Book Order Form | Table of Contents | Preface | Part 1 | Part 2 | Part 3 | Part 4 | Part 5
Appendix A | Appendix B

NEGOTIATING

    Not everyone is a born negotiator. Here are some basic ways to create the proper mindset for entering into a sales negotiation.

    Negotiating can be a stressful event and all issues must be put on the table, even if they irritate the other side. Having a good guy to balance the bad guy can be quite effective in getting an agreement.

    If more than one person is participating from your side you can play roles. Someone like Mary Marketing can play the “bad guy,” by presenting everything the company wants and challenging everything the customer wants. On the other hand, the customer needs someone to understand his or her reactions and feelings about the entire negotiation, and Sally Sales can be the “good guy” working the customer issues, but avoiding confrontations or asking for sticky points that might irritate the customer.

    The worst thing to do is to send the top decision-maker to open up a negotiation. With Fred Founder on hand, there can be no recourse to change agreements reached in negotiation sessions and, more importantly, it lessens the chances to go off and think about it. Number-one is needed in case agreements are made emotionally or too hastily under pressure.

    The board of directors can also play the bad guy role. The negotiator can agree to things to keep the activity rolling along with a caveat that she must still get board approval.

    Pricing pressure from the buyer to gets lower prices upon request will encourage Bill Buyer to keep pressing on to get even lower prices. In fact, if the buyer barks and gets a response, why should he stop trying to get even lower prices? The buyer cliché, “You’ll have to sharpen your pencil,” should not be met simply with lower prices. If it seems reasonable to give a lower price, something should be asked for in return. This can be in the form of a greater commitment, such as larger quantities, higher shipping rates or better payment terms. Keep in mind the buyer is trying to use all the competitors against each other in order to drive the price down. In fact, buyers like Bill who take multiple proposals may drop the lowest bidder from consideration but will use the low numbers to get what he wants from the other bidders.

    It’s not a bad idea to get the other side to spell out just what it is they want. Once you understand their position, you can be more flexible and try to match your needs to theirs. It helps to have them define many points so that if there is a dispute later and your point seems logical, you might win because their wording is considered unclear. The issue would be, “if you wanted that interpretation why wasn’t the wording clearly defined?”

    When negotiating never be the first one to name a price; it can only lock you into a poor position. Their counter offer will only go in the wrong direction.

    More often than not, there will be a downward pressure on pricing, but be wary about giving up all the terms in the contract. Get one or the other: price or terms. If the pressure from the customer is absolutely to get the best price, then he should be willing to make concessions for you on all other issues. For instance, Ed Engineer was pressed for a low price by a client who wanted a development contract for an engineering product. Normally the client owns the design rights when he pays for the development. In this case, Ed agreed to the low price, but in return he got paid up front and got to keep the intellectual rights to the product.

    Take a break after a long discussion in which you believe you have conceded the issue. In long and hard negotiations with many issues to resolve, giving in on them one at a time may seem like taking reasonable incremental steps toward a worthwhile goal , but if you were to sum them up from your starting position, you would be amazed at all you have given up for very little in return.

    I have found that some people who are really excited with the potential deal can start negotiating with themselves. After presenting an offer and getting no response, they offer an even better one before the customer has had a chance to respond. I have even seen a salesperson offer a better deal after the customer just cleared his throat. It always pays to be a good listener and observer of body language. Wait it out, watch and listen. Silence on your end can be your best tool.

    There are times when both sides really want to work together to reach an agreement. If it’s possible for the two primary decision-makers to meet (provided they honestly want to make a deal) then they should get together without the army of supporters.

    Fred Founder has done this many times: First, in two columns, he and the client list what each wants that are clearly “deal breakers”-issues that must get resolved without compromise. Fred then suggests that just the two of them lock themselves up until they come out in agreement. It usually works.

    Keep the lawyers from defining your business intentions. This prevents the deal from breaking down and everyone going away angry and frustrated. Fred has learned the hard way that after reaching a friendly agreement with a client, the lawyers can screw up the contract so badly that some customers go away mad. Fred first tries hard to get the intent of the agreement resolved with his customer. Then, when possible, he and the customer explain their intentions to the both side’s lawyers in the same meeting. Whenever problems in the contract arise and the lawyers from opposite sides disagree, Fred always asks his client to go back to the original agreement of intent.

    Unfortunately a large percentage of agreements do sour, so do engage lawyers. Many people define agreements based only on success. This is far too general and optimistic. Stuff always happens. The lawyers will be very good at defining the “what ifs.” “What if the program fails?” “What if you don’t do your commitment on time?”

    Markets are moving towards situation where both sides win. The challenge to see who can come out on top is being replaced by how a deal can be structured where both sides can win. Today, I see more and more customer/supplier alliances that result in success.

    I believe Confucius may have said it first, “A good contract is where both sides walk away from the negotiations smiling.”

PRICING IS AN ART

    Fixed formula pricing is swayed by market conditions and changing product mixes that strain all formulas. It’s great to build pricing formulas; but in today’s market with smaller runs, more customization and increasing competition, the formulas become more of a guideline for pricing than a rule. I have seen situations where marketing personnel swear they have bid everything based on the formula to yield 20 percent bottom-line profit. Seldom are these kinds of margins in the results, and bottom lines too close to zero can occur if the environment is different from that used in the formula.

    Pricing has to be based on several elements, including:

• Fixed and support costs

• Direct costs

• Profit objectives

• The sales channel

• Product mix

• Market competition prices (very important)

• Gut feelings.

    When the goal is to sell the value of the product and service and to gain higher prices than the competitors, pricing based on costs alone may lessen the chance for higher prices and margins.

    Back in the dark ages only two channels existed: OEM and end-user. Either you sold products to Original Equipment Manufacturers to be incorporated in their equipment or you sold to the user. Because of the higher marketing costs and customer support, end-user prices had to be higher than OEM pricing. There was far less risk in selling to the OEM.

    Today there are numerous sales channels:

    On the Internet there are even bold activities that give away the product-shareware software and even PCs-or services-data storage or information retrieval- for free. Of course, suppliers are hoping for advertising dollars or follow up transactions and service income. But before any pricing exercise, it is extremely important to understand the cost of building the product or service, and all supporting costs should be covered before quoting the price to the customer. To support this, the product mix and utilization of resources must be understood, since they will strongly effect profitable pricing.

    In small companies and startups, it’s possible early on to build to order, but as the company grows and competition increases, the risks become higher. Initially profit is measured by the “goesinnas” (payments) exceeding the “goesoutas” (expenses and cost of the product.) However, to be competitive, features and product lead-time deliveries need to be added on the come. This means providing reserves for inventory and bad debt write-off-the willingness to take higher risks.

    Marketing needs to be cognizant of all of these changes and to price products and services accordingly. Be wary of just using formulas for pricing. Be extremely aware of the necessary internal costs that support the market in which you are selling.

    Moving from being an OEM supplier to selling commodity products can be dangerous and risky. Not only are the market requirements far different, but the additional infrastructure can be extensive and costly.

    When customers buy your product wholesale to incorporate into theirs, you are spared such heavy costs as:

Definitions and Terminology

    To begin with, we must understand the cost factors and elements that go into pricing formulas.

    Direct Costs include all the labor and materials devoted to manufacturing the product. They do not include manufacturing support and general operating expenses. This is sometimes referred to as the Cost Of Goods Sold, or COGS.

    Operating Expenses are all the costs associated with running the company; however, this does not include direct manufacturing costs. Operating expenses do include manufacturing overhead, sales and marketing, engineering, and general and administrative expenses. When “labor in place” (the core manufacturing personnel) is included this is sometimes referred to as the “nut.”

    Sales Dollars are defined as the total income from sales. This can be expressed as the number of units sold times the price per unit.

    In this exercise, the Gross Margin will be defined as the percentage of sales dollars left over after taking care of direct costs. The gross margin must cover both operating expenses and profit. The gross margin percentage is calculated by dividing the gross margin dollars by the total sales dollars.

    The Break-Even Point is the price at which sales dollars cover all expenses but yield no profit.

    The Profit Margin is the percentage of sales yielded as profit.

    The ideal pricing formula allows sales dollars to cover direct costs, operating expenses and the profit target. The basic sales equation must be:

To make this equation useful for pricing, it must be restated as:

Sales Dollars (% of sales) = Direct Costs (% of sales) + Operating Expenses (% of sales) + Profit (% of sales)

    When it comes time to set a price, you find yourself in a “chicken or egg” situation. You must decide what is to be determined first, the sales level or the operating expenses. Here, we will start by covering planned operating expenses.

    For this example, assume that there are $60,000 in operating expenses either planned or in place. If our goal is a 10% profit margin, the sales dollars must cover:

Operating expenses = $60,000
Profit = (10% of sales dollars)
Direct Costs = ?
Sales Dollars = ?

    Direct costs can be developed as a percentage of sales dollars. In our example, Manufacturing determines the direct costs per unit and Marketing determines the market price:

Direct Costs = $6,000 per unit
Market Price = $10,000 per unit

    To find the gross margin, we figure the percentage of our direct costs in relation to the market price (per unit Sales Dollars):

    This leaves a 40% gross margin to cover operating expenses and profit.

    The company must now be able to sell enough units so that 40% of the total sales dollars covers both costs and profit.

    How many units are required?

    If our profit margin is to be 10% of sales dollars, 30% of sales dollars are left to cover operating expenses (40% GM-10%PM = 30%OE). Since we know that the $60,000 operating expenses must now constitute 30% of the sales dollars, we can now calculate the total sales dollars required.

30% of Sales Dollars  = $60,000
or 0.3 x Sales Dollars = $60,000

    This simple calculation shows what the total sales dollars must be:

Sales Dollars = $60,000 / 0.3 or $200,000

    Now working backwards, we arrive at the following:

Direct Costs = 60% of Sales Dollars
or 0.6 x $200,000 = $120,000
Operating Expenses = 30% of Sales Dollars
or 0.3 x $200,000 = $60,000
Profit = 10% of Sales Dollars
or 0.1 x $200,000 = $20,000

    Since Marketing has determined that the market price is $10,000 per unit, simple division shows that the company must sell a minimum of 20 units to reach the desired goal. When this is accomplished, sales dollars will cover direct costs, operating expenses, and profit; and everybody will live happily ever after!

    Covering the gross margin is only part of the task. Unless you are bringing in sufficient real dollars, you are still not where you need to be.

    Continuing with our example, if the sales department is able to sell the product at a gross margin of 50% instead of 40%, but sells fewer units, the real dollars will still not add up.

    For 20 units, total sales would reach $140,000. With a 50% gross margin the actual dollars will equal $70,000, of which $60,000 must cover operating expenses. This leaves $10,000, or 7% of sales, to go to profit-well below the profit target.

    However, there is an even more dangerous problem. Remember that competition forces prices down!

    In our example, let’s say that sales wants a price cut of $2,500 per unit in order to be competitive. They claim that the market requires a price of $7,500. This would constitute a 25% price cut-not that uncommon in some market segments today.

    Because operating expenses and direct costs remain the same, this price drop would decrease the total sales dollars for 20 units to $150,000, yielding not a profit, but a loss of $30,000, as shown below.

Sales Dollars - Operating Exp. - Direct Costs = Net Profit (Loss)
$150,000 - $60,000 - $120,000 = ($30,000)

    If the 10% profit is required, then the shortfall is even greater. Sure the profit target is important, but in tough times, survival is more important until adjustments can be made and a recovery is possible. During periods of intense competition, you must be aware of the break-even point and maintain this last threshold until other adjustments can be made.

    Since the operating expenses must be covered in real sales dollars, the smaller the gross margin, the more sales will be required. When direct costs ($6,000) are 80% of the market price ($7,500), the gross margin of 20% must cover the operating expenses and profit target. Just to meet the operating expenses ($60,000) sales would have to be $300,000, or double the original sales target. And there is still no profit!

    This shows the tremendous impact of a 25% price reduction. If we just want to break even, we must sell 40 units at the new price. If we want to hit the10% profit, we must sell 80 units at the new price.

    From a practical viewpoint, however, matters are much worse, because it is unlikely that the costs in place to support the manufacture of 20 units will be sufficient to support the manufacture of 40, much less 80! Therefore, operating expenses would increase, requiring even more units to be sold in order to cover it.

    This is the danger of selling a commodity product in a highly competitive market. It becomes necessary to seek out other, more stable markets, or to find ways to add value and outstanding customer service in order to maintain a price advantage over the competition. The almost casual request from sales for a “competitive price change” has taken many a company with healthy sales and profit to disaster.

    Don’t get on this toboggan!

REPLICATION IS NOT EASY
WITH HUMANS

    Any good industrial engineer realizes that every new function takes time to learn. For the rest of us it is important to recognize that in high growth mode all planning must be sensitive to loading functions that involve new assignments and learning. Calculating loading in manufacturing is more easily measured, because the repetitive tasks can be timed and used as the criteria for planning. However, spreadsheets are dangerous for planning high growth rates. It takes a fraction of a second to put a formula in a cell, and then one step to replicate the numbers at some proportional rate to the revenue. It just doesn’t happen that easily with people.

    Back in the days when GrowCo was heavily involved in high labor content, we went from under 100 direct labors to over 3000 in a few short years. There was a tendency to expect instant efficiency and people performing to “optimal standards” almost immediately. We got bit on this for a while but soon realized that it takes time to become efficient. Add this to a high turnover and we learned quickly that a big gap existed between our expectations and reality.

    We did an analysis of plants in Hong Kong, Singapore and Taiwan, each chartered to grow to 500 direct labor employees as quickly as possible. Even though our average assembly operations were on an 85 percent learning curve (it took 85 percent of the previous operation time to double output), in the first year of operation of these start ups, we only had an efficiency of 33 percent. In effect, we produced 33 percent of the product we had hoped for.

    The problem: continually adding new personnel to get to the 500 levels, was constantly dragging down the average efficiency. Of greater impact was the need to keep replacing the majority of people we had hired. The turnover was substantial and new replacements, who always start at the top of the curve, pulled the average efficiency down. What made matters worse was that many of the tasks for the indirect labor and support people (managers, accountants, clerks, etc.) were not repetitive, and the pressure of growth did not allow for training such people.

    Once our manufacturing people got the hang of planning direct labor, we finally overcame the phenomena. But it took time.

    It is a mistake to treat experience and knowledge with a learning-curve mentality. You can’t plan knowledge and experience. They can’t be converted into a learning curve. When people leave, they take their knowledge and experience with them. The new guy, no matter how intelligent, cannot bring in what you have lost.

    One of Mary Marketing’s shortcomings was her naiveté when it came to growth and in her belief that people skills could be replicated by multiplication. Mary isn’t alone. Many founders and company leaders don’t seem to understand replication either.

    Mary was selling for a printed circuit board company and, thanks mostly to Ed Engineering, the head of engineering, the company was on a great growth path. As the company grew, Mary was able to compound the success by adding new and larger customers to the backlog. For a while Ed was able to keep up with it. Then one day production seemed to break in half, and the output dropped dramatically even with all the same resources and number of people.

    Mary told me her biggest surprise was that this happened despite Ed’s promotion to head of operations, responsible for engineering and manufacturing.

    “That’s it!” I said.

    “What’s it?” she said. “Ed was our superstar. I thought he would straighten those clowns out in manufacturing.”

    “You cannot replicate superstars like some product,” I said.

    Ed Engineering had been responsible for defining the process for each order. He would release $1.2 million in potential revenue a month. When he got promoted, he replaced himself with an engineer who had to strain to do $400,000 a month. Without the product released to the floor, manufacturing couldn’t produce the line of product to be sold. Even when Ed realized he had lower output and kept adding personnel, he had to add two rookies who took time to come up to reasonable levels. To make matters worse, the quality of the engineering output went down during the learning period. The result: past due deliveries stretched out and some customers even went away.

    Unfortunately, this problem occurs in many business plans where increased output is covered by just duplicating personnel on paper. While you may come close calculating direct labor, it is very unlikely that such figures will be reliable in the support and management roles or in the service industry.

    Founders lose sight of the course also. A founder may be seller, designer, strategist and chief bottle-washer in building the company, but he or she can’t solve every problem just by doubling the number of people. It is more difficult for a founder to understand this concept when she is very good at all she does.

    It is the responsibility of senior management to recognize the difficulty of replicating itself on an one to one basis. Marketing people get in trouble by supporting forecasts for doubling sales by only doubling people on an instantaneous basis. Expecting sales to double by adding people or regions will get you in trouble. It takes time to develop a good sales team. Even if you find good people, there is always a certain time period needed for them to learn the company, the customer base and the products.

    Today we have to deal more carefully with the human assets than we do with the financial or more tangible assets. Manpower planning should be an important part of any growth plan. The skills, experience and unique work habits of the stars on board must be understood. The trick then is to determine which of those elements must be replicated for success, and then how to plan to make it happen.

IT'S THE FIRST DRINK THAT KILLS YOU

    In today’s world, with great emphasis on shortening product and service time to market, engineering performance is more critical than ever. In an industrial company, Marketing can go nowhere without Engineering. While Marketing can direct engineering in a mature company, it still depends heavily on engineering’s ability to perform. There is often a big mismatch between the departments when it comes to passion, urgency and customer sensitivity.

    Here are some examples taken from my book Will The Real Inventory Please Stand Up and Be Counted that show the havoc engineering’s bad performance can bring on the financial health of a company:

    In the normal course of business the engineering department plays a crucial role in controlling and optimizing the inventory. It all starts with a good design. The more complete and tested the design, the less likely changes will be necessary. Finalizing a design before creating a Bill of Material and going all out on production minimizes the possibility of filling inventory with parts and components that will go unused and have to be written off at year-end.

    I have seldom heard the words effectivity date coming from an engineer. The effectivity date of a component or part is the date by which the part or component can be used in manufacturing of the product. Mature companies establish formal guidelines defining the effectivity date in a way that ensures manufacturing will be prepared to make the change in its process.

    Too often an engineer sitting in front of his PC, completely oblivious to the outside world, unilaterally sets the effectivity date. For engineers the date of change is immediate and does not allow input from manufacturing, purchasing, sales or accounting. When such changes are made new parts and components are substituted for the old ones in inventory, and the resulting scramble to make the change is usually very costly. As purchasing rushes to find the new parts before the sales department complains about delays, they inevitably incur expediting charges that send accounting through the roof.

    Sure! At times there may be a defective or non-performing component that needs immediate replacement. Engineering is responsible for making changes to the product when dictated by performance quality, cost improvement or safety. However, there are shelves full of parts and components all over the world which are still usable and could have been phased out after depletion, except for that one design change.

    Don’t get me wrong; engineering departments play an extremely important role in any manufacturing company. The engineering perspective provides crucial input to the Material Review Board (MRB) by helping make quick decisions on the disposition of products and components. However, it does no one any good when engineering unilaterally makes decisions that delay getting designs into production and create pigeonholes that are classified “components to be disposed of” and “components for assemblies.”

    Effectivity dates should be set by multi-departmental consensus, which always takes into account the existing stock of usable parts. Otherwise you will end up stockpiling enough obsolete parts to sink your company’s profit margin faster than the Titanic.

    It is also engineering’s job -- and rightly so -- to select and qualify parts. But is should stop there. Engineering should never be left to negotiate prices and availability with vendors and suppliers. Vendors love to have engineers make a first buy before purchasing gets a chance to negotiate a fair price. And when engineers do buy, they buy too many parts, parts that have a high probability of being replaced in the near term. Parts like these live in limbo, like the unbaptized innocents. They are counted as part of the inventory time and time again, but are never moved out or used.

    An interesting inventory report to run in a heavy engineering company is one in which all components are noted, and parts “not used on a Bill of Material (BOM) are listed. If a component or part does not exist on a BOM, it will never be used by manufacturing to build products.

    In my experience, engineers are notorious for taking material out of inventory without recording the transaction or even without telling anyone in charge. I have known engineers who would climb over walls or squeeze into cages like mountain climbers or amateur magicians, just to get that part they happened to need right now.

    A more subtle impact on inventory and finances is the delayed development program. The often-used cliché is true: it takes engineering 95% of the time to do the last 5% of the design. In order for a product release and launch plan to be successful, several related activities in sales, marketing, finance and manufacturing have to be planned and acted upon parallel to the engineering design effort. These are all keyed to the release date specified by engineering and any delay creates havoc in all areas, with a large negative impact on a company’s cash flow.

    In order to meet schedules, manufacturing has to take a risk and commit to material purchases, which make material available, as it will be needed in the manufacturing process. The longer a design takes, the more likely parts will be changed or substituted, creating a pool of unneeded parts that will sit in inventory, and (no surprise now) eventually be written off.

    Team members who are only concentrating on their piece of the pie do not have the perspective to recognize the impact that delays have at the beginning of a program. Most programs build to a crescendo - the date of product release - and any delay in meeting that date is not only costly to the company financially, but hurts the company’s image in the marketplace.

    What appears to be a modest slip in scheduling and milestone commitments at the beginning of a program can have a devastating effect on long-term outcome. Windows of opportunity for new product introductions are often fragile, so a manager must be sensitive enough to catch them when they open and address them with the priority and level of commitment they require. I have too often heard the unabashed excuse; “We will only be a month late…”

    A one-month slip is like that first drink on a first date, it has tremendous impact on the big picture.

    Once, when I was a division manager, we had a purchase order from a Fortune 10 company. We would not have been considered eligible if we had not been a division of a multi-billion dollar corporation. Believe me, I got it from both sides. The customer wanted its deadlines met; the company wanted its reputation preserved. My staff was in complete disarray because of the pressure we all felt and its inexperience in dealing with companies of this magnitude.

    I received a visit from the customer’s representative, who wanted to make sure that we had the right attitude and were giving a high priority to its purchase orders and needs. After everyone was seated, the first thing he wanted to know was: “Why shouldn’t I worry about you meeting the schedules for the first article and the subsequent production buildup?”

    Surprising even myself, I remained very calm (I realized later I was able to remain calm because I was so underpaid I had very little to lose) and gave him my well thought-out answer.

    “First, if we miss the dates, every day we are late will cause cost overruns, hurting our bottom line and cash availability. Also, if we miss dates, we tie up personnel resources that we need for other projects, hurting our chances for future success. Thirdly, if we fail, all hell will break loose at corporate headquarters. Finally, if we miss our revenue and profit forecasts it will affect our bonuses, and maybe even my job. So I assure you that I will be watching the program personally and as soon as I see a problem that could cause us to miss a major milestone, I will force my staff to find alternatives to make very sure our final schedule commitments are met.”

    The man glared at me for what seemed a lifetime, and I was certain that he had interpreted my remarks in the worst possible way. However, when he finally replied, he told me he was very impressed with all my reasons. But it was my last one that had really hit home. He then made it clear that his people also were part of the team, and that if they could be part of any alternatives, I should call them.

    What happened? We got the order, and although we hit several bumps in the road, in the spirit of cooperation we smoothed them out and performed to everyone’s satisfaction.

    I have worked with this idea in mind over the years, and I try to get it across to everyone I work with:

    Missed schedules create extra costs and delay revenue streams. As a result, they delay profit and, most importantly, risk losing the customer and the product’s market window. Because keeping schedule commitments is so important, the management team must always have viable alternatives ready to implement on short notice, which will enable them to stay on schedule. It is like dominos; one bad program will knock down all the others.

    The way many companies tolerate missed commitments has always frustrated me. Unfortunately, big company environments are often more tolerant of such slippage than smaller companies can afford to be.

    I once worked in a $400 million electronics component group in a multi-billion dollar company. Sales were centralized at the group level for all divisions. The sales department started off the budgeting process for the coming year by presenting its sales forecasts to the various divisions in September. Division budgets were due in October, but the divisions got squeezed between the sales forecasts on one side and the corporate revenue and ROI targets on the other, making it very difficult for the divisions to make ends meet. Not having direct control of sales forced the divisions to fit their plans for operating expenses between two walls, a sales forecast and corporate requirements. It was not just a squeeze in planning - corporate requirements restricted the manufacturing divisions and kept them from trying to do great things with their business.

    They were caught between inflexible corporate goals for performances that were not compatible with revenue the centralized sales group could deliver.

    Usually by the end of October, Group Sales would issue a revised forecast downward by as much as 17%. Of course, group level management would then hammer the divisions to reduce their budgeted expenses across the board, with some arbitrary percentage required to meet the consolidated corporate profit goal. The new sales forecast for the Electronics Group dropped over $60 million in sales and $5 million in profit. As you can imagine, this created severe morale problems since Group Sales was always let off the hook.

    I saw division managers break down in tears when told to cut their budgets again and again, after having wrestled with them for weeks trying to get the first pass accepted.

    The big company attitude toward the operating divisions, which had less control over the process, was “It’s their jobs to do what we tell them. We pay them enough to respond to the directions we give.”

    You would think that management at the group level would have told Sales to find alternatives that would enable them to stick to their original commitment. Even if it required investments above the original budget, the overall results might still be improved upon, and with far less pain and risk.

    From the very beginning, focus must be on setting goals and making commitments that will stick.

    And then stick to them!

    Even short delays at the beginning of a program can hurt company programs and goals.

    Table 1 shows the monthly projected revenue for a new product, NuPro, during the first year. In this case, the revenue equals the per unit price of $25,000 times the number of units. The revenue starts out slowly, and after a slight dip in months 3 and 4, picks up steam in the second half of the year. The total revenue forecast for the first year is 166 units, or $4,150,000.

Table 1: Original Revenue Projection for NuPro
  

Table 2: Original Cash Flow Projections for NuPro
(thousands of dollars)
      

Table 3: Gross Margin Contribution (60%) from Sales
 

    After signing a personal guarantee with the bank loan, Walt Whimple, a company president, should have been religious on cash management and meeting commitments. He had to work hard on having engineering join the club, which wasn’t easy for him. Sam Action, VP of Sales and Marketing, tried hard to get the message across but didn’t always have Walt’s support.

    At a progress meeting, Ed Loosely, VP of engineering, casually announces that there will be a slight slip in the schedule and NuPro will not be released on schedule.

    Sam Action raises a fuss when he hears this because the marketing window will be missed. Sam has been fighting for years to get management to commit to the product and is fearful that with a slip in schedule the competition will move out ahead and kill their market impact.

    Paul Wimple, president, says, “Come on, Sam. This is the same old dialogue, and a little slip can be overcome by the team.”

    Sam is about to bring up other examples of programs that have been hurt by the company by being late, but he figures he had better stick to the issue at hand. Besides, his neck is already out pretty far, over his last revisions to the sales forecasts. He also has payments on that BMW to keep up.

    “Well, how long?” he asks.

    “Only one to two months,” Ed Loosely replies.

    Now Mike Response, VP of manufacturing, starts complaining that he has been spending money according to the original budget, and now he has inventory coming in, and this is going to make him look bad.

    At that point, Paul, who cannot stand division in the ranks, jumps in and says, “Let’s go with Ed’s schedule. It really shouldn’t hurt that much, being only one or two months late.” Paul is even thinking to himself that he might not even mention it to the board, since it’s such an insignificant change.

    Fred Numbers, VP of Finance, comforts Paul further by saying; “I could find ways to cover the potential impact on cash and profit.” He has a golf date with Paul for Friday afternoon.

Sam does not give up easily. Back in his office he begins to consider the impact on the original schedule. He calls up his friend in accounting, Andy Ledger, to do an analysis for him. The next day Andy comes back with some results that don’t surprise Sam, but sure will be news to Paul. The changes to the original schedule are shown in Tables 4, 5, and 6, which compare the first-year numbers of the slipped schedule with the original projections.

Table 4: Effect of a One-Month Slip on Revenue
  

    Table 4: The units shipped the first year drop from 166 to 118. This 48-unit drop lowers the revenue projections from $4,150,000 to $2,950,000. A revenue reduction of $1,200,000!

Table 5: Effect on Cash Flow -- One-Month Slip
  

    Table 5: The net cash for the year drops $675,000, from a positive $75,000 to a negative $600,000. Most of the impact comes from the fall-off in the last month’s shipments, which represents 29% of the shipments for the year.

Table 6: Gross Margin -- One-Month Slip
  

    Table 6: Finally, Sam and Andy’s analysis reveal that the gross margin would drop from $2,490,000 to $1,770,000. Nearly three-quarters of a million dollars ($740,000)!

Out of curiosity, Sam asks Andy to carry the analysis further and to look at a two-month slip. After all, when has Ed ever made even revised deadlines?

Tables 7, 8, and 9 show the impact of a two-month slip, which would extend the initial start-up schedule two months.

Table 7: Revenue -- Two-Month Slip
  

Table 8: Cash Flow -- Two-Month Slip
  

Table 9: Gross Margin -- Two-Month Slip
  

    In the case of a two-month slip, the first-year projections for units, revenue and gross margin would drop more than half, and the net cash would go from a small positive number to a negative $1 million!

    These substantial losses happen because the main revenue gains would have come at the end. In this case, the last two months represent 51% of the original revenue. In the new revenue forecast, the same period would only be 49% of the original projections, way down from the plan that was used to convince the board to make the investment in the first place.

    The impact on profit will be substantial because of costs already in place. The projections assume that development engineering stays with the program until it is complete, while sustaining engineering stays poised to take over and inventory build-up follows the original plan. Sam knows that his sales department can’t accelerate sales orders because the whole program relies on NuPro being available for immediate delivery.

    Based on the analysis both Andy and Sam realize that the two-month slip will kill the current year profits. Sam knows Paul will have a fit if he has to tell this to the board. Andy is so concerned that he asks Sam if he can take these results to his boss, Fred Numbers. Of course Sam agrees, because this is exactly what he wants.

    After Fred reviews the analysis, he gets Paul to call an immediate staff meeting so he can present the results. After everyone is seated, Fred gets their attention by hitting them right across the face with the proverbial flounder. Showing them the numbers from Andy’s analysis, he summarizes the difficulties as follows:

    “Revenue Down: This kills any growth plans we had for the year.”

    “Gross Margin Down: This falls so low that it will force a staff reduction.”

    “Profit Down: Kiss your bonus good-bye, and feel for Paul when he has to tell the Board.”

    “Increased manufacturing and engineering expenses: Expenses will exceed budget and require actions that may end up hurting the company even more by draining people and resources away from other projects.”

    “Development: New program development will be delayed, hurting future company performance. And worse yet, what about that initial public stock offer the board had planned to do at the end of the year?”

    “Delayed indefinitely.”

    “Why? Negative cash flow. Cash will fall far short of plan, which could force a private equity offering at give-away prices, diluting the value of the stock for the present shareholders.”

    “All of this because engineering is going to be only one to two months late!”

    Of course, Ed Loosley from engineering is the first to respond, “I don’t see why revenue schedules have to slip once the product is released, and anyway, why can’t such a cracker-jack organization as Sam’s make up the revenue in the following months?”

    Paul nods in support, and calls on Sam to define actions and programs that will enable the company to catch-up once the product is available.

    Sam is annoyed at Paul for not coming down on Ed hard enough. Instead of answering the question directly, he voices his frustration:

    “First off, Ed, why did you wait so long to tell us the program would slip? You are the one who encouraged us to put costs and resources in place because you were so confident you could make the schedules, which were, by the way, your estimated dates, not mine. We’ve all busted our butts trying to make this thing a go based on your timetable. We are too far into this now. Any delay will give our competitors a big jump on us, and the majority of sales depend upon people not only having the NuPro in their hands, but into the customer’s hands without delay. How can we sell something we can’t deliver?

    “And, it’s not just about sales. Look at the figures. With all the other pieces in place we can’t easily redirect them to overcome the problem you created. Your slip will cause a tremendous negative impact on the year, the year we were to shine both in the market and to the investment community. And I wouldn’t bet on just a one or two-month slip so expect it to get worse. It will be difficult to shift our employees and energy to overcome the slip unless we can help Ed find a way to recover his part before it is too late.”

    At this point, Sam begins to pick up support from the rest of the staff, and Paul swings toward the consensus. Soon Ed is asked to come back in 24 hours with alternative plans for avoiding the schedule slip. The staff will then evaluate costs and risks as a group, and look at ways to help engineering meet their original commitment.

Graph 1

Graph 2

    So what was the problem?

    Ed’s technical mind needed to see the problem graphically. The big gap between shipments (Graph 1) made an impression on him, but the cash flow curves (Graph 2) heading in opposite directions cemented his support.

    In a situation like this, you can be sure that whatever extra things the engineering department may need to do to make schedule commitments will be far more cost-effective in the long run than running the risk of losing all that revenue, profit and cash at the back end.

    Growth requires intensity and a firm commitment to meeting goals, no matter how impossible they may seem. Certainly management cannot permit casual schedule changes. Letting engineering off, the way Paul tried to do, would have violated the principles that encourage rapid growth and set off a chain reaction of devastating losses and problems that would most likely have ruined the company.

    Remember, it’s the first drink that kills you!

GOOD COLLECTIONS ALWAYS START WITH
A WELL-DEFINED PURCHASE ORDER

    I have recommended to presidents that they take on the task of trying to collect overdue bills. I have done it myself with some interesting and rewarding results. First, seldom has a customer who did not want to pay his bill deliberately stiffed me. There are many times that the invoice, although mailed on the shipping date, won’t get paid because the customer believes the product has not been fully delivered. I often found that although the basic product had been shipped, bits and pieces, such as software, user manuals, cables and labels, were either missing or wrong. Another problem many companies are slow to learn is that the invoice and purchase order must be matched.

    I had a client who would automatically add a restocking charge to invoices for returned power supplies that were tested and had no problem. Although the charge was nominal at $25 and a small part of the overall invoice, the customer was not paying any of the bills, and the total receivables added up to several hundred thousand dollars. This put my client in a severe cash problem. I was empowered to visit this Fortune 500 Company to resolve the issue.

    I sat down with the accounts payable supervisor. The invoices from us and the purchase orders from them did not match, and therefore their system would not authorize the invoice to be paid. I saw the problem with the unauthorized charges, and eliminated them with a stroke of a pen. The customer cut a check before I left the building and I returned a hero.

    I finally got Fred Founder to call some customer’s with overdue payments. In his dealing with customer’s payable personnel, he learned about problems that originated in his system, like poorly written internal orders, poor engineering release systems and problems at final quality checks. When the problems were corrected, invoices were paid and the accounts receivable aging improved considerably.

    One major problem I still see in my travels is related to acceptance, or under what conditions a product is acceptable. It sounds simple, but I have seen equipment sit for days at a customer before they believe its okay and they start the payment cycle. Products shipped can meet the client specs, but there are times where no criteria exists for product acceptance test results. Without specifying the nature of tests it is difficult to prove that the product meets the specifications if the customer puts it in their equipment and tries to break it. Acceptance testing should be called out in detail and be compatible with the test equipment both at the vendor and customer sites. It does not have to be overly elaborate. Something simple can work well, like connecting the product to this equipment, entering test criteria and watching to see if a green light goes on to indicate that it has passed the test.

    When I got involved in one turn-around situation, it took me awhile to learn what the “P” report was. It turned out to be the number of days the customer took to accept the system after shipping and installation. When I joined the group, this was averaging 25 days. Although we expected to get paid 30 days after invoicing and shipping, the customer did not start the payment period until the day of acceptance. Once the cause was understood, we improved all aspects of the process and reduced the average days to five.

    Holding accounting personnel responsible for poor collections is unfair. If the whole product isn’t delivered and people aren’t paying their bill, the system isn’t working. More than likely the product acceptance was not well defined in the purchase order.

    Too many purchase orders describe the product in depth, but not the criteria for properly testing it for acceptance. It is always worth the time and effort to have a well-defined sales order that includes the criteria for acceptance. This will surely aid the collection process and provide the cash input on a timely and projected basis.

RETURN ON ACTIVITY:
QUALIFYING CUSTOMERS

    I have often heard it said that time is the only essential factor in marketing decisions. While it is true that time is precious, human assets must be used with as much care as capital assets.

    It is natural for a marketing department to want to be all things to all people and to never lose. However, a new salesperson or a manufacturer’s rep can flood the system with weak and useless leads. If every opportunity heard about is fed into the system, it can strangle and stagnate the normal business process. As the keeper of the input gate, Marketing must intelligently guard against this, to keep in mind the best use of the company’s human resources, and always remember what might happen if those resources were ineffectively used. The Return On Activity (ROA) criteria must be conscientiously considered before getting everyone turned on to a new prospect. What is the activity, either financial or physical, that will be needed to cover the time, energy and costs to analyze an opportunity?

    More often than not, small companies fail when they try to grow by looking for customers in an emerging market because of a lack of focus. Trying to be all things to all people can be a death wish.

    One common trait for successful companies is the ability to qualify good opportunities and good customers. Almost all companies I have worked with end up with at least one customer from hell. It is often an order that was badly defined and a terrible customer attitude that results in never-ending problems. Good ROA study should include standards for qualifying a customer up front, and include credit rating, the need for product, and cultural fit. Energy put into qualifying customers and jobs can provide a good return on activity, and be a large contributor for a profitable business.

    The efficiency of market potentiality studies can also be improved considerably by having a clear mission statement and criteria for defining the opportunity before it is submitted for scrutiny. Regular sales meetings and constant input from the field can make the ROA factor acceptable. Any good marketing person should be able to recognize what is good for the company and determine the best utilization of all its resources.