Attempted Growth Can Leave You Broke (Part 2): Making a Sober Assessment of Demand

Mid-sized firms striving for growth are just as susceptible to running out of cash as firms that are shrinking. Simply put, they can spend too much too fast, or

spend too little too late.

In my 8/21/12 post, “When Shooting for Growth Can Leave You Broke”, I explained why this is so important to mid-market firms, and identified three elements of sound decision-making when cash flow goes negative. The first is market predictability, the focus of this article. Will your product be met with sufficient market demand when you need it? Your confidence in your ability to predict demand is a critical factor in deciding the right spending velocity.  Market predictability has earned the left (vertical) axis in our spending velocity matrix.

To assess market demand, the CEO and his top team must get out of the office and into the marketplace. Trade shows and industry association meetings are excellent venues for meeting other business people and asking their opinions. Customer visits are also invaluable. With your customers’ permission, you should record their responses to a standard set of questions (asked conversationally) and then look for patterns. For more ideas on this, read the article “Get Out!”

You can gain further insights on the status of your marketplace by tracking competitors and measuring objective indicators of their success. For those industries large enough to be followed by research firms (like Gartner in the IT industry), plenty of secondary data is available. Regular meetings with investment bankers who study your industry will yield more pieces of information. New data trumps old data; what you learned last year may not be relevant today.

But investigating the marketplace is not just the job of the CEO. Every member of the top team and sales department must collect this type of data. The CFO in particular should be involved since he will be the ultimate architect of the pro-forma financial forecast. Letting the management team – not just the CEO and CFO – gather and jointly discuss this market data will greatly reduce the chances of acting on biases and pre-dispositions.

I put far more trust in executives who have a stake in a business than in those who have only their job at stake. Venture capital firms often insist that all top management executives have stock or stock options. They have so much more to lose if they’re under- or over-aggressive. But mid-market companies are established enterprises, not startups, and so distributing equity is a little trickier. I’m not suggesting changing ownership in the short term. But as your executives weigh in about the state of your marketplace and the company’s ability to compete in it, you must carefully consider the source. Those with real skin in the game are much more likely to strive for the truth.

These dynamics helped the company I mentioned at the beginning of Part 1 of the article – BlueArc, a venture-backed data storage manufacturer – build cash despite having to make huge, risky investments. In 2008, BlueArc’s chief financial officer, Rick Martig, saw a worrisome trend: negative cash flow from operations and the macro environment started to decline by the end of calendar 2008. From getting out into its fast-changing marketplace, Martig and other BlueArc executives realized they had to add a mid-range product to complement their high performance product portfolio.  However, this required continued investment in product development and thus significant investment in R&D when cash from operations was not improving.  Based on the information they received from customers and market experts they knew this was vital for the continued growth of their company in midst of declining economy and cash flow.

Several larger competitors had started down the initial public offering path (before being snapped up pre-IPO by Dell , EMC and HP), so their financial and operating results suddenly became visible and were critical to proving that sales growth and market expansion via a mid range product was a way to expand their market. On the strength of all the research from Rick and the senior team  Rick initially raised $7 million in venture debt to bridge the company to complete the R&D work to complete the mid range product and introduce it in the market.  The senior team knew they needed longer term cash to continue investing in the business which the team did raise another $21 million in subsequent years prior to the acquisition. The new mid range product became a major market success, which enabled BlueArc to hit its targets and contributed to getting the company to EBITDA break-even a year and a half after market introduction. As the company prepared for its own IPO in 2011 (by that time, BlueArc’s revenue was $85 million, according to its stock prospectus), it was acquired by Hitachi Data Systems at excellent multiples of both revenue and earnings. The BlueArc team knew it was critical during a tough market and cash times to find resources in any way possible to invest where they thought the product would be successful and help the company grow in future years.

I doubt that this is your first time trying to assess your marketplace. But have you been caught by surprises where sales spiked up or down without a clear reason? Have you introduced new products or run promotional campaigns and received a very different result than you expected? Your past market assessment accuracy is a strong indicator of future accuracy.

Following the process suggested above takes time and resources. Some owners and CEOs of mid-market companies have a level of hubris that leaves them feeling invincible. Some of their sales leaders are very aggressive—cowboy style—and don’t have the patience for it.

But the key to not running out of cash in good times or bad is making a market assessment an ongoing process. Once it is part of your company’s DNA, all your forecasts and decisions will be far better informed.

I wish I could tell you that all markets are predictable. But they are not. You may have a gut feeling about the marketplace and you might be right. But your risk of failure is high, and it could well take you two or three adjustments to get it right. Reserving enough cash to finance several attempts to bring in new revenues is the best approach.

Step one in gauging how much cash should go out the door is getting clear on the predictability of your market.  In my next post, I’ll dive into the assessment of execution confidence.

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