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Issue Date: Vol. 49, No.5, May 2009, Posted On: 6/1/2009


Secrets Of A Successful Diversification Strategy


by Frank Seninsky
Frank Seninksy, amusement machine, arcades, family entertainment centers, vending, vending business, vending routes, coin-op, coin-operated, automatic retailing, small business, business diversification

Despite centuries of folk wisdom that urged "Don't put all your eggs in one basket," one of America's most successful industrialists used to recommend the opposite approach. Andrew Carnegie claimed that diversification was actually a terrible idea. According to Carnegie, the founder of U.S. Steel, the secret of success was to "put all your eggs in one basket -- and watch that basket!"

In fact, Carnegie went farther than that. He put everybody else's eggs in his basket, too. This ambitious tycoon bought up competing steel manufacturers and ore suppliers as fast as possible, until his company dominated the world steel market. It's hard to argue with success like that.

Was Carnegie right?

Plenty of amusement operators seem to think so. As the industry's economics get tougher and location traffic thins, many operators are pursuing a growth strategy that is based on rollups of competitors. Their favorite purchase is not a new game or jukebox, but a competitor's route.

Over the decades, some of America's largest operators have purchased dozens of routes. They are looking forward to buying almost as many more competitors in the next five to 10 years. These large operators believe this buyout strategy will allow them to dominate their town, county, state or multi-state regions; pick and choose the best locations; and put them into a far stronger position to negotiate terms with location owners.

Many of America's leading operators have proven the power of this strategy by building multimillion-dollar businesses. It's hard to argue with that kind of success, too.

Personally, I come down squarely in the middle between the two competing strategies of "one closely watched basket" and "many extremely profitable baskets." I happen to believe that the "many baskets" strategy can be adapted to conform to Carnegie's insights. This blended approach has also proved quite successful for thousands of operators.

To take the most obvious example, a sizeable number of operators are active in both amusements and vending. Others are involved in both street route operations and family entertainment centers. Still others run both amusements and bulk vending.

This form of growth comes so naturally to amusement operators that we almost don't think of it as diversification. It just makes good sense to deploy the same resources in the service of multiple types of machines in the same area.

I don't think Carnegie would have objected. Most of these multi-market operations are so closely integrated that the operating company still constitutes one basket. The same truck that supplies the cranes, also stocks the soft drink vending machine. The same routeman who collects the jukebox also collects the bulk vending head. And so on.

In any case, successful operators watch every penny very closely, regardless of its cashbox origin, and Carnegie would definitely have approved of that.


THE "THIRD WAY" APPROACH

There is yet another approach to diversification that, like the first two, has also proven successful for operators. This third-way approach aggressively combines the single-basket and many-baskets philosophies. My company has been using this approach for four decades.

In a nutshell, the "third way" is to eliminate one company that does several related things, like amusements and vending, and replace them with separate companies to do separate (but related) things. Each can exist under the same corporate umbrella, share the same office building, if convenient, and use similar staff and capital (management, technicians, trucks, repair facilities and the like).

But each company should have at least some dedicated personnel who maintain a tight focus on the separate company's core business. They "watch that basket" or, in another colloquialism, they stick to their guns.

Under this model, the operator-CEO who oversees this mini "empire" should set a definite limit to the growth and scope of each company under his umbrella. It's a lot easier to build six successful small companies than one large company that keeps getting larger and more difficult to control. When you reach a level of success and comfort in one business, peg that size and don't grow bigger; instead, start another company.

(As an aside, let me note here that, as a CEO, I focus on cashflow, paying bills and having a lot of money left over. A CFO would look at profitability in a different light -- using depreciation and other tax deductions to reduce profitability and therefore reduce taxes.)

Some leading operators have already taken significant steps in this direction without realizing it. Do you have a coordinator who focuses on league promotion? Do you employ an in-house prize merchandise expert who tends to cranes, rotaries and other merchandise-vending machines?

If so, congratulations. You have made a significant start toward third-way diversification. You are not just in the amusements business. If you have a league coordinator, you are also in the sports marketing and location traffic-building business. If you have a merchandise director, you are in entertainment retail.


A WORLD OF OPPORTUNITIES

Operators across the U.S. have found commendable levels of success by diversifying into new markets, products and services that go far beyond those discussed so far.

Successful street and FEC operators, for example, have expanded into equipment and rec-room accessory home sales; private backyard party rentals, which might include inflatables; corporate and grownup party rentals, with all kinds of music and amusement equipment; security system installation and management; sound systems; and maintenance and other services.

Quite a few operators provide sales and delivery of location supplies (tables, chairs, bottled water, napkins, salt and pepper, party supplies, etc.). Others are now providing outdoor heaters for bar and restaurant patios, air purification systems for location interiors and energy systems, including solar power generators.

Some operators have become successful realtors and/or commercial property developers as a thriving side business. After you have inherited and sold a dozen bars from tavern owners who walked away and handed you the keys [or kept the bar operational and collect rent now] … or after you have appraised the value of parcels for a dozen potential FECs … you get to know the local real estate market. Why not put that expertise to work?

A number of operators have even gone into business mentoring. This, too, is one of those surprising opportunities that looks obvious in retrospect. After all, these operators have already succeeded in one of the toughest businesses: amusements. They can certainly offer valuable lessons to wanna-be entrepreneurs, regardless of field.

Remember, most operators are self-taught experts in startups, management, ownership, customer retention, human resources, buying and selling, counseling and arbitration, among many other skills. They have valuable knowledge; the trick is marketing yourself to connect with those who are willing to pay for it.

Since 85% to 90% of Americans don't know how to run the smallest, simplest business -- (did you know that two-thirds of the U.S. population has never read even one book?) -- operators can go into the community and teach people how to run any sort of enterprise, because the underlying principles are the same.

I believe there are countless additional opportunities available to operators that most of us have not even begun to consider. For example, they could do repairs of all kinds (from lawnmowers to boats). Our technicians know more than the techs from Comcast and Verizon. There is basically nothing an operator can't repair. Operators are often good locksmiths; they usually know how to replace glass and install lighting. Many have abilities in carpentry and furniture refinishing.

Meanwhile, the U.S. public is constantly complaining that you can't find anybody who knows how to fix things. So here is a problem and a solution, waiting to be introduced to each other -- the very definition of opportunity. Properly marketed, the operator's expertise in all these areas is a major asset within a market that is screaming for it.


MANAGING DIVERSITY

How can an operator who is running a demanding route business, or one or more FECs, possibly pay enough attention to the complexities of these additional businesses? By wise and flexible management: Each market activity should be its own basket company. Each should have a dedicated member who watches that basket -- and that basket only.

I have used this approach many times over in the past 40 years and it usually worked well. The Alpha-Omega group will soon have a dozen separate companies that handle amusement route operations, FEC management, equipment sales and rentals to homes and events, support product sales, and software development and sales, along with equipment and parts sales to the trade, consulting, contract board/equipment repair, and educational programs and mentoring. We're even looking at launching a couple of more divisions this year.

Part of the preparation stage for diversification is to get your current company lean and mean. If you can scale down your amusement operations, yet bring in the same revenues, then you free up resources to start and fund a new company.

Start small, and keep it simple, by using your existing staff, strengths and efficiencies to attempt a trial run at something new. See if there is any interest and how profitable it might be. Try a small test that targets a specific amount of net profit within a year. (I start off with an annual net target of $50,000 and quickly grow it to $100,000.)

If you determine that the new venture can generate good income, then you can invest in building an independent division. Like an amusement route that is founded on a single jukebox and grows into a multi-state operation, this new division can grow to earning up to several hundred thousand dollars annually. Start with one person running the new venture, and as revenues grow, the business's staff can grow to meet its needs.

Can a firm grow too big? That sounds like a problem that most of us would love to have. When you see a new company start to take off, it's exciting. Most operators are entrepreneurs at heart; we feel that nothing beats the rush of seeing a fresh enterprise start to find its market and build success. But growth eventually reaches a point of diminishing returns. Therefore, setting limits to growth is important, and there are several reasons for doing so.

First, experience suggests that growth is hard to start, but even harder to continue. While taking a company from $100,000 to $500,000 in net profits a year is a huge task, taking a $500,000 net company to $1 million is four times harder. (And it's probably eight times harder to grow a $1 million net company into a $2 million company.) Each time you double the volume of net profits, it can also require quadrupling the staff and taking on four times the debt.

Secondly, it's easier to run eight or 10 smaller companies than one large company. When a company is smaller, you can keep a closer eye on every single thing it does.

Thirdly, controlling growth preserves flexibility. If you don't allow one company to suck up all your resources, you have more freedom to start another small venture that may grow fast during its initial stages.

The key is to find the sweet spot -- the exact tradeoff of overhead versus net profit revenues -- that works for you. Instead of dreaming of building one gigantic company, the diversified operator can build his own mini "empire" based on many small and midsize companies.

My sweet spot is to strive for $1 million in profit for each company. So my goals are to see if we can hit $10 million a year by adding up the net from 10 companies. So far, a few of the companies under our umbrella have hit that level. But my goal is unlikely to be reached because some companies can only make this kind of profit when other divisions are slowing down due to market conditions that are unpredictable (even with my trusty crystal ball).

What I like best about starting each day is to quickly decide which of the several companies is the most profitable and work on marketing it for the first couple of hours.


HEDGE AGAINST BUSINESS CYCLES

Perhaps the ultimate advantage of the third-way diversification strategy, or many closely watched baskets, is that it positions your company to ride out the inevitable business cycles. True diversity is a hedge against various sectors going up or down, as they constantly do. It's like investing in your private portfolio: When stocks are down, bonds are up. When real estate is down, precious metals are up. It pays to participate across the board.

The same lesson applies to diverse operating. In some years, certain basket companies will hit their revenue goals; in other years, conditions are less favorable for those baskets, but more positive for others. These days it's harder to sell real estate, for example, but easier to sell business mentoring and wealth advice. Today it's harder to make greater ROI from even the best-run street routes, but perhaps a bit easier in the average FEC.

Just as the investor shifts the balance of investments in a personal portfolio to adapt to changing markets, the diverse operator can do the same with his many baskets. As times and economic conditions change, you stop devoting labor and resources to the companies or divisions that are making less money, and you put more time and resources into those that are.

If you're lucky, the various companies can feed off each other. For example, in all cases, diversified operators can use their community contacts, customer databases and goodwill to generate sales in other sectors. Basic plant and equipment resources can also be used by different companies under your larger corporate umbrella. A diversified operator can obviously use the same trucks and manpower when they are least needed for the core business to help with some new businesses.

Even warehouse space and machines can double up. When my company went into the rental business, we found ways to store more machines without buying another building. We built special racks to store machines higher in our existing building (we put the least-used equipment on top, farthest out of reach). Equipment rentals typically took place on Friday and Saturday nights and Sundays, when our route and FEC companies' normal delivery patterns were less demanding. The same equipment that was reconditioned this week for delivery to our route and FEC locations the next week, went out to rentals on weekends and holidays, and the additional rental dollars piled up with no equipment expense.

But such synergy is not always possible. It's important not to get so caught up in the quest for perfect solutions that you forget to watch out for ways that your different divisions can compete with each other over scarce company resources -- not always in a good way.

At one time, my company had a full-line vending division for our college locations. The techs who fixed games and repaired the vending machines also ended up stocking the vending machines when they saw that they were low on product. They even started carrying extra soda and snacks in their cars so we could improve our service. But we found this was not a profitable use of time by our high-paid techs or central office management.

Still, once the habit of using techs and managers for double duty in both markets was ingrained, it was almost impossible to break. After four years, we sold our vending route because we realized it did not complement our core business. (It's also true that I got bored with analyzing in which columns chips or cookies should go, and in what patterns, to induce customers to buy more vended products.)


NATURAL DIVERSIFIERS

In today's tough economy, operators are looking for new strategies and new opportunities to leverage their assets, apply their knowledge and generate new revenue streams. Diversification is a great way to achieve this goal.

Operators are natural diversifiers because they wear many hats. Operators are CEOs, CFOs, marketing directors and human resources experts -- and they often are their own best legal counsel, too. The challenge is to view your assets in new ways, and then look around your trade zone with a new mindset that allows you to see the opportunities.

The first big secret to successful diversification is to expand not just our markets, but also our mindset. We must expand our vision of the possibilities for our businesses.

The second big secret to successful diversification is to manage accordingly. As long as an operator adopts a careful, conscious management strategy that is adapted for the unique demands and possibilities of diversification, it can be a workable, relatively low-risk, and highly profitable strategy. The operator who diversifies wisely can unlock growth even in the most challenging financial times.


FRANK SENINSKY is president of the Alpha-Omega group of companies, which includes a consultancy agency, Amusement Entertainment Management LLC, and a nationwide revenue-sharing equipment provider, Alpha-BET Entertainment; all are headquartered in East Brunswick, NJ. During his 33 years in coin-op, Seninsky has spoken at nearly 200 seminars and penned more than 750 articles. He served as president of the Amusement and Music Operators Association from 1999 to 2000. Seninsky can be reached at tel. (732) 254-3773 or by emailing fseninsky@aol.com.


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