Understate or Overhype?

“Marketing slime!” I used the term back when I developed software, then became its target after moving to the dark side (marketing).

Such statements are usually good-natured, yet tension can arise between software engineers and marketers when discussing appropriate language to describe a product. Engineers by nature must be very precise and may prefer to losing a prospect over misleading them. Marketers want to draw attention to a product by describing it in the most compelling terms possible and may prefer to stretch the meaning of a desirable word rather than lose a prospect.

Each group has a point. Prospects notice quickly and lose interest when a product description exceeds reality. On the other hand, an opportunity to address their problem can be derailed if a product description is devoid of words that connect with their needs.

Think about it like this. The diagram below represents the continuum between understatement and overhyping. Overhyping product capabilities hurts prospects by misleading them into thinking a problem can be solved when it can’t. Understating capabilities prevents them from solving their problem because they don’t fully understand what the product can do.

Clarity is the goal. What does the product do? What types of problems can be realistically solved? Language that both clarifies and motivates is the goal. Sales success is the result.

Are You Working On or In Your Business?

In a recent post, I mentioned that an article I’d written for TexasCEO magazine would show up soon on their web site. Here’s a link to the article and a picture from the party held at Annie’s in downtown Austin to celebrate publication of the current edition.

Defining Product versus Services Businesses

The genesis of this post is a comment I made about product companies at a large networking event earlier this week in Houston:

“If you think you’re a product company and you haven’t developed a repeatable sales model, then you’re a services company.”

In other words, if every deal closed is in a different vertical market and/or solves a different problem, then the transition from a services company to a product company is incomplete. What is the effect on the value of your company?

How to grow a company’s value is a topic I spend a great deal of time thinking about, and the 20/20 Outlook process focuses on aligning a company with others in the industry to grow a private company’s valuation. While that’s a vital driver of any corporate strategy, let’s consider how the form of a company’s offerings (specifically, products versus services) impacts its market value.

One attraction of starting a product company is the relatively rapid growth in valuation possible in comparison to that of a pure services company. To see why this is a critical issue, go to Yahoo Finance and compare the ratio of revenue to enterprise value for half a dozen public companies that derive most of their revenue from either products or services. For example, the well-run government services company Raytheon’s trailing twelve months’ revenue is $25 billion yet their enterprise value is only $18 billion, a ratio of 0.7. Compare that with your favorite products companies and you’ll find much higher ratios for well-run products companies.

Of course, customers demand varying amounts of service to accompany product purchases, thus few so-called product companies are successful without offering services as well. The percentage mix of product and services revenue can determine profitability and valuation, so it’s important to characterize the difference between products and services.  Products and services both solve problems, but in their purest form, they do it differently. The chart below depicts these differences.

Cost – Any problem can be solved with enough services, but the cost may not attract any customers. Creating a product to solve the problem is an alternative, and the gap for customers who want more customization than the product offers can be filled with services.

Fit – Services by their nature enable delivery of customized solutions. Products exist because enough problems of a certain class can be solved well enough to satisfy most needs with a generalized solution.

EBITDA – Earnings vary widely, yet as a general rule, the EBITDA of a well-run product company can easily double that of a well-run services company of similar size.

In the software industry, for example, it’s fairly common for a services company to evolve into a product company over time. Consider the continuum below that depicts such an evolution, starting on the left with totally service-based solutions (“Custom Services”) and incorporating product-like characteristics as we move to the right and end with Product/Service solutions.

To the right of Custom Services is “Packaged Services.” Once you’ve solved the same problem several times, you can package a partial solution (60%? 80%?) that can be customized for each customer. Basing the price of the solution on value rather than level of effort (hours), profitability increases.

Continuing to the right, next to Packaged Services is “Product-Related Services.” If your staff becomes expert at designing, implementing, integrating, and managing solutions using highly desirable but complex products, the result is a scarce resource that can be sold at a premium and that raises your margins. The classic historical example is a services company that became a leading expert at implementing SAP systems.

If yours is a well-run product business or is evolving into one, the benefits include higher EBITDA and a higher valuation than those of a similarly-sized services business (“product only”). And finally, the highest valued companies are often those that have desirable products with an abundance of product-related services available, whether supplied internally or by partners.

As the line between products and services blurs with the introduction of new types of products delivered in new ways, it’s important to understand how value is derived. Does the statement about claiming to be a product company without developing a repeatable sales process ring true?

I ask forgiveness for some sweeping generalizations. Certainly, exceptions to this high-level look at valuation abound. Feel free to point them out and elaborate or disagree.

Surprise: Clients Tell It Best

It’s been awhile since the last post was published. Client deliverables, non-profit activities, and family priorities, as well as continual business development, have made it a hectic time.

The 20/20 elevator pitch is that “it is a process that helps a company get ready and stay ready for an exit,” but it’s more than that. While helping shoot some videos during that non-profit work, we were close to Infoglide’s offices, so I asked CEO Mike Shultz to stand in front of the camera and share his thoughts on his use of the 20/20 process.

Mike has started and sold several companies, which enables him to speak with authority in this 2:47 of unedited footage. With just one take, Mike captures the essence of the process better than any marketing firm I could have hired. Enjoy.

The Mystery of a Disciplined Process

“Mystery” and “process” aren’t often used together. A process is commonly thought of as a way to replace mysterious methods of accomplishing a goal with a well-documented, step-by-step procedure that, if followed precisely, always produces the desired result.

CEOs can be mystified when a competitor with seemingly inferior products and services is acquired by a larger company.  The response is, “Why not my company?” The answer often isn’t self-evident.

In his book A Whole New Mind, Daniel Pink proposes the need to combine left-brain analytical thinking with right-brain creative thinking for those who aspire to succeed in the 21st Century. They must combine both modes of thought in order to “connect the dots” faster than their competitors.  The 20/20 Outlook process demands right-brain and left-brain thinking from management teams who implement it.

A client CEO commented not long ago about how the process has precisely positioned his company for an exit. “At first we just wanted to determine where we fit in the marketplace. During the process, we identified twenty potential acquirers and then narrowed our focus to two industry groups. What we noticed over time was that a market for our products developed around those two groups as though the market was mysteriously growing toward us.”

The CEO came to realize that the illusion of the market coming to his company was the result of decisions he and his team made to follow the decision framework they had put in place. Now those decisions have put them in a position to achieve significant payoffs from relationships created using 20/20 Outlook thinking.

Important Indicators are Up

Because I help companies define an exit strategy and grow value accordingly, I’m always seeking better sources of data that capture the current state of the investment world. Pitchbook is one source that publishes particularly useful information about fundraising, investments, and exits. A recent Pitchbook presentation suggests that we’re on the verge of significant growth in private equity investment during the next year, and that’s good news companies moving toward an exit.

One factor mentioned in the Pitchbook prez is that capital overhang is high and growing. When that happens, valuations tend to increase because so much money is looking for a place to land and produce a return.

Additionally, chart below depicts that the number of quarterly private equity exits through corporate acquisitions, initial public offerings, and secondary sales is on the upswing after reaching a low in early 2009.

Finally, one of the best analysts in the business, Richard Davis of Needham and Company, commented in his newsletter that it’s been 25 years since he’s seen so many companies in a great position for an IPO.

Taken together, all these indicators suggest that, despite the continuing malaise in the broader economy, a CEO who keeps his/her company’s partnerships, product strategy, services, and partnerships aligned with potential acquirers can expect to see greater opportunity this year and through the next.

Clarity Affects the Bottom Line

Last week I spent a morning leading a management team through a strategic positioning session to achieve more clarity about their business. The next day I read an article containing this quote by the leader of a technology incubator:

My team and I probably saw, heard or read more than 200 business pitches last year. And after about 75 percent of them, we didn’t understand the businesses. I’m convinced that this is a primary cause of entrepreneurial failure. Every entrepreneur needs to be able to clearly and succinctly communicate the essence of his or her business to an intelligent stranger.

While it’s important for startups to have an elevator pitch, it’s equally important for the management team of an existing business to share a clear vision that provides a context for making business decisions. The lack of this understanding is so common among $10-50M companies that I’ve stopped being surprised when they can’t articulate a clear positioning statement. Why do you think so many companies have trouble with something so basic and so important? I have a theory.

Recently a CEO friend in Dallas shared the “PerformanceManagement” matrix below. While the origin is unclear, it’s a useful framework for examining issues, and it offers a clue as to why so many companies lack the clarity they need to operate efficiently.

Urgent Important Matrix

For many CEOs, sustaining an up-to-date picture of the company’s value in the market is either neglected or delegated to Marketing because it lacks urgency compared to operation issues and cost management. This falls under the heading of “Poor Planning.” The CEO’s number one priority is growing shareholder value, and clear strategic thinking contributes directly by enhancing the quality of important decisions affecting future value.

If you’re a CEO, do you stay on top of your company’s value in the eyes of players that matter, especially potential acquirers? Or will you leave this non-urgent critical issue unaddressed until the day you’re shocked to read that your closest competitor was just acquired by a company with whom they’d partnered?

Restart with the End in Mind

Chances are you’ve heard Stephen Covey’s Habit #2 in his classic self-help book called Seven Habits of Highly Effective People: “Begin with the end in mind.” Or said another way by the author of the Peter Principle, “If you don’t know where you’re going, you probably will end up somewhere else.”

When a business is launched, founders typically have a clear end in mind. A successful company survives the first couple of years and finds its way to profitability or at least breaks even. Then a critical point is encountered where the CEO’s focus on “where we’re going” can devolve into a focus on “staying alive.”

An early 20/20 Outlook post tagged the resulting condition as “The CEO Dilemma.” The CEO lets the pressure to fix operational issues and manage cash flow dictate a daily routine of addressing those needs and neglecting his/her responsibility to relentlessly consider how to grow shareholder value.  Working in instead of on the business becomes a comfortable norm.

If this sounds familiar, realize that you can hit the RESET button by employing the 20/20 Outlook process. Understand how simply saying “if I build a great business, I don’t need to worry about my exit strategy” can keep you from leading the pack among acquisition candidates in your market space.

Instead “restart with the end in mind” by considering the sources that contribute to the value of your company’s product and service offerings. Drill into how relationships with potential acquirers and potential acquisitions can unlock and grow that value. And create and implement a rational plan to align your company with other organizations that can help your business reach its full potential and move into a leadership position.

I’m On a Mission!

In Bob Dylan’s song “Gotta Serve Somebody” he points out that, no matter who we are, we all have to make significant choices:

You’re gonna have to serve somebody
Well, it may be the devil or it may be the Lord
But you’re gonna have to serve somebody

The implication is clear for our spiritual life, but the broader principle applies in our work life. At the core of what drives us are competing priorities, and the one at the top will be the “decider” most of the time. What is the top driver in your work life?

What drives me personally is a passion for building effective business partnerships. Over the years, I’ve seen great ones lift companies to new levels of value and effectiveness. Much more often, I’ve seen poorly planned ones consume significant resources with little or nothing to show for the effort.

Three principles characterize the most effective partnership strategies – context, planning, and execution:

Context means understanding your own organization and its offerings in relation to the market they live in. What kind of company are we? What value do we deliver? Whom do we compete against? How are we unique? A simple positioning project can bring great clarity of thinking and purpose, yet it’s amazing how unclear the answers to these questions often are.  If you don’t understand your own company, don’t expect success in partnering with others.

Planning partnerships is imperative. Stephen Covey’s second habit “Begin with the end in mind” is based on ancient wisdom from Aristotle that’s often ignored. Once armed with a clear understanding of your market positioning, you’re ready to think about partnering and what you want to accomplish. What is your vision for growing the value of your company? If you clearly understand where you’re going, business partnerships will help you get there faster.

Execution of partnerships requires effort and resources. Why expend time and effort in creating a business relationship only to let it die from lack of care? A partnership needs focus in order to produce expected benefits. Increasing the odds of success requires architecting self-sustaining elements into the partnership from the beginning, and that can only be done successfully through clarity of purpose and a clear vision for growth.

Anonymous, my all-time favorite writer, said it best:

“Action without Vision just passes time.”

Technology M&A Is Accelerating

A few days ago, I posted links to interesting articles in an exit strategy update. Indications are that the next 12-18 months  will produce an increase in the acquisition of technology companies, so having an exit strategy in place and aligning with potential acquirers remains top of mind for CEOs. Let’s review some of the evidence.

One significant indicator is that tech companies have started using debt to raise capital. A recent WSJ article said that “the decision to take on debt breaks from tradition in tech, where companies have typically preferred to raise money by selling stock. Debt has become a more attractive fundraising option largely because interest rates are low… Turning to debt is an especially big change for software companies, which typically generate lots of cash and aren’t saddled with large one-time expenses like opening a factory.”

While the focus of the article was on the largest companies like Cisco, Microsoft, H-P, Oracle Corp., International Business Machines Corp., and Dell Inc. who raised more than $20 billion combined in 2009 selling bonds, smaller companies are following suit. Salesforce.com’s $575M debt offering and Adobe’s of $1.5B, both in January, mean that the acquisition drive is broadening.

Yesterday StreetInsider.com quoted an FBR Capital Markets report that “software vendors are flush with cash given the cashflow-rich nature of the software model and more than a handful of vendors have even recently raised additional capital.” The FBR Capital report even suggested some likely acquisitions:

So what should CEOs of smaller technology companies who want to grow shareholder value do? At a minimum, three things:

  1. Understand who your most likely acquirers are and keep the list up-to-date.
  2. Ensure that your company stays focused on activities that increase your attractiveness to those acquirers.
  3. Create partnerships with potential acquirers and other companies who make your company more compelling to those acquirers.

Whether you want to be acquired in the short term or the long term, your company’s value is in the eye of the beholder, and the most important beholders are acquirers.

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