Finding Your Growth Engine

As we discuss our approach here at Bacbone with founders of services and software businesses, a question that often arises is how we support the entrepreneur/CEO/founder in capturing hidden growth opportunities. Bacbone focuses on partnering with founders who want to expand the legacy of their firms and create even greater wealth and employee opportunity in the process. In this blog we explain why we believe these hidden growth opportunities really do exist and what founders might do to pursue them (with or without a partnership with Bacbone).

The Reality and Opportunity of Hidden Growth Opportunities

Even though the new growth areas may be “hidden” or non-obvious, we are highly confident that they exist for most successful companies because of the history of countless other companies finding ways to exploit them. There are the large and well-known examples like Apple where a returning Steve Jobs inherited a shrinking iceberg and found new avenues of growth hidden to former management – and to the marketplace more generally – creating the juggernaut that we know today. Jobs saw growth opportunities is mobile devices (beginning with the iPod) that were ‘invisible’ to prior management and to most of the rest of the consumer electronics industry.

Ahh, you say “that’s just because Jobs was a creative product development genius. That’s a unicorn”. Well, then let’s stay with larger companies and discuss the example of Microsoft after Satya Nadella became CEO and focused on the growth opportunity in cloud hosting and SaaS. Microsoft since Nadella became CEO has found dramatic ‘hidden growth’ opportunities.

Ahh, you say, “that’s only relevant in the software or tech industries where cloud or mobile devices suddenly took off.” But we can look at the example of Honeywell under David Cote or a range of other industrial and consumer companies that have found their own hidden growth.

Ahh, you say “that’s just about big companies with large resources. I operate a small company that can’t invest in new product development or acquisitions to enter new spaces like those companies.” We can offer our very personal example of RKNEAL, who we partnered with to create a legacy with its founder. RKNEAL was an industrial automation integrator with highly variable revenues with low growth. Together with the founder, we found new areas of growth adjacent to their current business. Over a 5-year period, the company grew 6X while shifting revenue from one to annually recurring. Or let us offer a different example from an industrial gas sensor manufacturer that we partnered with that tapped into adjacent markets to create a 15-20% consistent grower at 50%+ margins through new product innovation.

The reality is that the list of examples is long, but the list of companies that do not tap into those opportunities is even longer.

So, what are the drivers of finding and capturing these hidden growth engines?

Almost 20 years ago, the author was part of a McKinsey & Co. research project called “The Granularity of Growth”. The key finding of this research was that the companies which outperformed on revenue growth over sustained periods of time did so by tapping into higher growth “micro-markets”. Micro-markets were specific sub-categories of end markets which had higher growth characteristics. And the most consistent growers found a way to replicate their pursuit and capture of these growing micro-markets. Two companies might be operating in what appeared to be the same market; however, one was more exposed to a specific sub-vertical or geography or customer segment that was outgrowing the others by 2-3X. An example of this might be IT system integration. From the outside-in it might appear that two $100M system integrators in 2015 operated in the same “market”, but one had a particular focus on Salesforce.com or ServiceNow implementations while the other had a focus on utility and telecom BSS/OSS. The first was growing 20-30% per annum while the latter was struggling to maintain revenues. This wasn’t explained by their effectiveness compared to competitors, but in the micro-markets in which they operated.

We saw this clearly in the case of RKNEAL, where our growth far exceeded the average industrial automation firm because of our focus on networking and cybersecurity rather than general controls automation design. Most importantly, our partnership with the founder enabled him and his family to realize 5X more than he would have had he sold 100% of the business and exited completely.  Finding and exploiting hidden growth areas of cybersecurity and software transformed the business from a revenue and a valuation standpoint.

But how did these companies like RKNEAL find and tap into this growth?

First, the CEO had to overcome external and internal hurdles to pursue the hidden growth opportunities. We call them “hidden” for a reason. They are not obvious. If they were, then every organization would pursue them. In every instance we have seen, to pursue the hidden gems, the CEO had to overcome skepticism from employees, other investors or partners, or even their spouses who don’t want to pursue the new areas because of the risk or challenges involved. In many cases, the CEOs themselves, have their own internal fears or doubts which are only exacerbated by these external forces. Success requires belief before achieving results.

Second, the team needs to identify accessible growth micro-markets. This involves rigorous fact-based analysis combined with some creative vision work to imagine the “what could be” that might help form new markets. In most cases for smaller companies, you will be more exploiters of current high growth markets, but there are times where your vision may align with a big new space that has yet to emerge.

The search begins by breaking down the company’s revenues into sub-categories. In most cases, even small businesses have a much more diverse mix of revenue than the top line financials would indicate. They already are participating in multiple micro-markets hidden by the aggregated numbers. Several dimensions are worth exploring to understand the company’s current micro-market exposure:

• Geographic: a company with only US sales may not think that they have geographic differences, but market growth may be highly variable depending on the state or region they operate in. Or it may vary based on the suburban vs. urban dynamics. In the example of the gas sensor business mentioned earlier, the growth in the Permian Basin was three times the growth in other geographies. A shift of resources towards that geography and away from others allowed the company to add several points of overall revenue growth to the business.
• End-customer by segment (industry, financial status, age, etc.) One of the least hidden of the opportunities is where customers in one segment are growing more quickly but the sales force efforts are not directed that way. Over the past several years, if your industrial automation company was exposed to the data center market, you significantly outgrew equally talented firms focused on other industry verticals. Similarly, you might spend years trying to convince a low margin commodity producing client to buy from you, when a pharmaceutical manufacturer with 40% net margins might allow for faster growth with a similar value proposition.
• Product offerings (functional service offerings or product offerings). Your business may offer several distinct products. In many cases, services companies offer dozens of different micro-services even though they are all categorized by a common title. For instance, in the case of our industrial automation business, controls programming, electrical contracting, network design and programming, PLC installation, data historian maintenance, updating of software, cybersecurity software sales, etc. were all initially categorized under “industrial services”. By clearly defining the value offered we were able to focus on those offerings with higher current and potential growth.

Although the process begins with an internal review, looking externally is critical as well. In many cases, a company may not see the growth that is just adjacent to them because they have such a small presence in that space. Or the “hidden growth” market is only in a very emergent state and needs encouragement and initiative to take off. One of my favorite examples of this is that of mobile phone insurance. In 1995 a pair of recently graduated MBAs acquired a small roadside assistance business that sold their offering through wireless carriers and their retail partners. In their evaluation of the adjacent markets, they began to see the need for phone insurance. However, they didn’t have the necessary access to that market. The company acquired a small specialty phone insurance company. Today the company is the largest provider of electronic device insurance and repair in the world and a multibillion-dollar enterprise. They looked outside their direct market to adjacencies and had a vision of what the future might hold.

The reality is that for many founders, they did enter new markets when they started their businesses. They saw a need for a better way of delivering a particular service than their current employer offered or than they were offered as a customer. They took a family business and expanded into new markets that they believed had potential. They created a product based on a technical understanding and by listening to customers iterated so that product would deliver a truly different value proposition.

The discovery of your new growth engine means going back to those roots of discovery and dreaming of what could be that may have started the business in the first place.

The Challenges of Pursuit

The examples of success are numerous. As mentioned, many founders began their journey by finding hidden growth opportunities. So why is it so difficult to execute when the business reaches $15M, $30M, $50M in revenue? Although there are dozens of potential reasons, we see three most often in our experience.

1. Lack of resources. By resources here we are including financial capacity to invest and the human resources of skills and time to identify and then to successfully capture the hidden growth engines. By the time a company reaches $15M, $30M, $50M in revenue, capacity often becomes a major challenge.  We have yet to meet a founder of a company at this scale that says he or she has extra time to think strategically about new growth paths by breaking down customer offerings, segments, etc. or to analyze external market phenomena to spot potential new markets that may be in the process of emerging. Founder CEOs are running a business. They are interfacing with current and potential customers. They are dealing with supply chain issues. They address people issues. They are focused on improving current products to continue to satisfy current customers. Etc.   Other companies lack the financial capacity to invest in new growth vehicles, whether that be hiring new salespeople to target a new market, developing a new product, or making acquisitions. To be clear, we are generalizing here. There are certainly many founders who rigorously set aside time and money to do just these kind of growth analyses and investment. But for those that haven’t tapped into growth engines, this is what we see most often.
2. The status quo. Founder CEOs have invested their time, money, and soul into their businesses. In many cases it takes years for those investments to bear fruit in terms of profits to fund personal expenses or time to enjoy more of their life outside work. By the time the company begins to plateau from a growth point of view, these successful founders have finally begun to enjoy the fruits of their labor. Their lifestyle needs and wants have expanded with the profitability of the business. Finding new engines of growth is hard and takes time and, resources that might interrupt the near-term status quo which they have worked so hard to achieve. The decision to change the status quo is further complicated in many situations by other owners, family members, bankers, etc. Again, we are generalizing. Many founders keep the pedal down, reinvest all their earnings into the business, and work 80-hour weeks. But many, rightfully, want to both enjoy the benefits of success while also capturing the new upside that growth engines promise.
3. Lack of expertise, especially in innovative technologies or functional capabilities. This is perhaps the most prevalent among those that are willing to give up the status quo…or have always continually worked 80 hour or more weeks and can’t see not doing so. To pursue new growth engines often requires tapping into new capabilities. For instance, at RKNEAL, the founder had a passion for growth and had tested the market well enough to believe it was there. What he didn’t have were the enterprise sales or software development skills to build a true enterprise software business. Like many founders, he was willing to work overtime to achieve his dream, but he didn’t know how to build that business model. Many founders at this point get stuck and either stabilize their current business OR sell out completely. We think this will become an even larger issue as more business opportunities rely on modern technology to capture them. Artificial Intelligence will become a core element of future growth. Technology is moving so fast that anyone not engaged in it actively is falling continually behind. More tapping these growth engines will require this AI and software technology expertise.

Practical Steps to Begin

Given the challenges as well as the opportunities described above, what should a founder do to start down a journey of finding hidden growth engines for his or her business? Again, there are many steps one might take that would help make progress, our view is there are 3 key elements you can take right away.

1. Decide if you are deeply committed to this…and be very accepting if the answer is no. Finding and tapping into new growth engines is hard and risky. The analysis described above takes time and energy to complete. It may require spending money on external analysts to look at your data. Once a new opportunity is identified, it may require additional capital or a reduction in near-term profitability to execute. We recommend a discussion with other owners, stakeholders such as spouses, and an honest personal reflection on the desire to capture a dramatic new growth potential. There are many terrific paths for a successful company should you decide not to commit to it. Obviously, we believe the upside can be dramatic is you do decide to commit to it. But be sure that it is what you want.
2. Once committed, conduct an internal review of opportunities. This normally begins with a breakdown of the company’s revenues over the past 3 years or so. It includes looking at revenue by customer, services or product line, geography, segment, etc. You will want to understand growth rates by sub-sectors of the revenue. You should evaluate the “why” certain markets are growing faster or slower than others. Once the review of the current business is concluded, the analysis should then move to an initial external market review. By talking to customers, suppliers, industry analysts, and even competitors, you can begin to get an understanding of what market opportunities might exist just over the horizon from the markets you currently play in. For instance, at one of the companies that the author was on the board of, discussions with investment bankers identified a service offering that was growing quickly and could be accessed by our team by just shifting the resources a bit and hiring one or two key personnel.  This internal review will provide an initial perspective on the opportunities. It may not provide a comprehensive list, but it should give some guidance of what is possible to reconfirm your commitment…or not.
3. Consider external partners. Private equity and/or venture capital firms bombard almost every founder with inquiries to acquire or invest in the founder’s business. As a CEO of a mid-size business while at RKNEAL, the author received 2-3 emails per week from interested partners. It turns out that these potential partners (whether you choose to do anything formal with them or not) can offer an independent view on the market and the possibilities that your internal review may not capture. Sure, many of these firms know little about your market, and you can quickly spot them a mile away. But others have invested in similar businesses in the past or have spent considerable time analyzing particular market segments and are purposefully contacting you because they see an opportunity in your sector. We recommend accepting a few of these discussions, listening to their theses, and then testing your ideas on them. This external perspective, if done with an intentional mind of learning and testing the internal review done in step 2, can add significant insight to the possibilities.

You may decide after these steps that partnering officially with someone like Bacbone or others can accelerate your growth trajectory or provide you with the liquidity you need to sustain your lifestyle while participating in the potential for a bigger upside. You may do so because you believe that partner offers unique insights, beneficial capabilities, financial liquidity, additional capacity, or some other reasons. Or you may decide to continue independently. But in any event, external exposure can only increase your understanding of your market, its adjacencies and how others see it.

Conclusion:

Hidden growth opportunities exist for almost all companies. Some may be within arm’s reach and others may require stepping outside your comfort zone into new territories or product categories. Some may require additional financial resources to develop products or even to acquire other companies to gain a stronger foothold. Importantly, you do not have to do it alone. You can ‘have your cake and eat it to’ through the right partnerships that allow you to gain skills and financial capacity while participating in expanding your legacy as well as family wealth.