Managing in Financial Adversity, Part 2 (#151)
/In this podcast episode, we talk about how to save a company while switching away from a failing business strategy. Key points made are noted below.
Shifting to a New Business Model
In the last episode, we talked about dealing with a bloated cost structure. In this episode, we’ll talk about a situation where you know that the original business model is failing, so you’re trying to save the company by shifting to a new business model.
This means that profits are falling, or maybe they’re long gone, and you’re just trying to hang in there until profits from a new revenue source begin to appear. This is a really common scenario, and it results in bankruptcy a lot of the time. Chances are, management already knows the company is in serious trouble, and is doing everything it can to cut expenses and keep the company running long enough for the new revenues to kick in.
The real question is, will the new profits appear in time, and can you afford to wait that long? If not, you need to shut down the company right now, before it burns through any more cash. Otherwise, you’re just throwing away the cash that should go to creditors or investors.
This may not sound like very optimistic advice, but let’s face the facts. Businesses shut down all the time, because they do not have sustainable business models. They can either keep going until the last minute and have a messy collapse, or they can shut down early and in a more orderly manner.
Which Information to Collect
So how do you make the decision to keep going or to shut down? The central issue here is to collect the right information for making the decision.
First, you need the cash burn rate, to see when the company runs out of money. This calls for a detailed cash forecast, not just an average rate of cash usage, so that you know exactly how much time is left. This establishes the time period over which you have to decide what to do.
The next step is to collect information about the new business model that you’re trying to implement. Chances are, there’re very few hard facts available, so the way to approach this is to focus on the key data items that indicate success or failure.
For example, if you’re trying to relaunch a business as a website that sells Google advertising, the main information items to track are the trend line for page views and the ad revenue per page view. With those two items, you can estimate future revenues.
Or, what if you’ve decided to open a retail location, rather than using distributors? Then the questions revolve around sales per store location and the cost to operate each store.
These are open questions, and if the company stays in business long enough, you’ll eventually get the hard data you need to make a decision. The trouble is that the hard data may not arrive for a long time. So how to make decisions without the hard data in the short term?
What you do is build a table that itemizes all of the information you need, along with where the information needs to come from, and especially any substitute sources of information. The substitute information is key, because it may be all you have in the short term.
For example, you’ve launched the web site that’s supposed to survive on Google ad revenues. After a month, the Google ad reports tell you what the ad revenue per page is, so you can run a breakeven calculation to figure out how many page views it will take for the company to stop losing money. Then compare this figure to your competitors to see if anyone is generating that many page views right now. If no one is, then your obvious decision is to shut down the company, because the model doesn’t work.
If it appears that the model will work, then your next question is how long it will take to generate the required amount of page views. You can estimate this by seeing how long it took competitors to reach the required number of page views. This is good substitute information, and you can augment it with your own data as time goes by.
I’m going to keep beating on this concept of substitute information. This means that you use information generated by a similar business in a similar situation as though it were the results of your own business. Adjust this substitute information to most closely match your own estimated results, and then use the adjusted information to make decisions until your own business generates its own information.
Now let’s look at the other example, for a retail store. The main issue is sales per store location. Initially, you have no idea about what this will be. But, you can estimate it by looking at similar stores operated by competitors. You’ll have to adjust this substitute information for factors like differences in marketing, and customer service, square footage, merchandising, and so on.
Over time, you’ll start to pick up your own data from actual store operations, and you can then swap out the substitute information and use this in-house data instead.
If the business can survive for a year or so, chances are that you can swap out all of the substitute information with in-house information, which is way more reliable. The trick is surviving that long.
So, if you listened to the last episode, about cutting back on costs, you can see that this scenario calls for a completely different response. In the last episode, I recommended a historical cost analysis to figure out which expenses to reduce. In this case, the main issue is uncertain information, so the recommendation is to be very precise about the information you need to make decisions, and then carefully specifying the types of substitute information that you can access to make the decision. And the decision is to either attempt to continue the business or to shut it down now.
Additional Concerns
A couple of warnings about these concepts. First, business owners are very optimistic people, and they’re also deeply attached to their companies. And that means they usually believe in only the most optimistic projections. You can get around this by maintaining both optimistic and conservative forecast information, and giving each one equal presentation time with the owners.
The second issue relates to substitute information. You’re almost certainly going to have to use it. Be aware that it does not perfectly relate to your business, and so it’s somewhat unreliable. Therefore, when you’re using substitute information, write down the reasons why the company’s own results may differ. For example, there may be differences in target markets, price points, product quality, and so on that create different results for a competitor than what your business will experience. These can result in major differences between substitute information and your own results.