This article was written by Ed Hatton, the Start Up Coach for Entrepreneur Magazine (South African edition), as the My Mentor column published in July 2014 and is posted here by their kind permission
Are you paying enough attention to this profit generator?
The difference between turnover and cost of sales is the starting point of profitability. Entrepreneurs drive their sales aggressively and manage operational costs tightly, but seldom pay as much attention to the crucial issue of margin. This is missing an opportunity to increase profit substantially with a little additional work.
Margin (or gross profit) is the difference between turnover and cost of sales, and it often comes from a simple percentage mark-up on all cost prices. This is a lazy way of setting the amount of gross profit your business will secure, and ultimately the net profit. You can do a lot better than that.
There are at least four opportunities to increase the total gross profit: More sales, higher prices, lower cost of sales and changing the product mix to increase the percentage of high margin products or services sold. Naturally this last one only works if you do not have a one-margin-fits-all lazy margin strategy. A tip to sell more is to increase the average number of items sold per order. Even a tiny percentage increase can make a significant difference to total margin. Look at the example of burger franchises which invite you to add a slice of cheese to the burger. If just 10% of all customers buy that very high margin slice of cheese they make significant extra profit with minimal effort, and it is so simple. What can you do to increase the items per order? Extended warranties, service contracts and training all offer opportunities.
Bundling a slow moving or lesser known product with a highly desirable one, or a high margin item with a fast mover will increase sales if you make the bundle attractive.
Spend time getting to the optimum margin for different product groups, or even individual products. If you have a market leading or unique product which customers flock to buy, it makes sense to get a good margin with a premium price. On the other hand product groups under fierce competitive pressures may have to carry reduced margins to increase the volume of sales. A simple spreadsheet with projected volumes at various price therefore margin levels will allow you to choose the best margin for that product group.
This is a great time to look at the nuisance products and customers – those with very high cost of sale which you keep because nobody has the heart to abandon. Either kill the products, stop selling to the customers or increase the margins radically so you get some compensation for the nuisance.
If you reduce your cost of sale you give yourself the choice of reducing prices and selling more, or holding prices and making more margin. Either way you win. Focus on cost of sale it is an easy way to increase your net profit without massive effort. Before you even start in this area have accurate costs of sale and sales statistics. Hard information about previous sales of a product group, including seasonality means you can forecast demand accurately. Armed with these projections, approach your suppliers to give you a better deal in return for projected volumes. Then watch supplier prices like a hawk for unannounced price increases. Eliminate waste and emergency buying and see your profits grow.
Lastly review your product range. Launch desirable premium priced products in the areas where your company really shines, where customers seek your out. Drop the low margin low volume dogs which lose you money.
Where do you find the time to do all this? There is only one reason why you should not do any of this: You must be working on yet smarter ideas to increase profit. In all other circumstances it is a priority; make time, choose at least a few of the topics above then find time to implement them over the next few months.
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