Boeing’s 737 Max issues highlighted the company’s sacrifice of safety for financial performance, resulting in a tarnished reputation. The prioritization of profit over core values also damaged the FAA’s credibility and revealed a lack of accountability for top executives. This downfall serves as a reminder of the importance of maintaining core values and prioritizing them over short-term financial gains.
Over the many years I spent advising business owners on the sale of the companies, many owners had some specific date in mind for when they would be ready to sell. Usually, this was always five years away and as a result some higher figure than what the business was worth today. Well, COVID came along and changed the game! Whatever you thought your business was worth six months ago, think again!
Many well-performing companies that maintaining their historical levels of revenue and EBITDA might find that their value is half of what it was a year ago. Why?
What Drives Value
Many owners have told me how great their team was, but on inspection, the owner made all decisions and told them what to do. In that case, the owner doesn’t have a company, he has a job, and that you cannot sell.
Is the team managing indispensable or replaceable? The management team is essential, as they have to lead the company and deal with the fast-changing environment we are now facing. They need to understand and agree on:
- the company’s strategy;
- how each of them is executing it;
- the company’s business model;
- what the business’s value drivers are; and
- when the company needs a new plan and strategy.
What is your business model? How do you make money? This latter question is a great test for many because I challenge business owners to keep the answer as succinct as possible. The gold standard is Herb Keller, Founder of Southwest Airlines, “Wheels up.” With that, your employees can understand what they do helps.
Next, what is your Flywheel? Jim Collins described it as follows,
“The premise of the flywheel is simple. A flywheel is an incredibly heavy wheel that takes huge effort to push. Keep pushing and the flywheel builds momentum. Keep pushing and eventually, it starts to help turn itself and generate its own momentum–and that’s when a company goes from good to great. We all know success is based on focus and hard work. But dive a little deeper and the flywheel concept can provide clarity and help drive strategy for any business in any industry. Here’s why. A flywheel is also a self-reinforcing loop made up of a few key initiatives. Those initiatives feed and are in turn driven by each other, and build a long-term business.”
Amazon’s flywheel was described as follows in The Everything Store, “. . . Bezos and his lieutenants sketched their own virtuous cycle, which they believed powered their business. It went something like this: lower prices led to more customer visits. More customers increased the volume of sales and attracted more commission-paying third-party sellers to the site. That allowed Amazon to get more out of fixed costs like the fulfillment centers and the servers needed to run the website. This greater efficiency then enabled it to lower prices further. Feed any part of this flywheel, they reasoned, and it should accelerate the loop.”
The point to note is that “Feed any part of the flywheel, and it should accelerate the loop.” What is your flywheel and where is it not functioning well?
With that established the next questions to ask are:
- Is the business model still the right model?
- If your business model is a legacy model, what is it worth?
- Is there an emerging model complementary or competitive with the legacy model, and when could it take over?
The employees need to be passionate about the company, its mission, vision, and reason for existing. Culture and core values are essential! If your employees live the core values, know the company’s mission, vision, the reason for existing, and how it makes money, they will go the extra step and you can drive decision making down to where the information is. With this knowledge, the employees knowing that they will make choices in the best interests of the organization. Enabling decision making further down the chain of command increases the agility of your teams and improves performance.
With the rapidly changing environment due to COVID’s accelerating effects, the business landscape has changed, and to respond, companies need new strategies, actions, capital plans, and human capital requirements. If your employees can feed the information up through the organization and adjust to the conditions on the ground, the organization has a higher chance of success.
What brand equity do you have? Do your clients buy because they want your brand, or are you just a commodity. Are you like Apple and Patagonia with loyal clients who will put stickers of your brand on their cars? How well do your customers and prospects know your brand? Are you visible across all available digital platforms, and does the purchasing decision-maker quickly see your band? How engaged are your customers? Are you attracting substantial traffic to your site, and are they buying on it? What is your cost of customer acquisition across all channels, is it cost-effective, and can you move them to lower-cost channels? How would your customers rate their experience? Are you providing an experience along with the service or product? Is your customer experience rating improving or declining? Is there a difference between your customer experience seamless across online and offline interactions? Is it dependent on third-party providers? All these questions can help you understand your position in the market with customers. The more engaged and loyal your customers the higher your value.
What skills or capabilities does your company have that make your business work? Are they an asset to others, or do they give you a sustainable competitive advantage? To survive, organizations will have to adopt Kaizen – a culture of continuous improvement – and becoming efficient learning companies. Are you a “first mover,” a disruptor, or are you being disrupted? Strategic plans, budgets, variance analysis, processes, and data-driven decisions are critical. Are you sufficiently managing cyber risk, and does your security match your digital ambitions? Are you dependent on third parties for critical data? The plans and budgets may change a few times as we move through the business landscape changes, but having responses produced by employee knowledge and data will result in the organization responding better than those that are winging it!
Your organization must be a top performer in its sector. A devastating realization for many business owners is that not all companies are sellable. If you are not at the top of the pack and you don’t have any significant assets, then you may not be sellable at any price! Know how your peers perform and decide where you outperform them. Does the business have unique features that the competitors do not? Are your competitors more formidable with great resources? Do you have vendor contracts and relations that add to the value of your company?
Many years ago, I sold a company that had twice the profit margin of any of its peers. It had different processes and so the lowest percentage of working capital among its peers. Buyers fell over themselves to acquire it, and it realized over twice multiple of the industry leader.
- Sales, are they growing? What pricing power do you have? Has the company created new products or lines of business recently? What is driving your growth, and is ti sustainable?
- Do you “own” your customer data? Are you generating proprietary data that could be of value?
- Is the market growing or receding? What changes in the market could pose challenges for your business?
- Corporate Long-term Outlook – Does the future look rosy, or are headwinds approaching? Do you have the capital – financial and human to realize your strategy?
So What Has COVID Done?
COVID has triggered a recession more significant than the 2009 Great Recession, disrupting supply chains, changing historic demand drivers, and purchasing methods. These changes are driving digital transformation faster than at anytime as companies try to adjust to working from home, selling to customers in a virtual world, maintaining supply chains in a virtual world with continued buffering from traffics, closed borders, and logistics chaos. As a CEO of a large tech company recently stated, “We are witnessing what will surely be remembered as a historic deployment of remote work and digital access to services across every domain.” As I have said before, COVID has accelerated trends by 5 – 10 years and recent data show that in about eight weeks, we have vaulted five years forward in consumer and business digital adoption. As a McKinsey report recently said, “The COVID-19 recovery will be digital: A plan for the first 90 days.“
Without a successful digital transformation, companies will be left behind and migrating to irrelevance in most industries. In the face of accelerating change, corporate values are also in constant flux as the market responds to new information. Thus it is essential to keep top of mind the value your business is creating, how you make money and your flywheel.
As companies work through their digital transformation, many leaders have a clouded understanding of what drives their business’ value. If the organization doesn’t understand what drives value in a rush to develop new strategies, make new investments, and encourage cultural and organizational changes, efforts can be misplaced, destroying value rather than creating it. Also, there is often confusion within the organization as to what drives value when the organization is bifurcated between legacy and emerging models while facing unprecedented external challenges.
As you develop new strategies, plans, etc., ensure that you have metrics to measure the organization’s performance in the core business and its migration. If you are too focused on the new pivot, the core could start to underperform. A recent study by McKinsey & Co. says, “Business leaders must do the hard work of revising business strategies, reallocating resources, monitoring outcomes, and otherwise enhancing corporate performance over the long term,” to create value.
Many leaders try to reposition the organization as SaaS or recurring revenue businesses to realize higher multiples. However, if on examination, the company has not repositioned itself and is just imitating, then the leaders don’t know where the value creation lies. Understand your value creation is a competitive advantage and should drive everything.
A recent study by The National Center for the Middle Market at Ohio State University found that middle-market companies with a strategic approach to their digital transformation grew faster than their peers. While over half of the executives surveyed said digital transformation was necessary, less than 10% believed it was critical to their company’s strategy. Sadly, this reflects a failure to tie digital transformation to value creation.
As I used to say in my talk “Why Selling Your Business Is Like Dating at 50,” remember you want the buyer to fall in love with the business because then the price is no longer such a driver. Thus, you need to know what outside observers value in your business and use that to guide strategy. It may not be what you think it is. I remember early in my investment banking career looking at Playboy for a client. Our client was not interested in magazines or bunnies, but they wanted cable TV distribution. At that time, there were only about 30 channels, and they were all taken; however, Playboy was on just about every cable box.
So keep in mind:
- Who is the ideal buyer?
- How can my business add value to that company or companies?
- Where should I invest in my company to ensure that these buyers will find my business attractive?
The economic downturn has buyers looking for bargain purchases, according to a recent study by Deloitte of 1,000 executives at corporations and private equity firms about current deal activity and expectations for the next 12 months. However, for those owners who are planning to exit at prices they expected six months ago, those plans will have to be put hold while they work to return the value of their businesses to prior levels. Unfortunately for some, they will not have the energy to recreate the organization and drive value once more, given their age and shape of their organizations. Those organizations will probably be unsellable and die.
For those that can capitalize on the change and drive value, the outlook is good. I hope you are in the latter.
Copyright (c) 2020. Marc A. Borrelli
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