Growth is a normal and recurring component of most companies’ strategy and planning. We all want to grow and become better because like the old maxim says, “If you are not growing, you are dying.”
I agree that growth at a business and personal level is one of the key ingredients for success. However, many companies pursue any type of growth solely for growth’s sake, which is a mistake. I believe a strategy based on a generic definition of growth is a failed strategy without further clarifying what kind of growth you want.
The conventional thinking in many companies is that all growth is good and that the key to financial success is increasing sales. The most successful companies I work with all pursue growth, but they are very clear about the margins that have to come along with it. These companies have well-defined growth targets in specific lines of business with precise economic requirements. They are not focused solely on volume, but rather the right kind of volume that will drive their margins.
From a financial and valuation standpoint, sales and revenues are not the key drivers of value creation in a private company – net income or margins are. Growth for growth’s sake is not a strategy that creates value. Consider the following two companies:
| Company A | Company B | |
| Sales | $10,000,000 | $20,000,000 |
| Net Income | $2,000,000 | $2,000,000 |
| Earnings Yield | 20% | 10% |
| Invested Capital (Equity & Debt) | 6,000,000 | 12,000,000 |
| Return on Invested Capital | 33% | 16% |
Which company would be more valuable and better to own? Without knowing anything further, one would have to conclude that Company A is more valuable. It has double the earnings yield and would likely require less invested capital to create those earnings than Company B because it is a company half its size. What you can definitively say about Company B is that it has more employees, takes more risks, has more overheads, and requires more capital to operate than Company A. There is a lot more work involved in running Company B for a lot less return, making it considerably less valuable.
Those companies with the “right” growth are some of the most valuable businesses we work with, and they have a handful of things in common:
- Growth is a key component of their strategy.
- They have specific customer and market requirements for where to find growth.
- They have a clear economic model regarding customer relationships and margins.
- They have clarity around the customers or market opportunities that best fit their economic model, and they focus like a laser on those opportunities.
- They have the discipline to say no to opportunities that don’t work for them.
Some business owners feel they have to chase every opportunity because they view customer acquisition as a one-sided process centered on convincing the potential new customer to buy. We think the correct view is that it is a two-sided decision; your company needs to be just as discerning in accepting a new customer as the customer is in buying. After all, it’s your business; you have every right to choose with whom you want to do business. Plus, it is a critical component of your growth strategy.
Mario O. Vicari is a director with Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email.
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