If young entrepreneurs play it right, lemonade stands have fabulous margins. With big eyes and a hopeful, yet artfully pathetic, smile, they can get their parents to supply them with cups, mix, and ice. Those same assets work on neighbors, some of whom will give $1 for a 50 cent drink. Score. Pure profit in the piggy bank.
Your eyes, no matter how big, and your smile, no matter how hopeful, stop working after about age 9. Then, you’re on your own. Many businesses, small and large, struggle with small margins. While passion may have prompted them to start a business, profit is ultimately what’s going to keep them in it. How can they increase margins and maximize profitability?
The Big Issue of Small Margins
Without adequate margins, it becomes increasingly difficult to pay operating expenses and overhead. So, the first step is to figure out what’s going on. Do you have small margins because that’s the norm in the industry? Or do you have small profit margins because your cost structure or pricing structure is upside down?
To determine this, we compare your company to the benchmark. What are the average gross and net profit margins in your industry? How do you stack up in comparison?
The benchmarking data for public companies is relatively easy to access: you just need to look at the FCC filings, which are available online, to determine profitability. Private companies are harder to get to, so we subscribe to a service that provides the information. With this data, we can see how your business compares to the industry average.
If you are in line, then we look at:
Cost structure. What is the cost of goods sold (COGS) ratio? To improve profit margins, you need to either cut costs here or increase sale prices. We need to break down the components of the cost structure to determine if this is where the issue is, or whether it’s with your pricing. Could be both!
Pricing. What’s going on with your pricing? Is there, for example, some pressure from commoditization because there are so many other companies providing the same services or products? Is this reducing your margins? Pricing is so individual and unique to specific companies, but it’s helpful to know what the actual pricing has been and to glean some insight into competitor pricing.
Product Mix. It’s important to look at the mix of products to determine how it’s affecting your margins. Perhaps you’ve added another line of business that has a much smaller margin than the others. If the volume increases significantly for that one line of business, it’s going to impact the overall gross profit margin. We help our clients look at the individual profit margin by product line and the total to get a better picture of the whole situation.
We look at all of these parts of the puzzle to figure out which pieces we’re going to have the biggest lift on. That is, how can we “arrange” them to see the biggest gain in margins? Struggling with small margins is a fact of business life in many industries; by analyzing cost structure, pricing, and mix, companies can work to maximize their profitability – even when they have to buy their own lemonade and customers don’t pay double because they’re cute.