Let me demonstrate the high growth problem with a simple example:
I recall reviewing a budget projection for one of my businesses where we were examining the cost of recruitment. The recruitment cost seemed somewhat low. When I queried the underlying assumptions, I was told that it represented the cost of recruiting an additional 20 staff, a 40% growth. However, the numbers did not take into account that, of the current 50 staff, we had replaced 12 in the last year. Some had moved interstate with partners, some had gone back to full-time education and a couple had taken maternity leave. In fact, we had actually only dismissed two for poor performance. Thus, instead of recruiting 20 new employees, we had to recruit 32, 64% of our current staff.
When you look at average retention rates, you can expect some percentage of the employees to leave, not because they did not perform well, but because they have personal and family plans that might take them on another path. Thus recruitment and training in a high growth business becomes a real challenge. If you are growing at 100% and replacing 20%, you are recruiting 150% of those who are left at the end of the year. Now, add to that the resources needed for training and the impact on the productivity of the remaining staff who have to work with large numbers of new employees.
If you think that is a daunting task, work out the cost and work involved in putting in place the infrastructure needed to support them. Accommodation comes in discrete sizes, so when you run out of space you can’t simply add enough space for one more person, you might only be able to acquire space in blocks able to accommodate 10 or 20 staff.
At one stage I ended up with three separate offices in Northampton in England as we kept running out of space. Since I could not predict the growth further than about six months ahead, I was not prepared to invest in too much extra space, thus I ended up in a completely sub-optimal spread of staff with people in three separate offices around the town. I had the same problem with the phone system. It came in discrete sizes, up to 12, 64 or 128 extensions. However, when you moved up to the next system, all your investment in the prior system was wasted and you started again. Other infrastructure costs include computers, desks, meeting rooms, storage space and so on.
When firms grow quickly they have great difficulty managing the basic operations. Quality often suffers as firms grow quickly. Staff are recruited too quickly, job descriptions are loose, reporting lines are blurred, performance metrics are ill conceived and systems for dealing with complaints are poorly established. IT systems take a long time to choose, implement and bed down.
People simply haven’t the time to figure out how to work together. Often one part of the business does not know what another part is doing.
By far the biggest problem is financing the growth. Very few businesses are able to fund growth through internally generated funds. When you consider the costs which are incurred in recruitment, training, accommodation, computers and supervision, few firms generate the level of profit margins that can cope with more than a 15% growth rate.
For most fast growth firms, external funding is imperative. Even if some of the investment is in equipment, inventory and buildings, only a portion of that investment is going to be covered by traditional asset financing. What can’t be covered by internally generated funds has to be sourced from public or private investors. That activity will also take senior executive time away from running the business. Cash management is probably the most critical activity for the high growth emerging firm.
These factors not only make it hard to sustain growth but the constant changes being forced on the organisation sow the seeds of failure. Not a lot has to go wrong with such a finely tuned engine for it to collapse or get into serious trouble.
Most will recover, but they will lose a lot of the gains made in prior years. Others will not be able to turn the ship around in time and will end up insolvent, unable to raise debt to fund operations or will have lost key customers and employees during the disruption.
I would think there are very few entrepreneurs who would not desire their venture to grow to at least $2 million in revenue and yet we can see from the ABS data that only 6% of all private businesses exceed this threshold. I would also expect that any entrepreneur would want to create a new venture which would generate employment numbers exceeding 20 and yet only 10% of all businesses in Australia in the 2007 ABS report exceeded this number.
We can see from the prior explanation that there are significant challenges in growing the business and no doubt this is the underlying reason for such results.
Another way of looking at this problem is to see it from a predictive approach.
If we know that there are certain characteristics which have to be present for success, it is possible for us to rate any venture in each of these elements and then calculate the overall chance of success. The venture capital sector has been using this technique for decades to decide when to invest. However, even the best-rated ventures are still problematic.
The VC sector has a focus on high growth potential ventures and, over time, has come to identify certain attributes which give rise to higher chances of a successful return on the VC investment. If, however, you need a number of attributes of the venture to be present concurrently and each one has some limited probability chance of being successfully attained, the combined score can be relatively low. Thus even a good venture which scores highly across a number of attributes can still be problematic in terms of its overall chances of success.
When we see the probability of success in these terms, we can understand the level of complexity that must be managed in order to achieve success.
You can see in the table below just how difficult success is when you take this combined attribute approach.
This specific model was developed to explain VC investments where the investment is typically made when the business has already developed some traction in the market. Most VC investments are at the market expansion stage where products are already proven and a management team substantially in place, thus we would expect these ventures to have lower risks than early stage ventures.
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