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Does big mean profits?

October 20, 2016

 

Being big does not equal making big money. Unlike the way business used to be a couple of decades back, New Age tech giants can be big and still make no profit. That sounds counterintuitive, isn’t it? How do you grow double digits and still report zero profit? How do you pay wages, run ads campaigns and release new app updates every couple of months?Firstly, such companies do exist. They are household names that you happen to be familiar with – Amazon, Twitter, Uber, Spotify, just to name a few.Secondly, it is totally possible to grow and still make no profit. But we need to distinguish between making no profits with a purpose and making no money without a purpose. It is undeniable that such Amazon, Twitter, Uber and Spotify are showing increasing growth rate with no profit. However, they are making zero money in very different manners.

 

Purposeful Reinvestment

 

Amazon is the king of purposeful reinvestment. Going IPO in 1997, Amazon has been surviving on a great pool of public money for a long time. The company has a lot of earnings on top of that. However, it purposely re-invests most of the profit to new initiatives.Has one ever wondered how Amazon can afford gazillion different things at the same time, from Amazon Prime 2-Day Shipping to its own Kindle series and now Amazon Fresh local? Arguing that continuous innovation from within will keep the company competitive, it constantly spends most of the earnings on its own business development.

 

"Don't be seduced into thinking that that which does not make a profit is without value. -- Arthur Miller

 

Blind Expansion

 

Twitter might be a good example for this category. Initial growth in user acquisition attracted early investors. However, facing fierce competition from Facebook and Instagram, Twitter has struggled to re-identify itself in the social media category. It acquired Vine, Periscope and MoPub as a part of that struggle. This resulted in increasing operating expenses that surpass the low 7% growth rate, hence the zero profit.

 

In Europe, Spotify also falls into the category of hopeful expansion. Its strategy is to annoy listeners with the ads in between the free music so they have to pay for the premium service. While it still struggles to increase users paying subscriptions, the ads business has not been picking up. Apple Music and Tidal joined the game and took back a significant amount of market segment in America. Spotify also took heavy hit from celebrities such as Taylor Swift and Adele balking at Spotify’s use of their content for the free service model and publically banning them from doing so.

 

High Initial Growth

 

No one can deny the rapid expansion of Uber. The Multi-billion-dollar market valuation was established on the basis on its extreme growth rate. Yet, the company still expands globally with quarterly reporting showing that they are making no profit. However, the number of investors interested in its growth is so high that Uber is not shutting down any time soon and cash pours in at ever increasing enterprise values.

 

As an investor, would you invest in such high-growth, nonprofit, high-revenue company? Or would you prefer to take a safer bet, an earlier exit and cash in for a smaller return?

 

My experiences are that in high growth technology businesses, capturing the market should be the priority with profits secondary to revenue growth. Provided, as Amazon showed 18 years into its growth, that profits *could* be achieved at any time by simply slowing down the chase for revenue to illustrate the business model is profit generating. Ultimately, that’s the only way to dominate in the tech space.

 

 

 

 

 

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