Venture Capitalist at Theory

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2 minute read / Sep 13, 2012 /

Choosing market segments on customer profitability

When serving B2B customers, your pricing will be dictated by your customers' margins. The more money they make, the more they can pay for new technology.

Most businesses fund new initiatives including marketing and technology projects from profits. The more profits a company generates the greater their willingness to pay for services and ultimately the larger the market size for a startup.

Let’s compare the margins of grocery stores to restaurants to software companies to prove the point.

Type Grocery Restaurant Software
Name Safeway Chili’s (Brinker) Intuit
Market Cap in $B 3.9 2.6 17.6
Revenue in $B 44.1 2.8 4.2
EBITDA in $B 2.7 0.36 1.4
EBITDA per location in $M 1.3 0.35 58

On a percentage basis, Intuit is more than three times as profitable as Brinker which is in turn twice as profitable as Safeway. This means Intuit’s budget for new projects and initiatives is much bigger and they should be willing to spend more.

Many startups focus on restaurants or grocery stores whose ability to pay for new projects is limited by their relatively small profit pool. The average Safeway store sells about $25M of merchandise annually, but generates about $2.7M in profit.

These dollars are pulled in many directions: covering potential losses incurred through the year, remodeling, new online marketing initiatives and ideally profits.

Projects like mobile coupon applications or loyalty systems demand dollars also demand dollars from this pool of cash.

Due to the relatively small potential revenues from in restaurants, startups serving these customer segments have to build very efficient sales teams or online customer acquisition tools to aggregate many of them inexpensively. Restaurants simply can’t afford to pay very much.

On the other hand, startups targeting software makers have more flexibility in their approach because these companies generate multiples more profit. So these startups can afford higher paid sales teams.

Ultimately, the startups serving higher profit customers will be more profitable, because margins cascade down the value chain.

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