Surprisingly, a balanced approach may not offer highest valuation
The marketplace for graphic communications continues to get more complex and markets are becoming even more specialized.
Being “a printer that does all things for all people” is under real challenge today. That challenge comes from firms that have adopted strategies built around being a graphic communications firm that understands the special needs of specific markets.
This approach has produced a very wide range of possible strategies, and whichever strategies any particular firm chooses from this array will have significant impact of how the firm is valued, both today, and into the future.
Value is one of those very elusive concepts in any situation, and the valuation of printing companies in today’s markets is no exception.
On one extreme are the proponents of the simplistic, formula-based approach. This group would have you believe that valuing a printing company is somehow no different that valuing any other business, whether a retail store, manufacturer, or tavern. After all, they say, dollars are dollars, and current sales (or profits, or assets on the balance sheet) are the most important element in valuation. Usually, we CPAs fall into this somewhat unimaginative group.
On the other hand, there are those who would have you believe that value has nothing to do with financial issues, but rather is related to something usually called “market strength.” Under these rules, value is a function of how innovative management is, whether it is an industry leader, and how the market perceives the company. In this scenario, a company with the ability to do very high quality work for demanding customers is always worth more than a company that does one- and two-color work that might be perceived as simpler or more common, regardless of their relative financial strengths or their results.
Frankly, both of these views are wrong, and to some extent, they are also right.
Here’s why. In the long run, the value of any firm is dependent on its ability to consistently show a return to ownership which meets or exceeds the return from other alternative investments of comparable risk. This means that financial results are important. But so is the ability of the firm to maintain those results over time.
This usually is a function of the strength that the company has within its chosen market, relative to its competitors. It is also a function of the general conditions of both growth and value that prevail in the market in which the company has chosen to focus its efforts. For instance, the relative value of most short-run 1/0 printing is much lower than that of medium run size 4/2 or 4/4 work, if for no other reason than that relative inexpensive alternatives exist for the former (i.e., copy centers, or even laser printing), and generally the level of quality demanded (and therefore valued) by customers for the first, is much less than for the second. Therefore, both market and financial strength are essential to the value of your business.
How does this relate to strategic alternatives?
In most cases, firms face a number of specific strategies which can be grouped in essentially three categories. These are:
1. Market Innovation – These strategies include those that focus on adopting the newest trends, especially technological, in the belief that these innovations will enable those firms to differentiate themselves from their competitors. The upside for these firms is that if they select correctly, they will achieve early entry into marketplaces that may not even exist now, but will be large and growing in the near future. There is also typically a period of time during which the number of competitors will be relatively few. This also usually means that prices (initially) and profits will both be above-average and that customers will perceive extra value being provided by those firms that can provide these innovative solutions. However, the downside can be considerable. Not all innovations lead to market acceptance. Furthermore, the challenge of being at the “bleeding edge” of technological change invariably results in higher costs, and continual change. Thus, considerable downward pressure can be exerted on earnings — sometimes so severe that the risk of business failure increases significantly. But in either event, the results of innovation as a business strategy can only be measured at some point in the future.
2. High Yield Cash Harvesting – The strategies that fall into this category are those which are focused on taking the greatest amount of profit and cash flow out of the firm in the short run. This often can be seen in companies that defer not just equipment maintenance, but even equipment replacement, pay below average compensation to employees, and avoid new technology and marketing approaches for as long as they possibly can. Such firms generally are able to keep their debt levels very low and their short-term profits and cash flow fairly high. They are also usually faced with competing in either stagnant or very slow growth markets and find it very difficult to develop significant levels of market strength with which to resist competition. These strategies generally focus on price as the major competitive tool, sometimes adding service (i.e., turn-around time). The risks of this strategy, in the short run, are usually fairly low and, in fact, some firms are able to successfully implement such strategies for a number of years. However, they invariably face slow growth or even declines in sales over the long run, and these strategies will inevitably result in competing for smaller and smaller markets with less desirable price levels and customers. Even though such firms may look fairly good on paper in the short run, they have serious problems in the long run.
3. Balanced Strategies – As the name implies, these strategies tend to contain some elements of both the above types of strategies. They attempt to take advantage of innovation once a market has been clearly established for it, while at the same time maintaining a fairly traditional base of both clients and technical capabilities. Many owners seek to maintain this type of strategy because they believe that by doing so, they get the “best of both worlds.” However, like all strategies, there is a downside here as well. The danger is that if the market or the industry begins to move more quickly than anticipated, which has certainly been the case recently, such strategies may not allow the firms to stay in contact with the leaders of the industry. These companies then, will increasingly become forced into the same segment of the marketplace as the High Yield Cash Harvesting Strategies. Unfortunately, however, they will not have taken the cost-reduction steps that are essential to making such a strategy pay off, which means that they will not have the best of both worlds, but potentially the worst of both. This can be a fatal mistake.
So, how do these alternative types of strategies affect the value of a firm?
In most cases, the answer is that it has to do with the time frame in which an owner wishes to maximize value.
Since most valuations of companies being purchased are based on financial results, and past results are always more reliable than projected or planned ones, an innovative strategy can be quite dangerous for owners who are planning to capitalize on the value of their businesses in the near future. In nearly all cases, such strategies require a commitment to a number of years to pay off. This means that if the owner desires to sell in the near future, an innovative strategy can actually reduce value, in the short run.
If, however, long-term value is the focus, then clearly a policy which is based on maximizing short-run returns while conceding long-term market strength to more innovative competitors, is a mistake. It is in fact the market strength of the company that must first be built, and then capitalized on in the future, to assure the best result.
The key element, then, especially for the difficulties faced by many family-owned businesses today, is the focus on different time horizons. Often (but not always) the older generation is most interested in short run returns and value. However, the focus of the generation that will be running the company in the future, is, of course, the future. For this reason, many firms in this situation end up adopting what they think of as a balanced strategy, but what is in reality a compromise between two totally different approaches. This approach, as noted above, can be the worst of all worlds.
Therefore, when developing a strategy for your business, the most important thing to do first, is to decide what the relevant time horizon is. This is essential before any strategy can be evaluated. Not everyone can be an innovator, and not all short-term strategies are wrong. Just be sure that the choice you make at your company, fits your needs.
A management consultant since 1970, Gerry Michael, CPA, is Managing Principal of Carlson Advisors Seattle LLC (formerly G.A. Michael & Company). He is a Certified Public Accountant (CPA) licensed in in California, Oregon and Washington; a Certified Management Accountant (CMA); and a Certified Microcomputer Consultant. Gerry assists privately-held companies with organizational planning and design, change management, information system improvement, capital budgeting, and merger and acquisition assistance. His primary areas of expertise focus on managerial and organizational consulting. Visit http://www.carlson-advisors.com/aboutus-gerry-michael.html