Kevin Ready

Ideas on Business and Markets 


Wednesday
Aug042010

Will you be a Whale or an Eskimo?

Eskimos depend on killing one or two whales to survive for a whole year. They risk everything on being successful in this task. Whales on the other hand survive by eating millions of tiny shrimp. A failure to capture any one, any thousand, any ten thousand of those shrimp will not matter to the whale's survival.

Businesses are the same way.

You can position your business so that you need only a large value few clients, or so that you need to acquire many small value clients. This is a fundamental point of analysis when deciding what business to pursue, or how to position an existing operation or product offering for future growth and stability.

Neither of these options is “right” or “wrong”, but they each carry their good and bad points.

Scenario: The fictional OJC company makes bread. They bake and ship whole wheat loaves to several small grocery chains, and have experienced 2-3% growth yearly for the last 10 years. They get picked up in an article on healthy eating by the LA Times, which is quickly followed up by a proposal from MegaMart for them to provide heart-healthy wheat bread for 250 warehouse stores coast-to-coast. Great deal! That is a fantastic! Way to grow!

It is a terrific opportunity, and the knowledgeable CEO knows that saying "yes!" entails a major risk.

In order to meet the demand of the additional stores, OJC will have to triple their production capacity, and hire extra shifts. This entails an outsized capital outlay, which makes the CEO nervous. What would happen if they go for it, and then 8 months into the contract, MegaMart decides to pull the contract? It could put the future of OJC in question because they may not be able to cover the loan they took out to build out their factory.
Left with overcapacity and a huge debt to pay, they could be forced to shutter their operation.

The conundrum here is this: Follow fast, lopsided growth? Or choose slower, diversified growth? Following the diversified route, there is less risk from any one customer picking up and leaving, but lower profit potential over the short term. Our aggressive CEO may choose to take the deal, but prioritize the quick acquisition of more sales outlets to create a diversification structure that would support them if they were to lose the large contract.

This thought about outsized clients and the dependency that comes with them is part of a larger discussion in any business. The fact is that we can find ourselves in a lopsided situation, where one client, one sales channel, one marketing medium, one supplier, or other critical asset risks being too important by itself to allow us to feel comfortable. Take a look around your business and see if you have a critical dependency on any one person, client, or process. If you do, then look for diversification. One CEO that I admire said that "if you have all of your eggs in one basket, don't rest until you have them divided into five separate baskets."

 

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