Correlating “As A Service” with ROIC and Shareholder Value

My thesis for some time has been that the value from adopting progressive “As A Service” operating models – through next-generation outsourcing, subscription-based contracting, and shared services – can be measured through enhanced shareholder value.  But, it’s been an elusive metric to prove.

Does the reduction of capital spend on dedicated assets by partnering with service providers, subscribing to SaaS or BPaaS offerings, and acceleration of Shared Services lead to definitive improvement in the value to shareholders?

I know from conversations with corporate executives that it is a high priority for companies to improve their ROIC.  This is a very tangible metric of strategy and execution.  Furthermore, the Private Equity world grasps this concept intimately – carve-outs are often built to run on SaaS platforms, and new products are almost always designed to be offered on a subscription basis.

To help Alvarez & Marsal be better informed and better positioned to offer clients actionable strategies for ROIC improvement, I commissioned research into the ROIC performance of market leaders in several key industries to identify today’s most promising strategies.

I am sharing a summary of the findings of one industry – US-based Restaurants – to generate further conversation on this topic and gain new insights on what other companies are doing to improve their ROIC. I’d love to hear your feedback.

Here’s what our research told us:

•       Companies with high ROIC outperform those with low ROIC across virtually every financial measure

•       Companies that improve ROIC the fastest post stronger revenue growth, higher margins and greater capital efficiency than competitors

•       High ROIC growth companies can command superior valuations, with investors willing to pay higher prices per share

•       ROIC is gaining more management and Board attention and becoming a greater factor in executive comp

Are unconventional levers – techniques borne through the adoption of “As A Service” principles – driving ROIC improvement?

Our findings led us to a hypothesis that several emerging techniques are helping leading companies improve their ROIC. These unconventional levers represent new and innovative thinking that fundamentally reframes business models, supplier relationships and enabling technology to help companies create substantial advantages. The levers include:

•       Business process as-a-service

•       Leveraged partner and provider networks and partner-based business models 
•       Subscription-based procurement and contracting for services vs. products
•       Expanded enterprise shared services
•       Cloud computing for IT capacity
•       Monetized data incidental to the core business
•       Leveraged social platforms  
•       Enhanced self-service business operations
 
Why are these strategies working over conventional approaches?  I think that conventional ROIC strategies carry limitations and risks. Most companies try to improve ROIC by improving net operating profit after taxes (NOPAT) through revenue enhancement, tax planning and cost-cutting, or by capital reduction, through divestiture or limiting working capital.  But attempts to increase NOPAT may decrease business agility and management flexibility, while reduction in invested capital may disrupt a company’s normal operations.

The emerging ROIC strategies have one thing in common: they use capital redeployment thereby decreasing invested capital by shifting it to outside parties or using new business models with lower capital intensity. As invested capital becomes more efficient, ROIC improves. Capital redeployment strategies are often more effective than conventional strategies in improving NOPAT because management has greater flexibility to manage invested capital and limit the effects of changes on the core business.

We’ve also observed that industries will benefit differently from ROIC improvement. Several industry sectors show an unusually strong correlation between ROIC improvement and strength in other performance indicators. Across the industries we analyzed, this relationship was more pronounced in Restaurants, Apparel, Food Retail, Personal Products and Construction & Farm Equipment. Many other industries, particularly those that are not highly capital-intensive, feature similarly promising opportunities to improve ROIC. I’ve attached a summary of our findings in the Restaurant sector.  

 

The influencers of ROIC improvement are of great interest to me and our A&M clients and I view this initial research as the start of many important management conversations on what is driving ROIC. I welcome your thoughts and opinions and will use this forum to update you as we expand our research.  

Peter

 

IBM-Apple: All About the Services

All About the Services

I was all set to write a piece this week that was fueled by some of the email that I received after last week’s post (Pretenders Beware) about what it really means to be in the Services business.  Many Clients and service providers reacted to my assertion that a singular focus on transactional pricing was perfume on a pig.  That’s not exactly what I wrote, but you get the picture.

This week, I was going to comment on the practical feasibility of established ITO/BPO providers shifting their business model from being Client-focused to being Services-focused.  I’ll save that for next week because it’s still a worthy topic.  And, it’s one for which I anticipate a fair amount of discussion.

So, what preempted me? 

Yikes!  This IBM-Apple venture has the potential to be a world-changing event for the Services industry.  Talk about a poster child for how Social, Mobile, Analytics & Cloud are brought to reality for businesses, this initiative has the potential to accelerate the shift to subscription-based business operations like few others.

This isn’t about Facebook and Farmville.  This is about industrial-class business functionality provisioned on the most agile of mobile devices and backed by the analytics engine of the world’s most prolific developer of information-based services.  I like the ZDnet summary of the deal.

To me, this is a major disruptive move to the ITO/BPO industry.  Look at what the introduction of WorkDay did to the HRO market.  This new venture has the potential to shift corporate applications strategies overnight.  I’ve already spoken with several CIOs who tell me that they are launching studies to understand how this new industry capability might alter their roadmaps.

If there’s a hitch in this venture, it might very well be the capacity of the partners to keep up with demand.  Reports have stated that IBM and Apple have been working for months on the initiative and that more than a hundred industry-focused enterprise apps are on the horizon.  That should prime the pump for adoption.

I am eager to hear more about the commercial model around this offering.  Most of the people I speak with are expecting an experience analogous to iTunes or the Apple AppStore.  If so, the job of the CIO just hit an inflection bump as their business users look to subscribe to business services that take a wildly different form than the legacy models deployed today.

Who would have thought that Big Blue would have the moxie to lead this charge?  The implications to IBM are far-reaching – from sales and marketing, to client relationship management, to market coverage, to commercial models, to channel strategies, etc.

Even more exciting will be the responses that will follow … what new ventures will emerge to compete in the market that is reformed by the gravitational pull of this entrant?  That is the question worth watching be answered.

Personally, I applaud this move as being rocket fuel for the transition to subscription-based business services. 

Peter

Consider the Source

 

Pretenders Beware

There’s a new warning flag flying in the ITO/BPO industry.  If you’re a Client of one of the prominent services providers, I bet you’re hearing the term “transactional pricing” a bit more often than you have in the past.  Let me help to decode this term for you.

Starting with our “point of departure”, it’s quite common for companies to define their outsourcing arrangements as being “staff augmentation” or “offshore labor”.  Both of these terms refer to the convention of “paying for effort” or some similar means of contracting with a third-party to perform a well-defined task using less-expensive resources.

Effort-based contracting isn’t the only type of outsourced arrangement, but it’s more common that most people know.  In fact, for many functional executives in HR, IT, Finance, or Customer Care roles, this is the only form of outsourcing they know.  And, they love it.  It provides the ability to reap the benefits of less-expensive labor without the burden of actually industrializing the work processes. 

If any of this is news to you, there’s a nice description of what you get through out-tasking here.  You can look at your existing “outsourcing” contracts through the lens offered by that definition and determine whether your service provider is truly delivering an outsourced service.

Effort-based contacts often operate through Service Level Agreements (SLAs), so don’t let that fact obscure whether or not the contract is yielding a defined service.  Out-tasking SLAs often relate to time required to fill positions or process transactions that are Client-defined.

With that as context, there seems to be an ever-increasing hum around the shift to outcome-based arrangements as the “point of arrival”.  Sounds good, right?  Outcomes are things that we can measure in terms of value, as opposed to effort-based costs. 

Well, here are a few observations from the real world that might surprise you:

1)     The push for outcome-based contracting comes almost exclusively from the service providers.  Clients who are using out-tasking tend not to initiate the shift to a different form of buying.  Providers, on the other hand, see this as a way to improve their profitability and cement their relationships.  When I ask why Clients aren’t biting on the shift, I am told of two reasons:

a.     Lack of confidence that the incumbent provider can/will bring anything different than the same services under a different packaging; and

b.    Lack of Client management comfort with buying Services that would be implied by contracting for transactional Services.

2)     Transactional Pricing is NOT the end game that Clients are seeking.  Those companies that can see their way towards adopting true subscription-based services (see below), aren’t falling for the offer to convert effort-based work merely through pricing changes.

3)     Subscription-based Services are defining the expectations of progressive buyers.  There are a few straight-forward questions being asked of ITO/BPO service providers who are asking for the opportunity to be paid for outcomes:

a.     How many “subscribers” do you have for this Service?  (This implies that the Service is serving a market, and is not a bespoke solution)

b.    Can I subscribe/unsubscribe to the Service without undue penalty?

c.     Are all aspects of the Service delivery on the provider’s balance sheet (e.g., systems, software, etc.)?

d.    Are there well-defined interfaces between this Service and other enterprise functions/processes?

e.     What is the business case for converting from my legacy mode of operation?

f.     What is the volume-sensitive pricing schedule for this Service?

The sophistication of enterprise buyers – through functional leadership and Supply Chain professionals – to contract via subscription-based models is accelerating dramatically.  Questions like the ones I’ve outlined above are being asked of incumbent providers of effort-based work.  And, they don’t think foremost of their incumbent out-tasking providers for this sort of relationship.
It’s not acceptable for an incumbent service provider to merely offer “transactional pricing” in response to these new expectations. 

So, beware of the term “transactional pricing” as this is hardly sufficient to win in the “as a service” economy.

Peter

Consider the Source

The CFO Mandate

A recent article in Information Week struck a nerve with me.  It touches upon the common disconnect between the IT organization and the CFO around business requirements, the tendency to sustain addiction to heavy-handed ERP platforms, and the frustration at the time/cost to drive change through legacy processes and the systems that enable those processes.

The article was written by a reputable BPO services provider and promotes the virtuous claim that “process-based design and transformation can harness the newest technology for what matters, thoroughly utilizing process analytics and focusing on how business process (and the related human factor) drives the desired business outcomes”.

Well, I’ve had the privilege of being in a fair number of conversations with CFOs recently on this topic.  I am encouraged by the awareness that most bring to the table – they know that there are better mouse traps being invented with great pace.

The impact that WorkDay has brought to the HR function is an easy example.  Similarly, there are analytics tools and process engines for the Finance, Supply Chain, Procurement, and Planning functions that yield great promise.

The questions that I hear most often don’t relate to the availability of clever new applications to automate work.  Instead, they relate to the implications around leadership.  How is the CFO meant to provide the guardrails and ambition to enable the organization to break from the comfort zone of legacy ways of doing things?

I’ve been answering these questions with a playbook for the Finance function. 

1)     Don’t Assume.  The frame of thinking that worked in the past may not be suited to the new market dynamics of subscription-based business support functions.

2)     Think Subscribe.  No longer is it acceptable to build/operate a proprietary solution.  There’s almost always a market option to consider.

3)     No Victims.  The transformation implied here takes time … and deliberation.  Delaying only perpetuates the risk of being held hostage to the legacy.

4)     ROIC Rules.  Yes, cash is important, but the ultimate measure of leadership is the return delivered to shareholders from prudent investments.  Run the business through the P&L, not the balance sheet.

5)     New Friends. Finance leaders need to enlist many different competencies to conceive and enable new operating models.

6)     Time to Results.  It’s self-evident, but we live in times of immediate gratification.  The competition is moving fast, so urgency is the name of the game.

The mantra of Capital Utilization, Operating Agility, and Growth now dominates the halls of Finance.  Pretty nice contrast to the past 5+ years of cost-cutting to survive.

Peter