Tuesday, July 14, 2015

Strategic Planning Analogy #553 Part 1: Wrong Documents

I recently purchased a new smartphone. It came with a small booklet of instructions. The booklet gave me the information I needed to enjoy my phone.

However, as useful as that phone instruction booklet was to me, that doesn’t make it the ideal booklet for everyone. For example, what if that tiny instruction booklet was the only document given to the people who had to manufacture the phone? It would be a worthless document for the manufacturer, because it only talks about how to USE the phone, not how to MAKE it. They wouldn’t know what to do.

Because the manufacturer is a different audience, with different needs, it needs a different document.

The key documents from a finance department tend to be the:
·       Income Statement;
·       Balance Sheet; and
·       Cash Flow Statement.

Because they are such important documents, finance departments like to use them as much as possible. They even like to use them as the primary documents for strategic planning.

But forcing planners to use the income statement, balance sheet and cash flow statement as their primary documents is like asking phone manufacturers to rely on the owner’s instruction booklet as their primary manufacturing document. It’s inappropriate.

The phone user booklet is designed for people who want to use the finished product after it is made. It is not designed for the people who have to design, create and manufacture the phone. For them, other documents would be more useful.

Similarly, the income statement, balance sheet and cash flow statements portray a company “after the fact.” They show the finished condition of the financials. Their primary audience is not the people who build the business, but the people who interact with the finished product, like investors and bankers and regulators.

If you want to design, create and “manufacture” (i.e., implement) the business model, then you need other documents. Over the next several blogs, I will be describing the types of planning financial documents which should be used INSTEAD of the income statement, balance sheet and cash flow statement as your primary strategy financials.

The principle here is that strategic planning is more effective if you use planning documents instead of user documents. In this blog, we will look at some of the shortcomings of applying “user documents” for planning. In subsequent blogs, we will look at superior planning documents for planning.

1) Only Numbers From Ledger
The first flaw is that the income statement, balance sheet and cash flow statements are primarily numbers from the general ledger. They don’t mention strategy anywhere (in words or numbers). There is absolutely no way of knowing what part of any number is connected to what strategic initiative or mandate.

For example, you may have a number of strategic initiatives which impact sales, but with a single sales line on the income statement, there is no way of knowing:

  • What are the expected baseline sales?
  • What sales impacts are specifically expected to come from each strategic initiative?
How can you test the reasonableness of your sales line if you don’t know what actions are connected to it and what is expected from each action?

Another problem with only numbers is that, as we all know, there is more than one way to hit a number. For example, I can drop manufacturing costs by eliminating manufacturing and only sell out of inventory. That will work only until inventory runs out, and then you are in big trouble. The overall strategy is ruined, but you will look great on your manufacturing expense number. Without a documented link between strategic actions and numeric outcomes, one can “game the system” and hit the numbers for all the wrong reasons.

So without words about strategy and specific numbers connected to each initiative (even if the numbers do not have a label in the general ledger), the document is fairly worthless as a strategic tool.

2) Bias to Cost Cutting
Standard financial documents are mostly full of expenses. Therefore, if you want to make a quick impact to these documents, there is a bias towards focusing on lowering expenses/cutting costs. Unfortunately, cost cutting is not the only strategic option, and there are often many far superior options. Perhaps instead of focusing primarily on cost cutting, you company would be better off with a strategy focusing on one of the following:

  • Improving Quality
  • Improving Speed to Market
  • Changing Distribution Channels
  • Expanding into New Geographies or Customer Segments
  • Broadening the Product Line
  • etc.
Even though these may be superior strategies, many of these initiatives would probably increase expenses in the short run. But, by using documents with a bias towards cost cutting, I may be hurting my chances of approving or executing on these superior options. I would be better off if I was using documents that have quality, speed, etc., as prominent in them as costs.

3) Linear
Most of the standard financial documents are linear in design: you start at the top and work your way down to the bottom. Unfortunately, strategic planning is more circular.

Take for example, the relationship between marketing and sales. One time, I was in charge of the advertising budget for a company. The budget person, in a desire to cut costs, asked me to cut the advertising budget by around 20%. I asked him if they were going to cut the sales line as a result of my cut in advertising. He said no. Therefore, I suggested to him that they cut the advertising to zero, since it was apparent they saw no connection between marketing levels and sales levels. If you don’t think sales will fall as advertising falls, you may as well eliminate the advertising completely.

The point I was trying to make was that there are strategic implications which ripple throughout a financial statement when you alter a key component (like marketing). You cannot change one line at a time in isolation and expect everything else to stay the same. At the same time, you have to change all the ripple effects, too. Therefore, you need planning documents which make it easier to see the strategic links to other financials.

4) Mixed Responsibilities
Most standard financial statements tend to be all inclusive—selling, operating, and overhead are all jumbled up into the same document. This makes it hard to create a sense of ownership and accountability for any standard financial document. And if something goes wrong, there is all sorts of finger-pointing to the other people included in the document.

A better approach would be separate planning documents more segregated towards one main area, with the links to the other areas spelled out.

Just as the manufacturer of a phone needs different documents than the user of that phone, the “manufacturer” of a business strategy (planners and the ones the planners work with) needs different documents than those who interact with the finished product (bankers, investors, regulators). Right now, the primary documents from finance are pointed towards those who interact with the finished product. That’s fine for them, but not for the strategists. The strategists are the manufacturers of the strategy, so they need a different kind of document. In subsequent blogs, we will be discussing how those documents should look and work.

I also recently got a new washer and dryer. I’m glad they sent me the right type of documents. I hope you get the right types of documents to the participants building your strategy.

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