The company is an acknowledged expert in its field, as demonstrated by the bluest of blue chip customers.
Despite this pedigree, profits were negligible. The company supplies and manufactures parts to enable a continuous production process in the food industry. In particular, it distributes a machine that is very reliable. When I asked the management team if they supplied a support contract for this machine, there came a resounding ‘No!’
‘The machine never breaks down,’ they told me. ‘So why would a customer take out a support contract?’
Undeterred, I probed further. ‘Do you know how well the machines are optimised?’
Silent faces looked back at me.
You see, there was a market to sell a service here – not on servicing the machine itself, but on tuning the equipment to optimise a customer’s product line. And – surprise, surprise – there was some software available that could remotely monitor its performance over the internet.
We devised a service based on four visits a year using the software diagnostics and our in-house consulting expertise to carry out the tweaks that were needed to optimise production. In an instant, we had a new and highly profitable source of predictable revenue from an existing product.
Predictability of revenues is becoming more important, which is why I like software as a service (known as SaaS). It has many advantages, such as a low upfront cost for customers as opposed to outright expensive licence sales, easy set-up as the software is hosted remotely and of course, the ability to sign customers up for extended periods. Funnily enough, the SaaS model has not caught on as fast as many thought it would, but I expect to see massive demand for it in the years to come.
I like companies that have a large customer base – we are talking business to business here, rather than direct to consumer. If you have a large client base you can always find something else to sell to them. Of course hunting down new clients is still important, but it’s a well known fact that devising new products and services to sell to your existing customers consistently accounts for the most profitable portion of most companies’ revenues.
Moreover, I like uncomplicated businesses with a strong market presence in niche areas. By uncomplicated, I mean a simple business model that does not have a high burden of administrative overhead. A complicated model might include lots of small invoices (a pain to collect and process), a convoluted pricing and discount system, or having a complex commission structure in place.
Niche markets are also good news. For a start, there is less competition from major players who can outspend you in all areas, but also your cost of marketing and sales is substantially reduced. You can also focus your research and development spending on a specific killer product rather than generic, all-embracing applications.
Good businesses often have transparent reporting structures, where the checks and balances between management and shareholders are properly defined. Bear in mind that one-on-one reporting structures are wasteful and don’t work, and any MD who has more than seven people reporting to him cannot delegate properly.
Last of all, I favour companies with no funny accounting policies, where what you see is what you get. As legendary fund manager Anthony Bolton is fond of saying, ‘follow the cash’ – or, to you and me, profits should equal cash generated and if they don’t you need to know why.
