Use collapsible overheads to protect your real wealth. A recent article n USA Today entitled “Outsourcing Business Steps Up As Economy Slips” by Jon Swartz. This article shows that the downturn has prompted more companies to hire others to handle their information technology needs.
http://www.usatoday.com/money/tech/2001-06-22-outsourcing.htm There is a lesson here you should always use! In Lesson One, we looked at an important idea about selling products. Then the first session of this lesson reviewed the importance of focusing finances. This is because getting sales and having your finances right are two of the three most important business fundamentals.
An excellent book to study about this is “Peterman Rides Again”, by John Peterman published by Prentice Hall. You can order it from Amazon.com Peterman Rides Again
You may know of Peterman from the Jerry Seinfeld show or you may have been one of the 18 million people who received his mail order catalogue each year. As a marketing oriented person, Peterman has long been one of my heroes. However as good as he was at marketing, as well know he was from the publicity he received on Seinfeld and despite the fact that he sold hundreds of millions worth of goods, the J. Peterman company went broke! His book goes a long way to revealing why he had success and why he ran in to trouble.
One (in my humble opinion) of his problems was described on page 180 of this book when he wrote, “There are two theories of growth. One is to let your organization development lag behind business growth; the danger with that is you get too much business and your company crumbles from within because you don't have the systems and staff to handle it. The other approach is to build an organization that can handle the business you expect to get; that's what our investors favored.”
In Peterman's case, his business had grown from nothing in 1986 to $64 million in sales in 1994! But growth (not surprisingly) had slowed. He tried to stimulate more growth from a weak understanding of his market and staff up for that growth at the same time. His losses became monumental and he went broke.
He followed his investor's advice (one reason to not have investors) and it cost him his business.
I believe there is a third alternative to dealing with the rises and falls of business, called Collapsible Overheads. This approach has helped my business stay afloat and profitable through thick and thin (though never in Peterman's league) over the years. This system has kept my business up-to-date when business boomed and has saved me from huge losses when business has been slow.
The problem of fixed overheads is that when business slows down, one is forced to increase marketing to keep income up. This means one has to take the greatest marketing risks at the worst possible time. With Collapsible Overheads when business drops, so to can marketing expenditure. Reserves can be saved so marketing can be increased when times are good and chances of success are increased.
Collapsible Overheads have one more added benefit for small businesses (such as Merri's and mine). They can help the business avoid having employees.
Generally collapsible overheads are attained by using independent subcontractors to do work the business requires for low (or non-existent) fixed amount and a per piece or volume basis. In Merri's and my case our phone answering, printing, art work, list management, accounting, maintenance, product fulfilment, even filing and office administration were subcontracted in this way.
This saves a lot of paper work and cost not having employees, plus creates several tax benefits (for example one can have a much more efficient pension plan if only family members are employees). Plus a no employee system increases flexibility.
However there are two downsides to collapsible overheads.
First, collapsible overheads require more work from a business owner to maintain quality control. One has to really spend time selecting and training the right sub-contractors to make sure they know what is expected of them and how the system works. When this is done though, the subcontractor will actually want you to have success (so their income rises). The difficulty is that you have less control over your sub than an employee and may not (if they don't work directly at your place of business) have immediate access. You need to work out systems that deal with this different approach to getting things done. You need to create a smooth communications and follow up system to make sure your sub knows what to do and to make sure that it is done in a correct and timely way.
There is a secondary benefit to this system though if you create and maintain good systems. If you have employees during slow times and they get used to a low volume of work, they can resist or resent a flood of extra orders coming in. More business for employees means extra work without additional pay. Sometimes employees want business to be slow. And it is amazing how when you surround yourself with those who are wanting less volume, that is exactly what you get. Subs on the other hand want more work because it means more pay!
The second problem with collapsible overheads is that they increase costs when times are good.
For example if a business has ten employees that cost a total $1,000 a day that handle 200 orders a day, the handling costs per order is $5.
If 400 orders come in and the ten people can still handle this, the cost per order drops to $2.50. This is an alluring proposition for a business to have ever increasing volume with ever improving margins. But this rarely works
If you have contractors that you pay $5 per order for processing then your variable costs remain the same with increased volume.
This second problem is not as acute as it could be because boom times are when your business can most afford increased costs. Many businesses receive their income in spurts. During these spurts you can afford to give up a little profit to save losses during down times.
Most businesses dream of making a big hit. Beware! Sudden financial success creates disaster as often as not because of two mistakes. The first mistake is the belief that this is the only time there will be such an influx of cash. This tightens the business view and stops expansion when it makes most sense, which is during bad times when labor is more available and costs most likely to be low.
The other mistake is to think that large chunks of cash will come easily all the time. This thinking creates unrealistic work ethics and management practices that can lead to disaster
I have seen example after example of businesses where a sudden chunk of income destroyed a company. This is the riskiest time for a small business. Start-up is a dangerous time but the time when a business really begins to take off creates even more risk. The proud owner with his new found wealth, buys new cars, hires new staff, moves into a bigger home, spends more, works less, and creates overhead and debt. If there is a single reversal, he can be wiped out.
The reason spurts create problems is because they disrupt discipline. Money is discipline and financial affairs create a form of economic routine, either self imposed or not.
We develop a set of mental standards that causes us to think. I can afford this, but can't have that, etc. Spurts of wealth demolish these standards. Suddenly we can have many things we previously could not. We become, once again, kids in the proverbial candy shop and lose our ability to decide what we can and cannot spend.
Never-ending wealth is a process, (not a state) of taking a continual series of reasonable risks, making mistakes, doing refinements, learning lessons and taking actions that culminates in getting it right. When success arrives there may be a huge income (or capital) spurt. So a long term business goes through series after series of these spurts. The trick is to make profits and build up reserves during the spurts and then hang on during the times between.
Collapsible overheads impose an automatic discipline that helps surviving through the tough times.
The key to setting up contractors is to find good people and give them good deals. Peterman pointed out how one of the problems that led to his bankruptcy was caused by pushing one of his contractors too hard. Quality, speed and low price. Every businessman always wants all three. We can only have two. In Peterman's case he always made a point of paying his printer top dollar an had great results. As the business grew and he delegated this job, his staff squeezed the printer to reduce losses. This led to the printer missing a big mailing at the worst possible time.
Having a way to not get stretched thin is good advice in business and all of life.
Collapsible overheads can help your business meet peak demands and reduce costs during lags. Let's hear from you some of your ideas on how you can use collapsible overheads in any situation and your understanding of this to improve you financial affairs.
Next session of Chapter Two we will look at The Golden Rule of Business.
Until then, good global business and investing!