Tortoise or the hare: Can a company grow too fast?
Imagine you are a business owner. Would you say no if you were told you could achieve instant, meteoric growth for your business? Few can. This tendency led Alexander V. Izosimov in 2008 to coin the term 'hypergrowth' referring to stages in business that see explosive business growth of over 40% a year and fast growth in human capital.
Can a business growing too fast be a bad thing? This is what the science would seem to suggest. In 2002, Professor Cyrus Ramezani at California State University studied more than 2,000 publicly listed companies. What he discovered was that companies that saw bursts of sales growth averaging 167% over a decade actually saw their share prices do much worse than companies that grew at a much more modest average of 26%. Later on, another major study in 2014 by the Kauffman Foundation and Inc. Magazine decided to follow up on the 5,000 fastest growing companies that had featured in the magazine between five to eight years in the past. What they saw was that more than two-thirds of these fast-growing companies had either gone out of business, shrunk in size, or had been sold on the cheap. Why? The study concluded that was because, despite the dizzying growth of the past, most of these companies had failed to break into the final stage of ‘enterprise maturity’: stage one is finding a customer for an idea, stage two is coming up with a process to reliably deliver that product and finding new customers, stage three is coping with complexity and challenges and growing beyond being dependent on one or a few people and the final stage being growing into new products for new customers.
The warning signs
The reason most businesses that see fast growth cannot make it through the cycle is that they cannot navigate through some of the most common problems that such businesses face. Firstly, a company risks losing focus. If management is fixated on constantly chasing new customers and boosting turnover, you risk creating a company whose culture has become unrecognizable from when it started, or a giant that proves to have feet of clay. This can be solved by making investors understand that they are in for the long haul and should not expect to see a return before two or three years. Secondly, a fast-growing company can find out that it is very difficult to hang on to its talent. In 2018, KPMG found that the biggest problem that fast-growing companies had was keeping their talent. 57% of companies said they had this problem. The story here is a familiar one: a rapidly growing company feels pressurized to hire more people to keep pace with growth, which leads to the proliferation of mediocre middle management which in turn drives away real talent from the company. You soon run out of steam when you realize that you have not scaled up the innovation, but rather turned your company into a revolving door for talent to pass through. Eventually, this ends up in customer dissatisfaction and a downward spiral. Then there is the problem that many fast-growing companies cannot put in place what has been called the self-financeable growth rate where a company transitioning from a small to a large organization cannot reconcile the amount of time its money is tied up in inventory before it is paid for the goods and services it provides, the amount it needs to finance each rupee in sales and the real revenue generated out of each rupee in sales. Running into such cash flow problems is a common hurdle for businesses that grow too fast.
Sometimes it’s easy to get carried away with fast growth. A confluence of different circumstances such as digital transformations of economies, cheap capital, and the emergence of new middle classes can create a seductive cocktail for keeping faith in meteoric growth. And in some industries, such as mobile and telecoms markets, quickly growing and capturing market share might seem to be common sense. However, in such fast-moving markets such as tech and telecoms, ultimately, it’s all about the long haul. McKinsey studied 3,000 software and IT companies across the globe between 1980 and 2012 and found that although most of them reported strong growth initially, only 17 out of the 3,000 companies grew to sustain revenues of $4 billion annually. About 85% of fast-growing companies in IT were unable to keep growing as they did.
This is the other thing about fast growth: a company may be canny enough to spot an opportunity, but eventually tastes change and the circumstances in the market that initially fuelled explosive growth at the start usually does not last. Take the example of game developer, Zynga. The company developed massively popular mobile games and by 2011 had so much cash that it quickly invested $100 million in building new data centers to keep up with what it thought would be a constantly growing user base. The problem was that its customers soon moved on to other things and by 2015 the company was already massively downsizing and closed down its data centers. Today, it is a shadow of what it once was. Or take the example of Crumbs Bake Shop, once one of the largest cupcake sellers in the world. After it was founded in 2003, it saw stellar growth because of the popularity of cupcakes in the US retail market. The company responded by aggressively expanding its network of physical stores. But tastes soon changed and people lost interest in cupcakes. Declining sales and the extravagant costs of maintaining a huge network of shops soon pushed the company into bankruptcy by 2014. The problem with both of these companies is that having grown too fast, they thought it would just continue.
Who wins the race?
The difference between healthy growth and businesses that grow too fast all boils down to strategy. As US President Abraham Lincoln once said, “give me six hours to chop down a tree and I will spend the first four sharpening the ax”. There are generally three strategies for companies to cope with fast and extensive growth. The first is ‘scaling’, which is sticking with what your company is good at and looking at new markets within that segment. The risk is that companies adopting this approach often have to make decisions on investments before they have evidence for sales growth. The second is ‘duplication’; specializing in a certain segment and then looking to re-create that into a new geographical market. The risk here is that the company has to strike a balance between standardizing administration to be as close to the original location as possible in things like finance, administration, and accounting while still allowing for enough flexibility for outlets elsewhere to address the needs of their local region. There are limits to these two strategies; the products may fall out of fashion, low-cost competitors can emerge or there may be no major foreign markets to expand into left. This leads to the third, and most difficult, strategy ‘granulation’. This involves identifying a part of the business – or granules – that can be made autonomous and used to effectively create a new market and service and grow that aggressively.
While the evidence may suggest that being the tortoise is sometimes the wiser course in business, the hare is not destined to always lose provided he runs a smart race.
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