AFG Venture Group Dispatches

Corporate advisory and consultancy in Australia, South East Asia and India.

A business model for a model business – creating the right structure for corporate longevity

Suelen McCallum
CEO, dVT Consulting

Much is made of business models these days – but sometimes there is more focus on the phrase itself rather than the underlying structure.

A business model is a description of the operations of a business including the components of the business, the functions of the business, and the revenues and expenses that the business generates.  However, little is said about the structure of the business or matching the proper business structure to the business model – and yet this is crucial to the business having a long and healthy life by being more able to easily adapt to changes in the market.

A good business structure is one that minimises risk to a business by quarantining assets from threat as much as possible. Not all risk can be prevented, so it is best to ensure that all the eggs aren’t in one basket!

Take Company A for example – a small importer and wholesaler of specialised electronic gadgets and accessories, distributing to a select group of large retailers. It has just one company for all operations – imports, sales and distribution, employment and administration. There are a number of risk areas in this business model that instantly become apparent – statutory obligation for manufacturer’s warranty for imported goods, limited product range in a market that has a very short life cycle, and high dependency on players in a market that is itself going through a number of major changes and issues.

So the business model probably needs a lot of work to make it less risky, i.e. by expanding product ranges or selling to a larger and more mixed customer base, but the direct risk is also increased by the poor corporate structure in place. In this case study, Company A had the following problems:

  • It was selling electronic goods that were quickly being made redundant by advances in technology – specifically set top boxes for televisions. The introduction of digital televisions at decreasing retail prices made the set top boxes less attractive and demand waned;
  • Very few other replacement stock items were considered or planned to be introduced;
  • One major customer dropped its orders for the set top boxes, resulting in a 25% decrease in sales, devastating to the company, in addition to having a major claim against the company for rebates and discounts;
  • Faults in the items meant that the company had to fund replacements and/or repairs, further increasing costs;
  • A claim by a former employee in a workers compensation claim left the company vulnerable to increased premiums and legal costs.

The company was unable to continue operations because sales continued to fall, and the cash flow dried up from the loss of the major customer and the refunds and rebates that had to be paid. Tax and suppliers became an issue, and the company went into liquidation. A solution may have been possible if the company had introduced further products and further customers, but the problem became too big in the company and it became insolvent.

This then put all of the assets of the company at risk – and these weren’t just physical assets like cash and debtors. They included the import/distribution model, product support, contacts in the retail trade, relationships with suppliers, etc. The company should have been able to leverage these assets in order to regrow the business, but these were now lost with the company.

If the business model had included different corporate entities for different markets, it would have been simpler to cut loose the company that was not able to make it in the set top box market, and then concentrate energies and cash on developing the other existing businesses. Sure there would have been some issues, but all may not have been lost.

Likewise, if employment was done through a separate company, then if the issue with the employee became risky for the group, that company could have been isolated and the issue dealt with without too much impact on the rest of the group.

In a similar vein, if a dispute arises with a customer (or a supplier for that matter) and the issue becomes a risk to the business, then the entity associated with that customer or supplier can be isolated and dealt with separately, again without materially affecting the ongoing operations of the business.

Company B had a similar issue in regard to customers – this time, not with a dispute but with product ranges. The company is operating in a very competitive retail field and has over the past few years developed a wide range of products – varying in both quality and price. It has sold its products both as a wholesaler to retail outlets, and direct to the public via the internet. Obviously there are large differences in the prices that the company can obtain for its sales, and the retailers in particular are very price conscious!  Some of the larger retailers, especially, have a great degree of control in the marketplace and will often have the advantage of being able to force wholesalers to disclose their financial information so that they can negotiate lower prices or higher discounts.

The company had some valuable intangible assets in supply chain management, relationships with major specialist retailers, brand quality and appeal, and product positioning. If it had been forced to negotiate with the major retailers and give away higher discounts under the one structure, it would have faced the risk that other customers would have either demanded similar discounts or gone elsewhere, unable themselves to compete with the major retailers. This would have been devastating for the company and likely caused it to lose its market share.

A solution was to structure the business in such a way that some specific product ranges were purchased and sold in separate company structures. In that way, the information for products and dealings with specific customers/retailers were kept confidential from each other. It was also easier to market separate product lines to different retailers in the market.

The right business structure is essential if you are to be able to change your business model when needed. All businesses have issues – end of product life, disenfranchisement of customers, government regulations and liabilities – one way for the business model to survive is through the ability to restructure when necessary. Have a look at the top ASX 100 companies now – they are not the same companies that were there 20 years ago. Industries can change overnight, often due to matters outside their control – take for example businesses in solar or wind energy or insulation – but if the structure behind the business model is flexible and conducive to change, the players in those industries at least have the ability to respond to those changes by restructuring and living to fight another day.

 

About the author

Suelen McCallum is the CEO of dVT Consulting (www.dvtconsulting.com.au) a member of the de Vries Tayeh group.  dVT Consulting specialises in corporate strategy and turnaround management, particularly in the SME sectors, as well as due diligence, litigation support and business succession.