THE STORY
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:
- Underinvesting in the business model;
- Ruining the Balance Sheet;
- Short-term gains which ruin long-term prospects;
- 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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