When we analyzed the offers businesses that use The Value Builder System receive, they are 29% higher (4.8 vs. 3.7 times pre tax profit) if they are growing their top line revenue by at least 30% per year. That's one reason I was keen to get my friend Verne Harnish's new book, Scaling Up.
Scaling Up is an excellent read for an entrepreneur looking to grow a significant business. The definition of 'significant' is open to interpretation. For you, 'scaling up' may mean getting to a million dollars in sales. Or you could be gunning for a hundred million. Either way, Harnish has some suggestions for you, which are captured in our exchange below:
Warrillow: Can you talk about the economic value of scaling up? More specifically, if I own 100% of a 5 million dollar business, isn't that better than selling equity to fuel growth only to end up owning 10% of a 50 million dollar business I don't control?
Harnish: It's not either/or in our minds. With our approach, we help entrepreneurs hold onto 60+% of the company while also achieving significant growth. For example, Scott Farquhar, co-founder of Atlassian, has managed to scale to a valuation of $3.3 billion while holding on to (with his partner) 60% of the company.
Warrillow: The only way to scale up that much without a lot of outside money is to get your customers to pay in advance. How exactly do you get customers to pay upfront in an industry where paying upfront is not the norm?
Harnish: Costco is a great example. Who would have thought you could get customers to pay for the privilege of shopping at your store? Those $55 and $110 membership fees represent two-thirds of Costco's annual profits and fund all their store expansions. There are a number of examples in John Mullins' new book The Customer Funded Business, which came out in August--I named it one of the top five business books for 2014 in my Fortune column. People forget that Microsoft was funded by customers--Apple provided one of the first flat licensing fees--$21,000--and IBM was the big customer that essentially funded Microsoft. More locally, that's how I restarted Gazelles--17 customers in 2002 paid upfront the money they expected to spend with us--and we've followed that model ever since. And I still own 100% of the parent company Gazelles.
Warrillow: What would you say to a business owner who has carved out a nice lifestyle business that provides everything the owner and his/her family could want. Is there something wrong in your mind with the decision to not scale up?
Harnish: No-one is safe in the long run. Look at all the local retailers shutting down as a result of the proliferation of online purchases. This is happening in most industries, giving competitors twelve time zones away a chance to reach into your local market. For example, Ali in the southern province of Hatay in Turkey sells carved wooden doors for Christian churches. The key is that he sells them all over the world. Ali owns a huge market share of a very, very narrow niche.
Warrillow: One of the core ideas of building to sell is avoiding the common growth strategy of selling more stuff to a few people in favor of the opposite approach: selling fewer things to more people. How does that idea complement or contradict the growth strategies recommended in Scaling Up?
Harnish: We are closely aligned--it's about hyper-specialization, where you focus narrow and deep on a specific expertise and then chase the right customers around the globe. And in reality, you only want 5 to 7% of a market, but you want to own 70% of the special niche. For example, IKEA is a huge company, but only owns 6.8% of the global home furnishings market, yet they own almost 70% of the flat-packed furniture market. In the end you actually want to sell fewer things to a very tight segment of the market globally.
Warrillow: The last time I saw Jim Collins speak, he revealed that he worries about any company that grows more than 20% per year because it is difficult to sustain that kind of growth over the long haul without stressing the systems and processes of the business. Is there a growth rate you think is 'safe' or ideal that allows a business to grow in an orderly fashion?
Harnish: A company should grow at twice the rate of the market they are targeting; that way, they continue to outpace the competition. If you don't grow faster than the rate of the market, then you are definitely NOT safe! So I define the ultimate factor of safety as outpacing the competition.