Operations Forensics

Operations Forensics: Business Performance Analysis Using Operations Measures and Tools

Richard Lai
Copyright Date: 2013
Published by: MIT Press
Pages: 336
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  • Book Info
    Operations Forensics
    Book Description:

    Investors and analysts often need to look into a firm's operations more deeply than traditional financial statements and models allow. This book describes newly developed tools for using operations metrics to discern and influence the valuation of a firm. It is the first to present these techniques from a unified perspective: that of operations forensics, which looks at operations management not from the traditional point of view of a manager but from that of an investor or shareholder. After a discussion of financial statements and the useful but incomplete insights they provide, the book covers the three components of operations forensics: operational indicators, operations details that can predict future performance; operational due diligence, methods for verifying companies' claims about operational excellence and valuing their operational assets; and operational turnaround, an innovative approach to buyout and turnaround strategies. The text also offers brief reviews of operations management concepts, real-world examples of operations forensics, and a glossary. The mathematical material gradually increases in sophistication as the book progresses (but can be skipped without loss of continuity). Each chapter concludes with a "Takeaways and Toolkit" section, a brief summary of prior research, and suggestions for further reading. Operations forensics offers powerful tools and frameworks for financial analysts, private equity firms, managers, and consultants. This book provides a valuable resource for MBA students and practitioners. Downloadable supplementary material for instructors incudes figures form the text and 42 slides that can be used for class presentations.

    eISBN: 978-0-262-31300-1
    Subjects: Management & Organizational Behavior, Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-xvi)
  3. Preface
    (pp. xvii-xviii)
  4. Guide for the Reader
    (pp. xix-xx)
  5. Acknowledgments
    (pp. xxi-xxii)
    Richard Lai
    • 1 Operations Forensics
      (pp. 3-16)

      Operations forensics is comprised of operational indicators, operational due diligence, and operational turnarounds. Let’s begin by briefly introducing these three key components.

      In May 1998, Mark Gerson had just left Yale Law School when he met Thomas Lehrman, who had been working for two years at a major hedge fund, Tiger Management. Together they founded a business based on the proposition that financial analysts crave information beyond the scope of traditional financial models and statements.

      By 2010, the Gerson-Lehrman Group operated a network of over 250,000 experts to provide detailed, operational models and information to blue-chip clients such as Credit...

    • 2 What Financial Statements May or May Not Reveal
      (pp. 17-38)

      In 1955, Anthony “Tino” De Angelis formed the Allied Crude Vegetable Oil Refining Corporation to sell shortening and other vegetable oils to Europe (Time, 1963).¹ His company operated out of Bayonne, New Jersey, where he constructed a farm of oil tanks to store oil. By 1962, De Angelis was borrowing heavily from American Express’s (Amex’s) Field Warehousing subsidiary and other banks, using the oil in the Bayonne tanks as collateral. With the loans, De Angelis became a major player in the salad oil market. But judging from his balance sheet, Amex should have been curious: the assets entry showed that...

    • 3 Indicators of Accounting Performance
      (pp. 41-62)

      In this chapter, we focus on operational indicators of accounting-based performance—such as return on assets (ROA) and its drivers like sales and earnings. Specifically we ask:

      What indicators drive current performance?If we were to decompose performance—say ROA—into its operational components, what would these be? Not surprisingly, the answer is industry-specific, and we construct “ROA trees” for some representative industries.

      What leading indicators drive future performance?While ROA trees are useful, they mostly provide only a view of performance at a snapshot in time (e.g., today’s ROA is, by definition, today’s earnings divided by today’s earnings divided...

    • 4 Indicators of Stock Market Performance
      (pp. 63-76)

      While it is surely important for an investor to look at the accounting performance of a firm, as we have in the last chapter, it is also important to look at the firm’s stock market performance, if the firm is publicly listed. After all, it is by buying and selling the stock of a firm that the investor participates in a firm’s performance.

      But one can ask the obvious question: doesn’t accounting performance more or less track stock market performance, so why look at the latter when it is sufficient to look at just the former?

      One important reason is...

    • 5 Indicators of Disruption
      (pp. 77-84)

      TheEncyclopaedia Britannicawas started in 1768 as a compendium of human knowledge. Through the years, its contributors have included luminaries such as Marie Curie, Albert Einstein, Benjamin Franklin, George Bernard Shaw, and Leon Trotsky. Its ownership has changed from the founding Scottish entrepreneurs to American hands, variously the Benton Foundation of Chicago and the Sears Roebuck Company. By 1989, its sales were at a record high of $627 million, and growing at 8.1% a year.

      But the introduction of the compact disk (CD) clipped Britannica’s wings. In a space of seven years, sales plunged by more than 50% to...

    • 6 Indicators of Distress
      (pp. 85-92)

      As we discussed in the last chapter, in 1989 Encyclopaedia Britannica was at the top of its game. Sales were at a record high of $627 million and growing at 8.1% a year. In 1996, it declared bankruptcy.

      In 1997, Amazon was also at the top of its game following its founding just three years before. Its initial public offering valued the company at $438 million. But by 2000 it had cumulative losses of over $550 million and accumulated a number of derogatory monikers: Amazon.toast, Amazon.bomb, and founder Jeff Bezos’s favorite, Amazon.org, since “it was clearly a not-for-profit.”

      Lehman analysts...

    • 7 The Many Facets of Due Diligence
      (pp. 95-108)

      The most common types of due diligence deal with legal and financial aspects of a business. Operational due diligence focuses on understanding the efficiency and effectiveness of the business and is complementary to other aspects of due diligence. In this chapter, we address these issues:

      Whydo we do due diligence?

      Whatshould due diligence seek?

      Whenshould it be done?

      Howandby whom?

      In subsequent chapters, we dive into specific “how” questions that are particularly important:

      Howcan we verify that a company has implemented “lean management” programs such as the Toyota production system?

      Howdo we value...

    • 8 Assessing the Customer Base
      (pp. 109-122)

      For one retail bank, 80% of its customers make up 125% of its profits; the other customers are loss-making. For an auto dealership, reducing defection from 10% to 5% improved the net present value of its customer base by 81%.

      Not surprisingly, many due diligence programs have assessing the value of the customer base as their core. The media is filled with headlines such as: “TelePacific to acquire SMB customer base and network of O1,” “Direct Energy acquires Entergy’s ERCOT customer base,” or “Dieringer Research acquires Lein/Spiegelhoff customer base.”

      Yet the pertinent aspects about a company’s customer base are not...

    • 9 Assessing Lean Management
      (pp. 123-136)

      The Toyota production system (TPS) has been so admired that many companies claim that they have implemented it. As Jim Kotek, a vice president of the manufacturing firm ORBIS, said: “At ORBIS’ manufacturing plants we have found lean principles to be applicable to not only our on-the-floor production, but also to our warehouse operations, to our purchasing practices and to how we arrange freight for our customers.”¹

      Even some service companies claim that they have implemented the TPS. For example, Virginia Mason Medical Center, in Seattle, Washington, is an example of a hospital that has done so. Figure 9.1 shows...

    • 10 Assessing Risks
      (pp. 137-160)

      Thus far we have looked at risks as something that we want to anticipate—as in the chapters on indicators of disruption and distress—or to manage down—as in the Toyota production system’s emphasis on reducing variability. Some investors, such as Berkshire Hathaway, claim, as their risk management strategy, that they only buy into low-risk businesses. Warren Buffett, Berkshire’s chairman, said in his 1996 letter to shareholders: “I should emphasize that, as citizens, Charlie [Munger, Berkshire’s vice chairman] and I welcome change: Fresh ideas, new products, innovative processes and the like cause our country’s standard of living to rise,...

    • 11 Assessing Options
      (pp. 161-180)

      On September 15, 2006, Freescale Semiconductor agreed to a buyout by the Blackstone Group for $17.6 billion. Freescale’s profits were just $584 million in 2005. If these profits were considered cash flows into the future, with a discount rate of say 10%, the net present value of Freescale would have been just $5.8 billion. What could account for Blackstone’s bold valuation?

      One possibility is that Blackstone was buying the option that Freescale would grow tremendously. Freescale had been making static random access memory (SRAMs), which was at the tail end of its product lifecycle. However, more importantly, SRAM manufacturing positioned...

    • 12 Turning Around Purchasing
      (pp. 183-198)

      For the average US manufacturer, purchases from suppliers constitute as much as 50% of its sales revenues. This percentage has been trending up, with increasing reliance on outsourcing even of services. Not surprisingly, the purchasing function has become strategic.

      Yet there appear to be many challenges with the function. Many businesses cannot buy products at the right time and place. As a result, suppliers find themselves writing off and marking down enormous amounts of inventory, to the tune of about $30 billion for the food industry. These problems arise despite enormous efforts by businesses. To enhance feedback for purchasing, they...

    • 13 Turning Around Production
      (pp. 199-216)

      In production, the core turnaround opportunities are in installing the appropriate process, building forecasting capabilities, addressing capacity investments, and driving down costs. Another opportunity arises from rationalizing production processes; this is similar to the reengineering described in the previous chapter.

      Many high-performing businesses—or at least companies that stay in business—match their process structure with their product type. In figure 13.1, we see examples at the industry level. There tends to be a migration of product and process type to the lower right over time, as products and processes mature. This provides a way to anticipate future process changes...

    • 14 Turning Around Distribution
      (pp. 217-226)

      We have already discussed a strategic aspect of designing distribution, which is to match the type of supply chain—Physically efficient or market-responsive—to the product type (see section 12.3). Here we dive into tactical issues, focusing on what distribution strategy we should have.

      It often pays to start from customer needs and profitability. Customers have different needs, buying different products and incurring different costs to serve. For example, a very profitable bank customer might be one who purchases a range of products—deposits, credit cards, loans, investment products, financial advice—and prefers a light touch with easy accessibility, using...

    • 15 Sustaining the Turnaround
      (pp. 227-258)

      We have seen in the previous chapters how we can reconfigure our various functions: purchasing, production, distribution. We end this book by assuming that we have optimized our configurations—supplier base, sourcing contracts, production capacities, distribution channels, and so on. Now we consider how we need to run some core areas day to day so as to sustain an operational turnaround. We focus on five vital areas:

      1.Quality management.How do we maintain or improve quality—a particularly tall order during turnaround situations. We will see that a key is to drive down variability.

      2.Innovation management.Like quality,...

  10. Appendix A Industry ROA Trees
    (pp. 259-290)
  11. Appendix B Resources
    (pp. 291-296)
  12. Appendix C Glossary
    (pp. 297-300)
  13. Notes
    (pp. 301-304)
  14. Index
    (pp. 305-310)