Over the past months we looked at two lessons for business survival. Last month we discussed the business offering and the lesson that you must be selling some good or service that people actually want to pay for. The month before that we looked at the lesson that money earned must be collected or insolvency will result.
This month we look at indigestion and starvation. When thinking of business insolvency most people will automatically think of businesses with no customers, or fewer customers than needed to make a profit. These businesses eventually die from starvation once working capital is exhausted. But too many customers can also be dangerous to business health.
Lesson Three: Indigestion kills as fast as Starvation
In 2004 and 2005 we wrote two articles starting with the anonymous quote: “More businesses die from indigestion than starvation”. While we do not know the numbers, certainly we know that many businesses become insolvent (commercially die) from having too many customers and not having the business model to handle them. This is indigestion and can be described as the pain caused by taking on too much.
We wrote about three reasons for death by indigestion.
1. Uncontrolled or mismanaged growth. The expansion of a business is a process that needs to be controlled. Few business models can be expanded simply by adding more customers. Most businesses will need extra staff and facilities, possibly new premises, and the controls that go in place with a larger business. New work has to be profitable after those costs, but many businesses grow by undercutting competitors and this affects profits on all trading. The growth process needs to be controlled. If not, the result will be the expenditure of large amounts of money to obtain a lot of unprofitable and mismanaged work.
2. Lack of Funds. Available working capital needs to be sufficient to fund a large and fast increase in turnover. Growth costs money. It may require expenditure on equipment, people, consultants and – importantly – supporting the business, or the new part of the business, until it again becomes profitable. Many growing businesses fund their expansion through credit – whether from banks (if the growth is planned) or from trade creditors (if not). In these cases more trading means more debt.
3. Post-growth management. More staff, more locations, more stock and equipment means more management is required to run the business. Some business owners try to manage the business part-time whilst still trying to work a full week ‘on the tools’ – or on the other end of the scale – some business owners lock themselves in the office trying to manage the paperwork monster, while delegating all on the job work (including quality control) to staff. Obviously a balanced approach is preferable.
TC Pty Ltd’s demise was brought on by indigestion. It was in the commercial construction industry and was run by two brothers (one being the director). For years these brothers ran a very successful business, charged a good price and made good profits. Each brother ran a team of people so work and quality was closely monitored. The company had a good reputation for quality work and was the business of choice for many builders and developers. It seemed like a good business model.
But its success ultimately was its downfall. The company received more orders for work than it could handle with its available two teams. A decision was made to create 5 teams – the two brothers each running a team and three employed foremen would run the other three teams. Extra people were sourced and extra equipment was obtained (read: financed). The brothers had to delegate quality control and job management in three of the teams to the foremen.
There were problems with the work done by the employed foremen and this lead to rework and large rectification costs. A lot of the work was unprofitable and the few profits that were made could not support these losses. The two brothers started spending more time solving problems, neglecting the teams they controlled leading to more problems. Then one large job that should have been very profitable went bad and very large losses were incurred. The brothers rightly considered that the company had become or would very soon become insolvent and we were appointed.
This is a case where people that were very good at their trade, and capable of running a business that earned good profits from that trade, went broke expanding the business. We have seen the same phenomenon in house building companies, retail stores (opening new stores) and restaurant businesses opening new outlets. It also occurs when business owners try to enter into a very similar business but where their expertise does not transfer. One example was a wholesale seafood outlet that was very profitable attempted to get into cooked retail outlets (fish and chip outlets). It only lasted a few months.
Business owners have to ensure that all growth in controlled. The infrastructure in place either must be sufficient to manage the grown businesses, or it must be increased and controlled. If not, business owners will have uncontrolled growth and run the risks of getting indigestion.
The lesson is that growth needs to be properly and financially planned, because indigestion kills as fast as starvation.
Next Month – Who’s job is that? – Maintaining proper business controls