Reach Multipliers

Teachers are a scarce lot nowadays. Teaching is a noble profession no doubt and a highly honorable one too, but like a lot of other noble professions nowadays it is losing its shin in this modern age. There is no glamor in being a teacher anymore; hence not very many of the younger generation aspire to become teachers these days. Consequently their tribe is only decreasing. Paradoxically with the increasing population, school enrollments are on the rise. With the result that the demand for teachers today is more than it was ever before. I see a shortage of teachers in primary schools, secondary schools, junior colleges, engineering colleges, medical colleges and Universities. In short, I see a shortage of teachers in the whole teaching system. Yet I also see more and more schools and colleges coming up everyday. It requires an explanation. How are these schools and colleges managing to teach their increasing number of students with lesser numbers of teachers? I was prepared to see visiting teachers from other faculties, cramped classrooms reflecting a higher student to teacher ratio and self-study student groups in those schools where teachers were missing altogether. And I did see all of these. But I also saw something else. A handful of innovative institutions had attacked this problem by multiplying the reach of their teachers. They had installed video conferencing equipment in their classrooms using which multiple students at dispersed locations could attend the lecture of a single teacher at the same time using the power of video conferencing. In effect these institutions had managed to solve the problem of scarcity of human capital by strapping structural capital in the form of video conferencing equipment to their human capital, the combined effect of which enabled them to reach out to a larger number of students in geographically dispersed locations!

I was hardly surprised this time when I saw the same solution being applied effectively in another noble profession – medicine. Like good teachers, good doctors are also becoming a rarity of late. And patients who can afford it always seek a second opinion especially when they have to make a decision based on the opinion of their doctor. Some innovative hospitals have resorted to video conferencing technology to enable their patients to seek a second opinion from doctors in other hospitals, perhaps those in their own network of hospitals. Case history of the patient is available to the remote doctor electronically which he can browse and consult with the patient simultaneously over video. This much is becoming pretty common. Meanwhile medical solution providers are working on building technology solutions that will enable doctors to remotely examine patients and even conduct surgeries remotely using remote controlled robotic arms. This may sound like science fiction right now, but we are getting there slowly but surely. This is one more instance of specialists reaching out to a larger audience beyond the confines of their own physical boundaries through the leveraged use of structural capital.

While video conferencing has been enabled in leaps and bounds by gigantic advances in telephony, the Internet has also been a great enabler in this regard. One example of this is webcasting, a medium that is being increasingly adopted by businesses nowadays to peddle their products and services. The traditional approach would have been to invite a select audience into an attractive downtown location, make the sales pitch, feed them lunch or dinner and offer them networking opportunities with their peers. This high cost approach is a rarity nowadays. Webcasts are not only cost-effective for the business itself but also time-effective for the target audience, since they do not have to commute anywhere but can attend the conference right from their desktop. Moreover, webcasts enable the business to reach out to a worldwide audience at the same time which would be physically impossible using the traditional approach.

Structural capital that enables businesses to address much larger audiences than they can do at present is a very attractive proposition to every business. It is so attractive that I have coined the term “Reach Multipliers’ to denote such capital. Reach multipliers are critical for any business to increase the reach of its human capital manifold. Those businesses that have devised reach multipliers are well on their way to achieving the next level of growth in their business lifecycle. Others will be constrained by the limits of reach of their human capital.

As attractive as Reach multipliers are they still are dependent on the presence of human capital in the back-end. The scale that can be achieved using Reach multipliers is a limited therefore by the amount of human capital in the back-end. The question that arises then is – Is there a way of achieving unlimited scale? Turns out that there is and some have already done it. Wait to read about it in my next post.

The Power of Personalization

Have you ever wondered why in this day and age of giant shopping malls, branded retail chains, self help shopping and barcode based point of sale systems, there are still some Mom and Pop stores that manage to survive and even do well despite having none of the above mentioned advantages? Perhaps, you yourself frequent one or more such stores regularly – it could be your neighborhood baker, convenience store, grocery store or even your local co-operative bank – without realizing why it is you do so. Here are some clues - Does the owner of the store greet you with a smile? Does she know you by name and address you by your name? Does he go out of his way to suggest good deals? Does he even engage in a bit of a casual conversation with you at times? In short, does he try to personalize your visit to the store? Do you leave the store with the feeling that you have been served well, served personally and have been given preference over other customers. That last point is the essence of generating repeat business. As human beings, we all have the innate need to be recognized and for our desires to be pampered. Personalization is just a high sounding term that satisfies this need.

Mom and Pop stores have known for years that big name commercial chains cannot compete with them on the personalization front – it is just impossible to know every customer by name when you have thousands of them. And hence they have leveraged this knowledge to their advantage and managed to survive and even thrive during the retail boom of recent years. Yet what I am about to discuss today is not the friendly personalization in neighborhood stores that you and I have come to experience often. I am going to discuss the commercialization of personalization itself. Yes, you read it right – the commercialization of personalization itself. But wait a minute - Isn’t personalization an intangible thing? – is the thought that crosses your mind immediately. How can you even describe an intangible, leave alone make any attempt to commercialize it? This sounds insane.

Does it? I could have perhaps agreed with your thinking had I not had two very compelling experiences of the commercialization of personalization. The first one was when a good friend of mine had a need to hand out corporate gifts in his company’s name to a select list of his prospects in order to promote his business. I short-listed a corporate gift provider for him and together along with him visited the provider’s office. There we were presented with a variety of gift articles ranging from pens, cups, mugs, key-chains, card holders, stress busters, T-shirts, etc. all of which could be personalized with the corporate logo and the tag line. The shape of the gift did not matter. Neither did its size nor the material from which it was made of. The corporate logo could either be printed or it could be embossed or outlined or even engraved on the gift. Having being sufficiently impressed by this personalized display, all that was left for us to do was to select the gifts that fitted our budget and place our order, which we did right then and there. The gifts were delivered to my client after three days, which he is handing out to his clients and prospects and impressing them every day. Business is also picking up of late, he informs me.

My next experience was more personal. I recently came across a retail chain which sells T-shirts, mugs, clocks, picture frames and other articles that can be personalized with your picture and slogan of your choice. They have a variety of such articles on display in their store, which you can browse through and select. In the middle of the store is a table full of sleek computers where you can choose the background design of your choice. Having done that, you get your photo clicked (handy nowadays due to mobile cameras), add a slogan and hand it over to the designer behind the computer to put it all together. Within 15 minutes or so the designer mixes your picture, the selected background pattern and the slogan text to create a design that will fit on the article that you have selected. After you are satisfied with the design, it is finalized and the design is printed on the article in the store itself. After 30 minutes or so you can walk out of the store with your personalized article.

Do you see now how personalization is being commercialized? Yet you ask, what is so great about it? It looks so straightforward and simple. Let me tell you, it wouldn’t be great if it wasn’t simple. And in hindsight things always look straight forward. But if you apply your mind you will realize that commercialization of personalization requires a mixture of human, structural and relational capital. The human capital is by way of skilled designers who can apply their creative and designing skills to quickly create computer based designs. The structural capital is by way of having computers, a catalog of readymade designs and special transparency printers and embossing machines that can transfer the design to the article at hand. And finally relational capital is by way of having links with suppliers who supply the bland gift articles of the desired quality and of course customers such as yourself who will go out and spread the word once you have experienced delight with this service.

What about price? My experience was that personalized articles are being sold at a price which is at least two to three times the price of the bland article. Can you imagine what that does to the seller’s profit margins? Your guess is as good as mine. The power of personalization is in not only leaving the Customer with a sense of delight but also in doing it in a highly profitable manner.

Franchising – Structural Capital in action

I had the opportunity to visit a franchising exhibition recently where more than 100 different businesses of various types had put up stalls staffed with smartly attired and neatly groomed salespeople trying their best to convince visitors why their franchise business model was the best choice to opt for as a new franchisee. The businesses on hand ranged from education (coaching classes), fashion clothing, food and beverages, jewelry, real estate agencies, healthcare, solar energy, finance and securities, libraries, childcare, coffee shops, etc. While the diversity of businesses present was tremendous, there was a uniform thread running through all of them that had brought them together to that exhibition in the first place – all of these businesses were capable of growing through the franchisee route. Franchising as a business model is hugely popular and successful especially in the retail world. Next time you have a value meal at McDonald’s realize that you are actually at a franchise of McDonald’s and not at a Company owned Store. If you still have doubts, look at the top of your receipt and you will read the name of the franchisee that is actually operating that particular McDonalds location. It is estimated that more than 50% of all retail sales in the US and one third of all retail sales in the UK come from franchises. Such is the reach and penetration of this model.

Franchising in its simplest form is an arrangement in which the owner of a product, process or service (franchisor) licenses the distribution of these products by someone else (franchisee) in the name of the franchisor in exchange for royalty income. The franchisee brings physical and financial capital to the relationship in the form of location space and cash, while the franchisor provides the know-how of the products and services and the process of selling them. Franchising is therefore an instance where the monetization of intangible assets of the business (in this case, of the franchisor) is easily demonstrated.

The question however is why do franchisors opt for franchising instead of opting for the traditional route of opening company owned stores? Aren’t they giving up some of their profits to the franchisee in the process? Indeed they are, but they are also avoiding the risk of opening a store in a new location when they do not have knowledge of the local business climate. Secondly, they avoid bloating their own employee rolls since the staff at the new location belongs on the roster of the franchise. Finally by opting for the franchise route they convert the need for capital expenditure for opening a company owned store into capital income by way of franchise agreement fees from the franchisee. Isn’t that terrific?

The next question that arises then is that if franchising is such an inviting proposition, what are the key drivers for its success? What are the critical success factors for this model to be successful? The answer to that question in simple words is Structural Capital, in this case the franchisor’s Structural Capital. This has to be developed to such an existence that it can be leveraged in far-away locations without too much of an additional effort on the franchisor. Let’s take an example. Suppose you have decided to open a coffee cafe franchise in your neighborhood because you can feel the business potential for just such a café. You have also identified the franchisor and have signed the franchise agreement and paid the initial fees. This is when the franchisor’s work begins. Based on the size of your shop, the franchisor has to provide you the interior décor plan and organize to have the décor made to specifications including the all important front signage. The signage by the way reflects the franchisor’s brand which itself is a significant portion of its structural capital. Brand building is a long term and capital intensive process. Suffice it to say that a well known brand is highly critical to the success of the franchising model. Next, the franchisor has to provide your café with bean crushing and coffee dispensing machines. Cash registers are next, loaded hopefully with Point of Sale software that connects directly to the franchisor’s central database everyday for sales data updates. Next, the franchisor has to give you access to his ordering system, either phone or web based, using which you can re-order supplies like cups, spoons, stirrers, etc. and maintain your minimum inventory levels. In order to deliver your orders, the franchisor has to update its delivery schedules and processes to include you in the loop. Once you have started your café, the franchisor has to keep track of your daily sales in its central database and invoice you for supplies and royalty income on a monthly basis. If your coffee dispensers develop any type of snag the franchisor has to be able to dispatch technicians to your location as soon as possible. This is the scenario for a simple coffee café. Multiple products/services create more demands on the structural capital of the franchisor. However one thing is clear, the structural capital has to be automated as much as possible in order to accommodate increasing volumes. Structural Capital riding on human hands is a sure sign of non-scalability and hence failure of the franchise model.

In summary, franchising is a very mature business model which has been used successfully the world over by many businesses, especially in the Retail sector, to grow their businesses very quickly. It works because franchise owners are entrepreneurs who are highly interested in their own success unlike store managers whose primary interest is their monthly paycheck. Franchise owners bring local business climate knowledge to the table and they undertake the risk of running the business successfully. A franchisor whose structural capital is automated and scalable has a very good chance of expanding his business through franchising.

Is there a case for Intangible Expense Reporting?

I had recently blogged about the need for publicly listed firms to embrace IC Reporting as a tool for providing their current and prospective investors with more incisive information about their business. A handful of businesses around the world have already adopted this practice but the vast majority is yet to start, perhaps they are awaiting industry or regulatory guidance in this matter. Meanwhile there is another school of thought among the IC community that suggests that a more practical and less stringent approach would be to have businesses report their expenses incurred on developing intangible assets along with their statement of accounts. The logic behind this suggestion is that businesses already keep track of their operating expenses and capital expenditures. Hence it should not be too difficult to keep track of specific expenses incurred on developing intangible assets. Let’s try and dissect this approach and try to understand its pros and cons.

Let’s set the ground rules first. Let us agree that we are only considering the interest of investors here. There are other stakeholders that could also benefit from an Intangible report on the firm such as employees, suppliers and partners, yet we are not addressing their concerns here because these stakeholders have a direct access to the business through which they can get reliable information about the business that is useful to them. Investors however do not have access to any such direct channels and have to rely solely on the formal communication from the business as the only authoritative source of reliable information about the business.

Next, let us think about what investors are interested in. Very simply they are interested in Return on their Investment or ROI. ROI is the bottom-line interest of every investor. Yet it is not enough for the management to commit a particular ROI to investors which they will accept at face value. Investors also need to see the proof of why their investment in the business will be a multi-bagger.

An astute investor will choose to invest in those industries whose products and services will be in great demand in the coming years. Within that industry, the investor will then choose to invest in that specific firm which is best geared up for catering to the forecasted demand of the industry. Choosing the industry whose products and services will be in demand in the future requires a thorough understanding of the macro-economic environment of the geography where the industry is located. Investors rely on a variety of research reports and other inputs for deciding the industry of their choice. But once an investor has decided on the industry that he wants to invest in, all that remains to be done is choosing the firm that is best equipped to meet the demand for products and services of that industry.

At this point investors will start looking at performance of the various firms in the industry, one at a time. And all they will have for doing so is the published financials of the business. Since investors know that more than 70% of the value of any business is generated by intangible assets, this is what they will try to figure out from the financial statements, but will fall woefully short. Let us assume here for the sake of argument that the published financials for the business also include the expenses specifically made for developing intangible assets. Is this a good assumption? Will this really work in practice? Technically it is very easy for accountants to ‘group’ intangible expenses and publish the same along with their financials. However, let us look this situation from the point of view of the company’s managers, the people who will be responsible for publishing this information in the first place. What is their objective? Clearly they are motivated by making the most amount of operating profit for the business, since that will fetch them the maximum compensation (assuming their compensation is linked to operating profits). And how is operating profit calculated – simply by deducting all operating expenses from all operating income. If managers now have an avenue of categorizing some operating expenses as capital expenses, what do you think they are going to do? They will clearly reduce operating expenses and increase capital expenses, which in turn will directly inflate profits in the current period at the cost of deflating profit in future periods since all capital expenses need to be depreciated in the future. This will directly benefit managers when their performance is reviewed for the current period but it will hurt investors who will be left with reduced profits in the future. A discounted cash flow analysis of the business will show that the value of the business is less now. Therefore what is good for managers will turn out to be not so good for investors. It is exactly this behavior of managers that is curbed by accounting guidelines that have strict rules for determining the expenses that can be capitalized in the statement of accounts.

The above argument against reporting of expenses incurred on intangibles is in the best case – that is when all such expenses are actually incurred on developing intangible assets. However, since accounting principles in this matter are not yet evolved, frivolous practices may soon kick in around expenses that center on the ‘grey’ area. For instance, all or part of employee wages may be shown as expenses incurred on developing human capital. Expenses incurred on annual maintenance of information technology assets such as computers, video conferencing equipment, etc. may be shown as expenses incurred on developing structural capital. And routine expenses incurred by salespeople for soliciting customers may be shown as expenses on developing customer capital. These and other such ‘creative’ accounting practices will flourish to the point where operating expenses will be negligible. Is this a desirable state? You may say it is desirable for managers but investors will be worse off than they are now.

The conclusion I am arriving at therefore is that whereas the suggestion for reporting of intangible expenses is a noble thought, in practice it will only lead to obfuscation, deceit and chicanery. Instead what we need is an Intellectual Capital Report of the business that is drafted by an independent IC professional. This report should be published along with the statement of accounts and it should be audited by external IC professionals in the same manner that the accounting statements are audited by external accounting professionals.

I invite fellow IC professionals to submit their own point of view to this discussion.

Packaging – Relational Capital in action

Of the three components of Intellectual Capital - Human, Structural and Relational – it is most difficult perhaps to understand the contribution and value of Relational Capital in real life. I decided therefore to focus this week on the one industry that contributes immensely, entirely and solely to the Relational Capital of its Customers. I am referring here to the multi-billion dollar packaging industry dominated by players such as Tetra Pak, Alcan Packaging, Crown Holdings, Alcoa, Amcor, Rexam, etc. 

The importance of packaging is critical to the successful selling of any product, especially in the Retail sector. New product launches especially benefit from an attractively designed package that clearly engraves the value of the product in the minds of the consumer. Initial sales of such products are driven by the attractiveness of the package (and also the price) while repeat sales depend on other product attributes such as quality, durability, reliability, satisfaction, etc. Next time you visit your local grocery store or a nearby shopping mall, try and find new product launches and then take a probing look at the packaging around the product. Compare that package to that of existing products in the same category and you will soon realize what I am talking about.

Packaging is an art, although over the years savvy marketing professionals have detailed it down to a science. Many a time, the package has nothing inherently to do with the product per se, but is designed solely to convey a positive impression and familiarity on the mind of the buyer. For e.g. have you ever wondered why products targeted for kids invariably have cartoon characters depicted on the package? I am quite sure that Mickey, Mini and Goofy have sold more toys, school supplies and snack items than Walt Disney could have ever imagined in his wildest dreams! Yet there is rationale behind this approach. Since the product package is a very tangible item, marketers leverage the physical properties of the package in order to draw the attention of buyers. These include color, shape, size and convenience among other things. Many different rules have evolved in this regard based on the conditioning of the human psyche. For instance, black implies luxury, brown conveys an earthy feel, green projects nature and freshness, sky blue implies purity, etc. The size of the package is determined by consumption patterns – this explains why cola cans have a capacity of 355 ml, a very odd number. The shape of the package is often dictated by optimum storage criteria – this is the reason why even cylindrical or spherical packages like cans and playing balls are aggregated together in rectangular shaped boxes. Finally, the package is often designed to enhance consumer convenience for e.g. fruit drinks packed in tetra-packs have a straw attached to the package and creamy cheese and yogurt packs come with a handy plastic spoon attached to the top.

Lest you get the impression that packaging is relevant only for the retail sector, let me dispel that notion by telling you that nothing could be further from the truth. Packaging is highly important not only to other products but in fact also to services. Consider a software product such as Windows, the Operating System that runs most personal computers on this planet. Microsoft, the maker of Windows, has a virtual monopoly in this category, yet Microsoft invests heavily into improving the User Interface of Windows and releases a newer version of the product every three years or so. The User Interface is the packaging of Windows – it is how you see the product and how you use it and get used to it. Improving it is the only way by which Microsoft can attract you to upgrade your operating system to a newer version every three years and thereby generate new sales on essentially the same product! If Microsoft did not improve the User Interface of Windows, you would have no need to upgrading your operating system, would you? Moving on to services now – let’s take the example of Banking. All banks essentially do the same thing – borrow money at the lowest possible rates, lend it at the highest possible rates and make money on the spread. All banking services therefore fulfill either the borrowing need or the lending need of the bank. Looked at this way, banking is really a commodity service isn’t it? Yet have you noticed how some savvy banks package their services differently. In their bid to attract you (the customer), they pamper you with special privileges such as free debit cards, no annual fee credit cards, gifts at the time of account opening, cash delivered to your home, etc. not to mention exclusive privileges such as private banking and wealth management that are offered only to the choicest few. Similarly airlines, that essentially offer the commodity service of transporting you from point A to point B, ensure your loyalty and your business by packing their service with a loyalty program into which you are enrolled free of cost!

There is no doubt about the huge value that the packaging industry creates. Yet it is a surrogate industry – the tangible packages that the industry develops fulfill the intangible needs of the product manufacturers. The product manufacturer focuses on developing the best quality product at the lowest possible cost whereas the packaging supplier focuses on developing and delivering the packaging concept for the product. This is a great example of how product manufacturers leverage the Relational Capital of their package solution suppliers. The deep relationship between two enables them to work jointly together on the best package for the product. Packaging solution providers are so glued-in on their Customers and their target markets that they themselves invest heavily into developing newer packaging materials such as recyclable and biodegradable materials that are in demand by end consumers. In the process they generate a steady quantum of value add for their Customers which looked at from the perspective of the product manufacturers is really nothing but Relational Capital.