It’s common sense but often overlooked: To start a business, you must plan a strategy to decide what part of the potential marketplace you are going to attack. First, obtain the relevant facts about your competitors and the importance of your chosen marketplace and its potential for growth. From this, assess what you can aim to achieve and how you can be different from what others offer. Price, although not the only consideration, is an important factor in your business plans.
Selling at a lower price than a competitor just to increase sales will not necessarily improve your profit. This is usually a foolish move because your competitor may also reduce his price, to just above your reduced price — which will push your price even lower and you will not make money. In fact, it is more than likely that his sitting on your prices will force you out of business.
This is common practice when a new business starts to enter an industry with low prices. The established company will have larger resources and can sit on you by lowering its prices and force you out of business. Once you have closed down, the other company can raise its prices again to profitable levels as before.
Perhaps surprisingly, the opposite approach can provide a successful entry. Some years ago, a cosmetics manufacturer was set to launch a new cream it claimed would reduce facial wrinkles. Products with the same or similar ingredients were already on the market, selling at $15 to $25. The company’s research team suggested pricing the new product at $95, as this would appear to make it far better than the others simply because of its price. Guess what? They were right. The product sold well, even though it had the same ingredients as the other creams.
Low prices are not always the way forward. Many people are willing to pay a bit more if it gets them “Rolls Royce service.” People will pay for something special or something that makes them feel special. It is the equivalent of giving customers one-on-one service, something we all love and want. If low prices were always the major factor for products, why is it that we do not all buy the lowest-priced cars? The cheapest-priced houses? Fly on budget airlines?
We all want to choose how we spend our hard-earned money and choose the level of quality and service we want. That is why price is not as material as many people think. If you can survive in business only with lower prices, you are on thin ice. Businesses survive on good service, customer loyalty and innovative ideas.
Vanity or Sanity — Sales or Profit
Do not be blinded by your sales figures. If they do not produce a bottom-line net profit, they are meaningless. Sales figures are vanity; profit is sanity. Growing your company’s sales is great, but only if the bottom line grows at the same rate. Profits must increase in line with additional sales — the top and bottom lines must be in sync with each other for you to make a real success of your business.
One company I worked with had sales of about $2 million, but with net profits of only a few thousand. When I looked at the company’s overall costing structure, I found it to not be based on any particular strategy or even related to the actual running costs of the company. Rather, charges to clients were based purely on guesswork and varied with the individual client. The largest customers were charged less, took the longest time to pay and always questioned every invoice. These clients got their invoices discounted because they played up the fact of being major national companies. Incidentally, the large customers also expected an immediate visit from a service technician when they called, often refusing to pay overtime for night and weekend call-outs.
I found that of the company’s $2 million in sales, $750,000 was coming from the larger customers who were abusing the company with payment terms. I suggested that by removing these customers, the company’s profits would increase substantially, and recommended substantially reducing the sales figures to make the business profitable. Very unusual to voluntarily reduce sales to make a profit!
I also put in place a minimum maintenance call-out charge plus a contribution to travel expenses, charging each mile of travel to clients for service calls. This was accepted by all of the customers as being fair and reasonable.
The business reduced its sales by 37.5 percent, which, combined with a few staffing changes as well, translated into a net profit in excess of $100,000 — more than 33 times its previous profits.
What counts, then, is the bottom line — the net profit. You, the boss, get paid only from what is left after everyone else has been paid. Make sure your efforts are sensibly rewarded.
The Risk of Large Customers
It is dangerous to have a customer — or supplier — that accounts for most or all of your sales. Such reliance leaves you vulnerable to their failure, so spread your risk. If you rely on one supplier or major customer and that company goes broke, you will likely go down with them. Just look at the recent recession that saw suppliers to banking services and the automotive industry lose their businesses overnight.
You should have a maximum exposure to a client or supplier of no more than 20 percent. Then, if either the customer or supplier should stop doing business with you for any reason, your business will still be able to function.
This may not be feasible if yours is a specialist business. However, if you do rely on only a few suppliers or customers, maximize your profits, save them and then use them carefully to diversify your business. This will reduce your reliance on a few customers.
Sales and the P&L
There should be only one answer to the question, “Are you financially managing your business successfully and profitably?” It has to be, “Yes!” And to run a business profitably, you must have accurate and up-to-date financial information; you cannot guess if you are making a profit or a loss. People who say they are doing well but do not have a monthly Profit and Loss Statement don’t really know if they are making money. They are just kidding themselves. It’s like flipping a coin: Heads, we’re making a profit; tails, we’re taking a loss.
The excuse for not having up-to-date financial information is often, “I cannot afford an accountant.” But for a nominal hourly rate once or twice a week, you should be able to afford one. If not, then we know you are losing money — or you are not making much money.
Every business, large or small, needs financial information. And it will tell you more about your business than just whether you are operating at a profit or a loss. It is important to take the time to read, understand and interpret your P&L.
A detailed P&L is a breakdown of income and expenditure over a 12-month period. This will show, monthly, exactly the amount you have sold and the type of products you have sold. It also lists exactly what you have spent to get your sales income, plus detailing your overhead and expenditures.
From this information, you will be able to see sales trends, such as whether sales were higher in one month and lower in another. You can then investigate the reasons for those differences — perhaps a holiday period, or hot or cold weather. Once you have the answers, you can direct your advertising and marketing to peak periods and reduce them when the sales are low. You can also devise promotional activities when times a good and even when they are bad, to improve sales.
Likewise, you can look at the expenses in the P&L to see if you can reduce them at bad times and save money — which, in turn, translates into increased net profit.
Going through the expenses each month will also enable you to look at ways of reducing costs by reorganizing some of your business practices and operations. Do you need so many cell phones, cars or trucks? Are you spending too much on gas and vehicle maintenance by making your own deliveries?
Business owners, be sure to include your own salary in the P&L. One of the reasons businesses do not make a “true profit” is the owners often forget to include this vital cost in their overhead. You must always add the salary you think you should earn, even if you do not take it initially. This will at least take into account what you want to earn once the business is successful. If you do not add in your salary initially, you will need to make substantial increases to your charges later on, which may well cause problems for your business.
Developing and running a successful business requires research and forethought, fulfilling customers’ needs and taking a hands-on approach to each and every project. Owners need to leave their egos at the door. The most important thing to remember when starting or running a business is that it is there to make money. The last time I checked, no bank accepts ego as a deposit.
Victor Green, author of How to Succeed in Business by Really Trying, has a long record of founding and growing businesses in a variety of industries. Now retired, he lectures and mentors small business owners and new entrepreneurs in conjunction with SCORE and the U.S. Small Business Administration.