Seeing Red

Why one out of every three companies on the INC. 100 is losing money.

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THERE IS ANOTHER WAY, APART from growing very quickly, by which INC. 100 companies distinguish themselves from the rank and file of American business. They are . . . shhhhh . . . a great deal more likely than other companies -- those, say, on the Fortune 500 -- to be money-losing propositions.

Unprofitability is a frequent but not always uninvited companion to hypergrowth. It rarely, however, gets much publicity. The companies involved would rather talk about their strides at the top line than losses on the bottom. And you won't see losses highlighted, for example, in any of the boxes scattered throughout this section. In fact, you've got to be willing to do your own counting even to discover it.Go to the list of companies that begins on page 44, run your finger across to the "Net income" column and then down. Find the '85 net incomes, beginning with Piezo Electric Products Inc. (#2), that are embraced by parentheses. Did you count 30? That's how many there are.

Thirty percent of this year's INC. 100, with their exploding sales, showed losses. In contrast, only 6.8% of the Fortune 500 last year failed to report a profit even though total revenues of Fortune 500 companies actually slumped by 1% over the period 1981-84. Surprised at the difference? David Birch isn't. "If it were not that way," says the Massachusetts Institute of Technology researcher, "it would surprise me." Birch, who did pioneering work on the role of small companies in job generation, observes that rapid growth is always risky. "Companies that rocket up," he says, "often rocket down. Look at Apollo." Apollo Computer Inc. (#14) has grown at a 205% compound annual rate for five years, giving it an early lead in the market for engineering workstations. Its reported loss of $1.5 million in 1985 after three profitable years, if not a surprise to management, was certainly not part of the company's long-range growth strategy. Like many companies that grow fast in a market they themselves helped to create, Apollo has run up against new competition from the bigger companies that their market has attracted.

Fast-growth companies aren't immune to bad luck, errors, and plain boneheadedness. They are also vulnerable to conditions that, usually, aren't fatal to larger companies. Because they frequently rely for their sales on a single product, technology, or market, for example, what might be a pothole to a bigger company with other revenue sources and a larger capital base looks like a ditch to the small growth company. Further, explosive sales growth often requires a company to add costs -- payroll, plant, equipment -- at an equally rapid rate. If the growth rate slows abruptly, a company can be caught with excess capacity, personnel, and fixed costs. Then it is time to pare down quickly, with big write-offs, or face worse problems later. The INC. 100 landscape is dotted, if not littered, with the corpses of onetime high fliers like Air Florida System Inc. (#14 on the 1982 list), which couldn't adjust to its changing competitive landscape. It filed for Chapter 11 protection and was acquired by Midway Airlines Inc. in 1985.

For bad luck, nothing tops the falloff in world oil prices that has killed demand for High Plains Corp.'s (#61) high-priced ethanol, which it proposed to mix with gasoline to make gasohol. G.D. Ritzy's Inc. (#54) erred, however, according to analysts, by not establishing a clear marketing proposition for its fast-food restaurants. What are they? A chain of burger restaurants? Or ice cream parlors? Nobody knows. Then there is (or rather, was) Chemical Investors Inc., which closed its many doors in June 1983, just a year after it sat in the #9 spot on the 1982 INC. 100 list. CI's founder and chief executive officer, Gary Zintgraff, had a lust for acquisition but very little taste in what he acquired, and not the slightest talent for managing any of them.

Growing quickly on the tiny capital base that most young, first-spurt companies have leaves little room for even small errors and none for egregious greed.

No, what's surprising about bottom-line losses among the INC. 100 is not that they crop up so often, but how frequently they are either cultivated deliberately or calmly taken as inevitable -- part of the planned investment in growth. Companies competing in new industries or in significant markets in older industries often buy sales growth at the expense of profits. They're hoping to build market share; profits, presumably, will follow. Not every negative net income reported by a company on an INC. 100 roster qualifies as investment, but some do.

Comp-U-Card International Inc.'s, for example. CUC (#48) runs a computerized shopping service with 1985 revenues of $28.7 million and an accumulated earnings deficit at year end running to more than $10 million. The company recorded losses from its 1973 founding until 1984 while it built up its database of consumer products, prices, and vendors. It recruited members who would use their telephones or home computers to shop and buy through the database. Number of members, not dollars of profit, was the quantitative goal each year.

To have been profitable before 1984 (when it earned a scant $31,000) would have been shortsighted, CUC founder and CEO Walter Forbes argues, because it would have meant that the company wasn't spending enough to sign up new members. The formula, he says, is fairly cut and dried. Every new member costs the company about $30 in direct-mail costs to recruit and, on average, generates about $30 in revenues for the company in his or her first year. Thus, a new member represents a first-year loss because revenues don't come close to covering marketing costs and overhead. But membership renewal rates -- dependent upon keeping the customer satisfied -- run about 80%, and renewals cost relatively little. Thus, every new member means a loss in the short run but a profit in time. Taking short-term profits by holding marketing costs down, says Forbes, would have jeopardized long-term profitability. Last year, with membership reaching 4.5 million, the company -- finally -- earned $3.1 million to begin reducing its deficit.

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