BERKONOMICS – Business insights from Dave Berkus

Surely you’ve heard the buggy whip analogy.  A business making those necessary items ignored the signs of progress and found itself without a market.  Perhaps that happened to sword smiths upon the invention of the rifle, and certainly to the makers of cassette tapes upon the dawn of the CD.

I found myself in the middle of such a slow-rolling change twice in my career.  First, in the late 1960’s (yes, I know, a long time ago), there were 31 phonograph record manufacturing plants in Southern California alone.  By 1975, there were only two.  That is sudden change, brought about by the fast acceptance of the cassette, which in turn gave way to the next technology, CDs, after a rather short lifecycle.  Record plants were noisy, dirty places, using chemicals I can only imagine now rest somewhere in the ocean, to electroplate the “stampers” and press the records.  Cassettes, in contrast, could be manufactured in small rooms with much less expensive equipment and no damage to the environment.

The second time I learned the buggy whip lesson was at the dawn of the personal computer age, and this time we guided our firm without a hitch from minicomputers to networked PCs, even growing the business as we gave up the lucrative $100,000 hardware sales in return for service fees to network our customers’ systems, install our database, and migrate to customer-purchased desktop and servers.

[Email readers, continue here...]  Here it is, not so many years later, and the signs are more subtle yet, but the speed of obsolescence is much faster.  Take for example, the public’s quick acceptance of Facebook, Zinga, Mixi, and other social networking portals, leaving early leader MySpace wondering what happened to their comfortable lead and large fan base.  With rapid sharing of information and recommendations, a fickle public can change its mass preferences seemingly in an instant.

How do you spot the buggy whip trap and differentiate it from a simple business cycle slump?  The answer is simple, but somehow out of reach for most senior executives and entrepreneurs.  Micro trends may seem to be a whisper, as mini-trends follow with leading adopters making a bit of noise.  It is those leading adopters who take the chance on new technologies, new companies, new styles, and new idioms.  That is why so many larger companies pay specialty marketing firms to find, court, and listen to those individuals who lead the pack in taste and action.

For those of us who don’t have the resources to hire these expensive market trend-watching firms, there are more simple yet effective opportunities.  Usually, technology and style trends begin with those aged between 15 and 23.  And which of us doesn’t have at least one close relative or child at or near these ages?  Have you ever asked for an hour of such a relative’s time to discuss what’s “cool” or “coming” or “must have” in their lives?

It is human nature to protect one’s investment of money, time and brand in an enterprise.  That leads naturally to a resistance to change and inability to willingly move to replace your own product with something new that will kill its revenues.

But we all know that if we do not do it when offered the evidence of obsolescence, someone else will.   So, are you investing in your own form of buggy whip product or service today?

Great executives and managers seem to intuitively know what they don’t know.   But it is not at all uncommon to not even know what questions to ask.

How do you avoid being sideswiped by the new product you never saw coming, or by the “black swan” event no-one ever thought of – that might threaten your business?

Speaking with a roundtable group of fellow associates, most all of them CEOs, we addressed this question and spent an hour brainstorming how to protect against just such a lack of forward vision.

One CEO stated that she engages regularly in scenario planning with her executives, asking “what if” questions to explore the edges of the group’s thinking about everything from disruptions of supply to changes in customer taste to acts of God such as floods or earthquake.  The group agreed that this is an excellent process, engaging the entire team and members’ experience to explore the unknown.

But what if no one in the group thinks to ask the pertinent question that leads to the most impactful unknown?  What if that threat is outside of the experience of anyone in the room?  What if no one knows what to ask?

[Email readers, continue here...]  Another CEO chimed in with an answer that made us all think.  Most every technology advance has been predicted in works of fiction years before the fact, he stated.  Why not look to fiction for clues?  From devastating events like tsunamis to future user interfaces predicted in such films as Star Trek or Minority Report, there are liberating clues within the experiences of most of us.  Think of Flash Gordon or Dick Tracy, characters from many decades ago with communication devices that have not only come to life but have been far surpassed in reality.  Tom Cruise’s virtual handling of graphics by hand movements came true only a few years later, even popularized as a game with Microsoft’s Kinect system driven by body movement alone.

Our frame of reference must be as broad as possible when asking “what if” questions to protect our future.  Read more science fiction if you are involved in technology.  Read more disaster novels to expand your thinking to the very edge, even if only for a minute as you examine what and how to react to the unknowns that are sure to someday challenge us.

As a manager, you have a number of critical tasks that are general to your position as opposed to specific to your industry.  These include ensuring the continued health of the organization, setting the moral compass for your stakeholders, providing for succession by training and documenting, leading the effort in compliance of regulations and safety needs, and … elimination of all possible bottlenecks that impede the efficiency of your organization.

The definition of a bottleneck in your business is one that constricts the flow of work from one area to another in the flow of product or service through your organization.

[Email readers, continue here...]  A bottleneck in your organization’s flow of product or service can happen, shift, or disappear quickly.  Common to all bottlenecks are three factors:

1. All product, labor, and cost before the bottleneck are impeded from creating maximum efficiency by being forced to slow output or build inventories. This is a costly loss for any business and one that should be a focus for your management as soon as identified.
2. The bottleneck itself strains to keep up with demand, often to the point of reducing its own efficiency in the process of attempting to keep up with demand.
3. All processes after the bottleneck are slowed for lack of flow into their zone of control and waste time, money, space and output, always resulting in reduced revenues and profits.

You can be the bottleneck.  If people are waiting for you to respond to a question or make a decision about design, process, spending for a core need, or any of tens of critical decisions, you are creating a slowing or stoppage of work before you and idle resources behind you.  If this describes you at any moment in your day, you should consider removing yourself from the bottleneck list by delegation, reduction of your non-critical workflow, or (heaven forbid) increasing your hours of production.

If failing to hire a critical employee is the cause of reduced efficiency, you must act quickly to either make an effective hire or alter the environment that creates the urgent need, all to remove that bottleneck.

And if an inefficient or undersized machine or department or process is creating a backup of critical path work flow, you must address this as an urgent matter whose cost is much more than the cost of the machine or person needed, but the amplified cost of the lost output it affects.

You, as a successful manager, must be attuned to and responsible for elimination of all forms of bottlenecks within your span of control.  Watch for, and stamp out, all those you identify as soon as you find them.  The effect of your action is magnified several-fold at the output stage of your business, leading to increased customer satisfaction and increased profits.

Reduce the emotion; reduce the threat of lawsuit.

You’ve certainly experienced the angry outburst from an associate or employee who has just learned of an event that the person took as “unfair,” no matter how rational the explanation by the decision maker.

Most emotional responses to decisions in business are generated not because the person making the response feels the decision was unwise, but rather unfair.

So I’ve created the “Fairness Doctrine,” as a stated element in the cultural fabric of businesses where I am involved.  Simply stated, a decision or action that affects an individual must be made with consideration of the affected individual’s view of the fairness of that decision.  This doctrine is a variant of “do unto others” but with a twist.  The recipient of the decision in this case usually has little opportunity to respond in kind (“as you would have them do unto you”).  It is this frustration coupled with the simple outcry of “That’s not fair!” – that can affect the culture of a company in ways never considered by the original decision-maker.

People sue others and their companies usually because they feel emotionally that they have been treated unfairly, not just because they were affected financially.

[Email readers, continue here...]  Firing a person considered a key associate without any advance warnings or public revelation for the reason, such as the need to consolidate or downsize, is a good example of setting up such a groundswell of accusations of unfair treatment.  Public dressing down of an employee in front of associates is inhumane and often generates a negative response from all who witness or hear of the action.  Closing a highly effective department, shutting down a marginal company, canceling a promising project all are good examples of management setting up a visceral response of “unfair” among those affected.

I have often addressed the issue of maintaining the dignity of the individual in a business environment.  The two are linked: the fairness doctrine and treatment of an individual with dignity, no matter how distasteful the decision implemented.

So my advice is to take the time to establish the reasons for pending actions – if not in an emergency environment.  Speak privately to employees who are in danger of being fired, documenting the discussion to the employee’s file.  Open up to the general group with facts that might later affect them, even at the risk of losing one or more to a hunt for a new job.  Most employees and associates, treated with respect and dignity, will respond with understanding and lose the emotion that might have accompanied receiving the later news of a negative event.

In fact, many times over the years, I have seen whole companies rise to new levels of efficiency, creativity, and sense of urgency when informed of the alternatives being considered by a board or management.

At the risk of losing talent not targeted, it is only fair to treat people as intelligent beings capable of understanding the dilemmas faced by management, and sometimes able to find solutions to problems not seen by those in control.

How many of us have “hired” independent contractors over the years, a bit worried over the gray area between employee and contractor as defined by the IRS?  I’ve experienced the results of a wrong decision, and the IRS and state agencies are not forgiving in their pursuit of penalties, interest and most damaging, assessing a company with the on both employer and employee taxes when reclassifying the person as an employee.

Yes, that’s right. The company must pay the employee’s portion of the taxes (and penalties on these) as well as paying those they would have paid if the person were an employee.

And the IRS has raised the bar on its test as to whether an independent contractor is not in reality an employee.   So it is important – no really urgent – that we review some of the twenty – yes twenty – tests the IRS now uses to determine if a person is an independent contractor.

1. Contract for service:  An independent contractor should work under a written contract with the company, defining the end result expected, time to achieve, lump sum or unit cost, ownership of intellectual property created and more.

[Email readers, continue here...]  2. Direction: The contractor directs itself, rather than being managed as an employee.   And just as important, a contractor does not supervise any of the company’s employees directly.  This is tricky when a contracted CFO assumes a position of directing an accounting department.  Usually, in acceptable cases such as this, the contracted executive comes from a recognized agency with a history of paying its own employee taxes, health insurance, and other benefits.   Without this protection, a contracted executive is suspect, even if working with more than one company at a time.

3. Integration: A contractor provides services which are not an integral part of the core business of the employer.  This one is tricky.  Is a contracted CFO an employee because the CFO job is integral?   How about a contractor CEO?   The person must pass all the other tests when one of them, such as this, crossed into the very gray zone.

4. Individual on the job: A contractor may hire a substitute without the company’s permission – although the company should then be able to terminate the contract with the contractor if the substitute is not acceptable.

5. Term:  A contractor is hired for a specific project, usually tied to a time term. An undefined period of time favors the ruling as employee.

6. Reporting: Here is a surprise. The IRS wants to test that a contractor is NOT required to submit regular reports.  Yet, most of us would want to have such documentation of progress other than an invoice.

7. Tools and materials: The contractor must supply his or her own tools.  This is tricky when a contractor sits at your desk using your computer and your phone system all day.

8. Physical facility: The contractor must have its own “home office” even if in a bedroom, from which primary work is performed.

9. Works for more than one company:  If such a person works only for a single company for any period of time, that person will probably be determined to be an employee.  A contractor must make services available to the general public.

10. Termination: A contractor works under a contract – which means that an independent contractor cannot be “fired,” as long as results are satisfactory as defined within the contract of service.

There are more tests, but these are the ones most often used by the IRS.  States add a few of their own; so beware.   Pay contractors using account payable systems, not payroll services.  Pay only upon receipt of invoices, not with regularly triggered checks or transfers of uniform amounts without invoice documents to back up the payments.

Many small or early stage company CEOs look for opportunities to cut cash drains, knowing that payroll is usually the greatest cash drain of all. The temptation to reduce that by fourteen percent or more by classifying a gray area employee as a contractor is very high.  And that includes self-payments to a founder.

Founders working for a company are employees if they take regular payments, subscribe to company benefits, attend regular company meetings, or fail any of the tests above.  The temptation to just draw cash and call it a loan, or document a year’s withdrawals with a 1099 is great, but highly risky.

There is nothing worse than a large tax bill and threats of a government agency seizing a cash account when a company cannot or does not respond with proper documentation or payment.  And even a single year’s worth of transgressions, when added into a single tax bill with penalties and interest, can appear daunting to small and young companies.

Like payment of payroll taxes by incremental impound each pay period, as opposed to waiting until the last minute and making manual tax payments, it is a proper discipline of management to “take the hit” incrementally to protect the business from a catastrophic failure to pay a governmental agency any form of tax when and as due.   Need we emphasize the personal liability of management AND the board of directors attached to tax payments?

Good management takes discipline and enough knowledge to prevent these possibly crippling errors in judgment that stem from decisions made to avoid or put off tax payments when accrued or due.

It is not common for the CEO of a rapidly growing company to think of slowing down the furious pace enough to have each manager (including the CEO) document the job process managed, as well as see to the documentation for each process managed below.

And it is even more of a challenge to consider documenting the tribal knowledge of a company’s key employees.  Examples include forcing the entire sales and customer support team to use a single database such as SalesForce or Sugar or Act to document the interactions with prospects and customers, or using “REM” statements liberally inside software code to notify future coders of critical information contained and reasons for making code branches, assigning variables with unusual names or more.

[Email readers, continue here...]  As CEO, have you made a list of your critical chain of advisors, including bankers, accountants, industry advisors, and more?  Do you have a “secret spot” for critical information someone might need if you were incapacitated or worse?  Especially when we are young, we feel invincible, and documenting tribal knowledge seems a chore with no reward.

Then inevitably a key employee gives notice and we begin to worry over what knowledge we will watch walk out that door, wonder how we will recover in the short term and grow out of the problem in the long term.  We worry that asking our subordinates to document their processes will look like the first step in removing them from their job. And we worry over lost productivity during this effort.

But if we make this a part of the culture of the corporation starting at the top and from an early point in the life of the organization, this process becomes an accepted way in which managers learn and leave behind, able to move up the chain with minor disruption both in the job left behind and the job assumed.  It makes for a smoother process for seeking outside hires by providing a model for the job specification to be written.

And it allows everyone to better appreciate the organization, understanding the limits of each position and the duties performed, avoiding conflicts between managers when in the future changes are made in the organization and in personnel during periods of growth or even downsizing.

Tribal knowledge is an asset of the corporation, to be protected as much as cash in the bank.

Sometimes it is the first thought you or your managers have when in need of skilled talent, especially for sales or product development.  It is not hard to find and observe the best employees of a good competitor at work, skillfully moving the competitor forward in a visible way.

And it is a tempting slice of pie – two slices for one price – to take a critically needed employee from a competitor, damaging that firm while building yours.

The problem is that a visible hire that “cuts” the competitor makes the competitor’s management bleed.   And you’ve heard of blood revenge.  That’s the worst kind, because it results in emotionally lashing out at the offender (you) with a response that is greater than the action that precipitated it.  In many cases, your firm can withstand the response.  In some though, cross-raiding of employees by offering unsustainable salaries or perks you cannot offer to all because of your size and financial position will leave you in a position to pay grandly for your action.

Consider the relative size of the competitor, the visibility of the target employee, and your ability to withstand a backlash before exercising the two slice tactic.

It has happened to all of us who have been leaders in business long enough.  One of your employees is approached by an employee of a customer or of a supplier, stating that “It sure would be great to work in your company.”  And without a policy or sometimes without thinking, your employee responds with a “Let me help,” or worse yet, “I have a position open.”

You should be clear from the start that no one at your company may offer a job to any current employee of a stakeholder – a customer, a partner in development or in distribution, or of a supplier. The rule should be one that includes only one “out”: if a person resigns from the position with the stake-holding company, then you will be happy to talk about a position.  No winking, sending signals, or quiet promises.

[Email readers, continue here...]  There are instances where such an existing stakeholder employee offers to go to his or her boss and ask permission to speak with you, and the boss not only concurs but agrees to call you (not just to take your call).  In that case alone, it is proper to continue as far as the offer and beyond.

Let me tell you the story from one of my companies that recently learned about the recruiting boomerang the hard way.  The CEO checked into a hotel that was a customer for its enterprise management system, and through a few innocent questions found that the owner was about to purchase several new systems for his new projects.  The front desk clerk cheerfully gave the CEO the owner’s contact information.

So the CEO called the owner that day.  “I will never deal with your company again!” was the short reply from the owner to the CEO.  It turns out that a manager from the CEO’s company had recently thrown the recruiting boomerang at that very same cheerful clerk, hinting that a job would be available if she’d like to apply.   The clerk told the owner, and the rest is history.

Properly, the CEO begged the owner for forgiveness, immediately sent an email to all managers reinforcing the existing policy of not hiring a stakeholder, and spoke to the person making the offer in a non-threatening tone, again reinforcing the policy.  During the phone conversation with the owner, the CEO carefully set the stage for a later call to mend fences and check on progress with the existing system already installed.  He made all the right moves given the situation.

But wouldn’t it have been easier to avoid throwing the recruiting boomerang in the first place?

You’ve heard the old one – that a banker always seems willing to offer a loan when you don’t need it.  For small businesses, there is such truth in that statement that you can trust the story to be based in reality from experience.

There are great exceptions for growing businesses and for businesses that have a track record with a banker.  Working capital loans and lines of credit are needed for growth and during times of business stress.  If a business were operating above breakeven and revenues and expenses steady, profits would flow to either the shareholders’ pockets or to working capital and taxes. Each cycle gives the CEO a chance to use those profits to some positive advantage, including increasing the marketing budget, paying down loans, building working capital, increasing “sticky cash” balances or paying shareholders.

[Email readers, continue here...]  But if a good business finds itself in a bad downturn, there may be a need that did not exist before for temporary cash, even as management reacts and moves to trim fixed overhead.

Approaching a banker during such times tests relationships.  If there was no previous relationship, few bankers would rely upon anything but a personal guarantee backed by hard assets before considering a loan.  But for those wise executives who included their bankers in occasional update calls, press releases, invitations to company events and an occasional personal visit, the strength of the relationship will often show its benefits during times when lending rules of the bank are near the “can’t do it” point.

For those with existing bank loans, that constant attention is more than just important.  As loan covenants become closer to being violated or after such an event, bankers have some latitude in deciding how to handle their accounts.  Upon discovery without prior notice or updates, bankers sometimes turn the company over to the bank’s workout group – a place you never want to visit.  In the gray area where covenants are broken but barely, covenants can be waived for a period of time as companies rectify the problems, all based upon the quality of the relationship between banker and client.

It is during those challenging times that it is most difficult to tell the story to your banker, but just then the most important of times.

Investors sometimes join into investment rounds that have been pre-negotiated by others, receiving the paperwork already created by attorneys from that negotiation.  It is not uncommon for a sharp investor to discover a “stinky” clause or two in such agreements when reading them in preparation for signing.  Bill Payne came across just such a stinky clause in a recent deal we both were late in the process of joining.

Changing the deal that late in the game is nearly impossible, after other investors have already completed their documents and the deal supposedly put to bed.  So what does the latest tag-along investor do?

You can tell from the title of this insight that the usual result is to passively sign while holding the nose, a trick perfected by experienced investors suffering this malady for not the first time.

What if it is the company attorney or entrepreneur that finds the stinky clause so very late in the game?  How do you confront the investors who have already agreed to terms and even perhaps signed their documents?  Is it worth risking the deal to negotiate a late change during the equivalent of the ninth inning?

[Email readers, continue here...] The answer is obviously in the importance of the issue to the person discovering it.  In most cases, the probability of whatever the clause being triggered sometime in the future is slight, and therefore the risk remote.  So it is a bet against the event made with chance on your side.

Then again, it is those improbable future events that end up causing lawsuits years later, often just because a party to an agreement did not understand the implication of a clause or even a document.  We hire attorneys precisely to help us prevent future conflict by resolving issues before they happen.

Most of us will let the matter slip and sign while holding our nose, a feat in itself (holding the nose, paper and pen at the same time).  Some of us will pass on the deal rather than confront the issue, especially if it is an important one to the late signer.  And that often happens when just such an issue has bitten the candidate investor in some past deal, making the likelihood of such negative reaction higher with sophisticated, long time investors.

Maybe there are skunks in the woods that don’t even know they smell.  Or maybe there are targets in the woods without the capacity to even catch the odor of a bad negotiation or deal documentation.  Either way, there are risks in deals we sometimes never catch – that later catch up to us in the most surprising places and times.