We must all become believers at the Church of Gross Profit
Tracey launched her business about 4 years ago, and in that time she’s built something quite special. Tracey’s business sells a unique home delivered fresh food solution online for busy professionals who want to have a healthy balanced diet that tastes great as well.
Tracey’s business model is in fact so successful that it attracted not only growth but competition. Entrants copy what she’s been doing so well for the past 4 years. Some of those competitors are trying to compete on price, some are offering delivery to different areas of Sydney and others are offering different payment models.
Tracey is annoyed, she’s worried and she’s determined. Annoyed that others are stealing her ideas, worried that they’ll kidnap her customers and determined to fight the bastards. Good for her, and I’m going to fight right alongside with her and teach those upstarts a lesson they’ll never forget.
Good news and Bad news
As always, there’s good news and bad news: The bad news is that it seems that some of these bastards have actually gained a foothold in Tracey’s market, but the good news is twofold:
- The bastards are demonstrating that there is room in the market. It’s clear that there are a lot more people who want what Tracey has to offer than she might have thought.
- The bastards are testing some new ideas that Tracey herself has been considering for a while, but now those ideas are being tested free of charge or risk to Tracey’s business.
Tracey’s knee-jerk temptation is to attack. And the obvious attacking strategy is to meet the competitors head on and offer the same things they do. One of those things revolves around delivery options. Tracey’s products are delivered for a flat fee, by courier, on the day of ordering to a limited number of areas of Sydney. It has always been a core principle of Tracey’s, to keep the whole thing super simple. A flat delivery fee fits that principle. The flat rate means the delivery has to be restricted to certain areas of Sydney, or Tracey can’t maintain her minimum margins.
Same day delivery everywhere
But one of the new upstarts is offering same day delivery everywhere in Sydney and Tracey feels she needs to match the competition — that flexibility.
But I’ve advised her against doing so, for one reason and one reason only:
Buying growth always leads to disaster.
Sure, it would be nice to move into the untapped regions of Sydney, but Tracey would only be able to do so by paying a lot more for her deliveries. She’s costed the various options and her delivery costs to those new areas will increase by about $2 per item. $2 Doesn’t seem like much when the average price per meal delivered is roughly $30. But, the fact is that her current Gross Profit Margin (profit per meal) would reduce by 33%. At the moment, she makes about $6 gross profit per meal. With an increase in courier cost of $2 per meal, she would suddenly only make $4 per meal delivered. Doing that spells disaster, as sure as God made little apples.
Not long ago we updated our breakeven calculations for the business and we worked out that at a certain level of sales, the Gross Margin on each item sold had to be at least $5 to be able to break even. At a Gross Margin of $4 per item, Tracey would need to sell 25% more meals just to break even.
The Red Queen never stops running
It’s what someone recently referred to as The Red Queen Problem.
The Red Queen being one of the Queens in Alice in Wonderland who says:
“My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.”
In effect what Tracey would be doing by delivering to new areas at the cost of her minimum Gross Margin is running harder, but standing still. No doubt Tracey would be selling more meals if she offered same day delivery to other areas, but in all likelihood, she’d make less money than she is now, she might even lose money. The profitable areas of her business would be subsidising the unprofitable areas and if there was ever an unsustainable way to grow a business, that’s it.
Growth is irrelevant. I’m not sure who ever made growth such a focus in business, but he (and it’s guaranteed to be a he, btw) should have been strangled at birth. The blind focus on growth that we are told to chase in business is crazy. Successful business owners, business owners that build Great Small Business that are Fun and that stand the test of time are devoted believers at the Church of Gross Margin.
I have no doubt that Tracey’s business will be a Great Small business that stands the test of time. Building Tracey’s business model is much more complicated than it looks and consistently making money in this business is a tough challenge. I’m sure that some of those new bastards are not making money at the moment and that they’ll fall over soon enough. One or two of them might get established and survive, but it’s clear the market is big enough and they’re going to be driving Tracey to innovate and come up with new solutions and new approaches to doing things and that’s healthy.
But buying customers at the expense of Gross Margin, that’s a disaster… I promise you.