Why every company should be doing scenario planning

Editor's Note:
I have had a number of conversations with  companies in recent months about the duration of the economic upturn and the direction of their markets. Do we really know how this is going to play out over the next few years? No, there could be several very different views of where the markets and economy may go. But we all need a direction. 

With great uncertainty and multiple different views of the future, a company needs to do scenario planning, so that it thinks about the different possible views of the future and how it would move or adapt to best position itself.

The Mead Consulting Group utilizes scenario planning to help clients build flexibility into planning and execution and to help leaders think broader. This last recession was a game-changer. While scenario planning was once conducted primarily with our larger clients, today, over half of our clients (owner-operated, strategic, and private-equity- backed) have discovered the benefits of scenario planning.  - DPM]
  
 Why every company should be doing scenario planning

If your business or industry is predictable, you need not continue reading. If, however, there is uncertainty about the future of your markets or industry, then your company should examine the way it plans. It isn't just healthcare companies, either. I would submit that there is little predictability in most industries.

Making assumptions gives us a false sense of security and puts blinders on us. What is the old line about the word "assume" making an "ass out of you and me?" Not to be profane, but traditional strategic planning totally botched the economic downturn/recovery of 2008 - 2015. Traditional strategic planning is based on assumptions. The planning group makes certain assumptions about the future - about variables such as economic, political, social, technological, regulatory, environmental, etc. Making assumptions is just another way of saying we are attempting to predict the future.

Really? I would suggest that there are situations where economic, social, political, technological, regulatory, and environmental factors will drive fundamental change in every business and industry of every person reading this e-Letter. It's really only a question of degree, pace, and timing.

Various organizations (e.g. Blockbuster, Kodak, Encyclopedia Britannica, print media, broadcast media...the list goes on...) could have avoided significant market pain by utilizing scenario planning. Without being overly critical, these organizations were complacent - and they made assumptions about the future that proved to be very wrong. Each was overtaken by forces that were not within their traditional industry competitive analysis.

Have the courage to consider the tough questions. How will your business be impacted by the following?

•    Technology - How much will technology change your industry?
Will your business or industry be affected by any of the following:

• Mobile ordering; Mobile product/ price comparisons
• Mobile payments
• "Showrooming" in brick and mortar stores and buying online  (e.g. Best Buy and Amazon)
• Contextual offers/specials, loyalty programs, other specific knowledge about customers
• Social commerce
• Apps for everything
• Efficient visibility and management of supply chains (from end user order entry - directly impacting each step of the supply chain)

•    Social/Environmental

• Power moving to the consumer (away from institutions)
• Buyers have equal or greater knowledge than sellers

•    Changes in culture, attitudes

• Will today's 20-something millennials abandon the desire for home ownership?
• What long-term impact will the "green" movement have on markets, products

•    Demographics - Is your customer base affected by demographics?

• Aging population in certain markets
• What does the negative birth-rate and aging population mean for European economies like Greece, Spain, Italy, or Iran and Iraq
• Baby boomers retiring, selling businesses, eldercare, etc.

•    Economic

• Is the U.S. facing a period of structural high unemployment?
• Long periods of "stagflation" or inflation
• Will increasing labor rates continue to make China less competitive? How will outsourcing look in 5-10 years?
• What will happen to Europe?

•    Regulatory - The list is endless...

• Affordable Care Act
• FDA
• EPA
• Trade
• Tax reform (Elimination of subsidies, elimination of deductions (e.g., mortgage interest), business expenses, etc.?)

Some organizations will say scenario planning is too difficult and elect to take a simpler course.  Most organizations perform traditional strategic planning or business planning/ budgeting because it is comfortable and addresses a short timeframe. However, we now know that the world is uncertain and interconnected. Companies can no longer ignore uncertainty or try to assume it away.  As author H.L. Mencken is quoted, "For every complex problem, there is an answer that is clear, simple, and wrong."

That is your opportunity. Since 2008, we've seen the number of our clients that are doing scenario planning more than tripled.  Companies that are scenario planning are examining different possibilities of the future and determining their competitive response. They are modifying the trends and information that they monitor so that they can develop "early warning" signs. These companies are building flexibility into their planning and adaptability into their leadership and culture.

If you want more information on the Mead Consulting approach to scenario planning, please contact me.

Prepare your company to be bought

Editor's Note: As we entered 2015, three of our clients received unexpected offers to sell their businesses. Because they were prepared, they held the line and the prospective acquirers significantly bid up the offers to a range that the owners decided they could not refuse. Two of them closed in 60 days. The third company decided to run a competitive process and is generating exceptional interest from additional buyers. This is a sellers' market. Well-prepared companies are receiving very high selling prices.

Many business owners fail to prepare their businesses for a sale either because they believe that a potential sale is far off in the future or because they are focused on current issues and do not consider preparation to be a priority. We would submit that companies need to be "prepared to be bought." Sometimes lucrative offers come unexpectedly for companies that are well-positioned. We typically recommend that a company engage an experienced investment banker to assist them in a sale - often even if they have received an offer - in order to generate a competitive environment.

Some business owners who have tried to "time the market" at some point off in the future have found that unpredictable events such as the 2007-2012 recession, credit and stock market crunches, tech bust(s), 9/11, industry issues, etc. can derail their ability to sell at maximum value. We recommend to our clients to work each year to make certain that their companies are currently desirable to buyers. - DPM]

How best to position a company to be attractive to buyers:

1.    Demonstrate Strong Financial Performance
 
 a. Historical Financials

• Consistent revenue growth (at least upward trend)
• Recurring revenue is a plus
• Strong operating margins
• Increasing profitability
• Importance of last twelve months

  b. Operating Cash Flow

• Focus on hitting projected revenue and earnings numbers
• Review net profitability of customers and products

2.    Maintain "clean" financials

  a. Audited or "auditable" Financial Statements

• Have your financial statements audited with a reputable firm to add credibility
• Use GAAP accounting. If not, identify how practices differ from GAAP
• Understand cash vs. accrual accounting - timing differences can be material

  b. Income Statement Adjustments and "Add-backs"

• Buyers are skeptical of earnings that rely on substantial add-backs (one-time, non-recurring charges, private company expenses, etc.)

3.    Diversify your customer & supplier base

• Diversification signifies a healthy business and reduces risk
• Buyers will pay less for companies dominated by one or two customers
• Examine what % of sales your top 10 customers represent?
• How stable are your top suppliers? How stable are their terms?
• Do you have multiple suppliers for critical components/services?
• What % of total purchases does your top supplier represent? Top-5 combined?
• What % of the company's sales are related to a few key employees?

4.    Develop a Strategic Growth Plan

• Maintain a clear strategy and be able to demonstrate your history of execution
• Be able to articulate specific future growth opportunities
• Position your company to take advantage of them

5.    Build a capable Management Team

• Invest in training and key strategic hires, if needed
• Motivate management to add value to the company through a potential sale
• Focus on building a deep management team that can thrive without your continued leadership

6.    Eliminate potential "Gotchas"(these are items that could result in significant discounts to value)

• Maintain legal documentation (licenses, regulatory filings, contracts, intellectual property, incorporation, etc.)
• Clear title to all assets
• Document processes and procedures
• Resolve legal disputes

7.    Build a team of Qualified Advisors

• Minimize distractions from running your business effectively
• Get advice from professionals who have expertise in areas you do not and have done it before
• Beware of advisors that outstep their areas of expertise

Are you and your company ready if a buyer appeared on the radar?
Most business owners who have executed a successful sale of their business will tell you the most important thing is: BE PREPARED.

Selling a business is very different than operating a business. As a business owner you know your industry, your product or service, your customers and your markets. Most business owners will only sell a business once in their lifetimes - and it can be by far the most important financial transaction of their lifetime.

Minority Recaps - A great option for some business owners (Capital is available for growth or stabilization)

Many company CEOs and CFOs today spend a good deal of time working the banking environment.  Many of our client companies are performing at very good levels. Some are interested in taking advantage of acquisition opportunities; others in growth plans with new products and new markets. Some are looking for the opportunity to hedge the risk and perhaps take a few chips off the table. Other have good performing companies, but have issues with their balance sheet.

I have been surprised at how few business owners, CEOs and CFOs are aware of MINORITY RECAPS as a potential means for growth capital, taking a few chips off the table, and possibly providing for balance sheet stabilization. We recommend consideration of minority recaps.
Minority recapitalizations (Minority Recaps) - Owners of mid-market and family-owned companies can sell less than 50 percent of their shares at minimal, or no, minority discount and still retain control.

Owners of mid-market and family-owned companies can sell less than 50 percent of their shares at minimal, or no, minority discount and still retain control; they can receive cash for their shares; they can use debt, as well as equity, to enhance returns; they can keep a significant equity tranche for a second exit - when market conditions might again be peaking; and they can pursue an aggressive and ongoing business plan designed to stimulate organic growth and finance acquisitions. This allows private company owners to lower risk by lowering the personal financial concentration they have in their business through diversification.

Common Myth
A common myth is that all private equity firms want control. While that may have been true ten years ago, in today's environment, many PE firms are enthusiastic about teaming up with management to grow good companies with less than a controlling interest.

Minority recaps are not an appropriate for every business owner
The company needs to have the following characteristics:
•    Good operating performance (cash flow and revenue growth
•    Good management team
•    Strategic Growth Plan (tangible opportunities for growth)
For those companies that meet these parameters, it might be just the ticket.

Second bite of the apple can be better and sweeter than the first.
For those companies that sell a minority stake with opportunities to grow, the results can be compelling. In many cases, partnering with the right private equity firm can provide growth that is many times higher than the company could have achieved without outside capital. When the company is ready to sell in an additional five years, perhaps, the owner can reap significantly higher returns.

Example:
Five years ago a client of ours was doing $26 M in revenue with good margins and cash flow. The owner wanted to expand beyond the region into other markets with new products, but lacked the capital and financial expertise. We helped the company develop a strategic growth and execution plan and shored up some weaknesses to present the company in its best light. We assisted the company in finding experienced, knowledgeable resources to help. The company sold 35% interest to a private equity firm. The owner was able to take a few million of his ships off the table ( his family was very happy that his exposure was lowered) and still had significant capital to expand. The private equity firm assisted with introductions, and recommended the addition of a terrific CFO and a strong VP of Operations. The company last year recorded over $130M in revenue. That second bite 65% share was worth a lot more than it was five years ago. The owner had this to say: "I had heard terrible things about private equity. But these guys really became our partners and helped us become a better company. Thanks to Mead Consulting for helping us get it done with the right team."

Market Challenges
The current market offers interesting challenges. But some companies will be able to navigate these waters and put themselves in a lasting competitive position. Think about how your company could gain with capital to acquire and grow during a period when everyone else is in the bunker with their heads down. One caution - before embarking on this path, seek help from those professionals with experience working with mid-size companies in your position. If you would like more information on minority recaps please contact me.

Five ways for you to fail - Using customer profitability to become customer-centric Part 2

Part 2 - Using customer profitability to become customer-centric
   Five ways for you to fail

[Editor's Note: This is Part 2 of a series on customer profitability. I hope you find it useful.  - dpm]

We hate to present things in negative terms. However, many companies try hard to be customer-centric, but their efforts fail to add value to the company. Frequently, they commit some - and sometimes all - of the following sins:

DENIAL
Do you insist that the differences in the profitability of your customers aren't important or aren't measurable with current systems? Do you deny that you have unprofitable customers? If you try to calculate customer profitability, do you exclude some operating or capital costs? Does every cost in your company get allocated to a customer?

THE GROWTH ILLUSION
Are you adding lots of new customers without knowing how much they cost to acquire or how long they're likely to stay? Most important, do you know about the economic profit (operating profit minus a capital charge) you can expect from each new customer?

THE ILLUSION OF AVERAGES
Do you make decisions based on average customer profitability (profitability by segments or markets)? Are you aware of how much profit comes from the best 20% and the worst 20% of your customer? Are you unsure about which specific elements of customer behavior cause customers to fall into the top and bottom groups?

FAILURE TO ACT Do you fail to make specific managers fully accountable for acting on customer profitability? Is your strategic plan disconnected from the economic profitability of customers?

FAILURE TO DRIVE COMPANY VALUE
Have you stopped short of figuring out how much each customer segment contributes to your share price or overall company value? Have you told your board and your stakeholders how you're using your knowledge of customer profitability?

 

Focusing on customer profitability is key to becoming a truly customer-centric organization. Calculating net profitability by customer is the start. Sustainable improvement to company performance requires changes to strategy, structure, organization, culture, and measurements.

 

Improvement can start immediately! The good news is that many of our small and middle market business clients see measurable profit increase within the first three months of implementation.

Congratulations to Mark Phillips and the SLI Global Solutions team on the sale to GLI Group

SLI Global Solutions Joins the GLI Group of Companies

LAKEWOOD, N.J. (March 2, 2015) – The Gaming Labs International group of companies is pleased to announce the addition of SLI Global Solutions (SLI), a leader in Quality Assurance and Software Testing Services, to its growing portfolio of companies. With this acquisition, SLI Global Solutions and GLI combine to form one of the largest organizations with a singular focus on software testing and quality assurance worldwide.
GLI President/CEO James Maida said, “Just as GLI is recognized for its global leadership in gaming testing and professional services, SLI has long been recognized as the leader in government solutions; testing for certification of health IT, and voting system certification testing; software testing and quality assurance. Those similarities extend to the culture of each company. With testing and certification at our core, both GLI and SLI have shared beliefs in excellence, passion and commitment to our clients and to providing the best services available anywhere. Moving forward together, we will share that culture and commitment to excellence, providing even more customers with broader levels of testing, certification and professional services.”
SLI President Mark Phillips said, “SLI has built a scalable delivery model using documented and repeatable processes delivered by highly credentialed and experienced staff and enhanced by innovative tools and techniques. Because of this, SLI has been able to provide significant value to both private and public sector clients as they develop their most strategic IT products. We are excited to join the GLI family of companies to rapidly scale and deliver these solutions to a much broader range of clients.”
SLI ensures information technology investments result in products that are built according to agreed upon standards, perform as expected, and fulfill business needs. Together, GLI and SLI will represent one of the world's largest providers exclusively dedicated to quality assurance, technology testing and IT governance-related solutions.
SLI brings a broad portfolio of services and solutions to GLI including world class software test automation, quality assurance, and independent verification and validation for commercial and government agencies.  SLI has earned a number of designations including an ISO 9001:2008 certification for its Quality Management System and ISO/IEC 17025:2005 accreditation for software testing for electronic health records and voting systems. SLI leads the industry with its own proprietary quality management methodology, SQM³, which is based on practical applications of IEEE, PMI and ISO standards.

About SLI Global Solutions:
Since 1996, SLI Global Solutions has been helping customers manage their technology risks and investments. As a company that has earned an ISO 9001:2008 certification for its Quality Management Systems and ISO 17025 accreditation for all laboratory work, we provide software testing, quality assurance (QA), and independent verification and validation (IV&V) for commercial and government agency clients that are based upon our proprietary quality management methodology, SQM³.
www.sliglobalsolutions.com.

About Gaming Laboratories International:
For 25 years, Gaming Laboratories International, LLC has continuously delivered THE best quality land-based and iGaming testing and consulting services with supreme accuracy while reducing time to market. With 20 laboratory locations spread across Africa, Asia, Australia, the Caribbean, Europe, North America and South America, GLI is the only global organization of its kind to hold U.S. and international accreditations for compliance with ISO/IEC 17025, 17020, and 17065 standards for technical competence in the gaming, wagering and lottery industries. For more information, visit www.gaminglabs.com.

# # #

GLI Contact: Christie Eickelman, Vice President of Worldwide Marketing
+1 (702) 914-2220, c.eickelman@gaminglabs.com

SLI Contact: Cassandra Pierce, Market Operations/Recruiting

+1 (303) 575-6881, x161, cpierce@sliglobalsolutions.com

 hillips

Using customer profitability to become customer-centric

[Editor’s Note: We initially published this eLetter in 2002. Since that time, we have assisted many clients in gaining a better understanding of their customers and profitability. I hope you find it useful.     – dpm]

Some companies calculate the net profitability of every one of their customers every month!  Why? Because they have discovered that the company profitability is built “one customer at a time” and that all customers are not the same.

What should be included in your calculation?
Every cost in a company should be allocated to a customer. In a manufacturing company, for example, costs should include the product cost, freight and delivery, cost of generating and processing an order and collecting from the customer (from sales, sales support, customer service, technical service, order entry, scheduling, rent, warehousing, picking, staging and loading, insurance, accounting, credit and collections, terms, warranty costs, cost of capital for plant, equipment, information technology), R&D, and corporate overhead.

Why spend so much effort at this micro level?…Because companies have discovered that examining profitability at the customer level provides not only amazing data about the cost of acquiring, servicing, and maintaining customers, but perhaps most importantly can provide insight into new product and service opportunities to gain a better share of their best, most profitable customers.

Cost of serving customers. One of our distribution clients found that, due to the cost of processing and special packaging an order, order size was a far greater determinant of profitability than gross margin. Product and pricing was adjusted to reflect the value of special packaging, while introducing new standard packaging that covered a broader number of customer needs.

Cost of acquiring new customers. Another client discovered that marketing programs that were designed to grow revenue were inherently flawed. One program, (judged a great success since it added $7 million in revenue by the second year) added customers that cost $2,000 to acquire, but who only generated $1,350 of profit during their tenure as a customer. In truth the company lost $650 on each new customer acquired under this program.
                                                           
Insights into best customers.  Opportunities to cross-sell additional services and products. One client found that its best customers in the construction trade were notoriously poor planners and had difficulties forecasting demand. By providing a rather basic scheduling service for these clients, it now provides better service at lower costs and charges a premium price. It has solved a real issue of pain for both customer and supplier …AND…with the increased knowledge about the customer’s needs, it has begun to develop and sell additional products to their best customers.

Calculating Profitability per customer does not require a significant new investment in Information Technology or Accounting Systems? Most of the small and middle market businesses we work with have implemented some form of customer tracking software and cost tracking software(CRM, Manufacturing, Order Processing, etc….some may have Activity Based Costing) which is sufficient to get started. Following the customer interaction through the company’s business processes and establishing some cost allocations is the next step. This is an iterative process with calculations and allocations improving over time. Typically, the segmenting of customers by profitability is easy to discern and companies find that they can begin to implement measures quickly.

Focusing on customer profitability is key to becoming a truly customer-centric organization. Calculating net profitability by customer is the start – sustainable improvement to company performance requires changes to strategy, structure, organization, culture, and measurements.

Companies are generating outsized improvements. Mead Consulting clients that have embraced customer profitability have enjoyed significant improvements in performance both in revenue as well as profitability. To see more information on some of our client improvements, visit our client success stories page.

In work with our clients, we utilize proven methods designed to center the business around customer profitability. If you would like more information, please contact me.

Seven traits of Colorado success stories. Why some companies grow and others get stuck.

[Editor's Note: Over the past seven years, we have met with the CEOs or owners of over 200 private Colorado companies. These companies range from new technologies, products and services in such diverse fields as education, web conferencing, technology, construction, trucking, logistics, medical devices, outsourced services, among others. Some of these companies are growing - some quite rapidly; others are stagnant or stuck.]

Why are there such differences? Certainly companies that depend on some industries such as homebuilding or construction were severely impacted by the economic downturn. However, blaming stagnancy solely on economic malaise is an oversimplification. The recession – and subsequent “selective recovery” has highlighted the differences between the good, well-managed companies from those others whose fortunes rise and fall with the economy. We have found that industry, size, and the overall economy are not necessarily the determinants of company success.

Companies that have become "Colorado success stories" share certain traits. While this is not intended to be an all-encompassing list, this list is intended to provoke some thought about what breeds success.

1. Lifestyle or Equity Value. How many of you have ever been involved with a company where the owner was conflicted about current compensation or cash flow vs. investment for the future?
Be clear with what type of company you want to be. A lifestyle company can allow the owner to call his/her own shots and to move at his/her own pace. It is run for the cash flow and lifestyle benefits of the owner(s). In an equity value company, the owner strives to build real assets with a scalable, tangible value that can be bought and sold. This leader is willing to sacrifice some short-term gains in order to invest in growing the market value of the business. These “equity value” owners focus more on building value as seen by potential buyers: sustained improvements in revenue/EBITDA, and a strong management team that can operate and grow the business without the owner's constant involvement.

There is no right or wrong answer to the lifestyle vs. equity value question, but owners must be clear in the distinction. Straddling both lifestyle and equity value camps is sure to generate both lower current cash (compensation for the owners) as well as lower growth and value potential (lower equity value).
Below are some of the characteristics of Lifestyle vs. Equity Value companies.  Lifestyle companies tend to have a short –term focus; they tend to run at the owner’s pace or comfort level. Investment in the business may be secondary to a passion of the owner, such funding the as sponsorship of a team, or sport, or the arts. While these companies may have some elements of other management styles, in the end, there is a centralized nature to decision-making and authority. Likewise, since there may be limited empowerment or upward mobility for managers, high performers are not attracted to Lifestyle companies, or do not remain. See the article “Which do you have – a Lifestyle Business or an Equity Value business?”

Table 1

	Lifestyle	Equity Value
Focus	Short-term Lifestyle; Run for Owner’s compensation	Long-term Equity Value; sacrifice short –term comp
Pace	Owner’s pace	Dictated by desired outcome
Management style	Command & Control; Centralized	Decentralized; individual decision-making
Owner Management	Can tend to be viewed as inconsistent, capricious and changing	Consistent with overall strategy and core values
Expense Control/Spending decisions	Tightly controlled at top	Managed through approved dept budgets and policies
Outside Capital	Debt; Investors not interested; Growth may be restricted due to availability of capital	Equity investors
Empowerment	Limited; Loyalty Rewarded; Small circle of trust	Expansive; Performance rewarded; Systems to enhance empowerment
Objectives	May change at owner whim	Clearly outlined; transparent
Employee Equity	No	Yes; equity awarded
Career Development	Limited upside	Significant upside
Employee Capability	“Steady Eddies” Thrive here	High performers thrive here
Sale of Business	Usually only to Employees or Family	To third-party Buyers (Strategic or Financial)

2. Empower employees. Companies can't grow beyond a certain point if all of the real decision-making stays in the hands of the owner or a small group of managers. Growth companies look to empower employees to make decisions. They also develop a culture that allows employees to make mistakes and a mechanism so that they can learn and grow from the mistakes.

3. Hire for the next level. Companies that want to grow understand that they need talent that can manage at the next level. Successful companies hire people who can grow 1-2 levels higher in the organization so that the talent pool is constantly being strengthened. These companies also understand that paying more for top talent more than pays for itself.

4. Develop flexible strategies you can execute well. Traditional approaches to planning and execution assume away uncertainties and set a fixed plan in place for a year or more. Successful companies are developing multiple possible views of the future, developing a plan and actions, then revisiting the plan every 8-12 weeks to adjust to changes in the market or the competitive landscape. Otterbox, the designer and marketer of protective cases for smartphones, has grown from $15M revenue in 2008 to approx. $1B revenue with a flexible approach that re-evaluates all strategic operating plans every 6-8 weeks for possible adjustment. Other companies are utilizing scenario planning to develop and “rehearse” their responses to different possible future states in order to maximize their competitive position. See our article “Why every company should be doing scenario  planning” and the 5-part series on Scenario Planning.

5. Develop an adaptable organization. Successful companies focus on creating a culture of adaptability. They develop an organization, and leadership that can react quickly and make necessary course corrections in response to market opportunities. See the article “Adapt is new thinking” and the 7-part series on Creating an Adaptable Organization.

6. Focus on a superior customer experience. Dan King of ReadyTalk calls it developing "emotionally-connected" clients; Maria Vogt and Sonya Yungeberg of government contractor, Ayuda Management, call it "under-promising and over-delivering". These companies focus on wowing the customer and build systems and hire and reward people who want to delight the customer with every interaction. Engagement of customers is key.

7. Play offense instead of defense. If you do anything long enough it becomes a habit; then it becomes part of your culture. Many companies have created defensive cultures with several years of cost-cutting and deferring or eliminating new projects and new products. "NO" has become the operating word for "stuck" companies. Successful companies look for opportunities to develop and test new business models, new products and new projects. They see the market as ripe with opportunities to grow and innovate. "HOW" is their operating mantra.

Conclusion: Examine your company. Do you live the traits of successful companies?

Let us know your thoughts.