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Summary.

How does growth transpire in the underrecognized midsize firm? In the authors’ research, they found that the owners, CEOs, and top managers of midsize companies tend to describe their competitive advantage in terms of who they know (connections) and what they’re able to do (capabilities) — and that these variables change and interact to facilitate growth. Their findings offer a model of how midsize companies can manage connections and capabilities to achieve desired growth objectives.

 

Much attention is paid to either the startup or stardom — the most exciting business idea (that has yet to make a profit) or the star that began in a garage and is now a worldwide powerhouse, trading actively for billions. But what do we know about the transition of growth between those two extremes? How does growth transpire in the underrecognized midsize firm? We sought to find out.

Over the course of our respective careers, we’ve had the opportunity to work with many different midsize firms, helping them enhance capabilities, expand operations, and enable exports. We’ve found that the owners, CEOs, and top managers tend to describe their competitive advantage in terms of who they know (connections) and what they’re able to do (capabilities)We’ve also noticed that these variables change and interact to facilitate growth. We made those variables the focus of our research.

In our study, we asked CEOs of established midsize manufacturing firms to describe the key variables that contributed to their companies’ growth over a period of five to 10 years and the processes they followed to achieve it. Their descriptions encompassed both personal connections and their companies’ capabilities. They identified personal rapport with executives at customer and partner firms, as well as their firms’ specialized expertise and ability to operate efficiently and/or adapt, as drivers of their growth. Then, it got interesting: We found distinctive patterns of connections and capabilities based on each firms’ revenue stage.

Midsize firms are commonly funded by commercial banks, so we grouped them into categories consistent with commercial lending underwriting practices to see what differences would emerge among the groups. The largest U.S. commercial banks categorize their industrial clients according to total revenues as follows:

  • Business banking: $2 million–$20 million
  • Mid-market: $20 million–$50 million
  • Upper mid-market: $50 million–$250 million

Of course, not all of the midsize firms we studied were growing. In fact, some were stagnating or experiencing slow growth. So, we explored the differences between slow and fast-growing firms to learn what causes the difference. We found that the key drivers for growth within a revenue category differ from the drivers to jump from one revenue category to the next. Our findings offer a model of how midsize companies can manage connections and capabilities to achieve desired growth objectives. First, let’s explore the interaction of connections and capabilities as a growth mechanism within each growth-stage category.

How midsize firms grow

CEOs of successful midsize firms described themselves as their companies’ primary contact, with direct hands-on influence over its connections and capabilities. Their companies achieved growth through investments in relationships and proving to be reliable over long periods of time. They offered advantages over their immediate competitors through speed in their core competencies (i.e., what the company does, and what it does well). As a value-add, these firms developed specific complements to their core competencies based on their key clients’ needs — for example, adding intermediate warehousing to complement local logistics. From the hours of interviews we conducted, it’s clear that these CEOs parlayed their connections to bring in contracts and used their companies’ competencies to deliver superior value.

How midsize firms change to continue their growth

Our previous experience in the field had shown us that midsize firms don’t follow the same playbook all time; the strategy that’s effective when a firm is smaller won’t work when its revenues grow multifold. We can all name some firms that continue to grow and others that stagnate or slow down. We wanted to know why.

Although the CEOs mentioned that they relied on their connections and capabilities to achieve growth for their firms, the relative emphasis on the underlying components of those connections and capabilities shifted as the revenues grew. When the firms were smaller ($2m to $20m revenue), the CEOs described their connections as singular and focused on their primary customers and their capabilities as aligned to solve the customers’ problems. But as they grew and added more customers, the emphasis shifted. For firms in the next tier ($20m to $50m), the CEOs described their connections and capabilities as “well-oiled machines,” driven by proven relationships with key clients and winning formulas based on reputation, trust, and niche. These firms’ core competencies included flexibility and quickness in production processes, as well as distinct capabilities compared to rivals as a growth mechanism.

As the firms entered the next tier ($50m to $250m), the CEOs described their connections and capabilities as strong and dominant alliances and affiliations with key customers, suppliers, and partners. The firms offered integrated solutions, continuous innovation, and cutting-edge offerings. Growth was achieved through aggressive broadening of applications, progressive learning, and new market creation. Overall, firms within our study built distinctive profiles of connections and capabilities for growth and stability within their revenue category.

Even as the midsize firms grew and achieved stability within their communities (and perhaps more importantly in the eyes of their funding source, the commercial banks), some firms, even those that had reached the pinnacle within their revenue tier, were unable or unwilling to jump to the next tier. This issue represented the final focus of our research.

How midsize firms transition from one stage to the next

As you recall, we purposefully asked our CEOs to describe their connections and capabilities and how they changed over a five-to-10-year period. As a result, we were able to capture changes in the firms’ connection and capability profiles as they transcended growth between stages (or revenue tiers).

The excerpt below is from the CEO of a small pump manufacturer that successfully managed growth past the $20 million mark. The CEO describes incremental improvement in processes as a mechanism to facilitate and manage growth through its OEM (original equipment manufacturer) client:

From five years ago to now, there’s been a continuous investment in technology. We’ve made great advances in our building to design stuff more quickly, our analysis tools are way better, a lot of fluid dynamics software we’ve just continuously upgraded…that along with the IT.

And then the other thing is basically our manufacturing system, the lean principles that we’ve applied…you know, minimum part travel, the part goes into a cell and [comes] out of a cell complete, and it’s simplifying the manufacturing process, and then basically driving your production cycle down to two-day intervals…has sucked out so much lead time. So the lead time and the productivity, those two things together.

Notice the emphasis on continuous refinement of what’s working, application of lean principles, and process simplifications to hone the firm’s capabilities as a way to achieve growth. This CEO further describes his firm’s connections with key clients:

[I]n OEM environments, there’s a trust thing built there. It’s getting that perfect balance to value and then consistently performing. So you build that trust [to] where the guy goes, “They give me the value and they’re never going to screw me”…and so you’ll keep those guys. …[Our company], we’re kind of unique in the world; we’re known for honest, straightforward, our word is our bond. As we build that relationship more and more and more, they become less and less concerned that we’re going to steal stuff. And then that releases energy that would not become realized.

Trust and reputation are built intentionally over time to gain exposure to other potential clients. Performing successfully with current clients, garnering reputation for integrity, and creating value is how the firm grew past the early client list and thus zoomed past the $20 million revenue mark.

Although the formula of refinement and improvement in capabilities and wider penetration into potential customer bases can result in success in the early stages of growth, the formula wears out. To transition into the next stage ($50m–$250m revenue), we found that firms leveraged their core competencies toward new applications while strategically partnering to enter new markets.  Essentially, those firms that transition to the higher tier redefine their internal dialogue. The scripted growth story that once enabled the firm now constrains it. The CEO of a robotics-integrator firm explained this process:

I can talk for a long time about characterizing [our company] when I say a systems integrator.  Historically, that has been about welding, metal joining and cutting…and we recently diversified from metal joining and cutting to other, more elaborate processes…which has kind of brought us some growth and maybe a new generation of life.

The strategy for growth was really two facets, one was to expand the processes that we offer…so we did a technology expansion, and at the same time, concurrently, we did a global expansion. So we moved into [foreign country] with a joint venture, and we’ve also moved into [another foreign country] with a small start-up. So we put together a 5-year plan, and it included specific growth targets.

The firm recognized the need for transition and the limitations of prior scripts, then sketched out expansion pathways to grow into the highest growth stage we studied. The CEO of an industrial seat manufacturer that moved into that same growth stage viewed his firm’s connections as a joint commitment to investment with the client, including a willingness to deploy resources on their collective behalf. High levels of collaboration with a client helps remove investment risk for the midsize firms in new applications, and mutual commitment serves as a sturdy ladder for growth.

The smaller firms we studied grew by managing their connections and capabilities through building firm bonds with early clients and serving them reliably. They then transitioned from a few focal clients to a larger base by increasing their efficiency and core competencies and winning new clients through their reputations for integrity and value creation. The changed emphasis helped them grow to a point, but to transition into the next stage, organizations leveraged their core competencies toward new applications while fostering relationships toward joint investment and new market creation. In this final stage we studied, growth was achieved through strong alliances, integrated solutions, and cutting-edge offerings.

We offer our model in a summarized table below.

Lacking established brand equity, midsize enterprises often rely on close relationships and unique and sharply defined capabilities to earn business. In early stages, they could earn business by building close bonds with key clients and aligning the firm’s capabilities to deliver unique value. As they achieve initial growth, their managers could apply the firms’ core capabilities to new industries to deliver uncommon value.

Smart young firms know that before there’s a product, there are capabilities. Rather than producing a routine product, young midsize firms might draw on their proprietary capabilities to initially build distinctive solutions for a very small number of clients. To grow, managers should emphasize persistent refinement of the solutions to deepen distinctiveness and then widely peddle the solutions to other clients.

Growth plateaus are common, even for healthy and strong midsize enterprises, and they occur when firms seem to have exploited all available opportunities in current industries. To grow, managers should encourage their firms to find ways to transfer their capabilities to new industries. We have to warn, however, that this would require reconfiguring the incentives, reporting lines, management structure, and processes to encourage and support new applications and new markets.

 

By Gary Wolbers and Arun Pillutla

Source: https://hbr.org/2021/06/what-drives-growth-in-midsize-firms

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