A Project Is Expected To Produce Cash Flows Of Integrative Business Planning – A Case Study On Insufficient Planning

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Integrative Business Planning – A Case Study On Insufficient Planning

introduction

Entrepreneurs always do some form of business planning before starting a new venture. Often this will result in a formal business plan. Format may be determined by one of the following:

  • business planning software package;
  • Guidebook to Business Planning;
  • Another business plan;
  • External consultants.

Although all of the above can yield satisfactory results, they all have potential drawbacks. A critical problem (when using one of the first three methods) is the way the entrepreneur handles the problem. Although all methods provide for addressing clear salient features and interdependencies among them, they cannot address all the complexities and multi-directional relationships between different business features.

Even outsourcing the entire business planning process to a consultant does not solve all problems. The consultant has to work in real interaction with the entrepreneurs.

For more than a decade Ventex Corporation has advised and assisted companies from business planning to harvest and beyond. This case study highlights the importance of a well thought out and implemented integrated business planning process. This shows how small problems that are overlooked in the planning process can have serious consequences for entrepreneurs.

Salient features of an integrated business planning process

The first aspect of integrated business planning is to ensure that all key features are met. These characteristics can vary greatly from one profession to another. Some of the more common features are:

  • Business – Opportunities, business concepts, products and services and growth strategies.
  • Marketing – Marketing strategy (price, promotion, etc.).
  • Market Research – Customers, market size, trends and competition.
  • development – New products, services, markets and facilities.
  • Operations – All aspects.
  • team – Management team, required skills, training, board structure and composition.
  • financial – Investment-, financing- and dividend decisions and policies. Also cash flow, profit margin, costs and growth.
  • Risk Management – Business-, operational- and financial risks as well as potentially fatal defects.

Remember multi-directional relationships in business planning

Unfortunately salient features cannot be seen in isolation. Each feature influences various other features and is also influenced by many other features. These multi-directional relationships are found within each individual broad specialty (e.g., finance) as well as across specialties (e.g., between finance and marketing).

A higher profit margin may for example reduce sales volume, but increase net profit. On the other hand, higher volumes (with lower gross margins) may increase sales volume, but decrease profits.

On the other hand, excessive production can increase stress factors among employees (who are already working at maximum human capacity), leading to high absenteeism, low productivity levels, overhead costs, and reduced profitability. Unfortunately this complexity cannot be ignored and an integrated approach to business planning is a long way off.

Examples of things that are wrong

Ultimate Holidays was a very ambitious business concept in the tourism industry. The industry was booming at the time and he elaborated plans to build a luxury lodge combining health hydro, hotel school, conference facilities, adventure center and eco-cultural tourism. (Details have been changed for confidentiality purposes – however, all details simulate real-life situations sufficient to demonstrate real learning). Entrepreneurs’ experiences include business, entrepreneurship, tourism, archaeology, law and politics. The nearly $320 million project was a lifelong passion for all of them. They cover architectural designs, legal requirements, development and operational planning issues, marketing plans and employee development strategies in depth. He also ensured that he had senior politicians and excellent service providers.

But the business never took off. What have experienced entrepreneurs not seen? What could they have done differently? They felt that they covered various aspects of the business. Analyzing the facts, the following major issues emerged:

  • Entrepreneurs were not flexible – they had strong preconceived notions;
  • No detailed market research has been done. Not specifically on industry specific occupancy rates and critical investment criteria that investors are looking for;
  • All planning was done on individual aspects which were optimized as much as possible. How these factors might have affected other factors was not considered.

Entrepreneurs were very proud. He believed that any entrepreneur would be foolish not to invest and would typically say that he just wanted investors who shared his dream and that the financial situation would sort itself out.

The business plan promises a “conservative” 22% internal rate of return (IRR) over a seven-year period. This included the expected capital growth of the facility. The expected occupancy rate was given as 50% in year one, which increased to over 75% in year four. IRR and occupancy rates were initially very low and were based entirely on thumb-sucks. Entrepreneurs then chance the statistics to make financial sense only without making any changes to other relevant factors.

Investors are often very excited about the concept, until they realize that occupancy rates are inflated. Actual figures based on realistic values ​​show an IRR of only 15% – at least five percentage points lower than what investors expect. The financial risk was too high. Moreover, there was a breach of trust. It was an insurmountable problem from the entrepreneurs’ point of view – they wanted it their way. In the end no one invested. Much effort was made and the personal costs skyrocketed. High visibility was also created in the business and tourism industry. In the end some entrepreneurs are financially (and emotionally) devastated and all lose credibility.

The key questions in hindsight are: Could the entrepreneur save the project? Would they have included all the features and really expected an IRR greater than 20%?

If entrepreneurs had used an integrated business planning process, they would have made sure to examine all the salient features first. Second, they would have ensured that all multi-directional relationships (causality) between the various traits were balanced.

By mapping the relationship between various salient features it has been shown that:

  • Occupancy rates are driven by service levels, product offerings, marketing and pricing.
  • Occupancy rates on the other hand can affect turnover, profitability and marketing (through word of mouth).
  • Turnover (by residents and outside guests), business and cost of doing business (cost of sales and other expenses) results in profit.
  • Profitability on the other hand has a direct impact on IRR, cash flow and sustainable growth of the business.

Only a very small portion of the multi-directional relationships that exist within and between the various salient features are shown above.

Entrepreneurs should ask more in-depth “what-if” type questions. They can start with questions such as: What will happen to the occupancy rate if the price per night increases by 10%? What would happen if different aspects of the business were taken step by step? Will it be possible to cut marketing costs and increase occupancy rates? The last question usually sounds like an oxymoron. This is part of integrated business planning – looking at two opposites and trying to find a solution that provides both aspects. In practice this can be achieved by using more free advertising in newspapers, internet articles and blogs and working directly with tourism organizations in the region.

A major aspect (constraint) of this whole new venture is the high capital outlay. By focusing on this salient feature it has been shown that costs can be significantly reduced without any detrimental effect on occupancy rates. The use of light steel frame construction instead of ordinary bricks would have resulted in huge savings. Construction time could have been halved saving labor and interim interest. Longer distances would have greatly reduced transport costs (light steel frames are much lighter than bricks). Additional savings are also possible due to other construction advantages and different finishes. No negative effects were observed.

Health Hydro’s building costs were 50% of the main complex, but projected figures showed it would generate only 33% of the main complex’s turnover (with a much lower gross profit margin). This component can be built in stages when the complex is already in full production and the potential occupancy and profit is high.

A business analysis showed that by changing only these two factors (construction method and phased hydro) and using a realistic occupancy rate, the expected IRR would exceed 21%. Further measures would have been taken to reduce the cost of capital and this could have further increased the IRR. The cost of high street construction (up to the complex) could possibly be shared with the government and other potential developers (eg a shopping complex or a nearby time-share game farm).

Summary

Ignoring some salient features or failing to recognize and plan for an important kill can create problems or even be fatal for a new business. It is necessary to cover all the salient features and at the same time balance the multi-directional relationship between them. One aspect of business cannot be favored to the detriment of some of the others. Finding the optimal balance for the entire company requires an integrated business planning approach.

Copyright © 2008 – Wim Venter

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