I met an entrepreneur who was having trouble growing her marketing agency.
She was buried in the day-to-day of running the business when she really needed to be out making sales. She wanted to hire a marketing assistant to help push the business to the next level but didn’t know if her business pipeline was sufficient enough to hire another employee.
Like many entrepreneurs, she felt stuck in a Catch-22: she couldn’t stop doing the day-to-day, but she also knew it wasn’t the path to growth for her company.
In spending time with her, it was clear that she just needed to pull together information to help with analysis and decision making.
The solution: We helped her calculate the breakeven point. Without the breakeven point, she was relying on some critical assumptions: How long would it take to train the new hire? How much work would the new hire have? How much would this person cost on a monthly basis? Once she knew her breakeven point, she quickly discovered that hiring a new marketing assistant represented a very low-risk “bet” to her company.
We used data from her business operations to create a clear set of decision-making assumptions that would determine the exact hire she needed to make, which she did. As a result, she was able to focus significantly more of her effort on selling, and in doing so, added more profit to her company. In fact, she went on to double the revenue of her marketing company.
The Case for Calculating Your Breakeven Point
As businesses grow and become more complex, the breakeven point is an effective tool to help evaluate competing projects, investments or ideas to one another.
Should we hire a sales rep to grow revenues or invest in a tool in our manufacturing process to reduce production costs? Multiply that times the dozen or so other “opportunities” in the business and it becomes a significant challenge to consistently and effectively make good decisions on how to utilize the precious resources of people, cash, and time. The breakeven point can pull these elements together into a common way to view these opportunities.
The simplicity of breakeven point is that it says “let’s do the quick, easy, low hanging fruit projects” first. It’s about getting profitability into your business, fast.
More time introduces more risk. Thoughtful breakeven analysis helps reduce decision paralysis and gets change happening!
How To Calculate A Breakeven Point
First: The 3 Types of Breakeven Points
- Projects & Capital Expenditures (I call these investments)
Business: This looks at the company as a whole. Based on your operating costs, how many units per month do you need to sell, or how many customers per month do you need to have, in order to reach breakeven? This is a good analysis for business planning and understanding the impact of increased expenses.
Customers: This analysis looks at the investment made into acquiring a new customer, the profit (gross margin) earned from that customer, and the time to get to breakeven. The quicker the better! What levers does the business have to improve this breakeven point?
Projects & Capital Expenditures: A project could be the cost of bringing on a new marketing associate, developing a new product feature, or improving automation. It’s often driven by the number of hours or the number of people. If you’re a factory this might be a new piece of equipment or appliance. It’s anything you put in hard dollars to acquire, grow, improve scalability, or reduce long-term costs in your business.
Second: The Inputs and Outputs
As you set up, there can be numerous inputs. This is where strong, consistent accounting and other operational data elements of the company help smart companies make better decisions. Document assumptions where little historical data is available, but remember to use these assumptions and measure them in the future. That way you know whether or not your assumptions are on track!
Ultimately, there are 3 inputs to determine your breakeven point.
- Time: How long does it take?
- Return: What are the benefits?
- Investment: How much does it cost?
Strong Data Is Important
The better your historical information, the better decisions you’re able to make in terms of your breakeven point. We saw this in play in the lead-up to Blue Apron’s IPO. There was a lot of interesting data published on Blue Apron, including customer acquisition costs and churn rate.
Using this public data, one blogger illustrated that the cost to Blue Apron of acquiring 1 customer was $150, and their breakeven point was 6 months on a gross margin basis. The blogger’s calculation showed that the incremental new customer is not as profitable as prospective IPO investors may have thought, which severely dampened the excitement of the IPO. Today Blue Apron represents one of the biggest IPO failures of the past year, perhaps even the decade.
What Is a Good Breakeven Point?
Without context it’s hard to say what makes a breakeven point good and what makes a breakeven point bad, but I have 2 rules of thumb.
- The “Less than 18 months” Rule
One CFO, in an interview with a prominent magazine, said not to look at anything with a breakeven point of over 18 months. If it takes more than 18 months for an input to break even, forget about it. It’s typically too complex or too risky. If this is your case, does your business have lower-hanging fruit to go after? Perhaps an investment that will break even in 6 or 9 months instead?
- Project Returns that exceed the expected company target returns
What does an investor want out of your business? Do they want a 2X return on their money? Do they want a 15% return on their money? You want to select only projects that can clearly exceed your investors’ expectations. Otherwise it’s probably not a project that needs to be executed.
Next time you’re considering making an investment in your business — whether that’s a new hire or new piece of equipment — calculate the breakeven point first. Your profit margins will thank you.