You are currently browsing the monthly archive for September 2012.

Effective capital planning and capital investment are vital to a company’s long-term success. The choices a company makes – how much to invest and in which facilities or projects – have a profound effect on its long-term success. For that reason, companies take pains to ensure that these decisions support their long-term strategies and are made as rationally as possible. Because Ventana Research is frequently involved in software acquisition discussions, return on investment is a topic we frequently see raised.

Long-range planning is a process and discipline that companies use to ensure they have the right strategy to succeed in the markets they serve and the right assets to support their strategic objectives. To do that they must allocate their investments in those assets as optimally as feasible and  possess sufficient resources (both financial and other elements, such as personnel with the appropriate skills) to support those investments. The key activities in the long-range planning process are:

  • Establishing the best strategic course based on a company’s current market position, its resources, the competitive landscape and external factors such as economic and demographic trends, the legal and regulatory environment and technology trends.
  • Determining what assets will be required over the planning period to support the company’s strategy.
  • Identifying the ongoing operating activities, such as research and development projects or brand advertising, needed to support the strategy.
  • Ensuring that there is adequate funding to support investments and ongoing operating activities over the planning period.
  • Ascertaining that the capital structure is adequate and optimized to support the needed investment.

The time span covered by “long-range” planning can differ significantly from one company to the next and especially from one industry to the next, but in almost all cases it exceeds one fiscal year. The actual length is in part a function of the natural business cycle of the industry. For many manufacturing and services companies it is typically three to five years. For industries that have long development cycles, such as pharmaceuticals and aerospace, it can be as long as 15 to 20 years. Even businesses that are notoriously unpredictable and that have short business cycles benefit from having a strategic planning discipline. Decades ago, when I was interviewing with investment banks, I had a standard business-school set of questions prepared, including one about their strategic planning. Some Wall Street companies did have a strategic planning process, but most didn’t – dismissing it as impossible in what they saw as a “highly opportunistic” business. Two that did were Goldman Sachs and Morgan Stanley. Two that didn’t were the now defunct Bear Stearns and Lehman Brothers.

Companies face multiple challenges in managing their long-term planning processes. These include:

  • Determining the appropriate methods for assessing plans and their constituent investments.
  • Achieving alignment between company strategy and the long-range plans of the constituent parts.
  • Ensuring consistency in the preparation of long-range plans across the organization.
  • Optimizing investment decisions consistent with long-term strategy.
  • Maximizing the productivity of the long-range planning process, which means minimizing the amount of time required to execute the purely mechanical aspects (acquiring data, validating it, creating, maintaining and running the appropriate analytical model) to enable more time to be spent on the analytical and assessment aspects.
  • Performing more comprehensive what-if scenario planning.
  • Reducing cycle times to allow for a more nimble process.

In capital spending decisions the burden of proof is heavily on the side of the proposer. Project champions must jump through hoops to make a convincing case that an investment is not only worthwhile but also better than alternatives. Strangely, though, once a capital project is approved, a vanishingly small percentage of companies assess whether the projected returns were ever realized. In the decades that I have been asking the question, I have yet to find a single company that does any post-investment measurement of specific projects. Since I’m a rational numbers guy, I’ve long wondered why. One reason might be that, acknowledged or not, one of the main objectives of the capital spending decision-making process is not necessarily optimizing capital investments. Rather, it’s simply to separate the obviously bad ideas from the rest. Applying any rigorous methodology to quantifying potential returns from a capital project is bound to expose many or even most of those with limited potential, faulty assumptions or too much risk. Yet I think this approach sets a very low bar. Having a more rigorous post-investment analytical process would enable companies to do a more effective job of allocating resources.

Ultimately, the success of a company’s long-range planning and investment process can be measured over time in its gross return on assets relative to its competitors’ and, if it’s publicly traded, partly by the company’s share price. A gross rather than net asset approach is useful because it reduces accounting distortions in cases where companies may have written off poor investments or used different reported depreciation approaches for similar asset classes.

Companies – even small businesses – should have a rigorous long-term planning and capital spending discipline in place to ensure that they successfully manage for the long term. Companies that already have such a process in place should reexamine it regularly to determine where it is falling short or failing to identify the right path and the appropriate investments for their strategic direction.

Regards,

Robert Kugel – SVP Research

I cover the meat-and-potatoes aspects of corporate computing. I also pay attention to the special needs of midsize companies (by our definition, those with between 100 and 999 employees), which are unlike those of either small business or large corporations. After attending this year’s Dreamforce conference, Salesforce.com’s annual user meeting held this week in San Francisco, I can appreciate how difficult it is for executives and people who work in back office functions to cut through the technology hoopla to find the utterly practical (but certainly not dull) reasons why the cloud can help them run their businesses better. In fact, cloud-based software-as-a-service (SaaS) offerings can give midsize companies a leg up in ways that on-premises alternatives can’t. Here are four big ones that top my list.

The most important benefit for midsize companies from the cloud is gaining business capabilities for both the front and back offices at an earlier stage than was feasible with on-premises software. For example, one of the most difficult challenges finance executives face as their companies begin to transition from a small to a midsize business is deciding when to replace their entry-level accounting package with a more sophisticated one (a topic I have covered in depth). The on-premises versions of midsize accounting packages represent a significant investment for a company, not only for the software and potentially new hardware, but for the internal resources needed to support a more sophisticated accounting package. Because of this, many organizations delay replacing their entry-level software until the smooth functioning of the finance department is in jeopardy.

However, scalability is not the only advantage a company achieves when it migrates. Improved process management and the better reporting capabilities that go with it result in greater efficiency, more timely reporting and deeper insight sooner.

Customer service in the cloud has radically changed the economics and provided midsize companies with internal capabilities that in the past were within reach only of the largest companies (a topic my colleague Richard Snow recently covered). Before service in the cloud, the large investment required for a call center meant you either had to be a very large company or, for a hefty fee, outsource the function (which also put it out of range for most midsize companies).

Dreamforce was replete with examples of small and midsize businesses harnessing their imagination, rather than large budgets, to provide themselves with sales and marketing strategies to address targeted markets more effectively or to punch above their weight in broader ones. This was most apparent with companies that address consumer markets, especially those targeting younger audiences that are more attuned to social media.

A second nuts-and-bolts reason for a midsize business to put its applications in the cloud is to gain the ability to collect and maintain a common set of data for multiple purposes. When a company has disparate on-premises systems, it often must reenter information in multiple systems and desktop spreadsheets, which is time-consuming and can lead to errors that take even more time to fix. One factor inhibiting cloud adoption among larger companies is the challenge of data movement between existing on-premises data stores and cloud-based platforms. The exact opposite is almost always the case for midsize companies. Having their data in the cloud means that companies’ front office, back office and operational data can be readily available for use in a wide range of business activities. They can have a single set of up-to-date customer data to use in sales orders, invoicing and service processes (to name three). Moreover, depending on which software a company uses, information entered in the sales order process can automatically populate all related forms in the ERP system.

A third benefit is that cloud-based applications may be a better fit with a company’s structure than on-premises alternatives. An ongoing revolution in American business is its use of technology to embrace increasingly flexible business structures. (This is one of the important strengths of the U.S. economy relative to others in the world.) As an example, consider how today’s human resources software routinely handles many different flavors and shades of working relationships. It allows companies to define relationships that range from full-time to casual and contract labor, as well as handle those relationships over time. Today, HR software embraces the reality that a full-time employee may retire and come back to work years later as a part-time consultant without creating a new individual and losing easy access to the employee’s history. Today, many midsize companies have a large number of virtual employees (outsourced but still with an ongoing, intimate relationship) or staffers who are geographically dispersed. Small and midsize businesses routinely take on projects that are handled by full-time workers and contractors sourced globally. Cloud-based offerings allow a geographically dispersed company to work simultaneously in a single system. They enable companies to immediately add new offices without having to consider how to handle the IT aspects of the expansion. Cloud ERP systems enable a small or midsize organization to hire a part-time CFO – gaining the benefit of that person’s experience without having to pay the full price – because that individual has ready access to the system. To be sure, this capability has been in place for a couple of decades and was possible even with client-server systems, but they were more difficult and expensive for midsize companies to use than native cloud applications.

A fourth benefit from SaaS is safety. This assertion may seem strange given that many executives are reluctant to adopt cloud solutions precisely because they believe having a server securely locked in that closet down the hall is safer. It’s physically there and seemingly less prone to hacking. That’s an illusion.

There are two basic issues here: disaster recovery and data security. As to the former, it’s conceivable that some natural disaster or a nuclear attack will reduce the cloud provider’s facility to rubble. However, it’s also the case that the provider has backup levels (note the plural) that will ensure continuity. If in doing your due diligence a company cannot show you evidence of this, find another provider. At the same time, let’s assume there’s a fire in the floor above a company’s offices and as a result its server room is flooded. The disaster recovery plan has been to use the backup tapes kept in the server room, but these are now useless. Plan B is – what?

And what of data security? Today, you can get a 64-gigabyte thumb drive for 30 bucks at Wal-Mart. That’s all your company’s sensitive data going out the front door with a disgruntled employee. To be sure, before a company signs up with a cloud application provider it must do its homework to ensure that the provider has the proper security certifications. And it must have a checklist that includes periodic reviews to ensure that the vendor is maintaining the highest standards of safety. If the vendor is, using the cloud is probably at least as safe – if not safer – than having the applications installed on premises.

Cloud-based computing is no longer hype or a fad. Inherently, its business model is congruent with the requirements of midsize (and small) businesses: those with limited up-front capital that also need a pay-as-you-go, gain-as-you-grow approach. At the same time, I don’t want to be completely uncritical. Some cloud-based offerings are less mature or less well-suited to the specific needs of some companies. I find it amusing when a cloud vendor boasts of doing many more releases per year than on-premises competitors. To a critical thinker it suggests that the cloud vendor’s product is not as mature as the on-premises alternatives and therefore needs constant upgrading to make it functionally competitive. As well, the user interfaces of some cloud offerings are constrained by the technological limitations of the Web and may not meet a company’s needs.

It’s all too easy to dismiss “the cloud” as so much hype and sizzle. For those of you who have built small businesses into midsize ones; who are put off by any focus on what’s new in information technology; and who think this is just one more attempt to separate you from your hard-earned money, think again. There are important business reasons why the cloud can make you more successful. It’s time for all midsize businesses to figure out how to make the cloud work for them.

Regards,

Robert Kugel – SVP Research

Twitter Updates

Stats

  • 70,569 hits
Follow

Get every new post delivered to your Inbox.

Join 67 other followers

%d bloggers like this: