Identify Your Competitive Advantages

This blog is a continuation of our last one, entitled "What's Your Competitive Advantage?" Part one overviewed how competitive advantages provide the opportunity for improved margins and enhanced business value. Next, we turn to how to identify your competitive advantages.


Identifying Your Company's Competitive Advantages

Your competitive advantage may lie in the product or service you provide. But chances are that is not the case. Save yourself a lot of time and money trying to convince your customers that your product/service is better than your competition when it really isn't. Even if your product or service isn't special by itself, the way you make it, test it, package it, deliver it and any other extras you provide can make the critical difference in customers buying decisions.

The following is a sample list of deliverables that you can measure against your competition in order to arrive at competitive advantages for your company:

• Product knowledge


• Post-sale technical support


• Inventory availability and selection


• Product performance


• Tech-savvy reps
  
  


• Consistently complete shipments


• Good delivery condition


• Easy installation


• Fast response to customer inquiries


• Superior communications
  
  


• Unique design


• Installation training


• Shipping documents


• Sales leads


• Product training

Internal Competitive Advantages

Your company may have some strong internal competitive advantages that your customers don't see which can and should influence their buying decisions. A few of those may be:

Buying power:
If you do a high volume of business or hold exclusive franchises on certain products you have clout with your suppliers. Let your customers know about these.

Substitute products or services:
If you have alliances or networking arrangements that strengthen the entire range and quality of services you can bring to a customer, make sure they know about them so they don't feel they have to switch from you to another supplier to get them.

Market position:
There is security in numbers and if a potential customer knows you dominate the market they are more likely to feel comfortable dealing with you. Your market position doesn't need to be national to be impressive. A strong regional or county market share can be just as impressive.

Experience:
More important than how long you have been in business is the expertise you bring to the game. Make sure your customers/clients know about it.

Production advantages:
If you've invested in the latest equipment, have better access to materials or boast a heftier inventory, look for impressive metrics that will demonstrate a benefit to the customer and tell them about it.

Distribution advantages:
If you are a supplier, perhaps the physical location of your warehouses or the size of your truck fleet gives you an edge in receiving and shipping materials and products. This can translate into faster order fulfillment. Find out how to measure the benefit to your customer and let them know about it.

Government relations:
Experience in dealing with the various layers of government laws and regulations doesn't come easily. Your customers can benefit from both the results of your experience and the relevant knowledge you can pass on to them. Additionally, you may act as an advocate for your customers' best interest in dealing with regulators and legistlative initiatives.

In summary, minimize or eliminate your customers' concerns about any risk of buying from you. Give them confidence that they are in good, responsible hands with you.

Reference: Creating Competitive Advantage by Jaynie L. Smith

What's Your Competitive Advantage?

Know the Reason You're in Business
If you can articulate a clear, specific reply to the following question from your customers: “Why should I do business with you?” you know your competitive advantages. Your competitive advantages should be the foundation for all your strategic and operational decisions. Most companies have them (or had them) or they wouldn’t be in business. If you don’t have them, you can create them.

Don't Play the Lowest Price Game
Play the price game and you are tossing margins to the wind! Most businesses cannot exist by being the lowest-cost providers. Without a competitive advantage, price becomes your only differentiator. That’s not enough.

Become more conscious about why you are in business in the first place and what you are delivering that makes you unique. Help your customers increase sales, save money, be more productive, save time, solve problems, look good to their customers, enjoy life more and they will pay you for it. Offer something more important to the customer than the lowest price.

Competitive Advantages and Business Value
Business value is all about future cash flows generated by profitability and the risk associated with the predictability of those cash flows. Higher predictability enhances business value. Competitive advantages provide the opportunity for improved margins that are sustainable for some period of time in the future. This assumed sustainability improves predictability of
future cash flows and, in turn, enhances business value.

A Competitive Advantage is:

Objective, not subjective - Words like “quality”, “trust” and “reputation” are so overused - they have become nothing more than meaningless noise in the market place. Steer clear of claims that are matters of opinion.

Quantifiable, not arbitrary - A statement that “95% of our business comes from referrals” is more likely to be believed by your customers than “we have great customer service.” Get specific.

Not claimed by the competition – Identify exactly what benefits your product/service brings the customer that others don’t. Claim it first.

Not a cliché - If you say “we exceed our customers’ expectations”, do you know what those are (in their terms not yours)? Do you measure and can you articulate how you exceed them? Would your customers confirm that statement? Walk the walk if you’re going to talk the talk.

Sustained Competitive Advantages
The best competitive advantages are long-term sustainable ones. But most are not. They can last months or years but, seldom decades. They have to be recreated. Identifying your competitive advantage is not a one-time exercise.

Competitive Advantages Are Not Simply Strengths
A strength is not a competitive advantage. Strengths such as quality, knowledgeable people, low-cost production and good customer service are important to compete but they are givens - not differentiators. As much as you might like them to be, there is nothing unique or noteworthy about responsiveness, longevity or being a family-owned business.

Strengths are defensive weapons. Competitive advantages are offensive weapons.

Customers need you to show them what you mean by “quality” and “good customer service”. What makes a true impression are facts and details.

Instead of saying: "We provide...

"...Good Customer Service", consider saying:
“Our service staff promises to return all calls within one hour of being received and, if necessary, we will have a technician at your location within six hours” Be specific. Consider offering a financial penalty to yourself (benefit to the customer) if you don’t deliver on the promise.

"...Quality", consider saying:
“Last year, less than half of 1% of our customers returned one of our products.” Return costs are low with good products.

"...Customer Satisfaction", consider saying:
“If you are not satisfied, return it for a full refund, no questions asked.” Reduce your customers’ buying risk.

"...Our People", consider saying:
“Our engineers have a minimum of 15 years of experience, twice that of our nearest competitor.” Simply stating “our people are the best in the industry” won’t cut it. Back up your boast with measurable numbers.

If you claim a competitive advantage, make sure you provide it every time. Broken promises will drive your customers into your competitors’ arms. Making claims you can’t meet is worse than not making them at all. In our next newsletter we will discuss Identifying Your Companies’
Competitive Advantages.

Best regards,

Steve Hammes
Hammes Business Planning

References: Creating Competitive Advantage by Jaynie L. Smith and Gaining
and Sustaining Competitive Advantage by Jay B. Barney

Internal Valuation Formulas - Know their limitations

At some point in the life cycle of a business the owners must deal with the question of what their business is worth. If there are multiple owners this is typically addressed when drafting business formation documents. Often in these closely-held ownership situations that issue is answered by defaulting to book value as an internal valuation formula.

Book value is quantifiable and easy, assuming accurate financial statements are prepared. But it almost never represents the fair market value of a business.

In today’s business environment many revenue producing business assets are not reflected as such on the balance sheet – such as technology and intellectual property. In business, the most important assets walk out the door every day and the cost is expensed through payroll. Internally developed systems and competencies that contribute to profitability are expensed when paid. And off balance sheet commitments and contingencies will not be reflected in book value.

You sometimes hear the argument that as long as all owners buy in and sell out of the business under the same valuation methodology - such as book value - it is consistent, fair to all and doesn’t matter whether it represents fair market value or not.

But other external factors will start to disturb these well intended arrangements.

Consider:

• If the ownership interests are ever included in an estate or gifted, they are required to be valued at fair market value, which will usually require an appraisal. It may be difficult to get business appraisers and the IRS to concur that book value is fair market value.
• A disgruntled exiting shareholder may challenge the valuation arrangement as not being fair market value which can be costly to defend even if unsuccessful.
• Ultimately most businesses are sold to third parties which will determine fair market value. In that event previous ownership interest transactions may be challenged.

Some advice on internal valuation arrangements:
• Tie any internal valuation formula to the income statement.
• Have calculated values documented and agreed to annually by all owners so the topic has a chance to get fair discussion and thought.
• Stay in touch with valuation issues in your industry and similar organizations so you can continue to factor new information into your valuation methodologies.
• Consider getting input, either formally or informally, from a business valuation professional on your ownership interest valuation methodology.

Whatever valuation method you use make sure you consider fair market value and try to stay within some range of it.

Think Win Win…or No Deal!

We’ve all heard of the philosophy of thinking win-win when dealing with others in business and personal aspects of our lives. It calls for a frame of mind or heart that constantly seeks mutual benefit and sees life as a cooperative, not a competitive environment. It is based on an abundance mentality, the paradigm that there is plenty there for everyone.
An extension of that philosophy that is very useful in business negotiations is what Stephen Covey refers to as Win-Win... or No Deal. This negotiating philosophy sets the stage at the onset of negotiations that ending the process with no deal is OK, a viable option. It does not represent failure on the parts of the parties involved.
We usually enter business negotiations with reasonably high expectations of what the outcome might be. As discussions proceed and we come face to face with the reality of the issues and potential obstacles that must be addressed it is easy to allow frustration and disappointment to set in. This can result in a feeling that the other parties were not fair to the process in some way. One or both parties can leave the negotiations with a feeling of failure that the dreamed result did not materialize because of the other parties’ attitudes or positions.
When No Deal is an option we can feel liberated from the need to push our agenda and manipulate people. We can focus on facts more than feelings. It helps parties to think freely about various options that are mutually beneficial. We simply agree at the start that if we can’t find a solution that will benefit both we agree to disagree agreeably. No expectations have been created, no performance contracts established. We can think objectively about whether our values or goals are aligned as they should be for this deal to proceed. It can help preserve relationships after the negotiating process has ended if no deal is where the process ends. This result often increases the chances of a renewed and successful negotiation process later when the environment for the deal may have improved.
We all want favorable (win-win) results when we invest time and financial resources in a negotiation process. All parties should strive for that. But when both parties acknowledge that No Deal is a viable option at the start the resulting emotional freedom can actually improve the chances of the desired Win-Win solution.

Business Value, It's All About Future Return and Risk!

Value is the expression of the worth of something. It can be measured in different ways. Some things may have sentimental value but little financial value. Many businesses have sentimental value, but when business value is discussed it should be focused on financial value.

Business value is future oriented.
Last year’s earnings of the business are valuable to a prospective buyer only to the extent they give some indication of future earnings. This is often the case but should not be assumed too readily. Businesses are always changing. Customers and employees come and go. Contracts expire and may not be renewed. Technology is changing most industries.

The future business earnings and cash flow potential from a group of assets is what a prospective business buyer is purchasing. That is the only financial benefit they will get.

Business value is about getting a return on an investment.
Return is the anticipated future cash flow from an investment to an investor. It is the cash flow that will be available to them to be considered a return on their investment and not consumed by the business for capital expenditures or working capital. Quantifying what is often referred to as future net free cash flow to invested capital and discounting it back to present day value is critical to arriving at an accurate business valuation.
One of the first due diligence procedures a sophisticated business buyer will perform is to ask management for their projections of the next few years’ business operations in the form of financial projections. This is the first step in quantifying future expected cash flows. If they are not available prospective buyers may work with management to create them based on the best available information and assumptions.

From the sellers prospective it is best to have these available before engaging in discussions with potential buyers.

Business Value is a Function of Risk
Risk is the essential variable used to quantify the fair market value (present value) of future cash flows to an investor. Risk measures the uncertainty that the future net cash flows will be received. Without consideration for risk every dollar of future return, no matter how speculative, would be equally attractive. Increased uncertainty in future cash flows will increase risk and reduce business value. Reducing future uncertainty will increase business value.

Quantified risk in the form of a desired rate of return can range from the return on a 10 year U.S. treasury security, normally considered the risk free rate of return, to high rates of return with numerous risk premiums required on highly speculative investments. Quantifying the risk of future cash flows from a business in the form of a required rate of return requires substantial insight, business knowledge and judgment.

So, business valuation is really very simple. Just measure the future cash flows and convert them to present value using a discount rate (expected rate of return) that fairly measures the risk involved.

Cash Is an Asset: Everything Else A Liability

When I was a young CPA one of my senior partner mentors used to have a favorite saying when talking about analyzing financial statements. It was “Cash Is an Asset: Everything Else Is a Liability”. He obviously new the difference from an accounting perspective. His intent was to emphasize that business value creation is all about maximizing cash flow. Things that get in the way of that (consume cash) can detract from value creation.
You cannot make debt service payments or buy equipment with accounts receivable, inventories or prepaid expenses. These assets consume cash and capital (which always has a cost) and have risks associated with them that cash does not. When a good financial analyst reviews financial statements of a business they immediately go from the Income Statement to the Statement of Cash Flows. That statement has the following three main sections:

Cash Flow from Operating Activities:
This section shows how much of the income reflected on the income statement was really in the form of cash inflow, sometimes referred to as free cash flow. A business that shows profits that are continually being consumed by growth in working capital items other than cash detracts from business value and indicates issues in the cash conversion cycle that need to be addressed.

Cash Flow from Investing Activities:
This section shows the investments in capital assets the business has made. The cash for these investments has to come from cash flow from operations, financing sources or the liquidation of other assets for cash.

Cash Flow from Financing Activities;
This section shows the change in how the business is financed, both debt and equity financing.

The Statement of Cash Flows starts with net income and then reconciles it to changes in the balance sheet and ultimately changes in cash. It addresses the question of where the profits from the business ended up and whether they were put to productive uses or not.
If you find yourself asking the question “If I made so much money last year why do I feel so poor?” a proper cash flow analysis will answer that question.