Get Big: How Company Scale Drives Profits — Or Not

Quick: Which is more important… Profits or Sales?

Three companies were on my radar this week, all CRM companies competing for the same customers: Avidian (Prophet), 37 Signals (BaseCamp) and SalesForce (SalesForce).  Which do you suppose has the most sales?  Which do you suppose is making the most profit?  Which one has the happiest shareholders?

Lots of companies are scrambling for sales these days.  But the smart ones are focused on different metrics.  Like profitability.

I spoke with the CEO of Avidian, James Wong in Belleview Washington.  He has a clear mandate for Avidian:  “We have to be profitable – people need to see that we’re not just growing but viable and growing.”  Wong says he targets a minimum of 15% net profits at all times – and considering that he has experienced 200% annual growth without outside funding, that’s saying a lot.  I expect that as his growth levels off, his profit numbers will climb like crazy.

I heard similar sentiments from David Heinemeier Hansson of 37signals at a speech he gave to Stanford … paraphrasing, David said that “true scalability was the ability to add millions of dollars of revenue without hiring any more employees.”  That’s the kind of focus on profits I’m talking about.  37signals has managed to accumulate many millions of users with only 15 employees.  Crazy.

And finally, SalesForce.  I did not speak with anyone at SalesForce, but from my experience with the company and David’s remarks at Stanford, it sounds like SalesForce is a very different kind of company.  Their margins are in the single digits and their headcount is, well, immense.  Since they assign each customer a dedicated rep, their expenses continue to grow as fast or faster than their revenue.

Flash back to Wong, who says, “I’ve learned that profitability takes conscious effort,” he says. “If you just keep growing for growth sake, you won’t be nearly as profitable.”

Why all this talk about profits?

Again, it’s Wong that answers, “I’m serious about profits because that shows our strength and position in the marketplace. Our goal is to build a great company,”

Amen brother.  A great company requires profits.

I’ll go one step further and say that a company needs to be profitable even when it is NOT growing – even when it is shrinking.  (Maybe especially then!)

Let me end with “Do the Math” and “Bottom Line”…. Are you ready?

DO THE MATH: Selling something costs you money.  Figure out how much it costs to find, service and keep a customer.  Make sure that every customer is contributing enough Gross Margin (see my Gross Margin Video) to not only pull his weight, but to fuel the growth of your company.  Gross margins in the service business, for example, should be between 60% and 90%.  Software is probably even higher.  Keeping “gross profits” high will ensure that your net profits are reasonable – 15% to 25% in most cases. (I think 37signals probably blows this away!)

BOTTOM LINE: Go for growth, but only when you can keep it profitable.  There is little sense in taking on business that will not add to the health and wealth of your company.

Dedicated to your profits,

David