Removing Growth Constraints

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Overview

The need for and desirability of growth is taken as a given by most business leaders, and justifiably so. All things being equal, the ability of a company to foster and extend growth, and in particular profitable growth, is perhaps the most substantial contributor to value creation for many companies. Moreover, growth prospects also weigh heavily on the availability of financing and the ability to attract and retain talent.

The challenge for business leaders is that too often planning does not grapple with the need to not only take steps to foster growth but the frequent need to invest considerably in removing impediments to growth, whether they be immediate or impending.

Maximizing a company’s growth trajectory, and enjoying the resultant maximized value creation, requires both identifying an attractive market and value proposition nexus and working vigorously to remove impediments to growth. Those impediments can take many forms, but among the most common are:

Unit Economics. A company’s growth strategy must be in line with the fundamental nature of its business, and the absolute first step in that is to understand unit economics and the implications thereof. Unit economics refers to the price/profit/term characteristics of an individual unit of the goods or services that a company provides. A high fixed cost business with 80% gross margins will and should have a different go-to-market approach and different growth prospects than a company with modest fixed costs, high variable costs, and gross margins of 45%.

Scale or Niche. What type of business are you in, a scale business or a niche business? During the long boom that ended with the COVID-19 pandemic, a small number of companies attained stratospheric valuations as they were revealed to be capable of achieving high levels of growth over considerable periods of time; and as a result, the shareholders of these companies enjoyed stellar value creation. However, these companies, admirable as they are, do not reflect the circumstances of most small or mid-sized enterprises (SMEs). Rather, these noteworthy exceptions have tended to obscure a truism that was clearer to prior generations of business leaders: growth prospects flow from structure and some structures are inherently more supportive of growth than others.

Operational. Too often business leaders assume that constraints do not exist simply because they have not yet been reached. A manufacturing company running at 70% utilization is not capacity constrained in its production capability, but there is a level of sales as which it would be. The same holds true for nearly every type of business. Understanding operational constraints and how/when they will manifest themselves is crucial to ensuring that a company reaches its maximal growth potential.

Capital Availability. Growth is expensive. Companies seeking to execute a growth strategy must understand each of the above points while simultaneously remaining clear-eyed about the availability of capital and the terms on which that capital will be available. Is the goal that all growth be self-funded? Is the company willing to take on debt to support growth? Is the company willing to pursue equity financing to support growth? What are the terms that various capital providers will demand? What is the value that will be generated with or without this incremental capital?

Conclusion

The desirability of growth is taken as a given among business leaders, and for good reason. Unfortunately, constraints on growth vary considerably by company, even among companies in the same industry. When developing a growth strategy, it is vitally important that business leaders rigorously interrogate the growth constraints facing their company and chart a path for maximal growth that either acknowledges or minimizes those constraints (ideally both). Many promising companies have failed or fallen far short of their potential due to an unwillingness to engage with these key issues. A holistic approach, though more time consuming, is also far more likely to result in an extended growth trajectory and accompanying value creation.

About the Author

David Johnson is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to companies in transition. Over the course of a 25-year career, David has demonstrated a commitment to thought leadership, with multiple speaking engagements and articles to his credit on the topics of change management, business transformation, restructuring, turnaround, and value creation.

David can be reached at: david@abraxasgp.com.

 

 

Value Creation Traps

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Overview

One often misunderstood element of successful business transformation efforts is the importance of minimizing self-inflicted wounds. Toxic modes of thinking, unexamined assumptions, and decision-making processes that repeatedly fail to generate positive outcomes are all commonly found, in abundance, in underperforming organizations. As experienced change agents seek to implement and lead a successful business transformation, many select as their top priority reorienting the thinking of leadership, staff, and key stakeholders towards value creation.

Leaders of faltering organizations too often lapse into modes of thinking that are counter-productive at best and are worst are antithetical to value creation. I refer to these modes of thinking as value creation traps and consider highlighting and minimizing them to be a key element in any successful business transformation effort.

Value creation traps, in the form of modes of thinking, often fall into two main categories: errors of omission and errors of commission.

Errors of Omission

Failure to understand the problem. Too often, decision makers facing a crisis (and any company that embraces the need for a business transformation is implicitly acknowledging that it is a company in crisis) confuse symptoms (the “what”) with root causes (the “why”). A clear understanding of what the problem is makes subsequent efforts to address that problem much more likely to succeed. Conversely, absent a clear understanding of the problem, including its scope and severity, it is often difficult to win a mandate for an appropriately scaled business transformation.

Failure to make leadership team changes. Regardless of personal feelings, any company seeking to embark on a business transformation must embrace the reality that changes in the leadership team will likely be crucial for success. Leaders who have authored failed strategies are sometimes extremely reluctant to acknowledge their error, and the perception within a leadership team that there is a valid constituency for an in-progress business transformation effort to fail is toxic and value destructive in the extreme. Additionally, making changes in the leadership team sends a powerful signal to internal and external stakeholders and offers an opportunity to reset the dynamic at the highest levels of a company.

Failure to define success. For organizations that have struggled with underperformance for a period of years, success is an undiscovered country, and as such it is very often misunderstood. Managers who have endured years of insufficient budgets may believe that post-transformation, budgetary discipline will be relaxed, or that their own priorities will be met due to the increased availability of funds. It is vitally important for all key stakeholders to receive appropriate and consistent communication regarding what the goals of the business transformation are, what the timing and progress is, and what the end state is expected to look like. The effort to create a deeper sense of understanding of what success looks like will guard an organization against a sudden slump in morale when the goals of the business transformation have been reached but individuals feel that their key priorities have not been met.

Errors of Commission

Data agnostic decision-making. For companies that are laser focused on value creation, there are no “bad facts”; there are favorable and unfavorable facts, but even unfavorable facts can yield valuable learning opportunities. In a time of abundant data and a paucity of insight, a commitment to place gathering and analyzing data at the center of organizational decision making is a de facto commitment to value creation.

Slowing the rate of change. Business transformations, even wildly successful ones, can be traumatic for an organization. Staff are dismissed. Processes are upended. Long-standing practices are thrown into question and the internal politics of an organization are inevitably scrambled. And in the midst of this swirling change, leadership is busy reorienting the company to incentivize a set of behaviors and outcomes that had not been the focus before. The logic here is sound: a business transformation is essentially a sanctioned catch up period for an organization, and as such the scope of change will be broad and disorienting to many. But this is also a necessary element of a successful business transformation, as an organization seeks to make the leap from a status quo that is value destructive to one that is value accretive. The danger here is that, as business transformation efforts begin to bear fruit, the sense of urgency in an organization will lessen, and a de facto “slow down” constituency will begin to make itself heard. No organization can sustain a sprint indefinitely, but neither can an organization afford to cut short a period of rapid change aimed at meeting the value creation goals of a previously underperforming company.

Conclusion

Toxic and unexamined thinking creates value creation traps that collectively present the most formidable challenge for change agents. These value creation traps must be addressed both directly through a robust and disciplined communication strategy and indirectly by ensuring that business transformation efforts are successful in driving positive change that is perceptible to all key stakeholders.

About the Author

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies.  David is a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.

Value Creation in a Family Business

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Overview

Value creation is a challenge in any setting, but for those seeking to navigate a path to maximal value creation in a family business, the need for a nuanced, holistic understanding of the strengths and weaknesses of these organizations, and why these characteristics persist over time, is essential.

Family businesses have an outsized role in the U.S. economy, and yet they remain poorly understood by current and prospective stakeholders including advisors, capital providers, employees, professional managers, supply partners, and others. The root cause of this misunderstanding is the fact that for those who find themselves working with a family business, the experience presents a dizzying array of contradictions. A family business will often seem to have a preternatural ability to execute on the “hard” problems of managing a business. Frustratingly, this characteristic strength is typically offset by a stunning tendency to fall short on the “easy” issues of governance, strategy, succession planning and talent management, among other areas.

Successful value creation in a family business context, therefore, requires change agents to identify levers that will allow them to emphasize the strengths that these companies often possess while working to minimize the challenges with which many of them struggle.

Attributes of Success

McKinsey has identified five key attributes correlated with long-term family business success. These attributes, when carefully tended to, have been shown to be sources of considerable competitive advantage and drivers of long-term value creation. Understanding and marshalling these attributes offers a way forward in any planned business transformation. However, failure to address each of these attributes in a disciplined manner can lead to organizational chaos, strategic confusion, and a painful cycle of value destruction.

The five attributes are:

  1. Family. Ensuring the capture and dissemination of key informational aspects of a business is something that many leaders agonize over. Remarkably, family businesses often seem almost custom built to excel on this very issue, with many possessing a deep reservoir of business-critical knowledge spread across multiple employees (often not all family members).
  2. Ownership. Engaged ownership comfortable with their company’s leadership and enthusiastic about future opportunities can serve as a stabilizing influence in charting a strategic course for long-term value creation, neither overreacting to periods of market exuberance nor panicking during periods of market stress.
  3. Governance. Having a structure in place to ensure that the family has a mechanism for involvement in the business, particularly for those family members whose stage of life might suggest something less than full-time involvement, is critical.
  4. Wealth management. When family businesses take the time to address family member wealth management and planning needs upfront, they eliminate a potential source of stress. A clear set of expectations regarding family member wealth management needs, whether a scheduled capital return policy or a focus on generational liquidity events, can free up the time and attention of the family and leadership team of a family business to focus on execution of the strategy and fostering long-term value creation.
  5. Foundations. Not every family member will be interested in or well suited to an active roll in the family business, especially in later generations. The creation and support of family philanthropic efforts, many times in the form of a family foundation, can offer family members an alternative means of involvement that might be more in line with their interests.

Strengths of a Family Business

Outsiders underestimate the strengths of the family business model at their peril. There are structural advantages that these firms wield which combine to allow family businesses to thrive on a level of trust and a web of informal communication that should rightly be the envy of any company operating under a different structure. Family businesses are adept at managing for the long-term, maintaining and utilizing both formal and informal communication channels to foster decision making, and maintaining a coherent sense of corporate identity across generations.

For leaders seeking to chart a strategic course, change agents seeking to catalyze a business transformation, capital providers seeking value accretive partnership opportunities, and all other current and prospective stakeholders, understanding and fully exploiting these strengths is critical.

  • Long-term focus. Charlie Munger, co-chair of Berkshire Hathaway and long-time partner of famed investor Warren Buffet offers sage advice on the power of compounding: “the big money is not in the buying or selling, but in the waiting”. The family business model, with its inherent multi-generation outlook, is particularly well-suited to this approach, and as a result, family businesses can reap the incredible value creation rewards bestowed on investors willing and able to allow a compounding investment to continue compounding.

 

  • Clarity of purpose. Family businesses often exhibit a profound clarity of purpose, passed on in many cases from generation to generation. As a result, leaders of a family business often feel empowered chart a more conservative approach to value creation, featuring lower levels of leverage than their comparably sized peers. Family businesses may often not seize full advantage of growth opportunities, but they are also less inclined to value destructive transactions, with the result that many family businesses have demonstrated a structural ability to outperform businesses operating without family involvement.

Leading a business transformation requires identifying and catalyzing a virtuous cycle in a business. For a family business, the rough outline of a value accretive virtuous cycle would be as follows:

Long-term focus > Clarity of purpose > Compounding strategies > Conservative capital structures > Increased versatility > Fewer but higher ROI investments

Weaknesses of a Family Business

The weaknesses of a family business are in many respects the mirror image of their strengths, with patience, clarity and a disciplined approach giving way to complacency, risk aversion, and resistance to change.

  • Complacency. The extreme value creation potential of uninterrupted compounding turns from a blessing to a curse when the sign changes. Too often, family businesses are slow to acknowledge negative trends and act decisively to address them, leading to an unnecessarily severe level of value destruction before corrective action is taken.

 

  • Risk Aversion. When the traditional conservative bent of a family business shifts to risk aversion, promising opportunities are disregarded, and de facto risk appetite can fall to zero, leading companies to unnecessarily cede opportunities to their competitors.

Transformational leaders should be on the lookout for signs of the typical value destructive vicious cycle for a family business:

Complacency > Inward focus > Risk aversion > Resistance to change

 

Conclusion

A necessary condition of successful value creation in a family business is an understanding of the unique strengths and weaknesses of this ownership structure and a sense of how these strengths can be leveraged and weaknesses mitigated in support of the goal of maximal value creation. When this condition is met, the stage is set for a compelling long-term value creation opportunity, to the benefit of the family and other key stakeholders of the business.

About the Author

David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies.  David is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation.  He can be contacted at: david@abraxasgp.com.