“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
By Alec Pendleton, Big Ideas for Small Companies
I grew up in a family manufacturing business, which my father had built from nothing over years of assembling the right management team, acquiring compatible companies, and steadily improving operations. By the time I arrived on the scene, there were about a dozen plants and almost 1,000 employees, and the company was well respected in its various markets.
And after fifty years of high margins and good profits, it was losing money.
Although there was quite a range of products, the heart of the business was several brands that had recently been blindsided by a flood of imports, changing the whole character of the market. To fix the problem, we were going to have to completely re-think our business model.
To sort things out, I rearranged the business into two divisions. Into one, I put an isolated product line that dominated its small market, so was not (yet) subject to pressure from imports, and thus was able to sustain high margins and good profitability. I appointed a capable young manager to run that division, and he did very well. Into the other division, I put all the troubled products, thinking we could improve their operations enough to enable us to stand up to the importers, and this one I ran myself.
What a hero I was! It took me years, during which we were living off the profits from that first division. I slashed costs. I combined factories. I slashed costs again. And again. And finally, I got it to the point where it could operate profitably on a margin of about 18% – less than half of what we had enjoyed before the import flood. It was exhausting, and certainly not much fun, but I did it: I saved my father’s business!
Then I came across a quote from Warren Buffet: “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact”. Ouch!
At about this time, I was approached by another company in our industry, a fellow I knew. His company still had good margins, because he had similar products but sold into the professional market, whereas our stuff went to the consumer market. He wanted to expand, and he was dazzled by our customer list (Wal-Mart, Sears, etc.), so he offered to buy this division I’d struggled so hard to fix. I gratefully accepted his offer, sold him that business, and watched as he tried to meld my low-margin business into his high-margin one. It was not a pretty sight, and within about three years he gave up and closed the plants he’d bought from me.
In the meantime, I turned my attention to our remaining division, the one that had carried us through this tough period and was still earning a good profit. Imagine, I thought, how much we can grow this business, now that we no longer need to use all its profits to sustain the loser! So its excellent young President and I set out to grow. We accumulated a good amount of cash over a couple of years, and started looking for other companies to buy that fit well with ours.
Pretty quickly, we found one. It had some overlap with our customer list, and some with our manufacturing skills, and the areas that didn’t overlap seemed like opportunities. We thought we’d found a very good start for our ambitious growth plan. It had some problems, but we were confident we could quickly fix them, so we bought it. We were on our way!
Oh, and by the way, it had lousy margins – almost as bad as the turkey I’d unloaded.
You can imagine what happened next: we tried to meld this low-margin business into our high-margin one, it was not a pretty sight, and within about three years we gave up and closed the plants we’d just bought.
And it was that experience that taught me (at last) the lesson that inspired the title of this essay: Margin Isn’t Enough.
What I learned was this: not only do you need to have a business with decent margins and a sustainable business model, you need to have common sense. You need to actually learn from experience (and observation), and you need to apply that learning, rather than ignore it in pursuit of some fanciful goal. Even after watching my competitor fail to make a low-margin business profitable, I thought I could do him one better in turning my own low-margin purchase around.
I once had a business school professor who referred to people who make mistakes like this as EIH – Entrepreneurs In Heat. That pretty well defines the problem. In the heat of an opportunity, we’d lost our objectivity, and it cost us dearly.
Profit margins and growth strategies are important, but at the end of the day, there’s no replacement for common sense. Even the most seasoned executives could use a reminder of that every so often.
© 2016 The MPI Group
