Are you optimizing Your Cash Conversion Cycle for growth?

Are you optimizing Your Cash Conversion Cycle for growth?

This question always gets a confused response, as many don’t know their Cash Conversion Cycle or how it impacts growth. So how and why can they optimize it? Companies need cash to fund growth, and profit is not the same as cash flow. The longer the Cash Conversion Cycle, the more cash is needed for growth and external sources. In many cases, that cash may not be available at rates that make economic sense. If access to external capital is hard, growth may not be possible.

Your Cash Conversion Cycle is the amount of time taken from when you first engage with a potential client to being paid for the work you do or the product you deliver. The Cash Conversion Cycle is typically broken down into four components:

  • Sales Cycle – the time taken from the initial sales contact to the order being placed or product purchased.
  • Make/Production & Inventory Cycle – the time taken that you hold inventory for products and the time taken to produce the product or deliver the service.
  • Delivery Cycle – the time taken to deliver the product or install it.
  • Billing and Payments Cycle – the time to issue the invoice after the product or service is delivered and the time to collect payment.

If we add up in days for these various cycles, we get the Cash Conversion Cycle time. The Cash Conversion Cycle differs between companies, even those in the same industry, for multiple factors.

So if, for example, we have Company X, with a Cash Conversion Cycle of 120 days comprising the following: Sales – 40; Make/Production and & Inventory – 30, Delivery – 5; and Billing and Payments – 45, the issue is how can we reduce the length of the cycle.

There are three ways to improve the Cash Conversion Cycle in any situation:

  1. Eliminate mistakes
  2. Shorten cycle times
  3. Improve business model

Eliminate Mistakes

Of the three, this is the easiest. Look at why the specific cycle takes so long and see where mistakes lead to delays. Mistakes can be as follows:

  • Sales cycle – the proposal is incorrect and doesn’t meet the buyer’s needs. This part of the cycle is rarely considered.
  • Make/product & inventory – there is insufficient inventory, so delivery delays. There are defects in the work, whether it be a product or service, causing delays for rework.
  • Delivery time – for shipments of products, it can be mistakes in addresses or delivery methods.
  • Billing and payment cycle – issuing incorrect invoices in the amount, rate, or coding causes delays.

While this is the easiest way to improve your Cash Conversion Cycle, I have found that many don’t measure it and don’t know the extent to which errors are causing problems.

It is best to work with your team to identify the errors and their effect on the cycle. Once you have identified the mistakes that cause the most significant delays, then put a program to reduce them. As John Doerr said, “Measure what matters.” You need to measure your cycles and the errors to ensure you keep the delays to your Cash Conversion Cycle to a minimum.

Shorten cycle times

The following method to improve your Cash Conversion Cycle is to investigate the cycle times and look at the underlying processes for an opportunity for improvement. Achieving this is a little more difficult as you have to step away from your existing processes and ask more complex questions.

A couple of ways to look at this are:

Got a Wicked Problem? First, tell me how you make toast. This exercise, developed by Tom Wujec, comprised three parts.

  1. Start with a clean sheet of paper, a felt marker, and draw how to make toast without words. Most drawings have nodes and links. Nodes represent tangible objects such as the toaster and the people, and links represent the connections between the nodes. The combination of links and nodes produces a full systems model, and it makes our private mental models visible about how we think something works. The number of nodes reflects the complexity of the model. The average illustration has between four and eight nodes. Less than four, the drawing seems trivial, but it’s easy to understand. More than 13, the picture produces a feeling of map shock. It’s too complex! So the sweet spot is between 5 and 13. 
  2. Now with sticky notes or cards, we again ask, “How do you make toast.” You now see the step-by-step analysis that takes place, and as they build their model, they move nodes around, rearranging them like Lego blocks. This rapid iteration of expressing and then reflecting and analyzing is the only way to get clarity. It’s the essence of the design process. 
  3. Third, draw how to make toast, but this time in a group. It starts messy and becomes more chaotic, but the best nodes become more prominent as people refine the models. With each iteration, the model becomes clearer because people build on each other’s ideas. In the end, we have a unified systems model that integrates the diversity of everyone’s points of view. These drawings can contain 20 or more nodes, but participants don’t feel map shock because they built their models themselves. If you want a better result, have the group do this in silence.

Below is a video of Tom Wujec explaining the process.

Having done this with something as simple as making toast, now apply the same methodology to your team concerning one of the cycles. New processes and improvements may be developed, reducing the cycle time.

If you were starting again, would you do it this way? Another exciting way of improving the cycle times is to ask how we should do it if we were not doing it this way already. Such a process is more challenging as the existing method has a built-in bias for the team. A good facilitator can question each step, asking the purpose of the action and whether there is another way to achieve the same goal. 

One way is using the 5 Whys. The Benefits of Five Whys are:

  • It helps identify the root cause of a problem.
  • Understand how one process can cause a chain of problems.
  • Determine the relationship between different root causes.
  • Highly effective without complicated evaluation techniques.

A Gravitas client that used this methodology to improve its Cash Conversion Cycle was The Camel Soap Company. The company was based in Dubai and facing working capital issues and negative cash flow. While the sales were growing, the sales manager was struggling to keep up with the growth. Also, he was dealing with some deliveries taking him away from sales. They had substantial inventory problems (260 days) and were paying up front. Examining their Cash Conversion Cycle, they undertook the following:

Sales cycle

  • They hired a delivery driver to allow the sales manager to focus on sales.
  • Installed a CRM, and revenue increased, which improved cash flow. 

Make/Production & Inventory Cycle

  • They introduced lean methodology. 
  • Looking at how many times the soap was handled during the manufacturing process shortened the cycle. 
  • Reduced finished inventory to 100 days from 200 days. 

Billing and Payments Cycle

  • Negotiated better terms from their suppliers.

Within six months, the company became cash-flow positive.

Improve business model

The most challenging method of the three, but the one that can provide the most significant benefits if done correctly. Here the objective is to look at your business model and ask how we can change it to improve our Cash Conversion Cycle.

The most famous example of improving their business model belongs to Dell Computers. When Dell decided to build a computer only when a customer ordered it, they achieved the following:

Sales Cycle

  • Since each customer customized the computer they purchased when ordering; Dell reduced its sales cycle.

Make/Production & Inventory Cycle.

  • This cycle was dramatically reduced as there was no finished inventory anymore. Also, because Dell built computers to order, they need less inventory as they ordered inventory against production orders. 
  • There was less obsolete inventory as they purchased inventory for specific orders.

Delivery Cycle

  • By having customers pay for the computers when ordered, the delivery cycle became irrelevant.

Billing/Invoicing Cycle

  • As computers were paid when ordered, Dell received all the cash from the sale before starting production.

As a result of this effort, Dell reduced its Cash Conversion Cycle from 63 days to -39 days; yes, negative 39 days. Dell was using the customers’ cash to fund its growth which is a great model.

So, returning to the initial question, are you optimizing your cash conversion cycle? Do you know the lengths of the cycles of each part and how you can improve them? Improving your Cash Conversion Cycle can reduce your need for bank lines of credit and other sources of debt.

If you would like help in determining your Cash Conversion Cycle and shortening it, contact me.

Copyright (c) 2021, Marc A Borrelli

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Why You Need to be Famous for Something

When I started my M&A business, I didn’t appreciate this concept, and our response to any question about what we can lead to the answer, “Yes, we can do that.” When starting, I am sure many entrepreneurs will take any business offered because they need revenue to survive. However, this dilutes the understanding of what you do to everyone. 

People need to precisely understand your services or products and whom you serve to refer you business. If your definition is too encompassing or vague, they don’t know whom to refer to you, so they don’t.

What is the job to be done?

When thinking about what you do, I always return to Clayton Christensen’s “The Job to be Done.” As Christiansen says, people buy your services or products because they hire you or your product to do a job. If you or your products do a good job, they will rehire you. Here is a video of Christensen explaining the “Job to be done.”

So the critical question is, “What is the job to be done?”

When I ask CEOs, “What is the job you are hired to do?” I often get rambling answers as they cover all the things they do for clients. For example, I have had a CEO tell me that his company:

  • implements software solutions; 
  • delivers timely reports;
  • helps clients understand their spend on external consultants;
  • manage relationships with external consultants, and
  • the list goes on,

But is that the job to be done? I have challenged this CEO, “What do your clients Google when looking for your services.” What is the overarching problem they want to solve? We have all heard the statement, “No one buys a drill; they buy holes.” So if you are telling me all about the “drill,” I want to know what are the clients’ “holes” they need. 

My Definition

Today, I am a coach; however, what services do you think I offer given that role? The answer could cover any of the following:

  • Life Coach
  • Sales Coach
  • HR Coach
  • Financial Coach

So, I have narrowed the definition of my services and probably need to narrow them more. 

“I am a growth business coach focused on working with CEOs and Leadership teams of companies with revenues from $5MM to $50MM who are looking to build a growth engine for dramatic profitable growth.”

I am working to refine it further to make it very clear what I do.

However, I do many things within that job description, including team alignment, strategic planning, understanding core drivers, and financial improvement, but they are all about “creating a profitable growth engine.”

Now figuring out what job your client hires you to do, is not always easy and can take a while working with your leadership team to get the answer right. However, the benefits are enormous.

It feeds Jim Collins’ BHAG.

In discussing your BHAG (“Big Hairy Audacious Goal”), Jim Collins says one of the things you need to identify is “What can we be the best in the world at?” Understanding this answers the old question of “Why do you exist?” and helps frame your passion. Without these answers, it is harder to develop your BHAG and set your strategic vision. With them, you get clarity for much of what you do!

People know what you do.

If you can easily describe what job you do, everyone precisely knows what you do and why they should use you or refer others to you. Also, when they hear someone discussing a problem or issue they are facing, they can easily understand if you provide a solution to that problem.

To frame this, think of how specialized medicine has become. Today we have oncologists who specialize in medical, surgical, and radiation solutions. The surgical specialist doesn’t do radiation. If you say you are looking for a surgical oncologist, no one recommends a radiation specialist.

You can find your Tribe.

A sales consultant told me years ago, “Find your Zebras.” He meant that if you were a lion, zebras were the best thing to eat. So who are your zebras? Where do you find them, and what are their identifying characteristic and behavior?

That is what I mean by finding your Tribe. Your Tribe is the collective group of your Core Customers which have specific characteristics. However, it is easier to identify your “Tribe” if you are specialized because by being specialized, you narrow the size of the Tribe. Once you know your Tribe, you can then start to determine:

  • How they buy.
  • Where they get information for their buying decision.
  • Who are their influencers?
  • What are their characteristics – size, revenue, budgets, etc.

With this information, you can now target your marketing towards them with a great deal of accuracy. You can ensure that your Brand Promise will appeal to them, and finally, any offers you make will entice the correct response.

If you focus on a “job,” you can do it well.

However, with that specialization comes increased skills, which leads to better recognition within the field. Keeping with oncologists, the radiation oncologist probably knows a lot about surgical oncology, but that is not “the job to be done.” With the focus, they probably attend many seminars and read journal articles on how to improve their services better. They become the best in their field and achieve better results.

If you cannot distinguish your services or products from the competition, you are in the commodity business, and with all commodity businesses, it is a race to the bottom in terms of price. So, you don’t want to be in the commodity business if you are selling services or manufactured products.

If done well, you sell “Value.”

If you are better than average and in the top quartile of the “job to be done” in your market, then the value you provide your clients is no longer based on the time taken to do the job but the value you provide. As discussed in How do you price your products and services?, once you deliver value, your pricing is now independent of time and materials but is based on the client’s BATNA (Best Alternative to A Negotiated Agreement) – what other options does the client have.

With value-based pricing, you can improve your margins and invest in maintaining your leadership position. Through Kaizen, you keep your leadership position and recognition as a leader in your market. 

So what do what to be famous for? 

Determining this often takes time and lots of work, but as I said above, the effort provides a massive return if the job is done. It helps to get a coach like myself, to facilitate the discussion among the team. However, whether or not you engage a coach, figure what you want to be famous for. 

Copyright (c) 2021, Marc A. Borrelli

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Recently I have been addressing this issue with many clients. It appears for many that the model is either (i) some hourly rate that covers costs with a markup; or (ii) some markup over costs. Does this fit with your model? However, there are many models concerning your pricing, and I challenge you to think differently.

I think the key is to start from two points:

  • What is the value that you are providing: and
  • What is the customers’ BATNA (Best Alternative To a Negotiated Agreement)

The first is to identify the value you provide, and the second is the customers’ next alternative to you. Your pricing needs to fall between these, but even within this space, there are many options.

Here are a few examples.

Selling products on the web.

If you are selling products on the web, what is the value you provide your customer? If there is no value other than a low price, then your customer’s BATNA is whomever else is selling the same products. Now you are competing on price, availability, and shipping costs. If their BATNA is Amazon, how much margin do you have if you match Amazon’s prices? Probably not much. Therefore you need to find a way to distinguish yourself so that you are not competing on price. 

Some companies provide lots of information on the products they offer so customers can make more informed decisions. We have all seen Amazon’s reviews being increasingly filled with fake reviews. The company provides more value by providing this information; however, how does it ensure customers purchase through it versus using it for information and then buying from Amazon.

Stopping customers’ switching is especially hard if they are Prime customers or this is not an impulse buy. In many cases, having got the information, whether on the website or through a phone line, the time to switch to Amazon and find the same product may not be worth it, and so they will purchase from such a company’s site. However, I am sure many sales are lost because the customer reverts to the company they know or look at the price and, having obtained the information, no longer value it to justify the price difference.

If the information is on the company’s website, that may be a cost of doing business. However, if there is an option to phone a support line and get advice on determining the appropriate product, maybe this service can be sold on a subscription basis. If customers pay for the advice line, they may become more “sticky,” preferring to buy from a company that provides excellent advice rather than purely on price. Also, since they are tied into the advice line, they may go there more often, increasing the volume of repeat business for the company.

Selling Knowledge

Recently talking with a company, “Z,” with a great deal of expertise in the manufacturing sector, Z is often retained by customers to solve their problems. However, once provided with a solution, the customers use other lower-priced manufacturers to produce the product. The company was struggling to price this service because using an hourly metric, the rate seemed excessive to get the return on their expertise. 

Returning to the two points I mentioned above, the value this company provides is enormous. Their customers’ BATNA may be six months of delay and thousands in costs to correct the production process. In such a case, it is hard to justify an hour rate, but in such cases, I am constantly reminded of the story of Neils Bohrs.

“A company’s machine breaks down. The company’s owner, an old school friend of Niels Bohr, calls in the physicist to help fix it. Bohr examines the machine. He draws an X on the side and says, “Hit it right here with a hammer.”

The company’s mechanic hits the machine with a hammer. It springs into action. The company’s owner thanks Niels Bohr profusely and sends him on his way.

A few days later, the owner receives an invoice from Bohr for $10,000 and gets on the phone with him immediately: “Niels! What’s this $10,000 invoice? You were only here for 10 minutes! Send me a detailed invoice.”

A few days later, the company’s owner receives this from Bohr:

INVOICE  
Drawing X on the side of your machine $1
Knowing where to put the X $9,999
Total $10,000

So do you price your services because you know where to put the “X.” In discussion with a company on this point, they were concerned that charging the value of their knowledge on where to place “X” would put off the customer. However, it is critical in such moments to realize the customers’ BATNA. If a six-month production delay would cost them $100,000 on top of $150,000 of costs in getting the production process right, then the customer profits from any option less than $250,000.

Realizing that in such a case, even a price of $225,000 might cause the customer to walk, price it differently. If the cost to produce the product is $20, then charge 25c per product made. The cost would increase production costs by 1.25%, which barely moves the needle. However, provided the customer is expected to produce more than a million of them, it is better for the expert and maybe more palatable for the client.

Selling Vistage

As a Vistage Chair, I am often asked by possible members how to justify the membership price. What they are looking at is a monthly fee that equates to about $20,000 per annum. However, what we are providing is value, and the BATNA is very large.

Members are CEOs of companies with revenues of $5 million and up, so my response is, “What is the value of your average decision?” If, as CEO, you decide on new ERP systems, hiring key executives, determining strategy, then I would argue that those decisions have a value of at least $200,000 or more. 

So to make a better decision, the CEO would either have to hire a consultant or go with what they know. Assuming they hire a consultant, the cost comprises:

  • time required to find the consultant who doesn’t gain from the decision (i.e., the consultant is not selling you the system or getting the recruitment fee);
  • time required to brief the consultant on the issue; and 
  • the consultant’s fee.

I estimate that this cost would be $40k to $50k. Therefore, your Vistage group provides you with an answer for 50% or less of the consultant’s price. Not only that, but you can have the group help you with many such decisions during a year. So your ROI on your Vistage membership is probably 200% or more. Where else can you get such a return on investment?

So what are you going to do?

For all CEOs and salespeople, the answer is to slow down and look at what you provide to the customer. What is the value of that product or service, and what is their BATNA. Determining this may take time, but it is well worth it. Because once you have completed this exercise, you can price your products and services in such a way that maximizes your margins while providing profit improvements for your customer.

So, sit down with your product team and salespeople and start brainstorming on the value and BATNA. You may find opportunities to increase your pricing or realize that a particular product or service is not worth offering as it is a commodity.

If you want help with pricing better and increase your margins, contact me, and I can help you.

 

(c) Copyright 2021, Marc Borrelli

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