In today’s blog we explore business growth, and the challenges it brings about in terms of efficiency.
First, we will understand the various stages of a business lifecycle. A business goes through a broadly defined life cycle consisting of the following phases:
In the startup phase, businesses are focused on developing and marketing their initial set of products and on breaking even. This phase usually has businesses operating at a net loss as the cost of marketing, research and development far exceed the revenues generated. Also, startups are not overly complex in their structure and do not employ many people. This means that they normally operate at an efficient level due to being small as well as limitation of resources. If they are not operating efficiently, they risk going under very quickly, hence it can be said that efficiency is forced upon them.
In the growth phase, businesses have started to make profits. The marketing, research and development costs incurred would have started paying off dividends. The revenues generated at this stage are enough to cover all expenses and overheads. At this stage, businesses are looking to expand. They now look to increase their set of product offerings, or access other demographics, etc. They are looking to actively grow. Growth can occur in two ways, i.e., organic and inorganic. Organic growth is when businesses expand using internal resources to expand operations thereby leading to increased revenue whereas, in inorganic expansion, businesses grow by buying out other businesses. Generally, inorganic growth poses more challenges to efficiency than organic growth and we will look at the why in the later paragraphs.
The maturity phase is not clearly defined as businesses generally continue growing and rarely remain stable. A key indicator to know if the business has attained maturity is to see if the growth rate of the business is equal to the GDP of the country it operates in. As businesses go from growth stage to maturity stage, their growth rates decline until they reach the long-term growth rate which should naturally not be above the GDP rate of the country. Another easier to understand but harder to define indicator would be time. Generally, firms more than ten years old can be thought of as mature companies. This is extremely hard to define as the difference in time taken by a business to reach maturity varies greatly across various industries and in various economies. In this stage, external growth opportunities would be limited and hence the best way to increase profit would be to improve efficiency. Mature companies use methodologies such as lean system, six sigma, kaizen costing, etc. to improve the quality of their production systems while reducing costs at the same time, thereby increasing profitability.
Lastly, we have the decline phase where we see businesses go under as they could not keep up with the competition or lack of proper strategy in line with the current business developments or bad financing decisions such as employing too much leverage or just lack of efficiency in operations leading to widespread failure in the business. Businesses in this stage either have declining profits or are loss-making and their values are massively discounted since they may not be around for the long run. An economic crisis or external negative event does well to serve the death knell to such businesses as they must file for bankruptcy or wind up as it becomes unsustainable to run them.
Let us now understand what efficiency is.
Efficiency is not a one-time objective but an ongoing one. It is the idea of producing the same output with lower resources or producing higher output with the same resources. Resources could be in the form of time, material and energy or other immeasurable aspects such as effort. When we look at efficiency in an organization, there are quick fixes that can yield instant results which is called short term efficiency objectives and the fixes that are undertaken over years which would then be called long term efficiency objectives.
The long-term efficiency objectives can only be sought after once the short-term efficiency objectives are accomplished. This is because the long-term objectives may not be as apparent or easy to fix and may require additional investment while short term objectives generally do not require much investment and are easy to identify and fix.
If left unaddressed, inefficiency is like the dead weight that slows down a ship for no real reason and over time it only increases the costs at a compounding rate.
Let us now understand how growth brings about challenges for efficiency.
As I discussed earlier, there are two types of growth, organic and inorganic. I also mentioned there that inorganic brings about more challenges to efficiency than organic growth. Let us understand why this happens.
When a business grows organically, new divisions and new employees are only added when there is a need for the same. This means that there is generally no duplication of work among the divisions. This means that the inefficiencies in the organization are not easy to identify but once identified they should be easy to fix. Hence organizations that grow organically must look deeply into their processes to identify the inefficiencies as they may not be apparent at first glance.
This contrasts with when a business grows inorganically. When a business grows inorganically by acquiring other businesses, it has taken over divisions and employees from the other business who do the same job in many areas. Just to illustrate the same, think about the accounts department in a business. As accounts is an essential function, most businesses would have a dedicated staff of accountants. Hence, when two business combine to form one, there would exist the staff from the accounts department of both divisions. This leads to duplication of work and inefficiency in the accounting process as there would be at least two people doing the same work. This leads to immediate problems which many companies only uncover after the acquisition. The synergies from an acquisition only come to fruition if there is a clear-cut plan on addressing the inefficiencies. Otherwise, the added costs and inefficiencies make it hard to operate the combined entities.
The best way for businesses to stay profitable is to identify inefficiencies on a regular and continuous basis. This is mainly because the costs associated with inefficiencies are not linear but compound over time. This means the earlier you fix inefficiencies the greater the long-term benefit from the same.
In reality, many companies go under because the loss from inefficiencies is far greater than the cost of capital which means they could be saved just by fixing inefficiencies on time. Therefore, many a time we see bankruptcy filings where the company files for restructuring instead of liquidation. This means the offerings of the company have potential, but the inefficiencies have posed so much a problem that it is time to go back to the drawing board and fix these inefficiencies which should lead to a profit-making company.
Have you analyzed the business processes in your organization to check if there are any inefficiencies? Have you noticed increase in costs which are not justifying the use of additional resources? If you feel you would require a subject matter expert to help you with identifying opportunities to increase efficiency and profitability at your organization, please feel free to reach out to us and we will be glad to assist you with the same.