Building Breakthrough Competences
We will focus on entrepreneurial opportunities you can create by deliberately reconfiguring your company's competences—the combination of skills, assets, and systems you use to compete—to change the business model for your existing business or to create a business model for an entirely new venture.
We present some ways to assess where you are with respect to target competitors and to identify new ways to beat competitors on criteria that increase your profits and profitability.
There are two realities that no organization can avoid.
The first is the reality that competitors simply cannot allow you to go unchallenged and must try to erode your position. Understanding where to create a competitive position that cannot easily be overcome is thus essential.
The second reality is that you are not only competing with other organizations in customer markets. You are also competing with them in the capital markets for the critical funds you need to build future competitive position.
To cope with these two realities, you must demonstrate that your organization has what it takes to beat the competition in one simple way: creating superior ability to deliver on one or more key ratios that drive profitability in your business. Key ratios are measurable components of your business model that allow your business to be compared to others and that give you an early indication of where your opportunities are taking your profit growth. You can use your insight into these ratios to build new competences.
The key ratio concept invokes a core discipline you'll need to develop an entrepreneurial mindset. This is to make things as simple as possible, and to stay focused. Understanding your ratios and developing new ones will allow you to know when you are performing well (or badly) and how to target the few critical areas that will make a true, competitive difference.
a) Identifying Key Ratios
In established industries, time and experience eventually create a consensus .. ratios.
As a consequence, two of the key ratios commonly used by airlines analysts are cost per passenger-mile flown and passenger yield (meaning the overall percentage of the seats on the planes that are filled).
In the insurance industry, therefore, managers and analysts look at the loss ratio (the proportion of losses claimed to premium revenue received), the expense ratio (the proportion of sales and general administrative expenses to premium revenue received), and the combined ratio (a mix of the two).
Interestingly, many companies in the insurance industry today earn the bulk of their profits not on their underwriting, but on the investment yield that they earn after premiums are received and before losses are claimed.
Retailers face a different challenge. Conventional bricks-and-mortar stores have only so much floor space for the display and sale of items. This space limitation has for years led analysts of retail stores to use ratios such as same-store sales (in which sales for one period at one store are compared with a similar previous period) and sales per square foot (either compared to the store's previous record, or compared to the performance of different stores).
Higher stock turnover means that more stock is moved, less money is tied up in working capital and the company can enjoy greater velocity of sales, all of which have a positive impact on profitability. Another key ratio in traditional retail businesses is thus inventory turns, on an annual basis, meaning the number of times inventory must be restocked per year.
In new industries, or industries whose value chain is undergoing rapid change, it's harder to determine which key ratios to use. For instance, nobody yet knows what the critical ratios are for e-businesses (Should the model be transaction based? Should it be an advertising model? Will customers prefer fixed prices or dynamic pricing?).
Online business focusing on two new revenue model ratios: revenue per click and revenue per transaction.
The reason key ratios are such a powerful device for directing entrepreneurial thinking is that they help align the efforts of everyone in the company around a common set of measures. Describing and consistently using these ratios makes abstract statements about strategy more concrete for people and helps focus their energies. Kept simple and meaningful, key ratios can be crucial.
The guiding principle is that the model should be used to help the manager achieve a ten-x target, meaning, a contribution of 10 percent growth in profits and 10 percent better profitability for the manager's business compared with last year (if an ongoing business). If it is a new business, the ten-x target would be a 10 percent performance improvement over the manager's average business. Asking managers to boil down the business challenge to a few key ratios makes their challenges in achieving the ten-x goal more realistic. Setting key ratios in this concrete, realistic way allows our entrepreneur to operate many businesses (at last count, he had more than thirty in his portfolio) with a high level of assurance that the critical issues will be addressed without
his having to micromanage people.
b) Applying Key Ratio Analysis to Remodel a Business
A manager transformed his business by first determining what the most important key ratios were, then creating the organizational competences to do better on these ratios than the competition did.
Distribution businesses in general have a well-known set of key ratios, so we started with these.These were the percentage of customers who made the firm their first choice and the employee satisfaction index, which we thought would reflect how well employees were being managed and which would in turn influence customer satisfaction and loyalty.
Key Ratio Analysis for an Industrial Distribution Business
Annual sales growth
Margins
Percent "preferred choice" customers
Inventory turns
Fixed-asset turns
Days receivables
Deliveries within expected time frame
Error rates
Employee satisfaction index
Debt-to-equity ratio
Competitive weaknesses can lead you to discover new opportunities, which emerge as you learn to overcome weaknesses through the creation of new combinations of skills, assets, and systems—or competences. New competences can generate entrepreneurial profits in two ways.
First, if you can deliver what customers already want and expect (basic attributes) but do so at a lower cost than your competitors do, you can generate better margins than the competition's, even without price premiums.
Second, if you deliver more positive and/or fewer negative attributes than your competitors do, you can get premium prices or better payment terms.
Further analysis showed that our client did very well with those customer segments who simultaneously had a high need for on-time deliveries and staffed a large inventory-management operation. Years of focus by our client on on-time delivery had resulted in relatively good performance in this area.
For another segment, packing errors created enormous problems at the receipt link in their consumption chain. They tended to be contractors without the budget to keep a lot of inventory around and without the staff to handle incorrect shipments. For them, the process of identifying errors, correcting the paperwork, and returning incorrect items was enormously costly—to the point that some would keep the incorrect items rather than go through the hassle of returning them.
We found that the top competitors were turning inventory faster, getting paid more quickly, using less debt to finance operations, and capturing slightly higher margins than our clients were. These gaps suggested a need to think through what new competences might be needed (1) to bring our client's competitive profile up to industry standard and (2) to create new areas of distinctiveness.
The manager started by setting up an internal task force to identify what could be done about the customer preferred choice percentage. He organized a mix of sales, delivery, marketing, and telephone service people to complete a consumption chain analysis for key customer segments. His reasoning was that if the company could improve repeat sales, it could maximize the returns it would receive as a result of addressing the newly identified operational problems and make the most of the investments made to create those customer relationships in the first place.
They could come up with a way to do much better than the industry with respect to the time needed to collect receivables, the competences put in place to achieve this could be a significant source of profit growth. By collecting more, faster, without increasing costs, the firm could increase profits without increasing investment. The result is a productivity enhancement, which could contribute to superior competitive performance.
Our client's company was using an unwieldy twenty-year-old system to manage inventory and deliveries. The programs were old and hard to maintain. To feed the system, someone had developed a set of arcane commodity codes for items. The codes were nonintuitive and lengthy. The process of getting customer orders in and generating picking and packing instructions was largely paper-based and depended on special printers that pumped out multiple carbon copies of orders. By the time the last copy had been printed (the one used by the stock pickers), it was smudged and difficult to read. Not only that, but the organization of the warehouse had changed little since the computer was installed. It had not kept pace with changing customer demand patterns, which made
it difficult for stock pickers to locate new items. Even worse, the whole invoicing and payment system depended on paper copies and manual reconciliation, as this operation had never been integrated with the stocking system.
The result of all this was that customers found it hard to order what they needed and often ordered incorrectly. The pickers in the warehouse found it hard to get the right stuff off the shelves. The packers, similarly, found it difficult to match up the items picked with original orders and delivery instructions. Finally, the whole invoicing system was so complicated that customers were perennially late in paying the company because (among other problems) they couldn't figure out why they owed what they owed!
All the preceding situations translated into a barrage of negative attributes throughout the consumption chain. A substantial percentage of orders and invoices were contested. Customers received deliveries that reflected incorrect orders on their part or orders that were packed incorrectly. In these cases, unwanted items had to be repacked and shipped back, items had to be reordered and resent, and everybody's nerves became frayed in the process. This put the company at a competitive disadvantage, even relative to slower-delivering competitors.
At first, the task force groups recommended tackling the problems piecemeal, by adding staff in quality control and inspection, for instance.He begin a process of reconfiguring the competences of the firm.
Using the two new key ratios, the customer first-choice percentage and the employee satisfaction index, to explain his reasoning to his people, he showed how the numbers were interrelated. If operations could be improved to lower error rates, returns should drop. This in turn would reduce receivables and allow better control—and therefore, faster turnover—of inventories, which would in turn improve asset utilization. Better performance on packing should help the repeat purchasing process, which in turn should allow greater volumes and better margins on the same asset base.
Borrowing a page from the just-in-time movement, in which companies cut down on inventory costs by obtaining materials close in time to when they will be used, our client found that he could generate considerable economies for customers by promising to deliver goods on an as-needed basis in the amounts needed for a particular job. This was a major advance over prevailing practice, in which customers ordered lots of extra supplies and let them sit around until needed to avoid being caught short. By capturing data on customer use, the company could be more proactive—reminding customers when they had forgotten something they usually ordered, for instance.
To make this vision concrete, the firm began to build what (at the time) was a highly innovative electronic data interchange ordering system based on the Internet. The system replaced cumbersome inventory codes with simple descriptions and pictures. Customers could order on-line without filling out a single form on paper. Moreover, customers could call up past orders, sorted in a number of ways (by similar items, by time of year, by nature of project), so that all they had to do was make minor adjustments and submit the order as new. In the warehouse, a reorganized stocking system utilized electronic identification tags to help employees find items, pack them, and ship them, significantly reducing the error rate.
There was a price in terms of heavy investment in systems development and information technology (IT) equipment and in personnel retraining. Initially, this investment was expected to reduce fixed-asset turns and require a higher debt-to-equity ratio. Being realistic about the investments that will be required to upgrade competences is as much a part of the entrepreneurial discipline as any other part of the process.
Assessing and Developing Competences
To determine the relative value of various competences to the firm, it is useful to divide them into three categories: mandatory, distinctive, and latent.
a) Mandatory competences give you competitive parity. Creating or acquiring the competences that allow your company to meet industry (or major competitor) performance .. ratios is not optional if you are to sustain your competitive position. Activities that allow you to deliver nonnegotiable attributes and avoid dissatisfying ones seldom convey a significant advantage. Not having them, however, can put you at a major disadvantage.
b) Distinctive competences give you comparative advantage. These are the activities that lead to differentiating attributes. They allow a firm to deliver performance that positively differentiates it from competitors on a key ratio. This difference may be in value to the customer, in which case the company can generate better margins over alternative offerings by getting premium prices, or in efficiency, in which case the company can generate better margins by operating more productively.
c) Latent competences are possible activities through which your company could offer future differentiating or nonnegotiable attributes. Major sources of future competitive advantage typically emerge from the mobilization of latent competences.[7] DuPont's ability to produce Gore-Tex, for instance, grew out of its existing ability to manufacture Teflon. In consumer applications, Gore-Tex eventually became wildly successful in ways that were unforeseen at the time of its invention, including by DuPont, who licensed it to W. L. Gore!
If you cannot at least match competitive benchmarks, you will not be able to match competitors' prices or other positive attributes for very long and success in the marketplace will not be attainable, or at least sustainable. Furthermore, if you can't outperform competitors on at least one industry benchmark, you probably cannot deliver the kind of profits needed to attract prime investors in your competition for capital.
The Building Blocks of Distinctive Competences for GEFS (GE Financial Services)
The main drivers of profitability in this business are the ability to evaluate potential customers' creditworthiness, to handle huge numbers of transaction records efficiently and flawlessly, to manage cash flows with skill, and, of course, to collect on defaulted payments. Among the many competences the company developed, the most fascinating to us was its competence in handling delinquent accounts. At one stage, the GEFS bad-debts-to-book ratio—a critical benchmark for industry profitability—had dropped as much as 30 percent below industry norms.
Consider the difference once GEFS began to focus on creating significant competences in the handling of delinquent accounts.
Today, potential delinquent payments are identified by an electronic tracking system. Once a potential delinquent is identified, an automatic dialing system is activated and places a call to the customer every twenty minutes. When a real voice answers the phone, the call is immediately switched to a carefully selected and highly trained GEFS representative. Taking cues from a comprehensive on-line record of all the information GEFS has about the customer, the representative uses her training to compose a highly personalized conversation with the delinquent. (Most representatives are women, who generally tend to be less confrontational than men are in this uncomfortable situation.). In particular, she has been carefully selected for her skill at very nicely and politely but equally firmly persuading delinquents to pay their bills.[9] In addition, GEFS has developed automatic systems to eliminate paper handling and to keep her from wasting her time on anything other than using this skill. Thus, the system brings up records as appropriate and saves the information in a central file without requiring the representative to handle the forms manually. Should her approach not succeed, the debt can be referred to the collections department for further action. GEFS thus developed a distinctive competence—a combination of delinquency-handling skills, assets, and systems that for many years allowed it to incur a cost of bad debt on installment loans that was far below the industry average for durable goods loans.
a) The first building block is an entrepreneurial insight that is not widely shared. In the case of GEFS, it was early insight into the behavior of
delinquent customers. For the industrial distribution company, it was insight into how the company could help its customers compete.
b) The second building block is determining the linkage between the entrepreneurial insight and the key ratios that fuel performance. For GEFS, the critical linkage was time—if potential delinquents could be reached during the time at which they felt most uncomfortable with their failure to pay, the company would have to spend less money and would likely collect more than if it allowed these customers to become hard-core delinquents. The critical linkage of the distribution company had to do with a different kind of time. The company developed ways for its customers to get on with their businesses without spending time on obtaining routine supplies. By helping the customers compete, the business improved customers' propensity to repurchase.
c) The third building block is the creation of a combination of skills, assets, and systems that allow the company to achieve a distinctive level of performance with respect to the identified linkage. Thus, GEFS's investment in building the persuasion skills of its delinquency handlers by careful selection and training can be connected directly to its achievement of better collection results, and its investment in assets and systems to leverage the persuasive skills of its staff achieved maximum leverage. For the industrial distributor, the information intensity and responsiveness of the new system directly affected customer satisfaction and propensity to repurchase. Further, in dismantling its old system, the distributor was able to leverage employee skills that had been underutilized—their ability to relate to and creatively serve their customers.
In order to capture above-average returns, the company needs to create a competitive position that competitors will find difficult to attack.
A dilemma, however, is that to capture a legitimate position in the capital markets, you must explain your strategy to analysts and investors in a way that is compelling and believable. This forces you to share critical elements of how you plan to compete. Understanding the key ratio idea can help you to tell a convincing story without necessarily giving up critical insight.
What they would not have seen is the entrepreneurial insight into how emotions affect the customer's propensity to pay. Even if they put the same training program and computer systems in place, these competitors would not be privy to one crucial element—the insight that makes it all meaningful.
Setting the Stage for Competence Creation
The first task is to identify the seven to ten benchmark ratios that you believe to be behind profit growth in a business like yours.
The next step is putting these numbers together in a comparison table.Comparisons can often be found with a little persistence. Data has often been collected by commercial bankers and investment analysts to assess the relative performance of competitors. Data may also be also available in publications like Value Line, in on-line data services like Compustat, and through industry associations.
Benchmarking against private companies can provide a bit more of a challenge, as they are not required to report large amounts of data. You may need more extensive intelligence gathering to make estimates of these competitors' performance.[14] For instance, you might rely on inferences based on responses to bids, or on information from key customers or knowledgeable industry experts.
Once your benchmarks are in hand, your next step is to understand how each group within your company influences performance on the key ratios, which in turn affects the profitability of your business model. People can compete much more effectively if they see enough of the big picture to understand their role in profit growth. Linking functional activities to competitive benchmarks is crucial. Unless all the members of the firm know what connects their day-to-day actions with the firm's performance factors, how can they possibly know how best to contribute to profitability?[
You are now ready to begin addressing the gaps (whether positive or negative) between your performance and that of your competitors. Adverse gaps represent opportunities for competence development. The critical question becomes one of generating some kind of insight around which you could build a distinctive competitive position.
You may already have these insights in your opportunity register. Scan it for indicators that would suggest you have a significant opportunity to do better on a particular benchmark.
With your new insight, you can take specific steps to create new competences. The more specific you can be about the outcome and the linkages, the easier it will be for your people to execute your ideas.
Summary of Action Steps
The action steps that follow are meant to get you started on the concepts and processes discussed in the chapter. Feel free to elaborate in a way that works for your company.
Step 1: Create a short list of the seven to ten key ratios associated with growth and profitability for your business model. If you have multiple businesses with different business models, you will need a different set of ratios for each of them.
Step 2: Collect data on your performance on each of these key ratios as well as on competitors' performance and put together a table similar to table 6-1. Identify gaps, both positive and negative.
Step 3: Whenever you are below competitive parity on one or more key ratios, repeat the five-whys exercise in chapter 5 to begin to understand why. Involve people with exposure to the diverse functions of your firm, so that they can help you make the necessary linkages among different operations. Document your findings.
Step 4: If none of your key ratios shows that you have a distinctive competence, you at least have an opportunity to build new competences. Scan the opportunity register, repeat the consumption chain and attribute mapping activities described in chapters 2 and 3, or do both, with the objective of uncovering insights that might form the basis of a new, distinctive competence.
Step 5: Building on these insights, start first to consider what you can do to attain competitive parity on most of the important ratios and second to
create distinctiveness relative to competitors on at least one ratio.
Step 6: The best ideas should be entered into the opportunity register, especially if they offer the potential for major improvements in productivity.
For more Information
* Collaborative Entrepreneurship, Investment Strategy, Cost Reduction and Control, Debt Management, Business Investment Books, *
We will focus on entrepreneurial opportunities you can create by deliberately reconfiguring your company's competences—the combination of skills, assets, and systems you use to compete—to change the business model for your existing business or to create a business model for an entirely new venture.
We present some ways to assess where you are with respect to target competitors and to identify new ways to beat competitors on criteria that increase your profits and profitability.
There are two realities that no organization can avoid.
The first is the reality that competitors simply cannot allow you to go unchallenged and must try to erode your position. Understanding where to create a competitive position that cannot easily be overcome is thus essential.
The second reality is that you are not only competing with other organizations in customer markets. You are also competing with them in the capital markets for the critical funds you need to build future competitive position.
To cope with these two realities, you must demonstrate that your organization has what it takes to beat the competition in one simple way: creating superior ability to deliver on one or more key ratios that drive profitability in your business. Key ratios are measurable components of your business model that allow your business to be compared to others and that give you an early indication of where your opportunities are taking your profit growth. You can use your insight into these ratios to build new competences.
The key ratio concept invokes a core discipline you'll need to develop an entrepreneurial mindset. This is to make things as simple as possible, and to stay focused. Understanding your ratios and developing new ones will allow you to know when you are performing well (or badly) and how to target the few critical areas that will make a true, competitive difference.
a) Identifying Key Ratios
In established industries, time and experience eventually create a consensus .. ratios.
As a consequence, two of the key ratios commonly used by airlines analysts are cost per passenger-mile flown and passenger yield (meaning the overall percentage of the seats on the planes that are filled).
In the insurance industry, therefore, managers and analysts look at the loss ratio (the proportion of losses claimed to premium revenue received), the expense ratio (the proportion of sales and general administrative expenses to premium revenue received), and the combined ratio (a mix of the two).
Interestingly, many companies in the insurance industry today earn the bulk of their profits not on their underwriting, but on the investment yield that they earn after premiums are received and before losses are claimed.
Retailers face a different challenge. Conventional bricks-and-mortar stores have only so much floor space for the display and sale of items. This space limitation has for years led analysts of retail stores to use ratios such as same-store sales (in which sales for one period at one store are compared with a similar previous period) and sales per square foot (either compared to the store's previous record, or compared to the performance of different stores).
Higher stock turnover means that more stock is moved, less money is tied up in working capital and the company can enjoy greater velocity of sales, all of which have a positive impact on profitability. Another key ratio in traditional retail businesses is thus inventory turns, on an annual basis, meaning the number of times inventory must be restocked per year.
In new industries, or industries whose value chain is undergoing rapid change, it's harder to determine which key ratios to use. For instance, nobody yet knows what the critical ratios are for e-businesses (Should the model be transaction based? Should it be an advertising model? Will customers prefer fixed prices or dynamic pricing?).
Online business focusing on two new revenue model ratios: revenue per click and revenue per transaction.
The reason key ratios are such a powerful device for directing entrepreneurial thinking is that they help align the efforts of everyone in the company around a common set of measures. Describing and consistently using these ratios makes abstract statements about strategy more concrete for people and helps focus their energies. Kept simple and meaningful, key ratios can be crucial.
The guiding principle is that the model should be used to help the manager achieve a ten-x target, meaning, a contribution of 10 percent growth in profits and 10 percent better profitability for the manager's business compared with last year (if an ongoing business). If it is a new business, the ten-x target would be a 10 percent performance improvement over the manager's average business. Asking managers to boil down the business challenge to a few key ratios makes their challenges in achieving the ten-x goal more realistic. Setting key ratios in this concrete, realistic way allows our entrepreneur to operate many businesses (at last count, he had more than thirty in his portfolio) with a high level of assurance that the critical issues will be addressed without
his having to micromanage people.
b) Applying Key Ratio Analysis to Remodel a Business
A manager transformed his business by first determining what the most important key ratios were, then creating the organizational competences to do better on these ratios than the competition did.
Distribution businesses in general have a well-known set of key ratios, so we started with these.These were the percentage of customers who made the firm their first choice and the employee satisfaction index, which we thought would reflect how well employees were being managed and which would in turn influence customer satisfaction and loyalty.
Key Ratio Analysis for an Industrial Distribution Business
Annual sales growth
Margins
Percent "preferred choice" customers
Inventory turns
Fixed-asset turns
Days receivables
Deliveries within expected time frame
Error rates
Employee satisfaction index
Debt-to-equity ratio
Competitive weaknesses can lead you to discover new opportunities, which emerge as you learn to overcome weaknesses through the creation of new combinations of skills, assets, and systems—or competences. New competences can generate entrepreneurial profits in two ways.
First, if you can deliver what customers already want and expect (basic attributes) but do so at a lower cost than your competitors do, you can generate better margins than the competition's, even without price premiums.
Second, if you deliver more positive and/or fewer negative attributes than your competitors do, you can get premium prices or better payment terms.
Further analysis showed that our client did very well with those customer segments who simultaneously had a high need for on-time deliveries and staffed a large inventory-management operation. Years of focus by our client on on-time delivery had resulted in relatively good performance in this area.
For another segment, packing errors created enormous problems at the receipt link in their consumption chain. They tended to be contractors without the budget to keep a lot of inventory around and without the staff to handle incorrect shipments. For them, the process of identifying errors, correcting the paperwork, and returning incorrect items was enormously costly—to the point that some would keep the incorrect items rather than go through the hassle of returning them.
We found that the top competitors were turning inventory faster, getting paid more quickly, using less debt to finance operations, and capturing slightly higher margins than our clients were. These gaps suggested a need to think through what new competences might be needed (1) to bring our client's competitive profile up to industry standard and (2) to create new areas of distinctiveness.
The manager started by setting up an internal task force to identify what could be done about the customer preferred choice percentage. He organized a mix of sales, delivery, marketing, and telephone service people to complete a consumption chain analysis for key customer segments. His reasoning was that if the company could improve repeat sales, it could maximize the returns it would receive as a result of addressing the newly identified operational problems and make the most of the investments made to create those customer relationships in the first place.
They could come up with a way to do much better than the industry with respect to the time needed to collect receivables, the competences put in place to achieve this could be a significant source of profit growth. By collecting more, faster, without increasing costs, the firm could increase profits without increasing investment. The result is a productivity enhancement, which could contribute to superior competitive performance.
Our client's company was using an unwieldy twenty-year-old system to manage inventory and deliveries. The programs were old and hard to maintain. To feed the system, someone had developed a set of arcane commodity codes for items. The codes were nonintuitive and lengthy. The process of getting customer orders in and generating picking and packing instructions was largely paper-based and depended on special printers that pumped out multiple carbon copies of orders. By the time the last copy had been printed (the one used by the stock pickers), it was smudged and difficult to read. Not only that, but the organization of the warehouse had changed little since the computer was installed. It had not kept pace with changing customer demand patterns, which made
it difficult for stock pickers to locate new items. Even worse, the whole invoicing and payment system depended on paper copies and manual reconciliation, as this operation had never been integrated with the stocking system.
The result of all this was that customers found it hard to order what they needed and often ordered incorrectly. The pickers in the warehouse found it hard to get the right stuff off the shelves. The packers, similarly, found it difficult to match up the items picked with original orders and delivery instructions. Finally, the whole invoicing system was so complicated that customers were perennially late in paying the company because (among other problems) they couldn't figure out why they owed what they owed!
All the preceding situations translated into a barrage of negative attributes throughout the consumption chain. A substantial percentage of orders and invoices were contested. Customers received deliveries that reflected incorrect orders on their part or orders that were packed incorrectly. In these cases, unwanted items had to be repacked and shipped back, items had to be reordered and resent, and everybody's nerves became frayed in the process. This put the company at a competitive disadvantage, even relative to slower-delivering competitors.
At first, the task force groups recommended tackling the problems piecemeal, by adding staff in quality control and inspection, for instance.He begin a process of reconfiguring the competences of the firm.
Using the two new key ratios, the customer first-choice percentage and the employee satisfaction index, to explain his reasoning to his people, he showed how the numbers were interrelated. If operations could be improved to lower error rates, returns should drop. This in turn would reduce receivables and allow better control—and therefore, faster turnover—of inventories, which would in turn improve asset utilization. Better performance on packing should help the repeat purchasing process, which in turn should allow greater volumes and better margins on the same asset base.
Borrowing a page from the just-in-time movement, in which companies cut down on inventory costs by obtaining materials close in time to when they will be used, our client found that he could generate considerable economies for customers by promising to deliver goods on an as-needed basis in the amounts needed for a particular job. This was a major advance over prevailing practice, in which customers ordered lots of extra supplies and let them sit around until needed to avoid being caught short. By capturing data on customer use, the company could be more proactive—reminding customers when they had forgotten something they usually ordered, for instance.
To make this vision concrete, the firm began to build what (at the time) was a highly innovative electronic data interchange ordering system based on the Internet. The system replaced cumbersome inventory codes with simple descriptions and pictures. Customers could order on-line without filling out a single form on paper. Moreover, customers could call up past orders, sorted in a number of ways (by similar items, by time of year, by nature of project), so that all they had to do was make minor adjustments and submit the order as new. In the warehouse, a reorganized stocking system utilized electronic identification tags to help employees find items, pack them, and ship them, significantly reducing the error rate.
There was a price in terms of heavy investment in systems development and information technology (IT) equipment and in personnel retraining. Initially, this investment was expected to reduce fixed-asset turns and require a higher debt-to-equity ratio. Being realistic about the investments that will be required to upgrade competences is as much a part of the entrepreneurial discipline as any other part of the process.
Assessing and Developing Competences
To determine the relative value of various competences to the firm, it is useful to divide them into three categories: mandatory, distinctive, and latent.
a) Mandatory competences give you competitive parity. Creating or acquiring the competences that allow your company to meet industry (or major competitor) performance .. ratios is not optional if you are to sustain your competitive position. Activities that allow you to deliver nonnegotiable attributes and avoid dissatisfying ones seldom convey a significant advantage. Not having them, however, can put you at a major disadvantage.
b) Distinctive competences give you comparative advantage. These are the activities that lead to differentiating attributes. They allow a firm to deliver performance that positively differentiates it from competitors on a key ratio. This difference may be in value to the customer, in which case the company can generate better margins over alternative offerings by getting premium prices, or in efficiency, in which case the company can generate better margins by operating more productively.
c) Latent competences are possible activities through which your company could offer future differentiating or nonnegotiable attributes. Major sources of future competitive advantage typically emerge from the mobilization of latent competences.[7] DuPont's ability to produce Gore-Tex, for instance, grew out of its existing ability to manufacture Teflon. In consumer applications, Gore-Tex eventually became wildly successful in ways that were unforeseen at the time of its invention, including by DuPont, who licensed it to W. L. Gore!
If you cannot at least match competitive benchmarks, you will not be able to match competitors' prices or other positive attributes for very long and success in the marketplace will not be attainable, or at least sustainable. Furthermore, if you can't outperform competitors on at least one industry benchmark, you probably cannot deliver the kind of profits needed to attract prime investors in your competition for capital.
The Building Blocks of Distinctive Competences for GEFS (GE Financial Services)
The main drivers of profitability in this business are the ability to evaluate potential customers' creditworthiness, to handle huge numbers of transaction records efficiently and flawlessly, to manage cash flows with skill, and, of course, to collect on defaulted payments. Among the many competences the company developed, the most fascinating to us was its competence in handling delinquent accounts. At one stage, the GEFS bad-debts-to-book ratio—a critical benchmark for industry profitability—had dropped as much as 30 percent below industry norms.
Consider the difference once GEFS began to focus on creating significant competences in the handling of delinquent accounts.
Today, potential delinquent payments are identified by an electronic tracking system. Once a potential delinquent is identified, an automatic dialing system is activated and places a call to the customer every twenty minutes. When a real voice answers the phone, the call is immediately switched to a carefully selected and highly trained GEFS representative. Taking cues from a comprehensive on-line record of all the information GEFS has about the customer, the representative uses her training to compose a highly personalized conversation with the delinquent. (Most representatives are women, who generally tend to be less confrontational than men are in this uncomfortable situation.). In particular, she has been carefully selected for her skill at very nicely and politely but equally firmly persuading delinquents to pay their bills.[9] In addition, GEFS has developed automatic systems to eliminate paper handling and to keep her from wasting her time on anything other than using this skill. Thus, the system brings up records as appropriate and saves the information in a central file without requiring the representative to handle the forms manually. Should her approach not succeed, the debt can be referred to the collections department for further action. GEFS thus developed a distinctive competence—a combination of delinquency-handling skills, assets, and systems that for many years allowed it to incur a cost of bad debt on installment loans that was far below the industry average for durable goods loans.
a) The first building block is an entrepreneurial insight that is not widely shared. In the case of GEFS, it was early insight into the behavior of
delinquent customers. For the industrial distribution company, it was insight into how the company could help its customers compete.
b) The second building block is determining the linkage between the entrepreneurial insight and the key ratios that fuel performance. For GEFS, the critical linkage was time—if potential delinquents could be reached during the time at which they felt most uncomfortable with their failure to pay, the company would have to spend less money and would likely collect more than if it allowed these customers to become hard-core delinquents. The critical linkage of the distribution company had to do with a different kind of time. The company developed ways for its customers to get on with their businesses without spending time on obtaining routine supplies. By helping the customers compete, the business improved customers' propensity to repurchase.
c) The third building block is the creation of a combination of skills, assets, and systems that allow the company to achieve a distinctive level of performance with respect to the identified linkage. Thus, GEFS's investment in building the persuasion skills of its delinquency handlers by careful selection and training can be connected directly to its achievement of better collection results, and its investment in assets and systems to leverage the persuasive skills of its staff achieved maximum leverage. For the industrial distributor, the information intensity and responsiveness of the new system directly affected customer satisfaction and propensity to repurchase. Further, in dismantling its old system, the distributor was able to leverage employee skills that had been underutilized—their ability to relate to and creatively serve their customers.
In order to capture above-average returns, the company needs to create a competitive position that competitors will find difficult to attack.
A dilemma, however, is that to capture a legitimate position in the capital markets, you must explain your strategy to analysts and investors in a way that is compelling and believable. This forces you to share critical elements of how you plan to compete. Understanding the key ratio idea can help you to tell a convincing story without necessarily giving up critical insight.
What they would not have seen is the entrepreneurial insight into how emotions affect the customer's propensity to pay. Even if they put the same training program and computer systems in place, these competitors would not be privy to one crucial element—the insight that makes it all meaningful.
Setting the Stage for Competence Creation
The first task is to identify the seven to ten benchmark ratios that you believe to be behind profit growth in a business like yours.
The next step is putting these numbers together in a comparison table.Comparisons can often be found with a little persistence. Data has often been collected by commercial bankers and investment analysts to assess the relative performance of competitors. Data may also be also available in publications like Value Line, in on-line data services like Compustat, and through industry associations.
Benchmarking against private companies can provide a bit more of a challenge, as they are not required to report large amounts of data. You may need more extensive intelligence gathering to make estimates of these competitors' performance.[14] For instance, you might rely on inferences based on responses to bids, or on information from key customers or knowledgeable industry experts.
Once your benchmarks are in hand, your next step is to understand how each group within your company influences performance on the key ratios, which in turn affects the profitability of your business model. People can compete much more effectively if they see enough of the big picture to understand their role in profit growth. Linking functional activities to competitive benchmarks is crucial. Unless all the members of the firm know what connects their day-to-day actions with the firm's performance factors, how can they possibly know how best to contribute to profitability?[
You are now ready to begin addressing the gaps (whether positive or negative) between your performance and that of your competitors. Adverse gaps represent opportunities for competence development. The critical question becomes one of generating some kind of insight around which you could build a distinctive competitive position.
You may already have these insights in your opportunity register. Scan it for indicators that would suggest you have a significant opportunity to do better on a particular benchmark.
With your new insight, you can take specific steps to create new competences. The more specific you can be about the outcome and the linkages, the easier it will be for your people to execute your ideas.
Summary of Action Steps
The action steps that follow are meant to get you started on the concepts and processes discussed in the chapter. Feel free to elaborate in a way that works for your company.
Step 1: Create a short list of the seven to ten key ratios associated with growth and profitability for your business model. If you have multiple businesses with different business models, you will need a different set of ratios for each of them.
Step 2: Collect data on your performance on each of these key ratios as well as on competitors' performance and put together a table similar to table 6-1. Identify gaps, both positive and negative.
Step 3: Whenever you are below competitive parity on one or more key ratios, repeat the five-whys exercise in chapter 5 to begin to understand why. Involve people with exposure to the diverse functions of your firm, so that they can help you make the necessary linkages among different operations. Document your findings.
Step 4: If none of your key ratios shows that you have a distinctive competence, you at least have an opportunity to build new competences. Scan the opportunity register, repeat the consumption chain and attribute mapping activities described in chapters 2 and 3, or do both, with the objective of uncovering insights that might form the basis of a new, distinctive competence.
Step 5: Building on these insights, start first to consider what you can do to attain competitive parity on most of the important ratios and second to
create distinctiveness relative to competitors on at least one ratio.
Step 6: The best ideas should be entered into the opportunity register, especially if they offer the potential for major improvements in productivity.
For more Information
* Collaborative Entrepreneurship, Investment Strategy, Cost Reduction and Control, Debt Management, Business Investment Books, *
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