The Growth Challenges Facing Middle Market Companies
Global economic growth is sliding towards a five-year low, a gloomy backdrop for all but the most nimble of businesses. The silver lining for North America is that the regional economy is driven by the kind of entrepreneurial firms that have opportunism etched into their DNA – middle market companies that combine scalability with flexibility. They are now the ones to watch.
In the U.S., we define middle market companies as having annual revenue of between $100 million to $1 billion. A purely quantitative definition however, misses many of the qualities that these companies typically share. They are usually privately-owned and are often leading providers of a specialist product or service; and collectively, they play a key role in creating growth in many of the world’s largest economies.
The U.S., for example, has the largest concentration of middle market companies among major global markets with 55,700 companies contributing an impressive 17 million jobs – 13 percent of national employment – and $1.7 trillion in economic output in 2012. But despite the major impact that mid-market companies have on the overall U.S. economic and employment outlook, they are often perceived as too small to be considered influential stakeholders and too big to benefit from the incentives and support afforded to smaller ones. Given middle market companies’ vital contribution to the dynamism of the U.S. and global economies, we should all care about their health, and ensure that they can enjoy sustainable growth.
In the U.S., California leads the nation with the largest number of middle market companies in the top five industries, including wholesale and retail ($249 billion in revenue) and business services ($69 billion in revenue). Nationwide, the most significant cluster of middle market companies is found in the wholesale and retail sector.
This dynamism helps provide an insight into the kind of problems a middle market company can encounter when it grows. Instead of looking for an inflection point in revenues to find a magic number that can be used to predict when the company will find further expansion difficult, it is much more effective to evaluate whether additional growth could cause the company to lose the advantages that define it.
One of the reasons that middle market companies are so nimble is that they are often specialists in their product or service that have direct contact with their clients, rather than via a third party. The result is a deep understanding of their customers and their needs. Combine this with the entrepreneurial spirit that would normally find in a smaller firm, and you have a company that can rapidly maneuver to take advantage of new trends.
The risks grow when a middle market company starts thinking about an expansion that takes it outside of this comfort zone. It might have focused on a particular category of products, but has plans to grow into a new area where it has yet to develop such a close relationship with customers. Moving into a new geographical region can present a similar leap into the unknown.
And when problems do occur, they tend to reflect the fact that a middle market company doesn’t yet have the resources of a large corporation. Consider for example, the process of developing a new product – a costly exercise that comes with a number of risks. Development could overrun, or the finished product might not sell as well as expected.
When a large company encounters this kind of situation, it can be a significant setback, but one that is mitigated by its extensive access to financing. For a middle market company that lacks the deep pockets of its larger counterparts, the impact of a failed product is likely to be much worse. And in this period of global economic malaise, making the wrong move could be fatal.
Another area where middle market companies can find it difficult to compete with a big corporation is in the area of attracting and retaining talent, as they are often outbid by larger firms when it comes to compensation. If a middle market company does not have the right management in place to lead an expansion, or if key managers leave the company half way through its growth plan, its chances of success diminish significantly.
Since the stakes are high, it is essential for middle market companies to undertake extensive planning before going ahead with any major expansion plan. Part with of this will involve making a detailed plan of action, while at the same time ensuring that all the relevant stakeholders are on board – a long list that will include senior management, the board of directors, as well as potential clients.
How to finance the expansion will also be an important consideration. Banking partners must be engaged with as early as possible to work out how much capital is needed, and whether it is available.
Careful planning will take into account the potential risks and the impact that they could have on the company. And this will involve asking tough questions. What if the new product fails to catch on? Does the company have enough reserves to weather a drop in prices and at the same time maintain its expansion plans? Does the company have enough people with the necessary management experience to lead the change?
Sometimes the answers to these questions will be negative, and if that is the case, then it is worth considering putting an expansion plan on hold until the company is confident that any potential mishap will not seriously affect the company.
The middle market company, however, that has analyzed the risks through careful planning is in a much stronger position to successfully grow in scale. That is not only good news for the business, it is good news for all of us – as sustained growth in the middle rung of the corporate ladder provides a bright spot in a period of broad economic gloom.
Martin Richards is Head of U.S. Middle Market Commercial Banking for HSBC Bank USA, N.A.