Tuesday, October 12, 2010

The myth of the one version of the truth


Since the dawn of MIS (Management Information Systems), the most important objective has been to create a single version of the truth. That is, a single set of reports and definitions for all business terms, to make sure every manager has the same understanding. Most organizations have many different definitions of the business terminology they work with on a daily basis. This is often visible with common business words such as "revenue," "number of employees", and "number of customers." For any given market, there are specific terms that have different meanings within the industry and to the outside world, such as the word "flight" for an airline, "account" for a bank, and "student" for a university. There is actually a rule for this:

The more connected a term is to the core of a business, the more definitions of it exist.

In the last 20 to 30 years, countless efforts have been made to identify different versions of the truth and collapse them into a single definition so that all business departments can align along the same meaning of business-critical terminology. Rarely have these exercises been successful. In fact, I would call most of them misguided. There is a reason for so many definitions. If a term is closely connected to the core of the enterprise, many business functions will add their unique interpretation of that word. You might wonder what value a business department brings to the organization if it does not have its own unique view. This doesn't mean every single definition for a term is valid and useful. On the contrary, many may be redundant. The challenge, of course, is how to decide which definitions are valid and which ones are not.

A good example can be found in the software industry. If we look at the term "revenue," many versions of the truth emerge during and after the sales process. Here are just a few variations:

  • Gross revenue: Total sales before software discounts, customer bonuses, and lead incentives for partners. Customer bonuses may comprise discounts on or free consultancy, training or other services.
  • Net revenue: Total sales after software discounts, customer bonuses, and lead incentives for partners.
  • Net own revenue: Net revenue minus royalties. Royalties are fees that need to be paid to third parties whose software the company resells as part of its own portfolio.
  • Recognized revenue: Due to compliance regulations, not all revenue on the contract may be recognized in the period the contract is signed.
  • Revenue U.S. GAAP: Revenue, including corrections based on U.S. reporting regulations.
  • Revenue Local GAAP: Revenue, including corrections based on reporting regulations specific to the country where revenue is recognized.
  • Management revenue: Total revenue as the base for internal reporting, using net revenue as the starting point. Revenue recognized in other countries but belonging to the account management structure in the manager's country must be added. Revenue recognized in this country but realized for an account manager in another country needs to be subtracted.
  • Commission revenue: Revenue specific to a sales person, upon which his or her variable income, bonuses, and other incentives is based. Corrections may appear for recognized revenue for and from other account managers.
  • Invoiced amount: The amount that is invoiced and received in the current or next period. This amount may not all be revenue for the current quarter. For instance, multiple years of maintenance revenue is invoiced upfront.
  • Statutory revenue: Recognized revenue aggregated to the legal entity level. A sales office in a specific European country, for example.
  • Fiscal revenue: Revenue for a fiscal entity for which corporate income tax (CIT) needs to be paid. Legal entities and fiscal entities are not necessarily the same.
  • Revenue for value-added tax: The total of invoiced revenue broken down into the various categories of VAT.
  • Cash inflow: Invoices paid by customers in a certain period, including other sources of income such as interest. 

In this somewhat simplified list, there are thirteen variants of revenue. In many cases, management reports will refer to the generic term "revenue" for many of them. Which definition of revenue is actually meant is often determined by the manager or business domain for which the report is created.

How Different Versions of the Truth Provide Insight

With the idea of a value chain in mind, having different versions of the truth provides additional insight. However, this insight only occurs if these different versions of the truth are placed into context. One way of doing so is to create a revenue report that cuts across the various definitions of revenue, such as:

gross revenue  >   net revenue  >  net own revenue   >  recognized revenue  >

management revenue  >  commission revenue  >  invoiced amount  >

statutory revenue  >  cash inflow

By organizing the different definitions of revenue in a flow, we can see which existing definitions make sense and lead to alignment, and those that add to confusion. The former definitions should be kept, the latter eliminated. In a sense, the revenue report-with the various definitions of revenue that it includes-has created the long-wanted single version of the truth, almost intuitively. There are no synonyms possible anymore, as all terms appear in the same report and the combination of them represents a single flow of revenue. We have essentially created one context of the truth.

This one context of the truth brings not only more alignment, but also a deeper understanding of the business. For instance, an account manager may already know the difference between gross and net revenue-but through net own revenue, sees that his or her contribution is really low because of all the royalties that have to be paid to third parties. Or the account manager may notice that his or her clients take a very long time to pay their invoices, negatively impacting cash inflow. Through management revenue figures, a sales manager may see how much of the revenue is not realized for his or her geographic region, possibly leading to a reassignment of customer accounts. Lastly, looking at statutory revenue, all managers see how their operational decisions affect external reporting and compliance.

Want to know more? Send me an email, and I happy to share the examples I have collected working with many customers on the subject.


--frank

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