Andrew Bartels, a respected Forrester Analyst, in his recent research makes two broad points:
- IT industry has a predictable business cycle with 8-10 years of Tech introduction and growth, followed by a roughly similar period of Tech refinement and digest. We are currently in the beginning of the Tech introduction and growth led by what Forrester calls “Smart Computing” (and you can read more on his blog about What is Smart? and Why Smart?).
- More importantly, Smart Computing is more about optimization of assets and liabilities on the balance sheet, as opposed to earlier cycles that were more about income statement items (increase revenues, cut expenses).
In his words, “Still, the next big business challenge lies more in the balance sheet — in optimizing the value of and the returns on assets and minimizing the costs and risks from liabilities. New tools will provide businesses and governments with far better real-time awareness of the status of their assets and liabilities, as well as vastly improved analysis of how to maximize the returns from the assets and the costs and risks from their liability. Today, companies and governments have awareness and analysis of their financial assets and liabilities (although these areas still have ample room for improvement). In the next phase, awareness and analysis of the balance sheet will focus on physical assets and liabilities, such as cars, trucks, airplanes, office buildings, hospitals, transmitters, pipelines, equipment, and machinery. And awareness and analysis technologies will quickly spread to intangible assets like intellectual property, brand, customer or supplier contracts, or knowledge workers in a workforce.
The abilities of Smart Computing to optimize the management of the balance sheet will meet a ready audience because the current recession has heightened CEO awareness of the importance of the balance sheet.”
In my earlier posts, I had talked about how one could be misled by Return on Common Equity (ROCE) and the right metric to consider is Return on Net Operating Assets (RNOA – pronounced “Roh-na”). And Bartel’s key point is that Smart Computing will help a company improve it’s RNOA.
Note, one can use operating liabilities to lever up RNOA, similar to how one can use financial liabilities to lever up ROCE.
RNOA = Return on Operating Assets (ROOA) + Operating Liability Leverage (OLLEV)*Operating Liability Spread (OLSPREAD)
where OLLEV = Operating Liability/Net Operating Assets (NOA)
And how can firm improve its OLLEV? By leveraging non-interest bearing supplier/customer credit, the firm can reduce it’s own investment in net operating assets and lever up RNOA. Think of Dell’s earlier direct business model where it carried minimal inventory and used supplier credit to lever up it’s RNOA.