When revenues soar, the smart CEO keeps an eye on the bottom line.
By most measures, Gordon Black's market research firm was impressive. The nine-year-old company, based in Rochester, N.Y., was doing more than $1.5 million in annual business, and was winning six-figure contracts against a field of larger and betterknown competitors. With names like Eastman Kodak and Gannett Co. gracing its client list, the future of Gordon S. Black Corp. seemed bright indeed.
Last February, however, Black discovered just how deceiving appearances can be: The business he thought was so successful turned out to be hemorrhaging money at the rate of about $40,000 a month."We were totally swamped with work, but we had outgrown every one of our internal control systems," he explains. "I had no idea how much our current jobs were actually costing, and nobody else did either. We were underpricing our bids by about 20%."
Black took swift action to stop the bleeding. He laid off 11 people, slashed salaries and other expenses, and renegotiated prices on several contracts. Thanks to such measures, the company -- #453 on this year's INC. 500 -- seems to be on the road to recovery. But the experience has prompted the 43-year-old former political science professor to adopt some new attitudes about growth.
"My assumption had always been that if the top line was growing, the bottom line would take care of itself," he notes. "But if we had followed that way of thinking, we probably would have been out of business by last summer."
Although Black's situation was more serious than most, it is hardly unique. Well before things get out of hand, a lot of INC. 500 chief executive officers are finding that the dramatic success they have registered on the top line doesn't always lead to healthier earnings, and that a single-minded focus on sales growth isn't necessarily the most fruitful strategy. At times, in fact, companies discover that more growth along the same lines is precisely what they don't need -- that their challenge, rather, is to branch out, stabilize, cut costs, boost profits, and thereby prepare for the next stage of expansion. Like fast-growing saplings, they need to put down roots.
Contextural Design Inc., for example, has embarked on an ambitious program to control its costs when less farsighted companies might still be basking in the warm afterglow of a sales explosion. The young Raleigh, N.C., furniture manufacturer (#177) had gotten its start by subcontracting for other furniture makers, recalls co-founder and CEO Bruce Sauls, an architect by training. But when the company signed a lease for a new 15,000-square-foot facility in 1980, it needed more business to cover its overhead. The product sauls came up with -- ready-to-assemble furniture units designed for easy shipping -- were made to appeal to as wide a market as possible.
The first major order came in 1981, from a local unfinished-furniture store. Since then, Sauls and his partners have had all they can do to keep up with the business. Right now, Contextural Design is producing for about 650 furniture stores in 46 states, and Sauls expects that this year's sales will exceed last year's $2.1 million by at least 70%.
Such growth, naturally enough, has put tremendous pressure on Sauls's ability to increase output, train people, and finance inventory and receivables. Yet Contextural Design is concentrating as much on efficiency as it is on growth. Although the company doesn't intend to scale back its marketing or production efforts, the new focus, Sauls says, will be to get "better control of costs as a way to maximize our profits." To this end, he and his three partners plan to invest as much as $400,000 over the next few months in sophisticated computer equipment, which will speed up and automate many operations. A computer will be used, for example, to scan each plank of wood and plot optimum cutting patterns, thereby reducing waste and permitting the company to price its products more accurately.
It is, Sauls concedes, a far cry from the seat-of-the-pants methods of the past. "But in our business," he notes, "the profit is made or broken in the yield we get from the wood. I know it sounds like a lot of money to invest, but we think the new equipment will pay for itself on a cash basis in less than a year. And if we didn't move in this direction, we'd probably find ourselves priced right out of the business." Once the new equipment is installed, he adds, the company's goal is to see pretax profit margins of 10%, more than twice its recent percentages.
For John Kane, paying attention to costs was only the first step in a strategy designed to stabilize his fast-growing company over the longer term. Kane's Equitrac Corp. (#318), a seven-year-old service firm based in Coral Gables, Fla., built its business around a data processing service that helps law firms track their photocopying expenses for billing purposes. On the strength of this specialized service, which it now sells to some 650 law firms around the country, Equitrac's revenues shot up to $4.3 million.
Despite this impressive record, the task facing the company today is staying alive in a market vulnerable both to technological innovation and to price cutting. As a first step, says Kane, "We have shifted from a growth-at-any-cost philosophy to a focus on profitable growth only." Instead of being rewarded strictly on the volume of business they write, for example, the company's salespeople are now held accountable for selling costs as well.
Kane also concluded that he had to find new avenues for growth or risk seeing his business shrivel. Equitrac has thus been putting a heavy emphasis on research and development, an area it paid almost no attention to before. It hopes to come up with a series of products and services for its current customers, such as the new service it introduced in 1983 to track telephone billing information. "If we were a one-trick pony, we'd be very vulnerable," concedes Kane, who is 40. "But by coming up with new products, we hope we'll be able to stay in business for a while."
A business doesn't need to be in a high-technology field to realize that growth based on the same old range of products or services is bound at some point to taper off. Before the curve begins to flatten, the CEO needs to figure out new ways to beef up sales and margins. That can mean moving into new market niches, as Equitrac hopes to do -- or it can mean planning a kind of quantum leap in the positioning of the business.
George Carruthers, for instance, recently relized that there was no way to continue profitable growth along the same high-speed avenue that had led his company to the INC. 500. Carruthers established Polycoat Systems Inc. (#50) back in 1978 as a distributor of insulation, roofing, and coating materials.Yet as the Hudson Falls, N.Y., business grew -- Carruthers opened branch offices in Pittsburgh, Atlanta, Dallas, and Los Angeles -- the CEO felt more and more unhappy with the results. Prices of building materials were under continuing severe downward pressure. Finally, Carruthers concluded that the market was so competitive, "the only real way for us to increase sales and market share [was] to cut our prices."
That, to Carruthers, was unacceptable: Lower prices would lead directly to thinner profit margins. So he decided to turn Polycoat, whose 1983 sales were $17.4 million, in a new direction. "We're planning a major move into manufacturing," he says, an "upstream move within our industry." Polycoat, he explains, will create new products and manufacture them, and may acquire some of the companies whose products it now distributes. The goal, Carruthers says, is a pretax profit margin of about 10%. "You can only increase profits in so many ways, and manufacturing is at the top of our list."
For some INC. 500 companies, the most pressing challenge is preparing for a new stage of growth, even if that involves reining in current expansion. Tool King Inc. (#162), a Denver-based retail chain specializing in home power tools and related equipment, spent its first few years establishing a name for itself in its marketplace and building an internal organization. In close to six years of operation, the company opened seven stores in Colorado, investing heavily in advertising, personnel training, and computers. From 1980 to '83, Tool King's sales grew from $1.2 million to $6.5 million.
From the beginning, notes CEO Donald Cohen, the company financed its growth almost entirely with internal cash, and profits were commensurately skimpy. In fact, he says, "we deliberately took losses in order to build a quality organization and to penetrate our market. We might not have been able to grow anywhere near as quickly if we had focused on being profitable too early." Today, Tool King sells nearly three times as much merchandise on a per-square-foot basis as the average home improvement center.
Now that many of the substantial investments have been make, however, 34-year-old Cohen thinks the time has come to prepare for the future.Last year, the company slashed its advertising budget by nearly half, and with sales still increasing by about 30%, Cohen found his pretax profit margins for 1984 were up to 3%, versus around 1% in 1983. These higher profits, Cohen hopes, will give him the momentum he needs to open several stores at once in a major new market, such as Minneapolis/St. Paul or Boston. For such a move, the company would need about $2 million of outside equity, something Tool King has nevel before required.
"When you start depending on banks and other investors," says Cohen, "you're forced into thinking about profits. Until recently, we weren't ready to be measured that way. But now that we've built our prototype organization, we don't think we have anything to be afraid of."
The one inescapable fact of growth is that it creates pressure for more growth. The CEO of a rapidly expanding company is therefore faced with a unique set of challenges: selecting the right opportunities while not losing sight of the business's fundamentals. "We wanted to be respected in our business," says Craig F. Lieberman, executive vice-president of Sunbelt Distributors Inc. (#203) in Houston, "and we wanted to build an organization that we could be proud of." Lieberman, 33, and his partner, Robert Wise, began their company in 1977, four years after they had graduated from the University of Texas. Beginning with a Haagen-Dazs ice cream distributorship, they have since taken on an assortment of other upscale frozen foods and have moved into the food service business.
Sunbelt's 1983 revenues were $5.6 million, an enviable six-year growth record. From the beginning, however, the founders have been interested in more than top-line expansion. Growing too quickly, Lieberman worries, might cause dislocations within the business and force Sunbelt to raise outside capital. To limit these pressures, he and his partner have held back on expanding until "we're satisfied that what we have is working."
As Sunbelt has developed a track record in the market, its menu of expansion possibilities has become a lot longer, says Lieberman. Food manufacturers interested in launching their products in Texas now call upon Sunbelt with increasing regularity. More and more supermarket chains are interested in the company's products. The trick, says Lieberman, is to sort out the options and to avoid biting off more than the company can chew. "We feel strongly about managing our growth. But we don't mind all the attention. I guess you could say that the recognition itself is some measure of success."
For Gordon Black, the market researcher, fast growth presented rather more pressing problems than Sunbelt's. But the solution was similar: Black became a lot more circumspect about pursuing new business than he used to be. "We no longer go after every job in sight," he says. The company's costs are now being tracked with great care by a newly hired chief operating officer, who generates computer reports almost daily.
Given the way things used to be managed, Black concedes, it is a miracle that the damage wasn't a lot worse. "The easiest way for any business to go under is to grow too fast, unprofitably," he says. "If you really want to grow -- and continue growing -- you have to be in control."