Conventional wisdom says that only the lean will survive in the current business climate. But can a company actually be too thin to get rich?
Several years ago I helped found a company that was going to revolutionize the way the architectural and engineering communities would do business. At a time when computer-aided design was just coming in, we had a software and hardware package that was going to be faster and cheaper than anything else then available.
Somewhere along the line, though, our grand vision got small. We went from trying to change the world with innovative products to being just another local reseller and computer consultant. How did that happen? Why am I now a university professor and not a semiretired philanthropist and angel investor living off the profits from my successful IPO?
Our skills and talents aside, we made a critical error by running the organization too lean. Incrementally, we made choices that maximized short-term cash flow at the expense of long-term vision and planning. Opportunities to bring in immediate revenues arose -- through consulting contracts, reselling computer systems, and providing training and support -- and in our eagerness to see immediate growth of profits, we pursued them. We hired more employees and moved into bigger offices, increasing our monthly cash-flow requirements, which in turn increased our need to find more consulting contracts, sell more systems, and keep our ever expanding client base happy. We no longer were willing to slow down our cash flow by budgeting time or resources to envision new products and interesting offerings, and we stopped reaching for the innovation that would be essential if we wanted to become a $50-million or $100-million company.
Our key technical employees were too busy reacting to the moment, working 60 hours a week building or fixing clients' systems instead of designing or developing or refining new products. After three years of operating that way, we came to the conclusion that we didn't have the time to do real development projects, so we might as well quit talking about them.
If you look at it in terms of revenues per man-hour, our productivity was incredibly high, but we were on a treadmill. We had started out as what I call a venture, an effort to pursue growth and create new value for customers by coming up with revolutionary products, ideas, or services. Instead, we managed ourselves into a niche where we would survive and make a little money but never offer anything unique or grow significantly -- in other words, a small business, and a relatively low-margin one at that.
Which just goes to show, if you run a venture too leanly, you can easily strangle it. In today's business environment, that is a revolutionary statement, but management scholars -- beginning in the 1960s with such theorists as James Thompson, Richard Cyert, and James March -- have pointed out the critical importance of slack resources. They considered a certain amount of redundancy to be the cushion that allows an organization to successfully adapt to change and pursue opportunities. However, somewhere in the lean, mean 1980s and '90s, the importance of slack resources was lost. That is not an argument for a return to the bad not-so-old days of extravagant dot-bomb spending. I believe and teach that cash-flow management is the most critical tool in an entrepreneurial manager's skill set. But let's not confuse cash-flow management with maximizing short-term cash flow.
Here are a few simple questions: Are you working more than 60 hours a week just to keep your customers happy? Are the vast majority of your employees working more than 50 hours a week just trying to get the product out the door and servicing customers? Has it been a while since you introduced a major innovation in your product or service? Do you have a lot of ideas for new products or services that, though really good, have never been tested because no one is available to work on them? Is the ratio of the time you spend managing costs to the time you spend developing new revenue streams in excess of 5 to 1? If you answered yes to most of the questions, you are probably running too lean.
Growing businesses are rarely the most efficient providers of any product or service. Generally, they haven't realized significant economies of scale, and they don't have deep pockets. Growing ventures survive by doing something different, by creating new products or services that nobody else can provide. When the innovation stops, the venture's competitive advantage erodes. So you create the leading product and you prove the market, and while you're running to deliver the product and run a lean machine, the big boys catch up. You end up as the bug stain on their windshield. Another common outcome -- the one that I faced -- is getting trapped on the treadmill with a lot of great ideas that never get developed, tested, and put on the market. After all, there's always another client call to make.
So how do you avoid both the windshield and the treadmill? Remember to invest in your vision on an ongoing basis. Remind yourself that even though today's bottom line is important, so is the future bottom line.
To illustrate the point: I met last year with a former student whose start-up had stalled. The business was profitable and cash-flow positive, but it had essentially stopped growing. We dusted off and reviewed her original plan versus current revenue mix and expenditures. The problem was obvious. Most of the revenues were coming from consulting work that she was doing for her former employer, rather than from the sale of her products. So she cut back on the consulting and hired an administrative assistant, thereby sacrificing revenues and lowering profits but freeing up time for her and her chief engineer and designer. They invested their newfound time in developing new products and customers. A year later, she is about to launch her second new product, revenues are growing again, and cash flow is lower but positive. Success is far from certain, but the company is no longer on the treadmill.
The first key is to schedule time for you and your staff to work on, and think about, new products and new services. Innovation demands a certain amount of slack time so that your employees can think about what the customers are telling them, how to improve the product or service, and where to find the next challenge or opportunity. Budget time for you and your team to invest in the future. If you run a tight job-costing system, create a job number for innovation, and budget hours for that job. Just as you would in any other job, monitor progress and demand some tangible results. And remember that eliminating bad ideas is also a valuable part of the innovation process.
Also, set goals for the introduction of new products or for the percentage of revenues that new customers or new products will generate, and then commit resources toward achieving those goals. Even in tough times, your success hinges on your ability to create more value for the customer through innovative products and services, not on your ability to run the leanest organization. Encourage your employees to spend time on new ideas and demand that they bring those ideas to the table. Let them know that promotions and bonuses depend not just on grinding it out on a daily basis but on contributing to the creation of the next great product.
After several years on the treadmill, I got off and left it to my partner. The company continues as a reasonably successful small business, but every time I go back, the conversation always returns to "What if?" If we hadn't gotten sidetracked, after three or four years we would have been successful and substantially larger or we would have been out of business. Whatever the outcome, a company that operates on that sort of scale, with its attendant risks, is a true venture. Either the vision you're pursuing is right and you'll execute it and win or you'll find something else to do. In the end, we'll never know how successful we might have been.
David Deeds is an assistant professor of entrepreneurship at the Weatherhead School of Management at Case Western Reserve University. He specializes in the challenges of technology ventures. Senior staff writer Emily Barker coedited this column.
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