SMEs Strategic Decision Making (part 1): Sense-Making template

Decision-making in a small or medium enterprise involves several parameters, and personalities! The decision-maker has to make sense of information related to performance and operations, the competing stakeholder interests, the problems to be identified, defined and prioritized, the planning of required resources, and steer the organization through internal & external turbulence throughout.

Strong leaders focus on getting the firm’s bearings, i.e. where the organization is, envision ‘What can be’ from ‘What is’ and define common goals collectively. But given the challenges, the problem is: How to diagnose the present and act to chart a better future, bearing responsibility to stakeholders, accountability for performance and stake in equity.

1. Key elements of sense-making for a SME Leader
   1. Nature of business growth
   2. Problem statement for SME Decision-maker's template
   3. Defining what's required
2. Fundamentals of performance improvement
   1. Financial statements: the performance lingo
   2. Analyzing & improving costs
   3. Evaluating Competitive Position

Key elements of sense-making for a SME Leader

Nature of business growth

If we apply the proverbial bird's eye view in business, ventures trace S-curves in growth as adoption grows among experimenters, early adopters, early & late majority. Competitive moves erode the gained ground and with price wars, customer tastes & regulations, saturation sets in. Unless the organization's presence in a saturated market isn't as a market leader, it's strategic options become limited.

The fluctuating returns (bottom curve in graph) reflect the current profit pools being created. To prevent decay, the organization must disrupt into higher S-curves. New customer segments & new value propositions help it capture the market and evolve & utilize the organization’s capabilities. Further growth needs the creation of new growth engine by acquiring new capabilities, and multi-disciplinary solutions mostly from outside the organization.

Internally, the organization moves across inception, survival, growth, expansion & maturity stages in each of these curves. Management style evolves from direct supervision, to supervised supervision, to functional, to divisional, to line and staff. Extent of formal systems grows from minimal during inception and survival, to developing in growth stage, to maturing during expansion and extensive when mature. 

Problem Statement for the SME Decision-maker's Template

Internal dynamics across products, processes and people, drive the organization's customer, supplier, debtor and investor relationships and ultimately business performance. Environmental changes in social, political, technological, and economic situation, customers preferences and competitive actions create new opportunities and threats. So, a Decision-maker's early days need an intensive process of making sense of the external environment & internal factors and mapping out specific objectives & initiatives.

But, countless possible points of entry can make the task daunting. Should one start by talking to the customers or distributors or sales/ customer service/ operations managers? Some start with whatever they know best – product lines or customer segments or supply chain, etc. Alas, these approaches are neither thorough nor accurate in terms of what the management and business situation requires.

Defining what's required

What the leader needs is a sense-making & performance improvement template. Sense-making is how the organization obtains information about its environment, interprets it, and acts on it. Four components of strategic sense-making include:

1. Data gathering,
2. Information categorization
3. Internal communications, and
4. External communications

Research finds a positive and significant relationship between the ability of strategic sense-making and value creation of SMEs. SME which is aware of its environment and has smooth information and communication within the organization, acts with ‘organized meaningfulness’. Its decision to improve the value of the entity and adapt to the conditions are better and more appropriate.

On flipside, SMEs that do not have this ‘organized meaningfulness’ pay less attention to their environment, and this means less attention to the threats and opportunities ahead. It is literally "Garbage In, Garbage Out" as new organizational order is done through sense-making about structures and strategies, as a logical response to environmental changes.

Also, the desired template should be within the constraints of a SME, and:

1. Reflect fundamentals of business performance,
2. Be comprehensive and focused,
3. Use readily available information,
4. Be simple and inexpensive, and
5. Enable easy communication and action

Fundamentals of performance improvement

Incoming leaders find that reaching a diagnosis within their first three to four months helps them lay a foundation for breakthrough performance - and avoid the pitfalls that other new leaders encounter. Wherever the organization is in its journey, a successful performance-improvement program applies four widely accepted principles:

1. Costs and prices almost always decline
2. Competitive position determines options
3. Customers and profit pools are dynamic
4. Simplicity gets results

Financial statements: the performance lingo

Question is: how well are the internal actions giving external outcomes? Financial statements report and quantify the organization’s performance. Any organization's current and past financial health are key indicators of its long-term growth potential. Balance sheet and income statement are produced by most SMEs.

They are used by funding organizations, credit rating agencies, customers and suppliers to manage their decisions. But what about SME leaders? E,g. in Mexico, 120 MSMEs surveyed reported that more than 70% of small and medium business apply financial analysis, versus only 17% micro companies.

Access to aggregated sector & regional performance informs SME leaders of their business’ relative performance. Such financial benchmarking also provides SME leader key insights on how talent, investors, lenders & regulators see the industrial activity, and what is the business’ ‘relative clout’ to negotiate needed resources and which outcomes hold greater significance.

To embed the financial statements in the performance management template and make informed decisions about corrections and/or revisions, it is important to identify which actions influence which results.

Analyzing & Improving Costs

In nearly every competitive industry inflation-adjusted costs and hence inflation-adjusted prices decline over time. Asking “How does our cost curve compare with the industry’s and with our competitors’ cost curves?” is the first key diagnostic question. Understanding the overall cost trend has to be done at every cost segment level.

After comparing your overall costs with industry prices and your competitors’ costs, take a more detailed look at your cost position in your industry. But, rather than simply comparing with your top competitor, figure out which firm (including yours) is the best in each area. Where can you improve most relative to the minimum – versus a hypothetical competitor representing the ‘best of the best’?

1. Manufacturing and Supply chain domains determine the Cost of Goods Sold. COGS is the significant part of a manufacturing firm’s expenditures. It includes raw materials consumed, change in finished goods, stock-in-trade, work-in-progress, including direct production labor costs
2. Human resources domain determines Employee benefits expenses. It includes wages, salaries and social security contributions, paid annual leave, profit-sharing and bonuses, medical care, life insurance, housing, cars and free/ subsidised goods or services, gratuity, pension, other long-service, retirement and termination benefits
3. Manufacturing and Supply chain domains determine Manufacturing expenses. It includes plant power & fuel, machinery repair & maintenance, tooling used, material handling, processing, indirect labour and other such production overheads
4. Human resources domain handles Administration and Selling expenses. It includes legal and professional fees, traveling & accommodation, lease, use, repair & maintenance of vehicles, computers, telephones, buildings, etc.
5. Finance & Accounting domain handles Finance cost. It includes interest on secured and unsecured loans, working capital facilities, advance tax shortfall, discounting & bank charges

Once you’ve established that past trend & current cost situation are sustainable for future versus industry prices slope and ‘best of the best’ competitor, then and only then should you move to other performance improvement fundamentals. Else, cost control initiatives with respective domain should be prioritized.

Evaluating your competitive position

Market leaders typically outperform market followers on ROA; they have greater accumulated experience, leading to lower costs and superior customer insights, which in turn lead to higher profits. They thus have a greater ability to out-invest the competition in innovation, customer service, branding, and product support. To visualize your entity’s competitive position within peer, plot the companies in your industry according to their relative market share (RMS) and their returns on assets (ROA).

The ROA/RMS chart helps you narrow down your options for performance improvement. There are five generic positions: in-band leaders, in-band followers, distant or below-band followers, below-band leaders, and overperformers. In-band leaders can raise the bar for competitors by investing in higher market share and improved offerings. In-band followers usually need to work hard just to keep up and Below-band companies have probably not been managing their costs down the experience curve. Overperformers, need to check in whatever has enabled them to escape the pull of the band, and see they aren’t simply capitalizing on a temporary price umbrella.

Band analysis thus helps the leader determine whether the organization is achieving close to its full-potential performance. It can also be used for anticipating competitors’ improvement strategies as well. Mapping your organization against competitors is the first step toward seeing how each firm is making money or where it is failing to do so. It allows you to spot potential threats to and opportunities for your business, and to assess the strategic options available to others.

Part-1 Conclusion

By understanding the unique context of Small & Medium Enterprises, and designing a fool proof template for sense-making we build the right foundation for greater confidence and wider stakeholder acceptance when we proceed to taking calculated risks for strategic decision making with which we will deal next in part 2.