The Best Time to Diversify

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The Best Time to Diversify

Professional, investing and business success in the natural resources realm are often well-served by adopting a contrarian philosophy. A contrarian takes a position opposite to that of the majority, or works against conventional wisdom. They zig when the majority zags.

But positioning yourself against the consensus opinion or prevalent trends requires a high degree of intestinal fortitude. Some will argue that our psychological well-being is rooted in social acceptance. Making a bold move against the group opens one to isolation and criticism. And you may also be fighting against your own personal fears or greed. And both are powerful motivators that make people act irrationally. But given that underlying markets and production dynamics in food, fuel and fibre are cyclical, sustainable success usually requires repositioning yourself in anticipation of the episodic ups and downs. Buying when everyone else says ‘sell’, or stepping back when the crowd is jumping in, can save you a great deal of emotional and financial pain when the market or production conditions inevitably change.

A contrarian philosophy is reflected in my belief that the best time to diversify is when you least think it is needed. But why shift from a great market, when revenues are up and growing? Moving to diversify away from a business that is performing well, not only reduces the risks of a market meltdown or production disruption (which perhaps also reflects cyclical weather, pest or other natural patterns), it is also often optimal from the perspective of having the resources to invest in researching and developing new ideas. When things are going well you will have the profits and cash-flow to invest in new ventures or service debt. If you wait until your primary market has already turned, you can be scrambling to find resources to keep your business afloat, let alone invest in something new. Wait until the market has bottomed before you move and you are largely reliant on outside help if any assistance comes at all.

And a contrarian view on diversification functions on many levels – be it for an individual, business, industry group or regional economy. If you are among the employed, it can be advantageous to start planning a career shift while your employer is enjoying success and may even be willing to pay for your professional diversification path, not after a recession forces your lay off. Industry groups often only get serious about diversifying at the bottom of their market cycles, when they should be making those moves before they hit a wall. For example, the North American lumber industry only looked seriously to Chinese markets after the US housing collapse. And most pulp producers are only now developing bioproducts and bioenergy options, after the paper markets have seriously, and some argue permanently, eroded. And governments and regional economies only seem to be engaged in large-scale diversification when their primary industries are faltering. This often comes at the cost of deficit financing for support programs when public treasuries are better positioned to help diversify the economy when the economy is booming and tax revenues are flowing in.

There are no guaranteed paths to success. And diversification also come with their own risks (Diversify Don’t Diworseify), but the best time to invest in products, services and markets is when you have the resources needed to commit to the process. And if you have no back up plans, the second best time is now.

Darwin and Small Business Survival

For those of us in businesses tied to natural resource sectors, one quickly gains an appreciation for the ups and downs of market cycles that drive investments and returns. Surviving as an independent or small business is tough in any sector, but particularly challenging when the ‘goal posts’ keep moving. In Canada, about 30% of small businesses fail in their first 5 years of operation (Key Small Business Statistics – January 2009, Industry Canada). The failure rate rockets to over 80% for those businesses posting less than $30,000 in sales per year (micro-enterprises and part-timers).

With survival elusive for so many start-ups, it emphasizes for me how small and micro-businesses in forestry, agriculture and other natural resource enterprises could benefit from the mentoring of other entrepreneurs that have weathered one, two, three or more market cycles. Unlike large corporations where CEOs regularly gain celebrity status, we don’t often acknowledge success or tap into the wealth of knowledge and experience in this entrepreneurial network.

Some may see this as a contradictory notion to my own consulting business where I focus on research and development support, and bringing new ideas to market and new production systems online. But quite the contrary, I have the utmost respect for individuals that have been educated at the ‘school of hard knocks’ and weathered many business and market cycles and still found ways to thrive. Talk is cheap, but these are people that walk the talk.

I also believe the whole process of small business survival is an extension of the social evolution of our species. At the risk of being lynched by a group of creationists or black flag anarchists, I freely admit to being firmly in the Darwinist camp. Survival of the fittest is what drives biological and social evolution. Unlike many on either side of the Darwin debate however, I’ve read (and on multiple occasions) The Origin of Species by Means of Natural Selection. And for those that have not taken the opportunity to do so, I think it is good point out that the source of contention for most anti-social Darwinists is one of the most misinterpreted – that everything can be rationalized from competition. Darwin put forward the hypothesis that the struggle for existence was the driving forces behind natural selection of the fittest. But he also clearly notes that he uses the term ‘struggle for existence’ in:

…a large and metaphorical sense, including dependence of one being on another…

In other words, survival can result from cut-throat competition, but also validly stems from co-operative and mutualistic processes. So too in business and other social arenas, your ‘survival’ may come from driving your competitors into the ground, but often success hinges on strategic co-operative investments, working in partnerships and joint ventures. Indeed the laws of the jungle are as much about facilitation as they are about competition.

And one should not conclude that there is only one strategy to follow to success. Many small businesses have succeeded by transitioning between different operating structures and working arrangements as needs dictate. Adaptation to the ever changing business climate is what matters most.

It is this Darwinist approach that logically leads me from seeing how difficult it is to survive a full business cycle to deeply respecting those that have made it through many of them, and wanting to learn from them.

So while we put forth private and public investments into new ideas and cheer loudly for start-ups and new entrepreneurs, it would be prudent to give more recognition to the survival of the fittest and devote resources to tap into that vast network of small- and micro-business experience.

And if you are starting a new business or venture, find a mentor and learn from their experience. A bi-weekly or monthly coffee or lunch meeting could be your most important step towards surviving and thriving.

A Lesson from Dr. Seuss in Protecting your Niche

I’ve been fortunate to benefit from the wisdom of great mentors who passed down their knowledge and helped me to learn and develop. But I wasn’t introduced to one of my most enduring sages at either of the fine universities I attended or through my professional exchanges, but rather my pre-school readings. The immortal Dr. Seuss (“‘On Beyond Zebra!” 1955) gave us these wise words on competition:

And Nuh is the letter I use to spell Nutches
Who live in small caves, known as Nitches, for hutches.
These Nutches have troubles, the biggest of which is
The fact there are many more Nutches than Nitches.
Each Nutch in a Nitch knows that some other Nutch
Would like to move into his Nitch very much.
So each Nutch in a Nitch has to watch that small Nitch
Or Nutches who haven’t got Nitches will snitch.

While I presume the good Doctor was primarily relating an ecological parable, I think it is also apt for understanding the importance of protecting your market niche. Specialty crop producers often look to a market niche to generate a fair return on their labours. But committing to any market brings the risk that some other grower/harvester ‘Nutch’ will snitch your Nitch. Without differentiation, a compelling and sustainable low-cost structure, or other means to protect your market share, you may soon see yourself on the outside of the niche/Nitch looking in.

An example of what can happen when you don’t protect you niche can be seen in the production history of North American ginseng (Panax quinquefolius) in British Columbia. Chai Na Ta Corporation, the first commercial grower in the province, established 5 ha in 1982. Thanks in no small part to the dedicated support of a horticultural extension officer in central BC, by 1994 production grew to 130 producers generating 1,100 tonnes of ginseng from 700 ha and with farm receipts of about $78 million (data from Association of Ginseng Growers of BC and Statistics Canada). But things started to go awry in the late 1990s. Ginseng prices peaked in the mid $70s (USD) per kg in 1993 just as most producers were jumping on board. By 1999 prices had fallen to $18 to $25 per kg, which while still nominally high relative to carrots or potatoes, did not cover the very high establishment and production costs.

By 2003 consolidation had reduced the number of BC growers to 30, with a smaller production area but more than double the total annual production to 2,500 tonnes. This larger production volume however, only grossed $45.7 million. Working harder, producing more and making less is not an uncommon situation to many agricultural and forestry operations, but they are not the hallmarks of a sustainable market niche. Rather it looked very much like ginseng was sliding down the slippery commodity slope to profit oblivion.

The general decline of the sector was reflected in Chai Na Ta’s rise and fall. As a publicly traded corporation, filings with security regulators show Chai Na Ta’s net annual earnings grew from $0 in 1982 to more than $6.8 million in 2000. This fell to a net loss of $9.5 million in 2006, and the following year the company discontinued operations.

The industry collectively had fallen into a commodity trap. From it’s onset, North American ginseng was highly dependent (95% +) on export to China via the Hong Kong market place. Producers did little or nothing to add value or differentiate their output from ginseng produced anywhere else in the world. Ginseng was initially a high value commodity that ultimately went bust because the market became saturated with supply. First from other areas in North America (most notably in Ontario and Wisconsin) and then from China. Once the Chinese started growing North American ginseng, their minuscule labour costs, lax environmental standards and general lack of enforced regulations gave them the low-cost production structure that ultimately gave the PRC Nutches ownership of the North American ginseng Nitch.

The few remaining producers are now moving down the path towards creating an identifiable brand for North American ginseng, focusing on adding value to their production rather than trying to market dried roots to processors in China, moving away from high cost artificial shade systems to natural shade agroforestry systems, and marrying their operations with agri-tourism ventures to gain new revenue streams outside of primary production. Restricting production, serving smaller specialty markets and moving from “price takers” in the commodity market to “price setters” of products and services may finally land them the deed to a sustainable Nitch.

Diversify, Don’t ‘Diworseify’

Diversification can be a double edged sword. Know yourself and your capacities to find winning business ideas.

Don’t put all your eggs in one basket. An oft repeated axiom (particularly by me) for farm, woodlot, ranch or any enterprise highly dependent on one revenue stream. Recent painful lessons in what can happen to the highly concentrated abound. Lumber and log markets tanked in the wake of the US housing collapse; meat export markets frozen after disease outbreaks for beef (BSE), chicken (avian influenza) and pork (swine / Mexican / North American / H1N1 / your name choice here flu); E. coli found in one lot of spinach and sales plummeted across North America.

Clearly there can be a high degree of risk in relying on a single commodity or market, and losing that market can be fatal to your business. But does diversification always make sense? Is it possible to weaken your business by straying from the core? In short, the answer is a resounding yes. Diversification does not always lead to success.

I’m self-employed, and like many other entrepreneurs, I rely on my own resources to fund my potential emergency, disability and retirement needs. This means investing has de facto become one of my hobbies. As such, I do my best to keep up to speed with what’s happening on Wall Street, Bay Street and even Howe Street (although, admittedly I should be paying more attention to financial districts in Mumbai and Sao Paolo). Long before Jim Cramer was launching chairs across his set at CNBC (a kinder, gentler Cramer has stopped this practice in recent years, but he is still the most animated and entertaining financial adviser today) I teethed my self-guided portfolio education on the sage words of Peter Lynch. The highly successful manager of the Fidelity Magellan Fund shared his winning investing strategies with the retail investor in “One Up on Wall Street”, one of the best selling financial books of the era. Lynch’s advice on stock picking included a chapter on “Stocks I’d Avoid” in which he coined the phrase, “diworseification” to describe companies that bog themselves down with non-complementary subsidiaries (often through costly acquisitions) that end up draining the organization by moving it away from what it does best.

The same can hold true for small businesses in forestry and agriculture (or any sector). Diversification becomes diworseification when the cash flow or profits from your new venture don’t come close to compensating you for what you will lose by taking time and resources away from your main business. Clearly, diversification can be a double-edged sword. Being overly concentrated entails risk, but so does straying too far from core competencies. There really is no clear way to know before hand (sorry, the free market never comes with guarantees), but there are some steps you can take to avoid diworseifying and give your new venture the best chance to prosper.

First, do your homework and find your niche. This can be done with ‘bottom-up’ approach of finding someone successfully doing what you are interested in and copying them, or through a top-down approach of studying the trends for “good ideas”, finding a new or under-served market niche that fits with your goals and capacity and building a business plan to capitalize on it.

Second, filter your ideas with your personal interests, strengths, weaknesses and capacity. Follow your heart, the best of ideas will wither and die if you can’t devote the time to develop it into a new venture, and you are most likely to keep at something that interests you, rather than simply jumping on a ‘hot idea’. Look at your current production constraints, time commitments and resource needs and decide if the new work will complement or clash with it. Understand and be honest about your weaknesses. Some can be over come with education and support, but others may doom your venture. For example, you wouldn’t consider adding a highly service-oriented component to your enterprise such as farm bed and breakfast if you truly don’t interact well with the public.

Finally, don’t ride a bad idea into the ground. Not every business idea or new market entry is going to be a success. No one bats 1000. Part of any good small business strategy should be a formal business plan. This will help you keep focused and will also allow you to revisit your diversification venture and see if your expectations are being met. Pride and an exaggerated sense of determination can become your worst enemy. We all want to stand tall in the face of adversity and no one would be in business if they collapsed at the first road block. But you must remain realistic about the long-term viability of your businesses, and if the market consistently tells you that you don’t have a winner, it’s time to cut your losses and move on.

© 2009-2018 by George W. Powell. All Rights Reserved.

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