Most businesses think about selling more items or services.
Why not?
Done properly, selling or providing more of what you
already offer can be a big help in creating efficiencies.
But sometimes you are serving virtually all of someone's
needs for those items.
The application to a for-profit organization is obvious.
What else can you profitably sell or provide at a fair
price with desirable qualities and service that the
customers you already have want to buy? The advent of the
Internet makes this evaluation much more potentially
rewarding because postal, air freight, and electronic
delivery choices enable you to serve most of the world with
your added offerings.
This for-profit challenge requires considering the
potential volume and the effects on overhead costs and
profit contribution margins. Example 1 shows the kind of
effect that a positive change in volume can make by adding
volume through more profitable items that do not increase
overhead costs very much.
Example 1: Adding More Profitable Items to Expand Revenues
Without Increasing Overhead Costs as Rapidly Further Speeds
Profit Growth
This example shows the profit multiplying potential of
increasing profit contribution margins from 30 percent to
40 percent while decreasing corporate overhead costs from
20 percent to 3 percent of revenues. The result is a 7,700
percent profit solution. If revenues could be grown even
more, a 40,000% improvement (a 2,000 percent squared
improvement) could result.
Annual Pro Forma Financials Before Volume Expands
Revenues $1,000,000
Cost of providing offerings $ 700,000
Profit contribution $ 300,000
Corporate overhead cost $200,000
Pretax profit $100,000
20 Times Volume Increase with Higher Profit Contribution
Products and Limited Additional Overhead Expenses
Revenues $21,000,000
Cost of providing offerings $ 12,600,000
Profit contribution $ 8,400,000
Corporate overhead cost $ 600,000
Pretax profit $ 7,800,000
The challenge in making such a change is to focus on both
higher profit contribution offerings and keeping overhead
and operating costs low. The mistake that many make is to
only look at the contribution percentage. When that
happens, the gains in profitability may be eaten up by new
costs to deliver the added offerings that more than offset
the profit contribution of those offerings. Exhibit 2
demonstrates that point.
Example 2: Adding More Profitable Items to Expand Revenues
Hurts Profits When Overhead and Waste Costs Grow Too Rapidly
The potential profit gains from higher profit contribution
percentages (going from 30 percent to 40 percent in this
example) can be more than offset if waste and overhead
costs grow too rapidly in providing required items.
Perishable, high-tech, and fashion items often have this
problem as time causes value to decline, resulting in waste
or markdown charges. Higher profit contribution offerings
often require more administration and service to support
them.
Annual Pro Forma Financials Before Volume Expands
Revenues $1,000,000
Cost of providing offerings $ 700,000
Profit contribution $ 300,000
Corporate overhead cost $200,000
Pretax profit $100,000
20 Times Volume Increase with Higher Profit Contribution
Items and Faster Growth in Overhead and Waste Expenses
Revenues $21,000,000
Cost of providing offerings $12,600,000
Profit contribution $8,400,000
Added waste and markdowns $3,150,000
Corporate overhead cost $5,200,000
Pretax profit $50,000
How can these mistakes be avoided? The best way is to
start with small experiments where you can measure the
increases in volume, profit contribution, and costs before
committing to a major change in your business model.
Copyright 2007 Donald W. Mitchell, All Rights Reserved
----------------------------------------------------
Donald Mitchell is chairman of Mitchell and Company, a
strategy and financial consulting firm in Weston, MA. He is
coauthor of six books including The 2,000 Percent Squared
Solution, The 2,000 Percent Solution, and The Ultimate
Competitive Advantage. You can find free tips for
accomplishing 20 times more by registering at:
====> http://www.2000percentsolution.com .
