Musings on Strategic Investigation, Performance Improvement, and Rhetoric

Business turnarounds - troubleshooting performance problems (3/3)

In our last post we looked at our two most fruitful areas of analysis when an under-performing company has issues with sales (or gross profit) growth. In this post, we look at the two areas of investigation that we find most useful for companies with profitability problems.

Again, the most useful analyses are the ones that are rarely done. Board packs, management KPIs and performance measures often track return on sales and total profit by line and by customer group. These analyses ordinarily have value, but don't add to what the Board already knows, and so do not provide insights to a performance problem that the Board has to date been unable to address.

The analyses we find most useful are related to lifetime profits:

1. Analysis of profit contribution of assets over their lifetime
2. Analysis of profit contribution of customers over their lifetime.

Profitability analysis of asset usage

Capital constraint is a critical issue in turnarounds. However, profitability numbers in Board KPIs often either ignore asset usage or treat amortisation uniformly for each product line, not distinguishing asset-intensive versus asset-light customers.

Accounting for each customer group’s asset usage often highlights major cash sinks. It can overturn previously held understanding of customer profitability and often reveals where companies have historically focused time and resource on what turn out to be loss-making or value-destroying customers.

Example – gaming machine operator turnaround

Profitability had declined for five consecutive years in a highly capital intensive sector, resulting in low return on investment and ultimately covenant breach.

The business had focused on maintaining high machine rents, by targeting sales on high end managed pubs and by rapid and continuous new product introductions. The business deprioritised lower end free trade customers that required lower rates of introduction and paid correspondingly lower rents.

Using a simplistic assumption for machine depreciation, managed houses appeared profitable, free houses unprofitable.

Correct accounting for machine asset depreciation showed the historic focus on managed pubs to be value-destroying.

The business consequently renegotiated its managed pub contracts to reflect the accurate understanding of cost structure, grew profitability and has successfully refinanced.

Customer acquisition cost and lifetime value

Management accounts and monthly KPIs can hide the true cost of acquiring customers, and the payback over the customers’ lifetimes. This can be particularly true for larger deals or new services where the customer contributions appear large, but the time and cost taken to acquire these customers can make them loss-making over their lifetime. This is further exacerbated when accounting for a high time value of money in distressed situations: a large initial sales cost outlay and delayed incoming cash flows can generate large negative net present values and heavy cash requirements for some major prospective customers or ambitious new services.

Example – telecoms reseller turnaround

A corporate telecoms reseller had operated at low scale and with heavy losses for several years, and faced closure by its financing parent.

The business perceived greatest potential from large corporate customers and focused sales efforts on these accounts.

Analysis of customer lifetime and acquisition cost arising from low hit rate, resulted in the conclusion that the business was incorrectly focused on loss-making large corporates and under-investing in sales to highly-profitable SMEs

The business refocused onto SMEs and subsequently achieved trade exit in excess of £150m.

So, there we have it, four rarely-used but commonly insightful analyses to perform on struggling businesses, when the usual KPIs and Board packs have not given any productive clues to the causes of decline.

Given the recent trend for debt holders to delay taking control of breached or distressed companies, we believe that management and equity now has greater breathing space to diagnose financial issues. And we believe that a rigorous understanding of such issues is value-adding for everyone involved.

Copyright Latitude 2009. All rights reserved.

Latitude Partners Ltd
19 Bulstrode Street, London W1U 2JN

For the full text of this series email

Business turnarounds - troubleshooting performance problems (2/3)

In our last post we pointed out that the most fruitful areas to investigate for unaddressed causes of performance problems are, by definition, those that aren't covered in standard KPIs or Board packs.

We find four analyses particularly insightful, depending on the area of underperformance. The first two are suitable for understanding issues of sales (and gross profit) growth/decline, and we cover them in this post. The third and fourth are more suitable for issues with profitability; we will cover these in our next post.

To diagnose issues with sales or gross profit growth/decline, the two most commonly insightful analyses are:

1. Reviewing market and competitive benchmarks, in order to understand whether the company's product mix matches market growth areas and if gross margins are in line with peers, or if, more likely, the company is working hard to hold back the tide by growing share in a low margin segment

2. Analysing the year-on-year sources of business, to understand the reliable base line of secure business, and whether the company's underperformance is a result of issues with customer acquisition, customer retention, or both.

Review of market and competitive benchmarks

A market and competitive review generates rapid and useful benchmarks of reasonable growth expectations for a company’s services and expectations for gross margin. Problems with revenue and gross margin can often be simply the result of a poor business mix, skewed towards the low growth, low margin market segments.

Plans to exceed market benchmark growth or margin are too unconservative for a sound turnaround plan. Changing business mix to higher growth, higher margin segments, achieved by reprioritising marketing and sales investment, is almost always a more pragmatic path to follow.

Given the generally strong positive relationship between gross margin and market growth, such a reprioritisation kills two birds with one stone.

Example – technology services turnaround

Sales had slowed below historic rate in the previous 18 months, and gross margin shrinkage caused impending covenant breach.

Rapid analysis of market growth and competitor margins showed that business had focused excessively on a low growth, low margin segment. This growth in excess of market had depressed margins even further. A return to sales and margin growth was possible from rebalancing business mix to higher growth segments.

The refocus took 8 weeks to implement and resulted in business returning to full-year budget performance within 4 months. The business refinanced successful with all solvent banks retaining participation and is now the most profitable player in its sector.

Analysis of new versus retained business

Understanding a company’s reliable base of recurring business is clearly important in the context of turnaround financing and planning. In addition, a review of new versus retained business over months or years illustrates whether the revenue problem is one of acquisition or retention, each of which has very different restorative actions.

Example – tour operator turnaround

Sales had declined for three consecutive years in a steadily growing niche, resulting in declining total profit, with trend rate threatening covenant breach.

The business had cut unprofitable discounted lines but maintained traditional efficient distribution in an unsuccessful attempt to reverse profit decline.

Analysis of sources of yearly bookings showed a strong stable base of regular customers but a continual annual decline of new customers, resulting in steady decline of volumes.

Cumulative bookings from previous customers show consistent annual spend

Cumulative bookings from new customers show ongoing annual decline

Evidence of reliable loyal booking provided a solid baseline for a successful refinancing.

The business refocused on new customer acquisition through a successful new online channel, regional departures to reflect changing travel patterns and the launch of lower-cost introductory products to capture new customers.

Of course, there are limitless other analyses that can be used to address the underlying causes of sales underperformance, but the two in this post are the ones we find most useful and under-used.

In our next post, we will cover our two most fruitful approaches to understanding profitability issues.

Copyright Latitude 2009. All rights reserved.

Latitude Partners Ltd
19 Bulstrode Street, London W1U 2JN

For the full text of this series email

Business turnarounds - troubleshooting performance problems (1/3)

Turning around an under-performing company has one major characteristic in common with fixing your central heating - unless you work out what went wrong, you'll never fix it, at best you'll patch it up, keep your fingers crossed and sit there shivering next time the weather turns cold.

We have worked with hundreds of companies with performance problems. Only a handful of these had a clear and accurate picture of what went wrong to get them into trouble. With the exception of one (extremely fortunate) company, we have not seen any recover from distress without knowing the problem that got them into it.

There are occasional examples when the problems are obvious to everyone. In these cases, the decline is often rapid and can be associated with something specific, such as loss of a key contract, a change in legislation or a change in the market or competitive environment. Handling a potential turnaround in such a situation is usually straightforward, requiring brutal but obvious decisions. However, these sudden-dive situations are uncommon.

The majority of financially-troubled businesses that bring us in have experienced an extended decline, one that current or previous management has worked unsuccessfully to reverse. In these situations, management can often identify some areas of underperformance through various KPIs. However, without a clear and correct diagnosis of the underlying causes, management is shooting in the dark. It cannot possibly address business underperformance and more usually makes decisions that worsen the situation. As a result of such flawed or incomplete understanding of customer or service profitability, we have witnessed heavy targeting of loss-making customer groups, withdrawals from profitable, cash-generative business lines, proliferation of product into areas of marginal or negative return, together with a long list of progressively desperate gambles as performance deteriorates.

In a turnaround situation, the two major constraints are time and capital, and management needs to know where to direct them. To achieve this, we believe that a business needs to undertake a complete diagnosis of where it is making and losing money, and the underlying causes of performance problems. Only once it does this can it identify which areas of the business to protect, which to cut, and where to address scarce time and resources in performance improvement.

The most fruitful areas to investigate are, of course, the ones most commonly over-looked - ones that by definition do not appear in the Board pack or management accounts. In the next four posts of this series, we outline the four most common problems we see, and the ways to identify them.

Copyright Latitude 2009. All rights reserved.

Latitude Partners Ltd
19 Bulstrode Street, London W1U 2JN

For the full text of this series email

Turning around distressed companies (3/3)

In the previous two posts, we covered the first four stages we see in successful turnarounds: establishing the facts about the business and its market; working out what went wrong to get the business into its distressed state; and, once the problems have been identified and solutions proposed, taking control of time and taking control of money in the turnaround process.

Once in control, the turnaround team needs to make the first steps to develop some momentum in the right direction.

5. Make a series of promises you know you can keep

At the start of a turnaround every party with an interest is worried: employees, shareholders, banks, creditors, business partners, customers and suppliers. Increasing their confidence is critical to making any progress.

It is in management’s interest to be proactive and make a series of promises, which it knows it can keep. Hitting these checkpoints is the most effective tool management has to build its credibility. The most basic, and likely required, is a revised budget, but other forward-looking checks are also helpful. With every check management hits and promise it keeps, it builds credibility and confidence, financiers become less stringent and heavily involved, customers and suppliers go back to their regular relationship with the company.

To be successful, this approach naturally works its way down the organisation. For the CEO to promise a series of financial achievements to investors, he needs to be confident that his team can deliver on their promises in each of their areas, and so on.

This approach also has enormous and innate internal benefits - hitting promises helps organisational self-belief when the company needs it most.

The most important characteristic of such promises is not that they are ground-breaking, but that they are achievable in short time. As the mantra went in IBM’s turnaround “win small, win early, win often”.

6. Change the team

We have never seen a dramatic change in the fortunes of a company without a corresponding change in the senior team. This means at least two or three changes in senior personnel, almost always including the CEO.

It is usually self-evident, and often self-selecting, who is engaged in the turnaround and who wants out. We believe it is the job of the CEO to check the attitude of each member of the team and make the decision quickly. We have yet to come across a successful turnaround CEO who has regretted changing the team or has said they did it too quickly. We also find that getting the right turnaround team together is predominantly a matter of attitude; aptitude rarely comes into it.

7. Simplify

Complexity is a double-edged sword in turnarounds. Companies often get into trouble when they have taken on too much; and when they are in trouble they try extra things to get out of it.

By definition, many of these are not working and at best create a mass of distraction that the business can do without.

When cash and time and goodwill are constrained, the business needs to concentrate on doing a small number of things well. This can mean reducing product lines, cutting or selling business units, outsourcing business processes or numerous other simplifications depending on the situation. Whatever is done, the process of simplification needs to go far enough to give the remaining activities the focus of management time and investment required to do them well.

So there we have it, the seven stages we have seen successful turnaround teams take that distinguish them from the 70-80% of turnarounds that fail:

1. Establish the facts
2. Understand what went wrong
3. Take control of time
4. Take control of money
5. Make promises you can keep
6. Change the team
7. Simplify

All of these things are common sense and relatively obvious, but all of them are also easy to duck or delay. Hopefully, this article illustrates that our clients that have performed successful turnarounds simply do the sensible things that experienced managers know they should be doing anyway.

Copyright Latitude Partners Ltd. All rights reserved.

Please email for the full pdf.

Turning around distressed companies (2/3)

In our last post on successful turnarounds we covered the first stage: establishing the facts about the company's performance, particularly the often-disregarded investigations of whether the market remains attractive, if the competitive position remains secure, and what customers plan to spend with the company next year.

Having established whether the business has potential worthy of continued investment of time and money, the next stage is to understand what went wrong to get the company into its current sorry predicament.

2. Understand what went wrong

Companies we support in turnaround find themselves there for two generic reasons: either something major went wrong for a short time, usually loss of a dominant customer or a dramatic market change; or something minor went wrong for a long time, usually poor understanding of customer or product profitability, that led to misguided allocation of capital and resources. Either way, the reason for the problem needs to be flushed out and addressed. Any recovery plan is simply not credible without this process. In our experience, the forensic exercise to find the source of the problem is rarely difficult for fresh eyes.

It is tempting to blame market changes when things go wrong, and we hear this all the time. Sometimes market downturns do happen unexpectedly and these can land the company in trouble. So the company was unlucky. That doesn’t matter – the turnaround doesn’t hang on whether anyone was to blame or whether they were battered by fortune. What matters is that we need to establish whatever went wrong and fix it.

3. Take control of time

Senior teams, and particularly CEOs and finance teams, in distressed or turnaround situations, experience relentless demands on their time from all sides: owners, owners’ advisors, banks, banks’ advisors, customers, creditors, worried employees, worried Board members; the list goes on. At the same time, management is constantly harried by a series of apparently urgent tasks, each of which appears to be critical in its own way.

Tempting though it may be to heroically charge from fire to fire, coming up occasionally for air to report to lenders or answer questions from advisors; the senior team cannot possibly effect any sort of successful turnaround in such a responsive way.

The CEO needs to create breathing space for the business.

From our observation, the first thing successful turnaround CEOs do to achieve this is take control of time. They understand the requirement to accommodate communication needs and put out the urgent fires; but they also recognise the crucial necessity to protect the time that they and their team need to think, understand the problems in the business, formulate the plan, delegate and implement it. This protection takes numerous forms, such as establishing regular update meetings with all parties to limit repetition, setting weekly time aside to plan or talk to key customers; whatever it takes to promote the important so it is on par with the urgent.

4. Take control of money

Equally important to taking control of time is taking control of money, understanding where every pound is going and coming from. It goes without saying that the CEO needs to take decisive action on business solvency and a plan to return to profitability, which most usually means addressing cost. Where successful turnarounds differ is in the management of details, and the corresponding flows of money. The most effective turnaround CEOs we know make a habit of establishing and monitoring a realistic pipeline, creating a bottom-up budget and making the team accountable for every pound of income and spend.

In addition to problems of solvency and profitability, most companies in turnaround situations have issues with liquidity. Whereas profitability can be addressed internally by sensible planning and performance management, liquidity usually requires external support from financiers, ranging from payment holidays through to cash injections.

This liquidity brings breathing space that allows management to make calm, rational decisions that support long term survival and profitability. Without it, the company can end up in a frenzied cash and business chasing environment, of constant triage with an eye only on today’s problems.

The senior team has numerous tools at its disposal to persuade financiers or creditors to extend liquidity: the CEO’s personal turnaround track record, the business pipeline, the bottom-up budget, evidence of future customer spend or market growth, a plan to address what went wrong. But management’s strongest card, and now a regular requirement from lenders, is to make the liquidity conditional, i.e. making continued or extended financing subject to hitting a number of agreed goals. We cover this in our next post.

Copyright Latitude Partners Ltd. All rights reserved.

Please email for the full pdf.

Turning around distressed companies (1/3)

Turnarounds of distressed companies rarely succeed. Here are some observations of what I have seen to work.

First, to be clear, the common definition of a turnaround is very broad. It is basically about improving performance from bad to good. At one extreme, turnaround stories are about turning an under-performing company into a world-beater; using sports language, taking a regular team player and turning him into the world champion. This article is about the other extreme of getting the regular athlete out of intensive care: taking a company that will not survive in its current form to a position where it is profitable and sustainable.

Using this definition, most turnarounds do not succeed. The majority of respected surveys put the success rate of turnarounds between 20% and 35%, depending on the definition of underperformance and success. Those with turnaround experience know also that they are usually highly stressful and, if unsuccessful, very poorly rewarded.

We believe that it does not have to be this way. In our experience, there is almost always a decent business in amongst the detritus of a struggling company; which a smart CEO can rejuvenate with some tough decisions and a close eye on the business.

We work with some outstanding turnaround CEOs, whose success rate is close to 100%, and whose approaches share a series of common measures, which we summarise below. This list is not meant to represent a guaranteed recipe for turnaround success, it does not reflect the importance of addressing the specifics of each unique situation, and by definition it is incomplete. It is nevertheless a set of simple actions common to all the successful turnarounds we have witnessed and supported. We describe these measures in the broad order in which we observe them:

1. Establish the facts
2. Understand what went wrong
3. Take control of time
4. Take control of money
5. Make promises you can keep
6. Change the team
7. Simplify

We have written this article from the perspective of the new CEO. This is because we believe that a new CEO, brought in or promoted internally, is pre-requisite for getting a company out of intensive care or creating any step change in company performance.

1. Establish the facts

It is an almost universal practice and requirement for turnaround and recovery experts to establish the short term (three to six months) viability of the business. This is typically a rapid, internal exercise focused on contracts, commitments and cash flows. The exercise is absolutely necessary, but sufficiently well-understood and common that we will not cover it further.

Less common, but equally vital is ascertaining the one-year viability and two-year potential of the business.

This exercise is not a luxury: successful turnarounds almost always require liquidity from either debt or equity; and these sources will need to be reassured that there exists a viable business in the mid term, and that they are not throwing good money after bad.

The work requires an investigation of commercial reality, looking both inside and outside the business.

Externally, it requires interviews at a micro level to understand as clearly as possible customers’ budgets and spending intentions, and research at a macro level to garner the full facts of relevant market trends and competitive developments.

Internally, it requires a robust analysis and understanding of sources of profit and loss by either product, customer or market.

The entire exercise can take as little as two to three weeks for an experienced team, can be performed with minimal disruption to the business and if done well forms the basis of evidence for the recovery strategy. Armed with genuinely solid and accurate information about the external and internal business reality, the recovery strategy is rarely complex and generally obvious.

It is rare that we look beyond two years in distressed or turnaround situations. The time to look at outer years is when the fires are mostly out.

In our next post, we will look at the next three elements of the most successful turnarounds we have experienced: working out what went wrong, taking control of time, and taking control of money.

Copyright Latitude Partners Ltd. All rights reserved.

Please email for the full pdf.