When to Grow and When to Cut
Economic conditions often drive growing companies to invest on the upswing and cut on the downturn. But for the best-run companies, deciding to turn on and off growth investment is much more of a pinpoint approach than a blunt tool. In some cases, it makes more sense to cut investment in relatively good times and or sustain investment in bad times.
One of our clients, a large enterprise technology provider, decided it needed to continue growth investment through the Great Recession of 2008-2010. They were fortunate enough to build up a significant cash position prior to the downturn, which gave them more options than most companies. Their market was negatively affected by the downturn in corporate technology spend during the recession, but they saw the opportunity to invest into the economic headwinds because their offering gave customers significant cost savings relative to competitive products. They had a chance to gain share while their competitors were struggling.
Another company we work with is going through some strategic cuts despite participating in a growing market. They've realized that their market has become more competitive and less profitable as it has matured. Most of their mainstream business is commoditized and the client has realized that they don't offer much of an advantage relative to their competitors.
However, in a smaller, more specialized segment of their business, they have an opportunity to make significant profits because they can offer something much more attractive than competitors. So they are cutting investment in their mainstream business while investing to significantly grow their specialized business. This will result in overall profitability growth, despite lower revenue.
Even though most businesses follow the simple rule of grow in good economies and cut in bad economies, we prefer the following approach:
Invest for growth when:
- You have access to growth capital
- You know you can create significant return on investment from investing that capital in the business--i.e., the investment will more than pay for itself in the future
- You have the opportunity to improve your competitive position in a specific market--either by enhancing your customer offer or improving your cost position -to create higher share or profitability in the future
Cut investment when:
- You don't see a clear return- i.e., you'd make just as much money or more on less revenue or there's no clear future benefit from the investment
- You see an opportunity from focusing on a limited segment of your market
- You believe that improving your profitability in the short term will better position you to invest for growth in the longer term
The mistake many growth businesses make is to believe that gaining market share is always good. Every business has profitable segments and unprofitable segments. Almost always, the most profitable segments are ones where the company is offering its customers a distinctive, advantaged offering. These are the areas that businesses can invest to fuel growth over the long term.
Send us your comments and questions on where to invest for growth. We can be reached at firstname.lastname@example.org.
KARL STARK AND BILL STEWART | Columnist | Co-founders, Avondale
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 a two-time Inc. 500 honoree.