What does it really take to create a sustainable business?
A lot of people have great ideas.
But unfortunately, turning those great ideas into an actual sustainable business requires a lot of important steps, and answers to some difficult questions.
So what’s the key? Let’s take a look.
Defining Your Market
Ok, so you have a great idea. Now what?
The key factor in whether your idea generates sustainable profits is people.
Specifically, an audience of people who will pay their hard-earned money for your idea.
Understanding these people, and how they interact with your business is an important first step.
Users vs Customers
Is your business user-driven or customer-driven?
Users spend time on your platform. On the other hand, customers pay you for the products you sell.
And honestly, we often get this confused. Just ask yourself who are Facebook’s customers?
Are they the people who scroll through posts?
Or are they the businesses paying Facebook money to get their ads in front of those using the platform?
When you have users, there is an ongoing, supporting relationship.
With customers, it’s more transactional – meaning you need to create a machine to continue bringing in customers that keep buying what you’re selling.
What is the exchange of value between your customers and your company? Value comes down to two things:
Are your customers paying you money for a product you sell?
Are your customers/users spending time on your platform? (i.e. you’re capturing attention).
Either way, people only stick around if you offer them something of value.
Key point: Finding product/market fit is where your value aligns with your audience in a way they predictably come back to buy your product or service.
Doing a simple survey is not good enough. The crucial question is whether they’d part with their time or money for it!
Frequency of Transactions
How often do customers pay for your product/service? Is it recurring? Or is it one time?
Recurring revenue is ideal because it makes your revenue predictable.
If it’s not recurring, you’ll need a really strong understanding of marketing and conversion metrics to create predictability in your revenue.
How do you get customers to keep buying from you? One-time transactions aren’t bad but you have to create a system that encourages people to keep buying. This can be very lucrative.
Do you want to know about a company that absolutely hits this one out of the ballpark?
Look no further than the medicine cabinet with Gillette Razors and razor blades.
They practically give the razor handles away. That’s one-time revenue and maybe even sold at a loss. But they have recurring revenue because you must buy razor blades to fit the razor handle. So…
- Razor = one-time revenue
- Razor blades = recurring revenue
How can you increase sales? Is your product something that is volume-driven or price-driven?
Every company must make a choice:
- Do we sell more stuff = increase volume?
- Do we charge more for stuff = increase prices?
What are the biggest costs in your business?
- Software Startups? It’s the initial cost of building the product.
- Services Businesses? It’s the people (i.e. payroll) that deliver service.
- eCommerce businesses? It’s the cost of goods sold/inventory.
Knowing your costs well helps you find the proper margin so you can grow sustainably.
Revenue is an important metric, but you can’t let your costs get out of control!
Revenue vs. Cash Flow
When do you book revenue in your company? When do you collect cash from your customers?
Oops. Did you think we accidentally repeated ourselves? These two events are not the same thing.
Cash is real money you can use in your business. Making money on paper doesn’t necessarily translate to cash flow.
This is true for two key reasons:
- Because revenue is not revenue until you’ve collected the cash
- Because revenue has associated costs, and the true cash generated is a wholly different metric
You need a good handle on both metrics, revenue, and cash flow, to build a solid business.
How to Add Customers
How do you get a new customer?
Regardless of how great your idea is, you need to keep adding customers because some customers may leave or stop buying.
To get new customers, you may need to invest in:
- A sales team
- A customer support team
- A marketing team
If any of these are underfunded or non-existent, you’ll lose more customers than you earn, which leads to our next point.
How many customers will stop buying your service or product every year?
You need to know this. The number of new customers you add every year needs to make up for the customers you lose and then some.
That’s the only way you grow.
Cost of Acquisition
How much money do you need to spend to get a new customer? In order to have a sustainable business model, your revenue per customer should be higher than your cost of acquisition.
So, if you’re spending $10 in sales and marketing to acquire a customer, they need to buy something from you worth more than $10. If not, you’re losing money on each customer.
There’s something to be said about lifetime value, but that takes time. Treading water while you increase lifetime value is not sustainable.
Variable Costs vs Fixed Costs
Not all costs are created equal. Knowing this gives you the power to influence costs and improve profitability.
Variable costs fluctuate based on how much product you sell.
These are things like:
- Cost of goods sold
Alternatively, fixed costs are incurred regardless of how much product you sell.
These are things like:
Your gross margin is how much money you make after you pay the cost to make or deliver your product. It takes into account costs that go up as you sell more of your product i.e. variable costs.
For example, in an eCommerce business, gross margin is calculated as:
Revenue – cost of goods sold = gross margin.
As stated above, revenue is often the focal point for all business owners. But you’ll have to go deeper and understand what happens to that revenue, and how it converts into cash flow. The first starting point is your gross margin.
Every good business owner knows how much gross margin or profit they make by selling a single unit of their product.
They understand the revenue per unit and they know the cost per unit.
At the end of the day, if you don’t know this about your product on a per unit basis, your business won’t survive for long.
Want Help Building a Sustainable Business?
Great ideas happen all the time. But without a solid plan, that idea never becomes a thriving business. Answering the above questions for yourself will get you on track to building a sustainable business.
Too often we think of accounting and finance as a boring list of numbers and rules. In reality, it’s more like a story. Your business is a complex story with all these data points weaving together to make everything work.
But just because it’s a lot of numbers, doesn’t mean it has to be complicated. By knowing your numbers and tracking them, you’ll understand your business and make it truly sustainable.