You know your price must deliver enough margin, after variable costs, to cover overhead and leave the target profit you want. This means that margin analysis, i.e., understanding all your variable costs, is crucial to setting your price.
Variable costs are those costs whose amount changes with another sale. They include
- subcontracted services
- sales commission
Owners increase their margins, and hence their profits, by reducing these variable costs on a per product basis. For example, if I cut my variable costs from 55% of revenue to 50%, then my margin grows from 45% to 50%.
Margin Analysis by Product and Customer Group
Margin analysis gets bebeath the Buisness P&L, to assess the margin on each product and each set of customers.
Owners need to know which products have the highest and lowest margins. There may be a role for low margin products, to attract new customers, or fill a hole in the product line. But there may also be opportunities to raise those low margins by product or process redesign, or charging for shipping, or reducing sales commission for such products.
Why pay the same % commission on sales that generate a different % margin? You want salespeople to focus on selling high margin products, and a differentiated commission plan motivates that behavior.
A second technique is raising the price to achieve the desired margin. If it is not making enough money, why are you selling it? Consider using a series of small increases to get the price where it needs to be (see Pricing Tips: Start High; Big Results from Small Changes).
A third technique is to boost the prices and margins for products with little competition. For example, once the customer has bought the main item, you will have little competition for accessories and replacement parts. That means these can be priced with very high margins. One example would be a replacement battery for a laptop computer.
A fourth approach uses innovative bundling. In Know Your Sales Margins – Business Profit Margins | Entrepreneur.com, Randy Myers tells of a company who paired high and low margin products into an offer that produced a higher blended margin. He says “think fast-food value meals.”
Other examples of pairing low and high margin products would be maintenance contracts, or a discount on an already-high list price for replacement parts.
The other direction for margin analysis is looking at customer groups. Some types of customers cost more than others. Reasons may include their need for after-sales support, or warranty replacements, or a lengthy sales cycle, or custom ingredients or processing.
Managing your margins means controlling these extra costs, or charging more to cover them, or even “firing” these customers.
Profitability depends on knowing your margins by product and by customer group. Armed with that knowledge, business owners can focus on which costs to control, and choose prices that deliver their target margin and profit.
Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or firstname.lastname@example.org. See www.tom-gray.com.