Pushing the Performance Edge of Your Business Model

By Michael Kanazawa, Guest Author

Many companies play it too safe within the confines of their business model. That’s a fancy way for saying they often accept too little in terms of pricing and don’t fully leverage their purchasing power. For private equity investors, one driver of finding new value in existing companies is to push the performance edges of the business model to test the limits. How can you avoid playing it too safe and maximize your potential business model profits?

Back in college I sailed 12 foot racing boats with the sailing club. The instructor/coach, E.W., rode around in a Boston whaler motor boat, had a megaphone and wore a huge cowboy hat. After capsizing outside of the breakwaters on a very stormy day, E.W. pulled up along side of our boat as we re-entered the harbor and yelled through his bull horn, “how was it out there boys?” We yelled back, “not too good, we dumped it over out there.” E.W. quickly shot back, “That’s great! Now you guys are the only ones on the team who know just how far you can push the performance edge in this type of weather before you actually tip over. Good going!”

One of the stories by private equity investor Bill Hopkins in our book BIG Ideas to BIG Results captures a great example of how a company can generate huge profit gains by pushing the limits of it’s business model.

According to Bill Hopkins, “Private equity investors are often much more willing to push things to the edge to find the performance limits of a business than existing owners, which is another reason private investors can find new value in old companies. They typically are more willing to encourage management to take the risk of testing traditional limits.” One business model shift in the highly commoditized business of renting construction equipment illustrates the edge well. The CEO and private investors believed that prices were too low.

Management knew that the company was in a cyclical, commodity business and had been driving toward raising rates that brought it back to the levels of prior peaks. Some operating managers were concerned that increasing prices any further would start to drive down utilization rates, leaving equipment unrented. The CEO and investors felt that the market was too tight with supply and the building markets were coming back quickly—leading to even more opportunities for pricing improvements than had been historically available.

To test the limits, management agreed to set a floor in pricing that none of their local outlets could go below. To drive alignment, incentives in the field were reworked to encourage optimizing earnings rather than just high levels of utilization of the equipment. It was concerning to hold firm on higher prices based on a belief that competitors would undercut pricing. However, the market was strong enough that the rental companies who jumped at the low prices sold out their inventory quickly, whereas our sample company waited and was able to sell through its inventory later, but at a 20% to 25% price premium that all went straight to the bottom line. That is how you test the edge. It takes a strong stomach to take the risk; but if you don’t risk going over the edge once in a while, you’ll never know what is possible.

Tips for pushing the performance limits of your business model:

– Identify any potential areas where pricing may be soft or negotiations with vendors may be underleveraged.

– Manage controlled tests of deliberate changes to the business model to see how the market responds.

– Change incentive structures to protect those who take a risk and reward those who help find the performance edge.