What exactly does it mean to grow a company?
In the age of the internet, it seems that growth means eyeballs. You need to add users, quickly.
It doesn’t matter if those users are unprofitable. The idea is that if you add enough people, then a larger company will buy you just to be able to talk to your customer base and sell them more stuff.
Most businesses, however, don’t work like that.
They have three levers they can push – money, customers and operations.
According to Peter Lynch, the well-known manager of Fidelity Investments’ Magellan Fund until 1990, there are five things companies can do to increase earnings.
An investor would look at which of these options are open to any particular company before investing.
1. You can cut costs
Focusing on costs can be boring, but every penny you save has an immediate impact on profits.
Some costs, like electricity, gas and water, may be small – but their impact on profits can be considerable, especially in a competitive, low margin marketplace.
In an ideal world, you would compare costs against expectations daily, taking action to correct variations as soon as possible.
2. You can raise prices
If you raise prices, you will lose some customers.
That is no reason to keep prices low.
The calculation one needs to make is to work out at what price point a further increase will result in a net loss from customers leaving as a result.
This can be calculated – it requires a pricing model and charting, or if you’re feeling in the mood, differential calculus. Let me know if you’d like more information.
3. You can sell more to old markets
You may have more services that existing customers would take, if they were aware of what you did.
If you already have an existing working relationship with someone and have provided a good service you have an advantage over the competition.
4. You can expand into new markets
Now we’re looking at how you can get new customers.
The easiest place to start is to find customers like the ones you already have.
It’s much easier to have a conversation when you already have similar customers to the one you’re trying to work with.
And those conversations may tell you where the opportunities are for new products and services.
5. You can fix, close or sell a losing operation
If a part of the business is hurting profits, then you need to look at it carefully and work out what your options are.
It’s easy to fall into the sunk cost fallacy, where previous decisions and investments stop you from just stopping.
If you can’t fix it, then you need to close the operation or sell it – and that will have an immediate impact on your profits.
Lynch argues that how a company plans to deal with these five areas is its “story”.
As an investor, a company needs to to have a plausible and preferably compelling story about how it plans to increase profits before you put your money into it.