While some businesses struggle to achieve a small 2% profit rate, others manage to easily surpass the 18% net profit margin. Why is that exactly? What makes a business more profitable than the next? Is it linked mostly to proper management of operation costs or is there more coming into play?
When starting out, these questions can keep entrepreneurs up at night. While they are ready to take the leap, they wonder if the journey will be worth it financially. They also want to ensure they’ll have all the key elements in place to optimize the profitability of their business project.
So, how do you build a business that will truly be profitable? Here’s the first of two blog posts on the subject, which, I hope, will help you fill your entrepreneurial toolbox.
As with the Ying and the Yang, creating value and managing costs are interconnecting parts to business profitability. This first blog will focus on one of these two key elements: creating value.
First off, let’s start by breaking a myth. Some entrepreneurs wrongly believe that some business sectors or industries are more profitable than others. But that’s not the case.
It could be tempting to assume, for example, that the tech industry could be more profitable than the restaurant industry. That said, industry does not guarantee business profitability. Profitability depends on the business project, and not the sector or industry. Dealing with deficit is entirely possible in the tech industry, just as is making a profit in the restaurant industry.
A business’s profitability relies more on the strength of the business project which informs the creation of said business. A business project encompasses many elements, such as its market, its business model, its innovation or its promoter, meaning you, the entrepreneur. A business project also fits within a specific timeline, which means a business project with a high profitability potential today might not have the same potential tomorrow. The concept of time is therefore crucial to its profitability potential.
The goal here is not to elaborate on the building blocks of a business project, but rather to give you some areas to think about when it comes to factors influencing business profitability. Remember that profitability is linked to the business project as a whole. Here though, we’ll be taking a closer look to some specific profitability factors.
It goes without saying that profit is calculated by subtracting the total operating costs from the sales revenues. All entrepreneurs understand this simple equation. However, most entrepreneurs don’t realize the importance of having the right sales price to optimize their profitability. Most settle for selling at the same price as their competitors.
But to maximize profitability, you need to complete a comparative analysis of the competitors’ prices. This means you’ll need to identify what price all your competitors are selling for, but also highlight the value they bring to the consumer in each specific case. In other words, you’ll need to ask yourself the following questions: What does my competitor offer the client for the same price? What tangible benefits does the client derive from the product? Can they find the same benefits elsewhere? At what price?
When you ask yourself these question, you can make the connection between what you offer and the value it brings to the client. In the end, what’s bankable is not your offer; it’s what benefits your client can take away from it.
Being aware of the benefits associated to your offer will allow you to charge for their true worth. There must be something specific to your product or service which justifies a more appealing price for you as an entrepreneur. So then, what feature is unique to you? What specific value do you bring to your client?
Profitability is not only about your sales price. Another important variable also comes into play: your business model.
What level of service will you be offering your client? What distribution channels will you be using for your product or service? Who will pay for your product or service? Will you have different rates for different types of clients? Which of these customer bases will be the most profitable? How will your product be produced?
These are only a few of the questions which will help you uncover the underlying business model to a project. All the elements have an impact of your business profitability.
For example, if you are alone in offering a certain product or level of service, you’ll have more flexibility to generate more substantial profits. On another level, if your business model allows you to bypass a more traditional distribution system, you’ll be able to make a profit where your competitors will need to cover costs.
In other words, it pays to have an innovative business model! You’ll just need to take the time to design it well and consider different option instead of sticking to your first idea.
As I’m sure you’ve understood, profitability happens through creating value for the client. This value, which is built upon your business model, will then have repercussions on your sale price. But let’s not forget that profitability is not only about creating value for the client. You also have to manage your costs effectively!
The second part of this blog will explore how to tackle the costs associated with your business to boost profitability. Don’t miss The Yang of profitability: Managing costs in the upcoming weeks.
Written By: Jean-Philippe L’Écuyer, Entrepreneur in Residence, Futurpreneur Canada, firstname.lastname@example.org