Chapter 16

Detecting Hidden Problems and Adapting before It’s Too Late

In This Chapter

Working on your business model (It’s like a magic wand!)

Looking at common issues like the need for more sales and the need for more time

Identifying the root causes of everyday business issues

Adapting your business model while you still can

Sometimes everyday business problems really are more of a problem than they seem. Many times these problems are symptoms of a deeper business model issue. By learning to recognize the root cause of these everyday problems, you can save yourself tremendous grief. If you address the business model as the root cause of the issue, you’ll find that many problems simply disappear.

In this chapter, I tell you about some of the common symptoms of business model issues and their solutions. Be prepared for a bit of a shove toward confronting and dealing with these issues now rather than later. Then I discuss the process of business model erosion and how to mitigate its effects. By counting on change, you can maintain a stronger business model than your competition.

Fixing Your Business Model to Make Other Problems Disappear

I always joke that there is no magic wand in business. However, the closest thing to the elusive magic wand is addressing a root business model issue effectively. When you solve a root business model issue, ten other so-called problems magically disappear.

The best way to explain this phenomenon is to use an example. Occasionally, many business owners get frustrated with employees’ poor performance. They say things like, “How hard is it to . . .,” or “Why anyone can’t just . . ..” I call the issue “inferior work by employees.” The root issue here isn’t dumb or lazy employees; it’s more likely a combination of poor pay and lack of training.

Don’t stop there. Assume the business in this example is like most small to mid-sized businesses and can’t afford to pay top-shelf compensation packages. If the business could recruit better qualified people, job performance would improve. It sounds simple; pay more and get better people. Why didn’t these owners think of that sooner? They didn’t think of it, because the current business model doesn’t support paying more. If the true root of the problem is the need for a higher caliber employee, the business model must support the pay of the more expensive person. Currently, the business model doesn’t support the higher pay, ergo the performance issue.

If you believe the pay level and caliber of the staff isn’t the issue, then the staff’s poor performance is probably rooted in lack of training. More than 90 percent of mid-sized and small businesses significantly shortcut training or skip it altogether. You can assume that an outstanding training program would solve or significantly mitigate the performance issues, because it would.

You probably understand the importance of training. It’s hard to argue that inadequate or bad training beats quality training. So why shortcut the training? Necessity, that’s why. The time and human resources necessary to train the employees simply weren’t available.

Most business owners and their staff are time starved. They’re time starved because they’re paying for the staffing level the business model can bear. Change the business model to generate more margin, and — poof — the problem disappears.

Examining Some Disguised Issues

Sometimes what ails a business is exactly what it seems. If you need more customers to buy your products, the obvious solution is better or additional marketing. If you want to expand but don’t have the capital, finding a willing lender is a good option.

However, sometimes the obvious solution to a business problem is a symptom and not the root problem. A business can need capital for many reasons: capital expenditures, expansion, funding receivables or inventory, or buying a competitor. These are all good reasons to need additional funds. In some cases, however, the business needs funds because the model isn’t generating sufficient profits. The loan doesn’t fix this problem; it only artificially subsidizes the weak business model.

This section describes several instances in which “the problem may not be the problem” and is more likely a business model issue.

Disguised issue: The need for more sales

There’s no such thing as a successful business model that doesn’t have a successful sales model. If you can’t sell a product profitably, you won’t stay in business very long. Although sales are fundamental to a successful business model, many entrepreneurs overemphasize the idea that simply increasing sales will solve all problems. The salespeople are underpaid? Sell more. The business is losing money? Sell more. Customers demand more for less? Sell more.

It’s difficult to find a business owner who doesn’t say, “We need more sales.” After all, additional sales can provide much needed cash and margin. Additional sales volume greases the wheels of business, including yours.

However, your bills are paid with gross margin. Consider these formulas:

Sales – Cost of Goods Sold = Gross Margin

Gross Margin – Administration and Overhead – Interest = Net Margin (also called Net Profit)

Additional sales volume doesn’t always translate into more net profit. Trading $1 of sales for $0.80 in cost generates cash flow, but it may not generate enough of what you really need — profit.

The real issue is that you need more profit! Yes, adding more customers is one way to get more profit. If getting more customers was simple, though, wouldn’t you already have done so? The real issue is a problem with your business model.

In many cases, the sales volume of the business is acceptable. Sales can’t be easily increased. For instance, a plumbing contractor with an eight-percent market share may be doing pretty well. All the low-hanging fruit has already been picked. Increasing sales means increasing market share from an already respectable eight percent and working to attract ever more difficult customers. This plan may increase sales, but the ever-increasing cost of customer acquisition may outweigh this gain.

Additional sales may not be the best way to increase profits. In fact, the lack of new customers is a less likely cause of the root business model issue than a financial issue, such as:

A cost structure that’s too high for the current sales level

A competitive disadvantage regarding cost (think of Walmart versus a local grocery store)

Total margin that’s simply too low for a viable business model

Cost accounting issues or not properly accounting for margin

For example, many car dealers sell vehicles for “below invoice.” Theoretically, this appears to be selling the vehicle for less than it costs. However, dealers get multiple rebates and kickbacks worth thousands of dollars per vehicle. So what’s the margin per car, $0 or $2,000? It all depends on how you choose to do your cost accounting.

Figure 16-1 shows what raising prices can do for your margins. At a 20-percent margin, a price increase of only two percent allows you to lose nine percent of your business and make the same profit.

Figure 16-1: Impact of pricing on margins.

Perhaps the answer is adding new customers. Sometimes, you want to attract new customers but can’t seem to do so. You try and try, but sales increase only marginally. You continue to press on the sales gas pedal when it’s already floored. The real issue is that your existing sales and marketing system isn’t working, yet you insist on trying to squeeze more sales from it.

To fix the root cause, stop trying to work a flawed sales system. Address the underlying issue. Most likely, it’s one or more of the following:

An undifferentiated or “me-too” product or service. Premium pricing is difficult to command from a “me-too” product or service. For instance, most consumers don’t care what brand of gasoline they purchase because gasoline brands are undifferentiated.

Poor marketing of a good product/service.

An under-leveraged brand.

A sales or marketing effort that’s failing to sell a sellable product or service.

Blindly chasing more sales only exacerbates the real problem. It doesn’t fix it. Generally, one of two fundamental business model issues is at the root of the problem:

You’re not generating enough margin from existing sales.

You have an issue with the salability of your product.

Fix these issues and your “we need to sell more” issue will disappear.

Disguised issue: The need for a 26-hour day

One of the traits I most admire in business owners is their dogged persistence. You are one hard-working group. Many times I hear, “If I only had a 26-hour day . . .” Wouldn’t it be wonderful to be Samantha on Bewitched? Wrinkle your nose and everyone around you freezes while you keep working. Implicit in this wish is the knowledge that your business isn’t performing as well as you know it could. If you only had more time, you could tackle all those big opportunities.

It’s probably safe to assume that you’re the most valuable person at your business and that your time has the highest per-hour value. If your time is the most valuable, the obvious solution is to delegate some of your work to your subordinates. Shoot, why didn’t you think of that before? Oh, you did, but you have no one to delegate to. You have no one to delegate to because you lack the funds to pay someone to do the work. Your solution is to donate your extra time for free to the business.

This issue is so common that I have a name for it — The Big Subsidy. The logic goes something like this: “I don’t have the money to pay someone to do this task, but I’m on salary, so I’ll do it.” The business model can’t support paying the required staff to complete the work, so you jump in and donate your personal time for free. Now you’re trapped doing $12-per-hour work instead of more important tasks.

The solution to the The Big Subsidy is to challenge your business model instead of your work ethic. Why doesn’t the model generate enough margin to pay the $12-per-hour person? Fix the business model issue and you won’t need a 26-hour day.

Ignoring Business Model Issues Only Extends the Pain

In Secrets of the Millionaire Mind (HarperBusiness), author T. Harv Eker points out that if you tend to the roots of the tree, the fruit harvest is bountiful. However, if you tend to the fruits and not the roots, eventually, your harvest will decrease and your tree may die.

The same is true for your business. The profits are the fruits, but the business model is the roots. If you don’t tend to the roots, your problems will not simply go away.

If you insist on tackling the obvious issues instead of their root business model causes, you will suffer unnecessarily. At some point, you’ll need to tackle the root cause(s) regardless of how difficult it may be to do so. Instead of viewing a business model tune-up as daunting, view it as the chance to create a competitive advantage. Be willing to do the work your competitors aren’t willing to do. While they’re sitting on their laurels, you’ll be fine-tuning your business model. Use your knowledge of business model design and innovation to outsmart your competition.

As a consumer, you can spot root business model issues a mile away. If the retail store is dirty or the parking lot is empty, you subconsciously know that the problem isn’t the parking lot; there’s a business model issue. Spotting problems with your own business, however, is much more difficult. Take heed when any issue arises, and if need be, make sure you dig all the way to the root to fix it.

Considering the Consequences of Not Adapting

In order to keep your business model working at its best, you need to innovate, adapt, and be flexible. Building a business isn’t like building a house. When you build a house, you get to cut the ribbon on the front porch when you’re done. Building a business model is more like building a sandcastle. You finish and then the tide comes in and knocks some or all of it down. The issue is how fast the tide comes in — not whether it comes in.

Your job as a savvy businessperson is to understand the tides and proactively move your sandcastle where the tide won’t destroy it.

Your model is eroding, but how fast?

All business models erode — some fast, some slow. How quickly your business model erodes depends on a variety of factors:

Use of technology in the industry: Technology tends to cause disruption and create competitive advantage. If the industry has a general propensity to leverage technology, count on your business model eroding faster.

Competitive intensity: Fiercely competitive industries are always scratching and clawing for a better, faster, or cheaper way to do business. Many of these turn into business model innovations and work to erode yours.

Economic factors: A good economy may either slow down or speed up the erosion of your business model. For instance, a strong economy spurred massive investment in Internet-related businesses, causing excessive competition and eroding otherwise good business models. A good economy made the entire construction industry fat and happy and lessened competition. The same can hold true for a bad economy. A bad economy may cut risk-taking and extend the life of your business model, or it can cause competitors to deploy unused resources toward innovation.

Convergence of industries: The digital camera business isn’t being eroded by a better digital camera or an innovation. It’s being eroded by cellphones. The two businesses are converging, and cellphones are eroding the digital camera market significantly.

Industry attractiveness: High profile investments in Facebook had many venture capitalists, technology entrepreneurs, and well-established companies looking for new business models in social media. A highly attractive market created a highly competitive market.

Barriers to entry: Industries that require hard-to-find skills, large sums of capital, or other barriers to entry can expect their business models to erode more slowly than others.

Dependence on trends: A business model dependent on trends will usually erode faster than others. That doesn’t mean a trend-dependent business model is a bad one. Companies like Ralph Lauren, Chanel, and Tiffany’s have successfully navigated fashion trends for decades.

Availability of information: One of the huge advantages early social media companies like Facebook had was the dearth of data available for competitive analysis. The industry was so new that no meaningful data existed. Lack of information causes uncertainty. Uncertainty raises risk. Increased risk lowers the entrance of competitors and makes the business model last longer.

Stodginess of industry: Banks have a reputation for stodginess; marketing agencies have a reputation for the opposite. If your industry operates like bankers, expect business model changes to come more slowly.

Risk aversion of industry: Large pharmaceutical companies spend hundreds of millions of dollars every year trying, and sometimes failing, to develop new drugs. You can assume large pharmaceutical companies aren’t risk averse. Insurance companies employ armies of actuaries to assess and avoid risk and have entire departments dedicated to risk avoidance. You can assume insurance companies are somewhat risk averse. If your industry is full of insurance companies, your business model will erode more slowly than if it’s full of pharmaceutical companies.

Change always seems risky

Change stinks. You toil away for years building a great business model and a great business, and then change comes along and messes with it. In business models, the devil you know always seems better than the devil you don’t know.

Eventually you will need to change your business model. It’s not a question of if; it’s a question of when. So the hundred-thousand-dollar question isn’t “Should I change?” The question should be, “Is it riskier to change now versus later?” Generally, it’s less risky to change too soon than too late even though it doesn’t feel that way.

After World War II, a devastated Japan was looking to rebuild its industrial base. Clamoring for any edge, Japanese manufacturers turned to W. Edwards Deming’s statistical quality control methodologies. For years, Deming tried to convince U.S. manufacturers to adopt his process to no avail.

The Japanese used Deming’s techniques to create radically superior manufacturing processes, which resulted in higher-quality products produced at a lower cost. Large American manufacturers were profitable and growing, so the addition of Deming’s process was an annoyance.

In the early 1980s, Ford dealers discovered that among models with U.S.-made and Japanese-made transmissions, customers requested models with the Japanese-made transmissions much more often. Customers were even willing to wait for long periods to avoid the U.S.-made version. After record losses in 1981, Ford called upon Deming to bring his practices to Ford. While U.S. automakers were languishing, Japanese automakers were flourishing due to lower costs and higher quality production.

This example may seem old, but U.S. automakers are still paying the price for their slow adaptation. U.S. automakers viewed change as dangerous because their existing business model was quite profitable. Their unwillingness to change resulted in a 30-year head start for the Japanese. When weighing risk, make sure to account for competitors who are willing to take the risk you aren’t.

Not changing may be worse

An inherent part of human nature views change as risky or bad. Famed psychologist Abraham Maslow theorized that one of a human being’s core needs was safety. Maslow also stated that higher-level needs, like belonging or self-esteem, were impossible to achieve without an individual’s safety needs being met. Figure 16-2 shows Maslow’s Hierarchy of Needs. I have to believe this hierarchy affects the behavior of businesspeople — safety good, risk bad. In other words, change is bad, no change is good.

Figure 16-2: Abraham Maslow’s Hierarchy of Needs.

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In business, situations are fluid, not static. Safety today may be risk tomorrow. Risks taken aren’t permanent. If you make a significant change to your business model and get evidence it’s a bad idea, you can adjust. Business models are molded out of clay, not chiseled out of marble.