Staying in the Sweet Spot

For the majority of business owners we deal with one of their key goals is growth. In fact, there is a general fixation on growth within New Zealand, but as we’ve seen with the recent growth in the Auckland population, growth often comes hand in hand with pain.

When I hear that growth is a goal for a business, the big question I ask is why.  Why do you want to grow?  How big do you want to get? What’s the end game?  For many owners, they don’t have the answers to these questions, it’s just ingrained into them that businesses must grow.  Grow or die.

The problem with unplanned growth is that it can often lead to growth in the top line, with no corresponding growth in bottom line, or worse, the bottom line going backwards.  Can revenue growth be achieved without investing in infrastructure or adding to overheads?  If so, how much growth can you load in before you are forced into a step change in overheads?   Is it growth in revenue that you want, or can growth in profitability be achieved without growing the top line?

For most businesses, there is a sweet spot in a growth cycle where the current overhead structure can just handle the level of trading activity, and profitability is maximised.  For example, if your premises can handle 20 staff, but suddenly you need 22 staff, you will likely end up with a large increase in rent, plus relocation and fit out costs.  Profitability will go backwards until you grow further to utilise the new space you’ve taken on.   Are you then confident that the growth will continue so that the drop in profitability is only temporary?  Has the maths even been done to see how much growth is required to cover the new overhead costs?

There is a lot to be said for taking a breath in the sweet spot, maximising profits, building up resources and taking the time to develop and test strategies that either justify loading up the overheads and going all out for growth, or alternatively show that you’re best to stay the size you are for as long as possible and harvest the profits.

However, sometimes growth is essential simply for business survival, so staying in the sweet spot too long can become problematic in itself.  An example from a couple of years ago was a professional services firm who had several hungry young employees looking to progress their careers by taking an equity stake in the firm they worked for.   The firm was well and truly in the sweet spot, maximising profitability and stretching its current resources.  The current owners either needed to accept that these highly valued employees would leave, or find a way to give them equity, ideally without reducing their own earnings or retiring to make way for them.  The key way to do this is obviously to grow the business, either organically or through acquisition.  Staying still for too long wouldn’t create the opportunities the younger professionals were looking for, unless the older partners were going to exit.  At the same time, any material growth would require new premises and larger overheads, so a hit to profitability would come from the next wave of growth.   To add to the puzzle, growth sufficient to cover the additional overheads associated with new premises was by no means guaranteed, and history told them it could take years to achieve.

The answer in this example was that they used equity introduced by the new partners to acquire another business, and grew both the revenue and overheads proportionally.  Ironically, two years later they are now almost back in the ‘sweet spot’ and will shortly be facing exactly the same situation again.

The moral of the story is simply to take a planned and reasoned approach to growth.  If you want to grow, make sure you know why you want to grow, what the financial implications of that growth will be and what success will look like.

Tristan Dean
Business Advisory Director
T +64 9 448 3231
E tristan.dean@hayesknight.co.nz