(0:00) If you have a high invested capital turnover, that means you're pursuing a cost leadership (0:06) strategy effectively, and therefore you are a cost leader in your space, and that's why you (0:12) have higher profits compared to normal.

Welcome to Business Strategy, where we are documenting (0:17) the best strategies and valuable lessons learned to build more profitable and iconic companies. (0:22) Please share and enjoy.

Welcome to Strategy Trivia. My name is Steve Coughran, and today (0:29) I will be your game show host, just like I'm your host every other week, but today we're going to (0:34) have some fun.

Now, check this out. If you want some more trivia and you listen to my other (0:39) podcast, Boosting Your Financial IQ, I just did an episode on cashflow, so be sure to check that (0:44) out if you want to get nerdy with me and dive into cashflow.

Here's the deal. It doesn't matter where (0:50) you're at from a strategy perspective. If you have zero knowledge about strategy, it's okay.

(0:55) We're going to go through these trivia questions, and we will provide you some great questions to (1:01) consider, and if you consider yourself a strategy master or masteress, well, let's put your knowledge (1:08) to the test.

No harm, no foul. If you score zero and you don't get a single gold star today, that's (1:13) okay. It's all about having fun.

Now, this is the framework that I use to turn around and grow (1:18) companies. I use it at Coltivar. I've used it for over a decade to turn around and grow businesses, (1:24) and that's what we're basing today's trivia on, just so you know.

All right, so question number (1:29) one is this. Is strategy and strategic planning the same thing? Because you'll hear this oftentimes (1:37) in business.

Somebody's like, yeah, we need a strategy. We're going to do strategic planning, (1:40) and those words are used interchangeably. The question is, do they mean the same thing?

I'll (1:46) give you a few seconds to think, and if you answered no, congratulations, you just got your (1:52) first gold star.

Check this out. I don't know what happened, but somewhere along the way, (1:59) poor planning wasn't sexy enough. So somebody's like, you know what? Let's add strategic in front (2:05) of planning.

We'll lump those two things together, and we'll just call it strategic planning. (2:09) And too many people are confused because they believe that strategy and strategic planning (2:13) are synonymous, but they're not.

Here's the deal. Strategy consists of interrelated choices about (2:20) where a company will compete, how they will compete, and ultimately, how they will win.

(2:26) A plan is how you will execute that strategy.

So when people are talking like, yeah, we need to (2:33) get the whole company together, and we need to do some strategic planning, I cringe because (2:37) immediately they go into planning mode, and without a strategy, you just create a plan with (2:42) a bunch of initiatives or objectives or whatever you call them, and they don't relate to a strategy, (2:48) and you can get into a lot of trouble.

So that's question number one. Strategy is not the same (2:53) thing as strategic planning.

I do other episodes on this. If you want to dive deeper, be sure to (2:57) check out my other content.

Okay. Question number two. Before diving into strategic options, (3:05) right?

So you want to start exploring strategic options for your business. For example, you're (3:09) like, okay, should we expand geographically? Should we introduce new products? Should we acquire (3:15) another business?

Whatever your options are, before you get into those options, what's the (3:19) first thing you should do? Give you a few seconds here.

If you said strategic problem, and if you (3:27) said it out loud, hey, kudos, you just got an extra gold star because you're a nerd like me, (3:32) and you're talking to yourself.

Okay. That's okay. But the first thing you need to do, (3:36) being serious, is you need to have a strategic problem clearly defined.

Because if you don't (3:43) know what the problem is, it's going to be really difficult to vet out strategic options.

Now, (3:48) remember, a strategic problem is the number one thing. It's the constraint that's preventing your (3:54) company from achieving its full potential.

Now, it takes a lot of time, and it also takes a lot (4:00) of humility to come up with a good strategic problem.

I've worked with some companies that are (4:05) like, Steve, we don't really have problems. We just look at things as opportunities.

And I'm like, (4:09) you do have a problem. Your invested capital is way too high.

And if you keep growing like this, (4:14) you're going to grow yourself out of business. That's the problem.

Now, companies have a variety (4:19) of problems. Every business has a problem. They have a constraint that's preventing them from (4:23) going to the next level.

Identify what that is before you start diving into strategic options.

(4:29) That's question number two. Let's keep going.

Number three, what are IARs? Remember, this is (4:36) a Steve thing. This is a Coltivar thing. I wrote about it in my second book, Outsizing, years ago.

(4:42) IARs, what does that stand for? If you answered Initiatives, Actions, and Results, (4:49) you are a winner. Another gold star to you.

Essentially, what IARs are is a (4:55) framework that empowers you to execute your strategy.

Think about it. You have a strategy, (5:00) and then you ask yourself, okay, what do we do next? You're going to set some goals.

Now, goals (5:06) are just disaggregated into these three component parts—Initiatives, Actions, and Results.

(5:11) Initiatives are the broad directional moves that you'll make in your business to execute your (5:16) strategy and to make it into a reality.

Typically, a company sets one to three initiatives. If you (5:23) want to get really ambitious, you could add more. I just wouldn’t do more than five.

But they are (5:28) also long-term in nature, and they also involve other criteria.

But that's my next question, (5:34) so I can't tell you what that is right now. But those are Initiatives.

Actions are the steps you'll (5:39) take, the moves you'll make in order to advance your Initiatives.

Actions are hypotheses. In (5:47) other words, you're saying, we believe if we take these actions, we will be able to advance (5:52) our initiative.

Those are Actions. The Results are how you measure success along the way and (6:00) determine whether or not your Actions are allowing your Initiatives to advance.

All right, (6:05) that's enough for that question.

Moving on to the next question—how do you know if you have (6:11) good initiatives?

There are four things—four criteria. If you've listened to my other episodes, (6:17) you'll know these. If not, how do you know?

How do you know if you have good Initiatives or not?

(6:21) You get together with your team. You have a strategy. You put in place a plan. You start (6:25) executing that plan with Initiatives.

How do you know if your Initiatives are good?

(6:29) How do you know if they're on track?

There are four things.

All right, if you listed those out, oh my gosh, (6:34) extra credit to you because that's really awesome.

All right, let me tell you what Initiatives do.

(6:39) Number one, they help you to overcome your strategic problem.

(6:45) Number two, they enhance the customer experience.

(6:51) Number three, they foster innovation.

(6:56) Number four, they help you to build competitive advantages.

Those are the four things you can use to test (6:56) whether or not your Initiatives are good.

If your Initiatives don't touch on any of those, (7:00) you may want to reconsider your Initiatives.

All right, next question.

Isn't this so much fun?

(7:06) I'm having a lot of fun.

What's the difference between Actions and Results?

A lot of (7:12) companies get tripped up on Actions and Results.

For example, they may have an Initiative that (7:18) is "expand market presence." Then they move on to defining Actions and Results, (7:24) and this is where they get confused.

They're like, okay, in order to improve our (7:29) market awareness, we need to create a website.

Is that an Action or is that a Result?

Because you (7:34) can define it almost as a task—like, you're going to create a website—but you could also define it (7:38) as a Result because you’re getting a website.

And then they go back and forth and get all confused.

(7:43) So let me just make it really simple.

Actions are inputs. These are things you will do that you (7:48) input into the system.

Results are your outputs, right?

So an Action is "create a new website."

(7:56) That's the Action.

The Result is higher traffic, better conversion rates, more subscribers—whatever you want to measure to track market awareness.

(8:03) Your Results measure the progress of your Initiative.

So just think of it as Inputs and Outputs.

(8:14) Actions are Inputs. Results are Outputs.

And you will be good.

(8:21) We've got two more here. Stay with me.

What's the purpose of Key Performance Indicators (KPIs)?

(8:28) I'll give you a few seconds to think.

KPIs are intended to measure whether or not the company's strategy is working.

(8:36) And how do you know if the company's strategy is working?

Well, I can't tell (8:40) you because that's the next question, all right?

But that's what KPIs are for.

They help you to evaluate whether or not the strategy is creating firm value.

(8:45) And if it's creating firm value, increasing value, and allowing you to build a great company—a company that creates healthy and stable cash flows—then you'll know you're on the right track, right?

(9:02) So that's the purpose of KPIs. They help you measure whether or not your strategy is working.

(9:05) And remember Key Results, right?

The "R" in IARs helps you to measure whether or not your Initiatives (9:11) are working.

And if your Initiatives are working, then your strategy should be working because they (9:15) all roll up into the same thing.

(9:22) So you have a strategy in place for your business. How do you know if it's actually working?

(9:27) Because the last thing you want to do is pretend like you're playing strategy, but your strategy (9:32) is actually not working.

You waste all this time, all of these resources, all this energy.

Trust me, (9:36) I've been there before. You don’t want to do the same thing.

It’s not good.

Not good for your (9:40) reputation as a leader. Not good for morale. Not good for the business.

And it’s not good (9:45) for your resources.

So how do you know if your strategy is working?

(9:50) All right, this is where strategy and finance come together.

The most basic way is to determine whether or not you have a competitive advantage.

(9:55) So you can look at your income statement, go to the very bottom, and look at (10:01) your net income as a percentage of revenue—better yet, your operating profit.

Then compare (10:06) that to the industry average.

And if you’re earning profits higher than the industry average, guess (10:12) what?

You have some type of competitive advantage.

That’s a really basic way (10:17) to determine whether or not your strategy is working.

(10:22) The advanced way is to look at your Return on Invested Capital (ROIC).

So let me get nerdy with you here for a second.

(10:27) Return on Invested Capital is calculated by taking your Net Operating Profit After Tax (NOPAT).

That's how much money you make (10:34) from normal operations in your business after taxes, divided by your invested capital.

(10:41) Invested capital has two components:

• Working Capital
• Net Property, Plant, and Equipment (PP&E)

So (10:47) that’s your capital base.

In other words, that's how much capital is required in your (10:52) business in order to produce that Net Operating Profit After Tax (NOPAT).

(10:57) So if you just do the math,

NOPAT ÷ Invested Capital = Return on Invested Capital (ROIC)

(11:04) Now, Return on Invested Capital (ROIC) can be broken down into two components.

If you break it down even (11:09) further, you have:

1. NOPAT as a percentage of revenue
2. Invested Capital Turnover (computed as Revenue ÷ Invested Capital)

(11:16) And if you calculate those two subcomponents of ROIC, you’ll know whether or not you are pursuing differentiation or pursuing cost leadership effectively.

(11:27) In other words, if you have an ROIC that exceeds the ROIC for your industry, okay, check (11:39) mark.

Your strategy is working because you're producing returns higher than industry average (11:44) from an ROIC standpoint.

(11:50) Then if you disaggregate ROIC and you find out that the reason why you have a high ROIC is because you have a high Net Operating Profit After Tax (NOPAT) as a percentage of revenue,

Oh my gosh, I probably just gave you brain damage there.

(12:02) In other words, you have higher profit margins compared to the industry.

That means you are pursuing a differentiation strategy effectively because you're earning profits higher compared to your competitors.

(12:12) If you have a high Invested Capital Turnover, that means you're pursuing a cost leadership (12:20) strategy effectively because you are efficient with your capital and therefore you are a cost leader in your space.

And that’s why you have higher profits compared to normal.

(12:31) All right, enough with that, but just know that there is a way to mathematically measure (12:37) whether or not your strategy is working.

No longer do you need to guess.

(12:42) If you want to learn more about this, I have a free gift for you right now.

As of this recording—this may change in the (12:48) future—but right now, you can go to Coltivar.com and get my brand-new book.

(12:53) It’s called Cashflow.

In this book, I walk you through the drivers of cash flow, (12:58) which ultimately leads to firm value.

And I have a whole section about how strategy relates (13:05) to cash flow, to firm value, and finance in general.

Be sure to check that out.

(13:10) Go to Coltivar.com.

All you have to do is cover the shipping and handling, but you have to live (13:15) in the continental U.S.

(13:20) So I’ll cover the cost of the book, you cover the shipping and handling, and we all win because:

1. You’ll become smarter with strategy
2. You’ll build a better business
3. And who knows, maybe one day we’ll get to work together.

(13:25) All right, that’s my gift to you.

I hope you had fun playing Strategy Trivia today.

(13:30) And until next episode, take care of yourself.

(13:35) Cheers.