Relieving the Growing Pressure on Profit Margin
Tracking profit margins is a relevant but underutilized tool. Find out how you can implement it in your organization.
While most businesses carefully monitor volume and revenue, many lack the same diligence when monitoring their margins. By implementing the steps below, you will be able to gain a deeper understanding of the often overlooked factors that drive margins and improve the ability to project and interpret profit potential.
Take a hard look at the relevance of your product or service.
There is a positive correlation between the relevance of your products or services and your margins. However, the challenge with the relevance side is that it is a constantly moving target. It not only requires keeping a finger on the pulse of your customer needs but also tracking how well your product or service is meeting those needs amidst economic changes, competitive solutions, and disruptive technologies. Some factors can quickly make your product or service line suddenly obsolete while others will slowly whittle away at it, leading to a slower decline that may be harder to detect on the surface. Regardless, each can put pressure on margins, especially if you are considering price or cost reductions as the answer to any challenges regarding product or service relevance.
Pay attention to what is generating your biggest and lowest profit margins.
It is common to find companies disproportionately allocating resources to lower margin areas and/or lower revenue products or services. A complete understanding of your product or service line is required to identify how to efficiently allocate the increasingly constrained resources needed to build the business and prioritize where to look for cost efficiencies and opportunities to increase or decrease pricing. This approach may help expedite the decisions to eliminate products or services that are taxing your overall margin.
Understand how your business is spending money.
Knowing what makes up your costs will not only eliminate surprises but will also provide more clarity as to which actions are most likely to have the intended impact.
Tracking expenses will also reveal a lot information on how to influence margin. For example, if your gross profit margin is healthy but the operating profit margin is low, you likely have nonessential operating costs and overhead reduction opportunities.
Plan and monitor your pricing.
Pricing is a common lever to pull when trying to increase sales volume. It can take many forms that range from special perks to value-adds like shipping or extra back-end support to volume discounts. While discounting is often a requisite to maintain top accounts, it can very quickly erode your margins. Each “discount” establishes an expectation that can be difficult to reverse. To protect margins, it is critical to set and adhere to discount ceilings, which will set expectations for customers and will help you protect margins from eroding uncontrolled.
Consider the indirect consequences of any cost and pricing changes.
As Newton’s Law goes, “for every action there is a reaction,” and that certainly holds true for the factors that drive profit margins. Efforts to reduce cost of goods sold (COGS) may come with unexpected cost impacts such as the disruption of day-to-day operations or widespread layoffs. It is critical to consider both the impacts and sustainability of these actions on other costs and revenues.
In tough economic times, and frankly even in good ones, tracking margins is an underutilized tool. Making decisions without understanding their impact on your margins might initially generate some short-term gains but likely at the expense of keeping the business strong enough to withstand higher levels of current or future volatility. You should always track your margins, not only to monitor the health of your business but also to guide the decisions that affect your costs and sales volume.
By The RVR Team
RVR has helped numerous clients in the past with the efficient management of their profit margins. Please contact us if you are interested in discussing further.