7 Ways to Increase Your Gross Profits

 

The most frequent comment I get on starting a consulting assignment is "How can I increase sales?"  So when I ask "why?" the answer is always "To increase profits!"  The 'stupid' is usually left unsaid.   So that is the real reason - to increase profits, and perfectly understandable it is too. 

But is increasing sales the quickest and easiest way to do this?  

To increase sales we have three options:

  • Persuade our existing customers to buy more. Some customers may be spreading their purchases around to avoid being dependent on one supplier. Others may not, for example, service their equipment as often as they should. The opportunity will depend on the nature of your market and product offering. There may be some room to move here.

  • Find new customers. Most customers have their existing suppliers. You have to give them good reasons to drop their current supplier (as long as they are performing) and change to you. So a new marketing campaign (and its associated costs) is called for.

  • Finding new uses for our capability, products or services. Market research is required to identify the right market.

This is the old "Usage, Users and Uses" adage.

Some companies have capacity restrictions - they don't have the space or workforce or capital to handle more sales.

Instead of increasing sales, is it easier to increase Gross Profit margins, and what is the impact? 

Let's have a look at the alternatives around a hypothetical company.

Promisealot Pty. Ltd. has a turnover of $250,000 with a Gross Profit of $87,500 (35%) and a Nett Profit of $25,000.  

Suppose Promisealot Pty. Ltd. increases sales by 5% with no change to their Gross Profit Margin, and assuming no increase in costs such as advertising (unlikely) to achieve the higher sales:

Increasing Sales

 

Old

New

Increase

Sales

$250,000

$262,500

$12,500

Gross Profit $

$ 87,500

$91,875

$4,375

GP %

35%

35%

 

Expenses

$62,500

$62,500

$0

Nett Profit

$25,000

$29,375

$4,375

Nett Profit %

10%

12.27%

17.50%

 

Now let us have a look at the impact of increasing the percentage Gross Profit Margin by 5%, i.e. from 35% to 40%..

Increasing Gross Profit Margin

 

Old

New

Increase

Sales

$250,000

$250,000

$00

Gross Profit $

$ 87,500

$100,000

$12,500

GP %

35%

40%

5%

Expenses

$62,500

$62,500

$0

Nett Profit

$25,000

$37,500

$12,500

Nett Profit %

10%

17.27%

50.00%

 

Pretty impressive - but can it be done?

There are a number of possible ways you can lift your Gross Profit Margin:

  • 1. Increasing your Margin - by increasing your prices;
  • 2. Improving your Margin - by recovering the true Cost of Sales; or
  • 3. Improving your Margin - by reducing the Cost of Sales

1. Increasing Your Margin - Can You Increase Your Price?

Most people in sales hate raising prices.  After all, "Customers always go for the lowest price, and if I increase my prices I'll lose sales to my competitors".  And "Once my competitor gets my customers I won't get them back".  Actually neither statement is true. 

Most customers buy on value, or at least value as they perceive it.   They will make a decision to buy based on the 'perceived worth of your offer' compared to the 'perceived worth of your competitors offer', that is, the 'relative value' of your offer.  Whether you deliver goods or services, to the customer you are delivering a 'value package' to meet the customer's specific needs.

It has been said that you can increase prices by up to 4% without losing sales.  Obviously that will depend on a range of factors such as the 'relative value' of the product or service, number of competitors in the market place and other such factors.  But generally it is true.  The important thing is that 4% will go straight through to the bottom line.

As an aside, the longer you put off raising prices, whether for the fear of losing sales, or for whatever reason, the more you will eventually have to raise them to recover your margins - and then the size of the price hike might cause you to lose customers.  Incremental increases have far less impact on the customers.

Smart businesses won't just do a blanket price increase.  There is more to increasing prices than just that.  Most businesses have a range of product lines or services.  Each may be targetting a different customer group or market segment, with different levels of competition and offering different relative value levels.  So some may be able to stand price rises than others.  Some may not stand a price rise at all.  So the smart business will look at its marketing strategy, including price, for each market segment in which it is operating.

It may be you can add a little value to the offering and increase the price by more than the value of the additional factor.  One shoe retailer I dealt with noted their competitor was regularly offering 10% discounts on sporting shoes (shudder - what does that come straight out of - the bottom line!).  He countered by giving away a pair of socks with each pair of sporting shoes without cutting his price, adding value.  It worked, he didn't lose sales.  In fact he increased them.  And the socks cost him far less than the 10% discount the competitor was offering!   You might consider reversing this strategy to increase your price.

So there is most of that 5% increase in Gross Profit Margin we were seeking.  Now where can we find that other pesky 1%?

Remember - unless your are profiteering a 4% increase in price is unlikely to impact on your customer buying behaviour!

2. Improving Your Margin 

2.1 Recovering the Costs.

Margins are not just the result of prices alone.  You have to understand the role of all variable costs in your 'real' Cost of Sales.  Recovering the real cost of sales will improve margins.

Do you recover all the variable costs associated with an individual sale?  I have found that many organisations such as repair shops, jobbing shops and business which charge out labour often fail to include in their invoices actual costs that were incurred only through that job.

Let me give some examples.

  • Handling - goods coming in for repair may require to be taken from a vehicle, unpacked, packed upon repair and reloaded. If no items come in there is no handling. So if there is, where do you record, and recover, the time involved?
  • Shop floor consumables - most repair and jobbing shops incur a range of consumables on a daily basis; cleaning rags and aids, nuts and bolts and other loose items. If their costs are not directly recovered against the job they become an overhead cost which must be recovered out of Gross Profit.
  • Freight - freight costs may be incurred on incoming raw materials, parts or items for sale. They may also be incurred in delivering products to customers. There may be a case for including incoming freight as an overhead, although my preference is to see it included in the value of Stock. Outgoing or delivery freight should be recovered against the customer incurring it..

Do you include handling, freight and consumables in your invoices? 

 

2.2 Recovering Actual Labour Costs

Those of you who charge out labour, be it for repair, manufacturing or professional services, need to ensure that the times recorded against each job are accurate.  Some businesses allow their staff to estimate the time spent on each job at the end of the day.  Such Job Cards are rarely accurate.  Inaccurate Job Cards can lead to many problems.  For example:

  • Too few hours recorded will mean the actual cost of doing the job is not recovered.
  • Too many hours recorded may result in you gaining a reputation for being too expensive, or having to write-down the hours to something you believe will be acceptable to the customer. Those write-down hours can't be recovered.
  • Poor information can lead to poor decision making overall for your business. You may not really know which areas of the business perform the best or have the most opportunity for improvement.

3. Improving Your Margin - Reducing the Cost of Sales

The two principal elements in your Cost of Sales are usually Labour and Materials, depending on the business, or Purchases.

  • Better purchasing - do you regularly check that your suppliers are giving you the best prices? How long is it since you have tested by seeking quotations from a range of sources? Are there alternative materials or supplies out there?
  • Better processes - reducing the time it takes to do the job by simplifying the process or reducing the number of steps. The longer you have been doing the job the same way the more likely there are to be opportunities to improve the process. You might want to share the gains with your customer! Wouldn't that impress them?
  • Make fewer mistakes - saves time and materials! There are two costs from getting things wrong: the additional time and materials to get it right for the customer; and the opportunity cost of the additional sales you could have made while you were fixing the mistake!

Let us take this a little further.  An analysis of the jobs you undertake may well show that some may make more money than others, and some may be downright losers. 

So what if you learnt to say NO to the less profitable jobs (or increased your price accordingly)?   Is your reaction "I can't refuse jobs.  I don't know where the next one is coming from."  How often have I heard a variation on this.

But if you learnt to say NO I guarantee your profits will rise.

So, in summary, working on your Gross Profit Margin may offer greater returns for less effort than chasing increased sales.

Like to learn more?

Contact me !

Adam Gordon

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