Editor's Focus

Watching an early round NCAA tournament basketball game, my wife and I each expressed the same thought during one particular sequence of the game. Both teams (which shall remain nameless to protect the innocent) took turns turning the ball over, or matched poorly selected shot with poorly selected shot, while defenders stood idly by as opposing players grabbed offensive rebounds through non-existent box-outs.

“What happened to the fundamentals?” we asked each other almost in unison, while also wondering aloud how teams so lacking in the fundamentals could have reached the tournament in the first place.

The criticisms of a couple of past-their-prime athletes (sorry, dear, but I certainly include myself in this category) may not seem relevant to the business world, but there are parallels. College athletes failing to box out may not be the only people performing their jobs without paying attention to the fundamentals. Many of us who are older, wiser and should know better may also wish to consult the playbook.

The scrap and recycling industries witnessed a version of style over substance just a few years ago, when a handful of highly-capitalized companies purchased scrap facilities well above market price, while trumpeting (in the oft-repeated words of one of the consolidators) the “revenue run rate” of the assets they were consolidating.

But revenues aren’t the same as profits—one of those business fundamentals that eventually catches up with companies that don’t pay proper attention to it.

Savvy scrap dealers who have survived numerous downturns and rebounds hold to the rule that every transaction—every scrap purchase—has to be considered for its profit/loss potential. This fundamental rule was set aside by consolidators in a headlong quest for market share. It remains to be seen whether the strategy may yet pay off for the likes of Philip Services and Metal Management.

Metal Management is now in the hands of Al Cozzi, a scrap industry veteran, while the new president of Philip Metals Inc., steel industry veteran Fred Smith, acknowledged at the ISRI Annual Convention that, “Philip has been the poster child of how not to consolidate.” The company is nearly ready to emerge from Chapter 11 bankruptcy with a “stronger financial base,” according to Smith.

Perhaps worrisome to a larger number of Americans is whether the fundamentals have been ignored by institutional bankers and brokers on Wall Street. The rush to herald the new economy, to more cynical ears, sounds like a clarion call to ignore business fundamentals.

The ability to turn a profit isn’t so important, investors are being told, as long as market share is being accumulated and lines of credit exist to fund future activities. Institutional investors, followed by individual investors, have poured a great deal of money into companies that boldly challenge the wisdom of “old” fundamental rules regarding earnings and cost of sales.

Some of these bold pioneers may successfully turn the fundamentals upside down and prove to have created profitable companies that defied the old rules. But mathematical models haven’t changed since the days of Pythagorus. Unless a company begins to take in more cash than it is spending, it can only remain viable for a limited amount of time no matter how much market share it gains or what type of “revenue run rate” it can accumulate.