Wednesday, March 27, 2013

Strategic Planning Analogy #494: The 3 Keys to Success (Part 1)

When I was a young boy, I owned a Piggy Bank. It had two holes. The first hole was a slot at the top, used to put money INTO the piggy bank. The second hole was on the bottom. It was used to take money OUT OF the piggy bank.

My problem was that I tried to take money out of the bottom of the piggy bank more often than I put money into the top of the piggy bank. As a result, my piggy bank was almost always empty. That made it a fairly worthless bank.

Businesses are a lot like that piggy bank. Money comes into the business through sales.  It is like putting money into the piggy bank’s top slot. Money is taken out of the business through events like salaries, profit sharing and dividends. That is like taking money out of the bottom of the piggy bank.

If you take money out of the business faster than you put it in, the result is similar to my empty piggy bank. It becomes worthless.

Most traditional small entrepreneurs I’ve met get this principle. They put a major emphasis on cash flow, to make sure that money coming in the top slot exceeds money going out the bottom hole. They realize that if the money is not coming in the top, there will be no money for them to buy groceries to eat. 

This principle, however, seems to get lost in a lot of modern digital/social businesses and large enterprises. The connection between inflows and outflows becomes less obvious. After all, there are digital/social businesses out there valued at huge sums of money (and making their owners rich) which have little or no source of income coming into the top slot.

Without strategic concern for both holes, the business (piggy bank) eventually becomes empty and worthless.  This is why you ended up with the bubble bursting on the original dotcom boom and many stock market disappointments in the current digital/social boom. The private equity contributors to the piggy bank eventually want to get their money back out. But since more money was coming out the bottom than was going in the top, there was not enough to satisfy everyone.

In this blog (and the next two), I will be talking about the keys to real success in business. I’ve spent a lifetime in the business world and have witnessed first hand (and second hand) a large number of successes and failures. 

Based on what I have seen, it appears to me that there are three key differences between the big winners and big losers. So in this and the next two blogs, I will be looking at these three characteristics which differentiate the winners from the losers. 

Passion for the Business Model
The first characteristic has to do with passion—that which captures the attention and focus of the leaders (and their followers). In the losing companies, the passion and focus tends to be on wealth.  The focus is on profits or personal wealth—making them as large and as quick as possible. By contrast, the passion of the successful firms tend to focus on the business model. The focus is on making the model ever better at serving the customer.

Does this mean that profits are bad? Is it wrong to want your business to have larger profits? Of course not. But if you are more passionate about profits than the business model, then you are like me when I kept taking money out of the bottom of my piggy bank without putting money in the top. Eventually, the model falls apart and the business becomes a worthless empty shell.

If you ignore the business model, then the only way to keep taking money out of the bottom is by “financial engineering.”  This is essentially the idea of putting other people’s money in the top so that you can keep on taking out money from the bottom. As a child, that financial engineering would be to convince my father to loan me some money beyond my allowance, so that I could keep on taking out money beyond what I earned. In the business world, this consists of taking on extra debt or equity, either private equity or public equity. 

The problem is that these types of contributions to the piggy bank come with strings attached.  These contributors also want a turn at taking more money out of the bottom of the bank than what they put in the top. And, as it turns out, it is impossible for all of you to take out more from the bottom than you put in the top if the business model is not sufficiently multiplying the money.

By contrast, if you have a passion for the business model, you will be always looking for ways to improve the way the business fulfills its position in the marketplace. This leads to efficiencies (a less expensive way to serve) and effectiveness (a more valuable service for customers). This makes the money in the piggy bank grow by getting satisfied customers to contribute to your success in ever more profitable ways.

Hence, the irony. If you want a lot of profits, don’t focus on profits; focus on the business model.  Focusing alone on profits can lead to bad behaviors, such as:

  1. Underinvesting in the business model;
  2. Ruining the Balance Sheet;
  3. Short-term gains which ruin long-term prospects;
  4. Ruining the relative value for the customers (as you give more value to yourself than to your customer)

These actions all cripple your ability take money out of the bottom of the bank over the long haul.  However, if the passion is about improving the business model, the profits will be there for years to come and the piggy bank will never be empty.

Example #1 Euro Zone
Just look at the economic challenges in Europe.  Rather than a passion for building a solid business model for a continental economy, the Euro Zone has been plagued by governments and citizens who keep taking more out of the bottom of the piggy bank than is put in.  To fund this passion of taking money out, the governments took too much of other people’s money in the form of debt. Now the piggy bank has nothing but debts that cannot be paid. And the governments seem unwilling to make the tough choices on how to fix the broken business model.

The exception is Germany.  And guess what—the Germans have focused for decades on building a solid economic business model. This business model passion means that more is going into the piggy bank than is coming out. Germany is solid

Example #2: Formica
Awhile back, I was in discussions with the top executives of Formica about doing some consulting.  They explained to me the history of the company. Decades ago, Formica had been a strong brand with great profits. They essentially owned the countertop industry. 

But then, Formica was bought by people whose passion was profits. They started taking more out of the bottom than was coming in at the top. This caused two problems. First, the countertop marketplace was changing and they underinvested to meet the challenge of the change. This hurt the status quo business model, weakening the ability of Formica to fund obligations. Second, taking too much out of the bottom required loading up the balance sheet with debt, thereby increasing obligations. Eventually, since they couldn’t make ends meet, they sold the company to others.

The “others” also had a passion for profits and continued these practices. In due time, they sold the business, too. After several iterations of this process, Formica had been so weakened, that it had become an empty shell full of IOUs that could not be paid.

Eventually, Formica ended up in the hands of Fletcher Building of New Zealand. This was a company which had a passion for the building materials business. They focused on the business models within the industry they loved. As a result of their passion for the business model, they are bringing back Formica from the dead.

Example #3: Amazon
Recently, I had discussions with some executives at Amazon. In my discussions with them, they never really talked about profits. Their talking pointed to their passion for the Amazon business model. All they wanted to do was improve that model by making it faster, easier and cheaper for customers to interact with Amazon.

As a result, the Amazon business model keeps getting better and better. This is increasing their competitive advantage in the marketplace. Yes, the near-term profits have recently suffered a bit, but that was because of extra investments in the business model, not a failure to win in the marketplace. Amazon is on strong, solid footing. It survived the dot com bust and the digital/social slump. And it has the big box stores around the world panicking as they continually lose share to Amazon. Founder Jeff Bezos was the 2012 Fortune Businessperson of the Year. This is a company built for long-term success.

Long-term winners tend to have characteristics that are different from long-term losers. One of those characteristics has to do with where the passion lies. The losers tend to have a narrow passion focused around rapid personal wealth-building. This usually leads to bad behaviors which choke the prospects for long-term business success. They prematurely empty out the piggy bank.

The winners, by contrast, tend to have a passion for the business and its business model. They are more concerned with improving how the business works in the marketplace than how much they can pull out of the business for themselves. They get interested in all the little details about how to make the business better. They build piggy banks which are full for a long, long time.

Now that I am grown up, I have an electric bank which sorts coins and puts them into the appropriate paper rolls.  And when the rolls get full, I take them to the bank rather than spend it right away. That is the better path for the long term. Is your corporate culture promoting actions like what I did with my boyhood bank or my adult bank?

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