Good Growth vs. Bad Growth
Generally, American companies – and Americans themselves – are pretty darn bullish on growth. In fact, our entire financial system is set up to measure growth specifically – to the exclusion of virtually all other measurements. Stock prices are based on publicly held company’s future growth in revenue, and venture capitalists look for growth rates of 25% or more per year when making their investment decisions.
In short, we are growth nuts.
At BottomLine Growth Strategies, we like growth, too. We want to see our clients grow and we want to see all companies grow in general. But what we desire even more than plain old growth is profitable growth. And the truth is that growth and profitability are not always roommates.
Following are several pitfalls in thinking that we’d like you to avoid as you work toward significant growth in your organization.
In other words, here’s what NOT to believe to stay on the good side of growth:
“We’ll make it up in volume.”
This is the concept of variable pricing. Business owners who buy into this belief are willing to skinny margins on large contracts because of anticipated volume. While it is true that certain costs do not or may not change with higher volume, there are many costs that do increase and those need to be considered.
As an example, costs such as salaries for the CEO and other executive positions and even salaries for other administrative staff will not change with the addition of a larger contract. And, unless a larger facility is required to service the higher volume, rent won’t change either. But expenses like materials costs in the cost of goods sold equation are highly variable. Even customer service and billing costs are variable if to a lesser extent.
All too often, in the heat of the bidding process, entrepreneurs lower their pricing too much because they think they’ll “make it up on volume.” But as we all know, if pricing is lower than variable costs, you will not make it up on volume. Instead, you’ll lose money on every unit.
In general, your pricing should not only cover variable costs, but also make a contribution to administrative overhead and provide a profit.
We recommend that you know your costs and how they relate to volume before the bidding process begins – including fixed, variable and semi-variable costs. Further, develop a model that enables you to price based on incremental volumes. If you do not have the talent to do this internally, buy it. The up-front investment in a solid pricing model will pay for itself over and over again in profitability down the road.
“We’ll be able to provide excellent service to a new contract, even though our service is a little below par now.”
If you want to continue to have business knocking at your door, you must pay attention to your customers. If your service is under-par now, it won’t get better with higher volume.
We strongly advise that you address customer service issues prior to making any major expansion.
“We’ll get the work done. It doesn’t matter if it takes a little longer than we anticipated.”
Quite a few of our clients are in service industries where labor is the key cost of services. Carefully and pro-actively managing productivity is critical to profitability for these firms. When a project is priced to complete in three months with dedicated resources, but delays and performance issues cause the project to take four or five months, profits disappear into thin air.
We recommend developing productivity metrics for all billable employees against a target. Share this information with your team and manage client exceptions.
So, what philosophy should a business owner “buy into” to achieve good growth?
Assuming you’ve addressed the above false beliefs and, therefore, have positioned your company for “good growth,” what should your new philosophy look like?
To answer that question, let’s look at what it means to achieve sustainable growth.
A company’s sustainable growth rate is the measure of how much they can grow without borrowing more money. After the firm has exceeded this rate, it must borrow funds from another source to facilitate growth. In other words, a company will reach a point at which cash from current operations is maxed out. The key here is to be able to identify when a cash crunch will occur in advance so that you can obtain appropriate funding.
Preventing a company from running out of cash requires thoughtful planning and analysis. You can also adopt policies that will internally maximize your cash position. For instance, you can reduce the time it takes to receive payment from your customers, carry lower levels of inventory and pay your vendors later.
These are good financial management strategies whether your company is funding growth or not. They’re about sustaining your business.
Committing to Good Growth
CEOs and the management team have a responsibility to put the brakes on growth when it is not sustainable or when it’s incapable of creating value.
This is easier said than done.
Most CEOs are “builders” who want to grow an empire. It’s just not as inspiring or motivating to simply maintain a business. But at the same time, the attractiveness of a company to outside investors, bankers and potential buyers is based on cash flow and profitability.
Justifications for fast growth come fast and furious, even when it doesn’t make the best of sense for increasing a firm’s value. When evaluating growth opportunities, CEOs need to step back and consider the holistic implications, and whether or not their company is prepared internally and has the funding to grow smart.
So, is your company’s growth GOOD? Is it sustainable? We encourage you to find out. Then create an action plan that lets you answer our question with a resounding “YES!”