Articles

Change Management in High-Growth Firms

Introduction

In many developed countries, a large amount of net employment growth (>50%) has been found to be concentrated in a small percentage of high-growth firms (<5%) which are defined as firms “growing at least 20% yearly for at least 3 consecutive years, with a base year revenue of at least $100,000.” (Mogos et al., 2015). This phenomenon can be explained by Schumpeter theory of dynamic economic growth also known as creative destruction (Schumpeter, 1934). Creative destruction is defined as the “incessant product and process innovation mechanism by which new production units replace outdated ones” (Schumpeter, 1934). As such, new and more innovative firms disrupt incumbents and the displaced resources (capital, employees, customers) are reallocated towards these innovative firms which leads to firm and economic growth (Schumpeter, 1934). According to Lee (2013), these high-growth firms are attractive to policymakers who can focus their attention on a few firms and reduce expensive, and often ineffective, business support.

However, it is not as simple as it looks. Starting a new business is easy, but making it a growing sustainable business is hard. 80% of new businesses are nonemployer firms, only about 4% of these new businesses will grow to have 50 or more employees and less than 0.1% can be expected to grow to the level of having 500 or more employees (Freeman and Siegfried, 2015). For the few companies that achieve to attain the high-growth firm status, many challenges are in front of them: recruitment, skill shortages, obtaining finance, cash flow, management skills and finding a suitable office space to operate (Lee, 2013). Furthermore, these problems seem to become increasingly acute as firms grow more rapidly, which means that failure to address these issues may slow subsequent growth. In order to make the small company a growing sustainable business, leaders need new capabilities: strategic thinking, the ability to be a coach to the team and self-evaluation (Freeman and Siegfried, 2015).

The article is structured as follows. First, we will explore the challenges high-growth firms are facing with an emphasis on financial, social and human capital. Finally, we will look at how leaders can help their companies through the changes imposed by growth as they transition themselves, or not, towards new roles and skills.

Challenges Facing High-Growth Firms

According to Lee (2013), high-growth firms perceive problems in six areas: recruitment, skill shortages, obtaining finance, cash flow, management skills and finding a suitable office space to operate. Considering that research from CBInsights (2018) found that companies running out of cash was responsible of 29% of business failure and team problems were responsible of 23% of business failure, for the purpose of this article, we will cover obtaining finance and cash flow as well as management skills combined with recruitment and skills shortages.

Obtaining Finance and Cash Flow

According to Lee (2013), high-growth firms are typically cash starved as they need money to commercialize innovations, double down on what is already working and enter new markets. To solve this challenge, companies can either use a variety of financing sources like debt and equity financing or grow organically by reinvesting profits. However, each of these sources have their own particularities and challenges.

For equity financing, even in one of the most mature capital environments like the United States, a survey by the Kauffman Foundation (2016) found that only 0.2% of firms were able to raise equity financing. Companies seeking this type of capital typically underestimate the time commitment necessary to successfully complete a financing, which usually take between 500 to 1000 work hours and spread out over a 6 to 9-month period (Lavinsky, 2018). Time spent in the capital-raising process entails that leaders don’t spend time with customers and can’t focus as much on operations which can make growth problems worse. Finally, investors may have different interests than the leaders of the company. Venture capitalists, which are the primary providers of equity financing, need at least a 10x return within a 10-year period to achieve an acceptable rate of return on the money they invest (Suster, 2016). Investors need for high returns may lead companies to act in an irrational way, which can impact the long-term sustainability of the business. For example, it can lead to overspending on problems and investors can try to force the company to grow in an unsustainable way to reach a higher valuation so they can reach liquidity for their limited partners (Suster, 2016). Given that equity financing is hard to get, businesses will usually fund some of their business activities using some type of debt financing (Kauffman, 2016).

Debt financing can come from multiple sources (Kauffman, 2016): business loan from a bank or financial institution, business loan from the government, business loan from family/friends, personal/family home equity loan and personal or business credit card(s). Research on this topic is not conclusive as leverage can both hinder (Lopez-Garcia, 2012) and support firm growth (Anton, 2016). The relationship between debt financing and firm performance is crucial as it is associated with a trade-off between costs and gains, and there is a debt level beyond which the costs are higher than the benefits (Yazdanfar, 2015). Managerial finance theory expects leaders to choose the optimal capital structure and, as such, a firm’s financing choice does not affect its capital cost, value or operations (Yazdanfar, 2015). While debt financing allow companies to maintain ownership, deduct the principal and interest payments at tax time and obtain lower cost of capital, circumstances in the real capital markets are more complex than what is assumed in managerial finance theory (Allen, 2018). According to Yazdanfar (2015) financial markets are imperfect and associated with agency conflict costs, moral hazards and information asymmetry that are further reinforced by the highly volatile environment in which high-growth firms operate. Companies using debt financing need to make sure that they generate sufficient cash flow by the time repayment of the loan is scheduled to begin (Allen, 2018). Lee (2013), found that cash flow was often a problem, as the instability of growth means that it is harder to plan and adjust to the needed level of expense. As such, leaders need to be able to build a company infrastructure to gather inputs quickly and make decisions without perfect information which often requires leaders to learn new management skills as they transition from working in the business to working on the business (Freeman and Siegfried, 2015).

Management Skills, Recruitment and Skills Shortages

During the initial phase, leaders are being actively involved in all aspects of a company from customer research to product design, getting orders, attracting and serving clients as well as human resources and financial management. At this stage, leaders need to be close to the operations and to customers to make sure that the company is on the right track (Freeman and Siegfried, 2015). In this context, leaders often try to do everything by themselves as their technical expertise and operational skills are key to meet the execution challenges. As the business grows, there is an increase in organizational complexity which makes the environment chaotic and necessitate new types of skills to deal with all the changes happening (Lee, 2013). In this chaotic environment, everything is new, resources and staffing are lean, team member responsibilities are often unclear, and processes are created on an as-needed basis (Freeman and Siegfried, 2015). As Freeman and Siegfried (2015) describe: “Executing the company’s business model in this environment involves constantly prioritizing, reprioritizing, and reflecting on outcomes to determine what’s being done, what needs to be done, what’s working, and what needs to change.” In order to execute in this environment and sustain rapid growth, leaders need to build management structures that are able to address barriers that come up, act flexibly to integrate new staff and that are able to expand products as well as to seek new opportunities (Lee, 2013). Fischer and Reuber (2003) found that entrepreneurs that were the right fit at the initial stage often lack the skills required for each subsequent stage of development of the company and can be unwilling to bring in outside help. Failure to create these management structures put these companies on the road to slow or no growth and possibly failure as it leads to reduced quality in decision-making, worse product quality, production logjams and friction between staff (Hambrick and Crozier, 1985).

Most strategic leadership models are based on the ‘bright’ side of leadership which assumes that managers should be able to build the required management structures as they are rational decision makers who utilize human, social and financial capital to build and operate a successful business (K.T. Haynes et al., 2015). However, there is also a ‘dark’ side of leadership, where leader’s desire for power, material wealth and celebrity can motivate them to ignore ethical values and engage in dysfunctional behaviours (K.T. Haynes et al., 2015). The line between ‘bright’ and ‘dark’ sides of leadership is often blurred as behaviours that initially made leaders successful can become sources of destructive needs that endanger the business over time (deVries, 1985). An example of this kind of behaviour is leader’s confidence in their abilities and in the firm’s capabilities. By nature, leaders must be confident because they have to take significant risks and bring innovative products to the market at the beginning if they want to be successful at exploiting the opportunity they identified. As the company grows and the leaders enjoy some early successes, confidence can transform into hubris. K. T. Haynes et al. (2015) define hubris as “an extreme manifestation of confidence, characterized by preoccupation with fantasies of success and power, excessive feelings of self-importance, as well as arrogance.” When hubris occurs it can result in unrealistic and unwarranted optimism, causing leaders to overestimate their own abilities and underestimate the need for human and social capital to ensure organizational viability, growth and survival (K.T. Haynes et al., 2015). While hubristic leaders are likely to encounter problems in recruiting and maintaining quality team members, contributing to the high rate of failure of firms, human and social capital is a challenge for many high-growth firms.

High-growth firms usually need new employees in a short time frame and may be susceptible to shortages of available workers, particularly when specialist skills are required (Lee, 2013). Integrating employees in a high-growth environment is challenging as leaders need to manage both new and existing employees while the culture and the roles are changing, making expectations and results less clear. These situations create resentments for employees and make the environment even more chaotic as leaders try to keep their head above water. As such, even if firms are able to recruit and select new staff, it is also harder to train and integrate new staff into the organization, limiting the process of expansion and slowing future growth (Lee, 2013).

Dealing With Changes

When firms are in high-growth mode, they are in a constant change mode. These firms must anticipate and understand the metamorphosis they are undergoing. These firms must manage the change and the transition by bringing people, systems, and processes in line with the need of the organization (Hambrick and Crozier, 1985). Furthermore, they need to acquire new skills and capabilities to continue to lead their companies during the growth stage (Freeman and Siegfried, 2015). Hambrick and Crozier (1985) found patterns from firms that were able to manage this metamorphosis and they summarized these observations into six key themes: envision and anticipate, build the team, save and reinforce the culture, manage the dynamic tension, structural smallness and pay for performance. In the next sections, we will integrate these patterns with the Ulrich change model which argues that “culture change must improve a firm’s competitive position in the market by changing its identity to accord with customer needs” (Ulrich, 2005).

Envision and Anticipate

The first thing leaders need to do is to envision and anticipate the firm as a larger entity to prepare the firm for that state (Hambrick and Crozier, 1985). The process of preparing the firm is substantive both on the business side and on the psychological and emotional side (Hambrick and Crozier, 1985). Leading this initiative requires both leadership and management as the leaders need the ability to envision unclear future states and also to hold themselves accountable as they monitor that the future states happen (Saggers, 2018). Koryak et al. (2015) found that diversity in leadership teams is important for growth as it increases the pool of knowledge, ideas and mental frameworks, available to decision makers. However, change leaders will need to be able to overcome the potential for emotional conflict which is inherent in diverse teams if they want to take advantage of the benefits of team diversity (Koryak et al., 2015). As such, teams need to identify who will be responsible for leading the continuous change while keeping diversity in mind and keeping an eye on team dynamics. Finally, they need to make sure that it is clear for the rest of the organization that the leaders responsible will build the shared need and vision necessary to achieve the metamorphosis (Ulrich, 2005).

Save and Reinforce the Culture

Organizations often thrive because of their strong cultures (Hambrick and Crozier, 1985). However, as they enter high-growth mode, the core vision and philosophy are easily dissipated (Hambrick and Crozier, 1985). Successful high-growth firms don’t let this happen as they constantly reinforce the culture by creating a shared need and communicating the vision of what the organization will look like at the next stage (Ulrich, 2005). Effective shared need and vision have the following characteristics: it creates a picture of the future, it appeals to others’ interests and needed, it is realistic and attainable, it is clear enough to guide decision making and it is easily communicated and explained (Saggers, 2018). In being effective at formulating and communicating a shared need and vision, change leaders will make sure that the employees understand why the change is important and how it will help them and the business in the short and long-term (Ulrich, 2005). Furthermore, employees will have a good idea of the outcomes of the change and are excited about the results of accomplishing the change (Ulrich, 2005). Once the future requirements of the firm are in better focus, change leaders can mobilize commitment and build the team that will be the coalition of support for the change (Ulrich, 2005).

Build the Team and Pay for Performance

According to Hambrick and Crozier (1985), successful firms tend to view all their employees, from top managers to middle managers, technical staff and entry-level employees, as important. These firms tend to extend a piece of the firm, through stock options, stock purchases plan and profit-sharing plan, to all levels (Hambrick and Crozier, 1985). Furthermore, retention through management and personnel development is needed, since these companies are becoming far larger and complex, requiring skills and abilities beyond what were needed at previous stages. As such, by offering a financial stake and development opportunities in the company, it is to be expected that employees will be more flexible and more open-minded about the need to change (Hambrick and Crozier, 1985). However, in determining who else needs to be involved to make the change happen, replacement of key people might be necessary if the change leaders find that the skills gaps are too important (Ulrich, 2005). The organization might be reluctant to these replacements and people might be concerned about their position (Saggers, 2018). While reluctance is normal and to be expected in a high-growth environment, quality can’t be compromised and people must fit with what the company is and wants to be (Hambrick and Crozier, 1985). Change leaders must be upfront in dealing with reluctance by managing the dynamic tension that exists between yesterday and tomorrow.

Manage the Dynamic Tension and Structural Smallness

In dealing with reluctance, change leaders must implement new processes, information and modified structures as supplements to rather than replacements for existing approaches (Hambrick and Crozier, 1985). High-growth firms must balance an ongoing view of how and where to compete with a process to modify that view and realign HR practises to be consistent with the desired culture when necessary (Ulrich, 2005). In designing the organization, Hambrick and Crozier (1985) found that successful firms tend to have very flat organizational structures with semi-autonomous task or project groups. As such, high-growth firms minimize hierarchy and expand the spans of control of existing layers by designating leaders for each of these units and with the participation of top managers on an ad hoc basis (Hambrick and Crozier, 1985). This structure allows for speed in decision-making and makes it faster to integrate new people as these teams are relatively small and oriented towards specific targets (Hambrick and Crozier, 1985). While this can create some duplication of effort, it is also an effective way to deal with reluctance and making change last as it creates an environment where employees keep their autonomy and be supported by managers who can effectively help in developing mastery (Saggers, 2018; Ulrich, 2005). Along the way, change leaders must monitor progress of these units to make sure that the culture and the support systems are not going too far off what they intended (Ulrich, 2005). Change leaders should include other top leaders and middle managers in determining what and how to best measure both qualitative and quantitative metrics (Saggers, 2018). As they collect and track these metrics, they need to communicate progress to the entire company which will further mobilize long-term commitment (Saggers, 2018).

Conclusion

Change is a process by which you move from where you are to where you want to be (Saggers, 2018). Managing change is not easy as you need to always confront reality and be comfortable with the discomfort that learning from the process brings (Saggers, 2018). The chaos generated in high-growth firms environments makes it even harder as you are in a constant state of unfreezing, moving and refreezing and, at the same time, you are trying to create a balance between yesterday and tomorrow (Spector, 2013).

The implications of this article are that while the challenges we covered, namely: recruitment, skill shortages, obtaining finance, cash flow, management skills and finding a suitable office space to operate, are diverse and not easy to solve, they are not insurmountable. The firms that manage the change and the transition by bringing people, systems, and processes in line with the need of the organization experience less painful challenges and, as a result, are able to continue to adapt and grow at a fast pace. Common to all these challenges is the need for the leadership team to recognize their limitations and learn new skills. Given that companies become positioned for growth primarily because of the leader’s abilities, work ethic and persistence, it can be expected that they will be positively biased in their self-assessments (Freeman and Siegfried, 2015). Failure to recognize their limitations and biases result in the leadership team becoming a severe constraint on a company growth as their skills does not evolve with what the company needs (Freeman and Siegfried, 2015). In mitigating the biases in the leader’s self-assessments, research by K.T. Haynes et al. (2015) has found that human capital can act to keep greed and hubris in check.

Firstly, the presence of other individuals in top management and ownership positions, who represent a close-knit community, may develop an informal system of checks-and-balances to ensure that each team member contributes as much as they receive. Second, the presence of external stakeholders involved in corporate governance such as shareholders, advisors or consultants, may help develop the same system of checks-and-balances as they have the incentive and the ability to intervene (K.T. Haynes et al., 2015). More research is needed to fully understand the role of external stakeholders on the change process itself and how their role and responsibilities in corporate governance functions can act as mitigating factors to the leader’s biases. Another potential research opportunity is to examine how leadership team composition impacts the way leaders deal with changes in high-growth firms. In order to implement change successfully, it is important to deal with both the minds and hearts. That means that the leadership team must be complementary and be able to deal with changes in different ways (Saggers, 2018). If you want to explore the sources of this article, you can find the full references here.