Archive for the 'Franchise Fortification' Category

Sustainable competitive advantage (or franchise in Buffett lingo) is essential in creating long term value for shareholders.  Developing a thorough, honest, and appropriate understanding of a company’s franchise is essential.  Ensuring franchise is clearly communicated throughout the enterprise is essential.  What follows is this:  the strategic focus of all companies needs to be on how to strengthen its franchise.   Strategy is all about determining how best to fortify the franchise.

VC-backed start-ups are typically good at this. Their resources are entirely focused on “what unique competitive position do we think we can create for ourselves?”. The question is grounded in the company’s brief and clear history–to get funded, the company almost certainly had a well-thought out answer to “what is unique about us”.  Since the upstart is toddler-age, the strategic premise is both backwards-looking (what do we already have that is unique?) and forward looking (what execution is required to parlay this uniqueness into long term value creation?). A capable venture capitalist ensures the start-up stays narrowly focused on these two questions.

Larger companies can lose their way.  The meandering might be due to a misconception of what the nature of their franchise really is (and isn’t).  The other culprit is strategy straying away from franchise fortification and toward new endeavors.

“Our franchise isn’t as strong as it needs to be. Our strategic priority must be on making in stronger.”  How many times have you heard an executive say these words?  More times than not, especially in a developing industry like telecom and Interent, this should be the overarching mindset.  Instead, many companies spend their scarce strategy cycles on exciting new areas.  This results in the enterprise’s resources being directed to distractions (relative to the priority of ensuring the franchise is sufficiently strong).  Shiny new objects such as new features, fancy products, geographic expansions, or entirely new lines of business take center stage.

Companies sometimes are too casual in describing the nature of their advantage.  Let’s consider a company that convinces itself: “Our advantage is that we are great at sales”.  Many telecom companies, including a large one that I took private in 2004, developed this notion. “The network is a commodity, but we are successful because of the relationships we have with our customers.” Well, if this is believed, it follows that a company can sell most any product in most any geography.  It suggests the act of hiring more sales people is the key to earning unfair returns.  The fiber network is of limited relevance.

Many telecom companies marched down this path. Not only did they waste a lot of other people’s money, they also missed the opportunity to use their precious resources to strengthen their competitive position. The telecom meltdown provided a nasty and hasty correction. When left with no choice but to retreat to their “franchise”, most companies realized it wasn’t sufficiently strong to support the collapse of everything else.

Companies with strong franchises can branch off into new areas. However, the question of franchise strengthening should remain at the core of expansion decisions. The first set of questions pertain to readiness for branching out:

  • Do we have a sufficient understanding of our existing franchise?
  • Are we applying appropriate resource to fortify the franchise?
  • Do we have sufficient capacity to branch off without distracting from fortifying our existing franchise?
The next set of questions address the merits of specific initiatives:
  • Does our existing franchise make it materially more likely we will be successful at the extension?
  • If we are successful, does the initiative materially help fortify our current franchise?
  • For the new initiative, what franchise must we successfully develop to achieve a sustainable advantage?
  • Is it reasonable to expect that successful development of franchise can be achieved?
A for-profit business’ goal is to create an extraordinary return for its stakeholders.  Having a franchise is a must.  Understanding the franchise requires work.  Fortifying the franchise is the first priority of strategy and resource allocation.

 


I led a buyout of ICG in 2004.  We raised $8.7M from two investors.  Two years later, investors and management exited for more than $225M, which is  26X return on investment.  Not too shabby.

As you can imagine, I am often asked how.  A number of factors contributed, though my focus here is narrow.  ICG, circa 2004, was an example (among many) of a company that misunderstood its franchise.  Their franchise was deep fiber networks in certain geographies of the country. In a world where companies and individuals of all types need more bandwidth, deep fiber in select metros is a meaningful franchise.  In ICG’s case, the Colorado network, in particular, was special.  It was the most extensive network in the front range.  Moreover, the Colorado business community is skewed toward companies that need lots of bandwidth.  If you had to pick a region to have a robust and unique fiber network, Colorado would be a good choice.  ICG had several other juicy metro fiber networks as well.  Though these franchises were exploitable, they were in desperate need of fortification.   Fortunately for my team, management’s attention, and purse book, was elsewhere.

ICG’s management convinced themselves that the real opportunity was the small and medium enterprise market. Further, a well oiled sales engine (not a deep fiber network) was the most important capability needed to exploit this market.  First alarm bell: a robust sales engine doesn’t sound like much of a differentiator.  In ICG executives’ mind, this was good because they saw sales as a strong competency of theirs (circular logic perhaps?).  However, to be safe, they decided to be a pioneer in an advanced area of VoIP called Hosted PBX.  The combination of a robust sales engine and a leading edge product would become their franchise.  Note that fiber networks play a minimal role in VoIP.

To recap the strategic thinking: (1) Fiber doesn’t matter because the VoIP opportunity is with smaller enterprises; (2) Sales is the company’s competency; (3) The company will be a pioneer at VoIP; (4) VoIP success will be achieved because of an unmatched ability to sell.  This led to the following conclusions.  New York, Boston, and Chicago (where ICG didn’t have fiber networks) should be the focus, as there are more prospective customers than in ICG’s fiber markets.   The more sales people they’d hire, the more value they’d create.  This led to adding a lot of sales people, and a lot of cash burn.   Finally, the most valued technical resources were concentrated on VoIP (instead of fiber), with the hope that technical innovation would differentiate their VoIP product.  Resources that might be spent fortifying their already unique fiber properties were directed elsewhere.

When we assumed control of ICG, we aggressively scaled back activities in non-fiber markets.  Further, in the fiber markets, activities shifted to core bandwidth products–which directly exploit fiber.   VoIP was de-emphasized.  In a short period of time, we became a growing company with a solid EBITDA margin.  We had ample capital to further fortify our already strong fiber networks.  Moreover, we were generating free cash flow.   Less than two years into it, we exited with $225M in our pockets.

Those outside of telecom will probably chuckle and assume this story is unique to ICG.  They might wonder if I am embellishing (no!) or oversimplifying (a little).  Self-reflecting souls who were in the middle of the great telecom boom and bust will react differently.   They will cringe as they reflect on similar situations that hit a bit close to home.  For those still in telecom, the real question is how this reflect son your company’s existing strategic activities.  Does your company understand its franchise?  Is it focusing its resources on exploiting and enhancing its franchise?  Or is it getting distracted or diluted?


Franchise fortification is the focal point of strategic decisions and resource allocation.  Microsoft Office strikes me as a great positive example.  DOS/Windows was Microsoft’s franchise, and for decades they applied their resources on the protection of this franchise.  Microsoft Office was one of their major business expansions.  At the time of Office’s emergence, Lotus 123 was the dominent spreadsheet application and Wordperfect led word processing platforms.

DOS/Windows provided Microsoft with a competitive edge that could be leveraged in its Office aspiration, allowing Microsoft to overcome the headstart of 123 and Wordperfect.  Moreover, success would further strengthen its DOS/Windows franchise, as the prevalence of Office makes DOS/Windows platform harder to displace.  A sustainable advantage of Office was its preferential access to future DOS/Windows development.  The result: Office wins. 123 and Wordperfect lose.  Bill Gates becomes the world’s richest person.  Microsoft is sued for engaging in monopoly practices.

Microsoft successfully exploited and fortified its franchise.