Porter's Five Forces

Prof. Michael Porter’s created his Five Forces analysis as a framework for industry analysis and business strategy development, in 1979. He developed it in response to the more popular and commonly used (at the time, and still today) SWOT analysis, which he considered as unrigorous and/or too ad-hoc.

Porter is a Professor at Harvard Business School.  He is regarded as a leading authority on company strategy and the competitiveness of nations and regions. His work is recognized by global governments, corporations and within academic circles. He also chairs Harvard Business School's program dedicated for newly appointed CEOs of very large corporations.

Porter has penned about 18 books. He is also a lifelong academic. His attempt at a for-profit venture - or foray into real business if you’d prefer - was his co-founding of The Monitor Group. However, it was sold to Deloitte Consulting in 2013 through a structured bankruptcy proceeding.

I explored Porter’s work 3 decades ago while completing undergraduate study, and again more recently during a stint at grad school, as part of an MBA Strategic Management curriculum.

This blog posting may appear a little academic, but I thought to use everyday examples to allow for a little fun and familiarity, in order to illustrate the Five Forces Analysis concept. Let’s explore a short summary of the Five Forces, as shown in the illustration above (image: Wikipedia).

Threat of new entrants

Example:  Apple displaced Blackberry as the smartphone or mobile device, of choice

Threat of substitute products or services

Example:  Apple’s market share - taken from Blackberry - was itself eroded by Android devices, led by Samsung. Furthermore, an iPhone 5 replaced an iPhone 4, leading to better Apple client retention and some new clients/users, via the launch of a substitute device.

Bargaining power of customers (buyers)

Example: Resellers like Best Buy, Verizon, etc. often wield great power in determining the ultimate sales success (and/or failure) of new products. This often results in product companies (e.g. Apple and others) to consider opening their own, dedicated product retail stores. Today, aggressive marketing and readily available product information allow retail customers to make informed shopping decisions based on features, price, etc. by themselves, in advance of possible purchase.

Bargaining power of suppliers

Example: The more a corporation buys from one single supplier, the more beholden the corporation may become to the bargaining power of the supplier. This may impact quality control, manufacturing lead times, etc. Vertical integration strategies become more desirable (where a corporation starts to ‘own’ the entire supply chain), i.e. from manufacturing all the way through to retail in these examples.

Intensity of competitive rivalry

Example: We - as potential consumers - are able to witness (and benefit from) vendors’ competitive rivalry, daily. The intensity of their competitive offerings allows us to be able to consider ever better products, featuring enhanced user features and/or usability, often at continuously lower (real) retail prices. As in, the devices get ‘better’, but prices keep declining!

Back to Prof. Porter:  Upon review, would one consider the Five Forces to be groundbreaking academic discovery and/or innovation? 

I report, you decide.

One of the benefits of a Harvard pulpit, complemented by a captive audience (students) as consumers of one’s work, allows for the privilege of publishing thought-leadership of this nature. Concepts like Five Forces are then regurgitated without much further thought, to business leaders and graduate school students all over the world. Consumers who lap up the academic knowledge shared with insatiable appetites, while trying to outsmart the next guy in business.

As for me, I thrive on counter-opinion. For this reason only, I automatically default to questioning everything that may be presented as The Five Forces, The Ten Commandments, The Ten Best Movies, Ten Worst Dressed People, etc.  Questioning, usually in this order: (1) according to whom? (2) really? and (3) maybe there's more to it than just this?!  Meaning... these are BesterInvestor's Three Steps To Questioning Anything!

In my personal business experience (including an occasional taste of success), somebody’s Ten Steps To Achieving Success may often have seen me starting somewhere in the middle, or at number 10 and working my way back to begin... or enjoying success achieved while being completely oblivious to the existence of ten steps that should have been followed! This may also be the reason why there are so many self-help books at the bookstore?

In business, as within life in general... it remains far better to question... than to simply believe!

Closing Down

Every small business has growth aspirations.  In a capitalist business environment, no small businesses exist purely for the purposes of supporting its owners, the government (via taxes withheld) or its ‘immediate family’ (workers and their dependents).

Every business owner or senior manager I have ever spoken with, or worked closely with, had varying aspirations for business growth.

We’ve probably all heard the cliché, “No businesses plan to fail… they just fail to plan.”  So, while you’re planning your next move, consider the following:

1. Create a management team that is able to run the company in your absence. Empower your employees (or at least ‘a few chosen ones’) to make some important decisions that you will support.

Your employees already know that you are in charge.  Allow managers to direct meetings, and also their personal areas of responsibility with limited interference.  If you feel you can’t trust them to make good decisions, replace them!

2. Create an exit strategy, because you’re not going to live forever.  If you are a proverbial one-man business - despite having employees - there will be very little sustainable value in your business, without you!

3. Spend time away from the business in bite-sized chunks. That will allow you to assess how your managers, and the business, are able to function without you (or not).

Great entrepreneurs - like Sam Walton or Andy Grove - spent most of their available time ensuring that they knew their competitors.  In Walton’s case, he had spent most of his working hours (especially earlier in his career) in competitors’ retail shops, studying sales methodologies, client behavior, etc.  Grove, on the other hand, spent half his time visiting with his customers.

If you don’t know what your competitors are doing, your business will fail.  To date, the only entrepreneur that I’m aware of, who had successfully decided that he would tell clients what products they needed… was Steve Jobs.  At the risk of sounding overly facetious I’ll add: “I knew Steve Jobs, and you’re no Steve Jobs.”

And while I’m at it… your company is not called Apple Inc.!

4. Pay your best employees a few points above market rates. This will help mitigate retention risk, and deliver more loyal, motivated employees.  If you pay your best employees at market - or above - they’ll be less likely to shop their services around to companies likely to bid higher for their services.

5. Most importantly, know your ‘financials.’  Review your financial statements regularly to ensure you know your where you stand, financially speaking. If you’re financially ‘illiterate,’ hire a bright accountant to help you to interpret and understand financial ratios, and your general, financial business foundation.

One could probably add many more good management suggestions to the short list above.

I did not intend for this prescription to be exhaustive, but rather to provide a ‘highlights reel’ to encourage entrepreneurs to think longer term, and to create some strategic vision beyond the ‘here and now.’

Best of success in managing your business growth… free market enterprise needs champions like you to help secure the people’s wealth, well-being, and future financial sustainability.

Now, get back to work!

Recurring Revenue

For businesses, recurring revenue, or re-occurring revenue, is the opposite of ‘one-time’ revenue.

Simplistically defined, recurring revenue should be continuous and/or predictable.

People sometimes regard regular one-time revenue as being recurring.  A business may do different work for (or sell different products to) the same client, every month, for varying fees (based on work effort or product)... kinda like me shopping at Costco ($COST) every month.

The example above demonstrates regular business with a loyal client, which is obviously good, but ≠ recurring revenue.  To be viewed as recurring, revenue should be pre-determined and predictable, like a contracted, monthly support fee.

When helping to create a business plan to secure a round of financing, or valuing a business for sale, we first inquire about current, predictable, recurring revenue streams... ideally generated under contract arrangements with clients.

Recurring revenue streams allow for the use of sophisticated accounting valuation methodologies, like Discounted Cash Flow (or DCF).  However, DCF can be as vague as one would like it to be.  No different to asking your CPA “What is 1 + 1?” and having her respond with “What would you like it to be?”

Let’s explore a few different types of recurring revenue, some more predictable and/or preferred than others.

(1) Recurring revenue on consumable products

An example of this may be a client purchasing a very expensive coffee machine.  An investment in expensive equipment - which some valuation experts informally refer to as sunk money - usually indicates that clients would also likely be willing to buy the consumable product (in this case coffee packets, or brewing cups), on a recurring basis.

The manufacturer of the coffee machine has therefore created an after-market recurring revenue stream that is somewhat predictable (barring market conditions, competitor entry, etc.).  This example illustrates a business-to-consumer model.  Valuations for business-to-business sales models are often valued higher (described below).

(2) Subscription revenue

At its most basic, examples include a subscription to a magazine, professional association, membership of an organization, etc.  A publisher of a magazine may be able to share subscription numbers with would-be advertisers, thereby creating an opportunity to generate greater one-time revenue from advertising clients.  Client subscriptions, on the other hand, would generate recurring revenue for the magazine's publisher.

(3) “Sunk money” subscriptions

This indicates - unlike the magazine subscription example above - that a subscriber has had to make some kind of an investment, in order to subscribe to the service.

An example of a ‘sunk money” subscription would be a stock trader (or financial advisor) who had made an investment in (or sunk money into) a Bloomberg Terminal, providing up-to-the-minute information about stock market activity, as required for his or her business.  It’s unlikely that the trader would stop payment for the ongoing subscription, when they had invested in the underlying terminal required to support their business.  Today, a Bloomberg Terminal is a software solution, rather than a physical terminal.

A financial advisor paying a recurring Bloomberg Terminal subscription would likely be a more reliable revenue source, than a coffee-by-the-cup retail client, buying consumables for their Nespresso coffee machine!  However, Nespresso also offers club membership… hmmm, good coffee + recurring revenue!

(4) Evergreen recurring revenue

This arrangement is common for companies that provide services that can be cancelled at any time.  Companies like Iron Mountain ($IRM) or Cintas ($CTAS) have predictable revenue streams.  They deliver services to clients on a regular basis, over a regular and predictable billing cycle period.

(5) Contracted recurring revenue

Arguably a Best Practice business strategy:  Contracted clients pay monthly or annual fees for a certain period, e.g. 2-5 years.

Today, this type of recurring revenue is often referred to as a user license subscription fee business model.  It is almost standard business practice for SaaS - Software as a Service - technology companies, e.g. SuccessFactors (An $SAP Company), or SalesForce ($CRM).  A common consumer example would be a 2-year Verizon ($VZ) mobile phone contract.

Several overlaps exist in the descriptions above.

One could say that subscription = evergreen = contracted recurring revenue.  But, subtle (and/or not so subtle) differences can also be observed in the examples offered.

Consider evergreen ≠ contracted, based on a termination clause.  A client may be able to cancel an evergreen agreement within 30 days at no cost, whereas a contracted client canceling an agreement may be subject to the entire remaining and/or outstanding fees, as per the agreement.

I trust that the information will be beneficial to entrepreneurs, especially the start-up technology geeks who ask questions related to pricing their products and services, on a regular basis!

#Bitcoin

"The trouble with quotes on the Internet is that you can never know if they are genuine" 

- Abraham Lincoln

First, some technical stuff:

Bitcoin is digital currency.

Bitcoin is an open source payment network.  Open source is a model that promotes universal access via free user licenses to the product's design or blueprint, and allows universal redistribution of that design or blueprint.

Bitcoin is a peer-to-peer payment network, meaning that tasks (e.g. searching for files or streaming audio/video) are shared amongst multiple interconnected peers, who each make a portion of their resources (like processing power, storage, bandwidth, etc.) available to other network participants, without the need for centralized coordination by servers.

Transactions transfer bitcoins, the individual units of currency, between Bitcoin addresses derived from public keys.  To spend the funds associated with an address, a user must broadcast a payment message that was digitally signed, with the associated private key. 

Transactions are verified by a decentralized network of computers globally.  These computers use a unique system to prevent people from copying and spending the same bitcoin multiple times.   Operators of these computers are called miners, and they are rewarded with transaction fees, and newly minted bitcoins.

Now, the fun stuff:

Bitcoin was supposedly created in 2009 by Satoshi Nakamoto.  However, the name "Satoshi Nakamoto" is a pseudonym for the unknown person or people who designed the original Bitcoin protocol in 2008 and launched the network in 2009.

Investigations into the real identity of Satoshi Nakamoto have been attempted by The New Yorker and Fast Company, but unsuccessfully, to date anyway.

And now, even more fun stuff:

Last year The Economist reasoned that Bitcoin has been popular because of "its role in dodgy online markets."   And earlier this year, the FBI shut down Silk Road, a service specializing in illegal drugs (after which the FBI took control of about 1.5% of all bitcoins in circulation).

However, bitcoins are increasingly being offered and used as payment for legitimate products and/or services.  Incentives for merchants include lower transaction fees, e.g. 2-3% less than typical credit card processing fees.

Speculators have been attracted to Bitcoin, fueling volatility and price swings. As of November 2013, the use of Bitcoin in the retail and commercial marketplace is relatively small.  On the other hand, the use of bitcoins by speculators is relatively huge!

These speculators expect the currency to increase in value as its popularity widens.  But, bitcoins really lack any intrinsic value (underlying fundamental value as an investment vehicle), because the value of bitcoins depend only on the willingness of users to accept them.

Some investment funds have shown interest in Bitcoin.  Recently Peter Thiel's Founders Fund invested $3 million.  The Winklevoss twins – of Facebook fame – are said to have made a $1.5 million personal investment.

As for BesterInvestor… no position, while I watch the drama unfolding, with my sense of humor still intact!