-.-.- KAHNAWAKE ECONOMIC DEVELOPMENT COMMISSION -.-.-

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SESSION 10

Operations
Session Outline

Objective

The Operations section of the business plan deals with the supply side of the business. The marketing section deals with the demand ( sales ) side of the business and determines the projected revenues for the business.

The objective of this session is to analyze and detail the specifics of the back room operations of the business. This includes suppliers, alliance partners , resources ( human, equipment, financial ) and the process of scheduling the activities necessary to get the product/service to the customer.

The session also develops the estimate of the costs necessary to do the activities associated with purchasing, processing and providing the product/service. Once completed, this estimate of costs will be compared with the revenue projections to get an assessment of the profitability of the business.

Learning Points

�        Determining the �team� including alliance partners
�        Understanding partnership agreements
�        Learning small business human resource management
�        Developing cost projections
�        Creating your back room process and scheduling

Overview

Marketing focuses on the demand side of the business. Marketing is concerned with revenues and getting prospects to try the product/service and become loyal, repetitive customers of the business.

Operations is concerned with the supply side of the business. The focus in operations is on costs. The expenses that the business incurs while selling the products and services. This includes everything from the purchase of the raw materials (or the finished goods in the case of a re-seller) through the direct labor and materials necessary for getting the product ready for sale. It also includes the overhead that the business has and any transportation. Essentially, all the costs the business has in getting the product/service to the customers.

Both marketing (demand side) and operations (supply side) are important to the success of a business. Often the marketing side is overemphasized and the supply side is neglected. Saving money (on the supply side) is as good as making money (on the revenue side) - in fact, when the competition is strong and the customer is buying on price, then the business that saves the most money on expenses is often successful because they can have a lower price, get more customers, and still make a profit.

The skills needed most on the supply side ( operations ) are the following:

1) Negotiation skills - the ability to get a good deal with suppliers and the ability to continuously seek and look for a better deal from other suppliers (on price, quality, delivery, and service).

2) Managerial skills - the ability to reduce labor costs through good hiring, motivating and management of employees.

3) Organizational skills - the ability to create a very efficient system of providing product/service to the client in a way that minimizes your cost but maximizes the service to the customer.

4) Creativity skills - the ability to constantly seek better ways to reduce internal costs through attention to all aspects of the costs of the business. This involves knowing what the costs are for your major expenditures and finding new ideas to reduce these costs. E.g. A garage significantly reduced the heating and lighting costs (a major expense) by insulating the walls, changing the garage doors and painting the interior a lighter color (reduces the need for lights). The investment in the improvements was repaid through the savings. Whenever there is an opportunity to save money through an improvement, businesses should do a ROI and payback calculation to assess the viability of the investment.

ROI? Payback

ROI is Return On Investment This relates to the gain you make from an investment of money. For example, if you invest $5,000 to start your business and your profit the first year is $1,000 then your return on the $5, 000 invested was 20%

$1,000/$5,000 = 20%

Return on Investment is Return/Investment

So, let's assume, in the garage example, the owner paid (invested) $10,000 to have the insulation upgraded, garage doors changed and walls painted. Let's also assume this yearly savings on heat and light were $2,000. Then the Return on Investment will be 20% per year and at the end of five years the investment will have been paid back by the savings. After 5 years the savings will be like getting extra income because the investment will have been paid back.

So, the return on the investment and the payback period (time for the savings to re-pay the investment) are the key indicators as to whether the improvements should be made.

So, sourcing suppliers, negotiating contracts, determining location, making decisions about employees, ensuring that every employee contributes {remember, an investment in an employee (salary) also needs to be justified by either savings (operations)or increased revenue (marketing) to ensure that the return on the employee salary is greater than the salary/investment}.

Think of a family where there is income and expenses. There are many instances where the family does quite well because of good purchasing decisions and excellent household management. The income may not be great but good management of expenditures can compensate for this. Some families, with large incomes are always in debt and living on the edge. Many families with little income have a superb household manager and the family lives quite well despite limited income.

Business is the same. You need excellent marketing ( revenue ) but you need an equally excellent internal business manager who can manage the resources ( physical and human ) within the business for maximum savings without compromising customer service or quality.

The Team

The first section of the Operations plan should focus on the entrepreneur, partners, employees and alliances. A business plan reader is most interested in the competency of the people to make this business successful. There are a few critical factors that the business plan reader looks for:

a)     The knowledge/experience that the entrepreneur has had in this industry.
b)    Who will be doing the �key� jobs in the business? What is their experience and what will prevent them from leaving to become a competitor?
c)     What exclusivity does the business have with suppliers? Who are the back-up suppliers?
d)    What other alliance partners? Is there any sub-contracting? Is there any barter opportunities?
e)     Who are the partners in the business? What are their roles, skills, investment and expectations?
f)      What employees will be needed for the business? What skill levels, what salaries, what working hours?
g)     How will all the skills of marketing (sales), production, creativity, finance, negotiations, customer service, and problem solving be done? Who will do them?

The most important element is the management team. The feasibility of the business plan is based not only on the market opportunity but also the expertise and experience of the entrepreneur and his/her team.

The major weakness is to partner with friends or family who don�t add value to the business. The investors are looking for competence in complementary skill areas , not friendships nor nepotism ( putting family members in the business who don�t have the necessary skills)..

Realistically, however, utilizing family as financial investors is probably the most opportunistic method of financing and hiring family will help to reduce �burning cash� at the critical start-up phase because they will work for equity, defer salary and give you the 120% commitment. (A business "burns cash" until it reaches a point where the revenue can pay for all the costs, (fixed and variable).

A good starting point is to establish the role that you, the entrepreneur, will be doing and the core competency that you have. This will establish where you should be spending most of your time and indicate the areas where you will require expertise. The dilemma is how to offset that weakness:

�        Partners will take equity (risk) with you , forego salary and give total commitment. They usually want input in decision making, however and it is difficult to work with partners (especially ones who are friends).
�        Employees want a regular paycheck and give you the 9-5 commitment. It is difficult to justify hiring full time employees at the start-up phase because of the cash drain and the lack of full time work. Competent employees are usually looking for full time jobs. Hiring on a part time basis will help but the employee will always be looking for a better position on a full time basis.
�        You can outsource contractual work to specialists on a �pay for performance� basis. For example, you would pay a sales agent on the basis of sales made (commission).

The right mix is a blend of the above, depending on your needs for skill and commitment. Entrepreneurs are usually cautious about expenditures for human resources early in the start-up phase. Business plan readers will also be looking closely at your human resource expenditure early on, particularly high fixed costs for employees.

"Key" employees are particularly important. These are the employees ( or partners ) that are essential for business success. In a restaurant that would be the chef. Chad Rice ( Old Malone's ) is the chef - so, as an entrepreneur, he has the core competence to be the "key" employee. Suppose Chad wanted to open a restaurant but didn't want to be the chef. What then? Well, from a business plan perspective he would have to show how this employee or partner was "locked-in" to the business.

Locked-in

Key employees/partners need to be locked-in because without their expertise the business will quickly decline. A chef is an example because customers come for the specialties they make - if they leave then the customers will also leave. A clerk with an excellent personality may also be a key employee because people come back because of their personality. There are a few methods to "lock-in" employees:

1) Non-competitive contracts. Key employees should sign a non-competitive contract that prevents them from learning the business from you and then going out to become a competitor to you.

http://www.ilrg.com/forms/nocompet.html

http://www.ilrg.com/forms/non-disc.html

2) Putting key employees on a profit sharing program will help to get them to stay.

3) Giving key employees a share of the business is another excellent way to get them to stay ( make them a partner even if it is only a minority one ).

4) Nothing retains key employees more than just plain old-fashioned respect. Treating them well, giving them a day off when they need it, and making them an important part of your business "family" establishes loyalty.

Employees in a small business environment

Small businesses do not have the ability to tolerate idle resources as a large business does. In a large business, 10 � 15% of the workforce is not productive on a regular basis ( holidays, sick days, vacation, or just not busy ). Small business needs to get 120% from all employees, it can�t have inefficient labor.

So, many small businesses work on a basis of �just-in-time� employees. They hire and pay for performance not time served and they don�t keep employees during slack times. They often hire people contractually rather than hiring them as permanent employees.

CASES

Actually, there are a few case examples for this section, mostly in reference to the use of employees. Employees are a large expense for any business and the efficient use of them and "locking-in the key employees can spell the difference between success and failure.

Laurie Deer

Laurie Deer learned to be a good manager. With "Tentsations" she is dependent on employees to put up and take down tents. Initially she was very strict and often yelled at the employees and was critical of their performance. Rather than getting better performance, the performance got worse, with lots of damage, sabotage, employees not showing up, etc. Employees who are not treated well will always find a way to "get back" at the employer. They can't do it on the surface - it will usually be below the surface, but it will show the owner what they are capable of doing,

Laurie became a better manager of the employees and there are considerable savings in the better treatment of the equipment, better service and employees that are more willing to work.

Eileen's Bakery

No surprise that the key people at Eileen's have been with her for a long time. Eileen is demanding but is very sensitive to employees at the same time. Eileen's success is attributable to her management of employees.

Old Malone's

Chad requires a lot of employees to run Old Malone's. He and his wife perform the "key roles" ( Chef and Hostess ). They use a lot of employees, some who stay a little while and some who stay quite a while. Chad lets go employees, who are not performing, quickly - otherwise the business could not survive. When an employee shows a willing attitude to learn, Chad promotes them and mentors them to attain more success.

The common theme in all three instances is an ability to manage and retain key employees. Also the ability to terminate, quickly, employees that are not providing a return on investment. There are some entrepreneur's ( e.g. Johnny Montour ) who only have themselves and occasionally hire some part-time help or use family. Johnny, however, has a network of advisors, suppliers and contacts. They are not on his payroll but they help him in his business decisions. Not all "key people" have to be paid. Smart entrepreneurs are always looking for advice and help from professionals and experts in their business industry.

The bottom line is that you need people to help you. There isn't any business that isn't dependent on others helping them become successful. Managing those relationships and being efficient on the cost side will go a long way toward business success.

The Process

Every group develops a �system� or process of work flow to enable work to be accomplished efficiently and to establish a �culture� or methodology of interaction that guides behavior within the system.

Families, schools, churches, informal groups and businesses all develop a �system� that has entry and exit points as well as roles and responsibilities for those who are �in� and �outside� the system.

Let�s consider a restaurant as a system. When you enter the system you find that some restaurants expect you to serve yourself (buffet style ), some have you wait to be seated and served, some have counter service, etc. Each restaurant has a somewhat unique way of processing clients which gives them differentiation and establishes their system. When you leave the system, some have you pay at the table, some at the cash, some won�t accept certain credit cards, some give discounts for cash, some won�t allow tipping, etc.

Inevitably, the entrepreneur establishes the culture and system according to his/her own specific tastes. Will the staff wear uniforms? Will only family be hired? What will be the compensation for employees? All these are usually functions of the entrepreneur�s style and values.

The process should be designed with care to ensure that the maximum efficiency is built into the system. A good process will save money and that will enable you to be competitive with prices while still maintaining a profit.

For the purpose of the business plan, you should identify the process of your system, the methodology on how your client will be served.

Business structure

Business structure can be a sole proprietorship, a partnership or an incorporated business. All have particular strengths and weaknesses, depending on your situation. The choice you make should be clearly identified in the business plan as well as the reason for your choice.

Essentially, the simplest form is to register a sole proprietorship. Least cost and least paperwork. You are personally tied to the business in this situation, however, and can be sued for your personal assets beyond the business assets. Unless your business has the danger of a significant lawsuit you would probably be best to start with this form of ownership. Insurance and a partnership agreement (if necessary ) can cover risks and you can incorporate later when justified.

If you have a partner, you need to legally protect yourself in the event of bankruptcy or lawsuit. Particularly if the business partner is/was a friend/relative (There are more �horror stories� about friend/relatives in partnerships than you can imagine). The important issue is that you are legally bound to your partner�s share of the lawsuit if the partner skips out on you. Let me give you two true cases of partnerships that went sour:

EXAMPLES

� Two partners in a very successful computer refurbishing business. One dies. There is no reciprocal life insurance policy ( which would give the surviving partner the funds to purchase the 50% of the business from the deceased�s estate). The spouse of the deceased partner gets 50% of the business as part of the �estate�. Spouse is now the �new partner� but doesn�t have any skills or abilities to provide the value added participation that the deceased had been doing. Spouse, however, is entitled to 50% of the profits.

� Man marries woman. Man and father-in-law go into business and become very successful commercial painting contractors. Man divorces woman. Father-in-law sells his 50% to someone who is incompetent and the man dislikes. Man has to dissolve the business to avoid partnership.

These are just a couple of the numerous stories about partnerships. Some work well, but the odds are definitely against you. The message is simply this � if you are in a partnership make sure you make a partnership agreement to cover issues of dissolution.

Partnership agreement

A partnership agreement is a binding contract that specifies the terms of the partnership. There are standard partnership agreements available at Bureau en Gros and on the Internet. There are some important clauses that need to be covered in every partnership agreement:

1) Dissolution � In what ways can the partnership be dissolved ( death, agreement, bankruptcy ). What are the terms of dissolution? This is where you need some form of reciprocal life insurance to purchase the partner�s share from the estate and some form of �shotgun� method of determining price in a voluntary dissolution.

2) Conflict resolution � the determination of a mutually agreed upon arbitrator for the purpose of resolving disputes between the parties.

There are free partnership agreements and other business forms at the websites below:

http://www.ilrg.com/forms/partnership-agreement.html

http://www.ilrg.com/forms/

Incorporation is the 3rd form of structure. Incorporation is costly (around $1000) and requires yearly audits, board of directors, minutes, etc. The upside is that incorporation protects you by separating the business from your personal life. Incorporation can replace the need for a partnership agreement (agreement is included in the incorporation). An incorporation is best suited for businesses that are in danger of large potential lawsuits that could bankrupt the business. Restaurants for example (food poisoning, customer injury, etc.). It doesn�t eliminate the need for insurance but it does provide peace of mind knowing that you are legally detached from the business.

Costs

The operations section assembles the costs for starting up the business and the costs for the ongoing operations of the business. It is important to get accurate cost estimates, ideally in writing and you can include them in an appendix.

Start-up costs
These are the costs that are necessary to begin the business. Typically they are renovations, initial inventory, equipment, auto and furnishings. Start-up costs are one time costs necessary to begin the business.

Ongoing operations
These would be the costs that are the regular monthly costs of doing business and the costs of labor ( variable, direct costs of labor on a per unit basis or fixed, overhead costs of labor on a time basis � hour, week, year ). Also an important cost would be the direct variable cost of goods sold. This is what a unit of product costs you to buy or make. If you are providing a service it is the direct cost of providing an average unit of that service. For example, if you are cutting lawns, the average lawn takes one hour to cut. Direct labor cost for one hour is $15 (including travel) and direct material cost ( gas, wear and tear ) is $3. So, the cost of goods sold, per unit of sale ( lawn cut ) is $18. If you do video, the cost of goods sold would be the direct labor and material cost of shooting and editing a 30 second video (or whatever a typical video would be for you.

Once all your costs are found and verified then you are ready to start assembling the financials.

Summary

This session develops the supply side of the business to communicate to the business plan reader. The following information needs to be communicated in the operations section:

� Who will be making this business happen? Who is the entrepreneur, what are his/her strengths? Who else ( partners, employees, alliances ) will be involved? Which of these are key to the success of the business and which will be just labor? Where will the expertise come from to perform the functions ( Research/innovation, marketing, production and finance ) of the business?

� What will be the costs of labor (direct and indirect ), the costs of assets ( equipment, furniture, auto, inventory )? What will be the ongoing overhead costs, monthly ( rent, loan repayment, utilities, auto, insurance )? What will be the start-up costs ( renovations, inventory, equipment, furnishings, printing, advertising )?

� How will the process of serving customers take place? How will the customer become aware, decide to buy, be processed and pay? How will you use your human resources ( schedules ) to serve the customer?

Discussion Questions

� What are some techniques to use to make sure that key people in your business ( cook, artist, designer, production expert, marketing expert, etc. ) stay in your business and do not go to competitors or start their own business?

� What are some creative methods to reduce:
               - start-up costs
               - monthly costs
               - cost of goods sold

� What are some creative methods for getting �just-in-time� employees who are paid on a performance basis and not on an hourly basis?

Exercise # 1

In many businesses, particularly retail, you need to cover many hours of operation. Using the chart below, indicate the staff needed in each timeslot for the week. If more than one person is needed then indicate that in the relevant time periods.

Once completed, calculate the total number of hours for the human resources for the week ( include yours also ) and multiply by the average salary per hour ( include what your it would cost to replace your hours also ). This will give you your total, indirect fixed costs for staff salaries weekly.

Monday Tuesday Wednesday Thursday Friday Saturday Sunday

9 to 11am

11am to 1pm

1pm to 3pm

3pm to 5pm

5pm to 7pm

7pm to 9pm

Take all hours ______ and multiply by average hourly wage ______ = ________ weekly payroll for fixed staff labor

N.B. If grants are available for training allowances this should be noted. Also the duration of those grants should be noted because at some point you will have to begin to pay those employees.

EXERCISE 2

As an exercise in determining your costs, let's look at start-up costs. How much will you require to get your business going?

Estimated Start-Up Costs: First 3-Months

Rent

Renovations

Auto

Insurance

Computer(s)

Phone/cellular

Equipment

Office furniture

Inventory

Salaries

Other

EXERCISE 3

Another key area is the on-going costs to maintain the business. Particularly at the beginning, when sales are low, conserving cash is very important.

Estimated Monthly Expenses