Revenue and margin growth are two of the most important metrics when it comes to analyzing the health of a company. It lets you know A) sales are increasing, B) the costs of goods and services are decreasing while selling prices are getting higher, C) you are acquiring new customers, or D) a combination of the above. All of which bode well.
However, growth – whether related solely to revenue or to margins – can be deceptive. It does not paint the whole picture and can often be misleading. Instead of taking revenue and margin growth at surface value, it’s best to look under the hood to see what’s driving them, and what these metrics might not be telling you.
What is Revenue Growth?
Revenue growth represents how sales have increased or decreased between two defined periods of time. The metric is very easy to calculate: take the latest revenue figure and subtract the previous revenue figure. Then, divide the result by the previous revenue figure and you have your result.
So, let’s say a company saw $1 million revenue in Q1, and $1.5 million revenue in Q2, then the company has seen revenue growth of 50% from Q1 to Q2.
Just as importantly, revenue growth can also be negative – telling you that your company is making less money than before. So, a company that saw revenue of $1 million in Q1 and revenue of $500,000 in Q2 saw revenue growth of -50%.
It’s important to note that factors like seasonal trends could be behind these changes and should be taken into account when comparing one period with another.
Breaking Down Revenue Growth
Truly understanding revenue growth isn’t as simple as measuring your sales or number of new customers month on month or quarter on quarter, however. Growth will look different and can be attributed to different factors depending on your business model. For example, in subscription-based businesses where revenue is recurring, customer churn plays a bigger role than almost any other KPI.
There are numerous potential factors behind revenue growth, and looking at each of these factors in closer detail can give you a more accurate picture of how well or otherwise your company is performing. Looking at each factor individually will tell you which departments are performing well, and where there is room for improvement.
There are various strategies that can drive up revenue, some of the most common are:
- Free Trials: Free trials exist for the sole purpose of getting customers’ attention. Once you gain that early traction, it’s easier to turn a customer into a long term source of revenue.
- Marketing: Investing a greater percentage of your budget into targeted marketing means getting your product or service in front of a wider audience of committed buyers.
- Referrals: These are normally incentivized with a giveaway or reward, but are a good way of consolidating your existing customer base as well as acquiring new ones.
- Discounts: Discounts give new customers an incentive to start buying from you and existing customers a reason to continue the relationship.
- Upselling and Cross-selling: Existing customers and prospects at the bottom of the funnel are often an untapped source of revenue because so much importance is given to attracting new ones.
What Can Cause a Revenue Decrease?
You’ve run promotions and dedicated time and resources into marketing efforts, but revenue is still trending downwards – why? When it comes to revenue decreases, there are a few factors (both long and short term) that can be in play. Here’s a look at some of the most common.
Churn is a metric that applies to companies that work on a subscription model and similar. One example is a SaaS company offering access to web-based software for a monthly fee. Churn is the metric that tells you how many of your subscribers are canceling their subscriptions and, for companies that operate on this model, it’s a metric that should not be taken lightly.
If you have high churn levels, then your company could be in bad shape regardless of any revenue increases. If your churn levels become high enough then the number of new customers you attract won’t make up for those you are losing. For a lot of businesses, it’s a better idea to focus on reducing churn levels rather than focusing on attracting new customers that you’re likely to lose in the short-term anyway.
Another potential cause of revenue loss is competition. New players can enter the market at any time and potentially attract your customers, and your revenue streams along with them. It pays to monitor the market and keep an eye on competitors, new and old, to see what their moves are.
Although there is a chance of other companies taking your customers, don’t forget that it can work in the other direction as well. Look for weaknesses to exploit and you could see a considerable boost in your own revenue streams.
Seasonal differences are another potential reason for revenue loss from one period to another. If you’re selling summer gear, for example, then it only makes sense that sales will drop away once the summer is over.
To get a more accurate assessment of performance, it might be more beneficial to look at the corresponding previous period rather than the period that has just passed. For example, although your sales might drop when compared to the summer that has just passed, they might still have improved over the previous fall.
Set Some Targets
Revenue growth as a stand-alone figure will often mean little without context. Even what appears to be impressive revenue growth at first glance might be less impressive when you take into account factors like investments into acquiring new customers, and seasonal changes.
To get a better picture of how your company’s revenue metric is really performing then set targets to achieve. Identify the revenue sources most important to you. See how well they are doing compared with how well they should be doing to keep the business healthy.
Set KPIs to make it clear what your targets are. If you aren’t reaching those targets then you know where you need to improve to keep your revenue growth healthy. Is your online marketing not driving as much revenue as expected? Speak with your marketing department if you have one and ask them to identify why, or consider hiring the help of professionals if you haven’t done so already.
Also remember that you can look for brand new revenue streams to bring more money in. It’s fine to be creative and you can look for inspiration from what your competitors are doing. When looking to competitors for ideas you might also notice gaps that they are not exploiting, giving you an opportunity to take advantage.
Last but not least, limiting losses of existing revenue streams can be just as important as generating more. If you do start losing your existing revenue streams, then you might get to the point where any new revenue streams you generate can’t keep up. This may potentially cause you to start making a net loss regardless of how much new money you are bringing in.
The Role of Revenue in Margin Growth
Revenue growth and margin growth are often talked about together, and with good reason. Your margin is ultimately a byproduct of your revenue. It represents how much capital your business retains for itself after the production costs are taken into account.
You’ll be familiar with the two ways of looking at margins – net and gross. While net margin gives a more definitive picture of profitability, gross margin is the figure most closely related to revenue and the cost of goods sold (COGS).
Net margin = Total revenue – COGS, wages, company expenses, operating costs, etc.
Gross margin = Total revenue – COGS
Explaining Margin Growth
Margin growth is a simple enough concept; having a high total revenue and a high gross margin will help to achieve a higher net profit margin. But that is not the only factor that can impact the margin. To further explain the changes with a margin bridge analysis.
In the past businesses have sought to reduce costs by focusing on individual parts and suppliers. The theory is, if the costs that go into creating a product can be decreased, profitability will go up. The thought process may be right, but the execution is often wrong.
Constantly finding cheaper suppliers or aggressively negotiating discounts are temporary fixes only, plus the time and effort that goes into these deals outweigh any benefits. Instead, businesses need to focus on streamlining their processes and making small adjustments where they can in order to facilitate long-term decreases in COGS and increases in margins.
Specifications & Material Costs
Lowering COGS comes down to controlling what can be controlled – this means focusing on direct costs. Undoubtedly, one of the largest direct costs is materials. However, cutting costs on a component-by-component basis isn’t sustainable. Taking a more holistic approach ensures the quality and functionality of a product aren’t compromised.
In other words, the requirements and expectations of customers and the specifications and functionality of a product should align. For example, there is little point in pumping money into the materials and larger components needed to produce a commercial plane that can go above 900 mph if, in practice, it never reaches above 500.
While automation has led to great improvements in efficiency, waste reduction, and decreased labor costs, off-shore manufacturing still proves to be the biggest cost-cutter.
Outsourcing production is a tried and tested strategy. China, Taiwan, and Vietnam offer lower labor and utility costs which result in savings that often outweigh the added shipping costs. That said, the high upfront costs and the risk of unpredictable fluctuations in currency are why it’s almost exclusively larger enterprises who choose it.
Inventory costs also contribute to COGS. Deadstock and excess inventory, therefore, represent wasted capital. This is why retailers switch over to on-demand production strategies. This ensures products are made to order, once payment has already been received. Think of a print-on-demand service like Redbubble or Printify – these businesses begin the production process once an order has been submitted.
Above we mentioned the wrong way of approaching supplier relationships. Aggressive price negotiation tactics are too often used by businesses looking for a discount. The success rate can be greatly improved with a more strategic approach to price negotiations. A business should know exactly what their current manufacturing, material, and labor costs are in order to know a realistic discount figure.
Relationships also come into play here. Co-operative relationships between retailers and suppliers are more common in industries such as car manufacturing where it’s normal to choose one supplier for the long term. However, to get the best benefits and deals from suppliers, it’s important to cultivate partnerships.