Businesses experience financial difficulties for many different reasons in all economic environments. While a recession is never good news, things can go off track even when the economy is booming.
Business longevity is no guarantee of continued profitability – even a business that has been around for decades can find itself in a turnaround situation.
The important thing is for business owners to recognize that they are in a turnaround situation and promptly figure out the underlying cause and take action. Simply hoping that things will somehow improve on their own (highly unlikely) is not a good strategy.
In this article:
Pt. 1: Signs of a Struggle: Does Your Business Require a Turnaround Management Strategy?
Pt. 2: Company Rescue: How to Manage a Company Turnaround
Part I: Signs of a Struggle: Does Your Business Require a Turnaround Management Strategy?
How do you know your business requires a turnaround? Here are some of the tell-tale signs:
- Conversations with your bank are becoming uncomfortable. You may be close to breaching one or more covenants in your loan agreement.
- You have been telling yourself that you just have to get past this next month/quarter, and things will get better, but there is no real reason to expect that the situation will improve.
- Your investors are becoming frustrated and impatient because your financial performance is far below expectations.
- You have been in business for many years, but it is a struggle to turn a profit. Note: In a start-up phase where growth, rather than profitability, is the key objective and growth targets are being met, that does not indicate a turnaround management situation.
- Your company’s profitability is much lower than the average for your industry.
- Even though the business is generating revenue, you constantly have problems with cash flow/ and liquidity.
Acknowledging that the business is struggling and that things are not going to improve on their own is an important step.
It means you have accepted that you need help.
But what help?
When you see a doctor because you feel unwell, they do not prescribe a course of treatment before examining you and analyzing the causes of your symptoms to make an informed diagnosis.
When your business is not doing well, you need to analyze the financial symptoms before designing a “treatment plan.”
1. Start with revenues.
Is your industry facing a temporary problem hitting sales (such as a shortage of raw materials)? Or, are your revenues declining faster than the industry average? Are you struggling while your competitors are doing fine or even gaining market share (yours?).
If you have multiple product lines or different types of services, which are most important in terms of revenues and unit sales? How has that changed over time?
2. Understand what drives your margins.
Understanding what drives profit margins will require an analysis of gross profits by product line or type of service.
Analysis may also involve drilling down to the SKU level to determine sales growth vs, profitability. If unit sales for a vital product line are steady or even growing, but gross profits are shrinking, that is an important clue.
3. Analyze profitability by customer.
Analyzing profitability by customer means determining your gross margin per customer and the cost of acquiring and supporting that customer (or the average customer acquisition cost for a business where revenues are spread out over a large number of customers).
Sometimes, companies will do anything to get a big company as a client, even lowering prices to where the relationship is not profitable. That is not always a problem – if having that big client boosts your brand, improves your visibility, and brings in other new business; it could be worthwhile.
But, it could run you into the ground if you have to devote too many resources to service that client, and the margins you earn (or losses you incur) do not justify it.
On the other hand, if a relationship does not require much support, even a small profit margin can be justified in dollar terms.
Customer profitability can be tricky to analyze. A business has to spend money to acquire customers and maintain those relationships, but this should be measured and evaluated in terms of costs and benefits. What does it cost, in terms of sales and marketing expenses, to acquire a customer?
When money is spent on marketing, do you measure conversion rates? Does your customer lifetime value exceed your customer acquisition costs?
4. Look at your cost structure, starting with headcount.
Personnel costs often represent the most significant expense category – potentially 60%-80% of operating costs. Are you keeping employees who are not contributing what you need?
What are the other big expense categories? Have they changed significantly in recent years? If so, why?
Optimizing your cost structure will require buy-in from the leadership team, as well as a certain level of financial discipline.
5. Analyze R&D spending, which drives growth.
Is product development taking longer than expected, assuming you have a good estimate of how long it should take and what that should cost? Are you releasing new products less frequently than your competitors?
You might be underinvesting and not innovating at the rate needed to stay competitive in your industry. What level of growth are you projecting from releasing new products?
If your forecasts are not anticipating an increase in sales from new products, you may be underinvesting or taking too long to come to market.
Part II: Company Rescue: How to Manage a Company Turnaround
Now that we have uncovered the ways in which you can identify a turnaround management situation and whether or not your business is in a temporary setback or a systemic problem, it is now time to discuss what to do to turn things around and get back on track.
We have all seen medical dramas on TV where a patient shows up with a weak pulse, low blood pressure, shallow breathing, etc., and the doctor has to figure out what to do next. Surgery? Blood transfusion? Drug therapy? The treatment that will save the patient’s life depends on the underlying cause of the problem. The same idea applies to saving a troubled business.
The right diagnosis is critical
When a company is in trouble, the first step towards a turnaround is determining whether the problem is due to insufficient top-line growth, i.e., revenues are stagnant or declining, or a problem with profitability, indicating that expenses are too high.
These are very different challenges that call for different “treatment plans”. Of course, these conditions are not mutually exclusive (the patient could be suffering from both a weak heart and internal bleeding) — in other words, there could be both a revenue problem and an expense problem.
Lack of top-line growth?
If revenues are shrinking, you need to find out why — asking the right questions will lead you to what you need to do next. Have you been losing customers, or is your customer base stable but orders are shrinking in size, or becoming less frequent?
- If you have been losing customers, see if you can talk with one or more of them (especially any big, important ones) to find out why they left. It could be that your market has become more competitive and customers perceive your prices to be too high. If so, you will need to choose whether to compete by lowering prices or figure out a way to provide more value for what you charge and focus on demonstrating your total value proposition to your customers.
- If the issue is not pricing but you are losing customers, you may have quality problems. Or, competitors may be innovating more rapidly, making your products look old and tired by comparison. Be honest about whether you need to step up your game. Do you need to improve your QA processes? Look at the number of defective units produce, or software bugs created. Have they been increasing? Or, do you need to upgrade your designs, or modernize your “look & feel”?
- If you can legitimately state that your products are as good as, or even better than what competitors offer, you may have a sales or marketing issue. Your current salespeople may not know how to sell the features and benefits of your products — they may not be sufficiently knowledgeable, or may not be working their territories very well. That could be fixable with training, or you may need to make some personnel changes. Your marketing efforts may need a reboot. Compare your online presence to your competitors. Where are you advertising, and how effectively those ads are generating leads? You may need to make changes to boost awareness among new customers and to remind existing customers of your expertise, quality, value, etc.
- If you are not losing customers but they have cut back on how much they buy from you, get in touch with some of them to find out why. Is something changing in their industry that makes them need you less? If so, could you step in to fill a different need?
Declining profitability?
If revenues are increasing but profit margins are declining, you will need to investigate different issues:
Your customer acquisition costs could be too high. Analyze this by assessing all of the costs associated with bringing in new customers — including commissions paid, trade shows, discounts granted to new customers, and marketing campaigns. If customer acquisition costs are too high, the lifetime profitability of each relationship will suffer.
Is your Cost of Goods Sold rising faster than your prices?
Examine the cost of creating your products or delivering your service.
If raw materials and/or direct labor costs are increasing but you have not changed your prices in years, you will either need to (1) become more efficient – in other words, produce the same products using fewer inputs, (2) find lower-cost materials without compromising quality, or (3) explain to customers that a price increase is necessary.
If customers balk at higher prices, remind them of the overall value of what you offer.
Remember, there is no point in hanging onto orders and customers that are not profitable.
Before you decide that your prices are too low, look at your competitors’ prices. You do not necessarily have to match the competition, but you need a pricing strategy. Charging more for higher quality can be a winning strategy.
Analyze what would happen if you increased prices by X% and lost Y% of your customers. Would profitability suffer or improve (you may only lose marginally profitable customers)? If the analysis says you will be better off, you need to have the courage to implement the price increase.
- Determine whether your company’s identity is consistent with the way you are pricing your products and managing the business. If you are perceived as a low-cost provider, is your cost structure consistent with this? Being a low-cost provider can be profitable, but the business needs are extremely efficient and costs must be strictly controlled to make it work.
- Is overhead too high? Examine how each type of G&A expense has grown relative to revenue growth. Measure the rate of growth in each expense category and compare that to inflation, and to the rate of growth in revenues. This analysis may reveal that the company has become complacent in controlling expenses. Start with personnel costs, as this is a big expense. Evaluate your sales team’s productivity by looking at new orders per salesperson. Service businesses could look at billable hours. Software businesses could look at the percentage of time spent writing code for new features that bring in new business and help to retain customers, versus time spent fixing bugs (if too many critical bugs are created when new code is developed, that is inefficient).
Now that you have identified the main source(s) of the problem, take a deep breath – there is a good chance you will be able to turn things around (note: if this analysis shows that revenues are growing and expenses are being controlled but the company is chronically short of cash, you are not in a turnaround management situation; you probably have a working capital problem).
Turnaround Management Services
Consider bringing in a turnaround management firm that can help to reveal faulty assumptions you have been making, and can challenge your preconceived notions about what is actually going on. But, do not procrastinate.
The situation is not going to improve on its own.
You need to confront the reality of what is happening in your business and figure out what you can do with what you have while remaining optimistic – that is part of being an entrepreneur.
G-Squared has deep experience in identifying and addressing the challenges that put businesses into a turnaround situation. To discuss your company’s situation, get in touch with our team.
