Many merchants pay close attention to the revenue part of the gross profit margin calculation. Driving sales, getting new customers, and adding new products are all important and tangible ways to show your business is growing. However, the second part of the calculating gross profit is the operating expenses side of the equation: and here’s where your costs can kneecap your business’s success.
Remember: gross profit is calculated by subtracting your business’s total expenditures from your total revenue to get your net income. Then divide your net income by your total revenue to determine your profit margin. Calculating your profit margin helps you see how much profit your business is generating at various revenue levels.
Savvy merchants know that cost increases on key supplies can threaten the health of your gross profit margin. Even just negotiating $0.15 less per shopping bag can impact your productivity. ising supply costs on a popular product can often lead to bigger issues down the line. Costs can continue to inch up bit by bit, shrinking profit margins to an unacceptably low point.
What do you do when costs start creeping up on you? Avoid making these easy mistakes to keep your profit margin healthy and your business booming.
Mistake 1: Assuming higher costs mean higher demand.
Does it seem like you’re constantly shelling out cash for supplies like shopping bags, receipt paper, plastic cutlery, or other basic business necessities? If you’re in the weeds of your day to day operations, it can appear that these high costs are going straight into meeting high demand. Don’t make that assumption without checking the bigger picture. Double check to make sure unnecessary business shrinkage going on. Inventory waste can be a silent killer of budgets.
Mistake 2: Not entertaining bids from new vendors.
Actively managing your vendor agreements might be a thing you only do once a year or once every few years. However, keeping informed about your suppliers – and their competitors – can help you manage cost creep. One survey showed that it’s common practice for small businesses to renegotiate long-term contracts. Obviously, it’s important to go about negotiating your supplier contracts ethically and transparently. Here are some ways you can reduce costs when soliciting bids from a new vendor:
- Get the specifics on each product or supply, including the size and the state it is in when it’s delivered.
- Cut down on the frequency of your deliveries to reduce overhead
- Buy in bulk as much as possible
- Have specific quality standards that you can communicate during the bid process
Loyalty is nice, especially as a small business owner. But if your vendor prices have only been increasing over the years, it could be time to find someone new.
Mistake 3: Becoming super-dependent on one product.
A common mistake many merchants make is becoming something of a one-trick pony. A product or service may sell out each and every week; it’s easy to become reliant on that one thing to make your revenue goals each month.
However, leaning too heavily on one product to drive your profit margin opens up a big risk. This approach commodifies your business and could open you up to being undercut by Amazon or another corporate giant. If your customers can find your product or service for cheaper, they may abandon your cart. Instead, consider a profitable approach that harnesses your customer relationships, your expertise in your vertical, and insight into your customers’ preferences.
Mistake 4: Not recognizing trends in your customers’ tastes.
On that note, this is perhaps one of the most common mistakes of all. As a small business owner, you have the opportunity for a much closer relationship with your customers than a big retailer or corporate entity. Take advantage of this connection to think strategically about what your customers like to find products they will also love. This can diversify your product mix over time, lowering your risk if supply costs for one product rise.
It also presents an opportunity for you to upsell, cross-sell, or bundle products. Increasing the amount you sell to your customer at one time means you will increase purchase velocity, an important KPI that indicates you are lowering your cost per sale in terms of overhead. How can you increase your average ticket amount per customer? Can you offer larger units of purchase? Can you cross-sell complimentary products or services?
Mistake 5: Never raising your prices.
Many merchants are loathe to raise their prices, with high-profile controversies like the Netflix price hike providing plenty of discouragement. However, sometimes raising the price tag is just necessary. Costs will rise as a natural part of economic upturns and downturns: otherwise, movie tickets would still be 46 cents and soda would cost 5 cents.
If you do decide it’s time to raise your prices, make sure to implement some kind of communication plan so your customers aren’t caught by surprise. Give customers plenty of warning, prepare your employees to answer questions about the price hike, and be clear about how much you actually need to raise prices to cover your costs.
Overall, keeping costs down requires a little three-dimensional chess. Think about your product mix and diversity, costs versus profit, customers buying habits, and how all these elements interrelate to impact your bottom line.