A topic that receives little attention – the concept of operating leverage (not financial leverage) and its relationship to strategy and forecasting. Operating leverage is the degree of fixed and variable costs in a growth company’s operating strategy. It matters depending on your market and growth expectations.
The Sustainable Growth Rate, as discussed in this podcast, is a ratio that suggests how much you can grow your sales next year based on maintaining your profit margin, profit retention, financial leverage and asset turnover ratios. Growth companies face the issue – how to finance and maintain their growth. The podcast discusses the ratio in greater detail.
Before going for financing, many growth organizations need to examine their operations to determine if there are ways to extract more cash from operations. This podcasts examines the topic:
Extracting Operating Cash Flow Podcast Link
Starting a series of podcasts on entrepreneurship, finance, and growth topics.
The State of Wisconsin ranks last of the 25 largest states in Startup Activity as measured by the Kaufmann Foundation for the second straight year. The alarm bells are being sounded, the criticism being directed, and other warning cries, for the second year in a row. Is this a worrisome situation or should the State of Wisconsin not be concerned?
First, before getting into criticism and potential solutions, let’s review the metrics as used by Kaufmann. The Foundation, out of Kansas City, was started by the late Ewing Kaufmann, founder of Marion Laboratories (It was ultimately sold to Merrill Dow in 1989) and owner of the Kansas City Royals, endowed the Kaufmann Foundation to research and participate in the field of entrepreneurship. The foundation is worth billions and is one of the largest and oldest foundations specifically focused on the study of entrepreneurship. It is a very serious organization.
The Foundation uses three key metrics in its measurement of Startup activity, 1) Rate of New Entrepreneurs, 2) Opportunity Share of New Entrepreneurs, and 3)Startup Density. Based on definitions provided by the Kaufmann website: Rate of New Entrepreneurs measures the # of Adults in an area that become entrepreneurs in a given time period; Opportunity of New Entrepreneurs measures the number of adult entrepreneurs who started a business NOT because of unemployment; and Startup Density is the # of firms less than one year old that have at least one employee. So, are these reliable measures of a region’s startup activity? Probably. However, the more important question is ‘should we care?’.
Whatever the study and measurement(s) used, it’s never good to be last two years in a row. So, yes, the state of Wisconsin should be concerned or at least be asking many questions. For instance, is it really that important about the # of firms started?
From a state perspective, do the number of startups relate to high-paying jobs or increasing wealth? If a company only has one or two companies like an Epic Healthcare software (generating upwards of 1,000 or more high paying jobs per year) and a several related consulting firms hiring hundreds of consultants, is this not a sign of economic success? Such developments wouldn’t show as a positive sign in the Kaufmann.
With that said, I’ll leave the discussion about the reliability and validity of the Kaufmann data to others. If we assume that being last two years in a row is not a good thing, what are potential causes and remedies for the situation? Successful ecosystems require an interrelationship of a variety of integrating variables to support the entrepreneurial environment.
Using the often-used Silicon Valley example, Professor Tom Byers, Professor in Management Science and Engineering and founder of the Stanford Technology Ventures Program, suggests that at five variables have been instrumental in Stanford’s successful ecosystem. They are: 1) A Market of Early Technology Adopters, 2) A talented, motivated and diverse labor pool, 3) A large services support structure (lawyers, accountants, etc. ) that allows outsourcing of many key services, 4) a Venture Capital industry that provides more than just financing, and 5) an entrepreneurial culture that exhibits openness, collaboration, and flat organization structures.
It may be valid to argue that using Silicon Valley as the model for a successful ecosystem may be problematic as there are so many significant differences between Wisconsin and the Bay Area. Yet, one can compare oneself to a benchmark to ascertain are their changes that can be made in the current Wisconsin environment to increase the number of startups. Tom Still, President, Wisconsin Technology Council and columnist for the Wisconsin State Journal suggested in a recent article (Wisconsin Startup Issues) that some of reasons for Wisconsin lagging in the national index were:
- We’re older than most states
- We have fewer immigrants than most states
- We’re more “inbred” than other states
- Most of us already have jobs
All are probably valid reasons. When comparing it to the variables mentioned by Byers of Stanford (above), the reasons cited by Still may not be going far enough. Do we have a technology oriented market in Wisconsin, both B-2-B or B-2-C? In other words, do they demand and seek the latest technology to adopt or do they take a ‘wait and see approach’?
Second, do we have the talent pool needed to develop a sizable tech ecosystem? When discussing talent pool, there are plenty of engineers, biologists, and other STEM related workers in Wisconsin generated by our University system but what about entrepreneurial managers? Business people with the experience of starting and scaling a company.
Finally, Wisconsin has a limited pool of venture capital in the State. There seems to be plenty of resources available at the One additional reason cited by many is the limited amount of risk capital available in the state, mainly in the form of venture capital from institutional investors and angels for seed and early stage financing. But, there is a limited number of venture firms located in Wisconsin providing growth financing for the tech firms (capital needed to expand, hire, etc as sales take off). One caveat that many investors will remind you of is that if there are good growth opportunities, the capital will find its way here. However, if they were more local based and possessed total capital in billions of dollars, it would be fun to see what impact could be.
A popular topic in entrepreneurship these days is the concept of ‘scaling’ or how to substantially grow your business. Many articles are being written about a the ‘hockey stick growth’ phase (Recent Forbes blog post). The hockey stick is an important phase that can elevate a firm or in many cases, destroy it, depending on how management handles the growth spurt. With that said, there are some important caveats to many of the hockey stick models that different writers address.
- The timing is hard to predict. In most models presented, it shows the scaling phase as pretty smooth and sequential. However, in real life the timing of when it occurs and how long it will last is very difficult to predict. We like to show that smooth S-curve growth rate but rarely does this happen.
- False Signals – as Geoffrey Moore presented in Crossing the Chasm, the market place may send false signals about if the hockey stick growth is really occurring. Moore noted that companies may get false impressions from the early adopters or tech enthusiast segments of the market as the early excitement after a new product or service is launched may not transfer to the middle majority.
- Hard to estimate the market or growth rates. Again, we tend to show a smooth S-curve growth rate when the hockey stick phase begins. On paper, it looks rather simple to examine the rate of change in the slope and measure the growth rate of the sales. However, in reality, they may be ‘fits and starts’ where exponential growth occurs for a month or so, slows down and picks up again.
- If the Hockey Stick is really happening. It will attract new attackers quickly. So what looks like a smooth path may change dramatically as competitors react and compete directly, usually dropping prices or some other steps to gain share.
Why is this important to understand? It’s important for entrepreneurs to be cautious when the hockey stick growth phase occurs. Depending on the type of product or service offered (for example, if it’s software program, scaling will be easier and less expensive), it’s key to remain lean and nimble ready to adapt as necessary. Usually, it’s best to outsource as much as possible to avoid the heavy fixed investment that’s needed to support the sales. You want to be in a position to unwind as quickly as you build up your infrastructure unless you realize that the growth is here to stay and greater infrastructure will be needed to support future products, etc.
In class this week on Entrepreneurial Management, we discussed what I believe is an important question for any startup and small business. Using Peter Drucker’s article in the Harvard Business Review as the foundation, we discussed how to get a small business to identify “The Theory of their Business”.
Drucker notes that most businesses, especially when performance is suffering, focus on new management techniques or what he calls ‘how to-do’ tools. In many cases, Drucker observes that the problem doesn’t lie in what the company is doing but more in what is happening outside the firm. Example after example can be provided where at one time a company is doing well leading their industry then in a short time, becomes an industry laggard. Nothing the firm is doing has changed but something in the outside environment has altered the conditions of the industry.
Drucker blames this on the business’ theory or the assumptions that the firm’s foundation was built on no longer fit reality. These assumptions may include markets, customers, competitors ( both their values and behavior), technology and the company’s strengths and weaknesses. In other words, the Business Model is not as relevant.
The way to deal with identifying if your business theory is relevant is for the leadership of the organization to re-look at its assumptions about the environment of the organization(society and its structure, the market, the customer, and technology), assumptions about the specific mission of the organization, and assumptions about the core competencies needed to accomplish the organization’s mission. This should be done on a continual basis to assure that reality is not drifting from the business. Additionally, the theory must be constantly tested and communicated throughout the organization.
While Drucker passed away several years ago, his writings still hold true. Constantly evaluate the theory of which your business is based upon and it will assist your firm in making sure its still relevant.