Business owners dream of growing their business and making it the best it can be, but oftentimes they struggle to follow a unified strategy to get there. They’re unsure which areas to focus on to have the biggest impact and are left confused and frustrated.
Profitability, not profit, is a key ingredient to a successful business. The main difference between the two is that profit is an absolute number where as profitability is a measure of profit relative to revenue. It measures the efficiency of the business.
Fundamentally, there are four ways to increase profitability (without merging with another company). There are no quick fixes. Gradual progress will get you there, but you, as the business owner, must focus your strategy and execution on at least one or two of these to be successful.
1) Raise prices.
When’s the last time you had a price increase? Most of us are afraid to raises prices because our client may go to the competition. However, clients that come to you on price will also leave on price. More often than not, your clients do business with you because you have differentiated yourself from your competitors for reasons other than price. A 1% price increase can mean a significant change in your bottom line.
2) Increase volume.
Increased volume can either mean more clients or more revenue per client. However, I would discourage discounting prices to get more volume. I had a client that was recently approached by a client asking for volume discounts. He discovered that a 1% decrease in pricing meant an 8% decrease in his bottom line. If your clients are asking for a volume discount, don’t be deluded that you can make it up on volume. Often, you can’t.
3) Reduce COGS (cost of goods sold).
If you’ve been doing business with the same material supplier for years, their pencil may not be as sharp now as when they first got your business. I’m not suggesting you shop based on price only, but if you’re not current on competitor’s pricing, you may find you can get as good or better materials or labor for the same or even lower prices.
4) Reduce overhead.
When times are good and the money is flowing, we don’t pay as much attention to overhead as we did when we first started our business or during recessions. It’s very easy for overhead to become a larger percentage of revenue than necessary. You and your financial manager should be diligent in looking for ways to cut costs to be more efficient. Trimming the “fat”, every once in a while, is healthy for all businesses.
As mentioned above, it’s a good idea to look for 1% improvements. Here’s why:
If revenue is $5 million, a 1% increase in prices or volume is $50,000 each.
If COGS is $3 million, a 1% decrease in material cost is $30,000.
If overhead is $1.5 million, a 1% decrease is $15,000.
The total opportunity in this example is $145,000 in profit improvement. The reason for 1% is it’s incremental and certainly attainable. Over time, this can have a huge impact on your business and help you reach the profitability you’ve always dreamed of.