What is the Law?
In all my experiences, there is one law that rings true in business. I wish I learned this rule when I owned my own company, but I learned it when I worked for a corporation. This corporation never taught me this law. It’s an unwritten law, and many think it is common sense, but it’s violated everywhere.
You’d be surprised how many people you see in your daily life who don’t know the law, and if they knew the law, they may find purpose. I also noticed that this law applies to many aspects, whether you work for someone else or are your own boss. Violation of this law leads to doom.
What is the law, you ask?
The First Law of Business is your job is to make the company money!
This can be worded in many ways, your job is to bring value, or the goal that Finance students learn in school is to maximize shareholder wealth.
Making the company money involves three levers. If you work for yourself, you balance all three. If you work for someone else, you more than likely focus on one. The higher your level, the more levers you pull and push.
The Levers?
The three levers are Increasing Revenue, Decreasing Operational Expenses (OpEx), and not losing money. The latter is so important that it’s Warren Buffet’s number one rule for investing, and his second rule supports his first rule.
This law and these levers sound like a no-brainer; of course, we need to increase revenues, of course, we need to decrease OpEx, and of course, we don’t want to lose money. Still, I am shocked at how many intelligent people I encounter that completely miss the mark. I miss it too sometimes.
You affect these levers if you work in IT, HR, Product, or customer service, so don’t think you have no impact on a lever. Everyone at every phase of the company affects the levers.
If you’re a leader whose profits are not scaling with your revenue, or you think departments like IT and HR are cost centers, or you rate projects based on a person’s perception of a system for sorting company initiatives, this is for you. If you think you know this, you don’t need to read anymore; absorb and live the law.
Let me start with the view from a macro level or the view from the sky. The revenue lever has multiple components. It has three inner levers to increase its overall Revenue. Those are increasing the quantity you sell, increasing your price, and increasing customers’ life cycle. Lifecycle can be thought of as extending a customer’s duration or retention, like getting them to subscribe one more month, or, in the case of some companies like Apple, getting them to replace their hardware faster.
Revenue is easy; it’s what everyone learns and focuses on. Focus on these three micro Revenue levers in your business. If you increase each lever by 10%, you grow your Revenues by 33%. I’ll take it!
OpEx, you want to move in the opposite direction as Revenue or at a lower growth % than Revenue. We look for opportunities to reduce OpEx; this can come from simple things like spending less or more complex, like reducing complexity in systems. OpEx is one of the levers that move on its own into the increase direction and is much harder to decrease once it’s already increased unless there’s constant strength pulling on it. It always needs a thoughtful eye and a strong hand.
To be healthy, Revenue and OpEx are a single pendulum that swings back and forth between the two. When you run a startup, the pendulum is stuck into the wall on the Revenue generating side with little concern for OpEx; as a company matures (a future topic), the pendulum unsticks and swings into OpEx efficiency. The velocity of that swing depends on past steps by leadership, but at this point, it should swing freely back and forth. Sometimes, an enterprise’s reaction to no Net Income violently thrusts the pendulum into the OpEx savings wall on the opposite side, where it sticks and should be followed by an all-hands-on-deck to unstick.
The challenge is that it’s easy to miss that it is actually stuck. Companies use a standard budget practice of assigning costs to a rigid yearly budget, which inevitably falls victim to Mike Tyson’s quote, “Everyone has a plan until they’re punched in the mouth.” There is a mad dash to trip over the dollars to pick up pennies, people are laid off, vendors are cut, and first principles are tossed. We can do better.
The third lever is “don’t lose money,” also known in Finance as Risk. This comes in multiple forms. Here are a few for starters: returns, Bad Debt Expenses, Lawsuits, or an intellectual property leak. Many holes in the dam need to be closed as best as possible.
What’s important about those focused on risk is that there must be a threshold. Risk can almost never be 100% contained, so there is a balance between OpEx used to prevent or divert risk and the actual cost of the risk. Chasing risk always yields diminished returns, hence why thresholds need to be established, or risk chasing becomes higher OpEx than the actual risk.
For Example, if you work in HR, risk may be the lever you interact with most. The loss of good employees due to toxicity or harassment could be an example, with hard to quantify loss.
The Path Forward
There is an easy way to know when your focus should be on OpEx over Revenue. The simple answer is when the OpEx growth rate is greater than your Revenue Growth rate. The more complex answer is when the return on investment from revenue-generating initiatives falls below a company’s required rate of return (known as the hurdle rate, WACC, and more).
As mentioned earlier, there’s a trap we all fall into, and that’s focusing on a perception-based rating system. I love an excellent Value vs Effort scale. I love to see quadrants and say these are “low-hanging fruit,” but I have since learned this did not help me, my startups, or the companies I worked for. Value is a perception provided by the eye of the beholders. A Product leader, COO, or CEO may have fundamental differences in the project’s value. How do they rank Value? Is it Revenue? What if the OpEx is so high, that any revenue generates a loss.
A more complex answer is to use an NPV or Net Present Value calculation. NPV is mainly indifferent to opinions. The only opinions going in could be perceived time of effort, resources needed (Headcount, time, money, etc.), and potential net income. I use net income because Revenue needs costs applied to it (usually EBITDA). In contrast, OpEx does not require a net income modifier applied to it.
Sort your NPV calculations from highest to lowest, and you will know what to work on first. Don’t touch any negative NPV because it costs you premium resources in cash flow, time, and opportunity costs.
There are plenty of sites and YouTube videos dedicated to calculating NPV for those who don’t know how.
Here are some things missing in most NPV calculations:
- For cash inflows notes:
- For all revenue increase projects, multiply your EBITDA (operating margin if you don’t know EBITDA) against it so you can gauge the cash inflow impact.
- All OpEx-reducing projects can use straight savings of the OpEx change.
- For cash outflows:
- Include headcount (time to complete project/maintain x salary); I’m amazed at how this is not used to calculate the return on investments in many projects.
- Don’t include sunk costs, like things we already have and can’t get rid of, office space, vendor offerings, etc.
- For periods:
- If you work in Tech, use up to three years, no more. This is the max I’ve noticed before a service, vendor, or product is replaced.
I hope this thread gives you value and an enhanced perspective on things. No matter where you are in your journey, whether you’re owning your own journey or working for someone else, always remember this law.