When asked how to improve the profitability of a business, the default response by your typical robot accountant is to “restructure your costs”. Translated to non-accountant terms, that means slash your overhead expenses and fire staff.
They’ll offer a bunch of recommendations like replacing the espresso machine with instant coffee, or cancelling the annual staff Christmas party, or sucking the soul directly from your employees’ eyeballs like a dementor to save on oxygen. Sound familiar?
The problem I have with this advice is that it’s wrong. Cutting petty expenses is not a sure way to improve profitability. In fact, it can have the reverse effect.
The problem when typical accountants and CFOs undertake cost cutting exercises is they only consider numbers on a profit and loss statement. What they often don’t consider are the non-financial consequences of being a tight arse who everybody now refers to as The Tight Arse.
Because, ah, that espresso machine and the medical grade caffeine hit it provides might have been the only thing keeping your staff coming to work in the morning. No staff = no profit.
Fortunately, there are actually three effective ways you can improve the profitability of your business. Let’s call them the three profit levers.
Let’s look at your profit and loss again.
Notice how it’s split into three distinct categories? Revenue, direct costs and operating expenses? Think of these as levers for your company’s profitability.
The three levers that form the controls are:
- Sales lever
- Direct costs lever
- Operating expenses lever
Here’s how you can use these three levers to actually impact your profitability without destroying the soul of your workforce.
Lever 1: The sales lever
The sales lever is the top line – revenue. You can pull the sales lever in two ways:
- Increase prices – increase the per unit price of your product/service
- Increase volume – sell more units
Ask most people about sales, and they might think about this fascinating, borderline insane monologue:
OK, I’m no Alec Baldwin. And this article is not about how to close. What I’m here to talk about is how pulling the sales lever can impact the profitability of your business.
To demonstrate the impact of pulling these levers, let’s review the following set of accounts.
In this example, we’ll be increasing prices and volume by 10%.
As you can see, increasing prices by 10% has a whopping 53% improvement to profit. Increasing volume by the same rate, increases profit by 16%.
Increasing prices is always better than simply selling more units. That’s because raising prices doesn’t impact the unit costs of every sale you make. It all goes straight to the bottom line.
Buuttt, it’s not that easy. Whacking a 10% price hike on your products will probably annoy some of your price-conscious customers, which could cost you their business. In competitive markets they may switch to your competitors, which can result in less overall sales.
It’s a balancing act.
We need to be smarter. And we can be – by getting our hands down and dirty in the data. I’m talking about upselling.
While upselling can do magical things to your profitability, it also increases your customer lifetime value, and can have positive effects on customer loyalty which, you guessed it, also increases profitability.
Does your tech stack support effective upselling? Can you look into your customer data and see who is ripe for nurtured cross-selling? You may find it could be one of the easiest parts of the sales lever to pull.
Lever 2: The direct costs lever
If putting your prices up isn’t an option (and let’s be real, it isn’t always the lever you need to pull), there’s another lever you can try. The direct costs lever.
Direct costs are all the expenses attributed to the production of your product or service. They are typically variable, which means they increase as your sales volume does. This is sometimes referred to as your cost of goods sold.
So how do we pull this lever?
You can renegotiate terms with suppliers, and get more optimal contracts for your business. You could look into your data and see which vendors and brands are performing or tanking, and then consolidate. You might even find value in long-term deals with suppliers where it benefits you on cost. While you’re at it, you could analyse your inventory management system and find the optimal balance of demand (things racing out the door) and stock held (the cost of stacking things in your warehouse, or your garage) and then adjust.
You can even look at reducing wasteful product features – can that epic unboxing experience have the same impact without every bell and whistle?
But if you’re squeaky clean on the direct costs front (honestly, you’re probably not but anywho), there is the third lever.
Lever 3: The operating expenses lever
When the COVID lockdowns first started, we heard of one business that pulled the operating expenses lever and found $250,000 (WTAF) in excess, unused annual tech subscription fees in their business. Booya. But also Cheesus Christ.
The fixed operating expenses you incur, irrespective of your revenue volume, are overhead expenses like rent, wages, utilities, insurance and tech subscriptions. All of these things are reviewable, negotiable, renewable and imminently forgettable. So it pays to analyse all of them and find where there could be waste and shift the dial.
Power prices are up, so see who is offering a better deal. Office spaces are free (I mean vacant) literally everywhere. Can you find a better fit? Are your insurances magically doubling year on year? Shift that sh%t!
You could also find cheaper, more efficient staff. Though that whole ‘killing your culture’ thing could be a problem.
These three levers form the profit controls to your machine. Within the levers, there are several moving pieces to coordinate – your product and service, wages, sales and marketing costs, and other expenses.
The sum of these parts equate to the respective levers on your Profit & Loss statement. Know which levers to pull, before you take the easy way out and simply get on the bad side of your staff.