Companies that have grown to midsize distinction (revenues between $10 million and $1 billion) have the luxury of free cash flow -- a welcome change from the resource-starved startup days. While this cash flow brings the opportunity to invest in growth, often funds intended to spur growth are gambled away on risky new ideas and projects that have little hope of working well.
For instance I know of a firm that spent its first free cash flows to create variations of its products for a new market. Without testing and with no executive experience in the new market, the $30 million revenue firm sunk $4 million into R&D and marketing. The result? They lost it all and had nothing to invest in their core business for 18 months, further slowing growth.
So how do organizations determine which ideas to pursue—and to what means?
Carefully explore growth opportunities
Midsize firms must take a careful, disciplined approach to investing in growth -- with only the best ideas receiving funding. New ideas should be collected and written up as business cases so that they can compete with each other for available resources. Arrange a series of trials (i.e. a focus group, a regional marketplace pilot or a customer response test) to de-risk them and to test for scalability. Only after ideas have competed, been tested and de-risked should the decision be made as to whether to invest and at what pace.
De-risking has two critical focal points. First, let’s talk about the risk of marketplace acceptance. Understanding the market -- and the demand -- for a new idea before moving forward is paramount. Companies with low marketplace risk have executives who are intimately familiar with future customers. They have sat across from buyers who clearly indicated their demand for the new product and the price they are willing to pay for it.
Second, firms have to address the execution risk. Through partnering, small scale R&D or talent acquisition, business leaders must become increasingly confident that the new product can be produced on time and to specification. This may require you to reduce head count in the sales department in order to fund engineering with key talent -- even if just temporarily. It could also mean buying a small company to get access to crucial intellectual property and talent or raising additional capital to assure the financial capability you’ll need to go the distance.
In some cases, where risk is low, firms may be well advised to spend aggressively, knowing that their chance of success the first time around is high. On the other hand, some cutting edge opportunities are inherently risky, and in these cases, leaders should spend conservatively, knowing that it will take several iterations to find the path to success.
Consider the forecasting track record of your team.
Another crucial aspect to determining how fast to spend on new avenues for growth is the forecasting track record of your team. The forecasting experience of the CFO is crucial to knowing the surprises that always pop up. Building a useful model of future costs and revenues is a mix of art and science. But the quality of the forecast is just half of the solution. The resolve of the CEO and management team to stay on plan is crucial as well. Good teams fight distraction and the temptation to go off script. They react quickly to deviation from plan and take strong actions to adjust. It is a matter of professional pride.
Bottom line: Don’t gamble on growth. Invest in it by de-risking marketplace acceptance and execution, and build a realistic