SCVBJ Contributing Writer
To improve business profitability, you must either make a larger gross profit on each dollar of sales or sell more without increasing fixed costs.
Whether you are a service firm, distribution company or a manufacturer, you must continually look at your direct (variable) costs to see if you can maintain or improve the quality of your product or service at a lower cost.
You also need to focus on maintaining or reducing fixed costs. Many of my clients set a goal to keep overhead as a set percentage of sales.
It goes without saying that the biggest improvement in profits will occur if you can achieve both simultaneously.
Start with direct costs
Remember your Gross Profit is the difference between the price of your product or service and what it costs you to purchase or create it. Therefore, the only way to increase your gross profit is to sell at a higher price or purchase/produce at a lower cost.
In most instances — but notably, not all — you will have limited scope to purchase or produce at a lower price.
However, it never hurts to ask for and to attempt to negotiate lower costs or more favorable terms and conditions from your suppliers. I have one client who negotiated with a key supplier not only a lower price for a direct cost, but also received a six-month hiatus on payments.
Second: Address pricing
Without a doubt, the biggest single barrier preventing CEOs from making an acceptable profit is their refusal to charge a price that will enable them to achieve this goal.
You are not in business to match the price your competitors set; you are in business to service your clients and to make a reasonable profit when doing so.
In fact, studies of the various factors that buyers regard as important influences on their decision to deal with any business indicates that product and price are relevant in only 15% of cases.
Not every buyer is a price only buyer and you need to ask yourself if that is the kind of client you want to have in your client portfolio.
Trying to hold or win market share using price discounting is the lazy CEOs competitive strategy.
It is relevant and applicable in only one situation and that is 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.
As an example: United Airlines has “owned” the Denver market for decades. Every time a competitor would enter the market, United would lower fares and simply wait until the competitor gave up the battle and left the market. United would then raise prices back to where they were once again making a profit.
I have done some number crunching on the subject. If your gross profit margin is 30% and you reduce prices by 10%, you need a huge sales volume increase — 50% — to maintain your gross profit dollars.
Rarely has such a strategy worked in the past and it’s unlikely that it will work in the future.
Once you start reducing prices it is very hard to increase them again. In most market segments, it soon becomes a race to the bottom, and no one wins.
Buyers understand justifiable price increases if they can be explained. My own advice to my clients is to raise prices on a regular basis, backed by data from the Consumer Price Index or the Gross Domestic Product Price Index, which measures changes in the prices of goods and services produced in the United States.
Ken Keller is an executive coach who works with small and midsize B2B company owners, CEOs and entrepreneurs. He facilitates formal top executive peer groups for business expansion, including revenue growth, improved internal efficiencies and greater profitability. Email:[email protected]. Keller’s column reflects his own views and not necessarily those of the SCVBJ.