Organizational change management

  

After reading Chapter 12, create 5 discussion questions based on your reading
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TRACK 12: DELIVERING RESULTS
Delivering high performance today and tomorrow
‘Intellectual capital is the sum of everything everybody in a company knows that gives it a competitive
edge’
Thomas Stewart
images
The twenty-first century business is largely intangible.
Measuring and managing the performance of an intangible business is different. Quarterly results are
easily manipulated and even financial accounts do not reflect the real value of the business. This makes
strategy and decision-making, management and evaluation more difficult.
To understand the ‘invisible business’ we need to return to ‘value’.
The business seeks to create economic value – to generate a return on investment, beyond the cost of
that investment. It grows and sustains this value by working with a range of stakeholders –
shareholders, customers, employees and others – and, when successful, shares value with them.
The value of a business, or ‘enterprise’ to be accurate, reflects its potential to generate cash in the
future. This potential is influenced by how it is likely to grow, how quickly, and the likelihood of this
happening. A fast-growing, reliable business will be very valuable.
The ‘enterprise value’ of a business is the business’s own calculation of the net present value of the sum
of its future cash flows, adjusted for the risks involved in delivering them. The ‘market value’ is the stock
market’s own version of this, based on its perception of the company. A company that manages its
investor relations well will find agreement between the values. An ‘undervalued’ business needs to
convince investors, an ‘overvalued’ business should caution investors so as not to disappoint them with
the actual future performance.
12.1 BUILDING THE INVISIBLE BUSINESS
The value of today’s business is in the intangibles
In the past, companies were largely tangible – they were manufacturing businesses which owned
factories and equipment, making and selling definitive products. The future potential was simple to
estimate, based on how many products could be sold, and the value of the plant.
Today’s business is based on its brains rather than its brawn.
The most valuable assets in a business are no longer the hard things but the softer attributes, the more
subtle or intellectual aspects of business that are hard to copy – ideas, knowledge, brands, relationships,
design, patents. Non-core activities such as manufacturing, systems and logistics can be done in
partnership with others and are therefore less valuable.
In his book, Intellectual Capital, Thomas Stewart defines three main categories of intellectual capital, the
building blocks that collectively represent the intangible assets:
Human capital – the talent that lies in your employees – the knowledge, skills, experience and ideas
inside people’s heads.
Customer capital – the relationships you have with customers – and the positive reputation and
advocacy they have for you.
Structural capital – the retained knowledge in the organization, in its databases and manuals –
technical data, process maps, product patents and publications.
To understand the value of these assets, we need to quantify what likely ‘uplift’ will be gained in future
performance due to the ownership and application of each. For example, what are the additional
revenue, margin and reduced costs due to having long-term relationships with key customers rather
than having to continually attract new customers?
In accounting terms, the international standard ‘IFRS 3’ defines an asset as a controlled ‘resource’
expected to provide future economic benefits.
It goes on to define an ‘intangible’ asset as such a resource which is non-monetary, non-physical and
identifiable (meaning that they can be separated; for example, sold off, transferred or licensed). Of
course, this definition excludes a wide range of other attributes – such as people and their talents –
which are often included in a more general definition.
The International Financial Reporting Standards define five categories of intangible asset:
Marketing-related (including trademarks, domain names, uniformed dress, etc.).
Customer-related (including customer lists, orders, contracts, relationships, etc.).
Contract-based (including contracts for services, leases, rights and licensing, etc.).
Technology-based (including patented technology, software, databases, etc.).
Artistic-related (including books, magazines, music, lyrics, photos, video, etc.).
‘Intangible assets’ now account for around $22.2 trillion, 61% of the overall value of the world’s quoted
companies, according to the Global Intangibles Tracker published annually by Brand Finance.
And the intangible proportion of a business’ value is increasing. In the last five years, these companies –
which represent a total of $36.2 trillion in terms of enterprise value – have grown by $9.4 trillion, with
64% of that growth due to intangibles. In some sectors, such as media (91%) and pharmaceuticals (89%),
it is virtually all intangible. Similarly, in certain geographies – such as Switzerland and India – business is
almost completely composed of this ‘soft stuff’.
As an example, consider the acquisition of Gillette by Proctor & Gamble in October 2005. P&G
completed the largest ever acquisition in the consumer goods sector by paying $53.4 billion for Gillette,
which generated profits of $2.5 billion. The preliminary post-purchase allocation is shown below:
Source: McKinsey Quarterly, 2007 (based on the 10 year performance across industry sectors)
Source: Brand Finance
Gillette $ billion
Purchase price 53.4
Tangible fixed assets
4.5
Intangible assets
29.7
Brands 25.6
Patents and technology 2.7
Customer relationships 1.4
Working capital 0.6
Long-term liabilities
(16.2)
Residual goodwill
34.9
An invisible business, one where the majority of the assets is intangible, requires a different form of
management from traditional, physical organizations. Investment should be focused on these intangible
assets rather than traditional buildings or stock, even if they are harder to see and measure. This
increases the need to measure them.
Each organization must find its own ways to unlock and apply these assets, relevant to their goals, and
distinctive from others. Owning the assets is no guarantee of their effective use.
Intangible assets need to be addressed together. Their value can rarely be locked in isolation. Branding
is an example of the collective application of assets. They are cross-functional tools, requiring
collaboration and collective responsibility – from product innovations or customer relationships.
Human capital has established the most sophisticated measurement and reporting techniques,
championed by the HR department. Other assets need more dedicated management. Customer capital
can be the most significant asset, but is also the most fragile. Reputations and relationships can take
years to build, but can quickly become unravelled.
More generally, value-based management will apply these ideas to every aspect of running the business
– for example, ensuring that strategy is focused on the long-term value creating activities, and that
people are measured and rewarded on their long-term performance. An executive bonus scheme, for
example, that ties business leaders into the 3- or 5-year value growth of the business, overcomes the
urge to take short-cuts and forget the future, whilst also retaining your best people.
Insight 34: GREEN & BLACK’S
The luxurious chocolate with accelerated growth
Green & Black’s makes the most mouth-watering, organic chocolate you have ever tasted – and
epitomizes the new triple-bottom line focus of the enlightened business, one that delivers sustained
profitable growth for its shareholders, but also measures its impact on society and the environment too.
Yet, however ‘green’ you are, consumers still want a great product – so if you can make these factors
work together, the results can be staggering.
‘I was born on a farm in Nebraska. I learnt the fundamentals of business as a paperboy, for the Omaha
World Herald. In 1966, before moving to England, my Uncle Floyd offered me a deal on 1000 acres of
rich riverside land in Iowa and a 700 head beef feedlot if I would join him in the farming business after I
graduated from Wharton. Instead, like many of my contemporaries, I discovered the macrobiotic diet
and developed an awareness of the unsustainability of the way that food and farming was going. I didn’t
want to be part of the problem and I aspired to help bring about the solution.’
It was 1967, Britain was at the peak of flower power, and Craig Sams arrived in London to set up a
macrobiotic restaurant in London. Two years later, a retail store, and another year later he launched the
Whole Earth brand of brown rice and macrobiotic foods. A wholefood bakery followed with organic
peanut butter and jams – he typically sought out finding healthy and sustainable alternatives to the
foods he loved most. Most of all, he loved chocolate.
In 1991 he was sent a sample of organic dark chocolate from Africa. His wife, the environment columnist
Josephine Fairley, found the half-eaten bar on his desk and sampled some for herself. The intense
flavour was unique and unlike anything she had tasted before. She was convinced other chocolate lovers
would appreciate it too and they set about making the world’s first organic chocolate.
The final product was a high-quality, bittersweet dark chocolate bar, packed with 70% cocoa solids made
with organic cocoa beans grown in Togo, West Africa. It was organic and fairtrade, the legacy of a French
foreign aid project to stop environmental degradation in Togo’s highlands.
They needed a name. They wanted something that sounded English and with heritage, like their
childhood favourites such as Barker & Dobson. They eventually seized on green to symbolize organic,
and black to represent the rich, dark chocolate.
Sales rose gradually, although it was still very much a niche brand serving a narrow customer base. It
was initially embraced by chefs who valued the intense flavour in their cooking and by health food
addicts who went out of their way to find ‘good’ products. Its distribution was therefore mainly through
small, independent stores and it was very much a chocoholic’s secret.
Eventually, the business recognized that it needed to do something different to grow, but without
compromising its values. The insight they gained from consumer research was that whilst ‘organic’
products – which their marketing and packaging focused on – was appreciated, it was the flavour that
mattered much more. They switched emphasis from green to black. The brand was repositioned as the
most luxurious, most intensely dark chocolate around.
images
Growth was phenomenal. The insight was profound. From 2002 to 2005, sales grew from £4.5 million to
£29 million – at 544% it became the UK’s fastest growing consumer food brand. The brand could more
than hold its weight against the much larger, more widely advertised competitors. Through word of
mouth, eye-catching repackaging, clever advertising and targeted sponsorships, the brand took off, and
by mid-2006 held 7.4% share of the UK chocolate market, whilst the average selling price rose from
£1.19 to £1.54.
In 2005, Green & Black’s became part of confectionary giant Cadbury Schweppes, rewarding its founders
and investors with a £25 million return on their passion and perseverance.
The chocolate company is still run as an independent business – with its own small, funky Offices near
London’s Waterloo Station, caring entrepreneurship, and with Sams as chairman. The parent company
keeps its distance, providing support in terms of new packaging techniques, for example, and the
financial resources to enter new markets around the world, but otherwise the business stays true to its
original principles in respect of organics, fair trade and corporate social responsibility. Has Green &
Black’s sold out to the big commercial world? As Sams says:
‘Some people have said that ultimately we will have engineered a sort of reverse takeover, on a
cultural level, of the world’s largest confectionery company. Remember that Cadbury’s were founded on
the Quaker belief that a steaming cup of cocoa would help wean the working classes off beer and gin.
There are still no pubs in Bourneville, the town they built as their corporate headquarters,
manufacturing base and for housing their workers!’
12.2 MANAGING FOR HIGH PERFORMANCE
Intangibles require a different style of management
The old adage that ‘what gets measured gets done’ is still true, and even more so ‘what gets rewarded
gets done’.
Targets, metrics and rewards should not, therefore, be considered the end point, but the starting point.
The wrong performance indicators, an unreasonable performance target, or a badly balanced ‘Balanced
Scorecard’ (measuring people, customer, financial and improvement factors) will drive business in the
wrong direction. Strategic decisions will be based on false criteria, investments will not deliver optimal
returns, people will become demotivated by their inability to hit targets and investors will lose
confidence.
Get the right measures, then you can make the right decisions, people and resources are focused in the
best places for high returns, and everyone can share in the rewards.
Market share, for example, is increasingly meaningless, depending entirely on how you Define your
boundaries – you could have a 100% share of one market and a 0.1% share of another. As customers’
needs change, and market profitability varies, markets are not equal. Rarely are two companies in the
same market – P&G and Unilever might be big competitors in some sectors or segments, but irrelevant
to each other in others.
There is, of course, a better way, as Diageo demonstrated, in using what some call the ‘ultimate
measure’ of business performance – the total long-term return to investors (in both the form of capital
growth and dividends) – measured across sectors, against a group of peers.
This gives the big picture and a unifying goal, but is less practical in enabling day-to-day decisionmaking.
Developing a business scorecard, the right portfolio of metrics should be based firstly on the ‘ value
drivers’ of the business. These will differ by company, but in simple terms there are:
Inputs – such as operating costs, headcount, and time to market – factors that can be managed
directly because they relate to decisions and actions.
Throughputs – such as productivity, sales growth, customer retention – factors that are direct
consequences of operations and can quickly be influenced.
Outputs – such as profitability, return on investment and share price – factors that are more complex
to influence, but are clearly driven by the previous metrics.
Another dimension is to consider the implications of short- and long-term actions and effects in the
organization – a sales promotion will give an immediate return, building a new brand will take longer for
its impact to be seen, investing in new product development will take even longer.
Short- and long-term both matter – which is why a simple comparison of this year’s costs and revenues
is a rather simplistic way of looking at business – particularly when most of the value lies in intangible
assets, which typically deliver long-term returns.
images
VALUE-CREATING MANAGEMENT FRAMEWORK
‘Value’ provides the answer – calculating the sum of likely future cash flows, embracing both the shortand long-term. Value-based decision-making therefore becomes crucial to deciding:
• Strategically – which are the right businesses and brands, markets, products and customers to focus
on for the longer-term? Out of the business portfolio, which businesses ‘create value’ and which
‘destroy value’?
One business might have strong sales and market share, and even operating profits look good, yet
because the cost of capital is greater, every additional sale will destroy value.
Operationally – what is the most effective allocation of budgets of people and resources in the shortterm? Whilst long-term performance matters, the markets might still be immature, and the business
needs to generate cash flow in the meantime to survive, and to fund the longer-term investments.
One of the most perverse attributes of boardrooms is that they typically spend less than 10% of their
time focusing on where 90% of their success comes from. Little time is spent on discussing where the
revenue comes from and how they could be improved, before the conversation quickly progresses to
operational performance and cost management.
Customer-related performance metrics are typically more informative about the future health of the
business, whilst most financial metrics look backwards.
Board meetings for executive and non-executive directors.
Quarterly business reviews for managers and staff.
Investor relations briefings to analysts and media.
Annual reports available to all stakeholders.
Imagine the CEO standing up at the next board meeting, or the first page of the annual report, with
customers and brands being the focus of commentary, their current performance, and the investments
that are currently been made to secure and enhance future results.
This might seem an obvious and engaging place to start in reviewing a business, yet the vast majority
will start with costs, processes and supply chains.
One retailer was amazed at the impact it made when it went into the investor briefing and started
describing the financial impact of getting new fashion from catwalk to clothes rail in two weeks less than
anybody else on the high street, and the incremental sales and margins that this drives.
Of course, at the end of the day, business is not a machine and performance does not come out of a
calculator. Business needs to bring together internal and external insights, financial and non-financial
information, business and personal beliefs in order to make the right decisions.
Insight 35: PORSCHE
Small in stature, big on impact
‘The mouse and the elephant’ is how Fortune magazine described the tiny sports car maker Porsche, in
comparison to its much larger cousin, Volkswagen. The elephant, which has the mouse as its largest
shareholder, is 15 times larger in revenue. However, the mighty mouse has superb profit margins
(dwarfing the elephant’s seven times over) – the best in the world.
Ferdinand Porsche grew up in Bohemia, in Vratislavice, which is now part of the Czech Republic. After
learning his business as technical director at Daimler-Benz, he left the company having failed to convince
the company to make small cars. At 55, he started his own design firm for all sorts of vehicles, and
became a charismatic although hot-tempered entrepreneur. In 1934, he was asked to develop a cheap
and reliable family car by the German regime. He called it the ‘people’s car’, the Volkswagen. In 1948,
Porsche launched its first independent car, the 356. Made in Stuttgart, Germany, it was distinguished by
its aluminium frame, rear-mounted engine and roaring high speeds.
In 1954, Porsche, now run by its founder’s son, also called Ferdinand, launched its first racing car, the
550, and began to create a global reputation. The 911 followed shortly after in 1964. Designed by the
founder’s grandson, Bultzi, it became a design legend and still lies at the heart of the range today. In
1972, when the Piech family bought a share of the company, Bultzi left to form an independent design
studio, ‘Porsche Design’.
Porsche’s expensive cars made it vulnerable to global economic health, and it struggled in the late
Eighties and …
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