BUSINESS BRIEFS: Take the Risk Out of Your Next Expansion

Have you ever wondered how a business that has been in existence for over 50 years suddenly fails? There are many reasons, but, surprisingly, one of them is growth. If improperly managed, growth can drain cash from your business and build risk into its operations. In the past, we have explored the cash-draining effects of growth. Today, let’s look at how growth-driven expansions can put your business at risk.

Figure 1. This business' revenue stream is cycling within its historic profit zone.

Expansion Scenario

Figure 1 illustrates a business with a revenue stream that is cycling within its historic profit zone (defined as the area between breakeven and capacity). In year A-B, the company experiences a growth spurt. Whatever the cause, the company’s potential sales are above its capacity, as evidenced by firming prices, extended lead times, and customers’ rejections of quoted delivery dates.

Figure 2. Expansion creates additional fixed costs.

What would you do in that situation? One possible option would be to expand capacity so that you could capture those lost sales and profits. However, as Figure 2 indicates, expansion creates additional fixed costs like new facilities and equipment, expanded energy and insurance needs, and even increased fixed staffing. These added fixed costs increase the breakeven point, which, given the sales profile in Figure 2, also increases the risk of losses.

Figure 3. It might be prudent to delay expansion until the downside of the sales curve rises above the projected breakeven of the expanded operation.

Consider Alternatives

One alternative would be to delay expansion until the downside of the sales curve rises above the projected breakeven of the expanded operation (see Figure 3). This allows you to capture the increased sales without incurring the downside of risk, which could prove devastating if sales were ever to follow line d-t in Figure 2.

Of course, having the patience to wait for one or two slowdowns to confirm the low end of the sales profile is a lot to ask of most managers, who see lost sales at the upper end of the chart. However, it’s not necessary to increase capacity in order to capture them.

Why not contract those sales out? When contracting, maintain control by bringing the product into your facility for quality assurance before shipping it to your customer. This will reduce your profit margin, but it will protect your reputation and the confidentiality of your customer base.

By focusing on the upside of your sales curve, you will identify opportunities for increased sales and profits. By focusing on the downside of the curve, you will identify the risks of unbridled growth. A good manager anticipates the bust as well as the boom.

Any views or opinions expressed in this column are those of the author and do not represent those of Ceramic Industry, its staff, Editorial Advisory Board or BNP Media.


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