Here’s why it’s still a good idea to keep your company on a monetary diet even after you’ve achieved monumental success.
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The following excerpt is from Benjamin Gilad and Mark Chussil’s book The New Employee Manual: A No-Holds-Barred Look at Corporate Life. Buy it now from Amazon | Barnes & Noble | Apple Books | IndieBound
What’s obesity in business? As companies consolidate, grow, and prosper, they accumulate “fat” in several forms: Large cash reserves, surpluses in department budgets at the end of the year, or a bureaucratic maze of business units, product lines, partners and subsidiaries. What started out as a lean and mean organization is now a fattened calf of a company.
No one talks about it as putting on weight, of course. Instead, executives use corporate-speak to talk about “moving increasingly into …” “securing our future with additional vital …” “offering a wide range of solutions,” “meeting new customers’ needs” and the capstone, “ensuring our leadership position in a wide range of industries.” In human terms, we say “This company has money to burn.”
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There’s no clear financial measure of corporate fat that can be taught at a business school. Some small fat reserves become obvious toward the end of the annual budget cycle when departments and functions rush to spend what’s left of their budget so they don’t get their budget cut the next year. You know this spending isn’t essential because if it were, they would have already spent it. But this spending is just peanuts.
We call silly, unnecessary, or outrageous spending or investments “free fat flow (modeled after free cash flow, a financial concept)”. Free fat flow is clearly exhibited in investments and spending that defy competitive logic or economic principles but are publicly hailed by the CEOs as essential to “positioning the company for the future.”
Free fat flow is the classic warning sign that a company is approaching a heart attack, or crisis. And the classic home remedy following the crisis is to slim down considerably via laying off a third or more of the work force.
Today, Apple, Microsoft, Cisco, Alphabet (Google’s parent) and other giants have enormous cash reserves tucked away in tax shelters outside the U.S. There’s absolutely nothing illegal about it. But here’s a prediction: When you have so much free fat, you’ll be spending like the proverbial sailor on shore leave or like an unfortunate lottery winner.
A bulging cash stockpile isn’t necessarily evidence of free fat, though. It’s not wasteful to use cash to make strategic acquisitions at a reasonable price, to experiment with ventures with good competitive strategies (not just wishful thinking), or even to pay dividends to stockholders. Holding profits as cash in low-tax countries to save on taxes may still serve the interests of stakeholders.
Also, the size of the stockpile isn’t necessarily an indicator of potential waste, depending on the size of the industry. For instance, pharmaceutical giants Amgen and Gilead Sciences had together about $60 billion stashed away as of June 2017, but as buying the rights to even one miracle drug can cost a fortune, this cash isn’t necessarily a sign of lax competitiveness.
So we conclude: Corporate fat would be a great predictor of decline … if only we could measure it.
Peter Drucker is rumored to have said, “If you can’t measure it, you can’t manage it.” What he actually said was make sure you measure the right things. Measuring the wrong things because they can be measured is one example of wasteful activity — and a little, clot-sized part of free fat flow. Bringing a famous basketball coach or a former president to an annual sales meeting for a motivational speech at $10,000 per motivated second is another. Bring in a less-famous person; they’re motivated!
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We can’t directly measure corporate fat and its associated wasteful spending, but we can describe its development. At the entrepreneurial stage, companies have very little “fat.” There’s just enough to get coffee in the morning and rent a bicycle for the founders so they can travel from their garages to the nearest Kinko’s office. Kinko’s itself couldn’t afford much fat since it served entrepreneurs with little free fat flow. FedEx bought Kinko’s and renamed it FedEx Office. FedEx is relatively fat free because its founder is still the boss. This is a great stage to work for a company as mavericks have real influence, see real action, and exercise real impact.
If the company grows rapidly, and especially if it expands globally, “fat” grows with it. Our carefully controlled double-blind studies suggest BMI at that stage is around 10 percent of the total budget, and mostly spent on more lavish executive travel and dubious client entertainment. Some of that fat is diverted into free coffee or free snacks for all employees or even a chance to see an A-list movie star at a product launch party. But don’t be fooled by the fun: That fat could be better spent on keeping the company competitive, funding your projects, or planning for the long run.
When the industry consolidates, the big player, one of the few remaining, has considerably more “fat” — around 17 percent on average. By the time convergence is complete, where the large incumbents look alike and chase each other’s tails, corporate fat is the highest, reaching a peak of around 31 percent.
In business-school case discussions, teachers will often point out a company’s inability to adapt to change as the reason for their decline. But that explanation doesn’t go far enough. Why can’t the incumbents adapt? Because they’ve become too fat to move fast. They recognize the change; they’re just stuck in the door frame. Don’t let that happen to your growing business.