59. Keep two accounts
Set up two business accounts with your bank. One account is for the day-to-day running of the business. The other account is for the investments that the
business wishes to make.
Any manager who wishes to make the case for an investment can do so on the basis that only what is available in the investment account can be spent and that his or her idea needs to compete with any other idea to take this money. This structure can also help to manage your profit bonus.
A pre-agreement that a fixed percentage of cash (say 33%) will be placed in the investments account each year and the remaining 67% paid out to shareholders is a quick way to:
solve the issue of profit bonuses – i.e. what is the size of the pool and who gets to decide it?
show that reinvestment is available for the business to grow as a whole, which will help drive profitability in future years.
Of course, the board of directors reserves the right to change the allocations when the business is under considerable pressure, but any change should be on a
temporary basis such that it defaults back to the norm when markets stabilise.
60. Pride goes before a fall
Puffed-up pride is a classic sign that a business is going to hit trouble and then fall rapidly from grace. My wife says that if you own shares in a company that moves from shabby buildings into a nice new shiny city-centre glass tower, you should sell all your shares immediately.
Pride before the fall is a grave danger for successful businesses. The telltale signs include expensive cars, unnecessary trips and costly ‘training’ regimes. Do you recall the AIG debacle of September 2008, in which the board members went on a multi-million-dollar brainstorming weekend (a golf outing) just days before the US government bailed it out for $85bn?
Even if you are not particularly prideful, after years of success you are likely to believe that anything you begin will succeed. So, in your second venture you may spend too much cash too fast. You may not be heedful of serious market pressure in your business until it is too late.
The advantage of an experience of a failed business is huge – it reminds you to stay humble and avoid such mistakes. You are more likely to perceive problems while you still have time to do something about them.
Obviously there is no point in setting out to fail deliberately, just for the valuable lessons – so should you be in this (dubiously?) fortunate situation of having experienced a failed business, do all that you can to avoid hubris. Pride is the ultimate form of carelessness. So be careful.
61. Don’t diversify to escape trouble
Typically if a business is in trouble it begins thinking about diversification – which sounds like a good idea, but actually, simply encourages trouble… In many ways, this is similar to a political leader who, running into trouble domestically, becomes interested in foreign policy; and then makes a hash of both.
Diversification is not the same as following shifts in the market. Instead it is the attempt to create brand new products in new markets where your teams don’t have any real experience.
If a business is losing money, this is a very high-risk strategy because you need, firstly, to be right first time round about the needs and pricing power in the new market (you won’t have the cash to attempt it a second time), and secondly, it all has to happen in a fixed time frame; namely, before the core business goes bust.
Hence, diversification can often be disastrous.
The other occasion when diversification does real damage to a business is when the core business has matured and the executives are looking around for more exciting things with which to occupy themselves. This tends to happen in large companies, but the source of the problem is the same – the desire to make the company big in volume, as this reflects well on the directors, with less attention paid to quality.
Remember, the measure of quality in your business is your profit margin.
Therefore, if your diversification efforts are forecast to reduce your profit margin – even temporarily – they are probably a very bad idea. This is why a mature company is better to accept a shrinking market or no growth, and to concentrate on profit margin.
If profits are good, these can be paid out to shareholders and directors via profit bonuses. If those shareholders wish, they can take their money and invest in new businesses with separate legal structures – so that the performance of one
company will not bring down the other company. In some cases, this can be managed within a group.
In the meantime, get back to your core business and reduce it to a level at which it has a strong profit margin. A business that is in trouble is better off spending its time reviewing its key managers to see why they are not delivering, than running after half-baked new ideas.
It might also be time to consider exiting your existing business if, on reflection, your desire for diversification is simply a symptom of your disbelief in its strengths.