Investing Successfully for Your Company's Future

Date: Sep 10, 2004

Sample Chapter is provided courtesy of Financial Times.

In this introductory chapter to his book Minding the Corporate Checkbook, Steven Kursh explains the basics of investing and previews the subjects which he explains in greater detail throughout the rest of his book.

"At the end of the day you get nothing for nothing."

—Foreman in Les Misérables, musical by Alain Boublil, Claud-Michel Schönberg, lyrics by Herbert Kretzner, original novel by Victor Hugo

The Challenge We Face

It is the day after the day after. The party was great while it lasted, the hangover was painful and miserable, and the cleanup of the mess that companies made is nearly finished. Outrageous ideas for businesses no longer receive funding, and the previous decade's unfortunate combination of arrogance and youth in the business world is long gone. The basics are back in style, and talk of revolution is now a subject for history classes, not corporations.

Even the stock market has recovered. Although we are still far from the heights reached in early 2000, as early 2004, the NASDAQ was up over 85 percent from its lows in October 2002. The Dow Jones Industrial Average hit a five-year low in October 2002, but since then it has risen by more than a third. Unemployment is also falling, and there is at least limited optimism about the future for many companies.

The challenge now is investing a company's resources successfully for the future while remembering some of the financial hurt from the past. A quick survey of the business press finds stories detailing failed IT investments, failed mergers and acquisitions, failed human resource management initiatives, failed products and service offerings, and failed research and development efforts from the late 1990s to today. A consistent theme for all of these failures is loss: loss of shareholders' money; loss of time, energy, career growth opportunities, confidence, and even jobs for employees and managers; and loss of management will and desire to invest resources in their corporations' futures. Today, it seems that managers don't just keep an eye on expenses; they have glued their checkbooks shut.

At the same time, companies must grow revenues and profits to survive, let alone prosper. Growth in revenue and profits starts with investments in capital goods (e.g., machinery, equipment, and computers) and people (new employee hires and training for existing employees that increases their productivity). Avoiding investments in capital goods and human capital entirely and indefinitely might be an extremely short-sighted way to manage a company.

The advances in the values of many publicly traded stocks in 2003 and early 2004 indicated that the stock market expects future growth and profitability from such investments, which is reflected in rising stock prices. The key to meeting these expectations is growth in revenue and earnings, but without investments in capital goods and people this growth is not likely. Little will be gained without the critical ingredients of more equipment and people.

Data from the U.S. Department of Commerce indicates that many companies, both publicly traded and closely held, are not making investments for the future, or even attempting to improve efficiency today. Business capital spending fell from 11.8 percent in 2001 to 10.6 percent in 2002. Although data on spending for the last part of 2002 was very encouraging, anecdotal information, including surveys of executives, indicated that overall investment activity is likely to be sporadic and volatile, particularly when interest rates rise. Anecdotal evidence, including statements by business leaders that they are "still waiting" for capital spending to pick up and "don't see" the need to hire more employees, indicates that investment activity is likely to remain relatively low, particularly when compared to the late 1990s.

Yes, some companies, as reflected in recent government statistics, are beginning to invest, but these companies are the exception, not the rule. With the exception of a selected set of companies in a few economic sectors, companies are not investing in capital equipment and goods to enable greater efficiencies and growth. The decline involves much more than just technology-related investments; it is pervasive across nearly all types of capital goods and equipment.

Employment growth is similarly dismal. Whereas many of us once felt that we could leave our jobs and find something better relatively quickly, today most people are content to just have a job. Layoffs continue to loom, and even profitable companies are cutting back on employees. Indeed, many observers have taken to calling the current upswing in the economy a "jobless recovery."

You probably know someone (or are such a person yourself) who continues to get his or her old car fixed again and again rather than purchase a new one, no matter how cheap the financing terms offered by the automakers (zero-percent financing is about as cheap as you can get). Why does George Foreman, former heavy weight boxing champion and current spokesman for Meineke mufflers, tell us that he won't pay a lot for that muffler?

The reasons people offer for replacing exhaust systems and making other repairs to their old autos rather than letting the old cars die and buying new ones vary, but a key consideration for many people is a concern about the future, particularly after suffering the pain of a downturn in the economy. No one wants to waste their money while difficult economic times are still fresh in their minds. Nothing focuses the mind like fear, and the reminder of pain from recessions past is present in our thoughts.

Corporate decision makers apply the same logic to business investments—the hangover, long and painful, is still with us; it just seems to make sense to delay or avoid investments for growth and efficiency right now. The concern is survival, not growth. Finance departments at many companies seem to know only one word— no—in response to funding requests.

Return on Investment and Finance Metrics Are Not Enough

The hesitancy at corporations to invest in growth or greater efficien-cies is particularly curious given that many of these prospective investments pass the traditional finance metrics of return on investment (ROI) with flying colors. Put simply, following traditional finance metrics, a company should invest when the expected return from an investment is greater than the costs incurred to make that investment. From a strictly theoretical perspective, it makes sense to invest when your returns are greater than the costs of the investment. Obviously, companies should select investments that both fit within strategic objectives and provide the greatest return relative to costs, but even with these caveats, the data on capital spending and human capital clearly indicate that companies are not doing much investment of any kind, even in investments with high ROIs.

Like a child who shouts louder in response to an initial "no" answer, many vendors have raised their voices regarding ROI and other finance metrics to support the purchase of their products and services. Some companies even have ROI calculators on their Web sites. Try one—it can be fun to pretend that you are making an investment. Plug in different numbers and—surprise!—the calculator will likely give you a high ROI value. Check out sales literature, too; many companies in a wide range of industries—human resources management services, credit cards, technology products and services—claim high ROIs and short payback periods (how quickly you will get the money you invest back in returns). Several companies claim almost immediate financial returns, implying that an investment in their product or service is nearly equivalent to free cash pouring into your business. Unfortunately for vendors and people looking for work, the shouts of "high ROI" still do not work; companies just are not investing or hiring. There is an economic recession in spending for capital goods, and an economic depression in the labor market.

The Paradox

There is a paradox here. Senior managers know that they must grow revenues and profits. They recognize that low revenue and profit growth could mean the loss of their own jobs. Mid-level managers are hesitant to propose new investment opportunities, and finance departments are applying greater levels of rigor to every corporate funding proposal. The exception is when senior management wants specific investments to be made. In these instances, no matter what the financial analysis shows, managers go along for political reasons and survival. Apart from these "pet" investments, it seems increasingly difficult to get resources for new investments that could result in greater revenue growth, efficiencies, and higher profits. A common maxim, "Nothing ventured, nothing gained," describes the situation well; in this case, very little is being ventured, so it should not be surprising when little is gained.

Visions and Strategies, Finance Metrics, and the Execution Gap

Broad visions and grand strategies are a wonder to behold. Who hasn't felt like they were making a difference in their company by helping to develop a "strategic plan"? You might have felt the excitement after participating in the presentation or viewing a PowerPoint presentation that outlines your company's strategy, often by providing examples of what "worked" for a different company at a different time. It seems so simple: All you need to do is adopt those best practices or the strategies identified at the winning companies, and your company, too, can achieve sustainable growth in revenues and profits that will create value for your shareholders. What's not to like?

The problem is that vision statements and strategies are broad, sweeping generalizations. They are important, but at best they provide only a framework and the starting point for creating shareholder value. At worst, they become the standard reference point that people in a company use to support and justify almost anything. In fact, sometimes it seems that vision statements and strategies are like horoscopes, always offering advice that is general enough to apply to everyone, but not specific enough for anyone to really act on the advice.

At the other extreme from vision statements and strategies, finance-based metrics, like ROI, provide a proven methodology for allocating scarce corporate resources. The methodologies of finance are straightforward and logical: gather the data, do the analysis, get the answers, and make the decision. The analysis and results can be easily replicated, and the facts are on paper. The facts resulting from financial analysis appear to be black and white, and, therefore, some people argue that financial analysis and ROI are the way to allocate corporate resources.

If you have sought corporate resources for an investment in new plant and equipment or personnel, you probably have experienced the process, sometimes painful and always time consuming, of building the business case for the investment. (A business case is essentially a financial model showing that the financial returns to the company will exceed the cost of the investment.) Outside of a general reference, broad strategies and visions have no standing in the development of a business case: it is numbers pure and simple. Still, the finance department can, and usually does, say no.

Unfortunately, finance metrics, the key variables in business cases, often do not mean much once the investment is made. Consider the Quaker acquisition of Snapple. The deal was easily justified by financial projections. Unfortunately for Quaker share-holders, the projections did not take into account the fact that Snapple did not fit into Quaker's business model, which was focused on the supermarket distribution channel, rather than Snapple's target channels of small retail stores, restaurants, and delica tessens. In less than two years, the value of Snapple declined by more than 75 percent, based on the price paid by buyout firm Thomas Lee & Partners. A short time later, after rebuilding the value Quaker had inadvertently destroyed, Thomas Lee & Partners sold Snapple to Pepsi for a sizable profit. From the perspective of Thomas Lee & Partners, it was a tremendous deal. Needless to say, for Quaker shareholders it was anything but a good deal, and many senior managers left Quaker. Quaker is now a division of Pepsi, largely as a consequence of the failed Snapple deal.

More recently, AOL Time-Warner decided to drop AOL from its name. This decision was obviously more than a name change; it acknowledged the failure of the merger between two very different companies that was supported by extensive financial analysis. The stock price of AOL Time-Warner has fallen more than 70 percent from the time of the merger and, as of late 2003, was not worth much compared with the value of Time-Warner itself prior to the merger. These numbers are particularly astonishing when you consider the accolades that AOL and Time Warner managers received from institutional investors (the people who manage pension fund money) and the business press at the time of the deal. Statements like "deal of the century" and "merger of the new economy and the old economy" were bandied about, and Ted Turner, the largest single shareholder in Time-Warner, compared his enthusiasm for the transaction to his anticipation of losing his virginity in his youth. The failure of this deal has already been and will continue to be fodder for numerous business books and business magazine articles.¹

A tremendous number of acquisitions fail to achieve their expected financial returns because management does not execute the investments within the overall context of their organizations, people, and strategies. They seem to ignore that the real issue is making the acquisitions work. The critical execution issues are related to the who, what, when, where, why, and how of the deal, particularly in relation to bridging the gap between the financial analysis and the grand statements made at the time of the deal.

The limits of financial metrics as decision tools are not just apparent with mergers and acquisitions. More often than not, information technology investments are supported by financial analysis framed in the context of the technology, rather than the more important and critical issues of how the investment will leverage the existing strengths and competitive advantages of the company. Consider the investments that many companies have made in customer relationship management (CRM) systems. Many of these CRM systems were implemented without sufficient input and participation by the primary users (the sales forces), a critical execution-related factor. Monster.com, for example, spent more than $1 million to acquire and implement CRM software. The resulting system was so slow and difficult to use that the Monster.com sales force simply stopped using it. Monster's experience is not a rarity. Many large banks have invested in CRM systems and received zero or only minimal returns, even excluding training time and costs for their staffs.

Even research and development (R&D) investments that are justified financially might not provide the expected returns to shareholders. Several researchers have found no relationship between a company's investment in R&D and positive returns to investors. Look at the returns to the respective shareholders of Dell Computer and Sun Microsystems as an example. As Figure 1.1 indicates, Dell spends much less on R&D as a percentage of revenues than Sun Microsystems. In the past 10 years, however, Dell shareholders have received more than 10 times the financial returns of Sun's shareholders, reflected in the market capitalization of the two companies, shown in Figure 1.2. A dollar invested in Dell in the early 1990s would have returned to its investor more than 10 times the amount of a dollar invested in Sun. As of late fall 2003, Sun was trading at less than $4.00 a share, significantly less than its highs of a few years ago. One indicator of the company's difficult position is that it has reported a tenth consecutive quarter in which revenues were lower than the comparable quarter for the previous year. The stock market has apparently decided that Sun has too far to go from its visions to the reality of growing revenue and profits.

Figure 1.1. R&D Investment for Dell and Sun Corporations (as a Percentage of Revenues)

Figure 1.2. Market Capitalization for Dell and Sun Corporations

Dell spends significantly less on R&D as a percentage of revenue compared to Sun, but Dell has a much higher market capitalization. Although spending on R&D tells only part of the story of the differences between Dell and Sun, there are many other examples that reinforce the point that investments in R&D do not necessarily result in increased company value. Consider IBM, which in the late 1980s was investing more in R&D than the rest of the computer industry combined. In fact, IBM's R&D spending was eclipsed only by that of the federal government. At the same time, the flow of products through IBM's pipeline was barely a trickle, compared to other technology sector companies, and the company's market capitalization suffered as a consequence. By the late 1990s, IBM had cut its investment in R&D as a percentage of revenue by more than a third; at the same time, it substantially increased its flow of new products, and returns to shareholders increased dramatically.

The limitations of financial analysis have been well documented by others. You might be familiar with the Balanced Scorecard, an analytical framework developed by Robert Kaplan and David Norton that provides an alternative approach to what they label the "traditional financial accounting model" for measuring and managing corporate performance.² Kaplan and Norton advocate that financial measures are important, but that other factors drive corporate success as well. As evidenced by the great success of the Balanced Scorecard in the marketplace, they are absolutely correct and, indeed, financial analysis is necessary but not sufficient for achieving corporate strategies.

The Execution Gap

There is a major gap between visionary strategies and financial analysis. At one extreme are the bold strategies of where we would like to be, and at the other extreme are finance-based analytical tools for evaluating investment opportunities that need to be made as an important step in reaching those strategic objectives. Unfortunately, neither the grand visionary strategies nor financial tools are enough on their own. There is a huge gap between strategy and financial analysis, what we call the execution gap. As shown in Figure 1.3, the execution gap is where managers create value for their companies by building a bridge between the financial analysis and corporate strategies. This step is the essential task and responsibility of management.

In one of his earliest meetings with security analysts after becoming IBM's CEO, Lou Gerstner, who recently retired from IBM, said that "the last thing IBM needs right now is a vision." Gerstner and his management team then committed their company to the business basics of execution. The company's subsequent success is well documented, and although Gerstner was obviously referring specifically to IBM when he made that statement more than 10 years ago, his words were prescient for all of us today.

Note the key word of execution as compared with the word vision. Gerstner clearly recognized the importance of getting the job done versus merely talking about it, and he focused the company's efforts accordingly. He was emphasizing the importance of moving away from management theories and talk to reality and results.

Gerstner's comments are not an isolated thought by an individual manager. The new CEO at General Electric, Jeff Immelt, was recently quoted in the Wall Street Journal. When discussing two major acquisitions by his company he said, "Most companies ultimately get judged on their ability to take a good strategy and execute it." Note again the key word execution.

In fact, the word execution is in the title of a recent best-selling business book, Execution: The Discipline of Getting Things Done.³ The authors of that book, Larry Bossidy, the former CEO of Allied Signal (now Honeywell), and Ram Charan, a consultant with McKinsey, write, "Execution is the great unaddressed issue in the business world today. Its absence is the single biggest obstacle to success and the cause of most of the disappointments that are mistakenly attributed to other causes."

The fact that Lou Gerstner, the CEO of IBM, Jeff Immelt, the CEO of General Electric, and Larry Bossidy, the CEO of Honey well, are focused on execution indicates its importance in the executive suite and for senior-level managers. Execution is just as important for midlevel managers, those charged with the day-to-day task of getting the job done. Many midlevel managers are often caught between the extremes of expectations of achievement of strategic visions and the constraints of financial tools. You want to get the job done well, but the execution gap holds you and your company back.

Although measurement and management systems like the Balanced Scorecard can provide an alternative to bridging the execution gap, most companies and most managers within them do not have the time or resources to devote to the development or implementation of broad-based management initiatives. These initiatives can often be very useful, but those managers on the firing line every day frequently find that what works in the corporate classroom is often just too complicated or difficult to remember or keep track of in the battlefield of day-to-day business. It is hard enough just to catch up with the work that piled up while you were away at a corporate seminar and training program, let alone put what you have learned into practice. Besides, you might have had the experience of being burned by your manager, who simply ignores you when you try to implement what you have learned, often with a comment along the lines of, "That's nice, but we have got to get the job done now."

You might be familiar with Good to Great by Jim Collins, which is one of the most successful business books of the past decade.⁴ Collins and his team studied companies in the Fortune 500 from 1965 through 1995 to determine which companies made, using their words, "the leap" from good to great. Their findings and suggestions for senior management are excellent, but, unfortunately, they are simply not enough in terms of the execution that is needed on a day-to-day basis by all levels of management to make the "leap." After reading books like Good to Great, you feel excited and enthusiastic about what should or could be done in your company, but ultimately you are left without a clear roadmap for implementing such fundamental changes.

This book provides you with a fabric that meshes the energy and the transformative capabilities of strategy together with the basic blocking and tackling of business basics, including basic and essential financial performance metrics. This approach does not require you or your company to go through extensive and expensive corporate transformation efforts. Read on, and you will see how you can build your existing methodologies and approaches to become significantly better and more effective at evaluating and executing the investments your company needs to gain efficiencies, grow your business, and increase your profits.

This approach enables you to move from theory and talk to reality and results, because it puts everyone in your company on the same page, allows them to see an investment through from the beginning to the end, helps to ensure that precious resources are not squandered, and provides opportunities to increase value for all stakeholders in your company. You will be able to leverage your existing knowledge and resources and get an immediate benefit in the work that you and your team are involved with every single day.

The key theme throughout the pages that follow is that success comes not from the choice of a specific investment, but from developing the competencies to assess and to manage the investments your company does choose with a clearly defined, disciplined approach, an approach called the Business Investment Roadmap^TM. Fundamentally, the Business Investment Roadmap is built on the concept that successful investments require a mastery of the business basics. If you are used to analyzing opportunities primarily with financial metrics, you will see that the Business Investment Roadmap uses financial analysis as only one (albeit important) aspect of the investment process, and, therefore, it complements and enhances traditional finance-based analytics, rather than substitutes for them.

The Business Investment Roadmap connects strategies to financial analysis; it gives you the framework to bridge the execution gap. In fact, although ROI and other finance-driven analytical tools will certainly remain important in evaluating investment opportunities, the most crucial metrics are those that will enable you to achieve and deliver the promised returns to your company's shareholders. These are execution-driven metrics, and they directly relate to the who, what, when, where, why, and how of investments.

The Business Investment Roadmap

This book focuses on what really matters: making and executing investments that grow the value of your company. Traditional approaches to investment analysis typically involve performing complex financial analysis primarily before an investment decision is made, rather than throughout the investment process. In addition, these approaches tend to be focused on execution only after the investment decision has already been made. One of the most important ways that the Business Investment Roadmap is different is that both execution and evaluation are important before, during, and after making an investment. With the Business Investment Roadmap, your assessment of investment opportunities begins by considering execution-related issues even before the detailed financial analyses. You will see that financial metrics are still quite relevant in your analysis of investments, but you must also think of returns in terms of risks and execution.

You will also be asked to evaluate investments that your company has already made. Historically, companies have devoted too much time and energy to analysis prior to making investments. Once investments have been started, however, they are often treated as if they are irrevocable. It is rare that companies devote sufficient resources to looking back and learning from past investments to improve the success of future investments. Some failures are much more dramatic than others, and some of the worst failures are investments that could have been stopped earlier, if someone had just taken the time and effort to reassess the investment after the initial decision was made and as conditions changed. For example, think about the investment of more than $1 billion made (and lost) by IBM in OS/2, an operating system that was supposed to compete with Microsoft Windows. At some point along the way, once Windows was clearly established in the marketplace, IBM should have pulled the plug. Most investments are not the equivalent of jumping off a cliff with no returns, but, rather, journeys that can be stopped along the way or changed when you run into detours along the road.

Using the Business Investment Roadmap, you will be able to develop and use methodologies that do the following:

Link your evaluation of investments directly to your company's strategies to grow value.
Improve your investment management competencies to minimize the risk of failures.
Enable you to evaluate past investments and determine the key factors for success in the future.

A Note of Caution

The Business Investment Roadmap, and the analytical framework behind the methodologies, will help you and your company make investments more effectively and efficiently, but they are not the single solution or set of strategies that will guarantee high returns to your stakeholders. Unfortunately, there is no miracle business solution or strategy that can substitute for disciplined, active management. Even so, senior managers and the business press too often get caught up with new-and-improved solutions and strategies, supposedly proven at some Fortune 500/Global 2000 companies. This is great public relations, but it ignores the realities that managers face on a day-to-day basis, which are critical factors in the success needed to grow corporate value. Far too many of the new-and-improved solutions are based primarily on the experiences of particular companies at particular times. At best, adopting these solutions might enable your company to be a follower; at worst, you might put your company at risk by assuming that what worked elsewhere will necessarily be as or more successful for you. It is rare that you can easily exchange and wear someone else's clothes, yet it seems that companies are willing to assume that what fits at another company will work with minimum customization for them.

Keep in mind that just as insufficient or improper analysis can lead to poor investment decision making, too much analysis can also be detrimental to the investment process. Managers made many poor investments in search of revenue growth in the 1990s, especially IT investments that were insufficiently analyzed and vetted. At the other end of the spectrum, however, overanalyzing investments can lead to what some people call "analysis paralysis," with the result that a company makes minimal investments for the future and will invariably decline. There is also the simple fact, as noted earlier, of politics. Many of us have had the experience of seeing an investment made because a senior manager wanted it done, even if the facts available did not support it.

Who Should Read This Book

This book has important implications for any manager responsible for making investment decisions, executing investments or for proposing investments within his or her company. Using the Business Investment Road-map will help:

CEOs and CFOs lead organizations to more productive and effective investments that increase returns to stakeholders.
CIOs, CTOs, and senior members of their staffs establish priorities, support organizational strategies, and prepare business cases for review by senior-level finance staff and executives.
R&D managers develop objectives and agendas, track and manage R&D investment opportunities, and prepare business cases for finance staff and executives.
Marketing and HRM managers develop the business case for your initiatives.
Project managers achieve the holy grail of investments completed on time, on budget, and at the quality and scope levels required by your organization.
Product and service vendors provide empirically positive returns to your customers, beyond just financial benefits.

What Follows

Chapter 2 provides a formal introduction to the five steps in the Business Investment Roadmap^TM. The chapters that follow discuss each of the five elements in detail. Chapter 3 provides a detailed discussion of preliminary analysis, and is premised on the critical question of whether or not the investment will provide long-term growth and value to your company. Chapter 4 is devoted to the analysis of business impact analysis, where you determine the primary drivers of value in your company. Chapter 5 focuses on risk analysis and stresses the importance of identifying the major risks your investment faces and the development of a risk mitigation plan. Chapter 6 discusses execution analysis, where you determine the who, what, why, where, how, and when needed for an investment, as well as other critical factors that will make the investment successful. Chapter 7 is devoted to ongoing manage-ment, where you monitor progress and take corrective action when, and if needed, to ensure that your investments will result in growing corporate value. Chapter 8 pulls together the discussion in the earlier chapters.

You will find at the end of several of the chapters a section called "Following the Roadmap" that gives more detailed examples of how to apply the Business Investment Roadmap using a sample company. Depending on your specific interests and needs, as well as the time you have available, the sections at the end of the chapters will provide you working examples of the Business Investment Roadmap to use as a template in your company. The sample company in these sections is called Fresh Breeze, a manufacturer and distributor of personal care and household cleaning products. It is a composite based on financial data from similar companies in the industry. The Appendix reviews some elements of accounting and finance that might be of help to you when you apply the Business Investment Roadmap at your company.

Thank you for taking the time to read this book. We know that what follows will be of value to you and your company, and we appreciate any comments and suggestions you can offer as you put the Business Investment Roadmap to work in your company.