Leslie Stevens-Huffman

Sunday, 25 November 2007 19:00

Managing cash flow

For optimal cash management, executives must forecast cash requirements of their business plan and contemplate possible adverse business scenarios, such as the inability to meet current financial obligations or the loss of a major customer. Anticipating such threats helps CEOs prioritize expenses, objectively evaluate current business investments and explore alternate financing options, says Dan O’Connor, tax partner with Haskell & White LLP.

“I’m hearing from many of my clients that cash management is becoming more important,” O’Connor says. “If they’ve been through a recession or credit crunch before, they know it’s a time for tough decisions. But, it also provides the opportunity to reassess fundamentals and find creative ways to finance growth.”

Smart Business spoke with O’Connor about the ways that CEOs can manage cash and survive more volatile economic times.

What are the fundamentals that help increase cash flow?

Certainly, reviewing expenditures with the goal of slowing down your outgoing payments will ease cash flow problems, and it’s an opportune time to eliminate any nonessential expenses. One of the most critical exercises is preparing a cash flow budget. Predicting cash inflows and out-flows on a month-to-month, weekly or daily basis can help you foresee your business cash flow gaps or any periods when cash outflow may exceed inflow.

Also, during times when it is more difficult for your own business to secure credit, it’s important not to be too liberal in your credit policies with your customers. Review your collections policies and days outstanding and place late-paying customers on a payment schedule. Consider offering incentives for faster payment or charging interest on outstanding balances. Review credit ratings on new and existing customers to determine their creditworthiness and ask for more retainers and upfront fees to free up cash and reduce exposure to bad debt.

What are some traditional and nontraditional ways to secure financing in a tight lending market?

There are sources of cash and financing that can help you continue the growth of your business when traditional business loans are hard to come by. Here’s a short list of options:

  • Line of credit: A growth company that’s profitable is the best candidate for this type of short-term loan, which can smooth out the timing of business cash flow needs. If you don’t need to make capital purchases for items such as equipment but you need to advance material and labor costs for new orders, this may work for you.

  • Investment capital: If you aren’t quite eligible for a bank loan or you need more than a bank is willing to lend, consider bringing in an equity partner. By selling off an interest in the business for cash, you can continue growth, investment and profitability.

  • Factoring: This is receivable-based lending where you actually sell your accounts receivable to a factor [a type of lender], which collects the money. You get only a percentage of the invoice until the principal is paid, and interest rates are higher than normal.

  • Mezzanine financing: Often used in real estate transactions, this type of gap financing helps fill up the shortfall between what banks will lend and the equity required for a project. The loans will tend to be at higher interest rates and are secured by partners’ interests in the company.

What are some short-term strategies for improving cash flow through increased sales?

Certainly, when cash is tight, you want to look at reducing inventories, so offering concessions to customers can be an effective strategy. If you can’t sell the inventory, consider leasing it or offering lease-to-buy options as a way to increase cash. For example, homebuilders may not be able to sell inventory despite offering concessions, but leasing the homes will help make the loan payments, and doing so offers tax advantages.

What are some managerial strategies for surviving a cash crunch?

If you run short of cash, here are some tips to help you get through:

  • Do be very transparent in your communications with employees and vendors. If you will be paying vendors more slowly, let them know when they can expect payment and how much to expect.

  • Don’t put off paying taxes, including payroll taxes. You can slow down some payments, but you must pay your employees and your tax obligations on time as well as your rent and utilities. If you need certain products or services that are critical to manufacturing, you want to continue paying those vendors promptly.

  • Do use your accountant as an intermediary who can help negotiate or renegotiate more favorable lending terms or larger loan amounts. Your accountant can speak to the financial strength of your business and your balance sheet and can speak in terms that will both allay lenders’ concerns and highlight your business’s potential.

DAN O’CONNOR is a tax partner with Haskell & White LLP. Reach him at (949) 450-6200 or dconnor@hwcpa.com.

Sunday, 25 November 2007 19:00

Trends in compensation and benefits

Chief executive officers no longer need to be educated on the importance of establishing global governance around compensation and benefits; the key issue now is how to design and implement an efficient global governance framework — this is where many organizations are struggling.

Watson Wyatt Worldwide conducted a recent survey of 101 multinational companies focusing on global retirement governance. It indicated that, while 78 percent recognized the importance of efficiently managing their worldwide pension plans, only 39 percent had taken the initiative by establishing a global governance committee.

“Obstacles to global governance abound,” says Frazer Russell, international practice leader with Watson Wyatt Worldwide. “Having a logical step-by-step process to implement a structured framework is the most successful way of getting your hands around all of the potential issues. A successful framework brings together data, tools, policies, roles and responsibilities and approval processes in an easy to understand manner that, crucially, does not impose a large amount of bureaucracy.”

Smart Business spoke with Frazer about how companies can go about designing and implementing a global governance framework around compensation and benefits.

What are the steps for developing a global governance framework?

  • Readiness assessment: The first step is to determine if your company has the infrastructure and the tools in place to support the implementation of a global governance framework. For example, if you don’t have the necessary resources (internal or external), access to good data, buy in from senior stakeholders or the capability and structure to effect changes globally, any plan you put in place is likely to fail in the execution stage.

  • Baseline assessment: It is key that the current status of your existing global governance framework is understood. This can involve gathering a complete inventory of benefits and compensation provision and policies, checking for compliance and competitiveness and analyzing the current operational and investment protocols.

  • Philosophy: Now that a clear idea of the starting point is known, it is simpler to develop a global compensation and benefits philosophy that defines the guiding principles shaping the subsequent objectives and strategy. The philosophy is developed based on your business vision, objectives and culture. Examples include: above-average compensation to attract top-performing employees and a desire to care for sick or injured workers, etc. A well-formulated HR strategy and, in turn, compensation and benefits strategy, supports your overall business strategy.

  • Objectives: The objectives are the specific goals of the global governance framework linking your overarching philosophy to the strategy.

  • Strategy: This is essentially the roadmap that defines who will be responsible to deliver the plans and programs globally. Having clearly defined, assigned and communicated roles and responsibilities is vital to implementation success and the ability to achieve ongoing compliance.

  • Ongoing governance: During implementation you will have assigned roles and responsibilities for each facet of the ongoing governance cycle including: annual planning, oversight, financing, accounting, plan design, administration, communication and investment, etc. This needs to be monitored and reviewed in a planned manner.

What role should CEOs play in implementing a global compensation and benefits governance framework?

Executive sponsorship of the initiative is vital to achieving success as is a clear communication structure. We recommend adding the framework’s roles and responsibilities into each individual’s performance plan to make certain that both implementation and compliance is a priority and that expectations are clear. Last, CEOs should establish a global benefits committee and work through that group to keep track of implementation progress and ongoing compliance.

Which human capital programs make the most sense to manage globally?

One issue to consider is which compensation and benefits elements should form part of the framework. Watson Wyatt produced another survey, jointly with World at Work. From the results we can see that not all components of compensation are candidates for centralized management. Base pay, for example, can be driven at the local country, regional or global level — either way, local market conditions must be closely considered. On the other hand, more than 90 percent of the companies we surveyed govern executive compensation globally, and nearly 75 percent do the same with long-term incentives.

Most of the companies surveyed require approval from global management for new equity plans, expatriate policies and for bonus plans. These are rewards that are either linked to the performance of the organization overall or are global in nature, so global consistency makes sense.

In recent years there has been an increase in global management of benefits and perquisites too. Retirement plans are governed globally for around half the companies.

There is no single solution among companies or even within industries. One thing is clear, however: the optimal balance will shift as a multinational company expands and moves into and out of local markets.

FRAZER RUSSELL is an international practice leader with Watson Wyatt Worldwide. Reach him at (415) 733-4354 or Frazer.Russell@watsonwyatt.com.

Friday, 26 October 2007 20:00

Nonqualified retirement plans

The dust is just settling after the first proxy season following the implementation of the SEC’s disclosure rules around executive compensation. The new policies demand greater candor and disclosure about executive earnings and compensation plans. If meeting the spirit and intent behind the SEC requirements wasn’t enough, now public companies must contend with meeting the final rules of IRS Section 409(A), and the Pension Protection Act, both of which take effect Jan. 1, 2008.

With the final regulations in place, companies need to revise their deferred compensation plans, including nonqualified retirement plans, before the deadline.

“Section 409(A) applies to every non-qualified retirement plan,” says Pete Neuwirth, senior consultant with the Retirement Practice at Watson Wyatt Worldwide. “All aspects of the plans are coming under review, including plan design, funding and administration.”

Smart Business spoke with Neuwirth about how CEOs can prepare for the upcoming changes in deferred compensation and nonqualified retirement plans required as a result of all the new rules.

How do the new proxy disclosure rules come into the picture when discussing the Section 409(A) requirements for nonqualified retirement plans?

The proxy filings represented the first time that we’ve seen many of these executive compensation numbers laid out in public. At Watson Wyatt, we conducted a survey of 690 proxy statements, specifically looking at the compensation that was associated with nonqualified retirement plans. In general, the pension portion of the executive compensation was equal to base pay and averaged about 10 percent of the total compensation the executive received, which also included performance-based compensation and bonuses. For some CEOs, however, the nonqualified retirement program represented a much larger component of compensation. One important component of the proxy statements is to explain the link between performance and pay for executives. This is difficult to do for a nonqualified retirement plan. Because the proxy statements must include the present value of any accumulated benefits, including deferred compensation, it brings forward the issue of explaining how performance is tied to deferred compensation and nonqualified pension plans. The proxy also requires a discussion of the rationale for adopting the retirement plan in the first place, something that most companies are not able to readily do.

What design changes to nonqualified pensions plans do you recommend to meet the new requirements?

First of all, one size does not fit all. It’s not necessarily the answer to eliminate all of your deferred compensation plans, including your nonqualified pension plans, to comply with the new rules. For example, the nonqualified plan may have been put in place for retention purposes or to augment succession planning goals by helping your company attract midcareer employees, so you still want to derive the benefits while complying with 409(A). You should think about the type of nonqualified retirement plan that will best meet your objectives and, in particular, review how your non-qualified plan dovetails with your qualified plan. You may, for example, find opportunities to achieve your goals through the qualified plan, i.e. QSERP. You may want to consider lowering your Supplemental Executive Retirement Plan formula and using total compensation in your benefit formulas as opposed to base pay only to better tie the plan to performance. Rather than throwing your SERP out the window, carefully consider the reasons for the plan and, where possible, tie the value of the plan back to performance. Doing this helps companies meet both the 409(A) and the SEC disclosure requirements.

How does 409(A) impact funding requirements?

While, historically, there’s been no formal way to fund nonqualified plans, executives want some type of security for their retirement funds. That security has generally been achieved by funding nonqualified plans through a ‘rabbi’ trust or allowing executives early access to their benefits through in-service distributions with a small reduction, or ‘haircut,’ applied. (The name comes from the first IRS private letter ruling approving such a trust, obtained by a synagogue on behalf of a rabbi.)

Unfortunately, 409(A) sharply curtails your ability to get at funds even if a haircut is applied. Rabbi trusts, however, are still viable. While securing against a ‘change of heart,’ rabbi trust assets are still accessible by creditors in the event of bankruptcy. Also, because earnings on trust assets are subject to income tax, many companies place the trust assets backing executive’s deferred compensation into Corporate Owned Life Insurance (COLI). This funding strategy provides positive tax consequences and security for the executive, but results in increased frictional costs and a lack of liquidity.

How does 409(A) change plan administration?

Certainly 409(A) has complicated plan administration considerably. In the past, the administration of nonqualified pension plans has tracked closely with requirements for 401(k) plans. You may want to consider outsourcing the plan administration since the complexity of 409(A) will require someone on the staff to be very attentive to the requirements and, given the number of people covered by the plans, it may not make financial sense to keep administration in house.

PETE NEUWIRTH is a senior consultant in the Retirement Practice for Watson Wyatt Worldwide. Reach him at (713) 733-4139 or peter.neuwirth@watsonwyatt.com.

Tuesday, 25 September 2007 20:00

The idea collector

The mention of the debt collections industry frequently conjures up images of dark, smoke-filled rooms occupied by employees who utilize tough-guy tactics to demand payment from delinquent consumers over the telephone. But industry boiler rooms represent a bygone era for young, data-savvy leaders like J. Brandon Black, president and CEO of Encore Capital Group Inc.

Black relied heavily on increased employee productivity to initially turn Encore Capital Group around after assuming the position of chief operating officer in May 2000. Since 2000, he has continued to drive the company to new heights by attaining a revenue growth rate of nearly 40 percent from 2001 to 2006 and net income of $24 million in 2006 on revenue of $255 million. Along the way, those numbers also earned Black a promotion to the CEO role in October 2005.

“When I started in 2000, the company was close to bankruptcy, and we were losing almost $23 million,” Black says. “I had a mandate to make the company profitable in 90 days because in 91 days, we would be in default. I hadn’t done something like this before, but I learned to just trust my instincts. I think that sometimes when you’re a leader you can get too emotionally attached to the business to see the solutions, and that’s what had happened here. Sometimes when the plane is out of control and falling toward the ground, you just don’t think to change the pilot.”

Black became the pilot who managed to pull up on the company’s throttle just before it crashed and burned. Since then, he’s continued to grow revenue and net income by attracting a new breed of employee, harnessing the power of performance-based compensation to drive employee productivity and learning to anticipate problems before they occur. Most important, he says that he’s learned to avoid the trap of letting his emotional attachment to the enterprise keep him from conducting timely and objective evaluations of his team’s performance — even when the numbers are good.

Don’t let up

With only 90 days to turn the company around, there was no time to spare. Black says that he initially looked at the big uses of cash and the return for those expenditures to take speedy, cost-cutting measures.

“In most companies, there are five to 10 meaningful places where cash is spent,” Black says. “Generally, salaries and benefits are one of those biggest areas of cash expenditures, so I looked at the return we were getting for our investment. I looked at the three different sites where we were running our collections operations and each had a different return. I think we fell into that typical 80-20 rule. We were getting 80 percent of our return from a few sites and collections teams. Then, I looked at how the employees at each site were spending their time and the return for their efforts. Because each site handles different client portfolios, it helped me rank the portfolios and the teams according to profitability. We had a number of places where we had efforts but no results.”

The evaluation helped Black make his first tough leadership decision. To stop the bleeding, he needed to downsize the company from three offices to two, and he would have to get the same or better results with 400 employees instead of 500. The financial improvements afforded by employee productivity gains proved to be a winning strategy not only during the turnaround — but when applied continuously.

“One of the biggest lessons I’ve learned as a CEO is to continue to employ the same review strategies and the same level of energy toward productivity improvement in good times and in bad times,” Black says. “I think during that initial 90-day period I was extremely focused and disciplined, but during good times, you have a tendency to let up and not be as disciplined. In order to sustain growth, you have to be consistently focused and disciplined.”

After the first few years on the job, Black says that he found himself falling into the complacency trap and not managing with the same level of intensity that brought him success in the early years. As a remedy, Black initiated an ongoing site and team review process that is strictly focused on productivity and continuous improvement.

Black conducts a robust planning cycle four times per year with his management staff diving down into the detailed returns for each account’s portfolio and each collections team. In particular, he measures activity levels and the corresponding results generated by each team across the company, looking to extract the best practices and assure continuous improvement companywide.

“To drive productivity you have to focus on it, and that’s what our planning process is all about,” Black says. “It would be like the CEO of a door manufacturing company taking his management staff aside for the express purpose of focusing on what will help them manufacture doors more quickly. I’ve learned not to just look at each collection unit’s results in a silo but to compare the results of the various collections teams against each other horizontally across the enterprise. That best practice has helped me optimize productivity throughout the company because now we’re more team-focused, and we work to continuously improve all of the collections teams. When I get down into the detail and compare the units, I can ask why one group may be achieving better results than another, and we can make adjustments.”

Driving productivity

Black acquired much of his expertise in modern collections strategies during his previous tenure at Capital One. Like so many industries, profitability in the collections business is commensurate with the cost of the labor relative to the results achieved. So maximizing employee efficiency through properly aligned incentives is vital to making money.

“I don’t generate any money in this company. It’s all about the people on the phones,” Black says. “I’ve aligned everyone’s incentives with the company’s performance goals, starting with the CEO and going five levels down because everyone has to be rowing the boat in the same direction or else it will sink. Before our variable compensation was function-specific, and it was not aligned to overall company or team goals. Since we’ve taken this step, our results have improved dramatically.”

About 90 percent of Encore Capital Group’s work force has a variable compensation plan and 25 percent, mostly the management team, has equity incentives in the form of restricted stock and stock options. Black has realigned the agents’ pay to reflect both individual and team bonus opportunities, which meshes with his team-focused business model, and it isn’t unusual for top collectors to make six-figure incomes. Black says that paying top dollar is important because good collectors, like most good employees, can find work opportunities anywhere.

Black says that he achieves buy-in from the agents for implementing new collections techniques or agreeing to a new compensation plan by protecting them from financial loss in case the new process or compensation plan doesn’t work out as expected.

“Not everything works in any business,” Black says. “I’ve learned that in order to retain top collectors, you can’t get into the production workers’ pockets. If we change something in a comp plan, we’ll run both the new and the old plan in parallel for a while, and we’ll pay based upon the greater payout between the two plans so people are encouraged to step across the line and try new concepts. In a production-oriented environment, you can’t change comp plans too often because anybody only has so much change quotient, and you have to respect your relationship with that worker because it’s like an informal social contract.”

Black points to Encore Capital Group’s voluntary average annual employee turnover of 25 percent versus an industry average of 100 percent as proof that he’s on target with his compensation plans and philosophies.

In addition to redesigned financial incentive plans, much of Encore Capital Group’s improved productivity has resulted from Black’s initiative to train collections agents to review all of the available data on a consumer before deciding on a situation-specific collections strategy. The agent also decides how long he or she will work the account before referring the case for litigation, so in this case, increased worker effectiveness and decision-making translates to profitability.

Conducting data analysis and making crucial business decisions such as these on the fly are a far cry from merely reading a script over the phone, so in many cases, upscaling the work force was vital in order to achieve Black’s vision of increasing worker productivity as a means of increasing company profits.

“When I got here, I embarked on the process of bringing in workers and new managers based upon their intellectual capabilities with no collections experience because success was commensurate with being smarter than the competition,” Black says. “It was hard to attract people to this old-school business, so you have to start in a hole and work your way out. I start by dispelling the traditional notion of the collections business and appealing to a prospective candidate’s sense of opportunity.”

Black says that he’s upscaled the company’s talent by hiring most of the company’s mid-level and senior-level managers during his tenure and favors using a series of interviews that put the candidate face to face with peers, managers and subordinates as a way of getting a behavioral read on the candidate as well as assessing the candidate’s ability to adapt to the industry. Referrals are a major source of new agents, but many of the new managers have been sourced from unrelated fields. Black says that exposing potential high-caliber employees to other Encore Capital employees who have made a successful jump to the industry appeals to the candidate’s desire to achieve similar goals.

Anticipation sustains growth

“I think one of the mistakes that I made, which I’ve learned from, is that in order to sustain growth, you can never think too far ahead,” Black says. “Since I’ve been here, after initially scaling back, we’ve increased our number of collections sites up to five, including one in India. You have to anticipate the increased demand for people that accompanies growth, so you can conduct proactive hiring.

“You also have to be realistic about everyone’s ability to continue to rise up to the increased expectations by asking yourself and your management team if anybody appears to be stretched too thin or can’t keep up with the pace of the growth. I’ve learned that anticipating potential cracks in your operation and filling them before they blow open is the key to sustaining growth.”

Black says that an outgrowth of his revelation is that he now devotes more time to forward-looking activities and conducts weekly leadership meetings with his 35- to 40-member management team reviewing strategies and people issues related to growth. The team continually forecasts forward at six-, 12- and 24-month intervals, which Black says puts it in a proactive planning mode and eventually reduces the amount of time that managers spend putting out fires. It also means that Black has had to learn to be open to hearing about potential problems.

“One of the things that was brought to my attention as a barrier to anticipating problems was a communications issue in the company,” Black says. “People said they were afraid to fail, and consequently, they didn’t want to tell me or other members of the senior management team about potential problems, and they also said that oftentimes if they did tell me, they thought I wasn’t listening. So I acknowledged the issue, partnered with a firm to help break down those communications barriers and went through outside communications coaching along with our top 35 to 40 managers. Now, I spend a great deal of my time in informal sessions with employees, and I try to willingly listen and give people the benefit of the doubt. I think I approach those situations completely differently now.”

Black says that potential cracks in the company’s infrastructure also come to light during the staff evaluation segment that is conducted as part of the firm’s quarterly planning cycle reviews. It’s also during those same staff evaluations that he’s reminded that growth not only results from anticipating problems but from using emotional intelligence in tough situations, as well.

“As I compare the productivity of the different collection teams, I can see that 50 percent of the time, the people on the lagging team just can’t keep up with the increased complexities of the job and the rapid growth, and the other 50 percent of the time, the team falls behind for other reasons that we can work on,” Black says. “Then I think about how that person stuck with us during the hard times in 2000 and realize that I’m in the trap of being emotionally tied to the business and that it’s my responsibility to make those tough calls when they’re necessary.”

HOW TO REACH: Encore Capital Group Inc., www.encorecapitalgroup.com

Tuesday, 25 September 2007 20:00

Avoiding audit headaches

Many CEOs are aware that achieving Sarbanes-Oxley (SOX) compliance means they must consider the interrelated nature of accounting and information technology internal controls.

However, if CEOs take a deeper dive into the compliance pool, they may find that the company’s policies and procedures, which are meticulously described on paper, don’t actually mirror the firm’s IT control processes that are enforced by the system.

Lee Barken, IT practice leader for Haskell & White LLP, says that user access controls are just one area that might need a review. As an example, Barken says that sometimes when he inquires about the company’s purchase authorization limit for employees, he discovers that the IT system will accept purchase requests for far greater amounts than what is specified in the company policy.

With no carry-through of the company’s policies into the IT control systems, a breakdown in controls can occur. User access controls are just one area that CEOs should be aware of when it comes to tightening internal control processes.

“CEOs can no longer just focus on dollars and cents at audit time,” says Barken. “They must also think about zeros and ones when they set up and review their internal controls.”

Smart Business spoke with Barken about the steps CEOs should take to avoid weak IT control processes and audit problems.

How can CEOs assure that company policies are reflected in the IT system and control processes?

First, check your software configurations and run numerous tests of the system to see if the company’s policies match the system. For example, if you have a company policy that only allows certain users the authority to approve purchases up to $100,000, log in as one of those users and see if the system will let you approve a purchase order for $100,001.

Second, make sure all of your control processes and your tests are thoroughly documented. Many chief information officers do a lot of things right, but they fail to document, and inquiry alone does not constitute a test of a control process. When the auditors arrive, they will want to see evidence that is documented.

Last, role-play some of the worst-case scenarios to make certain you’ll be ready come audit time. For example, what happens if our CIO wins the lottery and disappears to a Caribbean island? Do we have policies and procedures documented? Will we have the proper documentation of the control tests and the results to provide the auditors?

Is testing and documentation of the company’s data backup system required for an audit?

Having a clearly defined data backup policy is a vital control process because data loss can happen at any time, without warning, as a result of anything from a power loss to a natural disaster or even a simple mistake like someone accidentally deleting the wrong file. We learned a number of these lessons following Katrina and Sept. 11, so now auditors ask companies to provide evidence that the company will be able to continue after an unplanned service interruption.

Data should be frequently backed up and the tapes should be stored off-premises as part of the control process. While the tapes are awaiting transfer, they should be stored in a secure and fire-resistant location. Keep a log that documents when backups are made and transferred and, on occasion, run a test of the restore process and document the results to demonstrate that you can restore the company to operating mode quickly. If you are storing tapes off-site, be certain to encrypt them, especially if they contain sensitive information, such as social security numbers or credit card information.

What type of network security documentation should be maintained for audit purposes?

Devices called firewalls control what information is allowed in and out of the company through the network. Firewall parameters should be established and tested in accordance with the company policies and procedures around information security.

With more wireless access to networks, how should control processes be established and documented for audit purposes?

Our traditional methods for securing the company’s buildings and the information they house, like door locks and security cards, all go out the window when companies add wireless access to their networks. Think of encryption as the keys and access cards to your wireless network. Create a company policy about who can access the information and make certain that the data is properly encrypted with the appropriate encryption for wireless networks.

LEE BARKEN is the IT practice leader for Haskell & White LLP. Reach him at (949) 450-6200 or lbarken@hwcpa.com.

Sunday, 26 August 2007 20:00

Gliding into retirement

Target date retirement funds emerged on the scene as investment vehicles about 10 years ago. Widely popular among 401(k) plan participants, the plans are designed to make retirement investing easier for those who lack the time or the expertise to manage their own retirement fund investments.

The plans are designed to provide a “plug and play” scenario for investors who begin by initially selecting their projected retirement date and then continually fund the account over the course of their career. The plan relies on a glide path investment strategy, which gradually rebalances the portfolio comprised of cash, bonds and stocks toward a more conservative investment allocation as the time for retirement nears. Despite the fund’s low maintenance philosophy, each target date fund has a different allocation model, and plan participants still need coaching and communication from plan sponsors to avoid making mistakes when investing, says Michael Ford, senior investment consultant with Watson Wyatt Investment Consulting, a subsidiary of Watson Wyatt Worldwide.

“As we study 401(k) participant behavior, aside from not saving enough for retirement, participants often fail to take enough risk, or they take too much risk with their fund choices,” says Ford. “In the case of target date retirement funds, a frequent participant mistake results from altering the asset allocation model by investing in more than one fund. All of these mistakes may cause 401(k) participants to be financially unprepared for retirement.”

Smart Business spoke with Ford about how CEOs can help employees invest wisely in target date retirement funds.

What is the most common investment mistake made by employees when investing in target date retirement funds?

The funds are designed to be all-inclusive investments. Frequently, plan participants become accustomed to spreading their investments among many different investment vehicles, like mutual funds, so naturally they are inclined to do the same thing with target date retirement funds. However, in this case, investing across multiple funds alters the glide path investment strategy, which, in turn, might cause plan participants to miss their financial retirement goals. It’s really not designed to be a mix-and-match investment concept.

How do retirement date funds fit into a plan sponsor’s full suite of investment options for employees?

It’s important to recognize that one size does not fit all when it comes to assisting employees with retirement planning. Each employee has a different risk tolerance, financial circumstance and level of investment savvy. We advocate structuring investment options into three tiers, with each tier appealing to different segments of the employee population.

  • Tier one — Target Date Retirement Funds: this tier is designed for participants who don't want to make asset allocation decisions and would rather have someone else do it for them.

  • Tier two — Core Options: this tier is designed for participants who want to make their own asset allocation decisions from a set list of investment options.

  • Tier three — Brokerage Window: designed for the small percentage of sophisticated investors who want maximum choice in their investments.

How can CEOs and plan sponsors help employees manage their retirement funds more effectively?

Communication and consultation with employees is absolutely vital. Plan sponsors should provide tools to participants that help them assess their risk tolerance and investment knowledge. If they are a tier one investor, it is important to communicate that this is a stand-alone investment option, not to be mixed with assets from the other tiers.

Plan sponsors should communicate with participants initially upon enrollment and then at least every six months about the nature of target date retirement funds and the investment strategy behind them. At Watson Wyatt, we recommend varying the communication method from print materials to in-person meetings to accommodate the needs of a diverse employee base.

What is the role of the plan sponsor’s record keeper in safeguarding employees?

Plan sponsors should coordinate safeguarding efforts with their record keeper to prevent tier one participants from mixing their allocations among other tier one funds or crossing their investments into the other tiers. Some record keepers are able to put safeguards in place that will not allow participants to mix asset allocations, so keep this in mind as you establish your selection criteria for record keepers.

With more and more employees taking on the responsibility of financially securing their own retirement, employers need to assist them by providing tools and the proper oversight of plan record keepers. Used properly, target date retirement funds can provide a majority of plan participants with a highly effective investment solution to help them save for their retirement

MICHAEL FORD is a senior investment consultant for Watson Wyatt Investment Consulting, a subsidiary of Watson Wyatt Worldwide. He is a seasoned professional with 23 years of extensive and diverse experience in the investment field. Reach him at (818) 623-4500 or michael.ford@watsonwyatt.com.

Sunday, 26 August 2007 20:00

No excuses

It’s no fluke that accountability is on the list of Gen-Probe Inc.’s core values. It’s on the list because Hank Nordhoff, chairman, president and CEO of the company, put it there.

If you ask Nordhoff why he’s succeeding in the business of developing, manufacturing and marketing molecular diagnostic tests, which is known as an investment-laden and failure-prone industry, he’ll tell you that it’s because of the performance of his employees.

“It can be a tough culture to bring, but you have to let people know if they’re messing up,” Nordhoff says. “You have to have those frank talks because you can’t accept mediocrity.”

Average is neither part of Nordhoff’s vocabulary nor a description of the financial results on the firm’s balance sheet. What makes Nordhoff’s financial performance so unique is that he’s investing 25 percent of the firm’s revenue in research and development, which is roughly double the average investment by peer firms in the industry, while simultaneously delivering top- and bottom-line growth.

Gen-Probe has increased annual revenue from $155 million in 2002 to $354 million in 2006 and full-year results for 2006 also show that the firm returned 17 percent of its revenue in profit, which beats many of its much larger competitors.

Since assuming the CEO position in July 1994, Nordhoff has taken on the giants in the industry, such as Abbott and Becton Dickinson, and delivered value to customers and a strong return to shareholders through execution and a low failure rate on new product approvals. Nordhoff credits all of those achievements to a company culture that fosters exceptional employee performance.

Performance incentives

Nordhoff ties employee performance directly to financial rewards. It starts with stock options being given to everyone in the company but goes even further than that.

“We also offer both individual and team bonuses that are performance-based,” Nordhoff says. “There are three bonus tiers. The employee can receive a great bonus, an average bonus or zero bonus based upon how they perform. I like to set the total compensation for employees who are exceeding expectations at just above the market average for similar industry positions because I expect greater things from them.”

He establishes team performance benchmarks for each business unit because when each group achieves its goals, it contributes to the success of the entire organization. For example, in the R&D unit, Nordhoff sets expectations around delivering new products by a specified date and within the allocated budget. Performance expectations within the department trickle down to each individual team member who can earn bonuses based upon his or her solitary contribution to the departmental goal.

Nordhoff says that using variable compensation to drive performance is just one of the incentives that he relies on to keep employees motivated. Besides a pleasant work atmosphere, the company provides a subsidized cafeteria and a workout room.

“It keeps the employees on the property at lunch, and they stay focused on work because they aren’t running out for fast food,” Nordhoff says.

Employees who frequent the company cafeteria might find great bargain prices on lunch, and they might also find themselves in a one-on-one coaching session with Nordhoff.

It’s one of the many ways he keeps tabs on what’s going on in the company and allows him to help people succeed.

Nordhoff says that merely wandering around and shaking hands won’t give a CEO enough of a true feel for the work environment and the pulse of the employees. He says that he prefers to hang around the cafeteria and the hallways hoping to catch up with some employees he hasn’t seen in awhile, just so he can have an extended conversation with them. Demanding greater employee performance goes hand in hand with offering a superior work environment and coaching for improved performance, so he checks in with employees frequently and offers them advice.

Finding people who fit in to his high-performance, high-accountability culture isn’t easy. Nordhoff uses a bounty program, paying a referral bonus when current employees refer friends and acquaintances who fit the firm’s environment. In addition, he focuses on a selection process designed to weed out those prospective employees who can’t hack the performance requirements.

“We do lots of interviews with prospective candidates because we want to see if they have tough enough skin for our culture,” Nordhoff says. “We really put candidates through the ringer because we want to see if they know their stuff. We don’t have a single culture in the company. Each business unit has their own uniqueness so we want to expose candidates to that so they can understand each team’s personality and assess the fit for themselves.”

Learning from failure

As one of the smaller firms in the industry, Nordhoff says that failing to get Food and Drug Administration approval for the vast majority of its new products is a luxury that Gen-Probe simply cannot afford. However, no company gets 100 percent approval ratings in the medical research field.

In order to avoid costly errors, Nordhoff has installed a system that creates learning opportunities from failures. The management teams from the various departments that were involved in the project and the members of the executive committee meet when a new product fails to get approval. They dissect the results, understanding what caused the failure and exposing what they can learn from their mistakes.

“I started the practice of holding post-mortems with the appropriate managers of the business units if a new product fails at some point in the development or approval process,” Nordhoff says. “The idea is that we need to learn from our mistakes so we can focus on what we should have done and what we will do differently next time.

“I tell everybody this isn’t about finger-pointing, and it’s not personal, we messed up, we need to learn from it so we can do better next time. As a matter of fact, if anybody tries to throw blame on someone else during the session, I kick them out. We don’t want to dwell on our failures, but you’ve got to do it — you’ve got to learn from your mistakes.”

Nordhoff credits the post-mortem process with improving the firm’s success rates and achieving a higher-than-average return on its substantial R&D budget. He also keeps a close eye on projects by following their progress via a detailed timeline and by requiring his managers to submit monthly progress reports, so he can look for early warning signals that a project may be in trouble. However, the cultural tone that Nordhoff sets in the organization requires managers to communicate all information to him — good or bad — and that openness in communication is what he relies on to avoid surprises.

“People really have to feel free to tell the CEO what’s happening; they can’t sugarcoat it,” Nordhoff says. “As a matter of fact, if they do sugarcoat it, you have to let them go. I don’t want to hear that everything is going great, only to hear later, that there’s a big problem. As the CEO, you really have to learn not to shoot the messenger or you will end up shooting yourself.”

Increasing margins

Much of Gen-Probe’s financial success results from garnering a 70 percent gross profit for the diagnostic medical tests that the firm markets, which is nearly double the gross profit of other firms in the space.

Delivering near-term profit increases has not only been good for investors and employee stockholders, Nordhoff reinvests some of the firm’s profits in R&D, which reduces the need to borrow and the cost of debt. He attributes the above-average margins to product superiority, which creates customer value and the improved performance of Gen-Probe’s sales team.

Nordhoff says that initially, it was tough to persuade the sales team to be less-focused on market share and to convince them that they could sell the testing products at nearly double the going industry rate.

He provided the sales team with the necessary data confirming that the firm’s medical diagnostic tests produced fewer failures than those offered by competitors. Fewer failures would mean savings in total costs and time for customers, but the team remained reluctant to approach customers with such a large price increase. It was finally Nordhoff’s performance challenges that convinced the sales team to try selling the product at a premium price.

“We were selling the tests at half of the price that we’re getting now,” Nordhoff says. “So I challenged the sales team to go out and get the higher prices,” Nordhoff says. “They were reluctant at first, but I told them that they were better than that. When I told the sales team that they were capable of achieving more and when they started actually generating more sales at the higher prices, they were elated. As the CEO, you have to challenge your people because people need to be challenged. I couldn’t accept that we weren’t going to get the higher rates, so I challenged the sales team to achieve at a higher level. Now, I approve all pricing to make sure that we’re getting the best margins possible.”

Getting feedback

When he’s not coaching the sales team or hanging out in the cafeteria in search of an impromptu coaching session with some of the firm’s 1,000 employees, Nordhoff is soliciting anonymous employee feedback and third-party opinions as to Gen-Probe’s status as an employer of choice. The information provides him with honest opinions and opportunities to improve the culture and the work environment.

Formal employee climate surveys are taken among the staff every other year. Nordhoff received feedback via one of the surveys that the employees wanted additional tools to help them achieve at the performance levels he was expecting. In particular, they wanted more training and development programs. As a result of the information he received, Nordhoff developed formal employee education and mentoring programs that augment the culture.

“As a result of the survey, we really stepped up our training programs,” Nordhoff says. “We teach soft skills so our management team can be adept at having performance conversations with their staff, and we teach them how to set performance measures and objectives. Providing helpful feedback to employees about their strengths and weaknesses is part of what we believe in, so we want to train our managers how to conduct an effective feedback session.”

The firm has also received external recognition for its work environment. In 2003, the company was awarded the Workplace Excellence Award by the San Diego Union-Tribune, and in 2005, the company was named as a finalist for an award given by the San Diego Business Journal recognizing Gen-Probe as one of “The Best Companies to Work For.” Those report cards tell Nordhoff that he’s on the right cultural path and the balance sheet confirms it.

“In order to be successful as a CEO, you really need to get the best people that you can, not necessarily the smartest people, but the best people and then give them a shot,” Nordhoff says. “You need to treat people as though they are your most valuable asset — because they are.”

HOW TO REACH: Gen-Probe Inc., www.gen-probe.com

Monday, 25 June 2007 20:00

Managing litigation costs

Escalation in the hourly rates charged by attorneys, experts and court reporters has driven the cost of litigation up. This makes the need for pragmatic decision making by CEOs vital — especially when it comes to deciding if “having your day in court” is the best way to handle business disputes.

Using an average cost of $400 per hour for attorneys’ fees and the customary charges for court reporting services, a oneday deposition taken from a single witness in preparation for trial can cost $5,000. While the trial itself may only last a few days, most of the costs associated with going to court revolve around all of the discovery and preparation needed to actually bring the case to trial.

“It’s vital for CEOs and other executives to really conduct a thorough cost-benefit analysis before deciding if they want to litigate a matter, and they need to have a cost estimate based upon winning or losing the case,” says Richard A. Heller, partner with Procopio, Cory, Hargreaves & Savitch LLP.

Smart Business spoke with Heller about how CEOs can manage these costs.

What makes litigation expensive?

Clients have played a role in attorney rate increases. While clients don’t want to be charged above-market hourly rates, they often correlate an attorney’s capability with the rates he or she charges. This assumption may not be accurate and it could result in overpaying for attorneys’ fees. I also recommend a process that I call reverse engineering the litigation budget. Before deciding if you want to take a case to trial, request a full disclosure of all immediate and long term litigation costs. While trials aren’t cookie cutter, you should be able to get a fair estimate of the total cost from your attorney, so you can make a pragmatic business decision.

What is the client’s role in managing litigation costs?

The client needs to be engaged and maintain a proactive posture from the outset.

Inquire about the outcome of various steps in the litigation process, such as the result of hearings conducted on pre-trial motions. E-mail is a cost-effective way to get updates about the status of your case, and staying involved keeps attorneys on their toes. Also, while you don’t want to nit pick invoices, you certainly want to review them. Look at the trends and keep a running tabulation of the total costs of projects so you can continue to track actual expense versus budget. Also, note how many attorneys are billing on the matter. Each time you bring in a new lawyer, he or she needs to get up to speed on the case, which generates billable hours.

Is mediation an effective alternative to litigation?

I have observed that clients frequently have the notion that if they propose mediation to settle a matter that it’s a sign of weakness. As a 32-year litigator, I don’t see it that way. When used at the right time, mediation can be a cost-effective solution to disputes. The key is proposing mediation when you have conducted enough relevant discovery to begin to project an outcome for the case and to allow both sides a clear understanding of the issues, but before the cost of conducting full discovery is incurred. It also allows diversion of funds earmarked for trial costs to be used toward settlement of the matter. The thing to remember about mediation is that the process itself doesn’t decide who was right and who was wrong, and participation is purely voluntary. This is where pragmatic decision making comes into play, because success is not always about being right — it’s about how little you have to pay.

When should arbitration be used as an alternative to trial?

Arbitration used to be considered the cheaper, faster alternative to trials, but today that may be changing. Arbitrators are independent judges who can make rulings as to who wins or loses the case, but those rulings do not have to follow the law and they cannot be appealed. In addition, more discovery is allowed in arbitration these days, which doesn’t do much to reduce litigation costs. And arbitrators can charge up to $1,000 per hour.

Aren’t litigation costs paid by the losing party?

Frequently disputes occur over issues governed by business contracts, and unless the contract contained a provision stipulating that the winning party can recover attorney’s fees, you will be unable to do so in California. Clients sometimes mistakenly think that it’s better not to settle a case because if they prevail, they’ll recover attorney’s fees. Knowing if it will be possible to recover attorney’s fees is all part of doing your homework and should be part of your cost benefit analysis before deciding if you should take a case to trial. More facts and less emotion make for good litigation decisions and better managed costs.

RICHARD A. HELLER is a partner with Procopio, Cory, Hargreaves & Savitch LLP. Reach him at (760)496-0774 or rah@procopio.com.

Companies seeking to lease a corporate facility justifiably spend a great deal of time and focus with a qualified broker hammering out location, rent, term and other primary business points. Many executives mistakenly feel that once the key deal points are covered in a letter of intent or otherwise, the rest of the lease document is mere “legalese” or “boilerplate.”

That kind of thinking will get you burned. The lease agreement has been carefully drafted and refined by the landlord’s attorneys. Consequently, the overwhelming majority of the terms contained in the lease are heavily weighted in the landlord’s favor. These terms often include critical provisions such as the method for calculating triple-net pass-through charges. At the very least, having the lease agreement closely reviewed by qualified legal counsel will help level the playing field between the tenant and the landlord.

“The tenant and the landlord often have totally different views about the intent of the initial draft lease document,” says Tom Turner, managing partner with Procopio, Cory, Hargreaves & Savitch LLP and a long-time commercial leasing expert. “The landlord typically expects the tenant to use the document as a starting point for negotiations. The tenant often assumes that boilerplate leases are all about the same so the detailed terms aren’t worth negotiating. This assumption can leave the tenant extremely vulnerable.”

Smart Business spoke with Turner about the negotiable elements generally contained in “standard” lease agreements.

What are some negotiable financial terms contained in boilerplate leases?

Provisions regarding the pass-through of triple-net operating expenses should be reviewed carefully, because the language often shifts the majority if not all of the operational expense responsibility to the tenant. The lease should expressly exclude numerous inappropriate expenses from the pass-through calculation. In addition, the tenant should have the unfettered right to conduct an audit of the costs after the fact. It is important that the audit not be restricted as to when it is performed, what time period it covers or who the tenant chooses to conduct it. Many other financial components, such as late charges and holdover rent, security deposits and other credit enhancements, are often presented by the landlord as ‘standard,’ but are in reality very much negotiable.

Are lease expansion and termination provisions negotiable?

The right to extend or terminate the lease or to shrink or expand the space are negotiable areas that are often overlooked.

It is not unusual for a lease agreement to have a heading titled ‘Option to Extend,’ but in reality provide the tenant with little more than an option to negotiate. This really isn’t a tenant benefit at all. The tenant needs to work carefully through the lease language to make certain that these are truly enforceable rights that are also workable from a practical perspective.

As an example, if you think your business may be growing, you may want the right of first refusal on any adjacent space that becomes available, on pre-established terms. Moves under any circumstances are costly, so by anticipating growth, you can eliminate much of the cost of expansion by simply adding on rather than relocating. But if you are not careful about the detailed language of the lease, you may end up with a worthless right to sit down and talk with the landlord.

Why are boilerplate relocation provisions problematic?

In the event of disasters, such as floods, fires or earthquakes, the lease typically allows the landlord to evict tenants or move them to an alternate location of the landlord’s choosing. You can bet these provisions are overwhelmingly favorable to the landlord, so it’s important to spend the effort to assure they are fair and reasonable.

Also, it isn’t uncommon to find a hidden provision near the end of a standard form lease that gives the landlord the right to actually relocate the tenant to other premises, almost on an unrestricted basis. Usually, if you push back, this provision will simply be deleted; at a bare minimum, should relocation be required, the tenant should have the right to acceptable comparable space and be completely reimbursed for all related expenses.

What eviction provisions should tenants watch out for?

I have seen landlords actually searching out a basis to put a tenant into a technical default, in order to give them the boot in favor of a more attractive deal. As an example, the landlord requests that you deliver an estoppel certificate and subsequently evicts you, without recourse, if you deliver the certificate a day late. As the tenant, you want to retain the right to be notified of any default and a specific time frame to cure it before you can be evicted.

By closely reviewing the entire lease document before signing it, the tenant can gain important leverage by negotiating all of the terms and conditions up front, when the landlord and the brokers are eager to get the deal done.

TOM TURNER is a commercial real estate attorney and the managing partner with Procopio, Cory, Hargreaves & Savitch LLP. Reach him at twt@procopio.com or (619) 515-3276.

Saturday, 26 May 2007 20:00

Reducing the cost of risk

Most CEOs purchase insurance coverage believing that it will protect their business from risk. The reality is that buying insurance merely transfers the potential for economic loss to an insurance carrier. To truly reduce the possibility of financial loss, the core culture must include an effective risk management program.

Over the past 60 years, risk management has become a sophisticated discipline. Today’s best-in-class risk management programs help keep workers safe and on the job, and define accountabilities for results and ways to measure them.

“The total cost of risk (TCOR) includes, but is not limited to, insurance premiums, retained losses, the indirect cost of losses, outside services and risk management administration costs,” says William A. (Bill) Werber, a Certified Risk Manager (CRM) with Westland Insurance Brokers. “The indirect costs of a loss, such as training time, overtime, lost productivity, opportunity costs, lost customers and management time dealing with claims, increase the direct loss by two to five times, and that directly impacts after-tax profit. Truly controlling the cost means stopping the losses from occurring and aggressively managing those losses that do occur.”

Smart Business spoke with Werber about how CEOs can design and implement an effective risk management program.

What defines the risk management process?

Risk management is the practice of protecting an organization from financial damage by identifying, analyzing and controlling risk at the lowest possible long-term cost. The phases of the risk management process contemplate the identification of risk, then analyze and quantify the exposures based on the potential for economic loss. Then select effective risk management techniques for controlling and financing the risks, implement the selected techniques and continuously monitor the results.

The process itself has value because it causes managers to be focused on the continuing dynamic process. Insurance premiums will go up and down as part of the cyclical nature of the insurance business, which is naturally tied to the stock market. Workers’ compensation costs are directly tied to your experience, so regardless of what happens with rates, you can exercise greater control over your costs by reducing your losses and subsequently your experience modification factor.

What constitutes an effective risk management program?

Many components individually may produce some results, but the synergistic combination of the important elements of a best-in-class risk management program will produce dramatic results.

  • Establish a corporate culture that highlights safety accountability as a core value and a way of doing business. It is unacceptable to get hurt on the job or crash a company vehicle.

  • Initiate a well-defined process around incident and injury reporting that places clear accountabilities for managers and employees alike and includes the necessary protocols and forms.

  • Establish and communicate an effective ‘return-to-same’ work policy coordinated with medical treatment and work restrictions.

  • Train supervisors and employees in incident and injury prevention and what to do when they happen. Injured employees often seek attorneys because they don’t know what to expect.

  • Develop and implement an incentive program that rewards supervisors and employees for working safely. Carefully done well it will produce excellent results.

What risk management factors should be tracked and monitored?

CEOs should develop a ‘vital signs report’ of key risk management indicators. Measure your results — what gets measured gets managed. Monthly track your data and weekly manage your claims-loss ratios, loss frequency and severity, employees with multiple injuries and, most importantly, the status and strategy to get an employee back to work and well.

In the experience modification calculation and also in real life, claim frequency will breed severity. It is important to focus on the small claims and near misses to prevent the large ones.

Finally, hold everyone accountable.

How much money will a quantified risk management program save?

Two janitorial clients in a tough risk management business have reduced their workers’ compensation costs by 50 percent to 60 percent. Another client in the vending industry embraced effective components of a risk management program, improved its excellent core culture, and the result has saved hundreds of thousands of dollars.

In the long run, CEOs will see dramatic financial benefits from embracing an immediate and long-term risk management culture.

WILLIAM A. WERBER is a Certified Risk Manager (CRM) with Westland Insurance Brokers. Reach him at (619) 584-6400 ext. 3254 or bwerber@westlandib.com. For more information, visit www.westlandib.com.