Profitability is freedom

Intro

Friday evening, after a long week: my wife and me treat ourselves to a nice wine at a close by winery. Leaving, I pay with cash and we tip the waiter who recommended the bottle. We don’t think twice, we earned that money.

As private citizen the matter of profitability is a simple one: in our society, there’s no way to participate in the market without income that matches the money outflow (at least on average).

A definition of freedom

At work, I’m moving in different circles all together: Circles of debt and foreign control. So far, I never worked at a company that was free. Let me define freedom shortly:

Profitability is freedom.

Isn’t this a brash oversimplification? Definitely! Economic freedom is, like all areas, capped by laws, limiting the freedom of individuals and companies alike to ensure a civilized environment allowing for markets to work in the first place.

Lack of profits? Here’s what’s going to happen

  • Want to hire someone to move forward quicker? If you’re making losses, that’s not your call, but your investors.
  • The idea to pivot is obvious to you, but your investor doesn’t believe in it? That’s a nope to change. Or – worse – your investors believe they understand your business better than you? Well, you’ll be the one to execute on their hunches!
  • You’d like to build out in the product before selling it? Not your choice, if the lenders are not patient.
  • You realise your KPIs are not realistic, or lead you down the wrong path? If the KPIs are in the business development plans, they are irreversible marching orders!

I’ve seen all of the above play out, in two scenarios. The everyday in both companies was scarred from the lack of freedom, which stemmed from a lack of profit:

  • VC backed startup: Chasing new investor rounds. Getting new investment rounds apparently was easier than chasing product-market-fit. The investments were too small to warrant strong VC oversight, so the startup was actually mostly free when it came to what to do. As attempts at establishing product-market-fit fizzled out, we also reduced the burn rate. The degree to which we kept operations lean are worth a separate story.
  • A “startup in a grownup”, a product spun up in a big company in a new internal digital “incubator”: The big mother-ship promised long-term thinking and domain knowledge (compared to VCs). To impress the mother with quick successes, the startup went crazy with marketing. We were seriously into A/B testing to improve conversion funnels before we had a single paying user. As we lured more users with heavy facebook ad dollars into a free product, we burned through millions. Quickly the carefree-ness was replaced with top-down control. Re-organization (where top heaviness remained) created a playground of dirty compromises, and the imbalance of attention between internal quarrels and the actual product slowed the product’s momentum.

Both individual cases are without statistical validity. Nevertheless I bet that most unprofitable companies will share some characteristics. An unprofitable company is unstable, unsustainable, and the market’s incentives will pressure for quick changes in outcomes, even in ways that are not sustainable themselves.

After profits, prison looks differently

The company made it, and is clocking in profit? Nice, now you’re in much more subtle chains:

A profitable company is victim of its own success.

The first rule of profitability: it was just a moment’s temporary relief from the chase of being broke. Now you need to stay on the mountain-top. You apparently have customers who make you profitable. To keep rolling, you need to keep them happy, a careful act of balancing preservation and keeping up with times and competition. Attempts at moving the company forward might fail from customer’s or internal resistance. After all, what you’ve done so far put made you profitable, and the team is now infected by loss aversion. Of course not innovating is just as risky, in a less visible way.

Why is loss making 👌 for companies but not for citizens?

There’s no market for investments in private citizens – because there’s no upside, a human won’t bring in profits. There’s interests for credits, but money from credits usually flows into purchases, where the bought items can be security for the credit (exception: in countries with private education, education is obtained on borrowed money that flows directly into humans). Without investments in citizens, living beyond the own mean is not carried by any party in the market. Risky private behavior is disincentivized in society. Society has strong interest that the “material” it’s made of is resilient to economic instability.

Different story for companies: there’s tangible upsides for excess capital (especially in times of low returns for less risky investments) to put “play money” into experiments. The capital put at risk is capped (it can be lost at most 100%), whereas the upside of a succeeding experiment is virtually without upper limit. That a market carries companies who are losing money is therefore not sign of a market dysfunction, but a mechanism that ensures innovation, an incentive to participate with new ideas. If you trust the “invisible hand of the market” in most cases, your position will be that the money lost in investment on average could not have been spent more efficiently.

TLDR

When starting at a company, the profitability of the company is an indicator of freedom and pressures you’ll be facing.