What do golf tournament payouts and executive compensation have in common? More than you might think. For starters, both offer rewards based on relative — as opposed to absolute — performance, and research shows that the bigger the purse, the harder people play.
Moreover, a review of executive compensation reveals that the economic theory of tournaments may justify the blueprint and the level of executive pay, and this is just one of the ways that economists are using sports data to test business theories.
“We can learn a lot about human nature, motivation and beating the odds by studying copious data from the world of sports,” says Dr. Stephen Shmanske, professor emeritus of economics at California State University, East Bay.
Smart Business spoke with Shmanske about what business leaders can learn from economists who use sports data to test market efficiencies and business theories.
Why are economists studying sports?
An abundance of accessible, high-quality data has made it possible for economists to study the management, turnover, performance and compensation of professional athletes and correlate the results to a wide range of economic and business theories. For example, economists can review the results of golf or tennis tournaments to determine the optimal way to structure sales contests or other incentives.
An early study looked at the impact of pay discrimination, in which economists compared whether men and women perform differently based on prize structure. The researchers found no differences in performance when the participants were vying for the same purse.
What does an in-depth analysis of sports gambling reveal about market efficiencies?
Various analyses have revealed that stock and gambling markets are equally efficient because all relative information is captured and considered when the betting line or stock price is set. In other words, the company’s management team, competitive position and future earnings are considered when investors decide how much to pay for a share of its stock.
Likewise, odds makers consider each golfer’s strengths and weaknesses and the course layout when they set the tournament betting line. The odds and share price shift based on changes in demand or circumstances leading up to the event. Because both markets are efficient, you’ll need luck or inside information to consistently beat the odds.
What is the Tiger Woods effect, and what can economists learn from this phenomenon?
A study examined whether Tiger skewed the odds or the wagering volume when he played in a tournament, which is similar to a thin market versus thick market effect. Although more people bet on Tiger when he’s the favorite, and they bet on the field when he’s not, those scenarios were consistently factored into the odds. If greater amounts are wagered on a tournament, it might allow the casino to offer more favorable odds, much as transactions costs, measured by bid-ask spreads, are lowered in thick markets. The study concluded that gambling markets are efficient because odds makers consider Tiger’s participation.
What can we learn about profitability by studying golf wagering and bettor biases?
One of the themes in existing literature concerns whether there are identifiable biases in bettor behavior or in posted odds that can lead to positive profit strategies. Studies show that there’s no way to increase profitability by taking shortcuts, employing arbitrage betting techniques or contrarian betting algorithms because the markets are efficient. In fact, there’s no secret market intelligence or formula that increases profitably when taking risk, because the favorites generally return less on every dollar wagered but win more. You need luck to beat the house and anyone who says they have a surefire system is mistaken.
What can we learn about predicting winners and losers?
Certainly every fan has an opinion about who might win or lose a tournament but the odds makers have access to the same information. They factor in players’ injuries, outing tendencies and even the weather forecast when they set the line, and they’re right most of the time. It’s like trying to predict whether the price of a stock will rise or fall by monitoring the trading activities of insiders when the information is released to everyone after a transaction. It may be possible to consummate an advantageous stock purchase if you have exclusive information about a new contract or product release, but while you might make more money, you could wind up in jail.
How are economists using sports data to test other business theories?
The theory of tournaments is often applied to compensation since economists can see how various structures and payouts impact individual motivation and performance. For example, top golfers tend to focus and put forth their best effort because sinking a put or managing to birdie the next hole can earn them an additional $100,000. While lower performers may only earn $200 for shaving a shot or two off their score so they’re inspired to preserve and improve their technique, in hopes of earning a bigger payout next year. Similarly, vice presidents are inspired to go above and beyond because they want to ascend to the CEO’s chair. What we can conclude is that the size of the prize does not guarantee absolute performance in any one match, but it does raise the absolute standard over time.
Dr. Stephen Shmanske is professor emeritus of economics and director of the Smith Center for Private Enterprise Studies at California State University, East Bay and the author of Golfonomics. Reach him at firstname.lastname@example.org.
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It’s not surprising that the cost of labor was cited as the second-largest executive concern in CFO Magazine’s Global Business Outlook Survey, as the total cost of employee compensation often accounts for 40 percent to 70 percent of a company’s operating budget. The challenge is in finding a way to attract, motivate and retain top performers without breaking the bank.
“You can’t succeed by taking a one-size-fits-all approach,” says Jed DeVaro, Ph.D., chair of the Department of Economics, College of Business and Economics, at California State University, East Bay. “Companies need to analyze historical data, elicit employee preferences and strategically allocate expenditures to maximize their return on employee compensation.”
Smart Business spoke with DeVaro about the process of aligning employee compensation with critical business goals.
How can aligning compensation boost the success of major business initiatives?
While compensation alone won’t ensure the attainment of the business plan, customized, strategic alignment of total rewards increases the likelihood of success. The key is taking a data-driven approach so that pay and benefits are allocated toward the positions and workers that yield the greatest return, require in-depth training or who are difficult to source.
Most companies are sitting on a treasure trove of historical data, making it possible to ascertain the cost and output for each position at specific tenure levels and strategically apportion compensation to yield the best return. For example, you probably need to pay market rates for software engineers and project managers because unplanned turnover of these scarce professionals can increase development costs and the productivity of these professionals increases over time. However, you may be able to pay below market for customer service agents who reach maximum productivity levels within a few weeks.
In addition, a review of previous successes and failures helps companies tweak designs and allocate expenditures toward programs that have successfully attracted, retained and motivated top performers in the past.
How can early stage companies gather the necessary data to calibrate compensation?
While the basic tenets of the compensation alignment process remain constant, early stage companies need to adapt their approach due to a lack of historical data and their need to attract and retain nontraditional candidates. For example, startup firms often want energetic risk-takers who are willing to accept a smaller salary in exchange for stock options.
It’s important to gather current market intelligence instead of waiting until turnover occurs or relying on third-party wage surveys that are often out of date. Human resources can help ascertain competitive positions and employee preferences, and proactively design an effective plan by following up with lost candidates, conducting exit interviews and informally surveying referred candidates.
What kinds of compensation practices can boost employee retention and productivity without breaking the bank?
Employers often think they have to pay top dollar to attract, retain and motivate employees, when these innovative, budget-friendly techniques are equally effective.
- Positive work environment. Being nice to your employees may not be the first thing that comes to mind when you consider compensation strategies, but workers are less likely to leave or become disenchanted if they feel appreciated and appropriated challenged. Salary usually comes in second or third in surveys of employee preferences, while a positive work environment is often their top priority.
- Reasonable hours. Even if you can’t give large raises or bonuses, you can boost hourly pay for salaried employees by reducing their work hours and letting them go home instead of scheduling a two-hour meeting for 4 o’clock on Friday.
- Customized benefits. Instead of offering the standard fare, optimize benefits expenditures by creating programs that resonate with your employees and your prospective talent pool. For example, young tech workers may prefer career development, training and certification stipends, while more mature workers with family obligations value flex time and a robust retirement program.
- Team incentives. Group incentives boost overall performance by encouraging top performers to mentor and train neophyte or less-skilled workers. Team incentives aren’t a substitute for individual rewards, but they serve as a rising tide that raises all boats.
- Deferred compensation. When strategically applied, deferred compensation can help employers retain scarce-knowledge workers or control the exodus of retirees to coincide with long-term business cycles or shifting labor market conditions. Examples include unvested stock options, which act as a cost lever by slowing or hastening the departure of employees.
What else can employers do to maximize their return on total compensation?
First and foremost, listen to your employees, because they will tell you what they value and whether they’re motivated by raises, bonuses or other perks. Informal conversations are the best way to gather intelligence because employees can become disgruntled if employers conduct surveys and then disregard their opinions. Second, ensure that top performers receive the largest raises and bonuses relative to actual, observable differences in productivity. Awarding raises based on discretionary criteria or a manager’s desire for reciprocal favoritism in 360-degree surveys can result in pay inflation or compression and erode the efficacy of a pay-for-performance program.
Finally, treat employees well. It’s easy for executives to lose sight of the fact that compensation goes beyond salaries and benefits. A positive work environment and a windfall of free time may be more valuable than working 60 hours a week for a nominal raise.
Jed DeVaro, Ph.D., is chair of the Department of Economics for the College of Business and Economics at California State University, East Bay. Reach him at (510) 885-3289 or email@example.com.
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Most companies want to grow, the issue is just how and when. And determining an advantageous growth strategy can be challenging for executives. Less than 1 percent of companies ever reach $250 million in annual revenue and fewer still eclipse $1 billion. Unless you judiciously evaluate your options and select the right growth strategy, your small business may stay that way.
“Some companies boost revenue through organic growth while others diversify their products/services or build strategic alliances,” says Yi Jiang, assistant professor and associate director of MBA for Global Innovators for the College of Business and Economics at California State University, East Bay. “The key is understanding your options and selecting a growth strategy that fits your situation.”
Smart Business spoke with Jiang about growth strategies and what executives should consider when making a selection.
How have growth strategies evolved over time?
History and experience have altered our thinking about growth strategies. For example, vertical integration was a popular diversification strategy in the 1960s and 1970s. Companies decided to boost profits by expanding into upstream or downstream activities, thereby seizing control of the entire supply chain.
Oil companies were among the first to embrace vertical integration. They ventured beyond traditional petroleum exploration activities by purchasing refineries and distributors. However, the strategy’s popularity waned when several large, multinational companies were accused of monopolistic practices and their diversification efforts were thwarted by U.S. and European anti-trust regulations. In addition, many companies struggled to manage a slate of unfamiliar entities.
As a result, smart companies turned to building a network of complementary offerings to create synergistic expansion opportunities and economies of scope. For example, Amazon boosted e-book sales by introducing Kindle, and Sony grew from a tape-recorder company to an entertainment provider with a wide range of movie and music products, which helped it to edge out Toshiba in the format war.
What kinds of companies should focus on organic growth?
Niche companies with limited market penetration should focus on building brand equity before incurring additional risk by venturing beyond their core competencies. Organic growth maximizes existing resources and helps companies gain market recognition without diluting their brand. Organic growth is a good way to show the strength of innovation to investors who are interested in paying more for a strong brand with a loyal customer following and continuous growth potential.
The downside to organic growth is time. Executives have to be patient, committed to the company culture and willing to make additional investments without succumbing to the instant revenue gratification that accompanies cultural divergence.
When should executives consider strategic alliances?
Strategic alliance is a viable expansion strategy when the joined forces in technology development and market dominance benefit all players in the coalition. Google TV is an example of a collaborative effort in which a few strong players have united to make an even stronger team. Google, LG, Sony and Samsung are contributing technology and resources and joining market power in an effort to develop a smart television platform that may revolutionize the home entertainment industry.
The bottom line is: Why risk being left behind when you can be part of a winning team?
Are companies changing the way they view and integrate acquisitions?
We used to believe that fully integrating acquisitions was the best way to lower operating costs and reap the union’s financial rewards. But assimilation is tricky and executives often failed to meld disparate cultures and people.
Instead of making integration mandatory, companies should selectively and strategically integrate parts of an acquired organization. They may combine rudimentary functions such as distribution and accounting, while allowing areas of strength to flourish autonomously.
For example, Disney wanted to strengthen its market position with young boys by acquiring Marvel Comics’ cast of super heroes such as Iron Man, Thor, Captain America and the X-Men. However, if Disney execs were to force the influence of Disney’s culture on Marvel, Marvel’s brazen creativity would be stifled.
What should executives consider when selecting a growth strategy?
Time and timing are key considerations because organic growth and synergistic expansion tend to be slow and safe, while an acquisition or merger is risky but jumpstarts new growth. History shows that growth is rarely sustained when it results from knee-jerk reactions to unanticipated competitor moves or industry changes. Executives need time to build consensus and socialize their ideas, and half-hearted alliances or acquisitions often fail because it takes commitment and tenacity to work through the inevitable challenges.
CafePress, a San Mateo company that debuted on Nasdaq last month, has been growing slowly and steadily through both organic growth and acquisition. CafePress committed many years in organic growth and developed the strength in print-on-demand services. The acquisitions helped it to diversify the portfolio and establish a network of partners and customers. Without clear positioning and dedication, CafePress may have jumped into other services and diverted from its competence.
Lastly, even the best marriages sometimes fail. So with alliance or acquisition, executives should hope for the best but plan for the worst by developing an exit strategy to end the relationship and still be friends.
Yi Jiang is an assistant professor and associate director of MBA for Global Innovators for the College of Business and Economics at California State University, East Bay. Reach her at (510) 885-2932 or firstname.lastname@example.org.
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You need operating cash to grow your business, but securing a traditional commercial loan hasn’t been easy, especially for small business owners. Bank loans to businesses grew 10 percent in 2011; however, commercial lending has not returned to pre-recession levels, largely because companies that experienced a decline in sales or profitability can’t meet today’s strict underwriting standards.
Fortunately, Small Business Administration (SBA) loans are a worthwhile financing option for small to mid-sized companies. An SBA loan typically offers longer terms and more competitive interest rates than other commercial loans and, best of all, bankers can be more lenient when considering your request because the government guarantees up to 75 percent of the loan amount.
“An SBA loan is a sensible option for businesses that experienced a decline in sales and profits during the recession,” says Santiago “Chico” Perez, SBA sales manager for California Bank & Trust. “Bankers can consider your financial projections, along with historical data, when evaluating your loan application.”
Smart Business spoke with Perez about the growth opportunities for small to mid-sized business through an SBA loan.
When should small business owners consider an SBA loan?
New ventures traditionally have a hard time securing working capital, but you may get $100,000 to $5 million through a government-backed SBA loan, as long as you’ve run a similar enterprise in the past and propose a viable business strategy. You can also use SBA funding to expand by purchasing another company or using the proceeds to procure equipment or inventory to fulfill a new contract. Businesses that use an SBA loan to pay off or restructure an existing mortgage or other business debt can free up cash for other investments, such as hiring or purchasing supplies.
How do SBA loans differ from traditional commercial loans?
Generally speaking, SBA loans can offer more favorable terms than traditional commercial loans. For example, you only need 10 percent down to purchase real estate and you don’t need to come up with a lot of cash because the SBA lets you roll the fees into the loan balance. SBA loans feature higher loan-to-value ratios, longer repayment periods and no balloon payments; consequently, companies often qualify for higher loan amounts because they can amortize the purchase of buildings over 25 years or equipment over the remaining economic life, and therefore need less cash flow to service the debt. In addition, owners can use the funds to buy raw materials, as well as finished goods or equipment, which gives manufacturers the flexibility to expand into new markets.
How does the SBA’s underwriting criteria differ from traditional commercial loans?
Bankers will review standard requirements such as financial statements and credit reports, but some criteria differ from traditional commercial loans.
*Projections. Bankers can consider future sales as well as historical data when evaluating your loan application, but be sure your projections are realistic and correlate with your current financials and forecasts. For example, earnings won’t automatically double if you purchase a larger facility or new equipment. Instead, explain how the equipment will boost the bottom line by lowering operating costs or how you’ll use the extra space to increase revenue by adding a new production line. Finally, substantiate your claims by furnishing copies of customer agreements and contracts.
* Resumes. Tout your management team’s industry experience and track record, particularly if you plan to start a new business.
* Ownership. Owners with more than a 20 percent stake in the business must submit signed personal financial statements and tax returns.
* Down payment. Lenders must determine the source of a borrower’s down payment, even if the funds have been deposited into an escrow account.
* Collateral. The need for collateral hinges on the loan purpose and program, so be sure to review the underwriting criteria at SBA.gov and specifically state the need and purpose for the funds in your proposal.
* Tax returns. Owners must supply three years of tax returns, financial statements and balance sheets instead of two to qualify for an SBA loan.
Does the SBA offer other support to small business owners?
The SBA provides myriad tools and support to help business owners create a loan proposal and navigate the underwriting process. Small Business Development Centers offer free assistance with financial, marketing, production and feasibility studies, and many centers engage local CPAs, retired executives and consultants to advise small business owners.
The SBA also provides mentorships, free counseling and business plan expertise through a nonprofit organization called SCORE, which helps business owners across the country with various aspects of their business.
What else can owners do to successfully navigate the SBA lending process?
Loan approval hinges on an accurate, thorough proposal, so it behooves you to take your time and seek expert advice because you only get one chance to make a great impression. Bankers want to hear the story behind your numbers, so be ready to explain how you overcame adversity during the recession and how you’ll use an SBA loan to take your business to the next level. Help your banker understand your customers and add value to your proposal by including links to your company’s website, LinkedIn page or Facebook page in your loan proposal. Finally, it may be possible to accelerate the process by selecting an approved Preferred Lender’s Program lender because they have the authority to approve your loan without submitting the entire package to the SBA.
Santiago “Chico” Perez is the SBA sales manager for California Bank & Trust. Reach him at email@example.com.
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Executives are jumping on the outsourcing bandwagon as cloud service providers promise unlimited scalability, reduced expenditures for hardware and IT staff, and the ability to offload software and routine maintenance at a moment’s notice.
In fact, Gartner analysts predict that 35 percent of enterprise IT expenditures will be managed outside the IT department’s budget by 2015.
But overzealous executives eager to jump to the cloud may encounter security issues down the road, as the security practices of the cloud service provider are often unclear — up to and including where the data is stored. A survey by Symantec shows that only 27 percent of companies have set procedures to approve cloud applications that use sensitive or confidential information.
“It’s easy to deploy data and applications to the cloud, but most executives don’t have a handle on the true risks associated with those decisions. So they fail to build the proper assurances into the procurement process,” says Brian Thomas, IT advisory services partner for Weaver.
Smart Business spoke with Thomas about the risks of outsourced computing services and why companies should seek an auditor’s assurance during the procurement process.
What are the specific risks associated with the cloud and outsourced computing?
Possible issues include data integrity, confidentiality, privacy and security, system availability and reliability, and data retention and ownership. But the threat level and mitigation strategies vary depending upon the importance and sensitivity of the data being processed by the cloud service provider.
It may not matter if you can’t access your sales prospects for a few hours if your hosted CRM application goes down, but business would come to a halt if your hosted e-mail or e-commerce system crashes. Therefore, the provider’s server redundancy and service-level contract guarantees may be the most critical risks to address, where in other cases, the primary concerns may be security and privacy issues. Certainly, regulated companies need to pay particular attention to how the cloud service provider addresses their regulatory risks.
How can executives identify outsourcing risks?
When considering cloud computing project ideas, executives should ask a lot of questions. First, they must understand the nature of the cloud services being procured and the sensitive aspects of the systems being hosted or managed by the provider. After getting an understanding of the types of data and systems that will be exposed to the cloud, executives should ask ‘what if’ questions of their project teams. Such questions should be focused on general risk areas including data integrity, confidentiality, privacy and security, and system availability and reliability.
Executives should also get an understanding of their company’s exposure to risks related to data ownership and retention. Examples of questions to ask include, ‘What will happen if we lose connectivity to our cloud service provider for an extended period of time?’ And, ‘What happens if our cloud service provider is acquired by another company?’
How can executives use an outside audit to ensure the performance of service providers?
A third-party assessment by a qualified professional is the only way to know whether a cloud service provider has designed and implemented effective measures to identify and mitigate relevant risks, as self reporting is inadequate and providers may simply tell you what you want to hear.
You can save money by having your auditor review a cloud service provider’s service organization controls (SOC) report. There are three reports available under the AICPA’s standards for service providers. SOC 1 is based on the Statement on Standards for Attestation Engagements No. 16 (SSAE 16) and is best suited for companies that previously used SAS 70 for Sarbanes-Oxley or financial audit compliance. SOC 2 addresses the design and operating effectiveness of a service organization’s controls over the security, availability, processing integrity, confidentiality and privacy of a system. This may be more valuable for executives evaluating the controls a cloud service provider has in place to address risks beyond those relating to financial reporting.
SOC 3 involves the same scope as SOC 2; however, the report contains less detail and is intended for broader (marketing) audiences.
When are SOC 2 and SOC 3 appropriate?
Executives should request that their cloud service providers submit a SOC 2 report where applicable. The scope is generally best suited to address the concerns of users of cloud services. SOC 2 reports provide details of the procedures executed by the auditor to test the controls in place at the cloud service provider, and the results of those procedures.
If a cloud service provider only has a SOC 3 report available, that may be sufficient for getting comfortable while evaluating the service provider during the procurement process. However, executives responsible for the cloud services should request that the service provider submit a SOC 2 going forward to ensure that they can monitor the provider’s efforts to address any failed control activities.
Are there other certifications that can help mitigate risk when transitioning to the cloud?
If the provider cannot provide a SOC 2 report, see if they are certified as ISO 27001 compliant or if they have obtained assurance reports from a security firm addressing the ISO 27001 standard. If the provider processes, stores or transmits credit card information, it is required to meet the Payment Card Industry’s Data Security Standard (PCI DSS). Be careful when using these other forms of assurance. Their scope is generally narrower than SOC reports and may follow less rigorous quality assurance standards. However, in the proper context, they can be useful for executives attempting to get information about the activities performed at the cloud service provider.
Brian Thomas is an IT advisory services partner at Weaver. Reach him at (713) 850-8787 or firstname.lastname@example.org.
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Although the stock market has rebounded, most defined benefit pension plans are still facing difficult decisions related to their retirement philosophy and related workforce strategy. General Motors, Sears and Bank of America are a few of the companies that have recently announced major plan changes, but even small and mid-size companies are reviewing their retirement strategy.
The underfunding and asset-liability mismatch continues to challenge plan sponsors. According to the 2012 MetLife U.S. Pension Risk Behavior Index Study, plan sponsors no longer believe they can rely on traditional portfolio diversification alone to meet future obligations; many are considering changes.
“Despite on-going cash funding of pension plans over the past 10 years, many plan sponsors still find their plans underfunded due to market volatility and low interest rates,” says Steve Parsons, FCA, MAAA, and principal with Findley Davies, Inc. “This situation has resulted in employers reevaluating their pension strategies. This evaluation process includes a review of potential changes to plan design, funding, and asset allocation strategies. Several have reduced their commitment via plan changes, plan freezing, or terminating a defined benefit pension plan.”
Smart Business spoke with Parsons about the current pension underfunding crisis and the possible solutions for plan sponsors.
Why has pension underfunding reached a crisis point?
Although pension portfolios took a hit during the 2008 market correction, the current crisis has really been brewing over the last 10 years. Marketplace volatility, low interest rates and changes in accounting procedures and cash funding rules have converged and boosted the number of companies with underfunded plans by 20 to 30 percent. The Pension Protection Act of 2006 reduced the opportunity for employers to have funding strategy options and now requires them to fund shortfalls over a seven-year period. The bottom line is that companies have taken this opportunity to reevaluate their retirement strategy and philosophy. As a result, employers tended to elect one of three paths: maintain their commitment to the current plan, keep their current plan with a reduced formula, or freeze their pension plan and shift to a 401(k) strategy.
When is freezing a plan a viable solution?
Defining options and strategy can empower an employer to properly align market competitiveness, cash funding strategies, and strategic work force plan. When evaluating a freeze to the pension plan, an employer should consider how the decision to freeze its defined benefit pension plan will impact talent acquisition, morale and retention down the road.
Freezing the pension plan can be accomplished several ways, including closing the plan to new participants, partially freezing the plan that protects older participants, or a hard freeze impacting all participants.
A soft freeze allows companies to grandfather the current plan for older employees based on age and/or service and move everyone else to a 401(k) plan. A hard freeze shifts the risk to all employees via a defined contribution plan from the plan freeze date forward. The transition may cost the employer more to shift to a 401(k) plan in the interim years as the employer continues to fund the pension plan while contributing to the new 401(k) strategy.
What are employers doing to target plan termination in the future?
Terminating the plan and providing a lump-sum payment or purchasing annuities with the proceeds is certainly an option for participants. But given today’s low interest rates, most companies need to provide additional funding to purchase annuities that fulfill their long-term pension obligations. The key is connecting your actuary, financial staff, and investment advisors, defining the glide path and seeing when it might be advantageous to pull the trigger. We could see higher interest rates or get regulatory relief down the road, impacting the timing of the decision. As of now, about a third of our clients are committed to their current plans, a third have frozen their plans and shifted the risk of retirement planning to employees, and a third are still considering whether to freeze or terminate their defined benefit plan in the future.
Should employers be considering other solutions?
Employers should redefine their pension strategy in relation to total rewards and how they want to allocate internal resources in the future. For example, administrating a frozen plan may not be the optimal use of internal staff and resources. They will also need a comprehensive communications plan to explain pension plan changes to current staff and retirees. If stakeholders will be assuming responsibility for selecting investments and planning for retirement, they should be given the opportunity to provide feedback through a compression planning process. All of these issues must be considered and addressed before a company decides to freeze or terminate their defined benefit pension plan.
What’s the best way to evaluate the various options and select the right solution?
Consider how each option will impact the company and employees both short-term and down the road, because among other things, companies may no longer be able to control turnover or the timing of employee retirements if they switch to a defined contribution plan. Examine the impact of the change on administrative policies and procedures to determine the cost benefit of internal versus external management to minimize cost and liability. For a frozen or terminated plan, allow sufficient time for the transition, because employees will need considerable education before they’re ready to take the reigns of their retirement planning process. Finally, don’t be hasty. The solution to the pension plan crisis is different for everyone and changes can be reevaluated down the road if the pension plan is maintained in either an active or frozen state. This will give employers options for future work force issues and strategies.
Steve Parsons, FCA, MAAA, is a principal with Findley Davies, Inc. Reach him at (216) 875-1924 or SParsons@findleydavies.com
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Despite a stabilizing economy and a letup in the banking crisis, small community banks approved approximately 47.5 percent of commercial loan applications in January, while banks with more than $10 billion in assets approved just 11.7 percent, according to Biz2Credit.
In comparison, lenders like community development financial institutions, accounts receivable financers, merchant cash advance companies, micro lenders and others approved more than two-thirds of applications from potential borrowers. The data confirm that executives have to be resourceful and think outside the box to secure the funding they need to expand their small or mid-size business in today’s tight credit market.
“Executives may be forced to restructure, cede market share or relinquish prime opportunities unless they avoid a short-term cash crunch by securing alternative funding,” says Eric Fricke, assistant professor of finance, Department of Accounting and Finance at California State University, East Bay.
Smart Business spoke with Fricke about the ways to finance growth by tapping alternative funding sources.
How can alternative financing help small and mid-size companies grow?
It’s great when a small business consummates a big sale, but it often ends up being a catch-22, because small and mid-size companies may not have the cash to purchase equipment or inventory to fulfill a substantial order. Alternative financing provides up-front capital when traditional commercial loans aren’t available. Best of all, the loans are scalable and may be easier to secure because they’re tied to a specific asset or invoice, so you may not need to submit a full business plan, financial statements and cash flow projections as is normally necessary to comply with today’s strict underwriting requirements.
When is alternative financing appropriate?
Alternative loans are perfect for businesses that have predictable cash conversion cycles. For example, importers and exporters have to advance cash to purchase products, and then wait until they reach stores and finally sell. And retailers and restaurateurs may have immediate needs for cash but can’t wait for future credit card transactions to finalize. Companies can close the gap in cash conversion cycles by securing a loan tied to a particular transaction, like accounts receivable, inventory, machinery, equipment and/or real estate.
What’s the best way to research and uncover alternative funding sources?
Sometimes traditional banks offer asset-based loans and other forms of alternative financing. But, you can find additional sources by searching the Internet or contacting your industry association and equipment manufacturers, since some vendors offer financing if you purchase their products.
What are the best sources of funding?
These are common sources of alternative funding.
- Asset-backed loans. Asset-backed loans are secured by collateral like accounts receivable, inventory or equipment and they may be easier to get because the lender may consider the credit worthiness of your customer. So, if you’ve sold a large number of T-shirts to a major retailer, a lender may be willing to lend you money against that invoice because of the retailer’s ability to pay.
- Equipment leasing. Equipment leasing is a popular option for companies with limited capital because the bank or equipment manufacturer purchases the equipment and leases it back to them in exchange for a monthly payment.
- Factoring. Factoring lets you sell your accounts receivable to a third party. The factoring company buys your invoice from you for an amount below the actual invoice amount. You get the up-front cash you need to fulfil the order and the factor collects the invoice once the transaction is complete.
- Merchant cash advance. This provides a lump sum cash payment in exchange for a percentage of future credit card or debit card sales. It facilitates cash flow because the lender deducts a portion of every credit or debit transaction until the debt is repaid.
What’s the downside to alternative funding?
Alternative loans tend to be more expensive than traditional loans, but the costs may be more easily allocated to certain customers, so you can more easily build the costs into the price of your products and services. Plus, the loan amount is scalable with your sales or a particular transaction instead of being tied to your net worth or cash flows. Some executives view the outsourcing of accounts receivable to a third party as a welcome benefit, while others like to maintain control of the collections process and client communications. But, for most owners, the benefits of accessing funds on an as-needed basis without navigating a grueling underwriting process far outweigh any drawbacks.
What else should owners know before pursuing an alternative loan?
Shop around, because the costs of alternative funding vary among banks and other financial institutions, and if possible factor the cost of your financing into your pricing. Finally, read the fine print to make sure you understand not only the costs, but also the process and timeline for distributing funds, since some lenders may collect receivables for you and delay dispersal of funds from risky sales orders.
Eric Fricke is an assistant professor of finance in the Department of Accounting and Finance at California State University, East Bay. Reach him at (510) 885-2064 or email@example.com.
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As if competing against corporate America and big box retailers weren’t enough of a challenge, smaller merchants have to contend with tectonic shifts in the way consumers shop and pay for goods and services.
For instance, e-commerce wasn’t a factor just 10 years ago, but in 2011, U.S. online sales reached $194.3 billion according to the Commerce Department, and more than 90 percent of online transactions are paid by credit or debit card. Gift cards are the latest craze, according to First Data’s “2011 U.S. Gift Card Consumer Insight Study.” So merchants need to stay abreast of the latest and greatest in technology to support their revenue goals.
“Offering customers multiple payment channels opens up new sales opportunities, and, best of all, merchant services provides the ability to increase revenue without investing in additional staff, technology or brick and mortar,” says Lynne Duke, vice president and merchant services manager for California Bank & Trust.
Smart Business spoke with Duke about the opportunity to cost-effectively attract new customers through merchant services.
How has merchant services evolved to meet shifting customer preferences?
When credit and charge cards became popular during the 1950s, retailers needed a way to accommodate their customers and provide payment alternatives, so merchant services was born. Over time, both the services and technology have evolved due to changes in customer buying habits and preferences. Today, even the smallest merchant can compete against giant e-tailers by giving customers the ability to buy products online; purchase, redeem and reload cards; and even use a smart phone or tablet app to pay for goods and services.
How can merchant services improve the customer experience and help small retailers compete?
Providing customers with every possible purchase or payment option increases customer convenience and satisfaction. This will make it more likely that they’ll be a return customer. Many customers prefer to shop online or avoid credit card debt by paying with a check or debit card, so by providing these payment options you’ll help ensure prosperity.
How do merchant services help boost the bottom line?
Business of all sizes are now able to cost effectively sell their products and services across the globe. The only requirement is to have a merchant account with Web access and online processing. In today’s market, there is no need to invest in pricey point-of-sale systems when you can easily transact business 24/7 by accessing a virtual terminal via a personal computer. If a customer requires mobile processing for events such as fairs and art shows, wireless terminals and technology support those venues.
Which merchant services are most helpful?
Merchant services provides solutions to meet business needs for many industries, and helps level the playing field between small and large merchants by providing several benefits:
? Robust online reporting: Provides a real-time view of sales transactions and detail for customized reporting, transaction analysis and trend monitoring.
? Online gateway/virtual terminal: Eliminates boundaries by allowing customers to complete secure online transactions using any major credit or debit card. A virtual terminal provides the best solution for the ‘card not present’ environment.
? Wireless solutions: Accept credit card payments and print receipts at trade shows, farmer’s markets and other remote venues through a wireless credit card processing machine. Smart phones are entering the race and provide another avenue for payment processing.
What should merchants consider when selecting a provider?
The industry is very competitive with a mostly generic product offering; however, pricing strategies for merchant services are complex and vary dramatically by provider. Consequently, merchants need to scrutinize proposals, review pricing components, calculate the effective rate and estimate the bottom line impact of each pricing model before selecting a provider. For instance, the options available today are bundled, tiered or pass through. Each includes a per-item fee and a discount rate. Each price plan carries its own pros and cons. Always be vigilant about hidden charges and know exactly how much you’ll be paying each month for merchant services before you sign a contract.
Service levels and reliability also vary by provider. Surprisingly, some of the biggest processors actually have the least favorable service. Will someone be there to take your call 24/7? Will you be talking to a bank employee or an offshore representative? How quickly will they respond to equipment failures? Ask to see a copy of the provider’s service level agreement, and make sure the provider has a solid reputation in the marketplace, because success abounds when you partner with a trustworthy merchant services provider.
Lynne Duke is vice president and merchant services manager for California Bank & Trust. Reach her at Lynne.Duke@calbt.com or (619) 446-2240.
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Although energy executives can’t control some factors that influence the IPO market — like economic conditions, global turmoil and interest rate changes — they certainly have the power to ensure their company’s readiness for the big event. Creating a scalable infrastructure well before a public offering not only helps private companies manage growth and thrive in a highly regulated environment, but it also ensures a smooth transition by imposing a diligent, sequential preparation regimen.
“Building a strong, scalable infrastructure helps private energy companies handle the growth that accompanies public registration in a well-managed, compliant fashion,” says Alyssa Martin, executive partner in advisory services at Weaver.
Smart Business spoke with Martin about the steps executives should take to proactively prepare their private energy company for an IPO.
Why is creating a scalable infrastructure the top priority?
You’ll crash if you try to build the airplane once you’ve left the ground, so energy executives need to proactively prepare their company for future growth by uniting people, process and technology to create a scalable infrastructure. Of course, it’s important to assemble an upper and middle management team of veterans with energy experience and public company expertise, but preparing for the event in an organized manner is vital, particularly in private companies that may have limited staff and resources. Otherwise, your team can become overwhelmed with trying to juggle their regular duties with a hefty list of complex, pre-IPO tasks.
A best practice is for senior management to create a roadmap to shepherd their staff through the daunting IPO preparation process, as well as enhance the private company foundation to become a company that is publicly fit.
What are the first steps in the IPO preparation process?
Start by enhancing your financial reporting capabilities so you understand the key critical risks and key performance indicators that drive the business. Timely, accurate and usable financial reports allow you to make informed business decisions, meet shareholder expectations and prepare accurate disclosure statements. In addition, the data will help you analyze trends and craft a strategy so you’re ready to answer questions from underwriters, attorneys and auditors.
These experts want to hear the story behind the numbers, including a description of the factors that drive the business up and down. They also want assurances that the company has the necessary procedures to comply with the regulations imposed on public companies.
Creating robust procedures is the next step because they emanate from the financial reporting system. The procedures will help you spot and report changes in control and material contracts, since public companies must demonstrate that they can comply with SEC reporting rules and stay ahead of disclosure requirements by creating a warning system that alerts them to reportable activities.
Once you have enhanced the financial reporting process and created robust procedures, its time to undergo a comprehensive risk assessment. A facilitated risk assessment not only helps your company comply with regulations like Sarbanes-Oxley, the risk analysis and response plan also allows your team to view the entire risk portfolio, agree on the priorities, and tackle mitigation and other related tasks in a logical manner.
It’s important not to overload employees during the IPO preparation or the early stages of implementing public company standards, since people can only initiate and absorb so much change at once.
How can private companies prepare for an IPO by instituting corporate governance practices?
Using external consultants to assess risk, conduct gap analysis and implement procedures helps private energy companies evolve from being lean, internally driven organizations to substantial, regulatory-driven public companies. Policies tend to be unstructured and undocumented in private energy firms, but internal audit consultants working under the direction of an audit committee can help institute written procedures and documentation guidelines.
This provides employees with a chance to form new habits and comply with governance practices well before an IPO.
How can private companies strengthen internal controls and IT systems?
In private companies, risk is usually managed at the process level based on comfort with the employee base. In public companies, it must be managed at the enterprise level first and then balanced through controls at the process level to comply with the strict guidelines for business operations and Section 404 financial reporting requirements.
Accordingly, it can take 12 to 24 months and a hefty financial investment for private companies to adequately strengthen their internal controls and IT systems to meet public company standards. Have internal audit consultants assess your internal controls, highlight areas of potential risk and provide recommendations for improvement. Then start early, so your IT staff has the bandwidth to implement the required changes while performing their regular duties.
Finally, facilitate a smooth transition by building control components into each step as you navigate the public company requirements.
Do you have any other tips to help energy executives prepare for an IPO?
Seek outside assistance and guidance before embarking on the journey from private to public status. External consulting experts who have travelled the path and understand your industry can help you navigate the process and reduce the chances of a false start. Prevent errors, costly rework and stress by tackling each step in the process logically and sequentially.
Finally, create a scalable infrastructure so your company is ready to handle the growth that accompanies public status.
Alyssa Martin, CPA, MBA, is an executive partner in advisory services at Weaver. Reach her at Alyssa.Martin@WeaverLLP.com or (972) 448-6975.
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A popular theory in the business world is that three decades of burgeoning environmental controls and regulations have strangled the economy and undermined our economic competitiveness. Given the buzz, it’s no wonder executives often prefer to do the bare minimum or delay regulatory compliance as long as possible.
But what if adhering to the planet’s highest environmental standards actually created a competitive advantage by allowing agile, mid-size firms to zoom past their monolithic competitors? And what if compliance led to reductions in manufacturing and distribution costs? Being proactive and viewing compliance as an opportunity instead of an obligation could be just what the doctor ordered to heal our ailing economy.
“Adhering to the highest environmental standards can inspire innovation and the development of cutting edge products, because it can force everyone in the organization to coalesce around ways to meet the most stringent requirements,” says Dr. Gregory Theyel, associate professor of Business Management at California State University, East Bay. He teaches undergraduates and graduates about environmental, social and economic sustainability and helps companies with business development and the introduction of sustainability into their daily practices.
Smart Business spoke with Theyel about creating a competitive advantage by treating environmental compliance as an opportunity instead of an obligation.
Why should executives consider adhering to the highest global standards?
First movers often have the upper hand in the marketplace, and developing a product that adheres to the highest environmental standards can allow you to sell it anywhere on the planet without changing the design or manufacturing process to meet disparate regulations. Plus, proactive companies have more time to adapt to new regulations and grab market share by appealing to green-minded customers and touting their environmental stewardship. Meanwhile, the laggards stymie production, efficiency and profits when they wait until the eleventh hour to find new vendors or secure alternate manufacturing materials.
How can companies spot opportunities to benefit from environmental compliance?
First, interact with stakeholders to find out what they care about and anticipate their needs. Second, observe social change and stay connected to the community, because environmental laws usually begin as social movements before giving rise to new policies and regulations. For example, after environmental concerns surfaced following the Fukushima disaster in Japan, Germany decided to shut down its 17 nuclear power stations by 2022. The law has spawned a spate of new ideas for producing environmentally safe power across the European Union. Finally, stay in touch with regulators and engage in the law making process to give you a preview of pending legislation and the chance to influence the regulatory process by sharing information and ideas with political leaders and committee members. Regulators often seek input and solutions from the business community when evaluating new laws.
How can companies use open innovation to solve sustainability issues and reduce operating expenses?
Don’t focus on just R&D or fixing a single problem; invite everyone into the discussion and rethink your entire innovation process and business model. By attacking the problem holistically, you may uncover opportunities to sell ancillary services, reduce production costs, boost margins or enter new markets. For example, when an electronics manufacturer needed to find a substitute coating for its wiring products, it brought in customers and members of the supply chain to brainstorm solutions. In the process, they created an environmentally safe, yet more pliable material that not only opened the door to new markets, but also reduced manufacturing costs by facilitating the consolidation of several production lines. This company didn’t focus on meeting the minimum standards; it was successful because it seized the opportunity to rethink how it does business.
How can executives orchestrate an attitudinal shift?
The idea is to weave compliance and innovation into the culture of the organization and ensure that everyone is looking out for new ideas and the advent of environmental regulations. Start by asking employees to interact with stakeholders and participate in industry associations, and by hiring employees with collaboration skills so everyone is capable of nurturing relationships and developing strategic alliances across the entire supply chain. The idea of excluding outsiders is old school; successful companies remove the barriers to innovation by inviting everyone into the process. They even collaborate with competitors when it benefits the entire industry, such as for infrastructure development or standard setting. Finally, examine every component and step in the manufacturing and distribution process to identify chemicals and activities that are harmful to the environment. Once you’ve created a list, stay ahead of new regulations by investigating alternative systems and solutions. In the process, you may uncover ways to reduce waste, negotiate lower prices for raw products, substitute nontoxic chemicals or consolidate distribution simply by viewing compliance as an opportunity instead of an obligation.
Dr. Gregory Theyel is an associate professor of Business Management at California State University, East Bay. Reach him at firstname.lastname@example.org or (510) 885-3078.