How many times has a member of your management team, or a valued worker, come to you with a “great new idea” to help the company get better at something – a new machine that will shorten processing time, a new software service that will help you sell more products or services, or cut the cost of whatever? How many times has it delivered the promised results and been the best use of the money? And of course the idea is always presented with enthusiasm and reasons why it’s a great idea.
“Almost always” would be a phenomenal answer – and hard to believe. “Most of the time” would be a tribute to your team’s expertise and your leadership. “Almost never” would be a problem, and “I really don’t know” is a BIG problem, and the subject of this post.
Leaders can often see if a change delivers on its promise of doing something better. Processing time indeed shortened, sales indeed went up, etc. The second part is the tough one – was it the best use of the money? Very often ideas get implemented in the excitement of seeing improvements without taking stock of the total cost across the organization and comparing that with the net income improvement produced by the new shiny thing.
- How much did it really contribute to the company’s bottom line?
- How did its net profit improvement compare with a different idea that would have required the same amount of capital needed to carry out the idea you adopted?
The part of the decision making process that typically gets overlooked is the analysis that answers those questions. Of course if there is something that’s critically broken that must be fixed now, there’s no real opportunity for that hard look. You’ve got to fix it now. Understood. But let’s be honest: most of the time that’s not the case.
You see, there’s always a good reason to spend money. The question that’s harder to answer, given we all have limited resources, is the one that asks: Is this the BEST use of our money at this time, and down the road? Taking the time to do the analysis and answer that question, before giving the go-ahead, can be frustrating to the avid proponent of the great idea, but essential in doing what is best for the company.
Tools that are available to answer that question – besides reining in the boundless enthusiasm that you don’t want to discourage – include:
- having your finance team calculate the Internal Rate of Return (see our post of October 22), based on the real Contribution Profit expected (see our post of September 3),
- comparing it with what can’t be done elsewhere if the money is spent here and now,
- determining if this supports the long term direction of the company (as outlined in your strategic plan, of course), and
- assessing the likelihood that your management team can utilize the full effectiveness of the new idea, an assumption likely adopted without challenge by the presenter of the idea.
Your job as the leader of the team is to resist the urge to jump on the bandwagon until the idea has been fully vetted using the options list above. That’s how you build a great company.
Gene, I find your blog the best thing I read on a regular basis! Keep it up.
In the nit-pick department, my personal view is that NPV is better than IRR. I am the Lone Ranger on this next point: When Kaplan invented discounted cash flow methodology, he did it for capital budgeting reasons. So comparing two mutually exclusive opportunities (which you do) is a valid application. Running NPV or IRR on a single project is probably an invalid use (in my opinion) because the geometrically compounding error in the discount rate does not get cancelled out by the same error in the alternative project. I have seen Anderson School MBAs misapply discounted cash flow methodology.
I totally agree, Ramon. Perhaps the subject of a future post. Thanks for your thoughts.