How to Increase The Gross Profit Margin By Being a Customer Driven Company

OVERVIEW

Many business owners recognize the need for dramatic changes in the way business is done. Some are just starting out and want to start out right. That is, all over the world, companies are recognizing they have to do it right by the customer every time.

It’s been said that, “We should not try to sell things just because the market is there, but rather we should seek to create a new market by accurately understanding the potential needs of customers and of society.” At The Social Marketing Agency, we help our clients define new markets by listening and understanding market needs through the proven practices of market sensing.  Because of this capability, our clients consistently produce delighted customers.

There is a lot of talk about the “Customer Driven Company”, and after all the talk settles, the topic is on quality. Quality as the customer perceives quality. This perception of quality drives the customer’s perceived value of your offerings, and your customer’s willingness to pay premium prices for your goods and services. This willingness to pay premium prices has direct impact on your gross profit margin (GPM) and competitive advantage.

After a short review of the Gross Profit Margin, this article will present some Key Strategic Areas that the Customer Driven Company must focus on, and some milestones along the journey of business transformation.

THE GROSS PROFIT MARGIN

The Gross Profit Margin is used by many managers to help guide business decisions and business comparisons. Understanding the tenants of a Customer Driven Company can help a manager use the GPM as a performance measure during a firm’s transition to higher Quality, at least from the customer’s perspective. This capability requires a little understanding about the GPM as well.

The Gross Profit Margin is defined by a firm’s Total Sales Volume minus its Variable Expenses and then divided by the Total Sales Volume. That means subtract what you paid for your goods, from the amount you sell them for, to get your Gross Profit Margin. The division operation in this formula converts the GPM into a percentage used to compare values between with other companies and even across industries..

 A firm’s Variable Expenses are all those expenses that are dependent on the total sales volume. Specific accounting practices will take us off topic, but we may accept this much as accurate. Any expense that changes because of the sales volume is normally part of the Variable Expenses, category of expenses.

After studying the above description of the Gross Profit Margin (GPM) its clear that two factors, the Product or Service Revenue, and Costs to Acquire those products or services will impact the GPM. For this article, consider the general case of “product” to include both products and services.

After taking a look at the GPM ratio, notice some interesting trends. If the relationship between Revenue and Variable Expense is constant, then regardless of an increase of Sales, the GPM will stay the same, because in the example of a constant relationship, variable expenses have the same proportion to revenue, as in this example. In each increase in revenue, the variable expenses rise proportionally, and the GPM stays the same.

REVENUE

VARIABLE EXPENSE

GPM

$50,000

$15,000

70%

$100,000

$30,000

70%

$150,000

$45,000

70%

$200,000

$60,000

70%

$250,000

$75,000

70%

 However, there exist examples, when the relationship between revenue and expense doesn’t scale the same. In this scenario, as you increase your revenue, the variable costs will actually go up faster than the revenue does, resulting in a decrease in GPM, even as your revenue is increasing, as illustrated in this example.

REVENUE

VARIABLE EXPENSE

GPM

$50,000

$15,000

70%

$100,000

$33, 122

67%

$150,000

$54,855

63%

$200,000

$80,752

60%

$250,000

$111,446

55%

 An example of this type of scenario could be when the cost of maintaining a firm’s clients increases with each new client. One case that we’re familiar with is when companies try to do their own Social Marketing. They may find that their variable expenses go up due to additional training and customer relationship repair costs; as new social marketing employees typically require more training than experienced ones.

The bottom line is that in these scenarios, variable costs increase faster than revenue. The relationship between variable expenses and revenue in this example scenario are inversely proportional. Understanding these relationships around the GPM can be more important than the value of the GPM itself.

Another more common scenario, (which is typically assumed) is when the Revenue and the variable expense is directly proportional, but not equally proportional; meaning the higher the revenue grows, the faster the GPM increases due to an economy in scale, as illustrated in this last example.

REVENUE

VARIABLE EXPENSE

GPM

$50,000

$15,000

70%

$100,000

$27,118

73%

$150,000

$36,768

75%

$200,000

$44,314

78%

$250,000

$50,071

80%

 The moral of the story is to know the relationships between the firm’s Revenue and Variable Expenses. Now let’s say the GPM relationships are known inside and out. In this article’s review of things so far, we haven’t distinguished between the revenue on the books, and actual collected revenue. When computing GPM, the total revenue is used, that’s everything on the books, collected or not. Problems arise when the gap between revenue in accounts receivable and collected revenue grows too large. The effects on cashflow is disastrous.

While discussing the GPM, it is important to point out that enterprises with a low GPM can still be a viable company. The lower the GPM ratio, the higher the number of sales there needs to be. A firm with a high GPM, typically needs to make fewer sales than those with a lower GPM. This is typical in a retail industry, high sales frequency, and low GPM are the rule of the day.

Now, what can a “Customer Driven Company” do to increase our GPM, and reduce the probability of this looming cashflow disaster identified earlier? For one thing, it has been shown that across the board, Customer Driven Companies have smaller percentages of uncollected revenues than their counter parts. To understand this and other facts, let’s take a deeper look at the Customer Driven Company.

CUSTOMER DRIVEN COMPANY

So, what does it mean to be a Customer Driven Company? A lot has been written on the subject, and the intent of this article isn’t to explain everything. Richard C Whiteley’s book is a classic. In that book he identifies 7 imperatives that are just as essential today as the day they were identified.

1 Create a customer-keeping vision. The customer-keeping vision as presented in the literature is now not just contained within the bricks and mortar of traditional firms. Today, the vision must be clearly stated, and be presented to the market repeatedly. The employees of yesterday with the customers of tomorrow, must clearly visualize the customer-keeping vision of the firm. Social Marketing plays a bigger role than ever to help keep this vision relevant to employee, investors, customers, and prospects. This vision can directly impact the perceived value of your products and services, which in turn, enables the collection of premium prices and rises the GPM.

2 Saturate your company with the voice of the customer. By doing this, you’ll revolutionize your own behavior, that of your employees, customers, and even your sales prospects. They will begin to feel the responsibility of producing a clear voice. Using the proven principles of market sensing, you have access to those customers. But don’t forget both the external and internal customers while saturating your company. Social Marketing plays a principle role in activating all your communication channels. This focus, causes perceived value agreement and generates higher behavior accordingly.

3 Go to school on the winners Most great companies don’t hide their way of doing business- and most don’t try. Market sensing is the practice of studying their methods and practices. Those who study others find themselves building commitment to serving their own customers – and learning techniques that will help them discover and eliminate the causes of customer’s dissatisfaction. Because of this customer satisfaction, the gap between expected revenue and collected revenue will shrink.

4 Liberate your customer champions Most of us want to serve our customers well. One survey showed, surprisingly, that the factor most strongly correlated with employee’s remaining in a company was simply whether employees thought the organization was providing good service to customers. The effects and value of Social Marketing with 360-degree feedback with Market Sensing cannot be overstated here.

5 Smash the barriers to customer-winning performance The more we learn about quality, the more we realize that the systems we’ve built into our own businesses often inadvertently create barriers to serving customers. But knowing these potential issues also means that we have enormous opportunities to serve the customer better and increase our GPM.

6 Measure, measure, measure In the organizations that are transitioning most rapidly, people measure almost everything that can tell them what kind of job they’re doing for the ultimate judge of effectiveness, the customer. They analyze their performance not only against their own past and their customer’s desires, but also against the performance of the people who, anywhere in the world, are doing a job like their's best. Gaining a more accurate perception of the market, and their customers needs help provide future decisions that drive the company and drive larger and larger GPM.

7 Walk the talk Successful managers who carry out these customer-focused principles are creating a new view of leadership. These leaders personally put the customer first. They promote their companies’ visions. They become “students for life,” constantly seeking new ways to conduct market sensing and learn. And of course, then communicate this insight through Social Marketing to impact their internal and external markets and customers.

These seven milestones will help firms transition toward being more of a Customer Driven Company. There are very few things that can impact your GPM as much as a Customer Driven Company Initiative. The principles of Social Marketing, whether you employ them internally, or outsource them to others, will help direct that effort of understanding the needs and values of the customer, and create higher sustainable Gross Profit Margins.


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