Business Evolution - Part 2
When opening a second location, be cautious. Many business owners build a successful operation in one place and then pursue expansion onto another site – only to realise that the first location’s success relied heavily on their presence.
If you’re considering expanding into a second location, try going on holiday for eight to twelve weeks and seeing how well your business runs without you. Only when your business is fully systematised, works smoothly under delegated management, and operates successfully while you’re on extended leave should you seriously consider multi-site operations. You just can’t be in two places at once.
Another consideration in growing your business is cash flow. If your customers pay in advance before receiving products or services and you hold little or no inventory, you’ll be able to grow much faster than businesses which collect payment after delivery or maintain large inventories. This is because your money isn’t tied up in inventory or as “loans” to your customers (debtors). The type of business you operate determines your maximum desirable growth rate.
Many businesses struggle to grow at more than 30% per annum without a continuous injection of equity or debtor factoring (invoice financing).
Alternative distribution channels
If you offer a high-margin product that’s suitable for direct-to-consumer sales, consider expansion through network marketing. The Direct Selling Association of Australia features a range of highly profitable businesses in this channel of distribution.
Maybe your business is ready to go online and sell to the world. Do you offer unique or niche products that could appeal to a worldwide market? Many small local businesses have developed a huge international client base by going online and mastering web promotion.
You might also consider forming strategic alliances with key customers or suppliers, where you earnestly help them grow their business and thereby grow your own. Also try working cooperatively with some of your competitors in pursuit of a bigger new market.
Every business should perform a SWOT analysis annually. Bring together a group of your top employees and brainstorm your business’ foremost Strengths, Weaknesses, Opportunities and Threats. Consider ways to decrease the weaknesses, overcome the threats, build upon the strengths, and capitalise on the opportunities. Remember though: just because you can do something, doesn’t necessarily mean that you should.
Long-term thinking is always to be encouraged. Once you know your long-term outcomes, you can plan scenarios to get there.
Your scenario planning might include the effects of interest rate rises, currency fluctuations, market reductions, global or political changes, or technological impacts. Sony Corporation has a 500-year plan, and Shell Oil employs a team of specialists to continuously update their contingency tactics for operations all over the world, so they can instantly respond to any crisis or opportunity.
Money spent wisely today can return tenfold in the future. The ability to take a longer term view is often more beneficial than focusing on annual profits and a one-year ROE. This is especially true for venture capital based businesses in Biotechnology and IT.
Observing and lobbying governments may bring strategic advantages and opportunities. Changes in government policy and legislation can dramatically affect entire sectors. For example, when tariff changes impacted the textile, clothing and footwear industries in the 1990s, manufacturers that swiftly moved their production overseas enjoyed a distinct low-cost advantage over those which remained in Australia – many of whom ultimately closed down.
Conversely, whole new industries can be created to fulfil legislative requirements. Recent legislative changes have provided opportunities for businesses to service the safety, environmental and construction equipment markets. Similarly, deregulation of the financial sector has given rise to businesses such as Aussie Home Loans and Mortgage Choice. Changes to telecommunication and media laws have enabled the proliferation of alternatives to free-to-air television.
Merger and acquisition
Two common approaches to company growth are merger and acquisition. You can quickly acquire a greater share of your market, as well as a larger customer base, by buying out a struggling competitor. Being a listed company and trading shares for equity in other businesses is a fast path to growth – provided that the buy price is right and the businesses enjoy good synergy. You can often sell a business for three to seven times EBITDA (“earnings before interest, taxes, depreciation and amortisation”) to a listed company which will add that profit to its own. This in turn will increase the value of the listed company by ten to twenty times EBITDA, depending on its price-to-earnings (P/E) ratio.
Listed companies are an excellent source of potential business turnaround. Larger listed companies often sell non-core parts of their business, or businesses they have recently acquired. This might be a whole subsidiary business, or just a product range. Well- connected business owners can acquire “orphan” businesses at a very reasonable price this way.
Timing is everything
In his book The Roaring 2000s, Harry Dent explains the nature of the product and business lifecycle: its slow initial growth phase; subsequent rapid growth due to strong demand as the product is accepted; slow-down as the market matures and demand is saturated; and then decline as the product is replaced by another or interest in it wanes.
Adrian Slywotsky in his book The Profit Zone – identifies 22 different models of highly profitable, businesses. Many of these models relate to ideal timing of the marketplace, (being in the marketplace at the right time and place), during the profitable “high demand” growth phase (above). This is the most profitable time in business when there is high demand, few suppliers and price is no object. After this, more suppliers arrive and margins drop leading to maturity of the market (e.g. DVD Players). Before this, the costs of developing the market and the slow penetration rates make the business less profitable (e.g. HDTV and 4G phones).
Timing in the market can have a downside too. Palm Corporation, manufacturer of hand held Palm Pilots, discovered this when it introduced colour screen units to the marketplace and it was suddenly left with hundreds of thousands of unwanted black & white screen units and a massive demand for coloured units it could not fill.
The other big issue with market timing is to identify trends as distinct from fads. Products like Rubik’s Cubes and Razor scooters can have a dramatic short-term impact on sales, but may have a very short product life. The Tipping Point by Malcolm Gladwell and Next: The Future Just Happened by Michael Lewis are excellent books on picking trends in the future.
How to manage it all
When everything is said and done, your business is an investment vehicle. The profit you make at the end of each year is your ROE on the money you invested in it – or its value if you sold it. How much ROE did your business generate last year? Could the money be better invested elsewhere?
If you increase your profits by $100,000 this year, you have added anywhere between $200,000 and $500,000 to the value of your equity in the business (based on a valuation of two to five times EBITDA). Of course, to access this equity you’d have to sell your business, but it nonetheless illustrates the value of becoming more profitable.
The main lesson here is: don’t get carried away with your passion for the business. Don’t overspend on assets that won’t return better than 30% per annum in profit. Under-utilised machinery and unnecessary (but fun) expenditures fit into this category.
Ultimately, your most important business plan is your exit strategy. Identify and truly understand the circumstances under which you’d sell (or pass the business on to your family). Everything up until that point should work to ensure you part ways in a state of profitability and market strength.