Let’s start with an apt truism: bigger isn’t always better.
Most entrepreneurs will be quick to agree with this, at least in principle. How could they not? Part of running a small business is leveraging less size into more adaptability to stay competitive with larger rivals. Small-business owners know their size can add value and give them an edge, and they want others to know it too. After all, it’s hard to acquire customers if your philosophy is, “Don’t worry, we’ll be much better at this when we’ve grown.”
Unfortunately, many entrepreneurs will acknowledge the virtues of smallness while doing everything they can to get big fast. It’s not misdirection or hypocrisy, it’s just a widespread cultural myth: lots of people tend to assume that the small business with the highest growth rate holds the most promise.
Why wouldn’t they assume that, considering the power of today’s massive corporations? Our lives are filled with the traces of businesses so huge as to be considered institutions; even though we know such enormous corporations are capable of faltering, it’s hard to imagine a world without them. We can all come up with a long list of examples.
Now according to the myth of growth, a growing business is a business edging closer to institutional status, which is supposed to mean more stability, higher profits, and eventually, something akin to permanence. It’s one of many ideas people accept without even realizing they accept it, precisely because it seems so obvious.
But it’s incorrect, and it ends up hurting entrepreneurs, who, in our experience, have a tendency to embrace growth for growth’s sake. Not necessarily as part of their business plans, but more as a matter of ingrained instinct. Unlearning this faith in growth is critical if a small business is going to succeed, because growth is not a reliable predictor of a business’s success, and can in fact be detrimental.
We’re not saying growth is fundamentally bad—that would be absurd. It can be an excellent thing. But it should be pursued judiciously, always in the aftermath of careful self-analysis and planning. The problem is that many entrepreneurs start by asking, “How can we grow?” Better questions are, “How should we grow, and when?”
Reasons to be Cautious of Growth
The relationships between growth, profit, and the economy as a whole are generally too complex to map. There’s a lot of data, but much of it is the wrong kind of data, which doesn’t do us any good. Similarly, there are countless theories that try to explain why some small businesses succeed and others don’t, but they’re all limited and fallible. No conceptual framework or collection of statistics is capable of predicting how a particular small business should behave. Entrepreneurs have to cope with so many unique contingencies that experience is more valuable to them than statistics or models.
Even so, it’s worth taking a look at some empirical data, just to contrast the myth with the numbers. What the numbers tell us is that growth and profitability, or growth and success, do not go hand in hand.
For instance, businesses that start off growing fast are likely to end up shrinking fast immediately afterward. The US Small Business Administration (Office of Advocacy) reports:
Fast-growing firms had higher rates of shrinkage in employment following their large one-year employment increase. The year after fast growth, 55 percent of fast growers declined in employment versus the universe’s 25 percent. Former fast growers continued to have higher rates of employment decline for at least eight years after their large employment growth. (Head and Kirchoff 2007, emphasis added)
Of course, employment growth is only one possible metric. What about sales? Quite a few schools of thought associate sales growth with increased profitability (see Davidsson, Steffens, and Fitzsimmons 2009). We’re professional businesspeople, not professional economists, so we won’t go through a drawn-out survey of these schools and their academic niceties. It would take up too much space. Suffice it to say that research has uncovered some problems with the “growth=profitability” complex:
These theories suggest growth will drive profitability either through the lowering of costs or by establishing a stronger market position. However, there is little empirical support for a strong and general growth-profitability relationship. For example, research in industrial economics [has] shown that scale economies are not much of a barrier to entry; that surviving new entrants operate for long times at sizes far smaller than the industry average; that minimum efficient scale is typically reached at a rather small size; that very limited cost advantages are usually gained beyond that minimum, and even that it is possible to operate significantly below it without severe cost disadvantage. (Davidsson, Steffens, and Fitzsimmons 2009)
So much for the myth: rapid growth is a poor predictor of future size, and growth in general doesn’t go hand in hand with profit. We’ll even take it a step further and say that growth can serve as a red flag (or maybe a yellow one):
At least in some cases, rapid growth should be taken as a sign not of astonishing success, but as indication that while the firm is evidently creating value for its customers (hence the very high demand), it is failing to appropriate enough of that value in order to secure its own survival. (Davidsson, Steffens, and Fitzsimmons 2009)
For the same insight in less abstract terms, consider this small-business owner’s self-critique, as published by Practical eCommerce:
As I reviewed our 2010 performance against our goals this month, it became obvious that we had missed a key target—our net profit objective. We actually fared pretty well on revenue growth, new customer acquisition, product expansion and operational efficiencies. But, at the end of the day, or the year in this case, missing your profit objectives makes all the other accomplishments seem almost irrelevant…
We ran an aggressive [marketing] campaign back in September that brought us a lot of new traffic and sales, but the cost was way too high . . . It’s possible that some day the new customers will actually pay for the campaign with their repeat sales, but I don’t have an effective way to measure the value of a new customer over time at this point. (Traxler 2010)
Pursuing rapid growth can be exciting, affirming, and personally rewarding. It’s not as if it should be avoided at all cost. It’s just that it doesn’t necessarily lead to greater profits or greater chances of success, and is associated with risks. In other words, empirical evidence gives us plenty of reason to reject the myth that growth is a blessing bestowed on the most worthy. The reality behind the myth is far more complicated and, as with most realities, far less certain.
Here we want to emphasize something that, if you’re an entrepreneur, you already know: academic research is not proof positive. It never will be. You could spend decades poring over sweeping longitudinal studies, painstaking statistical analyses, and abstruse theoretical manifestos, and even though you might learn a lot, you wouldn’t guarantee yourself a profitable business venture. Much more valuable than textbook treatises are lessons learned from years of observation and personal experience, with empirical research serving as a supplement.
The existing data on growth and profit is complex and, in some ways, equivocal. Even so, the message is simple: growth may be popular and widely celebrated, but it is not the same as success, and there are right ways and wrong ways to go about pursuing it.
Growth in Practice
Again, avoiding growth is obviously not the answer. To do so would be bizarre and unhelpful. We don’t want to see that—rather, we want to see entrepreneurs be more selective about when and how they grow. You might say we want growth to be a bit more modest. To take its place as an element of a business strategy, rather than a defining characteristic of a business.
It’s not so easy to accept that growth is best pursued cautiously, rather than automatically or by default. The idea sounds reasonable on paper, but the habit of construing growth as the end-all be-all of small-business development runs deep, and is often reinforced by popular business literature. In other words, it’s tough to shake. So don’t underestimate the sheer value of saying to yourself, “I need to pick and choose when and how this business is going to grow.” That’s a lesson most entrepreneurs have to learn the hard way.
And of course, it’s only a starting point: you have to go on to actually construct a growth strategy. Here you’ll truly run up against the limits of books, articles, and blog posts, including this one. None will give you specific, detailed instructions—at least, none worth reading. That’s because there is no generalizable recipe for successful growth, and in our practice, we don’t pretend to have one. You, as the person running the business, already have all the answers you need. What remains is to ask the right questions.
With that in mind, we’ve created a list of critical strategy points. The purpose of the list is to provide a helpful lens through which to see your business, a lens particularly suited to planning for growth. It’s not a magic recipe, comprehensive template, or mystical forecast. It’s simply a set of basic, general areas you need to be thinking about when you consider expanding. Articulating your approach to these areas is a necessary part of maintaining a positive ROI and gross margin during the growth process.
What is it about your products/services that makes them especially desirable? If you’re attempting to grow by expanding your customer/client base, then the last thing you want is to get into a price war with other (larger) vendors who can afford to underbid you or who simply have larger marketing budgets. That’s a perilous position for a new business.
To avoid it, you’ll need to be able to clearly, persuasively, and succinctly convey what it is about your products/services that distinguishes them from the field of other, related commodities. This is about more than advertising a particular item or deliverable: it’s about creating an image of yourself to present to (1) customers/clients and (2) your own employees.
How do the particular features of your products/services translate into an overall identity for your business? Is the market for that identity large enough to sustain your growth?
Which subsections of the market are you selling to, and which products/services interest those subsections most? A small business can’t afford to see its market as homogenous or monolithic. To turn your size into an advantage, you need to be intimately familiar with the detail-level differences between your customers/clients—not only those you’re pursuing, but also those you already have.
What are their genders? What are their ages? What’s their average income? What’s their average level of education? Do they live in the city or the suburbs? Do they own multiple homes? Do they use smartphones? Do they prefer Macs or PCs? Which professional conferences are they likely to attend? Do they see themselves as more academic? As middle class? As working class? Are they interested in social justice issues, like environmentalism? Are they more likely to spend their vacations backpacking in the Rockies, standing in line at Disney World, tanning in Cancun, or shopping on Fifth Avenue? What products do they currently purchase that are related to yours?
In addition, which customers/clients are the most profitable? Which are likely to stick around? Which are likely to provide referrals? (Strickland 2010)
Being able to answer these types of question is crucial to marrying increased size with increased profit. You should be able to paint as clear a picture of your customers/clients as you can paint of your own business. That means understanding both your clients’ needs and your clients’ image of themselves. You want to describe meeting their needs in a way that reinforces or enhances their self-image.
Ultimately, it’s an issue of how well you know whom you’re growing for. Are you growing into something that will appeal to the market segments you depend on, as well as the segments you’re going after?
Margins Analysis By Product/Service
You can probably say which of your products/services yields the most favorable returns—can you also say why this is so? Do you have the whole story?
To grow in the right direction, you’ve got to completely understand the relationship between the size of your business and its individual ROIs. Are you able to grow in areas that will emphasize your most profitable products/services? Is the market prepared for growth in those areas, and will it respond the way you’re hoping to your business’s expansion? How will your growth in one area of products/services affect other, less profitable areas?
Cross-Selling High-Margin Services/Products
Are you doing everything you can for your current customers/clients? Expanding the products/services you provide for your existing customers/clients can be a powerful engine of growth and make you more attractive to the rest of the market. If you can create incentives for clients to purchase multiple products/services from you, then you’ll increase your value to them, increase your chances of retaining them, and increase both your ROI and gross margin. As your business grows, will you develop new ways to serve customers/clients even as you acquire more of them?
Communication/ Human Resources
Are your employees aware of how the company is going to change, and how the changes will affect them? If you’re pursuing growth, you’ll need your employees to understand the direction you’re taking and support your plan. They should feel like stakeholders (metaphorically, at least) in your vision, and most importantly, they should feel they’re being treated fairly within that vision. This means communicating frequently with them and cultivating a sense of mutual trust—both of which have been found to increase organizations’ profitability (Blaker 2010). Do you have open lines of communication with your current employees? Are they going to feel blindsided by any aspects of your strategy?
On a related note, how are you going to handle the influx of new employees that may well coincide with your business’s expansion? Do you have human resources materials and protocols? Will they need to be modified to be relevant to a larger staff?
Answering the questions in the above list will provide a strong foundation for planning profitable, sustainable growth. That is, it will help you determine the right time and type of growth for your business. In our experience, this sort of strategic approach to growth can make all the difference. It runs contrary to the popular approach, which too often treats growth as if it were good at any juncture and in any quantity, despite empirical evidence and practical know-how that say otherwise. Small businesses that analyze and articulate the details of their growth potential—and avoid rapid, incautious expansion—are more likely to stick around for the long haul and more likely to turn a profit in the process.
Blaker, Rodger. 2010. Business growth statistics summary. Blaker Business Coaching.http://blakerbusinesscoaching.com/business-growth-statistics-summary.
Headd, Brian and Bruce Kirchhoff. 2007. Small business growth: Searching for stylized facts. Small Business Administration, Office of Advocacy. http://archive.sba.gov/advo/research/rs311tot.pdf.
Steffens, Paul, Per Davidsson, and Jason Fitzsimmons. 2009. Performance configurations over time: Implications for growth- and profit-oriented strategies. BNET. http://findarticles.com/p/articles/mi_hb6648/is_1_33/ai_n31342276/.
Strickland, Lea A. 2010. Managing customers for profit and long-term growth. Technovation entrepreneur. http://www.technovationentrepreneur.com/2010/09/managing-customers-for-profit-and-long-term-growth/.
Traxler, Dale. 2010. Revenue growth versus profits. Practical eCommerce. http://www.practicalecommerce.com/blogs/post/794-Revenue-Growth-