Small Business Techniques

Staffing Strategy and Scheduling People

by Tom Gray | on Jul 02, 2014 |  Comments

You know how many people you need, but how do you fill those requirements: hire permanent or temporary employees, whether full or part-time; build and store inventory in low months; work overtime, outsource, or even accept backorders in peak months? Once you decide this staffing strategy, then you can move on to scheduling people.

Gather Your Inputs

Good decisions require good information. Gather some numbers, survey the market, and set some policies before deciding how to staff.

Numbers:

  • How much does hiring cost: advertise, interview, background check, training hours for instructor and student, low productivity for the first few weeks/months, higher loss rate for new hires?
  • How many people can you hire in a month? Limits include your HR staff and instructor training time available, and the ability of the production team to absorb new members.
  • What does it cost to store a finished item in inventory? Interest expense on the delay in gaining sales revenue is probably the only variable cost, but you may also have to provide more storage space and warehouse personnel.
  • What does it cost to work overtime? Note that often employee benefit costs do not increase for overtime hours. What is the limit on overtime, assuming excess overtime causes absence and quality/rework problems? My advice is to not exceed assume 20% of regular time, or 8 hours per week, for six consecutive weeks.
  • What does it cost to outsource work? Are there suitable suppliers? What do they charge, and what is the shipping cost? Will you incur other costs to deal with them? Any union isues?

Market:

  • Availability of outsourcers?
  • Availability of other employers for employees feeling stressed by overtime?
  • Prevalence of overtime at other employers? Do employees count on some level of overtime to make ends meet?
  • Will your customers accept backorders for deliveries in peak months, or will they go elsewhere?

Policies:

  • When there are more employees than work, will you give them the opportunity to voluntarily accept an offer to go home early without pay?
  • What level of certainty do employees expect about their scheduled hours of work? Can you change schedules every week, or do they expect to have the same hours and days off for months at a time?

Select a Strategy

Having gathered this information, you can select a staffing strategy. Most companies end up with a mixed strategy. They decide not to hire and fire according to monthly demand (“chase strategy”) due to the cost of taking on and training new people. They also decide that working the same hours regardless of demand (“level” strategy) is too rigid and expensive.

A mixed approach employs enough people to meet demand in the lowest month, and stretches to meet peak demand. Some stretch techniques are limiting off-line nonproductive hours, overtime, extending hours of part-time people, and/or hiring temporary workers. If materials are not a major cost element, a few more people can be employed to make extra product in low months, so that inventory is available in peak months.

If non-paid excused time is an accepted tactic, the number of permanent workers can be a little higher, but note that benefits costs apply whether or not the employee goes home unpaid. Outsourcing is not a good match for seasonal peaks because outsourcers do not like peaks and valleys either.

Part-time employees are an excellent safety valve, especially if their hours can be extended without affecting benefits. In addition, these people can be an excellent source of speedy replacements for departing full-timers. However, the downside of part-times is weaker communications, weaker cultural integration with the full-time workforce, and higher loss rates as they find full-time work. The same drawbacks apply to weekend-only workers.

Develop the Schedule

The art of scheduling is to balance the needs of customers, employees, and cost control.

  • Customers want the product or service without waiting. This can cause scheduling more people than needed for immediate demand. Solution: build planned “ready-to-serve” idle time into the forecast of people required (see previous article).
  • Employees want job security and a stable schedule so they can plan their lives. This creates the potential for too few employees at peak days or hours, and too many at slow times. Solution: use a stable schedule for most employees, and provide flexibility with voluntary unpaid time, part-timers who can extend their hours, and overtime.
  • The company wants a perfect match between demand and workers at every hour. This can result in scheduling too few people, relying on “stretch” techniques to meet bubbles of demand. Solution: make a weekly forecast of hourly requirements for each day, using records of past daily and hourly demand. Adjust that demand upward at times when customer waiting experience shows that too few workers were available, because these shortages artificially reduced recorded demand. Then adapt the weekly schedule of offline time and part-timers to cover peaks and valleys within the week.

This approach blends a stable long-term schedule with active weekly/intra-day staff management. It becomes more important for both cost control and customer service as the business grows larger.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

How Many People Do I Need?

by Tom Gray | on Jun 25, 2014 |  Comments

Balancing customer service and production level while controlling staff costs is an issue for every business, large and small. It’s an issue because it’s important for key results (customer and employee retention, revenue, expenses, and profits) yet doing it well requires predicting the future. You must anticipate both customer and employee behavior! Other than that, it’s easy!

Forecasting Production Hours

Every solution for planning people requirements involves forecasting the future volume of business and the amount of work an average employee can produce. This tells you production time required. You should forecast each month separately, to recognize seasonal peaks and valleys. Your business could even require a weekly breakdown in the most variable months, such as November in retail. Later, when it comes to scheduling staff, you’ll consider whether volume of business on any particular day is significantly higher or lower than the week average (e.g. Monday may be 110% of average weekly requirement). But stick to a monthly forecast for now.

Refer to your records of demand and productivity to decide:

  • Current demand growth vs. same time last year, and vs. the last few weeks.
    • If work-time per unit varies by type of unit, you may want to make three separate forecasts, one each for big, medium, and little units
  • Expected growth for the next 12 months, based on above or other inputs.
  • Today’s employee work-time needed to produce the average demand element (unit, widget, order, task).
    • If work-time per unit varies by type of unit, you may want to make three separate forecasts, one each for big, medium, and little units.
  • Expected change in that work-time per element for the period you are forecasting. For example, consider a new machine, or a change in staff’s average experience level.

Forecasting Non-Productive Hours

The next step is translating production hours required into people required. No, you don’t just divide by eight hours to find number of people required. Just look in the mirror, and you’ll realize people are not productive all the time! Unlike robots, employing a person involves planned off-line time (e.g. scheduled breaks and lunches, training, meetings, vacations, holidays), unplanned unavailability (absence and unscheduled breaks), and on-line “ready-to-serve” time to make sure someone is available so that incoming customers do not have to wait too long.

  • For planned off-line time, consider your policies. For example, a company may expect 10 days of vacation, 10 holidays, and 12 days in training/meetings (about 2 hours per week), which sums to 32 days or 12% of 260 workdays in a year (52 weeks x 5 days).
  • For a service business, add some level of idle time while employees are on-line, so someone is available for the next customer without excessive waiting. This applies if idle time is not already built into your work-time estimate. First, decide on your target level of customer waiting time. If they leave without buying due to the wait, will they come back later, or buy elsewhere? Then estimate how much on-line idle time is needed to meet that target. 10% is a minimum, or 26 days per year.
  • For unplanned off-line time such as absence, consider your experience. Maybe that uses up 3% of payroll time, or 8 days per year.

Forecasting People Needed

To find the number of people needed, combine production time required with your forecast of nonproductive time per employee, and then divide that by scheduled hours per employee to find “equivalent full-time” (EFT) people needed. Later, you may decide to meet some of these EFT needs with two part-time people each.

  • Total nonproductive time in this example is 32 + 26 + 8 days = 65 / 260 = 25%.
  • To find EFT people required assuming eight hours per day without scheduled break/lunch, divide production hours required by .75 (that is, 1.00 – .25 nonproductive in this example). Assuming you needed 100 production hours in the average day, you need 125 payroll hours, or  16 EFT.
    • Note the arithmetic here. You divide by productive hours by (1 minus nonproductive % of total). You do NOT multiply productive hours by 1.25. If you did that, you would be 5 hours (one person) short.

Knowing how many people you need per month is the first step in deciding staffing. The next step is deciding how to fill those requirements: hire permanent or temporary employees, whether full or part-time; build and store inventory in low months; work overtime, outsource, or even accept backorders in peak months. See the next article for Staffing techniques and for Scheduling.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

Tips on Labor and Material Cost Levers

by Tom Gray | on Jun 18, 2014 |  Comments

Labor and material costs are worth examining closely. Each can amount to 20 - 25% of revenue, or run much higher depending on the type of business. In total, they can amount to 40 to 50% of revenue. They are the major elements in variable costs, and thus (together with price) determine the product and business margin.

Tips on Labor Cost

Employees are a critical resource for adding value to the finished product, so we are looking for ways to remove only wasted labor cost, not all labor cost! Three factors drive labor cost:

  • Efficiency of productive time: previous articles show how to reduce production hours that add no value to the finished product, such as waiting within the process, rework, chasing parts, and moving material.
  • Non-productive time: hours devoted to non-product tasks, such as training, setup time, cleaning, maintenance, paid absence, and other miscellaneous tasks that do not produce the product.
  • Cost per labor hour: pay rates, overtime, commissions, and benefits.

Non-productive Time

We humans never spend 100% of our time being productive. We take breaks, get paid time off, spend time learning and planning and getting ready to work, and keep records and maintenance up-to-date. None of these directly add value to the product in the customer’s eyes. They may enable value-adding behaviors, but they don’t add value themselves.

In a good operation, about 20% of paid time is nonproductive. If it is 40% in your operation, you need to make some changes. Do you know what that percentage is?

First of all, it’s important to recognize and measure the difference between productive and nonproductive hours when setting your prices. The common mistake is setting a price based on the variable labor hours/cost, which is job-dependent and 100% productive, but forgetting to count employee nonproductive hours as part of overhead. Your price must recover those costs too, or you will miss your profit target.

The technique is to show each type of labor (and payroll taxes) separately in your P&L or income statement. This way, when you develop your price quote by using a multiplier of wages (“shop rate”) to cover overhead and target profit, the nonproductive labor cost is already included in the overhead. Accountants and software (e.g., QuickBooks) will not do this without special instructions. They like to treat all labor as a variable cost, which overstates your cost of production, or treat all labor as a fixed cost, which understates the production cost.

Hourly Labor Cost

Wages should be competitive in the market. If they are, there are still several tools to control labor cost.

  • Incentives should be a high percentage of a competitive compensation package, and they should be paid only when both quality and productivity minimums are met.
  • Benefits should match rather than exceed the market.
  • Commissions should be higher for selling high margin products, and lower for low margin products.
  • The cost of new recruits (hiring, training, and low productivity) must be considered when deciding how to handle fluctuations in demand.
  • Overtime is usually cheaper than using subcontractors with similar pay scales. Why? Overtime does not change your benefits or fixed costs much, but the full impact of those costs are built into subcontractor fees.
  • However, overtime should be limited to 20% of regular hours to minimize quality problems, declining productivity due to fatigue, and employee turnover.
  • Unfortunately, the extra pay for overtime can be an incentive to reduce regular productivity, making proper performance standards and rewards even more important.

Tips on Material Costs

You want to avoid excess material costs. You want enough material with the right quality at just the right time for the best price. Your enemy in this effort is complacency: accepting that the status quo is good enough, without trying to find better alternatives. Here are some improvement techniques:

  • Keep statistics on supplier performance: timely delivery, percent rejects, and your satisfaction on special orders.
  • Schedule supplier reviews, where you look at the marketplace to find other potential suppliers, and request bids to find the best offers. Do this every two or three years for your most important materials. One approach is to schedule one review. i.e., competitive bidding process, every six months.
  • Negotiate everysupplier offer. Offer a longer commitment, or choose a lower grade, or suggest less processing by the supplier to make it worth their agreement. It costs you nothing to ask. The only risk is that they say no!
    • It’s worth doing! If you can cut your material cost by 10%, and material is 25% of revenue, that savings of 2.5% of revenue becomes a profit increase. If your profit is 15% of revenue and you grow it by 2.5 to 17.5%, you boost profits by 1/7 or 14%.
    •  If your gross margin is 50% of revenue with material costs at 25% of revenue, negotiating supplier prices down by 10% reduces variable costs by 2.5%, increasing gross margin to 52.5%. In terms of profit as a percentage of revenue, this 2.5% margin gain is worth the same as growing sales by 5%. Which one is easier and more under your control?
  • Review your replenishment order schedule to reduce inventory and improve cash flow. Forget the concept of “economic order quantity.” Calculate how much safety stock you really need according to the supplier’s best delivery interval and frequency. Then set up your internal “pull” signals to trigger a replenishment order when your safety stock reaches the minimum. Order just enough to tide you over until safety stock will reach that level again.
  • Reconsider material storage. Find ways to store it near the operations that will use it. Make sure it’s visible, not buried in a warehouse. This prevents the buildup of excess.

Fixed Cost Levers

Small business owners usually have a pretty good handle on their fixed costs such as rent, utilities, and professional services. However, some of the these tips apply to fixed costs as well, such as periodically considering alternatives, negotiating prices, and minimizing usage.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

Proven Techniques for Removing Waste from Processes

by Tom Gray | on Jun 11, 2014 |  Comments

Robots are not the answer for a small business! To produce value at optimal cost, small businesses need simple techniques, not expensive robots and complex MRP systems,. Your processes should be able to produce a high variety of outputs at high quality levels with fast cycle time, low operating cost, low inventory, and good information flow.

Start with understanding your process today, displaying it on a process map. In the book Lean Thinking, Womack and Jones described the mindset for process mapping this way: “Can you put yourself in the position of a design as it progresses from concept to launch, an order as information flows from initial request to delivered product, and a physical product as it progresses from raw material to the customer, and describe what will happen to you each step along the way?”

Process Design Principles

1. Standardize: Define how your process should work, and how you measure whether it does, at each step along the way. Standards enable a common assessment, a common understanding of success, and a shared basis for analysis.

2. Simplify: Shorten the flow so less can go wrong. Remove steps that do not add value, either eliminating them or moving out of the critical path with work cells, subassemblies, or shifting tasks to other steps, or to the customer, supplier, or outsourcer.

3. Balance the Steps: Organize your process into major steps so that each requires the same time interval (called takt time by Toyota). This enables work to flow through the process at a continuous pace, without wasting time in queues waiting to be processed.

4. Use a pull system to obtain continuous flow: Each work step pulls what it needs from the prior step “just in time.” You don’t order or produce large quantities that wait for subsequent processing. Instead, each step produces only small buffer quantities, not mountains of “work in progress.” Continuous flow is the opposite of “batch and queue.”

5. Visual Alerts: Design visual signals for monitoring progress, prioritizing work, triggering the pull (and ordering) of inputs, and displaying incomplete sets of parts (“kitting”). Visual signals enable quicker response than burying these key measures and events in expensive information systems.

6. Find and Optimize the Bottleneck: Identify the one process step that determines the pace for the entire process. Focus on improving its throughput to drive the productivity of the entire process. See below for tactics. Once you improve the bottleneck, rebalance the steps for a faster cycle time, and look for the next bottleneck.

7. Continuous Improvement (kaizen in Japanese): Improving one process affects other processes. Modify them, and then return to the first one to improve it further. This yields constant gains in productivity and profits, rather than delaying benefits by waiting for the perfect overall solution before implementing.

Some Proven Tactics to Implement the Principles

A. Standardize

-        Establish time, volume, and quality metrics for key steps; these enable workers to inspect the quality of their own work. Monitor results per person and per product. Investigate and correct shortfalls.

-        Rejects must be corrected by the group who produced them.

-        Design work processes and tools so they can be used only in the right way or edits to prevent input errors, e.g., tabs on jigs (mistake-proof, or poka-yoke).

B. Simplify

-        Create subassemblies removed from the main flow.

-        Condense work steps or subassemblies so several are done by a single person or work cell. This removes handoffs, which often result in batch-and-queue delays.

-        Use your computer system rather than manual records for recording and storing information about process flow and task completion.

-        Limit options offered; customization is inefficient unless it comes with a high enough price premium.

-        Look for ways to offload tasks. Consider whether customers or suppliers can perform some inputs themselves.

-        Periodically assess outsourcing alternatives for non-core tasks and processes.

C. Balance the Steps

-        Reorganize tasks into equal-length work steps.

-        Use work cells and subassemblies.

-        Recognize that one worker can operate more than one machine.

-        Prescribe and limit the size of buffer stocks.

D. Pull and Continuous Flow

-        Prevent overproduction in any one work step by triggering replenishment of the buffer stock via a signal from the following work step.

-        One example is a colored card (kanban) placed within the buffer stock so that it is exposed when the stock is low enough that replenishment is needed.

E. Visual Alerts

-        Kanban is one form of visual alert.

-        Another is kitting: making a box with a shaped spot for each part in a set to be delivered to a work operation, to reveal when the part is missing.

-        Colored flags can show whether a work step’s progress is in danger of missing its time target.

-        Jobs waiting for bottleneck processing can be marked with colored tags to show priority for customer due dates.

E. Optimize the Bottleneck

-        Offload work by (1) re-examining product design to avoid the need for the bottleneck processing, (2) outsourcing, and (3) inspecting for rejects before they reach bottleneck processing.

-        Minimize bottleneck downtime by scheduling operators and maintenance.

-        Maximize the bottleneck throughput by adding more capacity such as a bigger machine.

-        Optimize its flexibility to adjust to shifting priorities by organizing the work in small lots and streamlining setup routines.

-        Improve the operations within the bottleneck step.

-        Place the bottleneck as late in the production process as possible.

F. Continuous Improvement

-        Implement improvements quickly to gain immediate payoffs. Just as small lot sizes improve efficiency, small improvement steps improve quality and profits.

-        Plan for a series of process improvement efforts.

-        Reflect on newly-learned methods and expertise, and standardize them so the same type of gains can be applied to other processes more quickly.

This article draws on “Lean” techniques based on the Toyota Production System, and the Theory of Constraints first demonstrated in Eliyahu Goldratt’s The Goal. GE’s famous Six Sigma methods support these approaches by stressing measurements and analysis techniques at each step of the analysis and improvement effort.

Creativity in Process Improvement

Operations people often have limited opportunities to use their natural human creativity at work. So when they have the opportunity to use that creative ability to map a process and then improve it, the employees enjoy the change and appreciate the owner’s trust and respect for their abilities. They get great satisfaction from designing improvements, and go beyond the norm in their efforts for successful implementation.

Employee motivation, teamwork, and satisfaction all get a boost, at the same time company quality and profits grow. Use their creativity! It will be one of your best investments.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

The Process Mapping Conversation – Seeking Improvements

by Tom Gray | on Jun 04, 2014 |  Comments

The excitement starts for the team once they’ve collected their observations to show how the process is actually done today. Listen to their buzz – that’s the sound of creativity, teamwork, and engagement. It’s the sound of motivated employees!

Step 4: Map the Current Process

Gather the observed information. Write the major elements of the process on post-it notes (because they can be moved around easily) and put them on the wall in order, so the entire team can see them at once.

Then insert components (on post-it notes) under each of the major elements: decisions, inspections, rework loops, approvals, record-making, and sub-processes used to create inputs or specialized steps. Some of these sub-processes will be important enough to require their own process maps.

The second level of analysis puts all these post-it notes in order, showing the sequence in which they happened. Now you have a high level map.

Like any early mapmaker, you will see areas of unknowns. Some may be important enough to fill in based on further observation. After adding these post-it notes in another meeting, you’ll have a mid-level version of the map. Test this version by reviewing it with those who do the work, and insert their corrections.

Step 5: Analyze the Map for Possible Improvements

The goal here is to simplify the process (and the process map) by identifying wasted time and effort. Some questions like these may trigger important ideas:

  • What would happen if this step were eliminated? Are any steps redundant?
  • Can rules such as approval levels be changed to make any steps unnecessary?
  • Can visual signals be introduced to avoid delays or smooth the flow of priority tasks?
  • Can some steps be done in parallel rather than waiting for completion of a previous step, such as by using subassemblies?
  • Is the step being done by the right person?
  • Is the step a work-around due to poor training or parts shortages?
  • Is the step a rework loop? How can you eliminate the need for it?
  • Does the step add value to the product or service in the customer’s eyes? If not, what would be the result of eliminating it?
  • If more work was added to one step, would that eliminate a subsequent step and save time overall?
  • Which steps seem to have the greatest impact on cycle time? Do we need to know more details about them to make them more productive?
  • Do current computer systems have unused functions that could be “turned on” to replace time spent on record production, gathering inputs, or production steps?
  • How could we use a wireless computer (e.g. tablet) to speed up some steps?

Step 6: Estimate the Value per Improvement, and Collect Data to Verify Estimates

The team is not finished until it can predict the value of its changes – do they deliver the target level of improvement on the chosen measurements?

Significant changes must be tested in operation, observed, and measured for their impact and unintended consequences. Predictions without verification aren’t worth much more than telling you what to test.

The testing effort also helps clarify how implementation should be done. The team’s final recommendation will include changes, measured effect, implementation plan, and timeline. The implementation plan must consider communication, training, job aids, measurements, and incentives, i.e., all the aspects of setting your employees up for success. See Setting Up Employees for Success, or Failure.

The Extra Dividend is the Conversation

You went through a few weeks of extra effort, and what did you get from it? What value was added?

  • You understand a key business process better than ever before.
  • Your employees found improvements that will boost quality (sales) and productivity (profits).
  • Your employees were honored by your trust in their judgment; their motivation has never been higher.
  • Your employees began to think like an owner, which promises more improvements both in their daily work and when you analyze the next process.
  • Your employees developed better team spirit from working together on an exciting project.

So what do you think? Does it seem worthwhile to map and improve a key process? Are you or they working on anything more important right now?

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

The Process Mapping Conversation – Getting Started

by Tom Gray | on May 28, 2014 |  Comments

“A picture is worth 10,000 words.” The visual nature of a process map makes it understandable. Once employees can see the process laid out in steps, they can start communicating with each other about their experience with it and their ideas to make it better.

A team of employees creates a preliminary high level view called SIPOC (see below), and then uses observations to create a first draft process map from observations. Then the team members improve the first draft by adding decision points, customization steps, rework loops, response to shortages of parts, and pursuit of approvals. At the same time, they’ll ask aloud, “Why do we do it that way? What if we did this activity differently?”

Developing the process map as a team triggers discussion of ways to improve the business. This interaction is a major benefit of process mapping, in addition to the process improvements themselves.

Google offers plenty of examples of process maps. At least one has an embedded video showing the development of a process map for peanut butter and jelly sandwiches! See Process Maps / Flowcharts. Slideshare is a good source as well. A good tutorial on process mapping can be found at Balanced Scorecard’s “Handbook for Basic Process Improvement”, especially pages 21-24 in the PDF page count.

In keeping with our focus in techniques, this article and the next will focus on the step by step process for building a process map and seeking ways to improve it, with an emphasis on the conversation along the way.

Step 1: Choose a Process

Make a list of the “high level” processes that define your business. A previous article offered some examples, such as ordering, production, invoicing, receiving, and inventory management Choose one, or a sub-process within a high level process, where changes would offer major impact on quality and productivity. After you have worked through one process, you can repeat the effort for a different process later.

Decide how to measure success in the chosen process, e.g. widgets per hours (or hours per widget) with x level of quality. What level of performance does the current process deliver, specifically, in numbers?

Next, how much improvement is your goal? It should be major. Maybe a 50% improvement?

Step 2: Assemble the Team, Define the Rules, Develop the SIPOC

The team should not exceed five to seven people. They must be knowledgeable about the process. All the departments with a major role in the process should be represented. Appoint a team leader, whose job is to manage progress and team dynamics, and keep bosses informed. The leader’s job is to foster the conversation, not to insist on their own view of the right answer!

Team rules include the target completion date, how much time they will spend per day or week, their authority to arrange tests of improvements, and approval of any resources they will need. Rules also include ground rules on meeting preparation and behavior

SIPOC is a summary view of the process at a very high level. The acronym stands for Supplier, Input, Process, Output, Customer. As you can see, the name is the sequence for adding value. Here’s an example for Car Repair:

Supplier
Input
Process
Output
Customer
-Vehicle owner -Customer service representative
-Facility manager
-Parts window
-Repair inquiry
-Vehicle for repair
-Permission to proceed with individual recommendations
-Open bay
-Parts for approved repairs
-Observations
-Schedule visit
  -Diagnose problem
-Prepare work order
-Source parts
-Perform repairs
-Notify that service is complete
-Appointment date and time
-Repair recommendations and cost estimates
-Work order
-Parts for approved repairs
  -Telephone/e-mail/text message notification
-Repaired vehicle
-Vehicle owner
-Mechanic-Customer service representative

 

A more complete example would also show completion time targets and other “critical to quality” requirements for each input and output. Later, the employee team’s process map will add detail to every entry on the SIPOC.

Step 3: Observe the Current Process

The team must fully understand the process before trying to change it, to avoid creating problems rather than solutions! Understanding starts with observation (usually several times) and recording what they saw, in detail. It helps if they know what to look for! They should try to answer these questions:

  • What inputs are needed, and how are they gathered, by who, when?
  • What are the processing actions taken, decisions, inspections, and approvals?
  • Again who does these, when, and how long do they take?
  • What are the exceptions, and how are they handled?
  • What documents are produced or updated, and what is done with them?

The team will take pains to record what really happens rather than what is supposed to happen! They will focus on activities in all the involved departments, especially on handoffs from one department to another.

The Extra Dividend is the Conversation

You know the team is already trading ideas for doing things better, even before they create the first draft of the process map. How valuable is that interest and engagement?

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

 

Techniques to Manage Bottlenecks

by Tom Gray | on May 21, 2014 |  Comments

When one operations step controls the flow of the whole process, that choke point is called a “bottleneck.” The previous article explained how to find bottlenecks. What techniques can solve or manage this traffic jam? This article explains those techniques, sorting them into three types.

Type 1 Techniques: Don’t Waste the Bottleneck

Since the availability of the bottleneck is in short supply, you certainly don’t want to spend its time on unnecessary tasks, or let it sit idle. You don’t want to waste a scarce resource. What does this mean in practice?

  • Check product design to see if you really need to use the bottleneck for all the products or processes using it today. Maybe product design can be changed.
  • Check for outside suppliers who can do some of the bottleneck functions for you, thus adding capacity.
  • Don’t use the bottleneck to make spare parts when customer orders are waiting.
  • Inspect for faulty inputs before they go through the bottleneck, because any time spent processing faulty pieces will be wasting the bottleneck’s time.
  • Have a small “buffer stock” of inputs ready to be used by the bottleneck without further transport, so it does not sit idle waiting for a new batch to be prepared.
  • Schedule staff so someone is always available to keep the bottleneck running, including breaks and lunches.
  • Schedule maintenance of the bottleneck for times when customer orders and due dates are less demanding.
  • Don’t let the bottleneck break down!

Type 2 Techniques: Optimize the Bottleneck’s Operation

Watch the operation, map it onto a flowchart, and brainstorm ways to do it better. To prompt ideas, consider using a Fishbone diagram (see “Measure to Manage Quality” article) . Here are some techniques: using a different grade of material for inputs to smooth and speed up processing, shortening or deleting processing steps, shifting them to other processes, using subassemblies as inputs, training, posting job aids to minimize rework, and restructuring employee incentives.

Note that small batch sizes make the bottleneck more flexible, and thus better able to respond to customer order priorities. They also result in smaller inventories of inputs. But smaller batch sizes use more setups, so at the same time setup  or “get ready” processes must be optimized as well.

Type 3 Techniques: Change the Operations Environment to Fit the Bottleneck

The operation can only produce as much as the bottleneck can process, so the bottleneck’s pace is the pace of the whole operation. It makes no sense to build or buy more inputs than the bottleneck can handle, and there is no need for downstream capacity greater than the bottleneck’s output. This means you can reorganize the entire operation into steps that move at the same pace and quantity as the bottleneck. One balancing method is to group faster-paced steps into subassemblies, perhaps produced by a multi-skilled group of employees called a work cell.

Once the operation is reorganized to match the bottleneck’s pace, and the process is shifted to focus on small batch sizes, the whole operation can shift to a “replenishment” mode. Rather than making inputs according to some master schedule, this means each step calls for its inputs when it is ready. The prior step then delivers that quantity and begins to process its own inputs to make the next batch ready, that is, to replenish a small buffer stock. Often companies use visual cues, such as a yellow card inserted in the pile, to show that the buffer stock has dwindled to a point that replenishment is needed.

Replenishment applies to purchasing as well. Orders for supplies (inputs) are staged according to the expected “pull” of the first step in the process, to replenish the safety or buffer stock only when needed. Orders are delivered “just in time,” and inventory costs plummet.

Taken together, these techniques increase throughput, reduce labor costs, and reduce inventory costs as well. The process becomes more efficient, so customer satisfaction and profits both get better. That’s the payoff for managing bottlenecks!

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. Contact Tom via tgray@tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

 

Bottlenecks Are Opportunities

by Tom Gray | on May 14, 2014 |  Comments

When looking for opportunities to improve operations, look for the bottlenecks. Picture how the top of a soda bottle narrows, letting less liquid flow through. A bottleneck in your operations slows “throughput” in the same way. You can’t fix it until you find it, so where should you look?

Finding the Bottleneck

“Where should you look” is a reminder that to find a bottleneck, you watch the operations – you look. You do more than listen to people’s reports or read the numbers. You go out of your office and watch how they actually do the process you designed. Was that what you had in mind? Before jumping to how you would make it better, pause to consider why people do what they do at that time. Are they working around some obstacle, such as a stopped-up bottleneck in the process?

While you are watching, look for piles of work waiting to be done (“work-in-progress” inventory). Whatever it is waiting for is probably the bottleneck. At the same time, look for people or machines that are waiting to work. Whatever they are waiting for is probably output from the bottleneck.

Which of your people seems to be busiest? Can they handle an unexpected task quickly? If not, maybe they are the bottleneck. This doesn’t mean they are slow; it just means there is too much work for their capacity. That could be because the work is not organized well, or contains errors that need to be resolved, or just requires more hours than are available from this one person. We’ll talk about managing the bottleneck in the next article.

You might also look in the mirror. Most of us have tasks that we put off, either because we are not sure how to do them, or we feel inadequate doing them, or we just don’t like the work involved in doing them. Maybe it’s marketing, or sales, or preparing quotes, or invoicing. Could your own delay in completing such tasks be delaying your company’s throughput? Is there a pile of such work not done? Are there downstream steps that are waiting for you to finish these tasks? To paraphrase the cartoon Pogo, “We have met the bottleneck, and he is us!”

Capacity Itself Could Be the Bottleneck

Your system’s capacity could be the bottleneck itself. If capacity equals overall demand, there will be times when a temporary spike in demand exceeds capacity. Imagine a “catch-up” situation, where delays at the front end are resolved, unleashing a flow of work to the back end. Capacity that assumes steady demand will not be enough when the real world varies the timing of demand. When throughput is limited by your capacity, capacity is the bottleneck.

To maximize throughput, capacity must be somewhat greater than demand. With people, we stretch their capacity when we ask them to work overtime. Their capacity is really 48 hours per week, not 40. This means they have adequate capacity to handle bunches of work, even if normal demand requires 40 hours per week. Now consider the rest of your operational resources: do they have capacity beyond normal demand? If not, they will be a bottleneck when demand is bunched into a spike.

For a memorable image of bunched demand, consider the “pig-in-the-python.” A python can swallow a whole pig, and as the digestion process goes on, you can see the shape of the pig as it moves through the snake’s body. That snake is your business or your process, and the pig is bunched demand. The snake is flexible enough to stretch to accommodate that bunched demand. Your resources and your process need to be able to stretch, too. Those elements that cannot stretch enough become bottlenecks.

Wait, There’s More!

Operations are often said to flow, like the flow of a river. Bottlenecks restrict the flow. We’ll discuss techniques for widening and relieving that bottleneck in the next article. Once you have done so, you’ll find another bottleneck! The wider flow, which was restricted before, will now exceed the capacity of some downstream person, machine, or process. Once you widen that second bottleneck, a new choke point becomes apparent.

Don’t worry! Be happy that you can progressively improve the pace and reduce the cost of your business. Every bottleneck is an opportunity to do just that. Faster production of more units with less waiting means less inventory cost and less production cost per unit, which means higher profit per unit, and more units/more profits overall. So be glad each time a bottleneck presents itself. Fix it and enjoy the flow while you turn to fixing the next one.

For the original analysis of bottlenecks, see The Goal, by Eliyahu Goldratt and Jeff Cox, North River Press, 2004 (3rd edition).

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

Managing Quality in Seven Steps

by Tom Gray | on May 07, 2014 |  Comments

No one can tell a small business owner how to define quality, and no one can tell an owner when the firm’s quality is good enough. But when it comes to measuring quality, and finding the underlying reason when your quality falls short, some proven techniques can help you figure out what you really have to fix – the “root cause.”

Step One: Decide What Matters

Start by deciding which elements of your product or service matter to customers, and which ones matter to company cost control. These will be the items you want to measure. You want a fairly short list of key quality items, and you do NOT want to fill it up with the owner’s personal preferences if they do not matter to customers!

A quality item matters to customers if they will pay more for having it, or if they refuse to buy as much or at all when it is missing. It matters to company cost control if its absence raises costs significantly.

Step Two: Specify Your Standards

If you don’t know what you’re managing for, any result is acceptable. But the idea of quality is that some things are NOT acceptable! You cannot manage quality unless you define what level of performance is the target, and the limits of variation you will accept.

Your standard is a measurement: the target or ideal result for that quality element, the upper and lower limit of acceptable variation (called “control limit”), and the method of calculation. For example, the target is 16 ounces per package, acceptable variation is 0.1 ounces above or below, and the calculation is percent of packages within the acceptable range per day’s production.

Small businesses are famous for not writing things down. Don’t make that mistake with your quality standards. Put them in writing and display them. Your employees deserve to know what they are held responsible for, and putting standards in writing provides you with the discipline to clearly specify how to make your product or deliver your service.

Step Three: Measure Performance

Perform the calculation as designed and when planned.

Step Four: Find a Pattern in the Results

When measurements show variation beyond the acceptable control limit, you must change something to restore quality – to make sure it does not happen again. You can only do that if you find what caused the variation. The first step in finding the cause is to identify patterns, such as day of week, time of day, workers involved, materials or machine involved, type of variation (e.g. over vs. under), etc.

Often several types of patterns can be found, so you need to focus on those happening most often. Fixing these will solve most if not all of the problem. A good tool for this is the Pareto chart, based on the 80/20 idea: 80% of the problem is caused by 20% of the inputs. For example, 80% of the complaints come from 20% of the customers, or 80% of the failures happen on Fridays, or use a certain machine. The SORT and graphing functions in Excel can put this into a simple bar graph.

Step Five: Brainstorm to Find the Root Cause

Why does that pattern happen? Don’t just jump to a conclusion. Open your mind and think about the potential reasons that might appear under these headings: Materials, Machinery, Methods, Manpower. Other categories can be Technology, Processes, and Facilities. A tool called the Fishbone or Cause-and-Effect Diagram can remind you what to consider. For an example, see Cause and Effect Analysis (Fishbone Diagrams) – Problem Solving Tools from MindTools.com.

In the brainstorming session, generate ideas by asking what is being done, when, by who, where, how, and how well according to your measures of quality and success.

Step Six: Select a Remedy

Selecting the remedy can be a creative moment. These same six brainstorming questions can trigger ideas on what to change. Your solution might be incentives to change behavior, or managing suppliers for better materials, or redesigning a process to deliver better output faster. See future articles for more on process improvement.

Recognize that this step requires testing your guesses. You can’t be sure you’ve found the root cause until you correct it, and see that the problem goes away. So there may be some repetition as you try various solutions, or realize that something else is the root cause.

Step Seven: Thoughtful Implementation

Armed with your test results, you can now decree how things will change. But if the people don’t follow, nothing will change. How do you get them to want to change to your new plan? It’s not easy. Decrees are not the answer. People don’t like change. To make it work, you need their buy-in (commitment) and you need to train them.

Buy-in comes from shared vision/values, explaining the reasons for the change, and how the change enables reaching the vision better than the old way. Training is a wide umbrella. It includes role changes as well as methods changes. You’ll need to explain the new way and why, show test results, demonstrate, and then have the staff demonstrate. You’ll need visual reminders (”job aids”) as well as training material. You’ll need to measure performance to see that the change was really implemented, and measure results to see if it worked as planned. Did it work? If not, why not? Are there incentives to make the change, or are incentives working against it?

If you want better results, you’ll have to change something. These techniques help you find that lever, and then make the change happen.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

Finding Opportunities for Operations Improvement

by Tom Gray | on Apr 30, 2014 |  Comments

To make a diagnosis, doctors ask patients about their history and symptoms. They’re looking for signals pointing to a problem. A ship’s pilot looks for familiar landmarks to find the safe channel. A business analyst uses the same approach, looking for familiar signals to find improvement opportunities, based on experience in assessing many companies. The analyst starts with a set of questions.

When the analyst asks what you do, why you do it that way, and what you don’t do, resist the natural tendency to be defensive! Remind yourself that every weakness today is an opportunity to improve quality and profits tomorrow. Rather than withholding information and rejecting new ideas, work with the analyst to seek out the signals to start your growth engine! You wouldn’t withhold symptoms from the doctor, so don’t hide signals from the analyst you hired to make your business healthy.

What to Look for: The Eight Wastes

Waste is any activity that absorbs resources but creates no value in the customer’s eyes. You and the analyst will identify opportunities by examining your operations to find the Eight Wastes (muda) made famous by the Lean movement, based on the Toyota Production System. They are:

1. Overproduction: Some steps or some entire processes produce more than is needed now; excess sits in inventory. The solution is small batch sizes, and quick set-up time between batches.

2. Inventory: This is money sitting idly, adding no value. It could be raw material, or partially completed production, or finished goods awaiting sale. The solution is ordering in small amounts (“just-in-time”) while managing shipping costs, and processing in small batches to avoid stockpiling finished work. This requires good demand forecasts and efficient setup routines.

3.  Waiting Time: Work waits in queues if it is completed before the next step is ready to handle it. People wait for work (shifting to nonproductive tasks in the meantime) if the prior step takes longer than their step. Both types of waiting time make production slower, resulting in resources adding cost without adding value.

Many solutions can be considered. The first is balancing the workflow, so all the steps take the same amount of time, called takt time. Another is eliminating handoffs, so there are fewer waiting queues. Quality initiatives can minimize rework, which makes all the downstream steps wait for nonproductive do-overs. Other solutions include shorter set-up time, parallel processing, and subassemblies.

4. Transportation: Time and effort spent moving materials, partially finished assemblies, and finished goods add no value to the finished product. These tasks delay finished goods and sales, tying up resources in the meantime. Solutions deal with logistics: locating production closer to markets, locating supplier and storage closer to production, shipping at night, receiving at night, and ordering with proper lead times.

5. Over-Processing: Avoid time and machine hours spent producing “bells and whistles” which add no value for customers, i.e., they do not enable a higher price. The solution lies in revising product design, especially any design element that requires use of a crucial or “bottleneck” machine also used for key production steps. You want to make sure the load on such machines is limited to only the essentials, since their availability determines your pace of output.

6. Motion: Time spent moving people or materials from one place to another within the production process adds no value in the customer’s eyes. The solution can involve layout of the production facility’s machinery and storage, assignment of tasks to workgroups, and finding faster ways to move.

7. Defects: Poor quality production results in wasted material (scrap), wasted labor hours for rework, and warranty costs. These not only waste resources themselves, but can slow the entire output cycle, delaying cash flow and making downstream resources less productive due to waiting time.

Solutions involve standards and measurements, in-process inspection by the workers themselves, designing methods and tools that prevent mistakes (poka-yoke), holding each workgroup accountable for correcting its own mistakes, and incentives for achieving both quality and productivity targets together.

8. Underutilizing Skills: When people can do more than they are asked to do, the money spent on others doing that work is waste. The solution is to look to your own staff first. Recognize that one person can operate more than one machine, and fill more than one role. Consider work cells where one or more people handle a variety of tasks as a team. Challenge the team to invent new methods for significant change.

Keeping in mind the Eight Wastes, you and the analyst will look for signals that point to Waste, to find opportunities to remove it.

Operations Signals

  • Piles of Work in Progress indicate an unbalanced production line, bottlenecks, and parts shortages. These can signal several types of waste, such as overproduction, waiting time, over-processing, defects, inventory, and wasted motion to move around the piles.
  • Scrap, field failures, and warranty costs indicate defect wastes.
  • Rework hours indicate defect wastes as well.
  • Machine downtime can indicate wasted hours as employees wait for work.
  • Uneven line speed is another indicator of employee waiting waste.
  • People waiting for work, and work waiting for people.
  • Absence of visual progress indicators hides quality and delay issues, resulting in waiting and defect wastes.
  • Absence of standardization and measurements also hides quality and delay issues, and hampers improvement decisions.
  • Employee workpaths, such as chasing parts and visually checking inventory before taking an order, can reveal inaccurate inventory waste as well as excess labor hours.
  • Transport time and costs involve their own expense and delays.
  • Excessive customizing suggests wastes such as over-processing and waiting.
  • Absence of any recent 5S event suggests wasted inventory costs, potential safety issues, processing delays for finding the right tools, and wasted motion as workers move around barriers such as surplus materials and machines.
    • 5S stands for Sort, Straighten, Shine, Standardize, Sustain. It is a Lean technique to transform a sloppy shop into a smooth-running machine by disposing of unnecessary supplies, tools, and equipment, while sorting the remainder into a clean layout that supports efficient production. The morale boost is an additional benefit!

Purchasing Signals

  • Inventory turnover analysis assesses money tied up in unused materials and finished product. One benchmark is a two-week supply. Comparing your turnover to industry benchmarks reveals the waste.
  • Absence of performance measurements for key suppliers suggests possible part shortages, quality issues, and even cash management problems.
  • Absence of recent competitive bids indicates that material costs may be too high.
  • Absence of outsourcing comparisons signals opportunities for process improvement and cost savings.
  • Asset utilization measurements reveal bottlenecks and surplus, each representing their own types of waste.

Management Signals

  • Absence of forecast vs. actual comparisons indicates potential for excessive inventory or staff, as well as cash flow issues.
  • Absence of measurements on “% quotes accepted” can reveal pricing and differentiation problems, which can turn into wasted inventory and hours.
  • Statistics on the timing and accuracy of invoices and payments can suggest problems in these processes. These can threaten cash flow, the lifeblood of the business.
  • Absence of documentation for key processes, often due to over-reliance on the knowledge of a few key workers, creates greater risk if they leave, potential internal controls problems, and wasted opportunities to improve those processes.
  • Weak internal controls create the risks of fraud and poor cash flow. Internal controls are methods to ensure the integrity of operational, financial, and accounting information. They also ensure that management policies are followed throughout the organization. One example of internal controls is the requirement that at least two employees are involved in every financial transaction.
  • Distributed authority to reduce prices creates the risk of poor margins, damaging cash flow.
  • Operating more than one IT system indicates unreliable information flow due to discrepancies between systems (e.g. inventory, variable cost, margin analysis). Wasted hours is one result.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

Business Techniques for Growth

by Tom Gray | on Apr 28, 2014 |  Comments

As a small business owner, you know you need to grow. You need more revenue to offset overhead. You need efficient operations to make a profit on every unit. No has to tell you small business operates on the edge. There’s no cushion. You see it every day.

You know it’s risky to remain unchanged. Competitors pass you by. Customers move away. Technology enables alternatives to your methods. But change is risky too, and resources are tight. Every small business owner asks “How can I make the right decisions to build size and profits?”

Which path to growth makes the most sense for your business? Which has the best balance of risk and return on investment? When you choose a path, how can you make the most of it?

New Book from Tom Gray: Business Techniques for Growth

Now there is a new book filled with the answers you’ve been looking for: dozens of practical techniques, clearly-explained and proven by experience. Business Techniques for Growth helps you see opportunities and manage risk to grow your business based on prudence, not passion.

“How can a small business change to keep up and grow? This book explains all the levers, from employee performance to revenue growth and operations improvement,” says Mark Petrilli, State Director, Illinois Small Business Development Centers

  • Managing People: Results improve with high-performing and well-motivated employees.
  • Growing Revenue: From quick wins to new distributors, new markets, and new products.
  • Improving Operations:  The fastest and least risky way to grow profits.
  • Negotiating and Deciding: Key skills to choose your course and make it happen.
  • Selling Your Small Business: the ultimate test of growth.

Each of these “parts” of the book contains one or more chapters, composed of a series of short articles explaining business techniques. It’s designed as a “toolbox” for hands-on owner-managers, so they can jump directly to a topic to find a proven technique. They can return again and again for more solutions as their business evolves.

Want a Taste? Here’s an Excerpt

“Imagine yourself as the operator of a business growth machine, with dials to show changes in key business results, and lots of levers that enable you to cause those changes. You are the ‘great and powerful Oz’ – the small business owner! Which levers should you pull first, and when will the results change?

“Start with reading the labels on the levers. What are the techniques for growing? If growing profit is the goal, then our search for growth goes beyond increasing revenue. It also includes cost control and even additional investments to enable more profits. The revenue row levers are…”

Why This Book Now?

Business Techniques for Growth is especially timely because small businesses produce most of America’s new jobs, and jobs are the critical ingredient to sustain families and our budding economic recovery. Will small businesses keep pace and help America grow? With Gray’s book, they can see all the levers and choose the path to growth that fits them best, building successful companies and making America a better place to live.

This book builds on Gray’s first book, Business Techniques in Troubled Times: A Toolbox for Small Business Success, designed for start-ups. This new book continues the thread, targeting the need to build a sustainable and growing bottom line. Together, the two books form an invaluable set of clearly-explained real-world-tested solutions for growing a small business.

Both books are available from Amazon.com in paperback, or as e-books from Kindle and Nook. To learn more or order, visit http://www.businesstechniquesbooks.com/. Tell your friends, and post a review on the book’s page at Amazon!

Want Some Training?

Later this year, watch for the launch of Tom’s Business Techniques Institute – Chicagoland, offering half-day workshops to explain techniques and coach you to apply them to your own business issues.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

Improving Operations: The Low-Risk Path to Growing Profit

by Tom Gray | on Apr 23, 2014 |  Comments

Is your business a “fixer-upper?” Success depends on a solid foundation, whether you are building a house or building a business. You wouldn’t build another level on a crumbling foundation, and you shouldn’t try to grow a business with fundamental weaknesses. The foundation of the business is Operations – the way you use resources to add value to raw materials so that customers want to buy the output.

Thinking about The Business Growth Machine, this means you should work on the Cost Control levers before the Revenue Growth Levers.

Cost Control

Variable Cost

Fixed Cost

  •   Labor hours
  •   Labor wages
  •   Labor benefits
  •   Material amount
  •   Material cost
  •   Subcontractors
  •   Shipping
  •   Sales commission

 

  •  Rent%
  • nonproductive labor
  • Marketing
  • Office supplies/misc.
  • Your salary/benefits
  • Professional services*
  • IT systems
  • Interest
  • More!

*Professional services includes consultants, lawyer, accountant, other outside services

Cost control, along with quality, is how we measure operational success. Revenue Growth and Cost Control can both improve profits, but you have more control over improving your own operations than growing sales. You know your operations and your people, but growing sales depends the unknown – the decisions of potential customers you have not yet been able to attract.

Starting your growth efforts with improving operations makes sense for two reasons:

  • More control means less risk, so forecasted results are much more likely to actually happen with cost control than with revenue growth initiatives.
  • Revenue growth moves will have a higher payoff if they are based on excellent rather than weak operations.

For example, if 25% of the units produced by ABC Widget Company need “rework” to fix quality problems, adding more sales results in more rework. If ABC can reduce rework to 5%, its sales growth will result in much greater profit growth.

Finding Opportunities: What Needs Improvement?

How do you spot the signals showing opportunities for improvement? Every business has these signals, but owners usually overlook them as they focus on day to day tasks. You need a frame of reference to know what to look for, and an outside perspective to know what level of performance is good. A consultant can offer both, based on broad experience analyzing many types of companies. The next article suggests what to look for.

How to Improve Operations

The goal of operations is high quality production based on efficient use of materials, machinery, and labor. Production is the output. Materials, machinery, and labor are the inputs. Productivity – the end result of cost control – is the value of the outputs divided by the cost of the inputs.

How do you improve operations to achieve better productivity? You use a combination of people management and process improvement.

People Management

Earlier articles explained how to motivate and train your workforce. Employees must want to do the right thing, know how to do it, and know why the right methods work best. See Motivating People and  Employee Performance

A well-managed workforce is the key to efficient and predictable production, and it’s also the key to improving operations. Here’s why. The best managers invite motivated, well-trained employees to participate in finding better production methods. These employees know the details, the opportunities, and the potential pitfalls you’ll encounter in implementation. This opportunity to improve the design of their jobs strengthens their motivation even more, creating a virtuous circle – a spiral of continuous improvement.

Process Improvement Begins with Mapping a Business Process

A business process is the sequence of steps used to produce an output. Every business has several processes. Examples of “high level” processes include ordering supplies, producing widgets, quality control, billing and collection, hiring and training, and cash management. Most of these have sub-processes, such as accepting, stocking and counting inventory, delivering it to work stations, and the various production steps.

Improving a process is the fundamental route to improving operations quality, cost control, and productivity. Process improvement is the best technique for profit improvement because it produces more profit with every sale, and it’s under your control.

Process improvement generates more and more profit as the business grows because it controls variable costs, increasing the contribution or gross margin in both dollars and percentage of revenue. If fixed costs (overhead) stays the same, then this higher gross margin increases profit by the same amount.

To improve a process, you must understand how it works today. The tool is a process map — a special kind of flowchart. It’s a visual method for showing the process in steps, crossing departmental boundaries and linking it to preceding and following processes. The best process maps show more than the physical output. They also show how long each step takes, who does them, and the paper or digital record produced as well as the physical output.

Once you can see the process as it is today, you can also see how it might be changed. Your goal is substantial change, reducing cost or improving quality by as much as 50%. Following articles tell you what signals to look for, what questions to ask, and how to map and improve your processes, the surest way to grow profits.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com. For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbooks.com/

Successful Cold Calling Techniques

by Tom Gray | on Apr 16, 2014 |  Comments

Growth is the most fundamental challenge to a small business. Will you take the passive approach, relying on marketing, word-of-mouth, and a small customer base to generate incoming transactions? Or will you use marketing as only the base, and build on it with active selling to potential prospects?

Cold calling is part of the active approach, growing the client base and replacing the natural erosion of current customers. It’s a great opportunity to bypass propsects’ current suppliers, pre-empt competitors, and open up huge new possibilities.

The ingredients for a successful cold calling recipe are your attitude, prospect list, script, communications style, and follow-up. Without the right attitude, the rest of the ingredients don’t matter!

Attitude

As always, start by understanding your goal. Fundamentally, you want to your business to survive and grow by finding new customers. Your goal in cold calling is to open a dialogue so you can find prospects where there is a fit between what they need and how you can help them. For those people, your goal is to continue the dialogue so they can make good decision. This might be an appointment, or just an agreement to keep in touch until they are ready to buy. Rather than focusing on your needs, let them guide you to the outcome that meets their needs best. Don’t try to make the sale in a phone call!

The dispiriting aspect of cold calling is rejection. Handle this by recognizing it in your goals, and reflecting on what works.

  • Set a schedule, such as one hour per day, and set a target, such as two appointments per session. If you reach the goal in less than one hour, stop calling and celebrate success!
  • Set the situation to fit your positive approach. Eliminate distractions and background activities. Stand up when calling. Focus on the needs of the prospect.
  • After each call, think about what you could have done differently to make it a success, or what techniques or words seemed to work best to open dialogue. Then adapt your approach for future calls.

Remember, you are looking for people who want your help, not trying to force your attentions on those who don’t.

Prospect List

Call people like those who are already your customers, e.g., same industry, circumstances, geography. If you already have some connection with them, they are more likely to listen. Do a little research on their industry, company, or circumstances before you call, so you can show your interest in solving their problems. If you decide to rent a list from a list broker, experiment with small segments to find the right kind of list.

Script

A three or four line script makes it easier to call, but sounding like a script means you get treated like a robo-call – a quick disconnect. In the first 30 seconds, you are seeking permission to continue dialogue into a needs analysis.

  • Identify yourself and your firm in the first 5 seconds.
  • Express respect for the prospect’s time in the first 10 seconds.
  • Communicate a compelling and quantifiable customer benefit in the first 20 seconds. Defer details.
  • Ask for permission to continue the call in the first 30 seconds.

The second part of your script is a few questions designed to understand their needs and how they make decisions on meeting them. Listen to the responses! Your replies must position you as an expert advisor, not a seller. Your “close” is an arrangement to be involved and coordinate a solution for their needs.

Practice your script with someone. Anticipate objections, craft your response as part of your script, and practice natural and respectful delivery. The goal is to know your message well enough so you can concentrate on what the prospect is telling you, rather than being focused on your response.

Communications Style

Cold calling works when your communications focus on the customer needs, not your own. The image you want to project is the professional expert advisor. This table sums it up:

How sales people typically see cold calling How customers see cold calling done poorly What successful cold calling should be
fearfulboring,   repetitiveunpleasantpressurizedunimaginative

rejections

thankless

confrontational

unproductive

demoralizing

unhappy

numbers game

nuisanceunwantedindiscriminate,unpreparedpressurizing

tricky, shifty

dishonest

reject, repel

shady, evasive

contrived

insulting

patronizing

disrespectful

honest/openstraightforwardinteresting/helpfuldifferent/innovativethoughtful/reasoned

prepared/informed

professional/business-like

efficient/structured

respectful

enthusiastic/up-beat

informative/new

thought-provoking

time/cost-saving

opportunity/advantage

credible/reliable

demonstrable/referenced

Source: Cold Calling Techniques – tips, cold calling that works for sales introductions, telephone prospecting and other examples for cold calls in selling

With this approach, you will naturally end the call when the prospect offers three objections. End it with respect, and keep the door open to future contacts when the buyer feels a more imminent need.

Gatekeepers

When you cannot reach the prospect directly, don’t give up! If you reached their Voice Mail, leave a short message saying who you are and why you called, promise to call back on a certain date, and mention you would appreciate a callback. Then make that follow-up call as promised!

If you reach an assistant, ask if the prospect is in the office. If not, say you’ve been trying to reach him or her, and ask for a good time to call back. Make the gatekeeper your friend: treat them with respect, make a personal connection, and mention briefly why the prospect might want to talk (compelling and quantifiable benefit).

Cold calling is a tool for growth. Treat it positively, and do it regularly. After all, helping customers meet their needs is the reason you’re in business. Cold calling helps you stay that way!

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

Finding the Tiebreaker to Close the Sale

by Tom Gray | on Apr 09, 2014 |  Comments

Sometimes your prospect just doesn’t care about your differentiation! How dare they? You’ve done your research and found the competitive edge to attract your target market, but some of those buyers just don’t need that feature. To them, you are just another supplier who can meet their general need, so now they are trying to decide how to choose.

You could cut your price, but then they will just go back and ask the competitors to match it. They may even fear choosing the lowest bidder, to avoid quality issues or later added charges for change orders.

In this B2B sale, the Purchasing Manager is looking for a reason to choose one supplier out of many who would be adequate. What can you do to give him that reason – that justifier for choosing your firm?

A three-year study of 46 companies points the way. See “Tiebreaker Selling: How Nonstrategic Suppliers Can Help Customers Solve Important Problems,” by James Anderson, James A. Narus, and Marc Wouters, Harvard Business Review, March 2014.

The answer lies in understanding the customer’s business well enough to offer something that enables them to do their job better. This creates a “visible win” for the Purchasing Manager – status for finding a way to improve his company’s results.

Real-World Examples

  • Right to cancel without penalty.
  • Changing the timing of payments.
  • Performing a customer function for them, such as pasting their inventory part numbers on the units before shipping.
  • Integrating your product or service with their other suppliers.
  • Performing preventive maintenance on your products while in use by the customer.
  • Creating a team to share some of your company’s expertise, such as packaging.

How to Find the Tiebreaker

To find their tiebreaker, salespeople need to make an extra effort to understand the customer’s business. Too often, this does not happen. The salesperson just sticks to the script of emphasizing product differentiation even when it does not matter to the buyer, and then reverts to cutting price. Instead, you need to take the time to listen, ask, and talk to the users.

Listen when the Purchasing Manager talks about what the company needs. But, most importantly, talk to the people who use the product.

Ask them (better yet, watch) how they use your product, what problems they encounter when using it, what are their objectives and priorities, what their customers need, and how your firm could be a better supplier to them.

Listen for quality problems you can solve, operating costs you can reduce for them, and objectives you can help them meet. Think in terms of “what if” we did this for you, or did that differently. Would that help you meet your goals?

The answer to these questions is your tiebreaker, the justifier for choosing your offer. Your goal is to make the sale with a 3-5% price premium over the lowest-priced competitor. This price will be within the Purchasing Manager’s acceptable range, and your tiebreaker makes him a hero to colleagues. Meanwhile, you avoided a price war!

You’ll want to concentrate on only a few industries, due to the time and effort needed to talk to users to understand the customer’s business. This enables you to re-use your findings and your tiebreaker with several customers in the same industry.

Competitors will eventually match your tiebreaker, so this is a never-ending process. But you’re in a lot better position if they are reacting to your success than if you are simply seen as no better than they are – a commodity continually subject to price pressure.

Your tiebreaker is a new differentiation, a new competitive edge, but it goes beyond the product itself. It’s based on how well your firm, not just your product, solves the customer’s problem.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

Negotiating Tactics: Content and Style

by Tom Gray | on Apr 02, 2014 |  Comments

Once you understand the issue, the other party, and your own BATNA and threshold, you can move into Phase 2 of the negotiating process:

  • Phase 1: “Can’t we do better than this? How much better?”
  • Phase 2: “We’re supposed to meet with them next week. How should we play it?”
  • Phase 3: “Good morning! I’m glad we’re finally talking face to face about this issue.”

Think of Phase 2 as Content: what you will negotiate on and for. You’ll decide these before the negotiation starts.

Think of Phase 3 as Style: the way you behave during the discussion itself. Recognize that although you may plan such tactics, your behavior must adapt to conditions “on the fly.” As the boxer Mike Tyson says, “Everybody has a plan ‘til they get punched in the mouth!” That’s when you adapt!

Phase 2: Plan the Content of Your Negotiations

1. Do your best to make sure you are negotiating with the Decision-Maker. If not, after you make a compromise deal with the subordinate, you may end up making further concessions to satisfy their boss. Some bosses need to prove their worth by being “tougher” than their subordinate.

2. Design some win/win solutions, considering the interests (not positions) of both sides. Then you can plan to take positions where the compromises lead to these win/win outcomes. For you to win, the other side does not need to lose. The best outcomes satisfy both sides.

3. Plan “off-target” responses to expected proposals. Direct, adversarial responses do not move the process forward. They just force the other side to try harder to justify their position, making progress even more difficult. Instead, your response can suggest a changed basis, such as bundling commitments or orders, or revised timing. You veer away from the position the other party has staked out. You change the terms of the discussion, in search of an area of common interest: win/win.

4. Choose your crucial negotiating points, and be prepared to yield on others. When the other party says “no,” research shows they subconsciously feel an obligation to say “yes” later. This means that yielding on some points can help you win acceptance on other points. See “Defend Your Research,” Harvard Business Review, December 2013.

Phase 3: Style — Tips for Behavior in Discussions

1. Don’t bid against yourself! When you propose a price or position, wait until the other side makes a change or concession before changing your offer. If they say, “That’s too high,” do not come back with a lower price. Instead, explain why that price is reasonable, and suggest a change in their specifications that might open the door to a lower price.

2. Be careful about which side mentions their price first. Some say you should try to make the other side be first to mention a price, because that becomes the basis for negotiation, and it may be more favorable than what you would have offered. Others say you should be the first to state a price, because you want to set the basis for price negotiations! If you want to specify the basis for price discussions, then be the first.

3. Keep the tone light. Not only is it more pleasant, but your good-natured style shows you don’t need this deal, that you have other equally-attractive choices. The result could be a more accommodating person across the table.

4. Paraphrase what you heard them say or saw them feel, and invite correction. This avoids wasting time with misunderstandings, and builds goodwill by being a visibly interested listener.

5. Ask open-ended questions. “Why do you say that” is not open-ended, because it forces the other party to defend a statement or position. This makes it harder for them to back away from that position later. Instead, ask questions like “help me understand something better” or “tell me more about…”

6. Non-verbal cues can be a less adversarial way to get your message across.

- Silence creates discomfort. So the other party will often fill the silence by saying more, revealing more about their interest.

- Delay can make the other party anxious about unknown developments or overtures from your alternative suppliers. Their response is to become more flexible in what they’ll agree to.

- Other signals to make the other party doubt the strength of their position: arriving late, taking phone calls during the meeting, closing a portfolio, not taking notes, stepping out to discuss with colleagues, and any number of others.

This planning and behavior can get you where you want to go: an outcome that satisfies your interest. Your behavior need not be bombastic or cruel. Research enough to know the other party’s interest, develop win/win solutions to satisfy their interest as well as your own, and negotiate off-target by changing the basis of discussion without directly opposing the proposals of the other side.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

Knowledge Is Power: Five Ways to Win Negotiations before They Start

by Tom Gray | on Mar 27, 2014 |  Comments

For a successful negotiator, the guiding motto is this: “If it’s worth doing, it’s worth planning.”  Winning negotiations is less about how you behave across the table, and more about research and preparation before you sit down.

The negotiation process begins long before the parties meet. It starts when one party decides it needs something from the other, or that it might get a better deal than the current arrangement.

The first two phases are complete even before the two parties sit down to talk:

  • Phase 1: “Can’t we do better than this? How much better?”
  • Phase 2: “We’re supposed to meet with them next week. How should we play it?”
  • Phase 3: “Good morning! I’m glad we’re finally talking face to face about this issue.”

This article is about Phase 1; the next article addresses Phases 2 and 3.

Winning negotiators depend on winning research. To choose their negotiating strategy, they seek answers in five areas.

1. Know the topic and the other negotiator.

Knowing the topic is not as simple as it sounds. You need to know the facts and context from four viewpoints: unbiased outsider; man-on-the-street (how the media would report it); the other party’s interpretation; your own perspective. Each viewpoint has different values and biases, supported by the value (non-neutral) words they choose to describe the situation.

Your knowledge should include assessments of the likelihood and risks of possible outcomes: “Will they really file that lawsuit? Could they win? What if they did?” Leave the rose-colored glasses at home! These assessments will guide the positions you plan to take, a Phase 2 activity.

Knowing the other negotiator is obviously important, but the information might be hard to find. Social media and industry contacts can be good starting points. You want to know their career history, their biases, what they value, positions they took in other negotiations vs. final outcomes, and the importance of this negotiation on their reputation in their company. You would also like to know what kind of negotiating style to expect, and the limits of their decision authority.

2. Know two other suppliers who could meet your needs.

The other negotiator may be more accommodating if they realize you have other options. You will let them know, but first be sure the alternatives can really meet your needs.

3. Decide your BATNA and your threshold: the lowest offer you would accept.

These are your boundaries. BATNA stands for Best Alternative to Negotiated Agreement. It means your course of action if these negotiations do not result in a deal meeting your minimum threshold. What will you do then? Negotiate with the other two potential suppliers? Change the design to avoid using this supplier?

Knowing your BATNA helps you measure the lowest acceptable offer, or “threshold.” The threshold will be a deal worth slightly more than the BATNA.  Having these two boundaries in mind, you can develop several better positions prior to taking your seat at the negotiating table.

4. Understand the other party’s real “interest;” it’s likely to be different than their “position.”

Their position is the set of terms/price they propose. Avoid limiting your thinking to merely modifying their package. Instead, research to understand what they really need: their interest. Do they need the corn, or only the cob? Rather than being stuck dealing with their difficult position, there are probably many ways to satisfy their interest and yours at the same time. Knowing their interest (and yours) lets your creativity find a win/win solution, so your win does not mean their loss.

5. Forecast the other negotiator’s BATNA and threshold.

“What else could they do?” Put aside your arrogance and belief in your own wonderful company, and try to think like the other party. How would they assess their alternatives? Who are their other two potential suppliers or customers? How does the other party think those two companies compare to yours? How much more would they pay to use yours?

Is the answer the same when you replace the value words in your analysis with neutral words? Using value words is how we fool ourselves! For example, change “legacy systems” to “proven systems”, or change “inconsistent” to “flexible.”

These five findings simplify and focus your planning. They set the minimums, and guide you to solutions the other party is likely to accept.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

Selling, Then Staying

by Tom Gray | on Mar 19, 2014 |  Comments

Staying with the business – how can that be an exit strategy? Seems like a contradiction, doesn’t it? The answer depends on the terms of the deal.

It’s natural to want a gradual transition. Sellers want to protect the legacy of their life’s work: the brand and the relationships with customers, employees, suppliers, and industry colleagues. Sellers who are planning to retire may prefer to remain engaged part-time, smoothing their own transition to a new lifestyle. Buyers can benefit if the seller helps retain customers, employees, and suppliers.

But this natural desire for gradual change becomes turbocharged if the sale deal defers some of the purchase payment into future years. When the seller finances the buyer’s purchase, or agrees to make a portion of the purchase price contingent on the company’s results in future years (“earn-out”), the post-sale success of the business determines whether the seller will eventually receive full value for the business. Facing the risk of not being paid in full, sellers find ways to limit their risk and help the business succeed.

Frequency of Seller Financing and Earn-outs

How often does this happen? Most of the time! “Seller financing is involved in up to 90 percent of small business sales, and more than half of mid-size sales,” according to Options for Financing Your Business Sale | BizFilings Toolkit.

Seller loans amount to 1/3 to 2/3 of the purchase price, with a term of three to seven years (see Key Deal Terms: Seller Financing). Earn-outs are involved in 15% of deals, and generally involve payments over two to three years (see Key Deal Terms: Earn-out).

Pre-Closing Risk Protection

Sellers recognize that seller financing and earn-outs are essentially their investment in the buyer. To avoid unpleasant and costly surprises:

  • Sellers carefully research the buyer’s professional and personal life to decide which buyer they can trust.
  • Like any lender, sellers will require that the buyer provide a business plan prior to closing. They are looking for plans to support the growth and culture of the business: technology, markets, products, marketing, and employee relations. The business plan projections become milestones or loan covenants, triggering payments or remedies such as foreclosure.
  • Collateral for an owner loan is another risk-reducer, but if there is a bank loan as well, usually no collateral remains available to protect the seller.
  • Access to the company’s future accounting information is often part of the deal as well.

Post-Closing Risk Protection: Staying Involved

Not content with these “passive” pre-closing protections, sellers can negotiate an ongoing role in the business after the sale until the loan term or earn-out is completed.

In addition to a few days per week supporting relationships or pursuing new clients, sellers can gain the buyer’s commitment to continue to use the same accountant and authorize the seller’s access to financial inputs and reports. This helps the involved seller spot problem trends and offer solutions.

When the deal terms defer payment via seller financing or earn-out, the seller is motivated to help the business succeed. Staying involved is the best way to leverage a lifetime of knowledge and relationships to gain the full value of a business sold this way.

“It’s really a win-win because the seller can help the buyer retain clients, customers, and vendors,” says Andy Cagnetta, chief executive of Transworld Business Advisors LLC (quoted in Lisa Ward, “Stick Around After the Sale,” Wall Street Journal, February 3, 2014).

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

 

Closing Conditions

by Tom Gray | on Mar 12, 2014 |  Comments

Most acquisitions do not close when the parties sign the Purchase Agreement. There is a time interval between signing and closing, often 90 days if regulatory approval does not require longer.

This interval enables the parties to complete some tasks to finalize the transaction, such as assignment of leases and buyer financing.  However, it also adds complexity because the business is operating and changing in the meantime. Changes may include receivables and payables (working capital), customer contracts, employees, and other possibilities such as litigation.

To manage such risks, when they sign the Purchase Agreement the parties also negotiate and agree to a group of commitments, deliverables, and assurances concerning their actions between signing and closing. Together these are called “closing conditions.” If these commitments are not satisfied by the responsible party by the closing date, the other party has the right to refuse to complete the transaction.

Promised Pre-Closing Behaviors (Covenants)

  • Seller will not create a competing company, hire employees from the business into another business, or solicit customers to move to another supplier (“non-compete” and “non-solicit”). This covenant usually lives on for a stated period after closing.
  • Seller will not seek or negotiate with other buyers (”no shop”).
  • Seller will get the buyer’s approval before taking actions that could materially change the value of the business, such as limiting normal capital investment, acquiring or divesting major assets, or signing major contracts with customers, employees, or suppliers. Buyer’s response will be timely and reasonable.
  • Seller may be required to take certain actions that would enable the buyer to take advantage of opportunities more quickly after the sale.
  • Neither party will announce the transaction or its details without the other party’s agreement unless required to do so by law or regulation.

Assurances about Condition of the Business at Closing (Reps and Warranties)

  • All reps and warranties agreed to at signing are true at closing, subject to materiality and knowledge qualifiers negotiated earlier, except as disclosed in updates to disclosure schedules. This “bring-down” condition is the most important closing condition, and will be covered in more detail later in this article.
  • All covenants governing behavior between signing and closing have been complied with.
  • No changes with material adverse effects on the business have occurred since signing.
  • No litigation has started which would restrain or prohibit the transaction.
  • Buyer guarantees to take certain post-closing actions, such as continuing employee benefit plans for a specified period, providing D&O insurance for the seller for a specified period, changing titles on assets, and cooperating on the post-closing working capital adjustment to be completed by a certain date. This latter item is the other highly-important closing condition, addressed later in this article.

Deliverables (Documents)

  • Stockholder and Board of Directors consents to the transaction as agreed.
  • Corporate Secretary’s certificate as to accuracy of company formation and capitalization documents.
  • Regulatory approvals, licenses, permits, etc.
  • Ancillary agreements such as seller financing and employee retention agreements.
  • Third party consents, such as leases and assignment of contracts to the buyer.
  • Release of liens and settlement of litigation.
  • Standard deal documents, such as bill of sale for assets and escrow agreement.

Termination Rights

The transaction can be terminated

  • If both parties agree to do so.
  • If a legal impediment makes the transaction illegal.
  • By one party if the other has not completed its closing conditions by a “drop-dead date.”
  • By one party if the other has materially breached a rep/warranty or failed to perform according to a covenant, after an agreed “cure” period (such as 30 days) to make it right.

“Bring-Down” of Reps and Warranties

The parties and their attorneys will burn plenty of negotiation calories defining which changes in the business since signing allow the buyer to walk away without closing. Materiality issues will include the threshold over which a change in one rep will be considered material, the threshold for the total of all changes before the total can be considered material, and whether the seller can exclude changes from this tabulation by updating disclosure schedules. Sellers want flexibility without enabling the buyer to change the agreed price or walk away, and buyers want the right to do both for the lowest possible materiality threshold.

Post-Closing Working Capital Adjustment

The working capital adjustment is the most common source of post-closing disputes. At signing, the Purchase Agreement uses an estimated figure for working capital, and promises that the actual figure for the closing date will be calculated 60 to 120 days after closing. The difference is paid out of escrow to the seller if actual exceeds estimate, or to the buyer if actual is less than the estimate. This process is called a “true-up.”

Working capital is usually defined as current assets (cash, inventory, accounts receivable, and prepaid items) minus current liabilities (accounts payable and accrued expenses). The parties can minimize disputes if they define all these terms clearly in the agreement, if the definitions follow accepted accounting principles, and if the seller has the right to examine pertinent company records after the closing as part of the “true-up” process.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

Due Diligence and Deal Terms

by Tom Gray | on Mar 05, 2014 |  Comments

What does the buyer do with all this due diligence information? After due diligence is complete, some buyers may decline to participate further, but most will seek agreement on deal terms that minimize the risks they verified or discovered in the due diligence. They spent time and money to go through the document review process, so they are likely to seek solutions rather than simply walk away.

First, Buyers Assess Their Findings

After due diligence, buyers assess their findings. They list the risks and opportunities, and prioritize them according to financial impact. Together with their advisors, they may create several preliminary forecasts of business results. They’ll use different scenarios for future outcomes of the most important risks and opportunities.

Second, Buyers Discuss Their Concerns with the Seller

Buyers will want to hear the seller’s view of the risks and opportunities. The seller may clarify misunderstandings, point out connections among findings that change the risk assessment, or explain how current initiatives are expected to reduce the risks or take advantage of the opportunities. As a result, buyers change their assessments and preliminary forecasts.

Third, Buyers Seek Deal Terms to Minimize Risk and Optimize Opportunities

This step is the heart of deal negotiations. If buyers can gain protections or guarantees to back up the seller’s assurances, the deal is likely to go forward. Buyers try to shift risk to the seller through deal terms. Methods may include seller guarantees (reps and warranties), exclusion of certain liabilities or assets, closing conditions, installment payment terms contingent on results, or reductions in the price offered.

Closing conditions require the seller to accomplish certain activities between signing the Agreement and actual transfer of ownership (“closing” the transaction). Examples of seller closing conditions include gaining government and lender approvals, release of liens, and gaining commitments from employees to remain with the business. The seller may also be asked to perform certain activities to make buyer synergy opportunities more likely to succeed. The next article is devoted to closing conditions.

Installment payment terms contingent on results include earn-outs, seller financing, and perhaps the seller’s role in the business after sale. See previous articles in this category for more on these.

Reps and Warranties

Buyers usually seek new or modified reps and warranties to make the seller responsible for risks identified in due diligence. These are usually limited to material (sizable) risks/costs discovered within a specified time after closing, such as 6 to 18 months. Four different approaches are:

  • No risks: Seller states there are no risks of this type (e.g. product liability) and agrees to reimburse buyer for the cost of any that appear after closing. This is ideal for the buyer.
  • No known risks other than those disclosed: Seller promises to reimburse buyer for any costs for risks the seller knew about other than those disclosed in an Appendix to the Purchase Agreement. The cost of disclosed risks is reflected in the agreed selling price.
  • No risks seller should have known about other than those disclosed: Same as above, except seller’s liability for disclosure is expanded to cover what a diligent manager should have known.
  • Seller accepts liability to reimburse buyer for losses of a certain type up to a cap. For those costs not disclosed in the Appendix mentioned above, the seller’s duty to reimburse the buyer is limited to a maximum amount, in addition to limitations on materiality and time discovered. Sellers prefer the certainty of a cap on potential future liabilities.

As noted earlier (cite), the parties may agree that part of the purchase price is placed in escrow by the buyer to pay for any such liabilities discovered after closing.

Asset Sales

If the buyer believes liabilities of the business could be worth more than its assets, the offer could change from buying the business to buying only its assets. Buyers usually make this decision on deal structure earlier in the process, such as during preliminary deal term discussions after reviewing the Offering Memorandum. However, there have also been cases where due diligence findings caused buyers to change their deal structure strategy.

Buying only the assets leaves the original business (not the buyer) responsible for its own liabilities. Without its assets, the original business will cease operations and may declare bankruptcy to void the liabilities.

Buyers prefer an asset sale if there is a significant tax advantage due to restarting depreciation from a new basis – the price they paid for the assets. In contrast, when they purchase the business as a whole, they adopt its existing depreciation schedules, and some assets may already be fully depreciated. According to a recent ABA study, 87% of acquisitions were asset sales.

The downside of asset sales is that they do not automatically include the business contracts and intellectual property, requiring separate valuation of these components if they are part of the assets purchased. Valuation of non-physical assets is not well-defined and thus can be an obstacle to reaching agreement.

Shifting the deal structure from sale of the business to sale of its assets changes the basis of valuation and price. In an asset sale, the price is no longer based on the value of future cash flows of the business as a whole. The price basis becomes the value of its assets if sold in the market today, whether sold together or piecemeal. Valuation and selling price are based on appraised value of assets rather than discounted cash flow analysis and multiples of comparable transactions.

In an asset sale, the parties must also agree on how much of the purchase price is allocated to each type of asset, including the premium over market value, called goodwill. Historically goodwill represents about 30% of the purchase price, though recently it has averaged only 19% according to an ABA survey.

Exclusion of Certain Assets or Liabilities

Due diligence findings may show the buyer that certain assets of the business do not contribute to its future value. Examples include facilities with low utilization, inventory more than one year old, and machinery no longer used or duplicated by the buyer’s machinery.

Buyers may also decide that certain liabilities can or must be retired by the seller prior to closing, to reduce the buyer’s risk.

In such cases the buyer’s remedy may be exclusion of such assets or liabilities from the purchase, perhaps with a corresponding change in purchase price. The Purchase Agreement may still apply to the business as a whole, but the unwanted assets or liabilities to be excluded would be listed in an Appendix.

Role of Advisors

Sellers may be shocked and dismayed by these dispassionate assessments of the components of the business. Often the seller has not assessed the business as a buyer would. The seller’s advisors – attorney, investment banker/broker, and accountant – play an important role in these negotiations. They can help the seller see the reasons for the buyer’s proposals, and suggest compromises based on experience in dozens of other transactions. Their counsel can enable the deal to be completed with a fair distribution of value and risk, rather than crumble into acrimony and rejection.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

Due Diligence Topics and Checklist

by Tom Gray | on Feb 26, 2014 |  Comments

Due Diligence Topics and Checklist

Sellers can use the following categories to organize the documents in their due diligence data room. Note that some of these documents may already have been shared and discussed prior to due diligence, but those documents need to be available in the data room anyway.

  • Financial: Financial; Insurance
  • Legal: General Company; Corporate Agreements; Intellectual Property (IP); Litigation; Environmental; Tax
  • Operations: Customers; Marketing; Sales; Support Services; Products and Pricing; Processes and Production; Facilities
  • Information Systems (IT):  Software; Hardware; Data bases; Internal controls
  • Personnel: Employees, pay, benefits, and other HR matters

Extensive checklists for documents can be found at Due Diligence Checklist. Here is a summary description of the ideal documents for each of these topic areas, from the buyer’s perspective.

Financial: Audited financial statements for three years; unaudited results for the current year; budgets vs. actuals for two years; other financial reports for three years; detailed capital expenditures (capex) for three years; receivables aging schedule; correspondence with auditors for three years; projected financial results for the next three years.

Insurance: Summaries of insurance policies including “key man” life insurance, property, general liability, vehicle, worker’s compensation, employee health, and umbrella liability. Include the name of carrier, annual premium, coverage, claims over the last three years, self-insurance amounts reserved, co-payments/deductibles, and type of policy (occurrence vs. claims made).

General: List of subsidiaries; capitalization, number of shares, and owners; certificate of incorporation and bylaws; minutes of stockholder and board meetings including committees for three years; any other agreements among stockholders relating to management, ownership, loans, employment, or indemnity; all financing agreements; stock records; rights and warrants lists and the supporting agreements; address of all land and buildings; all material permits, licenses, government authorizations, and related correspondence; any other agreements with government entities except customer contracts.

Corporate Agreements: Borrowing agreements; credit line correspondence; acquisition and asset disposition agreements; joint venture, consulting, franchise, and other conditional agreements; distributor contracts; non-compete agreements; all other material contracts.

Intellectual Property: List of all trademarks, service marks, trade names, copyrights, and patents; evidence of registration, ownership, and/or first use of these; agreements concerning employee or outsider rights to products; procedures for maintaining trade secrets; end user license agreements; escrow agreements for computer source code; records of claims and disputes for IP;  product literature made public in past two years; product maintenance logs and error reports for past 12 months.

Litigation: List of resolved litigation for past five years; summary of pending or threatened litigation; list of all attorneys acting for the company currently; summary and copies of all court and arbitration orders and settlements currently binding on the company.

Environmental: All permits and notices or demands from environmental authorities; written reports on environmental testing or other such matters; estimates of future remediation costs; records of compliance activities; location of all hazardous waste disposal sites; locations of all underground tanks and lines including those no longer used; any history of leakage or spillage from such facilities.

Tax: All tax returns from the last three years plus any open years; all information on past and pending audits and judgments concerning any open returns; tax waivers or collection agreements; all requests for rulings by taxing bodies; any material tax decisions or elections by management.

Customers and Marketing: List of top 20 customers with revenue billed and collected from them in past three years; total customers by product for past three years; number of monthly website visitors for past two years; description of sales channels per product and their percentage of revenue; target customers and marketing plan per product; description of sales organization and sales/purchase order process; key customer relationships; industry segment description including brand awareness and product introductions/success; competitive analysis including differentiation; customer base vs. that of competitors; strategic alliances.

Sales: Revenue from new customers for past three years; international sales revenue in total and for top ten countries for past three years; planned new product releases; description of significant new business and lost business; growth opportunities; major partnerships and their effect on revenue growth.

Pricing and Support Services: Explanation of the economics behind all fees and prices; level and source of margins per product and support service; significant customer contract terms; process for delivering upgrades to customers; discussion of product customization and effect on margins; description of the customer support function and its availability.

Processes and Production: Process maps for key processes; description of facilities, their role in production, and any significant expected facility upgrade or maintenance costs; list of critical raw materials and key suppliers, and their value and continuity; list of critical production skills and their continuity; utilization rate per asset and monthly utilization rates to show seasonality; percentage of invoices paid in full, percentage or value of warranty returns and key production metrics such as units per hour and percentage of hours devoted to rework; inventory turnover by type, and value and type of any inventory unused for 12 months.

Information Systems and Internal Controls: Describe software, hardware and databases, and how they compare to those used by competitors; identify costs for such assets over the past three years, and any material future expenses expected; describe IT and Internet security, backups, remote records, and disaster recovery plans; describe accounting and financial controls and IT departmental functions.

Employees and HR: Union contracts and any related correspondence; management employment contracts or other agreements such as severance, consulting, and non-compete; organizational chart with names of function heads and number of subordinates; list of all employees earning over $100,000; employee benefit plans and related correspondence, reports, and filings; funding status and non-funded liability of each benefit plan; liability for termination payments to employees; details of other employee plans and arrangements; list of active and inactive employees for last three years with title, function, tenure, unique skills, and compensation; description of any order or decree applying to any senior executive which could affect the company’s conduct of business.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or tgray@tom-gray.com. See www.tom-gray.com.  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see http://www.businesstechniquesbook.com/

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