A few weeks ago, I was speaking to a management consultant. He explained that he had been advising a small manufacturing business. The business made products but also ran a servicing operation. Manufacturing was profitable but not as profitable as servicing. He advised the business to concentrate solely on servicing and to forget their manufacturing arm.
I was extremely puzzled by his advice. Of course, I had no access to the business and I had not seen the data provided to the consultant. His advice may have been 100% correct. It just seemed to me that the option given to the business was a bit final and, in the long run may be damaging to the business.
His advice reminded me of a lecture I had attended whilst completing my degree. The lecture looked at Ford’s response to the importation of Japanese cars into America during the early 1980’s. Ford’s profits were being hit by the Japanese imports and the company’s response was to contract and cut jobs. Ford closed several factories and tried to up productivity in the remaining plants. The result was a loss of expertise at Ford, a reduction in economies of scale and the focusing of existing costs onto the reduced production capacity. Instead of Ford’s profits increasing, it incurred significant losses. The collapse of Ford and General Motors in the US is covered in the book, Stupid White Men by the left-wing activist and film-maker Michael Moore.
In previous blogs I have mentioned value chain analysis as a way of focusing costs on areas where customers see value. It also appeared to me that the company may not have been making the best use of cross-selling its products with its service offer. Probably the thing that struck me most was that the decision to end manufacturing was based on one element, the level of profitability achieved. A focus on this single measure seemed to me a narrow base on which to make such a drastic decision; especially when the manufacturing arm was still making profit.
Many management consultants take an accountancy view of a company’s performance. They focus on the bottom line and cost-centres. Often they fail to appreciate the wider picture of a company’s activity. Industry is filled with examples of where a focus on financial data alone has led to short-term success but long-term failure.
Of course, financial statistics are important in measuring business success. Making returns is the primary role of a business. However, financial data can be manipulated and a false picture of a company’s place in the market can be given. For example, since the Brexit vote many right-wing commentators have implied that the rise in the FTSE 100 indicates that the risks of EU exit are over-stated. What they do not mention is that the majority of the FTSE 100 is multi-national firms who do not report in pounds sterling. The low value of the pound increases the profitability of these firms in other currencies. This apparent increase in value boosts their shares. These commentators barely mention the loss of the UK’s credit rating, that our banking sector has been hugely hit by the referendum or that UK bonds and gilts are showing their lowest returns ever.
Share price is a particularly bad measure of business success. Share price can be manipulated e.g. by a firm buying its own shares to artificially maintain its market value.
Many marketing measures are not based on financial data. Marketers look at footfall, consumer brand recognition, market share, customer loyalty and other non-financial metrics.
Kaplan and Norton, two Harvard Business school academics, have developed the Balance Scorecard method of measuring business success. This method includes financial metrics such as turnover and profitability but it also looks to wider indicators which are less able to be manipulated.
The balanced scorecard looks at business success in four quadrants:
- Learning and Growth
- Business Processes
- Financial Performance
Key performance indicators are then identified in each quadrant to give a holistic view of a company’s performance not one based on narrow financial measures.
For the customer quadrant this could be:
- value for money
- product quality
- price competitiveness
- customer satisfaction
For learning and growth:
- product innovation rate
- time to market for new products
- continuous improvement measures (e.g. Kaizen)
For business processes:
- delivery logistics – cost per delivered unit and timescale
- product quality – rework rates
- speed of product development
- cost per unit when compared to competitors
and finally financial data:
- return on investment
- cash flow
- profit growth
When making major business decisions, it is important to look beyond the balance sheet and the profit and loss account and to take a wider view of business performance. A reliance solely on accounting data may give a false picture of the current status of your firm and its future potential.