There is one thing almost all entrepreneurs have in common; they want to grow.  They seem to have an insatiable appetite for more; more customers, more margin and more revenue.  The most fundamental of entrepreneurial questions is what business to be in, and expansion into new markets can reframe everything from branding to resource requirements.

Within our work (as strategists and facilitators of strategic planning retreats), clients often pre-determine the industry they are in based on some core competency. While the core business may be somewhat static, selecting what sectors and niches to focus on can be tricky.

While many business executives focus on the things they can be good at, the capabilities of the firm only tell half the story. One must also decipher what products and services customers will value. The question of market scope can be be best addressed through an assessment of “industry structure”. Industry structure demonstrates how a series of economic and technical  attributes determine the strength of an industry.[i] Ignoring industry structure is like standing in the ocean in high tide; one can attempt to swim with the current or against it.

Companies should seek to capitalize on favorable market forces and then align their capabilities to profit from the most attractive markets. Much has been written about the Five Forces model (originally authored by Michael Porter), but a contemporary view of the theory would suggest that entrepreneurs must consider the following:

1. Savvy customers have access to information, and hence more suppliers. They leverage the information to work suppliers against one another.  Customer’s buying power is promoting commoditization in most every industry. A world of reverse auctions and the like depress prices beyond fluctuations in economic conditions.
2. Suppliers have been chomping at the bit to raise prices (in a period of zero inflation). They must be more inventive in their approach in charging fees (such as airlines charging for baggage, and upgraded economy seats). For B2B companies, there must be a clear understanding of what services customers are willing to pay for, and which they will demand for free.
3. Low cost entrants will seek out business segments with low entry barriers and use price as a disrupter. With the development of e-businesses, virtual offices, outsourcing of customer service and production, competitors can emerge quickly.
4. Substitutes are adopted much faster than in the past. Within about a year, local storage was replaced by products such as Carbonite, which months later was made irrelevant by Dropbox and Evernote.  These products came to market with a price that can’t be beat – free.
5. Switching costs are low unless suppliers provide a barrier to exit, such as warranties, etc.  For example, auto manufacturers make special offers to induce existing leasing clients to stay in the fold.  Conversely, cell phone providers often provide lower prices to non-customers in an effort to make them switch, resulting in poor customer loyalty.

Every industry has a unique set of variables that synthesize these forces. Expansion is often necessary, but entering new markets should be approached with data, evaluation of the Five Forces and an abundance of caution.

All of this being said, executive teams should be purposeful about where their future growth will come from. It is overly convenient to believe that one’s existing market will continue to provide a satisfactory level of growth.

Smartphones and tablets have disrupted every industry, and we are moving towards a society where the vast majority of our tasks are completed on our devices. I have spoken with some entrepreneurs of the grey haired set that think they have a website and that they have the bases covered. Those who confuse a web strategy with a mobile strategy could be leaving money on the table.

Only 7% of teenagers check email every day. The technology that is the basis for communication in commerce is completely irrelevant to them. In the case of technology, there are entirely different populations: those who grew up with technology (under 40) and those who have adapted to it.

There is a revolution taking place where smartphone transactions are not only driving B2C, but will soon be crucial in B2B as well. Business to business users are utilizing their smartphones differently, accessing portals, ordering systems, etc. at home while watching TV, on airplanes and even in their automobiles. Smartphone purchases aren’t just for kids anymore.

The experience of a user on a smartphone or tablet is completely different than that of a website, and thus your web strategy must be built with mobile in mind. As the screen of a smartphone has a much smaller footprint than a PC, the information displayed should only be that which is most relevant.

In London, patrons use an app called Nearest Tube that allows one to find the closest subway station. The view of the user changes based on the angle in which the user is holding the phone. When pointed straight ahead, arrows guide the user (as in left or right) but when the phone is held downward, the user sees 4 arrows. When held up at a tower in the distance, the app indicates how many kilometers away it is. The use of apps in this way is an indication the traditional viewpoint of web applications does not apply directly to mobile technologies. That is web technology and viewability does not translate directly to mobile.

According to a study conducted by Comstore, one third of all searches today are on smart devices, and searches on devices are growing at 6-7 times the rate of PC’s. In other words, we are a year or two away from most internet activities being conducted on smartphones rather than on PC’s.

The proliferation of native applications reflects the poor user experience on websites. While not all businesses (especially B2B businesses) warrant the development of an app, they can take steps to integrate mobile into their marketing plans and optimize their websites to be device friendly.

I am proud to have authored one of the top 10 most popular posts in the history of Executive Street: The 3 Stages of Innovation. In that post, I pointed out that various innovation strategies are directly correlated with industry stage. When it comes to innovation, timing is everything.

The other critical variable in continuous innovation is an entrepreneur’s tolerance for risk, which is often driven by a multitude of factors such as the profitability of the business, level of private equity investment, etc. What wagers to make and in what amounts could be the single most important decision a business owner makes.

In the 3 Stages article, I referenced three distinct innovation types: market disruption (white space), up-market disruption (service innovation) and low-end disruption (commoditization). Another spin on this theory was recently articulated in the Harvard Business Review (Managing Your Innovation Portolio-Nagji and Tuff May, 2012) who outlined the optimum innovation allocation strategy for established firms.

Naji and Tuff suggested that the most profitable of companies (according to two recent studies) allocate roughly 70% of resources to core businesses, 20% to adjacent businesses and 10% to disruptive innovation. This allocation is based on risk and reward: companies can realize the highest likelihood of ROI in the business they already know, can invest in short term growth in businesses directly adjacent, and invest for the future in white spaces.

The science employed in these studies would validate previous writings of Keith McFarland in the Breakthrough Company who maintained that many entrepreneurs are overly eager to expand into adjacencies (and disruptive innovation) when they sense they are running out of runway in their core business. There are many variables to consider, but as a general rule, it is easier to grow share from 20% to 40% in an existing business than to try to grow from zero to 20% share in a new market. Naturally, the amount of competition, channels of distribution and other factors can dramatically affect the impact of any innovation strategy.

The motivation of the entrepreneur can not be understated when considering risk tolerance. Some business leaders (such as those in technology or those that employ high levels of financial leverage), may be driven towards a higher appetite for risk (and resulting returns). In such cases, investment in core businesses could be significantly less (perhaps 40%-50%) while investment in new offerings and disruptive strategies are ratcheted up.

The chosen risk tolerance will dictate which innovation investments will be made. For example, to grow into white space may require hiring staff with specialized skills. To expand a core competency may require better systems, processes or command over raw materials, such as is often achieved in a vertical integration strategy.

It is important for management teams to consider these factors early on in the formation of strategy.

Businesses constantly struggle with capacity issues. Manufacturers seek access to the ideal manufacturing capacity, and service providers look to employ the optimum number of employees.  Both understand their labor spend is a key component of a company’s profit formula. So how is the entrepreneur to scale in an uncertain economy?

Those who had not experienced rapid market erosion previous to the liquidity crisis learned an important lesson; high fixed costs can be truly catastrophic when demand contracts quickly. Employers must marry labor costs with demand. There are several steps one can take to mitigate labor capacity risk:

Optimize Labor Efficiently- Most entrepreneurs intuitively understand that they should push low value activities down through (or out) of the organization.  Senior managers should aim for “zero administration”, where virtually all of their time is spent improving service or profitability, and not loading paper in the copier.  A good administrative assistant is worth their weight in gold. Similar thinking should apply to all; all work should be allocated to the appropriate staff based on their skill level, experience and cost.

Outsource Low Value Activities Based on Demand- The zeal for outsourcing is far from over. Organizations are not only seeking lower costs, they are looking to move resources outside their organization so that they can scale  their bandwidth quickly. Look for outsourcing partners who have infrastructure that can move, (in real time) with your business. Such organizations typically have an existing core competency in the services provided, including technology and human capital geared towards executing such work.

Increase Weighting of Incentives to Total Cash Compensation-Those who only provide subjective bonuses are actually doing themselves a disservice. Practically the entire Fortune 500 have moved to some type of performance based pay. Part of the rationale is to only pay out incentives when an organization reaches certain performance thresholds.  Failure to have a significant portion of cash compensation in incentives (20% or more) creates fixed costs and puts stress on a business and on employees. Fluctuations in demand require drastic action such as lay offs or furloughs.

Measure Labor Meticulously- Labor KPI’s are amongst the easiest predictive indicators to measure, and directly affect the bottom line. Examples include overtime, labor dollars per unit, direct labor, indirect labor and labor as a percentage of revenue.

Beware of External Demand Indicators- Within virtually every business segment there are external measures that provide context on future demand.  Add external indicators to your scorecard/dashboarding system so that you can stay in tune to the market place. Government websites, trade associations, and private research organizations offer a litany of statistics.  Plot such data  against company revenue to find which numbers correlate with business growth.

There has been the occasional business leader whose reign has been magical (Welch and Jobs come to mind).  Yet their business often fall to sustaining enterprise value after they leave. GE’s revenue and stock appreciation has been stuck in neutral since Welch’s departure, as the 20^th century’s most profitable company tries to find its way.  Apple has been trading all over the map in the last few weeks as the market tries to reconcile a world without the imagination of Jobs and his fancy gadgets.

A systemic problem for private companies is that a lack of management and bench strength.  This dearth of talent goes deeper then inhibiting productivity in the short term; it is a significant barrier to value creation for the entrepreneur.  If an exit is an objective (as is often the case), buyers generally want to see a strong management team and bench that can support future growth. If it is the business owner and his brother-in-law that possess all of the tribal knowledge (intellectual capital) about how a business operates successfully, the enterprise can lose luster with investors.

There are similar problems when one or two employees within a company are technically superior to those around them. Often, feeling their power and value, they are unwilling to teach, document, and delegate. When management and boards allow such conditions to persist, they are doing a disservice to the shareholders and are putting the company at risk.

Organizations should:

1. Require that every manager have a delegate – Identify and develop strong number twos that can eventually step in and take on the job duties of every manager. If people can’t attend conferences or go on vacation, because no one else can cover their desk, it is a sign that they have not developed the talent around them. To develop others takes time and investment including focus on performance reviews, career pathing and training.
2. Institutionalize activities, duties and best practices – Develop thorough documentation. Companies must maintain policies and procedures if they are going to be operationally excellent. When a supplier errs, it is usually because an inexperienced junior staffer doesn’t do something the way his senior counter-part would have. Often the junior staffer is criticized, even though it is their management who put them in position to fail.
3. Teach - Great leaders are usually great teachers; they aspire to develop others through daily interaction, and the sharing of information. The inability to teach is often a sign that a manager views themselves as the only person competent enough to complete certain tasks, and makes excuses as to why they can’t find other people to step up.  Great companies have development plans for every key employee, and make resources available for their continuous improvement.

Organizations that formalize these practices in their companies will maintain a long term strategic advantage over those who do. The talent war has only just begun.

Everybody likes to think of themselves as a strategic thinker.  From advisory board members, to CPA’s and marketing consultants, lots of people list “strategic planning” within their list of competencies. Yet, there is a big difference between thinking broadly about strategy and creating a functional, tangible, strategic plan.

Strategy is somewhat esoteric, and theoretical. It deals with broad decisions that must be made about a business such as what products to offer; in which markets, using which core capabilities. The carefully crafted strategic plan has tactics woven into it, in the form of goals, objectives, initiatives, and action plans.

Unfortunately, some companies have a strategy and no strategic plan (and vice versa). If the strategy is stored solely within the confines of the thinking of the entrepreneur, there is no strategic plan.

There are books written about preparing a strategic plan in an hour and writing a marketing plan out on the back of a napkin. The napkin’s evil cousin is the one page business plan, which may tout simplicity as grand, but lacks depth, scope and detail. As the thinking goes, anything as important as the future of a business (and the implications for its employees and investors) should be explained in a few paragraphs. Using the same mindset, an airline pilot’s flight plan could be drawn on a napkin.  A cancer researcher’s thesis should be able to fit on an index card. Perhaps we can cut a few corners and keep the design of that skyscraper to a minimum. Who has the time?

The other problem with the napkin analogy is that it suggests two guys sitting in a pub dreaming up the grand strategy over a Guinness. Some of history’s most ingenious strategies may have been dreamed up that way. Yet the grand strategies do not always translate into a functional strategic plan based on research, thought, prodding, challenge and development of core capabilities such as supporting human capital and technology.

Most importantly, the people who will be responsible for buying into the grand scheme need to be included in the process of developing it. If a board of advisors or two guys in a bar craft and develop the strategy void of management’s input, they are likely to sabotage it or at least slow down its momentum.

Thus, the distinction between being a closet strategist and creating a thorough strategic plan is an important one.  The finer things in life, like a great cabernet or scotch, take time. Building a strategic plan requires patience and a level of expertise that you would expect out of a CPA or intellectual capital attorney.

Take the time to convert your strategy into a tangible strategic plan that you can share with your investors, employees, vendors and even customers (when appropriate). Isn’t the future of your company worth it?

Being Opportunistic in a Volatile World

Last week my post drew considerable attention, perhaps because of its shock value at a time when the news was truly shocking. While the tsunami was a natural disaster, the response on the part of the Tokyo Electric Company was a human calamity. Lack of preparation will invariably lead to unintended consequences, if you are managing a nuclear power plant or any other business.

The reverse is also true. The entrepreneur capable of understanding seemingly unrelated external forces, and weaving them into a thoughtful strategy, will clearly realize strategic advantage. How might the strategist consider social, technological, economic, ecological and political factors to gain insight on how to take advantage of ever changing market conditions?

Scenario planning is a methodology whereby the entrepreneur considers converging factors that (in combination) creates a tipping point. Consider some of the following predictions, based on facts already in evidence today.

In the next decade, we are likely to see:

Predicative Modeling-Cloud computing enables the migration and cross-referencing of large institutional databases.  For example, actuaries, using sophisticated algorithms are able to model ailments based on lifestyle choices monitored in real time. They are able to calculate your risk of a heart attack based on which smoothie you tend to order at Jamba Juice, your frequency of exercise, prescriptions you use, etc. Offered as a benefit of a health care plan, the member is offered incentives to opt-in and receive preferential rates. Such tools slow down rampant health care inflation.

A Cashless Society-The majority of transactions amongst big banks are managed by exchanges where no money actually changes hands. Coins of small denomination are nearing extinction. Today, you can download an iPhone app that serves as a debit card, and can be swiped within Starbucks locations.  For most transactions, cash is already irrelevant.

Smart Infrastructure- Automobiles come preinstalled with all of the features of an iPad (the 2011 Hyundai Equus will come with one) and all the benefits of the internet. Smart grids control the flow of traffic, directing drivers to particular lanes at a given speed to optimize drive time and reduce accidents. Traffic signals are regulated based on traffic volume. Sensors predict bridge and rail failures.

Of course, rapid change will occur in every industry, and the strategist must weigh various opportunities based on an organization’s ability to take advantage of them. As a general rule, organizations should seek to achieve scale and reach within its core (at least 30% market share) before expanding into new endeavors. As Jim Collins points out in his sequel to Good to Great (How the Mighty Fall), many companies fail because of an “Undisciplined Pursuit of More”.  In their zeal for diversification they often leap too far from their core competency.

Each opportunity must be assessed within the context of the organization’s resources, bandwidth, and human capital.  For every opportunity there is a cost, and an opportunity cost. To pursue any new opportunity an organization must leverage resources which dilutes focus on the core business.  Choose your opportunities carefully.

Most of our clients aspire to a similar end game; some type of liquidity event (sale). Often, such transactions lead to extraordinary material wealth, and provide a payoff for the entrepreneur’s years of sweat equity.

A recent study validates content previously published in this space. The value of businesses is not proportionate based on size. A $50 Million revenue business could be worth significantly more than 10 times that of a $5 Million business.  Within the current M&A environment, the “size premium” is magnified further by a dearth of “deal quality”.

In 2009, companies with less than $5 Million in EBITDA (earnings before interest, taxes, depreciation and amortization), yielded an average 5.1x multiple, compared to those with more than $5 Million who commanded a multiple of 5.9x.   The premium paid (16%) for profitable larger companies last year was five times the premium paid in 2006 (3%). A study conducted by GF Data Resources concluded that “average performers” (companies with less than a 10% EBITDA) earned a 4.3x multiple compared with 5.7x for above average performers. That is, a company that earns a $5 Million profit before taxes is a far more attractive asset than one with less revenue or lower margins.

As an organization moves through its lifecycle, there is a disproportionate multiplier effect to its value by virtue of which buyers are in play. Private Equity investors and lenders view the $5Million EBITDA business as better prepared to weather economic fluctuations.  We have heard the cries of smaller, poor performing businesses that have very little access to capital. Conversely, the flight to safety has created remarkable competition for businesses of the desired scale ($5 Million+) .

Thus, the entrepreneur needs to be patient and focus on the infrastructure required to support growth.  Taking the time to grow a business delivers an incredible incremental return. Assume a $40 Million business earned an 8% EBITDA ($3.2 Million) and was valued at five times ($16 Million). If the business were to leverage its infrastructure and grow to $50 Million at 10%, it would realize a $5.0 Million EBITDA. If the higher margins and scale were to produce a half turn (multiple) increase, the enterprise value would be: ($5M x5.5=$27.5M) Thus, the 25% increase in sales and 25% increase in profitability yields a whopping 72% increase in enterprise value.

The size premium should give us pause. It provides the entrepreneur with motivation, and the knowledge that his years of work and grit can provide a significant pay off.