Your organization can't keep pace with demand. Banks won't lend to you. Longtime staffers need to be replaced. Here's how to cope.
Your organization can't keep pace with demand. Banks won't lend to you. Longtime staffers need to be replaced. Here's how to cope.
Running a successful company can be a thrill. But for many CEOs, there's a point at which it becomes no fun at all. Doug Tatum has a name for this phenomenon; indeed, he's written a book about it: No Man's Land: What to Do When Your Company Is Too Big to Be Small but Too Small to Be Big (Portfolio, September). Tatum, co-founder of Tatum LLC, an Atlanta-based consulting firm, is no stranger to no man's land; his firm negotiated that dangerous zone and now specializes in helping clients do the same. Tatum recently spoke with Inc. editor-at-large Bo Burlingham, author of Small Giants: Companies That Choose to Be Great Instead of Big, a look at entrepreneurs who made the conscious choice to avoid no man's land altogether and instead remain small.
Bo Burlingham: I'm curious how you discovered no man's land.
Doug Tatum: It was a year or two after we started our firm. Our business plan was to provide rapidly growing companies with financial expertise. We were all finance guys--me, my brother John, and the cadre of partners we'd put together. Every week, we'd have a meeting and talk about what our clients were doing. Pretty soon a pattern emerged. We saw that below one level of sales, you were sort of in a safety zone. Above another level, you were more or less out of the woods. But the transition from one level to the other was just incredibly painful. I remember saying, "My gosh, it's like a no man's land. You can't survive there. You've got to push through to the other side or go back to start." I began to see that it was a universal phenomenon, regardless of the business. Later, I wrote a little pamphlet about it.
Do you mean a marketing brochure? That's a funny way to market yourself: telling your customers how horrible their lives will be if they do the one thing they're hiring you to help them with.
It was for explaining, not marketing. We'd found it awfully hard to tell entrepreneurial CEOs what they would face in no man's land--especially how they'd have to replace folks who, in many cases, had been with them from the beginning. The pamphlet gave people a chance to read about it and think it through. They'd come back saying, "I'm going through that. I thought I was the only one." We described what happened in no man's land and explained why it happened in terms of their market, their economic model, their management, and their needs in the capital markets. Those are what we call the four M's--market, model, management, and money.
Okay, let's start with the first M. I suppose that's the market.
Right. When you think about it, a company's strategy is nothing more than what you tell me, the customer, you're going to deliver to me. It's about making certain promises to certain customers. A company enters no man's land when it begins to experience a disruptive change in its relationship with its customers. Something happens to the value proposition, which is the thing that makes a customer applaud you by paying you a profit over and above your costs. I view profit as the customers' applause; they're applauding you for something you're giving them. My partners and I saw that, at a certain point, the value proposition had to be transferred from the entrepreneur to the rest of the company. It couldn't just depend on the entrepreneur's personal expertise. The breaking point came when the company got so large that the entrepreneur could no longer be out there in front of the customers and still managing the operations.
But can't you choose to stop short of that? Maybe getting big isn't part of your vision.
I don't believe most entrepreneurs start off with a vision about what's going to make them successful. Their success comes from their ability to look around the corner and bet on things that the rest of us can't see. They're out there making promises to get customers and figuring out where the value is, and they're also keeping on top of operations, making sure the company is aligned with the customer, and delivering on the promises they've made. Each promise is a bet on the future. Then one day you make a bet that all of a sudden leads you into a stadium full of new customers. It drags you into growth and it's very hard to say no.
That's where things start to go wrong, because you aren't physically capable of doing it yourself anymore. So it all breaks down. The customers start moving away, and the business stalls. In effect, the customers stop applauding. They start complaining: "The only way I can get things done is talk to you." You put salespeople out there and they make promises, but they're the wrong promises. Sales and operations are at each other's throats because there's no alignment between the two. Meanwhile, the customers don't find it simple to do business with you anymore. That's my definition of a market-driven business: one that allows customers to get what they want in a very simple exchange. Think of Google. It's the simplest company in the world to do business with.
How do you make the exchange simple again? How do you get sales and operations realigned?
There are two ways to do it. One is to go back to where you were before. The other is to push on through to the end of no man's land, which means building an organization that can do on a larger scale what you used to do on your own.
That's the choice I was talking about.
Yes, and it's critical to make the right choice for you, because no man's land is no fun. You're going to have to make some excruciating decisions, particularly about people. You're going to have tremendous problems raising capital. You might never make it to the other side. No matter what happens, the experience will have a profound effect on you and everyone around you. So you'd better be sure the journey will be worth the pain.
You also better be sure that it's mathematically possible for the company to get through no man's land. What's really stupid is to force a business built around an entrepreneur, or around a human-scale concept, into a transition that will make it economically unviable. If you can't come up with a scenario under which the company becomes profitable again, you'd have to be crazy to go forward.
You're saying that people need a theory of how the company will operate profitably in the future--a theory that can be tested mathematically to see whether or not it's realistic.
Exactly. Unfortunately, most entrepreneurs don't take that crucial step. They say, "If I make this promise, I can probably get five customers to say yes right now. And if they say yes, there's a whole bunch coming in behind them. That's my theory." But they don't see how that models out financially. You have to decide whether you have a scalable business model.
What do you mean by "scalable"?
Able to make money at much higher volumes. A new customer promise is going to add new revenue but also add new costs. Those costs don't start slowing down until out in the future somewhere. That's when you can get into trouble. There's a critical decision you have to make early in the process: "If I keep the business at human scale, I can make money because part of the profits are for my own individual efforts. But if I make a series of promises that gets me out of human scale--which means that the business has to become good at what I was doing on my own--I'd better be certain there's a profit zone we can get to in the future."
Let's talk about making the business good at what you were doing on your own. I assume that's where management comes in.
Yes. The entrepreneur thinks, "Omigosh, I can't do all this. I have these customers asking me to do things, and I need an organization that can deliver." The problem is, you don't have the right people in your organization. You have the people who started out with you and whom you promoted, giving them titles because you couldn't pay them. Your senior accounting person is now your CFO. Your top salesperson is your vice president of sales. And trust me, those titles are very important compensation to people. But now you need people who know what to do before the big increase in sales because of their experience. They aren't learning on the job. Well, you can't get those people unless you can give them the top title, and somebody else already has it. That person has to be replaced.
If you're going to make the passage through no man's land, you can't afford the risk of having senior managers who have never been where you're going. The challenges you'll encounter are the most difficult in business--much more difficult than those faced by larger companies because you can't afford big mistakes. A couple of them will kill you, and they usually come in this part of the process, the people part.
So now you're faced with the absolutely most wrenching, emotionally draining, cruel decision that any person ever has to make. How do you tell people who believed in you when you started, who stayed with you when you didn't have any money to pay them, who did everything you asked--how do you tell them they're not capable of doing what the company needs? I mean, it's brutal.
Did you have to do this at Tatum?
Yes, I had to do it. With people who'd been with me at the beginning. It pains me to this day. And more than anything in the world I wish some of them were still in the organization--just not in the jobs that they had. We were able to move a few people. That's always the first thing you try, but it rarely works. People don't give up titles easily.
Are you still friends with them?
I'm on talking terms with all of them. How you do it is important. When I let people go, I immediately went to work to help find them jobs elsewhere. I felt my responsibility for their well-being didn't stop when I made the decision to replace them. But even if it worked out better for them, there are still scars there. Then again, whenever I talk to CEOs who have gone through this, they always say they waited too long to make the change, and there were always dramatic results when they did. That was true for me, too.
Doesn't every company have these problems, whether or not they go through no man's land? We hear constantly from readers who are struggling with such issues. It's just the Peter Principle, isn't it?
Maybe, but other companies aren't under the same pressure. Actually, that's one of the wonderful things about being a small giant: You don't have to let all those people go. If you stay at a certain scale, they'll have time to learn what they need to know. But if you're going through no man's land, you have to bring in new managers. If you don't, the market will kill you.
Here's what I don't get. If the company has been so dependent on the entrepreneur's instincts and intuition, how do you replace that? How do you transfer that to the organization as a whole? I mean, look what happened to Apple after Steve Jobs was forced out.
That's actually one function you probably can't transfer to the whole organization. It's important to preserve the entrepreneurial ability and get the company behind it. If you lose it, you're going to be busted every four or five years, when you need to come up with a new value proposition. I think of it in terms of messing things up and then cleaning up the mess. By messing things up, I mean making new promises to customers that keep you aligned with the market as it changes. Those promises mess up the organization because it doesn't yet know how to fulfill them, which is very frustrating for the operations people. But they need to remember that if the entrepreneur doesn't keep making those bets, the company will stop growing. You can't just make one big bet and expect everything to work after that. If you get rid of the entrepreneur, if you decide you don't need a messer-upper, only a cleaner-upper, you will die a slow death--like Apple before Jobs came back.
Then again, if the entrepreneur is so dominating that the organization can never clean things up, you will die a fiery death. That tension between messing up and cleaning up is something you'll find in every company that sustains its growth over a long period of time. It's the balance of the two that keeps the company growing.
So making this transition doesn't involve putting the entrepreneurs out to pasture or giving them some honorific role, like "keeper of the flame."
Absolutely not. The entrepreneur's skill set is still important, but you'll never get a chance to use it unless you systematize the core value proposition and let people clean up behind you, which some entrepreneurs have a hard time understanding. Your ability to see around corners and make the right bets is crucial to the process. So is your respect for a group of people who have to deliver on the promises, who keep the business in alignment and growing. And it doesn't stop. It's an ongoing cycle with a new transition every few years. But the first one--no man's land--is the most difficult. It almost kills you, because you've never faced that situation before, and also because you may not have access to the capital you need to get to the other side.
Which brings us to the fourth M: money.
That's when you really start feeling that you're too big to be small and too small to be big--because you're too big to be getting bank loans secured by your personal credit and too small to be eligible for private equity. I did a study of banks. I asked them to tell me confidentially why they'd lend to small companies and to large companies but not to companies in between. They said, "We can't make money on loans to those businesses. If your personal credit score is good, we'll lend you money all day long. It's highly efficient for us. But if you start asking us for more money than you can repay--because your business needs it--we now have to depend on the business, right? Well, you'd better be asking for a lot of money. Otherwise we can't earn a profit on what it will cost us to figure out whether your business can pay it back. We won't even start that process unless you need at least $5 million." That's the crux of the problem. You're going from being scored on your personal credit to being scored on the business.
So you find yourself in the capital gap-- where $10 million or $20 million is much easier to raise than $750,000. Private equity guys will tell you there's more money than places to put it, but they only want to do $10 million deals. Their economic model says they can't make money on $1 million or $2 million deals. Capital isn't a problem for small companies, either, as long as you have good personal credit. But most people going through no man's land can't raise money to save their souls. It takes a series of minor miracles to get to the point where the capital markets start opening up for you again. That won't happen until you're north of $10 million in revenue.
You had to go through this, didn't you? Where did you get the capital you needed to get through no man's land?
We were fortunate because we could fund it with partners' capital. In a professional services firm, you put up capital when you join. That was our capital mechanism.
Did you know in advance when you were getting into no man's land?
Oh, yes. We forecasted it, and we also knew when it would end. I think it lasted about 18 to 24 months in our case.
So you made a conscious decision to go through it?
My partners did, yes. We had a meeting to ask whether they wanted to branch out. At that time, we were located in just one city and we didn't need much infrastructure. We had a pretty unique value proposition. The average tenure of a CFO was about three years and going down. If CFO was your profession, it was unlikely you'd be able to work for a single company for your entire career. But you could have a career inside our firm. When you left one client, you could move to another. The bigger we became, the more opportunities the partners would have. So, on one level, spreading out was good for them. But to do it, we would need capital, their capital. We wouldn't be profitable for a while. We'd no man's land have all the issues our clients dealt with. John and I asked the partners, "What strategically should we do?" They said, "Go wide, young man. Go wide."
But you could also tell the partners how long it would last, right?
Uh-huh, because we were all financial guys. We had an economic model that showed us how much money we would need every time we added an office and how long it would take for the revenue to come in. We'd have to make a certain investment in infrastructure, accounting, and so forth, and we knew how much that would be, too.
It must give you a lot more confidence if you know in advance what's going to happen and how long it will last.
That is so true, and it's why you have to find a high spot where you can scan the horizon and ask, "How big is this desert I'm fixing to cross?" If you can't see the end of it, maybe you shouldn't venture out into it. I usually tell people to start by looking at their competitors. If you're at $10 million and there are no competitors in the market until $50 million or $100 million, there's probably a reason. You need to think strategically about that.
Don't you also need to think about how the culture is going to change? That is certainly a huge issue for small giants. The ones I'm familiar with place a high value on having a relatively small, intimate company in which everyone knows everyone else.
I'd be the last person to suggest that culture isn't important, and it does change as you grow, particularly when you start bringing in outside investors. But that doesn't necessarily mean the culture gets worse. I think culture is about having a decision-making process that everybody trusts. When you talk about a strong culture, you mean there's a predetermined understanding about how decisions are made and what the priorities are that shape the decisions. When you have a culture in which people understand the decision-making process and trust it, everything is so much nicer, so much cleaner, and so much better for everybody. There's consistency in how decisions are made. When people start complaining that they don't understand how decisions are made, you know the culture is broken.
Isn't that exactly what happens when you bring in a bunch of new senior executives and outside investors?
It shouldn't, although I admit that's a common excuse for failure. I strongly believe you can come into an organization and change it on a dime as long as you have a trusted decision-making process that you make sure remains trusted. You can change the products, the services, the people. But if you lose the trust, you're going to have problems. Unfortunately, that does often happen: New people come in and don't respect the decision-making process. When they fail, they say, "The people wouldn't change, they wouldn't go after a new market." Baloney. What happened was they didn't trust how the decisions were being made.
But when you bring in, say, private equity, doesn't the culture have to change?
Absolutely. You have a whole new constituency to take into account. After all, the private equity guy isn't investing his own money. He has investors, too, and at the end of the year they do a calculation that determines whether he wins or loses. It's pure, ruthless math. Not that he doesn't believe in you and your business. He wouldn't have given you the money if he didn't. But he needs your help to fulfill his responsibilities. So suddenly you realize, "I no longer work for myself. I can't be absolutely loyal to individual employees anymore. I have to be loyal to the business, which can't go on without this capital. To stay alive, it has to deliver the returns our investors need. My responsibility is to make sure it does."
That's a helluva transition for somebody to go through. But if you handle it right, people will understand why the decision-making process has changed, and they'll continue to trust it. Some of them may not like the new culture. They'll leave. But those who remain will adjust.