Growing a small or medium-size manufacturing business can be difficult. Or worse — unprofitable.
The amount of time and money to expand is usually big: You’re adding equipment, production space and staff, and likely spending more upfront for raw materials and waiting on the backend for payment on more invoices. Poorly planned or poorly funded, growth can backfire.
Even successful manufacturers caution against pedal-to-the-metal growth.
“Don’t grow too fast. You’ve got to have the cash available to sustain the growth, whether that’s your own cash or cash through a line of credit. That’s real important,” said owner Jesse Cherian, of ST Fabrication, a growing manufacturer of steel beams for constructing commercial and industrial facilities.
The potential strain on cash flow is just one challenge a growing manufacturer faces, which is why “smart growth” is more important than ever. Manufacturers should step back and ask two essential questions: What is smart growth? And, what are some steps a small or mid-size manufacturing business can take to achieve it?
What Is Smart Growth?
Rarely do we pause to ask, “Is growth healthy for my business?” Without a solid plan, the answer may be, “No.”
One of the pre-eminent experts on the topic of smart growth, Professor Edward Hess of the University of Virginia's Darden School of Business, has shown that it can be incredibly difficult to create value through growth. His research has found (1) many businesses lose money as they expand, (2) companies that grow at an above-average pace year after year are rare, (3) many businesses assume greater risks when they get bigger and (4) "improve or die" is far more accurate than the common mantra of "grow or die."
This isn’t to say manufacturers should not grow. Instead, they should shy away from preconceived notions about the right path for any business and rely on a well-thought-out plan for whatever path is chosen.
Before taking the growth path, a manufacturer needs to ask the right questions:
- Is there an ideal size for my business so I’m competing in my sweet spot and avoiding administrative costs?
- What is my greatest profit opportunity? Is it in expanding sales or increasing operational efficiency?
- How do I ensure increased sales lead to higher profitability?
- For how long is growth sustainable, and how prepared are we for potential slowdowns?
- What levers do I have to help manage cash flow during growth periods and lulls?
Smart growth will look different for every manufacturer, depending on unique circumstances. In some cases, the smart path may mean maintaining your current size, and in other cases making investments today may lead to huge bottom-line growth tomorrow. Recognizing the correct answers can create a firm foundation for manageable and profitable growth.
How Do You Achieve Smart Growth?
Although at times growth just happens, it often requires deliberate planning. We typically find the manufacturers that are expanding most effectively have a growth plan that defines objectives, provides the strategy and tactics for achieving growth, and identifies the risks. These plans are reviewed and refined quarterly, if not monthly, as goals are met or missed and circumstances change.
Look for profit-generating opportunities to invest in your business. Small- and medium-size businesses clearly understand the value of investing in their companies; as the U.S. economy has strengthened, three out of four business owners invested in their operations in the past 12 months, and a similar ratio intend to invest in the coming year, according to the Bank of the West Small Business Growth Survey. Further, our research and conversations with manufacturers point to a common investment theme: technology.
The Bank of the West Small Business Growth Survey found that growing companies are twice as likely as declining businesses to say investing in technology is extremely or very important to success in the next year. More than half of growing businesses indicate that they have increased their technology budget over the past 12 months.
Tales of tech investments by our manufacturing clients back the numbers.
“We’re constantly searching to evolve all aspects of our manufacturing, including the engineering process with new software development,” said Nancy Mercolino, president of Ceilings Plus, a Southern California manufacturer of ceilings and wall panels for large-scale projects, such as airports and museums. “We’re able to do more — design 30 percent more interesting, progressive and parametric designs now, and still be 30 percent faster doing it. Manufacturing really consists of making the product as well as engineering the product.”
Six years after the U.S. economy began to recover from the Great Recession, manufacturers and other businesses are still credit-cautious and relying on cash flow. Our survey found that while many small businesses are poised to grow, only 31 percent plan to acquire financing in the next year. Similarly, a Federal Reserve survey of companies of all sizes found that only 22 percent of businesses sought credit in 2014.
Cash and credit options have very different implications. Relying on excess cash generated by the business saves financing and interest costs and may reduce risk. Relying on profits to grow imposes financial discipline that may help keep a business from expanding too rapidly.
But, relying on excess cash may also constrain growth and limit a manufacturer’s flexibility in good times and bad. Conventional lines of credit, commercial real estate loans and Small Business Administration (SBA) loans have helped many manufacturers to expand in economic upturns as well as ride out rough patches or business disruptions.
Keeping smart growth in mind can help a manufacturer identify the right options. Once the decision is made to grow, developing a plan that lays out both the strategy for investing in the business and the strategy for funding growth can help position the company to take advantage of opportunities as the U.S. economy continues to expand.
About The Author: Michelle is executive vice president of small- and mid-size enterprise banking at Bank of the West. She joined the firm in 2008. She graduated from UCLA with a BS in Psychology and MBA, as well as from USC with an MsEd in special education.