Profitability vs. Growth—Where Is the Balance?

To say that a main goal, perhaps the main goal of any company is to make money is to state the obvious — or is it? There are times when other goals are more important than profitability, especially when a company is ramping up and investing in market penetration and infrastructure. It’s a rare company that makes money consistently from Day One of its operations.

Aside from a company’s early stages, other situations might require operating losses, for example when a company is undergoing a restructuring or is executing a strategy to be the low cost company, trying to drive competitors from the market.

We asked our partners to speak to the issue of when a CEO and their investors should be willing to experience negative operating income.

Helen Bulwik

Helen’s career has focused on developing and executing strategies for business development and growth for leading retail and consumer companies. She has worked with private equity for more than 25 years-- as CEO of seven PE-owned consumer and retail companies and as an operating partner to eight PE firms.

It takes time for a company to ramp up and grow. It is not a question of validating losses but rather a tight business plan that budgets for both growth and capital requirements. Capital does not create profits. Its purpose is to assist the company during a growth period to cover the costs of growth. Once the company reaches profitability, the need for outside capital is greatly diminished. Capital is simply the yin to profitability’s yang.

Ferey Faridian

Ferey is a senior strategic investment professional with 25 years of experience spanning management consulting in 12 countries, investment banking and principal investing, as well as serving as CEO/President of high-technology ventures.

Typically, it is only larger companies that are in a position to go for a cost leadership strategy. Most companies opt for a differentiation strategy instead. Few companies have the scale and the staying power to be in a position to afford the risks of cost leadership.

Fred Fink

Fred has been successful both as an executive and an entrepreneur. Much of his career has been spent in different sectors of the healthcare industry.

I haven't seen many companies that are willing to make this trade off to lose money in pursuit of growth unless they are private equity backed. If they're playing with house money (as is the case with PE), they're more likely to adopt a long-term investment/short term loss approach than if they're investing their own dollars.

Bill Heermann

Bill has deep expertise in building and running industrial manufacturing and construction companies.

A financial plan or budget is the underpinning for the management team's decisions as they guide an organization. The contents and timing of the plan typically vary dramatically based on whose capital is in play and the company’s vision of how quickly it can scale.

Private owners most often start an organization with a vision of creating revenue and a personal income stream, built on a foundation of their own limited capital with minimal borrowing. In this case profitability and growth must go together, until accumulated earnings provide the basis for an expanded vision for growth. Operators in this position can't validate losing money because they can't fund the negative cash flow beyond personal reserves.

In a case where capital is less constrained, allowing creation of a scenario to experience negative cash flow before scaling creates profits, you must have a multi-year financial plan in place. Validation of short term negative results can only come from positive results in later periods, so that the company achieves an acceptable return over the entire duration of its existence. But to do so it must overcome substantial risk that sales growth will not actually materialize in return for spending down its capital.

Lynn Lednicky

Lynn Lednicky is an experienced leader with a track record of success in the energy industry. As President and Founder of Lednicky Enterprises, he has provided expert advice to the energy, utility, and infrastructure sectors. His engagements have included M&A support, operational and financial restructuring, renewable energy, project development and financing and advising on production and use of natural gas as a domestic transportation fuel.

Losing money in pursuit of growth or another strategic imperative requires a combination of blind faith and experience. It helps if the entrepreneur and his or her investors have had the experience of being part of a losing proposition that turned out to be profitable after all.

Billie Otto

Billie is a Newport partner in the Pacific Northwest who has been Executive VP and CIO of TrueBlue Inc. (NYSE: TBI) the largest industrial staffing firm in the U.S.

Planning is key. A management team needs a member who is passionate about running models and picking apart different approaches — as much as it needs a visionary who lives and breathes their product/service. The best planning involves developing, say, 3 initial models and then stress test them based on key assumptions being 50% more or less of what you are assuming (such as market uptick taking 50% longer than the worst case). When things get tough and the company finds itself in a scenario it hasn’t anticipated , they will have a greater likelihood of surviving both the financial and emotional stress. Stress testing the best case is equally as critical since firms also fail due to an inability to keep up with demand, even when there is room to move price up.

Kevin Poole

Kevin Poole is a seasoned leader with diverse experience as both a senior advisor to CXOs of middle-market firms, and as an operating executive at a Fortune 500 company.

Striking the right balance between profitability versus growth requires both a clear understanding of your financial backers investment horizon and sophisticated financial modeling skills. All too often entrepreneurs will obtain investment capital without fully understanding their financial backer's investment time frame, risk appetite and ability to make subsequent investments in the business to sustain growth. Even when there is good alignment around investment time frames, the average entrepreneur will generally struggle when attempting to model the cash required to sustain the business under multiple growth scenarios. Being able to accurately model cash needs is often the difference between striking the right balance between growth and profitability, versus quickly burning through your investor’s precious capital with little to show for it.

Mark Rosenman

Mark is a co-founder of Newport Board Group and its Chief Knowledge Officer.

Losing money should be a fundamentally unnatural act for any business. A company that is losing money needs to be aggressive in validating metrics that its strategy is working e.g. that notwithstanding losses it is building market share or creating products that the market will eventually embrace. CEOs whose bottom line is negative need to question relentlessly whether their company is actually meeting tangible milestones toward profitability.

John Sullivan

John has delivered top-and bottom-line results running a wide range of companies and dealing with challenges like acquisitions, lean manufacturing, supply chain optimization/low cost sourcing, new product development and brand and channel management.

Pricing, in my view, is one of the most complex topics in business. There are very few, if any, winners of a price war. The successful business owners I know rarely price their products at a point where they are losing money, even temporarily. Instead they tend to avoid adding overhead so that they can, at least, break even as they launch their product.

Eran Tagor

Eran has diverse experience in executive management, venture capital, private equity and M & A, including turnaround, restructuring and special situations transactions.

In the tech sector primarily, the justification for negative cash flow is that it is necessary to provide the opportunity to capture a market and build a brand and scale as fast as possible -- and figure out the profitability model later. The plan is for the company to ramp up a customer base, brand and scale that can facilitate a liquidation event. But this high risk/high reward model is primarily relevant to VC-backed tech startups.

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