Increasing Profitability

Once you have established yourself at markets, it is very common to “plateau” where you are limited by how much profit you bring home each month. This may be exactly where you want to be but for many of us, we want to continue to grow our business.

To begin this discussion, we have to assume that when the market is over, you have product left over that hasn’t sold. You take that home and use it for your inventory next week. If this isn’t the case, then I think we know what limits your profits. You don’t have enough product to sell! If this is the case, all you have to do is make more product. If not, read on…

Increasing profitability is easy, right? You just raise prices! Not quite.

101
Supply/Demand Curve from Basic Economics Class

Lets take a trip back to your high school economics class. In class you learned about the supply/demand curve. The basic theory is that as you raise prices, demand will fall as there is not enough perceived value for the asking price. The theory also says that if you lower prices, demand will go up as people consider it a deal!

As an aside, economics is a little more complex than that because the basic theory glosses over the concept of perceived value. To see perceived value in action, consider an old refrigerator that you want to get rid of.  Ever try to give an old refrigerator away? Its almost impossible. However, if you want to get rid of it quick, just put it on the curb with a sign that reads $20. I bet by the time you wake up in the morning, it will be gone.

Sure, you can’t give a refrigerator away, but someone will take it if they perceive that it has some value greater than what they are paying for it.

The lesson to take away from this aside, is that there is a limit to how much you can raise prices. The price you charge for a product must be less than or equal to your customers’ perceived value of the product in order for a sale to take place. Yes, there are a few customers who will over pay for a product because they like you, but customers in general will not.

Since we are limited to how much we can raise prices, lets look at other ways to increase profits.

Assuming you read a previous post “How to Price Your Products“, you know that that there are two basic cost types; direct and indirect. Direct costs are those costs that incur that are directly related to the production of your product. Indirect costs are all the other costs that support the business.

Direct Costs

When it comes to direct costs, you can increase profitability by paying less for what you put into the product. Building on the cupcake example in “How to Price Your Products“, our cupcakes need eggs. We can lower the cost of eggs by finding a wholesaler to sell us eggs directly instead of going to the store.

As you can probably see, this has a practical limit. We need to be able to use all the eggs we purchase before they go bad. Also, we need to be able to store the eggs.

A really good example of this was on an episode of “The Profit” on CNBC. If I recall correctly, it was an episode about a salsa maker who was struggling with improving profits while lowering costs. Marcus (the hero of our show) swoops in and explains that they are buying grade A tomatoes for their salsa when they don’t need grade A. He introduces them to a supplier of grade C tomatoes that are just as good, but don’t have the same visual appeal. They lowered their tomato costs by a good margin.

To determine your direct costs, make a list of all the things that go into making your product. Include all the ingredients or supplies, any disposable items that you use on that product (such as disposable gloves and paper towels), and don’t forget packaging. Packaging can very easily cost more than the actual product you are making.

Once you have this list, evaluate it. Look for places where you may be using the best of something when the best may not be required. Maybe you are making home decor items and are using fine art paints. Are these higher cost paints actually required or can you substitute something less expensive without sacrificing quality?

Also, look for places where you can purchase wholesale in bulk. This is particularly true for non-perishable items. Maybe you are like me and go through paper towels like crazy. Unfortunately for me, I can only use one particular type of paper towel because the other types react poorly to a chemical reaction in my finishing process; they catch on fire! Every other month or so, I go buy the biggest bulk of paper towels I can. This brings down the per unit cost significantly.

While a paper towel or disposable gloves may seem insignificant, the costs accrue very quickly if you are not watching.

Indirect Costs

Another place to increase profitability is by understanding your indirect costs. These costs are the costs you incur for everything that is not directly related to your product. These costs include equipment, rent, storage fees, bank fees, office supplies, and all the other costs of running a business.

These costs must be controlled as well. Thought should be put into lowering your indirect costs just like the direct costs. However, a common mistake that a lot of businesses make is to lower their indirect costs so much that production of the product is jeopardized. Be very careful of this trap.

Another way to improve profitability may actually be to INCREASE indirect costs. Yes, that is correct. Investing capital in your business, but doing so wisely, may actually increase your productivity allowing you to get more done in less time.

Take for example the oven required to bake cupcakes. Maybe you are using a regular household oven and can bake 24 cupcakes in an hour. What if you were to replace this oven with a convection oven? A convection oven may reduce the overall time it takes to bake cupcakes by 35%. This means that you can bake 35% more cupcakes on average in the same time frame. This increase in production may pay for the cost of the oven over time. NOTE: I’m making all these numbers up so don’t run out and buy an oven based on my assumptions!

Another indirect cost that is worthy of consideration is the cost of the space in which you create your product. Maybe, like me, you are stuck in a cramped garage with little room to move around. Perhaps finding a warehouse to work in would increase your productivity significantly allowing you to make a whole lot more than what you do today. Yes, I think about this every day but don’t know if it is the right thing to do yet. I know that it would increase my productivity, but would it increase it enough to pay for the rented space?

Paying attention to your direct and indirect costs can help you understand where profitability can be improved. Also, finding the right places to invest in your business can dramatically improve productivity and therefore increase profitability. It is up to you to understand what is right for you and your business.

However, these are not the only places where you can improve profitability. One other technique to improve profitability is to actually lower costs. Another is to increase perceived value. Its even better if you can do both. I’ll write more about these techniques in a future blog post.

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