The curse of perseverance: How to tell a rough patch from business collapse

One of the qualities of entrepreneurs is their undying optimism in the face of disaster. Perseverance is what sets entrepreneurs apart from the rest of us.

As Anita Roddick, founder of The Body Shop famously said: “Nobody talks of entrepreneurship as survival but that’s exactly what it is and what nurtures creative thinking.”

So no matter how bad things get, entrepreneurs keep pushing, expecting the next big sale will turn everything around.

But perseverance can only take you so far. At what point does the entrepreneur realise things are in meltdown, and that no amount of perseverance will save the business? How can they tell the difference between Armageddon and a rough patch, which all businesses face?

Most importantly, how do they recognise that the market has changed, that hope, faith and unshakeable perseverance will not be enough? If a company can’t see that that everything has changed, it will go out of business. Where do they get the intelligence from? How do they analyse it?

One of the best examples of that problem was Kodak, one of the world’s most famous brands which filed for bankruptcy protection in January 2012. Kodak made a bad judgement call. It could see the market was changing and being transformed into a digital model but it didn’t move quickly enough. It stuck to its business model of film and equipment. It assumed it was in a rough patch and only realised too late that the business model was no longer viable, that the market had changed.

The challenge for entrepreneurs is making the right call and not becoming another Kodak.

Mark Allsop, a partner at Deloitte Private, sums up the management dilemma.

“Ultimately there comes a point where judgement needs to be exercised as to whether or not you think it’s the right thing to invest in and whether this is the right time,’’ Allsop says.

“That’s the nature of entrepreneurship and risk and reward.”

Silvio Salom, the director of aviation control systems company Adacel Technologies, says it’s difficult for any entrepreneur.

“The mere fact that you are an entrepreneur means that you are always thinking you will get through most things,” Salom says.

“So that means the end of a company can sometimes look like a rough patch, that’s the nature of the beast.”

“It all comes down to your cashflow. You are always thinking you will get the money but there comes a time when there is so much pressure from the legal side that it’s getting too hard.”

“When you are looking forward, you may not be able to meet your payments but most entrepreneurs think they can get the money from the sales coming through. So you keep going until such a time that you have litigation happening and you get wound up and that’s normally when things shut down. Otherwise you generally keep going.”

For some entrepreneurs, ignoring reality might come with the territory. But as Salom says, that’s what makes them special.

“It’s why they can make things happen that other people think can’t happen,’’ he says.

Reading reality

But then, director of taxation and business planning specialists Hayes Knight, Greg Hayes, says that business people need to get real if they want to stay as entrepreneurs. Unfortunately, he says, many entrepreneurs are kidding themselves.

“You need to get a really good handle on reality that you’re not carrying lots of slow-moving or dead stock, that you’re not carrying debtors who won’t pay you,’’ Hayes says.

“That’s where a lot of businesses get caught out because they’re not dealing with reality. Their information isn’t strong enough to give them a clear picture of where they are up to at that point in time.”

“They are either relying on figures that are well out of date or that are inaccurate. They just don’t have that hard data that tells them exactly where they are up to and where the trend is going.”

The key, he says, is that every business needs accounts that are constantly updated. Those numbers will tell them where they’re at and where the trends are heading.

So what are the danger signals?

“The fact that you’re not meeting your payments when they’re due, that you’re deferring things, that you are robbing Peter to pay Paul, that you’re running late on tax payments, they are probably all the early signs. It’s probably the severity of it that becomes an issue,” he says.

Hang on, isn’t that just part of normal business life? Some businesses will defer payments and run late on their tax, and still thrive. All businesses go through a rough patch, and come through the other end. How do you know the rough patch isn’t anything worse?

Hayes acknowledges many businesses get through it. But the key, he says, is the combination of cash and profit. If cash flow is tight, that’s manageable. But if cash flow is tight and profit is falling, that’s the tipping point.

“The first stage of it tends to be cash driven,’’ he says. “That might not necessarily mean that you are in trouble. It might be a short term timing thing but if you get lack of cash with lack of profit, it’s a no win situation because you have nothing that will dig you out of the problem other than the hope that the next big sale will come along or something like that.”

A rough patch versus a meltdown

John Downes, a consultant who runs the company Acorro, says there’s an obvious way to tell the difference between a rough patch and a meltdown.

“In a rough patch you go through periods which are seasonal or episodic. Your customers are talking to you. They might have delays in their purchasing and they might have reductions in the size of orders in line with their demand but they’re still talking to you. There is hope on the horizon that things are likely to rebound. You might have strong competition but you are not seeing any game-changers like a shift in the tech or a shift away from the product.

“So in a rough patch, you have the capacity to trade on. Perhaps it’s unacceptable but it’s not a case of dire margins. And service differentiation might be enough to keep your customers.”

“So that’s a rough patch. Business is not doing brilliantly. Things are tough but you are seeing some light at the end of the tunnel.”

Serious trouble is completely different. When there’s financial disaster, Downes says, volumes are down and declining, and working capital, tax debt and supplier credit terms are creating anxieties about reporting to the bank. The market has shifted away from the product, a new breed of competitors is entering the market, customers have stopped talking to you about your products and are now asking you questions like “how’s business and how are you coping?”

“You know your business is stuffed when you don’t have any customers because your customers have bypassed you. Your lead indicators are your customers. There’s a problem if they aren’t talking to you because there’s no demand for your product. There is a market, you’re just not in it!”

Allsop says there are also non-financial warning signs.

“At the smaller end of the scale, the entrepreneur needs to reflect on whether the business is enabling them to do what they set out to do,’’ Allsop says.

“A lot of business owners set up a business to give them freedom, flexibility and autonomy.”

“Over time, they realise they have no freedom, very little flexibility and not a whole lot of autonomy because they are beholden to their customers, clients, their financiers, their business partners, so the impact can become quite significant, not just at a financial level.”

When that happens, he says, entrepreneurs might consider bailing out and just getting a job.

“You see it if the business isn’t enabling them to achieve what they want to achieve, either within the business or more broadly within their family and social constructs. Are they overly stressed, are they unhealthy, is that having an impact or impost on their life?”

“When that happens, they may be able to go and work in an industry and get a salary that is a lot greater than what they are able to achieve in their own business. If that opportunity cost becomes too significant for them, that’s the time for reflection around what they should be doing.”

The problem of picking market changes

Picking out when the market has changed often comes down to a judgment call. Kodak is a case in point. Contrary to what has since been written, Kodak actually embraced the low margin digital revolution. It built one of the first digital cameras in 1975 and introduced the first camcorder into the American market. The problem for Kodak was that it stuck to a business model that focused on film. It was overtaken by the digital juggernaut. FlickR, Facebook, Twitter and smartphones turned its business model into a dinosaur. Kodak recognised the changes early on, it just couldn’t run fast enough.

But it was a difficult judgement call. Put yourself in the position of a product manager in the 1970s urging the company’s executives to take a gamble on digital. The managing director sits back in his chair and says: “Let’s get this straight. You want us to invest millions of dollars in a market we’re not even sure exists and adopt a product that contracts our margin from 80% to 25%? Get outta here.”

Allsop says Kodak’s mistake was failing to keep checking the market and reassessing that decision.

“You would question the extent to which they revisited that initial decision over the course of time,’’ he says. “Because it wasn’t a good idea in 1975, it doesn’t mean that it wasn’t a good idea in 2005.”

“That’s good business practice. You keep your eyes on the market and what’s happening, what’s coming through the pipeline, what the future scenarios are and you apply judgement as to the best bets for capitalising on those opportunities.”

Hayes says that comes down to the entrepreneur having a good “business radar”. The financial figures will only tell you half the story, he says, you have to look beyond the numbers.

“Your numbers are going to tell you that things are getting worse but they’re not going to tell you why things are getting worse,’’ he says “As much as you need a good financial system, you need non-financial information as well.”

“Any business that does not have what I call a good business radar system about what’s going on in their market and in their industry, is really putting itself at risk. If all of a sudden the business model changes and you don’t have your radar system up to pick things up at the front end of the change, then you will be caught out by it.”

Companies need to pick the changes and get in early before the changes happen, he says.

“So you do absolutely need to understand what’s going on in your business and if you see changes are emerging, then the reality is you should probably be at the front end of those changes. You will probably have to wear some pain if you are late to adapt to what’s going on.”

A good example of that is Domino’s Pizza. While retailers like Harvey Norman and David Jones are struggling with online retail, Dominos got into it years ago. Online purchases now account for about 40% of sales and Dominos chief executive Don Meij says that purchases made by smartphone will soon overtake purchases from people calling in. Dominos was quick to adapt and is thriving, Harvey Norman, Myer and David Jones were too slow and are struggling.

Hayes says there is no shortage of data out there.

“One of the great things about the world these days is that information flows pretty quickly and pretty readily,’’ Hayes says. “You need to be reading industry publications and that type of thing. You need to be wandering across the web. If you belong to an industry association, you need to see what they’re saying and to some extent, if you have competitors, you talk to them and get data from them. And you need to talk to customers obviously.”

“I don’t think there is one source that will get you all your information. You just need to have your radar up and pick up what’s going on in the market place.”

“The business radar kicks in when you ask if there’s anything going on in the broader industry that’s causing a shift. Or is it just a case that have we been sloppy in our marketing or our sales execution is not good? Are our displays tired? Has someone moved into our space to take away market share? That’s where the business radar comes in and explains why the figures are what they are.”

Downes says the answer is to stick close to customers. That’s where competitive intelligence comes from.

“Your competitors may not be good indicators of what’s happening in the market place because all they’re trying to do is produce products and services, whereas the customers are out there trying to find a better product at better service and better price,’’ Downes says.

“When things are getting tough, the place to be is to get closer and closer to your customers. If you are serving them well, your customers will be the ones who can give you all indicators of where the market is going.”

But that can also be about making tough calls. Consultant Kevin Dwyer from the Change Factory sums up the problem for entrepreneurs faced with a changing market. “If you don’t find ways of breaking the business model and stay innovative, someone else will. There should always be someone in the organisation coming up with ways to break your business model.”

That might be the biggest lesson from Kodak: how to tell the difference between financial disaster and a rough patch, and how to change with the market. Kodak made the mistake of dismissing a failing business model as a rough patch, and could not meet the changes in the market quickly enough. Kodak needed to break its business model and create a new one.

The challenge for entrepreneurs is analysing the numbers and intelligence, and then making the right judgement call. That will be more important than perseverance.

This article was first published on March 19, 2012.

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