I’ve been binge-watching David Rubenstein’s excellent TV show where he interviews news makers. And let me say that if you haven’t seen the show, check it out. It is really wonderful television. But let me explain the show’s connection to the point of this post, which is small business profitability.
On one of the early episodes of the show, Mr. Rubenstein interviews Warren Buffet. Which is interesting of course. Buffet’s interviews often provide insights for investors. But answering a question from Rubenstein, Buffet says something thought provoking for small business owners struggling with profitability.
Mr Buffet says the railroad he bought (more info here) has been a good business. And then he qualifies his comment saying “not a great business… but a good business.”
A bunch of interesting notions and ideas drop out of Buffet’s comment, I think. First, that Warren Buffet can’t necessarily identify “great” businesses. Second, that Buffet happily accepts a merely “good” business.
But maybe the most interesting thing to me is the idea that the profitability of businesses spans the spectrum. A few firms show great profitability. Some show good profitability. But then many other firms show only “fair” or maybe “poor” or even downright “terrible” profitability
Falling down the rabbit hole, this line of thinking has got me wondering how you and I should grade or evaluate small business profitability. So what follows amounts to my grading rubric for categorizing small business profits as terrible, poor, fair, good or great.
But feel free to post your own ideas… and free feel to point out flaws in mine.
What does a FAIR small business profitability look like
Let me start with a description of what I think is “fair” profitability.
I’m going to use a standard definition of “fair” and say that a “fair” business is one where you and other team members get paid reasonably and where you and other any investors get a reasonable return.
In short, a “fair” business is one that’s fair to the stakeholders. And probably, the more I think about it, the more it seems a “fair” business also needs to deliver reasonable value to customers and act reasonably in the community. But that’s really it.
The one awkward reality, I think, is “fair” isn’t actually a given. A “fair” business usually isn’t easy to achieve. Or at least that’s my observation. Many small business owners don’t achieve “fair”… often without realizing it, I will guess.
What does a TERRIBLE small business profitability look like
So let’s get the awkward definition out of the way, too.
My idea is that small business profitability gets a “terrible” grade when the business destroys wealth, when it loses money year after year.
In other words, if year in and year out the business pays workers less than they should earn (this includes the entrepreneur) and then the business also fails to pay out a reasonable return on the investment made by the founder and others, that small business fails.
Potentially everybody loses: the employees, the owner or owners, the investors.
A terrible business (unless it can be fixed quickly) needs to terminated because every year the business continues, it financially damages the stakeholders involved.
For the record, I think more terrible small businesses exist than people realize. If employees or owners make less than they would someplace else or if investors earn less than they should, the awkward reality is that people should quit the business and participate in some other better venture.
So what about BAD small business profitability?
My idea is that a bad small business profitability is profitability that falls between terrible and fair.
Maybe the business doesn’t work today but will in a few months or in a year? So that means the venture isn’t paying people fairly… but it could down the road.
Or maybe people get paid fairly, but the business causes people to suffer in other important ways. Maybe the business prevents people from having work-life balance or forces them to live some place that’s a crummy or dangerous.
We need to be realistic of course. Work isn’t play or simply fun. People pay us because we are working. But if you or I really could do something else and get a “fair” deal, well, the current deal is (by my definition) “bad.”
What GREAT small business profitability looks like?
Mr Buffet didn’t elaborate on why the railroad he bought is only a “good” business and not a “great”business. But I am guessing the business isn’t profitable enough. In other words, sure, maybe it pays people and investors an average amount. But not more.
I think a great business (whether you own it or Buffet does) probably does pay workers and investors above average amounts, thereby allowing stakeholders to really build wealth.
Another way to say this same thing is that a great venture truly creates wealth—the mirror image of a terrible business that destroys wealth.
A sneaking suspicion: I wonder if many businesses, including many small businesses, fail to get a grade of “great” once they do a good accounting for their people costs (including the owner) and once they account for the cost of capital.
A related comment: If Mr. Buffet has trouble identifying “great” businesses, you would think we small business folks will too.
What does GOOD small business profitability look like?
A final question: What does “good” small business profitability look like?
My idea is that this firm is better than “fair”… but not “great.” So the business does something more than pay fair wages and returns.
Maybe it pays fair wages and above average returns. Or vice versa.
Or maybe it pays fair wages and returns but provides for lots of work satisfaction or allows for great work-life balance or lets you live and work someplace wonderful.
But the business doesn’t through both above average wages or returns to shareholders create wealth. Workers and owners aren’t getting something significantly more than what’s, relatively speaking “fair.”
Three Wrap-up Comments About Small Business Profitability
Let me wrap of this rambling post with three related comments:
First, Mr Buffet obviously thinks (and I do too) that there are great businesses. Some of the giant US technology firms qualify as great. (Look at their wages and the returns investors enjoy.) And some small businesses generate great profitability too. As you would expect. But the number of great firms is a pretty small. (I know the way the statistics look for single owner CPA firms as I’ve blogged about here. And I would guess the same general situation applies to your industry, too.)
Second, you probably noticed that amateur triangle graphic at the start of the post? Let me say that I’m not sure what the right proportions or percentages are for the various grades. I only know that “great” businesses are unusual and that “terrible” and “bad” businesses way too common.
Third, just a general comment about that “fair” grade. That’s actually a pretty good place to either be or to aspire to if you’re a small business owner. If you can run your operation in a manner that means stakeholders get fairly paid, well, that’s a fair deal for everybody involved… which is actually saying something pretty important.