September 14, 2004
Editor's Note: This is the ninth episode in a mountaintop dialogue that Gerald has been having with a "wise business guru." They have been talking about business network tiers, and the guru has asked Gerald to identify which tier his job shop is in.
I sucked in my gums and tried to ape his sagacious countenance. What was he carrying on about now? "Well, among my competitors, I'd say we are the upper crust. Not Tier 1, exactly. But we are not the bottom of the barrel, by any stretch," I proclaimed.
"My, oh my, oh my," he groaned. "Try to remember that we are talking about strategy. In the business world there are large economic forces from which manna flows. In the region where your business operates, you probably can identify major organizations that dominate the local economy. Yes?" he prodded.
"Those are the Tier 1 companies. They purchase goods and services from Tier 2, and so on."
"Big deal," I thought to myself.
"Have you noticed that top-tier companies handle more cash than those in lower tiers?"
"Are you suggesting that my strategy should be to become a Fortune 500 company?" I guffawed.
He scowled. "Are you trying to be dense, or does it just come naturally to you?" he retorted. I began to pout.
"You are not accustomed to my version of strategic thinking, so I will be more patient," he apologized. He pointed to a hawk that was soaring on the thermals rising from the valley below us. At this high elevation, it was amazing to see the bird nearly at eye level. Its attention was on something on the valley floor.
"You are familiar with ecology? With environmental niches?" he asked.
"Sort of. That hawk probably feeds on mice. The mice eat bugs. Bugs eat plants. Plants eat air and dirt," I replied.
"Close," he concurred, encouraging me. "Rather than focus on the predator versus prey relationship, however, note that each organism has evolved to prosper in an available environmental setting. No other organism is as good at being a hawk as that hawk is. The hawk is the way it is both because of the nature of its environment and because it has adapted to its environment. Furthermore, without the available niche, the hawk would not be."
"So, you are suggesting that my strategy should be to become a hawk?" I snorted.
"I am suggesting that in the business environment there are niches of opportunity. I am suggesting that you study the business environment around you, target an economic opportunity, and formulate a strategy based on prospering within that niche," he sternly advised. "If you design your business properly, it will fit its economic niche as perfectly as that hawk fits its environmental niche!" he intoned.
"Well, that is just obvious," I blurted, slightly embarrassed.
"I also encourage you to consider the profit opportunities and risks at the various tiers in your business network." He did a yoga contortion to make himself more comfortable while I pondered this.
"You already pointed out that there is a cash reward for being at the top of the food chain. I guess it is kind of risky, though. Everyone wants to be at the top," I surmised.
"Yes, competition is fierce," he agreed. "But that is true at every level and in every niche. I think the main risk at the top tier is managerial malaise. Particularly in large organizations," he suggested.
"That makes sense. If people get lost in the bureaucracy, then the company loses vigor. Money can get wasted in overhead," I observed.
"The incentives are significant, however. If you can control the profit and cash flow at every level of serving a market, it can be very lucrative," the guru said.
"In your case, my boy, you are not going to become a large organization. Your skills, the things that make you happy, and the resources available to you have made you a creature of small business. That is neither good nor bad. It just is," he stated flatly.
"I bet you are going to say that one's ability should limit one's ambition, which should form one's strategy," I suggested.
"If that 'one' be thee, then yes!" he agreed. "Please do not limit your concept of the supplier tier relationship only to size," he warned.
I pondered that for a moment. We watched as the hawk swirled and pivoted toward the horizon. "You mean that small companies can buy from big ones," I offered tentatively.
"Although that is true, that is not the point I was trying to make. For one of your customers, you build a gizmo that is completely ready for resale. All your customer has to do is distribute the product to the retailers, right? That makes you a first-tier supplier to that customer," he noted. "You collect all of the available profit in manufacturing that product," he continued. "Your customer makes all of the profit in distribution and product support."
"OK," I agreed.
"For another customer, you make a doodad that goes into a power supply. That customer makes the power supply and sells it to his customer. In turn, that customer builds a machine to make computer chips. That means you are a fourth-tier supplier to an electronics company somewhere. You probably are a supplier to several electronics manufacturers that you have never met."
"So, your point is that top-tier firms make more money?" I asked.
"That is not how I would put it, but that is basically true. Top-tier companies usually have larger cash flows, and a percentage of the profit on a big pile of cash is larger than the same percentage on a small pile," he explained.
"Why do top-tier companies have larger cash flows?" I asked.
"I must apologize. I have made some generalities that are not carved in granite. Let me backpedal just a little bit." With a dry erase marker he drew a pie chart. "The entire pie represents all of the available profit in this project. This segment represents the profit from manufacturing the product." He pointed to another slice. "This segment represents the profit from distributing the product to retailers. And this could be profit from inventing the product, and this is the profit from supporting the end user with repairs and training," he said as he pointed to the fourth slice.
"Some pies are big, some are small. An organization that can manage and control more than one segment holds an upper-tier position," he explained.
I wanted to hurry him through this, so I said, "Perhaps a company that mines bauxite, smelts aluminum, stamps cans, grows the grains, makes the beer, fills the cans, runs the advertisements, owns the stores, and operates detoxification clinics would be an example of a Tier 1 organization?" He smiled at my elaborate example and nodded.
"Closer to your reality, you certainly do not collect all of the available profit in making a motherboard. At the same time, you do not have to carry the risk of product obsolescence. You chose lower risk and accepted a different profit opportunity."
"So?" I asked as brightly as I could. "So, you have made a strategic decision! Unfortunately, you did it subconsciously."
I responded to his barb with dignity. "As part of my strategic planning, I should identify an economic opportunity, or niche. In my case, it is manufacturing precision metal products on demand. Then I can focus my business goals within the constraints of the available business ecosystem. Presumably, my business strategy is well-grounded in terms of my ability and opportunity. Inevitably, both of those will change. I must monitor and adjust my strategy accordingly." I was amazed at my brilliance as I spouted this.
"Well said! So, your strategic goal could be to be an economic dynamo that manages cash flow and profits by the conversion of raw materials into goods made-to-order. But I want you to think about what it takes to hold the top-tier position. Discipline, reliability, and mastery of the service that you are providing are vital! If you are unworthy, the customer will second-source you in order to protect his self-interests. If you compete only on price, it is a sure thing that your customer will always be willing to do business with your competitors!" he warned.
I drifted with the hawk.
"Do you know what the best part of your little soliloquy is?" he asked. I waited breathlessly to hear his praise. "Your awareness that understanding your niche is only part of the job of strategic planning!" he beamed. "Remember the time line of money?" he prompted. "When it comes to longevity, there is nothing like survival. Remind me of what you have tried so far to improve your cash flow," he prompted me.
The saga continues ...
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