The Facts of Business Life

by Bill McBean

  In the 1960s, for example, if you owned one of the four “C” franchises—Caterpillar, Cadillac, Coke, or Chevrolet—you were most likely a millionaire. Ironically, these brands were so strong at the time that even if you were only a mediocre owner-operator, you could still be very successful. Customers want what they want, which in a competitive market means some products are far easier to sell than others. So if you have one of these “A-list” products, owning a business and competing in the marketplace is going to be considerably easier. Current examples of products like this include Pepsi and Coke in the soft-drink market, Harley-Davidson motorcycles, and Nike in sports equipment and apparel, among others. Perhaps most important, selling products or services that already have a strong presence in the market can serve as a foundation on which to build an aggressive and highly successful business.

  But whether or not you offer a dominant product or service, it’s always appropriate for you to be both concerned and optimistic. That’s because the market is constantly changing, and what was true yesterday isn’t necessarily going to be true tomorrow. Look, for example, at the “C” franchises mentioned earlier. Of the four, only Caterpillar has remained basically the same. Coke is still dominant, but the rules have changed. The company has bought back most of its franchises and distributorships, so while the brand is still strong, a lot of the owner-operators are gone. And neither Chevrolet nor Cadillac dominates the marketplace anymore. In other words, three quarters of the most dominant brands in the world have shifted over less than one lifetime.

  Will Google exist in 20 years? It’s hard to think what would replace it today, but tomorrow, who knows? RCA Victor and Capitol Records, Oldsmobile and Plymouth, AIG and Bear Sterns, AOL and Exxon, and many more, have disappeared or are only remnants of what they once were. The point is that having a successful product today is no guarantee of success tomorrow, and it’s important that you, as an owner, be aware of that. This is true for the service industry as well. At one time there were blacksmiths everywhere, but today they mostly ply their trade in restored eighteenth- and nineteenth-century villages. Nor are there any more electronic or appliance repair shops because the prices of these products have fallen so dramatically, it’s usually better—and cheaper—to buy a new one than fix the old one.

  The realities of the marketplace, then, are that customers first have to want or need what you’re offering, there will always be preferred brands to compete with, and both your competitors and the market itself change over time. And if that doesn’t look like a war zone to you, you might want to take another look.

  How Your Business Operates

  In the marketplace war zone, the best operators are not necessarily those who make the most money. At first glance this may not seem to make sense, but it makes a lot of sense when you factor in product inequities. As I mentioned earlier, some companies have a very strong market presence, which in turn enables those who sell their products to make more gross profit on what they sell. Nike, for example, is able to command a higher price than a “no name” brand for its sportswear, even if the two are of equal quality. The Nike “swoosh” has a customer demand that drives sales and gross profits. By contrast, retailers who handle less popular brands have to sell their products for less money in order to create sales, and in turn make less money for every item sold. This is a reality that is often disregarded when owners are evaluating opportunities.

  Whether your business sells a high-demand product or brand or one on the opposite end of the spectrum, the basic rule of thumb for operating a business is that you sell for gross profit and manage for net profit. This means there are basically two areas you have to concentrate on in order to make an acceptable profit. The first is finding ways to maximize your gross profit through volume sales, achieve a significant gross profit on every item you sell, or a combination of the two. The second is managing expenses. Once you calculate your anticipated gross profit, you have to manage your expenses in order to make sure you have more gross profit than expenses.

  The fact that these product inequities exist also presents three operating issues that impact on profits and the need for operational skills. The first is how A-list product owners operate their businesses and the effect it has on the entire market. Since markets are finite, the more market share these owners have, the less there is left for the smaller market niches. This is true basically because of price. By choosing to operate with fewer sales but higher gross profits on what they sell, A-list owners leave more buyers for the inexpensive brands. However, if one of these A-list owners decided to lower its prices and operate on very little gross profit but more volume, the other A-list owners would have to lower their prices as well, thereby attracting and selling to more buyers, and in turn limiting the number of buyers for the inexpensive brands.

  Second, owners who represent products on the A list have to operate their businesses better than their head-to-head competitors in order to get the lion’s share of the brand’s business. For example, two NAPA parts stores compete for business with those customers who prefer NAPA brands as well as with the rest of the market. But the NAPA store that meets more of the customers’ expectations—that is, the one that operates better—will be more successful.

  Third, owners who don’t have the advantage of a strong market presence should use a different business model than those who do, because they usually have smaller gross profits when compared to their counterparts. That means they have to make up for those lower profits in different ways. For example, Maytag appliance stores don’t make money on repairs (or so their marketing suggests), they make it on selling their appliances. But those selling brands with less of a market presence, who will therefore sell fewer appliances and realize lower gross profits, can only increase their profits by selling more items, providing service, and possibly by selling add-on products. The point is that the products you sell, service, or manufacture have to dictate how you operate your business in terms of your expense structure and your gross profits. If you don’t operate your business this way, you won’t have one for long because in the war zone it’s survival of the fittest, and the fittest is measured by net profit.

  How Your Business Competes—The “X” Factor

  Competitiveness, the third element of the marketplace war zone, also has a direct connection to the product or service you sell and how your business is operated. For example you can have a great product and develop a great marketing campaign that attracts hundreds of potential customers. But if they discover that your business is disorganized, or that your staff is discourteous or lacking in product knowledge, it’s not going to do you much good. However, when you have a great product and creative, targeted, and aggressive marketing and advertising, and your business is operating well, you will have developed the X factor. And it’s developing that X factor that will enable you to increase your market share and take business away from your competitors, whether you have an A-list product or not. So while it’s true that owners who represent top brands can dominate their markets, even those who have lesser brands can work their way up the market share ladder and be strong market competitors.

  Unfortunately, the X factor, like the other elements of the marketplace war zone, can’t increase your business’s market share over an extended period of time—at least it can’t do it alone. In the end, being competitive is not just about having an aggressive market reputation and creative marketing and advertising. It requires additional weapons to be fully competitive, including price, customer service, selection, convenience, and location, just to name a few. And, because of the way the war zone works, that is, because the competition continually heats up, these weapons have to be continually redefined. It’s not easy, but if you want your company to move ahead, it has to be done. As I said at the beginning, that’s just the way it is. The marketplace is a war zone, and the battle never ends.

  Level 1: Ownership and Opportunity

  As is always the case, regardless of which Fact of Business Life is be
ing discussed, Level 1 is essentially about looking into the future and asking yourself two questions—“Do I want to be an owner?” and “If I do, what opportunity do I want to pursue?” This is essentially how Level 1 works—if you decide that ownership is for you, then you begin to look for opportunities. As you do so, though, you’ll soon begin to realize you are not alone. That is, there are others who are exploring opportunities, including already established companies that are using Level 1 research techniques to expand their businesses. In other words, you have competitors even before you’ve started. Welcome to the war zone!

  One of the benefits of looking at opportunity through each Fact of Business Life is that it enables you to see it in several different ways. This is important because opportunity comes in many forms, and studying it from different perspectives allows you to see opportunities others may have missed as well as recognize potential threats or problems. The war zone perspective on opportunity begins by focusing on the market’s dominant brands, or A-list products, their market share, and the impact they can have on the market you are interested in. If, for example, you’re considering opening a home improvement store, you have to bear in mind that Lowe’s and Home Depot already have 60 percent of the market, so that if you want to compete, it will have to be for part of the 40 percent that remains. Of course, if you were the only competitor outside of the A list, you’d be in great shape, at least until other competitors enter. But if your business were one of 20 competitors, the size of your market would be extremely limited.

  In addition, when A-list companies command such a large part of the market, they can make the environment even more difficult for competitors. If, for example, Lowe’s or Home Depot decided they wanted to squeeze out some of their competitors, either one of them could do it by lowering its prices. And if one of them lowered its prices, the other would certainly do the same, which would have an enormous effect on the entire market because by expanding their sales and market share, they would be lowering the market share available for their smaller competitors. And even if one of those smaller competitors decided to lower its prices, all it would serve to do would be to put a squeeze on the company’s gross profit, which would have a negative effect on its bottom line. A true lose–lose situation.

  These are important points to consider in any opportunity evaluation because they take into account both market share and gross profit, the two variables that ultimately define opportunity. The preceding example also indicates the importance of price in the market. Pricing is important in any opportunity analysis because it defines gross profit or lack of it. However, some industries are more price sensitive than others, and if this price sensitivity (also referred to as price elasticity) is an issue in the market you’re looking at, you should consider it to be a red flag. This is because if A-list brands like Lowe’s and Home Depot want to expand their market and have a pricing war, they will still be standing when it’s over, but not all their competitors will be. The market is a war zone, and it has many victims. The opportunity decision, then, should be focused on determining if there is enough opportunity outside the dominant brands in the market and, if so, whether it can generate enough gross profit to make it worth your while well into the future.

  The Benefits of Understanding the Marketplace War Zone at Level 1

  Understanding the marketplace war zone gives you an additional means of evaluating the opportunities you are considering, whether you are just starting a business or expanding an already existing one.

  Understanding the marketplace war zone provides you with a competitive edge by enabling you to prepare for it even before you enter it.

  Understanding the marketplace war zone forces you to consider the strengths and weakness of your potential competitors in terms of product, operations, and competitiveness.

  Understanding the marketplace war zone helps you determine which brands dominate in the markets you are considering as well as identify the effect pricing has on the total market.

  Understanding the marketplace war zone enables you to determine if the market is overcrowded, or could become overcrowded, by the dominant and nondominant brands.

  Understanding the marketplace war zone allows you to identify and use the weapons you will compete with to measure—and decide on—your opportunities.

  The Products or Services You Sell at Level 1

  The primary focus for products or services at this level is on the size of the selling opportunity and the gross profit attached to those sales. Again, a good way of looking at opportunity is by looking at the dominant brand or brands in the areas you’re considering. If, for example, you find out how well those dominant brands sell, and determine the size of their national and regional market share, you can compare those figures to their share in the market area you are studying. Doing so will give you a good idea of how the market you’re considering compares to the industry or national sales averages, and the result may well show some inequities you could take advantage of. If, for example, you are thinking of opening a high-end furniture store, and you find a city in Florida that compares favorably with other Florida cities in that it doesn’t have any stores selling A-list furniture, there may be an opportunity there. Similarly, if you are looking at a market where there is an A-list retailer, like a McDonald’s, whose sales are weak compared to national and regional sales, you might consider approaching the owner to suggest purchasing his or her business.

  Once you have determined that there appears to be ample sales opportunity in the business you are considering, and approximately what those sales might be, the next step is to calculate the gross profit attached to them. Sales information is relatively easy to find through public records or industry reports, but determining gross profit can be more challenging. If you are familiar with the industry, though, you can usually find many people who can direct you to places where this information is available. Gross profit can be calculated in two ways—the gross profit made on each sale or the gross profit made on all sales. The first can be determined by subtracting your cost for the product from what the products sells for in the market. If a package of razor blades cost you $4 and you can sell it for $7, your gross profit is $3 per sale. To find the gross profit from all sales, you simply multiply the number of packages you expect to sell by the expected gross profit per sale. So if you anticipate selling 10,000 packages, your gross profit would be $30,000. Your new sales and gross profit estimates should line up with your other gross profit calculations from the other Facts of Business Life, and if they don’t, you need to find out why.

  Since the war zone is such a competitive arena, there is one other issue you should look at after you have calculated sales and gross profit. This is the matter of whether it is likely that other competitors might enter the market. This issue presents two questions you have to answer—“If there are few barriers to entry, how will this affect my operations and forecasts?” and “Once my business is up and running, is there anything I can do to discourage others from trying to enter the market?” Unfortunately, at this point there is no way to answer either of these questions. Only time will tell. They are both, however, questions you will have to think about and address if you choose the opportunity.

  How Your Business Operates at Level 1

  The basic purpose of a business’s operations is to make a profit. The goal at Level 1, then, is to define the opportunity in terms of how much money (profit) can be made each year over an extended period of time. Since this is a preparation level, you don’t have to concern yourself with how well you will operate the business, but rather with how much potential there is to make money. Up to now I’ve been talking about sales and gross profits because they are product or service issues. But on the issue of how your business operates, the focus is on net profit and how it relates to the opportunity. Net profit can be calculated by subtracting the cost of products and services from the revenue generated from sales, which, as noted above, leaves you with your gross profit number. Once you have t
he gross profit, you subtract all your costs for operating the business, and the difference—whether positive or negative—will be your net profit.

  For example, if you owned a clothing store and your sales over the course of a month added up to $200,000, and your cost, or what you paid for the clothes you sold, was $125,000, your gross profit would be $75,000. If you then subtracted your total monthly expenses of $20,000, your net profit before taxes would be $50,000 for the month. Net profit gets extra attention in the marketplace war zone because it can be a tactical as well as a strategic weapon both offensively and defensively. For example, on the offensive side, the stronger you are financially, the more money you can spend on marketing and advertising, generating additional sales as well as gross and net profit. Defensively, profit can be used to fend off any attack on your turf from a competitor.

  A War Zone Story

  I was once very familiar with a market area in which there were four dominant companies. These four businesses were owned by four different individuals, each of whom had been in business for nearly 20 years. They all had their own turf, and they were all content with their sales, gross profit, and net profit. Then one of the four sold his business. The new owner, wanting a make a name for himself and increase his market share, decided to lower his selling prices.

  For the first few months the new owner had impressive sales increases. And then, four or five months after he had taken over, one of the other three owners dropped in to welcome his new competitor to the city and the market. After some general pleasantries, he brought out his financial statements and showed the new owner his impressive financial position. Then he told the new owner that unless he increased his pricing he would begin selling his products at a loss and bankrupt the new owner. The market returned to normal very quickly.