A Profitable Path

Ah, one of my favorite subjects:? Profitability. Isn’t it everyone’s? It should be.

Because we all want to be desirable. Don’t we? And in business, #profitability is, well, very alluring, especially in today’s markets.

But personally, I think expectations have gotten a little out of whack.?

In the tech industry, we’ve experienced a decade-long cycle of growth.

Over those ten years, the fundamentals of value generation (i.e., free cash flow…per share) were ignored. “So what if we lost money on every [unit] we sold? Our plan is to sell more [units], and we’ll be infinitely valuable as we take share.” Sound familiar?

So, what does the path to profitability look like today?

Unfortunately, a lot of investors and executives go straight to cutting #headcount . I get it - most of our expenditures, especially in technology companies, are on people.

But you know what? Those same people drive #innovation and build the products that drive growth. Hello. Letting them go to ensure short-term profits really impacts your long-term prospects.

What’s an investor (or executive) to do??

So glad you asked.?

Fix your business model. Sounds hard??

Not really… all you need to do is look at your gross margin, and you’ll see everything you need to know.

1. Find and eliminate unprofitable customers. At HotelTonight , we identified customers that were using a $30 first-time user coupon to buy $50 hotel rooms in #lasvegas (fee to HotelTonight approx $5). Gross profit negative $25, and much worse when you add in customer service, web hosting, and card processing fees. Objections were raised - “we are slowing down growth… we are acquiring long-term customers” No, we weren’t. Customers in the market for a $50 room were bargain hunters, not long-term loyalists. Those aren’t repeat customers - they move to the next (cheapest) place. We increased the minimum spend required for a coupon, decreased the coupon value… and ultimately eliminated them. Gross margin up!
2. Identify the segments that represent your good customers. You know… those customers that make repeat purchases (or engage regularly) aren’t bargain hunters expecting 4-5 times the value they pay you. Where do they come from, how do we speak to them, what do they like to consume? With a good product/market fit, you’ll find margins increasing.
3. Improving the fees to match the service you provide, or substitute equivalent lower-cost goods, will serve the company in the long run. At HotelTonight, we charged #hotels too little for last-minute, expiring inventory. We increased our fees in line with the service we provided. At Scribd, Inc. , we found book content for our readers (think a good mystery novel) that engaged them the same as other (more expensive titles) but at a lower cost.
4. Focus hard on all those other line items that are seemingly small but really add up for the remainder of your cost of revenues. Efficient customer service? The right communication channels (voice, email, chat), and the right response times to get back to customers. Efficient hosting expenses? That Amazon Web Services (AWS) bill only goes up unless it’s managed properly by Engineering: efficient code and some visibility about who and how often they are spinning up new instances. Transaction processing fees. Do you understand the black box that today is Braintree/Adyen/Stripe? Cross border fees, chargebacks, FX, gateways fees. There’s a reason the fee schedule for these agreements is more than a page long. How about fraud? Stolen credit cards, returned goods. All of this takes a toll on your gross margin, and unless you really dig in and squeeze out every cost, you're throwing money away. The work isn’t wasted - at Scribd, we worked on scrubbing all these costs and increased margin by over 5%. Those pennies add up.

As you build volume, with sound unit economics, and by virtue of your #growth you’ll improve bottom-line profitability (and cash flow!).

But still, executives will argue that “...we’re getting market share, and can increase fees later on.” But unfortunately, in many cases, there is not a “later on.” The customers you attract when you’re a low-cost provider are the ones who go away when you raise your prices, leaving you with none.

And of no surprise, with good #uniteconomics customer acquisition becomes more efficient.?

Trust me.