I have worked on business cases for many years, across deals ranging from in-licensing a new product to divesting a business or acquiring a whole company. One thing they all have in common is that you start by trying to make the deal work. You build the sales forecast, calculate the margins, model the investment and look for ways to improve the return. But at some point, an interesting question emerges: What if a deal is profitable and still isn’t worth doing?
Every deal is an exercise in trade-offs. A good business case doesn’t make the decision for you. It gives you a better way to think about the decision.
Comparing two projects
A company has to prioritize in much the same way you do. You cannot do everything you want to do over a weekend. There are only so many hours and choosing one activity usually means giving up another. Companies face the same problem, although the activities tend to be rather more expensive.
If a company is looking at two similar projects, it may not have the people, money or time to do both. A profitable project can therefore be rejected simply because another project offers a better use of the same resources.
Imagine two projects that would each cost the company €10 million. Project A is expected to make €2 million a year, while Project B is expected to make €1.5 million. At first glance, Project A looks like the obvious choice.
But what if Project A requires 20 additional people who are already in short supply, while Project B can be delivered with the existing team? Suddenly, the decision is no longer as obvious.
This is where a business case becomes more than a calculation of profitability. There are many resources that need to be considered in a company, not just money. Do we have the employees to make this deal happen? Or are people working on other things already? Does the new product fit into our product mix? Or will it have a negative impact on our customers?
A profitable deal is attractive. But if the company has a better use for the same resources, rejecting it may actually be the more profitable decision.
Value over time
The business is looking for a certain benefit. Usually, this is higher sales or lower costs or a combination of the two. One important question in any deal is when the benefits will materialize.
You do not get these benefits for free. To achieve them, you usually have to invest upfront. How much you have to invest and how much you get back over time determine how profitable your deal is.
It is better to get your money back sooner rather than later. Some projects have a very short payback period, sometimes as little as one year. This means that the benefits generated in the first year already outweigh the initial investment.
These projects are rare, though. Usually, it takes much longer. What is considered acceptable depends heavily on the industry. Many businesses want to see their investment paid back within three to five years, while in some industries, a payback period of more than ten years may still be acceptable.
Technically, a project can still be profitable even if it takes many years to pay back the initial investment. But a lot can happen over such a long period. The longer you have to wait for the benefits, the more uncertainty you are taking on.
Sometimes there are ways to improve the deal without becoming more optimistic about the future. For example, instead of making a large upfront payment, the buyer might negotiate smaller payments linked to milestones or actual sales. This can bring down the initial investment, improve the payback period and reduce the risk of the deal turning sour.
That is a much healthier way to improve a business case. You are not changing your assumptions about what will happen. You are changing the deal so that you have less to lose if things do not go according to plan.
When the risk is too high
But even if the alternatives look less attractive and the payback is acceptable, there is one more question: how confident are we that any of this will actually happen?
The spreadsheet may tell you with impressive precision that sales will be €127.4 million in year seven. This precision can create an illusion of certainty. You simply have to make assumptions when building a business case. But those assumptions determine how risky the project really is.
The difficult question is whether the assumptions are realistic. Especially if the team wants to make the deal happen, the assumptions are often very optimistic or even based on wishful thinking. If that means assuming faster sales growth or a quicker uptake simply to make the project look better on paper, we have to be very cautious.
Therefore, management has to ask how much could go wrong. How much of the expected benefit depends on things we cannot control? How much room is there if sales are lower than expected or costs are higher? And what happens if several assumptions turn out to be wrong at the same time?
This is usually much harder to capture in a spreadsheet. But it is an essential part of the decision.
A project can promise a profitable outcome and still be rejected because the path to getting there is simply too uncertain.
A profitable business case is not always a good decision
The goal is not to make the numbers look good enough to get a deal approved. The goal is to understand what needs to be true for the deal to work, what could go wrong, and what else you could do instead.
A good business case should make it easier to see the deal for what it is, rather than what we want it to be.
