Introduction
Entrepreneurs would always do some kind of business planning before starting a new business. Very often this will lead to 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;
- Another business plan;
- An external consultant.
Although all of the above can have satisfactory results, all have potential difficulties. A serious problem (when using one of the first three methods) is the way that entrepreneurs approach the problem. Although all methods are adapted to the treatment of the apparent salient characteristics and even to the interdependence between them, they cannot satisfy all the complexities and multidirectional relationships that exist between the various characteristics of a company.
Outsourcing the entire business planning process to a consultant doesn’t solve all problems either. A consultant would have to work quite interactively with entrepreneurs to have real value.
For more than a decade, Ventex Corporation 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, which are neglected in the planning process, can have serious consequences for entrepreneurs.
Outstanding features in an inclusive business planning process
The first aspect of inclusive business planning is to ensure that all salient features are addressed. These characteristics can differ drastically from company to company. 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 council and organizations.
- Finance – Investment, financing and dividend decisions and policies. Also cash flows, profit margins, costs and growth.
- Risk management – Business, operational and financial risks, as well as possible fatal failures.
Multidirectional relationships to take into account in business planning
Unfortunately, the salient features cannot be viewed in isolation. Each role has an impact on various other roles and is affected by many other roles as well. These multi-directional relationships occur within each broader individual characteristic (for example, finance), as well as between different characteristics (for example, between finance and marketing).
Higher profit margins can, for example, reduce volumes sold, but increase net profitability. On the other hand, higher volumes (with lower gross margins) can increase volumes sold, but decrease profitability.
On the other hand, higher volumes can increase the stress factor on production staff (already working at their maximum human capacity), leading to higher absenteeism, lower production levels, additional hiring costs and a corresponding decrease in profitability. Unfortunately, these complexities cannot be ignored and an integrative approach to business planning is very helpful in handling them.
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 to build a luxury lodge that would combine a hydroelectric plant, a hotel school, conference facilities, an adventure center, and eco-cultural tourism. (Details are changed for confidential purposes; however, all details simulate real-life scenarios close enough to demonstrate actual learnings.) This about $ 320 million project was a lifelong passion for all of them. They covered in depth architectural designs, legal requirements, development and operational planning issues, marketing plan, and staff development policies. They also made sure they had high-level politicians and excellent service providers on board.
However, the business never took off. What didn’t seasoned entrepreneurs see? What could they have done differently? They thought they had covered all aspects of the business. Analyzing the facts, the following major problems were highlighted:
- Entrepreneurs were not flexible, they had strong preconceptions;
- No detailed market research was conducted. Specifically, not on niche industry occupancy rates and critical investment criteria investors are looking for;
- All planning was done in individual aspects that were optimized where possible. How these factors might have affected other factors was never considered.
The businessmen were quite arrogant. They believed that any entrepreneur would be stupid if they did not invest and would generally say that they only want investors who share their dreams and that finances will take care of itself.
The business plan promised a “conservative” internal rate of return (IRR) of 22% over a seven-year period. This included the facility’s expected capital growth. Expected occupancy rates came in as 50% in the first year, increasing to over 75% in the fourth year. IRR and occupancy rates were much lower initially and based purely on thumb sucking. The 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 that 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. From the businessmen’s point of view, this was an insurmountable problem, they wanted it in their own way. In the end, nobody invested. A lot of effort went into it and personal expenses went through the roof. High visibility was also created in the business and tourism industry. In the end, some of the entrepreneurs were financially (and emotionally) bankrupt and all lost credibility.
The important questions in hindsight are: Could the entrepreneurs save this project? Could they have included all the features and were they really expecting an IRR greater than 20%?
If entrepreneurs used an inclusive business planning process, they would have first ensured that all salient features were examined. Second, they would have ensured that all multidirectional relationships (causality) between the different characteristics were balanced.
By mapping the relationships between the various prominent features, he showed, for example, that:
- Occupancy rates are due to service levels, product offering, marketing, and price.
- Occupancy rates, on the other hand, can affect billing, profitability, and marketing (through word of mouth).
- Profitability is due to turnover (through occupants and external guests), occupancy, and cost of doing business (cost of sales and other expenses).
- On the other hand, profitability directly influences IRR, cash flow and sustainable business growth.
Only a very small portion of the multidirectional relationships that exist within and between the various prominent features are shown above.
Entrepreneurs should have asked deeper “what if” questions. They could start with questions like: What would happen to the occupancy rate if the price per night increased by 10%? What if the various aspects of the business are 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 tourism associations in the region.
An important aspect (limitation) of this whole new venture was the provision of high capital. By focusing 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 structure instead of normal brick could have generated huge savings. Assembly time could have been cut in half with temporary savings in labor and interest. Long distances would have resulted in much lower transportation costs (light steel frames are much lighter than bricks). Additional savings are also possible due to other construction benefits and different finishes. No negative effects would have been expected.
Construction costs for the sanitary hydroelectric plant were 50% of those of the main complex, but projected figures showed that it would only produce 33% of the main complex’s turnover (with much lower gross profit margins). This component could have been incorporated at a later stage when the complex was already in full production and when potential occupancy and profits were much higher.
The business analysis showed that simply by changing these two factors (construction method and hydroelectric in phase) and using a realistic occupancy rate, the expected IRR will exceed 21%. Other solutions could have been explored to lower capital expenditures and this could have resulted in a further increase in the IRR. The high road construction costs (for the complex) could possibly have been shared with the government and other potential developers (for example, of a nearby shopping complex or timeshare game farm).
Resume
Neglecting some of the salient features or failing to recognize and plan for significant downsides can be problematic or even fatal for a new business. All salient features should be covered, and at the same time, the multi-directional relationships between them should be balanced. 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
