August 29, 2019

Profit vs Growth — Part 2: What’s Best for your Business?

In part 1 we explored how tech unicorns are maximising growth and building up significant losses in the process. In this article, we will look at the benefits and costs of maximising either growth or profit.

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Profit vs Growth — Part 2: What’s Best for your Business?

The Modern Method

Uber, Lyft and Pinterest, all founded since 2009, each have valuations higher than $1 billion, making them tech unicorns. They also don’t make a profit, in fact, they operate at a significant loss. Fuelled by investment from large VCs, these tech unicorns can afford to rack up huge losses while growing at a breakneck pace.

Uber, founded in 2009, has raised a total of $24.7bn, but in 2018 ended the year with a net loss of $1.8bn. However, its growth has been stratospheric, it now operates in over 700 cities and 80 countries, having delivered more than 5 billion rides. The question is, why is growth being maximised with little consideration for profit?

The Path to Profit

The theory goes that once these businesses have gained enough market share, or, ideally, a monopoly position, they can slow their growth, increase prices, improve their margins and turn a profit. However, earlier this year, Uber warned that it “may not achieve profitability”, highlighting a potential flaw in the business models of many tech unicorns.

Operating with high costs, despite low salaries, tech unicorns will have to increase their pricing in order to turn a profit at a later stage. A report by NYTimes argues that employees at Uber will not accept lower salaries, while customers are likely to accept higher prices. But with investor-backed competitors willing to keep their prices low, has this ‘grow at all costs’ approach created a race to the bottom?

What’s right for your business?

Growth vs. Profit

Is maximising growth the new norm for tech startups? Or is there a more sustainable method for your business to pursue? When it comes to balancing profit and growth there are a few simple rules for you to accept:

You cannot maximise profit and growth simultaneously. To maximise growth, you will have to invest in sales, marketing and other efforts which will impact profitability. Alternatively, if you’re maximising profit, you will need to pass up on costly growth and investment opportunities.

Striking a Balance

So which of these objectives should your business prioritise at each growth stage? The key is to decide what your objective is and understand your strategy. You need to be mindful of what your business will look like in each scenario.

Our view is that the issues arise when you maximise either growth or profit for too long without a robust strategy. For example, with today’s tech unicorns, after maximising growth for years, we question whether their business models will transition to being profitable. The theory went that growth would grant monopoly positions in markets, and with that, scale efficiency and monopoly profits. This hasn’t come to pass as barriers to entry have reduced, thereby keeping a lid on pricing.

Going for Growth

Achieving Growth:

  • With access to investment or a loan, you will be able to pursue growth before turning a profit, an essential first step for most of today’s tech startups.
  • Using a strong PR & content strategy is increasingly beneficial for young tech businesses. Gaining public exposure will not only play a key role in attracting investment and building your brand exposure but will also be an important defence mechanism against competitors.
  • Expanding into new territories is a very effective way to grow your customer base, source talent and attract investment; all valuable growth resources. (check out our recent article on how to expand overseas).
  • Another increasingly popular growth method for startups is to undercut the competition on price. However, this can make becoming profitable at a later stage more difficult, as is the case with the likes of Uber and Lyft.

The Upsides of Maximising Growth:

  • If your business has ambitious growth objectives, it will be far more attractive to most investors, even if it means forgoing profit in the short-term.
  • Now is also a good time to borrow the money you need to grow, as capital costs have been low since 2008.
  • Once growing quickly, you’ll be able to gain PR exposure organically.
  • Fast growth will mean more market share. If you’re first to market this is especially important as competition will be quick to replicate your business once they see your rate of growth, even if you’re yet to turn a profit.

The Downsides of Maximising Growth:

  • You will either need to raise profit before you grow, borrow money or raise investment. Each of these has risks, challenges and sacrifices, whether that’s time, equity or interest.
  • If you’re maximising growth at the expense of profit, meeting growth targets becomes a key metric by which the public and your investors will measure success. Failure to meet these targets can quickly result in a loss of confidence and investment.
  • If your business is backed by a VC who is financing your growth, you will likely become reliant on their investment. If they choose not to support you in later funding rounds, you may need to quickly become profitable, which many won’t be able to.
  • Many of today’s tech unicorns are now struggling to find a path to profit. You may have to raise prices, lower wages or reevaluate your business model.

Going for Profit

Achieving Profit:

If I could tell you how to make your company profitable in a few simple steps, I wouldn’t be here today, I’d be on my yacht. However, there are some steps you can take when you want to improve or maximise your margins.

To turn a profit you will likely have to sacrifice some growth potential but to maximise profit, you will have to stop growing altogether. If your business is a size you’re happy with, this may be the way to go.

When maximising growth, it helps to keep fixed costs low. When maximising profit, both fixed and flexible costs must be kept to a minimum.

The upsides of maximising profit:

  • If your company is profitable you are more likely to get acquisition from a larger business.
  • If you’re not looking to sell the business, high-profit margins will also attract the attention of investors who are seeking instant returns and long-term profits.
  • You will also have more negotiating power with investors as you are not reliant on their contribution, making your equity more valuable.
  • As you aren’t reliant on investment, you can keep more equity and have more control over the direction of your business.

The downsides of maximising profit:

  • If you are not focusing on growth, but rather on profit, then you may be outgrown by a competitor who is willing to sacrifice their margins in order to get more market share.
  • Without strong growth targets, it can be hard to attract the large portion of VCs who are looking for disruptive tech unicorns that can produce fast returns.
  • In funding rounds, your business will also have lower valuations as your growth potential is not as great.
  • Innovation can be stunted by cost-cutting in the name of profit. Competitors who are willing to incur higher costs in order to improve their product or service will likely be able to disrupt your model.

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