Monday, August 16, 2010

The Rationale Behind Fast Growth

2nd in a series on Strategic Growth

Last week we discussed some of the pitfalls in uncritically buying into the Silicon Valley growth mystique.  This is not to say one should not pursue fast growth!  But because of these challenges, it is important that entrepreneurs understand their reasons for pursuing it.  Some of the common ones:
  • Industry competitive dynamics require it
  • To gain 1st mover advantage
  • Industry is capital intensive
  • To make an impact
  • To create opportunities needed to attract and retain great people
  • To get rich quick
Let's examine each of these.

Industry Competitive Dynamics
There are two cases where the nature of the industry may require fast growth. The first is where inherent barriers to entry are low or difficult to develop.  The second is where technology change is frequent and rapid.

Internet social media is an example.  In many cases, the core ideas and business models are not readily protectable by patents, the viability of the business is heavily dependent on network effects, the technology is constantly changing and because of SaaS ("software as a service") and cloud computing, the cost of entry is low and getting cheaper by the minute.  As a result, it's a race to see who can aggregate the most users fastest and perhaps build brand name recognition or create other switching costs before the inevitable industry shakeout.  Once consolidation occurs, most industries end up being dominated by 2-4 large players with a myriad of smaller players.

So how do small players survive?  Are they doomed to mediocrity and eking out a profitless existence?  No.  Smaller players thrive by effective segmentation - providing a superior offering to a narrower niche and erecting effective barriers to entry.  Of course, their business models will be vastly different than the market share leaders.  (E.g, a niche social media company might be heavily reliant on subscriber revenue vs. Facebook's which can pursue and ad share model.)  The more effective the barriers to entry, the more likely the company will be able to sustain healthy margins and have the ability to control its own growth.

However, if you decide that you don't want to or can't pursue a niche strategy, then at least don't kid yourself that you're going to bootstrap your way to dominance.  You've just entered the Red Queen's Race, you will need institutional money, and you will need to grow fast.

1st Mover Advantage
This is often closely related to the above, but even if industry dynamics don't require fast growth, there is a belief that being first to market yields strategic advantage.

Unfortunately, the evidence for this belief is shaky.

In fact, a 1996 study by Gerard Tellis and Peter Golder indicates that being a fast follower may be a better path to industry leadership than being a first mover.  Well known cases of fast followers cited by blogger Don Dodge include Google (over Alta Vista), Internet Explorer (over Netscape), and Facebook (over Friendster) just to name a few.

Being first is not necessarily synonymous with becoming the market leader, nor is is a precondition for fast growth.

Industry is Capital Intensive
Highly capital intensive industries often force companies to pursue high growth.  The medical device industry is an example.  Because of the highly regulated nature of the FDA product development and approval process, it takes millions of dollars to get an innovative new medical device to market.  For a medical device startup, this typically means venture capital money is required.  In order to get this funding, it is necessary to pursue a growth rate commensurate with the returns required by the VC funds.

Increase Impact
Another argument for fast growth is the entrepreneurial motivation to make a big impact.  Think Elon Musk with Tesla and SpaceX.  But making an impact is often more about scope than speed.  Certainly SpaceX is going to take a long time to grow given the technological, political, and other challenges associated with developing commercial space flight.  If fast growth were required, this venture would be dead.  Scope is not analogous to fast growth.

Create Opportunities Needed to Attract and Retain Great People
Growth is definitely a plus in providing opportunities for the best and the brightest.  But in this case, its not a case of more is better, but rather finding an optimum.  Too little and people stagnate, get bored, or depart for greener pastures.  But too fast and people don't have the time to learn, make mistakes, and receive the training they need to master the skills needed to grow.  And while promotions can be rapid in a hypergrowth environment, too often you end up with the Peter Principle in action, the situation where people are promoted to their level of incompetence.  What is the optimum growth rate?  In my experience it seems to be revenue growth somewhere between 15-50% per year.

Get Rich Quick
While rarely spoken of openly, this is an underlying motivation for pursuing fast growth and it's a bad one.  It's not bad because it's immoral;  it's bad because it doesn't work.  Maybe I hang out with the wrong circle, but I have yet to meet a successful entrepreneur who got rich because that was their main objective.  The ones I know who did get struck by financial lightening got there because they first and foremost wanted to achieve something and make a mark but also believed that they should be rewarded for it.

Why?  Because people who just want to get rich tend to flit from one hot opportunity to another.  They tend not to have the patience or perseverance required to work through the knotty difficulties that every startup encounters.  When faced with a brick wall, they zoom off in another direction (not always the wrong thing to do) or even another venture.  They are prone to making short term compromises that undercut the creation of long term value. Creating value requires the ability to say "no" to the expedient at times.

On the other hand, I do know several successful entrepreneurs for whom financial wealth came almost as a surprise.  While they all had a burning  desire to create something unique or great, they had modest ambitions with respect to how quickly they wanted to get there and for their own personal wealth.  The funny thing is that it's for these people for whom the lightening sometimes strikes and it's not entirely an accident.  Next week, we'll examine some of the reasons that may be behind this.

Next week:  The Case for Controlled Growth

No comments:

Post a Comment

Post a Comment