When people ask me about starting Capitalise, the conversation usually gravitates to cash flow. With small businesses, all roads tend to lead to cash flow, but ultimately, we want to navigate our operations towards profitability. Few start-up companies talk about profitability (likely because it's difficult to initially achieve), but it's one of the most important metrics in building a business.
I ran across some interesting stats about profitability on the website Statista.com that I believe shed light on the challenges SMEs face as they grow. When comparing profitability in the years ending June 2014 and June 2015, enterprises with 1-9 employees showed a steady increase in profitably from 2014 to 2015, which seems to support the reported improvement in the economy.
However, profitability actually declined between June 2014 and June 2015 for businesses with 10-49 and 50-249 employees. Why the difference? I suspect it has to do, at least in part, with leadership not being able to effectively focus on the big picture while experiencing growth.
Underperformance is often due to business owners having a myopic view of their companies and basically not knowing what they don’t know. Involved in tasks such as hiring, taxation, compliance, marketing and IT, they can easily drown themselves in the micro and never devote the proper time to planning for the future.
SME business success can be achieved by not only thinking ahead, but also obtaining practical advice from advisors and fellow entrepreneurs that will help you properly manage growth. Here are some of my best tips for improving small business profitability:
1. Find a sustainable advantage
Warren Buffet refers to this as the "economic moat" where the castle is a metaphor for a company, and the moat represents a strong competitive advantage. The wider the moat, the larger and more sustainable the competitive advantage. By having a well-known brand name, pricing power and a large portion of market demand, a company with a wide moat possesses characteristics that act as barriers against other companies wanting to enter into the industry.
2. Aim for predictable cash flows
Those of us who have larger sales cycles or a dependency on a concentrated set of clients for distinct periods of time may find it difficult to predict cash flow as the business scales. Securing longer-term customer contracts and stipulating longer "notice" periods for cancellations can reduce volatility around earnings. The longer your sales cycle, the more important it is to have "clues" that tell you where things stand with the business. Also command a larger share of wallet by looking for products or services you could cross-sell or upsell.
3. Make yourself invaluable to stakeholders
While customer retention is key to profitability, your stakeholders also must have an equally strong need for your product or service. Speed, simplicity, cost savings, lead generation are just a few of the perceived benefits that can make your offerings "sticky." Also create a high cost of switching, if possible. Productivity losses or the high cost of transition can lock in stakeholders.
4. Maintain good margins by managing variable costs
Covering fixed costs is necessary to keep your business alive, but it's the variable costs that can doom it since they do not rise and fall based upon the company's revenue. Since they can rapidly increase, decrease or eliminate your profit margin altogether, variable costs are important to consider when establishing prices. Knowing and managing variable costs is essential as you respond to changes in the marketplace and in your company’s growth patterns.
5. Be a price maker, not a price taker
Businesses who are heavily reliant on a small number of customers can easily find themselves managing a declining price structure or meeting an increase in demand for the same pricing. Diversification in both products/services and customer base will generate more predictable cash flows and help to keep your offerings interesting.
6. Concentrate on organic growth
Organic growth allows you to focus on factors directly within your control, such as identifying more cross-sell and upsell opportunities for your existing buyers. All too often, customers who come to you with one specific pain point have others that can be alleviated by other products or services in your portfolio. According to a study in the book Marketing Metrics by Paul Farris and Neil Bendle, the likelihood of selling to an existing buyer is 60% to 70% while the chance of selling to a new prospect is only 5% to 20%.
7. Plan ahead for funding needs
Many SMEs stifle their growth because they take a reactive approach to funding, typically leaving only seven days, on average, to finding suitable finance - and usually with only one lender. This often results in rejection, a frustrating waiting game or second-rate terms if you're fortunate enough to get a timely approval. Partnering with an advisor who can help you answer the tough questions and position your business in the best light to lenders can be instrumental in facilitating the process and helping you find the right funding.