There’s a simple rule which says that you can either manage your business to maximise profits or you can price for growth. You can’t do both. This simple rule is misunderstood by many business owners, because they fail the relationship between bottom line growth (profit) and top line growth (sales).
Managing your business for growth means actively planning to grow your business, to do this you’ll need to get your resources; people, product and organisation ready to support sales growth, but each of those three areas have a different time lag between the decision being made and the results implemented. Let’s look at a simple case of recruiting a member of staff. Let’s assume that he’s paid monthly, that generally means a month’s notice before he can start. We also expect that the selection process takes a month. So we need to start the process a minimum of 2 months before we think we need them. If that person also needs training or familiarisation then we need to add that time on so let’s also assume it takes 1 month to bring them up to speed. Our decision point is now 3-4 months ahead.
This time lag also increases the risk, as we have to be confident that our sales will be at a level where we need this person or at least close to it. When driving for growth these decisions like this are taking place right across the business. This typically results in resources being pulled in ahead of time so that they are in place to support growth, which in turn increases costs and so reduces profit. Supporting high growth requires a detailed understanding of the mechanics of your business and the marketplace in which it operates. This detailed knowledge needs to translate itself into a comprehensive financial forecasting model on which to assess the performance of the business as a whole and its individual components. It also requires a degree of risk taking that many owners don’t want to take for fear of getting it wrong.
Pricing for profit is taking the view that we maximise the performance of each component of the business before adding further investment, whilst this has the advantage of having the business run efficiently it puts a cap on growth because resources are only acquired after its it certain that they are needed rather than in anticipation of their need. We therefore assume that pricing for profit is better since were making, or at least should be, profits at all levels of turnover.
In real life things aren’t so simple. Profit and growth are two ends of a see saw, businesses need to decide for themselves where the balance point falls as the trade off between them will be a function of many things including management strength, funds available for investment, market characteristics, risk aversion of owners/directors.
The truth is that pricing for profit tends to be adopted after the business has gone through its growth phase, although many businesses suffer low growth not because they’re pricing for profit but because they’ve hit the limit of their management capability, which of course is another story completely....