Increasing User Buy-in of Financial Forecasts

Business HandshakeLet me begin with two assumptions: first, your primary modeling tool is Microsoft Excel; second, you share model projections with others. If both these assumptions are correct, I have two secrets of success for those new to financial forecasting.

The first is that everyone who sees your forecast assumes they know more about what the modeled results should be and better understand the impact of changes than you do. That you spent countless hours constructing the model, studying company and industry trends, back-testing formulas and validating every assumption will be quickly lost in their rush to point out what to them appears to be “obvious errors”.

I frequently develop complex models generating quarterly projections of full financial statements for a three to five year horizon. Models usually involve the consolidation of multiple entities and detailed ratio analysis. A typical model has 35 to 60 variables. Every variable is contained in named cells on an assumptions tab (immediately behind the title tab). All formulas utilize the appropriate variable name rather than a cell reference or hard coding.

For those not familiar with the use of named cells in Excel, go to the File Manager icon on the Formulas tab. Additional guidance is available online. One source is http://bit.ly/18tl7OP.

Typically, a client will zero in on one or two variables, insisting (as an example) that sales growth projected in year 3 is clearly wrong! He or she is so confident of their belief that the model has likely lost significant credibility with them.

Invariably, the impact of the user’s change is not as significant as they suppose. Sticking with the sales example, changing the growth rate has no impact on earlier years. Furthermore, the effect on future income is reduced by resultant increases in the cost of goods sold, inventory carrying costs, variable expenses such as commissions and shipping, borrowing costs and so on. Finally, income taxes further reduce the bottom line impact by another 35% to 40%.

Rational discussion and logic serve no purpose in this situation. You cannot change human nature! Your goal is merely to channel it in a productive direction.

I do this by simply asking what they think the number should be. I then take them to the assumptions tab and change the offending variable to their number. The model then recalculates, eliminating any guesswork on the impact of the proposed “correction”.

Seeing is believing.

The second “secret” complements the first. Without exception, even the most complex models come down to a mere handful of key variables. Since your goal is to redirect rather than change behavior, help users focus on those that drive projected results, rather than getting bogged down in immaterial detail.

You can accomplish this by highlighting which variables have an individually material impact on the cumulative results of your forecast. Begin by deciding what the appropriate base or dependant result is. I find it is most often one of three things depending on the primary use of the model: net income, stockholders equity or the internal rate of return.

I then test every variable in isolation with a 10% unfavorable change. For example, a 20% sales increase is reduced to 18%. I note the impact of each variable on the cumulative base result. I then typically use a materiality threshold of 2% for disclosure. The less attention drawn to non-critical variables the better!

Rarely will a variable have a high correlation to the measured result. A typical scenario might be that a 10% change in each of my 35 to 60 variables produces four to six with an impact greater than 2%, with none exceeding 8%.

This sensitivity analysis is the third tab, immediately behind the variables. By quantifying and clearly presenting the impact of changes in this manner, you are inviting needed input (and therefore user buy-in), without having to debate or justify the majority of variables that will have minimal or no impact on your forecast. Users can then concentrate on achieving a comfort level with a relative handful of model inputs, saving everyone time.

As a closing note, while the focus is on the cumulative impact of variable changes, there are times and circumstances when individual period results are also important, regardless of the dollar impact. For example, loan covenant compliance is a constant requirement. If a change in an otherwise insignificant variable creates an incidence of non-compliance, the change cannot be ignored.

How I handle that situation is the subject of a future article. Here is a hint: conditional formatting!

We Have Meet The Enemy & He Is Us, Dealing with Entrenched Policies & Procedures (Part 2)

On Monday, I introduced the topic of inefficient and outdated policies, processes and procedures using the cartoon character Pogo, and the mid-twentieth inventor and cartoonist Rube Goldberg.

After coining a new acronym (RGP3s) and describing some common characteristics, I ended with the obvious question, what is a manger to do about them?

First, be open to the possibility of their existence in your organization. Every company has some areas that need improvement. You cannot assume that something is “best practices” simply because it worked in the past. If a department is unable to keep up with current workloads, there are only two possible reasons. Either they are understaffed, or they are operating at less than peak efficiency. Adding staff adds costs. Improving efficiencies is likely a cheaper and perhaps faster alternative.

All successful organizations eventually reach a size where managers are not expected to be familiar with the application of every policy, process and procedure. Even if they are, RGP3s can be virtually invisible to the familiar (or complacent) eye. That suggests one of two possible approaches.

The first approach is to constantly challenge and encourage employees to identify efficiency improvement opportunities. Maintain an open and direct line of communication through brief but regular interaction. Actively solicit employee input and implement at least one idea every month. Publicly reward accepted suggestions in ways they value. That may mean an employee of the month plaque in the lobby, a front row parking spot or an AMEX gift card.

Unfortunately, relying solely on employees’ willingness to point out flaws has a major limitation, human nature! People seem to have a tendency to accept most things as they are. Furthermore, asking questions and challenging the status quo may be viewed as career limiting in some corporate cultures. That is not to suggest people are by nature lazy or apathetic. It’s just how things are.

The second approach is to bring in a fresh pair of eyes. A while back, I shared a story about an experience in a new job. On my second day, I was reviewing a lengthy payment report when I spotted something unexpected. About every 20 pages or so, there was an entry with a negative amount. Based on my still limited understanding, there was no reason for negative numbers. To make a long story short, I had stumbled across an internal control weakness that allowed certain items to be paid twice.

The point is that other people who worked with the report every day had undoubtedly noticed negative entries before. Yet they failed to follow through with a few simple questions. If they had, they might have closed the control weakness years earlier.

In closing, let me clarify what constitutes a “fresh pair of eyes”. It may mean a consultant. This outside resource could be an expert in your field, or someone well versed in common business practices and operations. An auditor or independant CPA with other clients in your industry may be a valuable resource, especially if the area of concern is one they review as part of their evaluation of internal controls.

In my example, a fresh pair of eyes merely meant introducing a new employee into the mix.

Either way, the path to improved efficiencies in your business may be as simple as finding someone unburdened by the “But we’ve always done it that way” mentality.

That mindset, Mr. Pogo, is the real enemy.

© 2012 by Dale R. Schmeltzle

We Have Meet The Enemy & He Is Us, Dealing with Entrenched Policies & Procedures (Part 1)

Students of American pop culture will recognize the title of today’s post as a quote from Pogo, the swamp dwelling possum in the classic comic strip of the same name. I use it to introduce a discussion of an all-too-common business phenomenon.

Owners and managers are often their own worst enemies when it comes to recognizing what I call Rube Goldberg policies, processes, and procedures (RGP3 for short).

What exactly are “Rube Goldberg” policies, processes, and procedures? Rube Goldberg was a twentieth century cartoonist, famous for inventing complex devises to accomplish the simplest of tasks. He was the inspiration for the 1960s game Mouse Trap.

Michael Hammer gave a perfect example of a modern day business mousetrap in Reengineering Work: Don’t Automate, Obliterate. A company required that the “corner desk” approve all overseas invoices. The policy had been in place for many years. It turns out it originated back when many customers were French, and when an employee who was fluent in French occupied that desk. However, the employee had long-since left, and fluency in a foreign language was not a requirement for assignment to the desk.

In other words, the original value of the policy was lost long ago. All that remained of the legacy were unnecessary costs and shipping delays.

This example exhibits several common characteristics of RGP3s. Those characteristics may include:

  • They are overly complex for their intended purpose.
  • They involve outdated technology.
  • They are not integrated with other systems.
  • They involve manual input of paper records.
  • They are labor-intensive.
  • They are non-scalable and unable to keep up with demand.
  • They are poorly documented.
  • They have been in effect for as long as anyone can remember.

In other words, they are inherently inefficient and outdated.

Yet with all these negative attributes, RGP3s seem to enjoy a sort of sacrosanct protection. Decision makers are reluctant to identify, let alone change them. Perhaps like an old pair of shoes or a childhood tradition we cling to in adulthood, we take comfort in our inability to remember life without them, even if we outgrew them long ago.

Although my RGP3 experience is mainly in finance and accounting, I am certain they exist in all areas of company operations including production, distribution and customer service.

So what is a manger to do about them? More about that on Friday.

Until then, have a great week.

© 2012 by Dale R. Schmeltzle

I HATE TO SAY I TOLD YOU SO!

This is a sad day for long-time antique Kodak camera collectors like me, not a day to remind readers about the critical importance of cash flow to business survival.

Unfortunately, as demonstrated by the following timeline, the inventor and one-time “King of Cameras” has been reduced to a shadow of its former greatness. It was victimized by slow strategic decision-making and the dreaded negative cash flow.

Here is a brief summary of their 128-year history.

  • 1884: George Eastman developed film technology to replace photographic plates. He founded Eastman Kodak in 1892. With the slogan “You press the button, we do the rest” he introduced photography to the masses with cardboard box cameras that sold for $1, the equivalent of $24 in 2009 dollars.
  • 2009: With its market steadily evaporating since the 1975 invention of digital cameras, Kodak ended a 74-year run when it discontinued production of Kodachrome film. Their SEC filings reported a $210 million loss that year. Ironically, a Kodak engineer invented the digital camera.
  • January 19, 2012: The market for film cameras now virtually extinct, Kodak has witnessed its market value plummet from over $30 billion to $150 million. Today, they filed for Chapter 11 bankruptcy protection, having endured an operating cash drain of $750 million over the past twelve months alone. A company spokesperson said they “intend to sell significant assets” during the bankruptcy.

The moral of the story is this: few things in life are absolute. The laws of gravity and physics come to mind. Another absolute is the need for positive cash flow.

Almost everything else is negotiable.

© 2011 by Dale R. Schmeltzle

CFO America: Your Cash Flow Optimization experts

CASH: NOW YOU SEE IT, NOW YOU DON’T – PART 2

Last week I introduced the topic of cash flow management, using the graph below. Cash flows generated or use by any business are the net result of the inter-action of three inter-related cycles. They include the expense and revenue cycles, which I discussed last week.

Today I complete the topic with a review of the capital cycle.

The capital cycle:

If you have been in business any length of time, you know that capital is always a scarce and expensive commodity. Therefore, the capital cycle involves allocating or assigning available cash to its highest and best use. The process analyzes competing alternatives, such as opening a new location, expanding your sales force, product research and development, increasing inventories, debt repayment and so on. Unlike cash, the list seems almost inexhaustible.

Therefore, this cycle requires a quantified prioritization that incorporates a variety of factors including expected returns, time horizons, risk assessment and the cost and availability of required capital. Most business people are familiar with some applications of capital allocation. A simple example is whether to buy or lease company vehicles.

Other applications are not as well recognized. For example, assume two identical businesses earned a $100,000 profit. Company A had $1 million invested in the business, while Company B only had $500,000 of capital. Company B’s 20% return is double that of Company A. Unfortunately, it is not as simple as the math implies. While reducing capital increases returns, it also increases the risk of running short of cash and failing due to unexpected events. Every business requires some level of cash to serve as a buffer against this uncertainty.

Another application of the capital cycle is identifying and quantifying the need for outside funding to meet your needs. Obtaining adequate funding under terms and conditions that make economic sense in light of expected benefits is crucial to the process. This includes short-term needs like financing seasonal fluctuations in receivables and inventories, and long-term needs such as procuring equipment and facilities.

The capital cycle also includes securing “start-up” money, probably the greatest challenge and source of frustration most small businesses encounter. New businesses owners frequently make two critical mistakes in their search for start-up capital. The mistakes are:

  • They significantly underestimate the amount of cash needed to carry the business until it turns cash positive. Again, a clear distinction exists between turning an accounting profit and being cash positive. If you sell something for $100 that cost you $85, and the related operating costs are $10, you have made a $5 profit. However, if you need an additional $30 to expand your inventory and prepay next month’s rent, you are $25 short of cash. Lack of cash is a more immediate and serious problem than lack of profit.
  • The second mistake is assuming a business can borrow 100% of its initial capital needs from a bank or similar source. I cannot begin to count the number of times I have encountered entrepreneurs with an attitude of, “I’m supplying the intellectual capital. It’s my great idea. Surely I can find someone willing to put in all the cash!”

Banks are interested in financing established companies who need capital to expand, not start-ups wanting cash to test their ideas.

Conclusion:

Let me end with two simple statements. First, in business, success is a four-letter word. It is spelled C-A-S-H!

Finally, measuring, monitoring and managing all three cycles is vitally important to optimizing your cash flow, and ultimately to your very survival.

© 2011 by Dale R. Schmeltzle

 CFO America: Your Cash Flow Optimization experts

CASH: NOW YOU SEE IT, NOW YOU DON’T

The first response to a cash crisis is usually to tighten up on expenses, cut back on something, or generally to make do with less. That may be necessary, but it is usually only part of the answer.

As shown in the diagram below, cash flows generated (or consumed) by any business are the net result of the inter-action of three related cycles. They are the expense, revenue and capital cycles. I will discuss the first two today, and conclude next Friday with the capital cycle.

A brief description of each follows, along with what I consider the most common problems within each cycle. All three cycles presuppose that you have the ability to measure and monitor its activities and results.

The expense cycle:

Let’s start with the expense cycle, the assumed “bad guy” for most small business cash problems. This cycle is largely what the name implies. It is also the easiest to fix.

The expense cycle involves the cash used to pay vendors, employees and others for the goods and services they supply. It also includes operating expenses such as rent and utilities.

The biggest obstacle to correcting expense cycle issues is one of attitude. Your goal is not to “pinch every penny” and second-guess past spending decisions. Experience teaches that it is too easy to miss the big picture while focusing only on inconsequential items. Reducing paper clip expenses by 80% will not save your company.

The focus of your expense cycle review should be to ensure that costs are planned and justified by their expected benefits. Ask yourself whether they are consistent with your business goals. If the answer is no, the appropriate action is to eliminate the expense. It is that simple!

Furthermore, expenses must be incurred within an environment of adequate internal controls. This control environment includes management tools such as monthly financial statements, a detailed budget and basic procedures such as a purchase order process with competitive bidding. Without these controls, it is simply not possible to manage expenses.

The revenue cycle:

The revenue cycle deals with money coming into your business. If only it were that simple!

Problems within this cycle are the most difficult to identify and analyze, especially if management lacks a solid grasp of the numbers. Consequently, the root cause of many business failures lies within the revenue cycle. They are unpleasant to address, since they ultimately affect customer relations. Two examples follow.

Money coming into a business always starts with a sale to a customer. However, it does not end there. If your business offers credit to customers, making a sale actually drains cash until you collect the receivable. This creates an inherent conflict between the desire to increase sales through generous credit terms and lenient collection procedures, and the need to maximize cash flow. Success in this area requires adequate internal controls including standardized billing and collection procedures, a balanced customer approval process, and sound treasury management.

One unpleasant aspect of squeezing more cash out of the revenue cycle is the prospect of having to raise prices. Perhaps the single most common mistake is under-pricing products and services relative to your cost structure. Correcting this challenge is even more difficult after you have established unrealistic customer pricing expectations, or if you operate in an especially competitive environment. People who do business with you primarily because you offer the lowest prices are unlikely to exhibit much customer loyalty.

We will finish this topic next Friday with a discussion of the capital cycle and a closing comment on cash flows.

© 2011 by Dale R. Schmeltzle

CFO America: Your Cash Flow Optimization experts

 

CASH IS KING, LONG LIVE THE KING!

 

 

Today’s title is an obvious parody on the old phrase, “The king is dead. Long live the king!” It dates to thirteenth century England. It conveyed the immediate transfer of power between a deceased monarch and the heir to the throne. More relevant to our purposes, it signified the continuity of sovereignty, or the supreme authority.

Future articles will explore where cash comes from, and where it goes, two critically important issues for every small business. For now, I will discuss the more basic question of why cash is cash king in today’s business world.

First, allow me to quote the experts. A 2005 study titled Small Business: Causes of Bankruptcy by Don B. Bradley III and Chris Cowdery of the University of Central Arkansas explained the supreme importance of cash rather succinctly:

“A lack of cash flow is often the biggest failure indicator. A lack of cash flow could cause a business to fall behind on wage payments, rent, and insurance and loan payments. A lack of cash flow also could inhibit the company’s ability to reinvest for future profits such as the ordering of products or supplies and marketing execution. When a company is borrowing to pay off past debts, it is usually a sign of disaster to come.”

They also said, “A significant shortage of cash flow limits the company’s ability to respond to outside threats. This is critical for fledgling businesses since new threats seem to appear every day.”

The only thing you can be certain of in business is that things will never turn out exactly as you planned. Adequate cash allows businesses to survive extended periods when sales, profits and cash flow are running behind plan, whatever the cause. Every business requires some level of cash to serve as a buffer against this uncertainty.

You could say cash provides sleep insurance. Constantly worrying whether a large customer will pay their invoice in time to meet Friday’s payroll, or whether you will have to turn away sales during your busiest season because you cannot stock sufficient inventory to meet demand is too often part of a businessperson’s everyday thought process.

Adequate cash levels are especially vital during the initial start-up period of a business. However, while the risks and challenges change as a business grows and matures, cash is supreme during any stage of a company’s life cycle.

For example, imagine that a 120-year-old company generated $1.2 billion in net losses. My immediate reaction is they certainly won’t be around to celebrate their 125th anniversary. That company is Alcoa. They lost $74 million in 2008 and a staggering $1.1 billion in 2009. Yet, Alcoa is still the world’s third largest producer of aluminum, and still trades on the New York Stock Exchange.

How is surviving such staggering losses possible? It was possible because during the same two years Alcoa generated $2.6 billion of positive cash flow from operations. As the old adage goes, “You can survive almost anything if you just have enough cash.” Businesses close their doors when they run out of cash to pay vendors and employees, period!

Here is an even more dramatic and current example of why cash is king.

AMR Corporation, the parent company of American Airlines, filed for bankruptcy protection in November 2011. During the previous 15 quarters, the company accumulated over $4.9 billion in net losses. Yet industry experts seem confident the company will successfully emerge from bankruptcy. Why? AMR has over $4.3 billion in cash on its balance sheet.

Far too often, the immediate response to a cash crisis is to tighten up on expenses, cut something back, to make do with less! That may be an appropriate tactic, especially if you have not scrutinized expenses closely in the past, or do not have a good handle on your cost structure.

However, cutting back is not the only tactic.

Next week I will begin a discussion of how cash flow generated (or used) by any business is the net result of the inter-action and proper management of three related cycles. They are the revenue, expense and capital cycles.

Until then, long live the king!

© 2011 by Dale R. Schmeltzle

 CFO America: Your Cash Flow Optimization experts

WHAT A CPA KNOWS ABOUT MARKETING: MORE SALES AREN’T ALWAYS THE ANSWER

There is an old joke about a marketing executive who bought a truckload of melons from a farmer for $1 each. He advertised them for sale at $0.85. When his CFO asked how he planned make a profit, he proudly replied, “Volume!”

Does that sound absurd to you? Surely, the story must be a throwback to the days before we had MBAs and complex modeling systems to direct our every move.

May I be honest? I have a degree in accounting, and have done graduate work in finance, not marketing. I have never worked in a purely marketing or sales function. Any marketing professional worth his salt has probably forgotten more on the subject then I will ever know. That explains the often-asked question of why a CPA wrote a book called Highly Visible Marketing, and blogs about marketing related topics.

I do not see myself as writing about marketing; at least not as the average person understands the word. I write about a business approach that is foreign to many marketing professionals. It is largely unheard of among small businesses.

I call it marketing accountability.

I focus clients on improving cash flow by growing the bottom line, not the top line. It is that focus that adds value.

Too many business people think like our melon-selling friend. They assume they can make money on any product or service, if they can just sell enough.

As obvious as it may sound, there must be a reasonable and measurable relationship between marketing costs and the expected cash flow and other benefits.

Without that mindset, there is no perceived need to compare costs and benefits. Little or no effort is spent matching expenses and revenues until someone asks why the cash balance is circling the drain or vendors start calling asking where their payment is.

Do you think I might be exaggerating the importance of accountability?

A 2005 study titled Small Business: Causes of Bankruptcy by Don B. Bradley III and Chris Cowdery of the University of Central Arkansas reported that of businesses in their study that filed for bankruptcy, 58% admitted to doing “little to no record keeping.” I assume a business that keeps no records has no ability to compare costs and benefits, let alone manage them.

I encounter this “I’ll make up the difference on volume” mentality with alarming frequency. One of those encounters was the cathartic event that led me to develop my marketing accountability approach.

I had a growing client who had reached $5 million in sales. Unfortunately, losses were growing even faster. They were in desperate straits, virtually out of cash. They thought the answer was to slash expenses and eliminate staff, while continuing to grow sales. In other words, they followed conventional business thinking.

I discovered they were losing money on their largest customer class, where all marketing efforts were directed. Much to their surprise, I did not suggest eliminating a single position. On the contrary, I recommended hiring a marketing person for the profitable customer base. I then directed  procedural improvements to make it easier for those customers to do business with my client. Finally, I suggested an immediate reduction in unprofitable customers.

Even more alarming is how often clients I assume are financially astute fall into the same trap. I worked with a very large company that started a bonus program on their entire product line. The problem was they lost money on some products, primarily because they were underpriced. The bonus structure did not differentiate between products. When sales of already unprofitable products increased, the added cost of bonuses produced a “double whammy” on the bottom line.

An appropriate tactic would have been to reward the sales force for increasing total sales, while also decreasing sales of unprofitable products.

As both examples illustrate, growing sales and increasing profits are not always synonymous. Admittedly, decreasing sales to improve cash flow and profits sounds counter-intuitive to someone lacking a firm grasp of their cost structure.

That is no excuse.

Knowing how to sell something without understanding the economic impact of those sales is a recipe for disaster. Those responsible for a promotion should also be held accountable for its results, good or bad. The ultimate result companies must focus on is how much cash a promotion puts in the bank. It really is that simple!

Does my marketing accountability approach work?

Here is what the client in the first example said, “While many companies are looking to cut back on employees as their first resort to handle cash shortages, CFO America was quick to point out that the right mix of customers was the crucial area of concern. They also were quite helpful in directing us in some marketing improvements that we could make. We are now in the process of implementing changes that are destined to enhance our financial picture.”

I leave you with that quote.

© 2011 by Dale R. Schmeltzle

CFO America: Your Cash Flow Optimization experts

You Can Have Any Color You Want, As Long As You Want Black (Part 2)

Today I conclude the article on product driven versus market driven companies. I began by discussing the cultural differences between the two. Product driven companies concentrate on achieving and maintaining technical superiority. Market driven companies devote resources to brand development and customer communications.

Companies and industries sometimes attempt to adapt their marketing strategy in response to changing competition and other market forces. For example, conditions slowly but dramatically changed for the entire American automotive industry over the next 50 years. Detroit’s response to the 1973 oil embargo was a textbook case of a failed attempt to adapt. Faced with the first ever non-wartime limit on the availability of cheap gasoline, the American consumer suddenly became very conscious of gas mileage.

At the time, Japanese and European companies dominated the market for fuel-efficient sub-compacts. American manufacturers’ knee-jerk response was to jump headfirst into a market they had ignored until recently. They stepped up production of the notoriously undependable Ford Pinto (voted the worst car of all time), the Chevrolet Vega and the AMC Gremlin.

Detroit’s failure took a personal toll on an entire generation of consumers. My first car was a red, white and blue Pinto. It was a cornucopia of expensive mechanical problems, unrelenting frustration on a 94-inch wheelbase. I sold it just before a massive recall for an exploding gas tank problem that would eventually cost Ford millions of dollars in legal settlements.

My next car, a Toyota, sparked a love affair with foreign cars that continues today. It was 30 years before I bought another Ford, a pickup truck for my son. It took almost as long for American manufacturers to overcome the image of producing inferior cars. It remains to be seen whether they will ever regain the world market share they once enjoyed.

How have things changed since I bought that damn Pinto?

A national chain of men’s discount stores advertised, “An educated consumer is our best customer.” For a product driven company in 2011, an educated consumer might be more aptly described as their worst nightmare. Service industry executive and strategic planning expert Michael O’Loughlin recently summarized the reason. He said, “Thanks to the Internet, the consumer has come to believe that no concessions are ever necessary. They expect unlimited choices in meeting their needs.”

Potential customers are only a few clicks away from a myriad of rival goods and services. A consumer with a smartphone can compare competitors’ prices on the spot. Any business, even the smallest local operation, ignores those powerful market realities at their own peril. Broadening your product line or services can help fend off competition by better addressing market needs, and improve customer retention in the process.

The men’s store chain recently filed for Chapter 7 bankruptcy. One analyst said they had failed to keep up with the increasingly competitive off-priced clothing market.

My final point is that few successful companies employ an entirely one-sided strategy. They operate along a moving spectrum on which there are few absolutes, and no strategy guaranteed to bring success or failure.

Consider Ford one last time. Product limitations notwithstanding, they still managed to sell over 15 million units between 1908 and 1927. At one point, half of all the cars in the world were Model T’s. That production record stood until the Volkswagen Beetle finally surpassed it in 1972.

The correct strategy for your business is the one that is executable within the constraints of your cost structure and marketing budget, and that produces the highest net cash flow given all the relevant factors at work in your market and your competition.

I began this article with an old quote. I end with another. A marketing adage says, “You have to sell from your own wagon.” It refers to a bygone era when merchants plied their trade by pushing handcarts up and down urban streets. The adage may be true. However, today you get to decide how big your wagon is, and what products or services it carries.

Go forth and sell!

 © 2011 by Dale R. Schmeltzle

You Can Have Any Color You Want, As Long As You Want Black (Part 1)

This week, I get to incorporate two of my favorite topics, history and old cars, into a two-part article. My title is one of Henry Ford’s most quoted statements. He actually said, “Any customer can have a car painted any color that he wants so long as it is black”.

He said it in 1909, ironically at a time when black was not available. The Model T originally came in grey, green, blue and red. He did not implement his all black policy until 1914. However, He could have accurately said customers can have any model they want so long as it is a 2-door. But his quote sounds better, so I’m throwing journalistic accuracy to the wind and going with it!

I use it to introduce my real subject, product driven versus market driven companies. Henry obviously believed in a product driven strategy.

My first goal is simply to understand the difference between the two strategies and the corporate cultures that define them at the most basic level.

If you were involved in Ford’s marketing efforts back then, your job was to convince potential buyers they needed a black Model T, period! Your marketing approach was something like, “Here is what I have to sell, and this is why you need it.”

Contrast that to a market driven strategy that asks, “What do you need, and how can I best meet that need?”

The cultural differences between product and market driven companies run deep. Product driven companies will spend relatively more resources on product development. Their primary goal is to achieve and maintain technical superiority. In extreme examples, they believe their products are so good they simply sell themselves. Engineers will always outrank marketing in the corporate pecking order.

Market driven companies will devote more resources to brand their company and products, and on customer communications. Technical superiority is secondary to understanding customer needs and anticipating market changes. Product development is less mission critical than advertising, since the marketing department rules the roost.

My second point is that if you are going to sell a limited product or service line, you need to be very good at it. Ford was fanatical about producing cheap, dependable cars. He managed to reduce the original $850 sticker price to $290 by the 1920s. At that price, he owned the working family automotive market. He was so confident that the cars’ features and low cost could generate sufficient sales that he did no corporate advertising from 1917 to 1923.

Unfortunately, being first to market with a technically superior product offered at an affordable price is no guarantee of long-term success. As Ford Motor Company subsequently learned, competitors (increasingly on a global basis) have a long history of unseating early market leaders who grow complacent about ever-changing customer needs and wants.

Being a product driven company is certainly easier if you exercise some degree of control in your relevant market, and if consumer tastes are stable and predictable. Perhaps Ford was lulled into a false sense of security by assuming past market conditions, under which they flourished for decades, would continue indefinitely.

Car buyers in the 1920s were unsophisticated by today’s standards. They could not have imaged, let alone demanded the range of choices, options and features currently available. Ford was not the first company to replace dangerous hand cranks with electric starters. Cadillac beat them to market by seven years. However, when the world’s largest car manufacturer finally made the change in 1919, consumers and the rest of the industry fell in line. Ford defined the new standard, not Cadillac.

I will conclude this article on Friday, when I write about how companies sometimes attempt to adapt their strategies to changing market conditions.

Until then, best wishes for a joyous Thanksgiving holiday.

 

© 2011 by Dale R. Schmeltzle

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