Start-ups Turnarounds and Growth CompaniesFacing Similar Challenges

Norman Augustine, retired CEO of Lockheed-Martin, authored an excellent book entitled

<i>Augustine's Laws.</i> In the book, he spends time discussing the challenges facing a business

enterprise and presents an interesting chart to make his point (<a href="#figure1">Figure 1</a>).

</p><p>Until reviewing his findings, could you ever imagine that an outer space mission, an Indy 500

race or some guy in a barrel going over the great falls would have a lower risk of fatality than a

U.S. business surviving 10 years? Let's examine why all businesses, be they start-ups,

turnaround situations or growth companies, face such challenges, and why these challenges

remain level for all three categories.

</p><p>Turnaround situations best demonstrate what can go wrong and, with objective analysis, why

these events occurred. If start-up enterprises and businesses reaching and surviving their

10th anniversary were to employ management techniques similar to those required in a

turnaround, they would likely not become a statistic.

</p><p>There can be little debate that the abundance of private and public capital has spawned a record

number of new businesses since 1990. (Start-ups will likely exceed a record seven million

this decade.) But this abundance has also contributed to a management style that does not fully

recognize the urgency with which strategies, decisions and, at times, changes need addressing.

There is at least more than a suspicion that the presence of capital resources has greatly

assisted marginally managed companies. In the mid-1980s, when selected pension fund assets

were restricted from investing in higher risk investments, business failures rose quickly.

Conversely, failures subsided in the 1990s when venture capital and private investment dollars

began to exceed $10 billion annually. There is clearly an inverse correlation between the

presence of capital and the reduction in failures. There are also a number of operational

restructuring announcements in <i>The Wall Street Journal</i> describing strategies that were once

thought attainable as being financed through secondary offerings and private placements. Would

some of these hyper-growth strategies even been pursued without an over-abundant capital

market seeking the next "home run"? Not likely.

</p><h3><a name="figure1">Figure I:</a> Probability of Fatality for High-Risk Activities</h3>

<p></p><center><table cellpadding="5" width="400">

<tbody><tr>

<td><b>Activity</b></td>

<td><b>Probability of Fatality</b></td>

</tr>

<tr>

<td nowrap="nowrap">Indianapolis 500 (10 races)</td>

<td>5%</td>

</tr>

<tr>

<td nowrap="nowrap">Sport parachuting (1000 jumps)</td>

<td>6%</td>

</tr>

<tr>

<td nowrap="nowrap">Astronaut (10 missions)</td>

<td>20%</td>

</tr>

<tr>

<td nowrap="nowrap">Ascending Mt. Everest (1 attempt)</td>

<td>30%</td>

</tr>

<tr>

<td nowrap="nowrap">Going over Niagara Falls in a barrel (1 time)</td>

<td>33%</td>

</tr>

<tr>

<td nowrap="nowrap">New Business in 1-5 years</td>

<td>51%*</td>

</tr>

<tr>

<td colspan="2"><small>Source: <i>Augustine's Law</i><br>

* Dun and Bradstreet Corp.</small></td>

</tr>

</tbody></table></center>

<p>What then are the challenges facing all businesses that make the young, weak and seemingly

strong so closely allied? From its inception, a business selects a market to serve, reviews the

strengths and weaknesses of its competition, assesses opportunities, and sets out to either create

additional market demand or to penetrate existing market share, and, if successful, both. Upon

achieving initial success, comparisons become the subject of analysis. The start-up perhaps has

an advantage, for its management realizes that without continued efforts to achieve market

share, it will soon become a statistic. The turnaround already has begun to experience market

loss, and the 10-year-old cannot ignore the up-starts. Certain industries, such as technology,

are glowing with successful companies such as Microsoft, Intel, etc., but at the expense of those

whose names have long been forgotten. Gains and losses of market share are an everyday

occurrence, but managing this precious "asset" is critical to success. General Motors, although

still successful, would certainly choose to have the 50 percent market share it enjoyed in the

early 1980s before Roger Smith thought the market would accept a Cadillac built on a Chevrolet

chassis.

</p><p>Start-ups seek initial capital from venture capital firms to develop and market their chosen

products/services. But, as in turnaround situations, vendor credit support can be elusive. This

is common ground—without vendor support the equity base erodes quickly. The 10-year-old, or

growth company, is generally spared this challenge until it begins to lose market share and

watches profits and cash flows dissipate; then it becomes a turnaround.

</p><p>Key management is certainly common ground, but often the start-up's management has good

ideas but can't execute them because of insufficient management skills. Bill Gates, Michael Dell

and Andy Grove are rare. Many high-tech companies did not survive initial and secondary

capital infusions because the "idea guy" could not manage.

</p><p>But where is the similarity with turnarounds? One of the most detrimental losses to a company

is the loss of a key manager. Key management losses can trigger other management defections.

Turnarounds suffer from a loss of good management as the situation heightens fears for the loss

of jobs, security and prestige. While the start-up might not have all its key management

assembled, the turnaround is experiencing a management exit.

</p><p>Further review of market share, customer base and the population of qualified customers with

clients requires thorough analysis to avoid credit losses and customer concentration. It is

especially tempting for the start-up to pursue volume, but volume as a priority can and often

does lead to a concentrated customer base. (If one customer accounts for 25 percent or more of

your volume, a warning sign of failure has just been recorded.) Middle-market and smaller

market companies are most prone to concentration. Manufacturers of widgets for large original

equipment manufacturer (OEM) companies or to mass merchants can easily be lured by the

prospect of increased volume, only to learn that they no longer have a customer but more likely

a partner—and more likely a partner with pricing leverage.

</p><p>Start-ups and turnarounds are often associated with customer concentration, and they pay the

price. The 10-year-olds can become turnarounds if they allow customer concentration to occur.

Imagine 50 percent of your volume tied to one account—and that account takes a long strike or

begins to face financial problems of its own. The result: the 10-year-old is now a turnaround.

</p><p>Vendor concentration is often associated with lower costs because of volume purchases. OEMs

reduced suppliers in the 1980s to lower costs and many middle-market suppliers obliged, not

realizing the ultimate price they might pay. Here again, it is tempting for the start-ups,

turnarounds (even more so) and the 10-year-olds to lower their selling prices to gain volume.

One concentration leads to another.

</p><p>In summary, start-ups, turnarounds and growth companies (the 10-year-olds) share many of

the same challenges and can easily become a failure statistic. Employing crisis techniques in any

category could eliminate the need to chase volume, incur concentration (customer or vendor),

and prevent the loss of talented management.

</p>