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17th June 2011
When we start out in business, we tend to think that all sales are equal. One €100 sale seems much like another, and when we are in start-up mode we tend to be grateful for every single sale. However not all sales are equal. The single biggest factor that we should use to evaluate sales is the profit margin that we make. We don't want to be in business just to break even or to scrape a living. We need to maximise profits, and to do that we need to maximise our profit margin.
What is Profit Margin?
Your profit margin is a measure of profitability, and is calculated by expressing net profit as a percentage of sales.
Profit Margin = Net Income / Sales x 100
How can you improve your margin?
If we leave aside the math, this is where it gets interesting, because you can improve your margin, and therefore your profits, by putting your efforts into making sales with the highest margins. In general, it takes as much effort to make a sale with a high margin as one with a low margin, and therefore it is better to focus on making high margin sales. Let’s take a look at some of the main factors that affect your margin, namely; price, customer mix, product mix and costs.
Setting your price is one of the biggest challenges that businesses face. A lot of start-ups set price simply by benchmarking themselves against competitors. However this can be a mistake, because how you pitch your product or service to your customers and how you communicate the value that you deliver are often more influential than price in closing a sale. You need to differentiate your business from your competitors when making a sale, because if you don't, you can only compete on price and nobody wins price wars. Remember when setting your prices, your customers don't care about your costs or your time; they only care about the value that you deliver to them. So, focus on explaining what you are delivering to the customer, rather than just talking about price. For example, are you saving your customers money, solving a problem, giving them a system for the future, delivering a unique experience, or giving them the best product for their needs?
The mix of customers that you have can have a huge impact on your profit margin. For example some customers are just very “needy”, and can take up huge amounts of your time as you answer their questions and deliver special requests. That is time that could be better spent servicing the needs of your “A” type customers who are willing to pay a worthy price for your standard product. You should therefore categorise your customers by type. The price, the size of orders, reliability of payment, lead times, complexity of orders and even customer communications are all factors to take into account when evaluating your customers.
Some products are just going to be more profitable and easy to deliver than others. The ratio of the different products that you sell to each other is known as your “product mix”. Even if you seem to only have one product, you can sell and package it in different quantities and at differing prices to provide choice, or product mix, to your customers. For example, a restaurant might offer a special meal deal on a designated night; say €25 for a three course meal on Thursday. This special menu could have a limited, but varied, menu choice. This special offer will bring in customers, who upon seeing the price, will appreciate the value and book a table. A nice atmosphere, comfortable surroundings, a little wine perhaps, and a customer will relax and change their perception of value. The restauranteur will obviously provide them with full price à la carte menu on the night, in addition to the restricted menu, which will tempt some customers. The à la carte menu will contain higher margin food items. Customers will also buy wine to accompany the meal, and again, the margin is higher on wine than on food. Successful restauranteurs are masters at “up – selling” so that they make as many high margin sales as possible.
Keeping your costs to a minimum requires a methodical approach. Cost control should be an ongoing part of your business, and not just something you do once a year or when you are in trouble.
When looking at your costs, look at the biggest ones first and work your way through them all, before starting all over again. Can you negotiate better prices, substitute products better payment terms or better delivery schedules with your suppliers? Is there another supplier that will offer you better prices without compromising on quality or delivery? If you are in the happy position of having money in the bank, see if you can get a better price from your suppliers for early payment. If you do negotiate reduced prices, advise your accounts department and make sure that you are charged the new price on the invoices. Don’t assume that the supplier will change their accounting system to invoice you the new agreed price – often they don’t. Also, don't forget to look through your bank statements, and make sure that you don't have any subscriptions or direct debits for products and services that you no longer require.
Remember, not all sales are equal. Improve your profit margin per sale by focusing on your price, product, customer and costs. You will be rewarded with improved profits.