Building long-term profitability allows you to grow your business and the personal rewards you get from it. Creating and increasing profitability depends on doing many little things better than the competition.
Many businesses manage to increase their profits by focusing on cutting costs, growing turnover, or both. For others, the key to success is an emphasis on building the right team of employees and striving to make gradual but continuous improvements.
1. The main chance
The best opportunities for increasing profitability vary from business to business.
For most businesses, the easiest way to increase profitability is to reduce costs
- If you have a low gross profit margin, reducing direct costs dramatically increases the profit on each sale.
- Eliminating unnecessary overheads has an immediate impact on the bottom line.
- See Reducing costs.
For others, the best way to improve profitability is to increase turnover
- If you have a high gross profit margin, every sale is highly profitable. Once your turnover reaches breakeven, profits will increase rapidly.
- Reaching critical mass creates a virtuous circle. Acquiring new customers is made easier by your market presence and reputation, and unit costs are reduced through economies of scale.
- If your customers tend to be loyal, the value of each new customer lies not just in the immediate sale, but in future sales as well. The cost of selling to existing customers is almost always lower than the cost of acquiring new ones.
- Defending a high market share against competitors is easier than defending high profit margins. Focusing exclusively on margins is a common mistake. But so too is an over-emphasis on turnover. Keep a sensible balance.
- See Increasing turnover.
Every business can increase profitability by reducing hidden costs
- Small, young businesses and mature, stagnant businesses are particularly susceptible to hidden costs.
Every business can increase profitability by creating an appropriate framework
This helps you to:
- focus on profitability;
- make the most of your personnel;
- manage for continuous improvement;
- increase or optimise prices.
2. Increasing turnover
Aim for sustainable growth.
Focus on a niche market
- Understand this market.
- Segment your target customers, so you can fine-tune what you offer.
Invest resources in increasing sales volume
- Use advertising and other promotional techniques, such as seminars, online marketing and exhibitions.
- Actively sell. Do not just take orders.
- Retain existing customers.
- If appropriate, extend your product range (but without distracting yourself from your main offering).
- Be careful if sales to a particular customer go up significantly. Consider a credit check: you could be left in the lurch if the customer goes bust while owing you money.
Maximise the value of your sales
- Consider moving upmarket and providing a premium product and service. Add features to products if the perceived value to the user is greater than the cost to you.
- Charge a sensible price and get value from the extras you provide.
- Keep your product or service up to date. If possible, make sure it stays ahead of the competition.
- Compare price and quality with competing products.
Focus your efforts on your most profitable customers
Target customers who:
- place large or frequent orders;
- pay full price;
- reliably pay on time;
- are low maintenance.
Adjust your sales mix to favour your most profitable products
- See The sales menu.
The sales menu
Businesses which offer a menu of products can use a simple technique to improve overall profitability. Sales and profit margins are reviewed periodically, and products (menu items) are divided into four categories.
High percentage of sales and high profit margins
- Nurture these stars.
High percentage of sales but low profit margins
- Consider a price increase.
- Examine how you can cut costs to increase your profit margins.
Low percentage of sales but high profit margins
- Consider a sales push.
Low percentage of sales and low profit margins
- Eliminate these where possible so that you can focus resources elsewhere.
Take into account any knock-on effects before making decisions
- For example, a low-profit product might be the one most valued by a major, highly profitable customer.
3. Reducing costs
Minimise direct costs, such as the purchase of raw materials
- Specify supplies of the right quality and minimise wastage. Periodically compare suppliers.
- Negotiate good prices.
- Involve the person responsible for purchasing in product development to help reduce costs.
Eliminate unnecessary costs to cut overheads
- Keep all costs under constant review. They tend to escalate if left alone.
- Check that you are on the best tariff for all utilities.
- Negotiate lower bank charges.
- Ask a different broker to conduct a review of your insurance.
- Improve systems to reduce hidden costs.
Maximise the cost-effectiveness of assets
- Base purchase decisions on lifetime costs.
- The hidden costs of inappropriate equipment can be substantial.
- Your human assets are crucial. Make sure you are using your employees effectively.
- Identify surplus space in your premises and consider sub-letting it.
4. Hidden costs
Few people would dream of running a production line where every item was made differently, and without the right tools. The effect on efficiency and quality would be disastrous. But in far too many cases, that is exactly how other parts of the business are managed.
Create systems (eg procedures and methods) where possible
- They will help you minimise errors and reduce time and money wasted fire-fighting.
- Time invested in creating systems is usually minimal compared to that spent solving a problem from scratch every time, and has a lasting positive effect.
- Systems are a vital part of quality control.
- Put checks in place to ensure that employees continue to follow systems. Never assume they are doing so.
Systems can improve every area of your business
The costs of not having effective systems and policies go on and on. For example, if you recruit on an ad hoc basis:
- the manager wastes time working out how to recruit;
- the process of recruitment is less effective, so you end up with a less than ideal recruit;
- because of the employee’s poor quality, you have to spend more on training;
- the employee still makes mistakes, with a knock-on effect on your business;
- eventually, the employee leaves or is dismissed, so you have to start again.
Turn decisions into policies to avoid having to make the same decision again
- Communicate your policies in writing to make them more effective.
Keep systems and policies simple
- Build systems from common components and apply them across the company. They will be easier to use and improve.
- Avoid overloading employees by creating too many systems or policies, or by making them too complex. They will waste time or be ignored.
Learn from mistakes and problem areas
- If systems go wrong, fix them. In any case, review systems periodically to see where improvements can be made.
- If regular tasks are time-consuming, investigate how you can improve matters. Finding information is a common time waster.
- Prioritise systems in areas where costs are high, or where mistakes have a major impact.
Use the right equipment
- Labour-saving equipment can reduce costs and errors substantially.
- Information technology is a powerful way to improve efficiency and control processes.
- Replacing outdated equipment may more than pay for itself by improving productivity and reducing waste and energy use.
Be decisive, but think first
- Putting off decisions, once you have the information you need, wastes time and delays progress.
- Indecisive leadership demoralises employees.
Simply focusing management awareness on profitability can have a dramatic impact
- Even if cash flow is your top priority, this need not be at the expense of profitability.
- Make sure all your employees are aware of the importance of profitability.
Understand the key drivers of profitability
- Set and monitor performance indicators. The most commonly used key performance indicators are sales against forecasts, costs against budgets, gross margin and staff costs.
- Make sure they are the right indicators. Staff tend to work towards them whether they are good for the business or not.
Minimise the effect of distractions
- Avoid unprofitable distractions - for example, one-off projects that do not play to the company’s strengths.
- When managers need to temporarily shift their focus (for example, if you plan to float your company), act to control the impact. You might nominate one key individual to take charge, or pay an outside consultant to free up staff time.
Create an effective team
- Recruit talented people.
- Train them.
- Motivate them.
- Monitor and measure their performance and productivity.
- Think how you will allocate staff during peak sales periods.
Create a working environment that maximises profitability
- Reduce distractions (eg interruptions, unnecessary paperwork).
Give employees the support they need
- Provide effective equipment.
- Provide good support systems, especially for accessing information.
- Ask senior staff to delegate simple tasks that more junior staff could do just as well.
Reward your employees
- Give appropriate remuneration by linking pay to effectiveness.
- Provide career progression.
- Praise and thank staff when it is due.
7. Continuous improvement
A simple planning cycle vastly enhances your ability to make continuous improvements
- Base your plans on accurate information.
- Consult, to improve the quality of your information and to involve employees or other key people in your decisions.
- Set measurable, time-limited targets.
- Monitor the effectiveness with which your plans are implemented.
- Review what you have achieved.
Learn from experience and make continuous improvements
- Keep improving underlying systems and the planning process itself.
- Be ready to alter your strategy if necessary. Good planning helps you to anticipate problems and adapt as things change.
Apply lessons company-wide
- Set up systems that encourage communication.
- Benchmarking different parts of the business against each other can be a useful way of sharing best practice.
Improve communications with your customers and suppliers
- Your customers will be aware of any problems and can tell you what you need to improve. Avoiding confronting issues may simply make matters worse.
- Your expertise may help them solve a problem they did not even know existed.
"Lots of companies only invoice customers at the end of the month. But if you want to give your cash flow a boost, send out your invoices as soon as you can." - Brian Hayden, Hayden Associates