This is the third post in the fortnightly series of Strategy Dynamics Briefings. There are three distinct, but related questions lying behind the issue of how businesses and other organizations perform through time…
What are they?
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In my last post I explained that the time path of future performance is central to the concerns of investors in commercial firms.
The three distinct questions lying behind the issue of how businesses and other organizations perform through time are:
- Why has our historical performance followed the time path that it has?
- Where? will the path of future performance take us if we carry on as we are
- How can we improve that future performance?
The first question may not be relevant in every case — for example a new venture startup has no history. However, in most cases, history is highly relevant to the likely trajectory of future performance. To illustrate the importance of these three questions look at the example of Amazon.com, mentioned last time. This story is dealt with in more detail in the book.
Amazon.com is an outstanding growth story, as the company expanded from online books sales to an increasingly wide range of other high-value/small-size consumer goods. Since its founding in 1994, the company has promised and delivered growth in its business although it took until 2002 to translate increasing sales volume and revenue into profitability.
So how do our three questions apply to Amazon.com?
Why has our historical performance followed the time-path that it has?
Sales have grown strongly as consumer uptake of online purchasing has spread and as Amazon.com has extended its product range and entered new geographic markets. Earnings have bounced back from heavy losses into positive profitability, as early expenditure generated the sales growth and gross profits to more than cover the continuing costs of serving customers’ demand.
However, the company’s development could feasibly have followed a different path, even if it ended up at the same point in 2005. Figure 1.6 in SMD, shown above, compares the company’s actual record with an alternative, fictional history. In this other world, the answers to our first question would be quite different. The company might have grown its revenues still more strongly between 1999 and 2002 than it actually did, due to an even faster penetration of online shopping by consumers or extension of its product range and services. From 2002 to 2005, sales growth could have slowed and reversed, perhaps due to saturation of the potential market, the emergence of strong competitors, or a slowdown in the company’s expansion of its offerings. The alternative income line is more worrying still, and explanations might include reduced margins due to competitive activity, poor cost control, or deliberate increases in spending in an effort to restart growth.
Where will the path of future performance take us if we carry on as we are?
This second question shows the importance of answering the first. The two alternative histories must imply very different prospects for the future, even though the 2005 endpoint is identical. If we extend the time horizon beyond 2005, a plausible future for Amazon.com is that sales continue to grow for much the same reasons they have in the past—more consumer use of online shopping and extended coverage by the company of product and geographic markets. As a result, profits continue to grow.
But the answer to “where might we be heading?” would likely be very different, had the alternative history occurred. Now we are worried that the slowdown in sales could become a serious downturn, especially if the recent history had reflected progress by powerful rivals. If this were to come about, the profit forecast could be very disappointing, with the company slipping into losses as it struggles to contain costs that it has built up to support a growing sales rate.
How can we improve that future performance?
Amazon.com’s actual history to 2005 offers encouraging prospects for sales and profit growth thereafter, so in reaality. answers to this third question focus on pushing growth just a little faster, while not risking damage to the business system that supported its performance to date. Perhaps further product and service development would drive additional growth, and this could plausibly lead to still higher profits.
The answers to this third question would have appeared very different if the company had reached 2005 by the alternative path. Instead of asking how the firm might safely push for even faster growth, it would instead be worrying about how to stop sales revenue slipping backwards, and then how to restart growth. Such a turn-round would likely be costly, so the time path of recovery might well show an even worse profit performance in the next year or two than the “do nothing” projection.
Your business history will probably be quite different from Amazon’s, but the questions will be the same. Through the course of the book and these emails I will show more examples, in different cases that I hope will demonstrate that for you.
Remember we welcome your comments at any time.
Until next time…
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I love it when the lightbulbs go on!
When I am teaching it’s great to see the reactions when people identify something that makes a real difference for them. In my executive classes in particular there have been insights related to areas that, from the outside, you would have thought would have been obvious – but the sad reality is that people are so often chasing a target that they often don’t manage to look at the overall picture.
I recall one person who ran a mid-sized security firm – the kind that provides guards for buildings of different kinds. He kept driving his head of sales to win new clients, but business was still not growing. When we looked at his numbers, it turned out that he had about 100 client, and each year added 100 new ones, but lost the same number. [Not many cases are quite so extreme!]
How had he got in this awful situation? Well a few quarters ago, HQ were pressing for more profit, so he had to cut back on the staff who did the actual security work for clients. Service quality fell, so next quarter some of his clients did not renew their contracts. Sales and profits fell, so HQ said ‘More profit please’. [Only not so politely!]
In order to sustain profit growth he set bigger sales targets – which his head of sales managed to hit. Taking on new clients meant more work, and with no more staff, service quality fell again, so next quarter still more clients cancelled their contracts. So sales and profits fell … so HQ shouted again … and so it went on, with ever-growing churn amongst his customers.
Getting out of the mess was tricky. Clearly, chasing still more new business was not working – apart from anything else, he was fast working through all the potential customers in his region! The solution was a significant, but selective cutting of still more clients. Mad eh! .. our business is in a mess, losing customers, so you tell me I should deliberately throw away some of those I’ve got? Yes – but the selection process isolated a significant number who were unprofitable, because they had demanded uneconomic prices or service levels that were too costly. Serving a smaller number of customers, even with the same number of staff actually raised profits and improved service. [We will see more about how this can happen in a later briefing – but that is some way off yet].
… from where he could start building business again, but with a little more care.
Read more about the book on our website