Category Archives: business model

How to Try Before You Buy a Company

While lots of mergers fail, and if you had to pick one reason – it is companies rushing in without really vetting the potential match.

It seems there is news everyday about a proposed merger or acquisition between two companies. While buying another company is certainly a viable strategy for helping your company achieve your long-term vision, the statistics about the failure rate of acquisitions is certainly sobering. One KPMG study found, for example, that 83% of all M&A deals end in failure.talk to us

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Moats and Machines: How Warren Buffett Analyzes a Business

Warren Buffett knows great financials are critical to the success of any business, they are really just outcomes from having a strong “machine” and an impenetrable “moat” for your business.

When you ask most CEOs about their vision for their business, they usually give you an answer built around metrics like number of customers, market share, or profitability.

But what I would argue is that while all of those numbers are critical to the success of any business, they are really just outcomes that result from having a strong “machine” and a “moat” for your business.contact us now Continue reading Moats and Machines: How Warren Buffett Analyzes a Business

Apple’s Boring Mission Statement and What We Can Learn From It

Thousands of hours have been wasted talking about mission statements that are, quite frankly, boring. The best mission statements, are both inspirational and to the point.

Mission statements are critically important to your organization because they drive alignment in your organization toward the vision of what you want to get done. That’s why it should be the inspiration that your organization rallies around. Unfortunately, many thousands of hours have been wasted talking about mission statements that are, quite frankly, BORING! talk to us

The best mission statements, on the other hand, are both inspirational and to the point.

Consider the example of Apple. When Steve Jobs started the now iconic company, his mission statement was: “To make a contribution to the world by making tools for the mind that advance humankind.” Wow; that’s something I would get out of bed in the morning for.

But as much as Apple has contributed to the advance of technology, the company has come under increasing criticism that it has lost its way since Jobs passed away in 2011.

One of the changes the company has made in the years since is to change that original mission statement, which now reads like this: “Apple designs Macs, the best personal computers in the world, along with OS X, iLife, iWork and professional software. Apple leads the digital music revolution with its iPods and iTunes online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App store, and is defining the future of mobile media and computing devices with iPad.”

 

Which mission statement do you prefer? While the newer version is very specific about what the company does, it certainly fails to meet the criteria I suggested earlier: it’s not inspiring and it’s certainly not brief and to the point.

Now compare Apple’s latest mission statement with some other major companies. For many years, Pepsi’s mission statement was: “Beat Coke.” That’s certainly simple and while it doesn’t get into the tactics of how they will fulfill that mission, it gives everyone in the organization a clear vision of what they need to accomplish.

Another great example comes from Medtronic, the medical device manufacturer, whose mission statement is: “To extend human life.” That’s an exciting mission and certainly something that is inspirational for anyone who works inside the business producing products like pacemakers and defibrillators.

But you don’t have to be a major corporation to have a great mission statement. I worked with a business that competed in the exciting field of humidity measurement. It’s not a big market, maybe $500 million in total, but this company established its mission as: “Global domination of the humidity measurement industry.” Not only is that clear and inspirational, it gives everyone plenty of scope for the business to aim at over the next several years.

What happens in situations like what we see with Apple is that you are trying to please everyone. You worry about offending someone, or leaving someone out. But by trying to be inclusive and non-offensive, you lose that focus and inspirational tone you need for your mission statement to be meaningful. That then leads you down the path of a favorite quote of mine from the movie RoboCop where executive Dick Jones says, “Good business is where you find it.” It basically means, “We will do anything for anybody, if we can make money”. That’s not too inspirational.

In other words, you chase every opportunity you can–which can be the worst thing for your organization to do. As I have written about before, your organization is actually defined by what you say no to.

Worse than trying to please everyone are mission statements designed by committees. Mission statements are also like strategy in that they are best done in smaller groups–preferably one using the seven plus or minus two rule. When you give the job of crafting your mission statement to a committee, you end up with boring, multi-syllabic paragraphs that say a lot about nothing, much like the one from Apple.

So take another look your company’s mission statement. If you start yawning when you read it, it’s time to make a change by making it shorter, tighter and more inspirational. Grab a small team – be bold, say no to lots of things and inspire your team!

Want to Win? Keep Your Strategy Short and Sweet

When it comes to communicating about your strategy with your organization, and ensuring you don’t out think it, the phrase to remember is: keep it short and sweet.contact is we help you grow

Everyone who runs a successful business believes that they have the best people working for them. And that’s no accident since we invest so much time and effort in screening and interviewing people to ensure they are smart, capable, and a culture-fit all in one.

But the truth is that no matter how hard you work on attracting and hiring the best of the best, the collective intelligence of your organization is still just about average, especially if you have a larger operation. Maybe your organization is the exception and you are really, really good at hiring–but that only means the total team might be 5% to 10% smarter than everyone else. It all comes back to averages. It’s just a mathematical reality.

At the same time, one of the aspects that set great leaders apart from the pack is that they tend to have special skills–particularly the ability to see over the next hill and make connections and correlations that the rest of us can’t. Much of that ability comes from experience, knowledge, and the ability to do complex thinking. These are the people who can see into the future, if you will, since they are the ones who are great at mapping out the kinds of strategies that put companies on the fast track. They can anticipate how doing A plus B, contingent on C, equals Z.

Guess what happens, though, when great leaders like this try to explain their complex strategies to the average worker? They get looked at quite literally as if they were from another planet. Sure, most people might understand A and B, but how the heck did you get all the way to Z?

To put that another way, great leaders need to learn to not out think their organizations.

What this means at a practical level is that when it comes time for you as a leader to explain your company’s strategy, you need to pare it down. Yes, you can talk turkey with your senior leadership team. But when it comes to company-wide communication, make things short and sweet enough to give your team the information they need to act without overwhelming them. Boil it down to a maximum of three elements since that’s the maximum amount of information most of us can process. Not seven, not five–three is the magic number. Then take those elements and repeat, repeat, repeat as a way to drive them throughout your organization.

Consider the classic example of legendary CEO Jack Welch’s reign at GE. At the time, GE was a massively complex organization worth more than $100 billion with its fingers in all kinds of industries like light bulbs, locomotives, jet engines and finance. You can imagine the kind of complexity that went into managing the strategy for that kind of multi-pronged business.

But if you worked at GE at that time and heard Welch speak, he would have focused over and over again on just three things: globalize the business, drive service and recurring revenues, and improve quality throughout the company by embracing the discipline of six sigma.

Of course, Welch could peel the onion or dive deep whenever he needed to. But it was by repeating those three basic elements that he knew he could get everyone in his organization, no matter how average they were, aligned without fearing of talking over their heads.

I actually had a similar experience with a boss, Paul Snyder, earlier in my career. Paul was the CEO of High Voltage Engineering and, while we weren’t on the scale of GE, we were a multi-faceted and growing business with thousands of employees. But I remember even to this day the three things Paul repeated over and over again about our strategy: make the numbers, grow the business and invest in the people. Guess what we talked about every time we got together?

Boom: easy enough for anyone to remember, including me–for many years! That’s the real value in not out thinking your organization. So when it comes to communicating with your strategy with your organization, and ensuring you don’t out think it, the phrase to remember is: keep it short and sweet.

How to Avoid Mission Drift and Stay True To Your Purpose

Mission drift is an irresistible force. You need to build in measures to help you avoid suffering from this crisis of identity. If you don’t, you might end up running a company that is very different than the one you intended to build. contact is we help you grow

As every company gets older and matures, especially around its tenth anniversary and after, it can be become difficult to remember the reasons why it was founded in the first place. When you look to those organizations that have been around 30 to 50 years and older, it can be really hard to believe you’re talking about the same place.

For example, did you know that Harvard University’s founding purpose was to “prepare ministers of upright character”?

It would be tough to argue that Harvard still operates by that same purpose today even though it’s in the exact same place it was founded back in 1636. So what happened?

In short, mission drift.

This is something that threatens every organization out there and, unless you put some safeguards and preventative measures in place, you could find yourself running an organization you don’t even recognize anymore.

What makes this challenging is that mission drift isn’t something that happens all at once. Think of it more as being nibbled to death by ducks. It happens one little decision at a time, where you go astray by just a bit. Maybe it’s a decision about chasing revenue from a customer that doesn’t really fit with your mission. It doesn’t seem like a big deal at the time. But, when you add that decision up with all the others like it, you can’t believe how you got where you ended up.

Take another example, this time from the retail sector. Entrepreneur Dov Charney founded his company American Apparel back in 1997 because he was tired of seeing American manufacturing shop being shipped overseas. He started his company to create jobs by starting making clothes in the U.S. again.

But over time, the business experienced mission drift. Eventually, rather than focusing on creating American jobs, the company became known for its sexually charged ads. For his part, Charney became known as the Hugh Hefner of retail as the business continued to shift away from its original mission. More recently, the company declared bankruptcy, which should serve as a sobering reminder of what can happen when you lose touch with the values you began your business with.

So how do you avoid mission drift and keep your organization on the right path? Here are a few tips:

Your Board Tip one is to enlist a board that is fully in line with the organization’s mission. Make sure they buy into your purpose and then charge then helping make sure they say something if they think a decision is out of alignment with your values.

Your Executive Team The second tip is to hire executives and leaders who also buy into the mission, purpose and values of the organization. Then exit the people who don’t–regardless of how great a performer they are. While that might be a painful decision to make to your bottom line in the near term, it will pay off big time over the long run.

Embed Mission into Your Culture You can also use stories and symbols as ways to embed your mission and purpose into your organization DNA in such a way that everyone in the organization can make their own course corrections on a daily basis.

Similarly, everyone in the company should use the mission and purpose of the company as their North Star of sorts as they make their decisions. Everyone needs to be encouraged to act on the notion that if something requires him or her to act against those values, they quite simply shouldn’t do it.

Measure the Mission And finally, constantly measure how true you are acting when it comes to your mission. You need only look to the great retailer Nordstrom for inspiration in how to do this. Every day, Nordstrom posts a list of the top ten salespeople in the company: everyone knows who the rainmakers are. But just as importantly, the company also publishes the letters from customers who are saluting those employees who stood out in supporting the company’s mission, which is is to “provide outstanding service every day, one customer at a time.” Seeing those letters every day is a way to measure how well Nordstrom is tracking to its mission.

One day, for instance, the company posted the letter from a customer who couldn’t believe how, after she called a store to see if they had found a diamond that gotten loose from the customer’s engagement ring, the staff at the store scoured every inch of floor looking for it. More incredibly, they also went through every dirty vacuum bag until they found it. How’s that for supporting your mission?

The key again is that as your company gets going, you need to build in measures like these to help you avoid suffering mission drift. If you don’t, you might end up running a company that is very different than the one you intended to build.

 

 

Simple Is Hard: Design Secrets of Jeff Bezos and Steve Jobs

According to many iconic leaders, simple is hard, but it’s also an incredible advantage. So if you make time to make things simple, your customers will thank you.

The French philosopher and mathematician Blaise Pascal once penned a letter to a friend in which, at the end, he wrote: “If I had more time, I would have written a shorter letter.”

This quote is quite famous and, like many well-known quotes, often gets attributed to other luminaries such as Abraham Lincoln or Winston Churchill. But what Pascal meant when he wrote those words was that he had simply scribbled down what he was thinking as he wrote rather than spend the time to plan and process his ideas before he picked up his quill and ink bottle.

Pascal of course couldn’t edit as easily as we can with the help of our word processing software, so he meandered and digressed as he scratched the words into his piece of parchment, which resulted in a longer and denser letter than he might have liked to have sent.

But this exact same thing happens all the time when it comes to designing our business processes and systems. When we don’t do the necessary work up front to create a design that is simple and elegant, we end up building products and services that are complex and cluttered. Put another way: Simple is hard.

Simple is hard.

This is actually something that great business leaders understand quite well. Think about how Jeff Bezos helped design the way Amazon.com works–especially if you are an Amazon Prime member. Every time you return to purchase something, everything –your address book, credit card information, shipping preferences–is all ready to go with literally one click of a button. It’s incredibly simple to use and it shouldn’t come as a surprise that when Amazon introduced one-click shopping, the company’s revenues skyrocketed.

But what might go unappreciated is how much work Bezos and his team put into making that design so simple. They very likely invested thousands of hours in user testing to streamline the process that we now benefit from. Again, simple is hard.

Consider also any Apple product you’ve ever handled. Not only are they gorgeous to look at, they’re incredibly intuitive to use, so much so that Apple famously doesn’t even ship user manuals. Apple products are so simple to use, even children can literally pick them up and operate them.

But if you know anything about Steve Jobs, you know that he was fanatical about design and he spent countless hours obsessing over even the most minute design detail as a way to simplify it and make it easy to use. Repeat after me: Simple is hard.

Simple is a competitive advantage.

Now think about the processes and systems in your business. How much time are you spending up front to make them simple and intuitive for your customers to use? Have you fallen into the trap of relying on a user manual as thick as your forearm while making the assumption that your customers will just figure it out?

It’s worth thinking about, especially if your competitors are offering an easier-to-use alternative. If you had to reenter all of your billing and shipping information every time you placed an online order, versus just clicking a button, where would you spend your money?

Or what kind of device would you rather buy: one that you can pick up and start using right out of the box, or one that makes you fall asleep trying to pick your way through a user manual? Customers like simple. And simple wins in the marketplace.

Simple is hard, but it’s also an incredible competitive advantage. So make the time up front to think hard and write a shorter letter; your customers will thank you.

The 5 Best Kinds of Recurring Revenue

The 5 Best kinds of Recurring Revenue picture

Not all recurring revenue business models equally valuable. You can think of it as a scale with five levels where the higher your business model falls on the scale, the more valuable it is. And the key to value in this case is making it hard for competitors to take your customers while also making it undesirable for your customers to switch their business.

In a prior post, we talked about the power of recurring revenue. But some recurring revenue business models are more valuable than other kinds. You can think of it as a pyramid with five levels where the higher your business model falls on the scale, the more valuable it is. And the key to value in this case is making it hard for competitors to take your customers while also making it undesirable for your customers to switch their business.

Repeat Customers are Good

At what we’ll call Level One of the pyramid is a business model based on Repeat Customers, say something like a grocery store. Having folks around the neighborhood stop by every few days to pick up their staples like milk and eggs is a great thing. By providing solid customer service, you can hope to attract those same customers on a weekly basis for years. The rub is that there is really nothing stopping your customers from stopping by a new store that opens on other side of town. Other than the possible cost of fuel, there are no switching costs for that customer. So, while having repeat customers is far better than not having them, your revenue stream remains risky because you can’t count on your customers sticking with you. Many firms in this mode have build affinity programs, like frequent flyer cards to create stronger brand preference and make their offers stickier.

A Network Effect is Better

That leads us to Level Two of the pyramid, which is called Repeat Revenue with a Network Effect. What this means is that the more someone uses the company’s product or service, the more each individual customer gets out of the experience–something called the network effect–which creates a barrier to that customer leaving because no other network is as good. Consider the appeal of a company like eBay. Regardless of whether you are a buyer or a seller, the more people that participate in the company’s online auctions, the more valuable it becomes for you to the point that you wouldn’t even consider switching to a competing offering. Can you even name a viable competitor to eBay these days?

Sequenced Product Purchases are Great Revenue

The next level up is Level Three: the Sequential Revenue Model. The idea behind this approach is to create recurring income by encouraging your customers to consistently upgrade to new product and service offerings. Consider the example of a company like Constant Contact, which starts customers out on a basic plan that costs $10 month. As you begin to use the system more, you can then upgrade if you like, spending an additional $5 a month to get unlimited image storage or the ability to input a larger number of contacts. In other words, the more you use the system, and the more valuable it becomes to you, the more you’re willing to pay. This model also works where companies may offer a free service as a way to attract new customers, something known as a “freemium” model. DropBox, for example, has both a free service and a premium service where customers can access advanced features. Even if the company can convert just a fraction of its customers over to the premium service, it can create an extremely valuable recurring revenue stream.

Good Until Cancelled Revenue is Really Great

Level Four of the pyramid is called Good Until Cancelled Recurring Revenue, where you find examples like insurance agencies or your cable company. What makes this model powerful is when it’s based on an “opt-out” model where the customer has to terminate your relationship with them. Think about when you sign up for your auto insurance policy: You agree to pay a certain amount of money every month until you cancel, which makes for a fine source of recurring revenue. You actually have to make an effort to stop using the insurance. Credit card or bank account billing, where the customer pays their bill automatically, is an extremely powerful way of keeping customers over the long haul.

Contractual Recurring Revenue is the Best

Level Five, the highest level of the pyramid, is Recurring Revenue with a Contract. Think about the contract you signed when you got your new cell phone. Not only did you agree to pay a certain amount of money each month depending on the plan you selected, you also agreed to keep paying for something like two years. Sure, you can change your phone provider, but this time it will cost you, say, a $175 switching fee. That makes changing a little more painful for you as a customer, which, in turn, makes for a better business model. The phone company also runs promotions where it offers you a discounted new phone every year or so. Of course, there’s a catch: You need to sign a new two-year contract to take advantage of the offer. Again, this is an extremely valuable model because you can predict with a higher level of certainty what your recurring revenues will be both in the short-term, as well as over the longer term.

In our next post, we’ll talk about some of the strategies you can use to build recurring revenue into your existing business model.

Building A Better Business With Recurring Revenue

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One truth in business that most CEOs and entrepreneurs alike tend to overlook: not all revenue is created equal. Sure, a dollar in sales is a dollar in sales. But the more predictable that dollar is, as in the more likely that you will receive that dollar from your customer every month, the more valuable it becomes. When you begin to multiply that dollar by adding new customers and creating an annuity of cash flow, you begin reaping the benefits of what is known as a recurring revenue stream. And people pay for that!

Examples of businesses that have built recurring revenue into their business models range from companies like Salesforce.com and Constant Contact, which charge their customers a monthly fee to use their services, to the online GoDaddy! and dating site e-Harmony, who make their services “sticky” based on the power of their communities of customers. The point is that these companies have found ways to keep their existing customers month after month and year after year rather than having to find a new crop of customers each quarter to keep the business growing.

What makes recurring revenue so valuable is that you can spend more of your energy growing your business rather than on trying to acquire enough new or repeat business just to hit the same revenue level you did the year before.

Easier to Grow

Let’s say you run a business with $10 million in sales, 90 percent of which is recurring. Since you can already bank on receiving $9 million as you kick off your next fiscal year, all you need to find is an additional $1 to grow. Compare this to a business built with no recurring revenue. You might earn $10 million in a single year. But, every subsequent year you begin again at $0–something that makes it difficult to sustain growth.

Which business would you rather run? The answer is obvious.

Predictable Costs

The beauty of recurring revenue is that because you can predict what you’re going to earn, you can also predict your costs better which results in less risk–something that investors love (one private equity firm even hands out bumper stickers that say: “I heart recurring revenue.”). In fact, the more recurring revenue a company has, the higher the valuation it will receive from prospective investors and buyers. That’s why recurring revenue has become the gold standard of business models and something that every CEO should be working towards building into their own business.

Higher Business Valuation

Consider the example of ADT, which provides security systems. When you sign up for ADT, you sign a three-year monitoring contract. ADT knows that once you clear the three-year mark, you are highly likely to remain a paying customer of theirs–perhaps for another 5-7 years! That kind of predictable revenue stream helps explain why ADT currently has a market capitalization of about $5.87 billion with revenues of $3.3 billion. When you do the math, we see that the market is valuing every dollar of revenue at ADT as $1.78

In contrast, we can look at Ford Motor Co., which has revenues of some $123 billion. And yet, its market cap is just $30.4 billion–meaning the market values every dollar of revenue Ford generates as just $0.25. Why the difference? Because ADT has recurring revenue with lifetime value of customers and Ford is still stuck with a largely transactional business. That’s why, to repeat, not all revenue is valued equally.

Small Steps Matter

Whether you’re the CEO of a company or an entrepreneur hammering out your first business plan, you need to be thinking of how you can drive a higher percentage of these flavors of recurring revenue through your company. Even if you can move from 0 percent to 15 percent recurring revenue, you have done wonders for the value of your company. Ideally, as a culture, we’d never see another business started that didn’t have recurring revenue woven into its core. The point is that if you’re not thinking along these lines, you’re putting the future of your business in jeopardy and making your life harder.

In our next post, we’ll discuss a few strategies for integrating the power of recurring revenue into your existing business.

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How to Help an Underperforming Worker in 6 Steps

number-rankings underperforming players

One of the most challenging tasks for any leader is figuring out what to do with an underperforming team member in your organization– a C player. The challenge is that your employee might be a good person, probably someone who has even bought into the values of your culture. The simple answer is to fire them and move on, but that isn’t the way to treat people. But they simply aren’t performing the way you need them to. So what do you do?

Step 1: Make Them Aware There’s An Issue

The first step in dealing with an underperforming employee is to make them aware that they are, in fact, underperforming. Simple, right? And you need to be as specific as possible about where they are falling short, which means it helps to bring data with you to prove your case. It’s also something you need to do as soon as you know it’s happening–regardless of whether they just joined the company three months ago or even if they just had their annual review. The point is that you can’t afford to wait until an end-of-year review to let them know that a problem exists; it needs to happen immediately.

Step 2: Offer Coaching for Improvement

Once you have let your employee know that they are underperforming, there are some things you can do to help coach them to improve their performance. Before you get there, though, you need that employee to “own” the fact that they are falling short in their performance. If you can’t break through to them at that level, then your conversation, and their time with the organization, will become very short.

But, if your employee does own their performance–and commits to improving it–then you can work together to put a plan in place to get their performance up to standard. If your employee works in sales, say, and is only closing five deals a month and they should be closing 15 or more, you can ask them what they will do differently to reach that new level. You can then begin a monitoring program where you see how that new plan of action is working. Where are they after 15 days? At 30? If they aren’t tracking toward their goal, then you know you have a problem on your hands and can begin planning your next move.

Step 3: Educate Them

It’s possible that your employee might actually lack the skills they need to perform their job well. That’s an opportunity to offer them the chance to learn those skills that will help elevate their performance. But remember, this is a short-term effort targeted specifically at helping them learn the skills to do their job better. It’s not about offering to pay someone to go get his or her MBA.

Step 4: Shrink Their Job

Sometimes, especially in the case of fast-growing companies, employees find that the company’s growth outpaces their own ability to keep up. You see that a lot with managers and executives who excel during the early years of a startup but begin to fall behind as the company continues to scale up. One of the options you can employ to help an underperformer is to break up the job as a way to make it more manageable.

Take a sales and marketing leader, as an example. Perhaps you could divide up the job into sales and marketing, leaving the incumbent in one of the roles and hiring the other. While this can often be effective, it also involves someone checking his or her ego at the door to make it work–which isn’t always possible.

Step 5: Change Their Position

If you have an employee who continues to underperform despite the help of coaching, training, and shrinking their job, your option of last resort might be to move them into a different position in the organization where they might be a better fit. Think about a salesperson who you might move into more of a product support role where they can worry more about helping other salespeople be successful rather than filling their own quota. Again, you might encounter ego issues with such a move. But it’s advisable to keep that person’s salary the same even after the shift as a way to mitigate that. They might not get any raises for a while, but it will help them keep a positive mindset as they attempt to scale up into the new position.

Step 6: Exit Time

If you’ve done everything possible to put your C player in a position to succeed without success, then it’s time to exit that person from the organization. If it comes down to this, you can give your employee the chance to take the soft road out, wherein you give them three months or so to find a new job as a way to avoid terminating them directly. This strategy is generally in place of a severance arrangement.

But, if that, too, doesn’t work out, you’ll eventually need to make the hard decision to terminate them with the hope that they’ll find a new job soon.

Obviously no one likes to terminate anyone. But it’s essential for you, as the leader, to remember that your organization can’t afford to rely on C players for its future success. Ultimately, the organization is looking at you to be the Head Coach and make changes on the team if needed. If you aren’t, they begin to wonder if you aren’t a C….

Have a Good Business Model? Take This Test

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Do you have a great business? One thing I’ve learned from coaching hundreds of entrepreneurs is that just about every one of them thinks they have a “great” business model. Do you? If you want to test how great your business really is, ask yourself how it rates on the following four factors:

Lots of Demand–Book to Bill Ratio

While it’s nice to build a business around a niche that your competitors have overlooked, a great business has significant demand for whatever it sells. One way to gauge that is to look at your book-to-bill rate, which you can calculate by dividing how many orders you’ve taken in by the orders you have shipped. If you have strong demand, you should score a ratio of 1.2 or higher, which means you’re booking more than you’re shipping and growing. Think about how good boutique wineries operate. They always sell out their entire inventory each season–which means their demand is always higher than their supply. Why is that a good thing? Because it keeps their prices high.

You Have a “Mafia Offer”

A Mafia Offer is where you can offer your customer such a good deal, they would be crazy to turn it down. Just think about the history of the video rental industry to see how powerful this can be. Remember when you used to have to go to the video store to pick up your movies? That was fine until Netflix came along and made their first Mafia Offer, which said, why go to the store when you can just order your movie online and we’ll ship it to you? Even better, we won’t charge you a late fee and we’ll give you the envelope to mail it back to us. You’d be crazy to turn that down, right? Of course, Netflix did it all over again when it introduced its streaming movie plan. Now, you can do everything with your remote control in just seconds. Oh, and they’ll charge you less to do it. You can tell a good Mafia Offer whenever you see an existing business model folding under the pressure created by a new one.

Strong Gross Margin

Your gross margin is the amount of profit your business has earned before paying overhead and after you’ve paid for the cost of making your product or delivering your service. Great businesses have gross margins of 50% or higher and net margins, which account for general overhead, in excess of 20%. Think software companies, professional service firms, and pharmaceutical manufacturers. When you have margins like these, you don’t need to tap external financing to keep growing and you’ll net sky-high valuations if you want to sell your business.

Your Assets Work Hard

To calculate your return on assets, add up all the assets in your business–including your cash, equipment, and working capital–and then compare that to your profits. If your profits don’t represent at least 20% of that figure, then you don’t have a great business. Why? Because that means you’re not generating a high enough rate of return to justify the risk of operating your business. You could put that money into the market and return a similar rate without the risk of, say an employee lawsuit, your building burning down, or even running out of cash. You need to generate a return that’s materially better than anything you could get from the market to make it worthwhile. In fact, if you have a 20% return on your assets, you have a really good business. But of you earning a 50% return on assets, that you truly have a great business on your hands, usually because you’re not burdened with a lot of inventory, equipment, or working capital.

Use these four factors to take a hard look at your business. Give yourself a score on each and see how you rank. That’s how you’ll know how great your business really is.