There are hundreds of books about starting or buying a business. Most address the issues surrounding choosing the right operating entity, raising capital, finding and dealing with lawyers, accountants and insurance agents, and choosing vendors, contractors and employees. All are topics worthy of consideration by a new business owner.
But what about the difficult decisions facing the seasoned, battle-tested business owner? Growth and expansion require careful research and planning. You cannot simply wake up one day and decide to move into a larger commercial space, venture into a new market, or take on a new product line outright.
Not as much has been written about the appropriate questions a business owner ought to ponder when it’s time to grow or move. The decision to extend the scope of your business must be a result of thoughtful analysis, including the financial, logistical, and even your emotional readiness to shake things up. What follows is just a primer on the subject of taking your business to the next level. Ready? Let’s go…
Timing is everything
The rule of thumb about when to make a move is that you should only expand when there are growth opportunities that can benefit your business and give you an immediate—typically, less than one year—return on investment. Think of it as planting a tree that already bears low-hanging fruit. There may be an untapped market niche on which you want to capitalize; or, perhaps, a new location that will deliver significantly greater traffic at your grand opening. In any case, whatever change you initiate, have a well-developed plan with plenty of contingencies should events not pan out as expected.
And certainly understand that expanding operations does not always guarantee success. You may be doing more volume by moving to a larger facility or adding a second location, but with the additional overhead, you may not make any more money.
You may ask yourself, “Why then should I even undertake the challenge?” The only point being made here is there are no guarantees, but a lackluster result is certain if you don’t know how much more you will need to sell in order to cover your investment.
Accordingly, allow me to introduce the break-even formula:
Break-even volume = Fixed expenses (overhead) divided by Gross-margin percentage minus Variable-expense percentage
If you refer to the company’s most recent Consolidated Income Statement (aka profit-and-loss (P&L) statement), you should be able to locate or calculate your gross margin percentage. It’s usually the near the top of the statement on the line labeled Gross Profit.
If, on your P&L statement, there isn’t a separate column with the heading Percent of Sales, you may have to take that dollar amount and divide it by the top line, Total Income or Gross Sales Revenue.
For example, if the company’s gross sales revenues are $1,200,000 and the Cost of Goods Sold is $500,000, then the Gross Profit is $700,000 and the Gross Margin Percentage is 58.3 percent or 0.583 ($700,000 / $1,200,000).
Look down the rest of the P&L statement, and classify each line item as either Fixed Expenses or Variable Expenses. The easiest way to do this is to go line-by-line and ask yourself, “Would the company be required to pay for this regardless of how much product or services it sold?” If the answer is “yes,” then that total gets added to the Fixed Expenses. If the answer is “no,” that amount is determined to be a Variable Expense.
For instance, if the company does not have an advertising firm on retainer or on a fixed contract, and it decides to promote and market itself as the need arises, then the total spent on advertising would be classified as variable expense. Conversely, the line item labeled Payroll Expenses—that is, compensation and taxes for salaried employees excluding production labor—usually becomes part of the Fixed Expenses tally. Commissions and bonuses paid to sales people, being determined by how much was sold, would be considered a variable expense.
Once you have a total for Variable Expenses, divide that amount by the Total Income or Gross Sales Revenue to come up with the Variable Expense Percentage. Let’s say the variable expense total, for the same example above, is $180,000. The Variable Expense Percentage would be 15 percent or 0.15 ($180,000 / $1,200,000).
Finally, if the Fixed Expenses totaled $400,000, the Break Even Volume would be $923,788 ($400,000 / 0.583-0.15 or 0.433). It is at this point that a smart business owner can play “What if?” . . . provided only one factor is changed at a time.
Let’s suppose the above example describes a successful sign and digital graphics shop that will, in eight months, see its lease expire and face a rent increase of 75 percent because of new ownership. That’s a situation where the business owner has no choice but to begin exploring options. Using the Break Even Formula will definitely help.
If the increase in rent causes Fixed Expenses to climb to $450,000, then the new Break Even Volume becomes $1,039,261—an increase of 12.5 percent. The next most logical question posed is: “Can the business remain in its current location with the same equipment and people and sell 12.5 percent more stuff just to cover the rent increase?” Some business owners might reach the inevitable conclusion: “It’s time to move elsewhere.”
The beauty of the Break Even Formula is how clearly it indicates the effect of any change to the organization—hiring a new salaried employee, buying or leasing a new piece of equipment, moving into a new facility, whatever.
Movin’ on up
In an ideal world, a company’s decision to change its physical location should be an integral part of its business strategy. For the brave, a move can trigger a radical cultural change in the business and how it is perceived by all others—customers, employees, vendors, the new neighbors and new community. Unfortunately, many business owners don’t have the time, objectivity and resources to thoroughly research and analyze their situation—that is, for each option, reveal every direct and hidden cost associated with such a move—in order to improve their chances of making the best decision, the one with the most pluses and the smallest downside.
Even if you are not considering relocation any time soon, try some of the following exercises:
- Create a diagram of your current office and production area. Be sure to include measurement of each room or area, the location and size of equipment and furniture, and the position and capacity of all utilities—electrical, water, gas, and the like. Indicate with arrows how the work flows through the shop—where supplies are received and stored, the path along which the production process begins, continues and ends, and where finished jobs are staged, packed and shipped. Look for bottlenecks and other inefficient practices and eliminate them, if you can.
- Solicit the help of a commercial real-estate professional and identify several available industrial spaces or parcels that could identically replicate—or accommodate some growth in—your current operation. That is, the approximate same or slightly more square footage, available utilities and work flow. Take note of how far away they are from your present location. Now, make a list of advantages and disadvantages of the new places compared to where your business is today. How would a move affect your employee’s travel time to work? Will your customers think the new place is easier to find, or will the move predictably result in some lost business? Do the new locations make you more or less accessible to your vendor’s and shipping carrier’s trucks? Be sure to record the rent prices, length of leases and any differences in utility or tax rates for each option.
- Many businesses totally overlook the great opportunities that are gained from moving into a bigger location or into tailor-made premises. In this current economy, there are bargains to be had as property management companies may be motivated to lease larger spaces and offer incentives for custom build-out modifications at less than market value prices. You could continue to work with a commercial real-estate agent, entertain the notion of buying an undeveloped parcel of properly-zoned land and build your own place, as well. Keep in mind how you would improve on your current operations in a larger facility. You cannot get too detailed when it comes to specifications for a new location. Remember, you probably aren’t going to (or won’t want to) move again any time soon.
Expand outside the lines
If you aren’t totally spent from the aforementioned mental gymnastics, here are even more ways you may want to expand the business without relocating:
- Offer your business model as a franchise or business opportunity. Sure, there are hundreds of sign and digital graphics businesses in the United States, but perhaps the unique way your company meets and exceeds the expectations of a particular clientele could convince another budding entrepreneur to duplicate your concept and leverage the name-brand recognition. How do you think founders of Subway or The UPS Store got started and became rich? It will require you sharing your expertise in getting your franchisees up and running and making money quickly; but remember, you are getting paid a royalty for your good name and reputation and it didn’t cost you a dime.
- Form or join an alliance or buying group. Aligning your company with similar types of businesses can be a powerful way to expand quickly. First, there are economies of scale when your buying group negotiates better prices for everything from raw materials to transportation to warehouse space to needed services. The buying power of the group should bring your cost of goods down and improve your profitability and competitive edge.
- Merge with or acquire another business. There are, from time to time, opportunities to purchase or integrate the capacities of a struggling enterprise, and you could benefit greatly from such a union. Sometimes, the acquired company is in such dire straits that it’s only other option may be to fold up its tent. When you scoop them up (at a bargain-basement price) set them on better footing, and get them productive again, you increase your capacity without a large investment outlay.
Market intelligence should play a key part in your decision to expand the business. There are important clues about the market, and some indication about what your competition is doing, that is easily obtainable by a clever, Internet-savvy sleuth. If your competition is expanding their operations, it is likely they see untapped opportunities in the market. Do your homework and don’t just duplicate what others are doing. Stick to what your company does best and, instead, widen the value gap between you and your competitors.
Whatever you decide to do, try to finance the expansion with company assets instead of borrowing capital from a lending institution or your investors. Many a modestly successful small businesses met with an untimely demise because of overly-aggressive, under-developed growth strategies that required seed money. To learn more on the subject, you may want to check out Arthur Rubinfeld’s book Built for Growth: Expanding Your Business Around the Corner or Across the Globe. Good luck!