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Is expansion on your horizon? Should it be?

November 9, 2011 by Dale Furtwengler — President, Furtwengler & Associates, P.C.

I was listening to a company's CEO/founder relate her company's rise to success, warts and all, when she stated that when they hit $3 million in revenue they had to buy additional equipment to handle the demand. Is that what you'd have done?

The vast majority of business people would, but I'd like to suggest that there is an alternative that makes more sense. Yes, I'm talking about raising prices.

Whenever a company reaches its capacity it should review its customer list. It'll inevitably find customers whose margins are very low and who are so demanding that it doesn't make sense to continue accepting their business.

If you're looking for a quick and easy way to identify these customers just ask your staff "Who are the most challenging customers with whom you deal?" They'll rattle off a list so quickly your head will spin. Here's what you'll find when you investigate these customers' history:

• They're high volume customers - otherwise why would you have tolerated their demands?
• Their margins are well below those of most of your customers, possibly even negative when you factor in how many resources are expended trying to satisfy them.
• They're regularly demanding that you do things that are outside your normal business activities, increasing the likelihood of errors and lost productivity.
• Late in paying because of all "the problems" they encounter.

Ouch! That stings doesn't it?

Now, let's imagine that the increased demand for your offerings is coming from people who really value what you have to offer. You've attracted them because you're the best, if not the only company that can do what you do. As a result they're paying higher prices than the customers identified above. What will that mean for you financially? You'll:

• Enjoy much higher margins when you replace troublesome customers with new customers.
• Eliminate the time and energy drains on your staff thereby increasing productivity and, in essence, adding capacity to your organization.
• Avoid having to make additional capital investments, which conserves cash.
• Avoid borrowing money for capital investments and weakening your balance sheet.
• Keep your infrastructure costs flat while raising margins, thus increasing profitability.

Given these options, expansion or customer replacement, which would you choose?

Surprisingly, more than a few of you will still opt for expansion. It's tough to forego bragging rights associated with a growing customer base, isn't it? The reality, though, is that somewhere in the not too distant future, you'll be complaining that running your business "isn't fun anymore." Why? Because those price buyers found a lower price somewhere else.

The problem becomes even more profound if you suddenly feel the desire to sell your business. Why?

• Your company's profits aren't what they could have been.
• Productivity (revenues per employee) is low compared to the industry.
• Free cash flow is marginal, if it exists at all.
• You have significant amounts of debt on the books.

As a buyer, how much would you pay for a business like that? Indeed, would you consider buying it at all given all the unraveling you'd have to do?

Don't live this nightmare. The next time you feel the need to expand:

• Review your customer list.
• Fire those who are most demanding and take you outside your organization's strengths.
• Replace those customers with your ideal customer and significantly higher prices than the old customers were paying.

It's a much more effective way to deal with growing demand.

About Dale Furtwengler

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