Operating Models

Different businesses adopt different business models in terms of strategies of pricing, volume and service being deployed.

• Walmart and McDonald’s have a Low Price, Low Margin, High Volume model. They sell products at a low price, their profitmargins are low and therefore they must generate high volumes(meaning they must sell a lot of products to a lot of people) toachieve profitability.

• The Ritz Carlton and Neiman Marcus have a High Price, High Margin and High Service model. Their prices are steep, but theyoffer exceptional service which requires high overhead costs. TheRitz Carlton will serve far fewer customers than a Holiday Inn,but they will make a satisfactory profit because of their highermargins.

• Most other models fall somewhere in between.

You must choose a model that best fits what you are offering and what your customers want. You also need to determine which key customers you will focus on. When you try to serve and please everybody, you end up not pleasing anyone.

Let’s look at Costco and Whole Foods to understand their models and financial performance.

For Fiscal Year 2014,Costco has annual sales of $113 billion while Whole Foods ismuch smaller, but still does a very respectable $14 billion.Costco prides itself in providing very attractive prices: hence itkeeps prices low, which result in a low Gross Margin of only 13%. Itmust therefore keep its Operating Expenses very, very, low at 10%. Thisleads to an Operating Margin of 3%. Because it has high sales / store, itsfixed asset / sales ratio is only 13%, which means that it generates $100of sales for $13 of fixed assets. Costco is an excellent example of a lowprice, low margin and high volume business.

Whole Foods provides high quality natural products at a relatively higher price. They earn a Gross Margin of 36%, but they also provide a higher level of service, which costs 29%, resulting in an Operating Margin of 7%. Because it has many smaller stores it needs $21 of fixed capital to support $100 of sales.

Both of these companies are profitable and do a good job meeting the differing needs of their customers. The point to be underscored isthat there are many ways to develop profitable business models.

Let’s look at one more example. Apple is mostly a hardware company, albeit an upscale hardware company. Its Gross Margin is 39%, but because it outsources most of its production, its Operating Expense is only 10%, giving it an Operating Margin of 29%. Microsoft, in contrast, is a software company with a high Gross Margin of 69% despite wasting a ton of money on its extraneous businesses. With its bloated bureaucracy, Operating Expenses are 37%, but this still delivers a very healthy Operating Margin of 32%.

One is a hardware company and the other a software company. Both find ways to serve their customers while making a lot of money in the process. The trick is to find the business model that will work for you, while deeply satisfying your customer.

Verinder Syal, Author:Discover The Entrepreneur Within

Understanding Costs

There are two broad categories of costs: Cost of Goods and Operating Expenses.

Cost of Goods is the cost directly related to the product or service. For example, the cost for a pair of jeans at Costco would be the cost of buying the jeans from the manufacturer plus the labor cost that was incurred in selling it to you.

Operating Expenses are the expenses beyond the above costs. For Costco, this would include advertising, utilities, accounting and legal fees, salaries for its buyers and management, leasing and other costs.

Subtracting Costs of Goods from Revenue gives us the Gross Margin. From this we subtract Operating Expenses to calculate the Profit (before taxes). A business must evaluate each element of cost and try to reduce it wherever possible while providing the level of service that it desires to offer.

 Capital Needed

To start a business, you will need Start Up capital before you have even made your first sale. Money will be needed for several things and this list will vary by type of business. Items may include costs to develop your product, legal and accounting fees, marketing help, website development, getting patents, etc. The business itself may need to be underwritten for some time before it becomes profitable. Think of these costs as start up costs.

Once the business gets rolling there are two other key needs for capital.

  1. Working Capital: This is the money that is needed to run the day- to- day business. There are three key components: Receivables, which is money that people owe you, Payables, which is the money that you owe others and Inventory, which can be in theform of finished goods or raw materials.

Let’s start with Receivables. Assume you are a small winery selling to wine distributors and you have to give them 60 day terms, meaning they will pay you 60 days after they receive the wine.(These terms are negotiated between the parties, but size and industry practices often determine such terms.) This is a Receivable on your book because the money is owed to you and you anticipate receiving it.

In turn, you have to pay your suppliers in 30 days for the glass bottles and the grapes you buy from them. This becomes a Payable on your books.

In addition to this, let us assume that you will need to keep 1000 cases of wine in Inventory to be able to fill the orders as they come in. This too will cost money.

In this example, you will receive the cash from receivables in 60 days, but you have to clear up your payables in 30 days. Hence you will need money to fund this gap. In addition, you will need money to fund the inventories that you stock. These are the three main things you will need to monitor and fund on a day-to-day basis. This is called Working Capital.

2. Fixed Assets: You also may need to buy equipment such as computers, cars and perhaps even land to build the winery. This capital is called Fixed Assets.

Admittedly, these components have been simplified, but by and large they are adequate to understand the concepts we are discussing.

Verinder Syal, Author: Discover The Entrepreneur Within

Generating Revenues

 

revenue

Revenue (or sales) is the money generated by selling a product or service. Without revenues can a business exist? In the vast majority of cases, noThere are some startup exceptions, especially in Silicon Valley, where businesses are funded in the hopes of hitting a home run later. Instagram and Snapchat are recent examples of this phenomenon but are rare instances.

There are many ways to generate revenues:

  • Selling Units: A grocery store on average carries 20,000 items such as food products, toiletries, medicines etc. There you will find many products from P&G including shampoos, toothpaste, Gillette blades, laundry detergents and so on. Each of these products is sold as a unit. P&G sells these units to the grocery stores, which in turn sells them to people like us.
  • Services: Doctors, plumbers, accountants and lawyers are examples of businesses providing a service.
  • Advertising: Newspapers and magazines make most of their money from selling advertising in their publications. Google makes 90% of its revenues from advertising.
  • Licensing: Software companies like Microsoft and Adobe generate revenues by licensing their products to companies and individuals.
  • Franchising: Examples include McDonald’s, Burger King, Subway and H&R Block tax services.
  • Subscription: Virtually all newspapers and magazines, including The Wall Street JournalNew York TimesNew Yorker and Vogue generate part of their revenues from subscriptions. Netflix and Spotify also generate all their revenues in this manner.
  • Memberships: Examples include Costco, Sam’s Club and many museums.
  • Intermediary: eBay is an excellent example of a company that generates revenues by being an intermediary between buyers and sellers.
  • Transactions: A real estate broker only gets paid when a transaction is completed. Schwab makes money when an investor buys or sells a stock.

Do not get hung up on the exact classification such as whether Netflix is a subscription or a membership service. Just understand that there are many ways to generate revenues. Businesses often combine several of these sources.

  • Amazon sells units (books) and has a subscription service (Amazon Prime). It is also experimenting with a new same day delivery service.
  • Microsoft licenses software, sells Xbox and also sells a monthly Xbox membership service.
  • The Wall Street Journal sells newspapers through annual subscriptions and daily unit sales. They also sell advertising.
  • eBay provides both an online intermediary service and a payment service through PayPal.
  • Costco sells products but makes most of its profits from memberships.

Bottom line, by mixing and matching different processes there are a variety of ways to generate revenue.

In considering revenues, you must not only think about the units you will sell, but also the selling price. There is no exact formula to determine the right price. While competitive prices can provide a barometer, the fundamental factor is the value perceived by the user of your product. Existing businesses also must reexamine their prices periodically. Many consumer items go up in price with inflation. Some products continue to add real or perceived value and are priced accordingly.

We will look at Costs in my next post.

Verinder Syal, Author: Discover The Entrepreneur Within

What Is a Business Model?

 

business model

At one level, a business model answers the question: “How will the business make money?” Beyond that it is also an idea, process, strategy and an insight that results in value creation for the customers and profits for the enterprise.

IBM, HP, Compaq and others were selling personal and business computers before Michael Dell thought of a new idea while sitting in his dorm room. He reasoned that costs could be reduced by selling directly to the customer and eliminating middlemen like Best Buy. The customer would pay at the time of ordering the computer. This money would be used to finance the inventory. By ordering the exact inventory required, the risk of obsolescence would be reduced. The resulting lower costs could then be passed on to the customer, which would lead to higher sales. This, in a nutshell, was Dell’s business model – new, clean, efficient and elegant.

What was Starbuck’s initial business model? It started off selling upscale coffee beans then pivoted to delivering an experience. It was a high quality, highly customized iteration of coffee and milk in a friendly environment. That is why Howard Schultz coined it “a third space” away from home and work. This allowed them to charge $4 for a product where the ingredient cost of coffee, milk and a paper cup added up to about $0.60.

Without the aid of any business books, The Grateful Dead developed a very successful business model in the 1960s and became one of the top grossing bands without ever having a number one hit. Since they did not like working with the record labels, they concentrated on doing live concerts where they encouraged people to record their music for free. They made their money from selling concert tickets, clothing and other paraphernalia to their intensely devoted following of Deadheads.

The profit component is an important part of the business model. Without profits, a business cannot survive for long; the law of financial gravity inevitably reasserts itself. New business models put pressure and sometimes obsolete even seemingly strong businesses.

Newspapers are a current example of such obsolescence underway.“Newspapers with declining circulations can complain all they want about their readers and even say they have no taste. But you will still go out of business over time. A newspaper is not a public trust – it has a business model that either works or it doesn’t.” – Marc Andreessen

The financial purpose of any business is to make money. You sell a product or service for a certain price, which creates Revenues. You incur Costs to generate these revenues. The difference between the two is Profit.

Revenue – Costs = Profit

This is the fundamental equation of a business. Making a profit is a necessary condition for a business to survive. Yes, there are a few details involved, but this is the basis of profitability.

A business model helps us examine and understand the key elements of the financial equation: how the revenues will be generated, what it will cost to provide the service, what support (overhead) structure will be required and how much capital will be needed to start the business. The goal is to both understand these factors and to find ways to improve the model.

We will discuss all this in greater detail in my subsequent posts. Till then, think about what your business model will be.

Verinder Syal, Author: Discover The Entrepreneur Within

Getting Things Done is Hard

 

to do

Dreaming is fun. Talking is easy. However, getting things done is really hard.

Most organizations develop detailed and lengthy plans. There is a minor problem though: most plans never come to fruition. Just look around you. Virtually all organizations talk about what they plan to do in lofty terms, mistaking their verbosity for actual results. Size is a natural enemy of getting things done. Governments and large organizations are a good example of this phenomenon. Numerous layers of management lead to greater bureaucracy, lengthy processes, less accountability, all of which then result in lesser productivity.

Size can be an inhibitor, but so can one’s actions. How would you rate yourself? Do you regularly make deadlines? Did you finish that project you committed to? Is your inbox cleared out? Have you called your parents recently?

Entrepreneurs view themselves as people of ideas and action, and they are. But some of them also think of themselves as visionaries, dashing around, formulating ideas and directing action. Before anything is actually done, the word goes out – “Hold it”- the visionary has a new idea.

While it can be exhilarating to play the lead role, chaos, bedlam, frustration, fear and ire are often the end result. An excerpt from a 2015 Fortune article titled “Jawbone: The trials of a 16-year-old can’t-miss startup,” described the story of well-loved entrepreneurs with big ideas who often missed product deadlines. After 16 years they are still in the startup phase. Another article talks about “Fab the design-focused e-commerce site that said it would generate $250 million in revenue in 2013. It ended up bringing in around $100 million…Fab shrank from 750 employees to 150.” Ideas and execution are different creatures.

Shakespeare was evidently thinking about this when he developed the concept of Prattle without Practice” in Othello. I have encountered many prattlers in my business life. Sometimes people prattle because they think their role as the head honcho demands it. Humans also babble when they are either bereft or have an overabundance of ideas. I plead guilty too. I love discussions and I take great pride in talking to the rank and file about all sorts of ideas. The problem is that when a boss utters an idea, it is sometimes hard to distinguish between an edict and an unformed suggestion that can be safely discarded. At the end of my first year of running a very large business, I was asked what the most important lesson I had learned was. “How to keep my mouth shut,” was my answer.

Verinder Syal, Author: Discover The Entrepreneur Within

People Are More Important Than Ideas

people

In reading the works of Jim Collins, Peter Drucker, John Maxwell and others, as well as thinking of my own experiences, I have been struck by how important it is to have the right people in the organization. Jim Collins’ notion of “First Who, Then What” reiterates the fact that people are more important than ideas. The right people are not motivated by money. Yes, of course they need to make a living, but they are motivated by something far greater, namely learning, growing and making the organization successful and exceptional. Such people always do the right thing. They like to be trusted, given responsibility and they deliver exceptional results. They hold themselves responsible to a standard much higher than anything you can possibly ask for.

When you find such people, hang on to them. They don’t come often. Work to find the right seat for them. What should you do if you are not sure of someone? Take a pass. Wait until you find the right person. Character is the most important trait that I want in a team member. Nowadays most skills can be outsourced, but not character and integrity.

If perchance you happen to get a person who does not have character on your team, hope like heck, as Warren Buffett said, that they are stupid, because otherwise the consequences will be disastrous.

“Most people say that it is the intellect which makes a great scientist. They are wrong: it is character.” – Albert Einstein

“People grow through experience if they meet life honestly and courageously. This is how character is built.” – Eleanor Roosevelt

“Be more concerned with your character than your reputation, because your character is what you really are, while your reputation is merely what others think you are.” – John Wooden

Food for thought.

Verinder Syal, Author: Discover The Entrepreneur Within

A TEAM CONTRACT

A few years ago, I used Professor Goodman’s methodology and starting asking my students to develop a team contract at the outset. The teamwork has improved considerably.

Here is another anecdote from a student: “There was something about having the structure of the charter in the very beginning. We took the time to sit down together in my living room and seriously thought about what we individually wanted to get and give in the class, but more importantly, what we as a team wanted to achieve. Getting down on paper what we’d need to do to be successful solidified our sense of camaraderie and got us excited for the endless possibilities the future held.”

I recommend you develop a team contract too. RIGHT NOW!

Here is how to do it:

 To Do as Individuals

  • Think about a team that you were on that was highly successful. Write down three factors that you think made that happen.
  • Think about a team that you were on, that was a failure and a miserable experience for you. Write down three factors that you think made that happen.
  • What lessons did you learn from the above?

 

To Do as a Team

  • Discuss lessons learned above.
  • What things are important to the team members and the project?
  • Develop a team Charter with the following components:
  1. Lay out some things you will do and will not do.
  2. What behaviors are desirable and what are not?
  3. How will you treat each other?
  4. How will you listen to each other?
  5. We suggest no more than five guiding behaviors.

Revisit the charter every month to discuss how your team is doing. Revise as necessary.

contract

Let me know if this helped you!

Verinder Syal, Author: Discover The Entrepreneur Within

A Circuit Breaker

team building

Will your team break down at some point? You can bet on it.

Someone will develop a penchant for being late or always have an excuse for not getting their assignment done. Another person may suck up all the oxygen in a room while the “quiet” one will rarely participate because “he prefers to listen.”

Sometimes you will need to talk to a person alone and other times it’s best to do it as a team. The circumstances will dictate which route you take. In either case, consider following these words of wisdom from John Maxwell, who writes and speaks on leadership:

  • Do it as soon as possible after the incident.
  • Speak to one issue at a time.
  • Don’t keep repeating the same thing. Do it once.
  • Avoid sarcasm.
  • Avoid words like “never” and “always.”
  • Present criticism as suggestions.
  • Don’t apologize for the confrontational meeting.
  • Don’t forget the compliments.

Once again, these are all basic courtesies that we should readily afford one another. However, in our emotional state, we are prone to forget. Have I ever repeated myself? Been sarcastic? Dredged up three lifetimes of history? Did I ever win the argument? Surely you jest.

A student shared this story: “We had been doing great work throughout the quarter, but one of our team members was constantly late. It was starting to grate on us as we felt that his lateness indicated a lack of dedication to the team and that it was hurting our efficiency. We sat down, shared our feelings and told him that we wanted everyone to do the best work possible. We were open and honest and so was he and things improved greatly from thereon.”

So, do not be afraid to use this circuit breaker when needed. You will be far more effective and less stressed.

Verinder Syal, Author: Discover The Entrepreneur Within

What Do Good Teams Look Like?

team

Where there is a team, there is bound to be dysfunction. And that is good to an extent. We need to get rid of fake harmony. Very simply, conflict of ideas is healthy, but a conflict of personalities is cancerous. Argue about the ideas as much as you like, but don’t demonize one another or someone’s point of view. The permission to do this comes from the trust you have built.

Since everyone has had a say and has been listened to, commitment comes more easily. People do not demand that their point of view be accepted, but they do want to be heard. Whenever people feel they have had an input into something, they feel committed to it. The outcome becomes “ours.”

With these steps, people embrace personal accountability. Even more importantly, they hold their teammates accountable for the goals that were assigned to them. Everything then is about team goals and not about me, what I did and what others did not do. Remember people do like to accomplish things and do like to be held accountable as long as everyone is being held accountable.

Not surprisingly results improve. While good results can never be guaranteed, the likelihood of better results is enhanced. More importantly, the journey becomes fun.

My good friend, Professor Adam Goodman, Director of The Center for Leadership at Northwestern University, makes several suggestions to my students as they embark on forming teams.

  • Get to know each other by spending time together.
  • Talk in person whenever possible as opposed to emailing and texting.
  • Come to the team meetings on time.
  • Come prepared having done all the homework you were supposed to do.
  • Come ready with your questions and suggestions.
  • Learn to have honest conversations, not polite ones.
  • Clearly define the tasks and roles for each member.
  • Demonstrate your commitment through small wins as opposed to trying to impress people with big things.

Does anything seem like brain surgery here? No. It is simple. It is a lot of singles and very few, if any, home runs. But why is it so hard then? The reasons lie in our impatience, which has been made worse by the onslaught of the 24/7 tools of technology. Slow down, breathe and finish what you have committed to doing, now.

Professor Goodman further counsels: speak less, listen more, ask questions, talk about mistakes and seek feedback. Understand differing perspectives; pick what is best for the team and self-reflect often. Embedded in this advice is a lifetime of wisdom.

Building a team is akin to cultivating a garden. It takes time, energy, water and a big dollop of nourishing. Every human being is both similar and different. We need to work with both ends of this spectrum to discover and unleash the richness that lies within.

Before asking others to do something, I have often found it better to set the example myself. A leader does not do what he wants to do; he does what is required to be done. I once witnessed a team that was in total disarray come together quickly, productively and joyously, when the leader took the feedback to heart and changed the way she approached the team.

Are you a leader? If so, you must lead the change.

Verinder Syal, Author: Discover The Entrepreneur Within

Engendering Trust

trust

What is required to build trust? Perhaps Emerson had the answer: “Trust men and they will be true to you; treat them greatly and they will show themselves great.”

The starting point of trust is getting to know each other. You need to be willing to be vulnerable, share your fears, weaknesses and to listen with an open mind. How do we do this? By spending time together, sharing and listening. Let me share with you a few exercises (none of which were created by me), which would help in the process:

Six Questions: each team member takes 10 minutes to answer these questions:

  1. Where were you born?
  2. How many siblings did you have?
  3. What was the most challenging experience you had growing up?
  4. What was the best job you ever had and why?
  5. What was the worst job you ever had and why?
  6. Share something that very few people know about you.

You will be surprised as to how much you can learn about a person by just listening to their answers. Human beings have a need to share and open up, but this can only be achieved in an atmosphere of trust.

The second exercise is called Share Your Shield. The various segments of the shield are designed for the participants to share their inner feelings. How do you see yourself? How do you think people see you? What can you offer others and what would you like others to help you with? What motivates you and what irritates you?

Each member can also mention his personal motto at the end of the shield. The mottos – what people stand for – are always interesting and revealing.

The third exercise, called the Johari Window, is especially helpful when the team has worked together for a few months. It focuses on the “Blind Self,” a side of ourselves that we do not see but others do. The purpose of this exercise is for our teammates to help us see this hidden part. Everyone jots down two things about the other people in the room: 1) Things they do that are positive and helpful to the team and 2) Things that they do, perhaps inadvertently, which hurt the team.

The team starts with giving feedback to one person, generally the leader. One at a time, you tell this person what you see their positive attributes to be. The recipient of these comments can only ask a clarifying question but cannot defend, make any other comments, or argue. Now the team shares the second part of the equation: things that you would like this person to improve or abstain from. The same norms apply.

There are many such exercises. Please keep using them and getting to know each other better. Truly understanding someone takes time. Be respectful of the other person’s feelings. However, you must also be honest. Being politically correct is both demeaning and unproductive. The purpose is to give constructive feedback and help one another grow. In an atmosphere of trust, virtually all things can be put on the table and addressed.

Everything starts with trust.

Verinder Syal, Author: Discover The Entrepreneur Within