Agile Business Transformation

Overview

Business transformation professionals understand that their role, distilled to its essence, is to serve as a change agent for their clients. Catalyzing business transformation is challenging, and doubly so in the always tumultuous middle market. In order to effectively drive change, it is of paramount importance that a solid foundation for that change be laid upfront.

There must be consensus among all parties on the goal, including an agreement on what success looks like. This agreement must have a firm objective basis, so that in the future it can be conclusively established whether or not the goal was achieved. Responsibilities and lines of authority among and between advisors, company leadership, middle managers, line staff, and any other key stakeholder groups must be clearly mapped out. A detailed project plan, timeline and budget should be created and broadly disseminated, and these should be coupled with a reporting framework that includes a regular check-in cadence to ensure that a business transformation initiative is proceeding on schedule and as planned. In many ways, middle market business transformation is a testament to the awesome transformative power of diligent planning.

As the economies of the world face an economic downturn unlike any in living memory, how can change agents succeed at a time when long-standing assumptions are giving way to the awesome and destructive power of an unseen and unlooked for cause of disruption? How does one lay the foundation for change when the ground is shifting beneath our feet?

The answer is to take a hard look at the components of a successful middle market business transformation effort and deconstruct it. This is a moment that calls out for a retooling of traditional delivery models. What is needed instead is an agile business transformation approach. This agile delivery model is better aligned with the lived reality of middle market companies in times of extreme uncertainty and market shifting emergent developments.

Related Concepts

Many professions have grappled with the inherent trade-offs that organizations must consider when assessing operating models that offer greater flexibility. In the interest of becoming maximally impactful change agents, those active in the work of business transformation should seek to become conversant not only in the trade-offs relevant to their specialty, but to the broader set of interdisciplinary corollary concepts that bear on this tendency.

  • Fixed vs. variable costs. The agile business transformation framework has a corollary concept in management: the practice of optimizing a company business model by determining which costs should be fixed and which variable. There are benefits to each. An emphasis on fixed costs implies a higher break-even point, but after clearing that threshold, profitability increases rapidly (this is known as “operating leverage”). By contrast, an emphasis on variable costs offers the benefit of a lower break-even point with the trade-off that operating leverage is forfeit.

 

  • Triangle offense. In basketball, the triangle offense, championed by many but perhaps best popularized by coach Phil Jackson during his tenure as head coach of the Chicago Bulls (1989 – 1998) and Los Angeles Lakers (1999 – 2004), is the hallmark of team over individual, and flexibility over all. This offensive approach allowed Jackson to earn 11 championships as a coach. However, the triangle offense challenged individual scoring greats Michael Jordan (Chicago Bulls) and Kobe Bryant (Los Angeles Lakers) to retool their approach to a game that they excelled at. The changes were difficult, but the results were undeniable.

 

  • Game development. In the world of game design, the announcement of No Man’s Sky was met with a mix of awe and skepticism. Rather than present players with a series of explicitly designed environments and situations, No Man’s Sky featured a procedurally generated universe of worlds for the player to explore. Despite the impressive technical accomplishment of offering game players a potential universe of 18 quintillion worlds to explore, the limitations of the game quickly became apparent. While acknowledging the technical achievement that the game represented, it initially received only lukewarm reviews and it was only after the game developer invested the time and effort to bolster other, key design elements that the game began to be regarded as having closed the expectations gap that had grown over the years.
The Agile Change Agent

The Agile Change Agent

The Agile Change Agent

Change management in the era of COVID-19 must embody all the traits of which change agents are justifiably proud: the ability to alter the status quo, a structured approach to execution, a tested process for upskilling client staff, an ethos of accountability, etc. And yet, the current moment presents us all with an opportunity for self-reflection. Have the best practices of business transformation professionals been getting in the way of delivering change to our clients? Is our approach to service delivery becoming too doctrinaire and over-structured? Do we need more flexibility? The answers are yes, yes, and yes.

Now is the moment to loosen the reigns and approach middle market business transformation with the goal of inserting flexibility into the delivery of transformational change. In the process, we all have the opportunity to become more agile, and impactful, change agents.

By blending the traditional focus on objective measures with a bias towards maximal flexibility in the following key areas, business transformation professionals can take a major step toward becoming agile change agents:

• Goals
• Project Plan / Timeline
• Responsibilities
• Consensus
• Budget

The agile change agent is not an irresponsible or undisciplined business transformation professional. Rather, they are those who recognize that must by definition proceed from and be judged by the initial starting point. And when the macro state of affairs is ever shifting, the delivery of business transformation must shift as well.

Conclusion

A successful approach to middle market business transformation during a historic downturn caused by a global pandemic but sustained by previously unaddressed weaknesses that have built up throughout the economy over the course of the long boom will require a change in mindset. We are truly living in a period in which perfection can be the enemy of progress for our clients. Rather than being overly structured, business transformation professionals must instead seek opportunities to increase the flexibility of their delivery models in order to deliver the maximum level of impactful change for their clients under conditions of heightened uncertainty. Flexibility, and the capacity to incorporate emergent developments into in-progress business transformation initiatives, will be the hallmark of successful change agents in these challenging times.

About the Author

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition. Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. David is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation. He can be contacted at: david@abraxasgp.com.

Value Creation in a Downturn

Overview

Value creation is a mandate for leadership teams regardless of industry or company size. This mandate is both an economic necessity and a nod to the element of stewardship inherent in leading an organization: good leaders improve the companies they lead and work to ensure that they leave them financially stronger, in a more robust strategic position, and more valuable at the end of their tenure than at the beginning. The challenge for every leader is that the optimal mix and weighting of value creation levers changes over time, sometimes due to idiosyncratic factors, and sometimes due to sudden, exogenous shocks.

The impact of COVID-19 has been a severe negative shock to global growth prospects. Even worse, research suggests that below-trend growth could persist for years. There will of course be exceptions, and some quite notable, but for many companies and in some cases whole industries, the prospects for year-over-year revenue growth in 2020 are decidedly bleak. In some cases, the prospects for 2021, even accounting for the lower bar of comparison, are daunting. For many companies, pursuit of a growth-oriented value creation strategy in this environment is no longer viable.

Growth is a proven engine of value creation, and over the last decade it has been the lever on which leadership teams and capital providers have focused their efforts. But there are many ways to increase the value of a company, and as companies grapple with a radically altered business landscape, now is the time for leadership teams to reacquaint themselves with equally proven, though at times less sexy, value creation drivers.

While there are many value creation drivers, in looking to recast a strategy there are certain characteristics that should be sought out:

  • Actionable. Focus on measures that leadership can influence.
  • Scope of Impact. Focus on measures that will deliver a considerable impact to company performance when optimized.
  • Scalable. Focus on measures that scale.

The fact that COVID-19 acted as the catalyst for the end of the most recent expansionary phase serves to obscure the reality that systemic weaknesses have been steadily building throughout the long expansionary phase that the U.S. and global economy enjoyed from the end of the global financial crisis to February of 2020. Middle market companies that respond to the shifting zeitgeist with a focus on pivoting to value creation drivers other than growth will be setting the stage for compelling value creation in the years to come.

Unit Economics

Generally, companies on a robust growth path will experience a steady decline in gross margins. There is no hard and fast business rule that dictates this trend, but companies and their leadership teams must understand the implications of their own strategy, and a strategy that seeks to maximize revenue growth is a strategy that, at the margin, will tend to be associated with gross margin erosion (absent technology driven network effects other structural idiosyncrasies).

The impact of flat or declining revenue can be offset, in part or in whole, by improving unit economics. When gross margin ([Revenue] – [Cost of Goods Sold] / [Revenue]) is rising, a company enjoys an increasing level of incremental benefit (profit) from each sale. Despite this fundamental benefit, it is organizationally very challenging to focus simultaneously on executing a successful growth strategy and driving persistent gross margin expansion.

Working Capital

Working capital management should appear high on any list of organizational value creation drivers. The impact of optimizing working capital does not appear on the income statement, but savvy leadership teams and capital providers understand that by offering the prospect of increases in both cash flow and capital efficiency, working capital is an attractive value creation driver at all points in the economic cycle.

Net Working Capital, or the net amount of capital used in the normal operations of a business, is calculated as the sum of total Current Assets (excluding cash and equivalents) less the sum of total Current Liabilities. Since any increase in Current Assets represents a use of cash, and any increase in Current Liabilities represents a source of cash, the goal is to reduce Accounts Receivable, Inventory, and Other Current Assets while increasing Accounts Payable and Other Current Liabilities. Working capital improvements cannot be accomplished in a vacuum, as the parties on the other sides of these initiatives are often important stakeholders for a company, but nevertheless, the basic arithmetic remains unchanged.

Analytic Insights

Mastering the implications of their own data remains perhaps the greatest untapped source of competitive advantage available to every company. Data is ubiquitous but as a result of that ubiquity it carries with it a low signal-to-noise ratio. Leadership teams must champion efforts, and ultimately structured processes, to generate insights that will point to opportunities for improvement. Once generated, insights should be regarded as maps to untapped pockets of value creation.

Conclusion

Growth cures many ills, but expansionary phases, whether at the macro or micro level, contain within themselves the seeds of their own dissolution. At the level of individual companies, long growth phases are often associated with sub-optimal levels of profitability, as the mandate to grow consumes the time and attention of leadership teams, and the discipline necessary to improve underlying operational efficiency becomes an early casualty of a company’s narrative of growth as the dominant value creation driver.

In the face of the massive economic disruptions arising from COVID-19, middle market companies and their leadership teams will find any growth oriented strategy severely tested. The end of positive momentum for revenue growth, even over an extended period, does not presage an end to value creation. Rather, in an economic environment that will prove hostile to the growth ambitions of many companies, middle market leadership teams must reset both strategy and operations in order to maximize a different set of actionable value creation drivers.

About the Author

David Johnson (@TurnaroundDavid) is founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition. Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. David is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation. He can be contacted at: david@abraxasgp.com.

Middle Market Transformation

Middle Market Transformation

“Change, when it comes, cracks everything open.”

Dorothy Allison, Bastard Out of Carolina

Middle Market in Flux

The successful design and execution of a middle market business transformation poses unique challenges for company leadership. In good times, when the cost of a strategic change initiative can most readily be afforded, and the risk most easily managed, there often seems to be no need, and hence little urgency on the part of company leadership. But in challenging times the cost and associated risks of business transformation can seem to be insurmountable obstacles, and company leadership may feel intense pressure to defer action for another month/quarter/year while performance steadily declines, rather than make the leap.

Leadership in the middle market is challenging in any time, but the middle market leaders of today must become quick studies in the key tenets of business transformation as they seek to make adjustments commensurate with the external changes facing them. Change has come to the business world in 2020, vast in scale and scope and breathtaking in its speed. It remains to be seen how many businesses will be equal to the challenge, but it is a certainty that some businesses will fail.

The most potent enemy of middle market business transformation is not fear, risk aversion, lack of strategic clarity, or the leadership challenge of implementing change. Rather, for middle market companies the most potent enemy of business transformation is the failure to recognize that change has come, and that the only viable strategy for a company is to meet external change with internal change.

While change itself is a constant, 2020 has been a year of profound and wrenching change for organizations everywhere. In the U.S. and elsewhere, the combination of governmental restrictions and a radical shift in the internal risk calculus of consumers has eviscerated the business models of companies across a broad swath of the economy. Sectors such as airlines, hotels, event planners, restaurants, bars, movie theatres, playhouses, retailers, commercial real estate, and more, all now face a radically altered outlook from that of only a few months ago. Companies in each of these sectors, and many others, are now confronted with the grim specter of a new status quo that is inimical to their viability.

A natural and understandable reaction to the massive economic shock that the coronavirus pandemic and protection measures meant to address it have imposed on businesses is to hope for a deus ex machina. Something that will provide deliverance from the life and death struggle that the leadership teams of millions of organizations now find themselves engaged in. If only we could return to the halcyon days of 2019, if only this legislative relief would be extended, or changed, if only…

Hope is not a strategy.

It is a worthwhile thing to hope, and if your conscience leads you there, to pray, for change. But the role of company leadership is to calmly assess the challenges of the moment, objectively weigh the known and unknown risks, and design and implement a plan to win in the current environment.

The world has changed, and across the middle market survival and ultimate market success will go to those companies that recognize our current moment as one crying out for business transformation, and act accordingly.

A New Paradigm

In a recent research report: “Handicapping the Paths for Pandemic Recovery”, Moody’s Analytics notes the following:

  • Global GDP is forecast to see a peak to trough decline of 10%.
  • Unlike prior global downturns, there is not currently any country that appears well-positioned as a catalyst for global recovery.
  • Fiscal support by the U.S. government has already totaled 14% of GDP.
  • Moody’s projects a non-negligible risk of a double-dip recession in the U.S. if fiscal support is withdrawn too early.

If anything, the view from a U.S. middle market perspective is even worse. The “2nd Quarter 2020 Economic Outlook Survey”, released by AICPA, was full of sobering statistics that illustrate just how dire the outlook has become for the leadership teams at middle market companies:

  • 92% of respondents indicated that the pandemic has had a negative impact on their business.
  • 81% of companies have made downward revisions to their financial forecasts.
  • Nearly 50% of companies across all size ranges surveyed (<$10MM, $10MM – $100MM, $100MM – $1B, and >$1B) expect some contraction in their business over the next twelve months.
  • 25% of companies report having an excess of employees (versus 7% in Q1).

Middle Market Change

The greatest danger in the middle market today is that leadership teams will continue to labor under the old assumptions, disregarding mounting evidence that we are living through a paradigm shifting event. The world has changed. Economic activity has experienced a drastic decline, and the path out of that decline is unlikely to be the V-shaped recovery we all pine for. To assume that the strategic landscape for any middle market company will be unchanged by this crisis is naïve.

Absent knowledge of when a vaccine or effective treatment for COVID-19 will be broadly available, we are all nothing more than amateur economists choosing to assume a can opener as a way to keep opining, abiding by an unspoken agreement that we will not grapple head-on with the gaping hole in our own logic.

We simply do not know when this will end.

But the world will look different when it does.

Strategy is your own bespoke plan to win. What is your plan to win the environment as it will be, not as it was?

Competitive Landscape

Formerly struggling giants are collapsing into bankruptcy (JCPenney, Neiman Marcus, J. Crew), and a far larger number of middle market companies will pursue restructuring as an option (whether in or out of court) as well.

Companies are going out of business. Now. Business bankruptcies in the United States rose 48% in April. A broader measure of distress (one that might encompass businesses that shut down but did not file for bankruptcy, those in the process of pursuing bankruptcy-like solutions such as an Assignment for the Benefit of Creditors, as well as those being pressured into an out-of-court restructuring by their lenders) would undoubtedly show an even more profound increase.

According to Moody’s Analytics: “Of the 8 million business establishments operating prior to the crisis in the U.S., it would not be surprising if close to a million do not make it.”

Post pandemic, every company will be faced with an altered, and in some cases radically altered, competitive landscape.

Multinational Business Transformation

A crisis often provides the necessary external catalyst for leadership to acknowledge the need for business transformation. Unfortunately, even in the face of the current crisis many companies, particularly those in the middle market, are thinking too small in terms of the changes they are considering.

The reaction by many of the largest companies in the U.S. to the current crisis is instructive. To a large extent, these companies and their leadership teams have discerned a need to fundamentally rethink key aspects of their business. The business transformation efforts of these companies to date have signaled the breadth of the change that they view as necessary. By attacking their cost structures, bolstering their liquidity positions, reassessing their channels for customer interaction, and reviewing their talent management policies, some of the largest and wealthiest companies in the U.S. have signaled unambiguously that they view the current moment as one that requires business transformation on an ambitious scale.

A sample of companies and their business transformation efforts in the face of the coronavirus pandemic will illustrate the point:

  • Gap. The clothing retailer has been hard-hit by the pandemic. Management has reported that 90% of stores globally were closed starting March 19, leading to a 61% year over year decline in same store sales, partially offset by an aggregate 13% YoY increase in ecommerce sales. In May the company announced a private placement of debt facilities and amendment of the terms to its revolving line of credit. Gap is also in the midst of resetting its cost structure by engaging in contentious negotiations with its landlords.

 

  • Starbucks. The company that brought coffee culture to the United States is clearly less sanguine about our prospects for a rapid economic recovery, and it is acting accordingly. Leadership is accelerating rollout of the “Starbucks Pickup” store format, originally projected to take five years, and now slated for completion in 18 months. The company closed on a debt financing in May aimed at improving liquidity and has negotiated a relaxation of certain debt covenants with existing lenders. Additionally, Starbucks has contacted landlords for its corporate owned stores and is pursuing aggressive rental concessions.

 

  • Facebook. CEO Mark Zuckerberg has announced an intention to transition as many of 50% of roles to remote work in the next five to ten years. The challenges of rolling out this policy are considerable, especially as Facebook has stated that it intends to maintain a pay differential by location, which may be less defensible in a remote work environment.

Transformation in the Middle Market

The challenges of the moment are profound, and for middle market companies seeking to navigate a path through the global pandemic the energy involved in imaging a radical shift in business while simultaneously working to ensure viability on a day-to-day basis can seem too much. But such is leadership in the middle market. This is the moment for companies and their leadership teams to take bold action, move forward with aggressive business transformation initiatives and position themselves to not only survive the immediate crisis but also secure for themselves a prosperous future. The host of unknows facing us all is no excuse for inaction. When the history of the pandemic is written, this moment will be recognized as one that offered extreme value creation opportunities for those leaders bold enough to take action.

Middle market companies are not smaller versions of larger companies. Rather, they are sui generis, and should be viewed as such. Nonetheless, no middle market leadership team can afford to regard with complacency the signals from economic forecasts and multinational companies that indicate adjustment to a post COVID-19 world will require business transformation on an epic scale.

Effective business transformation requires not only a plan, but a mindset oriented toward change. Leadership teams in the middle market should look to answer the following questions about their own companies:

  1. What are the key assumptions about our business that we believed to be enduring at the start of 2020?
  2. Have recent events undercut our confidence in any of those assumptions?
  3. Are our current sources of competitive advantage stronger or weaker now than they were at the beginning of the year?
  4. How secure are our finances? Profitability, cash flow, liquidity? If we needed to raise capital quickly, do we have a sense of how much capital would be available, on what terms, and from whom?
  5. Is our company positioned to be an acquirer if a major competitor fails?
  6. How strong are our relationships with key stakeholders? Is there more that we can do to bolster these relationships?

The exercise of answering these questions, with a self-critical lens, will help middle market leadership teams identify areas of weakness to be addressed in a business transformation initiative.

Conclusion

We are in the midst of a period of undeniable economic and social change, and the impact of these changes will reverberate for years to come. Business models will be upended. Competitive dynamics will shift. This is a moment for forward-looking leadership teams to set their companies on an upward trajectory of value creation. But for those who do not act, history offers a bitter lesson: change is inevitable, and failure, no matter how remote the prospect is in our own minds, is always a possibility.

 

About the Author

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. David is a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround and value creation.  He can be contacted at: david@abraxasgp.com.

 

Funding Transformation

Recognizing the need for change, developing a plan for change, and gaining support for change are all necessary steps in a successful business transformation.  Necessary, but not sufficient.  An actionable business transformation plan, especially in the middle market, must also grapple, in the harsh glare of objectivity, with the cost of transformation and how best to fund it.

The question of how to fund a business transformation can test leadership teams that already feel themselves at the razor’s edge of endurable pressure, and for too many companies the question of funding is where a promising business transformation runs aground, as that same leadership team finds itself unable or unwilling to think through or engage outside support to advise on how best to chart a path to the desired outcome in light of available resources.

Timidity in the face of resource constraints, and the scarcity mindset it implies, serves only to narrow the horizons of those most desperately in need of a business transformation.  Luckily, engaging proactively with the sources and uses of funding does not need to serve in any way as an inhibitor of aims.  Rather, the discipline of addressing resource constraints and funding sources upfront can serve as a valuable spark to the creative process, yielding a more capital efficient, and oftentimes more ambitious in the long-run, business transformation.

An Umbrella When the Sun is Shining

The result of an extended period of below trend (or any) profitability for a company is that ambitious business transformation initiatives become increasingly difficult to fund just as they become increasingly more necessary.  For many leadership teams, the answer to this quandary is simple: borrow.

Efforts to borrow in order to fund a business transformation often run into a frustrating challenge.  Companies find that the ease with which outside funding can be procured for a business transformation project is inversely correlated to the importance of the project’s success for an organization’s future.  Capital for low-risk, high return projects is abundant, but for those business transformation initiatives that truly represent a do-or-die crossroads, capital is more scarce and much more costly. 

Mark Twain famously quipped that: “A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain.”

The availability and sophistication of risk capital has certainly increased since the late 19th century, but the central point that Twain was seeking to make remains as true today as in his own time: for the majority of lenders, and certainly the sources of the cheapest outside capital, the most attractive candidates for a loan are those that do not need the money.  Luckily, there are lenders active across the risk spectrum, and prospective borrowers have no need to limit themselves to banks.

Internal Sources

Middle Market leadership teams often have less exposure to the capital markets, and hence are more susceptible to shock when they realize the challenges that come with certain types of funding sources.  Absent expert support, this shock can impose costly delays on, and even derail, promising and even existential business transformation projects.  In order to prevent this, it is important to consider the internal sources of funding available to any company, and the pros and cons associated with that source.

  • Operating Expenses.  Too often leadership will view an existing cost structure as a fact of life, rather than a set of circumstances that can be easily changed.  The inadvertent misallocation of resources is unfortunately the norm throughout the middle market, and as a result the gains to be achieved through a rigorous assessment and reprioritization of spending are considerable.
  • Working Capital.  The capital tied up in an organization’s operations represents an immense opportunity and is one of the lowest cost sources of funding for a business transformation initiative.  Too often management teams severely under-estimate the magnitude of the opportunity that working capital management represents, and so fail to consider working capital as a viable source of funding.  

There are pros and cons to funding a business transformation via internal sources of funding.  Among the pros are the high level of control that companies have on both their internal cost structure and in their approach to working capital management.  Cons include declining employee morale, dissatisfaction among customers and suppliers, and increased strain on management.  Regardless of whether or not internal sources of funding ultimately utilized for a given business transformation initiative, they should always be considered.

Conclusion

The ultimate source of value creation in a company is improved performance.  Industry, positioning, and timing all matter, but robust profitability and cash flow enables an organization to maintain control over its own destiny.  The funding of a transformation project should be looked at as a question of carefully assessing the project, how and why it is expected to improve performance and moving forward aggressively with any transformation project that makes sense.  Faced with a compelling business transformation initiative, leadership teams have several viable avenues to explore for funding, and so should not allow their horizons to be narrowed.  In business two things are certain: change is constant, and the returns to controlling your own destiny are enormous.

About the Author

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies.  David is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround and value creation.  He can be contacted at: david@abraxasgp.com.

Reporting: A Catalyst for Improvement

 

Becoming a company that learns, rather than one that simply reports

 

Overview

Business owners today are stretched for time, and so are all the members of their team.  The pace of business can seem unrelenting, and in that environment abstract goals can seem frivolous.  The ever-present temptation, given this state of affairs, is to regard the past as a curiosity, and a topic as banal as reporting to be a matter of creating something that is good enough, in order to move on to the next thing.  This view is almost invariably wrong and has often proven to be a fatal mistake for companies large and small.  Rather, an investment in robust reporting should be considered a necessary step for every company seeking to utilize its own data to maximize value.

Reporting, whether on financial, operational, or business intelligence data, presents every company with an opportunity to develop insight into its own business as well as its broader market.  Too often that opportunity is not seized.  Opportunities to begin building an insight advantage are deferred, and eventually lost.  Reporting that presents sufficient data to answer the question of what happened must be considered to be merely the starting point and must be enhanced first with comparative information and qualitative context in order to transmute the simple reporting of data into the creation of insight.

Successful companies understand that data-driven insights are the one universal value creation opportunity.  Every company sits on immense data about both itself and its market, but few make use of that data in a thoughtful way.  By investing constantly in data reporting and analysis, high-performing companies develop crucial insight into themselves and their markets and then seek to constantly push out the frontier of that insight.  These companies are invested in knowing not only the “what” but the “why” behind it.

 

Giving Context to “What”

For entrepreneurs and business owners who do not possess an analytical background, many reports can seem daunting at first glance.  The data is evident, but it often takes additional time and thought to see all that is missing. Consider a simple quarterly income statement (see Exhibit A):

 

Exhibit A: Quarterly Income Statement

Amounts in ($000s)

The above income statement provides sufficient data to answer the question of what financial performance was for the first quarter and takes the next step by providing useful profitability measures.  But how should this performance be assessed?  Absolute measures of performance at most companies are meaningless.  Context is necessary to better understand whether performance was superior to, in line with, or below expectations.

Consider the same income statement, with added context (see Exhibit B):

 

Exhibit B: Quarterly Income Statement (with context)

The additional data included above (the Q1 budget) was limited, and likely already known to whoever would be viewing this report, but the value of the report has been substantially enhanced.  With the benefit of additional data, a deeper understanding of performance is now possible. 

It is now clear that the company under-performed on revenue expectations but outperformed on profitability (in both nominal and percentage terms).

 

The Power of “Why”

The strength of comparative analysis is that it provides useful insight for report audiences.  But comparative analysis alone is not sufficient.  High performing companies look to provide additional context that will further aide in understanding the drivers of performance. 

Consider the additional utility of a further revision to the quarterly income statement (see Exhibit C):

 

Exhibit C: Quarterly Income Statement (with additional context)

The above format now provides a level of context that allows for the development of a few key insights:

  1. Revenue. Adjusted for timing, revenue seems to be tracking to budget.
  2. Gross Margin. Improvement due to better pricing with a new supplier is higher than forecast. Why was this opportunity missed or under-represented in the budget? Has the market changed?
  3. Operating Expenses. Out-performance was temporary and directly tied to the delayed customer order.

The more robust report format has yielded superior insight of both the company’s own performance as well as offering tantalizing hints about the broader market.  Additional follow-up in these areas would likely yield further insight.

 

Conclusion

In an era of rapid innovation, industry shaking disruption, and voracious competition, no company can afford to disregard opportunities to create and enhance competitive advantage.  Unfortunately, mastery of data, through robust and thoughtful report design, is too often considered to be merely a use of time, rather than an investment in developing superior insight.  Those companies that invest in the necessary mindset shift and seek to understand the “why” behind every key “what” are on the path to becoming the industry leaders of tomorrow.

 

About the Author

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career, David has served as financial advisor and interim executive to dozens of middle market companies.  David is also a recognized thought leader on the topics of business transformation, change management, interim leadership, performance improvement, restructuring, turnaround and value creation.  He can be contacted at: david@abraxasgp.com.

Stakeholder Support

A business transformation presents an abundance of challenges for any leadership team, regardless of tolerance for conflict.  In the business press, financial issues often take center stage in reporting on a business transformation, and with good reason.  The task of systematically resetting the capital structure and profit potential of an enterprise is an enormous endeavor, and when that task is combined with intense time pressure, it is easy to see how financial concerns naturally take the forefront, particularly in the discussions of outside observers.  The challenge in focusing too narrowly on financial issues in a business transformation is that such a focus obscures a key driver of success: fostering stakeholder support by rebuilding relationships and crafting a narrative of future success that effectively sets the stage for productive collaboration moving forward. 

It is difficult for many leaders to intuit the crucial importance of stakeholder support, and as a result that importance is felt most keenly when it is absent.  By their nature, relations with stakeholders are often marked by long stretches of monotony interspersed with intense periods of rancor.  The time commitment necessary for productive relationship building with multiple stakeholders has none of the glamour of the 11th hour restructuring that saves a company, or the heroic return to profitability following years of losses that the most dramatic business transformations are known for.  And yet, as the work of professor Michael Jensen at Harvard Business School suggests, value maximization is inextricably tied to cultivation of stakeholder support.  Simply put, the headline grabbing value maximization results of a successful business transformation are impossible without stakeholder support. 

The stakeholders in every situation are varied, but the overriding theme in the early stages of a business transformation is their sense of anger and betrayal.  Capital providers feel misled by performance that has fallen short of forecasts and are impatient for a credible pathway to an acceptable level of profitability or a palatable option to cut their losses and exit the investment.  Employees are demoralized by poor performance and frustrated by management’s inability to solve the problems that are overwhelming the company.  Suppliers are furious at a lack of communication as they nervously assess their exposure while hoping for a return to better days.  Each stakeholder group has a good deal to gain from a successful business transformation, but the reality is that, for any transformation effort to truly be successful, each stakeholder group is going to need to grapple with a set of hard truths first.  

Earning stakeholder support in the context of a business transformation is very much a process of guiding stakeholders through the acknowledgement of hard truths and on to a workable framework for a forward-looking relationship with the company.  Over time I have come to see this process as one of the defining crucibles of transformational leadership.

Stakeholders

We can safely generalize stakeholder constituencies into the following groups: Capital Providers, Employees, and Suppliers.  Each of these broad constituencies has a unique set of concerns, risk tolerances, and levers at their disposal to help or harm a nascent business transformation.  It is the role of leadership in a business transformation to manage each constituency for the maximum benefit of the enterprise.

With each of these constituencies a few key principles apply:

Rebuilding Trust

Capital Providers: This group, which comprises lenders ranging from banks to private credit funds and shareholders ranging from family owners to private equity firms, is broad but has a common interest in earning an attractive risk-adjusted return on investment.  The challenge with this group is in respecting a party’s risk/return preferences and structuring a formal proposal that will result in a palatable long-run equilibrium.  Banks, almost always at the low end of the risk/return spectrum, will seek a path to reduce their exposure in a business transformation, while private equity firms, at the opposite end of the spectrum, will be more amenable to deploying additional capital at an attractive return.

The hard truth for this stakeholder constituency is the definitive end to prior forecasts and a resetting of the baseline, both short and long-term.  In the short-term, this resetting of the baseline will often involve a violation of lending covenants, a worrisome level of liquidity (cash plus untapped borrowing capacity), and a need on the part of capital providers for intensive monitoring (often weekly, but usually no less than monthly).  In the mid-term, a restructuring is often necessary, which raises the specter of considerable losses to all capital providers, but most often to equity investors and subordinated debt providers.  Given these dynamics, trust is low, all analysis is heavily scrutinized, and it is of the utmost importance that leadership at the company under-promise and over-deliver.

Capital Providers

Employees: As a group, employees are the stakeholder group most open to a plan that will return the company to success, but most resistant to the idea that they (individually) had a role in the company’s troubles.  Executive team members are often defensive and unrealistic in assessing their performance prior to the launch of a formal business transformation initiative and are noteworthy in their frequent attempts to envision a successful business transformation that somehow leaves their personal status quo unchanged.  The hurdle with this constituency is to address layoffs, reassignments and key promotions quickly, and instill a sense that, following a brief but intensive transition period, their efforts will again be the prime determinant of their future success at the company.   

The hard truth for this stakeholder constituency is that the status quo is at an end, permanently.  People will lose their jobs, and for those who remain there will be considerable changes: departments will be reshuffled, executive departures and new promotions will scramble old power dynamics, former sacred cow divisions or projects will be objectively reassessed.  The promise here is that the change is premised on making the company better, the challenge is in recognizing that such an outcome will be secondary to those facing an individual loss in power, status, or control. 

Suppliers: This broad stakeholder group encompasses landlords, key supply chain partners, and miscellaneous service providers large and small.  The key dynamic for this group is the overwhelming desire to maintain and grow their commercial relationship with the company, mediated in part by concern over their current level of financial exposure and a desire for clarity on the path forward. 

The hard truth for this stakeholder constituency is that every business transformation takes time, and so the fix is unlikely to be immediate.  Past due balances are more likely to be worked down over time rather than paid off immediately.  In some cases, this disappointing news must be delivered simultaneously with a request for additional concessions.  The key here is to focus on the plan that is being executed, and appeal to greed (growing with the company post-transformation), over the fear of current levels of financial exposure.

Employees and Suppliers

Time and Attention

The investment in leadership time and attention necessary to rebuild stakeholder support is considerable.  In the short-term, even formerly low-value stakeholder communications should be handled by executive leadership.  Routine interactions such as vendor calls, quarterly financial reviews with capital providers, and employee townhalls should be recast as opportunities to reinforce the message that a business transformation is in progress, get real-time feedback on how the process appears to those outside the c-suite, and provide a forum to address questions and concerns promptly. 

Leaders executing a business transformation must recognize that they swim in a sea of skepticism, and that the way to change that condition is to address the skepticism patiently, clearly, and often.  Results ultimately carry the day in any business transformation initiative, but in the early stages the process can also be envisioned as a series of interlocking public relations campaigns to different stakeholders.

Capital provider communications can most effectively be recast through upgraded report quality and an accelerated reporting cadence.  If updates had been quarterly under normal circumstances, consider a weekly or semi-monthly update call along with appropriate financial reporting.  Look to provide additional metrics, featuring an appropriate mix of leading and lagging indicators, and tell a consistent story.  Once the transformation has gained traction, invite capital providers to an on-site presentation of the long-term strategy.  The goal here is to provide visibility into near-term performance, provide advance warning of any issues, showcase improved performance, and build excitement for the future. 

Employee communications offer the prospect of the rich bounty of energy and goodwill that comes from an energized, enthusiastic workforce.  Unfortunately, the risk of declining morale and skepticism is ever-present.  Communication to this group must represent a mix of styles: townhalls, small group gatherings, email, etc.  Few people are equally disposed to all methods of communication, and leaders in a business transformation should keep that in mind when crafting an approach aimed at winning, and keeping, the hearts and minds of this group.

Vendor communications are a risk area for all but the most iron-willed leaders in a business transformation.  Accusations and threats are to be expected in the early days, as months or years of pent-up frustration are released, ironically on the very leaders with the discipline to hear out angry vendors.  The key with this group is consistency and access; setting a rhythm of weekly updates with critical vendors and providing them with an executive level point of contact goes a long way toward reestablishing a positive working relationship.   

The investment in time and attention necessary to rebuild stakeholder support is considerable.  In the short-term, even formerly routine stakeholder communications should be handled by executive leadership.  While this approach might initially seem to represent a questionable allocation of precious time, when considering the crucial importance of stakeholder support, the cost is low. 

Conclusion

Business transformations strain the political skills of even the most persuasive leaders.  The dynamic challenge of setting expectations, addressing past missteps and rebuilding trust, all while driving cultural, financial, operational, and strategic change, is daunting.  But with stakeholder support even the most challenging business transformation becomes less so, and without it even seemingly minor situations can falter.

About the Author:

David Johnson is founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. 

David can be contacted at: david@abraxasgp.com.

The Evanescence of Strategy

Every strategy has a sell-by date, and the costs of ignoring that reality are steep.  Recently General Electric took the radical step of terminating CEO and Chairman John Flannery after 13 months on the job (prior to this action GE had had a total of 11 CEOs and 10 Chairmen in its 126-year history) and replacing him with the company’s first outside CEO, Lawrence Culp.  The break with history was certainly necessary, as General Electric had seen its market capitalization decline by $100 billion in the past year, and $500 billion in the past 18 years.

GE Stock Performance
Value Destruction at GE

GE rose to prominence by constructing a set of self-reinforcing advantages that were largely industry agnostic. Under the leadership of Jack Welch the potential cacophony of multiple lines of business became a sublime orchestra, with GE Capital as the engine that powered the whole.  But the global financial crisis changed the outlook for massive financial businesses, and Welch’s successor, Jeff Immelt, spent much of his tenure untangling the byzantine, and formerly massively profitable, conglomerate.

What happened?

Strategy, a high-level plan to achieve one or more goals under conditions of uncertainty, is the answer to a question.  That question: what set of actions, utilizing what resources, will produce the best outcome.  A company’s strategy is its theory of self, its reason for being.  Unfortunately, few organizations, or the people leading them, can adjust to the cognitive dissonance of an ever-changing answer and all that that implies.

Since at least the Jack Welch era General Electric’s strategy was to compete only in sectors in which it could be a dominant player and rely on what was seen as an advantage in leadership training and internal capital allocation to drive efficiencies that would beat the market.  The strategy worked both long and well (the company first had to attain a market capitalization above $500 billion in order to lose that value), but over time challenges that were long apparent took on increasing importance.

  • Pace of Change.  As the pace of change across industries has ramped up, being a major player in disparate industries became a tax on leadership attention, making it impossible to focus or marshal the resources necessary to make sound strategic adjustments.
  • Leadership Training.  It may have been the case once upon a time that GE had an inherent advantage in leadership training, but with the workforce investing heavily in education and training, this one-time advantage has been negated.
  • Capital Allocation.  Jack Welch took the helm at General Electric after a period of flat equity returns, when many U.S. companies were bloated and inefficient.  In 1981, perhaps a case could have been made that GE could more efficiently allocate capital within the company than the capital markets were able to.  Increased competition, new classes of investor (private equity, activist, etc.), and heightened shareholder expectations have changed that state of affairs.

There is a strong case to be made that complexity killed GE, but the wonder is the extreme longevity that an outmoded strategy enjoyed.  Much like the wooly mammoths (or, for a separate example, the dodo) that lived as recently as four thousand years ago on a small island off the cost of Siberia, General Electric had been a living anachronism for years.  With new leadership, GE is making a break from its past and speeding the dissolution of its current, anachronistic form.

About the Author:

David Johnson is founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. 

David can be contacted at: david@abraxasgp.com.

Distressed Retailers Groping for Viability

The challenges that retailers have faced in the past few years have been nearly biblical in size and scope.

• The unstoppable rise of ecommerce, driven by voracious competitor Amazon, has siphoned revenue growth from competitors great and small, and forced every retailer to reassess their vulnerabilities and contingency plans.
• Shifts in consumer tastes have left retailers struggling to reposition store footprints that are increasingly at odds with where and how their customers prefer to shop.
• Business model innovations, particularly among apparel retailers have forced legacy retailers to rethink historic approaches to sourcing that maximized volume procurement over speed and flexibility.
• And for private equity backed retailers, debt burdened capital structures have increasingly come to seem less like savvy aspects of financial engineering than millstones around the necks of companies robbed of the ability to pivot.

Perhaps most challenging: during this industry’s (most recent) hundred-year flood, the ominous specter of an emerging consensus has hung like a pall over executives, investors, vendors, and advisors: bankruptcy had become a death sentence for retail, a roach motel with straightforward entrance but no viable way out (at least as a going concern).

Recently, the clouds have lifted somewhat. Retailers Toys “R” Us, Payless, and Gymboree are each on a path to successfully emerge from a chapter 11 bankruptcy filing with a substantial percentage of their pre-bankruptcy store count intact.

Enlightened self-interest has driven retail stakeholders to reassess their approaches to the challenges inherent in supporting a distressed retailer and better align their tactics with the twin goals of minimizing losses and repositioning struggling retailers for long-term success. As a result, following years of disappointing retail restructurings, stakeholders are more actively supporting a purposeful restructuring process as the best option for a distressed retailer, holding the prospect of considerably higher recoveries than a fire-sale liquidation.

The structural challenges facing retail are likely to persist, but with renewed signs of aligned interests among stakeholders, it now appears likely that struggling retailers can navigate a restructuring without the process devolving into a value-destroying liquidation.

About the Author

David Johnson, founder and managing partner of Abraxas Group, has a 20-year track record of driving organizational change. David has served as interim executive or financial advisor to dozens of middle market companies in turnaround and restructuring situations.

Burger King Revival

burger-king

For years, Burger King was the sick man of the quick service restaurant industry.  A perennial laggard to McDonald’s in scale, the company was also widely seen as hamstrung by poor execution, a revolving door of leadership (Joe Nocera noted in 2012 that the company had had 13 chief executives in the prior 25 years) and an unclear strategic vision.

The company’s purchase for $1.5 billion by a private equity consortium of Bain Capital, Goldman Sachs and TPG in 2002 marked a brief resurgence, but when private equity firm 3G, acquired the company in 2010 (for $3.3 billion), Burger King was still seen as a troubled operator.

What a difference focused ownership can make.  Burger is now setting a grueling pace that its fellow quick service restaurant competitors are being pressured by Wall Street to match. 

3G’s playbook has been heavy on the fundamentals, and laser focused on solid execution. 

  • By refranchising restaurants, Burger King is challenging industry orthodoxy that a franchisor should operate a large number of its own restaurants.  Also, divesting those company owned restaurants has allowed Burger King to offload the capex requirements for those locations onto franchisees, boosting free cash flow.
  • Increased focus has been placed on international expansion, an area where Burger King had long been seen to be badly trailing McDonald’s and others. 
  • General and Administrative costs have been rationalized, creating further operating leverage to the business model. 
  • Increased focus has been placed on advertising and marketing. 

This approach is simple, but not easy.  The focus and clarity of vision that 3G seems to have infused into Burger King is generating excitement on Wall Street, while driving competitors (in particular McDonald’s, Wendy’s and Yum! Brands) to adopt similar approaches.

The example of Burger King highlights the value potential of an outside perspective paired with a simple yet audacious strategic plan.  In a market awash in capital, private equity firms will increasingly seek to execute value creation strategies premised not on simple financial engineering but on re-envisioning their portfolio companies, as 3G has done with Burger King.

About the Author

David Johnson is the founder of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to companies in transition.  David has served as advisor or interim manager on over $5 Billion of distressed transactions, and is a recognized expert on the topics of value creation, change management, performance improvement, turnaround, and restructuring.  He can be contacted at david@abraxasgp.com or 312-505-7238.

Interim Managers: Value Creation Catalysts

There is a tendency among the leadership ranks of most organizations to espouse the virtues of disruption, but only when that disruption is focused on somebody else.  When incumbent leadership is unable or unwilling to drive necessary change, creditors and other stakeholders are showing an increasing willingness to press for interim managers to supplement the senior management team and drive the change necessary to save what is often a faltering organization.

Recent news regarding two troubled organizations highlights the value interim managers can bring, especially in periods of distress:

Holly Etlin - AlixPartners

Holly Etlin, Interim CFO of RadioShack

  • RadioShack.  The struggling electronics retailer announced recently that CFO John Feray would resign, after only seven months on the job.  Mr. Ferary will be replaced by Holly Etlin of Alixpartners, would will assume the CFO role on an interim basis.  According to Michael Pachter of Wedbush Securities, Ms. Etlin’s appointment is a negative to shareholders, as she will “represent the creditors”.  Mr. Pachter’s comment is actually a strong endorsement: given the fiduciary duty of officers of a company operating in the zone of insolvency, Holly Etlin should be working for the benefit of creditors, not the shareholders who are almost certainly out of the money.

Kevyn Orr - Detroit Emergency Manager

Kevyn Orr, Emergency Manager of Detroit

  • Detroit.  In his nearly 18 months as emergency manager of Detroit, Kevyn Orr has presided over the largest municipal bankruptcy in U.S. history ($18 billion) and pushed that contentious process toward what looks to be a remarkably successful resolution.  The Michigan law which allows for emergency managers dictates a term of 18 months, but in light of his successes many in Detroit are arguing for Orr’s continued involvement, if only to provide continuity throughout the bankruptcy and immediate post-bankruptcy period.

Experienced interim managers, such as Ms. Etlin and Mr. Orr, are professional change agents, responsible for both catalyzing and driving the change necessary for organizations to raise their level of performance.  In periods of turmoil, these change agents can be the difference between success or failure for struggling organizations.

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.  He can be reached at 312-505-7238 or at david@acm-partners.com.