Growing an Entrepreneurial Business

Concepts & Cases

Edward Hess

• Publisher: Stanford Business Books
• Year: 2011
• ISBN:
  9780804777568
• Edition: 1
• Topic: Business
• Subtopic: Business Development
• Index: Business

Growing an Entrepreneurial Business: Concepts and Cases is a textbook designed for courses that focus on managing small to medium sized enterprises. It focuses on the major management challenges that successful start-ups encounter when leaders decide to grow and scale their businesses. The book is divided into two parts—text and cases—to provide professors with maximum flexibility in organizing their courses. The thirty-five cases can be used in conjunction with the text, or independently. Twelve cases are written as narratives with multiple teaching points, but without a focus on a particular business decision; the remaining twenty-three cases were written around specific conundrums related to strategy, operations, finance, marketing, leadership, culture, human resources, organizational design, business model, and growth. Discussion questions are provided for each case.The text portion of the book discusses key issues derived from the author's research and consulting, and is meant to complement the case method of teaching, raising issues for conversation. In addition to the real-world knowledge that students will derive from the cases, readers will take away research-based templates and models that they can use in developing or consulting with small businesses.

PART I

1

Growth Can Be Good and Growth Can Be Bad

We live in a country that values individual spirit, entrepreneurship, and growth. Business growth generally is assumed to be good; bigger is assumed to be better. These assumptions underlie the mantra that businesses must “grow or die,” which propels many business decisions, sometimes undermining the very viability of those businesses. The purpose of this chapter is to challenge those assumptions by presenting real-world examples of some of growth’s pitfalls as well as empirical data to encourage business students to develop a more nuanced view of growth.

CLASS DISCUSSION QUESTIONS

1. Why must every business continuously grow?
2. When should a business grow?
3. When should a business stop growing?
4. Is growth the right objective for every business?
5. What are other alternative objectives for a business?

In Smart Growth: Building an Enduring Business by Managing the Risks of Growth, I challenged the “grow or die” mantra and the “Wall Street Rules,” which assert that public company growth should be continuous, smooth, and linear, and should occur quarterly. Most view corporate quarterly reports of steady growth as the crucial metric of a public company’s health. However, after reviewing relevant research in economics, finance, strategy, organizational design, complexity theory, and even biology, I concluded that there was no empirical basis for the “grow or die” axiom or for the Wall Street Rules. Given the lack of empirical basis to support the axiom that businesses must “grow or die,” it is surprising that it continues to dominate both Wall Street thinking and graduate business education. An examination of how businesses actually grow shows us that continuous, smooth, linear growth is the exception rather than the rule and that growth actually can bring about significant problems for the company, sometimes leading to the premature death of the company.

The Reality of Growth

Business growth is a complex process involving strategy choices, execution challenges, competitor responses, and changing customer needs. Although many business theories assume efficiency and rational decision making, this does not translate well in the real world. Growth results from the interactions of imperfect people who make mistakes. Moreover, people have cognitive limitations and biases that make certainty and predictability difficult. The reality of business is that individuals do not always behave efficiently or rationally, and neither do markets. As a result, business growth is unlikely to be smooth, linear, or continuous.

Instead, growth is a dynamic, interactive, interdependent process that generally involves false starts, learning as you go, adaptation, and failed initiatives. Growth is messy; growth is change; and growth has spurts, detours, downturns, and spikes. Growth requires constant learning and improvement. Growth requires people, processes, and culture to be aligned in order to drive desired value-creating behaviors. Businesses make people mistakes, process mistakes, and alignment mistakes. Growth, if not well-planned and managed, can stress people, processes, and controls and often can outstrip the capabilities of people and companies. In fact, growth creates another category of business risks that must be proactively managed.

I am not anti-growth. I am simply presenting my research findings, which challenge the basic business assumptions that a business must “grow or die” and that all growth is good. I want to begin a conversation about the realities of business growth based on empirical research and real-world business experience. Growth should not be accepted as a given. Rather, growth should be a strategic decision made only after the risks of growing and the risks of not growing have been assessed. As important, I have suggested a more nuanced view of growth that replaces the mantra “grow or die” with a more accurate but less catchy “all businesses must constantly improve so as to continuously meet customer needs better than the competition.” Businesses do not have to grow but they do have to constantly improve.

My research on high-growth companies has led me to the following conclusions:

1. Growth can be good or bad;
2. Bigger is not always better;
3. There is nothing wrong with a business maintaining a steady state provided it continues to meet customer needs better than its competitors;
4. Growth should be an informed strategic decision made only after analysis of the pros and cons of growing and not growing;
5. Growth can stress people, processes, controls, culture, and customer value propositions;
6. Growth usually means adding employees, and having more employees requires building a larger management team, both of which are disruptive to a business and challenging to execute well;
7. Growth sometimes catapults businesses into a different competitive space where they will be forced to compete against bigger and better competition;
8. Growth materially changes the role of the entrepreneur who built the business and often requires the entrepreneur to enlarge his or her activities into areas where there is neither expertise nor enjoyment; and
9. To manage the risks of growth entrepreneurs must manage the pace of growth.

Growth is change. Growth requires the entrepreneur and the organization to evolve, which changes the personal dynamics and inner workings of the business. All of these changes in people and processes increase the risks that quality and financial controls may be violated and that culture and customer value proposition may become diluted, both of which are not good.

When Is Growth Bad?

There are several reasons why an unquestioning quest for growth can lead to bad outcomes. First, growth can be bad for a business if it requires the business to increase the magnitude of output so quickly that quality declines below customers’ expectations. This produces dissatisfied customers who will then look elsewhere. Second, growth can be bad if it requires significant investment ahead of when the anticipated increased revenue will be received. The result can be that the business runs out of cash and cannot pay its bills. Third, growth can be bad if a business diversifies into a new related business that, while it might have looked good on paper, turns out to be too different from the core business and causes unexpected losses to occur. Fourth, growth can be bad if the business expands geographically without adequate management depth, causing a dilution of leadership since it is impossible for the entrepreneur to be in two places at the same time.

Growth also can be bad if an entrepreneur assumes that success in one area of business will ensure success in a different business area. For example, why does a successful residential real estate developer think he can build an office building or a shopping mall?

What may not be obvious is that growth requires more and qualitatively different controls and processes, plus a culture to drive desired behaviors to avoid negatively impacting quality, brand reputation, customer relationships, and financial stability or viability.

Why Should a Business Grow?

Common reasons given by the DPGC research entrepreneurs as to why they should grow their business were

• To make more money;
• Because more customers kept showing up;
• To give my employees a chance to grow in their jobs;
• To be more competitive;
• Because businesses are supposed to grow;
• Because I [the entrepreneur] am bored;
• Because my banker wants me to grow; and
• Businesses either “grow or die.”

Are any of those reasons valid? Why? Why or under what circumstances do you think a business should grow? Why does a business have to grow revenues by more than the rate of expenses inflation?

In the next section, we will examine some growth tools that were generated by my research findings and developed for both my consulting practice and Darden Executive Education programs: the Growth Decision Template, the Growth Risks Audit, and the Managing the Risks of Growth Plan. These tools were designed to enable entrepreneurs to systematically assess the risks and benefits of growing their business.

Strategic Growth Decisions

I developed an appreciation for the necessity of strategic growth decisions and managing the risks of growth from research not of public companies but of private high-growth companies. This is somewhat surprising because, unlike publicly traded companies that are strongly affected by the public markets’ push for quarterly growth, private company CEOs should, arguably, be free from such pressures. Why were these private company CEOs more aware of and concerned about the risks of growth than the public company CEOs? I do not know the answer to that question. Could it have something to do with the fact that private company CEOs in many cases have invested their own money, often a significant portion of their wealth, in their business?

In general, what I found was that entrepreneurs who had previous bad entrepreneurial experiences were more aware and respectful of the challenges and risks presented by growth. These experiences resulted in caution and sensitivity to the need to pace growth.

Growth Decision Template

In Smart Growth, I advised business managers to make decisions about growth only after systematically weighing the reasons and opportunities to grow against the risks of growth. For example, an entrepreneur should continually ask the following:

1. Should we grow?
2. Why should we grow?
3. How much should we grow?
4. Are we ready to grow? What preconditions for growth from a cultural, structural, management, people, capital, process, controls, and technology perspective need to be met?
5. What are our growth alternatives?
6. What are the pros and cons of each alternative?
7. Have we completed the Growth Risks Audit?
8. Have we designed a Growth Risks Management Plan to manage those risks?

Growth is change and change is risky. Growth challenges people and internal systems. When companies grow, they change beyond simply getting bigger.

Growth Risks Audit

The purpose of the Growth Risks Audit is to sensitize an entrepreneur to the proposition that managing growth includes managing risks as well as opportunities. I have used the Growth Risks Audit (Figure 1.1) in some executive education and consulting work, and it has worked well, but by no means should it be viewed as the only possible tool. Each company has its own stresses and fault lines, so any audit tool should be modified accordingly.

The next step after completing the Growth Risks Audit is to create a plan to manage the risks identified. I have found in my work with companies that it takes a different perspective to think about growth risks and their management than to think about growth. I have found very few managers who can switch back and forth quickly from a risk management mindset to a growth mindset. As a result, one has to put in place processes that give early warnings of growth risks issues, and one has to allocate specific management time to monitoring growth risks frequently. This takes discipline and focus.

Let me emphasize again that I have found no empirical basis for the commonly held beliefs that a business must “grow or die,” nor for the assumption that growth should be continuous. I suggest that the corollary to “grow or die” is in some cases “grow and die.” That is why growth should be a strategic decision, not just assumed as a rule of the business game. Businesses do not have to grow past a certain stage, but they do have to constantly improve.

Figure 1.1.

Growth Risks Audit
1.	For each growth initiative, evaluate if, how, and to what extent that ini tiative will put material stress on your
	• Culture;
	• Structure;
	• Management team;
	• Employees;
	• Execution processes;
	• Quality controls;
	• Customer value proposition;
	• Customer experience;
	• Financial controls;
	• Financial safety net; and
	• Image and brand reputation.
2.	What specific behaviors create material business risks for you? Will growth increase the likelihood of those behaviors?
3.	Based on your answers to questions 1 and 2, prioritize those risks in or der of harm to your business.
4.	How do you know if those risks are occurring? What is your early warning system for each material risk? How do you monitor and detect those risk-inducing behaviors? How do you manage against creeping additive risks?
5.	Does your measurement and reward system encourage or discourage those risky behaviors?
6.	Managing growth requires a far differ...