I’m approaching my sixth year as an online entrepreneur and I now finally have some data and business skills to answer that question to some extent.
Retail vs Internet Companies
No two businesses are alike. Retail businesses rely on high revenues, but their profit margin is usually only a few percentage points. When you’re generating a few billion like Carrefour or Walmart, a few percentage points ain’t so bad, eh?
Online businesses on the other hand usually have a high profit margin. Facebook for example is just below the 30% profit margin line.
Growth Vs Profit: Amazon LLC
Amazon is one of the best examples when it comes to profit margin. They keep investing all of their profits back into the company. While that is the best strategy to grow a company, it certainly isn’t without its own risk. One of the reasons why Amazon’s stock crashed at the beginning of this year (from $400 to $300) was that shareholders of Amazon were getting worried that the company would keep this up forever, never turning a real profit.
Unjustified if you ask me, because Amazon has some of the most loyal customers and their products sell out like hot cakes. They recently introduced the Amazon Fire TV and it sold out immediately due to overwhelming demand. Bezoz and his team are seemingly capable of entering any market and catching up a large piece of the pie instantly. They now have their own smartphones, own eBook readers, own entertainment devices, one of the largest cloud services (AWS) and even own various smaller internet companies like Alexa(.com) and IMDB(.com). They’re everywhere.
Why is Amazon doing this?
They invest as much as possible back into the company to create loyal customers and get into as many related markets as possible. They’re not an online retail company. They’re a hybrid tech company and will heavily compete with APPL in the near future.
Is growth at all costs sustainable?
Certainly not. If you keep diversifying and entering new markets all the time, you may become a household name initially if you have a user base that is only interested in buying whatever you offer them, but sooner or later new companies will emerge that focus solely on one thing. Beating you at all costs – and they can put all of their efforts into a single product.
I am not implying that Amazon will have to sacrifice some of their products, but much like Google has never managed to get a foot into social media, there may come a day when Amazon launches a product that will not sell out after 24 hours. However, Amazon is certainly one of the best managed companies in the world and they will not enter markets they couldn’t compete in. Amazon will very soon turn things around, generate higher profits and even pay a small dividend to keep their shareholders happy.
How Does This Help Me (A Small Business Owner)?
As a small business owner you can’t possibly compare your own company with a billion dollar company, but you have to ask yourself similar questions.
Do I want to grow or am I happy with my current revenues? Are my customers happy with me or do I have to offer more to keep them around? When thinking about this, you also have to figure out how likely it is that your current revenues will fall.
If you invest too much and your revenues don’t grow quickly your cashflow will be low and you’re unable to build up cash reserves. Invest too little and your company will not grow at all, making it even more vulnerable to stagnation.
In my opinion you have to keep building up multiple revenue streams, especially if you’re in the internet business. Depending on a single revenue stream leaves you vulnerable. What if your business partner you heavily relied on goes broke or the income drops to unsustainable levels? Ad revenue can very quickly drop, sometimes even 50% in just a few months.
With that being said, you also have to make sure you’re not sacrificing the quality of your original product that is bringing in the most cash (your cash-cow). Finding a balance is really difficult and requires good judgement. Sometimes factors like motivation and interest play a big role as well. When you’re working on a new product line it’s exciting and maybe even more so than working on your original product. Being aware of that makes a difference. Delegating more work to 3rd-parties can and will affect your bottom-line, but may be necessary to keep your customers happy.
Team Up: Whitelabel Reseller
Let’s say you are in the publishing business right now and already have a large audience, then it may be the right time to build a related product or invest into building a low-maintenance service that you can run simultaneously. The keyword is low-maintenance: Most products and services require extensive support services, that’s why it is often a better idea to team up with another company and resell whitelabel services. You don’t have to worry about customer support and you can focus on selling a product.
Affiliate marketing is the most obvious solution. You promote products on a cost per action basis and can build up additional revenue without maintaining a product. However, this approach means you are sacrificing a lot of profits on the backend. Product owners earn a lot more than affiliates if they’re any good.
Example: Profit Margin Of A Small Business
My own personal profit margins dropped from year to year to support growth and next year will be the first time I am actually increasing my profit margin again, decreasing my overhead and cutting costs wherever possible to generate higher profits.
This is real-life data of a small internet publishing company that I run (with multiple revenue streams):
- 2010: 90% profit margin
- 2011: 70% profit margin
- 2012: 50% profit margin
- 2013: 20% profit margin
- 2014: 35% profit margin (expected)
- 2015: 50% profit margin (planned)
My goal is to get back to 50%. I believe a small internet business should always try to aim for at least 50% in order to build up cash reserves. However, certain situations (like building up a new revenue stream) often require a lot of capital and may eat up more profits than expected!
A sidenote on failed investments: Running a business is always risky, but sometimes you just have to be patient and keep pivoting. Abandoning your original idea you invested capital in completely like many failed startups do is often a bad idea, you can always build on something and use it as a foundation for something better. Find a market-fit and you’re golden.
So, to answer the initial question, “what profit margin should you aim for”, I’d say: It depends. It solely depends on your strategy.
Aiming for the highest margin rate possible is rarely a good idea, unless you run a very special type of business that requires no capital to grow, so if you invest back 50% of your income you can grow and build up cash reserves at the same time. It certainly worked out well for me in the past, but again, every business is different. Make up your own mind.
If you have never given it much thought, now may be the time to think a little about it and write down a few notes. Look at your own profit rates throughout the years. Do they fluctuate much? Why? Are there many one-time costs eating up your profits? Is it possible to cut costs somewhere?
Part 2: Let’s Break It Down
In part 2, we’ll take a look at the costs itself and break down some of the costs of a typical internet business and what you can do to save money. We will then analyze how you can increase your profit margin without having to sacrifice the quality of your product.
Keep pivoting, keep cutting costs my fellow webmasters!