What's Wrong With Sales or Revenue
Every company needs sales. Value creation is strongly associated with sales growth. In many sectors, sales has a higher correlation with shareholder value than any other measure, including profits. That is probably why sales or revenue growth is the second most tracked financial measure of performance.
Yet, while profit growth is strongly associated with sales growth, the opposite is not necessarily true; there are many ways of growing sales that do not accrue to the benefit of shareholders. That is because companies generally need to incur at least some expenses in order to achieve sales. In other words, companies generally "buy" their sales at some cost.
This leads to one of the more counterintuitive results in performance measurement: Mature companies that focus on profit growth generally grow their revenues along with their profits. That is what accounts for the high correlation between revenue and shareholder value. However, companies that focus their top executive attention on sales growth often achieve that growth--often more successfuly than their peers--but underperform them in shareholder value.
The lesson of this seeming paradox is that it is difficult to grow profit without growing revenue, but rather easier to grow revenue if you don't care about profits.
What Sales misses
Sales misses everything below its line item on the income statement. And everything else on the balance sheet, too. It misses the administrative costs of managing receivables, and the capital costs of the receivables themselves.
In a business where sales are generated by physical goods or services that incur costs in their generation, sales misses most of what business activities are geared toward.
When it works
Businesses in the early stages of growth may still have a lot of expenses to incur in order to establish their long-run business model. They may necessarily incur far more in cost than they should expect to recover in sales for the time being, and probably benefit from a focus on sales growth, even if expenses are growing faster.
Some businesses, such as Internet-based services, are built upon initial investments that enable significant sales or revenue growth at a negligible incremental cost. However, even these business have to incur some expenses to monetize their platform and, more importantly, must reinvest in their platform to maintain their competitiveness.
Facebook, which incurs relatively little marginal costs in acquiring new customers, still spends two billion dollars to support its $12 billion in revenue (2014). More importantly, it spends much more than that in R&D in order to sustain and improve its site. Therefore, while such companies can focus on revenue growth with decent confidence that it will show up in their value, even they must be careful not to overdo it.
