Your Customers' Profitability is Your Startup's Future Health
Ten years ago today, I wrote a post titled “Choosing market segments on customer profitability.” How healthy are the business’s underling customers?
Today, that question matters more because of the recession than at any point in the last decade.
Selling to very profitable customers benefits a startup. Account executives can charge a highly profitable company more than one without much money. I compared the profit margins of selling to a grocery store, a restaurant & a software company to illustrate the point.
|Market Cap in $b||2.6||3.9||17.6|
|Revenue in $b||2.8||44.1||4.2|
|EBITDA in $b||0.4||2.7||1.4|
The grocery store generates $44b in annual revenue but only 6% falls out the bottom of the P&L as earnings to invest in new projects like a modern data stack. The restaurant fares a bit better with EBITDA margins of 14%. The software company towers above them all at 33%. A third of their revenue can be reinvested in new ideas.
Which customer segment would you prefer to sell to?
In addition to industry, customer size also impacts profitability. Enterprise customers’ demand is price inelastic. The delta between a $100k contract and a $150k contract sums to a few basis points of their budget, loose change found between the Nappa leather cushions of the mahogany-paneled board room.
But for a small company, $50k could represent the cost of an employee or a meaningful fraction of annual revenue.
The single most important business decision in evaluating a business is pricing power. And if you need a prayer session before raising price, then you’ve got a terrible business –Warren Buffett
Hermann Simon, the founder of renowned pricing experts Simon-Kucher partners, wrote this in his book Confessions of a Pricing Man.
Product category & product execution certainly play an important role in pricing power. But so does the underlying health of the buyer.