Tuesday, May 7, 2013

The color of the t-shirt

In a recent conversation I was told by the founder of a failing firm that the only difference between his firm and that of a major competitor was "the color of the t-shirt".

Did you wince? I did.

This post is to use that failing firm as an example to point out some pitfalls that should have been avoided - in business analysis, business models, and business modeling - in the hope that others can avoid similar pitfalls.

As you read this, you may think: "basic mistake"; "common sense" etc., and you would be right. That said, this post is not to shame but to inform, for sadly many young firms do not think things through. Many large firms also make some very basic and similar mistakes though often for different reasons (organizational silo's, ego, too many "yes men" etc.).

I also do not want to shame because I found the entrepreneur to be a likable person, who gamely pursued an idea that he thought was good and I believe that he has learnt a few lessons from his ventures (this was the second one that failed). He also called a spade a spade and closed the business down when he realized that the venture was not viable. It takes courage to admit when you are wrong. Also commendable was the comment he made about feeling bad for those employees that had stuck with him. The entrepreneur in question will not be named nor will the type of business be mentioned.

So back to the beginning ..... and let's call the entrepreneur in question "E".

E came across my blog and wrote in asking for the link to the position papers and followed that up with a request to meet. We also discovered that we had a firm/client relationship. The meeting was to discuss E's business.

I started by asking E a few questions about his business and began listing out thoughts and ideas as E filled me in on his business (I already knew the product offering as a client) model i.e. purchase products on demand from low cost suppliers and charge clients typical retail rates. The product would also be delivered for free.

After this introduction but before exploring cost and revenue aspects I pointed out to E that essentially he was taking on what other businesses avoided i.e. "the last mile". As one can imagine, it is possible to build scale efficiencies before the last mile via distribution hubs, inventory management and so on. The last mile however is by definition distributed and costly to serve. An analogy would be that the process before the last mile is "mass production", while the last mile is a "custom" product. Businesses that have to be engaged in the last mile typically do so by having the customers pay for it and/or outsourcing the last mile delivery.

Given that E was taking on the last mile, he had scaling issues unless he found alternatives. Therefore the hope was that he was at least making money on the value chain before the last mile.

It turns out he was not. He had only one supplier who would not discount the goods purchased, and had (albeit small) working capital costs to boot because there could be a day or two between when E paid the supplier and when he collected from his clients.

At this point in the conversation I already had a sinking feeling. I pressed ahead with some cost and revenue aspects hoping to hear of cost efficiencies and pricing based on value. At a minimum, the hope was that the difference between the low cost supplier and typical retail price would allow for a sufficient net margin.

The opposite happened to be true. E had played the "lower cost to you" rather than the "value to you" card. He started off by offering a 20% discount on the delivered product thinking that it would be an investment (the difference between the discount supplier and "typical retail" being much less than 20% E was clearly buying customers) and build his customer book. It did build his customer book but it also hurt him badly when customers took up the offer en masse and overwhelmed the fledgling system he had resulting in his inability to deliver products to some customers; and it hurt him because clients now used him to simply get the discount, and left as soon as the discount stopped i.e. the customers were loyal to the discount, not to the firm.

My point here is that that thinking should have occurred before the business was launched. It took me about 15 minutes to get to the crux of it and by experience, E had learned his lesson. The point here is that one should model their businesses before they start it. Had E modelled his costs, and noted that he had no wiggle room on the supplier side, and that he had transportation and operating costs he would have come up with a simple revenue less costs equation that would have given him a clear picture as to the viability of the business model.

It would also have led him down the path of exploring whether he could price on value to start with. Having gauged the competition, and there was one large competitor that was getting investor funds and competing on price to customer, E concluded that the only way to compete with the larger competitor was on lower price to the customer i.e. to do exactly what the larger competitor was doing. As an aside, apparently this competitor has stated that it was losing money too but hoped to turn things around.

Again, had E modelled that aspect (i.e. low price) it would only have confirmed to him that he should not be entering into that business in the first place - unless of course he used a different approach/strategy, and had viable means of getting market share or extracting more value from the very start.

Yet, when I asked E what the difference was between him and his competitor he said that it was pretty much "the color of the t-shirt". It was actually a lot more. Some examples: they had a brand of sorts; they had some scale efficiencies in comparison; they give clients the option to pay before receiving the product (reduces working capital).

The writing was on the wall for E. He shared some of his numbers with me and then confided that he had already decided to shut down and had only wanted to convince himself that he had not left any viable avenue open (he owed that much to himself and his loyal employees in his opinion).

My suggestion to him was to either re-launch using a value strategy and building in (higher value) bespoke services while outsourcing delivery; or to shut down. Given that he felt he had explored some of the bespoke services I mentioned as examples, and his belief that customers would not pay for value as soon as the first cheaper competitor arrived on the scene, he really did have only one option.

Shut down.

I am now, because the service was so useful, a client of the competition.

A sad story because it could have been avoided. Sadder still because it is not the only such story.

Here is to hoping that entrepreneurs will take the time to think some of the basics through, and use realistic assumptions and different scenarios to do so.

Stay well. Stay true.

Vishnu.