Profit may be made by generating revenue from sales or building an asset that can be leveraged to make money at a later stage. Photo: iStockphoto
We are seeing a new trend in the market where start-ups are more interested in free sign-ups, number of app downloads and building online communities. Upon asking or trying to understand how they will make money, you get vague or no answer at all.
When did start-up founders stop caring about revenue? It’s a strange phenomenon for the traditional business world. Do start-up founders think they can hide behind products and sign-ups? Successful businesses are usually measured using one simple yardstick—profit.
Profit may be made by generating revenue from sales or building an asset that can be leveraged to make money at a later stage. Established global companies such as Snapchat or WhatsApp have built businesses purely valued on assets, which will be leveraged for revenue in the future.
Profit is the single-most important yardstick of running a business, unless you are a social enterprise; even then you need to cover your cost. When you are on a mission to solve a problem, or revolutionize the market with a new offering, the business is likely to need some financial backing to keep it on track of money and that money will only come when people will see the possibilities of turning your mission-based start-up into a profitable enterprise.
The challenge from a culture obsessed with user growth is that we are raising a whole generation of entrepreneurs who have never sold a thing in their life. Recently GrowthEnabler research disclosed a sizeable number of food tech companies had laid off employees as they struggled to generate revenue to cover their outlay (due to premature scaling), or had not convinced their investors to provide another round of funding.
Businesses struggle to work without financial fuel. In 1999, Kozmo began with the idea of delivering Krispy Kreme doughnuts to your doorstep within an hour. Consumers loved the idea of home deliveries, and were excited about an array of goods arriving at their door, including video games, book, snacks, etc. Kozmo featured in Forbesmagazine and CEO Joseph Park declared he would put Amazon out of business by delivering goods at no cost.
A year later, Kozmo grew to having 400,000 members and attracted Amazon to provide its next round of funding. Despite this large investment, it quickly showed worrying signs of decline. Although Kozmo had sales of $3.5 million, it had lost $26.4 million. The company was not making money and had limited scope to make money. In 2001, Kozmo fired 1,100 employees and shut down the company. The idea of delivering food may sound promising, but few have made money in this business yet.
If you are running a start-up that is struggling to make the financial numbers work for your business, we would recommend that you ask yourself the following questions about your venture.
Have you gone through all the income assumption?
Go back to the basics. How much does it cost to buy your product or service? How will you sell the product? Directly or through a distributor? What commission are you going to pay? Are you willing to discount to build your initial market? Or do you want to offer free sample to the first 100 buyers? How will you charge for your product after that? Have you thought about economies of scale? Are you applying that scale for future profit?
Go through all the costings (include salaries, even if you are not initially taking one).
Most start-up founders go through this classic mistake of not adding their own salary as a part of the cost and as soon as they start paying themselves, they realize profit is on the decline. How can you build a business without paying yourself?
Go through the entire cycle of building a product or services to customer acquisition (direct or indirect), customer delivery, customer servicing and finally client renewal to ensure you have added all the applicable aspects of costing.
Is there a profit after your calculations?
Please remember that revenue minus expenses equals profit. You don’t need to complicate your profit matrix; it is very simple. You don’t need to be a top-notch finance person to figure this out.
I would normally write all the costing (expenses) on one side, decide my margin and create the price of product or service on the other side. Profit is what is left over, once you have paid yourself a market salary.
Does it pass that critical smell test?
Whenever I talk about profitability of any start-up, I look for a simple smell test. Let me give you a smell test example of a property start-up. Suppose you like a business property in a nice business district and you want to buy that property to rent it out. You may need an initial down payment of 10-15% depending on your market.
Now you approach a bank to take a loan for the balance, the bank will ask you a simple question, is that property leased? If the answer is no, then they will want to know how will you pay the mortgage or equated monthly instalments? This problem is simplified when you have a large corporation as a tenant with a two-three year lease agreement. If you don’t get the loan, this business is not going to work out. A smell test is looking for a building where you either have or there is possibility of getting a tenant (big corporation) to support your application for a loan from a bank.
Can you deliver at a mass scale?
This is another area where most start-ups struggle. Every start-up goes through a maturity curve, but you need to plan for what is coming your way. It may be easy to get a couple of customers and deliver to them, but can you do this on a mass scale? Whether you are building a product that needs manufacturing or a service that requires manpower, you need to ensure you have the ability to do it at scale and still make money.