Doing More with Less . . . to Get More
Becoming a Master of Capital Management Now
If you are a CFO, you may be thinking that you now spend a lot of time on capital management and feel that you do a pretty good job. If you think so, let me ask you whether you are currently focusing on providing capital for attractive investments at low cost (what has been known as financial management), or better, whether you are actually focusing your company's corporate strategy on accessing and using low-cost capital. Focusing your corporate strategy in this way is part of the aim of what we are calling Theoretical Best Practice Capital Management.
If you are not a CFO, you may be thinking that this is of no concern to you. However, chances are that no one in your company is doing Theoretical Best Practice Capital Management now, and the opportunity will be lost to do so unless you help organize some effort to learn more about this. Although I have mentioned this exciting innovation before in my recent report about the February 11th meeting we had with Peter Drucker at his request, the fact that I have not heard from you makes me think you are still skeptical about the urgency of adopting this new approach. Let me describe the benefits you will receive.
Benefits for You and Your Organization
You will reduce the amount of capital you need, lower the cost of capital, and earn a higher return above your cost of capital than ever before while expanding your access to low-cost capital. If you are like most companies, you want to make high return investments. For a typical company, the value of adopting this approach will be measured in billions of dollars in savings and growth over the next ten years. You can understand why we think that the benefits will outweigh the costs by more than 1000 times. That is a very nice return on investment, in itself.
You will greatly expand the attractive business choices available to your company because you will have access to more resources at lower cost. Appropriately used, this should cause your performance to improve versus your competitors. Decisions will also come more easily because you will be better able to accurately document their effect on the company.
You will have a much better idea of how likely you are to succeed, and how rapidly, with your available alternatives. We will show you how to give these alternatives a more thorough testing than usually occurs.
If you are a financial executive, you will take less risk in your career. This process allows you to locate the risks that are not worth taking, so you can avoid many of them. Your CEO and board will have a much more realistic idea of what to expect and to track your progress, so that they can be more appropriately supportive as the inevitable minor delays and setbacks occur.
If you are a nonfinancial executive, you will also take less risk in your career. The company will be a much more effective competitor, and in a better position to weather whatever ups and downs the external markets provide.
The mix of your work will improve. Instead of always focusing on firefighting of the problem areas, you will have fewer areas needing firefighting so you can pay attention to areas of high potential instead. That can also be more fun and rewarding, from a career point of view.
The appropriate influence of financial thinking on operating executives will greatly increase. The tools and process involved are very easy for operating executives to understand and use . . . much more so than Discounted Cash Flow, Economic Value Added, and other financial concepts now in wide application in companies. You will have a faster and easier time communicating about capital management questions what you want to do and why, so implementation should be better and easier as well.
The Best Theoretical Practice Process
Many people know our work only through stock-price improvement, financial management, or corporate or business-line strategy -- depending on what organization they are involved with. They are surprised to learn that we have developed parallel management technologies (working with other executives who are expert in these areas and surveying the best practitioners in the world) in many different areas. All of these technologies have the same overall framework:
1. Understand the importance of measuring performance in the most highly leveraged ways
2. Focus on a particularly important process within a company or organization and determine what it is about this that we want to measure to make more rapid process
3. Identify the best practice and measure it
4. Find ways to bring everybody else up to the best practice
5. Identify the theoretical best practice (the best that we can imagine anyone will ever be able to do)
6. Try to bring the best practice much closer to the theoretical best practice
7. Create a match of incentives, appropriate people, and education to pursue implementation and
8. Keep repeating the process.Naturally, the exact details of how to do this vary from organization to organization, and from process to process. It is, however, this general problem-solving process that Peter Drucker has identified as being capable of being applied successfully to more than 85% of business issues. In fact, a highly-beneficial activity for your company will be to train people in this general process and how to use it. As you know, Peter has encouraged us to spread the application of the process into as many areas as possible to help our clients make enormous progress, easily and effortlessly in a short amount of time.
This new Theoretical Best Practice Capital Management Process is the finest service related to stock-price improvement that Mitchell and Company has ever had the pleasure to offer. Our new diagnostic process is built on SHARE PRICE GROWTH 100 processes that have been successfully used for several years and begins with the assumption that the money invested in the company now is also available for use in different ways whether that be putting the money into other businesses or returning it to shareholders in some way. The work does not include a look at strategy or business operations.
STEP 1 is to compare the returns on capital for the lowest return businesses to the highest marginal capital costs. For most companies, marginal capital costs greatly exceed the returns of at least some of the businesses.
However, a business may be contributing a lot to stock price. In STEP 2, we test that by looking at the value per share added or subtracted by each business based on where the money comes from or how proceeds are used, by using a combination of the Demand Measurement Interviews with current and potential investors, verified stock-price correlation, and case histories of companies with similar correlations who have added or subtracted businesses.
STEP 3 is to use a quadrant analysis to look at the combination of cash and stock price contribution or cost by business over different time periods and scenarios to locate the optimal business mix. Note that acquisitions can be added to this analysis.
STEP 4 looks at the proper mix of financing to use for the resulting optimal business mix, by looking at the effect on stock price.
STEP 5 looks at the most effective ways to adjust the capital base to generate the most cash and stock price improvement, by testing them against estimated benefits as tested through relevant case histories of those using these changes.
STEP 6 once again checks the fit with the people in the company.
STEP 7 adjusts rewards, feedback, and people to match the selected direction.
STEP 8 is to reiterate the process in light of the successes and issues that arose.
To get the most benefit from this work also entails increasing the effectiveness of the CFO, which is currently low in the eyes of many CEOs and boards due to conflicts about what the role of the CFO should be. Our current benchmarking project for LEADING CHIEF FINANCIAL OFFICERS to enhance CFO effectiveness should help. Peter encouraged us to offer a service to help each CFO member implement this work effectiveness benchmarking work as soon as possible.
Why Doing More with Less . . . to Get More Is Important
Any first year business student knows that in organizations, less is often more. . . . The smaller the team that develops a new product on average, the faster the product will be developed. . . . The fewer the requests for information from the boss, the more work gets done by the staff. . . . The fewer people involved in a decision, the faster a decision comes. . . . One good meeting with a large customer usually creates more profit than $10 million in advertising aimed at many tiny customers. In fact, the very notion of profit assumes that costs must be minimized while benefits are maximized.
Of course, this is also true in the field of capital management. If a business uses less capital to get the same results, the value is higher. With less debt, the bond rating is higher, debt costs are lower, and earnings are higher. With less equity after repurchases, the share price may grow faster. A research project done more rapidly (as long as additional errors do not occur as a result) will often cost less, and earn a higher return. Increasing efficiency often decreases waste.
Wouldn't it be wonderful if we could cut out a large percentage of the resources we currently use, and have better results? Capital Management is a new management process that provides just such an opportunity.
A Colossal Success from a Modest Base
The building is small, a little dowdy, and quite unprepossessing. Next to it is the local sales office of one of the company's many competitors. The sales office is far larger, very beautiful, and expensive-looking (a typical Fortune 500 sales office building). . . and the sales office is up for sale because the parent is having severe profit and growth problems.
Now let's look at the track record of the company with the unimpressive headquarters. When Mitchell and Company was founded twenty years ago, the local company had revenues of $60 million, earnings of $2 million, and a stock market capitalization of $30 million. Recently, we updated that picture. Revenues last year were $2.9 billion (a 47 fold increase), earnings were $195 million (a 96 fold increase), and the stock market capitalization of it and its subsidiaries was $17.7 billion (a 590 fold increase). Over the 20 years, return on shareholder's equity reached a maximum of 11.7% in 1989, and was under 11% for all but 5 years. Recently, the company held $1.7 billion in cash. Over the last 10 years, the company raised a net of $2.3 billion in cash from external sources and has made many stock acquisitions, which have expanded shares outstanding from 30 million to 145 million.
How was this done? This organization rigorously sought out the largest, least risky, lowest-cost sources of money by using any country and structure that made sense for a company like them, found the lowest risk ways to invest that money, and diversified their risk to statistically-significant levels. Then they aggressively invested the money as rapidly as they could find good ideas.
What does that mean? They simply reduced their risk-adjusted cost-of-capital for new products and technologies to remarkably low levels (often below 4 percent after-tax), and invested at a hurdle rate that reflects that low cost of capital rather than the much higher level that the conventionally-employed CAPM Theory produces. This allowed their subsidiary stocks to trade at very high multiples compared to the market, so they could pay high prices in stock for acquisitions without diluting earnings per share using Pooling of Interests accounting. Executives were eager to merge with them because of the enormous potential compensation that could come from stock options in the acquiring company compared to the prospects of the company that was bought. The acquisitions they sought usually sped up earnings growth from more revenues, lowered costs of combined operations, and had a short payback period.
In sum, Thermo Electron has achieved all this from making much more from much less. We will be spotlighting this company as one of our many best practice firms during SHARE PRICE GROWTH 100's research project on a Capital Management process to reduce the cost of capital while increasing capital availability.
As powerful and impressive as this example is, you have a very nice surprise. We have found that the Theoretical Best Practice provides far more benefits than what even the most advanced people like Thermo Electron are doing today. In June, that Theoretical Best Practice will also be described to SHARE PRICE GROWTH 100 members in terms of entirely new financial tools and a process to integrate them together with what you do now. At that same time, Mitchell and Company will also begin to assist members of SHARE PRICE GROWTH 100 to apply this remarkable Theoretical Best Practice in their own companies. In the next sections, I will tell you a little about the Theoretical Best Practice, having shown you how powerful the less effective, best practices can be.
How to Get Started
I want to help you personally now, as your lead consultant on a project to focus your organization on finding the best route for Capital Management so that you will enjoy all these great benefits.
We should begin by discussing this over the telephone (especially if you could not be on one of our conference calls on this subject), and developing a joint plan of how you and your company should evaluate and design an appropriate process for your needs.
You can speed your progress by calling me at just as soon as you finish reading this. Or you can reach me by e-mail to askdonmitchell@yahoo.com and I will usually respond the next day.
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