For the vast majority of entrepreneurs, growing the top line is the most exciting part of running a business. But at what cost do you increase the top line? Do you offer 50% discounts just for people to buy your product? Or do you spend millions of dollars in marketing to attract customers that perhaps are not part of the company’s target? Many CEOs have a strategy of growth at all costs. I’m not suggesting that top-line growth is not essential, of course, without the top line, there is no bottom line. What I’m suggesting is that there must be a strategy behind pursuing revenue and achieving profitability, and these two concepts are not mutually exclusive. For example, Uber in 2019 reported revenues of $14 billion, a considerable increase from 2017 of $7.9 billion. However, their operating loss went from $4.0 billion in 2017 to $8.6 billion in 2019. Is this growth worth it? Obviously, for them, it is since they are trying to be the first to market in many different initiatives such as Uber Eats and Uber Freight.
On a much smaller scale, there are companies that, after 5, 6, and even ten years, have not to turn to profit yet? I believe that if a small business hasn’t turned to profit in 5 years, there is something wrong with the business model. The exception to this rule of thumb are companies in long revenue cycle industries or disruptive companies that are well funded and are trying to capture a significant part of the market (e.g., Uber).
Any good business plan should incorporate a detailed description of the revenue model, specifically, what are the resources needed to grow the top line and how those resources are adequately managed to show profitability in x number of months/years.
For example, let’s assume that we are selling a new clothing line for men, and we have these numbers for the first two months of operations:
In this simple illustration, to double the sales, we had to double our marketing cost, which meant that we double our losses. This situation of negative contribution margin may be perfectly ok, assuming two things:
The revenue plan for this company should explicitly include when and how the CM turns into positive. The same goes for any other profitability indicator that applies to the company, operating profit, net income, Ebitda, etc.
It is equally important to identify the Key Success Factors related to growing the company and incorporate them into the plan to increase contribution margin.
A credible roadmap to profitability is key for any new start-up, especially because liquidity is not infinite, even for well-funded companies. There are plenty of examples of companies that have raised millions of dollars on ideas that didn’t have a profitable revenue roadmap and ultimately failed.
