Thursday, April 12, 2007

Bob The Basketball Player

Once upon a time, there was a man named Bob. He loved to play basketball. Unfortunately, he was awful at making layups. Bob would always miss when trying to get the ball in the hoop via a layup.

Every day, Bob would practice his layups for hours, but it did him no good. He would always miss.

One day, Bob’s friend Sam dropped by to watch him practice. After an hour or so of watching Bob miss every shot, Sam commented to his friend, “You know, Bob, you’ve been trying the same thing hour after hour, day after day and it is not working. You are not getting any better. Maybe it’s about time you tried something different.”

A few weeks later, Sam ran into Bob at the mall. Sam asked Bob, “So how’s the layup practicing going?”

“Great!” said Bob. “I took your advice and tried something different. Now I make every shot.”

“That’s wonderful,” replied Sam. “What did you do?”

Bob proudly exclaimed, “I lowered the basket by 3 feet.”

Strategies are about setting and achieving goals. Many times there are goals already set for you by your investors, lenders or shareholders. For example, they may require a minimum return on investment.

If you continue to fall short of reaching those minimums, you may be tempted to solve your problem by lowering your goals, similar to how Bob “solved” his problem by lowering the basketball hoop. Unfortunately, just as there are rules in basketball about how high the basket needs to be, there are rules of thumb in finance about how high the returns on investment need to be.

Generally speaking, people do not invest in you because they like you. They invest because they believe they are going to get a return on their investment higher than their minimum requirement. If you cannot meet their requirement, they will invest their money elsewhere. Similarly, if Bob cannot make baskets at the required height, people will not put him on their team. They will look elsewhere.

You may be able to fool yourself for awhile into thinking you are a great basketball player by lowering your hoop three feet. Eventually, however, you will have to play on someone else’s court. Then you will find that if you are like Bob, you cannot effectively play by the normal rules of basketball.

The same thing can happen in business. You may be able to capture a large bonus or two by lowering the goals and trick yourself into believing that you are doing well. It will not last long, however. It is a highly competitive marketplace out there. If you cannot play to the high standards expected in the marketplace, you will eventually fail.

The principle here is about finding ways to fill the strategy gap. Returns on investment are based on anticipated future cash flows. Is the cash coming in at a large enough and fast enough rate to meet the goal? If so, you will do alright. If not, you are in trouble.

It is not uncommon for a company to add up all of its anticipated future cash flows and find that there is not enough there to reach their goal. The gap between what you think you can achieve and what you are required to achieve is called the strategy gap. Strategic planning is then needed to find a way to fill that gap. If you cannot find a way to fill that gap, the value of your company will go down.

There are many ways to fill that gap. Some are better than others. Here is a listing of some of those methods:

1) Redefine the Goal
2) Deceive Yourself About Expectations
3) Work on the Denominator
4) Work on the Numerator
5) Work on the business portfolio

Each of these is discussed below.

1) Redefine the Goal
To redefine the goal is to do what Bob the Basketball Player did. He redefined the height of the basket to a low enough level so that he could make his shots. In other words, businesses can fill their strategy gap by effectively eliminating the gap—lowering the goal until it exactly equals what the current business model is already obtaining.

Although this process may theoretically eliminate the gap, it may not produce enough of a return to satisfy your investors/creditors/shareholders. Instead, it may only produce a high enough incentive among these people to get them to replace you with someone else.

2) Deceive Yourself About Expectations
This second option is very similar to the first, except that instead of lowering the goal to meet what you can do, you artificially inflate the expectations of what you can do in order to predict a return that exactly achieves the goal. That would be like Bob the Basketball Player promising that the next time he would make all of his layups with a regular height basket, even though past experience would lead one to believe that he will miss most, if not all of them.

The good news is that this process gives the appearance to your investors/creditors/shareholders that you can achieve their goals. At the same time, it makes your job relatively easy, because you just continue business as usual. However, since the expectations made for the business are unrealistically high, it is only a matter of time before your lies are found out. Eventually, you will run out of excuses for the repetition of disappointing performance and have to face the fact that you are not capable of meeting the expectations with the current business model.

It may not be outright deception which causes one to over-inflate expectations to meet a target. It may just be over-enthusiasm and overconfidence…or maybe you think you’ve fixed the problem, so this time the results will be different. In any event, too much optimism can blind us to the fact that perhaps we do not have as good a business model as we think we do. As a result, even though we claim to have filled the gap, we really have not done so.

3) Work on the Denominator
The concept of return on investment is a ratio. The numerator is your return and the denominator is your investment. One way to increase your return in order to fill the gap is to work on the denominator of that ratio. In other words, find a way to get the same return, but with a lower investment.

There is a healthy and an unhealthy way to reduce the denominator. The healthy method usually involves an emphasis on improving the efficiency and productivity of your resources, so that you need less of an investment in order to achieve your return.

The unhealthy method involves deep cost cuts and taking unnecessary risks by eliminating testing or spreading your resources too thin. They say you get what you pay for, and if you pay too little, sometimes you end up getting less than you bargained for. For example, by eliminating maintenance, you may be able to improve your returns and look good in the near-term. However, long-term, without maintenance things will eventually fall apart and cost more to repair than the cost of the maintenance. Then your returns will plummet.

4) Work on the Numerator
The other side of the ratio is to work on the numerator. In other words, improve your return on investment by increasing your returns.

As with the denominator, there is a healthy and an unhealthy way to increase the numerator. The healthy method usually involves an emphasis on improving the efficiency and productivity of your marketing, so that you are better serving your customer, resulting in improved sales.

The unhealthy method involves either:

A) Promising more than you can deliver, which may increase revenues near-term, but reduce repeat business long-term; or

B) Luring people to purchase with excessively high loss-leader purchase incentives (i.e., bribes) which cannot be cost-effectively sustained over time (for more on this, see “If You Want Loyalty, Get a Dog”).

5) Work on the Business Portfolio
The idea here is that if your current business portfolio cannot achieve your goal, add or subtract business and/or capabilities which will create a more effective portfolio. For Bob the Basketball Player, if he cannot make the layups himself, get him some help on the team. For example, use Bob’s skill as a passer and have him pass the ball to someone who can make the layups. Or, to go back to the height issue, have him sit on top of the shoulders of someone else, so that the two combined are tall enough to reach the basket.

High levels of return usually involve tapping into the synergies which come from combining multiple resources. If you can create the right combination in the right way, you can tap into higher returns.

In this short space, we were only able to touch on the surface issues concerning the achievement of business goals. The key point is that not all methods succeed over the long-term. By taking shortcuts in the near-term, we can actually make our long-term prospects even worse. The best way to fill in the gap between current performance and desired performance is to work on a combination of productivity enhancements, marketing enhancements, and portfolio enhancements. The strategic planning process can help find the best path for your company amongst these options.

When you see someone making excessively high bonuses, it may be more of an indication of their skill at negotiating their compensation than their skill at achieving high long-term returns for their company. Just wait awhile and see if they get those bonuses three or more years in a row. Then you will know how good they are at building lasting performance.

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