Seeing Red

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IF PROFITABILITY IS AN EVENTUAL objective of the young, growing company, it is also a useful measuring tool for gauging management's performance. A difference between companies on the Fortune 500 and those on the INC. 100, though, is that negative profitability is nearly always an indicator of poor management performance in the former. In the latter, on the other hand, the right negative profitability, or loss, can indicate a job well done. And the right loss, as Datacopy's Esteverena puts it, is the one that was planned on. "Negative earnings are not a problem," he says, "so long as you have a kept plan." Robin Grossman, a vice-president at Salomon Bros. Inc., the New York City-based investment banking firm, says that losses among the companies in Salomon Bros.'s venture capital portfolio don't necessarily bother her. But, she adds, "We like to see them meet their business plan."

The point is that a fast-growing small company with big losses shouldn't be presumed profligate. The obverse of expanding profits is declining losses, which are equally useful signposts of progress if the rate of decline meets budgeted expectations -- or of trouble if it doesn't.

ORS Automation, which is developing products that help industrial robots to "see," lost $2.2 million on sales of $4.8 million in the first nine months of 1985. Yet ORS's vice-president of finance, Donald Shelton, gives the impression that no one runs a tighter budget than he. The company's five-year strategic plan, revised each year, is broken down into quarterly revenue-and-loss goals, and every phase of every product's development and marketing is budgeted and subject to monthly review. Without strict budget discipline, Shelton says, it is always easier to spend a little more on a project that isn't going well than to cut off its funding and reallocate the money to a more promising area. "You could throw millions of dollars into marketing [a bad product]," he says, "and most of it would go down the drain. The budget lets you exercise good business judgment in deciding how much to spend."

BUT WHEN ALL THE STRATEGIZING and budgeting is done, the INC. 100 is still about sales growth, not profitability. Maryam Wehe, a consultant with The MAC Group, in Washington, D.C., observes that Americans have a fascination with growth for its own sake, and a national assumption that growth is good. "Society endorses it. Bigger," she says, "is almost always seen as better, pushing back the Western frontier and so on. In America, you're taught this all your life. The fact that INC. publishes this list just feeds into that lust for growth." But it is also worth remembering that a lust for profitability, a common criticism of some very large public companies, can also be damaging to a business when long-term considerations are sacrificed to short-term gain.

Some growth among the INC. 100 companies is lustful and reckless, valued for itself and with regard for no other ends. But ambition of that sort predates the 100. Zintgraff of short-lived Chemical Investors sought to emulate Jimmy Ling, the Texas entrepreneur and prototypical conglomerateur, who built LTV Corp. from scratch in 1947 to the 14th spot on the Fortune 500 in just 20 years. Ling's principal objective in building a business empire was size, not coherence. The whole of LTV has never exceeded the sum of its lackluster parts.

What is surprising, given the lust that Wehe points to, is not that the occasional INC. 100 company has failed so spectacularly as to wind up in liquidation, but that so many have not. Of the 80 companies that have been listed on the 100 while showing a net loss on their income statements, only 9 have subsequently filed for bankruptcy. Four of them -- Chemical Investors, Allied Technology, Psych Systems, and Movie Systems -- are no longer in business. The others continue to operate; either they are reorganizing or they have been acquired by other companies.

Anyone who nevertheless finds disturbing the idea that 30% of the country's 100 fastest-growing companies in 1985 reported negative income should consider how jobs are created and how economies grow. MIT's Birch, in 1980, reported that those cities and regions whose economies were growing the fastest actually lost a higher proportion of their businesses to failure every year than did the declining Rustbelt. This is no paradox, Birch said. The high-growth regions had more failures, but they also had more births. The number of births, not the number of failures, makes the difference."It simply reflects the fact," says Birch, "that the healthier an economy is, the more active it is and the more its corporate population is turning over."

Losses and failure are an intrinsic part of economic growth -- the macroeconomic corollary of nothing ventured, nothing gained. Are INC. 100 companies unstable, volatile, and risky? Of course they are. Why shouldn't they be?

THE TOP 10:

Profitability

Net income

Company (rank) as % of sales

Certified Collateral (31) 24.12%

Energy Oil (8) 19.74

Electronic TeleComm. (36) 19.59

Forum Group (1) 19.13

Enzo Biochem (100) 19.12

Centocor (38) 15.49

DEST (67) 14.10

Iomega (5) 12.79

V Band Systems (22) 12.78

King World Productions (64) 12.11

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