How do companies grow? Some little-known insights for investors and teams

A few years ago, there was a major study carried out by the Enterprise Research Centre (ERC) at Aston University which looked at the performance over time of 48,000 high growth firms (HGFs) in the UK. HGFs are defined by the OECD as companies ‘with average annualised growth (in number of employees or turnover) greater than 20% per annum, over a three year period, with a minimum of 10 employees at the beginning of the growth period’. The research checked what happened to the 48,000 firms over the three years following their first three years’ growth spurt. Before you read on, what is your prediction of how many kept growing – to any degree - given their momentum?

The answer is that just 37% did – with little variation by the initial size of company. Of the rest, 17% stagnated while 46% either shrank or died. The study doesn’t offer analysis of why this occurred, but even the basic facts should give us pause when the next information memorandum arrives and we see that the business has achieved three years of healthy growth! How do we ensure that this is one of the 37% not one of those which needs a rest before it can try another burst of growth? Of course, hopefully, the investment screening process will identify those companies with better market conditions and superior business models. Moreover, with the additional financial firepower, improved governance and skilled strategizing that private equity aims to bring, we should be loading the odds in their favour.

In that vein, some recent video interviews with people who have direct experience of getting all that right can offer well-informed suggestions on creating and executing sensible growth strategies:

But it is worth also keeping in mind the work of an economist, Edith Penrose. Back in 1959 she published The Theory of the Growth of the Firm, based in part on astute observation of companies in practice. She identified what she called the Fundamental Ratio which proposes that “The factors determining the availability of managerial [capacities and capabilities] and the need for them in expansion … therefore determine the maximum rate of growth of the firm”. On the need side of that equation, she reckoned there is a sizeable demand for management bandwidth to handle the business-as-usual requirements of a company - with only whatever was left over available for growth. On the capabilities side, she noted that it took time for new managers to learn enough about company specifics to add real value.

Based on this analysis, Penrose warned that “If a firm deliberately or inadvertently expands its organization more rapidly than the individuals in the expanding organization [acquire the capabilities] necessary for the effective operation of the group, the efficiency of the firm will suffer, …, and a period of stagnation may follow”.

There have been various attempts to test her hypothesis over the last 60 years and the evidence broadly supports her. There is also suggestive evidence from a recent paper by the ERC, with the evocative title ‘Too fast to live’ which analyses 6,500 new ventures who banked with Barclays over up to 10 years. That study found that, beyond a certain point, higher growth led to decreased likelihood of survival - due either to excessive risk taking – or the inability to remain coherent from an organisational perspective.

The punchline to retain from all this is that creating or ignoring the balance between the demand for, and supply of, managerial bandwidth can lead to limits on growth at best - or stagnation and failure at worst.

War Stories

Investors and managers who ask us about psychometric tools sometimes imagine that they bring super powers to determine good and bad managers. Others may dismiss them as mumbo jumbo. As the stories below demonstrate, the reality can be weirder and more subtle.

Chalk meets cheese

The investor, Tim, was worried about his relationship with the CEO, Eric, of a business services investee. There seemed to be constant friction in board meetings and in other situations – and that wasn’t helpful given a full agenda of performance and growth issues needing attention. Tim asked whether we could use psychometrics to throw light on the dynamics and get the two men talking about how to improve matters. It seemed like a good plan but when I first saw the results, I was sufficiently worried to question whether sharing the raw reports would be a helpful idea.

To understand my reluctance, we need to touch on a technical feature of psychometrics, namely the concept of ‘acquiescence’. Faced with a personality questionnaire, we may tend to agree with multiple statements confirming that we are good at, or are inclined towards, activities like leading teams, analysing data or selling. That demonstrates high acquiescence. Alternatively, we might be more self-critical and generate lower overall scores. Our preferred tool, Saville’s Wave, will adjust to some extent if candidates appear too self-positive or the opposite, but acquiescence remains an important influence. On a scale of 1 to 10 (where ten is extremely self-positive), the majority of the 700 candidates for whom we have data tend to cluster around the central part of the spectrum.

The problem with our investor-CEO duo was that Eric was very high acquiescence while Tim was on 1. The result was like putting them in front of two crazy mirrors, with Tim turned into a pygmy and Eric an unconvincing giant. In their working relationship, when Tim asked questions, Eric seemed to reply with ridiculous over-confidence (but lack of delivery). From Eric’s perspective, whatever he did, Tim always came with a ‘yes, but’ response – the glass was always half empty. The wildly differing perceptions made conversations frustrating on both sides.

The fact that there would be some difference in their approaches wasn’t a complete surprise. Different role groups have varying averages for self-positivity. Sales directors and CMOs are higher than average; FDs and CTOs lean below average; CEOs and COOs sit roughly in the middle. Curiously, the private equity investors for whom we have data are the lowest of all – i.e. tending to be self-critical both of themselves and often others. But both Tim and Eric were extreme cases.

When I asked Tim how he approached the questionnaire he explained his unusual approach. If asked, say, about how he handled detail, he would think about the best person he could think of when it comes to detail, and score himself against them. Inevitably, he ended up scoring lower than most people on most things. More importantly, though, he effectively painted a weird image of himself – because those who work with him know Tim as a likeable, thoughtful, balanced and strategic professional. The happy conclusion to the story is that a coach was introduced to help Tim and Eric work on smoothing their interactions and this has facilitated decent collaboration and economically valuable results. 

From a psychometric perspective, there is an apparently contradictory lesson from this story. Personality results can seriously distorted by extreme types of response – but still point to a fundamental truth about the individual concerned.

Green section line

Unbalanced but strong

"Before we begin the interview, I need to comment on the leadership profile you sent me”. The software company CEO, Hans, was within his rights to do so but I worried that he might be one of those (relatively few) people who take personal offence when the output doesn’t match their perceptions of themselves. Only a minority of those who start annoyed are open to our explanations that the results need to be seen in the context of comparison groups (other senior executives and entrepreneurs) and, like any self-score questionnaire, taken with a good pinch of salt. In one unhappy case, a CEO accused us of falsifying the results to make him look bad. 

But Hans started with a question: “Would you say that my results look unbalanced?”. The honest answer, and the only one I could give him with the results spread out in front of us on the table, was ‘yes’. While his predicted strength in innovation, change and driving performance were all unusually high, his scores around handling detail and process and, even more, dealing with people were strikingly low. Before I could shift the conversation in a more nuanced direction he charged on. “Although I have a few quibbles here and there, I completed the questionnaire honestly and the results are a fair reflection of my relative strengths and weaknesses.”

I was already intrigued what Hans would say next because quite a few people, faced with apparent weaknesses, feel the need to almost apologise for their gaps and commit to working on them. However, that is rarely convincing because senior managers in private equity backed businesses are usually very busy with limited space to focus on personal development. Instead, Hans went on to explain that, knowing his preferred approach to work, he had set up his team to handle the people and detail aspects so that he could focus on strategy and the performance framework. He insisted that I check his description with other colleagues.

What emerged from the subsequent discussions was a team organised through a clear division of labour and held together through the application of the Rockefeller Habits (a methodology for scaling up growth companies). Hans was liked and respected - although he wouldn’t be anyone’s first choice for a sympathetic shoulder to cry on. Even more importantly, he provided focus and coherence for his team and delivered growth and value to his various stakeholders, including the investors who had backed him.

There are several take-aways from this story. Firstly, there isn’t a specific success profile for a CEO and being well-rounded isn’t necessarily an advantage. Secondly, CEOs do need to be self-aware and organise other people to leverage their strengths and cover their weaknesses. Lastly, the main unit of performance is the team – and there are many combinations of personalities and skills which can work well.

 

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