By Itay Sagie
In the “good old days” — i.e. just two years ago — making a profit wasn’t top of mind for venture capitalists and thus for entrepreneurs. When there was more venture capital money than good startups to invest in, fiscal concerns often took a back seat.
But times have changed. In today’s market, even fantastic companies struggle to secure scarce venture capital. Nowadays, you need to have a rare combination of high growth, profitability, low customer churn and high net dollar retention just to get your foot in the door.
The financial benchmark known as the “Rule of 40” — which is used to balance growth and profitability, meaning YoY revenue growth beyond 40% could allow for negative profitability — now seems to be changing. Today, both profitability and growth are needed to attract investors.
Achieving this benchmark was already tough, but now the bar has been set even higher, making it a complex puzzle for tech entrepreneurs to solve.
I will refrain from the obvious cost reduction tactics such as optimizing the cost of goods sold, and reducing cloud and other operational expenses, as these are trivial, and can prove to have a limited long-term impact.
I will instead focus on three strategic points to consider when steering your company toward profitability and growth.
Are you targeting the right customers?
When crafting your go-to-market strategy, identifying your target audience is paramount.
Let’s say you manage a cybersecurity company targeting large enterprises with $45,000 in annual recurring revenue and $30,000 in annual gross profit per customer. You might have some big-name, Fortune 500 logos, but you are also likely bleeding money.
Given the price point, it might be time to consider focusing on small and medium-sized enterprises. Attracting large enterprises can be a costly, time-consuming endeavor, costing hundreds of thousands of dollars per customer, involving innovation centers, pilots and endless hoops to jump through only to find out your champion has left their role.
If all these efforts only yield $30,000 in gross profit per year per customer, even at a decent retention rate, the customer lifetime value ratio will not be 3x the customer acquisition cost — you will bleed hundreds of thousands of dollars per client leaving you in a cash crunch.
It would be helpful to read my previous article on Unit Economics. Going after SMEs is less time-consuming and expensive, therefore, if CAC is $40,000 and your customer lifetime is four years and you can achieve an LTV/CAC ratio of 3. Notice that now your CAC payback period is just under a year, which is ideal.
Are you making the most of your existing customers?
Entrepreneurs often rush to acquire new customers when they raise capital. That’s great, but only if you’ve mastered two things first: monetization and retention.
If you do not know how to retain and monetize your existing customers, best not to bother chasing new ones.
For example, if you’ve shifted your focus to SMEs and spent $40,000 to acquire a new customer who contributes $30,000 in annual gross profit and leaves after six months, you’re in trouble. You’ve only made $15,000 in gross profit, but with the $40,000 acquisition cost, you’re losing $25,000 per deal, creating a cash crunch.
Knowing how to keep customers around for many years with superb customer service, knowing how to upsell, cross-sell and grow the value of each customer over time is crucial for sustainable growth.
I would also suggest reading up on net revenue retention and gross revenue retention calculations to learn about how much money is retained vs. how many customers are retained. This metric is highly important to understand, and is requested by all investors and acquirers.
Are you focusing on the right place in the value chain?
Companies often expose themselves to unnecessarily costly operational burdens, attempting to take on a larger portion of the value chain than necessary.
Consider, for instance, a company specializing in medical sensing technology powered by advanced AI. Such a company faces a strategic choice: It can either sell its unique AI-based sensing algorithm to prominent medical-device manufacturers, or it can embark on the ambitious path of developing its own medical device, integrating its AI internally. While the latter route may hold promise, particularly with substantial funding and a highly skilled team, today’s funding landscape encourages a more pragmatic approach.
In the current climate, it would be prudent to lean toward the former option. By positioning itself as a pure software company, it can shed the burdens associated with hardware manufacturing and regulatory approvals, and adhere to compliance standards, manage complex logistics and endure the high costs of direct commercialization when competing against industry giants.
Even in the realm of pure SaaS, such as in the case of a cybersecurity company, there’s an opportunity to strategically focus on specific technological strengths while outsourcing or integrating third-party solutions for complementary functions such as data visualization. Every company should hone in on its core strengths, cut unnecessary operational expenditures and maximize efficiency.
In today’s competitive landscape, achieving both growth and profitability is a must. To succeed, entrepreneurs need to be agile, make data-driven decisions, and be ready to adapt their strategies. It’s about focusing on your core strength and going after the right customers and maximizing their value over time.
These practical considerations can help tech entrepreneurs navigate the challenges of achieving sustainable growth and profitability in today’s demanding market.
Itay Sagie, a guest contributor to Crunchbase News, is a seasoned lecturer and strategic adviser to startups and investors, specializing in strategy, growth and M&A. You can connect with him on LinkedIn for further insights and discussions.
Illustration: Dom Guzman
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