Many consultants talk about the 4 ways to grow your business. The 4 ways they quote are:
1. Increase the number of customers (of the type you want);
2. Increase the transaction frequency;
3. Increase the transaction value or “average sale”;
4. Increase the effectiveness of each process in your business.
But does growing your business increase its value, and if so, how do these concepts increase value? Let’s break this down into bite-sized pieces.
First, let’s talk about measuring value. Very simplistically, let’s assume that for a stable operating business, measuring value can be stated as:
Value = Expected Economic Benefit* divided by (Required Rate of Return less Expected Growth)
*Economic benefit can be some measure of income or cash flow
Mathematically, anything that increases the economic benefit, reduces the required rate of return for that economic benefit, or increases future expected growth in that benefit will increase value.
Second, what about each growth strategy’s effect on business value? Let’s start at the bottom and work up. There can be two results of growing your business the fourth way, “increasing the effectiveness of each process in your business.”
First, you reduce costs. If you reduce costs, all other things remaining equal, you improve profits, which will increase value (by growing the numerator in our simplistic value measurement model).
Second, you increase capacity; you can do more with the same resources if you are more efficient, so you can grow without increasing costs. More revenues with same costs mean more profits, again increasing value. This second result also will affect growth, which also increases value by decreasing the denominator in the formula. Of course we’re assuming here the operational risks are not increased.
One caveat here – you can only improve efficiencies so much. So while you can increase value through increased efficiencies, the increase is limited. Long term and material increases in value have to come from the other three ways to grow the business.
This is part one of a three part series of blog posts on this topic.