When Is It Okay to Defer Profitability?

Businesses must be profitable to survive. That’s one of the reasons that business owners are so often told to make sure they are profitable before anything else.

Profitability is Goal Number 1 because it ensures that companies can keep on going. Everything else is Goal Number 2.

Profit is always job one.

Deferring Profitability to Build a Network

Yet as a recent Harvard Business Review article points out, the digital world abounds with instances in which profitability was intentionally delayed to gain customers. These companies are following another standard dictate: maximize profits. It’s that, in their business strategy, maximum profitability can be achieved only via the attainment of a critical mass in their networks.

With only a small network, Facebook, for example, would not be able to command maximum profitability. By growing its network and making its network additive, it can achieve maximum profitability. Same with eBay. Without a large marketplace, eBay can’t attract either the number of buyers or sellers it needs to survive.

The HBR article posits that the ability and desirability of deferring profits to build a wider network is a key difference between the industrial era and the digital. In the nineteenth century, and most of the twentieth, goods and services lost value if they were more abundant rather than scarce. Take chocolate, for example. If there were a very limited amount in the world, it would be expensive as well as desirable. If it were everywhere, it would be relatively cheap and less an object of fascination or intense desire.

The digital world and technology have reversed the relationship between scarcity and desirability. Networks, whether of friends to friends, worker to coworkers, buyers and sellers, or businesses and suppliers, gain desirability by their ubiquity. Whether you’re a Facebook user or an eBay seller, the bigger the network, the more valuable it is to customers and clients.

The Ability to Forecast

But how can companies tell whether deferring profitability is a good idea?

Ultimately, there is no surefire way to tell. Amazon Web Services (AWS) is an example of a business that has lowered prices and offered features at a low cost to lure customers. Essentially, the return will eventually be based on how many users are unified under AWS.

“Stickiness” is also a factor. Will customers return? Must they get certain features?

Yet one has only to think of the current retail bricks-and-mortar bust to realize that the dream of a captive audience — customers who must come to you to get what they want — can vanish given a newer and more convenient model, or a cheaper one. Digital companies have to think about this kind of competition too.

Thinking through priorities and features and what effect each will have on both current and future profitability is key in the evolving digital world.

The article suggests forecasting net present value (NPV) into the future, as it gives a metric for forecasting returns.

The digital world is one of the few in history where the more widespread something is, the more valuable it might become. As a result, some companies may be able to defer profitability in order to grow a network that will increase profitability in the future.