Meeting Transcript: Strategic and Commercial Thinking A Framework

You are specialists in HR, so your perspective on corporate issues is on the people who work in the organisation. It is true that organisations are their people. But recognising this doesn’t tell a company what strategy to adopt and implement, nor how to make commercially shrewd operating decisions. Indeed, the necessary inward focus in day-to-day HR work can be an obstacle to such understanding.

We are here to talk about strategic actions and commercial decisions, that is, what the people in the organisation need to do to ensure its viability and success. Most of my time will be spent illustrating this in the context of for-profit enterprises, which have the goal of creating substantial value for their owners. However, the logic is identical for not-for-profit enterprises, whether they be charities or departments of government. Every type of enterprise has long-term goals and measures of success and must structure and operate itself to achieve them. And every type of enterprise needs to make decisions along the way that promote rather than dilute those achievements – which is the meaning of effective commercial decision-making.

1. Where You Always Start
   Don’t be fooled by accounting. The life blood of business is money. So, we will talk about cash, and we will talk about value. The value of a business at any time is what the owners estimate to be the value today of its future cash flows. So, value doesn’t look only at the likely cash flow of the next month or year, but puts a number on the net cash flows to the owners over the entire future of the business.
   
   How long and cash-rich that future is likely to be, is determined by the strategy of the business. Examples:
   • As you know, many tech start-ups have a plan to be bought by one of the giants – Facebook, Microsoft, Apple, Nvidia and others. They intend to demonstrate a technology that will be irresistible to a buyer within a short number of years. These are businesses with a 2-to-5-year anticipated life. They are unlikely to have positive cash flow during their period of independent operation. They seek to demonstrate that these cash flows will be large in the future.
   • Some businesses are in decline because a new technology is supplanting their core activity. They could choose to invest, perhaps massively, to adopt new technology and renew their life, or they could choose to simply cut costs faster than revenue falls and milk the business out of existence. You have to bet on which will produce more net value, that is cash flows after deducting the costs of the transformation. Netflix used to rent out DVD ROMs so that people could watch films at home. It reinvented itself as a streaming company. That seems to have been a good bet. An example of something that has been milked to death is the selling of classic, whole life insurance. There, for a long time, the positive cash flow came from people paying on existing policies, while new business acquisition expenses exceeded the value of the relatively few new policies that could be acquired. This is because a whole life policy is a forced marriage of an actuarial bet on life expectancy and an investment strategy. Life expectancy is what it is, but it is much cheaper to do passive investing with Vanguard. You can’t imagine how warmly I was received by an audience of life insurance executives, in the 1980s, when I gave a speech advocating this.

Note, finally, that value is what the owners estimate to be the future cash flows. Estimates don’t always work out because no one can predict the future. But there are some common pitfalls that you must avoid. At the end I will come back to these, under the tantalising headings of Follow the Smart Money and Baffled by Bullshit.

2. Every Business Operates Within Constraints
   All businesses are forced to work within a legal, regulatory, and social framework. The former two grant a formal, the latter an informal license to exist and operate. These licenses delimit the boundaries of what strategic and commercial actions are possible. When the license conditions change, how the business operates (indeed whether the business operates) must change. Two examples:
   • As regulations and social expectations about pollution and environmental protection have developed, energy companies, water companies, plastics companies, supermarkets, and others have had to change their operations to comply.
   • I live in Bath, a lovely 18^th city with many grand mansions built on the profits of sugar plantations worked with slave labour in the West Indies. We don’t do this sort of thing any more. Indeed, now there is a giant stigma attached to any company that imports products from, or sells products to, places that violate humanitarian social norms.

Any successful business strategy or commercially shrewd action must be ‘socially responsible’. We will take this for granted in what follows.

3. Strategic Thinking
   All businesses intend to create net positive value. Their strategy explains how this good thing is to happen. Value is a calculation, taking into account what might happen to revenues and costs over time. So, strategies need to have content in terms of intent and actions, but they are subject to metrics. The arithmetic has to be believable.
   
   A strategy must begin with a concrete aspiration which becomes the touchstone of all the decisions that the business makes, short-term or long. Jeff Bezos started out with an online bookshop and then, very memorably, said “we are going to sell everything”. Taiwan Semiconductor Manufacturing Corporation aims to be the most advanced maker of chips in the world. You and I might say that we want to run a profitable Italian restaurant.

2. How plausible is it that we can get there from here?
   Even if the idea is, conceptually, a good one, can the entity in question actually implement it successfully? Every organisation has a capability and a culture.
   • Capabilities include things like financial resources, brand and customer base, supply chain relations, physical locations, licenses to do various things, proprietary technology and deep skills, reputation with regulators and the like. Think of these as the tools that need to be used to achieve the goals of a strategy.
   • Culture embraces, for example, what the organisation feels comfortable or proud in doing, what they would be very reluctant to do, and who among suppliers, customers, regulators and so on it interacts with effectively, or not. Think of culture as the worker that wields the tools to deliver the strategy.
   • Closely associated is what I would call perceived culture, what key outsiders think the organisation is and is not capable of doing well. These outsiders include shareholders and investment organisations, regulators, and customers. Staying with the tool metaphor, if your strategy is not perceived to be within the grasp of your culture, the outsiders may well take the tools away. For example, they won’t provide equity or debt to invest in your strategy, activist investors may try to take control of the Board and change your plans, or the bank regulators may show up at your door and shut you down.

By and large, the tools can be bought. The largest pharmaceutical companies routinely buy smaller ones that bring with them intellectual capital. Clever people can be hired if the pay is right. You can rent office space, warehouses and capacity in the cloud. It is the culture that determines if even the most promising business strategy will pay off.

I can give you many examples from my own experience. Most of my management consulting was for financial institutions. In the 1990s there was ‘investment banking envy’ among commercial banks. The latter had come to see themselves as stodgy, slow, boring, and relatively less profitable, whereas Goldman Sachs, Warburg, Morgan Stanley, and the like were seen as the leaders and the most profitable. So, the commercial banks piled in, mainly by buying investment banks, less often by hiring a small army of very expensive people.

Mostly, these efforts failed spectacularly, causing great financial loss to the buyers. The market opportunity was real and accessible. The source of failure was culture.

Manufacturing yields other good examples. Aston Business School is a leader in research on and implementation of servitization. This ugly word connotes the replacement of the sale of an item with the sale of the stream of services that the item produces. So, airlines don’t want to own engines, they want guaranteed movement of their aircraft. That is what the engine manufacturers sell. They have to do all the monitoring, the servicing and the replacement. Office building owners don’t want lifts, they want the ability to move so many hundreds of people per hour up and down. So, lift manufacturers now own the lifts and do all the monitoring and maintenance.

Aston has long worked with companies that wish to move to this business model. None of the work is engineering, although Aston’s key staff have engineering backgrounds. It is about culture change. Organisations used to packing things in boxes and shipping them out, need to learn customer service and customer management techniques, and how to respond on a timetable dictated by the customer, not by the manufacturing processes. If you can’t make these changes, the strategy will fail, no matter how good the ‘product in the packing box’ is.

4. Commercial Thinking
   A strategy gives direction and defines big and long-lasting actions. Commercial thinking is about day-to-day choices along the way. It entails making every such choice one that is likely to make more money. For example, would it be better to hire a new member of the team or pay the existing members to do overtime?
   
   Commercial thinking guides all continuous improvement process management. You look at each step, you ask if there is a cheaper/faster/higher quality way, you incorporate the hypothetical change in the entire process and estimate the overall outcome. And to reprise what I said at the start, what you are estimating is the implied change in profitability.
   
   But, but, but these commercial choices can’t be allowed to compromise the core strategy, however immediately appealing their outcomes might seem. Here are examples.
   • The system of metrics in your organisation can make seemingly commercially smart actions totally negative for the strategy. For example, one of my bank consulting clients had very high bank teller turnover: their average tenure was about 3 months. The manager of the tellers paid the absolute minimum, which he and his boss thought was very commercially shrewd. The result was that people would leave the job whenever a better-paid opportunity arose, but the annual total of teller salaries was commendably low compared with the industry. Now move to another department in the bank, the training department. It was chronically over-budget and expensive, because it had to train new tellers every 3 months. Paying a little more, enough to increase the average tenure to a still ridiculously short 6 months would have lowered the total sum spent across the two departments.
   • A good example of failure to make day-to-day decisions compatible with the big picture of the strategy comes from UK auto insurers. Their strategy should be to build up a pool of repeat customers. Marketing to get new ones is expensive: churn is the bane of businesses like this. However, most decided that it would be clever to offer low initial rates and then sharply jack them up in the second year, on the assumption that many customers were indeed sticky and wouldn’t do comparison shopping. This has provoked the regulators and the practice has been outlawed. Moreover, the bad PR has created public anger and stimulated the emergence of shopping sites like Go Compare. Short-term cash optimisation has most likely led to long-term loss of customer franchise value.
   • Let me return to metrics. The best management lesson I ever learned was from a client who said, “people don’t do what is expected, they do what is inspected”. How true. Most actions in an enterprise are part of a larger process, which has an overall end in sight. The process has a number of steps, involving various entities, some of which may be outside the enterprise altogether, either upstream or downstream. In general, commercial thinking should first identify the entire process of which the activity you are going to make changes in is part. A truly commercial benefit is one that makes the entire process more profitable, not just some part less costly or more revenue-positive. Your metrics must incorporate the impact of proposed actions on the outcome of the entire process, before making decisions.

In summary, commercial thinking is a state of mind. You always ask: how can I make more out of this, how can I turn this meeting to my advantage, isn’t there some way of doing things better/cheaper/faster. But then you must subject your answers to the tests of the bigger picture.

5. Dumb Stuff Not To Do
   The things I have described entail hard work. In many organisations, the leadership has FOMO, the fear of being left behind by new developments. Alternatively, the leadership’s aspirations may outstrip the organisation’s capacity to do the needed preparatory work. So, they seek short cuts.
   
   The most common short cut is one that seems very sensible: follow the smart money. If all these clever people are doing something, they will surely have done the up-front validation work. Unfortunately, the smart people often don’t, not least because they have come to believe in the brilliance of their own, unaided judgment.
   
   There are many examples of such folly, where famous investors with great reputations have put money into fraudulent things, to be followed by a parade of other famous investors. Two spectacular ones, separated by a decade, are SinoForest and Theranos.
   
   A more recent example is cryptocurrency. Here the ‘follow the smart money’ strategy has been technologically updated and has become baffled by bullshit.
   
   Crypto has been fronted by people like Sam Bankman-Fried who walked around in a t-shirt and baggy shorts while speaking in a language that few could understand. He famously played video games while a pitch for his business was being made to big venture investors. People invested in all this because other, earlier investors seemed to have been making a lot of money.
   
   The entire crypto industry is now collapsing. Bankman-Fried’s exchange, FTX, seems to have misplaced $8 billion of customer money. Binance is now under investigation for diverting billions of customer money into opaque institutions secretly owned by Binance’s chief executive. In the preceding year, all sorts of other remarkable cons have folded, for example the Terra ‘stablecoin’ which was backed by an imaginary currency called Luna. The old-fashioned name for such enterprises is Ponzi schemes.
   
   What you don’t deeply understand, you shouldn’t do.

6. Not-for-Profit Enterprises
   The logic of strategic and commercial thinking applies to social enterprises and government entities as well. They should have long-term goals; they face constraints; and there are day-to-day decisions that need to be taken. A prerequisite for going beyond fine phrases and good intentions is to create measurable goals. Only then can you specify actions to get there and decide whether the actions are paying off.
   
   The ‘competitive strategic context’, what others ‘in the same market’ are doing, is just as relevant. For example, many non-profits are founded by well-meaning philanthropists. In the US there are hundreds of thousands of such entities, with many focusing on the same themes such as support of the performing arts or addressing homelessness. The problem is that too many are too small, and the overheads of a small organisation consume too much of the available funding. The rational answer is to combine many small ones into fewer bigger ones so that the ratio of operating cost to benefit created is more favourable. Market pressures do this in the for-profit context. Deliberate action is needed in the social enterprise arena, and this very often conflicts with the wishes, and the egos, of the founders/funders.
   
   Interestingly, a for-profit outlook is often an essential component of strategic success for social enterprises. An example from my own experience comes from the National Park Service, which maintains the national parks. It operates these for the benefit of the nation, but it is always short of funds. They own Alcatraz Island, in San Francisco Bay, the site of a notorious Federal Prison. This island was turned into a significant revenue source for the Park Service after I created the original audio tour of Alcatraz, now a spectacularly successful tourist attraction. It is a business and runs on business logic. The Park Service simply didn’t recognise the possibility because its personnel didn’t think in that way. The culture caused them to miss the strategic opportunity.
   
   There are many parallels also to day-to-day decision making that becomes destructive of the long-term strategy. Short-sighted embrace of dodgy funding sources has brought many non-profits to grief. They have taken money from oligarchs and rotten opioid manufacturers. The lure of present cash blinded them to the long-term reputational consequences.

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If you take only one message from all this, it is that good decisions come from big picture thinking. Get away from an internally oriented focus on immediate problems. Look at the outside context and your organisation’s place in it. And look at all the internal activities within the context of the end-to-end processes of which they are part, and with reference to the strategy that they are supposed to support.