This post originally appeared in The Starting Gate, the Miami-Herald blog by Nancy Dahlberg on entrepreneurship and the SFL tech scene. This post has been reformatted. Each post in the three-part series will appear first in the Miami Herald and then be reblogged here.
The development of an entrepreneurial company can be understood in terms of the natural conflict in the objectives of the company. I believe the three most important conflicts to understand and manage are:
- Revenue growth versus cash flow;
- Customer versus shareholders;
- Market opportunity versus execution.
Revenue Growth versus Cash Flow
A healthy business should be trying to achieve maximum growth in revenue without running out of cash and cash reserves for future operations. Essentially a company balances the risk of generating revenue growth against the risk of going out of business due to no cash. Many struggling companies sacrifice revenue growth to conserve cash, which generates a death spiral to oblivion.
There are many benefits to revenue growth:
- Product Market Fit. Revenue growth confirms and documents that the product is being accepted by the target customer
- Market Share. Revenue growth at a rate equal or greater than the competition insures that a company is maintaining market share, which is critical to maintaining cost competitiveness in terms of both fixed and variable costs
- Avoid Complacency. Aggressive annual revenue growth targets, perhaps 100-200% annually at startup and gradually declining to 20% for a “mature” company, force a company to constantly re-work and improve the value proposition, product, sales strategy and business model; effectively the pressure for revenue growth becomes the impetus for continuous innovation.
Recognizing the importance of revenue growth, how do we manage the risk of not running out of cash? There are two techniques that I use:
1. Customer Acquisition Cost (CAC)
Customer acquisition cost is the marginal cost to acquire a new customer. As soon as a company starts to see traction in their market they should begin determining CAC. Over time CAC will stabilize and many industries have been shown to have fairly standard CAC. Once there is confidence in the CAC for a product, then it becomes highly predictable how much budget (cash) needs to be put at risk to achieve the desired revenue growth. (Note: using CAC a company is able to determine if a problem is the number of new customers, the spending to acquire the customers or simply a budgeting issue.)
2. Add-on Sales
The cheapest sale to achieve is typically the sale to an existing customer. These add-on sales are another, less cash intensive way to accelerate revenue growth. Most early stage companies overlook the opportunity for add-on sales as they struggle to grow revenue from their initial product. A good example of the add-on strategy is a premium priced software product where the customer pays additional money for an expanded feature set.
My last advice on how to manage the conflict between revenue growth and cash flow comes from Texas Hold’em poker. Professional poker players typically never go “all in” unless they know with a high degree of certainty that they have the winning hand. Unless you have a very high confidence that you understand the CAC, do not bet all your cash on forecasted revenue growth. Even then, I would hold a cash reserve in case of Murphy’s Law.
[The next post, on Wednesday, Sept. 18, will be on the conflict between customer and shareholders.Read more here: http://miamiherald.typepad.com/the-starting-gate/#storylink=cpy ]