Workbook for Small Business Management: Theory and Practice [4th ed. 2020] 978-981-13-9512-3, 978-981-13-9513-0

Table of contents :
Front Matter ....Pages i-xiv
Work Book: The Role of the Small Business Within the Economy (Tim Mazzarol, Sophie Reboud)....Pages 1-7
Work Book: Entrepreneurs vs. Owner-Managers (Tim Mazzarol, Sophie Reboud)....Pages 9-17
Work Book: Surviving the Early Years (Tim Mazzarol, Sophie Reboud)....Pages 19-28
Work Book: Planning and Strategy in the Small Firm (Tim Mazzarol, Sophie Reboud)....Pages 29-39
Work Book Creating Customers (Tim Mazzarol, Sophie Reboud)....Pages 41-50
Work Book: The Process of Growth in the Small Firm (Tim Mazzarol, Sophie Reboud)....Pages 51-66
Work Book: Small Firms and Human Resources (Tim Mazzarol, Sophie Reboud)....Pages 67-73
Work Book: Operations Management (Tim Mazzarol, Sophie Reboud)....Pages 75-92
Work Book: Using Technology (Tim Mazzarol, Sophie Reboud)....Pages 93-105
Work Book: Debt Versus Equity (Tim Mazzarol, Sophie Reboud)....Pages 107-116
Work Book: Cash Flow, Profit and Working Capital (Tim Mazzarol, Sophie Reboud)....Pages 117-125
Work Book: Franchising and Legal Issues for Small Firms (Tim Mazzarol, Sophie Reboud)....Pages 127-133
Work Book: The Owner-Manager and the Troubled Company (Tim Mazzarol, Sophie Reboud)....Pages 135-147
Work Book: Buying, Selling and Valuing the Business (Tim Mazzarol, Sophie Reboud)....Pages 149-155
Back Matter ....Pages 157-269

Citation preview

Springer Texts in Business and Economics

Tim Mazzarol Sophie Reboud

Workbook for Small Business Management Theory and Practice Fourth Edition

Springer Texts in Business and Economics

More information about this series at http://www.springer.com/series/10099

Tim Mazzarol • Sophie Reboud

Workbook for Small Business Management Theory and Practice Fourth Edition

Tim Mazzarol University of Western Australia Crawley, WA, Australia

Sophie Reboud Burgundy School of Business Dijon, France

ISSN 2192-4333     ISSN 2192-4341 (electronic) Springer Texts in Business and Economics ISBN 978-981-13-9512-3    ISBN 978-981-13-9513-0 (eBook) https://doi.org/10.1007/978-981-13-9513-0 3rd edition: © Tilde Publishing and Distribution 2017 © Springer Nature Singapore Pte Ltd. 2020 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

Contents

1 Work Book: The Role of the Small Business Within the Economy ��������������������������������������������������������������������������������������������    1 1.1 Learning Objectives������������������������������������������������������������������������     1 1.2 Chapter Review������������������������������������������������������������������������������     1 1.3 Quiz Questions��������������������������������������������������������������������������������     2 Fill in the Blanks����������������������������������������������������������������������������    2 1.4 True/False����������������������������������������������������������������������������������������     3 1.5 Short Answer����������������������������������������������������������������������������������     3 1.6 Essay Questions������������������������������������������������������������������������������     3 1.7 Class Assignment Activity��������������������������������������������������������������     3 1.8 Key Lessons from the Chapter��������������������������������������������������������     4 2 Work Book: Entrepreneurs vs. Owner-Managers��������������������������������    9 2.1 Learning Objectives������������������������������������������������������������������������     9 2.2 Chapter Review������������������������������������������������������������������������������     9 2.3 Quiz Questions��������������������������������������������������������������������������������    10 Fill in the Blanks����������������������������������������������������������������������������   10 2.4 True/False����������������������������������������������������������������������������������������    11 2.5 Essay Questions������������������������������������������������������������������������������    11 2.6 Class Assignment Activity��������������������������������������������������������������    11 2.7 Case Study Analysis������������������������������������������������������������������������    12 Questions/Tasks������������������������������������������������������������������������������   12 2.8 Case Studies: Telarny and Nairi������������������������������������������������������    12 Case Study: Telarny������������������������������������������������������������������������   12 Case Study: Nairi����������������������������������������������������������������������������   13 2.9 Key Lessons from the Chapter��������������������������������������������������������    14 3 Work Book: Surviving the Early Years��������������������������������������������������   19 3.1 Learning Objectives������������������������������������������������������������������������    19 3.2 Chapter Review������������������������������������������������������������������������������    19

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3.3 Quiz Questions��������������������������������������������������������������������������������    20 Fill in the Blanks����������������������������������������������������������������������������   20 3.4 True/False����������������������������������������������������������������������������������������    21 3.5 Short Answer����������������������������������������������������������������������������������    21 3.6 Class Assignment Activity��������������������������������������������������������������    21 3.7 Case Study Analysis������������������������������������������������������������������������    22 Questions/Tasks������������������������������������������������������������������������������   22 3.8 Case Study: Sporting Chance����������������������������������������������������������    22 3.9 Key Lessons from the Chapter��������������������������������������������������������    25 4 Work Book: Planning and Strategy in the Small Firm������������������������   29 4.1 Learning Objectives������������������������������������������������������������������������    29 4.2 Chapter Review������������������������������������������������������������������������������    29 4.3 Quiz Questions��������������������������������������������������������������������������������    30 Fill in the Blanks����������������������������������������������������������������������������   30 4.4 True/False����������������������������������������������������������������������������������������    31 4.5 Short Answer����������������������������������������������������������������������������������    31 4.6 Case Study Analysis������������������������������������������������������������������������    31 Questions/Tasks������������������������������������������������������������������������������   32 4.7 Case Study: Comfort Homes����������������������������������������������������������    32 Old Hands, New Roles��������������������������������������������������������������������   32 Slow and Steady������������������������������������������������������������������������������   32 Minimise Overheads ����������������������������������������������������������������������   33 Home from Home ��������������������������������������������������������������������������   33 Better Building, Reducing Risk������������������������������������������������������   34 Window of Opportunity������������������������������������������������������������������   34 Marketing and Management ����������������������������������������������������������   34 Four Factors for Financial Success ������������������������������������������������   35 Quality Control ������������������������������������������������������������������������������   35 Future Directions����������������������������������������������������������������������������   36 4.8 Key Lessons from the Chapter��������������������������������������������������������    36 5 Work Book Creating Customers������������������������������������������������������������   41 5.1 Learning Objectives������������������������������������������������������������������������    41 5.2 Chapter Review������������������������������������������������������������������������������    41 5.3 Quiz Questions��������������������������������������������������������������������������������    42 Fill in the Blanks����������������������������������������������������������������������������   42 5.4 Short Answer����������������������������������������������������������������������������������    42 5.5 Class Assignment Activity��������������������������������������������������������������    43 5.6 Case Study Analysis������������������������������������������������������������������������    43 Questions/Tasks������������������������������������������������������������������������������   43 5.7 Case Study: Malrica International (Aust) Pty Ltd. ������������������������    44 Selling Style and Innovations ��������������������������������������������������������   44 Production and Distribution������������������������������������������������������������   44 Price Structure��������������������������������������������������������������������������������   45 Marketing����������������������������������������������������������������������������������������   45

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Financial Management��������������������������������������������������������������������   46 Recent Developments ��������������������������������������������������������������������   47 Future Growth ��������������������������������������������������������������������������������   47 5.8 Key Lessons from the Chapter��������������������������������������������������������    47 6 Work Book: The Process of Growth in the Small Firm������������������������   51 6.1 Learning Objectives������������������������������������������������������������������������    51 6.2 Chapter Review������������������������������������������������������������������������������    51 6.3 Short Answer����������������������������������������������������������������������������������    52 6.4 True/False����������������������������������������������������������������������������������������    52 6.5 Individual Research Paper��������������������������������������������������������������    53 Requirements����������������������������������������������������������������������������������   53 6.6 Case Study Analysis������������������������������������������������������������������������    54 Questions/Tasks������������������������������������������������������������������������������   54 6.7 Case Study: KITSOL: The One Stop Kitchen Solution������������������    54 Cooking Up an Idea������������������������������������������������������������������������   54 KITSOL Launched��������������������������������������������������������������������������   55 Business Booms������������������������������������������������������������������������������   55 Friends and Partners������������������������������������������������������������������������   56 Financial Flavour����������������������������������������������������������������������������   56 Hey Big Spenders ��������������������������������������������������������������������������   58 Too Many Cooks����������������������������������������������������������������������������   58 The Proof of the Pudding����������������������������������������������������������������   59 6.8 Key Lessons from the Chapter��������������������������������������������������������    62 7 Work Book: Small Firms and Human Resources ��������������������������������   67 7.1 Learning Objectives������������������������������������������������������������������������    67 7.2 Chapter Review������������������������������������������������������������������������������    67 7.3 Short Answer����������������������������������������������������������������������������������    68 7.4 True/False����������������������������������������������������������������������������������������    69 7.5 Case Study Analysis������������������������������������������������������������������������    69 Questions/Tasks������������������������������������������������������������������������������   69 7.6 Key Lessons from the Chapter��������������������������������������������������������    70 8 Work Book: Operations Management ��������������������������������������������������   75 8.1 Learning Objectives������������������������������������������������������������������������    75 8.2 Chapter Review������������������������������������������������������������������������������    75 8.3 Quiz Questions��������������������������������������������������������������������������������    77 Fill in the Blanks����������������������������������������������������������������������������   77 8.4 Short Answer����������������������������������������������������������������������������������    78 8.5 Case Study Analysis������������������������������������������������������������������������    78 Questions/Tasks������������������������������������������������������������������������������   78 8.6 Case Study: HomeColour Pty Ltd��������������������������������������������������    79 Background ������������������������������������������������������������������������������������   79 Marketing and Sales������������������������������������������������������������������������   80 Distribution and Branding��������������������������������������������������������������   80

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Influences on Demand��������������������������������������������������������������������   82 Reputation ��������������������������������������������������������������������������������������   82 Market Trends ��������������������������������������������������������������������������������   83 Promotion����������������������������������������������������������������������������������������   83 Sales and Promotion Planning��������������������������������������������������������   84 Advertising��������������������������������������������������������������������������������������   84 Production and Warehousing����������������������������������������������������������   85 Future Possible Avenues of Activity ����������������������������������������������   86 Standard Industrial Metal Work Paints ������������������������������������������   86 Automotive Paints��������������������������������������������������������������������������   86 Powder Coating������������������������������������������������������������������������������   87 Structural Paint��������������������������������������������������������������������������������   88 8.7 Key Lessons from the Chapter��������������������������������������������������������    88 Reference ��������������������������������������������������������������������������������������������������    92 9 Work Book: Using Technology����������������������������������������������������������������   93 9.1 Learning Objectives������������������������������������������������������������������������    93 9.2 Chapter Review������������������������������������������������������������������������������    93 9.3 Quiz Questions��������������������������������������������������������������������������������    96 Fill in the Blanks����������������������������������������������������������������������������   96 9.4 Short Answer����������������������������������������������������������������������������������    96 9.5 Case Study Analysis������������������������������������������������������������������������    96 Questions/Tasks������������������������������������������������������������������������������   97 9.6 Case Study: Survival Aids Pty Ltd��������������������������������������������������    97 Diversification of Customers, Markets, Products and Services������������������������������������������������������������������������������������   98 Management and Team Development��������������������������������������������   98 Business Operations������������������������������������������������������������������������   99 Management Systems and Use of Technology ������������������������������  100 Financial Challenges and the Ambition for Growth ����������������������  100 9.7 Key Lessons from the Chapter��������������������������������������������������������   101 Reference ��������������������������������������������������������������������������������������������������   105 10 Work Book: Debt Versus Equity������������������������������������������������������������  107 10.1 Learning Objectives������������������������������������������������������������������������   107 10.2 Chapter Review������������������������������������������������������������������������������   107 10.3 Quiz Questions��������������������������������������������������������������������������������   108 Fill in the Blanks����������������������������������������������������������������������������  108 10.4 Short Answer����������������������������������������������������������������������������������   109 10.5 Class Assignment����������������������������������������������������������������������������   109 10.6 Case Study Analysis������������������������������������������������������������������������   109 Questions/Tasks������������������������������������������������������������������������������  110 10.7 Case Study: Accent Learning Pty Ltd��������������������������������������������   110 Background ������������������������������������������������������������������������������������  110 The Accent Learning Programs������������������������������������������������������  110 Client Base��������������������������������������������������������������������������������������  111

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Profile of Management��������������������������������������������������������������������  111 Loan Details������������������������������������������������������������������������������������  112 Repayment of the Loan������������������������������������������������������������������  112 Personal Financial Position������������������������������������������������������������  112 10.8 Key Lessons from the Chapter��������������������������������������������������������   112 Reference ��������������������������������������������������������������������������������������������������   116 11 Work Book: Cash Flow, Profit and Working Capital��������������������������  117 11.1 Learning Objectives������������������������������������������������������������������������   117 11.2 Chapter Review������������������������������������������������������������������������������   117 11.3 Short Answer����������������������������������������������������������������������������������   118 11.4 True/False����������������������������������������������������������������������������������������   119 11.5 Class Assignment����������������������������������������������������������������������������   119 11.6 Key Lessons from the Chapter��������������������������������������������������������   120 12 Work Book: Franchising and Legal Issues for Small Firms����������������  127 12.1 Learning Objectives������������������������������������������������������������������������   127 12.2 Chapter Review������������������������������������������������������������������������������   127 12.3 Quiz Questions��������������������������������������������������������������������������������   128 Fill in the Blanks����������������������������������������������������������������������������  128 12.4 True/False����������������������������������������������������������������������������������������   128 12.5 Short Answer����������������������������������������������������������������������������������   129 12.6 Class Assignment����������������������������������������������������������������������������   129 Questions/Tasks������������������������������������������������������������������������������  129 12.7 Key Lessons from the Chapter��������������������������������������������������������   130 13 Work Book: The Owner-Manager and the Troubled Company����������������������������������������������������������������������������  135 13.1 Learning Objectives������������������������������������������������������������������������   135 13.2 Chapter Review������������������������������������������������������������������������������   135 13.3 Quiz Questions��������������������������������������������������������������������������������   136 Fill in the Blanks����������������������������������������������������������������������������  136 13.4 True/False����������������������������������������������������������������������������������������   137 13.5 Short Answer����������������������������������������������������������������������������������   137 13.6 Class Assignment����������������������������������������������������������������������������   137 13.7 Case Study Analysis������������������������������������������������������������������������   138 Questions/Tasks������������������������������������������������������������������������������  138 13.8 Case Study: Robotics Pty Ltd ��������������������������������������������������������   138 Humble Birth����������������������������������������������������������������������������������  138 Dealer Network������������������������������������������������������������������������������  139 Extended Credit Terms��������������������������������������������������������������������  139 Vertical Expansion��������������������������������������������������������������������������  140 Cash Surplus ����������������������������������������������������������������������������������  140 Enhanced Performance ������������������������������������������������������������������  140 New Markets ����������������������������������������������������������������������������������  141 Costs������������������������������������������������������������������������������������������������  141

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Contents

Intellectual Property Protection������������������������������������������������������  141 Body with No Brain������������������������������������������������������������������������  142 Systems Lagged Behind Growth����������������������������������������������������  142 Decreasing Liquidity����������������������������������������������������������������������  142 Product Profitability Re-examined��������������������������������������������������  142 Inefficiencies and Lost Orders��������������������������������������������������������  143 Search for Extra Funds��������������������������������������������������������������������  143 A New Beginning����������������������������������������������������������������������������  143 13.9 Key Lessons from the Chapter��������������������������������������������������������   144 14 Work Book: Buying, Selling and Valuing the Business������������������������  149 14.1 Learning Objectives������������������������������������������������������������������������   149 14.2 Chapter Review������������������������������������������������������������������������������   149 14.3 Quiz Questions��������������������������������������������������������������������������������   150 Fill in the Blanks����������������������������������������������������������������������������  150 14.4 True/False����������������������������������������������������������������������������������������   151 14.5 Short Answer����������������������������������������������������������������������������������   151 14.6 Essay Question��������������������������������������������������������������������������������   151 14.7 Key Lessons from the Chapter��������������������������������������������������������   151 Appendices��������������������������������������������������������������������������������������������������������  157 Appendix A – Work Book����������������������������������������������������������������������������������  157 Small Business Diagnostic: What Does It Tell Us About SMEs?����������������  157 References����������������������������������������������������������������������������������������������������������  201 Appendix B – Work Book����������������������������������������������������������������������������������  203 Small Business Diagnostic����������������������������������������������������������������������������  203 Appendix C – Work Book����������������������������������������������������������������������������������  237 Action Learning Project in Small Business Management����������������������������  237 References����������������������������������������������������������������������������������������������������������  269

List of Figures

Fig. 3.1

Sporting chance—purchasing and cash flow projections year 1�������������������������������������������������������������������������������� 24

Fig. 8.1

Monthly sales activity white-label and HomeCharm brands by month over two previous years������������������������������������������ 81

Fig. A.1 Fig. A.2 Fig. A.3

The bar chart of small business performance����������������������������������� 164 The radar chart of small business performance�������������������������������� 164 Group performance of the owner-managers in the CEMI development program�������������������������������������������������� 165 Industry sectors of SMEs������������������������������������������������������������������ 167 How long has the business been in operation?��������������������������������� 168 How many employees does your business have now and 3 years ago?�������������������������������������������������������������������������������� 169 What best describes your firm’s annual turnover now and 3 years ago?�������������������������������������������������������������������������������� 169 Do you actively identify and seek out individuals who may be able to assist you with a business problem and approach them for help? (Employment size) ���������������������������� 170 Do you actively identify and seek out individuals who may be able to assist you with a business problem and approach them for help? (Annual turnover)������������������������������ 171 Marketing and sales�������������������������������������������������������������������������� 176 Customer interface���������������������������������������������������������������������������� 178 Financial management and performance������������������������������������������ 179 Management intent���������������������������������������������������������������������������� 182 Process capability������������������������������������������������������������������������������ 184 Internal integration���������������������������������������������������������������������������� 185 Products�������������������������������������������������������������������������������������������� 186 Quality���������������������������������������������������������������������������������������������� 187 Management information������������������������������������������������������������������ 189

Fig. A.4 Fig. A.5 Fig. A.6 Fig. A.7 Fig. A.8 Fig. A.9 Fig. A.10 Fig. A.11 Fig. A.12 Fig. A.13 Fig. A.14 Fig. A.15 Fig. A.16 Fig. A.17 Fig. A.18

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List of Figures

Fig. A.19 Fig. A.20 Fig. A.21 Fig. A.22 Fig. A.23

External integration�������������������������������������������������������������������������� 190 Operations ���������������������������������������������������������������������������������������� 191 Strategy and innovation�������������������������������������������������������������������� 193 The radar chart of small business performance, full sample������������ 196 The key problems facing owner-managers (Leximancer concept map)��������������������������������������������������������������� 198

Fig. C.1

Key stages of action learning. (Source: developed from Revans (2011)) ���������������������������������������� 238 Integration of the Small Business Diagnostic and Action Learning Tasks���������������������������������������������������������������� 241 Strategy Development Framework���������������������������������������������������� 242

Fig. C.2 Fig. C.3

List of Tables

Table 3.1

Sporting chance—record of sales and purchases for first 8 months������������������������������������������������������������������������������ 24

Table 6.1 Table 6.2

KITSOL Pty Ltd. balance sheet previous 2 years���������������������������� 60 KITSOL Pty Ltd. profit and loss account previous 2 years�������������������������������������������������������������������������������� 61

Table 8.1 Table 8.2

HomeColour Pty Ltd. 5-year sales trend������������������������������������������ 79 HomeColour Pty Ltd. percentage turnover and profit contribution by product line �������������������������������������������� 80 HomeColour Pty Ltd. 5-year sales history of HomeCharm brand ���������������������������������������������������������������������� 82 Available sales promotion options���������������������������������������������������� 83 Relative pricing of HomeCharm brand by distribution channel���������������������������������������������������������������������� 84 Relationship between % of the population OTS and ratings���������������������������������������������������������������������������������������� 85

Table 8.3 Table 8.4 Table 8.5 Table 8.6 Table 9.1 Table 9.2 Table 9.3

Survival Aids, analysis of the year to date contribution to net profit ������������������������������������������������������������������ 99 Survival Aids Pty Ltd Balance Sheet previous 2 years ������������������ 101 Survival Aids Pty Ltd. Profit & Loss Account previous 2 years������������������������������������������������������������������������������ 102

Table 11.1 KITSOL Pty Ltd Balance Sheet previous 2 years�������������������������� 120 Table 11.2 KITSOL Pty Ltd. Profit & Loss Account previous 2 years������������ 121 Table 13.1 Robotics Pty Ltd costs summary���������������������������������������������������� 141 Table A.1 Table A.2 Table A.3 Table A.4

Management performance benchmarks������������������������������������������ 161 Advisors and the perceived value of their advice �������������������������� 171 Financial performance (average for sample)���������������������������������� 173 Average total sales and gross profit margin by industry sector������ 175

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Table C.1 Table C.2 Table C.3 Table C.4 Table C.5 Table C.6 Table C.7 Table C.8 Table C.9

List of Tables

Customer Feedback – Things they most like about your firm�������� 244 Customer Feedback – Things they most want to change���������������� 245 Product or Customer Segments������������������������������������������������������ 247 Top competitors or competitor products and services�������������������� 247 Key strengths and weaknesses�������������������������������������������������������� 248 Key threats and opportunities �������������������������������������������������������� 248 Sales platform – provides a monthly guide to planning and sales activity ���������������������������������������������������������������������������� 249 Business generation system calculator�������������������������������������������� 250 Key performance indicators for marketing and sales���������������������� 262

Chapter 1

Work Book: The Role of the Small Business Within the Economy

1.1  Learning Objectives After completing this chapter, you should be able to: • • • • •

Define the term ‘small business.’ Understand the role of the small business owner-manager. Overview the nature and structure of the small business sector. Describe the growth cycle of small business. Review government policy toward the small business sector.

1.2  Chapter Review Small and medium-sized enterprises (SMEs) comprise the majority of firms in most economies, and are predominately micro-enterprises with typically only one employee  – the owner-manager. They contribute a substantial proportion of the workforce and have been viewed by many governments as a key source of new jobs. However, the majority of SMEs are non-employing and most that do employ are not interested in growth or the employment of additional people. Only a few, high growth Gazelle firms generate most of the net-new jobs in the economy. International data suggests that the ‘churning’ rate of job creation and destruction remains quite stable and relatively balanced over time, with the exception of economic crises such as the Global Financial Crisis (GFC) of 2007–2009. Definitions of small business are not uniform across countries, although most governments recognise employment, turnover and capitalisation as key measures. Common problems facing small businesses include financial management, market-

© Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_1

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1  Work Book: The Role of the Small Business Within the Economy

ing and sales, quality management in production, human resource management and the adoption and use of new technology. Small firms are thought to move through defined stages in their growth cycle, each of which creates specific challenges for management. The discontinuance of small firms within the first 2–3 years from start-up can be high, although relatively few firms experience bankruptcy. In most cases the owner-manager simply winds­up the business and ceases trading either to reduce or avoid significant losses, or to pursue alternative goals. Vulnerable businesses are typically those experiencing market growth rates, low returns to investment by their owners, and poor management skills. Small business management is generally quite different from that found in larger firms. Small business owners lack the systems and skilled support teams that their counterparts in large organisations enjoy. Governments seeking to assist small business owners need to adopt a dual track approach with policies designed to provide direct assistance and support to SMEs, and more indirect ways such as via industry policy, investment in infrastructure, taxation and legislation (e.g. labour laws, competition and consumer laws). Governments have also become more focused on ‘entrepreneurship policy’ rather than more traditional ‘small business policy’ in recent decades. The first is focused on high-growth start-ups and Gazelle firms. However, it is relevant to only a small proportion of businesses. This is focused on ‘relational’ issues (e.g. networking, mentoring). By comparison, the latter is focused on the ‘ordinary’ small business and is largely concerned with ‘transactional’ issues (e.g. taxation, regulation and subsidies).

1.3  Quiz Questions The following questions are aimed at testing your knowledge of definitions associated with small businesses and the nature of the small business sector.

Fill in the Blanks 1. Management within a small business is ____________, and managers are also ______________. 2. In Australia, a micro-enterprise has less than ________ employees, but a small business has between ________ and __________ employees. By comparison, a medium-sized enterprise has up to _________ employees. 3. Within most small businesses, the owner-manager is responsible for supplying all the _____________ as the owner must take responsibility for all _________________ associated with their business. 4. The most common types of business entity in Australia are ______________, at least half of which have no _________________.

1.7  Class Assignment Activity

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1.4  True/False

1. Culture rather than systems pull a small business together 2. Banks are willing to lend to the majority of small business owners 3. The primary motivation of most people in establishing their own small business is to make a lot of money 4. Most small businesses experience failure and bankruptcy in their first few years of operations 5. The majority of small business owners have a well-prepared business plan that guides their operations 6. There is a common definition of small business used in most countries throughout the world 7. In defining small businesses, the most common criteria used are employment and turnover

True [  ] [  ] [  ]

False [  ] [  ] [  ]

[  ] [  ] [  ] [  ] [  ] [  ] [  ] [  ]

1.5  Short Answer Explain briefly why small to medium enterprises are so important to their national economies.

1.6  Essay Questions 1. List the five common problems identified by the Bolton Committee in the United Kingdom in 1971 that are faced by most small business owners, and explain how each of these may impact on the survival of a small firm. 2. Describe the major stages that define the growth cycle of firms as they move from small to large size, and explain the managerial challenges within each stage.

1.7  Class Assignment Activity Working in small groups, interview several small business owners (one or two per group member) and examine the following: • their behaviour and lifestyle, e.g. hours worked, stress; • family background, personality;

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• • • • • •

1  Work Book: The Role of the Small Business Within the Economy

motivation for establishing the business and continuing its operation; management skills and capabilities including level of formal education; management methods and problems faced; future ambitions for the business, e.g. growth, lifestyle, exit; relationships with external groups, e.g. customers, suppliers; and sources of financing the business and relationships with banks.

Consider each of these issues and compare individual findings with those from other owner-managers, and consider your reading of the literature relating to the nature of small business owners. Then address the following questions: 1. What do these interviews and readings tell you about the nature of small business owners? Is there a pattern that emerges? 2. In terms of the management of a business, how does the small business owner-­ manager differ from their colleague in a larger organisation? 3. From a policy perspective, what do your investigations suggest about the small business sector that may be important considerations for a government seeking to encourage the growth of the small business sector?

1.8  Key Lessons from the Chapter • Small businesses typically make up the majority of firms within most economies: 97% in the APEC region, 99.8% in the EU, employing 67% of the workforce and contribute 58% of gross value added, and 99% of all business enterprises in the OECD, approximately two-thirds of all employment, and over half of all value added are provided by small firms. • In times of economic downturn, it is often the small business sector that is worst affected. Such firms find it difficult to downsize as they are already small and any additional loss of employees can significantly reduce their capacity to operate. • Within this group the major contributors to net new job creation are the small proportion of Gazelles, which are young firms, aged less than 5 years, having an annualised average growth rate of more than 20% per annum over a consecutive 3-year period. These Gazelle firms, typically export focused, innovative, good at exploiting their intellectual property assets, well-networked and able secure access to financial resources are not just high-tech, and can be found in almost all industry sectors. • The vast majority of ‘ordinary’ SMEs are not focused on rapid growth, have only modest levels of innovation and employ few people other than the owners. Most are micro-enterprises with fewer than 5–10 employees, or nano-enterprises that have only one employee, the owner-manager. • Owner managers of such firms appear to be a predominately middle-aged male group of owners with a ad hoc, non-strategic approach to management, resting upon a highly personal approach to the development of systems, long working hours and reliance of one or two key staff – usually a frontline manager – and a

1.8  Key Lessons from the Chapter

•

•

•

• •

•

• •

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handful of key customers, are the characteristics of the typical small business manager. Small business owner-managers seem to face particular problems in at least five important areas: (i) Financial  – particularly raising and using finance, costing and control information; (ii) Marketing – identifying and developing new markets and products; iii) Production – particularly scheduling and purchase controls; (iv) Human resources  – particularly organisation and delegation, and personnel management; and (v) Physical resources – particularly management of technological change, and the implementation and use of information systems. Not surprisingly, for the past 18 years, the top five ‘prime concerns’ facing these small businesses have been reported as a lack of sales or work; cash flow; the economic climate; the difficulties in finding and keeping good staff; competition from large firms; and paperwork and bureaucracy. However, while many small businesses may experience some or all of these problems in their lifetime, much of this ‘doom and gloom’ view is based on well-­ cultivated myths: small business owners would struggle alone to succeed, burdened down with excessive government regulations, starved of capital and motivated only by the desire to make money. However: The high ‘failure’ rate of small firms in most economies is explained less by the financial collapse of the business and more by the decision of the owner-manager to abandon the operation. Most business banks are highly competitive with each other, and do actively seek SME clients. However, the cost of securing capital is often as much as seven times higher than the cost for larger companies because financial institutions see SMEs as posing a greater risk and therefore demand a premium for their capital. Many of the government-related compliance issues (e.g. GST, income tax, workers compensation, occupational health and safety) are administrative issues that a small firm should be able to monitor. Goods and services tax (GST) compliance, for example, has the potentially positive aspect of requiring the owner-­ manager to keep a close eye on his/her cash flow and pricing policies. Most small businesses are personal or family affairs and often require a ‘social’ rather than purely economic interpretation. The growth cycle of small firms includes a number of defined stages. In seeking to assist small firms, government policy makers need to recognise that an SME faces different challenges at different stages of the life cycle: 1. In the first stage, the business is conceived and established. All attention is given to finding customers and maintaining adequate cash flows to survive. The owner is the most important asset of the business. 2. The second stage is known as survival. During this period, the business is financially viable and may even hire additional staff. The owner-manager usually remains in control of the business and usually undertakes only minimal formal planning.

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1  Work Book: The Role of the Small Business Within the Economy

3. From the perspective of growth, it is the third stage that may be most critical. If the owner-manager decides to opt for growth, the owner-manager frequently places the business under risk to finance its growth. The need for professional managers may also increase along with the need for systems and enhanced planning. 4. The fourth stage is the take-off or expansion. It involves a process of team building and delegation. Major crises facing the business during this stage are frequently those associated with the distancing of the original entrepreneur owner from the day-to-day running of the firm. Expansion requires the introduction of more professional managers: 5. The fifth and final stage is one of maturity or resource maturity. This stage sees the business with sufficient resources to conduct formal strategic planning. • Small firms face common problems that impair both their performance and survival rate. These problems include: lack of managerial competence, under capitalisation, disadvantages of scale, and failure to update market knowledge or adapt to new technologies. However, there is also a tremendous diversity among small and medium-sized businesses, which is important to consider given the support they require. Therefore, it is important that policy makers do not view the small business sector as a coherent group. • The most common problems facing small business owner-managers are: –– Financial management – particularly raising capital and securing credit, cash flow management and cost control; –– Marketing and sales management – identifying and developing new markets and products; –– Production and operations management – particularly scheduling, procurement and quality control; –– Human resource management – particularly organisation and delegation; and –– Physical resources and systems management – particularly the adoption and use of technology and the implementation of digital information and communications technologies (ICT). • It is a myth that most SMEs are high risk and prone to failure. However, while many small firms are vulnerable in their first 3 years of existence, the actual rate of formal bankruptcies is low and has declined in many countries. However, SMEs are impacted by external economic shocks such as the GFC, government regulatory change, compliance burdens (e.g. ‘red tape’), and disruptions to their industries. Most small business owner-managers don’t engage in management education and learn by experience. The majority are also not motivated entirely by money, with many seeking lifestyles and a desire to pursue their own goals as greater priorities. • Government policy designed to assist small firms to grow and prosper requires a dual track approach that focuses simultaneously on two ends of a continuum: start-up programs including training and financial assistance, business ­incubators

1.8  Key Lessons from the Chapter

• • •

•

•

7

which aim to foster successful business operations, and advisory or counselling services. However, the proportion of SMEs that make use of government advisory services is often low Government support for high growth ‘gazelle’ firms should focus on enhancing the business environment by removing bureaucratic and regulatory obstacles and improving the access of such firms to external debt and equity financing. When seeking to develop policies to support the small business sector, attention should be given to the personal values and orientation of the individual owner-­ manager and not of their firm. It should be recognised that the owner-manager is a more important point of focus than the firm itself. In seeking to understand the importance of this issue, government policy should acknowledge that entrepreneurs come in several varieties, and each type is likely to require different policy responses: driven by opportunity or necessity, experienced in terms of business or not, etc. Government policy should concentrate on establishing focused industry programs to encourage the growth of existing industries and assistance should be provided to all industries  – not just ‘favourites’  – with the understanding that while there may be uncompetitive firms, there should be no such thing as an uncompetitive industry. There are six elements that comprise a small business policy framework. The first three are small business policy centric fields, that relate to the government’s regulatory environment (e.g. laws, taxation), that impact small businesses, as well as public goods infrastructure (e.g. roads, telecommunications services, utilities); business development services and financing (e.g. access to credit). The next three elements relate to entrepreneurship policy centric fields. These encompass, the fostering of an entrepreneurial culture (e.g. via education and training, incubators and publicity); innovation and technology (e.g. investment in R&D, IP rights); and market access, in particular to providing SMEs with assistance in exporting and connecting into global supply chains.

Chapter 2

Work Book: Entrepreneurs vs. Owner-Managers

2.1  Learning Objectives After completing this chapter, you should be able to: • • • • •

Define the terms ‘enterprise’, ‘entrepreneur’ and ‘small business’. Understand the difference between entrepreneurs and owner-managers. Review models of new venture creation. Understand the ‘barriers’ and ‘triggers’ to new venture creation. Examine the process required to assist start-up firms.

2.2  Chapter Review The process of small business management needs to be understood within the context of the overall enterprise environment that consists of micro, small and medium-­ sized firms, within the entrepreneurial culture from which they are formed, and within the support networks that allow them to get started. Enterprise, entrepreneurship and small business management are closely related concepts but are not identical. Entrepreneurship is about new entry, new products or services, and the desire to grow a venture and maximise profits Entrepreneurs are typically strategic in their outlook. Small business management is about the operation of small ventures that may or may not have entrepreneurial capacity. Owner-managers of small firms are often focused on lifestyle. Many myths exist about entrepreneurs. Generally, they are not as risk oriented, not high-tech, not experts in their fields, and not strategically focused or supported by venture capital as is popularly believed. Entrepreneurs typically identify opportunities, marshal the necessary resources needed to launch their venture, and then build capability over time. Most entrepreneurial ventures are © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_2

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2  Work Book: Entrepreneurs vs. Owner-Managers

led by one or two entrepreneurs who are supported by a small development team and a wider constituency of customers and employees. Small business start-ups are generally lacking in resources and should be managed to achieve break-even quickly with low fixed costs and a strong focus on cash flow. The start-up process typically involves: acquiring the motivation to start; identifying the idea and validating it through market feasibility testing; acquiring the resources to launch; and then launching. Most nascent entrepreneurs are influenced by common barriers and triggers when establishing their new ventures. These are a combination of internal and external factors. While each individual is different, motivation and a desire to follow personal goals or creative ideas may be the most powerful factors.

2.3  Quiz Questions The following questions are aimed at testing your knowledge on the material covered in this chapter.

Fill in the Blanks 1. The ability to identify opportunity and pursue personal goals to achieve self-­ sufficiency and self-fulfilment through the exercise of enterprise attributes is called ______________, while the individual who demonstrates a marked use of these attributes in business could be described as an ___________. 2. The entrepreneurial process involves three distinct stages. What are they? 3. ___________________ involves the act of new entry into markets, new products or new ventures. It can involve both ______________ and small firms. By contrast the _______________ must carry total responsibility and risk for the new venture, and may not be highly innovative. 4. William Gartner’s (1985) conceptual framework describing the process of new venture creation identifies four key variables that should be considered. What are they? 1) _____________________________ 3) _____________________________

2) ___________________________ 4) ___________________________

2.6  Class Assignment Activity

11

2.4  True/False

4. Most entrepreneurs take substantial risks in launching their new business ventures 5. Most successful entrepreneurs start their new businesses ventures though the launch of a new break-through invention, often of a high technology nature 6. Most successful entrepreneurs are experienced business people with strong track records in their chosen industries 7. Most successful entrepreneurs have a well-considered business plan and have researched their markets carefully prior to launching their new business ventures 8. The majority of successful entrepreneurs launch their new business ventures by raising millions of dollars in venture capital to finance their product and market development

True False [  ] [  ] [  ] [  ] [  ] [  ] [  ] [  ]

[  ] [  ]

2.5  Essay Questions 1. List the five key elements of the Timmons model of new venture creation and discuss each element describing its nature, role and importance within the model. 2. Describe the concept of ‘bootstrap’ financing as it relates to small business start-­ ups. Why is this approach the most common method of starting up a small business? 3. Why should the owner-manager of new business venture focus on cash flow, quick break-even and high gross profit margins?

2.6  Class Assignment Activity Working in small groups, interview several small business owners (one or two per group member) and see if you can classify them into one of the six entrepreneurial Archetypes identified by Filion (1996, 2000). Prepare either a short report or class presentation explaining your reasons for classifying these people and what you feel these cases tell you about the nature of small business managers versus entrepreneurs.

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2  Work Book: Entrepreneurs vs. Owner-Managers

2.7  Case Study Analysis Read the following case studies of Telarny and Nairi, two women who are interested in launching their own small businesses. We now want you to image that they have both come to visit you and seek your advice as to what they should do to get their businesses established.

Questions/Tasks 1. What are likely to be the main problems faced by these two people launching their business ideas? 2. What key actions do they have to take to get their businesses off the ground? 3. Prepare an assessment of their business prospects.

2.8  Case Studies: Telarny and Nairi The following short case studies are of two nascent entrepreneurs, both women, who have identified a potential business opportunity and are engaged in the process of assessing what they might do to pursue this idea, or even if they should do so at all. They provide examples of the common issues facing people considering new venture creation, and the cases offer you the opportunity to consider what advice you might give to them if they were to ask you for your help in getting their businesses launched.

Case Study: Telarny Telarny is a rather shy young woman of 19 years who is interested in setting up a business importing gemstones from Sri Lanka – her family’s place of origin. She lives at home with her parents and has a long-term ambition of opening her own jewellery store. Her knowledge of precious stones and jewels is good, although she has had no formal training. Telarny left school at Year 11 where she took Tertiary Entrance Examination subjects and performed well in English and Geography. She has been unemployed most of the time since, apart from two temporary jobs as a sales assistant in a local clothing store and in a sporting goods store. She is not interested in working for someone else and would like her own business. An uncle in Sri Lanka is a gem merchant and has agreed to help her import sapphires and other precious stones.

2.8  Case Studies: Telarny and Nairi

13

She has a range of samples supplied at no initial cost by her uncle, and has made some contact with local jewellers seeking their interest in having her supply them. Some of these jewellers have asked her to supply samples without making a payment or on credit terms. Telarny has declined this arrangement but is not certain whether this was the right thing to do. Her only resources are $1200 in a building society – a legacy from her grandmother.

Case Study: Nairi Nairi, aged 27, is the daughter of migrant parents from Ethiopia. She has always wanted to establish a restaurant business. After leaving school she had wanted to be a chef, but her mother had not felt that it was a suitable occupation for a woman. She had worked in restaurants and had successfully managed several restaurants for other people. For 5–6 years, she had seriously considered establishing a restaurant business. Last year, Nairi and her fiancée David decided to set up their own restaurant. Although no formal planning on paper was undertaken, they spent 6 months in ‘intensive preparation’ considering their options. The examinations of a potential restaurant found that cost was likely to be a prohibitive barrier. She did not want to rent or lease premises. This meant that she would have to outlay approximately $150,000 for a building and another $100,000 for the fitting out. She did not have this money and was not prepared to go to a bank for a loan. This reservation was due to the extent of the financial risk involved. As Nairi explained: I am prepared to lose $30,000 and put it down to experience. But $250,000 is too much.

Following this, she explored the option of purchasing an established lunch bar. It was decided that the outlay for this was likely to be only between $20,000 and $60,000. She looked at four lunch bars that were for sale in the Weekend Newspaper. Her process of examination was to consider the location of the business, its layout and presentation, the number of competitors in the area within 2 km, and the number of businesses likely to generate customers within the same radius. Finally, she examined the books. Her experience managing restaurants meant that she was confident looking at a set of accounts. None of the prospective lunch bars she investigates seemed to represent value for money. She looked first at one for $20,000, but felt that it must be in trouble as it seemed too good for the price. The others ranged in price from $50,000 to $60,000. However, she didn’t view any of them as worth the money. Nairi has not consulted either her bank or an accountant. She expresses a negative attitude towards accountants and lawyers, whom she feels do not really justify their high fees. Her father owns a small factory unit and has agreed to let her use it for a low rent. She now plans to establish a car cleaning and detailing business based in the unit. This will attract custom from the used car sales and fleet owners’ market

14

2  Work Book: Entrepreneurs vs. Owner-Managers

in the local business parks. Once she has raised enough money, she might reconsider investing in a restaurant.

2.9  Key Lessons from the Chapter • Entrepreneurship and small business management are frequently considered as representing the same thing. This is not so, and it is important to identify how these two concepts differs from the other. –– On the one hand, entrepreneurial studies focus on theoretical frameworks within which to understand the entrepreneur and the various forces that create motivate and sustain their behaviour. –– On the other, small business management is frequently about process. • The principal characteristics that define the entrepreneur tend to be a strong drive to achieve and a sense of competitiveness. In an attempt to classify these different entrepreneurs, academics have created numerous typologies and taxonomies. These usually involve measures of the individual’s risk-taking propensity, growth orientation or strategic vision. • Several myths surround entrepreneurship. These include the notions that: entrepreneurs are born not made; that anyone can start a business; that entrepreneurs are gamblers who want to dominate the entire show; entrepreneurs want to be independent, they should be young; they are only motivated by the dollars to be earned; and if they have enough start-up capital they cannot lose. All these notions are myths. • The process of entrepreneurship has been likened to a three-step process that are: Opportunity recognition: the process of identifying the business opportunity and developing sufficient passion to want to drive it forward to a reality that generates wealth. Marshalling of resources: the entrepreneur must seek people, money, equipment and support in order to follow their vision. Developing capability: the successful entrepreneur is able to marshal sufficient resources to start a business and then learn how to develop the new venture’s capabilities to achieve prolonged sustainable growth. • An entrepreneur is an individual who establishes and manages a business for the principal purpose of profit and growth. The entrepreneur is characterised principally by innovative behaviour, and will employ strategic management practices in the business • A small business owner is an individual who establishes and manages a business for the principal purpose of furthering personal goals. These owner-managers must not only carry out the productive work of the business, but keep the books, pay wages, collect and pay GST, target new customers, service existing customers, purchase their own materials, and do all the other numerous things that comprise the functioning of a business venture. It is also common for small business

2.9  Key Lessons from the Chapter

•

•

•

•

15

owner-managers to lack the necessary skills required to perform many of the management tasks they are frequently faced with. In the causation process, there is a clear sense of the variables that need to be controlled in order to achieve a given outcome or end result. This implies cause-­ effect logic in which investment of time and resources in a project will lead to relatively predictable outcomes. This type of process is well suited to the exploitation of known markets and established knowledge. By contrast the effectuation process is more suitable where the variables – and even the end state – are unknown or unpredictable. The focus is on the control of things that might assist in articulating through the process into an uncertain future. Effectuation assumes that the environment is dynamic, nonlinear and ecological in nature. It can be useful in the creation of new markets and products in which strategic alliances and collaborative strategies are important for success. The four principles of effectuation theory are the following: affordable loss, rather than expected returns; strategic alliances, rather than competitive analyses; exploitation of contingencies, rather than pre-existing knowledge; and control of an unpredictable future, rather than prediction of an uncertain one. Several critical forces drive the creation of new business ventures. These factors involve: 1. Opportunity – the entrepreneur needs to identify an opportunity that is sufficiently attractive to warrant the expenditure of time or money. 2. Leadership – the new venture is usually given its initial drive by the efforts of a lead entrepreneur or entrepreneurial team. 3. Resource allocation and creativity  – the new venture requires the creative allocation of resources, e.g. time, money and intellectual property. 4. Fit and balance – the entrepreneur needs to ensure that there is an adequate relationship between the resources available, their fitness for the purpose to which they are applied, and the capacity to balance frequently-competing needs. 5. Integrated and holistic – management of the SME requires an integrated and holistic approach in which everyone must learn to ‘muck-in’.

• The owner-manager who seeks to start the new business must consider: the level of demand for their product or service within its market, and how profitable the product will be. How quickly it might return their investment is also an important consideration. • Following checklist is important when seeking to employ ‘bootstrap’ financing: Implement proven market ideas, Look for a quick break-even, Look for high gross profit, Sell directly, Keep the team lean, Control growth, Focus on cash flow, and Cultivate banks early. • The new venture is usually created in an environment of ambiguity and uncertainty. The exogenous forces that are frequently beyond the control of the entrepreneur and their team create market and financial constraints. How well the entrepreneur manages to balance these elements is important to overall success.

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2  Work Book: Entrepreneurs vs. Owner-Managers

• Support agencies seeking to assist small business start-ups often place a heavy emphasis on the formal business plan. However, as noted above, most successful enterprise start-ups do not involve formal plan preparation. • Until entrepreneurs have more experience of what they are seeking to achieve and where they wish to take their business, formal business planning is likely to be difficult to undertake with any confidence. Once the venture has been launched, the entrepreneur will need to identify and marshal resources. If money or people are involved, the entrepreneur may be required to prepare a formal business plan. • The more complex or innovative the business idea, the more time it may take between the emergence of the initial idea, its validation and resource acquisition. • The lack of suitable motivation and commitment, poor cash flow, lack of profitability and personal problems experienced by the owner-manager(s) are likely to be the greatest cause of small firms being abandoned during the start-up phase • The main causes of small business failure: –– Underestimating the time required to bring the business to the point of break-even. –– Undercapitalisation of the business, particularly a lack of working capital to fund growth. –– Overestimation of the size of potential markets or sales growth. –– Lack of management/marketing skills by the owners. –– No unique selling proposition or point of differentiation forcing the venture to compete on price instead of value-adding. –– Low profitability caused by confusing high sales/turnover with high profit margins. –– Failing to retain profits in the business to fund future growth. –– Recruitment of the wrong people within the start-up team. –– Poor or inappropriate business location selection. –– Failing to monitor the business performance, particularly cash flow and profitability. • Key start-up trigger factors appear to include: –– –– –– –– –– ––

The desire to invest; The creativity drive; The desire for autonomy; The desire to increase status within the community; The pursuit of a market opportunity; and The desire to earn more money.

• Key barrier factors found were: • The lack of start-up resources; –– Compliance costs including the lack of suitable labour; and –– The hard reality of high risk and uncertainty.

2.9  Key Lessons from the Chapter

17

• While the external environment cannot be discounted, research suggest that the personality of the entrepreneur may play an essential role in the start-up process. –– Those who effectively set up a new business venture are those who have an overriding drive to create. –– Both starters and non-starters appear to face similar types of barriers. –– Some non-starters did all the ‘right things’ to successfully launch a new business venture, that is, they saved money, drafted a business plan, and sought the advice of government agencies. –– However, they abandoned the idea to start because they lacked the passion to carry out their entrepreneurial dream.

Chapter 3

Work Book: Surviving the Early Years

3.1  Learning Objectives After completing this chapter, you should be able to: • • • •

Examine the concept of opportunity recognition. Understand the key factors leading to new venture failure. Understand the new venture screening process. Review new venture screening approaches and apply them to the early stage small firm.

3.2  Chapter Review Small business owner-managers need to learn how to screen business opportunities and adopt a more strategic mindset. Most tend to be more reactive and short range in their thinking. A lack of adequate market analysis and a reliance on guess work and intuition are common problems. Common causes of failure in small businesses are a lack of capital, poor financial management, lack of industry knowledge and managerial expertise, poor planning and staffing decisions, inadequate marketing and poor use of professional advisors, and personal problems experienced by the owner-manager. Opportunities should be screened prior to the commitment of time and money, with attention given to the market’s willingness to adopt the product or service. A good understanding of the customer’s needs and likely purchasing patterns is also vital.

© Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_3

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3  Work Book: Surviving the Early Years

In screening a new idea, particularly an innovation or new product, it is important to determine the likely return that may accrue from the investment. The potential rent return from an innovation is a function of the volume of sales, rate of profit and length of the product lifecycle. Assessing the future volume, rate and length of an innovation and then its residual rent once the erosion effects of various external forces have been considered, and finally its appropriable rent are very important strategic considerations. Prior to starting up a new venture, small business owners should consider their own motivation and commitment to the business, the market potential, the resources required for the venture, the management skills required, the plan for future growth, and how the business will operate. External advisors to small businesses can play a valuable role in helping the business survive and grow. Attention should be given to identifying foreseeable problems (e.g. pricing and cash flow management), as well as unforeseen problems (e.g. insurance risks) which should be planned for. The early establishment of business management and control systems within the firm are important to survival. Owner-managers should be encouraged to think and act strategically and develop a network of competent business advisors.

3.3  Quiz Questions The following questions are aimed at testing your knowledge on the material covered in this chapter.

Fill in the Blanks 1. Small businesses that are vulnerable to possible failure generally suffer from low ________ and frequently seek to compete in ______________ sensitive markets where they are faced with _____________ competition. 2. Among the strategy evaluation problems common to small businesses are a lack of ____________ analysis, a tendency to _______________ the impact of marketing efforts and ________________ the capabilities of ________________. Small businesses also frequently fail to _____________ their resources to support their strategy.

3.6  Class Assignment Activity

21

3.4  True/False

9. New business ventures that start up without adequate working capital are more likely to fail than those that are well funded 10. Most successful entrepreneurs start their new business ventures though the launch of a new break-through invention, often of a high technology nature 11. Younger people are more likely to succeed in small business ventures than older people 12. One of the most important things for a small business owner-manager to do when considering a new business opportunity is to develop a clear vision for how and why they will proceed 13. The motivation and determination of the owner-manager to succeed in their chosen new business venture is as important as the business opportunity itself 14. The level of family support to the owner-manager of a small business is unlikely to have any significant impact on the success of the new venture

True False [  ] [  ] [  ] [  ] [  ] [  ] [  ] [  ]

[  ] [  ] [  ] [  ]

3.5  Short Answer 1. Why is under-pricing a major cause of failure in small businesses during their early years of existence? 2. What is a unique selling proposition (USP) and why should a new business venture have one? 3. In evaluating the idea and the market for a new business venture, what things should the owner-manager consider? 4. In undertaking market research to assess the feasibility of a new business opportunity, what are some of the key things that a small business owner-manager should consider? 5. In determining the resources needed for a new small business venture, what are some of the key issues that should be considered by an owner-manager?

3.6  Class Assignment Activity Working in small groups, develop an idea for a new business venture then undertake an assessment of the opportunity using the key concepts outlined in this chapter. You should be able to undertake a good deal of research using the internet. Once

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3  Work Book: Surviving the Early Years

you have developed your idea and screened the opportunity, prepare a written proposal and make a short presentation to the class as to what you found and why you may either not now wish to proceed, or why your findings have encouraged you to potentially give this idea a try.

3.7  Case Study Analysis Read the following case study of Sporting Chance, a small business that has recently launched and is now experiencing some problems in its survival. Your role is to assume that you have been approached by the owners of the business for advice on what they should do.

Questions/Tasks 1 . Assess the performance of Phil and Trish so far as owner-managers and 2. Assess their current business position. Is this business sound? 3. What lessons does this case provide in relation to the things that should be considered during the screening process for a small business start-up? 4. What recommendations would you give to Phil and Trish about how to save their business?

3.8  Case Study: Sporting Chance Philip is 36 years old and is married to Trish who is 33 years. They have recently established a business making and selling sporting merchandise – called Sporting Chance – and have been trading for approximately 12 months. Prior to starting their business, they were both unemployed. Philip had been a machinist and Trish had worked for a contract cleaning service. Philip had suffered a workplace injury leaving him a worker’s compensation payment. Trish had quit work during Philip’s recuperation. They were both bored of staying at home and wanted something more to do. They were wondered what they could do when the idea to start this business came to them. Prior to commencing their business, they contacted the Small Business Development Corporation to find out about licensing and regulations, particularly concerning copyright. They also contacted various professional sports teams and got a positive response for their idea. Since then, they have lined up some clients,

3.8  Case Study: Sporting Chance

23

including sports retailers and wholesalers. However, none of the banks they have approached would lend to them unless they were already making money. They have used several thousand dollars of their own (saved from their unemployment and compensation benefits) to purchase the equipment and materials necessary to produce the sports merchandise. Philip and Trish have already sold a limited range of their products after sports games (soccer and basketball), at local markets, and at the Royal Agricultural Show. Phil’s pricing strategy, generally, has been to be competitive but profitable – aiming for 12.5% net profit. They now have orders backed up and can’t produce on the scale that is demanded. Unfortunately, they have spent the remainder of their own capital and can’t purchase the materials to manufacture any more of their products. They tried again to raise funds, this time from the various sports teams and their sponsors. Although the general consensus was that the idea was excellent and very marketable, they haven’t managed to find anyone willing to lend further capital until the idea has proved itself by making large profits. This lack of capital is threatening the future of their business. An additional complication is that, after contacting the Australian National Football League about their idea. While it could not be proven, Phil believes that the ANFL suggested the idea to another very large producer who in turn has purchased the rights to produce the merchandise for all the teams in the ANFL. Production of the merchandise for the ANFL teams was intended by Phil and Trish to be the main market for the product and their business. The couple hadn’t consulted an accountant prior to starting their business, although they have subsequently taken some advice. Phil found out about the New Enterprise Initiative Scheme (NEIS) courses on how to start a small business, but couldn’t spare the time to attend the course because he was working full time to manufacture the products to meet demand. Phil and Trish consider their main problems to be cash flow, job-cost estimates, and new product development. Cash flow statements prepared by their accountant show that for the first 12 months their sales have been $22,969 and expenditure has been $47,289 (see Fig. 3.1). This has left them with an operating loss of $24,320. When they first planned their new venture, sales and cash flow projections were prepared for the first 12 months (see Fig. 3.1). These had forecast sales of $31,500 and expenditure of $49,445 leaving an operating loss of $17,945. An examination of the firm’s monthly sales revenues and key variable costs was undertaken (see Table 3.1) in order to examine the gross profit that was being made each month. The results have Phil wondering if his pricing strategy is appropriate. Phil claims that another major problem has been invoicing. If his customers don’t receive invoices by the end of the month in which a job is completed (i.e. Month 1), the invoices will be regarded as Month 2 invoices due for payment at the end of Month 3. As far as Phil can estimate, the standard for debt clearance is 90 days, i.e. he has had to wait 90 days for payment and he in turn has made his suppliers wait the same.

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3  Work Book: Surviving the Early Years

Annex A: Sporting Chance—Purchase monthly ledger—Year 1 NOV

DEC

MAY

JUN

$

$

$

$

$

$

$

$

$

$

$

$

$

4,075 1 70 109 20 11 176 4,462 -4,462

943 61 81 2 50 19 51 34 1,240 -1,240

388 13 29 20 73 10 533 -533

222 133 158 30 291 373 98 1,080 200 182 751 3,518 3,450 -68

466 166 40 103 84 1,922 432 495 364 4,073 394 -3,679

1,150 330 189 20 335 371 127 658 3,181 1,445 -1,735

603 192 554 20 195 435 318 448 1,862 1,128 5,755 3,639 -2,116

250 40 239 167 87 1,443 150 200 139 1,389 4,103 2,726 -1,377

1,660 181 258 10 1,560 412 30 8 1,286 5,405 1,789 -3,615

477 193 188 1,307 206 102 2,209 1,666 6,348 2,809 -3,539

76 74 234 174 1,093 189 113 2,141 205 4,299 3,739 -560

500 149 187 142 1,681 153 113 30 1,418 4,373 2,978 -1,395

10,810 1,534 2,226 555 482 9,827 542 2,632 1,604 1,294 4,596 10,231 956 47,289 22,969 -24,320

EXPENDITURE Capital expenditure Advert printing Motor expenses Telephone Light/heat/power Materials Insurance Consumables Professional fees Equipment lease Rates Direct labour Sales tax INCOME BALANCE

JAN

FEB

MAR

APR

JUL

AUG

SEP

OCT

TOTAL

Annex B: Sporting Chance—Cash flow projections—Year 1 EXPENDITURE Capital expenditure Printing stationery Motor expenses Telephone Light/heat/power Materials Insurance Consumables Professional fees Equipment fees Rent & rates Direct labour Sales tax INCOME BALANCE

NOV $

DEC $

JAN $

5,000

600

400

50 120 110 40 20 50 200 700 6,290 -6,290

60 120 20 40 50 890 -890

200 120 20 40 500 50 90 1,420 -1,420

FEB $

MAR $ -

200 120 20 140 540 300 50 1,200 90 440 3,100 -3,100

APR $

2,000

5,000

100 180 60 100 50 90 440 3,020 -3,020

100 180 60 100 1,000 75 90 500 440 7,545 1,000 -6,545

MAY $

JUN $ -

100 180 60 100 1,500 75 1,270 90 440 3,815 2,500 -1,315

3,000 100 180 60 100 1,600 75 90 440 700 6,345 4,000 -2,345

JUL $

AUG $ -

100 180 60 100 1,500 75 90 500 1,000 3,605 6,000 2,395

4,000 100 180 60 100 1,500 75 90 1,000 7,105 6,000 -1,105

SEP $

OCT $ -

TOTAL $ -

100 180 60 100 1,600 75 90 1,000 3,205 6,000 2,795

100 180 60 100 1,500 75 90 1,000 3,105 6,000 2,895

20,000 1,310 1,920 650 1,060 10,740 820 775 2,670 900 1,000 6,200 1,400 49,445 31,500 -17,945

Fig. 3.1  Sporting chance—purchasing and cash flow projections year 1

Table 3.1  Sporting chance—record of sales and purchases for first 8 months Month November December January February March April May June July August September October Totals

Monthly sales – – – 3450.00 393.68 1455.12 3638.51 2726.11 1789.39 2808.98 3739.01 2978.18 $22,979.00

Materials – – – 290.70 1922.24 334.66 194.57 1443.26 1559.68 1306.89 1093.36 1681.19 $9827.00

Consumables 10.88 50.58 73.44 98.18 431.80 371.01 435.08 200.04 412.32 205.63 189.22 153.25 $2632.00

Direct labour – – – 181.96 363.92 658.29 1127.98 1388.90 1285.74 1666.10 2140.88 1417.58 $10,231.00

Gross profit (10.88) (50.58) (73.44) 2879.16 (2324.28) 91.16 1880.88 (306.09) (1468.35) (369.64) 315.55 (273.84) $289.65

3.9  Key Lessons from the Chapter

25

3.9  Key Lessons from the Chapter • Small business owner-managers as a general rule are optimistic and frequently find ways to achieve their goals, even when more ‘rational’ heads, e.g. bankers and accountants, are warning caution. • Many small business owner-managers find difficult to assess the merits of a particular opportunity as they often lack experience in making such assessments, or lack of resources or skill in collecting information. Furthermore, they have a tendency to be more reactive and lacking in long range strategic thinking. • The development of a well-known brand is one of the most important things that small firms can seek to achieve, however such brand equity may take between 5 and 10 years to generate. • The firm that seeks to enter new markets may find the reaction from competitors unpredictable and surprising. Larger competitors frequently react swiftly to shut down emerging competition. • Small business owner-managers frequently make decisions based on their intuition. This has been described somewhat crudely as ‘scientific wild arse guessing’ (SWAG), which can have a 50/50 chance of success, and the odds may even be higher if the owner-manager is experienced in a particular market or market segment. However, the majority of small business owner-managers are limited in their resources. As such, they must be careful how they allocate their money, time and people and use a systematic scanning and building process • The revenue (rent) coming from the innovation is based on three components: the volume (annual sales due to the innovation), the rate of profit (thanks to the innovation) that can be expected, and the length of the innovation’s anticipated lifecycle (time were the innovation exists in the market). The total rent obtained thanks to the innovation is the product of the three elements. • To assess the potential value of a future investment in either the creation of a new product or service or in the foundation of a new business venture, it is necessary to assess the future rent that might be generated from the innovation/ invention/ venture over time. You should look at how unique your idea is and whether or not it seeks to create an entirely new product and market or simply substitutes for existing products and markets. Depending on how much it seeks to change/challenge the existing status quo, the more risk your idea will face. • It is worth noting that the real value of the opportunity is the appropriable rent, not the potential rent, after taking into account the Porterian forces and their likely impact on its success as well as the competitor reaction and the availability of resources to take the idea forward. • Potential Rent: –– To assess the potential volume of sales from this innovation, consider how large your future market or markets might be and how many units of your product or service will be sold in the first 2–3 years.

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–– To estimate the rate of profit from your idea, consider whether you can launch and fully commercialise the product or business venture alone, or whether you need others. –– To estimate the length of the lifecycle of your innovation, you should consider how easily the customer can switch to an alternative supplier, or how easy it might be for competitors to copy your idea. You can protect yourself from this by formally registering your designs, trademarks or patents (if applicable). • Residual Rent: –– You should look at how unique your product or service is likely to be and the readiness of the target customers to buy. A key issue here is what is called the Customer Perceived Utility Value (CPUV= perceived benefits  – perceived sacrifices). This is a measure of how much the new product or innovation is seen by customers as offering benefits for the sacrifices that they must make in order to adopt it. A key consideration when assessing the CPUV of your innovation or idea is to determine how transparent the benefits will be in the eyes of the customer. –– The power of customers and suppliers to negotiate prices and conditions is also something that should be considered. Many small firms are dependent on a few lead customers or key suppliers for their business. This can see them squeezed on margin and the profitability of their new products and services eroded. –– In addition to considering the power of customers and suppliers, attention should also be given to the impact of government regulations or other barriers to market entry. • Appropriable Rent: –– Of particular importance is to consider how unique the new product or service will be within its chosen markets. It is also important to consider how strong any barriers that might block its sales volume might be. –– The ability to overcome existing market entry barriers and successfully deal with incumbent competitors is an integral part of any new business venture. Having a clearly differentiated product or service offering that can provide benefits to customers that outweigh any perceived sacrifices is crucial. –– A key issue for small business start-ups and small firms seeking to launch new products or enter new markets is whether they possess the necessary resources and competencies to fully exploit the opportunity. • Just having a good idea does not guarantee that you will be successful. • A lack of focus and direction can lead to strategic drift that may risk the owner-­ manager expending time, money and other resources for limited gain. • A common problem is under-pricing their products or services. This in-turn can lead to low profit margins. With inadequate margin, the business is likely to struggle financially. Getting into markets where the main point of competition is

3.9  Key Lessons from the Chapter

• •

• • •

•

•

•

• •

price-cutting is another trap for small business owners. Competing on price  – particularly if profit margins are thin – is a sure way to get into difficulties. In considering new venture opportunities, the small business owner-manager should seek to avoid market segments that are highly price sensitive. A reason many small firms become vulnerable is that they focus on highly-­ localised markets. If these markets are protected from substantial competition, the owner-manager can operate successfully. However, should the market become deregulated, the small business may suffer. Questions should be asked by owner-managers prior to launching a new business venture about the customer, their decision-making process, the cost of acquiring supporting and retaining a customer, and the pricing of the offer. The most likely successful start-ups are often found in market niches that have a relatively high level of uncertainty, but low capital and opportunity costs Small business owner-managers should consider the following questions before deciding to proceed with a new idea. Have they (i) conducted an analysis to assess the market demand? (ii) calculated the cost—in time and money—of marketing? (iii) fully assessed their competitor capabilities? (iv) exhausted other possible strategic options? (v) examined the impact on their existing products/ markets? (vi) addressed any dissenting voices within their firm? (vii) ensured their firm has the resources to achieve the task? (viii) fully costed the project and forecast cash flows? (ix) avoided making decisions using SWAG?1 Important questions to ask before launching a new business venture: Why are you going into this particular business? What previous experience do you have? How much has been learnt by you about the business prior to start-up? Do you have family support for this venture? How will you live during the early years of the company’s survival? The level of support the small businessperson can expect from their family is also likely to be of importance to their future success. A small business is as much a social phenomenon as it is an economic one. Owners who have family support and encouragement are more likely to survive than those who don’t have it. Most small businesses need to focus their attentions on niches within the market as they lack adequate resources to target all segments at once. As a general rule of thumb, the more saturated a market becomes, the more a business needs to seek niches where it can dominate or at least maintain its competitive edge Most businesses obtain around 80% of their sales from approximately 20% of their customers. Put another say, 20% of products generate 80% of sales There is much market research that can be undertaken by the owner-manager alone and at minimal cost. National statistics institutes (ABS in Australia, Eurostat in the EU, and INSEE in France) are a ready source of high-quality data on a wide range of information that can be useful in estimating the size and structure of a market. Small business owner-managers can also obtain economic forecasts and assessments from a variety of organisations. For example, local

 SWAG – Scientific Wild Arse Guessing.

1

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•

•

•

•

3  Work Book: Surviving the Early Years

chambers of commerce and some government agencies maintain in-house economists For many small business owner-managers seeking to launch a new venture, another important question is whether or not the market segment they are targeting is likely to grow and by how much. Measuring the potential of a market is more difficult than simply describing it. It is to be encouraged that an owner-manager undertakes an honest self-­ assessment of his or her own skills and abilities. This is not designed to discourage them, but by conducting a personal SWOT analysis the emerging owner-manager can identify what their strengths and limitations honestly are. Small business management requires the owner to understand their operations in a holistic manner. Planning the general direction of the new venture is critical to success, but the key point to remember is that it is the process of planning that is important and not the plan itself. Most small businesses don’t plan in a formal way. However, if they do plans, they will need plans for three key reasons: (i) to communicate their vision and mission to customers or suppliers, (ii) to secure debt or equity financing from external parties, (iii) to coordinate the activities internally of staff. The most important assistance that can be given to a novice owner-manager is to assist them to think and act more strategically. This should not be confused with business planning, although the development of formal business plans may be an outcome. A common problem for small business owner-managers is that they are so consumed with daily survival and short-term crisis management that they lack adequate long-term focus and direction.

Chapter 4

Work Book: Planning and Strategy in the Small Firm

4.1  Learning Objectives After completing this chapter, you should be able to: • • • • • •

Prepare a strategic plan for a small business. Understand the role of planning in the small business. Recognise the importance of strategic focus and direction. Understand the process required to undertake an industry and competitor analysis. Conduct a SWOT analysis. Determine the competitive positioning best adopted by a small firm.

4.2  Chapter Review Small business owner-managers are not generally engaged in formal business planning. However, they can derive benefits from strategic planning. The development of a clear vision for their business is an important step in successful strategic management. Formal written business plans are often prepared by small firms to secure financing from banks or venture financiers, or at the request of suppliers and customers. However, the most valuable use for a plan is to guide the internal operations of the business. Small business owners should plan to replace themselves with a system, placing attention on the design of a business model and structure that allows them to work on rather than in the business. The process of strategy is continuous and involves setting a clear vision and mission, identifying the critical success factors needed for the firm, then setting clear objectives before developing a plan for implementation. An important element of developing a strategic plan is to undertake an analysis of the external environment and competitors, which includes © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_4

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understanding the ‘rules of the game’ that exist in the firm’s industry. Environmental analyses should focus on the factors driving competition within the industry, as well as the political, economic, social and technological forces likely to impact on the business in the future. Small firms should seek to adopt competitive positioning strategies focusing on securing niches in the market that allow them to make best use of their internal resources. Future growth is likely to involve a balance of matching product and market opportunities and following emergent strategies. There are at least four main planning responses that the small business owner can adopt depending on their environmental uncertainty and organisational complexity. These responses will involve varying degrees of formality and sophistication and operational or strategic levels of focus. Selecting the right planning response for the conditions under which the business is being managed can be important to the overall success of the firm.

4.3  Quiz Questions The following questions are aimed at testing your knowledge on the material covered in this chapter.

Fill in the Blanks 1. Having a formal business plan is not e______________ to small business success, but owner-managers that have one are more likely to s_____________ than those that don’t. 2. The three main types of business plan that a small business owner-manager is likely to need are: 3. an application for ____________; 4. plans for either ______________ or _______________; and 5. plans for ________________ use. 6. The PARTS model is comprised of five elements. What are they? 7. The RIVAL model comprises five elements which are: _________, _______________, ________________, _______________, _______________. 8. The four planning responses that a small business owner can adopt are known as: __________________, _________________, __________________, and __________________.

4.6  Case Study Analysis

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4.4  True/False

15. Research into small business management shows that small businesses that have formal business plans are more profitable than those that do not 16. It makes no difference in the longer term if a small business owner-manager plans their business around themselves as the key decision maker 17. In preparing critical success factors and objectives for a business plan, the critical success factors should focus on what will happen, while the objectives should focus on what is needed to achieve the vision 18. In developing a pricing policy for a small business, market share growth is generally more important than profit margin per unit sold 19. The motivation and determination of the owner-manager to succeed in their chosen new business venture is as important as the business opportunity itself 20. The level of family support to the owner-manager of a small business is unlikely to have any significant impact on the success of the new venture

True False [  ] [  ] [  ] [  ] [  ] [  ]

[  ] [  ] [  ] [  ] [  ] [  ]

4.5  Short Answer 1. Describe the major factors that need to be considered when undertaking an industry analysis? 2. When analysing competitors, what are the key elements that should be considered? 3. What are the main competitive positioning strategies that a business can adopt and what are the most appropriate strategies for small firms? 4. List the four qualities that an internal resource or asset must have to provide a business with the basis of a sustainable competitive advantage? 5. What are the four planning responses and what should a small business owner focus on within each type?

4.6  Case Study Analysis Read the case study Comfort Homes and prepare a report for the owner-manager to assist him when preparing a future strategy and plan for the business. In doing so, consider the following questions.

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Questions/Tasks 1 . What has been the performance of James as an owner-manager? 2. In preparing a strategic plan for the future of this business, what should James consider?

4.7  Case Study: Comfort Homes James felt a puff of pride. Four years in the driving seat and he had turned an ailing building business, trading at a loss, into a multi-million-dollar success story. The end-of-financial-year figures on his desk were proof that Comfort Homes had disclosed a healthy growth in profit for the 4th year running. Not bad for a former building supervisor turned owner-manager. James recalled when he’d first bought the business that he’d boasted to workmate Kevin – now one of his own employees – that a business could not only survive trading cycles and but also grow if it was focused. Well, he’d proved his point.

Old Hands, New Roles Kevin had been cynical about a small business that built steel-framed transportable houses, competing in a trading environment dominated by the big boys. He thought James lacked the outgoing, gregarious personality that would win orders, and that his mate’s trade background was insufficient preparation for the role of owner-­ manager. Yet, James knows all about sour grapes and personal agendas. He believes ownership brings new responsibility and personal accountability—two key ingredients for success in any venture. Kevin didn’t realise that, as owner-manager, James viewed Comfort Homes from an entirely different perspective. Being in charge is quite unlike being a paid employee.

Slow and Steady James is the silent type, but his quiet confidence and straight talk have won him respect from customers, employees and suppliers alike. His business style is careful and considered, like his speech – slow and steady with the long-term view in mind. He never acted on a whim and made few mistakes. True to character, James’

4.7  Case Study: Comfort Homes

33

decision to buy Comfort Homes was careful and considered. The business had been trading at a loss for a couple of years, and the owners were desperate to sell. The purchase price was fair, based on the poor trading performance. He paid only for plant and equipment and nothing for goodwill, the client list or intellectual property. He was not out to make a fast buck, but as the results demonstrate, his financial success has surpassed many get rich quick schemes.

Minimise Overheads Controlling overheads is a big concern in the building industry and many high-­ profile companies have gone under. James doesn’t have deep pockets and he has no intention of taking any unnecessary risks. From day one, he set up a low-overheads business. He minimised his wage exposure (a big cost for any building company) by ensuring all work was on a sub-contract basis. Although this added a premium to normal award wages, it reduced the company’s exposure significantly in an industry subject to trading cycles. All sub-contractors had to meet fixed quality and delivery standards. As a result, shop floor productivity was high and the company’s break-­ even sales point was lower than if all tradesmen were on the payroll.

Home from Home In his own quiet way, James was a pioneer in the building industry. He saw a niche in the market and grabbed it. The Australian mining and resources industry was booming. Most mines have a lifespan of 1–10  years, and so it makes economic sense to erect transportable homes on-site and then transfer them elsewhere when the mine shuts down. Competition between individual mining companies is fierce and many recognise the link between employee comfort and productivity. James knew from his own on-site experience that employees working in remote locations were more productive and suffered less stress if they had good living accommodation. This ‘home comforts’ concept offered the perfect selling pitch  – the home-­ from-­home transportable. Comfort Homes started to manufacture top quality transportable homes for the mining industry. They were constructed with invisible steel frames to look like a real home from the outside. Floor space was optimised to provide comfortable self-­ contained accommodation. Several mining companies tested this superior accommodation on their senior employees and soon others were forced to follow suit in order to attract skilled labour and reduce staff turnover.

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4  Work Book: Planning and Strategy in the Small Firm

Better Building, Reducing Risk James’ own building competitors soon pirated his ideas, but he just took up the challenge to design even better transportable homes using the latest building concepts. As a result, Comfort Homes has remained at the forefront of the industry. However, Comfort Homes is not quite the high-risk trailblazer that its promotional pitch suggests. The new designs are simply imported residential housing improvements applied to the transportable market. The cost of researching and developing new designs is insignificant in terms of the company’s annual turnover, and the construction methods make economic sense. The transportable homes are manufactured in town where labour costs are low and tradesmen abundant, and are then transferred to the mine sites. Quality control is paramount. Each transportable is checked thoroughly by the building supervisor before it leaves the company premises, as it is easier and cheaper to rectify problems before delivery.

Window of Opportunity James has recognised another window of opportunity and has begun to market Comfort Homes to the rural sector. Farm properties are valued on a per hectare basis, often with little value attached to the homestead. In addition to the low cost of building, he could see the attraction to canny farmers of erecting a transportable home that could be moved when the farm was sold or passed on to the next generation.

Marketing and Management To promote an existing product to a new market is a smart move, even if it is not part of a considered strategic or marketing plan. Kevin’s lack of confidence in the company’s future was based on his perception of James’ personality and his mate’s lack of marketing experience. Marketing is James’ responsibility and he does not always make time for it. He is a perfectionist and finds it difficult to delegate. He realises that, whilst he has steered Comfort Homes to financial success, the company’s marketing is limited to chasing leads in the mining industry and, to a lesser extent, the rural sector. He has no marketing program aimed at specific industries or geographic regions and the idea of building business networks has been overlooked. Although at heart he knows it is important, urgent issues always take precedence over the valuable but not-so-­ pressing need for marketing. Somehow James has to learn to delegate the daily,

4.7  Case Study: Comfort Homes

35

routine tasks to his staff so that he can devote his time and energy to working on the business. Delegation is fine in theory, but difficult in practice. At Comfort Homes, communications between management and staff is poor. James and Kevin have never sat down together to discuss ideas, despite their long years of friendship. Kevin is a long-term employee whose knowledge and skills have not been used to their full potential. James lacks experience in human resource management. He likes to be in control and is not comfortable sharing ideas with employees. On the whole, the job gets done but his employees never feel part of a team.

Four Factors for Financial Success Despite these in-house management problems, Comfort Homes has performed well in an industry subject to trading cycles. Four factors have contributed to this success. James is very astute in financial matters. He ensures all contracts earn a good profit margin and generate cash flow by way of progress payments invoiced on completion of agreed milestones. Apart from a nominal bank overdraft, the company has no debt. Turnover runs into millions but the debtor position at any point in time is insignificant. There is no incidence of bad debt. Most clients are established blue-chip mining companies who pay on time. Demands on plant and equipment are modest, but substantial industrial land is required for construction. Comfort Homes has no capital to invest in property and has opted to lease suitable premises. James is a model tenant and pays rent at market price. James is fastidious about product quality. He has built a team of loyal, conscientious sub-contractors and he rarely ventures outside this core team. He ensures sub-­ contractors are briefed before each job commences and he always pays his tradesmen on time as soon as they reach the agreed milestones. He almost has the advantage of his own work force without the financial responsibility.

Quality Control James knows quality control is one of Comfort Homes’ critical success factors. He has spent 4 years complying with Government Quality Assurance requirements and is critical of his competitors. He believes that they rely on official paperwork to ensure quality assurance procedures are followed. James prefers to inspect construction first-hand against accepted national benchmarks of quality.

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4  Work Book: Planning and Strategy in the Small Firm

Future Directions As he contemplates the future and how to expand the business, James is considering a potential new market—to supply transportable homes to the Queensland Housing Commission. As a State Government agency, the Queensland Housing Commission demands Quality Assurance under ISO 9002, but this Government directive irritates James. He believes it is administered by bureaucrats with no idea of the difference between Quality Assurance and Quality Standards. In his deliberate, considered way he has begun to weigh up the benefits of winning this contract against the hidden costs.

4.8  Key Lessons from the Chapter • The SME owner manager needs to know where they are going, or they run the risk of ending up somewhere that they would rather not be. To ensure a clear focus and direction for a small business, the owner-manager should give consideration to developing a clear vision and mission for their business. In addition, they need to understand their core skills, i.e. the things they are really good at, and identify the key resources, e.g. the people, patents, markets, products, and equipment, etc., that are likely to be essential for their business success. • Strategic orientation may differ among senior management teams: Managerial firms (analyse their markets and made use of marketing strategies); Technological firms (launching new products that apply technological innovations); Traditional firms (more risk-adverse firms avoiding growth and major changes); Impoverished firms (lacking any coherent strategies and typically reactive) • A major problem for many small business owners is that they suffer from what can be described as ‘strategic myopia’ as they possess only short-term and not long-term vision • The reasons so few small business owners engage in strategic planning is often attributed to their lack or time, their lack of the knowledge and skills to develop a plan, their lack of willing to formalise their plans and share their ideas. However, it is also likely that many simply see little need to engage in strategic planning, because they know where they are going and how they will get there. If their business is operating in a stable environment with little uncertainty and they know how to make their product or deliver their service, why would they bother developing complicated strategic plans? • At least three broad strategic types can be found: Growth focused (requires a clear market opportunity and sufficient resources); Lifestyle focused (requires a consolidation of the business and the implementation of systems to ease the workload of the owner-manager); Exit focused (requires the owner-manager to prepare their business for succession transfer or sale). A fourth one is the stasis option that may at first appear a passive strategy, however this strategy is ­common

4.8  Key Lessons from the Chapter

37

amongst firms that have experienced periods of rapid growth, or that have reached a point of maturity where their owners have decided to cap any future expansion • The benefit of formal planning to small business performance has been debated within the academic literature throughout the past 20 years. The question remains as to whether it is the plan or the process of planning that is important in determining small business performance Research suggests significant relationships between formal business planning and growth in sales revenues – but this relationship was not evident in terms of profitability. • At least three broad types of plan can be identified: plans for applications for finance, plans for customers and suppliers, and plans for internal use. 1. Plans for finance: an application for a bank would be likely to focus on the tangible assets that the applicant has and the capacity the business has to repay its loans. By contrast, a venture capitalist will be more attracted to the management capacity of the applicant and their vision for the development of the firm. 2. Plans for customers and suppliers: aims at reassuring the customer or supplier that the owner-manager has the capacity to meet the demands of being part of the value chain. A business plan prepared for a major customer will need to emphasise the capacity of the firm to deliver on time, on cost and on quality. Plans prepared for suppliers will need to focus on the capacity to build up a market and grow the business potential for expanding the supplier’s own market share. 3. Plans for internal use: small business owners may find themselves employing staff and the business will need to become more formal in their planning. Such plans serve to coordinate the activities of the workforce • The tendency in small business is to organise around people rather than around functions. This is generally not a good practice over the longer term. • Business planning commences with strategy formation. No plan can be of much use unless the strategy upon which it is based is valid. Strategy and planning are closely related but are not the same. • Rather than moving their business along a path that they have determined; most small business owners find themselves responding to short term issues triggered by internal and external forces. They feel that their business is running them rather than the other way around. • Small business vision is also concerned with finding the future that the owner-­ manager wants for the business, and determining any action required to achieve that future. Once a clear vision for the business is identified, it should be communicated to all staff. The more a vision is discussed with others, the better. • A mission statement assists to: clearly define the business, aid planning, and communicate the organisation’s purpose to others. Mission statements need to be: short, clear and simple, able to clearly state the purpose of the business, avoid too many generalities, and focus on the business as it is in the present rather than the future.

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• Critical success factors are what the owner-manager needs to be successful at in order to achieve the mission of the firm. Objectives are best defined as what needs to be done to meet the critical success factors. Objectives must possess three key criteria: A quantifiable performance benchmark, a deadline for completion, the Ownership of the task. • Strategy can be defined as the process of matching the external opportunities identified in the market with the resources and capabilities found within the business. At least nine key issues need to be considered by the owner-manager when seeking to undertake a strategic assessment of their firm’s market and industry setting: Industry trends. Competitors. Target markets. Barriers to market entry. Market penetration. Pricing and margin targets. Marketing channels. Primary research and sales data. Ability to deliver. • For an owner-manager to be fully in control of their business, it is important that they examine their industry and monitor its trends and cycles. One way to examine this is via the PARTS framework that contains five elements, i.e. the Players, Added value, the Rules, the Tactics and the Scope. • During the first phase of an industry analysis, attention needs to be given to the five forces that determine the level of the industry’s competitiveness. How many competitors are there and how saturated is the sector? Do these competitors follow a set of rules that you can understand? How will they react to your moves? Are you able to find a point of competitive difference in this market where your business can offer superior value adding? • During the second phase of the analysis, it may be wise to undertake an historical review of the industry to map out how it has changed over time. Key political, economic, social and technological (PEST) forces need to be examined. • Finally, the owner-manager should look to the future and try to analyse the way that their industry might look in 5–10 years’ time, e.g. the impact of digital technology on such areas as printing, graphic design, and a host of other sectors. • Where the stakeholder has high levels of power and a high level of interest in the firm’s activities (e.g. shareholder, lead customer), it is appropriate to see the stakeholder as a key player, or even a strategic partner. • A TOWS matrix can be useful in which the threats and opportunities are considered first, and then matched against the organisation’s weaknesses and strengths. Environmental impact considerations can be better assessed using this approach. Once a TOWS matrix has been completed, the organisation is in a good position to formulate a range of strategic options • It is generally impossible for a small firm to be successful in all market segments and across a wide range of industries. A firm can effectively compete on only two levels: By being the lowest-cost producer. By differentiation. Whichever strategy a firm chooses depends upon its market and possibly upon its products. • A business that seeks to follow a cost leadership strategy will need to ensure that they maintain continuous lower costs either by vertical integration (not usually possible for small firms) or by the application of technological process innovations and learning effects to ensure that it has sufficient economies of scale (again, something not many small firms can achieve

4.8  Key Lessons from the Chapter

39

• To secure a sustainable differentiation strategy, a business must have customers who view price as less important than product or service attributes when making purchase decisions. • Finally, the key risks are that competitors will seek to imitate the strategy or that the niche segment becomes unattractive over time. • The RIVAL mode helps to assess the sustainability of a competitive advantage: R (Rare). I (Difficult to imitate). V (Valuable). A (Attached strongly to the firm with no strategically equivalent substitutes). L (Long lasting). • Four generic strategic planning types can be identified that are appropriate responses to the level of uncertainty found within the task environment and the level of complexity found within the firm’s organisational configuration. 1. The shopkeeper: The focus in this situation should be more operational than strategic – or ‘fine-tuning the business.’ 2. The salesman: This planning response is that of the salesman and the focus is primarily on market development. Salesman strategy involves a high emphasis on marketing and networking. 3. The administrator: Here the emphasis is on operational efficiency and cost control. This planning response is that of the administrator with a primarily internal rather than external focus. 4. The CEO: the appropriate planning response is structured and strategic in nature. This response type is the CEO, and the focus is on strategic transformation.

Chapter 5

Work Book Creating Customers

5.1  Learning Objectives After completing this chapter, you should be able to: • • • • •

 nderstand and apply the concepts used in marketing, sales and service. U Identify customer needs and wants to create customer delight. Develop a market segmentation strategy. Understand the sales process and sales cycle. Develop a marketing strategy.

5.2  Chapter Review Marketing within the small business is not the same as found within larger organisations due to limited resources, but also the owner-manager’s ability to get closer to the customer and understand their needs and wants. The term “customerising” has been coined to describe the process of marketing within the small business. This involves the ability to delight the customer by offering significantly better levels of product or service quality. Successful small firms have formal approaches to marketing and secure an above average level of word of mouth referrals. These firms have business generating systems and know why their customers buy from them and how they make buying decisions. Small business owners need to understand customer needs while monitoring the past performance of their firm within its market. They also need to develop a coherent and well considered sales management process and a marketing strategy that considers each of the seven elements of the marketing mix. This strategy must identify selected target markets, develop a position within these markets and create appropriate plans for the management of products, © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_5

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5  Work Book Creating Customers

pricing, distribution, promotion, process, people and physical evidence. Further, by paying attention to the quality of service that the firm can give to its customers, and engendering in them a perception of value it can generate customer loyalty, repeat business and positive word of mouth referrals.

5.3  Quiz Questions The following questions are aimed at testing your knowledge on the material covered in this chapter.

Fill in the Blanks 1. Marketing within the small business involves four stages. What are they? (i) _________________________________________; (ii) _________________________________________; (iii) _________________________________________; (iv) _________________________________________; 2. Customerising comprises five elements. What are they? (i) _________________________________________; (ii) _________________________________________; (iii) _________________________________________; (iv) _________________________________________; (v) _________________________________________; 3. The AIDAS model stands for: A _____________________________: I ______________________________; D _____________________________; A _____________________________; S ______________________________.

5.4  Short Answer 1. Describe the five elements that comprise a marketing framework for a small business. 2. What is a focus group and how does it differ from an interview in market research?

5.6  Case Study Analysis

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3. List the principles of good survey design and explain how response rates might be boosted in surveys. 4. What is a sales track and why is it important for a business to develop one? 5. What is the 10/30/60 formula? 6. Describe the five steps to brand name development. 7. What are the three elements that comprise the total product concept? 8. What is the difference between a message strategy and a media strategy?

5.5  Class Assignment Activity Working in small groups, undertake a market scan of several small firms within the same industry sector. Look at their marketing profile with reference to the marketing mix (Fig. 5.5  in the textbook) and if possible, the service quality framework (Fig.  5.6). Then prepare a short report and class presentation that discusses how these firms appear to be managing their marketing and customer creation activities. Try to identify areas of strength and weakness with a view to identifying what it might tell you about how most small businesses approach marketing.

5.6  Case Study Analysis Read the Malrica case study and address the questions that follow.

Questions/Tasks 1. What lessons can Malrica learn from its past marketing efforts about what not to do in the future? 2. If Malrica wants to develop an effective marketing strategy what advice would you give them? Consider the following things when making your answer: 3. Their positioning in the market. a. Their pricing strategies. b. Their use of promotion (advertising, selling, publicity, sales promotion). c. Their distribution strategies. d. Their need for market research information.

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5.7  Case Study: Malrica International (Aust) Pty Ltd. Authors: D.A.  Rosmianingrum Nainggolan and Vicki Htwe Thein and edited by Diana de Bussy.

Selling Style and Innovations Two years ago, a unique, stylish, detachable rack system for audio visual and hi-fi equipment hit the Australian market. Asia Audio Rack Sdn, Bdn, a company owned by the Khor family manufactures these units in Penang, Malaysia. Malrica International (Aust) Pty Ltd., a small business established by James Khor and Caroline Nguyen, imports them into Australia. At the time of writing, Malrica was the sole distributor in Australia and New Zealand for the Asia Audio rack system and a matching range of elegant speaker stands. Malrica claims there is no similar product of the same quality on the market in Australia. The closest competitor is the entertainment unit available from retail furniture shops. The Company therefore bases its sales pitch on the rack system’s novelty value, elegant looks and competitive price. Asia Audio’s rack systems are popular in South East Asia and have penetrated the Hong Kong, North American and European markets. But how long can novelty remain a key selling factor before Malrica must find an alternative marketing strategy in Australia?

Malrica’s audio racks

Production and Distribution The Asia Audio (AA) rack system is designed as a high-quality detachable stand suitable for televisions or hi-fi equipment. The systems and their matching range of speaker stands are manufactured in Penang from specially selected materials, including MDF board imported from New Zealand, 18 K gold plated footings and

5.7  Case Study: Malrica International (Aust) Pty Ltd.

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stainless steel. Since production began, the initial product range has expanded from 24 to 45. The systems are imported from Malaysia, stored in warehouse in Welshpool, WA, and then distributed to the various retail outlets by road. Within 2 years of its arrival in Australia, the AA rack system was available in 90 retail outlets in Perth, Sydney, Melbourne, Adelaide, Brisbane, Canberra, Tasmania and the Northern Territory. Last year some products were damaged in transit to Sydney, due to inadequate packaging. Distribution to Sydney and Melbourne ceased for 2 months until tougher packaging was introduced. At the same time, Asia Audio improved the strength and durability of some models within the range. The MDF board is now twice as thick and painted to protect the surface.

Price Structure The wholesale price comprises the manufacturing costs, freight costs, landed costs (i.e. stamp duty, fumigation, documentation and broker fee, shipment from port to warehouse) and wholesaler’s mark-up (80–89% for hi-fi racks, 40–41% for speaker stands). Wholesale prices range from $26 to $305. Malrica relies on the experience and personal judgement of its principals to determine the recommended retail price, which comprises the wholesale price plus retailers’ mark-up (50–65% for hi-fi racks, 49–58% for speaker stands). The Company believes it offers a competitive mark-up deal. The retailers’ mark-up is based on where a particular model is placed in the market and whether it is low or high selling. For example, an Audio Asia rack system made from MDF board should sell for a lower price than an entertainment unit manufactured with a more expensive glass surface. If no orders are received for over 3  months, the model is classified as low selling and 10% is subtracted from the wholesale price as a special discount to the retailer. This way the recommended retail price remains constant until a new model replaces the low selling product. Recommended retail prices range from $65 to $506. Malrica offers a 5% discount to retailers paying cash on delivery. Orders over $2000 receive a “gift” unit to be used for display purposes. Large orders of $5000 include longer credit terms, extended from 30 to 60 days, no freight charge and one or two “gift” units.

Marketing Initially Malrica relied on the Yellow Pages to select potential retail customers for the imported rack system and speaker stands. Mrs. Nguyen was impressed by large advertisements placed by furniture stores. Selecting those known to carry a wide range of branded hi-fi equipment, she sent details of the Company’s background,

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product features, and a brochure and price list. She hoped to initiate a personal relationship with potential customers, but the “cold call” approach generated only a 5–6% response rate. Malrica then decided to include an offer to provide product samples, paid for by the retailer if an order was forthcoming. Mrs. Nguyen also travelled interstate and followed the same Yellow Pages routine. She telephoned shops to obtain appropriate contact details and made appointments to give sales presentations. In all its marketing exercises, Malrica has stressed the rack system’s high quality, unique features, technical specifications and competitive price, believing these to be key selling factors. However, the Company believes sales-persons do not communicate these facts to shoppers and so it has tried to encourage retailers to promote the product by offering competitive wholesale prices and favourable terms. Until recently, two sales representatives were employed in Sydney and Melbourne to obtain new accounts on 10% commission. But after 1  year their results were found to be unsatisfactory, as they were selective in whom they approached. Malrica decided to continue supplying these same stores without the intermediary of a sales representative. Currently Malrica advertises in the West Australian, Sunday Times and Sunday Times magazine. These media are considered to be cost-effective due to the size of the readership and life span of the magazine. An experiment with cinema advertising was costly and ineffective, securing only one new retail customer. Malrica has also participated in electronics industry trade show in Perth, Sydney and Melbourne. Sharing exhibition space with a hi-fi retailer halved cost. Compared to advertising, the trade shows were judged to be cost-effective in promoting product awareness, but required considerable commitment and effort. The Company does not plan to participate in trade shows in these three cities again, but will test the same marketplace in Adelaide, Brisbane and Canberra. Malrica has conducted no formal market research to measure the effectiveness of current marketing activities. They have considered developing an online marketing strategy with an updated website and online ordering system. However, the cost and complexity of this, and the owner’s lack of experience in online marketing, led to them taking no action at this time.

Financial Management Sales have risen by 22% over the past 2 years, from $120,810 to $147,291. However, operating costs have also risen by 24% from $78,414 to $97,191 over the same period. This resulted in a small loss of $591, mainly attributed to the expensive cinema advertising.

5.8  Key Lessons from the Chapter

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Recent Developments Malrica’s has a policy to introduce a new product line every 6 months to keep retailers motivated. Four new hi-fi racks were added to eight existing product lines, as the result of a survey of 15 of the Company’s most successful retail outlets. When asked to rank their preferences, the hi-fi racks rated higher than the speaker stands, on the grounds that they are more profitable and popular. A recommended retail price for the new hi-fi racks was determined on the basis of the demand derived from the findings of the survey. Recently Malrica expanded into New Zealand, appointing a shop owner as sole agent for the region. By operating through an agent rather than supplying product direct to retailers, the Company is not obliged to set up an office in New Zealand and is able to conserve its resources.

Future Growth Malrica has a plan to open a warehouse in Melbourne if it can secure ten new retail accounts, which will provide large, regular orders. The Melbourne warehouse will supply Sydney and Brisbane, providing a faster, more efficient service to Eastern States retail customers and saving on freight costs. The Company will also open a branch office in Melbourne if an approach to secure an account with a large bulk discount furniture group is successful. Overall prices are estimated to fall by 15–17% when the price of existing product lines drops to match that of cheaper, new models. The Company hopes to attract new customers and increased sales with low prices. Malrica has no plans to finance its operations by borrowing, but believes increased market share and profit margins will make it possible for the Company to perform well in the future.

5.8  Key Lessons from the Chapter • Understanding what customers need and want, how they make their buying decisions, and how they use products or services is an important first step in the process of developing an effective marketing strategy. Once these customer needs and wants are identified, the firm can either develop or modify its product or service to meet customers’ needs and specifications. • Research shows that success is associated with: –– regular use of customer surveys to identify customers’ needs and wants; –– systematic branding of products and services and the development of their corporate image; –– possession of a formal marketing plan that is reviewed regularly; –– formal customer tracking and recording;

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–– staff training in customer service skills; –– regular product reviews following market feedback; and –– formal market research before a new product launch • Whenever a customer contacts a business, they are assessing the firm’s capacity and reputation. Such ‘moments of truth’ should result in customers being so impressed with the firm’s performance that they are delighted and are willing to provide word of mouth referral to others. However, if they have a bad experience, this word of mouth will be negative and the damage to the business will be immeasurable. • Listening to the customer and being responsive to their needs rather than simply trying to sell products or services is a key hallmark of customer delight. Ownermanagers of small firms should be able to provide at least six good examples of customer delight and a similar number of clear examples of how their business has demonstrated its commitment to customers from the recent month’s business activity • The aim of any small business owner should be to widen their range of leading customers in order to avoid becoming overly dependent on one or two key accounts. • For most small firms, the best time spent is that devoted to networking with leading customers. Owner-managers from small businesses can use strategic networks to secure new business opportunities, defend existing market share or acquire access to resources that might otherwise be outside their reach. Unfortunately, many small business owners don’t fully appreciate the importance of strategic partnerships and are often reluctant to engage in strategic alliances out of a fear of losing valuable information, or out of a desire to remain independent. • Being key data aware refers to a situation in which the owner-manager knows how they win their business and what information they need to gather to monitor their customers. Such information includes knowing: who buys, why they buy, and how they buy (frequency and search patterns). • Customers buy hopeful expectations not actual things (Theodore Levitt, Harvard Business School). Thus, it is important to focus on the customer and not the product. This has several important consequences: Research the customers’ needs and wants; Segment the market; Adapt the product or service to the customer; Seek competitive advantage by value adding not cost cutting. • The process of gathering data to identify customer needs can involve a range of market research techniques comprising both qualitative and quantitative methodologies. –– The focus group often stimulates participants’ thinking and can elicit information that could otherwise be missed in surveys or one-on-one interviews. However, the focus group needs to be facilitated by an experienced researcher –– An alternative is to conduct one-on-one interviews with customers. This is more time consuming and therefore more expensive, but can be just as revealing.

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• A part of the segmentation process is to classify all customers or customer segments according to their value to the business. There are various ways that a customer might be classified. One suggestion is to apply various customer classification methods: Cash flow (classify customers according to how regularly and reliably they pay their invoices); Investment portfolio (customers can be viewed as investments); Image enhancement (the customer viewed as an opportunity to secure positive image benefits for the firm); Compatibility (select customers according to their ability to fulfil the firm’s mission); The 80/20 rule. The truth in most firms is that 10–20% of all customers generate around 80–90% of sales and profits. • Keeping KPI figures is important not only to guide activities associated with the implementation of the marketing strategy, but also to ensure that corrective action can be taken if goals are not achieved. • Realistic benchmarks should be set that keep the business moving along at a pace that is desirable, but that also allow the management team the opportunity to deal with unexpected developments. • Without a coherent and effective approach to selling, it is unlikely that a small business will have success in its marketing. Key questions that the owner-manager should ask about how selling takes place in their business are –– Who does the selling in the company? Is it the owner-manager or a sales team? –– How well organised and briefed is the sales team to allow them to sell the benefits of the firm’s products or services and to highlight its distinctive competencies? –– How does the firm measure sales performance, e.g. conversion rates, new business created, selling the range, call rates? –– How effective is the feedback on customers, competitors and the environment? • All staff – particularly those that have contact with customers – should be aware that they are essentially frontline sales people and should be well trained in how to deal with customers; a key question to ask is: Do your meetings with customers leave them better off? • There are at least three broad types of relationships that a small business can develop with its customers during the sales process: 1. The supplier. In this relationship the role of the sales person is to solve a logistic problem such as shipping, billing or replacing 2. The counsellor. In this type of relationship, the sales person is viewed as having expertise in a given area. 3. The systems designer. The customer wants a total solution to their problem and need a sales person who can design and implement a systematic approach. • A sales track is a systematic plan designed to guide the sales presentation. It needs to be well thought through and rehearsed until it can be delivered much as an actor might deliver his or her lines in a play. It is important that this sales track be delivered in a natural manner, supported by a genuine belief in the product or service being a solution to the customer’s problems.

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• The 10/30/60 formula of top-of-mind marketing suggests that they target about 60 percent of their marketing and sales effort at existing customers. The next 30% of sales efforts should be targeted at new customers who are well suited to the firm’s mission and fit the profile of a target customer. Finally, the last ten percent of any marketing and sales efforts should be spent on the general community or mainstream market as a form of image building exercise. • The market mix has been described as the 4-Ps comprising: product, price, placement, and promotion, around which any marketing plan should be developed. For service firms these four elements are complemented by a further three: process, people and physical evidence • Because all people are not the same it is essential that target market segments are identified. This involves dividing a heterogeneous group of buyers or potential buyers into more homogeneous groups with relatively similar product needs. Market segmentation is important as it improves a firm’s understanding of the target market. For a segment to be worthwhile it must be sufficiently large to provide good sales volume over a long time period and from customers willing and able to pay a price able to produce strong profit margins. • The larger the market the more specialised the firm may need to become if it wishes to maintain a competitive edge. It is important to understand that in marketing perceptions are really what make or break the business. • The development of a brand name for a business or its products is one of the most important things that an owner-manager can do as part of their marketing strategy. It is likely to require a good deal of time (perhaps 5–10 years) and a significant investment to build a brand. However, money spent on branding is an investment not a cost. • The quality of people is often measured by how responsive and empathetic they are to customers. Responsiveness is associated with a willingness to help customers when they experience difficulties and to respond promptly. Empathy toward the customer can be demonstrated by the degree of personal attention shown and how well the firm’s employees appear to understand the specific needs of the customer. • Small firms seeking to enhance their credence qualities should take care to ensure that their image is carefully controlled to project the best possible impression. Brochures and marketing materials should be professionally developed and the product’s presentation and packaging should be designed to provide an image of quality and functionality. • A model for measuring customer service quality is known as the SERVQUAL scale, it consists of 22 question items, grouped into five dimensions, that deal with: (i) empathy; (ii) responsiveness; (iii) reliability; (iv) assurance; and (v) tangibles.

Chapter 6

Work Book: The Process of Growth in the Small Firm

6.1  Learning Objectives After completing this chapter, you should be able to: • • • • • •

Understand the growth cycle of small firms. Understand the importance of the owner-manager influence on growth. Understand models of small business growth. Examine the owner-manager’s perceptions of growth. Recognise the key problems facing small business growth. Apply growth management principles to a small business case.

6.2  Chapter Review Growth is only one option available to small business owner-managers and one that most do not chose to follow. Most small business owners are content to manage their firms primarily for lifestyle rather than growth. If the owner-manager decides to pursue growth they must learn how to manage ever increasing scale and scope, putting in place systems to allow the business to be effectively controlled. Keeping the business profitable during major periods of expansion is one of the most important challenges as overheads rise and working capital is at a premium. As the business expands, the owner will find they must deal with a succession of crises that are brought about as a result of expansion. However, growth in the small firm is not linear and may depend upon the owner’s management skills, and their capacity to implement operational systems in a timely manner. The key elements that must be addressed as the business seeks to expand are those related to the firm (e.g. systems and resources) and those related to the owner-manager (e.g. skills and strategic vision). © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_6

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For owner-managers who wish to succeed in growing their business it is likely to be necessary for them to first recognise the need to change, and then gradually develop a management team within the firm to whom they can delegate authority. For most small firms the key to growth is to identify new product or market opportunities that allow the business to build upon its existing resources, skills, knowledge and reputation to pursue them. In developing future growth, the business will need an entrepreneurial leadership with clear vision, a sound innovation strategy that allows it to create a sustainable point of difference, strategic networks from which it can access resources and access to new markets, and a well-considered product-market development strategy. The owner-manager will need to maintain a balance between the firm’s strategy, structure and resources as they manage the growth. Small business owners are not necessarily motivated to grow their business out of purely financial interests. They may be also motivated by external and even altruistic reasons. Growth will require them to acquire new management skills, and systems to control marketing, human resources, quality and finance. Successful firms will need to be very customer focused and able to build a competitive advantage not based on price. They will also benefit from a systematic approach to business development and sales management, as well as seeking external expert advice to help shape strategy.

6.3  Short Answer 1 . Explain why a small business owner might choose not to grow their business. 2. Describe the phases associated with stage models of small business growth. 3. What are the seven stages through which an owner-manager should move when seeking to develop a professional management team within their business? 4. If your profits for this year are $880,000 and the profits from last year were $560,000, and this trend continues into future years, what would your growth factor be? 5. The owner-manager seeking to grow their business needs to launch from five main ‘bases’. What are they? 6. List the five main elements associated with growth in small entrepreneurial firms.

6.4  True/False

1. Growth is a primary motivation for the majority of small business owner-managers 2. Diversification into new markets with new products is usually the most successful strategy for small businesses

True False [  ] [  ] [  ] [  ] (continued)

6.5  Individual Research Paper

3. Growth can frequently have an adverse impact on a firm’s profitability 4. The key to successful growth in a small business is the owner-manager’s ability to delegate and transfer their knowledge to a team 5. Successful growth in the small business is a process involving three key elements: key data awareness; not price driven; and use of experts and family

53 True False [  ] [  ] [  ] [  ] [  ] [  ]

6.5  Individual Research Paper The purpose of this assignment is to assess your understanding of the nature of small business management and their managerial environment. In undertaking this assignment, you should draw on the experience of working within your class on group assignments, and/or any direct experience you may have had with small businesses. You should build on that personal experience and also use the textbook, recommended readings, class lecture notes and other relevant material to provide you with sufficient information to address the assignment tasks.

Requirements Small businesses are important to the economy and governments want to assist SMEs to grow and generate more jobs. However, not all small business owners are entrepreneurs, and most don’t seek to grow. Further, the process of growth is challenging and requires the business to have a good system of creating customers, and also the competence and systems to manage profitable, sustainable growth. Drawing on the readings and your own experience with the group project discuss the realty of small business management and growth and key factors that must be understood to allow sustainable, profitable growth to occur. Write a research paper of around 2500–5000 words and address the following issues: • • • • • • •

Discuss the nature of small firms and their role in the economy. The difference between entrepreneurs and owner-managers. The factors that influence survival and growth in small firms. The role, nature and importance of planning. The role, nature and importance of marketing, sales and service. The role, nature and importance of financial management. Support your research by providing evidence from academic literature sources.

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6.6  Case Study Analysis Read the KITSOL case study, which provides an example of a typical small business that has grown strongly but now finds itself in need of consolidation and restructure if it is to avoid a crisis. Image that you have been approached by these two owners who seek your views on what they should do next.

Questions/Tasks Prepare a report for the owners that draws together the readings for this topic and other topics with attention given to the following: 1 . Identify the key problems currently experienced by the business. 2. Prepare a growth strategy for the business that provides guidance to the owners as to how they should prepare their business for successful expansion.

6.7  Case Study: KITSOL: The One Stop Kitchen Solution Author: Aniket Maroo This case study relates to the story of Bill and Dean, two Australian friends living in Sydney in the 1990s in the period leading up to the Olympic Games held in that city in 2000. Inspired by a desire to make best use of their skills and talents, they embark on a business venture focusing on the design and manufacture of domestic and commercial kitchens. As outlined in this case, their business is initially very successful, but it also experiences a common problem of growing too fast and outstripping the management skills of the two owners. Despite the passage of time, the lessons from this case remain valid today.

Cooking Up an Idea On 30 September 1993, Dean decided to pack in his job as a salesman. Sure, he had a respectable middle-class lifestyle, a house on the outskirts of Sydney, a beautiful understanding wife and two adorable children, but he felt he had little else to show for all his hard work and long hours. He loved cabinet making and dreamt of being his own boss, using his carpentry and marketing skills for his own benefit. And so, with 12 years’ experience in the commercial kitchens industry, $12,254.45 savings in the bank, faith in his abilities and the use of a large two-car garage as a temporary workshop, he started his own business manufacturing domestic kitchens.

6.7  Case Study: KITSOL: The One Stop Kitchen Solution

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Dean’s reputation for fine craftsmanship and attention to detail brought him many orders. By the middle of 1994 business was booming and his bank account was comfortable, but he was still working long hours and his wife was becoming less understanding. The garage was full of half-finished kitchen cabinets, work was spilling over into the house and tradesman came and went as they pleased. Dean had a dilemma. As Dean contemplated his future over a beer with his mate Bill, Bill said he was looking for an opportunity to employ his entrepreneurial skills. There was a strong possibility that Sydney would be awarded the Olympics in the year 2000. Countless cafes and restaurants would open to meet the expected tourist bonanza and this would present a huge window of opportunity for any Sydney-based business involved in the hospitality industry. The boys had another beer and agreed they had a common goal, to be successful. They realised Dean’s success so far was due to his “one-stop-shop” concept to manufacture and market domestic kitchens under one roof. The chance to cash in on the Sydney Games and build up Dean’s backyard business was irresistible. Bill and Dean shook hands and formed a partnership to supply kitchen cabinets to the restaurant market.

KITSOL Launched The partnership was formalised by Dean’s accountant, Terry, who structured the new business in a unit trust, with the boys’ family trusts owning an equal share of units. Terry explained that a unit trust was like a partnership with the trust deed being the equivalent of a partnership agreement. Within 48 h of his first meeting with Bill and Dean, Terry had organised the purchase of the unit trust deed and a shelf company to act as trustee. An application for a new business name, KITSOL short for Kitchen Solutions, was registered by the Ministry of Fair Trading and a 5-year lease on a factory unit in a nearby industrial area was signed. KITSOL was launched with much fanfare in July 1994. A brief one-page business plan stated the Company’s vision was “success” and publicity brochures described its mission “To be the best supplier of kitchens to the dining out market in NSW”.

Business Booms The boys worked hard to ensure their new business prospered and KITSOL’s took off like a rocket. Dean still worked long hours, but there was less stress at home now the rapidly expanding business was based in a factory unit. Additional warehouse space was leased adjacent to the first unit and specialised staff were hired to keep pace with orders. Within 2 years, KITSOL employed a designer, a skilled fitter, four

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carpenters and an administration manager, Laura. But as the work force grew, the boys remained involved in the manufacturing process, to control overheads and quality. Bill and Dean got a real buzz from KITSOL’s rapid success and they soon realised that their business was the only business in the industry offering a total kitchen solution, from the initial free design concept to manufacture, installation and after sales service. KITSOL capitalised on its total kitchen solution concept by designing and building customised kitchens from its own handcrafted or commercially manufactured cabinets and by suppling kitchen equipment directly to the customer from the factory.

Friends and Partners Bill and Dean worked well together, which was no surprise to people who knew their friendly, easy-going personalities. They agreed on most business decisions and found mutual ground to deal with problems and differences of opinion. On a personal level, they had a lot in common and became close friends. Dean’s wife Lyn got on well with Bill’s wife Julie and as a consequence the four often socialised together. They had one golden partnership rule, to do everything fairly and equally. If Dean wished to purchase an asset for his family using partnership funds, Bill would purchase something of an equal value for his lifestyle needs. Despite KITSOL’s fast growth, cash flow was never a problem and the two partners were able to purchase the few luxuries they had always wanted. These included smart clothes and new cars, to present an image of success as their jobs focused more on sales and marketing. New family cars were also purchased for Lyn and Julie, financed through the business with a lease from the local bank.

Financial Flavour Dean and Bill had both been through the recession of the early 1990s and they decided to build a nest egg for a rainy day. They put $50,000 into a bank account and stretched their credit terms as long as possible, to ensure they enjoyed maximum benefit from the credit period. KITSOL had very few bad debts, largely because customers were required to pay a 30% deposit before orders commenced and periodic payments as work progressed. The industry is subject to a 10% retention for a 30-day period after jobs are completed. KITSOL had little difficulty collecting these outstanding monies, due to its ability to deliver a quality product on time, but on average retentions were collected 60 days from job completion. As the gross margin for their work was normally 30%

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on sales, Bill and Dean were not too concerned about pursuing retentions. By the time a job was completed, they had collected and banked 20 of the 30% margin. They had a business philosophy that it was better to win further work and earn the first 20% margin, rather than waste time collecting the remaining 10% on completed orders. By the end of its 1st year, KITSOL showed a turnover of $1.0 million, which the boys believed was exceptional by any standards for a newly established business. By December 1995 turnover approached $550,000 for the first 6 months of the 2nd year of operation. Bill and Dean met with Terry in January 1996 for their annual meeting to discuss KITSOL’s financial performance and tax issues. Clearly 1995 had been a good year and 1996 was looking bright. Sydney had been chosen for the Olympics and the boys knew orders would now pour in, as restaurant and café owners refurbished in anticipation of the bonanza. However, Dean expressed some disquiet about the monthly results he had been reviewing. They appeared to show the Company trading on a 25% gross margin and not 30%, as previously indicated. Terry suggested this may be due to any number of factors including a lack of proper month-end cut off procedures, but suggested there was no need to worry as long as cash flow remained positive. The boys were reassured. Dean also had some qualms about KITSOL’s accounting systems. When Laura first joined the company as administration manager, she muddled her way through a new accounting package she had selected, but her financial skills never progressed beyond book-keeping level. This was an embarrassment to Bill who had hired Laura largely because of her excellent resume and a letter from her previous employer, which spoke highly of her accounting skills. Terry used the rest of the meeting to explain some clever tax planning which involved re-financing their home loans in the Company name, so that KITSOL paid interest from pre-tax dollars. The idea appealed and the boys asked Terry for his advice on a property they wanted to buy in Manly as an investment for capital appreciation and a holiday home, to be shared between the two families. Terry proposed the same finance arrangement could be applied to an investment property, which was let on a full-time basis. Later in the meeting all three lamented the staff problems they were experiencing, in particular high turnover and lack of motivation, which was affecting productivity and profit margins. Terry mentioned a program of appraisals and counselling which his firm had introduced recently, to evaluate staff performance. Bill made a mental note to try something similar at KITSOL. He raised the issue with Dean, but he said that because of his production background, he found it easier to complete any outstanding job rather than broach the subject with the employee, in the belief that this approach sustained a harmonious working environment. As a consequence, staff evaluation was deferred until a future date when KITSOL recruited a specialised manager.

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Hey Big Spenders By March 1996, Bill and Dean were very pleased with the way things were going, so they went ahead and purchased the holiday home and an investment unit in Manly for their family trusts and financed through a bank loan in the Company name. They also bought by hire purchase two motorbikes for weekend country rambles and two ski-jets, financed through leases organised via KITSOL. In June 1996 it appeared KITSOL would end the financial year with a turnover of $1.2 million. The Company’s cash position was satisfactory, even though it was now servicing a bank loan to support property and other assets extraneous to the business. Neither Bill nor Dean were working the same long hours as before, although they spent more time supervising jobs than they would have preferred, due to lack of confidence in their staffs’ commitment to finish orders to their high standard. Only Greg, the factory supervisor, seemed to relish the business as much they did. They often thought how lucky they were to have somebody of Greg’s calibre working for them and wished they could find two others like him to supervise all the jobs and relieve them of this responsibility. The monthly accounts were still causing Dean some confusion. He could not reconcile the reported profits, which were lower than their cash flow forecast. His knowledge of accounting was rudimentary, but he told Bill he was not concerned because Terry had said positive cash flow was the key issue. While they were comfortable with Terry’s advice, Bill and Dean felt they needed a business mentor to advise on future direction. They appointed Andrew, who came highly recommended, as their future business adviser and tax accountant. At their first meeting with Andrew, Dean explained the tax driven rationale for their borrowing’s through the Company. However, when pressed further by Andrew, he could not explain why the idea was tax-effective and suggested he ask Terry to explain.

Too Many Cooks In May 1996, KITSOL purchased some inexpensive coffee and muffin-making equipment and the boys decided to open a coffee shop, to be run by them initially and then sold for a profit as an operating business. The economics of the venture were sound and did not compete with their existing line of work. Of course, KITSOL would build the cabinets for the fit-out. As it turned out, Bill and Dean did not have time to look after the coffee shop themselves and so they invited Greg to be a one-third partner in the new venture. They both believed this was an appropriate reward for Greg’s diligence and hard work over the preceding months. Greg was keen to spread his wings and eagerly accepted the offer.

6.7  Case Study: KITSOL: The One Stop Kitchen Solution

59

In July when the fit-out was finished, Greg asked Dean if he could run the new business for the first 4 weeks until an experienced operator was recruited. Dean was not keen on this idea. He wanted Greg to continue to supervise production whilst he used the time to come to grips with KITSOL’s finances. Greg then broached the subject with Bill who agreed on the grounds that as it was winter and orders were a bit slack. Dean blew his top when he found out. Bill and Dean had similar managerial styles. Both preferred to avoid conflict and tried hard to appease everybody. They discussed the issue at length. Bill recognised Greg’s input was indeed required at KITSOL, but he believed greater damage would be done by reneging on his offer, rather than looking for a mutually satisfactory solution. In the end Bill’s view prevailed but nothing was communicated to Greg about the importance of his work at KITSOL. Dean felt he had no alternative but to support Bill’s view on the matter. Reluctantly he agreed to supervise production in Greg’s absence but he was unhappy with the situation and discussed the matter with his wife Lyn over dinner. Lyn suggested he refer to the partnership agreement to ensure a similar situation could not arise again. The following day Dean could not find the partnership agreement in his filing cabinet. He called Terry to ask for a copy. Terry suggested he look up the unit trust deed which governed their corporate partnership, to see how these issues could be resolved. Dean was mystified and confused, especially as he also wanted to know what would happen to his share of the partnership if something happened to him. He decided to ask Andrew next time they met. In the event, in the hustle and bustle of business, the matter was forgotten. Greg really enjoyed operating the coffee shop and offered to buy-out his partners at a price, which gave them a modest profit. This was a double blow for Bill and Dean. They had anticipated a higher profit and now found themselves in an awkward position. If they refused Greg’s offer, they were sure to lose him as an employee. The coffee shop would be left without an experienced operator and a 30% minority partner who would want his cash back. With some reservations they accepted Greg’s offer and vowed never to undertake a project with an employee in the future. In the meantime, as part of their financial year-end tax planning exercise in June 1996, Bill and Dean purchased some new equipment for the factory and contributed $20,000 to a newly established superannuation fund, with a view to purchasing a commercial property for their future needs. The property acquisition was discussed briefly with Andrew, but due to pressure of time they carried on and signed an agreement for the super fund to make the purchase.

The Proof of the Pudding In September 1996 KITSOL took part in the annual Hospitality and Catering Expo and won two awards, including best stand. As a result, business has gone through the roof and the boys have been run off their feet satisfying all the customer orders.

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At least three scheduled meetings with Andrew have been postponed due to their workload, but cash flow remains satisfactory. Despite the long hours they have put in recently, Bill and Dean are very happy with their progress to date. When they set out in partnership, they had a vision to succeed and judging by the size of KITSOL’s turnover, they believe their goal has been reached and their mission “To be the best supplier of kitchens to the dining out market in NSW” is almost fulfilled. In addition to the Hospitality and Catering Expo awards, KITSOL won three small business awards in 1996 and was featured in a catering magazine (Tables 6.1 and 6.2). As the boys reminisced over a Christmas Eve drink, Dean said, You know Bill, we have only failed in a couple of areas over the past couple of years. One was to lose Greg, but then he would have left at some stage anyway and the second is that we are still working really long hours. Do you remember when we first started, we used to have a weekly meeting with the staff over a few drinks? Well that’s not happening any more. But I don’t think we are any worse off, because we still end up having to make sure each job is done right.

Bill agreed. Table 6.1  KITSOL Pty Ltd. balance sheet previous 2 years

Trust capital Issued units Total Trust Corpus Current assets Cash Receivables Inventories Total current assets Non-current assets Property, plant and equipment Advances to unit holders Total non-current assets Total assets Current liabilities Creditors and borrowing Deposits in advance Total current liabilities Non-current liabilities Bank borrowings Provisions Total non-current liabilities Total liabilities Net assets

1996 $

1995 $

50 50

50 50

57,513 50,031 29,251 136,795

41,467 25,925 29,251 96,643

32,080 581,276 613,356 750,151

33,894 23,565 57,459 154,102

186,300 50,200 236,500

131,201 21,236 152,437

511,986 1615 513,601 750,101 50

− 1615 1615 154,052 50

6.7  Case Study: KITSOL: The One Stop Kitchen Solution Table 6.2  KITSOL Pty Ltd. profit and loss account previous 2 years

Sales revenues Sales from operations Other sales Total sales Cost of sales Opening work in progress Purchases Sub-contractors Less closing work in progress Cost of goods sold Gross profit on trading Interest received Total income Less expenses incurred: Accountancy Advertising Bad debts Bank charges Borrowing expenses Cleaning Computer software Depreciation Electricity Fees and permits Freight and haulage Fuel, oils & lubricants Hire of plant and equipment Hire purchase charges Insurance Interest and other loan charges Interest and charges recovered from unit holders Lease payments Motor vehicle expenses Car lease payments

61 1996 $

1995 $

1,110,963 − 1,110,963

1,091,969 − 1,091,969

29,251

8887

331,689 360,455 721,395 (29,251)

557,444 210,362 796,693 (29,251)

692,144 418,819 4169 692,144

767,442 324,527 − 767,442

9245 18,864 12,152 3434 1931 688 3242 8970 2658 3094 6328 10,528 930

− 3554 − − 2177 100 425 − 8985 1290 795 9836 8758 6674

680 9303 22,365

1980 22,215 117

(22,365)

−

20,005 3892 6895

10,922 2612 − (continued)

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Table 6.2 (continued) Printing, stationery and postage Professional fees Protective clothing Rent, rates and taxes Repairs and maintenance Security Staff training and amenities Subscriptions Superannuation Sundry expenses Telephone Tools replacement Travelling expenses Wages Waste removal Total expenses incurred Net profit Distribution of surplus Dean family trust Bill family trust

1996 3960

1995 3286

5758 1060 33,298 5030

6169 945 10,381 7190

1565 5132

195 2661

681 9571 2030 5362 2161 10,271 216,871 600 426,189

2652 6657 450 6466 2299 9715 157,418 263 297,187

58

30,798

29 29 58

15,399 15,399 30,798

Good thing we have our meeting with Andrew next week, but what I can’t understand is how it is we have just posted a turnover of $700,000 for the last six months, have a budget to achieve $1.5 million by the end of the financial year and we still find ourselves working the same long hours as when we started.

“You know Bill” Dean concluded, We need someone like Greg to look after the factory. Maybe I should call Simon. He’s good and I hear he’s not too happy at work at present. I tell you what, Laura has just produced the Company’s 1996 results and I must say they don’t look so flash at first sight, but I am sure Andrew can throw more light on that. How about we mention Simon to him when we meet in mid-January to discuss the 1996 finances?

6.8  Key Lessons from the Chapter • Research into the growth of small firms has indicated a series of stage-models in which the business moves through a number of defined stages as it grows. An underlying assumption of these models was that most firms will follow the same

6.8  Key Lessons from the Chapter

• •

•

•

•

63

trajectory from one stage to the next. While the actual growth of individual small firms may not be as linear as such theoretical models suggest, they provide a useful framework against which to analyse the experiences of particular firms At each stage of the process the small firm can grow, plateau or even die. It is common for many small firms to plateau and remain quite small with limited resources and local horizons. This capped-growth is usually the result of a conscious decision by the owner-­ manager to restrict the firm’s expansion out of a desire to avoid risk, uncertainty and the general problems associated with hiring more employees, winning new markets, developing new products or securing new capital investment. There may also be a lifestyle decision involved in which the owner-manager chooses not to grow the firm due to satisfaction with a small-scale operation that delivers low stress and an easier life. Such decision by the owner-manager may take place in the relatively early stages of development or it may take place later For many firms, growth is painful and requires change in management style and structure. As firms grow, they invariably have to take on more employees and management staff. These managers are frequently specialists in fields such as marketing, accounting or production. Increasing the size of the management team without developing the teamwork within this team can result in inefficiencies. The option of growth requires a focus on market opportunities and these must be supported by good levels of innovation within the business. Sustained growth will require the business to launch products into markets that have above average profits and returns to investment for the business. The option requires the owner-­ manager to possess visionary leadership and the ability to set clear strategy and implement it. One of many five-stage models of organisational growth suggests that the firm grows via a series of ‘crisis’ usually preceding a transition to a new phase where more evolutionary growth can occur. Five distinct phases are identified during the growth cycle. The managerial practices to be found in most firms at each of the five phases of the growth cycle vary 1. The first phase is that of Creativity: the characteristics found within the firm are those of informal communication and control structures, and a premium on managerial leadership – 2. Once the firm grows to a scale and complexity that cannot be easily managed by one or two persons, the firm experiences a crisis of leadership and must establish a team of professional managers. This phase is called Direction, and features the introduction of systems to ensure control and coordination. 3. Once the scale and scope grow too large, the firm experiences a crisis of autonomy whereby sub-units within the firm seek greater independence from central control. This forces the firm to enter the next phase of Delegation. 4. If diversification becomes too great, the firm experiences a crisis of control and the firm enters the next phase of Coordination. Here, the senior manage-

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ment seek to regain control via formal portfolio planning and divisional configuration. 5. Finally, the firm experiences a crisis of red tape and enters the Collaboration phase, where senior management is more flexible and sophisticated in its control measures. • Small business growth is not necessarily a linear process and is likely to depend upon the managerial learning of the owner-manager. The management structure of a small firm may or may not follow the well-defined frameworks outlined above. In some cases, the business may leap forward and be formed with a more advanced managerial structure despite its modest size. The business may have some of its functions (e.g. marketing, finance, operations, and human resources) move at different speeds in terms of how they are professionally managed within the firm. • Although successful growth within the small business sector is contingent upon many factors, the most important is arguably the attitude of the owner-manager. The decision to grow is a risky one that many entrepreneurs choose not to make. • The reasons why so many small business owner-managers should not desire growth are numerous. Concern over having to go into debt is a deterrent to many; growth can also represent a loss of personal control by the owner-manager; inadequate management skills, particularly in strategic planning, can serve as a deterrent; access to finance has also been identified as a major impediment to small business growth; the inability of the small business to seek out sources of information and technology needed for growth has also been found to act as a potential barrier • A particular strength of small firms is their ability to flexibly adapt, with their organisational culture being adaptable due to their small size and openness. Firms with too much rigidity and formalisation or those with no structure or rules are less likely to succeed than those that can strike an effective balance • The need for the owner-manager to adapt their management style and thinking to meet the challenges of growth is particularly important among firms that experience rapid growth. A study of firms experiencing rapid growth rates found that the firms which successfully made the transition from small to large were characterised by owner-managers who could create a vision of the firm as a larger entity. • The key elements which should be examined in reviewing the base potential of a small firm that is considering future growth include five ‘bases’: –– The resource base: attention should be given to the firm’s financial resources, particularly its cash reserves, the firm’s plant and equipment and its state of repair; its products or services; the firm’s employees and management team, the possession of state-of-the-art technology –– The experience base of the business relates to its corporate knowledge of doing business in a given market or markets.

6.8  Key Lessons from the Chapter

65

–– The control base: Control within the firm is likely to occur as a result of the ability of the management team to secure reliable information, and then to use this data to make decisions. –– The ideas base: Attention should be given to the firms’ capacity to undertake R&D and new product development –– The leadership base: Key issues that should be examined here are the age, education and family influences of the owner-manager. What are their personal goals for the firm and their motivation to achieve their goals? • The process of growth within a small firm framework may be understood thanks to a model that comprises five key elements and is built around the basic entrepreneurial process of opportunity recognition, resource accumulation and capacity building. 1. Entrepreneurship: Growth requires an orientation that is entrepreneurial. In essence the mental attitude of the owners of the business can determine how well the firm is likely to perform in the future. 2. Innovation: Any business that does not continuously seek a competitive edge through value adding to products, services or processes is unlikely to achieve much sustainable growth. 3. Strategic networking: The third element of the framework relates to strategic networking. Because small firms lack the resources needed to undertake all the work, they need to do to achieve their goals it is necessary for them to form strategic alliances with other organisations. 4. Growth vector: The fourth element within the framework is the growth vector suggesting that growth is achieved by a combination of matching products to markets. 5. The strategic triangle: Finally, the framework includes the balancing of the strategic management triangle comprising the three elements of strategy, structure and resources. Strategy requires the owner-manager to clearly define the future vision they have for both the firm and themselves. • Once the strategy is clear, the owner-manager needs to review their structure and determine if they have an appropriate organisational design. For many small firms the lack of internal resources is likely to require them to form strategic alliances to allow them to access management and operational skills and resources • Research suggests that contrary to economic theory, the desire to achieve financial gain from the growth process is not always the primary motivator. Growth motivations among small business owners were significantly associated with achievement drive but also about maintaining independence and their sense of purpose. • An important issue in the management of growth is how to measure it and whether or not the rate of the firm’s expansion is controllable. For small business owner-managers, the physical size of their business (e.g. its structural quantity) may be of less importance than the overall sustainability and functional quality of the firm.

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• Some initial research undertaken with small fast-growing businesses in Australia suggests that owner-managers of such firms are likely to be associated with four distinct characteristics. 1. Key data awareness: Owner-managers within the above average growth group were more likely to score highly on Possession of key data to allow them to delight their customers. And Knowing how their business was won and what information to get to monitor their customer’s behaviour. 2. Not price driven: Owner-managers within the high growth group were strongly associated with being able to state confidently that price increases will not affect the demand for their products. And that price is not the key buying criteria for their customers. 3. Business generating system: Owner-mangers within the high growth group were able to state with confidence that they sold proven products into established markets, they had confidence of continued growth in their established markets; they actively planned for new products and markets and they possessed a business generating system. 4. Use of experts and family: The owner-managers within the high growth group were more likely to: make use of external advisors for assistance with their business and make time to be with family and friends to achieve life balance.

Chapter 7

Work Book: Small Firms and Human Resources

7.1  Learning Objectives After completing this chapter, you should be able to: • • • •

 ompare human resource management (HRM) in small and large firms. C Understand the importance of delegation and team building. Consider case studies of team building in small firms. Understand the importance of coaching and how to apply a coaching model. • Develop human resource management systems for a small firm. • Understand the general legislative environment surrounding small business employment.

7.2  Chapter Review The classification of firms into micro, small, medium and large is undertaken primarily on the size of their payroll. As the business expands in size the role of the owner-manager becomes more complex and leadership more important. The owner-­ manager’s ability to develop his or her staff into a team who can operate systems efficiently and effectively is one of the most critical elements in the firm’s long-term success. If the owner-manager is unable to develop an effective team, capable of taking over responsibility for operation of the business, it is problematic that they can ever successfully grow their firm. In this chapter we look at the duties and

© Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_7

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responsibilities of small business owners when recruiting employees, and the importance of team building to the successful development of a small business. We also examine the need for the owner-manager to view their role as that of a coach and the importance of coaching skills to successful team building. Effective human resource management within the small business is essential to the longer-term productivity and growth of the firm. Small businesses do not apply human resource management processes in the same way as large firms, and are typically more informal. However, as the size of the firm’s employment base increases, the need for systems and a more formal HRM system becomes necessary. The owner-manager is a critical element in the success of any small business HR strategy, and should seek to develop a partnering with employees to foster the most appropriate culture and workplace environment. A common trap for small business owners is to micro-manage employees. This should be avoided by a decision to delegate authority and build self-managing teams. Small business owners need to learn to become coaches and a process of delegated coaching and team building should take place within the business. This requires the owner-manager to step back and let go to key team leaders or front-line managers, who may be referred to as the E-Team. In seeking to build an E-Team the owner-manager can make use of psychometric tests such as the social styles framework, which helps to determine differences between individuals and match team members. Owner-managers should also ensure that they have clearly defined values and seek to build their business on strong, ethical foundations. The owner-manager should be able to design jobs within their firm and undertake effective recruitment and selection interviews. The small business owner must also understand the industrial relations legislation within their locality.

7.3  Short Answer 1. What are the main risks of micro management for a small business owner-manager? 2. Briefly describe the key differences between human resource management in small and large firms. 3. What are the six stages through which an owner-manager should move when undertaking a performance review process? 4. What are the five main considerations in good job design? 5. List the main obligations an employer has in relation to their employees. 6. What are the four basic social styles found within people? 7. What are the key elements that should be incorporated into job design, description and motivation systems?

7.5  Case Study Analysis

69

7.4  True/False

1. The introduction of the new awards system under the fair work regulations of 2009 means that all workplaces in Australia are subject to the national employment standards 2. XYZ company which employs 10 people dismissed John, an employee who has worked for the business for the past 6 months. John has the right to seek an unfair dismissal claim 3. Small business owners are liable to pay a sum equivalent to 9% of their employee’s wages into a complying superannuation fund if that employee earns more than $450 gross income during a calendar month and is of normal working age 4. Worker’s compensation insurance is not compulsory for small businesses but is a desirable option in case employees injure themselves at work 5. Sally is a small business owner who has decided to terminate the contract of an employee Sam (aged 46), who has been working with the company for 5 years. In this case Sally will need to give Sam at least 4 weeks’ notice

True False [  ] [  ]

[  ] [  ]

[  ] [  ]

[  ] [  ] [  ] [  ]

7.5  Case Study Analysis Read the KITSOL case study from the previous chapter, which provides an example of a typical small business that has grown strongly but now finds itself expanding with a need for more effective team-based management. Imagine that you have been approached by these two owners who seek your views on what they should do to improve their workforce productivity and assist with delegation of responsibility. Prepare a report for the owners that draws together the concepts outlined in this chapter and those covered elsewhere in this book and other readings. You should give attention in your report to the following questions and issues.

Questions/Tasks Prepare a report for the owners that draws together the readings for this topic and other topics with attention given to the following: 1. Identify the key weaknesses in their existing approach to human resource management.

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7  Work Book: Small Firms and Human Resources

2. What are the key things that the owners of KITSOL should consider if they wish to develop an effective approach to human resources management in their company, and create team-based operations?

7.6  Key Lessons from the Chapter • The owner-manager is usually burdened with a variety of HRM functions for which they are generally poorly equipped. What is required is the development of a suitable HRM policy and procedure. Ideally this should be flexible and not a mere addition to the bureaucracy. As the number of people employed within the firm increases the need for a formal HRM manager or process also becomes more pressing. With less than 100 employees the firm can probably operate successfully without a full-time personnel or HR manager. However, once the employee base exceeds 150 a professional manager may be required and over 200 a dedicated HR department can be necessary. • Major external factors influencing the adoption of formal HRM practices by SMEs were the nature of the firm’s corporate governance and proprietary control. For example, firms that had boards and outside directors were more likely to adopt formal HRM practices. The presence of Trade Union involvement with the firm’s workforce also served to trigger increased formality in HRM practices. • Small business owners are also faced with a need to adopt a strategic approach to HR policy and practice. For them the growth of their company is often linked to the removal of HR related bottlenecks that would otherwise inhibit successful expansion. • Research into how small business owner-managers deal with HRM issues during growth cycles suggests that the process involves a dynamic interaction between: the owner-manager’s characteristics; external market conditions; the company’s structure; and the nature of the work environment within the firm. A crucial element of this process is the owner-manager’s commitment to partnering with their employees  – that is finding ways to motivate and lead them via establishing mutually beneficial outcomes. • Effective management of small business growth demands a commitment from owner-managers to put in place structures, policies and practices that enable employees to take on greater responsibilities and participate in dynamic innovative teams. • A typology classified small business HRM practices into four categories. 1. The first of these is Sweating, an unhappy environment in which the owner has little concern for the development of their employees and has an authoritarian management style. 2. The second type of HR experience is Paternalism. While their style of management is generally fairly egalitarian, they have a low level of interest or concern for the development of their employees.

7.6  Key Lessons from the Chapter

71

3. The third type within the model is Benevolent autocracy, where the owner has a high concern for their employees’ personal and professional development. However, they are also authoritarian in their management style and intolerant of contrary views. 4. Finally, the fourth type is Fraternalism. This is viewed as the best situation, where the owner is concerned with their employees’ personal and p­ rofessional development. However, they are also egalitarian in their management style. As such, they are open to new ideas and willing to delegate authority • The problem of Nano management refers to the risks of the owner failing to break free from the constant micromanagement associated with the early stages of the firm’s lifecycle. These risks include a lack of time for the owner to undertake important planning and business development tasks, failure to get the best out of their people, and owner burn-out under the work pressure. A series of strategies helps to avoid the micro-management trap: 1. Flexibility: the owner-manager needs to establish trust with and in their employees, and a willingness to listen to their opinions. It is not always true that the boss knows everything. 2. Establishment of SMARTER goals: Specific, Measurable, Attainable, Realistic, Timely and Easily remembered. 3. The focus should also be upon results or outcomes more than the process of how these are achieved. 4. Finally, the idea of being a player/coach involves provision of constructive criticism of work performance, and the opportunity for 360-degree feedback. • Learning to step back and let go requires the owner to identify clearly where they wish the business to move over the longer term, and then develop a blueprint for their business accompanied by staff training and development. The six stages of delegation can be listed as: 1. 2. 3. 4. 5. 6.

Select the appropriate task – which can be delegated. Choose the right people – who can undertake the task. Briefing in detail – set clear objectives and standards. Coaching and training – offer the right level of support. Controlling the process – seek feedback and reporting times. Evaluation of the process – were the goals achieved and benchmarks met?

• If the owner cannot learn to delegate responsibilities, they risk becoming overextended, with detrimental impacts on their capacity to plan and to successfully develop market opportunities • Small business owner-managers seeking to develop their own entrepreneurial team (e-team) will need to allocate sufficient time and resources to the team building process. Note that the delegation of responsibility to self-directed teams when employees are not ready to assume such responsibilities can be detrimental to the organisation.

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• As the firm moves through various stages of growth the size and complexity of the management task will also multiply. Owners must shift from doing to leading, working on not in the business. While this seems obvious it is not an easy task and is frequently the most challenging aspect of growth in the small firm. • The concept of situational leadership is a contingency model that recognises the leader exists within a given context or organisational situation. 1. The first of the situational leadership styles is a directing style of leadership in which the focus is on giving subordinates clear instructions for how they are to act and keeping a close eye on their performance. 2. The second type is a coaching style of leadership in which the leader explains what needs to be done and why, with scope for more feedback and clarification of what is expected from the team members. 3. The third style is a participation style of leadership in which the leader and their team share ideas and reach decisions via mutual agreement. 4. Finally, the fourth style is a delegating style of leadership where the leader delegates authority to their team for all decisions and implementation. • Where the team members are unable or unwilling to accept the responsibility for their own management, or feel insecure or are willing but unable to do so due to lack of experience or skills, the leader must take responsibility. In these instances, the most appropriate leadership style is coaching or directing. Where followers are able and willing to assume self-management, or where they are able but unwilling or lacking confidence, the delegating and participating leadership styles are more appropriate. • The leader-manager should, therefore, assess both the willingness and the ability of their team members before deciding which leadership style to employ. • Coaching is a process of unlocking a person’s potential to increase performance and to help them to learn rather than attempting to teach them. The power of coaching is that if done well, the learner builds confidence and develops self-­ managed behaviours when acquiring new skills. However, effective coaching should be indirect and requires the coach to be a facilitator rather than a teacher. It does not generally work well in organisations that have highly directive and autocratic management cultures • The qualities of an effective coach are listening skills, good questioning techniques, empathy, the ability to read non-verbal behaviour, and the capacity to establish motivation and commitment in others. • Coaching should not be restricted to just the new hires or those employees that are experiencing underperformance. All employees need to have coaching support, even those that have been with the business for a long time. Coaching does not take place in a vacuum. The quality and success of coaching depends on the culture and climate that the organisation has. Finding the time to coach employees is one of the most difficult challenges facing busy managers. • Coaching is more than a training or instruction process. It requires a two-way engagement between the manager (coach) and the employee. While coaching is not a replacement for formal training, it can be a valuable extra component in the

7.6  Key Lessons from the Chapter

• •

• •

•

•

•

73

employee’s learning. An important outcome of coaching is to place the responsibility for learning with the employee. Building a well-managed, high performing team-based business will require the owner-manager to outline a clear set of values to assist in guiding the activities of all employees. Values should be based on a holistic and ethical foundation. Four key principles for the ‘holistic’ management of a business on ethical lines. These principles are: hire the right people, set standards more than rules, don’t let yourself become isolated, and set an example for others to follow. The main areas of focus for job design are the components associated with skill variety, task identity and significance, autonomy and feedback. In recruiting and selecting new employees the owner-manager needs to carefully match the applicant’s skills, education and experience, against the requirements outlined in the job description. Interviews with potential applicants should be undertaken and should involve assessing not only the person’s skills, qualifications and past work experience, but also their personality and capacity to ‘fit in’ within a small business. Research undertaken by the ILO, UN Economic Commission for Europe and Eurostat into labour force management within SMEs, identified seven key areas that are important to the provision of quality of employment. T work safety and health, plus the ethical treatment of employees is an important first issue. This is followed by ensuring that wages and benefits are also adequate. A third issue is working hours and the ability of employees to secure sufficient balance between their work and non-work life. Other important issues are the security of work and the protection of employees in relation to sick leave, maternity leave and redundancy. Also important is the social responsibility of the employer to their workforce, as well as their ability to provide adequate skills training and development, and the maintenance of a harmonious, productive workplace. Labour laws vary from country to country, but most generally outline the rights and obligations of the employer and employee within the workplace. Most labour laws will specify the working conditions including hours of work and minimum wages.

Chapter 8

Work Book: Operations Management

8.1  Learning Objectives After completing this chapter, you should be able to: • U  nderstand the nature of operations management systems within a small firm. • Understand the fundamentals of a management system. • Apply concepts of control and the development of meaningful KPIs. • Examine Short Interval Control, Product Mix Reports and Service Level Agreements. • Understand the nature and application of quality assurance management systems. • Understand and apply business process analysis and benchmarking.

8.2  Chapter Review Operations management is crucial to the success of any small business. It impacts both the firm’s financial and non-financial aspects. Of importance is the control that can be obtained over the firm’s cash flow, stock and other productive assets to achieve the maximum levels of operational efficiency and effectiveness. Each business is likely to be different in how it operates, and the key performance indicators (KPI) that it needs to monitor how it is performing. This chapter examines operations management and how it applies to small businesses. It includes a review of business process analysis, the development and use of meaningful KPIs, operations management systems and techniques. Operations management involves the management of human, technological, financial and cultural systems that relate to the production of products and services © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_8

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produced by a business and sold into its markets. The aim of OM is to ensure that all these systems and activities are appropriately configured and aligned, so that they simultaneously achieve desired performance benchmarks of quality, flexibility, costs and deadlines. At least five things are important to the efficient execution of OM within SMEs: Process, People, Plant and Equipment, Premises and Control. An effective management system needs to be an integrated system that draws together a range of strategic and operational activities, and ensures that they work together in a manner than generates both synergies and desired levels of performance and quality. To control the business the small business owner must manage these individual functions and integrate their control activities at the correct level. Senior management within the company, in most cases the owner-manager, is responsible for directing the business strategically, but in order to do this effectively they must have operational control. Successful implementation of strategy requires the communication of goals, objectives, standards and directive throughout the organisation. Systems develop in organisations over time, and no matter how formal the process designed to monitor and administer them, it is rare that any single person has the full picture of what is happening. This is typically the case as a business grows in size and complexity. As such, when the small business owner is seeking to grow their firm, they need to realise that this growth can quickly outstrip the capacity of any existing control systems to adequately manage operations. In general terms TQM (Total Quality Management) is a philosophy designed to bring about the process and management of change. As an approach it involves every aspect of the business and is the responsibility of everybody, including suppliers and customers. For many businesses, TQM is difficult to fully harness and manage. It requires constant top-level management, time and attention. Besides funding the initiatives, themselves, TQM requires significant investment in time for training. Quality assurance management systems (QAMS) include the process of TQM and the family of QAMS performance standards that are recognised by the International Standards Organisation (ISO). Historically, QAMS can be related to the World War II, where quality controls on military equipment were a major problem. Later, organisations such as the North Atlantic Treaty Organisation (NATO) established common standards for all alliance members and in 1987 the first international standards, ISO 9000 system was introduced. Business processes describe how the work that gets done in a company actually gets carried out. Business process analysis then takes this a step further and looks critically at the work done inside the process, identifies gaps, duplications and dead ends and finally re-engineers the process to make it more efficient and more responsive to customers’ needs. The simple definition of a process is a series of linked activities which take an input from a supplier and produce an output for a customer where an activity is a task or set of tasks that can be described. The customer of the process is responsible for defining the output and its quality characteristics. Most non-trivial processes have more than one customer and frequently the output of a process is information. All processes will have key stakeholders both internal and

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external to the business. Likewise, there will be resource requirements, standards and measures that all impact productivity, costs and margins. The key to gaining control over the entire business is to recognise that the system is a sum of its constituent parts and that the ability to control each part ultimately results in the control of the whole organisation. This is where business process mapping helps managers and their teams to examine each individual, separate process within the system, and identify how it is being managed, and where it might require attention for improvement. Business process maps are sometimes referred to as a Brown Paper, which reflects their origins in business process consulting in the 1970s, where the business process was physically mapped out on a long roll of brown paper stuck to the wall and the entire system was drawn up in a flow diagram to help management teams fully understand the end-to-end process of their firm’s operations. Today, business process mapping is undertaken with visualisation software. The Brown Paper becomes a working document that can be referred back to on a constant basis. It never becomes a finished article because that is not the nature of a business process. All relevant staff should have some involvement in its development. After completing a comprehensive Brown Paper exercise many employees and managers have gained increased insight and understanding into the process that surround them in the work place. Most SMEs lack formal systems of management and control across all areas. Formality in a small firm during its early stages of life is usually low due to the lack of systems, the dependence on a single owner-manager, or a small team of owners and/or managers who are essentially learning by doing. However, as a firm grows in size and complexity, it becomes increasingly important for it to adopt formal systems to protect its quality, provide guidance to its employees and relieve the pressure on its senior management having to personally direct all activities.

8.3  Quiz Questions The following questions are aimed at testing your knowledge of definitions associated with small businesses operations management.

Fill in the Blanks 1. The five things that are important to the efficient execution of operations management in most small businesses are: (i) ____________________; (ii) _____________________; (iii) ___________________; (iv) ___________________; (v) ___________________. 2. DPSC refers to: D____________, P ______________, S ______________, C ______________.

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3. DWOR refers to: D____________, W ______________, O ______________, R ______________. 4. In most small businesses, operational efficiency and effectiveness can be assessed by looking at the ___________ of labour and equipment, the ___________ of operations, the ____________ of the firm’s standards and performance, and the monitoring and control over ______________. 5. The four stages of the TQM are: (i) ______________; (ii) ______________; (iii) ______________; (iv) ______________.

8.4  Short Answer 1. What are the seven key attributes that are essential to the operation of a good management system? 2. Briefly describe the nature of forecasting, planning, scheduling and control within the management system. 3. What is a DWOR and how is it used within a small business? 4. Explain the concepts of Short Interval Control, Product Mix Reports and Service Level Agreements, and how they are used. 5. What is ISO certification and what are its origins and application? 6. What is a Brown Paper Exercise and how is it used?

8.5  Case Study Analysis Read the HomeColour case study, which provides an example of a small business that has grown strongly but now finds itself expanding with a need for more effective operational management. Prepare a report for the owners that draws together the concepts outlined in this chapter and those covered elsewhere in this book and other readings. You should give attention in your report to the following questions and issues.

Questions/Tasks Prepare a report for the owner that draws together the readings for this topic and other topics with attention given to the following: 1 . Identify the key weaknesses in the firm’s existing operations management. 2. Apply the principles of operations management to the case with reference to how these can be employed to assist the owner-manager with future growth. 3. Make specific recommendations for future action.

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8.6  Case Study: HomeColour Pty Ltd This case study was adapted from West (1991).

Background You are a director of HomeColour Pty Ltd., a paint manufacturer that has been supplying own-label paints to DIY1 retail hardware chains. For the past 10  years, HomeColour has developed its own range of branded paints but continues to manufacture paints for the retailers. Sales growth has continued through the last 5 years, but increases in net profit have been much more difficult to achieve, as illustrated in Table 8.1. In addition to the modest net profitability experienced by the company, HomeColour’s return on capital employed has dropped over the same period. Despite the large capital investment program instituted by HomeColour, to meet rapidly rising sales volumes, the company’s results have failed to provide the anticipated return and as shown in Table 8.1, this has declined from 38% to 18% over the past 5 years. The company’s Board of Directors is to meet to review the future of the business. Initially a brief summary document is required to assist the Board in its discussions. Decisions on the company’s future direction will have considerable impact on the production plant, and the type of packaging that the company manufacturers. Along with the other directors of HomeColour examine the firm’s past performance and prepare a plan for how the company should act in future years. You will be required to prepare a report to the Board for consideration of your suggestions. Specific attention should be given to the improvement of the firm’s production process and operations management. Table 8.1  HomeColour Pty Ltd. 5-year sales trend Year 1 $ Sales revenue 15,000,000 Less: cost of goods sold 600,000 Gross profit 14,400,000 Gross profit margin: 96% Less: overhead costs 13,600,000 Net profit 800,000 Net profit margin: 5.3% Capital employed 2,100,000 Return on capital employed: 38%

 DIY = Do-it-Yourself.

1

Year 2 $ 17,000,000 800,000 16,200,000 95% 15,000,000 1,200,000 7.1% 3,000,000 40%

Year 3 $ 19,000,000 900,000 18,100,000 95% 16,700,000 1,400,000 7.4% 3,500,00 40%

Year 4 $ 22,000,000 1,300,000 20,700,000 94% 19,200,000 1,500,000 6.8% 5,500,000 27%

Year 5 $ 25,000,000 1,500,000 25,000,000 94% 21,900,000 1,600,000 6.4% 8,900,000 18%

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Marketing and Sales Research undertaken by HomeColour suggests that the DIY retail paint market is worth around $300 million at an average of $2.25 per litre, a consumption of 120 million litres per annum. This market is highly competitive. Paint manufacture has been concentrated by a series of industry takeovers with smaller producers being absorbed by larger firms. HomeColour has faced a steady decline in its profit margins and has struggled to achieve the same economies of scale available to the larger national manufacturers – in both production and promotion. Over the past year the company spent approximately $1.5 million in marketing and promotion, compared to an estimated $12 million spent by the industry leader. Price competition has also increased over the past few years lead by the larger producers. AC Nielsen audits have revealed that price elasticity has changed from six to four over the past 5 years. There is also little evidence that consumers have bothered with price points or other psychological pricing effects. Consumers tend to purchase paint along with other DIY products and view paint as one of a range of products needed for decorating. HomeColour’s sales have totalled 15 million litres giving the company around 12% of the local DIY consumer market. The two leading manufacturers account for over 60% of total market sales. It has been HomeColour’s focus over the past 5 years to concentrate on supplying “white-label” products to major hardware retailers rather than developing its own HomeCharm brand paints. This has provided a high proportion of both turnover and profit as shown in Table 8.2.

Distribution and Branding HomeColour has supplied consumer paints to the larger hardware chains. Most of its own-label paints are sold to the leading retailers with the four customers making up 95% of the sales of its own-label. Each of these four leading customers provides approximately 20% of HomeColour’s turnover over the past 5 years. Distribution of the firm’s HomeCharm brand has grown to over 200 wholesalers and smaller DIY retail hardware stores. Total market size has been estimated at 4000 such customers. The HomeCharm brand contributes 32% of HomeColour’s Table 8.2  HomeColour Pty Ltd. percentage turnover and profit contribution by product line White-label retailer sales White-label retailer profit HomeCharm Brand sales HomeCharm Brand profit

Year 1 (%) 55 45 45 55

Year 2 (%) 57 46 43 54

Year 3 (%) 63 47 37 53

Year 4 (%) 68 42 32 58

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total turnover, but 58% of total profits. This trend has been established over the past 5 years, with the branded product providing a steadily greater profit contribution as price pressures in the own-label business segment has intensified. HomeColour has achieved market-wide coverage via these two distribution channels and has separated the market into metropolitan, regional and trade. Sales have been evenly spread and related to population density. Wholesalers work on a profit margin of around 10% of sales. By contrast the smaller DIY hardware and specialist paint retailers work on a 35% retail margin. The attraction of the white-label business was that the company produced on long-term contracts and does not need to hold stock, supplying customers at regular and determined intervals. This is in contrast to the branded sector, which suffers from both a high level of seasonal fluctuation in demand. While external paint finishes tend to be in high demand during summer, indoor paints are more popular during winter. This pattern has changed as a result of weather changes. For example, a dry winter could see a rise in outdoor paints during that season. Sales patterns over the past 2 years are shown in Fig. 8.1.

Fig. 8.1  Monthly sales activity white-label and HomeCharm brands by month over two previous years

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Influences on Demand Weather is not the only major influence on demand – changing disposable incomes and mortgage levels also have some impact on total sales. When the housing market slows down, consumers tend to spend more on DIY activity to improve the attractiveness of their houses. This has an inevitable effect on the level of paint sales. Within the branded segment, alterations in colour demand mean that sales volumes need to be continually monitored. The trends in demand are shown in Table 8.3. The HomeCharm brand has ten colour types produced in two can sizes, 2 and 4 l. Sales vary considerably within the range with the best-selling line over the past 5 years varying between brilliant white, clear blue and bitumen.

Reputation HomeColour has a reputation in the trade, and among the more knowledgeable customers, for producing higher quality exterior paint than the competition, and it is in this sector of the market that the company achieved its highest sales. Market surveys suggest that HomeColour have around a 5% quantity advantage over the competition. The own-label production has been more varied in colour and tin size. Over the past 2 years HomeColour has produced around 50 different colours in up to 5 different can sizes. Currently there are considerable variations in the type of packaging that is provided in the own-label and branded sectors. The company has yet to standardize on a single branded theme and the level of instructions on the packaging varies considerably throughout the product range. Each pack has the HomeColour logo and instructions.

Table 8.3  HomeColour Pty Ltd. 5-year sales history of HomeCharm brand Colour

Year 1 Year 2 Year 3 Year 4 Year 5 Total Litres Litres Litres Litres Litres Litres Brilliant white 400,000 425,000 500,000 600,000 750,000 2,675,000 Magnolia 325,000 400,000 420,000 400,000 425,000 1,970,000 Oyster 200,000 220,000 250,000 275,000 325,000 1,270,000 Sand gold 260,000 280,000 280,000 270,000 260,000 1,350,000 Black 225,000 380,000 380,000 400,000 550,000 1,935,000 Lime green 160,000 120,000 200,000 160,000 125,000 765,000 Clear blue 450,000 400,000 450,000 550,000 650,000 2,500,000 Aluminium 500,000 200,000 350,000 440,000 640,000 2,130,000 Bitumen 200,000 300,000 450,000 700,000 600,000 2,250,000 Textured white 300,000 300,000 300,000 500,000 450,000 1,850,000 Total HomeCharm sales 3,020,000 3,025,000 3,610,000 4,795,000 4,775,000 19,225,000

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Market Trends A recent market research study commissioned by HomeColour found that consumers were expressing dissatisfaction with paint quality due to their failure to prepare surfaces properly. The study also revealed that 46% of DIY customers failed to remove the old paint from surfaces. Over 50% expected that one coat of paint would be sufficient to cover all previous paint or wallpaper products. In order to remain competitive against the two major competitors in the market HomeColour has to ensure that high levels of stock are maintained in the major outlets. The pressure on selling space within most retail outlets is becoming intense, and shortage of stock has in several cases ended in the company being de-listed by three regional DIY chains. The current sales pattern has shown that HomeColour is experiencing major problems in certain of the outlets with sales significantly below plan. White-label brand sales have been 20% down on plan – which had envisaged a 5% increase in volume. HomeCharm branded products have been within 2% of the plan – based on an 8% volume increase over the past year.

Promotion HomeColour has developed a range of promotional concepts – shown in Table 8.4. Historically the company has spent around $500,000 per year on ad hoc sales promotion to boost volume. This year HomeColour has attempted to be more systematic in its approach. It is anticipated that this will focus on their trade distribution agreements with major distributors. As a result of this decision no promotional expenditure has been undertaken during the first half of the year. Sales promotion campaigns have been developed for both existing products and some of the new developments that are currently under consideration.

Table 8.4  Available sales promotion options Marketing and sales channel Competition Coupons Extra pack Branded pack Discount Self-liquidating offer Sample pack

Time Months 2 1 3 2 1 3 4

Cost per litre Cents 10 20 10 40 30 10 60

Sales increase Percent 3 7 4 6 10 3 8

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Sales and Promotion Planning HomeColour employs five sales representatives. Two of these negotiate with senior buyers at the major multiples for the supply of own-label products. The other three are responsible for ensuring that the 180 main wholesalers that stock the HomeCharm brand. The sales team has been recruited from a variety of backgrounds, but has considerable skills in selling paint and paint products. HomeColour feels that the current team can be retrained, if required, to concentrate on the new areas of development. The most important of these areas described below. At present HomeColour negotiates annually with the multiples on price, and has loose agreements with the wholesalers who primarily consist of attractive discounts on quantity. The price position of the company over the past 5 years is shown in Table 8.5. It can be seen that HomeColour pricing relates to the weighted market average in the various distribution channels of 100.

Advertising The advertising budget for the current year is $1.5 million and has to be spent on television during the months of September, October and November. HomeColour has received information about the consumer and relationship between coverage and exposure to help plan an advertising campaign. Each $1000 spent will  – on average – achieve one rating point. Table 8.6 shows the relationship between expenditure and television viewing levels. Market research has suggested that HomeColour needs to achieve 4 OTS to reach the maximum potential sales threshold. Advertising’s decay rate over the past 3 years has been in the range of 40% per month. The most expensive period for Table 8.5  Relative pricing of HomeCharm brand by distribution channel Marketing and sales channel Metropolitan major retailers: Retailer A Retailer B Retailer C Retailer D Retailer E Regional retailers: Independents Wholesalers Trade retailers: Independents Wholesalers

Year 1

Year 2

Year 3

Year 4

98 96 101 97 100

99 97 103 101 102

100 96 104 101 103

102 101 105 102 103

94 97

94 96

95 98

94 97

95 97

93 98

93 99

94 100

Figures represent a weighted marketing average of 100 in each channel

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Table 8.6  Relationship between % of the population OTS and ratings Ratings 50 100 150 200 250

1 OTS 30 45 65 85 92

2 OTS 20 35 50 75 78

3 OTS 15 25 35 60 72

4 OTS – 20 30 50 55

5 OTS – 15 25 40 50

6 OTS – 5 15 20 35

OTS Opportunity to see

advertising is over Christmas. Space has been around 50% more expensive than during the winter months. HomeColour has been very concerned that the structure of the campaign has not been sufficiently considered, and that the company needs to think about transferring some of the budget to other types of media.

Production and Warehousing HomeColour has invested heavily in modern, flexible manufacturing facilities over the past 5 years. This was undertaken to meet a forecasted increase in demand for paint. The production plant can switch within 30 min from the production of one type or colour of paint to another, with a set-up cost of $550. This figure is substantially below the competition. With its microprocessor control systems, the plant is able to operate on a 24-h day basis with low staffing requirements. In the current year the plant has operated substantially under capacity, producing only 15 of the possible 29 million litres. This inability to achieve production targets means that the company has failed to achieve the return on capital that was originally planned. As part of an expansion program, the company has a new warehouse alongside the production facility. The integration of the warehouse with the production facility and advanced automation allows filled paint to be moved from the manufacturing point to the warehouse storage point with a minimum of physical involvement by factory or warehouse staff. HomeColour currently uses a range of outside contractors to handle distribution, although this has substantially raised costs as the number of wholesalers supplied with branded paints expanding. The average cost of delivery is $350 per round trip for the company’s 40-ton truck and $250 for the three 20-ton trucks, each of which can carry 32,000 and 15,000 l of paint respectively. One of the advantages of the white-label business has been that HomeColour can maximize vehicle use into the 55 central depots of the DIY multiples, whereas deliveries of HomeCharm branded products tends to be only 35% full. Expansion into other areas, involving smaller volumes to individual customers, would mean that the average cost of delivery for a litre  – currently $0.10  – would rise substantially.

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Future Possible Avenues of Activity HomeColour has special expertise in the production of technical paint products. The production department has one of the best reputations in the market, which has helped in the acquisition and maintenance of the own-label products. HomeColour is looking for avenues of activity that will exploit this technical strength, improve company profitability and lift sales volumes. The main options to be considered are discussed below.

Standard Industrial Metal Work Paints There are an estimated 6000 consumers of standard metalworking paint products in the market. These range from the smallest metal-bashing firm to large construction and fabrication companies. The total market is estimated to be around $1.7 million, at an average price of $3.50 l, or a total of 5 million litres. Small firms tend to buy products from the 120 industrial wholesalers in the market who stock this type of paint. Larger firms purchase directly from manufacturers. Price sensitivity is significantly lower than the household consumer market, and margins in consequence are higher. Estimates undertaken by the HomeColour production department suggest that 55 per margins can be achieved when the company sells direct to the end user. However, using wholesalers will mean that margins would drop toward 40%. The range of colours that is generally in demand in this segment is limited. Black accounts for over half the volume with brilliant white, aluminium and beige making up the remainder. Research has also shown that a majority of users tends to hold low stocks of the relevant paint and will generally wish to receive new stock within 2 days of starting a new run of metal production. HomeColour would like to produce a new product formulation to service this market segment. It also will have to decide on the size of the container, the name of the product and the type of instructions, guarantees and service support that the company should provide.

Automotive Paints Paints, specially formulated for automotive use are – on the surface – an attractive opportunity for specialist paints. There are an estimated 7000 outlets that carry out some vehicle paint and repair work. This varies from minor repairs undertaken by

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panel and paint shops to the large quantities used by national automotive manufacturers such as General Motors, Ford, Toyota or Mitsubishi. This market is estimated to be worth around $45 million per annum, with the majority of demand among the manufacturers. The manufacturers determine which paint manufacturers are listed to supply both them and the repair market. Gross margins on the product is high – estimated at 65% – with a per litre price of $5. Small repair shops tend to order paint via the spare parts departments of the vehicle manufacturers who hold stock of all the colours currently used by their company. A small retail market also exists where consumers purchase product for touching-up small paint damage of individual vehicles. HomeColour faces numerous problems in this market segment. First, there is a demand for a wide range of colours – in the current year a total of 45 would be required to service 85% of the motor vehicles currently on the road. The large automotive manufacturers also demand both exceptionally high technical specifications – resistance to chipping and scuffing being especially important – and absolute guarantees on quality. Due to these requirements the car industry prefers to deal with large paint manufacturers who have a demonstrated technical competence. Computer-aided manufacturing systems, such as just-in-time (JIT) inventory control systems, means that the suppliers have to meet 24-h delivery schedules. Although HomeColour can meet the technical standards of this market segment, it is unclear as to the level of technical support that will be need to be provided and what shape this will take.

Powder Coating A growth sector in metal manufacture has been powder coating to protect metal work, especially in furniture. This market has an estimated worth of $3 million in the current year. There are some 65 companies who are active in the production of powder-coated products. The present price powder-coated product is $7.50 per litre. This will give HomeColour a 60% gross margin. All large powder-coating manufacturers buy directly from to manufacturers that currently supply the market. Generally, each company will carry out powder coating in batch production and concentrate output in 3 or 4 days in a 2-week period. The powder-coating companies are able to forecast their production requirements several weeks in advance. Most of the paint requirements are in four colours that make up 85% of total demand. Customers tend to prefer to purchase product in large containers, which can be fitted into existing powder coating equipment. As the market is demanding on quality, companies operating in the sector have to provide detailed guarantees on their quality.

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Structural Paint There is a large existing market for the supply of structural paint. This is specialist product used to coat buildings and steel frameworks. Small independent contractors buying from builders’ merchants undertake most of the work. There are an estimated 2500 of these in the market selling significant volumes of structural paint. Some structural paint is sold through DIY wholesalers who are already HomeColour customers. However, paints that are available from the consumer sector meet this demand. Price competition has been extremely severe – the average price has been below that obtainable in the consumer sector, and there is substantial import substitution. HomeColour estimates that it has the ability to enter this market segment, but anticipates potential margins per litre on basic products are unlikely to better 10–15%. HomeColour remains confident that over time it can develop a premium sector in the market. Based on current product experience in the consumer sector. Estimates suggest that HomeColour might – over time – secure as much as 30% of the market and improve margins to between 30% and 40%. Marketing will focus on the relationship between long-term protection for steel and the performance of existing paint products. The product will have to be packaged into larger containers of 10 l or more. This packaging will also need to include contact points for spray equipment.

8.7  Key Lessons from the Chapter • At least five things are important to the efficient execution of Operations Management within SMEs: 1. Process: How well the employees within the company do things in a systematic manner and in doing so how well they pay attention to working smarter not harder and seek to continuously improve the systems and processes. 2. People: Employees need to be well trained, motivated and fully aware of the best-practice benchmarks that they need to follow and achieve in order to deliver the necessary levels of quality of product or service outcomes required by the business. 3. Plant and Equipment: The business needs to have the most up-to-date and appropriate equipment to allow it to achieve its operational task and meet its best practice performance benchmarks. All equipment costs money to purchase, hold and maintain. 4. Premises: The building or buildings in which the business is located should be reviewed to ensure that they are appropriate for the purpose. 5. Control: Finally, the business must have appropriate control systems in place that balance efficiency and effectiveness. These can be manual or supported by enabling technologies.

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• A good management system should have at least seven key attributes: 1. Transparency: information should be available to all relevant employees and communicated in a timely and effective manner. 2. Work must be related to time: all activities should be scheduled so as to be performed on time and within the most time-efficient manner. Time is a critical and finite resource and must be managed well. 3. Performance expectations impact productivity: all employees should have well-defined and clearly understood KPIs that allow them to understand what is expected of them, how it is expected to be performed, when it is expected to be completed and the quality to which it is to be performed. 4. Manage the whole by managing the parts: a management system is a sum of its parts. If the individual elements and activities are not all performing to the optimal level, the entire system can become adversely affected. 5. Continuous improvements: not only should a management system be designed to achieve best practice benchmarks, but it should also be configured so that all employees are focused on making continuous improvements in products and processes. 6. Interdependent: the various elements of the organisation (e.g. procurement, production, sales and marketing, administration) should be viewed as parts in a management system with each connected to and providing information and guidance for the others. 7. Measurable: all activities within the organisation should be managed by KPIs that are measurable in a timely, efficient, reliable and relevant manner. • Successful implementation of strategy requires the communication of goals, objectives, standards and directive throughout the organisation. To exercise control over each of these elements requires an appraisal of the objectives of the total company. Critical questions to be answered are: –– What systems are in existence? –– What are they actually doing? • In developing effective business operations, attention should be given to four key elements: 1. Utilisation: How well are you using your labour and equipment or premises? 2. Efficiency: How efficiently are these assets being used? 3. Quality: Do you have clear standards for quality and performance? 4. Wastage: Do you monitor wastage rates to ensure that they are minimised? • It is common for small business owners to lack adequate measures to monitor these four areas. • At least three controls can be readily applied within a small business to assist with operational control: (i) short interval control, (ii) product mix report, and (iii) service level agreements:

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(i) The purpose of the Short Interval Control is to provide a tool to allocate work and monitor key volume and performance indicators by each person within the business on a daily basis. The Short Interval Control: –– Records actual time and the status of assigned work activities by person and area. –– Records lost time and variance to plan. –– Is a management tool to enable transparency of work activity by person and area. The Short Interval Control enables the supervisor or manager to: –– –– –– ––

Plan, assign and prioritise work to achieve service levels on a daily basis. Assign work across the available resources. Follow-up on work and to take prompt corrective action if necessary. Control lost time either obvious or hidden.

(ii) The purpose of the Short Interval Control is to provide a tool to allocate work and monitor key volume and performance indicators by each person within the business on a daily basis. The Short Interval Control: The product mix report should be prepared at least annually, as part of the firm’s forecasting process of strategic planning. However, it should be updated regularly and adjusted in response to any changes to market demand, customer requests or supplier-side influences. (iii) The Service Level Agreement (SLA) is a document that describes the commitment a maintenance department or contractor has made to the firm’s production (or other departments) to deliver its services with measurable KPIs including quality of service and timeframes for response etc. The SLA should be designed around the following key principles: • Visibility: In order to be effective, management needs visibility. Key indicators are kept transparent and accessible, thus communicating what is important to management to act upon. • Objectivity: The cornerstone to having a collaborative management focus is to ensure discussions are based on facts (objective measurements) rather than perceptions (subjective basis). • Measurement: What is measured is acted upon and determines the focus of management’s time. • Continuous improvements focus: Improve performance by planning the resources at the desired level of performance – start with the end in mind. • Equity: All personnel and departments are accountable for their performance based upon mutually agreed and measured bases. • The ISO 9001 framework is designed around 7 Quality Management Principles (QMP): –– QMP 1 – Customer focus: The focus of quality assurance is the ability to meet and exceed customer expectations.

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–– QMP 2  – Leadership: The firm’s management should communicate to all employees the organisation’s vision, mission and strategy. –– QMP 3 – Engagement of people: The firm’s management should communicate to its employees the importance of their contribution, and promote collaboration throughout the organisation. –– QMP 4 – Process approach: The management of the firm should define objectives and the actions needed to achieve them, and establish authority, responsibility and accountability for all activities. –– QMP 5  – Improvement: The management should promote improvement objectives throughout the organisation, and educate and train people how to apply basic tools for improvement. –– QMP 6 – Evidence-based decision making: The firm’s management should determine, measure and monitor the key indicators that demonstrate benchmark performance, and make all relevant data available to the employees. –– QMP 7  – Relationship management: The firm should identify and engage with all key stakeholders and determine how to manage their priorities and interests. • TQM requires constant top-level management, time and attention and significant investment in time for training. The following seven principles underpin total quality: 1. 2. 3. 4. 5. 6. 7.

Philosophy: Prevention not detection, Approach: Management led. Scale: Everyone is responsible. Measure: Costs of quality (non-conformance). Standard: Right first time. Scope: Companywide. Theme: Continuous improvement.

• The TQM cycle is a four-process of continuous improvement: Plan, Do, Check, Act. These are discussed below: 1. Plan: The work allocation is typically planned around the skills of the employees or operators. It incorporates the flow of goods, materials and information critical to the successful execution of a business process. 2. Do: As the work is carried out, performance is measured and resource planning is done at intervals during the day to ensure that the plan/target is met. 3. Check: The data, which is generated, is analysed and performance is plotted. Attention should be given to where the data suggests there are significant variances between what is planned and what actually happens. 4. Act: Corrective action is taken and fed back into the plan and allocation of work. • Business process management principles: –– Define the six to ten cross-functional business processes that describe your organisation.

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–– Assign business process owners who will have oversight responsibility for their process. –– Identify approaches to understanding existing processes, focusing on problems, issues, and opportunities for improvements, particularly looking at those places were errors occur, or where handoffs between departments are problematic, or inefficiencies exist (a process of selecting analysis and design tools). –– Design process flows between transactions or events that address these issues.

Reference West, A. (1991). A business plan, NatWest business handbooks. London: Financial Times, Prentice-Hall.

Chapter 9

Work Book: Using Technology

9.1  Learning Objectives After completing this chapter, you should be able to: • U  nderstand the nature and use of information and communications technologies (ICT) systems within a small firm and the problems facing SMEs in the adoption and use of technology. • Recognise the nature of the Fourth Industrial Revolution and its impact on SMEs. • Understand the nature and use of Enterprise Resource Planning (ERP); Customer Relationship Management (CRM), and Knowledge Management (KMS) systems within SMEs. • Develop a digital business strategy for a small firm. • Understand the use of ICT systems for development of e-commerce, e-­marketing and e-business strategies within SMEs.

9.2  Chapter Review Technology offers small business owners an opportunity to enhance the productivity of their firm, widen its marketing reach and significantly improve the level of control they have over information and communications within the company. The use of technology, particularly information communications technologies (ICT) by small businesses has grown significantly in recent decades. This is due to the proliferation of high performance, but relatively low-cost ICT and their enabling software. One of the main areas in which this technology use has manifested itself is in the area of online and ‘in-the-cloud’ business software for marketing, accounting, HRM and operations. This chapter examined the use of technology in SMEs such as © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_9

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enterprise resource planning (ERP), customer relationships management (CRM), and knowledge management systems (KMS). It also examines the use of e-­commerce, e-business and e-marketing within the small business. Although SMEs can benefit significantly from the adoption and use of technology, in particular ICT, most small firms lag behind their larger counterparts in this regard. Factors that are likely to influence the adoption rate of technology by SMEs are the age of the business, the age of the firm’s owners and managers, the type of industry the firm is operating in, and the overall size of the business. What ICT systems are employed by most SMEs are relatively ‘basic’ software tools for accounting and office administration, as well as simple websites and data bases. The use of more complex and sophisticated ERP, CRM or KMS technologies are less common. Assisting SMEs to adopt technology is likely to require education of the owners and managers. The adoption of technology by SMEs has been likened to a ladder that has five steps: (i) basic use of email; (ii) creation and publishing of a website; (iii) use of the website for e-commerce; (iv) adoption of ‘back-office’ ERP and CRM systems for e-business; and (v) a ‘transformed organisation’ that has technology embedded within its business model. The evolution of a micro-business in the use of ICT for e-commerce and e-marketing is often facilitated or inhibited by environmental factors, resource-related factors internal to the firm, and the characteristics of the firm’s owner-manager. Adoption of e-commerce will generally flow from an initial one-­ way information-centric approach to a two-way transactional level until it is an integral part of the firm’s business strategy. All industries are facing digital transformation via the Fourth Industrial Revolution or Industry 4.0, which draws together a range of ICT and digital technologies that will significantly change the nature of existing industries and the business models of the firms within them. SMEs will need to understand and embrace these new technologies, or risk becoming uncompetitive. The adoption and use of technology-based systems such as ERP, CRM, KM, e-commerce, e-business and e-marketing, will all be impacted by the Industry 4.0 transformation. How well the firm adapts to this challenge will most likely determine its survival. ERP systems are an essential part of any firm’s operations, and can range from simple to complex programs. An ERP system is responsible for integrating all data processing and related systems across the business. Designed originally for use within large manufacturing enterprises, they are now accessible to SMEs and can offer these firms significant benefits in productivity. However, SMEs should select their ERP systems carefully, and avoid spending too much on an overly complex system that might prove difficult to implement. The ERP system should be viewed as a strategic asset and must be designed to meet the needs of the firm both now and in the future. CRM systems are designed to capture, store and analyse customer data and use it to assist the company to manage their customers. As with the ERP system, a CRM system should be viewed as a strategic asset within the business, and one that links

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marketing, sales and service to ensure maximum customer satisfaction and retention. CRM systems can be relatively simple or sophisticated and complex. Most SMEs adopt CRM tools to help them with customer retention and loyalty, and to keep track of customer details and contact with the business. A well-designed CRM can offer enhanced management of customer data, and also form the basis of a market analysis tool that can provide information on customer behaviour. Cost and complexity are the most common barriers to SMEs adoption of CRM, but a CRM system should be viewed as a strategic investment in the development of a long-­ term, customer-centric business model focused on attracting, delighting and retaining customers. KM systems are designed to capture, store and disseminate knowledge and information. They can be relatively simple systems or highly sophisticated and complex tools. There are now many relatively low-cost KM systems that SMEs can purchase. KM systems are technology support tools for a more important approach to KM within the company that examines how people within the business and with outside stakeholders, communicate, share information and knowledge, and co-create value as a result. Research into large companies has identified a knowledge transfer process across four domains: (i) socialisation (tacit to tacit knowledge exchange); (ii) externalisation (tacit to explicit knowledge exchange); (iii) combination (explicit to explicit knowledge exchange); and (iv) internalisation (explicit to tacit knowledge exchange). KMS platforms should be viewed as strategic assets and their design focused on what the system should be capable of doing, how data is to be captured, codified, connected, co-created and converted in value within the firm. SMEs should also develop e-commerce, e-marketing and e-business strategies and their associated technologies. E-commerce involves buying a selling online and the design of any system needs to ascertain what the specific requirements of the firm’s business strategy are. Related to e-commerce, is e-marketing, which is the use of the internet to undertake marketing and promotional activity. Investment into e-marketing by SMEs can yield significant returns. It is important for SMEs to embrace e-marketing and e-commerce because consumers, particularly the younger demographics, are increasingly using the internet to find, evaluate and purchase goods and services. E-business is the use of digital ICT technologies to undertake back-office transactions. Many SMEs adopt simply e-business suites, but they can be forced to adopt such systems if they are members of larger industry supply chains. Many SMEs a reluctant to adopt e-business systems due to cost, lack of compatibility with existing systems, lack of skills and knowledge about how to use such systems, and lack of trust in ICT systems vendors. ERP, CRM, KMS, e-business, e-commerce and e-marketing systems and strategies should be seen as parts of an overall integrated management system. A well designed and managed system can link the firm’s technology use to its strategic goals and enhance productivity and competitiveness. The integration of ERP, CRM and KM systems within the firm’s value chain can provide a foundation for competitive advantage. The firm’s business strategy, organisational strategy and information management strategy should be closely aligned.

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9.3  Quiz Questions The following questions are aimed at testing your knowledge of definitions associated with small businesses use of technology.

Fill in the Blanks 1. The five steps that most SMEs following in the adoption of technology according to the United Kingdom’s Department of Trade and Industry are: (i) ____________________; (ii) _____________________; (iii) ___________________; (iv) ___________________; (v) ___________________. 2. ERP refers to: E____________, R ______________, P ______________. 3. CRM refers to: C____________, R ______________, M ______________. 4. The Use of ICT to capture, store and report intangible assets within the firm, including knowledge, skills and competencies upon which to build a competitive advantage is known as: ______________________________. 5. The four key elements of the SECI model of knowledge transfer are: (i) ____________________; (ii) _____________________; (iii) ___________________; (iv) ___________________.

9.4  Short Answer 1. Describe the meaning of the term Industry 4.0 and list as many of the technologies that are associated with it. 2. Briefly describe what an ERP system is and how it works within an SME. 3. Briefly describe the meaning of the terms e-commerce, e-marketing and e-business. 4. What are the five key measures that should be contained within a CRM system? 5. Briefly describe the concept of a KMS and how it might work within an SME.

9.5  Case Study Analysis Read the Survival Aids case study, which provides an example of a small business that has grown strongly but now finds itself expanding with a need for more effective management and control systems to enable it to manage any future growth. Prepare a report for the owner-manager that draws together the concepts outlined in

9.6  Case Study: Survival Aids Pty Ltd

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this chapter and those covered elsewhere in this book and other readings. You should give attention in your report to the following questions and issues.

Questions/Tasks Prepare a report for the owner that draws together the readings for this topic and other topics with attention given to the following: 1 . Identify the key weaknesses in the firm’s existing use of technology. 2. Apply the principles of technology management within the SME to the case with reference to how these can be employed to assist the owner-manager with future growth. 3. Address the use of ERP, CRM and KMS systems, as well as the development of potential e-commerce, e-business and e-marketing strategies that the firm might follow. 4. Make specific recommendations for future action.

9.6  Case Study: Survival Aids Pty Ltd Source: adapted from Small Business Centre, DUBS (1995). Managing Director and principal shareholder of Survival Aids Pty Ltd., Nick Steven sat back in his chair and sucked the end of his pen. The sun shining through the window made gentle patterns on the carpet and filled the room with a warming glow. Nick was pondering the future direction of the company and reached a critical point in his deliberations. Six years ago, he had founded Survival Aids Pty Ltd. following his departure from the Army where he had been a member of the Special Air Service. The company had first commenced marketing military equipment and clothing, branching out into outdoor wear, survival and protection gear for camping and outdoor adventure pursuits. Three years after start up Nick had expanded the business into survival training and now operated a dedicated school. Customers were both civil and military. A mail order catalogue was used to reach many customers directly but the company also operated a wholesale business selling to specialist retailers and through direct contacts. In addition, Survival Aids operated a retail shop front from its own premises. Products were of high quality and many carried premium prices. The combination of self-sufficiency and professional survival was the lure for the sale of such items as sleeping bags at $375 each, or charcoal-filled filtering straws at $10 for five (for drinking brackish water). There were about 300 items in the catalogue. Some of these products were Survival Aid’s own-brands. The others were good quality prestige brands. According to Nick no other firm could offer such a wide range of products in their catalogue.

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Nick was proud of Survival Aids. Sales were now running at $2.5 million per annum and growth over the past few years had been rapid. Survival Aids now employed 28 people including 4 directors and 3 part time employees. Nick was keen to expand the company’s operations and increase turn over to around $20 million over the next 4–5 years. The forecast for the coming financial year was for a turnover of around $3.6 million. Nick was optimistic that the market would permit such an expansion although the pressure on the existing rented premises would be substantial.

Diversification of Customers, Markets, Products and Services About half the company’s sales were achieved from direct retail sales from the mail order catalogue. It had about 50,000 customers registered in the computer database. The computer system had been in operation for about 3 years and was quite sophisticated. A central server connected the firm’s terminals. Management had complained that the system was ‘OK’ but they would have liked more information to help them with their decisions. Sales orders were entered directly into the computer and from this the customer files were updated. The computer also produced stock picking lists and invoices. Recent increases in volume meant that the current system was becoming overloaded. The mail order customer lists contained a strong element of military clientele. This included individuals and military units who wanted to upgrade their equipment at their own expense. About 30% of the sales were coming from overseas customers including foreign military customers. Of the total sales 30% were through trade retailers. The retail prices were recommended to be the same as in the catalogue. This meant of course, that Survival Aids’ profit margins were lower on the retail sales. The rest of the sales came from exports, direct contracts and the training school. As shown in Table 9.1 different market segments provided different profit returns.

Management and Team Development There were four directors of Survival Aids. Nick Steven was Chairman and Managing Director. There was also a Marketing Director, a Contracts Director and a Production Director. The Marketing Director was also the company’s landlord and owned an adjoining building that was vacant. The four shared the same office and worked well together. Nick applied to the business the same leadership ethic that he had used as a Captain in the SAS. He believed in encouraging people to be responsible, feeling that this provided real motivation. In delegating responsibility, he believed in fostering an environment where people were not afraid to stick their necks out, even if that meant individuals made mistakes sometimes. There was a

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9.6  Case Study: Survival Aids Pty Ltd Table 9.1  Survival Aids, analysis of the year to date contribution to net profit

Sales % of sales: Less: cost of goods sold Gross profit Gross profit margin: Less: Direct expenses Net profit Less overhead share % of overhead share: EBITa

Mail order and retail $ 1,300,000 53% 764,000

Trade $ 736,000 30% 538,000

536,000 41% 212,000

198,000 54,000 27% 29% 80,000 24,000

324,000 226,000 53% 98,000

Export $ 188,000 7% 134,000

Direct contact $ 180,000 7% 110,000

School $ 72,000 3% 72,000

Total $ 2,476,000 100% 1,618,000

70,000 39% 18,000

–

858,000

10,000

344,000

118,000 30,000 128,000 32,000 30% 7%

52,000 30,000 7%

(10,000) 514,000 12,000 428,000 3% 100%

(10,000) (2000)

22,000

(22,000) 86,000

EBIT Earnings before interest and tax

a

strong team spirit in evidence and an apparent absence of the nine to five approach to work. Staff adaptability was essential to such a business, with its seasonal variations in workload. In the rest of the workforce, some people carried responsibility for specific functional areas. The company had recently arranged for a College of Technical and Further Education to provide courses for its staff in skills, communications and ‘business.’

Business Operations The ‘production process’ at Survival Aids was essentially packaging and dispatch. All the products were bought in or subcontracted. Finding and developing new ideas for the catalogue was a major activity. It was something that Nick had been involved in but he had less time to do this now. There was no shortage of ideas – there were currently about 150 ideas for new products. The catalogue had to contain a balance of the practical, the innovative, the exciting and the old favourites. Each product had to be of high-perceived value. Survival Aids had a number of suppliers and had experienced difficulties recently over delivery and quality. This was reflected in a lower standard of service to their customers. Nick attributed the success of Survival Aids to his own persuasive disposition and professional expertise and he swears that personal commitment and an ability to deal with a variety of people in different circumstances are vital ingredients for success, especially in small business. Communication and customer satisfaction are high on his list of critical factors, but when a company’s reputation relies on one

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man’s skill and character, how will it survive in an intensely competitive industry without losing its personal touch? One way the directors of the firm had made up for their own shortcomings in management and marketing skills was to engage outside consultants. These were used in new product design and development, and in the design and production of the new catalogue. A public relations agency was also employed. PR was a major form of promotion for the company. Of the total premises occupied by the firm, about one quarter was used for offices, and one quarter for packaging and dispatch (production). There was also a small retail shop that was linked to the main dispatch department. The survival school, located in a separate building a 100 m along the road, took up about 40% of the space.

Management Systems and Use of Technology Although Survival Aids had been profitable the level of profit was much less than Nick had expected. The company had its own management accounts system operated by an inhouse accounts clerk. This system was not very accurate and Nick was forced to rely on ‘gut feel as well as figures’ to determine where the business was financially. Stocks tended to be too high or too low, and the overdraft was often bumping up against the limit – particularly in times of peak demand. Sales forecasts were within 10% of the planned value, but profits were considerably lower than planned.

Financial Challenges and the Ambition for Growth The growth of the company had placed pressure on the existing finances (see Tables 9.2 and 9.3). The bank overdraft was currently guaranteed by the directors up to a limit of $160,000. The bank would not make any increase in this limit without further personal assurances. The mail order business was cash-with-order but the other outlets required credit facilities of 2 months. The forthcoming financial year was to be a time of major decisions for Survival Aids. Nick knew that he had to ensure a strong financial base for the company. He had looked at nine different strategies for growth and was considering two of them in detail. He felt that growth could come from more penetration of the civilian market and from better designed ‘own label’ products of high value in the catalogue. He also had his eye on the United States market. Nick’s forecasts for growth see turnover growing to around $20 million after 4 years. He is confident of Survival Aid’s ability to grow, even though, for the first time, some genuine competition was appearing in his markets. Nick considered that the key decisions to be made were:

9.7  Key Lessons from the Chapter Table 9.2  Survival Aids Pty Ltd Balance Sheet previous 2 years

101 Year 2 $ Current assets Cash Receivables Inventories Total current assets Non-current assets Property, plant and equipment Total non-current assets Total assets Current liabilities Creditors falling due within 1 year Deposits in advance Total current liabilities Non-current liabilities Creditors falling due after 1 year Provisions Total non-current liabilities Total liabilities Net assets Capital and reserves Called up share capital Profit and loss amount

Year 1 $

976 756 216,066 153,128 340,248 298,834 557,290 452,718 100,466 91,636 100,466 91,636 657,756 544,354 532,242 465,688 – – 532,242 465,688 3766 18,040 21,806 554,048 103,708

– 18,676 18,676 484,364 59,990

52,002 2002 51,706 57,988 103,708 59,990

1 . How to strengthen the financial base of the business? 2. How to provide sufficient space for expansion? 3. Whether to upgrade the firm’s computer systems (estimated cost $100,000)? 4. How to improve the overall effectiveness of the staff?

9.7  Key Lessons from the Chapter • Technology, specifically digital ICT systems, offer SMEs significant benefits in enhanced control and reporting, productivity, market access and innovation. However, most SMEs are laggards in the adoption and use of technology. This is primarily caused by their owner-managers being uninformed of the benefits of these systems. • Technology adoption within SMEs is usually contingent on the willingness of the firm’s owners and managers to recognise the value and seek help and support in acquiring and installing the most appropriate systems for their specific needs.

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Table 9.3  Survival Aids Pty Ltd. Profit & Loss Account previous 2 years

Sales revenues Sales from operations Less cost of sales Gross profit Distribution and administration costs Less distribution costs Less administration costs Operating profit Interest receivable Less interest payable Pre-tax earnings Less tax on profits Profit after tax Retained profit from previous year Capitalization issue Net profit

Year 2 $

Year 1 $

2,475,694 (1,617,404) 858,290

1,574,126 (1,040,832) 533,294

(166,090) (606,862) 85,338 – (23,086) 62,252 (18,675) 43,577 56,907 (50,000) 50,484

(113,648) (344,968) 74,678 678 (5490) 69,866 (19,878) 49,988 8000 – 57,988

The technology adoption process within SMEs is likely to follow a defined transition based on the initial acquisition of relatively basic systems (e.g. email, office software), then building a website, and as the business grows, the firm engages with e-commerce and e-marketing, then e-business suites and eventually builds technology into its strategic business model design. • Industry 4.0 comprises a range of interrelated digital technologies such as: the internet-of-things, cyber-physical-systems, cloud computing, big data analytics, virtual reality, co-bots, artificial intelligence and machine learning. These are set to disrupt existing industries and production systems, and will require the adaptation of most firm’s business models. There are significant benefits to SMEs in embracing this new technology, but failure to take appropriate action will place such firms at risk. The key benefits of Industry 4.0 technologies are greater managerial control, monitoring, optimisation and autonomy, which will generate enhanced flexibility, cost reduction, productivity, quality and speed of delivery time. • The key technology systems within most SMEs are: –– Enterprise Resource Planning (ERP): Use of ICT to integrate internal business systems for enterprise-wide optimisation of data capture, storage and reporting within a management information system. –– Customer Relations Management (CRM): Use of ICT to integrate external and internal business systems to monitor and support customer engagement throughout the full buying cycle and customer lifecycle.

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–– Knowledge Management (KM): Use of ICT to capture, store and report intangible assets within the firm, including knowledge, skills and competencies upon which to build a competitive edge. –– E-Commerce: Use of ICT to undertake transactions such as business to business (B2B) and business to consumer (B2C). Essentially selling goods and services via the internet. –– E-Business: The use of ICT to enhance production processes, customer engagement processes, and internal management processes. Includes ERP, CRM and Supply Chain Management (SCM) systems. –– E-Marketing: The use of ICT to undertake marketing and promotion that complement e-commerce and e-business strategies. –– Social media use: Social media use to support e-marketing and CRM activities. • An ERP system can be relatively simple or highly complex and sophisticated. However, its primary role is to bring together the firm’s sales management (e-marketing), operations management (e-business), CRM, HRM, financial management and supply-chain management systems to provide an integrated framework to facilitate the overall management system. The ERP should link quality management and resource scheduling together via the operations and supply-chain management systems. It should also provide the data management (capture, storage, retrieval and reporting) support to the firm’s daily review, and daily planning schedule and control (DPSC) systems. • A CRM system should bring together the firm’s marketing, sales and customer after sales service activities so as to track the customer throughout their lifecycle. This flows from the customer as a prospect, their receipt of a quotation or sales offering, their placement of an order and then their purchase, then the post-sale service and support they receive, and finally, their loyalty and retention as a customer. A business that can keep its customers loyalty will secure significant benefits from the lifetime value of each customer. A good CRM will also provide the business with data on sales activity, customer satisfaction, and customer retention, that can assist with strategy and business planning. • There are many relatively low-cost ERP and CRM software packages that an SME can afford to adopt. However, any adoption of such systems should be viewed as a strategic decision and the design of the system tailored to meet the firm’s overall strategic goals. Care should also be taken in the selection of any systems vendors, with attention given to how appropriate their systems are for SMEs, their cost and complexity, and their ease of adoption. Here, the key issues are how well these systems integrate with existing systems within the company, and the ease with which employees will understand how to use them. Vendor training and support will also be important considerations. • SMEs can make use of social media as a form of e-CRM through the use of such tools as Facebook, LinkedIn, Twitter, Tumblr, Instagram, YouTube and Reddit. These and many other social media platforms offer SMEs a relatively low-cost opportunity for e-marketing and some engagement with potential and existing

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•

•

•

•

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customers. Feedback from customers via such social media can offer a useful source of market research, and may help to boost customer engagement and loyalty. However, social media is also relatively uncontrolled, and can demand a lot of time to be spent by the small business owner-manager in regularly uploading content and moderating the online communication. Any use of social media should therefore be undertaken in a systematic and considered manner with a social media strategy guiding activity. Knowledge management systems (KMS) offer an important tool for assisting an SME to enhance its innovation, and improve its team performance and overall competitiveness. KMS can be supported by ICT platforms that serve to manage interpersonal communication, teamwork, information and knowledge exchange. Many relatively low-cost systems can be obtained by SMEs to facilitate and support KM, but it is critical to understand that technology is just a tool, and that an effective KMS is built around the way in which the firm’s managers, employees and their external stakeholders communicate, collaborate and engage with each other to co-create value. Organisation culture and structure are of equal importance as technology in KM.  The KM process involves the creation, encoding, sharing, retrieval and exploitation of knowledge within the company and between the company and its key stakeholders (e.g. suppliers, customers). KMS should be designed to facilitate and manage the cycle between knowledge creation, encoding, sharing, retrieval and exploitation. They should be integrated with the firm’s HRM and skills flexibility matrix, to ensure that all employees are well-informed, well-trained, aware of what they must do, and have a good understanding of the wider context within which their particular tasks and role take place. All good KMS should be focused around the integration and continuous improvement of the firm’s leadership, people, strategy and its processes, products and services. An important strategic issue for SMEs is the need to develop a digital business strategy. This should include e-commerce, e-marketing and e-business strategies, that also integrate with the firm’s ERP, CRM and KMS platforms. Most SMEs don’t have such strategies and tend to use ICT and online digital systems in a fairly rudimentary and ad hoc manner. However, SMEs that are engaged in national or global supply chains are often required to adopt such digital strategies by larger suppliers or customers. In those cases, the SMEs are typically required to adopt the systems that have been developed by their larger partners. This can be beneficial, by connecting the smaller firm into best practice systems, but it can also restrict the smaller firm’s flexibility and autonomy. A strategic approach to the adoption of technology should align the firm’s business strategy and organisational strategy with its technology or information strategy. Mapping this into the firm’s value chain can align the ERP, CRM and KMS to enhance the overall value creation within the firm.

Reference

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Reference Small Business Centre DUBS. (1995). Survival Aids Ltd. In Training as an entrepreneurial business: Module 4  – Facilitate entrepreneurship and business. European Centre for the Development of Vocational Training, Durham University Business School, Small Business Centre. Training manual.

Chapter 10

Work Book: Debt Versus Equity

10.1  Learning Objectives After completing this chapter, you should be able to: • • • • •

Identify the main sources of entrepreneurial capital. Understand the nature of bootstrap finance. Know the difference between cash flow and profit. Understand the nature of bank financing. Understand the nature of equity financing.

10.2  Chapter Review Financing a small business venture requires the owner-manager to determine the amount of capital that will be required to achieve the level of activity and growth within the business over its early years. How large this amount of capital is will depend on the nature of the business, its industry dynamics and the ambitions or goals set for it by the owner-manager. Many small firms are established with relatively small amounts of capital. They also manage to trade successfully for long periods without seeking external funds from banks or venture capital. In this chapter, we examine the financing of a new small business venture. One of the most common sources of finance for a small business is bootstrapping, or the funding of growth via retained profits and cash flow. A critical issue for small business owners is to ensure that they have sufficient working capital (e.g. liquid assets and cash) within the business to fund daily operations and growth. Debt financing is typically obtained from banks while equity financing is secured from investors who can be either private, informal sources such as family and © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_10

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friends, or business angels (high net worth individuals willing to invest in a small firm). Bootstrapping offers a lower risk and greater control than debt financing and does not dilute equity as is the case with equity financing. Small business owners seeking to fund using bootstrapping need to understand the difference between cash and profit. A business might be profitable, but if it cannot access good cash flow it might still face financial ruin. Debt financing can be short, medium or long term in nature and usually requires the owner-manager to show a good trading history, strong cash flows and the ability to underwrite any borrowings against collateral such as property or fixed assets. Banks are competitive and owner-managers should shop around but should also cultivate a good working relationship with their banker before they need to raise money. Equity financing is not usually available to small businesses unless they have a strong technology base or the ability to grow rapidly. Venture capital moves through distinct stages, each of which has larger levels of financial investment and greater levels of complexity. Small business owners seeking to raised venture capital need to prepare a sound business case and be willing to surrender equity and control over their business in order to secure faster growth. The ability for SMEs to secure external funding is critical to their capacity to grow, but many small firms struggle to obtain bank financing and very few will receive VC funding. This “funding gap” is a problem identified by policy makers, although it is not a uniform problem and varies from country to country.

10.3  Quiz Questions The following questions are aimed at testing your knowledge of testing your knowledge on the material covered in this chapter.

Fill in the Blanks 1. W____________ c ____________ refers to the available liquid assets the owner-­ manager can employ within the trading period for daily expenses. 2. B___________ f __________ involves the owner-manager raising capital from sources internal to them and their firm, including personal savings, borrowings from family or friends and retained profits from the business. 3. A bank is likely to look for the following things when assessing a small business loan application: C ________ h __________, c _____ f ______, c ___________, c ____________, d ___________.

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10.4  Short Answer 1. Stevenson et  al. (1999) outlined a checklist for financing small firms without resorting to outside funding. Briefly describe the key elements of this checklist? 2. Briefly describe the stages through which venture capital moves. 3. What is a “business angel” and what role might they play in the financing of small firms? 4. What are the main things that you should consider when seeking to pitch for venture capital?

10.5  Class Assignment You are the owner-manager of a small business that employs 19 staff and has had annual turnover figures over the past 4 years as follows: Year 1 $2,433,105

Year 2 $2,664,060

Year 3 $2,984,605

Year 4 $3,433,930

Year 5 $2,433,105

Your gross profit is an average of 40% of sales and your overheads (including wages) run at around $950,000 per annum. You are seeking to raise $350,000 to finance future growth, particularly the purchase of some capital equipment and stock. Private equity is not available and you are seeking to raise this money from the bank. You also feel that you will need an overdraft facility of around $150,000 to help ease your cash flow. You lease your businesses premises, but currently have personal assets including a home worth around $460,000, which is mortgaged. Prepare a short report (maximum two pages) outlining your financing options and how you would raise this money. In doing so you should contact a business bank (most have online information or over the phone business bankers), and research their funding options, borrowing requirements, and willingness to lend. What does this exercise teach you about the process of securing financing from a bank, and the things a small business owner should consider when seeking such funding?

10.6  Case Study Analysis Read the case study Accent Learning and prepare and address the questions that follow.

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Questions/Tasks Prepare a report for the owner that draws together the readings for this topic and other topics with attention given to the following: 1. What should Julie consider before making an application to a bank for funding? 2. How do you think the bank will view Julie’s loan application and would there be any concerns for them in considering her case? 3. Prepare a short report for Julie (approximately two to three pages) outlining your views as to her chances of raising a loan from the bank, and listing the alternatives to funding her business if the bank were to decline her request.

10.7  Case Study: Accent Learning Pty Ltd Background Accent Learning is an executive coaching organisation dedicated to the development of business management teams. The primary objective of the business is to assist organisations to improve their team’s ability to manage staff. It achieves this via team relationship training that works on communication skills, goal setting and development of the vision for the organisation. This is achieved via two key objectives: 1. improving the awareness and performance of the individuals who make up the team; and 2. recognition that the ability to do a task and the ability to manage people requires different skills. It was founded in 10 years ago by Mr. John and Mrs. Julie Ellison and generated an annual turnover of $220,000 in the last financial year. Two years ago, sole ownership of the business passed to Mrs. Ellison following a divorce settlement.

The Accent Learning Programs Accent Learning seeks to focus its training programs around what may be described as hard vs. soft skills. The majority of people in management positions have excellent technical or hard skills. Frequently lacking are soft skills, which relate to the interpersonal skills required to get others to perform. They have direct relationships with the bottom-line performance of all organisations. Accent Learning provides coaching to the executive team members. This delivers a dynamic, flexible and

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productive team where personal fulfilment and profitability are the norm. The Accent Learning program involves testing of individuals to identify the following attributes: Personal honesty Team work Sales ability

Conflict resolution Leadership Communication

Organisation Awareness

The firm offers four separate testing products: 1. Opinion survey: team works – a measurement instrument for a person’s ability and intention in relation to team spirit and personal attitude. 2. Executive aptitude profile – a test to measure a manager’s aptitude and ability in areas relating to management skills. 3. Trait finder – a test which measures personality traits important to teamwork. 4. Sales aptitude profile – a test of a person’s ability to be a sales producer. These programs are marketed at the following prices: • • • •

Opinion survey: team works (55 questions) $35 each. Executive aptitude profile (110 questions) $45 each. Trait finder profile (100 questions) $45 each. Sales aptitude profile (20 questions) $30 each.

These prices include a verbal interpretation of the results. A written report fee of $150 per person per set of questionnaires applies.

Client Base Accent Learning has developed a client list of over 150 companies including such names as Prudential Insurance, Jennings Homes, FJ Sweetmans, J. Corp Pty Ltd., Nutrimetics, the Law Society and the Real Estate Institutes of NSW and South Australia.

Profile of Management Julie Ellison (aged 38) has 20 years’ experience in business and has been recognised formally as a successful business woman via Chamber of Commerce Awards. She has built up three high performance sales and business teams in training and direct marketing. Julie is also regularly called upon to serve as a key note speaker and presenter in the area of people relationships, team building and sales-boosting strategies.

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Julie was previously a regular contributor on the Australian Broadcasting Corporation (ABC) radio on human behaviour and how it affects profitability in the workplace. About 10 years ago she decided to sell her other business interests to focus on her area of expertise  – presentations and workshops on sales-boosting strategies and creating peak performance teams. In addition to Julie, Accent Learning employs one full-time personal assistant and three sub-contractors.

Loan Details Julie is seeking an 8-week $20,000 business overdraft. She requires the loan to pay a provisional tax bill. Accent Learning currently has requested this loan due to a series of outstanding accounts receivable having not been paid when anticipated.

Repayment of the Loan It is the intention of Accent Learning to repay the loan within 3 months. Julie is seeking a competitive interest rate and has been expecting to pay up to 12%.

Personal Financial Position As an education and training provider Accent Learning has few tangible assets. Julie estimates that her two computers, photocopier, fax machine and printer are probably worth around $8500 on the open market. Julie owns a late model Ford Falcon but is currently renting her home following her divorce settlement with her husband.

10.8  Key Lessons from the Chapter • The owner-manager seeking to launch a new business venture or expand an existing one must ensure that they have sufficient working capital to allow their business to survive. Working capital relates to the available liquid assets the owner-manager can employ within any trading period for daily expenses. It is essentially the liquidity of the business and is important because the owner-­ manager must be able to meet current liabilities, some of which may be unforeseen.

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113

• A common cause of small business failure in the initial years after start-up is a lack of working capital. This is caused by such things as the lag between when money can be recovered from customers and put at bank, and the need to pay creditors, employee wages, taxes and overhead costs such as rent payments. • The important benefit of bootstrap financing is that it costs little or nothing. • Use of bank or venture capital will incur a cost of capital requirement on the business. However, the small business owner that uses the company’s own cash for growth avoids this cost. • Further, the owner-manager can have total control over the funds and their use. • There are also no applications to worry about and for many owner-managers who have been rejected by banks this is important. • Finally, many banks and venture capitalists have minimum amounts of money that they will lend. • Use of the firm’s own capital or money drawn from the entrepreneur’s savings or from family and friends carry no such minimums. However, if borrowing from family or friends it is important that the owner-manager deal with this money in a professional manner, it should be correctly recorded and repaid. • The following checklist is important when seeking to employ ‘bootstrap’ financing: implement proven market ideas; look for a quick break-even; look for high gross profit; sell directly; keep the team lean; control growth; focus on cash flow; cultivate banks early. • In seeking to make use of bootstrap financing the small business owner-manager should ensure that they fully understand the nature of cash and profit within their new venture. Cash and profit are not the same and should not be confused. Profit is important in any business but even a profitable business can run out of cash and a non-profitable venture can become cash rich from time to time. • Good cash flow management is about ensuring that the business receives the money owed by debtors before it needs to pay its creditors. This is somewhat different from profitability, which is related to the pricing and costing of products and services. • Many small businesses get into difficulties over their cash flow for a number of reasons: Not collecting money owed; Holding too much stock; Upsetting the bank manager; Buying too many fixed assets; Trying to do too much; Taking too much out of the business; Not considering seasonal swings in trading; having a bad financial management. • Lack of cash (is usually linked to the lack of profitability within the business. Profit problems are usually related to the issues relating to the firm’s cash turnover, profitability, as well as how its internal pricing and costing structure has been able to address variable and fixed costs • Debt financing is one of the more common sources of capital raised by small business owner-managers. Debt financing is generally divided into three categories: short term loans; intermediate term loans; and long-term loans. • Short term debt financing consists of loans that must usually be paid within 1 year. It is therefore used to finance such things as trade debtors or trading stock.

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–– Care must be taken to ensure that the business has the necessary cash flow to pay trade creditors when required. It is important for owner-managers to watch their level of creditor strain –– The advantage of overdraft facilities is that they only become drawn when the money is required and interest is only paid on the money drawn not the entire loan. The cost of maintaining an overdraft facility can be high with establishment fees and administration charges. –– Factoring is not suitable for all firms and is usually appropriate for trade debtors rather than debts owed by the general public. The advantage of factoring is its ability to provide cash quickly – and without the need to secure additional debt. The disadvantages of factoring are that it can cost more than other forms of financing, and it may put relations with customers at risk • Intermediate term loans are so called because they offer financing over a period from 1 to 10 years’ duration. These loans frequently have the requirement to be paid back in large instalments over a short time period and can incur higher rates of interest. The final cost of borrowing money often involves much more than just the interest rate. A variety of other monetary and non-monetary costs should be considered in determining the real cost of borrowing. • The long-term loan generally has a period of contract lasting in excess of 10 years. Because such loans are so long-term, it is usual for the bank or other financial institution to require the business to demonstrate that it has a good track record of trading and is stable. Such loans also require collateral, usually in the form of a mortgage against property or other assets. • Small business owner-managers frequently view bankers as lacking sufficient understanding of their business, being inflexible and lacking creativity. Like many entrepreneurs, the owner-manager views him or herself as a possibility thinker while the banker sees him or herself as ‘bringing realism to the situation’. A major cause of failure in bank loan applications by small firms is the existence of information asymmetries where the information available to owner-­ manager and banker are not identical • Insurance companies and merchant banks can also be sources of funding. Insurance companies have offered financing through the security of life insurance policies with a cash value for many years. • What is not commonly appreciated is that, if the business is unable to secure funding from either debt or equity to provide its working capital requirements, the only source of financing available is usually trade creditors. When a business experiences rapid growth without sufficient working capital to fund its operations, and cannot obtain additional funding from other sources, it invariably increases its creditor strain, i.e. the time taken to pay the suppliers. While the process of straining creditors is frequently viewed as a legitimate business, it is a risky strategy. • What are bankers seeking from small business owner-managers? Unlike venture capital, the banker is not seeking to achieve rapid return on investment and an early exit strategy. Most banks want small business clients, and are usually

10.8  Key Lessons from the Chapter

• •

•

•

•

•

•

•

•

115

s­ eeking to establish and maintain a long-term relationship with the owner-manager. Bankers are generally highly risk adverse by nature, and are keen to see a steady and reliable repayment plan with security against possible business failure or default of loans. There are several things that small business owner-managers should do to improve the relationship between themselves and their bank: keep the bank fully informed; accept advice and build a relationship; negotiate carefully. Despite the best cash flow management and even with support from a banker, most entrepreneurs usually reach the limits of bootstrap or debt financing over time. To fully expand the business, they require large sums of money that must come in the form of equity capital. Initial funding for small firms typically starts with the personal savings of the owner-manager and perhaps the provision of loans or other borrowings from family and friends. These informal sources of equity financing have been found to be among the most important to small firms, particularly highly innovative SMEs. The fast growing, high technology or high innovative firm is inherently risky and may not find it easy to attract debt financing from banks. Small firms are also often too small to secure investment from formal venture capital funds. The most common type of initial equity capital accessed by small firms is private equity (from family, friends and fools (FFF)), who provide informal funding to the business and usually don’t seek substantial returns or demand high levels of due diligence. Once the business needs larger amounts of investment the owner may need to turn to more substantial sources of equity funding which is frequently supplied by business angels. Unlike formal venture capital investor, these business angels tend to use intuition rather than a rigorous assessment of the firm’s balance sheet and financials. They also seek a seat on the company board to keep a close eye on their investment. Angel investors have been identified as playing three broad roles within the ventures in which they invest. The first is a strategic one, providing guidance to the entrepreneurs. The second role is an operational one, frequently networking the venture to a wider market or management talent pool. Finally, the angel can play a personal role guiding the entrepreneur as a mentor A new developing in equity financing is crowdfunding or crowd-sourced financing. This occurs when a business or entrepreneur raises capital from a large number of investors to either launch a new venture, or commercialise a product. It is usually undertaken via online platforms and include donation crowdfunding; reward crowdfunding; debt crowdfunding; and equity crowdfunding. By contrast with business angels the venture capitalist is usually a professional funds manager who is willing to invest in a business if the returns are high enough. As professionals, these venture capitalists will demand good management from the entrepreneur and usually put a higher priority on this than the product or market potential. While there is no clear definition of the term venture capital, there appears to be at least four common elements associated with most venture capital deals: The

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investment in the venture is facilitated by equity; The investment in the venture involves higher than average risk; The investor adds non-financial value to the venture by provision of management skills or advice; The purpose of the investment is to secure above average returns through capital appreciation. • A study of venture capital investors found that the top five things that they looked for when deciding whether or not to invest in a deal were: the entrepreneur’s personality, the entrepreneur’s experience; characteristics of the product or service; characteristics of the market; and financial considerations. • In order to do a deal over securing finance, the entrepreneur needs to understand three key things: (i) they must understand their business; (ii) they must understand the viewpoint of the venture financier; and (iii) they must understand what their own needs are in relation to the money being sought. • It is important to remember that, while the venture capital investor is taking equity in the business, they will generally want to have a clear exit strategy. This should be determined in advance.

Reference Stevenson, H., Grousbeck, I., Roberts, M., & Bhide, A. (1999). New business ventures and the entrepreneur. New York: McGraw-Hill International.

Chapter 11

Work Book: Cash Flow, Profit and Working Capital

11.1  Learning Objectives After completing this chapter, you should be able to: • Know financial accounting terms. • Understand the importance of the working capital cycle within the small firm. • Understand and calculate the break-even point. • Understand and apply the power of gross profit margin. • Recognise the importance of pricing for profit. • Review credit policy issues and relate these to cash flow management and profitability.

11.2  Chapter Review While many small businesses start up with only bootstrap financing, it is usually necessary for them to expand their operations and invest in both new capital equipment, employees and marketing or advertising activities. The expansion  – even modest expansion – of a small firm can place a strain on the firm’s resources and it is possible for a small business to overtrade and find itself in a financial crisis even though sales are increasing. This chapter explores the importance of understanding the working capital cycle and the need to monitor the break-even sales within the firm while understanding the importance of ‘gross’ rather than ‘net’ profit. It should be noted that the purpose of this book is not to cover financial accounting issues in any detail as this would be beyond its scope. Instead this chapter aims to provide an

© Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_11

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overview of key financial management concepts considered important to the successful operation of the small business. The financial control of a small business is one of the most important tasks the owner-manager can undertake. To undertake good financial management the owner must be familiar with the ‘Holy Trinity’ of financial reports comprising the balance sheet, P&L statement and cash flow forecast. The key elements of the balance sheet are the firm’s assets, which are the things it needs to undertake its operations. Plus, the liabilities and equity, which are the debt, share capital and retained profits available to fund the assets. The P&L statement shows the sales revenue generated by the business, less any variable costs resulting in the firm’s gross profit, and then the allocation of fixed costs before the final net profit is shown. The cash flow statement shows the allocation of cash from accounts receivable (debtors) to accounts payable (creditors), then the allocation of any cash inflow from non-sales items. Forecasting cash flow and monitoring cash flow are among the most critical aspects of small business management. Cash flow is essential to fund the firm’s working capital cycle. Working capital (cash and short-term assets) is needed to keep the business operating. The small business owner must learn to use financial analysis via ratios in order to monitor their firm’s financial performance. These ratios can be used to examine liquidity, solvency, efficiency and profitability. Key measures are the firm’s gross and net profit margins, break-even point, working capital requirement and external funding need. Conventional balance sheet presentations, while useful, can be supplemented with dynamic balance sheet and graphic displays to help the data become more meaningful to the owner-manager and their staff. Regular monitoring of a set of six to eight financial KPI can be an essential mechanism to maintain control of the small business.

11.3  Short Answer 1. Briefly describe the key things that the owner-manager of a small business should consider when seeking to prepare a cash flow forecast? 2. If the Ace Printing Company has an annual turnover of $600,000, variable costs of $260,000 and fixed costs of $160,000 what will be its break-even sales point? 3. If the Quick-Fast courier company has a sales turnover of $900,000 and break-­ even sales of $460,000 what will be its break-even gap? 4. The Purple Songbook Music store has a gross profit of $550,000 and overheads of $350,000. What is its Quick Profit Calculation? 5. The Jackson Furniture Company has an annual turnover of $2.5 million, $50,000  in owner’s share capital, fixed assets of $120,000, stock on hand of $5000 and retained profits of $30,000. The company also owes $12,000 to trade

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119

creditors but has $15,000 in receivables. Calculate the firm’s external funding need. 6. Bob’s business is experiencing tough competition and he has decided to offer a price discount of 10%. His company generates a gross profit margin of 30%. How much sales volume would he need to attract to achieve the same gross profit as he is currently experiencing?

11.4  True/False

1. If Company A and B have the same sales revenues, but Company A has a gross profit margin of 60% and Company B has a gross profit margin of 40%, company A will have higher variable costs 2. The net profit is a more important figure than the gross profit because it tells the owner-manager how much money that they actually have to work with 3. Mary should be happy that the annual sales turnover of her small firm has increased by 60% over the past 3 years even though her costs of operation have risen due to this increased activity 4. Creditor strain is the amount of unauthorised extra credit that a business takes from suppliers 6. David is a busy fool if he thinks that he can solve his cash flow problems by heavily discounting his products even though he cannot lower his cost of operations

True False [  ] [  ]

[  ] [  ] [  ] [  ]

[  ] [  ] [  ] [  ]

11.5  Class Assignment Following is the balance sheet and profit and loss statement for KITSOL Pty Ltd. a small firm engaged in commercial kitchen design and manufacture. Having re-­ viewed these financial reports: 1. Assess the financial performance of KITSOL so far, examine its break even, gross profit and working capital requirements. What type of managers have the owners been (e.g. excellent, good, bad or busy fools)? 2. Prepare a dynamic balance sheet and a radar chart for KITSOL. 3. Calculate the funding requirement for KITSOL and determine if the owners can afford to fund a future planned growth strategy (Tables 11.1 and 11.2).

120 Table 11.1  KITSOL Pty Ltd Balance Sheet previous 2 years

11  Work Book: Cash Flow, Profit and Working Capital

Trust capital Issued units Total Trust Corpus Current assets Cash Receivables Inventories Total current assets Non-current assets Property, plant and equipment Advances to unit holders Total non-current assets Total assets Current liabilities Creditors and borrowing Deposits in advance Total current liabilities Non-current liabilities Bank borrowings Provisions Total non-current liabilities Total liabilities Net assets

1996 $

1995 $

50 50

50 50

57,513 50,031 29,251 136,795

41,467 25,925 29,251 96,643

32,080 581,276 613,356 750,151

33,894 23,565 57,459 154,102

186,300 131,201 50,200 21,236 236,500 152,437 511,986 1615 513,601 750,101 50

– 1615 1615 154,052 50

11.6  Key Lessons from the Chapter • The ‘holy trinity’ of accounting includes the three principal reports: the profit and loss statement, balance sheet, and cash flow statement. An understanding of these documents is important to allow the owner-manager to understand the basic information emerging from their businesses accounting systems. –– Balance sheet: Provides a cross-sectional snapshot of the firm’s net worth. Assets – Liabilities = Owner’s equity. The balance sheet shows the amount of cash and liquid assets that are available at a given point in time, and it accounts for money that is to be paid to the firm in the future from customers and other ‘accounts receivable’. The balance sheet also provides information on the long-term assets that the business has. This is important because a business only has assets because they are the resources it needs in order to undertake its work. The owner’s equity is equal to the value of the firm’s assets less its liabilities, thereby resulting in a net worth position. The need for a balance

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Table 11.2  KITSOL Pty Ltd. Profit & Loss Account previous 2 years

Sales revenues Sales from operations Other sales Total sales Cost of sales Opening work in progress Purchases Sub-contractors Less closing work in progress Cost of goods sold Gross profit on trading Interest received Total income Less expenses incurred: Accountancy Advertising Bad debts Bank charges Borrowing expenses Cleaning Computer software Depreciation Electricity Fees and permits Freight and haulage Fuel, oils & lubricants Hire of plant and equipment Hire purchase charges Insurance Interest and other loan charges Interest and charges recovered from unit holders Lease payments Motor vehicle expenses Car lease payments Printing, stationery and postage Professional fees Protective clothing Rent, rates and taxes Repairs and maintenance

1996 $

1995 $

1,110,963 – 1,110,963

1,091,969 – 1,091,969

29,251 331,689 360,455 721,395 (29,251) 692,144 418,819 4169 692,144

8887 557,444 210,362 796,693 (29,251) 767,442 324,527 – 767,442

9245 18,864 12,152 3434 1931 688 3242 8970 2658 3094 6328 10,528 930 680 9303 22,365 (22,365)

– 3554 – 2177 100 425 – 8985 1290 795 9836 8758 6674 1980 22,215 117 –

20,005 3892 6895 3960 5758 1060 33,298 5030

10,922 2612 3286 6169 945 10,381 7190 (continued)

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Table 11.2 (continued)

Security Staff training and amenities Subscriptions Superannuation Sundry expenses Telephone Tools replacement Travelling expenses Wages Waste removal Total expenses incurred Net profit Distribution of surplus Dean family trust Bill family trust

1996 $ 1565 5132 681 9571 2030 5362 2161 10,271 216,871 600 426,189 58

1995 $ 195 2661 2652 6657 450 6466 2299 9715 157,418 263 297,187 30,798

29 29 58

15,399 15,399 30,798

sheet to balance relates to the requirement for the bookkeeping process to balance what a business owes (e.g. liabilities), and what it owns (e.g. assets). –– Profit & loss statement: Provides a picture of the firm’s past trading history. Income – Expenses = Net profit. The profit and loss (P&L) statement (income statement) provides an overview of all income and expenditure throughout the accounting period. In essence it provides data on the activities that have taken place between the balance sheets that report at specific points in time. The P&L statement is a valuable tool for showing the firm’s performance over a given time period. It can break the income and expenses down into major categories, and can be used to identify areas of cost and profitability –– Cash flow forecast: Provides a forward estimate of the firm’s expected sales income and expenditures. Debtors – Creditors = Net income. Cash flow is the lifeblood of a small business, and monitoring the firm’s cash cycle and forecasting future cash flows are critical to survival. Preparing a cash flow projection involves a good deal of judgement and some guesswork. While it may not be possible to predict the future when preparing an estimate of future sales, it is most important that the forecast is not too optimistic or too pessimistic. Overly optimistic sales forecasts can prove disappointing and may lead the business to hold onto unused inventory. Pessimistic forecasts can result in the owner-manager failing to hold sufficient inventory, which can be just as problematic. A cash flow budget is principally designed to ensure that the business has sufficient income to cover its expenses and must incorporate any major expense that may fall due during the trading period.

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• The small business owner-manager seeking to gain control over their firm’s finances needs to understand both the working capital cycle, and how to prepare and use a cash flow forecast. • The working capital cycle refers to the flow of cash and other liquid assets through the business during the course of its regular operations. Until income is received from sales the firm will need working capital to furnish the necessary cash to pay for the other operations throughout the production process. The owner-manager must determine how much working capital they need. • Having identified the working capital needs through this process of matching expenses against cash flow, the owner-manager should prepare a worst-case scenario and determine the amount of cash required for covering emergency periods when there is a slump in sales. • If the owner-manager chooses to draw out the profits and distribute them as dividends rather than invest in assets or repay liabilities, the business will be unable to grow. Further, if it needs more assets, particularly working capital, the business will be forced to take on additional liabilities. • Small business owners should monitor their cash flow and profitability, and put in place key performance indicators (KPIs) that can allow them to monitor and control finances more readily. • At least four important areas must be considered in assessing the financial performance of a small business. –– The first is the liquidity of the business, particularly the working capital required to keep the firm’s operations going and to allow for expansion or growth. –– The second is the overall solvency of the business. Here the attention needs to be given to the balance of assets to liabilities. –– A third area of concern is the overall efficiency of the business, which is essentially about how well the owner-manager is running the venture. –– Finally, there is a need to examine the firm’s profitability. Over the longer term the most important issue in any business is how much profit can be made. • How profitable a small business is ultimately determining how well it serves its owners as a valuable investment for their time and effort. A business that is not profitable is unlikely to grow and unlikely to be much fun to own. There are a number of profitability measures that can be used to keep an eye on the firm’s performance in this regard. –– The gross profit margin is probably one of the most important figures a small business owner can monitor. It is a measure of the amount of money generated from sales after variable costs or the costs of goods sold are deducted. Low gross profitability means that the business will not have sufficient cash flow to cover overheads and therefore break even. Even if it does break even, it may be unlikely to see much profit or earnings before interest and tax (EBIT) –– If the firm’s net profit margin is rising it suggests that the owner-manager is demonstrating good control of fixed costs (overheads). However, a falling net

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profit ratio suggests that the business is experiencing too many overheads that might be caused by rising salary and wages, rising costs of rent or too many long-term borrowings to service. –– An owner of a small business should view himself or herself as an investor. The return they are getting from the capital employed in the business tells them how well their business venture is as an investment. • A principle of dynamic accounting is that a single number in isolation is of little value to the manager seeking to understand their business. Numbers are only of real value when placed into time series or in relationship to others. The annual financial statement that indicates whether a business has made a profit or a loss is substantially less useful than a continuous set of numbers indicating the trend in business activity over time. • The day to day or month to month trading of the business is where the dynamic indicators become important. These measure the firm’s profitability, break-even and general operational efficiency. For this reason, gross profit margin is a more useful measure than net profit. Also important is the ability to examine the break-­ even point in a dynamic way. • The break-even point is the volume of sales required to cover both fixed and variable costs. Knowing the firm’s break-even point and determining how many sales are required per month, week or even day, can significantly empower the small business owner to gain control over their company. Monitoring the firm’s break-­ even point, calculating the number of sales required to achieve break-even, and carefully watching cash flow are all essential to the successful financial management of a small firm. • Before an owner-manager decides to reduce prices, they should consider their gross margin and the impact a price reduction will have on their break-even. They might also consider a price rise instead if they can make the same profit margin with fewer sales. A problem with a traditional break-even analysis is that it views the business activity at a single point in time. To overcome this weakness, dynamic accounting uses a moving break-even that permits analysis of profitability in a more effective way. • The break-even gap is the difference between actual sales and break-even sales. This indicator provides the owner-manager with a measure of how many sales they require to reach break-even. This can be particularly useful when monitoring the firm’s performance after start-up, or when planning new products and business development opportunities. By converting the break-even gap into a ratio, the small business owner can produce a useful KPI and plot this trend over time. • The need to keep the break-even point down suggests that small firms should avoid competing on price. Following a cost leadership strategy is usually problematic for the small business, as they are often unable to secure adequate economies of scale and simply end up with thin profit margins, break-even problems and customers that only value their cheap prices.

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• How well the owner-manager is able to determine their funding requirements can be crucial to the future sustainability and growth of the firm. To assess the external funding need the firm may have, the owner-manager should consider undertaking a calculation of their net fixed assets and true working assets (e.g. stock and debtors, less creditors) minus any equity. From this, the owner-manager can determine how much capital they could raise from external sources pledged against their net assets less any owners’ equity. Through this process, the owner-­ manager can determine the overall strength of their firm’s funding base. • Cash within a business can only be found in two places: in the hands of shareholders; or tied up in the balance sheet. The dynamic balance sheet is divided into four parts. The columns provide the separation into assets and liabilities, but these are classified as: assets = funding needed, and liabilities = funding available. A key element in the dynamic balance sheet format is its recognition of the relationship between the firm’s total asset need and available funding. A graph offers a better way for many people to see the structure of the firm’s financial position in the balance sheet.

Chapter 12

Work Book: Franchising and Legal Issues for Small Firms

12.1  Learning Objectives After completing this chapter, you should be able to: • • • • • • •

Define the term franchise. Understand the difference between franchising a product or service and an entire business operation. Recognise the importance of franchising as a business model. Consider the advantages and disadvantages of franchising. Recognise the legal structures applicable to small businesses in Australia and the advantages and disadvantages of each. Understand the key legal issues facing small businesses and how they impact on operations. Describe the nature of intellectual property rights and identify each of the main types.

12.2  Chapter Review Franchising has become one of the most successful forms of business model in recent years with business format franchising systems spreading rapidly throughout the world. Franchising offers the advantages of a proven business system, training and management support, and ongoing marketing. In this sense it is often viewed as being less risky than starting or buying an independent operation. However, franchising may be overly restrictive for many owner-managers and can incur high up-­front and ongoing costs. Not all franchising is successful and franchisees may not make as much profit as independent operators. Care should be taken when selecting a franchise, the need for due diligence is no different to other forms of business purchase. Australia © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_12

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has introduced a Franchising Code of Conduct that aims to regulate franchises and protect franchisees. Franchising has proven a highly successful business model for exporting as it serves to reduce risk. Franchisors seeking to enter overseas markets are likely to seek partners to assist them to secure local knowledge and access to resources. A key decision for small business owners is what legal form to make their venture. Incorporated entities, partnerships, sole trader and trusts are all available options. Each requires a trade-off of complexity and liability protection for cost and simplicity. The protection of intellectual property is important to firms seeking to grow and can take the form of formal registration (e.g. via patents, trademarks, designs and plant breeders rights), and informal non-registered rights such as copyright, circuit layout rights and trade secrecy. Also, important consumer laws and privacy laws that can impact upon the small business.

12.3  Quiz Questions The following questions are aimed at testing your knowledge of the key concepts covered in this chapter.

Fill in the Blanks 1. A franchise system involves a legal contract between two parties; on one side is a supplier of goods, services or business systems known as a _______________ while the other party is a distributor or operator known as a __________________ who secures the rights to use a trade name or business format to sell a particular product or service. 2. A franchise system that involves the sale of a well-established brand name is known as _______________ franchising. While a franchise system that also offers both branding and a business system is known as _______________franchising.

12.4  True/False True False [  ] [  ] 1. The Franchising Code of Conduct is a piece of Federal Government legislation that is part of the Competition and Consumer Act 2010 and is enforced by the Australian Competition and Consumer Commission 2. Under the Franchising Code of Conduct if Robert wishes to sign Kathy into a [  ] [  ] franchise agreement with his business, he is required to disclose to her all aspects of the business to allow her an opportunity to make a rational decision about its merits, and she has the opportunity to change her mind even after signing up but within a specified cooling off period (continued)

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True False 3. Franchising is a significantly less risky method of establishing your own [  ] [  ] business than going it alone. 4. In selecting a legal structure for a new small business, the most important [  ] [  ] consideration should be how tax effective the final outcome is. [  ] [  ] 5. Bill is a business partner with Ralph, who incurs a legal liability of $five million dollars. However, as Bill was not responsible for this liability he should not worry as it is Ralph who will have to pay any costs

12.5  Short Answer 1. Briefly describe conversion franchising and why it might be of benefit to a small business owner-manager. 2. Briefly describe the main advantages and disadvantages of establishing a proprietary company as a small business owner. 3. List the main duties of a company director. 4. Under the Competition and Consumer Act 2010 what is price fixing and why is it illegal? 5. Describe the main types of intellectual property and whether they are formal or informal in nature.

12.6  Class Assignment Imagine that you are seeking to establish a new business venture and wish to consider franchising in addition to a traditional independently owned and operated business. Having read the course notes provided for this chapter, select your chosen business opportunity, and research it using websites or newspapers. Prepare a short report for subsequent submission.

Questions/Tasks 1 . Would a franchise offer a superior business model to a solo business? 2. What legal structure would you need to establish to proceed with your new venture and why?

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12.7  Key Lessons from the Chapter • A franchise is a contract by which a parent company (the franchisor) gives an individual operator (the franchisee) the right to use a trade name or a business format to sell a particular product or service. The franchisor will usually provide the franchisee with their knowledge, operating and marketing techniques. In other words, a franchise is a pre-packaged business that you can operate under agreement with a franchisor. It is essentially a means of reducing the risk (both financial and managerial) of the franchisor. • There are two principal types of franchising agreement that can be used to establish a franchise business. The first of these is the product and trademark franchise, while the second is the business format franchise. Each of these has a slightly different legal structure • In summary, the key advantages of a franchise business are the prospects that if it is well designed and managed with a sound track record and brand image it will be a lower risk than establishing an independent business. The training and systems support provided by the franchisor also allows the small business operator to get established with proven operational and administrative controls in place, which should reduce risk. • Franchising has the disadvantages of high fees and ongoing royalty payments, loss of control and the legal pressures that might be used by a franchisor seeking to enforce their rights against a franchisee that they feel is not fulfilling the agreement. Many franchisee-franchisor disputes arise over these issues, and many franchisors will require franchisee’s source all their ingredients or materials from the franchisor, even when these may not be the cheapest. Royalty fees may also be charged as a percentage of sales, or a flat fee, resulting in the franchisee having to pay them even if their business is not profitable. Franchise businesses seem to have a substantially better survival rate than independently owned and managed small firms • Research suggests that many franchisees are lured into franchising deals with the promise that they will make money without the usual risks associated with a normal small business start-up. Franchisors will appear to be successful and able to offer the necessary marketing and support to the franchisee. However, there is no guarantee that the franchisor will not fail thereby taking the franchisee down with them. • For those deciding whether to start up via the purchase of a franchise or to launch an independent green fields venture, the key issues to consider relate to the owner’s background and start-up capital. Many new franchisees are former salaried professionals who are generally well educated and who have accumulated good financial assets, but who lack experience in independent business operations. These people generally make good franchisees. They can learn quickly to manage and operate the systems developed by the franchisor, and typically are happy to follow the script. For people with a more independent and innovative mindset who may value independence, the franchise route is likely to be less attractive.

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Franchise businesses may also not generate the same level of profit or growth potential as a new independent business. Therefore, the individual who is willing to take the risk to secure the superior return may be better to follow the independent business option. • When considering whether to buy a franchise the small business owner-manager should investigate the franchisor with the same scrutiny they would with any other established business. Of importance would be such things as: the territory assigned, the success of other franchisors, the terms of the franchise contract, the level of on-going support, the quality of management systems, and the contract termination. A four-stage model for successful franchise system development has been proposed –– Hatchling: concept development. As with any start-up firm the owner-founder is usually engaged in ‘hands-on’ management, ad-hoc planning and simple or informal business and control systems. –– Nestling: business development. This stage usually sees the franchisor developing and testing a business system that can be configured for expansion. It should offer franchisees profitability and expansion. –– Fledgling: initial franchisees. The system must offer a fully developed support infrastructure for management, marketing and financial support to franchisees. Company-owned outlets may be sold to franchisees at this stage. –– Adult stage: franchise expansion. It will require the franchise to have developed a well-structured Head Office, full procedural manuals and a succession plan for franchisees. Important issues for the franchise during this expansion stage will be handling franchisor-franchisee relationships, particularly as the franchisees mature and seek growth. • It must be realised that the franchisor-franchisee relationship is not one of employer-employee, but a commercial partnership with obligations and rights on both sides. The role of a good franchisor is to create and maintain a well-designed business system that allows the franchisee to make a success of their business, and to maintain steady profits with less stress and risk than might be the case were they independent. • In summary, the franchising model has proven highly successful for businesses seeking to grow rapidly both at a national and international level. The choice of foreign market entry strategy is likely to be a critical decision by franchisors that will be influenced by their capacity to control the marketing channel. Most small franchisors will be forced to form joint ventures in the form of master franchise entities and share ownership within a selected country with local partners. Nevertheless, the business format franchise system has this growth potential due to its capacity to be replicated at site after site once appropriate systems and training have been put in place. The opportunity to build a successful small business through a turn-key environment has attracted the many thousands of franchisees who have paid to join these systems. • An important consideration for the owner-manager seeking to establish or develop their business enterprise is determining the corporate structure that the

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entity will have. Decisions regarding how the business will be structured are complex and may have profound influence on the future management of the firm. The structure of a business has legal as well as managerial implications and is likely to incur a range of different taxation effects. • There are four main business legal structures. The key differences between these different structures relate to the way taxation and legal liability is dealt with. –– The company structure creates a business entity that is legally separate from its owners and managers. A private company or proprietary company is the most common within small business and comprises firms in which all share capital is held privately (it can have only one shareholder). By comparison, the public company is listed on the stock exchange and must provide annual, audited financial reports to all shareholders. Key advantages for a company structure are the limited legal liability it offers, thereby protecting the owner-­ manager’s personal assets from claims against the business. –– The key advantage of being a sole proprietor or sole trader is the simplicity of the legal structure. There are few costs of establishing this system and few ongoing compliance responsibilities in comparison with other systems. Registration of a business name is frequently the main activity required in the establishment of this system. However, the sole proprietor legal structure suffers from several disadvantages. The first is the legal liability of the owner-­ manager. From a legal perspective there is no difference between the owner-manager and their business entity. This means that any legal claims against the business will most likely impact directly on the owner’s personal assets. –– The partnership structure involves two or more individuals engaged in the same business entity. Like the sole trader/proprietor structure, the partnership is reasonably easy to establish, but also suffers from the lack of legal separation between the business entity and the owner-managers. The failure of partnerships is frequently due to differences of opinion between the partners that cannot be resolved. Research has highlighted the importance of effective communication strategies between partners. Mechanisms are required to allow disputes to be resolved – or avoided – through communication flow. –– In legal terms a trust is ‘a relationship or association between two or more persons whereby one party holds property on trust for the other. The first party is vested with property. The holder of the property is called the trustee. The other party (for whom the property is held) is called the beneficiary. Trusts may be made expressly in writing or implied from the circumstances. • The formation and development of many small firms may revolve around their ability to make use of commercially valuable intellectual property. Owner-­ managers with valuable intellectual property should take steps to protect their ideas. This can be achieved through taking legal action over patents, trademarks, copyrights or trade secrets. • There are several types of IP, some of which must be formally registered before rights can be legally assigned. The following types of IP are generally recog-

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•

• •

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nised: patents, trademarks, designs, copyright, circuit layout rights, plant breeder’s rights, confidentiality/ trade secrets Once registered, the patent documentation is published by the patent office, making it available to the general public. The patent then becomes recognised as part of the ‘state of the art’ associated with the field of science or technology within which the patent lies. Anyone can then access the patent documentation and comment on it. Trademarks are generally used to identify goods and services from one supplier from those of another, making it impossible to register generic products. Geographic place names, surnames and given names are often difficult to register as trademarks, although these can be registered if they have been used in the market place for a long period of time If a business has used a trademark or brand name in the market for a period of time without formally registering it and then finds that another business has begun to make use of the same trademark, they might still have a legal claim. To be eligible for registration, the design must be new, meaning that there is no identical design already in public use in Australia or published in a document either in Australia or overseas. It must also be distinctive, in that it is not similar to any existing designs in terms of its overall appearance.

Chapter 13

Work Book: The Owner-Manager and the Troubled Company

13.1  Learning Objectives After completing this chapter, you should be able to: • • • •

Understand the causes of small business failure. Examine causes and danger signals of impending trouble. Understand the characteristics of poorly performing firms. Review turnaround strategies for small firms and apply the principles to a case study.

13.2  Chapter Review Crisis management, turnaround strategies and reengineering are just as important to the small business owner-manager as they are to the managers of large corporations. Unlike their large business counterparts, the small business owner-manager is likely to experience not only loss of profits and shareholder value if things don’t go well, but may lose their entire livelihood, personal assets and reputation. Fortunately, the small business is capable of getting itself out of trouble just as quickly as it may get into difficulties. This chapter examines how small business owner-managers can deal with trouble and overcome difficulties by problem solving. It explores the process of crisis management in the small firm and suggests that reengineering and turnaround strategies are not only the preserve of large firms. The main causes of failure in small business relate to financial, marketing, production, human resources and physical resources, but are predominately due to poor management skills of the owner-manager. While bankruptcy is the most dramatic form of failure in the small business it is not as common as other forms of termina© Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_13

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tion. Research into small business failure has identified many “deaths” of small firms, including bankruptcy, termination with loss to creditors, termination before losses, discontinuance for other reasons and simply “failing to make a go of it”. Small firms typically fail in their early years due to poor planning or lack of motivation by the owners. Good management is the key to small business success and this involves not only good cash flow management, but also the ability to think and plan strategically, create and retain customers and lead teams. Small firms often find themselves in financial trouble because of poor financial and accounting controls, record keeping and key performance indicators. While some problems can be foreseen, others are not easily recognised, but having effective management systems in place can alleviate the impact of such unforeseen problems. It is not uncommon for the owner-manager in a crisis to be overly optimistic and anticipate that the market conditions will improve. Keeping an eye on cash flow and working capital (liquidity) within the company is critical to survival in troubled times. When faced with a financial crisis it may be necessary to cut overheads and this may require the laying off of employees. Owner-managers need to be open and honest with employees and customers, and keep everyone in the company fully informed of the situation. Getting cash into the business is critical and it may be necessary to negotiate credit terms and early payments from customers to help ease cash flows. When faced with problems the owner-manager should approach them in a systematic manner, gathering facts and developing a clear understanding of the underlying causes of the problem before seeking to produce solution.

13.3  Quiz Questions The following questions are aimed at testing your knowledge of the key concepts covered in this chapter.

Fill in the Blanks 1. One of the most common forms of ‘death’ for a small business is where the owner-manager simply decides not to trade any longer. This is known as d_____________________. 2. When a small business is forced into liquidation due to financial problems, we refer to it as a f__________ failure. However, when the owner-manager decides to abandon their business due to excessive workload we describe this as a p_________ failure.

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13.4  True/False

1. Maintaining close relationships with customers and suppliers can assist the small business to better manage its cash flow 2. Diversification is a successful strategy for small firms, enabling them to spread their risks across many different product-market combinations 3. Mouse trap myopia is where a small business owner-manager focuses too much effort on one single product line or customer 4. Mike and Wendy have a small business and their annual sales turnover has been growing steadily each year as their business builds up. They plan to offer big discounts to customers next quarter to secure even more market share. Based on this assessment it seems things look very good for the future of their company 5. When trouble hits a small firm, it is not uncommon for the employees to be the first to notice

True False [  ] [  ] [  ] [  ] [  ] [  ] [  ] [  ]

[  ] [  ]

13.5  Short Answer 1 . Describe the most common causes of failure in a small firm. 2. Jane has $6000 cash in the bank and $12,000 in other liquid assets, she estimates that her business will have to find $8000 in the next month to pay some contractual obligations. Her business has total assets of $160,000. Given this information calculate her Net Liquid Balance to Total Assets Ratio. 3. What are the main turnaround strategies that might be used by an owner-­manager facing a crisis? 4. What is the purpose of a problem statement in the integrated problem-solving approach?

13.6  Class Assignment Working in groups read the case entitled “Lessons from a Crisis: The Pretzel Logic Story” (Chap. 13 of Textbook). Discuss the key lessons that Steve Pretzel outlined in that case and why he feels that they are important. What do these ‘lessons’ suggest about the way a small business owner should approach the task of running their business both before a financial crisis and if they find themselves caught in one.

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13.7  Case Study Analysis Read the Robotics case study and imagine that you have been approached by the owners, Robert and Claire, for assistance in getting their business back on track. Address the following questions and tasks.

Questions/Tasks 1. Prepare a problem statement for Robert and Claire that summarises the main cause(s) of the difficulties that Robotics Pty Ltd. has found itself confronted by and explain why you have identified these as the main issues to be confronted. 2. Prepare a list of key things the Robert and Claire should consider when developing a turnaround strategy for Robotics

13.8  Case Study: Robotics Pty Ltd Author: Aniket Maroo “Too much engineering, too little marketing” is how Robert and Claire summarised their company’s position. They were confident their product far exceeded anything comparable on the market, but their faith in the engineering excellence of Robotics Pty Ltd. had failed to translate into a healthy bank balance. Robert relished the challenge of solving engineering problems, but his motivation was not profit driven. As a consequence, the time spent on research and development was disproportionate to the company’s revenue base. As a result, Robotics owned a substantial intellectual property base, but the accounting standards did not permit intellectual property to show as an asset on the company balance sheet and the bank appeared to overlook its value. Was this the key reason Robotics failed to post a healthy profit?

Humble Birth Like many family businesses, the birth of Robotics Pty Ltd. was modest and unplanned. But the energy, enthusiasm and drive of its husband/wife partnership offset a lack of financial resources. Robert was an engineer turned businessman. Robotics manufactured automated flat-bed cutting machines, but the similarity between the names was pure coincidence. In fact, Robotics’ operations began accidentally in an altogether different field under an entirely different name, IntelliDesign Pty Ltd.

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Robert had become bored with his job as a mechanical engineer. During the course of a telephone conversation with two old mates from his post-graduate days at Imperial College in London, he secured the Australian rights to distribute IntelliCAD, a suite of software products designed especially for the signwriting industry. Combined with the advent of affordable personal computers, IntelliCAD revolutionised the signwriting industry. Small franchise signwriting businesses proliferated across the country and IntelliDesign prospered.

Dealer Network Robert made all the initial software sales and secured a list of long-term clients, to whom he could provide ongoing support and product upgrades. The 1st year of business was so sensational he considered opening an office in every capital city in the country. However, Claire’s caution prevailed, which proved fortunate when competition from other products mounted and it became apparent IntelliCAD lacked the “blue sky” potential it had previously exhibited. Instead Robert appointed regional dealers in each of the major metropolitan cities. Based on a simple 30:30:40 formula, he offered a 30% dealer margin on every sale. Each dealer was responsible for local advertising and marketing. IntelliDesign received 30% and the remaining 40% covered costs of sales.

Extended Credit Terms IntelliDesign secured 90-day terms of trade from the software supplier. This was a huge benefit, as all sales were made and monies collected well within the 90-day period, which allowed the new business to build up a surplus cash pool. Unfortunately, this surplus was misinterpreted as business profits before depreciation, due to an absence of monthly financial accounts. In hindsight, this was regrettable for a number of reasons: IntelliDesign failed to demand timely payments from its dealer network whenever they fell behind with their credit terms. As a consequence, some dealers began to use IntelliDesign as a quasi-banking facility. Robert and Claire thought they had a brilliant accountant because their annual reported results and tax bill were much less than anticipated based on the cash reserve. It never occurred to them to query this apparent discrepancy. The business failed to budget effectively. As there was always cash around to spend on business development, IntelliDesign experimented with new growth opportunities without proper strategic planning.

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Vertical Expansion After 3 years in business and with a steady cash flow from the software sales and support, Robert turned his attention to a vertical expansion of his operation. His mechanical engineering background had enabled him to answer client software support calls by fixing the sign writing hardware. Problems often arose from poorly designed low-grade hardware. The challenge to design and engineer, high quality hardware was too much for Robert to resist. Whilst Robert devoted his attention to the research and design of hardware, Claire stepped into the business to manage the software dealer network. She was so successful at balancing this responsibility with her role as mother of three, that few people would have known the business was shifting direction, if the name had not changed to Robotics Pty Ltd.

Cash Surplus These were exciting times. The cash surplus generated by software sales and support was ploughed back into the business to finance the manufacture of better and smarter flat-bed sign writing hardware, which was marketed through the established dealer network using the 30:30:40 formula. Forty percent covered the cost of manufacture but now, for 30%, the dealers were required to promote and install the hardware on delivery at clients’ premises and to provide a 3-month after-sales support service.

Enhanced Performance Robotics was driven by the engineering excellence of its flat-bed sign writing hardware and strove to improve and enhance product performance. The hardware was keenly priced and, in Robert’s view, the best value on the market. Yet most sales were achieved either by trimming the price further or by making specific modifications for a nominal extra charge. Robert saw each customer requested modification as a further engineering challenge and costed jobs on the nominal time rather than the actual time taken. However, most modifications were client specific, requiring research, experimentation and individual development. They did not translate into a body of knowledge that could be copied for other customers to save time and costs.

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New Markets Aside from sign writing, Robert identified other industries where he could modify automatic flat-bed hardware, such as cutters for wood, metal, fibreglass and cloth. In essence, each cutter comprised the flat-bed, a cutting mechanism (blades, routers or laser beam) and an automatic controller. But Robotics had no formal marketing plan and devised no new marketing initiatives. The company simply continued to advertise in the signwriting industry magazine, participate in trade shows and rely on any direct marketing undertaken by its dealer network.

Costs Robotics’ retail price for flat-bed hardware was in the order of $25,000, made up from the components outlined in Table 13.1.

Intellectual Property Protection Robert could have patented his flat-bed hardware designs, which were easy to copy by reverse engineering. To save time and money, he devised a simple solution to protect his intellectual property. In effect, each controller was just a small black box implanted with programmed instructions. It was impossible to duplicate these controllers without Robert’s assistance. Irrespective of the cutting application (wood, metal, cloth etc), the controller boxes looked identical, but their capacity was determined by the implanted software.

Table 13.1  Robotics Pty Ltd costs summary

Item

Costs $ Flat-bed hardware and cutting tool 9000 Controller 1000 10,000 Robotics profit 7500 Dealer profit 7500 25,000

Percentage

40% 30% 30% 100%

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Body with No Brain A large share of expenditure went into the research and development of the controller boxes, but the cost of production was negligible compared to the cost of the flat-­ bed cutting unit as a whole (see table above). The hardware production, which could be copied and manufactured by any able machine shop, generated most of Robotics’ growth in terms of rental space, employees, stock holding, debtors etc., but the controller box gave it value. In Robert’s words, With no controller box, the hardware is just a pile of metal with little commercial value, like a body with no brain.

Systems Lagged Behind Growth When Robotics moved into hardware manufacture, Robert and Claire failed to realise their accounting systems and credit control policies had not kept pace with the company’s growth and new direction. Due to their lack of skill in product costing, Robotics sold a superior product for the same price as the competition. The retail price was market not cost driven and the gross margins were mediocre. Robert and Claire also fell into a common trap. They assumed all was well because Robotics seemed to be making a profit, but they overlooked the key area of working capital management. Evidence suggests many profitable businesses go under because they neglect this issue.

Decreasing Liquidity During the days of software-only sales, company credit policies evolved that gave unofficial extended trading terms to the dealer network. Naturally, the dealers utilised these terms when purchasing hardware. This drained Robotics of its liquidity, because the trading terms for imported materials were either payment on delivery or at best 30 days. Labour was paid weekly, as incurred. The company’s liquidity position changed from a healthy cash surplus to delayed creditor payments in a space of 2 years.

Product Profitability Re-examined The cost table shows that Robotics’ flat-bed hardware returned $7500 for every $10,000 invested in manufacturing, or a gross margin of 42.9% on the dealer price of $17,500. The company was drained of its liquidity because it spent $10,000

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before it saw its share of profit, after the dealer received his sales cheque. For an ongoing manufacturing operation, a gross margin of 42.9% would be considered an adequate return. But for a company ploughing its receipts back into further R&D, it left nothing for growth or working capital management.

Inefficiencies and Lost Orders The lack of sufficient working capital created inefficiencies in the business and resulted in lost orders. Many raw materials used to manufacture hardware were imported, with a 2-to-3-month lead-time. Without sufficient stock on hand, Robotics was forced to order from suppliers after sales orders were received. This created delays in delivery that intensified the working capital deficiency. In addition, the company lost orders to competition when deliveries could not be guaranteed within a customer’s time frame.

Search for Extra Funds Robert and Claire believed their financial problem was only a temporary glitch and they applied for a bank overdraft facility of $50,000. The facility had to be secured on company assets, but because Robert and Claire had ploughed all their profits back into the business, they had no bricks and mortar property to offer as security. From the company’s summarised financial results, it was evident Robotics’ turnover had doubled in a space of 8  years, but net profit results were static and the company’s liquidity had eroded. The bank concluded that the liquidity problems were due to diminished owner participation and increased personal drawings. A full examination of the company’s position was overlooked and the overdraft application was refused.

A New Beginning Various issues have emerged from this story and Robert and Claire have decided to seek advice. They assumed the market knew their products, due to their reputation of engineering excellence, but this amounts to nothing if the company is unknown. The biggest challenge now facing Robotics is to switch direction yet again, from a focus on design and development to management and marketing. Robert and Claire’s business education is about to begin.

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13.9  Key Lessons from the Chapter • It has become a well-accepted view that the majority of small business start-ups fail. The statistics that are quoted argue that for every ten firms launched, five fail, four will struggle and one will be a success. Most of these businesses don’t fall into bankruptcy; their owners simply decide to close the business because they found it too difficult to manage or not what they wanted to do. • Small firms experience a variety of different deaths. These can include bankruptcy, termination with or without losses to creditors, and failure as an opportunity cost while the owner seeks better investment prospects. Each of these forms of death has its own dynamics and causes. • Failure generally occurs when the firm is unable to continue trading usually due to the owner-manager being unable to successfully run the business. The firm may not be facing bankruptcy, although it may face financial difficulties caused by internal or external factors. This can involve termination with loss to creditors. It might also include termination to avoid losses and to cease trading due to insolvency. • The most common ‘death’ of a small business is where the owner-manager(s) simply decide to terminate the firm and cease trading. Discontinuance of the business may not result in financial failure and all creditors may be paid. • A less public form of small business death is personal failure or simply failing to ‘make a go of it ‘. The owner-manager is faced with burn out caused by long hours, high stress and the inability to find a way out of a workaholic tread mill. This is common among many owners who are operating quite sound firms with growth potential. • Some of the more common causes of failure in small business are due more to the ineptness of the owner-manager than the hostility of competitors, government policy shifts or disloyal customers: too much trust to their good fortune, too many decisions based on a hunch or intuition, crucial obstacles unnoticed for too long, to big amount of time and/or physical effort demanded, an amount of capital needed either not estimated or grossly underestimated. • Some of the major causes of bankruptcy are poor planning, lack of financing, lack of business experience and lack of personal discipline. Anyone considering opening their own business should have not only the vision of where the business is going to end up, but a strong business plan. An important part of this business plan should be an exit strategy in case the business runs into problems. • Some of the principal causes and danger signals of impending trouble within a small business have been grouped together into three broad categories: strategic issues; management issues and financial issues: –– It can be identified six strategic issues commonly identified within small firms that might lead the business into trouble and can be viewed as danger signals for owner-managers or their advisors: Misunderstanding a market niche; Mismanagement of supplier and customer relationships which requires high standards of ethical and moral behaviour, as well as the development of empa-

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thy, understanding and trust; Diversification into an unrelated business area, where they lack knowledge and benchmarks; a propensity to dream up what they feel is a great idea and then convince themselves that it will sell well in the market; a tendency to become excited by a big opportunity and over invest in it based on overly optimistic or poorly researched expectations; and a lack of contingency planning –– Poor management skills, particularly cash flow management and the ability to effectively manage human resources within the business are likely to be significant causes of future problems. For many small business owner-managers the problem is simply that they don’t know what they don’t know. The most common management deficiency among small business owner-managers is a lack of financial or accounting skills. Many small firms have difficulty finding and retaining all the staff they need, particularly when experiencing periods of growth or change. –– In conjunction with poor management skills there are several financial issues likely to lead the small business into trouble: Poor pricing, over extension of credit terms and excessive leverage; Lack of cash budgets and projections; Poor management reporting; Lack of standard costing; and Poorly understood cost behaviour. • An analysis of the differences between successful and unsuccessful firms suggests that: –– The more successful are adaptable and display both a capacity and willingness to change their organisational structure to meet the changing strategic directions they undertake. A change in strategic direction or mission requires the business to adjust its structure, which in turn requires flexibility among employees and management. Successful firms are also likely to be more innovative and entrepreneurial in their management and are willing to take decisive action when required. Such firms are also well focused and understand their core competencies. They are less inclined to engage in strategies that take them away into directions where their capabilities are poor matched to the market needs. In doing so the successful firm is able to clearly articulate a single common value proposition that makes them more competitive than the others in their industry. Finally, such firms seek to gain consensus with employees to build mutual trust and encourage innovation in the workplace. –– In contrast to the successful firm, the unsuccessful firm is found to suffer from external shocks frequently resulting from the emergence of new technologies or similar changes that allow competitors to seize the initiative. Firms that become too reliant on a key supplier, or key customer or market segment are also vulnerable to changes in the market. Failure has also been attributed to poor monitoring and control systems that make financial reporting, budgetary or cost controls ineffective. • Things that can be predicted with small businesses relate to the basic business model. Whether the business is a start-up or has been in operation for several

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years the following issues should be considered: Ideas, Resources, Finance, and Management. Finally, the issues of management such as the level of skills that the owner-manager has in the management of the firm, or family and partner problems that can impact on the business are important. These things are so common to most small businesses that they can be largely foreseen. While many things can be foreseen there are many others that cannot. Among these are economic downturns, sudden changes in key personnel caused by death, injury or resignation, and illness or changes in family circumstances. Other unforeseen circumstances are the failure of a lead customer or key supplier, or changes to government regulations or legislation. For most small firms’ business-related difficulties are the result of problems that build up over time, frequently periods of 2–5 years. Symptoms begin to manifest themselves in various ways perhaps via such things as falling quality, strategic drift, excessive debt levels, falling sales or profits. Employees and outside stakeholders such as banks, accountants or even suppliers and customers may notice and either disengage from the firm or seek to advise the management of the need for change. Owner-managers that are willing to listen and take corrective action have the chance to survive, while those that ignore such warnings may not. It is common for small business owner-managers to resist acknowledging that they may be facing difficulties. This is particularly the case if they have had a successful track record until that time. The naturally strong ego drive and optimism of many entrepreneurs makes them less inclined listen to bad news. They therefore fall into the ‘paradox of optimism’ syndrome. As the crisis builds the small business manager can be paralysed with indecision and may even go into psychological denial, seeking to simply avoid facing the reality of collapse or ruin. Due to their close association with the business it is common for employees – particularly those with supervisory or managerial responsibilities – to be among the first to notice the business is facing problems. If they seek to bring these matters to the attention of the owner-manager without satisfaction, their morale is likely to suffer. Increasing staff turnover by key employees is frequently a sign of a business in trouble. In addition to keeping an eye on the cash flow, the owner-manager or their advisors can also monitor several non-quantitative signals that might indicate trouble: Changes in management or key network support, an inability to produce financial statements on time, an accountant’s opinion which is qualified not certified, Owner-manager’s behaviour changes, New competition, new markets or new ‘big’ products The general principles that small business owner-managers should consider when undertaking a reengineering program are: –– be open with all employees regarding the process; –– solicit input from all employees; –– involve everyone in the implementation of the new systems; and

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–– understand the systems yourself because this understanding is more important than bringing in consultants and helps to ensure that costs are kept under control. • The small business owner-manager facing a crisis is likely to need urgent attention to be given to financial controls and the acquisition of cash inflows or cost reductions. The following strategies can be useful under such conditions: quick cash; negotiating with lenders and trade creditors; workforce reductions; longer term remedial action; and better defining the size of the problem from the outset. • When seeking to address problem-solving within the business it is important for managers to approach the process in a systematic way. It is common for managers in a crisis situation to seek immediate solutions to the perceived problem without undertaking an adequate diagnosis of its causes. This frequently results in the causes going untreated and the problem failing to improve. • An integrated approach to problem-solving involves an eight-step process in which time is devoted to analysis of the causes and identification of the full nature of the problem before proceeding to solutions: (i) problem finding initial statement; (ii) fact-finding; (iii) cause and effect analysis; (iv) the problem statement; (v) creative idea generation; (vi) idea screening; (vii) implementation plan; (viii) innovation.

Chapter 14

Work Book: Buying, Selling and Valuing the Business

14.1  Learning Objectives After completing this chapter, you should be able to: • • • • •

Understand the concept of business valuation. Overview and assess different business valuation methods. Understand the nature of goodwill and how to measure it. Examine the advantages and disadvantages of buying an established firm. Understand the process of preparing a business for sale.

14.2  Chapter Review This chapter examines the issue of valuation and the related issues of purchasing and selling a small firm. It highlights the fact that valuation is not a precise science, and there is no established formula for determining how much a business should be worth. It also considers consolidation and harvesting of the wealth from the business. The process of buying, selling and valuing a business can be among the biggest challenges facing the small business owner. In particular, valuation of the business is one of the more complex issues facing the small firm. For many owner-managers the value of their business is not something that they measure in an overall sense. The firm is for them a vehicle for personal and professional growth, a source of income and a place of work or lifestyle choice. However, once the owner seeks to sell their business the issues of how much it is worth comes sharply into focus. The valuation of a small firm is not a precise science but can be undertaken with at least three well-established methods. These include the book value or value of © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0_14

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saleable assets method, gross income multiplier method and discounted cash flow or NPV method. Of these the most commonly used are the first two, although the last is likely to be the more accurate if appropriate data is available. Most valuations use a maintainable future income measure and a risk multiple that can range from 1.5 to about 4, plus the cost of fixed assets. Research suggests that many small business valuations are unreliable and may either under or over value the business. A key issue is the valuation of goodwill, which is difficult to measure as it deals with reputation and future earnings potential. When valuing a small firm, it is advisable to take a holistic approach and consider what makes the business valuable to a future buyer. The business that is systems dependent is likely to be more valuable than that which is dependent upon people. When selling a business, the owner-­ manager should consider how to communicate the value of their business, when to time the sale and whether they have a viable brand image to sell. It is a good idea for the owner-manager to start preparing the business for sale from the moment that they buy or found it. Buying an established business has many advantages, mostly the ability to generate cash flow quickly, to have a good location and to have well tested systems to work with along with a team of employees and customers who are in place and loyal. However, the established firm may also suffer from ageing plant and equipment, poor work practices and a culture that is resistant to change. In seeking to buy a business the prospective buyer may consult a business broker, and should carefully define the parameters for their business. It is important to undertake appropriate due diligence on the business and spend time negotiating a fair price that reflects the true market value of the business. Location is a critical concern for many businesses as is the ability of the new owners to manage the firm.

14.3  Quiz Questions The following questions are aimed at testing your knowledge of the key concepts covered in this chapter.

Fill in the Blanks 1. The difference between the value of the firm as a going concern and the sum total of the current values of individual net assets can be described as g____________. 2. The future benefits from unidentifiable assets are described as g__________.

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14.4  True/False

1. The process of valuing a business prior to sale is something that can be largely worked out from an examination of the balance sheet, profit and loss account and assets register 2. A business can be packaged for sale for different types of buyer in a similar manner to the packaging of any product 3. An important question that should be asked when seeking to purchase an established business that has been offered for sale is why the current owners are selling? 4. It is frequently possible for a new owner to arrange a hand over period with the existing owner who will stay on to assist the new management settle in

True False [  ] [  ]

[  ] [  ] [  ] [  ]

[  ] [  ]

14.5  Short Answer 1. When deciding on the value to place on goodwill within a business what key questions might be asked? 2. Briefly describe the key differences between book value, replacement value and liquidation value.

14.6  Essay Question 1. What are the key questions that a prospective owner should ask prior to purchasing an established small business that has been offered for sale?

14.7  Key Lessons from the Chapter • An important issue for many small business start-ups is whether to launch the business from scratch or whether to buy an established business. There are advantages and disadvantages for both. For small business start-ups the decision can be critical to determining how quickly the owner-manager can achieve certain levels of activity. For many established firms the opportunity to grow through a process of acquisition is frequently attractive. In both cases the principles of evaluating the merits of a green fields or established option are much the same.

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–– To begin with the business is already in operation and will be generating cash almost from day one. –– If the business has had a good trading history it should have a pool of established customers with a degree of loyalty to the business. –– This loyalty and the general capacity of the business to secure its niche in the market will ensure that it has a degree of goodwill to allow it to generate above average returns to the initial investment. –– It may also be easier for the owner-manager to secure bank financing as the trading history and established customer base will give greater confidence than a green field site. –– Another reason for purchasing an established business is that buying out a going concern does not increase the number of competitors in the market. • While the advantages of buying an established business are substantial, there are also many disadvantages. –– One of the major disadvantages is the cost. A well-managed, established firm is likely to cost a significant amount of money. –– There may also be problems with the business that may not be easily identified prior to purchase. These may include such things as equipment that is ageing or not as productive as initially hoped. Inventory may also be too old and a good quantity may need to be written off. –– When taking over a small business the new ownership will need to consider the impact on existing managers and employees who may not respond well to the change in leadership. It may also transpire that the customer base of the business may not be as good as initially thought. There may be more “bad and doubtful debts” than shown in the accounts receivables. • Prior to embarking on a decision to purchase small business, you first qualify yourself as a buyer. This entails having a critical look at whether you have the required experience and skills to run the business you are seeking to buy. Also, do you have necessary commitment and passion for the challenges that this new venture is going to demand? If this is all positive, you will then need to ensure that you have sufficient financial capacity to make the purchase, cover all additional costs and fees, and put in sufficient working capital to ensure that the business can survive. • In conducting your search, a useful starting point is to sit down and map out the parameters or guidelines that define the type or types of businesses that you are looking for. Knowing what you don’t want is just as important as knowing what you want. It is important that you feel happy with the business and that it fits your own vision of the type of venture that you will be content to own and manage. Select advisors who have some experience in business acquisitions and/or the industry that you are seeking to enter. Good advice can save you a substantial amount of money and grief over the long-term. • It is important to learn as much as possible about the business and its current ownership before making a commitment to purchase: Why is it on the market?

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What is a typical day or week like for the existing owners? What will the owners do after the sale? Will they simply retire or will they be tempted to start up again in competition to the business they have just sold? What is the outlook for the market? What is the current physical condition of the business? What is the condition of the inventory? What is the state of the company’s other assets? How many staff will remain? What type of competition does the business face? What does the firm’s financial picture look like? How much additional investment is needed? Determining the price to be paid is likely to depend on how the assets of the business are valued. This process can be assisted by undertaking some calculations focusing on the book, estimated replacement and liquidation value of the business, as well as its past earnings and cash flow. The purchase of a small business is a negotiation process and there is the risk in all cases that the final purchase price will be too high Don’t be rushed. The time taken to get the deal struck is worth taking and could mean the difference between paying many thousands of extra dollars for the same business. Being willing to walk away from a deal even after protracted negotiation and due diligence is something that prospective buyers should be prepared to do. An important question that any prospective buyer of an established business must ask is whether they have the management skills and determination to manage the business they will be buying. The most important impact will probably be on the staff, which will not always find the new owner-manager and their new ways of doing things to their liking. Customers also may find the new management less amenable to their needs. In deciding whether or not you have the management capacity to run the business it is prudent to spend time working in the firm – at least for a short period of time – with the original owner serving as a mentor and guide. This hand over period can be crucially important to how well you do in the first few months or even year. As with any selling process the target customer or buyer needs to be considered, and an appreciation of who they are and what their needs are likely to be. Is the potential buyer looking for a business that can offer them a rapid expansion base and the potential for high returns albeit with high risk, or are they seeking steady returns, and a lifestyle with low risk? The current economic and market environment into which the business is to be sold also needs to be assessed. Having good data on the future trends within the industry or the potential actions of competitors will enable the owner-manager to answer questions and concerns by potential buyers during the negotiating process. At least three things need to be considered when seeking to package the business for sale. The first is how best to communicate the benefits of the business. The second is when to time the sale. The third is how to develop the brand image of the business to assist in the enhancement of its goodwill.

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• The small business owner should commence preparing for the sale of their business from the moment they buy it or establish it. By deciding on an exit strategy as early as possible, and preparing their business for sale by continuously adding value, they are more likely to be in a good position to secure a premium price for the business at time of sale. When it does become time to place the business on the market the owner of a small firm should take into consideration market conditions (especially in case of a seasonal business, or of a type of business having major assets that expire within a specified time period, or where the impact of technological change may be high) • There are three methods of valuing a small business: the value of saleable assets method (or book value method); the gross income multiplier method; and the discounted cash flow method. Each of these has its respective strengths and weaknesses. The simplest is the first although it does not always provide the true worth of the business. The third method is much more complex and less used within small business valuations. • The valuation of a small business can be complicated by the lack of reliable financial reporting and record keeping within the business. Few small firms are subject to independent audits of their books. Another problem is the absence of reliable benchmarks that can be used when seeking to make comparisons. • Most established businesses will include within their price a value of the intangible assets commonly referred to as goodwill. It is a complex issue but one that frequently determines whether the purchase price is higher or lower. • Therefore, when deciding on the value of any goodwill the following questions might be asked: (i) How long would it take to set up a similar business and the expense and risk associated with such a venture? (ii) How much additional income is likely to be generated by purchasing the established business as opposed to setting up a new business? (iii) Does the goodwill value reflect what other similar businesses might charge for their goodwill? • The true value of a small business is determined not just by the figures in its balance sheet, P&L and cash flow forecast, but also a proper review of its management and operating systems, the quality of its products or services, the quality and loyalty of its customer base and the composition and character of its human resources, the possession of long-term commercial contracts and leases, the firm’s ownership of intellectual property or the skill levels and experience of the employees. • In essence the true value of a business lies in more than just its financials, although the current measures, which are relatively imperfect, are still the most reliable guide. It needs to be recognised that while a standard valuation method might be used across several different companies, the results can be quite different because not all companies are identical. • A business is dependent on systems when it can be operated successfully regardless of its ownership, or its employees. Well-designed business format franchises are an example of a predominately systems driven model. These firms maintain fully documented methods for their operations and management that can be

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r­ eplicated with adequate training. The success and survival rates of well designed, systems driven businesses are typically high. • By comparison a business that is dependent on people is one in which the firm’s overall value and success is contingent on the presence of its owners or key employees. This can be the case with many professional services businesses where the skills of the principal partners may determine how successful the firm is. As a general rule, businesses that are overly dependent on people are likely to have less value than those that are systems dependent.

Appendices

Appendix A – Work Book Small Business Diagnostic: What Does It Tell Us About SMEs? Tim Mazzarol © Copyright, T Mazzarol 2014. All rights reserved. Materials are made available for educational use by students, teaching staff and researchers with appropriate recognition to the authors. No commercial gain may be made from the materials presented here without the express written permission of the authors. Background to the Study This chapter is a republication of a discussion paper originally published by the Centre for Entrepreneurial Management and Innovation (CEMI) (Mazzarol 2014). It outlines the findings from a study of 241 small business owner-managers who were asked to complete a diagnostic assessment questionnaire designed to examine their management practices. This was part of a best practice benchmarking study being undertaken by the University of Western Australia (UWA) through its MBA program. Commencing with a pilot study of 21 owner-managers engaged in a business development course run by CEMI in 2005, the use of the diagnostic tool continued via the MBA program as a teaching mechanism for students studying small business management. The diagnostic assessment tool examines 12 areas of management practice across a range of measures. It compares the firm’s performance against best practice standards and also seeks comment from the owner-manager over problems they are experiencing in each area. The findings from this study suggest that most ­owner-­managers have a relatively good understanding of their customers and how © Springer Nature Singapore Pte Ltd. 2020 T. Mazzarol, S. Reboud, Workbook for Small Business Management, Springer Texts in Business and Economics, https://doi.org/10.1007/978-981-13-9513-0

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to satisfy their needs. Most were also getting adequate information on key areas such as cash flow, supply and stock turnover. They also indicated an active engagement with outsiders to help keep them informed of trends in their market. However, few had formal business or marketing plans and quality assurance systems. Few also had a systematic approach to product and market assessments, quality control or the development of new innovative approaches to the development of products and services. There were major differences between firms based on size, with micro-enterprises demonstrating much less formality or the use of outsider support than their small and medium sized counterparts. This paper provides a context for the diagnostic assessment questionnaire that is contained in Appendix B, and the action learning tasks that are outlined in Appendix C. Introduction Small to medium enterprises (SMEs) comprise the backbone of most economies. Firms with fewer than 250 employees make up over 99% of the businesses found throughout the 34 advanced economies that comprise the Organisation for Economic Co-operation and Development (OECD) (OECD 2010a). However, the majority of these firms are micro-enterprises with less than 10 employees. For example, in 2009 there were an estimated 2.05  million actively trading businesses in Australia, of these less than 1% was large firms with over 200 employees. Yet within the vast number of SMEs 60% were micro-enterprises with no employees other than the owner-manager (DIISR 2011). According to OECD research SMEs provide a high proportion of the employment within their economies as well as a significant amount of the value added (OECD 2010a). This is also the case in Australia where SMEs contribute about 71% of all employment, and 58% of industry value added (DIISR 2011). However, most small businesses are not fast growth, entrepreneurial companies that emulate what has been described as the “Silicon Valley Business Model” (Cohen 2010). Such high growth firms comprise no more than 1–2% of all firms and most small business owners do not have such ambitions for growth (OECD 2010a). Further, most SMEs are not high-tech, but low to mid-tech in nature, with more modest ambitions and levels of innovation (Hirsch-Kreinsen et al. 2005; Reboud et al. 2014). Developing the Mainstream SME Community Despite this lack of rapid growth, the majority of SMEs still play a significant role in the national economy. This is particularly the case for the established small and medium firms that employ. With unemployment rates across the OECD hovering around 8% or higher (OECD 2013), it is important to strengthen the existing stock of SMEs. Most are low to mid-tech firms operating across a wide range of industries and experiencing steady but modest growth or at least profitable, sustainable operations. They represent what might be described as the “ordinary SMEs” (Mazzarol et al. 2011).

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Government policy has been focused on the development of SMEs due to the expectation that such firms can assist with the generation of new jobs, and stimulating economic growth. This is a pattern that has been seen since the 1980s with the research undertaken by Birch (1987) that suggested SMEs were the primary source of new job creation in the United States. This recognition of the importance of SMEs and entrepreneurship to the national economy stimulated a strong interest by governments and academic researchers in small business and new venture creation. A major feature of many government-backed initiatives and programs run by universities has been the encouragement of new venture creation via business start-­ ups. However, the success rate of start-ups is low, with a high rate of “churn over” whereby the majority of newly created firms do not survive their first 3 years. In fact, it has been estimated that around 43 new firms will need to be created in order to produce 9 new jobs a decade later (Nightingale and Coad 2014). Research by the Kauffman Foundation (Reedy and Litan 2011) has indicated that since the Global Financial Crisis (GFC) of 2008–2009 the trend is towards start-ups that have little or no job generation capacity. For example, in the period 1999–2000 around 4.6 million new jobs were created in the United States as a result of start-up activity. The average employment for each start-up in the 1990s was about 7.5 people. However, by 2010 the average start-up employs around 4.9 people and most don’t employ at all. In the period 2000–2010 job creation in the USA through start­up activity plunged to 2.5 million. According to Reedy and Litan (2011): Summing up, one key undisputed finding emerges. The employment that a new business cohort is born with in the United States is likely the maximum employment that business cohort will experience in its lifetime. (p. 13)

Investment in new business start-ups is therefore problematic as a mechanism for fostering economic growth and job creation (Nightingale and Coad 2014). However, it might be argued that investment into high-growth firms or “gazelles” is equally problematic. While such firms may – if successful – generate significant economic and employment returns, by their nature they are high risk ventures. For example, a high-growth firm is one that has been in operation for more than 5 years, has had average annual growth for three consecutive years of more than 20% and had employed more than 10 people at the start of the measurement period. A gazelle is a firm with similar average annual growth, but one that is less than 5 years old with 10 or more employees at the commencement of the measurement period (OECD 2010b). By this definition high-growth firms comprise around 3–6% of all businesses and gazelles around 1–2% of all firms (OECD 2010b). Further, the nature of such rapid growth, particularly for younger firms such as gazelles makes these businesses particularly prone to failure. The nature of rapid growth is that it is highly risky and requires highly competent management able to adapt quickly to external and internal factors (Smallbone et al. 1995). For SMEs to take up the challenge of growth they must have both a desire to do so and the capacity to undertake this potentially risky process. For small business owner-managers to sustainably achieve growth they will need to enhance their management skills (Agarwal and Green 2011).

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Assisting Owner-Managers with a Small Business Diagnostic Assessment If the quality of management and management control systems is a critical element in the success and future growth of an SME, then attention should be given to enhancing the management skills of small business owner-managers. There is evidence that benchmarking and formal quality assurance systems adoption in SMEs can play an important role in enhancing small business performance (McAdam and Kelly 2002). For example, a study of 86 SME manufacturers in Australia found that most firms used financial measures to assess performance, but that as the firms increased in size the range of non-financial measures used increased. Further, firms led by professional managers were more likely to use a wider range of performance measures than those led by owner-managers (Perera and Baker 2007). It is also important to provide small business owner-managers with opportunities to improve their management skills if such firms are to become more successful and sustainable (Kilpatrick and Crowley 1999; Curtin et al. 2011). Enhancing managerial competencies and business systems has been identified as important to the longer-­term performance of SMEs (Man et al. 2002; Pansiri and Temtime 2008). Many owner-managers have the skills to deal with the strategic, operational and financial management requirements of their existing market, but are challenged when they seek to grow or when their market conditions change (Romero and Gray 2002). Other research into management practices within Australian SMEs suggests that there is a need for greater improvements in the adoption of ‘high performance’ management practices (Wiesner et al. 2007). During 2005, CEMI ran an executive management development program targeted as small business owner-managers. As part of this program CEMI developed a small business diagnostic tool designed to help the owner-manager review their business management practices. The program also involved mentoring and peer-to-­ peer coaching and support (Mazzarol et al. 2006). Since then the diagnostic tool has been used in the UWA MBA program as a teaching mechanism for students, as well as providing benefits to small business owners who agree to participate in the process of completing the diagnostic. This report provides an overview of the findings from a sample of 241 small businesses that have participated in the diagnostic assessment since its introduction in 2005. The responses included firms from Australia and Singapore where the MBA program was run. The report is largely descriptive in nature and provides a snapshot of the findings with some observations made as to the meaning and implications of these findings for research, education, policy and practice. Background to the Diagnostic Assessment Tool As noted above the small business diagnostic was developed as a mechanism for assisting small business owners to better understand their business operations and examine both strategic and operational aspects of the management process (Mazzarol et  al. 2006). The questionnaire associated with the small business

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diagnostic has 124 items. The items from which the diagnostic was designed include international benchmarks and formal management standards including ISO9001 (quality management), BMS4581 (business management systems), ISO4360 (risk management), ISO15504 (information technology), plus items developed specifically for the tool. The questionnaire collects information on the owner-manager of the business including their past use of and attitudes towards outside assistance. It also gathers financial information on the business and examines the firm’s gross profitability and break-even. However, the core of the small business diagnostic is the 12 areas of management performance which are listed in Table A.1. The benchmarking undertaken in the diagnostic assessment examined these 12 distinct areas of management competencies against international best practice and provided the owner-manager and their mentor with a baseline from which to ­commence. The purpose for developing this diagnostic tool was to assist businesses, small or large to quickly determine areas of their business which were not performing to expectation, or needed to be improved. Using these tools will enable a business to develop a well-constructed management operating system (Fassoula and Rogerson 2003). Each of the key areas drawn from the ISO standards is briefly described in the following sub-sections. Table A.1  Management performance benchmarks Section 1. Marketing & Sales 2. Customer Interface 3. Financial Management & Performance 4. Management Intent 5. Process Capability 6. Internal Integration 7. Products 8. Quality 9. Management Information 10. External Integration 11. Operations 12. Strategy & Innovation

Description How well the owner-manager systematically generates new business and tracks existing sales. How well the owner-manager monitors customer satisfaction and seeks to generate customer delight. How well the owner-manager monitors their financial performance and seeks to gain control over the business. How well the owner-manager sets a future strategic direction for them and for their business. How well the owner-manager seeks to establish formal planning and control measures for processes within the business. How well the owner-manager matches their planning and performance via KPI benchmarking data. How well the owner-manager monitors product performance and develops new products and services. How well the owner-manager creates systematic quality assurance within their business. How well the owner-manager obtains regular data on business trends and performance levels. How well the owner-manager builds around them a strategic information and support network. How well the owner-manager integrates marketing and sales with their operations management. How well the owner-manager builds a competitive advantage and seeks to add real value to their business.

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ISO 9001 Quality Management Systems Requirements This benchmark is one of the most widely recognised management standards and has been adopted by many small firms (Karapetrovic et al. 1997). The current methodology of Plan-Do-Check-Act (PDCA) used in this standard provided the substance to link all the standards used together. Using the PCDA component of the AS/ NZS 9001 creates a common platform and language that allows a small firm to more effectively meet customer requirements and satisfaction, reduce non-conformity and provide quality products or services (Sohail and Hong 2003). ISO 4360:199 Risk Management Standard This was selected because it was felt that regardless of size, from a best practice perspective, an effective management system needs to incorporate elements of risk management. Using this risk management standard was also driven by the fact that organisations normally use it to reduce liability while seeking re-insurance yet they rarely understand the potential to use it as part of their daily operational processes. The key areas that were looked at in depth while developing the diagnostic tools in relation to using this standard were: (i) communicate and consult; (ii) analyse risks; (iii) evaluate risks; and (iv) monitor and review. ISO 15504-1 Information Technology-Process Assessment This standard was selected as it contains a Process Assessment Relationship containing three interlinked components: (i) process assessment; (ii) process capability determination and (iii) process improvement. These form the basis of an effective management operating system that is important in the implementation of quality management systems (Naveh and Marcus 2005). It is this standard that defines process improvement methods allowing the evaluation of processes in terms of strength, weaknesses and risks. The other component is process capability. The standard uses this as a tool that enables balance between the pros and cons of changing, redesigning or implementing a new process. BMS AS/NZS 4581: 1999 Management System These Integration standards were chosen because they clearly outline the components which are common to all management systems regardless of the type or size of the organisation as many such standards are viewed as only appropriate for large firms (McAdam and McKeown 1999). This standard also defines the roles and responsibility for management of any organisation, specifically the communication path required, internal and external stakeholders, suppliers, customers, etc. It also clearly defines the process by which management should control the daily operations of the business. The diagnostic tool covered the key elements for running a business successfully, and this standard clearly defined how to manage a business. An added benefit of using this standard was that it allowed for easy linkages to other standards used in the development of the diagnostic tools.

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This combination of recognised standards was seen as optimum in terms of validity and acceptance (Stickley and Winterbottom 1994). The standards used for the development of the diagnostic tools were carefully studied and specific elements were selected to show a coherent relationship for the development of each section of the questionnaire used in the diagnostic tools. The combination provided a complete solution to improve overall performance of a business (Shea and Gobeli 1995; Thor 1996). The tools aimed to operate as a change agent without significant capitalisation in areas such as information technology or a change management expert. A comprehensive approach to diagnostic benchmarking was considered appropriate for small firms (Haksever 1996). The diagnostic assessment tool was also administered to a control group of owner-managers drawn from well-established and ostensibly well benchmarked firms such as major food service franchisers and pharmacists. The purpose of this was to provide a base line comparison for the owner-managers engaged in the program. These benchmarks were developed into the set of 12 management performance indicators which are outlined in Table A.1. The Bar and Radar Charts of the Diagnostic The small business diagnostic provides a report on these 12 areas and issues two graphs displaying the results. This includes a bar chart as illustrated in Fig. A.1 and a radar chart as illustrated in Fig. A.2. As shown in Fig. A.1 the bar chart gives an immediate snap shot of the owner-manager’s performance on these 12 areas displayed in the “traffic light” colours of red, yellow and green. This allows the owner-­ manager to quickly identify areas of concern (shown in red), and those that need less urgent attention (shown in green). Where a large area of red is found attention can be given to the specific items that make up this area of the diagnostic and corrective action taken. For example, in Fig. A.1 there are many items showing substantial areas of red. However, the area of greatest concern is “Quality”, which has both a large red area and a very small green area. By drilling down into the specific items that comprise this Quality section the owner-manager can examine areas of management practice that require attention. As shown in Fig. A.2 the radar chart gives a different perspective of the same 12 areas. However, this time they are compared against best practice benchmarks and the owner-manager can readily see how their business management performance compares to international standards. The radar chart depicts the 12 areas on a plot in which the centre of the radar represents zero and each axis on the chart radiates out to 100%. The outer black line indicates best practice and the blue line the reported performance of the firms. Data from the diagnostic has been converted to a ratio so as to account for the different scales used to measure the 12 areas. By examining this radar plot the owner-­manager can quickly see how close or far away they are from best practice. From this diagnostic analysis the owner-manager can prepare a road map for future business development aimed at correcting any areas of weakness or defi-

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Fig. A.1  The bar chart of small business performance

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Fig. A.2  The radar chart of small business performance

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ciency in their management performance. It serves as an important foundation for future learning requirements and helps the owner-manager seek outside assistance in areas where this is deemed necessary. Results from Use of the Diagnostic Tool The management development program undertaken by CEMI in 2005 with 21 small business owner-managers used the diagnostic tool as a pre-test and post-test evaluation measure. Fig. A.3 shows the “before and after” scores on the diagnostic with the initial scores displayed in green and the follow-up scores in blue. It can be seen that the initial scores were generally quite low across all measures. By contrast the follow-up scores displayed a significant improvement in the performance of these firms. There were many factors that influenced this. The diagnostic tool was not the primary factor in these improvements, its role was to provide a starting point for the owner-managers to identify where within their firms changes or improvements were needed. With this “benchmarking” as a starting point, the owner-managers were able to work with their mentors (business consultants who met with the owners outside of

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Fig. A.3  Group performance of the owner-managers in the CEMI development program

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the management development course in small group and one-to-one counselling and coaching sessions), on business improvement activities. The course also helped the owner-managers by providing them with information and concepts that they could take back and apply into their firms. The learning undertaken by these owner-­ managers can be illustrated from the following comments they made at the end of the program: I’ve been doing courses on small business management for too many years now, and there are a lot of courses out there, but the way this course was structured has done me a lot of good. As far as my own business, the course has been fairly dramatic in the last four months. I have implemented so many things; I have increased my staff members by two…it has made me look at my whole business structure, organisation, how we conduct business, the way we appear in the general public’s eye and how we differentiate ourselves from others. (Male owner-manager, construction firm, over 20 years in business). This course has made us do at least two things; first, it has made us go back to basics and to start to fill in the gaps that we have missed, because sometimes when you are trying to run a business you just run along and don’t stop to think. Second, it has made us focus on the future and working on the business rather than in it. That has probably been the most significant thing, to step outside our day to day and really think about where we are going. (Female owner-manager, building supplies retailer, over 5 years in business). Having this course to point me in the right direction has really been invaluable. Rather than going from day to day I now have a much clearer sense of vision…having a clear path and your ideas set down is a real help. Also, having a better understanding of who my customers are and what they want from me was very important. (Female owner-manager, music retailer, under 5 years in business). Strategic management is now part of my role as Managing Director and I am encouraged by the improved understanding of my role and the roles of other managers in the firm, the course is also providing me significant help to structure theses aspects that I am increasingly finding are so very important. That old cliché of working on the business is gaining clarity. To work effectively on business new skills are required as the operator’s skills working in the business are not applicable although the knowledge from within is useful. My business had progressed with a number of business elements before commencing the course but now has the benefit of being able to improve those elements and fit them in better context. I have also been able to identify and address factors that were not previously evident particularly the relationship with other Directors, roles and review of strategic direction significantly improving cohesion and effectiveness. (Male owner-manager, professional services firm, over 20 years in business).

Post-course evaluations undertaken with the owner-managers indicated that 11 new employees had been hired by the participating firms as a result of the program. Furthermore, 40% of the owner-managers reported a significant increase in sales over the period covered by the program, with 30% reporting having weeded out poor or “dog” customers, 20% having experienced significant improvements in their profitability and 10% having experienced significant reductions in costs. All owner-managers reported experiencing a significant improvement in their strategic focus and general sense of direction as a direct result of undertaking the program (Mazzarol et al. 2006).

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An Overview of the Sample The sample from which this review of the small business diagnostic is drawn comprises 241 small firms interviewed over the period 2005–2010. The majority of respondents (90%) described their role in their firm as “owner-manager”, the rest described themselves as either “executive-manager main-shareholder” (2.5%), “executive-manager shareholder” (2.9%), “executive-manager non-shareholder” (4.1%) or some other title (0.4%). As shown Fig. A.4, the firms were drawn from a range of industries. One of the most dominant groups was retail Pharmacies (health and community services 26.5%) that were collected as part of the Pharmacy Management unit for the UWA Master of Pharmacy. Compared with the overall SME population in Australia the sample is heavily weighted towards services. As shown in Fig. A.4 the proportion of firms from areas like accommodation, cafes and restaurants, communications services, health and community services, retailing and personal and other services were much higher than found in the true population. The reverse is true of areas such as construction, agriculture, forestry and fishing, finance and insurance, manufacturing and wholesaling. Age and Size of the Firms Most of the firms (65%) were under 10 years old with 41% less than 5 years old. The next most common type of firm was those aged over 20 years. These findings are illustrated in Fig. A.5. It is worth comparing these results against the census data

Wholesaling Manufacturing Property & Business Svcs Retailing Personal & Other Svcs Health & Community Svcs Finance & Insurance Education Cultural & Recreational Svcs Construction Communication Svcs Agriculture, Forestry & Fishing Accommodation,Cafes & Restaurants

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Fig. A.4  Industry sectors of SMEs

ABS Census 2009

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Fig. A.5  How long has the business been in operation?

provided by the Australian Bureau of Statistics (ABS). According to ABS data around 44% of Australian SMEs have been in operation for less than 5 years, 14% between 6 and 10  years, 22% between 10 and 19  years, and 21% over 20  years (ABS 2011). This suggests that the age profile of the sample was fairly congruent with the known population of SMEs. In terms of firm size, all firms had fewer than 200 employees in keeping with the Australian definition of what an SME is. However, as shown in Fig. A.6, the majority of firms had fewer than 20 employees, and most had experienced growth in employment size. This growth in the size of the firms’ employment base was also evidenced in their annual turnover reporting. As illustrated in Fig. A.7, the majority of firms had reported annual turnovers of between $500,000 and $5 million. However, while 3% reported nil turnovers 3 years prior to the interview (presumably as these firms were not yet created), all firms were now trading. Also, as shown in Fig. A.7, more firms reported higher annual turnovers at time of interview than had existed 3  years before. This suggests a degree of growth in these firms, with strong increases in the proportion of firms reporting turnovers in the $1 million to $5 million range. Assistance and Outside Support The owner-managers were asked a series of questions relating to their use of outsiders for assistance. When asked if they actively seek out individuals who may be able to assist them with their business problems and approach them for help, the majority (71%) said that they did. The majority (76%) also felt that they could be more active in seeking business assistance and advice. No statistically significant differences were found in these responses in relation to the age of the business, however differences were found in relation to the annual turnover. The owner-managers from

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