The Three Year Itch, The Second Scale

BigRedCar
10/9/21

If you are a startup that has survived for three years, have a substantial gross revenue, are EBITDA positive, are GAAP earnings profitable, and have an attractive annual growth rate — CONGRATULATIONS.

You are a top 1-5% startup company and now you face the Three Year Itch or the Second Scale issue.

The problem is this —

 1. You are as busy as a one legged man in an ass kicking contest. Everybody is working their butt off. You can feel the effort in the air. Taste it. You are proud, but exhausted.

 2. Noting the above, you feel the need to add hands and person hours to the organization — maybe, just to relieve the perceived burden currently. Belay that thought.

In your exhaustion, you are struggling to figure out how. Perfectly normal, sorry.

 3. You want to grow — double in sales in the next 2-3 years [in my mind, you are in the $10MM range headed to $25MM in Year 3 of the New Plan (meaning Year 6 from founding)].

 4. You are clearly a powerful entrepreneur, but you have no idea how to handle the next three years — you had no idea how to form a company and take it to market, but you seem to have knocked it out of the park, so do not fret.

 5. You are going to do this thing. Why not do it under control?

So, what now, Big Red Car?

Let’s try something we’ve seen work before? Why not?

Here is how you do it:

 1. Know your numbers. Know them backward and forward. Know every product and what it generates, all the margins.

Take a second to ponder where each product sits in its product life cycle — growing, mature, declining, headed to the bone yard.

 2. Know the Revenue/FTE — gross revenue per full time equivalent employee.

 3. Do the same thing with each department — gross revenue per marketing employee, gross revenue per warehouse employee.

 4. Construct a dollar weighted organization chart with every position identified by discipline (management, operations, tech, marketing, fulfillment) andindividual, but any way you want to do it. Take a first pass and build more detail on it the second, third, fourth times.

You dollar weight it by putting the all in cost — compensation, benefits, short term incentive comp, long term incentive comp, anything special — to the company of every position. Yes, you include payroll taxes — every penny.

 5. Stare at the dollar weighted org chart and the revenue KPIs and really know your point of departure. Understand the BEFORE like it’s an HGTV makeover.

Run it by everybody involved with making decisions and make damn sure you and they know from whence you are springboarding forward.

I cannot tell you the number of times I have seen companies trying to plot their growth when they don’t collectively know their point of departure. It is bloody apocryphal. Do not be bloody apocryphal.

 6. Some principals of growth:

 a. You will increase sales of your existing products or services.

 b. You will introduce new products or services.

 c. You will see changing cost structures of your business — as an example shipping costs with increasing gas prices and ballooning container shipping prices will change. Make a list of all the variable expenses that will change.

 d. Labor expenses are going up.

 e. Income taxes are going up — if you voted for Joe Biden, this is on you. Thanks.

 f. In a healthy company, Revenue/FTE will be increasing as you become more efficient and achieve economies of growth. This is very important. It is why larger companies make more per widget because they can spread their corporate overhead over a larger base of products.

You may be able to produce $25MM in revenue out of the same warehouse or production facility from which you produced $10MM in revenue thereby spreading the same rent expense over a larger base. You will be surprised at how many different things work like this.

Aim for, look for, and achieve these efficiencies and economies of scale. This is exactly why you want to grow — you will become more profitable. If you are not able to find these in the final numbers, then you are doing something wrong.

 g. If you are spreading your fixed expenses over a growing pool of revenue, then margins should show evidence of upward mobility — margins should be increasing.

Let me REAL WORLD it for y’all — maybe margins don’t go up, maybe you just absorb the increased cost of transportation, labor, taxes, but you maintain your margins.

Margins are not something you calculate and accept; margins are objectives toward which you work. If you are a SaaS company, they are huge; if you are in eCommerce they are tighter, but make no mistake — margins are where the profits come from.

Ahhh, Big Red Car, how do we actually do it?

Just as you laid out your existing dollar weighted org chart, you build a dollar weighted org chart for Year 3 of the New Plan (Year 6 of the company) and work backwards.

Here are some tips:

 1. Build the dollar weighted org chart the exact same as you did your point of departure dollar weighted org chart — functional and by individual with the cost of each employee identified.

 2. If the target is a $25MM company, then you can take some guidance as to how many warehouse workers you will need by going back to your Revenue/Warehouse Worker metric and applying it (and the targeted efficiency) forward.

 a. You will have more employees at $25MM than at $10MM, of course.

 b. Start with the Revenue/Warehouse Worker metric at some higher level of efficiency — meaning going up.

As you can see, it is not a perfect arithmetic science, but it is pretty damn close if you play with and document your assumptions. Wages go up 5-10-25% over the next three years and how much per year?

 c. You do this with every function within the company.

 3. Once you have your Year 3/$25MM New Plan dollar weighted org chart, you walk the cat backwards.

You make annual dollar weighted org charts — Year 1, Year 2, Year 3 of the New Plan. Each year has a different, growing, level of revenue and cost.

This type of incremental planning is crawl, walk, run in reverse.

 4. When you like Year 1, Year 2, Year 3, you add more sensitivity by doing Month 6, Month 12 (Year 1), Month 18, Month 24 (Year 2), Month 30, Month 36 (Year 3).

In this way, you have created a road map for growth in digestible bites that you can really follow.

 5. Take these dollar weighted org charts, drop them into a spreadsheet, add corporate overhead, and VOILA! you have a pretty damn good idea of what it will take to grow to $25MM.

Practical takeaway: Your hiring plan will simply be adding the right people in the right positions at the right time as shown in the dollar weighted org charts. How many people do you need to hire in the first half of 2022? It’s in the freaking plan.

Pro tip: Hire the revenue producing people first, if you can.

This is the start.

OK, Big Red Car, what next cause we have college football today?

With your initial plan completed — INITIAL — do the following:

 1. Test it for all the KPIs — Revenue/FTE by department and margins.

Does it show the revenue per employee increases and the margins increases/protections it should? If it doesn’t — back to the drawing board.

 2. Have you considered vertical management — add 25 warehouse workers, you have to add a supervisor, right? Is the vertical management in the plan?

 3. Graph everything — take the first real three years and extend those graphs into the future.

Do the graphs make visual sense? There should be an inflection point in the New Plan as the efficiencies kick in. Can you see it, find it? It could just be a continuing upward slope.

I think graphs and charts of financial information and plans is the smart way to “see” the results. It helps the visual learners.

 4. What does your gut tell you? Never, ever fail to make a gut check. You are an experienced, savvy “seer” because you are a successful entrepreneur.

Women are infinitely better at this than men because they are often mothers and understand things men never will.

A Mom can tell the sound of their baby’s crying in a Super Bowl stadium full of crying babies. That is straight from the Holy Ghost — who if you think about it, invented the startup game.

 5. You will not make the rookie mistakes you made when you started the company because you have three years of grad school level education in the REAL WORLD — run it by everybody who will look and make sure you have not missed anything.

Pro tip: Start really paying attention to taxes and how to legally avoid them.

A special word about new products

If you are a company that has expanded and grown by new product innovation, then you have to also plan and budget for new products. In fact, they may be critical drivers of growth — no, your initial core products will not disappear, but the juice may be in the new products.

Start by laying out the new products and how much revenue you expect from each one. New products with existing products have to add up to $25MM, right?

 1. Start segregating the cost of new product development, so you know the cost of a failed or “DNL” did not launch product development effort.

 2. How many products did you launch in the first three years of the company and how many will you launch enroute to $25MM — more, less, don’t know?

“Don’t know” is not an acceptable answer. S0rry.

 3. For planning purposes this is very important — because it tells you and the new product group how many products they have to work a year with some room for a handful of DNLs.

 4. Put a number to each product effort.

 5. You don’t have to know exactly what product you will launch in Month 18, but you do have to know if you will launch one in Month 18 and how long it takes to do it correctly.

In all of your thinking about products, you also have to know the financial outcomes of each product line — cost to make, cost to market, price, gross revenue, and velocity (sales going up, down, flat).

At some time if you are in the multi-product business — and who isn’t — you have to devolve to being a manager of competing products. You have to grow the winners and one day you may have to cremate the ones that are no longer viable. It happens.

A word about customers

All the money in business comes from customers and in a just world the customers buy a single product and then broaden their purchases across the entire brilliant product offering landscape. You are seeking customers for life, loyal customers.

You are, of course, trying to broaden your customer base and drive more revenue/customer. These are givens.

Which all stands for the proposition that to grow, you will have to know your customers and grow your customers — both new customers and more revenue from existing customers.

I will not insult you to say, “You have to know your cost to acquire a customer and their long term value.” Haha. Of course I will.

 1. How many customers do you have, what is their average spend, what is the total spend, when do they spend?

 2. What is the universe of customers and how many of these customers are “addressable” meaning you can reach?

 3. What can you do to broaden the pool of customers — not just from a product perspective, but also from a promotional/marketing perspective.

I am limiting this discussion to the mechanics of plotting growth, but there is another parallel discussion as to how a growing company manages its evolving Go To Market Strategy. The Internet is changing and channels of marketing and customer outreach are constantly changing. You have to be on top of this stuff. I know you are, but double down.

 4. How can you get the customers’ sweaty fingerprints on the murder weapons — get them involved in new product development by telling you what they want?

Then, again, Henry Ford story: “If I had asked my customers what they wanted, they would have said faster horses.”

 5. The most important check point on customers is how many customers at some range of revenue/customer are necessary to drive $25MM in sales? It all starts and ends with $$$/customer.

OK, Big Red Car, we’re out of gas — get it? Bottom line it, please.

Yes, dear reader, I get it.

Here is the bottom line:

There is a way to carefully, thoughtfully plot the growth of a $10MM company to a $25Mm company that is precise, mechanical, and built piece-by-piece that relies upon specific tools, an organized, methodical approach, and your historic information whilst respecting the necessity to achieve increases in revenue/FTE and margins.

You can do this. It is not easy. It will take time, but you will know the plan because you made it.

In the absence of a plan, anything can happen.

“The first casualty upon contact with the enemy is the plan.” This was Dwight David Eisenhower speaking to the plan to invade Europe on D Day. He went on to say that part of planning was contingency planning — alternative plans based on battlefield developments — and that having a plan was essential to be able to plot those deviations.

Good luck. You got this.

But, hey, what the Hell do I really know anyway? I’m just a Big Red Car.

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(Source : https://themusingsofthebigredcar.com/the-three-year-itch-the-second-scale/)