Understand your Business Model

Understand your Business Model

Do you really understand what makes your organisation perform (well or badly)?  How it all hangs together?  What needs to happen.  The interdependencies?  The income generators?   Where the big costs lie?  You might assume that the Board will have a grip on this but typically it’s far from straightforward, especially in complex multi-line or multi-market businesses.

For non-executive directors it may not be obvious or transparent.  They are the recipients of the final, consolidated accounts and business plan but often the picture is too high level or condensed to see what’s going on underneath.  And NEDs don’t benefit from the view that comes from bottom-up budgeting modelling: how it all comes together based on assumptions that often aren’t visible.  Without that view of what really has an impact, they are not in the best position to judge risks or make strategic decisions.   So here are a few suggestions on good practices.   In the main these are points for management as they take explanations to the Board.  But NEDs should think of it in terms of what they need to seek from management to make sure the fundamentals are clear.

Good practices to consider…

Work out how to “tell the story” of the way the business makes its money.  (And before those of you from non-profit organisations stop reading, the same principles apply: where your income comes from and how you spend it.)  As far as possible, use simple graphics to show the flows and to indicate the relative scales and levels of importance.

Things to avoid…

Assuming it’s so simple that it must be clear to everybody.  That’s unlikely to be the case (and, in any case, it will often change over time and there’s always benefit in just checking that long-held assumptions still hold).

Good practices to consider…

Road-test the explanation with the NEDs, maybe at the strategy day or as part of the budget sign off.  At least some of them are likely to be coming to it relatively fresh, with the benefit of new eyes and without having been socialised into looking through the same lenses as management.

Things to avoid…

Thinking that walking through “the obvious” will be a waste of time.  We often hear boards talking about the value of the “stupid” question.  Going step by step through the basic model can give ample opportunity for the Board to kick the tyres of management thinking and assumptions.  The value of the discussion that’s prompted may well be surprising.

Good practices to consider…

Take the explanation down to the next level or two.  That means breaking down the top-level picture into component parts by country, market, product category… whatever view is insightful.  Just don’t overcomplicate it or you’ll get lost in it.

Things to avoid…

Sticking only to the “top level view” because it starts getting complicated as you go further down.  If it’s oversimplified, the insight will be too limited for the Board’s discussion to be useful or for the logic to be tested.

Good practices to consider…

Attach some numbers (big, rounded ones) to the explanation and the graphic.  It will help in maintaining a view of the relative importance and materiality.

Things to avoid…

Using only descriptions that are not supported by measurable indicators and facts.  Adding the numbers introduces discipline and structure to “the story” as well as helping the reader understand the scales and reflect on relative importance.

Good practices to consider…

Tie the picture into the main risks and uncertainties.  That way you can highlight to the Board the possible points of weakness and the interdependencies.  It should also help bring focus to the principal risk list, turning it from something that risks becoming theoretical to one largely tied directly to performance and success.

Things to avoid…

Presenting a picture that assumes stability and predictability.  It won’t work out like that in practice.  So explaining the nature and scale of the uncertainties helps explain the assumptions, possible stresses in the business model, whether inherent or potentially emerging.

Good practices to consider…

Use your collective imagination to identify the things that are being taken for granted.  Which of them are unchangeable facts and which are actually just assumptions that might one day be challenged?

Things to avoid…

Assuming that the “things you don’t even need to think about” will always remain that way.  Just like Northern Rock worked very hard at liquidity management but never considered the possibility that one day global liquidity might just dry up.

Good practices to consider…

Link the flows and drivers to core business processes to bring the model to life.  For example, if it’s a manufacturing process, go from R&D through design to production and customer support; if it’s a service business, from specification of customer needs through to routine delivery.

Things to avoid…

Allowing the “story” or picture to become sterile.  Theoretical models might appeal to some but most of us want to hear about what is happening on the ground and how changes in reality influence the outcomes depicted or predicted on paper.

Good practices to consider…

Explain where the big costs are incurred – the ones that can move the needle.  And where are the greatest sensitivities to changes in external factors and other assumptions.

Things to avoid…

Providing a static picture, rather than giving an indication of where and by how much things could change for reasons both within and outside your control.  Particularly things which might actually bring the business model into question.

Good practices to consider…

Remember to highlight the people angle and the softer influences on success.  This might be hard or even impossible to quantify, but that doesn’t stop it being really important.

Things to avoid…

Reducing the human factor into a number in the model.  Yes, that might reflect the costs or the financial returns on the spend on people.  But it misses a whole crucial area: the business model’s dependency on the way people behave, how we manage to recruit, train, motivate, retain… And what we do if new generations don’t make the same assumptions we do…

Good practices to consider…

Use the board meeting discussion to spot areas where NEDs feel they need more information or training.  And make the explanation of the business model a core part of induction training, to help new directors identify areas they need to know more about.

Things to avoid…

Presenting the model in a way that assumes everyone has perfect knowledge.  If the audience is made to feel awkward at gaps in their knowledge (and NEDs will always have some), it will take a lot longer to get the real value from them.  And good explanations of complex topics take time to give and to absorb, so don’t assume that a quick aside during a discussion will sort everyone out.

Good practices to consider…

Look forward.  Explain to the Board how the proposed strategy will impact the different components of the business model: the revenues, the costs and the risks as well as the returns.

Things to avoid…

Talking about today’s business model but forgetting that the Board needs to be looking much further ahead.  It’s the organisation of the future that they need to focus on: the financing and capital requirements, the people, culture and skills, the markets and customers…

Good practices to consider…

Highlight the external influences.  Explain the potential for significant shifts (geopolitical, macroeconomic, competitive, technological…) to impact the business model.  Take the opportunity to ensure that attention is turned away from the routine inward-looking focus on making the most of what you currently have.

Things to avoid…

Looking inward and assuming that the business model is under your control.  Management is often the art of responding well to externally-generated change – and for Boards it’s often about helping management anticipate that and think through the consequences.



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