The End of the Quarter Shuffle

by BILL WADDELL

When Norm Bodek and I wrote Rebirth, we included a chapter called "The End of the Quarter Shuffle", describing the lengths public companies go to in order to make the quarterly and year end numbers look good, and often doing very destrucive things to accomplish that end.  Those of you working for publicly traded companies know exactly what we were talking about.  The end of the quarter is a huge deal in those companies responsible to Wall Street.  It is not much more than just another day on the calendar in privately held companies.

The news of the day is the settlement between GE and the SEC over GE's accounting practices.  According to the SEC, "GE misapplied the accounting rules to cast its financial results in a better light." They were cited for 4 different abominations, but the goal of all of the dishonest practices was to inflate quarter-end earnings and drive the stock price up.  The problem the SEC had with GE was that the company misled investors and caused stock prices to move based on false information, which hurt investors.

It seems to me that the financial community is missing the big picture here. To heck with the stock price - that will right itself sooner or later.  In the meantime we have real money being thrown away.   Let's look at one of the four shady dealings at GE - "selling" 381 railroad locomotives to financial institutions for $370 million.  It really was just a financing deals that left the locomotives in GE's hands to sell to real customers.  Using GE's own numbers, $370 million in gross sales translates to $44 million in Pre-tax profits.  Again, using GE's average results, $44 million in false profits results in $6,947,000 in unnecessary taxes to be paid.  That means GE paid almost $7 million in taxes on profits it knew were not real in order to jack up the stock price.  That is $7 million of the company's money they paid out knowing full well they did not owe it.

OK - let's give GE the benefit of the doubt - although I can think of no reason to do so - and assume they would have sold the locomotives to some real customer soon - even though that is an awful lot of locomotives.  GE says they make 14.8% on their money.  So if we assume they would have sold the locomotives, and paid the taxes three months later - that amounts to $257,000 in lost earning straight down the drain.  That would have paid the salary and benefits of two or three of those 'headcounts' GE eliminated.  That is like dumping a truckload of perfectly good parts into 4 Mile Creek, which runs next to the locomotive factory.  That is as wasteful as waste can get.

It is impossible for companies like this to really emulate Toyota, or actually adopt lean management practices, or a lean culture.  How many people had to work on how many six sigma and kaizen events to save the quarter of a million the executives burned simply to manipulate the stock price?  The locomotives were really one of the lesser infractions at GE.  They horsed around with aircraft spare parts to the tune of $585 million in profits - that means at least $3.4 million gone based on the same 'give them the undeserved benefit of the doubt' logic.  That is something like 30 families hammered by a GE layoff to recoup the money burned to manipulate the stock market.

GE, of course, is the extreme case, but every company that plays games with quarter end results is doing the same thing to some extent.  Every company that builds inventory, or refuses to reduce inventory in accordance with good business practices, so as to prop up reported earnings is deliberately overpaying taxes - giving away real money that belongs to the stockholders - the collateral damage of playing the Wall Street game. 

It is style over substance - looking good rather than actually being good.  The saddest part is that most of the stockholders would be appalled if they knew what senior management does with their money.  The school teachers with their retirement money in the hands of some fund manager are the real losers.  That was their money the shysters burn to make themselves look good.  Those school teachers are not concerned with quarterly stock prices - they are in it for the long haul.  They want Warren Buffett, long term value based investing.  They want their money in the care of managers committed to lean business principles. 

Comments

[Michael F. Martin]

"They want Warren Buffett, long term value based investing. They want their money in the care of managers committed to lean business principles."

It would be interesting if you could elaborate on the relationship between Buffett-Munger-Graham style investing and lean. What do they share in common? I have my own views on this, but I would be curious to hear others.

[Bill Waddell]

Buffett has been discussed a number of times over the years in Evolving Excellence, and I don't think he knows lean manufacturing from lean roast beef. His investment theory - his application of the old Graham principles - however, aligns almost perfectly with fundamental lean principles.

Investment is all about value, according to Buffett. "Finding an outstanding company at a sensible price," says Buffett, and, "Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

Lean is, at its heart, a continuous effort to pare away everything that does not create value for the customer, and it has a very long term focus. The ultimate goal is to create the maximum value for the owner by focusing on maximum value for the customer. While Buffett does not expressly endorse lean manufacturing, the companies he buys and holds on to tend to be very lean - Gardner Denver, for example.

Other, I am sure, know Buffett's theories better than I and I look forward to hearing their thoughts on the subject.

[Jamie Flinchbaugh]

Bill, what really amazes me about the end of the quarter shuffle is that people seem blind to the waste that it causes - rework, reshuffle, remix, distraction, etc. I think if we had really good accounting of the costs of doing this, it might not be the same.

I recently focused on the related topic of the hockey stick effect in one of my Assembly Magazine columns: http://www.assemblymag.com/CDA/Articles/Column/BNP_GUID_9-5-2006_A_10000000000000575746

[Scott Aden]

What isn't mentioned is the obvious cost in all of this...THE 50 MILLION DOLLARS PAID. Talk about waste. That on top of the taxes, lost profit, compensation due to performance, stock based compensation, lost of good talent, etc comes out to over a hundred million dollars. The real sham, is that shareholders suffer twice due to these shinanigans. Not only does the management pull these tricks to boost there pay and stock price, they aren't held accountable when they get caught. Why is this 50 Million coming out of company funds? Shouldn't this come out of Jeff Imelts pay? Or the board of directors? Or Jeff Imelts golden parachute (plus interest)? What will stop this from occuring in the future if those responsible aren't held accountable? As it stands now, public companies are inticed to cook the books. If they get caught, the company pays the fines out of shareholder money (or in the case of GE or Bank of America, perhaps taxpayer money) and they go on, business as usual. This administration talks a lot about accountibility, but till the SEC takes the steps to hold those responsible and accountable for management quarterly decisions, we'll continue to see this.

[Louis English]

Is it concern for stock price or concern for bonus that is causing this insane risk to company profitability and reputation?

[Anonymous]

I work in a GE facility that finished the quarter significantly under our inventory target, then proceeded to blowout the number in the first days of the new quarter in order to correct the large number of people idled by a lack of raw material. Our plant manager calls this "good general management". I won't mention the air freight bills to bring in the raw material... oops, I just did.

[Anon]

When I worked at a computer company whose name sounds like "Hell", I was in a green belt class. One guy in there was from customer service. We were all discussing the end of quarter push (they had a horrible hockey stick effect). From manufacturing, we talked about how weeks 12 and 13 of the quarter were crazy.

Customer service guy said "nope, our busy crazy weeks are weeks 2 and 3."

"Why?"

"Because that's when the customers call to complain about the crap we ship at the end of quarter."

He claimed that, to make the production numbers and clear out inventory, that production would ship computer chassis in a box with loose components. Count it as revenue, deal with it later.