I recently read an article talking about the school voucher program and how it would force schools to be more competitive. While I think there is some merit to the school voucher program there is a much more important business lesson here. A school voucher program would mean that parents could send their children to the school of their choice. What could be wrong with that?
Parents would likely look at each school’s academic performance and enroll their kids in higher performing schools. These schools would expand to take advantage of the new money pouring in. However, scaling the school up would undoubtedly have a negative impact on the quality of education. To be more specific, class sizes may increase due to the influx of new students, or the district might have to build more schools and hire more teachers, perhaps having to lower their standards to achieve their expansion goals.
In the end, scaling would reduce the following year’s performance. In the subsequent year, as the performance metrics decreased, these same parents might send their kids to the new top-ranked school. This would affect that school in the same way. The first part of the business issue here is relying on lagging performance indicators to determine future performance in a free market.
The stock market is no stranger to this phenomenon. That is why financial advisers recommend investors follow what is known as an asset allocation model. As one sector does well or a particular fund group outperforms its peers, more investors want to invest in that sector or fund group.
More money makes it harder for the sector or the fund manager to continue to invest as wisely, resulting in poorer performance in subsequent years. With the poorer performance, investors pull their money and move it to better performers, repeating the cycle. Being forced to scale your business negatively affects your future performance.
Do you resist the temptation of using past performance to predict your business’s future performance when scaling your business? Do you account for the negative effects of scaling and not simply apply a multiplier to past performance when forecasting the future?
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