It Seemed Like a Good Idea at the Time…
My wife and I are in the throes of a bathroom renovation project. Our two daughters share a bathroom upstairs and it is in dire need of a complete overhaul.
If you’ve ever embarked on such a journey, you know that it’s fraught with expensive surprises (Note: any story containing both the words “fraught” and “throes” means there is serious danger ahead.)
To be clear, we are not even remotely thinking about selling our house, but it’s wise to keep an eye on value so “over-the-top” themes are out of the question (go ahead and google “unconventional bathroom theme” if you don’t believe me). Thankfully, my college-age daughters are ALMOST out of the “Disney Princess” phase.
We’ve all seen those home renovation shows where the homeowners make choices about what projects to take on to increase the value of their homes and there are lots of choices; some of them promise to increase the resale value of the house and some not so much.
Isn't that pretty much what the management of a company does?
Whether it's an acquisition, hiring a hot-shot salesperson, or a new warehouse in Walla-Walla, if it doesn't add value (the fancy word is "accretive"), it's not a good idea.
Most of you have heard this before but value is a function of the future benefit to be derived and the risk associated with deriving that benefit. In a company, that's typically measured by future cash flows and the risk, as measured by a discount rate (or "required rate of return") associated with generating those future cash flows. Note that I said "future" (actually said it thrice). You have to look ahead - and who is to say what the future holds? Yes, the past is certainly relevant but the lazy river behind you has little to do with the rapids ahead.
It's might be simple but it’s certainly not easy. Look, we’ve all done things that turned out well and some that turned out not so well and nobody has a crystal ball but having more than one perspective is generally a good thing.
Long ago in a galaxy far away, I worked on a bankruptcy/restructuring project where the managers of a company had invested tens of millions of dollars into a state-of-the-art facility that they believed would greatly reduce production costs, and accordingly, send gross margins rocketing skyward. Great idea, huh? I suppose it seemed like it at the time because management, the Board of Directors, the state legislature, and even the media touted the virtues of this plan as a “game-changer” and a “job-saver.”
The company borrowed lots of money, built the facility and even had a fancy ribbon cutting ceremony.
Here's where it all went south. The cost of this project was simply too great and nobody bothered to look things like the industry’s competitive landscape, energy and labor costs, and some environmental issues that had been long ignored. Moreover, the company had been steadily losing market share and revenue had been in freefall and ultimately, the company never came close to generating enough cash flow to pay their loans.
The project that was going to save the company actually sank it.
A gold-plated hot tub and a faucet that recites the Gettysburg Address might appeal to someone but it’s probably not a great idea as far as home resale value is concerned.
Look, I’m not in the business of saying “I told you so.” Truly, I’ve NEVER had a client hire me to them what went wrong but I have been hired to help quantify what COULD happen so that decision makers could make a more informed decision. As for the aforementioned company, they were already in a hole and kept digging with bigger shovels.
Clearly, management overestimated cash flow and underestimated risk. Sorry but that’s just bad mojo.
And now some words of wisdom from people who aren't me:
- "Experience is simply the name we give our mistakes." - Oscar Wilde
- “It is the eye of other people that ruin us. If I were blind I would want, neither fine clothes, fine houses or fine furniture.” – Benjamin Franklin
- "Sooner or later, everyone sits down to a banquet of consequences" – Robert Louis Stevenson
Be good and be well.
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