Many businesses focus solely on revenue growth, but this approach carries many downsides. Growing revenue only matters if it helps you add to your company’s profits. Sometimes, companies increase revenue without considering the added labor costs incurred. Once businesses reach the labor productivity black hole, they will struggle to get out if they don’t relentlessly focus on improving their labor efficiency.
What Is the Labor Productivity Black Hole?
The labor productivity black hole happens when you are between $1 million and $5 million in revenue. At this stage, your business starts having to hire significantly more workers in order to grow. However, each additional worker reduces your labor efficiency because they have to be trained before they become profitable.
Recently, Greg Crabtree talked about the black hole during a Mission to Grow podcast on “Labor Productivity: Understanding Labor Productivity for Sustainable Growth”. When you hit this stage, you have to push as hard as you can to make it to at least $4 million because the stretch between $3 million and $4 million is the darkest part of the black hole. Crabtree says, “Tons of people get to that $3.5, and they got to give back to $2.5. And they just get stuck in purgatory.”
Often, it is during the black hole that you start having to hire chief operating officers and other employees to handle the founder’s additional tasks. This contributes to the black hole because these new hires are less efficient than the founder, and it takes time to train them. Additionally, founders often hire someone else to replace them in sales. In most cases, the founder is the best salesperson in the entire company, so they should focus on handling sales and let new hires handle operations instead.
Common Pitfalls as Businesses Enter the Black Hole
If you’re about to reach the black hole, there are a few effective steps you can take to avoid getting stuck in it. Learn from the following common pitfalls so that you can navigate the black hole and come out on top.
Focusing Only on Revenue
Companies have a tendency to focus entirely on their revenue growth. However, it’s entirely possible to grow your revenue and still end up bankrupt. To get out of the black hole, you have to focus relentlessly on your pre-tax profit. The only thing that matters is how much profit you make from each transaction after you subtract the cost of goods sold (COGS).
One of the main reasons why using a labor efficiency ratio (LER) is so effective is because it focuses on how efficient and profitable your company is instead of how much revenue you have. The LER creates a ratio of gross margin revenue to labor costs, and companies are successful if the resulting ratio is higher than 2:1.
Adding More Labor
A major contributor to the black hole is labor costs. At $1 million to $5 million in revenue, companies have to start adding significantly more workers. While this may be necessary to support growth, it must be done mindfully.
Simply adding workers isn’t going to get you out of the black hole and boost your revenue enough to balance out the added labor. You have to be mindful of who you hire and how much you can afford. Ideally, you should have a safety net that covers the employee’s wages until they are productive enough to have a 2:1 LER.
When you’re in the black hole, you need to be slow to hire and quick to fire. Otherwise, your company won’t make it out.
Slowing Down Revenue To Get Caught Up
Another common mistake is to slow down revenue growth to get caught up. Often, teams will be behind on projects and work while they’re in the black hole. They’ll want to stop bringing in new revenue so that they have time to get caught up on everything else.
If you do this, you’ll never make it out of the black hole. Your LER will drop as soon as there isn’t additional revenue coming in, and you’ll slow down your company’s growth. To get out of the black hole, you have to reach $5 million in revenue while simultaneously keeping your LER above $2 of gross revenue per labor dollar.
Having Inefficient Labor
When your company jumps from having 10 workers to having 100 workers, you’ll naturally end up having employees who are less productive. Small companies focus relentlessly on productivity. Everyone has to be productive because there simply aren’t enough workers to cover an inefficient worker.
Once you reach 100 employees, it’s easy for an employee to be less productivity-focused. More workers spend their time doing busy work or just looking for something to do. Because of less efficient labor, workplaces will struggle to make it out of the black hole.
Forgetting To Develop Talent
When you’re mired in the black hole, taking extra time for training and development can seem impossible. However, your employee training programs are the key to boosting your labor efficiency and profitability.
Employees have a productivity lifecycle, and businesses that understand this lifecycle will have an easier time navigating the black hole. Typically, employees go through a training zone, a chasing zone, and a replacement zone. The training zone is at the start of their career. During this stage, they are less efficient than they should be, but they can be trained until they reach the chasing zone.
The chasing zone is where you want all of your workers to be because it is where they are providing a higher LER and more profitability. You need to develop your talent until they reach this level.
After this level is the replacement zone, which is where employees cost more than their LER justifies. At this point, you should transition the employee out of your organization.
While it’s hard to prioritize training costs when you’re struggling to stay afloat, it’s a necessity if you want to get out of the black hole. Through training, you can quickly boost your workers’ efficiency so that they start adding to your profitability as soon as possible.
Exposing Yourself to Hiring Creep
One of the biggest dangers in the black hole is hiring creep. When companies are growing so much, they have to hire people to handle the added workload. Unfortunately, this hiring means you’re often paying workers to handle annoying, tedious tasks.
A way to avoid this problem is to simply outsource these tasks. Outsourcing administrative, payroll, HR, and business management tasks allows you to focus on what you do best and scale effortlessly.
How To Navigate the Productivity Black Hole
Once you reach the productivity and profitability black hole, there are a few things you can do to ensure your company makes it out of this stage as quickly as possible.
Work To Reach 15% Pretax Profit by the Time You Reach $1 Million in Sales
Sometimes, companies will try to grow their revenue like crazy to get over the $5 million mark. This generally isn’t a good idea. If your business isn’t profitable at $1 million, growing your revenue won’t magically make you profitable. You’ll simply become a business that is still unprofitable at $5 million.
Instead, try to reach a 15% pretax profit when you reach $1 million in revenue. Then, do everything you can to maintain that profit level as you grow. To do this, you’ll need to relentlessly focus on your LER and your labor costs. If your LER is good, you can grow confidently.
Stay Above 10% Pretax Profit When You Hire
If you’re growing your business to get out of the black hole, your profit will likely drop. To avoid putting your company’s financial stability at risk, you should strive to keep your pretax profit above 10%. If new hires bring you below 10%, reduce the number of hires, train them up, and increase your profitability again before you hire more workers. It’s also a good idea to have a salary cap when you’re at 10%. Once your profitability is back to 15%, you can increase salaries again.
Pay Yourself a Wage
Reaching 10% or 15% pretax profit goals isn’t real unless you’re paying yourself a wage. You need to start paying yourself a wage so that you can see how profitable your business actually is. Then, you can make a realistic plan for your company’s growth.
Have the CEO Focus on Sales
According to Crabtree, one of the best things businesses can do is have the CEO focus on sales. As the founder, you understand the business, its clients, and the selling points of each product. No one is better at handling sales than you are. Founders will often hire someone else to handle sales and switch to handling operations. However, their real comparative advantage is in managing sales, so they should generally stay focused on sales.
Relentlessly Focus on Labor Costs
To navigate the black hole with ease, you need to focus relentlessly on your labor costs. Labor is one of the biggest expenses your company has, and it is directly linked to your productivity. If you aren’t using labor efficiently, you won’t be able to sustain profitable growth.
Get Professional Help When You Need It
When you’re growing, hiring an entire HR department or accounting team is expensive and likely unnecessary. If you hired an employee to handle each specialized task, they’d end up with a lot of downtime. More importantly, your company’s productivity would suffer.
Instead, hire a professional to handle these specialized tasks. For example, a top HR and payroll provider, like Asure, can handle HR compliance, time tracking, and payroll-related activities as your company grows. You can also outsource lead generation, bookkeeping, customer service, marketing, and technical support.
Push Hard to Reach $5 Million in Revenue
By pushing hard to reach $5 million in revenue, you can potentially jump the black hole and avoid some of the productivity pitfalls involved. However, this must be done with care. If your growth isn’t managed effectively, it can end up hurting your labor efficiency and profit margins. In turn, this can cause you to get stuck in the black hole.
Navigate Your Growth Plateau With Ease
To avoid falling into the black hole, you need to create a plan and hire slowly. By tracking your LER, labor hours, and gross revenue, you can instantly see where you need to make adjustments. With the right planning and analysis, you can ensure your company’s long-term growth and productivity.
If you’re interested in finding out more information about growth plateaus and navigating the black hole, we can help. To learn more, reach out to our team of small business and HR experts today.