Tips to improve your company: Protecting Profitability

Condensed summary of remarks to the annual meeting of National Association of Small Business Investment Companies (NASBIC), Palm Beach, Florida, October 17, 2006

Bob Sherlock, The ProAction Group, Chicago

Not long ago, we worked with a well-positioned, private equity-owned manufacturer whose innovative products had grown revenues significantly in the past few years. The company had been profitable until the prior year, when it ran into what management called “The Perfect Storm.” In the same year, they encountered three

big adverse events:

  • Doubling of materials costs
  • Near-doubling in energy costs
  • Loss of a major customer

They went from respectable profitability to below breaking even. They experienced a confidence problem with their workforce and customers. Ultimately, the company had problems meeting their covenants. Their challenge: How to survive and get growing again. Their situation holds lessons for lower middle market companies trying to grow to the next level. As in any business, one cannot always avoid bad conditions. However, the company had missed several opportunities to grow and protect earnings through improved productivity. Since their growth had relied on product and technology advantages, which were expensive to keep up, growth derailed.

The root problem was the company hadn’t proactively positioned itself to ride out the “storm” so it could continue growing. Nor have most middle-market companies.

Common Opportunities to Protect Earnings and Support Growth

There are several improvement opportunities that we frequently see in mid-market companies that can increase a company’s ability to ride out tough external conditions and keep growing. These missed opportunities can be tremendous sources of productivity and growth:

  • Understanding customers: Identify their priorities and needs, current and future
  • Segmenting customers and products: Analyzing true profitability
  • Streamlining business processes: Eliminating ad hoc processes and system workarounds that don’t deliver value to customers
  • Defining clear growth strategies: Aligning the organization with common goals
  • Setting effective pricing strategies: Optimizing policies, systems, tools, authorities, incentives, and metrics
  • Creating robust sourcing practices: Demanding continuous improvement from suppliers

Productivity & Growth
Productivity is a critical source of, and support for, growth. Increased productivity allows a company to:

  • Handle the same volume with fewer people, assets, and financial capital; protecting earnings for reinvestment, even in challenging times
  • Handle more volume with the people, assets, and financial capital you already employ; self-financing some of the company’s growth
  • Outperform the competition through productive processes; earning more business from customers

The innovative manufacturing company might have faired better had it focused on its productivity and required fewer people, assets, and financial capital to handle its current volume. Companies often add product or service variations over time, many of which are low-margin and divert attention from more profitable products. The management of pricing and terms is also a crucial productivity initiative. Customized pricing often siphons valuable time away from selling activities. Had the company aggressively pursued a strategy of product line rationalization and closely managed pass-through pricing terms, they may have weathered the “storm” more successfully.

Taking Good Portfolio Companies to “Great”
Adding value through operations hinges on the creation of a culture focused on productivity:

  • Believe that productivity and growth opportunities exist. They always do.
  • Understand and affect the mindsets, beliefs, and values of management and employees.
  • Question the team: “What other ways might this [function or activity] be handled?
  • Seek fresh perspective. Visit other companies outside the industry, or bring outside perspective in.
  • Persist. Make the team rise to the occasion.

In the end, this approach will produce delighted customers, engaged employees, top line growth, and improved returns. When a company knows what customers value, gears its processes to efficiently provide it, and manages pricing and terms in accordance with its value, good things happen. We’ve seen:

  • Double digit share gains
  • Double digit EBITDA increases
  • Capacity increases of 60% with no significant capital expenditure
  • Committed teams that focus on achieving greater success

Think about what it would mean to fund returns if one could accelerate portfolio company cash flow improvements by a year. That opportunity is out there!

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