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This One Mistake Can Eat Your Business Alive

P&L targets are supposed to help a company create more value. But used incorrectly, they can erode business value and consume growth opportunities from the inside.

Are you making the one critical mistake that can consume true growth opportunities within your company?

We saw a business recently that was being “eaten” by its P&L targets. Sounds crazy, right?

Targets and goal-setting are supposed to help a company develop effective strategies and employ the capital and resources necessary to create more value. But in this case, the targets were eroding business value and, as a result, the CEO was losing control of the company.

How was this possible? First of all, this business is owned by a larger corporate entity but operates autonomously to set targets and deploy capital. This is a common situation in which a larger organization—which could be a parent company, a private equity firm, or even an absent owner—controls the capital allocation but allows the management team to run the business. Management agrees to financial targets with the parent company, then attempts to meet or exceed the targets.

The problem for this company, as with many businesses in the same boat, is that the parent company expected a constant year-over-year growth rate of around 6 percent bottom-line growth.

Most of us who manage growing businesses know that with the right strategic investments, it’s entirely possible to get 6 percent or higher top-line growth, even in slower-growth markets. But to do so, you often have to invest, in resources such as new salespeople and R&D, which often drives down short-term profits in exchange for achieving a higher long-term growth trajectory.

Delivering annual 6 percent increases in profits, however, is a different matter entirely. Because the subsidiary’s management team could not make a valid case for growth investment to its parent (or shareholders), it had to commit to 6 percent profit growth year-over-year—in a market that was growing 3 percent annually.

Guess what came next? Cost-cutting. And where was the easiest place to cut costs? The sales force and R&D department—the same places where the business needed to invest to create growth.

The result was that the growth-oriented CEO was slowly losing a turf battle to the cost-oriented CFO. Every time the CEO wanted to invest in the sales force to develop more business, the CFO countered with a plan to cut salespeople. Guess who won every time?

Fortunately, the CEO has changed the game. He is in the process of implementing a plan for growth that is endorsed by his shareholders—in this case, the parent company. The fundamental mistake this business made was not pitching a fact-based plan to the parent company for moderate, long-term growth. Only later he realized that the parent company actually had money to burn in the form of a growing cash account—which was funded in part by squeezing costs out of the business. Once he convinced his shareholders of a fact-based plan that created a significant return on the capital invested, they bought it and gave him the runway to execute it.

No business can cut its way to growth. Eventually, the P&L targets will eat you alive.

Karl Stark and Bill Stewart are Managing Directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself, and is ranked No. 95 on the 2011 Inc. 500 list. @karlstark