It’s not how much money you make; it’s how much you get to keep. Unfortunately, as the cost of labor, materials and shipping goes up your profit margins go down and you get to keep less and less of your revenue. The natural response to this dilemma for many organizations is to raise prices, reduce services, cut overhead or just accept lower margins and hope to make up for it in volume. Any one of these options has risks that must be weighed very carefully. If only there was a way to allocate resources in a way that results in lower costs, increased revenue and profitable margins.
As counterintuitive as it may sound, spending more resources on Market Effectiveness can result in lower costs and higher margins. Many organizations have misguidedly tried to increase profits by cutting back on market-facing activities and reducing their marketing budgets, product development or R&D only to find themselves with fewer sales AND lower margins. This has been especially true during the Pandemic where consumers flocked to the internet to find goods and services. When faced with tight margins, tough competition and declining revenue, it can feel like you’re trying to make a hairpin turn at maximum speed on a dirt road; and just like professional racers do in that situation you have to steer against the turn to come out on top.
So how do you accomplish higher margins without reducing your budget? Here are some suggestions:
• Understand the nature of your costs
• Target the right customers
• Focus on customer profitability
• Measure right and measure well
Understanding the Nature of Your Costs
Before you can address any issue, you must first understand it. Overhead, direct labor and material costs are the basic building blocks of running a business, but if you think about it, you are not “spending” the money. You are investing it in order to get more money back in return. You should analyze your books with an eye on your investments, where they are working and where they are not. There are several methods to help measure the ROI of your resources: Inventory turns, productivity, conversion rates, customer profitability, product profitability and many other KPI’s. The key is to conduct an in-depth analysis of your operations and determine which assets are affecting profitability in a positive or negative way. A well-executed analysis will run through scenarios that will demonstrate the net effect of changes you make: ie cutting back on advertising costs or realigning your sales force.
Targeting the Right Customers
Even the most exceptional marketing campaign will not work if your target audience is not interested in what you are selling. Many organizations focus on their product or service instead of consumer needs. The old movie quote, “If you build it; they will come” just doesn’t work unless you’re promoting it to the entire world which would require a sizeable marketing budget. An effective marketing strategy must focus on the pain points of the consumers that want your product and are willing to spend their hard-earned money on it. A well-crafted marketing campaign may mean a larger investment of resources, but this investment will pay off because you’re only spending money on those who are receptive to your message which leads to higher conversion rates, sales growth, and better ROI.
Focusing on Customer Profitability
Beyond the fact that it is 5-7 times more expensive to acquire a new customer than it is to retain an existing one, there are two concepts to keep in mind: Customer Lifetime Value and Customer Profitability. While both of these measurements approach it from different angles, the goal is the same: How much is a customer worth to your organization?
Customer Lifetime Value
Customer lifetime value measures the amount of revenue that a given consumer will spend with you over the length of your relationship. For example, a company like Apple Inc. can expect a recent college graduate to buy a new iPhone every 2-3 years at around $400 for the next 40 years. At an assumed 5% discount rate, the net present value of this transaction is around $4,500, assuming things like brand loyalty, product releases and economic stability. This calculation shows that Apple can spend $4,000+ per customer on acquisition and still come out on top. It is not a simple calculation for every industry, but it is a valuable one.
Other companies also consider how much they are spending on their customers. Many organizations only look at the revenue a customer is providing and forget to account for time and effort they are devoting on customer service, warranty claims or training. These costs can quickly erode margins. When implementing its loyalty program, Harrah’s found that some of their guests were costing the company money in “comps,” or free items given to guests to entice them to stay and play, and were actually losing money on every visit. When the “freebies” went away for these customers, they took their money across the street – reducing their competitors’ margins. Not every customer is a good customer if your ultimate goal is to increase profit margins.
Measure Right and Measure Well
The key to using metrics is establishing a baseline, determining your goals, and continuously tracking progress. To do this effectively, you have to ensure both consistency and transparency. In order to implement organizational change, all employees must be aware of the end-goal and they need to believe that the organization is committed to it. Just saying that you want to increase inventory turns is not enough, you must give your warehouse staff and your purchasing department the tools and the authority to address any issues that affect the metric. When everyone is involved, it makes meetings and decisions easier. One common way to achieve this is to implement dashboards were everyone can see progress and have ownership. When everyone is on the same page you can all celebrate together when you reach the finish line. But beware: Not selecting the right metrics can lead to misunderstanding and conflicting incentives that will only slow you down. It is important to make sure the metrics selected are appropriate, achievable and are the right ones to help you achieve your goals.
The most successful organizations recognize that their resources are investments and work to make sure that they provide a good ROI. Using your capital wisely and making it work for you by understanding your costs, targeting the right customers and making sure your customers are profitable is the best way to increase profits.
The Market Effectiveness professionals at Group50 can work with you to develop a needs assessment, identify the proper metrics and implement a plan to address your market facing activities, and increase profit margins. Give us a call at (909) 949-9083, email us at firstname.lastname@example.org or request more information here to discuss your options or to schedule a time to speak.
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