Is “Grow Your Business Fast at All Cost” a Sound Strategy? Massive, New Study Says NO!


Finding a strategy that is best suited to achieve success is a challenge for millions of founders and managers around the globe. Growth and profitability are key dimensions in dealing with this challenge. If a firm has high profitability but does not grow, it may be “leaving money on the table” by passing on opportunities for profitable growth. If it has high growth but doesn’t make a profit, it may simply be accumulating larger losses than its competitors. Therefore, profitable growth is arguably what commercial businesses should aim for. For firms with a social mission, growth is also appealing but it is only if it is attained on a sound financial basis that expanded fulfilment of the social mission can be sustained. So, the goal function is more similar than sometimes thought.

But how does a firm reach the enviable position of having high growth and high profitability at the same time? A range of theoretical notions such as economies of scale, experience effects, first-mover advantages, and network externalities more or less clearly suggest that growth leads to increased profitability. In the current entrepreneurship eco-system, there is a lot of emphasis on fast scaling, as if the strong network effects and advertising revenue potential underpinning the success of Facebook, Twitter, Amazon and a few others were universal phenomena.

In fact, the evidence across numerous studies does not convince that there is a strong link between growth and profitability. Yet, given the above beliefs it was seen as quite controversial when ACE professor Per Davidsson and (then) QUT colleagues Paul Steffens and Jason Fitzsimmons published a study suggesting just the opposite: prioritize profitability before going for growth.

They reached this conclusion by analysing how samples of several thousands of Australian and Swedish businesses move over time in a performance matrix as depicted in the figure below (higher number equals higher performance). They found that firms are much more likely to move to “Star” (High Growth/High Profitability) if they come from “Profit” (High Profit/Low Growth) than from “Growth” (High Growth/Low Profit). That is, firms do usually NOT grow into profitability. Instead, “Growth” firms are MUCH more likely to become “Poor” than “Star” in the following period. The figure shows this through the breadth of the green (=good moves) and red (=bad moves) arrows.

Although the research does not give a direct answer to WHY this is the case, Per Davidsson and his team offered a plausible interpretation: If you can show high profitability at modest size, this likely reflects that there is something superior about your product/service or your business model – you offer something customers value higher than the cost of providing it, and competitors aren’t able to satisfy your customers to the same degree at lower price. Starting from that sound basis, it should be possible to expand without sacrificing the level of profitability. If on the other hand you try to grow starting from low (or no) profitability and no proven superiority, you need to “buy” customers with lower prices and more intense (=costly) marketing. Moreover, you need to finance the growth externally, which is more expensive than using retained earnings. It doesn’t sound like a recipe for improved profit margins, does it?

But although the results were strong and held up in various sub-group analyses, like all research the study had some limitations. The data were from the 1990s and covered only two countries. More importantly, the longest time horizon covered was three years—maybe the profitability payback comes later? For these reasons, doubters had excuses for not being convinced.

Excuses hold no more. Now, much stronger, contemporary evidence has been presented in a massive new study of over 650,000 firms in 28 countries over the 2011-2019 period. In “Questioning the Growth Dogma: A Replication Study” Cyrine Ben-Hafaïedh and Anaïs Hamelin replicate and extend the original study data and find impressively consistent support for the original results:

– Separately in each and every one of the 28 studied (European) countries
– Across different industry sectors and firm age-/size-classes
– Using time lags from 1 to 7 years
– Using alternative ways of measuring growth and profitability
– Using the matrix transitions approach as well as other and more sophisticated analysis techniques

No matter how the data are sliced, those coming from “Profit” are MUCH more likely to become “Stars” while those coming from “Growth” are MUCH more likely to end up “Poor”. In fact, few if any conclusions in business research have as solid support in data as these.

At this point, some doubters would insist that this still doesn’t apply to technology ventures that are said to have to scale fast to win the market, often with the help of venture capital investments. Well, there is actually an earlier replication of growth-profitability transitions among biotech firms by Brännback and colleagues. And the conclusions remained the same: “Our empirical results support Davidsson et al. A high profitability – low growth biotech firm is more likely to make the transition to high profitability – high growth than a firm that starts off with low profitability. (…) Since our empirical results come from the biotech sector where profitability has typically been suggested to follow growth our results add particularly strong support to the findings of Davidsson et al. ”

This pretty much means CASE CLOSED – GO FOR PROFIT BEFORE GROWTH! There are some exceptions, for sure. However, considering the total evidence we now have across 30 countries, three time periods and various industries, firm ages and size classes, it is time for believers in the soundness of the “growth first/at all cost” strategy to show us THEIR solid, systematic evidence for their stance. Or, simply, to reconsider.

Ben-Hafaïedh & Anaïs Hamelin’s large-scale replication is available here.
Brännback and colleagues’ biotech replication is available here.
The original study by Davidsson and colleagues here or here.
An 8-minute sketchbook video based on the original study is available here.