Five ways smart companies maintain growth and profitability
Knowing that there’s a cyclical pattern to many markets, savvy owners and executives figure out how to take advantage of business cycles to create a continuing growth trajectory and boost profitability.
Here are five action items that are critical to middle-market companies for maximizing growth, profitability, and value — in any economy:
- Develop a strategic plan
- Grow your customer base
- Make better decisions through data analytics
- Take a flexible approach to real estate
- Maximize value when selling your business
You’ll hear a common refrain in all five: planning, planning, and more planning. And, that said, flexibility, flexibility, flexibility.
1. Develop a strategic plan
Companies that withstand the ups and downs of the economy share several qualities that consistently drive value. These companies offer compelling products and services, from both the strategic and customer perspectives. They have healthy equity positions and strong balance sheets. They maintain a flexible cost structure. And they plan ahead to identify new opportunities and can quickly deploy resources to seize those opportunities.
To begin planning ahead, glance backward. Consider how previous recessions affected your company, your industry, your customer base.
The main enabler for all of the above? High-level planning that informs strategic directions.
Conduct a financial stress test
To begin planning ahead, glance backward. Consider how previous recessions affected your company, your industry, your customer base. How much did revenue decline? How much were your margins compressed? How long did the effects last — were they short and sharp, or longer and more gradual?
A key tool for planning is an assumption-driven integrated financial model that includes a forecasted income statement, balance sheet, cash flows and, where applicable, borrowing base calculation. This model can be used to stress test how your company would perform if a future recession has the same impact on total revenue and profit margins as past downturns. Run different scenarios in the model to see the effects of changes in fixed and variable costs, revenue, pricing, margins, and other parameters. Ask yourself this: How would the company fare if history were to repeat itself? Use the answers to prepare now for the next downturn.
Unfortunately, we don’t see as many middle-market companies doing this type of financial modeling as we’d like — especially considering that it doesn’t require a large investment of dollars or time. Remember, you can keep it high level and still draw insightful, actionable information.
Dig deeper for growth opportunities
If your stress test results come back positive, great. Still, look for less obvious issues beneath the surface. Survey the ecosystem around you. Who are your key suppliers and customers? Which are your most profitable products? How does this compare to your competitors? How will the health of particular customers, suppliers, and competitors affect your business in a downturn? Most importantly, what threats and opportunities can you discern?
We saw several clients enter the Great Recession with the financial strength not just to survive but to also take advantage of opportunities because they used alternative cost reduction techniques. Some made acquisitions of weaker competitors or assets at distressed prices. Other clients saw opportunities to grow their customer base. They had production and support capacity to step in when other suppliers stumbled. As a result, they gained market share and penetrated new accounts.
When it comes to R&D, we counsel clients much the same way. Smart companies continue to innovate while others are crouched defensively. On the talent side, sharp people working for distressed companies often get concerned and look for alternatives. Again, rather than pull back on talent, be on the offensive to invest. At the same time, engage your talent in discussions about the company’s future, and their future with the company, so you don’t lose capable staff.
Strengthen your balance sheet to enable strategic moves
Companies often ask us how to do this. The short, but not easy, answer is this: Perform well, consistently. Some companies lose discipline when times are good and business is highly profitable. Based on the results of your financial modeling, ask yourself: What would you do in an actual downturn? Then do some of those things now, before a downturn occurs — that's the foundation of a sound profitability strategy. Practice better working capital management; sell excess assets; lock in favorable interest rates and lease terms (more on that shortly); spend or expand only when there’s a clear-cut opportunity that promises good yield and strong impact.
When those well-aligned strategic opportunities — be it an acquisition, an innovation, a talented new hire — do arise, you’ll have cash available to react.
With the many distractions middle-market executives face, it’s hard to know where to focus your efforts. Asking hard questions and putting the company through its financial paces can point you to the right strategic initiatives to solidify profits and cash flow. Is it an exact science? Of course not. But begin working your way forward, and be prepared to course correct as you go.
2. Grow your customer base
It’s more expensive to acquire new customers than to retain them — we’ve all heard that maxim before and, most of the time, we remember it. But sometimes we get spooked — after all, aren’t more customers better than fewer customers? Not necessarily.
When it comes to high-value customer growth, top-performing companies do a few things consistently, in both good times and bad. First, they take a structured approach. We use a customer strategy framework with our clients to help them deepen their customer relationships. The framework guides companies, first, to articulate a vision for serving customers. Next, businesses look at how they must perform to achieve that vision. They then establish a baseline to assess how well they’re doing in terms of capabilities, plans, and current customer relationships.
Often, the assessment doesn’t align with the vision, revealing gaps to address. This should lead to important strategic discussions about your core competencies as they relate to customer needs and how you want to differentiate your business from competitors in the marketplace. How are you positioned against them? All of these answers should be synthesized into your overarching strategy and tactical plans for moving forward.
The last step of the framework is to monitor progress. Are you making headway? Are you making inroads with that particular high-value customer you’ve targeted? At a minimum, you should be assessing progress quarterly. It’s critical to hold internal discussions and solicit feedback from customers; we wish we saw more middle-market companies doing both — formally and frequently.
Know your customers better
Top-performing companies seek new opportunities with existing customers. Use the framework to explore current customer relationships further. From a strategic and sales perspective, can you see where growth is going to come from? Are there other divisions within the business that your company could penetrate?
On the tactical side, make sure your company has more than one point of contact within the business. Engage those individuals in a discussion. What do they see in the marketplace? Who in the customer’s organization interacts with its customer base? Gain a more robust understanding of your customers, who they’re selling to, how strong demand is for your products and services and, ultimately, where your products and services are going.
Likewise, your company’s “relationship team” should be just that: a team. For example, involve engineering, finance, and management when dealing with a key strategic customer. If you have a direct sales force, salespeople should be well-versed in your products, so they add real value, and their incentives should reward retention and new business from existing customers.
But here’s an important caveat: Not all customers are good for your business. Some customers are more profitable or more strategic in value than others. Are you able to discern which are which? How do your customers’ profit margins compare? How easy are they to work with? How important are they for future business? The extra time you spend on care and feeding of low-margin or high-maintenance customers is time not spent finding others who might be a better strategic fit for your company. The opportunity costs of “bad customers” can be quite high.
Create a memorable customer experience
Top-performing companies create memorable customer experiences to build loyalty, often by solving customer challenges. Tesla, with a loyalty rate of 85 percent, developed a more affordable Model 3 to broaden its base. Pre-orders alone brought $400 million in cash to the company.
In the middle market, we helped a client who was struggling because it had few “very good” customers. Management was concerned it had tapped out its customer base. The company developed a new strategy around helping customers solve problems. Our client developed new relationships with its key customers, broadening its interface beyond purchasing, and proactively learned about the customer’s challenges. When meetings were held, the client came prepared with solutions. At that point, the customer saw our client in a new light, no longer a commodity but a strategic business partner.
3. Make better decisions through data analytics
Many middle-market executives are concerned they’re behind the trend when it comes to data analytics. Indeed, it holds great potential for improving decision making and thereby performance, profitability, and value. We also see a lot of hype around data analytics, making it easy to jump in without a deliberate and flexible approach.
Data analytics is the transformation of information into actionable insights that can lead to competitive advantage. There are three types.
- Descriptive analytics answers questions such as, “What happened and why?” Why is turnover so high? How much does it cost, or how long does it take, to hire a new employee?
- Predictive analytics takes that a step into the future, answering “What will happen if...?” Amazon’s product recommendations are a great example of how predictive analytics can be used to suggest other items you might like based on your history, wish list, and other customer purchases.
- Prescriptive analytics go another step further, pointing to specific actions to take depending on the outcome you seek. Google Maps is a good example here. Enter your destination and, based on your current location, traffic, network of available roads, and previous preferences, Google displays what it thinks is your optimal route.
All three types of analytics lessen the personal biases and preferences we so often use to make decisions. As good as our instincts may be, analytics reduce uncertainty. They also can lead to improved efficiency and revenue. Companies use analytics to experiment with real-time pricing based on demand, inventory, and data about how much different customers will pay. Manufacturers use data analytics for preventive maintenance to reduce downtime and prevent shortages. Others use it for insight into absenteeism patterns to predict plant shifts that may be short-handed. And one property and casualty client that had sat on years of archived adjustor reports turned data into $12 million in subrogation recoveries.
You might think analytics is the province of large corporations, but...not so. Smaller companies may have the advantage here. The trove of data middle-market companies possess likely will be easier to mine. Still, you must be intentional. Data is an asset, and organizations that get that are culturally well-positioned to leverage it.
Align questions with business strategy
We often use the analogy of a house when we talk about data analytics, and your business strategy functions as the all-important roof. Any project or initiative must fit under that roof — that is, align with your strategy. This ensures the questions you ask, and the answers you uncover, contribute directly to gaining competitive advantage or solving a particular problem.
The walls of the metaphorical house represent performance management. What are your key performance indicators (KPIs)? When making the investment in a data analytics program, you need a systematic way of measuring progress against your business objectives.
Organizational infrastructure — people and processes — are the support beams of the house. This is by far the greatest challenge for many businesses. The results of your data analytics projects will drive change in how people work. Spreadsheets and old processes go away, and this can make people uncomfortable. Strong leadership commitment and involvement are key to smoothing transitions.
The cost of undertaking data analytics initiatives is often a concern, but the investment doesn’t have to be prohibitive. How much to invest should be based on the type of business. Certainly, if you’re Uber, and your business model relies on analytics to deliver services, then, yes, you’ll have to spend more. Otherwise, many reasonably priced tools with robust capabilities exist today. In addition to software costs, you should plan to spend up to five times that amount for services and labor to normalize data.
Narrow the focus to start
We recommend companies begin with a pilot. Focus on one aspect of the business and identify specific questions to answer. To find that fitting first project, look at your internal and external stakeholders — shareholders, customers, staff, suppliers, and others. Develop a plan for what information you’ll retrieve to answer the question and how you’ll apply the results. The pilot you conduct should be important to a key constituency and enable you to move the needle on KPIs, in alignment with your strategy.
Formalize your program by involving the right people, including leadership. Your IT folks and many other functional areas should be involved but not leading the charge. Data analytics is not “an IT thing.” Create a sandbox, make mistakes, learn, and then widen the scope to tackle more.
4. Take a flexible approach to real estate
The space a business occupies does a lot: It can enhance your brand and company image, attract talent, support growth, and help drive and maintain profitability. Does your office space attract and retain staff? Here are a few things to consider as you evaluate your real estate in the months and years to come.
Think about space needs early
Last-minute decisions can be costly. Our clients know we’re not kidding when we counsel them to start thinking about their next move the day after they sign a lease. Planning ahead for company growth and expansion is especially important now since space is limited. Pickup has been slow after the last two recoveries. There isn’t a lot of new construction, and we don’t expect that to change in the near future.
While long-range planning is critical, long-term promises can be expensive
We can all think of companies who, in 2008, lost significant business and found themselves with too much space on their hands and too much time left on their lease. Negotiate termination and contraction clauses carefully up front, and seek expert input to be sure you understand the full impact. There are costs associated with termination and contraction, but at least you know what they’ll be and can plan ahead.
Be creative — and consider millennials’ open office needs
Look at how your business currently uses its space and the styles your employees need to work in. Sometimes staff need to be heads down and focused; sometimes they need to be more collaborative. Does your space accommodate these varied seating arrangements? Just as you build flexibility into your lease agreements, you want to build flexibility into the space itself.
Benchmark against your peers to learn how they configure their space. Bring HR into the decision-making process, and look at the demographics of your staff and at larger trends. Be creative — hoteling, desk sharing, multiple seating configurations for solitary and collaborative work. Any number of options exist, with plenty of upside potential.
Over 50 percent of the workforce is composed of millennials, and remote work arrangements are still rising. We had one client with a traditional office build-out and significant employee turnover. Each employee move cost $3,600. The company spent more on internal moves than rent! By reconfiguring the space into an open office design, we were able to drop the client’s cost to $30 per move.
It’s a new era for lease accounting
New Financial Accounting Standards Board (FASB) guidance will have far-reaching implications for how leases are reflected on your company financial statements. The most significant change is that lessees will be required to report lease obligations on their balance sheet, with few exceptions.
Especially if you have historically structured lease arrangements as operating leases, you may see significant lease obligations on your financial statements. This change could impact operating and financing decisions, thereby requiring you to reevaluate your “brick & mortar” and debt-sourcing strategies going forward.
Review your existing leases. Make sure you and your accounting and finance team understand all the implications around the recording of assets and liabilities, buy vs. lease decisions, sale-leaseback arrangements, related party leases, financing decisions, and other considerations to ensure your financial statement and real estate strategies are in alignment. Then make appropriate changes to internal IT systems and controls, and clearly communicate the changes and impact to stakeholders.
Changes go into effect December 2018 for public companies and December 2019 for private firms. There are many details to be aware of, so start planning now since the standard requires existing leases to be transitioned to the new rules at implementation.
5. Maximize value when selling your business
If you’re thinking about selling your business within the current cycle, we counsel clients to plan to transact within the next 12 to 18 months. But timing isn’t everything. Relying solely on the strength of the market may not bring you an optimal outcome. “Readiness” for a liquidity event encompasses both personal readiness of the owner as well as the readiness of the business.
As an owner, what are your wealth objectives? What number do you need to maintain your lifestyle going forward? What future role do you envision for yourself within the business — do you want to continue being involved on a daily basis? Serve in an advisory role? Ride off into the sunset?
On the business front, readiness means several things. First and foremost, do you have demonstrable growth and a compelling growth story? Growth is the single most important factor in valuation and readiness to go to market.
Create a powerful growth narrative
We advised a particular client, in an out-of-favor industry — which therefore increased the business’s risk profile from a buyer’s perspective — to bucket forecasted revenue into several high-level categories: revenue that was booked; revenue that had been quoted but was not yet booked (with the company’s historical win-rate average applied); and additional revenue opportunities that had significant support and a track record of sales efforts. As investment bankers, that’s how we assess robustness, and this company had a motivating growth story.
That said, growth isn’t the only factor driving value:
- Do you have an exceptional management team?
- Do you have a living, breathing business plan with built-in accountability, and are you using KPIs?
- Does the company have a differentiated competitive position (perhaps including intellectual property)?
Know what other levers help drive value
Look to improve gross margins by changing customer selection, pricing, or market entry strategies. Leverage SG&A (selling, general and administrative expense) costs as the company grows. Manage debt load to boost equity value.
And don’t forget your basic blocking and tackling: updated and accurate finance reporting and accounting records; non-compete agreements in place with your management team; and buttoned-up human resource-related compliance.
If you’re not ready to transact now but want to be ready for the next window, develop strategies to make a series of improvements in specific categories over your time horizon. These kinds of bite-sized efforts become more tangible to digest and implement. Once complete, you’ll have gone through an important process, made a number of positive changes, and be well positioned for the rebound.
In conclusion – leverage current conditions, whatever they may be
No matter how economic winds may swirl around them, smart companies consistently seek to maximize growth, profitability, and value. All of the considerations we’ve discussed comprise key pieces of your business strategy, regardless of economic conditions. Fortunately, those conditions are good right now, so leverage the current upcycle to make headway. Then, if (when) a downturn comes, you’ll emerge in a stronger position, ready to move even farther and faster along your growth trajectory.