The Ah-Ha Blog! is published daily by Felicia Joy of Ms. CEO Media Inc. Tuesdays focus on “Business by Design,” covering various topics to improve the components of your business. Questions or comments regarding the blog can be posted simply by clicking on ‘Comment’ above. Felicia Joy is a real-world entrepreneur with nearly 10 years of experience in building businesses. In addition to her daily blog, Felicia hosts a weekly national talk radio show on entrepreneurship on www.msceoshow.com—and in June will begin publishing Ms. CEO Magazine for distribution to 100,000 women throughout the U.S. She is also an in-demand speaker who travels the country delivering her message of enlightened entrepreneurship and personal transformation.
Got Margins?
There are two ways to make a profit in business: By selling a high volume of your product or service and making your investment back after a set number of units are sold and then collecting as pure profit the proceeds from every unit sold thereafter. Or by making a profit on each unit sold along the way.
For example:
High Volume Sales Profit Approach
Initial Investment $200,000
Cost Per Unit (all costs) $2
Retail Price $2
Profit Per Unit Sold $0
Sales Required to Recoup Investment 100,000
Per Item Profit Approach
Initial Investment $200,000
Cost Per Unit (all costs) $2
Retail Price $4
Profit Per Unit Sold $2
Sales Required to Recoup Investment 50,000
I prefer the latter approach—especially for small business owners. You can easily get away with the first approach of selling a kajillion units and making money on the back end when you are a Wal-Mart—the largest retailer in the world—with nearly the whole world population (kidding!) coming through your doors every day. With that kind of traffic you can afford to risk this approach.
However, as a small business you are fighting everyday for market share so to risk making your money back on the backend is not only questionable—it is simply unnecessary. With the per unit profit approach you still have to sell enough of your product or service to justify being in business and to maintain the solidarity of your company long term, but you can get there much faster if you’re making profits consistently along the way (especially if you find a way to manage inventory so that you don’t actually spend a lot of money upfront and only spend money as you make sales –- but that’s another topic).
Small businesses tend to fall into this trap of generating revenue, but not nearly as much in profits, for one or more of a few reasons:
· Not totally counting the costs. You’re not totally counting the costs of what you’re spending to deliver your product or service to the consumer and to handle customer service. This means counting every penny of what it costs to make, market, transport, package, ship, deliver and follow up on what you sell. Only after you count all these costs can you set your product or service price at a rate to ensure that you are making a healthy profit margin on every unit sold.
· Knowing the cost but being concerned that your price to recoup costs is too high. Entrepreneurs fret about pricing, and with good reason—especially in today’s economy. However, you have to maintain healthy profit margins, so if you think your price is too high you have to re-work something else in your business to reduce your costs so you can reduce your price. Or, you’ve got to find the marketing language and sales staff that can build such value in the mind of the consumer that they willingly pay the additional costs for your product. There are tons of examples of where this is done in business. You can buy a designer t-shirt for anywhere from $12 to $200. What’s the difference? One brand has created such value and desire in the mind of the consumer that they are willing to pay a super duper premium just to sport the same cotton fibers with a different name. If you’re worried about price reduce your costs or increase your value proposition.
· Involving too many intermediaries in your supply chain that you have to pay. It’s definitely a bonus in business to collaborate with others but if others want a piece of the action then they need to share in the risk too. I have seen entrepreneurs collaborate on business projects with others who wanted to be paid for their contribution to the project but didn’t want to take any risk. So the businessperson leading the project might have a healthy profit margin set but so many cooks in the kitchen to pay that they effectively are back at square one making their profit on the backend after so many units are sold and everyone else is paid. If you work collaboratively in business—which can often be the case with service-oriented companies and professionals—make sure others who are making money from the project are also sharing the risk or that they are willing to take a significantly reduced fee for taking little to no risk. We all know the adage: Great risk, great reward; little risk, little reward. Don’t give out free lunches (because they are costing you)!
If you’re just getting started make sure you generate revenues and healthy profits by (1) counting the costs, (2) setting a good price and building value, and (3) equally sharing risks and rewards. If you’re already in business and have been generating revenue but you haven’t seemed to feel that lifting affect that makes every entrepreneur do the happy dance, meaning you haven’t been seeing and feeling the affects of profits, then it could be your margins that are anemic.
Check and correct!
Be Encouraged,
Felicia Joy
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