Top Ten Lists are ubiquitous at this time of year, and who am I to buck the trend?  Here are ten stories that grabbed my attention over the past 12 months:

1. The Canadian Dollar:
Good news in the short term for importers and southbound travellers, but bad news, at least in the short term, for exporters, the Canadian Dollar is closing 2010 at, or close to par with the US Greenback. I was never a proponent of the low-value dollar policy adopted a decade or more ago by successive Liberal Governments at the federal level, since it excuses business process inefficiencies that creep in to many industries. The Canaidan economy appears to be responding well to the economic crises of 2008 and 2009 in spite of a high dollar (or a low greenback), and insofar as the high dollar increases consumers' buying power, I say "bring it on!".

2. The HST is Implemented in Ontario: 
Many of my colleagues will disagree with me, but I say the HST (Harmonized Sales Tax, which is a combination of the old GST - Goods and Services Tax - and the PST - Provincial Sales Tax) is a bad tax implemented at the wrong time for Ontario. It has its benefits (such as system simplification), but I do not believe for one minute that the HST will be the job-creation machine that our Province's Premiere claims it will be. The middle class is being ripped apart in Ontario, and the gap between the very rich and the poor is widening. This is just another level that the governments can pull to draw more wealth out from the beleaguered middle class. Besides, the manner in which the tax was introduced to Ontarians was underhanded, to say the least.

3. The BP Gulf Oil Disaster:
BP's initial estimates of the volume of oil leaking from the Deepwater Horizon site was 1,000 barrels per day. This estimate grew to 5,000, then 12,000, then 25,000 then 40,000 then 60,000 barrels of crude, or 2.5 million gallons per day, pumping into the Gulf. The scars left on planet Earth are immeasurable. It was an abject failure of safety standards. In a move reminiscent of comments made by Snow Brand Milk's President Tetsuro Ishikawa on July 1, 2000 the the wake of a Japanese food poisoning catastrophe, BP President Tony Hayward says, "we made a few little mistakes early on", and his famous, There is no one who wants this thing over more than I do. I want my life back." (For the record, Mr. Ishikawa yelled eerily similar comments to a press gallery who were pursuing him for answers, "I haven't slept!". My heart bleeds for these poor folk.  
And today 12/30/2010 it is revealed by the Washington Post that the administrator of the $20 billion compensation fund set up for oil spill victims, Ken Feinberg, is paying an ethics professor from New York University to testify that he is independent of influence from BP. The madness never ends.

4. The Price of Gold:
As the year closes, the price of gold surpassed $1,400 CDN per ounce. I clearly recall sitting in the parking lot outside the Bank of Nova Scotia in Markham, Ontario with the intent of going inside to purchase $20,000-worth of gold bullion at $800 per ounce about three years ago. I talked myself out of it, as too risky a venture. Stupid, stupid stupid.

5. The Toronto Mayoralty Race:
In October, the City of Toronto made a monumental decision in electing conservative candidate Rob Ford. After years of hubris, waste and arrogance at City Council, Ford's message was simple: "I will stop the Gravy Train." Ford promised that City Hall would, subsequent to his election, respect the taxpayer, and that all staff would focus on the needs of the citizens. What a novel idea. There were many interesting sidebars to the election, which included the Toronto Star newspaper's unabashed support of candidate George Smitherman, and their raw hatred of Mr. Ford, Smitherman's attempts to distance himself from the notorious eHealth scandal which occured during his watch as Minister of Health and Deputy Premier with the Ontario Government, Councillor Kyle Rae's inexcusable retirement party, where $12,000 of taxpayers dollars were wasted, and mud-slinging extraordinaire at Mr. Ford. It is my hope that Toronto will become a more business-friendly jurisdiction as a result, with more value being delivered to the community.

6. eco-Fees in Ontario
Hot on the heels of 2009 spending scandals from eHealth and the Ontario Lottery and Gaming Corporation, where it was found that crown corporations / agencies were wasting billions of tax dollars with little or no return and certainly no oversight, the governing Ontario Liberal Party found itself stuck in another tarpit. While the Libs were foisting an unpopular HST on the public, a new set of so-called eco-Fees were applied on over 10,000 products effective July 2, 2010 without warning. Here was an example of taxation without representation if we ever saw one. It would be kind to say that the tax was applied arbitrarily and unevenly. Eco-fees were being applied to grass seed, sun block and vitamins among  other such toxic materials. The fees provided no incentive whatsoever for vendors to bring products to market in an environmentally friendly manner. Eventually, public pressure forced the government to back down and the eco-Fees ended up in the junk yard.    :

7. The Recovery of General Motors:

Many of us were digging the grave for GM to fall into - in 2008, it appeared to be just a matter of time. But we must extend credit when credit is due. The Wall Street Journal Reported yesterday 12/29/2010: 

"In a series of bullish reports from banks involved in GM's initial public stock offering last month, the analysts predicted GM shares would hit anywhere from the low $40s to $50 within the next year. GM stock has been trading in the low- to mid-$30s and closed Tuesday at $35.32 in New York Stock Exchange trading, up 72 cents.

But even the most optimistic prediction would have the U.S. government losing money on its $50 billion bailout of the auto maker last year. To break even, the U.S. must sell its remaining GM shares at around $53 each.

The reports come as GM and its stock underwriters are increasingly optimistic that the Obama administration will sell most or all of its remaining stake next year, rather than offloading shares gradually over the next few years. The U.S. Treasury reduced its GM stake to about 33% from 61% in the $23.1 billion IPO."
 
Great news for my friends in Oshawa and St. Catharines, and even a confirmed Hyundai owner like myself was impressed with some of the new GM products, including the GMC Terrain and Chevrolet Equinox. Congratulations, and keep up the great work. 

8. The Eruption of Icelandic Volcano Eyjafjallajökull
Thank goodness that the human cost of this disaster was minimal. However, the volcanic eruption disrupted travel and exposed flaws in supply chains around the world. With JIT and Lean processes in place, it is more important than ever to plan for potential disruptions. Firms must look for vulnerable spots in their supply chains and plan and practice evasive actions.   

9. Potash Corporation:
A staple of the Saskatchewan landscape for decades, August of 2010 saw Australian mining giant BHP Billiton mount a $40 billion hostile takeover bid of the Canadian PotashCorp. The bid was considered by the Federal Government for some time, amongst considerable drama. Finally, Industry Minister Clement announced in December that the deal was effectively dead.  

10. After some deliberation...
It was difficult for me to select my tenth story this year. On the short list were rising energy prices in Ontario, the meltdown of economies in Europe including Greece, Ireland, Spain and Portugal, the growing trend of co-opting of the term "green" to justify all sorts of consumer rip-offs, the suicide of Mark Madoff and the tragedy that was his father, and even the continued meltdown of the Tiger Woods Empire. In the end, I decided to go with what has almost been a non-story: the strength of Canadian Banks and the Canadian Banking System. In Canada, we love to hate our banks, and often with good reason. They charge us with userous credit card interest, exhorbatent user fees for account maintenance, and offer measly interest rates on savings of less than 1%. But, their strength, and the strength of the system, carried Canada through the Recession that endured from late 2008 through most of 2009. I am thankful that our economy did not collapse, and that my savings were relatively safe throughout. I was thankful that I was able to proceed through the last two years being able to make normal transactions in my accounts with no interference. And I am thankful that I have made the right deciions regarding my savings for my children's education. So, I somewhat begrudgingly give a thumbs-up to our banks - even if we the public do have to carry the bankers on our backs to the Champagne Bar on Friday afternoons.
 
Cheers!, and Happy 2011.

JDS 

This is just a quick note to wish all of my readers and their families and friends a very Merry Christmas, and the happiest of Holiday seasons. I wish you, and your businesses, a healthy and profitable 2011!
Cheers!
John

The New York Times reported this week that NY Attorney General Andrew Cuomo sued Ernst and Young on Tuesday, accusing the accounting firm of helping its client, Lehman Brothers, to "engage in a massive accounting fraud" by misleading investors regarding the financial health of the investment bank.
 
It seems that Ernst and Young approved a controversial accounting maneuver known inside Lehman Bros. as "Repo 105", which involved the "surreptitious removal of tens of billions of dollars of securities [debt] from Lehman's balance sheet to create a false impression of Lehman's liquidity, thereby defauding the investing public". The NY Times reported that this tactic temporarily removed as much as $50 billion from Lehman's balance sheet to give the appearance that Lehman had reduced its debt levels. 

Cuomo referred to the practice as a "House of Cards business model, designed to hide billions in liabilities before Lehman collapsed." The shock waves were felt with great pain around the world.  

The "repo" transactions, variations of which are employed ubiquitously on Wall Street, occur when an investment bank raises cash by selling assets, then buying them back a few days later. These transactions would typically occur just before the close of the books at the end of financial quarters.
 
Ernst and Young argue, of course, that such transactions are allowed under GAAP (Generally Accepted Accounting Principles). I am not an Accountant, and as such cannot express an opinion one way or the other. But this certainly fails to pass my ethical "sniff test": is management interfering in the normal patterns of business in an extraordinary way in an attempt to distort reality and otherwise mislead stakeholders?   

There is an analagous practice which occurs frequently in the Canadian retail, wholesale, and manufacturing supply chains. From the point of views of the industrial customer, this is called "forward buying." It works something like this:

As a manufacturer or wholesaler approaches its fiscal period end (month, quarter, or year), management realizes that it is about to fall short of its sales targets. It creates incentives for its customers to buy product in quantities that the customer would not normally need. These incentives are frequently expressed as reduced cost prices or discounts from contracted prices, if the customer will buy quantities prescribed by the seller. The customer, let's assume that in this case it is a retailer, performs a quick analysis of the "deal" (comparing the reduced prices to the related inventory carrying costs, for example) and arrives at a decision to buy or not buy the incremental quantities. 

Incentives need not necessarily come in the form of reduced prices. Occasionally, they can come in the form of an "exchange of favours" by individuals in senior management, extended payment terms, and a variety of other arrangements. 

As a professional inventory manager, I have always argued strenuously against this technique. Not only does it open the seller/customer relationship to unethical practices, but the true costs of such transactions are frequently overlooked. From the seller's perspective, I call it "mortgaging the future" to relieve current pain.  

It often takes a long time for conditions to develop which lead to offering such deals, but once the firm is on the merry-go-round it is very difficult to get off. It is like a heroine addict who receives great pleasure and results from the first hit, then spends a lifetime trying to replicate that first feeling.

Pretend that Wholesaler ABC has enjoyed 50 years of relatively stable growth, with sales averaging +5% growth annually. Senior management at ABC sign on to a +5% budgeted sales increase for 2010. Shipments in 2009 were 100,000 cases of widgets. ABC must therefore ship 105,000 cases in 2010 to meet their sales target. The average price of a case is $1,000, so annual sales in 2009 were about $100,000,000. 

Significant unexpected changes happen in the marketplace in 2010. Such changes might include the entry of new competitors, a softening of the macroeconomy, a change in consumer tastes, or government legislation. Whatever the negative issue, sales for ABC start to trend downward, at a rate of 95% of the prior year's volume. Management at ABC either ignore the slide, or dismiss it as a temporary "blip", or are completely unaware of it due to flaws in their sales analysis system.     

On Dec.  1, 2010, the sales trends hit management at ABC like a shovel in the face. Not only are sales down relative to last year, they will never make budget! In fact, the gap between actual and budgeted sales looks like it will be 10%! (5% vs.LY + 5% growth). After 11 months, they realize that their shipments will be about 95,000 cases, versus a target of 105,000 cases and the shortfall is therefore about 10,000 cases ($10,000,000).

Management panics. It's "Let's Make a Deal" time at ABC. They approach their top two customers, Customer 123 and Customer 456. If each of these two customers buy an extra 6,250 cases, to be shipped before December 31, 2010, ABC will extend a 20% cost discount on the incremental purchase. (6,250 x 2 x $800 per case = $10,000,000 = sales shortfall).

On Dec. 15, 2010, both 123 and 456 agree. The incremental purchases represent about 3 months' worth of stock at each of Customer 123 and Customer 456. Ultimately, ABC achieves their 2010 sales target.

What are the costs of this deal to ABC?

One might answer, correctly, that ABC has lost potential gross margin dollars of 12,500 x $200 / case = $2,500,000. Incidentally, ABC had  to ship 12,500 cases, and not just the "gap" of 10,000 cases, because the selling price has been reduced to $800 per case rather than the contracted $1,000 per case. So, 12,500 x $800 is enough extra volume to make up the shortfall in dollars. 

But, there are other costs to ABC. Since they are shipping an extra 12,500 cases, which is about 4 weeks of normal stock, in the last two weeks of December, they are cramming 6 weeks of work into 2 weeks. This means extreme pressure on operations.
- overtime might have to be paid to warehouse workers
- inbound product (e.g. subcomponents or raw materials) might have to be expedited. ABC have to incur air freight and premium routing costs in order to ensure backorders are not accumulated?.
- standard manufacturing or assembly maintenance procedures might be foregone, as lines are dedicated to increased production or assembly.
- standard Health & Safety considerations might be overlooked in the month-end rush. Might there be a higher risk of accident, injury or burn-out?
- this is Christmas Break time, and the extra work could effect employee morale.
- integrity of inventory record accuracy and inventory control measures might be compromised in the rush to finish paperwork.

At the end of the day, is ABC any farther ahead? In many cases, the answer to this is "no." Their Big Customers, 123 and 456, have simply "bought forward" 3 months' of supply. They now have surplus. They will simply shut down their purchasing for 3 months, until the surplus is reduced to normal levels. At the end of the First Quarter, therefore, Supplier ABC is in even worse shape than they were in December! The gap between actual sales and budgeted sales widens further. 

Besides, ABC has now misled their investors, by overstating their sales potential, and the financial health of their company.

Unless ABC is willing to tackle the underlying causes of the 2010 sales erosion (competition, style, or legislation) ABC's financial condition will continue to worsen. 

Customers become perturbed as well! Customers 123 and 456 now have surplus. Their careful management of inventories for the past 11 months has now been eradicated. Their warehouses are strained to find homes for the extra inventory. They are exposed to shelf-life issues, increased risk if shrink, and increased risk already associated with forecast accuracy.
 
I have see situations where Customers 123 and 456 end up returning the surplus stock! What a disaster for everyone!

There are too many reasons not to jump on merry-go-rounds of this nature. Do the right thing: address the underlying problems and take your lumps when you have to do so. But do not matrgage the future with schemes such as these.    


  

     

Greg Walsh, a minor league hockey coach in the city of Peterborough, Ontario, was recently suspended for pulling his team off the ice during a November 15th, 2010 Midget Class hockey game. This violated Hockey Canada and league rules, and officials suspended Walsh for the balance of the season. For good reason, hockey league officials don't want coaches to nonchalantly withdraw their teams from competition because they don't like the colour of the referee's hair. Mr. Walsh's  motive? One of his young (16 years of age) players suffered verbal abuse on the ice, as an opposing player uttered racial slurs in an effort to throw Coach Walsh's player off his game. When game officials allowed the offending miscreant back on to the ice, Walsh withdrew his team from the game. 

Eventually, the offending (and offensive) player received a three game suspension. For his uncompromising support of his player, and in a valiant show of team solidarity, Coach Walsh was handed a one year suspension, "for breaking Hockey Canada rules".

In the wake of the suspensions, many have argued that the one-year penalty was unfair. Many argue that the league ought to use some discretion, and forgive Walsh's violation. No young player should be compelled to play in unsafe, or abusive conditions. 

However, Mr. Walsh pays a steep price for his actions. I heard him interviewed on radio today, and he does not sound bitter. He would have done the same again, given similar circumstances. He has shown great class, and in the face of a flawed rule book, decided that he was willing to pay whatever price was necessary to DO THE RIGHT THING. 

Frequently, there is a price to be paid for having the courage to act on principle, and to exercise good ethics. This is true in sports, in society, and in business. 

The price of unethical behaviour can be even more dramatic. Mark Madoff, son of disgraced fraud artist Bernie Madoff, committed suicide last weekend. Some feel that he was in father Bernie's inner circle, when Dad was bilking widows of billions. Father Bernie os rotting in jail for the rest of his life, and his name will be forever linked to all that is wrong with the American financial system. His son has killed himself. A costly venture indeed.

Ethical dilemmas are seldom as cut-and-dry as the examples referenced above. This will be the theme of my next few postings.   

Consider the following four scenarios:   

Scenario A:
A man has worked for a major player in the financial services industry for over ten years. He has accumulated considerable expertise, is very reliable, and has become the "go to" guy within his department. He is reliable, honest, a team player, and has a great work ethic. He was recruited into the company, in part, on the promise that the company was utterly committed to the value of "promotion from within": if you are talented and make an enduring contribution, you will advance. His paycheck is satisfactory, but unspectacular. After receiving a few modest raises and level advances in his first five years, his career has stalled. The business is successful. The employee has noticed that HR has developed a habit of hiring new MBA graduates, fast-tracking their careers, and rapidly promoting the new hires to senior executive positions such as Assistant Vice President within one or two years. He, and many others like him are routinely bypassed. He has been told to "be patient, and good things will come to those who wait." Last month, he applied for a new position within the company and his credentials matched the position exactly. A new MBA was hired into the position, directly from University. Behind closed doors, the Vice President of HR has been told by expensive consultants that MBA's must be hired to ensure that the company stays in tune with new industry trends and best practices. On the other hand, if the company rescinds the "promotion from within" policy, they will lose considerable expertise when fed up employees look elsewhere. 

Scenario B:
A large North American retailer, who has dominated the landscape for decades, is faced with fierce price competition from a new entrant into the industry. The new competitor has two distinct advantages over the older established firm: a superior logistics network which replenishes stock more quickly and efficiently, and a supplier/vendor network that is based primarily in southeast Asia. By sourcing from Asia, the new company takes advantage of labour and manufacturing costs that are one tenth of that in North America, where the established company has most of its vendors. The older retailer decides that it must aggressively develop vendor relationships in Asia to drive its costs down. Many of the vendors that it meets routinely use child labour. The vendors argue that this is culturally acceptable in Asia, and it is the only way many families can escape poverty. If the retailer turns away from such supplier opportunities, they will be unable to meet or beat the new competitor on price. Customers are flocking to the new retailer by the thousands.

Scenario C:
A European manufacturer who has been in business for centuries is facing intense competitive pressure. A major player in their market, who is in worse financial shape than they are, has decided to relocate manufacturing facilities in SE Asia. Labour costs are 90 percent lower than in their old traditional plants in Europe. Our company decides to follow suit. Their brand name has a strong association with the neighbourhood in which they have manufactured for several generations. Our company's marketing team assures the Executive Team that the brand image will not suffer, since the Asians can produce high quality product, and profit margins will skyrocket. Our company decides to sink tens of millions of dollars in setting up a set of factories in SE Asia, like the competition. The little European town where the company grew up is decimated, as our company has been the major employer in that area for more than 200 years. Supply of product to the key North American and European markets is damaged for months in the transition period. Inventory stability is destroyed. Consumers clue in to the fact that goods produced under our company's brand name is no longer from that little European town with a great reputation for craftsmanship. Our company's reputation as a producer of prestige product is at risk.     

Scenario D:
 A new Vice President is hired in to a retail company who is struggling to achieve former glories. The new woman's credentials are impecable. She is experienced, skillful, and possesses great drive. She works hard with her staff to build an internal analytical infrastructure to guide buyers in their appreciation of the impact that purchasing decisions have on inventory management, gross margin, ROII, and company profitability. Some buyers had to be terminated for refusing to accept the new direction. In the fullness of time, the changes start to take root, and ROII begins to recover. The new VP is rewarded with a new car, raises in salary and richer benefits. She goes on a Buying Trip in Asia. While there, she ignores the new buying infrastructure and decides to go with her "gut feel". She spends too much money on new inventory. Far too much money. This crushes the frail financial recovery that the company has recently enjoyed, and sends it on a downward spiral to bankruptcy. The VP is fired, but walks away with a $1 million severance. The employees are now out of work, and the company's assets are sold.   

These scenarios are loosely based on fact. 

How might a strong sense of ethics have helped resolve these problematic stuations?      
  

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