I have noticed a trend with many of my clients over the past year or two. While their sales numbers have increased, so have their costs of goods sold. In other words, they have sold more but made less.
How can that be?
Of course, the recent bout of inflation is partly to blame. As costs of materials, products, and services spike, businesses no longer enjoy the same profit margins when selling their final product at the normal price.
So, with your profit margins dwindling, what should you do? Let’s look at three strategies you can use to increase those profit margins!
1. Lower Your Costs of Goods Sold
The most obvious place to start is with your costs of goods sold. If you can reduce the amount you pay to your vendors without negatively affecting your products in any way, you can effectively increase your profit margins.
There are a couple of ways to go about this:
You can achieve this by finding new suppliers and asking them for quotes. At the same time, let your current vendors know that you’re considering other vendors. Many times, this will earn you a price reduction. Put yourself in the vendor’s shoes. It’s much harder to get a new customer than it is to keep the one you already have!
Order Larger Quantities
Many suppliers will offer significant price breaks and discounts on large orders—allowing you to pay a lower price per unit. If all of your options have similar prices, giving your business to the one with the large-order discount is a great way to break the tie.
2. Pass the Price Increase on to Your Customers
If you aren’t able to lower your cost of goods sold, consider passing them on to your customers by raising your sale prices. This will allow you to recapture your original profit margin.
You would be surprised at how often businesses raise their prices without experiencing any pushback from their customer base. The caveat, of course, is if pricing is one of your business’s main selling points. In this case, you will need to tread carefully so as not to alienate customers.
3. Make Changes to Your Product Mix
Finally, one of the most effective ways to increase profit margins is to make changes to your product line—namely, eliminating products that aren’t profitable for your business.
Consider the 80/20 rule. As it pertains to your product line, the rule states that 80% of your company’s revenue is generated by 20% of your products. This leaves a whopping 80% of your product line that only generates 20% of your company’s revenue.
By refining your product mix, you can eliminate the products that aren’t helping your business and emphasize the products that are your biggest profit generators.
You can achieve this through the following steps:
Gather Data for Your Entire Product Line
Enter all of your products into a spreadsheet and be sure to incorporate all relevant data points for each line item—including the individual cost of goods sold, the number of units sold, and the gross profits generated. If you can also list these figures from years past, it will make it easier to identify issues when auditing your products.
Sort the Data and Apply the 80/20 Rule
Next, you will need to sort your list by your most important data points. Flag the worst performers each time (or the bottom 20% in each exercise) and create a new spreadsheet that only contains these products.
Audit Your Low-Performing Products
Next, it’s time to audit the bottom 20% of your product line. While you may feel some level of attachment to certain products, it’s important to take a step back and be as objective as possible when evaluating each item. Ask the following questions:
- Why is this product performing poorly? Is it due to being priced too high or too low? Did a recent addition to our product line make it redundant?
- Is this product approaching the end of its life cycle?
- Could we sell more of this item if we promoted it differently?
- Does this product have an untapped market that is being overlooked?
- Could we redesign the product in a way that might improve sales?
- Would it make sense to add this item to another product in our line and raise that product’s price?
After auditing a product and determining that it isn’t worth salvaging, simply drop it from your product line. Otherwise, make changes to the product that will allow it to become more profitable. In the meantime, be sure to promote the top 20% of your product line!