Monday, May 10, 2010

Strategic Planning Analogy #324: Protect the Core

I used to work for a company where the legal department seemed to get the best perks. They had the larger offices, the better equipment, the larger staffs, and the higher wages. I did some investigation to find out why the legal department was getting preferential treatment.

As it turns out, when budgeting time came about, the legal department would justify their existence using large hypothetical numbers. They would say something like this: “Just one smart move by the legal department can prevent a future legal liability of hundreds of millions of dollars. Considering all the potential legal liability avoidances, they add up to a huge number. By comparison, spending a little more on offices, equipment and salaries in the legal department looks like a real bargain.”

Since that approach seemed to work for them, I decided to try a similar approach for the strategic planning department. I said that good strategic planning puts companies on a path to long-term success and keeps them off a path to failure. Given the alternative of good strategic planning or failure, how much would you be willing to spend on Strategic Planning in order to avoid failure?

I may have over-reached on that appeal, since the top executives would not accept the idea that they could possibly fail if the strategic planning department disappeared. Therefore, in future years, I toned down the message and said that Strategic Planning could find new paths to growth that were worth hundreds of millions of dollars and avoid hundreds of millions of dollars of losses from poor investments. That approach worked better.

In retailing, there is an old saying that “There are no cash registers in the corporate office.” In other words, all the money is made when a customer buys something at the store. Therefore, focus investments on getting the store right, because otherwise there will not be any income to pay for that corporate office.

Yes, it is true that getting things right at the point where sales are made is very important. Without sales, there are no profits. Sales, however, are not the only factor determining profits. As my friends in the legal department pointed out every year, bad legal decisions can cause all of your profits to disappear through legal liability payments. In other words, profits are also impacted greatly by actions at the home office—far away from the cash registers.

If the legal department could portray themselves as a savior of profits, and I could portray the strategic planning department as a savior of profits, I’ll bet a lot of other corporate office departments could do the same. Are we missing a lot of potential profitability if we focus too exclusively on just where the cash register is?

The principle here is that strategy needs to be concerned not only with cash flow creation, but cash flow protection. Without proper concern for protection, the cash flow machine can stop working.

There have been lots of stories in the news recently of threats to cash flow machines:

1) The oil leak in the Gulf of Mexico is putting a big dent in the BP cash flow machine.

2) Several recent mining disasters (like the Massy Energy mine in the US, the Raspadskaya mine in Russia, or the Guomin mine in China) have crippled the cash-making ability of these mines.

3) Quality issues at Toyota have had a negative impact on image and cash flow.

4) A little typing error on a stock trade caused computerized trading on Wall Street last week to destroy stock values, wiping out huge amounts of profits in a short amount of time.

In many of these cases, the disaster occurred due to too much emphasis on cash flow creation and not enough emphasis on cash flow protection.

At Toyota, the cash flow strategy—based on a superior quality product—was taken too much for granted. Emphasis was placed on increasing the cash flow from that strategy through more rapid expansion and more strident cost control. However, those measures to increase the cash flow worked to destroy the cash flow machine. They took the focus off quality and put extras stress on the ability to continue quality. As a result, quality suffered. The core strategy was damaged.

Productive mines and oil wells can be great cash flow machines. However, there is the risk of assuming the cash flow machine will continue all on its own. Hence, one can be tempted to cut back on mine-related costs in order to increase that cash flow. If you do not protect that mine or well with the proper safety, maintenance or employee training, disaster can erupt, shutting down the cash flow machine and causing huge sums of additional costs to fix the problem.

The point here is that all company actions impact the core strategy. Some of those actions may create near-term boosts to cash flow, but destroy the long term functionality of the core cash flow machine. Don’t assume that the cash flow machine will continue on its own. Put into your strategy and tactics proactive means to protect that cash flow.

Sure, I hear people strategize about some of the key threats found in Porter’s Five Forces, like competitive threats or new product threats. But what about some other threats to the cash flow machine, like:

1) Putting the wrong people in charge of key functions (I have seen this mistake literally destroy entire businesses).
2) Ignoring safety, maintenance, and training issues
3) Growing faster than you can manage the growth
4) Legal Liabilities
5) Risk Management
6) Swings in foreign currency translations
7) Tax issues (earlier, we spent an entire blog on just this one issue)
8) Computer programming errors.
9) Breeches of privacy or data theft

Cost cutting in areas such as these may look like a way to increase cash flow. But if the cost cutting damages the core cash flow machine, you are worse off. If cash flow protection investments are made, you can actually increase long-term cash flow while spending more money, because the investments increase the effectiveness of the core cash flow strategy.

So what can we learn from this?

1) Understand what is the core of your strategy
In most cases, strategic success is based on excelling at the key differentiating point of your strategic position. Mess that up and the whole strategy starts to crumble. Therefore, it is essential for everyone in the organization to know where that key focus is, so that it can be protected.

If the key focal point is quality, everyone needs to know that—not just the folks on the assembly line. There are lots of areas in a business where decisions can be made which affect quality, from finance to human resources to expansion planning and so on. If you want to protect quality, you need to protect it from all of the decisions throughout the business that can potentially impact quality.

The best way to do that is by holding everyone accountable for their impact on the core focus of the strategy. And of course, this means that companies must first know what that key focus really is (from the perspective of the customers). Then they must communicate it as a priority for all decision making, regardless of where you are in the organization.

2) When developing a new strategic initiative, design protection into the setup
The best way to protect a cash flow is to incorporate the protection in up front at the beginning. Once the oil rig in the Gulf of Mexico erupts, it is too late to start the protection process.

This applies to numerous areas. For example, how you initially set up a business or an acquisition can have huge impact on your level of legal liability or tax liability. The type of people and process you use to integrate a new initiative may have more of an impact on cash flow than the actual initiative.

Considering all the risk issues up-front allows you to incorporate more protection into the process, before all the contracts are written up and all the deals concluded. Think beyond the point where business in transacted (the “cash registers”) to all the places that could indirectly impact success.

3) Don’t assume that a cash flow machine will work forever if unprotected.
Left unattended, cash flow machines will break down. They can be made less efficient through hundreds of little decisions around the company which each have a small impact of compromising one’s ability to excel at the point of strategic focus. They can be rendered obsolete by competitive advances. Lack of investment in maintenance or R&D can slow it down.

If this is the key to your success, don’t take it for granted. Protect it like the crown jewels, because that is exactly what it is. Protect it from inside threats as well as outside threats. Invest in your point of differentiation so that it is always a step ahead of the competition. Keep awareness of what is the core of your success at the top of mind, so that it will be given its proper attention. Whenever big decisions are being made, always ask yourself “How will this decision impact the core of our cash flow machine?” Be vigilant.

Great strategies need to be more than just great ideas. They need to become the core of how your business operates. This can only happen if you put in place strategies and tactics to protect this core from losing its strategic focus.

One little drop of water is pretty harmless. But get enough of them and the dam won’t be able to hold back the water and it will burst, destroying everything below the dam. Similarly, get enough little, seemingly harmless, decisions that weaken a strategic position and before you know it, the strategy bursts.

1 comment:

  1. Gerald, I read this post many times. It is a gem. In life we do not get anything for nothing. To get better cash flows we need to pay for it and hedge for it. This is one of your most illuminating posts.