Last week we started a new series of SMB Financial Fundamentals. Today we continue with part 2 (of 5) and talk about Revenue & Profit Drivers.

We talk about my (least) favorite NBA player, Draymond Green, again and 4 categories of revenue and profit drivers.

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REVENUE & PROFIT DRIVERS: 18 (AT LEAST) WAYS TO MAKE YOUR BUSINESS MORE PROFITABLE

Back in December, I tied Draymond Green and his poor decision-making to the key moments in your business when you make the most important decisions… it’s honestly one of my most proud moments as a writer. I was smiling the whole time I wrote it.

I couldn’t come up with quite the intro today, so I’ll just refer you that one… but today we’re going deeper on the topic we intro’d that week: the “drivers” in your business.

This week we’ll discuss Revenue and Profit Drivers, and next week cash flow drivers.

So what are drivers? They’re the elements in your business that have an outsized impact in the outcome you have.

It’s time you make a pricing change.
It’s when you set your marketing strategy and then don’t change it for years.
It’s when you do a handshake deal with a supplier for your main product because he seemed nice.
It’s firing that one employee that came back to bite you.

Whatever it is (I realize these examples aren’t great), they’re the turning points in your business.

Sometimes they’re made passively, sometimes actively.

Today we’re going to try and systematically walk through the potential high-impact items that could fundamentally change the revenue and profit in your business.

The hope is they’ll change them positively, but only you can make that determination.

When it comes to revenue and profit, there are four main categories we’ll focus on:

1. Product & Pricing (services, too)
2. Cost Optimization
3. Marketing Strategy
4. Financial Health & Structure

As we go through these four categories today, my focus will be speaking broadly, as we’re still not narrow enough to really dive deep. I’m sure in the future we’ll hit on individual elements of this framework and start really putting the screws in these topics.

Until then, my goal is this sampling will get your wheels turning, which will allow you to reframe some elements within your business and create one of those inflection moments.

Product & Pricing

Differentiated products have a higher perceived value, but homogenous products offer different value propositions, as well.

The reality is, there is always some sort of differentiation that’s happening within markets, even if it seems minuscule or imperceivable.

Fast food burger joints all offer burgers, but they have their unique brand that creates some sort of differentiation. You can differentiate in a few ways:

1. Quality of offering
2. Branding and positioning in market
3. Diversification of offerings

Aligning these levers with your pricing is key to customers seeing they’re receiving the value expected from the product.

Even brand colors can signal or connect with different consumers.

I’m a Home Depot loyalist strictly because I love the orange (and grew up an Oklahoma State fan). Sure I’ve justified it other ways in the past, but proximity to home made it a no-brainer. Now, while living closer to a Lowe’s, I still choose Home Depot. These small differences and relationships with the customer matter.

Walmart signals low quality but also low price. The value aligns, so people choose Walmart. For others, Whole Foods is their preferred shopping experience.

Even within the low-price market, Aldi has chosen less diversified offerings and a lower price. There are infinite combinations and most small businesses don’t consider these.

When a small business brand is thrown together, with the truck not logo’d and no website… that tells you something about the business owner’s relationship with their customers. And in most cases, that’s what the customer wants from that relationship. When this business chooses to “professionalize,” they could lose a segment of customers who don’t want that (they want “their guy”) but will gain others.

The goal, from a financial standpoint, is to maximize the value draw from your business. If you have a $20 brand, we want to extract $19.95 from that customer. Not because we’re greedy, but because that’s what the customer values the interaction at.

But, if your brand is value, you may choose to leave something on the table (say extract $15 instead).

This play is more an art than science, but only one that can worked through with open discussions and much thought.

And most businesses aren’t giving pricing much thought.

We need to change that.

Consider all 3 elements listed above (quality, brand/positioning, and diversification) of offering and what signal it’s giving to your customer.

By offering one product or service, you’re signaling you’re an expert at that specific thing. Adding more could reduce that authority or it could add to it.

The same goes for the other elements. There is no one right answer to any of these, as they’re all unique to your business and your industry.

Consider each point on it’s own and together. Start crafting your message, then circle to pricing.

We’ll get in more specifics in the future, but this should get you started thinking down this line of processing.

Cost Management

Product and pricing is the most important lever, in my opinion. But I typically start with cost. Why? Because it’s easier to get quick wins and show forward progress. It’s also a temporary destination.

Pricing is an ongoing discussion. Cost optimization is something we address and move on from (to areas that need constant maintenance).

Operational Efficiencies

The first lever within cost management is looking for operational efficiencies. It’s cutting what’s obvious and automating or systemizing what’s repeated.

Some examples of ways to optimize cost:

1. Cut unused software or subscriptions
2. Consolidate vendor relationships to get better terms (and purchase in bulk where possible)
3. Outsource specialized services where staff is losing time or not fully utilized (IT, HR, cleaning, etc)
4. Consolidate staff duties through a process and procedure audit
5. Implement software solutions to automate repetitive tasks, reducing need for future hiring

COGS Optimization

Next, and most important, is COGS optimization. Cost of Goods Sold is often the largest cost in the whole business, which means optimization here can have the biggest immediate impact to a business.

Too often businesses start by sourcing through one channel and stick with that channel despite increased scale opening up new opportunities. I absolutely get it… there is a significant cost to change. But being comfortable isn’t a good reason to stay. Choosing the stay because the other options are only marginally better (but add uncertainty) is a good reason to stay.

Some examples of way to improve COGS:

1. Renegotiate supplier pricing based on changing market or business conditions
2. Improved production process that reduces cost of assembly
3. Outsourcing underutilized items to an expert in that vertical
4. Source materials (or product) from a new supplier
5. Introduce automation to your process
6. Improve quality control
7. Negotiate better freight and shipping relationships
8. Implement software that optimizes the process
9. Maximize labor usage, lowering labor cost per unit

Many of these are geared towards product businesses but also apply to services.

Because every business is unique, there are a million answers in this area. This is just a sampling to get your wheels turning.

Say your Gross Margins are 40% and Profit Margins 15%. On a $1 million revenue business a 1% increase in Gross Margins means $10,000 dropping the bottom line. That’s a 6.7% increase in profit ($150,000 to $160,000). On a $10 million revenue business, that’s a $100,000 difference.

Small numbers turn big as you grow and getting these right early will allow you to grow well.

I have some stories here I’d love to share, but this post will already be plenty long enough, so I’ll save them for later. 🙂

Marketing Strategy

Once we’ve gotten our product and pricing nailed down, it’s time to talk marketing.

The two elements to focus on are customer acquisition cost and retention. When we know what it costs to get a customer, we know what we should be spending to grow.

When we know our retention, it helps us increase the efficiency of the business profits.

Each of these can be summed up with LTV, or customer lifetime value. Customer Lifetime Value is calculated by taking multiplying customer value by the average customer lifespan.

If the average shirt costs $50 and the average consumer buys 4 shirts over 2 years, their customer value is $400 ($50 x 4 x 2). If your margin is 15%, their value to the business is $60.

If our CAC (Customer Acquisition Cost) is more than $60, this business can’t make money long-term. But if the CAC is $30, that means for every $1 to acquire a customer, you’re getting $2 in profit. This is a great trade and means that any cash issues should be temporary.

So to optimize marketing, we need to:

1. reduce customer churn (keep them longer)
2. get the customer to buy more (increase frequency)
3. reduce cost of marketing to acquire customers

Each of these can be accomplished 20 different ways, like:

1. Offer a referral program (reduces cost to acquire)
2. Seek out new marketing channels
3. Improve sales process (improve conversion, make more efficient, etc.)
4. Upgrade customer service, thus depending and lengthening relationship

The type of business is going to determine the right marketing channel and cost structures of these channels can look different depending on the industry.

Tracking these metrics and understanding them deeply is key to managing the business well, as they can change quickly.

Software like NetSuite will allow you to track these metrics all on a financial dashboard, so you can see them live anytime you need them.

Financial Health & Structure

This gets a little into the cash flow discussion, so we’ll go light on this one today.

But, it’s a part of revenue and profit drivers as debt costs you real money on the Income Statement in the form of interest.

Too much debt on low-margin businesses can strangle the business's ability to reinvest as interest from debt eats up excess cash flows.

To stop this strangle, the only way is to improve debt structure. This is:

1. Reducing debt load on the business
2. Lengthening terms on onerous debt
3. Seeking lower, and more predictable, interest rates

The main mechanism banks look at is the Interest Coverage Ratio. This is EBITDA (Earnings before Interest, Taxes, & Depreciation/Amortization) divided by Interest Expense (sometimes they use EBIT or other Earnings metrics). This tells us how many times the business could cover interest payments. A higher ratio is better, because that means the business has:

1. More free cash flow to cover debt and reinvestment
2. A larger margin of error in case of a downturn

A good Interest Coverage Ratio depends on the industry and specific situation. If you have debt through a bank, it’s likely they’ve requested this number and have a minimum requirement.

Wrapping Up

Different variables are more important for different businesses. Only through going through the different elements of your financial statements can you ask the deeper questions needed to analyze these costs. Here is a handy little cheat sheet with the concepts we talked about today:

Next week we’ll be talking about Cash Flow Drivers, but on Feb 29th and Mar 7th we’ll be talking about KPIs and converting numbers to decisions. In these weeks we’ll help you evaluate your numbers more deeply.

See you next week as we talk cash flow!