A recent Benchmark column (see "Worth the Risk? Part 2," February 2003) prompted an e-mail response from Bob Hanbury, CGR, of House of Hanbury Builders in Newington, Ct. Hanbury points out that the relationship between risk and owner's compensation isn't static and is affected by any change in a company's normal course of business. More important, says Hanbury, risk increases with any change in volume, but especially with rapid growth. He also suggests that there is a limit to growth beyond which it is difficult to compensate for the risk taken. We found his arguments compelling and reproduce his comments here, moderately edited for length. Seems like you're on track regarding risk, but I think there is an overarching principle that has been missed. Whenever a business is shrinking or growing, the owner's compensation is at greatest risk.
When your business volume is shrinking, unless it's accompanied by an intentional increase in margins or a reduction in overhead, there will have to be a reduction in available gross profit for owner's compensation. Conversely, when volume is expanding -- and especially when it is rising rapidly -- there is an even larger risk to profitability and owner's compensation. To grow rapidly requires new marketing programs, unless the market is on fire (but for how long?); more help in the field and office, with associated overhead; new and potentially different customer and project profiles; and maybe even diversification, which is the most risky.
Not one of these changes guarantees increased gross profits that can pass through to the owner. In fact, the changes increase the chances for variance from projections. They either make the investment a big success, because they hit the nail on the head, or they miss and the effort is a huge setback.
Whenever a business leaves its comfort zone of standard operations, job size, typical customer, project duration, or affiliation (or lack thereof) with design professionals, the profitability outcome is at much higher risk. A sound business strategy will weigh the risks and make an informed choice based on the probability of achieving the owner's goals. When planned and executed correctly, the risks can be reduced.
How big, how fast?
Growth is always more risky than the status quo, so the rewards must be much higher. How much higher and certain must the rewards be to tackle rapid, increased growth is the million-dollar question. I believe there is a business volume level beyond which any increase in volume leads only to marginal increases in owner compensation compared to the potential returns and investment required.
If your company doubles in volume, I guarantee that owner's compensation will not double. Only in a small, immature company is there a strong relationship between increased sales and increased owner's compensation. That's because there is often unused capacity, as well as the ability to become more efficient and productive as experience is gained. For the larger, more mature company, however, there is no new magic pill that creates new productivity and efficiency.
Less is more
Too many people think the path to increased compensation and benefits is only through growth and increased sales. It's much riskier than just doing what you do now, only better, more efficiently, and with higher pricing. Why do $2 million and make $200,000 when you can do $1.5 million and make $200,000?
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