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Archive for January, 2008

China’s Booming Dairy Market

Posted by iBlog on January 6, 2008

China’s dairy industry will double in size, to nearly $20 billion, by the decade’s end, McKinsey research finds. More important, changing consumer tastes, retail modernization, and the country’s increasing affluence will transform competition in this nascent industry and likely usher in a wave of consolidation—a transformation that could be mirrored in other product categories across China. The findings for the dairy industry suggest that foreign companies considering their prospects in China have a window of opportunity because they bring much-needed capabilities in areas such as product development, branding, and channel management.

To map the contours of China’s dairy industry—the largest in Asia after Japan’s—and to predict its likely evolution, we studied consumption patterns and consumer preferences in more than 150 Chinese cities and towns.1 This effort, together with our experience with clients in China’s retail sector, highlighted three important findings.

The first is the rate at which China’s consumers are adopting the purchasing habits of their Asian neighbors and seeking higher-value-added products such as milk beverages, cheese, and yogurt. Today these products account for one-quarter of China’s dairy consumption, compared with nearly 60 percent of Japan’s (Exhibit 1). This proportion will change as Chinese incomes rise; indeed, we expect that over the next five years revenues from sales of milk beverages, cheese and desserts, and yogurt in China will grow by 22, 38, and 31 percent a year, respectively (Exhibit 2). For dairy companies, this is welcome news—such products command margins two to three times higher than that of liquid milk.C

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Posted in Sectors and Regions | Leave a Comment »

Latin America Price Promotions

Posted by iBlog on January 6, 2008

Certain techniques retailers have long used to persuade their customers that they offer good value—frequent discounts, two-for-one deals, and other promotions—have limited effectiveness in Latin America. Far more important are factors that have also come to the fore in developed markets: the price of products that shoppers buy regularly, for example, and whether a store has a broad range of goods at different price and quality levels in key categories.

These findings emerged from a survey of more than 3,000 shoppers in and around Bogotá (Colombia), Buenos Aires (Argentina), Mexico City (Mexico), Santiago (Chile), and São Paulo (Brazil). Each city’s sample—600 to 700 people—matched the socioeconomic composition of its country’s overall population. One key component of the survey was our effort to get shoppers to identify, from among a wide range of tactics1 that retailers use to influence price perceptions, which tactics the shopper’s primary store employed. We then used regression analysis to understand the impact of various tactics on the consumer’s perception of stores as inexpensive, very expensive, or somewhere in between. This analysis allowed us to examine the relationship between each tactic and price perceptions (Exhibit 1).

Posted in Pricing | Leave a Comment »

Profiting From Proliforation

Posted by iBlog on January 6, 2008

n explosion of new customer segments, sales and service channels, media, and brands is challenging marketers to reinvent themselves so they can simultaneously prioritize opportunities in a more sophisticated way and increase the consistency and coordination of their marketing execution.

June 2006


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The proliferation challenge

David Court, Thomas D. French, and Trond Riiber Knudsen

The scope of today’s marketing challenge is breathtaking, and proliferation is the reason. Recent advances in technology, information, communications, and distribution have created an explosion of new customer segments, sales and service channels, media, marketing approaches, products, and brands. But despite better customer information management and lower communications costs, marketing to consumers and businesses is becoming more complex and difficult every day. Marketers—even the most sophisticated—are struggling to keep up.

To understand the full impact of proliferation, consider the wireless-telecommunications market. Carriers used to manage 3 demographically oriented consumer segments; today they manage more than 20 need- and value-based ones. Rather than view baby boomers as a single segment, the industry has created 6 or 8 subsegments, differentiated by their usage tendencies and product needs. The number of discrete offerings has ballooned into the hundreds: prepaid and postpaid calling plans; family-friendly and nights-and-weekend plans; text-, data-, and messaging-capable mobile telephones; video and music phones; and so on. The number of distribution touchpoints has increased from three to more than ten, including company-owned stores, shared and exclusive dealers, telemarketing agents, affinity partners, and the Web. As a result of customer-specific service bundles, the number of price points exceeds 500,000. And the number of communications vehicles will continue to grow dramatically as event marketing, viral marketing, product placement, and other approaches augment traditional media such as television, whose effectiveness is under assault.

The same picture holds true in business-to-consumer (B2C) and business-to-business (B2B) industries as varied as packaged goods, pharmaceuticals, retail banking, post and parcel, automotive, and advanced materials. Although proliferation is playing out differently across sectors, a few common characteristics underlie its challenge for marketers:

  • Polarizing and fragmenting customer segments. In many industries, including cars, clothes, computers, and retailing, revenues are growing faster at the high and low ends of the market than in the middle (Exhibit 1). At the same time, in B2B markets such as air cargo and specialty chemicals, customers are becoming more discerning about when they are, and when they are not, willing to pay extra for premium offerings or solutions. For B2C and B2B companies alike, staying in the middle is often a death sentence, while focusing on just one end of the market is a recipe for slow or no growth.1 What’s more, in many B2C industries, marketers must contend with an increase in the number of meaningfully different customer segments—an increase resulting from factors such as the greater influence of ethnicity and lifestyle differences in consumption patterns.
  • More sales and distribution touchpoints. To meet the rising demand for convenience and flexibility, nearly all marketers are adding new channels, touchpoints, and, sometimes, distribution partners. By offering more sales and service options, marketers help consumers to cope with a busier, more complex world and enable B2B buyers to deal with an increasingly competitive environment. In so doing, these marketers have conditioned customers to expect great flexibility and choice. Even in an industry as basic as maintenance and repair operations, new technologies let companies offer more just-in-time channels, such as Internet ordering and on-site automatic parts dispensers. Yet the channel and touchpoint needs of customers vary widely by segment, and giving all of them everything they want is a recipe for financial ruin.
  • Diverse communications vehicles. Advertising is exploding; in Germany, for example, the number of television commercials increased from 400,000 in 1991 to 2,500,000 a decade later. Cutting through such clutter is challenging and will become even more so. Rising advertising costs, an increasingly fragmented viewership, and the growing prominence of digital video recorders are reducing the efficacy of TV advertising, which by 2010, we estimate, could be only 35 percent as effective as it was in 1990. A similar story is playing out in direct marketing. For B2B marketing, the impact of recent trends is harder to measure but probably will be equally dramatic as media proliferation dampens the effectiveness of traditional vehicles, including sponsorship events and trade magazines.

    Alternative vehicles—such as the Internet, viral marketing, and product placement—show great promise: in some categories, banner ads and online video generate brand awareness more cost effectively than traditional television advertising. But these alternatives haven’t achieved the scale needed to pick up the slack from traditional “workhorse” communications vehicles. Advertising will thus be effective only if marketers can manage a diverse and complex media mix.

Posted in Branding | Leave a Comment »

Networking

Posted by iBlog on January 6, 2008

For most companies, innovation is a proprietary activity conducted largely inside the organization in a series of closely managed steps. Over the last decade, however, a few consumer product, fashion, and technology businesses have been opening up the product-development process to new ideas hatched outside their walls—from suppliers, independent inventors, and university labs.

Executives in a number of companies are now considering the next step in this trend toward more open innovation.1 For one thing, they are looking at ways to delegate more of the management of innovation to networks of suppliers and independent specialists that interact with each other to cocreate products and services. They also hope to get their customers into the act. If a company could use technology to link these outsiders into its development projects, could it come up with better ideas for new products and develop those ideas more quickly and cheaply than it can today? Suppose that a wireless carrier, say, were to orchestrate the design of a new generation of mobile devices through an open network of interested customers, software engineers, and component suppliers, all working interactively with one another.

This is the model of innovation as a convergence of like-minded parties. Increasing numbers of organizations are now taking that approach: distributed cocreation, to use its technical name. LEGO, for instance, famously invited customers to suggest new models interactively and then financially rewarded the people whose ideas proved marketable. The shirt retailer Threadless sells merchandise online—and now in a physical store, in Chicago—that is designed interactively with the company’s customer base. In the software sector, open-source platforms developed through distributed cocreation, such as the “LAMP” stack (for Linux, Apache, MySQL, and PHP/Perl/Python), have become standard components of the IT infrastructure at many corporations. What facilitates this new approach to innovation is the rise of the Web as a participatory platform. What will drive its adoption by an increasing number of companies is the growing competitive need to uncover many more good ideas for products and to make better and faster use of those ideas.

Distributed cocreation is too new for us to draw definitive conclusions about whether and how companies should implement it. But our research into these online communities and our work with a number of open-innovation pioneers show that it isn’t too soon for senior executives to start seriously examining the possibilities for distributed cocreation or to identify the challenges, such as the ownership of intellectual property and increased operational risk, they face in adopting it.

The new face of innovation

In nearly every sector, many of the ideas and technologies that generate products emerge from a number of participants in the value chain. Boeing designs its aircraft, but suppliers make (and own the intellectual property for) many of the components. Likewise, HP’s computers and Apple’s iPod include hundreds of parts invented and manufactured by companies in more than two dozen countries. In many sectors, suppliers understand the technology and manufacturability of their pieces of the end product better than the OEMs do. Eli Lilly licenses and sells products that other companies develop; high-technology and media giants continually scan the horizon for innovations developed by start-ups and try to acquire whatever seems promising.

The benefits of specialization and collaboration seem obvious today. Clearly, an automaker’s suppliers can make better headlights at lower cost than the OEM can, because specialization promotes focus and innovation. Many companies participate in joint ventures for individual products or marketing packages and collaborate with university labs or specialists. Businesses are increasingly open to insights and ideas gleaned from any source—especially their customers, through call centers, retail data, and focus groups. Collaboration extends in many directions: when companies pursue a new product, many of them consult with contract specialists and suppliers and test prototypes with their customers.

But collaboration looks very different on Wikipedia, the online encyclopedia that represents a true phenomenon on the Internet. Wikipedia is created entirely by its users, not by a corporate-development staff in California. It is a living and continually expanding global reference work, which has expanded in less than seven years to offer more than six million articles in over 250 languages.2

The example of Wikipedia suggests that companies can take even greater advantage of specialization by ceding more control over decisions about the content of products to networks of participants (suppliers, customers, or both) who interact with one another. Does this seem far-fetched? IBM apparently doesn’t think so: it has adopted the open operating system Linux for some of its computer products and systems, drawing on a core code base that is continually improved and enhanced by a massive global community of software developers, only a small fraction of whom work for IBM. In software, open-source packages are gaining such favor that they are cutting into profit margins and drawing market share from proprietary software brands.

Many other examples of cocreation are now under way. One of them, participatory marketing, which encourages customers to help create marketing campaigns, is sometimes more than just a new tactic to attract attention. Approached in the right way, it is also an opportunity to start cocreating products with them. Last year, for instance, Peugeot invited people to submit car designs online and attracted four million page views on its site. The company built a demonstration model of the winning design to exhibit at automotive marketing events and partnered with software developers to get it included in a video game. Even business-to-business companies are starting to cocreate with customers: corporate users of SugarCRM’s customer-relationship-management software customize it to meet the specific needs of their industries.

Companies have three ways to win by adopting distributed cocreation. First, they can capture value from the cocreated product or service itself, as LEGO and Threadless have, by merchandising good ideas gleaned from the network. (In South Korea, the cocreated cosmetic brand Missha has seized a 40 percent market share in its segment.) Second, companies can capture value by providing a complementary product or service. Red Hat, for instance, sells a host of technology services to users of Linux. Third, they can benefit indirectly from the cocreation process—for example, through an enhanced brand or strategic position.

Hurdles ahead

While distributed cocreation does seem promising, it isn’t entirely clear what capabilities companies will need (or how they will organize those capabilities) to make the most of it. Many of the answers will become clear as companies gain greater experience with various open-innovation approaches, including distributed cocreation. But a few challenges are already apparent.

Attracting and motivating cocreators

Since companies must provide the right incentives to the right participants, they should understand what talented contributors find valuable about interacting with a community. Financial incentives may be necessary in some instances, but other participants can be inspired to cocreate by mechanisms like community recognition. Companies will also have to spot hurdles to participation—such as the ease or difficulty of contributing and the time needed to do so—and take steps to minimize any problems. In addition, they may need to implement well-structured paths to coax participants to move from lower to higher levels of participation. Wikipedia, for instance, now has 500 participating administrators who have earned special privileges to prevent edits on certain articles, usually to stop vandals who have targeted them.

Structuring problems for participation

To make it possible for many contributors to participate effectively in a cocreation community, problems should be broken down to let contributors work in parallel on different pieces. Otherwise, it will be impossible for a critical mass of participants to cocreate effectively. A global team of more than 2,000 scientists, for example, participated in the design of the ATLAS particle detector, a complex scientific instrument that will be used to detect and measure subatomic particles in high-energy physics. The effort was disaggregated into many different components and distributed across 165 working groups, which used Internet-based tools to help coordinate the work.3

Governance mechanisms to facilitate cocreation

Communities are productive when they have clear rules, clear leadership, and transparent processes for setting goals and resolving conflicts among members. Sun Microsystems, for instance, developed its Solaris operating system, cocreated with a global community of software developers, in the early 1990s. The company established a board, including two Sun employees and a third member from the larger software community, charged with loosely overseeing the project’s progress. Even then, by the way, the community wanted Sun to relinquish more control.

The leadership must also maintain a cohesive vision, since there is always a risk that community members will “fork” intellectual property and use it to develop their own cocreated product or service. Mozilla, the online application suite distributed by the Mozilla Foundation, was cocreated by a software community.4 As the programs were being developed, two contributing engineers, dissatisfied with the project’s direction, used the Mozilla code to create the Firefox Web browser. Community leaders eventually made it the primary supported browser.

Maintaining quality

Many cocreating online communities assume that “crowds”5 know more than individuals do and can therefore create better products; as the open-source-software expert Eric S. Raymond has said, “Given enough eyeballs, all bugs are shallow.”6 It is far too early to know with certainty if this idea holds true across all kinds of products, but a growing consensus maintains that in software development, at least, distributed cocreation is a ticket to quality. A study published in the European Journal of Information Systems in 2000, for instance, noted that “open-source software often attains quality that outperforms commercial proprietary” approaches.7 What’s more, a December 2005 study published in the scientific journal Nature concluded that Wikipedia’s entries on scientific subjects were generally as accurate as those in the Encyclopædia Britannica.8 Still, some have questioned these conclusions and the accuracy or insights of the entries on which they were based.

A number of cocreated products have crossed a quality threshold to become widely adopted. A survey by Netcraft, an Internet research firm, showed that the cocreated open-source Web-server program Apache runs more than half of all Web sites and that eight of the ten most reliable Internet hosting companies run Linux. While the general thesis that cocreated products are higher in quality is difficult to prove, companies are increasingly willing to rely on them for mission-critical business processes.

Lessons from communities

Although it is still too early to develop useful frameworks for success with cocreation, they will no doubt emerge over the next few years. Meanwhile, some lessons about how to proceed are coming out of both the consumer and the professional online communities.

Participative media supply some of these lessons. Our research suggests that 25 percent of Western Europe’s Internet users now post comments and reviews about consumer products of all kinds (exhibit). User-generated media sites are growing in numbers of visitors and participants by 100 percent a year, traditional sites by perhaps 20 to 30 percent.

Posted in Networking | Leave a Comment »

Applications

Posted by iBlog on January 6, 2008

The online delivery of software—sometimes labeled software as a service—has been a long-standing dream for some vendors and CIOs. The concept is simple and attractive: rather than buying a software license for an application such as enterprise resource planning (ERP) or customer relationship management (CRM) and installing this software on individual machines, a business signs up to use the application hosted by the company that develops and sells the software, giving the buyer more flexibility to switch vendors and perhaps fewer headaches in maintaining the software. For many years, traditional software vendors (those who sell licensed and packaged software, often along with a maintenance contract) have been able to overlook a rising crop of competitors that offer software as a service, as the latter have struggled to develop truly competitive services. It’s now time for traditional companies to pay attention, for they risk losing their privileged position to attackers that offer applications in this new way.

The complacence of traditional vendors is easily understood in light of the record: the first generation of online software delivery, in the late 1990s, failed to meet the reliability and quality standards demanded by business users. But the new delivery method appears to be taking off. While it won’t replace existing licenses and in-house custom-developed code overnight, an IDC report1 projects that 10 percent of the market for enterprise software will migrate to a pure software-as-a-service model by 2009. Our analyses suggest that software as a service is a growing priority for CIOs and venture capital investors.

Our review of venture capital investments shows that companies whose main business is delivering software as a service saw their revenues rise from $295 million in 2002 to $485 million in 2005, an 18 percent increase. On the buyer’s side, our fall 2006 survey of senior IT executives indicated a dramatic jump in the number of companies considering software-as-a-service applications during 2007.2

With software as a service, a customer contracts to use an application, such as ERP or CRM, hosted by a third party, rather than buying a software license and installing the application on its own machines. Just as consumers can check e-mail or use mapping programs with their Web browsers, so too can enterprise customers access business applications over the Internet.

Several factors are spurring the growth. New software design and delivery models allow many more instances of an application to run at once in a common environment, so providers can now share one application cost effectively across hundreds of companies—a vast improvement on the old client-server model. Bandwidth costs continue to drop, making it affordable for companies to purchase the level of connectivity that allows online applications to perform gracefully. Perhaps most important, many customers are eager for the shift, as they’re frustrated by the traditional cycle of buying a software license, paying for a maintenance contract, and then having to go through time-consuming and expensive upgrades. Many customers believe they would have more control over the relationship if they simply paid monthly fees that could be switched to another vendor if the first failed to perform (see sidebar “How CIOs can get maximum value from software as a service”). And finally, the successes of early leaders, such as salesforce.com and WebEx, have demonstrated the viability and value proposition of this model.

Market indicators suggest that investors share the enthusiasm of vendors and CIOs. Our index of companies whose main business is software delivered as a service3 outperformed the overall software company index (excluding Microsoft) by more than 13 percent from January 2002 to December 2006.

Although software-as-a-service vendors are less profitable than some traditional software vendors today, this gap is primarily caused by a lack of scale. We expect the economics of online delivery to change as the model gains wider acceptance. Large software companies (excluding Microsoft) typically have operating margins of around 25 percent. However, the margins of companies with revenues below $1.2 billion a year hover around 14 percent—close to the 13 percent margin of the average software-as-a-service vendor (Exhibit 1). A few service vendors already have much higher margins (WebEx, at 26 percent, and Digital Insight, at 19 percent) because they’ve been able to achieve scale and a leading position in their niches. Other leaders, such as salesforce.com (which provides on-demand CRM and sales force automation tools) and ADP (the world’s largest automated check processor) have also gained mainstream uptake among midsize and large companies.

Posted in Applications | Leave a Comment »

Economic Studies

Posted by iBlog on January 6, 2008

Struggling credit markets, slumping stocks, and a sliding dollar have been generating anxiety among executives and policy makers in early 2008. Amid the turmoil, it’s easy to forget that long-term structural change in the world’s capital markets will probably prove more important than short-term fluctuations, as it did after the 1987 US stock market crash, the 1992 assault on the British pound, and the 1997 unraveling of Asia’s financial markets.

Recent McKinsey Global Institute (MGI) research highlights several trends that look set to continue during the years ahead, long after the present bout of market turbulence has ended:

  • the continued growth and deepening of global capital markets as investors pour more money into equities, debt securities, bank deposits, and other assets around the world
  • the soaring growth of financial markets in emerging economies and the growing ties between financial markets in developed and developing countries
  • the shift of financial weight in Asia from Japan toward China and other fast-growing emerging markets
  • the growing financial clout of the eurozone countries and the significance of the euro
  • the burgeoning role of oil-rich Middle Eastern countries as suppliers of capital to the world, along with the rise of new financial hubs in the Middle East to complement the rapidly growing hubs in London and Asia

While these trends reflect a shift in financial power from the United States toward other parts of the world, the sheer size and depth of the US market will give it a leading role on the international financial stage for years to come.1

The exhibits that follow track the progress of these long-term shifts. The research rests on several proprietary MGI databases that cover the financial assets, cross-border capital flows, and foreign investments of more than 100 countries since 1990. Most of the analysis focuses on developments through 2006, the most recent year for which comprehensive data are available. But some data also show that many of the broad trends continued through late 2007 and will probably persist in years to come.

Posted in Economic Studies | Leave a Comment »

Valuation

Posted by iBlog on January 6, 2008

Talk about summertime blues. After peaking above 1,500 this July, the S&P 500 suffered an abrupt 10 percent correction before ending the month of August at 1,475. As of the publication of this article, the broad market has rebounded following interest rate cuts by the US Federal Reserve bank in mid-September. But stocks remain buffeted by a volatile credit market and by concerns that current high price levels might succumb to the same economic forces. Forces that caused the markets to plunge more than 40 percent in the three years after the last peak, in 2000.

As central bankers warily eye credit markets and ponder further interest rate cuts, no one can really anticipate what might happen next in a market wracked by volatility and skittish investors. Nonetheless, a comparison of the fundamentals underpinning the S&P’s recent performance and those at the time of the 2000 peak offers insights about the parallels and divergences between the two periods. These insights can give investors a better feel for where the market is now—and where it might head next.

First, the similarities. At one level, during both the run-up to the recent peak and the earlier dot-com market surge, most of the growth in market values was concentrated in a few sectors. Performance during the subsequent decline also varied by sector.

However, the peak in 2007 differed considerably from the one in 2000. During the 1990s investor euphoria and a highly speculative atmosphere overtook the market, raising P/E ratios to heights that made valuations unsustainable. In contrast, this year the market rode to its July peak on the back of exceptional corporate earnings, healthy GDP growth, a fast-paced M&A boom, and amazing consumer resilience despite a slump in the US housing market.

To get a better look at what exactly was driving the broad market during these periods, we analyzed two components of the market value of companies in the S&P 500—earnings and P/E ratios—assessing the performance of both over the past four decades at the market and the industry level.

As a first step we analyzed recent P/E levels. In an earlier article we described our simple P/E model,1 driven by a few fundamental factors that explain these ratios: long-term returns on capital, long-term real growth, the cost of capital, and expectations of inflation (Exhibit 1). Our model does a good job of explaining aggregate-market P/E ratios over the past 45 years—except during the speculative period around 2000. In that year overoptimism about the prospects of the technology, media, and telecom sectors and of megacompany stocks led the overall market P/E ratio to unsustainably high levels disconnected from the fundamental value creation potential of companies. The earlier article also shows that interest rates (and investors’ expectations of inflation) are inversely related to P/E ratios and have driven most of their fluctuations over the past 45 years.

Posted in Valuation | Leave a Comment »

Performance

Posted by iBlog on January 6, 2008

CFOs and the finance organizations they head are under intense pressure from the capital markets and activist investors to keep pace with a rapidly changing global market—to go beyond merely crunching numbers and create value on their own. Although finance organizations have a reputation for resisting change, those at world-class companies have made some progress in promoting it.

Such companies require finance professionals to be competitive as well as competent, to lead activities that the finance organization is uniquely suited to direct, and to assume responsibility even for activities that some find uncomfortable, because otherwise those things just won’t get done. Such expectations mean companies must attract and retain the best finance professionals they can—which in turn perpetuates an environment where the finance organization can create more value and do higher-quality work.

These are among the perspectives of a panel of experts convened at McKinsey’s 2007 CFO forum in London. The panelists were Jesper Brandgaard, executive vice president and CFO of Novo Nordisk; John Connors, a partner at the venture capital firm Ignition Partners and former CFO of Microsoft; Jonathan Peacock, CFO and chief administrative officer of Novartis Pharmaceuticals; and Helen Weir, group finance director of Lloyds TSB. Herbert Pohl, a partner in McKinsey’s Dubai office, moderated the discussion. What follows is an edited and abridged version of it.

Posted in Performance | Leave a Comment »

Capital Management

Posted by iBlog on January 6, 2008

Most business executives around the world agree that global social, environmental, and business trends are generally more important to corporate strategy than they were five years ago. But relatively few companies act on these trends, and many of those that do appear to be acting tentatively and have yet to see significant positive results, according to the latest McKinsey Quarterly survey.1

Take, for instance, the growing number of consumers in emerging economies. Almost eight respondents out of ten consider this trend important for global business, and six in ten think it will have a positive impact on their companies’ profits. Yet little more than one-third say that their companies have taken active steps to address it.

The survey also revealed that only 17 percent of the executives report that actions their companies have taken on such trends have produced a significantly positive result. One reason might be that companies are not making all of the (or the right) strategic moves to realize the full opportunities of the trends. Almost seven executives out of ten, for example, say that their companies addressed the consumer trend by building operations or expanding existing ones in emerging economies. But just slightly more than four in ten report that their companies developed new, lower-cost products or services for customers in these economies—which is often a prerequisite for serving the huge and fast-growing middle-income segment in, for instance, China and India.

Why don’t companies act on trends that their executives say are important? Respondents often cite higher strategic priorities and a lack of skills and resources or say that their companies simply haven’t yet decided whether or not to act.

Posted in Capital Management, Finance | Leave a Comment »

Starting Up As CFO

Posted by iBlog on January 6, 2008

March 2008


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In recent years, CFOs have assumed increasingly complex, strategic roles focused on driving the creation of value across the entire business. Growing shareholder expectations and activism, more intense M&A, mounting regulatory scrutiny over corporate conduct and compliance, and evolving expectations for the finance function have put CFOs in the middle of many corporate decisions—and made them more directly accountable for the performance of companies.

Not only is the job more complicated, but a lot of CFOs are new at it—turnover in 2006 for Fortune 500 companies was estimated at 13 percent.1 Compounding the pressures, companies are also more likely to reach outside the organization to recruit new CFOs, who may therefore have to learn a new industry as well as a new role.

To show how it is changing—and how to work through the evolving expectations—we surveyed 164 CFOs of many different tenures2 and interviewed 20 of them. From these sources, as well as our years of experience working with experienced CFOs, we have distilled lessons that shed light on what it takes to succeed. We emphasize the initial transition period: the first three to six months.

Early priorities

Newly appointed CFOs are invariably interested, often anxiously, in making their mark. Where they should focus varies from company to company. In some, enterprise-wide strategic and transformational initiatives (such as value-based management, corporate-center strategy, or portfolio optimization) require considerable CFO involvement. In others, day-to-day business needs can be more demanding and time sensitive—especially in the Sarbanes–Oxley environment—creating significant distractions unless they are carefully managed. When CFOs inherit an organization under stress, they may have no choice but to lead a turnaround, which requires large amounts of time to cut costs and reassure investors.

Yet some activities should make almost every CFO’s short list of priorities. Getting them defined in a company-specific way is a critical step in balancing efforts to achieve technical excellence in the finance function with strategic initiatives to create value.

Conduct a value creation audit

The most critical activity during a CFO’s first hundred days, according to more than 55 percent of our survey respondents, is understanding what drives their company’s business. These drivers include the way a company makes money, its margin advantage, its returns on invested capital (ROIC), and the reasons for them. At the same time, the CFO must also consider potential ways to improve these drivers, such as sources of growth, operational improvements, and changes in the business model, as well as and how much the company might gain from all of them. To develop that understanding, several CFOs we interviewed conducted a strategy and value audit soon after assuming the position. They evaluated their companies from an investor’s perspective to understand how the capital markets would value the relative impact of revenue versus higher margins or capital efficiency and assessed whether efforts to adjust prices, cut costs, and the like would create value, and if so how much.

Although this kind of effort would clearly be a priority for external hires, it can also be useful for internal ones. As a CFO promoted internally at one high-tech company explained, “When I was the CFO of a business unit, I never worried about corporate taxation. I never thought about portfolio-level risk exposure in terms of products and geographies. When I became corporate CFO, I had to learn about business drivers that are less important to individual business unit performance.”

The choice of information sources for getting up to speed on business drivers can vary. As CFOs conducted their value audit, they typically started by mastering existing information, usually by meeting with business unit heads, who not only shared the specifics of product lines or markets but are also important because they use the finance function’s services. Indeed, a majority of CFOs in our survey, and particularly those in private companies, wished that they had spent even more time with this group (Exhibit 1). Such meetings allow CFOs to start building relationships with these key stakeholders of the finance function and to understand their needs. Other CFOs look for external perspectives on their companies and on the marketplace by talking to customers, investors, or professional service providers. The CFO at one pharma company reported spending his first month on the job “riding around with a sales rep and meeting up with our key customers. It’s amazing how much I actually learned from these discussions. This was information that no one inside the company could have told me.”

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Lead the leaders

Experienced CFOs not only understand and try to drive the CEO’s agenda, but also know they must help to shape it. CFOs often begin aligning themselves with the CEO and board members well before taking office. During the recruiting process, most CFOs we interviewed received very explicit guidance from them about the issues they considered important, as well as where the CFO would have to assume a leadership role. Similarly, nearly four-fifths of the CFOs in our survey reported that the CEO explained what was expected from them—particularly that they serve as active members of the senior-management team, contribute to the company’s performance, and make the finance organization efficient (Exhibit 2). When one new CFO asked the CEO what he expected at the one-year mark, the response was, “When you’re able to finish my sentences, you’ll know you’re on the right track.”

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Building that kind of alignment is a challenge for CFOs, who must have a certain ultimate independence as the voice of the shareholder. That means they must immediately begin to shape the CEO’s agenda around their own focus on value creation. Among the CFOs we interviewed, those who had conducted a value audit could immediately pitch their insights to the CEO and the board—thus gaining credibility and starting to shape the dialogue. In some cases, facts that surfaced during the process enabled CFOs to challenge business unit orthodoxies. What’s more, the CFO is in a unique position to put numbers against a company’s strategic options in a way that lends a sharp edge to decision making. The CFO at a high-tech company, for example, created a plan that identified several key issues for the long-term health of the business, including how large enterprises could use its product more efficiently. This CFO then prodded sales and service to develop a new strategy and team to drive the product’s adoption.

To play these roles, a CFO must establish trust with the board and the CEO, avoiding any appearance of conflict with them while challenging their decisions and the company’s direction if necessary. Maintaining the right balance is an art, not a science. As the CFO at a leading software company told us, “It’s important to be always aligned with the CEO and also to be able to factually call the balls and strikes as you see them. When you cannot balance the two, you need to find a new role.”

Strengthen the core

To gain the time for agenda-shaping priorities, CFOs must have a well-functioning finance function behind them; otherwise, they won’t have the credibility and hard data to make the difficult arguments. Many new CFOs find that disparate IT systems, highly manual processes, an unskilled finance staff, or unwieldy organizational structures hamper their ability to do anything beyond closing the quarter on time. In order to strengthen the core team, during the first hundred days about three-quarters of the new CFOs we surveyed initiated (or developed a plan to initiate) fundamental changes in the function’s core activities (Exhibit 3).

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Several of our CFOs launched a rigorous look at the finance organization and operations they had just taken over, and many experienced CFOs said they wished they had done so. In these reviews, the CFOs assessed the reporting structure, evaluated the fit and capabilities of the finance executives they had inherited, validated the finance organization’s cost benchmarks, and identified any gaps in the effectiveness or efficiency of key systems, processes, and reports. The results of such a review can help CFOs gauge how much energy they will need to invest in the finance organization during their initial 6 to 12 months in office—and to fix any problems they find.

Transitions offer a rare opportunity: the organization is usually open to change. More than half of our respondents made at least moderate alterations in the core finance team early in their tenure. As one CFO of a global software company put it, “If there is a burning platform, then you need to find it and tackle it. If you know you will need to make people changes, make them as fast as you can. Waiting only gets you into more trouble.”

Manage performance actively

CFOs can play a critical role in enhancing the performance dialogue of the corporate center, the business units, and corporate functions. They have a number of tools at their disposal, including dashboards, performance targets, enhanced planning processes, the corporate review calendar, and even their own relationships with the leaders of business units and functions.

Among the CFOs we interviewed, some use these tools, as well as facts and insights derived from the CFO’s unique access to information about the business, to challenge other executives. A number of interviewees take a different approach, however, exploiting what they call the “rhythm of the business” by using the corporate-planning calendar to shape the performance dialogue through discussions, their own agendas, and metrics. Still other CFOs, we have observed, exert influence through their personal credibility at performance reviews.

While no consensus emerged from our discussions, the more experienced CFOs stressed the importance of learning about a company’s current performance dialogues early on, understanding where its performance must be improved, and developing a long-term strategy to influence efforts to do so. Such a strategy might use the CFO’s ability to engage with other senior executives, as well as changed systems and processes that could spur performance and create accountability.

First steps

Given the magnitude of what CFOs may be required to do, it is no surprise that the first 100 to 200 days can be taxing. Yet those who have passed through this transition suggest several useful tactics. Some would be applicable to any major corporate leadership role but are nevertheless highly relevant for new CFOs—in particular, those who come from functional roles.

Get a mentor

Although a majority of the CFOs we interviewed said that their early days on the job were satisfactory, the transition wasn’t without specific challenges. A common complaint we hear is about the lack of mentors—an issue that also came up in our recent survey results, which showed that 32 percent of the responding CFOs didn’t have one. Forty-six percent of the respondents said that the CEO had mentored them, but the relationship appeared to be quite different from the traditional mentorship model, because many CFOs felt uncomfortable telling the boss everything about the challenges they faced. As one CFO put it during an interview, “being a CFO is probably one of the loneliest jobs out there.” Many of the CFOs we spoke with mentioned the value of having one or two mentors outside the company to serve as a sounding board. We also know CFOs who have joined high-value roundtables and other such forums to build networks and share ideas.

Listen first . . . then act

Given the declining average tenure in office of corporate leaders, and the high turnover among CFOs in particular, finance executives often feel pressure to make their mark sooner rather than later. This pressure creates a potentially unhealthy bias toward acting with incomplete—or, worse, inaccurate—information. While we believe strongly that CFOs should be aggressive and action oriented, they must use their energy and enthusiasm effectively. As one CFO reflected in hindsight, “I would have spent even more time listening and less time doing. People do anticipate change from a new CFO, but they also respect you more if you take the time to listen and learn and get it right when you act.”

Make a few themes your priority—consistently

Supplement your day-to-day activities with no more than three to four major change initiatives and focus on them consistently. To make change happen, you will have to repeat your message over and over—internally, to the finance staff, and externally, to other stakeholders. Communicate your changes by stressing broad themes that, over time, could encompass newly identified issues and actions. One element of your agenda, for example, might be the broad theme of improving the efficiency of financial operations rather than just the narrow one of offshoring.

Invest time up front to gain credibility

Gaining credibility early on is a common challenge—particularly, according to our survey, for a CFO hired from outside a company. In some cases, it’s sufficient to invest enough time to know the numbers cold, as well as the company’s products, markets, and plans. In other cases, gaining credibility may force you to adjust your mind-set fundamentally.

The CFOs we interviewed told us that it’s hard to win support and respect from other corporate officers without making a conscious effort to think like a CFO. Clearly, one with the mentality of a lead controller, focused on compliance and control, isn’t likely to make the kind of risky but thoughtful decisions needed to help a company grow. Challenging a business plan and a strategy isn’t always about reducing investments and squeezing incremental margins. The CFO has an opportunity to apply a finance lens to management’s approach and to ensure that a company thoroughly examines all possible ways of accelerating and maximizing the capture of value.

As an increasing number of executives become new CFOs, their ability to gain an understanding of where value is created and to develop a strategy for influencing both executives and ongoing performance management will shape their future legacies. While day-to-day operations can quickly absorb the time of any new CFO, continued focus on these issues and the underlying quality of the finance operation defines world class CFOs.

About the Authors

Bertil Chappuis and Paul Roche are directors in McKinsey’s Silicon Valley office; Aimee Kim is an associate principal in the New Jersey office.

Notes

1Financial Officers’ Turnover, 2007 Study, Russell Reynolds Associates.

2We surveyed 164 current or former CFOs across industries, geographies, revenue categories, and ownership structures. For more of our conclusions, see “The CFO’s first hundred days: A McKinsey Global Survey,” mckinseyquarterly.com, December 2007.

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Staying Motivated In Sales

Posted by iBlog on January 5, 2008

Staying Motivated in Sales

Common Failure Mistakes

1. Giving up too soon
2. Not acknowledging that even good prospects will say no several times before they say yes
3. Quitting too soon

80% of customers say yes after the sixth call

Why People Fail at Sales

1. They don’t want to sell
2. Confidence, lack of
3. Expecting perfection
4. Circles, getting stuck in cycles
5. Not having what they want

How To Stay Focused

Release, letting go of the feeling
Notice, sit back and be aware
Respond, make a choice of what you observed
Witness, look at everything from a different perspective
Repeat, repeat the process until you have no emotional attachment
Business is getting the work done

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