As a Numbers Coach, we consult with many growing companies. One unhealthy trend we often encounter is a company whose revenue growth is not keeping pace with the growth of its fixed overhead. This situation is manageable in the short term, but problematic in the long run.
In today’s economic climate, many businesses find it difficult to increase prices or find new sources of revenue. For those businesses, revenues are stagnant or perhaps even declining. At the same time, employee salaries and benefits, rent and utilities are all trending higher. So, what do do if you find your business facing this predicament?
Let’s take a look at two possible solutions for this challenge.
Possible solution #1: Lowering prices
Given stagnant or declining revenues, lowering prices to grab market share is one possible strategy. To increase revenues under this strategy, you need to increase the volume of products/services sold. This may be feasible, especially in mature industries where a fairly uniform set of product/service features makes differentiation difficult to achieve. In these circumstances, price can be an important differentiator.
- Possible pitfalls:The tricky part is assuring that a price decrease results in more volume and, therefore, increased revenues. By offering lower prices, you bet that a reduced profit margin per sale will be more than offset by a volume increase. If you can’t accomplish that with certainty, you may cause a potential disaster – by lowering your gross profit to the point where it still doesn’t cover your overhead!
- Our advice: Carefully analyze the financial ramifications of a proposed price change before implementing it.
Possible solution #2: Lowering Salaries and Benefits as a Fixed Expense
For many businesses, particularly those in service-oriented industries, employee-related expenses are the biggest part of overhead. There are instances where cuts to employee expenses make a great deal of sense.
For example, consider a local plumbing contractor who has significantly less work than he had three years ago. Prospects for next year aren’t good, because construction starts here in the Atlanta area are still suffering. The contractor has to consider how to reduce his overhead, since revenue growth will be marginal at best.
- Possible pitfalls: In theory, employee-related expenses are a logical place to look when overhead needs to be reduced. However, most business owners are very reluctant to make cutbacks in this area – with good reason. Cutting salaries produces immediate financial benefits, but those benefits may be offset by a loss of employee trust and loyalty. By following the advice below, it is possible to reduce overhead while retaining loyal employees.
- Our advice: When there isn’t enough work to keep existing staff busy on a full-time basis, an employer has several options. First, he may choose to cut back the hours of all employees. Our plumbing contractor put his non-administrative staff on 30-hour work weeks. All the employees share the pain equally, but they still have jobs and they seem grateful for that. Another option is to identify employees who are under-performing and make necessary cuts. Every business has high achievers that need to be retained and rewarded. That is difficult to do in a poor economic environment, especially when other employees aren’t achieving nearly as much. For our contractor, eliminating a single position meant keeping five high achievers happy and motivated. From a long-term perspective, it was the right business move.
So when your fixed overhead expense growth outpaces your revenue growth, look to alternative pricing strategies or reducing selected overhead expenses to set you back on track. But remember: rational analysis trumps emotion when it comes to financial decision-making.
If you need an objective opinion about your options, just give us a call at (404) 370-6147 or send us an email, and we are happy to advise.