Meadow CreekNews

How Much Should a Business Make?

Filed under Business Management, Small Business, Venture Capital and Start Ups on December 24, 2008

How much a business should be making is not an easy question to answer, although all too many answer it without a lot of thought. Too often those who put themselves ahead of the business consider the answer to be as much as possible no matter what the circumstances. This can only be acceptable if more senior management have an equally short-term, self serving and/or simple minded view of life. A somewhat more thoughtful, but nonetheless equally inane response is to establish the profitability of the industry leader as the benchmark.

The majority of companies that I have worked with were once profitable industry leaders, subsequently pillaged by management trying to make themselves look good. Any fool can cut cost and increase short term profitability. It takes a little more talent than that to actually run a business for the long term. All businesses have intrinsic costs and an intrinsic value to their customers. That leaves a level of profitability that is largely dependent upon whatever competitive advantage the company happens to enjoy.

If a company cuts cost below that required to maintain its position net of that competitive advantage, it will lose share and or profitability. These changes are cumulative and the longer the imbalance is sustained, the more pronounced the imbalance and more rapid the decline. Likewise, recovery becomes longer and more expensive.

Strategy needs to honestly reflect this. My experience has been that companies have a far easier time recognizing issues of competitive advantage versus the time and cost to correct them. Common solutions are Hail Mary plays like leap frog product development plans involving concurrent design and production, solutions based on cumulative dependencies on developing technologies and a belief that it can all be done on a shoestring budget. Others include the development of something far less expensive and time consuming, a false reality. The continuous redefinition of their served market to show share growth while maintaining unsustainable low levels of spending to show profitability. Either way, the business is doomed.

A good strategic plan should not always be a pretty picture. Recognition of the harsh realities of the competitive environment is imperative. If it is unacceptable, the company should explicitly state an exit strategy such as divestiture or milking the business (a more accurate description of this would be running it into the ground). It has always frustrated me how difficult it is for firms to accept the latter even when it is obvious that the net effect of their actions is just that.

Strategic planning requires a dispassionate view of the business. Most importantly, it takes seasoned management to recognize the real time and cost required to effect change and the supremacy of that judgment over what someone wants to or thinks a business can make.

Richard Gabel

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