A New North Star: Profit Vs. Revenue
[ALIGNED] series, Post VIII
A New North Star
Profit Vs. Revenue
By Mike Brcic,
Chief Explorer, Wayfinders
This is post 8 of the [ALIGNED] series, with tips, tools and wisdom to help you build an Aligned Company (resilient, self-managing, and purpose-driven) and Aligned Life (lived in line with your values, purpose and ideals).
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“In a chronically leaking boat, energy devoted to changing vessels is more productive than energy devoted to patching leaks.” – Warren Buffett
A New North Star: Profit Vs. Revenue
<< PREVIOUS: I Am Ego, Great Destroyer
(Spring, 2017)
The following describes events that took place in my previous company - a global mountain bike adventure company - during the tumultuous years of 2017 and 2018.
It describes the process I used to bring my company back to profitability, along with many tips and tools you can use in your own company to become profit-oriented.
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The long-overdue realization that so much of what I’d been pursuing was driven by my ego and my need for validation set in motion a massive change in how I approached my business.
For the past 4 years, since bringing on my first investors in May of 2013, we’d been in a relentless pursuit of growth.
That biggering took many forms - the number of destinations we were operating in (our BHAG, or Big Hairy Audacious Goal, was to be operating in 150 countries by 2021), the number of trips we ran, customer numbers - but it was primarily driven by a pursuit of revenue growth.
I wanted to reach $10 Million in annual sales; that seemed like a number that was worthy of respect: from my peers, from the industry, from the media, and from myself.
Once I achieved that, I would have ‘arrived’.
It didn’t occur to me to question if revenue and revenue growth were meaningful metrics to focus on. I simply took for granted that revenue was the primary metric by which entrepreneurial success was measured.
Among my entrepreneurial peers, revenue was the most common barometer of success, indicative of one’s acumen and one’s worth as an entrepreneur.
Events I attended often used revenue as a filter for who could or couldn’t attend. Entrepreneurial awards usually did the same. Lists such as the Inc 5000 and Profit 500 focus exclusively on revenue growth. Making the list is a marker of pride and accomplishment for any entrepreneur.
Revenue was and continues to be the primary barometer of success.
But the more and more I thought about revenue, the more I realized how detached it is as a metric from any meaningful measures of success - for me at least.
I knew plenty of people who were running $10M, even $100M-revenue companies, that were struggling to stay afloat, or who could barely afford to pay themselves a living wage. I knew companies with growth rates exceeding 100% that could barely make payroll.
As I spoke to many of my ‘successful’ entrepreneurial friends, many running $10M+ revenue companies, I realized that many, if not most, of them were no happier running a large/huge company than when their company was small.
Many of them were downright miserable.
“I don’t even know half of the people working for me,” was a common refrain.
So why was I focusing so intensely on revenue growth?
I began to reflect on the past 3 or 4 years: years of courting investors (which I hated), hiring and growing the team (which I’m not particularly good at), and rapidly expanding around the world (which is kind of exciting but also stressful) - and realized that the stress of those years far outweighed any good feelings I got from the company’s growth.
While our growth rates had averaged an impressive 45% per year over the past 5 years, our profitability had tanked and the company was losing money. I’d added lots of overhead to our profit and loss statement, and the constant influx of investor money and available cash had caused me to take my eye off some crucial fundamentals of our business model.
For starters, our gross margin (the percentage of revenue that remained as gross profit after our Cost Of Goods sold - the cost of running our trips) had come in at a dismal 18% the previous year. That 18% profit margin needed to then pay for the bloated operating expenses I had added to our bottom line - and it was woefully inadequate.
As I crunched the numbers I realized that I would have to grow our revenue by another 40% - while holding operating expenses steady - just to break even, a proposition that didn’t seem very attractive.
The first time I truly looked at these numbers in detail, I felt sick to my stomach.
How had I let my business get away from me so much? How had I become so blind to the basic fundamentals of my business?
As I explored the situation further and spoke to more and more of my colleagues, I realized how common my situation was.
So many entrepreneurs push growth at any cost, and achieve impressive growth rates but their expenses outpace their revenue and they often grow themselves out of business. Then they find themselves needing to raise more money, which then comes with more expectations of rapid growth, which then leads to a never-ending hamster wheel of madness.
I made a decision that I was going to get off the hamster wheel.
I asked myself a simple question:
Why does my company have to keep growing?
Growth for growth’s sake didn’t seem to correlate with anything that I really wanted, other than stoking my outsized, hungry ego.
If I had graphed my life out over the past few years, it would have looked something like this:
I decided it was time for a new north star: a new destination for the company, a new vision.
Over the past few years, our conversations and our KPI (Key Performance Indicator) dashboards were hyper-focused on growth. It was all about sales, sales, sales, and how much they were growing.
No more: revenue and revenue growth were out as primary metrics. We would track revenue only insofar as it contributed to more meaningful metrics.
Our cash flow issues and our lack of profitability had been the biggest contributors to my stress over the previous few years. I would raise money from investors, use it to hire new people and aggressively ramp up our marketing, then start to run out of money within a year, freak out, and go back to investors. It was a stressful cycle and an emotional rollercoaster.
What were missing from the equation were profitability and a sound financial model.
It was time to reorient the company.
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That spring my company had just gotten through - barely - its 3rd significant cash crunch in 3 years.
Although we had a decent number of offseason (winter) trips in places like New Zealand and Guatemala, our cash flow was still very seasonal, with 75% of our departures taking place between May and October.
Our cash flow cycle looked something like this:
March to June: customers paying their balances on their trips. Cash coming in like crazy. I think I’m god’s gift to entrepreneurship.
June through October: I pay my suppliers for all of those trips. Cash going out like crazy. I’m starting to worry about the fall.
November through March: Barely enough cash to cover operating expenses. Panic! I’m such a loser.
I hadn’t yet developed the financial acumen and restraint to help us manage those cycles and the stress of those offseason cash crunches had been slowly killing me. Add to it the difficult Canadian winter, lack of sunlight and Seasonal Affective Disorder, and it was a perfect recipe for turning me into a bundle of frayed nerves.
Every winter my fingernails looked like shit from being chewed to the stubs as a result of the stress of managing our cash and figuring out how to make payroll and other expenses.
That spring, I vowed that I would not go through another offseason like the previous three.
Look at those beautiful nails.
I wanted to have long, beautiful fingernails.
My first action was to do a deep forensic audit of the company’s income statement.
Our P&L had become something that I glanced at once a year when reviewing our financials with my accountant at tax time. Amazingly, for the past 4 years I didn’t feel like I needed to review our financials: I had investor money coming in and as long as the top-line revenue was growing nicely - and it was - then we were good.
Even though we had faced major cash crunches every year for the past 3 years, I always managed to convince myself that they were just temporary and that doing another sales push would get us in the clear for next winter. We just needed to boost our revenue to some magical level where all of our financial problems would disappear.
As I sat in my office reviewing our income statement in detail, for the first time in years, reality came crashing down - depressingly hard.
Our financials were a mess.
Our cost of goods sold (COGS) was so high that our gross margin - the percentage of revenue that remains as profit after COGS is paid - was consistently coming in below 20%.
Put another way, our Cost of Goods Sold was a depressing 82%. That measly 18% then had to pay for all of our operating expenses.
Which had also become extremely bloated. In my mad rush to take over the world, I had been on a spending spree with investors’ and banks’ money: hiring new staff, throwing tens of thousands of dollars at Facebook Ads (you’re welcome, Mark Z), expanding our office, etc.
The result was a financial model that didn’t work.
That realization began the long process of fixing our financial model and orienting it toward profitability instead of revenue and revenue growth.
The changes I made ended up:
raising our gross margin to 33% (or reducing COGS to 67% from their current 82%)
reducing operating expenses by 35%
The first order of business was to look at our gross margin, which, as mentioned, had been coming in at a dismal 18-20%. It would be extremely difficult for almost any business to be profitable with a gross margin like that.
There are basically two ways to increase gross margin: 1) Raise your prices or 2) Lower your Cost of Goods Sold.
I didn’t have much leeway to reduce COGS without affecting the quality of our adventures, so my focus turned to raising our prices.
Pricing is a topic that could take up an entire book on its own, so I won’t go too deep into pricing strategy, however I will recount the process by which we raised our prices by an average 25%.
Looking at the competitive landscape of our industry - which is made up of a handful of larger operators (like my former company) offering mountain bike adventures in multiple locations around the world, and countless small operators offering adventures in their local area - a picture began to emerge.
Almost all of the operators offering similar products (multi-day mountain bike adventures of a week or more) followed a similar pricing strategy of pricing their trips at around $200-$350 USD/day. So a weeklong trip, including lodging, most meals, guides and transportation, might come in at around $1500-$2500 USD. My company was in that range as well.
When I began to look at other sectors of the adventure travel industry, such as road cycling, an entirely different picture emerged. Companies like Backroads, DuVine, and Butterfield and Robinson were charging significantly more, with some trips coming in at over $1000 USD/day!
The lodging for some high-end bike adventures. Clearly we needed to do some upgrading.
Clearly there was a market for more upscale, higher-priced adventures in other sectors. But there didn’t seem to be one for mountain bike adventures.
Or was there?
The stereotype of a mountain biker is not a flattering one. Typically it’s an 18-year old kid doing backflips off 30-foot-high cliffs. This is the image the industry typically uses to sell itself to the world (don’t get me started). This has created a misconception in the industry that mountain bikers don’t have much money, but as I was thinking about our pricing strategy I thought back to my recent trip to join the Wednesday night ride with a local club just outside of Toronto.
The DMBA is Canada’s largest mountain bike club, at last count with over 500 members. When I pulled into the parking lot that Wednesday evening, I was immediately struck by the vehicles filling the lot, and the bikes being unloaded from them. From Lexus to Mercedes to Tesla, the lot was full of luxury cars hauling luxury bikes. It was a common sight to see someone pulling a $10,000 bike off of a rack attached to a $75,000 car.
If mountain biking was a sport of poor dirtbags, someone forgot to tell these people.
Although there aren’t many reliable sources of data about recreational mountain biking, anecdotally I knew that the riders on my local trails, and other trails around Southern Ontario, were overwhelmingly composed of people in their 40s and 50s. It made sense to me: these were people who got into the sport when it first exploded in popularity back in the 80s, and they were now in their prime income-earning years.
I dug into the data from our annual Rider Understanding Survey, an annual survey that we send out to our customers and fans, and discovered that the median household income was over $150,000 USD.
There was money out there, and I had a hunch that there were mountain bikers out there prepared to spend it. Looking at the industry - overwhelmingly priced in the midrange - and the customer segment - seemingly fairly wealthy - I realized there was an opportunity to capture market share and address our gross margin problems by developing trips for the higher end of the market - trips for people with money to spend who were willing to pay more for high quality experiences.
Looking at our customer feedback, I knew that we were offering a premium product: our average trip rating over the past year had been 8.6 out of 9 (I won’t go into why we use a 9-point scale instead of a 10-point one). We had spent a lot of time working on our operational capability and ability to offer consistently high-quality trips.
From conversations with our customers I knew that we did a better job of consistent high quality than any of our competitors.
RAISING OUR PRICES
I told my team about my plan to raise our prices by an average of 25 to 30%. This would put us squarely in the high end of the market, with average per-day pricing exceeding $450 USD/day, in some cases as high as $600 USD/day. I knew this seemed high, but it was still quite affordable when compared to other adventure travel trips.
This put us in an almost unmatched area of the market, with the high end almost all to ourselves and everyone else competing in the middle and low ends of the market.
My team was nervous about this change and expressed skepticism that the market would pay these prices, but I felt confident about my hunch. Because so many of our trips were already high-quality experiences, there weren’t many changes to be made to bring the level up to what the pricing would dictate. In some cases we had to make some hotel and other upgrades, but for the most part we didn’t make many changes to the trips: we would let our reputation for high quality experiences - a reputation borne out by numerous awards and sky-high ratings on Tripadvisor and other platforms - justify the cost.
The net result of these pricing changes was that our gross margins increased overnight from an average of less than 18% to almost 35%.
Next in line for cleaning our financial house was our operating expenses.
Since first bringing on investor money in May of 2013, I’d been steadily increasing our operating expenses, especially with respect to salaries. I’d made a few hires that had significantly increased our operating and sales capacity, but they had even more significantly added to our monthly expenses.
Those operating expenses meant that we had to keep increasing revenue to keep up, which put a lot of pressure on our marketing and sales. Even though we had made significant changes to our pricing and gross margin, we still needed to address our operating expenses.
Operating Expenses
Our operating expenses - those overhead expenses we were paying, regardless of whether we ran any trips or had any customers - had ballooned by over 160% over the previous 3 years (that’s almost triple) and had reached unsustainable levels that were putting continual pressure on the team to keep growing revenue.
I needed to get our operating expenses back to a more reasonable, and sustainable, level, to ease that pressure.
I opened up our Quickbooks accounting software and turned back to our profit and loss statement, moving down from the revenue and cost of goods section to the operating expenses section. I was going to do a line-by-line forensic audit of our operating expenses and find whatever savings I could.
I started by clicking on the ’Software’ line, which brought up a list of transactions from the previous year. Our regular, used-frequently technologies were there: our monthly Drive upgrade for storage and sharing, Mixmax for emailing, Infusionsoft for marketing…
But mixed among those software items I knew we were using regularly and getting value from were many I didn’t recognize, or only vaguely remember signing up for. A quick review of the charges revealed over a dozen subscriptions for software services I or my team hadn’t even used (I’m good at starting things - finishing… not so much).
I went through each of these subscriptions (some were monthly, some were annual), logged in to each company’s website, and promptly cancelled my subscriptions.
Boom. $4500/year saved - right onto our bottom line. An hour well-spent.
There were another half-dozen software subscriptions I recognized, but wasn’t using myself - these were tools my team had requested.
I checked in with the team (‘Are you actually using this software and getting value from it?’). They begrudgingly admitted that half of those tools weren’t really necessary, or they weren’t even using them.
Another quick visit to each provider’s website…
‘Are you sure you want to cancel your subscription?’
Yes.
Another $1800/year saved.
I’d spent an hour and a half on the process so far and had already ‘earned’ $6300, for an hourly rate of $4200/hr. Not bad.
The next 2 lines on our income statement were our banking and merchant credit card fees.
First, the credit card fees, almost $50,000. $50,000 just for the privilege of accepting credit card payments from our customers.
A quick calculation revealed that we were paying about 3% for credit card fees - I’d known this, and I’d known we could probably do better, but it was just another one of those things that just sat on my to-do list forever.
We were using PayPal as our merchant credit card provider so I reached out to my contact there and asked if we could get a better rate. While waiting for my PayPal contact to get back to me, I did a bit of research and contacted two other providers, Stripe and Beanstream.
A guy from Stripe got back to me right away and we hopped on the phone. He asked me to send him some statements from PayPal and after doing so, he let me know he could beat their rate by at least 0.5%.
Within two days he got back to me with an offer of an effective rate of 2.4%.
Another $9000/year saved.
Next in line: our banking fees. Because of our seasonality, I tended to rely on and draw from our line of credit heavily during the offseason. The previous winter I’d almost maxed it out. I looked at the interest we were paying on those funds and it was high. Not sky-high, but high enough that I thought I could get a better rate.
I wrote my client rep at my bank and told him that I felt I was paying too high a rate on our line of credit. I also stretched the truth a little and told him I had been offered a significantly lower rate by another bank that was aggressively courting my business. I told him I liked my existing bank, buttered him up a little by telling him how much I’d liked working with him, and asked if he could match the rate.
Then I waited.
Two days later, he wrote back to tell me that he couldn’t match the rate but could come within 0.2% of it. Would that be OK?
With that 2-paragraph email, I lowered my line of credit interest rate by 2.5%. Based on our typical usage, I estimated this lower interest rate would save us about $3500/year.
So far I’d reduced our operating expenses by an estimated $18,800/year, and I’d only spent about 5 hours on the process. This was encouraging, and I was just getting started.
Next in line was ‘credit card interest’. The previous year we’d paid over $3000 in credit card interest! I knew this wasn’t because we were using our credit cards to finance operations; I’d always been wise enough to know that financing operations on high-interest-rate credit cards was the beginning of the end.
This was simply sloppiness: I hadn’t been on top of our banking enough to pay down our credit cards on time consistently. This wasn't hurting the company’s credit rating because I’d set up automatic monthly payments to make sure the minimum monthly payment was always more than covered, but I’d let large balances sit for too long, to the point where we were getting charged significant interest.
I resolved I would no longer be responsible - from that day forward - for managing our finances and our bookkeeping. I’ll be going into detail about delegation in a future chapter, but the short version of the story is that I ended up fully offloading all responsibility for financial matters - banking, paying invoices, paying credit cards, payroll, etc. - to our bookkeeper.
This was stuff I hated and was terrible at, and consequently did a terrible job of. The only financial thing left on my plate was reviewing financial reports, something I’ll go into in a later post.
I gave my bookkeeper instructions to always pay our credit cards down to $0 every week - another $3000/year in savings.
Going through the rest of our operating expenses, I managed to discover another $4000 in easy cost savings. Over the span of a few days and less than a dozen hours, I’d reduced our operating expenses by over $25,000/year - simply by actually paying attention to what the income statement was telling me.
The Harder Decisions
Although these easy wins had netted over $25,000 in cost savings, it still wasn’t enough to make a truly meaningful contribution to our profitability goal: I still needed to cut operating expenses by another $75,000 or so in order to make our profitability goal more feasible.
It was time for harder decisions. I’d never laid anyone off before, in over 20 years of business, but it was looking more and more necessary if I was to get the company back to profitability and end the cycle of cash flow despondency.
There was one obvious place to start: since 2013 we’d been investing heavily into our IT infrastructure, first with a new website, and then investing in a custom booking platform that had then become a full-fledged operations system and then even a customer/staff social platform.
In 2016, flush with cash from another round of investment, and in order to develop the technology for our Getaways program, I’d hired another full-time developer (to add to our existing full-time developer). Although we were paying super-affordable offshore rates for our developers (about $4000/month for both of them at 40 hours/week, which was ridiculously cheap for the quality of work we were getting, when compared to North American rates), this was still almost $50,000/year.
With the bulk of our technology development complete I realized we were keeping two developers on just to satisfy my own hunger for more flashy software features. We could make do with just one.
Our developers Pawan and Sandip worked for a boutique web development shop in India and I knew that they were always expanding so I didn’t worry that they would find work - whomever I chose to ‘lay off’ would step right into another project and continue getting paid just the same.
Since Pawan had been with us since day 1 of our working relationship with Signity, I opted to keep him on board and sent the owner of Signity an email to let her know what we wanted to go back to 1 full-time developer. Another $24,000/year saved.
What remained was the hardest of all decisions, to lay off my own staff.
I knew it needed to be done, and if I didn’t do it now I could find myself in the same situation I’d been in a few months earlier: close to bankruptcy and all of my 50+ staff out of work, including me.
With a small office team working closely together, my office staff had become like a small family. We worked together, played together, rode our bikes together and laughed and cried together. The thought of laying anyone off made me sick to my stomach. Laying off a developer whom I’d never met, and who would step immediately into a new project, was one thing - layoff off a family member was another thing. This was one of the hardest decisions I’ve ever made in my 20+ years of entrepreneurship.
In the end it was our operations director whom I ended up laying off (I also moved another staff member to part-time hours). Ironically, she had done such a good job streamlining our operations and implementing solid systems that she was no longer as necessary as she once had been. Our field teams had an average tenure with the company of over 6 years; they knew their jobs well; our technology gave them easy access to all of the customer information they needed to operate amazing trips; and we now had great manuals for most of the regular operations of the company.
I felt confident that the rest of the team could manage the operations side of the company without too much difficulty. I requested an in-person meeting with our operations director (by then she was mostly working remotely) and on a warm day in September, on a couple of public benches in front of a library on Roncesvalles Ave., I broke the news to her.
I can still remember the look of shock on her face when I told her she would be leaving the company. I reassured her that it had nothing to do with her performance (which I was a big fan of), but that the time had come for difficult decisions and the difficult decisions ultimately meant her departure.
She was shocked, angry and sad all at once. I hated making someone feel like this, especially someone whom I’d come to consider like a family member. I won’t say much more about this other than it was painful but it was ultimately something that made a lot of sense for the company.
After breaking the difficult news to the rest of the team, I was surprised at how well they and the company managed. There was a bit of a transition period in which responsibilities for our operations director’s duties were unclear, but soon we realized that there wasn’t a lot to manage on the operations front and life continued almost as it had been before.
By then it was late September and we were heading into our low-cash-flow season. I did a 6-month cash flow projection and discovered that despite the significant cuts to our operating expenses, we were still going to be on the edge that coming winter and more needed to be done.
I ended up moving my customer service person to 3 days/week (from full time) with the promise that I would bring her back to full time as soon as possible. My timeline was to bring her back to full-time in March.
With the work to address our financial model complete, I ran the numbers again, and this time they told a different story: with our improved gross margin and reduced operating expenses, we could afford to take a 20% hit to our revenue and still be profitable!
Profit First - your new north star
PROFIT: YOUR NEW NORTH STAR
Much of this blog series is about how to create systems that allow you to step away from the day-to-day of running your business and free up your time (I ended up with a business that only required 2-3 hours/week of my time). In order for you to begin that process, you’ll need to get your financial house in order.
No matter what systems you implement, you’ll inevitably get sucked back in if your financial house is a mess: only you as the owner can deal with - and is responsible for - the serious cash flow issues the result when your financial model isn’t sustainable.
Before I share with you some guidelines for addressing your own company’s financial health, I want to take a moment to give credit to one of the systems that guided my modelling and actions once I started to address our financial model.
That system is called Profit First and it was developed by entrepreneur Mike Michalowicz. In a nutshell, it goes something like this…
Most businesses look at profit as something that’s left over (if at all) at the end of the day (or month or year) after revenue has been collected and all expenses have been paid.
With this approach, profit ends up being an accidental byproduct of a business’ operations, and many companies end up with little or no profit as a result .
The Profit First model starts uses profit, as the name suggests, as its starting point: you set a profit target and then make changes to the business model in order to achieve that target.
Although the Profit First model typically suggests reducing operating expenses in order to achieve profit targets, I suggest an alternative approach that looks at both gross profit/gross margin and operating expenses, with adjustments to both that will give you the intended net profit result.
Start with a target net profit %. I suggest 10% as a starting point.
Based on a reasonable estimate of your future sales, estimate your target net profit.
For instance, if your sales expectation is $1,000,000 and your target net profit % is 10%, then your target net profit is $100,000.
TARGET NET PROFIT %: 10%
ESTIMATED REVENUE: $1,000,000
TARGET NET PROFIT (TNP): $100,000
Add your current operating expenses to your target net profit - this will give you your Required Gross Profit
OPERATING EXPENSES (OE): $300,000
REQUIRED GROSS PROFIT (RGP): $400,000
This means that the business needs to earn $400,000 in Gross Profit ie. Revenue minus the Cost of Good Sold (COGS).
Put another way, this is revenue minus the actual cost of deliver the product or service, excluding the general operating costs of the business, such as rent or bookkeeping, etc.
Operating expenses are the expenses you would pay even if you didn’t deliver a single product or service. COGS are costs that increase with each new unit sold.
Now divide your Required Gross Profit by your Revenue. This will give you your Required Gross Margin.
REQUIRED GROSS PROFIT (RGP): $400,000
REVENUE: $1,000,000
REQUIRED GROSS MARGIN: 40%
By looking at your existing Operating Expenses and existing Gross Margin, you can then choose a path forward.
In some cases, you may feel there are no savings to be had on Operating Expenses; in other cases you may feel there is nothing to be done about your Gross Margin (you can’t raise prices or cut COGS). Most businesses have some opportunity for improvements on both. I’ve outlined a few scenarios below.
Scenario 1: Operating Expenses Can’t Be Cut
In this scenario, your operating expenses can’t be reduced in any meaningful way (for instance, you only have 2 staff and laying either of them off would be catastrophic, and there are few other savings to be had). In this case, you need to make adjustments to your Gross Margin so that you can achieve the Gross Profit you need to pay your Operating Expenses and achieve your Target Net Profit.
TARGET NET PROFIT %: 10%
ESTIMATED REVENUE (ER): $1,000,000
TARGET NET PROFIT (TNP): $100,000
OPERATING EXPENSES (OE): $300,000
REQUIRED GROSS PROFIT (RGP) = TNP + OE = $400,000
REQUIRED GROSS MARGIN = RGP/ER = 40%
EXISTING GROSS MARGIN = 30%
If your current Gross Margin is only 30%, then you need to make changes in order to achieve that 40% target. You can either raise your prices accordingly, or lower your Cost of Goods Sold (raising prices is generally preferable to lowering COGS, as that often leads to a decrease in quality).
Scenario 2: Gross Margin Can’t Be Changed
In this scenario, you can’t make significant changes to your Gross Margin, either because you feel the market won’t bear a price increase, or you cannot reduce your Cost of Goods Sold. In this case you need to lower your Operating Expenses. As outlined in this chapter, there are often many ways to lower your Operating Expenses, some easy, and some hard.
TARGET NET PROFIT %: 10%
ESTIMATED REVENUE (ER): $1,000,000
TARGET NET PROFIT (TNP): $100,000
OPERATING EXPENSES (OE): $300,000
REQUIRED GROSS PROFIT (RGP) = TNP + OE = $400,000
GROSS MARGIN: 30%
GROSS PROFIT: $300,000
GROSS PROFIT SHORTFALL = GROSS PROFIT - (TNP + OE) = -$100,000
In this case you would need to find a way to reduce operating expenses by $100,000.
Scenario 3: Make Changes to Both Operating Expenses and Gross Margin
Most businesses have some leeway in addressing both Operating Expenses and Gross Margin. For instance, in the scenario above:
TARGET NET PROFIT %: 10%
ESTIMATED REVENUE (ER): $1,000,000
TARGET NET PROFIT (TNP): $100,000
OPERATING EXPENSES (OE): $300,000
EXISTING GROSS MARGIN: 30%
EXISTING GROSS PROFIT: $300,000
The business still needs an additional $100,000 – either in Gross Profit or reduced Operating Expenses - in order to achieve the Target Net Profit.
The business could, for instance, lower Operating Expenses by $50,000 and raise prices in order to achieve a 35% Gross Margin.
Whichever approach you choose, get profit-focused! You can still drive revenue growth, but it shouldn’t come at the expense of profit (which is often the case).
PRESCRIPTION: GET PROFIT-MOTIVATED
(the Prescriptions sections of many of the posts in this series contain actions you can take and tools you can use in order to create a self-managing company that can thrive without you)
Although there’s nothing wrong with revenue growth and scaling, scaling and growing revenue simply for the sake of scaling has led many a company to bankruptcy, and doesn’t necessarily align with the founders’ happiness or fulfilment, or create a sustainable company.
If you’ve been pushing revenue growth for some time, perhaps that growth has created extra pressure, both financially on the company and emotionally on you as the founder. It’s time to focus on other more meaningful metrics (note: focusing on other metrics doesn’t mean you have to say goodbye to growth, it simply means that you’re not going to pursue growth just for the sake of growing.)
THE PROFITMAKER TOOL
Regardless of which metrics you chose in the step above, you need to also get profit-motivated. If you ignore profit and focus on revenue growth for too long, you run the significant risk of growing yourself out of business. Profit - and its sister cash flow - are the lifeblood of a sustainable business.
I’ve included a Profitmaker tool to help you plug in your financial numbers and assess where you can make changes in your operating model and what your targets are.
DOWNLOAD THE PROFITMAKER TOOL
(if you like these free tools, why not subscribe to my weekly [Aligned] email and get more of them in your inbox?
MEANINGFUL METRICS: THE NEXT STEP
Creating an [ALIGNED] Company requires orienting your company toward the right goals. Profit is the lifeblood of a company and should be something, as I’ve mentioned, you should strive for and constantly focus on.
You should also ask yourself what metrics, if tracked, would support your most important personal goals?
For instance, when I wrote my Vivid Vision (I’ll write more about this in a future post), one of my most important goals was to have a company where I and my staff truly loved coming to work and loved what we were creating. So it made sense to track staff happiness on a regular basis (“What gets measured, gets managed.” - Peter Drucker).
I implemented an ongoing tracking system for staff happiness, with a simple survey and monthly notifications going out to office staff, and a quarterly survey for my field staff. The survey had just one numerical question (“On a scale of 1 to 10, how happy are you working for Sacred Rides right now?”), along with a couple of text-based questions which I could use as a basis for making improvements and implementing ideas.
One of our Guiding Principles was ‘WOW our customers.’ Meaning that we didn’t simply want to provide adequate, or even great, customer service. We wanted to completely blow them away. So measuring and reporting on customer service metrics was extremely important.
Once you’ve decided what your most important metrics are, make sure you have a system in place to regularly track them, and regularly report on them and discuss them as a team. If possible, place them in a prominent spot in your office (or your virtual office if you have a remote team). The ultimate system is to have a large-screen monitor in a prominent place - where everyone can’t help but see it - that updates these metrics in real time.
NOTE: I’ll write extensively in a future post about how to develop excellent metrics and metrics dashboards that will help your company thrive. Subscribe to the series and you’ll get notified when I release new posts.
Yours,
Mike Brcic, Chief Explorer, Wayfinders
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WHAT’S NEXT?
Read the next post in the [ALIGNED] series, Get Vivid: Create Your Company Vision
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Check out the Table of Contents for previous posts in the series you may have missed.
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