Scaling Up When You’re Still Small

The advanced robotics business that Eric Close runs has less than $100 million a year in sales, but sales are growing by 30 percent a year. RedZone Robotics, a privately held company based in Pittsburgh, is finding strong demand for its mobile robots that can inspect municipal sewer or water systems for leaks and other potential problems. Customers from as far away as Singapore are buying RedZone’s robotic inspectors. Close says he wants to build sales to $1 billion a year.

But to get there, he has to solve a key managerial problem that faces thousands of similar entrepreneurs. RedZone’s robots are very sophisticated technologically, combining advanced visual, computing, sensory and software know-how, much of it from nearby Carnegie-Mellon University. Close, an MBA who took over as CEO of the company when it was in bankruptcy, has to stay in touch with those technologies and also with what customers are demanding. Yet at the same time, he has to cope with more employees than ever before—some 75—and with increasing demands to scale the business and manage its finances. Very few CEOs of small and medium-sized companies can do it all.

Close is tackling the dilemma by hiring a chief operating officer with experience running larger businesses. In February, RedZone brought in Chris Dunkerley, who had been executive vice president and chief financial officer for Siemens Water Technologies, a $2.5 billion division of the German technology giant. “It frees me up to do more strategic things like mergers and acquisitions and new product development,” says Close. “Chris will focus on day-to-day operations to make sure that the financial targets are hit and operationally we’re achieving the goals that we set forth.”

Just as his own management formula has to change, the kind of people whom Close needs to hire has evolved. In the early days, he says he needed “gunslingers—the super-creative types who come up with brand new ways of looking at problems.” He still needs those creative people, but as his company has scaled up he needs mid-level managers as well. “You have to create new departments and new leaders to empower them to meet the needs of the organization,” he explains.

This challenge of changing the way a CEO manages innovation as his or her company grows can be harder than simply launching a company—and is not well understood. The business media and academic experts concentrate on start-ups on one hand and on large multinationals on the other hand, but they largely ignore the challenge facing companies in the $100 million to $500 million a year sales range, says Filipe Santos, associate professor of entrepreneurship at INSEAD, the business school based in France. Many of these small to midsize enterprises, or SMEs, are family-owned or privately held, so their growing pains are not often visible to the outside world. Yet figuring out how to grow companies of this size into much larger companies is key to addressing the American job creation challenge. This sector is at the heart of where jobs are created in the U.S. economy.

As these companies grow, they need new layers of management and they may have to manage multiple product divisions in more geographies than when they were in the start-up phase. “When you are the CEO of a small and medium company, you are relatively in direct control of the company,” Santos explains. “You know everyone in the company. That works until you have 100 or 200 employees. Then you get into an additional level of complexity and another level of management. You have to delegate and have to empower others. Your style has to change from that of a leader who is managing everything into someone who allows others to manage. That is a difficult transition that many CEOs don’t react well to.”

Scale Up or Fade Away

But adapt they must or risk being blown away by competition. After a small company identifies an industrial or technological niche and starts to exploit it, competitors take note and begin imitating it. “Once your market niche matures, it becomes much more competitive; you have to invest resources in opening new market segments,” Santos explains. That helps force a series of complicated tradeoffs in how a CEO manages his or her time and the company’s resources. “How much of your time should be dedicated to innovation versus maximizing the efficiency of the whole company?” Santos poses.

“The CEO’s chair gets filled with a lot of different folks who got there for different reasons.”

Both traditional manufacturing companies and high-tech companies face this need to adapt their innovation model—and the CEO’s role in it—as they grow. It may have to occur faster in Internet-based companies because barriers to entry are so low and product cycles are so fast, but the pattern is much the same. Founders of these companies often are replaced by professional managers, at the insistence of venture capitalists or more experienced board members. Or, the founders step into the role of chief technology or scientific officers, while professional managers take over as CEO. That’s what Google did in bringing in Eric Schmidt as CEO for a decade, allowing the company to enjoy a period of sensational growth. Microsoft, Dell and Apple also have wrestled with what role the founder should play in the company’s innovation efforts as they have grown.

“It’s typical that the entrepreneurial founder is not the most effective at scaling up the organization,” says Santos, who studied American high-tech firms while based at Stanford University in Palo Alto, Calif. “They are prone to be innovative or creative, but at some point, you need more process orientation and reliability. They don’t do well in that kind of environment.”

There does not appear to be one-size-fits-all prescription for the innovation dilemma because CEOs come in so many different varieties. “The CEO’s chair gets filled with a lot of different folks who got there for different reasons,” says Mark Payne, president of Fahrenheit 212, a New York-based innovation/consulting firm. “Where you have a CEO who is the ideas guy, who produced the original insight that created the business, his approach to spawning the next wave of growth is going to be different from a CEO who was brought aboard and handed something to commercialize.”

Know Thyself

One key to a successful CEO is self-awareness. After a small company enjoys its first wave of growth and starts to reach for size, the experts say a CEO should look within to ask what his or her strengths truly are, and concentrate on building the right team of people around him or herself. “The CEO has to obsess on what he’s good at and surround himself with other people who are good at what he isn’t,” says Payne. “It doesn’t matter whether the ideas come from the CEO or other people in the organization, but it has to happen. Knowing your own strengths and your gaps is fundamental.”

Joe Redling, CEO and chairman of Fort Washington, Pa.-based NutriSystem, proved adept at this. Redling, who was in charge of marketing at AOL and also held top positions at Six Flags Theme Parks, joined the publicly traded company in September 2007 at a moment of crisis. Then-CEO Michael Hagan had built a $700 million company specializing in weight management products and services that were advertised on television and then fulfilled from seven warehouses around the country. But competitors such as Weight Watchers and Jenny Craig counterattacked and sales flattened.

“The company spiked and hit the wall,” Redling recalls. “They didn’t have the operational expertise to manage that kind of scale.” One big problem was keeping track of what products were stocked at the seven warehouses and making sure customers received exactly what they had ordered.

“That’s one of the things that entrepreneurs have failed at—bringing in people who know more than they do.”

When Redling became CEO in the spring of 2008, he put the company through a gut-wrenching transformation, cutting the number of distribution centers from seven to two and bringing in a supply chain specialist as part of his top management team. He shifted the sales model to emphasize Internet sales, which soared. He also brought in a chief marketing officer and a senior vice president for operations, and hired a scientist from GlaxoSmithKline to become head of the company’s research. “I would say that we moved from a purely entrepreneurial culture to a professional entrepreneurial culture,” Redling explains. “We have big company controls and processes but we’re also fluid and flexible enough that it still feels very entrepreneurial.”

Since Redling is not a scientist, he relies on the head of R&D to develop the company’s core technology, low glycemic index foods that help stabilize blood sugar, and to come up with new product lines such as frozen foods. After stumbling, the company had sales of $509.5 million in 2010, but Redling sees it recovering to the $700 million level and moving beyond that. The key is the team of five executives he built around himself, and the culture they have forged. “It’s critical that the type of people you’re bringing in fit into your culture,” he says, “because one out of five who doesn’t could really disrupt your processes.”

Companies in the $100 to $500 million sales range often undergo bigger upheaval than their presumably more mature multi-billion dollar counterparts as they seek to balance the imperatives of innovation and growth. It also seems easier to experiment and find the right innovation-growth balance when a company is privately held or family-owned, and is not exposed to the scrutiny of investors and Wall Street analysts.

Of course, there are some founding CEOs who stay true to their core mission of innovating without getting bogged down in growth issues. One is Hartley D. Peavey, founder and CEO of privately held Peavey Electronics in Meridian, Miss., one of the world’s largest manufacturers of musical instruments and professional sound equipment. Peavey won’t disclose sales figures, but says the company is in the $100 million to $500 million range. Customers include Disney theme parks and ocean cruise liners. Half the company’s products are exported to an impressive 136 countries.

Peavey started out in 1965 building amplifiers, sound equipment and guitars by himself, and now holds 180 patents worldwide. But he has never sought a role in which he merely administers. At age 69, he’s still working on new patents. “I’m not so good at details and day-to-day administration and management,” he says. “That’s one of the things that entrepreneurs have failed at—bringing people in who know more than they do. It’s an ego thing. I am not particularly good at repetitive things. I get bored. I have more than a little bit of Attention Deficit Disorder. I’m the mad inventor. That’s what I love to do.”

Peavey says he won’t study a spreadsheet and does not want to spend his day looking at a computer screen, so he has found others “who do things I don’t want to do or things I can’t really do.” His chief operating officer, for example, is currently his stepson who is “good with figures,” but does not have an engineering or technical background. Even though Peavey holds the title of CEO, he relies on others to engage in conventional management activities. “I’m having fun if they let me do what I do best, and that is invent things,” he says.

Peavey almost certainly has sacrificed some scale by not dividing his time between innovation and growth more equitably—a choice that many entrepreneurs make. Spending more time on expansion and less time on the excitement of innovation can be a difficult trade-off to make. But the evidence is overwhelming—for the vast majority of small and medium sized companies, growing the business to a size at which it can compete and endure for the long-term requires that CEOs adapt the way they innovate.

Key Takeaways

1. Companies in the post-startup phase often require new layers of management.
2. As companies scale up in size, sitting CEOs should consider stepping aside.
3. CEOs seeking to bring their companies to the next level need to focus on recruiting talent who fill gaps in their own skill set.