If you’re looking for ways to increase your profitability, you have to focus your attention on the 4 profit-determining factors: price, volume, variable costs, and fixed costs.
Let’s look at each of these 4 factors under 3 headings:
– the factor
– the possible action you could take to enact change
– the required conditions that would have to occur to increase profits
It’s important to note that profitability can be increased by taking action to increase or decrease any of the 4 factors, as long as some conditions are met.
|Price||Increase||Sales volume could either remain unchanged or decline. If sales volume declines, the decline would have to be less than the offset created by the price and resulting profit increases.|
|Decrease||The sales volume would have to increase sufficiently to compensate for the decline in price. If the sales volume increases as a result of the decreased price, there is a possibility of a decrease in the per-unit price fixed and variable costs because of increased economies of scale.|
|Variable Costs||Increase||The increased variable costs should lead to or be a result of improved product or service quality. The market would have to accept a higher price, or the heightened quality would have to attract enough new buyers to offset the increased variable costs.|
|Decrease||The sales volume would have to remain unchanged. The decrease in variable costs could not be allowed to affect product or service quality, which would have a consequential effect on sales. If they did decline, the fall in gross profit would have to be less than the decreased variable costs|
|SalesVolume||Increase||The price could either remain unchanged or decline. If the price were reduced, the reduction would have to be less than the offset created by the volume and resulting profit rises. Another possibility is to achieve a reduction in per-unit fixed and variable costs due to increased economies of scale.|
|Decrease||A savings in fixed costs would have to be achieved by reducing the size of the business, or production levels would have to be evaluated to find variable cost economies of scale. This savings would have to be greater than the reduction in gross profit due to the decreased sales volume.|
|Fixed Costs||Increase||The increase in fixed costs should lead to or be a result of improved product or service quality. The market would have to accept a higher price, or the heightened quality would have to attract enough new buyers to offset the increased fixed costs.|
|Decrease||Sales volume would have to remain unchanged. The decreased fixed costs could not be allowed to affect product or service quality, which would have a consequential effect on sales. If they decline, the fall in gross profit would have to be less than the decreased fixed costs.|
The interesting thing to notice about the previous summary is that no single factor can be considered without considering its impact on, or the impact from, each of the other factors.
The second thing to notice is that a profit improvement strategy may involve either an increase or a decrease in each of the 4 factors.
There is no standard formula for improving profitability; it depends entirely on specific circumstances and the relative strengths and weaknesses of your business.
The second blog in this series introduces the concept of “Gross Profit Margin per dollar of Sales”, then goes on to provide an example of the four factors working together to improve your position.