Growth Strategy: The Entrepreneurs Dilemma
Most business owners want to grow. They intuitively know that growth yields significant benefits ranging from lower costs to higher enterprise values. The question becomes where and how to grow.
My world is similar to the one embodied in the book The E Myth by Michael Gerber. Most businesses are built on the shoulders of a technician, who had a core competency in a given field or discipline. One of the watershed moments for any small business is moving past its initial core competency into new products and markets.
This transition is easier said than done. Unfamiliar markets are ripe with risk. Growth into a new sector can require additional talent, processes, and technologies and create a significant strain on a company’s infrastructure. It is almost always more expensive and time consuming to grow from 0 to 5% share in a new market than to grow from 20 to 25% share in a market you already know.
Yet many entrepreneurs stay awake at night, afraid that they have all of their eggs in one basket. Thus the entrepreneur’s dilemma; diversification can become a strategic imperative, but is inherently risky. The more a company grows in its core business, the bigger their concentration risk becomes.
The larger the core business the harder it is to diversify, because a new business must grow at many multiples of the existing business to contribute enough margin to reduce risk. For example, if you had a $25 million business growing at 10%, and add an adjacent market channel that was worth $1 million, that business would need to grow 250% ($2.5 million) a year to match growth in the core (and reduce concentration risk).
Like any other important decision, the entrepreneur needs to take a strategic viewpoint and consider their desired endgame. If the objective is a liquidity event (sale), some buyers would place a higher value on a diversified business. Others could see non-core businesses as non-essential.
I use the following rule to assess the appropriate level of growth that a company should pursue in non-core businesses (growth strategy).
If the total industry revenue has strong momentum, the argument can be made to spend 80% or more (in terms of sales, marketing product development, etc.) on growing its core business. If a market is in decline, then the company should invest 40% or more in growing new businesses.
Of course there are many factors that should be considered in such a determination such as the industry structure (i.e. number of customers, competitors) and/or how well the company develops new products.
The point is that every company should be purposeful in weighing growth, diversification, enterprise value, and risk.
Category : Business Operations
About the Author: Marc Emmer
Marc Emmer is President of Optimize Inc., a management consulting firm specializing in strategic planning. Emmer is a 19-year Vistage member and a Vistage speaker. The release of his second book, “Momentum, How Companies Decide What to Do Ne…
Marc, I couldn’t agree more with your rule of thumb assessment as to whether a business should take on a new endeavor. I often apply a similar first cut analysis to both business extensions as well as initial entrepreneurial undertakings. As you mentioned, I don’t look to the result to provide a definitive go / no go decision. But, it does give clarity on which base assumptions need to be tested before too much money and more importantly time is expended.
“The more a company grows in its core business, the bigger their concentration risk becomes.”
Some businesses are lucky to establish themselves as a leader in their niche and only offer one or two core competencies. Other businesses however, need to continually test new business ventures to continue to generate new business. A company can’t move forward and grow if it doesn’t have new business coming in.
Having a Market and Product Diversification Strategy is imperative for your future growth. Here are some ideas to consider:
• Entry into new market segment with existing product offerings
• Acquire additional/broader product offerings to service existing markets
• Enter new markets through formation of a strategic alliance/partnership with a strategic enabler/collaborator
This is a long term strategy that needs commitment and investment as you stated Marc. It is also important to have a management team that can take you beyond the technical core competency and look at diversification strategies from a business and finance point of view. Putting all your eggs in one basket creates an enormous risk for your business. Start your diversification strategy plan today.
Great info Marc, I have actually been in a situation where I really a service and it was already in a competitive market but I continue to try to break open after years of trying money running out I hand make some changes and add other services at the end the one I thought that was going to provide me very profit ended up creating more 80% of my profit.