Everyone loves a headline and a quick fix. Business owners are no different, and many think growing revenues quickly is the key to success. This is confirmed by some of the most respected business magazines, like Fortune (home of the eponymous Fortune 500) and our own BRW, which rank businesses according to total revenue rather than profit, or the even more critical, return on equity.
There’s a perfectly good reason for this – revenue or ‘top line sales’ is simple, easy to compare and very obvious. Calculating net profit can be affected by all sort of accounting provisions, while return on equity can vary massively between industries and companies.
Walk before you run
As the late Richard Pratt observed, ‘revenue is vanity, profit is sanity,’ But even that is an understatement – in our opinion, profit should always take a back seat to returns on capital. Why? Well, if you double your profit, but triple your capital base, then the result is terrible.
We’ve seen the revenue grab firsthand in the ecommerce sector. Rightly or wrongly, ecommerce generates a lot of media space because the blue sky of a disruptive industry is exciting, but essentially, the economics of ecommerce isn’t really any different to that of bricks and mortar. While our competitors have been spending upwards of 25 percent of total sales on marketing (and as a result, operating unprofitably), our focus has since the start been to ensure everything we do is viewed in the prism of ROE.
When a marketing campaign isn’t immediately profitable – in the sense of generating a direct, observable return through incremental sales and profitable acquisitions – then we have immediately stopped it. This has, at times, meant that we have seen our market share drop significantly – at one stage, we were “only” the seventh largest in our sector. But we had long-term goals in mind. We were willing to sacrifice market share and revenue in the short term to build a solid base, ensure profitability and solvency.
Inevitably, rationality prevails – and while the notion that the market can stay rational longer than you can remain solvent has merit – eventually, the strongest businesses will emerge victorious. This has happened time and again in the online space. Almost always, the winner has the best management, the best systems, the lowest cost base and the most competitive structure. Think Amazon, eBay, or Priceline.com.
Most businesses aren’t overnight successes – Henry Ford famously failed several times before hitting on his profitable low cost model. Spending the early years perfecting systems and developing competitive advantages is critical. At the same time, ensuring that the business is lean is a vital prerequisite to future growth. Once the building blocks are in place, you can take the next step.
Running a business is a marathon
Once you’ve got the systems and structures in place, you can start to take the step from being a small business, to being a medium or large business. There are two ways to grow – organically (largely through a significant marketing spend) or through acquisition (or most likely, a combination of both).
Most large businesses tend to growth through acquisition, which can be incredibly risky. If done correctly, it can be very rewarding. Warren Buffet started Berkshire Hathaway with a largely unprofitable clothing mill in America’s rust belt – he used cash flow from that inferior business to invest in successful insurance companies and used that cash flow to purchase businesses with incredible economics. Buffett is less of an investor than he is master capital allocator.
The same principles should apply with a growing business. Capital needs to be deployed into areas where you are able to reap the highest returns. If a business or segment isn’t successful, you need to be able to quickly divert valuable capital to areas which are generating a strong return. That means backing strong performing business units with not only money, but management attention.
The other area where you can spur growth is through careful acquisition. The emphasis is on careful. There’s no point in purchasing a business if you lower your over return on equity – too many acquisitions occur when managers seek to broaden their empire, rather than improve real returns for owners.
We’ve found the best combinations are bolt-on acquisitions, where we can add to an existing business line with a similar offering. This allows the ability to realise actual synergies, at both the expense side (through removal of obvious duplication) and more importantly, the revenue side. Adding synergistic bolt-on businesses gives you the ability to add critical scale across the group. In ecommerce, and most sectors, scale is critical.
It’s easy to fall into the trap of growing through acquisition too quickly. We never like to undertake more than one acquisition at a time. It’s a delicate balancing act of ensuring that the synergies are realised but at the same time, critical staff and customers aren’t alienated in the quest for short-term profits. In most of our acquisitions, we have experienced a short term sales drop off, but a substantial improvement to longer term profitability.
You can do everything right, but without a hefty dose of luck, it could all come to nothing. As Malcolm Gladwell noted in Outliers, you have to be in the right place at the right time and be able to execute to be successful. To grow your business you need to be lucky enough to be in a sector that allows that growth. But if you are in the right place at the right time, the key to short-term growth is being focused on the long-term.