Navigating challenging times

With increasing coverage in the media about the number of businesses in financial distress or starting to feel the effect of economic headwinds, how can you ensure that your organisation is safely navigating through difficult times?

Companies finding themselves with rapidly declining profits or in loss-making situations can happen more quickly than many people think, and can rapidly overcome the organisation if not addressed quickly.

As a result, it is important to be able to recognise that your business environment and your performance within it are becoming more challenging so that you can act accordingly – your ‘Early Warning System’.

One company once hired me to develop and lead an aggressive M&A-driven growth strategy, but had not realised that their underlying performance was highly precarious.

The company’s leadership had taken comfort that their revenues were continuing to grow, but had missed that the market was growing considerably quicker and competitors had captured significant market share. Conversations with customers indicated that the company was not addressing their current or future needs, and instead tried to push products on to them – the company had lost touch with its market.

In addition, increases in direct costs had not been passed on to customers and consequently gross margins had been compressed in recent years (at a time when competitors had moved manufacturing to low-cost countries). This, together with the costs from additional roles and other ‘growth’ expenses accumulating, the company was rapidly heading towards a significant loss.

I ended up leading an aggressive turnaround strategy to secure the company’s future before we could start to think about true growth.

What steps can organisations take to ensure they receive an early warning of impending performance challenges, and have time to make the necessary changes?

CASH IS KING

When I took my first overall company leadership role I was advised by a mentor to always keep a copy of three financial documents in my briefcase - the profit and loss, cash flow, and balance sheets for the business - so that I never lost sight of the business’s financial performance. Every month I would work with my finance team to analyse the key variances to understand what was driving performance differences, particularly negative ones. As a leveraged business, I was always most focussed on operating cash flow to ensure that earnings were dropping through to our bank account.

Whilst this gave me a good insight to the financial performance of the business I rapidly realised it didn’t tell the full story and that the ‘noise’ of many competing factors could hide critical trends. In particular, this monthly snapshot was always backwards-facing and didn’t necessarily tell us what future challenges we were going to face.

MAINTAINING AN EXTERNAL PERSPECTIVE

The most successful organisations I have worked with always maintain an acute awareness of what is going on in the markets around them: What are customers asking for? What are they actually buying (not always the same thing)? Which competitors are winning the big bids, and why? What are customers telling us about our products and services?

These questions provide critical insights to identify new growth opportunities and the tactics required to capture them.?

They can also help to provide an early indication of future challenges.

If my previous company had looked critically at its market share and bidding performance it would have realised that its competitors were making rapid gains in the market, partly due to the poor competitiveness of its products and services, but also due to internal organisational barriers.

Creating a system which captures this market data and provides meaningful management information should be the starting point for any commercial team.?

ARE WE EARNING WHAT WE THINK WE ARE??

Does your organisation track the profit per individual product sale at a headline price level or do you seek to understand what the net price realisation is once all discounts, rebates, free-issue products, etc. are included? If you are not measuring the latter you might be missing out on understanding another important source of underperformance for the business.

Similarly, is your organisation actually earning the revenues from each customer that you are factoring into your pricing formulae, or is there significant profit leakage that you are not keeping track of?

On many occasions I have seen companies earning significantly less than 80% of the net revenues they thought they were from sales. Sometimes, once associated production and distribution costs are included, the marginal profit can be negative and each additional sale can actually cost a company money.

Such analysis is not difficult, it is just time consuming to initially set-up, but nevertheless should be a core process for commercial teams.

ARE WE CONTROLLING WHAT WE CAN CONTROL?

When business is going well, companies will naturally seek to invest to maintain the trajectory: new sales roles; increased travel to see customers, possibly in upgraded cabins; new marketing initiatives; sales offices in new markets; additional production resources to meet demand.

How often do these companies assess the return on these investments in the good times, and how quickly do they react if these returns are worse than expected, or broader business performance starts to slide? Frequently the answers to these two questions are that the returns are rarely assessed, and reactions to worse returns are pursued only slowly, building up problems for the future.?

Functional heads need to introduce metrics which keep track of the additional costs they are introducing into their organisations and delivering the benefits they expect. For example, the operations team should be routinely tracking the actual production costs for its product portfolio and sharing these with product management and commercial teams to ensure that prices are set appropriately and margins are maintained.

At a company level, the finance and senior management team need to be assessing these costs in aggregate and ensuring that they reflect the real requirements of the business, and that the overall cost structure is not becoming inflated – whilst the company might be able to accommodate increased costs when things go well, they can rapidly take the organisation into a loss-making situation if sales slow.

Proactive cost control and continuous improvement are key tools that the most agile companies employ even during high-growth phases.

ENGAGE WITH FRONTLINE STAFF

Building the processes and systems to collate the external and internal data to provide meaningful management information can take time, but is a critical investment to provide an early warning system for potential challenges.

Even companies which successfully introduce such systems often neglect one of their most powerful data sources – their own staff!

Nothing is more frustrating for hardworking teams than to see their efforts and good work undone by lax processes and poor behaviours in other parts of the organisation – tapping into their views and insights should be a key activity for management.

In a past role, one of my production facilities was being pressed by the sales team to significantly increase volumes to meet market demand, and had started to evaluate a potential major capital expansion. However, when the team started to build the business case they realised that the average sales price had dropped in recent years, despite them notifying the sales team of raw material and labour cost increases. Net margins had fallen badly, with some customers being at or below breakeven – inadvertently the sales team had ‘bought’ market share. The optimum strategy to create economic value for the company was actually to forego the investment and instead increase prices; remarkably the volume lost was very small indicating that the company had been under-pricing its products for some time.?

An ‘Early Warning System’ should be a strategic management tool for any company leadership team, and can have substantial upsides as well preventing existential performance declines.

In future articles I will address what practical steps organisations can take if they do start to find themselves in a performance decline. In the meantime if you have any questions about how to build your early warning system or if you are already facing performance challenges and need support, please get in touch.

Smart Sustainability ltd Emery Quinn