Look for recurring revenue

Long term customer contracts can guarantee certain levels of revenue for years into the future.  This can provide a degree of stability in financial results.

Know the business. Understand the business model.

Understand the business model is important as this will provide insight as to the kind of financial results the company may produce.

Look at the big picture when Investing

How does the company fit into the economy; and is there a need for the company’s products or services.

Look at the company’s business model (found in the company’s SEC form 10k) and determine if it coincides with your thinking, your goals and your investment objectives.

STRATEGY & INNOVATION May 26, 2010, 4:40PM EST

How to Succeed at M&A

All too often, mergers and acquisitions fail dismally. That, says Innosight's Mark Johnson, is because executives don't understand what they're really buying

By Mark W. Johnson

Companies constantly seek new growth opportunities, but organic new growth is far from a sure bet. While business model innovation is a powerful path to sustained, robust growth, new businesses can take years to mature. The skills needed to conceive and incubate them present a unique set of challenges that many companies find difficult to overcome. "A large enterprise has trouble making an investment in innovation," says Brad Anderson, the recently retired CEO of electronics retailer Best Buy (BBY). "It's in part because Wall Street has trouble imagining a new way to operate but, more important, because people inside the company can't see the value of a new idea and so won't allocate the resources and support the new initiative needs to succeed."

But organic growth is not the only option available to companies seeking transformational growth. Though most of my book Seizing the White Space: Business Model Innovation for Growth and Renewal is dedicated to developing new business models within incumbent organizations, I don't mean to imply that incumbent companies shouldn't seek to achieve transformative growth and exploit opportunities in their white space through mergers and acquisitions—they should. Building models in-house is not the only option for companies seeking transformational growth. Corporations can transform their business models through acquisitions as well. When Anderson took over Best Buy, in fact, he led the company through a series of strategic acquisitions that helped it grow beyond a pure retail sales model.

But it's no news to point out that acquisitions, at the best of times, are tricky. Study after study finds that acquisitions tend to disappoint, variously estimating that half to as many as 80 percent fail to create value. The high-profile struggle of AOL (AOL) after its $180 billion acquisition of Time Warner (TWC) is one obvious example of an acquisition gone bad. But there are others: Daimler/Chrysler, Sprint/Nextel, and Quaker Oats/Snapple, to name only a few. Quaker Oats paid $1.7 billion for the Snapple brand in 1994 but sold it to Triarc three years later for a mere $300 million.

BUSINESS MODEL DEVELOPMENT

I believe many M&A disappointments stem from a failure to understand the fundamentals of business model development. When one company buys another, what it's really purchasing is the target company's business model—its customer value proposition, its profit formula, its resources, and its processes. The new company's resources can be folded into the core of the acquiring company, but new business models resist such integration. Consequently, successful acquisitions tend to fall into one of two camps. 

• An acquirer can buy a company solely for its resources, which it would then fold into its own business model, while jettisoning the rest. The bulk of Cisco's (CSCO) acquisitions follow that pattern. 
• Alternatively, a company can seek to acquire another company's business model, which it then needs to keep separate, but can strengthen by injecting into it its own resources. That's what Best Buy did with Geek Squad.

Johnson & Johnson (JNJ) has understood this, buying business models at an early stage and then keeping them separate. For example, its Medical Devices & Diagnostics (MD&D) division bought three business models that were fundamentally new to its respective markets: Vistakon (disposable contact lenses), LifeScan (at-home diabetes monitoring), and Cordis (artery stents used in angioplasty procedures). J&J bought these companies young and incubated them into the larger enterprise, where they became the growth engine of the MD&D division for many years.

All too often, attempts to fold an acquired business into the core can kill what made it unique in the first place. Video game maker Electronic Arts (ERTS) learned this the hard way. Propelled by investor expectations, rising development costs, and an industry consolidation trend, EA aggressively bought up small companies led by creative teams that had found success in the market. To profit from anticipated economies of scale, it built up a standardized technical infrastructure and imposed streamlined production processes on its new acquisitions.

The results were abysmal. EA fell into a pattern of producing mediocre products based on movie licenses and sports franchises, which were updated each year. Forcing creative teams to follow core processes was killing their innovative spirit. Luckily, CEO John Riccitiello saw the writing on the wall and announced a sea change in EA's operations: Independent creative studios would operate as "city-states" within the EA corporate structure.

ACQUIRED MODEL TAKES WHAT IT NEEDS

Most of the principles that govern the incubation, acceleration, and transition of homegrown new business models apply to acquired ones as well. Equally important is leadership's ability to allow a newly acquired business model to pull what it needs from the core, rather than having elements of the core model pushed onto it. Best Buy's Brad Anderson expressed this idea succinctly when, referring to the Geek Squad deal, he said, "Geek Squad bought Best Buy, not the other way around."

Anderson knew that the new model would produce growth and transformation for the company, but he also knew that the low-margin, high-volume, retail mentality of Best Buy could easily suffocate the high-touch, high-margin service orientation of Geek Squad. He let Geek Squad pull from Best Buy what it needed to thrive. At the time of acquisition, Geek Squad had 60 employees and was booking $3 million in annual revenue. Today, working out of 700 Best Buy locations across North America, Geek Squad's 12,000 service agents clock nearly $1 billion in services and return some $280 million to the retailer's bottom line.

As Vijay Govindarajan and Chris Trimble noted in Ten Rules for Strategic Innovators, a newly acquired business based on a model distinct from the core should decide what it can borrow from the parent, what it should forget (or forget about), and what it will do or learn that is completely new. The key to understanding what to forget and what to learn lies in the business model. You must understand both your own business model and the new company's model completely, so you won't throw away the most valuable thing you bought—the very thing that will help your company grow.

Mark W. Johnson is Chairman and Co-Founder of innovation consulting and research firm, Innosight. He is the author ofSeizing the White Space: Business Model Innovation for Transformative Growth and Renewal, (Harvard Business Press, February 2010) and a co-author of The Innovator's Guide to Growth (Harvard Business Press, July 2008).

http://www.businessweek.com/innovate/content/may2010/id20100525_156769.htm

****Best Businesses to Start or Buy: Recurring Revenue Business Models

Best Businesses to Start or Buy


Recurring Revenue Business Models
Starting a business? Buying a business? If so, there's one question that you absolutely must ask. Does your new venture have a recurring revenue business model? If not, you might want to go back to the drawing board and look at other options.

The best businesses to own are recurring revenue businesses.
(article continues below)

If you are a new entrepreneur or are searching for a business to start or buy, you might overlook this simple fact. If so, you are making a huge mistake.

To make the most money as a business owner, you want a business model that has built-in recurring revenues.

Examples of Recurring Revenue Business Models

Here are a couple of examples of recurring revenue businesses.

One friend of mine sells telecommunications services. In short, his company sells bandwidth to companies. The offerings include T1 lines, T3 lines, OC3 lines, OC12 lines and other internet access and point to point telecom offerings.

His business is a reseller of telecom services from big companies like AT&T and MCI. He doesn't have the massive overhead that those companies have. He just sells their services and offers a small amount of first-call support services.

The business has recurring revenues because whenever he sells, say, a T1 line, my friend gets a commission on every single payment the buyer makes. In other words, it's not a one-time fee. Rather, it's an annuity. As long as the customer keeps that T1, even if it's for 10 years, my friend is making money. He only had to sell the deal once, the customer typically renews every year, and he just watches as MCI and AT&T transfer money into his bank account.

That's the beauty of a recurring revenue business. In essence, you earn money now for work you did in the past.

Here's another one. Another business acquaintance of mine sells health insurance to companies. At any given time, he has maybe 50 companies with an average of 40 employees each. I'm not sure exactly what an average health premium is for his clients but let's guess that it's $500 per month. For having sold the health insurance plan, he gets 4% of every premium payment made to the health insurance company.

So, do the math. He's making 50 X 40 X $500 x 12 X .04 per year. That works out to top line revenues of $480,000. Not bad.

He has one employee on staff…a troubleshooter who handles those situations when an employee of one his clients runs into an issue with a health insurance claim. He also has rent expenses on a small office. All in, I'm guessing he's pulling in $300,000 net before taxes worst case.

If he left the country for a year to take a long vacation, he might lose a few clients. But his able assistant could handle most of the service issues. He'd still be receiving revenues in the form of commission payments. In other words, he'd be benefiting from the recurring revenues related to work he did years ago.

Alternatives to Recurring Revenue Business Models

The mistake that many new entrepreneurs make is that they don't figure out how to build a recurring revenue business.

Instead, they earn only as much money as they deserve based on very recent efforts.

This is the taxi company business model. You get a fare, drive them, and get paid. Now, to make more money, you need to find a new fare.

There are no rewards for what you do long ago. There's no cumulative building up of revenues. It is always "What have you done for me lately?" from customers. No new sale, no new revenues.

Entrepreneurs on this track are on a treadmill. If they get off the treadmill, they stop making money.

Always Look for Recurring Revenues

The key takeaway from this article is that owning a business is not a generic concept. Every business out there has different dynamics to it, which in aggregate amount to a business model.

Some business models are better than others. As an entrepreneur, you need to evaluate the business models that are available to you and choose the most profitable…offering the maximum reward for the minimum effort and risk.

Take our word for it. The best business to buy or start will be one that has recurring revenues built into the business model. Without that, you can do OK but you will always be on the treadmill. In that case, the business owns you instead of visa versa.

Related Articles

Want to learn more about this topic? If so, you will enjoy these articles:

Evaluting Business Models When Buying a Business


http://www.gaebler.com/Recurring-Revenue-Business-Models.htm