Business Administration

High Threshold of Knowledge

Three Primary Characteristics of Successful Businesses

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by

David J Hoare MSA
in

Three Primary Characteristics of Successful Businesses

Well, this is my 200th article in two years. I’m going back to the very first article I wrote and essentially rewriting that piece. When I reviewed it, I thought how poorly written and formatted the piece is and therefore I wanted to make my thoughts clearer. Here it goes: 

Over the last 27 years of working in the world of accounting, I have become convinced that to be successful in business, you must have three primary characteristics. It is the common thread that binds all successful operations in every industry I have witnessed. The first primary characteristic is acquiring a high threshold of knowledge related to your business. Secondly, you must have adequate capital to invest and retain in the business to provide proper financial leverage. Finally, you as the owner, must persevere over time. Time is the ultimate test for any business. 

To fully explain these characteristics, I am going to first define success. Then I will describe the concept of knowledge and define the barriers that you must overcome to claim acquisition of a high threshold of knowledge. The following section I will explain the second characteristic of success which addresses capital. Capital comes in three different forms, the first is financial which is the traditional understanding, but there are two others.  These include labor and intangibles. Not every business has to have pure financial investment, many require one or more of the different forms of capital. In my last section, I’m going to explain perseverance by illustrating various situations so you can fully grasp this particular characteristic of a successful business operation. 

Definition of ‘Success’ in Business

This is somewhat an elusive concept because it is driven by individual definitions. However, there are some core underlying agreements related to the fundamentals of success. First off, there is financial reward given the risk involved. In my opinion, if you are running a full time business, anything less than $100,000 per year for your physical presence is inadequate. Naturally this value should be higher for your more expensive areas of living in the US (Southern California, New York City, Washington D.C. and other major metropolitan cities). This income does not include return on your capital; it is strictly related to your management position in your business.

I have written several articles related to evaluating financial success in business and they include:

A close second to financial success for owning a business is providing long-term security to not only your family but for the employees that work for you. Ideally, you want a business that has long term potential and can provide a continuation of value to your family in case of unfortunate circumstances. These unfortunate circumstances can be economic, industry related and even personal. Imagine having a business operation that could provide for your family for many years if you suddenly had a health issue preventing you from continued employment. Inclusive of this secondary definition of security is the meaningful employment for your staff. A business operation where they feel they can contribute to and receive a fair compensation from for their families. 

Finally a third level of success relates to the product or service you render. Imagine overhearing a conversation between some folks and they are saying something wonderful about your business. A positive comment about your business environment or the product you sell or even the timeliness involved. This would make any owner beam with pride. 

Success comes down to financial, security and product. I discuss these three characteristics of business in another article and if you desire to learn more than read: Comparison of Profit Driven and Non-Profit Businesses.

There are other minor characteristics to define success such as self-made, high growth or even independence.  But these pale in comparison to the three identified above. Now that I have defined success it is time to look at the three principle drivers that provide success. The first one really focuses in on you. What do you personally bring to the business? Let’s explore the first characteristic of successful business – A High Threshold of Knowledge.

High Threshold of Knowledge

This is the one element that most closely parallels the economic understanding of supply and demand. It is important for readers to realize that some functions of our economy have very few individuals that can perform this job. Think of a brain surgeon. How many do you think exist in the United States? Well, I would imagine there are less than 3,000. Why? Well, think of the time it takes to get to that level of knowledge. After an undergraduate degree, there is medical school and then internship in a hospital somewhere, then general surgery and specialty and then finally you get to work with an existing brain surgeon to gain experience. Think about this, it probably takes well over 12 years of education and experience to finally be certified as a brain surgeon. Not too many people have not only the intelligence nor the drive but the steady hand that is involved here.  This is an extreme example of high threshold of knowledge. There is going to be demand for them, but due to the restrictive nature of the profession, there will a limited supply of qualified doctors.

This concept exists in every business and in every industry. Let’s go to the other extreme of requirements and see how this concept works. Let’s talk about a sandwich maker.  I’m not talking about the local kid putting together your Subway sandwich. I’m referring to someone owning their own sandwich shop. How do they garner a threshold of knowledge? Simple: they experiment and finally create a unique sandwich. Be the first to offer it to the public, maybe have some secret recipe or even a presentation process that brings the customer back. It is the process of separating your business from others. I’ll give you a personal example in the pizza business. 

When I was a boy, my older brother loved this place called Shakey’s Pizza. We live east of the Mississippi and back then there were several in the state. Today, there is one in Auburn Alabama. It is too far for us to go to get a pizza. But, the pizza sticks in my brain like the beauty of the opposite gender. What was so special about this pizza? Well, I think there were two distinct characteristics. First, the pizza was more of a cracker style but had the toppings all the way to the edges. In addition, there was some kind of granular spice on the underside that really brought out a distinct taste that I just can’t forget. Secondly, it was the environment. The restaurant was a self-serve style and there were old fashion 20 minute movies playing. These included the old Vaudeville Acts and the comedians from 30’s and 40’s. It was a wonderful way to have good food and have a laugh too. Today there are about 60 restaurants in the U.S.; most of them are west of the Mississippi. 

Notice how this business separates itself from your other national chains; nothing fancy, just good food and a different environment. It isn’t going to appeal to everybody, but it has an appeal to enough folks that it is able to garner a faithful customer base. I guarantee you it took years of testing, trying new presentation formats before it finally clicked. And this is PIZZA!

This characteristic of a high threshold of knowledge exists in every business. Think of Walmart for a moment. How can their retail concept be so much more impressive than other retail chains? Seriously, all they do is sell food and other department store products. Every one of their items can be found in a similar grocery or department store. What did they do to gain so much market share? What is their threshold of knowledge? 

Well, it is complex but the reality is that it took them years to develop a purchasing system, a distribution chain, proper location and understanding the demographics of customers. To achieve the same level of knowledge for any retail operation just starting out, it will take years of work to even get to a marginal mirror image of Walmart’s current status.

If you ever wonder why certain businesses are so successful, excluding the other two characteristics below, think of the high threshold of knowledge. For some industries, this one single characteristic almost guarantees success. The following are some examples of professions that immediately fall into this requirement to even have a chance of being successful:

  • Engineering
  • Professional Services
  • Industrial Construction (Roads, Bridges, High-Rise Buildings, Technology Facilities, Shipbuilding)
  • Manufacturing
  • Raw Resources Processing

This doesn’t mean you can’t gain this characteristic, it just means you need to be realistic in achieving this goal. Experimentation, education, and often failure are the attributes to achieve a high threshold of knowledge.  But once acquired, it sets you apart from the multitude of other businesses. This is only one of the three primary characteristics. Without the other two, the chance of you being truly successful is remote at best. It is time to go to number two on my list: Capital.

Adequate Capital

I have had probably 10,000 different business conversations over the last 20 years. One of the more common topics is why businesses fail. Invariably, the more novice business entrepreneurs will tell you that it is because of a lack of capital. I will endorse this if the business industry requires significant financial capital to operate (see below my example list). But overall, a lack of capital is a contributing factor not necessarily the entire reason for failure. 

To appreciate capital, one must understand that there are three forms of capitalization of any business. The primary one and the most often conceived form is financial in nature. That is, actual cash investment is made to get the business up and running. I can go on for hours with this one subject alone. But my goal in this article is to describe the three forms of capital and the general levels of capitalization for any business to have success. If you are interested in reading more articles about capital, I have written several on this site and they include:

Every business is going to be different in the required level of financial investment. Those businesses that receive their payment for services or product up front and even before rendering the product or service generally have lower capitalization needs. Examples include your vendor route delivery operations, some tradesmen in the construction industry and entertainers. Whenever the business can receive compensation as a deposit before rendering services or immediately upon completion generally have lower levels of required capital to fund the operation. The absolute best example is the airline industry. They are truly thinly financially capitalized, why? Because they get a lot of cash up front from airfare sales sold in advance. Even you paid for your last airfare well in advance of your flight, right?

On the flip side of this are those operations that extend significant credit to their customers. Especially if the customer is government or higher institutional based (hospitals, universities, and Fortune 500 companies). Here, the business has to carry the receivable for several business cycles and must fund work in process in the interim. Some really extended situations include those businesses whereby the product or contract cycle is extended over several months and the customer only progress pays based on completion of certain goals. These generally exist in the large contract based businesses such as shipbuilders, military contract development and governmental suppliers. 

The difference between the two extremes approach 10% funding of the business for prepay or demand pay operations and sometimes exceeding 50% capitalization for the extended pay operations. The more interesting aspect is that those extended pay operations are greatly larger in scope than the prepay operations. As an example, a prepay operation might be your local magician so for him, a 10% capitalization may only mean a $10,000 investment. Whereas, a contractor that builds Jeeps for the army may have to have 50% capitalization of a $200 million dollar asset business. In effect, as you head towards extended pay businesses, the capitalization requirements grow at a faster rate.

The second form of capitalization is labor based. 

In labor based capitalization, having all the cash in the world isn’t of any help to you without adequate labor. The key is having access to not only the physical requirements to provide services but the educated level of labor too. Without this form of labor, you may not meet the requirements of a contract or you could be penalized for failure to complete the contract on time or in a timely fashion. The industries that require extensive labor to fulfill the requirements of production or serve include hospitals, waste disposal services, security, emergency services and utilities. Notice the underlying common denominator of these businesses? They work 24/7 365 days a year. Without adequate labor and labor sources, there is no way they can meet their obligations and thus success will be difficult to achieve.

Unlike financial based capitalization forms of business where financial capital is up front attribute, labor based forms of capitalization must be able to have access and acquire the labor which is an ongoing attribute.

The third form of capitalization is those businesses that have intangible requirements. In effect, these businesses have to have certain rights via patents, copyrights and certifications in order to generate revenue or fulfill the goals of the operation. These rights are acquired through contractual agreement over time. The key is that these rights give an advantage over competition. Ultimately, customers prefer this advantage to serve them in some way. The one underlying attribute of intangible based capitalization is that this is generally a time derivative and not necessarily instantly invested. However, the value is long term and essential to fulfill the primary goal or goals of any intangible based operation.

A final note, the labor and intangible forms of capitalization are generally not reflected in the capital section of the balance sheet. The capital section of the balance sheet typically refers to financial forms of capitalization.  Labor and intangible forms of capitalization are sometimes referred to as ‘off sheet assets or equity’.

Examples of Various Capital Intensive Based Operations

  1. Financial Based – (Requires extensive financial investment due to the nature of operations)
    • Site Development Contractors – financial investment into equipment, carry receivables and work in process
    • Real Estate Investors – the 2008 real estate crash has modified lending conditions requiring around a 25% equity position
    • Industrial Level Equipment Manufacturers – think of the companies that build buses, fire equipment, trailers, railroad equipment, manufacturing equipment
    • Contractors – How to Find Capital for the New Home Contractor
    • Agricultural/Fishing – extensive amount of land/equipment/fuel etc.
  2. Labor Based – (labor intensive operations)
    • Catering/Food Service
    • Arborist
    • Cleaning/Janitorial
    • Fine Woodworking/Furniture
    • Distribution – this one is a combination of both financial and labor based form of capitalization
    • Auto Repair – notice that experience plays a significant role in delivering quality of service
    • Maintenance
    • Personal Hygiene – hair salons, barber shops, nail technicians
  3. Intangible Based – requires some form of specialized certification, creativity, and/or restrictive rights
    • Entertainment – music and theater
    • Franchise – fast food, car dealerships, movie theaters, bars and pharmacies
    • Recreational – parks, race tracks, marinas and high adventure
    • Manufacturing – specialized products, processes and conversion
    • Airwave – TV stations and radio broadcasting
    • Marketing – access to logos, brands, geographical territories etc. 

Some of you may have noticed what appears to be some bleeding over from the primary characteristic of a ‘High Threshold of Knowledge’ into one of the forms of capitalization, specifically the intangible based. Well, let’s distinguish the differences between them. In the high threshold characteristic, I’m referring to the primary owner or via the key man. Whereas in the intangible section, these rights or specialized skills may have been identified or even created by you, but in reality, they should be able to exist without you. The threshold of knowledge is able to take these rights and turn them into cash, in effect capitalization is the title to the rights; high threshold of knowledge is having the ability to turn those rights into cash. There is a difference between these two characteristics of success in business.

All of the above can create a successful business without the next characteristic. However, I’ve noticed that this is extremely rare. I mean really, some boy band makes it big in a year and so they definitely didn’t demonstrate this third characteristic. However, there was a lot fortunate timing involved.  Believe me, this is the exception and not the rule. In general, the rule is that the businessman must have both a high threshold of knowledge, proper capitalization and endure through time to acquire true success. What do we mean by enduring time? Let’s find out.

Perseverance

The third characteristic of success in business is what I call perseverance. Gaining true success doesn’t happen in an instant. Business is not a viral video! Sure I used the boy band in music as an example of an exception. But are they truly successful based on the definition above? Answer is most likely ‘NO’. Although they may have some financial value, they haven’t truly provided long term security. As with most musicians that suddenly make it big, the consumer will soon forget them unless they continue to work hard and create good music. To achieve true success, the band must endure the hardships of a public life, constant life on the road and a lack of privacy. All conditions of business many of us would avoid. These musicians will have to surround themselves with knowledgeable and loyal advisors. Again, all of this takes time which is the basic or primary definition of perseverance.    

Look around you in the business world. Think of your fellow business owners that you consider successful. Did they do this overnight, in a month, in a year? Odds are it took many years of hard work and dedication to persevere through the trials of business. It takes time to make errors and learn from them. It takes time to find the right staff and train them well. It takes time to overcome the economic cycles that exist in your industry. 

Every one of the individuals that I considered successful took more than 10 years to get there. They endured not just one or two, but several and often many hardships to get to this point in their business. Time is an essential characteristic of success.  

Now for some real life examples:

  • RV Dealership – one of my very early clients was a southern gentleman named Crosby. This man started out with his RV dealership way back in the early 70’s. He even has a picture of himself in one of those bright multi-color suits and bell bottom pants. And he had a lot hair. He told me back in those days, he worked long days, every day at the dealership. He did everything from selling to repairing the units. It was hard times, but he believed in his product and that ultimately others will too. Well, it took him 25 years to finally achieve true success. Today, he has one of the best dealerships in his state, he is well respected for his knowledge of the industry and he has a legacy for his family. His daughter currently has a significant management role at the company and she runs a good business.  

In his case, he does indeed have a high threshold of knowledge. He is very acute to the ratio of new and used unit sales; adamantly monitors Finance and Insurance, exercises his service and parts managers to take care of meeting goals and is truly customer oriented. He has an annual Christmas party whereby he invites all of customers that bought a unit during the year to come and have dinner with him. He utilizes several open houses each year to thank customers for shopping at his store. As it relates to capital, he exercises all three of the forms of capital. Financially, he has allowed the equity to build by retaining all earnings; this allows him flexibility in his floor plan. For the labor side of the equation, he finds people that actually care about the customer and then trains them to understand the product. For the intangible capital, he has territorial rights to certain lines of RV’s including the big motor homes.

The perseverance is self-evident. He said the worst time for the dealership was back in the late 70’s when gasoline went through the roof and interest rates were over 15%. Sales plummeted and he relied heavily on repair services to get by in life. He has now been in business for over 35 years. This man is the best symbol I can think of as a true self-made successful businessman.

  • Charlie – a residential contractor that changed gears after a few years of being a residential contractor. He switched to church additions, renovations and restoration. By adhering to a program of communication w/the Deacons or Trustees of the church, he was able to create his own niche. He understood the value of art and symbolism in religion and incorporated this into his business. This is that high threshold of knowledge characteristic of success I described above. As it relates to capital, he focused on using his profits to purchase real estate as the real estate acted as collateral in hard times. The man has been in business for over 40 years and to this day; he can drive down the town’s main street and point out all the churches that he has had contracts with over his lifetime. 
  • Children’s Therapy – the patriarch of the business started out as a mental health therapist. He decided to broaden his service by getting involved in providing therapy to children. It turns out he had to have a special license (intangible capital) to charge the state for services to the indigent. Over a course of 20 years he expanded the scope of services to include foster care and adoption. He’ll tell you he made a lot of mistakes along the way, but learned from them (high threshold of knowledge). Today, he has several state approved licenses related to children services and has a compliance program as they are audited several times a year by Social Services. He was fortunate in hiring one lady early on that was extremely detailed driven and is 100% loyal to him like a daughter to a father. The business continues today under the watchful eye of the son.  

I asked him how much did he initially invest and he tells me that he basically didn’t take a paycheck for a couple of years and that his wife supported the family in those days. All of his earnings were reinvested into the business. It took about seven years before the company started to perform well and provide security to all involved.

Summary – Characteristics of Successful Businesses

To appreciate the three characteristics of success in business, you must first define success. It is different to each one of us, but in general we all can agree on some core elements. Success can be defined as financial in nature, providing long term security for your family and your employees and finally, success is defined as delivering a quality product or service that customers appreciate. To achieve this basic definition, all successful businesses have three similar characteristics.

First, there is a high threshold of knowledge achieved by the primary key man of the business. There may be more than one person here, but the idea is that one or a few individuals possess the wealth of knowledge for your company and your industry.

Secondly, the company must be well capitalized. Capitalization has three distinct forms. The first is the traditional financial capitalization. The second form of capitalization is related to labor, having access to an adequate labor pool and furthermore, that pool meets the minimum level of education and/or experience. The third form of capitalization includes intangible based resources. This reflects having the proper rights or certifications to render service or produce a quality product. This area of capitalization is relatively young, but it is growing at a fast rate in our technology based economy.

The final and third characteristic of successful business is persevering over time. This is the one characteristic many business owners fail to achieve and is usually the primary culprit of failure. Remember, it’s supposed to be hard, if it were easy, everybody would do it! 

There is one last comment related to all of this. No one single characteristic makes you successful. It is usually a combination of all three to varying degrees. In some businesses, the high threshold of knowledge dominates the equation (architect), whereas in others, it might be intangible capital investment (writer with copyrights). But to be truly successful, you must have some combination of all three characteristics. Act on Knowledge.

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