Sales is the engine that runs the business. It can also add significant or actually harm value. A number of businesses were started around one customer and when they represent more than 10% of revenue or 5 or fewer customers there is a customer concentration risk.
This is the sixth in a series of nine articles that follow a business owner, John. He is taking action to increase the value of his company before transitioning or selling it and moving into retirement. In the first article, he learned that Tom—who owns a similar business—had sold it for a much higher price than John was told his company was worth. In the next few articles, John discovered the importance of having a business plan, what it should include, and how strong leadership, his people and marketing drive the value of a business.
Business Value Enhancement 101
Value drivers affect either the earnings or the worth of an operation. Being in business is about making a profit and creating sustainable transferrable value.
Value isn’t always about the numbers. Environmental and qualitative value drivers have a dramatic effect on a company and its ability to grow. Knowing what creates—and destroys—value helps owners and managers make better day-to-day decisions. That also allows them to build increasing a company’s value into its culture.
The place to begin is a detailed discussion about the quality of the organization. This should include the owner, management team and advisor. At Birkdale, we use the results in our Deep Discovery and an Enterprise Value Assessment and the Value Enhancement Process. An initial conversation broadly examines the eight main value drivers:
In taking an in-depth look at each area, John and his business advisor were ready to move to the fifth category: sales.
Sales is the engine that runs the business. It can also add significant or actually harm value. John just learned the distinct difference between marketing and sales. A summary of this bears repeating.
Marketing versus Sales: The Chicken and Egg Debate
Almost every company has an ongoing conflict between marketing and sales. Some say that without marketing, you wouldn’t have prospects or leads to follow. But without good sales techniques and a plan, there’s a poor closing rate. Marketing and sales departments must work together. However, they often don’t speak to each other.
John now knows the useful distinction:
Marketing is everything you do to reach and persuade prospects
Sales is everything that you do to close the business
A company generally can’t be successful—and create value—without both, or when they don’t work well together. However, if the efforts are unbalanced or departments don’t communicate, growth can’t occur.
John saw that sales is a process of interpersonal interactions. These usually involve cold calls, networking, one-on-one meetings, and proposals/estimates. In other words, sales is anything that engages the prospect or customer on a personal level rather than at a distance. This focuses on the customer: the needs that will make these people buy or continue buying. Sales is tactical; marketing is strategic.
Good marketing adds value to the sales process. A good sales process adds information to marketing: through customer feedback and a better understanding of the marketplace. When both work hand in hand, growth happens.
A diversified customer base, types of sales, and recurring revenue can significantly affect value.
Diversified Customers: More than One Basket
Many established businesses started around the needs of a particular customer and grew from there. Companies often have customers that represent more than 10% of their revenue, or five or fewer customers that generate more than 25%. These operations have customer concentration, and the risk of losing these relationships—or owning this kind of company—is significant. In addition, concentrating the business in a particular industry also can present a tremendous risk.
Serving different customer segments presents the opportunity to increase revenue—and affects a business’s growth potential. Buyers are interested in companies that have a strong present value but also have the chance to expand, so the future value will be greater.
Like other business owners, John didn’t realize that customer concentration is a risk to the current viability of the business. It can cause pricing pressures, because a few strong customers may have leverage in negotiations.
In these cases, diversification needs to happen as soon as possible. This can include finding other customers and channels, and possibly phasing out large, low-margin customers. In these situations, it’s easy to get distracted by catering to every need of the few large customers at the expense of finding other higher margin ones. By focusing on several higher margin customers, a company often will be more profitable and have less risk, resulting in a higher valuation.
Recurring Revenue: Having Better Eggs
John had thought, “A dollar of sales is a dollar of sales.” However, his advisor explained that not all revenue is created equal. The more predictable sales are, and the more certain it is that the company will receive sales from those customers, the more valuable the company becomes. When you can begin multiplying the sales by adding new customers and developing an annuity cash flow, you begin reaping the benefits of a recurring revenue stream.
Here’s an example. A business has $10 million in sales, 85% of which is recurring. The company can reasonably count on sales of $8.5 million as a new fiscal year kicks off, and then find another $1.5 million. Compare this to a company with no recurring revenue—beginning the year with zero sales. If they both have the same costs and expenses, their valuation will be quite different.
These are common examples of recurring revenue:
Repeat Customers – While having them is far better than not, the revenue stream is still risky because you can’t count upon their return. Companies in this category can build loyalty programs—frequent flyer or diner cards and other discount programs—to create a stronger brand preference and make their offers “stickier.”
The Upgrade Revenue Model – This encourages your customers to consistently upgrade. It’s supported by offering a low-cost or free service as a way to attract customers, then work with them to upgrade.
Good Until Cancelled – These instances involve automatically billing a credit card or bank account until customers “opt-out” to terminate, such as subscription-based services.
Contractual – Revenue with a contract is the best kind. This is an extremely valuable model, because you can predict with a higher level of certainty the dollar amount of recurring revenues in the short and long term.
Consumables – These are items such as toothpaste, toilet paper, soap, etc., with a strong identity. Make the brand popular, and you will sell more consumable products.
Sunk Money Consumables – This is the “Xerox effect.” When customers buy the copy machine or printer, they need to purchase ink cartridges forever.
John took a deep breath. It was clear there were many ways his company hadn’t actively worked to build value in its sales activities. His advisor reminded him that these were all opportunities. Now John could focus on increasing sales, making them more predictable and reducing the risk of his investment—which would increase his company’s value over the long run.
Our next article will examine how John can add value by taking a strategic approach to operations.
By H. Barry Goodman CPA CEPA CMAA CVGA
Managing Director, Birkdale Transition Partners
Copyright: Cannot be Reused without Author’s Permission
Birkdale Transition Partners LLC is the objective source for those seeking business sustainability, growth or considering a business transition. Our goal is to ensure business sustainability and to maximize the value of an enterprise before any transition or transaction. Business owners without a transition plan often are unable to sell or transfer their company at its highest value. We help them to balance a company transition with the owner’s personal goals. Then we work with them to avoid problems caused by the lack of planning and/or not recognizing what needs to be added, corrected or modified before then.
Birkdale is unique because it only offers an unbiased assessment and solutions for the company owner. We do not sell any other products or services, so are a fee-only firm. We work in partnership with the company’s current professional advisors and staff. Because we help companies increase their monetary value, owners view our assistance as an investment—with payback and payout occurring during and at the conclusion of an engagement.
For a no-obligation, confidential discussion of your situation, please contact Barry Goodman at 312-626-1820 or contact us.
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