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Business transformation - Building the company to Sell

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Small companies though faster and nimbler than larger companies and MNCs, do experience headwinds, hit a growth plateau and face uncertainties. Small companies are faster because of the founder mentality, which is a sense of mission and a passion for front line customers. They have a deep understanding of what their customers want. This is what makes them successful. However, smaller companies tend to be very dependent on a few customers. They find it difficult to sustain their effort in the long run. The owners of these companies usually depend on preferential access to clients, capital and talent to achieve initial success. Replicating this pattern in the long run is difficult. To be sustainable in the long term needs an ability to scale. At this stage, founders are faced with two options – grow and transform the company so that it can be sustainable. Or, they often think of exiting the business due to challenges in succession, lack of ability to invest etc. Even if they need to sell the business, there still is a runway to grow and transform the business for sale. Though the two options involve undergoing a transformation of sorts, the agenda and goals will be a different in each.
It is clear that companies, whether old economy or start-ups, need to work on a few areas before they sell out. All of these companies seem to be adding value somewhere which is what makes them attractive to buyers. Start ups in Israel take 4 years to sell out and on an average make 7 times their Return on Investment. In France they take 7 years to sell out and the ROI is less than 4. German companies too an average of 4 years to sell out, and their return was 2.5 times their initial investment. For most start ups, it is new technology which others think will be the next big thing. But there are lot of investors like Warren Buffet and large corporations, which make strategic investments to park their cash safely, especially given the uncertainty in the global economy. For them, old economy companies that can deliver regular dividends and has a self sustaining business will always remain attractive. Hence the question is what companies need to do to transform themselves to sell. Asian paints for example bought out the brand and entire front end sales of Ess Ess bathroom products, because of the capability Ess Ess had developed in this area. French company Lactalis acquired Tirumala Milk products for its niche products and infrastructure that it built over the years. Be it chemicals, pharma or engineering, M&A of small companies have been happening for various reasons like the people and skills possessed, functional competencies, benefits of integration to the buyer, regulatory clearances available or strong presence in the value chain.

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Business transformation - Building the company to Sell

  1. 1. 1 | P a g e Business Transformation – Building the Business to Sell R.M Sanjay, Director (Sales and Marketing Group) rmsanjay@browneandmohan.com Abstract: Small companies grow quickly & hit a growth plateau. Founder-owners then decide whether to grow or sell the business. Even if they decide to sell, there is need for transformation and capability building to make the business attractive and valuable to potential Buyers. This paper talks about the value drivers along which to transform the company to sell. Introduction Small companies though faster and nimbler than larger companies and MNCs, do experience headwinds, hit a growth plateau and face uncertainties. Small companies are faster because of the founder mentality, which is a sense of mission and a passion for front line customers. They have a deep understanding of what their customers want. This is what makes them successful. However, smaller companies tend to be very dependent on a few customers. They find it difficult to sustain their effort in the long run. The owners of these companies usually depend on preferential access to clients, capital and talent to achieve initial success. Replicating this pattern in the long run is difficult. To be sustainable in the long term needs an ability to scale. At this stage, founders are faced with two options – grow and transform the company so that it can be sustainable. Or, they often think of exiting the business due to challenges in succession, lack of ability to invest etc. Even if they need to sell the business, there still is a runway to grow and transform the business for sale. Though the two options involve undergoing a transformation of sorts, the agenda and goals will be a different in each. It is clear that companies, whether old economy or start-ups, need to work on a few areas before they sell out. All of these companies seem to be adding value somewhere which is what makes them attractive to buyers. Start ups in Israel take 4 years to sell out and on an average make 7 times their Return on Investment. In France they take 7 years to sell out and the ROI is less than 4. German companies too an average of 4 years to sell out, and their return was 2.5 times their initial investment. For most start ups, it is new technology which others think will be the next big thing. But there are lot of investors like Warren Buffet and large corporations, which make strategic investments to park their cash safely, especially given the uncertainty in the global economy. For them, old economy companies that can deliver regular dividends and has a self sustaining business will always remain attractive. Hence the question is what companies need to do to transform themselves to sell. Asian paints for example bought out the brand and entire front end sales of Ess Ess bathroom products, because of the capability Ess Ess had developed in this area. French company Lactalis acquired Tirumala Milk products for its niche products and infrastructure that it built over the years. Be it chemicals, pharma or engineering, M&A of small companies have been happening for various reasons like the people and skills possessed, functional competencies, benefits of integration to the buyer, regulatory clearances available or strong presence in the value chain.
  2. 2. 2 | P a g e Challenges There could also be succession issues where the next generation would like to explore their own life and not be very interested to run the company. Alternately, the founder’s knowledge could have been the foundation of the company. It can be a niche technical field where offsprings do not have the necessary knowledge. At these times, the owner can decide to sell and retire, so that his offsprings can pursue their passion. But founder run companies rarely are ready to sell. Dimensions of Transformation Build to Sell Build to Grow Goals  Increase profitability, reduce losses & wastage, predictability in revenues  Sustainability - Improve and build capabilities, transform behaviour, teamwork and coordination Leadership  Is usually top down, since speed is necessary  It is more consensus oriented to elicit employee commitment, change comes from bottom up. Drivers  Structures  Systems  Mobilize resources – eliminate waste  Organize  Financial incentives for results  People, skills  Knowledge, culture  Mobilize resources to invest  Innovate  Skill based pay, corporate wide bonus sharing Consultants  Hired to implement and drive change  Engaged to elicit and catalyze employees to own and drive change Regardless of the path to transformation that is taken, with scaling comes problems like slowness, that erodes competitiveness. This is the growth paradox. When revenue grows faster than talent, companies put in place systems. They hire average talent, and the mission becomes a rule book. Accountability starts to erode. Managers become math oriented, and analyse abstract concepts. In the old days, the founder and his team would have only talked about the most important customers, treated resources as if it were their own, and used it judiciously. But now it's not the case. As companies add functional professionals, the voices from the front line which were part of decision making, start to fade away, and are replaced by middle managers. But as complexity increases, founder-owners can be overwhelmed by the new reality and their focus gets diffused. Given this informal set up, no buyer would be willing to wager a bet on the company. Hence moving from an owner-controlled structure to a formal one becomes a necessity to overcome this challenge. Sometimes the owners may not have the right perspective. A 20 year old magazine publication that had a good circulation slowly saw its circulation fading, and eventually sold out to another entrepreneur. The buyer did not see value in the physical magazine, but saw immense brand value in the badly managed website of the old company. He leveraged the brand transformed this into an online model. The previous owner failed to see this possibility and sold the company as it was, without working on it. The owner’s name is associated with the product. The company is all about him. Customers trust the owne, it is due to this relationship that business grew thus far. The founder is the hub and everyone reports to him, and all decisions are made by him. He knows it all, and there is rarely any need for documentation and systems and processes. But in order to derive value out of the company, there is need to detach ownership from management, so that a prospective buyer has visibility into the nature of the business. This can involve a letting go of the control by the owner, coaching existing
  3. 3. 3 | P a g e talent to become leaders, bringing in new layer of leadership and making the company financially attractive. At the same time, there is need to address the fears of long term employees, and they need to be carried along as well. Their support in this matter is crucial. Hence how can the owner plan to share some of the sale outcome with his existing team of core employees while at the same time looking for a strategic buyer who will provide these employees with a much better career path that comes with large scale. How to transform the company to sell Goal Setting Founders are passionate about what they have built over the years, they are proud of it and would like it to be highly valued and taken to greater heights. Many of them would like to continue with the company – but at the same time spend more time and energy with family and other interests which they would most likely have sacrificed all these years. But they would still like to be involved to see their employees grow and flourish. Others would like to sell off completely and retire. While some may have a shorter time frame and horizon of a year, others would like to take a slightly longer term view of 2 to 3 years, and explore how they can actually build capabilities in the company that make it more valuable. The bottom-line is all about improving profitability, making sales predictable and de-risking the company. These goals and timeframes based on individual priorities determine the way to go about it and the outcome as well. Identifying Gaps When the time frame is smaller, there is need to bring small and quick changes in critical areas and functions within the company. The gaps that exist within the firm in the form of individual talent, a second level of leadership, functional expertise etc need to be identified. Gaps could also
  4. 4. 4 | P a g e be in the form of missing performance management systems to professionally manage the company, a weak sales and marketing organization that is reactive in nature, an unsuitable organization structure that hinders the firm from responding effectively to the market, or systems that are not facilitating share of information for effectiveness. Benchmarking with competition is useful to identify these gaps and bridge them. Identify core and extend Core business capability of the company needs to be identified. For some companies, it could be product development, R&D, engineering skill, operations, support, marketing, brand, sales or channel networks. The contributors to these over time could have been the R&D work done (knowledge or IP), operational efficiencies brought about, brand, or unique systems of management that has led to the success of the firm. In building the core, firms could have inadvertently built inhibitors that prevent it from succeeding in changing environments. Since customers would have praised the R&D capabilities or perhaps the quality of the product, the company could have focussed too much on this aspect neglecting or at times not realizing the value of other functions such as sales, marketing and support. At times, the company could be entirely support driven, neglecting the ability to spin off something that is core as perhaps a product. Hence there is need to identify these inhibitors and implement changes to overcome them. Once core of the firm is identified, efforts need to be made to strengthen the core, and at the same time overcome the inhibiting factors that will prevent future growth. Adjacencies around the core have to be evaluated. These adjacencies or extensions could be internal or external. On the external front, companies might have developed a product for a particular usage. Being a victim of repeat orders and satisfying business over the decades, their sales team would have become order takers, and would never explore attractive markets that are adjacent. They may unknowingly let go untapped opportunities. Or, they may have a set of good customers, but would never have explored cross-selling their other capabilities, and have not deepened existing markets, exploring how to expand share-of-wallet among existing customers. In the case of product extensions and product-market extensions more attention has to be paid to the type of investment, the effort it entails and the short term benefits. Resources and energies should not be frittered away on extensions. It is better to strengthen the core product. Build Capabilities along Drivers that increase Value Value drivers that enhance value of the organization need to be identified and the transformation plan should revolve on putting in place systems, processes and people to increase value along these lines in sales, marketing, alliances, for review and control. The PSPD (Predictability, Sustainability, Profitability and De-risking) methodology can be used to identify these drivers. Making cash flows predictable and stable, building customer diversity, de-risking from certain technology platforms, building and executing a realistic growth plan, systems and procedures, product diversity, an effective sales engine, human resources and leadership are all drivers of business value. Some of these drivers are listed below and explained. Organization capabilities Capabilities in a company arise from the type of resources that are available, both tangible and intangible. Tangible resources could be assets and people, while intangible assets are the knowledge
  5. 5. 5 | P a g e base created. Capability building at the fundamental level starts with assets and skills of individuals. At the initial stages of the organization, such individual skills are critical. As the organization matures, there is more complexity, and structures & systems need to mature suitably. There is more need now for functional capability in terms of having an effective sales, marketing, product development or operations team. Capabilities within these functions need to be built up. If an organization really needs to exploit these capabilities, all these functions have to work seamlessly. These cross functional capabilities enable the company to organize itself and develop its business and grow effectively. At a more sophisticated level, companies will also be able to build the ability to restructure teams to respond to the environment very swiftly – to form alliances, gain and shed resources etc. Companies need to have a robust HR platform. There need to be clear objectives, standard execution method and measures of success. HR policies and procedures should be driven by employees themselves. The closer decision making is to the marketplace, the more effective is the organization. But usually, decisions get delegated to the wrong levels in the organization, causing loss of focus on the customer. As companies mature in having sophisticated systems, they can lend an ability to even co-create with customers. The truth is, only few companies will be able to master these socially complex capabilities effectively. It takes time and effort to develop, it is rare and difficult to imitate, and is also not visible to outsiders. But even to get better valuation for a company, a start needs to be made in this direction. Putting these structures and systems in place are effective since they give the prospective investor a great deal of visibility into the workings of the business. It helps outsiders to realize that the business is no longer about the owner, but that there is a system functioning effectively even without the owner. To them, there has to be a return from the investment from a business that being effectively organized and managed. Building Organization capabilities in steps Organizational Culture Cross functional skills  Performance driven culture  The entire organization plays like a soccer team – with ability to respond to the environment at the very lowest level  Sustained performance advantage Functional Skills in the company  Organization  Systems for seamless information exchange  For effective business development Build the next layer of leadership  Build effective sales, marketing, product development functions  Implement processes  Structures Owner centric Company  Individual skills Having a Product Focus When we are building the company to sell, it is better to focus on a few products that are scalable. A single product focus is best – especially a product that is complementary to a large market leader, or Build to Sell Build to Grow
  6. 6. 6 | P a g e perhaps a standardized product with minimum customization. Most start-ups get desperate quickly and start taking all business that comes their way. This culture enshrouds them over the years. But somewhere down the line, there is need to pick up only those that make sense. To scale, small companies must stop responding to all and sundry RFPs and not spread themselves too thin. Focus on high margin business. Expand the customer base for this product and grow revenues here. The product should also be scalable, where one is able to foresees future requirements and build in the ability to modify the product with minimal effort. Amidst all the noise and a plethora of products in the market, be careful to avoid commoditisation and make sure the product is valuable to customers, and that they keep coming back for repeat business. The routines to build the product or service also need to be standardised so that owner is not sucked into it. Only when the owner is free from this routine and it becomes executable by the second level of staff, will scaling really happen. Companies built to sell would standardize their offerings so as to restrict projects with complex work contracts and customization. Customization and clauses in work contracts bind the company to various activities which might not be acceptable or in good taste with the buyer. The buyer would look at contracts which are hassle free, less binding and easy to execute. Instead of developing generic products and services where the market is large but the competition too is neck deep, companies intending to sell, explore whitespaces where the market is yet to assess the potential and the company has a first mover advantage. These companies often try to capitalise on the rarity or exclusivity of the product / service. They create a position by understanding the market. Buyers/investors find these companies attractive as they have a foothold in the market and growth is evident due to less competition and established product/service. Hence try and dominate a niche product/market. Becoming Market Driven Many small companies grow their business by word of mouth. Such companies mostly have order takers in sales. Very few in the initial stages of maturity have full fledged sales and marketing functions. Their product or service could be well received in the market. But outside that small pond, the brand largely remains unknown. But to sell, the company seeds to demonstrate its brand value, the importance of a full fledged marketing and sales function that will enable the firm to sense the market, build new products and grow revenues. This is where investments would yield big returns in terms of premium valuation. It will project the firm in a very different light as one that has consciously developed business, and will surely be a very attractive acquisition candidate. A self perpetuating business with a visible funnel of prospects, predictable revenue streams, and de-risked sufficiently with more than a few customers will create that much needed comfort factor for a buyer that it is indeed a safe investment even if the founder exits. In order to grow, companies need to build a market driven culture. Companies need to be able to sense trends earlier than competitors, have a strategic planning process, and be able to analyse market information. Systems to gather such market information, analyze it, disseminate the information internally within the organization, and internally act on it are critical if companies need to scale. In small companies, market information that is captured by sales people, usually resides in their minds, and is rarely captured and codified. The sales person usually downloads this information to the owner, and the owner by virtue of his deep background knowledge, immediately gets the idea. But sometimes, in the flood of information, the loop with the sales person does not get closed,
  7. 7. 7 | P a g e and there is lack of clarity for the sales team on what next they need to do. How do they prioritize and move forward? Are there things they should focus and others that need to be dropped? This loop gets closed and becomes effective only with processes in place. Further, this information needs to be shared amongst the employees. When employees – at least the ones who matter, apply this deeper knowledge to solving marketing problems, the firm's marketing capabilities are enhanced. Few key marketing capabilities are therefore Market research, pricing, product development and managing distribution channels (will develop better ways to service and support channels), developing relevant marketing content, executing a marketing plan, frugal branding will not only lend a much higher value to the company, but also bring in the much needed short term revenues to demonstrate growth. Building and effective sales organization is crucial. Experienced salespeople have to be brought in, who lend a sense of professionalism, lend credibility and make the organization look larger than it really is. It helps in better reach and branding too. Sales metrics, processes and reviews have to be designed and implemented to function effectively. Regularly tracking prospects, pipeline and conversions, shows buyers that there is visibility into sales, and it can be forecasted. They get a grasp of the conversion rate. Also, it is good to invest in more than one sales person. Have a team. If a buyer walks in tomorrow, the first thing they ask is the customer list and details of the sales team. Apart from demonstrating this to them, we need to show a level of maturity which provides the buyer with the much needed comfort factor. Increasing predictability of revenue streams How predictable and repeatable are revenues from products and services. Is it like a consumable, where consumers keep buying again and again? Or is there a platform that they are locked into like an ink-jet printer, and then the consumables business becomes even more sticky? Or, are they locked into contracts like mobile phones; Or, is it a subscription business like a magazine, or perhaps a more sticky subscription model like a Bloomberg terminal? Acquirers will look whether revenue models such as these exist and this creates value and a sense of predictability and manageability for the buyer. Try to explore AMC type of revenues that are more predictable. Positive cash flow cycles Unlike magazines that charge an upfront subscription fee for the entire year, many businesses may not be able to collect all of the fees upfront. But try to get at least some part of the revenue upfront. It improves cash flow, reduces working capital requirement and makes the business attractive. A potential acquirer will not have to set aside a large part of the capital for Working Capital requirements, and hence will be more willing to value the business much higher. We must be able to demonstrate such positive cash flows at least for a couple of years before selling the company. In fact, in the first year, we may be better off taking a hit in the P&L accounts just to improve the cash flow situation. Remove all NVA activities that are a drain on the finances. Although buyers look into at least 3 years of the statements, a serious effort in this direction needs to be enforced. Building a leadership level Many small businesses are identified by their owners. They are the rainmakers for the business. They really need to wean the company off themselves and build in a strong second level of leadership. In SME or family owned firms, there are usually no layers between. There is need to attract talent. But
  8. 8. 8 | P a g e to attract talent the company has to create the right business culture. The question is how can this be done? Identify and put in place a pool of leaders. These leaders need to be in a position to identify goals, customers, markets and basically address “What is to be done”. They also need to work on the execution plans which talks about “How to do it”. For success, decisions and ideas have to come from the lowest level of the organization – it has to be like a sports team, where all know the goal and can effectively change tactics at any time. As the company matures, the leadership style has to change. Initially it is like a Tennis player who is individually driven. Then it should become a basket ball team, where a handful know how to play ball and the coach keeps shouting from the sidelines. In the advanced stage, it has to be a soccer team – complete with manager, extras, club etc., but completely focused on the goal and with an ability to change tactics according to the environment. Long term incentives plans Incentives are a must to get the leadership team committed to the company in the long term. Avoid giving out equity, since this complicates matters during the sale process, and can dilute the owner’s holdings. Instead have an incentive plan, where significant amounts are set aside for key employees every year – which they can withdraw only in the long term. In the event of a sale, a large bonus can be given to them, to ensure that they are committed to the sale process. Employees are aware of the intention to sell even before it is communicated to them. It is naive to assume that it can be kept under wraps. Usually, the sale can turn out to be beneficial for the employees in terms of career growth, options to work for a larger company, etc. Business plan and strategy Have a clear business plan and strategy for at least 2 to 3 years. This is to show the road map, the growth plan, investments required and vision for the company. This is required regardless of the fact that an owner would want to sell the company. It helps clarify purpose and reinforces the vision of the buyer or investor. Clarity on the type of capabilities that need to be built to reach a certain goal is important. Detailed plans in other functional areas will also help to show that much of what is being done has been thought through carefully. High Leverage of Network Having eminent professionals on board (management) and being associated with market renowned institutions provides that extra mileage or push the company requires to position itself in the market or related industry. Companies often get noticed because of their management or investors. These professionals/institutions play a major role in the market perceptions about the company and its credibility. Leveraging the standing of these entities or persons, the company can signal the market about its arrival, potential and capabilities. Avoid heavy investments in tangible assets Some companies make the mistake of starting to acquire assets like land, office space, plant and equipment. They want to look larger than they are to investors. But companies rarely get paid a premium on market prices for such assets, unless the assets are actually infrastructure for effective operations. Hence it is wise to not invest on long term assets or capital with long term obligations. Focus on short term/immediate investments which would yield quick returns and liquidation.
  9. 9. 9 | P a g e Duplication of manufacturing facilities and vertical integration would make the organization heavy on assets /capital, making it difficult to be sold and easily liquidated. Managing the change Business Transformation is all about holistic change companies need to undergo to basically grow faster or become more relevant to the market. This change can be implemented incrementally with small measured steps. There surely would be resistance on the path. The first question when companies attempt transformation is which process to touch. In most businesses, the easiest function that is amenable change and one without too much dependencies and investments is “sales”. Moreover, any minor changes in sales function has a direct impact on the “outcome”, be it new customer acquisition, or more orders from existing customers. Any win, however small, can uplift the mood for change and thaw the resistance to change. Employees should not feel threatened by change; instead they must be allowed to participate in this change – especially the critical members of the team who are key influencers. It must vibe with a sense of growth and pride in the organization. Such changes convince fence-sitters that change is good and doable. A highly visible short term win will also enable the top leadership of the firm to start change on a winning note. Once this clarity of purpose is communicated through initial changes, it becomes necessary to get the second level involved and broaden the base. Create groups to improve their respective functions, ask them to identify and drive changes where they feel empowered. Next involve people in information, communication and advocacy changes. Ask the employees to suggest changes to website, the sales and marketing collaterals that work best and ask them to drive these improvements. Their buy-in is absolutely essential to drive the second-order change. Now that we have a broad based team that believes in the new vision, we need to build a sense of urgency so that the change that has been demonstrated can be capitalized upon. Once this happens, creative inputs on products, offering and markets start to pour in. It also gives everyone a chance to delve deeper into the core offering and strengthen it. Once we have the top and second level of leadership involved in this exercise, they believe in the new vision and positioning, especially since it is their aspiration that has been translated into the firm’s vision and strategy. Training and reviewing team members to drive this, building their capabilities and motivating them becomes essential. Working as teams and leveraging off each other needs to become a habit, a new way of working. Once success can be shown in a couple of inter-functional initiatives, a broad base of employees becomes adept at adopting such structures across the entire organization. Making change happen in other functions and departments new becomes a lot easier. Hence managing transformation in stages with the right vision, by building the right capabilities, help build the foundation for a large business transformation. To bring about change for building and organization to sell, the implementation needs to be faster, and hence a top down approach is suitable. Conclusion When small companies face growth challenges, succession challenges or an increasingly complex environment, they sense the need to exit the business. Rarely are companies ready to sell. A hasty
  10. 10. 10 | P a g e sale always results in a low valuation not commensurate with the toil and sweat that has gone into building it. The key to get the right valuation for the company is to transform it over at least a year to build in certain capabilities that will make it look attractive to potential suitors. This transformation form owner driven to professional company with functional capabilities and a second level of leadership involves crafting a carefully thought out plan with clear goals and timelines, and implementing it with least disruption. Bibliography Alshawi, Missi and Irani, 2011, Organizational, technical and data quality factors in CRM adoption – SMEs perspective, Industrial Marketing Management, Vol.40, No.3, 376-383 Drayton and Buderich, 2010, A new alliance for Global change, HBR, September 2010 Eisenhartd and Martin, 2000, Strategic Journal of Management Vol 21- 2000 Farrel, 2000, Developing a market oriented Learning Organization, Australian Journal of Management, September, 2000 Foss, 1999, Networks Capabilities and Competitive Advantage, Scandinavian Journal of Management 15(1999) 1-15 Ghosh, Liang, Meng, Chan, 1999, The key success factors, distinctive capabilities and strategic thrusts of top SMEs in Singapore, Journal of Business Research, December 1998 Gulati, 1998, Alliances and Networks, Strategic Journal of Management, Vol 19-1998 Kotter, 1996, Leading Change: Why Transformation efforts fail, Harvard Business Review, April 1995 Narver and Slater 1990. Journal of Marketing, October 1990 Vorhies, Harker and Rao, 1999. The capabilities and performance advantages of market-driven firms, European Journal of Marketing, Bradford, 1999, Vol33, Issue 11/12 Browne & Mohan insights are general in nature and are not refereed papers. Open Universities and other academic institutions may use the content but with prior approval of Browne & Mohan. © Browne & Mohan 2015. All rights reserved Printed in India

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