Category Archives: Predictability

Looking a Little Farther Ahead

I almost got hit by a truck the other day driving home from golf. Now a lot of you may be wondering what that kind of statement has to do with the nominal topics of business management and sales that I usually deal with here. I’ll get to that in a minute. For those of you that live here in Texas, you know that the word “truck” can cover a lot of territory. Everything from a go-kart with a toy wagon bed welded on, to a Peterbilt cab-over semi tractor-trailer. In this case I’m pretty sure that it was a Dodge Ram 2500 Crew Cab since the badging was at eye height as I looked out the window at it. In Texas, this qualifies as a “standard” sized truck. Anything smaller and you’re considered either a poser or a city-boy. Still, it outweighed my full-sized car by close to a ton.

Driving on the freeways in Dallas can usually best be described as a cross between bumper cars and playing a game of “chicken” at seventy miles an hour. As long as everybody abides by the same rules and speed, traffic seems to flow along reasonably, bumper to bumper at seventy miles an hour with a minimum of bad language and hand gestures.

However, occasionally there are those that appear to be unfamiliar with the freeway rules of the road, and opt for what I am sure they feel is a little more intelligently safer speed when changing lanes or taking exit ramps, and other such things. They also usually use their turn signals when performing these maneuvers, and equally importantly, turn off their turn signals when they are done. These people are easy to identify in that they usually have a very long line of impatient drivers behind them.

In this case, I was the then last car in such a line of several cars behind one of these drivers, as we all were taking an off-ramp which connected one high-speed freeway to another.

This position is the most feared position in all of Texas driving. You are going slower than everyone behind you, with little to no options of avoidance in front of, or to the side of you. You have a tendency to watch your rear-view mirror rather closely in such situations.

The SUV immediately behind me was a little slow on the recognition of the situation, but was still able to slow down and pull over to the left side of the ramp, but remained behind me. This maneuver on their part took them out of harm’s way and still left me fully exposed. The truck in question behind them however, did not seem to be as alert to the situation.

Did you know that even though they do not cause the loud, wailing skids that we are all accustomed to on television, you can still hear anti-lock brakes as they try to stop a large truck coming toward you? It’s sort of a staccato noise as the brakes bite and release as they avoid the skid. It is not something you really want to hear as it gets louder or closer.

At the last moment before hitting me, the driver of the truck swerved up over the curb on the ramp to the right of me. His truck came to a stop alongside my car, where as I noted earlier, I could very clearly see its name and size outside my passenger side window.

As traffic started to resume speed, I went ahead and let him pass me on the right. This is not usual protocol for Texas driving, but in light of the circumstances, I felt an exception might be in order. After a moment’s hesitation, the truck drove off and my journey home resumed.

So, here is where the business lesson for this event comes into play.

Most of the time we are all focused on what we are doing at that particular time. We are minding our own business. We are focused on our deliverables. We are paying attention to our deadlines. We have our own worries.

Occasionally we look up to see what the next step is. We have a process. We are preparing for what we must do next. We are looking ahead, but only at what comes next. We are aware that there are other factors that are coming into play. We are in effect checking the car in front of us.

For the most part, this approach will keep you out of most of the trouble that is out there. However, there will come a time when the expected events will not occur. The situation will present itself with alarming speed.

In other words, you could find yourself driving along in your big Texas truck, minding your own business, when suddenly the car directly in front of you dodges out of the way and you find yourself presented with the opportunity to smash into me from behind.

It’s not enough to only be aware of what you are doing and what those immediately around you are doing. On occasion, you need to be looking up and checking the horizon. What is coming into view? What are the competitors doing? Are they adding or deleting resources? What are the customers doing? Are they buying and spending, or are they delaying purchases? What are the analysts saying about the market in general and the company in particular?

Are there multiple cars up ahead with their brake lights on, and should you be prepared to, or possibly already be in the process of slowing down?

The combination of the increased reliance on process, along with the seemingly continuous growth in the reverence for the corporate fire fighter when the process fails, does not seem to mesh with this anticipatory approach to things. Processes have been implemented for the most part to reduce the reliance on this kind of judgement. It almost seems that the corporate fire fighter has been integrated into the process for those times when the process breaks down.

Sort of a “In case of Fire, Break Glass” kind of thing.

The lanes in business continue to be further refined by process. Dotted lines become solid lines, become multiple solid lines, become fixed dividers. If you don’t believe this to be the case, just look at any inter-organizational process flow chart.

It is very easy to focus solely on what you are doing. To perform your function in the process. The organizational structure and incentives now focus on that type of professional behavior. And for the most part, things can and do go relatively smoothly. Until they don’t.

Inevitably someone will miss a step, or improperly hand-off an incomplete work project, and things will unexpectedly slow down. Customers may decide to postpone their next purchase and wait for the next generation of product. Competitors may introduce new technology ahead of when it was expected. Foreign competitors may decide to instigate a new competitive approach based on price.

Processes are resistant to change, and will take time to adapt. They don’t come with anti-lock brakes. They have an inherent amount of momentum associated with them. Just like a speeding full sized, crew cab Texas truck. It’s not enough to be performing your operational duties in a vacuum. You need to be looking forward at the traffic and events in front of you.

Markets don’t provide plenty of warning when they are going to change. Customers rarely tell you when they are going to slow down or stop buying altogether. Companies usually don’t give you a pre-notice when they are going to have to react to the changes in customer and market status.

Looking out, looking forward, anticipating the changes in the business environment are still key to navigating in business. Processes are helpful in simplifying the immediate and making it somewhat more predictable, but it is still your responsibility to be anticipating those future needs and directions that the business environment will present you.

Now if I could just get the people in those large trucks when they following me to do that a little better.

Forecasting: Gaps and Plugs

It has been raining here in Dallas. It has actually been raining a lot here in Dallas. It is week twenty of a fifty two week year and we have now officially had more rain in the last twenty weeks than we had ALL of last year. The drought that has plagued us for the last four years is now officially over. The lakes are full. It can now stop raining. Please.

The reason I bring all this up is because it points out that at least for the last little while the weather forecasters in this area have had it pretty easy. All they had to do was mention the word “rain” in their forecasts somewhere and they were golden. They were going to be right. It was probably going to rain.

But even that didn’t seem to be good enough. It now became a forecasting contest to see who could be the most accurate in predicting the amount of rain we were going to get each week with each ensuing storm. Even this doesn’t seem too difficult. It’s week twenty and we have had almost twenty two inches of rain. I’m usually a pretty good numbers person, but this one should be pretty easy for everyone. We are getting a little more than an inch of rain a week here.

Forecasting. Go figure.

If only forecasting orders in business could be so easy.

For the most part it should be. We know how much rain (or how many orders) we already have. These amounts are called “actuals”. As an example, in Dallas we have actually had twenty two inches of rain so far this year, or “year to date” as we like to say. Management likes to work with trends. If we are trending at a little more than an inch of rain a week, they will more than likely expect at least another thirty three inches of rain over the next thirty two weeks. (Did you catch that? I told you I was good at math).

Knowing that everyone expects their fourth quarter to be their best quarter (for orders) they could conceivably expect even more rain, but we won’t get into that at this point.

Extending this example a little further, we could now say that we have a “gap” between the twenty two inches of rain that we “actually” have year to date and managements desired target amount of fifty five inches of rain for the year. This “gap” is obviously the target amount less the current actual amount. This is a pretty straight forward system and process. Take what you have and subtract it from what you want and there is your gap.

It works the same way for orders. Take the amount of orders you have (actual) and subtract it from what you want (plan) and there is your gap.

As time passes and more rain (hopefully) falls, the amount you have, your “actual” amount of rain, should grow and through the wonders of mathematics your “gap” to your desired annual rainfall target or plan should reduce.

But we have a slight problem. Despite what we have seen for the first twenty weeks of the year here in Dallas, we know that rain will not continue to fall at the rate of slightly more than an inch per week. We have a time here in Dallas that is known as “summer”. This is the time when you can replace the word “rain” in the forecast with the words “hot” or “heat”, and again be referred to as a brilliant and accurate forecaster. The only problem is that when it is “hot” in Dallas, it usually doesn’t “rain” much. It is usually dry.

Despite management’s belief and demand that twenty consistent weeks of rain performance does constitute an unbreakable trend, nature does not usually pay attention to these management expectations. There will inevitably be weeks where it does not rain.

Here is where weather forecasters and order forecasters begin to diverge. Weather forecasters would continue to look at the “actual” amounts of rain, compare it to the desired or “plan” amount of rain and calculate the “gap” or amount of rain needs to reach the plan. Order forecasters have developed this concept called a “plug”. A “plug” is something that is inserted into your forecast so that management can feel better about the team’s ability to reach the goal.

Dropping back to our weather and rain example, it can be expected to be both hot and dry in Dallas through most of June, July and August. It might rain occasionally, but it won’t rain at the afore mentioned rate of a little over one inch a week. It will be nowhere near that amount. Somewhere in late July or early August you can reliably expect the ground to dry out and start cracking due to the lack of rain. It would be fair to estimate that instead of the twelve or more inches of rain that the trend would show you to get, and that management would want, we might more realistically expect about two inches of rain in this period.

If this is truly the case, we would then expect to miss the annual rainfall plan of fifty five inches by as much as ten inches. From a weather and rainfall point of view this miss will probably elicit a collective “so what” from those of us who live here and see that the lakes are already full anyway.

If we are talking about orders however, this is unacceptable, unless you really want to invite a significant amount of management attention and assistance in your efforts to get more orders. So what happens here is that the orders forecasters understand that more orders are usually generated in the fourth quarter of the year than in the other times of the year, so what they will do is forecast ten weeks with more than two inches of rain in the fourth quarter.

Do they know if it will in fact rain this much? No. Is the plug amount twice as much as the rate for what is already one of the wettest years in a very long time? Yes. Do they have any idea as to if this increased performance rate is attainable?

In short a plug is something that is inserted into a forecast in order to make sure that the forecast ends up balancing with the desired annual target or plan. It is an as yet unidentified event or opportunity that is going to hopefully bring more rain after a dry period. In this example the forecasters do not know where they are actually going to find that extra / desired ten inches of rain that was missed in the summer, they are just committing to do it, somehow. It may not have any real substantiation, but it is now in the forecast so everyone now feels more comfortable about meeting the rainfall target.

The problem with putting plugs in a forecast is that they have a tendency to hide or mask an issue. As the actual performance diverges from the desired trend line, plugs have a tendency to be inserted. This may reassure some people that the target is still the target, but it does not solve the issue. Plugs are very good a defining what the problem is. The issue to be solved is how the lack of desired incremental rain is going to be obtained. Where is the incremental rain that is needed to reach the goal going to come from?

A “plug” in a forecast should be an alarm to anyone that sees it. A plug usually appears when there is a gap between actual performance and the desired goal. It is usually put in place to acknowledge that there is a gap and that there is every intention to try and close it. What it does is obscure whether the gap can in reality be closed and the goal attained. It provides the illusion of goal attainment when the reality may call for other actions to be planned or implemented.

There is a reason that weather forecasters don’t insert plugs into their weather forecasts. The lakes here in Texas for the last three to four years were well under their capacities. Water conservation measures were enacted to limit use so that things didn’t get any worse. Every year that the drought went on, the conservation efforts increasingly limited water use. Can you imagine what would have happened if rainfall “plugs” were inserted into the weather forecast in order to let everyone think that it was acceptable to continue to use water at the accelerated rate? When the shortage was finally acknowledged, it would have probably been too late and even more draconian measures would have been required.

Such is the case with orders plugs too. It is always best to acknowledge orders gaps and try to close them than it is to obscure them with plugs and have to deal with any potential shortfall consequences.

The Past

A lot of people may think that I live in the past because of all the references that I make to it. I read business books that are hundreds of years old because I have decided that almost all new business books and articles are a recycled version of the classics with some modern jargon thrown in to make it seem fresh and contemporary. I compare present generational norms and business performance to the past because they are good benchmarks and yardsticks for what has been done as compared to what is now being done. Those comparisons do not always favor the past generations or business performance. I am eminently aware of the past because without knowledge of the past how would we know what direction we are going? I am definitely aware of the past but I definitely don’t live in the past.

It’s time to get a little esoteric, but why not? George Santayana, the twentieth century philosopher, poet and essayist wrote is his book “The Life of Reason”, (1905):

“Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it.”

Many think that Winston Churchill was the author of the famous quote “Those that fail to learn from history are doomed to repeat it”, but he was in fact paraphrasing Santayana. This is just a small literary nugget for your historical learning pleasure.

The key point here is that the retention of what we have learned is the key to progress. This would logically mean that the future is built upon the past. Go figure. It takes a visionary to be able to interpret what was and extrapolate to what’s next. Just as Sony took the leap from portable transistor radios to portable cassette players (the then ubiquitous, and now all but forgotten Sony Walkman – ranked as one of the top TWO technical inventions of the last fifty years), Steve Jobs and Apple took the next leap along the same path with the now ubiquitous iPod (which ranks number THREE behind the Walkman). Contrary to popular belief these products did not materialize out of thin air. They had their roots in the past.

Conversely, there is the ubiquitous financial caveat contained in every investment prospectus that I have ever read, that states very clearly:

“Past results are not a guarantee of future performance”

In business as in sports we always keep score. That is how you tell who is successful and who is not. A very good example of this is the batting averages of baseball players. While the player’s batting average is not a guarantee of the performance of any individual at bat, it does give an indication about what you might expect from that player over time. There are always hitting streaks and slumps that must be factored in, but in general past results are a reasonable predictor, not guarantee, of each player’s future batting performance.

This fact may also be demonstrated in the Walkman – iPod comparison as well. The Walkman was indeed a game changer in the market, but not anymore. The iPod has supplanted it – but it was not until after twenty years had passed where the Walkman was dominant that the iPod was introduced, and even then it took a few years.

The same concept would logically be analogous to business. Understanding past business performance allows you to understand what worked well and what didn’t. Just like knowing individual batting averages or team won-loss records may give you an insight into how they may do for the rest of the season (although no guarantee), in business we like to know who has been profitable, how profitable they have been and how long they have been profitable. It doesn’t mean that they will continue to perform the same way that they have done successfully in the past, and it doesn’t mean that they will have to change everything if they were not successfully done in the past, but it is a good indicator (not a guarantee). There are hopefully always ways to do good things better and ways to improve on failures without starting changing everything and in effect starting anew, or returning to the “infancy” that Santayana mentions. There is that retention of the past thing again.

Staying with my esoteric bent I am going to go a little further into the past. Heraclitus, the fifth century B.C. Greek philosopher said:

“Nothing endures but change.”

This statement has been quoted and paraphrased by everyone from Plato to Diogenes to the latest business management books de jour . We like to all say that the only constant is change. The concept comes from three thousand years in the past, but still seems reasonably applicable today.

However, staying focused on your past is like trying to drive a car forward by looking in the rearview mirror. I don’t know who said this one, and it didn’t seem to be so valuable a quote to spend the time looking it up. Even so, it is reasonably accurate. But you do need to have some idea of where you have been if you are to successfully get to where you want to go. The past is where you were, the present is where you are and the future is always a goal.

So enough already with the philosophy and esoteric. What has this got to do with business?

The past is no guarantor of the future, and we know things are going to change. Knowing the past allows us to understand what the business has done right and what it needs to improve. Even the most disruptive of market forces take time to take effect. Walkmans replacing radios, iPods in turn replacing Walkmans, CDs replacing LPs, digital replacing analog technologies or even automobiles replacing horses for transportation did not happen overnight.

It takes people who understand the past and the trends and directions that it has imparted on the present to make sense of and deal with the present. It is the visionary who understands the past and the trajectory that it has put us on, that can take the next leap and either extend or modify this trajectory as is called for in business to realize the future. The past is useful in that it tells us where we have been in comparison to where we are. It is also a necessity if we are to recognize what we must change and what we should retain to get to the future. You can’t live in the past but you need to be aware of and understand the past if you are to make it to the future.

Cost Centers

Throughout history there have always been significant conflicts. The ancient Romans and just about everybody else. The North and the South. The East and the West. Capitalism and Socialism. Yin and Yang. Republicans and Democrats. Dogs and Cats. The list goes on and on. In business the applicable equivalent conflict seems to be between Cost Centers and Profitability.

There appear to be two ongoing schools of thought when it comes to business management structures and organizations. There are probably many more than that but for purposes of the time and space that I have here, I am going to impose the writer’s “power of the pen” and focus on the two that have already alluded to, namely cost centers and profitability (and loss). For the most part just about every other organizational structure is a variant or hybrid of these. You will also occasionally see them referred to as “Matrix” management models and “General” management models.

There are competing schools of business thought when it comes to costs centers. On one side it is felt that it is easier and more efficient to manage your costs when you group them into one specific organization. The idea here is that if you get your costs into one location that there will be several obvious efficiencies and economies of scale that can be taken advantage of to either reduce costs or at the very least slow their growth. As we all know, reducing costs will help improve profitability and creating cost centers is a very seductive argument for reducing costs.

A potential disadvantage to this model is that costs end up being the responsibility of a group other than the business group responsible for revenue or profitability. Because the costs are assigned from a shared pool, the cost center, they may or may not be directly linked to the revenue or business activities that the associated costs are supporting. Here costs are in effect “assigned” to rather than directly associated with the revenue they are responsible for generating.

The other school of thought when it comes to cost centers is that costs should directly be associated with the revenue that they drive. This is the general management model. The idea here is that the revenue, profitability and the costs for a specific business unit should all reside in that specific business unit. In doing this you enable the business unit leader to manage and “fix” his costs in direct proportion to and in association with his revenue in order to achieve his profit objectives.

A potential disadvantage with this model is that some businesses may be too small or may not be far enough along the efficiency curve to endure the incremental costs they require and hence suffer reduced profitability. Because costs are not shared each business unit may in effect be less efficient than they would be if their costs were shared.

So with the lines being drawn and the costs piling up, what do you do? Which structure to implement for the best profitability of the business?

Businesses (and business analysts for that matter) like predictability. They like to know in very specific financial terms what they can expect from their businesses. While the Cost Center and the Profitability models both offer certain aspects of predictability it seems that the profitability model offers the best financial predictability. It is only in this model that all specific and applicable costs are known, defined and fixed within the confines of the business. In the Cost Center model costs are allocated according to some predefined algorithm. While the method or algorithm may be fixed, the actual value of the costs that are assigned can vary. Adding another variable into a business’s cost structure increases the unpredictability of its performance.

As an example, assume there is a cost center that allocates its costs based on support requests. If there are three businesses sharing the cost center and one of the three experiences an unexpected increase in its support requests on the cost center, its costs will rise during that period while the other two businesses costs through no action of their own will go down. Conversely if one of the businesses experiences a reduction in support requests its costs will go down while the other two businesses through no action of their own will go up. In this way cost centers can turn fixed costs into variable costs.

Lastly when dealing with cost centers there comes the issue of governance and leadership. In business for the most part we are looking to grow. We want to grow our business, and with it, our responsibilities. When it comes to cost centers we must always ask the cost center leadership to take the contrary approach and reduce the cost center or at the very least limit its growth. In my experience this has seldom been the case with cost centers. If the supported businesses do not have direct control over the cost center growth and costs, they invariably grow at a faster rate than the supported businesses grow.

In the profitability / General Management model all costs directly associated with a particular business are attached to that business. The market doesn’t dictate what costs the business can or will bear. The market dictates what price the business can expect for its good or service. It is then the profitability objectives of the business that dictate what costs the business can bear in the pursuit of the market price. By putting the cost and price controls in the hands of the business owner, instead of separating them into the hands of the cost center owner and the business owner, you will far more regularly get a more efficient and lower cost solution.

There may be questions regarding lost efficiencies, or biases against smaller businesses in this profitability model. These types of businesses may in fact be able to be served by a cost center model, but should be only in a cost center model where fixed amounts of costs are purchased from the cost center by the business. The idea here is that the business must always decide on the amount of cost that it wants or can afford, hence the cost purchase approach to cost centers.

As I noted before, businesses like predictability, and there is nothing more predictable than a fixed cost. It may be good or bad, but it is known. And known costs can be planned for and dealt with. When direct costs are associated with and controlled by the business, they can and will become fixed. When multiple business’s costs are lumped together into a “Cost Center” there will always be a question regarding the efficiency and value received by the business for the amount of cost allocated to each business. There will be the incremental cost of the cost center management that must also be allocated and paid for. There will also be less control over the content and growth of those costs in the cost center, unless a budgeted cost arrangement can be put in place between the served businesses and the serving cost center.

As I also noted, the arguments in support of cost centers are seductive, but in the reality of their implementation they present multiple issues to the efficient operation of a business. Every effort should be made to find a way to directly attach and fix the costs and decisions about the costs to the revenue and the business that is recognizing the revenue for the most efficient and lowest cost business operation.