Companies routinely make more money without making any more money. In 2014, the whole Californian farm industry did it. It generated 3.5% more revenue than it did in 2013, but it ended up with about 10% less net income. Somewhere along the way, something went wrong.
Now, in California’s case, what went wrong was a change in product mix, driving a change in water consumption, which was all wrapped up with some tough drought conditions. For a small business, there’s likely to be a more straightforward explanation.
When there’s a disconnect between revenue and profit growth, you can often look to one of three drivers.
Customer acquisition costs.
Product delivery costs.
A change in product mix.
Let’s take a closer look at all three to see how you can stem the bleeding and stay in the black as your company grows.
Your customer acquisition costs are killing you
I’m going to guess that the number-one culprit of declining profit in the face of rising revenue is customer acquisition cost (CAC) growth. At most tech and service-focused businesses, CAC is tracked like a 50-point buck. In newer or smaller businesses, CAC may end up being an afterthought.
The “all business is good business” mantra still holds a lot of sway, even if it’s not true. The problem with customers is that they rarely seek you out just because they like the idea of working with you. Those that do then rarely go on to just walk into your office and sign a contract.
Most customers require some amount of courting. You go to their office and give that one presentation that everyone seems to like. You meet up for coffee – your treat. You mock up systems, websites, and landscapes. Sometimes, you do all of these things and you don’t even land the deal.
CAC is a measure of how much money you’re dropping into bringing the average customer onboard. To figure out your cost, you’ll add up all the costs associated with your new customer acquisitions and divide the result by the number of customers you actually ended up with.
So if you spent $500 on marketing, $200 on material prep, $50 on travel, and $150 on food, you’ve spent $900 on customer acquisition. If you ended up with 20 new customers, then your CAC is $45 ($900/20). If your customers are worth $300 over the span of their relationship with your business, then you’re out ahead – at least from this perspective.
If, instead, you’re spending $75 on each new customer and their lifetime value is only $70, you’re losing money by acquiring new business. Here’s the situation we’ve set to remedying.
Your revenue will go up with each new customer, but your costs will go up faster, cutting your total return down.
To fix the problem, you’ll need to do one of two things – well, three if you count running your business into the ground as an option. First, you can make your customers worth more. You could increase your revenue even further by charging more for your services or by shifting your product mix to make sales more valuable – more on this later.
The key to finding a solution to your CAC problem is to understand that you have one in the first place. List out those costs, determine your CAC, figure out how much each customer is generating for you, and re-balance your business to grow your bottom line.
Your product costs too much to deliver
If your acquisition costs are as low as possible, it’s time to take a look further down the chain. How much are you spending on actually delivering the product or service to the customer? These costs – the cost of goods sold (COGS), as they’re sometimes called – are a classic bugbear for small businesses.
COGS can rise as a result of scope creep, an increase in materials costs, or an increase in other major costs – wages, rent, or technology, for instance.
For most small businesses, scope creep is going to be a huge hit to COGS. You spend more on wages, consume more materials, and spend more time communicating – and therefore not selling – when scope creep sets up shop.
We could talk about scope creep for weeks, but the small business issue usually comes down to one stumbling block – you can’t make customers mad.
Scope creep is your way of acquiescing to the customer’s requests. It’s a way for you to give more than they ask for and beat their expectations. It’s also a great way to lose money on a job. We’ll do more on this in another article, but, for now, here are three simple steps to avoiding scope creep.
Write down the scope in detail before you start. Seems like a fundamental step, but many small businesses don’t want to include constricting language up front, for fear of alienating a client. They don’t care – put the scope in from day one.
Offer scope creep options right out of the gate with associated costs. Sure, you can have the bells and whistles – the bells are going to add three weeks and cost $4,000 and the whistles are $3,000 and two weeks.
Beat out expectations in other ways. Plan more conservative timelines, respond to questions within an hour of receiving them, do a better job than they ever could have hoped for – anything to make the experience a winner, but keep it in-scope.
You’ve got a fouled up product mix
When I worked for Barclays, we kept a close eye on how much of everything we were selling. It’s easy to see why, as a massive bank has to balance the amount it holds for deposit against the amount it lends out. Those products all generate different values for the bank, and to keep your revenue in line, you have to know what to sell.
Small businesses need to do the same things. At Cuberis – a web and graphic design shop in Durham, NC – we had to consider how much time we were spending on logo design versus web design. They were both valuable services to the business, but we could have easily ended up in a place where one overtook the business.
Imagine logo design took off. In that instance, we would be bringing in more revenue than before, but maybe at a smaller margin. Sure, we’re still making money, but we’ve got coders sitting idle and designers getting paid overtime. Now profit is falling, even though we’re busy, working within scope, and managing our CAC.
Just as you would re-balance your personal investment portfolio to cut out risk and low earners – you’re doing that, right? – so too should you be re-balancing your product mix. Promote the higher margin business when you’re busy and the quick and easy stuff when you’re slow.
Get the most out of your time to keep both revenue and profit growing. As with CAC and your COGS, you can’t figure this out if you’re not paying attention. Look back over the last year to see what you were selling and how that was affecting the bottom line.
Tools to keep you winning
The best thing you can do to overcome all of these problems is to hire good people. Good sales and marketing people keep CAC low, good project managers keep scopes in line, and a good accountant or financial officer can keep your product mix balanced.
Beyond those folks, there’s plenty of good software to help you along the way. Accounting software is a great place to start, as it usually forms the center of your financial universe. Reporting software can help you dive into the details of the money you’re making – and spending. While solid project management software can keep you on track.
With a few tools in place and a good head for business, you shouldn’t fall into any of the usual traps. Now, you just need to keep making more money and growing that business that you’ve worked so hard to build. Simple. Good luck.