BERKONOMICS – Business insights from Dave Berkus

Creative entrepreneurs find niches for their business that are not full of competitors fighting over the last dollar of margin, or niches that are mature and shrinking in size.  They search for areas unexplored, or those covered by companies with less of a vision for quality, service or innovation.

But even creative entrepreneurs are often trapped inside the box of their experience.  Recently in a discussion of this very subject in a roundtable of CEO’s, one CEO reminded us of the Titanic tragedy.  She stated that those in charge during the last hours aboard had options probably never considered that could have saved many more lives, given the limited number of life boats available.  She listed several, including pulling up the teak floorboards and throwing them overboard along with the deck chairs and dining tables, all to be used for floatation.  It made us all think that we had never considered such solutions when contemplating that disaster after the fact.

[Email readers, continue here...]  With that challenge, we turned as a group to discuss how CEO’s could make a culture of thinking outside of that restrictive box of experience.  We considered adding questions to the interview process that could bring surprising answers from a job candidate, pointing to a creative thinker that might complement the team.

We challenged ourselves as a group to think of answers to problems that a writer of fiction might create, unconstrained by conventional thinking.  We worried over the fact that we may have hired people in the past that fit our image of the proper addition to our core staffs, people with similar experiences and training, constrained by the same experiential thinking as ourselves.

And we left that meeting each more willing to search for talent to help us and our enterprise find creative alternatives that would challenge us, expand our product, marketing, sales and process abilities beyond the constraints of our present definition of our company and its core.

It is a rule that early stage managers should find, protect and grow the core business, finding resources wherever possible to service that core in the form of variable expense, to be added to or shed at will as the company finds its niche and establishes a pattern of growth.

From administrative services supplied by personal assistants located in India, to designers and producers of prototypes in China, to call centers managed and located in the Philippines, there are efficient, well organized solutions for virtually every process needed by a company to surround its core.

In earlier college business administration courses, professors often touted the advantages of “vertical integration,” the process of bringing all production from raw materials through the finished product under one roof.  With the advent of worldwide seamless communication and cheaper skilled labor available through virtual relationships, that old school thinking no longer holds, even for the largest corporations capable of performing all operations in house.

[Email readers, continue here...] Henry Ford located his auto plant near the river so that his steel mill could cool the raw product and feed the plant across the property.  And in the 1960’s, I created a vertically integrated record manufacturing plant where raw materials came in one door and finished record albums out the door of the same building.  It was considered the most efficient possible organization at that time.  But it proved impossible to shed overhead during downturns.  Labor and downturn cash flow issues and management distractions contributed to offsetting the positive effects of such a practice.  I doubt Ford would organize his plant that way today, and neither would I.  There are far too many alternatives that serve to protect the business during downturns, give management alternatives and provide superior results when not at the core of the company’s offering.

Consider your core.  It is the one skill, process or advantage you have over your competition.  Then think of all the things you do to surround that core with people and assets that complete the company and allow you to release your product or perform your service.

Now consider how many of those surrounding assets and services are really necessary for you to perform in order to protect and grow your core.  For most small and medium-sized businesses, there are lots of wheels spinning around the core that take up the attention and resources of management, but add little or no value to the core of the business.

These are new times, enhanced by our global ability to find resources anywhere on earth to complement the core of our business.  And most often, the companies supplying those services are much more efficient at doing so than we could be because of their experience and  advantages of scale, and the cost to us of such services is lower than performing them ourselves.

So – what is your core offering?  Are you building it more slowly because your resources and attention are focused around many processes not critical to that core?

Some of us remember things better when given a catchy phrase or rhyme.  Here’s one to help you with squeezing the most out of your available resources.  It reflects the new reality in our business world, one with little room for mistakes and no room for bloat within our companies.

The first “P” stands for people.  The wrong person in a job causes all below or above that person in the production system, that depend upon that person, to operate at a reduced rate or quality of output.  And if there are people depending upon the output of that wrongly-placed individual, they too will suffer from reduced resources to complete their jobs.  The cost of a bad or failed placement in any position in a company’s critical chain is enormous and goes far beyond the salary paid to that individual.

The second “P” is for productivity.  If a good person is failing at the job, it may be because you have not provided the resources necessary for that person to do the job expected.  Hire a great sales person then fail to support him or her with a good marketing effort or a properly priced quality product, and that person will be set up to fail, and for reasons you might have fixed.

[Email readers, continue here...]  Then there is the third “P” – performance.  Like a great orchestra, it takes a skilled conductor to bring the best out of the collective members of the group.  You are responsible for the quality of performance that defines an excellent enterprise and assures long life for the company as competition becomes more aggressive and geographically extended.

The fourth “P” is for process.  How to get your offering from development to market?  How to stage and tune a production line for maximum quality and output?  How to penetrate an established market with a groundbreaking new product, but on a limited budget?  All these are process questions, often faced by management when seeking success.

All of us have limited resources and must deploy them effectively to gain the most possible ground in the marketplace.  Like a chain with four links, no one of these can be weak and allow us to succeed in our endeavor.  Focus and attention must be paid to each to strengthen the chain.  Over time we will explore these issues more deeply using the “theory of constraints” (TOC) method of looking into your physical and financial roadblocks.

The four “P’s”:  People, productivity, performance and process.

Which of these four P’s is your weakest link?  What can you do to rethink, reinforce and redirect resources and remove roadblocks to the success of that link and enhance your whole organization?

Professional investors laugh when they hear an entrepreneur state, “We have no competition.”  That statement has killed more investment deals than almost any other.  It is a failed litmus test for the entrepreneur, even if the plan is for a totally new device or service that could take the world by storm.  Well, come to think of it, this is especially true in such an instance.

The statement shows a lack of research or previous thinking that is a red flag for investors.  Whether the entrepreneur has not been able to find companies doing “something like” the plan, or s/he has not considered the most obvious killer of new ideas – doing nothing, it is a faux pas that should never be allowed to happen.

Doing nothing is the main competitor for most products and services, whether a compelling new idea or a seasoned product long proven to be effective.   Remember that the buyer must commit resources, money and time, toward the purchase of your product, and even if the product repays its investment in a few months, there may be issues you know nothing about that make no decision the right decision for this and perhaps many buyers.

[Email readers, continue here...]  Consider the state of the economy. Perhaps buyers cannot obtain attractive financing in the current market.  Maybe there is advance knowledge of new technologies around the corner that makes any decision today a risky one.  It could be that a larger competitor has met with its customers, promising to extend its product line into this very niche.  There are thousands of variants of the theme, where no decision is the right decision.

So, do your homework especially well by putting yourself into the minds of your potential customers.  Widen your search to include companies with products peripheral to yours, where extension of their product would seem logical, especially if you plan to be successful early in making sales into their market.  If you are raising funds, list “do nothing” as a viable competitor in your slide deck.  If you are training your sales staff, work especially hard on responding to emotional and factual counters to a final close of a sale.  Practice overcoming the potential objection long before standing in front of investors, customers or even your board.  After all, fooling yourself should never be an option.

In the creation of a new enterprise, there are five principal risks to be addressed by the entrepreneur.  Professional investors will probe these five risk areas and make the decision to invest based upon comfort with each.  So it is important for the entrepreneur to identify, address and mitigate each of these in order to increase valuation and decrease the risk of ultimate loss of the business.

First:  Product risk.  Is the product or service possible to produce at all, let alone economically enough to compete in the marketplace?  One way to mitigate this is by using early money to create a prototype, to perform market research, to complete the first generation of the product, or to deliver the service to a satisfied customer.

Second: Market risk.  Are you ahead or behind the market with your product or service?  Will the public respond in numbers to buy, license or rent your offering?  This risk can be mitigated by finding a customer willing to purchase as soon as a proven model is completed, and willing to state this in writing.  Another is to gain the support of a core vendor who is willing to offer special extended terms to the company as its investment in creating the product in a finished state.  A third demonstration of overcoming market risk is by holding controlled focus groups and gathering information from unbiased potential customers supporting the acceptance of the product or service.

[Email readers, continue here...]   Third: Management risk.  A great idea often fails from the inexperience or inability of management to bring the idea to market.  Similarly, great management often can manipulate an original idea or business plan into one much more attuned to the market, adding tremendous value that might have been lost sticking to the original plan.  This is sometimes labeled “execution risk” addressing whether management can create and run the company producing the product acceptable to the marketplace.

Fourth: Financial risk.   Any new enterprise is at risk if there are not enough resources to get the company to breakeven, which is a proxy for stability.  If a company truly needs five million dollars to get to breakeven, investors that provide the first million are greatly at risk of the company failing to raise the remaining capital or of subsequent investors valuing the company at a lower price than the first investors, causing a “down round” in which the early investors are punished for taking the first risk.

And fifth: Competitive risk.  If there are high barriers to entry with such protections as patents, long development time already spent or contracts with the major potential customers, then the risk of a competitor with more resources jumping into the frothy pool and taking advantage of the demand created by the company is minimized.

Reduction or elimination of one or more of these risks increases the valuation of the company and certainly improves its chances of survival and growth.

I love this statement from John Tukey, coiner of the word ‘bit’ to describe a single switch of digital micro-data.  Tukey was a statistician, one you would expect to describe events in terms reeking with precision.

Instead, Tukey implored us to think in terms of relevancy, cause and comparisons to known events.  And all this ethereal talk makes me think of how we investors and entrepreneurs are often led to search for instances in which our plan can be wrong, based upon a past measure.  Or how one fact in an argument can be disproved, making the entire argument in error in the minds of some.

Yet, if we do bet upon the jockey with more weight in our decisions to invest than upon the horse (or business plan), then our goal is to be approximately right and not to discount the plan for failure of one element which can be proved precisely wrong.

I made an investment in 2000 in a company that a decade later returned 110 times our investment at its IPO on the NYSE.  I invested in the jockey even though I liked the plan.  And that plan changed several times during the early years, molded into one that worked unbelievably well, enough to create an entire debit card industry which the company dominates today.  It would have been easy for early investors to find reasons not to invest based upon any number of facts upon which the original plan was based, many of which could be proved exactly wrong in the minds of fellow would-be investors.

Early stage investing is more risky than later stage when we can look back, know and measure prior successes.  But the bet is more often upon the jockey and that s/he will be approximately right by maneuvering the plan with the management team, rather than executing a plan that was flawed as originally written, and in retrospect exactly wrong.

Professional investors want to live by this rule. With the first round of funding, there should be milestones to be achieved.  If they are not achieved within the expected time, the reasons must be analyzed and acted upon to avoid loss of capital beyond plan or expectation.

And if the vision of the entrepreneur is flawed, or the product impossible to create within cost and time expectations, or the demand impossible to quantify, or revenues never close to plan, then it is time to rethink the plan and product.  An excellent management team is perhaps the greatest asset for any company because it is just this team that has historically been able to make a drastic alteration of the plan, ultimately making a failing vision into a wildly successful one.

But if neither great management nor the entrepreneur’s vision for the product shows real signs of success in the market, it is the hope of professional investors that the company fails fast, reducing further expenditures of remaining capital and protecting the assets purchased with the original investment.

[Email readers, continue here...] My favorite story of a fast failure was of a technology incubator started in the year 2000 with optimistic money from a number of angel investments, including mine.  Within a month after the tech crash, the founder of the incubator (who remains a close friend) decided that it made no sense to incubate companies that were not likely to receive new investments soon following incubation in the winter-of-cash that followed the tech crash.  He volunteered to close the incubator and returned 96% of our investments to all of the angel investors.  (That return proved to be the best investment return any of us saw in the several years that followed.)

Half of all professionally managed venture capital or angel investments fail.  There should be no shame to the entrepreneur in admitting such a failure.  Some angel and VC investors will give special credit to those entrepreneurs who have experienced failures when investing in their next effort.  The lessons learned are difficult to teach and are great assets in the next effort.

Yes, this is a takeoff from Frank Sinatra’s song, where he did it his way and got away with it.  You’re building a company from your vision and a passion, and lots of people are going to tell you that you have this or that wrong, and that it just won’t work.

The truth is that very, very few early business plans survive in a form completely recognizable when looking back a few years.  But even with massive changes, the vision and passion usually don’t diminish in the process of morphing a business plan into a profitable business.

Investors will invariably try to tell you that they know much more about the “how to” than you do, and that you should listen to them.  And because you need their money, the temptation is to listen a bit too well, and take all of the advice thrown at you during your presentations and during due diligence and finally from the vantage point of a board seat.  A good entrepreneur-turned-CEO listens, takes it all in, responds with reason, and stands up for what s/he believes for the parts that matter most.  It is good to listen.  And it is better to assimilate the best suggestions into your cake as you bake it. 

[Email readers, continue here...] But there is a limit, a point where your gut is more important than your ear.  If you reach that point with suggestions from these people trying to help, think carefully about how to respond, whether with facts, instinct or support from others.  Make your case for staying the course.  Remember the same passion you demonstrated when you first attracted these well-meaning helpers.  And push back.  Some investors may drop out if you are in the pre-funding stage. But they are not the ones whose support you would later want.  Some board members may show dismay.  But most often, a good case made with passion wins the day and unites the group to move forward.

I was chairman of an excellent company where I had led the deal, attracting angel investors through several rounds as the company grew to a breakeven with over four million dollars of gross revenues.  We then sought and received a venture investment from a top tier Silicon Valley VC firm, whose partner came onto the board.  After several months on the board, he spoke up. “I don’t like the niche we’re in. It will never grow enough to make this a valuable company. Forget this niche and turn the battleship. Let’s go after the Fortune 50.”  “But that’s walking away from an industry where we are #2, growing nicely and already becoming profitable,” the CEO responded. 

“Don’t worry. We’ll be there in six months when you run out of money with your new R&D focus”, the VC board member replied.  The rest of the board, including myself, went along with this because, as I’ve stated often, the last money in has the first say.

Can you guess the end to the story?  Six months later, the company ran out of cash, as planned, when ceasing to focus on the original niche. And the VC firm’s partners voted not to fund the restarted venture.  A good company, in a fine industry, ended up being dismantled just to repay the bank loan. No investors received anything. And the rest of us just shook our collective heads.  No one stood up to the VC board member, even though all of us heard but ignored our respective gut responses pushing back, as we remained silent.

It is years later, and the memory of that failure to push back remains fresh for me and surely for the rest of the former board members.  As chairman, I should have pushed back.  Certainly the CEO-founder had a duty to push back.  Another VC from a smaller company should have pushed back.  In retrospect, we were intimidated by the first tier VC, and half wanted to believe that he knew something we did not.

He did not.  Now, with that lesson firmly behind, I often remind members of a board when in a situation where someone on the board pushes to change the plan that the vision of the founder ignited us to bring us together.  If we believe we have a better idea, we should convince the founder and the rest of the board that we have strong beliefs that dispute the current plan.  But we should not be so loud as to drown out those other voices – you know – the ones from the gut and that of the founder’s dream.

               Look this up sometime in your browser: “Success is a byproduct, not a goal.”  You will find it attributed to tens of originators.  I first heard this in an episode of Friday Night Lights, when sage Coach Taylor began a locker room speech with those words.

                And yet, when I facilitate strategic planning sessions, I often lead executives to create a goal for their enterprise, one which can be reached by successfully accomplishing a series of strategic actions, each of which is braced with a series of tactics to accomplish in its support.  The goal is often stated in revenues, such as “Become a twenty million dollar company in three years.”

                Achieving such a goal is a direct measure of the success of the company’s strategies and tactics.  But in this case, the goal is success, which is counter to the locker room speech by the good coach.

                It is most important to focus everyone in the organization on a goal.  And when that goal is achieved, another should be set, then another.  Achievement of the goal is a byproduct of the successful accomplishment of each of those strategic and tactical actions called for in a good plan. 

                The point to remember is that you, as leader, must set and broadcast a clear goal, one that rallies your troops to succeed.  Don’t let the goal be achieved merely by the accident of good work and practice.  Make it tangible, obvious, attainable with effort, and worthwhile for the players on your team.      In that sense, success is a goal, contrary to the locker room encouragement by the coach.