Your Options for Improving Profit in a Business
For businesses, improving profit is the ultimate goal. The options for improving profit in a business boil down to three critical factors, listed in order from the most effective to the least effective:
Increasing margin per unit
Increasing sales volume
Reducing fixed expenses
Say you want to improve your profit from the $1.5 million you earned last year to $1.8 million this year, which is a $300,000 or 20 percent increase. Okay, so how are you going to increase profit $300,000? Here are your basic options:
Based on a 100,000 units sales volume, you could increase your margin per unit $3, which would raise total margin $300,000.
Sell 12,000 additional units at the present margin per unit of $25, which would raise your total margin by $300,000. (12,000 additional units × $25 = $300,000 additional margin.)
Use a combination of these two strategies: Increase both the margin per unit and sales volume such that the combined effect is to improve total margin $300,000.
Reduce fixed expenses $300,000.
The last alternative may not be very realistic. Part of your fixed expenses ($250,000) is the amount allocated from headquarters, over which you have no control. Reducing your direct fixed expenses $300,000, from $750,000 to $450,000, might reduce your capacity to make sales and carry out the operations in your part of the business. Perhaps you could do a little belt-tightening in your fixed expenses area, but you likely would have to turn to the other alternatives for increasing your profit.
The second approach is obvious — you just need to set a sales goal of increasing the number of products sold by 12,000 units. (How you motivate your already overworked sales staff to accomplish that sales volume goal is up to you.)
How would you go about the first approach, increasing the margin per unit by $3? Your options include the following:
Decrease your product cost per unit $3.
Attempt to reduce sales commissions from $8.50 per $100 of sales to $5.50 per $100 — which may hurt the motivation of your sales force, of course.
Raise the sales price about $3.38 (remember that 8.5 percent comes off the top for sales commission, so only $3 would remain to improve the unit margin).
Combine two or more such changes so that your unit margin would increase $3.