Revenue vs. profit: What’s the difference and why does it matter?

It was our most successful year. The business grew 20 percent compared to the previous year and the CEO was about to share the results in detail.

“We delivered 280 million EUR this year. It’s our most successful year and there’s still plenty to grow. Alongside this, we had 3 million EUR of net profits.”

As I listened to the CEO, I was confused. How could we capture so much revenue and generate so little profit? I couldn’t connect the dots, so I asked the CEO and she replied:

“We’re in the growth phase, meaning we’re investing most of our profit to expand our reach and capture more revenue. Our investors support this strategy as we acquire more market share, which is better than having high profit and paying more taxes.”

Everyone laughed as I started understanding the game was about balancing present and future, not about playing it safe and collecting profits immediately.

In this post, you’ll learn about revenue and profit, as well as the difference between the two. Along this, we’ll cover the strategies for the two.

The difference between revenue and profit

Revenue relates to the overall income the company manages to create, while profit refers to what’s left over after covering all costs. More revenue doesn’t necessarily mean more profit and more profit isn’t always the best strategy.

However, without revenue, you cannot have profits. An unprofitable company won’t live long.

The critical question becomes how you balance revenue and profit.

The importance of revenue and profit for business strategy

It’s important that you first determine your business strategy before you try to understand how revenue and profit affects your product.

Here are five typical business models for digital products:

• Subscription — Here, the user pays a recurrent fee. It’s possible to have different tiers differentiating the service offering. Netflix and Amazon Prime use this model
• Freemium — In this model, users can benefit from the product’s value without paying anything, but they face a few limitations that only premium users can get. Dropbox uses this format by offering free storage up to a few gigabytes but requiring users to pay if they want more
• SaaS — Instead of hosting a product on-premise (local data center), companies can hire software as a service product. Personio reached an 8.5 billion USD valuation in 2022 with a full-service human resources solution in Europe
• On-Demand — Pay for what you use has become increasingly popular, as this reduces friction to hire a service. That’s the case for Amazon Web Services (AWS), Google Cloud Platform, and many others
• Marketplace — If someone wants to sell something and someone wants to buy, this model enables that to happen. Airbnb and Uber are marketplaces and the first charges the buyers (guests), and the second charges the sellers (drivers)

In early-stage start-ups, generating revenue justifies more investments because it proves market fit. In such cases, it’s fine to have negative profits as the business strives to find its place on the market. Meanwhile, the strategy will differ in scale-ups where growing sustainably is important.

How revenue and profit impact product strategy

Looking at revenue and profit alone won’t cut in most cases. It’s vital to understand how much it costs to create the revenue you have.

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We “bought” revenue to prove market fit in an early-stage start-up where I worked. To do this, we invested in high-quality service so customers would seek us out and then return back after. At first glance, you may think this is unsustainable, but once you look at the big picture, you can understand it better:

• Customer acquisition cost (CAC) — How much does it cost to acquire your customers? Track such costs as fast as possible because this will be fundamental to deciding on further investments
• Customer lifetime value (LTV) — How much revenue can each customer bring throughout the relationship you built with them?
• LTV: CAC ratio — The relationship between acquisition costs and lifetime value helps you understand how sustainable your business is. For example, a 1:1 ratio means your business won’t be profitable, while a 5:1 ratio shows that you’re highly profitable

Tips for maximizing revenue and profit

In any business, you’ll have opportunities to optimize how you create revenue and collect profits. Here are some aspects to explore:

• Double down on high runners — What are your most sold products or services? Once you identify them, you can reinvest the profit into making such offerings even more successful
• Cut the low runners — What’s in your product that your customers ignore or barely use? Remove such parts as fast as possible. Cluttered products distract customers, increase maintenance costs, and slow teams down
• Encourage higher commitment — This is common in subscription models. The advantage of such a model is that customers can quickly leave when they lose interest, but that’s painful for the business. You can increase revenue by offering considerable discounts (15 percent +) for yearly subscriptions
• Make or buy — Don’t build everything. Many businesses do everything on their own, which increases costs and reduces profitability. Focus on the core of your product while partnering with other companies to reduce your product complexity
• Cross sale — Building an ecosystem will create a highly profitable business. Once you get an iPhone, you may opt for an AirPod, Apple Watch, or Apple Music

Key takeaways

Revenue and profits are fundamental to any business. Once you understand their relationship and how you can create one while driving the other, you’ll be better equipped to manage your product moving forward.

However, make sure to avoid becoming tunnel visioned about them. Strive to understand the big picture by considering your customer acquisition cost, lifetime value, and ratio. Always look at the big picture before making any premature decisions.

Featured image source: IconScout

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