Article published in Critical Eye on how large should your business be

1. How Big
Should
You Be?
By Robert Shaw & Susan Goldsmith
Sizism is an unhealthy prejudice to make business
ever larger. It ignores the laws of economics
– Pareto, scarce resources, diminishing returns.
Yet, it underpins much of the target-setting in
business today, as well as reward systems. Through
ten simple questions this article shows how sizism
can best be understood to the benefit of the CEO
endeavouring to ‘rightsize’ business operations.

2. Big? Really big? The biggest? Conventional basic economics and the Pareto principle
wisdom says big is beautiful. However, is about scarce resources and diminishing
that true? Today, size seems to be viewed as returns. In reality, sales volumes are limited
the uncontested success factor in business. and relentlessly pursuing higher volumes
Indeed, sometimes it seems like the only will drive up costs disproportionately, as
factor which is a form of business sizism. customer needs and wants become satiated.
Yet 50 years ago, size was a hotly The second fallacy, which comes from
debated strategic issue, and usually the the PIMS studies (Profit Impact of Market
first factor company strategists would Strategy – research study commenced
consider. ‘Rightsizing’ a business unit, in the 1960’s in General Electric) cited in
as it was known, was a serious issue, and most strategy textbooks, suggests that,
this article argues that it should be put on average, big business units are more
back onto the strategic agenda of every profitable than small ones. Here, the fallacy
business. We begin by examining the is one of logic, namely by extrapolating from
fundamental flaws in the ‘big is beautiful’ the average to arrive at the universal, thereby
argument, and then discuss ten rightsizing concluding that every big business unit is
questions every CEO should ask to find more profitable than every smaller one, and
the most successful size of a business. thus growth will always translate into profits.
Fallacies about revenue The third fallacy stems directly from
size and growth management gurus like Michael Porter and
Jagdish Sheth, who claim that firms ‘stuck
Three sizist fallacies have contributed in the middle’ are financial disasters. Yet,
to the current obsession with there are very many middle-sized firms that
growing ever bigger businesses. have good financial performance, and there
are many giants that are poor performers.
The first fallacy comes from cost-volume-
profit analysis (CVP), a foundation stone of So, if getting bigger is not the answer,
management accounting. Many accountants what is? Well, there are several questions
behave as if increasing volumes higher and an inquiring CEO should ask, if he or
higher will cause profits to rise towards she would like a more precise answer
infinity. Accountants seem to forget their to how big business units should be.
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3. By modelling and optimising the customer
lifetime value, it was discovered that the
company could be much more profitable,
if it operated with far fewer customers
ten rightsizing questions spent over 20 per cent of their revenue
2. How many ‘customers’ should I have?
every ceo should ask Rightsizing customer numbers is next on on advertising expenditure, keeping new
the agenda. In too many organisations customers flowing through the front
sales people are indiscriminately rewarded door, and maintaining the two-million
How many/much?
for new customers, who are ‘collected’ by level. A new CFO arrived and ordered a
1. Revenue
them, whether they are profitable or not, review of the organisation’s KPIs (Key
2. Customers
e.g. bad debtors and late or troublesome Performance Indicators) and targets. By
3. Innovation
payers. In particular, banks and insurance modelling and optimising the customer
4. Globalisation
companies exhibit an unhealthy obsession lifetime value, it was discovered that the
5. Distribution in new channels
with customer numbers, as they make company could be much more profitable,
6. Distribution in existing channels
competing and boastful claims about if it operated with far fewer customers.
7. Quality
them in annual reports and shareholder In fact, nobody could remember where
8. Pricing
presentations. the 2m target came from, and yet
9. Promotions
nobody had thought to challenge it.
10. Marketing communications
Maths can come to the rescue of the CEO in
rightsizing the customer base. Get a bright
1. How much ‘revenue’ should I have? 3. How much ‘innovation’ should I have?
Rightsizing revenues is top priority. Remove analyst to estimate the cost of acquiring Rightsizing innovation is next. You can be
revenue targets from staff appraisals and the extra customers, and to make a realistic too innovative, and too much innovation
bonuses, unless absolutely essential. Many projection of the profit streams they will can trigger competitive warfare that is
boards award themselves a salary increase, generate this year. Add in an allowance destructive. Of course, CEOs like making
every time the company gets fatter. Sales for estimated future profit streams, then claims about innovation - it’s fashionable,
directors and their teams, and marketing calculate the net present value. Subtract it’s fun and it’s often unprofitable. The
teams too, are rewarded for ‘pumping up’ the cost of acquisition, and you will main pretexts for innovation are growing
volume. Have you ever felt you distrusted have an idea whether the customers are and protecting revenues. Innovators
your sales chief or the head of marketing? worth having. Plot a graph of customer claim they are the engines of growth, yet
They are probably good people, but their acquisition. It will not be linear, and you all too often what they do is burn costs,
behaviour is likely to be heavily influenced will see a turning point after which profits with a track record of about 80 per cent
by revenue targets, and they may sacrifice fall. Our conclusion is that CEOs should not failure. Innovators also claim that they
costs and efficiency in the struggle to get treat all customers equally; some will be protect existing revenues from the threat
higher revenues. highly profitable, others losers. Do not let of new competitor products, but, in truth,
the sales people talk you into treating them it is often cheaper and better to copy a
Even shrinking can be a good strategy, if as special cases, or believe exaggerated new idea, once it has been tested in the
it halts inefficient marketing expenditure. claims of higher profits at some point marketplace. Innovators bask in the glory
The right revenue level cannot be in the future. of inventions, yet, after the excitement
determined top-down as a matter of has died down, and the products fail, the
principle; it can only be determined As an example, a major direct marketing lessons of failure are forgotten, the costs
bottom-up by answering the remaining retailer had operated for years on the written off, and the cycle repeats itself.
nine rightsizing questions, and then assumption that two million customers Multiple innovation projects co-exist
adding together the associated revenues. was an important target to hit. They alongside one another, and sometimes

4. Too much innovation can trigger
destructive competitive warfare
get managed on the unscientific principles breaking even. They then implemented the allocation across its global markets; the
of funding innovators who shout loudest, portfolio system as a standard procedure, model told them not to invest in China.
or funding the pet projects of senior keeping sales and marketing in charge of At first, they wondered if it was short-
executives. These are not arguments for the innovation budget, but making sure termism, so they asked the modellers to
stopping innovation altogether, but rather that they had the discipline to spend on extend the models first to 10 years, then
they are arguments for proceeding with brands which earned not burned profits. to 20. Still the model came back and
caution, and bringing some science and said, “Don’t invest in China, if you want
maths into the evaluation of innovation. to make profits in the next 20 years”.
4. Which ‘global markets’ should I be in?
Rightsizing your geographic footprint
Maths can come to the rescue in makes sense too. Globalisation certainly 5. ‘Distribution in New Channels’
rightsizing innovation in that innovation grabs headlines, which explains its Rightsizing your channels is the next step,
forecasting can add rigour and precision to popularity with boards and CEOs. starting with new channels. Multi-channel
innovation decisions, and there are dozens There is something exciting about it, a marketing has been a fad now for several
of methods available such as researching distraction from the mundane realities years, on the fallacious assumption that, if
analogues, conjoint analysis and of daily routine. It is also a decision trap, a new channel opens, you must get in it at
simulated test marketing. Ignoring them bigger even than innovation. any cost. This has been a bad decision for
on the grounds of forecasting inaccuracy many organisations, and also something
is foolishness; better to be approximately As with innovation, forecasting methods of a black hole into which senior executives
right than precisely wrong. Portfolio for predicting export growth are now have kept throwing ‘good money after
analysis is also a powerful tool, bringing available, which use analogues and bad’, fearful of admitting defeat.
objectivity into the subjective world of parallels to estimate market size, market
innovation, and providing the foundation share and profitability. Portfolio analysis During the past decade financial services
for learning and improvement. can help get a realistic perspective on firms rushed to offer customers an
global priorities and the importance of array of internet services, on the flawed
For example, a global drinks company China relative to the countries where you assumption that every customer would
was heavily into innovation. Each year currently operate. Scenario planning tools want to transact on the web. Market
another batch of new drinks landed can then estimate up and downside risks. research indicated that under 20 per
on the shelves, and the sales people Market entry analysis can estimate the cent of the population actually wanted
had something new to talk about with size of the sacrifice in being a late entrant to do this, but the data was overlooked
customers. Then, a new CFO arrived and to a market. DCF (Discounted Cash Flow) during the dot.com craze. Prudential was
asked, “are we innovating too much?” He calculations can put everything into long- one of the first to take part in this craze,
ordered a portfolio review, with financial term perspective. by launching its Egg online bank in 1998
and risk models of all the new products in and attracting much publicity. By 2004
the pipeline. To the surprise of the sales A global oil company has filling stations the allure was gone, and Egg was put up
and marketing team, this proved the CFO in over 20 countries and set its sights on for sale. It was offered £1 billion, which it
right. The most profitable activity was conquering the Chinese market. Doing so turned down. By 2007 a buyer was found,
selling the existing portfolio, and far too grabbed headlines, but after five years, for £575 million, and it was disclosed
many SKUs (Stock Keeping Units) were results were still poor. Management that in the previous year Egg was running
launching, when having no chance of decided to model the optimum resource at an operating loss of £145 million.
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5. Multi-channel marketing is
something of a black hole into
which senior executives have
kept throwing ‘good money after
bad’, fearful of admitting defeat
strive for perfection, will perfection at
6. ‘Distribution in existing channels’
Rightsizing your existing channels is next. any cost drive up revenues and profits? Is
This is often a hidden side of growth, but quality the real issue, when the product
it can be very costly. Adding additional is outdated or simply boring? Often the
distributors may seem like a good idea, quality revolution is about making a
but is it really necessary or profitable to substandard product perfectly rather
be in every outlet in the market? Yet CEOs than driving profitable revenues.
on their travels love to see their company
wherever they go, and targets of 100 per The chain store magnate, Chester M
cent distribution are set. Woolworth, decided to sell a higher
quality mouse trap through his nationwide
Maths again comes to the rescue. Channel empire. It flopped. Customers of the older
maps with volume flow rates provide the model tended to dispose of it along with
starting point. In the case of supermarket the dead mouse, whereas the high-quality
distribution, shelf planograms are the trap was thought too good to throw away,
equivalent mapping tool. Overlay costs so much so that its customers felt obliged
of supporting channel relationships, to clean and re-use it. Those who did try
distribution and other services. Estimate the high-quality trap quickly switched
the transfer pricing to the channel back to the original low-quality one.
partners, the costs of distribution deals
and listing allowances. Do the sums and 8. ‘Pricing for profit’
you will see the volume-cost-profit graph Pricing has been described with some
for penetrating up to 100 per cent of the justification as the ‘Cinderella’ of business
channel. The curve will not be linear, in decision-making. Misunderstood,
fact profits will peak and fall, as you move neglected and misused, pricing is too
towards 100 per cent distribution. often used to grow volumes and not
profits. Management of pricing is a
A major brewer realised that its product, political fight, in which operations,
the market leader, was not available in 60 finance, sales, key accounts and even
per cent of pubs and bars. So, it calculated the chief executive’s partner can throw
the costs and benefits of increasing ideas around, and finally a compromise is
distribution by 5 per cent, 10 and so on. reached that defies any logical analysis.
To its surprise, it was discovered that
its distribution was already optimal, The rightsizing of price levels can
and the cost of accessing the remaining benefit enormously from the application
60 per cent, of small and unattractive of a little maths. All that is needed is
bars, was just not worth the extra cost. information about costs (a given) and
rough estimates of price elasticity. The
price level that optimises profits drops
7. ‘Quality’
Rightsizing quality has a ring of unreality out of the equations, and the good news
about it in the wake of the quality is that rough estimates of elasticity are
revolution. Some CEOs have aimed for good enough, high levels of precision are
quality perfection, supported by the claims not needed. When good data is available,
of quality gurus. Yet, do customers really econometric analysis can be used, but

6. CEOs on their travels
love to see their company
wherever they go, and
targets of 100 percent
distribution are set
even when the data is poor, judgmental Typhoo Tea saw its advertising spend cut rackets of ‘lowballing’, ‘sandbagging’,
estimates are often good enough. to ribbons under pressure for more and slack and deliberate waste. It also requires
more promotions. BOGOF promotions employing some mathematical skills to
Budweiser conquered Europe with a canny (Buy One Get One Free) achieved volume analyse and optimise the size of the business.
price strategy. When they arrived from spikes of 2000 per cent, but at what Today, such models are being employed
the USA, they priced low and secured cost? Worried about the slippery slope, successfully in some businesses, and they are
massive distribution, around 80 per cent. management commissioned some growing their business earnings without the
After a few years at rock bottom, they econometric modelling to quantify inefficiencies of the size-obsessed business.
shot prices up, while at the same time the effects. Using the models to play
running massive advertising campaigns. ‘what-if’ games, the executive team © Criticaleye 2009
The price offensive decelerated growth, realised that they had let promotions
but then profits rocketed, making it one of grow too much, and so revised their
the most valuable brands in the market. promotional spend and volume targets
downwards, thereby raising profitability.
9. ‘Profitable promotions’
If pricing is the Cinderella, then 10. ‘Marketing Communications’ –
promotions are the Ugly Sisters. Advertising, Direct Marketing, etc
Robert Shaw
Promotions are one of the most Rightsizing your communications is Director, VBMF
misunderstood and misused of all revenue important. You can communicate too
drivers. When demand fluctuates, as it much with customers, as most customers Robert is Director of the consultancy VBMF
always does and will, scattering a few agree, when they empty their spam filters and visiting Professor at Cass Business School.
He has provided strategic advice to BP, IBM,
promotions to customers will start them or put their direct mail unopened into
Manchester United, Unilever as well as
buying more. In a target-driven revenue the paper recycling bin. This is not a view
being an advisor to the Chartered Institute
world, promotions provide the silver shared by most media owners, most
of Management Accountants, the Chartered
bullet needed to hit targets and win agencies, and most marketing directors,
Institute of Marketing and the Chartered
bonuses. Unfortunately, they also destroy who see relentless communication as a
institute of Procurement and Supply. He
profits in eight cases out of ten, but weak business imperative. has published over 100 articles and books.
accounting and poor record-keeping mean
Susan Goldsmith
that managers are ignorant of the issue. A major music company uses TV
Finance Director, National Express Group Plc
Often, by manipulating the numbers, it is advertising to sell pop music. Their
possible to appear to hit profit targets, in management spent millions on national
Susan is currently Finance Director of
the short-term, by burying or hiding the advertising campaigns, particularly National Express Group Plc, Rail Division.
costs of the promotions, allocating them at weekends. Procurement began to Since qualifying as a Chartered Accountant
to future periods or even writing them off, wonder if all this air time was profitable, in 1989, Susan has performed a variety of
and by raiding advertising budgets. so they commissioned an econometric senior finance roles across the Retail, Media
and latterly Transport sectors. A move to
study. This disclosed that over half
Kingfisher Plc followed to take on the role
Mathematical models of marketing mix their advertising was wasted, and it
of Director of Investor Relations. Susan
allocation can help show the true financial pinpointed which half should be cut.
subsequently spent four years as Financial
picture. These entail simulating the profits
Controller of Woolworths Plc, part of the
conclusion
and volumes that result from a range of
Kingfisher Group. The move to National
promotional scenarios. ‘What-if’ analysis Express Plc followed five years later.
and optimisation can help discover the Our remedy for sizism is rightsizing. This
profit-optimal mix of promotions and involves throwing out size targets other Contact the authors through ‘My Criticaleye’
other elements. than earnings; combating the scams and
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