The Train, the Tracks, and the Trett

“Trett (or tret) was an allowance made up until the early 19th century, for waste, dust, and other impurity in items in commerce, generally amounting to 4 pounds in each 104 pounds (3.85%).” — Wikipedia

In the second half of 2015, the scare word in the venture market was Unit Economics. Just over a month into 2016, that term has been replaced with another mot du jour that similarly strikes fear into people on both sides of the table: Margin Compression.

Like any occurrence that causes a major psychological or behavioral shakeup, the response by public investors to margin compression among many publicly traded tech companies strikes at core, strongly held beliefs. In this case, as Emergence Capital’s Joseph Floyd noted, that belief was that predictable SaaS business models lead to predictable growth and predictable valuations.

As earnings started coming out in early February, public market investors resoundingly voted that top line growth matters very little if it is not efficiently moved to the bottom line.

via Joseph Floyd

This concept holds true for any activity where you need to balance speed with moving something from one place to another. An example that mirrors the “transportation of revenue” from top line to bottom is train transport.

In this analogy, the train — locomotive and freight cars — is your business, responsible for shepherding the goods (revenue) from the point of origin (top line) to the destination (bottom line) along the tracks (your P&L) without burning up too much fuel (invested capital).

This brings us back to the trett, which was last widely used in the 19th century — coincidentally, this also happens to be the last time profitability was so highly regarded for startup businesses. The trett was an allowance made for any waste that made its way into the goods on the journey.

In our business case, the trett is comprised of different characteristics you build into your business — higher price point, lower cost of servicing customers, a better way of identifying and leveraging profitable distribution channels — to ensure that you end up with the right amount of goods (again, revenue) left over at the end of the trip relative to other companies you are being compared with.

Of course, building a trett into your business is easier said than done. Each of your competitors is trying to raise prices, leverage new distribution channels, and eliminate unnecessary costs. Still, there is major precedent for successfully pulling this off.

What are we already doing?

If your margins — this assumes you have margins…negative gross profit is so 2015 — are coming under pressure, the best reaction may be reinvention. It seems strange to talk about early stage companies disrupting themselves but the shift in what the market values necessitates a new approach.

A great example of this type of reinvention, albeit a much later stage one, is Amazon’s success with AWS.

via Deutsche Bank, who if facing some margin compression or their own…to put it kindly.

By looking at where they could capture value from efforts they were already making, the company has built a multi-billion dollar business that makes an outsize profitability contribution and gives the company leeway continue heavy spending (read: losses) in other business lines as they grab market share.

You, however, are not Amazon. If you were, you wouldn’t be reading this. But that doesn’t mean trett-like expansion options don’t exist in your business. If you have focused on owning a specific customer niche, there is likely an adjacent market you can apply some of your processes or learnings to. If you’ve built technology to scratch your own itch or have a product that can be inexpensively retargeted to different markets or solution, reinvention becomes even easier.

Easier, but certainly not easy. In a market like the one companies are tasked with competing in today, nothing is.

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