Profitability & Growth
Further growth is a common, corporate focal point. It is often assumed that growing bigger will help to benefit an economy of scales and increasing operational profitability. It is also often assumed that business diversification can help reducing exposure to changes in market conditions, for any given, single line of business. Such assumptions lead companies to extend their clientele in existing lines and expanding into new ones. But down the road, it is often observed that such growth has not increased the firm’s profitability and that bigger size does not necessarily mean greater profit, or stability. An indeed, many companies managed to increase their profits by sloughing some of their customers and lines of business (a recommended read: Cameron, 1994).
In fact, growth exceeding a firm’s financial and managerial resources was found to be the most common source of organizational decline and crisis. Paradoxically, an existing competitive advantage led to overexpansion, which triggered deterioration. And as far as such deterioration stemmed from changes in market conditions, return to a firm’s profitable core-business was consistently found as an effective turnaround strategy. As such, Overexpansion is the first, strategic risk a given firm may want to consider.
Additional risks are related to the decision-making process, aiming at soughing customers, or lines of business, or specific products. One of them is the risk of making decisions based on inaccurate data, especially margin-related. Therefore, data used for such decisions must be carefully examined. Another one is the risk of losing competitive advantage as a result of such decisions. To reduce such a risk, companies are advised to simulate and consider the option of keeping given segments, or lines of business, despite their lower, or even negative contribution.
Lastly, there is that risk of higher cost per unit, following such changes. The final effect will depend on your cost structure. Specifically, how your both revenues and costs will change following such decisions. A given, proposed change may pay-off if associated costs are higher than associated revenues. Be careful, however, with such analyses and calculations, and pay specific attention to overheads being loaded before and after.
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