The Dangers of Single Metric Management
Sales growth is essential to a young company. In fact, until you’ve reached break-even cash flow, sales growth may be the most important thing. There is danger, though, in focusing on sales to the exclusion of other aspects of your business. Innumerable young companies have experienced rapid sales growth without a commensurate increase in their profitability.
I spoke with our friend Jen Nord recently to discuss the disciplines of “optimizing revenue.” With her background as a CPA and Certified Management Accountant, Jen has worked with many companies to help wring more profit out of their sales.
Counting Calories Before We Gain Weight
We don’t become overweight because we eat too much over the holidays. We pack on the pounds because of the accumulated effect of excess calories over an extended period of time. The same is true for our business expenses. They become misaligned with our revenues not because we binge spend. Rather, they tend to grow insidiously. We stop noticing when we are making expenditures that aren’t truly necessary.
the quality of being particularly noticeable or important; prominence.
As our businesses grow, they become abstract. Our experience with day-to-day interactions with customers and suppliers becomes more indirect. That’s particularly true as we add employees. As a consequence, expenditures can become less salient. When expenses become less salient, we tend to spend more.
Think about the difference between paying for dinner with a credit card and paying with cash. Paying with cash seems more tangible and real, while using credit cards seems abstract – as if you are using Monopoly money. Credit cards make it easy to spend, in part because we enjoy the benefit today, and the cost is pushed into the future.
Jen advocates techniques for making expenses more salient. It’s kind of like counting calories upfront to help us stay lean.
In particular, translate an expense – hiring a new employee, for example – into the number of units of product you’ll need to sell in order to cover the cost. Let’s say the fully loaded cost of an employee (salary, benefit, payroll taxes, added administrative burden, your management time, office space and equipment, etc.) is $45,000 a year. In addition, let’s say the profit contribution of a unit of product is $15. You’ll need to sell more than 8 additional units every day to simply cover the cost of the employee.
How many more prospective customers does that require? What additional marketing expenditures will be necessary? Does hiring an additional employee really make sense, or is it merely expedient? When you make expenses salient, you can be more mindful about your commitments, and the chances for profitable growth increase.
That Extra Sale Can Cost a Lot
Most times – not always – sales tend to grow smoothly and granularly. That’s particularly true if we sell direct-to-consumers. In contrast, our operating costs can be a bit lumpy. When we hire a new employee, add new warehouse space, or purchase an additional packaging machine, there is a stepwise jump in costs. When an incremental change in demand results in a disproportionate increase in costs, profit can go down.
There are a couple of ways to avoid this situation:
- We can be choiceful about sales growth. Rather than pursue growth for growth’s sake, we can actually choose not to grow in order to avoid what Jen refers to as “diminishing returns.”
- In addition, we can seek ways to make expense growth more incremental. That way, we stand a better chance of keeping expense growth in-line with revenue growth.
Instead of hiring a full-time employee, might it make sense to hire somebody part-time? Might hiring a freelancer via a platform like Upwork make more sense in the near-term than a part-time employee? Instead of leasing a warehouse, might it make sense to outsource fulfillment?
Revenue growth is generally a sign of a healthy business. However, not all sales growth is healthy. If we’re not careful, rapidly growing sales can translate into a disproportionate increase in recurring expenses that kill profitability. Jen sees it all the time. Follow her tips to make sales and expense growth more choiceful and profitable.