As you’re on your pathway to profitability and looking to build your business, you may want some benchmarks to measure if you’re growing at an appropriate pace.
How do you find the balance between growing too fast and not being able to keep up with demand, or growing too slowly and not having the resources to create demand?
In short, what constitutes a healthy growth rate for companies in the IT services space?
Understand the numbers
In general, most economists peg good economic growth as 2 – 4 percent of GDP, with the historical average around 2.5 percent annually.
As usual, the technology industry is operating within its own special universe, and most of us would consider a 2 – 4 percent growth rate rather tepid. So we set out to see if we could arrive at a growth rate formula that is reasonable, advisable, and achievable for companies competing in our unique industry.
We scoured the literature for data on growth rates we could apply to our industry. In their book Growing Pains: Transitioning from an Entrepreneurship to a Professionally Managed Firm, UCLA professors Flamholtz and Randle identified five growth rates for small business firms:
- Less than 15 percent annually: Although many may consider this rate rather unspectacular, a firm will double its size in five years while growing at a 15 percent rate
- 15 – 25 percent annually: Rapid growth
- 25 – 50 percent annually: Very rapid growth
- 50 – 100 percent annually: Hyper growth
- Greater than 100 percent annually: Light speed growth
We’ve seen growth rates across this enormous spread in the IT industry, from the smallest companies to the global behemoths, with many companies seeming to shoot for the fastest possible growth. But is that really the way IT services executives should focus their efforts?
The sweet spot
Sustainability is truly the key for balanced growth. Think of your break-even point – the absolute minimum in sales you need to make in order to stay in business. That’s the floor for your sales growth. The sustainable growth rate, then, is your ceiling: It’s the optimum level your sales can grow without new financing and without exhausting your cash flow.
We set out to locate the optimal sustainable growth rate for IT services firms, and came up with the Revenue Rocket Growth Principle, or the Rule of 45.
Here’s what you need to know:
In a nutshell, after studying a number of our clients with revenues greater than $5MM, we discovered that your topline year-over-year growth rate as a percentage, plus your earnings before interest, taxes, depreciation, and amortization (EBITDA) as a percentage of revenue, should not exceed 45 percent if you want to grow profitably.
The ideal mix between the two components of this principle works out to be a 30 percent year-over-year top line growth, and a 15 percent profit growth, thus equaling the 45 percent rule.
No need for light speed
It’s been our experience that firms that outrun this 45 percent target are likely not growing profitably. They are probably borrowing from the past with accumulated cash on their balance sheet, or they’re stealing from the future, sourcing funds from a credit facility or an investor. Neither scenario is good. Taking cash off the books to fund profit robs the business of operating monies, and borrowing money to fuel profit only increases the need to grow faster to satisfy the creditors, and the craziness begins.
As a growth consultancy, we advise and encourage companies on responsible, manageable, sustainable growth. We worry when we talk with executives whose business model, or whose dreams, have hyper growth or light speed growth in their sights. Be careful what you ask for.