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Business Insights From Conway MacKenzie
April 28, 2015

Growing Business, Shrinking Profits?

When times are good, businesses often invest – new hires, new equipment – to keep the good times rolling. When times are bad, businesses also invest – marketing, sales, new product or service offerings – to stem the tide. Investment is good when there is return on investment. But too much investment – in good times or bad – can negatively impact what really matters to a business: profit.

Investments can lead to increased revenue and growth, but without profit (or outside financing/investment) growth is unsustainable. So while growing your top line is important, maximizing bottom line profits is key to long-term business success.

So what are some tactics that businesses can employ to increase profitability?

Pricing Strategy

Raising prices, even nominally (although customers rarely describe any price increase as “nominal”), is often the quickest route to raising profits. In a landmark paper published in the Harvard Business Review in 1992, the authors found that a 1% price increase results in an 11.1% profit increase.

Raising prices should never be done, however, without a clear explanation to customers about why price action was taken. Businesses should explain to customers why increased costs necessitate a price increase, or why added value in the product or service they are purchasing justifies the additional cost.

Some brands use pricing strategy as a point of brand differentiation. They charge more to differentiate from lower cost competitors, and buttress the premium image of their brands. Many brands that charge premium prices, such as Apple and Starbucks, are among the most profitable companies in the world.

Efficiency Strategy

Increasing efficiency is another way businesses increase profitability. By making a product or providing a service more efficiently, a business’ profit margins will go up.

Adopting ever leaner manufacturing strategies was key for U.S. automotive industry OEMs to compete with their more efficient Japanese competitors in the 1980s, and critical to their very survival during the recent economic crisis. By wringing operational waste out of the system, they survived big challenges and are now highly profitable. One of the most successful efficiency strategies in business history was executed by Henry Ford when he developed an assembly line for the Model T that allowed him to sell lower-priced automobiles at a healthy profit. Increased productivity leads to increased profits.

Cutting Costs

It’s often easier to reduce expenses than increase sales, so cutting costs is a good way to boost profit margin. After all, if a business’ profit margin is 7%, reducing costs by 7% (admittedly, no easy task) doubles its profits. From renegotiating contracts and leases, to consolidating business units, there are many ways businesses can cut costs. However, while cost cutting is an effective strategy, it’s often a short-term one. At some point there’s no more fat to cut. At that point new stimulus is needed – such as increased sales – to widen profit margins.

80/20 Rule

The Pareto Principle (commonly called the “80/20 Rule’), named after Italian economist Vilfredo Pareto, stands for the proposition that 80% of value comes from 20% of effort. In business terms, 80% of business revenues (or profits) come from 20% of customers. While obviously not scientific or universally applicable, the 80/20 Rule stands for an important principle nonetheless: if a business can determine who its most profitable customers are, and what its most profitable activities are, then it’s in a good position to boost profit margins by better focusing its collective energy. Put the 80/20 Rule into action and boost profits by analyzing customers and pruning those that take up time and resources but do not generate significant revenues, and analyzing products or services and directing effort to those that are high margin and in high demand.

There are countless ways that businesses can boost profits by taking smart, strategic actions – we’ve touched on just a few here. The key point is that while you’re growing your top line revenues, always stay focused on improving your bottom line profitability. For more insights on business improvement strategies, visit us regularly on Facebook, Twitter and LinkedIn.