By Tom McKaskill

Principal Topic
Methodology
Results and Implications
Contact
Abstract
Introduction
Conclusion
References
Principal Topic

As part of the development of the Exit Ready Index by McKaskill, Weaver and Dickson (ICSB Conference 2003), identified informal and formal trading relationships as an attribute in the measurement of the quality of the trade sale exit strategy.

There is a small body of literature that indicates that some prior relationships may lead to acquisitions. Bleeke et al. (1995) state that ‘an alliance can be a good acquisition or divestiture vehicle if its evolution is planned’. Buckland et al., (2003, p30) noted that one of their four primary methods for achieving growth and renewal was corporate venture capital. They defined this method as ‘minority investments in a portfolio of relatively small companies for both financial and strategic gain, sometimes leading to acquisitions’. However this relationship has not been examined from the seller’s viewpoint. Specifically there is no research on whether the proactive development of a relationship by the seller with targeted prospective acquirers can assist in the creation of a trade sale event.

Methodology

Where there is not a comprehensive body of literature that sets out a useful framework for further research, some exploratory work into the field using case studies or other investigative approaches can help to uncover tentative relationships which can be later explored further using more structured research methodologies. In this paper the author uses a qualitative research approach called autoenthnography.

Autoethnography is a qualitative research method which includes within its scope both personal narrative as well as reflective enthnography. This method of investigation allows the researcher to write from their own experience. (Ellis, 2000, p741)

This method was chosen in order to bring forward personal experiences of the author in the area of exit strategies. This paper reviews the specific contribution of prior informal and formal relationships to the trade sale event based on a review of a network of related firms in the applications software sector over a period of 25 years.
Results and Implications

The study shows how informal relationships provided the starting point for many of the subsequent formal relationships. Many of these resulted in acquisitions. Sixteen acquisitions can be traced back to the involvement of several key individuals. The examination of historical events provides some support for the hypothesis that a proactive trade sale strategy can use these relationships to develop a platform for a subsequent trade sale.

Contact: Dr. Tom McKaskill, Australian Graduate School of Entrepreneurship, PO Box 218, Hawthorn, Vic 3122, Australia. Tel: +61 3 9214 8422 Fax: +61 3 9214 8381, tom@tommckaskill.com

Paper Type: Research Paper

Academic Stream: Entrepreneurship

TRADE SALE EXIT STRATEGIES – THE CONTRIBUTION OF PRIOR RELATIONSHIPS

T. McKaskill
Australian Graduate School of Entrepreneurship
Swinburne University of Technology
Cnr. Wakfield and William Streets,
Hawthorn, Melbourne, Victoria
Australia 3122

Ph: +61 (3) 9214 8422
FAX: +61 (3) 9214 8381

e-mail: tom@tommckaskill.com

ABSTRACT

TRADE SALE EXIT STRATEGIES – THE CONTRIBUTION OF PRIOR RELATIONSHIPS

As part of the development of the Exit Ready Index by McKaskill, Weaver and Dickson (ICSB Conference 2003), the authors identified informal and formal trading relationships as an attribute in the measurement of the quality of the trade sale exit strategy.

This paper reviews the specific contribution of prior informal and formal relationships to the trade sale event based on a review of a network of related firms in the applications software sector over a period of 25 years.

The study shows how informal relationships provided the starting point for many of the subsequent formal relationships. Many of these resulted in acquisitions. Sixteen acquisitions can be traced back to the involvement of several key individuals. The paper postulates that a proactive trade sale strategy can use these relationships to develop a platform for a subsequent trade sale.

Keywords: Harvesting, Exit Strategies, Trade Sales

Trade Sale Exit Startegies – The contribution of Prior Relationships

This paper examines relationships between firms that ultimately lead to acquisitions from the viewpoint of the acquired firm. There has been very little research in the area of trade sale exit strategies (McKaskill et al., 2003). In that paper, the research question posed by the authors was; What factors contribute to the seller achieving a premium on sale of their business? In that paper, the authors presented a tool for measuring the quality of an exit strategy; the Exit Ready Index. The Index was composed of a number of attributes of an Exit Strategy that had been validated with a number of venture capital firms. As part of the development of the Exit Ready Index, the authors identified informal and formal trading relationships as an attribute. This paper reviews the specific contribution of prior informal and formal relationships to the trade sale event.

Acquisitions stemming from strategic alliances are relatively common. Bleeke et al. state that ‘an alliance can be a good acquisition or divestiture vehicle if its evolution is planned’. They looked at acquisitions from the acquirer viewpoint stating that ‘an alliance may be used as a low-risk, low-cost option on a future acquisition’. At the same time, they acknowledged that ‘potential sellers should seek partners that would be the best buyers later on’. However, they warn firms looking to sell that entering into a strategic alliance may not ‘capture the full value of their business for their shareholders’ as the alliance may deter other potential buyers thus frustrating the ability of the selling firm to ‘orchestrate a bidding process to drive up the acquisition price’. They also show that this risk may be offset by building into the alliance agreement ‘explicit exit provisions that ensure a fair value in the event of a sale’. (1995)

Minority equity investments can also lead to an acquisition by the minority shareholder. This is often the motivation behind corporate venturing. Buckland et al., noted that one of their four primary methods for achieving growth and renewal was corporate venture capital. They defined this method as ‘minority investments in a portfolio of relatively small companies for both financial and strategic gain, sometimes leading to acquisitions’ (2003, P30).

A good example of a corporate venturing model is found at UPS. They state that, with their Strategic Enterprise Fund, UPS invests where “strategic investing allows UPS to collaborate with and learn from companies actively developing new businesses, market-spaces and technologies’ and “evaluating emerging industries from the inside allows us to observe new, leading edge business models and provides informal market research.” (UPS, 2004). While alliances and minority investments are formal commercial or trading relationships, this research project also set out to identify whether informal relationships were present prior to an acquisition.

THE RESEARCH APPROACH

Where there is not a comprehensive body of literature that sets out a useful framework for further research, some exploratory work into the field using case studies or other investigative approaches can help to uncover tentative relationships which can be later explored further using more structured research methodologies. In this paper the author uses a qualitative research approach called autoenthnography.

Autoethnography is a qualitative research method which includes within its scope both personal narrative as well as reflective enthnography. This method of investigation allows the researcher to write from their own experience.

“Thus, to a greater or lesser extent, researchers incorporate their own personal experiences and standpoints in their research by starting with a story about themselves, explaining their personal connection to the project, or by using personal knowledge to help them in their research process (Ellis, 2000, p741)

This method was chosen in order to bring forward personal experiences of the author in the area of exit strategies where very little research has been undertaken and where this personal experience can be used to stimulate discussion in the area and open up the field for more structured research.

Since narrative is by its nature personal reflections on historical events, reliability of data can be a problem. This can be overcome somewhat through ‘reliability checks’ (Ellis, 2000, p751). This can be achieved by having other people who were present at the historical events review the narrative or by reference to historical documents or other independent descriptions of the same events. In this paper the author has referred to such documents, including web sites and did contact several of the executives involved to verify details.

This project was intended to be exploratory in design. It reviews a network of firms that the author had been associated with. Some relationships were formal, such as through a management role, as a shareholder or through an alliance or partnership. Others involved personal connections through former work colleagues who continued to work within the sector. This personal association with all the firms over the 25 years of the review provides insights into the relationships through successive evolutions. For example, many acquisitions started as loose partnerships, evolved to formal alliances and then ended in an acquisition. The purpose of this activity was to see whether it would support the hypothesis that informal and formal relationships are closely associated with subsequent trade sales.

The research undertaken involved a review of a network of software firms involved in the development and implementation of commercial software applications. Over the period 1979 to 2004, 16 acquisitions are identified. These companies are all linked in some manner through formal trading relationships, informal contacts or intervention by venture capitalists that had a prior relationship with some of the executives.

As the personal examination of this experience unfolded, the author was able to develop a list of identified formal and informal prior relationships. Formal commercial or trading relationships are associated with formal agreements or contracts. There are a variety of ways in which formal relationships can be established. These could include:

Management and/or shareholder roles:

• Member of a Board of Advisors
• Member of the Board of Directors
• Minority shareholder
• Venture capital provider

Formal trading relationships:

• Distributor
• Alliance partner
• Joint venture partner
• Consortium bidder
• Customer
• Supplier

Informal relationships are those that link individuals or organisations in ways in which parties have some knowledge of each other as a firm or knowledge of individual executives. Such relationships could include:

Personal relationships:

• School alumni
• Community activities
• Former work colleagues
• Sporting or social activities
• Introductions by mutual acquaintances
• Venture Capital contacts

Informal business relationships:

• Common suppliers
• Trade associations
• Professionals associations
• Competitors
• Professional service provider introductions
• Sales and marketing partners

Formal relationships are generally well documented and in the public domain. Informal relationships are generally not publicised and can often only be identified through interviews with the respective parties. In the network of firms involved in this review, the author knew all the key executives and could recall most of the associations. In some cases, the key executives were contacted to establish prior relationships.
Case Study One: Pioneer Computer Systems, Distinction and Cimdec Systems

Pioneer Computer Systems (PCS) was formed in late 1979 by Dr. Tom McKaskill, his wife, Anne McKaskill and a work colleague of Tom’s, Graham Menzies. The three principles and 6 other minor external investors contributed STG 20,000 to start the company. The new venture was started in the McKaskill’s dining room with a Digital Equipment Corporation (DEC) computer, the PDP 11/03. Shortly after this, Ian Campbell, an inventory controller and New Zealander working in London, was recruited as a programmer and consultant. In 1980 PCS moved to Northampton in England and hired more staff.

In 1983, PCS decided to build an enterprise resource planning system (ERP) for the PDP computers. Anne’s father was actively involved in the computer industry in NZ in a firm called Datacom and introduced them to a 4GL (4 th generation language) supplier, NCCS, in California. The language, USER 11, was then used to build a new software ERP system, COMMAND. COMMAND was subsequently distributed by 16 software firms around the world including NCCS, and Computer Express. Both NCCS (1985) and Computer Express (1987) were later acquired by PCS.

Ian Campbell left England to return to NZ in 1983 where PCS set him up in a business called Pioneer Business Systems. At the same time Datacom were signed up as a distributor of COMMAND. Ian subsequently left PBS to join DEC in NZ. DEC NZ and DEC Australia were at the time distributors of a competing ERP system from NCA. In 1987 when DEC lost its distributorship of the NCA software, Ian Campbell suggested that DEC approach PCS for a new package to distribute.

Lindsay Rewcastle of DEC NZ was sent to San Diego to investigate a new software package that PCS were developing called PROMIX, an ERP for process manufacturing. At about the same time DEC HQ appointed Dan Sweeney to become the account manager for PCS for the process manufacturing sector. Dan Sweeney was also account manager for CSI in Kansas, a control systems integrator. CSI subsequently signed up as a PCS distributor of PROMIX.

Click here to view Figure 1

DEC NZ and DEC Australia agreed to fund part of the development of PROMIX and agreed to distribute the product in Australasia. The ERP team at DEC NZ were however made redundant in 1990 and formed CIMDEC Systems. CIMDEC took over the distributorship from DEC NZ. Lindsay Rewcastle became CEO and Ian Campbell one of the directors. Tom McKaskill became a small shareholder in CIMDEC.

From late 1989 and throughout 1990, PCS were looking for an acquirer. With disappointing valuations in the UK, they sought a potential buyer in the USA. After an extensive search they identified a software firm, ROSS Systems that was using DEC hardware and selling financial applications software. PCS approached ROSS suggesting that their product PROMIX might offer expansion for ROSS into the manufacturing sector. Subsequent to this approach, ROSS Systems ( Asia) signed up as a distributor. Six months later in September 1991, ROSS purchased PCS.

In 1993, McKaskill established a consulting branch of CIMDEC NZ in Kansas, CIMDEC USA, with two managers from CSI in Kansas who joined as founder shareholders together with CIMDEC NZ. Subsequently, in 1994, Motherwell Bridge PLC from Scotland, that already had a minority interest in CSI, acquired the CIMDEC businesses and, with other firms it owned, created Motherwell Information Systems. On leaving ROSS in early 1995, Tom McKaskill signed an agreement with a research institute in London to distribute their production scheduling software through a new venture he started called Process Logistix. McKaskill had seen this software at an APICS exhibition and encouraged ROSS to distribute it. In late 1995 McKaskill and two managers from the research institute bought out the business unit and named it Proasis Pty Ltd. Process Logistix was rolled into Distinction Software in 1997 along with Lark Software and Scope Software, two other firms started in Atlanta by the McKaskills. Distinction Software developed supply chain optimization software. The Poasis software was then distributed by Distinction Software.

One of the developers at Distinction, Russell Strachan, subsequently left to join Peoplesoft. In 1998 when SAP introduced their supply chain optimization solution, Russell Strachan approached Distinction to enquire if it would be possible for Peoplesoft to distribute their software in order to complete with SAP. This discussion quickly moved to an acquisition which was agreed in October 1998. The acquisition formally concluded in mid 1999.

The Proasis software was not required by Peoplesoft and thus the connection with Distinction was severed. However Proasis needed to replace the Distinction software components that they had been integrated to as part of their wider software solution. McKaskill introduced them to Prescient Systems, a competitor of Distinction. This subsequently resulted in an acquisition of Proasis by Prescient in August 2000 (Prescient, 2004).

Case Study Two: ROSS Systems and Datalogix

ROSS systems continued with the development of the PROMIX product, making it their flagship product and becoming a leader in the process manufacturing ERP sector. More recently they signed Chinadotcom as a distributor. Chinadotcom has subsequently made an offer to acquire ROSS. That acquisition should be completed in mid 2004.

In 1993 the President of ROSS, Richard Giordanella and the EVP of Sales, Peter Sobiloff resigned from ROSS to take up the senior positions of a competitor, Datalogix (Insight, 2004). The offer had come via a venture capital firm. Datalogix at the time was in trouble and the VC intervened to put new management in charge. Datalogix in 1994 signed a distribution agreement with Oracle. The introduction to Oracle was made through a fromer DEC executive then working at Oracle. From this initial introduction, Oracle and Datalogix started working on joint proposals. Oracle subsequently invested in Datalogix and in October 1996 acquired the firm. (Datalogix, 2004)

Peter Sobiloff left Datalogix in late 1996 and was recruited by another VC to become the President of Think Systems, a high end sales forecasting software developer. (Sobiloff, 2004). Think Systems had been working with I2 Technologies on some partnering deals prior to Peter joining Think Systems (Sobiloff, 2004). Peter had an existing personal relationship with the newly appointed CEO of I2 Technologies through his association with that individual at Oracle. Within weeks of joining Think Systems, Peter proposed that I2 Technologies acquire Think Systems. Within a few months the acquisition was completed (Think, 2004).

Click here to view Figure 2

RESEARCH RESULTS

Very few key individuals are required to link all these firms. Dr. McKaskill as Managing Director of Pioneer Computer Systems was responsible for the development of trading relationships with Computer Express, NCCS and Ross Systems ( Asia). PCS subsequently acquired NNCS and Computer Express. Ross Systems ( Asia) was acquired by ROSS Systems Inc. at the time they undertook an IPO in May 1991.

Ian Campbell, an employee of PCS from 1979 to 1993, provided the link to DEC NZ and DEC Australia which resulted in a distributor agreement being entered into between PCS and DEC NZ. This subsequently resulted in the formation of CIMDEC (NZ), CIMDEC (USA) and the ultimate sale of the CIMDEC firms to Motherwell Information Systems.

While working at ROSS Systems between 1991 and 1994, Dr. McKaskill worked closely with both Richard Giondanella and Peter Sobiloff before they left to take leading roles in Datalogix. On leaving Ross Systems in late 1994, he undertook consulting assignments with Datalogix for several years. Also while at ROSS Systems, Dr. McKaskill met Dr. Chris Taunton at an APICS conference. This relationship resulted in the buy out of Proasis from the research institute and subsequently to the sale of Proasis to a competitor, Prescient Systems.

It is clear from the case studies shown above that both informal and formal relationships contribute to an explanation of how and why the 16 firms in this study were acquired. While the reasons for the acquisitions are not a matter of public record, the author was associated with many of these and can recall the main objective.

PCS acquired NCCS to take control over the direction of the development products that NCCS owned and were used by PCS to develop their application products. PCS acquired Computer Express in order to increase the size of the business subsequent to seeking an acquirer. ROSS systems acquired ROSS Systems (Asia) as part of a prior agreement relating to the valuation of ROSS Systems ( Asia) at the time it was setup. That agreement provided for the Asian firm to be acquired when the ROSS Systems Inc. went public. ROSS Systems Inc. acquired Cardinal Data Systems and Argonaught in order to build revenue and critical mass from which to launch an IPO.

Motherwell Information Systems acquired the CIMDEC firms in a consolidation transaction designed to build sufficient critical mass to spin out the systems part of the business from Motherwell Bridge. Motherwell Information Systems subsequently went public. Proasis was sold to Prescient Systems as it could not survive as a stand alone company. Oracle acquired Datalogix to take control over a critical supplier. I2 technologies acquired Think Systems for a similar reason.

PROACTIVE TRADE SALE STRATEGIES

This examination of the author’s personal experience in the software industry provides reasonable support for the hypothesis that prior relationship can contribute to trade sale exits. It would seem apparent from this brief review that it should be much easier to set up a trade sale deal where existing relationships exist, especially if the firm has taken the trouble to meet the key representatives of the potential buyer. Within most sectors, the number of key executives is quite small and they can often be met at seminars or conferences. This applies even to competitor’s executives. Also in most industries there are people who have worked for several companies, thus the network is often well connected across companies. When they need to sell, or when they get an attractive offer, or when they wish to sell, these prior connections will help ensure the right potential buyers are brought into the sales process.

A firm can often position itself well in advance of making an approach or being approached. Executives can use their time at conferences positioning the firm in the market where competitors and other industry providers will be in the audience. They are simply letting people know about the firm and what it does well. For a presentation on the company an executive could, for example, describe their core strengths and produce an interesting case study around it. This can be presented to industry participants in the trade press or at a conference.

CONCLUSION

This study of prior informal and formal relationships in trade sales contributes to a better understanding of both trade sales strategies and acquisitions strategies. While this is a limited study, the number of acquisitions that resulted from this network is quite impressive and does show clear linkages over time. Additional networks could be studied to provide a more through understanding of the contribution of prior relationships to acquisitions.

In terms of the longer term objective of developing an understanding of proactive trade sale strategies, this study provides some useful insights into how relationships could be used to position a firm for a subsequent sale.

Future studies might examine whether formal relationships have a high conversion rate to acquisitions if the firm proactively seeks out potential buyers to develop trading relationships with. It is a ‘try before you buy’ transaction. It would seem logical that, where the buyer has more of an inside view of products and management and has a better understanding of the fit of the two firms and of the potential benefit of the acquisition, that this would improve the chance of an acquisition.

This examination also suggests that, where the seller has taken the trouble to develop multiple informal and formal relationships, that they can create’ competitive tension’ in the trade sale process. Future research might look at situations where such competitive tension was created and determine to what extent this impacted on the final sales price.

REFERENCES

Bleeke, Joel., & Ernst, David.,1995. Is your strategic alliance really a sale? Harvard Business Review, Jan./Feb 1995, Vol. 73, Issue 1.

Buckland, William., Hatcher, Andrew., & Birkinshaw, Julian., 2003. Inventuring: Why big companies must think small, McGraw Hill: London.

Datalogix, 2004. http://www.lionhrtpub.com/IM/IMsubs/IM-10-96/news.html (accessed 1/3/04)

Ellis, Carolyn and Bochner, Arthur P. “ Autoethnography, Personal Narrative, Reflexivity – Researcher as Subject” in Denzin, Norman. K., and Lincoln, Yvonna. S (Eds) , (2000) Handbook of Qualitative Research 2 nd Edition, Sage Publications Inc. Thousand Oaks CA, USA (pp 733 – 768)

Insight, 2004. http://69.20.19.254/cgi-bin/insight/team/teammembers/peter_sobiloff (accessed 1/3/04)

McKaskill, T., Weaver, K. M., & Dickson, P., 2003. Development of an exit readiness index, ICSB Conference, Belfast.

Prescient, 2004. http://www.prescientsystems.com/news/release.asp?pr_ID=19 (accessed 1/3/04)

Ross, 2003. http://www.rosssystems.com/ accessed 6 th September 2003

Sobiloff, 2004. e-mail 29/2/2004

Think, 2004. http://www.row2technologies.com/guest/aboutus/investors.jsp (accessed 1/3/04)

UPS, 2004. (http://www.ups.com/sef/sef.html) accessed 3/3/04

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Presented at the AGSE Entrepreneurship Teaching Exchange 2005
By Tom Mckaskill

Entrepreneurs who create new ventures are often mesmerised by the revenue potential of the total market and put too little effort into seizing a segment of it and protecting it. The business that can gain a strong foothold on part of a market often has the luxury of time to work out how best to grow the business. While many focus on growth strategies, the smart entrepreneurs build a wall around their business that can protect the critical mass of their business. It is from this platform that they can then plan longer term growth.

Once the survival and sustainability conditions are established the entrepreneur then should think about how best to position the firm for growth. Many owners are so focused on the next deal or short tem gains that they forget to structure their businesses for growth. Understanding the best structure at different sizes of the business can set the strategy for organisational growth.

How do you protect your current business from competitors

There are two critical factors in sustaining a business; getting the business and keeping the business. The size of the market or the growth in the market does not guarantee that you will have a share in it and your competitive advantage today may not be a competitive advantage next year. Your major threat may be that your best customers may be purchasing from your competitor next time they buy.

Most entrepreneurs understand the concepts associated with creating a competitive advantage to win the business in the first place, few however, seem to take the necessary action to protect that business from competitors. Since most resilient businesses aim to have around 50% recurring revenue from current customers, protecting that part of the business from erosion is critical to long term sustainability. This is especially important in fast paced businesses where product innovation is rapid. You need to deny your competitors access to your customer base by building a wall around the supply chain to the customer.

Competitive advantages are transient. There are numerous forces acting within markets that will undermine competitive positions. These include such factors as;

• Expiration of patents, licenses and copywrites
• New inventions which provide better, cheaper and/or more effective solutions
• New processes that increase productivity or provide new benefits
• New ways of doing business that customers prefer
• Competition arising from more open trade agreements

Thus a strong position at one point in time may be eroded either by the passage of time or by new products and/or new competitors coming into the market. Competing in the market with a constant stream of new products and penetrating new markets is hard work and fighting it out prospect by prospect puts a considerable strain on the business and it’s staff. In the absence of some overpowering long term competitive advantage that allows the business some margin for error, you are going to have to battle for each new customers.

Few businesses have the ability to sustain a superior competitive advantage which will ensure a constant stream of new customers. To survive the downturns and competitive attacks you need to build a buffer which will give you time to regroup and come back with new products and/or services. That buffer needs to be built from the existing customer base through recurring revenue, cross selling and account penetration. In order to do that, you need to protect your current customer base from erosion, even in the face of superior products or services from your competition. The task of the entrepreneur is to anticipate new competitors, better products and new business models and to create barriers to these so that the current customers either can’t move or don’t want to move to a competitor.

Many entrepreneurs think that their business is sufficiently protected by having a superior product or service or by making the product or services offering different in some way from their competitors. This is normally achieved through a combination of feature and functions which customers value or it could be through superior customer service, availability, after sales support and so on. It is highly likely that a winning combination can help secure the initial sale, however this does not stop the competitor from copying what you do, maybe doing it better, and then chipping away at your customer base.

Some entrepreneurs are mesmerised by the size of the potential market. They take comfort in the fact that there will always be new customers to sell to. They seem to think that because there are large numbers of potential customers, that they have some divine right to get their share of the potential customers as they pass by. However the rate of company failures would suggest otherwise. It is not just the competitors you can see that should give you cause for concern; it is new entrants that come into your market with a different business model that can turn an industry on its head. Your hard won competitive advantage goes out the door and your current customer base is under attack. Holding onto your current customers and protecting your recurring revenue is an imperative for survival. The firm that has not bothered to block off the competitors will be the most vulnerable to such changes.

Many entrepreneurs search for the holy grail of ‘first mover advantage’. Certainly being first to market can often provide a business with an opportunity to gain premium prices. For example; new markets can sometimes be readily harvested if the new business solves an important problem. Early demand often allows ‘cherry picking’ – taking those with the highest needs or those that are the most innovative as early customers. First mover advantages are most often associated with new inventions but can also be associated with new ways of doing business. However, there is nothing in this strategy that suggests that you can sustain the initial advantage. Once competitors imitate your product or service, they can attack your customer base.

Whether you have an overpowering competitive advantage or not, you should still implement blocking mechanisms to protect current customer business. The planning question is; “What is going to stop my competitors taking away my customers?”

You need to block competitor’s access to your supply chain

Protecting the Business

Blocking out competitors 100% is an ideal. It is unlikely that you can develop a business concept that can protect you from competitors over a very long period of time. However, having an understanding of the ultimate or ideal techniques of protection can help you to identify ways in which you can protect your business from competitors. Each link in the supply chain from component to customer provides you with opportunities to block out competitors. Any link that is blocked from competitive access might be sufficient to protect the business. Combinations of blocking techniques over several links will increase the probability of success. The objective of a blocking strategy is find ways to protect each link in the supply chain so that the competitor is denied access. Where that is not 100%, you want to make it difficult, time consuming or expensive to overcome your blocking factors thus limiting the erosion of current customers. For example, if you have an early warning of an approach to a customer, but the competitor has to do a lot of work to undermine your position, you have the opportunity of working with the customer to create further impediments.
Customer Blocking Techniques

Most firms have repeat sales to their existing customers. Once the initial sale is made you need to move immediately to closing the door behind you to your competitors. You need to construct a situation that will ensure that future purchases are sent your way and not to your competitors. If you can prevent your competitors from selling to your customers, you have effectively protected that part of your income stream from. Your objective is to lock down your customer so that they have no choice but to buy from you even when your competitor introduces a better product or service that could more effectively satisfy the customer’s needs. I am not suggesting you do anything illegal or unethical to gain the business, only that you undertake sensible and legal blocking techniques.

Clearly the most effective way to lock down the customer is through an exclusive purchase agreement. This need not be to the customer’s detriment. There are some very good reasons why the customer may allow or even encourage this arrangement

• Reduction in costs of preparing procurement agreements
• Economies of scale in ordering, freight, receiving and storage
• High learning curve costs in understanding the complexities of each organization, their ordering and fulfilment processes.
• Time and resources required in building relationships at multiple layers in each firm
• High start up costs in bringing on a new technology or process. This could involve organisational changes, data conversion and training costs.
• Committed capacity to customers business

Many companies have implemented single source procurement agreements to provide stability with their suppliers and to show that long term relationships are more important than short term cost savings. It is very common for this structure to be used to implement the exchange of intellectual property, joint design teams and sharing of cost savings.

This arrangement can be sold to the customer only if the customer can be convinced that such an exclusive agreement is in their long term interest. The customer has to be presented with a convincing argument of benefits, economies or efficiencies that would accrue to them from locking themselves into such a relationship. This is the ultimate in customer lock-in and the time taken to design products, services and relationships with this end in mind can be the key to long term protection of recurring revenue. The sales process needs to see long term protection of recurring revenue to be as important as the initial sale. Once the relationship is in place, not only will it protect repeat purchases of the same products or service but it can result in lower cost of sales for cross selling products and services.

Some corporate customers are prepared to agree long term procurement agreements in return for discounts, additional customer services or simply to keep life simple. Many corporate buyers believe in building relationships with a smaller number of suppliers in order to gain better attention from the supplier and to ultimately drive costs down and quality up through working together on procurement programs. You should try to move a preferred supplier agreement to an exclusive arrangement.

Complex products that require considerable up front installation and on-going support are also effective ways of capturing customers over a long period. The ‘switching costs’, which includes costs, time and stress of moving to another product, can often be very high, thus once sold, customers tend to stay with the initial supplier for a long time. This relationship can be used to leverage cross selling opportunities, especially where additional products can be easily integrated into systems or products already in place. Many software products fit this category.

Some products have a lock in feature due to the conditions under which they are acquired. Life insurance and health insurance, for example, can be prohibitive to change if personal circumstances change and a new policy would be difficult and/or costly to acquire. To retain the benefits, the customer has to stay with their existing policy.

While not 100% perfect, many membership programs create some form of lock in for the customer. Airline frequent flyer programs or store frequent purchaser programs attempt to create loyalty and to provide the customer with additional benefits that only accrue with frequent or volume purchases.

Arthur Leontaritis, part owner of the Basque tapas and wine bar in lower Chapel Street in Melbourne is highly enthusiastic about his loyalty program. They give one free coffee for every 6 purchased. “We have been open since September 2003 and introduced the loyalty cards about three months later” said Arthur. “The effect on the business is significant. At the time of introduction we were doing about 9-10 KG of coffee per week, now we do 15 – 20 KG. Our takings are up 4 fold.” Arthur was emphatic about the effect of the loyalty cards. “We get about 80% to 90% retention due to the program. There are a lot of good coffee houses in this street. These cards really make a difference”
Outbound Distribution Channel Blocking Techniques

Gaining control over the point of sale to the customer is an effective way of controlling the customer purchase. While the customer might have a range of choices in theory, they might be willing to limit their choice through a preference for a particular method or place of purchasing. The corporation that habitually buys office supplies from Office Works chooses only from those products stocked there and when they use a mail order catalogue, they limit their choice to the products listed. A customer that only buys groceries at the local supermarket is restricted to the product range offered. When you choose your mobile phone company you may limit which mobile phones you can use.

Gaining access to a preferred channel, or owning or controlling a preferred channel, gives you effective control over the final purchase. The question that the seller needs to ask is “Where does my customer buy?” Can you then construct a blocking strategy so that you are the product or service of choice? If you are the only product in your category at Office Works or Toys R Us, then you have greater influence over the ultimate customer purchase. Supermarkets understand this and use shelf space as a bargaining chip with their suppliers.

Internet sites which have frequent return rates provide sellers with a greater chance of selling to the loyal user. Internet portals like Yahoo or MSN can be used to offer customers limited choice. While this does not deny customers the right to go elsewhere, the purchase decision is made easier where access is already set up through a favourite portal. If you can be the only product in a category offered by such sites, you have some control over the channel to the customer.

Airline booking systems can act as channel conduits. Some customers will prefer to have all their flights managed through the one system rather than have to deal with multiple carriers themselves. Linkages through such systems to hotels and rental cars can provide the secondary service providers with advantages.

You might be able to use the synergies of an existing preferred channel to reduce costs and gain premium profits or lower your price and undercut competitors. Some firms are able to significantly reduce their costs by using distribution channels that already serve the desired customer. Thus a firm that introduces a new product to an existing distribution channel need only recoup the marginal costs of using that channel. Excess capacity in the channel can be used to cross sell additional products thus achieving deeper account penetration.
Supplier Blocking Techniques

Owning, controlling or being able to influence the availability of a limited, unique or rare input can give you effective control over the entire supply chain. Companies that have integrated backwards to own specialist components or rare commodities have greater control than their competitors who must work with less favourable inputs.

Inputs can be physical, like a commodity or a component, or it can be information or expertise. For example; specialist staff with deep expertise that are in limited supply can be an effective a blocking factor if you can develop some form of exclusive supply arrangements. Many situations require an accredited specialist or highly trained or experienced or knowledgeable expert, the firm that has long term access to them through their supplier has a sustainable advantage.

Another form of exclusivity exists where specialist stores and wholesalers have an arrangement with their suppliers where the supplier will not place another store or use another distributor in their immediate vicinity or region. This protects their immediate market and should assure them of limited competition. This is especially effective where the supplier provides brand name products that have high customer loyalty.
In Bound Distribution Channel Blocking Techniques

Another effective way of controlling the supply chain is to limit the access of other competitors to the point of supply. Owning or controlling the inbound delivery channel can provide this level of protection. The most obvious example of this type of control is unique distribution agreements with overseas suppliers. Where the distributor has an exclusive distribution agreement, they have effectively locked out their competitors. This is especially effective where the product solves a unique or difficult problem and has a high customer compelling need to buy.

A good example of this is where Australian firms have been founded on the exclusive importation rights to a new or novel product. Being first to secure the rights to the product or service is a common strategy for a start up firm. They then use this leverage to build their business. I have often said to entrepreneurs. “Go find something overseas that you can sell here and tell them that Australia only has 20 million people and it’s too small and too far away for them to bother with”. The aim is to secure a long term distribution contract that you can use to build a secure revenue stream.

Many companies have grown on the back of such initial contracts. Sometimes they have taken the risk with new brands or products. As their supplier has become more successful, so have they.
Protecting Your Product or Service

The last point of protection is with the business itself. There are two layers of protection, stopping someone coming into the industry and stopping a competitor from copying your product or service. ‘Barriers to entry’ is the common term used to describe the blocking factors that inhibit new entrants from coming into a market. Many industries have significant industry based entry barriers but, while they protect you from new competitors, they don’t protect you from the competitors that are already there.

Industry barriers are those things that build a wall around the industry that excludes potential new entrants or requires considerable cost or time to overcome. The number of ways in which this type of protection can be achieved is extensive but would include such things as:

• Licenses, accreditations, registered rights
• Regulations that limit new entrants
• High cost of set up
• Extensive network of outlets or contact points
• Deep expertise of a situation, process or market
• High economies of scale or high learning curve effects
• Ability and capacity to retaliate
• Protection through subsidies, trade barriers or quotas

If you are already in the industry, you want as many of these as possible. If you are entering a market or trying to grow the business, these can be serious impediments. They can also have negative consequences. For example; high costs of set-up might limit the number of effective competitors in a market but the same high costs may lead to intense price discounting when business levels decline. It may deter others from coming into the market but it may not be sufficient to protect the profits of those that are already there.

Many companies see their relationships with their customers as an important blocking factor to new entrants. Some firms have nothing else going for them other than strong customer loyalty, but this has been sufficient to protect their business over a long period of time. Their level of customer service, customer empathy and willingness to go the extra mile to delight their customers is their strength. You should closely examine how effective your relationships are with your customers and find out how important that is to their willingness to place future business with you.

Employees can themselves be a major competitive strength. In many businesses recruiting and retaining the best people is the key to long term success. Retaining the best people for research and development may give the firm the ability to bring great products to market quicker and cheaper than competitors. As an example; from 1985 to 1999 I was fortunate enough to have an outstanding team of software developers that moved with me from Northampton in the UK, to San Diego in California and then to Atlanta in Georgia. During that time I was involved in three separate businesses and this team came with me each time. Many people tried to recruit individual members of the team but they stayed together, not because of the salaries, but because I offered an interesting and challenging environment in which they were respected and treated well. I ended up with a real star team that was incredibly knowledgeable and productive.

However these factors merely deny easy access to the industry by outsiders, they don’t normally provide sufficient protection against close competitors. Other blocking techniques are needed to fence off your customers. Such things as;

• Patents, trademarks and copyrights
• Highly prized locations
• Well established brand
• High customer loyalty
• A way of doing business that is highly valued by your customers but is not understood by others
• Secret formulas or processes

A patent that solves a unique problem can be a powerful blocking strategy. The other techniques may be more or less effective but are not guaranteed also they may only work in some circumstances. They are however all factors that can impede the effectiveness of a competitor. The greater the time and/or cost to duplicate or overcome, the greater the level of protection.

Few of these barriers are however permanent or 100% effective. Many people believe that patents and other registered intellectual property rights provide the ultimate protection. In truth, these rights are only effective if you have the money to defend them. Many patent holders have been worn down by the time, stress and expense of litigation. A large corporation simply might be willing to take the risk of an infringement suit or be willing to spend a large amount of resources finding a way around the patent.

Integrated Solutions

Few companies can achieve long term sustainability without re-inventing themselves and developing new innovative products or services. In the short to medium term, the best approach is to develop a combination of strategy, protection and employee and customer relationships that can best meet the business needs. Implementing an integrated solution of blocking techniques or factors across the entire supply chain will be the strongest mechanism you can have to ensure protection of future revenue from existing customers. One hundred percent protection is an ideal but that should not stop you from implementing a range of blocking techniques to give you the strongest position.

Competitive advantage simply gets you into the game; protecting your existing customer base can help ensure survival and growth. The business needs to look at more than its competitive advantage to find long term profitability. Each element of the supply chain should be examined for mechanisms which can protect the business. At the same time the impact of building great relationships with customers, employees and suppliers should not be underestimated as a form of competitor blocking. In the long run, those that have the most effective blocking techniques are more likely to be more successful.
Scalability

The business you have today will not look like the business you have when you have 5 times the number of employees and/or 5 times the revenue. It is almost inevitable that you are going to have to change the way you do business to manage the increased complexity of a larger business. Don’t put your business at risk by discovering as you go along. Plan what the business will look like in the future and work backwards to the business you have today. Now build the right foundation for that growth You will be surprised at what you discover about yourself, your structure and even your marketplace.

Entrepreneurs who have grown a business from a start-up will tell you of the transitions that they had to go through as the business grew. I discovered major transition points in my own businesses at 12, 50 and 100 staff. One business also went through a major organisational crisis when it undertook an acquisition 12,000 kilometres away. Many of the problems associated with growing the business could have been predicted if our management team had only undertaken a simple scalability exercise. What would the business have looked like at different stages of growth?

There have been several well accepted theories defining the organisational changes that occur with different stages of growth of the new firm. Larry Greiner published an article in the Harvard Business Review in 1972 entitled ‘Evolution and Revolution as Organisations Grow’. Neil Churchill and Virginia Lewis developed this further into a 1983 article entitled ‘The Five Stages of Small Business Growth’ also published in the Harvard Business Review. Mel Scott and Richard Bruce looked at growth crisis points in their article entitled ‘The five Stages of Growth in Small Business’ published in Long Range Planning in June 1987.

These models all show that significant changes will occur within the business as growth occurs. The major complexity factors are numbers of staff, numbers of customers, numbers of products and numbers of locations. In order to achieve 5 times the level of business you have right now, most of these parameters will change. What is not so obvious to most entrepreneurs is that the business will need to be managed differently with each additional level of complexity. You can thus learn a lot about what your business will need to do by setting out what the business should look like at each level of complexity.

Almost without exception, small businesses face a crisis of management as they grow. The entrepreneur in the early days is able to drive the business through sheer energy, passion and vision. He or she knows everyone and staff are motivated because they are part of the grand adventure. As the firm adds staff, new people come into the business who were not part of the grand vision and their motivations and needs are likely to be different. They may see it more as a job that a mission. They have different needs and thus management styles have to change. At the same time, the growth brings with it specialisation of tasks and more formal organisational structures. Reporting lines become clearer, job descriptions become the norm rather than the exception and performance targets and monitoring is introduced. Soon there is a new layer of management between the CEO and the operations. What was a project has now turned into a business.

As the business grows further, communication becomes increasing formalised as communication lines become longer. The left hand no longer knows what the right hand is doing. Customer service quality falls as new customers don’t have the advantage of personal links with the founders. Problems escalate with the second location and now daily face to face communication is not physically possible. External shareholders and/or external Directors force more transparent decision making and thus the entrepreneur can no longer make decisions on the fly. Larger numbers of staff, customers and other stakeholders now depend on the business for their livelihood. Many entrepreneurs simply are not able to make the transition or don’t want to.

There are important strategic insights that can be gained from undertaking a scalability exercise. It is almost certain that you will discover that you have the wrong organisation structure and the wrong IT systems to support a larger business. What can be more surprising is that you will also discover that some of your best staff are unlikely to make the transition. They may lack the skill, personality, work ethic, or experience to work effectively in a more complex situation. This is very confronting but it is better to discover it early than have the disruption of having to replace loyal staff when it is really too late. With time on your side, you can undertake retraining, change job responsibilities or transition them out of the business.

Look at what will constrain your business as it grows? Are there things you can do now to overcome those? Can you change the structure of the firm now so that the transitions are easier to manage? Don’t let hope be your strategic plan. Sit down and work out what you have to do to grow and how you are going to proactively manage the process.
Tom McKaskill
20/12/04

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