Make an Elephant Dance

Suppose you’re the CMO of a public company and took my recommendation to get a user ID and password to one of its financial databases. Now that you have access, what do you want to know?

HOW TO MAKE AN ELEPHANT DANCE

In his book “Who Says Elephants Can’t Dance” Lou Gerstner reported that his CFO Jerry York found their competitors were spending just 31 cents while IBM was spending 42 cents to produce $1 of revenue. He concluded that when they multiplied that eleven cents (inefficiency) times total revenue of the company they had a $7 billion dollar problem.

ENTERPRISE MARKETING EFFICIENCY

The math is simple. IBM’s sales in 1992 were $64.523 billion. When you multiply $0.11 time these revenues you get $7.1 billion. That was IBM’s “$7 billion dollar problem.” How did Jerry York come up with those eleven cents? I don’t know for sure, but it just happens if you take the company’s selling, general and administrative (SG&A) expenses in 1992 ($23.048 billion) and divide them into sales revenues in that year you get $0.40. If you do the same thing in the same year for the sum of Hewlett-Packard, Dell and Compaq you get $0.29. The difference between IBM’s and these competitors’ cost per dollar of sales just happens to be eleven cents! That was IBM’s enterprise marketing (in)efficiency in 1992. For a review of these expenses see my 12 minute audio slide show Enterprise Marketing Expenses.

SIMPLE BUT POWERFUL

SG&A expense per dollar sales is simple to calculate. But it has powerful implications, since it is a direct measure of a company's enterprise marketing efficiency [EME]. For IBM in 1993 the implication was that Gerstner had to cut $7 billion dollars out of SG&A expenses. These expenses had been built up over the years to a level that IBM no longer could sustain in the face of explosive competition from old enemies and new kids on the block. As a result, IBM shed 35.7 market share points over the next seven years.

WHAT’S YOUR EME RATIO?

What are your company’s (and its top competitors’) enterprise marketing efficiency ratios? Don’t you think you should know the answer to this question? Well, you can find out the same way IBM did. Just pull those revenue and SG&A numbers up on your screen and do the math. How do you compare with the competition? You can bet your CFO will be interested in the answer to this question.

~V

Comments

[Doc]

You're exactly right, John. In 1991 IBM was paying an extraordinarily large premium to sustain its 76.6% share of the $84.6 billion in revenues generated by the strategic group in that year. And your second comment cuts right to the quick ... IBM already was experiencing diminishing returns to its SG&A expenses.

Here's a surprising fact. In 1991 just 1/100th of IBM's next market share point had an incremental cost of $15.6 million. The earnings from that market share basis point after SG&A expenses were $4.9 million. In other words, acquiring just 1/100th of next revenue share point theoretically would have cost IBM $10.7 million in lost earnings after SG&A expenses. In 1991 the company actually spent $28.0 billion on SG&A. If the company had maximized earnings in that year it would have spent $21.6 billion to sustain a revenue share of 58.2%.

Chapter 6 "The Battle for Your Desktop" is dedicated to how Gerstner turned the ship around over the seven years of his tenure. In 200 he actually achieved maximum earnings market share of 42.9%.

The conventional wisdom is to trash Gerstner for destroying a great company. The truth is he saved the mother ship by trading market share for earnings. In 1991 IBM had a market cap of $50.8 billion. By the close of business in 2000 its market cap had increased almost three fold to $148.1 billion. And while IBM's market share fell dramatically, revenues increased to $88.4 billion by 2000.

If you're interested in how the desktop drama involving IBM, Compaq, Dell and Hewlett-Packard unfolded from 1991 through 2000 take a look at my 17 minute narrated Breeze presentation on Chapter 6 http://breeze.tulane.edu/cookchaptersix/

Thanks for you insightful comments!

[John Dawson]

Interesting point but surely there is another point-of-view on this - namely that IBM were paying a premium in order to sustain a higher share.

I'd also assume that like most things, SG&A will at some stage enter diminishing returns - the $7bn is a great figure and highlights a big potential issue. However to then turn round and say let's wipe $7bn from SG&A doesn't necessarily follow. Would that £7bn have protected IBM and helped them maintain dominance? Unlikely because the operating model they had wasn't quite what consumers were after. However whether any reduction in SG&A would have left enough resource to turn the ship around more quickly is a different question to which i don't know the answer.