This is a question that often gets raised within CIG interventions. It’s an important question that is unfortunately not that easy to answer. The context for the question is usually whether new initiatives you have kicked off to grow the business are viable long term growth platforms. This is actually two questions wrapped up in one. Is the business currently viable and will it be a material long term revenue and earnings contributor. In my experience a significant amount of the new plays are not meeting management performance forecasts, raising concerns as to how much additional investment should be made. Discussions become quite intense and often defensive especially when we start to ask the viability question not only of new adjacencies but also of the core. Having heard various definitions of what might constitute viable I have come up with the following checklist.
As a proviso, I am referring to the viability of an existing business and not that of an idea you are thinking of getting off the ground. There are very useful tools that can be applied to the testing of ideas, business model options to deploy them through and the competencies needed to go-to market. Ultimately the viability of ideas is best tested through small bets incorporating lean start-up thinking. I believe the “going concern” viability question is made up of three sub questions with the answers becoming progressively harder to answer.
Firstly, is your business currently viable?
I believe there are 3 tests for this question:
- Is it profitable? – Creative accounting aside, do you have a positive NPBT
- Is it self sustaining? – Does the business sustain itself off internally generated cashflows or does it require external support
- Does it generate returns that exceed the WACC? – This measure must either incorporate the beta of the initiative itself or the beta of the parent company investing the funds. A business that is profitable and self sustaining is destroying shareholder value if returns are not exceeding your hurdle rate. Business’ in this space are typically not profitable enough or have overinvested capital
Secondly, could it become viable?
This question needs to be asked if your current business(s) fails the first test. This is a harder question to answer and is one of business’ most perennial and challenging management calls. Not only does one need to take into account which of the above tests it has failed, but also manage the subjectivity within the answers and the systemic interplay of the test variables. That said, I believe there are 5 generic tests for this question:
- How much additional investment is required? – here less may not be better
- How long will it take to become viable? – the shorter the better
- How big is the upside when viable? – This covers both the quantum and duration of the upside
- How much influence do we have over the elements required to make it viable? – The less control you have the greater the subjectively in all of the above and the risks incurred pursuing viability
- What risks do we incur through the process? – This needs to account for both venture specific and core business risks
Thirdly, if currently viable, will it stay viable?
This I believe is one of the hardest business questions to answer which is probably why there are so few Warren Buffett’s around. This question alone and small variations therein have the makings of a PHD thesis and entire books by the likes of Tom Peters and Jim Collins. Trying to do justice to a question this size in a one page blog is unrealistic. I thus believe one need’s to use guidelines rather than tests to this question and that management teams and investors need to apply their minds with a fair amount of gut feel tossed into the mix. On the assumption of a five year outlook the key guidelines are at a minimum:
- How enduring are the underlying need sets and states that the core business meets. How many different ways could the same needs be met?
- How strong is the core business? – The state of the core is probably the biggest predictor of growth success and thus potentially ongoing viability.
- What is the source of the competitive advantage – How distinctive is this advantage and what sort of isolating or diffusion mechanism does it possess. Is the source structural, positional, resource based, reputational and how easy is it for competitors to replicate, nullify or out manoeuvre. Structural and resource based sources are often derived over time and very difficult to clearly understand and compete against, ceteris paribus.
- How interesting is the competitive advantage – Do you in any way have the ability to enhance the quantum of the advantage over time through mechanisms you possess or can influence.
- Will the underlying competitive advantage continue to provide sufficient financial gain? Advantage and gain are not always positively related. Business may continue to have advantage but fail to operate at WACC exceeding ROI’s
- How much industry slack exists – How well are the industry stakeholders configured to meet the needs. How much inefficiency exists within incumbent and foreseeable future demand states and supply options
- How successful has the existing management team been at identifying and building new growth platforms. Have these been primarily focused on bolstering the core from the inside out or bringing three to four step adjacencies to the market
- The quality of the management team
While none of the above are comprehensive tests or guidelines, they do start to frame the archetypal problem space the management team is dealing with. The strategy options available to a company trying to become viable may well differ along goal, objective and immediacy levels.
Does your business pass all three tests?