“If you wake up on a Casper mattress, work out with a Peloton before breakfast, Uber to your desk at a WeWork, order DoorDash for lunch, take a Lyft home, and get dinner through Postmates, then in the space of just one day, you’ve interacted with seven companies that have stellar reputations as cutting-edge, tech-led businesses, enjoy enviable market share – and … collectively lost $14 billion this year.” When I read those lines in an article a few months ago in The Atlantic, I had to grin, but shake my head in amazement at the same time.
Burning money for the sake of growth is (not) cool
What’s really remarkable is that nobody seemed to mind. These are all highly valued companies that others seek to emulate. In fact, until recently, the spirit among founders and even some VCs reminded me of the time just before the dotcom bubble burst. Back then, companies were seemingly in a competition to have the highest ‘burn rate’. Yup, burn rate … aka how much money goes up in smoke every month!
Until a few months ago, it seemed like no one cared about profitability as long as a company was growing, whatever the cost may be. Growth alone was the name of the game and the key to your business’ reputation, funding, and most importantly valuation. Some of the most admired companies compiled staggering losses in pursuit of growth. In fact, it even seemed that the more staggering the losses, the higher the valuation of these companies would climb!
Clearly, this could not go on forever. The comparison with the dotcom bubble should be a wake-up call in itself, but not simply because ‘what goes up must come down’. Some companies really do keep going from strength to strength. The question is: What is the basis of that strength? And it always eluded me how bringing in even more revenue makes sense if you lose more than a dollar for every dollar of revenue you earn.
Follow the dollar instead
So let’s go back to the basics. When evaluating a company’s strength, let’s not be dazzled by its pure growth. Let’s play a game called ‘follow the dollar’ instead. Let’s imagine a customer’s dollar comes into the doorway of your company. You’ve already spent some part of that dollar on product development, marketing, and sales. Now let’s follow the dollar through the value chain. At each necessary step to create the product or service concerned, we spend a few cents – on materials, on energy, on human resources. At the end of the process, you hopefully have at least a few cents left from the customer’s dollar. That’s your profit.
If you really want to understand what makes a business tick, you should play this game for each product or family of products. You should play it for each customer segment, and in some cases even for each individual customer. That will not only show you what brings in revenue but also what drives your profit (or loss) at the end of the day. This solid understanding of where, how, and why you are making or losing money is so basic in nature but surprisingly often forgotten. Most importantly, it is your key ingredient when it comes to strategizing about growth.
Correlation is not causation
At this point, the ‘prophets of burn rate’ will object that I’m not only stuffy and old-fashioned, but short-sighted. What about companies like Amazon that lost scary amounts of money early on, only to become global, cash-generating superpowers? Indeed, there are true and inspiring success stories along those lines. But there are even more horror stories about companies that lost scary amounts of money early on, and then … kept losing money – until they went out of business!
This would be like pointing out that Bill Gates and Mark Zuckerberg dropped out of college, and advising young would-be billionaires to do the same! This argument only makes sense if you forget about the many thousands of college drop-outs who end up unemployed and poor. Correlation is definitely not causation.
Don’t try to defy the laws of gravity
So, call me old-fashioned, but for 99.99% of all businesses, the key to success is to focus on profitability. Profits prove beyond suspicion that you’re creating enough value through your products and services for all stakeholders to make some money. And the term ‘all’ stakeholders includes yourself! Understanding profits is the sine qua non to understanding your market, your customers, and ultimately your business. It is the most important ingredient for your growth strategy. And, at the end of the day, profits are the single most reliable source of funding.
You wouldn’t jump off a cliff just because it’s considered ‘cool’, would you?! Well, building and running a business with a sole focus on growth and without understanding your profits is like trying to defy the laws of gravity. That’s why I’d insist that every good business leader needs to have a deep and systematic understanding of where, how, and with whom they generate profits. Only once you have that understanding, you might choose to adopt a winner-takes-it-all strategy that involves temporary losses on your way to becoming the next Amazon or Facebook. Without such an understanding, however, a loss-making strategy is no more than a strategy for, well … losing money!