Earlier this week I received an email from a past participant of a senior leadership development program I ran for his company a few years ago.  The subject of the email read: “Confidential – Idea for
your Blog.”  As I am always looking for new and interesting material, I opened it right away.

Some of the most valuable companies in the world – the ones that we know as the darlings of Wall Street – have never made a profit.  Twitter, one of the most innovative and disruptive companies ever to be created (and one of my personal favorites), has lost $78 million, $635 million, $538 million, $450 million, and about $275 million in the last five years.  That is around $2 billion in negative net income during this time.  Yet as of today, Twitter has a market capitalization of about $12 billion. Only until recently has another darling, Amazon, turned a profit after years and years of losing billions of dollars.

Last week, I was facilitating a Business Acumen program for a very established company fighting off new emerging companies. The established company has been making a profit and paying a sizable dividend for years, yet their market cap is very low and their overall perception in their business markets and the financial markets is very stale.  One of the major questions that consistently comes up during these Business Acumen training workshops is about profitability and when should an emerging business make a profit?

Like many things in the world of finance and business, the answer is, “It depends.”

It depends on many things such as the long-term strategy, the goals of the investors, the cycle of technology, the cycle of incoming competitors, and many other factors.

It’s probably appropriate given the new US President’s rhetoric on imports to start with a brief story of the Japanese entry into the US car market in the late 1960’s and early 1970.  Up until that time, the US car market was dominated by US manufacturers and some “foreign” cars that were both common such as Volkswagen and exotic such as Rolls Royce.  The Japanese entry was much different; it was planned and it was strategic.  In 1972, the Honda Civic entered the US market with basically a motorcycle engine and a very low price.  The strategy was to capture market share and then over the long term build brand loyalty through quality, service, and unique marketing.  They executed flawlessly. 50 years later, Japanese brands such as Honda have their core brands such as the Accord – which is extremely profitable – and the Acura which is positioned as the luxury brand.  Unfortunately for Honda, Acura is easily beaten by Lexus (Toyota) and Infiniti (Nissan) in that luxury segment of the market.  But they are all, very, very profitable as a result of a long-term strategy.

Which brings us back some of the emerging disruptive technology companies of today and the answer to the question.

Emerging companies don’t have to make a profit for a long time as long as there is a potential of a profit.  The reason why a Twitter has a market cap of $12 billion is that the investors are “betting” that one day they will be profitable and be able to pay a dividend and increase even further the total shareholder return. 

As recently as the beginning of 2015, Amazon’s stock price was $290 a share. And that is around the time they were losing over $100 million in 2014.  When things started to change in terms of sustainable profitability in late 2015 and into 2016, the stock price rose dramatically to over $800 a share; the promise of the one-day-soon profitability finally came and it was a wonderful thing for shareholders.

These examples are good archetypes for understanding this complex issue.  Here are two important business acumen analysis tools to further explore the question of this blog:

1. What is the rate of revenue growth vs. expense growth? If Revenues are growing faster than expenses, then by default, there will be a point in time that the revenue is greater than expenses (which is a profit).
2. Does the company have at least 5 years of cash to pay for the losses and execute the strategy? By checking the balance sheet you can easily answer this question.

In summary, sometimes companies who lose money and have a high market cap make no sense.  It takes strong business acumen and analysis to figure out the reasons and embrace the impact.

I recently read an interesting article in the Harvard Business Review called “Customer Loyalty is Overrated.”  The essence of the well-received piece is that over time, brand and customer loyalty become so strong that companies selling products / services to customers don’t have to try as hard over to retain their customers because customers become so accustomed to buying their products / services that any marketing investments spent on creating and maintaining loyalty are “wasted” and could be used in other parts of the organization.

As a lead Consultant for the design, development, and delivery of hundreds of sophisticated business simulations that teach business professionals the Business Acumen skills needed for success, I couldn’t disagree more.  Over the past 25 years I have refined our core simulation algorithms to reflect the practical realities of competitive markets and the skills needed to execute the chosen strategy that will yield the desired business results.

As we all know, customers can be fickle and can change their minds at a moment’s notice.  However, we also know that every customer makes buying decisions based on a concept we call the Value Dashboard™ which is basically a combinations of reasons and factors that drive the decision making process.  In most free-market systems, it is the perception of the elements of the value dashboard –relative to competitors – that drive decisions and are the foundation for customer loyalty.  Based on our work, I am pleased to share three Business Acumen skills that drive customer loyalty and are needed by your organization:

Determining the Complete Customer Experience Relative to Price

Every customer going through a purchasing process is buying an experience.  That experience is essentially the use of a product / service to provide value to make something better or to satisfy a need that can’t be met any other way.  As a simple example, we buy cold medication to relieve the symptoms of a cold.  If you are suffering from a nasty cold and you need to get better quickly, there are an assortment of different cold remedy solutions to choose from or you simply don’t spend any money and stay in bed suffering until you get better.  Most of the time, a person with a bad cold will purchase the product that gives them the best perceived relief at the most reasonable price.  The Business Acumen skill needed to do this is the ability to determine the best price for the value provided relative to the competition.  That price has to be consistent with the overall strategy and create the appropriate margin for that overall strategy.

Determining the Complete Customer Experience Relative to Quality

In addition to price, every customer is going to make a buying decision based on their perception of the quality embedded into the complete customer experience.  Continuing with my earlier example, the customer with a bad cold can buy a branded product, a generic product, or no product.  The branded product has the perception of quality and in most cases real ingredient-driven quality to offer a strong solution to the customer.  The generic (low cost) product offers the perception of acceptable quality at a lower cost.  Either of these approaches requires a strict discipline of Business Acumen to help determine the best levels of quality at the right price supported by brand awareness to create the ultimate value proposition to customers.

Determining the Connection Between the Company and the Customer

The third element is a relatively new one, but very important in todays’ digital world of marketing.  Companies must now have the skills and tools to create connections between themselves and their customers; connections in terms of information, the ongoing reinforcement of the value proposition, and potentially additional and unexpected value.  Imagine for a moment that after your bad cold was over you went to the cold product’s web page and signed up for more information about their product, tips on cold prevention, and opportunities for new product testing.  Then one day you walk into your large drug store and as you are approaching the cold products section you get a text message on your smartphone with a limited coupon to try the new cherry vanilla flavor of the product at 50% off.  Business Acumen today is having a sophisticated skill set to help understand, determine, and build the connection your company has with your customers.  I believe the more investment made here, the more loyalty you can build.

In summary, I feel strongly that customer loyalty is more important now than ever before.  It is critical for organizations to invest in the skill building and training needed to develop the skills required to build strong relationships which will in return yield more revenue and hopefully more profit.