Christian Brim, CPA, is CEO of Core Group. Grow profitably.
This question sounds like heresy, I know. Entrepreneurs hate the idea of going backward or “failing.” However, there are times when shrinking your business is the correct strategy. In my experience working with hundreds of small businesses over the years, these are the signs that it’s time to shrink — and how to do so while focusing on profitability.
You’re facing a lack of profit.
Businesses often grow expecting profits to come later. “Invest in the business” is a common mindset. However, the wrong growth will only cause more problems. The entrepreneur has to have a crystal clear idea of who their ideal customer is. Your ideal customer should also be your most profitable.
How do you determine who your most profitable customer is? By analyzing your gross margin. First, identify any direct cost in delivering goods/services to each customer and subtract the related revenue; this is your gross margin for that customer. You need to calculate both the total dollar amount and the percentage of revenue. For example, if you have a customer who spends $1,000 a year with you and the direct cost of delivering those goods/services is $600, that means your gross margin is $400 and your gross margin percentage is 40%.
Next, rank all our customers by percentage, worst to best. Now comes the difficult part. The best strategy toward profitability is typically to “fire” the bottom 20% or more of your customers. Challenges arise when one of those customers has a large dollar gross margin but a small gross margin percentage. It takes guts to get rid of those dollars, but the reality is that you are consuming a lot of resources for not much return.
You hit the ceiling.
To continue growing, businesses often have to continue to narrow their focus. That means that some customers and clients who were profitable — in other words, were not among the bottom 20% — still need to go away. This culling is usually even more distressing to business owners than firing customers who aren’t profitable.
When you narrow your focus, certain customers just don’t fit anymore. Continuing to serve them will just be a distraction from investing in your best customers.
Your goals have changed.
Ultimately, your business should be designed to deliver the life you want. Businesses often grow beyond what the founder originally intended. Alternatively, maybe something changed in your life that means the business needs to look different to give you the life you want.
For example, maybe you don’t want to work as many hours in the business because you now have children or want more flexibility to travel. Reorganizing your business to fit your needs is perfectly acceptable, and sometimes this means shrinking the business to accommodate.
It goes beyond the owner.
The major governor of any business growth, in my experience, is the capacity of the person in charge. Growing the company from point B to point C will require a different skill set than what got you from point A to point B. Many entrepreneurs reach the next plateau, look at the next mountain and blanch. That is absolutely OK! There is no harm in being satisfied with the business as it is. You don’t have to keep growing just because there is nothing else to do.
I know many entrepreneurs who decided the next step was too large. They scaled back their business, hyper-focused on profitable customers/clients, and made the business work for them. It is much better to have a healthy bottom line and lots of free time than to keep grinding out growth.
So, is it time for you to shrink your business? Only you know, but my admonition is to do whatever you do with intentionality. Don’t let the business be the dog that wags your entire life around. Grow, shrink, it doesn’t matter — have a life that is worth living.