Archive for the ‘The New Normal’ Category

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Getting out of Technology Jail #2

September 16, 2011

In the past few decades there has been a veritable explosion in innovation, accompanied by exponential growth in important technology drivers, including Internet bandwidths, the performance, the speed and RAM power of computers.  As a result of these and other changes, the engine of growth in our economy has migrated from its traditional industrial base to something substantially different.

Today nontraditional assets, new ideas, patents, software and other forms of intellectual property underpin many of the most exciting businesses in our economy.  Needless to say, these new sources of wealth do not appear on the company’s balance sheets, and sometimes not even on their management’s radar screens.

Despite the fact that these new assets form the largest part of our economy now-a-days, important institutions including business schools, banks, accounting professionals, securities and exchange commissions have not kept pace with these changes and as a result do not know how to interact with the new innovative businesses that have emerged from all this.

With Western economies failing rapidly, there is a desperate need to bridge this yawning gap. What’s required is a means of translating the institutional standards, management disciplines, operational processes and leverage of traditional assets into this rapidly developing knowledge driven ‘new asset’ space.

This means treating nontraditional assets like traditional assets.

Essentially the first step is for management to properly identify and capitalize the nontraditional assets on its own balance sheet on an historical cost basis – which will at least identify the important value drivers in the business. This is NOT traditionally done in the normal course of business, but does conform to a rapidly evolving GAAP (Generally Accepted Accounting Principals)

As important as this step is, its does not extract the full ‘enterprise’ value from innovation.

So… what is enterprise value? If you’re fortunate enough to own traditional assets, developable property for instance, accounting standards allow you to estimate the property’s value on a ‘best use’ enterprise basis.

Highest and best use, or highest or best use (HBU) is a concept in real estate appraisal that shows how the highest value for a property is arrived. HIGHEST AND BEST USE is calculated optimistically on the reasonably probable and legal use of property, that is physically possible, appropriately supported, and financially feasible, and that results in the highest value.

This enterprise value will very often be many times the purchase price. This kind of valuation technique allows property developers to accelerate their businesses through increased financial leverage.

Translating these traditional valuation concepts into nontraditional assets assumes a ‘best use’ valuation of the intellectual property with all kinds of caveats and assumptions. Enterprise valuations tend to be larger than standard values at play in the market today because of many factors, including optimistic assumptions about:

(1)  Access to capital and other resources of all kinds

(2)   Management competency and skill, and not least

(3)  Globalization’s impact on Market Size calculations.

So why is Enterprise Value so important?  In a word… LEVERAGE

Leverage the Assets at Full Value: traditional businesses take full advantage of leveraging their assets on a best use basis. For instance owners of development property are able to use the full develop-able collateral value of their assets to attract bank finance, to establish valuations when going public, doing joint ventures etc. Enterprise valuations unleash this best use value of nontraditional assets so they can be leveraged in the same way, commercially and in the stock market. 

By identifying the asset strength, bolstering the company’s balance sheet and structuring properly, it is possible to greatly increase the Net Worth of a company, preparing it for investment, increasing the bargaining power in real financial terms.

What’s the benefit of Enterprise Value: Now, it is possible to fit a substantial investment into the company without punishing dilution.

Things to Think About:

  1. Unfortunately it is very difficult – if not impossible  – for your ordinary accountant to obtain Enterprise Value for nontraditional assets in the originating organization. Specialized GAAP accounting techniques (it really is brain surgery) are required to accomplish this goal.
  2. If you’re interested in more details on how to accomplish all this, write a summary of your new asset business in the comment box below and I’ll see that someone contacts you.
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‘Servicing’ the Economy

May 17, 2011

The Irish property boom and subsequent bust is a portent reminder of the hazards of the Wall Street version of banking, which over several decades has managed to turn the most conservative institutions in our economy into Las Vegas like gambling casinos.

Bankers have traditionally been the guardians of assets, its why it they were so dour; their job and role was to protect the value in assets, and thereby protect their depositor’s principle and the integrity of the capital system. In Wall Street’s version of the game, traditional banking is a bit of a dog; much better to turn boring (low return) mortgage assets into a stream of high value ‘services’ that generate multiple sources of immediate fees (earnings and personal bonuses).

The ‘sub-prime’ mortgage scandal demonstrated clearly that under this regime, NOBODY in the system is focused on stability. Every player in the property game these days, mortgage ‘originators’, servicers, securitization specialists, banks and their and sophisticated investment advisors, even credit rating agencies are focused entirely on fees, no one is watching the asset. In changing the focus of attention and misaligning the incentives in the system, the quality of mortgage assets was degraded – to devastating effect.

Assets matter, for instance, with a solid housing market individuals are able to leverage their homes to raise funds for, perhaps, sending their children to school, for investing in their businesses or expensive life-savings operations. Businesses are able to leverage their commercial property for a variety of purposes, including managing cash flow. Banks holding solid mortgage assets are able to leverage these assets to provide liquidity for the local business community, while national governments are able to leverage the housing stock to support currency values and central banking liquidity to the benefit of the economy as a whole.

As the Irish are discovering today to their dismay, blindly following Wall Street model of ‘servicing’ an economy creates instability; for the Irish it created a kind of economic whiplash.

Assets, and their sustainable value are the underpinnings of the capitalist system and all nations value and in many ways ‘rest’ upon their asset foundations. Turning assets into fee generating ‘services’ is the reverse of what a sensible economy should be doing. Unfortunately the game today is all about finding new and exciting ways of converting assets into services; this means that capital stability is sacrificed for expediency.

‘Servicing’ the economy not only degrades an economy’s strength but also reduces leverage and growth potential. Not that leverage disappears in this new Wall Street system, banks, naturally, publically traded, are able to leverage their new ‘mortgage’ related earning steams – good for them. Unfortunately this is very bad for the rest of us.

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Another Oil Bubble Brewing?

February 24, 2011

There’s trouble in paradise again. It looks like oil prices are taking off as political tensions rise in the Arab world.  In addition, there is a puzzling spread in pricing between two of the more important benchmark crudes, with Brent trading at wide margins to the West Texas Intermediate (WTI). What the heck is going on?

The extraordinary volatility of oil markets in the past few years has been a function of several major developments: (1) there have been significant changes in the oil ‘formula pricing’ regime in the past few years, (2) Index ‘securitization’ of commodities has become big business and (3) there is heightened political risk, driving oil and other commodities on an historic run up in prices.

Oil’s Formula Pricing Model

The older system for pricing oil contracts was fairly simple. Contract prices were determined by adding a premium to, or subtracting a discount from, benchmark crudes. Generally, West Texas Intermediate (WTI) was used as the benchmark for oil sold to North America, Brent for oil sold to Europe and Africa, and Dubai-Oman for Gulf crude sold in the Asia-Pacific markets.

However in the past few years this all changed when Middle Eastern producers noticed that the spot market was subject to increasing manipulation. Basically producers didn’t trust the market so they changed the rules of the game. Instead of using dated Brent as the basis of pricing crude exports, Saudi Arabia, Kuwait and Iran came to rely on the IPE Brent Weighted Average (BWAVE). The BWAVE is the weighted average of all futures (Brent crude) price quotations that arise for a given contract of the futures exchange (IPE) during a trading day. These changes in ‘formula pricing’ have placed the futures market at the heart of the Brent oil pricing regime. So unlike the more spot oriented WTI, which is experiencing a localized over-supply of NA crude, Brent benchmark pricing is going its own direction; factoring in the growing political instability in North Africa and the Middle East.

On top of all this, commodity markets tied to the futures market, the Brent benchmark in particular, are subject to a volatility accelerator in the form of index Speculators; major institutional investment in the oil futures market, trying to cash in on market instability. Index speculation in commodities is being driven by a potent cocktail of political instability, a lack of confidence in global stock markets and rising commodity prices.  Importantly – there are enormous volumes of index speculation sloshing around in the futures market, and after recent events the vast majority are leaping on preprogrammed ‘long’ positions in oil. The net effect is to drive oil-futures yield curves into the stratosphere in a self fulfilling death march to oil bubble land. I believe we’ve seen this movie before, a couple of years ago in fact.

Things to Think About

  1. Could it be that the Brent – WTI spread, which has been as high as $15 a barrel, is really a measure of the speculative bubble in oil pricing?
  2. If history has any lessons, it’s that these markets are not accurately pricing crude which is likely going to over shoot its strike price in both directions. Timing is everything in life, it’s the difference between winning and losing in oil markets these days. Heads up.
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Navigating the Age of Volatility

January 14, 2011

How did your organization cope with the Financial Crisis in 2008? If the answer to that question is “not as well as we should have” then ask yourself the following question:

  • How are we going to manage a future crisis that will be twice as deep and twice as long?
  • Will we even survive?

 The World has Changed

 The world of business is in the midst of a paradigm shift that is changing the economic reality profoundly. Consequently, the global economy has entered the Age of Volatility; a faster pace commercial environment that shifts gears suddenly and unexpectedly.

 

[The diagram above is a graph of global crude steel production over the course of the past century. Crude steel production, tied to industrialization and urbanization, is used as a global growth and GDP indicator. It reveals a succession of roughly 30 year growth patterns that have characterized the economy over time.]

 What it Takes to Succeed Today

In a global economy as volatile as today’s standing still is not an option. The question is what steps should a leader take to ensure success?

Ultimately successful companies need to be more adaptive, resilient and strategic. However, this scale of organizational change doesn’t happen overnight.  In the meanwhile there are some measures you can take immediately to prepare your organization for disruptive change, whatever its origin.

  1. Improve your Situational Awareness, most people today are finally starting to relax, they’ve come through the recession of 2008, business is returning to normal and, as far as they can see, no storm clouds are on the horizon. Don’t follow the complacent crowd, develop a High Altitude Mindset. In other words operate in what appears to be a normal world with the attitude that crisis could strike at any moment.
  2. Do not delay, develop options NOW. You have a plan, now is the time to stress test it and build in greater resiliency.
  3. For instance, rationalize your corporate finance, renegotiate terms on your debt if necessary to provide you the flexibility to manage through a sudden spike in interest rates sometime in the next five year interval.
  4. Strengthen your balance sheet, identify and sell non-essential assets, pay down debts prepare your organization for ‘heavy weather’.
  5. Raise awareness within your leadership teams and begin contingency planning. Revisit foundational assumptions; revise your strategy where necessary. Every departmental VP should have options laid out for a variety of futures, with tactical plans ready for implementation at short notice.
  6. Begin planning for the kinds of business you’ll be able to do profitably during and after a major correction; identify the necessary plant and machinery, core employees and supply partners that you’ll need.
  7. Prepare the board and shareholders, make them aware of the risks and brief them on your heightened level of preparedness.
  8. Where possible practice executing your options – remember fear and panic could cripple your organization’s ability to act in a crisis situation – it’s why we do fire drills.

Consider that you may not be able to survive on your own. Once you have examined your own situation and have a clear idea of the weaknesses and strengths, start having conversations up and down your supply chain. It is the entire supply chain that is potentially at risk, work with your partners to:

  •  Identify important areas of commercial interdependence, remember your customers tend to be adversarial in good times, but they would definitely not want to see their vital sources of supply disappear in a crisis.
  •  Be creative in your joint planning, even a deep downturn must end sometime – plan accordingly. For instance you could agree emergency business minimums with important suppliers, emergency sales volumes with important customers, all with terms agreed in advance to ensure your mutual survival.

Remember that volatility is not necessarily a bad thing; it’s really only a problem for the unprepared. With proper planning and appropriate timing you could gain significantly market share and competitive advantage if you are ready and your competitors are not. 

Never forget the old adage,  flexibility is priceless in a crisis

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New Normal: Strengthen your Social License to Operate

November 16, 2010

An Adaptive Organization is deliberately designed to survive in tough times. In the new volatile business climate today it is important to think of adaptability in business as you would in nature; it’s a key to survival.  Many leaders think their organizations are fit and competitive, but how adaptable are they to sudden changes in the business environment?

Consider a new and virulent threat to business in First Nation activism. Consider TransCanada Corp, who at present is finding out the hard way that its social license to operate can’t be ignored, or left to chance. TransCanada Corp. (TSX:TRP) is in a dispute with the Lubicon First Nation, a northern Alberta aboriginal group over a proposed pipeline. The pipeline is planned to go across Lubicon territory, land which the Lubicon claim they never ceded to Canadian government. The Lubicon have gone on a major blitz and as a consequence, their approval is going to be required for any development. The strategy of TransCanada was first to ignore the Lubicon, claiming they had no jurisdiction in the matter, and then to deal with them as a problem.  Neither strategy has worked particularly well, as a consequence the fate of their billion dollar Northern pipeline project hangs in the balance.

Given this and similar events of the past few years, it’s becoming obvious that CEO’s are going to have to pay more attention to the ‘softer’, sides of their businesses. In particular many businesses are going to have to identify the important asset quality in their ‘social license to operate’ – and start to treat it like the important asset it is.

This kind of problem is not confined to local resource based companies. British Petroleum is facing a similar hurricane of bad press, litigation and demonization, as a result of its handling of the Gulf ‘blowout’ disaster, which is seriously affecting its ability to operate in this important market. We should remember the words of Pierre Lassonde, President of Newmont Mining Corporation: “You don’t get your social license by going to a government ministry and making an application or simply paying a fee… It requires far more than money to truly become part of the communities in which you operate.’

The lesson many companies refuse to learn is the social license is rooted in real relationships with real people: customers, employees, government officials, the media and the public. In the particular case of TransCanada it’s a function of their relationship with the Lubicon people. Clearly they’re failing the test.

Things to Think About

  1. Adaptive Organizations accept change, adapting as required to new circumstances. It is important to avoid becoming trapped by your own often outdated ‘winning strategies’. This applies to organizations large and small. Consciously avoid an automated repetition of older success strategies; face the new and unfamiliar realities head on.
  2. If you’re in business, particular in the resource business in Canada, it’s time to think ahead and start becoming part of the solution instead of the problem. For instance with First Nations;  business could support programs at a very personal level, perhaps utilizing charitable organizations to work directly with First Nations helping identify youth leaders on reservations, building programs to reach disaffected youth, helping native leader discourage harmful addictions and other bad practices. It might just help build relationships of the most important kind, trusted personal connections rooted in our common humanity. This may not be the complete answer to the problem but it could strengthening the social license to operate so that when, not if, you need a friend, you might actually have one.    
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New Normal: The Naked Corporation

September 18, 2010

Big news today in London’s Financial Times, “computers set for quantum leap”, apparently a new computer chip has been developed that works on light rather than electricity. This new development will “pave the way for the production of ultra-fast quantum computers with capabilities far beyond today’s devices.” In the not too distant future quantum computers will be able “pull important information out of the biggest databases almost instantaneously… making it easier for people to search with precision for what they want.”

This is good, right! Well that’s hard to say, but there’s no doubting it is inevitable. The disturbing thing for managers today is that it is the beginning of the end for secrecy. The effect of quantum computing and generational attitudinal change spells the end of corporate anonymity and perhaps any meaningful corporate security.

I’m old enough to remember a time when corporations operated with a strong sense of employee loyalty, a supportive public and little if any press coverage. It was a world that respected privacy and where, even if discovered, an admission of regret solved most problems.

How the world has changed. Corporations, once considered champions of our material wellbeing are today looked at very suspiciously by large sections of the population. Simultaneously to this fall from social grace, technology is rapidly unraveling the corporate veil. The Internet, social media and iPhones have created a stunning new world of immediacy in communications. If this immediacy happens to be pointed at your poor environmental record, or your mistreatment of minorities, these ‘problems’ can instantly become front page news around the world. And once your company is ‘framed’ in the public’s mind, no amount of traditional communications and PR support after the fact is going to completely repair the damage.

This situation is critical and, assuredly, is getting worse. Consider a recent contest: “How to steal corporate secrets in 20 minutes.” No, it’s not a joke. Turns out it is surprisingly easy to steal even the highest security information from Fortune 500 companies – in a matter of minutes.

Things to Think About

  1. Prepare for transparency, a volatile combination of rapidly advancing technology, changing attitudes and instantaneous global communications is unraveling the corporate veil. Pumping up the PR machine or clamping down hard on security managers will not get the job done. This is a strategic issue that requires a new mindset and a new approach. Don’t delay.
  2. Singularity – most people don’t know what this means. In the technological sense ‘singularity’ describes a point in the not too distant future when technology simply runs away from us all – becoming an uncontrollable force. As Y2K proved beyond question, the technology revolution can be confusing and can have dangerous unintended consequences. This is another strategic issue that can’t be wished away.
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