How to increase profit margins
Running a successful business is a balancing act that can grind to a halt if your spending exceeds your income. To stay afloat and remain attractive to your market (and investors), you must stay in the black. You must scale and increase profit and revenue, but also keep an eye on your profit margins.
More sales and customers are always good things for a business, yet there’s more that goes into how to increase profit margins. In addition to boosting revenue, you must understand the profit margin formula and how you can take control of it to succeed.
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What are profit margins?
Your profit margin is how much money you actually get to walk away with after a transaction is complete. The profit margin formula is the difference between your revenue (the amount of money your company brings in) and your costs. To calculate it, divide your net income (i.e. total revenue minus expenses) by your net sales (i.e. gross sales minus returns, discounts and allowances) and multiply the result by 100.
A company’s profit margin indicates its ability to manage its expenses, so investors use it as a basis of comparison when sizing up a potential investment. Understanding how to improve profit and elevate the profit margin of your business is vital to your bottom line and ability to attract investment.
What is a good profit margin?
To get a sense of a firm’s overall performance in the market, investors compare operating profit margin (its dollar-to-dollar conversion of revenue into profit) to that of the entire industry or to a benchmark index like the S&P 500.
While profit margins vary from industry to industry, the average profit margin is around 10%. A business whose margin exceeds the average is outperforming the overall market, while a margin that’s consistently subpar may signal a failing business.
Whether or not you’re over 10%, there is always room for improvement to increase profit margins and your business’s overall resiliency.
What causes profit margins to decline?
Profit margins are based on expenses vs. revenue. When profits decline or expenses increase, the margin will go down. A decline in profits can be a product of the economy, a sign that there has been a social shift in your customer base or a red flag that your business model is no longer relevant.
Profit margins are also subject to a variety of influences that can cause them to decline. All industries are at the mercy of overall economic conditions, which impact everything from consumer behavior to interest rates to the cost of raw materials, labor and production. Your industry may find itself upended by a disruptive new technology that changes the market overnight. Something as straightforward (and fixable) as careless accounting procedures can also throw off your revenue vs. profit ratio, causing your profit margins to dip.
How to increase profit margins
Understanding how to increase profit margins in business is fundamental to growth. By learning to increase profit and master your margins, you will empower yourself to face challenges with confidence.
1. Strive for incremental growth
It’s easy to get ahead of yourself, especially when you’re working to increase profit margins and profits as a whole. You start thinking about your ultimate goal, and forget about all the little steps it takes along the way to get there. Instead of falling into that trap, learn to strive for incremental growth.
It’s important to have an end goal, but it’s even more crucial to set small goals that you and your business can manage and track over time. This allows you to make consistent progress and monitor how your business is performing. Check in with yourself – do you have the time frame and resources needed to consistently achieve your goals? It’s great if you want to make $50 million, but that doesn’t happen overnight. Set goals along the way to increase your profit from $5,000 to $10,000 and so on until you’re in a position to set your sights on your ultimate objective.
2. Focus on strategic innovation
There aren’t many companies that can say they honestly offer their customers something brand new. At this point, successful businesses expand on existing ideas, but they do it in a way that’s useful and appealing to their customers – they strategically innovate. To truly understand how to increase profit margins for your business, identify who your customer really is. Who is this person and what need do they have for your product?
An example of a strategic innovator is Netflix. Before the streaming service came along, people were happy to rent tapes at Blockbuster. Netflix saw how they could capitalize on this need for home entertainment, and found a way to make movies even more accessible for their target audience. They strategically innovated. If you’re able to create an innovation culture, you’ll be leagues ahead of your competitors and can expect your profit margins to rise accordingly.
3. Create an incredible team
Increasing your profits is partly about the service or product you’re offering, but it’s also about your success in building a team that works. Who do you have on your side that supports you 100%? Who works for your business that not only knows the company inside and out, but is willing to rave about your business and bring in new customers?
To increase profit margins for your business, creating an internal culture of raving fans is just as critical as locating your target audience. When you assemble a team of people who are excited to work for your brand and spread your message, it becomes a hundred times easier to be successful.
4. Identify what’s not working
If you are not happy with your profit growth or margin, you need to take an objective look at your business and identify the gaps. Even if your company is successful, there’s something you can do to make it more profitable. Look at your expense reports, personnel reviews and current sales. What area is lacking? If there’s a noticeable gap, address it.
Why did your business spend $10,000 on office supplies last year when nothing major, like your copy machines or computer chairs, has been updated? Have you stopped identifying ways to get new customers? Assessing the current state, and possible shortcomings, of your business will help you create a better plan to move forward and increase profit.
5. Fine-tune your production processes
The laws of physics apply in business, and velocity matters. The faster you can turn a product around from order to delivery, the lower your overhead and the faster you’re able to generate revenue. In other words, the fewer steps you have and the faster you can complete those steps, the more you can increase profit margins.
Take a close look at your production processes, from your first contact with a customer to the moment your product is delivered safely into their hands. How can you speed up each step? Automation is already transforming the way we work, from repetitive tasks to customer service roles – can you better leverage it to create new efficiencies? By streamlining, you’re able to trim costs and increase profit margins for your company.
6. Waste not, want not
The beauty of studying how to increase profit margins for a business is that profit margins are by definition ratios. You don’t necessarily need to increase your profits to improve your margins – you’ll likely find success in reducing your expenses as well. Examine all the ways your business spends money.
Where are you losing money through spoilage, scrap or waste? Is your forecasting off, causing you to purchase too much raw material? Are there quality control issues with your product? Is your product selling so slowly that it becomes obsolete? Are your distribution channels efficient? By carefully considering all your options for trimming loss, you can cut your costs and increase profit margins.
7. Prioritize higher-end products
When your profit margins dip, it’s easy to take an “anything goes” approach to marketing and production. This approach may backfire in the long run, since a low-margin product produces less bang for your buck. To increase your profit and overall margin numbers, focus on products that sell best and deliver the highest profit. Quality products inspire loyalty as well as boost revenues.
If you provide a service instead of a product, this still applies: You must cut low-margin clients so that you can put your resources toward better-producing areas of your business. It can be hard to sever the cord, especially if it’s a client that has been with you since the beginning, but there are professional ways to fire clients. Remember, your business is a valuable commodity, not a charity.
8. Capitalize on other people’s resources
Marketing guru Jay Abraham believes that most business owners think too small when it comes to increasing profit margins. While most companies believe a 10x growth strategy equals success, Jay thinks that they are capable of much more – up to a 100x internal growth model. How do you accomplish that?
One of the ways to increase profit by that much is to capitalize on other people’s resources. By capitalizing on another company’s tangible and intangible resources, you can achieve explosive yet sustainable growth. Jay suggests finding ways to utilize other people’s money, time, experiences, ideas and current customers to fuel your profits. Capitalize on this formula by acquiring smaller companies, working with influencers and creating cross-promotional campaigns with those you can share resources with.
9. Get unstuck
Are you stuck in your business and feel you can’t figure out how to improve profit no matter what you do? Or, as Jay suggests, are you stuck thinking a 10x growth strategy is all you can achieve? Jay has a nine-step plan for getting unstuck that includes gaining your market’s trust, developing a maven persona, developing a vision for your marketplace, telling your creation myth and creating a velvet rope community. It’s all a part of having a powerful company vision – one that others can’t help but follow.
Another way to get unstuck is to reconnect with your passion. As Keith Cunningham has said, lots of people go into business and end up with a hobby. The difference between business and a hobby is that a business makes you money. If you’re feeling stuck, you’re only nailing part of the equation: You’re either making money but your passion is gone, or you’re ultra passionate but aren’t using your business sense. When you combine passion and profitability, you’ll fuel profit margins you never dreamed possible.
10. Use the Power Parthenon method
Most businesses have one primary marketing method that is generating 90 to 100% of their revenue. Jay refers to this as the “diving board method.” It may be direct sales, referrals, digital marketing or brand building. But what happens when that method becomes less effective? Your profit margins decline and you lose market share. That’s why Jay suggests using a Power Parthenon method with different pillars instead, each of which is a revenue-generating activity.
Joint ventures are one smart method to add to your strategy. Look into creating partnerships, endorsements and other unconventional methods. This way, you won’t be dependent on a single activity for your profits and all activities will work together to improve each other and create much larger profit margins.
11. Create a loyalty program
Return customers add to your profit margins at a much higher rate than new customers. Why? Because they tend to spend more and tell others about your products or services. Return customers also cost less as you don’t have to spend marketing money to convert them from prospects into customers.
Increase profit margins by creating a loyalty program for those who already do business with you to take them from regular customers to raving fans of your company. You can entice them with exclusive sales, cash back, rewards or perks such as free products or extra discounts.
12. Increase pricing
If you consistently make high-quality products or perform professional services and have not had a rate increase recently, you have an easy way to increase profit. Pricing must increase with inflation and with the growth and experience of your company.
If you have a strong core customer base that you’ve served well and kept happy, a modest increase in price will not cause you to lose business. Along with the increase in profit margins, a price increase can make you appear more valuable in the eyes of your customers.
13. Outsource when possible
Is payroll eating up your resources and decreasing profit margins? Many small businesses struggle with keeping the right number of people on staff. Too few and you cannot properly take care of your customers. Too many and you have a high payroll with idle employees. One way around this is to outsource some parts of your business to freelancers or contracted workers. You can use them only when demand is high and won’t have to pay them when they are not needed.
There’s an art to increasing profit and it’s one that not everyone can master. Many businesses fail, but yours doesn’t have to. The key to professional success is in realizing how and when your company needs to adapt. Are there ways you can move forward that you haven’t considered? Is there a key leadership position you need to fill? By knowing what your business truly needs, you’ll create a sustainable, profitable company that you can reap the benefits of for years to come.
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