I was recently talking to a client of a fast-growth company and they were considering whether to a) grow patiently after carefully assessing their options, or b) throw caution to the wind and “go for it”. Clearly, these are not valid binary choices, the answer is to find the right balance that is right for their business at this point in their growth and evolution.
A few thoughts around finding the right balance in growing your business, with a final caution to “invest before you need to”.
Balance – Tradition and Innovation
A little over a year ago I wrote: Balancing Tradition and Innovation, noting:
This week I had the privilege to be given a tour of the production facility of a third-generation family business by one of the current generation. One of many resonant moments was when they proudly showed me a piece of equipment their grandparent had installed so many years ago and that they still used every day. It is no longer the most efficient available, but they love it and it is a daily reminder of what they stand for and the traditions they hold dear.
At the same time, when we spoke after the tour, that current generation leader expressed how they felt that what had got them through the pandemic was one word. Innovation. They are a wonderful example of balancing Tradition and Innovation.
To use that business as an example, if they had kept only using the equipment that they had been using for the last three generations, they would have fallen behind or even failed as a business, but they chose to keep what was still worthwhile to use, whilst investing along the way in new ways to do things, new innovations.
Balance – doing the work whilst also investing in innovation
A second example comes from early in my career. I found myself, at 25, in my first role outside public practice accounting, as an accountant in an airline, an area of business that is highly dynamic and needs numbers to make decisions. A problem with this was that our finance department was using old systems and it took us up to a week to answer questions from the leadership of the airline such as, say “what if we opened up this new route and redirected aircraft from another route?”. This was way, way too long!
As a young accountant (with no family or other commitments, and with boundless energy), one thought gnawed at me, and it was “there has to be a better way to do this!”.
I already had a really full workload to get the routine accounting out each week, month, and quarter for the business, but I could not rest until we solved this problem. I quite literally worked 70-80 hour weeks for months on end to both do my “day-to-day” job and also focus on building new financial models for the airline.
The moment then came when I gave the regular monthly financial forecasts based on the current routes and schedules to the CEO, but then asked them to give me some of their “what if?” questions around route planning and options.
I said “give me half an hour” and went back to my computer. Something that used to take a week to do, I changed a few variables in the new model and was able to go back to them in (under!) half an hour. As kids these days would say: “game changer”, and it came from investing today in something that would pay returns in the future.
Balance – invest for the future while running the business
Ok, so my personal example relied on passion from an energetic 25-year-old to find an answer to “there has to be a better way to do this!”, but that is not scaleable. The hard answer is that we can’t have maximal short-term margins and income and still invest in the future of the business, we have to find a balance.
As an idea, let’s say your business has revenues of $100m and you make a net margin of 10% and that is what you as CEO, your board, and your shareholders expect. Oh, and they expect you to grow those revenues by 60% in the next five years (at ~10% per year compounded, having already done similar over the last five years.
However, your vision for the future (with the vision and point of view of the CEO) sees challenges up ahead in maintaining that margin as you grow as you need to invest in improving process, systems, developing your people etc. You see that the margin would drop several percentage points if you kept growing without making improvements say from 10% to 7%.
What to do? What to say to your board and shareholders?
One idea is that you tell the board “in 3-5 years I can radically grow the size of this business and I can run margins of that 10% yet on far higher revenues. However, in order to get there, we need to sacrifice 3% of that margin for the next two years and invest in that future”.
Let’s run the numbers
- Currently, revenues are $100m at 10% = $10m profit per annum,
- If the status quo within the business is maintained and so margin drops, in five years at £160m revenue and 7% margin = $11.2m annual profit, only 10.2% growth in profits in five years time, despite all of the effort to grow revenues by 60%!
- However, if you sacrificed the margin from 10% to 7% in the next two years by consciously investing in improvements that will support the business in the future, then yes, your profits in the early years of your revenue growth over the next five years would be lower, but once the benefits of investing in improvements start to pay off in the latter years, you would grow margins back up to 10%, so at that $160mm revenue level in five years back up to $16mm in profits
Rationally the choice is obvious, but it is also all to easy to keep looking to repeat hitting those revenues and margins month after month, quarter after quarter, year after year, until the natural force of entropy sees the profitability drop, seemingly mysteriously, until you get “under the hood” and realise that things have been lacking investment for years.
Invest before you need to
In closing, the approach I suggest is highly logical, yet again and again, I see businesses so, so busy doing what they always do that they don’t invest in growth until the point where things start to break.
Most of us would not run a car for so many years that it becomes totally unreliable with the rationale that “it costs less to run than investing in a new one”, as there comes a point where, with foresight, we know when to invest in the future by selling our car and buying a newer one. That point is, simply “before we think we need to”.
Let me be more pointed. Do you run an ERP system in your business (eg SAP, Oracle)? If you run a large business you probably do.
If you set it up ten years ago, you may remember how much it cost, how the process slowed things down, cost you money in the short run, but then was a real benefit to operational effectiveness and growth for years and years. Sound familiar?
Now, perhaps it is still running well, but if you are honest, at ten years old there have been so many customisations, tweaks, and patches to the system. It likely still only costs you annually a fraction of what it would cost to replace with an all-new and modern system, so it is easy to rationalise “we will keep it another year or two”. The moment that small voice says “we will need to replace it at some point”, don’t wait, start planning to replace it soon, even if it is “before you need to”.