A formula for a successful business is a very rare thing - it is never that simple ! But when a successful one emerges then it is worth a look.
In the autumn of 1999 the executives of Southwestern Energy Co, a gas exploration and production company based in Arkansas USA, were meeting to discuss their business strategy. The company was struggling. They had lost a $109 million lawsuit and the the total value of the companies assets was greater than its capitalisation. They were wondering whether it was time to pack it in. “We were not healthy. No one wanted our stock” the CEO Mr Korell recalls. He remembers uncapping a black marker pen and writing:
in other words the Right people doing the Right thing by wisely investing the cash flow from Soutwestern’s Assets creates Value. Using this formula the company steered its way to success.
What was written on the board shows the relationship between people and the assets. The “right people” are those with the correct skills, experience and attitude for the business. Doing the “right thing” covers not only the activities in using the assets but also making the correct decisions about future assets. Therefore to improve the performance of the business the numerator of the formula shows that it is people that have the greatest impact on creating value.
Although the formula was derived by a business operating in the Oil & Gas industry where the assets are very large it can be used for any business no matter how small the assets, for example a coffee machine is a small asset in a coffee shop but it is critical to adding value - without it there is no business ! For businesses where the assets are knowledge e.g. consultancies, marketing companies, training etc , then the formula still applies. For example the knowledge assets can cover Intellectual Property, Trade Marks, licensing agreements, methodologies etc. And just like physical assets that wear out or are no longer generating any value, then knowledge assets need to be maintained or replaced with new ones.
So what makes this a good formula for a business? First, it is easy to understand - it doesn’t require graph filled reports to explain its elements. Secondly, it generates a series of questions e.g. do we have the right people doing the right things ? Are the people properly trained to take full advantage of the assets ? which assets should we invest in or sell to improve value generation ? and so on. The formula implies a disciplined approach - if the questions are not focussed on improving the elements of the formula then time shouldn’t be wasted trying to answer them. Finally, and most importantly, it can be quickly communicated and easily remembered, in the case of Southwestern it has formed part of their culture where it is known as “The Formula” and is so important that it has a trademark.
Sometimes business formulas can be viewed as being too simplistic - too abstract and not capturing enough of the complexities of a business to be of any use. But when they are found and used they the can provide clarity and direction to a business. In the case of Southwestern it was applied through focusing on the companies core competencies, increasing production, adding low cost gas reserves, improving efficiencies, lowering drilling costs, reducing debt and investing wisely. The companies capitalisation went from $187 million in 1988 to $2 billion in 2005. Today, it is a successful and vibrant company with a capitalisation of over $2.6 billion - proof that a formula can work !