Profit is the difference between what something costs and what you sell it for. If you want to make more profit it would seem that you should either increase the selling price or reduce the cost, and indeed both avenues should be explored.
But there is a third factor to consider, and that is volume. Volume matters because not all costs are related to sales volume. Take insurance, for example. That's a cost that will stay fixed regardless of what happens to your volumes. Of course, other costs are tied directly to the volume of business you do. Shipping boxes might be an example; the more goods you sell the more boxes you have to buy.
So increasing profit demands that you understand all the components of the cost of your product or service. In particular, you need to know how they change with sales volume.
A simple graphical technique can help you understand how sales volume affects total cost and profit. Start by drawing the two axes of a graph, volume along the bottom and cost up the side. Then work out the total cost at each level of sales volume. The volume depends on your type of business, so for an example, imagine you're shipping hand turned wooden bowls. Work out your total cost to make, sell and ship ten bowls, twenty, thirty, and so on. Plot this as a line on your graph and notice how it rises as volume grows.
Now let's think about the income your sales generate. That can be plotted on the same graph, so draw a line that shows the total income at various levels of sales. If your bowls sell for fifty dollars apiece, your total income from twenty bowls is one thousand dollars.
This is where it gets interesting. What you should observe on your graph is that when volumes are very low the income is less than the costs. This makes sense because as a businessperson you know that even if you sell nothing you still have some bills to pay; rent, insurance, internet service and so on.
But look at the graph and observe what happens as the volumes grow. You should see that the income line rises faster than the cost line. At some point they will cross. This is your breakeven volume, where income equals costs. As the volumes continue to grow income will rise faster than costs. The gap between the two is your profit. Now should see that if you want to increase profit you need more volume.
One nice thing from this analysis is that you'll probably find you don't need to sell twice as much to double your profits. This is because only a proportion of your costs are volume-driven, the rest are fixed regardless of how much you sell. If you want to get really fancy, you can start thinking about how much extra volume a price cut might generate, and see if that gives you more profit.
The bottom line is, price increases are great if you can make then stick, and cutting unnecessary cost is always good practice, but neither of these strategies is likely to double your profit. You're only going to achieve that by first understanding how your costs vary with volume, and then finding ways to increase volume.
But there is a third factor to consider, and that is volume. Volume matters because not all costs are related to sales volume. Take insurance, for example. That's a cost that will stay fixed regardless of what happens to your volumes. Of course, other costs are tied directly to the volume of business you do. Shipping boxes might be an example; the more goods you sell the more boxes you have to buy.
So increasing profit demands that you understand all the components of the cost of your product or service. In particular, you need to know how they change with sales volume.
A simple graphical technique can help you understand how sales volume affects total cost and profit. Start by drawing the two axes of a graph, volume along the bottom and cost up the side. Then work out the total cost at each level of sales volume. The volume depends on your type of business, so for an example, imagine you're shipping hand turned wooden bowls. Work out your total cost to make, sell and ship ten bowls, twenty, thirty, and so on. Plot this as a line on your graph and notice how it rises as volume grows.
Now let's think about the income your sales generate. That can be plotted on the same graph, so draw a line that shows the total income at various levels of sales. If your bowls sell for fifty dollars apiece, your total income from twenty bowls is one thousand dollars.
This is where it gets interesting. What you should observe on your graph is that when volumes are very low the income is less than the costs. This makes sense because as a businessperson you know that even if you sell nothing you still have some bills to pay; rent, insurance, internet service and so on.
But look at the graph and observe what happens as the volumes grow. You should see that the income line rises faster than the cost line. At some point they will cross. This is your breakeven volume, where income equals costs. As the volumes continue to grow income will rise faster than costs. The gap between the two is your profit. Now should see that if you want to increase profit you need more volume.
One nice thing from this analysis is that you'll probably find you don't need to sell twice as much to double your profits. This is because only a proportion of your costs are volume-driven, the rest are fixed regardless of how much you sell. If you want to get really fancy, you can start thinking about how much extra volume a price cut might generate, and see if that gives you more profit.
The bottom line is, price increases are great if you can make then stick, and cutting unnecessary cost is always good practice, but neither of these strategies is likely to double your profit. You're only going to achieve that by first understanding how your costs vary with volume, and then finding ways to increase volume.