One of the biggest mistakes made by startups is to confuse making sales with making money. New business owners seem to think that business is about busy-ness--that is, how many times the cash register rings. They fail to take even simple steps to ensure they earn enough to cover their costs as well as take home a healthy paycheck. Without that, you may as well be working for someone else.
Everyone who goes into business knows the need to make a profit, but somehow it gets lost in translation. People neglect to do the math to determine whether there will be money left over after they pay their bills. They promote deep discounts that cut profits to the bone. They even give services away when they shouldn't.
Case in point: a company that offered computer-based training to businesses. Part of its model was to provide free training to one person from each client's corporate staff. When one client brought four additional people to the session, the company comp'ed the four extras as well. At $1,000 a pop, that was $4,000 of pure profit lost.
The first step in maximizing your margins is to take profitability into account on every policy you set and every sale you make. Second, hire an accountant who can help you see the forest (net revenues after expenses) for the trees (cash on hand). Third, keep operating costs as low as possible by justifying expenditures and outsourcing services like bookkeeping and telemarketing. A dollar saved is a dollar earned in profit.
Next, follow a few simple rules to generate peak profits from each transaction. For example:
1. Take the high road on pricing. Many startups think they need to undercut their competitors to bring people in the door. That's a recipe for failure. If your only appeal is a low price, there will be no reason for customers to come back to you if they find a source that's even cheaper. And you won't make the profits you need to stay in business.
To develop your pricing, look at your costs and break-even point. Then look at your competitors' pricing levels, particularly the business that's been around the longest. Don't be afraid to be the highest in the market or to increase your prices if they're too low, but offer better a product and/or value to justify your rates.
2. Push high-margin products and services. Different brands, SKUs or service offerings have different profit-making potential. Knowing the margin difference between Product A and Product B is critical for shaping your profit plan. One tire retailer I know significantly boosted his bottom line by pushing a lesser-known tire brand that had a bigger margin than the one with a household name. The dollar value of those sales was smaller, but he put more money in his pocket.
3. Dump the discounts. I once coached a men's clothing store that regularly ran a 20 percent off promotion on men's suits. If someone bought a $500 suit, the store lost $100 in profit. I counseled instead to give away a $100 shirt that cost $50. Customers perceived it as the same dollar value, but the store retained more money (and margin).
The same concept can be used in any industry. For a computer store, the giveaway might be an hour or two of a technician's time. For a beauty salon, it might be an eyebrow waxing. Offers like these help draw customers or close sales without taking such a big bite of the profits.
4. Cross-sell/upsell high-profit items. In last month's column , I talked about a hardware store that created a checklist of add-on items like brushes and drop cloths for customers who bought paint. Those items helped increase the profitability of paint sales because they had higher margins. In another case, I worked with a TV store that drove profits to a new level by improving the way it sold service warranties. This skyrocketed from one in 10 customers to one in four, becoming a key profit center.
5. Put your product mix on a diet. Imagine you're a jewelry store with 25 percent of your inventory tied up in stock that sells once or twice a year. By getting rid of those slow-moving items, you can put the money into merchandise with the highest turnover. The same principle applies to service businesses. If you're a day spa with body wraps that attract only a handful of clients per week, put more resources into facials or other services that will keep your appointment book filled.
There are other tactics you can use, but the key is always to keep your eye on the profit prize. Remember, it's not how much you sell, but how much you earn. Otherwise, when you're out of working capital, you're out of business. If the dot-com companies of the late '90s had kept that lesson in mind, the internet bubble might never have burst.
The author is an Entrepreneur contributor. The opinions expressed are those of the writer.