The One Simple Mistake That Turns CEOs into Job-Hunters

The most common mistake venture owners make is fixating solely on business expansion without considering demand capacity. Here’s a simple but crucial reality: you can’t sell more than the market demands.

Many entrepreneurs get excited when sales start climbing. They see growth as the opposite of death and believe rapid expansion means success. They dream of sales skyrocketing through the sky, past the solar system, and into deep space. But here’s the truth: the sky actually does have a limit.

You must stop expanding before hitting your demand cap. If you don’t, you’ll experience a dangerous chain reaction: costs related to overcapacity will increase, sales will stagnate, and you’ll start making losses. Eventually, this path leads to bankruptcy—a fate that’s more common than most realize.

The key is to carefully watch your demand cap. Demand is determined by two critical factors:

1. What you are selling
2. Who your target market is

By strategically defining these elements, you can actually design and expand your potential demand.

Let me illustrate with an example: American Apparel.

American Apparel was a clothing company that made and sold USA-made clothes to young adults. It was a unique player in the fashion industry, but its story ended in bankruptcy in 2015 when it ran out of cash to operate the business.

Let’s look at their journey:

• 2005: $200M in sales
• 2006: Went public
• 2008: Sales skyrocketed to $550M
• After 2008: Sales stagnated around $600M until collapse

So what went wrong? It all comes down to a crucial mismatch between their target market and their solution (what).

The Target: Young adults

Their Problem:

• Want cool, trendy clothes to show off and be popular
• Need new multiple outfits regularly (who wants to wear the same clothes all the time like a lunatic?)
• Have limited money (they’re young, remember?)

American Apparel’s Solution: High quality, made in USA clothes – they were kinda expensive.

See the mismatch? They should’ve aimed for older adults instead. Why?

1. Older people can appreciate good quality clothes and tell the difference.
2. They have money to buy expensive clothes.
3. Older folks tend to be more patriotic buyers.

This mismatch limited American Apparel’s demand to about $600M/year. No matter how hard they tried, they couldn’t sell more than the market demanded. The sales growth stagnated after reaching $600 million, even though they rapidly increased the number of their shop

Here’s another problem: their solution didn’t directly address their target market’s needs. If they had, they could’ve charged higher prices. Instead, their operating income/sales rate was a measly 4.4% in 2009.

American Apparel made a critical mistake in their business strategy. They chose to use borrowed money (debt) to open new stores, which proved to be a poor decision. This was problematic because the company already had low profit margins on their sales. When they rapidly opened more stores, they took on more and more debt, which led to higher interest payments. As a result, even though they managed to increase their operating profit slightly, most of this extra money went straight to paying interest on their loans instead of helping the business grow.

Their only viable option was natural growth using cash from operations. But did they take it? No.

American Apparel’s growth plan seemed impressive on paper, and Wall Street investors initially supported it. However, the reality turned out quite differently. While they kept opening new stores with borrowed money, their total sales hit a ceiling at around $600 million and wouldn’t grow beyond that, despite having more locations. This showed there was a limit to customer demand. Meanwhile, each new store added to their operating costs, and the expensive process of opening and closing stores drained their resources. The combination of these factors caused their profits to steadily decline, eventually leading to major financial losses starting in 2010.

Check out these numbers:

$million	2013	2012	2011	2010	2009	2008	2007	2006	2005
sales	633.9	617.3	547.3	533.0	558.8	545.1	387.0	285.0	201.5
net profit	(106.3)	(37.3)	(39.3)	(86.3)	1.1	14.1	15.5	(1.6)	3.5

American Apparel had its sweet spot around 2007. More stores after that? It cost more than it brought in sales. The CEO should’ve ignored Wall Street and stopped chasing sales increases. But he couldn’t. Why? High stock price due to rapid growth. Stopping growth meant losing that high valuation. Loss aversion kicked in, and they kept opening stores…

Even when profit rates dropped significantly in 2008, they kept opening new shops. It seems borrowing money and opening new stores was their only solution for everything.

Now, let’s talk about economies of scale. It’s when sales increase and the cost rate decreases. For example:

• You make a video for $100
• Each viewer pays $1
• 100 viewers: Sales $100, Cost $100, Cost rate 100%
• 1000 viewers: Sales $1000, Cost still $100, Cost rate drops to 10%

Sounds great, right? But here’s the kicker: it doesn’t work well in the retail clothing industry. Because it’s labor-intensive.

American Apparel made clothes in their own factory and sold them in their own stores. Most costs were labor costs. And labor costs don’t benefit from economies of scale. If you use 100 units of labor, you pay for 100. If you use 1000, you pay for 1000. The cost rate stays the same.

So, increasing store numbers wasn’t a solution for the company. It just dug them deeper into trouble.