The simplicity of the business purpose, introduced in Part I, does not lessen its importance and significance. The business that fails to satisfy customers will see its revenues eventually disappear. Similarly, the business that doesn’t pay its capital providers for the use of the capital invested will eventually find itself without capital. Perhaps surprisingly, it is the maturing middle-market business most benefited from understanding this issue.
Customer Satisfaction
It’s misleading to confuse revenues for customer satisfaction or profit for Return on Capital. Revenue and capital work together to create customer satisfaction and produce a Return on Capital. Customers trade revenue for satisfaction. Customers do not pay for a product (or a service); customers pay to solve a problem or satisfy a need. When a lender, equity investor, founder (sweat equity), or a provider of intellectual property contributes capital they do so because they expect to be rewarded with a return sometime in the future.
Some years ago, I worked with a client that had developed a sophisticated method of performing advanced numerical analysis. This method was used when designing a structure, such as a combat jet, to simulate and analyze its response to all different types of operating conditions. These conditions included mechanical loads, different thermal exposures, or any other kind of physical phenomena. The company was staffed with very capable engineers, mathematicians, and scientists producing breakthrough analytical methods.
Strategically the company was intent on developing the most advanced numerical methods that could be used in structural simulation and design. The company believed it could monetize its methods by selling a software package to analyze structures. They believed that anyone from aerospace engineers to architects would replace their existing systems for more advanced methods.
Like so many companies the only thing preventing them from success was more money. As a consultant or any outsider, it’s tempting to point out the obvious at the onset. To do so, however, sidesteps the value of outside or meaningful guidance. As a consultant, my job is enabling a client to successfully perform in the future, long after I’m gone. In this case, the executive team and its board of directors needed guidance to think about their business differently.
Rather than analyze the company’s cash flow, marketing plans, operating budget, or capital requirements I started by asking “what is the customer satisfaction you are creating?” This seemingly innocent question turned out to be difficult to answer. The first attempts exposed the executives’ confusion with a description of a market: aerospace companies. Aerospace companies aren’t the buyers or the users. Aerospace companies employ buyers and users as well as adopt systems prescribing institutional criteria for procurement. My client’s executives then identified design engineers and analysts, individuals who would use the product. Eventually, a distinction took form between the “buyer” (who makes the decision to buy), the “end-user” (who uses the product) and the “influencer” (specialists who influence the decision to buy). A sale would require navigating a complex network of buyers, end-users, and influencer (IT department).
Armed with a more nuanced understanding of the “customer,” we tackled the concept of satisfaction. Satisfying the IT specialists would require confidence that the software purchased would integrate with other existing systems as well as satisfy reliability, documentation, support, and security requirements. The buyer needed satisfaction that a better product wasn’t available and they were getting the best price. Satisfying the user, on the other hand, would require a user environment that included a graphical interface, the ability to easily use legacy data, and familiar software utilities. Additionally, my client needed to demonstrate that its technology performed significantly better than current systems and was worth the time necessary to learn to use.
Rigorously working through these questions, the executives began to see that selling the product (creating customer satisfaction) was far more involved than writing software code, and it required satisfying different decision criteria. Creating customer satisfaction was clearly more complicated and costly than guesstimating revenues.
Investor Rewards
This discussion led to the equally important second half of the Business Purpose equation: creating a return on invested capital. The more complete understanding of customer satisfaction exposed the need for significantly more capital than anticipated originally. A detailed financial analysis wasn’t needed to show that satisfying investors’ expectation of a return on capital would be impossible pursuing the original strategy.
Requiring coherence between the Business Purpose and the orthodoxy strategy exposed the deficiencies and produced the revelation, as I like to say, “We can’t get there from here.” This analysis did, however, reveal a new strategy that would be successful: sell the technology to a company that already had the other pieces. This strategy not only made sense; it also worked.
The above example is all-too-familiar to many readers. It is a common scenario with an obvious solution, unless of course you are completely invested in an alternative. The example shows how testing the fidelity to the Business Purpose reveals not just the land mines but also feasible alternatives. The best results are a product of good questions. And good questions start with the basics – the Business Purpose.
Hindsight is clearer than foresight. Had the company considered fidelity to the Business Purpose in its early strategy deliberations it would likely have deployed its capital and its efforts very differently. This may have resulted in the need for less outside capital, reduced risk, accelerated the time to a liquidity event, and produced a much better return on capital with fewer sleepless nights.
Executives and directors have a responsibility to ensure that the business satisfy The Fundamental Business Purpose. Doing so with serious and rigorous determination will steer the business on a course away from many of the dangers that can lead to failure and towards a destination of success.