Should Startups Focus on Profitability or Not?

There are certain topics that even some of the best journalists can’t fully grok. One of them is profitability.

I find it amusing when a journalist writes an article about a prominent startup (either privately held or preparing for an IPO) and decries that, “They’re not even profitable!”

I mention journalists here because they perpetuate the myth that focusing on profits is ALWAYS the right answer and then I hear many entrepreneurs (and certainly many “normals”) repeating the same mantra.

There is a healthy tension between profits & growth. To grow faster businesses need resources in today’s financial period to fund growth that may not come for 6 months to a year. The most obvious way to explain this is with sales people.

If you hire 6 sales reps in January at $120,000 / year salary then you’ve taken on an extra $60,000 per month in costs yet these sales people might not close new business for 4-6 months. So your Q1 results will be $180,000 less profitable than if you hadn’t hired them.

I know this seems obvious but I promise you that even smart people forget this when talking about profitability.

Hiring more people isn’t always the right answer. You have to understand whether they’re likely to yield revenue growth in the near term OR whether you have access to cheap enough capital to fund your losses until your investments pay off.

Exec Summary:

Most companies (98+%) in the world (even tech startups) should be very profit focused.

Being profitable allows you degrees of freedom you don’t have when you rely upon other people’s money.

  • You may have leverage when you DO need to fund raise. (There are many investors who are not looking to build enormous businesses who value the fact that you can run a business profitably)
  • It allows you many more exit opportunities. While Google and Facebook will buy “acquihires” (at least as of Dec 2011), many acquirers hate the idea of buying companies that aren’t profitable. When they look at buying your company they often think in terms of “how long will it take until I earn back the profits to pay for my acquisition price?” If you’re not profitable you’re purely a cost center to them.
  • Being profitable certainly makes your company more sustainable in difficult times.

The characteristics of somebody who should NOT focus on profitability include those who:

  • Have or perceive that they have the opportunity to build an immensely scalable businesses. Internet scale.
  • Have easy access to capital by investors who are committed to building businesses at Interent scale

As I like to say,

“If you’re really on to an enormous idea then other people in the market are going to spot that and want to compete with you.

If you have a market lead then raising capital and making investments now will help you as others enter the market.

If you don’t, somebody else WILL!”

The Details

I have had this discussion with many a first-time entrepreneur. They have have raised $2-3 million, built a product that has some amount of market traction and got to annualized revenues of around $1 million.

At this level, as a founder you feel SO CLOSE to profitability that many say, “I’m going to keep my costs really low this year to try and hit profitability. I don’t want to be beholden to investors.”

My response is often, “That’s fine. What’s your objective? Are you looking to potentially sell the company in the next year or two? Do you plan to run this as a smaller business but maintain healthy profits? Do you imagine eventually raising VC and trying to build a faster growing company?”

Because of the circles I run in I tend to meet many people who eventually do want to build large companies and therefore do want to eventually raise VC and “go big.” But they want to do it with leverage.

I often point out that investors at this stage care way more about growth than profits so be careful not to shoot yourself in the foot. I certainly understand the desire to be in control, which is what you are when you earn a profit. Just be careful that it doesn’t come at the expense of investments in growth.

The likely response of a VC to your company that raised $3 million and now is profitably doing $1.5 million in revenue three years later is, “So effing what?” Harsh, but reality.

If you had huge customer growth but just didn’t focus on revenue that’s a different story. If you spent the 3 years perfecting some hugely differentiated technology IP that may also be different. But if you simply went more slowly to show you could earn a profit you may need to look for alternative funding sources to fuel your future growth.

Understanding Profits

No discussion about profitability can sensibly happen without covering the basics first so please forgive the 101 nature of these charts.

Simplifying:

Revenue -
Cost of Goods Sold (COGS) =
Gross Profit (also called Gross Margin or sometimes “Net Revenue”)

- Operating Costs
= Profit

When I look at an income statement (also called a profit & loss statement) I start by focusing on the revenue line.  One thing that should matter to all people trying to understand the performance of a company is whether they have revenue growth.

I always remind this to journalists who ask me about public stocks. If you had two companies each with $100 million in “earnings” (profits) they might have vastly different prospects for the future. One company might be growing its revenue at 50% per year and the other might be growing at 5% per year.

And assuming they both had the same net profit margins (profit / revenue) then the former company would be much better off at the end of the year.

So while the simplest way that people often evaluate stocks is by P/E ratios (price-to-earnings), one also needs to look at other metrics such as the PEG (price-to-earnings-growth). [of course there are MUCH more sophisticated financial tools than either of these, but PEG is a short-hand many people use]

Investors value growth.

The value of a company is the expected value of all future cashflows discounted back to today’s dollar (because as you know a dollar next year is worth less than a dollar today) and a company that is growing more quickly is more likely to yield better overall profits in the future.

So for a start when you want to evaluate companies you want to evaluate “growth.” Looking at earnings alone across two companies won’t tell you the picture of the different prospects.

And when you’re looking at even earlier-stage companies (as VCs do) you might be even more focused on customer growth than revenue growth.

The Nature of your Revenue Matters

When I do evaluate companies that already have revenue, I actually want to understand the revenue line in more detail. What makes up revenue? Is it one product line or multiple? Do 20% of the customers make 80% of the revenue or do the top 3 customers represent 80% of the revenue.

This is called “revenue concentration” and the more concentrated your revenue the higher the risk that your revenue could decline in the future.

I also try to understand things like how you’re pricing your product, how your competitors price and what your pricing expectations will be in the future. Fast early growth in a market is often eroded when competition gets fierce and prices are forced down due to competition.

Revenue is Not Revenue is Not Revenue
But it’s not as simple as just looking at revenue in dollar terms. For example, look at the following graph. You’ll notice that although both companies have the same revenue every year, Company 1 has MUCH higher gross margins than Company 2 because the cost of sales (COGS) is much lower.

“COGS” represents the amount that each sale costs you. For example, if you sell your product through a third-party reseller who charges 30% of any sale then your COGS will be 30% of revenue (assuming no other costs of sales).

The example chart is not actually atypical. The first company represents a normal software company that sells its products directly (either via sales staff or directly off of the internet). Many software companies have 85-90% gross margins, which is why it has historically been a very attractive industry.

Company 2 might represent an “ad mediation company” where the company gets paid by ad networks for running ads on publisher websites and the company in turn must pay the publisher 85% of the revenue it collects. This is not atypical for “middle men” who often take 15-30% of the value of the sale

This could also be a travel website who gets paid a bounty for selling airline travel.

Companies like to have high numbers in their revenue column but this can be quite misleading. After all, if you sell $500 million of United Airline tickets that isn’t really YOUR revenue. Your revenue is the $75 million you got paid in booking fees.

It could be an eCommerce website or “flash sale” where they are booking revenue from customers but then having to pay out a high percentage of the sale to the clothing manufacturer. Many eCommerce companies are in fact, middle men. Gross margins can range from 15-40%.

I know you’re shaking your head and thinking, “duh” but I promise you that even some of the most sophisticated people I know get off track on this issue of “gross revenue” versus “net revenue.” I saw this first hand with the growth of the “flash sale” category.

People kept saying,

“Company X is already doing $100 million in revenue! Wow! Amazing growth!”

Um, no,

“Company X is doing $100 million in gross revenue but is only at 12% margins which means the majority of the value is in the goods.

Many of these companies weren’t even taking physical possession of the goods in the early days. So they are really doing $12 million in “revenue.”

That in and of itself is an achievement. But it’s very different than $100 million in two years.”

Shouldn’t All Companies Want to Be Profitable?

Not necessarily.

Let’s consider the following two software companies, both of which have 66% gross margins.

Both companies look the exact same after one year. They both raised angel / seed money of $1.5 million to fund operations in their first year of operations. Both companies lost $1 million in their first year.

Gross margins at 66% is fine (they’re selling through a reseller who takes a 33% margin) but their sales aren’t yet large enough to cover the costs of their IT development team + management + marketing + office costs, etc. In many Internet startups 80% of the operating costs will be people.

So which company is better run?

The answer is that you have no way of knowing. A naive journalist might lament the fact that Company A is “not profitable” or is being a typical Internet startup and not worried about costs. After all, they doubled their operating costs when they weren’t even profitable.

What did they actually do? They raised $5 million in venture capital to fund growth. They used the money to hire a bigger tech team so they could roll out their second product line. They hired a marketing team to promote their products more broadly.

They hired a biz dev team to work on deals where their product could be embedded in other people’s products as a way to increase customer demand. They got a bigger office space so their employees would feel comfortable and they could improve employee retention.

If there was strong market demand for their product then this investment might pay off handsomely.

Let’s look at years 3-5 of the two companies.

Even though Company B initially looked prudent, it turns out that the investment that Company A made in people led to a higher annual growth rate. At the end of year 5 Company A has earned $14 million in cumulative profits (gains – investment years) while Company B has made $5 million.

Company A is now doing $47 million in annual revenue which Company B is doing $12 so years 6-10 appear rosier for Company A as well.

I know which company I’d rather have invested in. Growth matters.

But let’s consider an even more aggressive scenario. Let’s call it the “super high growth” Internet company. You know, the kind that unknowing commentators would be quick to lambast as being wasteful because they’re not profitable.

The company would have had to raise at least $35 million in venture capital to have funded operations like this. More likely they raised $50 million or more. Note that they likely raised this in 2-3 tranches, not all up front or all at once.

Crazy? Stupid? Should they have slowed down operating costs in order to “make a profit.”

Again, it depends. If the growth is as spectacular as it is here and IF they have access to cheap capital then they’d be crazy not to have raised the VC and instead stayed unprofitable.

This is the trade-off between profits & growth. You can drive profits up by not investing today’s dollars in tomorrow’s growth.

The next time a journalist wants to slam Amazon for not being more profitable I wish they’d understand this. Amazon is continuing to grow at such a rapid pace that of course it should take some of today’s profits and reinvest them in growth.

If there is a company that can’t grow fast enough then they should do other things with their profits, like return it to shareholders.

A Final Note on Profitability vs. Being Cashflow Positive

More 101, but experience tells me this is worthwhile to many. Many investors care much more about cashflows than income statements.

It’s worth noting just for those that aren’t familiar with the difference between an Income Statement and a Cashflow statement that being “profitable” is not the same as being “cashflow positive.”

You can be profitable while losing money.

Huh? I thought profitable meant you were making money?

Income statements are designed according to accounting standards that are designed to “match revenues & costs in the period for which they should be attributed.”

Quick examples:

1. An ad network (the middleman) might sell $500,000 in ads. It might agree to pay the publisher who runs those ads in 14 days. The advertiser who bought the ads might pay the ad network in 60 days.

So for this money I might show that I’m profitable on my income statement but I might actually have paid out $500,000 that I didn’t receive yet (negative cashflow)

2. I might have sold a $1.2 million contract over two years. I therefore might be “booking” $50,000 per month in revenue on my income statement. But the customer may be paying me quarterly in arrears (at the end of the quarter). So for the first two months of every quarter I’m showing revenue on my income statement that I don’t yet have in cashflow.

3. The same is true obviously on the cost side. I might have bought $450,000 in equipment that I amortize over the three years that I expect this equipment to be useful. So every year I show costs of $150,000 but I really spent the money up front.

  • http://www.bluecoastrecords.com/ Cookie Marenco

    Very helpful!  Growth vs Profit.I wish I knew this 12 months ago.  Biz 101 is great!  Thanks, professor!

  • Guest

    I’m still unsubscribed from your RSS feed, but I manually checked in to see if you had responded.I’m convinced that you’re a really sharp guy, have much to teach us, and that you care deeply about doing good. I mean that with all sincerity. I’m not angry with you but after reading some of your blog posts I feel worried and disgusted.I don’t want to come off as a pompous pedant but I want to be sure we are clear: you are not your posts; your posts are your posts; you are you. (I disagree with Seth Godin: sometimes semicolons are necessary).If genius is the ability to take an apparently complicated concept and make it simple, then taking an otherwise simple concept and making it complicated is not genius. Or then again. Maybe it is.  (I was not attempting to segue from science to marketing by employing a clever rhetorical device, but rather merely typing what just came to my mind. Often I don’t really know what I’m going to type: I learn as I type. “Or then again. Maybe it is.” just popped into my mind). But it’s not the kind of genius we normally associate with “great men” such as Edison or Einstein but instead with hucksters like P.T. Barnum or Bernie Madoff.Let’s think about your “Learn or Earn” post (I don’t remember what precisely you titled it). Essentially you were saying, “Sometimes you learn (invest); sometimes you earn (profit). Trying to profit without first properly investing is like trying to reap your crop before you sow it.” That is the sort of synopsis I’d like to see at the top of each of your blog posts.I’m sorry if this sounds harsh but that advice doesn’t seem like “tough love” but instead a simple way to improve your blog posts. I’m tired of reading half way through a blog post of yours only to find you are teaching me something I already know well. Frankly, I suspect that many of your loyal readers have had a similar thoughts but simply haven’t mentioned them to you. In other words, before you go off on one of your “deep dives” please give us the Cliff’s Notes version first. (you want Evite to go away? I’d like “deep dives” to fall out of our lexicon because seems like a poor analogy that would be better replaced with something like “foggy swamp” or “dense jungle”). One of my teachers taught us that when you write an essay, “Tell ‘em what your gonna tell ‘em; tell ‘em; tell ‘em you told ‘em.” Redundancy is very important. After all, “Repetition is the mother of learning.” Of course, there’s a fine line between using redundancy properly and becoming overly verbose. Frankly, I probably crossed that line in this comment.Here’s a Saturday Night Live sketch with Steve Martin that humorously explains the chicanery related to one form of modern loan sharking, er, uh I mean personal finance (revolving credit card debt) http://www.youtube.com/watch?v=fr1nzilLtkASee what Steve Martin did? He takes a very simple mistake we make: getting trapped in credit card debt and shows in a humorous way how we might avoid such a trap. By getting us to laugh at our foibles he’s helping us to see that we are merely fallible human beings who need to be reminded to “do the right thing.” (I never saw the movie and find Spike Lee’s persona revolting, but am trying to use language that will resonate with your audience).If I had the time I’d write something succinct, clever and funny like Giant Robot’s hilarious post about “Sell the sizzle not the steak” which he recast as “Be the bacon not the bread” as he parodied the current buzzacronym MVP which some might opine is overly used on, er, um, “some tech blogs which shall remain nameless” http://www.avc.com/a_vc/2011/09/minimum-viable-personality.html In other words, to paraphrase something you noted in one of your previous blog posts, “If I had time I’d have written you a shorter letter.”To take that analogy further, trying to discuss calculus with kinder-gardeners is not merely unnecessary, but inappropriate and confusing. Sure, for the high school or college student discussions about calculus may be appropriate. But this blog appears to be aimed squarely at novices and advanced beginners; not experts.And when you factor in that of the 100-150K people who read your blog many are easily confused and misled, if you are trying to be like Edison and not Barnum then you owe it to these students of yours to make the complicated simple, not the other way around.Furthermore, I wish you’d simply say, “We’ve returned to Mark Twain’s Gilded Age or Social Darwinism. The big and strong dominate the weak and powerful. We now have “The Cheating Culture” http://en.wikipedia.org/wiki/The_Cheating_Culture Here are the rules of the game: find someone really big and really powerful and join his gang, er, uh corporation, otherwise someone else who is in a bigger and more powerful gang, er, uh corporation, will crush you. Watch the utterly brilliant movie http://en.wikipedia.org/wiki/The_Corporation_(film) and you’ll understand where we are and how we got here. Now, just like in the era right after the Civil War (“War between the States” for your Southron readers) there are new and powerful technologies that enable folks to amass great fortunes in legal but unethical manners. See, “The Victorian Internet” http://en.wikipedia.org/wiki/Victorian_Internet Futhermore, just like Coca-Cola legally put cocaine in its beverages and sold them to children, we too can sell heroin, er, uh I mean multiplayer real-time virtual world games to children. Sheesh, we can even convince their grandmothers to buy them an iPad to smoke our crack, er, uh, play our games!” Something like that would transform you from Shylock into, dare I mix my metaphors, a white knight who has gone over the dark side but come back into the light!Remember how Steve Jobs famously rhetorically asked John Scully, “Do you want to spend the rest of your life selling sugared water or do you want a chance to change the world?” I think what historians looking back and our “Second Gilded Age” will see that Steve Jobs (much like his 80 year old workaholic biological father who runs a casino in Reno) found a way to sell people legally yet highly addictive products and services. (Yes, I’m on the Nature side of the entrepreneurial DNA debate). If someone hasn’t already parodied it, I’d like to see a skit in which Steve Jobs’ character asks, “Do you want to spend the rest of your life selling sugared water or do you want a chance to sell something much more addictive and far more lucrative? I mean this stuff is so good we don’t even to bother with a bottling plant or delivery trucks! We can send it to them through the clear blue sky and they’ll happily pay us billions of dollars for it!” By the way, people give Bill Gates a hard time for a good reason: he acted in an evil and sinister manner for a long time and cruelly harmed many people. But at least he seems to have repented and is trying to do good now. Steve Jobs, on the other hand, acted in an evil and sinister manner for a long time and cruelly harmed many people *but* never seems to have repented yet has been generally beatified (at least by the popular press).If newspapers were like coca leaves; radio like cocaine, and television like crack then what would we say video games + the internet are? Super-duper crack cocaine? Fred Wilson seems like a warm, generous, kind-hearted man but investing in Zynga? Are you serious? How about just going out and selling crack? Oh wait! Selling crack is illegal… nowadays in the US. But when Coca-Cola started out selling drugs wasn’t merely legal, sheesh “patent medicines” of the 19th century were normally laced with opiates which were subsequently outlawed.(By the way, I  favor legalizing drugs- even heroin-  not because I like them but because Prohibition Part II has been an unmitigated disaster). Actual slavery in this country was legal when the US started too. But legal doesn’t necessarily mean right; and right doesn’t necessarily mean legal.What do you think the Ramban would think about your blog? Well. Let’s take a look at The Talmud. It very clearly prohibits us to place an obstacle in front of a blind man. In my opinion (which is almost invariably flawed and certainly not even remotely in a league with the Ramban) it seems to me that when you write articles that appeal to the greed of your readers it is as if you are placing obstacles in front of blind men.Once you start discussing math, particularly when it relates to money, with most Americans they get lost. All they see are $$$ signs. “You mean I can have that house, car, new dress, etc. if I merely sign on this piece of paper? Hurry up and give me a pen!” In other words, their greed kicks in. Therefore, your blog says if they run to you and get some money then they can go out and get some of those $$$ themselves. But the reality is this: very few folks reading this blog will ever receive VC funding and even those few who do, most won’t “make it” anyways.Why not tell your readers, “Hey, instead of spending $100,000 to $250,000 on college, tell your parent you want to spend 4 to 6 years trying to start 3 or 4 new companies. If your readers are 18 years old and live at home (rent-free) until they are 24 years old then they’d have roughly $20,000 to $50,000 to start each new business. Even if each new business failed, they’d have received an education far more valuable than most of them will with a college education. I think that would make you look like a white knight in shinning armor instead of a greedy Jewish money lender.We Jewish men tend to be very clever when it comes to understanding numbers and money. When in your blog posts you combine sophistry (P.T. Barnum hucksterism) with money you are able trigger the greed reflex in your readers. Yet in the winner-take-all environment we are in, that means most people are losers-who-get nothing.Now onto my next topic: cruelty to delusional CEOs.The CEO of Forrester should not be belittled; he should be removed. He seems delusional. Seriously. Watching him speak in the video was reminded me of watching Mike Arrington attack Carol Bartz. She was so utterly arrogant, incompetent, and clearly “over her head” it was pathetic to watch her. Mike should have shown more restraint and compassion towards her just as you and Fred Wilson should have shown more restraint and compassion for the CEO of Forrester. I know Fred Wilson “merely” posted the video but it was like he dropped a lighted match onto some dry brush.Let me give you an extreme example to make my point: let’s think about George W. Bush. It seems to me that he’s very likely a war criminal but I strongly suspect he was way, way, way over his head (drowning in a sense) as President of the US. I suspect he honestly thinks he did the right thing by going to war in Iraq. Sure, *if* he were to properly tried by a court of proper jurisdiction and *if* he were found guilty of, say, Crimes Against Peace, then in that case he should be executed. I think that’s a path we should go down. But even if we were to go through that excruciating experience, we should not belittle a man who I suspect tried to do the right thing but sadly demonstrated, “The road to hell is paved with good intentions.”Watching you and Fred I’m reminded of how everyone on the block loves to belittle the pathetic crazy old spinster who lives down at the end of the street. It’s an ugly side of human nature. As my dad often reminded me, “Honesty without compassion is brutality.” Tempering justice with mercy is extraordinarily difficult. I am certainly a novice at that delicate art myself.Then when the inevitable crisis comes, and our fellow Americans start looking for a convenient scapegoat, they will be a little less likely to come after us Jews. Occupy Wall Street didn’t get far. But what do you think people in that movement were talking about? I’m sure not a single one of them talked angrily about rich Jewish bankers. (That last sentence was sarcastic). Being an affluent minority is always dangerous, just think about the wealthy overseas Chinese in Southeast Asia. We Jews have a long and tragic history being strangers in a strange land. It didn’t start with the Nazis and almost certainly won’t end with them either. But we keep forgetting that as a small minority (guests in fact though not in law), we need to be very careful to not just be as good as the local majority, but we need to behave better than they do so they have less of a reason to resent us.The next time you come across talks by CEOs who make fools of themselves, please, please, please don’t pillory them. It’s cruel. Instead, politely explain why you think they are wrong and if appropriate, gently suggest that perhaps they should be replaced not just for the sake of their employees, customers, and shareholders but for their own sake as well.It literally pains me to imagine what it must be like working at Forrester (CEO down to janitor) much like it pained me to imagine being a US solider (general down to infantryman) in Iraq. It seems like some sort of nightmare to me.

  • Martin S.

    cool story bro

  • http://expletiveinserted.com Greg Cox

    My impression is that the growth first mentality is alive and well among founders. I’m not sure who qualifies as a journalist in your book, but the tech press also seems very forgiving of companies going profitless for years.

    I also struggle to accept as an article of faith that Twitter has a great business model up its sleeve. It might have one. I just don’t know. As a user who loves the service, I see very little evidence of monetization and I imagine that they’re spending a pile on their infrastructure. Tumblr is perhaps a more extreme example of this.

    And as Twitter discovered with the “dickbar”, it can be extremely hard to retro-fit monetization into a product. This is one big risk of leaving monetization to later that is seldom discussed. Whatever that business model is, it is probably going to involve something changing in the user experience and that can be disastrous when the motivation for the change is transparently economic.

  • http://LeanStartPad.com/ Jeff ‘SKI’ Kinsey

    A most thorough look into such matters… I would just add that I still hear otherwise smart people talk about investment dollars as if they are revenue. A most excellent contribution Mark.

  • http://www.servicecentral.com.au/ Service

    Mark I wish you had posted this blog post years ago!

    Its not only journalists but the majority of investors as well that simply don’t get this concept. 

    One of the biggest challenges for a startup is justifying that the Customer Lifetime Value is greater than the cost of Customer Acquisition and Servicing costs. If you as a entrepreneur know in your heart of hearts that your CLV is way higher than the associated costs then you are simply mad if you don’t rapidly ramp up your sales and marketing effort and capture a huge chunk of your market. The outcome, however, is that when you do so your profits slump and investors and journalists start to question the true viability of your business. This is exactly what is happening to Groupon.

    Its a catch 22. Without great investors (and good PR if you can get it) the growth rate is forced to slow down until you have enough runs on the board to truly prove that the CLV is as high as you always knew it was.

    If only there were more investors out there that truly understood how this plays out.

  • http://lenticularimageprinting.com/ Lenticular

    Thank you for sharing your articles, I hope you have an interesting and creative new year.

  • http://www.branddikt.com/ Peter Kadas, Dr.

    This is an excellent article, and as a tech entrepreneur, I completely agree with it. Just two tiny amendments: as someone also mentioned below in his comment, a high Customer Lifetime Value is what really worth to invest in. If CLV is low due to the nature of the business (let’s say I’m selling unbreakable Christmas tree holders, which will last 50 years long) or due to a defective concept (like Groupon) then CLV is low, and market is finite even if it seems to be huge. In these cases, – if COGS is high as well – building a profitable company and keeping expenses low is much wiser than to grow fast.

    Second: growing is great, reinvesting profit is meaningful, raising following rounds to grow is a good idea, agreed with all of the above mentioned. But what if sh!t happens? And it happens quite often nowadays – dot-com crash, late 2000s financial crisis, competitor stars may rise, etc. A little cash-flow reserve can be a life-saver these times. Even if growth is the primary plan, every experienced entrepreneurs must have a warning sensor and must keep a balanced approach between utilizing growth potential to the max but also taking risks seriously and prepare for being in the dry tree.

    Thanks for this article, Mark, my fingers itch to read your next one.

  • Jsd4sales

    Great article Bonnie! As you pointed out, the devil is in the details and their are many questions one must ask. To start, what are you looking for “get” from this business/investment? As the owner, are you looking to flip it, secure a long term position in the market or maximize its potential? The outside investor would want to know the same as well.

  • Jsd4sales

    Mark, please forgive the typos and misdirect of credit. Great article all the same .

    Bonnie, thanks for bringing this article to my attention.

  • Rob Leslie

    Great article. For me, I have always rembered a former CFO of a major public company drilling the letters L P G into my head…. L for Liquidity (Without cash you go nowhere!), P for Profitability (profits make the world go round) and G for Growth (without growth a business stagnates and eventually dies). Every company needs to watch these things all the time. But the proportion of each changes depending on the stage of the company in its development. One thing is sure, without all three your company will die. 

  • http://mixely.com/ Maxim Razmakhin

    a very good refresher in my head. thx Mark! it’s surprising how quickly we can forget the very core principles of running a business.

  • Allen Roberts

    Startups should have a twin focus: customers and customers. Without these, nothing else matters.
    You needto control costs, invest, and particularly manage cashflow, but customers drive all this.

  • http://pulse.yahoo.com/_VQGNMM2LL4DPXVLIZ4CBV4RIP4 male

    This is always a good question but yes, they should think profit at some point, even if its long term.

    Jacob Evans, CEO

    http://www.ppm.net

  • Bruno Aziza

    Mark – great post as usual.  Well documented and attempting to help the community through the very important differences between cost of sales, bookings, billings, revenue, amortization and profit.

    I truly hope this post goes viral because I think that many of the writers I read these days either don’t understand the differences you highlight above or take advantage of the confusion to create sensation.

    In my humble opinion, a business is designed to drive business value within a market: by that, I mean, a company/product solves a problem an audience has and that it is willing to pay to get rid of.  That’s a business objective.  

    Profit, on the other hand, is an operational objective.  A company might be able to drive growth without necessarily compromising profit.  It might be able to re-engineer its business model in a way that it reduces costs of sale by increasing direct sales ramp time or finding more efficient channels.

    Best
    @brunoaziza:twitter 

  • http://seogear.net/ seo agency

    This article was extremely interesting, especially since I was searching for thoughts on this subject last week

  • http://x.co/gmglobal +++++ My Global Website +++++

    A: “yes”

  • http://www.thecrowdcafe.com/ Jonathan Sandlund

    Fantastic point. Also, this approach is backward looking, where everything looks clear. It would be more interesting to normalize for the failure rate of companies who go for big scale vs. those who do not. The social elements shouldn’t be lost in the discussion either.

    Also, ignorance of profits in the name of scale while pursuing the magic inflection point in year 4 looks great when modeling out. But can this inflection point be predicted?

    If not —and it’s actually influenced mostly by entirely exogenous factors— would it not be wiser to focus on staying in the game as long as possible (profitable, self-sustaining business model), opposed to planning for a day that may be completely out of your control?

  • http://twitter.com/mashnik MASHPOTATO

    If you know your free cash flow, you can plan spending on growth i.e. customer acquisition or sales activities. The result is less or no taxable income/profits – any educated investor should be able to see this.

  • http://yelland.org/ Andy Yelland

    Mark, great post again! From that clear explanation, it looks to me like it may be possible to get the best of both worlds.

    The issue to me looks like there’s too much bundled into “Operating Costs” on the P&L.

    Wonder if it would be possible to break it into two: “Servicing current business costs”, and the sub-heading “Current Profit” – followed by “Generating future business costs” and the actual “Profit” that the finance world already deals with.

    I’m guessing this would only be useful as a tool to the CEO, rather than potential investors, as it relies on costs being honestly booked between the two to be useful. However it would allow the company to state how profitable it believed itself to be, should it have to stop all growth activity.

  • http://blog.maxlytvyn.com/ Max Lytvyn

    There is one scenario where focusing on growth at expense of profit is catastrophically wrong, and I’ve seen a number of companies going down that path (luckily, some were our competitors). Let’s say a startup monetizes users at roughly $1 per user lifetime. At some point the startup finds a very scalable way to acquire those users at $1.05-$1.20. The numbers are close enough, so the team makes a decision to focus on growth, expecting that over time they find a way to monetize users better. Initially, it looks like hitting the hockey-stick – 2x-5x bookings growth per year may be easily achievable. Investors and founders are celebrating, and money flows into fueling “growth”. That’s usually enough to put the startup on the radar and attract competition, which will pull the CPA and LTV further away from each-other, collapsing the company like a bubble.

    So even focusing on growth profitability has to be in sight and the plan to get there would better not include too many words like “naturally” & “organically”.