Using Data Strategically – Or Why Harvard Always Bests MIT

May10

For many amongst us, the recent release of college admissions notifications can yield some unexpected data that require important follow up decisions and, perhaps, some rumination about what should have been done. One such data point produced much shock amongst the representatives of the Avalon team that matriculated at MIT, namely that MIT accepted over 40%….40%!… more applicants this past year than Harvard did.

Fortunately, we at Avalon are all highly trained professionals and know not to accept facts without validating the legitimacy of data, sources of data, and method of analysis. In this case, the source was reputable (i.e., actual admission rate data from MIT and Harvard), the data points were accurate but the measurement was done on a relative basis that made it easy to draw the wrong conclusion.

Turns out, Harvard let in 5.8% of its applicants this year and MIT let in 8.2%. If you take the 2.4% difference between these two admission rates and divide it by the Harvard acceptance rate of 5.8%, you get a 41% difference! Accurate, but once you understand this data and put it in the right context, you realize that both Harvard and MIT are extremely difficult schools to gain acceptance to and the data was presented in a way that made it sound like MIT was a safety school for those sharp Harvard applicants.

This example illustrates an important element of strategic analysis, namely that it is critical in conducting objective, rigorous analysis to validate data and understand exactly the context and assumptions behind the data. This is especially important in the middle market, where fewer companies are public and good data on markets, financials, and competitors can be hard to come by. The old cliché “trust but verify” is highly applicable here, and the better discipline you employ with understanding the data, the better foundation upon which you can develop your strategy.

The Art of Strategy in Practice: Emerson Electric

Apr04

I read a recent interview with David Farr, CEO of Emerson Electric with great interest.  Emerson is a Fortune 500 company that was founded in 1890 and has nearly 128,000 employees and $25 billion in revenue today.  Given this scale and heritage, it would not seem a likely candidate for any awards involving nimbleness and innovation. After reviewing this article you might think again, as Emerson has done an admirable job of adapting to its competitive environment, leveraging its competencies and continuing on its impressive growth trajectory; in short, effectively employing elements of the Art of Strategy.  Some examples:

  • Emerson closely monitors its competitive environment and understands when the playing field has evolved in such a waythat they should either double down or exit a business, even if it involves exiting their original business (i.e., electric motors), as David Farr did shortly after becoming CEO.
  • Emerson is attune to industry trends and understand the opportunities and challenges associated with such trends and adapts accordingly; one key trend impacting their U.S. operations is the high rate of innovation in manufacturing automation (which is partly a response to high quality competition from other countries and also the drop off in U.S. technical skills).
  • Identifying and attacking new market opportunities that leverage Emerson’s core strengths and take advantage of trends; new markets include cooling in data center operations and industrial scale garbage disposers to handle food waste.

Our highest growth middle market clients may not have the resources of an Emerson Electric, but they share an appreciation for the importance of thinking strategically about their business and effectively employing the tools of the Art of Strategy on a regular basis to ensure that they maintain their leadership position.

What is Your Business Worth?

Mar26

One of the principle, if not most critical, considerations that either a buyer or a seller of a business has is valuation.  There are a number of well-used tools and approaches to business valuation that are commonly grouped into one of three categories:

  • Cash Flow/Income-based Valuations: as a business is ultimately only as good as the cash flows that it generates, this approach involves estimating the cash flow generation potential of the business over time.  Net Present Value (NPV) is one of the most common approaches used here.
  • Market-based Valuations:  this approach involves evaluating comparable companies in the market, deriving benchmarks for how these companies are valued and then applying these benchmarks to your company.  The most common approach here is using a multiple of earnings, typically EBITDA (Earnings before Interest, Tax, Depreciation and Amortization).
  • Asset-based Valuation: this approach involves estimating the value of all of the assets in a company, both tangible and intangible, and using that to estimate value.  This is frequently used in instances where there are lots of intangible assets and/or limited current income in the business.

A less frequently used method for businesses (but one which is used for real estate) would be to estimate replacement costs i.e., how much would I need to invest to build a similar business and use that as a basis for value.

There is no one right way to value a business and, although valuation professionals do not like to hear this, there is a healthy balance of both “art” and “science” in deriving a fair valuation.  In fact perhaps the most reliable method that Avalon has found in valuing small/midsize privately held companies is to ask the owner what they think their business is worth and then divide that number by two!

If you are a small or midsize business and are considering selling your business, or are a buyer seeking acquisitions of this size company, a few tips on how to handle valuation considerations are:

  • Be aware of how the other party thinks about valuation, and also how your particular industry customarily looks at value.  Different industries use different valuation metrics, and also command much different valuations.
  • Size does matter;  companies that are $20 M in revenue and lower command much lower relative valuations than large companies in the same industry.
  • Be current in your knowledge; EBITDA multiples, for example, will change depending on overall market and economic conditions, and that 7x that you could have gotten 18 months ago might now be more like 5x.
  • Use multiple methods to estimate value.

Ultimately, the right valuation is what a buyer and seller can agree to, and keep in mind that there might be other options (e.g., earnouts, contingent payments) that can help bridge gaps.

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