Do you run a business with consistently low or sub-optimal profits? If so, you may simply have a crappy business model, where no matter how much time and energy you put in to the business, the low profits will remain.
Chances are, you haven’t gone through a thorough evaluation with your accountant as accountants aren’t really geared for business model analysis. This can leave you frustratingly stuck in the cycle of low profits and unsure of what to do.
Having reviewed the profitability and business models of many businesses, what has struck me is that some basic understanding and quick and easy changes can make a significant difference. From this experience, here are five steps to consider to fix a broken business model and start turning your business around.
- Make sure you know the profitability of your different products or services and different customer segments.
The 80/20 rule often applies to profitability, with 80% of profits coming from 20% of products or services and/or customer segments, so chances are, you are spending time and devoting resources to unprofitable products and customers.
To understand the profitability of your existing products and/or customer segments, complete a table on a spreadsheet that looks something like the table below.
| Product or Customer Segment | A | B | C |
| Price | $150 | $200 | $250 |
| Profit per product sold | $60 | $80 | $140 |
| Sales volumes per month | 120 | 70 | 50 |
| Profit per month | $7,200 | $5,600 | $7,000 |
Your calculations may be more complex depending on your business and in many cases will focus on labour costs, charge-out rates and productivity. No matter the complexity, the net result should be a clear picture of how much profit your different products and services generate.
Once you’ve gone through this evaluation, you’ll be ready for step 2 and to look at your pricing, product and customer options.
- Change Pricing, Products and Customer Focus with the Information Gleaned from Step 1
Now that you understand product and customer profitability, you can decide;
- What prices of what products can increase and by how much,
- What products and customer segments to focus on, and
- The likely impact on profit of doing this.
To do this, you need to consider the market you operate in and what is feasible. In the example using the table above, to assess the impact of changes of price and sales volume, the following changes are considered feasible and are modelled;
- the price of the lowest profit product ‘A’ has increased by 10%, to reflect its existing low cost and the possibility or more easily increasing a low cost product,
- the mid-range product ‘B’ has a price and sales volume increase of 5% each, and
- the most profitable product ‘C’ has a sales volume increase of 10%, to reflect extra efforts to sell the more profitable product.
- To increase sales volumes of B and C, marketing costs of $500 for each of these products has been incurred
Editing the table above, the analysis would look something like this.
| Product | A | B | C |
| Price increase | 10% | 5% | 5% |
| Price | $165 | $200 | $263 |
| Profit per product sold | $75 | $80 | $153 |
| Sales volume increase | 5% | 10% | |
| Sales volumes per month | 120 | 70 | 52.5 |
| Less increased marketing cost | ($500) | ($500) | |
| Profit per month | $9,000 | $6,300 | $8,032.5 |
| Profit increase | $1,800 | $515 | $200 |
Our analysis shows us that simply increasing the price of product A will produce the greatest impact on profit, so this is the logical change in this instance.
Our analysis also lets us examine different scenarios and play around with different changes and thus shows us what to focus on to improve the business model.
- Focus on Rare and Valuable Knowledge and Products or Services that Solve Difficult Problems
Consider how you can increase your skills or focus on solving a particular customer problem or a more difficult problem, so that you can provide higher-value products or services that you can charge more for. The rarer and more valuable your knowledge or product is and the more difficult the problem it solves, the less your product and service can be commoditised and competed with on price and the more you will be able to charge.
- Improve Your Messaging
Consider how you can position your product in such a way that makes it more desirable and thus allows you to charge more. Once you clearly articulate exactly what your product or service does, how it helps make the customer’s life better or easier and exactly what steps are required to purchase the product or service, you will attract more customers and in the process, be able to charge more and improve your business model. When you combine this with a focus on rare and valuable knowledge, you will more easily separate yourself from your competition and create your own niche.
- Consider a Different Business
If you go through all of the above and you still can’t make a decent profit, then it’s time to consider doing something else. Many business owners are great operators stuck in low profit business models that are virtually impossible to change because of industry dynamics. For example, a franchise business may be locked in to purchasing from head office at high rates and have to rent an expensive showroom. In such instances, no matter how much sales go up and no matter how well the business is run, profits won’t occur. As Warren Buffett says, when a great manager meets a bad business, the great manager will always lose. If this is similar to your situation, it may be time to get out and let your talents loose elsewhere.
Want to apply this to your business?
If you’ve found this valuable, want to want to understand what changes you could make and you want further assistance, you can
- Consider the financial modelling course at courses.morrisonabs.com.au here, which contains in-depth training about reviewing and mapping out your business model,
- Consider the other financial management courses at https://courses.morrisonabs.com.au/,
- Book a financial assessment, so we can assess your business model in detail together and create a plan with steps to take straight away to make it more profitable. More information on financial assessments can be found with this link https://www.morrisonabs.com.au/services/financial-assessments/, or
- Book a 15 minute call here to discuss your business model and how we may be able to work together to improve it.
All the best with your business model and success.
Regards
Angus Morrison
Chartered Accountant, Profit First Professional, Registered Tax Agent and Certified Xero Partner
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83A Balcombe Road Mentone VIC 3194 t 03 9584 6422 e angus@morrisonabs.com.au www.morrisonabs.com.au
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