Little Giants – When staying small is the best option and when growing can be counterproductive

It is the vision of all companies to eventually grow and become more successful in the industries that they compete in.  In a world where market share provides direct competitive advantages and provides the opportunities required to generate lucrative returns growth has, and will continue to be king. 

However, just because growth is the goal doesn’t mean that the goal is always correct and doesn’t mean that every opportunity to grow is a good one for your company.  When opportunity strikes the instinct of any good  executive and manager is to explore the situation to determine whether the opportunity in question is in the best interest of the company.  If it is shown that the opportunity is in the best interest of the company, and the resources can be (notice I didn’t say should be) acquired then the executive will likely move forward with the transaction.  The problem is that executives are so anxious to grow their companies that sometimes they fail to realise that those very investments that are being made also present a higher degree of risk for the company (especially in certain situations). 

The purpose of this article is not to discourage growth, no matter the state of the global economy, growth is always necessary to drive our companies to higher heights and to provide a larger platform for economic development which tends to benefit a large population of people.  The purpose of this article is to assist executives by identifying when taking advantage of a growth opportunity may not be in the best interest of the organisation. 

The following situations are those that have been highlighted as times where management may be better served by allowing certain growth opportunities to pass: 

When the financing required moving forward with the growth is considered to be too costly – Funding is a major part of most growth initiatives for the simple fact that no opportunity can be advanced without the money to advance it.  With this said, many executives often find themselves placed in positions where they are required to seek outside funds to move forward with a growth initiative and in some cases the cost of capital is so high that the entire decision should be reconsidered.   

Example: A mobile applications company has the ability to purchase a company that produces several popular mobile applications.  While the targeted company is small, it has quickly developed a solid market and the owners are now in a position where they want to sell the company.  The potential acquirer is very interested in moving forward as this investment would open up a new market to them; however the company doesn’t have the funds available (internally) to make the investment.  Due to the tight credit markets there is very little opportunity to acquire debt so for this reason the company seeks a private equity deal to move forward with the project.  In this deal they would be forced to give up 40% of their common stock and 60% of their preferred stock which would equate to a decision making interest of 50/50.  While this company is in demand and others are willing to buy; the company comes to understand that the cost of this investment is likely more than they want to bear.  There is a good possibility that the investment would pay off, but there is a certainty that the company would have to give up a lot of control and future earnings whether the investment was a success or not.  In this case the financing required to move forward would be too costly. 

When your operational and capital resources are already being absorbed by other initiatives - Growth can be like a trip to the candy store; there may be a lot of attractive options but in many cases you have to choose the one you like the best. In many cases, especially over the last few years, executives have several opportunities to achieve growth in a fairly short period of time, and with easy access to capital and resources they were able to move forward with several opportunities at once.  As those days are now gone it has become incumbent on these same executives to focus their attention on one opportunity and see that to fruition.  Failure to do this could place the company at risk of failing to capitalise on either investment. 

Example: Through its sales and distribution arm an international manufacturing company receives the opportunity to provide manufacturing and packaging to one of the largest producers of consumable products in the world.  This opportunity could more than quadruple the size of the companies revenues and could produce the type of long-term capital that could sustain the company for the foreseeable future.  However this opportunity requires that they make considerable investments in their manufacturing plan in an attempt to increase capacity.  While it will be costly to take advantage of the opportunity management decides to move forward.  However, within a few weeks the company also has the opportunity to provide the same services for another major company.  This would further increase the size of the company but would also require the company to invest its remaining capital resources (and borrow more as well).  The company could do both but would be left undercapitalized.  If both opportunities work out then the returns would be highly lucrative, but if either one fails it could destroy the company.  

In times like these where there are limited methods upon which to obtain more resources an incorrect decision could be the end of a company so it may be wise to be cautious and not “bite off more than you can chew”. 

When the opportunity to grow takes you into “uncharted waters” – It should come as no surprise that executives moving forward are going to have to be more cautious as it relates to the risks that they take.  With that said, one of the most dangerous (and lucrative) ways to grow is to move outside of your industry and into another industry that might be ripe with opportunity.  Whether it is a Data Security company moving into Software Design or an insurance company moving into banking, the fact is that you must respect the fact that other industries require different capabilities and therefore you should be willing to invest the time into learning the industry before you jump in. 

Example: A data security company has been very successful in protecting the technical infrastructure of financial institutions throughout the world.  As a part of their business model they work with software developers who produce security software which is resold to the customers.  After a while, one of the developers informs the company that they are selling the company and asks if the data security company is interested.  Seeing the market opportunity the data security company decides that this is an opportunity that can’t be passed up.  As a user of the software they assume they understand the market landscape, and they take over the company.  However, what they find is that as a software company significant investments must be made in Research and Development, there is a high turnover in talent, and the cost of client acquisition can be substantial, while they eventually learn these lesson they lose a substantial amount of capital before the lesson is learned. 

The point is that there is a reason why companies grow in particular industries, and that is because they understand the market and how to operate within it.  Assuming that this is easy or can be done “on the fly” is extremely arrogant and presumptuous and can lead to many problems. 

Growth is good, but like in many other areas of business, knowledge is better.  As with everything you should have a full range of knowledge on any initiative that you decide to undertake, especially those that can have a major affect on operations and the financial stability of the company.  In a time where the economy has left executives very little room for error, you must be cautious about the decisions that are made or risk the consequences.

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