APPENDIX A

“WHY” AND “SO WHAT”

A real-life example to demonstrate the use of “why” and “so what” to create effective financial measurements and reports:

Around 2002, when the Hong Kong economy was very depressed, I worked on a study for a leading property investment company. one of its income streams is rental from its shopping malls. The company was experiencing declining income and an even faster decline in share price. This resulted in pressures from shareholders, banks, and rating agencies. The objective of the study was to investigate how to improve performance.

When I arrived at the company, the first thing I did was look at the financial data. I found that only two major reports were readily available: the monthly financial statements and the detailed lists of the rental paid by each tenant. The study went on for three months. Here is a summary of the process:

CONSULTANT (me): So what do these rental figures mean? Are we doing well or not well?

COMPANY EXECUTIVES: We don’t know since we cannot compare with market.

CONSULTANT (ME): Why not?

COMPANY EXECUTIVES: Like most businesses, we don’t know the details of our competitors’ pricing. Even though we have some market intelligence through our tenants and agents, retail is tricky. No two shops are the same. Even if two shops are around the corner from each other, the traffic and storefront can result in very different rentals.

CONSULTANT (ME): So this means we need a way to assess our rental performance. Let’s talk to our friendly competitors as well as our tenants and our staff—people who know about our competitors. Let’s also try to study best practice companies overseas to see how they assess their performance.

After about a month of data collection, the results confirmed that even best-practice retail landlords could not easily compare their rentals with those of their competition. But it was found that retailers assess their store success by measuring sales per square foot. Their rental affordability has a ceiling of about 10–20 percent of sales depending on their category. For example, it is about 18 percent for fashion and 15 percent for restaurants. If a retailer’s actual rent as a percentage of sales is consistently above this ceiling, this means judging from the business that the retailer is conducting, the location is too low to justify the rent. If it is consistently significantly below the ceiling, this means the rent is set too low. If many retailers in the same mall have the ratio above the ceiling, it could indicate an issue with the overall management and marketing of the mall. If most have ratios below and only a few above it, this could indicate the problem lies with the retailers, not with the mall management overall.

CONSULTANT (ME): Can we generate a report with data on sales per square foot and rent as a percentage of store sales for each tenant? We should do this by retail category, as rent affordability is different for different retail categories.

COMPANY EXECUTIVES: But we don’t have sales data.

CONSULTANT (ME): Why not? Why do competitors have them and we don’t?

COMPANY EXECUTIVES: Leading competitors ask tenants for a base rent plus a turnover rent. Turnover rent is a percentage of sales. For example, they may ask a tenant to pay a base rent of US$2 per square foot plus one percent of each month’s sales if sales exceed a certain threshold. Say the threshold is US$100,000. If sales are below US$100,000, tenants pay $2 per square foot. If above US$100,000, they pay US$2 per square foot plus one percent of the amount over US$100,000. To calculate the dollar value of this one percent, tenants have to submit monthly store sales.

CONSULTANT (ME): Why are we not charging turnover rent?

COMPANY EXECUTIVES: Because we have little negotiation power in this depressed market.

CONSULTANT (ME): So does this mean we can never get the data?

COMPANY EXECUTIVES: Well, maybe we can charge a turnover rent with a high threshold so tenants will know they probably do not have to pay turnover rent unless business is very good. This way, turnover rent is not an income for us. It is a data source.

Consultant (me): Assuming we can have the data, we can display the data on a graph and draw some conclusions (see Figure 3.8.)

COMPANY EXECUTIVES: So what do we do after we have these conclusions?

CONSULTANT (ME): We should have an action item for each tenant. For example, if a certain restaurant tenant has low sales per square foot and high rent as a percentage of sales, we know it is not doing well in business. We should meet with its owners to discuss the problems and solutions. We should also be monitoring them very closely as small restaurant and small business owners often default on rental.

COMPANY EXECUTIVES: Yes! We once had a steakhouse owner who just closed down overnight and left town! Maybe we should also have a monthly meeting to discuss and brainstorm on actions.

So at the end of the three-month project, we set up a new rental policy, a new report format, a regular rental meeting, and a small task force that provides advisory services to tenants with depressed businesses. The client’s business steadily improved. As you can see from all this, the outcome was driven by asking “why” and “so what” on financial data available.