Where do you fall right now on the growth vs. profitability spectrum? Many CEOs will push growth at all costs. After all, high-growth companies are often dramatically more valuable than slower-growing companies in the same industry. However, if as revenue grows profit margins become negative, the CEO may be driving the company toward a death-by-growth experience.
On the other hand, focusing on profitability by limiting expenses can lead to stagnation. Whether you are focused on growth or profitability, you must know when and how to build each into the culture and operations of your company. Here are four steps to balance both.
Decide what the goal of your company is.
Is it to maximize revenue or hit a certain level of profitability? Or is it a bit of both? CEOs of different companies will have different answers to this question. For privately held companies that are supporting their owners, maximizing cash flow may be the overwhelming goal. If you are focused on growth and are operating at a loss, you should have a clear plan and potential timeline for heading into the black. Public companies will be focused on maximizing the share price, which often means trying to positively position the company in either growth or profit against others in the same industry.
Use the “Rule of 45.”
An experienced Wall Street banker once told me about his “Rule of 45.” He explained that for a company to achieve an exceptional valuation in the market, its annual growth rate plus its operating margin needed to exceed 45 percent. While this is just a rule of thumb, it is surprisingly valuable in thinking about balancing growth and profitability. At one extreme it means that if you grow at a rate north of 45 percent, you can break even or actually operate at a loss and still be rewarded in the market.
On the other end of the spectrum, if a company is not growing or is growing slowly, it needs an operating margin north of 45 percent to achieve a high valuation. High operating margins are very tough to obtain and even tougher to maintain over time. This is just one supporting point for the idea that companies cannot stagnate for very long and remain valuable or relevant.
Use the Rule of 45 as a simple way to benchmark your business against the best in the world. If you are striving for a certain growth rate, consider how that might affect your operating margin. If you are striving for a certain level of profitability, consider how that might affect your ability to grow.
Communicate the goals to everyone.
Regardless of the overall goal, it is your job to clarify the financial goals of the company and communicate them to every member of the team via quarterly plans, annual plans, and a three- to five-year plan. The purpose of these plans is to help the team understand the inevitable short and long-term tradeoffs between growth and profitability as well as how making those tradeoffs will move the company closer to its vision. Knowing the goals will help employees make more informed decisions in support of them.
Provide the proper resources.
If you want growth, you cannot limit expenses. You have to invest in new ideas, new products, and new resources in order to maximize productivity. But you must balance those investments against the long-term plan for eventual profit. If you want profitability, you will still need to provide resources to maximize productivity and maintain enough growth to ensure that the company is moving forward and staying relevant by adapting to the changing market.
The most valuable, successful business would have a high level of profitability while also growing very rapidly. Of course, achieving this combination is almost impossible, because high growth is a drag on profitability. Finding the right balance means leading your organization to success.