Archive for March, 2012|Monthly archive page

Reduce risk via operational hedging

Exchange rates play an important role in determining corporate profitability and competitiveness. The current strength of the Canadian dollar poses unique risks and opportunities for Canadian companies with global supply chains and those who sell in many geographic markets.

Specifically, firms must manage having their revenues denominated in Canadian dollars and their costs denominated in other currencies. Exchange rate fluctuations, specifically a steep fall in the loonie, will introduce significant variability in costs and revenues potentially wreaking havoc on profitability, competitiveness and shareholder value.

While there are solid benefits to a strong dollar (e.g. stronger purchasing power), there are also compelling financial and strategic risks around a rapid and sustained fall in the loonie. Managers would be wise to pursue a more holistic and longer-term approach to risk management, with particular attention paid to operational strategies.

The loonie is at a record high versus key foreign currencies. Canada’s dollar traded stronger than parity with its U.S counterpart on average this year for the first time in three decades. The currency averaged 98.92¢ per U.S. dollar in 2011 – the highest annual value since 1976 when it traded at US.63¢. The loonie’s relative value against the greenback is vital to almost every company as the U.S. is by far Canada’s largest trading partner.

Furthermore, the loonie is overvalued against other key currencies. For example, Canada’s dollar had its strongest annual close against the euro since the shared currency began trading in 1999. Is a strong loonie sustainable in the long term? Not likely. According to the IMF, the loonie is will be 20% overvalued versus the greenback on a purchasing power-parity basis. The larger the overvaluation and the longer it is sustained, the greater the business risk.

A rapidly falling loonie will have serious implications for Canadian firms with outsourced production including higher input (raw material, labour and transportation) costs, a potential loss of domestic market share versus domestic producers and eroding profit margins. There are many macro-economic and political reasons why the loonie could drop quickly and precipitously.

Ongoing uncertainty around the European debt crisis as well as a slowdown in Chinese growth may dampen the global economy and demand for the commodity-driven loonie.  Canadian fiscal performance may hit the skids plus there remains the potential for falling interest rate spreads versus the U.S. Finally, continued political instability in the Middle East and Asia threatens to create instability in the currency markets. Canada is a relatively small currency market and is not a safe haven for international investors in times of turmoil. When fear grips markets, flight-to-safety flows hurt the loonie.

The impact of a long-term fall in the dollar’s value and the associated exchange-rate risk is not only limited to short-term financial exposure. In an integrated global economy, companies face strong interdependencies across their risk categories – strategic risks, operational risks, financial risks and external risks – which can quickly degrade their competitive position, limit decision-making flexibility and shrink operating margins.

Traditional financial hedging tools, designed to smooth out short-term cash flows, are often insufficient or too expensive to address large and sustained exchange rate shifts. To effectively manage these longer-term risks, companies should employ “operational hedging.”

Operational hedging is a holistic risk-management approach that allows for greater flexibility in how supply chains, product distribution patterns and market-facing activities are designed and changed. Managers would use operational hedging strategies in conjunction with financial hedging to pre-empt or mitigate the effects of a large, exchange rate-triggered change in their cost structure, customer demand and competitiveness. Typical operational hedging strategies could involve revamping a firm’s supply chains, go-to-market program and purchasing strategies based on their unique business model and market environment.

Firms should approach operational hedging in a systematic fashion by: determining the vulnerable areas in the business (i.e. the cost and revenue drivers that are most impacted by large exchange-rate swings); considering various scenarios for currency-related risk impact (e.g. using multiple exchange rates over different periods); perform a sensitivity analysis on these drivers to determine the total business impact; and adopting operational hedging as a foundational risk-management strategy. In terms of operational hedging, strategic choices could involve evaluating the location of production facilities, sources of raw materials, pricing strategies, logistics networks, and how sales and marketing channels by geography are organized.

When deployed proactively and carefully, operational hedging can be a powerful tool to minimize the impact of major currency shifts on costs and revenues, while enabling firms to potentially leapfrog less-agile competitors. Managers need to be mindful that a proper operational hedging strategy may require significant time and investment to implement, whereas a steep decline in the dollar’s value could erode operating margins and competitive positions rapidly.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.


In praise of middle managers

If the popularity of Dilbert cartoons is any indication, middle managers do not enjoy a sterling reputation.  They are often perceived as bumbling bureaucrats who get in the way of the real work being done in the sales, production or finance departments.  New Wharton Business School research published in their Knowledge@Wharton newsletter may change that perception. The findings suggest that middle managers have a greater impact on company performance than the business strategy, organizational structure or contributions from individual innovators and leaders.

The author, management professor Ethan Mollick, studied the role of individual, team and strategic contributions on firm performance in the computer game industry.  Specifically, he looked at “how performance changes as you combine different people in different companies in different ways.” He used the revenue of each company, controlling for costs, to measure corporate performance. Mollick’s research focused on the development of individual games over a 12 year period.  These projects represented $4B of revenue and included 537 individual producers, 739 individual designers and 395 companies.

Mollick’s findings negated conventional wisdom that says: 1) performance differences between firms are due mainly to organizational factors – such as business strategy, leadership and practices – rather than to differences among employees and; 2) middle managers are typically interchangeable between companies, possessing few unique attributes that propel project success. Mollick concluded that it was middle managers, rather than innovators or company strategy, who best explained the differences in corporate performance. Within the research, managers accounted for 22.3% of the variation in revenue among projects, as opposed to just over 7% explained by innovators and 21.3% explained by the organization itself.

“Far from being interchangeable,” Mollick writes, middle managers “uniquely contribute to the success or failure of a firm…. Additionally, even in a young industry that rewards creative and innovative products, innovative roles explain far less variation in firm performance than do [middle] managers.”  While innovators may come up with new games and new concepts, middle managers assume the more crucial role of project manager i.e. executing the initiatives.  Specifically, they decide which ideas are given resources and figure out how to coordinate various initiatives within the larger organization.  Other essential roles played by middle managers included motivating the team, managing budgets, ensuring a free flow of information and facilitating “collective creativity.”  Fortunately for most employees and organizations, these are teachable skills.

In order to see if these skills were transferable, Mollick analyzed individuals who moved between companies. He found that middle managers who switched employers had an even larger impact on performance than those who remained within organizations. “This is not about a person being a good fit in just one specific organization. Their skills are useful anywhere.” It’s more evidence that managers are not “cogs in a machine. There is something innate in them that make them good at what they do.”  A middle management “skill set” appears to be a prerequisite for driving performance in industries and fields that value knowledge, problem-solving and collaboration, like software, advertising, life sciences and professional services.

The above conclusions, however, do not necessarily translate to scale-driven, process-based industries. In these enterprises, Mollick writes, “Individual workers are ultimately replaceable and interchangeable with others who have received the same extensive training.” The business model “does not rely on any individual worker’s skills but rather firm-level processes to hire and train the appropriate individuals for the appropriate roles.”

Mollick’s conclusions have a number of organizational implications:

  1. Pay closer attention to hiring and fostering the right skill set, and less so on corporate fit;
  2. Link a manager’s decision and information rights to their true role and responsibilities;
  3. Align a middle manager’s performance and reward system to a project’s revenue contribution.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

New IT, a diamond or a lemon?

When it comes to deploying new technologies in areas like social media, mobile enablement and cloud computing, CIOs face a bewildering array of hardware and software choices. Moreover, management dynamics can further complicate matters. For example, IT professionals often fall into the trap of chasing the latest technology fad, over-designing for the application or over-committing to their internal stakeholders. All of these issues will ratchet up complexity, making it hard to separate the good technology – for your company – from the bad stuff.

The cost of choosing the wrong combination of hardware, software and services can be high in terms of wasted investment, greater project risk and longer time to business value. How do managers determine whether a new technology is suitable for their requirements? Our firm helps IT departments make these important decisions through the use of a common-sense yet rigorous 6-step vetting process:

  1. Is there a commonly accepted nomenclature for the technology? Immature or early stage technologies often feature a disparate set of names and descriptions. A new technology is not sufficiently advanced if the industry can’t align around agreed upon terms and definitions.
  2. Have standards emerged? New technologies do not coalesce around standards quickly, as vendors jockey to gain market penetration for their products.  A lack of standards will pose challenges for prospective buyers who want to compare vendors on performance and features, as well as integrate the new technology into their existing IT infrastructure.
  3. Is there competition? The presence of multiple providers validates that a new technology is evolving into an established category.  Having more than one vendor allows managers to evaluate different solutions, set reference prices to minimize cost and avoid single vendor lock-in. 
  4. Is there clarity around functionality and attributes? A lack of clarity in marketing materials or specifications is evidence that an early stage technology is immature or has been over-sold.   Managers should not purchase any new technology unless they are very clear about its functionality, features and value. If you don’t truly understand what the technology is supposed to do, chances are your technical and business users won’t either.
  5. Are there customers?  Having existing (and paying) customers using the technology is crucial to providing your company with use cases as well as ensuring the vendor offers sufficient support and ongoing product development.  Be wary if vendors can not provide a client list.  It is also important to understand whether an ecosystem – customers, consultants, 3rd party developers and community – has evolved to support development and implementation.
  6. What have other user’s experienced? CIOs should be concerned if the new technology has no verifiable and ROI-driven success (deployment and production) stories.  Failures matter as much as successes as they will help you set realistic expectations and understand technical gaps.

There are no guarantees that a new technology will not turn out to a lemon.  However, insisting that vendors answer some simple questions can significantly reduce the performance, implementation and financial risks.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

The best innovation strategy

It’s one thing for a company to prioritize innovation. It’s quite another to reap the rewards over the long run.  The hard reality is that most product innovations will fail the market test.  Our research has shown that a company can increase their R&D returns by better aligning their innovation initiatives to their core business strategies, management systems and cultural norms & practices.  A recent survey of global innovators bears out this learning 

In their annual survey of the top 1000 global innovators, Booze & Company looked at the relationship between strategy, culture and innovation.  Three different approaches to innovation emerged from the corporate feedback – Needs Seeker, Market Reader and Technology Driver.  

Many high performance firms such as Dell,Toyota and Samsung are Market Readers. They use innovation to keep up with, not outflank, competition in their core markets.  These enterprises take a cautious approach to innovation preferring to be “fast followers.” On the other hand, Needs Seekers like P&G, GE and 3M pursue customer-centric innovation strategies.  They actively survey current and potential customers about their existing or unmet needs in order to shape new products and services.  Technology Drivers like Google, Apple and HP let their technology direction and existing intellectual property dictate the pace and scale of their innovation.  Technology Drivers seek out first mover advantage with breakthrough products that redefines existing markets or creates new market space.

According to the research, all three innovation approaches were successful in delivering positive financial results.  However, the study found that the Needs Seekers had a superior approach to turning potential innovation into superior financial performance. Six of the top ten most innovative companies were Needs Seekers, although they represented only two of the ten largest R&D spenders.  This variation in innovation outcomes did not trace to R&D spending levels or prior success.  Rather, differences came down to how enterprises managed two critical organizational variables: how receptive were their cultures to innovation and how innovation efforts were aligned to their business and functional strategies.

Needs Seekers out-perform as a result of their deep understanding of the customer and innovation management expertise in areas like failure analysis and commercialization.   These firms combine excellence in customer research, product development and operations with tight strategic alignment and an innovation-accelerating culture.  They are also very open to collaborating with external organizations for ideas and technology.  Needs Seekers are passionate about delivering and marketing superior products that address customer needs and experiences.  

Because of management, resource and cultural factors, not every company can be (or wants to be) a Needs Seeker.  These organizations can be successful by borrowing from the Needs Seeker playbook and maximizing their own unique attributes.

Market Readers will drive innovation by staying attuned to local markets customers and competitors. Once a Market Reader detects an important product innovation hitting the market, they must be quick to replicate, and if possible, leapfrog it.  As a result, they require effective decision making and resource allocation mechanisms, agile product development and close partnerships with their supply chains.

Technology Drivers seek both incremental and game-changing product innovations. They fund both applied and basic R&D initiatives, looking to develop compelling platform technologies that can germinate new product categories and create legions of new customers.  To be successful, these companies must: have an ambitious, technology-inspired vision; foster creativity and technical excellence, and; encourage collaboration between R&D, marketing and product groups.  As well, Technology Drivers will regularly seek out exploitable ideas and innovations from outside their organizations using sophisticated Open Innovation strategies.

Although there are different paths to accelerating innovation, all firms can leverage the above best practices:  expert innovation management capabilities, strong familiarity with relevant markets, customers and technology ecosystems, cross-functional strategic alignment and an innovation-supportive culture.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.