Contractor’s Corner: Up your game and add a new business niche - Aug/Sept 2022
By Dave Stafford
With the challenging times in 2022-slower deliveries of products, price increases, stressed-out clients and the political climate-it is no wonder that most business owners are again examining their business mix. How might the addition of another market niche relate to selling the business or passing along a valuable entity for business continuity? Your decisions now can help you withstand the upheaval that is sure to unfold over the next year or so.
ONE-TRICK PONY vs. DIVERSIFIED BUSINESS
I had a conversation with the general manager of 40+-year-old flooring dealer who admitted that his business was 75% builder and the balance retail residential. I asked him if he was happy with this business mix. “No, I lose sleep over this, but the owner likes the status quo.” After more conversation, he admitted that bankruptcy and slow pay by several builder clients had taken their toll, “but times are good now and we just landed another builder.”
My frank analysis was that he was at the mercy of a consumer downturn, and his cash flow would dry up when his builder clients started using him as a bank or went bankrupt. He had a large hospital complex, a few corporate clients, school systems and a university in his geographic area; however, his sales efforts were not toward them.
Within a year, this well-regarded company was sold to an absentee owner, who continued along the same path. After several years, he was bankrupt and out of business-a sad fate for what used to be a major flooring business in the local area.
Hedge your volatility and limit your risk by balancing your business segments. If you have builder clients, you should also have some retail clients for their cash flow potential. Add in sales targets in healthcare, local government or a school system. One large corporate client or local commercial business will also help. Track your categories by business volume, profitability, cash flow/collection and installation difficulty. Develop your own internal rating system so you know what works for you.
We’ve all had situations where we must say, “We love you but cannot afford to continue to do business with you.” I reached that point with a property management company (good volume but lower profits, insane time requests and slow pay) and some government agencies (low volume and high profit but very slow pay and challenging installation).
BUILDING A DIVERSIFIED BUSINESS: STRATEGY
If you are aiming for business continuity, do your potential legacy heirs or partners have an interest or experience in the new business segments? In more than one case, a son who excelled in the free-wheeling residential and mainstreet commercial sales did not have the patience or interest in to develop local and federal government multi-year contracts. A “round peg in a square hole” scenario ensued, frustration abounded and the heir-apparent left the business.
This same situation exists when one is thrust into a management position and is emotionally unsuited or trained for the task. Nepotism only works when the recipient is qualified.
Does the new segment represent a minor or major addition to the existing business, overall? For instance, if local government contracts are already part of your marketing thrust, it might not be too big a step to add a state government contract when it’s focused in your geographic region. In fact, both may be enhanced by expertise in the other. Contract bids, administration and project management may be handled by the same personnel.
The same may not be true when one is eyeing a federal government term contract. More than one business owner has heard of the large potential sales volume but overlooked the time, expertise and agony required to receive an award. Then there’s the marketing required to actually make sales, and the myriad of regulations with which one must comply.
In my own painful experience, an administration “investment” of possibly $15,000 to $25,000 and patience-usually one to two years-is needed to gain a contract. And for every success in this area, there were others where the venture became a money pit with little to show beyond having a contract number. Worse yet, these contracts may be canceled when sales volume cannot be demonstrated over a reasonable time, usually two years. I used to provide consulting to owners or managers who were considering this specialized area. When confronted with the cost, red tape, and need for marketing and administration, most decided there was a better way to earn a buck.
BUILDING A DIVERSIFIED BUSINESS: FINANCES
How you plan to finance the learning curve and new personnel is always an issue. Be honest with yourself and look at cash flow from operations and accounts receivables: What if you added another $250,000 of expenses with zero expected return? How many personnel will you really need? How long will it take for them to show some return rather than a dead loss? Unless an exception, that new salesperson will not be pulling dollars to the bottom line for at least a year-a project manager or coordinator even longer-assuming your segment is successful.
May your existing credit lines be tapped for some cash flow, or will you have to open new ones? Suppliers can be reluctant to grant credit to a new buyer except under the most stringent terms. You may find an increase in your bank credit line is necessary until you prove yourself. When you have a solid reputation of business success and good credit history, a small credit line with a new supplier and quick-pay terms may be the answer to proving your mettle.
One question you must be able to answer for their credit manager is, “What is the dollar volume of our products you expect to purchase over the next 18 months?” You’ll have to back into that number by looking at planned gross sales and cost of goods sold to refine the number of units you’ll buy. Everybody knows this is an estimate, but be able to break it down. It must be reasonable. Better to underestimate and pay bills ahead of time rather than the alternative.
BUILDING A DIVERSIFIED BUSINESS: MARKETING
When working on a minor addition, it will make sense to promote the segment as part of the larger, established business as “now being offered in-house.” Floor leveling, specialized cleaning, floor refinishing or polishing are examples. You’ll have the advantage of credibility and reputation from your existing business, the “halo effect.” Certain costs can be absorbed within the larger business to offset actual expenses, including ancillary personnel.
If a major addition is planned, consider the relationship between your existing business, reputation and brand and the new one. Are they compatible and able to integrate seamlessly? Is a new brand identity (and the associated costs) necessary? When there is a large investment being made or when potential liability is an issue, perhaps it makes sense to incorporate a new entity. There is no need to drag down a profitable business with a failed startup. This is why test marketing and research are essential. We’ve all had great ideas at 3:00 a.m. that unraveled in the bright light of the day-“Yes, we could probably make it happen, but not with existing personnel; we’d be faced with leasing additional storage space and setting up a new work area.”
BUILDING A DIVERSIFIED BUSINESS: SUCCESS
Being realistic with sales, profit and payback goals is the cornerstone of success with any new venture. If there is a failing among owners, it is usually that of overestimating profitability and underestimating related costs and the effect on company personnel who must now divide their time and energy with the new niche.
When you’ve done effective research and test marketing, you’ve found (or been told) sales unit prices and approximate gross-margin levels. If you plan for 80% to 85% of those unit prices by allowing for promotional discounts or enticements, that’s probably about right. With gross margin, factor in mistakes in estimation and installation screwups, because they will happen. Overall, plan for 75% to 80% of your goal for the first year.
Now, how do your sales and first-year profitability look? If either is lacking, how can this be fixed? Find an answer before the rollout. Where possible, increase the sales unit price and markup slightly. Perhaps your supplier can do a bit better on price or terms. Are you able to negotiate a better installation rate with your team(s) by giving free training during the first six months with a bonus on profit goals?
In one aborted personal scenario, I found the biggest learning-curve cost was the inability to quickly sell enough projects to keep the specially trained crew busy. The crew was talented, but installation techniques learned through experience in the new area were lost because project installation was sporadic. It’s tough to install carpet one day and make the shift to a poured floor the next. You can re-seam carpet or power-stretch, but one prep mistake or a miscalculation in the mixing ratio and a poured floor is a total loss.
The gross margin was above target levels but could not overcome the slow pace of sales. Existing sales personnel were afraid of the exacting nature of this segment and were reluctant to push it. Estimating was tricky. The amount of site prep, floor repairs and liquid product varied from job to job. Installation parameters changed. Though there were incentives, it was so much easier to sell sheet vinyl or carpet tile.
One project was a write-off because of a product mixing mistake; another was under 8% gross profit due to estimating errors, and product wastage was double that projected. An inspection of the storage area revealed non-compliance with local regulations, and those had to be addressed.
Then there was the potential liability. A large project was canceled mid-delivery because of bad publicity for the government client. For me, that was the last straw. We did not need the spillover from a hysterical press that might tarnish our other business. The new business was just too fraught with peril for the payback, even though we made a profit on paper.
If you are entertaining an upgrade to your current business and want to enhance its value, are you going to stick your toe in the water or dive into the deep end of the pool? That decision can usually be made when you look at available cash flow and credit lines, or it may depend on the nature of the new business. Some will require significant equipment and personnel commitments that preclude half-measures. How does this new venture fit with your existing viable business? Have a trusted advisor, such as an accountant or attorney, look over your business plan. With their feedback, does this venture still make sense? That’s the question to answer before you begin, not postmortem.
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