Past Lessons for Future Growth
Reviewing prior academic and industry research can unveil compelling insights on how to succeed now, Glenn G. Kautt says.
Reviewing prior academic and industry research can unveil compelling insights on how to succeed now.
Think of your business as an investment portfolio, where you’re striving to position it on the edge of the efficient frontier.
TWO DIFFERENT YEARS-OLD REPORTS from industry researchers and the academic world offer predictions and analysis that are surprisingly suited for today’s world. And the current generation of decision-makers would be wise to heed those lessons.
Harvard University business historian Alfred Chandler wrote “The Visible Hand” in 1977, taking his cue from the invisible hand concept Adam Smith introduced in the “Wealth of Nations” two centuries earlier.
Chandler’s book described how the definable, controllable factor of management exerted a more powerful influence than free-wheeling, invisible market forces. He showed that managers running large enterprises exerted greater influence in determining size and concentration in American industry than capital or market forces.
With Chandler’s findings in mind, I researched our industry and considered my business future. First consideration was another report from a mutual fund called Undiscovered Managers that forecast a decline in profit margins and consolidations. (Undiscovered Managers sought out unappreciated businesses initially, and has evolved into the Undiscovered Managers Behavioral Fund, which selects small-cap stocks based on behavioral finance factors.)
I was struck by several things in their report. First, the principal author was bright, focused and well-educated. Also, the report’s message was in agreement with the findings of a long line of research on business evolution, including Chandler’s assertion about the power of management in dealing with business challenges.
Still, the report ignited a firestorm of controversy at the time because it stated profit margin compression, firm consolidation, the emergence of niche practices and a host of financial woes for small practices were coming. Today, the same forces are still at work.
Undiscovered Managers followed up a year later with a prescriptive report, including their recipe for success: Find a niche or get big. The whole thing sort of disappeared after that, but that does not mitigate the overall message for today’s businesses.
ANALYZING PROFIT MARGINS
A substantial amount of business research shows maximum profits depend on business strategy, organizational structure and where the firm fits in the marketplace.
But knowing the difference between strategy and operations is key. Attempting to improve service quality and reduce the cost of that service fall under operational effectiveness (moving from A to B on the Strategy vs. Operations chart). On the other hand, the decision to offer high-quality service at a high price or lower quality service at a lower price is a strategic positioning choice (moving from P to Q on the chart).
Think of your business as an investment portfolio, where you’re striving to position
it on the edge of the efficient frontier. Some decisions move you around, toward that frontier or away from it. Simply put, you can’t operate two very different businesses optimally using the same operational model.
Expecting higher profits without understanding where you are in your marketplace is a waste of time. Analyzing profit margins must be done in the context of your organizational structure and profitability drivers. Different organizational models with different profit margin structures will work fine — if you know which one is right for you.
Competition will force the inexorable drift from firms that once practiced cuttingedge operation to becoming commoditized. If your firm continues to do the same thing year after year, you’ll find yourself becoming less competitive and profitable. Here’s what we decided at our firm:
• Studying industry surveys, we recognized we were above average margins for our industry.
• We confirmed how we operate in the financial planning market: an established, knowledgeable firm based on a comparison of our company’s operating practices and financial characteristics.
• We understood we could not compete with the high-volume/low-margin firms unless we changed organizationally to be exactly like them.
• We realized we could not compete as high-margin or high-volume using the same organization.
• We saw that doing nothing would start our drift to becoming commoditized. After that bit of self-analysis, here was our reaction. We made a long-term strategic decision to stay in the forefront of the industry technically and intellectually. Our advisors would become experts, publishing professional contributions in journals and white papers based on solid research.
Then we’d share our expertise by writing and speaking about it. We made clients and prospects aware we were recognized experts, backing that up with practical application of our skills. And we added more services such as 401(k) services and tax preparation as stand-alone profit centers, and less-costly/less-sophisticated services for smaller clients in another profit center.
Our industry continues to change. These changes are typical of every maturing industry, and there’s not much you can do about the big trends. But, there is plenty you can do with your business to take advantage of these changes if you realize where you fit in the marketplace and operate accordingly.
To do so, you need to get very real with your business. Hire an expert to help determine where you are in the marketplace and where you should be heading.
Next, consider how to get there. “Should you be moving from a Q to a P firm, or focus on moving from A to B on the chart? Should you consider combining with another firm to change more quickly?
And bear in mind, it is your total profits, not profit margins, that are important. Take a lesson from the past: How you increase profits depends on company organization, which depends on your strategic goals and vision for your business.
If your firm continues to do the same thing year after year, you’ll find yourself becoming less competitive and profitable.
Maximum profits depend on business strategy, organizational structure and where a firm fits in the marketplace.