For private equity firms managing small and mid-cap companies there are five common reasons that growth gets stuck in first gear. But that doesn’t mean it has to stay there.
Given the high prices of assets these days, GPs need full-fledged growth at portfolio companies to generate the returns that will bring LPs back for the next fund. So we sat down with David Vroom of Chief Outsiders to discuss the five most common challenges small and mid-cap companies have with growth.
Vroom speaks from experience, having interacted with hundreds of such companies over his career as a CMO. Since joining Chief Outsiders, he’s dealt with over a hundred PE firms as well, helping them spark the kind of the growth that can be all too hard to generate at these enterprises. Here are the 5 most common challenges he’s seen.
1. Marketplace Changes
Too many companies are slow to understand that what worked before, won’t work now. “The reality is that the market changes rapidly,” says Vroom. “The competitors, the customers, and their expectations can shift, and it can be hard for a smaller company with limited resources to evaluate and understand the market movements and then make the necessary moves quickly.
2. Navigating New Terrain
Often the company may see the potential of a new geography or new market segment, but won’t have the in-house expertise to execute that move. “They’ll often pick one initiative, execute it half-heartedly and then regret it soon after,” he says. “When what they need is someone to review the top four or five options for that new geography or segment, and ask, which has the best chance of success?”
Then, Vroom advises making sure that they tap the right counsel to guide that initiative. He recalls an oil company that assumed they could move into Texas easily, but after reviewing the market, competitors and margin potential, realized that was a terrible idea. “Even a small geographic or segment move still requires review and expertise,” says Vroom.
3. Misunderstanding the Competition
With the market in such flux, it’s hard for companies to truly understand the competitive landscape, and more to the point, their place in it. Vroom suggest companies inventory their current competitors and name their top five. “Then, they need to take a good, hard look at what the competition does better than they do, and what they do better than their competition,” says Vroom.
This allows the company to decide when to play offense and go after a competitors’ customers and when to play defense. And even playing defense doesn’t mean ceding the field. Or as Vroom explains, “Sometimes first is better than better.” If a company can talk about a need that a customer really cares about, even if they aren’t superior to their competition, if they can find a way to differentiate themselves and brand it in the customers mind, they will have a point of differentiation.
Vroom recalls a client who did have an edge over its competition when it came to customer service. “So we had them tell customers they were launching a ‘concierge service program’, which gave customers a single ‘concierge’ for any problems they have, from billing to engineering,” says Vroom. “And that concierge would jump through hoops to solve the problem. We branded that effort and soon, prospective clients were intrigued by this new program and actually were talking about our superior customer service by name.”
4. Eroding Margins
There are a number of factors squeezing margins, but smaller companies often begin with a “cost plus” pricing mentality that can be detrimental in the long term. These enterprises make a great product and charge the cost plus, say 30%. When their costs go up, they can go to customers and raise prices. “But they’re teaching their customers, when costs go up, so do prices, and when costs go down, they’ll expect prices to follow,” says Vroom.
But what he helps his clients do is move to a marketplace value pricing model, based not on cost, but on how much the customer values it in the market. This allows companies to pursue value add initiatives that can result in even more price increases and improving margins overtime.
5. Random Acts of Sales
There’s a sense at many small and mid-cap companies that the one and only route to increase sales is to hire more sales staff. “We call this bias the “theory of random acts of sales” where adding bodies will work magic,” says Vroom. “And usually, sales people are less effective per head than they were ten years ago.”
The solution is to make the sales effort more strategic, by identifying the five or six segments of customers and picking the best growth and profit customer profile. “Then you task the sales staff to identify and prospect four or five of those ideal customers in the next year. Sure, other customers can walk in the door, but that focus can work wonders.”
Vroom also suggests making sure companies look at the “lifetime value” of a customer: “A customer that buys $10,000 worth of goods one year and never comes back isn’t the same as a customer that buys $5,000 this year and might buy $15,000 three years from now and double that a few years later.”
Vroom makes it clear that all these solutions still take discipline, focus and talent, but knowing these common pitfalls can help inform a first 100-day plan that will set the portfolio company up for an exit worth celebrating.