There is currently plenty of good C-19 advice aimed to help business owners; get through tight cash flow periods, find the subsidies they deserve and manage their remote workforce from afar. All good stuff but it can take your eye off the ball. No wonder we currently see so many business owners distracted from the basic levers they already have to drive business performance.
There is no doubt that the relationship between the cost, the volume and the price of the goods and services that you sell is the single most important thing you need to understand in your business. That relationship determines your Gross Profit. And Gross Profit underpins everything.
Gross Profit represents the contribution that your business activity makes towards your overhead (rent, administration, owner’s salary, depreciation), finance costs and hopefully, the owners return (profit). The bigger the Gross Profit, the more money you take home.
Okay then, what drives a healthy Gross Profit? There are three basic levers.
Seems obvious enough. Price is certainly something that your customers consider from time to time. But do you?
Here is a simple test. How much more volume would you sell if you dropped your price by 10%? Have a guess. You may (like most owners) answer “probably nothing”. Good, we won’t be dropping prices. You can see where this is heading.
So how much less volume would you sell if you increased your prices by 10%. Again, you may well say negligible. But wait, you say… we don’t want to put prices up because we only just put them up 2% just 10 years ago. Correct. Time we had that chat.
Let’s assume that a price increase does not impact sales volume (not completely true perhaps). Your turnover is currently $5 million, and you are making $250,000 bottom line. You were told that your business enjoyed a multiple of say, 3 times. Your business might therefore be worth $750,000.
Okay, you put the price up 10%. What happens?
Based on our assumptions, revenue goes up from $5 million to $5.5 Million. That’s good. Easy. What were the costs involved? Probably nothing. Therefore, how much did the bottom line go up by? Yep, that whole increase in price went to the bottom line.
Your profit has gone up to $750,000. A 10% increase in price resulted in a 300% impact on profit.
Now… how hard was that? Next year we might have another crack at it too. Frankly, unless you are getting a bit of pushback from clients and customers (and you need to test this), you are probably too cheap. Owners must drive pricing all the time.
And don’t just listen to your salespeople for feedback. Give them the chance and they would happily give your products away for free. Do your own research. This is very important.
Our clients know how we push them all the time about their pricing. You can see why.
Sure Chris, just sell more. Easy for you to say.
Obviously for every extra dollar of sales you make, multiply that dollar by your Gross Profit percentage and that amount goes straight to the bottom line. Grow sales by 10% from $5 million to $5.5 million and, if your Gross Profit margin is 30%, then the extra $500,000 of sales adds $150,000 to the bottom line.
Not quite as impactful as the price increase example above, but there is no reason you can’t do both. Do both and your net profit would now be $900,000. Now we are getting there.
What are the drivers of more sales? Certainly not dropping price. We rarely ever advocate that.
The clue to this is knowing your value proposition. What does your brand say about who you are?
What is it that your customers like about what you offer? How do you know? What is the essence that makes you special? How can you differentiate your business and product from your competitors? How can you identify and nurture Competitive Advantage? This is a good exercise that we regularly undertake with clients and is invariably part of our Strategic Business Planning methodology.
Next, build a Strategic Marketing Strategy around that proposition and you can grow your revenue without having to discount. (Check out how to build your strategy in our Downturn Survival Guide, page 9).
3. Costs of Sales
The last magic lever in our toolkit is the Cost of Sales.
Perhaps the obvious place to look to control the cost of what you produce is the price you have to pay for the inputs. If you buy better, buy in greater volumes, find a cheaper supplier and save some money, you will definitely improve your cost of producing your product.
The problem is that you may already be on a reasonably good price. A new cheaper supplier may have an unacceptable proposition for you. Their quality may impact your quality, their supply unreliable or they could be hard to deal with.
Similarly, as labour is a major component of most business’s Cost of Sales, dropping the price might be out of the question, especially in the face of awards and unions. In the end, your people are a key stakeholder in the business, and you probably want to share the love, not take it away.
This is where the owner has to do their “owner thing”. It all comes down to productivity, efficiency and waste… whether you have a factory making widgets or a service business selling time.
In every business, the owner’s key role is to look at how the business runs and continuously identify areas of improvement in the very basic things you do. From estimating a project, to monitoring the workflows, to recording and reviewing what gets done and taking decisive actions to drive outcomes.
This attention to detail (part of “Housekeeping”) is a key component to running any business. Introducing systems and procedures, good simple measures that your people understand and proper structures with transparency, responsibility and accountability can deliver the icing on the cake.
And imagine from the example above. In addition to the actions taken with the other two levers, our example owner (perhaps you) also takes a good look at how they produce what they do. And she finds efficiencies, reduced labour and materials waste, and production improvements that yield a 10% decrease in the overall costs of input.
Okay, 10% less cost would reduce the Cost of Sales from $3.5 million (being 70% of Sales) to $3.15 million, a saving of $350,000. All of that goes to the bottom line too.
Get all three levers right and the impact is huge. In our example, they would deliver an extra $500,000 from Price, $150,000 from Volume plus $350,000 from driving Costs of Sales. Net Profit is now $1.350 million rather than $350,000. Wow.
By the way, there is a very good chance your multiple might have gone up too, perhaps from 3 to 4, now that you are managing your business better. The business might now be worth $5.4 million, up considerably from $750,000. Indeed, a 720% change in value.
You can see why these three levers figure so highly in our Exit Strategy planning for clients!
Business Specialist Partner