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05/01/2012

Scott Tibbitts: Surviving Famine to Feast

To manage high growth, question your instincts

Scott Tibbitts, former CEO for manufacturing firm Starsys, shares his insight on why too much revenue growth can be detrimental to long-term success. Tibbitts was the keynote speaker at NAHAD’s recent convention in Las Vegas.

This article was originally published by Modern Distribution Management.

Things are looking up for many distributors and manufacturers. The latest Institute for Supply Management Manufacturing Report On Business reported that 15 of 18 manufacturing industries experienced growth in March. And earnings reports from many manufacturers and distributors highlight double-digit sales increases.

I experienced this firsthand on a recent visit to a high-tech manufacturing firm in Colorado. The CEO shared that he was expecting a 20 percent annual sales increase as new markets emerged. Their downturn had passed, and the sales pendulum was swinging back hard. His countenance was a familiar blend of excitement and trepidation. I pictured big wave surfer Laird Hamilton dropping into a 75-footer at the Jaws surf break off Maui: “This is incredible!” quickly followed by “Holy smokes, what have I done?”

In business, this type of worry is well-founded. Of the 10 top reasons for small business failure noted by Jay Boltz of The New York Times, five are directly related to challenges from rapid growth, something we at Starsys became more familiar with than we would have liked.

Back in 1995, we were stuck at $6 million in revenues, hungry for growth, and for a couple years had not been able to solve the puzzle of taking our company to $10 million. Our leadership team was benchmarking other high-tech companies in Colorado to see how they were handling their particular growth challenges.

While touring a company that manufactured airbag explosive initiators – in many ways a very similar technology to the paraffin actuators that we provided for spacecraft – I asked the COO what their biggest challenge had been over the past five years. He stopped, put some thought into the answer and turned with a half-smile: “Growth pretty near killed us. For years we had been waiting for airbags to become mandatory in the U.S. When it finally happened, we had positioned ourselves perfectly to be the go-to company. The success almost ended the company. We had an alligator appetite and a field-mouse digestion.”

For a company that was starving for revenue growth the irony was hard to miss. I remember at the time dismissing the comment as irrelevant to our company; it was a problem we would have loved to have. He was trying to explain to a man crossing the desert that it was possible to die from drinking too much water. My subconscious whispered “Pay attention to this, it is wise counsel.” I told it to hush.

We figured out our revenue puzzle two years later when we acquired a spacecraft motor company that was the perfect technology match. Our customers had wanted us to provide more than just wax actuators, and now we were able to provide motors, robotics and mechanisms.

In six months we went from downtrending sales to 50 percent annual growth that continued for four years. The first two years were a heady ride: We were the go-to company that had the right technology and talent. We were asked to develop a docking system between spacecraft: “Yes!” Then a deployable structure the length of a football field. “Can do!” Then a winch to lower a spacecraft to the Martian surface. “Absolutely!” The contracts were now $2.5 million instead of $250,000. The operating capital needs from the growth were tremendous, but our bank was willing to extend credit given our 10 years of profitable performance.

In retrospect, we had the capability to execute any of these programs successfully, but all at once was another thing altogether. By the third year, the strain of growth was tangible. Program costs expanded and our profitability was gone. In the fourth year the bank said “About that loan...”

Growth is what we dream of as business leaders. It’s about size, but even more so it’s about the derivative, the rate of growth. The company that is growing fastest is de facto the most successful.

Growth provides great reward; growth can also hurt and kill. I’m not talking about the polite, 5 percent organic growth with which our business learning can keep up. I’m talking about sudden, in your face, 20 percent or more annual growth that will challenge every business system, especially for high-touch businesses such as distribution.

The challenges of aggressive growth are hard to fully grasp until you are in the middle of them. We learned much in those five years as we survived the tsunami. If I bundled the million-dollar lessons we learned into a single mantra it might be this:

Question your entrepreneurial instincts.

Instinct: To capitalize growth, take full advantage of low-cost bank financing.

Some businesses generate cash as they grow, restaurants for instance, where money comes in before it goes out. You are not one of these. You are going to need additional operating capital to grow, and more than you think because your systems are about to become less efficient. Project your growth cash needs and multiply by 1.5. Now you are getting close.

We projected we were going to need about $3 million additional growth capital, and we had two options: a Japanese strategic partner that offered to purchase $3 million in stock or a bank that was willing to increase our credit by $3 million at 6 percent interest. Being in the middle of 50 percent revenue growth rate, the equity offer seemed expensive money; we would be giving them a 50 percent return on their investment compared to 6 percent a year from the bank. It seemed obvious to go with the bank. What could possibly go wrong?

In the end, we discovered how truly unforgiving bank financing can be. As our growth impacted profitability, profitability affected loan covenants. Despite being able to fully cash-flow the loan, when our debt-to-equity ratio increased, the bank quickly ended up on the other side of the table. Their concern for supporting us through our growth was replaced by the need to limit their risk. Bank financing is cheap for one reason: When the going gets tough, they have the ability to get their money back.

Reality: Capitalize growth by sharing equity with the right strategic partner.

In contrast, with the Japanese equity partner, when the going got tough they would have been on our side of the table, working with us through the rough water. As we succeeded and needed more growth capital, the relationship and trust would have already been in place.

More importantly, as a strategic partner, they would have ensured our dominance in the Japanese aerospace market. We would have had a slightly smaller slice of a much bigger pie, with the additional strategic advantages far outweighing the dilution.

The substantial risks associated with bank financing should be carefully vetted before biting into that apple. Take a close look at the covenants as a pessimist and you will pale. Instead, find a partner with deep pockets, strategic advantages and a commitment to your success.

Instinct: Take Advantage of Every Opportunity to Increase Revenues.

Revenue growth was like a siren’s call. The value of our company was directly related to revenues, and even if margins were lessening, our overall earnings were up. And let’s not forget the accolades from being at the helm of a company growing like the wind.

We were not good at saying no. Every opportunity became a must-win as we opened up new markets and customers. We believed we could hire into the problem: Put out a cattle call and choose the best of the bunch to join the team. And on top of it all, we had the financing to make it all happen. It is not too much of an exaggeration to say our approach to new business was “if we can get the business, let’s get the business.”

When demand for our business increased, the question we asked ourselves was: “Can we get this work?” We should have been asking: “Why would we take on this work?”

Reality: When You Are In Demand, Get Picky.

Revenue growth that outstrips your business systems threatens your business. Significant new business warrants scrutiny to ensure the substantial risks are worth the potential rewards.

Get Picky. When your business is in demand, you have a golden opportunity to take those chips and use them to be better, not just bigger. It allows you the luxury of saying no to new business that isn’t properly valued, is risky, or is just too far from your wheelhouse. Let your competition wrestle with how they are going to make money from those contracts.

Establish a growth ceiling. Conservatively determine a growth rate that you can finance, that you can hire properly into, that will not outstrip your systems – and stick to it. Southwest Airlines refused to enter a new city until they knew it would be a home run. Cities begged for them to open hubs, throwing incentives at them, and they would say “not quite yet.” Competing airlines dreaded when they would finally say “yes.” You may fail at staying under this ceiling, but at least you will go kicking and screaming and will have put the right disciplines in play.

Choose a profit margin floor. Your instincts are telling you to risk profit margin to win new business. Don’t. Here is a contrarian challenge for those of you in demand: Commit to take on growth revenue only if it betters your profit margin, not just gross profit. Manage your company so that it has multiple year double-digit growth AND a profit margin increase and you will rule your world.

Get picky about who you hire. Your instincts will be saying hire as quickly as you can. Resist the urge. When you need to grow quickly is exactly when you need to up your hiring standards. Your resources are likely already strained – which is why you need more people in the first place – and you won’t be able to train them properly before throwing them into the battle.

Set your standards high. Hunt for the right talent that can succeed with limited direction. Don’t settle for the best of the bunch. If they don’t get over the bar, go back to the well until you find the ones that do.

Ask the “Get Better” questions before taking on new work: Your instinct is to ask the Get Bigger question: “Can we capture this business?” The Get Better questions are more powerful.

Ask how this new business will:

  • Make us more profitable
  • Be able to be executed within our existing people and systems
  • Help our cash situation
  • Decrease risk in our business
  • Improve our efficiencies

Sudden revenue growth is like being called up to the Majors in baseball. There is nothing like the rush of recognizing that the hard work is about to pay off in spades. The commitment, the positioning, the market development, the ability to make it through the drought are all about to be rewarded.

But … be careful of what you’ve wished for. Revenue hunger is the engine the drives business. It is a powerful force that brings out the very best in us, but when you finally do crack the nut and solve your own revenue puzzle, question your instincts. When you’ve finally crossed your desert and are faced with a banquet table, it can be best to skip the gooey buns and go for the granola.

Scott Tibbitts is the founder and former CEO of Starsys Research and a nationally recognized speaker on entrepreneurship and legendary corporate cultures. Scott is the co-founder of eSpace: The Center for Space Entrepreneurship, the only congressionally funded aerospace incubator, and is currently working with telecom providers to deploy an invention that prevents texting while driving.

Connect with Scott at scotttibbitts.tumbler.com or on Twitter @scotttibbitts.


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