Growth is so 2021. Profitability is the in-thing.
Some of the operators who are not from the world of brands asked this question – why is profitability fashionable again? Here is a primer.
The risk-free interest rate in the US is moving up and will be in the 5% territory in 2023. This makes risk investing and lending hard.
- B2B lenders have to make >10% for their investors to be attracted towards investing money in these loan products. A lot of lenders bundle their loans into asset-backed bonds and sell them to investors. The demand for such bonds dries up, cutting one more lucrative revenue stream for the lenders. Brands that take loans cannot stomach a high-interest loan in an environment where demand is likely to be weak.
- Equity investors, be in PEs or VCs have an even more arduous task. They take higher risks with their investments, unlike debt investors. So the expectations are high and they are taking a risk with their investments at a time when their investors (LPs) demand returns that are better than corporate bonds. So, for the same money, risk investors are going to demand more ownership of the businesses they invest in (or they simply don't invest.)
There is a third source of money. It is the profit that you generate from selling to customers.
When the macroeconomic climate makes it hard to raise risk capital or the cost of loans is high, the market will prefer brands that are profitable. The playbooks change.
- Less or no budget for brand advertising and more focus on the best-converting ad campaigns
- Price increases – not all categories can afford to increase prices in an already inflationary environment
- Long-term lock-in on interest rates for borrowing
- Cuts in discretionary budgets, experiments, new product development, and hiring
All of these unlock cash from the business and reduce the need for borrowing.
2019 is the last time businesses forecasted demand based on normal (albeit in a zero-interest rate environment) business conditions. It is time to revisit those spreadsheets and the assumptions there. A lot of our readers are software businesses. Here's what brands need:
- Better returns on ad spend and so products and features that enable these returns
- Better demand forecasting so that they don't rake up inventory carrying costs or suffer from stockouts
- Better ability to manage the pricing of products because it is the most dynamic variable to adjust and see results quickly
- Better control over returns and churn (for box subscriptions)