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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How do you price your products and services?

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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What is Profit/X?

Jim Collins, in Good to Great, said,

“The essential strategic difference between the good-to-great and comparison companies lay in two fundamental distinctions. First, the good-to-great companies founded their strategies on a deep understanding along three key dimensions; what we came to call the three circles. Second, the good-to-great companies translated that understanding into a simple, crystalline concept that guided all their efforts … one particularly provocative form of economic insight that every good-to-great company attained is the notion of a single ‘economic denominator.'” 

The economic denominator is Collins refers to is “X.” So if you could pick just one “profit per X” ratio to increase over time systematically, what “X” would have the most significant and sustainable impact on your business?

Whatever it is, it is your single, overarching KPI, and to achieve that status, it needs to meet the following:

  • Everyone in the business knows it.
  • It is the factor by which all significant, strategic decisions are measured.
  • It has a positive impact on revenue and is cost-effective
  • More “X” is desirable.
  • It is tightly aligned with your long-term vision.
  • It is unique within your industry.
  • It should improve your team’s discipline and focus.
  • It should decrease the likelihood of spending on initiatives that end in failure or don’t align with your strategy.
  • It can always tell you whether you are trending forward or backward? 
  • Everyone understands their role in driving its improvement.

How do you determine it? 

Again from Good to Great, “The denominator can be quite subtle, sometimes even unobvious. The key is to use the question of the denominator to gain understanding and insight into your economic model.”

So, determining your “profit per X” is not just choosing what appears to be the most obvious answer, as many do. Instead, you need to understand your company’s economic model. Don’t just accept any denominator, but figure out what is the strategy to increase it.’

However, determining your “profit per X” is difficult! It requires an investment of time and effort and will be the source of many debates and disagreements. Not only that, but once you do agree on your unique KPI, it needs to be managed, which is also tricky. Finally, it requires the discipline to review and monitor it continually; otherwise, it won’t provide helpful insight.

Determining your unique economic denominator is difficult. Because it’s complicated, many companies are unwilling to invest the time and effort required for this exercise to succeed. 

Remember, what works for one company may not work for yours!

Those who struggle to determine it?

Some of the CEOs I asked struggled to develop their “profit per X.” What is apparent is that those companies are not clear on their core customer and marketplace, so they cannot clearly articulate what problem they’re solving and for whom.

A CEO didn’t have the data on their profitability per client, so without that, they couldn’t determine effectively who their core customer is. However, he informed us that the larger customers were the most profitable. Suppose the data shows that is the case. In that case, they are probably over-servicing their smaller clients and making barely any money from them.  If the company lost all these smaller clients, they would be only marginally worse off.  It would be better for them to focus most of their resources on our higher value, larger customers, which will lead to exponential growth.

It needs to align with your strategy.

It is critical that “profit per X” is tightly aligned with your long-term vision. Many companies either pull a random number out of thin air or align it to a vague aspiration statement. That will not work! Your strategy and “profit per X” must support each other, and your strategic goals should be measured in the same units as “X.”

Some of the CEOs I mentioned said “gross profit per FTE” and another revenue per FTE with a general assumption on profit levels. The latter fails the test above because no one in the company knows it, gets behind it, and it’s not measured regularly. Gross profit per FTE reflects efficiency, but does it align with the strategy and drive growth? If the strategy is to be the most efficient in the industry, maybe. But if your strategy is to grow to $XMM in revenue and be the market leader, probably not. Using up valuable management cycles and energy to improve efficiency will distract from your growth objective. Instead, find a “profit per X” that drives revenue growth.

Unique within your industry.

When discussing this concept recently, someone mentioned that they didn’t believe it needed to be unique to your business. However, suppose the key driver in your economic engine is the same as your competitions’. In that case, you are all focused on pursuing the same outcomes from the same market. The result is that you are viewed as a commodity rather than differentiated from your competition. Once you’re a commodity, it is a race to the bottom.

Also, a good “profit per X” can provide an advantage to your business even during an economic downturn by differentiating the company from the competition and focusing on revenue and costs containment. It can help a business succeed, even if it’s in a dying sector.

Here are some examples of how uniqueness can enable your business to scale dramatically.

Walgreens. In Good to Great, Collins uses Walgreens chemists as an example. The industry model was profit per store, so to increase “profit per store,” the trend was fewer larger stores. Instead, Walgreen adopted the Starbucks model of profit per customer visit. As a result, they focused on opening lots of smaller stores instead of a few big ones. With more (conveniently located) stores, customers’ likelihood of coming to one of their stores increased. Since the customers were no longer visiting for a single purpose, customers’ spend per visit increased.

Southwest Airlines. The world’s most profitable airline. Southwest identified that their core customer was someone who would otherwise get the bus or drive. They weren’t solving the problem of a Fortune 1000 executive who needs to fly from the US to Europe on a flatbed. With customer clarity, their “Profit per X” was profit per airplane. They made their money while their planes were in the air. They identified their competitors, not as other airlines, but bus companies. So, their business was focused on price. They stripped out food and assigned seats to increase profit per airplane and only used one model – the 737.

Autopia car wash. Like many companies, it was focused on “profit per customer.” While they offered car wash memberships, the “profit per customer” metric showed membership customers were less profitable. They took up more admin time to update credit card details than single-transaction customers. 

However, looking at the data and examining the company’s economic engine, the CEO realized membership customers were ten times more valuable, not the inconvenience he perceived. The company pivoted its model to focus on memberships, making customer satisfaction and member benefits central to the strategy.  Profit per membership card became the new “profit per X,” the one metric that drove the company’s growth. (Thanks to Doug Wicks, a Scaling Up coach, for sharing this story).

New System Laundry. New System Laundry serviced the hospitality industry, picking up and delivering laundry. Again their “profit per X” was profit per customer. However, given their core customer, they could only scale the business by increasing business per customer or prices. They re-examined their business and economic model. Changing their “profit per “X” to “Gross profit per truckload” enabled them to focus on reducing cost per delivery through more efficient delivery routes and schedules, customer clustering, and core customer locations. They added new customer locations strategically, and the business grew dramatically! 

A jewelry design firm. Their initial “profit per X,” like many, was profit per customer. However, looking at the data, it was apparent that many showroom customers were not profitable as they took up too much time and didn’t spend enough. As a result, the owner closed the showroom and moved into a studio, taking customers by appointment only. Taking appointments on weekends and offering champagne and hors d’oeuvres while customers shopped, revenue per appointment increased over 400%. As a result, “profit per X” is now “profit per appointment.” By optimizing appointments, the business can scale dramatically. (Thanks to Glen Dall, a fellow Gravitas coach, for sharing this story.)

So what is your “profit per X?”

As I have tried to show above, profit per X is different for everyone. It needs to align with your strategy and drive dramatic growth. What works for one company doesn’t necessarily work for you. 

Below are some examples to get you and your team’s imagination going about what is the unique economic denominator for your company:

  • Profit/customer visit or interaction
  • Profit/customer
  • Profit/employee
  • Profit/location
  • Profit/geographic region
  • Profit/part manufactured
  • Profit/division
  • Profit/sale
  • Profit/purchase
  • Profit/life of the customer
  • Profit/plant
  • Profit/brand
  • Profit/local population
  • Profit/invoice
  • Profit/market segment
  • Profit/store
  • Profit/square foot
  • Profit/fixed cost
  • Profit/recurring revenue client
  • Profit/seat
  • Profit/plane
  • Profit/product line

If you would like help determining your “profit per X” and dramatically scaling your business, contact me.

(c) Copyright 2021, Marc Borrelli

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  • the processes; and
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I am a supporter of EOS in that I believe all companies should have some system to improve their performance. However, as I have worked with clients who have implemented EOS, I found that it is just that, an Operating System and not a business model that enables the organization to grow!

As defined by Wikipedia, an Operating System is “the software that supports a computer’s basic functions, such as scheduling tasks, executing applications, and controlling peripherals.” So for a business, I defined it as “a model that supports the company’s primary functions, such as identifying a vision, getting the right people in the organization, improving meetings, defining goals (rocks), etc.” At the risk of upsetting EOS Implementers®, I think EOS satisfies these metrics to a varying degree, but in most cases, doesn’t enable the company to build a growth engine.

Here is what I believe is missing to develop a growth model.

The Hedgehog Concept

In Good to Great, Jim Collins talked about the Hedgehog Concept named after Isaiah Berlin’s essay, “The Hedgehog and the Fox,” which divided the world into hedgehogs and foxes. The theme is based upon an ancient Greek parable where “The fox knows many things, but the hedgehog knows one big thing.” Collins found that those companies who became great followed the Hedgehog Concept. Those companies which didn’t tend to be foxes never gaining the clarifying advantage of a Hedgehog Concept, being instead scattered, diffused, and inconsistent. 

The Hedgehog Concept is based on the questions prompted by the three confluence of questions. 

  • What can you be the best in the world at?
  • What are you deeply passionate about?
  • What drives your economic engine?

The EOS Model® doesn’t focus on the hedgehog concept, and so many companies using EOS have goals and strategies based on bravado than from understanding.

Knowing your hedgehog concept will keep the organization focused on something that aligns its passion with what it can be the best at. Being good at something means you are only good and indistinguishable from many others. If you are the best at something, then you stand above the crowd. Finally, the economic engine keeps the company focused on a metric that drives profit.

Vision

While the EOS Method® works to develop a ten-year goal, I find that is not as compelling as Jim Collins’ BHAG. A BHAG, Big Hairy Audacious Goal, is a clear and persuasive statement and serves as a unifying focal point of effort with a defined finish line. It engages people, is tangible, energizing, highly focused, and often creates immense team effort. People “get it” right away; it takes little or no explanation. 

A visionary BHAG is a 10-25 year compelling goal that stretches your company to achieve greatness. It should be a huge, daunting task, like climbing going to the moon, which at first glance, no one in the company knows how on earth you will achieve.

As Collins’s noted, the best BHAGs require both “building for the long term and exuding a relentless sense of urgency: What do we need to do today, with monomaniacal focus, and tomorrow, and the next day, to defy the probabilities and ultimately achieve our BHAG?”

Profit/X = Economic Engine

The BHAG’s economic engine is the concept of Profit/X. In Good to Great, Jim Collins defines this strategic metric as “One and only one ratio to systematically increase over time, what x would have the greatest and most sustainable impact on your economic engine?” Unfortunately, too many companies don’t have an economic engine, so they fail to deliver hoped-for profits. This metric is not easily identified; however, Collins noticed that the companies that took the time to discuss, debate, and agree on one key driver for their economic engine are the ones that went from good to great.

Profit/X how you choose to make money; it is a strategic metric, not an operational one. This ratio is a key driver in your financial engine and when you make decisions about how to spend money. When developing your Profit/X, you need to have that is unique and not the industry average because if you choose the latter, then everyone will be pricing and driving costs the same way to maximize it. Like the BHAG, a correctly defined Profit/X will promote teamwork as everyone can focus on their role to drive the metric, from how many people to hire, where to open new operations, etc.

Here are some examples of Profit/X.

  • Profit/customer experience or customer visit
  • Profit/customer
  • Profit/employee
  • Profit/location
  • Profit/geographic region
  • Profit/part manufactured
  • Profit/division
  • Profit/sale
  • Profit/brand
  • Profit/local population
  • Profit/invoice
  • Profit/market segment
  • Profit/store
  • Profit/plant
  • Profit/purchase
  • Profit/square foot
  • Profit/fixed cost
  • Profit/recurring revenue client
  • Profit/seat
  • Profit/plane
  • Profit/product line
  • Profit/life of the customer

To frame this in a real-life context.

Southwest Airlines: Profit per plane

Walgreens: Profit/Customer Visit

New System Laundry: Profit/Delivery Truck Load

I think the EOS Method® ignores the following areas, but to me, they are part of the Hedgehog Concept. If you are doing something with clarity and focus, you need to have clarity and focus on these areas.

Value Creation

It is said, “A Business That Doesn’t Create Value for Others is a Hobby,” so what value does your organization create? Value creation is part of what you can be the best at. However, organizations need to know, “What is the problem they are seeking to solve for their customers.” Christian Claytonson defined this as “What is the job your customer is hiring you or your products to do?” Too many organizations define the job to be done as what they do, e.g., “We integrate your systems.” While that is what they do, that is not the job they are hired to do. The job they are hired to do may depend on the client but could be, “Provide information from across the organization to make better-informed decisions.” Knowing the job to be done enables your marketing and sales efforts to focus on the customers’ needs rather than on what you do. No one cares about what you do; they care if you can solve their problem. I don’t see the EOS Model®’s focus on this crucial question, but it is central to a company’s growth.

Core Customer

Who is the company’s core customer? I have discussed this before, and many companies can identify their core customer. However, most haven’t analyzed their customers from the point of view of Profit/X. If Profit/X is the driving metric of the organization’s profitability, then failing to know which customers meet and exceed it is crucial in defining your Core Customer. There is little point focusing on a Core Customer that doesn’t meet your economic engine’s critical financial metric, hoping that somehow you will magically capture the lost profit elsewhere. Furthermore, if you don’t know your Core Customer, your marketing and sales activities will be directed towards the wrong groups, further weakening your performance. 

Brand Promise

What is your Brand Promise, and how is it measured? This question is one that the EOS Model® doesn’t address. However, it is crucial.

  • It is what convinces your targets to buy from you. 
  • It is what you stand for and promise to deliver. 
  • It is the metric against which you will be measured.

Some organizations do have a brand promise, but it is not measurable. In that case, it is “valueless” because if it is not measurable, no one knows if you are delivering it, and in that case, it has no value to prospects or clients.

Value Delivery

Value delivery is vital for knowing how customers value the performance of the organization. While the EOS Model® discusses many metrics, this one does not get enough focus. Companies need to understand if their customers are satisfied with their performance. Recently, I spoke with a CEO who said that 80%+ of their customers were “Very Satisfied.” However, on further investigation, I discovered:

  • It was just a guess as they didn’t measure it.
  • 7 – 10% of their customers had complained in writing about their product and delivery in the last year.
  • None of their clients had recommended them.

Here is wishing over reality. I would expect that the company had a “Very Satisfied” score of less than 25%, and they should be working hard to improve their delivery and start collecting customer satisfaction data.

Critical Number and Counter Critical Number

The EOS Model® deals with goals (Rocks) and meetings, and that is one area that I think it does very well. However, I notice that the Rocks are not aligned to improving a critical number for the quarter. The Rocks should seek to improve some Critical Number each quarter. Without a Critical Number, you are once more a Fox, not focused. Those that use Scrums know the importance of the Critical Number. 

Rocks are great, but they need to improve a single business area to have the most significant benefit. As the saying goes, “You cannot defeat ten soldiers by sending in one soldier every day for 100 days.” For example, if our Critical Number is Customer Service in a Call Center, then the Rocks could relate to:

  • Hold time
  • Time on the call
  • Customer satisfaction at the end of the call
  • Percentage of calls resolved in one call
  • Employee satisfaction.

The Counter Critical Number is essential to preventing the critical number from overwhelming the company and leading to adverse effects. For example, if our Critical Number is project completion, then a Counter Critical Number would be customer satisfaction. This metric would counter the attempt to deliver incomplete or defective products or projects.

Focusing on a Critical Number and Counter Critical Number for the 13-Week Sprint is essential to developing focus and alignment within the organization.

Team Alignment

The EOS Model® does a great job of looking at the “Right People” in the “Right Seats.” However, what it doesn’t look at are alignment among the leadership team and employees’ satisfaction. Is your leadership aligned around the company’s direction or not? Culture will bring them to agree on values, but not necessarily alignment.

Your employees may all have the correct values, which is crucial, but if they are not engaged or dissatisfied with the leadership, cultural values will not prevent them from leaving or, worse, showing up but not there. Companies need to survey their leadership teams for alignment and their employees for satisfaction to ensure everyone is working in the same direction and committed to its success.

Conclusion

Thus while I like the EOS Model®, I think it doesn’t deal with many of the key things involved in the Hedgehog Concept. This failure enables companies to perform but not grow at an optimum rate. I am not ignoring many of his other areas of focus in Good to Great; however, this refinement of the Hedgehog brings an additional guide that the EOS Model® doesn’t. 

The above model is most of Gravitas 7 Attributes of Agile Growth® model, and if you add in the rest, you have a model that will propel you to growth while keeping your operations running smoothly. The 7 Attributes of Agile Growth® focuses on:

  • Leadership
  • Strategy
  • Execution
  • Customer
  • Profit
  • Systems
  • Talent

making it a more encompassing system. If you want to start your transition to an agile growth company as a certified Gravitas Agile Growth coach, please contact me.

 

 

Copyright (c) 2021, Marc A. Borrelli

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While I have known this for a long time, last week, it was brought home to me how many conflate the two. Profit and Cash Flow are not the same. I have known many profitable companies have negative cash flow and some unprofitable ones have positive cash flow. Knowing the difference is critical. 

As I have mentioned before, cash is the blood in a company. Without it, the company dies, regardless of how profitable it is. Many young companies that take off don’t appreciate the issue and believe that they will solve it with growth. However, this is similar to the old business joke, “Of selling at a loss but making it up on volume.”

How the Statements Connect

For non-accountants and finance people, the issue is that they look at the Profit and Loss Statement, Balance Sheet, and Statement of Cash Flows as separate entities without realizing the interconnectedness. Finally, the way a standard statement of cash flows is laid out, most don’t know what it is saying. 

It takes a while to realize that the P&L shows you the earning for the period, then the statement of cash flows shows the adjustments required to get to the cash generated from the different sources. Finally, the balance sheet is the statement at the end of the period of what is owned and what is owed. They flow in that order, generating the statement of cash flows from the profit and loss statement, and the balance sheet really cemented the relationships in my mind.

The Dates

Again, I was made aware of this when I was presented with a profit and loss statement and balance sheets, but all as of different dates. If the dates don’t sync, you can’t deduce much from them. The profit and loss statement must cover the same periods. The balance sheets must be as of the starting date and the ending date of the period. Sounds simple, but many look at these financial statements for different periods and don’t realize that you can’t tell much from them.

How to Determine Your Cash Flow

Now many people don’t understand the statement of cash flows, and I understand that. The key information is how much cash the firm generates or absorbs, what it will do with it, or how it funds the shortfall. For many entrepreneurs, here is an easy way of looking at Cash Flow. Assume your company has a Gross Margin and Net Operating Margin of 20% and a 10.15%, respectively. In addition, your Accounts Receivable, Inventory, and Accounts Payable are 80, 35.7, and 45 days respectively. If you grow revenue by $100, the effect is as follows.

Revenue + $100.00
Cost of Goods Sold 80.00
Gross Profit = 20.00
SG&A (Overheads) 9.85
Net Operating Profit = 10.15
Accounts Receivable (80 days) 21.92
Inventory (35.7 days) 9.78
Accounts Payable (45 days) + 12.33
Cash Shortfall = $9.22

Thus for every additional $100 of revenue, you need $9.22 of extra cash. This is why many fast-growing companies implode, they cannot get sufficient cash to fund their growth, and without cash, the company dies. Now some will argue that I have not added back depreciation etc. That is true; however, I have found that CapEx is equal to depreciation over time if you wish your company to keep functioning, so that is just a timing issue.

How to Improve Cash Flow?

So understanding your cash flow is a vital part of understanding the financial model of your business. If you generate a shortfall, you need to figure out how you will finance it. There are really three options,

  1. Arrange to finance for your working capital.
  2. Shorten your Cash Conversion Cycle
  3. Use the Power of One to change the cash generation of the business.

There are a number of companies that provide working capital financing, so if you need some names, let me know. If you don’t know your cash flow cycle, it is the time from when you start the sales cycle until you get paid. It is broken into four areas – Sales Cycle, Make/Production & Inventory Cycle, Delivery Cycle, and Billing and Payments Cycle. The Power of One, developed by Alan Mills, determines which of seven variables most influences increased cash flow.

I know many companies don’t have this information, and their accounting systems don’t know how to produce it. In that case, get a coach or adviser who can help you. The investment will be well worth the effort to understand how to drive your business without ongoing funding. If you want more information on how these work and how to implement them in your business, message me.

 

Copyright (c) 2021 Marc A. Borrelli

Do You Truly Know Your Core Customer?

Do You Truly Know Your Core Customer?

Who is your Core Customer?

In working with many clients on improving their business and developing a growth model, we soon get into the issue of their “Core Customer.” I have realized that many have not given this much thought and cannot easily define their “Core Customer.” Your Core Customer is the customer you are targeting, the customer that is preferred, and the one that your marketing and sales efforts are focused on. A Core Customer has the following attributes:

  • A real person with wants, needs, and fears.
  • Will buy for optimal profit.
  • Has an unique online identity and behavior.
  • Pays on time, loyal, and refers others.
  • Exists today among your customers

Not knowing your Core Customer is not a terrible problem, as we can quickly work through a session to put a definition in place. However, a more complicated issue is knowing their Core Customer but unable to define their “Economic Engine,” or profitability per customer. Lack of good data is always a severe problem! If you can’t measure something, then your performance is purely an assumption, and down that road is chaos.

Profit per Customer

If you don’t know your profit per customer, the customer you consider your “Core Customer” may generate sub-par profits pulling down the company’s performance. During a recent conversation, a CEO told me their metric was revenue per employee. While that would generate top-line revenue, it does nothing for profit, efficient customer targeting and marketing, or market differentiation. The business adage, “We are losing money on each item, but will make it up on volume,” seems to be the driving force.

Many companies I have worked with cannot tell me the profitability per customer and so work on the assumption that they are performing well, but cannot understand why they cannot scale and have profit and cashflow issues. Also, often their data is corrupted by the “Flaw of Averages.” So to paraphrase the proverb, “First get your data.” Sometimes getting good data on project costs is difficult, but without there cannot be:

  • Knowledge of performance;
  • Plans for improvement;
  • Measurement of improvement.

And “Hope is not a strategy.”

Select the Right Core Customer

Once we have data showing your Core Customer’s profitability, we can determine if they generate optimal profit. Since a requirement of a Core Customer, as mentioned above, if your Core Customer is not generating optimal profit, then there are one of two choices:

  1. Change your economic model so that they do, or
  2. Change your Core Customer.

When examining the data, many companies have found that the companies they were targeting as their “Core Customers” were their less profitable customers and ones that everyone in the market was fighting over. Targeting a different segment of customers that generated optimal profit could increase its profitability and differentiate itself from its competition, a great “Blue Ocean” strategy.

Lake Truck Lines, a Gravitas client, was focused on large customers. However, when analyzing its data, Lake Truck Lines realized that everyone was targeting those customers so there was pricing pressure and low margins. By make mid-sized customers its Core Customer, the company was able to operate with less competition and generate the optimal profit per customer. Similarly with Build Direct, focusing on young women seeking to do DIY, it was able to realize a much higher margin and operate in “Blue Ocean” waters compared to when it was focused on supplying general contractors.

The time spent analyzing your clients, their profitability, and your Blue Ocean possibilities can result in you operating at higher margins with less competition.

Profit / X

I have discussed the “Economic Engine” before, but it is the concept of “Profit/X,” Profit/X is the crucial part of your strategy, and it must:

  • Tightly aligns with your BHAG®
  • Be the fundamental economic engine of your business
  • Be a single overarching KPI to scale your business
  • It must impact revenue while controlling cost.
  • More X must be desirable.
  • It must be unique within the industry – you have to differentiate yourself from your competition.

What is critical is finding a Profit/X that is unique within your industry. If you choose the same Profit/X as everyone else, you are all competing on the same drivers, and you cannot differentiate yourself from your competition. Having identified our Core Customer, the appropriate Profit/X can be identified. Picking the wrong Profit/X given your Core Customer again will lead to sub-optimal results. These two concepts are interconnected and for you to achieve the best results, you need to determine both and have them connected.

Having the Right Profit/X

If your Profit/X is defined as profit per employee, you have only three ways to achieve this: increase the price, improve employee performance or cut the product’s quality. Since price should be driven by value creation, not employee profitability, raising prices may be difficult. We do not want to cut value delivery, and driving employees harder is no recipe for success. Thus a better metric may be profit per customer.

With customer size, if you are servicing large customers it may require longer larger projects compared to mid-sized companies. If mid-sized companies have more set up and administrative costs then your Profit/X must be different between the two.

There are many examples of Profit/X from Southwest Airlines’ profit per plane to a dry cleaner who measured it by profit per delivery truck. The key is to find the one that drives your business and will also differentiate yourself.

Conclusion

Many CEOs and Business Owners are salespeople and are not interested in digging into the financials and getting to the data I have discussed above. However, the effort is well worth it, as once you have a clear understanding of where you are, you can:

  • Target marketing towards your Core Customer;
  • Differentiate yourself from your competition;
  • Ensure that all projects, services, or products meeting your Profit/X to ensure profitability; and 
  • Position yourself for growth and profitability. 

Get your CFO, your team, and a coach and spend a day or two to determine the ideal results. The payoff will be huge.

 

Copyright (c) 2021 Marc A. Borrelli