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The Expansion Dilemma

By Elie Kochman on January 27th, 2011

Perhaps this issue is more relevant to those in service-based businesses, though I believe that no
matter the nature of your business, this issue will resonate with you. I would be interested in hearing
your feedback on this issue – as I believe that it has no right or wrong answers, merely a large set of
choices.

At some point during the life of a business, the amount of work coming in the door will exceed the
limits of the business. Product based businesses will see this when demand outstrips their ability to
supply, service-based businesses will see this when the demands on their time exceed the number of
hours available to work. In a large business, this issue may have already been solved, either by having
a process for increasing the supply, or by increasing the price to reduce demand.

However, smaller businesses walk with trepidation when faced with this issue. On the one hand, their
ability to increase supply is severely limited – they may not have the necessary cash flow to handle
additional hires, or to front the money required to pay for additional goods. On the other hand, the
inability to supply the increasing demand may hamper their ability to expand, and may result in a
negative impact on their existing business.

Additionally, there is the inability to see the future, which means that the business owner trying to
decide whether or not the sudden increase in demand justifies hiring another employee must guess
(hopefully with some helpful data) whether the sudden demand is merely a spike in activity, or if it is
sustainable. This has ramifications on what is needed to ensure that the decision is made with
appropriate resources allocated to support it, should the spike in demand be followed by a dip.

To determine how to best handle the spike in demand, it is necessary to look at the goals for the
business. If the aim is to grow by hiring more people, to increase the supply, then the spike in demand
can be one way of moving toward that goal sooner than expected. If the aim is to reach a certain level
of activity, or, in other words, to cap the supply at a certain point (for example, to work 40 hours per
week), then the decision that needs to be made is only how to go about reducing the demand – should
you raise your prices, or merely refuse to take on additional customers?

Others, though, are stuck between the two decisions. While they don’t mind working more than a
certain number of hours, or, in other words, to work with an expanding business, they also may not be
actively looking to expand. As a result, they are unprepared for the expansion, both from a fiscal point
of view, and psychologically as well.

Some may choose to bridge the gap by using sub-contractors to take on the work they are unable to
do. This can help defer the decision until it is clear whether or not the increase in demand is going to
be enduring, but it also exposes the business owner to various risks associated with delegating work
(the quality may not be up to standard, managing the contractor can be complicated). Others may
raise prices moderately, in an attempt to drive up margins while they debate internally how to handle
the demand.

What would you do? How have you handled sudden spikes in demand beyond your abilities to
provide?

Related posts:

1. Growth, Expansion, and the First Hire

2. Growth and the Panic Response

3. Managing Accounts Receivable

4. Goals and Fitness

5. A Time for Action

Categorized under: Advice for Small Business Owners, Motivation, Work at Home, business.

Tagged with: business growth, demand, expansion, goals, growth, pricing, quality, subcontracting, supply.

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ekochman5 days ago

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http://www.post-gazette.com/pg/06292/731375-28.stm

Wal-Mart's expansion dilemma

Thursday, October 19, 2006
By Kris Hudson, The Wall Street Journal
If Wal-Mart Stores Inc. announces next week that it will slow its expansion in the
U.S., investors are likely to applaud.
The company has grown at a ravenous pace, building hundreds of stores each year
to increase its dominance of the nation's retailing. This year, it will erect as many
as 370 U.S. stores to keep up with its typical annual square-footage growth rate of
8 percent.
But in recent years, Wall Street has become increasingly concerned that Wal-
Mart's new stores are stealing sales from its older outlets. Another worry: the
higher costs of opening stores in markets where it isn't already dominant.
Some investors and analysts prefer that Wal-Mart throttle back on its growth by
next year or 2008, diverting money that would otherwise be spent on expansion to
shareholder-friendly uses such as share buybacks and dividend increases or more
extensive remodeling of older stores. Should Wal-Mart signal at its annual session
with analysts next week that this will happen, the stock, which has risen more than
6 percent since early September because of falling gasoline prices, likely will get a
pop.
In 4 p.m. composite trading Wednesday on the New York Stock Exchange, Wal-
Mart's shares were up seven cents to $48.35, giving the company a market value of
$202.2 billion. Its shares currently trade at 16.5 times estimated earnings for fiscal
2007, cheaper than its rivals. Costco Wholesale Corp.'s per-share multiple is 21.5,
and Target Corp.'s is nearly 19.
"If they do rein in that 8 percent (expansion rate), expect deafening applause from
the investment community," Goldman Sachs Group analyst Adrianne Shapira said.
Ms. Shapira rates Wal-Mart's shares a "buy," with a 12-month price target of $57.
She owns none. Her firm has done business with Wal-Mart in the past year.
Wal-Mart will end the speculation Monday, when it begins its meeting with
analysts and investors in Teaneck, N.J. Some observers say signs point to a modest
pullback of Wal-Mart's U.S. expansion. Top Wal-Mart executives acknowledged
in June that they have cut back on opening new stores so close to established stores
that they siphon sales from those older stores. Wal-Mart declined to comment
further.
Merrill Lynch analyst Virginia Genereux predicts Wal-Mart will expand its U.S.
square footage at a 6.7 percent rate next year. She rules out a significant pullback
because it may take Wal-Mart a while to slow its momentum. Wal-Mart executives
have talked of plans for an additional 1,400 stores in the U.S. in the future. Ms.
Genereux rates Wal-Mart's stock "neutral" and owns none. Her firm has done
business in the past year with Wal-Mart.
The growth-rate debate represents a growing split between Wal-Mart and Wall
Street, which once idolized the Bentonville, Ark., retailer. Some analysts argue that
the company no longer reaps lofty returns from slapping up hundreds of stores, as
illustrated by its capital spending outpacing the growth of its operating cash flow
since 2000. As Wal-Mart pushes into its final frontiers in the U.S. -- namely large
cities, the Pacific Coast and the Northeast -- it is finding the costs of doing so
higher and its sales weaker than in its traditional strongholds. Wal-Mart executives
argue that the retailer's returns remain high and it should build as many stores as
possible sooner rather than later because U.S. zoning laws will only get more
restrictive.
Wal-Mart currently operates nearly 4,000 stores in the U.S., including its Sam's
Club warehouses, and more than 2,700 abroad.
Not everybody wants Wal-Mart to slow its growth rate. Kevin Grant, co-manager
of Harris Associates' $5 billion Oakmark Fund in Chicago, is among the investors
who see Wal-Mart's U.S. expansion rate as a minor issue in comparison with the
retailer's international growth and efforts to bolster sales in its existing stores. "We
feel that this management team has proved themselves to be very focused on
maximizing returns and on allocating capital wisely," said Mr. Grant, whose firm
holds 9.9 million Wal-Mart shares.
Yet Carl Lytollis, head of U.S. equity research for Phillips, Hager & North
Investment Management Ltd. in Toronto, would rather see some of the money that
goes to U.S. expansion spent elsewhere, such as on share repurchases or higher
quarterly payouts. He noted that McDonald's Corp. in April 2003 announced a
turnaround plan that included reduced expansion, a beefier dividend and more
share buybacks. McDonald's stock doubled within a year, and it has risen by more
than 30 percent since. "I think the reaction would be somewhat similar with Wal-
Mart," said Mr. Lytollis, whose firm, which has 63.3 billion Canadian dollars (U.S.
$55.51 billion) in assets, holds 3.5 million Wal-Mart shares.
Some observers envision a compromise. Deutsche Bank analyst Bill Dreher said
Wal-Mart could pare its square-footage growth but still open a steadily increasing
number of stores by making its new stores smaller. The chief executive of the
retailer's U.S. operations, Eduardo Castro-Wright, rose to prominence in Wal-
Mart's Mexican operations from 2001 to 2005 by tailoring stores and their
merchandise to local clientele. He has taken similar steps in the U.S. and launched
an aggressive reduction of the inventory in stores. Thus, Mr. Dreher foresees Wal-
Mart eventually needing less than the regular 200,000 square feet for a supercenter,
its preferred format.
"While the number of new stores should increase at the same rate, the size of those
more-efficient boxes will moderate," Mr. Dreher said. "With that, we will see an
inflection point in return on invested capital."
He rates Wal-Mart's shares a "buy," with a 12-month price target of $58. He owns
none. Deutsche Bank has done business with Wal-Mart in the past 12 months.
First published on October 19, 2006 at 12:00 am