“If your business isn’t growing, it’s dying.” I’ve been saying that for over 40 years. The thing is, it isn’t true — not anymore. Simply put, growth for growth’s sake is outmoded. In fact, we’re starting to see that it never really worked.
The pandemic brought a valuable lesson to anyone paying close attention: scalability is the key to a successful business.
Owners can’t judge their business growth by revenue alone, because not all revenue is profitable.
Not all growth is good, and not all revenue is growth.
The Ponzi Schemes We Play
All too often, businesses play into a Ponzi scheme they create for themselves. What do I mean by this?
Say a business hires more people to make a busy month — say March — even more profitable.
But July is a slow month, and the company still has to pay those new employees in the slow months.
The business lowers the price during the slow season so they attract more customers and bring in more revenue.
Of course, by lowering price, they reduce their profit for the whole year.
What happens when you learn to live with lower and lower profits?
In 1995, the average net profit in our industry was around 15% to 20%. By 2006, it was down to 8%. In 2019, it was 3%. Year after year, people are ratcheting up their business in busy months to add 20% more revenue, so they can withstand the slow months. They’re paying for the losses of the slow months with the profit of future busy months.
In doing this, businesses are lowering their overall profit as a percentage of their revenue. In other words, many businesses willingly, and quite possibly blindly, reduce their net profit on purpose!
And when something comes in to upset the expected profit from the busy months — like, say, a pandemic — the whole house of cards comes tumbling down.
This is a version of a Ponzi scheme you need to recognize and avoid.
The way to avoid the above scenario is scalability. Scalability is the ability to operate profitably at ANY level of business.
Scalability allows you to deal with the fluidity brought on by challenges like the pandemic and still make a reliable profit.
The premise is that 100% of your overhead should be dedicated to the acquisition of business and the planning of execution. Acquisition and planning make up 100% of your overhead, and execution makes up none of it. This is the ideal scalable model. (Perfect scalability is almost impossible, but more scalability is always a good goal.)
In this scenario, it doesn’t matter what cycle the business is in, fast or slow. You’ll make a profit regardless. By implementing scalability, the same team that runs a $2M company can conceivably run a $20M company. They just have to procure more supply chain.
There are three core concepts in the scalability model: procurement, utilization, and gross profit per employee.
To develop and maintain a scalable business, you need to realize that outsourcing is your friend.
When business starts moving fast, you procure more help from freelancers, subcontractors, and part-time workers. When things slow down, you release them back into the workforce pool. You dial everything back to the acquisition and planning of business, and anything else is surplus.
Where you used to outsource 10% of a job, maybe now you have to source 90%.
When most of your execution is outsourced, procurement becomes your most valuable skill. Your role becomes the procurement of outsourcing, and you become a procurement professional.
Sales and procurement must work together to achieve a gross profit. For example, sales has to provide the raw data on cost so you can sell at the right price. And when sales sells something, procurement has to work with the cost basis to make sure you make a margin in the delivery process.
Procurement buys at cost. Sales sell at margin.
You’re always going to have assets (in equipment, intellectual property, project management skills, etc.). The challenge is how well you use them.
For example, the project manager who can manage 20 projects for $1M is more efficient than the project manager who can only handle one project at $500,000.
The key to utilization is process. It’s redefining processes to make sure every contributor can work at their highest level of contribution.
Gross Profit per Employee (ROI on Overhead)
After accounting for the building you’re using, inventory, and payroll, how much gross profit can you generate for the expense? That’s the question.
Before the pandemic, more business meant hiring more employees. Overhead increased along with revenue, meaning gross profit didn’t rise at the same rate as the acquisition of new business. But that was the old model.
Once the scalability model is in place, you can handle more projects with the same team. They can operate a $10M company or a $7B company, and gross profit increases accordingly.
This boosts team morale because they understand that they’re needed and appreciated. Motivated teams are more efficient and productive.
That’s the beauty and the power of scalability. The new normal is that if you embrace scalability and develop the supply chain, there’s really no limit to how much business you can operate with the same team.
To repeat: scalability is the ability to operate profitably at any level of business.
Scalability in Action
A client sent me their September P&L statement compared to their August results. Their busier month didn’t yield more profit, so I knew something was wrong.
I did a simple comparison of the amount of labor revenue versus labor costs in the two months, and I found a huge accounting error. (Big variances are often in labor, so always check there first.)
The client quickly found they’d done some accruals incorrectly. When they corrected the mistake, the numbers all fell back into line, and they saw they’d had another great month.
I was able to point out this discrepancy because I knew this company was already scalable. Two years ago, this variance might have been met with a shrug and the error not uncovered.
That’s the beauty of the scalable model. When overhead is low and fixed, and you always buy at a profitable level, you’re always going to make money. If for some reason it looks like you didn’t, go back and figure out where your math went wrong.
The key in all this is in keeping the margin gap between cost and income. That’s the partnership between sales and procurement. Set the right prices, keep your costs low, and scale up as much as you’re able while maintaining a great profit.
If your business isn’t scalable, you’re subject to the slings and arrows of a wildly fluctuating marketplace. These days, success isn’t so much about growth; it’s about scalability.
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