News and Views, a publication of Bessner Gallay Kreisman,
L.L.P.,
is a bi-monthly communication platform designed to identify and
simplify notable business themes and developments in the arenas
of tax, accounting, finance and consulting. For further information
about this communiqué, or any of the services available at Bessner
Gallay Kreisman,
L.L.P.,
please visit our website at
www.bgk.ca.
Weathering the Storm:
How To Fortify Your Business In A Sluggish Economy
When the economy is down, doing business as usual is a challenge -
but out of need comes opportunity.
If harnessed properly, difficult times can allow you to innovate,
set your company apart from competitors, rally your workplace,
eliminate inefficiencies and position your company more strongly for
the future.
Stop and look at the big picture
The first thing to do when the economy is slow is to stop and look
at the big picture rather than taking immediate scattershot actions.
It is important to renew focus on the essential mission and goals of
the business in order to direct the resources of the business
efficiently.
This process may – or may not – mean that you stick to your
historical objectives. In fact, when the economy is sluggish, it may
be just the time to reinvent your business.
Whether you stick to the past or move in new directions, be sure
your objectives are specific. Communicate them throughout the
business so that everyone will be rowing the boat in the same
direction. This process will focus the energy of the business and
allow it to move forward strategically. It will also allow you to
make a stronger case to existing and potential customers.
Take advantage of the situation
A sluggish economy can actually create opportunities for business
that look outward rather than focusing all efforts on cutting back.
Problems for your competitors can mean new opportunities for you if
you are more nimble and creative.
For example, you may be able to gain market share from competitors
who are retrenching until the economy shifts. On the flip side, you
may be able to arrange more beneficial terms with existing
suppliers. This may also be the right time to approach new
suppliers.
Make customer service a priority
When the economy turns downward, customer service is more important
than ever. Consider the maxim that it takes five times more effort
to get a new customer or client than it does to keep an existing
one.
Make a concerted effort to stay in touch with your customers to head
off competitors. This will give you an opportunity to strengthen the
relationship and get early notice of any concerns.
Make customer service a priority. Before cutting your own payroll,
consider negative consequences on sales. Remember that customers may
look elsewhere if they have to wait unacceptably long to obtain
service, information or deliveries.
Keep an upbeat atmosphere for employees
While it may be unavoidable to cut down on payroll, do not
immediately turn to layoffs. Consider shortened work hours, job
sharing or pay cuts as alternatives. Remember that motivated
employees are crucial to the success of your business – try to keep
an upbeat atmosphere. While you may need to cut budgets for parties
or other events, try not to eliminate them. Also, consider low-cost
ways to keep the workplace fun.
Meet with employees regularly and, to the extent possible, involve
employees in decision-making, especially those related to the new
policies for shortened hours or job reassignments.
Finally, try to find ways to continue to reward high-performing
employees. If employees know their efforts will be rewarded, your
employees may offer some of the best suggestions for cutting waste
and costs, and improving productivity and sales.
Run
lean but smart
Have a good budgeting process in place and do regular cash flow
projections to project your needs and avoid being blindsided.
The challenge is to be strategic and imaginative, not reactive. If
you need to cut costs, do so strategically, not simply across the
board – and consider when cutting costs may be counterproductive.
Before cutting out an expenditure, ask whether it might help to
improve sales, bring new leads or improve customer retention.
For example, during hard times, many businesses reduce advertising
budgets. However, maintaining or increasing these items during
slowdowns can increase sales and pull customers from competitors who
are spending less.
Keep lean inventories, but not so lean that you will lose sales.
Navigating your business
Navigating your business through the storm of a sluggish economy is
not easy. But if you use these difficult times wisely, when the
economy begins to turn around, you may find that your business is
stronger and better positioned for the future as a result.
For more information, please contact Louis Ruta, CA at (514)
908-3612 or
lruta@bgk.ca
Better Customer Service Crucial In A Down
Economy
Times are tough. The marketplace is competitive. You need an edge to
keep your customers from going to your competitors.
The more homogeneous your products and services are, the more
critical it is that your customer service be the best that it can
be. Don’t take current customers for granted in your vigour to get
new ones.
At the same time, you need to manage your cost structure. How can
you enhance your customers’ experience without breaking the bank?
Think like your customer
Your customers are probably trying to be frugal just as you are.
Perhaps you can help them work smarter. What information can you
offer that will help them get the most from your product or service?
For example, one company sent success stories to illustrate how
various customers were using the products and services. Those
stories gave other customers ideas they could implement.
Sharing knowledge can build goodwill and help your customers save
time and money.
Save your customers more by selling them more
Shipping costs are skyrocketing because of the price of gasoline.
Can you reduce your customers’ costs and yours by suggesting
bundling options or economic order quantities?
Depending on the sophistication of your customers, they may not be
thinking of these things themselves. This can truly be a win/win.
Improve your customer service department’s knowledge
How often do your customer service representatives have to go to
others for answers to a customer’s question? Do your reps understand
the customers’ businesses so that they can better anticipate their
questions?
Now is a great time to enhance the knowledge level in your customer
service department. Training can be done from within your company.
In other cases, your vendors might be willing to come in and train
the reps on their product lines. Take advantage of the time to make
your team more knowledgeable and therefore more helpful.
Maximize the way you use your equipment
Many companies know only a fraction of what their phone systems and
computer systems will do. Ask the software and telephone system
vendors to take a look at what you’re doing and suggest ways to make
it more efficient – for you and your customers. They may suggest
add-on features but often there are features you’re already paying
for that aren’t being used to their fullest advantage.
Make it easy for customers to do business with you
Look at your ordering systems. Are they easy to navigate? Is it easy
for your customers to find the information they are looking for? How
about your invoices? Are they easy to read and process? Are they
timely and accurate?
Billing may not be part of the customer service department but it is
surely part of the customer experience. Make sure you’re easy to buy
from and to pay.
Listen to your own automated attendant, if you have one. How long
does it take to get to a live person? Do you have to listen through
lengthy instructions before making a selection?
Automated attendants can be helpful and efficient but they can also
be annoying. Make sure your system is user friendly and doesn’t
leave customers in voicemail purgatory. There’s not much that is
more annoying than that.
Don’t assume you know how your system works. Call in and “be a
customer” to see what it feels like. Take notes and address the
snags you see. When you’re involved with your vendors, note what
drives you crazy about their customer service process and then
measure it against your own. You might be surprised to find that you
have some of the same issues.
For more information, please contact Alison Miller, CA at (514)
908-3626 or
amiller@bgk.ca.
The Magic of Diversification
Why diversify?
There are many terms in the world of finance that get thrown around
with reckless abandon, but often have very little meaning when the
rubber hits the road. One of the most common culprits is the term
“diversification”, which has largely been the investment mantra
since time began.
Unfortunately, diversification is often misconstrued as simply
meaning “own a lot of stocks or mutual funds”, which ignores
the fact that owning lots of different securities does not
necessarily make one diversified. Rather, the key to diversification
is to own a group of securities that at least in some way behave
differently from one another. That is, what is good for one security
might not be good for another and vice versa. To best explain how to
properly diversify, we must bring to the fore some financial
concepts.
We will attempt to do this in layman terms, as one can get bogged
down in mathematical minutia when studying financial terminology and
we are neither “mathletes” nor do we assume that our audience is.
That said - the following might be best read with a strong cup of
java.
What is correlation and why does it matter?
When two assets are highly correlated to one another, they will tend
to move in the same direction. Correlation is measured between -1
and +1, with anything close to 1 suggesting that two assets are
highly positively correlated (i.e. they will tend to move together),
anything approaching zero suggesting that the assets will tend to
move independently of one another and anything close to -1
suggesting that two assets are highly negatively correlated (i.e.
they will tend to move in opposite directions). For example, the big
six banks in Canada are very highly correlated to one another
(around 0.80), which is probably not all that surprising to most.
Now before we can hammer home the importance of correlation in
creating the optimal portfolio, we need to bring in two more
concepts: expected return and standard deviation.
Expected return
Embedded within owning a stock or a group of stocks like a mutual
fund is an expected return based on a vast array of probabilities
and outcomes. Simplistically, if we buy a stock or mutual fund for
$10 that we believe has a 20% chance of being $8 one-year from now,
a 60% chance of being $10 and a 20% chance of being $20, then the
stock has an expected value of $11.60 (20%*$8 + 60%*$10 + 20%*$20)
or an expected return of 16%.
Now, we could be wrong about the probabilities and the outcomes, so
expected return says nothing about actual return, but when we buy a
stock or mutual funds, we are consciously or unconsciously embedding
an expected return in the purchase. Intuitively, when we buy a stock
with higher perceived risk, we must be embedding a higher expected
return in order to compensate us for the higher perceived risk. To
get a better measure of this risk, we can bring standard deviation
into the analysis.
Standard deviation
Standard deviation measures the dispersion of returns around a mean
(average). To translate this into plain English (or at least into
something resembling plain English), standard deviation measures how
volatile a stock or a portfolio of stocks is expected to do based on
past performance. The higher the volatility, the more risky a stock
or portfolio of stocks will be and vice versa.
For example, let’s assume that we own a portfolio of stocks that has
an expected one-year return of 10% and a one-year standard deviation
of 20%. This would be statistical speak for “roughly 70% of the
time, the return on our portfolio will be in a band of 10% + or -
20%, which equates to a range of -10% to +30%. Now, there is often a
trade-off between the size of the expected return and the width of
the band around it. The goal of a diversified portfolio is to
maximize this trade-off.
Thus, one intuitively might see that if we can increase expected
return, while also decreasing the portfolio’s standard deviation, we
could potentially do some pretty fantastic things to the future
returns of our portfolios. But is this possible?
Risk-adjusted return and correlation
Armed with a cursory understanding of expected return, standard
deviation and risk-adjusted return, we can now bring correlation
into the analysis. Essentially, as we bring more investments have a
low correlation to the investments that we already own, we lower the
overall standard deviation of the portfolio, even if the investments
that we are adding have a higher standard deviation (individual
risk) than the portfolio.
How is this possible? Again, correlation approaching zero means that
the performance of one asset will tend to have little relationship
to the performance of another, so as we add low or even negatively
correlated assets to a portfolio, the expected returns are
essentially smoothed out (i.e. standard deviation of the overall
portfolio drops).
To bank or not to bank
One of the dangers of the idea of diversification is thinking you
are diversified simply because you own a lot of stocks or mutual
funds. Diversification is really only achieved when the mix of
investments that you own at least have some lack of
correlation to one another.
For example, as we mentioned earlier, the Canadian banks are very
highly correlated to one another (0.80), while they have a
collective standard deviation of returns of about 25%. The energy
sector has a much higher standard deviation (not surprising) at
around 33%, so one might assume that adding an energy component to
our bank-only portfolio would increase risk. However, the energy
sector has a correlation of only 0.26 to the financials and thus
when we add say a 30% component of energy to our bank only
portfolio, the standard deviation of our portfolio actually drops to
about 22% or more than a 10% reduction in overall portfolio
volatility.
Interestingly, since the beginning of 2007, the financials and
energy stocks in Canada have moved in opposite directions on a given
trading day nearly 40% of the time, which speaks directly to the low
correlation between the two assets. Further, sectors such as
materials and stocks also tend to have very low correlation to the
financials and thus despite their higher volatilities, can also
lower overall portfolio volatility.
Diversification and black swans
Black swan events are highly improbable outcomes that are hard to
predict and beyond the realm of normal expectations. 9/11 is a
primary example of a black swan event; while the housing meltdown in
the United States is arguably a black swan event (hockey fans would
argue that a Leaf’s Stanley Cup would be a black swan event). The
easiest and most effective way of protecting a portfolio from a
black swan style event is to make sure that at least some of the
investments in your portfolio are uncorrelated to one another. Thus,
when black swan events occur (e.g. oil going to $140), the impact on
your portfolio may be mitigated.
What are some black swan events on the horizon?
We are obviously only kidding with the above question, as black swan
events are by their very nature unpredictable. That said, we can ask
some questions about our portfolios to make sure they withstand a
rudimentary black swan test.
• What happens if oil goes to $200 or more? Answer – diversification
(i.e. have exposure to the energy sector to offset weakness in rest
of portfolio).
• What happens if oil goes to $50? Answer – diversification (i.e.
own some other stuff to offset weakness in the energy sector that
are in your portfolio).
• What happens if bank stocks trade down another 20%? Answer –
diversification (you get the point).
Can we withstand every black swan event? No, events like 9/11 are
going to do serious damage to portfolios (at least in the
short-term), but by making sure that we are properly diversified, we
can insulate against most of them.
In final point on black swans, the Canadian banks are down about 20%
year-to-date, which may not qualify as a black swan event, but it
may feel like one. Despite this, the TSX is only off about 3%, which
is, in a sense, a real world example of how proper diversification
can insulate a portfolio against black swan style events, as the TSX
has about a 30% energy component (not to mention a near 20%
materials component, which also exhibits a low correlation to the
banks).
Conclusion
Two myths of investing are thinking you are diversified simply
because you own a lot of securities and that riskier securities
automatically increase portfolio risk. Rather, proper
diversification is based on owning a collection of securities that
at least moderately uncorrelated to one another. Further, riskier
securities that have a low correlation to other stocks that we own
can actually lower overall portfolio risk. Following a proper
diversification discipline can not only smooth returns, but also
better protect against unforeseeable risks that lurk on the horizon.
For more information, please contact Peter Goncalves, F. Pl.,
Financial Planner/Mutual Funds Representative, RBC Wealth
Management, Royal Mutual Funds Inc.
BGK Briefings
•
New to the BGK family is Suzanne Grant, CA. Suzanne possesses
close to 20 years’ experience and specializes in real estate. She
has worked with both small and large real estate groups.
Additionally, Suzanne has provided services to clients in the
private and public sectors. We look forward to our clients
benefiting from her proven expertise and impressive business acumen.
Welcome aboard, Suzanne.
• Did you recently receive a copy of A Bulletin from BGK – Turbulent
Times Call For Cautious Measures? This informative bulletin cites
precautionary measures you might want to consider in light of
today’s economy. If you did not receive your copy, please call or
e-mail Ruth Lecker at (514) 908-3623 or
rlecker@bgk.ca
and we will gladly forward one to you.
• Interested in contributing an article to BGK’s News & Views? We
consider all submissions and encourage you to forward your article
to BGK’s Marketing Committee care of
rlecker@bgk.ca.
Second Thoughts
“Success in business requires training and discipline and hard
work. But if you’re not frightened by these things - the
opportunities are just as great today as they ever were.”
David Rockefeller
