Now that we have examined some of the negatives of expansion from a very small business to a medium-sized small business, let’s give equal time to the potential benefits.
One of the most important components of gross profit is the degree to which you’re able to set your selling price. Your ability to set that price is largely a function of your control of the marketplace. At one extreme, you may have a patented product for which there is no substitute, and for which there is totally elastic demand (people will buy it at any cost). If that item costs you a dollar, you may be able to sell it for ten dollars, one hundred dollars, even one thousand dollars. At the other end of the spectrum, you may be selling wheat in Nebraska. In that case, it’s unlikely that you’ll be able to command one-tenth of one cent over the market price on the day you sell.
It’s amazing how important control of the marketplace can be to a small company. Let’s say there are five companies competing for your customers’ business in your territory. If you open a second location, you’ll go from representing 20 percent of the outlets in your area to 33 percent. If your aggressive action forces one competitor out of business, you’ll have 40 percent of the locations. You’ll clearly have a better chance of being the price leader (setting prices that will hold regardless of competitive action) with 40 percent than with 20.
The second advantage to expansion is in purchasing. Increased volume generally brings lowered costs from suppliers. The most sophisticated players use their leadership position to work for even lower prices.
Many suppliers are just as interested in market share as they are in customer base. As you square one vendor off against another, each may be willing to use an even sharper pencil to earn your business . . . just to create more awareness of their brand name in your market.
Price is not the only negotiable aspect of a purchase. Your additional market strength may allow you to demand terms, freight allowances, or merchandise set aside just for you in local warehousing to draw on as you need it.
The third opportunity afforded by growth is availability of lines. Certain products, franchises, and so forth, are considered to be premium. The suppliers of these items may only wish to deal with the largest operation in each area, or they may have a policy of only servicing a limited number of businesses. While you’re still operating out of a four-hundred-square-foot ministorage unit, you may not be able to get their attention.
For many kinds of business there can be a substantial increase in income to the owner due to additions in volume. Although there are times when an increase in sales may actually result in a temporary decline in net profit, generally this will be more than offset as the company adds additional sales.
Many of the benefits of growth have nothing to do with money. Increased satisfaction may come from many directions. The challenge of learning new skills and dealing with new opportunities offered by a larger firm may be very appealing to some entrepreneurs. The appearance of success created by a large location, staff, or fleet of trucks is very appealing to others.
While this year’s profit may not double from a doubling of sales, there will almost certainly be an increase in wealth.
Income is that amount you take home every week, month, or year. You generally use this money for current obligations, normal living expenses, and savings and investment. Unless you’re a very unusual individual, you are probably using all of your “income” as you earn it. The average American puts less than 5 percent of his paycheck into investment.
Wealth is the ability of your net worth to earn income without any additional input from you. If you have a house that is increasing in value due to inflation, it is creating income just by virtue of the fact you own the house. This would also be true of stocks, bonds, savings certificates, rental property, and the like.
It’s possible for a small business to be a mediocre income producer, but a fantastic wealth builder. This is because someoneelse is willing to pay you for your business based on a combination of asset value and the income stream your business produces.
Therefore, if you increase the size of your business, you may not take home much more current income. However, a purchaser will decide how much your business is worth based on various aspects that are generally related to size. Therefore, your growth may result in big increases in your “wealth.”
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