Making a Profit Takes More Than Just Cost-Cutting!

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Over the course of the last 40 years working as a business owner, management consultant, and entrepreneurship professor, I’ve seen the financials of as many as a thousand or more privately-held companies. One thing is very clear — making a profit in any business isn’t easy — and it takes a lot more than cost-cutting to do it over the long haul.

The truth is that not every business owner goes into business to make a lot of money. Believe it or not, it is usually way down on the list of motivators for someone who is starting a new business. There are a whole bunch of other drivers. Doing something that needs to be done in the community, creating good jobs, promoting a hobby, being able to live a particular lifestyle, being your own boss — there are many other motivators beyond making money. That said, making a profit isn’t optional for most of us. In fact, it is essential to our survival!

It is conventional wisdom amongst business and management experts that a “lack of capital” is the greatest single reason for business failure. That always sounded like an absurd statement to me. So if you had just enough cash to lose money forever you could stay in business indefinitely? A shortage of capital isn’t the problem — it’s a shortage of profits. A profitable business will generate its own capital.

Each year, the students in my Small Enterprise Management class at the Sam M. Walton College of Business at the University of Arkansas are required to do a consulting project for a small, privately-held business. Their assignment requires them to study the business, its competition, its market, its customers, and much, much more, and then make recommendations to increase revenue, profits, and value, while at the same time reduce risk for the businesses’ owners.

I find it interesting to see what my students do with their charge to increase profitability. With few exceptions, they act as if the only way to accomplish that goal is to cut costs. I even had one student tell me this past semester that “cutting costs was a requirement of the project.” When I asked him where that was written in my syllabus, he pointed to the requirement of the project to give recommendations to increase profitability. The implicit assumption of nearly everyone you could ask about increasing profitability is that you do that by cutting costs. But in my experience, there is a limit to the costs that can be cut, and it’s rarely the best way to be profitable on a sustainable basis.

What, then, does it take for any business to be profitable over the long haul? Let’s take a look at some alternatives to cost-cutting:

• Drive demand such that it exceeds supply. The best way to ensure consistent profitability is to make sure demand exceeds supply. Increasing demand takes an investment in marketing. That investment is not one to be minimized, and to the dismay of management, it can’t always be justified by tying each specific marketing expense to specific quantitative results. And that flies in the face of cost cutting – especially overhead-related cost cutting – where everyone tends to focus their energies. I like to think of marketing as an “off balance sheet investment” in the firm. Grow revenues versus reducing costs (and capabilities/service/offerings).
• Raise your prices. Do you know how many business owners who have told me that they cannot meet the demand for what their business does, yet who won’t raise their prices? It’s crazy. Many are afraid they will lose customers. I will never forget a sub shop owner in the town we lived in in Massachusetts (he had the only one in a very affluent community) who would not raise his prices even though every day and night there was a line out the door. When demand is greater than you can meet, you have to raise prices to increase your margins and reduce demand. Your alternative is non-performance. Never a good one!
• Differentiate. If you want to be able to raise prices, you have to be providing something people can’t get anywhere else. That’s the problem a lot of struggling businesses have today. Consider buying a new leaf blower. If two dozen online suppliers can all supply you with the same Black & Decker leaf blower in a day or two, which one will you buy it from? The answer is whichever one has the lowest price. Many businesses are in the same boat. Their products, services, pricing, and customer service are all perceived (and this is a critical word, perceived) by their clients and customers as being more or less the same. If that’s the case, why would anyone pay them a higher price than the other guy (or gal)? If you want a premium price, you cannot sell, do and act the same as your competitors. You have to be different.
• Specialize. The best way that I know of to differentiate the products and services of one business versus another is to specialize. Be really good at doing something for a specific market or customer base so you have an unmatched understanding of the needs of that market. A good example would be a gym or exercise facility that specializes in serving pregnant women/new mothers versus everyone in the community. Or an auto repair shop that works on Mercedes Benz cars only, and not on BMWs or Toyotas. Or an on-call transportation service for elderly and disabled people versus just anyone. The business I started in 1988, Zweig Group, is a good example of that. We are experts in one industry – architecture and engineering. We don’t work for any other types of clients. It makes it easy for us to win a strategic planning consulting job or merger and acquisition job because it’s all we do and clients can’t find anyone with more experience than we have at doing these things. Price is less of a consideration when you specialize. You’ll be more efficient, anticipate problems, come up with more new and innovative product and service ideas, and do a better job in the end than a non-specialist would.
• Inspire. Getting everyone to care more and work harder always makes it easier to be profitable. You get more productive capacity out of less people. And work is done right the first time. This may seem obvious and I know it isn’t easy, but if you are the business owner/leader, it is your job. And you need a team of other leaders who can inspire people — people who “sell” your special Kool-Aid. You and your business need to stand for something. This is especially true today in cases where your business employs and serves a higher income/better educated customer base. In short, you need to have a higher purpose than just making a profit, and you must effectively communicate that to everyone inside and outside of the company.

Of course, if all else fails you can always fall back on the fundamental idea that making a profit requires revenues greater than costs. I never understood how a company doing $20 million a year in revenue couldn’t be profitable when all that was required is revenues greater than costs. This does mean cost cutting. But my version of cost cutting and that of most privately-held business owners isn’t the same. Cut from the top. Cut owner pay and benefits. Cut out dead weight and toxic people who pollute the minds of your other employees, not just low level workers, marketing expenses, healthcare benefits, and free Cokes in the lunchroom. Those kinds of cuts may have some longer-lasting benefits for you.