Tuesday, April 28, 2009

Strategic Planning Analogy #255: Growth

Once upon a time, there was a boy named Bobby who dreamed of being a great basketball star. Bobby’s dream had a problem—Bobby was short. Bobby knew that if was ever going to be a great basketball star, he would need to find a way to grow a lot.

One day, Bobby went to the carnival. In a dark corner of the carnival, far away from the midway lights and the noisy crowds, Bobby found a small tent with an old woman inside. The old woman claimed to have all kinds of magic potions for sale.

Bobby was excited! This was his chance to grow, so that he could finally become a great basketball star. Bobby asked the old woman for the strongest growth potion she had. As the old woman handed Bobby the growth potion, she tried to warn him about how it worked, but Bobby was too excited to stick around and listen. He ran straight home to take the potion.

Sure enough, the growth potion was very strong. Unfortunately, the only thing that grew were Bobby’s earlobes. His earlobes became so long that they dragged on the ground. Whenever Bobby tried to play basketball, he tripped over his earlobes and fell down. His dream had become a nightmare.

Bobby dreamed of growth. He was willing to do almost anything to grow. Bobby got so focused on growth that he did something foolish. It lead to growth, but not the kind that helped him. Instead the growth made his situation worse.

Businesses tend to have a strong desire to grow as well. Just like with Bobby, not all business growth is good growth. Some growth can make your situation worse. Growth at any cost can often be too high of a cost.

The principle here is that growth is only desirable if it makes you stronger. Growth in earlobes or cancer is not very useful. Growth in muscle and stature is. Therefore, be very careful about the type of growth you focus on. Here are my three rules on growth.

1. Focus on Growth of Market Position Rather Than Growth in Sales
Strong companies have strong market positions. Just think of the companies that tend to do well consistently over time. Nearly all of them have a strong position in the marketplace. Wal-Mart owns the price position in the marketplace. Apple owns “cool” design and usability. Toyota owns quality and reliability. Four Seasons owns Customer Service.

Conversely, struggling companies tend to have weak positions. What does Buick own? What does K Mart own? What does RCA own?

Therefore, a key growth measure is how fast you are growing the strength of your position:

A) In terms of how much your targeted customer prefers your brand (How loyal are your customers? Do they recommend you to friends? Would they pay a premium to get what you offer? How much repeat business do you get? Am I loved?);

B) In terms of performance relative to competition on the key positioning attributes (Are we the best at what matters?).

The particular metric in this area depends on your particular situation and what position you are trying to own. The key is to find a metric (or two or three) that shows how strong you are at a) rational performance on the key positional attribute, and b) emotional bonding with the customer. Think of rational performance as “muscle” and emotional bonding as “stature.”

A side benefit of a strong emotional bond is that it opens the door for the consumer to trust you as you migrate to new growth categories. For example, Apple’s emotional strength with the iPod position created the opportunity to successfully migrate to the iPhone.

This is superior to focusing on just growing sales, because not all sales are good sales. Sometimes sales growth can be like fat, or cancer, or big earlobes, rather than muscle. For example, to get extreme growth in sales, you can destroy your image. Just ask every exclusive fashion brand over the years what happened when they branched out to the masses. They got a near-term burst in sales, but in the long run destroyed the brand with its core customers and lost its ability to turn a profit.

Sometimes, the way to boost sales is to lower the price to virtually free. This can destroy profits and weaken the brand image (you get what you pay for).

Too many sales can overcome your ability to meet demand. Your standards may fall or disappointments may rise.

Or you can increase sales by venturing into diversifications in areas away from your core strengths where someone else already owns the market. Or you can pay way too much to get sales via an acquisition. Both of these can destroy profitability.

If you win on growing your market position, growth in desirable sales tends to follow. But if you look for sales growth at any cost, you can end up destroying your market position and end up with neither sales nor profits in the long term.

For more on this idea, check out my earlier blog on balloons.

2. Focus on Growth in Cash Flow Rather Than Growth in Profits
It is good to be loved and to be the best, but that isn’t worth much if you lose money on every sale. We also need to make money.

The best measure of how well you are making money is cash flow. Cash flow is about making sure more money is coming in than going out. The #1 factor determining stock price is anticipated future cash flows. The more cash flow potential you have, the more valuable is your company. Cash flow, provided it is not part of a ponzi scheme, is true muscle.

By contrast, net profits are a weaker measure. Yes, they can be muscle, but profits can also be fat, cancer or big earlobes. For example, you can buy profits through overpaying for acquisitions, which may make the bottom line go up, but create a negative return on investment and actually destroy value.

A profit focus tends to look only at outcomes. This can lead to growing near-term profits by starving investment in the future. One of the big problems at Enron was that it had such a strong focus on quarterly profits that it tended to ignore the idea of building sustainable business models.

By contrast, a cash flow focus looks at both inputs and outputs. It realizes that it is the net of the two that is most important. As long as the investments are sound, a lot of spending can be a good thing, because it builds muscle. I’d rather have a steady stream of good cash over time than a burst of profits in one year that comes at the expense of any future profit potential.

3. Strike a Balance Between Market Position and Cash Flow Growth
Both Market Position and Cash Flow should be a part of your growth plan. A focus on market position alone can lead to giving all the value from the strong position to the customer. Conversely, a focus on cash flow alone may result in not giving enough value to the customer.

However, by looking at the two together, one creates a balance. Company needs and customer desires both get fed, creating a long-term sustainable (and profitable) model, capable of growth over time.

Growth is good, provided you are growing muscle rather than fat. To make sure the growth is muscle, focus on two things: growing Market Position and Cash Flow. A balanced approach in these two areas will almost always lead to muscle. By contrast, a focus on sales and profits may or may not lead to muscle. Instead it might result in fat or cancer.

They say that muscular people are more efficient at burning calories and can keep off new fat better than people who are already fat. Similarly, companies with historically strong market positions and cash flow orientation tend to continue to stay strong and avoid getting fat. So protect your future by getting into shape today.

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