I have decent understanding of every business topic except why business are running with cost of capital 10-12% but they make only 5-8%. If they keep losing at some point the debt becomes unsustainable. How come they keep getting funds?
What’s the point of such business? Is it only to create jobs?
In: Economics
>How come they keep getting funds?
Because investors believe that company will eventually make money. Many of these companies are offering their products/services below cost in order to grow market share and get users. Then once they become established they can raise prices to become profitable. Uber, Amazon, Netflix, pretty much every social media platform are examples of companies doing this exact playbook.
I always wondered this with the grocery business that I worked in making 3-5%. Why bother putting any money into it?
That company in particular has continued to shrink over the years.
Every business will have their own explanation but it always comes down to the investors being confident that the company will become profitable in the future.
The easiest to understand is Temu. They operate at a MASSIVE loss because they sell products at a price that often doesn’t even cover the shiping expenses, let alone the cost of manufacturing itself. But that’s ok, because while they do that, they build market share. One day they will eventually start raising the prices and begin turning a profit. Even if they lose some market share, whatever people remain customers will be enough for them to repay the investment… or so the investors believe.
You can also look at Netflix. They operated at a loss because the subscription was just too cheap but that allowed them to build a nice marketshare and now that prices tripled they are still enough to turn a profit even with the appearance of many competitors and the decrease in market share.
very broad question but the most important factor is economies of scale. let’s take amazon. building out warehouses and centers is extremely capital intensive. however, it enables faster deliveries and therefore more orders. for many years, amazon refused to be profitable, choosing to spend it money on more and more centers. this enables it to deliver the one day shipping we know and love. many companies can choose to either raise debt to fulfill this or sell shares to raise capital. typically, they choose the latter as it doesn’t put the business as risk and just uses shareholders as an atm.
last year, amazon decided enough is enough and we need to start showing profits for our shareholders. they pulled back on the buildout money and went from losing 30 billion dollars a year to making 40 billion dollars a year to show investors they can be a powerhouse if they want to (their stock price was crashing as investors were losing faith when the market was crashing)
this is not the case with all businesses. a bad example would be selling a dollar for 50 cents. yes, you’ll make tons of revenue. but you’ll never ever make a profit. examples would be wework, casper, blue apron. they were never able to truly achieve economies of scale where they could become profitable if they wanted to because their core business was just too expensive and couldn’t be dialed back.
You spend investor money to attract customers, then once you have enough customers relying on the business the investors can make a profit from them.
That’s one of the reasons for the current enshittification of everything – investors have decided they have paid you enough for good cheap services so it’s time to jack the price up and cut back service so you pay them back.
Their returns are 5-8% of SALES. That translates to 15% on invested capital. If they’re paying 10% for their debt, and they’re capital is 50% debt and 50% equity, that means they’re getting 20% ROE.
The only reason to care about profits as a percentage of sales is to compare efficiency of firms in the same industry.
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