Diversification – not always the golden path

 

One of the most difficult challenges a business faces is diversification.

Very often a company is faced with the dilemma of diminishing revenue returns and a tired business model which is either irrelevant or obsolete.

Diversification is seen as the solution to this problem. However, the mechanism for achieving this objective can be particularly difficult.

The first step is examining why the current business model is not working. This requires an honest appraisal from the Management in respect of their own performance.

Then the areas of diversification have to be closely considered, very often people plunge into businesses in which they have little knowledge or experience and the results pretty quickly show up these deficiencies.

Thirdly one should always respect geography it may be very tempting to consider that there are opportunities just waiting to be picked up but to underestimate the advantage of local knowledge and conditions can again prove costly.

In essence diversification can provide the answer to a company’s need for increased revenue but without a clearly defined strategy it can equally provide another drain on an already embattled balance sheet.

Today’s watchword – focus on cutting costs

 

With operating margins being continually squeezed it is imperative that costs are rigorously controlled. 

 

Every business sector is seeing the impact of spiralling costs  e.g. FedEx the world's second largest package Delivery Company have seen their customers moving business from air to slower and less expensive routes. 

 

Manufacturers of electronics and mobile phones are now shipping cargo by sea because competition was eating into their profit margins meaning they needed to cut delivery costs.

 

Traffic will continue to moving onto the water because moving goods by air is very energy-intensive and the high cost of jet fuel was making air freight too pricey.

 

Facing marked resistance from consumers to price increases and a greater level of competition, those companies who are unable to control costs face an uphill struggle to maintain their position in today’s market place.

 

Lessons from history

  

Rarely in life either privately or in a commercial environment do we come across a unique or totally new situation.

History provides us with many examples of financial crises such as the 18th century South Sea Bubble, the Victorian banking crisis of Overend & Gurney, the Great Depression which followed the 1929 Wall St Crash, the Dot Com Crash. In all of these episodes the common denominators were reckless pursuit of profit whilst fundamentals were ignored, the so called “get rich quick” school of business.

Following each of these debacles there was a collective reigning in and return to the principles of sound business.

However memories are short and it is not long before the blurring starts again and risky practices again become more and more the norm.

We may well be witnessing the start of a new “bubble” in the UK housing market where house prices on average have risen by 6.3% in the past year the biggest annual increase since the start of the financial crisis in November 2007.

As George Santayana commented “those who cannot remember the past are condemned to repeat it”.

 

Making the best use of your cash flow means scrutinising stock turnover.

 

Stock turnover ratio equals cost of goods sold during a specific time frame, divided by the average stock holding during the period.

The result of this ratio gives the "number of days that on average money is tied up in stocks". The longer this is, obviously the worse this is for the business as the money is not available to be used elsewhere. .

An stock turnover ratio of 20 means that the average amount of stock holding during the year has been renewed, or turned over, 20 times over the course of the year.

Dividing the number of days in the period under consideration by the turnover ratio tells you how many days it takes, on average, for the warehouse to empty and then be refilled. The number of days in a year, 365, divided by 20 is 18.25. So the entire stock is fully sold and replenished every 18.5 days, on average.

As a general rule, the higher the stock turnover ratio, the more efficient and profitable the firm. A high ratio means that the firm is holding a low level of average inventory in relation to sales.

Carrying stock ties up money. This money is either borrowed and carries an interest charge, or represents funds that could otherwise be better used in servicing other elements of the business.

There are additional costs in holding stocks such as storage and the risk of getting spoiled, breaking, being stolen, or simply going out of style.

Wherever possible companies need to reduce stock holdings and there are various means by which to achieve this aim:

Liquidate slow-moving or obsolete stocks.

Introduce more efficient production techniques to reduce stock holdings.

Rationalise the product range weeding out the under performers and thereby reduce stock carried.

Negotiate sale or return with suppliers in order to avoid being stuck with unwanted product.

The value of a pre-emptive strike

The current economic inputs point to the fact that the coming months will continue to produce difficult challenges for all.

As domestic budgets are ever more squeezed this will impact on businesses across the board.

This is an appropriate time to conduct a top to tail analysis of your business.

Undoubtedly there are areas which would benefit from some radical adjustments/ change of direction. The consequence is not acting now could have very negative effects in the next few months.

Now is the opportunity to prepare for difficult times rather than adopting an ostrich "head in the sand" attitude.

When trying to explain a disastrous strategy to your shareholders or bankers there is little merit in falling back on the old standard “it seemed a good idea at the time”.  

The cost of denial

As a result of ignoring obvious problems the management and shareholders of troubled organisations subsequently end up asking “why did that go wrong?”

It is simple, a large number of companies fail to address problem issues early enough to avoid an oncoming crisis.

The signs of a troubled business are all too apparent – these include lack of controls, lack of strategic vision, a demotivated workforce and obsolete or valueless stocks etc.

Instead of grasping these nettles, the preferred option in many instances is to engage in a totally pointless exercise such as a rebranding exercise or the launch of another product range destined to fail for the above reasons.

At the time it seems a rather painless way to deal with problem issues but for the most part it only buys a limited reprieve before the harsh realities come into play.

 

More evidence of smoke and mirrors

RBS have announced that they may face full-year losses of up to £8bn, after the bank said it needed another £3.1bn for claims relating to the financial crisis.

The boss of RBS stated "the scale of the bad decisions during that period means that some problems are still just emerging."

This is straight out of the manual under the heading “nothing to do with me guv”.

There have been repeated assurances that the banks were putting their houses in order but there is a growing feeling that many of the problems have been swept under the carpet rather than acknowledged and dealt with.

This announcement from RBS adds credence to this view.

 

It is hard to believe that we have seen the end of issues with the banks when we consider their recent history of financial mismanagement and sheer scale of incompetence.

 

 

There is no doubt that the internal controls of these institutions appear seriously deficient but there is a question mark concerning the obvious lack of professionalism on behalf of the independent auditors.