I recently had a discussion with a business owner who was just about to launch his mobile dry cleaning and laundry operations. We discussed how the number ‘one’ is the most dangerous number in business for him, and when he pitches to investors he should have answers to the following questions:
1) You have 1 van. What if it breaks down for 2 days? How will the business keep running? What back-up delivery options do you have?
2) You have 1 dry cleaning service company you’re using. What if they hold you hostage to a higher split of the fees or fail to deliver on time consistently? How could you get at least 3-4 cleaners to work with you?
3) You want your sales funnel to be based on just one marketing pillar, namely door-to-door sales. What happens if it fails for 2 months and you only reach 1/3 of the sales you expect? What other marketing pillars could you use?
If any one of the items in the above three points fail, it will stop his entire system from working. This is called a Single Point of Failure (SPOF) and is defined as “a critical component of a system for which no backup (redundancy) exists and the failure of which will disable the entire system.”
Every entrepreneur’s starting point is 1: one customer, one supplier, one employee, one marketing pillar, one price. As the business grows, it attracts many customers, works with different vendors, and receives funding from a variety of investors. The entrepreneur now works in 5th gear all day. Before he can resolve one problem another has already appeared. And this leaves no time for thinking. Although he has grown beyond the number ‘one’ in many areas of his business, he has blind spots that could cripple his operations. His perfect design for a business turning over GBP100,000 has become flawed as he now generates over GBP500,000 revenue per year. Single points of failure become dangerous liabilities when your company starts to grow quickly.
SPOF IN FINANCE AND NUMBERS
In investment management, there is a rule that says the more you diversify your assets the lower your risk for a similar or higher expected rate of return. The key is to own a variety of assets that have a low or negative correlation with each other. For example, the equity markets have historically had a negative correlation to the price of gold. If one goes up, the other will go down and vice versa. Similarly, for good risk management in your company, diversify as much as possible and work with as many uncorrelated funders, vendors, customers, etc. as you can.
A second definition for a SPOF is ‘a risk posed by a flaw in the design, implementation or configuration of a circuit or system in which one fault or malfunction causes an entire system to stop operating.”
A FLAW IN DESIGN CREATED BY GROWTH – BANK ACCOUNTS
When you start your business, you open 1 bank account. Complicating things at this stage would be foolish as your focus should be on launching and operating your company. Over time though, you should spread your assets and risk over different banks. Your personal banking should be separate from your business banking, which should be separate from your investment funds. In 2008-2009, the world experienced a black swan event – the housing crisis. A black swan event is “an unpredictable or unforeseen event, typically one with extreme consequences.” The banks ONLY survived due to a government bailout. Don’t put all your eggs in one basket.
Similarly, don’t have all authority for money and payments sitting with one individual. When it comes to bank accounts, ensure you have multiple authorised signatories in your company. Name these people in your finance and accounting manual and require any payments to have dual signature approval. This includes wires, cheques and cash advances above a certain GBP threshold.
A FLAW IN DESIGN CREATED BY AN EMPLOYEE – ORGANISATIONAL STRUCTURE
In the following story, I provide an example of how an employee single handedly created a single point of failure inside a company. You’ve hired a new branch manager who, unbeknown to you, will become a future problem employee. Obviously, this is not ideal, but the damage could still be averted if your internal hiring controls can alert you to the fact that he will look to recruit his cronies. If he is able to hire his own team who is loyal to him, he may slowly start altering the organisational chart and put each one of them in senior positions. He may alter the functioning of the branch from one that has an open group leadership style, where all staff contribute to new ideas and growth, to one that has a closed group leadership style and is more dictatorial. As the business owner, you’ll inadvertently start talking more and more with the branch manager and less, if at all, anymore to anyone else at the branch. In this way, the branch manager has slowly and strategically moved himself into a position of a ‘single of point of failure’ in your organisation with the ability and authorisation to breach your internal controls without your knowledge.
NUMBER ‘ONE’ S THE MOST DANGEROUS NUMBER IN BUSINESS
The solution to this problem is a diversification of authority and a return to an open group leadership style. As soon as you’ve removed the culprit, first create a new organisation chart. Your old structure has been distorted and roles and responsibilities must be made clear again to all staff members. Secondly, create more points of interaction between the head office and the branch to eliminate communication and work flowing through a single person. Third, revisit your work plan. This difficult situation has likely caused the organisation to fall behind on its targets and each employee must again understand their plan to reach their goals. It’s important to note that good quality work is more important than hitting targets that may have become too much of a stretch. Finally, revisit your core values and communicate them frequently to staff. The culture needs to be built again.
A FLAW IN DESIGN CREATED BY BOOM AND BUST CYCLES
The 1973-1974 stock market crash (oil), the 2000 dot-com bubble (internet), and the 2007-2008 Financial crisis (housing) had a catastrophic impact on those businesses that had leveraged themselves to the boom going on around them. If your customers and vendors were all internet companies in 2000, and you didn’t diversify your revenue streams, you probably filed for bankruptcy soon after the bubble burst.
THE BIGGEST FLAW OF ALL
Key man risk is the danger of over-reliance on one or a few individuals in your organisation. It’s so prevalent among small businesses, that ‘key man risk insurance’ exists. The biggest flaw in designing a company is when the business owner keeps himself at the centre of his empire. Everything goes through him and he makes all the decisions. In 2009, Berkshire Hathaway’s credit rating was downgraded due in part to the issue of key man risk. The credit rating agency had a long-standing concern that the company’s long-term investment results and ability to identify and purchase attractive operating companies was intimately tied to Warren Buffett.
Every business problem can be traced back to a design flaw. Where have you left “one” of something in your original design of your company? If you can find these areas, they will show you where your business could be at risk.