Posted by Dan Caruso
May 19, 2008
Ike has had several posts recently on Vonage. Mr. Blog (a blog new to me) challenged Ike’s assertion that Vonage needs to ramp up marketing spend. Today, Ike responded to Mr. Blog (http://ikeelliott.typepad.com/telecosm/2008/05/vonage-needs-a.html).
I agree with Mr. Blog’s point that ramping advertising is likely throwing good money after bad. I also agree with Ike’s post today–Mr. Blog’s conclusion suggests that Vonage needs to answer the ”then what do we do?” question.
Many companies make a huge mistake when they get into a situation where their main business thrust proves to be flawed. These companies (assuming they have access to some cash) frantically ramp up spending in hopes an answer will emerge. They panic. They need an answer so bad that they hang their hopes on a questionable one because having none at all is far more frustrating.
In the end, they usually make the situation worse. They consume their most valuable asset–cash–on activities that are unlikely to put a dent on the main problem. They seal their own fate.
ICG was definitely in this mode when we bought them in 2004. It is part of what made our turn-around plausible. Level 3 was in this mode in 2005, when it plowed a tremendous amount of resource into VoIP/IP Centrex. Earthlink was recently in this mode when it pursued municipal WiFi networks because its dial-up Internet business was hitting maturity and decline. Many DSL and UNE-P CLEC businesses went through this stage.
So what do you do if (a) you have cash or cash flow (b) your core business is flawed or end-of-life and (c) you don’t have a new initiative to replace it? The first thing you do is buy yourself time. You do this by putting the core business into a harvest mode. Make sure it is being run for maximum profitability and cash flow. This includes maintaining spending to keep current customers happy, as you want churn to be lower, not higher. But spending levels should be spent with a realistic expectation on the prospects of the core business–if it is in the mature stage, treat it as such and make sure cash is generated.
Next, consider the possibility that new material new initiative will be discovered to replace the core business. Model the free cash flow of the business in this scenario. How much cash can be squeezed from the business over time? Does it cover paying off the debt? Does it imply any equity value? It is important to make this scenario as accurate as possible. Inaccuracy on this scenario–whether to the positive or negative–will almost certainly lead to bad decision-making.
This scenario should be considered the baseline against which alternatives are measured against. This scenario also becomes the basis for setting budgets for the business, and bonus plans for the management team.
With this baseline established, new initiatives can be considered. New initiatives must be vetted every bit as carefully as if the company was in start-up mode. On a stand-alone basis, is it a good initiative and do others outside the company agree? Is there a reason (i.e., synergy) that this initiative should be pursued within the company? Does the company’s challenges in its core business hurt or help the prospects of the new business? It is hard to be candid in answering the last question–as the answer is usually “hurts”, not “helps”. Hurts is not the answer the company is looking for but they most be open and honest about it.
If initiatives pass these screens, start slowly. Allow time for feedback loops prior to committing major dollars. Just because the company has cash or cash flow doesn’t entitle it to be careless in throwing money against new initiatives. What if, because of problems in its core business, the company doesn’t have time to be patient? See the previous paragraph. Almost certainly this means that the new initiative shouldn’t be pursued.
I can write a ton more on this topic. Perhaps I will pick it up in a future series. Bottom line–companies who find themselves in Vonage-like situations are best off slowing down. Get very good at running your core business for nearer-term profitability. Understand what this means in terms of shareholder value. Be very conservative on all discretionary spending until you are highly confident that you have something to invest in.
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