Self rating white_paper


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Self rating white_paper

  1. 1. SELF-RATING A BUSINESS RATINGAN ON-LINE DYNAMIC RATING SYSTEMWHITE PAPERSelf-rating is a revolutionary internet based service that allows even the smallest companies rating internet-basedto diagnose and expose the hidden fragilities of their business models. The service helpsbusinesses protect themselves from the dangers of excessive complexity which is the primary whichsource of exposure in a turbulent economy economy.
  2. 2. A RADICALLY NEW EXCESSIVELOOK AT RATINGS COMPLEXITY IS THE MAIN ENEMY OF ACONVENTIONAL RATINGS BUSINESSAs a result of the global financial meltdown and economic crisis, ratings andrating agencies have come under heavy fire. Ratings are highly subjective – Highly complextwo rating agencies don’t always issue the same rating for the same company.Moreover, ratings are expensive. Most importantly, rating typically involves businesses suffer theinteraction between the rating agency and the company wishing to be rated. turbulence of theA DYNAMIC RATING FOR EVERYONE economy and areA conventional rating process is typically carried out once a year. But intoday’s turbulent and fast economy this is not enough. A quarterly, even much more exposedmonthly rating should be performed especially in the case of companies that than their simplerare globally exposed. But why should ratings be available only to the largeand rich corporations? The idea behind Self-Rating is to reach every corner of counterparts. Businessthe global economy, including small and medium enterprises. This is why Self-Rating is affordable and is available on the Internet. simplification acrossREDUCING BUSINESS COMPLEXITY the board is the keyThe goal of Self-Rating is to help companies diagnose and expose the hidden towards a more stable,excessive complexity which is the primary source of exposure and structuralfragility. This is why Self-Rating has the objective of actually measuring the resilient andcurrent complexity of a business and on pinpointing its sources. Businessesthat are simpler have the highest chances of surviving the turbulence of our sustainable globaltimes. The triple-A-rated corporations which have recently defaulted were all economy.highly complex. This shows that tracking the financial performance of abusiness is not enough - you also must keep an eye on its complexity.A RATING YOU CAN TRUSTUsing ready-to-use templates the process of self-rating takes a few minutesand is fully objective since the User is the only human in the loop. A businessowner knows well the financial situation of his enterprise. What he doesn’tknow is if his business has been affected by a new and deadly disease –excessive complexity. Because a complexity rating is not intended for publicuse, you can use monthly or quarterly data which you already have and whichyou can trust. 1 Copyright © 2011 Ontonix
  3. 3. INTRODUCTION EXCESSIVEComplexity is a newly discovered and fundamental property of all COMPLEXITYsystems. Its importance is comparable to that of energy. Like with allthings in life, a minimum dose of complexity is necessary in order to IS THE MAINfunction. Too much can cause grave problems. A good example ischolesterol, an illness of our modern times. It gives no symptoms and SOURCE OFwhen not monitored may severely endanger one’s life. Fortunately, not EXPOSUREonly we know of the existence of cholesterol, we also know how tomeasure its level and how to control it. The same may be said of the Highly complexcomplexity of a business. However, the production of complexity in allspheres of social life is inevitable. This is so not just due to our businesses are fragilelifestyles, but is a result of the laws of physics. Until recently managerswere not aware of the fact that complexity can be measured and and vulnerable. Theycontrolled. Fortunately, today not only are we able to recognize the are unable to faceexistence of the problem, we are also able to actually measure thecomplexity of practically any system. This includes, of course, extreme events andcorporations, ranging from huge multi-national firms to Small andMedium-size Enterprises. predicting theirComplexity cannot grow indefinitely. The laws of physics ensure that performance is almostevery system can sustain its own specific maximum amount of impossible. Financiallycomplexity before it becomes unmanageable and before it losesintegrity. This limit is known as critical complexity. In the proximity of healthy companiesthis threshold systems become unstable. Close to critical complexity acorporation loses resilience, becomes fragile and vulnerable. can still hide highPrediction of performance becomes unreliable and the business is complexity. It isunprepared to face extreme events (the so-called Black Swans). therefore paramount toHigh complexity leads to many adverse consequences whichmanagers know only too well: monitor its value. o Low profitability o High inefficiency o Limited growth potential o The business is unsustainableBecause we are all confronted with complexity on a daily basis it hasbecome almost a matter of common sense to opt, with all things beingequal, for the least complex solution when given the chance to make achoice. Many of our every-day decisions are instinctively based on aminimum-complexity approach. This is why managers prefer a leanbusiness model to a highly complex one. Making decisions in a highlycomplex situation requires more knowledge and resources and is 2 Copyright © 2011 Ontonix
  4. 4. generally more difficult. From a practical standpoint high complexityimplies: EXCESSIVE o surprises are more likely COMPLEXITY o high interdependency, numerous constraints , IMPLIES THE o high uncertainty o multiple converging stresses multiple points of failure stresses, ABILITY TO SURPRISECOMPLEXITY RATING OF A BUSINESS A system functioningJust like in the mentioned example of cholesterol, the state of health of close to its criticala business is proportional to the difference between the current andlimit (critical) value of its complexity. A healthy business functions at a complexity limit is ablesafe distance from its critical complexity. Like with your cholesterol to suddenly developlevels, or the balance of your bank account, so with complexity youshould know its current value as well as the limits you can safely reareach surprising behavior. In Iand sustain. the case of a businessBecause everything in life is relative the mere value of complexity of abusiness means little until the corresponding critical limit is specified. this can mean suddenFor this reason, it is not necessary for a company to be huge to say default. The currentthat is may be highly complex. In fact, an SME may be closer to its omplex.critical complexity than a multi-national concern even though it may national crisis has providedhave a lower complexity. It’s how close you function to your owncritical complexity that matters not the value of complexity itself. numerous andBased on how close a business functions to its critical complexity it is illustrious examples.therefore possible to issue a complexity rating. We may distinguish fivecategories of business complexity. Each level is assigned a number ofstars ranging from one to five – a five star bus business being best:Business complexity is very high. The business is globally close to .its critical complexity. Its structure is weak. The business isunsustainable and very fragile. Exposure is very high and the business .is highly inefficient and very difficult to manage. It is impossible to fficultmake forecasts and define realistic goals. Rating:Business complexity is high. The business is highly complex anddifficult to manage and control. Exposure is high as well as ol.inefficiency. The structure of the business is fragile hence vulnerable. It tureis difficult to make forecasts. Rating: 3 Copyright © 2011 Ontonix
  5. 5. Business complexity is medium. The structure of the business is .fairly robust. Performance predictability is acceptabl Exposure is redictability acceptable. COMPLEXITYmoderate. Rating: RATING MEASURESBusiness complexity is low. This indicates a robust business BUSINESSstructure. Predictability is high, exposure is low. Business sustainabilityand efficiency are quite high. Rating: RESILIENCE While conventionalBusiness complexity is very low. This business structure is very . ratings attempt tostrong. Exposure is very low. The business is manageable and it is .possible to make credible forecasts. The business is potentially highly measure a company’ssustainable and efficient. Rating: ability to honor its financial obligations or its probability of default, complexityWHAT DOES A COMPLEXITY RATING MEASURE? ratings reflect theA complexity rating of a business does not measure its financial plexity stability and resilienceperformance. Unlike conventional ratings it says nothing of acompany’s ability to honor its financial obligations or its long long-term of its businessprobability of default. What it does measure is its current resi resilience. Inother words, it reflects the stability of the structure of its business structure.model. In an increasingly turbulent economy – this too is consequenceof the laws of physics – it is one thing to show great long long-term growthpotential based on exotic math models, having a resilient businessstructure today is another. This is precisely what a complexity ratingreflects – the robustness of the structure of the business of acorporation. And this is something that managers and investors shouldknow. For the rest there are accountants and analysts.HOW IS A COMPLEXITY RATING COMPUTED?This brings us to the fundamental issue of data. Complexity ratings,just like any other indicator, require data. Because complexity ratingsare a corporation’s internal affair, data which reflects the trueperformance of a business on a monthly or quarterly basis should beused. The more accurate and trustworthy this data is the morecredible will the complexity rating be. It is in the company’s interest to ng 4 Copyright © 2011 Ontonix
  6. 6. use for the purpose as many significant business parameters aspossible. This is the fundamental difference between a complexity THE GOAL ISrating and a conventional one – instead of using balance sheets, A HEALTHYwhich are prepared once a year, dynamic and genuine operationaldata is used for complexity rating. An example of business AND LIGHTparameters in the case of an SME can be the following: BUSINESS  Orders  Backlog end of period STRUCTURE  Value of production Without a healthy and  Revenues  Costs for purchases sound underlying  Costs for services structure a business is  Personnel costs  Financial expenses potentially fragile and  etc. exposed. Moreover, itA minimum of twelve samples of each of these parameters should be is unable to safelyused. In case these parameters are available on a monthly basis, the face the extremedata will obviously span one year. When data is available withquarterly frequency, the spanned period will be three years. Monthly events known asdata is of course preferred because this will allow management tohave a near real-time and dynamic picture of the complexity and Black Swans.resilience of a business. In a turbulent and global economy this is amust.Free MS-Excel templates are available for downloading. It is sufficientto fill-out a template and to upload it to our site for processing - thistypically requires around one minute. Templates may be used in theiroriginal form or may be modified to suit user needs. Users may ofcourse create new templates for very specific needs. Portion of anexample input data set is illustrated below. Each row corresponds to aquarter. 5 Copyright © 2011 Ontonix
  7. 7. EXPOSING THE STRUCTURE OF A BUSINESS STRUCTUREThe self-rating process synthesizes the so-called Business Structure ANDMaps (BSM). These are built based on the user’s raw data. BSMs areof fundamental importance towards the understanding of the structure KNOWLEDGEof a business. BSMs indicate which business parameters are relatedand which are particularly important. An example of a 10-parameter FROM DATABSM is indicated below. Self-Rating exposes the structure of a business process based on raw performance and operational data, providing insight into the interdependencies and constrains that a business really faces.Figure 1. Example of 10-parameter Business Structure Map.In the Business Structure Map the following components are present: o Nodes (these are the business parameters) located along the map’s diagonal and represented by red squares or discs o Links – these are either “strong” or “weak” and are represented by black and grey connectors respectively o Hubs – the red discs correspond to those parameters which are related to the highest number of other parametersUnderstanding and BSMs is easy using the interactive MapView™ toolwhich is available for free downloading at our site. The fundamentalbusiness characteristic which a BSM reflects is its interdependency.Being able to visually grasp which parameters within a business arerelated to each other is of immense value. Running a business meanssetting goals and identifying constraints as well as feasiblecompromises. An example is shown below. Positioning the mousecursor over the node “Net Earnings” illuminates the paths to all the 6 Copyright © 2011 Ontonix
  8. 8. other business parameters to which that particular parameters islinked. This is illustrated in the figure below. BUSINESS STRUCTURE – SUPERIOR BUSINESS INTELLIGENCE Increasing business inter- dependency leads to constraints. These, in turn, make it difficult to implement new strategies or to grow the business. Business Structure MapsFigure 2. Business Structure Map in which paths to “Net Earnings” are highlighted. provide superiorOne may note that “Net Earnings” is linked strongly to: “Net sales”,“Total assets” and “Number of stores”. It is also linked in a weaker information necessary forfashion to other parameters, such as “Long-term debt” or “Employees”.What does this mean? For example, one may conclude that, based on the formulation of realisticthe current business model, it is not possible to alter “Net Earnings” and feasible businesswithout altering, for example “Number of stores”. If one changes so doesthe other. This is illustrated in the plot below, which reflects the goals. Quickly.relationship between these two parameters based on User data.Figure 3. Example of relationship (scatter-plot) between two business parameters. 7 Copyright © 2011 Ontonix
  9. 9. In particular, it is evident that both parameters either increase ordecrease, as indicated by the red arrow. This means that if, for COUNTERINGexample, the management wish to increase “Net earnings” they must BUSINESSbe prepared to increase the “Number of stores” or to change thebusiness model. But the “Number of stores” is also related to FRAGILITY“Employees”. Evidently, more stores mean more employees and highercosts. One quickly realizes that even this simple system hides ANDnumerous constraints. Modifying the structure of a business is INEFFICIENCYexpensive, costly and takes time, not to mention the risks involved. Thealternative, at this point, is to pursue higher profitability without AT THEchanging business structure or strategy. But how can a businessbecome more profitable without modifying its structure? A modern SOURCEapproach is to reduce its complexity. A fundamental result of a complexity self-rating is a breakdown of businessTHE SOURCES OF BUSINESS COMPLEXITY complexity into itsThe most important result of a self-rating analysis of a business is the components. Since highso-called Complexity Profile which provides a breakdown of the total complexity makesbusiness complexity as described by the user’s data. Let us considerthe case of a large software and services company. Its Business business inefficient andStructure Map is depicted in Figure 4. non-profitable it is paramount to counter complexity at the source.Figure 4. Business Structure Map of a large Software and Services company. 8 Copyright © 2011 Ontonix
  10. 10. Reduction of business complexity, as has already been illustrated,leads to two beneficial results: it reduces the global exposure and COUNTERINGincreases profitability. Two birds with one stone. In the case in question HIDDENthe complexity of the business is 15.7, as shown below in Figure 5. BUSINESS FRAGILITY The fragility of a business is often hidden.Figure 5. Complexity and corresponding rating of the company depicted in Figure 4. The recent defaults ofThe critical complexity, at which that particular business becomes banks and corporationsfragile and extremely inefficient, is 18.7. Because the current have shown that sizecomplexity – 15.7 – is at a safe distance from the critical value, thisleads to high business robustness (resilience) and a four-star rating. doesn’t make a companyFigure 6 illustrates the business complexity breakdown which is ofinterest independently of its state of health. immune to the turbulence of an economy. Huge companies can be more fragile than one can imagine.Figure 6. Complexity breakdown of the company depicted in Figure 4. 9 Copyright © 2011 Ontonix
  11. 11. The top three complexity contributors are “General and Administration”,“Consulting Revenue” and “Sales and Marketing”, totaling approximately COMPLEXITY30% of the total business complexity. What is the practical meaning of MANAGEMENTthis? What makes a business difficult to manage are not only thefluctuations in the values of the critical parameters, it is also the fact that – ADVANCEDare often tightly correlated. Every business is a dynamic network inwhich information flows according to certain patterns. If these patterns – RISKwhich are reflected by the Business Structure Map – are unknown, it will MANAGEMENTbe difficult to: & STRATEGY o Establish correct and realistic performance targets o Make credible forecasts IN ONE.When it comes to establishing performance targets the Managing the complexityinterdependency (correlation) between business parameters iswhat gives rise to constraints. of a corporation not onlyAn example of parameters interdependency is illustrated in Figure 7. establishes an advanced and holistic means of managing risk – it also constitutes a foundation on which to build a solid corporate strategy for a turbulent global market.Figure 7. Example of parameter interdependency – crisp (left) and fuzzy (right).One may observe that the relationship between “Total operatingexpenses” (left) and “Sales and marketing” is quite crisp. One maydeduce that the two parameters are constrained to “move” together. Inthe case on the right this is no longer the case. In fact when one of thetwo parameters changes it will be difficult to specify what the other willdo. This is natural and is consequence of the fact that uncertainties arepresent both inside a corporation as well as in its ecosystem (clients,suppliers, market, etc.). The presence of these uncertainties on top ofconstrains is what increases the complexity of a business producingknown adverse effects on business manageability, profitability, stabilityand exposure. The Complexity Profile provides an invaluable rankingof business parameters and indicates those which are injecting the 10highest amount of complexity into the business. Is it on these Copyright © 2011 Ontonix
  12. 12. parameters that management should concentrate first in order toreduce complexity. What does this mean? If one is unwilling to alter the COMPLEXITYbusiness structure (i.e. the business model) the alternative is to MONITORING“stabilize” the parameters at the top of the Complexity Profile. Inpractice this means reducing the variability in the values of those - A UNIQUEparameters. How to achieve this is beyond the scope of this WhitePaper. The first step is to diagnose a problem and to pinpoint its PRE-ALARMsource. The cure comes later. SYSTEM Sudden changes in the complexity of aSELF-RATING AND EARLY WARNINGS business point toIf there is one fundamental law in business it is the one which states potential instabilities.that time is money. Having time, no matter what the circumstances, isequivalent to an advantage. As the current crisis has shown, a Conventional methodsprestigious business can collapse suddenly and without early warning.Surprisingly, it can do so in the face of a triple-A rating. Sheer size and are unable to deliveris no longer guarantee of business stability. The so called “Too Big To similar information.Fail” concept is replaced today by the more appropriate “Too ComplexTo Survive”. Huge and excessively complex organizations are not onlyimmensely difficult to manage and steer – they hide a multitude ofpoints of failure and sources of surprise which increase with the size ofthe organization. But also small organizations face the dangers of highcomplexity. A turbulent and unstable global economy is a threat tomillions of SMEs. One way to face turbulence is to be less complex. Aless complex and manageable business is able to better respond tounexpected and extreme events. Unfortunately, these will increase innumber and magnitude. This means that an apparently healthycompany can suddenly find itself out of business. Healthy-lookingbooks don’t necessarily imply a healthy business structure, just like ahealthy-looking individual may not be aware of a severe illness.Because hidden and increasing complexity can cripple a business it isof paramount importance to track it. This is where self-rating comesinto the picture. The process is as follows: o Gather monthly/quarterly data reflecting the performance of your business. o Run a self-rating analysis. o Monitor the value of your complexity rating. Be aware that one or two-star rated companies are good candidates for default or take-over. 11 Copyright © 2011 Ontonix
  13. 13. o Any sudden changes in the rating point to potential “traumas” and reflect low business stability. GETTING [TYPE THE MORE VALUEEvidently, based on the sort of data that is analyzed, self-rating can be SIDEBARdone for an entire company, for a subsidiary or for a department or FROM DATAbusiness unit. TITLE] WHICH YOU ALREADY S [Type the sidebar HAVE content. A sidebar is aGETTING MORE VALUE FROM YOUR DATA [TYPE THE standalone Self-rating not only SIDEBARPeriodic business self-rating not only allows a corporation to expose its supplement to thehidden fragilities and provide precious pre-alarm signals. It also helps expose hidden TITLE]establishes a mechanism thanks to which it is possible to add value to main document. It isthe data available within an organization. Data is expensive to collect sources of fragility in aand maintain. When collected properly and maintained in a rigorous often aligned on the business – it also adds [Type the sidebarfashion it provides a credible reflection of the functioning of a business. left or right of the tremendous value to a content. A sidebar isAs the current crisis has shown, conventional techniques of data page, or located at thetreatment don’t always provide the right answers. Traditional statistics, your data. standaloneregressions, or data modeling have serious limitations of which not top or bottom. Use theevery user is aware. Unfiltered data hides precious information which supplement to thenew methods are able to expose and make available in the form of Drawing Tools tab toactionable Superior Business Intelligence. Our self-rating system main document. It is change the formattingadopts such new methods and delivers information which until recently often aligned on thehas been unavailable. of the sidebar text left or right of theThe rapid growth of complexity is the main problem facing our global box.]society. In order to counter its adverse effects we must start to monitor page, or located at theand manage complexity at all scales and levels, from SMEs to largemulti-national concerns, from financial products to banks, from IT top or bottom. Use thesystems to communication networks. Today, the technology to do is Drawing Tools tab toavailable. On the internet. change the formatting of the sidebar text box.] 12 Copyright © 2011 Ontonix