Dashboard: Why Chasing Growth So Often Backfires

Welcome to another 21 Hats dashboard. I'm Lauren Feldman [music] and I'm here with Gary Kungl who is an economist who identifies himself on his LinkedIn profile as a sustained growth [music] researcher. Welcome to the podcast Gary and please tell us what what exactly is a sustained growth researcher? >> Thank you Lauren. I'm happy to be here. Well, re sustained growth researcher just essentially means that I'm trying to untangle the mystery of why only 1% of the companies are generating twothirds of all the employment. Um, and these are the companies that grow again and again. So, what makes them different than all the other companies that are flatlined or in in decline or only have, you know, one growth event every, you know, five or 10 years and what makes them different? and how are they making decisions differently and and that's what I research. >> That's a really interesting topic especially to to business owners and I I I want to explore that with you but first te take us through your background a little bit. Um have you ever owned a business? >> Uh yes I have as a matter of fact. So when I was about 40 years old, um I found myself in Europe with my own consulting company had about 12 employees and um our biggest client was the state of Maryland and we were doing foreign direct investment attraction. So we were trying to get European companies to build factories and facilities in the state of Maryland. And the key to that is to try to get to them in that small window of time when they're making a decision where they're trying to evaluate where they're going to put their plant for instance. And so I knew that my job would be a lot easier if I could come up with some kind of predictive methodology that I could whittle down tens of thousands of companies down to a small group that I should focus my attention on. So I gathered data sets and started playing with predictive models and became really fascinated with that. But I realized with a bit of humility that I didn't have the the statistical training um and the background really to do this kind of work. So I exited the contract with Maryland and I came back to the states to get a PhD focused on sustained growth and what the impacts are on regional economies. So it was that experience that really spurred you to develop this area of expertise. >> It was um so while we were doing the project we had this data set this unique data set that tracks every company in the economy and um so I was working with Pennsylvania the data set with Pennsylvania and we had about 9 million companies in Pennsylvania that had survived a 5-year period of time. [clears throat] When we measured it, we found that 1% of those companies generated about twothirds of all the jobs. And we we played that backwards and played it forward in time and we saw the same pattern. Subsequently, I've done studies for um Pennsylvania, which I just said, Virginia, Texas, Louisiana, Michigan. We see the same exact pattern uh there as well. The the numbers, it's always about 1%, could be a half percent to a percent and a half. It averages about a percent. and on average they're they're creating twothirds of the jobs. So that that came to us as a big question is is what are they doing differently and um I'm a behavioral economist so wanted to think that it was their decisions that they were make the behaviors that they had that were different. So, we categorized, we cataloged about 500 variables, uh, company characteristics, decisions that were made that were supposed to be connected to growth. So, everything from open book management to how much money you spend on R&D to whether or not you have bike racks or on a public transportation [laughter] route. >> Wow. >> All of these kinds of crazy things, right? And we collected thousands of of surveys from CEOs across the growth spectrum in order to compare what was that top 1% doing differently than the other 99%. And when we boiled it down, we found that there were only 50 decisions that separate these companies, the ones that are in the top 1% and the other 99%. And this 50 set 50 this set of 50 decisions is what forms the basis of the executive leadership training that I do for Tugboat Institute and on my own uh separately. >> Well, I'm dying to hear. Can you give us a hint [laughter] what are those decisions uh that make the difference between growing or not growing? Well, before we answer the question, I just want to say that um a company is a complex system. So, we have decisions that can culminate in an outcome that we can't get directly. So, all these decisions culminate to push six things forward. These are these six things really are the are the are the drivers of sustained growth. So, do you attract high margin customers? Can you keep high margin customers? Do you introduce new high margin offerings? Do you keep margins high on existing offerings? Do you have pricing power and excellent cash flow? So, those are the six things that come out of these 50 decisions. And so, we link them back to those. You know, >> explain what you mean by that. Um, how do you link decisions to high margin customers? So one of the things that we use is a is a tool is something called a customer profitability whale. And this is a diagram that is sort ofly sort of indicates the way the typical company um is is configured with their customer. So if we were to line up all of a company's customers and the first person in the line is the most profitable customer for the company and at the end of the line is the least profitable and we chart those against cumulative net operating profit. We find that the first like 20% of customers the most profitable are responsible for as much as twice or more of your net operating profit. So they they they drive they drive the profits way up and then you've got about 70 60 70 75% of companies or customers in there that are not profitable. They're just right at the line and then you've got about 15% of the customers that are you're losing money on. So what we are trying to do is isolate into that top 20% where you're generating most of all your profits are. [snorts] And that's where we want to do a very determined uh customer customer acquisition and retention. That's where we want to innovate new products and services in there. That's where we want to have pricing power and that's going to drive our excellent cash flow. you gave us those six factors that explain why that 1% of companies that you look at are are responsible for so much of the growth. Um, and the the six factors you identified are all things that are the the companies are very much aware of. They know it's good to have high margin customers and high margin offerings and cash flow and pricing power. Everybody's trying to do that. Um, I'm wondering what's the difference between those who accomplish it and those that don't? Have you figured that out? >> Yeah. So, at Tugboat, we train companies. We train 25 companies, about 300 executives, and they range in size from about 10 million annual sales to 1.2 billion. So, it's a big wide variety. But what we've got to see throughout that is that um part of this is scale dependent. So if you look at a smaller company, say 10 million sales, 5 million sales, something along that line, they're going to intuitively kind of know which of their customers are more high margin than other customers are. And they would intuitively understand that there's some that they're losing money on, but they don't have necessarily the investment in the ability to determine what those really are in a numerical sense. in the numerical terms, right? The way that we get there is through cost accounting, activity based costing that that allows us to really analyze. We can do it at the transaction level or we do it at the customer level. We do it at the market level, the product level, whatever we want to do, but in this case, we're talking about customers. So, we see that as C as companies move through the middle market phase, they start to formalize some of these activities um around And this is a really loosey goosey number, but around a hundred million in annual sales is where I I really start to see that the businesses are are able to quantify this distribution of profits across customer base. And that's really essential if you want to start really drilling down into why are they there? And you know, what kind of features are they buying? What distribution channels are they buying from? Where are they geographically? you know, other other characteristics that'll help your hunt for these best best customers as you go forward. And and in in a way, it's it's similar to what I was doing in Europe. >> How so? >> Because we're trying to find activities and characteristics that are indicative of growth for the future that tell us that we're pointed in the right direction. And there's really no stronger tool than activity based costing and cost accounting. As as as dull in quotes as that may seem, it is penetrating insight. >> And you're saying that generally in your experience, there's a dividing line somewhere around $und00 million. And companies below 100 million typically don't necessarily know the extent to which um their best customers are providing most of their growth. >> Well, you know, there's a difference between sort of instinct and and uh numbers on a page. So, that's what we're trying to get to is is to really be able to quantify uh who those who those customers are, who are the ones that you want to replicate, who are the ones that you need to shift along that curve so that they're not marginally profitable anymore, that they're actually profitable. Uh, a lot of that um can come into transaction costs are one of the reasons why um some of those are marginally profitable because you spend a lot of money and time trying to acquire them, but they only buy from you once. So that when you net that out, you're netting it out close to zero profits. So you're able to treat that more uh determined in a in a more measured way. and uh and also the the customers at the end of that tail that where you're really losing money on um either shifting those uh to another point on the distribution or getting rid of them. >> So you mentioned you do these kind of analyses for uh on on your own for companies I guess that hire you uh directly and also through the tugboat institute. Uh the Tugboat Institute is a terrific organization based in Idaho uh created by Dave Wharton. Uh and they [clears throat] practice uh something called uh evergreen growth. Their idea is uh to build a business that can last a 100red years. Uh they discourage uh sales to private equity. Uh they you know venture capital. They like owner operators. Is that fair? No, it's very good and it is an excellent organization. The members are really uh dedicated to uh growing their company in a paced way like sustained growth. Same thing uh really driven by their purpose and perseverance. It's a great organization. >> You mentioned the sustained growth again. Is there something magical about sustained growth as opposed to haphazard growth or [laughter] when it happens growth? But why sustain growth as a focus? >> You know, when I when I started this um I looked at uh all these academic articles and books that had been written that were looking at different kinds of growth. And in the past when people were saying that a company was growing, usually they look at the percentage of growth or the absolute amount of growth. Um what I did is I introduced a new a new variable a new a new dimension on this and that is the number of times a company grows and the reason why I did that is because um it's like most human activities the more times we do something the better we get and then the more likely we are to do it again. So what we want to do is get inside that process so that growth is repeatable uh over time. It's interesting because we we took uh we took the nine I took the nine million companies in in Pennsylvania and I looked at all three of those growth measures and I was trying to see if those three growth measures would predict if we looked at how a company grew over a five-year period of time and then we looked at the next five-year period of time to see whether or not how they grew predicted future growth. We found that absolute growth, the amount, the total amount that you grew in a five-year period of time has no bearing on whether or not you survive or grow in the next five years. The faster you grow, it's actually negatively correlated. So that means that the faster you grow, the more likely you are to go out of business. Um what we did find highly significant was the more times you grew in the fa in the past significantly higher survivability in the future and more likely to grow again and again in the future. So it becomes sticky. So if we can get companies through this sort of episodic oneoff growth and put them on a track where they can grow again and again and again. Now remember all of this growth is highly profitable growth. We're not we're not growing at a loss. We're growing at a in such a way that we can support the profitability and do what we need to do as companies which is to uh serve our shareholders as well. >> So that has interesting implications what you just said. I mean I like you I used to work at Inc. magazine uh where for a while I was largely responsible for the Inc. 500 Inc. 5,000 uh list of fastest growing privately owned companies in America that we produced every year. If I heard you right, what you're saying is growing really fast, being at the top of that [clears throat] Inc. 5,000 list is kind of dangerous. Your chances of going out of business are much greater than if you're growing consistently at 5 or 10% a year. Did I hear you right? >> That's right. So one of the reasons behind this is debt. So companies that are looking to grow really fast are usually out there raising a lot of debt in order to do that. Um when you build capacity um at a at a rapid rate or you exceed the the growth in demand, you're going to get yourself in a position where you have a cash flow problem. you know, you've got to pay for the note for all the debt that you you did, but but you don't have the business hasn't caught up. So, it leaves you in a really vulnerable position if there's a market downturn or sudden competitor shift or something else along that line. And that's why we see the faster that they grow, the tends to be um the more likely that they are to to collapse. >> Interesting. So, so I was asking you about the Tugboat Institute before and you do these analyses on their companies and I've been to uh several of their conferences. I've met a lot of the owners of of the businesses. They're they're fabulous businesses. It's it's an amazing organization as we were saying. I I I'm curious what your typical experience is when you when you do an analysis on a you know, a really successful company like that. I mean, it costs money to be part of the Tugboat Institute. these these are largely uh successful businesses you're dealing with. When you go in and and and do this analysis, what's your process and what do you typically find? >> Well, the analysis usually comes through the training. So, we we run we run the companies that are that are training clients through seven modules of information that comes from the research. shows them. We go through the customer profitability whale. We talk about complex systems, but then we drive down into the 50 decisions that that really are supporting sustained growth. And as we do that through questions and answers and an extensive sets of surveys that we we ask them as they're going through, we ask them to identify the bottlenecks that they see in their own company as we go through, you know, decision after decision after. Is this a big problem? Is this something you got under control? You know, and this this becomes a self diagnostic for them because we've given them the information on how to think about these issues. Really, what we've done is we've given them a tool to prioritize. You know, one of the the things that's that's really true is that as a company scales, complexity rises a lot faster than you expect. So what we're what we're trying to do is put them in a position where they're thinking about the 50 or so decisions that they can make that have the most leverage on growth. And what's the reaction like typically when you share this information and allow these owners to self diagnose and they realize that they've been devoting a lot of energy to unprofitable customers uh and and not putting as much energy perhaps as they should into their most profitable customers? Um, are they stunned? Because these are all really well-run companies. Um, what what what do you hear from them? [clears throat] >> I think that there is a little bit of a stunned moment there. It's one of these it's one of these moments where, you know, you're you're moving from a position where um some of these these topics, these these decisions, they're intuitively known, but they haven't been concentrated on. So they they don't really realize how important these parts of these decisions are. So that they are um really attuned. Of course, when you're when you're talking about like the customer profitability whale, when you put that up there, they can immediately identify which customers are going where on that, but they never really had a conceptual framework that they can talk about it among themselves. And that's one of the big things that they that they take away from the training is a common language that they've they can now talk about these issues. They know how important they are and it focuses the team on on problem solving. >> I think you use the term customer profitability whale. What what does that mean? >> Correct. That's the That's a a diagram [clears throat] that essentially plots out uh customer profitability along the x or horizontal axis and cumulative um gross profits on the y or vertical axis. And it when you draw it out, it kind of looks like a whale. So, at the head of the whale, you got the top most profitable, 20%. Then you've got this long back kind of sloping downward, which are the ones that are marginally profitable. And then the tail of the whale is is where you have that 15% or so of customers that you're really losing you're losing money on. So, it's roughly 20% high margin, 60% um a wash, and 15 or 20% where you're losing money. >> Uh that's correct. That's it's a kind of a rule of thumb and the numbers will be a little bit different for every company, but that's that's the construct. >> And for almost every company, you're saying >> for just about every company. Yeah. And one of the reasons why is this is that you know when we start off in business maybe we have one customer and we do a great job on that somebody else hears us and they and then they come to us and they want something a little bit different and that customer is a different kind of profile as the first one. Then we add a third one also very different wants something different. So we get this proliferation of different profiled customers wanting very different things. And so, um, it's not until you sort of build up that pattern and you start realizing that not only is profitability really strong within a subset like 20% and that we're losing also on about 10 or 15% on this, but also we can see the same pattern when we apply this cost accounting back to which products, add-ons, distribution channels or other dimensions. We can do the same analysis and that'll show us as well. Well, this product line we're killing it on, but this one over here is killing us, you know, or or this distribution channel is very So, it's a it's a way that we can set up the numbers so that we can do an analysis to make better decisions. And you've really found this across the board with from relatively small companies with say $5 million a year in revenue um to to very large companies and across industries across geographies. >> Yeah. The the typical motivation behind this is because all companies are facing this once they get a little bit of mass to them as you said about 5 million or something along that line. when you've got uh depends on it depends on the company and what they're selling, but as soon as you've got uh a goodsized collection of customers, you're you're going to get a pattern that looks somewhat similar to that. >> And what what's the logical next step for most companies who realize that they in fact fit this pattern? What do you advise someone in that situation to do? Well, as we're as we're going through the training, particularly with Tugboat, uh we have a capstone at the end of the course, which is a half-day problem-solving workshop. And as they've gone through the training, um through surveys and discussions, we've gotten them to identify which of the the topics, which of the decisions that we're talking about, which of these decisions are they having problems with? And then when we go to the whiteboard at the end, we pick four of those and we we we drill down into those. So we say what does an optimal solution look like? Well, we start off with what is the nature of the problem? What does an optimal solution look like? What kind of data do we need or information we need to make a decision? Uh what kind of other resources are involved? Who should be invol who should be involved particularly? And what are the first steps and and what are the hidden risks? So those six dimensions there, we go through each of these four problems and try to work that out so that when they get finished with the course, they've got, you know, a set of um topics, assignments, if you will. Most of the companies as we're going through this actually assign people on the executive leadership team to champion one of the one of the problem sets to see it through into implementation. Does it usually end up with the company deciding that [clears throat] they either have to get rid of that 15 to 20% of uh customers that they're losing money on or raise their prices considerably. >> Well, there's a variety of different things that they can do. A lot of the reason why, you know, again, that we have um marginally profitable or negatively profitable customers is because of transaction costs. Um, and you can think about these as all the all the extra costs that you would spend. You can kind of think in your mind on a on a customer that's too demanding, if you will. You know, we have to do special shipments for them. We have to pack it separately. They want a different color than we've got. You know, they they want it delivered in a certain way. Um um we have to chase them for bills. There's all of these extra costs that go along with serving the customer. That's usually not what we're including when we think of the profitability of that customer. But through activity based costing, we can assign those costs back down to the company so we can see where they are. And some of it can be as simple as charging for some of these special handling things and and whatnot so that you're not losing money on those. That's that's a softer thing than than essentially firing your customers, right? >> So, for people listening to to this, some of whom are are less than $5 million, but there's probably still a chance that they fit the pattern you're you're describing, um, if somebody is concerned that they do in fact fit this pattern, what what would you suggest to them? >> Well, um, you know, I certainly would be happy, you know, to talk to talk with them. You want to give your email address? Oh, >> certainly. Um, my email address is GM Kungle. Ku N Kle, that's gmunk@yahoo.com. That's my personal one. [snorts] And I have a website at sustain-growth.com. Um, but [snorts] any first steps that you would suggest if somebody uh suspects that they fit the pattern other than reaching out to you, which obviously would be a fine one? >> That would be a fine one. Yeah, it's I think you know one of the first things that they should do is is is really uh take a look at the distribution of your customers by profitability. That's one of the the first thing. Now, you know, we when we do the training, we've got we've got 10 sessions here that we're doing the training on and we don't talk about cost accounting the whole time. We just set up the model and then we move through. So, don't think the training is all cost accounting stuff. It's not. But it sets forth a sort of a conceptual model that we can work with and we can say okay now that we've got this who are so the first thing I do to answer your question would be do we really know who our most valuable customers are in in true terms and do we know the ones that we're subsidizing on the back end you know what should we do with those what should we do replicate the good ones and um manage in some ways um the ones that are not profitable. >> Got it. Uh so I just have one other question for you. Uh you know we we talked about the kind of the the myth of fast growth. I mean so many businesses are focused on their annual growth percentage. That's the whole point of the Inc. 500 Inc. 5000 as as we discussed. People are very proud to make it onto that list. Um, >> of course. >> Are there other things we get wrong about growth that you would call our attention to? >> Well, you know, we've spent a we spent a good bit of time here already talking about um how poor growth quality zaps growth momentum. You know, if we've if we've got um if we got too many customers that we're losing money on, that's going to zap our momentum. If we have more customers that are aligned in the high profitability zone, it's going to help us. So trying to manage that is a big is is a big thing and that's what we've talked about here throughout. But there's a lot more dimensions that we go over during training. Um we we talk a lot about decentralization. Decentralization is so important as a company grows again because complexity and the number of decisions that are made is going to expand with scale and a very rapid rate. So that's one of the reasons why executive training is important. But it's also important for decentralization. How do you get your people to be working in pursuit of the the vision, the plan, and the target? How do you incentivize them and lead them so they're motivated to do that? Um, that's that's going to that's going to go a long way. >> Got it. Gary, I suspect you've opened a lot of eyes with this conversation and there are going to be a lot of owners who listen to this who take steps [music] to find out whether they in fact are are fitting this pattern. Uh, I really appreciate you taking the time to speak with us. >> Thank you very much. I I appreciate that. >> Gary Kungl [music] is a sustained growth researcher. Um, Gary, let's uh let's keep in touch. I suspect there's more to talk about here. >> Absolutely. Thank you, Lauren. >> Thank you.