Business on A Philosopher and A Businessman

When Sales Prevention is Good

Wed, 19 Apr 2017 00:00:00 +0000

Cashflow is the lifeblood of small business. With a never-ending onslaught of salaries, rent, insurance, accounting fees etc, any cash coming through the door is a good thing. Or is it?

Quick Quiz: Deal or No Deal?

Time for a quiz. Have a read through the following scenarios and figure out whether you should do the deal or not. The answers are below.

We haven’t sold into this country before. They don’t speak much English and are eight timezones away. Trying to get the contract agreed was a painful process. We need to lodge a performance bond. It is pretty good margins and the main user is excited to be getting our product.
We don’t really do what the customer wants. We should be able to wing it. The team will have to burn a bit of midnight oil. But we’re at the limit of our bank overdraft and if we don’t see some cash in the next week or two the bank will probably call in the loan.
The customer wants a fixed price for the whole project. However, the tender documents specify that phase 2 and 3 scoping and design will only happen in phase 1.
I have to make a small “facilitation payment” to a foreign government official to get the sale over the line.
The customer wants uncapped liabilities on any loss they suffer as a result of using our products.
The customer requires me to add a whole load of features to the product. It’s highly unlikely any other customer will want those features.
The customer wants to own any IP developed as part of the deal.

Answers

Probably not, but it depends. There’s going to be a lot of pain involved in completing the sale, getting the all the documentation together, figuring out how to operate in a new jurisdiction etc. The project is likely to overrun as it is almost certain that what they think they bought is quite different to what you thought you sold. If there are really hefty margins in the deal, you are trying to open up this territory anyway and have a decent bank balance in case it takes a while to get paid then in may be worth doing the deal.
You probably have no choice. Leave signing to the last minute to see if you can make a sale closer to your core business. Price in paying the team a bonus if they pull it off.
No. Signing up for a fixed price contract with variable scope projects is just plain stupid. I was plain stupid once. Not quite as bad as the example above, but it hurt all the same. Talk to the customer’s procurement team as it is an uncommercial request. If they don’t budge, you could either submit a non-conforming bid or walk away. If your competitor wins a deal like this you can be sure they will be kept busy and out of your way for a long time.
No, No, No, No, No. Seriously. Most western countries have an equivalent of a “Foreign Corrupt Practices Act”. Even if you are operating through local agents or local subsidiaries, as a citizen of a western country you can be heavily fined and jailed for this kind of thing. If you think you got away with it and want to sell your business in the future it may not be possible due to the potential liabilities and reputational risk for an acquirer.
No. Not unless you can convince your insurer to pick up the tab if things go wrong. Good luck with that. If you don’t even understand what this is all about, find a good, pragmatic commercial lawyer and get them to explain the key concepts around warranties, indemnities, liabilities and commercial risk management.
Probably not. Every semi-custom feature costs money to develop, diverts resources from features that have a bigger market and creates a long term maintenance liability. If you really want the deal, at least price it in a way that passes on a good proportion of these hidden costs.
Probably not. If you are a product company, IP is the core asset you own. There’s no point being in business if you hand over everything you create. Pull out your negotiating manual and get back to basics. What does the customer actually need? What other deal frameworks can meet this need without breaking your business? Often a good IP lawyer can cook up a special licensing structure that meets their needs without compromising your ability to deal freely in the IP in the future, while also preventing your customer from setting themselves up as your competitor.

Deal Approval Framework

The board and senior management of an organisation should be focused on the long term goals and risk profile of the organisation in order to protect the interests of the shareholders they serve (I know that’s a somewhat old-fashioned and idealistic view).

Salespeople are typically focused on the current quarter’s sales results so they can collect their sales commission and buy themselves a nice new Maserati. If the company crashes and burns in 3 years’ time it is of little interest or consequence as they will probably have been fired well before then for missing a sales target. As a result, many salespeople will chase anything that has a dollar sign attached, even if it harms a company long-term.

To bridge these opposing objectives, most mid-size and larger companies have a deal approvals framework designed by the legal team (aka “sales prevention department”) and the sales operations management team. Both these groups typically have a longer tenure than the average salesperson so are more motivated to avoid blowback from bad deals. This deal approvals framework is used to assess sales opportunities, determine whether to pursue them, and if so, under what terms.

Not many small businesses have a deal approvals framework. However, it is useful to understand how they work in order to avoid issues down the track. As you grow it is useful to formalise one.

A Sample Framework

Here’s a very simple example of a deal approvals framework. It is not complete.*

It’s pretty self-explanatory. As a salesperson, for each opportunity you go through the checklist. If the checklist says you need approval you seek approval. The approver should, in theory, have a broader view of the business objectives and therefore be able to make an informed decision on whether to chase a higher risk deal. If a deal isn’t approved you either reshape the deal (e.g. negotiating liability caps and IP clauses) or go focus on the next deal.

If you sign a non-conforming deal that hasn’t got the right approvals you either lose your commission or lose your commission and your job. Harsh, I know. But so is losing your job because some stupid sales guy sold a deal that sunk the company.

* Normal disclaimers apply - don’t sue me if you rely on this and sign a bad deal.

The Real Reason for iPhone's Success

Sat, 02 Apr 2016 00:00:00 +0000

Much has been said about the iPhone’s success. The obsessive attention to detail in hardware and software design, and the unboxing experience is legendary. The developer platform and app store binds people to the Apple ecosystem. Tight integration with the Apple Watch somehow helps, although I’m too old to understand how. Procurement strategies keep margins high. The iPhone even has a functioning antenna so you can make phone calls. On it goes.

However, having observed iPhones in use over the last few years, I think there’s something more subtle and fundamental going on.

Before we get into that, let’s take a look at some basics around products and markets. I like the Lean Canvas framework that’s been heavily promoted in the startup community over the last few years. It captures the essence of a business on a single page.

The most important parts in the early days are:

Identifying the customer segment
Identifying the problem that you are attempting to solve for that customer segment
Your unique value proposition, or promise, for how you will solve that problem

For the iPhone, then, we could look at a customer segment:

Customer Segment: Business Traveller
Problem: Can’t respond to email on the go
Unique Value Proposition: ~~A phone handset with built in email client~~. Blackberry already did that, and better

OK, that didn’t work. Let’s try another:

Customer Segment: Teenagers
Problem: Can’t listen to music when hanging out at skate park
Unique Value Propositon: ~~An mobile music player where it’s easy to add new music~~. We already did that and called it an iPod.

Let’s try the same segment with a different problem:

Customer Segment: Teenagers
Problem: Too disorganised to get enough people together for a party
Unique Value Proposition: A mobile device that not only plays music, but also connects to our favourite social networks so we can organise things as they are happening rather than ahead of time

Not bad, but it’s a reasonably small market segment for a huge product like an iPhone and affordability may be an issue.

Where could we possibly find the massive market needed to make Apple shareholders incredibly wealthy?

Here’s a clue. According to PWC, global entertainment and media revenues will hit US$2t (yes - t for trillion) per year around about now. That isn’t much different from the size of the oil industry at today’s (early 2016) prices. It’s huge. And the problem this huge industry solves is simple.

Boredom.

Boredom is fascinating (at least, to a philosopher). What is it about the human condition that means we can’t sit still for a moment and be comfortable with ourselves?

From a marketer’s point of view, boredom is also a wonderful thing. It’s the perfect pervasive problem affecting 99.99% of the world’s population for many of their waking hours. Once we have satisfied basic needs, such as food and shelter, we spend most of our time looking for ways to entertain (or distract) ourselves. We obviously have movies, TV, books, music, magazines, theatre, vintage car collecting, trainspotting, adventure travel, art etc. But even food, shelter and careers are, for many of us in developed countries, a source of entertainment.

Our ability to distract ourselves continuously throughout the day has been limited in recent times. In the 60s and 70s, if you had 5 minutes between jobs, you could keep yourself occupied with a cigarette. Then they were renamed “cancer-sticks”, became unfashionable and more or less banned (at least in places they were most needed - on trains, eating out alone, queuing in the bank etc).

So now we have ourselves a serious business opportunity:

Customer Segment: The vast majority of the world’s population, provided they can pay.
Problem: The entertainment we need to distract us from having to face the reality of our existence is not available every moment of the day.
Unique Value Proposition: The promise to provide continuous entertainment of whatever flavour you want (social media, music, surfing the web, watching funny cat videos) whenever, wherever and for however long you want with the absolute ease.

All the fancy innovations (multi-touch user interface, iTunes integration, working antenna, app store) are enablers for this core promise.

Image credit: Steve Davidson

There you have it. The world’s most effective way of filling in those moments where there’s a slight risk we may become aware of how insignificant we really are.

iPhone: The ultimate remedy for existential angst.

And that, in my opinion, is the secret to its success.

Stock Picking - Pitfalls for the Unwary

Fri, 26 Feb 2016 00:00:00 +0000

I didn’t intend to publish another investing article so soon after the last one, particularly as this blog is meant to be about business and philosophy rather than investing. However, understanding how a long term investor looks at things is useful to see how to build sustainable success. There are many great resources online and in print covering many angles. It is, though, sometimes useful to illustrate these points using a very simple family business. What follows is a lightly edited (very long) forum post I wrote in reply to a question on stock picking. Enjoy!

Part I - Business Basics

Suppose your dad has a business running a small grocery store. The store takes in $500K per year, and rent, insurance and the cost of the goods sold comes to a total of $400K.

That leaves a gross profit of $500-400 = $100K. This would be called “EBITDA” - earnings before interest, tax, depreciation and amortisation.

The shop has a load of fittings and other things needed to run the business, plus a delivery van. These need replacing from time to time because they get old and wear out. An additional non-cash expense encapsulates the rate at which these things wear out. This is called depreciation. In theory it represents the money you should set aside each year to replace things you need to run the business. A building will typically wear out over 40 years so if you have a building which cost $1M to build you will charge depreciation at 2.5% = $25,000. After 40 years you should have set aside $1M to replace the building. Of course, by the time you get there it now costs $5M to replace a building, but that’s another story.

Anyway, back to the store earnings. We have $100K of gross earnings (EBITDA). We deduct another $20K of depreciation to cover things wearing out. This leaves $80K of EBIT (earnings before interest and tax). In case you are wondering where the amortisation went, it’s basically the same as depreciation, but for non-tangible assets (i.e. not buildings, computers, vehicles etc, but things like trademarks, valuation of brands - I’m sure an accountant will ping me on this).

So we have $80K of EBIT. Because we’re a conservative family business we don’t have any debt so we aren’t paying interest on loans. However, we do pay tax - let’s say at 25% to keep the numbers easy. This leaves $80K - ($80K * 25%) = $60K.

So our net earnings are $60K. This is often called NPAT - net profit after tax.

We have three choices what to do with this. We can pay it to the business owners - this is the dividend. In this case the owner is your dad, so he pockets a $60K dividend. We can retain it in the business as retained earnings sitting in the bank not doing much (except attracting interest from professional litigators) or we can retain it in the business to invest in growth. We can, of course, do a mix of all three.

For the sake of this example, let’s say we pay $30K to the owner as a dividend and keep $30K to buy a fancy new espresso machine and build a small deck with some nice tables and umbrellas at the front of the store. The “dividend payout ratio” is 50% because half of the earnings for the year are paid to the owner.

Let’s also say, for the sake of the example, that your uncle actually owns 30% of the business and there were 100 shares originally created. So your father owns 70 shares and your uncle owns 30 shares. The “dividend rate” is $30k/100 = $300 per share.

Now the shares, when the business was first created, were issued at $1 each. It was a long time ago. The dividend yield at the original share price is $300 / $1 = 30,000% !!! Outrageous. However, your uncle wants out. He shows your brother-in-law how great the dividend is and sells the shares to him for 10x the dividend rate, so $3000 per share. The new valuation per share (i.e. what the “market” will pay for them) is now $3000 rather than the original $1 that they were issued at. This makes the current “dividend yield” $300 / $3000 = 10%.

Your uncle, meanwhile, has made a handsome capital gain of $3000 - $1 = $2999 per share. And the taxman has made a handsome sum on this capital gain.

Part II - Capital (Mis)Management

Now, back to the $30K that your dad spent on the espresso machine. Although he is careful with his expenditure, most of the neighbourhood is not, so he sells 200 coffees a day at a $2/cup profit margin. This adds $400/day = $100K per year (give or take) added to EBITDA. Let’s say this ends up being $60K additional net earnings.

Net earnings has grown from $60K to $120K - 100% growth. Furthermore, the return on the additional capital invested ($30K) is 200% - Totally awesome. If you could buy shares in a growth business like this you are home and hosed, but they are very hard to find at a decent scale and publicly traded. This is what offices full of analysts spend their days searching for.

Now, not understanding how to pull apart the finances of a business can end in trouble. Here are a couple of scenarios with this example business to illustrate what can go wrong:

Instead of buying an espresso machine your dad gets the business to spend $30K on a fancy new car. This adds nothing to the revenue of the business but does add a fair bit of cost as it is a thirsty beast. $30K down the drain which could have been paid to shareholders. You see this every day with corporations. Big new architect-designed offices, sponsoring yacht races etc. Warren Buffet talks about corporate waste in the Berkshire Hathaway annual reports. You could get a lot worse education than reading through those.
Your dad misreads the market and it turns out he’s in Las Vegas where, apparently, no-one knows what a decent espresso tastes like. Especially at the convention centre. Rather than selling 100 a day he only sells 5 on average to a few folk from Boulder sneaking across the state border in their Subaru Foresters for a covert session at the tables. $30K invested yields $2500. Not bad, but not really worth getting out of bed for.
Your dad doesn’t invest in staff training so the barista doesn’t know how to dial in the grind, how to tamp the grounds properly, how to time the pour, how to texture the milk etc. Consequently a bad product is shipped to the customer. Word gets around. Same effect - 5 coffees per day sold to folks with no taste buds.
Your dad (with a vote from your mum - the other board member) awards himself a $30K bonus for great performance. Together with the $30K spent on the espresso machine there is nothing left as a dividend to the other shareholders. Brother-in-law is not happy. This happens very frequently too - the executive management, in cahoots with the board, create remuneration plans which strip the profits before they are even reported. In Australia there is an exec remuneration section in the annual report for publicly listed companies which spells out who gets what. It may not stop the practice, but at least you know how bad it is…
The majority owners of the business decide they want a fat dividend. They pull the whole $60K profit out leaving nothing to invest in growth. The $100K per year of additional earnings possible through the espresso machine is lost for the sake of an extra $30K of dividend distributed once. This typically happens when major institutional investors demand a certain dividend rate. For businesses that can effectively deploy cash to fuel growth this is a hidden killer.
Possibly the worst crime of all. The business made $60K profit, the owners demand a $100K dividend. The business borrows money or raises additional capital through creating and selling more shares to pay for the shortfall between profits and dividend payout. Although this is blatantly stupid it does happen. Not only has the business not reinvested into growth, it has taken on debt and the associated servicing costs which will eat away at future profits and eventually cripple the business.
$20K of the profit is booked because Mrs Meggs comes in and orders 16 tonnes of cabbages for the next 12 months. She will pay after they are delivered. That $20K is paid out as dividend because it is reportable as profit even though the cash hasn’t hit the bank yet. As a result the bank account is stripped clean and your dad can’t pay his suppliers. The company is now insolvent due to timing of when profit is reported, when cash is received and when supplier payments are due. This is a silly example, and one where the accountant should first be fired, then sued for letting it happen. But things like this happen all the time. Services companies, particularly ones which are growing aggressively, often have a big lag between work in progress being recognised as revenue and when the cash arrives. They can’t delay their expenditure because it is payroll and high paid consultants tend to quit if they don’t get paid on time. Net result is a cash-flow hole which leads to big trouble. The cash-flow statement will indicate whether this kind of thing is going on.

Those are some examples of some of the things which can go bad in a business. There are, of course, many, many more.

If you are going to invest in individual shares you need to learn to read balance sheets, profit and loss statements, cash flow statements and the boring notes which clarify how the numbers were derived. You can see most of these problems from the financial statements. However, it is hard to judge long term viability and growth potential just from the financial statements - for that you need qualitative data too. Phil Fisher had a lot to say about that. If you are seriously going to attempt share-picking you should get your hands on his books and read them carefully.

The Power Of Economic Moats

Tue, 09 Feb 2016 00:00:00 +0000

“Economic moats” isn’t the name of a company specialising in low cost medieval earthworks. An economic moat is a desirable attribute of a business close to the heart of long term investors. You can google “economic moats” to get a technical definition, but I prefer to illustrate their power through everyday things. And, as we’re business people here and often fly around the countryside for important meetings, what better example than air travel.

Brief and inaccurate anatomy of an airline business

Aircraft:

According to the briefest of google searches a 737-800 costs around $50-100m. An Airbus A380 currently costs US$428m. So you can rack up a few $b in capital expenditure for even a modest fleet.

They are so complicated, too. Apparently a 737 has hundreds of suppliers supplying 367,000 parts and all those parts need to be proven to be airworthy. And that’s nothing. The A380 has a staggering 4 million parts, with 2.5 million part numbers produced by 1500 companies from 30 countries around the world.

With the hundreds of km/miles of cables running around an A380 it’s no wonder they got a bit confused putting it all together.

Even the engines by themselves are super sophisticated. They have divisions of companies dedicated to watching them carefully, in real-time, as you fly around the world to make sure they are performing properly and aren’t likely to lose any important bits before you touch down.

All those hundreds of thousands or millions of parts need to be checked and maintained, too. What a ~~nightmare~~ amazing feat of organisation keeping track of what needs to be done to keep an aircraft airworthy.

Pilots:

An airline has highly trained pilots who really have to know a lot to get you to your destination safely. The training continues throughout their career as the industry learns. For example, training in new ways to get an A340 off the ground without hitting its long tail on the runway, new ways to close the cockpit door to keep terrorists out, new ways to close the cockpit door ensuring two or more crew are in the cockpit at all times in case it turns out the pilot was, in fact, the terrorist. And so on. Keeping the pilots up to date with the onslaught of new rules and regulations is a mission in itself. So of course, there are quite a few people employed to do that.

Other Stuff:

A team of financial wizards to raise the capital to buy and renew the fleet.
A sophisticated reservation system to maximise load-factors (aka bums on seats) for each flight.
A team of operations managers to make sure aircraft, landing slots, gates, fuel, crew, food etc, all come together in that amazing choreography of the modern airport.
Catering companies have to churn out hundreds of meals taking into account ovolactarians, vegetarians, vegans, pescatarians, gluten-intolerants, etc, etc. And these have to arrive on time and not look too unfresh.
Frequent flyer points-tracking systems to keep on top of the accrued liabilities. And, no doubt, a team of lawyers, marketers and accountants to figure out how to reduce those liabilities without annoying their most loyal customers. Clearly Singapore Airlines, with their somewhat hasty approach to expiring miles, forgot to include the marketing person in these discussions.

Such a sophisticated operation. Such a well-oiled organisaton. So many shiny new planes painted in wonderful brand colours. What a great business! Who wouldn’t be proud of it.

Brief and inaccurate anatomy of an airport car park business

Patch of Land:

Obviously you need a patch of land to park the cars. Maybe it took a bit of haggling with the local government of the day to get the long term lease set up, and maybe a contractor had to come in to smooth out the bumps and put some tarmac on top. For a really busy airport, maybe a few tonnes of steel and concrete had to be installed to create multiple parking levels.

Ticket Machine And Boom Gates:

Not much to say here really. You need some way to track how long people have parked and a way take money off them when they leave.

Parking Attendant:

Every now and then someone loses their ticket or the boom gate doesn’t work so you need to employ someone with relatively little skill to open the boom gate from time to time, and possibly charge a substantial lost ticket fee.

Other than an accountant and a manager to organise the parking attendants, pay the insurance bill and carry the bags of cash to the bank each day, that’s about it. What a dull, boring, unimpressive business. Nothing to be proud of.

And yet every time I book a week’s parking at the airport I’m staggered to compare the parking bill with the cost of the air ticket. They are often about the same. There are hundreds of millions of dollars in deployed capital, and thousands of moving parts that have to come together for me to fly somewhere. There’s a patch of ground, a boom gate and a parking attendant to store my car for a few days. I would expect the flight to cost at least 20 times more than the car park. What on earth is going on?

Simple. The airport carpark has an economic moat. A sustainable competitive advantage. Once an airport is built there is only one sensible parking option for that airport. Other players can build one down the road, but then you get into the whole “shuttle bus between airport and car” thing which destroys the key reason you drive to and from the airport - convenience. Other players can invest millions building the fanciest car park known to man, but if it isn’t right by the terminal they just aren’t in the game.

On the other hand, given enough capital, it’s relatively straighforward, if somewhat foolhardy, to start a new airline. As a result there is plenty of competition and that drives prices down to subsistence levels. Profitable airline routes are often those served by just one airline. As soon as they get too profitable, another airline steps in to try and take some of that excess profit.

So what is an Economic Moat?

A sustainable competitive advantage that allows you to earn above average rates of return on capital deployed in your business.

Quick “Economic Moat Ready Reckoner”

Supposing you have a nice business that’s earning way in excess of normal returns. There is really only one question you need to ask yourself to check whether it’s sustainable high returns and that you do, in fact, have an economic moat:

If my competitor had a billion dollars to spend on competing with me, what would they do?

Possible answers:

Spend $10,000 paying a local hack to reproduce what you’ve got and spend the change on yachts, cars and fancy office furniture. You don’t have an economic moat. You should probably have a good think about plan B.
Spend $200m trying to reproduce what you have, and a year later have something pretty good. You don’t really have an economic moat. You have a head start.
Spend $20m lobbying their local politician to change the rules in their favour. You have a head start. Hopefully you have good connections with some well-regarded journalists too.
Spend $1.2b and a decade to reproduce what you have. That sounds like a pretty decent economic moat to me.
It doesn’t matter how much they spend, they can’t take any business off you without the help of some thugs with AK47s. This is the real deal. When you find a business like this, hang on tight.

A lot of management literature talks about building competitive advantage through hiring well, marketing better, trimming costs from operations and so on. The problem is, anyone can do that. Economic moats, on the other hand, are sustainable. But building them takes a lot of hard work and often a good deal of luck.

Don’t get despondent if you don’t have an economic moat. You can still make a handsome profit if you continue to work hard and work smart. The problems begin when you stop working hard and smart…

To find out more, “The Little Book that Builds Wealth” by Pat Dorsey is a great read.

Photo credits: Qantas, Sydney Airport

The Small Business Manager

Thu, 10 Dec 2015 00:00:00 +0000

At last! Business is booming. Orders are flowing, the bank balance is finally climbing and everyone is happy! Not quite. There just aren’t enough hours in the day to keep on top of selling, invoicing, hiring, delivering projects, handling issues. It’s time to get some help. It’s time to hire a professional manager. And what better place to hire one from than the breeding ground of middle management - the large corporate. They know how to organise people, keep on top of projects, hire in new staff, manage budgets and so on. How could we possibly go wrong?

We’ll get to that shortly. First a story.

Imagine, for a moment, Captain Arthur Phillip (AP) and the First Fleet arriving in Botany Bay, Australia in 1788. There’s trouble brewing with some of the convicts so he calls the powers that be in London on his sat phone and gets them to fly over some law enforcement help. (Yes, I know there are certain timing flaws with this story, but bear with me.)

The help arrives in the form of Chief Inspector Barnaby Sidebottom. Let’s just call him Barnaby. Barnaby is a solid chap. He’s been with the police force for over 30 years, knows how it works and knows how to get things done. He tells AP about all the wonderful things he’s done enforcing the rules back in Blighty. Horse and Cart theft is at an all time low. A large sugar and spice smuggling ring was dismantled much to the delight of the East India Company. AP is mighty impressed. It looks like all his woes are about to be sorted.

Time to introduce Barnaby to the local law enforcement team. That doesn’t take long. There are two of them. “Right”, says AP, “You’ve met the team. Let’s start sorting out this convict mess.”

Barnaby replies “Excellent idea. When are you available for our convict raucousness inhibition strategy plan (CRISP) session.”

AP: “Ummmm. Really? Well tomorrow is ok, I guess?”

Barnaby: “We can’t do it tomorrow. I spent a full 24 hours on the plane over so I think I’m entitled to a day-off-in-lieu tomorrow. And anyway, a strategy planning session needs an objective facilitator.”

AP: “An objective facilitator. What’s one of those? Can’t we just use a blackboard?”

Barnaby: “Are you serious? Do you want this done properly or not? Don’t worry, I’ve already organised one to be flown over from London. They are from a company called McK-Centure - very well known and respected. All the best run colonies use them. They are only four guineas a day, plus expenses.”

AP: “Four guineas a day!!! Our total budget for the year is 250 guineas. Where are we going to find four guineas a day? I hope they’re flying over in economy.”

Barnaby: “No, no, no. You want them fresh when they arrive, don’t you? They’re flying at the front of the plane”

AP: “Ok, ok. We’ve blown our budget. Please try to keep a lid on any further costs. So how long is all this going to take?”

Barnaby: “Not long. We should have the strategy done within 3 months, change management plan within another 3 months and we should be able to start training the team in the new methods straight after that. Within a year we should see the first arrests made.”

AP: “~~OMG~~* Jeepers Hellfire. We’ll be broke, overrun and slaughtered by then.”

This is, in essence, the experience of a founder with no corporate experience hiring a corporate manager with no small business experience. A highly competent corporate manager with the best intentions in the world can trash a small business. In the corporate world the biggest issues for a manager are often gaining agreement and changing behaviour of a large team. In small business it’s often about juggling many roles, staying responsive to the customer, fighting fires and operating on a shoestring budget.

Under a corporate trained manager big business policies start to creep in. Expensive travel policies, detailed time tracking, corporate credit cards for all, the latest brand new ergonomic furniture in architect designed offices, salary packaging and on it goes. All of which have their place. Just not in a small, cash starved business. The focus shifts to policies, rules and “what’s in it for me” while the founders’ vision to change the world fades into the background.

So how can a small business owner avoid this?

Hire smart. Some corporate background is fine, and often desirable. But small business background is essential. Dig into their understanding of cashflow pain. Understand how they act when systems are less than perfect, or non-existent. Quiz them on how they get things done when they don’t have a full team. Get them to spell out examples of when and how they’ve done this in the past.

It takes time. Plan for 15-20 interviews. The first 5 will probably be written off as you figure out what the role actually is and what questions to ask. But you owe it to yourself, your vision and the team to get it right.

* Exclaiming “OMG” was considered highly inappropriate in general western society back then, but apparently enslaving others was not.

Quality of Recurring Earnings

Tue, 17 Nov 2015 00:00:00 +0000

Great businesses print money. Whether you go to work, stay home, mess around in the garage inventing a new gizmo, go for a surf or swan around the vineyards of Europe, the cash pours in. Who doesn’t want that?

Well it turns out we didn’t when we started out. Like many others we left a job and started consulting. All the downsides of a job - like having to turn up to get paid and natural limits on what you can be paid. Plus a couple of significant extras. If you get sick the money stops. If you don’t sell the money stops. We had no recurring earnings. We had no plans to build recurring earnings and we certainly had no clue as to the quality of recurring earnings.

When I finally got around to sorting out the business my advisor hammered four letters into my head. Q.O.R.E. Quality of Recurring Earnings. If you want cash pouring in regardless of how you spend your day it pays to get your head around recurring earnings, how quality of earnings varies and how to get some for yourself.

This is probably explained by looking at some examples. Let’s look at recurring earnings we’re all familiar with:

Bank interest. You get paid on savings you hold in a bank account. High quality in the sense that it’s predictable. Low quality in the sense that it takes a bucketload of cash to get an income stream above the poverty line and then the value of that cash gets chewed away by inflation.

Share dividends. You get paid out a share of the profits of a business you invest in. Each company you invest in will have totally different recurring revenue sources and qualities which flows through to you as a shareholder. Analysts spend their days looking at this to figure out which companies have the best cost/revenue models and whether the price paid to invest justifies the likely revenue now and in the future. We’ll look at some of the parameters they use shortly - they will be the same things the small business owner is likely to think about.

Rent from investment property. You get paid rent each week by a tenant living in your property. New, inner city property in a booming city with low vacancy rates is likely more predictable, higher quality recurring revenue than an old seasonal holiday rental in a waning country town.

Phone services. The phone company gets paid for line rental and calls made. It is relatively predictable when averaged across a huge number of subscribers. Churn rate, the rate at which subscribers move to another provider, affects the quality.

Consulting services. Many consulting firms use a retainer structure where they offer a lower hourly rate to their clients in return for a minimum spend each month over a minimum number of months. Not bad - the revenue becomes more predictable. But you still need smart people to actually deliver the consulting and smart people tend to be awkward to manage because they have strong opinions about how to do things.

Software maintenance fees. Enterprise software has typically been sold with an upfront license fee and then ongoing annual support and maintenance fees to entitle the customer to upgrades etc. If the software is easy to replace (e.g. a rostering tool for a single department) then the maintenance revenue is lower grade compared with software which is hard to replace such as an ERP. I have heard that an ERP is like a tattoo - the pain of removal far exceeds the pain of installation - so the maintenance revenue keeps flowing.

In each case, recurring earnings are earnings which have a very high probability of arriving in your bank account in spite of everything you do in the short term. There are a few factors that determine the quality of recurring revenue.

Effort: Do you have to have a lot of manpower to deliver against the revenue? For example, a consulting retainer requires a consultant to do something useful to maintain the revenue, whereas no human is directly needed to deliver a phone call.

Capital: Do you need to tie up a lot of capital to receive the earnings? While no human is directly needed to deliver a phone call, a lot of very expensive infrastructure is.

Risk: What is the risk involved in delivering the service? Does the revenue justify this risk? I would want to be very well paid if I was responsible for monitoring aircraft engines and potentially liable for an air accident. Complexity creates risk too. If I need 20 opinionated experts to deliver complex projects the likelihood of things going smoothly is nil*.

Predictability: Do I have a very low variance between forecast recurring earnings and actual? A phone company can predict earnings with a high degree of accuracy due to the averaging effect across a large number of subscribers. A holiday rental less so.

Sustainability: Can something happen to kill off my earnings over a short time period. For example, mobile phones replacing landlines or government legislation driving the price of thermal coal down.

So how do I get some high quality recurring earnings for myself?**

That’s a great question and the answer is, annoyingly, “It depends”. It depends on what you currently do, it depends on the markets you serve, it depends on your skills, capabilities and risk tolerance, it depends on access to capital and so many other things. But the trick is to identify the parts of your business that can systematically and repeatedly result in a benefit to your customers, package that up and teach others to sell and deliver it.

Too easy. Time for a surf.

* You could argue that complex projects don’t represent recurring earnings. They could, though, if you have been contracted to deliver installations across 300 sites for a single customer over 5 years.

** Of course, if you are the founders of some hugely successful social networking startup, high quality recurring earnings are the last thing you need as they may be used to value your business sensibly. Instagram, anyone?

Oops - The Gorilla Just Sat On Me

Sun, 15 Nov 2015 00:00:00 +0000

You’ve been sweating on that big deal for weeks. The gorilla deal. The one which will change the face of the company. Revenues will double overnight and all kinds of exciting things are about to happen. After arguing over the fine details of the contracts - conceding a few points here and there and winning a few elsewhere (but not many…) you finally get it over the line. Woo-hoo, we’re made!

Now back to reality.

Yes - this deal will indeed change the face of the company. It will either grow and succeed or crash and burn. There’s no half measures with a gorilla deal.

A good part of my working life has been spent building, selling and implementing business software so today we’re going to have a look at how big companies accidentally stifle or kill small software vendors. I’m sure this applies to all small technology vendors, and I’m sure most of this applies to all small vendors of any kind.

A deal isn’t a deal until you have the purchase order.

You go through the trials and tribulations of presenting, running demos, doing technical evaluations, having some forensic accountant delve into your books to confirm you are a viable entity and you come out victorious. You have a signed contract to supply the gorilla. As soon as you have recovered from the champagne hangover you go on a hiring spree to service the workload. Then you wait. Nothing’s happening… Not quite nothing - your cash is draining out of the bank account paying for all the new hires.

So what’s going on?

Possibly one of many things, but fundamentally you are dealing with different parts of a large organisation to pull off a big deal and a lot needs to be synchronised for things to happen quickly. For example, the procurement team will be working on multiple contracts and the line of business buyer will have forgotten what they were doing by the time the procurement team has finalised negotiations, fixed up terms and conditions and all kind of other legal minutiae and executed contracts with you. The line of business buyer then has to get back on track and start organising themselves around a project, but some operational issue has blown up in the meantime. So they get back on track and start the project a second time around, at which point they remember they need to issue purchase orders against the original contract to get something to happen. Meanwhile you’ve gone bust. The gorilla just accidentally sat on you.

What can you do about it?

Well, first of all, don’t get excited and start expanding before you see the initial contract turn into a commitment to pay. To support this you need to tie cost to revenue in the contracts. If you have to hire, hold resources or buy raw materials to service the contract then you need to be paid for it. If the gorilla customer won’t pay in advance then you don’t hold resources or lock in your costs. Non-negotiable. This is the kind of thing you will lose your house and family over.

Accounting revenue does not equal cash

Side lesson #1: You can book earned income (e.g. hours spent on a project, widgets shipped) and you can calculate profits but until the customer transfers the money you do not have the ability to spend that money on important things like rent and salaries.

Side lesson #2: Gorillas have two important attributes. They are dominating and they are slow. They dominate your management time and your resources and should dominate your revenue. However, they are slow moving, particularly with their accounts payable. That means a significant portion of your revenue may not convert to cash for some time. This is fine if you have a bloated bank account, but more than likely you will not have the money to spend on important things like rent and salaries.

Now gorillas generally aren’t slow because they want to be. They have internal processes to ensure people aren’t stealing money or spending it on stupid things like office dishwashers and bribing government officials. These processes can move slowly, particularly if key approvers are on vacation. They also have things called payment runs which may only happen every couple of weeks. If you miss one you have to wait for the next one to get your cash. Yes, I know we are well into the 21^st Century but it does still happen like this.

Gorillas also sometimes convince themselves they should implement ERP systems. These projects are big and complex and kill off accounts payable functions for months at a time.

What can you do about it?

If you are in the middle of this it is tough. The emotional and reputational pressure to keep working is intense. However, as a founder/director/senior manager of your company you have a duty to keep your company solvent. This gives you the “higher authority” you need to have the tough conversations with your customer.

If you need to camp outside their CEO’s office to get your invoices paid then that’s what you must do. If you need to divert all of your resources to fast sources of cash then that’s what you must do. And you should explain to the representatives of the customer you interact with what you are doing and why, and that you really don’t want to but under corporation law you have no choice.

An ounce of prevention is better than a ton of cure. Multiple calls to accounts payable and the customer’s nominated representative the second a payment is late sets the tone for the relationship - that you are professional and on top of the admin side of the business. And that you won’t tolerate being given the run around. Divert the project team for a day to another account, or onto internal projects to show you mean business. Again, you can lose your house and family over a gorilla’s glacial payment system so take it seriously and show you take it seriously.

“I insist on fixed cost even if it kills me too”

Big companies seem to think that fixed cost projects are lower risk to them. And they may be when dealing with mature vendors with mature technology who have done a hundred similar projects and have enough cash in the bank to get through the odd project overrun without losing their shirt. If you are a small vendor, however, you absolutely need to negotiate out of this for your sake and theirs. A large, fixed cost project can kill your business. Here’s how:

Big customers typically have big project management systems. These introduce way, way more overhead than you ever imagined possible as a small, agile vendor. In the contracts you skim over the clause which says you will abide by the customer’s project management systems. That one simple clause contains a world of pain. Change control documentation, acceptance testing, test evidence and on it goes. You can probably throw in the odd half day safety induction for each of your team members if you are working in that kind of industry.

You didn’t price in this overhead so you didn’t see the 40% extra cost coming your way.

Small vendors normally have a technical guy leading a project who thinks every new feature is a cool idea. When the customer says “Can we add a new screen which shows how late we are with the project?”, your technical guy says “Hey, that would be cool. Yes it should be in there - I’ll have it done next week”. Instead of: “That’s outside the project scope. If you send through a change request we’ll let you know impact on the price and schedule by mid next week and you can decide if you want to proceed”. The project never ends. Your costs never end. But your revenue grinds to a halt.

One of two things then happens.

You lose interest in the project which is haemorrhaging cash and it never gets finished - not good for the gorilla customer.
You go out of business and the project never gets finished - also not good for the gorilla customer.

Armed with this it should be possible, though not easy, to negotiate your way out of a fixed price engagement. Once you have done a few similar projects and know what’s involved and have reasonable working capital available by all means go fixed price - the margins can be way better when done properly. Just not for the first few.

Gorilla deals can kill your business in many other ways. Big companies like to ~~take over~~ have input into your development roadmaps so your products end up being designed for a single customer, not for a market. There goes your growth potential.

Big companies like to insist on locking your key staff into their projects. Congratulations - you just became ~~the gorilla’s bitch~~ a bodies-for-hire company, not a product company. There goes your growth potential again.

Big companies retrospectively insist on certified quality management systems. There goes another chunk of your shrinking margin. And on it goes.

A huge deal with a big customer can be a company maker, it’s true. But if you go in unprepared these huge deals will be a company breaker. If you don’t have anyone on your team who has the grey hair and scars from this kind of deal in the past, tread carefully. You will almost always be better off building capability, cash and experience with a few smaller, friendlier customers.

Photo credit: frank-wouters

The Acid Test For Business Ethics

Fri, 13 Nov 2015 00:00:00 +0000

When you’re busy and under pressure it’s easy to lose sight of what’s ethical and what’s not. Here’s a quick test to help you decide.

Would I be proud to tell my kids / parents / partner about what I’m planning to do?
Would I be embarrassed if the press got hold of it?
Would I like it if the same was done to me?

Climb A Tree

Tue, 03 Nov 2015 00:00:00 +0000

Imagine you are alone in the jungle, cutting your way through dense undergrowth with a machete. It’s dark and damp. Wherever you turn it looks the same. When you’re hacking through thick vines and dodging the odd snake it’s easy to veer off course. How on earth do you know where you are going?

Here’s how. Every few minutes you pull out your water bottle, take a swig and check the compass. And maybe every hour or so you climb a tall tree, locate the lost civilisation on the other side of a vast valley and figure out which course to set to get there, grab the treasure and get back to the pub before closing time.

An army has spotter planes, strategic planners, satellite communications, GPS and real-time tracking. One group figures out what the destination should be, another works out how to get there from where you are today. Yet another group monitors progress and provides regular course correction.

You don’t have that.

Big business is the army - lots of people, lots of technology, lots of cost overheads and crazy long discussions to change the strategic objective. They have the support but not the agility.

As a small business operator you are Indiana Jones. Self-reliant, flexible, a little brash maybe. You can make decisions in an instant and track down the treasure while a whole battalion of the finest troops fall over themselves.

But you need to know where you are going. You need to stay on course. And you need to hack through the jungle and fend off snakes.

This is strategy, management and execution.

A small business operator needs to do all three. If you do the work and check the course you could very efficiently end up in the wrong valley. If you set a destination and hack away you will give your better-equipped competitors a good laugh as they see you zig-zag through the jungle, and you’ll be worn out before you reach the prize. You need all three. Execution, management, strategy. Hacking, compass-checking, climbing a tree. Work, tracking, direction.

There are reams written on this but here’s a version you can fit into your backpack:

Once a month, think “Strategy”*. Climb the tree. Work on the business:

If I get hit by a bus tomorrow, is there any inherent value in the business if it is sold?
What do I need to do to build that value?
What’s the quality of my revenue? Does it rely on me coming to work tomorrow?
Where is the market going?
What’s driving the market?
Will my products or services be relevant for the next 12 months?
Are each of my product lines performing? If not, why not?
Should I sell off a product line? Or buy or create a new one. Maybe reposition one?
Do I have the resources to make these changes?
Do I have too many resources for what we’re doing?
Is my marketing performing? Is my sales pipeline overflowing with goodness?
Are my customers complaining about things I can fix?

From this analysis you will identify course corrections or potentially a new direction altogether. You then need to follow that direction, so…

Once a week, think “Management”*. Check the compass:

Is my cashflow position secure?
How are my growth metrics?
What is my utilisation rate?
What is my support backlog?
Is my sales pipeline converting into business?

The actual checks will depend on your strategic direction. From this, you will make minor tweaks to your execution. For example make a few more sales calls to lift utilisation or focus on clearing the support backlog.

Put it in your calendar. Really. Right now. Once a week**, check the compass. Once a month, climb a tree.

* Plenty more to come on these topics, so don’t panic if it looks a little light even for a backpack.

** If you are an internet startup in hypergrowth mode, you are going to need to tweak these. Eg check the compass every 7 pizzas rather than every 7 days.