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Top-Down or Bottom-Up Planning?

How often has this conversation happened in your company during the annual planning cycle?

CEO:  I want to push decision-making as far down as possible, and hold the business units responsible.

FP&A:  The corporation is responsible to shareholders, and we need to direct the allocation of resources as best we can.

Head of Business Unit:  I don’t want Corporate micro-managing my business, making every little decision.  We know our markets, and we should make those decisions.

Corporations are usually subdivided into business units, which focus on lines of business or geographical areas, or a matrix of both.  Ultimately, the organizational structure should support the company’s strategy and enable decisions to be made by the people with the best ability to make them.

Business units use corporate resources to generate returns for the corporation.  But who decides which resources the business unit gets, or how much return is expected on them?

The approaches are either top-down or bottom-up:

  • Top-down:  The corporation makes decisions about the next few periods’ goals and resources, and assigns them to business units often based upon their recent performance.
  • Bottom-up:  The business units develop goals, determine the resources needed to achieve them, and requests those from the corporation.

Both approaches may involve some amount of negotiation and recycling.  Depending upon the incentive system in place, business units may try to get lower goals and more resources than they believe are necessary, to make achieving the goals easier.

One organization I know used the top-down approach:  They incrementally adjusted the previous year’s numbers to reflect new goals and resources.  Their organization was split geographically, which made sense given they provided services to local businesses.  But the various geographies were not all the same.  Some were rapidly growing while some were slowly declining.  The organization should have been adjusting goals and resources according to what the areas could be doing based on the number and growth of local businesses, rather than what they had done in the recent past.

Another large corporation used a bottom-up approach, getting business units’ goals and resource requirements.  But the corporation had its long term goals, and knew that available resources were getting slashed, so there followed many rounds of negotiations and re-planning, leaving everyone exhausted and feeling they were needlessly swirling.

Using our goal-based planning approach, we recommend a hybrid approach:

  1. Corporate planning recommends a number of different scenarios for the business units to use in planning
  2. Business units develop plans supporting those various scenarios
    • Business units can use the goal-based planning approach to select from among their available alternatives, using the provided scenarios from the corporation for their overall goals/constraints.
    • Need to also specify whether the plans are scalable (e.g., can half the goals can be achieved with roughly half the resources, or twice the goals can be achieved with twice the resources), or is some fixed-cost investment required to get any return?  Scalable options can be adjusted by the corporation to more closely fit their goals.
  3. Corporate planning uses the npv10 solution to optimize the plan, picking and choosing from among the business units alternative plans, and then informs the business units which of their plans should be executed.

The recommended approach enables the corporation to use its corporate-wide view to most effectively allocate resources to best achieve the corporate goals, while enabling the business units to have a fixed number of plans to evaluate, and to make their own decisions within those scenarios.

When you are ready to pilot-test this approach, either for your corporation or business unit, we will work with you to gather an appropriate level of detailed data, work through many scenarios, and teach you how to use the tool to enhance your planning process in the future.

Why Apple Needs to Build an iCar

To everything … There is a season
— The Byrds – Turn! Turn! Turn!

Every company has to manage its portfolio of products or projects, as each undergoes its life cycle of birth, growth, decline.

Apple derives the majority of its revenues and profits from just a handful of products: iPhone, iPad, and personal computers. Each of the segments has had its day as a growth driver, and the iPhone is just now showing signs of slowing unit growth.

Their big question is what product line can become the growth driver, given that the phone segment generated over $140B in sales during the last year? (I realize that most Fortune 500 CEOs would love to have such a problem…)

They could of course come up with a new or improved existing product, and dominate the space, as they did with music players, tablets, and smartphones. The Watch is an early attempt at identifying the next market, and it’s doing well relative to other competitors, but not in sufficient volume to be relevant.

The company reportedly considered the TV market, which in some regards helps fill a short-term gap, as TVs are high-ticket item consumer electronics, but competitors seem all too willing to drive prices down on the latest innovations as quickly as possible. Apple could still develop something here, but seem content for now to use their Apple TV box to let them continue working on this segment.

There are only a few other industries with companies that generate revenue of Apple’s magnitude: Oil, Retail, Automotive, and Financial Services.

Only one of those plays to Apple’s core strength of developing cutting edge products for consumers: Oil. Just kidding!

Apple has experience with retail, but I don’t see them wanting to go beyond their high-end niche, and try competing with Wal-Mart or Amazon, purveyors of anything and everything.

The company is making forays into the financial world with Apple Pay, but for now need to leverage other competitor’s infrastructure, and it seems more like incremental efforts to bolster their ecosystem.

That leaves the automotive world. They started integrating their technology as infotainment devices, with Apple Carplay. This is again an incremental play, and enables them to build relationships, and see where they can add value, and play to their strengths.

But could Apple expand their forays into cars with an actual car? And would they compete with the BMWs of the world, or with Uber with a self-driving car service? The current rumors suggest they went down the path of having their own car design, but may have shelved it while continuing development of self-driving systems.

Nothing in their past suggests Apple wants to be solely a technology provider to other companies, and it’s unclear what competitive advantage they would have in the self-driving tech space. Pausing the development of the entire vehicle could simply be a pause, while they think through their options, and see the pace of the industry’s evolution from a “car in every driveway” to an “always available taxi service.”

Apple’s strength has always been in providing an integrated hardware/software/service experience, and the only way to achieve that in the auto industry is to develop or acquire their own car design. Others have suggested Apple acquire Tesla to quickly establish a strong position in the industry, but they have never used major acquisitions to enter a product category.

Where does that leave us, or Apple?

Our goal-based planning approach tells us that Apple need a replacement for the iPhone as its main growth driver. Their strategy has always been to have a focused product line, rather than a large collection of products. Together, these tell me that Apple will soon be filling its new spaceship-like headquarters with car designers and engineers.

 

What DOES That Logo Mean?

Our first logo is the mathematical formula for calculating the Net Present Value of Cash Flows (CF), using a discount rate of 10%, or as often called in industry, “npv10.”

The symbol Σ means to sum all the values in the series represented on the right.  Although I don’t include the bounds, they are often assumed to be from time period zero (initial investment) through some future time period.  CFt thus representing the cash flows for time period t.

The divisor is 1.1t, while the general formula should be divided by (1+i)t. As I named the company npv10, I just assumed the interest rate i was 10% or 0.1. For time period zero the divisor is 1.10 (equals 1), for time period 1 it is 1.11 (equals 1.1), and so forth.

But why the NPV of Cash Flows?  Why not NPV of Net Income or Revenues or EBITDA, or use IRR (Internal Rate of Return)?

The NPV of Cash Flows has been found to be a good way to compare projects to one another, and take into account the timing of the cash flows to the company.  Earning money back sooner is more valuable to earning the same amount later.

But the software does not compare projects against one another according to their individual NPV.  A number of successful companies do that, but they’re missing out on a number of important points:

  • Projects do not exist in isolation.  They compete for limited resources with other opportunities, so they are all interrelated even if not obviously so.  (See the example I did for a technology company.)
  • Projects may directly depend on other projects.  For example, an oil company may drill a test well, and the result of that test may determine how many other producing wells they drill in the area.  The test well is not expected to produce any return, so it has a negative NPV.  But if the test is positive, each of the production wells can move forward, producing positive returns.  Our software enables you to directly connect one or more projects, so selecting one or more producing wells (with positive NPV) requires that the associated test well (with negative NPV) is also selected.
  • Timing matters.  If you are attempting to manage the company, and it selects nothing but projects with large NPVs, where the positive cash flows are in the distant future, you will need cash to sustain you until those start returning cash.  This is why I often recommend setting minimum goals for Cash balances, to ensure the company survives any periods of low cash flow.  In this way, the software may select projects with smaller NPVs first, because they may return cash sooner, and that can be put back into funding the larger projects later.

The final point I wish to make is that while I named the company after a useful calculation, the software allows you to set goals and constraints on almost any of your metrics and KPIs, and decide which one you wish to maximize or minimize for each analysis.  You may wish to maximize Revenue, Production, or Revenue, or minimize Capital Expenditures, or Marketing Expenses, to see how you can best achieve your strategy.

As your company figures out which goals, constraints, and optimized metrics most matter, you will get the most value for your company, and help it develop its strategy and plan for the future.