Economic Realities is a concept I have worked with several small businesses and at Sprint dealing with relative product economics and how to optimize an entities performance. The key is to understand the capital and resources driven by product/market mix. My first development and use of this concept was at Sprint. My Long Distance Division Operations Analysis Team had recently completed several major initiatives:
- Activity Based Management prototypes for several shared services organizations
- Developed a Private Line pricing model
- Reviewed additional investments for several products
- Statistical study on the relationship of advertising spending to traffic growth for key industry players
- And, analyzed several large corporate contracts
Bill Gunter, SVP LDD Finance and I were waiting to meet with Art Krause, Sprint CFO to review a couple of these projects. Prior to our meeting starting, Art mentioned he just reviewed a major network growth investment business case and saw the growth driving the network elements needing to be purchased but at the Long Distance Division level, he wasn’t seeing that kind of growth. He asked me to take a look at it.
The initial answer was quickly derived. While the national accounts traffic was growing, the consumer business traffic mix was declining as AT&T and Sprit were seeing consumer market share shift to MCI as a result of their Friends and Family launch. Therefore, Sprint was seeing growth in traffic driving peak capacity needs; off peak capacity usage such as residential was decreasing as a percent of business. Thus, capital spending was disproportionate to overall growth due to peak/off peak capacity needs.
While the answer was easy, I started thinking about the strategic consequences of this shift and our Marketing Business Unit Growth Profitability since the Long Distance Division MBU’s had differing levels of profitability. I gathered my team and we discussed the issues and roughly tested several hypothesis. While we weren’t charted to do this project and still had a heavy workload, the team ended up working evenings and weekends to contribute to this project since we saw the potential of the project to be very strategic.
While the Sprint LDD MBU’s had Market Margins which reflected their access, marketing, and directly controllable costs, a lot of network and shared services costs were not factored in. Leveraging some of our studies and getting some help from other groups, we were able to develop contribution margins which reflected such costs as billing and network. We also overlaid Working Capital implications given different billing policies for different customer segments and different payable differences driven by switched and special access billing practices by the Local Exchange Carriers.
In effect, we ended up with mini balance sheets for the MBU’s so that we can drive a cost of capital charge. The MBU’s that drove the capital should cover the economic cost of capital. An interesting conclusion was that MBU’s with the highest contribution margins did not necessarily have the highest economic margin when the economic cost of capital was factored in. This work also enabled the Long Distance Division to quickly roll out Economic Value Added when that approach became a corporate initiative.
We then modeled the impact of value creation with a capital spending constraint in the five year forecast. This study showed large differences in shareholder value creation depending on what products grew with that fixed capital constraint. This caused significant focus on our product mix in the upcoming Strategic Planning and Budgeting process. It was rewarding to walk into conference rooms and see our concepts on white boards and how various Marketing and Network teams were going to work within that framework.
We ended up presenting this study to Sprint’s Executive Leadership Team and eventually to all of Sprint’s Divisions. This Economic Realities Study became a recurring study to kick start the Long Distance Divisions planning process. It is with pride that several of the analysts who worked on this project are eventually became Managers, Directors, and even Vice Presidents within Sprint.
In my consulting work, I was able to replicate this concept to small and medium sized businesses. Do you know the Economic Realities of your business?