Independent businesses are complex. Since all decisions are made by one person, or a very small circle, there are few of the organizational separations familiar to large firms. A large firm can identify certain operations – collections of assets, people, products, and opportunities – as belonging to a business unit. It is then possible to assign responsibilities and reporting systems to those operations. Further, you can undertake strategic and tactical planning on the same basis.
Small businesses lack these divisions. This is both a strength and a weakness. A strength, because there are few barriers to exploiting the same asset across all activities – more nimble, often more efficient. A weakness, because certain large business disciplines are seemingly impossible to apply. One of those is strategic and risk management.
The best technique I have discovered for conducting risk analysis on an independent business is by dis-aggregating the business – viewing it as a collection of investments. The trick is finding the correct entry point to break it down
Try this.
Decision Entry Point
Each business operator has a tendency to structure the business around what they see as the key decisions. More often than not, each of us see the key decisions as a reflection of our own strengths and experience. A marketing person views product decisions and target demographics as the pivot of the business. A manufacturing engineer might see production equipment and processes as really being the core of the business. A cabinet maker might see the finish detailing of a house renovation job as central, a framer might see the floor plan design as critical. This is what makes small business so personal. They are reflections of who we are.
Oh how very wise of you sensei…
Well how about this, then. Our marketing person invested in some detailed research to investigate the life style, aspirations, and disposable income of a group of people – let’s say, oh, recently empty-nested mothers, age ranging from 38 to 49, suburban dwelling, with minimum education at the college level. The research pinpointed a number of common but untapped aspirations ranging from upgrading education, travel, greater cultural involvement, and a new circle of friends. On this basis a series of investments under a common banner was launched – one targeted at each of the above aspirations. Each of these is a specific investment, carrying its own unique risks and opportunities, despite the common banner and joint promotion activities.
Our manufacturing engineer started his business with three stamping presses, to manufacture cases for custom made electronic devices. One of his clients inquired about the availability of a new electro-static paint finish that would be resistant to the corrosion effects of in water immersion. The engineer investigates, and acquires the equipment. In looking to make better use of the new equipment, he discovers that several other manufacturers can supply him with base products for dock fittings, and in ground pool hardware. Distribution of such products is relatively easy to arrange. There are now two investments – the original plant equipment, and the new finish coating facility. Each share in the production of some products, but also have their own unique products. The investment is on production facility, and not on either products or distribution channels. This business is now a portfolio.
Our cabinet maker has a practice of adding a special ornamentation feature to each renovation he takes on – a showpiece, as he views it. On some jobs, it is a unique set of custom fitted built-in cabinets, in another, a ceiling relief piece in exotic hardwoods rather than plaster. One job saw him turning and hand carving a series of display bowls that matched a feature of the architecture of the main living space. It became a grace note to his contracts, and a selling feature for his bids. To accomplish this, our entrepreneur invested in $15,000 in custom wood milling and shaping equipment for his shop. He trained two local high school students to make these items. He also invested in a design workstation to prepare renderings of the proposed feature. Despite the general contracting nature of his business – these investments are specific, and differentiable from the investment in general contracting equipment. The revenue stream is different, the risks are different, and the opportunities for developing this into a manufacturing line are different. This entrepreneur has two investments in his portfolio.
So What – Risk through Diversification
Well, it matters. Handled properly, it can make a big difference.
Our manufacturer has a risk in his original business, in that the market for his boxes is dependent on the demand for electronic control equipment for manufacturing. This is dependent on the investment atmosphere in this sector, which is dependent on the business cycle. This systematic risk is not mitigated – there is nothing in place to deal with a downturn other than the usual lay-offs and belt-tightening. However, adding the second investment can make all the difference. The water immersion finish is needed for equipment used in environmental monitoring in mining and in ocean oil projects – and the market for such cost reduction technology is actually counter-cyclical to most other business investment cycles. This means, that when the market drops for one product, it will pick up for the other, and so reduce the systematic risk of the business cycle. The added bonus of offering products to the consumer markets also reduces the sensitivity to the business-to-business economy. The result is a lower risk business, and better sleep. Unfortunately, it also means the loss of the excuse to lay-off that brother-in-law that has been such an irritant…
Our cabinet maker now appears to have two investments in his business portfolio, While they each benefit the other, the renovation market is cyclical as well as seasonal. This means that there are periods of down-turn which creates cash shortages. From time to time, there are gaps between contracts, and he risks losing key people and skills. The new investment adds at least two additional sources of revenue,
- one being the production of special features for houses that do not require extensive structural renovation, but rather updating and decorating
- the other being the production of custom wood products such as frames, bowls, custom wood trims, and even furniture accent pieces
Each of these is less dependent on the renovation market, broaden his potential market, and make better use of his facilities. The added bonus is the competitive advantage of an enhanced reputation as an artisan anc craftsman, and not just a contractor. The result – lower overall business risk.
These Examples are Not Unique
Many small businesses have features of these kinds.
- Taverns that primarily offer entertainment and beverages add on a catering and take-out food operation.
- Software development houses who also provide implementation services
- Retail fixturing manufacturers who work on both a job (installed) and a product (unit sales) basis
- Ceramic manufacturers that make both home decorative products like vases, but also flame resistant tiles for laboratory equipment
- Retailers who not only sell products, but also offer courses
What is the difference? Large businesses are often told to focus on their core business and leverage their economies of scale – don’t dilute capital and management on peripheral operations and investments. Small businesses seek synergies amongst a number of allied business investments to reduce their risk profile. Which is more demanding and interesting? Its all up to us !
6 Comments
Geez, straining at gnats again, Pilot. Take me. you know my bar - I sell beverages and some snacks. That’s it. No portfolio of investments, no multiple businesses, no separate assets. How can something so simple be made so complicated by you!
Sure mine host - you don’t need to remind us that you played host to our original group. Sunday morning meetings were great, until everybody went off to the four corners of the earth. That what’s got your goat these days? look it worked great, and was a wonderful thing, but 1400 kilometers is a bit far to go for a coffee, or for any creature poured out of your tea-pot. no offense. We’re all sorry that things needed to change. Anyway I still stop by, right. Maybe we can plan a reunion in the late summer or something.
I’ve been there, remember. I know darn well that you cater to at least two completely different demographics - we talked about it enough. So don’t tell me they drink the same things, listen to the same music, like the same type of staff, or even eat the same things. Remember re-doing your menus to accommodate those two different groups? Well, different investments, and different risks. Sure they share some of the same pool of common infrastructure and assets - the premises, the chairs, the license, you . . but they are also distinct investments - product inventory, training, product development, marketing and advertising efforts. In fact - you could be my poster boy for this post. Nice try though, old son!
Hmmm, maybe I’m too close to it . . . still seems a little complicated to me. On the other thing - not at all, now I don’t have to get up and open on Sunday morning on my day off. At least on-line like this, I can always slience you by simply closing the browser. Big advantage.
Just found your blog. Some challenging posts you’ve made. Question, though - do you all know each other or something? It seems to have that flavour!
I’m in office services - copying and binding and supplies and so on, and have been at it for about two years. Seems to me that I also have a number of different business elements - the copying/binding for local businesses as opposed to municipal work, and the supplies is different than the copying/binding aspect. They not only are different products, the nature of sales is different even on the same product to different markets. I do have costs associated with the business copying/binding that I do not have for the other two sources of sales.
I tend to agree with your post - I find that I do this process informally all the time anyway, I just never took the step of really treating it as separate projects as such. Might be worth a try.
Welcome copycat
There is no real universally valuable tool for entrepreneuring. I find that the more tools you have in the pouch, the more effective you are as an entrepreneur. This is just one more tool. I like it.
Seems to me from the bit you mentioned that the tool might work for you as well. The challenge arises when you have to distribute the investment in common infrastructure - possibly your equipment or your premises, or even staff, across multiple projects. Sometimes you can simply ignore them as pooled items, and do your analysis at the gross profit level, other times resource consumption is uneven, and you have to determine how to allocate the investment between projects. Really, the tool is simply intended to bring a bit of discipline to what we do automatically every day anyway. The hope is that there will be less chance of overlooking something important.
Oh, and a lot of us do know each other. we started this online version of a group that used to meet face-to-face mostly weekly, for about two years or so. When some of our core people moved away, we wanted to keep going. So first it was face-to-face, then it went on on-line but completely private, and this is the third version, where we are broadening things to other people as well. The link to the Harbour Forum is on the blog’s main page if you are interested in learning more about it.
Good points in this one Pilot. A lot of people do not grasp the enormous differences between entrepreneurial independent businesses, and large corporations. Other than the fact that society recognises both as businesses, there is almost no similarity. Frankly, in a lot of ways they are opposites. Independent businesses tend to be organic in their drive to stay flexible and responsive. Large corporations have a tendency to rely on economy of scale and advertising. That is one of the challenges that face people who try to leave the large corp world they are familiar with to become independent. What was the right way in their original world, is completely wrong when they are soloing. Huge differences.
Hello copycat - we lost some of the personal face-to-face time we had in the beginning. Fortunately, we know one another sufficiently well that we can almost see the facial expressions that go with the words! For instance, the words Drinkwater has with our host here actually mean something very different to them. However, it is proving to be open enough to incorporate new voices and faces, and that is a good development.
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