Checks and balances…they’re a feature not a bug

It’s been an exciting few days for checks and balances.

Adam Neumann got ousted as CEO of WeWork after their IPO disappeared in a flash of unicorn dust.

The Democrats started an impeachment case against President Trump in Congress.

California Governor Gavin Newsom signed a new law forcing Uber, Lyft and similar companies to reclassify their contractors as employees…a potential knockout blow to the business models of those firms.

In the UK, Prime Minister Boris Johnson came off second best in the Supreme Court earlier this week.

And late on Friday evening, news broke that Boris Johnson’s behaviour while Mayor of London, by allegedly favouring a female entrepreneur he was close friends with, has been referred to the Independent Office for Police Conduct. (An oversight route made possible because, as Mayor of London, he was also London’s Police and Crime Commissioner.)

Much as I’m scathing about WeWork’s Adam Neumann on Twitter from time to time, in fairness he’s largely accepted the game’s up for him (albeit he has 700 million reasons not to feel too bad about the way things turned out).

In every other case, the response of those who’ve had their behaviour questioned is to say that the case against them is a political move by their opponents.

But is it?

A feature, not a bug

Having your political opponents take a case against you isn’t a bug in the system, it’s a feature of it. And one we should treasure.

After all, who’s going to keep you honest? Your cronies, your friends, the people who drink deeply from the same well of dodgy cash as you do?

Of course not.

It’s the people who have completely different views to yours, opponents who don’t bathe in the same water as you do, who keep you honest. That’s exactly how checks and balances are supposed to work.

The US Constitution, for all its faults, is still one of the finest structures for the separation of powers the world has ever seen.

The three elements of government – the Executive, the Legislature and the Supreme Court – have been set up in such a way that one element alone cannot act without the consent, tacit or otherwise, of the other two.

While that’s occasionally frustrating, we have to remember the drafters of the Constitution wrote it that way on purpose. They were the original “small government” pioneers who resented the Kings and Queens of England interfering in the affairs of the North American colonies.

That’s why the Declaration of Independence didn’t replace a King in London with one in New York or Boston. The colonialists wanted an entirely different model. One where no absolute ruler could tell them what to do.

So the US Constitution was designed to make it all-but-impossible for any one person to hold all the cards when it came to the business of government.

But the drafters of the US Constitution were also public spirited enough to recognise that they had a responsibility to, as the preamble to the Constitution says, “promote the general welfare”.

So if all three elements – Executive, Legislature and Supreme Court – agreed on a course of action, that was probably a sensible way forward which the country could unite behind.

The drafters of the US Constitution never quite put it in these terms, but they’d suffered under the yoke of far-off kings and noblemen for long enough to know that, in the famous words Lord Acton would utter a century or so later…

Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men…

Lord Acton – letter to Bishop Creighton, quoted by

From the Boston Tea Party to chocolate’s sugar rush

In the UK, we famously don’t have a written constitution. Most of the time it somehow all works anyway, but there are times when that unwritten constitution is strained to its limits.

The same is true in company law. For a long time company bosses could do pretty much what they liked. Most were decent people trying their best, but a few disreputable individuals with their eyes on the big money prize pushed things too far.

The late 1980s and early 1990s saw financial scandals like Polly Peck, Robert Maxwell’s plundering of his companies’ pension funds, the Barings Bank collapse and BCCI.

Even for a country with an unwritten constitution we Brits collectively decided there had been one corporate scandal too many, so decided we’s write a “constitution” for our businesses to follow.

The basic structure for this new system of corporate governance was laid out in the Cadbury Report, named after Sir Adrian Cadbury, of the Cadbury chocolate empire, who chaired the less than snappily-titled Committee on the Financial Aspects of Corporate Governance.

I did a law degree before being seduced by the bright lights of an accounting career, and had a particular interest in constitutional law, so I was probably less surprised than many to find the Cadbury Report highlighting the importance of the separation of powers in an organisation to help keep people honest.

This included the principle, familiar to drafters of national constitutions around the world for the last 250 years or so, that no one individual should have final decision-making powers in a business. This would be ensured by having independent non-executive directors in the majority on company boards.

In the most recent iteration of corporate governance standards in the UK, the UK Corporate Governance Code, there is an explicit requirement for the Chair of the board to be independent of the business and separate from the Chief Executive (Provision 9).

All UK-listed companies are required to comply with the UK Corporate Governance Code as a condition of retaining their stock market listing. Similar provisions apply in most major financial markets around the world.

From Sir Adrian Cadbury onward, those in charge of corporate governance in the UK have understood that “power corrupts and absolute power corrupts absolutely”. They have done their best to make sure nobody holds absolute power in an organisation.

Well, that’s the theory…

Of course, even a system with separation of powers built into it relies on people behaving honestly and sensibly.

And this isn’t an expectation for company bosses alone. It’s how the UK’s parliamentary oversight process is supposed to work, as is the governance process in trade unions.

However, as we’ve seen recently in politics, if you make sure…by fair means or foul…the people exercising oversight all share precisely the same position as you do on this issues of the day, or that they have some vested interest in the outcome you’re seeking for yourself, even if that’s for a different reason than the reason you have, then oversight can quickly become a sham.

Tiny numbers of people control the UK’s main political parties by taking positions which have alienated substantial numbers of their own supporters. Far from being political suicide, as you might initially think, this means those spouting the most extreme nonsense, on both left and right, hide under the language of “implementing a democratic mandate from my party”.

When “your party” means the 20 or so most vocal activists in each constituency cobbling together to ensure a vote which serves a party leader’s best interests, that’s not a democratic mandate at all. It’s closer to mob rule.

And the same is true of corporate governance.

Governance of any sort is a sham when the people doing the oversight are just as interested in reaping the rewards as the person heading the organisation.

Their precise objectives might be slightly different, but the key is that now, in effect, we have a single individual able to make all the decisions in direct contravention of every fundamental precept of corporate governance.

In theory, the governance structure has been set up to prevent that. In practice nobody wants to stop an out-of-control Chief Executive because they get a share of the spoils if the Chief Executive gets away with it.

Take the unfortunate WeWork saga.

There was absolutely nothing Adam Neumann did at that company which wasn’t public knowledge and which the chair and board of directors were unaware of. There was full disclosure in the S-1 form filed with the SEC prior to WeWork’s abortive IPO. There is no suggestion that any information has been withheld from either the board of directors or the SEC.

In fact, it was the disclosure of what WeWork had been up to in their S-1 which sank their IPO without trace.

The only question is – how on earth did the corporate governance abomination that was WeWork ever think their behaviour as a business, and their Chief Executive’s…shall we politely say…narcissistic idiosyncrasies were in any way acceptable for a public company with a supposed value of $47 billion?

The answer – any rational notion of corporate governance in that business had completely failed.

The consequence of that failure of corporate governance – WeWork went from a valuation of $47 billion to, effectively, zero in the space of a few weeks. That’s an expensive lesson, so let’s look at how such a spectacular failure happened on the eve of a major IPO.

Where was the board while all this was going on?

You might think the board of WeWork would have stepped in when Adam Neumann started going off the rails a little.

In fairness to Neumann, he clearly had energy, vision and a way of presenting his ideas persuasively which would have made him an asset to any business. But he was like the 3 year-old whose parents don’t stop them eating as many cookies as they want and instead end up dealing with their child’s poor behaviour as they ride the roller coaster of successive massive sugar rushes followed an hour or two later by deep crashes.

In the business world, as for toddlers, poor behaviour left unchecked tends to have severely negative consequences down the line. Not usually $47 billion-worth, admittedly, but still consequences.

Yet the board of WeWork displayed very little inclination to keep Adam Neumann’s hands out the narcissistic cookie jar, even though it is the role of the board to preserve the long-term health of the business. Whatever the people who lost $47 billion thought they were doing, they certainly weren’t preserving the long-term health of the business, as subsequent events have proved.

And that’s largely because the board of WeWork had their hands in a cookie jar too, albeit a financial cookie jar rather than a narcissistic one.

They didn’t get their “hits” from another narcissistic episode, like their Chief Executive basking in admiring articles in business magazines and speaking at top-line conferences around the world.

In the words of Vanity Fair…

It’s hard to overstate the degree to which WeWork’s business is built on the egomaniacal glamour and millennial mysticism of Neumann and his wife. Neumann sold WeWork not merely as a real estate play. It wasn’t even a tech company (though he said it should be valued as such). It was a movement, complete with its own catechisms (“What is your superpower?” was one). Many major players found this special sauce irresistible.

Vanity Fair, 23 September 2019

No, the board got their “hits” from selling shares in WeWork at successively higher valuations, which in turn made their personal shareholdings, and those of the investors they represented, more valuable.

WeWork was founded in 2010 and by 2012 had raised $17 million in a Series A funding round. A $40 million Series B followed and their $157 million Series C in November 2013 valued the company at $1.6 billion.

From there, it was up and up, all the way to $47 billion by summer 2019.

When you’ve got a charismatic founder with, ahem, those little idiosyncrasies generating significant personal wealth for you…or a substantial return on investment for your employers…or both…very few people are strong enough to want to knock that particular gravy train off its tracks.

And yet that’s precisely what should have happened long ago.

When fantasy meets reality

Sooner or later even gravy trains hit the buffers.

There’s even an expression for it in financial markets – the “greater fool” theory.

It states, roughly, that no matter how delusional you are, as long as you can find someone more delusional than you are to buy your shares from you at a fancy price then everything is OK.

Indeed, they’re buying those shares in the expectation that they’ll be able to find a “greater fool” a little way down the line to sell those shares on to and make a profit for themselves.

But if you’re the last “fool” in line before the market shifts south at a rate of knots, then you’re the one whose wealth is destroyed.

At lower levels of valuation, WeWork might have made some financial sense. London-listed IWG plc, which has been in the shared office business for 30 years and operates the Regus brand of shared offices, is worth a little under $5 billion.

But there was a point for WeWork when the valuation jumped across a line from “a very optimistic view of future prospects” to “delusional and not justified under any sensible economic model”.

And at that point, WeWork’s corporate governance failed.

Not because they didn’t tick any boxes they should have ticked. As I’ve said already, there is no suggestion that WeWork withheld any information from the SEC, the NYSE or the legions of public investors they hoped to attract.

But, had the WeWork IPO got away, there wouldn’t be a single person on their board upset with Adam Neumann. He’d still be their CEO, in all his idiosyncratic glory.

The early investors would have banked their cash and gone off into the sunset before the ordinary man and woman in the street realised they’d been completely stiffed by people who sold them a business model which made no economic sense.

And the board was egged on by the investment bankers at JP Morgan and Goldman Sachs who stood to make millions in fees from a successful IPO. In the memorable words of NYU Stern Business School Professor Scott Galloway

The bankers (JPM and Goldman) stand to register $122 million in fees flinging feces at retail investors visiting the unicorn zoo.

Scott Galloway August 16, 2019

Corporate governance failed at WeWork because nobody was prepared to take the other side of the deal.

While the investment bankers, board members and investors were licking their lips and planning to buy themselves oceangoing yachts and Gulfstream jets with their profits, nobody was saying “are we all sure this is a good idea?”.

Nobody was looking out for the retail investors, the ordinary people who invest their hard-earned savings in public companies, either directly or through their pension funds and mutual funds…except perhaps Professor Galloway.

And it’s not that nobody knew the truth.

People who work at JP Morgan and Goldman Sachs might not have moral compasses which work terribly well, but they’re smart people. They know how to run an Excel spreadsheet. And there’s no way on earth an objectively-constructed Excel spreadsheet loaded with WeWork’s business plan would have made any economic sense at any point in the next several centuries.

They must have known WeWork’s plans made no sense, but pressed on anyway with their eyes on $122 million in fees.

By the same token, the board of WeWork, which had plenty of smart people sitting on it, must have known the business plan made no economic sense, but pressed on anyway with their share of $47 billion as the prize for getting the IPO away.

WeWork, in a sense, did nothing wrong. Every box which should have been ticked was ticked.

And yet WeWork did everything wrong when it came to the fundamental principles of corporate governance.

Every business needs someone taking the other side of the deal

In the modern corporate world, pledging allegiance to some corporate messiah is what fancy business schools’ leadership programmes say should happen.

This is hokum.

The most valuable person in any business is the one who isn’t drinking the same Kool-Aid as everyone else. The person who can take an independent view, someone who can put themselves in the position of an outsider looking in on the business and ask the CEO and investors “are we quite sure we want to do things like this?”.

Like the little boy in the story about the emperor’s new clothes, someone has got to be given authority to speak out and challenge the prevailing orthodoxy without fear or favour.

Despite what people with fancy MBAs will tell you, that sort of dissent isn’t a sign of organisational weakness, it’s a sign of organisational strength.

And it’s the foundation of good corporate governance – not the tick-box type where your high-priced lawyers make sure you don’t get sued, but the type that matters. The type of governance that stops you making a $47 billion fool of yourself, destined to go down in business history as either a crook or a moron.

Checks and balances matter. They’re a feature not a bug, but when everyone’s drinking from the same ego-fuelled money trough, all the tick-box corporate governance in the world won’t save an out-of-control business from the consequences of its investors’ greed and its Chief Executive’s narcissism.

It cost WeWork $47 billion to learn this lesson.

Hopefully you’re a lot smarter than they were.

(Picture credit: Bekir Dönmez on Unsplash )

“Dear Abby, My CFO won’t listen to me. What should I do?”

My friend, Samuel Brealey, works in marketing. He was interested to know what marketers could do to get their Finance Directors or CFOs on-side when it came to marketing.

We had a good conversation and Samuel ended up writing a great article on the subject which was published by Econsultancy.

But he got me thinking. It’s not just the marketing department which struggles to communicate with their finance department. Most other departments struggle with this too.

So I took the questions Samuel had asked and answered them, not just for marketers, but for other professionals too. Hopefully there’s some food for thought in here for you….

What are CFOs’ biggest frustrations when dealing with non-finance people?

Financial people like certainty, or at least some broad rules which work most of the time.

This makes it easier for, say, engineers to have conversations with their finance colleagues because that process-based life of relative certainty is pretty much their world too. Yes, there are some specifics and explanations to sort out, but usually engineers can explain what the outputs will be for a given set of inputs because that’s the way they think about what’s going on too.

Great news for engineers, but what if you work in a department like marketing, customer services or HR?

Here, although some elements can be expressed as a process, outcomes tend to be more random. The marketing strategy you never thought would work turns into the campaign of the year. The “dead cert” employee engagement policy you developed has people more disenchanted than they were before.

That’s not necessarily because the original proposal was an inherently bad idea…although sometimes that’s undoubtedly true. But it just reflects that in the less-predictable world away from finance and engineering, outputs can be a bit more random.

There’s an old army saying that no plan survives the first contact with the enemy.

By the same token, no strategy developed in a conference room somewhere completely survives the first contact with its intended audience.

So what can you do?

Firstly, try not to go “all in” with whatever you’re proposing. For naturally cautious people, like the typical Finance Director or CFO, this seems foolhardy and unnecessarily risky.

Try things out first – pilot them in a remote office somewhere with a shoestring budget, then roll your new initiative out if it’s successful. That will look like a sensible, well-managed, low risk approach to your average Finance Director or CFO so they’ll be more likely to support it..

Secondly, be very clear about your assumptions. If what you’ve proposed doesn’t work, but you can explain back to your CFO which one of your assumptions…with the benefit of 20:20 hindsight, admittedly…was a little off-base and what you’re going to do to put it back on track, this makes it much more likely your CFO will listen to what you have to say.

You’ve opened the door for a conversation about “what do we need to do to get our conversion percentage up?”…or some other specific element of the plan…and demonstrates you’ve thought things through. The rest of the plan might well remain pretty much “as is”, but some element just needs tweaking a little. We’ll be much more inclined to listen to someone who can explain what happened in those terms.

If it just doesn’t work and you can’t explain why…or worse, if your explanation sounds like the sort of non-specific nonsense that your CFO has heard from too many people already in their career…next time you put a case forward, you’ll have a much higher credibility hurdle to get over with your CFO.

The key here is not that everything has to work all the time. We know that’s unlikely. But can you analyse and explain why it didn’t? If you can, we’re much more likely to support you next time you want to try something out.

How can non-financial people work more strategically with their CFOs?

In general, you’ll have better luck with your CFO if you engage them at the strategic level.

Explain why what you’re doing matters to the business. After all, good Finance Directors and CFOs are there to bring value to the business. No finance person worth their salt would turn down value-enhancing propositions on a whim.

Don’t just present us with a campaign or an initiative, seemingly on a whim.

Loop round to discuss the strategic background before illustrating why this particular proposal represents your best professional view of the most effective way forward.

Try not to sound like you’ve picked up the latest issue of your professional body’s monthly magazine and are just regurgitating its contents to us. We read the press too.

If all you talk about is “employee engagement is a good thing because the CIPD says so” or “influencer marketing is the way forward, according to the Chartered Institute of Marketing” we’ll quickly form the view that you don’t know what you’re talking about.

Not that either of those things is necessarily the wrong approach to take. But explain how that works for our business. Where does it add value? How will it improve our operations? How does it reduce costs or increase revenue?

Answer those questions and whilst we might still say “no”, at least we’ll give you a fair hearing.

But, and I can’t emphasise this enough, always loop around to the strategy. Maybe the expense of hiring and training new staff is getting out of hand, so your employee engagement strategy is designed to sort that out.


Be specific about that, explain what level of reduction in employee turnover means the programme pays for itself, demonstrate that you’ve found a way to pilot at least some of the key planks of your new initiative to make sure the data supports your conjecture and we’ll be all ears.

You don’t need to turn up with all the answers. Just be upfront about what you do know and what you don’t, what’s relatively certain and what’s a punt and we’ll have a debate with you just like we do with every other department with a wishlist.

But whatever you do, don’t just say what you think we want to hear so we say yes. You’ll only get away with that once…

How can we work with our CFOs to build and improve metric tracking, KPIs and reporting systems?

The key element here is the “work together” bit.

We’ve all got our own professional knowledge and specialisms to draw on. Accountants clearly don’t understand marketing or HR, say, in the same way an expert in those professions would. And vice versa, of course.

But we do understand tracking, measurement and reporting systems better than most other professionals. Working together means we stand a chance of coming up with something sensible that works for us both.

To kick things off, you need to have a very clear idea of your own department’s objectives and business processes, how they knit together and what different steps are involved in making sure your department hits its targets..

“We’re going to do some influencer marketing” doesn’t come close to doing that. Don’t tell us about Kim Kardashian’s influence unless you’re proposing we work with her. We get the general idea, just tell us how what we’re proposing to do will add value to our business, not businesses in general.

How will we know if it worked? How will we know if it didn’t? How will we control for other variables – for example if the upward bump in the sales line might have been caused by, say, a new salesperson starting at around the same time as the influencer marketing campaign kicked off?

Now we’re ready for a conversation. And now we can help build reporting systems we both understand.

That benefits us as CFOs because now we understand what you’re planning to do. And it benefits you and your department too because if you don’t do this, we’re very likely to impose some reporting processes or KPIs on you, over your howls of protest if necessary..

We don’t do this out of malice, or because we’re control freaks…well, not always anyway…but because we have to answer to the board for substantial budget spends.

If the business spends a million bucks on an employee engagement initiative or a marketing campaign, you can bet the board is going to ask how that’s getting on and so you can bet we’ll be all over it. We’re the ones on the spot answering the questions, not you, so we need to do what we can to make sense of your area of operations, with or without your help.

So work with us on the reporting systems, ideally as early as possible in the process and before we’ve started building our reporting templates so we can develop a set of metrics that work for us both.

Since people outside the finance department don’t tend to have those conversations with us very often, anyone who does will quickly be seen as a trusted partner of the Finance Director or CFO, not someone whose word we’re not entirely sure we can trust.

Given a choice, believe me, you want to be in that first group…

In an ideal world, how would non-financial people work together with finance day to day?

Always think about the process perspective. Everything we do in a business…every unit of input…is trying to get a unit of output of some sort. That’s the whole reason we do anything at all…to get whatever that unit of output is.

It’s not always a purely mechanical process, of course, for the reasons stated above, but the key here is we’re not doing things randomly, in abstract. We’re doing things for a purpose.

And probably more of a shared purpose than you might imagine. We almost certainly both want to build the business we work for, and make it more successful in the future than it’s been in the past.

So think about the process you’re running, even if it’s not absolutely quantifiable in scientific or engineering terms.

For example, we know not every sales call will result in a sale. We know there is a measure of good luck, timing and Act of God in determining which sales call turns into a client and which ones do not.

Maybe you can’t predict exactly which targets will become clients. But out of 100 or 1000, we’d expect you to have thought through a process which is designed to turn, say, one in three of the sales calls made into clients.

And if it’s not working for some reason, highlight the specific area that’s not working – are we seeing the right number of new prospects, but our conversion rate has dropped dramatically, or are we converting the right number of clients but their average order value has dropped?

What we’d do to put things right might be very different depending on what caused us to under-shoot the department’s target in the first place. So tell us what’s gone awry and how you believe you can get that part of the process back on track again.

Most CFOs are fairly pragmatic so once we know what problem we’re trying to solve, we’re in solution mode. But if nobody can explain what the problem is, or what we can do to put things right, we’ll rapidly lose patience.

If, heaven forbid, something doesn’t quite work, don’t put your head in the sand. Let us know…as specifically as possible…what’s not worked and why. We’ll happily work with you to try to turn things around.


CFOs are there to help the business succeed.

Good CFOs want to help each individual, and each department, in the business succeed, because that’s how the business as a whole gets to where it needs to be.

So we’re always up for a conversation about how to make the relationship between Finance and other departments better.

For a pro tip, things get pretty hectic in Finance when we’re sorting out that month’s accounts or doing the year end. Usually these are times of intense pressure which means there’s not a lot of room left in our heads for anything else.

But reach out. Ask for a chat at a time when we’re not busy with month-end and explain what you’re trying to do.

Any decent CFO will be up for that…and you never know, we might even be so excited that someone cares enough to have a proper strategic conversation with us that we offer to pay for the coffee…

( Photo by Austin Distel on Unsplash )

Is “How cheap can we make it?” always the right question?

A couple of years ago I helped judge a Dragon’s Den-type competition in a local school (you might know this as Shark Tank if you’re outside the UK).

Groups of students each had to create a gift which they could “sell” to students who wanted to say “thank you” to their teachers for being so helpful and supportive that school year (which I’ve always thought was a great use of the power of hypnotic suggestion on the teachers’ behalf…but that’s not entirely the point of this article).

On the appointed day, each group presented their suggestions to the panel of “Dragons”, of which I was one.

There were some super ideas in there, but the one I remember most was the group which proposed, in essence, using a free web design service to produce a quick design, which could be printed off on a piece of flimsy card, thin enough to fit through a home inkjet printer, and handed to the teacher at the end of the school year at a cost of just a pound or so each..

All the students took turns to present different elements of the idea to the panel, but I still remember the boy who led the pricing section of his group’s pitch beginning his remarks with “Obviously, we wanted to make this as cheap as possible…”

Whilst I didn’t interrupt the presentation or try to derail their ideas…I might be a Finance Director and CFO, but I’m not an ogre…I did seek out this group afterwards to give them some feedback.

“Why, ” I asked, “would you want to go out of your way to make something as cheap as possible when it’s intended as a heartfelt thank you to someone who has been extra-nice to you? When your parents give you their heartfelt congratulations on your exam results or passing your driving test, do they think “how can we make this as cheap as possible?” or do they try to get you the very best of whatever they can afford to show their appreciation for your hard work?”

Bear in mind, this was a school which caters to a pretty well-off group of parents. I lived close enough to know kids who went there were often treated to exotic holidays for doing well in their exams and new cars when they passed their driving tests.

I don’t begrudge them any of that…after all, who among us wouldn’t do the very best for our own children?…but it was an interesting perspective.

The boy who’d done the pricing section spoke up. “Well, we’re in business, so we have to make everything as cheap as possible.”

I agreed that no business would last for long if it over-paid for the products it buys. But I asked him what car his dad drove…and wasn’t too surprised to hear it was a swanky BMW towards the top end of their model range as that seemed to be about the running average when I saw parents dropping their children off at this school each morning.

Why is that, I asked…I’m sure your dad knows there are plenty of cars cheaper than his BMW. Any one of them would get him to work pretty reliably. Or he could catch a bus.

And BMW are a business, yet they sell products which both they and their customers know for sure aren’t the cheapest way of getting to work.

So how cheap they can make their transportation doesn’t seem to be the most significant factor for people who buy BMWs, at least. We know that for sure because, if lowest-cost transportation was their overriding consideration, they wouldn’t buy a BMW in the first place.

I ended up having a nice conversation with this group about how things like branding can make a big difference to what people are prepared to pay, and how, in the eyes of the receiver, an expensive gift might be viewed very differently from a cheap one.

I don’t know if I helped this group of students see the world in a different light. I’d like to think so but, as I recall from being that age myself, 16 and 17 year-olds have plenty of other things going on inside their minds, so I’m not banking on it.

Now, don’t think I’m being too hard on a group of well-meaning 16 and 17 year-olds. We were all young and foolish once…yes, even future Finance Directors and CFOs.

But I find it a lot harder when this conversation comes up in a business context. While, of course, having an eye on costs and margins matters, too often middle and senior managers in sizeable organisations spend their time focused on how cheap they can make something when that’s just about the worst question anybody in business can ask.

The question they should ask instead is how they could build in significant amounts of extra perceived value for customers, provided the business can deliver it for an additional cost which is less than their customers’ perception of what those extra features and services are worth.

This is Economics 101.

If a business makes a 10% margin on its £100 product, that’s a tenner in its bank account.

If someone finds a way to increase the price to £200 by packing in more value…in the eyes of their customers…but it only costs an extra £50 to build in those features, the business goes from making £10 per unit to making £60 per unit.

The margin has gone from 10% on a £100 product to 30% on a £200 product.

What’s more, your customers are happy to pay double compared to what they paid before.

I fully accept if you’re in the commodity business…mining for coal, perhaps, manufacturing paper or smelting aluminium…market forces mean you’ll only get the same price per tonne as everyone else who can deliver to the same technical standards.

But a lot more businesses behave as if they were commodity producers, competing purely on price, than actually are commodity producers. More often than not, that’s just down to the business’s lack of imagination.

Sometimes the £100 product is very little different to the £200 version, but at the higher price point it comes bundled with a range of extra services which justifies the higher price point in the eyes of customers.

There really is no excuse for businesses not to try to improve the value they offer to customers.

That doesn’t mean overpaying. You have to make sure the commercial terms work in your favour. But, strange as this may sound, it means businesses should be actively seeking to increase their costs, because…unless they’re staggeringly inefficient now…that’s how they’ll deliver greater value to customers.

To illustrate, let’s flip that around…very few businesses have customers who are likely to allow it to make more profit by providing a worse service or poorer-quality products.

If a business focuses on cutting costs, its £100 product with a 10% margin might…if it’s diligent with the cost-cutting and lucky enough that its customers don’t notice or don’t care too much about the corners it’s cut along the way…become a £90 product with its original 10% margin maintained.

Except now you’re making £9 per unit instead of the £60 you could have made. And making £60 per unit isn’t going to be six times harder than making £9.

If you’re doing it right, it’s likely to be no harder…perhaps even easier as you’ll have the budget for a slick, well-managed operation rather than running the business on a shoe-string which needs regular urgent intervention to keep its under-resourced people and services on track.

Perversely, it’s often a lot harder to run a business when you fire the expensive, long-serving staff who know all about your products and your customers and replace them with casual workers hired only when you’ve got something for them to do. Often businesses end up using a lot more labour as a “blunt force” solution to a problem when a much smaller number of highly-paid people might have crafted a more elegant and effective solution at a lower overall net cost.

Or when you replace the top-quality German computer-controlled machines which some pale imitation from goodness knows where at half the upfront cost…but which extract a much higher price in maintenance, repairs and additional downtime across the lifetime of the machine itself.

Not only is it a lot harder to run a business supposedly “on the cheap”…it’s usually more expensive in the end too.

That’s not what the business case for making the changes will say, of course, but it’s what people will gradually realise six or nine months down the line when holes start appearing in its product or service delivery and the business moves firmly into “recovery mode”.

That’s when the customer complaints department has to take on more staff. The quality inspections have to go up. The refunds to customers when the products don’t last out their guarantee period goes up. And the business will spend a lot more on marketing to attract a constant stream of new customers prepared to give a poor quality service a try than it would have to spend if the brand and reputation did more of the heavy lifting on the sales front.

If you doubt this, just think to yourself…when did you last see an advertisement for a Rolls Royce?

I’m not sure I’ve ever seen one. Yet everyone knows that “the Rolls Royce of the XYZ industry” is the byword for a product of unimpeachable style and reassuringly good quality.

Which is why I’ve always been mystified that supposedly intelligent people, often with fancy MBAs, spend so much time reducing costs…often to the detriment of their staff, their customers and ultimately their business…when they should instead be actively seeking ways to make their products more expensive by offering additional value to their customers and standing out from the crowd rather than becoming just another bland price-based operation.

Don’t blame your customers for choosing the cheapest deal if price is the only thing you’re competing on. Some customers will always choose the cheapest option because that’s just the way they’re wired.

But more customers…maybe even most customers…are only deciding on price grounds because you haven’t given them any reason to make a different choice.

Were businesses to work on improving their branding, their reputation, their customer service, the marketing, their customer loyalty, their staff motivation, their product development, their design and any one of the dozens of other aspects that define the customer’s perception of the product or service they’re buying…then they might be surprised how many customers will happily pay for the extra value they receive.

That’s why, whether you’re a 16 year-old student or a 45 year-old middle manager with an MBA, “how cheap can we make it?” is rarely a good question to ask.

A better question would be “how much additional value can we build into our products and services such that customers will happily pay more than any extra costs we incur?”

Perhaps we shouldn’t ask “how cheap can we make it?”.

Maybe we should ask “how expensive can we make it?”.

(Photo by Manuel Cosentino on Unsplash)

Why thorough processes delivered to a high standard might account for all the problems in your business

The world is becoming increasingly process-orientated. There are positive aspects to that – if you’re the pilot of a 747, the Operations Director of a nuclear power plant or a surgeon carrying out microsurgery on a vital organ, I’d feel a lot more comfortable knowing that what you do, and the order you do them in, has been designed in a reliable, dependable way.

Even though most of our daily work activities aren’t anything like as mission-critical as those examples, the business world seems determined to introduce ever-greater numbers of processes and procedures to govern every aspect of what they do.

I’m not sure that’s a good thing for a number of reasons, but in my capacity as a Finance Director and CFO what bothers me most about our process-heavy world is that this approach often turns into a really expensive way to do something simple, and can easily lead to a range of less-than-wise decisions.

There is a better way…which we’ll get there in a moment…

But first, the inspiration

This article was inspired by a tweet from the always-interesting Mark Pollard (@MarkPollard on Twitter) reporting on a conversation with Phil Adams (@Phil_Adams). Here it is:

Their conversation was specifically in the context of producing good creative work, but I’d argue this concept matters for just about everything a business does.

The maths is unarguable.

Phil Adams points out, correctly, that even with just a 5-step process, where each step is done right 90% of the time, the likelihood of getting to a perfect answer each time is less than 60% (59.049% to be exact), assuming we’re dealing with a sequence of independent events (quick statistics primer here if you would like a refresher)..

Yet the holy grail for most large corporations is a detailed process with dozens of precisely crafted steps, each done right at least 95% of the time.

For a business process with even just 12 steps, however, each done right 95% f the time, the likelihood of everything happening exactly as planned is even less than Phil Adam’s example above. In fact, that process will only work as intended 54.04% of the time on average for a 12-step process, or not much over half.

Think about this. With a 12-step process where each step is done right 95% of the time, nearly half the time this process will go wrong somewhere along the line.

With a more complicated process, say one with twice that number of steps, you’re down to things going right less than 30% of of the time (29.2%). More than two-thirds of the time, your customers will be disappointed or something will be going wrong in your business. This will inevitably, one way or another, increase your costs.

I’ve worked for some large multinationals in my time and it was never much of a challenge to find processes 24 steps (or more) long. But even in relatively small businesses activities such as manufacturing products, responding to customer enquiries and tendering for new contracts can quite easily have two dozen steps or more to follow before reaching the right answer.

So this is a real problem for many businesses. Especially in large businesses which don’t often realise how often the end-to-end process goes wrong because each department involved in the process trumpets their 95% success rates on the individual elements.

That goes double when the process involves several different departments within the business and everyone tries to claim their share of the credit for doing their bit well, while doing their best to deflect the blame for customer dissatisfaction, or manufacturing inefficiencies, onto some other part of the process for which they are not responsible.

But it gets worse…

After a while, let’s say someone notices that the customer service department has ballooned to 20 people because of the volume of customer service incidents generated. Each of these customer service people costs £30,000 a year with on-costs.

Someone who feels they have a point to prove about how good their thrusting entrepreneurialism is for the business turns up at a management meeting and says something like “over half a million quid a year on the call centre – we need to save some of that cost”.

Strategies what what happens next vary, but common solutions are one or more of the following…

First, starting salaries get pared back. In a high labour-turnover environment like a call centre, there are always people leaving. So, thinks some aspiring company superstar, when one of our £30,000 a year people leave, we’ll replace them with someone on minimum wage so that, over time, we’ll only spend half as much. The Finance Director and the CEO will be delighted, they imagine.

I’m all for saving money and for giving entry-level people an opportunity to embark on a meaningful career. The part of the equation that’s often overlooked is that junior, inexperienced people are very unlikely to carry out the assigned tasks as well as the more experienced person who has just left.

Our 95% success rate for each step in the process goes down to 90%, let’s say. So our 12-step process with each step done right 90% of the time means only 28.24% of transactions will go through properly. And for a 24-step process at 90%, only 7.97% of transactions will go through right first time.

What looks superficially like a smart cost-saving move is often one of the least smart decisions a business can take, for reasons we’ll cover in a moment.

Another popular option is to look at a £600,000 cost and try to outsource the work. Although the outsourced customer service industry doesn’t enjoy the best of press, there are good businesses in there (I know, I used to run one of them).

But the first thing any self-respecting customer service outsourcer will do is ask you to be really explicit on what steps there are in the process, how you want their agent to respond in a number of different scenarios, how the interface to the client’s IT systems will work and so on.

It’s almost nailed on that your 12-step process will have just increased to, let’s say, an 18-step process. However your 95% success rate for each step is unlikely to change. After all, you’ve told the outsourcer exactly what to do, haven’t you, which you’ve naturally based on what your current staff do now.

An 18-step process performed as intended 95% of the time will have a 39.72% rate of successful completion. A similar 50% uplift on a 24 stage process means it’s right just 15.8% of the time.

I won’t even calculate the 90% options – let’s just say they’re almost never right.

These scenarios are not the fault of either the new, junior member of staff or the outsourcer. They’re only working with the material you’ve given them, and frankly they were never likely to result in a positive outcome, although both are common “budget saving” strategies.

The final common approach is to decide that everything is going to be self-service through your website which means you don’t need a customer service department at all.

There are two major problems with this.

Firstly, it is literally impossible to do everything through a self-service website. Even the kings of web self-service, Amazon, have telephone based support for particularly thorny issues…which is, perhaps surprisingly, very good, in my own experience.

If Amazon can’t make an entirely web-based service work, let’s just operate under the assumption that your business is unlikely to achieve a goal Amazon hasn’t any time soon.

The second issue is that developing web self-service options to cover every eventuality is expensive. An external firm will charge a high six-figure sum to develop one for you, or you can do it yourself but you’ll need to beef up your IT department to do it. At least over time, you’re likely to spend as much in IT resources, internal and external, as you’ve been spending in customer service costs.

Oh no, it’s even worse than that…

Sorry to say, we haven’t finished with things getting worse.

All the common solutions lead to an increase in costs.

Hire much less-experienced labour who get things wrong more often and you’ll have to beef up your management resources to deal with queries, handle dissatisfied customers and authorise refunds, special deliveries and whatever it takes to try and put things right again for the customer.

You have fewer £30,000 a year call centre agents, but a lot more £50,000 a year managers to look after the new minimum wage staff. (Again, this is not the staff’s fault, the deck has been unwittingly stacked against them.)

Outsourcing can be a good idea, but if you’ve got a £600,000 a year outsourcing contract which is your main interface with all your customers, unless you’re an extreme risk-taker (which I don’t recommend if you still want to have a business to run in a couple of years) you’ll need a relatively senior manager to make sure the outsourcer keeps on their toes and delivers what they say they will.

So you can probably add £70-80,000 back into whatever savings you make…perhaps even more than that if you deal with complex processes or work in an industry where there’s regulatory oversight to contend with.

And as for the web self-service option, there’s a real danger that you’ll just swap 20 customer service agents on £30,000 a year for 10 software engineers in the IT department, each on £60,000 a year.

The simple, low-cost solution

The biggest, fastest, lowest risk way to reduce your costs (outside the flight deck of a 747 or the control room of a nuclear power station) is to look at the process and take some of the steps out.

If you reduce the steps by only 25%, what was a 12-step process becomes a 9-step process. At a 95% success rate for each step. a 9-step process goes right first time 63% of the time.

That’s getting on for a 20% improvement over the 12-step process, even though the average success rate for each individual step has not improved. In my experience, they often do, just because there’s less going on in a customer service agent’s mind and they’re likely to make fewer errors. But let’s not even factor that very pleasant surprise on the upside into the equation.

If we consider the 24-step process with the same success rates as above, a similar 25% reduction in the number of steps makes it into an 18-step process. End-to-end, that’s likely to work as intended 39.7% of the time. That might not sound like much to write home about, but it’s about 30% better than the old 24-step process.

The changes are even more dramatic when the percentage going right is 90% instead of 95%.

The old 12-step process, now a 9-step process, is now right 38.7% of the time, and the old 24-step process, now 18 steps, is right 15% of the time. That’s a 30% improvement and a near-doubling, respectively, compared to the original success rates.

So next time you want to save money, don’t just work with the numbers, think about the underlying processes. Simplify those and you’re well on the way to a low-risk way to save a lot of your budget.

And maybe ease back on the need to have detailed processes at all.

Years ago, I heard the CEO or Ritz-Carlton speak at an event and they had absolutely minimal procedures for their staff. Instead they told their staff to focus on the customers needs and deliver whatever they, in their best judgement, thought best-served the customer’s needs.

My memory is a little hazy on the detail, but I seem to remember that any staff member could, on their own authority spend a significant amount of money on the spot to satisfy a customer need. It might even have been as much as $5.000, but don’t quote me on that. It was certainly a number in the thousands of dollars.

I remember most of the audience wincing at this approach, but it’s actually one of the smartest ideas I ever heard.

How many complaints did Ritz-Carlton get into their call centre? Almost none as all their customers were satisfied at the point the problem arose. They spent a bit more on the front end, but they saved a fortune in their call centre.

How much did Ritz-Carlton need to spend in IT resources to develop a self-service model? Nothing at all. The staff member they first spoke to sorted out whatever the problem was and they never had to go onto the website to try to find a way to resolve their issues.

And how much did this really cost Ritz-Carlton? The CEO was a little coy on that point, but he did say that firstly they worked hard to make sure very few customers were dissatisfied, so complaints were relatively few anyway. Secondly, he hinted that the average charge was a lot less than the $5,000 (or whatever the number was).

Of course, some did cost the full allowance, and some went over that limit at which point a manager did need to get involved. The impetus was still centred around making the customer happy, so there were still no calls to the call centre and so on, but a manager had to authorise the budget in light of the amounts involved.

More often, I’m sure the guest’s problems would be rectified with some express dry cleaning or the cost of an extra cab to send on the glasses someone had left in the hotel. Minimal costs against a top-dollar five-star hotel room.

And that, for me, is the secret to cost saving.

To people who hadn’t thought this through, giving every member of staff $5,000 they could spend if they had to sounded like a needless extravagance.

It was actually the cheapest way to run their business. There was just a single step in the process “do whatever it takes to satisfy the customer, up to a limit of $5,000”.

In practice only tiny amounts were spent by staff members and Ritz-Carlton saved a fortune on call centre and IT resources.

I’m not suggesting this is the right approach for every business in every set of circumstances, but there’s definitely something worth thinking about in there.

So next time you want to do things differently in your business, or you’re under pressure to save costs, why not experiment with having fewer steps in your processes, or even just fewer processes, full stop.

Perhaps try giving your people a little more discretion. Even allowing for the fact that they’ll get it wrong some of the time, this is likely to be a much cheaper way of running your business than adding an extra half-dozen steps to your current processes in an ultimately futile attempt to “engineer out” things that go wrong.

It might seem a little counter-intuitive for a Finance Director or CFO to recommend a lighter touch on the process front, but even after allowing for the fact that things will still go wrong from time to time, that may very well reduce the overall costs in your business. And isn’t that what a good Finance Director or CFO is supposed to be concentrating on?

(Photo by Campaign Creators on Unsplash)

Too much love can kill you, sang Freddie Mercury. So can bad statistics…

Freddie Mercury sang “too much love will kill you”. That might be true, but as an accountant, I’ve got to say that love isn’t usually on anybody’s mind when they come to see me.

So I’m not qualified in the love department, but I do have stronger views on how businesses can end up doing crazy things just because people don’t understand basic statistics.

Now, I know what you’re thinking… “it’s easy for you, you play around with numbers every day so you’re used to them”. But I always struggled with statistics while doing my accounting exams, until, mercifully, something “clicked” shortly before my statistics exam and I managed to pass.

The problem I had with statistics was that, like most people, I was taught statistics as a series of techniques – how to do such-and-such a calculation – without being taught the broader concepts and underlying principles which made a particular technique work.

It wasn’t until I realised that the trick to making statistics easy was to do the thinking bit first, and only after sorting that out, getting your calculator out to crunch the numbers.

Don’t get me wrong, there are still some complications in getting the correct answer, but the way statistics is usually taught, emphasising techniques over thinking, accounts for many people struggling to understand what it’s all about.

In just the last couple of weeks I’ve come across these three examples which hopefully illustrate the point.

“Consistently high quality”

A recent article on suggesting that leadership teams in further education colleges were consistently better than leadership teams in schools caught my eye at the weekend.

I’ve worked extensively with schools, colleges and universities and encountered lots of leadership teams across the education sector. And while it;s almost certainly is true that a good leadership team in a college is better than an average leadership team in a school, this isn’t comparing like with like.

I’ve encountered appalling leadership teams in colleges and brilliant leadership teams in schools, and indeed vice versa. But on the average a good leadership team pretty much anywhere, inside or outside education, looks pretty much like every other good leadership team in the world.

There’s nothing “consistently” good about leadership in colleges, although Further Education does have some exceptional leaders, including some I’ve been privileged to work with.

However the sector also has its share of leaders who have led their colleges to disaster.

The TES article is only one person’s perspective, admittedly, and the writer makes that clear. I’ve no reason to suppose it isn’t an accurate reflection of his time working in both schools and further education colleges.

But one person’s perspective, however valuable it might be for them, isn’t necessarily reflective of an entire sector with hundreds of schools and colleges and thousands of people in leadership teams across the country.

So don’t make the mistake of scaling up one person’s experience and imagine it’s reflective of some bigger sector or market. It’s very unlikely to be anything of the sort.

Using outliers to prove a point

An “outlier” is a out-of-the-ordinary result that’s so far away from the “average” that relying on it might not be wise.

You see this in marketing a lot – “Apple do this and it works, so we should do it too”. Apple…or indeed any other business darling…does a lot of things that nobody else makes work. Just because Apple makes a premium price offering work like gangbusters doesn’t mean you can 10x your prices and still expect to win any business.

HR people like this line of argument too – “Google organise their teams this way, so we should too.”

Some people even wrote a book about how Indian managers are unusually good, due to, according to the authors, a combination of the Indian education system and the competitive upbringing for children there. They even cite half-a-dozen or so global CEOs who do, in fact, happen to have an Indian background.

But it’s also true that most global CEOs do not have an Indian upbringing, and it’s also true that there are many non-Indian CEOs who achieve the same or better results than the Indian superstar managers used as case-studies in the book.

India has approximately 17% of the world’s population, but considerably less than 17% of superstar global CEOs. India does admittedly have some business leaders who successfully steered global companies to considerable success. But, statistically speaking, you can’t infer that Indian managers are exclusively excellent, just because a handful of them clearly are.

Here’s the simple truth. Hard-working, smart, competitive people in just about every country of the world are more likely to end up as global CEOs than their countryfolk who prefer an easier life. This is true whether you’re American British, Bulgarian, German, French or any other nationality.

I’ve been to India several times and worked with Indian managers both there and outside India. My experience is that there are undoubtedly some exceptional managers amongst them, but average managers there are about the same as average managers in every other country, and a similar proportion to any other country in the world are truly appalling.

The percentages in each category are not materially different from any other nationality of ethnic grouping between India and any other place on the planet. Intelligence, a capacity for hard work, a competitive nature and many of the other personal qualities the book cites as evidence for Indian managers being so good are approximately normally distributed across every single human being on the planet as far as I can tell.

Nobody would write a book about smart, hardworking kids who went to Eton and Oxford ended up in a top job somewhere. A book about a Harvard graduate running a global business probably wouldn’t be a best-seller either. In both cases, that’s pretty much what we’d expect to happen – both are non-stories.

So it should be no surprise that, statistically, at least some of the population of India are world-beating international business executives. I’d be a lot more surprised if there weren’t any Indian executives leading global multinationals, given that 17% of all the people on the planet, 1.4 billion of them, live in India.

So don’t use outliers…management practices from Apple, Google, India or anywhere else for that matter…to evidence your arguments.

Outliers exist in every field, and I’ve no problem celebrating them where they exist. But be clear that the results of exceptional businesses or individuals are unlikely to be repeated if you try the same thing elsewhere.

By all means use outliers to inspire you to make improvements, but don’t imagine for a moment that the results outliers deliver are likely to be reproduced somewhere else by entirely different people, because you’ll almost certainly be disappointed.

Small groups

“Research shows…” is one of the most-overused expressions in management.

It’s often the magic key that someone hopes will unlock a budget or a strategic decision of some sort, but I always want to know exactly what sort of research has been carried out, and how rigorous it really was.

The tweet above is a great example. Even if you do research which is decent enough in itself, the results from any small group are, at best, no more than mildly comforting in terms of how an entire target market might view your business.

Sometimes people feel the need to draw statistical conclusions where none exist. Everybody likes to see some numbers and. as an accountant, I get to see more than most, to be fair.

However I also see enough numbers to get a feel for when I’m being fed a line.

If you’ve called together a focus group of 20 people and 58% of them say they like (or don’t like) something, in my book that means almost nothing.

58% of 20 people means 12 people in the whole universe like what you’re doing. All it takes is a couple fewer saying “yes” and it’s a 50:50 deadlock.

Even if those 12 are theoretically representative of your entire customer base, which has about the same odds as looking out your window and seeing unicorns dancing on top of rainbows, the realities of everyday life means just about no meaningful conclusions can be drawn from those 12 people’s responses.

Yet I’ve seen many a business case constructed on a similar premise. You might be surprised how few people seem able to explain their “research” in statistical terms.

Never take statistics at face value. Always find out how they did the research and if the answer isn’t “we ran a statistically-valid survey across a representative sample of couple of thousand people”, the level of reliance you can place on the numbers meaning anything sensible is probably close to zero.

Even professional polling businesses know their 2000-people surveys have an error rate of a few percentage points one way or the other. Your 20 person focus group will have an error rate many times that so you’d be unwise to make significant business decisions based on conclusions that could be out by 20-30% or more.

That doesn’t mean small group research hasn’t got any value. It most definitely does.

Individuals and small groups are ideal ways to get qualitative feedback about your business and its operations, or how people feel and experience your services.

Good qualitative research is under-appreciated in businesses because people are mostly looking to use numbers to support the case they’re making.

But most business cases which come my way have not been constructed using research methods rigorous enough to support the conclusion they propose.

Business cases tend to draw conclusions using quantitative research methods – that is, just using the numbers drawn from their research as if they were statistically valid – even though there was no statistical validity to the data at all.

That doesn’t meant heavy-duty quantitative research is necessary for every single business case, though.

If there isn’t a statistical basis for the conclusions, just say so, give me the verbatim feedback from a focus group to read through and let me understand what you’re proposing based on that.

Don’t present statistically-meaningless tables of numbers, graphs and charts to support your case when the underlying research isn’t rigorous enough to justify any conclusion, much less the one you’re putting forward.


The world would probably be a better place if we stopped allowing politicians to quote highly selective “statistics” (which is what they call their numbers…they’re nearly always a completely partisan interpretation of numeric information which was not been collected using valid statistical methods, just because it happens to suit their case).

But much as we rail against politicians’ misuse of numbers and statistics, something very similar goes on in every business in the country on a more or less daily basis.

And a large proportion of those end up on my desk “because we have to show the Finance Director some numbers to get his buy-in”.

I’d rather they didn’t bother. Either do the job properly and show me something that’s statistically-valid or stop pretending that some random numbers which were chosen because they happen to support your preferred outcome have any statistical meaning.

No Finance Director or CFO should be close-minded enough to rule out every initiative which doesn’t come accompanied by a bevy of numbers, charts and data tables.

We just want to know that you know your stats, because if you don’t, we’re unlikely to believe that anything else in your business case is going to be a solid foundation for decision-making either.

Next time someone presents you with a plethora of numbers to support a business case, try a quick “sense check” against the experiences above. You might be surprised by the insights you get from questioning people about how they’ve approached their research, and hopefully you’ll make better business decisions as a result.

(Photo by Stephen Dawson on Unsplash )

From Zero to Hero: How to be a Zero-Based Budgeting hero instead of a Zero-Based Budgeting villain

Zero-Based Budgeting has been in the news for all the wrong reasons lately. Kraft Heinz have reported a $15billion write-down after a focus on cost cutting, primarily using the Zero-Based Budgeting technique, resulted in the business taking its attention away from their customers.

Kraft Heinz investor, 3G Capital, is well-known for deploying Zero-Based Budgeting as a way of driving costs down. Their work at Burger King and HJ Heinz, pre-merger, encouraged them to try to repeat the same trick with Heinz Kraft.

This time they ended up writing off over $15billion.

Analysts believe too much energy within the business went towards reducing costs, leaving too little energy to focus on customer needs. That was unfortunate, to say the least, as the nature of Heinz Kraft’s traditional product lines meant that many of their products were precisely the products today’s more health-conscious, environmentally-minded customers were starting to move away from.

By the time Heinz Kraft caught on to the change in their marketplace, it was too late and $15.4 billion had to be written off the value of well-established brands like Oscar Mayer hot dogs and Kraft macaroni and cheese.

As a Finance Director and CFO, I always get concerned when businesses adopt a “paint by numbers” approach to anything. It’s a sure route to trouble.

At the very least, the business ends up falling short of its potential for transformation. At the very worst, it completely messes up a useful technique and ultimately puts the whole business at risk.

Now, I’ve no idea how Heinz Kraft approached their Zero-Based Budgeting exercise, and with deep-pocketed shareholders I don’t imagine their business is at risk any time soon.

But, from the outside, given their $15bn write-down and the accompanying analyst commentary, it’s at least possible that some of the common errors of a Zero-Based Budgeting programme were part of the experience at Heinz Kraft. Let’s explore where they might have gone adrift.

What is Zero-Based Budgeting?

Before we get into the details, perhaps first we need to explore what Zero-Based Budgeting really is, as it’s one of the most frequently misunderstood business models, in my experience.

I’m not sure if the term Zero-Based Budgeting was arrived at by an accountant trying to jazz something up with a bit of marketing hype, or by a marketer trying to over-dramatise what might have sounded to them like an otherwise fairly dull financial technique.

Either way, the biggest problem Zero-Based Budgeting has is that the term lends itself to an overly-simplistic interpretation, as this brilliant cartoon from Tom Fishburne illustrates…

That overly-simplistic interpretation is usually something along the lines of “every department has all their budgets taken away from them and they have to justify, line by line, every single item that gets put back in”.

Someone, usually the Finance Director or CFO (sorry…), is tasked with saying “no” to a lot of the budget lines that are requested with the net result that the business’s operating costs reduce substantially.

Expenses that look “optional” – pesky things like marketing, training and employee engagement – which perhaps lack the robust business cases which can be applied to, say, re-engineering a product to take a pound of aluminium out of each unit produced, tend to fall by the wayside.

Frankly any idiot can say “no” to a proposal for supporting customers better or training staff to be more effective, especially if the payoff is uncertain (in conventional business modelling terms, that is, they’re a nailed-on cert for anyone who has even a superficial knowledge of the role of human behaviour in decision-making).

So if this is what you think Zero-Based Budgeting is all about, the good news is that you don’t need to go to the expense of having a Finance Director or CFO go round saying “no” to people. Someone like Dilbert’s Pointy-Haired Boss is more than up to the task of making moronic short-term decisions.

But this interpretation of Zero-Based Budgeting is a gross over-simplification of quite a nuanced technique.

Zero-Based Budgeting was developed by Peter Pyhrr, at the time a manager at Texas Instruments. His objective was to break the historical way of compiling budgets which, back in the 1960s and 70s, generally involved taking the actual spend from the previous year and increasing it by some inflationary increment to arrive at the new year’s budget.

You don’t need to think about cost management for very long to realise that the “annual inflationary increase” method of budgeting was unlikely to be the most sensible way to run a business over anything other than the short term.

In the very short term in a stable business environment, it might be a reasonable enough approximation to reality. But at times of high inflation, as in the 1970s and 80s, or great technological change, such as the move to digital in the last 20 years, the likelihood is that “the way we’ve always done things around here”, supplemented by an annual inflationary increase is probably not going to cut it any more.

That’s why the original concept behind Zero-Based Budgeting was to re-imagine the best way to run a business on a reasonably regular basis to reflect changing economic and technological times.

Why Zero-Based Budgeting is a good thing, when applied properly

I’ve used Zero-Based Budgeting extensively throughout my career as a Finance Director and CFO, more often than not informally.

Of course, you can mobilise the entire workforce, employ gangs of consultants and spend millions of dollars to come up with some whizzy new plan if you want to, but that’s often unnecessary, especially in small-to-medium sized businesses.

For a Finance Director or CFO who knows what they are doing, a conversation, usually as part of the normal budget review process, with department heads, and an afternoon with a spreadsheet can usually get you the results you need without creating a ruckus within the organisation.

Whether you’re running a Zero-Based Budgeting project with teams of accountants, or just your CFO and departmental managers working together in a less formal way, any approach which doesn’t start with a thorough understanding of the results the business needs is doomed to failure.

And those results are much more than reducing costs just for the sake of reducing costs. In the short-term, earnings might mathematically increase as revenues hold constant against a background of reducing costs, but this is generally only true in the short-term.

That’s because of a significant assumption – one you rarely see in business plans, but it’s always there in the customers’ minds.

You see, businesses often think they “own” their customers. Many of the craziest decisions taken by large businesses were predicated on the belief that their customers were a constant and would never go elsewhere.

Thinking about that for just a second, of course every one of us would at least consider taking our business elsewhere sooner or later if we felt we were paying ever-higher prices for what we perceived as ever-poorer value. Yet this dynamic always seems to catch large companies like Heinz Kraft by surprise.

In the short term, businesses can be suckered into thinking they got away with it as revenues hold up after dramatic cost-cutting. What they’re forgetting is that brand loyalty is a lagging indicator, not a leading indicator.

In the short term, loyal customers will cut you some slack and hope you realise the folly of your decisions. Inertia means that hordes of customers won’t head for the exits the minute you make a change. And in markets like those Heinz Kraft serves, considerations such as how much shelf space you get in Walmart and what promotions you run might take the edge off a little for a while.

But in the end, you will be found out. And businesses whose customers don’t perceive them as offering good value will, sooner or later, start to decline.

In fairness to Heinz Kraft, the value they offered or didn’t offer was probably secondary to the fact they’d taken their eyes off a grocery market which was moving against the products they had traditionally sold while they focused on a massive internal project to reduce costs.

But the same principle applies – if you stop listening to your customers, whether that’s about the value you deliver or the products you supply and their position in your customers’ order of priorities, you’re putting your business at risk, sooner or later.

It doesn’t have to be this way. Here’s how to run a Zero-Based Budgeting process with a minimum of disruption, while keeping your eyes where they should be, on serving your customers.

A simple Zero-Based Budgeting approach that works

To run a sensible Zero-Based Budgeting project, here’s what you need to ask your budget-responsible managers: “Knowing what we know now, would we do things the way we’ve always done them…and if not, what would we do instead?”

This needs to work within the context of your business model, so if you don’t have a clear idea of how that works, make sure you develop a well thought-through business model first.

But assuming the business model is clear, those questions are all your Finance Director or CFO needs to ask at budget time (and perhaps, depending on how fast-moving your sector is, a couple of other times during the year too) to run a sensible, low-hassle Zero-Based Budgeting project.

Let’s make this into a practical example…

If your business needs 1,000 customer leads every year to generate the sales income the business requires, ask your marketing manager whether there is a better way (by, for example, accelerating the sales cycle), or a cheaper way, to deliver 1,000 suitably-qualified leads in the coming year.

To keep this simple, let’s assume the rest of the business model stays the same – your sales team converts leads into customers in the same ratio as before, customers spend the same amounts they did previously over the same customer lifetime, and so on.

In recent years, lead generation activity for most businesses is likely to have moved away from printed materials, outbound sales calls and personal visits from sales representatives to more digitally-based solutions. Perhaps Google Ads or LinkedIn sponsored posts play more of a role now, depending on your business.

The key point to remember, despite the name of the technique, is that the objective of a zero-based budgeting project isn’t to get the Marketing Manager’s budget to zero. It’s to determine how much of a budget he or she needs to generate 1,000 suitably-qualified leads, updated in this particular case, for the more digitally-based approach to lead generation.

What you’re doing is rethinking the business approach, without any preconditions or assumptions that things will continue into the future they way they’ve always worked in the past.

Done properly, a Zero-Based Budgeting project should also force you to consider the knock-on consequences of any changes. You’ve got to take these into account too before taking action.

Maybe you can halve the print advertising budget, but only if you invest in an upgrade to the website to enable a digital-only solution.

Maybe you can save a bit on the costs of the outbound telesales team that you need less of in the digital world. But you need to hire some digital marketing executives instead with the skills to fine tune your Google Ads campaigns and manage your social media presence.

And so on.

Business leaders who apply a “paint by numbers” approach to Zero-Based Budgeting, without really understanding the subtleties of the technique, tend not to think about the knock-on implications. And that’s usually the basis of their undoing.

Any idiot can suggest cutting out print advertising completely and using social media exclusively to generate leads because social media is “free”. (And, to be fair, plenty of idiots have done exactly that…)

But without the expertise and staffing the business needs, that strategy is the route to disaster. “Free” social media is actually quite expensive in terms of staffing requirement…those tweets and Facebook updates don’t write themselves, after all.

So any Finance Director or CFO worth the title should be considering the results in the round.

In addition, although “cheaper”, social media campaigns tend to have vastly poorer response rates compared to, say, traditional direct mail. You need to do the maths before deciding which approach is best, and perhaps selectively pilot some new strategies to make sure you’re on the right track before flipping the switch and doing things completely different.

That’s why, when used intelligently and holistically, Zero-Based Budgeting is a great system for continually reinventing your business, making sure you keep up with customer and market trends and giving you insights which allow you to service your customers better.

Problems with Zero-Based Budgeting

In my experience, the biggest problem with Zero-Based Budgeting is not the technique itself. All the problems come from those people who half-remember it from some management training programme and don’t take the time to understand it properly.

They inevitably end up applying Zero-Based Budgeting in a “painting by numbers” approach which is insufficiently customer-orientated.

This article from McKinsey highlights five common myths about Zero-Based Budgeting, and explains why those myths really don’t hold any water. But, in essence, the problems McKinsey highlights don’t come from the technique, or its underpinning philosophy, but in how people apply it when they don’t take the time to understand it properly.

Whilst Zero-Based Budgeting can realise substantial cost-savings – when done right – its more mindless proponents forget that one of the main reasons to make cost savings is to reinvest those savings, or at least a proportion of them, in making the business better.

As Accenture put it:

Strategic cost reduction [which includes Zero-Based Budgeting] can only be successful if the savings are reinvested in areas of the company to drive growth, innovation, improved productivity, better customer experiences and so on.


Accenture’s own research shows that only 51% of businesses are able to sustain their cost savings for 1-2 years. That’s because:

Piecemeal approaches that focus on overhead and cost of goods sold is a common mistake that occurs during cost-cutting. These efforts only scratch the surface and risk causing the company to lose valuable, differentiating capabilities.


But, for most people, their experience of Zero-Based Budgeting is exactly what Accenture say it shouldn’t be – a mindless cost-cutting approach which destroys the business’s operating model (if not in the short run, certainly in the long run) and doesn’t reinvest any of the savings to re-position the business for a more successful future.

Frankly there’s not a business technique in the world that will deliver something worthwhile in the face of that level of misunderstanding about what the process is supposed to be.

I’d also agree with Bain & Co that one of the primary reasons Zero-Based Budgeting, or ZBB, doesn’t work is this:

When ZBB fails, it’s usually because leadership is neither engaged nor aligned, cost-cutting is indiscriminate, cost control is the primary message, and execution is inadequate, prioritizing pace, tools and benchmarking over capability building.


People complain about Zero-Based Budgeting and say it doesn’t work. I’d respectfully suggest they only think it doesn’t work because they’ve never seen it applied properly.

If you want a high-level understanding of the potential of Zero-Based Budgeting, Bain & Co have produced a very helpful infographic which explains the underlying concepts succinctly.


Zero-Based Budgeting, in the right hands, can be a powerful technique to ensure your business is running in a cost effective way.

By getting your managers to consider periodically “knowing what we know now would we do this the way we always have done, and if not, what would we do instead?” you have the luxury of starting with a blank sheet of paper on a regular basis.

Zero-Based Budgeting put you in the fortunate position of being able to redesign your business as the world around you changes, at a time when most of your competitors won’t be.

Used by an astute leadership team, Zero-Based Budgeting is a wonderful tool for keeping at the forefront of your industry.

Used by a management team who don’t understand the subtleties of the concept and just use Zero-Based Budgeting to “slash and burn” their cost base without reinvesting the proceeds to position the business for the future, disaster isn’t usually far away.

For your sake, I hope your leadership team is an astute one.

(Photo by Eric Ward on Unsplash )

Corporate Governance is an action, not a framework

If you’re not a Finance Director or CFO, the intricacies of corporate governance isn’t the easiest thing to get people excited about. (Trade secret – even if you are a Finance Director or CFO, it’s still hard…)

Yet good corporate governance is fundamental to the effective working of the modern free enterprise system. We need to have at least a degree of trust in the people looking after our money, whether we’re customers, investors or employees waiting for our next salary payment. Without that, the whole system would collapse.

The trust that’s necessary for businesses to operate is much harder to create than it used to be. When we only bought and sold things with people in our home village, corporate governance was largely unnecessary because artisans had to be trustworthy and do least a reasonable job or they’d be thrown out of town, banished beyond the city walls.

But as the industrial revolution came along, creating multinational businesses which spawned global supply chains, we all started to depend on the honesty and trustworthiness of thousands of people we’re unlikely ever to meet in person.

Over time, structures and processes have evolved to give us all at least a modicum of trust in people in people we’ll never meet in person whether we’re buying or selling good or services, choosing which company we want to pursue our careers with and deciding which businesses have an ethos which most closely aligns to our views on specific ethical or social issues we feel strongly about.

From a Finance Director and CFO’s perspective, one of the most important structures in a world where we need to demonstrate trustworthiness is the modern system of corporate governance.

In the UK, corporate governance is generally reckoned to have started, in however modest a way, when Parliament passed the Joint Stock Companies Act of 1856. After that, anyone could invest in a business with the protection of limited liability for the actions of the company. The business was now, in the jargon, a “separate legal person” from its individual owners.

Without that level of legal protection, it’s quite unlikely the modern economy as we know it would even exist. Holding thousands of individual shareholders personally responsible for the debts of Enron, say, or WorldCom would be a mammoth administrative task.

And on a practical level, one scandal of an Enron/WorldCom magnitude which resulted in thousands of investors becoming destitute would probably end for good the access businesses currently enjoy to equity capital from thousands of individual investors.

Back in the mid-1800s, in return for this new limited liability structure, the 1856 Act required companies to hold annual meetings and present the accounts to investors on an annual basis so they could satisfy themselves the company was being run properly.

The limited liability company, in a form we’d largely recognise today, was born. And, in the same breath, the early stirrings of good corporate governance.

The concept of a business having to report on its activities to shareholders who didn’t work within the business was established, but it would be another 100 years or so before the term “corporate governance” was heard regularly, even amongst lawyers, accountants, auditors and company secretaries.

But following a number of high profile scandals, in both the UK and the US, the term “corporate governance” came into much more common usage from the mid-1980s onwards.

In the UK, the first flurry of “corporate governance”, as we’d think of it today, was sparked by the publication of the Cadbury Report in 1992.

Following the Maxwell and BCCI scandals of the late 1980s and early 1990s, Adrian Cadbury was asked to lead a group of the great and the good, formally called “The Committee on the Financial Aspects of Corporate Governance”. Their findings, colloquially called the Cadbury Report, was the starting point for what would evolve into the Combined Code, or the UK Corporate Governance Code as it’s now known.

Today, it is a condition of listing on the London Stock Exchange that the provisions of the UK Corporate Governance Code are adhered to, whether or not the company itself is based in the UK. Nowadays, a well-organised corporate governance process is seen as essential to any business which expects to trade its shares on major financial markets.

At around the same time, the Savings and Loan crisis, along with some large-scale corporate collapses, such as Enron and WorldCom, led to the US passing the Sarbanes-Oxley Act of 2002. Between the mid-1980s and the early years of the new millennium, there were few hiding places from the increasing pressure for good corporate governance.

But neither the UK Corporate Governance Code, nor Sarbanes-Oxley, were perfect solutions to a freewheeling corporate decision-making approach. The global banking collapse in the late noughties, for example, took place despite the plethora of corporate governance procedures and Sarbox compliance large businesses had spent the previous 20 years implementing.

In the meantime, the costs of compliance, audit committees, internal audits, independent directors and goodness knows what else kept climbing….and show no sign of stopping any time soon.

It probably is fair to say the penalties for being caught evading the principles of good corporate governance are getting tougher, especially if a corporate collapse triggers the attention of bodies like the UK’s Serious Fraud Office. But still companies collapse and investors, employees and customers find themselves out of pocket, despite all the corporate governance rules and regulations which are supposed to stop that happening.

As I write this article, the situation at Patisserie Valerie isn’t looking too pretty, the Carillion collapse remains fresh in the memory and another public service outsourcer, Interserve, seems to have just managed to squeak out of a similar fate by diluting their existing shareholders’ interests down to a mere 2.5% of the restructured business.

Yet all these operations had proper corporate governance in place, as did UK bank HBOS which recently saw a group of their former staff sentenced to a combined 50 years in jail for developing, in the words of the presiding judge, an “utterly corrupt scheme” to fleece borrowers and line their own pockets.

All these corporate collapses, or near-death experiences, have taken place under the noses of internal and external auditors, internal procedure manuals, independent non-executive directors and a panoply of other corporate governance structures, frameworks and processes.

The emergence of scandal after scandal, despite all the correct corporate governance structures being put in place, means the concept of corporate governance might have its credibility dented…perhaps even holed below the waterline.

But corporate governance is, I believe a valuable one. It provides reassurance and trust in a world where those qualities are sadly lacking, and which are essential to the proper functioning of a modern economy.

Here’s what most people miss, though…

Corporate governance isn’t about procedure manuals kept on a shelf somewhere. It’s about whether anyone follows them.

Corporate governance isn’t about having an audit committee. It’s about whether or not the audit committee asks searching questions about company finances, rather than just accepting vague reassurances from the CEO or CFO, ticking a box and moving on.

And corporate governance isn’t about being able to point to a rule book and saying “we did everything we were supposed to” after the balloon goes up. It’s about hiring trustworthy people and making sure they behave honestly towards customers, investors and colleagues.

Ultimately, corporate governance is about what you do, not what you say.

Earlier in my career I had the misfortune to work, very briefly, for a business whose supposedly independent directors appeared to think it was their job to sanction the Chief Executive’s kleptocracy, rather than stepping in to stop the Chief Executive’s unacceptable behaviour while running a business under severe financial strain.

All the independent directors were smart, intelligent people with jobs outside the business of considerable trust and responsibility. So I have to assume that they were also smart enough to realise the importance of good corporate governance. They certainly all attended the directors’ training courses on the subject.

But they took no action to put a stop to the Chief Executive’s behaviour. Ultimately this led to a major financial crisis which, in turn, resulted in the abrupt departure of the Chief Executive. (Either that or they were all in on a scam of some sort, which would be even worse corporate governance than merely being incompetent in discharging their duties as independent directors.)

Following the near-collapse of this business, an independent investigation personally censured the Chief Executive, the Chairman of the Board and the Deputy Chair for presiding over a serious business failure, caused by their poor oversight and inadequate governance.

Ultimately, the failing of this board, and the entire corporate governance structure of the business, came about because the noblest of aspirations, and all the procedure manuals in the world, counted for nothing without action.

The people with the responsibility to exercise independent control over the business were, even on the most positive interpretation of their behaviour, asleep at the wheel.

In concept it wasn’t much different to the situations at every major bank during the global banking crisis, or investors in Carillion, RBS, Patisserie Valerie and countless other large companies which have hit the buffers in a spectacular fashion over the past few years.

Every one of those businesses had in place all the rules, procedures, structures, committees, internal audit, independent directors, external oversight and other corporate governance structures and processes in place.

But they still collapsed in disgrace because their auditors, independent directors, the in-house company secretarial team and many, many others passed up the opportunity to action, hold the business to a higher standard and get things back on track again.

Without action, no amount of corporate governance procedures are going to save your business….as shareholders, employees and suppliers working in, and for, the large businesses which have collapsed in recent years can testify to.

Don’t make the same mistake those businesses did.

Corporate governance…when applied properly…is an important safeguard for your business in an uncertain world. Don’t just think the corporate governance procedures manuals will look after themselves, because they won’t.

Take action before it’s too late. Your business, your employees, your customers and your suppliers will all thank you.

(Photo by Jakob Owens on Unsplash )

The tiny difference that sold 50 million records, and what it means for your business

Business is a tough gig. Fine margins separate the winners and losers.

In two broadly equally-matched companies, success is often the result of something small which gives one party a slight “edge” at first. This compounds over time until one business is top of industry awards lists and the other so far behind, it’ll never catch up.

Here’s three quick examples. Then we’ll get to the 50 million records…

Facebook is currently one of the world’s most valuable companies. But when they started out a dozen years or so ago, was their service vastly better than MySpace, social media’s early market leader?

It was not. Yet today, Facebook is everywhere (perhaps in too many places, if you value your data privacy) while MySpace languishes in some almost-forgotten corner of the internet.

At first, the difference was tiny…and the smart money would have been on MySpace to win. You can read more about it here… Why Facebook beat MySpace.

Then we’ve got General Motors. In the early years of their century-long tussle with Ford over who could claim bragging rights as the US’s biggest-selling automaker, their tiny difference was to offer easy credit terms to people wanting to buy cars, which Ford was reluctant to do. That tiny change to make it easier for people to buy a GM car boosted sales volumes without GM having to solve a single extra engineering problem or make their cars any better.

And VHS beat Betamax, even though Betamax was generally agreed to have been technically better. The tiny difference was that VHS worked out how to put more recording time on a single tape, until movie studios could fit a whole movie on a single VHS tape. By the time Betamax got round to copying this feature, pretty much everyone who was going to buy a video recorder had already bought a VHS-format one and it was “game over” for Betamax.

Tiny differences are talked about more often in the business world nowadays, in no small part due to Dave Brailsford’s approach to leveraging 1% improvements for the British Cycling Team. With his strategies, a team of also-ran’s become world-beaters in pretty short order.

If you’ve made it this far, you might be wondering what all this has to do with selling 50 million records…

Well, those 50 million records (and counting…) were sold by Aussie rockers, AC/DC…

The one tiny thing AC/DC do differently from their industry which has given them a 40-year career at the very top of the music business. AC/DC’s 1980 “Back In Black” album remains one of the best selling albums of all time, outselling arguably more famous collections like Fleetwood Mac’s “Rumours”, The Beatles “Sgt Pepper” and Pink Floyd’s “Dark Side Of The Moon”.

While you might feel that examples from social media companies, the car industry, video-tape recorders and competitive cycling don’t have much relevance for your business, anyone can adapt AC/DC’s “secret technique” to make their business more successful.

And here it is…

When AC/DC make a record, they record it “live” with everyone in the same room at the same time. Many bands record their individual parts separately…sometimes on entirely different continents, not even in the same studio.

You can make perfectly acceptable music by recording each musician individually and stitching the results together in the studio. Most music you hear on the radio today has been recorded exactly that way.

But AC/DC, whose energy-filled live performances made their reputation long before they sold millions of records, recognised the energy they generated when they played off one another in the recording studio, just like they did when they were on a concert stage, gave their music an energy and an immediacy most other acts lacked.

This tiny difference in how AC/DC worked together in the recording studio resulted in “Back In Black” selling somewhere north of 50 million copies, more than just about any other record in history (Michael Jackson’s “Thriller” and The Eagles “Greatest Hits” are about the only albums most published rankings put ahead of “Back In Black”.)

So what’s the business application for all this?

The term “teamwork” is over-used, and often wrongly used, in the business world today.

I’ve only rarely felt part of a team during my working life. “Team” has just become an easier way to refer to a particular group of people – the Sales Team, the Production Team, the Senior Executive Team, and so on.

But in practice, there’s very little true teamwork going on. Most businesses run in a succession of silos with senior executives coming together for monthly meetings where they argue about whose fault it was when things go against them, and scrap for a share of the credit when things are going well, whether or not they had anything to do with making it happen.

Between meetings, however, those senior executives and their respective teams spend very little time with one another.

Some would say it’s more efficient that way. Tasks have been assigned and allocated. KPIs have been set. Bonuses have been tied to meeting objectives. People are often just expected to put their blinkers on and hurtle as quickly as possible towards hitting the criteria that triggers their bonus.

Which, in my view, leaves a major opportunity untapped.

You can’t truly operate as a team with people you never see and only deal with via reports and emails, with only the occasional formal meeting adding a touch of theatre to inter-departmental rivalries.

You get an energy from being together, and feeding off one another that the members of AC/DC, and their ace production team, understood.

When teams get out of their silos, my experience is that not only do you tend to get better solutions, you also find them a lot faster than wading through three or four formal monthly meeting cycles in order to get one department’s pet solution signed off.

And in the Darwinian world of business, as MySpace, Ford and Sony, the inventors of Betamax, discovered, it’s often the fastest to a solution, not necessarily the biggest or the strongest, that wins the battle.

So if you want to get to a solution faster, follow the example set by those best-selling Aussie rockers…make sure everyone is in the same room at the same time. Nobody leaves until you’ve made something you’re proud of.

That’s teamwork.

(Photo by ActionVance on Unsplash )

Are billionaires paying their “fair share” of tax?

Most people, if they’re asked whether billionaires pay their fair share of tax, answer with an emphatic “no!” But whatever your views of billionaires might be, it’s fair to say that some pay a lot more tax than others.

It can’t be because they lack access to top-notch financial advice. Your average billionaire has almost instant access to the finest legal and accounting minds on the planet any time they want to find a way to pay less tax.

Some just choose to work the system to their own personal advantage as much as they can, while others take the view that they should be paying tax in the same way as any of the employees in their business would.

I’m not expressing a moral judgement on that decision, one way or the other. It’s just an observation.

However, this debate has been ignited in the UK recently by the publication of the Sunday Times Tax List 2019, which aims to identify the UK’s top tax payers.

A couple of caveats though.

Firstly, I do understand the position might be different in other tax jurisdictions. All I can offer is a UK perspective on this as that’s where I work as a Finance Director and Chief Financial Officer (or CFO).

Secondly, as the Sunday Times itself acknowledges, their analysis is prepared from publicly available documents so this may well be less than the complete picture of any one individual’s tax affairs.

However their analysis recognises one important aspect…again, under UK tax law…which is that once someone is paid a salary or dividends in those legal forms, the same tax rules pretty much apply to everyone.

Unlike the US, for example, where there are multiple write-offs and exemptions which could significantly reduce someone’s pay for tax purposes, relative to their “headline” pay packet, things are pretty clear in the UK and, nowadays at least, there are very few ways to massage the salary appearing in your publicly available accounts into a much lower number to share with the tax office.

The Sunday Times has also added in the Corporation Tax paid by those companies run by high earners and a few other things as well.

Again, this is a pretty reasonable approach. If you’re running your a business, even a very large one, which you own personally, or perhaps close family members, it’s your own efforts which create the business profits which the Treasury assesses for Corporation Tax.

If your business didn’t exist, it wouldn’t make the profits that get paid in Corporation Tax, nor would it generate the salary payments that will be accounted for under the same PAYE arrangements as every other UK taxpayer.

So, the Sunday Times’ methodology is probably good enough for a “sighting shot” of the top-earners’ tax payments, as long as you accept that, again in the UK at least, every taxpayers’ tax affairs are strictly confidential. The only people who really know the true picture are your local friendly billionaires and HMRC themselves.

Reading the Sunday Times’ article, and a lot of the subsequent comment pieces on it, however, it’s clear that most people don’t understand how the UK’s tax system works.

For better or worse (more on that in a moment), the UK tax system over the years has become much more highly dependent on catching money-flows and removing a slice of those money flows as they pass through the system.

Again, for better or worse, VAT is a good example of that. Most things you buy in a shop in the UK have a 20% VAT uplift applied to them which the shop-owner sends on to HMRC after deducting any VAT they’ve had to pay on the things they bought to sell to you. The “added value” (the clue is in the title) is taxed at the point the money flows through the retailer’s till.

Last year, £125 billion was collected by HMRC for VAT in this way.

PAYE is another good example. If you’re paid a salary, however large, your employer has to account for the tax due direct with HMRC and pay it across on a monthly basis. The tax arises when the money flows from the employer’s bank account to the employees’ bank account so it’s easy to see and track, and there’s no dispute about the value paid across.

Systems like this, which work for many other taxes as well in the UK, use the exchange of money to capture the value that has been created and raise whatever tax charge Parliament, in their infinite wisdom, has chosen to apply.

But it comes as a big surprise to many people that wealth isn’t really taxed at all in the UK. There are some exceptions, but they are relatively minor for your average billionaire, so we’ll leave them on one side for the moment.

And there’s a good reason for that. Just because you’re wealthy, that doesn’t mean you’ve got any money.

I know…sounds crazy, doesn’t it, but it’s true.

Let’s consider a tech founder whose start up has just taken in some early stage funding from a VC or angel investor for a relatively small percentage of their business. If the founder gets £1 million of funding for a 10% stake in their tech startup to find the development of an idea (ie the business itself isn’t selling anything to customers yet), that means the business is “worth” £10 million in total. £9 million of that belongs to the founder, £1 million of it to their investor.

By most measures, someone who owns a £9 million share in a business would be considered rich. But people I know personally in that situation are earning nothing at all or are getting along on something like an average UK wage, currently around £25,000 per annum (on which they, too, pay tax of course) because any cash that comes in, whether from investors, customers or elsewhere, is used to build their business. Most founders don’t get paid unless everyone else is paid first.

So, how would you tax someone who owns a share in their business worth £9 million, but who has to live on, say, £1500 per month, after tax?

If you taxed their wealth at even a measly-sounding 1%, that would be £90,000 a year, or more than three times the income they have to live on each year.

And that assumes the business really is worth £10 million…the truth is that the business might turn out to be worthless, or it might turn into a billion-dollar business. At the time an investor puts their development funding in, there’s no way of knowing which the business will turn out to be.

The rate of tax on a business worth nothing is clearly zero. But how do you tax a business that might be worth billions, but on any look at the entrepreneurial odds is probably, on average, worth even less than its £10 million theoretical valuation, if it’s worth anything at all.

And, on a much smaller scale…in economic terms at least…taxing people on assets rather than income was the thinking behind the Poll Tax (properly called the Community Charge) which doomed Margaret Thatcher’s Prime Ministership and brought the career of one of the UK’s most transformational politicians of the last century to an end.

(Whether or not you supported her, I’m sure we can agree she transformed a lot of things in the UK during her time in office.)

So taxing wealth rather than income is a tricky business. You have no way of knowing what an asset is worth, really, until someone buys it or sells it and money changes hands.

And even if you do assess its value somehow, which was the idea behind the Poll Tax, to make people pay a tax based on the value of their property (an asset) irrespective of how much they earned, that’s not without its own problems.

Some 90 year-old lady living on her own, eking out a state pension in a house happens to be worth £1 million just because she and her husband bought a derelict wreck after the war, did it up, and 60 years later the “in crowd” decide that part of London is a desireable place to live for some reason…how would you tax her?

She’s got no money, but she’s a millionaire on paper.

Some people might say she should sell up, live somewhere cheaper and hand over some tax, but I think most of us would agree that’s no way to treat a 90 year old widow, whether she’s worth £1 million or not. Destroying an old lady’s life memories in the home she’s lived in for 60 years just so you can shake her down for some cash is no part of the values of any civilised society.

And that’s the problem with taxing wealth. If you start putting in too many exceptions and exemptions…even perfectly plausible and reasonable-sounding ones…you’ll end up with such a minefield of complexity that people who are minded to do so will work with their lawyers and accountants to find a way around that. (In a nutshell, that’s how the US tax system works.)

Billionaires the world over would be signing over their fancy London homes to their 90 year-old grandmothers because we don’t make those people pay tax on the value of their home. Designing a tax system which discriminated correctly between 90 year-old widows living in fancy houses would likely be outwith the skills of even HM Treasury’s most gifted parliamentary bill-writers.

So, if you read the Sunday Times article…or perhaps one of the many other articles that followed on from it to say “why isn’t this billionaire or that multi-millionaire on the top tax payers’ list?”, just remember that wealth and income are not the same thing, even though a lot of people think they are.

90 year-old grandmothers, tech founders and the like might have plenty of wealth, but very little income. And, at the end of the day, people can only pay tax out of the cash they’ve got.

The UK tax system isn’t perfect…far from it…but at its heart is the pretty sensible realisation, especially after the Poll Tax debacle, that the most unambiguously fair way to collect tax is to focus most of HMRC’s attention on picking up the money flows in the economy and leveraging a percentage of whatever cash is changing hands into HM Treasury’s coffers.

Of course, some people abuse the system…all the way from tradespeople who work for cash and don’t report their earning for tax purposes right up to billionaires who use offshore trusts and complex tax planning to sneakily move their wealth out of the reaches of their home country’s tax authorities.

But once you accept that people can be wealthy and not have any money because they don’t get much of an income, the UK tax system starts to make a lot more sense.

And it’s also good to see that some of the highest earners in the UK declare their income from salaries and dividends, just like you and I do, when it wouldn’t be the hardest thing for their accountants and advisers to put everything through complex tax minimisation arrangements.

Here, if you being paid a salary or dividends, as declared in your business’s end of year accounts which the team at the Sunday Times dug out for their Tax List 2019, HMRC will be automatically picking up the proper amount of tax as laid down by Parliament. There’s little or nothing those billionaires can do about it.

So I take my hat off to the ladies and gentlemen of the Sunday Times Tax List 2019 for not taking advantage of the tax system the way some others might.

Billionaires aren’t perfect, I’m sure, but at least this lot are playing fairer than most with the tax system. And in a country currently mired in Brexit gloom, I’m looking for positives everywhere I can find them at the moment.

Accountancy…the second oldest profession

We accountants like to joke that accounting is the second oldest profession…which might give you some idea why we’re accountants, rather than stand-up comics.

But ever since commerce became more complicated than agreeing how many chickens I’d need to swap at the market so I could take a goat home with me instead, accountants have been an important part of the economic system across cultures and continents.

From ancient Mesopotamia, through the lives of ancient Egyptians and Babylonians, there were people whose job it was to track what people spent and how much they owed to one another. Some of the oldest documents to survive from antiquity are tax records.

Accountants might not be quite the second oldest profession, but we’ve certainly been around for some time.

Any profession which has been around for some time, though, is in danger of becoming a little stuck in its ways. Which might not matter quite so much if the world hadn’t got a lot more complex in recent years.

So how do you know if your accountant isn’t just trundling along in a way that might have worked perfectly well 20 years ago, but doesn’t quite cut the mustard anymore as we travel deeper into the 21st century?

As the 2010s give way to the 2020s, I believe there are three areas where the “old rules” of the accounting profession need to change and modern accountants, especially Finance Directors and CFOs, need develop a different way of thinking in the face of a new economic reality.

Cost v. Bottom Line

Accountants are used to tracking costs and budgets. It’s often the first thing people think of when you say the world “accountant”. But that’s not enough any more. The key question now is how much of a positive impact an accountant, Finance Director or CFO makes to the bottom line.

Imagine you currently spend £100,000 a year on something. While you want to make sure you’re getting good value for your business’s expenditure, the maximum impact anyone can make on the bottom line with “cost-based thinking” is £100,000.

That is, if you stop the activity completely, you’ll save the entire budget of £100,000 a year. It can never be any more than that, no matter how much time and effort you put in because you can’t reduce any cost below zero, no matter what you do.

But what if your accountant concentrated their efforts making the biggest positive impact on the bottom line…what difference might that make?

For starters, a bottom line-focused accountant might recommend you don’t reduce your £100,000 budget at all, and perhaps even think about increasing it.

Let’s imagine the £100,000 was your business’s budget for customer loyalty initiatives. Everyone knows that it’s much cheaper to retain a customer you’ve already got than go out and find a new customer you haven’t dealt with before.

Slashing the customer loyalty budget (a cost-focused approach) could result in customers becoming less loyal to the business over time, which could in turn both reduce customers’ total lifetime value and increase the sales and marketing costs as the business would need to invest more money to attract new customers to replace the shortfall in sales from existing customers.

Admittedly, if you were only thinking about the short-term, you could probably slash the customer loyalty budget and for six months to a year you might just about get away with it. The loyalty built up in times gone my would probably see you through for a while.

But gradually, for reasons nobody could quite put their finger when it eventually happens, the numbers would start going the wrong way. Customer loyalty would decrease, previously loyal customers would scale back their purchasing and the business’s income would reduce.

By then, nobody would remember that the customer loyalty budget was slashed in half six months or a year earlier. Scapegoats would be found elsewhere when the business bumped up hard against its next crisis. But I guarantee you, the root cause of the next crisis will be the short-term move you made in response to the last crisis.

An accountant who focuses on the bottom line, instead of purely on cost makes a big difference. That’s where your Finance Director or CFO can have the maximum positive impact on the value to your business.

Tangibles v. Intangibles

Traditionally, we accountants have preferred things we can see, touch, feel and count, rather than the “fluffy stuff” like intangibles.

But the world has moved on.

Currently, the bulk of the market capitalisation of the S&P 500 is based , not on the value of tangible assets like factories, trucks and offices, but on their intangible assets. The precise number varies with the stock market fluctuations, but at the time of writing solidly over 80% of the stock market valuation of the S&P 500 companies is not derived from the tangible assets on their balance sheet.

For example, Coca-Cola’s market capitalisation is around $200bn today. But their latest balance sheet showed a little under $10bn in tangible fixed assets – the accounting term for their factories, machinery, trucks, and so on.

As you can see, the value of Coca-Cola is many times the value of its “hard” assets.

Which creates a dilemma for accountants.

Traditionally accountants would focus on things they can see, feel and touch. But if that’s all you do nowadays, you’re not spending any time looking after the assets which account for the majority of the company’s value. Surely that can’t be right.

I tell people that, if 80%-plus of the value of the S&P 500 is made up of the value of intangible assets, a good accountant should be spending at least as much time thinking about those things as they do about the more traditional definitions of the word “asset”.

Whether they’re quoted on a stock market or privately-held, for most businesses, their intellectual property (IP), customer loyalty, brand, marketing assets, track record of innovation and a host of other intangible factors will account for more of the business’s total value to a shareholder or potential purchaser than its traditional fixed assets.

If you want to make your business as valuable as possible, make sure your accountant spends at least as much time focusing on the intangible assets that account for 80%-plus of your business’s overall value as they spend on the tangible fixed assets which nowadays accounts for a tiny proportion of the business value, but which are admittedly a lot easier to count.

Yesterday v. Tomorrow

As a friend of mine puts it, how much time does your accountant spend looking in the rear-view mirror instead of keeping their eyes on the road?

Traditionally accountants focus on events that have already happened…last month’s management accounts, last year’s statutory accounts, the last VAT quarter, and so on.

Now, of course, there is a need to examine what happened last month, last quarter or last year and report on how well the business did compared to expectations. But you’re unlikely to create substantial value for many businesses from purely concentrating on yesterday.

It’s like being a CSI who comes along after the bullets have stopped flying and tries to work out who did what to who. Of course that’s important, but isn’t it better to work in such a way that nobody gets killed in the first place?

In a business sense, that means looking into the future and anticipating problems before they arise, making sure the business’s operating model is well-honed and understood by all, and that the business takes profitable opportunities to grow as they come along.

All those activities build value which is, after all, what anyone with an interest in the business wants.

So next time you’re wondering whether your accountant is adding value to your business, ask yourself how well they are performing against these three tests.

The commercial world has moved on rapidly in the last 20 years. It’s vital for the success of your business that your accountant has too.

(Photo by Patrick Hendry on Unsplash )