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ACCOUNTING

The Language of Business
 

Apart from traditional accounting, a CEO works out his own equations for success.
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Forget budgets, quotas, and expense accounts. Larry Stifler has figured out which numbers really matter

Larry Stifler loves numbers, but not the ones you think. It's true, he'd say, that conventional accounting techniques don't measure what matters -- but find the right numbers, the ones that express the relationships that make your company work, and numbers will be the best management tool you have. He'd say his company proves it. Let's see. -- T.R.

* * *

She won't enjoy reading this, even though she said it: Evie McFadden, the woman who runs the largest single department of Larry Stifler's six-year-old weight-loss company, can't balance her own checkbook. Or organize her calendar. And she doesn't begin to know how to draft a budget for her department or manage within one. But Stifler doesn't care.

The people working in Stifler's more than two dozen field operations don't have the foggiest notion of how much money they spent last year or how much they'll spend in the year to come. Again, Stifler doesn't care.

Here is a company that has, on average, tripled its sales every year since its founding in 1983; a company that in 1989 generated roughly $50 million in revenues and solid profits; a company with penny-pinching cost controls, checks on every facet of its operation, and impressive growth projected and planned for -- and still not a budget in the place.

Stifler doesn't care about budgets, and his people don't plan in dollar amounts, yet it would be hard to imagine a company that relies for its management any more than Stifler's does on numbers or one in which compensation depends more on profitability. He and his employees -- all 290-plus of them -- quantify everything they do. "Larry," says McFadden in hyperbolic understatement, "is a numbers guy."

What you notice right away about his numbers, however, is that they aren't straight dollar amounts, or at least very few of them are. Mostly he uses ratios -- the measure of one thing with respect to another. It's these ratios expressing relationships, not the counting of dollars per se, that give Stifler, his managers, and his employees useful information -- with emphasis on the useful -- about what they do.

With Stifler, says Julie Povall, director of operations, the ability to see relationships in terms of numbers is a "sixth sense."

Meaning what?

Meaning he has a way of looking at a company that is difficult for him to explain, but, says Povall, "He can't understand why everyone doesn't see it the way he does."

Stifler, a man who claims 49 years but looks no older than 30-something, holds a Ph.D. in behavioral psychology. As a kid, he says, he used to perform math tricks in his head on the stage -- complicated long division, for instance. Until 1979 he taught everything from college math to psychopharmacology, lecturing in his field at Boston University and Harvard. Then he got involved with a company that was making a lot of money running kidney dialysis clinics.

The company wanted to move into the weight-control business, which appeared then to be, ahem, an expanding market. American couch potatoes were sprouting at astonishing rates. Fitness was still a fad for the relative few. The company created a division called Institute for Health Maintenance (IHM) and hired Stifler, hoping that as a behavioral psychologist he could figure out how to help people keep the weight off once they'd lost it. Almost anyone, apparently, can shed pounds, but staying thin requires the dieter to learn a new post-diet behavior. So, as Stifler and others who were there then tell it, the company created a program that combined for the first time a medically supervised VLCD (for very low-calorie diet) with an extensive patient behavior-modification and support program. It was supposed to get patients slim and keep them that way. Stifler thought his program was good, and so did his employer, which began to market it. But soon Stifler and, eventually, most of his IHM staff resigned -- not because he didn't think the diet plan would work, but because Stifler believed the business wouldn't. "We differed over how to make it profitable," he says.

IHM and Health Management Resources Inc. (HMR), the new company that Stifler founded, were alike in many respects. Both thought of their customers as medical patients rather than packaged-goods consumers. Both targeted clinically obese individuals who were willing to enter an expensive and intensive medically supervised program -- not do-it-yourself or casual, post-holiday dieters. Both prescribed a fasting period during which patients consumed nothing but the liquid-diet supplement each company sold, followed by a months-long "refeeding" period and maintenance program in which patients learned how to handle real food again.

The differences between the two companies, however, were significant. The most obvious one was crucial. It was the point over which Stifler and his employer had parted company. He had argued, he says, that IHM should not create its weight-loss clinics as freestanding competitors to hospitals, health maintenance organizations, physician group practices, and so on. Instead, they should run them in cooperation with existing medical establishments. Preferably, the clinics should use the institutions' own physical facilities and their personnel. He showed his superiors a mathematical model he had worked out that demonstrated his contention. The model showed, he says, that a diet company could never generate enough patient revenue to cover its operating costs as well as amortize the high start-up costs and pay the maintenance expenses of freestanding diet clinics. IHM opened freestanding diet clinics nonetheless, but Stifler's model, apparently, spoke the truth. The company abandoned the weight-loss business after a year and a half of losses.

HMR, on the other hand, does business three ways. It invests between $25,000 and $30,000 to open new clinics that it runs within existing medical facilities. The clinics belong to HMR, and the hospitals take a percentage of the gross revenues. Of the more than 600 HMR weight-loss clinics, only 26 operate under this arrangement. With the others, HMR trainers show hospital personnel how to open and operate their own clinics, and the company provides regular, off-site training sessions for the doctors and clinicians assigned there. The cost of the training is included in the price of the liquid-diet supplement and other products that HMR sells these clinics. The company also makes supplement-only sales to hospitals or other weight-loss companies that run their own, non-HMR affiliated clinics. HMR is now the second-largest medically supervised VLCD plan in the country, and Stifler predicts that by the end of this year it will be number one. The irony is that the managers of IHM were the profit-driven businesspeople; Stifler, the behavioral psychologist, was not. "Larry," says one of his chief lieutenants, "has a commitment to health. He lives it. He's not in business just to make money. But he believes in capitalism, too. There's no conflict between profitability and running a good program. Profitability and clinical effectiveness go hand in hand."

A lot of companies say that sort of thing. Stifler's got a model that demonstrates it and a company that confirms that it's true.

Stifler was ill on the first of the three days we had agreed to spend delving into what people had told me was his unusual, by-the-numbers management style. His staff could tell he was sick because he had ridden, not walked, the three miles from his house in Brookline, Mass., to his office in downtown Boston and because he had alighted from the elevator on seven instead of taking the steps. (He had calculated, Stifler explained later, that calories expended on the stairs meant eight pounds that he didn't have to worry about gaining every year.) Anyway, not long after we got started I came to hope that he was sick and would feel better soon because he was showing precious little patience with me or my questions.

"So," I had begun after the pleasantries, "I understand that you have this interesting financial reporting system that lets you track the company's performance just by watching a few numbers. Want to tell me about it?"

No, it seemed, he didn't. He talked about a lot of things -- obesity statistics, liquid-diet supplement formulation, employee motivation and compensation -- that were not high up on my agenda. I could ask whatever I liked, but no matter what the question, Stifler was going to answer with what was on his mind.

"But what about this financial reporting system?" I'd insist.

"It's not just a financial reporting system," he'd say.

"OK, this management accounting system?"

"You're missing the point," Stifler insisted. "There's more to it than that." And he'd tell me about something else I didn't think I had come to hear.

Maybe, I speculated, it's the fever that's making him incoherent.

But you know, Stifler turned out to be right. It would have been missing the point to have insisted upon learning only about a novel financial reporting system and clever ways of tracking costs and revenues. Stifler has those, to be sure, and some other novel and elegant management control systems as well, all of which he eventually got around to describing. But what gradually became clear was that all of these techniques proceeded from a way of looking at the world and at business in particular that is decidedly iconoclastic. "I do everything by the numbers," Stifler said, time and time again. He does not, however, mean by that that he is a CPA-like bean counter. Not even close.

When most numbers-oriented people look at a company, they see dollar flows. Cash comes in and goes out. If more goes out than comes in, they start looking at costs: how much does labor cost, as well as materials, real estate, telephone systems, electricity, and so forth. Now, what expenses can we cut to get costs below income so that we wind up with a profit instead of a loss? If phone costs look high, we cut them, but we don't necessarily cut personnel costs. Telephone expense comes to so many dollars; payroll costs are another, separate item.

The nice thing about looking at a business as a series of budget line items is that you can move from shoe manufacture to computer making, and the cost accounting system looks pretty much the same. Accountants, after all, can't create a whole new system of counting every time they move their audit team from one client's business to another's. Also, investors want to compare opportunities with different companies in the same industry and in different industries, too. If you've got two apples in one hand and a banana and a grape in the other, you need to be able to talk in terms of fruit. Maybe the standard financial and management accounting systems do not fit perfectly every kind of company. Standard accounting rules, for instance, require radio and TV station owners to amortize goodwill as if it were an actual expense, when in fact it's an asset -- usually the station's most valuable asset -- that declines in value only if the station is poorly managed. Stations take the write-down nonetheless and so may look as if they're losing money while the real profit dollars pile up. Or maybe they aren't profitable. The point is that you can't tell by looking at the net income line on the stations' financials. And one other thing: by the time the accountants collect their numbers, do their calculations, and arrange them on the page, you're looking at the results of what happened quite some time ago, which may not be what's happening now.

Harold Geneen, the legendary chief executive officer of IT&T, also lived by the numbers. He wrote, "The professional's grasp of the numbers is a measure of the control he has over the events that the figures represent." But like the numbers he revered, Geneen's observation contains only some of the truth. Control does depend upon mastery, but also upon how completely and how accurately the figures mastered actually represent a very complicated reality. What people usually forget or ignore when they look at numbers is how imperfect this representation may be. Precision can mask misunderstanding. Numbers frequently don't measure what we think they do, or not all of it, or not accurately, or not in terms that are meaningful.

Accounting systems, which depend for their utility upon the similarities among companies in different businesses, paper over a world of differences that are crucial to the people running a company. The conventions of financial accounting often have no place in the real-time tracking of the day-to-day operation of a company -- or so Larry Stifler believes.

Nonetheless, practically everything Stifler's company does is captured by a number somewhere. So, what's the difference?

For one thing, Stifler's way of using numbers to represent relationships tells him things about how his business works that are not otherwise obvious.

For instance, HMR does very little consumer advertising. But it's offering a consumer-oriented service. Wouldn't it want to advertise? Stifler knows he doesn't have to, and he understands why. He figured it out by looking at a few numbers and thinking about them in terms of their relation to one another. He saw, from records kept, that on average every HMR patient who moves from the fasting stage of the VLCD into the 18-month maintenance stage recommends 2.2 additional patients who enter the program. If that's true, he said to himself, all I have to do is get at least 46% of the patients in the program into maintenance, and the program will self-sustain (since 46% times 2.2 equals 100%). If more than 46% make it into maintenance, the program will grow automatically. "So," says Stifler, "I said, set up the business for quality care and it'll grow by itself."

Looked at another way, the numbers tell him that every dollar spent providing good patient care comes back 2.2 times.

Or looked at still another way, they tell him that reducing the quality of patient care to save $1 actually costs the company more than twice that in revenue. It's a powerful tool to use with his hospital and medical establishment clients whose administrators tend to believe that you improve profits (or reduce losses) by cutting expenses. "A big part of our job," says operations director Povall, "is convincing hospitals not to cut corners."

In the 26 clinics that HMR operates itself, according to Stifler, between 60% and 70% of the patients who enter stick with the plan for the six months that it takes, on average, to get through fasting and into the maintenance phase. He believes that is the highest figure in an industry in which, more typically, half the patients drop out in less than three months.

When Stifler looks at a company he sees a set of relationships among people, things, and events. It's impossible, he says, to understand what happens inside that company simply by looking at what something cost or what revenue it brings in. Compared with what? he would always be asking himself.

Instead, Stifler's tendency is to build mathematical models that attempt to capture important relationships within the business. In the context of these relationships, numbers acquire meaning. Traditional budget line items expressed in dollar amounts don't give you that.

An annual budget will have a line for projected income and lines for anticipated expenses. Let's say there are three: salaries, telephones, and office furniture. Obviously, these three and the income line are related. If revenues rise more than projected, you'll probably have to hire more people, install more phones, and buy more office furniture. But a budget doesn't tell you anything about how these four items are related to one another. Changing one line item doesn't automatically adjust the others.

Here's the same problem seen in another way. You get your department heads' budget proposals for the coming year. Telephone expenses come to $100,000. Last year you spent just $70,000. You go through the roof: too much on phones, you tell them. But is it? So you assign someone to do a study of telephone costs, and three months later that person hands you the results. But then what about office furniture?

Here's how Stifler approaches the situation -- without a budget. The determining variable in his company is the number of patients enrolled in the weight-loss program. (In another company it might be the number of hamburgers sold or clients serviced.) Everything at HMR is related in some way to the number of patients enrolled. Stifler can begin by estimating a reasonable patient-staff ratio. Say, for instance, it's 50:1. And he knows what each employee costs in compensation and benefits. So, there is a direct and easily quantifiable relationship between the number of patients enrolled and the company's payroll costs. Each staffer needs a phone, desk, and chair. So phone costs and furniture costs also relate directly to the number of patients enrolled. Now, he builds a model, which is fairly easy to do, incorporating those relationships. For every 50 patients, he'll need a new staffer, a phone, a desk, and a chair. If they have this model to follow, clinic managers don't have to spend their time building budgets based on estimates and then revising them when actual patient enrollments are higher or lower than estimated. They just keep track of patients enrolled and do what the model tells them. If they get 50 additional patients they hire one new staffer; 100 and they hire two. And they don't have to find the money to pay for the staffers -- or to install the phones and furniture -- because each new patient brings in a known addition to revenues. "I never write a budget or proposals," testifies Dolores Gable, a behavioral health educator at HMR's Newton-Wellesley (Mass.) Hospital clinic. "I just work with patients, and in a year of working here there's nothing we've wanted that we couldn't get. The model tells us."

That's how Stifler and others at HMR use numbers to help them understand how the company works. They also use numbers -- ratios, once again -- to keep track of how well it's working. It doesn't take many. Stifler begins by looking at just two.

The first is productivity, and it's simple. He divides the month's net revenues by the number of people in the company (using FTEs, or full-time equivalents) and gets a ratio -- revenues per employee. If all else fails, he says, "this will tell me that there's something wrong. If productivity is the same or better from month to month, then we're OK." Last November HMR's monthly productivity figure hit a new high at something more than $140,000 per employee.

It's a quick check, a safety. If there's something wrong, the productivity figure doesn't identify it. Also, an improvement somewhere might offset a problem somewhere else, and Stifler's productivity figure won't catch that. But it's easy and current, and unlike the data that accountants work up, it gives him an instant view of the forest instead of a belated head count of the trees. "With this one number, I don't have to look at any other."

But he does look at a second number, a number that takes him down one level of abstraction, one step closer to what's really happening in the company. It tells him at a glance how two parts of his business -- product and service -- are doing relative to each other. HMR makes its money from selling liquid-diet supplement. It charges patients for the services it provides them, too -- the support group sessions and counseling. But the service, including the training provided to clinicians in hospital-run clinics, is basically a cost incurred in order to sell the product -- rather like customer support and field service are costs incurred to sell computers or other manufactured goods. You have to offer the service, but you don't want the cost to get out of line. So Stifler maintains two checking accounts. All the income from products sales goes into one, from service fees of company-managed programs into the other. Expenses, likewise, come out of the appropriate account. Because the company makes money on product sales and loses money on service, every month Stifler has to write a check from the product account to cover the service deficit. It is not the size of the check he worries about. It can grow larger so long as it stands in the same proportion to revenues as last month's check. If it's not, right away he knows that product and service have gotten out of whack. His accountants, he says, think it's a nutty system. But their reports, he complains, take too long. "It takes them months to find out that I've got a problem, but my system tells me immediately, not only that I have a problem but exactly how bad the problem is."

Furthermore, Stifler can figure out where the problem is by dropping down one more level of abstraction to find which cost has gotten out of line. Once again, he won't be checking dollar amounts but a set of ratios.

Not every month, but when he is so inclined or when either his productivity calculation or the check he writes to cover the deficit in the service budget tips him off to a problem, he calculates about 18 ratios. (He could have someone else do the calculation, he says, but doing it himself makes him pay closer attention to the result.) The denominator in every case is net revenue. He looks at 18 or 19 cost categories as a percentage of net revenue. His model tells him what the percentage ought to be; the calculation tells him what it is. "This may sound deceptively simple," says Stifler, "but nobody has to shuffle 150 pieces of paper after four months to see what went wrong. I can do it at the end of the month in three minutes."

The point, again, is that looking at the number of dollars spent in any cost category -- telephones, for instance -- doesn't tell a manager much. Who cares what the dollars are so long as they are the same percentage of revenue as they have been and as the model says they should be? If a ratio is off, Stifler knows exactly where the problem is. He doesn't know what it is. Maybe someone didn't follow the model or the price of phone service went up. The former has one solution; the latter, another. But figuring out where the problem lies doesn't eat up gobs of managerial time. "If you ask Evie how much her department spends," says Stifler, "she hasn't the slightest idea. Why should she? She's the world's greatest trainer."

"If we have to do more training," McFadden says, "it's because we have more staff, which is because we have more patients -- and the dollars are therefore there. In another company I'd probably be in trouble or in an element I wasn't good at. Thinking about dollars would keep me away from what I do best."

Quality is a squishy concept, especially quality in services. Stifler's model has shown him that quality pays off in a program that grows larger by itself. However, that model doesn't help him discriminate between a dollar invested in quality and one wasted in quality's name. Even here, though, Stifler uses numbers.

As part of their behavior-modification training, patients keep track of all sorts of things -- the number of calories they consume and the number they work off in exercise, for instance. Clinics keep track of these numbers and others, such as average weekly weight loss and the quantity of liquid-diet supplement each patient buys. Yes, one aim is to monitor individual patients' progress, but another is to check the clinic's performance. "You can look at those numbers and without even talking to patients know whether they're in trouble," says clinician Gable. At the same time, "the quality-control data lets us see that we have a problem before it shows up in attrition," says Povall. And it shows where the problem is. You know which patients are failing, and you know who instructs them.

Numbers are diagnostic tools, but they can't solve problems by themselves. That takes people. Stifler tries to instill in the people who work with him an appreciation for the limitations as well as the capabilities of mathematical models. "There is a point," says McFadden, "beyond which numbers aren't useful. Telling a clinician, for instance, that she's a 6 [out of 10] on average isn't useful. You've got to show her how to overcome the things that are limiting her."

Models can't offset bad attitudes, and they won't work if there's no agreement on goals.

HMR, for instance, spends tens of thousands of dollars on air travel every month for trainers and for salespeople who call on hospitals and other health-care institutions. The model helps management keep tabs on those costs, but it doesn't ensure that people fly at the lowest possible fares. That takes planning: training sessions are scheduled months ahead of time, allowing advance purchase of tickets. It requires attitude: everyone at HMR who chooses to -- and that's all but 8 out of nearly 300 employees -- gets a large share of his or her compensation through profit sharing, so the less spent on airplane tickets (or anything else, for that matter) the more profit there is to share. And it requires enlightened thinking: "This may look like a pressure just to cut costs," says Povall, "but it's not. A big part of the job is to recognize that there is a link between dollars spent and effect achieved." Of course, it's the understanding the models bring that enlightens people's thinking.

His way of looking at a business probably wouldn't work, Stifler says, in a public company with shareholders whose only interest was quarterly profits or in a unionized company in which the union's goal is to grab as much for its members as it can. Or, he might have added, in a firm where management's goal is to maximize its own take, unions having no monopoly on greed these days.

The next day Stifler was feeling better, and by the third day, he allowed, he was himself again. He not only walked to work, he worked out. And whatever flu-induced restraint he'd shown on day one had been banished with the bug. "Write this down," he told me, as if he thought I wasn't taking notes at the right time. "Your readers will want to know this." There was so much more he wanted to say about HMR -- that there were no fixed job descriptions or reporting hierarchies, that it's a company with a mission to improve the health of millions of Americans, that if he'd gone to business school he'd probably have hired a CFO and gone bust like the competition, that. . . .

But in the end it's the numbers that make it all possible. It's the model that makes it all work.

The irony, Stifler would say, is that being a numbers guy in the manner he's devised has enabled him to be a big-picture guy, too. Paying attention to the right numbers helped him figure out how his business should function. In detail. But he doesn't need to know details anymore. By watching just a few numbers, he can see they're working.

(continued)


BY THE NUMBERS

* Productivity: Because Stifler's main expense is people, every month he looks at productivity -- revenues divided by number of employees. The number he gets doesn't tell him much, but it is quick and easy, and if it starts going down he knows he's got a problem somewhere. 'With this one number, I don't have to look at any other,' Stifler says.

* The Check: HMR makes money on product and loses money on service, so Stifler has to write a monthly check from the product side's checking account to cover the shortfall in the separate account for service. His model -- and experience -- tell him what that check should be as a percentage of company revenues. If it deviates, he knows he has a problem.

* Expense Ratios: Patient enrollment is Stifler's key. Every patient should generate a known stream of revenues and expenses, and HMR's model relates the line items that result. If the productivity figure declines or the size of the check Stifler has to write gets out of proportion, an expense has gotten out of line with the model. To find it, Stiffler looks at expenses as a percentage of revenue.

Last updated: Feb 1, 1990




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