Generating sustainable new wealth from product innovation and brand-building
Bonus insights - trade secrets
Mark J. Henry
Dijon, May 2015
Copyright notice: all material remains the property of Mark James Henry, Dijon, France, and may not be copied or reproduced in any format without the author’s permission.
My SOLIDTEKNICS vision statement
This is my version of a great entrepreneurial business vision. This is lifted directly from my previously-confidential company vision statement, which was based one used by my dear old mentor Kevin Weldon (founder of Macquarie Dictionary and publisher of many famous Australian books):
SOLIDTEKNICS upholds its founder’s formula for life success in harmony with business success:
1. We are all dedicated to this Vision. Our Vision. It guides all our interactions, motivations and decisions, every moment of every working day. This shared Vision gives us the endurance to strive together toward building a truly great company: business, brands, and products that will be respected and loved for many generations.
2. Our management cares for the well-being of all Staff, and Staff reciprocate with respect for the company Vision, values, and goals, and all Staff pull together as a single Team. We were brought into the business for our valuable commitment to this Vision, and we will only remain in the business while we work and live this Vision.
3. Our mission is to research and develop highly innovative products which are the best in the world of their kind, with unique features and benefits which experts and the public recognize and value highly enough to pay premium but fair prices (and then they’re so impressed they tell everyone else they need our products).
4. We manufacture locally, wherever possible, with commitment to very high quality and reasonable cost for strong gross margins and great value for our customers.
5. We protect our unique intellectual property with a value-driven mix of strong patents, trademarks, copyright, trade secrets, speed to market and strong branding. Because our innovations are gained through hard work and significant investment, we jealously defend them. If polite reminders to morally respect our property are not heeded, we utilise the full force of the law to enforce legal respect.
6. We strive to grow revenues to generate solid net profitability for reinvesting in growth, long-term financial strength and rewarding shareholders for their faith and financial commitment to our vision.
7. Because it directly subtracts from the profit we need for reinvestment in growth, we all help constrain overheads with responsible and well-targeted spending. Remember: ‘Every dollar spent takes 10 dollars of sales to fund, and sales are much more difficult to achieve than lean spending!’
8. We all strive for exceptional customer service and respectful, positive relationships with customers, colleagues, competitors, and suppliers.
9. We embrace ethical business practices and conduct ourselves in our community and in the world with the highest levels of honesty and integrity at all times and at all levels. In our spirit of sustainability and responsibility, we strive toward building a positive legacy for our families, the community and the world.
10. We recognize business is never easy and competition is tough; but we are tougher, and we embrace with pride the daily challenge to build a truly great business. Our business!
· There is a lot of meaning in each of those lines, and a whole chapter could be written on each line, but this is a pretty good summary of what I consider to be a great business, not just a great vision, because it is my own vision for my business, Solidteknics, a business I believe will live sustainably well for generations. Bookmark this page and check on our progress in the coming decades and generations!
My prescription for building maximum brand value, realistically:
Though I’m a big advocate for beautiful broad vision and strategy, I am also painfully aware that business reality means generating survival cash flows and profits. Selling stuff. Paying the bills. Bringing in the bacon.
Product strategy and promotional strategy will be very different for brand-building products versus revenue-generating products. In the early lean days you will usually need to rake in the revenue as quickly as possible with ‘bottom up’ product/promotion strategy. Start with a balanced proportion of the ‘low-hanging fruit’ (those products that you know have immediate cash flow potential), and products that build your brand prestige but don’t really sell. Yes, you should plan to launch some products that sell only in very narrow but highly visible niches. Here’s how:
1. High quality/price position luxury products to build your brand:
· Your finest examples of paradigm-busting ‘industrial art’, at the absolute cutting edge of technology (for your industry) and quality, targeted only at the early adopters and experts (they’re the only ones who will ‘get it’, initially).
· Builds brand equity by demonstrating your mastery in the field. Generates huge awareness for all your products when you excite the VIPs and experts in the industry and gain lots of coverage in the media and glowing ‘mentions’ online.
· Not profitable, within any reasonable timeframe, due to high cost of R&D and manufacture, and small revenues from the narrow niche market.
· Timing: Launch first, to generate publicity and brand aura, but back up quickly with products that actually sell.
2. Upper-middle position premium products for solid revenues:
· Many of the same features as your premium product, but reduced cost, and affordable (just) for the larger market of early majority customers.
· Sub-brand of main luxury brand, linked intellectual property, and visual/performance similarities. Maintains strong brand credibility in upper-middle position of market.
· Wins moderate and sustainable revenues and gross profits to achieve breakeven within reasonable timeframe, but usually not enough to build and sustain a strong business of reasonable scale before you run out of cash.
· Generates lots of buzz among industry VIPs and the press among whom you can afford to ‘loan’ lots of trial samples (because product cost is not outrageous). Generates a lot of favourable reviews on relevant sites (partly buoyed by the opinion-leader reviews they’ve seen elsewhere in the media).
· Timing: launch after your luxury products, once they have generated significant brand exposure. There will be minimal erosion of your brand’s original luxury position.
Lower-middle position or upper-mass for serious revenues:
· Recognisable features from your premium products, but with clearly differentiated lower cost of materials/manufacturing, and reduced design features to match more economical price position.
· A different brand to your upper/luxury and premium brands to avoid eroding too much value already stored in those brands. But expect some high-end brand erosion and be sure the increased net income over-compensates for that erosion.
· Promoted as the ‘value’ and ‘practical, hard working’ brand for everyone (though still too high in price in reality for the mass retail market).
· Timing: only after your luxury and premium brands are firmly established and the broader public aspires to owning your premium brand.
Mass market, for somebody else’s brand, not yours:
· Don’t go there with your own brand! This end of the market will erode brand equity rapidly and once you’re there, there’s no climbing back up. You also don’t have the financial strength, administrative or logistical muscle to play with these big boys. It’s brutal.
· If you really do have strong innovation that is being under-utilised by your own brands, seek OEM partnerships (manufacture for another company’s brand), or license your IP for others to manufacture under a completely unrelated brand with no visible links to your brands. You will gain a lot of low-cost revenue (most of it profit) from ‘renting’ that IP to others who are stronger at the mass end of the market, and get your useful IP into the hands of many more people.
· You need strong IP protection (utility and/or strong design patents) for this to work of course. If your IP is very strong there should be a market for products derived from that IP at every level of the market. Ensure you have firmly staked out the higher ground in the market for your own brands (in contract, and in established brand power).
· Timing: much later than the launch and establishment of your own brands, to ensure you have brand power, strong credibility in the industry and strong position in B2B negotiations.
Brand building for equity – the marketing high ground
This is a valuable area where entrepreneurs with their strong intuition and savoir-faire can really build competitive advantage and wealth in brand equity. Why is the ability to build brand equity with marketing strongly linked to entrepreneurs’ intuition for creating value? Most ‘conventional’ businesses and their leaders underrate the value of long term brand equity because it is difficult to measure and difficult to justify when they’re under the ‘bottom line gun’ each quarter. But leaders with intuition for value can develop marketing that stores and uses big brand value wisely over the long run, instead of potentially eroding it for short-term profitability.
Talk about your business a lot, but maintain a veil of mystery…..
You want to hold a lot of conversations online with the influencers, but don’t reveal everything publicly. If something is semi-sensitive, move it to direct email. If it’s sensitive, call ‘trade secret’, and keep it that way. (Like this chapter: I’m telling you a lot, but not everything!) Your larger competitors will also be watching you closely because the smarter ones will already know you’re a serious threat. The smartest ones will know you’re going to grow the whole market, and they can grow too if they follow and don’t slip too far behind the new trend you’re driving.
Think ‘low-tech big fish’, not ‘high-tech small fish’
People often ask me, ‘How did a mechanical engineer become an entrepreneur in chef equipment industry’? They’re usually asking for several reasons:
1. Knives and pans are low-tech: they’re just a handle and a blade/pot, and there’s nothing left to innovate, right? They assume existing big/old brands must be making the ultimate products in their categories.
2. It’s a bit weird, compared to more ‘normal’ engineering jobs in say aerospace, mining, car manufacturing, railways, etc, etc.
Being the best in the world at something, and it being very hard for someone else to replicate that thing anytime soon, is a strong sustainable competitive advantage. In the new world where most things are quickly shared online, you really need to either be the best in the world at what you are doing, or the barriers of distance/cost too great for your particular thing for it to be too impacted by other things anywhere in the world.
I prefer to be a world leader in a low-tech industry than a small battler in a very smart high-tech industry. Why? Because if I can make the best innovations, strongest patents, coolest products in that low-tech industry, I’ll earn the highest margins, attract the most passionate followers, build the strongest brands and most sustainable business.
Oh, that and the food industry is a hell of a lot more fun than most engineering fields: the interesting people, the food, wine, travel…..! So it’s worked pretty well so far, enabled me to live sustainably well, and I wouldn’t have it any other way.
Does size matter?
Though I do like to build solid medium-sized businesses with reasonable industry influence, I’m just not made for big business. My limitation is the same as most entrepreneurs of innovative products: in reality we lack the ‘stuff’ that gets us from say $50 million to hundreds of millions or billions. Even if we got there we wouldn’t like it and wouldn’t be able to live well. Even $20 million for me as CEO was a pretty big barrier, so I guess I must be at the lightweight end of businesspeople…..and I wouldn’t have it any other way. Why? Because I know myself very well, and I know what myself, my family and loved ones need from me.
Entrepreneurs have their particular capabilities and limitations set so deep in their character that they are almost predestined, just like great CEOs of large traditional companies. Just different DNA. If you’ve read this far my guess is you’ve got some of my kind of DNA, so your definition of great business is hopefully closer to mine than the traditional big definition.
Innovation, big and small
Balance BIG innovation and small innovation in your brand strategy
· Big industry-leading innovation generates the biggest gross margins, biggest equity for the brand, but not always big net profits (high cost of R&D, IP protection, educating a whole market first)
· Small innovation can generate big profits from following trends, not leading them. These are incremental improvements in fast growing markets with big customer bases.
· If it comes from competitor or customer ideas, it just isn’t big. I’m talking real industry-changing pioneering innovation with enough novelty for strong IP protection.
· Look more for consistent unresolved problems in your industry. Get to know how the experts use products and use them yourself, a lot. Think very broadly about crazy solutions unlimited by resource constraints, then narrow down to realistic and achievable and viable solutions.
· Know your customer first, then develop what the customer base doesn’t know it wants (but will want in large numbers when you surprise and delight them).
Generating small evolutionary innovation (sometimes also called commercial prostitution)
· Most sales, particularly in ‘low tech’ industries like mine, are not generated from killer innovations. It’s all the incremental improvements, evolutions, repackagings, new combinations and sets, etc, that rake in the more solid and predictable revenues at mass retail. Problem is they’re also low margin and not great for building brands. So, if we want a great business, we need to be careful with our ratio of small innovations/evolutions to big innovations.
· If you want to focus on long term brand equity, then shift the weighting to bigger innovations at the higher end of the price/quality continuum. If you want to (or just must) pull in a lot of quick revenue from ‘low hanging fruit’, slide the scale toward the incremental small innovations that you know will sell, no matter how boring and disposable they seem in your big scheme image of your brand. We all love to take the high moral brand ground, but the reality is that you’ll need to turn a lot of tricks to ensure everyone gets fed!
o Talk to retailers and wholesalers: What are their customers saying and what they are buying? What do they wish they had to sell?
o Ask your customers to develop your volume product extensions. Ask your biggest retailer customers what they think would sell as an extension, exclusive colours or sets, or incremental improvement of your current products. There can be big revenues in this approach in the mass and middle mass markets. For example, in my knife businesses we would ask our retailers to work with us to develop new exclusive models of knife blade shapes, exclusive colours or combination sets. When it’s a 1,500 store chain in the USA it is well worth the effort. The buyers feel great about being involved because it makes them look good and they really enjoy it. Easy to understand when they’ve been looking at a long procession of sales reps all day trotting out the same repackaged crap from the Hong Kong housewares show….just as an example). It builds stronger relationships that are more enduring than most competitors exposed to the regular drill of; ‘Ok, who’s got the lowest price on those generic widgets?’
You will need a lot more money (and time) than you think….say 3x…..
One old truism is that everything takes twice as long and costs twice as much. That may be true of many projects, but it’s too optimistic for most first-time entrepreneurs: trust me! Sure, build your beautiful well-online-researched business plan with its ‘realistic’ projections. It’s an important exercise. Then please also build your contingency plan for the possible scenario of 3x cost and time. In my experience you’ll probably find yourself falling back on that contingency plan. So if you’ve planned it well and have options, you’ll survive. If it comes as a complete surprise (even after knowing the cliché and reading about it here), and you have no ‘wiggle room’, it will be all over before you really get going. So it’s serious.
The inverse relationship of growth and cash flow (or how to kill your business with too much sales success)
Before we move on with funding I want to be sure you understand another important business truism: the faster you grow the more cash you will need. It’s almost always true for ‘regular’ businesses who offer open-account trading terms to customers. This is because your creditors probably have tighter terms than you offer your customers, and your stock will possibly have been in the warehouse for longer than your supplier’s terms. So generally you would need to pay your suppliers long before your trade account customers (eventually) pay you. It’s a battle of your average creditor days versus average debtor days, and in most businesses it’s your debtors who win by stringing you out longer.
So, the faster you grow the more you will need to pay for your larger inputs in advance, the bigger your debtor book becomes, and the more cash you’ll need to fund the gap.
Sure, the sales you’re making now are shipped and on the P&L as a sale (and debtor asset), but you’re not collecting the cash in the same month. However, you’re forecasting for much bigger sales and paying now for your inventory, long before the cash comes in for those bigger sales. Therefore, the faster your sales growth rate, the more cash will be drained in funding inventory, and the more cash you will need to keep the machine churning.
This is one of the biggest killers of a business (apart from thinking you’re making money when you’re actually losing it: more common than you think, and solvable with good management accounting, but that’s a whole other book). It must be one of the saddest things for an entrepreneur to see the hot demand for their cherished products, after all the hard work to generate demand and make the revenues…..quickly followed by the reality of bankruptcy. Remember: the profits can be impressive on paper, but they are worthless if you run out of cash. Please understand this inverse relationship if your business has ‘typical’ trading terms.
Lean start-up: preserve your cash and equity, and theirs
Try not to be seduced by the availability of cash in the early days of a business, if some is available. You may think it’s ideal to have more money than you need in the beginning, but it isn’t. Sounds crazy if you’re new to this, but here’s why: like the way work expands to fill the available hours, so does expenditure expand to fill (or ‘drain’, in this case) the available cash. That means you will be spending money on things you probably shouldn’t (and in hindsight you will know you shouldn’t have). And that means you are not maximizing the return on investment. And that is always bad, whether it is your money, reinvested profits, investor equity, or debt.
This is particularly important if it is your first business venture. No matter how highly educated/experienced you are in your field or how strong your formal business education, and even with the expertise of financially skilled employees; you will make a lot of mistakes and waste a lot of money. Much better to be thinking lean and losing small amounts of money with these early missteps, than throwing away large amounts of precious cash.
Certainly continue cultivating your potential equity partners while you make the business more and more attractive by proving yourself. But don’t make them a concrete offer until you’ve grown the business as big as you can and you need their equity to make a big leap forward (but also before you get desperate – there’s as much art in this as science, like most of the entrepreneurial management skills). Otherwise you’re just giving away equity that is worth far more in the long run. I’ve seen it many times in my businesses and many times in others. Whenever I saw an investor cash out and make 3x or 4x their investment, first I’d be happy for them, and second I’d think, ‘wow, imagine if I could have kept that equity by spending my original money more wisely or changing my trading terms to fund my cash needs without giving away the equity. Or even taken on more debt instead of equity. I managed the balance well and retained a lot of equity each time, but I could see how it could have gone the other way, say into my pocket or business. And I can see where I could have done a lot better in the long run with more discipline.
Apart from control of the business, conserving equity is very important when it comes time to pay out retained profits as dividends, or sell the company. If you have a great business, it should eventually pay out great returns, and that’s when your skill at retaining equity will really be paid back, manifold.
Don’t lose control and reduce future returns for early cash: instead change your model entirely
If it seems like you’re going to need to give up most of your equity (or even a big chunk of it), or unduly pressure the business with highly-leveraged debt (particularly attached to the dreaded personal guarantee), mostly to fund inventory for a high rate of growth while you offer regular trading terms, I would say you have two good options:
1. Don’t grow fast. Put the brakes on and earn higher margins on higher prices to slow down your rate of growth to a controllable and self-fundable level.
2. Change your debtor/creditor model entirely.
I favor the latter for a number of good reasons:
1) If you’re a natural entrepreneur it will be almost impossible to control yourself and follow plan A. Admit it.
2) The worst thing to do is give up too much equity: it is the most expensive finance in the long run if you really do have a great business on your hands.
3) The next worst thing is to over-leverage with debt to fund credit for your debtors: basically you are using your scarce credit sources to give them easy credit, and they will never respect this credit like you must respect your source of traditional credit.
4) In the early days when a business is weak at attracting equity or debt, the best thing to do is shift most of your strategy into direct sales and/or cash upfront terms with customers. Sure this will reduce rate of growth, but if you can survive you will build brand and financial strength, attracting ever bigger sources of equity and debt at lower cost (if you want them), as you prove your business model is working.
Okay, if you must…..Credit terms: using creditors and debtors for cash flow
My advice is clear: do everything you can to build a business around positive cash flows, so you don’t need outside equity or debt and you can keep control (and dividends)!
But if you really can’t find a way to demand payment in advance, here’s some options to consider. And, yes, I’ve tested them all!
1) Crowdfunding projects through sites like Kickstarter are perfect for launching interesting new products and brands, if you have innovation and a great story (we’ve had 3 very successful campaigns at time of writing: search Kickstarter for ‘Solidteknics’ to see them all). This is not equity funding: it’s project funding with the new products shipped as ‘rewards’ for ‘backers’ after successfully reaching your funding goal. You get to see if you can accumulate the funding required to pay for the production before you start, otherwise you return the money and all you’ve lost is a lot of time. Our successful projects on Kickstarter have basically funded the whole Solidteknics business, because they funded our expensive Australian-made moulds, which in turn made production cost per unit more viable for retailers, who also got on board quickly because of the demand created by all the strong social media support. But you need great product and great story, and it helps to have a strong network of media influencers to help spread the word for you.
2) Weight sales toward direct-to-public in the early days, instead of wholesale to retailers: Start with direct marketing of high margin products, asking your public (direct end-user) customers to pay now and then wait for production. This is entirely possible: I’ve done it….a lot! If you have a product that is truly unique and people really want it, they will pay upfront then wait (somewhat) patiently. Remind them about the wait in your ‘thank you for your purchase and your patience’ email, otherwise you’ll do a lot of damage when customers don’t notice one of your terms is that they must wait.
3) FAQ: But how will our wholesale customers, our retailers/resellers, pay us in advance, when all our competitors are offering trade terms? Remember: if they want your products enough, they will pay! But first you need a product that is so attractive that they must have it (because their customers are demanding it), it must be innovative and have IP protection (so bigger suppliers don’t rip your product off) and have few substitutes. Otherwise you’ve got no chance: you’ll be scrapping it out for the lowest price and best terms with all the others, and small guys never win that ugly game. This should not be an option for you, if you’ve read this far and you want to build a great business.
4) In all my years of exporting I never gave open account terms to my export customers: they all had to pay in advance, and most had to then wait for production runs. I strongly recommend you follow this policy because the positive cash flow can help fund your domestic operations. Only give export trade terms if you have export insurance. Even better, demand that export orders be accompanied by a letter of credit, then you can use that instrument to finance your production with no risk (as long as you deliver exactly according to the documentation).
5) As you grow financially stronger (from your high gross margins and lean fixed cost base), but still don’t have the access to finance you need to grow faster, you can start to offer credit to ‘select’ domestic wholesale customers while still offering attractive discounts for early settlement of invoices, say 4% for 7 days and 2% for 15 days. Just be sure your staff enforce the terms strictly. Smart customers will take the discount because the real finance rate you are offering is very high. Similarly, you will discontinue the offer when you have access to more debt finance, because it will be much lower cost.
6) If you’re like me and you’re more interested in (and talented at) innovation than administration and logistics, obey your character and don’t attempt to become a distributor of your own products. I’ve done it, reasonably well and to moderately large scale across Australia and the USA, but really did not enjoy it. And life’s short, right? This time around I will be appointing a distributor to handle the sales and physical distribution even in our domestic Australian market, then supporting them with strong brand building activities. Yes, it’s giving up a lot of margin, but the intangible gains will be evident in the long run.
Gross margin is king…..
…..(well, after cash, but I told you how to take care of that), and there’s only one way to sustain it:
Yes, I’m like a skipping record: you must have strong gross margins. In fact, I’ll go further than that. I say don’t start a business unless you’re sure you will have industry-leading gross margins. Why so important? Remember the equation: revenue – cost of goods (= gross profit) – expenses = net profit. If you have the same lean gross margins as all your competition, what can you do to earn profits? You can sell more stuff (that will take very attractive products, marketing budget and financial strength), and you can control operating expenses. Of course we should do all of those, but which do you think generates the best environment for yourself and your employees? The biggest potential for reinvestment of profits and growth? When you come home to loved ones, which gives you the least headache and most security? In short, which is best for building a great and sustainable business?
- Understatement: I’m not a big supporter of building businesses based on the advantage of cost control. For starters, cost control is never a sustainable advantage and, more importantly, it’s plain bloody miserable way to spend most of your waking hours (…..and that’d be your life).
- So if expense control can’t be a sustainable financial advantage, what can? Gross margins. And, yes, it isn’t easy, but it’s a big theme of this chapter, and of my success.
- Apart from a stronger business in the long run, higher gross margins also get you to break even faster. That means you need less investment to generate your first real profits. You still need to take care of the cash side of course, and that’s different to profit, but getting to breakeven fast is an important goal for every new business and project.
Lean operation is queen
Even with attractive, innovative, protected products with strong gross margins, you can still make serious losses if you can’t control costs. I won’t attempt to preach to you about the technical aspects of cost control. I’m the first to admit I’m no expert in this field: my ratio of costs/revenue are always higher than industry averages. Why higher, and why am I relaxed about it?
First, a big part of my success is based on running my businesses true to my own character, and I’m more of an entrepreneur than an administrator. So I generally spend more than I should, or could, if I was the penny-pinching type.
Secondly, because no matter how good the product, it takes a certain amount of promotional spending to grow a strong brand (paying back in future brand equity). The final reason I’m relaxed about my levels of expenditure is that my gross margins are always higher than average, and usually so are my net profits. At the same time my customers are very happy with the value of the product. That’s the ideal situation, for everyone.
Never forget this:
Your children, family and friends are far more important than business success and money, but if you can cultivate synergy in life and business, you will find the two spheres are not mutually exclusive.
I’ve heard it said like this: live every day like you’re writing your own eulogy so at the end you don’t look back and regret that you wasted any of it. Ever notice that obituaries don’t recall the dearly departed’s excellent spreadsheeting, social media and smartphone skills? It’s always love, humour, family, giving, integrity, character – the only things that matter in the end.
Live every day like that, and you will string together a beautiful life.
Mark J. Henry