Friday, August 30, 2013

New Strategies Around Strategy

The financial crisis turned traditional budgeting and strategic planning on its head. Now companies allow for more flexibility in drafting their plans.
Russ Banham   

Strategic Planning Meeeting
Strategic Planning Meeeting (Photo credit: michaelcardus)
Along with the traditional annual budget, the five-year strategic plan is a staple of business, a rou­tine exercise with scant thought given its continu­ing utility. Most every company performs the ritual, consuming count­less hours of management time in the process, as if predicting the tortuous turns of markets, tech­nologies, political machi­nations and consumer preferences were a simple affair.
The financial crisis and subsequent recession turned these efforts on their head, rendering almost every five-year plan into worthless scraps of paper. ... “For most of us, the financial crisis and its aftermath was a truly dynamic event that we had not experienced in our lifetimes before,” explains Ken Esch, partner in PwC’s private company service practice.

Strategic Planning Meeeting
Strategic Planning Meeeting (Photo credit: michaelcardus)
We’d never seen such change happen with such velocity, and we’d never realized just how connect­ed we were to the global economy,” he adds. “It tested our ability to plan for the future.”
Yet, as Steve Player, North America program director for the Beyond Budget­ing Roundtable, points out, despite the constant winds of change, all organizations still must develop and act upon a strategic plan. “You have to have some idea of where you’re going,” Player asserts. “You need to establish what markets you’re going to compete in, which products you will produce, which services you will provide, and then posit out your strategy for winning.”
Both planning experts agree that the key to plan­ning is keeping the plan flexible, nimbly adjust­ing it based on dynamic forecasts that suggest changes ahead, if not already afoot. As Player puts it, “You plan for what you think will happen, but then constantly subject the plan to scenario tests based on your changing assumptions.”
These assumptions might be the price of a bar­rel of oil, the risk of an extreme weather event, the impact
English: Created for the WMF strategic plannin...
English: Created for the WMF strategic planning process (Photo credit: Wikipedia)
of potential currency fluctuations or the shifting economic conditions in Italy. In each case, a contingency plan is developed and kept at hand—just in case. The organizations that best assess these possibilities and expeditiously address them arguably are in a better competitive posi­tion than their peers.
Not all companies are tak­ing such actions, however. “Businesses seem to be diverging on their ap­proach to planning,” Esch says. “One camp continues to be uncertain as to what they ought to do in light of all these events occurring around the globe, and how they will impact their companies. They seem to be afraid to make com­mitments and big bets.”
The other camp has accepted that these dynamic events and changing times are the new normal. “They’re constantly figuring out how they’re go­ing to operate in this new environment, placing bets on a different market or new product,” he adds. “Their planning is agile.”
As always, information is vital to the planning exercise. In many cases, such business intelligence is not hard to come by. “Companies that have been around for awhile already have a repository of historical data indicat­ing what happened to the business the last time the economic cycle shifted or some unforeseen event occurred,” Esch notes. “Perhaps one part of the business suffered, but another part performed even better. That tells you something about where to allocate resources.”
Like Player, Esch does not advocate gutting the strategic five-year plan. Rather, he agrees that companies must write these plans not in ink, but in pencil. Keep an eraser handy.

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Wednesday, August 28, 2013

Obama Budget Changes to IRA, 401(k) and Other Retirement Rules

Financial Planning:


When President Obama unveiled his budget for the upcoming fiscal year, which begins on Oct. 1, it represented a wish list.
English: Retirement savings for various period...
English: Retirement savings for various periods with squirrel and nut analogy (Photo credit: Wikipedia)
But advisors should pay close attention to the eventual compromise because there were a number of significant proposals related to retirement savings accounts.
Here is an overview of six notable proposals and whether your clients would be winners or losers.
Under the administration’s proposal, employers that have more than 10 workers and have been in business for at least two years would face a new requirement to set up and provide automatic enrollment in IRAs for their employees. Employees would contribute to the IRAs through payroll deductions. In addition, they would be able to elect how much of their salary they wish to contribute to their IRAs (up to the annual contribution limit), or they could elect to opt out.

In the absence of any election, 3% of an employee’s salary would be contributed to the IRA.

The argument: For nearly 15 years, Congress, the Treasury Department and the IRS have been taking steps to increase Americans’ retirement saving contributions by making it easier for employers to establish auto-enrollment in company 401(k) plans. But many small businesses choose not to adopt a retirement plan because of the costs or the burden of complying with regulations. Many small employers also do not take low-cost steps to make retirement savings easier for employees.

A Millionaire by Retirement
A Millionaire by Retirement (Photo credit: mortgagepaymentplan)
The winners: Too few Americans actively save for retirement, and even fewer save appropriate amounts. Although there is some disagreement, numerous studies have shown that automatic enrollment tends to increase participation in retirement savings. The proposal also contains a number of tax credits that small businesses could claim for helping to facilitate employees’ retirement savings.

The losers: Many small businesses say that they are already overburdened with various compliance requirements and that any new rules or regulations would be unwelcome.

Most beneficiaries of IRAs and other retirement accounts would be required to empty an inherited retirement account by the end of the fifth year after the year of the original owner’s death, according to the administration proposal. (Presumably, required minimum distribution rules would apply, meaning the remaining balance would be subject to a 50% penalty -- like all other missed required minimum distributions.)

Max Baucus, U.S. Senator from Montana.
Max Baucus, U.S. Senator from Montana. (Photo credit: Wikipedia)
This proposal is a potential game changer for many clients’ estate plans. But this is not the first time the idea has been floated. In fact, since Sen. Max Baucus, a Democrat from Montana, initially introduced the idea several years ago, it has been revisted a few times.

The argument: The Green Book, released by the Treasury Department to explain the proposals in the president’s budget, says the reason for this provision is that “the Internal Revenue Code gives tax preferences for retirement savings accounts primarily to provide retirement security for individuals and their spouses. The preferences were not created with the intent of providing tax preferences to the non-spouse heirs.”

This point has been brought up a number of times when lawmakers are looking for revenue sources, which is happening again now. Some in Congress have often let it be known that IRAs were never intended to exist beyond the lifetime of the retiree who made the contributions. Instead, they argue, they were created to provide a source of retirement income, not a tax-favored inheritance to last another lifetime.

The winners: The required minimum distribution rules for non-spouse beneficiaries can be complex. Requiring non-spouse beneficiaries to withdraw inherited retirement account funds within five years would simplify the rules. The proposal exempts certain beneficiaries, including those who are disabled and minor children.

The losers: If this proposal is adopted, it would effectively end the “stretch IRA” strategy for most non-spouse beneficiaries. Beneficiaries would face more severe tax consequences upon inheriting retirement accounts, and the value of these accounts as potential estate planning vehicles would be diminished. This would also significantly reduce the value of Roth conversions as an estate planning strategy, particularly for older clients.

New contributions to tax-favored IRAs and 401(k)s would be prohibited once clients exceed an established cap, under the president’s proposal. This cap would be determined by calculating the lump-sum payment that would be required to produce a joint and 100% survivor annuity of $205,000 a year beginning when clients reach age 62. (This formula would initially set the cap at $3.4 million.)

Clients with cumulative retirement accounts in excess of this amount would be prohibited from contributing new dollars to retirement accounts on a tax-favored basis, although accounts could still grow as a result of earnings. The cap would be increased for inflation.

The argument: To increase tax revenue, the White House wants to use tax policy to encourage greater retirement savings where needed, but then phase out the benefit for the especially wealthy. “The current law limitations on retirement contributions and benefits for each plan in which a taxpayer may participate do not adequately limit the extent to which a taxpayer can accumulate amounts in a tax-favored arrangement through the use of multiple plans,” the Green Book says. “Such accumulations can be considerably in excess of amounts needed to fund reasonable levels of consumption
in retirement.”

The winners: Not many. In fact, at $3.4 million, this provision would impact only a very small percentage of retirement savers. But if interest rates increase, the cap could go much lower, since annuities paying $205,000 would cost less. This could affect many more retirees.

The losers: While $205,000 is nothing to scoff at, many clients will require substantially more annual income in retirement to maintain their desired standard of living -- especially after taxes are factored in. Such clients will need to look for alternative ways to shelter assets from taxes.

Another proposed change to tax benefits: The maximum tax deduction for making contributions to defined contribution retirement plans would be limited to 28%. As a result, certain high-income taxpayers making contributions to retirement accounts would not receive a full tax deduction for amounts contributed or deferred.

The argument: According to the Green Book, “limiting the value of tax expenditures, including itemized deductions, certain exclusions in income subject to tax, and certain deductions in the computation of adjusted gross income would reduce the benefit that high-income taxpayers receive from those tax expenditures and help close the gap between the value of these tax expenditures for high-income Americans and the value for middle-class Americans.”

The winners: For the country as a whole, this provision would help raise revenue. For individual taxpayers who are not in a federal income tax bracket higher than 28%, this provision would not increase their tax liabilities.

Seal of the United States Internal Revenue Ser...
Seal of the United States Internal Revenue Service. The design is the same as the Treasury seal with an IRS inscription. (Photo credit: Wikipedia)
The losers: High-income clients would no longer receive a full deduction for amounts contributed or deferred to a retirement account. For instance: If clients who have $500,000 of taxable income currently defer $10,000 into a 401(k), they do not pay any income tax on that $10,000. Without that tax deferral, the income would be taxed at 39.6% (currently the highest federal income tax rate). But if this proposal were to become effective, that $10,000 would effectively be taxed at 11.6% (39.6% minus 28%), since the maximum tax benefit that a client could receive would be limited to 28%. That would equate to an additional tax bill of more than $1,000.

Clients with combined savings across all retirement accounts of $75,000 or less would be exempt from required minimum distributions.

The argument: “Under current law,” the Green Book says, “millions of senior citizens with only modest tax-favored retirement benefits to fall back on during retirement also must calculate the annual amount of their minimum required distributions, even though they are highly unlikely to try to defer withdrawal and taxation of these benefits for estate planning purposes. In addition to simplifying tax compliance for these individuals, the proposal permits them greater flexibility in determining when and how rapidly to draw down their limited retirement savings.”

The winners: The proposal would decrease the compliance burden and increase simplicity for Americans with smaller retirement account balances. These individuals often have less savings on the whole and need to withdraw money from their retirement accounts anyway to meet expenses. In addition, those with low account balances often do not have access to the same level of financial expertise as those with larger account balances.

The losers: Not many. Indeed, it’s hard to find something to complain about. This provision would eliminate required minimum distributions for nearly 50% of IRA owners.

Non-spouse beneficiaries would be allowed to move inherited retirement savings from one inherited retirement account to another through a 60-day rollover period -- similar to the way they can currently move their own retirement savings.

The argument: The goal is to close the difference in treatment of spouse and non-spouse beneficiaries. According to the Green Book, “differences in rollover eligibility between surviving non-spouse beneficiaries and surviving spouse beneficiaries (and living participants) serve little purpose and generate confusion among plan and IRA administrators and beneficiaries.”

The winners: Unifying the rollover rules for retirement account owners and beneficiaries would greatly simplify this aspect of retirement accounts and reduce the number of irrevocable and costly mistakes frequently made by beneficiaries.

The losers: None. Of course, if most beneficiaries are required to empty the inherited account in five years (as required under the second proposal), this provision would be far less beneficial than it would be under current law.  FP

Ed Slott, a CPA in Rockville Centre, N.Y., is a Financial Planning contributing writer and an IRA distribution expert, professional speaker and author of many books on IRAs.

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Tuesday, August 27, 2013

The Secret to a Successful Divestiture

When you are selling part of your company, don’t just offer buyers a potential asset; give them the capabilities to gain value from it.

strategy+business magazine:

... Business strategy is always intertwined with capabilities. A capability is the combination of processes, tools, knowledge, skills, and organizational design needed to deliver a specified outcome. Thus, although most M&A departments spend much more time thinking about the sale price, attention to capabilities can make a major difference in a deal’s outcome.
For example, when you sell major assets, you can often maximize the deal price by identifying buyers with capabilities systems of their own that are a good fit. ... They are often willing to pay big premiums to complete the deal—and with good reason. Deals that leverage a buyer’s existing capabilities typically fare well (see “The Capabilities Premium in M&A,” by Gerald Adolph, Cesare Mainardi, and J. Neely, s+b, Spring 2012).
But maximizing price is only one of four major goals in a divestiture. The others are minimizing any disruptions to your retained businesses, keeping capabilities away from particularly strong competitors (which might mean turning down a deal that is favorable in other respects), and handing the buyer something that can be operated successfully from Day One. Your motive is not altruistic; in M&A, it is generally in a seller’s interest to minimize the length of entanglement, and to establish a reputation as a good partner for making deals.
... The leaders of any company divesting assets must deal smartly with capabilities issues or risk having the deal fall short.

Differentiating Divestiture

As a seller, you should begin your divestiture process by identifying the desired end state for the important capabilities involved: those you will still need after the deal is done, those you won’t need, and most importantly, those that both you and the buyer will need (see Exhibit 1). In each group, some capabilities are “table stakes”—every company in the industry needs them—whereas others are truly differentiating. The latter can distinguish your company in the market and give you an advantage over competitors. These capabilities require the most attention during a divestment, and you should seek to keep them intact while enabling the buyer to benefit from the deal in every other way (see Exhibit 2).
In practice, most sellers, facing the pressure of time, end up having to choose which capabilities to focus on. Your goal is to keep the process moving without sacrificing the quality of your decision making or jeopardizing the outcome.
There are certainly divestitures in which the buyer is known from the beginning, but it is not uncommon for a company to decide to divest something just because it no longer fits strategically, announce this plan publicly, and then search for a buyer. In these cases, major portions of a divestment plan must be executed before a buyer has been identified, and certainly before the transaction has taken place. This adds to the challenge.
There are also partial divestitures ..., in which only some assets of a given business or parts of an asset are sold. A partial divestiture is often more complicated from the standpoint of capabilities, because of the seller’s need to hold on to some people, processes, and technologies that it could let go of if it were selling an entire business or product line.
To make the process of divestiture more manageable, we recommend five steps. Each step gains its power from how it builds on previous steps, helping sellers during the critical period—usually lasting up to 18 months—when they are readying assets for sale. Note that these steps focus only on the analyses and business process changes that are relevant to managing the capabilities you are divesting. ...

Step 1: Capability Scoping

In the first step, you set the overall strategy for the divestment—including the assets you want to sell, when you want to sell them, and to whom. This takes place through an exercise called “capability scoping,” in which you take stock of the most important capabilities associated with the assets you are putting on the block. Often what’s up for sale is not a stand-alone business unit but ... a product, service, or asset that sits within that business unit. It likely draws on capabilities that are centralized within the company or that are used by other parts of the business unit (and therefore can’t be offered as part of the deal). This step usually precedes the identification of a buyer and should be done before any transaction-related activity, such as planning an auction. ...
Often, the seller realizes there isn't time to address every capability on its list, and it must set some priorities. ...
Undoubtedly there is a set of analogous activities at your company, drawing on people and technologies that are dispersed throughout the organization. A scoping exercise in and of itself isn't a plan for divesting assets—it doesn't answer the question of how to ensure the integrity of differentiating capabilities. But it does lead to a hypothesis of what will have to be accounted for, and either added to or carved out of an asset, in the months leading up to a divestiture.

Step 2: Baseline Analysis

This step involves understanding the components of key capabilities and how they come together to enable products and services to be successful. The idea is to break down those activities into their constituent parts—
English: Business Process Reengineering Cycle
English: Business Process Reengineering Cycle (Photo credit: Wikipedia)
what the activities consist of, who performs them, where in the company they are performed, how long they take, what technologies make them possible, and what problems are associated with them.
The baseline analysis identifies exactly what you can let go of and what you need to keep—and illuminates where a new owner might be left with a gap.
Not all buyers have gaps. Some may have capabilities systems that are a better fit for the assets you’re selling than your own capabilities are. In other cases, the ability of your activities to fill the buyer’s gaps becomes a point of negotiation in the deal—factoring into the price, the time to completion, or the transition services that you must provide. If no buyer has yet been identified, this is your chance to formulate a clear picture of the value that your divested assets might hold for someone else.
Completing a baseline analysis of your capabilities is more difficult than it might seem. The problem is that most people in a company—even, and sometimes especially, those with special talents or important functional roles—have a narrow view of what underpins a business’s success. The salespeople will describe the differentiating capabilities in one way, the marketing people in another, and the product development people in a third. From up close, and amid the competing perspectives, it can be hard to tell which activities truly make a difference. You may need to weigh all these inputs dispassionately—and pull back to get a wider perspective.

Step 3: Option Analysis

In this step, having identified one or more potential buyers, you look closely at the buyer’s capabilities needs and how your assets can help fill those gaps. This enables you to maximize the value of the deal. ...
The information uncovered during this step may prompt you to revisit a previous step. ...

Step 4: Transition Planning

Having identified the gaps and decided how to fill them, you as the seller now must start carving out the asset and making sure it has the capabilities it will need. This involves the creation of detailed project plans—perhaps one for each of the major capabilities involved—and of work teams.
Where to begin? At this stage, there is still no guarantee of who the buyer will be. Focus on activities that need to be conducted for any buyer. This forces you to tend to the known things first, as opposed to doing what comes more naturally and tending to the biggest things first. This approach can speed a sale once a buyer has been identified—and even if you don’t sell the asset, in the end, you won’t regret the planning effort. ...

Step 5: Buyer Engagement

Once you have a definite buyer and a signed contract, you can flip the switch on all the plans you have been making in Steps 1 through 4. Begin by sharing your thinking with the buyer, including which capabilities you see as most important and what your plans are for transferring them. Describe how you will deliver a fully functioning business to the buyer. The buyer has its own market strategy, quite possibly different from yours, and may have a different view of which capabilities are important. These differences sometimes lead the buyer to ask for something you don’t expect. That’s another reason not to start on this stage prematurely: That early work might have to be discarded. ...

Preparation, Skills, and Pride

Divestitures can be some of your company’s most complex transactions. They require strategic thinking, a massive amount of contingency planning, and—once a certain point is reached—the simultaneous management of multiple work streams and projects. You will need to be flexible and ready for the unexpected. This checklist can help you get ready for the process:
  1. Do you have a clear sense of what you’d like to sell, what you think it’s worth, and what capabilities might be involved?
  2. Do you know when you’d like to complete a transaction, and do you have a rough sense of the time line leading up to that?
  3. Do you have a list—if not by name, then by type of company—of who might be interested in your assets?
  4. Do you have a clear sense of how the sale will affect capabilities you’ll need for your retained businesses or assets?
  5. Do you have a dedicated transaction team, and if so, does the team have a clear set of priorities?
  6. Do you have measures in place to track your progress? Do you have clear measurements for the success or failure of the transaction?
The skills you develop during this process aren't relevant just to divestitures. They can also be used to reduce risk; create value; and improve the outcomes of acquisitions, spin-offs, and portfolio restructurings. Your work on divestitures can span organizational boundaries, geographies, business units, and functions, and thus help you develop the structures and communications links you need for other complex initiatives. The focus on capabilities involves accounting for factors that are often overlooked. It can help you avoid the tunnel vision that often accompanies a singular focus on financial matters during major transactions—and that can keep you from seeing the broader strategic impact of your decisions in general.
Many companies pride themselves on their ability to use acquisitions to drive inorganic growth. It’s far more rare to find a company that prides itself on the way it divests a business or asset. That’s understandable; by their nature, divestitures focus on businesses or assets that once seemed promising but no longer fit with where the seller is heading. It isn't surprising that there would be a mind-set of “the sooner, the better” and a narrow focus on the price. If you use the filter of capabilities, the divestiture might take a little longer, but it can leave your company better off in the ways that matter most. 
Reprint No. 00208


  • Eduardo Alvarez is a Booz & Company partner based in Chicago. He leads the firm’s global operations practice and is an expert in business process transformation and technology-enabled transformation.
  • Steven Waller is a Booz & Company principal based in Chicago. He specializes in technology strategy and the development of new operating models for energy and financial-services companies.
  • Ahmad Filsoof is a Booz & Company senior associate based in Chicago. His focus is on operations, business process transformation, and technology-enabled transformation in the energy industry.
  • Also contributing to this article was consulting writer Robert Hertzberg.

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Thursday, August 8, 2013

Persuading Consumers to Sign Long-Term Contracts

Companies that focus on driving customer usage and spending see their conversion rates increase.

strategy+business magazine:

Authors: Yolanda Polo and F. Javier Sese (both University of Zaragoza)
Publisher: Journal of Service Research, vol. 16, no. 2
Date Published: May 2013
Although contracts have become widely used in recent years, pay-as-you-go consumers still account for a large portion of the customer base in many industries and businesses, including legal services, media, telecommunications, repair and maintenance, and entertainment or professional sports. A 2011 study of U.K. and German mobile phone firms, for example, found that more than half of their customers had a prepaid plan and were not tied to a contract.
English: A business ideally is continually see...
English: A business ideally is continually seeking feedback from customers: are the products helpful? are their needs being met? Constructive criticism helps marketers make adjustments to their products and services to adapt to the changing needs of their customers. Source of diagram: here (see public domain declaration at top). Questions: write me at my Wikipedia talk page or email me at (Photo credit: Wikipedia)
That’s a problem for companies, because there’s no question that subscribers are more profitable. On average, they generate 4.5 times more revenue than noncontract customers, according to the study. It stands to reason, then, that a small uptick in the number of customers who sign on the dotted line would lead to a significant increase in revenue for companies—including those in business-to-business contexts such as tech support or consulting. However, despite contracts’ clear value to firms, surprisingly little research has been done on how managers can strengthen their companies’ ties with customers to encourage them to sign long-term deals.
This paper aims to fill the gap by identifying the key factors that lie behind customers’ decisions to transition from pay-as-you-go to contract status. Noting that their findings are applicable to several industries, the authors based their study on cell phone users, in part because of the massive size of the mobile market. ... The authors were also drawn to this sector because the contract problem is particularly vexing for telecom operators, who shoulder huge operational costs and face stiff competition for customers, which makes the negative impact of weak and short-term client relationships all the more damaging to their bottom line.
The authors tracked nearly 300 customers, all of whom began as pay-as-you-go clients, of a major mobile communications supplier for four years, gathering user and account data on a monthly basis. About 22 percent of the customers moved to a contract and 78 percent stuck with their pay-as-you-go phone cards, which shows how difficult it can be for firms to secure long-term commitments.
In a series of analyses, the authors found that the first key factor in the decision by customers to make the switch
English: A schematic illustrating the evolving...
English: A schematic illustrating the evolving relationship between the firm and its customers via the marketing orientation, which includes the introduction of a new marketing concept, customer enrichment marketing. (Photo credit: Wikipedia)
was whether they exceeded their expected usage: Did their usage regularly exceed the amount of credit they loaded on their cards, and, if so, how big was the gap?
The clear implication for telecom companies, and other types of service providers, is that they can increase the likelihood that customers will sign contracts by getting them to use their service more during the pay-as-you-go period.
In the mobile phone market, for example, companies should encourage their pay-as-you-go customers to install social media applications, online games, or other time-consuming programs that would increase their mobile service use. In other industries, offering discounts, promoting free trials, and bundling services with partner firms are all viable strategies. In addition, employed, female, and younger customers all had usage rates that exceeded their own expectations, so these groups should be among the first targeted by marketers, the authors write.
The second factor influencing the decision by customers to switch to a contract was a variation of the first: The more customers paid when not on a contract, the more likely they were to see the benefits of a long-term deal and make the switch. This doesn’t mean, however, that companies should simply raise rates for noncontract clients, the authors write; over the long term, the higher prices would likely drive away potential customers or cause existing ones to leave. Rather, managers hunting for contract contenders should begin by focusing on customers with a history of higher spending. Once they are identified, these customers should be plied with inducements to exercise their bigger spending habits during the noncontract phase. Companies should offer points for frequent usage in a loyalty program, among other incentives.
Last, customers who had had a longer noncontract relationship with the firm showed a higher probability of joining the contract program, the authors found. Thus, retention strategies and effective customer service are crucial. Although keeping long-standing low-end customers happy with good service is important, companies should keep their eye on the real goal: Strengthening these ties to convert them into more profitable contract-based relationships.
The authors stress that these managerial and marketing insights can be applied more generally to other industries. Internet-based phone companies, music streaming websites, file hosting services, and new-media businesses such as online newspapers and magazines are all facing the same challenge. These findings highlight the need for companies to encourage higher usage and spending during the pay-as-you-go phase.
The recommendations also extend to B2B firms, the authors write. For example, companies specializing in consulting, computer-related support, or legal services can team up with complementary firms to give customers easier access and more opportunities to use services.
“Marketing managers should move from the prevailing backward-looking focus toward a forward-looking focus,” the authors write, “in which each customer’s future considerations are monitored and managed proactively.”
Bottom Line:
Companies can lay the groundwork for customers to sign a contract by tracking and influencing their use of the company’s services in the pay-as-you-go phase. Although getting customers to make the switch is tough, it’s worth the effort because it is so profitable. Companies should target customers who have longer relationships with the firm, spend more during the noncontract phase, and have reason to think they will use the service frequently enough to offset the higher costs of a contract.


  1. Matt Palmquist is a freelance journalist based in Oakland, Calif.
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The Perils of Being a Social Media Holdout

Business (Photo credits:
Harvard Business Review:
by Clara Shih and Lisa Shalett  |  10:00 AM July 31, 2013

There are conversations taking place about your company or brand 24 hours a day, seven days a week in social media. Are you a part of these conversations? Or are you hoping that if you don't hear them, they don't exist?
English: Infographic on how Social Media are b...
English: Infographic on how Social Media are being used, and how everything is changed by them. (Photo credit: Wikipedia)
Social media offers a variety of opportunities for brands to understand and participate in those conversations. While participating in social media is not without risk, not participating might prove to be the greater risk — especially to reputations.
Here are three risks of not being in social media for big companies or major brands, small business owners, and service providers:
Having your reputation defined by others: People are talking about you, your company and your brand, and your stakeholders expect you to be paying attention in real time, especially when they have a customer service complaint or positive feedback to give. You decide whether to participate in this conversation or not, but at least you are aware of what is being said. This is the new frontier for reputation risk management. If you don't tell your story, others will tell it for you.
Being invisible and less credible: The social Web is changing how people communicate and access information. ... People are looking you up. Not having a presence means you are not easily "findable" and perhaps leads people to question whether yours is a credible business. ... On average, buyers progress nearly 60% of the way through their purchase decision-making process before engaging with a sales representative, according to Corporate Executive Board (link is PDF). If people are looking for information about you or your business, what are they finding? A social page or profile at its most basic level enables you to provide accurate and helpful information about what you or your company does to your intended audience. Additionally, social media pages typically appear with prominence in search results — without these online presences, relationship managers and organizations risk not being present in the search results when an interested prospect goes looking.
Being perceived as behind the curve: As consumers embrace new technologies, they expect businesses to do the same. Companies (and their representatives) that aren't using social networks will not be perceived as forward-thinking and, in the long term, will risk losing customers who want business partners who speak their language. Would you create a new personal checking account with a bank that doesn't have an online portal? Today, we depend upon online access to data, including our finances, so that seems unthinkable. Soon customers will feel this way about having a social connection with businesses.
Social media is perhaps best thought of as a set of new and innovative ways for businesses and customers to do what they have always done: build relationships, exchange information, read and write reviews, and leverage trusted networks of friends and experts.
As you contemplate the risks and rewards of social media, we would suggest that the key ingredient for evaluation is simply to experience it for yourself. There are many low risk ways to do this, even if you work in a regulated industry. One of the best suggestions we have is to take on a "reverse mentor," a more junior colleague who has grown up with social media, and have them share their knowledge with you.
Today's always on, social-mobile world is challenging all businesses, brands, and professionals to adapt — or at least make an informed decision not to. As you consider the full set of risks associated with being or not being in social media, it is important not to overlook the rewards and opportunities.
Clara Shih and Lisa Shalett


Clara Shih is the CEO & Founder, Hearsay Social. Lisa Shalett is the Managing Director and Head of Brand Marketing & Digital Strategy, Goldman Sachs
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Tuesday, August 6, 2013

Measuring the full impact of digital capital

Although largely uncounted, intangible digital assets may hold an important key to understanding competition and growth in the Internet era.

McKinsey & Company:

July 2013 | byJacques Bughin and James Manyika
Logo of the United States Bureau of Economic A...
Logo of the United States Bureau of Economic Analysis, a part of the Department of Commerce. (Photo credit: Wikipedia)
On July 31, 2013, the US Bureau of Economic Analysis released, for the first time, GDP figures categorizing research and development as fixed investment. It will join software in a new category called intellectual-property products.
In our knowledge-based economy, this is a sensible move that brings GDP accounting closer to economic reality. And while that may seem like an arcane shift relevant only to a small number of economists, the need for the change reflects a broader mismatch between our digital economy and the way we account for it. This problem has serious top-management implications.
To understand the mismatch, you need to understand what we call digital capital—the resources behind the processes key to developing new products and services for the digital economy. Digital capital takes two forms. The first is traditionally counted tangible assets, such as servers, routers, online-purchasing platforms, and basic Internet software. They appear as capital investment on company books. Yet a large and growing portion of what’s powering today’s digital economy consists of a second type of digital capital—intangible assets.
They are manifold: the unique designs that engage large numbers of users and improve their digital experiences; the digital capture of user behavior, contributions, and social profiles; the environments that encourage consumers to access products and services; and the intense big-data and analytics capabilities that can guide operations and business growth. They also include a growing range of new business models for monetizing digital activity, such as patents and processes that can be licensed for royalty income, and the brand equity that companies like Google or create through digital engagement.
Conventional accounting treats these capabilities not as company investments but as expenses, which means that their funding isn’t reflected as capital. Since the amounts spent aren’t amortized, they take a large bite out of reported income. Spending on those capabilities sometimes should be treated as capital, though, since they can be long-lived.’s development of an internal search process that promotes recurring sales or the efforts of Netflix to fine-tune personal recommendations to increase video viewing and retain customers are certainly more than expenses. Such capabilities, which are complex to build and replicate, can often help companies create enduring competitive strengths.
We’re acutely aware of misguided efforts to justify sky-high valuations during the late-1990s Internet bubble by claiming that finance and accounting fundamentals were no longer relevant. We also recognize that we’re far from the first to note the relationship among intangibles, company-level growth and productivity, and overall economic growth.1 What we want to suggest here is that those relationships, which once represented a small minority of business activities, are becoming the rule in the digital economy. In fact, much of today’s digital spending could pay for long-lived intangible assets that will define the competitive landscape going forward.2 The rising stakes are seen in the copyright battles between Internet and consumer-electronics companies and in major spending on patent portfolios.
Above all, we want to emphasize the importance, for many business leaders, of making the mind-set shift required to embrace the importance of digital capital fully. The disruptive nature of digital assets is intensifying in markets such as search, e-commerce, and social media (where attackers can build business models with near-limitless scale). Disruptive digital assets are also important in segments where behavioral data and user participation can be monetized, by defining entirely new business opportunities or fostering breakthroughs in collaborative innovation. As the mobile-payments start-up Square is demonstrating in the credit-card arena, increasingly, companies that deploy these assets have the potential to threaten large existing profit pools thanks to the challengers’ vastly different economics or radically new ways of doing things.

The big picture

There are parallels between what’s occurring today and during the period, 100 years ago, when electric motors gained widespread adoption. Early in that cycle, companies invested in physical motors, which like today’s servers and routers provided a new growth platform. But the more important kind of value appeared after companies began to understand how motors could change almost every process, improve productivity, and stimulate innovation. Companies that captured these benefits were more successful and more valuable than others.
Today, the market valuations of many Internet-based companies are higher than those of their counterparts in other sectors, including high tech. Many Internet leaders earn lower returns on equity than established technology companies do, yet there’s no reason to believe that markets are making irrational bets on the growth potential of digitally adept companies. As the sidebar “Valuation and intangibles: Viewing the numbers differently” illustrates, treating digital intangibles as assets rather than expenses clarifies the logic behind valuations. (We based these pro-forma valuation calculations on data compiled by academic researchers, as well as assumptions about rates of intangible and digital investment from our own and outside research.)
Macroeconomic studies we have done suggest that digital capital is not only growing rapidly but has also become a major contributing factor in global economic growth.3 We examined the national-accounts data of 40 countries, assigning values to tangible and intangible assets. In 2005, digital-capital investment represented barely 0.8 percent of GDP for those countries. This year, it will exceed 3.1 percent of GDP. Likewise, the accumulating global value of digital-capital investments has reached more than $6 trillion, about 8.5 percent of nominal world GDP. Globally, levels of digital intangible investment are more than half those of digital tangible investment. In more highly digitized economies, such as Israel, Japan, Sweden, the United Kingdom, and the United States, spending on intangibles represents two-thirds of digital capital’s total value.
This activity is starting to power growth. We estimate that digital capital is the source of more than one percentage point of global GDP growth (roughly one-third of total growth). Intangible capital already accounts for two-thirds of that slice, tangible investment for the rest. This growth flows from not only capital deepening but also increased labor productivity—a remarkable thing, since the digital economy has emerged in the relatively brief space of 15 years. By contrast, it took 80 years for steam engines to increase labor productivity to the same extent, about 40 for electricity, and more than 20 for conventional information and communications technologies.4 (For more on the relationship between capital formation and productivity, see sidebar “Innovation, capital, and productivity growth.”)

Navigating the new terrain

Intangible digital capital’s role in economic growth gives policy makers one more reason to favor investments in broadband and other forms of Internet infrastructure. Such investments correlate strongly with overall digital-capital levels. In our experience, though, the implications are even greater for executives, who often are not tuned into their organizations’ digital strengths or weakness. Few companies have gone through the internal exercise of reclassifying expenditures or segregating benefits from spending on intangibles. And of course, companies can boast a high ROE thanks to strong legacy-product margins but may nonetheless have muted growth prospects as a result of underinvesting in digital capital. To set a more effective digital course, leaders should consider the following ideas.
Take stock of your assets
Since identifying intangible assets is difficult, companies may be missing growth opportunities. Many have realized only recently that they can use social-media interactions with their best customers to leverage innovation efforts or that they may have unused data they could restructure into valuable big-data assets to sharpen business strategy. Similarly, companies should take stock of how digital capital they don’t own may be relevant to the business. A retailer that doesn’t have access to digital behavioral data on consumers, for example, may be at a disadvantage. So could a bank whose customers access products through a third-party platform that limits the bank’s ability to capture information.
Conversely, companies may wrongly assume that their growth results from conventional capital spending and therefore compromise growth by underinvesting in digital competencies. One online company, for example, stuck to a subscriber pay model in hopes of boosting returns on tangible investments such as server farms. It wound up missing a massive social-networking opportunity that would have yielded far greater returns on advertising revenues.
Our global research shows that the stock of intangible assets varies considerably by region. Some markets have larger numbers of strong digital contenders, others fewer. Companies could make those differences a factor in deciding which markets to enter and where to place digital bets.
Face up to looming threats
Assume that digital leaders in your competitive zone are relentlessly expanding their intangible assets both to attack existing markets and to create new ones., for instance, won share from brick-and-mortar retailers with its ease-of-purchase model and its ability to reach long-tail customers. Now it’s launching new business models (such as Amazon Prime) to further leverage its user base and logistics capabilities. It’s also using tangible server assets to offer cloud-based labor services (Mechanical Turk) that match freelance workers with demand for their labor.
A good first step is to identify which areas of your value chain are most vulnerable—for example, service delivery or weak digital brands. Competitors can slide vertically or horizontally into large gaps, so you’ll need to build digital assets quickly as a counterweight. Even companies that have a considerable stock of digital assets should understand that capturing value from them isn’t a given. Instead, such companies must define (and relentlessly innovate with) business models that can be scaled up to match those assets.
One clue suggesting that a company might face emerging digital challenges is the existence of businesses that have unusually high levels of revenue per employee in adjacent market spaces.’s employee productivity, for example, is double that of traditional retailers. Netflix, similarly, generates more revenue per employee than traditional cable operators do, by leveraging intangibles such as its highly evolved recommendation algorithms. Unusual financial profiles are another warning sign. Since digital funding is counted as operating expenditure, digital leaders often have small capital-investment levels relative to their size and growth potential. They also borrow less, both because they may not need to (some reap sizable market rents from, for example, search licensing fees or patent income) and because banks may be less likely to lend against intangible assets.
Partner with care
Most companies rely on digital agencies for things like optimizing search marketing. In such cases, they may be ceding digital capital, since they never develop a full understanding of consumer segments or what inspires a customer who searches for their products. Seeing such capability building as an investment may change the logic of using third parties. Similarly, when companies look to established tech players for partnerships shoring up weaknesses, they should be cautious: some seemingly high performers may be on the wrong path and could burden you with outmoded standards and platforms. Alternatively, if you deal with strong players, you may be leaving yourself vulnerable by letting them lead.
The need for growth and competitiveness will force companies to build strong digital capabilities. Viewing them as assets rather than additional areas of spending requires a new set of management and financial lenses. Embracing them is a major shift—but one worth making for companies striving to master a still-evolving landscape.
About the authors
Jacques Bughin is a director in McKinsey’s Brussels office. James Manyika is a director of the McKinsey Global Institute and a director in the San Francisco office.
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