is implemented and communicated properly and consistently, there will be no need for reconciliation. People need to understand the new notion of “continuously positive” results and that results will fluctuate over time. Responsible people recognize that there are expenses associated with maintaining the current operations as well as with growth. They also need to recognize that the level of incentive compensation is not guaranteed. It is variable pay, not base pay. This is another reason why incentive compensation should be based on blended results. It softens the blow of investment decisions. Communicating the appropriateness of the investment and how it is expected to benefit the business and its owners in the longterm will also soften the blow. 6. How hard is it to implement a value-based system in reality? The mechanics of implementation are not demanding or particularly difficult. There are some challenges associated with this aspect, but they are manageable. The more difficult aspect is the human nature part of the process. I cannot overstate the importance of recognizing how critical this is to success. Human nature is what makes your business. It is the most important tool you have in your leadership kit. How hard it is to implement any process is directly related to human nature. Human nature and culture are directly linked. Implementation does not occur in a few months. The process starts in that time frame and continues over a number of months. Remember the time-line matrixes. Effective implementation requires ongoing commitment and consistent communication. It takes place over a period of time. That can be difficult for many people because it requires patience and perseverance. The first few months and year of the process are critical to aligning culture, gaining acceptance, and establishing the basis for sustainability. How well this is done will determine how difficult implementation becomes. The bottom line is that the level of difficulty is directly related to the level of mature leadership that exists in the organization.

263

Creating Shareholder Wealth

7. What’s wrong with basing incentive payments on criteria that are in addition to SVC? It depends on what the criteria are. Incentive compensation should never be based on results other than Shareholder Value Created and directly related value drivers that are controllable by the individuals whose performance is being measured. Any other criteria will only serve to make the process confusing, dilute the ability to sustain the process, take away the focus, and create conflict. None of this is good. Don’t do this to yourself. 8. You place a great deal of emphasis on recognizing human nature in process development and implementation. One aspect of human nature is self-interest. How do you deal with the inevitable conflict that will develop when one manager pushes for a viable project that will negatively impact another manager? You are absolutely right, this condition will invariably develop in the organization. The answer is in two forms. First, the way in which information is communicated is extremely important. I also talk a great deal about the importance of ongoing group and one-on-one communications. This includes talking openly about change and the impact that change can have. Being open about what is under serious consideration is part of this communication. It is pre-emptive in nature in that it helps prepare people for this type of conflict. Another aspect of this communication is the continual reminder that the process is global in nature. It is a process that is designed to benefit the organization as a whole and create value for its owners. This aspect of the process is another reason why active participation in, and unwavering support for, the process must come from the top of the organization. The leadership team has responsibility for this type of communication and for playing the role of ombudsman. One element of properly implementing this type of improvement in the business is addressing the negative side of the project to minimize potential difficulties. This “addressing” may be in the form of some mitigating action that is appropriate or it may be limited to communication. Most importantly, it can’t be ignored. Doing so would be contrary to human nature. Second, the manner in which the incentive plan is structured is also very important. It pays for individually controlled results and corporate level results together. Everyone has responsibility for both. Everyone is on the same plan and shares in the risks and rewards. Hopefully, you will be able to implement a plan where portions of the payments into SVC accounts are in the form of stock so everyone becomes an owner as well. Taken together, these two approaches will minimize the level of conflict.

264

Questions & Answers

9. Can you talk more about how this process improves cultural alignment and stimulates initiative? As human beings, we want to be appreciated for our contributions, feel we are making meaningful contributions, feel like we are part of the whole and not just a “number,” and realize the rewards that come from making contributions. Successful change management and process implementation means making everyone part of the solution. Creating Shareholder Wealth accomplishes these things in two ways. First and foremost, everyone is on the same incentive compensation plan sharing together in the risks and rewards. I cannot overstate the importance of this. This alone will result in much stronger cultural alignment. There is an immediate focus on the common goal and achieving that goal. The drive for goal achievement tends to stimulate initiative. Second is the commitment and communications discussed earlier. These set the tone for the organization. This tone causes reactions and responses and results in improved alignment.

265

This page intentionally left blank.

Index 5S, 26, 60, 67, 74, 75, 128, 160, 171, 173, 179, 185, 190, 192, 239, 241, 244, 249 Accounting Measures, 85, 164 Accounts Payable, 82, 84, 148, 162, 213 Accounts Receivable, 84, 148, 162, 197, 198, 199, 214, 255, 256 Action Model, 21, 26, 142, 191, 193, 194, 195, 196, 197, 206, 251, 252, 253, 254 adjustments, 15, 47, 61, 64, 78, 79, 81, 82, 88, 109, 121, 126, 137, 157, 164, 205, 214, 223, 224, 225, 226, 233, 238 aligned, 17, 39, 56, 126, 134, 150, 216, 262 alignment, 17, 21, 26, 32, 55, 109, 265 assumptions, 100, 142, 206 barriers, 21, 26 boulder of competition, 14, 26, 38, 82, 85, 90, 127, 138 capital charge, 80 Cash Taxes, 79, 152, 163, 218 change, 14, 15, 16, 17, 18, 19, 34, 38, 45, 46, 47, 49, 51, 52, 54, 70, 71, 72, 79, 80, 85, 93, 95, 96, 97, 98, 101, 105, 107, 108, 109, 110, 113, 119, 120, 126, 132, 136, 137, 159, 177,

181, 184, 200, 211, 226, 228, 232, 257, 264, 265 Change, 46, 53, 93, 95, 96, 97, 98, 105, 107, 150, 155, 165, 216, 221, 225, 233 Change Management, 53, 105, 150, 216 CIT, 48, 59 CLOSEDMITT, 26, 60, 61, 66, 67, 74, 75, 128, 160, 173, 179, 180, 181, 185, 188, 190, 192, 232, 239, 241, 242, 244, 245, 249 commitment, 15, 18, 20, 24, 26, 27, 29, 30, 36, 50, 51, 59, 61, 65, 70, 71, 72, 83, 127, 129, 136, 168, 249, 262, 263, 265 communication, 30, 31, 49, 50, 53, 55, 58, 65, 67, 68, 69, 72, 95, 96, 98, 99, 100, 101, 102, 103, 104, 107, 110, 182, 202, 231, 246, 260, 263, 264 Communication, 24, 34, 48, 58, 65, 98, 100, 132, 169, 237 complexity, 16, 82, 134, 181, 243 Concept Model, 21, 26, 142, 191, 193, 194, 195, 196, 197, 206, 251, 252, 253, 254 conflict, 44, 59, 77, 98, 99, 100, 101, 108, 116, 181, 184, 211, 223, 236, 263, 264

Creating Shareholder Wealth

economic performance, 19 economic profit, 14, 15, 17, 82, 86, 89, 92, 119, 120, 121, 137, 262 Economic Profit, 78, 119 environment, 14, 19, 20, 36, 44, 51, 60, 82, 90, 99, 102, 103, 107, 108, 111, 112, 158, 159, 160, 179, 180, 188, 199, 235, 241, 242, 245 feelings, 99, 100, 101, 136 Five Critical Questions, 24, 26, 142, 206 focus, 13, 16, 17, 20, 21, 26, 27, 30, 31, 32, 33, 34, 35, 42, 44, 46, 52, 58, 70, 71, 72, 73, 77, 83, 85, 86, 87, 89, 90, 92, 96, 113, 114, 119, 120, 123, 128, 130, 134, 137, 149, 159, 169, 172, 175, 182, 186, 189, 190, 192, 203, 210, 223, 224, 227, 237, 262, 264, 265 forecast, 19, 116 formal organization, 17, 54, 55, 56, 150, 177, 216 Free Cash Flow to The Firm, 83, 197, 254, 255 full implementation, 26, 75, 262 functional level, 21 goals, 13, 15, 18, 19, 20, 21, 28, 29, 33, 34, 35, 36, 37, 38, 42, 46, 66, 77, 96, 97, 98, 99, 102, 113, 133, 149, 159, 160, 170, 171, 172, 177, 179, 186, 189, 201, 202, 206, 211, 215, 216, 236, 237, 238, 241, 251, 258, 259, 260 human nature, 15, 16, 17, 20, 51, 68, 69, 82, 85, 95, 102, 103, 105, 106, 107, 108, 111, 113, 169, 177, 200, 258, 262, 263, 264 Human nature, 17, 87, 96, 99, 102, 103, 105, 160, 263 improvement opportunities, 19, 37, 64, 141, 262 IN BRIEF, 14, 30, 37, 61, 107, 108, 249

continuous improvement, 15, 16, 19, 20, 113, 200, 258 Continuous Improvement, 19, 24 continuously positive, 20, 26, 46, 65, 110, 113, 117, 125, 127, 134, 172, 225, 263 corporate level, 21, 30, 37, 86, 158, 167, 168, 172, 186, 206, 236, 261, 262, 264 cost of capital, 78, 80, 81, 84, 87, 88, 89, 91, 92, 126, 133, 138, 218 Cost of Capital, 82, 84, 154, 155, 165, 219, 220, 221, 225, 233 Creating Shareholder Wealth, 11, 13, 16, 17, 32, 33, 38, 44, 45, 46, 49, 54, 56, 59, 68, 69, 82, 90, 93, 95, 96, 97, 98, 101, 103, 111, 112, 113, 117, 125, 141, 149, 157, 169, 170, 172, 189, 192, 203, 205, 208, 210, 216, 223, 228, 236, 237, 245, 246, 249, 251, 260, 262, 263, 265 CSWLT, 45, 59 culture, 16, 17, 18, 25, 32, 36, 52, 107, 109, 112, 126, 216, 236, 240, 262, 263 cultures, 17, 21, 103, 112, 126, 134, 249, 262 Customer Returns, 83, 197, 198, 254 customer service, 61, 78, 83, 112, 134, 149, 158, 179, 184, 186, 191, 202, 215, 228, 229, 241, 242, 243, 244, 245, 251, 259, 260 Determinant Assembly, 45, 70, 72, 74, 128, 130 division level, 21 drivers, 15, 18, 82, 84, 85, 113, 114, 115, 138, 168, 170, 172, 199, 200, 201, 217, 237, 257, 259 due diligence, 24, 49, 54, 59, 136, 150, 216 Earnings Before Interest & Taxes, 79 EBIT, 79, 152, 153, 163, 164, 165, 217, 218

268

Index

Managers, 15, 18, 34, 87, 105, 106, 108, 114, 159, 160, 170, 177, 228, 229, 230, 240, 257 Mature Leaders, 105 measurement, 14, 20, 26, 59, 67, 82, 86, 87, 117, 138 Net Operating Profit After Taxes, 78, 79, 83, 88, 120 Net Profit Before Taxes, 83, 92, 197, 223, 254, 255 NOPAT, 78, 79, 81, 82, 83, 84, 88, 92, 120, 126, 152, 155, 157, 163, 164, 165, 192, 221, 223, 224, 225, 233, 251 On Time Delivery, 83, 84, 197, 198, 199, 254, 255, 256, 257 Operations Organization, 45, 60, 61, 62, 77, 129, 141, 158, 176, 180, 184, 185, 193, 195, 197, 198, 205, 228, 230, 240, 242, 252, 253, 254, 255, 256 perception, 15, 103, 104, 108 perceptions, 99, 100, 101, 103, 108 performance feedback, 15, 102 performance measure, 49, 79, 85, 87, 89, 90, 91, 102, 112, 170, 237 Performance Measurement, 20 Performance Measures, 18, 83, 93, 122, 201, 259 primary measure, 14, 15, 18, 30, 33, 77, 91, 123, 134, 137, 138, 201, 202, 259 primary performance measure, 77, 78, 90, 122, 138, 151, 202, 217, 259 process improvement, 17, 26, 38, 172 PULSE, 18, 20, 31, 102, 104, 169, 201, 258 resistance, 15, 16, 56, 68, 96 Sales per Employee, 82, 83, 84, 197, 198, 254, 255, 256, 257 Shareholder Value Created, 14, 15, 33, 37, 38, 39, 42, 44, 47, 49, 53, 59, 64, 65, 66, 68, 74, 75, 78, 80, 81, 82,

incentive compensation, 15, 49, 50, 52, 79, 82, 102, 103, 110, 111, 112, 113, 114, 116, 117, 167, 168, 185, 186, 189, 191, 233, 244, 245, 251, 262, 263, 265 Incentive Compensation, 18, 26, 45, 47, 53, 59, 64, 68, 112, 167, 201, 236, 247, 248, 259 Incentive Compensation Implementation Team, 47 incentives, 17, 25, 58, 80, 111, 112, 113, 117, 172, 239 Incentives, 111, 112 informal organization, 17, 54, 55, 56, 106, 108, 150, 216, 246 Inventory Turns, 84, 197, 198, 199, 254, 255, 256 Key Philosophies, 18, 31, 191, 200, 251 LBIT, 48, 59, 70, 183, 184, 185, 188, 189, 245 Leaders, 44, 66, 99, 103, 105, 106, 107, 108, 216 leadership, 14, 15, 17, 19, 30, 32, 33, 34, 38, 44, 45, 49, 52, 54, 55, 58, 65, 67, 82, 96, 98, 99, 100, 101, 103, 106, 107, 109, 135, 150, 160, 216, 247, 249, 263 Leadership, 18, 44, 45, 46, 57, 59, 68, 105, 107, 170, 201, 237, 246, 247, 248, 259, 264 Lean business, 18, 129 Lean Business Implementation Team, 44, 45, 48, 59, 178, 181, 245 lean manufacturing, 17, 127, 128, 129, 130 Lean Manufacturing, 14, 44, 53, 59, 64, 66, 67, 68, 69, 74, 75, 128, 157, 169, 172, 239 lean manufacturing/business, 17 long-term, 16, 17, 19, 20, 26, 33, 52, 86, 87, 110, 112, 113, 114, 116, 117, 120, 169, 206, 224, 225, 230, 263

269

Creating Shareholder Wealth

SVC, 26, 37, 38, 45, 46, 47, 48, 49, 50, 59, 64, 65, 66, 68, 69, 70, 71, 72, 73, 74, 75, 78, 79, 80, 81, 82, 83, 84, 85, 86, 87, 88, 91, 92, 112, 113, 114, 115, 116, 117, 120, 121, 126, 137, 138, 151, 155, 156, 160, 165, 167, 168, 169, 171, 172, 173, 177, 181, 185, 186, 188, 189, 191, 192, 200, 205, 216, 217, 221, 222, 223, 224, 225, 226, 227, 231, 233, 234, 235, 236, 238, 239, 251, 257, 258, 260, 261, 262, 263, 264 SVCIT, 47, 59, 70, 186 talent, 16, 127 The Five Critical Questions, 11, 17, 19, 20, 21, 24, 26, 27, 82, 123, 191, 192, 251 The Five Phases of Organizational Growth, 56, 57, 58 top-level support, 16 Total Capital, 78, 79, 81, 82, 84, 88, 92, 120, 126, 155, 165, 191, 221, 223, 224, 225, 233, 251, 261, 262 Total Operating Capital, 157, 221, 224 training, 28, 31, 45, 46, 48, 49, 52, 53, 58, 62, 63, 65, 66, 68, 69, 70, 71, 72, 73, 101, 106, 150, 169, 173, 176, 184, 186, 187, 188, 189, 193, 194, 195, 196, 200, 201, 216, 236, 240, 245, 252, 254, 258, 259 value drivers, 73, 82, 83, 92, 102, 114, 120, 122, 138, 151, 168, 189, 200, 202, 257, 259, 262, 264 value-based, 14, 15, 16, 20, 82, 110, 116, 263 value-based metric, 14 WACC, 78, 80, 81, 88, 91, 92, 120, 126, 156, 157, 167, 218, 222, 223, 224, 226, 227 Weighted Average Cost of Capital, 80, 88, 92, 120, 218, 238

85, 87, 88, 93, 102, 110, 113, 114, 119, 120, 125, 126, 133, 134, 137, 138, 141, 142, 151, 160, 171, 189, 191, 197, 199, 201, 206, 215, 217, 218, 221, 224, 232, 238, 251, 254, 257, 259, 262, 264 shareholders, 13, 14, 16, 31, 33, 61, 64, 74, 78, 81, 86, 87, 88, 89, 90, 91, 92, 96, 113, 116, 117, 119, 120, 134, 135, 136, 169, 210 simplifies, 21 single unit flow, 181, 243, 253, 257 stakeholders, 15, 24, 135, 136 strategy, 13, 17, 20, 24, 25, 27, 30, 32, 51, 52, 82 Strategy Goal, 31, 36, 37, 38, 41, 42, 44, 52, 78 Strategy Goals, 11, 20, 25, 29, 35, 36, 37, 39, 41, 42, 43, 51, 66, 102, 149, 170, 193, 202, 215, 237, 247, 252, 259, 260 Strategy Implementation, 41, 42, 44, 74, 98, 100, 103, 126, 149, 170, 202, 215, 237, 259 Strategy Implemented, 11, 20, 42, 43, 60, 101, 195, 248, 253 Strategy Intent, 11, 20, 21, 24, 27, 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 42, 52, 64, 66, 78, 102, 107, 126, 149, 160, 170, 193, 202, 215, 216, 237, 247, 250, 251, 259, 260 Strategy Plan, 11, 20, 25, 29, 41, 42, 43, 44, 51, 66, 102, 215 Support Organization, 45, 60, 61, 63, 134, 141, 142, 158, 159, 185, 187, 188, 193, 194, 196, 197, 198, 199, 205, 206, 229, 231, 245, 252, 254, 255, 256 sustainability, 15, 16, 20, 102, 263 sustainable, 16, 17, 19, 20, 29, 69, 102

270

Bibliography Gary Hamel and C. K. Prahlad, “Strategic Intent” Harvard Business Review (May–June 1989) Peter Drucker, “Information Executives Truly Need” Harvard Business Review (January–February 1995) Renato Tagiuri, “A Note On Communication” Harvard Business School, 1972 Jeanie Daniel Duck, “Managing Change: The Art of Balancing” Harvard Business Review (November–December 1993) John J. Gabarro, “Understanding Communication In One-To-One Relationships” Copyright ©1976 by the President and Fellows of Harvard College Harvard Business School, Case 476-075 James P. Ware and Louis B. Barnes, “Managing Interpersonal Conflict” Copyright ©1979 by the President and Fellows of Harvard College Harvard Business School, Case 479-004 Alfred Rappaport, “Selecting Strategies That Create Shareholder Wealth” Exhibit—The Five Phases of Organizational Growth—modified with permission Harvard Business Review (January–February 1981) Ken Merchant, “Is EVA® The Measurement Panacea?” (EVA is a registered trademark of Stern Stewart, Inc.) Dean, Levanthal School of Accounting University of Southern California Marshall School of Business February 1999 The Boeing Company CLOSEDMITT © Copyrighted material of The Boeing Company and is used with permission of the company. Further distribution or use of the material may not be made without the express permission of The Boeing Company.

This page intentionally left blank.

Acknowledgements As nice as it might be to take full credit for the contents of this book, to do so would not be honest. In reality, many of the processes explained in this book are the work of other people who have demonstrated brilliant insights into the most effective ways to manage and lead a business. In doing so, they have developed individual areas of expertise and shared their knowledge with the world so that we may all benefit. My role in this effort has been to develop The Five Critical Questions and to recognize the direct and important linkage between two initiatives: Economic Profit and Lean Business. Also, it has been my job to point out the importance of human nature in the whole process and the role this plays in failure. This book is entitled Creating Shareholder Wealth: Answering the Five Critical Questions because that is the primary responsibility of every organizational leader. It is my goal to pass on knowledge and experience and show the reader how he or she might benefit by applying this information to his or her environment. Putting this information into a format that is easily understood and usable by managers and employees in organizations of any type and size has been an enjoyable exercise and learning experience. While gathering material for the book and writing it, I was able to apply these concepts in various situations and observe how effective they are at achieving the stated goals. The format used is to answer what I call The Five Critical Questions. In doing so, managers will develop the plan to Create Shareholder Wealth. These questions have challenged business leaders for as long as there has been commerce. The primary performance measure I recommend, economic profit, has been available to us as an economic theory for approximately 200 years. I use the term Shareholder Value Created, or SVC, to describe the concept and calculation method. My exposure to the these questions from an academic perspective and to economic profit has its roots in my participation in the Executive Master of Business Administration Program in the Marshall School of Business at the University of Southern California.

Lean Manufacturing has also been with us for many years. Its evolvement into what is now often referred to as Lean Business comes from many paths, both individual and corporate. Lean Manufacturing is sometimes referred to as the Toyota Production System and helped Toyota to become one of the most cash rich companies in the world. Lean Business includes Lean Manufacturing and is used in many companies and industries around the world. It has the goals of eliminating all forms of waste from every part of the organization, improving throughput, reducing space and travel time required to produce and deliver products and services, improving product quality, and simplifying the management process. Lean Business is the initiative that improves the organization by answering the first four critical questions. The fifth question utilizes Shareholder Value Created and focused subordinate metrics to measure that improvement. SVC aids in prioritizing improvement projects and establishing the incentives that change behavior so that everyone in the business can apply a high level of initiative toward creating wealth. SVC is also a valuable long tern risk analysis tool. My knowledge of Lean Manufacturing and Lean Business has its roots in my military experiences in the United States Air Force. It grew through my education at The University of Wisconsin—Milwaukee where I earned a Bachelor of Business Administration Degree with a dual focus on industrial operations management and industrial engineering. It continued with my employment at an electronics and specialty battery manufacturing company in Milwaukee, Wisconsin. My experiences continued further with a hospital products manufacturing company as director of manufacturing at their Milwaukee operation and after assuming the position of director of operations at a subsidiary company in Cerritos, California (near Los Angeles) when it was acquired. I gained further knowledge and experience while in other industrial settings in California and Washington. The consulting work I have done since the mid-1980s has also been invaluable to my knowledge of the practical applications of Lean Business. For me, much of the credit must go to the business owners, leaders, and managers I have been privileged to work with during these years. My experience and knowledge continued through the Executive Master of Business Administration Program and the Master of Science Business Administration Program at The University of Southern California—Marshall School of Business, both of which I participated in while writing this book. I completed the EMBA Program during that time. I owe a great deal to the professors I was privileged to meet and work with at both universities. The first professor to have a significant impact on my life and who launched my academic understanding of this material was Professor John Lindemann at The University of Wisconsin—Milwaukee. He taught me a great deal about industrial engineering, business operations, and the benefits of Lean Manufacturing. A great deal of credit also belongs to professors at the University of Southern California. Professor Timothy Campbell, Doctor of Economics, introduced me to the concepts and value of economic profit. Professor John Rolph, Doctor of Statistics, taught me the true value of statistics as a meaningful management tool. Perhaps most importantly, he was the catalyst in showing me how to do that in a simple and straightforward manner.

Professor Laree Kiely, Doctor of Business Communications, provided valuable guidance and material on communication, presentations, and change management. Professor Larry Griener, Doctor of Business Administration, provided extensive material on change management and strategy. Without the support and guidance of these outstanding academics, this book would never have been written. The insights, objectivity, and practical knowledge of these professors, as well other professors I was privileged to learn from, proved valuable to the process of developing Creating Shareholder Wealth: Answering the Five Critical Questions. It is also impossible to quantify the contributions of friends and advisors such as Chuck Eastwood, Jeff Higgins, Steve Barkley, and Andy Schickling. Chuck has been a valued friend since 1989. He helped me stay focused on my goals and keep my priorities in order. Jeff, Steve, and Andy became friends, critics, and valued colleagues during our time together in the Executive MBA Program at the University of Southern California. All were extremely helpful and important sounding boards allowing me to talk at length about my ideas. The support offered by other highly valued friends, specifically Michael Aloian, Joanne Mastrangelo, and Paula Davis, is also appreciated more than mere words can express. Michael was especially supportive and helpful during the writing of this book. A special thank you to my good friends and former business partners John and Darlene Cahoon is also in order. In this book you see that I make an analogy to the movie Raiders of the Lost Ark and its hero—Indiana Jones. I wish to thank Vic Verma, another teammate in the Executive MBA Program at USC, for providing this idea. I think it is a fitting analogy for the subject matter. I also wish to thank Ms. Shannon Murdock for all of her patience, assistance, and expertise in editing my raw material into a book that is orderly and useful. Any success this work enjoys will be, in great part, a result of her efforts. Dan Peter Redondo Beach, California

This page intentionally left blank.

About the Author Dan Peter has in excess of thirty years experience in various business leadership and consulting positions. His management positions have ranged from foreman to general manager running the company in every respect. He has worked in small, mid-size, and large corporations. In every case he has been successful in implementing process improvements that have resulted in profit increases for the organizations. In recent years, this has included application of economic profit, which has yielded even greater benefits to the organizations served. His consulting applications of this material have ranged from manufacturing companies, to service providers, to a large city accounting/finance department. Industry applications have included electronics, computers, high capacity computer driven printers, a communications satellite launch and operations company, aircraft manufacturing, aircraft components manufacturing, real estate loan processing and lending, and a community accounting service office. Supporting these successes is Mr. Peter’s educational background. He received a Bachelor of Business Administration Degree from the University of Wisconsin— Milwaukee with a focus on industrial operations management and industrial engineering. He has a Master of Business Administration from the University of Southern California Marshall School of Business. He was in the Master of Science Business Administration Program majoring in finance and business economics at the University of Southern California at the time this book was being written and published. Mr. Peter has been published on aspects of this subject matter in the California Society of Certified Public Accountants’ Monthly Statement. He has presented numerous training sessions to members of various organizations. Mr. Peter may be contacted via his Web site at www.shareholderwealth.com.

This page intentionally left blank.

Endorsements “I like everything about it….You’ve hit every nail on the head.” Gordon Clune, President/CEO, Klune Industries, Inc., Los Angeles, California “Your approach of adding human behavior considerations to economic value systems implementations is exactly right....You’ve correctly identified one of the flaws in other systems—the ratcheting of performance targets.” Professor Ken Merchant, Dean, Levanthal School of Accounting University of Southern California Marshall School of Business “The Creating Shareholder Wealth framework will provide us with big corporation tactics for small company costs enabling us to better serve the health research community.” Jo Anne Mastrangelo Manager of Corporate Development Health Research Association Los Angeles, California “The strategic road map outlined in the book is very straight forward and effective. Our fast growing company will benefit tremendously from strategic guidelines outlined in the book.” Val Keshishian, CFO Spanning Tree Technologies IT Infrastructure Consulting Glendale, California “An intuitive and practical handbook that demystifies Shareholder Value Added Analysis, and provides an important tool that the business world desperately needs.” Jeff Higgins Vice President of Compensation IndyMac Bank Corp. “Many leaders get lost in the world of day-to-day crises. This book is a homing device that re-orients management to the critical tasks of goal setting, planning and effective communication.” Norman Vinn, M.D. President, The Residentialist Group Inc.

This page intentionally left blank.