Thoughts on Growing, Part 2

February 17, 2006 on 12:54 am | In Musings by Josh Jones | 17 Comments

Getting big can be trouble.

Why grow?

Last week I talked about what I thought it took for a company to handle exponential growth (an “entrepreneur”) as well as non-exponential growth (an “MBA”). This week I’m going to rewind a bit and get into why companies like to grow at all.

Unfortunately, growing a lot generally comes hand in hand with spending a lot.

Sadly, most of the time, ALL the extra revenues you receive from your new customers was already spent trying to get those customers! In fact, the money you spend to grow is likely more than the revenues you collect as a direct result of that growth. Which is why businesses frequently need loans or investment to grow.

What IS that? 

But hey, what kind of special businessperson spends more on something than they expect to take in? Isn’t the point of a business to maximize PROFIT, not to maximize SIZE?

Indeed it is! So why grow?

Well, why was it that in 2000, Amazon was valued thousands of times more than DreamHost, even though we had double-digit profit margins while Amazon was losing more money each week than we had collected in our entire history?

I’d pay a heck of a lot more for a treasury bond that paid me interest of $500/day than one that cost me $600,000/day! So why would investors, no matter how irrationally-exuberant they may have been at the time, pay more for the latter?

BIG GREEN!

I think it’s because what entrepreneurs do is harder than what MBAs do. 

According to the US Census Bureau, 60% of US businesses have less than 5 employees. 80% have less than 10. And only 1.7% have 100 or more. Assuming most businesses are profitable (and if they’re still in business, that’s usually key), it seems pretty clear to me that a lot more businesses are profitable than big. It’s just easier.

Which is why you want to grow!

Wait, why exactly? What, just because it’s harder? Blow a bunch of money just to prove to the world you can do something difficult? The point of a business is to maximize profit, not pain!

No, not because it’s harder. The reason it’s much more valuable to get big (what entrepreneurs do) than to get profitable (what MBAs do) is because once you’ve grown a lot, it only takes a tiny change in your profitability before that $600,000/day loss transforms into a $600,000/day gain.

So you see, when you’re spending all that money on growing, you don’t actually spend more than the growth is really worth. Growth is actually worth a lot more than the average MBA might guess. Of course, it’s also not worth as much as some entrepreneurs value it. The trick is knowing (or at least guessing) how much it’s worth better than your competitors do.

Before he got big.

So how much is getting big worth? 

It depends. In web hosting, as in insurance, magazines, cell phones, cable tv, xm radio, and any other soul-stealing business, growing is worth exactly one bajillion dollars. After all, theoretically every new customer you add is an unending stream of revenue for all time! So it’s okay to spend one bajillion dollars minus one on growing by one customer, especially since there’s always one bajillion MBAs ready to swoop in and turn your business profitable the moment the entrepreneur can’t get it to grow anymore.

You see, heh heh, I lied before.

The point of a business is actually to maximize VALUE!

It just that for most businesses, maximizing profits is the best way to do that. However… 

A company’s value is maximized when it’s big AND growing fast.

(As I established, growing fast is more valuable than being profitable, and all other things held equal, a bigger company is worth more than a smaller one.)

Clearly, when you’re at the maximum value, it’s time to sell your company (ipso facto, as any other time it’d be worth less). Therefore, the best time to sell your company is right before your growth rate starts to decline. That is, the biggest you’ve ever been while still growing fast.

You see, as soon as you stop growing fast, people are going to start basing your valuation directly on your profits, and that’s not going to grow very fast, because, um, we just said your growth rate is starting to decline!

Case in point… wouldn’t you have like to have sold all your Google shares right before their last earnings announcement? You know, the one where they told the world they weren’t growing quite as fast as the world expected? 

Sell sell sellllllllllllll!

Me too. Trust me… ME TOO.

And that’s Part 2 of my thoughts on growing! There may be another part later or not! Stay tuned?

17 Responses to “Thoughts on Growing, Part 2”

  1. Simon Jessey Says:
    February 17th, 2006 at 3:51 am

    Interesting choice of “right here” arrow graphic. An example of maximum growth, Josh?

  2. santos Says:
    February 17th, 2006 at 6:56 am

    I caught that too, I said to myself, “No, it couldn’t be… it is!”

  3. Jennifer Says:
    February 17th, 2006 at 8:37 am

    The Jolly Green Giant’s crotch with Simon Jessey’s comment… yeah. lol

  4. Omar K Says:
    February 17th, 2006 at 10:23 am

    It’s interesting to hear you talk about growth, to spend so much time thinking about it. Perhaps you need to spend some time considering your current customers.

    I’ve been with Dreamhost a few weeks. Being new to the hosting game it was a no-brainer after reading all the glowing reviews you’ve received from across the web. Yesterday (about 18 hours a go..) my site went down. Up until this happened, everything had been wonderful, very quick setup, and quicker installs.

    Two tickets later and 18 hours later, my site remains down. I’ve not heard a word. You would think it would be easy to fix, especially since a Google search for “bad_httpd_conf” returned 188 results. I’m not the only one out there.

    I do not wish to lament about your support or lack of it. However, it’s frustrating that I have to post this as a comment to your blog.

    Service operations management theory suggests that customers get more profitable over time, due to lower retention costs and the benefits from their loyalty. On the other hand, gaining new customers is much costlier, offering them attractive incentives to join your service does not come cheap.

    I’ve had the incentive, the question is do you want to profit from me in the long term?

    Thankfully my site is a personal one, I don’t dare consider what the consequences may have been of hosting a business critical application with you.

  5. Dallas Says:
    February 17th, 2006 at 11:23 am

    Our growth is basically the number of new customers we add minus the number of existing customers we lose in that same time period so our strategy for growth involves both adding new customers as well as retaining existing customers. As Omar pointed out, it would be foolish to not pay any attention to our existing customer base.

  6. djsynthetik Says:
    February 17th, 2006 at 2:40 pm

    I have been with dreamhost for 1 year, I just signed up for another year.
    I love it.

    the only major downtown was when the california power outage was.
    and from my memory serves me right, it was quick for return.

    but I know for every 100 customers that give great reviews there will be one or two that don’t, the ones who get lost in the cracks.

    thank you dreamhost.

  7. riki Says:
    February 19th, 2006 at 4:08 am

    Does this mean we’ll be seeing Dreamhost on the market soon?

  8. riki Says:
    February 19th, 2006 at 6:45 pm

    Also how come does the main page say “No Comments”??

  9. Justin Says:
    February 21st, 2006 at 8:54 am

    I’m an entrepreneur and I happen to have an MBA also. My company’s growth rate (by customer count), has been 50-100% for the last few years, so I can certainly understand the issues you face.

    In terms of valuing Google, Amazon, or even your business.. while growth is often good, the driver of value is profits. Companies are just a cashflow (an investment), and you can treat it that way. If a company can only generate 5% return on its invested capital, you’re better of shutting it down and putting that same investment into something else like bonds because it takes less effort to get the same return.

    The reason that Amazon and Google are/have been so highly valued is that investors are considering future cash flows and the profits associated with them. It’s OK to lose money at various periods, as long as the net present value of those cashflows is positive, and better than alternative investments. You can say that investors are irrational in their valuations, and you’re probably right in some sense, but the major institutional investors have spent a lot of time on these types of estimates.

    In your situation (you guys must have high capital costs because of hardware), you can calculate the cost of your capital (loan or leasing rates on hardware), and then look at the expected cash flows from it. If your overall return is higher than a certain %, it’s worth it. Nearly all businesses reach a point of diminishing returns, where the cost to bring on an additional customer results in a lower average profit per customer. One possibility in your business is the point where your datacenter is physically at capacity and the only option is to build a new one (note there are cases when this is still financially viable, based on sales projections). The other scenario (and this happens in nearly all businesses) is you grow so big that your staff spends too much time coordinating and not enough time “doing”. Ask anyone in a professional (i.e. not manufacturing or selling hamburgers) company with 1,000+ employees what % of their day they spend in meetings versus doing their work. You’ll find it’s a whole lot higher than people in a 10-person company. Big businesses do well because despite this overhead of coordination, they have large economies of scale, and in some cases other barriers to entry.

    My advice to you is to look at profits over everything else. Figure out what type of customer you want to grow with, which will generate the greatest profits (compared to the expense you have to spend servicing that customer). I don’t know what customer profile that is, but such a strategy could serve you well, especially against your competitors. Your cost structure is likely very similar to theirs, so your advantage will be to generate the highest average profit per customer.

    Best of luck to you… I can say that I’ve been very satisfied with your service and I’m glad to see the company is doing so well! Cheers.

  10. feldmahler Says:
    February 23rd, 2006 at 8:58 pm

    My friends and I have coined the phrase “pull a DH” to describe the situation where a hosting company massively oversells their services, and in the end dug a grave for themselves as customers file out. I hope my new host doesn’t “pull a DH”.

  11. Mark W. Says:
    February 25th, 2006 at 4:48 am

    Is it my imagination, or have certain comments been deleted from this blog?

    If memory serves me correctly, these comments may have painted DreamHost in an unfavourable light, but otherwise were quite reasonable, no bad language etc.

    Censorship, if this is indeed what has occured, is a very slippery slope.

    Mark

  12. nate Says:
    February 25th, 2006 at 7:42 am

    It’s your imagination!

    We’ve only ever hosed spam or really nasty swear words. There are comments here and there with people who don’t love us; for example, #10 above!

  13. feldmahler Says:
    February 25th, 2006 at 11:29 am

    Hahaha yes! Big brother wins you.

  14. Mark W. Says:
    February 25th, 2006 at 3:49 pm

    “It’s your imagination!”

    You could be right, I aint as young as I used to be and the old brain does play tricks on me from time to time.

    However, the MSN cache seems to share my imagination. :)

    http://cc.msnscache.com/cache.aspx?q=2879504913296&lang=en-US&mkt=en-US&FORM=CVRE3

    You will notice that comments 10,11 and 12 from that cached copy are most definitely gone from the current page.

    I think this may be a simple case of a software glitch, given that you are correct and DreamHost does seem to tolerate dissenting opinions, both here in the blog and on the DreamHost forums.

    Mark

  15. Jesse Warden - Flash, Flex, and Component Developer Says:
    February 27th, 2006 at 8:05 pm

    Pay For Anonymity…

    I just got an email from Register.com. I can pay them $9 bucks so my address and phone number isn’t easily accessible via WHOIS information even though ICANN decrees it so. There are a plethora of other places to find……

  16. 高須クリニック Says:
    August 22nd, 2008 at 4:35 am

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  17. Topefielpicle Says:
    December 15th, 2008 at 4:59 pm

    Funny foto here

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