The Evidence & Intuition.
In a recent blog post I outlined the 5 aspects that make our intuition unreliable and inconsistent. We need to consider the alternative to purely relying on human intuition in business. There are numerous factors in play in business from the various market forces to the various customer, direct customer base to internal team issues, government issues, economical issues etc. Even the simplest business has a number of factors at play and relying only on human intuition means that some flawed decisions are being made.
I must reiterate that I’m not saying that we must never use human intuition. My point is that leading & managing only by intuition is a problem.
As I have asked in recent days “how do you know”. We must look at data and understand what pattern is in the data. But it is not just any old data. Just because it is easy to get it does not necessarily mean that it is important.
The first step is to understand what is driving the business and then determine what we need to measure.
There are a raft of statistical techniques designed to find patterns and I don’t wish to complicate the management of small business in referring to statistically techniques however a number of these are very simple to utilise in a small business but can be extremely useful.
The use of statistically techniques can be applied to any setting including wine evaluation. Princeton economist Orley Ashenfleter predicts Bordeaux wine quality and hence eventual price using a model he developed that takes into account winter and harvest rainfall and growing season temperature. Massively influential wine critic Robert Parker has called Ashenfleter an absolute total sham and his approach is so absurd as to be laughable. But Ashenfleter was correct and Parker wrong about the 86 vintage. Also his way out on a limb predictions about the sublime quality of the 89 & 90 wines turned out to be spot on.
It’s not just wine that we can analyse the data to determine a more accurate prediction or to make a more informed decision.
But we need to measure what is important to the success of the business. This success factor will be found in the operations of the business not the financials.
To illustrate the power of looking at the evidence a paper in 2000 surveyed 136 studies in which human judgement was compared to algorithmic predictions. 65 of the studies found no real difference between the two and 63 found the equation performed significantly better than the person. Only 8 of the studies found that the people were significantly better predictors of the task at hand. If you are keeping score that’s just under 6% win rate for the people and their intuition and a 46% rate of clear losses.
So why is it that we continue to place so much stock in intuition and expert judgement. Overall it is clear we get inferior decisions and outcomes in critical situations when we rely on human judgement and intuition instead of hard cold boring data and measurement. This may be an uncomfortable conclusion but it’s the fact. We need to make better judgements thus we need to have those boring data and numbers.
Again I’m not proposing that we remove or dispense with the human expert or the human business owner but rather we couple the humans in the middle of an evidence based process. This has been the situation with medicine where the evidence conducted from numerous studies of techniques and processes and drugs pave the way for doctors to provide the correct diagnosis but it hasn’t removed the need for intuition of the expert specialist to make a judgement call. They are just being able to make it with the cold hard facts and the knowledge of the studies undertaken previously.
In a business if we have the information if we have the right numbers, if we have the right measurement then the management will be able to have this as their starting point for making decisions and determining the future of the business. Surely these decisions will be better informed as a result.
The one main number is not found in the financials.
Businesses are used to collecting the financial information and with their accountants compiling financial reports. But the one main number that is driving the business is not found in the financials. The one main number that will predict where the future of the business is going is not in the financial data.
Because we are measuring the accounting data it is easy to be tempted to use this information to lead and manage the business. The accounting data though is a history statement and is useful to review but you will never find the engine of the business in these statements.
The one main number will be found in the operations. The operations of the business drive the future of the business. But be careful. It is imperative that we understand what is important to the customer to determine the engine of the business.
A great example from a few years ago is Contintental Airlines from 1997. Gordon Bethune became the CEO the airline had as the one main number as :- cost per airline mile. Now whilst this significantly impacts on the bottom line it is not what the customer sees as important. It lead to behaviour to reduce the quality of meals, fittings etc. Gordon changed this to :- on time arrivals. This changed the focus to something that the customer value. The airline went from worst to first.
The one main number was in the operations. Importantly though it was what the customer see as valuable.
How will you know?
In the recent blog post I asked a question that was provoked by a podcast by Joseph Michelli about “How do you know?” In other words, what data are you relying on in your business to make decisions?
The question now is “How will you know?” I’m here looking at the future, that you have some goals and objectives in the business, but how will you know whether you’ve achieved them?
See, often goals and objectives can be nice words but it is not clear that we will know when we’ve achieved those nice words. Words are important in a business, critically important, but also just as important is the data.
What number are we focusing on? What is the critical main number that we are targeting in the next 3 months, 6 months, 12 months? What is the number or the measure that matches those nice words in our strategic objectives and goals?
It doesn’t matter whether the organisation is a small local business, a big business, or a not-for-profit organisation. We all have a purpose with the services or products we are providing and we all want to achieve a better result in the future than we have in the past.
So the question that I ask is “How will you know” that you delivered a better result? What is the one main thing that will tell you that you have delivered a better result?
Do Your Frontline Staff Look At Things From The Customer’s Perspective
Recently I travelled to Tasmania on business and stayed at the Mid City Motel. I was there for 2 nights and the motel room itself is quite well appointed. The lady on reception was a little bit vague when I checked in. I got up to the floor and the swipe cards that had been presented didn’t work but housekeeping were there cleaning out other rooms and let me in and were quite friendly. I went back downstairs thereafter and the check in lady (reception lady) corrected the cards. so this point in time I’m still neither extremely happy or in no way could I say that I was unhappy. In the room it advertised that breakfast was a buffet breakfast available in the restaurant on the ground floor.
The next day I went downstairs to the restaurant and I couldn’t see the buffet breakfast so I asked the lady present and I was told no we don’t have buffet breakfast you just order al-a-carte. I’m thinking to myself that this is a little odd as it was contrary to the information in the room. But then it started to deteriorate from there. I was asked as to what room I was in and I stated the room 506 and she went off to her computer and came back to me and said nobody is in 506. I said well I am and showed her the envelope with the swipe cards in it that quite clearly showed that I was in 506. She asked for my surname went off and came back and said “No, you’re not in 506 you’re actually in 603.” I said “Well I am in 506, but obviously your computer system is saying 603.”
The upshot of the conversation was that this lady did not in any way believe that I was in 506. So that I could actually enjoy breakfast I signed the voucher as 603 and I’m thinking the poor person in 603 is going to end up with my breakfast bill, but I’ll go to reception straight after breakfast and sort it out. So after the breakfast I went to the reception and I was told by the person there that I was in room 603 despite me quite clearing saying where I was and the envelope. But they continued to disbelieve me.
The next day at breakfast again I thought “No, I’m not going to go to the motel’s breakfast service.” So I went off to a restaurant elsewhere to have breakfast, rather than argue which room I was in; so the business lost that service. Then I came to checkout, which could have been … well a tad intriguing. And once again I was told I wasn’t in 506, but 603. To which I then asked “Was there a difference in room rate?” And there was - $20 a night difference, so then an argument ensured to prove I was in 506 which after a few minutes they finally amended the bill to reflect that I was in 506 and I checked out.
The upshot of all this is that at no time did anybody that I dealt with try to actually take the situation in hand and resolve it. Customer service was not even in the consideration. The computer must be right, the customer must not have a clue as to which room he is in.
So the little thing of the sign in the room about the buffet breakfast became a big issue, because suddenly you are looking at everything.
Now I am telling the world and using the experience as an example of poor customer service. The attitude from the people was not of trying to help but rather it was “customer get away, you don’t have any idea, you are a pain”.
They did not even try to look at it from the customers perspective.
Do your frontline staff look at things from the customer’s perspective? How many clients are you annoying because of your systems and processes? How many customers are you turning away? Not because of necessarily hugely bad service, but just because of an attitude of ‘we are right, the customer is wrong’. I think lessons can be learnt from this example that in no way did they try to distinguish themselves from other accommodation in the town, but rather had the attitude of the customer is wrong. Suffice to say, I won’t stay there again and suffice to say that I’m recommending to everybody else to look at alternative accommodation.
Profit As Altruism
George Gilder has written extensively about entrepreneurism. Recently I read a piece by George where he called ‘profit an index of altruism’.
Often profit unfortunately in our society is automatically associated with greed. There is no doubt that there has been (unfortunately) cases of excessive profits and greed that has been espoused by some sectors of the business community.
This should not mean that profit gets a bad name as a result. It would be crazy to replace a flawed system with a failed system. The profit motive may be a flawed system but everything else are failed systems.
Profit is what is necessary to feed the spirit of entrepreneurism the world over. It is only through small-medium businesses that are willing to a risk and to explore the mysteries of business that society as a whole is better off.
It is only through the profit motive that inspires entrepreneurs to have a go that employment increases, general welfare of our society increases and we as consumers are served with better products and services for our enjoyment.
Altruism is considered to be inspired by something other than profit. But as George Gilder states profit is an index of altruism. Through profit society is better off.
Profit is good - don’t demonize it. Profit motivates positive society change benefiting all. We must be careful of regulation that would in any way stifle the entrepreneurial spirit that will lead to a better world for all.
Price is Not based on Cost.
Recently a graph of relative prices of various liquids was posted on ReflectionOf.me blog. The graph shows that HP Black Ink is the highest relative price with oil being the lowest. The comments people are leaving are also interesting. A lot are railing against Hewlett Packard and there is a discussion of the cost of the various liquids.
But PRICE is NOT based on COST.
Price is set by the value the consumers perceive. Price is affected by the competition and sometimes by the heavy hand of regulation.
So why would HP Black Ink so higher relative to other the liquids?
Remember price is a marketing tool. The price of the ink needs to be taken with the price of the underlying printer. For the consumer level printer HP make nothing. They have set the price low to get the printer into your house or office and then they can sell you the ink and make the profit.
But please price is not set by the cost of the item.
How are you setting your prices? If you are not differentiating your product or service from everybody else then you will be lead down the both of lower price. HP are differentiating their printers from the competitors which then leads to the ink sales.
Price is a marketing tool
A fun way to promote a brand & illustrate a point.
“We believe that the easiest way to change peoples behaviour for the better is to make it fun to do.”
There are a number of things to be learnt from the video below.
Firstly Volkswagon have nailed the viral video. At the last time of looked this video had been viewed over 8.9 million times. This is one video of a series. Have a look at The Fun Theory for the others. Volkswagon instead of trying to market their vehicles have set and image for their brand in a fantastic way. It is a brilliant use of Web 2.0 to build their brand but they are not selling their cars etc.
The other lesson from this is the fact that if we make it fun and amusing for people to do then we can change people’s behaviour for the better. Economists have long held the belief that people react to incentives. Too often in business this is taken to mean more money. But if we make a workplace fun for the employees and experience for the customers then we will get loyal customers served by engaged employees.
Watch the video and look at the two lessons from this. How can you promote your brand in a unique way and how can you make it fun for your team and customers?
Some observations on achieving superb team performance
Getting performance from any group of people means a permanent change in the way they think and operate a business. To achieve this permanent change it is necessary to consider some aspect of human behaviour.
People want to be great. If they aren’t it’s because management won’t let them be. People do not generally intentionally set out to do a bad job. This usually only comes about when the culture has turned sour.
Performance begins with each individual’s expectations. Influence what people expect and you influence how people perform.
Expectations are driven partly by goals, vision, symbols, metrics and partly by the context in which people work. That is by such things as the pay structure, incentives, operating practices and importantly decision making structures.
The actions of managers shape expectations.
Learning is a process, not a goal. Each new insight creates a new layer of potential insights.
The organisation’s results reflect the individual and the individuals performance. If you want to change the results, you have to change yourself first.
To make changes that will lead to great performance focus on goals, expectations, contexts, actions and learning. The leadership responsibility is to establish the conditions which superb performance serves both the company’s and the individuals best interests.
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How EBITDA Can Mislead
During the dot-com boom, EBITDA became a popular way to measure how healthy a business was. EBITDA scores became the talk of Silicon Valley cocktail parties, where party goers would ask each other, “How soon will you be EBITDA positive?”
Today EBITDA remains a valuable, if controversial, number for evaluating a company’s earnings. After all, the WorldCom meltdown was facilitated by financial fraud related to EBITDA.
Before we examine why EBITDA is favored by some and scorned by others, we need to consider EBIT (Earnings Before Interest and Taxes). As you might know, EBIT is synonymous with Operating Income, and is the profit or loss that is generated by operations of a business before interest expenses and taxes. In essence, it’s the number that tells you how much profit or loss your operation is generating.
EBITDA is a form of EBIT. Actually, Joe likes to say it’s an obvious form of EBIT — EBIT “DUH” (sorry…it’s hard to make jokes about EBITDA). It stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
Depreciation and amortization are unique expenses. First, they are non-cash expenses — they are expenses related to assets that have already been purchased, so no cash is changing hands. Second, they are expenses that are subject to judgment or estimates — the charges are based on how long the underlying assets are projected to last, and are adjusted based on experience, projections, or, as some would argue, fraud.
EBITDA is a number often used in the financial industry as a loan covenant. Borrowing limits for businesses often are set as percentages of EBITDA. One of the most common methods to value small businesses being acquired is by using multiples of EBITDA. For example if you own a business that generated $1 million dollars of EBITDA last year and companies in your industry typically sell for 7 times EBITDA, then the sale price of your business will probably be in the $7 million dollar range.
Bankers like EBITDA because it will eventually represent operating cash flow (since the non-cash expenses are added back in). That helps to explains why bankers like the ratio in loan covenants. If EBITDA is good, the thinking is, operating cash flow will not be far behind.
EBITDA can also be misused. In the mid-nineties when Waste Management was struggling with earnings, they changed their depreciation schedule on their thousands of garbage trucks from 5 years to 8 years. This made profit jump in the current period because less depreciation was charged in the current period. Another example is the airline industry, where depreciation schedules were extended on the 737 to make profits appear better. When WorldCom started trending toward negative EBITDA, they began to change regular period expenses to assets so they could depreciate them. This removed the expense and increased depreciation, which inflated their EBITDA. This kept the bankers happy and protected WorldCom’s stock.
Because EBITDA can be manipulated like this, some analysts argue that a it doesn’t truly reflect what is happening in companies. Most now realize that EBITDA must be compared to cash flow to insure that EBITDA does actually convert to cash as expected.
In our Financial Intelligence Test one of the questions people miss most often involves EBITDA (even senior finance people missed the EBITDA-based question). Many of us can define what the term EBITDA means, but we also should know why it’s important and how it is should be used.
Does your company measure EBITDA? How helpful have you found it to be?
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