It’s easy to fall into the trap of thinking that business is simple and especially that more sales equals more profits.
Sometimes it’s right but sometimes it’s wrong.
Sometimes growing a business can destroy it.
There are three big reasons:
- Growth can destroy your brand and market positioning.
- Growth can cause you to add costs faster than you add extra margin.
- Growth can cause you to run out of cash.
Let’s look at these three problems in more detail.
Growth Can Destroy Your Brand & Positioning
I blogged about whether Stella Artois are making a mistake by extending their brand to include cider.
It’s a great example of a business with a very clear brand image – Stella is a premium priced lager (light beer) from Belgium. But now after the introduction of Stella Artois Cidre, it’s not. Stella no longer means lager.
And that come mean that sales of the lager go down as sales of cider go up. Or it could mean that Stella lager can no longer command a premium price.
That’s not good news.
But it could get worse.
Lager drinkers and cider drinkers may have very different customer personas and it is tough to appeal to everyone with a well known brand. After all I can’t think of any drinks company that has crossed cider and lager.
When I think of cider I think of Merrydown (my personal favourite), Magniers, Strongbow, Taunton’s etc. When I think of lager I think of Carlsburg, Kronenburg, Carling, Heineken, Fosters and Castlemaine.
This blurring of position is a particular problem where:
- Prestige is an important reason for buying/owning – personally I think that both Mercedes and BMW have reduced the status of their brands by going into the mass market with the A class and 1 series respectively. I think Toyota got it right when they wanted to move upmarket and created a new brand, Lexus, to do it.
- Specialisation is important – people of wary of the jack of all trades, master of none and it doesn’t matter whether that’s in professional services, tradesman or your local takeaway restaurant. I’ve just had a flyer come through my door from a local takeaway offering pizza, kebabs, burgers, fried chicken, fish and chips… but it’s tough doing all those to a good standard when competitors specialise.
- Where capacity is limited – a shop selling a bit of everything is a useful convenience in a small village or on a housing estate but it lacks a clear reason for being in the city centre.
Growth Can Cause You To Add Costs Faster Than Margin
The easiest way to grow the top line sales numbers is to cut prices and offer customers a better deal.
There are four big problems with this approach.
First, what I call margin deception. This is when you think your gross margin or contribution is growing because sales are increasing but you’re deluding yourself.
The arithmetic of the extra sales required to make up for a price reduction can be alarming if you don’t calculate them in advance.
I’ll just take you through a numbers example.
Imagine you sell 100 units at a price of £1000 and you make a margin of 35% or £350 on each (i.e. costs variable costs are £650) every month.
That’s a margin of £35,000. (100 * 1000 * 35%) on sales of £100,000.
Now imagine you decide that it’s a good idea to reduce prices by 10% because you’re confident that you can get an extra 20% of volume.
And you’re proved right.
Sales volumes go up by 20% to 1,200.
Sales prices fall from £100 to £90.
Total sales are £108,000 – £8,000 higher than before – not as good as you expected because you hadn’t done the maths but it’s still up.
Unfortunately your margin has been battered.
The price reduction has reduced margins from £350 to £250 (that’s the selling price of £900 minus the cost of £650).
1200 units sold at £250 each gives a margin of £30,000.
That’s £5000 down from the original margin of £35,000.
Over 12 months, that’s a £60,000 drop in profit because you hadn’t bothered to check how the numbers work.
The second problems is that price discounting often attracts the wrong type of customers. Low prices are most appreciated by the people who really care about buying at the lowest price, and they have little loyalty. The first sign of a better price, and they are off.
Third, you can’t expect competitors to stand idly by and let you “steal” their customers by offering lowering prices. Your competitors are likely to react and match or even beat your low prices. They will find out and if you are taking much valuable business away from them, they’ll get mad.
And if they match your prices, all you’ve done is cut your profits and theirs. Even worse, you could start a price war.
Fourth, overheads are usually driven by transaction volumes. As you sell more, you need more people to handle the extra orders, to do the despatches and to follow up and collect the cash. You can try and hold the line but extra work creates pressures and it causes things to slip. Perhaps orders are delayed because the paperwork can’t be processed or mistakes are made in picking and packing as staff rush to meet targets. Either way customers get angry.
Growth Can Cause You To Run Out Of Cash
If you manage to avoid the first two ways that growth can kill your business, by staying focused and making sure that growth is profitable, it can still be profitable.
One of the reasons why the business failure statistics in the 2009 recession have not been as bad as you might expect is because a shrinking business generates cash as the working capital in stocks and debtors reduces.
It goes the other way for growing businesses so when the economy picks up, order books get healthier and sales go up, you can expect businesses to run out of cash. And in the current situation, banks don’t appear to be eager to lend.
Growth needs financing unless you’ve got a high margin business which has a favourable working capital cycle. Retail can be good because sales are paid immediately so provided stocks are smaller than creditors, the money to finance the business comes from the suppliers.
But if stocks are high, customers expect good credit periods and suppliers won’t give you credit, your cash flow gets squeezed as the business grows.
It gets even worse if you have to increase your costs in advance to either create the growth (advertising or extra salespeople) or to service the planned growth (extra warehousing).
Growth Can Be Profitable
You can get caught in profitless, cashless growth which damages your market position but growth done the right way can be very profitable.
My advice is to do your planning upfront and challenge your assumptions so you can see what happens if things don’t work out as you hope.
It’s very easy to make growth look good on paper by making over-optimistic assumptions about extra volume and ignoring the likely actions of competitors so do some what-if tests and see where your growth plan is most vulnerable.