One of my clients, let's call them the Jacksons (a husband/wife team), first came to me with a unique problem. They just started a home renovation business about a year back and they have been working real hard (12-14 hour days even on the weekends) to make it a success. They have always been working on client projects and hardly were idle since they started. Funny thing is that their savings continues to deplete and credit card balances continue to rise. They were extremely stressed out and on the verge of closing their business.
I sat down with them and went through their books. I started all the way from how they market themselves to their contract proposals to actual work they performed. Couple of things immediately stood out.
- To make sure that they win the contract, they consistently priced lower than the market. They priced the crew-lead at $30/hour whereas the going market rate was about $50/hour. They have similar low rates for the helpers in the crew.
- On top of that they promised lower estimated hours for each project. As a result of that they almost always spent more hours then estimated to complete the work, obviously at their own cost.
The combination of these two factors resulted in a higher cost for each project than the revenue it brought in; in other words a loss on every project. Do you understand what that translates to? The more projects they undertook the more money they lost. In other words they had a "Loss-incurring Revenue Growth".
It seems like a no-brainer as to why would anyone want to grow a business that doesn't make a profit; but you will be surprised at how many business owners overlook the profitability factor. Here is a primer on what profitable growth means.
Let's start with what is growth. Then we can discuss what "Profitable Growth" is.
Simply defined, "Growth" is calculated as increase in Revenue.
Let's say you sell widgets. Last year you sold 100 widgets at $10 each. Your annual sales revenue last year was $1000.
$10 x 100 = $1000
Price x Volume = Revenue
Suppose this year you want to grow your sales revenue to $1200. In other words you are hoping to grow by 20%.
[($1200 - $1000) / $1000 = 20%]
What can you do to increase your sales revenue?
- You can raise the price for each widget to $12, and sell to the same 100 customers (increase Price), or
- You can sale 20 more widgets at the same price (increase Volume).
As you can see, Revenue is a function of
If you increase either, your sales revenue will go up.
- Raise Price: $12 x 100 = $1200
- Increase volume: $10 X 120 = $1200
What if you can change both; that is, raise the price to $12 and sell 20 more widgets.
â€“ Your revenue grows to ($12 x 120=) $1440; a 44% growth, more than double the growth from previous scenarios.
Simple; right? Well let's take the first scenario.
You changed the price to $12 each hoping to increase your revenue by 20% by selling to the same 100 customers. What if 10 your customers refuse to buy at the increased price?
Your revenue will be $12*90 = $960
You lost revenue.
But for instance, say 80 of your customer really love your widgets and are ready to buy even if the price is $15.
$15 * 80 = $1200
You lost 20 customers; but your revenue went up.
Is it worth losing those 20 customers if you can make more money? How do you know what price is right for your widgets? Could you have sold something else to those lost customers and make some money out of it? Or is it better to focus on the profitable customers only so that your support and operations cost is less?
We will tackle these questions and many more in the subsequent articles.
PS â€“ Regarding the Jacksons. They increased their hourly rate to $45 (just below the market rate), used more realistic hour estimates and stood by their work with quality guarantee. They didn't lose any clients and increased revenue by five times in three years at a healthy 30% operating margin.