Top Line Growth Can Be Dangerous

Abstract: Managers have a strong preference for growing the top line. They mistakenly assume revenue growth will automatically improve profitability. The reason for this propensity probably lies in the emphasis on economics, win-lose rationality and growth. Experience and self-interest – salaries are better in large firms – form a potent mix. The drive for sales growth unmindful of competitiveness is risky and often leads to unhappy consequences. Great companies like Asian Paints (India) and Sigma Aldrich (USA) concentrate on building competitive edge. They focus on some customers and avoid doing business with others. As a result they develop capabilities that enable them to serve target customers better than competitors. This edge enables them to get bigger, gain leadership and achieve superior profitability. By contrasting examples of unsuccessful and successful companies, the article encourages managers to drive their firms to specialise and become great. Bigness is a product of greatness not the other way around.

To read the full article, click here (PDF version) or read the article on the Americal Journal of Business.

Introduction

Working with a number of mid-sized as well as large companies as a management consultant, I have observed that managers have a strong preference for growing the top line. They mistakenly assume revenue growth will automatically improve profitability. The reason for this propensity probably lies in the emphasis on economics, win-lose rationality and growth. Experience and self-interest – salaries are better in large firms – form a potent mix. The drive for sales growth unmindful of competitiveness is risky and often leads to unhappy consequences.

However, focused companies such as Asian Paints (India) and Sigma Aldrich (USA) concentrate on building competitive edge rather than engage in blind pursuit of top-line growth. They focus on some customers and avoid doing business with others. As a result they develop capabilities that enable them to serve target customers better than competitors. This edge enables them to gain leadership and achieve superior profitability. By presenting contrasting examples of unsuccessful and successful companies, I would like to encourage managers to drive their firms to specialize and become great. Bigness is a product of greatness not the other way around.

Revenue growth not a panacea

Managers assume that revenue growth is a natural and automatic panacea for most corporate ills. It is not. In fact, the desire for growth can be bad for a firm’s health. It leads to mindless pursuit of revenue growth. It is a slippery slope. Single minded quest for competitive advantage, on the other hand, is not only good for the top line, it fattens the bottom line as well.

Excessive focus on top line growth is common. It drives the strategy of many companies and propels them to fight for market share. Expensive promotions, sharp pricing and large sales force produce short-term gains. Managers begin to believe their steps are in the right direction. Soon competitors counter with lower prices, improved features or attractive offers and neutralize the effect.

Corporate initiatives that mistakenly aim for revenue growth without addressing the fundamental issue of competitiveness assume greater effort alone will win customer preference. For a time, higher levels of activity raise customers’ awareness of the company and create temporary advantage. Raising market profile without improving customer value can, however, hasten decline. More customers try the product or service, find it does not meet their requirements and are disappointed. Word spreads and ill repute grows. The company tries harder still. Expenses mount and margins shrink.

Too much attention to revenue growth gives rise to an opportunistic mindset. When leaders drive people to capture market share they often turn a blind eye to where business is coming from. New customers are acquired under relentless pressure from within, often at discount prices or promise of higher levels of service. Deals take longer to close. The greater cost of acquiring customers from outside target segments erodes margins and strains existing resources. In time, such customers discover the company’s offerings are not of great value and exit.

Opportunistic mind-set encourages grasshopper behavior

Sales managers exhort their teams to go after low hanging fruit in new markets. Sales people constantly seek new leads without regard to where they came from. It forces the organization to use resources sub-optimally. It weakens the ability to develop customer insights and new capabilities. Existing ones are eroded and the firm loses its competitive advantage gradually. When bigness is attempted at the cost of greatness, neither is achieved.

For example, in its early years a mid–sized Indian software company grew rapidly by entering new markets. Good, but unexceptional products had brought in substantial revenue growth from countries that were relatively unsophisticated. Their growing presence and efforts of new channel partners had fuelled their success. At a certain stage, the company’s leadership re-assessed their strategy. They decided market presence and aggressive selling methods would not be enough to succeed in mature and highly competitive markets. A unique sales methodology, they felt, would distinguish them from competition. Customers would also gain from the shorter sales and implementation cycles. They defined precisely how the new sales process will be carried out and adopted it as their key strategy.

Opportunism and a hunter mindset were, however, deeply ingrained in the psyche of the management. As they expanded presence to over twenty countries, they forgot their strategy and continued to scout for large opportunities. They entered new countries before consolidating old ones. Stretched thin, the top management had little time to implement the new sales process. Instead of recruiting and training more sales people, they appointed senior people to manage local relationships. They effectively abandoned the strategy that would have made them unique and effective. Not surprisingly, growth rate dropped by half in a single year!

On the other hand, consider Asian Paints (see box) the leading Indian paint company. They have persistently focused on painters and household consumers as customers. These customers prefer to buy a product that is readily available, other things being equal. The painter would not lose a day’s wages and the householder would not be inconvenienced because a small quantity was not on the retailer’s shelf. Competitive advantage of decorative paints, Asian Paints figured, flowed from improved availability of product, shade and pack. They reorganized supply chain, production and distribution to ensure their products enjoyed the highest availability of any brand.

They chose not to focus on the painting contractor market. That segment is characterized by few shades, bulk packs, low prices and larger volume orders. All their competitors operated aggressively in this segment; some even formulated products especially for contractors.

This deliberate avoidance of a sizable market would not have gone unchallenged in the Board Room. It must have been raised repeatedly and debated hard and long. The strategy to focus on the retail customer and avoid the contractor has survived. In the industrial paints market too it has stayed away from custom made stoving paints, electing to serve customers with standard formulations where they can leverage the supply chain better. To Asian Paints the choice of serving one segment went hand in hand with the decision to say “No” to the other.

The sales team of Asian Paints is expected to deliver bigger numbers each year. But they do not lose sight of what maintains their competitive edge. Their focus enables them to serve one segment better than others. It raises their capabilities and hones business processes. It has helped them build a larger network of retailers than any other paint company in India. And they have remained the undisputed leader among paint companies in sales as well as profitability for four decades.

Why the bias for bigness?

Managers have developed a compelling attraction for size. In the 1960s and ’70s most developed economies enjoyed steady demand and low inflation. To improve profits, firms needed to keep increasing sales while ensuring they operated efficiently. In the ’80s and ’90s rising energy costs and growing competition in international trade brought home the need to factor in the dynamics of the external environment. But the emphasis on economics, win-lose rationality and growth, on management education has been overwhelming.

The hunger for top line growth has become acute among western firms. Starved of growth in home markets, they are driving into Asia looking for revenues to beef-up bottom lines. Their hopes are headed for severe testing.

Economic reason for the hunger is only one of many motives. Size has a primal attraction, bigger also denotes more powerful. By virtue of size, a firm wields considerable influence over its stakeholders, especially in the community it operates in. Many customers, many employees and many suppliers mean none of them has much power in their dealing with the firm. Society and the political system tend to be wary of the large corporation. They prefer to leave them alone till things get out of hand. Size provides a degree of immunity. Enron was an apt example of the power of size.

That is probably why public corporations are more enamored by size than family owned firms. Private ownership imbues a successful firm with the values of the founder. Whether led by economic tenets such as shareholder value, or ethical principles, they appear less susceptible to bigness. Publicly owned firms are more likely to be drawn to the attraction of size. Perhaps it is because public ownership, especially when it is fragmented, gives managers considerable power over the destiny of the firm.

It matters not only to the firm, but also to employees. A big firm usually pays more than a small one. Bigger companies are thought to live longer. This belief is on its way to the grave, but myths persist. It seems more attractive to work for a giant. The sinister aspect of size, however, is vanity. It lends swagger to senior managers. Arrogance seems justified.

Board members are known to drive managers to pursue growth relentlessly. War chests are created and used for aggressive acquisitions. Laden and unwilling to jettison ballast, the firm slows down and weakens. Customer value and competitive advantage are treated as irrelevant and the firm sets off to become something to everyone. In doing so managers at the helm forget that markets sub-divide as they grow bigger. New segments emerge. Customers no longer feel satisfied with vanilla offerings and demand to be served in special ways. In maturing markets, the opportunistic mindset that chased every lead grows steadily dysfunctional.

Savvy firms look for customers they can over serve and say no to those that perceive a weak value proposition.

The virtues of focus

In his article ‘What is Strategy?’ , Michael Porter describes the plight of Maytag, the iconic American brand of washers, dryers and dishwashers. Maytag products were known for their reliability and durability. In 1980s growth of the home durables industry in the US slowed. Competition from companies marketing a full line of products increased. In 1986, The Maytag Company christened itself Maytag Corporation and acquired Magic Chef. In the next fifteen years they acquired a series of companies and brands some of them with disparate positions. They attempted to compete on the basis of a full range of durables and appliances instead of the strength for which they were known.

Between 1985 and 1994 Maytag grew in sales from $ 684 million to $ 3.4 billion, but return on sales dropped from 8-12% in the 1970s to less than 1% between 1989 and 1995 (Porter, HBR Nov-Dec 1996). On 31 March 2006 Whirlpool Corporation completed its acquisition of the $ 4.7 billion company.

Sigma Aldrich has not made the same mistake. The US specialty bio-chemical company has, for over fifty years, concentrated on doing business with research organizations worldwide. They produce over 200,000 different chemicals and supply them in small quantities, sometimes as little as 5 grams. They discourage, indeed avoid, large volume orders from the manufacturing sector. This focus has seen them grow to US $1.8 billion in sales.

Both Sigma Aldrich and Asian Paints have grown big by becoming specialists, by turning out to be great at what they do, by over serving selected customers and saying “No” to others. That is why they have achieved high profitability consistently. Since 1999, Sigma Aldrich has delivered profit before tax (PBT) above 14.6% of sales. In the last seven years Asian Paints’ PBT have stayed over 13% of sales. And they have grown. Growth is a consequence, not strategy. Being the best in the business makes a company bigger, gives it long life and puts money in the bank. Bigger is not better than greater. Being great can make you bigger and better.