Monday, May 5, 2008

When Numbers Don't Tell the Truth - But You Pretend They Do

I wonder at the logic of some executive decisions.

  • Q: Why would otherwise intelligent executives spend a dollar to save a dime?

  • A: Because they don't realize that they are.

They've been doing it ever since they learned to manage by financials.

If you consider what happens when business people start to think like financial people, it will make sense why. Financial people manage by manipulating line items on financial statements.

Here's the logic. Decrease an entry = reduce a cost.

All is proper. All is true. All is right. Manage by the numbers, and numbers don't lie - that is, unless you won't honestly look at all the numbers.

It's the age old, mythical discussion of "hard" costs vs. "soft" costs. And, this thinking is costing you money.

  • Lie: Hard costs are real costs. Soft costs aren't.

  • Truth: If money goes out, it is real.

There are no such thing as "soft" costs, only costs that cannot be connected to invoices, with corresponding line items on financial statements. As I said, if money goes out, there is a real, "hard" cost, even if you have trouble accounting for it.

The Health Insurance "Shop and Change" Model

Here's the real case of a 35 person company I worked with recently. It's the same strategy followed by countless companies, every day, all across the fruited plain.

The owner/operator is a prosperous fellow in his mid 40s. He manages by financials. He didn't like the 12% increase in his health insurance premium he was given upon renewal. It would increase a line item on his P & L. It would reduce his profits.

So, in accordance with his "mechanical" model, he had already fixed things. He had already followed the very same tried and true method he always used to handle any cost increases he faced. He shopped. He needed and got a better number for his financials.

Good strategy? Appropriate accounting? Not really.

My friend needed a lesson in real math, a lesson in real expenses, a lesson in accurately assessing the cost of anything. You see, his methodology makes financial sense unless the change causes the company to "spend more money" making the change than the change nets.

In his case, as in many others, it did. He just hadn't really looked.

Where Else do Costs Exist?

Here is the typical dynamic at work for most companies in their effort to manage the cost for employee health benefits. You'll recognize it. It is part of a cycle that goes something like this:

  • Set expectations based on rumors, news reports, comments by insurance people calling, wanting to “give you a quote”.
  • Become anxious about an approaching renewal date.
  • Get your renewal. It is usually "too high."
  • Listen to explanations, justifications, and excuses from your agent.
  • Go out for other quotes.
  • Shop plans, and plans, and more plans.
  • Set up spreadsheets.
  • Compare apples to apples. (Which cannot be done.)
  • Make the difficult decision to change.
  • Hold employee transition meetings.
  • Answer many questions. What? Why? Oh my?
  • Adjust, breath a sigh of relief if nobody quits, and pretend that you’ve done something good, something right, something necessary.
  • Begin the entire process all over again in 9 months.

You know the drill. So did my friend. He'd done it countless times before.

The problem was that he wasn't accounting for all his real costs. He never accounted for:

  • Cost of the distraction, the loss of his executive focus.
  • Cost of meetings with brokers and subordinates. (He held 6 over the course of 2 months. that is at least $1500 for a leader making $150k/year.)
  • Cost of non strategic use of his mental bandwidth. (Profitable projects needed his brain.)
  • Cost of subordinates time building projection models. (At 6 hours, at least $300, not counting other things that weren't done.)
  • Cost of the 120 minutes each member of the staff spent in direct transition meetings. (That single expense was $5500 for 35 employees averaging $45k/year.)
  • Cost for the breakdown and rebuilding of employee confidence that accompanies any change to benefits. (Employees talk among themselves and spend countless hours doing their own comparisons while at work. Let's be conservative and give each employee only 1/2 hour of wasted time. Cost: $1500.)

So, this corporate leader cost his company a minimum of $8800 to make the transition.

What Did it Get Him?

For all of his efforts, he was able to moderate the 12% increase ($15k) to 6% ($7.5k). He reduced a line item on his financial statements. He could report this "success" to the board.

However, the real bottom line reflected something completely different.

When you spend $8800 to save $7500, no matter how you do the math, you lose $1300. And that's only counting the actual labor dollars he could actually identify. Guaranteed, the losses are far greater if he were to account or any loss of attention, or loyalty, or goodwill, or whatever else he had the guts to consider.

Upon closer discovery, with the courage to be honest, my friend discovered that his real costs surpassed the financial savings he anticipated, and reported, in the change. – This means he, and his company, lost money making the change. He spent a dollar to save a dime.

Numbers really don't lie. They just don't have a chance to be accurate when the real variables aren't included in the equation.

Get smart. Count the real cost of your "cost saving" measures. Otherwise, you won't really be saving any money at all.

You might even save your way right into bankruptcy.

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