There’s no mystery to boosting your company’s profits. The question is whether you are willing and able to take the required steps.
Getting there starts with breaking down profit into its components and using six tools to move those pieces in the right direction.
Profit is revenue minus costs. But to boost profit, it helps to break it down further into gross profit — price times quantity minus variable costs (e.g., costs that increase with each unit of product you sell) — minus fixed costs (e.g., salaries, benefits, rent, and utilities).
In theory, it would be nice if you could simultaneously raise prices, lower variable and fixed costs, and boost the quantity of products you sell. And a handful of companies — think Apple when the iPhone was at its peak — have raised price above the industry average while lowering variable costs, a so-called dual advantage.
For example, in September 2012, the iPhone 4S’s $649 price was 44 percent higher than that of the Nokia Lumia 900, while its $190 unit cost was $19 below that of the Lumia. This yielded Apple a whopping 71 percent gross margin — compared with Nokia’s 54 percent.
But that rarely works. Instead, most companies need to choose a single source of advantage from among these two:
- Differentiation. By delivering customers a product that is much better than rivals’, you can charge an above-average price and make more profit despite the higher costs required to provide the superior product.
- Low-cost producer. By selling a good product at the lowest price in the industry, you can earn above-average profit because your company will gain market share, which will enable it to lower its costs thanks to volume discounts and other economies of scale.
Which strategy should you choose in 2017? Start by assessing how well your company does compared with its rivals on three differentiation drivers and three cost drivers. And to do that, you should assemble a team of your top executives and key suppliers and customers to help you collect data on each of the six drivers.
Three Differentiation Drivers
One of the most powerful reasons people pay more for a product is that they want a higher-quality product. Several years ago, Apple was able to charge customers 40 to 50 percent above the industry average price because consumers perceived that the iPhone was a better-quality product.
To find out whether your company has the potential to raise customers’ willingness to pay, ask 20 to 50 of your customers how they perceive the quality of your products compared with those of your leading competitors. If you charge a lower price but your customers believe your product is better, you should consider a price increase. If not, see if you could improve your quality enough to justify a price increase.
Another reason customers are willing to pay a higher price for a product is that the company offers them better service than rivals do. For example, many students tell me they are happy to go to a genius bar at an Apple store if they have problems with their devices.
To assess whether your company delivers superior service for which customers are willing to pay, you should ask a group of customers how they perceive your company’s service compared with that of rivals. If your service is better, raise your price; if not, consider whether you could improve your service enough to justify such a price increase.
Another reason people are willing to pay a higher price for a product is if they feel that owning it confers special social status on them. This probably helps explain why people are willing to pay $1,000 for a bottle of vodka to get table service at a Manhattan club with giant doormen who carefully select people they deem worthy of getting inside.
You could make exclusivity work for your company by making your product available only to the most prestigious customers and asking them to promote their use of the product among their followers. In this way, other people might be willing to pay a higher price to be admitted to your exclusive club.
Three Cost Drivers
If you try the three tools for raising price and you don’t see much opportunity, consider whether you could choose a cost-driven path to profit growth. Here, you would boost profits by cutting price to gain market share, which would give you some tools to cut your variable and fixed costs.
4. Economies of scale
If you buy raw materials for your business, it stands to reason that if you can increase the quantity that you buy, you should be able to ask the supplier for a volume discount. To see whether you could lower your costs below those of rivals, you should collect cost data for your raw materials and other inputs and compare them to your competitors’ costs.
If your costs are already the lowest in the industry, you may be able to cut your price and take market share, which would give you leverage to ask for bigger volume discounts.
If you are located near your customers, the cost of transporting your product is lower. You ought to compare your company’s transportation costs to those of your competitors.
If you are located closer to your customers than the rivals, then you should consider whether you can cut your prices to reflect those lower transportation costs–thus allowing you take market share. However, if your transportation costs are higher than those of rivals, you might seek to win customers that are located closer to you–or invest in new facilities that are closer to your customers.
6. Process efficiency
Another way to lower your costs is to cut wasteful steps from your business processes. For example, you could map out all the steps that your company follows from a customer’s order to your receipt of payment for the delivered product. In parallel, you could map out how your fastest-growing rivals perform this process and use the resulting insights to make your operation more efficient.
You can then cut your prices–passing along some of your cost savings to gain market share.
Start with these six tools and your company should be more profitable in a year.
source: inc.com By Peter Cohan