DrPhilGreenwood's Wisconsin Business Blog: Growth Strategies for Small Business

A Fund Raising Strategy

2012-01-17T09:18:00.000-08:00

Mark Suster, a venture capitalist/entrepreneur maintains one of the most popular blogs on VC investing. His most recent post provides an effective strategy for entrepreneurs in developing his/her own fund raising strategy http://www.bothsidesofthetable.com/2012/01/16/how-to-develop-your-fund-raising-strategy/.

In Wisconsin and much of the Midwest, we don't have access to the venture capital that one can find in Boston, the Bay Area, San Diego, and Austin, Texas. However, it's valuable to realize that the investing philosophy of Venture Capitalists doesn't differ from the more traditional investors the we find here in the Midwest - lenders and angel investors. Regardless of the type of investor, they are looking for great opportunities with market potential, solid teams, etc. but only differ based on the degree of the risk and reward.

Critical to entrepreneurs is that they understand the fit of their business to the risk/reward profile of different categories of investors. In general, less than 1% of new ventures ever receive financing from traditional institutional funds like venture capital. There are many reasons for this. A larger venture capital fund typically targets a fund internal rate of return of 25% per year or more for their limited partners. That fund, with a limited life of 10 years or so, will typically invest in ten or more companies. Historically, venture capital funds will see a few great investments that will generate a 5X-10X or higher return on the original investment but also see several investments where they might lose all their money. The remainder will return part or all of their principal without a much incremental profits above the capital investment.

Why is this important to understand? A few reasons. First, most VC firms will have a minimal investment they will make in a new venture. It just isn't worth their time to try to manage a small investment with the limited personnel most of the firms have. Second, and this is related to first point, the firms must make multi-million dollar investments in single firms. If they need an investment that will generate a return of 5X or 10X their invested capital, they need a high potential venture to do this. An example illustrates this.

Assume that XYVC investment firm makes a $5 Million investment in Firm Z. In five years, XYVC will desire a liquidity event that will generate a 10X increase or $50 million value. Assuming that the investment firm doesn't own all or a majority of the firm, Firm Z will have to have some extreme growth potential. If XYVC owns 10% of the firm at exit, the company will have to have an total equity value of $500Million or more. At that equity value, assuming a P/E ratio of 10, the firm will need to be at the $50 million level of net profits in only its fifth year of existence. Not many new ventures can meet these needs.

It's critical for new ventures when raising money to understand the investment criteria used by high risk/high reward investors. Doing so will save them a lot of time and effort.

The Entrepreneurial Plunge? Should you?

2012-01-12T10:25:00.001-08:00

The economy is beginning to pick up steam and I'm sensing, based on anecdotal conversations with business people, that many folks are getting the entrepreneurial bug. Either they've been out of work and are tired of the job hunting situation or they've been in the same job too long working long hours without any growth prospects. When discussing the prospects of a new venture, before even getting to the crucial elements such as market opportunity, financing, strategies, etc. I try to ask the prospective entrepreneur several questions about the realities of a startup to make sure they have a clear understanding of what they are undertaking and some critical elements that may assist the chance for success. Here's the list:

1. "Does your idea expand on your current knowledge base, experience, and/or skill set, or, is it totally different from what you've done before?". Before even getting to the feasibility of the idea, lots of descriptive research (e.g, backgrounds of INC Magazine 500 founders) shows a correlation between starting a business that you have experience in and the long-term growth of the firm. This makes sense - if an entrepreneur is starting a venture in an industry that they have experience, they will be well-along the learning curve and understand the nuances that the venture will have (customers, industry characteristics, etc.).

2. "Can you see yourself 'loving' what you do in the new venture?", and "Do you feel passionate about the venture idea?". In #1, you try to look for building on the existing experience base. These questions address how will the entrepreneur deal with the first adversity in that he or she faces as they start the venture? It's always inevitable that adversity will arise - key employees will quit, financing doesn't come through when expected, that customer who was so optimistic cools, etc. When facing major issues will the entrepreneur persevere? Critical to know up front.

3. "What's the absolute worst thing that can happen if you make the leap and start this venture?". Such a question gets the entrepreneur to think about the worst-case and if it occurs, what could be the impact on his/her financial, professional, and personal life? Are they willing to deal with the consequences if it occurs (losing a house, not spending as much time with family and friends)?

4. "Have you evaluated what you're good at?" and "What you are bad at?". Knowing your strengths and weaknesses will be critical to understand how your position and life should evolve over the startup's life. Experience typically shows that if an entrepreneur is self-aware of these characteristics it will guide them to identify when they need help and their long-term position with the firm. Also, we typically are happier when we work on things that we're good at. Sales and marketing people usually despise doing accounting for their business. People with accounting backgrounds usually don't like the marketing aspect.

Note, none of these questions get to the business model, financials or any other critical business elements to the plan. They are simply questions that I've found helpful for entrepreneurs to be aware of before making the plunge. Sometimes, it is best not to quit your day job.

Venture Capital for 2012

2011-12-15T05:16:00.000-08:00

The Wall Street Journal and National Venture Capital Association conducted the annual survey of Venture Capitalists for 2012. There are some interesting highlights from the survey but one that seems to standout is the continued decline in the number of venture funds and the high risk aversion that limited partners are facing based on the economy and markets.

At the same time as fund availability is declining, we're hearing a lot of news about the new startups in social media and other web-based areas. Typically, this is a tell-tale sign that valuations will be under pressure as the supply of funds will not be there for the greater demand from entrepreneurs. In the past couple of years, angels and angel networks have helped fill that void in the early stage investing game. The big question going forward is will the angels still fill this need or will they, too, begin to pull back from the risky environment and/or not having the dry powder of the past.

The Debt Crisis and Ceiling

2011-07-18T06:02:00.000-07:00

The actual raising of the debt ceiling is not so important but the inability of our federal government to address the issues is beginning to spook the markets. If S&P or Moody's were to lower the USA debt rating to AA instead of AAA, the congressional folks don't seem to understand the implications.

1. Many country sovereign funds have a mandate to invest in risk-free assets, AAA bonds. If we lose that rating they will have to shift investments to other countries or markets.

2. Many pension funds, insurance companies and mutual funds allocate a percentage of their investments to AAA rated stuff. This is part of their charter - they must put X% of their overall investment portfolio in safe investments. If downgraded, they would have to re-invest elsewhere.

3. Money market funds (low risk, short-term) put billions into short-term US Treasuries, they would have to re-evaluate.

4. In order to attract investors in US treasuries, the Treasury department will be forced to increase rates on bonds and notes. The interest costs to government will affect the deficit.

5. Mortgage rates are set based on what the US T-Bond rates are. If T-bond rates, this will increase mortgage rates, loan rates to companies, etc. A ripple effect that will be felt throughout the US economy as it continues to struggle to recover.

6. Finally, the US dollar will weaken even more. The US Government will probably print more dollars to 'monetize' the new debt that costs more thus creating a weak dollar for the world. This increases import prices (oil, etc.) and pushes the dollar away from being 'the reserve currency'. WE don't want this.

Talk me off the ledge, please. But not settling this debt crisis in a timely fashion without some long-term plan will potentially have terrible effects over the next years and decades. More important, it's a sign that our leadership in Washington can't lead, even in times near crisis. This is for all our leadership - regardless of party affiliation. Very sad for this country.

Skype and Stock Options

2011-06-26T13:01:00.000-07:00

Techcrunch and other news sources (link) are reporting about how Skype has cut short the stock options of some of its employees prior to the Microsoft acquisition.

A key point with any stock option for employees - read the fine print of the option plan. Look for these things:

1. What happens in event of change of control?
2. What defines change of control?
3. Vesting - does it accelerate or not?
4. What defines 'termination without cause'?

While how Skype is treating the employees by not letting them have all their options or buying them back at what ever the exercise price is, this is their right under the contract signed. Always, always read the option agreement and get good legal advice as to what happens under certain conditions.

Economic Slowdown? Why?

2011-06-03T10:44:00.000-07:00

First, I'm a little hesitant to join the 'ledge dwellers' that are announcing that a double dip is coming after hearing all negative economic information this past week and month. The Japan tsunami, floods, higher gas prices and other events have definitely had an impact but we won't know how much until later this year.

More puzzling to me is why the economy hasn't 'taken off' like so many other recoveries especially as related to hiring? Granted there is an enormous amount of debt still possessed by consumers and government but most businesses are having banner years in generating cash flow. Recent anecdotal discussion with a former colleague at an industrial supplier noted that things look strong.

Having been in companies doing long range planning , I have a hunch about the slowness in hiring. Companies are finally digesting the new health care reform and other regulations (e.g., Dodd-Frank) incorporating the costs and benefits into their long-term financial models. Their models may be telling them that labor costs per employee are going to increase dramatically. As a result, they may be holding down their hiring because they see that the incremental cost of bringing on that employee and keeping them will have a negative impact on long-term financial performance.

Companies are funny - they'll look at what the future costs may be and keep the work force levels low having existing workers handle higher demand through overtime instead of hiring new personnel. The companies may be seeing that if they hire new workers, the increased costs for each new worker due to health care is way too high.

LinkedIn IPO - Bubblesville, here we come?

2011-05-20T07:42:00.000-07:00

The IPO of LinkedIn brings back many memories for the DotCom bubble of the late 1990s when Internet startups were going public based 'Price times Eyeballs' or 'Price times Clicks' valuation multiples. We all know how that story played out. Should we be worried about the same outcome for LinkedIn? In short, 'no' but a cautionary 'no'.

LinkedIn has a viable business model that has real paying customers that generates a large revenue base and even profits for LinkedIn. This is good. Also, LinkedIn is tied to the corporate customer which is a more reliable long-term payer.

With that said, I get real worried about how contrived this valuation at IPO was done. The company, investors and investment bankers sold a small piece of the company (less than 8% per the Wall Street Journal) to an investor base hungry for new issues. This simply becomes a supply and demand issue - few shares offered to many investors creates an investment frenzy that drives the stock price to abnormal levels. This is great for the holders of existing shares, pre-IPO and great for the company in that it is able to raise an incredible amount of capital. But anybody who bought at the IPO or shortly thereafter will probably see a steep decline in the not too distant future. For investors that bought the stock on the private market like SecondMarket (latest price $35/share there, pre-IPO) may see the shares decline in future rounds.

So, what will probably happen? Pre-IPO shareholders will sell their stock after their lockout period is done (six months or longer). Employees, venture capital groups like Bessemer and Sequoia, etc. will do well. Second, LinkedIn will go on a buying binge of smaller, mobile app startups and other existing companies that will be nice add-ons to the LinkedIn platform using their overinflated stock price to purchase the companies. Finally, we'll now see a frenzy of IPO floats of the other social media companies - Zynga, Groupon, FACEBOOK, and so on. The high valuations for LinkedIn will serve as a justification for high values of these companies and IPO market will sizzle for the next several quarters. The next California Gold Rush will be on. At least these companies have revenues and even some profits.

As an investor who doesn't have access to these companies pre-IPO, hold back and observe. There will be a point in time when the prices of these stocks drop to an affordable level. Assuming the companies can sustain, that will be the buying opportunity.

Oil Prices and GDP Growth - the impact

2011-04-27T05:51:00.000-07:00

It seems every time that oil prices hit the $100-$120/barrel price the US appears headed towards a recession or at least slow economic growth. A paper by an economist at Eastern Carolina University examined the correlation between oil prices and US GDP growth as well as can Oil prices serve as a potential predictor of GDP growth/decline. There appears to be some support, which of course makes sense when oil hits certain levels.

From a business standpoint, what course of action at a macroeconomic view might have an impact on oil prices? The paper cites other studies and notes the role of a weak US Dollar and low interest rates. One of the suggestions or assertions is that low interest rates, while influencing a weak dollar, also have another important influence. Suppliers and distributors of oil may have little economic incentive to place the oil on the market since their holding costs (i.e., interest rates) are so low.

What might this suggest as to the price of oil? If the Federal Reserve were to allow interest rates to increase, there might be an even bigger impact on oil prices than many believe. If rates were to increase, we would probably see the US dollar rally having a strong impact on oil prices (i.e., lower prices). Additionally, if oil suppliers were to see their interest costs for holding oil increase, they may have an incentive to place inventory for sale on the international market. Such a two-fold impact could see a dramatic decline in the price of oil that would possibly have a very positive impact on GDP.

As with any actions, letting rates rise has its downsides (higher borrowing costs for all) and could dramatically impact our banking system as it recovers. However, the potential benefit from lower prices in the short-term could do wonders for consumer and investor psychology.

The Founder/CEO Model in Entrepreneurial Firms

2011-03-01T06:22:00.001-08:00

Bloomberg TV initiated a new show on Monday,Feb. 28, 2011, called 'Bloomberg West' with a focus on technology especially in Silicon Valley. Their first guest, Marc Andreesen, one of the founders of Netscape and now VC investor, discussed a variety of technology and investment issues. One issue he spent a good deal of time on was investing in firms that followed the 'Founder/CEO' Model of leadership.

In summary, Andreesen cited that his investment firm seeks technology companies where he believes the founder can also evolve into the long-term CEO. Citing founders/companies such as Bezos/Amazon, Jobs/Apple, Gates/Microsoft, Page and Brin/Google, Dell/Dell Computers, and Zuckerberg/Facebook as powerful examples for this model, Andreesen believes that long-term success is related to the original technology founder making the transition to the CEO/Manager.

While the cases discussed provide powerful support for such a model, one must be very careful to avoid the Halo Effect when trying to relate a firm's success to certain variables. The Halo Effect is a cognitive bias whereby the perception of one trait (i.e. a characteristic of a person or object) is influenced by the perception of another trait (or several traits) of that person or object. Phil Rosenzweig, PhD, a professor at IMD in Switzerland and author of The Halo Effect and the Eight other Business Delusions that Deceive", warns business leaders and researchers of mistaking causality for correlation. While one can probably find many successful technology companies where the Founder leads the company as the CEO through various stages, there are many examples of the opposite, where the Founder must be removed to bring in a Professional Manager as CEO.

Personally, I can understand Andreesen's principle about the Founder/CEO. Building and maintaining the organizational culture is an important component for an early stage company through maturity. However, many times trying to maintain the culture can 'strait jacket' a company not allowing it to adapt or change with the times. Flexibility and adaptability is the key as one size does not fit all startups.

Legal Advice for Startups

2011-02-17T06:25:00.000-08:00

In our class, MHR 722 - Entrepreneurial Management, we recently covered legal issues for startups and small firms. The course is a graduate level class is geared towards discussing a broad range of topics for entrepreneurial firms across all stages of the firm - legal, finance, marketing, management, etc. In the class yesterday, we focused mostly on a case study where two employees at different high tech firms create a new company based on the idea of one of the employees. The case examines what the employees did at the current employers and the risks they face with confidentiality agreement, non-compete agreements and invention disclosure issues.

In general, entrepreneurs face the major problem of wanting to seek legal advice but facing the high relative cost of that advice. For instance, it's not unusual for attorney's to charge anywhere from $200/hour to $500/hour for advice on company formation, intellectual property, or other important agreements for the firm. In wanting to save money, entrepreneurs may simply ignore dealing with such legal topics, do it themselves, or try to get by on the cheap.

As we discussed in the class, the short-term savings can lead to long-term costs. Failure to have a good attorney involved with key legal issues for a firm may lead to major future problems. For instance, one consultant in town developed a consulting agreement that was downloaded from one of the many legal websites now on the Interweb. The consultant tweaked the agreement a little changing names and dates but for the most part left in tact. When one client refused to pay for services rendered, the consultant ultimately sought legal advice as to how to collect the multi-thousand dollar bill from the client. In short order, the lawyer reviewed the consultant agreement and noted that the agreement did not state that in any legal action, even in small claims court, legal expenses could be re-couped. In other words, the consultant would have to invest a good deal of money to seek a case against the client with, even if the consultant won, would probably only break even after settling with the client but having to pay his/her own legal costs.

The advice for entrepreneurs thinking of starting, starting or running a startup - seek out legal advice early, make the choice of a lawyer one of the first things you'll do, especially if you plan to enter into agreements with stakeholders such as customers, shareholders, and employees. Take your time, seek out at least three different firms, interview them and make sure that the law firm you choose best meets your need. Also, definitely use the referral network from trusted other entrepreneurs. Finally, make sure that as you choose a lawyer you know who actually will be working on your legal issues. In the end, spending some money, even in the thousands of dollars up front will save major hassle and money later on.

Small Business - Improve Your Cash Flows - Mobile Payments is one way

2011-02-01T08:14:00.000-08:00

The new wave of mobile payments technologies and processes is on its way. Square, presided over by Jack Dorsey of Twitter-fame, was featured in the latest issue of Fortune magazine. Also, an entry by blogger Paul Zimbrado, part of Seeking Alpha,discusses the new Apple Iphone 5 Wave and Pay technology that will be introduced. Also, Android's Nexus has a similar technology.

For the small business owner, this creates even more opportunities to promote seamless and secure transactions for consumers. Either technology will take care of the payment process further eliminating the need for cash transactions. Still, be forewarned that there will be the fee attached to whatever process is used. Business owners will again have to weigh the benefits of faster payments and better security versus the transaction costs (depending on the technology, some will simply use existing credit cards - usually 2-4% of sale, where Square will charge 2%, according to the Fortune article). The ultimate goal and hope for such new processes, increased sales for the business.

Google vs. Facebook

2011-01-21T07:51:00.000-08:00

Eric Schmidt moving aside for Larry Page to take over at Google as CEO. It seems like not too long ago Google was thought of as the Innovation Organization that could do little wrong, how things change in today's world. It appears that Facebook now has that title. The press is going wild over this but it really comes down to several key issues:

1. It's all about face time, where the consumer is spending time. Facebook is beginning to dominate this and as Facebook makes acquisitions and develops its own technologies, it will begin taking revenue from Google. Google gets 90+% of revenue from Search Advertising and Marketing. It hasn't diversified its revenue base much so it is at extreme risk. Android and mobile will continue to be important as a revenue generator for Google.

2. Google has had mixed results in its acquisitions and attempts to compete head-on with Facebook. Orkut was one attempt at social networking but has gone no where. Key for Google is to get back to innovating in-house to meet these challenges.

3. Google and China - the whole China episode was at odds with Google's Philosophy of open info - they compromised and it appears that it didn't sit well with Page and Brin.

This is an interesting battle - we shall see how it plays out.

The Sale of another Wisconsin Firm

2010-12-17T14:15:00.000-08:00

It was reported today, December 17, 2010, that M&I Bank, Headquartered in Milwaukee, Wisconsin, was sold to the Bank of Montreal. This is another case of a corporation headquartered in Wisconsin that will now become a division of a larger, non-Wisconsin- based entity. The question has to arise - is this good or bad for the State of Wisconsin and Milwaukee, particular?

First, any acquisition can create wealth for the shareholders of the target company. In M&I's case, many employees, retirees, and other local state residents are or were shareholders. Second, and probably the most important benefit of such a purchase, is that the Wisconsin economy will now have a healthier bank for consumers to transact at. Bank of Montreal, like most of the large Canadian banks, remained relatively healthy during and after the recent recession. M&I, from most reports, had many poor performing real estate loans in Wisconsin, Arizona, and Florida. To rectify this, M&I most likely would have to divest itself of some strategic assets and/or raise large amounts of external capital. The former hurting the long-term value of the firm, the latter diluting the patient shareholders even more.

On the flip side, there are several downsides. First, the potential reduction in jobs, especially duplicitous administrative positions (e.g., two corporate benefits departments) that will ultimately be restructured at the local level of the target. Second, the impact on corporate philanthropy at the local level as the local headquarters is lost. Finally, the psyche of the town. Milwaukee has lost numerous corporate citizens of the past thirty years - Allis Chalmers, Firstar Bank, the breweries, etc. - to acquisitions or simply firms going out of business.

In the long run, this is the nature of dynamic capitalism, the weak don't survive but either get bought or simply terminate. It's in the local city, county, and state's best interests to develop long-term strategies that encourage new ventures and industries as well as keep existing companies strong. It's also in the interest of the companies to continually evaluate the strength of their management teams, their long-term strategies and how the world is changing around them.

Bi-Flation - the new economic buzzword?

2010-11-04T05:43:00.000-07:00

There is a new term among us, bi-flation, that is becoming used more often in the media. Inflation of commodity prices/equities (stocks, gold, oil), deflation of debt-based assets (house loans, company borrowings for assets). Not sure this is a new phenomena but an interesting term, nonetheless.

In the 1970s we experienced a decade stagflation. Oil prices increasing four-fold and more, gold jumping from $34 (or so) an ounce to $800/ounce. Correspondingly, no employment growth, wages growing rapidly to meet the rising living costs (remember COLAs in labor contracts). This created a very difficult period to operate in.

For bi-flation, businesses with a cost structure that is heavily influenced by the cost of commodities for their inventory, building/material, or transportation costs, their challenge will be to pass along their higher costs in the form of price increases. As long as the economy remains weak, this will be difficult. So, they'll be forced to continue to take costs out of other components of their operation - labor, service, etc.

For service businesses, bi-flation may have less an impact (unless there is a heavy transportation component). Instead, they should be able to maintain control of their labor costs due to the excess labor supply at almost 10% unemployment.

The major concern will be continued pressure on the consumer. Facing higher energy costs, continued stress on employment, etc., they will still hold back on major discretionary purchases. Demand at the macroeconomic level will remain weak with minor growth.

Currency wars and impact on small biz

2010-10-20T07:48:00.000-07:00

Every country in the world wants to lower the currency exchange rates in order to increase exports. A couple of questions come to mind. First, can every single country try to depress their currency at the same time? Heck no, somebody has to be the offset of this and it appears it may be China and possibly some of the other well-performing countries during this recession. If a currency rate war starts, that's just one more issue to face in trying to face down this slump.

More importantly to the small business owner, what does this mean to their business? Well, as usual, it depends on the industry, type of business and the composition of your customer base. If the business is a manufacturer or a supplier to a larger customer who exports to Asia, Europe, and other regions, there's a chance that a lower dollar will have a positive impact on revenues as the relative prices of your goods will decrease in relation to those regions with stable or increase currency rates.

If you're an importer, the opposite is true and this could possibly put more pressure on the cost structure of your business and the relative price of goods you bring into the country will increase.

Even if your business does no international business, you still may be affected. Lower dollars typically mean higher commodity prices such as oil. This will affect transportation costs and affect the relative purchase power of your customer's discretionary income (i.e., less of it).

The currency stuff, even though it seems far off and too nebulous to follow, you must follow it. It impacts everyone, even in flyover country.

Inflation - is it here?

2010-10-01T14:06:00.000-07:00

Boy, ask senior citizens if they feel any inflation pressures and you'll get a resounding 'yes'. However, do we have to worry about inflation, at least in the near term? Yes and no. Commodity prices have been heading higher from what appears to be due to demand from China and other emerging countries. For folks in the US, this affects us in the gasoline we buy and any other products where raw materials comprised of such commodities. For companies, the same - their input costs for raw materials are increasing dramatically and will put pressure on their bottom-lines unless the costs can be passed along in the form of higher prices.

However, 80% or more of our GDP is comprised of service firms. Yes, they purchase items like computers, buildings, and such for work in their business but as a percent of their total operating costs, commodity cost increases will not have as much effect. They will not begin to worry until labor costs begin to increase. I believe that labor costs comprise upwards of 70% or more of total operating costs for organizations in the US. Until we see pressure on salaries, wages, and benefits, inflation will not be an overall risk to our economy. With 10% unemployment and high underemployment, the excess labor capacity will take some time to lessen. Until that happens, inflation at a macro level will remain in check.

I assume the next 12 to 18 months will remain this way, at least till the Presidential election year. Once we begin to see dramatic gains in employment and increasing consumer demand, the inflation word will creep back into our vocabulary en masse.

Financial Metrics -Part 3: The Net Balance Position

2010-08-23T16:04:00.000-07:00

The final metric to be discussed in predicting or evaluating financial distress of entrepreneurial firms is the Net Balance Position (NBP). In many small companies, traditional ratios such as the Current Ratio (i.e., Current Assets/Current Liabilities) or the Quick Ratio (i.e., Current Assets excluding Inventory / Current Liabilities) ignore the realization that many times small businesses are 'resource-constrained' and unable to obtain traditional external financing in the form of debt or equity to finance their asset-base. Thus, the small businesses rely on extending their current liabilities to finance both working and long-term assets. Many highly successful small businesses possess 'awful' Current or Quick Ratios providing misleading information on the true capital condition of the firm.

Originally introduced in the Journal of Commercial Bank Lending (Miller, 1987, P. 45-61), the Net Balance Position was adapted and revised by Emeritus Professor Bob Pricer at the University of Wisconsin - Madison School of Business. At UW-Madison, Professor Pricer presented the NBP concept to numerous undergrad students, grad students, and business owners/managers over a couple of decades. In Pricer, et al., published a study in the Journal of Applied Business Economics applying NBP vs. numerous other financial models in predicting loan performance.

Conceptually, NBP is a non-traditional method for estimating the cash liquidity of a business over an operating period. In the loan study, if NBP was zero or positive, the loan was predicted to be performing, and if NBP was negative, the loan was predicted to be non-performing. It was calculated as follows:

Step 1= Add Long-Term Debt and Owner’s Equity
Step 2 = Subtract Net Fixed Assets, equals Working Capital Available
Step 3 = Add Average Accounts Receivable and Average Inventory
Step 4 = Subtract Non-Interest-Bearing Spontaneous Current Liabilities from Step 3, equals Working Capital Required
Step 5 = Subtract calculated value from Step 4, Working Capital Required from Step 2 value, Working Capital Available, and this equals NBP (Net Balance Position)

(Note: Non-Interest Bearing Spontaneous Current Liabilities are considered a category of debt entered on the liabilities side of a balance sheet under current liabilities that represent a sum of money that the company owes and must pay within one year, it does not require interest payments. Examples would be Accounts Payable, Accrued Wages, Income Taxes Payable, etc.)

The NBP calculation overcomes some of the weaknesses of the Current and Quick Ratio. By including both current and non-current items, it recognizes that small businesses use the entire capital structure (both long-term and short-term) to fund their operations. Secondly, NBP is an operational metric that provides management with an easy-to-understand process about how to improve their liquidity position. For instance, a manager can easily identify that by reducing accounts receivable or inventory, this will lead to an improvement in NBP. Finally, NBP is easily forecast-able. In other words, as long as the organization can forecast its income statement, the amount of profits retained in the business and related balance sheet components, they easily identify if any shortfalls in liquidity will occur in the future.

"Deflation" = the dreaded 'D-word'

2010-08-16T05:47:00.000-07:00

That dreaded 'D-word' is making its way back into the media vocabulary. Deflation, one of the most dreaded economic topics, has central banks and government economists contemplating strong measures to avoid it. Businesses should be aware of signs that deflation and the potential impact on their bottom-line.

Five items of note regarding deflation:

1. Defined as " a decrease in the Consumer Price Index for at least two consecutive quarters ".

2. The 'good' of deflation - if costs are declining due to productivity improvements without affecting demand, this is a good sign as profits in such a situation grow dramatically.

3. The 'evil' of deflation is that consumers will continue to put off purchasing items as they believe that the price of that item will continue to decline. By simply putting off the timing of the purchase, if done so on a mass scale, will see a long term decline in sales volume. In economic terms, the value of money 'deflates' or declines and the demand for money decreases. This initiates a self-fulfilling prophecy of lower demand, job cuts, wage cuts, less income, and the cycle continuing. Once this situation sets in, it becomes very difficult to slow or reverse.

4. Deflation is horrible for investments in stocks as profits decline for a long period and the overall demand for stocks due to less demand for money. Bond investments shift toward longer-term, safer investments that lock in a good interest rate. People will hoard cash simply because they will put off making purchases so money market funds and safe bank deposits will be popular. A recent Wall Street Journal article discussed strategies for investors to follow if deflation does in fact occur, according to the standard definition.

5. Banking systems can be severely tested as the value of the real estate and other hard assets that they have loans against declines. Banks move towards short-term loans as they worry about the default potential for longer-term loans.

While the government statistics such as CPI don't reflect deflation, haven't we in fact experienced it or are experiencing it? Real Estate values, the major investment for most consumers, have declined significantly over the past several years causing the bank problems and adding to economic troubles. While the government stats may not reflect the deflation in home prices,most home owners and local banks have felt it.

As a result, going forward, I'm going to assume that the risk for deflation is less than some think. I see the risk of 'stagflation' being much higher over the next several years. (higher prices leading to inflation, lack of demand). Commodity prices, food prices, and other items seem to be increasing dramatically. Ultimately, businesses will have to raise their prices to cover these higher costs as they have less room to cut costs as they have already done this.

Consumer demand, especially with discretionary items, will remain low as folks continue to pay off debt and are worried about jobs. Since demand will probably stay flat and costs going higher, businesses will continue to cut jobs or, at the least, not hire. Add in higher regulatory costs and potentially higher health care costs, look out.

The government is hamstrung. Interest rates can't be lowered much more. Fiscal policy is already in major deficit and the added stimulus over the past two years has seemed to have little impact as related to growth. Extending tax cuts may help but the added deficits add to the long-term fiscal stability of the country.

In summary, the best solution may be 'time'. As debt is paid off, as demand generally picks up, etc. the problem will resolve itself.

Financial Ratios to Monitor in Distressed Times Part 2

2010-08-05T09:45:00.000-07:00

A second financial model for predicting distress in firms comes of Cranfield University from Professor Taffler (1983) and updated/tested in 2007 (Accounting and Business Research, 2007) from a sample of non-financial companies on the London Stock Exchange from 1979 to 2003 including 223 companies that failed. The model included the following ratios:

The model is given by: z = 3.20 + 12.18*x1 + 2.50*x2 – 10.68*x3 + 0.029*x4
where
x1 = profit before tax/current liabilities
x2 = current assets/total liabilities
x3 = current liabilities/total assets
x4 = no-credit interval1 (no-credit interval = (quick assets – current liabilities)/daily operating expenses with the denominator proxied by (sales – PBT – depreciation)/365

In the UK study, the model is shown to have clear predictive ability over this extended time period and dominates more native prediction approaches. This study also illustrates the economic value to a bank of using such methodologies for default risk assessment purposes. Prima facie, such results also demonstrate the predictive ability of the published accounting numbers and associated financial ratios used in the z-score model calculation.

Financial Ratios to Monitor in Distressed Times Part 1

2010-08-03T11:46:00.000-07:00

During distressed economic times, it's critical for the small business to find ways to monitor his/her business especially regarding financial condition. Over the past 40+ years, there has been significant research on the relationship of financial ratios to financial performance. The 'Altman Z-Score', the 'Taffler Z-Score' and the 'Pricer Net Balance Position' are all financial metrics or equations that research has shown are effective in monitoring the financial condition of a small business.

The Altman Z-Score

Professor Ed Altman of NYU Stern School of Business developed one of the most famous distressed company predictive models in the 1960s and 1970s. The model, using multivariate discriminant analysis, identified five ratios that were significant in predicting bankruptcy of manufacturing firms. They are:

The original Z-score formula was as follows: Z = 1.2T₁ + 1.4T₂ + 3.3T₃ + .6T₄ + .999T₅.

T₁ = Working Capital / Total Assets.

T₂ = Retained Earnings / Total Assets.

T₃ = Earnings Before Interest and Taxes / Total Assets.

T₄ = Market Value of Equity / Book Value of Total Liabilities.

T₅ = Sales/ Total Assets.

Plugging in the ratios, multiplying each by its relevant weight and adding the results together calculated a raw Z-Score for a firm. The Z Score can then be categorized as to the potential for bankruptcy. The score ranges were:

Zones of Discrimination: Z > 2.99 -“Safe” Zone, 1.8 <>

Firms that were in the 1.8 or lower group were classified as distressed and had high likelihood of bankruptcy.

Over time, Altman developed a predictive model for Private firms:

T₁ = (Current Assets-Current Liabilities) / Total Assets

T₂ = Retained Earnings / Total Assets

T₃ = Earnings Before Interest and Taxes / Total Assets

T₄ = Book Value of Equity / Total Liabilities

T₅ = Sales/ Total Assets

Z' Score Bankruptcy Model:

Z' = 0.717T₁ + 0.847T₂ + 3.107T₃ + 0.420T₄ + 0.998T₅

Zones of Discrimination: Z' > 2.9 -“Safe” Zone, 1.23 <>

And, Altman developed a model for non-manufacturing firms:

T₁ = (Current Assets-Current Liabilities) / Total Assets

T₂ = Retained Earnings / Total Assets

T₃ = Earnings Before Interest and Taxes / Total Assets

T₄ = Book Value of Equity / Total Liabilities

Z-Score Bankruptcy Model:

Z = 6.56T₁ + 3.26T₂ + 6.72T₃ + 1.05T₄

Zones of Discrimination:

Z > 2.6 -“Safe” Zone

1.1 <>

Z <>

Key to either of these models is that credit analysts in financial institutions use them in the lending decisions and also to monitor the performance of firms who have already received lending.

Critical to the business owner is to understand what the models mean and to consider using the ratios to continually monitor their firm's performance in order to proactively avoid the downward spiral to bankruptcy.

In the next blog, we'll look at the other distressed model predictors.

Strategy Plan: Part 2 - The Strategic Lessons Learned

2010-07-29T05:05:00.000-07:00

Strategic Lessons Learned

After drafting the initial Mission Statement, the next step is to develop a series of the business principles where experience has taught major lessons to the management team over the years. The Strategic Lessons session borrows from the “Lessons Learned” process made popular by the US Military during the war-time engagements where organizations essentially develop a historical database of types of strategies applied, their effectiveness, and how they might be altered or altogether avoided for future use. The process aims to collect and preserve the knowledge of an organization so that when employees face conditions that they are unfamiliar with, the firm’s Strategic Lessons provide guidance when making strategic decisions.

Strategic Lessons is initiated by asking the executive team prior to the Lessons meeting to think to them selves, “I knew better than to get into that kind of situation” or “I recalled that we tried that strategy in the past and here’s what happened”. This is applicable to both execs with lengthy tenures in the organization and relative newcomers as the newcomers will be able to bring in experiences from their previous venues. Try to have the each team member recall as much of their experiences as possible including the details, what happened or didn’t happen, how have things changed (or not changed since that time), and how might things have been handled differently.

At the Strategic Lessons meeting, each executive should be able to produce five to ten lessons from the pre-meeting exercise. The lessons should be collected by a team member who will group and summarize the lessons. The summary should be the starting point for the team to discuss the lessons in the meeting allowing for additional questions, recollections from each member on a particular lesson to gain more knowledge, and a prioritization of the final principles.

You should end up with from 15 to 25 strategic principles that will guide future growth and development. When you have agreed on a set of strategic policies, have them typed and place a copy right behind the Mission Statement in your Strategic Planning report. Management will probably want to also take a copy to their Board of Directors for their review and approval. (In fact, you might want to include one or two board members in your strategic policy meeting.)

The outcome of this exercise provides several benefits for the organization. First, many times practical experience, despite favorable analytical information, tells you that the odds of success are unfavorable even in a specific case it might be hard to find justification for a decision in either direction. For example, an office products company which grew primarily by serving the small company market, ascertained through market analysis that the firm should enter the mass consumer market to take advantage of the home office trend. However, experienced management recalled that the company tried that ten years ago and got clobbered in the market place.

Second, is that by acknowledging the past lesson and writing it down, the company will overcome the issue of unwritten strategic policies where every manager establishes their own policy resulting in a loss of focus that leads to confusion and frustration among managers and employees. These principles are very important to the future and be sure you believe in them completely before you put them down.

Third, written strategic policies will save time as they will cut down on the need for meetings in the future. If you have many policies, you can move quickly, but down a very narrow path. If you have few policies, you leave your options open, but you will lack focus and clear direction.

An Example:

PDS Collection, a debt collection business located in the Chicago-region, put its executive team through a ‘strategic lessons’ process as part of its overall strategic plan. The company’s performance was relatively successful from a financial standpoint but the owner of the business, Paul Saxon, began to see signs of growth pains as the company continued to add new clients.

After establishing its initial mission statement, the team met two different times using a process similar to that presented here. Through discussion , the PDS identified a laundry list of many lessons of what worked and didn’t and ultimately narrowed the list to several key policies:

1. Expense management is an ongoing process, not just when profitability is low.
2. Consistent client communication is needed to continually inform the client the status of the collection and about other services PDS can offer.
3. While we continue to promote from within, the company has noticed that the lack of ‘new blood’ from the outside limits new ideas.
4. We’ve been too lenient on underperforming employees which affects the remainder of the work force.
5. The policy of customers coming first has provided a significant edge versus our competition.

As a country how are we doing? feeling?

2010-07-26T05:43:00.000-07:00

The Gallup Poll maintains several daily tracking polls that are interesting to monitor. Mind you, watching some of this data on a daily basis is not too meaningful but the trends can be pretty enlightening: Gallup Poll page link

1. 52% of those polled suggest life as 'thriving' as compared to 38% in December 2008. The 'thriving' amount has remained steady since August 2009.

2. Those suggesting a life of 'happiness/enjoyment' without much stress is at 46%, down from 63% on July 4th. This number varies quite a bit on a daily basis but the trend appears down since that day. About 13% show a life filled with more stress than happiness compared with a peak of 17% on Dec. 1, 2008.

3. From a health basis, about 50% report feeling 'energized' vs. 31% 'ailing'. The peak of those feeling energized was Feb. 14, 2010 at 64% (Valentine's Day) while the peak of those 'ailing' was Dec. 16, 2008 at 41%.

Such data can provide your small business with a 'heads up' as to consumer mood. An interesting exercise is to track such polls and correlate with your daily, weekly or monthly sales. These can be powerful indicators to gauge for planning and decision making.

The Beveridge Curve - unemployment

2010-07-21T20:27:00.000-07:00

Professor Morris Davis from the Real Estate department at UW Biz School highlighted the concept of the Beveridge Curve as an interesting phenomena taking place in our economy. This blog provides a more detailed explanation.

In summary, the relationship between 'Number of Job Openings' and 'Number of Unemployed' has fallen apart. Typically, the Beveridge Curve shows a strong relationship between the change in openings and change in unemployment (as openings increase, unemployment declines). In this recession, there is little correlation. So, the question arises as to 'why?'. One potential explanation is that the extension of unemployment benefits may be providing incentive to unemployed to remain out of work. Another explanation is that the jobs being created or open require a different skill set from those who are unemployed.

I believe the latter explanation is probably more accurate but, if so, presents some major issues for our economy that may exist for the long term. Hope our policy makers are aware.

Setting the Strategy - Mission and Vision,first! (Part 1)

2010-07-19T20:50:00.000-07:00

Developing a strategy and a strategic plan are instrumental for small companies as they organize to deal with an ever-changing economic environment. The starting point is to always develop (or in many cases, re-develop) the organization's mission and vision statements as the foundation for a firm's strategic direction.

So often, entrepreneurs argue that their mission and vision statements were exercises in futility that cost them lots of resources in lost time and money. . However, it’s the author’s belief that a passionate, specific Mission statement can provide a strong foundation in the culture and decision making processes of a firm. Much of this was addressed in the various books by Jim Collins and Jerry Porras like 'Built to Last' and 'Good to Great'.

The “mission” is the clear and compelling overall goal that serves as a focal point of effort. President Kennedy’s declaration in 1961 that “this nation should dedicate itself to achieving the goal, before this decade is out, of landing a man on the moon and returning him safely to earth” serves as an effective mission statement that drove the NASA organization to great achievements.

A mission must be achievable by translating an organization’s values and purpose into an energizing, highly focused goal – like the moon mission. It should be clear, crisp, bold and exhilarating requiring little or no explanation; people “get it” when they read or hear it. A mission is meant to “stretch” the organization into something that isn’t easily achievable. It has a finish line and serves as a “big, hairy, audacious, goal” for the company. Once the mission is accomplished, the next mission is put in place.

A variety of approaches can be utilized:

A. Targeting Approach - Set a clear, well-defined target and aiming for it. President Kennedy’s moon project was a “target” type of mission. Another approach is to set the goal of taking the company to an entirely new level of overall prestige, success, dominance, or industry position .

For example:

• Merck – “to establish Merck as the preeminent drug-maker worldwide in the
1980s” (set in 1979).

• Coors – “to be number three in the beer industry by the end of the 1980s”.

B. Common Enemy Approach – This approach sets out to defeat a common enemy. It appeals to people’s competitive instincts and can create an extraordinary unity of purpose. Common enemy missions are typically set by companies that are striving to become number one, but have not yet achieved it. It has an extremely powerful effect on an organization whose back is against the wall.

For example, Pepsi set its mission in the 1970s to “BEAT Coke!”. Or, when Honda was faced with Yamaha’s overtaken them as the number one motorcycle manufacturer in the world, responded with: Yamaha wo tsubusu!!!! (We will crush, squash, slaughter Yamaha!!)

C. Process Approach: This approach places emphasis on processing technology in strategic plans. An example is an injection molding company desiring to develop plans to gain advantage in injection molding technology for lowering processing costs, and to introduce injected molded products into markets that are currently being served by other products.

“… to develop and produce injection molded plastic products for the national market.”

D. Marketing Approach: A company is concerned with the targeted consumers and the marketing of company products to satisfy these customers. Strategic plans would center on the changing needs and desires of those consumers.

“… to develop and market office supplies under the company brand name which satisfy the needs and desires of the national market better than any competitor.”

E. Distribution Approach: With this approach, a company may develop plans that will allow them to sell to a certain link in the supply chain (i.e., mass merchandisers) better than competitors. The key to success with this mission statement is to provide a favorable price/quality relationship when compared to competitors.

“… to supply company brand office supplies to mass consumer merchandising organizations wherever they exist.”

F. Resource Approach: With the Resource Approach, management is concerned with investing resources in those activities that offer the highest possible return without concern for product or industry. The strategic plans of these companies usually center on diversification efforts without clear product or industry focus. To be successful with this strategy, a company must have, or have access to, free capital and many specialists who are capable of analyzing and managing in various industries.

“… to deploy the resources of the company to obtain the maximum return to stockholders.”

The Unemployment Picture in the US?

2010-06-28T18:22:00.000-07:00

We're getting differing data points from the economy this past month or so. While we see an increase in Gross Domestic Product, higher ISM readings, and increasing confidence, the one thing that remains stubbornly high is unemployment. In May, total US unemployment was almost 10% of the work force and another 10% are considered underutilized. What can be driving this phenomena?

1. Tight Bank Lending Requirements - Banks are facing tighter lending requirements as they try to improve their capital structure with all the 'bad' commercial real estate loans and high foreclosures. Until the banks have the ability to dramatically increase their lending, the velocity of money will remain stagnant and even companies in good financial shape will continue to face a shortage of available capital.

2. Global Uncertainty - European Debt Contagion, BP and the rest. Uncertainty leads business owners to hold back on long-term investments like capital expenditures and new hires. It's less risky to have your existing workforce work more overtime than to bring on new employees. The world still presents a lot of risks that cloud the long-term horizon.

3. Consumer Debt Overhang - Consumer data released today show income are increasing for the US consumer but spending looks flat. Consumers are saving more and/or paying off their debt from the pre-recession experience. Until consumers with jobs feel more safe and reduce their debt levels to management amounts, the lack of consumer spending will continue to hold back demand in the economy.

4. Higher Business Costs - Taxes are going up as the Bush tax cuts expire next year. Health care costs are uncertain but will in all likelihood increase regardless of the ultimate plan. Add on the potential for Cap/Trade combined with little growth in sales and business owners will continue to cut operating costs for survival. This means possible pressure on employee costs and may lead to more layoffs.

5. Technology - businesses are finally seeing the benefits of productivity improvements from all the technology they've invested in over the past years. Improved software, the Internet, etc. all have allowed businesses to do more with less and this may be a continuing trend. More over, it's becoming apparent that we have a mismatch between the types of jobs available and the skill base of many of our unemployed/underemployed workers. Jobs in health care, software and other high tech areas require highly skilled engineers, technicians, and scientists.

Managing Growth in the Entrepreneurial Firm - The Administrative Type Company

2010-06-28T18:15:00.000-07:00

Growth can be great for the new venture but it also can create all sorts of problems. This post describes the transition that entrepreneurial firms must make in order to manage their growth and build a foundation for long term sustainability. It's the transition that many entrepreneurs do not desire because they fear the loss of speed, creativity, and flexibility in their firm. It also can mean a loss of centralized control to the founder.

The Administrative Type Organization

The late Emeritus Professor Alan Filley, Emeritus Professor Robert Pricer, and Professor Ray Aldag, all of the University of Wisconsin - Madison School of Business, classified the ‘Administrative’ type of organization as a third form adaptive strategy for entrepreneurial firms. The Administrative firm exists apart from the people in it, has institutionalized practices through organization charts, implements formal strategic planning practices, job descriptions, and other policies that provide efficiency and rationality to the company’s decision making process so that the organization’s objectives are separate from that of the individuals in it.

The music company mentioned earlier that had become Market/Innovation type organization never made the transition to an Administrative firm and failed in just after five years. Once more efficient competition entered the market place, the music firm couldn’t compete on a cost-basis.

Leadership Structure

Unlike the Market/Innovation firm where the leadership structure is centered on the whims founder/owner of the organization, leadership in an Administrative company is that of professional managers. The professional manager’s behavior includes the display of social skills, use of instrumental behaviors, the ability to properly utilize an array of decision making strategies, technical knowledge, and a sense of futurity. Through impersonal records, the professional manager monitors pre-planned behavior and takes corrective action where required.

If you ask a leader in the Administrative firm what her objectives are, she’ll state the goals in terms of the firm, “our goal this year is 10% sales growth,” or “our return on investment for all investments require 15% return on investment.” Objectives are stated in terms of goals and plans where the company’s objectives differ from its individual employees.

Organization Structure

The structure of the Administrative Organization is that of a ‘rational hierarchy’ of defined positions. With the definition of legitimate job behavior, individuals in the system are free from discretionary power of subordinates and are limited in their own exercise of power as well. Office holders are selected on the basis of their presumed ability to perform the specified tasks and are rewarded according to their approximate contribution to enterprise goals and marketplace demands for their services. Structural arrangements will vary according to the information processing requirements of the firm and are consistent with the rational, adaptive posture of the organization.

The Administrative firm employs staff to perform activities related to planning and control. Whereas the Product/Service firm has little or no administrative staff as there is little change in the environment and the Market/Innovation firm runs things in a more ‘seat of the pants’ approach due to the quickly changing environment, the Administrative company hires and develops employees to perform strategic planning, production scheduling, and other non-technical activities. With the Administrative organization, one will see the traditional organization chart that reflects the full functional department organization of the firm.

The employee morale of an Administrative firm is more complex to evaluate than the other firms. In part, it depends on the satisfaction of the individual needs through rewards for job related performance. It also may depend on the equitable ratios of investments among personnel, vertically and laterally. In varying degrees, it depends on upon intrinsic satisfaction gained through performance. Administrative organizations anticipate needs and preferences of their members and provide rewards by an implicit definition of the climate to be maintained. The Administrative firm has a relatively high level of homogeneity of values among its members, established in part by indoctrination and in part by selection standards.

Policies and Procedures

Policies of the Administrative type firm are legislated and in writing representing the ‘rule of law’ at the organizational level. Because the company policies are explicitly stated, employees can gauge their decisions based on the guidelines and boundaries established by the firm. Moreover, the policies and procedures provide stakeholders with a clear understanding of what’s expected of them. Employees have job descriptions, managers have budgets, executive leadership develops strategic plans to guide decisions.

The planning, control and hierarchy in the Administrative provide at least one major benefit to organization – the organization is not dependent on any one key individual as systems, policies, and structure are in place to assure that the organization can operate independently.

Potential Issues of the Administrative Firm

The Administrative firm provides the benefits of planning and control by giving structure to the decision making process. This environment appears most advantageous for a firm that wants to manage its growth by emphasizing adaptation to changes in the environment and logical development of products or services that better fit the competitive environment.

The evolution to a structured environment does have potential shortcomings. The risk taking, creativity, and innovation of the early stage, Market/Innovation Centered firm is replaced by careful consideration of changes where costs and benefits. This development can produce an overly bureaucratic environment that destroys the culture of the exciting M/I organization.

Secondly, organizations can take the Administrative transition too far where decisions become overburdened with excess committees, paperwork, and politics that causes myopia as firms spend too much energy on the inner workings of the company without realizing or adapting to changes in the marketplace

Grow, Grow , Grow - The Market/Innovation Enterprise

2010-06-01T15:08:00.000-07:00

While our international economies are currently rising from deep recession, there still were a number of enterprises that showed significant sales growth. Many times these companies, commonly called 'gazelles' (i.e., an American expression for small, fast growing companies that have grown at least 20% for each of the last five years), are the job creation engines for our economy. Yet, with this great growth, companies such as this have a high 'crash and burn' existence as their phenomenal growth from a young age never provided the firm with the opportunity to institute the necessary steps that managed their growth. This blog addresses these types of companies, referred to as the Market/Innovation Enterprise, and the issues the typically exist within them.

The Market/Innovation Centered Enterprise

The late Emeritus Professor Alan Filley , Emeritus Professor Bob Pricer, and Professor Ray Aldag, all of the University of Wisconsin - Madison School of Business Entrepreneurship group, conducted significant analysis and research on the Market/Innovation Enterprise (M/I) that provided significant insight into the issues faced by such an organization type and processes and policies to deal with these issues.

The Market/Innovation Centered firm is structured to exploit an innovation that is perceived as new or unique – a new market, a new product or service, a new method of distribution, a new source of supply, or a new method of production – anything that gives the firm a distinct innovative, competitive advantage.

Since the Market/Innovation type form is based on exploitation of an innovative, success is based on the ability of the entrepreneur and employees to adapt to an uncertain, ever changing environment. Typically, such a firm experiences an S-shaped pattern in its sales growth as the new innovation is introduced to the market place. Initially, the company experiences rapid sales growth upon in a market that has few competitors.

The music store example described in the Product/Service Centered section of this chapter was ultimately sold by the two founders to one of their brothers. The new owner, not a musician himself, specialized in sales as his previous experience included sales of music instruments to high school and grade school bands. After buying the business, the brother built the business by focusing on selling accordions throughout the Midwest. The unique selling advantage of the business was that it sold the accordions by sending music teachers to small towns as the sales representatives in addition to providing lessons. This was a unique sales strategy that provided rapid growth for the business. Growth began to slow as other music sales competitors copied the sales strategy with their own distribution method through teachers.

Leadership

In a Market/Innovation type organization, the leadership role is filled by a charismatic entrepreneurial leader. In the initial stages of the firm, the entrepreneur is viewed as a ‘hero’ by many of the employees. They believe that the entrepreneur can perform in an exceptional manner to obtain the exciting goals established for such a firm. The entrepreneur is usually characterized by having a high need for achievement, as having difficulty dealing with authority, and as having the ability to make decisions under conditions of uncertainty. Also, many times the entrepreneur appears to have a difficult time differentiating the person from the organization, it is one and the same (i.e., the firm is the entrepreneur and the entrepreneur is the firm). Filley and Aldag appropriately classified this type of entrepreneur as the ‘promoter-style’ of leadership.

The personal influence of the promoter/entrepreneur on the firm influences the organization structure that evolves in the Market/Innovation Centered firm. Usually there is minimal hierarchy with the entrepreneur having contact, visibility, and direct influence with everyone in the organization. She functions as the central communications center and a major source of decision making in the organization. As a result, the structure tends to be quite flat, insofar as possible, everyone reporting to the entrepreneur.

As the organization gets larger, the promoter deals with the growth by working more hours, even weekends and holidays. Ultimately, the greater hours causes the promoter/owner to procrastinate with duties that don’t need to be completed on an immediate basis, only dealing with issues that are extremely urgent. Planning, never a strong suit of a promoter, becomes even less of an objective when, in fact, it should.

Finally, to deal with the time demands, the promoter/entrepreneur hires staff to serve as her ‘arms and legs’. Many times, these individuals are identified as an assistant, executive secretary, or a right-hand person. One day, the assistant is asked to make a phone call, the next day to open mail, the third day to find out the status of an order being built by the company. These individuals are not given any authority or responsibility, only to do the action that the promoter would normally have done based explicitly on the owner’s directions.

Objectives of the Market/Innovation Centered Firm

Because the Market/Innovation Centered Firms many times exhibits the personality of the promoter/leader, the objectives and goals of the firm reflect the promoter with exaggerated and appealing objectives of what the firm wants to achieve. For instance, you may hear founders/managers/employees make claims such as “we’ll all be rich some day,” “our stock options will make us millionaires,” “we’ll be a billion dollar company some day,” or “we’ll all be driving Porsches some day.” The firm, especially in the early stages of development, establishes high expectations and enthusiasm for its members creating an excitement level that is rarely seen in other organizations. This passion and excitement is intoxicating and provides the early motivation for “the cause” of the firm.

Policies and Planning

The formal mechanisms found in many firms such as policies, planning and procedures are minimal, if not non-existent, in M/I firms. The tactics and day-to-day actions are improvised and subject to the whims of the leadership within the organization. Organizational charts and strategic plans may exist only on paper as the leaders in this type firm create the rules ‘by the seat of the pants’. Because the firm is typically smaller in size at the onset, the leader has personal contact with many of the employees so such tactics are not totally inappropriate as the team can communicate informally on a relatively easy basis.

This type of organization is designed, either explicitly or tacitly, to be able to change quickly to take advantage of the unique innovation as bureaucracy and cumbersome decision making process impedes the need to move fast. Also at this point, a Market/Innovation Centered firm typically earns high gross margins on its revenues as competition is limited due to innovation allowing the firm to afford expensive operating practices.

Potential Issues with the Market/Innovation Centered Firm

As the Market/Innovation type firm grows, issues emerge. First, because the MI firm is set up to exploit some kind of innovation, a major problem usually develops on supplying the product or service to the customer. The unique structure of the firm where the promoter/leader is at the center of every decision makes it difficult to handle growth as the complexity and number of decisions needed to be made grow exponentially with higher sales. When small in size, the complexity can be handled by the owner and the few employees. However, when growth sales rapidly increase, employees hired, the promoter/entrepreneur is unable to make every decision for production, marketing and other functions in the company. Thus, employees constantly consult with the owner as to what he/she wants done which becomes untenable as the size of the firm increases.

Second, the M/I firm typically experiences fast sales growth and high margins as their unique innovation protects against competitive pressures. As a result, the promoter/entrepreneur fails to see the need for budgets and other cost control measures as the company’s growth in sales and profits allows sufficient funds to pay for an extravagant lifestyle. However, once sales growth declines due to competition, the Market/Innovation centered company has built an expensive, inflexible infrastructure comprised of mostly fixed costs. As a result, the financial losses are exaggerated as company experiences out-of-control expenditures continue to occur despite the lower revenue base.

Finally, as operations become out-of-control too much growth or a decline in business (combined with financial losses), morale of the employees is dramatically affected. In the initial stages of the company, the promoter/entrepreneur is able to attract a team and employees based on the excitement of the opportunity, the joy of a startup, and the charisma of the leader.

As time progresses, management and employees who seek responsibility for decision making leave due to the control nature of the founder. Usually, those who remain are ‘followers’ who are attracted to a ‘hero-type’ leader that they can put on a pedestal for adoration. As long as success continues for the firm, morale of the remaining team remains high. It’s when the downtimes occur that major morale problems emerge. Also at this point, the effectiveness of the founder/entrepreneur as prime motivator and the center of decision making may decline through loss of charisma, loss of energy, or some other reason.

At this stage, the entrepreneur goes from hero to anti-hero based on a number of factors. One, the exaggerated promises made early can seldom be realized, creating disenfranchisement and disappointment. Further, as the company suffers, management systems are installed to control the problems usually increasing accountability through tighter authority. Many times, this occurs with outsiders brought in to turn things around. With the inclusion of outsiders, the emotional bond that developed between employees and the founding entrepreneur is strained with the advent of greater authority.

Finally, charismatic leaders seem to attract people who want to be changed, save, or enriched in some way and the followers of this sort will continue to attach themselves to presumed charismatic leaders, only to move on in disappointment when the leader turns out to be fallible. In summary, the high to low morale patter is common, creating loss of long service personnel, bad feelings, and attempts to subterfuge or unionize when it happens.

Addressing Business Failure - What 'type' of business are you? Structuring yourself to grow - the Product/Service Configuration

2010-05-13T07:04:00.000-07:00

Many times, organizations kind of 'evolve' without any planning as to their structure (i.e., management systems, rewards, organization and job design, etc.) especially in relation to their operating environment

“Organizational typologies” can provide a parsimonious framework for describing complex organizational forms and for explaining outcomes such as organizational effectiveness or groupthink. Mintzberg (1979, 1983) identified five types of organizational structures that were hypothesized to result in maximal organizational effectiveness, and Porter (1980, 1985) identified three ideal-type strategies that are hypothesized to maximize competitive advantage.

Professors Alan Filley, Ray Aldag and Robert Pricer, at the University of Wisconsin – Madison, identified and developed a unique typology system that identified three adaptive strategies exhibited by entrepreneurial firms related to organizational structure and leadership to deal with the operating environment. The three types of firms – Product/Service Centered, Market/Innovation Centered, and Administrative – exhibit unique structural and leadership characteristics. This blog will discuss some of the characteristics of the Product/Service type organization including the strengths and weaknesses of it.

The Product/Service-Centered Organization

A Product/Service Centered firm is operated by the owners and managers who are technical specialists, not business specialists. One example used by Professor Alan C. Filley during his research at the University of Wisconsin- Madison to illustrate a Product/Service firm is that of a company owned and operated by a married couple, both of whom were expert musicians. They provided music lessons and sold music instruments without developing business functions such as merchandising, operations, human resources, finance, sales or promotion. The couple earned a comfortable living that allowed them to conduct a business that was their craft. The following sections provide greater detail about characteristics specific to the Product/Service Centered Business.

Objectives - essentially those of survival, the comfort of the owner and the well-being of the participants. Success is measured in terms of continued profitable existence of the organization. The product/service firm avoids rules, policies, and procedures in favor of traditional methods of operation.

Leadership- The owner-manager of such a firm operates more within an arena of technical knowledge than as a professional manager. She is likely to spend much time in production or sales and is involved in day-to-day operations. The founder in this type firm will rely on experience combined with the belief that he or she may not feel that other people can give him or her much useful information.

Levels of Power - The Product/Service firm is informally arranged into levels of power rather than into an impersonal hierarchy of offices, and each level defers to those at the higher rank.

Trusted Employee - Usually, the official family has assigned some supervisory responsibility as a reward for their loyal contributions to the organization and its owners. Many times trusted employees do not function well as supervisors as they may be reluctant to share knowledge with subordinates if doing so means that they have less power and prestige in the company.

Employee Morale - organization values comfort and low risk taking, it makes sense to expect that over time it will hire and retain employees with similar expectations.

Technology and Staffing - The Product/Centered firm, because of the goal of stability and not change, will typically center on using the same technology over time with little innovation (as evidenced by new product development, adopting new technologies or new methods in their operational processes).

Weaknesses - As long as the firm’s operating environment is not drastically changed by better competition, evolving customer needs, or other major alterations, the Product/Service firm will survive. However, if the environment does indeed change, the Product/Service organization does not have the necessary capabilities or desire to adapt, which can inhibit long term survival and success.

Identifying the causes of small business failure and termination

2010-05-06T05:51:00.000-07:00

Statistics from the Small Business Administration (SBA) show that "two-thirds of new employer establishments survive at lease two years", according to Brian Head, Economist with the SBA Office of Advocacy, noted that the latest statistics are a much more accurate assessment of new business success rates, and that "as a general rule of thumb, new employer businesses have a 50/50 chance of surviving for five years or more." These statistics are bit dated and are not reflective of the current economic situation but represent a more accurate picture we hope returns soon.

More important, however, is to gain an understanding of 'why small business fails'? In his book Small Business Management, Michael Ames gives the following reasons for small business failure:

* Lack of experience
* Insufficient capital (money)
* Poor location
* Poor inventory management
* Over-investment in fixed assets
* Poor credit arrangements
* Personal use of business funds
* Unexpected growth

According to Dun & Bradstreet statistics (“Small Business: Preventing Failure - Promoting Success,” Lewis A Paul, Jr., the Wichita State University, Small Business Development Center), 88.7% of all business failures are due to management mistakes. The following list summarize the 12 leading management mistakes that lead to business failures.

1) Going into business for the wrong reasons
2)Advice from family an friends
3)Being in the wrong place that the wrong time
4)Entrepreneur gets worn-out and/or underestimated the time requirements
5)Family pressure on time and money commitments
6)Pride
7)Lack of market awareness
8)The entrepreneur falls in love with the product/business
9)Lack of financial responsibility and awareness
10)Lack of a clear focus
11)Too much money
12)Optimistic/Realistic/Pessimistic

There are many other studies (anecdotal and empirical) that address the issue. If there's one conclusion that can be made is that many of the factors are under the control of the founder/entrepreneur and management team of the organization. In other words, most factors can be proactively avoided or corrected through managerial decision making and action.

Koss Stereo and the Trusted Employee Phenomena

2009-12-27T06:42:00.000-08:00

The Milwaukee Journal Sentinel reports on the alleged embezzlement of almost $20 million by the Chief Financial Officer at Koss Stereo located in Milwaukee. One can read the series of articles for further background but here are a few highlights:

1. Koss is a public company audited by Grant Thornton, one of the largest public accounting firms in the US. Koss' reported annual revenues were just below $40 million.
2. During the period of the alleged embezzlement, the article states that Koss reported only $18 million in profits yet the CFO may have embezzled up to $20 million.
3. The CFO was very involved in civic and social organizations within the Milwaukee area.

The question that comes to mind is how does something like this occur? The late Professor Alan Filley, Professor in Management and Entrepreneurship at the UW Madison School of Business, wrote extensively on what he called the 'trusted employee' issue at small or mid-size businesses that tended to occur in a certain 'type' of organization.

In many entrepreneurial firms, especially those that Filley classified as a 'Craft' or “Product/Service-Centered” type organization, there existed a class of employee that Filley categorized as a “trusted employee(s)”. A trusted employee can be defined as an individual who through relationships with other employees, lengthy tenure, or the type of position (i.e., which usually allows access to sensitive information or assets) has acquired an inordinate level of implicit or explicit knowledge within an organization leading to an inordinate level of power. Many times, this employee maintains the knowledge to his or herself. This power is rarely recognized until after the employee departs or an act(s) have been committed leaving the company at great risk.

The trusted employee, per se, is not necessarily a “bad” person but due to the level of implicit power and trust that they enjoy, serious problems may exist or develop in the management of the firm. This paper briefly discusses several examples and related characteristics in companies that I’ve observed where a “trusted employee” situation existed. Please note that this is not based on a body of academic research but simply anecdotal evidence observed in practice.

Observed Characteristics of a Trusted Employee

The following are some of the characteristics that I’ve observed in a “trusted employee”.

• Distant Family member, Long-Time Friend, or a past student where a “Father/Mother-Daughter/Son” relationship developed between the founder and employee.
• Perceived to be loyal, never complains, provides “inside info” from the grapevine to owner.
• Lengthy term of employment at the organization. Many times one of the original founding employees.
• Many times will have a “lower level” title like Office Manager, Accounting Manager, etc.
• Many times has access to the “till” or cash as well as the accounting records and ledgers
• Owner may feel that employee is so trustworthy that the owner can conduct business outside the organization and the employee will either “run” the organization while the owner is absent or at least remain as the “eyes and ears” for the owner while he/she is away.
• Often will not allow others to find out what he/she is working on.
• If in product development, may not commit to any goals or objectives because knows that owner will not hold accountable.
• Disregards owners’ requests for work

Risks associated with the Trusted Employee

• Embezzlement of funds
• “Doctoring of records”
• Other managers and officers feel lack of trust with owner
• Can develop power base where the trusted employee runs the business his/her way while owner is away.
• Typically “over their head” when attempting to run things
• May ignore other departmental heads and do things his or her way
• Inordinate amount of turnover.
• Ingrained knowledge, not easily transferable
• May make salary or benefit demands

Recommendations

When you see a “Trusted Employee”, here are some very suggestions:

1.Make sure in the entrepreneurial organization that proper checks and balances are in place to assure that no one employee gets too much power. An example would be to make sure that an accounts payable clerk does not have access to the cash or the general ledger records. Or at least someone independent of the clerk performs cash to bank reconciliations.

2.Attempt to implement some sort of purchase authorization level – amounts greater than $X must require two signatures, etc.

3.Annual audits are performed by a CPA firm especially making sure they reconcile cash and related revenue/expense accounts.

4.Assure that a mechanism is in place for employees to disagree with management or policies without potential consequences. A confidential process must be in place where an employee can talk to someone in Human Resources, Legal, or some other department without fearing for their job. Conceptually this sounds easy, however, in reality this is very difficult to put in place in an entrepreneurial firm.

5.See that a strong, independent board of directors or other independent body is in place to assure that the CEO and high level management is held accountable.

6.Create a job description and associated task list for all duties performed by the employee. If complete and done well, the task list will allow the position to be easier to fill with a replacement. Do not allow any vital job or task left undocumented.

7.Realize that the only true remedy for a trusted employee is usually to replace the person.

Even in larger small businesses like Koss that are publicly-held, this issue can exist. Attention to identifying the trusted employee phenomena and developing management systems to reduce the inherent risks to the organization may reduce the risk of such occurrences like that which occurred at Koss.

The 'Real' National Debt...

2009-12-21T12:31:00.000-08:00

How about some sobering statistics in this time of health care and environmental reform? The Peter G. Foundation estimates that today the National Debt is $56.4 Trillion. This is an estimate that attempts to put some reality about the fiscal condition of the US Federal Government. This is also prior to any health care or environmental reform. Finally, this number only represents debt at the national level. What about debt incurred at state, county and local levels of government?

Well, trying to get at this number is difficult but a Bloomberg report estimated that the States possess $731 billion in unfunded pension obligations as of 2006 or so. This was prior to the economic downturn and it doesn't appear to include obligations at the local and county level. Locally, the Milwaukee Journal-Sentinel noted that the City of Milwaukee Public Schools unfunded liabilities for its retirees will hit $5 Billion.

So, for the individual and the business owner, what is important to take away from this picture? First, I believe this will be the issue that outweighs all other issues over the next decade or so. The amount of money owed by this country, even if on paper, is in the hundreds of thousands per capita over the next several decades.

Even though the amount of the overall obligation may change over time, organizations should still incorporate this issue into their planning process. In general, several things must occur, either alone or in combination:

1. Major VAT or Income tax increases. Whatever the economic scenario going forward, it will take significant tax increases over the next two or three decades to make a dent in this debt level. The biggest question(s) is in what form these taxes will take and how it will affect the economy and the business? There will be an increase in income tax rates, both personal and corporate, that is a given. I assume that it will not be as high as some think especially when one compares US corporate tax rates with many other countries. We can't raise our income taxes much higher and still remain competitive in the international arena.

Without the flexibility of simply increasing income taxes, a lot of discussion has taken place about a national sales tax or a 'value added tax'. I'm not an expert in economics to discuss the pluses and minuses of each but I do know from experience that a VAT is very popular in Europe. A major issue I've observed is that it allows for huge bureaucracy to develop in order to levy and monitor it as well as the development of a black market. It tends to be a hidden tax as consumers never really see what portion of their purchases are paying for the tax but only see higher prices. One positive of the VAT is it will tend to encourage more savings vs. consumption (at least on the surface).

2. FICA and Medicare - these two programs are the big concerns. Look for the combo of higher FICA and Medicare taxes with a changes in the benefits. Extending the retirement to 67 or 70, reducing reimbursements for Medicare, and a combination of other things will reduce the obligation substantially. I believe that some where down the line the government will follow the example of business and offer folks an early lump-sum payout of social security (which will be substantially less than they would receive as pensioners) in return for leaving the system.

Also, an alternative system must be set up such as something proposed during the Bush Administration where individuals have an opportunity to invest a portion of their Social Security contribution.

As for Medicare, this will be the role of the health care reform. Regardless of all the promises and terms in the current agreement, they will have to figure how to resolve the Medicare liability. Higher taxes will only resolve a portion. Rationing, or whatever it will be called, will be the norm. Finally, the administration of these programs will have to be examined to ascertain if they are administered on the most cost-effective basis.

3. States and localities - the state, county and local retirement programs are mini-versions of the Social Security problem. Again, the guarantees for government employees will be under question as it will be highly unlikely that government will be able to raise enough funds to keep the systems solvent. Also, the programs can't hope to have ever improving stock and bond markets all the time.

4. More Debt - a terrifying scenario that is occurring in a smaller level now but could become the financing mechanism of choice is for government agencies to issue new debt to pay off old debt. For instance, the US Treasury could sell shorter term, higher interest rate Treasuries and use the proceeds to pay off old investors. While this sounds like the least painful, in the long run it is the most horrific. Interest rates will rise, debt service costs will explode and the currency will collapse leading to out of control inflation.

Business should look at a variety of scenarios and the impact of each scenario on the market place and their own business. For instance, if governments choose to solve much of the obligation through higher taxes, growth will be hampered as consumers and businesses will have dramatically fewer dollars to spend. This will affect demand and also drive operating costs higher. Businesses have to focus on productivity and expanding in international markets as the local market will be reduced. In summary, we can count on the following to occur regardless of the path chosen by government, only the degree of each occurring will vary:

1. Higher Taxes - Income tax, Payroll Tax, Medicare Tax, Addition of VAT, etc.

2. Higher Interest Rates - as more debt gets issued, higher interest rates will be demanded by investors to offset the risk of default. This affects all lending.

3. Fewer services - while the regulation train may be getting further down the track, government will not have the resources to enforce them. This will affect quality of business life in the US.

4. Weaker Dollar - short run - good for exporters and bad for importers. In the long run, bad for all as the dollar loses its value as the currency of choice around the country. It will be more likely for those doing international business that they will have to convert to Euros or some other currency to conduct commerce. This is an additional transaction cost.

Good luck everyone.

Sustainable Growth Rate - Applicable at the Macroeconomic level?

2009-04-23T19:28:00.000-07:00

In most of the 1980s-2000s we saw strong GDP growth in the US as compared to the 1970s. If one recalls the '70s, many suggested that the days of 3.0% or higher annual growth in GDP were done as the US was facing strong competition from Japan, high oil prices, and a host of other issues. In turn, some have suggested that the higher growth in the post-1970s was related to economic policy, lower input costs, and other positive items. In addition, many have attributed the growth, especially in the later phases of the period (2003-2008) to the productivity of the American companies.

What, in fact, caused this growth? Could it have been, at least in the latter phases, the increased use of leverage in the overall economy? Growth occurred despite low or non-existent savings rate, higher taxes and other extremes. For businesses, one way to estimate growth and the factors that influence it is by applying financial ratio that has been in existence for many years. The ratio, the Sustainable Growth Rate (SGR), as described by Professor Robert Higgins, University of Washington Business School, estimates the annual rate of sales growth that a firm can 'sustain' based on maintaining several variables. The variables of the SGR ratio are:

Profit Margin = P = (Net Income / Revenues)
Earnings Retention = R = (Net Income - Dividends)/Net Income
Financial Leverage =L = (Assets/Beginning of Period Equity)
Asset Utilization = A = (Revenues/Assets)

The Ratio can be calculated as: P x R x L x A

The question to pose is, could such a ratio be used to measure and explain growth at the macroeconomic level for an entire state or national economy? I believe there may be reasons to suggest that it can.

First, assume that the US economy or a state economy is a summarization of the financial performance of many companies - large and small. If we picture the US economy as one large for-profit organization, then assume SGR as an estimate annual growth in combined revenues of all organizations. In other words, instead of measuring the potential sales growth of a company, why not substitute the one measure that is a summary for economic growth,the Gross Domestic Product (GDP), the measure of sales for an entire nation?

Second, substitute other economic ratios for the four independent variables in the SGR calculation. "Profit Margin" in the Higgins ratio could be likened to income earned in the overall economy. Salaries, wages, investment income, capital gains and all other sources of income can summarized into a 'profit margin' type ratio, or as a percentage of GDP.

The second variable included in the SGR calculation, Earnings Retention rate, could be represented by the national savings rate at the consumer level and the earnings reinvestment rate made by companies. Investments as 401K contributions and other retirement investments would have to be evaluated as whether they should be included and how they would be calculated.

The third variable, Leverage (i.e., Debt to Equity), might be represented by the total debt at various levels in the economy - personal debt at consumer level (homes, home equity lines, credit cards, etc.); corporate debt; and government debt at the various levels. The denominator, equity, may be a combination of equity in the consumer's own home, estimate of equity in other owned assets, savings in equity investments, etc. At the corporate level, much discussion would be required as to how should equity be measured - the market value of equity investments or the book value off corporate balance sheets. An alternative for estimated economic equity would be to simply take an estimate of the market value of all assets in the US and subtract all debt. The residual could be used as a proxy of equity in the economy.

The final ratio, Asset Turnover, (Revenue/Assets), is a productivity measure that estimates how effective management is generating revenues based on the assets under management. At the macroeconomic level, such a ratio could be estimated by taking GDP divided by the market value of assets in a country as discussed in the previous ratio.

This is an oversimplification in trying to apply to the SGR ratio to the economic level and would require much in-depth investigation and discussion as to feasibility of using such a measure. However, if such metric could be utilized, it would hold much value for monitoring economic performance at the national level as it does at the organizational level.

If an Economic SGR metric could be developed, it would have dramatic significance in describing economic growth. Think of the four levers in the SGR ratio that influence growth - Income, Reinvestment, Leverage and Productivity. Referring back to the 1970s growth vs. the post-1970s (until the Fall 2008 collapse), the higher GDP might have resulted from an assortment of items. For instance, new technologies such computer hardware and software may have enhanced productivity over time (Revenues/Assets). Or, lower taxes at various times may have improved Margin thus increasing GDP growth. Finally, Leverage might have been major contributor to growth, especially in 2002 and beyond era. As shown in SGR, increasing Debt in relation to Equity can have a substantial impact on sales growth. Did this also happen at the macroeconomic level and could it have been the main driver for growing GDP until the implosion in 2008? It would be an interesting analysis to identify this impact.

More importantly from an SGR context, how will the US economy grow if one of its major levers (Leverage) declines as it currently is? Well, the country may counter this effect, as described by the SGR metric, by:

1. Increasing income in relation to GDP. Tax cuts, low interest rates, low inflation, improved productivity (lower costs in relation to output), etc. are all means that can address this.

2. Increase Savings and Income Reinvestment. Consumers are already doing this as the savings rate is increasing to 5% or more. Businesses are focused on increasing cash flow to provide a financial cushion for future uncertainties. Government can introduce policies to encourage savings and reinvestment even more.

3. Improve Asset Turnover - as the value of the asset bases decline for the entire society, businesses and government need to continue introducing policies that focus on increasing demand in relation to owned assets. Productivity improvements at all levels can positively affect growth.

Key to this discussion is can consumers, businesses, and government develop policies and practices that will offset the negative impact on growth from the deleveraging effect. Much discussion and analysis should be focused on improving the three levers - Margin, Savings, and Productivity - in order to offset the effects of less debt if high growth rates are expected to be maintained.

Starting a business now? Why not!!!!

2009-03-09T17:53:00.000-07:00

In my graduate class in Entrepreneurial Management a fine MBA student asked the question, 'why would anybody start a business in this environment?' At first, I had to ponder the question but after thinking about if for a few minutes, I responded, 'why not?' The discussion went on for a few minutes but most concluded that, especially for a young, energetic MBA student without a job offer, now is an opportune time.

From there, discussion centered on what one should focus on in the startup stage. There's a lot of research, anecdotal advice, and common sense suggestions from a variety of sources that can provide plenty of direction here. Here's my five suggestions to anyone thinking of starting a biz (note, I'm kinda into this 'list of five things'):

1. Find something you know. Research by Professor Amar Bhide (formerly at U of Chicago and Columbia, not sure where he is now) of the Inc. 500 companies found that a majority of the founders of these companies started a business in an industry that they had knowledge of. I'm going by memory here but I believe it ranges in the 70% level. Such findings make sense, people will enhance their probability of success in building a sustainable business if it's in the area they know best.

2. Don't be Einstein, Imitate but do it better. So many people feel that they have to have an 'original' idea when starting a business. In fact, research has shown that most successful businesses (again, related to the Inc. 500) are imitations of other business models. Find an existing business idea, maybe in another location, and bring that idea to your geography. Improve it, do it different, but don't feel you have to have the latest, greatest. If you wait till you have something totally original, typically you'll never start the business.

3. Find a PROFITABLE Niche. So many people start businesses with a great idea and have found some customers for it. Just having the idea with customers is just the starting point. You have to identify if there's a big enough market for you to make a living, that you can charge a high enough price and generate enough profit. Remember, you gotta pay yourself a salary.

4. Plan, Plan, Plan. Don't need a detailed 30+ page plan unless you're writing one for an investor or banker. Instead use the one page plan or at most the three to five page expanded exec summary. Cover the main points like you would in a detailed plan but keep it concise. Look at the market, the competition, the resources need, and what your competitive advantage will be. Examine the financial feasibility regarding pricing vs. costs vs. investment. The purpose is to make you put your thoughts on paper, not keep it between your ears. The act of writing it down forces you to look at things in different ways and also will require revision after revision after revision. You need the road map.

5. Bootstrap. Seth Godin, famous entrepreneur, speaker and writer, believes in the Bootstrap mentality. In my view, bootstrapping doesn't mean keep things cheap. Instead, think about what it is that is your critical success factor (might be the brand, the customer service, the food, etc.) and make sure you over-invest your time and money in that critical resource.

For all others expenditures, try to identify if you really need to spend money on an activity, can purchase it less expensively as used, can barter with somebody, or can even outsource it. So many times, new business owners feel the need to have a nice office, great furniture, expensive letter head, etc. I recall a former client who needed to purchase an expensive microscope for their research and development. A new one was upwards of $200 thousand or more. Instead they got on Ebay and found a lab in the Carolinas that had experienced a flood. Their microscope was fine but the lab was wrecked so the client was able to purchase a used but effective scope for $20,000.

Bootstrapping does a couple of things. First, the company requires less financing. Less financing either saves on interest expense or allows you, the owner, to keep more of the equity for you and the key employees. Second, bootstrapping sends a message to stakeholders - it tells them that the company values how the monies are spent and also what it is in the business that truly matters (you spend on the important stuff).

So these are my five items for starting a business. We could probably spend another three or four hours adding to it but based on my experience, these are some of the most critical. Why not start your business, NOW?

Guest Blogger - Dr. Rich Schifreen, CEO/President of Playtpus Technologies

2009-02-27T09:14:00.000-08:00

I'd like to welcome Dr. Rich Schifreen, CEO/President of Platypus Technologies here in Madison, Wisconsin as our guest blogger today. Rich has an incredible amount of experience in the life science industries as well as being one of the founding faculty members of the UW-Madison Masters in Biotechnology. Thanks RICH!

This is a first for me and I really appreciate the invitation from Prof. Greenwood to add my thoughts. Some very quick background - I teach with Prof. Greenwood in the business tract of the MS in Biotech program at UW-Madison. I'm also the CEO of a small early stage company - Platypus Technologies. This is a first CEO position for me and I have learned as much in 2 months as probably the last 10 years of executive positions in small biotechs.

Of course, all of our focus right now is on cash -- in short making certain we survive to reformulate and implement our strategic plans. There is endless discussion of this right now and I won't add to it. Once you get past the finances - its all about people. How many entrepreneurs set their first (or second or third) priority to establish a solid infrastructure for recruiting, retaining and evaluating people? The exception is they do focus on "rewarding" to the extent of creating a complex web of options, bonuses and other landmines in employment agreements. Sooner or later, the shine wears off and someone has to deal with having people work together productively to accomplish the company's objectives.

People are people and small companies eventually have all the same problems as their larger neighbors. One employee decides he doesn't like the job he's supposed to do and just does something else. Another has some personal issues that have overflowed into the workplace. A third feels she's underpaid and demands a major adjustment (coincidentally after she learned that the company has already caved-in to others). Then there are the run-of-the-mill performance issues, employees who just don't get along, people who say dumb and sometimes hurtful things and supervisors who just don't understand the difference between raising their children and managing co-workers.

I can't claim to have an answer to every problem, but I can urge you to resist the temptation of believing they will go away on their own. They won't. Another truth is that your best employees are the ones who will have the easiest time finding another job. If you don't address your problems, you'll be stuck with them -- while someone else will get the benefit of your stars. Thinking about trying to run a company that consists of only your most problematic and poor performers should spur you to action.

One very disturbing thing I've noted is that surprising few managers have ever received training in how to deal with problematic employees. Most have learned only one thing - give a warning and then you can terminate. In most cases there are much better approaches that have a good probability of success. Terminations create their own problems - in dealing with the affected individual, the morale of the organization and the reputation you develop with outsiders. It is usually preferable to take some corrective action to remedy the problem and bring the employee back to being an acceptable performer. Terminations should be the last resort.

You won't solve all of your problems overnight. However, having one less problem today than you had yesterday is always a good start.

DrPhilGreenwood's Wisconsin Business Blog: Growth Strategies for Small Business

A Fund Raising Strategy

The Entrepreneurial Plunge? Should you?

Venture Capital for 2012

The Debt Crisis and Ceiling

Skype and Stock Options

Economic Slowdown? Why?

LinkedIn IPO - Bubblesville, here we come?

Oil Prices and GDP Growth - the impact

The Founder/CEO Model in Entrepreneurial Firms

Legal Advice for Startups

Small Business - Improve Your Cash Flows - Mobile Payments is one way

Google vs. Facebook

The Sale of another Wisconsin Firm

Bi-Flation - the new economic buzzword?

Currency wars and impact on small biz

Inflation - is it here?

Financial Metrics -Part 3: The Net Balance Position

"Deflation" = the dreaded 'D-word'

Financial Ratios to Monitor in Distressed Times Part 2

Financial Ratios to Monitor in Distressed Times Part 1

T1 = (Current Assets-Current Liabilities) / Total Assets

Strategy Plan: Part 2 - The Strategic Lessons Learned

As a country how are we doing? feeling?

The Beveridge Curve - unemployment

Setting the Strategy - Mission and Vision,first! (Part 1)

The Unemployment Picture in the US?

Managing Growth in the Entrepreneurial Firm - The Administrative Type Company

Grow, Grow , Grow - The Market/Innovation Enterprise

Addressing Business Failure - What 'type' of business are you? Structuring yourself to grow - the Product/Service Configuration

Identifying the causes of small business failure and termination

Koss Stereo and the Trusted Employee Phenomena

The 'Real' National Debt...

Sustainable Growth Rate - Applicable at the Macroeconomic level?

Starting a business now? Why not!!!!

Guest Blogger - Dr. Rich Schifreen, CEO/President of Playtpus Technologies

T₁ = (Current Assets-Current Liabilities) / Total Assets