Growth II

(November 04, 2005) - So, how do you do it? How do you create more jobs at an already profitable technical company? How do you grow revenues from existing customers? How do you expand into new products? How do you take a one dimensional technical firm into a more secure existence as a full service provider?

It's not complicated but, it's hard and expensive.

The first rule of thumb involves investment. That is "you can only reasonably expect to make a return that is proportional to your investment." If you want to see $20,000 in additional margin at the end of the year, expect to invest at least $100,000.

Compared to the general stock market, a 20% annual return is a pretty good deal. The real message is that growth comes from investment, in proportion to that investment. Investments that return much more than the prevailing market are inherently risky. That is, they include the likelihood that you will lose your initial investment. In investment questions, return is proportional to risk. As we've been saying, growth can only come from investment.

At a 10% return (relatively low risk), it takes an investment of $1.2M to create one job plus overheads and profit. For a 20% return, the investment would only be $600K, but there would be more failure associated with the venture, i.e. of 10 $600K investments seeking 20% return, as many as thee or four might fail completely. Of course, the ground rules change as interest rates fluctuate.

So, the essence of growing a business past its natural limits is a series of actions that mitigate the risk, making the investment more palatable. Remember, what is available to be invested can only come from one of three places: new investment, existing profit or equity in the company (a bank loan is usually payments of profit secured by equity).

Almost immediately, the entrepreneur will consider cutting costs and raising prices in order to generate spare margin for investment in growth. It is rare to discover a cost structure that planned for growth. In a healthy enterprise, there is an R&D/spare margin factor of 10% floating, untouched, through the system. There are not very many healthy firms in this regard and there are even fewer bootstrapped, undercapitalized operations with 10% to spare. (Note: at a 10% rate of return, 10% of revenues might buy 1% of growth)

Further, the entrepreneur tends to see profit as "hers" and not the company's. Squeezing any of the "profit" into out-year investment is a profound mental challenge. Growth "should" happen in the way that it did in the company's beginning or "I've done it so I know it can happen." Quite surprisingly, the fact that growth requires capital continues to be lost on the entrepreneur in spite of years facing the undercapitalization problem.

The process of planning and developing consistent growth is straightforward. But, it involves a set of disciplines that are not characteristically apart of the entrepreneur's skills. Above all, it requires a detailed and thorough evaluation of customers, their needs, company finances (the ability to finance growth), existing development plans, product development and testing and clear indicators of success and failure (go-no go points).

- John Sumser © TwoColorHat. All Rights Reserved.