This is CFO Secrets. The weekly newsletter that looks forward to monthly business performance reviews.

5 Minute Read Time

In Today’s Email:

• 🦖 How to wrestle a T-Rex

• 🖼️ Thiel’s masterpiece

• 🍳 Succession is back - Episode 3 😱

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THE DEEP DIVE

The $50m problem that made the CEO lose his cool, and how we fixed it.

This is a part 2 to last week’s edition on problem solving. This week we go deeper into how to solve the biggest problems. The T-Rex.

“Another sh*t month. SH*T. SH*T. DOGSH*T”

It was the third consecutive month he started their business review with those words.

The CEO and I had a well oiled good cop / bad cop routine.

We’d take it in turns. For some regional reviews I’d be the good cop, for others I’d be the bad.

For this particular region, I was definitely good cop.

Unlucky for them.

Whilst I had my own effective bad cop routine, it wasn’t as loud and rude as the CEO’s.

“Well… what precisely would you do differently?”

The regional president snapped back.

One of those make or break moments.

Would the CEO a) throw him out the window, or b) respect him for standing up to him. If there was an option c)… it was not obvious to me.

But …

It was the right question.

I wouldn’t have delivered it so sarcastically. But lets look at the facts:

• Sales were down 6%. But the relevant market had shrunk by 12% in the same time frame.

• Gross margins were down. But the product range had become more commoditized. Falling demand meant the market was over-capacity. They had exhausted all tactical routes to increase prices or improve mix.

• Operating expenses had been well managed. They’d restructured and cut lumps from the cost base twice in the last 18 months. But efficiencies were down because volumes had fallen. This was a high fixed cost leverage business.

• This all led to a car crash at an Operating Margin level. 11% to 3% in two years. One of our cash cows had become a dog in record time.

And this was an $650m revenue region. Big numbers.

We needed to fix it.

I decided that there was an option c) after all.

I asked the CEO for ‘a word in private’.

“Boss. Before you kill him… He’s right. This isn’t about poor operations, or sloppy execution. This is the same team that were crushing it 2 years ago. Doing the same things. The problem is, the market has shifted quickly. And the strategy is now wrong. They’ve mis-read this. But so have we. We loved this plan when they pitched it. What we know has changed. We’ve got to get back to first principles. Rebuild the strategy from the ground up. And they need our help to do it.”

He said “Now you are p*ssing me off. Why are you being so reasonable?”

I still don’t know what that meant.

But what I do know is that he walked back in the room. Sat in front of the nervous regional leadership team (who were certain they were about to get fired). And then calmly repeated my appeal, back to regional president.

It reset the tone. And led to a common acceptance that we had a very complex issue. And one that was very important to fix.

A T Rex…

Last week, I shared the problem solving framework I use, based on the impact and complexity of a problem. We defined the most challenging problems as a ‘T Rex’.

This is the very definition of a ‘T-Rex Problem.’ High impact ($50m of EBIT at stake). High complexity (Complex dynamics and no obvious solution).

The approach I use to solving T Rex problems is by asking five questions (in order):

1. What exactly is the problem we are trying to solve?

2. What information, assumptions and opinions do we have? What is missing?

3. What are the real options we have?

4. What are the potential outcomes and consequences of each option?

5. What should we do based on the insights from the previous steps?

Before we get into the detail, this will feel heavy handed and quite structured. Remember, this approach is only for the small number of the most high stakes problems in the business. High impact, high complexity problems.

Let’s take each in order:

1. What exactly is the problem we are trying to solve?

You can’t solve the problem until you know what it is.

Sounds obvious, but few do it well.

The aim of this question is to end up with a simple written statement of the root cause problem.

These are the actions steps you can take to define the problem clearly:

• Assemble a small group of interested stakeholders

• Describe the problem as you see it

• Visualize what a ‘do nothing’ or current momentum situation would look like. What would the consequences be of not solving the problem? This will focus the mind

• Use the ‘5 Whys’ to get to the root cause problem. Peel back the layers

• Summarize the findings into a single clear written problem statement

In the example of the underperforming region, we did this in a Group of 6; Group CEO, Group CFO, Regional President, Regional CFO, Regional Sales VP, Regional Ops VP. The problem statement we reached:

It focused the mind …

2. What information, assumptions and opinions do we have? What is missing?

The purpose of this question is to build up a first principles understanding of the problem. We need to now strip out all the conjecture and get to the truths. Then we need to layer on opinions and assumptions, but only once we’ve started at first principles:

• What facts do we have? What is indisputably true?

• What facts do we not have, but could find out if we wanted to? What is the consequence of the time this will take?

• Where do we have known unknowns, and we need to make assumptions?

• What credible opinions do we have on the range for those assumptions?

• What are the pure unknowns? How much risk is in these.

It’s very important to think with real discipline here. Healthy skepticism is the order of the day.

‘Is that really true?’ Is a valuable question to ask in each stage of this.

Back to our example, we worked this over a four hour session in the same small group. It established a few killer insights:

• Our belief that the imported substitutions were a quality / price trade off for the customer was incorrect. Our product was dominated on price, and no better on quality. Ouch!

• The competitors had achieved this through new manufacturing technologies. We had failed to recognize and invest behind this tech.

• Our brands and IP built over a long period of time, was much harder for new competition to replicate. There was a durable advantage here.

• Market demand was volatile and hard to predict. We could spend months and months trying to develop better insight, but it was inherently uncertain. We had to act assuming that uncertainty.

• Our overseas competitors were now our biggest threats. They were dynamic. We couldn’t assume they would stand still in the same way our domestic competition had.

3. What are the real options we have?

The third step is to define the real options.

Given the inputs assembled, what are the ‘real options’ available to you?

The term ‘real’ is critical here.

You started this with a 3D problem. Now is when you turn it 2D.

It may have felt initially like there could be an infinite number of possible solutions.

This is rarely the case.

Often many potential ‘options’ are hypothetical and not practical. Strike them off.

Too much execution risk, or too far outside of capability? It’s gotta go.

Some options will be dominated by others. Often the ‘half way houses’ and compromise options get exposed by this process too.

You need to put your practical hat on.

You will boil it down to 2-3 options. Those options each need clear definition.

Back to our example.

Whilst we started with a universe of about 15 different ideas, we quickly struck off half of them. They weren’t practical. Then another 4 or 5, were good ideas, but not complete solutions. Nor were they mutually exclusive. So could be built into other options.

We got it down to 2 real options:

a) Partner with one of the importers. Combine our strong local presence with their low cost, best in class supply chain. JV or commercial partnership.

b) Redesign and respecify our products to create a new premium market segment. use our existing supply chain. Sacrifice some volume but at higher margins

4. What are the potential outcomes and consequences of each option?

This is the most fun step. Wargaming.

Wargaming is a process of role-playing and simulating scenarios. This helps identify potential outcomes and test the viability of different options.

In straight forward scenarios, a simple pros and cons / cost benefit analysis will do. The problem with that approach is that it is static.

A competitive environment is never static. Your competitors, customers and suppliers each have their own plans. And when you act, they will react.

Wargaming allows you to bring those dynamics to life.

You need to take each option of scenario in turn. Then run a wargame for each, as follows:

• You will need to identify the crucial stakeholders. For example; Company, Competitor A, Competitor B, Customer A, Customer B

• You need to create roles (1-2 people for each team).

• Define the rules;

  • Who has what information at the start of the wargame

  • How many rounds of the wargame

  • What are the objectives / agendas of each team

  • How long per round

  • What are the rules on interactions

• Ensure any necessary preparation work, or role play materials are prepared. Including financial modelling.

• Brief participants and run a structure war game (round by round)

• Debrief and discuss results / insights

In the example, we ran two wargames (in separate sessions). One for real option a) and one for real option b).

Ahead of this session, we had spent time running financial models on each option. This was important as both options meant a big change in the core business economics.

When we did so, we found that both options would be much better than our current plan.

But, the Wargaming unlocked one crucial insight.

If we selected option b) it would move us into a different market segment. We discovered that our overseas competitors would not be able to compete in this segment. Nor were they incentivized to do so. It was a blue ocean, vs the red ocean we had been fighting in.

It would mean selling fewer volumes but at higher prices, and revenue (in total) would grow. But at margins that were far more defendable in the long term. Even vs option a).

It was the Wargaming that unlocked the key point. How difficult (and unattractive) it would be for our competitors to compete in this segment.

5. What should we do based on the insights from the previous steps?

The final step is to make a decision. Based on the inputs, options, and insights gathered from the wargaming session, determine the best course of action:

• Evaluate the options based on the outcomes of the wargaming session.

• Identify any risks or opportunities associated with each option.

• Make a decision. One you can commit 100% to.

• Be clear on the assumptions that underpin that decision. Define what would need to be true for you to change your mind.

• Communicate it clearly to all relevant stakeholders.

• Establish a plan for implementing the decision and track progress.

In our particular case, the answer become very obvious following the Wargaming session. Option b) it was!

This is an example of a business strategy problem. But I have seen this process used to solve a range of T-Rex problems. Supplier challenges, financing and funding options, customer tenders, and more

As for the poor old regional president…

With the new strategy in tow, and some solid execution, he was able to steer the business back towards double digit operating margins. The boss was happy too.

And this time the margin was much more defendable.

It took longer to get free cash flow back where we wanted it, but it got there in the end. So eventually I was happy too.

A happy ending for everyone.

MEME OF THE WEEK

Just when you think the FTX thing couldn’t get any more ridiculous.

BOOK CLUB

This week I’m featuring Zero to One by oddball tech genius Peter Thiel.

Thiel was a founder of PayPal, Palantir, and was the first outside investor in Facebook. He’s Silicon Valley royalty.

In his 2014 book, he sets out his thoughts on how to build the future. It provides an insight into the mind of someone who sees the world from the other end of the telescope.

If you came into business through a classic finance route, then there are insights in this book that are truly framebreaking. I have read this three times, and love each time how it challenged what I thought I knew about business.

FEEDBACK CORNER

A review from last week:

“Online vigilante” … I like it!! 😎

POACHED GREG

Having spent last weekend catching up on Succession Season 4. There is only one thing I could put here …

This week I sent this on Saturday as a test. Normally I send it on a Friday. Help me decide:

I’m taking another one week break next week. I’ll get some content written, and I’ve got a quarter to close.

CFO Secrets will be back on Friday April 28. Until then, you can find me on Twitter, & now LinkedIn.

Until then…

Stay Crispy,

The Secret CFO

Disclaimer: I am not your accountant, tax advisor, lawyer, CFO, director or friend. Well, maybe I’m your friend. But I am not any of those other things. Everything I publish represents my opinions only, not advice. Running the finances for a company is serious business, and you should take the proper advice you need to make the right decisions.