I have previously written about WHEN
it is better to drive growth vs. profitability. But, what wasn’t clear in that post, which I
want to better explain here, is it is mathematically impossible to try to
maximize growth and profitability at exactly the same time. The math just doesn’t work. And, for the many companies I meet that are
trying to do both, I figured you could benefit from the below reality check.
The Math
What specifically drives growth? More salespeople for B2B companies and more
marketing budgets for B2C companies.
And, both of these typically have a ramp up period before they are
driving revenues. For example, if you
are selling enterprise software, you most likely will be incurring salaries for
your sales team today, well ahead of the sale actually closing a year from now
(given the long sales cycle).
Or, as another example, many B2C companies rely on a high
lifetime value of their consumers to get a payback on their upfront marketing
investment to acquire that consumer.
Said another way, they may need to spend $100 in marketing today, which
may drive $500 in cumulative gross margin over five years, at $100 per year
(with a break even in year one, and profits starting in the second year). What did you see in both examples above? Growth comes with near term costs which eat
into the company’s near term profitability.
You Need to Choose
Between the Two Roads
I won’t reiterate WHEN you should focus on driving growth
vs. profitability, as I already did that in the linked article I referenced above. But, understand, you need to pick one route
or the other. You are either in a rapid
growth phase with near term losses before the revenues show up. Or, you are in maximizing profit phase, which
means lifting off the accelerator, and cutting back on your sales and marketing
expenses.
As an example, a 40% growth company may be operating at a
break even, and a 10% growth company may be operating at a 20% profit
margin. If you are committed to driving
both, you really only have one option: a medium growth scenario that drives
medium profits. Continuing the example
above, this could be a 25% growth company driving a 10% profit margin (the
midpoints of the above examples). But,
to make it clear: using the above examples, it is mathematically impossible to
get a 40% growth rate and a 20% profit margin at the same time, so don’t even
waste your time trying.
Which Road Do
Investors Prefer
Since many of you desire to attract investment capital for
your business, it is a fair question to ask which route investors prefer. The answer is: it depends what type of investor you are
trying to attract. Most venture capital
firms are perfectly fine sacrificing near term profitability in exchange for
maximizing growth. Frankly, many venture
investors who see a race to lock up market share as a first mover in your space,
may want you incurring big losses in the near term to sign up as many customers
as possible today, before a competitor does.
On the flip side, most private equity firms need some base
level of profitability before they will invest, as they will most likely want
to lever up the business with debt, to reduce their equity investment. And, debt service will require cash
profitability to pay the interest expense on that debt. So, if you are trying to tee your company up
for a sale to a private equity firm, that would be a good time to lift off of
the growth accelerator and start driving some profits.
Closing Thoughts
As a marketer, it baffles me when a business leader doesn’t
truly understand what drives growth. Growth
doesn’t just happen on its own. You need
to invest in growth by increasing expenses around your sales and marketing
investment. And, the minute you say
expenses need to increase, that means profits only have one way to go:
down! So, be smart, understand the basic
math and pick which route is best for your business. But, to be clear, it is a fork in the road
where you will need to decide between the two options. As trying to maximize both at the same time
is a fool’s errand.
For future posts, please follow me on Twitter at: @georgedeeb.