NexGen Advisors

NexGen Advisors: Point of View

My doctor recently notified me that she will not be accepting my insurance carrier, due to the burdensome policies, processes and procedures it requires of doctors. My doctor is completely automated, with a website for making appointments, getting test results, etc. It seems to have become too labor intensive and expensive for her to accept its customers. The same thing occurred with my sister, who was being treated for Lyme Disease, and had to switch doctors midstream, because her doctor said her insurance was too cumbersome and difficult to deal with. Yet, even with inefficient processes, both doctors and healthcare companies continue to be profitable. Imagine how much less insurance could cost if insurers were efficient and easy to do business with. But, efficiency can be expensive, usually requiring investment in technology and process improvements, which would eat into profits.

For someone like me, who has been performing business process improvement for 20 years at some of the largest companies in the world and managed corporate benefits at a Fortune 5 company, the thought that insurers and the government are not focusing first on improved efficiency to lower health care costs, is problematic. Issues related to efficiency have always been the main drivers for customer dissatisfaction and increased internal costs at the Fortune 5 company and nothing has changed. We must first fix the internal systemic issues within the current healthcare system, before making drastic changes and adding programs for a new system. The administration is basically throwing more problems on top of an already broken process. The best approach the government could take is to build a multigenerational plan that includes identification of root cause issues within the current system using tools that will point to areas that must be fixed first to ensure that no downstream issues occur. Once the process and system requirements have been identified and fixed, then the government can begin to integrate new policies and required system changes.

The government appears to be tackling the issue of healthcare without the necessary preparation, which is a reckless move. I have heard “what” they plan on changing, but not “how” - the most crucial piece. As with most things, preparation is 80%, execution is 20%. Preparing for the new policies to take effect will be the most important part of this plan, and getting the systems and processes “prepared” to manage the changes is key. To do this, the healthcare changes and processes that will be impacted must be broken down into manageable parts. From there, root cause issues can be identified through detailed analyses, allowing issues to be fixed correctly the first time around. When you don’t fix root causes, the same problem occurs over and over, because the real problem is an upstream defect hiding in a defective downstream.

Some changes may appear small and easy to implement. However, something that seems easy, like forcing insurers to cover hospital stays, prescriptions and maternity care, is not as simple as changing a few rules in the system. Changes to the entire healthcare lifecycle are necessary for patients to use the benefits and for claims to be paid correctly.

Implementing a change like universal coverage is a daunting task. For something like universal coverage to work, the same processes and systems used in a country such as the Netherlands would need to be implemented. In the Netherlands, there is one system that all providers (doctors, hospitals, etc) and insurers use, with standardized, generic codes for treatment and price. This type of healthcare system works because everyone is covered under the same benefits, and there is one point of entry into the process through a primary care provider (PCP). A patient cannot go to the hospital except for extreme emergencies. Most PCP’s have the training to perform outpatient procedures, so the need to go to the emergency room is limited. The entire lifecycle of a patient from doctor identification to claims payment works because a well-thought out process was developed first. In this model, systems were secondary and were programmed to support the process - not the other way around.

The US doesn’t have the same luxury as the Netherlands when it comes to healthcare processes and systems because Medicare, Medicaid and insurers already have systems in existence. The complexity of changing all these systems based on new policies without the time to lay out a plan of attack for potential implementation issues that could arise will result in havoc, most-likely causing significant system errors that will impact end customers. It is impossible to identify just how much time patients, doctors and insurers would waste, let alone the significant amount of money that will need to be invested to fix all the issues that will arise.
To demonstrate the complexity of these issues, significant policy changes would be required to implement an expanded Medicare program to cover the poorest individuals and families, subsidies to help people forced to buy private plans that they can’t afford, out-of-pocket caps and preventative care programs. The implementation of these changes would entail significant system enhancements to current systems, or even possibly a new system altogether, not to mention the integration needed with all the other programs that exist under the proposed healthcare bill umbrella. Along with policy changes, you must change processes and procedures. They would have to be changed and documented, and employees would require training related to the new systems, policies and procedures. I wonder if anyone in Obama’s administration has the project plan and understands the cost this will incur? I bet not.

Finally, metrics would need to be implemented to ensure the processes and systems are running efficiently and effectively. A project of this size at a public company would take 8-12 months alone just to identify the root cause issues in the current systems and to identify opportunities for improvement. The actual improvements themselves could take years, and required process and technical experts to help with the analysis and implementation. Yet, our government is rushing to get all issues identified and fixed in just a few months, and from where I can see, without help from outside experts, there will be significant time and money wasted. And the paying “customer” will feel the brunt of it all.

Additionally, there is the discussion of who will manage and oversee this new healthcare system. What is the most efficient organization to control costs? When we think about outsourcing, we think about public and private companies moving non-core activities to suppliers that perform those functions at a lower cost. Representative Richard Neal complained that President Obama and Congress were “outsourcing congressional responsibility” for the oversight of the new health care system. Most business people would say outsourcing is great, assuming it is outsourced to a private company that does this type of work as their core business activities and has best practices and systems in place to make it the most efficient it can be. However, the proposal on the table calls for another government organization to manage a large and complicated process, and the outcome will be dismal. This requires expertise, thought leadership and a strong leader to drive the program and to achieve successful results. Without these three items, it will take tens of years and billions of taxpayer dollars.

In the end, it is not just about the policy changes that would be put into affect if the health care bill is approved, but it is also imperative to evaluate the processes they are using to identify issues and resolve issues, and the implementation plans on how to fix them. This is not just critical, but paramount to ensure continuity for the millions of Americans who already have insurance and the new customers that will be accessing the system through other programs. I hope Obama’s team knows what they are doing. If not, hire an expert that does….and I don’t mean another politician or financial advisor.

A broad range of industries are suffering through one of the worst economic crises America has ever seen and the Small Tools industry in the Industrial Goods Sector is no exception. But how these companies are performing today goes back to decisions they made in 4Q07 and 1Q08, many of which predate the official start of the recession. If they had a business strategy and plan that focused on innovation they may have had a better chance of survival without the need to take drastic measures like plant closings, headcount reductions, base pay cuts, 401K matching suspension and incentive pay cuts.

Although these tactics can deliver short term relief, having the right products that customers want, is the only way to deliver long term benefits and sustainability. All companies should be focused on innovation, no matter what the economic outlook. If you get it right, success will follow as it is the foundation of any viable business model. If you get it wrong, the result can be catastrophic for your business, resulting in excess inventory and lost market share…but not doing it at all or only making small changes to standard products is not an option. This is exactly what happened to some of the companies that make up the Small Tools industry.

Innovation is the most important core activity your company performs, especially if you are operating in a mature market. If Innovation isn’t something you do well, you will travel a long, hard road, and may never become a market leader. You must have innovative products and services that customers want to buy. Cutting-back on R&D during a downturn could spell disaster when the market recovers.

Companies like Snap On are putting their money where their mouth is, building a new Innovation Works Facility that will be at the forefront of new technology development and customer interaction. Without customer feedback, companies cannot develop the type of products that will sell in the marketplace. Snap On is breaking records with their MG 325 Power Tool even in a down market because they listened to their customers’ needs: a longer life, smaller, lighter and faster. Makita’s Lithium Ion Battery Products are another exceptional example of innovation based on customer’s wants and needs. Their hand tools have more power, less weight, and are more compact and efficient.

Toro met the needs of its’ customers by listening to their complaints, then creating a product that met both of their needs. The end consumer wanted to outsource the tedious task of mowing their lawns, but at an affordable price, while commercial customers complained that typical push behind mowers took too long to mow a standard sized lawn. Using the innovation process, Toro rethought the entire way lawns are mowed, with their Grand Stand Mower, which allows the individual to stand on the back of a larger, faster mower. It allows contractors to substantially increase the volume of lawns they can mow, increasing their efficiency which has been passed on to end consumers in the form of lower prices. What once was affordable only to the elite, has now become a low cost service offering available to a larger market. It allowed the average American to add more time to their day, and from the consumer’s perspective, the time gained outweighs the cost. This is example of innovation at its best!

Innovation alone is a necessity, but combined with a strong presence in Emerging Markets is the best option for Small Tools manufacturers. It’s not surprising that companies with a large sales forces and manufacturing facilities in Emerging Markets (i.e. Danaher, Makita and Snap On) are riding the market decline better than those focused solely on North America and Western Europe. Companies must be diversified to weather the storm and continue to grow. Continuing to focus on mature markets can be a successful business strategy, if you are developing new products and you have instituted Lean or Six Sigma into your manufacturing processes to remain cost effective and efficient. If however you are only updating standard models while focusing on mature markets, even with a good quality program, your growth potential will be small.

Countries like India, China and Eastern Europe are key Emerging Markets for both sales and manufacturing, so it is surprising that companies are taking baby steps instead of huge strides to enter those markets. Some are growing their market share through acquisitions, like Snap On which purchased Zhejiang Wanda Tools in China, and some, like Makita are doing it organically through the expansion of sales offices and manufacturing capability in that region. Either way, a business plan that includes Emerging Markets in conjunction with innovative products is critical to long term success.

Operating in today’s environment isn’t easy, but taking the right steps now can prepare any company for a rebound when the economy recovers. It sounds simple, but as we have seen, if you get it wrong, it causes drastic measures which puts you one step behind the competition.

When the economy is good, grocery stores profit. When the economy is bad, grocery stores profit…well some of them that it is. Nothing is a better barometer of consumer spending than grocery stores. And nothing gives us a view into the average American household than the stores consumers flock to, in order to get something they cannot live without: Food. It is something we should pay close attention to when gauging the end of the recession. With the economy still an issue for most households, it’s not surprising that a recent survey by the National Grocers Association Consumer Survey Panel indicates that “low prices are considered a very important factor in choosing a supermarket”. A New York Times article conveying the results of a recent survey on July 8, 2008, states that 20% of shoppers switched to cheaper stores due to current environment. Proof positive is that Wal-Mart is now the #1 seller of groceries in the U.S. But some grocery stores are fighting back and winning share. Unfortunately at the expense of specialty grocers.

The decrease in shoppers and revenue at specialty grocers, like Whole Foods is no surprise, but the issue is that it took so long for Whole Food to react to the negative environment and they are paying for it now. When the economy went into a tailspin at the end of 2007, a plan of attack should have been executed immediately, and we saw this with many grocery chains. But some waited, like Whole Foods, whose plan wasn’t executed until 5 months later in May of 2008. Expecting customers to be loyal to you is risky and misguided during a time of financial uncertainty, especially when it involves “commodity” products like groceries. Sure, a small devout following will remain and continue to pay higher prices, but without incentives, promotions and lower prices, market share is certain to be lost. With SG&A as a percentage of revenue more than 10% higher than their competitors, Whole Foods has no room to falter. Spending time and money on technology that does not directly benefit sales, like creating and managing Facebook and Twitter, which Whole Foods says is for the customer, but is something that holds no true value to them. As mentioned above, price is all that matters right now. The good news is Whole Foods has instituted aggressive pricing and promotions, and made available private label products that meet customer’s needs, but at a reduced price.

Private label products overall have been a windfall for all grocery stores that sell them, especially Kroger. Sales have increased 4.4% yr. over yr., in large part due to the 14,000 private label products which make up 27% of all sales. Kroger private label brands are produced in their own manufacturing facilities dairies and bakeries, resulting in the lowest SG&A as a percentage of revenue (18%) than any of their competitors. All cost savings recognized through procurement or manufacturing innovation, go right back into lower pricing of their products. Private label products combined with the Kroger Frequent Buyer Card (can sign up for free) and other special promotions create a proposition value most families cannot ignore. A variety of products including organic, and low prices are just two of the elements that make up the “Customer First” business strategy Kroger has implemented, allowing them to gain market share from their competitors. This puts them in a great position to weather the downturn in the economy and see continued growth in a recovery. As with most customers, if you can get them to switch over to your brand, they are likely to stay as long as nothing in the product or price drastically changes.

SUPERVALU stores, which include Dominick’s and Harris Teeter to name a couple, also use private label brands to boost sales. With almost 3000 products, they have seen an increase in penetration of 21.8%. This allows them to keep their SG&A as a percentage of revenue in the 19%, excluding restructuring and litigation charges, but even with those included they still retain a respectable 21%. And the restructuring charges are actually related to customer centric and store remodels that are intended to attract and retain customers, which must be working because their customer service scores are increasing even in this tough environment.

Even Safeway is remodeling, focused on a Lifestyle Format that is meant to create a warm ambiance, inviting décor and stations to meets the needs of a broad range of customers with sushi, olive bars, etc. The remodels have cause their SG&A as a percentage of revenue to be one of the highest amongst their competitors at 25%, but sales are up 3.4% yr. over yr., in large part to their private label products. Self manufacturing generics is a key focus for them, as well as promoting generic pharmaceuticals, since their Cost of Goods Sold is lower than the branded products. Significant cost reductions are already in place with 50% of them locked in and completed as of 1Q09. An important component of the cost reduction effort is the re-organization of their product control, occurring at the national level instead of the regional level.

For an industry like grocery stores, where most of the products are commodities, it is the ones that really listen to the needs of their customers that will outshine all the others. In this economy, it is all about price, so if you can keep your expenses down and pass on the savings to your customers, you will be able to capture market share and increase sales. While an inviting atmosphere is also important to customers, the fact that Wal-Mart is the number one seller of groceries in the U.S., points clearly to the most important customer need…lower prices!

As U.S. car companies continue to struggle, I can’t help but wonder why it appears so difficult to understand what went wrong, when it seems pretty straight forward to me. Either people are over complicating the situation or I am over simplifying the issues. If the saying is true, that the way to solve problems is to simplify the issues, then here is my best attempt. Some, not all, of the US automakers have a flawed innovation and R&D process that needs to be completely revamped. They can manipulate the numbers and conduct financial restructuring all they want, but until they change their process, they will continue to struggle.

For the purpose of this point of view, I will NOT be discussing debt structures, loan defaults, and financial restructuring, because all it does is provide short term relief. It’s like taking Advil for an inflamed joint, it only temporarily covers the symptoms, when a cortisone shot is what is really needed to end the swelling once and for all. I will also not address unions or workforce issues because the problems begin long before they come into the picture. I will be discussing what I believe is the root cause of the issues the US automakers are facing. It starts with the right business processes and focus to drive innovation and growth….something GM and Chrysler have been unable to do. Let’s look at three areas that tell the story of the decline of the US Auto Industry: Innovation, R&D and Leadership.

Innovation starts with understanding the market…your current customers and future customers. In general, the US automakers have had a hard time differentiating themselves and creating a value proposition that the market trusts and wants. Think about brands like Mercedes, Volvo and Toyota…most people can tell you what their brand value proposition is. Mercedes = luxury and comfort, Volvo = security, Toyota = reliability….what is GM’s? Or Chrysler? Frankly I can’t tell you, Nor can I understand why anyone would buy one of their cars. This is where Ford differs. They have created a brand and tag line that people know. I have never been in a Ford showroom, and I don’t know many of their brands, but I know what a Ford Taurus and Focus is and I know the slogan, “Ford Built Tough” from their truck commercials.

So how do the US automakers stack up in the area of Innovation? Well, if we look at the hybrid market, it’s clear that Asia has the lead, with the US far behind. When thinking about the hybrid market, who comes to mind? Toyota’s Prius, who as of May 18, 2009, had over 80,000 orders. And the only real competitor is Honda’s Insight whose goal “is to make the best use of the most cost-effective hybrid technology”. That means a 40-mpg+ compact car for less than $20,000—a figure designed to undercut the least expensive Toyota Prius by about $2,000.” The GM’s Chevrolet Volt excited the hybrid world when it was showcased at the January 2007 Detroit Auto Show, but has been unable to make it to market, and won’t until 2010. By then Toyota and Honda will have a hold on that customer segment and as I said earlier, and the US will be playing catch up. While Toyota and Honda range between $19,000 - $22,000, the US automakers start at $27,000. Why would anyone spend more for a US hybrid, when the others are proven entities?

Chrysler is way off the mark. They have lots of hybrids, but they are not practical, small, or energy efficient vehicles. “The 2009 Cadillac Escalade 4WD Hybrid is 17 feet long, weighs almost 3 tons, costs $73,000, and gets about 20 miles per gallon. That’s not what most people think of when
they hear “hybrid.” Who are they designing for? “The hybrid market is going to be one of the fastest-growing segments in the world” said JPMorgan Securities auto analyst Takaki Nakanishi, yet the U.S. Automaker’s are lagging behind. It is anticipated that 9.9 million hybrid vehicles will be on the road by 2018. Simply put, the US automakers innovation processes are slow, and hinder their ability to become a market leader.

If innovation is the means to increased market share and revenue growth, then R&D is the enabler to drive the growth through new products and services. But how much R&D spend is right, and what should it be spent on? Chrysler has EVNI, an in-house organization formed to focus on electric-drive vehicles and related technologies. Just the term in-house scares me. It cultivates “groupthink” and fosters a siloed structure that makes it difficult for ideas to penetrate the system. The fact that some of the money used from the government will be allocated to the EVNI group is quite disturbing. Consider, R&D and new product development was cut in 2007 in an effort to reduce costs, and they are paying for it as the one US automaker with the smallest number of new cars In their lineup. And so Fiat gets a 35% stake for brining small, efficient cars to Chrysler’s lineup, along with technology. Shouldn’t they be responsible for their own R&D costs? Ford didn’t ask for money, they will fund their R&D on their own. Doesn’t that give Chrysler an advantage over their competitors?

On the other extreme is GM, who were the ground breakers with the first R&D center for Automotive in the US in 1920. Currently, with eight labs, several science offices and relationships in twelve countries with universities, governments and other partners, they sound more like a pharma company to me. Now, I know auto making is more difficult than it appears, but is it so important in our everyday lives that they need to spend so much money on labs and science offices? I mean, if one of their car brands disappeared, it wouldn’t change my life.
GM will spend $9 million on the Institute of Automotive Research and Education. Its’ goal is to have engineering students from the University of Michigan study combustion engines, battery technology and electrician-vehicle manufacturing, in the hopes of hiring them out of school. They already have a similar institutes in China that cost $250M, and are planning one in Italy…but why? What is the ROI on this? Is there proof that this program works? Aren’t there experienced engineers from other industries that already have the skills, competencies, and experience that can hit the ground running for a fraction of the investment?

Ford has the biggest budget for R&D of any of the Automomakers, and is second in the world only to Pfizer on R&D spend. That is pretty amazing when you think about it. I guess the biggest question is how much R&D spend will result in profitable revenue. “A closer look at R&D spending by both OEMs and suppliers shows that around 40 percent of all investment go into innovations that never make it into the car or are never produced in sufficient numbers due to a lack of market acceptance. Of the remaining 60 percent, 20 percent is for necessary serial development. Another 20 percent is for innovations that fulfill legal requirements but do not add to the product’s distinctiveness. Usually, these innovations do not pay off either. That leaves only a small remainder of 20 percent that represents profitable innovation investment.”

So the question of “how much” and “on what” comes back to their Innovation and R&D processes. They should focus R&D efforts on what they do well, and get rid of the projects and initiatives that don’t link tightly with their vision. Trying to breakthrough a market with costly innovations will not be a profitable endeavor if you’re late to the game. .

The final area that has impact on the automakers is Leadership. It is very telling to look at the tenure of executives at GM, Chrysler and Ford, but the results were as expected. Most have been in one industry, and with the same company for decades. 50% of Chrysler’s leadership have been with the company for over 20 yrs. Yes, they brought in Press from Toyota in 2007, but that was too late. GM has even more tenure, with 75% of their leadership having an average tenure of 25+ yrs. Ford on the other hand, brought in three key leaders in the last 10 years, including the top job, and they are generating a new way of thinking. If you go to their website, and look under “Our Plan and Progress Review”, you will clearly see how they intend to accomplish their mission through four simple goals. They state very simply that they are headed in a new direction and are focused on conducting business differently than in the past. Obviously a new mindset , and driven from the top.

This is not to say that the executives from GM and Chrysler are not valuable, but innovation requires new ideas from new people. What often occurs with a lack of knowledge from other industries and other companies, is insular thinking, analysis paralysis and concenus decision making. Customer needs and market assessments can become intuitive instead of based on hard data. Fostering innovation by infusing new leaders from multiple industries (i.e. technology), can help leapfrog US automakers to the head of the market.

While not all issues facing US automakers will be solved by addressing innovation, R&D and leadership, it must be the first step for any hope of a positive restructuring and transformation of the industryStatus quo is not an option and as a taxpayer, I am hopeful that the US Auto Industry can turn around and be successful again in the future.