I believe there are two kinds of sales growth, good and bad. Bad sales growth is unsustainable, and in the end counterproductive. Bad growth maximizes sales growth over optimizing the factors which can lead to good sustainable growth.
Maximum sales growth seems great (who doesn’t want sales?) but it can lead to bad outcomes. A few examples, because the most instructive examples are the bad ones. I was working with a window covering manufacturing company that had a shot at landing a national big-box retailer. The CEO wanted the business and bid hard for the work. His company immediately increased by 50% but within 18 months went bankrupt. In his eagerness to get the business he bid below his fully loaded cost for the product and began to lose money quickly.
Under investing in systems and accounting kept the client from knowing their costs or how deeply they could cut prices. I met them about 8 months after the fateful bid, when I was brought in to purchase a high volume wood blind finisher to support their growth. While doing due diligence, I compared the costs for the target to the base company. Given that the target was specialized, 10x bigger and extensively automated, I was surprised that the target reported 15% higher costs than the base company. Digging into the internal cost data identified a problem in booking inventory that caused this discrepancy. The person in charge of inventory tracking (the owner’s sister) had no accounting training and wasn’t relieving inventory accurately. Her husband ran the manufacturing operation and he’d continually boasted about efficiency he’d gained. Those gains turned out to be spurious. It took only weeks to figure out that the base company inventory was overstated and that the new “big box” business had lost so much money that the equity was wiped out.
I once worked with an insurance company offering our customers the option of purchasing their product. The company was eager to grow the book of business quickly. They suffered adverse selection as the bad risks switched insurance to get the low introductory prices. Risk was significantly under-priced and profits, which were planned for year 2, ended up in year 4. Growing fast meant taking on unqualified and riskier clients. Bigness doesn’t overcome crappyness.
I was the lead auditor on a large auto company’s financing arm. At lunch one day, the top executive at the finance subsidiary said that the front office wanted more loans written and more cars sold. Since the financing division couldn’t access funds cheaply, the loans they offered had higher interest rates than average. Low risk borrowers weren’t interested in high cost loans as they had low cost options. Consequently the only way the company could increase loans was to take on riskier borrowers. Another example of adverse selection. I asked how this would play out. He said they’d write a lot of loans (and sell cars) but in a year a higher than average portion of the new loans would stop performing. Eventually the front office would ask that he clean up these delinquencies. He then would repossess enough cars to drop his delinquency rate to average. Repossessing cars is expensive and after the increase in losses due to the disposition of these vehicles he’d then be asked to limit these losses. If the scenario worked out as he’d foretold, he would likely obtain a bonus every year for achieving his objectives.
Creating growth like this is counter-productive. Yet lots of firms think it is as simple as the CEO ordering growth to happen. Smart growth is about balancing the factors of growth. People, resources, systems, processes, time and management must be balanced against sales growth. The factors must be optimized so that growth and profits continue. Optimization can be complicated, as there can be multiple successful solutions at varying levels of profitability. Some solutions are oriented to throwing bodies at the problem, other solutions might include implementing a computer system. Both ways will work, one way offers more flexibility and the other cheaper long term costs.
Most of the factors of growth can be quantified into costs, so there is a basic cost vs. profit model that needs to be managed, but time is the factor that determines the rate of growth. A firm that grows 10% and 9% in two years is roughly equal to a firm that grows 20% and 0%. The cost vs profit trade-off has to be seen over multiple years as costs often come as a steps. Investing in a new manufacturing facility or a new computer system is a step that will need to be cost justified over five or more years. Finding ways to minimize the height of the steps, planning on when to take the steps and grouping the steps into logical order are a big part of dealing with optimizing the growth rate.
It is easy to delay investment in these factors, but eventually the problem worsens which brings growth to a halt and sometimes worse. I am not suggesting that everything will be perfect before you can start growing – and growing fast. But as much as it is wanted or needed, when the car is doing 180 mph around Le Mans, you can’t change the tires. You can fix a foundation after the building is built, but it won’t be cheap or easy. Smart growth is about about balancing and managing these trade-offs.
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Dr. John Zott is the principal consultant at Bates Creek Research & Consulting.
I am the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and I comment regularly on issues that affect growth businesses. If you are looking for a CFO for your consumer company, or are a former student, colleague or would just like to connect – reach out.