Looking to Unlock Profit Growth? Look in your own Backyard.

 [Editor's Note: Recently I have had a number of conversations with business owners and CEOs about sustaining profitability. I thought I would reach into the "article archives." While we have published this a couple of times over the past twenty years, it is still relevant. - dpm]

Looking to Unlock Profit Growth? Look in your own Backyard.

Tier your customers by profitability by creating a profit map.  A profit map is a clustering of customers, products, services, and transactions by profitability, and an analysis of the key profit drivers. This forms the basis for rapidly improving a company's profitability through careful management of the details of the business without the need for major capital expenditures.

Let's look at the profit mapping process, using the example of a distribution company. The process has five steps.

Decide to analyze profitability at a "70 -80 percent accuracy" level. Some companies spend a huge amount of time and money setting up an activity-based costing system that is much too detailed. All too often, the measurement becomes the project, and after endless debates, many projects lose momentum before they are translated into actions that hit the bottom line.

The most important results usually will be very clear from rapid, intelligent analysis using best knowledge and rules of thumb. Once a profitability picture emerges, it makes sense to improve the accuracy only where better information will change an important action. In most companies, after the analysis is over, the managers institute only a few high-leverage initiatives.

Construct a profitability database for the company. Select a time period, often two to six months, that is representative, and load the full set, or an excerpted set, of transactions (i.e. order lines) onto a computer. Each transaction should carry crucial information including the identity of the customer and product, as well as special services. Next, develop cost functions and use these to net the transaction's gross margin (GM) 

In developing cost functions, it is generally best to allocate costs using an easy-to-measure variable. For example, allocating operations costs by transaction or order line usually works well, as each line entails order-taking and picking. Inventory carrying costs can be handled by rules of thumb, such as holding "A" items for two weeks, "B" items for four weeks, and "C" items for eight weeks. Transportation costs can be allocated through simple decision rules based on customer location (region, near to or far from a distribution center). Where a sales call is needed to take an order, that portion of the selling expense can be allocated by orders. Other costs can be similarly allocated with reasonable accuracy.

It's important to allocate all costs, including general overhead, for two reasons: (1) this enforces the discipline of viewing the whole cost of the business when determining whether to keep or change a major component; and (2) this ties the analysis directly to the company's financial statements, ensuring credibility and accurate projections.

  

This process will yield a database of transactions, each with revenues, GP, and NP. The database can be analyzed to display account, product, and transaction profitability. It will show you where the big pools of profits and losses are. The database also can be used to project the impact of changing the account and product mix, as well as changing the cost of key elements of operations and sales. The former shows the effect of focusing the company on high-profit market segments, while the latter shows the effect of altering the business model to change "bad" customers into "good" customers.

Model a customer - Determine the characteristics of the Chosen Customer. Choose a few customers and products that are reasonably representative, and look carefully at their economics. Try choosing a large and small customer each from a few key market segments, and a fast-moving and slow-moving product from each of a few key product families. Ideally, you will have about six to twelve representative situations to examine closely.

For each customer, look methodically at the profit drivers-revenues, margins, and costs-for different products. Try different business model configurations such as changing the order interval, sales interval, or service interval. Look at the pricing, both price levels and price mechanisms. Altering the product mix and developing substitution programs also can provide valuable levers for profit improvement.

Here, you are looking for "profit levers". Once you have found effective profit levers, check several other similar customers to be sure you can generalize your findings.

Modeling the effects of key profit levers on representative customers works well for three reasons: (1) it will be intuitively clear which elements of the business model (e.g. order pattern) can be changed and what the effect will be; (2) you can actually call the customers to see what their reaction to the potential changes would be; and (3) it will be easier to explain the changes using concrete examples when you "sell" the initiative to your colleagues.

Project to the whole business. Divide the entire business into clusters, or market segments, that are similar to the customers and products you've modeled. See where the big pools of profits and losses are now, and what the profit impact would be of making the changes. This will tell you what's most important to do.

With this picture of current profits and profit improvement potential, you can identify the few high-payoff actions that your company can take relatively quickly. First and foremost, act forcefully to secure the high-profit segment of your business. Only then institute a process to improve the profitability of the marginal part of the business. This process probably will include training front-line sales and operations associates in day-to-day coordination to improve profitability to its highest potential.

What about the unprofitable customers? Here's what the CEO of a major service company said about exiting unprofitable business segments or customers:  

"Before exiting, give them a chance to pay higher prices or modify the profit levers. We did exactly that. We knew our profitability was eroding. Through analysis, we found a business segment where we were losing money. Profit analysis allowed us to determine what changes would be required to generate acceptable returns. The underlying issue was not pricing-it was order pattern, order size, and delivery requirements. Before exiting the segment, we told our customers what we needed in order to continue servicing them. To our pleasure, they agreed to make the changes, and we saw a quantum improvement in profitability in six months!"

 

Finally, phase out the parts of the business that cannot be made profitable. This will be counter-intuitive and some in the company will resist, but keep your eye on the huge upside to refocusing 20-40 percent of your sales force and operations assets away from tending unprofitable business and toward aggressively growing your share of the highest-profit end of the business.

 

Institutionalize profit mapping. Reflect on the value produced by determining the tiers of customer profitability ("profit mapping") and decide to institutionalize the process. Repeat the analysis every three to six months. Once you have set up the analysis, subsequent rounds will go very quickly. The process itself will build teamwork and it will become a new way of looking at the business. In parallel, build profit mapping into the new account qualification process. As your profitability improves, new opportunities will constantly be created. The better you get, the better you can get.

 

From financial information to action.

The services company CEO mentioned above reflected on his experience with profit mapping, "Financial systems often do not have the information that you need. If they did, the problems would have been solved long ago. To be truly effective, you need to create a cross-functional team that understands how the business operates. This will allow the conversion of financial information into management information which, through analysis, will lead to action."

 

By the way, how do you hunt for profits? By looking in your own backyard-again and again and again! In work with Mead Consulting clients, our clients use proven methods designed to center their business around delivering continuous value to the best customers. Revenue and profit growth can be realized in the first 90 days of implementation.

¹Excerpted from an article by Jonathan Byrnes, The Bottom Line: The Hunt for Profits, HBSWK Pub Date: Nov.11, 2002

For more information on the process to unlock profits, please contact me at meaddp@meadconsultinggroup.com or (303)660-8135.

Plain Talk about Exiting Your Business: The Needs Gap and the Value Gap

[Editor's Note: Is this a good year to sell your business? There is a lot of misinformation about the state of the market for lower middle market ($10M to $200M in revenue) companies looking to sell - either now or sometime in the next few years. I asked some of our clients to provide questions that were on their minds. Answers have been provided by private equity firms, intermediaries, business owners, and bankers.

While excellent, well-managed companies are being sold at close to record prices, this article addresses a problem for companies looking to sell - how to address a "value gap" or "needs gap" that has developed between the current market value of their business and the amount they need or expect to get from a sale.

If you have any questions about this information or a question that we did not answer in the following, please do not hesitate to contact us. -dpm]

Question: How do I determine if my company has a value gap or needs gap?

Answer:

What many companies looking to sell are experiencing is called a "value gap" or "needs gap." This means that the company as it is performing or configured today will not achieve the sales price in the current market that it would have earlier before the recent rise in interest rates. This gap is the difference in value between then and now.

Question: How do I know the current value of my company?

Answer:

We suggest to our clients that they contact a reputable investment bank or M&A intermediary who can estimate a market valuation range for your business. This market valuation is very different than a valuation that an organization might do for estate planning or tax purposes. An M&A intermediary will value your company based on the current market for companies of similar size, industry, performance, and growth. A common mistake that owners make is comparing their company to the valuations of large publicly-traded companies in their industry. The truth is that large companies trade at higher valuation multiples - sometimes much larger multiples - because risk is generally perceived as significantly lower than with smaller companies. An M&A intermediary or investment banker can determine the appropriate market valuation range for your business.

Question: OK, so now I know the estimated value range for the business. Now what?

Answer:

Once a business owner knows the estimated value of the company, it's time to figure out how much the owner gets to keep and to determine if that's enough. Consulting with a competent tax accountant, you can calculate the net proceeds which is the estimated gross value of the business less the legal, accounting, and intermediary costs to sell the business, less the tax bite that Uncle Sam may take. [Many times there are built-in gains in the business that may make that tax bite significant - and your accountant and wealth management professional may be able to suggest ways to mitigate this BEFORE you sell.] Once you've determined the net proceeds, it's time to review this with your wealth management professional to determine how you might invest the proceeds to see if you will be able to support the lifestyle you expect.

Question: What if it's not enough?

Answer:

Then you and your wealth management professional must determine how much you do need. We then help clients develop a strategic growth and execution plan for the business, with specific steps necessary to achieve the increase in valuation in order to meet the owner's needs.

Question: Is that the needs gap?

Answer:

Yes. It is the difference between what an owner may need from the net proceeds of the company and what it's currently worth.

Question: Then what is the value gap?

Answer:

The value gap typically occurs when a company's performance slips. A company may have had a valuation of $1,000 in 2022, based on certain performance projections for growth of revenue and cash flow. If the company has failed to meet those projections for 2023, it may now only have a valuation of $700. That difference between the previously "expected" value and the current market value is the value gap. The gap may actually widen if buyers begin to suspect (or even imagine) that the business may have additional unknown risk. It is an uncomfortable place for all parties and typically the company is taken off the market.

Question: So what happens with a needs or value gap? Am I stuck staying with the business?

Answer:

Please note that in some cases, it may not be possible for a business to grow sufficiently to add enough value to meet an owner's needs, due to an aging industry, product obsolescence, etc. If that's the case, however, business owners tell us they would rather know that as soon as possible so they can possibly take other steps.

However, we have been pleasantly surprised over the years at how many businesses can actually achieve their needs with a good plan and great execution. Many businesses become a "lifestyle" business over the years, supporting the income needs of the owner. As a lifestyle business, many companies are worth more to the owner than to a prospective buyer looking for a return on investment. By focusing on the primary drivers of value for the buyer, a business can be transformed into a much more valuable entity.

Question: What are the drivers of value for the buyer?

Answer:

What are buyers looking for? It comes down to four things:

1. History of revenue and profit growth

2. Strong cash flow or EBITDA

3. Strong management

4. Opportunities for growth

In order to get the best price, you must be able to present a company that the buyer can see will bring them a reasonable return on their investment. That means the business has to have the potential to grow and has management that is knowledgeable in the industry that will help them grow the business. For more detail see "Prepare your company to be bought."

Question: Does that mean that businesses that don't have the four value drivers won't sell?

Answer:

No, but what is true is that flat or slow growth businesses, or those with an inconsistent history, are less desirable and therefore are typically "discounted" by buyers. Businesses without the four drivers have a higher risk of not meeting the desired investment return. Simply stated - higher risk means a lower price.

What is happening in today's market is that buyers are being more selective and those companies perceived as "less desirable" are either not sold because banks will not provide debt financing, or they are being deeply discounted.

Question: How long does it take a company to transform from a lifestyle business to a value business?

Answer: That depends on a number of factors. Based on the dozens and dozens of companies Mead Consulting has worked with, we would say it comes down to 12/24/36. That's 12 months, 24 months, or 36 months. We have found that by focusing company management on the key drivers, an organization can be ready to go to the market in as little as 12 months, but more typically it's 24 or 36 months. See "Maximizing Company Value at Exit."

We assist a company with direction and resources, but a lot depends on the commitment and discipline of the owner and management team. We tell business owners that there is no magic button to push - it's hard work. But, most successful owners agree that it's worth it. Many times, we can accelerate the process by helping the owner stay focused and hold himself and the management team accountable for progress.

Question: How much progress can a company make (over 12/24/36)?

Answer:

We've seen companies with needs gaps improve valuation by as much as 500% over 36 months. A $50M revenue client company that sold a few years ago had a 16X IMPROVEMENT IN EBITDA in the preceding three years. Another more recent client valued at $20M in early 2017 sold for $80M in 2019. While these situations are possible, it is more typical to see improvements in value of 30% - 50%.

Question: As a business owner, what should I be doing?

Answer: Act Now! The stock market is at record highs, borrowing costs, while high currently, are projected to begin to come down in the next few quarters and both private equity and strategic buyers have stockpiles to invest. Start today to work on preparing your business to meet the four value drivers. Only those companies that are well-prepared will gain a top price; the others will, at best, sell at a steep discount.

For more information, also see "Common misconceptions about selling a business" 

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 The Mead Consulting Group has helped dozens of clients prepare for successful sales transactions ranging from $15M to $350M in transaction value. We help companies increase the value of their businesses leading up to a transaction, minimize the things that cause potential buyers to discount the price, prepare to best position the company, and assist the owners in building a transaction team.

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What successful business owners say about us:

 ...We could not have completed the sale of our business without the advice and guidance of The Mead Consulting Group. Their experience was critical in helping us prepare, and endure, the transaction process to a successful outcome

. ...Charles M, President, Healthcare IT Company

 

A successful process is draining and stressful. The Mead Consulting Group brought the experience and expertise necessary to help our team focus on the critical issues and not get caught up in the multitude of items that can derail a transaction. Why reinvent the wheel? We chose to take advantage of individuals who could help us understand the nuances, negotiate effectively, and close the deal 

. ... Ken W, CEO, Behavioral Healthcare

...We missed the opportunity to sell our family business during the last upcycle. Mead Consulting helped us grow revenue and EBITDA to record levels and guided us through the selection of a transaction team. Dave Mead and his group provided great counsel throughout the sales process, removing obstacles and firmly encouraging us to a great deal with a strategic buyer that mirrored our family business values.

...Dan M, President, Building Products Company

...I do not know why anyone would attempt to sell their business without Mead Consulting. Since they have owned and sold their own businesses, they understand the challenges of continuing to run the business while trying to sell it. Their experience kept us focused on the right things and they helped keep our transaction team well-aligned during the process. They truly act as the advocate for the CEO and owner, helping to make sure that it was the best deal for the owner. ...Ron T, CEO, SaaS -Business Services

   

 Let us your your thoughts. Post your comments below.

For more information on the process to unlock maximum value, please contact me at meaddp@meadconsultinggroup.com or (303)660-8135.

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At The Mead Consulting Group, we have worked with many companies to prepare them for a successful exit.

Check out our website for descriptions of some client success stories.

If you would like to discuss how we might help your company begin the process of adding value and moving your company to the next level of preparation, please contact us for a free consultation. 

Best regards,

Dave Mead                

Preparing for an Exit - Take the Value Creation Assessment TM

 [Editor’s Note: Many business owners are busy running the business and do not take the time to prepare for an exit. Often, they do not even think about it until they receive an unsolicited offer from a prospective buyer. Business owners who have prepared for an eventual exit typically have a smoother transition and receive a higher value for the business. - dpm]

Preparing for an Exit - Take the Value Creation Assessment TM

An offer comes out of the blue. A company in your industry, whom you may have known for years, contacts you with an offer to buy your business and states that they can close in 30 to 60 days. What's next?

If it seems too good to be true, it likely is. History tells us that "one buyer offers" with promises of a fast close - for a company that was not prepared -wind up stretching out for many months, often with changes in the purchase price offer, and consuming lots of the seller's time and resources - only to end in a broken deal. Or...the offer is significantly less than the seller could realize with additional prospective buyers.

Businesses can operate for many years in a somewhat informal manner with handshake agreements, employees with tribal knowledge of process, etc. Many business owners are surprised when they learn that you can't sell an "informally run" business for a premium price.

What determines the value of a business... to others?

• Solid performance history.
• History of improving revenue and cash flow.
• Capable management team.
• Strategic growth opportunities.
• Documented repeatable processes.
• No "gotchas" (no surprises during due diligence).

Surprises will cost you. Buyers hate surprises. When a buyer discovers something during due diligence (issues with financials, issues with customers or suppliers, issues with employees, etc.), it causes them to look deeper, wondering what else they might discover that was not disclosed. This potentially breeds distrust and often results in a change to the offering price.

Identifying and resolving issues in advance saves money, time, and leads to a cleaner, more productive transaction. Identifying potential issues in advance allows the company time to resolve them over time, at lower cost...and a lot less stress. For example, it can take time to clean up contracts with customers and suppliers, resolve issues with financial statements, etc.

We can help. Take the Value Creation Assessment TM. For over two decades, The Mead Consulting Group has been working with companies to assess their preparation for a potential sale, identify issues and recommend corrective actions. Investment bankers and buyers have remarked that companies that have gone through this process are the best prepared that they've worked with. We help companies routinely go through this assessment in several days. Then they can be armed with detailed action plans to be best prepared.

For more information on the process to unlock maximum value, please contact me at meaddp@meadconsultinggroup.com or (303)660-8135.

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Steps to Best Prepare Your Company to Borrow

Preparing your company to borrow involves several steps to ensure financial stability and credibility and enable a smooth borrowing process.

1. Assess Company's Financial Condition: Conduct an in-depth analysis of your company's financial statements, including cash flow, profit and loss, and balance sheets. Ensure financial records are accurate, up-to-date, and reflect the true performance of your business.

2. Develop a Solid Business Plan: Create or update your business plan, outlining your company's objectives, target market, growth projections, and strategies for success.

3. Understand Borrowing Needs: Determine the specific purpose and amount of funds you need to borrow. Whether it's to purchase new equipment, expand operations, or cover operating expenses during slow periods, having a clear understanding of your borrowing needs is essential.

4. Strengthen Creditworthiness: Strengthen your company's creditworthiness by maintaining a positive credit history, paying bills on time, and reducing outstanding debts.

5. Prepare Documentation: Prepare and organize necessary documentation, including financial statements, tax returns, business licenses, and legal documents.

6. Research Lending Options and Establish Relationships with Lenders: Research types of lenders (banks, non-bank lenders, asset financing, etc.). Cultivate relationships with potential lenders by networking, attending industry events, and seeking recommendations from other business owners and outside consultants. Building rapport with lenders can improve your credibility and increase the likelihood of loan approval.

7. Create a Loan Proposal: Develop a loan proposal that highlights your company's strengths, borrowing needs, repayment plan, and how the borrowed funds will benefit your business. This can increase your chances of securing financing on the best terms.

8. Review and Negotiate Terms: Review loan terms, including interest rates, repayment schedules, fees, and penalties. Understand if personal guarantees are necessary and those terms.

9. Establish and Maintain Good Communication with Your Lender: Remain in regular communication with your lender throughout the borrowing process. Respond to any concerns or questions promptly and provide requested information in a timely manner. Maintain good communication with lender throughout the term of the loan.

New Approaches to Strategic Planning

 [Editor’s Note: As we enter 2024, uncertainties loom large for Business owners and CEOs. Navigating these uncertainties requires strategic foresight, adaptability, and a proactive approach. This article explores what new approaches to strategic planning that business owners and CEOs should adopt to prepare for the uncertainties that may arise, ensuring sustainable growth of revenue and profitability in the face of challenges. We hope you find this thought-provoking. –dpm]

New Approaches to Strategic Planning

Strategic planning is the cornerstone of any successful business, providing a roadmap for growth, sustainability, and competitive advantage. In the dynamic landscape of lower middle market companies, which typically operate with limited resources, limited access to capital and face unique challenges, traditional approaches to strategic planning may fall short. New innovative methodologies have emerged that address the specific needs of these businesses.

Flexible Plans with Frequent Updates. Traditional strategic planning often involves rigid, long-term plans. In contrast, an agile approach embraces flexibility and adaptability. Companies benefit from shorter planning cycles, allowing them to adjust strategies based on real-time feedback and market dynamics. This iterative process ensures that the organization remains responsive to changing circumstances. We recommend that companies review strategies every 3-4 months.

Scenario Planning. Given the uncertainty in the business environment, scenario planning has gained prominence. Prior to 2008, scenario planning was utilized mostly by larger companies. Since that time, a greater number of lower middle market companies have embraced scenario planning. Scenario Planning involves developing multiple strategic scenarios based on different possible views of the future. Companies can use this method to identify potential risks and opportunities, enabling proactive decision-making and risk mitigation. Managers can “rehearse” how the company would respond to various scenarios.

Data-Driven Decision-Making. Leveraging analytics for strategic planning is essential. Companies can harness data to gain insights into market trends, customer behavior, and operational efficiency. This data-driven approach enables informed decision-making, minimizing risks and maximizing opportunities.

Collaborative Strategy Development. Strategic planning is not a task for the executive team alone. Companies are involving key stakeholders at various levels, which fosters a sense of ownership and commitment to the strategic goals. Collaboration encourages diverse perspectives, leading to more comprehensive and innovative plans.

Customer-centric Planning. Understanding and meeting customer needs is paramount for success. Lower middle market companies can differentiate themselves by adopting customer-centric strategic planning. This involves a deep analysis of customer preferences, feedback, and market trends to tailor products and services accordingly.

Digital Transformation. Embracing digital technologies is no longer a choice but a necessity. Companies can use strategic planning to create a roadmap for digital transformation. This includes adopting e-commerce, enhancing online presence, and implementing automation to improve operational efficiency.

Strategic Partnerships: Collaboration is a powerful tool for growth. Lower middle market companies can explore strategic partnerships with other organizations to share resources, access new markets, and benefit from complementary expertise. Strategic planning should incorporate a roadmap for identifying and nurturing such partnerships.

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We can help. At The Mead Consulting Group, we utilize many of these approaches: 

Customer Forward™ Strategic Planning Process, Scenario Planning, and “Agile” or Flexible Planning are some of the approaches we use to provide the best tools available for clients.

Check out our website for descriptions of some client success stories.

 If you would like to discuss how we might help your company begin the process of adding value and moving your company to the next level of performance, please contact us for a free consultation. 

Best regards,

Dave Mead