What is the Value of Being 1% Point Better?
Have you ever missed a putt by an inch that cost you a match? Have you ever hit a tennis ball (or pickleball) out of bounds by an inch on a critical point? Of course, if the answer is yes, then you recognize the importance of precision and the penalty for even the slightest error. Life, like sports, is often a "game of inches" and the penalty for missing by inches can be significant.
WHAT INCHES ARE WE TALKING ABOUT?
I have seen software companies that could consistently hit 90% of bookings plan and I have seen software companies that would consistently hit 80% of bookings plan. When hitting 80% of plan, most think they are doing well. I've often wondered, though, what was the relative meaning of doing better than 80%. Feels like just inches. What is an incremental inch worth? The graphic below reveals what we are really talking about.
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THE MIRACLE OF COMPOUNDING
With two companies starting with the same annual revenue, after a five year period the one reflecting 90% of bookings plan is showing compound growth in revenues of about 32%. The one reflecting 80% of bookings plan is showing compound growth in revenue of about 30%. This is a difference of 2% points. Again . . . feels like maybe an inch . . . but the reality is miles. If we use normal DCF valuation techniques, a buyer is going to value the 90% company substantially higher than the 80% company given the fact that it has more revenue at time of purchase and it is likely to have more revenue over time. In fact, after an assumed 10-year hold period, the 90% company is going to produce enough additional cash flow that today it would be valued about 40% higher than the 80% company. So as a rule of thumb, we can consider (all other things considered equally) that a 1% point improvement in bookings realization results in an improvement in value of 4% points. This is a profound result.
It is very much worth solving this problem of incrementalism. If you are below the 90%, how can you get back up to where you want to be and get the exit multiple you believe you deserve? This is more than solvable. Email us at Maximize@MOICPartners.com to set up an initial call.
