Evaluating Management's Use of outside Expertise

Article excerpt

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Here are two multiple-choice questions:

1. The percentage of your bank's commercial loan write-offs attributable to poor management in the customer's company is (a) 10%; (b) 25%; or (c) 40%.

2. Companies can best address their management needs by (a) relying on in-house expertise; (b) relying on outsourced expertise; (c) knowing when one or the other is warranted.

Both questions are answered in this article.

RMA recently surveyed senior credit officers about how many write-offs they believe are directly attributable to inadequate management in their customers' companies. More than half said at least 41% of losses were management related in the small-business and middle-market portfolios, and a similar number gave the same figure for large corporate loan losses.

The survey also asked credit executives to describe the most important elements of performing due diligence on the management of prospective customers' businesses. Not surprisingly, high priorities across all markets, especially for underwriting new customers, were placed on gathering and checking the following information:

* Management experience.

* Educational background.

* Career credentials.

Despite the importance we place on management expertise, no company--not even a mega firm with global operations--has an expert on hand for every purpose. Ideally, company managers recognize their expertise and skill limitations and compensate for them by seeking support from outside sources. In many cases, it is costly or inefficient to maintain in-house expertise, and companies purposely minimize the internal investment in favor of tapping into outside resources when needed.

The best-managed companies make the distinction between expertise that must be on hand and expertise that's best acquired from the outside. As lenders, our job is to determine when and why it is appropriate for a company to use outside experts and then to assess whether managers leverage outside resources both willingly and effectively.

When and Why Should Company Managers Use Outside Experts?

Management groups may seek outside expertise for reasons that fall primarily into two areas: skill or expertise gaps and perspectives gaps.

* Skill or expertise gaps:

--A company may not have acquired, and possibly cannot yet afford, the full range of expertise needed. For example, the accounting staff may have a very strong technical focus but lack strategic knowledge of capital structure. Advice or consulting may be appropriate if it is premature to hire a chief financial officer.

--Market or industry change may introduce the need for new skills or expertise, and that expertise may initially be very scarce (and therefore expensive).

--Expertise in a field may be evolving rapidly, and it is less expensive to rent it than to commit to continuing education of a permanent staff in the field.

--A company may need to solve a problem that is unrelated to its central business. For example, a company that decides to change its manufacturing software support may retain a consulting firm to engineer and then lead implementation of the new system.

--A key employee may have left the firm, and the vacancy is proving difficult to fill. A temporary consulting engagement is a good alternative to a hasty or uncertain hire.

--An issue or problem requiring expertise may be short term, so a permanent hire is not the best solution.

* Perspective gaps:

--Management may determine that it can benefit from an impartial view of an issue, problem, or opportunity that has proven divisive within the senior team. Or, managers may find they are too close to other managers to be objective, such as the family business owner's difficulty in assessing the skills of offspring during succession planning.

--Family-owned companies may find they are missing a "devil's advocate" view on key management issues. …