Nathan Sykes

March 20, 2021

Higher Margin Businesses Will Always Win

Russell Brunson has a saying, "The company that can spend the most to acquire a customer will always win.", and I believe in that saying whole heartedly. It's given way to one of the core pillars of what we look for in a business at Howdy Interactive - we look for businesses with high margins. (Side note: I'm sure someone said it before Russell did, but he's who I heard it from.)

There are plenty of viable and lucrative business opportunities that are volume-based. You hook up your credit card, let the machine run, and it nets you 2-3% in profit, which adds up to six or seven figures depending on how large your operation is. They do exist, but not inside of our circle of competence. We focus on companies that operate on a 50% to 70% profit margin.

This creates something of a Goldilocks principle of being 'just right' for us. On the lower end, we have a 20% to 30% profit margin. This is what is traditionally taught as being an achievable goal for small business owners to meet, and seems to fall in line with what small business owners report to be the average profit margin for companies operating in the United States. On the high end are companies that are doing 500% to 1000% profit margin. These are, obviously, 'one in a million' kinds of opportunities for firms like ours to invest in. They could be very successful one product e-commerce stores, or a SaaS product with a cult following and organic growth, but most often, these kinds of opportunities float our way with some sort of baggage attached. It could be volatile, unstable growth, or unethical marketing methods, or a number of other things. We want calm and stable, and we're willing to take the hit on not buying these companies with this sort of financial performance. We sit those out.

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Our companies, where we aim for 50-70% profit margin, is the pot of porridge that's just right for us. With a 50- 70 focus, our portfolio companies are moving faster, have more cash flow, and are operating on a larger scale than competitors who might have been told that 20-30% is the goal to strive for. If we have competitors in any industry that are pulling numbers like 500% to 1000% profit margins, we'd re-assess our standing in the industry and see where to go from there. Luckily, that hasn't happened yet, so I'd like to focus on the smaller companies in any particular space we occupy.

There's a distinction between growth in profit margin and growth in other KPIs, of course. A company might have more revenue than one of our portfolio companies. Say they do $500,000 in revenue per year, and our portfolio company only does $250,000.

(All of these are fake numbers, of course, only here to prove a point.)

If our competitor has been told that a 20% profit margin is great, they're only making $100,000 profit on their $500,000. If we work our magic and approach the same industry at a 70% profit margin, we're walking away with $161,000 for half of the revenue.

It's not magic, of course. Our portfolio company would have to go without some of the premium amenities that I'm sure our competitor can afford. I wrote about the effect of Parkinson's Law on expenses, profit, and Generally Acceptable Accounting Principles on March 11th, and that has a lot more information on how we cut down on a lot of our expenses, increasing our profit margin. But I'd rather that money go into my pocket.