Winning Advice #3 Retain Profit Margins
I’ve talked before about the great advice I got from a mentor of mine. Profit Margins were the focus of Winning Advice #3 on a list of 5 that became part of my blueprint for success in the spring of 1997. In short, it said a business owner must understand the importance of establishing, understanding, and maintaining minimum Profit Margins. And yes, this means you first need to know your costs! This followed behind #1 Hiring Quality People and #2 Acquiring Customers which were previously shared.
In less than 25 words, the directive was simply scribed as this.
3. Retain Whole Goods Margin
A. Increase parts margins on (Proprietary) Parts.
B. Decrease parts margins on Fast Moving Parts to keep the will-fits out.
….and to clarify a couple terms:
“Whole Goods” refers to a whole product: a car, a boat, a tractor, a house – in this case, a piece of heavy construction equipment.
“Parts” would be the tires, a propeller, a fan belt, a door, a window, and so on.
Putting the advice to work in your business…
Retain Margins (on your Product or Service). First of all to be able to retain a margin, you first need to know what the cost is. Your fixed costs (what it costs to unlock the front door each day) and variable costs (those directly associated with the product or service) are the two categories of costs in running a business. If you don’t know your costs, it’s worth the time to figure them out – this break even analysis may helpful.
Once you know your costs you need to establish pricing that retains a margin high enough that it returns capital back into the business every time one it sold. Does this mean you will always get the profit margin you want? No. But, it will clearly establish baselines so you know when you are no longer making profitable transactions. Test: If your actual net cost of an item is $100, to sell it at a 25% gross margin what it the selling price? ________ (answer below) (Hint – the gross profit margin is different than the markup).
Increase margins on Proprietary (Products or Services). If your business sells something that is unique and they can only get it from you; you should get a higher margin for it. You deserve to be compensated for the time it took to develop it, refine it, and perfect it. So don’t give it away! Should you be reasonable in your pricing? YES. But treat it like a commodity? No. Take a look at your product offerings, if there are services or products that are uniquely yours and they provide real value (high Return on Investment) to your customers, don’t be afraid to put a higher profit margin on that product or service. This is an area that we see a lot of business owners struggle with.
Decrease margins on (common items) to keep the (competition) out. Think of this as the stuff your customers and clients can buy anywhere. It is a commodity. Even if you make it yourself, it is something that others make as well. Price is king, the main driver for buying it from your company usually centers on convenience, loyalty, and brand preference as much as anything else. You need to be competitive in your pricing on these items or services or you will not get the business.
That said, one way to increase margins on these items is to group them with something proprietary to your business or create a process that adds value to the commodity. An aggregate salesman (think crushed rock) once shared how they added significant margin to their bottom line by improving and streamlining the delivery options for their clients. The rock itself is a commodity, but they added value and separated their company from the others by improving their delivery options and their customers were willing to pay a premium for the service.
Profit margins, without them you do not have a viable business. When is the last time you reviewed yours? If you haven’t done so recently, it is probably time. If you’re not sure where to start, feel free to contact us and we will do our best to point you in the right direction. As always, we welcome any thoughts in the space below.
Chris Steinlage Kansas City Business Coach
Test Answer: Sales Price (SP) is $133.00 Gross Profit margin is calculated as Gross Profit / Sales Price. (And Gross Profit is Sales Price – Net Cost). So in our example the equation is (SP – $100)/SP = .25 Which gives you an SP of $133.00.