I Jonathan Levie and Michael Hay explain why so few young companies enjoy significant growth and offer some solutions.
Every year tens of thousands of new enterprises are founded. Very few of these grow significantly; yet those that do contribute disproportionately to exports, employment and growth of the economy. Why do so few young companies grow in a meaningful way, and what can be done about it?
The dilemmas of growth Entrepreneurs are regularly faced with dilemmas of growth. Consider the case of a young business with one successful, though increasingly, uncompetitive product. New product development costs money and since young companies usually have little in the way of retained earnings, outside equity is often the option.
The requirement to generate a return for the new shareholders almost certainly means the company must grow in size and scope. Should the entrepreneur accept a dilution of ownership in return for the funds?
Let us assume our company successfully develops its second major product. Later, it wins a large order from a multinational. The order represents 50 per cent of its annual capacity, which is already 80 per cent filled. Should the entrepreneur accept the order?
This may not be an easy decision. Further outside finance may be needed to fund the necessary expansion in fixed and current assets (in this case, debt may be an option). In addition, the increase in size of the organisation may require the entrepreneur to change the way the business is run, effectively reducing his or her direct control of day-to-day operations.
The issues that created dilemmas of growth for our hypothetical entrepreneur were intense competition and static markets, increased organisational complexity and greater reliance on external resource providers. According to survey research conducted at London Business School*, most owner/managers resolve these issues by treating them as barriers to growth rather than as agents for change.
We compared the results of three UK-wide surveys of small and medium-sized private companies conducted in 1992, 1994 and 1995 and found that perceptions of barriers to growth changed little with the economic cycle. The most commonly cited significant external barrier to growth was a market characterised by intense competition and lack of growth. Relatively few respondents included lack of access to finance, labour or equipment as big barriers.
Two main internal barriers to growth recurred in all three surveys: management capability to handle growth and owner/managers' reluctance to cede perceived control in return for growth finance (either equity or debt).
A common strategy for living with these perceived barriers is to identify and hold some small protected market niche and practise financial and managerial self-sufficiency. However, low barriers to entry to the industry (in printing, for example) or market or technological instability (in software, for example) reduces the feasibility of such a strategy.
If management is unable or unwilling to grow out of its present strategic position of weakness, then competition will intensify as more capable (or simply more resource-rich) competitors enter its domain.
Respondents in the survey may not have fully appreciated this link between internal and external barriers. Those who from low-growth businesses. Yet when asked to weight the relative importance of internal versus external barriers to growth, respondents tended to give greater weight to the external barriers.
The control barrier
In our view, the first barrier to be overcome is the control barrier. This is the perception that to gain the resources needed for the organisation to grow and thereby survive the entrepreneur must surrender control of the company "" to new shareholders, to bankers and to others in the organisation.
Many owner/managers refuse to grow their companies because they associate growth with loss of control. We argue that this association is based on an inappropriate model of management and that if this is recognised focus can then shift to the more real barrier of management capability for growth.
Our main point is that by thinking in terms of control "" rather than use "" of assets, the entrepreneur is using old models of capitalism that equate ownership with control and old models of administrative thinking that see control as the only form of management.
Research in the US has shown that high-growth companies make greater use of external resources than low-growth companies. In other words, the agenda of management in high-growth businesses is not control or ownership but use of assets.
This conceptual difference is not just about renting rather than owning. It is fundamentally about how to manage assets.
Recent research in the US reveals that chief executives of higher-growth companies put greater emphasis on developing an organisational culture that motivates employees and on creating and communicating a vision for the organisation's future. This motivation and communication is transmitted both within the business and to the owners of external resources. Successful motivation and communication by chief executives (as measured by their staff) was associated with higher sales and higher returns on investment.
The research found, however, that during rapid growth, these important behaviours often came under intense pressure and profitability declined. One of the main reasons may well be that chief executives were just too busy fire fighting at operational level or immersed in the new challenges that growth brings (such as communicating with new stakeholders) to fulfil the crucial role of motivator and communicator to the organisation and its other resource providers.
Inside the organisation
Let us describe what growth is like for unprepared organisations. A frequent complaint of both entrepreneurs and of their staff is that the culture of the company becomes colder as the organisation grows.
As one Danish entrepreneur put it, the culture of the very young company is like that of the family kitchen "" warm, intimate, where problems are shared and solutions sought informally, and where there is a clear sense of togetherness. Then, as more and more strangers enter and the kitchen expands to accommodate them, it becomes more of an impersonal institution. The entrepreneur complains that he or she does not know everyone's name any more. Staff who were there from the early days complain that relations with the entrepreneur are not what they were.
This estrangement results in misunderstandings, resentment and jealousy of the "9-to-5" newcomers and of the staff appointees who have privileged access to the entrepreneur. Employee comments on the entrepreneur such as "he's changed", "she is more remote", "he only cares about making money now" are typical.
As relationships become more distant, performance measurement becomes more formal. Long-serving employees get passed over for promotion and personnel problems fester. The threat of unionisation looms. The entrepreneur cannot understand the change in atmosphere in the organisation and looks back wistfully on the kitchen culture of yesterday.
These problems stem from a failure to communicate the changes that are taking place in the organisation "" and in the role of the entrepreneur. Frequently, rapid growth means the entrepreneur will be devoting more time to managing external resources, such as large foreign customers, merchant banks, corporate shareholders, the media and the stock market.
This tends to take up much more of entrepreneurs time "" away from the company "" than they expected. All their staff see of this is that they are not available in the way they used to be.
To make matters worse, the entrepreneurs former colleagues are now supposed to report to new functional managers, often recruited from larger organisations. These new managers tend to change the information flows inside the organisation from a web to multiple vertical funnels because this is how they were trained. Large-company systems and structures, however, may actually impede growth in a smaller organisation, whose strength comes from the rapid and focused combination of cross-functional skills.
Faced with this scenario, it is no wonder that so many owner/managers of young businesses are reluctant to grow. Is there an alternative to this unhappy path of corporate evolution? The answer is yes.
Agents for change
First, the entrepreneur has to be conscious of his or her critical role as principal communicator of the changes that are going to take place, both in the company and in the role of the entrepreneur within it. Organisations undergoing change need a strong figurehead. Research shows that the chief executives efforts on this dimension are critical.
Second, one structural solution, used successfully by many successful entrepreneurial organisations, is to replicate, rather than replace, the old kitchen culture. This can be done by superimposing on the emerging functional structure, a mosaic of project-focused, inter-functional teams. Canny entrepreneurs bring advisers, customers and suppliers in as team members where appropriate. These teams are formed in response to specific needs and disbanded when the project is complete.
Team leader
The entrepreneur's role in team management, as with the original team he or she brought together in the kitchen, garage or rented premises, is to recruit, motivate, envision, resource and reward the teams.
Conceptually, the multiple teams can be managed in the same way as the first team. (For example, reward systems still need to be based on collective results. In many start-ups, the entrepreneur will share some equity with the initial team.)
Significantly, our 1995 survey results suggested that businesses with employee share ownership schemes tended to have faster growth over the previous five-year period than companies with other incentives, such as performance or profit-related pay. There is one important difference, however, between then and now. This time, the entrepreneur will not be able to lead the team because there is not one team but many.
The transition from team leader to leader of teams can be extremely difficult for an entrepreneur, who became successful by doing not by getting things done through others. Some entrepreneurs eventually realise that they are just not enjoying the new role and sell out or bring in outside management.
Research suggests, however, that bringing in new management is not necessarily the solution. The solution is to match the form of management to the phase of evolution of the organisation. A young company undergoing rapid growth still needs entrepreneurial management. The role of the entrepreneur in a rapidly growing young business, however, is subtly different from that of the entrepreneur at start-up, as we have attempted to show.
External resource providers
The fear of loss of control to people inside the organisation is an innate fear of entrepreneurs. Much more explicit is the fear of loss of control to outsiders, particularly financial resource providers such as bankers, venture capitalists and private equity investors (business angels).
This fear is valid but only if the relationship with these resource providers is poorly developed. Failure to build and maintain close relationships of trust and mutual benefit with resource providers can result in loaded legal agreements, persistent demands for time-consuming but trivial data and unexpected withdrawal of resources just when they are most needed.
As with relationships inside the company, this is a communication issue. We have seen examples where a history of good communications maintained share prices during profit downturns, kept a bank manager calm as the company teetered on the brink of insolvency and maintained the loyalty of customers during a product quality crisis.
Of course, some resource providers may not respond to the need of the young organisation for long-term relationships of trust and mutual benefit. The path of growth is not smooth, and the entrepreneur will, at some stage, need to rely on those external resource providers to keep their nerve. If a relationship does not look as it will withstand difficult times, it is best to seek out a new partner. After all, resource providers should be agents for change not barriers to growth. n
*Hay, M and Khamshad, K (1994). Small Firm Growth: Intentions, Implementation and Impediments. Business Strategy Review 5(3): 49-68. The Quest For Growth: A Survey of UK Private Companies. London Business School/ Binder Hamlyn, 1994. The 1996 Pulse Survey: Survival of the Fittest. London Business School/ Arthur Andersen/Binder Hamlyn, 1996. (Free copies of a summary of this report are available from Arthur Andersen - please call Lorraine Hilder on +44 171 489 6075)
