As I understand, Todd Snodgrass is a financier and creates these insightful newsletters from time to time. With his permission, he as allowed me to repost. Let me know what you think.
=== Newsletter Repost ===
It is an age-old question in business, whether to put the major emphasis on revenues or profits? Since most real estate investors (REIers) are part time, that means many either work for a company or run their own firm. Either way, there are lessons to be learned from others in the business world that also apply to REI deals as well.
With many, if not most REIers and companies, increasing (top line) revenues is the main goal, i.e. close more deals. An improved bottom line is often a secondary consideration. However, without sufficient profits no business (REI or otherwise) can long exist. In most cases, the only reason you want to expend precious resources to grow revenues is if you can be assured that doing so will eventually lead to higher profits. Too many REIers seem to actually have that backwards. They undertake to do more deals, with the expectation that new profits will somehow automatically follow. Often the results are less than stellar because your first priority should be to boost the bottom line, not just the top line.
Here is how: First figure out exactly how much profit you must make on a deal, then work backwards from there to figure out how much you can afford to pay for the property or deal in question. If the numbers don’t work, be prepared to walk away from the deal.
On a larger scale, a good case study for a company that used to do a very good job of putting the bottom line first, before they lost their way, was Hewlett Packard. When the founders—Bill Hewlett and Dave Packard—ran the company from the 1940s-1970s, HP experienced decades of phenomenal growth in both sales and profits. It was a sight to behold. Many case studies have been written about how they did it.
In a nutshell, it is generally agreed that what they created is what has become known as “internalized entrepreneurship” or “intrapreneurship”. It worked at HP something like this: They allowed their engineers a few hours a month to experiment with new product ideas. Since they hired a lot of bright educated people, invariably some of those employees would create really good new products. What HP did was to vet the new product for profitability and feasibility. If it looked promising, they would provide some initial funding. If the profits were there, eventually the “intrapreneur” could even head up their own HP subsidiary. Many of these “intrapreneurs” wound up heading up billion dollar businesses. As long as the ROI (Return on Investment)–read increased profits over time–was there, everybody benefitted.
HP got so good at this, that at one time they had more than 100 operating subsidiaries under the HP brand. Total sales mushroomed to over $100 billion annually and profits gushed out at a record rate. The flow of new products that spewed forth from HP was astounding and included the ink jet printer, laser printer, scanners, fax machines and scads of other office and industrial products that survive even today.
And then it all started to go south. Once the founders retired, new management slowly changed the business model. They no longer provided the same opportunity for new subsidiaries to start up internally like they had before. The company culture changed from intrapreneurship to more of an acquisition model. They started chasing sales first, and hoped that profits would follow. Things have never been the same since.
HP is now just another lumbering corporate leviathan that has not invented any new blockbuster products in years. In fact, they have adopted the “growth-by-acquisitions” model that has become so common in corporate America over the past few decades. Too many US firms have gone from having the golden touch to the opposite: Almost every company they acquire winds up doing worse, not better, after a few years under the big corporate umbrella than they did when they were independent.
Result: Companies such as IBM, HP and GM have turned into the corporate poster boys for how NOT to grow and manage corporate entities from a profitability standpoint; all have churned through multiple CEOs over the past decades; share prices are in slow decline; profits are down, the best and brightest employees depart for greener pastures.
These are not isolated examples. On a smaller scale, the profits of REIers can easily suffer when they take their eye off the profit ball and substitute an increased volume of new deals instead. The lesson here is that you need to start first with your profit target amount. Then “reverse engineer” the deal back to the starting point, including all costs, etc. Where you wind up is how much you can afford to pay for the acquisition, and not a dollar more.
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