Analytics in the Middle Market

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“The future is already here, it is just not evenly distributed.”

William Gibson

Overview

The question of analytics, or more specifically how to deploy the tools and capabilities now broadly available for analyzing large data sets, distill actionable insights from that analysis, validate insights and implement the changes necessary to realize the potential that the analysis has uncovered, is a pressing one for the middle market. This question is pressing because the middle market is awash in data. However, the middle market lags far behind other segments of the economy in taking concerted action to seize the opportunity that analytics presents.

In 2021, analytics represents something truly rare: a broadly available but individually distinctive opportunity to improve the operations and enhance the strategic positioning of nearly every company in the middle market.

Multiple Points of Equilibrium

Experienced business transformation professionals know that organizations exist in a world of multiple points of equilibrium. A successful business transformation can be fairly described as the process of migrating an organization from one point of equilibrium to another, with the condition that the new point of equilibrium will possess superior return characteristics. Essentially, a successful business transformation results in an upward shift of the efficient frontier for a company. In 2021, analytics represents something truly rare: a broadly available but individually distinctive opportunity to improve the operations and enhance the strategic positioning of nearly every company in the middle market.

A successful business transformation requires identifying, refining, and applying levers to a business model in order to generate an outsized degree of positive change relative to the resources employed. Every business era has a go-to set of tools and capabilities to which the gaze of leaders inevitably drifts as they search for such a lever. In 2021, analytics is near the top of the list. Consequently, the development of an in-house analytics capability should be a focus for every middle market leadership team focused on value creation.

Implementation is the Goal

A depressingly easy way to stump a data scientist candidate is to ask them to map out a path from identifying a prospective avenue of inquiry through to the realization of measurable business improvement.

Generally, there is a grudging acceptance that time will be spent on data wrangling, or the process of cleaning and reformatting data for ease of analysis. There is a marked level of excitement in the discussion of the tools and techniques that can then be applied to the cleaned and reformatted data. Enthusiasm then dips when discussing the presentation of insights to those outside the data science sphere, although there may be a slight uptick when discussing data visualization.

Any discussion of the fate of analytics insights beyond the presentation stage represents something of a chasm among analytics professionals. On one side are the majority who are uninterested and unenthusiastic (they did their part), and on the other are the small minority who understand that insight without implementation has little value. This latter group works to become not just excellent technicians but able communicators and translators, helping to bridge gaps in understanding and foster the development of implementation paths for insights generated by the analytics team.

Analytics as a Lever

Marshalling the full potential of analytics in driving a successful business transformation requires a clear understanding of not only the potential but also the limits of these tools and capabilities and the organizational bottlenecks that inevitably manifest as middle market companies seek to fully exploit them. This challenge is further compounded in the middle market by resource constraints, a deficit of analytics savvy among management and leadership, and the communication challenges that are sadly persistent between analytics teams and all other members of a company.

The discrete steps that allow companies to best mitigate these challenges can be broken down into two groups: 1) Define the Problem, and 2) Path to Realization.

The challenge is that, while analysis scales, implementation does not. And results, not multivariate regressions, are the goal.

Define the Problem

Many impressive quotes have been attributed to Albert Einstein, but my favorite, perhaps, is this one: “If I had an hour to solve a problem I’d spend 55 minutes thinking about the problem and 5 minutes thinking about solutions.”

Modern analytics tools and techniques are incredibly powerful, and when deployed against the right data sets, with a clear understanding of the goal, they can and will produce impressive results in terms of insights. However, ensuring that an analytics capability results in not only insights but measurable business improvement requires the discipline to more rigorously define the problem, not only in its technical elements but the business problem as well, and to act only then, having taken the necessary steps to maximize the expected outcome of your efforts.

Data Mastery

The necessary condition for the development of an effective in-house analytics capability is a mastery of an organization’s own data. The phrase “garbage in, garbage out” has never been more apt than it is in our analytics age. The simplicity of this point belies just how profound it is. Nimble startups designed with a high level of data savvy and enormous multinational companies able to devote immense sums to digital transformation initiatives may have clear paths to data mastery, but for middle market companies, the path is anything but clear.

Target Selection

The tools now available and in wide use by data analytics staff and consultants create an illusory sense of boundless possibility when choosing targets. The challenge is that, while analysis scales, implementation does not. And results, not multivariate regressions, are the goal. The scalability of analytics tools has a tendency to blind even senior level data science practitioners to the many difficulties of implementation. The application of brute force algorithms to large data sets as a path to insights will inevitably yield results that are underwhelming. Choosing avenues of inquiry with care is essential, especially when seeking quick wins to build internal support for an in-house analytics team. Effective target selection requires that the analytics team not be siloed but be integrated into business operations. This can be as simple as including data analysts in key meetings and involving the analytics team in reviews of business unit performance. In the end, an analytics capability is meant to confer a business advantage for a company, and this will only happen if the analytics team is not walled off from the rest of the business.

 

Define the Question

After defining the data source(s) and target for an analysis, it is vital to define the question. This step is crucial in that it requires a nuanced understanding of the business. By investing the time necessary in defining the question, an analytics effort increases the likelihood that any insights generated will have a clear path to implementation.

Analysis is cheap, and implementation is a bottleneck. It is far easier, and cheaper, to test and refine the algorithms rigorously than it is to prematurely move ahead with the implementation of real-world changes in the business necessary to realize projected efficiencies.

Scrutinize

For middle market companies seeking to build an analytics capability, it can be easy to be lulled into complacency once there is a clear path to the generation of insights. This is a trap. Insights are not the proper endpoint of an effective analytics capability. Rather, insights are a stop along the way. A properly integrated analytics team will not only generate, but rigorously test and screen insights, with only the most promising being passed along for further investigation. Analysis is cheap, and implementation is a bottleneck. It is far easier, and cheaper, to test and refine the algorithms rigorously than it is to prematurely move ahead with the implementation of real-world changes in the business necessary to realize projected efficiencies.

 

Integrate

Insights that have been thoroughly vetted should be presented to leadership for review, with cross-functional implementation teams then formed to validate their real-world potential. Each insight becomes a project, with its own staffing requirements, timeline, and ROI characteristics. Resource constraints will necessitate that only the most promising insights will be acted on initially. This will ensure that only the most only high-return prospects are acted upon. Additionally, through detailed review of a targeted set of insights, company leadership will give itself much needed time to begin to integrate consideration of insights from the analytics team into the existing rhythms of company decision making, or change those rhythms, as appropriate.

 

Implement

Effective implementation will require a high level of communication between the analytics, business unit, and functional leaders in a company. This level of integration will initially feel awkward and forced for all parties, but over time it will become apparent that the returns to the company of the analytics staff having a direct line of communication with key decision makers will foster a higher level of business understanding in the initial stages of analysis, and a higher level of analytics understanding in insight review, yielding a virtuous cycle of improvement in the company’s ability to successfully transmute insights into enhanced business performance.

Conclusion

The middle market is traditionally a segment that is at best a fast follower of technology trends, and at worst a reluctant adopter of them. 2021 represents a crucible year, with broad opportunities and challenges for many middle market companies. There are few broadly applicable, high-return investment opportunities available for middle market companies, but investment in an analytics capability is one of them. Properly executed, such an investment can reset a company’s equilibrium point, permanently raising its level of profitability, with all the attendant value creation that such a shift implies. Like all business transformation opportunities, realizing this potential will not be easy, but the middle market companies that successfully pursue this path will find themselves richly rewarded.

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.

Maximizing Profit in the Middle Market

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Overview

The literal definition of margin in business is that it is an accounting metric that measures financial health. The profit margin is a ratio of profits earned to total sales over a defined period.  An internal operator of a business uses this statistic to determine financial and operational efficiency. She analyzes margin on a gross or a net basis, determining at different operating levels whether her employer is delivering goods or services economically. An outsider analyzes profit and loss statement similarly but also incorporates a broader industry analysis. This perspective can be helpful to management with determining what levers can be pulled to influence margins and what can be attributed to external market forces. When a middle market company falls under increasing scrutiny as a result of of declining or negative profits, leadership should consider bringing on an interim partner to review the business and to implement a business transformation.

Every industry will have specific dynamics impacting profitability, but in the end fixed and variable costs affect profitability whether the company in question is an airline or a metals fabricator. Understanding how each the key drivers of a business impact profitability is a crucial insight that must be present for any successful business transformation effort.

For middle market companies struggling with profitability challenges, the right interim leader, focused on driving a business transformation, is a key partner in this situation. Such a partner can serve as the catalyst a leadership team needs to foster understanding of the internal and external pressures that can lead to margin erosion while simultaneously leading the charge to develop a plan of attack to address them.

Change is Possible

Too often middle market companies view themselves as being subject to the whims of broader market forces, but even the smallest companies can develop and execute strategies to hit back at the persistent drivers of underperformance.

Helmuth von Moltke (the Elder) famously quipped: “No plan survives contact with the enemy.” This is certainly the case when seeking to execute a business transformation. Middle market change practitioners understand that versatility and the humility to seek out solutions that work, irrespective of authorship, are exactly the traits necessary to drive home a successful transformation initiative.

Identifying the drivers of weak or declining (or both) profitability requires a rigorous assessment of the present situation as well as the recent past. This process is focused on answering the questions 1) What is the situation now? 2) What is the near-term forecast? 3) What constraints is the company facing (financial, operational, supply chain, employee morale, etc.)? 4) What are the most promising avenues of change for the company? and 5) What is that impact of those change levers if the plan works?

Based on the understanding gained from a rigorous but expedited objective assessment, the focus will turn to implementation.

Value Creation Partnership

A faltering company presents a timing challenge, particularly in the middle market. The analogy of a melting ice cube is used frequently, and for good reason. Preventing value destruction relies not only on skill but also speed and focus. Turnaround specialists can implement a plan that focuses on driving profitability during good times and stopping cash bleed to stave insolvency during bad times. Affixing this financial management plan to a company dashboard can be part of a departing interim executive’s legacy.

Middle Market companies in distress are companies in dire need of partnership. Building the right advisory team, headed by a seasoned interim executive, gives shape and structure to a nascent business transformation.

Conclusion

Most companies will experience profit challenges at some point in their lifecycle. Persistent unprofitability, however, is a symptom of a larger problem, and often requires the expert help of an expert well versed in business transformation. The right partner will not only work in tandem with incumbent leadership to identify the root cause of a company’s profit challenges, but design and implement a comprehensive business transformation which will allow the company to address those persistent drags on performance and thereby enhance the level of profitability the company is capable of generating. For middle market companies struggling with profitability challenges, the right partner serves the role of teacher, mentor, and colleague, all in the service of creating value.

About the Author

Brett Ladendorf is a Managing Director at Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  He can be contacted at: brett@abraxasgp.com.

Agile Business TransformationAbraxas Group

Agile Business Transformation

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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.

Middle Market Transformation

Middle Market Transformation

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“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 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.

 

Challenges Facing Midsize Manufacturing CompaniesAbraxas Group

Challenges Facing Midsize Manufacturing Companies

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This article originally appeared in Business Insider

As we review the landscape for small and midsize manufacturing companies, we see considerable challenges.  A review of some items in the February 2013 ISM Report on Business® is instructive (see report here).

Gross Margins

Gross Margins have been an issue that we have focused on extensively at ACM Partners.  The operating expenses of a company are certainly important, but in our experience understanding where gross margins might be headed and why is often a useful exercise in predicting pockets of distress in the broader economy.

The gross margin picture suggests that challenges lay ahead.  In February the index of prices paid by manufacturers increased by 5 percentage points.  As companies lose the ability to protect gross margins, management teams often panic and seek to address the problem by increasing sales.  The pursuit of higher sales at declining margins and with less discipline over the costs of servicing new clients is a long-established recipe for taking a company from mild under-performance to deep distress.

Inventories: Up at Producers, Down Among Customers

Among small and midsize industrial companies we anticipate demand shocks as customers, now comfortable with a historically low level of inventory, respond more quickly to changes in end-market demand.  The disconnect between customer inventories having been below 50 (the point at which they are considered too low) for nearly 4 years and producer inventories increasing suggests that producers are increasingly ill-equipped to address fluctuations in demand, and may be making the implicit choice to tie up cash in increased working capital rather than in capital expenditures.

These diverging trends in inventories present two serious challenges to small and midsize manufacturers:

1.      From a pricing standpoint the existence of slow-moving inventory will provide for some companies a temptation to sell at reduced prices, further eating into gross margins.

2.      From a financing standpoint this approach is a recipe for trouble, as asset based lenders will advance considerably less on inventory than on accounts receivable.  Additionally, for troubled small and midsize industrial companies there are fewer options to get any availability on inventory, further heightening the risk of this approach.  

Changing Power Dynamics

Power flows up and down the supply chain, depending on industry, quality of management, availability of financing and a multiplicity of other factors.  At the moment large national and multi-national customers control the fates of their suppliers, both the small and midsize manufacturers making the products, and the similarly sized distribution companies that store those products and handle order fulfillment.  As these dominant customers seek to maximize profitability and optimize their working capital, they are causing ripple effects throughout their supply chains.  The dominant strategy for the small and midsize industrial companies seeking to adjust is to become indispensable by occupying high value niches or gaining scale.  

Conclusion

Companies will continue to make and ship things, and so manufacturers and distributors will continue to have a role in the economy. But there is not guarantee that their role will be a profitable one.

 

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.

The Base of the PyramidAbraxas Group

The Base of the Pyramid

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This article originally appeared in Business Insider and TMA Midwest Blog

There is a palpable sense of impatience in the business press when discussing our tepid recovery.  People are anxious to start up the music and resume the party and are seemingly resentful of those who point out that however much we might wish to be done with the Great Recession it is not done with us.

One area that has been receiving too little attention is the wide divergence in outlook between large (national and multi-national) companies and those in the middle market (here defined as companies with less than 500 employees; the two sides of that divide having an approximately equal number of U.S. employees as of 2008).  Companies in the S&P 500 are enjoying historically high levels of profitability (often driven by robust sales to emerging market countries) and sitting on a veritable mountain of cash.  Meanwhile, middle market companies are hard pressed to find growth domestically and many lack the financial and managerial strength necessary to exploit growth opportunities in emerging markets.

The divergence between the upper and middle markets is not limited to growth prospects:

  • Operations: Larger companies have aggressively taken advantage of globalization to remake their organizations in the past 15 years.  They have seized on labor force arbitrage opportunities, remade their supply chains and outsourced non-core business functions.  Companies in the middle market are woefully behind the curve, and as a result have both higher costs and lower operational flexibility.  Taking full advantage of globalization to remake operations is not solely a matter of finding the lowest cost.  Issues such as order lead times, strength of native labor pool, legal environment, etc must be taken into account as well.
  • Commodities: While commodity prices received considerable attention in 2011 the reality is that broad macro factor point to upward-trending prices and considerable volatility as the new normal.  For middle market companies this will necessitate considerable effort to preserve gross margins, in particular the adoption of hedging strategies and a revamped approach to purchasing.
  • Systems: All the buzz around Big Data tends to obscure the fact that many companies have yet to implement ‘small data” initiatives such as KPI dashboards and other simple yet highly effective business intelligence tools.  I have been on numerous client engagements at companies with sales up to $1 billion that have lacked the ability to identify their most profitable product or sales channel.

The opportunities inherent in the U.S. middle market are enormous, but many of the bullish pronouncements in the general business press ignore the challenges these companies face.  Many are considerably behind their larger competitors in enjoying the fruits of globalization.  The path to profitability and growth for this sector of the economy will be a focus on basics.  Rationalizing SKUs, firing bas customers, identifying and increasing investment in high-return sales channels and shutting under-performing locations/divisions are the kind of unsexy blocking and tackling operations that will drive middle market profitability through the current decade.

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.