As I’ve talked about before, we are either growing or dying. I just re-read a post I did last year about this time.
I encourage everyone to understand the basic profit model for most businesses. It works with GE, Bill’s Pizza, Boeing, Joe’s Garage, Worldwide Truck Parts, etc. Not all businesses, but many.
The Basic Business Model:
- Leads x Conversion rate = Customers
- Customers x Number of Transactions x Average Transaction Amount = Sales
- Sales x Profit Percentage = Profit
Some variables have more moving parts than other. Number of customers is easy. The Profit Percentage, on the other hand, is comprised of many elements: product cost, overhead structure, freight, employee costs, etc.
The basic model is pretty simple. I created a little model to see how powerful small changes can be. Check it out here.
First, start with actual numbers. Don’t make assumptions here. Again, most of the numbers are very easy to get.
Now peel the onion back a little and see what happens when you leverage small improvements a couple of these variables.
For small and medium size companies, I like to focus on average transaction, number of transactions per year amount, and gross profit. For the model, I increase .25 leads per day, increase average transaction size from $189 to $225 and increase gross margin 1/10th of a percent. The impact to this company is a 32% increase in profitability.
Strategies to increase average transaction size include:
- Change product/service mix.
- Offer add-on products and cross selling of similar products.
- Reduce number of low dollar customers: increase minimum orders, train sales staff.
- Look at your freight policy. Increase your free freight threshold.
- Bundle/kit products together based on customer needs.
- Raise pricing. This is never popular with the sales guys, but this can make a huge difference.