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2011

Dan Gilmore wrote in “The ‘Probability’ of Supply Chain ROI” propounds properly and rationally the fact that any “forecast,” including forecasts of ROI (return on investment) should not be a single number. Rather, as anyone properly trained in statistical methods will tell you, it should be a range of numbers. The range of numbers would generally be calculated based on a single calculated value plus and minus values that represent the confidence intervals or, simply put, how likely the statistician believes his estimates the calculates will approximate reality. A larger range indicates lower levels of confidence and a smaller range higher confidence levels. Now, while Gilmore is mathematically correct, the fact remains that most small-to-mid-sized businesses (SMBs) simply do not have anyone trained in statistics on their payroll and they are not likely to go out and hire a statistician to produce ROI forecasts for their IT projects – since this would, by definition, automatically reduce the ROI of the enterprise as a whole in the short term.

Back on a growth trajectory

Gilmore makes another comment in his article with which I wholeheartedly agree: “[T]here is some evidence that companies are in fact looking at investments that can help them to get back on a growth trajectory (read: increasing Throughput) without having to add much in the way of head count (read: Operating Expenses) by achieving productivity gains.” Given the world-wide economic malaise that is showing some signs of lessening (for the moment, at least), Gilmore’s description probably suits the vast majority of SMBs across the U.S. and beyond. Furthermore, many others besides me have written that a firm stand on return on investment will be the hallmark of technology spending in the 2011 and beyond. So, I can hardly fault Gilmore for suggesting that SMB executives and managers need to become increasingly sensitive to and realistic about ROI for every kind of investment in their firms’ futures.

Too much complexity already

Despite my agreement with Gilmore on theoretical grounds regarding forecasts – including ROI forecasts; and despite my agreement with him regarding the goal of companies to get back on a growth trajectory through wise investment of capital resources, I must disagree with him on the matter of adding useless complexity to the return on investment forecasting process. Allow me to explain why I use the harsh term “useless” to describe such an effort in the development of a ROI forecast for an IT project.

 

First  of all, let me say that statistical methods ought to be applied where they make sense. Statisticians generally agree that a valid statistical sample must contain at least 30 members. This works great where you have 30 dogs, 30 cows, 30 houses, 30 automobile, 30 miles of roadway, and so forth for comparison. Then, of course, you need to factor for environmental differences. Thirty or more cows all in the same pasture, eating the same foods, and enjoying the same climate would make a pretty good statistical sample for some studies of cows. On the other hand, three Holstein cows in northern Minnesota, two long-horns in west Texas, 15 black whiteface cows in eastern South Dakota, and ten mixed-breed cows in central Florida are not likely to constitute a good “sample” for cow studies.

 

Why?

 

Simply because there are too many environmental dissimilarities surrounding the cattle. By the time these factors were accounted for, (generally speaking) any results would have such a large confidence interval as to make any prediction almost meaningless. When considered as a whole, a typical SMB has tens of thousand of variable at work within the enterprise. Any number of those variables are likely to dramatically separate it from any “sister” enterprises in a sample group used to forecast ROI outcomes. Of course, the fact that traditional ERP – Everything Replacement Projects – are going to affect the whole enterprise is a big part of the problem of predicting ROI outcomes. With tens of thousands of variables at play, picking the winning number is far more challenging than winning the lottery.

Reducing the scope reduces the complexity

First of all, a good many SMBs today have a “pretty good” ERP system in place – regardless of its brand. Unless there is some pressing reason to undertake a traditional ERP – Everything Replacement Project, it is probably a far better idea to consider a New ERP – Extended Readiness for Profit project instead. Narrowing the scope of the project reduces the complexity. And, reducing the complexity increases the likelihood that your ROI forecast will be more on-target. Allow me to give you a couple of examples:

 

 

 

If your executive management team were to elect to pursue either of these projects – or both – the goals are specific and measurable – as would be the expected outcomes. ROI calculations become simple:

 

TOC ROI

Where delta-T = the estimated change in Throughput (Revenues less Truly Variable Costs), delta-OE = the estimated change Operating Expenses, and delta-I = the estimated Investment (including inventories).

 

Simple. Elegant. And, provided reasonable consideration is put into the estimates for the variables involved, such ROI calculations are far more likely to be right than any calculation around traditional ERP – Everything Replacement Projects.

 

©2010, 2011 Richard D. Cushing

I had a conversation with one of my daughters on the way to the airport recently. She was telling me about something that went on with regard to management decision-making at her work. (She works in the field of education, but the principle I wish to discuss applies everywhere, in every type of organization.)

 

The scenario is something like this: An executive (and here I use the term “executive” in the broadest sense, meaning any manager in a position to not only choose, but also to execute upon the decision made) states that he or she is going to make (or, has made) a management decision based upon a process (or, in this academic environment, a rubric – a process for scoring an otherwise subjective decision). However, upon further discovery and discussion, it becomes quite apparent to all involved that whatever “process” or “rubric” is ostensibly being applied is purely subjective and intuitive to the manager alone. That is to say, what is pretended to reduce an otherwise purely subject and intuitive decision to a “process” – a “rubric” – is merely a pretense. The decision being made remains purely subjective and intuitive and is not correlated to a “process,” at all.

 

Now, let me be clear. I am a free-market guy. I believe that business owners and their executive agents should be able to hire, fire and make other management decisions at will. I am fully committed to the fact that they may do as they please so long as their actions do not include coercion or deceit. In this scenario, it is not the executives decision with which I take issue – which is why the decision itself is not discussed here.

 

What I wish to discuss is how many times executives and managers are themselves deceived as to the presence of a “business process” or any kind of rubric by which they manage. From my experience, if I spent time cogitating, I’m certain that I could come up with a large number of examples. However, for brevity’s sake, let me just toss out a couple.

 

  1. Foremost in my mind are the numerous discussions I have had with executives over the years regarding so-called “sales management.” I say, “so-called,” because I have too many times been faced with one of two variations on the same theme in this regard. The first is where the owner of the small-to-mid-sized business (SMB) was the companies first salesperson (which is quite natural, as the organization was likely an outgrowth of some entrepreneurial venture) and remains today as the firm’s sales manager. He or she has, over the years, created a sales team of hand-selected folks, and the executive is convinced that each of these salespeople is unique and each requires special handling – a sort of prima donna approach.

  2. In the second scenario, the owner or chief executive is not in charge of the sales team. In fact, the firm has generally hired an experienced “sales manager” based on this persons history and background of producing sales at some other firm in the same or a similar industry. This person has then hand-selected a team of salespeople, the sales manager often doting over them making certain that each is uniquely satisfied with their particular arrangements. This is a variation on the same prima donna theme, but with a layer of middle management.    

    In both of these cases, however, the general attitude of top management at the firm is that, while they may give lip-service to something they call their “sales process,” when one digs deeper, it becomes abundantly clear that the “sales department” is really surrounding by mystique. Each hand-picked salesperson has his or her own mystical mojo that is performed in a somewhat ritual-like fashion. This mojo, when properly carried out and when not too much interfered with management and administration produces a life-stream of sales to support the rest of the company.  

    In these situations, the rest of the company’s executives and managers are under the implicit understanding that “I must not mess with the salespersons’ mystical mojo or things will go badly for the whole company.” Frequently, even top executives fear treading too much on the mojo, for fear there will be bad repercussions.    

  3. The third matter is that comes to mind is “sales commissions.” On numerous occasions I have asked executives, “How do you calculate and pay commissions?” A simple question?     

    To this simple question, I am not infrequently given a simple answer: something along the lines of, “We pay commissions based on gross margins.”        

    Simple enough, don’t you think? Until you begin to dig into the details. Then one starts hearing things like this: “Well, yes, we do pay commissions based on gross margins. But, if our buyers get a special deal on a purchase, we pay commissions on the ‘regular’ gross margins, not the actual gross margins of the sale of those special purchases.” Or, “Yes, we do pay commissions based on gross margins but, because the contract we signed with salesperson X is different from the deal we reached with salespersons Y and Z, the way we calculate ‘gross margins’ is different for each of salespersons X, Y and Z.”

 

So, I hear you ask, “What is the similarity between my daughter’s situation and the two examples I just mentioned?” The similarity is this: In each case the executive in charge called their decision-making a “process” (or, in the academic world, a “rubric”) or suggested that they were managing “a process” (i.e., “the sales process”). However, close inspection revealed that each decision was being made on a case-by-case basis without reliance upon a process or rubric, at all. Note, my objection is not to the case-by-case decision-making – although I offer that this is likely not a sound approach to managing a growing SMB. Rather, my objection is to the managers’ beliefs that they are actually managing to a “process” or by “a process.”

 

Simply put: If there is no process, it – whatever “it” is – cannot be managed. The key point here is to separate mere intuitive decision-making (sometimes--in fact, all too frequently--only slightly distinguishable from "guessing") from the act of “management.”  Management implies the existence of “a process,” – that is, an understood cause-and-effect relationship in a sequence of dependent events leading to a predetermined goal. There are three critical elements to this definition of “management” and “a process”:

 

  1. The “process” must have a goal or outcome. If there is no goal or outcome that can be stated in advance, then there is no point in attempting to “manage” it, for to manage it would be to somehow affect the outcome of the process (e.g., improvement). If the goal or outcome of the process is not understood or has not been articulated, then there is little need for the act of “management.”

  2. The “process” must include more than one step or event, and the steps or events must be related by their sequential dependence. One cannot manage, for example, “the big bang.”

  3. The “manager,” in order to manage effectively must understand both the goal of the process and the process itself.

If we return to the examples given, whenever an executive must deal with sales operations as mystical mojo that is carried out in some seemingly inexplicable way by certain persons who were hired because they have a demonstrated facility for working this “mojo,” then that executive cannot be said to be “managing” the “sales process.” He or she may be managing many things related to sales, like the expenses related to sales, the number of salespeople, the sales territory assignments, and more. But he or she cannot be managing “the sales process” any more than he or she would be said to be managing a group of witch doctors in the work they do.

 

Let me go further to say, that even though the executive may have a “prescribed sales process” that includes a number of “steps,” even if those “steps” are canonized in some CRM (customer relationships management) or other software application; and even if the salespeople are required to “check-off” against these prescribed “steps”; if such “steps” are subject to frequent manipulation by the salespeople or sales managers or if a near-constant series of concessions are being made to the demands of salespeople or sales managers in accommodation to their claims of “mojo,” (or something equally nebulous) then no real “sales process” exists in such an organization. Also, if management is repeatedly kowtowed by what amounts to little more than “threats” that “bad things will happen” if salespeople’s and sales managers’ demands are not met in this matter or that, then I would allege that no “sales process” exists.

 

Now, I hear you asking: “What difference does it make if we have a ‘sales process’ as long as we are making sales and surviving?”  To that question, too, there is a simple answer: If, as an executive, you do not have a real and manageable “sales process,” then you are at the mercy of the economic winds and the fickleness of fate. In the absence of a manageable process, you cannot know what actions will lead to improvement. Despite your title as “executive,” your only recourse is to try this or try that, because you have no comprehension of the actual cause-and-effect dependencies that lead to more sales or better sales.  Is that really how you want to run what is arguably the leading edge of your business enterprise?

Suggested Reading:

              
http://ecx.images-amazon.com/images/I/41jlqrxNqhL._SL160_.jpgReengineering the Sales Process

©2010,2011 Richard D. Cushing

I have been implementing PC-base technologies in small-to-mid-sized business enterprises since the mid-1980s, shortly after the introduction of the IBM Personal Computer (PC) in 1983.  In those more than  years I have seen too many companies shoot themselves in the foot by taking the wrong approach to buying IT systems.

 

The traditional approach to purchasing technology may be stated as follows (with minor variations):
1.    Create a budget
2.    Create a requirements list
3.    Review technology demonstrations
4.    Get proposals from the technology providers
5.    Buy from the lowest bidder if they meet the basic requirements

 

What's wrong with this picture?

 

What's wrong with this picture?  Let's drill deeper beginning with "Create a budget."

 

Typically the budget is predicated on what the organization thinks they want to spend on their new technology.  This is precisely the wrong starting place.

 

Getting started on the right foot--making more money!

 

The enterprise ought first to determine what strategic and tactical benefits they want their new technology purchase to deliver.  They should determine, in advance, how they expect their new investment in technology will help them increase throughput, reduce inventories and other investment demands, and hold the line or cut operating expenses.  These goals should be quantified and they should be rational.  For example, the organization might say:

 

INCREASING THROUGHPUT - Investment in CRM will help us segment our market in ways that will allow us to make more targeted win-win offers to our existing customer base while simultaneously giving us opportunity to make offers to new customers that will grow our market share.  Combined, we expect these two effects to add $4 million in revenues over two years and an estimated $260,000 to net profits before taxes (NPBT).

 

REDUCING INVENTORIES/INVESTMENT DEMANDS - Investment in improved warehouse, inventory management, and inventory replenishment (supply chain) technologies will allow us to reduce overall inventories by an estimated $2.5 million over two years.  By reducing inventories, this will relieve pressure on demands for new warehouse and production floor space.  Thus, demands for new capital investments are also attenuated.  The forecase $2.5 million reduction in inventories should save the enterprise an estimated  $72,000 in carrying costs in year one and $136,000 in carrying costs in year two after go-live.

 

HOLDING THE LINE ON OPERATING EXPENSES - The improved accuracy and enterprise-wide data visibility provided by the new ERP (enterprise resource planning) system should reduce the requirements to add personnel as revenues increase.  Our expected benefit would be 4.2 FTEs (full-time equivalents) over the coming two years at an average FTE cost of $78,000 per year for a total estimated benefit of $3.28 million over two years.

 

Summary of Net Estimated Benefits Over Two Years:

 

INCREASED THROUGHPUT ..............   $260,000
REDUCED INVENTORIES/INVESTMENTS ...   $208,000
REDUCED OPERATING EXPENSES ........ $3,280,000
==============================================
TOTAL ESTIMATED BENEFIT (2 YRS) ... $3,748,000

 


Having completed this kind of analysis, the organization has now quantified what it hopes to gain from its investment in the new technologies.  More than that, the management team is in a far better position to determine "requirements."  The requirements list will no longer be the 300 or more mostly meaningless items garnered from current users that do little more than reiterated things like "Must be able to print a check."  Instead, the team is ready to focus on that relatively small handful of things that a technology provider might show them that will really help them achieve the enterprise's goals for meaningful improvement.  Equally important, the management team is now prepared to set a meaningful budget based on realistic expectations and forecasts of return on investment (ROI).

 


SUMMARY


Business owners, executives, and managers that assume that buying information technology is best done by setting a budget, considering the options, and then buying from the lowest bidder are likely to be disappointed.  This is especially true if their budget amounts to nothing more than a "guess-timate" of what they think their "new system" should cost.  If they have not set strategic goals for their investment in new technologies, then their purchasing process will lack focus and it is all too likely that their acquired technology will not be fully integrated with their corporate strategies.  Furthermore, using the traditional approach will mean that it is less likely -- not more likely -- that the new technology will not deliver the return on investment (ROI) that stakeholders wanted.