Why small companies don’t grow into big companies

Most small businesses do not grow into large businesses, in spite of (i) dynamic business heads, (ii) delivering value very competently to customers and (iii) earning reasonable profits. Why?

I have seen a variety of recurring reasons, so here they are. This is not an exhaustive list. Some of these reasons hit companies started by techie entrepreneurs. Others hit even businesses started by traditional and experienced businessmen from business communities.

How much of this is India-specific? Frankly, I don’t know. I suspect about half of these points would either be less relevant to non-Indian entrepreneurs, or would be presented very differently in such contexts.

Build cash reserves

You cannot grow your business without cash reserves. This is Step Zero of any growth plan. I have seen case after case of growth plans executing half-heartedly because the plan needs a larger budget than the company’s available reserves. Result: the plan is executed too slowly or too badly, and growth does not happen.

Growth requires investment in the things which will push up your revenues. This could be plants and machinery, or paying salaries of additional people, or increasing your ad spend. So, you need additional cash till your growth initiative converts into higher self-sustaining profits.

Most companies are not lucky enough to be subsidiaries of big, cash-rich business houses; they need to generate their own cash. Banks, as the joke goes, want to lend only to those companies which don’t need the cash. Debt is hard to come by for small businesses. In that scenario, cash accruals from income are the only way to build reserves.

A business without easy access to capital must save a part of its income every month. Note that I said “income”, not “profits”. If it means you need to delay on some payments in order to save your monthly quota of savings, delay them. When income comes in, you must set aside your savings first, and then start paying bills. A fanatical adherence to this practice is particularly important for small businesses which have a roller-coaster cash flow. If you have a small cash loss in some months, just live with the loss but do not slacken your savings. If your business earned USD 100,000 last month and expenses were USD 102,000, then save your usual percentage (let’s say, 5%) even in that month, thus removing an additional USD 5,000 from your cash flow. This means that your cash deficit for that month goes up from USD 5,000 to USD 7,000. Live with it. If a deficit of USD 5,000 wouldn’t kill you, then neither will USD 7,000.

This fiscal discipline is something which the traditional Indian business communities are absolutely brilliant at. They track earnings, cash reserves, receivables and accruals so methodically that computers feel embarrassed. They have learned this over generations of running businesses. It is hard learning for first-generation entrepreneurs.

I know some small-business heads who are so methodical and cold-blooded about their savings that they actually take short-term loans during bad months to keep their savings routine intact. This flies totally in the face of the young know-it-all MBA’s thinking, because the savings interest rate is always lower than the loan interest rate, thus giving the business a net loss in its attempt to save for that month. But the seasoned businessman has learned that the discipline of saving every month is more important than the occasional negative interest rate spread. I admire them. Large enterprises with a hundred people working in their Accounts Departments can afford to fine-tune interest rate spreads and manage cash flow intelligently. An entrepreneur-driven small business must save fanatically every month.

Where should you invest the savings? I am not an investment expert, but I suggest any channel which gives you:

  • Liquidity: you will want guaranteed encashment within six months from the date on which you decide to pull your money out. This often rules out real estate.
  • Low risk: the value should not drop heavily without warning. Debt instruments are preferred; equity investments should be heavily diversified and in less risky scrips.

Those who understand investments better will have other views.

One usually looks at the following three parameters to gauge the health of one’s businesses:

  • Revenues: How are the current top lines and bottom lines?
  • Profitability: What percentage of top-line is the bottom-line?
  • Growth: How much have these figures grown over time?

I now add one more item to this dashboard: free cash reserves. What are your cash reserves, and how have they grown over time? I treat cash reserves as a number independent of your overall balance sheet. The balance sheet is confusing because it contains loans, sundry debtors, sundry creditors, delayed receivables, immovable assets, plant and machinery, and so on and so forth. I want to keep aside all these other line items and focus on just one: free cash reserves. If this is not healthy, your growth plans become very difficult to execute.

Replicable processes and skills

A scalable business is one where most contracts are similar. If you are breaking new ground and solving new problems with each contract, it is unlikely that your business will scale. This problem hits techie entrepreneurs every day — they revel in the complexity of the solutions they deliver. It rarely hits traditional businessmen from business communities.

Many technically brilliant small organisations are caught in this trap. Their size is too small for their risk-averse large clients to entrust the bulk of their business to them. Therefore, they get business from

  • smaller clients, who give smaller contracts, or
  • larger clients, who give them complex one-off projects which involve solving unusual problems which cannot be tackled by their usual vendors

In the former case, the overheads of managing each contract and delivering service eat up the margins. In the latter case, there is no scalability — each project is unique and the learning from one project cannot be rapidly taught to the entire team to help them deliver five or fifteen similar projects. When we get a technically challenging project from a large client, we often feel thrilled because (i) a large enterprise client who could have their pick of vendors has chosen us, and (ii) the project is too difficult for our larger competitors to tackle, thus proving our technical superiority. But in reality, we should probably keep away from such projects, or accept them in carefully calibrated small doses, if we want to grow our business. (I have been guilty of this mistake in my business for several years.)

The term “boutique business” does not refer to small size alone. It refers to a business which operates in this “boutique mode”, where each solution is hand-crafted, new and different. This sort of business is the best for techies to work in, because they see variety and grow rapidly as professionals. But the business does not scale.

The opposite type of example is any business which delivers cookie-cutter solutions, like body shopping (for long the staple of the larger players in the Indian IT industry) or selling burgers from a fixed menu. With good management and tight control of costs, such businesses can grow well.

There must be scope and a roadmap for growth

There is only so much that you can grow organically, by just continuing what you did last year and the year before that. Unless you innovate on your go-to-market strategy, the scope for growth is often limited. This problem hits techie entrepreneurs quite commonly, specially those in the SaaS business. There is a silly belief among a lot of SaaS entrepreneurs that if you set up a SaaS service, customers will come. Traditional businessmen too encounter this roadblock occasionally; they have old-world beliefs about unconscious and organic growth sometimes.

I remember one excellent SaaS-based project management service, started by a small team of talented young people. Their technology was excellent, their service’s UX and UI were very good, their customer service was smooth. They were advertising on Google Adwords.

But a few years after launch, they had 700 subscribers at the time when I met them. They were charging USD 25 per customer account per month. Their total annual revenue (at current exchange rates) was INR 1.4 crores (USD 200,000 or so). I don’t know whether anything was left over after paying salaries and expenses.

Even if, in their optimism, they hoped to grow incrementally to ten times this size in a matter of a few years, they would still remain small by any standards — USD 2m/year.

Their value proposition was relevant, quality was excellent. The challenge was to grow the business by at least 100x, maybe 500x, not 10x, in a reasonably short span of time — say, 3 years. This would require non-linear thinking. It would require one or more of:

  • extending their service such that they could increase their ticket size from USD 25/mo to maybe USD 100/mo (hard to imagine how, and that’s just 4x of growth even if they succeed)
  • strategic partnerships with complementary businesses which can drive more customers to their business
  • sharp increase in ad spend, assuming customer acquisition rates increase linearly with ad spend increase
  • white-labelling their service with some larger portal (that’s one kind of strategic partnership, really)
  • anything else which will break out of the expectation of linear and organic growth

As entrepreneurs, we often underestimate how much innovation is needed in go-to-market strategies. SaaS services are realising this all over the world today, when they see that it is easy to create a business of a certain (small) size by plucking the low-hanging fruit, but very difficult to grow beyond it.

Proceed to Part 2