Revenue vs. profit: What's the difference and why does it matter?
Simplifying the math behind revenue and profit.
It was our most successful year. The business grew 20% compared to the previous year, and the CEO was about to share the results in detail, which excited me.
“We delivered 280 million EUR this year. It’s our most successful year, and there’s still plenty to grow. Also, we had 3 Million EUR of net profits.”
As I listened to the CEO, I got confused. How could we capture so much revenue and generate so little profit? I couldn’t connect the dots, so I asked the CEO and she replied:
“We’re in the growth phase, meaning we’re investing most of our profit to expand our reach and capture more revenue. Our investors support this strategy as we acquire more market share, which is better than having high profit and paying more taxes.”
Everyone laughed as I started understanding the game was about balancing present and future, not about playing safe and collecting profits immediately.
Let’s use this blog to exchange about revenue, profit, and their relation. We will also explore strategy and different business models for them.
Sidenote: I’m extremely grateful to everyone supporting my book. The first reviews are available, and the messages I’m receiving are making my days brighter. Grab your copy if you’re up to some unconventional product management :)
The difference between revenue and profit
Revenue relates to the overall income the company manages to create, while profit refers to what is left after covering all costs. More revenue doesn’t necessarily mean more profit, while more profit isn’t the same as a sound strategy.
Both revenues are critical factors for any business. Without revenue, you cannot have profits. An unprofitable company won’t live long.
The critical question is: how do you balance revenue and profit?
The importance of both in business strategy
You must understand your business strategy to create revenue to understand the revenue and profit.
Here are five typical business models for digital products:
Subscription: The user pays a recurrent fee. It’s possible to have different tiers differentiating the service offering. For example, Netflix and Amazon Prime use this model.
Freemium: Users can benefit from the product’s value without paying anything, but they face a few limitations that only premium users can get. Dropbox uses this format by offering free storage up to a few gigabytes but requiring users to pay if they want more. This approach is a common strategy for product-led growth companies.
SaaS: Instead of hosting a product on-premise (local data center), companies can hire software as a service product. Personio reached an 8.5 billion USD valuation in 2022 with a full-service human resources solution in Europe. They made that possible with a SaaS business model.
On-Demand: Pay for what you use has become increasingly popular, as this reduces friction to hire a service. That’s how cloud solutions often work. That’s the case for Amazon Web Services (AWS), Google Cloud Platform, and many others. Another example is car sharing, where you pay per minute.
Marketplace: You connect offer and demand. If someone wants to sell something and someone wants to buy, you enable that to happen. This business model generally charges one side and makes it free for the other. Airbnb and Uber are marketplaces and the first charges the buyers (guests), and the second charges the sellers (drivers).
There are dozens of business models. You can learn more about it by reading the “Business Model Generation: A Handbook for Visionaries, Game Changers, and Challengers” by Alexander Osterwalder and Yves Pigneus (2010).
In early-stage start-ups, generating revenue justifies more investments because it proves market fit. In such cases, it’s fine to have negative profits as the business strives to find its place on the market. Meanwhile, the game will differ in scale-ups as growing sustainably is fundamental. Creating revenue while having profits is crucial to progress, while it’s fine to reinvest the profits into boosting revenue.
How revenue and profit impact product strategy
Looking at revenue and profit alone won’t cut in most cases. It’s vital to understand how much it costs to create the revenue you have.
We “bought” revenue to prove market fit in an early-stage start-up where I worked. We did that by investing in high-quality service and convenience so customers would come to us and return. At first glance, you may think this is unsustainable, but once you look at the big picture, you can understand it better:
Customer Acquisition Cost (CAC): How much does it cost to acquire your customers? Track such costs as fast as possible because this will be fundamental to deciding on further investments.
Customer Lifetime Value (LTV): How much revenue can each customer bring throughout the relationship you built with them?
LTV: CAC Ratio: The relationship between acquisition costs and lifetime value helps you understand how sustainable your business is, enabling you to adapt your pricing and acquisition strategy. For example, a 1:1 ratio means your business won’t be profitable, so your pricing isn’t fit, or your product doesn’t have a market. While a 5:1 ratio shows that you’re highly profitable, there’s demand, so you could invest further into expanding your market share.
Tips for maximizing revenue and profit
In any business, you will opportunities to optimize how you create revenue and collect profits. Here are some aspects to explore:
Double down on high runners: What are your most sold products or services? Once you identify them, you can reinvest the profit into making such offerings even more successful.
Cut the low runners: What’s in your product that your customers ignore or barely use? Remove such parts as fast as possible. Cluttered products distract customers, increase maintenance costs, and slow teams down.
Encourage higher commitment: This is common in subscription models. The advantage of such a model is that customers can quickly leave when they lose interest, but that’s painful for the business. You can increase revenue by offering considerable discounts (15%+) for yearly subscriptions. That way, you can guarantee more revenue.
Make or Buy: Don’t build everything. Many businesses do everything on their own, which increases costs and reduces profitability. Focus on the core of your product while partnering with other companies to reduce your product complexity. For example, Maven focuses on providing high-quality cohort training, so it continuously develops this part as the core of its service, but it doesn’t handle invoicing or payment directly. The platform partnered with Stripe, so they take all of it. By doing that, they didn’t have to create an invoicing and payment system.
Cross Sale: The longer you keep your customers, the more revenue and profits you can make. That’s what Apple does pretty well. Once you get an iPhone, you may opt for an AirPod, Apple Watch, or Apple Music. Building an ecosystem will create a highly profitable business.
Conclusion and key takeaways
Revenue and profits are fundamental to any business. Once you understand their relationship and how you can create one while driving the other, you will be better prepared to go the company further. Yet, don’t get tunneled vision with only them. Strive to understand the big picture by considering your customer acquisition cost, lifetime value, and ratio.
Here are the takeaways from this blog:
More revenue doesn’t mean better business. More profit doesn’t mean a solid business strategy. The relationship with both the present and future is critical to success.
Understanding different revenue models is critical to exploring other options to drive profitability.
There are many opportunities to increase revenue and profitability. The common ones are more investment into high runners, cutting investments into low runners, increasing customer commitment, reducing product complexity, and benefiting from cross-sales.
Ensure to look at the big picture before making premature decisions. Neither revenue nor profit will tell you the real story alone.
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Have a lovely day,
David
Thanks for this topic. We are constantly talking about it within my company especially for the marketplace business, where the more you sell, the bigger the lost can happen.