When a Customer Outgrows You

There is nothing that quite matches the excitement of landing your first really big customer. It often brings with it the confidence that comes with knowing, really knowing, that you can compete in the big leagues. There could be the added security of a baseline of business that permits longer-term planning. Even if you had to squeeze your normal margins a bit, the additional cash flow is worth it.

When you land a customer who is many times larger than you are, the disparity in size can be a trap. If the customer is ten times your size, a 5% growth in their business might mean a 50% growth in yours.

suit too bigEvery owner says that his or her company will grow in other areas to avoid being overly dependent on one account. In reality, just keeping up may be as much as their business can handle. Even if the customer is understanding of the small suppliers’ issues (not, for instance, demanding extended payment terms or exclusivity,) there are other challenges.

Larger customers may require more documentation, quality certifications, or compliant computer systems. They expect sufficient inventory to meet short-term surges in demand, and could ask for more visibility into financial statements than you would normally be comfortable with.

Does that mean small vendors should avoid chasing giant customers? Not at all. Most of the small start ups that I know who achieved mid-market levels (over $50 million in revenue) got there by riding one really large customer for some period. Eventually they grew up enough to attract a few more big players. There was risk, but the owners never lost sight of the long term benefits.

Eventually, they learned enough about how big organizations purchase and manage vendors to make themselves attractive to others. It was a wild ride, and not everyone comes out well in every such relationship, but the risk can be more than worth it.

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Is Your Business in the “Neutral Zone?”

As Baby Boomers business owners approach retirement (the youngest of them turned 50 this year) they face a unique challenge. The market for small businesses is increasingly a buyer’s smorgasbord A shrinking middle-aged population, corporate competition for talent and less interest in the long hours associated with many traditional small businesses combine to make selling many Boomer enterprises a more difficult proposition.

The best-of-class companies on both the smaller and larger end of the spectrum will still stand out as appealing propositions to buyers. On the main street side (companies selling for less than $3 million or so) there are still plenty of aspiring entrepreneurs who seek a lucrative opportunity.

The mid-market (companies with over $1 million of pre-tax income) has more money chasing fewer target prospects. Current estimates calculate over $1.6 trillion (about the GDP of Japan) allocated by Private Equity Groups and corporate M&A departments for purchasing those businesses.

stuck in betweenWhat about the companies in the middle? As in the Star Trek “Neutral Zone,” the place where neither the Federation nor the Romulans travel, these businesses have a special challenge when their owners seek to transition, and especially when they want to exit with the value of what they’ve built.

A generic history of these Neutral Zone companies applies to thousands of them. A Boomer entrepreneur bootstrapped a business thirty years ago. Badly undercapitalized, he or she struggled for years to make a decent living. As time passed, a four decade long expanding economy, driven by the influx of workers and consumers from the same generation, helped to grow the business until it provided a comfortable living.

Now in their 50s or 60s, those owners have achieved their life goals. Their labors have resulted in an enterprise that employs between 15 and 50 people, and puts between 300,000 and a million dollars to the bottom line above and beyond their own salaries. Compared to 95% of Americans, they are “rich.”

But they are too big to sell easily in the small business (main street) markets, and too small to attract mid-market buyers. They are in the Neutral Zone.

In main street sales (as I’ve explained here before) solid companies sell for an upper limit of around three times the pre-tax profit combined with the owner’s salary and benefits. As that pricing exceeds $3 million, and certainly above $4 million, it becomes difficult to find an individual entrepreneur who can leverage that purchase price.

In the mid-market, where the cost of a transaction limits targets to those with $1 million and more in EBITDA, many Neutral Zone owners would have to grow the business by 30% to 70% just to make the entry level numbers.

A Boomer entrepreneur who is in the “harvesting” phase of business ownership; enjoying the benefits that come from decades of dedication to the business, is often not interested in another big push. It may require more investment, more risk, and probably a lot more effort.

He or she built the company with a belief that it would fund a certain post-business lifestyle upon sale. Now they are finding out that a well run organization with solid and sustained profitability may not be enough.

I typically work with between 15 and 25 of these owners at any given time. For many, the solution can be to “hire a buyer.” Their companies are financially capable of recruiting top management talent. That talent should first be capable of taking the day-to-day management duties from the owner, but in addition, be entrepreneurial enough to eventually assume ownership in turn.

The secret to realizing the full value of a Neutral Zone company may not lie in bringing it up to another level (or, perish the thought, down to a lower level) of prospective buyers. Instead, consider using the organizational strength and profitability you’ve created to engineer an internal sale on your own terms, in your own time, and under your control.

 

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Posted in Building Value, Entrepreneurship, Exit Options, Exit Planning, Exit Strategies, Leadership | Tagged , , , , , , , , , , , , , , | 2 Comments

2 Responses to Is Your Business in the “Neutral Zone?”

  1. Clint says:

    Thanks John. Interesting what the future will hold for these businesses…Buying businesses for millions of dollars seems like pie in the sky for most of us Xers or Millennials. I totally agree with the “hire a buyer” future. When I told my boomer boss that I may be interested in opportunity for buying I think he woke up a bit and has started me on an upper mgmt ladder. I call this Intrapreneurship and have even started a community at http://www.IntrapreneurOnline.com where we IPRs can share our wins, grow and help each other. Maybe it will even turn into a place for nurturing these “hire a buyer”s.
    Thanks again,
    Clint.

  2. TKO Miller says:

    Great article, thanks for sharing! We\’ve written a blog post on why 2017 is the perfect time for baby boomers to consider selling their businesses. Read it here: https://www.tkomiller.com/blog/baby-boomers-and-business-owners-2017-is-your-year

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Police Deadly Force and Management

The outcry over the use of deadly force by police officers has dominated headlines. Ferguson Missouri, New York City, Virginia, Texas, Florida. Although incidents involving unarmed black men have dominated the headlines, the total number of deaths by law enforcement action, over 800 in the year to date, seems an astonishingly high number.

I think part of the problem is that police officers have fewer options for either self-protection or for subduing a suspect. They have to use deadly force, because they’ve been prohibited from other kinds in the name of protecting the citizenry.

Funny shore patrolMy dad was a Special Cop. That meant he had another full time job, but was trained in law enforcement (Navy Shore Patrol) and would work for a local department part time. Usually it was for big holidays or events.

When he put on a uniform, he was indistinguishable from a regular, full-time patrolman. His identification said he was a policeman, and he carried a gun. He also carried a nightstick.

In one town where we lived (Oakland NJ), there was a riverfront picnic and event property called Pleasureland. Since we were only about an hour from New York City, and there wasn’t much in the way of corporate amusement parks, it was a popular booking for union members’ family picnics.

Frequently there was more than one such event on the same day. The steelworkers and the bricklayers, for example, showed up in the summer heat and drank a lot of beer. Not surprisingly, someone would take offense at something a rival union member said or did, and his brothers-in-trade would rush to his defense. Melees of several score, and sometimes several hundred, weren’t uncommon.

No one was ever shot by an officer. In fact, Dad often said that he would prefer not to carry a gun, since he had no intention of using it on some family guy with a few too many drinks in him. He did allow, however, that it was useful for pulling the holster around in front to protect his private parts.

Instead, he employed his trusty hickory nightstick. I remember his description of breaking up the brawls. “Just keep it low. Never bring it above your shoulder where someone might grab it. No matter how big or how drunk a guy is, a good whack in the knee will take all the fight out of him.”

Unfortunately, nightsticks have become more associated with head cracking (bad form) in civil rights protests. “Police brutality” lawsuits have relegated the nightstick to the same fate as the thumbscrew and the rack. (BTW- those extendable batons that have taken their place, unless you know martial arts, are of limited value against anyone who is really intent on hurting you.)

Police are left with guns. Faced with a threat, they draw their weapon. In a really serious or chaotic situation, there aren’t many options after that.

We could accept a few broken knees as an alternative to shootings, but that is considered brutal. Police officers aren’t paid to lose. (Another frequent saying of my Dad’s). Now they are left without many in-between measures to take control without pulling a trigger.

How does this apply to management? Business owners hold the “deadly force” card in any employment relationship. They can fire someone. Experienced managers know that you don’t draw that weapon unless you really mean to use it, but many with less seasoning fall back on termination threats because they seem big and scary. They think they are using their power of position to correct a behavior.

“If you are late one…more…time, I’ll fire you!” OK. We all understand that coming in an hour late tomorrow means termination. What about next month? Six months from now? Is five minutes late enough to get fired? Fifteen? What if I have a job where I can just work faster and catch up? What if I am your top performer the rest of the time?

Make sure your managers have a nightstick; a clear and simple way to mete out corrective action without resorting to the big threat. It will make their jobs a lot easier, and probably help to keep some decent employees.

Please share Awake at 2 o’clock with other business owners. Thanks

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5 Responses to Police Deadly Force and Management

  1. Kyle Whale says:

    So what are some examples of “nightsticks”?

    • John F. Dini says:

      Sorry, I guess even the term is antiquated. A piece of hickory, cured and hardened, round (about 1.5 to 1.75 inches in diameter) and about 30 inches long. Longer than a Billy club, harder than a truncheon. Grooved handle for a good grip, with a strong leather thong for wrapping around your wrist. Formerly standard issue for every police officer in the country. Later “improved” with a second handle that came out 90 degrees from the side about 1/4 of the way up, but my dad never cared for those.

      • Russ Ronnebaum says:

        I don’t want to put words in Kyle’s mouth but I think he might have been referring to a “nightstick” in the context of what examples of a “corrective action” to mete out to an employee instead of the big threat of “deadly force” that results in termination.

        • John F. Dini says:

          Oh. Duh! Thanks Russ. A structured system of progressive discipline gives supervisors the ability to assign penalties without being accused of arbitrariness. Docked pay, deferred raises, forfeiting PTO (which in most states is only controlled by company policy), exclusion from an incentive pool and suspension are all options, but the supervisor needs to understand what is available and when it is appropriate.

  2. Chris White says:

    Perhaps some commercial examples might illustrate the point?
    1. Most serious examples short of termination might include probationary status, docking pay, demotion.
    2. Less serious examples might include a letter in the personnel file, attendance at a seminar on the topic causing the problem, loss of privileges such as parking space, etc.
    3. Least serious might just be a verbal reprimand without the “or else” attached to it.

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Don’t Train with Customer Pain

I have lot of favorite books. In business, they range from cutting edge theory to some of the little “quick reads” that build a single management or behavioral point around an allegory.

One of the best in the latter category is The One Minute Manager Meets the Monkey by Ken Blanchard and William Oncken Jr. As the title implies, it is a merging of Blanchard’s The One Minute Manager from 1982 and Oncken’s Harvard Business Review article “Who’s Got the Monkey?” from 1967, the most reprinted article in HBR history.

money down the drainLike most (if not all) of Blanchard’s book, this one has lots of white space, and call-outs that take an entire page. The best is “NEVER LET THE COMPANY GO DOWN THE DRAIN SIMPLY FOR THE SAKE OF PRACTICING GOOD MANAGEMENT.”

As owners, we unfortunately have to let employees make mistakes on our nickel. My friend Larry Linne, author of Make the Noise Go Away, tells this story.

An executive walks into the boss with a long face. “Boss, I screwed  up. I quoted that big job incorrectly. Instead of it being our most profitable work of the year, we will lose $100,000. If you want me to resign, I understand perfectly.”

The boss, like most of us, says something like “Bob, I presume you learned from your mistake, and it won’t happen again. We’ll just have to chalk it up to the cost of experience.”

Bob walks out, but an observer in the hallway would note that, as he travels down the hall, his step grows lighter and his head is held higher. He has dodged the bullet for his mistake, and the incident is over.

For the boss, the pain continues. It’s the employee’s mistake, but the owner’s consequences.

Sometimes, however, the opposite happens. The mistake doesn’t impact the company as much as it does the customer. How much of a learning experience should the customer bear?

A while ago I knew a CEO who had developed a great team. Her top executives were all very capable, both in their own technical areas and in developing people under them to take on more challenging projects. A customer was experiencing issues with her company’s service. Although her executives were on top of it, they let the responsible employee work through the issues at length to assess his problem solving skills.

The CEO called a halt to the process, and she quickly interceded to correct the situation. As she told me afterwards, “We don’t train with customer pain.”

I also have a long list of favorite sayings, and this one made it on a first hearing. As a mash up of the monkey and the CEO: “Don’t let the customer go down the drain for the sake of a learning experience.”

Enjoy “Awake at 2 o’clock?” Please share or pass it on to another business owners. Thanks!

 

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2 Responses to Don’t Train with Customer Pain

  1. Brent Lane says:

    John,
    You can usually recover from your pain, but not always from your customer’s discomfort – and especially if you do not know about it.
    With my firm, I would call every client every month just to say “How are we doing”? 99% of the time, I was met with appreciation. The other 1% sometimes involved yelling and occasional unpleasant suggestions. My response was always, “Thank you – now that I know about it, I can fix it.” And we always did.
    In 15 years our collection period was always less that an month and I never had a claim for any cause. I attribute it to good will and the ability to solve a problem before it resulted in slow payments, or worse, lost business relationships.

  2. I think they used to call it customer relationship management

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Why Health Insurance Isn’t

Last week I wrote about the success of Obamacare in driving people from the private insurance market towards a national healthcare system. Clearly, I touched a nerve when I look at the tone of the responses received. Although I don’t discuss big-picture issues in this space nearly as much as I do day-to-day business operations, there is one more item about the health care market that we should visit.

Did you ever think about the concept of health insurance? First, just to be curmudgeonly, we don’t insure against health, but rather illness. So it should be illness insurance. But I digress…

What is insurance? It is a form of gambling. Like the office Super Bowl pool. Everybody puts a little money in (they don’t call the participant base an insurance pool for nothing), and the “lucky” winner gets his or her bills paid. That’s how it works for cars, homes and property liability.

arab accidentIt’s for that reason that insurance is against the law in Moslem countries. It is considered gambling, even though winning a “prize” requires an unhappy accident. It is still a large number of contributors putting a little money in, so that one of them can get a large sum out.

What would happen to the office Super Bowl pool if it paid off equally on every single box that was purchased? Of course, everyone would only get out what he or she put in. That’s why health insurance isn’t really insurance at all.

Health insurance became a tax-deductible employee benefit after WWII, and grew widely in the 1960s and 1970s. I will beat my demographic drum once again. In the 60s and 70s the workforce was expanding at a record rate with young, relatively healthy Baby Boomers. Just as they did for Social Security, they carried the sick and accident victims in the insurance pools easily.

Today in the US, as in most of the developed world, the three major causes of death are Heart Disease, Diabetes and Cancer. I laugh at those health experts that point out how our unhealthy lifestyles make those the major killers. It is true that obesity, red meat and lack of exercise are contributors. But the biggest factor is age.

Let’s face it, in countries like Somalia or Myanmar, the biggest killers are communicable diseases from polluted drinking water, starvation and bullets. It isn’t hard to figure out why so few people die from diabetes. They don’t live long enough, or have enough food, to contract diseases from unhealthy eating habits.

No shared risk pool functions when everyone expects to take out as much as they put in. In a society where the vast majority will live long enough to require extensive and extended health care, insurance struggles just to maintain a zero-sum outcome.

Health insurance is no longer insurance. It is a lifetime prepayment program for the medical needs that each participant is statistically almost certain to need. About 30% of all Medicare claims are paid in the last 6 months of a patient’s life. Some use that as an argument against extending life, but I bring it up here just to make the financial point. Clearly 30% of recipients don’t pass away every year.

I can’t find any hard dollar figures past the mid-1990s for that end-of-life spending, but judging by my own and others’ recent hospital bills, I would consider $200,000 to be a very realistic number. If you work for 40 years, that means you’d have to save $5,000 a year net over your current health needs to build up enough to come out even. (I’m ignoring both interest on the contributions and medical cost inflation. Just making a point here.)

Of course, for the vast number who can’t pay in that much, someone else has to make up the difference.

There is no simple solution, but first we have to realize that our “insurance” is that in name only. It only works when each participant pays in as much as he or she is going to get back out.

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8 Responses to Why Health Insurance Isn’t

  1. Jim Marshall says:

    I had a great uncle who practiced medicine from the turn of the century until the mid 20th century. In the last chapter of his book “Doctor Do Tell” dealing mostly with his experience delivering medical care to the people of rural Wisconsin……he warned of the evils of “socialized medicine”. Much has changed since the time he practiced….including the willingness of health care providers to be “paid in pickles”. The evils of non “socialized medicine” have become crystal and painfully clear.
    The present health care system based on the idea that competition brings about the best result is a failure if for no other reason that there is and will not be true competition. Nationalized health care can minimize system costs….if design and operation remained focused on the goal of efficient, results oriented care measured by and paying for results. A single payer system that assures and pays for results oriented care (as opposed to pay per procedure) is probably the only way that a nation can bring about maximum care per dollar expended. The only logical single payer is government. If a clear goal (as mentioned above) was the standard to which any plan was held….much better product (our health care) could be brought about for all.

  2. Jim Marshall says:

    I neglected to mention his book was written in 1945.

  3. David Basri says:

    Except that not everyone is going to use all they did (or should have) put in. My mother will turn 99 early next year. She is in an assisted living center that costs thousands monthly, but uses just a small fraction of the services the price is meant to cover. This is good thing. Others use much, much more than they ever did (or could have) put in.

    The only solution is something based on the underlying concept of insurance. Many put in
    X and a fewer number take out Y. Even in countries where there is universal government provided healthcare, the concept is the same with taxes substituted for the bulk of premiums.

    The problem in the US is that the insurance paradigm is private and discretionary. Not everyone has to pay in, so healthier lower cost people opt out at a disproportionately high rate. The insurance companies are profit driven, so left to their own they simply do not want to cover those who represent a higher risk.

    Average life span in the US is into the 70s. That means both individuals and companies have to think very long term to justify the equation. In a system where participation is discretionary, and the actuarial pool is private and focused on making shareholders and executives happy the following quarter, the actuarial numbers will not to add up.

    Human nature simply does not work well in multi-decade time frames. Only an external entity can make the health care actuarial equation work. The ACA is bending the curve, but it is a poor mishmash trying to influence an inherently unworkable model based on private insurance and discretionary participation.

  4. Mike Weaver says:

    I have always thought it strange that people expect routine doctor visits and long term prescription medications to be covered under a health insurance plan. When you buy car insurance your tires and oil changes are not covered are they?

  5. David Basri says:

    It is only strange if you try to equate health care with consumer goods. Same basic problem as trying to force market principles to “control” health care costs. It is not a market or a consumer good, and should not be.

  6. Jim Morris says:

    If the legislature is required to live under the same laws, regulations, and healthcare systems that their constituents live under and lifetime healthcare benefits are eliminated for them, things will change. This will never happen as the fox rules the hen house. Corruption in government has become epidemic and it comes in too many forms and sizes.

  7. David Basri says:

    Most members of Congress may not like it, but could easily afford, good private health insurance. To really understand they should be forced to live six months or a year in the shoes of someone who either cannot afford the insurance, or can buy insurance but not possibly handle a $5000 deductible.

    The sad irony is that far more than enough money is actually being spent on health care in the U.S by citizens, employers and the government to provide excellent health care for everyone. It is the ridiculous wasteful way that we collect, allocate, bill and distribute the pool of money that is the problem.

    • John F. Dini says:

      Agreed, David. Quite simply, physicians, attorneys, hospitals, pharma and the insurance companies are five of the most powerful lobbies in the country with one joint aim – to keep healthcare expensive, unregulated and unbelievably profitable. And I don’t believe that putting everything into the hands of a Federal government that is already a large part of the problem fixes anything.

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