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Welcome to MentorNotes - Articles, comments, opinions and white papers from the MidasNation Mentors.  These works encompass a broad spectrum of industries, sectors, subject matter and disciplines.

 

July 29, 2010 - Lou De Rose, CMC

Debasing the Meaning of Value Demeans the Common Good

To paraphrase an old cliché, Value, like beauty, is in the eyes of the beholder. But unlike beauty, which is perceived largely at the personal level, Value and its meaning impact economic, political, and societal behavior. And here-in lies a problem of mammoth proportions. With so many notions of Value, and so many diverse and diversely motivated beholders of its existence, how do we avoid the danger of oversimplifying its attributes, even its reality? How do we reduce the risk of acting on the assumption that decisions will have desired outcomes, when in fact they’re invitations to disaster? In short, how can we even identify and separate the essence of Value from its mere illusion?
 
Sad to say, we can’t, and we don’t.   Proof of this can be seen in the recent and ongoing tragedy of the housing boom and collapse, where price and value were assumed to move in parallel, and assumed further, to rise forever. It can be seen in the 2000-2002 dot-com bubble and bust, which provided a clear warning about the relationship of asset prices and Value. It can be seen in the bankruptcy and bailout of General Motors, Chrysler, and the auto supply industry, where the notion that by cancelling out debts, supply contracts, and labor agreement obligations, the Value of these firms is enhanced. It’s evident in the “bridge to nowhere” and the myriad other earmarks our political representatives sponsored and approved, where Value and pure political interests are one and the same thing. Add in the failures in judgment made by the universe of buyers, sellers, investors, and voters who continue to make decisions, which equate a seemingly attractive price with Value, and we gain some perspective as to whether we truly know the difference between Value and its illusion.
 
So how did this all happen, and how do we even begin to address the issue? As I see it, there are three factors which lie at the root of this problem. They are intimately intertwined, and reinforce one another in their impact.
 
  • First is the explosive spread of technology in all areas of communication to the point that we are literally inundated with data, information, surveys, and polls, all purporting to present facts, but in reality expressing self-serving interests. Thus, whether it’s the Internet, TV, radio, or publishing medium, each promotes the concept of Value in loose and narrowly defined terms. Each relates the product, service, institution or interest to a value outcome. And with its pervasiveness, the medium becomes the message.
 
  • Second is the pressure to innovate as a means of gaining competitive advantage. Whether we look at the automotive, appliance, electronics or other consumer industries, a common strategy is to introduce new or different designs, applications, or performance features, and to characterize these as Value or Value-added. And looking beyond these industries to financial services, we see the quest for innovation in the once-lauded, but now infamous, securitized financial products, collateralized debt obligations, and credit default swaps. The point is that the more innovation is promoted as a business strategy and facilitated through advanced technology, the less it is understood and evaluated diligently by all those less informed.
 
  • And this suggests the third cause of our failure to differentiate Value from its illusion. The spread of popularist and activist movements and the “dumbing down” of their message has severely reduced our ability as a society to make deep and penetrating analysis of options and alternatives, and risk and reward consequences. We want quick and easy answers, and we want them now. So if issues like universal health care, immigration, education curriculum diversity, or financial reform can be expressed in terms of Value – promoting or discouraging it – let’s go for it.
 
In our day-to-day decisions, the most common standard we employ to reflect Value is price, that is the amount of money given or agreed-upon for a given good or service. And with this “standard”, we should see a prime example of the dangers implicit in how we use the term Value. If Value is equated with price, how do we, as its beholders, react to changes in the money supply or its volatility? Do we assume that changes in one have no impact on the other? The rash of foreclosures and mortgage defaults should provide a devastating answer to that question. There is little doubt that a prime reason for the housing meltdown was the ready supply of money circulating in global markets, and its easy availability through low interest rates. When that supply ran down and credit became tight, prices declined as well. However, it does not follow that the Value of specific properties to specific owners or investors went down as well.
 
What is the relationship between the price of corn, cotton, and other commodities, and their Value as seen by traders, converters, and users? Do we not realize that by the government’s subsidizing these commodities, their price is insulated from competition, and supported at arbitrarily-set levels?  Yet their Value to those traders, converters, and users could be easily satisfied by competitors shut out from the market by those penalizing subsidies. So how can price determine Value simply from a market’s competitiveness or price behavior? Indeed, how do we even get to recognize what constitutes a “market”, and “competitiveness” in price-Value determination? The fact is that most of us have no clue about either concept.   In a purely personal context, what guides us, and what do we rely on to avoid Thomas Jefferson’s sage admonition: “Never buy what you don’t want because it’s cheap”?  I, for one, can testify that there are too many times I’ve ignored that admonition. The result was faulty design, poor fit, damaged product, and wasted resources – in a word, an experience that was Valueless.
 
For more years than I care to remember, I have been preaching the need to make the distinction between price and Value. I have written five books and hundreds of published articles developing and expanding on this theme. I have consulted with Fortune 500, medium, and small-size companies on developing buying and selling strategies for competing more effectively on the basis of that distinction, and have trained thousands of management and operational people on employing practices and skills to implement them.  The results have been positive and significant.   But the problems still persists. Indeed, where I addressed the price-Value issue in the industrial and commercial arena, I now see its growth and consequences in the much wider political and societal arenas. And that raises the issue to a much higher level, a level affecting national stability, economic growth, and society’s greater good. Perhaps my failure to stem this development has been a failure to define my thoughts clearly. So let me again explain, hopefully more clearly, my concept of Value, and also propose a rationale for reducing short-sighted decisions in arenas where that concept is misunderstood or ignored.    
 
First, let me address the issue of Value and its understanding. The word is derived from the Latin valere, which means to be strong. Yet, if you look it up in Webster’s Dictionary or Roget’s Thesaurus you will find the following definitions: merit, worth, importance, esteem, respect, excellence – yes even “monetary worth”, i.e. price. Given all those beholders of Value I mentioned earlier, which definition will prevail? And given their varying motivations, which will be accepted if appropriate qualifications are added when buying, selling, investing, or when other economically-impacting decisions are made? I submit that without a clearer, more specific definition, the situation is hopeless. So let me offer my definition. I concede that it was developed from my work with industrial and commercial companies, but I believe it is applicable in the broader economic, societal, and political scene.
                       
                  Value is the satisfaction of requirements at the lowest
                        total cost of acquisition, ownership, and use.
 
Admittedly, this definition employs terms, which in themselves need defining. “Requirements” is one of them. These are needs, obligations, and interests demanding conditions or qualifications. For some kinds of markets or transactions, requirements can be even wants, desires, or simply recognition. Requirements can be expressed, that is they’re specifically stated; or they can be implied, that is expected or assumed. The importance of properly identifying requirements is that they constitute the basis for being supplied or provided, and hence, satisfied or not satisfied.  And this is one factor confusing price and Value. In the industrial and commercial arenas, requirements can be specified more clearly than in the consumer and political arenas. They’re related to engineering, manufacturing, and distribution processes, and constrained by technical and technological realities. In the broader consumer and political arenas, requirements are open-ended. They reflect the wants, needs, aspirations of all those making Value judgments, and they’re highly influenced by psychological and emotional considerations. This makes them difficult to specify, and hence difficult to assess “satisfaction”.
 
The next term in this Value definition is “lowest total cost of acquisition, ownership, and use”. Clearly, this language does not ignore price. Price is one cost, and only one cost of acquisition, among others involved in processes associated with decisions to take possession or ownership of a good or service. There are costs of sourcing, inspecting, transporting, and financing a transaction. In complex, high-tech markets, foreign markets, or those with powerful or limited sources, those acquisition costs may be difficult to identify, let alone accurately predetermine, before the decision to acquire is actually made. Yet, if they’re not considered when that decision is made, Value for the transaction is in jeopardy.
 
As to the costs of ownership, they are incurred in insuring, protecting, repairing, maintaining, replacing or disposing of what was acquired. We invariably consider the costs of mortgage payments on a purchased house, because they’re integrally related to the initial price. But when we buy that house, how much attention do we pay on what it will cost for fire, burglary, or flood insurance, costs for gardening, electrical and mechanical maintenance? Can we anticipate cost when the furnace breaks down, or the house needs repainting? And at the time of purchase, do we consider what we can sell it for should we choose do so, or we’re forced to do so? These are all costs of house ownership, but rarely do they influence our notions of house Value.
 
Costs of use are costs in employing, consuming, modifying, or correcting what was acquired. For industrial users, they’re the costs of engineering, manufacturing, distribution operations and activities. They’re the costs of labor, material, supplies, and utilities employed, and used in excess when they’re employed badly. For consumers, they’re costs of operating whatever we acquired, as well as the costs of maintaining them to operate as we intended. When they prove defective, there are costs for repairing or replacing them. We pay a price for what we acquire, but do we get Value when the cost in its use exceeds what we expected that cost to be? Or more likely to be the case, do we truly consider those costs when we pay the price initially?   And remember, the concept of Value I’m espousing entails least total cost.
 
Obviously, costs will vary by the nature of the industry, transaction, or the viewer of Value concerned with its incurrence or avoidance. And costs will vary by their nature and behavior, as well as by the nature and importance of the transaction itself.  For example, depreciation and maintenance are significant costs for a manufacturer in a capital intensive industry. They would be negligible in a personal services one. There are markets where costs are largely influenced by quantity or volume involved, as against markets where major costs are a function of calendar time. And there are opportunity costs, which are those incurred because capital was not employed to earn more by other investment decisions. Also, if we recognize that costs are not only monetary, they are also expenditures of resources not easily monetized -- information, ingenuity, and enterprise. Further, overlaying each of these considerations of cost is the factor of competition. In our market-oriented economy, the nature, size, transparency, and volatility of all costs are significantly impacted by competition, thus making competition a critical dimension for determining Value.
 
But what really complicates consideration of cost in identifying and assessing Value is the fact that cost is largely incurred after Value-impacting decisions are made or Value-impacting actions are taken. With the exception of price, all costs associated with owning and using what is acquired, are incurred after a good or service is acquired. Price, which is a cost of acquisition, but only one cost, is determined at the time of acquisition, but Value, which considers total cost is determined later.  Further, unlike price, total costs are largely conjectural. They’re assumed or projected from some standard or from past experience. They’re not real until they’re incurred. So cost can be easily overlooked, ignored, or assumed to have little impact on the Value outcome. But let there be no doubt, all Value-affecting decisions and actions have consequences. And the reality of cost is a major consequence.
 
To ensure Value as I propose it to be achieved, three conditions must be met:
 
1.      Requirements, as defined above, must be met fully and reliably. Clearly, requirements will be different – they may even conflict -- for different   buyers, sellers, investors and other viewers of Value. But if parties can agree that satisfying requirements is a necessary condition for Value to be realized, then negotiation and compromise can more easily achieve that desired result.
 
2.      Meeting requirements must result in cost- effectiveness.  By that I mean that the satisfaction of requirements must:
·         Reduce cost to affected owners, users, investors, or constituencies.
·         Avoid costs for these Value viewers.
·         Offset their costs by increasing their revenue or improving their cash flow. What makes these results “cost effective” is that they reduce the experience of total costs as a factor in the determination of Value.
 
3.      These results must be realized within the potential and constraints of a free and competitive environment. Value is not an arbitrary or absolute concept. It is comparative, elastic, and subject to changes in fact or perception. So, an important dimension for achieving Value is that its components – requirement satisfaction, costs – all meet the competitive criterion.
      
I believe this formulation I’m suggesting is broad enough and clear enough to allow those who create or assess Value to adapt strategies and practices, which can achieve their business, functional, even political objectives:
 
  • For buyers of goods and services, requirements and cost considerations must be seen from an internal perspective. By that I mean they must reflect the interests and concerns of those who pay a price in expectation of Value in return. It is those owners and users who must be satisfied, and who are accountable for cost results.
 
  • For product and service developers, marketers, sales and general management, the concept of Value must be seen from an external perspective. The notions of requirement and cost are the mirror image reflection of those seen by Value buyers. They are concerns of customer satisfaction, customer service and support, customer cost, customer revenue and cash flow.
 
  • For political representatives, those perspectives are both internal and external. Internally, they’re reflective of their constituency demands and interests.   Externally, they reflect considerations of the greater common good reflected in the law, and the overall economy.
 
Unfortunately but realistically, it is not likely that in today’s highly partisan environment, the political community can be easily converted to viewing Value as the achievement of a “greater common good”. It is too involved in pursuing the greater personal good. Nonetheless, let’s think about Value more clearly; make our value-impacting decisions more rationally; and through those endeavors help achieve that goal of the greater common good.
 
-Louis De Rose

 

January 22, 2010 - Lou De Rose, CMC

Value and Cost in Medical Care

In an article appearing in the Harvard Business School’s Working Knowledge publication, Michael Porter, the School’s eminent authority on competitive strategy, contends that the root of the Health Care problem is that competition “occurs at the wrong level, over the wrong things, in the wrong geographical markets, and at the wrong time.” He states that the “locus of competition has to shift from ‘Who pays’ to ‘Who provides the best value.’” Porter goes on and suggests ways of making that shift, which include steps involving strategic reorientation and more specific steps involving pricing, billing, and insurance underwriting.

 
The article is enlightening, but I believe there is one important omission in Porter’s assessment of the problem. When he talks about shifting from “Who pays” to “Who provides the best value,” he does not define “best value.” “Who pays” is simple to understand. It’s the amount of money given in exchange for the product or service provided. But what’s “best value?” Interestingly, the article is entitled “Michael Porter’s Prescription for the High Cost of Medical Care.” And here again, a critical term is not defined. What is “cost?” As far as the government, insurance companies, and HMO’s are concerned, cost is assumed to be the price paid for medical services, drugs, and hospital stays. And this is more at the root of the health care problem. We – the users, providers, legislators, the media –have not addressed, sufficiently, the issue of what constitutes “best value” in medical care. Nor have we defined what “costs” truly are in providing it. 

Let me illustrate what I mean by this statement. I recently visited a dermatologist for the removal of a common skin disorder, a sun-related actinic keratosis. I was given a full-body scan to determine whether other such disorders were present, and was zapped with liquid nitrogen for all that were found. As a younger sun-worshipper, I evidently accumulated quite a number of these disorders, because the number zapped came to 21. As an older, medically-insured patient, however, I was appalled by my bill. It was based on a fixed fee per zap for a procedure that took less than ten minutes to perform.

As a marketing and supply chain consultant, I naturally have to raise in my own mind the following questions:

  • Was I receiving value for what was charged? Granted, the treatment was paid by my insurer, but was that for value? Was it rather a price arbitrarily set by my insurer or some government agency?

  • Was the “cost” reflective of the time spent by the practitioner in providing the treatment? Yes, it seemed high, but did it accurately reflect all costs incurred such as those in running an office, nursing help, supplies, equipment, maintenance, liability insurance? 

These questions need more analysis, and clearly more thinking outside the currently stereotyped model. I’m convinced that we have the technology and tools to address the problem of health care better. But to employ them effectively, we need the understanding and will to employ them effectively. A way to begin is to better understand the basics of value, cost, and price. I’d like to suggest some thoughts:

  • In a medical context, value is the satisfaction of health requirements at the lowest    total cost of prevention, diagnosis, treatment, and rehabilitation. Clearly, this list of requirements can be expanded and fleshed out, but this is a start.

  • Cost I define as the expenditure of resources -- time, material, capital, information—necessary to provide value. Price is the dollar amount paid in providing those resources, but it is only one dimension of cost. Again, these suggestions can be expanded and spelled out in more detail. 

Without doubt, we have the medical competence to develop realistic criteria for identifying and evaluating the elements of “medical requirements.” We also have the economic and financial know-how to distinguish price from cost, and to establish criteria for determining reasonableness of cost. And, surely, we have the information technology to facilitate the design of systems and data flow to make these a reality. What are we waiting for?

-Lou

 

November 23, 2009 - Lou De Rose, CMC

Strategy, Tactics, and Small Business

A common criticism of small and not-so-small size companies is that their managements fail to think strategically. It’s claimed that they are so immersed in day-to-day tactical considerations, that they fail to develop longer-term strategies, and the tactics, which logically would flow from those strategies. Some may dispute the criticism, but my years of consulting experience in electronics and related industries, where small to medium sized companies prevail, confirms its validity.

To some degree, the failure to accept this criticism may result from a failure to recognize the difference between strategy and tactics. If that’s the case, let’s clarify the distinction. Both terms – strategy and tactics – stem from military usage. Thus, strategy is the process of planning and directing large-scale operations, as distinguished from tactics, which are the maneuvering of forces into the most advantageous positions prior to actual engagement with the enemy. Putting this into a business context, the distinction lies in the development of longer-term, broadly-based plans (i.e. strategy), as against more current, operational policies, practices, and actions (i.e. tactics). More specifically, that means managements must first set technology, product, market, and competitive objectives. Once those objectives are set, they can then develop and implement effective financing, sales, and pricing measures.

I submit that the global meltdown we have been experiencing over the past 18 to 24 months makes it imperative that managements think more strategically. The consequences of this meltdown are enormous, and likely to impact most dramatically small and midsize companies. This is particularly true for the semiconductor and electronic connectivity industries, where small and medium size companies prevail. According to recently published data, these industries are in the biggest slump in their 50 year history, with revenues falling by more than 20% in this year alone. These problems stem from two developments:

First is the fact that, increasingly, more products and applications now employ embedded microchips. This means that despite the downturn, companies must still expand or reconfigure capacity to meet this changing and exploding demand. Unfortunately, to do so means spending considerable amounts upfront, well before investments can realize profitable returns. And tactical measures cannot address this problem.

Second, and the flip side development, is that these industries have come to depend, increasingly, on how the rest of the economy fares. And given the current economic environment, and particularly, its consumer goods dimension, prospects are not good. To compete in depressed, yet changing markets, consumer goods producers must go, increasingly, “digital”. Microchips now find their way into everything from toasters and time pieces to hearing aids and hand-held computers. This rapidly changing technology increases the need for upfront investment, while multiplying the risks of volatile consumer demand.

Third, globalization is here, and it’s here to stay. This means that the impact of digitalization and volatile consumer demand is compounded. No longer can producers rely primarily on focus group readings of the “market”, reflecting    wants, needs, and preferences of domestic buyers, they must understand and correctly assess those factors globally. Without this focus, notions of competition, product mix, pricing, and inventory management, are woefully distorted.

So what are the strategic implications of these developments? It’s clear that there will be more industry consolidation, resulting in fewer companies, specializing more in product design, while outsourcing manufacturing, packaging, and testing operations. Additionally, it’s clear that these industries will be dominated by Asian-based companies. For small and not-so-small American companies, I would suggest the following strategic and tactical objectives:

  • Identify the technologies and market offerings in which you excel, and match them to current and prospective customers with growth potential. Concentrate on companies with design capabilities in leading-edge technology. Don’t try to be all things to all people. Reassess and focus on customers who make the greatest contribution to revenue and profit, and gradually weed out those who don’t pay their way. It’s incredible to me how little time and resources are spent determining how customers rank in terms of short and long-term revenue and profit contribution. In too many cases, poor contributors are bleeding away time, talent, and resources that could be profitably expended elsewhere.
  • Once you have established objectives for technology specialization, determining preferred customer mix, bases for competing more effectively, be it globally, regionally, or by industry and application, you are now able to develop tactics. These would address setting financial and budgetary priorities, policies and practices for sourcing, marketing, and pricing, promotional programs, identifying and exploiting opportunities. For dealing with competition from Asian suppliers, address firmly the issues of increasing costs of transportation, documentation, currency fluctuations, difficulty of communication, problems inherent in distance management and oversight. Specifically, understand and sell your advantages in total cost to the customer, other than merely price.
  • Lastly and most importantly, diligently seek out and promote prospects for moving up from a small or medium size enterprise to a larger, more diversified or specialized source. Consider merger acquisition, or partnerships. The prospects for surviving, let alone profiting as a small business, are not great. An economic environment of rapid technological change involves, increasingly, demands for large upfront capital investment, with high risk of failure to recoup that investment in the foreseeable future.

This is not a friendly environment for small and not-so-small companies.

-Lou