At Alpin, we often see many small/medium firms with great product & service offerings struggle in their early growth years by being expedient rather than strategic. Common missteps in these years can have profound consequences such as stalling growth, limiting options to merge or sell, or in the worst-case scenario, lead to disaster.
This is why we firmly believe that trusted advisors, not just hired consultants, who provide an independent ‘big picture’ viewpoint, are enormously helpful to SME owners in the early years.
4 common missteps businesses make during early growth years.
1. Chasing every sales opportunity
Smart, commercially savvy CEOs sometimes fall into the trap of chasing every opportunity available to fast-track profitability without regard to whether the opportunity is aligned to the greater goal/s for the business. Don’t get us wrong, we are not afraid of making early profits like the Silicon Valley financiers of the early 2000s, but we firmly believe not every sales opportunity that is profitable, is necessarily a valuable one.
Let us explain.
Recently we have been helping two clients in very different industries, unwind opportunistic decisions of the past. Both these businesses would if judged by sales growth and time to breakeven alone, be regarded as highly successful start-ups. But yet, they soon found themselves in trouble.
By chasing every sales opportunity, resources had been spread too thin across too many different clients and geographies. Management’s attention was also stretched yet everyone ‘felt good’ because ‘runs were on the board’.
The Misstep? Not clearly knowing what they were trying to accomplish in the early years. Trying to build a business for the long term that will ultimately be valued on a multiple of earnings, or trying to achieve trade sales with the highest value within a finite timeframe?
It matters which . . . and it matters a lot!
Upon trying to build a profitable operating company, businesses should be mindful of sticking to arenas where they continue to have a competitive advantage and be conscious of continually building scale economies.
If, on the other hand, businesses are looking for a trade sale based on the potential of their IP, they should be rifle-like focussed on demonstrating a business model to third parties who can then see the expansion potential.
This requires being very selective about how resources are allocated, trading off sales and profits if need be for market experience that demonstrates the business model.
2. Raising capital too early (or getting the wrong money in)
Nothing validates an entrepreneur more than the ability to get others to back their idea with cash. However, even if early-stage money can be raised, should it be?
Often there is no choice as money is needed to complete R&D or prove the concept in the market. But even if there is no choice, owners should think hard about who they partner with. Will they be understanding and adaptable as changes to the original plans occur? Too often we see early stage company’s options for growth impeded by having raised money too early and/or with unsuitable partners.
By accepting the first investor’s dollar, the degree of freedom a private company has to, say, restructure, to licence IP, or to change plans is dramatically reduced. It’s hard to predict all the twists and turns that a new, growing business will go through. With the wrong investors, there can be tension between hitting promised revenue and cash flow targets and what may emerge as a better option for growing the business longer term.
We had a client who after signing on an investor realised that it would be better to restructure each product and their IP into separate legal entities defined by specific geographic territories, as each product had different potential local buyers.
Easy enough to do if your private, potentially a slow and difficult process if your investor needs to be convinced of the necessity. It is like having raise the money you already have, all over again!
Private investors tend to be more understanding than investment firms that have their own financial quarterly targets to meet. Before accepting that first investment dollar, owners need to think through all the potential possibilities that might occur in the future and make provisions on the deal to allow maximum flexibility.
3. Letting early customers change your strategy
We are certainly advocates of the axiom that businesses need to ‘listen to the market’.
However, too often the pressure to get sales leads causes businesses to chase expedient but unsuitable early customers. Some businesses may even modify their product or business model in order to win early victories.
The result is that valuable resources and time are spent bending to the needs of an individual customer when their needs may be unique and not of value to the vast majority of the original target customers identified in the business plan.
One of our clients chased ‘easy to get’ contract packing orders as a way of utilising unused manufacturing capacity. Not a problem at first, but soon the Board’s expectations about volume growth drove management to start investing new capital to continue expansion of the contract packing business which after a few years became bigger than the firm’s own products.
The associated problems were:
• margins declined (contract packing is a low margin business),
• risk increased (as a huge proportion of their volume was on annual contracts),
• all the product and market development of their original product concept was diverted to meeting quarterly volume targets.
The business completely lost sight of its original goals and found itself over capitalised for the original business objectives.
4. Early success breeds hubris
It is well documented in business research literature that more often than not, highly successful, large multinational companies are unable to survive major technological changes. Kodak is the poster child for this dilemma. They took out the world’s first patent for a digital camera yet failed to change their highly successful and profitable film and film developing business to accommodate the new era of digital technology.
Small businesses that have early success, can lose their agility to the slavish belief that what worked last year is the best way forward in the next year. Markets change, competitors respond, and growing businesses need to respond. Never is this truer than when a successful business decides to take its market-proven business model overseas into a market that appears to be very similar to their own home market.
The language may be the same, the competitors may largely be the same, but this does not mean market conduct, aka how the game is played, is the same.
One of our NZ clients who had a very successful market leading business at home and with only a superficial study of the Australian market decided to commit millions of dollars across the ditch. The result was a disaster. Failure to understand that prices and gross margins for the same industry were much lower in Australia, led to years of losses. As a late entrant to the market in Australia, they also suffered from much poorer scale economies versus competitors they dominated in NZ.
Moving away from a market you intuitively understand to a dive into a new market may be necessary but needs careful study, regardless of how inviting the water looks.
A better way forward – Partner with advisors not just consultants
At Alpin, we seek, but admittedly don’t always achieve, a trusted advisor role with clients. It is fundamentally different to be regarded as an insider versus a ‘hired gun’. Don’t get us wrong, hired guns are useful. They can often overcome problems that businesses don’t have the resources or specific skills to tackle. But when it comes to the direction a business should take - different to what is working so far, the missteps outlined above can often arise. Typically, the owners/CEOs are unaware of these potential missteps, or worse are in some form of denial. Either way, CEOs are not likely to pay consultants to study these kinds of problems.
On the other hand, if trusted advisors are already on board as insiders, they have a much stronger mandate to challenge the management team and the management team, in turn, is much more likely to listen to the advice.
• Trusted advisors are on the same long-haul journey as the owners. Fees are only a part of the compensation; their real compensation is linked to the success of the business.
• Trusted advisors build deep personal relationships.
• Trusted advisors work with minimal transaction costs – they are always ‘up to speed with the business’ and a simple memo confirming a request for work replaces a formal letter of proposal.
Bottom line – try and find yourselves trusted advisors even before you think you need them as they will pay back many times over by helping you avoid these common pitfalls.