May 19, 2024

You’re the Boss: The Sweet Spot of Business Growth

Thinking Entrepreneur

The growth of business revenue can be steady or sporadic, and it can also reverse itself and go down. Even more complicated is profit, which does not always stay on speaking terms with revenue. Even when sales can go up, profit can go south. The reverse can also happen, which may seem counterintuitive. Let me explain.

Let’s start with bad growth, where sales go up and profits go down. This is easier to accomplish than you might think. Suppose you give your sales manager a new bonus plan — he gets 1 percent of sales, and he has full control of your pricing and discounting. He lands some big deals by discounting heavily. Sales go up a million dollars, but your expenses go up, too, and your profit shrinks. And the sales manager gets a $20,000 bonus!

In this scenario, the customers win, the sales manager wins, you lose. This happens all of the time. The answer is to keep an eye on pricing, and if you give a bonus (especially if there is some discretion on discounting) make sure it is based on profits, not sales. All of that might seem obvious, but the next example — where revenue falls but profit rises — is more subtle.

Suppose you are growing quickly, and you are starting to outgrow your infrastructure. That means you might need more space, more trucks, more computers, more equipment, or maybe a big time chief financial officer. This all costs money, and in many cases you can’t just buy as much as you need for the moment. You can’t buy half of a forklift or half of a new computer system. You have to plan ahead and buy more than you need with the idea of growing into it.

For instance, suppose you are growing at 15 percent a year, and you have a 10,000-square-foot building that’s getting tight. If you move into a 15,000-square-foot building, you will probably outgrow it in three years (assuming you continue to grow at the same rate). Understanding that moving expenses are substantial, you instead move into a 20,000 square-foot building under the theory that it should suffice for five years or more (assuming your growth will slow down eventually).

But here’s what happens: the year after you move in, you only do 15 percent more business but have 100 percent more rent plus some serious moving expenses. Surprise! You make less profit the year after the expansion, not more. Maybe the second year you get back to where you were, and in the third you make more profit. In the fourth and fifth years you make much more profit. Times are good, but now it’s time to move again. The cycle starts all over. Those years when you are nearing full capacity are what I call the sweet spot of making money. Those are the years before you decide to increase your fixed costs again.

If you want to stay in that sweet spot and perhaps make it even sweeter, there are other options. Rather than expanding your infrastructure, for example, you could eliminate poor-performing product lines to free up space and resources. Or you could just raise prices, which will slow down growth — if not eliminate it — but give you a better bottom line. That can be a better solution than spending the money to expand, especially if you would have to borrow the money.

There are many factors that might make you think twice before you start investing money to take the business to “the next level.” It could be the number of employees you are comfortable managing, the amount of inventory you want to carry, the amount of real estate you want to be responsible for, how much debt you want to take on, or how much you want to increase the size of your “nut.” With the recent volatility in business, there are plenty of business owners who wish they had kept their businesses smaller and more manageable.

There is another factor. As business owners get older, their needs and perspectives change. There is a price to pay for growing your business bigger and bigger. Some people get to a point where they conclude that they need more money less than they need more stress.

On the other hand, there are many people who need to keep growing because it is what they do. They wouldn’t have it any other way. You read about them in the newspaper everyday. Some of them are fabulously wealthy, some are going broke, some are very happy, and some are miserable. Some are suing or being sued by family members.

The sweet spot of making money could be where you have the biggest return on investment, or it could be where you are making enough money to live well (whatever that means to you), or it could be where you have no loans, no bad partners, no bad landlords and — as a result — very little stress.

Now, that’s sweet.

Jay Goltz owns five small businesses in Chicago.

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