College Woes

College Woes

While Harvard receiving bailout funds made the news, be thankful, you are not a university protest. Higher education in the U.S. is about to experience the most significant disruption ever, and the effects will change the industry forever.

As Scott Galloway has said, “University brands are the premier luxury brands globally, built over centuries, with margins and the illusion of scarcity that renders Hermès vulgar.” Well, for many of the lower-end brands, their stores will close and possibly not reopen. Colleges are facing several threats that will result in the closing or merging of up to 20 – 25% of the countries colleges.

 

Financial Stress

COVID has arrived and threw a spanner in “the works,” bringing budgetary hits to schools. Many colleges were not financially secure before COVID came. Forbes analyzed all 933 private, not-for-profit colleges in the U.S. with enrollments higher than 500, grading them on balance sheet strength and operational soundness, plus specific other indicators. You can see the results here.

Of the 933 colleges analyzed, 675 or 72.3% received a grade of C or D. These colleges are called “tuition-dependent schools,” meaning they survive year-after-year, often losing money or eating into their dwindling endowments. Things are not likely to improve, and more college defaults are looming. According to a study by Nathan Grawe, the population of high school graduates will drop by 9% between 2025 and 2031. In most of New England and some Mid-Atlantic states, the decline will exceed 15%. Falling demand is only part of the issue, according to a study by Kevin P. Coyne and Robert Witt, “Public colleges have 6.4% excess capacity, growing at about half a percentage point a year. But the private colleges have 12.4% excess capacity, growing at about triple the rate of public colleges. The smaller half of private, not-for-profit colleges, those with enrollments below 1,125, have an overcapacity of 28% and growing rapidly.”

Ignoring the future trends, COVID is already creating havoc. The University of Michigan estimates it may lose up to $1 billion and the University of Kentucky, it’s $70 million by year-end. Hundreds of schools, including those with billion-dollar endowments, i.e., Duke University, Virginia Tech, and Brown, have announced hiring freezes. Other institutions have cut pay and have laid off staff and contractors. The Vermont State Colleges System may close three of its campuses and lay off hundreds as it faces a potential 20 percent drop in enrollment and millions of dollars in losses related to COVID.


Foreign Students

The COVID outbreak has shown universities’ over-reliance on a multi-billion dollar international student market that underpins the finances of many leading institutions. China accounts for about one in six international students, and the Chinese spend an estimated $30 billion a year on overseas tuition alone. If you add in living expenses, the figure is even more significant. With college campuses closed in the U.S., U.K., Europe, and Australia, many Chinese students may not return and will look to attending or finishing college at Chinese institutions.

Nearly a million international students attend U.S. colleges, adding about $45 billion to the U.S. economy in 2018. These students are paying up to three times more than in-state students at public universities. They are thus “effectively subsidizing tuition costs for domestic students and functioning as a bailout for universities,” according to SelfScore. In 2015, public universities earned more than $9 billion in tuition and fees from international students.

If these students stay away because of travel restrictions, colleges closed, and other COVID issues, there it is unlikely that U.S. students can plug this hole. As a result, more financial strain on many schools and expected closings or mergers.


Auxiliary Operations

Schools, on average, earn roughly 10% of their income from auxiliary operations, including food and lodging. While students were forced to leave campuses, schools still owed them the right to use dorm rooms and be provided food under any purchased food plans. Harvard College, Princeton University and the Massachusetts Institute of Technology are among a handful of schools that plan to prorate room and board costs as the coronavirus has forced them to send students home. Other schools will offer refunds, and they will probably approach 2% of annual school revenues.

Declining Enrollments

Recruiting next year’s freshman class is posing a host of issues. First, admitted students cannot tour campuses. Thus students planning on attending will have to make the acceptance decisions based on online tours and presentations if they have not visited the school before. Second, no one knows if schools will be open in the fall and if they are, will they stay that way if a second wave hits. As a result, some commentators are suggesting that students should consider a Gap Year and wait for things to settle before starting college. Finally, for those who are determined to start school in the fall, if school classes are going to be virtual, are they willing to pay thousands more for a private school over a state school which is cheaper and may allow them to live at home? As a result, most people are predicting declining enrollments in the fall —the only issue is how much, possibly double-digit in some cases. As mentioned above, over 70% of schools are tuition-dependent; thus, a double-digit fall in revenue could drive many into bankruptcy.

Sports

The cancellation of NCAA men’s basketball means that the $600 million the NCAA was going to distribute to Division 1 members school, was reduced to $225 million. Such a significant decrease in income has left athletic departments everywhere scrambling. The fallout has some schools like Old Dominion University canceling its wrestling program, a move it expects will save $1 million in expenses, and Iowa State is cutting departments and suspending coaches’ bonuses and incentives.

Now the looming dread is what happens if the shutdown affects the big moneymaker: football. Jamie Pollard of Iowa State said, “We’re probably in a phase right now that we’re in a long hard winter, but if we can’t play football this fall, I mean, it’s ice age time.” Pollard penned a letter to Iowa fans laying out what they are doing in response to COVID.

According to a Forbes report two years ago, college football’s 25 most valuable teams generated a combined $2.5 billion a year in revenue. A large portion of those earnings goes toward supporting non-revenue sports like softball and swimming, and, to cash-hungry opponents. Last year when Alabama State lost to Florida State, Alabama State got what it wanted, a reported $425,000. Since it was a “Guarantee game,” one where a significant power beats minor football power and pays them a considerable amount to do so. Guaranteed games are critical for the smaller schools as they support the university. Failure to have Guarantee games can detrimentally affect a university. A scenario being considered for this football season, depending on the status of the outbreak, is playing a shortened season with just conference games.

Even for the major schools, cancellation of the football season would be hugely detrimental. At stake is at least $4.1 billion in fiscal-year revenue for the athletics departments at just the 50-plus public schools in the Power Five conferences — an average of more than $78 million per school, according to a USA TODAY Sports analysis.

Take Clemson, for example. Clemson’s “control budget” assumes the virus outlook improves so much that football games are allowed to proceed as planned this fall. Under that scenario, there is a 10% drop each in donations, ticket sales, and marketing revenue. All told, it would be a $7.5 million hit. The school’s more drastic scenarios include a 20% reduction in those primary revenue sources, so a drop of around $15 million. The school will look at the more significant loss scenarios if football can’t happen.

The University of Minnesota this month released its projections for its athletic department, which is roughly the same size as Clemson’s. Minnesota’s estimates were a $10 million hit in the “best case,” $30 million in the “moderate” scenario, and $75 million in the “severe.”

Thus, colleges are going to try their damnedest to have a season of 12 games, regardless of when. While a canceled season would have some cost savings, the revenue losses would be immense. Income from tickets; postseason games; game-appearance guarantees; and various game-day sales would be lost. There would also be a significant impact on payments connected to the right to buy tickets or obtain preferred seating, TV, radio, and digital rights and the value of marketing and sponsorship deals.

Concerning college-sports advertising and school-level sponsorships, everyone is preparing something between two scenarios:

  • The good. An optimistic approach to what still may be able to come to fruition with football and other fall and winter sports. If football takes place, opportunities to sell advertising for companies looking to make up for the lost Q2 will exist.

  • The bad. A canceled football season cancellation would mean a full canceled year of sponsorship activities. Advertising dollars that move out of college sports and would be reallocated in other places and may not return.

Related is the financial effect of football games on schools’ local areas. Public schools use these figures to demonstrate their economic impact to taxpayers and legislators, and it adds up to billions more. On average, an Alabama home football game has a “visitor expenditure impact” of about $19.6 million in the Tuscaloosa area.


Summer Activities

Many schools rent out facilities during the summer when most of the students are away. Writers’ workshops, corporate training events, weddings, and summer school programs rent parts of campuses, and this offseason revenue can account for up to 10 percent of annual income. With COVID, these are all canceled for this summer. Also, COVID canceled many summer abroad programs, which are a huge moneymaker for colleges as they cost way less than the colleges charge the students to attend.

Fundraising

The cancellation of fall sports will be a massive blow for college fundraising activities. However, of concern is other fundraising activities that colleges plan, i.e., parent’s weekend, alumni reunions around the country, and other promotional events. If people cannot get together, it is hard to get them to open their wallets. With many schools facing financial pressure, fundraising pressure will be enormous on alumni. While Sweet Briar managed to survive and raise significant funds from alumni to do so this time, it may be different for many schools. The falling stock market will hamper some contributions, while job losses will undoubtedly make a severe dent.

Public Schools

While the top universities have large endowments that will cushion the blow, public universities are going to be much harder hit. State budgets are turning red daily as they face decreased revenue from sales and income taxes, and increased payments for unemployment and healthcare. As a result, they will be in no position to bail out college. The only solution for many public schools will be with layoffs or closure. Vermont is already considering such steps, but expect many others to follow suit.

As I said, higher education as we know it is gone for most people, and one day we can explain what college was like to our grandkids and why Animal House was real.

 

Copyright (c) 2020, Marc A. Borrelli

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Airlines, What Does the Future Hold?

COVID is taking a massive toll on the airline industry. The chart below shows the fall in U.S. passenger traffic and airline values.

Finding the right space and conditions for 62% of the world’s planes and keeping them airworthy have suddenly become priorities for 2020. Not only do aircraft need dry climates, which makes finding space difficult, but they need constant attention. Tires need to be rotated, engines run, and aircraft powered up, flight controls checked, and sensors and engines covered to protect inner workings from sand and dust. Hydraulic fluid is put on the landing gear to protect against rust, and giant silica moisture absorption sachets are placed inside engines to keep them dry. At the same time, covering all external holes on the fuselage to block insects and nesting birds entering. All of this costs money, and storing one Boeing 737-800 costs around $3,100 a month, while a 777-300ER is $6,377 a month. Delta could pay $2.0 – $3.5 million a month for the storage of its approximately 600 aircraft. As a result, with all its other expenses, Delta is currently burning through US$60 million a day, and Jet Blue $10 million. Delta just announced a Q1 net loss of $534 million.

As of last week, the inactive fleet of aircraft was approximately 14,400, over two-thirds of the 22,000 mainline passenger airliners, leaving 7,635 in operation. In Europe, less than 15% are operating, while in North America, 45%, and or Asia 49% are working respectively. Narrowbody aircraft are less affected, 37% are operating vs. widebody aircraft 27%. In the U.S., domestic flights are averaging just ten passengers while international flights average 24, according to a trade group.

These costs have already had an impact.

  • Air Canada announced a temporary layoff of 5,100 employees, suspending most of its international flights.

  • Air New Zealand cut its long-haul capacity by 85%, suspending several long-haul routes, and reduced domestic route capacity by 30%.

  • American Airlines is cutting its domestic flight schedule by 80%–90% in May, with only a “handful” of international routes to stay in operation.

  • Cathay Pacific canceled three-fourths of its flights in March 2020, and 96% of passenger flights in April and May, but continued flying some passenger planes empty to transport cargo.

  • Delta suspended about 70% of its flights across its network from the end of March.

  • Emirates stopped all passenger flights from March 25, 2020.

  • Ethiopian Airlines reported a 30% reduction in passenger traffic in March, and in April, the suspension of flights to over 80 countries.

  • Finnair reduced its flight capacity by 90%, starting from April 1.

  • FlyBe, the U.K.’s most significant domestic airline, collapsed last month.

  • International Airlines Group (including British Airways, Iberia and Aer Lingus) announced a 75 percent reduction in passenger capacity for two months in mid-March 2020.

  • Lufthansa grounded its fleet of Airbus A380 aircraft and cut long haul travel capacity by 90% and intra-Europe flights by 20%.

  • Qantas suspended about 60% of domestic flights and all international flights. It put two-thirds of its employees on leave.

  • RavnAir, Alaska’s largest regional airline, collapsed.

  • Singapore Airlines cut 96% of its flights up to end-April.

  • South African Airways has shut down laying off nearly 5,000 people.

  • Southwest Airlines has suspended about 40% of its flights and expects to suspend 50% in June. Also, it stored 50 Boeing 737-700 aircraft

  • Swiss International is taking half its fleet out of service

  • Virgin Atlantic has asked for U.K. Government aid. It is 49% owned by Delta, but Delta cannot help and is expecting a $200MM payment from Virgin Atlanta this quarter.

  • Virgin Australia Holdings Ltd. was Asia’s first airline to fall.

Centre for Asia-Pacific Aviation, a Sydney based global airline consulting and analytics firm, concluded without government financial aid, half of the world’s approximately 800 airlines would be bankrupt by the end of May. Based on its analysis of cash flows. CAPA estimates that in less than 75 days, half the globe’s airlines will be technical insolvency.  Airlines, because of their financial structure, are heavily dependent on cash flow. Their primary assets, aircraft, are 20-plus year assets, financed via 20- to 25-year term loans or 12- to 15-year leases. As a result, airlines must receive enough cash to meet their monthly loan or lease payments. To cut costs, airlines are cutting fleets and other expenses.

American Airlines is accelerating the retirement of its oldest planes, Boeing Co. 767s and 757s, and it’s fleet of 20 Embraer SA E190s and some 50-seat regional jets. It’s also considering to retire its oldest Boeing 737s. Delta is studying the early retirement of its oldest Boeing MD80 and MD90 aircraft, while United expects its oldest Boeing 757s and some 767s to be grounded permanently. As a result, U.S. airlines could shed 800 to 1,000 aircraft, which could result in a reduction of 95,000 to 105,000 airline jobs. In the U.S. under the terms of the $50 billion government bailout, airlines are barred from cutting jobs through September 30; however, airlines are warning staff that cuts are coming. Southwest has said that it will be a much smaller airline going forward and for the foreseeable future.

If the airlines get through the next 75 to 90 days, what then? Well, the initial news from China is not favorable. According to Bloomberg, around 35,000 domestic flights are operating in China daily, compared with 80,000 before the COVID-19 crisis, according to the International Air Transport Association. The figure has been stalled at that level since services resumed in early March. While there was an increase in business confidence and journeys to visit friends and family, there’s been no resurgence in the vital tourism market, according to Brian Peace, IATA’s chief economist.

In the U.S., the future is even bleaker, with a return to travel inhibited by health concerns and the increasing economic impact. An IATA-commissioned survey said that 40% of respondents would wait six months or more to fly again following the containment of the pandemic. From a purely anecdotal perspective, this agrees with the majority of my clients, who are cutting travel budgets and don’t expect them to increase after infections fall. Thus, the high paying road warriors will be MIA for a while as companies have learned to function via Zoom, which is much cheaper than a business class seat. Even when business travel returns, long-haul international flights will take longer to revive. The airlines foresee an uptick in bargain-hunting leisure travelers this summer; however, historically, those seats have been subsidized by the road warriors. Delta’s Chief Executive, Ed Bastian, expects the recovery to take two to three years and that Delta will be a smaller airline for some time.

Since most of the European carriers, i.e., British Airways, rely on long haul high paying passengers to subsidize short-haul flights, their business models will have to change. In the U.S., the major carriers have also built on the ability to connect U.S. second tiers cities with other second-tier cities in the U.S. and worldwide as their business model, with falling business travel and especially international travel, their models will also need a reevaluation.

Overall expect the number of flights to fall and smaller planes on many routes, with overall increased fares. For many people flying will once more become the luxury it was before deregulation. Many flights to secondary markets may disappear altogether. The only upside is that for the moment, the dreaded center seat is no more! While Europe will not be as severely affected due to its rail network, in the U.S., the effects could be devastating for smaller communities that lose all airline service. Loss of airline services to these markets will have many knock-on effects, which will further limit their ability to recover from COVID. How much damage will Congress and the U.S. be willing to accept?

With government aid, comes the question, will we revert to the nationalization of airlines again? Since the 1970s, many airlines were privatized, new airlines entering the market, many went bankrupt, and there was much consolidation. Overall, airlines have been terrible investments, and most have lost money. In the U.S., bankrupt airline corpses litter the aviation sector. However, many countries, including the U.S., have claimed that domestic airlines are essential to national security, so what to do? If there are just bailouts, there will be a public revolt at an industry whose shareholders and management kept the gains and socialized the losses. Many expected a pandemic of some sort, and according to public health officials, COVID is unlikely to be the last. Thus, can airlines survive in a world of shutting down? Airlines suffered from SARS and the eruption of Eyjafjallajökull in Iceland. To have another hit soon after this, it may finish them off for good. If governments take equity as part of the bailout, is this the first step in nationalization?

I think the questions to be asked are:

  • Do we need national/regional airlines?

  • What do we expect from a national/regional airline in terms of service, market coverage, performance, costs?

  • What are we (the government) willing to pay for those needs?

  • If so, how do we structure a private/public model that meets national needs and generate sufficient return for the private market?

  • If we can’t, should airlines be nationalized to protect a vital asset? If so, would we want an airline modeled on Singapore Airlines or Alitalia?

An interesting discussion to be sure, and if we cannot make a private, public model work, nationalization will undoubtedly return. Airlines may return their model in the 70s and before.

 

Copyright (c) 2020, Marc A. Borrelli

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Employee Mental Health

Employee Mental Health

COVID is causing financial stress for many business owners, and employees and the daily news is not helping that fear go away. This week’s unemployment numbers are sure to cause more heartburn. Also, many of those still working are working from home, which is creating its own set of issues.

Those working from home are putting in longer days on average, approximately three hours, and working on weekends. The extra hours and limited space have destroyed any semblance of work-life balance.  The regretful formalities for calling or emailing at inappropriate times has gone by the wayside, and employees are suffering burn out. A month and a half into “work from home,” employees are overworked, stressed, and eager to get back to the office.

While this article focuses on employees, please, as business owners and CEOs, don’t ignore your mental health. Times like this are very stressful, and under severe stress, our mental systems can fail with issues like manic behavior, depression, etc. Make sure you are taking time to meditate, talk to people that understand the pressures you face. If you are not in a Peer CEO Group, like Vistage, get into one today. It will be better for you, your family, and organization to spend that little more than to hospitalized or make bad decisions that destroy your company’s value.

While wake-up times have shifted later due to no community, peak email time has crept up an hour to 9 a.m., according to data from email client Superhuman. However, employees are also logging back in late at night, and spikes in usage from midnight to 3 a.m. are becoming common and were not present before the COVID-19 outbreak. Furthermore, because no one can go out, there’s no escape. With nothing much to do and nowhere to go, people feel like they have no legitimate excuse for being unavailable. “You’re not escaping work,” according to Huda Idrees, CEO of Dot Health, a Toronto-based technology startup.

There is pressure on other employees to prove they’re working, especially with the prospect of layoffs. Employees at Constellation Software Inc. in Toronto, received an email from a superior saying, “Don’t get distracted because you are on your own. It is easy to get into bad habits, the lure of the internet, the endless box sets. Just think, would I do this in the office? If it’s a no, don’t do it.” Earlier the same manager had sent a message saying, “You know we will be watching closely.”

Research and anecdotal evidence points to increased productivity for nearly all of those working from home. However, by early April, about 45% of workers said they were burned out, according to a survey done by Eagle Hill Consulting. To help prevent burnout, some companies are attempting to help people cope through additional leave, free therapy sessions, and virtual meditations.

Regardless of the work-related stress, many other strains are taking a toll on many employees. Their concerns are:

  • their financial situation;

  • continued employment of either them or their partner or both;

  • having the kids home all the time;

  • having parents home all the time, or isolated in a senior living facility;

  • lack of social interaction;

  • the health of kids, parents and others who may not be with them; and

  • state of the country.

Given that everyone now says, “our employees are our greatest assets,” it is time to ensure that your actions match your words. What you do from March to July will be remembered by your employees for the next ten years. It is time to engage with your employees and check-in. By checking in, I don’t just mean a quick, “How are you?” Instead, take time to talk to your direct reports and ask:

  • How are you doing/coping?

  • How are you feeling?

  • Is everyone in your family ok?

  • Is anything wrong?

When doing this, start by telling them how you are doing. Do this regularly during these times. Open up and be vulnerable. Vulnerability creates TRUST! As I mentioned in the piece above, at this time, to capitalize on opportunities from COVID, we need open conflict in our discussion of the way forward. We cannot have that without trust.

You can also use products like Menti’s “Mentimeter,” a free, cloud-based polling tool that allows employees to provide anonymous feedback in response to a prompt. In response to poll to described work-life balance, the aggregated answers are presented in the form of a word cloud and included:

  • Better than ever

  • Non-existent

  • It depends on the day

  • Dream state

  • What work-life balance?

  • I had too many kids

While not identifying who to watch out for, it will indicate how the company is feeling and where the pressures are.

Unfortunately, I have not seen much available on how to measure or deal with employee stress. Googling “employee stress,” I could only find resources from Occupational Health Clinics for Ontario Workers. There was a straightforward survey questionnaire from The American Institute of Stress, which I found limited. I have identified some links dealing with employee stress, which I have listed on my website. Overall this is a sad indictment on the lack of tools for dealing with employee stress.

Severe employee stress is even more problematic when we are all working virtually and communicating by email, Slack, Zoom, or Teams. Stress manifests itself in many ways, but online communication can amplify it, causing the following problems:

  1. Confusion and doubt
  2. Bad feelings between people and departments
  3. Damage to company morale
  4. Project-completion delays

To prevent these issues, remind employees of how to communicate with others over such channels.

  • To prevent confusion and doubt. Keep your emails short and to the point. Put the most critical information at the top, so your recipient sees it right away. If you have a lot of information to share, skip email altogether and pick up the phone.

  • To prevent bad feelings between people and departments. Unless you know your recipient well, avoid easily misconstrued sarcastic comments. When in doubt, keep it professional. Save the humor for a phone conversation or face-to-face meeting where your recipient can hear and see you.

  • To prevent damaging company morale. Never hit “reply all” or include extra people on a message unless you are sure they need to join the conversation. Only include them in professional topics/issues. Do not argue with other people through email. Don’t try to prove you’re right and someone else is wrong. If it’s that important for you to get everyone involved, then it’s important enough to have a face-to-face group meeting or conference call.

  • To prevent project delays. Make sure your message is easy to understand. Proofread it before you send it. If you are not confident of your skills, use tools like Grammarly. A good check is to ask if you knew nothing about a particular project, would your message help your recipient understand what to do or confuse them.

Also, it is an excellent policy to have everyone on camera when doing video calls. It allows us to make eye contact and read body language. It will be easier to see those that are battling and get them any help sooner. Besides, we see into their lives as we see their homes, and this creates a greater understanding of them than we have had before.

One of my Vistage members mentioned that all their employees are retaking the Culture Index to remind everyone how to treat and communicate with each other. As a rule, “Treat others as they want to be treated.” I like this approach because it acknowledges that not everyone wants to be treated the same way. So I would recommend that everyone do something along those lines, using whatever employee personality test is standard within your organization, i.e., Predictive IndexCulture IndexEmergenetics, etc.

Finally, I recently came across a Dutch company, KeenCorp, which is using AI to analyze digital communication within organizations to measure personal involvement and tension. The results are produced in a single score, and so daily/weekly/monthly changes can be measured, and attention paid to those areas where there are adverse changes – below is an example of their work. I am sure there will be many organizations entering this field, but I think tools like this are bound to help and reduce issues within organizations.

Therefore, if your employees are truly your greatest asset you need to protect them. As I have said above, what you do during this period will be remembered for the next ten years. Take steps to help them cope with stress, show you are vulnerable, remind them how to communicate with each other, encourage work-life balance, and finally, look at other products that can identify issues before they become serious.

 

Copyright (c) 2020, Marc A. Borrelli

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For those of you who are not aware of EOS, it is the Entrepreneurial Operating System. It seeks to improve businesses by getting six components aligned to enhance business operations. The six are: the vision the people the issues traction - meetings and goals...

What has COVID done to Company Culture?

What has COVID done to Company Culture?

COVID has affected everyone. However, companies need to examine if they have lived their core values during COVID, how they are reinforcing them in a WFH environment, and especially with the onboarding of new hires.

Profit ≠ Cash Flow

Profit ≠ Cash Flow

Knowing how much cash you generate is essential for planning for growth. Too many companies don’t know and when they grow they find they are continually running out of cash. Understand your cash flow generation and how to improve it through improvements in your Cash Conversion Cycle and using the Power of One.

What Are Your Critical and Counter Critical Numbers?

What Are Your Critical and Counter Critical Numbers?

The key to achieving long term goals is to define short term goals that lead you there. Focusing those short term goals around a key metric is essential. However, ensure that the metric will not lead other areas astray by having an appropriate counter critical metric act as a counter balance.

Do You Truly Know Your Core Customer?

Do You Truly Know Your Core Customer?

Knowing the profit of your core customers is key to building a growth model. Many companies have identified core customers that are generating a sub-optimal profit and so they cannot realize the profits they seek. Identifying the correct core customer allows you to generate profits and often operate in “Blue Ocean.”

The Greatest Own Goal or the Greatest Collapse

The Greatest Own Goal or the Greatest Collapse

The European Super League collapsed within days of launch due to hubris and the founder forgetting the key parts of their business model, value creation, sales, and value delivery. The collapse might bring a high price.

The Ugly Duckling

The Ugly Duckling

I am sure we are all familiar with Hans Christian Andersen’s story of the swan that grows up among the ducks and is abused by the others until, much to his delight, he matures into a beautiful swan, the most beautiful bird of all. The story is beloved worldwide as a tale about personal transformation for the better.

It is irrelevant which you were a month ago; the issue to address is how you will emerge from COVID? A swan or just a duck? Thus, while many of my clients and other CEOs are, understandably, focused on cost reduction, you cannot cut your way to growth. Therefore, CEOs now need to determine how they will increase sales and take advantage of whatever opportunities COVID has provided? Now, as  Howard Marks said, no one knows what the outcome of this is and anyone who does it lying. However, CEOs need to start to try to conclude what they think will happen.

We have all lived through the lockdown for a month, and now some states are lifting the restrictions. But, as many commentators have mentioned, it is regardless of whether or not there are restrictions, as the critical issue is “Do you feel safe doing X?” where X could be going to a restaurant. Some individuals will say, “Yes,” and others, “No.” But that is a theoretical question. The real test will be, when you go into the restaurant will any of the following influence your decision to stay or leave:

  • Valet without masks and gloves?

  • No social distancing between tables?

  • Cutlery and glassware on the table all the time?

  • Unclean table or utensils?

  • Menus not wiped down after use?

  • Wait staff without masks?

  • Wait staff without gloves?

  • Kitchen staff without masks and gloves?

While some governors may issue the all-clear, the all-clear will happen when consumers feel safe for the activity.

While much of the current COVID-19 crisis is awful, it provides organizations a unique chance to experiment with radical new ideas and spur innovation. The innovation is essential as firms develop new methods to make existing products to overcome disrupted supply chains, or, as demand collapses amid self-isolation, create new ones.

Due to a lack of revenue, many organizations don’t have much capital available, and this is not the best time to tap the capital markets. So some organizations are changing the very way they innovate to discover ways to do things differently without huge capital outlays. A European food retailer has increased online fulfillment by over 50% without new money by all-night picking and packing. Other organizations are realizing the limits of insular development and turning to the Wisdom of Crowds approach. Examples of this are IBM, Microsoft, Ericsson, Tongal, and Lego, to name just a few. Topcoder sees a massive surge for its services, namely on-demand tech talent.

Also, COVID-19 is forcing organizations to innovate flat out and overcome “analysis paralysis.” Bain & Co. is urging companies to throw out old data, test quickly, and often, assuming you will be in testing mode for awhile. Long-delayed initiatives have suddenly been rolled out at scale overnight. According to the Economist, Sysco built an entirely new supply chain and billing system to serve grocery stores in less than a week. As the head of Fortune 500 firm recently put it, “We are learning more by testing than [from] months spent [with] analysts and endless meetings.” The crisis is emboldening managers to move faster, trying out risky new ideas on larger groups of customers. Learning from its experience in China with COVID, Nike undertook a digital pivot resulting in global internet sales of its sporting goods rise by over a third in the three months to February. Nike’s sweat-inducing masterclass is being streamed more than 800,000 times a week on YouTube.

Gao Feng, a consultancy, believes that autonomous delivery will be here much sooner than forecast, i.e., within 12-18 months. Companies are looking into automated cleaning robots and shelf stacking machines. Zipline, a Californian startup that delivers blood and medical samples by drone in Africa, is looking to do the same with coronavirus samples in America.

To emerge ahead, your team needs to work in sync and effectively, basically, make sure it is healthy.
Since COVID is an accelerant of all things positive and negative, a healthy organization is critical. As Pat Lencioni says, “If your organization is not healthy, then it doesn’t matter how smart it is, it will fail as the accelerant from unhealthy behavior will outweigh any benefits from Smart activities.” Until now, you may have ignored the health of the organization, but it never too late to start. Just make sure as the CEO you are modeling these behaviors, and that those in your leadership team and on your COVID response teams also model these behaviors. People who are behaving in a way that undermines the health of the organization have to go. At critical times like this, everyone needs to be working together to ensure the organization survives and emerges healthy. If negative behaviors compromise an organization’s health, it cannot arise healthy and in a strong position. Also, ensure that the leadership team is not exhibiting any of the five dysfunctions of a team.

With all the blocks in place, in addition to an emergency COVID response team, I hope every CEO has put together a cross-functional team to address the following:

  • Identifying the company’s unique skills and abilities, what does it do better than everyone, what is its competitive advantage?

  • What is happening to our traditional market? Nothing, some change, or dramatic change?

  • How should the company respond?

  • What new markets can the company enter with their unique skills and abilities that will give it an advantage?

  • Should the company change any of its processes? If we were starting again, would we do it this way?

  • Should we abandon specific markets? The future potential too low for resource commitments?

  • What can we implement now?

  • What should we get implemented to take advantage of the next wave of infections which the models predict are coming?

When looking at these items, as Bain recommends, look at testing often, throw out old data – before COVID, and implement changes quickly. Even consider A/B testing of processes to determine which is best. Now is the time to be creative. Look at things like Open Innovation.

This team should include a cross-section of the organization. As David Marquet says, “Move the decision making to where the information is.” With a cross-functional team including dynamic people from every level, the organization should uncover significant opportunities for growth and culling, With the right trust and conflict, the discussion around these questions should open up exciting areas for consideration and, once determined, a commitment by all to ensure they succeed.

If you can adjust your business model to take advantage of anything that is changing due to COVID, you could get an early start over your competitors or start a new market. Historically, those companies that emerge from any recession in a market-leading position hold onto for a long time. COVID is a huge disrupted in the business landscape and is leveling the playing field for many companies.

Do you want to emerge a beautiful swan or a duck? If the former, don’t waste the opportunity to take advantage of what COVID offers, and emerge stronger and in a leadership position in your market.

 

Copyright (c) 2020, Marc A. Borrelli

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COVID has affected everyone. However, companies need to examine if they have lived their core values during COVID, how they are reinforcing them in a WFH environment, and especially with the onboarding of new hires.

Profit ≠ Cash Flow

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Knowing how much cash you generate is essential for planning for growth. Too many companies don’t know and when they grow they find they are continually running out of cash. Understand your cash flow generation and how to improve it through improvements in your Cash Conversion Cycle and using the Power of One.

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The key to achieving long term goals is to define short term goals that lead you there. Focusing those short term goals around a key metric is essential. However, ensure that the metric will not lead other areas astray by having an appropriate counter critical metric act as a counter balance.

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Knowing the profit of your core customers is key to building a growth model. Many companies have identified core customers that are generating a sub-optimal profit and so they cannot realize the profits they seek. Identifying the correct core customer allows you to generate profits and often operate in “Blue Ocean.”

The Greatest Own Goal or the Greatest Collapse

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To Buyback or Not Buyback, That is the Question?

To Buyback or Not Buyback, That is the Question?

As part of The CARES Act, Congress imposed restrictions on stock buybacks. There was bipartisan support for this idea. Billionaire Mark Cuban argued that the rule for any company that receives federal assistance is, “No buybacks. Not now. Not a year from now. Not 20 years from now. Not ever.” Senate Minority Leader Chuck Schumer declared on-air: “Our motto in this is ‘workers first.’ …. These buybacks, they infuriate me. We should not be allowing them to do buybacks, raise corporate salaries.” Sen. Elizabeth Warren said that any corporate recipient of government assistance should be “permanently prohibited from engaging in share repurchases.” President Trump joined the chorus arguing, “I am strongly recommending a buyback exclusion. You can’t take a billion dollars of the money and just buy back your stock and increase the value.” However, others have argued that this policy is The Worst Coronavirus Idea.”

 

How it Happened

The airline industry was the poster child for arguments against buybacks.  Airlines for America, which represents major U.S. passenger and cargo air carrier companies, requested government assistance because of (i) the coronavirus crisis, and (ii) several of the largest carriers had used the majority of their free cash flow on share buybacks over the last decade. Given that airlines have a propensity for going bankrupt with over 60 since 1991, and being unprepared for hard times including the Sept. 11, 2001, attacks and the volcanic eruption in Iceland in 2010 that disrupted air travel, building up cash for a rainy day hasn’t been part of their plan.

Airline Free Cash Flow ($MM) Share Buybacks ($MM) Buybacks/FCF
Southwest Airlines Co. 15,103 10,650 71%
Alaska Air Group, Inc. 4,948 1,590 32
Delta Air Lines, Inc. 23,186 11,430 49%
United Airlines Holdings, Inc. 11,526 8,883 77%
American Airlines Group, Inc. (7,935) 12,957 N/A
JetBlue Airways Corporation 2,347 1,771 75%

Source: FactSet

However, airlines weren’t the only ones spending free cash flow on share buybacks. As can be seen below, nearly 50% of the saving from the 2017 Tax Cut and Jobs Act went to share buybacks.

Arguments For Buybacks

Share buybacks are very popular. According to Federal Reserve data compiled by Goldman Sachs, over the past nine years, corporations have acquired more of their stocks – $3.8 trillion—than every other type of investor (individuals, mutual funds, pension funds, foreign investors) combined. So why do they do it?

  • An efficient way to return money to shareholders. By reducing the number of shares outstanding in the market, a buyback lifts the price of each remaining shares.

  • A Valuable source of cash. Donald L. Luskin and Chris Hynes made this argument in a Wall Street Opinion Editorial. It has to be the worst reason I have heard. If people need cash, they can sell their shares on the market; they don’t need the company to repurchase them.

  • More tax-efficient than dividends. If the shareholder has held the shares long enough to qualify for long term capital gains treatment, this is true. Dividends are taxed at 22% while the tax rate for capital gains is 0%,15%, or 20% depending on the taxpayers’ level of income.

  • Management captures the share bump. An analysis by the SEC revealed that executives, on average, sold five times as much stock in the eight days following a buyback announcement as they had on an ordinary day. According to SEC Commissioner Robert Jackson Jr., “Thus, executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement.”

  • Boost management’s compensation. Following the adoption of Milton Friedman’s idea of “creating shareholder value,” more and more companies granted CEOs large blocks of company stock and stock options to align management with the corporate goal. However, with large portfolios of their own company’s stock, the desire to manipulate the share price with share buybacks was a temptation few CEOs could resist. As a recent article noted, “Today, the abuse of stock buybacks is so widespread that naming abusers is a bit like singling out snowflakes for ruining the driveway.”

Arguments Against Buybacks

  • Deprives companies of liquidity. As a recent Harvard Business Review article noted, when companies undertake buybacks, they deprive themselves of the cash that might help them cope when sales and profits decline in an economic downturn.

  • The share price boost is short-lived. A study by the research firm Fortuna Advisors found that five years out, the stocks of companies that engaged in substantial buybacks performed worse for shareholders than the shares of companies that didn’t.

  • The propensity to buy when the price is high and not when it’s low. Companies tend to overpay for their shares, diluting return to shareholders. The is overwhelming evidence that substantial buyback companies usually create less value for shareholders over time.

  • Lack of investment in things that grow shareholder value. Those companies that reinvested a higher percentage of their cash generation into capital expenditures, research and development, cash acquisitions, and working capital delivered substantially higher total shareholder return than those that reinvested less.

  • Lack of Imagination by Management. If the best use of the company’s money is share buybacks, then unless the shares are undervalued (20%+), management has effectively given up on planning to grow the company in new markets or products, through acquisition or investment. Such a strategy is a reflection of failed management.

 

Conclusion

 

From the above, it is apparent that there are few good reasons for share buybacks other than to boost management’s earnings. Hopefully, the current environment will cause management to reflect and do their jobs more efficiently so that there is real shareholder growth. As the Atlantic article pointed out.

“Craig Menear, the chairman and CEO of Home Depot mentioned on a conference call with investors in February 2018, their “plan to repurchase approximately $4 billion of outstanding shares during the year.” The next day, he sold 113,687 shares, netting $18 million. The following day, he was granted 38,689 new shares and promptly sold 24,286 shares for a profit of $4.5 million. Though Menear’s stated compensation in SEC filings was $11.4 million for 2018, stock sales helped him earn an additional $30 million for the year. 

By contrast, the median worker pay at Home Depot is $23,000 a year. If the money spent on buybacks had been used to boost salaries, the Roosevelt Institute and the National Employment Law Project calculated, each worker would have made an additional $18,000 a year. But buybacks are more than just unfair. They’re myopic. Amazon (which hasn’t repurchased a share in seven years) is presently making the sort of investments in people, technology, and products that could eventually make Home Depot irrelevant. When that happens, Home Depot will probably wish it hadn’t spent all those billions on buying back 35 percent of its shares. “When you’ve got a mature company when everything seems to be going smoothly, that’s the exact moment you need to start worrying Jeff Bezos is going to start eating your lunch,” said the shareholder activist Nell Minow.”

 

Copyright (c) 2020, Marc A. Borrelli

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