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.
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.
Posted originally on MOIC Partners Blog: https://moicpartners.com/ahead-of-the-curve by Partner Dave Levitt
