The Ceiling of Brute Force:
Small Businesses Don't Stay Small on Purpose
In an average month, my organization explores around 50 companies for possible investment. We review everything from organizational structure, culture, and financial performance, to sales systems, competitive position, and leadership style. This gives us an unusual vantage point from which to recognize patterns of success, and failure.
As a general rule, small businesses don’t stay small on purpose. Companies “top out” for good reason(s) and rarely because of the business model. Beyond a certain point, sheer effort no longer works to overcome critical challenges. This is the ceiling of brute force. Each company hits it at some point, but the size, specific issues, and level of complexity varies dramatically.
A comprehensive study of organizations by Dunn and Bradstreet concluded that 90% of small business failure was directly attributable to a lack of management expertise. In my humble opinion, that number seems low. If failure occurs, it’s virtually always a fault of leadership. The question is “what kind of fault, and is it preventable?”
Charlie Munger, Warren Buffett’s long-time partner said, “You can learn to make fewer mistakes than other people, and how to fix your mistakes faster when you do make them.”
With that in mind, here’s a roundup of the mistakes, weaknesses, or flaws we see most often in companies with less than $50M in revenue and/or fewer than 150 employees.
Virtually every business is relationship driven in some way. Even consumer products rely on the distribution of large retail relationships. A problem occurs when those vital connections are concentrated, especially amongst those with incentives that aren’t perfectly aligned with ownership. This issue can remain hidden for an extended period of time, but eventually causes major problems. Diversify high-level relationships to build a solid future for the company.
Most small businesses rely on the expertise, leadership, and decision-making of a select few. Challenges occur when their absences are considered unthinkable. People move on and you need to be prepared for the worst. We encourage every organization to have a “hit by a bus” backup plan for each key employee and review it annually to ensure it’s adequate.
Businesses need capital to grow. Anyone who tells you money is plentiful, or easy to get, hasn’t ever needed it, or has forgotten 2008. Accessing capital is an acquired skill and one that is often overlooked. Banks, funds, and individual investors all have different preferences, perspectives, and protocols. Organizations must be knowledgeable about why, when, how, how much, and at what terms are right for them.
Cash is like oxygen; you don’t notice it until it’s not there. Organizations often forget that while profitability ensures long-term success, without cash flow it’s irrelevant. This lack of attention manifests infrequently, but when it does, it’s an emergency. I can’t tell you how many organizations we’ve looked at that use asset-based lenders to augment cash flow, often with cost of capital exceeding 15%. These solutions provide life support, but often permanently weaken the organization. As we exit the zero interest rate environment, cash flow will play an even larger role in success or failure.
Reputation takes a lifetime to build and seconds to destroy. This goes for employee morale, customer opinion, and industry relationships. We pay close attention to what each stakeholder group thinks of the organization and how that opinion has evolved over time. There are usually warning signs of decay far before an implosion.
Scaling an organization requires talent, which makes good people not just important, but everything. Most small businesses consider recruitment and retention as afterthoughts, taking a backseat to the “sexier” sides of business. That is a big mistake and major reason organizations hit a wall. Be intentional, organized, and innovative when it comes to finding and keeping the right people.
We frequently find glaring deficiencies and ask the current owner/management why the problem hasn’t been addressed. The most common answer is complacency and a failure to make tough choices. Most tough choices actually aren’t difficult, they’re just uncomfortable. It’s crucial to the health of the organization to replace under-performers, shop long-term agreements, or pull budget from projects with little chance for success. Not doing so puts the rest of the organization in peril.
There is constant treadmill of business books preaching about how to out-do your competition. For the most part, it’s bunk. I’ve quite literally never seen a competitor cause the demise of a small business. The world is a big place and if you’re small, your biggest competitor is the person in the mirror, or your customer doing it themselves. We like to examine the competitive landscape to understand what others are doing and to find benchmarks, but we’re never worried about someone out-competing a small business.
The use of technology is a skill and should be viewed on a continuum, with either extreme being a net negative to the organization. A luddite culture breeds inefficiency by ignoring proven value-adds, while a tech-centric culture wastes resources chasing the latest-and-greatest that rarely, if ever, manifests. The correct approach is somewhere in the middle. Think technological Goldilocks. Embrace the obvious and be skeptical of the cutting edge.
Being everything to everyone ensures your business won’t amount to much. We see degrees of this even amongst companies that currently have, or had, a core competency. Growth either comes from doing more of the current offering, or expanding products/services. A “grass is always greener” mentality leads to a continual scope creep and eventual over-dilution. The strongest businesses have a clear value proposition, customer set, and expertise.
For the inexperienced, robust and repeatable systems seem like self-imposed handcuffs, destined to make the organization filled with cookie-cutter zombies. Nothing could be further from the truth. Systems create stability, predictability, and consistency. Ask customers if they want your product quality, or timeliness, to be variable. You know the answer. For most businesses, the investment in systems improvements pays for itself almost immediately.
Core vs. Non-Core
Outsourcing can be wonderful, or incredibly destructive. We follow the basic rule that if the function is a core competency, do it in-house. Otherwise, outsource. We find most businesses are a hodgepodge of skills and functions, driven by the least painful short-term path. Firms would see dramatic improvement in performance by understanding their core functions, and finding capable long-term partners for the rest.
The list above is long and every situation is unique. With that said, small businesses would be served well by some basic self-examination. What’s working and why? Where are the bottlenecks and catch-points? What seemingly “minor” issues are holding back progress and success?