Times are hard, for both businesses and individuals and we need to look at effectively increasing profitability or in the case of individuals income. There are many ways of doing this from increasing sales by cutting prices to cutting costs but we need to look at how to effectively increase profitability.
First, we must address the true problem. For most businesses (and individuals) the problem is fixed costs over which you have little or no control in the short term. In the case of a business that will be things like rent and rates together with associated costs together with wages and salaries. In the case of individuals mortgage, food, insurance etc. Whilst it is possible to make some changes by making people redundant (time consuming and expensive, not to mention demoralising) or cutting costs by no longer investing in things like training and investment (demoralising and expensive in the medium to long term) it is better to look at the effective solution (that of contribution).
Putting on my bean counter hat contribution equals selling price minus variable costs but what does that really mean in practice?
We all sell something. In my case it’s mostly time and that is true of most consultants and employees as well. In the case of other businesses it is products and / or services. Now contribution can get very complicated but we are looking for quick wins in the current crisis so KISS (Keep It Simple Stupid). Lets take a simple example (me). There are very few costs over which I have any control at all. I need to run the car, have a computer, heat and light for the office and so those costs are fixed (certainly in the short run). I could spend hours looking for the cheapest diesel and servicing costs for the car, I could turn the heating down in the office or find a cheaper supplier etc but none of those make a difference quickly or are significant and certainly not effective. I could cancel my subscriptions to professional bodies and stop paying for training. These would have a short term positive effect but medium to long term would be a disaster. Instead I can look to contribution.
Compare three scenarios:
Client 1 pays £400 per day but is organised and a day takes 7.5 hours and I can do 80% of my work from my office at home. Here there is very little in the way of expenses (say travelling at an average of £40 per day) The contribution per limiting factor (my time) is therefore £400 less £40 £360 or £48 per hour
Client 2 pays £700 per day (75% more than client 1) but is a shambles and is based in London and insists I travel to them. Travel costs are £150 and I have to leave early, get back late (a 12 hour day) and they regularly want work done outside of the day they pay for totalling another 2 hours. This time contribution per limiting factor is £700 less £150 = £550 which looks better than client 1. However per hour (time is the limiting factor) it is now only £550 divided by 14 = £39.29 Obviously, my high paying client is worth less than my lower paying one.
Scenario 3 I run a course for 20 people at £150 per head. I have travelling expenses of £450 and it takes me 3 hours to prepare, 7 hours to run and there are a further 3 hours of travel. Now my contribution is £3,000 less £450 giving £2,550 or a contribution per limiting factor of £196.15 per hour.
Now, it is unlikely that I will run as many days courses as I can do consultancy but what I can see is this. One day training is worth as much as 4 days with my best client (the one who pays the least) and 5 days with my worst client (the one who pays the most). It is also clear that if I want to do more client work I should choose clients with the profile of Client 1 not Client 2 in order to maximise profitability. Effective profitability does not equate to sales income. Sales are just vanity.
Of course an even more effective way of increasing profitability is to put the courses online and increase contribution per limiting factor further even if selling price per seat goes down.
If you want to effectively increase profitability then identify your limiting factor, calculate contribution and seek to maximise it. Don’t look to sales.
The same is true for individuals. If you want to increase your true income look for things where you can improve your income per limiting factor. Working from home may reduce your daily commute, increase your contribution per hour and release time to do something else.
The above examples are simple and use simplified and illustrative figures but they make the point. Chasing sales income or slashing costs are not effective ways of increasing profitability. Contribution per limiting factor is the effective way.
Every business and everybody has a limiting factor. What is yours?
To discuss further please drop me an email.
If you want to receive our regular blogs, please subscribe at Subscribe