Calculating the cost of a single mistake can be challenging in a small business, but experts warn that the initial cost is only part of the expense and it pays to have access to all possible information to better evade avoidable mistakes. One mistake can lead to lost sales and clients, legal action, repair costs and process overhauls, while collecting and reviewing available data is typically a much cheaper alternative. Business advisors recommend that even small businesses use tools to gather data, create operational protocols and emergency plans to be better prepared to manage costly mistakes. For more on this continue reading the following article from Blue MauMau.
It is important to have good data for your business. There are also ways to use that data to run your business better. One of the ways to run your business better is to catch problems early, while still fixable, instead of suffering the blow of a failed unit and wondering how it got to that point.
But how critical is it to catch problems early? In other words, what’s the cost of a mistake? Is it just the immediate damage (bad enough) or is it something bigger?
Let’s take a look at a couple of examples – one actual, one hypothetical.
Charles Nagel, the CEO of Qvinci Software, has a background as a turnaround expert, both on the consulting side and as past-CEO or COO of other technology companies. He understands small and mid-size businesses – what it takes to fix big problems and maximize the bottom line.
One of Nagel’s former clients was a construction services firm. “XYZ Company” was grossing over $23,000,000 annually, specializing in renovation of commercial real estate. One of their jobs was on the second floor of a medical building. On a Friday afternoon a faucet that had not been turned off overflowed the sink, flooding the space and another doctor’s office on the first floor. XYZ’s crew turned the water off on Monday morning. XYZ had not implemented a simple, end-of-day sign-off procedure with feedback to the corporate office.
XYZ did not have insurance coverage for this type of error. They cut checks totaling $65,000 for the damages. Was that the cost of the mistake? Not by a long shot. XYZ’s net profit margin was a thin 4% of revenue. How much revenue did XYZ have to book to net $65,000 in cash to make up the loss?
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Simple math tells us that $65,000/.04 = requires revenue of $1,625,000. Yikes! XYZ had to do $1,625,000 in additional business to make up the amount needed to cover the amount forked over for the water damages. XYZ’s owners were shell shocked.
But wait, there’s more.
We’re still adding up the cost of this mistake. The landlord and tenants of the building were upset with XYZ. They never worked in that complex again. Now XYZ had to find $1,625,000 in new revenue and one or more new clients to replace the lost client.
Still not finished.
The doctor on the 1st floor sued XYZ for lost revenue. So on top of it all, XYZ had litigation expenses and a contingent liability for disrupting a medical practice. All because a sink faucet was left on over a weekend. Do you have any potential “running faucets” in your business? Do you have a method for finding them?
Let’s use a fictional QSR franchise for the second example. Moo & Pinch, a 100-unit franchise concept that had experienced rapid growth over the last four years in a new crab-topped burger niche, was suddenly jolted by the closure of 10% of its franchised units in the space of six months. M&P corporate knew that an occasional closure was inevitable, but the multiple closures blindsided them.
What was the cost of this mistake? And how could it have been mitigated? Could M&P have been proactive, instead of reactive?
Post-mortem analysis revealed that all the closures were in one region, with the primary culprits being declining sales – and expenses that held steady or rose slightly. When compared with profitable units, M&P saw that sales on the closed units had been tracking downward for the previous six months, at an even pace, and that expenses actually had risen over the same time period by an average of 2%.
M&P did not have access to current financial/operating data on its units; corporate considered itself lucky to get an excel spreadsheet every other month, typically a month after close of the month to which the information related. And the information was never standardized; the charts of account were uniformly different. All in all, reporting was messy, and not practically usable for any type of proactive or collaborative management.
So what happened? Consumers in the region at issue began to turn away from the flagship beef/crab combo meal. What at first was “nouveau” became stale. The franchisees were slow to reduce labor costs in the face of slowing sales – many of the employees were friends. The franchisees doubled up on advertising in an attempt to reverse the sales slide.
Could the franchisor have helped? If it had seen the trend and the line-item anomalies, probably so. Menu, labor, and marketing adjustments all could have been made before it was too late. The franchisees involved could have acted in time if they had been looking at their data daily or weekly, watching the trending, seeing the deterioration in ratios and margins, and comparing their units with the top 10% or even the average across the ecosystem on a line-item basis.
What’s the cost of this mistake? The franchisor lost 10% of its royalty revenue, between $400,000 and $500,000 per year, or roughly $3,500,000 in net present value (using a 10-year life-of-project and 5% discount rate). It now has to grow by more than 10% just to make up the lost ground. The franchisees were wiped out, with one multi-zee losing over $1,000,000 after liquidation, not to mention the lost streams of income (NPV?) and the terrible, emotional toll on the families. The Moo & Pinch franchise brand suffered enormously, as prospective franchisees steered clear. Growth came to a halt, and the franchise went into quasi-turnaround mode.
The M&P story is fictional, but the point is that mistakes are far costlier than may appear at first glance. Whether you are a franchisor or franchisee, review your “early warning” indicators and reporting systems and procedures – so that you are in position to prevent “running faucets” and spot leaks while there’s still time to plug and repair.
This article was republished with permission from Blue MauMau.
