the structure of goodwill

In "The E-Myth Revisted", Michael Gerber distinguished between the operational work that entrepreneurs do "in" the business and the development work they do "on" the business.

In a professional service organization, there is a big difference between say a dental "practice" and a dental "business". A practice is a group of people performing technical services and a business is something quite different. In a practice, when I'm not working, I'm not earning, In a business, I can earn without working.

Accountants define goodwill in a business as the difference between the book value of the assets of a business and its market value. Capital assets are worth either what someone else is willing to pay for them if the company liquidated or what the accounting and tax rules determine through an on-going process of depreciation.

The value of any practice is pretty much the capital value of the assets, without much goodwill. Most accounting, law, engineering, architecture, dental and medical practices don't have much value over and above the physical assets required to perform the service. The same is true of any service practice.

A business has value over and above its capital assets and the wages I draw from working in it. From this perspective, the higher the goodwill I build into my business, the greater the premium I earn, either as profits I take from the business when I'm not working in it or the price I fetch for it when I sell it.

It's possible to consciously create goodwill in a business. Business development creates goodwill not business operations. This is hard for masterful service practitioners to grasp. Simply doing good work creates very little goodwill. It might create high wages for me, but the reputation I have for doing good work does not necessarily benefit other people on my team and it likely does not benefit someone who buys the business from me.

Goodwill has four components: brand, product, system and culture.

The brand is the name of the business. In time, the name comes to symbolize the value shared by the owners, staff and customers or the business and the reputation the business has for doing great work. With a strong brand, customers are willing to pay higher prices and stay bonded to the business for longer. The brand is everything that the business presents to to it's people: logos, taglines, slogans, the design of uniforms, interior spaces, signage, the statements of mission, vision and values.

The product is the package of everything the business delivers to a customer to satisfy their needs in ways that are better and different than other competitors. It's not merely the provision of a technical service–like pulling teeth, designing a building, writing a financial plan–but a way to structure the process, experience, results and relationship with a customer as a robust program of activities to create the most value.

The system is the set of all procedures, mechanisms and technologies that a business relies on for getting the work done in an efficient and timely manner. The system supports a team to come together around common business goals and manages the transmission of business objectives through each member of the team. It includes all job descriptions, ways to communicate and make decisions and resolve conflicts and the rules that determine how everyone get's rewarded for the work they do inside the business.

The culture of a business is its spirit. Culture is how the business smells and tastes and feels. It's like an invisible mist that guides the growth of the enterprise towards a common vision. A strong culture leads each member of a team to go above and beyond the call of duty and make the kinds of contributions that increase profit margins and cashflow.

Without a business that has a structure for creating goodwill, an entrepreneur has at best a high paying job. The true economic value of a business comes when entrepreneurs build a brand, product, system and culture that creates higher buy-in, quality, efficiency and cashflow. A business with a goodwill structure either generates higher residual income or a higher sale price.