managing risk

Modern companies as specialized venture capital firms

Philip Brewer — Wed, 15 Apr 2009 18:13:42 +0000

In the old days, companies actually produced stuff. They invented it, designed it, made it, marketed it, and sold it. Although there are still some companies like that, they're a lot less common now. Many companies have shifted to an "asset light" model where they no longer own their own factories and equipment. Instead, they hire other companies to do most of the work. Understand how this works and you can turn it in your favor.

I first came to understand this model with regard to publishing companies, so I'll use them as an example.

Publishing companies as specialized venture capital firms

What does a book publisher do? Very briefly, it finds things to publish, buys the rights, edits the manuscript, designs a book, markets it to bookstores (and other sales channels), has copies printed and bound, and sells them.

In the old days, one company would do all those things. Nowadays, very few do. In fact, some companies outsource every single one of those activities: Acquisition, editing, and book design are done by freelancers; marketing is outsourced to a marketing firm, printing and binding to a printer, and sales to a distributor.

Of course, a publishing firm may choose do one or more of those things, if it thinks it can do it better in-house--many firms still do their own acquisitions, a few old-line companies may do their own printing and binding, many do their own marketing. But they can all be outsourced if the company doesn't have the expertise in-house.

There is one exception: buying the rights. That--putting up the money--is now the core activity of a publishing firm.

This is why I call publishers specialized venture capital firms. Putting up the money--paying the writer's advance (and also fronting the money to pay the freelancers and the printer) in exchange for a big chunk of the profits from sales is a straight-up venture capital model. (Rights are usually acquired on a profit-sharing basis: The publisher pays an advance against royalties. If the book does especially well, the author will get further payments, if it does poorly he gets nothing more.)

Other companies as venture capital firms

As one aspect of globalization, more and more companies have shifted to this model over the last twenty or thirty years. Specialized tasks were outsourced early--everything from janitorial staff to lawyers got contracted out. Anything with high labor costs--manufacturing especially--was moved overseas in search of cheap labor. The idea was to identify a "core competence" and retain only that activity, outsourcing everything else.

To the extent that you can get things done better or cheaper, outsourcing is fine. At its current absurd limit, though, we've gotten to the point where companies no longer seem to have any "core competence" except hiring outsourcing firms. At this point their only competitive advantage would seem to be superior skill at managing deals with overseas contractors.

Actually, there's one other: cheaper access to money. In fact, for a specialized venture capital firm, access to cheap risk capital is the core competence. And US firms have had a huge competitive advantage, because in the years between the dotcom collapse and the recent financial panic, the Federal Reserve made money as cheap as it had ever been.

The financial crisis put an end to that. (The money is still cheap, but you can't get any of it.)

However, there's a more fundamental limitation to the whole system: When your competitors are all shopping from the same universe of outsourcing firms to hire things done, it gets a lot harder to find a competitive advantage.

Even if you have a real core competence, you're still suffering in this recession, but you're just suffering in the usual way--sales are down because your customers don't have any money. But if your so-called core competence was either your skill in managing outsourcing firms or your access to cheap money, you're in a world of hurt now. The people actually swimming in that quagmire don't need me to tell them that. But others are affected as well. Stockholders should take a close look at the companies they own. Vendors, clients, and suppliers should look at the companies they do business with. If the company still does something real, it may well have a bright future. If it hires everything out, though, there's no reason to think it will ever again do well (even if it might manage to hang on as a third-tier firm for a long time).

Why it matters

Having said all that, there are really two points I'd like to make.

First, ordinary people can also take advantage of the outsourcing phenomenon. If there's anything that you can do better than other people--if you have a core competence--there has never been a better chance to turn that into a business. The outsourcing firms that will do everything else for you will be begging for the work. Of course, since you're turning yourself into a specialized venture capital firm, you'd better have not only a core competence but also some capital--it's going to be tough to get much from the financial markets.

Second, though, understand that once your company gets to the point where it doesn't actually do anything except put some money at risk and manage contracts with other companies to do the work, it isn't really much fun to work for.

There are, I suppose, some people who like nothing better than managing contractors and managing risk, but the rest of us would prefer to actually do something--design something, build something, repair something, improve something, maintain something.

This matters for both managers and employees. Hire people whose skills complement your business's core competence. Work for companies where you'll be doing real work that you're interested in. Avoid owning or working for companies where there's no longer any real work going on. (Work instead for the outsourcing firms that are doing the work.)

In any case, understand what it means to own or work for a specialized venture capital firm: Success is mainly a matter of managing your contractors and coming up with risk capital that costs less than the profits of your firm. Finding some real work that you can do better than anyone else is both more promising for success and more fun.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

15 Ways To Manage Risk In Your Financial Life

Silicon Valley Blogger — Mon, 19 Jan 2009 07:17:53 +0000

Over time, I've learned that the best way to manage my money and financial health is to be acutely aware of the relationship between financial risk and monetary return. We all want to optimize our returns yet many of us forget that by doing so, we may be taking a lot more risk than we should.

By managing our risks, we are better equipped with addressing unpredictable scenarios that can wreak havoc with our finances. Risk isn't a bad thing, just as long as it's controlled or "calculated". So let me share a few strategies that I employ for keeping risks in check:

1. Know yourself.

To know yourself well is the cornerstone of many a financial lesson. With every mistake I've made I've filed the experience in my memory bank to remind myself not to repeat it. That was true when I tried to short the market during heavy volatility, and when I got involved in MLM marketing without realizing how lousy I was with sales. More lessons I've learned: understanding your risk profile and capitalizing on your strengths can increase your chances of success.

2. Keep your skills up to date.

At work, it's not a good idea to become too complacent, especially when you work in a competitive, dynamic industry. As the cliche goes: "nobody's indispensable." My takeaway? Develop skills and keep them honed in order to stay valuable in your field. Also develop skills to manage aspects of your life that will allow you to stay flexible and self-sufficient.

3. Carry the right amount of insurance.

Have you got the right amount of insurance? Many people take the massive risk of not having any auto insurance coverage, while many more are skipping out on health insurance or other important coverage. Unfortunately, sometimes there's not enough in the budget to cover premiums. But if you can afford it, make sure to keep policies up to date and sufficient for your circumstances.

4. Diversify your income sources.

When I read about the troubles of auto industry workers, it emphasized to me the importance of developing multiple streams of income. My best tip: invest early to allow your money to start working for you. Think of your money as yet another income generator for your household. Other ways to create new income sources? Some people are able to make money blogging, while others turn a hobby into a small business. Or how about moonlighting and getting a part-time job?

5. Build an emergency fund.

When I first started saving, my first priority was to build an emergency fund. I determined how much of my savings should go into short term savings (preferably in a high yield savings account) and how much to deploy into long term investments. I personally hold about 9 months' worth of expenses in my liquid accounts.

6. Check the financial ratings of institutions you work with.

After witnessing the downfall of many a financial company in 2008, I've realized how important it is to review the financial ratings of our banks and institutions. I keep regular tabs on my mutual funds and online bank accounts, along with the companies that house them.

7. Keep your savings under FDIC limits.

Many people grew lax about following FDIC guidelines and lost money when their banks folded. If anything happens to your bank, remember that your money is only guaranteed up to certain FDIC limits, so diversify your funds across several savings institutions.

8. Own stocks!

The current investment climate has scared many people away from stocks, and for some, it may have been for good! But owning stocks is one way to fight inflation risk. The best way to beat inflation is to own equities and invest for the long term. Work with reputable mutual fund companies, strong banks and solid online stock brokers as you manage your equity portfolio. I am particular about keeping my costs down with no load funds and low cost trades.

9. Diversify your investments.

Here's some proof that demonstrates that stock market diversification works and is the best way to balance overall portfolio risk and return.

10. Don't time the market.

Short-term or day trading hasn't worked well for me, and I doubt that it's worked for most people. You really need to know what you're doing if you're going to participate in this activity.

11. Limit debt and use credit wisely.

I don't carry much debt. But I do own credit cards, which I pay off in full each month and which I use to gain rewards. If you have great control over your spending (and only if you do), then using cash back credit cards is one way to leverage the use of credit to gain something extra for the spending you already do. But be aware that credit is a tool that shouldn't be abused.

12. Watch out for schemes that sound too good to be true.

Avoid get rich quick schemes, but it's easier said than done: just ask the Madoff investors! If you do ever fall for a scheme that turns out to be a scam, rule #9 (diversify) should help alleviate the sting of loss.

13. Don't burn your bridges.

I found my best jobs through my personal network of friends and former colleagues whom I remain close with. As yet another saying goes: "it's not just what you know, but whom you know". A good reputation and a social and professional network (have you tried Linked In?) can go a long way with providing a safety net, especially when times are tough.

14. Stay healthy.

The most common cause of bankruptcy is ill health. Unfortunately, good health is one of those things that we easily take for granted until it's too late. One of my highest priorities is to keep fit and say healthy: I've made the requisite changes in my lifestyle to ensure that I maintain these goals, by cutting down on the stress and improving my diet.

15. Do your due diligence.

And finally, whenever you purchase or sign up for anything that requires your dollars, remember that it's "buyer beware!", so make sure that you perform your due diligence and look over the "fine print".

The bottom line here is that it's best to be prepared. Prepare yourself well for emergencies and the unknown. But there may be times when no matter how well you do things right, you may still find yourself facing money troubles. In that case, hang on and hold on. The better you can anticipate and accept what does happen, the easier it will be for you to ride out the rough spots until your luck eventually improves.

This article is from Silicon Valley Blogger of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: