I once implemented SAP over the top of Quickbooks. We were on a fast growth trajectory and the venture funds wanted a solid system that we could use while we grew. The SAP ERP system was selected before I joined. The system wasn’t as mature as it is today and for our $1,000,000 check we received a lot of “Achtung” error screens. The one positive was that we used their system exactly as designed. Our processes didn’t exist, so there was no need for customization.
Managing growth is about managing the many changes that occur when you turn a small business into a big business. Start-ups lose money before they achieve scale. This is because costs aren’t perfectly variable. If you open a frozen yogurt shop, you’ve got to rent space, buy fixtures, yogurt machines and train a staff. All of this cost occurs before you bring in any revenue. These investments are a part of your fixed costs. Costs that vary with sales are called variable costs. A perfect variable business would not have any costs until revenue is achieved. Unfortunately, there are no perfectly variable businesses.
Costs grow in “steps” because the cost increases are not smooth, they increase in a bunch. For instance, you could start out renting a small space with a fixed rent, which is a step up from working on the kitchen table. A year later you pay the same rent but the staff has grown and people have to crawl under their desks to get to their chairs. A new space is located and rent increases, another step. Shared space operations like WeWork, Regus and Carr and hope to minimize the steps by allowing you to add space as needed.
A big change in business in the last 25 years has been the decline in the size of the steps and the ability to ramp a small business. We used to call the growth infrastructure problem “the tunnel”. Before you entered the tunnel you could make money – the business is small, not much investment in space or people, there was little structure and no overhead. You entered the tunnel when a step up in investment was required. Maybe you needed a larger office, or a new system or a warehouse. But whatever it was, until you grew sales sufficiently to cover the cost of investment, you had high costs and lower profits.
Years ago there were many, many large steps. Renting an office space used to mean a 5 or 10 year lease with guarantees by the founder. Not so anymore. You will pay a more per square foot for shared space, but you aren’t committed in the long term. Systems used to run six figures, while today I’ve worked with businesses with sales more than $40m a year running on a $400 copy of Quickbooks.
Financing can sometimes help make those steps smaller, too. You may only need to put down 10% on that frozen yogurt machine, so you pay the loan with money you’ve made selling frozen yogurt. The risk remains (after all you have to pay the loan), but you better match income with outflow.
These steps happen with staff, space, equipment and systems. Managing the growth is a lot about making the steps as small as possible while keeping your attention on the target. My SAP install turned out to be a bust. After losing $50m the company pivoted and we returned to Quickbooks.
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Dr. John Zott is the Principal consultant at Bates Creek Consulting and works as a CFO. John is a senior adjunct professor at Golden Gate University and comments regularly on issues that affect growth companies. If you are a former student, colleague or would just like to connect – reach out.