Every business owner is in business to make a profit. If you're looking for ways to work smarter instead of harder, and maximise the return you’re getting for your hard work, then our video may be for you. We'll help you better understand the relationship between price, volume, and costs; managing costs; and maximising returns.
Welcome to today’s Davidson Institute online seminar ‘Maximising profit’ – part of our Back to Business in 2021 series. My name is Rob Lockhart, and I will be your presenter for the next 20 minutes or so. People go into business for a variety of reasons, including wanting to help customers, provide employment for locals, needed a job and even saving the world. Amongst all the reasons there is one common reason that has to be there. To make a profit
Without profits a business has no future. It can’t replace equipment as it wears out. It can’t grow. It can’t repay its debts or provide a return to shareholders. Profit is essential to any business. And maximising profits, makes running a business more worthwhile and helps ensure its continued success.
As I said my name is Rob Lockhart. I started out my career many years ago as an accountant working with a mid-tier accounting firm, here in my hometown of Sydney. I probably found I was little boring to be an accountant, so I moved out of accounting into banking. Suddenly I had the best of both worlds, I was boring and despised by most people. But I have always believed if I can help other people be more successful, I will be more successful.
And that’s pretty much how life’s turned out for me and why I got involved with Westpac’s Davidson Institute. Because webinars like this and the other material on the Davidson Institute website are a great way for people to understand the story behind the numbers in their lives an businesses, so they can make more confident financial decisions an hopefully be more successful. Now for those who have not joined one of our webinars before, I have a few house rules.
With so many people joining us today it can be noisy in the background, so we have placed you all into what’s called listen only mode. This is a live webinar, however, and I do encourage you to ask questions. Please type your questions into the questions panel. If you are on a computer, you’ll find the questions panel as part of the control panel probably on the right-hand side of your screen. If you’re on a mobile device, it will be a ? at the top of bottom of your screen to tap on.
Type them in when you think of them. I will answer your questions at the end of the presentation.
We will send you an email later this week with a link to a recording of this webinar. If you lose audio at any point during the webinar, please stay on the line as we will be working in the background to get back to you as soon as possible.
Before we go on, I need to let you know that the information contained in this presentation is general in nature and does not constitute advice on your personal situation. As always at Westpac’s Davidson Institute, we recommend talking to your banker, financial advisor or accountant for detailed information relevant to your personal circumstances.
Today is all about maximising profits and to do this we are going to delve into: •how customers drive profitability, •understanding the financial levers of profitability, the relationship between price, volume and costs and •how to manage costs to maximise profits. The main determinate of profitability is your customers. They are the ones behind sales, the top line on your profit and loss, but they are also the ones behind your costs. We are going to explore a bit further why this is so.
A question I like to ask business owners to understand their success is, “What causes your customers to buy your services at a value (you could put the word price here) that will make you a profit?” There are three key words here: • Customers – who are they? Who is your target market? • Value – What do your customers value or, if you like, what price are they willing to pay for your goods or services?
And • Profit – Are there enough customers in your target market who are willing to pay enough to cover your costs so you can make a profit?
If you can answer this question, there is a good chance you will be maximising your profits and your business may be successful. But let’s look at the elements a bit further. Firstly customers - the people you build and market your products and services for. What do you know about them?
Ask yourself these questions. • Who are your current customers? • Now of your current customers which ones do you like dealing with? • Which ones like dealing with you? Once you have an idea of who your preferred customers are, your target market if you like, what do you know about them? What do they look like? By this I mean their demographics. Things like … How old are they? What is their gender? How much money do they make? Where do they live? And so on.
It can also be good to know a little about how they behave. Things like why they need your products or services and why do they buy from you? Part of this may be “How do they think?” How do they decide to buy your goods or services? Once you know your customers, you now need to know what they value about your goods or services.
Write up a list of all the things your customers value about your business. Think about why customers come to your business and not a competitor’s business. The list on the screen is just a guide. Every businesses’ list will be different. Even your competitors lists may be slightly different. It will depend on who their target customers are and what value they are delivering.
Most of these items cost you money. How much they cost may be determined again by who your target customer is and what they value. For example, what level of quality and service do your target customers want? Premium, good, average or cheap.
Take fast food for example, the quality, service and décor are not the same as a fine dining restaurant. Because of this, the prices are lower. The good news is fast food costs are generally less and the volume is higher allowing them to continue making a profit. It does not matter if you are selling fast food or fine dining, what matters is understanding what your customer values and providing it at the right price.
Another important piece here is consistency. How do you ensure you deliver consistently to your market to build your brand? What does your business stand for? What do you do consistently for your customers that your competitors may not be doing? Your list of what your customers value about your business is like the recipe for your business’s success. You could also call these items your USP or unique selling proposition.
This is what sets you apart from your competitors in terms of attracting customers to come to you … helping you grow your sales and maximise your profit.
Now that we have a bit of an idea about who our customers are and what they value, the next step in maximising profits is to understand the relationship between your price, volume and costs. Price of course is how much you sell your goods or services for; volume is how much of it you sell; Price multiplied by volume is your sales. Take away your costs. Whatever is left over is your profit.
By understanding how changes to any one of these elements impacts the others, helps you to make more informed decisions aimed at maximising your profits. Think of it this way. These three elements have to be in balance to maximise profits. If my customers are premium customers, they hopefully will pay a higher price, which is good because my costs will be higher but there may not be as many of them so my volume may be low.
I need to charge enough to cover my costs at my expected volume. Alternatively, you customers may be the price conscious ones only willing to pay a low price, there will probably be a higher volume at this price but you need to keep your costs low to be profitable. This relationship is foundation of a financial tool called breakeven analysis that can help you calculate the volume you need to sell at a particular price point to cover all your costs … among other things.
Have a look for the video on the Davidson Institute website ‘Using Breakeven Analysis’ which explains how to calculate and use breakeven analysis. Once you understand this relationship, you can look at what happens if price or costs change in your business, you can budget for how much profit you can make and much more. Here is an example of the impact of price changes on the volume of sales.
This is an example of a business selling pens for $1 each. It costs them $0.70 per pen to manufacture and distribute (these are called the variable costs), meaning they have $0.30 left over from every sale (called the contribution margin) to pay for their $900,000 in costs to operate the business and make a targeted profit of $60,000.
With these facts the business needs to sell 3.2m pens (or if you like have $3.2m in sales) to make their targeted profit. Let’s say they want to discount their price by 10% to get more customers. How much more in sales do they need to make to continue achieving their targeted $60k profit? It turns out they will need to sell $4.8m pens … which is an increase of 50% in volume, or to look at it another way, 50% more work. If the business does not get 50% more volume, they will make less profit.
This result is based on their cost structure. Your cost structure will be different and come up with a different result. Having said that, if you discount you will still have to sell more to continue to make the same amount of profit. Be careful of discounting your price as it may also devalue your products and services in the eye of your customers.
On the other hand, what if they put their prices up by 10%? How much would they then have to sell to make the same profit? At this price, they now need to sell 2.4m pens. That is a decrease in volume of 25%. And, if they do not lose 25% of their volume, they will make more profit. Again, your cost structure will be different, however if you increase your price you can afford to sell less and still make the same amount of profit.
This relationship between price volume and costs means if your costs increase you need to either increase your prices or your volume to continue to make the same amount of profit. If you don’t your profit will go down. This is why you should always reconsider your price as your costs change.
Having had a look at what drives customer value and how that may impact costs, and then a look at the relationship between our price, volume and costs, we are now going to have a look at ways to manage costs. The first way to manage your costs is to consider how they contribute to your business and whether their efficiency or productivity can be improved. Ask yourself, or your team, “Can you do more with less?”
Can your people complete more tasks in less time; or can you use less material in your finished goods, or perhaps reduce the amount of rework that it is done?
At Westpac we are always looking at ways to reduce errors on loan applications. Less errors means less rework, a better experience for our customers and we save money. Before you can answer these questions though, you need to have productivity measurements in place. Measure your various resources - people, equipment, space, marketing, stock and debtors - against time, cost, or another factor that is relevant to your business.
Once you know how productive a resource is, you can then tell if any changes you make improve the productivity.
Having the most productive/efficient way to use an asset written down as your, systems and procedures helps ensure everyone knows the preferred way to do things. This can lead to tasks being undertaken quicker, reducing rework, or other efficiencies being found. You can also look at paying less for your stock or services. When looking to buy better, always remember that you still need to maintain the quality of the goods and services you buy in line with the value expectations of your customer.
The 2nd way to manage your costs is to look at how much capacity you need. If you have more capacity than you need, you are paying for things you are not using. For example, if you have more space than you need, you are either paying rent for that extra space or, if you own the property, you could be renting out that extra space to get some more income. If you have equipment that is sitting idle, it is taking up space, losing value and not giving you a return on the money you have invested.
If you do not have enough work for your people, you are paying them for their time, but they are no adding value to your business.
If your sales or activity level is seasonal or unpredictable you may consider turning some of your resources from a fixed cost into a variable cost. Such as hiring contractors or casual staff or renting equipment when you need it rather than buying it. And, if you are unable to get rid of excess capacity without impacting the value you provide your customers, then factor it into your pricing.
To maximise your profitability, it’s important to price for the value you are providing your customer by making your product or service available.
The next place to reduce costs is to stop paying for things your customer does not value. Think back to your list of things your customers value about doing business with you, and then ask yourself if there are other things you’re paying for that aren’t creating value for you or your customers. How much are you paying for the level of quality and service you offer; or the look and feel of your business, or convenience you provide your customers?
And are your goods and services priced to recover those costs from your customers.
It pays to be very careful here, if you start cutting things your customers value, you may lose your reputation and your customers. You may find yourself competing head on with a competitor in a different customer segment, where the customers value things differently. But if it turns out they do not value you going the extra mile or the extra quality or service, cut it and you will cut your costs.
Remember though the customer does value your business being around tomorrow, so things like insurance, repairs, maintenance, accounting, admin, licences and profit still need to be paid.
The real key to managing your costs to maximise your profit is to ensure your customers are paying for the things they value rather than you. If you are operating as efficiently as you can, if you are not carrying any unavoidable capacity, and if your customers value your goods and services, then the price your customer pays needs to be enough to cover all your costs and make a reasonable profit.
If increasing your prices changes your customers’ value perception, then it may be time to revisit the value you’re providing your customers. Consider whether you can cut what they don’t value, educate them on the value, accept lower profits or whether perhaps this business is not right for you at this time. All tough decisions, but stay focussed on the fact that you are in this business to maximise the return on the money and time you have invested in your business.
In summary, we have covered: • Knowing who your customers are and what they value to understand why you are spending your money. •Understanding how your costs behave in relation to your sales by examining the relationship between price, volume and costs in your business. •Looking for cost savings through effectiveness, minimising excess capacity, not providing value your customers don’t want, and finally •Having confidence that you are pricing to capture all the value of your goods or services.
I encourage you to consider what you have heard today and, if you can, apply it to your business to help maximise your profits. That’s the end of the formal part of today’s presentation and I will now see if you have any questions for me to answer. If you haven’t put a question in yet now is the time to start typing.
As I said, if you are on a computer, you’ll find the questions panel as part of the control panel probably on the right-hand side of your screen. If you’re on a mobile device, it will be a ? at the top of bottom of your screen to tap on. I will now have a quick look to see if there are any questions. Just bear with me while I get this right on my screen.
Ok, I’ve got a couple of questions here. What if my customers are split with some willing to pay more and some less? It’s a great question and it’s going to come down to your business and what you want to achieve. If you’ve got customers. some who are willing to pay more and some who are wanting to pay less, there are a couple of way you can approach that. You can either say, are the ones paying more or the ones paying less the ones that I want to target? Are they the same types of people?
Cos there’s a good chance they have different value perceptions.
So, you might say I’m going to build all of my business, all of my products and services, for the value segment that I want to go for, whether that’s the more expensive ones or the lower ones. It may mean though, if you go for the ones who are paying more, you may lose some of those lower paying ones but hopefully because you’re going to make better profits from the higher paying ones that will cover the loss of those.
Or you might decide that you want to go for the lower ones. Which hopefully means you’ll get more volume, so you won’t be making as much profit off each sale, but with more volume you can probably still make the same profit. So, it’s really about having a look at your business and really deciding, who is it that I want to target as my customers?
Now, of course, there is the other one, where you can go for both, but you need to be able to differentiate what value each of those target segments is getting. So, you might want the ones who pay less and make a product that is cheaper that they can have so the ones who will pay more understand they are getting more value.
Ok, another question here. I’m not sure how I should find these things out? Do I do research? Yes, so if you’re looking at who your customers are, as I said, understanding who your target market is, I always say you’ve already got the best research. You’ve got customers already. See who they are. Who are the ones you like dealing with? Who are the ones that like dealing with you? Find out about them. Ask them questions.
You can do your own research … maybe do a little questionnaire up, as long as you don’t make it too onerous for them; or you can use a market research company to do it for you, but of courser you are going to have to pay for that. So, it does depend on where you’re going. But always be looking at where can I get the data from to tell me, who are the customers coming to me and what do they want from me?
What do they like about my business? What do they like about my products and services? Why do they buy it? Ask them these questions and then with the answers to those, start adjusting your business to meet what your customers want.
Another one here from David. I’m in a market where customers are very price sensitive, but I do need to put my prices up. We supply a quality product but don’t want to lose too many customers if we increase prices. David, a very interesting question. Now I don’t know your particular market, or business, or industry, or your thing so I can only answer this in a generic way. I can’t give you specific advice on your particular situation.
But the types of things I would be looking at … firstly, understand how your prices, you know that price, volume cost situation. Understand where your margin is. Understand how much, if I did put my price up, if you can use that breakeven analysis, it will give you an idea of how many customers you could lose and still make the same amount of profit.
So, if you’re looking at putting your price up, maybe just a little bit, that will give you a bit of an idea of what impact it will have on the volume. Now of course it doesn’t give you an idea of what you customers are ging to do, but again it will depend on your business. And, what you might find is, as long as you’re offering a value product, your customers love you … there’s a good chance if it’s only a small increase they’re going to stick with you.
Sometimes if you’ve got a lot of product lines, try it with just some of them to start with, and see what the impact is. So, you can just like test the waters with it a little bit as well. I’m a big believer that quite often in business, we are so scared we are going to lose business we don’t put our prices up. But our costs have all been going up which means it squeezes our profit.
You’ve always got to think about how do I monitor my price? How do I monitor what my customers are doing? And the best thing I always think is, put your prices up small amounts as often as you can get away with. Yes, you do have to take into account your competitors and that. The other thing with price is you do have to look at your market and you have to look at your competitors. You will find that some markets, because the competition is really hard in those markets, nobody’s making a profit.
Everyone should put their price up, but if you put your price up your customers are going to go to your competitors. In those type of markets, that’s a hard sell. You’ve either got to look at how do I become the lowest cost producer of my product or service in that market, so look at your cost side, or you get out of the market, which is a very tough decision, or you try and go along, you try and find a way to make sure your customers see the value for the extra they are going to pay with you.
Now I know that’s not giving you a definitive answer David but hopefully that’s helped you think through some of those considerations. I’m just having a look. I don’t seem t have any more questions at this time … so what I was going to say it, if I don’t have any more questions it might be because you had trouble with the technology, it may be that it’ll come to you this afternoon or whatever, you can always email us at the Davidson Institute.
But before I give you, put the thing up on the screen … you know, we’ve only got one more webinar to go in our Back to business in 2021 series, so I really do hope you can join us tomorrow for Sustainable Growth. If you missed the others but you feel they could be helpful for you, the recordings are going to be available up on the Davidson Institute website for a short time.
Now as I said if you do have any other questions the email should be coming up … firstname.lastname@example.org. Please send us questions we’re more than happy to come back to you. In closing today, let me thank you for joining us for our ‘Maximising profits’ webinar. I really do hope you found this information useful and relevant and I encourage you to check out the other webinars and resources on the Davidson Institute website to help build your financial confidence.
We’d love to hear your thoughts on the webinar so there’s a short survey coming up that we’d really appreciate you taking a moment to complete. Thanks everybody again for you time and I wish you every success with your maximising your profits, please enjoy the rest of your day.