"I
need
25% margin to be
profitable" you say. "So why don't you price to achieve that margin?" I
ask. "Your 25% mark-up is actually a 20% margin!" It usually takes half
an hour plus a calculator and several scraps of paper before they agree
that they are pricing their product/service 5% lower than they intended.
I am sure most
of my readers check the search words used by visitors to their website.
I do almost every day, and there are some very revealing and frankly
shocking facts which emerge. Perhaps the most shocking is the fact that
the commonest type of search which finds my site goes
something
like "What markup do I need for a 25% margin?"
"Why", you ask, "do you find that shocking?" The answer simply put is
that it shocks me that business owners are struggling with the concept
of margin when it is the basis of almost all business analysis, and if
they don't understand it, they are putting their business at serious
risk. To understand why let me give you a real life example.
I worked with an
HVAC contractor in the mid west and early in our relationship
he
showed me his financials prepared by his CPA. This CPA had done a great
job of presentation and had carefully separated variable and fixed
costs, and the contractor showed me that his fixed costs were running
at a smidgin over 25% of sales. "I use a minimum markup factor of 1.3
or
30%, so why don't I make a profit?"
If you don't
already see his error, you must read on because this is very important!
"You got the
first part right," I said, "If your fixed costs are at 25% of sales,
your margin must be greater than 25% for you to make a profit.
Unfortunately, a markup of 30% is a margin of only 23.08%, so at that
markup you must lose money." And, yes, he was losing money!
It took us only
a few days to correct the problem, put in place a proper pricing
structure, and he was off on the right track. A year later his margin
was nearly 27%, guaranteeing a profit, but with improvements in
processes which cut his fixed costs to 21% he ended up with a net 6.0%
on the bottom line.
For the more
mathematical reader it is simple to see how this works from the formula:
Gross Margin
% = Markup %/Markup
Factor.
This clearly
shows that gross margin percent must always be less than the
markup %, and is more so at higher markups.
That client will
never regret the decision to get some management training, and his
bottom line will be enhanced as a result. It is a smart thing to do to
acquire the knowledge you need to be successful.
The
Author
After 25 years consulting to small and medium sized companies,
Mike
Anderson, principal of
Train
Me To Be a CEO
realized that the most important part of his work was training the CEO,
and the reason he was such a good consultant was that he did that very
well.
Trained as an engineer,
he became a CEO of
a midsize corporation at the age of 35. After a spell at Harvard
Business School he entered the world of consulting.
3.
Ongoing mentorship. Begins with a minimum two
day one on one, but continues with monthly or quarterly follow up
sessions. (Smart and probably Best!) .
References
A New England Contractor
"Mike Anderson has been
working diligently
with the upper management team at (our firm). Mike is extremely
knowledgeable and has an exceptional way of dealing with many different
personalities. He has worked very closely with the Sales Team to
impress upon them the importance of using a consistent method of
estimating. He was instrumental in restructuring our accounting
procedures."
