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Business Margins: How They Evolve over Time

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Business Margins: How They Evolve over Time

The profitability of a company changes as it grows and evolves.

Let’s give it a look.

Stage 1: The early days

This is the moment of highest profitability. You do most of the work. So, with little overhead, you keep most of the revenue you make.

If you make $10,000 and you have $3,000 in total overhead, you keep $7,000.

After a certain point, you will stall as you only have so much time.

So, you need to leverage a combination of technology, labor, and capital to keep growing revenue.

Stage 2: First full-time hire(s)

As soon as you earn enough and learn enough, you can start hiring people.

Workers are often the biggest costs in a business and margins begin to drop.

If you had 70-90 percent margins before, you may see them drop into the 40-70 percent range, depending on the number, type, and cost of the hires.

Stage 3: Scaling

You have a full team now, and while revenue grows, margins drop. Expect them to be in the 30-40 percent range.

Important points:

There’s an intermediate stage between the second and the third

At a certain point you will need management layers and different “departments” to help organize and efficiently coordinate work.

This might be when you’re at 50-75 employees and it doesn’t make sense for everybody to report to a CEO. You will need higher-cost managers to run certain parts of the business.

Then a limited number of “department heads” will report to upper management.

During this phase, the margins could also go on the negative side depending on the nature of the business and how fast you’re growing.

It’s up to the key stakeholders to decide what to do.

Staying small and keeping most of the money? Or going for the big scale?

The extra revenue isn’t always worth the effort. And the economics aren’t always better at 1,000 employees than they are at 50 employees.

It depends on how big your market is and what you’re trying to accomplish.

Scaling also brings new costs, including:

  • Bigger facilities
  • More employees and higher-cost management
  • More benefits for employees (medical, dental, 401(k), vacation)
  • More employees are needed to support existing ones (you might have to hire 0.5-0.7 employees for each new employee just to support them)

If you want to stay small and focus on margins, stay in stage one and focus on higher-margin projects/markets.

If you want to get an exit or build something big, aim for stage three. If you get stuck in stage two, you can:

  • Charge more.
  • Leverage overseas talent to reduce your wage bill.
  • Leverage technology.

This type of progression can be applied to almost every business model.

So, whatever it is, make the decision of what you want to be:

Smaller business with higher margins or larger business with smaller margins?

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