The 5 Myths of Mastering Profit Margins
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Obviously, every organization wants to increase profit margins because there is a direct impact on the bottom line, but there are five myths that we need to dispel in order to truly master margins.
Don't fall for these five myths:
1. Increasing margins can only be done by reducing costs. Too often we default to cost cutting as a way to reduce our margins, looking for what costs we can remove and still make the sale. This often leads to a lower margin because the quality of what we are offering diminishes and we incur additional costs to remedy that.
Related: 10 Ways to Improve Profitability
2. Increasing margins can only be done by raising prices. As mentioned above, we can increase margins by reducing costs, but that should not be the only lever we try to pull. When we look to increase margins by reducing costs, we need to ensure that the quality of our products and services and our reputation stay intact.
3. You should compare your profit margins to your competitors. You should not. Your goal in every transaction should be to maximize your margin by pulling the different profit levers. You cannot compare margins with other organizations because you don’t know their pricing models or their cost structure.
4. Profit margin and markup are the same. They are not. Profit margin is profit as a percentage of revenue. Profit percentage (or markup) is profit as a percentage of cost (the percentage difference between your cost and the selling price). Another metric is cash margin, which is not expressed in a percentage.
5. We need to set a minimum profit margin target for everything we sell. This is not necessarily true. Some organizations use different criteria, like being first or second place in any market, or a specific profitability requirement. The challenge with setting a minimum required profit margin target (say 50 percent) is that it may not be attainable in some industries or markets. Or even worse, you may hit the target and never know if you could have achieved a higher profit margin.
To maximize margins, there are nine different profit levers you can pull:
- Pricing and payment terms.
- Procurement and managing suppliers.
- Cost of goods sold.
- Supply chain optimization.
- Customer growth and retention.
- Employee empowerment and retention.
- Brand recognition.
- Operational excellence.
- Innovating and collaborating.
By mastering which of these levers to pull and when, you will be well on your way to maximizing your profit margins on every sale.