Is diversification right strategy for SMEs in distress?
When going gets tough, many entrepreneurs look to salvage their entrepreneurial journey and diversify to other areas. However, those in distress avoid or make such move cautiously and after meticulous planning. Otherwise, it may lead to further worsening of the situation.
A few months back, I had an opportunity to interact with an entrepreneur who has established series of educational institutions in his hometown.
Initially, he started school for primary and higher education up to Plus 12. He got CBSE accreditation. He invested a large chunk of money into the establishing infrastructure.
However, after few years, he felt that the venture is not rewarding enough to remain attracted. He decided to move up the value chain by adding diploma course and thereafter engineering colleges. Since there was good traction in many colleges, he felt that he may also get a similar response. He borrowed heavily from banks to set up the college. However, that venture also did not work as expected. The returns were below the expectation. Debt servicing became challenging.
As the going became tougher he started another line i.e., an ayurvedic college with the expectation that fortune will favour him.
However, the venture is still struggling and bank loans are restructured to save the enterprise.
Searching for sustainable business proposition after launching it!
The entrepreneur is continually diversifying the streams of learning in hope of striking gold or his sweet spot in the venture. It is not wrong for an entrepreneur to review the going and take a strategic decision to diversify the business.
Diversification is a good business development tool for entrepreneurs. As one move along the new path, they may discover new opportunities through new product lines and services, as well as entering new markets. By means of its successful transition, one can offer similar or related goods or services in the existing market; establish a reputation on similar markets with their existing products or services, or they can enter completely new markets.
The weaknesses in the strategy of diversification in the instant case are:
A) Lack of Preparedness before launching the venture at the outset
B)Adding new ventures while in financial distress due to the accumulation of debt.
In the above case, he kept adding new lines hoping to break even because he did not make money in the previous ventures. At the hindsight it shows that he was not having a clear plan, just hoping to go with the wind.
Merely creating facilities and obtaining licenses did not bring in income as he expected. Activities like education attract more demand in the short term if there is short supply; once supply catches up, then it is the core competency, competitiveness and reputation matter to attract students. However many hope for a repeat of such events and incur a lot of money to create the facility.
Lack of preparedness while launching the venture:
Every business venture should be approached strategically either at start-up stage or in growth stage or diversification etc. Those who are already into the business, they may have lesser challenges to deal with. Still, they may encounter certain new things and there will be certain in amount of learning in at any stage,
Preparedness of any successful venture exhibits robust evaluation from the dimensions of Industry, Finance, Management and Business operations.
a) Industry dimension deals with characteristics of the sector one is into. Each industry is unique in terms of opportunities and risk.
b) Management essentially deals with the managerial capabilities and competencies required to deal with business.
c) Business operations head covers the operational details, inputs and marketing by the firm.
d) Lastly, the finance covers fundraising and cash flow structure of the business, the profitability of operations etc.
Create a business plan:
The process of writing out your plans is a great way to hone your vision: what problem are you trying to solve? Whose lives are you trying to improve? What’s your realistic timeframe for launch, sales, and profitability? How are you prepared with reference to various dimensions listed above?
You don’t need a 100-page document, but your plan should be detailed enough to determine if you have a good target market and business model.
Review and Rebuild the Financial Model: Financial projections show how a business will achieve its business plan and, ultimately, its strategic goals and objectives. Financial projections reflect and quantify elements of the revised business plan and provide it with rigour by confirming that the objectives are achievable from a financial point of view and by allowing changes in the business plan and in the resource mix to bring down the margin of error.
Please read: Financial Planning for Business
Prudent planning eliminates blind spots:
When you’re not looking for an investor or bank loan, it’s tempting to skip a business plan altogether. Further, in some cases, we have observed that entrepreneurs are opting for mortgages or rental discounts to raise the fund to start a new venture or expansion/diversification.
In many cases where project loans are opted for, SMEs tend to delegate the job of preparing a business plan to outsiders and submit to the bank for a loan. They do not involve in the process.
This is an unhealthy approach and likely to end in misery. A well-researched plan may not end in success, but ill-planned approach more likely to end in disaster.
The good plan protects against any wrong strategic move and your active involvement will protect you against unholy conflicts of interest if exists.
Make a longer runway:
It’s common for new entrepreneurs to give themselves a test year or two to see what happens. If they’re not profitable in that period, they tend to feel insecure and look to diversify hoping that it will reverse the cash flow. The problem is that many businesses need more time to reach profitability. The best way is to plan beforehand and endure with till it reaches profitability as planned. Also one need to ensure that bank loan repayment is scheduled accordingly.
Those experience such challenges should review the situation, explore turnaround ways and keeping the diversification as the least preferred one. It is because diversification in difficult time may not always is a wiser strategy.
Launching a business is a risky and stress-inducing endeavour. Any delay in achieving positive cash flow likely to disturb the entrepreneur as repayment commitment will start to haunt them. In the instant case merely adding new courses did not improve the finances but deteriorates further. The best way always is to plan well before execution.