How many people do we need to lay off?

Once upon a time, there was a chief executive officer (CEO) and his adviser. The CEO had been newly appointed by the board of directors of a publicly listed company. The company had existed for many years and was in an industry which can be, well, described as mature.

The CEO was focused. He believed that while the elite of the business world paid homage to stakeholder capitalism at Davos, Friedman had got it right.

There is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits.

― Milton Friedman

The corporation that the CEO had been appointed to, had failed to meet this goal in the last couple of years. To turn around the situation, he retained a management consulting firm. His trusted adviser represented this firm. After gathering and analyzing all relevant data, the CEO and his adviser had a conversation.

CEO: “So, what do you think? What is the problem?”

Adviser: “Well, you need to take action to increase the intrinsic value of the firm. Of course, investors and analysts’ perceptions also need to be managed, but first we need to focus on increasing value. I think that you know quite well what drives it.”

CEO: “EPS, that is earnings per share and growth of course.”

Adviser: “You are right. There are a few ways to describe it. Benjamin Graham described it thus.” Saying this, he moved to the whiteboard is front of them and wrote down the following equation —

Intrinsic value = [EPS × (8.5 + 2g) × 4.4]/Y

“Now, let’s not worry about the constants in this equation which have changed from 1974, when Graham last revised the formula, or Y which is the current yield on AAA-rated corporate bonds. What is obvious is that EPS and the expected annual growth rate g, are multiplicative.”

CEO: “So, where do you recommend that we start?”

Adviser: “You obviously notice two facts. One is that EPS has a higher weighting than growth, since it is also multiplied by another number in the equation. The second is that, increasing EPS can be done a lot quicker than increasing growth in a mature industry like yours.”

CEO: “Are you recommending to focus on EPS first?”

Adviser: “Well, we recommend a comprehensive road map with a three-pronged strategy.” Saying this, he switched on the LED screen in front of them, which had a slide with the following content.

He continued, “Let’s begin with the first point. You are the new CEO of this well-reputed corporation. In order for your firm to be competitive in the marketplace, you need to reduce costs? Which costs will you reduce? How will you reduce these costs? That is what, we will assist you with in the form of operating model redesign.”

CEO: “I am a man of action. I would like to see a concrete plan for increasing earnings for our shareholders through this operating model design.”

Adviser: “Precisely. Here’s a comparison of your gross profit margin, operating margin and net margin as a percentage of your revenue compared to your top two competitors.” Saying this, he transitioned to the next slide on the LED screen.

The CEO stared at the slide thoughtfully and spoke.

CEO: “So, our cost of goods sold (COGS) and operating expenses seem much higher than our top two competitors. Have you analyzed actions which we can take to reduce those?”

Adviser: “We most certainly have. Otherwise, I would not be doing a good job. Would I? We see five concrete opportunities for you to reduce your COGS and operating expenses, adding up an opportunity to increase your operating margin by 10%.” Saying this, he moved to the next slide.

The adviser continued, “I will walk you through the details for each of the five levers, but it will require some bold and firm decisions on your part.”

CEO: “What kind of decisions?”

Adviser: “Well, you see. We have analysed all your costs, across operations, sales, marketing, human resources, finance, IT, administration, etc. A lot of your costs are fixed. Among the variable costs, people cost across these various functions account for 80% of the cost. So, naturally this operating model redesign will result in a huge staff rationalization.”

CEO: “How many people do we need to lay off?”

To be continued …

Postscript: An alternative name of this article is “Think like a management consultant.” While this article can be read separately, it also forms a part of the series, “How can we solve problems in four ways?” This is the third article in the same series. The second one was, “Think like a software engineer.”