The profitability sanity test for VC-backed unprofitable cos. Ask this question: How much revenue would it take to be breakeven if: - gross margin % is held constant - all opex spend is held constant on a $ basis Is that revenue achievable with no additional cost? In the attached example, the company needs to grow revenues from $50,000,000 to $87,500,000 with no additional expense to be breakeven. That's $37,500,000 of incremental revenue with $0 of added expense. The question for this business is whether that's possible. If the gap seems too large, then to make the gap more attainable there are two levers: - increase gross margin % - reduce operating expense The best means to do that varies by business, but those are the two levers. And this needs to happen while the company is growing revenues. If the gap seems impossible, then you may have a fundamental business model issue that will make profitability a remote possibility. Of course, there are means in which companies can grow to achieve scale which will help with the profitability likelihood over time - but that will require outside capital which should never be treated as categorically attainable.
Thanks for taking the time to break this down, very insightful!
Love your posts Larry, always insightful!
Thanks for sharing the insightful chart. At last a "needle ball" methodology that highlights the right metrics for a company's growth. Your point about achieving a $35,000 revenue increase without a cost jump resonated with me. It suggests that the company might not be fully aware of the value proposition each product feature provides. Building on that idea, here's why: Identifying Core vs. Add-On Features: Analyze product functionality separating the "base product" from potential add-ons. This can reveal hidden gems – features with significant revenue potential that might be overlooked as part of a "monolithic" product offering. Strategic Pricing: Understand the true value of each feature and use that for pricing decisions. Startups offering free POCs are leaving money on the table. Instead, have the prospect pay for the POC with the agreement that if the POC is a success and they purchase the POC payment will be recognized in the purchase price. It all boils down to "where is your price book" (and what's in it) exercise.
It sounds like someone's been reading a lot of balance sheets and business models lately... Sometimes the question boils down to 'can you get there from here?' and sometimes the cold hard truth is "NO." In that case the leadership team is either competent and capable to do the hard things or everyone is wasting their time.
Spot on! The profitability sanity test is a clear-eyed assessment tool. It's about understanding if growth can be achieved without additional costs. The two levers, increasing gross margin and reducing operating expenses, are crucial. This test could save many businesses from a fundamental business model issue.
Simple model to drive strategic alternatives and test business viability.
75% increase in revenue with two constant assumptions (GM & all apex) is quite an aggressive model. Might work where co is offering unique product/services.
Always insightful, thank you. These little learning opportunities are always welcome!
Digital Marketer
3wDid chewy have profitable growth each year?