26 February 2009

The ValueTree™ is a great way to decode current headlines. CBS880 radio out of New York City recently reported that the transit authority predicts that future fare increases will be consumed with rising interest expenses on long-term debt. Let’s reference the ValueTree™ (http://www.myvaluetree.com/TheValueTree.pdf) to understand the situation. Management decides to take on long-term debt to pay for improvements to the system; this is found at the bottom of the tree. The interest that needs to be paid on the debt shows-up in the top of the tree in Accruals. Interest expenses start to layer on top of each other as more debt is taken on over the years. So, if Revenue is projected to stay flat, and Cost of Sales stays equal, each dollar of increased interest drives down the General Fund. Well-run institutions try to maintain around 12% of their operating budget in the General Fund and this practice gets favorable reactions from bond rating agencies. What a Mess! Fares have to be raised just to cover the cost of interest to keep the system in balance and this is a cost escalation locked in for years to come.

This situation highlights the importance of management taking a 30-year view when making financing decisions and considering the impact they will have on future customers. Well targeted Kaizens are a powerful strategy to reduce Operating Expenses to offset the increases in Interest. Before the customer is held hostage to fare increases, good management practices include long-term ValueTree™ forecasting and supportive project management plans for cost improvements using a 10+ year horizon.

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Be well and keep adding value!
Alden