Better change

New ventures and even existing businesses are not immune to the powers of change. Change also happens when it is least expected and the interaction between changes definitely can lead to drastic and dramatic shifts in a business. So how do we become better at change? Is it possible to become a change master? How can entrepreneurs better utilise change to their advantage?

A business is often as good as the manager or leader in the organisation. This leadership theory extends further to say that the person is as good a leader as they are a person. So a good leader will be a good person and will run a good organisation. While the empirical evidence for the two-way relationship between goodness and leadership is not perfectly correlated there seems to a natural link between the sustainability of leadership and the inherent qualities of the leader. This forms the basis of integral management theory as proposed by Shewart and Deming (1939) and further developed by others in literature (Avilo, Galindo, Mendez, 2012; Walton, 1986) and it starts giving us some new ways to look at change.

It basically states that the leader needs to be an expert at managing change. This means both responding to change and also creating change.

Very few leaders that are worth their salt does not ask what they need to change to make the business work. But it is not always responding to change that is the challenge but also how to initiate and sustain it.

Organisations need to change constantly. It seems that we all want “out of the box” perfect businesses and that planning and constant backwards and forwards engineering of processes consume most businesses and entrepreneurs. What most businesses often ignore is the market forces that necessitate us to look at change differently. We cannot however manage every required change as the business grows – so the question becomes how we maintain our culture and perspective that made the initial business successful.

As the social and business environment is constantly evolving, new entrants are entering markets, consumer preferences change, trends come up and the very people that you employ also change. Each person also changes and this change has an effect on the world around that person. There is a constant ebb and flow between seeking growth and accelerated performance while balancing with the realities of people that are expected to deliver on this.

To become a change master one has to start asking what is the changes that if you make them today will have a meaningful and long term positive impact on the organisation and to actively work towards that. This change needs to be embodied in the organisational vision or dream and needs to re-inforced at every turn possible.

To make a change based approach to entrepreneurship work it requires a long hard look at the facts of the business and to act on these premises to build a conclusion that is in line with your vision. If you see that the facts that are in front of you will lead to a result that is different from you vision – you have to start asking – what needs to change?

Once you find the change that is required – arguably the rest of the process is much easier.

It may be tempting to look at change as something that is delivered by consultants. Change is not easily something that is bought for a fee, however it may be useful if dramatic and incisive change is required in an organisation to employ these change experts and it is often useful to have to someone around to blame if it does not work. However – we may have moved beyond a more structured approach to change management as proposed by Kotter (1995) and can say that purpose driven change management presents a new paradigm in which real and systemic change in organisations are facilitated through a clear understanding of the purpose of the business to its customers and the subsequent operations that are required to support this customer driven focus through the purpose of the internal stakeholder.

Linking the customer purpose to the purpose of the individuals in the organisations is a powerful approach to massive success. We all like working for companies that make us happy and that makes their customers happy.

To this effect many propose that the correct process is to

• Dream;
• Execute; and
• Review.

This model assumes the following methodology:

• The company started with a dream and goals that generally arise from the entrepreneur’s personal or business philosophy.
• The entrepreneur’s business philosophy founded a group of policies that govern each of the strategic activities of the company, by a group of procedures for each of the links in the chain of success.
• The entrepreneurship proceeds to design and to enforce the activities proposed by the policies designed.
• The established procedures produce results that must be reviewed by a battery of diagnostics and must be compared with the original dream goals.
• The review could imply, if difficulties in achieving the goals appear, the introduction of decisions to correct the situation, trying to obtain continuous improvement and the achievement of the dream goals.

The strength of the dream and the skills of the entrepreneur or their management to drive the correction towards the dream will determine the progressive realisation of the vision as outlined.

This approach to managing change is supported by an action learning methodology which is based on the premise that you

• Learn;
• Correct;
• Redefine; and
• Execute.

The principles underlying action learning are:

• learn from personal experience and from the experience of others;
• consider the challenges posed by other entrepreneurships and listen to the suggestions of others;
• listen carefully to others in an environment with no prejudice;
• develop several possible courses of action that facilitate the entrepreneurships to develop their business and problem solve; and
• review the results of actions, taking into account the opinion of other members of the group and share the lessons learned.

We have to decide what to change today to make the business move closer to a dream and a future reality that is desirable to our customers and other stakeholders. We have to be decisive about these actions and execute on the changes – making sure that they are anchored in the organisation and that they continue to contribute to the on-going success of the organisation. We also need to let go of our fear to change things.

To really get better and to stop our business from getting stuck into a pattern that makes it resistant to change – we have to be open and inviting to change and also be the creators and masters of change or else things will change around us and we will be the victim of change.

Conclusion

Change is real. We have a choice to determine if we will change the world or if the world will change us. This choice is made by the millions of little actions that we do everyday to move closer to our dreams. If we start ignoring the sense that we are moving further away from where we want to be – then we are being led by change. To get back to our true purpose, dream and vision we have to make decisive steps to learn from the environment and share and grow with others to bring us closer to that vision. This is the call – you better change and you have to be better at change.

Kotter, J.P. (1995) Why Transformation Efforts Fail, Harvard Business Review, Mar 1995.

Shewhart, W.A. and Deming, W.E. (1939), Statistical Method from the Viewpoint of Quality Control, The Graduate School, The Department of Agriculture.

Edgar Muñiz Avila, Miguel-Ángel Galindo, María Teresa Mendez, (2012) “SERCREA+ model: a business tool for change management in Mexican organizations”, Journal of Organizational Change Management, Vol. 25 Iss: 5, pp.736 – 747

Walton, M. (1986), The Deming Management Method, The Putnam Publishing Group, New York, NY.

Adding economic value

When you study economics, you are taught that the price of a good or commodity is determined where there is a balance between the supply and demand for that good. If more people demand it, then the price is higher and when less is supplied then the price is also higher. The challenge in an open market is that if you limit supply, the next guy will supply more and you would have lost out. This is the power of competition. While that explains why monopolies limit supply to increase prices – it does not give a clear guideline on how to create value.

Value added in economic terms is the difference between the price of the finished product/service and the cost of the inputs involved in making it. So measurement of value added shows the enhancement a company gives its product or service before offering the product to customers. Value added is used to describe instances where a firm takes a product that may be considered a homogeneous product, with few differences (if any) from that of a competitor, and provides potential customers with a feature or add-on that gives it a greater sense of value. This increases the demand for the product and so increases the price that can be asked for it.

A value-add can either increase the product’s price or value. In marketing one gets taught that customers are weighing different features and benefits of options to find the correct price. For example, offering one year of free support would be a value-added feature and would be compared by the customer to other products without such a feature. Additionally, individuals can bring value add to services that they perform, such as bringing advanced skills to a position in which the company may not have foreseen the need for such skills. The combination of what makes your organisation different defines the value that is added to the end consumer. Bad choices in terms of adding value may cost more than it generates.

This is where management comes in. Managers also add value. Their primary stakeholder for adding value is the shareholder. The basic cost of doing business is defined as capital expenditure and through the management process, economic value is added to shareholders. This basic insight led to the formation of the theory of economic value added and provides a measure of a company’s financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit (adjusted for taxes on a cash basis). This is also referred to as the “economic profit” and is a measure of how well management created operating profit. The formula for calculating EVA is:

EVA = Net Operating Profit After Taxes (NOPAT) – (Capital * Cost of Capital)

If the EVA is positive then the company created more value than expected by shareholders. If the EVA is negative – then the company performed lower than expected by the shareholders. Cost of capital is a measure of the return in excess of market that is expected by the shareholder.

Another similar measure is Shareholder Value Added, which follows the same type of idea and is expressed as

SVA = Net Operating Profit After Taxes (NOPAT) – Cost of Capital

This gives a value based performance measure of the worth of the company to shareholders as it measures the value that is added, considering the profit that is generated in excess of what is required to outperform the requirements of the issue of debt and equity considering the weighted average cost of capital. (This may sound daunting – but read more on the MBA Finance Module to find out more).

So it should be easy. As long as management creates value, shareholders should be happy. The separation of ownership from the control of capital by managers creates a conflict of interest. Managers who run the business need not necessarily be guided by the same principles as owners in terms of enhancing shareholders’ wealth – but act in their own best interest. This is called the agency problem. While more complex, some companies use the incremental increase of EVA as a management performance measure in order to maximize shareholders’ wealth. This includes some of the world’s largest corporations.

EVA makes people accountable not just for the results but also for resources utilized in achieving the results. For example, without an EVA-based incentive system, marketing people generally want more resources to sell more and earn larger sales-based compensation even when the marginal benefit to the organization is less than the marginal cost of increased sale. This would also apply to the marginal cost vs. benefit of an employee and many other measures within the business. An EVA based decision-making and incentive system would determine if there is an economic value that will be created by this decision. To motivate managers to act in shareholders’ interests, one option is to link their compensation to increases in EVA they produce. Managerial objectives based on increasing income or market share, increasing return on assets or equity or other traditional measures can provide incentives that are not consistent with maximizing the shareholders’ wealth. Maximizing EVA will in most cases produce incentives to maximize shareholders’ wealth.

Organisations are a complex variety of explicit and implicit contracts involving several stakeholders, including, employees, customers, suppliers, lenders, the community and shareholders. Each of these contracts or relationships is a decision that must add economic value. You may say that this is great – as our company provides services without a lot of capital. Both tangible and intangible capital represents a choice managers make daily and the cost of that capital determines if the business adds value to shareholders or not. So, through managing these complex contracts you add value to the brand and to the operations and this adds value to the shareholders.

Most companies estimate the marginal profitability of their product without regard to opportunity cost of equity capital. So often it happens that companies are willing to accept business at a margin that is profitable, without considering if we have other choices in terms of using the same operating capital.

To be practical – think of it this way. Every day you earn a salary. If you take this salary and divide it by 21 workdays you get a number of how much you earned today. If you take this number and multiply it by 10 it gives you a sense of how much value you should create daily. If you further take this daily value add number and you multiple it by the number of people in your section or division – you need to ask yourself if your business unit created that much value today through the work that you have done. If you did not – then there is better ways in which the tasks or objectives of your section or division can be structured to add more value. The value may not be for today – but you must have worked on items that created that much value today for it to be profitable for shareholders to pay you to do it tomorrow. You may argue that you are an employee of a non-for profit – the same logic applies. You may also argue that you work for the government – the same logic applies.

In summary

Value added is a vital part of the operations of any organisation and has direct links to marketing, sales and the operations of any organisation. If more organisations focused on the value addition process it would direct the use of capital into increasingly relevant areas and build long-term choices that add maximal value to shareholders and build more sustainable organisations.

Economic value added (EVA) is an important measure to determine if there is value added to shareholders and can form the basis of incentive and decision making systems.

As an individual it is important to measure my own value added daily to find ways to ensure that the efficiency of an organisation improves.

Adapting business models for emerging markets

Increasingly companies are looking for their future growth in emerging markets. Up to now the recommendation has been that only way that companies can prosper in these markets is to cut costs relentlessly and accept profit margins close to zero.

The companies that are cracking these markets realise that opportunities in these markets don’t require companies to forgo profits, but it is not simply transplanting their existing business model and products into a new marketplace. This requires a new operational reality to make it work.

The key realisation should be that things like transferring money through cell phones, running hand-wash laundry services and improved distribution of traditional produce is typical of innovation that drives a new economy that requires a business unusual approach that makes commerce work in emerging markets.

That may sound overly simplistic; given the difficulty Western companies have had entering emerging markets to date. But we believe they’ve struggled not because they can’t create viable offerings but because they get their business models wrong.

Importing foreign business models.

Many multinationals simply import their domestic models into emerging markets. Through reduced functionality and branding changes, lowering prices and perhaps selling smaller sizes or by using lower-cost labour, materials, or other resources – these companies believe that they can take marginal profits and take market share. Sometimes they even design and manufacture their products locally and hire local country managers. The fundamental financial and operating models remain unchanged, limiting these companies to selling largely in the highest income tiers, which in most emerging markets aren’t big enough to generate sufficient returns. What they do not realise is that these upper tiers are spoilt for choice in most emerging markets where there is typically two economies and while they inch away at market share in these markets that typically represent at most 10% of the market, the remaining 90% does not have access to these products.

Many companies have already been lured by the promise of profits from selling low-end products and services in high volume to the very poor in emerging markets. And high-end products and services are widely available in these markets for the very few that can afford them: You can buy a Mercedes or a washing machine, or stay at a nice hotel, almost anywhere in the world. Our experience suggests a far more promising place to begin: between these two extremes, in the vast middle market. Consumers there are defined not so much by any particular income band as by a common circumstance: Their needs are being met very poorly by existing low-end solutions, because they cannot afford even the cheapest of the high-end alternatives. Companies that devise new business models and offerings to better meet those consumers’ needs affordably will discover enormous opportunities for growth.

Supply chains

To supply products in new markets requires both the supply chain as well as the customers. When you do not have the suppliers to can give you the raw products, then it is very expensive as it needs to transported or manufactured in that market. Many organisations move the product to a new market without the supply chain being in place. This is another key reason why local innovation is a key strategy.

Innovating for success

Leading scholars suggest that the best strategy in these markets is to find an idea where there are people that need a service in line with your core business, prototype and execute it. The aim is to build a new business model and to make it work. If you want to link this in time to your existing product range – this is great – but innovation requires local relevance as much as it requires the bells and whistles.

Back to the business model

So to move into these markets requires a lot of situational awareness and back to basics thinking. The very basic of any business model is to answer how plan to make money.

Behind that question is a line-up of other questions:

• Who’s your target customer?
• What customer problem or challenge do you solve?
• What value do you deliver?
• How will you reach, acquire, and keep customers?
• How will you define and differentiate your offering?
• How will you generate revenue?
• What resourcing (HR, Finance, Operations) supports this model?
• What’s your cost structure?
• What’s your profit margin?
• How will your customers pay?

These fundamental business questions need to be rethought when entering new markets.

Sophisticated business models can follow later and a lot of innovation may go into making this work but it must be back to the basics of the business model.

Understanding the basics of costs

For most large organisations the idea of fixed cost recovery and variable cost is already in place due to economies of scale. For smaller operations it is important to consider that start-up thinking is required.

Expansion into a new market means that there is a growing fixed cost base and also a variable cost to each new product that is produced, that initially is very high and later becomes lower. The refine a localised business model requires a clear understanding of this and to keep on linking the price to the cost and quantity being sold.

Some definitions that may assist for those unfamiliar with this include:

• Marginal cost is defined as (Fixed Cost + Variable Costs) / Number of products
• The marginal revenue is the additional revenue a firm gains by selling an additional unit of a good or service.
• Fixed costs: Your business will have plenty of costs — from renting an office and buying equipment to paying salaries and buying supplies. Some of these costs — office rental or salaries, for example — don’t change often and must be paid on a regular basis. These are fixed costs or overhead.
• Variable costs: Other costs, called variable costs, fluctuate with your sales volume. They include the materials that go into producing your product or service.

When marginal revenue is greater than the additional costs associated with producing an additional unit, known as the marginal cost, revenues will increase. Profit-maximizing firms seek to produce the quantity at which marginal revenue is equal to marginal cost.

Your sales must also cover your fixed and variable costs as well as your profit expectations and to know which is which. In start-up situations fixed costs increase and variable costs goes up initially and later decreases as production processes become more efficient.

On the ground, remote management or partnerships

When deciding to expand it is critical to decide if you are committing to a market. Without commitment you are setting up to fail. Emerging markets require commitment and a lot of initiatives fail because people seek local partners, do not commit to get their own staff and believe that they can manage the market the same as their domestic market. It is critical to think through the skill sets required, the people to do it, complex arrangements such as taxation, currency transfers and supervision and to do this while accepting that your business model will have to adapt to local conditions.

Conclusion

Most organisations are looking at to build their international presence and a lot of companies are betting on the fact that growth will come from the 5 billion people in emerging markets and the developing world. This market requires careful study and deliberate strategy in order to succeed. While there is money to be made – it requires an innovation mind-set and not simply the transplanting of what you do at home to a new place. If you are not thinking about your international strategy yet – maybe it is time to consider it.

http://hbr.org/2011/01/new-business-models-in-emerging-markets/ar/1