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Operations, Operations, Operations

The conventional wisdom of real estate moguls is location, location, location, referring to the geographic desirability of property. This singular focus has built a number of empires throughout human history, both business and political. Traditionally, economists have defined comparative advantage as those strategic aspects of international trade often associated with geography. Comparative advantage is difficult to overcome and is a significant barrier to entry enabling those with it to defend a competitive position.

Today, we see established comparative advantage changing. Whether the Internet or low cost air travel, geographic advantage has been diminished. Moreover, traditional workplace structure has been reestablished vis-à-vis high speed wireless communications and high performance compute power in either a laptop or handheld device. Finally, while firms seek low cost labor, they no longer settle for low quality labor.

In the late 1990s one of two phenomena took place, depending on the industry sector. The so-called New Economy was obsessed with growth at any cost and was singularly disinterested in profit or operational aspects. Executives in this sector even went so far as to expound the belief that profit did not matter and were seemingly supported with stock price multiples vastly exceeded those of established firms in some cases.

Those stuck in the Old or Smokestack Economy struggled with downsizing, low margins, and continual reorganization. This apparent divergence took on a perception of reality. Celebrity CEOs jetted around pontificating that asset light or asset free business models were the future—all the while latent operational variables began to dissolve the myth. The Ponzi scheme began to unravel, and as we now know much was a scam.

Meanwhile, the Old Economy lumbered along mired in its own muck. Outsourcing more functions, losing its way forward a succession of management teams struggled and lost to the same demons. Quarter by quarter firms spiraled downward in self-fulfilling expressions of their managerial wasteland.

Then a funny thing happened on the way to oblivion. Some in the New Economy discovered the age-old laws of economics still applied and when firms were well run with solid business models, profit was indeed possible and even attained. Some in the Old Economy rediscovered the managerial greatness left to them by previous generations.

A Dose of Reality

The laws of economics, like the laws of physics tend to have certain finality to them. Both have stood the test of time and like gravity, economic theory dictates a pull towards the reality of fiscal terra firma. The old axiom, what goes up must come down is true whether the gravitational forces are pulling a ball thrown in the air or an interstellar space probe—the universal gravitational force either draws the ball to earth or propels a spacecraft around planetary bodies to accelerate them out of the solar system.

So it is with economics laws. Firms that do not sustain a net cash inflow will not survive—eventually banks and investors will cut their losses and focus on other opportunities. This business model is not simple accounting positive cash flow; it is the more difficult task of earning the cost of capital. Cost of capital is the weighted average of debt load and equity. As one might expect superior firms with strong debt rating and excellent managerial track-record enjoy a lower cost of capital. This is a comparative advantage that is major barrier to others.

Just how does a firm achieve a lower cost of capital then its competitors? Treasury functions and strong governance are key performance indicators of corporations in the class; however, enlightened management is returning to their operational roots.

Case studies of firms that have achieve operational excellence cross all industry sectors, old or new of all sizes and market segments. With so much public information available on firms such as Wal-Mart, ExxonMobil, Toyota, and Microsoft, etc. one wonders why others have found it so difficult to achieve this performance level.

Much has been written on about the success in this area, but perhaps one should spend some time assessing why others continue to plow fallow economic ground. For example;

  • Resistance to Change—often focused on the workforce; however, top management with the large near-term incentive packages are often the least flexible. For example, with a reward system focused on the next quarter, long-term thinking is often the hardest thing.

    Managerial compensation should encourage change, not implicitly hamper it.

  • Lack of Innovation—as a general rule, firms do not truly encourage thinking outside of the box. True revolutionary thinking is rare and often vilified. Cultural forces often implicitly drive out creative thinking.

    Foster your mavericks.

  • Poor Decision-Making Process—how many meetings result in the scheduling of another meeting, and how many conference calls consist largely of individual with the phone on mute while they attend to email and other concerns? Decisions are not taken in a timely manner and as might be expected there are few if any consequences for lousy results.

    Ban laptops from meetings and turn off cell phones.

  • Lack of Focus—running from meeting to meeting, dabbling in every politically attractive activity and excessive CYA, often rewarded with promotion thus institutionalizing the behavior.

    A meeting must end with an action plan and accountability.

Other examples abound, but an organization consumed by the above four issues will most likely not return its cost of capital, thus consuming itself over time. The attention to the daily detail of business is key to successful execution of the business plan!

Operational Excellence

Business slight-of-hand is out today, replaced by a renewed focus on continuous improvement towards superior operational performance. Sometimes not the glamour of merger and acquisition or invading new markets, operational excellence is the stuff great firms are made of. Attaining superior performance achieving a low cost of capital, and associated advantage is not easy and is not rewarded next quarter. However, the great, sustainable organization is built one day at a time at the operations level.

Scott Shemwell's picture

Thank Scott for the Post!

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