What makes a business thrive?

December 6, 2018

Key Outcomes

A business thrives when it establishes two outcomes:

 

  1. It delivers positive economic value add (EVA); and

  2. Its sales grow faster than market demand.

 

EVA is what is left from operating profit after the business has paid its taxes, paid its lenders, and rewarded its investors; that is, the net operating profit after tax minus the cost of capital.  A firm delivering zero EVA is just surviving and can only invest in the future by reducing its rewards to investors.  A firm with negative EVA cannot reward its investors fully and is destroying value.  Ideally, businesses must generate sufficient EVA to secure their future.

 

What of sales growth?  If market demand grows at some rate, then the firms meeting that demand can expect to grow their sales according to their market share, much as a rising tide lifts all boats.  However, markets are dynamic, and firms whose sales grow faster than the market growth rate must be taking sales from their competitors.  In both a figurative and literal sense, the market increasingly buys their value proposition in preference to their competitors.

 

These two measures isolate four conditions: thriving, diving, skiving, and acquiring.

 

A thriving business has created a virtuous circle – more sales delivers more EVA – which allows the business to invest in the assets it needs to service more sales.  That is, its business model delivers this circle of value creation in the face of competitors.

 

A diving business is the opposite: it cannot reward its investors, and so destroys their value, while also losing sales, which means it is delivering progressively less of the value the market seeks.  These two vectors – serving investors and customers poorly – drive the firm into a death spiral: the more money invested in the business, the more money is lost.  This firm’s business model has become a vicious circle, and it will die unless the management grips the controls to at least bring it to a straight and level “survive” trajectory.

 

A skiving business falls between the previous two: it delivers positive EVA but, at best, keeps pace with market growth.  This is the “lifestyle” quadrant, where owners are content to accept the reward for their investment but have no desire to grow the business.  The danger is that the best they can achieve is keeping up with market growth, and anything short of this is declining sales.  The key question for these businesses is how long they can sustain this position?  As sales fall, so profitability may also fall, and their trajectory may be a slow slide towards the dive quadrant.

 

An acquiring business achieves sales growth but not EVA.  How?

 

  1. A business in the thrive quadrant has invested its war-chest in buying poorly performing firms to gain their clients/customers.  This has added sales but reduced profitability as the firm absorbs the value destruction of its acquisitions.  The acquiring firm will correct this by improving its acquisitions to its own level of competence, and this will return the combined enterprise into the thrive quadrant. 

  2. Its market entry strategy is to sell at a loss to grow market share, and then to steadily increase its prices to move it into the thrive quadrant.

  

Business Model

If sales are growing, then customers literally buy the firm’s value proposition.  That is, (1) they want the solutions the firm’s products and services offer to their problems; (2) they regard the price as representing at least acceptable value for money; and (3) they are content with the relationship the firm offers pre-sale, during the sale, and post-sale.  Profitability shows how well the business is tuned to deliver its value proposition while retaining value for itself.  The value proposition and profitability are the elements of the business model that drive its sales growth rate and EVA.

 

To deliver its value proposition the firm must secure various inputs and combine them with its know-how to provide products and services for which it must gain customers.  To thrive, it must manage its operations, its engagement with suppliers, collaborators, and partners, and its supporting activities to achieve positive EVA.  These rest on three components: processes, resources, and competences.  That is, the firm must employ its competences to deploy its resources to perform its processes to create and deliver its value proposition.  If thriving is about positive EVA and sales growth faster than demand, then securing this position must be the result of something inside the business that others cannot copy, otherwise competitors would soon be imitating thriving firms to improve their own performance.  To thrive, then, a firm needs unique processes and distinct competences and resources that others cannot discover to create and deliver a differentiated value proposition.  Whilst the value proposition must be public knowledge, how the value proposition is created and delivered is the source of competitive advantage.  A firm that maintains its position in the thrive quadrant must thus sustain its competitive advantage.  This requires it to invest some of its EVA in securing its future by continually improving its unique processes, distinctive competences and resources, differentiated value proposition, and superior profitability.

 

Being strategic

Every firm has a strategy; few are strategic.  A firm reveals its strategy through its actions, reactions, inactions, and interactions, regardless of what may be written in a formal document.  A firm shows itself to be strategic by (1) the degree to which it understands itself as a value-delivering system; (2) the attention it gives to detect change in the system; and (3) its responsiveness to change.  Demand, competitive positioning, knowledge, technology, and context are all changing.  The competitive advantage the thriving firm enjoys today may be a disadvantage tomorrow.  The strategic firm understands the pace of change in its industry and markets, regularly monitors the performance of its business model, and adjusts the components to sustain the competitive advantage that drives it to thrive.

 

Having a big enough why

Overarching all this, the thriving firm has a “why” that includes a set of values defining who they are, a mission that defines what they do, and a vision that specifies where they are going.  This purpose, which the firm aspires to fulfil, inspires staff to perspire in its pursuit.

In summary, the thriving business has a ready answer to the key strategic question,

 

What must we do to continue to thrive in fulfilling our purpose?
 

 




 

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