Introduction
Entrepreneurs would always do some type of business planning before starting a new company. Very often this will result in a formal business plan. The format will likely be determined by one of the following:
- A business planning software package;
- A Guide to Business Planning;
- Other business plan;
- An external consultant.
Although all of the above can have satisfactory results, they all have potential pitfalls. A serious pitfall (when using one of the first three methods) is the way entrepreneurs approach the problem. Although all methods deal with the apparent salient features and even the interdependence between them, they cannot address all the complexities and multidirectional relationships that exist between various features in a business.
Nor does outsourcing the entire business planning process to a consultant solve all problems. A consultant would have to work quite interactively with entrepreneurs to be of real value.
For more than a decade, Ventex Corporation has advised and assisted companies from business planning to harvest and beyond. This case study highlights the importance of having a well thought out and executed inclusive business planning process. It shows how small apparent problems, neglected in the planning process, can have serious consequences for entrepreneurs.
Highlights in an inclusive business planning process
The first aspect of integrative business planning is to ensure that all salient features are addressed. These features can differ drastically from business to business. Some of the more general characteristics are:
- The business- The opportunity, the business concept, the products and services, and the growth strategy.
- Marketing- Marketing strategy (price, promotion, etc.).
- Market research – Customers, market size, trends and competition.
- Developing – New products, services, markets and facilities.
- Operations – In all aspects.
- The team – Management team, necessary skills, training, composition of the board and organization.
- Finance – Investment, financing and dividend decisions and policies. Also cash flows, profit margins, costs and growth.
- Risk management – Commercial, operational and financial risks, as well as possible fatal failures.
Multidirectional relationships to consider in business planning
Unfortunately, the salient features cannot be viewed in isolation. Each feature impacts several other features and is also affected by many other features. These multidirectional relationships occur within each individual broader feature (eg, finance), as well as between different features (eg, between finance and marketing).
Higher profit margins can, for example, decrease volumes sold, but increase net profitability. On the other hand, higher volumes (with lower gross margins) can increase volumes sold, but decrease profitability.
Higher volumes, on the other hand, can increase the stress factor on production staff (already working at full human capacity), leading to higher absenteeism, lower production levels, additional hiring costs, and a corresponding decrease in productivity. cost effectiveness. Unfortunately, these complexities cannot be ignored and an integrative approach to business planning goes a long way in managing it.
An example of things that can go wrong
Ultimate Holidays had a very ambitious business concept in the tourism industry. The industry was booming at the time and they planned in detail the construction of a luxury lodge that would combine a health hydro, school hotel, conference facilities, adventure center and eco-cultural tourism. (Details are changed for confidential purposes, however all details simulate real-life scenarios closely enough to demonstrate actual learnings.) This project of around $320 million was a lifelong passion for all of them. They covered architectural designs, legal requirements, operational planning and development issues, the marketing plan, and staff development policies in depth. They also made sure to have high level politicians and excellent service providers on board.
However, the business never took off. What did experienced entrepreneurs not see? What could they have done differently? They thought they had covered all the various aspects of the business. When analyzing the facts, the following main problems were highlighted:
- Entrepreneurs were not flexible: they had strong preconceived ideas;
- A detailed market investigation was not carried out. Specifically, not about niche industry occupancy rates and critical investment criteria that investors are looking for;
- All planning was done on individual aspects that were optimized as much as possible. How these factors might have affected other factors was never considered.
Entrepreneurs were quite arrogant. They believed that any entrepreneur would be stupid if he didn’t invest, and would generally say that they only want investors who share their dreams and let the finances take care of themselves.
The business plan promised a “conservative” internal rate of return (IRR) of 22% over a seven-year period. This included the expected capital growth of the facility. Expected occupancy rates were reported as 50% in the first year, rising to over 75% in the fourth year. IRR and occupancy rates were much lower initially and based solely on thumb sucking. Entrepreneurs then simply risked the numbers to make financial sense without changing any of the other related factors.
Investors were often very interested in the concept, until they realized occupancy rates were inflated. Actual figures based on realistic values indicated an IRR of just 15%, at least five percent below what investors expected. The financial risk was too high. In addition, there was a breach of trust, which from the point of view of the businessmen was an insurmountable problem, they wanted it their way. In the end no one invested. A lot of effort was applied and the personal expenses were very high. High visibility was also created in the business and tourism industry. In the end, some of the entrepreneurs went bankrupt financially (and emotionally) and all lost credibility.
The important questions in hindsight are: Could the entrepreneurs save this project? Could they have included all the features and really expect an IRR of over 20%?
If entrepreneurs used an inclusive business planning process, they would have made sure that all salient features were examined first. Second, they would have made sure that all the multidirectional relationships (causality) between the different features were balanced.
By mapping the relationships between the various salient features, he showed, for example, that:
- Occupancy rates are caused by service levels, product offerings, merchandising, and price.
- Occupancy rates, on the other hand, can affect turnover, profitability, and marketing (through word of mouth).
- Profitability is caused by turnover (through occupants and outside guests), occupancy, and cost of doing business (cost of sales and other expenses).
- Profitability, on the other hand, is directly related to IRR, cash flow and sustainable business growth.
Shown above is only a very small portion of the multi-directional relationships that exist within and between the various salient features.
Entrepreneurs should have asked deeper “what if” questions. They might start with questions like: What would happen to the occupancy rate if the price per night increases by 10%? What if the various aspects of the business were introduced gradually? Would it be possible to reduce marketing costs and increase the occupancy rate? The last question often seems like an oxymoron. This is part of integrative business planning: looking at the two opposites and trying to find a solution that addresses both. In practice, this can probably be achieved by using more free advertising in newspapers, internet articles and blogs, and by working directly with the region’s tourism associations.
An important aspect (restraint) of this whole new venture was the provision of high capital. By concentrating on this salient feature, it was shown that costs could have been drastically reduced without having any detrimental effect on the occupancy rate. Using a light steel frame instead of normal brick could have generated huge savings. Assembly time could have been cut in half with savings in labor and interim interest. Long distances would have resulted in much lower transportation costs (light steel frames are much lighter than brick). Additional savings are also possible due to other construction benefits and different finishes. No negative effects would have been anticipated.
The construction costs of the health hydroelectric plant were 50% of those of the main complex, but projected figures showed that it would only produce 33% of the turnover of the main complex (with much lower gross profit margins). This component could have been phased in at a later stage when the complex was already in full production and potential occupancy and profits were much higher.
The business analysis showed that by simply changing these two factors (progressive hydro and construction method) and using a realistic occupancy rate, the expected IRR will exceed 21%. Other solutions could have been explored to decrease capital expenditure and this could have resulted in a further increase in IRR. The high road construction costs (to the resort) could possibly have been shared with the government and other potential developers (for example, from a nearby shopping complex or timeshare game farm).
Summary
Neglecting some of the salient features or failing to recognize and plan for major downgrades can be problematic or even fatal for a new business. It is necessary to cover all the main features and, at the same time, balance the multidirectional relationships between them. One aspect of the business cannot be optimized to the detriment of some of the others. An integrative business planning approach is needed to find the optimal balance for the business as a whole.
Copyright© 2008 – Wim Venter