Does more revenue mean more profit?
In this blog, we’ll explore – and potentially explode – the popular misconception that more work, more sales and more revenue means you’ll make more money.
From wasting precious resources to inefficiency and poor productivity, we hope this article will help you decide if it’s really worth taking on that extra client.
The Pareto principle states that, for almost all processes, 80 per cent of the output comes from just 20 per cent of the input.
And this rule is no less true in business. A huge number of leading companies rely on just one product or service to provide the lion’s share of income. Think Crocs’ flip flops, Michelin’s tyres, and Rolex’s watches. While they could expand and diverge into new product ranges, their success is built on the foundations of a single, high-quality offering.
In 2014, Forbes magazine published an article detailing Pareto’s law and how companies can utilise it to “dramatically grow your business”.
Commenting on the principle, Forbes writes: “The Pareto Principle, or 80/20 Rule as it is frequently called today, is an incredible tool for growing your business. For instance, if you can figure out which 20 per cent of your time produces 80 per cent of your business’ results, you can spend more time on those activities and less time on others.”
It continues: “Likewise, by identifying the characteristics of the top 20 per cent of your customers (who represent 80 per cent of your sales), you can find more customers like them and dramatically grow your sales and profits.”
So, how do you figure out what your most profitable products are and who are your best customers? The answer is management accounts.
While we could spend an entire day lauding management accounts, we’ll sum them up in just one paragraph:
Management accounts paint a complete picture of your business. They don’t only tell you how profitable your business is, but also why. By drafting up management accounts on a monthly or quarterly basis, we can distinguish which customers are the most profitable and which products move the fastest, identify late payments and poor suppliers, monitor production on the factory floor, collect and compare data by region or sales office, and lots, lots more.
High maintenance, low profit customers
Known as “problem customers”, high maintenance clients might be killing your business’ profitability.
Management accounts can help you identify your most profitable “80/20” customers and focus resources on them and target similar markets. Sometimes, however, intuition can tell you everything you need. Problem customers will often haggle and negotiate every deal. They might phone with a problem five times a day. They might be one-time buyers or ‘tyre kickers’.
However problem customers are complicating your business, it’s important to know that low-value clients spend around five times less than your top 20 per cent.
Ask yourself: are problem customers worth your time and effort? Could you reallocate your team and resources to service high-value targets, perhaps doing more to retain their business and up-sell?
Lacoste, the French fashion brand, illustrates perfectly how more does not necessarily mean better. In the 1980s, the plan was simple: sell, sell, sell. By 1990, the company was flogging its clothes in almost every sports shop and discount outlet across America. But where the company thought they would see improved profits, it instead saw a freefall in sales. Put in charge of the company’s turnaround, new CEO Robert Siegel removed Lacoste apparel from almost every shop except the most luxurious department stores. By targeting the top 20 per cent of its customers, sales shot up by 70 per cent in less than five years.
Focus on profitability, not revenue
While many business owners see sales as a measurement of growth, they tell you very little about your business. Sales in isolation do not tell you how much money your company is making. Only profitability can do that.
Evidently, a product with a break-even profit margin is going to add zero profitability to your business, whether you’ve sold it one or one million times.
Are costs the problem?
Before taking on more customers, consider how costs are weighing on your business.
The ‘bottom line’ starts with costs. Whether it’s the cost of raw materials, the cost of suppliers, or the cost of distribution, there is always room to negotiate.
It’s best practice to review your suppliers at least once a year, ensuring you are bargaining for the best deal. After all, they want your custom as much as you need theirs.
Use management accounts to pinpoint where you might be overspending and work from there. For example, cutting costs on the factory floor might include selling – rather than recycling – leftover resources or relocating to a more economical site.
Businesses, meanwhile, can save thousands by comparing insurance, energy and loan deals. If your contracts automatically renew, you could cut costs by going back to the market.
Technology is also driving down costs. By moving to cloud accounting or virtual meeting rooms, businesses eliminate the requirement for costly physical space and equipment.
Can you outsource the work?
We understand – turning down work sounds like blasphemy. So instead of rejecting new customers, can you outsource the work to a trusted subcontractor?
By outsourcing problem customers, you are reducing your overheads while also retaining clients in case they become more profitable down the line.
We work with business owners to build the businesses they need to have the life they want, so if you want to talk about how to grow business, get in touch with me on 01803 296678 or email email@example.com