In our last posts we defined profit and the factors which affect it, and discussed ways to increase profit. Now let’s talk about how to develop a profit improvement strategy for your small business.
To improve your profitability, you must either make a larger gross margin on each dollar of sales or sell more without increasing your fixed costs. It goes without saying that you’ll have the biggest improvement if you can achieve both simultaneously.
Improving your gross margin
Remember that your gross margin is the difference between the price of your product and what it costs you to buy or make it. Therefore, the only way to increase your gross margin is to sell at a higher price or buy/make at a lower price.
In most instances (but not all!), you have limited scope to buy at a lower price. For this reason, your selling price is the critical variable.
Without doubt, the biggest single barrier preventing small business managers from making an acceptable profit is their refusal to charge a price that enables them to achieve it. You are not in business to match the price your competitors set; you are there to serviceyour customers.
In fact, studies of the factors that influence people to deal with a particular business indicate that product and price are relevant only in 15% of cases—we’ll say more about that in the discussion on sales productivity.
Trying to hold or win market share on the basis of price discounting is the lazy manager’s competitive strategy. It is applicable in only one situation—where you have a definite cost advantage (either variable or fixed) over your competitors, and your product or service is one where customers are very price-sensitive.
The following table indicates the increased sales required to compensate for a price discounting policy. If your gross margin is 30% and you reduce price by 10%, you need sales volume to increase by 50% to maintain your initial profit. Rarely has such a strategy worked in the past, and it’s unlikely that it will work in the future.
If your present margin is
| 20% | 25% | 30% | 35% | 40% | 45% | 50% | 55% | 60% | |
| And you reduce price by |
To produce the same exact profit, your sales volume must increase by |
||||||||
|
2% |
11% | 9% | 7% | 6% | 5% | 5% | 4% | 4% | 3% |
|
4% |
25% | 19% | 15% | 13% | 11% | 10% | 9% | 8% | 7% |
|
6% |
43% | 32% | 25% | 21% | 18% | 15% | 14% | 12% | 11% |
|
8% |
67% | 47% | 36% | 30% | 25% | 22% | 19% | 17% | 15% |
|
10% |
100% | 67% | 50% | 40% | 33% | 29% | 25% | 22% | 20% |
|
12% |
150% | 92% | 67% | 52% | 43% | 36% | 32% | 28% | 25% |
|
14% |
233% | 127% | 88% | 67% | 54% | 45% | 39% | 34% | 30% |
|
16% |
400% | 178% | 114% | 84% | 67% | 55% | 47% | 41% | 36% |
|
18% |
900% | 257% | 150% | 106% | 82% | 67% | 56% | 49% | 43% |
|
20% |
– | 400% | 200% | 133% | 100% | 80% | 67% | 57% | 50% |
|
25% |
– | – | 500% | 250% | 167% | 125% | 100% | 83% | 71% |
|
30% |
– | – | – | 600% | 300% | 200% | 150% | 120% | 100% |
On the other hand, the next table shows the amount by which your sales would have to decline following a price increase before your gross profit is reduced below its previous level. At a 30% margin and a 10% increase in price, you could sustain a 25% reduction in sales volume before your profit is reduced to the previous level…you would have to lose 1 out of every 4 customers!
If your present margin is
| 20% | 25% | 30% | 35% | 40% | 45% | 50% | 55% | 60% | |
| And you increase price by |
To produce the same profit, your sales volume must be reduced by |
||||||||
| 2% | 9% | 7% | 6% | 5% | 5% | 4% | 4% | 4% | 3% |
| 4% | 17% | 14% | 12% | 10% | 9% | 8% | 7% | 7% | 6% |
| 6% | 23% | 19% | 17% | 15% | 13% | 12% | 11% | 10% | 9% |
| 8% | 29% | 24% | 21% | 19% | 17% | 15% | 14% | 13% | 12% |
| 10% | 33% | 29% | 25% | 22% | 20% | 18% | 17% | 15% | 14% |
| 12% | 38% | 32% | 29% | 26% | 23% | 21% | 19% | 18% | 17% |
| 14% | 41% | 36% | 32% | 29% | 26% | 24% | 22% | 20% | 19% |
| 16% | 44% | 39% | 35% | 31% | 29% | 26% | 24% | 23% | 21% |
| 18% | 47% | 42% | 38% | 34% | 31% | 29% | 26% | 25% | 23% |
| 20% | 50% | 44% | 40% | 36% | 33% | 31% | 29% | 27% | 25% |
| 25% | 56% | 50% | 45% | 42% | 38% | 36% | 33% | 31% | 29% |
| 30% | 60% | 55% | 50% | 46% | 43% | 40% | 38% | 35% | 33% |
If you’re like many small businesspeople who regard price as the only factor influencing the buying decision of their customers, you will undoubtedly reject the proposition that a high price strategy (and by implication, high value) will work.
You may accept that it’s right for some businesses, but it sure doesn’t apply to your business.
There’s no business that doesn’t have the potential to command a premium price for its products or services if—and this is the crunch—it is able to market those products or services in such a way that the customer perceives added value.
If all of your marketing effort, all of your advertising, and all of your sales dialogues focus on price, then you will be beaten on price every time a competitor comes along with a lower one. In other words, if you focus your customers on price as a critical factor, it will be one.
The only way to get out of the price trap is to promote other features and benefits that you can offer your customers (for example, better quality, longer warranty, satisfaction guarantees, 24-hour accessibility, more convenient location, greater resale value).
It may be that your competitors already offer all of these things…but unless they also emphasize this in their marketing, how will the customer ever know?
Think about it for a moment.
Your job as a marketer is to create the perception of value and then to back up what you sell with superb service. Remember, price is only important when all other things are equal.
Some customers think only in terms of price. They are better left to your competitors. What you should be doing is working with those people who are happy to pay for value.
This means 2 things. First, you have to deliver value (embody service). And second, you have to educate your customers to be aware that they’re receiving value. One without the other leaves you exposed.
A man named John Buskin once said,
“It’s unwise to pay too much, but it’s worse to pay too little. When you pay too much, you lose a little money, that’s all. When you pay too little, you sometimes lose everything because the thing you bought was incapable of doing the thing it was bought to do.
The common law of business balance prohibits paying a little and getting a lot—it can’t be done. If you deal with the lowest bidder, it is well to add something for the risk you run. And if you do that, you will have enough to pay for something better.”
This was part three in a series:
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