Growth versus profitability: the business leader’s dilemma
Focusing on building market share rather than making profits has proved a successful gambit for several tech startups in the past, but should most firms take the opposite approach today?
“Our valuation and size are much more based on our energy and spirituality than [they are] on a multiple of revenue,” Adam Neumann, co-founder of WeWork, told Forbes magazine in 2017. It was an unconventional statement for a business leader to make, but then WeWork wasn’t promoting itself as a conventional business.
In its heyday, the provider of co-working office space expanded at breakneck speed. The number of WeWork locations increased from just over 400 in 2018 to about 750 in 2019. During that period, its membership grew from 400,000 to 650,000, while its annual revenue shot up from $1.82bn (£1.56bn) to $3.5bn.
But in 2019 – the year of Neumann’s controversial departure as CEO – it was also losing about $220,000 every hour. When WeWork finally floated on the New York Stock Exchange in 2021, it was valued at a mere $9bn, rather than the $47bn price tag it had attracted in 2019. In the second quarter of this year alone, the business still lost $635m.
WeWork has followed a classic startup strategy of seeking growth at all costs: grab as much market share as possible and quickly establish yourself as the biggest player. Only once you’ve scaled up to a position of power do you start focusing on making profits. This sort of approach has worked for companies such as Microsoft and Amazon, after all.
Why didn’t it do the same for WeWork? The main reason, several observers noted at the time, was that the firm was not a tech startup. Whatever its maverick former CEO might have claimed about the business, they said, fundamentally it was just another commercial real-estate company.
For other startup leaders pursuing an aggressive growth strategy, deciding when to prioritise profitability over market share can be a tricky matter.
“When you have big ideas and solve big problems, sometimes you need to scale up at a faster pace,” says Harry Hurst, CEO of Pipe, a flexible financing platform that he co-founded in 2019. “It’s vital to grow quickly enough to have an impact and gain a foothold in your market, especially when you’re creating a new category, but the key is not forgetting to build it sustainably along the way.”
He continues: “If you focus on growing the impact, brand and value of your business, not just its size, it’s very hard to go wrong. After that, you can concentrate more on reducing the customer-acquisition-cost payback period and making a profit.”
Pipe has attracted a valuation of $2bn, even though it employs only about 100 people.
“What’s worked for us is maintaining our focus on efficiency and execution to ensure that everything we do has an impact – fail fast and learn even faster,” Hurst explains. “One way we do that is by tracking revenue per employee.”
Maciej Workiewicz is associate professor of management at the ESSEC Business School in Paris. He points out that, “in general, profits trump revenues. A company can easily increase its revenues simply by pricing its products below their production costs. Such an approach is clearly unsustainable. Setting sales revenue targets without accompanying profit goals is foolish, therefore.”
But Workiewicz accepts that there are “legitimate reasons for which a company may temporarily sacrifice profits. For example, it may choose to secure a bigger market share initially to reach a more efficient scale in production, marketing and distribution. Having a larger manufacturing capacity means that the average cost of each product will be lower, because the fixed costs are spread over a bigger production volume.”
Even long-established businesses will change tack in this respect as their markets evolve and consumers’ tastes change. Before he resigned as CEO of Volkswagen in light of the emissions-test cheating scandal in 2015, Martin Winterkorn had set the firm on the path to becoming the industry’s biggest player as measured by vehicles sold. This April, Dr Arno Antlitz, the group’s chief financial officer, announced that the business would be concentrating on profitability more than sales.
“The key target is not growth. We are more focused on quality and on margins, rather than on volume and market share,” he told the FT, as the company revealed that it would be reducing its range of petrol and diesel vehicles by up to 60% in Europe by 2030 to help it concentrate on the more profitable premium end of the market.
When Oliver North started at Venari Group UK as CEO in January 2020, the firm – the nation’s largest manufacturer of ambulances and fire engines – was under private equity ownership. It had a £30m turnover target, but little focus on profitability, resulting in a loss of £4.6m. Today, while still hitting this turnover figure, Venari Group has recorded a profit of £2m.
“Profitability was the only mechanism that could renourish the company and bring it back to life,” North says. “Social, environmental and economic factors are always taken into consideration, together with my own thinking about business strategy, but profitability is the fuel that keeps the engine running. Without it, it’s hard for any business to flourish in other areas – for example, staff welfare and R&D.”
The growth-versus-profit question is especially relevant in the current commercial environment. Given the explosion of digitisation, a high level of uncertainty in many markets and the increasing demand from consumers for cheaper and more accessible goods and services, the opportunities for disruption have never been greater. Under such circumstances, many people in business would say that the need to gain market share outweighs the need to make a profit, at least in the short term.
On the other hand, in a faltering economy, investors may well require companies to demonstrate their profitability sooner than might otherwise be expected. It’s a dilemma that will focus minds – and stimulate debate – over the next few years.