Fair Trade Entrepreneurship — Tool #1 — Structuring Incentives (Part 2 of 2)
I wasn’t always a good practitioner of fair trade. In fact, I only became engrossed in fair trade practices when I made a now-defunct investment in growing coffee in the Philippines, which I love. That investment fell through, but my passion for fair trade continued to flourish.
Fair Trade Entrepreneurship is a framework by which you govern your business dealings, that is really no more than just applying the golden rule to the way that you conduct business. These simple tools are based on the principles of Fair Trade, which can be applied to your relationships with your vendors and employees. I promise they will return dividends to you — in the form of both higher revenue and profits.
Keep in mind that I am not here preaching this philosophy without experience. If you’re an entrepreneur reading this, trust me — you’d make both more revenue and profit when you apply the golden rule liberally in your business dealings.
In Part 1 of Structuring Incentives, we first talked about the need for clear, easy-to-digest business terms. I always write these terms in bullets and make sure that they are full of action verbs. Bullets keep the negotiating process economical and allow the business people to agree on the relationship before the lawyers get a hold of it.
The second key topic in Part 1 is assessing the incentives in the transaction on both sides — yours and your counterparty’s. Here we look at how to assess incentives differently if you’re buying vs. selling, a few quick modeling tips for doing so, and most importantly, evaluating the profit potential of the transaction (not the revenue potential).
Part 1 closes with a discussion of ROI against profit and doing the unthinkable — asking your counterparty again why they’re doing this — what do they get out of the transaction. Again, it may seem like a very simple question, but one a lot of people fail to ask. You’ll find that if you understand why your counterparty is doing something, you’ll be in a much better position to keep the relationship sustainable over the long term.
If Part 1 talked about how to get it done and how much money you’ll make, Part 2 is firmly in the “shit happens” camp — otherwise known as “what could go wrong.” Fear not, there are really just two simple ways to understand if you’ll be in a transaction where something is going to go wrong.
Assessing the risks on both sides
After you’ve concluded that you will make more profit if you do this deal, than if you don’t, next up is to figure out what could go wrong. You’re now in the second phase of assessing the potential of this transaction — the “risk” part of the “risk/reward” equation.
We’ll start by assessing your risks first. The key to assessing the risk is to go back to those action verbs we talked about in Part 1 — the bullets that you used to describe this transaction.
You need to review those bulleted points in detail, and assess your ability to perform what you’ve promised to perform, along with the following broad areas of your business:
- Operational — have you over-promised on what you can deliver? Do you have the right personnel, systems, & knowledge available and ready that you need to perform?
- Financial — do you have sufficient capital to undertake whatever investment is required with what you’ve promised to do? Is your cash flow sufficient to support the billing cycle (receivables) you’re facing as a result of this transaction? Are you over-leveraging yourself with this transaction, or causing other financial harm to your company?
- Legal — are you creating any unnecessary legal risks with this transaction, opening yourself up to liabilities you can’t control? Are you using assets (hard or otherwise) in this transaction that aren’t yours?
- Strategic — how does this transaction impact your strategic position? Does it enhance or degrade it vis-a-vis the marketplace? Does this transaction create too much concentration risk for you (this customer is too great a percentage of your revenue)? Will serving this customer distract you too much from the ultimately goal/mission of your company?
[Download a custom-made infographic of this process here. Use it as your checklist for assessing the risks.]
I strongly encourage you to do the following process (it will sound silly as you read it, but you’d be surprised how much these small gestures can focus your mind):
First, print out your original terms on paper.
Second, turn around in your office chair and look out a window (if you have one — the key is that your computer screen isn’t visible).
Third, read the first business term aloud, hearing what you’re saying.
Fourth, ask yourself: “What are the operational risks?” then “Financial Risks?” “Legal?”, “Strategic?”.
Fifth, if you find that you hear your mind’s voice instantly starts asking a question about that business term as you consider these broad areas, write it down on a separate piece of paper.
Sixth: repeat steps 3 through 5 until you get through all the business terms.
If you honestly assess each term you’ve agreed to against these broad risks, you’ll have a list of questions you need to go answer before you can feel comfortable in this transaction. But review the list — I bet there are a lot of good questions on that sheet of paper, ones which, after answering them, will make your circumspection about the transaction as close to complete as it’s probably going to get.
Now that you’ve done this exercise against your side of the transaction, it’s time to tackle your best understanding of your counterparty’s reasons and gains in this transaction. So, it’s time to do this again.
Go get a new sheet of blank paper. Review each business term aloud, as described above, but instead, ask yourself the same four areas of questions (Operational, Financial, Legal, Strategic), but now do so from your counterparty’s perspective. It is critical that you review each term and write down any questions that naturally come to mind as you review these terms and the four areas of inquiry.
Doing this from your counterparty’s perspective will feel strange, and you will feel like there’s a lot you don’t know. And there is — but then again, that’s the point. Through this exercise, you will see the assumptions you’re making about your counterparty’s capability and ability to uphold their end of the bargain in this transaction.
[Download an infographic of these steps here. Create a poster out of it and hang it on your wall, so you can use it as a cheat sheet for assessing business risks.]
There are two key things happening here.
First, by making your mind go over the assumptions you’re making about your counterparty, you’ll inherently question your own comfortability with the assumptions you’ve made. Assumptions you are not comfortable with should be the focus of further questions with your counterparty.
Second, you will uncover questions you had yet thought of, even at this late point in the process. Thank your lucky stars if that happens, because it means that your terms contain issues that weren’t completely fleshed out between you, even from your side of things. In fact, coming up with more questions is exactly what we want here.
Now, don’t get discouraged. I know, looking at this process and the lists it produces will make you think that you’ve got more work to do on this transaction when you thought you were done. Sometimes yes, sometimes no. But remember, especially in large transactions, this level of thought and planning could literally save your company.
Look at it this way: make the wrong move in a transaction that could be 30% of your company’s revenue, and you’re sunk. Better to do the work and know you’ve done your best.
Final question — Will your Counterparty make money?
Most people approach business transactions with a counterparty with this following logic: “If, after agreeing upon terms, my counterparty can’t make money, that’s on them.”
I’m going to argue that that is a foolish assumption to make. It also squanders an opportunity to show your counterparty what type of business person you really are — someone who cares and values long-term productive relationships.
Yes, most business people are professionals and understand the risks to doing business and in this transaction. But remember, people can get it wrong, or they can get sloppy with the structure of deals when they’re under pressure to close.
Here’s how to do it. It’s very simple.
You: “Hey, I always like to ask this final question before we take our business terms to the lawyers. It has served me very well in the past.”
Counterparty: “Um, sure, I guess. What did you have in mind?” (NOTE: just their response to this can tell you volumes. If they’re suspicious, they can either be a not-so-confident person, or a taker (Adam Grant gives a great talk on this), and they’re getting nervous that good terms they got for themselves are about to blow up in their face.)
You: “Great, thanks. Will you make money on this transaction, in working with us on this deal?”
Generally, you will get one of three reactions:
First: “It’s not a bad deal, so I’m generally okay with it.”
Second: “Well look, we really need to do this deal, so it is what it is.”
Third: “Yes, I’m very satisfied with these terms and I’m looking forward to this relationship.”
Based on these responses, you can see why asking this question is so important. They really tell you where your counterparty stands in the deal, and most importantly, they instantly tell you which deal will hum along nicely, which deal will give you lots of problems, and which deal should not proceed.
If you get the first response, the deal terms aren’t finalized, and you still have more work to do.
If you haven’t evaluated the questions you came up with for the “Assessing the risks” section, above, do that immediately during this conversation with your counterparty, and see if you can elicit what needs to change. Then change it. Again, you will craft a stronger relationship by going through this process — there is no downside.
If you get the second response, then stop and take a breath.
First, as much as you can, mentally prepare yourself that you may need to walk away from this deal, and start dialing back your revenue/profit expectations from it.
Once you have a handle on that, your only response should be “Well look, I don’t want to be in a deal that’s unsustainable for you — that’s a bad deal for everyone. So did you want to try and go back to the business terms and tell me what doesn’t work? I can’t promise I can change things, but I’ll do my best.”
The key with your response here is that you’ve created a safe place for your counterparty to tell you what’s wrong. Without giving them that safe place, you have no shot of re-doing this deal in a way that works for both of you, and the deal is effectively dead. If they don’t feel safe, they won’t be creative with you to figure out a way through.
Of course, the flip side here is that, if you do an eventual deal, the sheer amount of relationship capital that this conversation builds for you means that, whenever this counterparty needs something more from anyone, you are their first stop.
Plus, if the deal doesn’t go through, you just boosted your relationship with this counterparty tremendously, so even if you can’t do a deal with them, they will certainly recommend you. Again, there is no downside to asking this question.
Finally, if you get the third response, you’re in great shape. For me, being in the call center industry, when I get the third response, I know this is a deal that will be on auto-pilot. It will be one where I rarely hear from the customer, and will automatically deliver profits to my door every month. This is music to my ears and wallet.
One last thing to consider: If you’re working with a counterparty from a large organization, think about why your deal will have to go through several layers of review, from several different departments, precisely because your counterparty is trying to minimize the risks to them in the transaction. It’s a pain for you — but once it’s done — it’s much easier to do business. Management of large organizations understand that, and so that’s why the layers exist. In general, I push less on a large organization than a small one with this question, because of these layers.
If you’ve gotten all the way through both parts of this post — congrats! I know it’s been long, but these tools will be valuable to you as you work to become a fair trade entrepreneur who thoroughly believes in the golden rule.
But most importantly, as you finish reading these posts, sit back for a moment and try and envision the type of professional and person you’re becoming when you apply the fair trade principles. In Yiddish, we call it a “mensch.”
By simply considering your counterparty’s perspective and needs, you’re instantly head-and-shoulders above most people out there — and you will inherently make better deals and make more money. But perhaps most importantly, when your counterparty’s are talking about you to new people, they’ll be saying glowing things, “You know, you should really talk to them, that so-and-so is really a mensch.”
I don’t know about you, but that’s the type of person I want to be.
** Want to download the custom-made infographic for the whole process? You can find it here. **
If you have questions about fair trade entrepreneurship and how it applies to your company or you want to talk generally about outsourcing and setting up a business in the developing world, feel free to contact me at mike[at]mikedershowitz.com or leave your comments below.