Why Profit First Failed You (Hint: Check Your Percentages)
Have you read the book Profit First?
It’s a great starting point for how to look at your expenses in order to pay yourself and generate profit in your business.
But, the ratios discussed in the book overestimate the costs for some models and wildly underestimate the observed costs for other models. And doesn’t help to illustrate the distinct revenue needs to support each business model.
And as you change or add to your model… the expenses keep rising. Without proper business model design, you might be working MORE and taking home less.
So let’s dive in to how the profit models work in your business design.
Do you know your business model design? Read this essay to know your model!
The Three Profit Variables
The three variables that tend to impact your profit model - and therefore, dictate your required revenue, include:
Costs to deliver your service
Costs to run/operate your business
Costs to market your business
The bonus variable? The cost of your personal development (coaching, consulting, etc.). We’ll come back to that one.
Cost of Service Delivery
Here, we look at the models that are largely solo client or channel facing versus team facing.
Solo models include the Craftsman, the Advisor, and small Gatherer, Teacher, or Edu-tainer models. In these models, YOU are doing the primary delivery, therefore your cost here is the cost of your time, baked into your owner pay.
Team models include the Agency, larger Gatherer and Teacher models, and Brand models. You’ll have team members actively involved in the delivery of your service - managing client projects, doing day-to-day work for agency clients, leading community calls, hosting office hours - as a direct part of your service.
Cost of Operating your Business
These costs include technology, software, accounting, legal, customer service, and support to set up and run offers. In this segment, costs tend to be linked to transaction volume - aka the number of client sales, relationships, and offers that run through your business.
If you have lower number of clients, like a Craftsman, you don’t need sophisticated proposal software or a higher-priced accounting firm, because with a handful of proposals a year and mostly recurring revenue and expenses, you don’t need heavy duty systems or an admin team to help you. Lower-cost business models include Craftsman, Strategist, smaller Agencies, and some Edu-Tainer businesses.
But if you’re running a Teacher or Gatherer business for example? You have lots of customers/clients in your business. You’ll need course software, email marketing software, accounting to manage all of the transactions, copy and graphics for sales pages and lead-in challenges - and a customer service and admin team to set everything up, upload recordings, create resources, moderate any group spaces, and respond to customer inquiries and disputes. You might eventually need a general manager/COO to manage the day-to-day.
What about Edu-Tainers or Brand that don’t work with clients directly? Your product is your speaking, writing, or digital products. If you’re an Edu-Tainer, you’d need an admin coordinating your speaking logistics, a team editing your videos or podcasts, or a team creating the downloads for your courses once it’s large or sophisticated enough to delegate.
Costs of Marketing your Business
The unspoken cost. This is how you need to keep new people finding your work and deciding to work with you - so the cost here is also correlated to how many people need to buy your work and how long they stay in relationship with you.
Craftsman models where you work with 5-10 clients per year? You’ll likely find these humans through relationships, referrals, and renewals. Please, please, please keep your marketing costs low. This means no spending money on ads, on funnel costs, or ongoing support for social media.
Advisor and Agency models need to attract slightly more clients, so this might be where you invest in one marketing strategy that you pay for - podcast pitching, producing your own podcast, or hiring a speaking agent. You’ll probably invest in branding and web design, in a team to help you with social media, on graphic design for downloads and lead magnets.
Where this gets interesting is in the Gatherer, Teacher, and Edu-Tainer models. Unless you already have a big audience, you’ll need to continually increase the number of people that are aware of you.
Social media (on discovery platforms, let’s remember) and SEO, are nominally free ways to get organic reach - if your content is sharable and you play the game on the platforms that actually drive growth. (IG feed, looking side-eyed at you).
You can also collaborate with other businesses by guest teaching, guest podcasting, or lists swaps.
But if you need to drive thousands of people to your work, in order to get hundreds of new customers every few months, you’ll likely also need to go paid. This means spending money on ads and ad management fees, content creation costs, and (for the big needs) referral or affiliate fees.
Some affiliate fees are up to 50% of the purchase price of the program, paid out to your affiliate. Facebook ad costs have skyrocketed since the iOS changes. With the advent of videos driving traffic comes the need for video editors and professional YouTube cover art.
I’m really excited to see some no-cost solutions to drive audience growth like the ConvertKit Creator Network and Substack referrals, but that still might not be enough to drive traffic to continually fill course cohorts launch after launch after launch.
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So how does this all come together? Profit Percentages based on your business model.
Here’s a first view of how these costs can compare across business models, based on what I’ve personally witnessed behind the scenes.
From top to bottom is marketing cost, operations cost, delivery costs, taxes, and owner pay as a percentage of revenue.
While not as scalable, the Craftsman model is very profitable - potentially taking home 60-65% of your revenue, especially after you’ve set it all up.
Other models start to hover between 30-50% of your top-line revenue. In order to take home $100K in these models, you’d need to be bringing in $200-$300K in total revenue, before you pay your team members and marketing/operations costs.
The large teacher model? If you’re not careful, you can hemorrhage cash.
You’ve heard the stories about the million-dollar launch… that actually depletes the business of cash because of payouts to the copywriter, launch team, affiliates, and ads.
And here’s another view that shows how much your target revenue needs to be in order to generate roughly $50K of owner pay, based on these percentages.
While you can generate $50K in owner pay with around $80K in revenue as a Craftsman, I’ve struggled to see Agencies have sustainable owner pay under about $170K in top line revenue.
And teacher businesses that rely on paid marketing need to generate $250K and up in revenue to make the same amount of money once you account for the costs of marketing and operations, unless you’re willing to do all of your admin, content creation, and community management yourself.
So before planning to switch from a higher-profit model to a model with more costs, make sure you’ve got the marketing engine ready to sustainably hit that higher revenue target and the business savvy to eliminate bloat as you grow, with a keen eye on these percentages.
When the ratios don’t work
There will be times in your business journey where the expenses outpace these guidelines. At certain points, you do have to spend money to make money, because being too restrictive will limit your growth. Here’s what to consider:
Start Up:
While you don’t need capital for a physical location or product, there are still upfront expenses to start, especially if you need to grow an audience to monetize.
Choose minimal viable options to get started… and actually get started. You don’t need the 5-figure coaching (or even the 4-figure cohort program). You don’t need the expensive website or the full blown branding package here.
Release the pressure for your business to fund you quickly. Consider keeping your full-time job or moving to a role with more flexibility. Add in coaching or “live” product support to generate some income while you build. Release the pressure of your business to be your financial support system before it’s naturally sustainable.
Scale Up:
When you’re ready for growth, you will need investments before you have the cash to fully support them. This is where you make decisions based on a view of your likely return on investment.
Get clear on ROI, the timeline, and the risks. If you bring on a team member to “buy back your time”, do you have the marketing infrastructure and audience to bring in more sales? Make a best-case and worst-case scenario of the new sales you need to cover your costs and projected timelines based on your historical time to close new business.
Have a plan for funding your growth. In the year before scale, start increasing your cash balance and build assets that can bring you short-term revenue. Look at your personal financial picture in case you need to cut back on your salary. Have a few short-term revenue-generating opportunities you can draw on, even if they aren’t sustainable long-term.
Slow Down or Sunset:
Ultimately, there will be times when business is tough, when you want to wind down a service, or even move to a new passion area.
Take stock of what’s next. Look critically at your business in the context of the macroeconomic environment and decide if this is a slow period to weather or a sign that it’s time to transition a product or sunset a line of business.
Proactively have a plan to navigate slow periods. Don’t plan your fixed expenses on your best month. Look critically at your personal and business expenses and decide what to cut, and assemble a support system (financially and otherwise) during the transition. Consider securing a business line of credit in advance to bridge you through slower sales periods.
Know your Numbers
The first step in managing your profit? Recognizing you’re a small business, being aware of how the cash moves in and out of your business, and knowing how much you’re keeping for you at the end of the day. When you review your revenue and expenses regularly, you’ll be prepared with a plan for when you hit either a start up, scale up, or slow down point.
In my work with small business owners, I always suggest reviewing your numbers monthly. Have a dedicated time to go over these each month–you will sleep better at night, and your business will have an infinitely better chance of surviving and helping you thrive. Invest in a finance team (a bookkeeper, accountant, and potentially a financial coach) that can help you understand your reports and plan for sustainable growth.
Every business owner has different money needs, different money stories, and a different level of access to capital and relationships. But knowing that you’re a small business, not a start up, changes the lens on your business management and investment decisions towards sustainability, not rapid growth that could lead to burnout or business implosion. Instead of building a business to sell, build a business that lasts.