Years ago, I started a business selling specialty journals and notebooks. The products were sustainably made, difficult for competitors to replicate and connected to a mission I genuinely believed in. Sales roughly doubled each year, and on our best day, we received approximately 500 orders.
From the outside, it looked like we had found a winning formula. Revenue was growing, customers liked the products and the business had a defensible position in the market.
But after operating it for approximately four years, I decided to shut it down.
The problem was not a lack of sales. It was everything required to produce those sales. Every new customer had to be found, every increase in demand required more inventory and every shipment depended on a complicated international supply chain.
Revenue was growing, but so were the capital requirements, operating complexity and risk behind it.
“A business can generate more revenue every year without becoming more valuable.”
The numbers looked attractive
A journal sold for approximately $30. Manufacturing costs were relatively low, perhaps around $5 per unit. After adding packaging, shipping, platform fees and allocated overhead, the total cost before advertising might have reached $10 to $12.
That left approximately $18 to $20 from a $30 sale before customer acquisition. On the surface, the margin looked healthy.
But customers did not arrive for free.
The business depended heavily on paid advertising, particularly through Facebook. When the campaigns worked, they worked extremely well. A successful advertisement could generate hundreds of orders and acquire customers for only a few dollars each.
Finding those successful campaigns required constant experimentation. We had to test different images, copy, audiences and offers. Some advertisements performed well, while many others did not. Looking only at the cost of the advertisements that converted ignored all the money spent discovering which combination would work.
On some days, I could spend approximately $500 on advertising and generate only $500 or $600 in sales.
If $600 of sales produced a 60% contribution margin before advertising, the business generated approximately $360 to cover a $500 advertising bill. It had lost money before accounting for all the other demands on the company.
Sales were increasing, but the growth was not generating cash. It was consuming it.
“Growth was not releasing cash. It was demanding more of it.”
The first customer was the expensive one
Once we acquired a customer, we could reach that person again through email, retargeting and future offers. The difficult part was getting the first order.
Journals are not purchased as frequently as groceries, software subscriptions or other recurring products. To keep growing, the business needed a continuous supply of new customers, and each one carried an acquisition cost.
This is why the blended cost of acquiring a customer matters. It should include not only the advertisements that produced sales, but also the unsuccessful campaigns, creative experiments and marketing expenses required to find them.
A company with frequent repeat purchases can afford to spend more acquiring a customer because that person may produce revenue for years. A company selling an infrequently purchased product has less room for error.
Our product margin looked attractive in isolation. But it was not always sufficient to absorb the full cost of repeatedly creating demand.
Advertising was also only one part of the challenge.
These were specialty products manufactured overseas at a time when finding and coordinating with international suppliers was considerably more difficult than it is today. I had to identify a qualified manufacturer, travel to meet suppliers and establish the production arrangement. I then had to coordinate shipping, customs and distribution in the United States.
Because the journals were affected by specific import and anti-dumping requirements, I also needed legal assistance and a special import license.
All of this created a genuine competitive advantage. Other businesses could not easily copy the product, which helped us stand out and win customers.
But a competitive advantage is not necessarily a profitable advantage.
“The same complexity that made the product difficult to copy also made the business difficult to scale.”
Inventory could take as long as eight months to arrive. When stock began running low, I had to forecast demand months into the future, commit limited capital and hope that customers would still want the same products when the shipment arrived.
If I ordered too little, we could run out of popular products and lose sales. If I ordered too much, cash became trapped in inventory. As revenue increased, the business needed more money for advertising, larger production orders and a longer pipeline of goods moving through manufacturing and shipping.
The business was getting larger, but it was not necessarily getting stronger.
What does it actually mean to create value?
A company creates financial value by investing cash today to generate more cash in the future. The value created is the difference between the future cash the business generates and the cost of the investments required to produce it, adjusted for the fact that cash received in the future is worth less than cash received today.
Put more simply, a valuable business does not merely generate sales. It converts investment into sustainable future cash flow.
Revenue matters because it shows that customers are willing to buy. But it does not tell us how difficult those customers were to acquire, how much capital the business consumed or how much cash remained after delivering the product.
It also does not tell us whether the customer will return, whether the company can continue operating without its owner or whether the same revenue can be generated again next year.
Two businesses can report identical revenue and have completely different values. One may generate recurring sales, require little additional capital and convert most of its profit into cash. The other may depend on paid advertising, long inventory cycles, expensive equipment or constant owner involvement.
The first business is generally more valuable, even if their revenue appears identical.
“Revenue measures what the business sold. Value reflects what the business can sustainably produce from the money invested in it.”
This does not mean a business should maximize short-term cash at the expense of everything else. My journal business also had a sustainability mission, with approximately 10% to 15% of profits supporting efforts to reforest the Amazon and combat global deforestation.
That commitment reduced the cash retained by the company, but it also differentiated the brand, gave customers another reason to buy and created environmental value beyond the financial statements.
Strong businesses create value for more than their owners. Satisfied customers create loyalty and referrals. Capable employees improve execution. Safe and reliable operations protect the company. A meaningful mission can strengthen the relationship between the business and the people it serves.
But those commitments need to be supported by a viable business model. A mission can strengthen a company, but the underlying economics still need to fund that mission.
Looking back, I would not simply have changed the advertising or negotiated a slightly lower manufacturing cost. I would have chosen a different business model.
The journal business had a differentiated product, strong customer interest, rapid revenue growth and a compelling mission. It also required continuous customer acquisition, significant capital tied up in inventory, long manufacturing lead times, complicated import requirements and substantial involvement from the owner.
It worked, but making it work required more cash, complexity and personal effort than the economics justified.
The experience changed the question I ask when evaluating a business opportunity. I no longer ask only whether people will buy the product. I also ask what the business must spend, build and manage to make each sale possible.
Revenue was never the final scorecard. It was only the first line of the calculation.
“A good product attracts customers. A good business model creates value after the customer buys.”
Your Better by Monday action
Take the revenue your business generated during the last 90 days and work backward from it.
Estimate what you spent to acquire those customers, including unsuccessful marketing. Then subtract the cost of producing, delivering and supporting the work. Identify how much cash became tied up in inventory, equipment or working capital, and consider how much of the revenue is likely to return without paying to acquire the customer again.
Finally, account for the additional people, systems, complexity and owner involvement the growth required.
Then complete this sentence:
“For every $___ of revenue, our business retains approximately $___ in cash after acquiring the customer and delivering the work.”
You do not need a perfect answer. You need an honest estimate.
By Monday, you should know whether your recent growth is generating sustainable cash or simply creating more activity.
~Alex
Until next time …
One practical way to improve your business each week