Both, profitability and growth, are important for a company but not achievable at the same time. This article by GEORGE DEEB provides a guideline and reality check for businesses doing the same mistake.
I have previously written on ‘When to Drive Growth vs. Profits’ in the Red Rocket Blog. But, what wasn’t clear in that post, and I want to explain that in a better way, 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 reality check mentioned below.
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 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.
As a marketeer, 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.