Entrepreneurs would always do some form of business planning before they start a new venture. Quite often this will result in a formal business plan. The format will probably be determined by one of the following:
- A business planning software package;
- A guidebook on business planning;
- Another business plan;
- An external consultant.
Although all the above can have satisfactory results, they all have potential pitfalls. One serious pitfall (when using one of the first three methods) is the way that the entrepreneurs tackle the problem. Although all of the methods cater for the addressing of the apparent salient features and even for the interdependence between them, they can not cater for all the intricacies and multi-directional relationships that exist between various features in a business.
Outsourcing the whole business planning process to a consultant also does not solve all the problems. A consultant would need to work quite interactively with the entrepreneurs to be of real value.
Over more than a decade Ventex Corporation advised and assisted companies from business planning right up to harvesting and beyond. This case study highlights the importance of having a well thought-out and executed integrative business planning process. It shows how apparent small issues, that are neglected in the planning process, can have grave consequences for the entrepreneurs.
Salient Features in an Integrative Business Planning Process
The first aspect of integrative business planning is to ensure that all the salient features are catered for. These features can differ drastically from one business to another. Some of the more general features are:
- The Business – 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.
- Operations – All aspects.
- The Team – Management team, skills needed, training, board composition and organisms.
- Finances – Investment-, financing- and dividend decisions and policies. Also cashflows, profit margins, costs and growth.
- Risk Management – Business-, operational- and financial risks as well as potential fatal flaws.
Multi-Directional Relations to Keep in Mind in Business Planning
Unfortunately the salient features can not be seen in isolation. Every feature impacts on various other features and are also impacted by many other features. These multi-directional relationships occur within each individual broader feature (e.g. finances) as well as between different features (e.g. between finances and marketing).
Higher profit margins can for instance decrease the volumes sold, but increase the net profitability. On the other hand can higher volumes (with lower gross margins) increase the volumes sold, but decrease the profitability.
Higher volumes on the other hand can increase the stress factor in production personnel (that already work at maximum human capacity), causing higher absenteeism, lower production levels, extra hiring costs and a corresponding decrease in profitability. Unfortunately these intricacies can not be ignored and an integrative approach of business planning goes a long way in handling it.
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 health hydro, hotel school, conference facilities, adventure center and eco-cultural tourism. (Details are changed for confidential purposes – all the detail does, however, simulate the real-life scenarios close enough to demonstrate the actual learnings).The experience of the entrepreneurs includes business, entrepreneurship, tourism, archeology, law and politics. This project of around $320 million was a life-long passion for all of them. They covered in-depth the architectural designs, legal requirements, development and operational planning issues, the marketing plan and personnel development policies. They also ensured that they had senior politicians and excellent service providers on board.
The business did, however, never got of the ground. What did the experienced entrepreneurs not see? What could they have done differently? They thought they had covered all the various aspects of the business. Analyzing the facts, the following major problems stood out:
- The entrepreneurs were not flexible – they had strong pre-conceived ideas;
- No detailed market research was done. 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 that these factors might have effected other factors were never considered.
The entrepreneurs were quite arrogant. They believed that any entrepreneur would be stupid not to invest and they would typically say that they only want investors that share their dreams and that the finances will sort itself 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 as 50% in year one, rising to more than 75% by year four. The IRR and occupancy rates were much lower initially and were purely based on thumb-suck. The entrepreneurs then just chanced the figures 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 occupancy rates were inflated. The real figures based on realistic values indicated an IRR of only 15% – at least five percent below what the investors expected. The financial risk was just too high. Furthermore a breach of trust occurred.From the entrepreneurs’ viewpoint this was an insurmountable problem – they wanted it their way. In the end nobody invested. Much effort was applied and personal expenditures were sky-high. A high visibility in the business and tourism industry was also created. In the end some of the entrepreneurs were financially (and emotionally ruined) and all of them lost credibility.
The important questions in hind-sight are: Could the entrepreneurs saved this project? Could they have included all the features and genuinely expected an IRR of above 20%?
If the entrepreneurs used an integrative business planning process, they would have first ensured that all the salient features were examined. Secondly they would have ensured that all the multi-directional relationships (causality) between the different features were balanced.
By mapping the relationships between the various salient features it showed for instance that:
- Occupancy rates are caused by service levels, product offering, marketing and price.
- Occupancy rates on the other hand can affect the turnover, profitability and marketing (through word-of-mouth).
- Profitability is caused by turnover (through occupants and outside guests), occupancy and cost of doing business (cost of sales and other expenses).
- Profitability on the other hand have a direct bearing on the IRR, cashflow and sustainable growth of the business.
Only a very small portion of the multi-directional relationships that exist within and between the various salient features are shown above.
The entrepreneurs should have asked more in-depth “what-if” type of questions. They could start with questions such as: What would happen to the occupancy rate if the price per night increase by 10%? What would happen if the various aspects of the business are phased- in? Would it be possible to cut marketing costs and increase the occupancy rate? The last question typically seems like an oxymoron. This is part of integrative business planning – to look at the two opposites and try and find a solution where both aspects are catered for. In practice this can probably be achieved by using more free advertising in newspapers, internet articles and blogs and by working directly with the tourism associations of the region.
A major aspect (constraint) of this whole new venture was the high capital lay-out. By concentrating on this salient feature it was shown that costs could have been drastically reduced without having any detrimental effect on the occupancy rate. By using a light steel frame construction instead of the normal brick could have caused tremendous savings. The erection time could have been halved with savings in labor and interim interest. The long distances would have resulted in much less transport costs (light steel frames are much lighter than brick). Additional savings are also possible due to other construction benefits and different finishes. No negative effects would have been foreseen.
The building costs of the health hydro was 50% of that of the main complex, but the projected figures showed that it would only produce 33% of the turnover of the main complex (at 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 profits were much higher.
The analysis of the business showed, that by just changing these two factors (construction method and phased-in hydro) and by using a realistic occupancy rate, that the expected IRR will be in excess of 21%. Further solutions to decrease capital expenditure could have been explored and this could have resulted in a further increase of the IRR. The high road building costs (to the complex) could possibly have been shared with the government and other potential developers (e.g. of a shopping complex or a time-share game farm close by).