Disclaimer: I am not a financial advisor or accountant. This article is for informational purposes only. Please use the info at your discretion.
If you’re starting out your business and you're selling through every channel you can, you might be doing it wrong.
You know what profit margin (PM) is, right?
It’s especially important that you focus on the highest profit margin products when you're starting out and trying to grow your business.
You only have so much time and product. You have limited resources. You need to use them to get the biggest bang for your buck (and minute).
This is simple. It makes sense. But we get distracted by opportunities for cash. When you start out, not all selling is “good”. We get excited that people like our product and think we should take on every opportunity to make cash. But we shouldn’t (as Isa Seminega testified to in this post).
Let’s look at a real-life example (specifics modified/removed for privacy) -
My friend runs a business where she makes and sells handmade items. When she started out, she went through the traditional wholesale channels to sell her product. She went with the traditional pricing as well (without really looking at her numbers) - she marked up her product for about 2x what it cost her. And the wholesaler marked it up 2x what it costs them.
She also sells her items online for the full retail price (plus shipping), so she’s making about 4x her costs on those sales (as opposed to 2x the cost on wholesale).
In a fairly short time, my friend found that there was significant demand for her product. So much so that she is having a hard time keeping up with demand. Now she’s gotten into a terrible pinch where she barely has enough working capital to pour into the business in order to keep up with demand.
How did this happen? Simple - precious product and time was frittered away on very low PM wholesale accounts.
After looking at the numbers, my friend isn’t making 2x her cost on wholesale after all, because the cost only included the variable costs, not her overhead costs. In fact, she may have just been breaking even on some of it. Also, by continually selling most of her products through wholesale, she lost the opportunity to sell it online for the higher PM. It became a cycle where her lower PM wholesale accounts were tying up her product, which kept her from making enough working capital to keep up with demand.
She could have avoided some of this pinch by going with the highest PM sales channels to begin with. However, it may be that her wholesale accounts were the reason for her increased demand and so they’re not to be vilified. The numbers should have simply been hammered out before setting the wholesale price to ensure she had enough working capital to keep up with and grow her business.
It may not always be as simple as cutting the low PM sales and focusing on the high ones. There are other factors to take into account - maybe you want to give some work away because there’s a decent chance you’ll get repeat business from it, maybe you have some accounts that depend on lower PM services, maybe the only way to get a higher PM right now is to sacrifice quality (and that’s not something you’re willing to do).
The bottom line is, you need to pay attention to your profit margin.
If not, you can get pinched for working capital and when that happens, the life-size Jenga that is your business can become unfortunately unstable. Not to worry though, because now that you know this, you can start making changes now to sure up your business for the long haul.
I'm so glad each moment is new, aren't you?