Neil Churchill describes the nature of different periods of business growth "" and sometimes extinction.
Entrepreneurship is widely recognised as creating value. This, in turn, is usually seen as starting a new venture "" recognising an opportunity, fashioning it to suit the entrepreneur, acquiring the resources to pursue it and then capturing the opportunity by creating a company.
But without discounting the importance of starting a business the value is
really created as the enterprise grows, creates jobs, satisfies the needs of more and more customers and, in the process, makes money for the stockholders. All of which creates value for society.
A growing company continues to create value if it spawns more and more new products or services, creates more jobs, pays more taxes and so on "" that is, renews itself after each product cycle.
This article describes the different periods, phases or stages of growth
most successful companies experience and the nature of those changes. A second article, in Part 9, will examine the problems most often encountered and solutions that have been used successfully.
Finally, a third article, divided into two parts on page 8 and in Part 9, deals with one of these big problems "" cash "" and why it is so important and how to manage it on a company and product-market basis.
Each stage of growth has its own challenges and these can be approached in several ways.
One such framework was developed in the early 1980s and has been used ever
since by entrepreneurs and consultants. It was re-examined in 1994, updated (five stages, one with two sub-stages, became six stages) and deemed by several hundred owner/managers to be useful in helping them assess what skills and resources were needed both for the present and the future.
Owners who can assess the stage at which their companies are operating can use the framework to understand better existing problems and anticipate further challenges.
The framework covers six stages of development (see Figure 1). Each stage is
characterised by an index of increasing size, complexity and/or dispersion and described by five management factors: managerial style organisational structure extent of formal systems major strategic goals and the owner's involvement in the business.
Stage I: Conception/existence
In this stage the company has not really come into existence. It is still somewhat conceptual; it has not solved the problem of obtaining customers or it cannot deliver the product or service contracted for in the necessary quantity or with the necessary quality.
Some key questions are:
l Can we get enough customers, deliver our products and provide services well enough to become a viable business?
l Can we expand from that one key customer to a much broader sales base?
l Can we develop the product from a pilot production process to a production
basis?
l Do we have enough money to cover the considerable cash demands of this start-up phase?
The organisation is simple one; the owner does everything and directly supervises subordinates, who in the main are of average competence. Systems and formal planning are minimal to non-existent. The company's strategy is simply to remain alive. The owner is the business, performs all the important tasks and is the major supplier of energy, direction and, with relatives and friends, capital.
Companies in the conception/existence stage range from newly started restaurants and retail stores to high-technology manufacturers that have yet to stabilise either production or product quality.
Many such companies or products never gain enough customers to become viable. In these cases the owners close the business when the start-up capital runs out and, if they are lucky, sell the business for some of its asset value. In other cases the owners cannot accept the demands the business places on their time, finance and energy and they quit. The companies that remain in business became Stage II enterprises.
Stage II: Survival
In reaching this stage the business has demonstrated that it is a workable business entity. It has enough customers and satisfies them sufficiently with its products or services to keep them. The key problem thus shifts from mere existence to the relationship between revenues and expenses. The main issues are as follows:
l In the short run, can we generate enough cash to break even and to cover the repair or replacement of our capital assets as they wear out?
l Can we, at a minimum, generate enough cash flow to stay in business and to finance growth to a size that is sufficiently large, given our industry and market niche, to earn an economic return on our assets and labour?
The organisation is still simple. The company may have a limited number of employees supervised by a sales manager or a general foreman. Neither of them makes major decisions independently but instead carries out the rather well-defined orders of the owner.
Systems development is minimal. Formal planning is usually limited to cash forecasts and project plans. The major goal is still survival and the owner is still synonymous with the business.
In the survival stage the enterprise may grow in size and profitability and move on to Stage III. Or it may, as many companies do, remain at the survival stage for a long time.
These companies are often "hobby'-type businesses where the owner, for example, enjoys skiing and so runs a ski shop and where the non-economic aspects of the enterprise are positive. They can also be family businesses, such as small restaurants employing extended-family members.
In many cases these businesses become profitable and move to the next stage. In others the founders have chosen non-viable enterprises in an overcrowded industry (often the case), badly located or faulty in conception and they cannot, or refuse to, do what is needed to make them profitable. They operate these businesses until they die or retire and while some are sold or passed on to children who wish to change them most just cease operating and drop out of sight.
Stage III: Profitability/stabilisation
In this stage the company has attained true economic health, has sufficient size and product-market penetration to ensure economic success and earns average or above-average profits. The company can stay at this stage indefinitely provided environmental change does not destroy its market niche
or ineffective management reduce its competitive abilities.
Organisationally, the company has, in many cases, grown large enough to require functional managers to take over certain duties performed by the owner. The managers should be competent but need not be of the highest calibre since their upward potential is limited by corporate goals. Cash is plentiful and the main concern is to avoid a cash drain in prosperous periods to the detriment of the company's ability to withstand the inevitable rough times.
In addition, the first professional staff members come on board, usually a controller in the office and perhaps a production scheduler in the plant. Basic financial, marketing and production systems are in place. Planning in the form of operational budgets supports functional delegation.
The owner and, to a lesser extent, the company's managers should be monitoring a strategy essentially to maintain the status quo. As the business matures, it and the owner increasingly move apart, partly because of the presence of other managers.
Many companies continue for long periods in the stability stage. The product-market niche of some does not permit growth "" this is the case for many service businesses in small or medium-sized slowly growing communities and for franchise holders with limited territories.
Other owners actually choose this route. If the company can continue to adapt to environmental changes, it can continue as is, be sold or merged at a profit or subsequently be stimulated into growth. For franchise holders this last option would necessitate the purchase of other franchises. If the company cannot adapt to changing circumstances, as was the case with many automobile dealers in the late 1970s and early 1980s, it will either fold or drop back to a marginally surviving company.
Stage IV: Profitability/growth
In this stage the owner-manager consolidates the company and marshals resources for growth. He takes the cash and the established borrowing power of the company and puts it to risk to finance growth.
The important tasks include making sure the business stays profitable so that it will not out-run its basic source of cash, to hire "" a bit in advance "" and develop managers of a higher quality than those needed to run a stable company. They will have to address the tasks of attaining a higher level of activity and manage it successfully once there.
Better systems are needed, and attention should be given to forthcoming needs. Operational planning is delegated and strategic planning is shared with the key managers. The owner continues as the owner-manager and is active in all phases of the company's affairs.
It is successful, the growth company may make a commitment to a higher
growth rate and transition to Stage V "" the take-off stage. Indeed, Stage IV is often a first attempt at growing, say regionally, before making a total commitment to growth. If a Stage IV company is unsuccessful the cause may be detected in time for the company to shift to Stage III. If not, Stage II may be possible before bankruptcy or a distress sale.
Stage V: Take off
In this stage the key problem is determining how to achieve rapid growth and how to finance it. The most important problems that then follow are
delegation, cash management and cost control.
Delegation. Can the owner delegate responsibility to improve the managerial effectiveness of a fast-growing and increasingly complex enterprise? Further, will there be true delegation with controls on performance and a willingness to see mistakes made or will it be abdication, as is so often the case?
Cash. Will there be enough cash from operations and savings to satisfy the great demands growth brings? If not, where and how can additional financing be obtained? Will the owner tolerate a high debt-equity ratio or a dilution of owners equity?
Cost control. Rapid growth can bring such demands on managers and at such a frantic pace that things begin to "slip through the cracks' as time is spent hiring and training new people and dealing with new and larger problems. And, as growth can cover normal signals, there may be inadequate warnings to alert the overworked management to what is going wrong.
The organisation is decentralised and, at least in part, divisionalised ""
usually either in sales or production. The key managers must be sufficiently competent to handle a growing and complex business.
Systems, strained by growth, are becoming more refined and extensive. A considerable amount of planning is being done that deeply involves all key managers. While the managerial staff has grown considerably, the company is still dominated by both the owner-managers presence and ownership control.
This is a pivotal period in a company's life. If the owner rises to the challenge of a growing company, both financially and managerially, it can become a big business. If not, it can usually be sold "" at a profit "" provided the owner recognises his or her limitations soon enough.
Too often, those who bring the business though the previous stages are unsuccessful in Stage V, either because they try to grow too fast and run out of cash (the owner falls victim to the omnipotence syndrome) or are unable to delegate (the omniscience syndrome).
It is of course possible for the company to traverse this high-growth stage without the original management. It is not uncommon for the entrepreneur who founded the company and brought it to success to be replaced either voluntarily or involuntarily by the company's investors or creditors.
If the company fails to make the big time it may be able to retrench and continue as a successful and substantial company in a state of equilibrium. Or it may drop back to Stage IV or, if the problems are too extensive it may drop all the way back to the survival stage or even fail.
Stage VI: Maturity
The greatest concerns of a company entering this stage are, first, to consolidate and control the financial gains brought on by rapid growth and, second, to retain the advantages of small size, including flexibility of response and the entrepreneurial spirit.
The corporation must expand the management force fast enough to eliminate the inefficiencies that growth can produce and professionalise the company by use of such tools as budgets, management by objectives and standard cost systems "" and do this without stifling its entrepreneurial qualities.
A company in Stage VI has the staff and financial resources to engage in detailed operational and strategic planning. The management is decentralised, adequately staffed and experienced. And systems are extensive and well developed. The owner and the business are quite separate, both financially and operationally.
The company has now arrived. It has the advantages of size, financial resources and managerial talent. If it can preserve its entrepreneurial spirit it will be a formidable force in the market. If not, it may enter a seventh stage of sorts: ossification.
Ossification is characterised by a lack of innovative decision-making and the avoidance of risks. It seems most common in large corporations whose sizeable market share, buying power and financial resources keep them viable until there is a major change in the environment.
Unfortunately for these businesses it is usually their rapidly growing competitors that notice the environmental change first.
Conclusion
The findings of the studies involved in the development of the six-stage model strongly suggest that the levels of chief executive leadership/ management skills, management team functioning and organisational culture are related to the financial performance of organisations.
Specific skills such as vision, communications, leadership, delegating and performance facilitation are positively related to company performance. Chief executives and management teams who rate low in these skills have lower company financial performance than those rated higher in the same areas.
Further, maintaining these skills as the organisation grows can be challenging. In many companies the higher the rate of sales growth the lower the level of the organisational culture factors mentioned above that relate to profitability. To maintain or improve profit margins management must focus on those elements that apparently become more difficult to execute often or well as the company grows.
The changing nature of managerial challenge becomes apparent when one examines Figure 2. In the early stages the owners ability to delegate is on the bottom of the scale since there are few if any employees to delegate to but it becomes critical later as the company grows.
In contrast, the owners ability to do the job in these built on the owners talents: the ability to sell, produce, invent or whatever. This factor is thus of the highest importance.
As the company grows other people enter sales, production or engineering and
they first support and then even supplant the owners skills "" thus reducing the importance of this factor.
At the same time the owner must spend less time doing and more time
managing. He or she must increase the amount of work done through other people, which means delegating. The inability of many founders to let go of doing and to begin managing and delegating explains the demise of many businesses in Stage IV.
The owner contemplating a growth strategy must understand the change in personal activities such a decision entails and examine the managerial needs depicted in Figure 2. Similarly, an entrepreneur contemplating starting a business should recognise the need to do all the selling, manufacturing or engineering from the beginning, along with managing cash and planning the business's course "" requirements that take much energy and commitment.
The importance of cash changes as the business changes. It is an extremely important resource at the start, becomes easily manageable at the success stage and is a main concern again if the organisation begins to grow. As growth slows at the end of Stage V or in Stage VI cash becomes a manageable factor again. Companies in Stage IV need to recognise the financial needs and risks entailed in a move to Stage V.
The issues of people, planning and systems gradually increase in importance as the company progresses from slow initial growth to rapid growth. These resources must be acquired somewhat in advance of the growth stage so that they are in place when needed.
A company's development stage determines the managerial factors that must be dealt with. Its plans help determine which factors will eventually have to be faced. Knowing its development stage and future plans enables managers, consultants and investors to make more informed choices and to prepare themselves and their companies for later challenges.
While each enterprise is unique, in many ways all face similar problems and all are subject to great changes. That may well be why being an owner is so much fun and such a challenge. n
(Italicised material in this article is taken from The Five Stages of Small Business Growth by Neil C Churchill and Virginia L Lewis, Harvard Business Review May-June 1983 Copyright ©1983 by the President and Fellows of Harvard College; all rights reserved.)