How to approach decisions about the growth of your business
In my strategy practice, I have worked with more than 125 business owners.
My observation is that, most nights, they go to sleep grateful for the abundance and flexibility that entrepreneurship affords them. They wake up excited to seize the opportunities ahead. In between, they may wake at three in the morning in a cold sweat, petrified that they could run out of runway.
Their fear is raw and real, and based on a universal truth: Any business worth being in will attract competition. It’s as if their core competency is on a collision course with commoditization, price pressure and margin erosion. At some point, a voice goes off in the entrepreneur’s head: “We should diversify.” Then, they chance exposing their businesses to another set of risks — most notably, execution risk.
How do management teams make the excruciatingly difficult decisions about how and where to grow?
Size makes a difference
First, the entrepreneur must decide if they view growth as an imperative. Growth is a critical driver in establishing enterprise value. Today, the average private company EBITDA multiple (during an exit) is about 10 times. Smaller companies trade for much lower multiples (five times or less). Public companies trade at 20 times, proving that size does matter.
Size matters for other reasons. Larger companies want to do business with other companies who can meet their onerous compliance requirements and payment terms. Larger customers push around small suppliers. Larger companies absorb overhead at a faster rate, and are more profitable. Small businesses face their own set of challenges. Maintaining reliable client and supplier relationships, establishing market niche and setting realistic growth goals are issues that should be identified and addressed. Small businesses may want to consider small business coaching to help establish how growth should be managed so as to maintain stability.
The 70/20/10 formula
A useful filter to consider diversification is to develop a “growth portfolio.” Famously, Larry Page of Google points to the company’s disciplined approached to diversification as critical to its success. The company applies a 70/20/10 formula to its investments, investing 70% in core growth, 20% in adjacent markets, and 10% in things that are truly transformational. If you went to an investment advisor and asked what you should do with your money, they would undoubtedly tell you to spread the risk.
Not every company should deploy a 70/20/10 formula, but every company should have one (a formula, that is). The weighting of 70% in core growth reminds us there is safety in what we know.
A trap many management teams fall into is failing to consider the growth trajectory of the markets they are in, or new ones they may enter. Marketers would make very different decisions in a market that is growing at 7% versus one that’s flat. In a flat market, the only way to grow is to take share from an incumbent, often at discounted prices. Growing markets allow space for new competition.
Evaluating core vs. non-core
Many a management team will define strategy as figuring out better ways to do the things they’re already doing, which is not strategy at all. It is inherently risky to place all your eggs in one basket. It’s also risky to attempt disruption (or transformation) if you don’t have the horses to take on such exploration. Strategy is the art and science of considering all the variables, so management teams can make informed decisions about where to invest (i.e., deploy resources).
For Vistage member companies, exploration into new markets can be particularly tenuous. The grass is not always greener on the other side. Small and mid-market companies often lack the bandwidth and experience to enter new markets successfully. Resource constraints limit their ability to conduct the needed research or support the required marketing. Sometimes companies even enter markets by accident, having failed to carefully consider the necessary technology, processes and people.
In fact, a study published in Harvard Business Review revealed that only 2% of companies can successfully focus on core and non-core at the same time. This is because there are very different skill sets required for succeeding in a core market (such as operational efficiency) than with exploration into new ones (such as being agile). Knut Haanaes, formerly of Boston Consulting Group, explores some of these dynamics in this Ted talk.
It’s not that core and non-core are in competition with each other; they are in direct conflict. Oftentimes, the business owner gets trapped in day-to-day operations, losing the ability to look around the bend. It is critical that companies have dedicated people, or at least dedicated time, for innovation.
A big-picture view of growth
Growth strategy is the foundation to many other decisions, including go-to-market strategy. One can’t decide how to succeed in various markets without first considering their contribution to the whole. Only then can rational decisions be made on how to deploy resources such as sales coverage, marketing spending, etc.
Never have such decisions been so complex. There is a new world order, where having channel strategies to drive growth may no longer be sufficient. Sales and marketing teams must employ omni-channel approaches that blend multiple strategies. For example, brick and mortar retailers recognize the need to sell online, and online retailers are seeking out brick-and-mortar solutions to satisfy their customers. A company is like an ecosystem, and its growth across verticals and markets must be considered from 10,000 feet.
So entrepreneurs and their management teams need to think carefully about their growth portfolio, and weigh growth prospects with the ability to earn a profit and mitigate risk.