HOW TO IMPROVE COMPANY VALUE: PROFIT MARGIN
Posted on February 2, 2011
Profit Margin is one of the key financial measures that drives company value. In Part 1 of this article series, we're going to focus on improving profit margin by looking at Gross Margin, R&D investment, and SG&A investment.
Gross Margin (Gross Profit/Revenue) reflects your ability to charge your customers more for products/services than it costs you to supply them - clearly something to aspire to. There are a few areas to focus on to improve Gross Margin.
Reduce Cost: to reduce your product/service cost, set specific goals and incentivize your employees to achieve them. You may set a goal to reduce manufacturing spending by $1M and then pay out $100K in incentive if the goal is achieved. Set goals and incentives each period, and make it a part of your company culture and a point of pride. To help seed cost reduction efforts, identify your largest cost drivers (like raw materials, rent, utilities, and labor), divvy up the spending categories, and assign a team to each area.
Cost reduction can become something that employees are proud of, but if layoffs are part of cost reduction, they can stifle the positive momentum. I prefer gradual personnel shifts enabled through attrition and performance management. Whenever possible, employees should be viewed as part of the cost reduction solution, not part of the problem.
Strengthen Pricing: Success here may mean charging more, holding prices flat, or even slowing price declines. When increasing prices with a repeat customer, you will often need a compelling business reason, such as fuel cost pass-through, severe supply shortages, or a breakthrough new product feature. Analysis on competitor's prices and your product advantages/disadvantages can give you a solid footing in price negotiations.
If you have a large number of customers (like a retail store), you can experiment with different prices to see the impact on sales volume and then set prices to optimize profits. Some customers are willing to pay more than others, and you should look for ways to set different prices for these different customers. Grocery stores do this through coupons, which only the more frugal customers are willing to clip out.
Optimize Product/Customer Mix: Some products are more profitable than others. Likewise, some customers are more profitable than others. When your operations are constrained (e.g. by manufacturing capacity or personnel), you may want to cut low-profit products and customers to make room for high-profit ones. Be careful here not to shoot your golden goose by losing a key customer that you will need later on. Remember to ignore fixed costs when prioritizing products and customers, as these costs won't go away.
