One Simple Business Hack for Healthy Profit in Expansion
The Common Startup Growth Trap
Here’s something interesting about business growth that many people don’t understand. You might think successful companies just keep growing bigger and bigger forever, like they’ll become the next Google or Apple. But that’s not what usually happens in real life.
Let me tell you what really happens to many fast-growing companies. At first, they grow super fast. But then, suddenly, their growth stops completely. Their costs keep going up while sales aren’t growing anymore. They start losing money.
The managers try to make the company smaller to save it, but even when they sell less, their costs stay stubbornly high. They work hard to cut costs, but it’s not enough to fix things. Soon, most investors give up and leave. The company becomes forgotten, just like yesterday’s fashion trend.
Understanding the Demand Cap
Why does this happen? There’s a simple reason: there’s a limit to how much people want to buy. We call this the “demand cap.” Think of it like this – even if you make good ice cream, there’s an upper limit to how many customers will buy ice cream in this area on any given day. The tricky part is that many companies don’t see this limit coming. They keep building bigger warehouses, hiring more people, and buying more trucks – all of which cost a lot of money. But they can’t sell more than what people want to buy.
When business gets tough, many company leaders think, “We just need to try harder and we’ll sell more!” But that’s like trying to sell umbrellas in a desert – it doesn’t matter how hard you try if people don’t need them.
Three Growth Strategies
So, what can a company do? There are three choices.
1. The “Right Size” Strategy
First is the “Right Size” strategy. You figure out how much people actually want to buy (maximum market capacity), simulate the profit, and find the size that brings maximum profit (not necessarily the maximum size, as smaller can be more profitable). Then grow your company to that size and stay there while making good profits.
2. “Sell to Everyone” Strategy
The second is the “Sell to Everyone” strategy. You try to sell to everybody from the start. Yes, you can grow bigger in a bigger market, but you’ll have to make your prices very low because you’re selling it as a commodity. Customers can’t tell the difference between products, so you have to engage in price competition to sell, and your profit margins become very thin per sale.
3. The “Niche Market” Strategy
The third approach is the “Niche Market” strategy. Like how Amazon started by focusing only on books, you concentrate on serving a specific niche market’s unique needs. While the demand cap in each niche is relatively low, you can maintain great profit margins because you can sell at higher prices. When you’re about to reach the demand cap in one niche, you expand into another related niche. The best expansion is into related products or services because you can sell them to your existing customers without spending much on acquiring new ones. This way you can keep growing while maintaining healthy profits.
The Costly Mistake: Ignoring Market Cap
The worst strategy is increasing supply even when you’re reaching the demand cap. Some companies think “if we make more available, people will buy more.” They keep increasing production capacity and inventory, spending a lot on storage, logistics, and operations – but they’re already at the limit of what the market wants to buy. This just leads to wasted money and resources because you can’t sell more than the market demands, no matter how much supply you create.
Understanding demand cap accurately is critical for business success. When you can estimate this number well, it opens up several important advantages. You can tell if a new business will make money before you start it, create better cash flow plans to avoid running out of money, and have solid numbers to show banks when you need funding.
A Real-World Example: Beyond Meat
Let me show you how this works using Beyond Meat as an example.
You’ve probably heard of Beyond Meat. They’re a US company making meat alternatives from soy – products that taste like meat but are plant-based. They mainly sell to vegetarians who miss the taste of meat but avoid it for various reasons. Some care about animal welfare, others worry about the environmental impact of livestock farming, and some just can’t eat meat for health reasons like high blood pressure.
The company was once worth $8 billion, and looking at its growth, you can see why. Their 2019 financial report showed sales doubling every year, with losses getting smaller as they grew. The growth story looked unstoppable.
From 10-K
The Sudden Fall
But then something interesting happened. By 2021, their sales suddenly hit a wall at $460 million, while their costs shot up, causing huge losses.
By 2023, they finally accepted reality. They stopped trying to grow and actually shrank their operations to about $340 million in yearly sales.
Their stock price collapsed from $8 billion to around $200 million – a 97.5% drop. It seems incredible that a company could double its sales until 2019, then suddenly reverse course just three years later. But if you understand demand caps, this was actually predictable.
Calculating the Real Market Size
Here’s a simple demand cap calculation:
- US population: 330 million
- Vegetarian rate: 5%
- Vegetarians who know about soy meat, have tried it, understand its benefits, and have easy access: 60%
- People who enjoy the taste of meat substitutes: 30%
- Beyond Meat’s market share among competitors: 40%
Assuming these consumers eat the product twice weekly:
- 50 weeks × 2 meals = 100 meals per year
- Each meal costs $5
- Total calculation: 330M × 5% × 60% × 30% × 40% × 100 × $5 = $600M per year maximum demand
And this is a great estimation since you aim for the difference to be less than 10 times (1000%) for a rough estimation. Our calculated cap of $600M compared to actual peak sales of $460M only differs by about 25%, which isn’t that big of a gap. At least you can see clearly that this business will never reach astronomical sizes.
This type of rough calculation is called “guesstimation” – making educated guesses using logic and available information. There’s a great book about this called “Guesstimation” by John A. Adam and Lawrence A. Weinstein that can help you develop this skill.
The Cost of Ignoring Market Reality
In 2021, Beyond Meat’s costs jumped dramatically, causing a huge $170 million loss. They invested heavily in expansion, believing their rapid growth would continue. They built bigger warehouses, expanded their delivery networks, stocked up large inventory, and hired many new employees – all of which significantly increased their fixed costs and operational expenses. But here’s the key problem: they were already approaching the maximum market demand. So while all these expansion costs piled up, sales couldn’t grow any further beyond the demand cap. They were spending money to grow in a market that had no more room to grow.
The Key Lesson
The key lesson here is simple: calculating your market’s demand cap isn’t complicated, but ignoring it can be devastating. Always figure out your maximum market size before starting a business, and make sure you can turn a profit before hitting that ceiling – many businesses need to be fairly large to be profitable. If your demand cap is smaller than the scale needed for profitability, you’re heading for disaster.
Once you find that sweet spot where you’re making good money, resist the urge to keep expanding beyond what the market wants.