Last week I talked about what I thought it took for a company to handle exponential growth (an “entrepreneur”) as well as non-exponential growth (an “MBA”). This week I’m going to rewind a bit and get into why companies like to grow at all.
Unfortunately, growing a lot generally comes hand in hand with spending a lot.
Sadly, most of the time, ALL the extra revenues you receive from your new customers was already spent trying to get those customers! In fact, the money you spend to grow is likely more than the revenues you collect as a direct result of that growth. Which is why businesses frequently need loans or investment to grow.
But hey, what kind of special businessperson spends more on something than they expect to take in? Isn’t the point of a business to maximize PROFIT, not to maximize SIZE?
Indeed it is! So why grow?
Well, why was it that in 2000, Amazon was valued thousands of times more than DreamHost, even though we had double-digit profit margins while Amazon was losing more money each week than we had collected in our entire history?
I’d pay a heck of a lot more for a treasury bond that paid me interest of $500/day than one that cost me $600,000/day! So why would investors, no matter how irrationally-exuberant they may have been at the time, pay more for the latter?
I think it’s because what entrepreneurs do is harder than what MBAs do.
According to the US Census Bureau, 60% of US businesses have less than 5 employees. 80% have less than 10. And only 1.7% have 100 or more. Assuming most businesses are profitable (and if they’re still in business, that’s usually key), it seems pretty clear to me that a lot more businesses are profitable than big. It’s just easier.
Which is why you want to grow!
Wait, why exactly? What, just because it’s harder? Blow a bunch of money just to prove to the world you can do something difficult? The point of a business is to maximize profit, not pain!
No, not because it’s harder. The reason it’s much more valuable to get big (what entrepreneurs do) than to get profitable (what MBAs do) is because once you’ve grown a lot, it only takes a tiny change in your profitability before that $600,000/day loss transforms into a $600,000/day gain.
So you see, when you’re spending all that money on growing, you don’t actually spend more than the growth is really worth. Growth is actually worth a lot more than the average MBA might guess. Of course, it’s also not worth as much as some entrepreneurs value it. The trick is knowing (or at least guessing) how much it’s worth better than your competitors do.
So how much is getting big worth?
It depends. In web hosting, as in insurance, magazines, cell phones, cable tv, xm radio, and any other soul-stealing business, growing is worth exactly one bajillion dollars. After all, theoretically every new customer you add is an unending stream of revenue for all time! So it’s okay to spend one bajillion dollars minus one on growing by one customer, especially since there’s always one bajillion MBAs ready to swoop in and turn your business profitable the moment the entrepreneur can’t get it to grow anymore.
You see, heh heh, I lied before.
The point of a business is actually to maximize VALUE!
It just that for most businesses, maximizing profits is the best way to do that. However…
A company’s value is maximized when it’s big AND growing fast.
(As I established, growing fast is more valuable than being profitable, and all other things held equal, a bigger company is worth more than a smaller one.)
Clearly, when you’re at the maximum value, it’s time to sell your company (ipso facto, as any other time it’d be worth less). Therefore, the best time to sell your company is right before your growth rate starts to decline. That is, the biggest you’ve ever been while still growing fast.
You see, as soon as you stop growing fast, people are going to start basing your valuation directly on your profits, and that’s not going to grow very fast, because, um, we just said your growth rate is starting to decline!
Case in point… wouldn’t you have like to have sold all your Google shares right before their last earnings announcement? You know, the one where they told the world they weren’t growing quite as fast as the world expected?
Me too. Trust me… ME TOO.
And that’s Part 2 of my thoughts on growing! There may be another part later or not! Stay tuned?