Category Archives: Finance

Public Equity or Private Equity? Which is Best for Your Next Funding Round?

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Although this is one area where the doctor will not profess to be an expert, especially since he primarily worked with, and for, private equity start-ups in his career, he will point out a good article from the winter edition of the McKinsey Quarterly on “the voice of experience” that surveyed 20 chairmen or CEOs from the UK who have served on both public and private equity boards. The survey found that not a single executive ranked public equity better while
75% of the respondents firmly believed that private equity boards clearly add more value. On a five-point scale, PE boards averaged a stellar 4.6 while public boards averaged a more meager 3.5.

According to the research, while public boards score higher on development/succession of management and governance (with respect to audits, compliance, and risk), private boards score higher on stakeholder management, performance management, and strategic leadership. Furthermore, the respondents strongly felt that PE boards were (much) more effective in adding value. The respondents universally agreed that value creation was the top priority of a private equity board, with an overall weighting that was 3.6 times as high as that for public companies, where value creation was at the bottom of the list. In comparison, the respondents were divided on whether or not governance, compliance, and risk or strategic initiatives were the most important priorities of a public board. Although this isn’t entirely illogical, as public boards are often not rewarded by a company’s success (unlike their private equity counterparts) and may lose their reputations if investors are disappointed, it does make a good point. If you want value creation, make sure your board is focussed on value creation and shares in the reward. It’ll also net you more of their time (as the survey found that PE directors spend, on average, nearly three times as many days on their roles as their public company counterparts), and that’s where the real value will come from if you have the right board.

The Hierarchy of Supply Chain Metrics

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A classic article in the Supply Chain Management Review discusses “the hierarchy of supply chain metrics” because measurement is the cornerstone of operational success. According to the article, which builds on AMR Research, the best approach to measurement uses a three-tiered hierarchy that allows managers to quickly assess overall supply chain health at the top level, diagnose problems at the mid-tier, and identify corrective actions at the ground level.

At the top level, there are three core metrics that allow a manager to quickly gauge the overall health of the supply chain:

  • Demand Forecast Accuracy
  • Perfect Order
  • SCM Cost

At the next level, a composite cash-flow metric provides a diagnostic tool that allows a manager to zero in on the components that are likely the cause of any inefficiencies. The metric allows managers to determine whether there’s a balance between the time it takes suppliers and the time it takes customers to pay, whether the inventory metric (which can contribute to high costs) needs further analysis, and whether cash flow is being appropriately managed. The metric consists of:

  • Accounts Payable Turnaround Time
  • Inventory Totals
  • Accounts Receivable Turnaround Time

At the bottom level are the day-to-day metrics that measure performance across the different supply chain management activities and allow root-cause analyses when one of the higher-level metrics indicates a potential problem with efficiency or cost management. These metrics measure supplier effectiveness, operational effectiveness, and cost management effectiveness and include:

  • Supplier Quality
  • On-Time Delivery
  • Remaining Inventory
  • Purchasing Costs
  • Direct Material Costs
  • Production Schedule Variance
  • Plant Utilization
  • Work-in-Process Inventory
  • Order Cycle Time

Utilized properly, the hierarchy can lead to great success. However, companies can face significant challenges when designing and implementing measurement programs. The article offers seven recommendations for tackling the challenges that will arise:

  • Follow these four universal principles
    1. Keep it Balanced
    2. Work from the Outside In
    3. Focus on the Outcome
    4. Use the 80/20 rule and don’t choose too many metrics.
  • Proactively address organizational resistance
  • Beware of tunnel vision and ensure the metrics you choose address interactions and interdependencies
  • Analyze root causes when issues arise
  • Use a top-down approach to analysis
  • Measure enablers
  • Measure in the context of a performance-management program

Retailers Have a Thing or Two to Teach Wall Street

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A recent articles in Stores on “six lessons Wall Street could learn from retailers” caught my eye because I just couldn’t fathom how, out of all the lessons Wall Street needs to learn (again and again) you could limit the number of lessons to just six, but since I’m a big believer in lean, and fundamentals, I decided I’d give the article a shot. After all, a blogger can never have too much material to write about. It was, at least, an interesting article and I would recommend you read it all the way through if you have the time.

So what were the lessons?

  • Times have changed since 1984.
    If bankers and financiers had been applying some of the basic business practices used by the retail industry, they might be doing the hula today instead of trying to undo countless missteps. After all, companies like Best Buy and Wal-mart are doing fine. (Most likely because good retailers don’t sell items [like complex derivatives] they don’t understand or don’t believe consumers will see a need for.)
  • If somebody calls himself a liar, maybe you should believe him.
    The principle of trust, but verify is etched into the way a good retailer does business. Trust without verification is a recipe for disaster. (Just like handing out loans to borrowers without credit checks.)
  • Hold the spaghetti sauce.
    Retailers know that focusing on what you do best yields the greatest returns. (Financial leverage spawns financial ruin.)
  • Don’t take the t-shirt.
    Retailers, like Wal-mart, have gifts and entertainment policies to prevent conflicts of interest. (Wall Street, in comparison, threw lavish multi-million dollar extravaganzas for its clients while Rome was burning. )
  • Give the lady what she wants.
    In retail, serving the customer is a long term strategy. The best retailers refuse to compromise customer service by adopting short term measures. (In comparison, the Wall Street crisis is intrinsically linked to a financial system obsessed with short-term gains.)
  • Keeping a dog around doesn’t change it into a cat.
    Retailers know that if a product isn’t selling after a short period of time, it’s not going to get better with age. (And throwing more money at it isn’t going to help.)

Ten Tips to Maximize Your Working Capital

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A recent article in the Supply Chain Management Review, a publication which never fails to deliver high quality content month after month, tackled the fact that, for better or worse, in this economy cash is king and you need to do everything you can to improve your working capital without hurting your suppliers. That’s why this was such a great article, it wasn’t the usual “reduce days sales/receivables outstanding and increase days payable outstanding” BS that doesn’t really help anyone. It was ten well thought out points of advice to help you tackle and analyze your supply chain and working capital situation and make good decisions on how to improve it.

The article noted that the first thing you have to do is get the organization working off of one set of numbers. Sales, operations, production, and procurement often work off their own sets of forecasts, padded to insure they are not penalized for late delivery. Adding excess inventory in every step of the chain can tie up a lot of cash needlessly. Also, while operations focusses on lead time, work order, surplus, quality, part, and finished good metrics, finance focusses on ledgers, forecasts, reserves, write-offs, debt, capital, and cash. The organization needs to focus on a common set of metrics and numbers that take into account the needs of both divisions and manage of those metrics and numbers together. Then, focus on each of the following points.

  1. Get Back to Basics
    Understand the planning parameters and whether or not they reflect (the new) reality. Only then can you build true models and forecasts.
  2. Get the Data from the Source
    The best way to find cash is to follow the cash trail and see where it is needlessly tied up. Create reports that monetize cash-critical decision points in key processes.
  3. Educate Finance on Operations
    Tie operational metrics to financial metrics to help finance understand the cash-flow requirements and break down the organizational silos.
  4. Educate Operations on Finance
    Tie financial performance to operational impacts to help operations understand the working capital restrictions and break down the organizational silos. Make sure operations understands how they contribute to RONA, ROIC, and ROCE.
  5. Benchmark Performance to Policies, Industries, the Fortune 500
    Are you exceeding your standards? Your peer group’s standards? The standard for big industry at large? If not, you have room for improvement.
  6. Establish a Metric Hierarchy Focussed on Freeing Up Cash
    For example, casual metrics such as early receipt of material value, quality discrepant material value, surplus material value, early purchase order to need date material value all directly influence the top level metric of days of inventory outstanding (DIO), which ties up cash and influences your top level metrics of RONA, ROIC, and ROCE as every day you hold inventory adds cost which decreases profit which decreases return. Understand your metric hierarchy and monitor the low-level metrics daily to identify little problems before they turn into big ones.
  7. Establish a “Cash Council” of Cross Functional Executives
    Improving cash flow and working capital needs to be everyone’s responsibility.
  8. Aim High, and Re-Evaluate the Business Model
    Creating a goal to reduce working capital requirements of the business by 30 percent may not be attainable by efficiency improvements alone. The business model may need to be evaluated and updated in areas such as customer contract type and terms, vendor management of inventory, outsourcing of business processes, portfolio re-alignment, divestitures or acquisitions, supply chain restructuring, and new partnership or joint venture agreements. And that’s good. A better business model may bring other improvements as well.
  9. Invest in Systems to Automate (Working Capital) Performance Reporting
    Don’t waste time building reports … spend time evaluating and diving into reports, getting to root causes, and solving the issues.
  10. Review Cash Policies on a Periodic Basis
    External business conditions and internal performance capabilities can change, which requires periodic review and update of key policies driving cash and working capital consumption.

Inventory is Very Expensive

A classic article in the Supply Chain Management Review does a great job of overviewing the cost components of inventory and breaking down what the total cost of ownership really is.

Simply put, the following costs are associated with holding inventory:

  • Product Costs
  • Warehousing
  • Depreciation
  • Obsolescence
  • Pilferage
  • Damage
  • Insurance
  • Taxes
  • Capital Cost
  • Administrative Costs

And that’s why, in an average scenario, in an average organization, the total cost of holding inventory is over 30% of the base purchase cost.

And that’s why you need to examine that special volume discount carefully next time your supplier offers you a special, limited-time, “buy more now, save more now” offer. Chances are, the supplier is just trying to pass their inventory costs on to you … which far exceed the meager discount they are offering.