The Profitability Illusion
As a growing company, it's easy to focus on revenue growth as the key measure of success. It's also hard to measure profitability accurately, especially as you grow and are continually sinking would-be profits into longer-term investments. Understandably, executive teams tend to equate revenue and revenue growth to creating customer value, because revenues measure how much customers are paying for your products or services.
In a recent article, we discussed the sticky customer trap, where growing businesses are lulled into complacency as customers continue to purchase their products and services. In these instances, revenue can be sustained or even increase even though the business is creating no new customer value. There's another instance where revenue growth creates the illusion that the business is creating customer value when it's not: we call it the profitability illusion.
It's a simple concept. To create customer value, you need to be earning a profit over time. Customer value implies that a customer is willing to pay more than the cost to produce and deliver the product. You aren't creating customer value if a customer doesn't derive any unique value when purchasing the product from you.
Here are two instances where the profitability illusion causes teams to believe they are creating customer value:
1. The start-up business that sells at a loss.
It's somewhat easy to create revenue and revenue growth when you are selling at a loss. If there is a customer need for a product or service, there's always a price that makes sense for a customer. Selling a product or service at a loss, however, is not sustainable in the long run, even though it is often necessary for a start-up business.
Until your business is profitable, you can't measure customer value. A sustainable business must eventually be profitable. If achieving profitability requires the business to raise prices or reduce costs--destroying customer value in the process--then the business hasn't actually created value, it has just traded price for revenue.
2. The unsustainable happy customer.
Measuring customer value is much harder than measuring customer happiness. For this reason, many growing businesses fall into the trap of focusing on customer satisfaction above all else. In many cases, overemphasizing customer satisfaction can actually destroy customer value.
Some businesses add people and resources to ensure customer happiness, which eats into profitability. Others offer an introductory price to a customer that doesn't have the capability to sustain full price, or they invest too much to acquire a customer that doesn't have the capacity to create ROI over the long term. In either case, the businesses are gaining customers without creating customer value.
The bottom line: If it costs too much to make a customer happy, it's not sustainable. If the customer is not willing or able to pay more for the extra customer service, you haven't created value, and the loss must eventually be remediated.
It's natural for growing companies to focus on revenue growth, but it's important to measure whether real customer value is being created. If not, the revenue growth will never turn into sustainable profits.
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KARL STARK AND BILL STEWART | Columnist | Co-founders, Avondale
Karl Stark and Bill Stewart are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree.