The larger you grow, the more profitable you become right? After all, that’s why companies decide to grow after all. Unfortunately, real life isn’t as simple as Economics 101. Real life is vastly more complicated and growing your company can actually reduce your profitability.
Costs, specifically how costs accrue in a staggered manner is one of the reasons for this. Fixed costs are the perfect example of, and most commonly known; cause of this. Let’s take rent – when you move from one rented building to another; your cost increases. Since most commercial ‘professional’ leases come in multi-year formats, you have to rent with growth in mind. As such, if you were renting for 3 years; you have to envision and plan for your companies size in 3 years. If you expect to be doing double your business by year 3, you can’t rent a building that is suitable only for your size now. Which means your profit (if you have any) in year 1 is going to be lower than those in year 3 just because you have to plan for growth in year 3.
Now, rent is a simple fixed cost example which most people can see and understand. However, let’s take another example – cardboard recycling. Having someone drop by to pick up our cardboard each month costs $40. Obviously, as we grow and receive more products, we need to recycle more cardboard. At a certain point, we have to do more than 1 pick-up a month. So that’s another increased cost, but it’s not gradiated at all. A 2nd pickup might give us enough space to grow for another year, but the cost increase (the additional $20 for another pickup) is fixed.
Complexity increases with growth. As you grow, the number of balls in the air increases and the ‘shape’ of those balls can change. When you’re smaller, many of the problems are simple to manage. As you grow though, what used to be a small problem increases in size as well and can become a major issue.
For example – refunds. Refunds are simple right? A customer asks for a refund, you refund him. Except; what if the customer asks for a refund on a card he longer uses? Normally, this is not something that would happen; but as your business size grows the number of exceptions/one-off cases increase too. As these one-off cases are just that, one-off’s; you can’t even write processes or procedures to handle them. You have to deal with them individually – and as such, the amount of time required to deal with them increases as well. Get enough ‘one-off’ cases; and you can find yourself spending half a day doing nothing more than fixing unique problems.
If you’re doing that, you aren’t doing something else just as important – so you have to add more hours, which means more cost, which can mean lower profitability. Again – things like this happen in ‘staggered’ formats; each addition coming after a certain cliff happens.
There’s also an issue of differing expectations – as you grow, you’ll find expectations for your company change too. The type and kind of service expected from an organisation that is 1 person large compared to one that is staffed by 100 is very different. More often than not, meeting those expectations require increased levels of management & bureaucracy, which results in increased cost. We found this out when we went from 2 to 3 employees. You’d think adding 1 more person wouldn’t be that much more complex; but to keep us as professional, we had to increase our bureaucracy levels significantly.
Economies of Scale
So what happened to economies of scale? Well, there is obviously some of that. Renting a 5000 sq ft warehouse is cheaper per square foot than a 1000 sq ft warehouse. When you finally reach optimum capacity, your margin will have improved. However, its the interim period where things are expensive. So remember, growth is not always the route to greater profit.