Strategic Planning Analogy #449: Scorekeepers Vs. Score Makers

THE STORY
Today, when you go to a sports arena they have those huge Jumbotrons showing you not only the score, but lots of high definition video in full color. It wasn’t always that way.

There was a time when scoreboards were only what their name implied—boards of wood with the score on them. When the score changed, a person had to physically take down the old painted number sign and put up a new number (by hand).

Those scorekeepers were kept pretty busy changing those signs during the game. But even though they worked hard to change the score on the board, the score keepers did not cause the score to change. They only reported on the action taking place on the field.

Sure, the scorekeeper put the larger score on the board, but if you wanted a larger score, you needed to have a coach with a great game plan and athletes who could execute it. Just because the scorekeeper was closest to the scoreboard does not mean he was closest to the action.

Don’t confuse the scorekeeper with the score makers. Don’t mistake them for being the coaches or the athletes. All he does is put the signs on the board.

THE ANALOGY
Now it may seem silly that someone would confuse the scorekeeper with the score makers. Maybe it wouldn’t happen in sports, but it seems to happen quite frequently in business. And that isn’t silly; it’s tragic.

In a lot of companies, we have employees who are referred to as strategists. Their responsibilities may use terms such as managing strategic planning or strategic plans. But when you look closely at their job descriptions, they are really little more than scorekeepers.

But instead of a scoreboard, they have a spreadsheet. They use the spreadsheet to keep score. First, they keep track of the desired score—the goals of what the company wants to achieve. Then they keep track of the actual score—what the company actually achieves. Finally, they compare the two scores to show a variance score.

Then, if these so-called strategists have a big enough budget, they create fancy dashboards to place on all of the executives’ digital screens to show off the results. These dashboards have lots of fancy colors and dials and charts and traffic lights—sort of like those fancy Jumbotrons.

But as fancy as they all are, the root function is not much different than that old-time scoreboard operator. The primary function is just to keep track of the score.

THE PRINCIPLE
The principle is that scorekeeping is not the same as strategic planning. And if the job description for your “strategists” is basically that of being a scorekeeper, then the task of true strategy is probably lacking—to the detriment of the company.

This is not to belittle the role of the scorekeeper. That is an important job. But it is not strategic planning. You need them both. Just as sporting events would be pretty worthless if only the scorekeepers showed up, all that business scorekeeping is pretty worthless if all the goals and measures being watched are not rooted in comprehensive strategic planning.

Asking the Tough Questions
Comprehensive strategic planning is not merely about coming up with a number. No, it tends to be more like an essay test. Great strategic planning has to answer a lot of tough questions, like:

Where are we going to play in the marketplace?

How are we going to win in that place?

What are the tradeoffs we are going to make to win?

What is the business model best suited for us to win?

What is missing in our resources to accomplish this? How will we obtain what is missing?

What threats are on the horizon which could change the way we need to play to win?

We talked more about the importance of answering these types of tough questions here and here. The key point is that until you answer these questions, there is no way of knowing how to score your progress. You need to know the rules for YOUR particular game before you can properly score it.

Otherwise, it would be like carefully measuring the speed at which you are driving when you have no idea of where to go. If you have not determined a destination and a path, then the speed at which you are driving is irrelevant. Getting nowhere faster isn’t much to be proud of.

To get a handle on where the profession of strategic planning is headed, I spend time looking at the job descriptions posted for “strategic” positions. It is fairly common to see lots of scorekeeping in the job description, but very little about tackling these tough questions. The qualifications tend to ask for people with expertise in accounting and spreadsheet modeling. They don’t tend to ask for people with expertise in positioning, business models, or how to win in a competitive marketplace.

I’m not so sure that accountants are necessarily the best qualified to answer these types of questions. And even if they were, they will be too busy with scorekeeping to spend much time focusing on the questions.

Don’t Merely Rely on the Operators
I’ve talked to some of the people who operate under these types of job descriptions. I ask them how all those tough questions get answered. What I hear is that the scorekeepers rely on the business operators for the bulk of the input. Unfortunately, there are many flaws in this approach.

First, the operators have a personal bias towards getting a large bonus. This can cloud their thinking regarding what a good score would be. A good score for an operator might be a beatable number, rather than the strategically correct number.

Second, operators tend to be highly invested in the status quo. That is their strength; it is what they know. Therefore, they tend to pick goals which are incremental extensions of the status quo. Strategically, the best solution might instead need to be a drastic change…perhaps even selling off that operation. Why would an operator volunteer to see his career path and platform for power go away?

Third, a lot of the best strategic moves are into new spaces. This is often referred to as the Blue Ocean strategy. By definition, new virgin spaces do not have an established operating base. Therefore, there is not an operating division naturally thinking about or fighting for this new opportunity.

Finally, operators tend to be overwhelmed by the Tyranny of the Immediate. In other words, a large percentage of their time is focused on the current crisis of the day. They are spending so much time putting out the current fire that they do not have enough time for the luxury of pondering the long-term. If you are not spending enough time pondering the big picture and the long term, then you will answer the questions in a narrow, short-term way. This leads to sub-optimization.

That is why companies need professional strategists who are not captive to these limitations. They do have the luxury of being able to focus on these big issues. That is, they have that luxury if they are not required to spend nearly 100% of their time as scorekeepers.

This is not to say that the viewpoint of operators is worthless. No, their insights are valuable to the process because they are on the front lines. But, it cannot stand alone. It needs to be balanced by the objectivity and big-picture thinking of a real strategist.

SUMMARY
Keeping score is not the same thing as providing key insights into answering the tough questions of strategy. If you reposition strategic planning as little more than scorekeeping, then a key aspect of strategic planning will be missing. As a result, you may end up with great measurements of nearly random activity which does not lead to a great long-term destination.

FINAL THOUGHTS
Today’s modern spreadsheet and dashboard tools can turn into great toys which are fun to play with. They can start absorbing an ever larger percentage of your time. But let’s not forget that they are only more sophisticated scoreboards. And although they can be very useful, the action on the playing field is still more important than the sizzle of the scoreboard. Keep it all in its proper perspective. The essay test of the tough strategic questions may not have as much sizzle as a scoreboard, but it still needs focused attention.

Strategic Planning Analogy #372: Spreadsheet Games

THE STORY
Sudoku is a wildly popular number game throughout the world. It is based on a 9x9 grid. This grid is further sub-divided into 9 3x3 grids. The idea is to fill all 81 squares in the grid with a number from 1 to 9 such that:

a) Every row will have exactly one occurrence of each number from 1 to 9.

b) Every column will have exactly one occurrence of each number from 1 to 9.

c) Each 3x3 grid will have exactly one occurrence of each number from 1 to 9.

Although the origins of the game go back to the 18th century, its recent popularity began back in 1986, when the Nikoli company in Japan started publishing books of the puzzles (they were the first to label the puzzles “Sudoku").

However, the global popularity didn’t begin until Wayne Gould, a retired Hong Kong judge, developed a software program making it easy to develop new Sudoku puzzles. This software started to be used in 2004. Nearly all Sudoku puzzles today are made with Gould’s software.

It is estimated that the size of the global Sudoku business is in the many hundreds of millions of dollars annually. However, neither Nikoli nor Gould see much of that money. Nikoli never bothered to trademark Sudoku outside of Japan, so they only get Japanese royalties. And Gould decided to let others use his software royalty-free (all they had to pay for was the software). It is estimated that of the hundreds and hundreds of millions made on Sudoku, Nikoli only sees about $25 million and Gould only earns about $1 million.

THE ANALOGY
Although Sudoku is a very popular number game, it has not financially benefitted Wayne Gould to anywhere near the extent of its popularity.

In strategic planning, we have a different number game which is also very popular (at least with strategists). It is the discounted cash flow analysis. The object of the game is to estimate future cash flows and then discount them back into today’s value by taking out the annual cost of capital requirements. When you solve this number puzzle, you will supposedly know how much a particular business or strategy is worth in today’s currency.

Companies spend a lot of time and money playing these discounted cash flow number games. However, I am afraid that many of the businesses using this game are like Wayne Gould. They are not reaping rewards anywhere near the size that one would expect.

In fact, I would argue that much of the claimed benefits of discounted cash flow analyses are no longer there. Much of the effort put behind them is wasted effort. You might be just as well ahead if you let your financial analysts play Sudoku as to have them play Discounted Cash Flow.

THE PRINCIPLE
The principle here is that merely solving a discounted cash flow puzzle is not the same thing as developing a sound strategy. And often, solving a discounted cash flow puzzle does not lead to as much insight as one might think. Therefore, you may want to reallocate your resources to solving fewer of these puzzles and more to deeper strategic thinking.

Is Cash Flow As Important As We Think?
Discounted Cash Flow puzzles are based on the assumption that cash flow is the most important determinant of value. And the proponents of using this game can point to historical evidence showing that cash flow has one of the strongest correlations to value. However, I believe that in the future that correlation will significantly weaken. Here is why I think so.

Cash flows measure how a business earns profits through operations. The underlying assumption is that the value of the business is based on how profitable its operations are. In other words, if you assume that business operations are the way money is taken out of a business, then modeling the cash flows of those operations will give you a good idea of what the business is worth to you.

However, it appears more and more that the primary way companies in the future will extract value out of a business will have little to do with operations. Instead, nearly all of the value will be created at the time ownership transfers.

For example, take a look at a lot of the recent activity in the digital space. Companies like You Tube, Alibaba, Webex, Google and Doubleclick created nearly all their value at the time they either sold out or went public. The value created at that instant was far in excess of any type of cash flow profits that they had created in their past or could be expected in their near future. In fact, it is hard to envision how any sort of cash flow could reasonable get to the evaluations firms such as these created at the moment of ownership change.

I think this will get even more distorted when firms like Facebook, Groupon, Zynga, Twitter and others do their change in ownership. You’re already starting to see it with the ownership money already flowing into these firms. The valuations are incredibly high.

If you put these values into a discounted cash flow model and solve for future cash flow, you get numbers which boggle the mind. Sure, I can mathematically make the models work. The models will solve for cash flow. But just because the model can determine what cash flow is needed to make the model work does not mean that those future cash flows are likely to occur.

Flip that Business
In the new reality, if value is made by ownership transfer rather than through operations, perhaps operational cash flow is the wrong place to be looking when trying to determine value.

Keep this in mind. If I know that I am running a business to create value through ownership change rather than through operations, how do you think I am going to run that business? Obviously, I am not going to fixate on operations, but rather fixate on that which influences the transfer of ownership. My definition of customers is no longer the people buying or using my product. No, my customers are now the people I am going to transfer the ownership to.

Think of the people who flip houses. These people find a distressed house, fix it up, and quickly flip it to someone else at a profit. These people have no intention of ever living in these houses. These people to not make investments which are in the best long-term interests of the house. Instead, they focus on superficial cosmetics (how nice the lawn looks—curb appeal) which make the house more appealing to the next buyer. Let the buyer beware!

Many of the businesses of the future will be operated the same way as house flippers. The original owners have no intention of sticking around long term. They are not incented to do what is best for the company long term. Instead, effort will be placed on the superficial cosmetics which increase the appeal to the next owner. Things like how many visits there are to the site (which may be adding no value but be appealing to future owners) will be focused on rather than building a viable long-term business model (the source of cash flows). Let the buyer beware!

Now you might think that future owners would still be fixated on cash flows. They may say so, and they probably should be, but that is not necessarily reality. With all of the well-financed hedge funds and deep-pocket companies out there right now, there is too much money chasing too few great opportunities. As a result, the rules of supply and demand overtake the rules of cash flow. Businesses get bid up beyond appropriate cash flow values due to supply and demand.

In addition, keep in mind that the next owner may not be a final owner, either. They may be purchasing the business in order to quickly flip it to a third buyer. Look how many businesses are taken private (new owner) just so that it can be flipped back public again a few years later (third owner). Therefore, the new owner may be just as disinterested in everyday operations as the old owner.

So What Should We Do?
If this is the case, then what should we do? If you are the owner wanting to flip the business, look for places where supply (companies) and demand (potential new owners) are in your favor. Focus on things which impact desirability at time of sale rather than fixating on cash flows.

If you are the buyer of businesses, spend more time looking beyond the hype to understand the fundamentals. Warren Buffett always puts more value on business fundamentals than on the magic of pushing around numbers in a spreadsheet. If the basic fundamentals of the business are solid and the business model is solid, then good things usually happen (regardless of the numbers).

Unfortunately, the reverse is often not true. You can make a pretty model with nice numbers, but end up with a disaster because the assumptions are not based on solid fundamentals. Without a solid underpinning, a completed cash flow model may not be any more valuable than a completed Sudoku puzzle.

This is not to say that cash flow puzzles should be abandoned. They are still a valuable tool. Think of them as like the speedometer on an automobile. If you glance at them every once in a while, they can be very useful. But if you stare at them constantly (and fail to look out the window), you will end up in a crash. Rather than agonizing over them to the utmost detail, just use them to check for broad reasonableness.

SUMMARY
As value creation shifts more towards ownership transfer and less towards operational cash flows, the value of cash flow tools also diminish a bit. More thought must be given to supplementing such analysis with deeper looks at either the fundamentals of the business model (if a buyer) or the tricks to increasing appeal to a buyer (if a seller).

FINAL THOUGHTS
Sudoku is played by a narrow set of rigid rules. This makes it easy to know if you have won. By contrast, strategy is played using a wide set of vague rules. As a result, in strategy you can solve the puzzle, yet still lose the game. Don’t assume that strategy is a simple as filling out a few spreadsheets.