3 Steps to Performing Your Breakeven Analysis
Finding out what sales volume you need to achieve to at least breakeven is critical to managing your business. Once you know what your variable costs and fixed costs are, finding your breakeven point is easy.
Variable costs are directly related to your sales levels in dollars or units sold. For example, materials and supplies, commissions on sales, sales incentives or bonuses for employees and shipping costs are all considered variable costs.
Fixed costs are those costs that remain the same no matter what volume of sales your business has. These include rent, insurance, licenses, wages for permanent employees, interest on loans and operational expenses.
How to determine your breakeven point:
1. Subtract your Variable Costs per Unit from your Sales Price per Unit. This equals your Contribution Margin per Unit.
2. Divide your Contribution Margin per Unit by Sales Price per Unit. This equals your Contribution Margin Ratio.
3. Now divide your Fixed Costs by your Contribution Margin Ratio. This equals your Breakeven Sales Volume.
If this seems confusing, consider this example when you receive your financial statements from your accountant you see that your:
Fixed costs = $25,000
Variable costs per unit of production = .50
Sales revenue unit of production = $1.25
From this you learn that 50 cents of every unit sold goes toward covering your variable cost per unit. Furthermore, you know that 75 cents from each unit sold can go toward covering your fixed costs.
Now if you divide your fixed costs ($25,000) by the contribution to those costs per unit (.75), you will know what level of sales you need to achieve in order to break even.
Fixed Costs/Contribution to Fixed Cost per Unit = Breakeven Point 25,000 / .75 = 33,333.33
Understanding your breakeven point is important. But if you take your analysis one step further you can better manage your business.
For example, you can see that a 10,000 increase in sales volume to 43,333 will yield a $7,500 profit. Likewise you can see that a 10,000 decrease in sales volume will produce a loss of $7,500.
Understanding your breakeven point is just the beginning to making the most of your financial statements.
If you would like to discuss your breakeven point or would like help with implementing any of the ideas in this article, the team at Whittaker would love to help. Contact us today to schedule a call or meeting.
3 Things to Consider When Creating Business Goals
Strategic planning is important for your business because it provides a sense of direction and outlines measurable goals to keep you and your business on track. In order to make the most of strategic planning, your business should give careful thought to the goals it outlines and then back up these goals with realistic measures for evaluating results.
Here are three tips on how to create business goals and things to consider:
1. Plan Strategically
The goals you set for your small business will be unique to your particular operation. Goals can include income or customer growth, market expansion, implementation of a new promotional strategy or development of a new product or service. All goals should be reasonable, achievable and measurable, as well as relevant to your business. Once you have goals established, assign them to an owner and prioritize them. The assigned priority could be driven by budget or business-building need.
2. Stick to Deadlines
Establish reasonable deadlines, and resist the urge to change them unless extreme circumstances warrant. Missing deadlines can result in additional project costs and slowed productivity. Encourage your team to meet their deadlines.
3. When to Deviate
Changes in your team, in your budget or in economic or market conditions may change the validity of your goals. While having specific goals and deadlines in place is representative of smart business operations don’t be so rigid in your planning that you lose the ability to be flexible when necessary. Periodically re-evaluate your operating strategy and goals to ensure they are still appropriate to your long-term business plans.
As a small business owner you can gain an advantage over your competitors by developing business goals. Developing a plan helps you assess your market, plan your course of action and devise specific ways to help you achieve desired outcomes. This approach can also keep your team members focused and on track, which can give you the added advantage of increased productivity.
As you would expect, several of our clients have been through the process of putting in place a strategic plan or need our help to organize their business. If this is something you feel you should be considering, the team at Whittaker would love to help. Contact us today to schedule a call or meeting.
Why Forming a Mission Statement is Critical to Your Marketing Strategy
If you don’t know the answer to this question, your customers surely won’t either.
More importantly, if you don’t know, you won’t be able to tell your customers why they should choose you over your competitors. Answering this simple question is critical to forming a mission statement and creating your marketing strategy.
Undoubtedly when you decided to start your business you had an inspiration. Was it to provide a service or product better, faster or cheaper than what was currently available? Was it to fill a gap in the marketplace? Perhaps you were inspired to run a business that people enjoyed working for or that maintained environmentally and socially responsible ethical standards or that surpassed existing companies in providing superior customer service. Whatever your mission, find it and then write it down.
Mission statements define, preserve & strengthen your company’s unique competitive advantage
Experience shows that companies with a clear and ever- present mission statement surpass their competition and last in the marketplace. Mission statements define and preserve and strengthen a company’s unique competitive advantages. Additionally, companies who are clear about who they are and what they do are less likely to make irrational decisions in response to competition and fluctuations in the marketplace.
However, that does not mean your mission statement should be inflexible. A good mission statement can lead a company for 10 to 20 years if time and effort were spent in creating it. However, re-evaluating your mission from time to time to see if it is still relevant, significant and appropriate is advised.
You want to create a statement that you and your team can look to every day and ask “Am I fulfilling the company’s mission?” For example, one mission statement could be “to be the leading game software developer for teens”. A more actionable mission statement would be “Surpass XYZ games developer in sales, customer experience and speed to market”. The second mission statement has clear goals and direction, while the more abstract version would be more appropriate for a vision statement than a mission statement. The second statement clearly supports the vision statement.
Think of Thomas Kincaid. He could have decided to paint bucolic scenes and sell them in a local gallery. Instead, he decided his business wasn’t just about making accessible art. Like Martha Stewart, Ralph Lauren and Eddie Bauer, he decided his business was about presenting a lifestyle. So he found a way to mass-produce what seem to be original acrylic paintings, opened franchises across the US and now sells everything from paintings to knick-knacks to homes in Thomas Kincaid developments. Now that is the sign of a clean and clear mission.
Include a call to action
You can distinguish your mission statement by including a call to action. This is missing in most company mission statements and has several defining and distinguishing characteristics:
- It motivates and generates an emotional reaction from your team
- It is easy to understand and translates into what your employees do every day
- It states a goal that can be measured and identified easily
- It reflects and is rooted in the competitive environment in which your company functions
Think back to this mission statement: “Surpass XYZ games developer in sales, customer experience and speed to market”, if you run this statement through the above four qualifications, you will get a yes every time.
Consider these when creating your mission statement
When creating your mission statement, consider these aspects of your business:
- What is your company’s history and tradition? How does it influence what you want to accomplish today and in the long term?
- How do you characterize the management philosophy of the company? What input does management have in the direction of the company?
- What distinguishes your company from all of the other companies that perform the same service or function? How do you already surpass the competition? What can you do to continue surpassing them?
- What goals are realistic when considering the available resources?
- Where do you need to improve in order to beat the competition? What are your competitors doing that you can imitate and improve upon?
Whittaker and Company can help you form your mission statement. Contact us today to schedule a phone call or meeting.
Designing Your Business to Meet Your Financial & Personal Goals
Very few businesses start ‘with the end in mind’ and design it from the ground up. Most businesses grow by default with people, systems, culture, clients, numbers, habits and attitudes.
If you take a good hard look at your business today, is it exactly what you want it to be? We would suggest that you focus on four key areas of business design.
1. Designing your business lifestyle
- How much cash do you want to take home each year?
- What are you going to spend it on?
- How much travel do you want to do?
- How many ‘free’ days do you want per month?
- What type of customers do you want to work with?
- How many real family vacations per year? 4, 6, 8, 10, 12 weeks?
- How many weeks of personal (no kids or partners) vacations per year?
- What role do you want to play in the business? Operational, non operational or other?
- How many promotional days per year?
- What are the three highest productive activities that you should spend your time on?
2. Designing the numbers
- What revenue do you want the business to be generating?
- What profit would you like?
- How many offices/locations?
- What does the headcount look like – the team? Less, same, how many?
- What is the ideal average revenue per customer?
- What is your personal wealth upon selling your share of the business?
3. Designing your culture
- What is your documented culture?
- What is the attitude of the team you desire? Positive, negative, neutral, miserable?
- What are the documented performance standards and values?
- What does the office layout and environment look like?
- What are the benefits and perks?
- Do you want a reactive or proactive culture?
- What are the rules of being a team member in your business?
- Who needs to stay and who needs to go?
4. Designing your customer base
- Which niche market(s) do you want to target? Or are you going to take on anyone as a customer?
- What denotes an A class customer? How many do you have?
- Do you have an ideal size of customer?
- What potential for additional products or services in your current customer base exists?
- How likeable are your current customers?
- Who needs to go?
- What is your marketing and sales plan to find the ones you want?
With these four areas you can have a business that works, is fun, is stimulating and makes money. It’s your choice what your business design looks like. Whittaker and Company can help you sort through these areas. Contact us today to schedule a phone call or meeting.
The Death Grip of Managing Your Business (and How to Release It)
Are you a business owner with no work life balance? Are you always at work? Thinking about work? Worrying about work?
The fact is, that’s no way to live your life. It’s not healthy, and what’s more, it can have a detrimental impact on your business. Sooner or later you’ll physically and mentally burn out, leading to poor performance, lack of direction, and – in some cases – the complete destruction of everything you’ve worked so hard to achieve.
As an entrepreneur, you need to be able to take a step back. Remove yourself both physically and mentally so that you can return with fresh eyes and a clear mind, ready to spot the opportunities and avoid the pitfalls.
Loosening Your Grip
When a business is small, you can do so much more. There’s more time, less pressure, fewer deadlines. But as it grows, there will come a point when you need to loosen your grip on certain tasks and responsibilities, instead employing people who are better suited to them.
And as you build your team and bring in more work, you must be careful that you don’t remain too involved with the day-to-day, to the detriment of the bigger picture.
By micromanaging your staff, you deny them the opportunity to buy into what your business is all about. Leave them to do what they do best, and they will more often than not form an emotional bond with the company, leading to a strong morale and a proactive workforce, actively seeking opportunities to help the business flourish.
Letting Go Completely
You then need to make time to work on your business, rather than in your business. And the only way to do this is to delegate more of your tasks to people you can trust within your organization.
Never be afraid to hire someone who is smarter or more talented than you in a particular area. They are not there to step on your toes; rather, they should unburden you, leaving you with a clear run at the things that you are good at and enjoy.
New faces also leads to new ways of doing things. By relinquishing your death grip on your business, you must also accept that changes will be made. As you give employees more autonomy, they will find better solutions, more cost-effective systems, and more agile workflows.
Don’t let the “well this is how we’ve always done it” attitude derail a positive change for your business.
Now Choose Your Role
With your business all but released from your death grip, you must now think about the kind of leader you wish to be.
Are you a dictator or a diplomat? Well, the trick is to land somewhere in the middle. Find a balance between the two and you will enjoy the respect of your employees without scaring them senseless or allowing them to walk all over you.
And in order to improve further, you must be confident enough in yourself as a business leader to ask for advice from professionals in their field. This could be a business coach or a CPA (like Whittaker) who will guide you and your business towards further growth and success.
With a wealth of experience often a phone call or email away, their advice can lead to invaluable action.
Strike the Right Balance
The day you get the balance right as a business owner is the day your business takes its first steps towards extraordinary success.
By taking the time to improve as a business leader, and understanding your own strengths and weaknesses, you can unlock potential that you perhaps didn’t know existed.
If you’d like to tap into our own business experience, and discuss the opportunities that come with better business planning and management, contact us today.
18 Value Drivers That Increase Your Business’ Value
According to the annual Business Reference Guide written by Tom West, 70-80 percent of businesses do not sell. One of the reasons this happens is because many business owners focus on current income generation as opposed to building the value of the enterprise. Profit or income does not automatically translate to enterprise value.
Enterprise value translates to the amount that business owners may realize when they sell or exit their business. There are 18 value drivers of a business, and each one of them can increase the enterprise value. They can be broadly grouped as Market Drivers or Operational Drivers.
The Market Drivers of a business are:
Growth – Your company has a history of consistent growth greater than its competitors, coupled with projected future revenue growth above the market’s rate.
Large Potential Market – The market supports significant growth of the business.
Dominant Market Share – Your company owns the highest percentage of the available market relative to its competitors.
Recurring Revenue – Your company can rely on a portion of future revenue from contractually committed customers.
Barriers to entry – There are significant obstacles facing a new entrant into your company’s market.
Product Differentiation – Your company has a product/service with unique characteristics that provide a competitive advantage.
Brand – Your company has a recognizable brand that reinforces the business presence in the marketplace and supports the company’s objectives.
Margin Advantage – Your company enjoys gross and net margins greater than the industry norm.
Customer Diversification – Your Company has a well-diversified customer base.
The Operational Drivers of a business are:
Company Overview – An outsider can easily obtain a holistic understanding of your company including your company’s performance, practices, culture, discipline, and mission.
Financial – All of your company’s financial matters are in order and you follow best practices.
Sales & Marketing – Your company can produce revenue in a proven and systematic way, ensuring the business is sustainable and not simply based on the efforts of individuals within the business today.
Operations – Your company has the ability to deliver on the sales promises made to the marketplace and to do it in a systematic and process-driven manner.
Customer Satisfaction – Your company tracks and uses key measures to meet customer expectations at all levels.
Senior Management – Your company has a leadership team/individual in place to realize the company’s vision and mission while helping the owner(s) achieve their objectives.
Human Resources – Your company has the ability to find, develop, and retain quality individuals that enables success in all aspects of the business.
Legal – You have all legal matters in order, documented, and your company follows best practices.
Innovation – Your company understands that innovation is invaluable to creating an ongoing competitive advantage; it has a proven and systematic way to drive and capture innovation at all levels and encourages innovation in every area of the business.
Do you know how your business is performing in each of the 18 value drivers? Spend some time with us and we can show you where your business is excelling and where there are gaps that you can close.
Which Key Performance Indicators Should Your Business Be Monitoring?
When you get behind the wheel of your car, you’ll see a row of gauges on the dashboard that give advance warnings of potential problems with oil pressure, engine temperature and other measurements. These gauges enable you to spot signs of potential danger at a glance and take corrective action.
Likewise, business owners should monitor gauges on their business dashboard that will give them a heads-up about financial problems down the road. These financial gauges usually consist of measurements that reflect the company’s key success factors, or key performance indicators (KPIs).
KPIs differ from one company to the next based on the industry, type of business — business to business or business to consumer, for example — and, most important, the company’s objectives. Your KPIs will come mainly from your mission statement and your short-, medium- and long-term goals.
Measuring the financial and the non-financial
There are two broad categories of KPIs: financial and non-financial. Financial KPIs often take the form of ratios, such as the current ratio, the debt-to-equity ratio and days sales outstanding. (See final section below “3 important parts of every dashboard.”)
Non-financial KPIs may include measurable business metrics in the areas of customer service, sales, marketing and manufacturing. Here are some examples:
- If a company’s goal is to improve its response time to customer complaints, its KPI might be to provide an initial response to complaints within 24 hours, and to eventually resolve at least 80% of complaints to the customer’s satisfaction.
- If a company wants to improve its closing rate on sales leads, its KPI could be to convert 50% of all qualified leads into customers over the next six months, and 60% over the following six months.
Notice that each of these KPIs is both specific and measurable. Just saying that your company wants to “provide better customer service,” “close more sales” or “reduce waste” doesn’t produce a sound KPI.
Benchmarking your data
Some basis of comparison for your KPIs is also important. A 50% close ratio or 1% unit reject rate might be good, but compared to what? Benchmarks will provide a standard against which you can compare your KPIs to see how they stack up against previous periods or the averages of other companies in your industry. Doing so will enable you to view your KPIs in the proper perspective.
Bear in mind that some formulas have slightly different versions. It’s important to know which formula is being used when comparing your results to those of other companies.
Start by benchmarking your KPIs from one period of time (for example, a quarter or year) to another. This will help you spot trends pointing to future problems so you can deal with them before they actually arise. If your accounts receivable days are lengthening, for instance, this might indicate that your collections are lagging and a cash flow crunch is looming.
For industry financial benchmarks, consult the Risk Management Association’s Annual Statement Studies®. This publication contains industry averages for financial ratios and metrics for hundreds of different industries. Click here to order the publication — or check with your industry trade association or area library for a copy.
Incenting your employees
Your KPIs should be shared with anyone in your company whose performance will impact them. You can even create performance incentive programs that are based on achieving KPI improvement goals. Again, it’s critical to make your KPIs both specific and measurable, and to provide your staff with regular updates about how well the company is doing.
3 important parts of every dashboard
In creating his or her dashboard, just about every business owner should concentrate on three important areas:
1. Growth. Hey, who doesn’t aspire to growth? But, if not planned for and controlled, companies can literally grow themselves right out of business. To manage your growth, monitor:
Debt to Equity: Total Debt / Shareholder’s Equity, and
Debt to Tangible Net Worth: Total Liabilities – Debt / Net Worth – Intangible Assets + Debt.
2. Cash flow. Poor cash flow, not slow sales or lagging profits, is one of the leading causes of business bankruptcy. To help circumvent future cash flow squeezes, keep a close eye on:
Current Ratio: Current Assets / Current Liabilities, and
Days Sales Outstanding (DSO): Number of Days × Accounts Receivable / Credit Sales.
3. Inventory. Many companies waste valuable cash by allowing slow-moving inventory to sit idle on their shelves for too long. To more carefully watch your inventory, track:
Inventory Turnover: Cost of Goods Sold / Average Inventory, and
Average Days to Sell: 365 / Inventory Turnover Ratio.
Whittaker & Company can help develop the right key performance indicators for your business. Contact us today to schedule a phone call or meeting.
Get Ahead of the Pack by Improving Your Business Systems
All businesses have systems – both formal and informal. They make the wheels of your business turn. However, informal systems can keep your business wheels from turning smoothly when it comes to day-to-day operations such as closing sales and ultimately from easily selling or passing down your business to the next generation (succession planning).
By creating and maintaining formal systems, you can avoid major issues and breakdowns within your business. These processes are comprised of one or more activities that will involve some or all of the following:
- Facility space
- Vendors etc.
Efficient Systems Create a Better Experience for Customers
Businesses that take the lead in the race for customers have all of their systems integrated and working efficiently. Ideally, your systems create an experience for the customer that makes them want to be a repeat customer. Every role in your company (and your customers) contributes to your customer experience. For example:
Owners: Set the company’s vision – an aspirational description of what your business would like to achieve or accomplish in the mid-term or long-term future.
Managers: Keep their eyes open, look for what will best serve customer needs and know how to achieve this outcome.
Team members: Energize the customer-facing systems that grease daily operations.
Customers: Drive demand for your products and services and therefore grow your business.
How to Improve Your Systems
Here are some tips to make sure your systems are up and running:
- Make sure you have a monthly or annual schedule for reviewing your systems and processes. Take note of any inefficiencies and identify ways to resolve and improve.
- Lead the pack. Do not follow. Just because a system worked for one company does not mean it will work for your company. Always consider your business and your customer needs first when looking at other business models.
- Make sure that your systems have a number of people able to pick up and complete the process. Do not rely on one person. People get sick, make mistakes and have emergencies. Whether it is accounts payable & receivables, ordering inventory or packaging your products, make sure that all systems have a back-up plan for day-to-day operations, technical failures and unexpected crises.
- Listen to your team. Your team members may have more insight into your customers than you think. They are the ones most likely to be working with customers on a daily basis. Their judgment, insight and input into system development can be an invaluable resource.
- It is imperative that all processes and systems are documented. Documenting how you do business safeguards your business in emergencies, alleviates confusion on the part of your team members and can ultimately protect you in potential legal matters.
Consider how more appealing your business would be to a potential investor, lender or buyer if you were able to present a ‘How We Do It Here’ guide.
Successful Businesses Virtually Operate on Their Own
Imagine if you were in the market to buy a business. Would you buy a business that can run on its own or would you buy one that could not run without the owner?
When a business has effective documented systems in place, it is more likely to:
- Be nimble and able to manage changes in its industry climate
- Be able to transition easily to new ownership
- Increase its value and potentially sell off at a much higher price
Whittaker & Company can help you improve and fine tune your systems. Contact us today to schedule a phone call or meeting.
Is Your Accounting System Giving You the Answers You Need?
In today’s Information Age, we expect granular numbers right away, However, often times many business’ accounting systems have limitations and can‘t deliver the kind of information that owners need, or the functionality has not been built in for the information to be tracked.
In this post, we’ll show you why you need to make the switch to the new way of tracking, accessing, and using information to give you the answers you need.
Choosing an Accounting System
This is the first place to start. If you can clean up your financial reporting system then your business will be in a much healthier place.
Rather than working with figures that are days or even weeks old, you can log into your cloud-based accounting system and examine up-to-the-minute data.
And once you have something in place, it’s important that you work with your CPA to make sure you’re looking at the whole picture. For instance, at Whittaker we take the information you want to look at in more detail and drill down even further, to the point where we can analyze by activity class or location, or regionalize sales activity.
You might think that only the very large companies can afford to access this kind of granular-level information, but we can assure you that smaller companies can too.
QuickBooks Online is an easy-to-use, web-based accounting software that allows you to see your financial data in real-time. It typically works well with other financial systems and reporting platforms.
Think of your accounting and reporting system as an ecosystem. While Quickbooks Online can be the ‘Central Hub’, you can have applications that feed the Central Hub, and other applications that the Central Hub can feed. For example, you can have bank feeds automatically populate QuickBooks Online to minimize data entry and you can link QuickBooks with electronic dashboard applications.
Using electronic dashboard and analysis platforms like Fathom with QuickBooks Online, you can gain deeper insights into the performance of your business. Fathom’s suite of analysis tools allows you to assess profitability, cash flow, growth, and many other key performance indicators (KPIs).
Just bear in mind the idea of “garbage in, garbage out”. If you’re not collecting the right data in the first place, then your analysis won’t be nearly as useful.
We’ll start by reviewing your numbers for accuracy and making the necessary changes so we can focus on the ones that really matter for your business.
Once we ensure your data is accurate and reliable, we then work with you to establish the information that you need to look at in more detail. In general, this is a six month process; three months to build out your data dashboard, and then three months to really drill down into that information in order to show you a clear picture of where your business has been, and where it can go in the next 12 months, and beyond.
Put a Dashboard Front and Center
The past is the past; it cannot be changed. However, by utilizing a dashboard view of your business, you can draw a line in the sand, put those previous years to one side, and store that information as a matter of historical record.
Your can now use the dashboard to track clean and clear data, allowing you to visualize the future direction of your business. Although there are undoubtedly some lessons to be learned from historical information, think of it as starting from scratch, recording and collating data that will provide you with a true picture of the health of your business.
Conversations Around Your Numbers
Once we have the necessary information to build out your dashboard, and six months of experience working with you under our belts, we can begin to identify trends and start asking the right questions, highlighting areas of opportunity for your business.
We can’t understate the importance of having this information at your fingertips. You have to start sometime, so why not today? Contact us to speak with one of our team members, and let’s get the ball rolling.
Small Improvements in Your Business Can Drive Big Results
What’s the difference between water and steam? At 99 degrees water is merely hot, at 100 degrees it turns to steam and can move locomotives. Just one degree—a one per cent change—makes the difference. This is a great metaphor for business.
In this short article we look at the impact that small improvements in the key drivers of profitability have on the bottom line.
The key drivers of profitability are price, variable costs (those costs that vary in direct proportion to sales revenue and which typically are represented by the cost of sales), the physical volume of sales (the number of transactions) and finally, fixed costs or enterprise overheads.
To illustrate this, consider a business that has the following financial performance characteristics:
A 1% improvement in each of the four profit drivers for this hypothetical business will yield a 40% improvement in net profit – an increase in profit of $294,000.
What’s really important to notice is the fact that for this business, the 1% improvement in price has more than 3 times the impact of a 1% increase in sales volume and nearly 4 times the impact of a 1% reduction in fixed costs.
While the relative impact of price compared to variable costs, volume and fixed costs will depend on the financial characteristics of the business, it will always have a greater impact than any of the other drivers and usually that impact will be in the order of more than two to three times the effect.
An increase in price for a given volume of transactions means that not only will total revenue increase but so too will the margin (price minus variable cost) on each transaction. A reduction in variable cost will change the margin but not the level of revenue. An increase in volume will increase revenue but will not change the gross profit margin and a reduction in fixed costs will have no impact on gross profit at all. Interestingly, reducing fixed costs will always have the smallest impact.
For example, in this hypothetical business, fixed costs would have to reduce to $625,000 to achieve the same result as a 1% increase in price.
If you look at a larger change such as a 10% improvement that will take your GP% to 38.18%, the differences are even more dramatic. With this scenario, a 10% price increase will increase net profit to $350,000 whereas a reduction in fixed costs of $350,000 (43% reduction) would be needed to yield the same profit.
If I raise my prices by 10%, how much business would I lose?
You might be thinking, “that’s all well and good in theory, but if I raise my prices by 10%, how much business would I lose?” That’s a good question but a better one is, “how many customers could I afford to lose without being any worse off?” For this business, the answer is 24%. This would result is a reduction in total revenue of about 16% given a current GP% of 32%.
You could lose 24 out of every 100 of your “average” customers and be no worse off. And if that were to happen, which 24 customers do you think you might lose? We suspect it will be the 24 people who are price sensitive and who keep reminding you and your team of that. You might also want to remember that a 24% reduction in the number of people you service will take the pressure off you and your team members and will, in all likelihood, enable you to cut back on some of your fixed costs.
The strategic implications of this type of analysis are very important. Most business people are preoccupied with getting more revenue—often from new customers. They pay very little regard to the customers they already have and usually adopt the view that price is something over which they have very little control because of competitive pressure. They also believe that seeking ways to reduce costs is the most effective way to build a profitable business.
This is absolutely the wrong way to run a business even though it may seem to make intuitive sense that the more revenue you generate the bigger, and therefore the better, your business will be. It also makes intuitive sense that cost reduction leads to improved profitability.
Let’s first address the cost reduction strategy. We have no argument with the proposition that reducing costs (whether they are fixed or variable) will improve profit. But there is a big qualifier to this. If a cost is necessary for you to do business, then reducing it may also reduce your capacity to do business. Furthermore, the costs that can be reduced are generally those of a “discretionary” nature and these tend to be the ones incurred today to build the future of your business (for example, marketing, team training, research and development.) A more useful strategy to pursue is to constantly review your costs and ask yourself the question “what are we getting for what we’re investing here?” and related to that, “Is there a way for us to get greater productivity from the resources that are driving these costs?”
Chasing new revenue is a major cost driver in itself
Chasing new revenue and the activity that involves is a major cost driver in itself. While we tend to describe enterprise overheads as being fixed costs, they in fact aren’t in the long run. They tend to be driven by the volume of transactions. If that was not the case every business would find that its net profit margin (net profit divided by revenue) would increase over time. That is rarely the case in practice.
By far and away the most profitable strategy is to aggressively price your products or services, elect to deal only with those customers who see and accept the value you deliver to them, do not allow customers (or competitors) who are price sensitive to dictate the pricing strategy that you adopt across the board and do not see “big” as being the definition of success and monitor the productivity of the resources that are provided by your fixed costs. At the end of the day, profit is the only measure of success. Revenue does not pay the bills or give you the resources you need to grow—that comes from profit.
Whittaker & Company can help you identify areas where you can make small improvements to drive big results in your business. Contact us today to schedule a phone call or meeting.