Navigating Growth Transitions

Market Share, Margin and Management

“There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things. For the reformer has enemies in all those who profit by the old order, and only lukewarm defenders in all those who would profit by the new order,  this lukewarmness arising partly from fear of their adversaries…and partly from the incredulity of mankind, who do not truly believe in anything new until they have actual experience of it.” – Machiavelli

Any engineer (or therapist) will tell you that transitions are where things go wrong most often. Business schools wax eloquent on tools and techniques to measure and evaluate performance but these are primarily steady state measures or ‘moment in time’ snapshots.  Those measures can be misleading during transitions, often with dire consequences.

Strong market share performance would appear to be a validation of a given business practice model when, in fact, market share growth requires constant re-evaluation and modification of said model. Margin is regularly taken to indicate general health and efficiency of operations when, in fact during periods of rapid growth, there exist inherent inaccuracies which mask cost structure anomalies that are unsustainable in the steady state. Finally, the structure and composition of the management system requires special attention during growth transitions as different size plateaus require different skill mixes and support infrastructure.

 Market Share

One of the common missteps during rapid growth of an organization is holding on to an operating model too long.  The thinking goes whatever worked to get this far should be sacrosanct lest everything fall apart from “losing the recipe”.  Markets are driven by customers not products or services and as such are not homogeneous.  Therefore, growing market share by definition means an increased diversity of customers and their requirements.  This necessitates adjustment of the operating model to account for that diversity, or the business will eventually shrink back to a size appropriate for the niche served by original model. A couple of examples might better illustrate the point, one from a product and one from a service perspective.

Take the Leatherman Multi-Tool, a product first introduced as a single universal pocket tool.  How many variations are there now?  How many does Leatherman themselves produce?  Clearly as the market grew, so did the range of customer needs. The business model that makes one thing and one thing only is vastly different than the one that has many offerings and has to adjust it’s processes to meet fluctuating demand across those offerings.  The first works fine with serial process, the second requires paralleled tasks, divisions of labor, resolution of conflicting objectives and other complexities that add structure and overhead to the process.  While the serial process can be forced to make all variants, delivery will suffer in both delivery time (queuing theory) and quality (human error induced by asymmetric job design).

From a service provider perspective, consider Manhattan tour guide services.  At the startup/niche size of a single tour guide doing custom tours for a small tour group you have low fixed costs and can provide maximum flexibility, even adjusting the tour while in progress based on customer needs. When you grow to the size of Grey Line Sightseeing tours you are forced to reduce your level of service in order to serve the larger market.  You can no longer adjust the tour in real time for a specific customer without risking the alienation of all the others who possibly couldn’t care less about the detours objective. (Ironically that would most likely include someone who had already benefited from such a redirection).  Also, you are unlikely to completely replicate the knowledge of a single tour guide across multiple tour guides and thus reduce the depth of information provided.

So one can see how holding on to an operating model that was stellar in the startup/niche phase becomes untenable at some point in the growth curve and that changes in structure and the level of service envelope are inevitable for long term success.

Margin

Read enough financial analyst reports and you may come away thinking that margin is the Holy Grail of business metrics.  Read enough annual reports of organizations forced to downsize after periods of rapid growth and you might change your mind. The underlying phenomena is a delay between sales recognition and correlated expense recognition.  While project based activities (building construction, weapons system development, motion picture production) can be actualized at the project level, general business expenses are not tracked in a way that supports analyzing the relationship between expenses occurred and actual related sales.

When sales drives the business, when expenses are driven by operational needs and with an inherent purchasing cycle time, there is a lag between sales and expenses required to support same.  In rapid growth scenarios this is exacerbated. This resultant artificially large margin is then used as justification for future financial commitments in the name of growth: capital purchase/improvements and senior staff. When sales growth levels off, either though increased competition or market saturation, these fixed costs are out of balance with steady state revenue, resulting in the hasty and therefore error prone process of shedding of excess resources. Since, by this point in time, the knowledge of how to run efficiently has long ago been lost, the cuts merely force a downsizing in capacity and a death spiral often results.

An illustrative example would be small bodega/coffee shop that has a long line of customers out the door each morning.  The owner has an opportunity to expand into the adjacent space and goes ahead based on his current margin numbers. The flaw in the thinking is that the current margin numbers don’t accurately reflect the expenses needed to support the current volume much less any expansion. There is “unaccounted” floorspace in the form of those standing outside on the sidewalk which distorts any ‘revenue per square foot’ estimates. Staffing is underestimated in that the current staff is working at an unsustainable “120%” but an incremental hire raises salary and benefits fixed costs.  Finally, customers are finding what they need within the current inventory, so adding inventory to partially fill the expanded space will raise carrying costs without corresponding increase in sales.

The expansion based on the uncorrelated numbers exacerbates the error and the owner finds himself saddled with increased fixed costs in terms of leasehold, labor and inventory carrying costs that are out of balance with the sales from the customers he expanded to serve.  He is now less able to absorb market fluctuations and may well be operating at a net loss.

 Management

Nine women can’t have a baby in one month.  At some point, simply scaling the number of bodies, no matter how highly skilled, does not provide incremental gains.  Often, the results are a decrease in productivity as well as customer satisfaction and employee morale.  Growth eventually requires division of labor and the requisite increase in overhead that management and administration impose.  An illustrative example is rowing a boat.

A single person in a rowing shell has the potential to maximize command and control as well power to weight ratio and thereby overall performance; albeit for a limited payload. To get more power you add a rower, taking a small hit in command and control performance as the movements of two individuals must be closely coordinated else the addition is counterproductive. Adding more rowers you need to add a coxswain (sometimes with 4 rowers, always with 8).  This person provides necessary command and control which this many rowers cannot accomplish by themselves and still maintain maximum power. Of course, adding the coxswain adds weight without contributing directly to power and is, therefore, “overhead”.  Thus, you cannot increment your crew to 8 without adding overhead. Continuing this example to a rowing galleon, adding a captain, dedicated helmsman, supervisors (the guys with the whips) and support staff (water boys); on to adding sails and eventually engines (with requisite specialized crew members) and you can see where this is all going: division of labor, dedicated management structure, increased overhead. Of course, this is not limited to “rowing a boat”, but rather an illustration  of the physical and psychological aspect of organizing humans towards a unified objective.

Note that the “manager as direct labor” role is diminished very early on – as early as 8 rowers w/coxswain and totally absent by galleon stage. Perhaps there’s a reason the military is so often the template for managing large complex operations.  When something screws up, good guys die – it’s a hell of an incentive.

Summary

Growing businesses pass transition points which must be adapted to.  The risk is in using steady state metrics to assess a dynamic process. Increased market share should be an indication of a need to reassess business operating models.  Margin, during periods of rapid growth, should be viewed with skepticism, and efforts should be made to accurately correlate current sales with anticipated expenses. Management systems need to implement division of labor with dedicated administration and leadership. At some point in time, in all businesses, in all industries, changes must be made to the structure, content and nature of operations with an implied increase in overhead.  How much increase in overhead is a function of efficiency, but undue restraint on overhead reduces efficacy and the long term viability of the business.