Friday, June 02, 2006

What's Math Good For?

I received the following email today. It's true, not one of those internet hoaxes. How do I know? Because the person who wrote it is the same person who sent it to me.

I used to teach in one of the major business schools in the US. I gave up my job so my better half could take a much better one, and I'm now an unemployed faculty spouse. I'm not broke, but to alleviate sheer boredom, I've been doing some consulting, like I was doing before I started teaching at that business school I used to work for.

Don't misunderstand me when I say that it's no wonder so many businesses go under. I wish they wouldn't. But again and again, somebody hires me to find out why they're losing money, and it takes everything I have to ask if they've ever looked at their books.

I'm not an accountant, and I don't do finance. I do operations and decision sciences. But anybody who can add and subtract, forget accountants, should be able to see the costs far exceeding the revenues.

Over and over again, I talk to business owners who tell me they were never any good at math, and what is it good for anyway? Uh, well ... if they could do simple arithmetic, they wouldn't be losing money, but of course, you can't say that to somebody who's paying you good money to do it for them.

Here's one recent example. When somebody hires me to consult, I always ask to meet with the accountant. I had been hired by a small local business, a photo developer. I went to meet with the accountant, and he was a sixteen year-old kid who had never taken a single accounting class, and had to hunt for an hour to find the books.

When you're losing money, it's always because your costs exceed your revenues. That much is, or should be obvious (my job is to figure out how that can be corrected). But it wasn't obvious to these people.

They never looked at the books -- in fact, the books hadn't been updated in several months. Looking over the numbers, it was obvious that they felt no great need to enter anything. So I really didn't have a good idea of what had been going on, or I didn't have as good an idea as I wanted, because all the data weren't there for me to see.

I think family businesses are great. In this case, it was a problem.

They were employing everybody they could in the family and paying them -- paying them hefty salaries. Hence the costs, or the major reason for the high costs.

Maybe I'm old fashioned, but why would you pay your sixteen year-old son 30K to more or less do nothing but call himself an accountant, yet not even know where the books are? That's right. 30K. One cousin was being paid even more to do nothing but take and process digital photo orders, while two other cousins were being paid to take and process film orders. Given the amount of business they did, they could easily have paid one person to take and process both the film and digital orders.

I met with the business owner. I showed him charts of the costs in salaries alone. I told him he would make a profit if he had one or two people taking and processing all orders. And I was firmly told that was not an option. So I asked if he could cut salaries. Nope, no way.

I tried reasoning with him. Fully 80-some percent of his costs were salaries. He was bleeding money. But he refused to even consider it. So I had to figure out another way to cut the costs enough that he would at least not be losing money.

I built a model for him in Excel -- he was amazed when I showed it to him, he had no idea you could do something like that -- where you could change the prices for the different packages they offered, and it would run a simulation and output the total profit. They have a pretty complex system of packages, some overpriced and some underpriced, and when I finally got his okay to fiddle with the pricing, I worked on it until we were getting a modest monthly profit.

Anyway, I thought the job was over, but six weeks later, the guy called me and was really pissed off. He said he was still losing money (how he knew whether he was or not is still a mystery), and wanted me to come fix it for him.

That's when I found out that he was paying into 401Ks for the two cousins. Paying a lot. No, it wasn't written down anywhere, I found out because he just happened to mention that he had to leave to deal with his cousin's 401K.

I trashed the model and wrote another one taking into account the costs of the 401Ks, and told him there was no way ever he was going to make any money without pricing himself out of the market. We went around and around, but I finally got him to agree to a matching plan for his cousins' 401Ks, and he's now making a very tiny profit, but at least he's not going bankrupt.

The whole family thing wasn't representative, but it's amazing how many people think they can just start up a business and make money without paying attention to anything because they don't like math. Business is at least 90% math. Yet, people still say "what is it good for?" as if they didn't realize it.

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