Revenues vs. Margins
Bank of America Perpestives
By Michael McDermott
with quote from Nicole Wright (thank you Michael!)
June 2013
It’s a dilemma most business owners will face at some point in their company’s development: Do you focus on revenue growth as the best path to value creation, or do you put more energy into boosting margins, thus making the business more profitable but potentially forgoing additional revenue and market share?
The short answer? “It depends,” says Mitchell D. Weiss, an experienced entrepreneur and adjunct professor of finance at the University of Hartford.
“Reaching for additional volume at the expense of profitability is a strategic ploy to gain additional market share, and that’s fine,” Weiss says. “But don’t overlook opportunities to leverage this additional business into a commensurate reduction in cost of goods sold.” Business owners need to think through the longer-term risks associated with price cutting to drive volume and boost market share. “What happens if you need to raise prices in the future? What if your competition matches your new price? Where do you go from there?” he asks.
Andreas Scherer, managing partner at Salto Partners, a management consulting firm that focuses on driving top-line growth, says marrying revenue growth and high margins is not only possible but should also be the preferred strategy for most companies. “Targeting profitable growth is actually how most companies should implement their go-to market strategies,” he says. Revenue-driven growth creates greater risk, but profitable growth validates a company’s value proposition and provides a buffer for the inevitable bumps in the road that come with a slow quarter or two.
But Scherer allows that there are circumstances where revenue growth trumps margins, at least temporarily, especially in the case of early stage companies with high growth potential. “In cases where there is a breakthrough product or service and a definitive time-to-market advantage, it might make sense to focus on growing revenues at the expense of margins. But even in those cases, CEOs need to be careful not to get carried away by their own hype,” he warns.
And favoring revenue growth over profitability can lead to the problem of cash inertia—the tendency of available money always to get spent. This can be a significant challenge for fast-growing companies. Access to a substantial pool of available cash can stunt the development of a corporate culture in which business decisions are consistently vetted in terms of risk and profitability. “If this kind of thinking is not embedded in a company early on, it is very difficult to right the ship after years of unprofitable growth,” Scherer says. “This is probably the single biggest risk associated with an aggressive growth strategy that neglects profitability.”
Nicole Wright, a financial and tax consultant at Wright Financials, proposes that it is possible for businesses to scale while remaining fiscally disciplined—and profitable—as long as clear goals, outlines, projections and budgets are in place. “Don’t make emotional or spur-of-the-moment decisions,” she says. “Strategically plan where revenues will be coming in and how they will be spent. Keep expenses consistently less than income to generate savings for growth-cycle spending.”
Some spending to drive revenue growth is clearly reasonable, even necessary, such as for infrastructure or defensive expansion into international markets. Other choices, such as deciding whether to invest heavily in sales and marketing to drive faster revenue growth, are more difficult. Salto Partners advises its clients to invest aggressively in sales and marketing only when three criteria are met:
The company offering is ready for prime time.
There is significant upside in target markets.
The company has established a successful business model with first-mover clients in those markets.
“At this point, it’s about scaling up the business,” Scherer says. “The investment in sales and marketing becomes a calculated bet to leverage your already established footprint in the target market by getting the message out and creating repeatable sales processes.”
AUTHORY: https://authory.com/walliserglobal/Revenues-vs-Margins-a8ed382afdb95598c09360a682f7a7f08
ORIGINAL: http://perspectives.baml.com/c.do?cid=749802&oid=604346&xsl=124/newsletter.xsl
