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Financial strategy — the most important, and most overlooked, business strategy

Cinema Paradiso
“It may look like a movie, but I see dollars, dollars, dollars.”

Let’s start with a bit of word association. When I say the word “Miramax,” what immediately comes to mind? You might say, “great movies,” or “Cinema Paradiso,” “Shakespeare in Love,” or “Harvey Weinstein.” All of these are fine, but for someone on the business side of films and entertainment, the first words that come to mind are “brilliant financial strategy” or “raining money.”

Why? Because when the Weinstein brothers started up their film company, their first concern was not movies or awards or glitz or glamour, but instead financial strategy, particularly a financial strategy unlike that of any other studio or distributor. Sure, you can say that films like “Il Postino,” “Cinema Paradiso,” and “Shakespeare in Love” made Miramax successful (and you’d be right, at least from a financial perspective), but lots of studios and distributors release highly entertaining, high-earning films on their inexorable path to bankruptcy (just ask Dreamworks).

In all my journeys in business, I have rarely encountered a startup, entrepreneur, or business “expert” who regards the financial end of the business as anything other than an odious housekeeping task, the strategy equivalent of washing windows. It’s all that other groovy stuff, like product development, marketing, social networking, branding, market research, and leadership that gets all the attention, effort, and energy of entrepreneurs and experts alike. Let’s be real. It’s just a lot more fun and exciting to write and read about purple cows and new rules of marketing than, say, operating margins and fixed costs.

It may not be fun, but the very survival of your startup or small business — particularly if you’re growth-oriented — relies on building as solid a financial strategy as a product, marketing, or competitive strategy (to say nothing of ancillae and sequelae such as social networking — unless you’re selling a social networking product).

I’ll go even further. While most startups and businesses can survive without purple cows or Facebook friends, a well-honed, creative, and detailed financial strategy is absolutely essential to building a high-earning business. And, since it’s the “washing windows” part of business strategy, sadly it’s the one area of business strategy entrepreneurs leave mouldering on the shelf.

Let’s return to Miramax for a second. The film business has far more in common with hedge funds and investment banks than it does with, say, movies. The business model is one of portfolio investments. A studio or distributor invests in a portfolio of entertainment properties. For films, those investments have several payout windows from theatrical release to on-demand to DVD/video to cable to broadcast and beyond, as well as ancillary payouts, such as merchandising (the movie Cars, for instance, is still making millions of dollars for Disney with all the toys and coloring books and kid’s underwear).

A portfolio investment firm, such as a hedge fund, investment banker, or mutual fund, takes on risk with each property in the portfolio. Some of these investments will pay off big, some will pay off, some will lose money, and some will lose big. If the investment portfolio company makes more money than it loses, then it’s successful. If it makes MUCH more money than it loses, than everyone goes home with ten million dollar bonuses.

Until Miramax, the studios made three types of investment “bets” in their portfolios of film properties: little bets that could make little gains (but lose little money), medium-sized bets that might make medium gains (but lose medium-sized amounts of money), and big investment “bets” that could make huge gains (Avatar), but also have the potential to lose huge amounts of money (Godzilla). Of course, every once in a great while, a “little bet” would make tons of money (While You Were Sleeping) and everyone went home happy.

The Weinsteins founded Miramax on a completely new model: making “tiny bets,” most of which would lose a tiny bit of money, in pursuit of the occasional big payoff. The other studios were playing quarter slots for (sometimes) dollar payouts and hundred dollar slots for (sometimes) thousand dollar payoffs. Miramax was playing penny slots for penny payouts and the occasional hundred or thousand dollar payoff. The Weinsteins acquired film properties for two, three, or five hundred thousand dollars and sink a little bit of marketing into the film. Most of the time, these films made them a million or so dollars (not bad, really). But they built their business around the concept that, every once in a while, one of these inexpensively purchased films marketed inexpensively would catch on with audiences, and they would then sink more marketing money into the investment. So they’re making little bits of cash on each of their films (or losing little bits), but once a year or so, an Il Postino or Cinema Paradiso would return tens of millions or hundreds of millions of dollars.

And they carried this financial model over into their marketing. Normally, film marketing is a high budget affair involving mass media advertising, theatrical trailers, newspaper advertising, and quite a hefty chunk of publicity in order to reach as wide a swath of the potential audience as possible. For all other studios and distributors, the marketing typically represents half or more of the money “invested” in the film.

Harvey Weinstein, however, was working on a financial model that limited the downside of his “film” investments as much as possible. Purchasing a film for five hundred thousand dollars and then sinking ten million dollars into marketing meant that Miramax had over ten million dollars invested in the film, not two hundred thousand. Without being a math whiz, you can see that the potential downside of a flop is much greater!

So Weinstein had the brilliant idea of marketing to a very limited and easily reached audience: the people who hand out movie awards. Miramax was the first studio to market its films using almost exclusively an “awards strategy.” There are a series of high-profile awards, starting with film festivals (Cannes) and ending with the Hollywood series: Screen Actors Guild, Golden Globes, Producers Guild, Director’s Guild, Academy Award. A significant win in any of the Hollywood awards would provide momentum into the next awards and provide literally millions of dollars of free publicity and advertising.

So how do you market a film with almost no marketing budget? You focus all your efforts on the members of the Screen Actor’s Guild (the first of the series), the Director’s Guild, the Producer’s Guild, and all the parking valets cum foreign journalists handing out the Golden Globes. Does it work? The last film that successfully pursued this strategy — on a marketing budget very close to zero — was the movie Crash.

That, of course, was why it literally rained money on Miramax when all other studios were bleeding money out of major arteries.

“What happened?” you may ask. “Miramax went out of business.”

Indeed, it did. Harvey Weinstein literally got out of the business of making movies and into the game of making movies. It’s hard to resist. As the years and successes (and cash) piled up, Weinstein began making bigger bets in the film properties. Remember: the winning financial strategy was to make tiny bets for tiny payoffs (or tiny losses) and the occasional mega-big payoff. Pretty soon, however, Miramax was pouring tens of millions to hundreds of millions into their films (Gangs of New York had a production budget nearing $100 million and a marketing budget of $35 million, but had worldwide receipts of $190 million, of which Miramax got less than half — losing tens of millions of dollars). Do you see? They adopted the exact same financial model that was causing every other studio and distributor to bleed money. What happened? Miramax bled money.

You can see that while financial strategizing can be very complex and creative, the fundamentals are relatively simple. Financial strategy is about limiting your downside while preserving or increasing potential updsides.

Taken in a more simple sense, winning financial strategies try to preserve as much of the margins of the business while insulating the business from potential and inevitable losses.

Let’s leave the rarefied world of movies for the more mundane world of small business startups. And you can’t get farther away from the glitter and glamour of Hollywood than putting signs in the ground. But many years ago, I worked with a business that did just that (I don’t have permission to name the business here, though).

This guy, “Iggy” (which is what he called himself, alas), started a business back in the late 1970′s where he offered one and only one service: sticking real estate “For Sale” signs in the ground and removing them when the house sold. Of all the businesses I’ve met in my years, it was probably the least glamorous. But the business made Iggy a multimillionaire tens of times over.

The financial model was very simple. Iggy would approach real estate businesses and offer them his services. The real estate business would purchase giant, wood post signs (not the wire kind, but the hefty cross-beam kind with large signs hanging from the top beam). Iggy would hire a contractor, who was responsible for the signs (so the real estate agent never had to see or use the sign — or carry it around in the trunk of the car). Every once in a while, the contractor was expected to repaint the beams. When the real estate agent required a sign be put up, he would call Iggy. Iggy would call the contractor and that contractor would drive to the address and plant the sign. When the house sold, the real estate agent would call Iggy and tell him to remove the sign and . . . Iggy would call the contractor who would drive on over and uproot the sign and fill in the hole.

Iggy got paid $20 each time a sign went in or came out. He would pay the contractor $10.

All Iggy had to do was go around selling the service, pick up clients, hire contractors, answer the phone, and, every once in a while, check to see that a contractor was doing his work. After a few years, Iggy was planting signs at the rate of tens of thousands a year. Whether he was planting one hundred signs a year or hundred thousand, his business model required only two full-time staff including himself.

What did this mean for the 50% margin he was making on each sign his contractors planted? He got to keep almost all of it.

Think about this. A business with almost a 50% net margin! Read that again. When I met Iggy, his business had net profits close to 50% of revenues. And he was making millions every year. Millions. He worked, on average, about twenty to thirty hours a week.

That, my friends, is a brilliant financial strategy. Think about it. Are you having trouble getting a business loan or line of credit? Imagine you walk into a bank with an ongoing business — even a small one — with profit margins around 50% that you can preserve no matter how big your business grows. What bank — really — what bank would turn you down?

When I met Iggy, he had befriended a high-powered former McKinsey consultant who thought that Iggy’s business could be a multi-billion dollar, coast-to-coast business. We were hired to help him persuade Iggy to turn his money-minting machine into a major national business. To which Iggy replied, “Iggy” — he always spoke of himself in the third person, never using the word “I” — “does one thing. He digs holes and puts signs in those holes. Iggy has three houses, millions of dollars, and kids who are going through college because Iggy digs holes better than anyone else and doesn’t anything else. Iggy works about thirty hours a week and has one employee. Why should Iggy do anything different? Why should Iggy learn how to run a big company with hundreds of employees?”

I must admit, Iggy was right and the McKinsey clone was way off base.

You can see the key outlines of Iggy’s financial strategy. He didn’t hire employees, he hired contractors. He paid those contractors only when he had a paying job. He offloaded as much costs as possible — the real estate agent bought the signs and the contractor paid to keep up the signs. His variable costs were always predictable — it always cost him $10 to put a sign in the ground or take one out. He reduced fixed costs to the lowest amount possible — he ran the business from his home and had only one full-time employee (he was the other). He also ran a sales-oriented business rather than a marketing-oriented business. All he had to do was build relationships and make sales — that always translated into higher volume without cutting into margins. Sales-oriented organizations — particularly when costs are related to performance — typically preserve margins far better than marketing-oriented organizations.

Believe it or not, most consumer retail businesses can thrive by focusing on sales to retailers rather than marketing to consumers — at least in the early growth stage. Sure, purple cows and new rules of marketing are cool, but most consumer retail success accrues to the startups which hit the streets and knock on retailers’ doors. Remember Chazz Palminteri’s saying, “It’s not about knocking at the right doors . . . it’s about knocking at every door.”

Granted, Iggy ran a blissfully simple business (we should all be so lucky), but it holds its own strategically in comparison with Miramax with all its glamour and big money. Miramax, too, reduced their variable costs (purchasing films cheaply and investing only small marketing budgets in those films unless they caught on with audiences), offloaded as much cost as possible (by paying small fees for their films and leaving much of the marketing and publicity to the awards), and keeping fixed costs predictable. And, during its heyday, Miramax was more of a sales organization than a marketing organization. It concentrated its limited marketing budget on “selling” the film to festivals, SAG voters, DGA voters, PGA voters, Golden Globe critics, and the Academy voters. When it successfully “sold” films to the awards people, it then invested in more traditional film marketing.

So, far from being the unglamourous aspect of business strategy, financial strategy is more frequently than not the determining variable in startup success. Like other strategic advantages, you can happen on a successful financial strategy purely by chance. But that is no excuse to ignore it!

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