High revenue, low margin business or vice versa
Which would you prefer? What other considerations should you think about?
Got the above in a PE interview
Suggestions on how to answer this?
Trending Content - Private Equity Forum
| +99 | Mid Level Career Freeze | 31 | 18h |
| +49 | Working on Juneteenth | 22 | 7h |
| +28 | Left PE for an operating role and starting to regret it | 6 | 2d |
| +24 | From Public Equities to Private Equities | 4 | 2d |
| +21 | PE Portfolio Management/Ops - pros and cons | 1 | 6d |
| +20 | Stealth-Listening Devices | 1 | 10h |
| +19 | Best Path to PE from BB Coverage w/ Outsourced Modeling | 7 | 5d |
| +18 | Weighing exit from LMM PC/PE | 1 | 1d |
| +17 | Becoming a great VC/PE investor - advice | 4 | 4d |
| Search Fund Internship Vs. Internship at my family's Family Office | 8 | 17h |
Career Resources
Simple answer is that a high margin is a trailing indicator that a company is differentiated in the market and is able to charge a premium.
In a perfectly efficient market every company would be operating at margins that return 0 economic profit (cost of capital), so a higher margin implies that there is a reason someone can’t throw money at a sector and build a competitor. Sometimes there are just inefficiencies, but in general it’s due to barriers to entry that are insurmountable (e.g. IP, density).
This is great for PE as it implies a lack of competition, which means pricing power and stable revenue.
Correct but sometimes its easier to cut costs than it is to grow revenue
I would tailor my answer to the strategy of the fund
It depends on how you go about growing revenue, pricing increase or unit growth; because most of the time, pricing growth can increase profits (as long as you're not losing customers, which shouldn't be the case as long as the product was selling at lower prices compared to competitors) more or by the same amount as cost-cutting eg. 10% price increase vs 10% reduction in cost vs 10% increase in units sold, the price increase would be the way to go.
In my humble opinion it all depends. The key is preservation of capital, not losing money first and foremost. 2nd is meeting the return hurdle and making sure that your investors will get the returns they are seeking. The nuts and bolts of high growth vs high margin or whatever are more of a means to an end. There are PE firms who have expertise operating in more of a high growth / high margin business and others who have more expertise operating in more of a low growth / low margin business. Either can be good. More about knowing your strengths and you can best serve your investors, clients, portcos, employees, stakeholders, community, etc. good luck :)
You can't just look at margins in a vacuum - need to look at returns on capital. For example, there are some low margin companies that are great businesses with attractive returns on capital (e.g., healthcare distributors). On the contrary, high margin businesses can be capital intensive (e.g., equipment rental) where the accounting does not accurately reflect the cash flow profile of the business.
All about ROIC imo. If you’re a grocery store (low margin) but can turn inventory very quickly, there won’t be much need for capital reinvestment and it can be potentially a good business
Enim quis nisi fugiat maxime qui. Voluptatem dicta quibusdam quod possimus eum omnis a. Enim debitis mollitia ducimus quia fuga qui est. Sit sunt esse voluptatem sed dicta sapiente.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...