Entrepreneurs understand the need to stand out in the market place. Standing out in the marketplace is a pre-requisite for long term sustainability. There are three areas in your business that need to work together to maintain a competitive edge.
- Finance
- Marketing
- Operations
Finance: Gaining clarity and handling your finances better
How do you compete financially in the market place?
To be a sustainable business, you must have clarity about how you compete financially in the market place. There are 3 main areas businesses compete in as represented in the accounting equation.
Assets = Liabilities + Equity.
A business competes either because it has high levels of assets, can stomach a high level of liability or can bring in high equity (mostly in the form of income). This means a business either brings in high margin, turns over assets quickly or uses other asses to increase equity.
Building equity with equity (high margins)
The first way a business competes financially, is by building equity with high margins. A business with high margins does not need to turn inventory as quickly as a business with lower margins. Low margin businesses compete on turnover. High margin business competes by differentiation.
For service businesses, the higher your margin the less the number of customers you need to meet your revenue goal. High margin service businesses can focus on doing quality work for a few customers. A high margin business increases its asset by increasing equity (net income). With high equity, less debt is needed to grow assets.
High margin business are often a result of having a very small niche market. You serve a few customers in the market well and get paid very well for it. Your competitive edge is you can serve this market better than anyone else.
Using debt to build equity
The second way a business competes financially, is by using debt to build equity. Businesses with low margins depend on high volumes to create profits. This means you have to sell something customers desire often at a lower price than your competition. The more often a customer uses a product, the more they comparison shop to get the best price. These items are known as commodities because in the customers mind it really does not matter if business x or z sold it to them as long as they got a good price.
A service business that chooses to compete on turnover will have to complete the work relatively quickly and serve as many customers as capacity will allow. This is the case when a service becomes a commodity. An example is bookkeeping. As technology advances bookkeeping service is seen as more of a commodity. A non-differentiated bookkeeper/ accountant will have to survive by using technology to increase turnover while reducing margins.
Most low margin and high turnover businesses use debt to acquire more assets. However, these assets are quickly turned over which reduces the default risk.
A high turnover business, is a result of finding a good product/ market fit either by disrupting the market or creating a larger niche. Your competitive edge is you can turn your goods over faster than your competitors.
One metrics a high turnover business needs is the breakeven point. This will tell the entrepreneur at what point he or she covers its fixed cost and begins to make profits. A low margin business should never set price below total cost per unit.
Building equity with assets
The last way a business can compete financially in the market is by providing leverage to its customers thereby building its equity with assets. This can be done in several ways:
- Increasing the length of time, it takes customers to pay, thereby financing their purchases
- Providing loan financing solutions to customers
Customers who need financing are more likely to patronize vendors who finance their purchase. In return the business is able to gain additional revenue by collecting interest from its customers. This form of leverage provides a competitive advantage to the vendor. We see this form of competitive advantage displayed in rent to own and car sales businesses. Your competitive edge is being able to use current resources to finance the business so you can handle more debts from your customers.
If a business competes by building assets with other assets, then the margins or interest on customer purchase has to be high enough to cover the collection risk. A lot of times, the business owner recoups its expenses after the customer pays its first few payments and everything later is interest.
As a business leader, you have to be clear on what front you compete. Having competing values will cost your dearly in your business as you hit the wall frequently trying to figure out what to track to stay competitive. A business competing with high margins will reduce its profitability by acquiring too much debt. A business competing with high turnover and low margins, needs debt to effectively compete but must be very careful about its asset levels. A business that competes with leverage will need high margins or interest payments to compensate for the delayed collections.
If a business owner is not clear on what financial front it competes, it cannot completely take advantage of the uniqueness of its position. For example, a business who builds assets with other assets might not charge interest for delayed payment because it does not understand that there is a cost for allowing others use its assets. On the other hand, a business competing with high turnover using debt will go out of business if it has slow collection practices. It cannot compete in the same manner as a business who competes with its assets.
Marketing: Gaining a competitive with defined marketing practices.
There are many definitions of a market. But to the entrepreneur, a market is the selection of people served by his/her business systems. Product/market fit happens when the business has a systematic way of consistently bringing in new customers. A market has to be large enough to make the opportunity worth pursuing and predictable enough to ease the customer acquisition process. An undefined market is one not clear enough thereby making the customer acquisition process harder. For example, as a tea manufacturer, your market could be defined as 20-40-year olds, who live in urban areas and drink tea. This market has already been defined by one of your competitors which makes identifying the market much easier. It is up to you to figure out how to make your product better to win existing tea lovers. On the other hand, if you define your market as 20-40-year olds who live in urban areas, you have an undefined market. There is no evidence your target already uses a version of the product you are offering. Targeting all 20-40 year olds is going to cost you a lot of extra resources due to your broad definition of your market.
It is much easier to serve an existing market. The best way to win market share is to disrupt the market. To disrupt the market means to come up with a much better way for consumers to get the same or better outcome by using your product or service. Customers find the new solution so innovative that they hardly think twice before switching over. However, finding market disruptors are not always an easy feat.
For those not able to disrupt the market, creating a niche is the next best thing. A niche means you are serving a small segment of the market in a way it finds very appealing. It is possible for niches to expand over time thereby stealing more market share. Using our tea manufacturer example, a market disruptor will be creating a tea sachet that comes with a foldable cup that fits in your bag and can be heated with the press of a button. A market niche will be serving tea lovers between 20 and 40 year olds who work in fortune 500 companies and live in suburban areas.
If none of this is possible, then you can create a whole new market. A new market is one not currently served by competitors in any significant way. However, creating a whole new market takes more time to validate when compared to serving an existing market. Product market fit is much harder to validate in a new market. This means you have the hard job of educating your target market on why they should adopt your product or service.
If you compete on the internet, then your predefined market is what the search engines says your target market is searching for. It is hard to clearly define who your competition is on the internet as they are often very many. Competition on the internet is always changing and is often defined as the business that can optimize your target keyword better than you. The goal here is to develop a system of constantly getting new customers using various techniques.
Operations: Gaining a competitive edge by improving efficiency.
Operations is another area an advantage can be built. Operations is how you organize your internal resources to deliver on your promise to your customers. Operations is the bridge between marketing and finance. It is the segment of your business that makes sure customers get what they want at a cost the business finds financially viable. For example, a business that operates in a broad niche with high turnover will need to design operations to make sure money is collected on time or before the sales, the business will also need staff and processes to manage the restocking of good very quickly. How you choose to compete, will set the tone of how you operate.
Entrepreneurs can gain competitive edge in operations by having an exceptional workforce with processes and procedures that create killer results every time. Customers are attracted to businesses with excellent internal operation processes. Of course, when starting out you want to keep your operations as lean as possible.