Entrepreneurs will always do some sort of business planning before starting a new business. This will often result in a formal business plan. The format is probably determined by one of the following:
- A software package for business planning;
- A Business Planning Guide;
- Another business plan;
- An external consultant.
While all of the above can have satisfactory results, they have all sorts of pitfalls. A serious pitfall (when using one of the first three methods) is the way entrepreneurs tackle the problem. Although all the methods address the apparent salient features and even the interdependence between them, they cannot account for all the intricacies and multi-directional relationships that exist between different functions of a business.
Outsourcing the entire business planning process to a consultant doesn’t solve all the problems either. A consultant has to work quite interactively with entrepreneurs to be of real value.
For more than a decade, Ventex Corporation advised and helped businesses from business planning right through to harvest and beyond. This case study highlights the importance of having a well thought out and done integrative business planning process. It shows how seemingly small issues that are neglected in the planning process can have serious consequences for entrepreneurs.
Prominent features of an integrative business planning process
The first aspect of integrative business planning is to ensure that all the key features are taken into account. These features can differ drastically from one company to another. Some of the more general features are:
- The company – The opportunity, the business concept, products and services and growth strategy.
- Marketing – Marketing strategy (price, promotion, etc.).
- Market Research – Customers, market size, trends and competition.
- Development – New products, services, markets and facilities.
- Operation – All aspects.
- The team – Management team, necessary skills, training, board composition and organisms.
- Finance – Investment, financing and dividend decisions and policies. Also cash flow, profit margins, costs and growth.
- Risk Management – Business, operational and financial risks as well as potential fatal errors.
Multidirectional relationships to keep in mind in business planning
Unfortunately, the prominent features cannot be seen in isolation. Each function affects various other functions and is also influenced by many other functions. These multi-directional relationships occur within each broader function (e.g., finance) as well as between different functions (e.g., between finance and marketing).
Higher profit margins may, for example, reduce the volumes sold, but increase net profit. On the other hand, higher volumes (with lower gross margins) can increase the volumes sold but reduce profitability.
Higher quantities, on the other hand, can increase the stress factor of production personnel (who are already working at maximum human capacity), which can cause higher absenteeism, lower production levels, additional rental costs and a corresponding decrease in profitability. Unfortunately, these difficulties cannot be ignored and an integrative approach to business planning goes a long way in dealing with it.
An example of things that can go wrong
Ultimate Holidays had a very ambitious business concept in the tourism sector. The industry flourished at the time, and they planned in detail to build a luxury cabin that would combine a health hydro, hotel school, conference facilities, adventure center and eco-cultural tourism. (Details are changed for confidential purposes – all details, however, simulate real life scenarios close enough to demonstrate actual experience.) Entrepreneurs’ experience includes business, entrepreneurship, tourism, archeology, law and politics. This $ 320 million project was a lifelong passion for all of them. They covered in depth the architectural design, legal requirements, development and operations planning issues, the marketing plan, and personnel policy development policies. They also made sure they had senior politicians and excellent service providers on board.
However, the company never got off the ground. What did the experienced entrepreneurs not see? What could they have done differently? They thought they had covered all the different aspects of the business. The following major problems were analyzed by the facts:
- Entrepreneurs were not flexible – they had strong preconceived ideas;
- No detailed market research was conducted. Specifically not on occupancy rates in the niche industry and on critical investment criteria that investors are looking for;
- All the planning was done on individual aspects that were optimized as far as possible. The way these factors could have affected other factors was never considered.
The entrepreneurs were quite arrogant. They thought that any entrepreneur would be stupid not to invest and they would typically say that they only want investors who share their dreams and that the economy will work out.
The business plan promised a “conservative” 22% internal rate of return (IRR) over a seven-year period. This included the expected capital growth of the facility. Expected occupancy rates were given to 50% in year one and increased to more than 75% in year four. Initially, the IRR and occupancy rates were much lower and were purely based on thumb suction. Entrepreneurs then just caught the numbers to make financial sense without changing any of the other related factors.
Investors were often very keen on the concept until they realized that the stock was inflated. The real figures based on realistic values indicated an IRR of only 15% – at least five percent below what investors expected. The financial risk was just too high. In addition, a breach of trust occurred. From the entrepreneurs’ point of view, this was an insurmountable problem – they wanted it their way. In the end, nobody invested. A great deal of effort was spent and the personal expenses were soaring. High visibility was also created in the business and tourism industry. Ultimately, some of the entrepreneurs were financially (and emotionally ruined) and all lost credibility.
The important questions from behind are: Could entrepreneurs save this project? Could they have included all the features and really expected an IRR of over 20%?
If the entrepreneurs used an integrative business planning process, they would first have ensured that all the salient features were examined. Second, they would have ensured that all multidirectional relationships (causality) between the different traits were balanced.
For example, by mapping the relationship between the different salient features, it showed that:
- The occupancy rate is due to service level, product offering, marketing and price.
- Occupancy, on the other hand, can affect sales, profitability and marketing (through word of mouth).
- Profitability is due to revenue (through residents and outside guests), occupancy and costs to trade (cost of sales and other expenses).
- Profitability, on the other hand, has a direct impact on the company’s IRR, cash flow and sustainable growth.
Only a very small part of the multidirectional relationships that exist within and between the various prominent features are shown above.
Entrepreneurs should have asked a more in-depth “what-if-type” question. They could start with questions like: What would happen to the occupancy rate if the price per night increases by 10%? What would happen if the different aspects of the company are phased in? Would it be possible to reduce marketing costs and increase occupancy? The last question typically seems like an oxymoron. This is part of integrated business planning – looking at the two contradictions and trying to find a solution that takes both aspects into account. In practice, this is likely to be achieved by using more free advertising in newspapers, internet articles and blogs and by working directly with the tourism associations in the region.
An important aspect (limitation) of this brand new business was the high capital structure. Concentrating on this prominent feature showed that costs could have been drastically reduced without adversely affecting occupancy. Using a lightweight steel structure instead of the normal brick could have resulted in great savings. The turnaround time could have been halved with savings in labor and interim interest. The long distances would have resulted in far less transport costs (light steel frames are much lighter than bricks). Additional savings are also possible due to other design benefits and different finishes. No adverse effects would be expected.
Building costs for healthcare hydro were 50% of the size of the main complex, but the projected figures indicated that it would only produce 33% of revenue in 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 when the potential occupancy and surplus was much higher.
The analysis of the company showed that by simply changing these two factors (construction method and phased in hydro) and using a realistic occupancy rate, the expected IRR will exceed 21%. Additional solutions to reduce capital expenditure could have been explored and this could have resulted in a further increase in IRR. The high road construction costs (for the complex) could possibly have been shared with the government and other potential developers (such as a shopping mall or a game sharing yard sharing the time) nearby.
Neglecting some of the salient features or failing to acknowledge and plan for important damage can be problematic or even fatal for a new business. All the salient features must be covered, and at the same time the multi-directional relations between them must be balanced. One aspect of the business cannot be optimized to the detriment of some of the others. An integrated business planning approach is needed to find the optimal balance for the company as a whole.
Copyright © 2008 – Wim Venter