On the face of it, improving business profits is fairly straightforward. You can generate more revenue. Or you can reduce your costs. In practice, there’s a bit more to it than that. This in-depth article will take you through each of these areas in turn. Hopefully, by the end of it, you will have some fresh inspiration for how you can improve the profitability of your own business.
If there is one key problem confronting most businesses, it is how to generate more revenue. Of course, it is often couched in different terms: I need more customers, I need more cash, I need more business. But underlying all these needs is the basic requirement to generate more revenue.
The solution to this problem is surprisingly simple.
Because there are only 2 ways to increase your revenue:
- You can get your existing customers to spend more money with you; or
- You can get more customers.
The most challenging of these 2 strategies is the second one. Paradoxically, it is usually the one businesses look to first. Huge sums are spent on marketing, website development, and social media strategies. They all have their place. And they’re particularly important if you are new to business. But if you have customers already, then the most effective strategy for generating revenue lies with them. And you should direct most of your business development efforts to them.
There are 3 strategies to consider when planning how to get your customers to do more business with you:
- Sell them additional products or services (upsell and cross sell).
- Encourage them to deal with you on a more regular basis.
- Or you can simply put your prices up!
Let’s look at each of these in turn.
There are many examples of this strategy begin successfully applied across a range of industries.
Perhaps the most obvious is the waiter in the restaurant who suggests a side order to go with your main course. Or a starter to keep you occupied while you’re waiting.
In the retail sphere, shoe shops often promote shoe care products at checkout.
And electrical retailers will try to upsell you on a product warranty.
The key feature of these upsells is that the cost of the product or service being offered is usually small compared to the main purchase. Which makes the decision for the customer quite straightforward. And the upsell an “easy sale”. After all, if you’ve just parted with £500 for a new range cooker what’s another £60 to protect it for the next 3 years?
So look at your existing offers and see if there are ways to link the different products or services. Then, when you next talk to a customer you can offer them something to enhance their principal purchase. But for only a moderate additional charge.
Another tactic to increase revenue is to encourage your customers to come back to you more frequently.
A typical example of this in action is the customer loyalty card deployed in coffee shops and in the large grocery chains in the UK. Note that these examples are particularly competitive niches in the retail market. Customers have many different places from which to buy a coffee in the morning on the way to work.
Maybe you don’t have your shop positioned on the station platform where you have a captive audience. Then a loyalty card is an excellent way to ensure that your customers keep coming back to you. Rather than going to the competition or varying their options on a daily basis.
Does this have any relevance to your business? Are there ways to encourage customers to come back to you instead of visiting the competition? It doesn’t have to be a loyalty card.
Maybe you can open slightly longer so you are more convenient for a section of your customers.
Or perhaps you have a superior standard of service that keeps them coming back for more.
One word of caution. Try not to compete on price. Unless you have a competitive advantage when it comes to your own costs. If you have the ability to buy in your goods cheaper than your competition, or a much lower level of overhead cost, then this might work for you. But only if you can be certain that your competitive advantage is sustainable.
The problem with price competition is that it becomes a race to the bottom. The business with the deepest pockets wins the race and everyone else goes broke in the process.
In many ways, this is the easiest of all these strategies to implement. And it’s the most efficient way to increase profit. A price increase incurs no extra costs and so the extra revenue raised falls straight to the bottom line.
Now, I know raising prices is a bit controversial. But there are plenty of businesses that use this on a regular basis.
Insurance is a case in point. You will always get a better price as a new customer to an insurance company than you ever will as an existing customer. Insurers know that most consumers are a “sticky” lot, disinclined to shop around on a regular basis. By providing you with an annual increase in your “no claims bonus” you get the impression of a price reduction. But in reality, a new customer coming to the company with the same details will get the insurer’s best price.
That’s the way that market works. And the consequence of this is that each year subsequent to this you will be presented with a price increase (even though it may appear to be a reduction!).
I’m not suggesting that you should develop sleight of hand techniques like insurers use. But properly managed, and with clear communication, you should negotiate price increases with your customers each year.
And remember, they don’t have to be large increases. All the additional revenue raised will be profit to your business. There are no costs associated with price rises.
Revenue Growth – Summary
So, there are 4 strategies you can follow to increase your revenue.
In fact, they are the only 4 strategies that are available to any business. You can only get more money from your existing customers by selling them more or putting your prices up. Or you can get more customers. That’s it. There are no other possibilities.
Most businesses default to trying to get more customers. But this is the least efficient way of going about generating extra revenue.
But on the path to profit, generating revenue is just the start. The next step in the plan is to ensure that as much of this as possible is converted profit.
I can promise you that there is no better way to increase profits than to increase prices. Almost every other possible way to increase profits will involve a lot of hard decisions. And some will involve up-front costs as well.
However, at some point, you will decide that you can’t realistically raise prices any further. At that point, we need to look at some approaches to cost reduction.
Reducing Direct Costs of Sales
Cost of sales are different from overhead costs as they are a necessary cost of each sale. There are, however, steps that you can take to reduce your cost of sales. And in the process, you will improve your gross (and hence your net) profit.
The first of these is to make sure that you regularly appraise your suppliers. You need to ensure that you are getting the best prices for everything you buy in as a component of your cost of sales.
The second approach is to ensure that your own processes are as efficient as they can be. This will ensure you are minimising wastage throughout your production process.
And the third is an extension of this and involves taking a big picture view of your business. The idea is to see if there is a different way for you to deliver what you do. You’re looking for different ways of doing things. Ways that will reduce your cost of sales dramatically (or cut certain categories of cost completely).
Reducing the cost of sales is the next best thing to increasing prices. An increase in gross profit will reflect in your net profit. Savings made here will have a disproportionate impact on your “bottom line”.
Once you have your gross profit maximized it’s time to turn your attention to your general overheads.
For these purposes it’s worth categorising your overheads into 3 main headings:
- Customer acquisition costs
- Customer retention costs, and
- Compliance costs
All costs need controlling, and just because you need to incur a cost doesn’t mean that you can’t do it cheaper. At the same time, you don’t need to pursue a scorched earth policy when it comes to cost reduction either. There is a price to pay for quality and your approach to this should be a drive to maximise value for money.
A good question to ask yourself when you review your costs is “do I need to spend this money?”. A business needs to spend money on customer acquisition and retention. And there are costs of doing business that legally or for regulatory reasons can’t be avoided entirely.
But what about costs that don’t fit into any of these categories? Well, that sort of begs the question. What about costs that aren’t required to secure new business or to retain existing customers? If they don’t qualify as bona fide compliance costs of doing business, then why are you incurring them at all?
Every organisation I have ever worked in and every client I have ever had, has had 10-20% of the overhead cost base that is not necessary. It’s effectively ego spend (large offices, excessive staff entertaining, luxury company vehicles). Or just plain old-fashioned waste.
The approach to these types of costs must be to eliminate them. At the very least, you need to reduce them to the minimum. IF you want your business to be successful, and IF you want to generate a significant level of profit then you need to look at every cost as an investment in the future of your business. And if the expenditure is not going to generate a return in revenue, profit and cash then it’s not an investment at all.
That’s why I have included the third category of costs above as they’re undoubtedly costs of doing business.
In most jurisdictions, if you have a limited liability company you will have to make certain regulatory filings. In the UK companies file annual accounts, an annual return, and a corporate tax return. Most business owners will not have the necessary training to be able to do this themselves in a way that complies with statute and regulation. Instead, they will pay an accountant to undertake this activity for them. This is a cost of doing business that you can’t avoid if you want to avoid jail (which is generally a good plan!).
But aside from these costs, everything else should be appraised as an investment with one eye to the potential return. Costs that won’t generate a return in revenue, profit, and cash should be eliminated.
Overhead and Growth
As your business grows, you might expect its overhead cost base to grow at the same time. At one level this is true. But the rate of overhead growth will depend on your business model and the nature of your business.
If you import goods for resale then as your business grows you will need to invest in larger premises to hold your stock. If you sell information products online, then you may be able to grow your business without increasing overheads at all.
But in general terms, you should work to the mantra of “no overhead growth” (as this will almost always be true in the short term). At the very least you should expect your overheads to grow less fast than your revenue and gross profit as you seek to maximise the economies of scale. Even a goods importer won’t need to increase warehouse space for every extra product sold. And growth in these overheads will come erratically at step points in the business’s growth.
Cost Management – Summary
In this article, we have looked at the key drivers of profitability. We took a look at implementing price rises as a fast way to increase profits. We then considered ways of controlling both direct costs and overheads.
If you can get a grip o the principles outlined here, you will be well on your way to securing a healthy, and profitable future for your business.