Traditionally, business owners have worked on the conventional accounting measure of profit: Revenues – expenses = Profits. But relying on this approach gives you few options for increasing profits.
You can basically increase your revenues (easier said than done), decrease your expenses (many businesses have already cut expenses to the bone) or do a combination of both. But there’s another option.
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The ‘5 Ways’ formula was developed by ActionCOACH founder Brad Sugars, and is as follows:
(1) Leads x (2) Conversion rate = Customers
Customers x (3) Number of transactions x (4) Average rand sale = Revenue
Revenue x (5) margin = Profit
(1) Leads is the number of business prospects you’re in touch with over a period of time. A lead is anyone who has expressed interest in your product or service, but hasn’t yet purchased from you. The important thing to remember is that enquiries don’t necessarily mean customers – just because your phone is ringing doesn’t mean there’s money coming in. Many businesses spend too much time and money on this element. But we’ll get to that in a bit.
(2) Your conversion rate is the percentage of people that made a purchase out of your total number of prospects. For example, if you had ten people in your shop on a day and only two bought something, your conversion rate was 20%. Before you can get started on boosting your profit, you need to know what your conversion rate is.
(3) Your total number of transactions is how many times your average customer buys from you over a period (say a year).
(4) The average rand sale is exactly that – how much does your customer generally spend each time he or she buys from you? To start, you can just divide your total revenue by the number of transactions to estimate this figure.
(5) Finally, the easiest step to increasing your profit is to bump up your profit margin. This is basically the percentage of each sale that is profit. If you bought something for R70 (or it cost you R70 to make) and you sold it for R100, your profit margin is R30. Divide your profit by your revenue (eg. R30 / R100) to get your profit margin.
Now, let’s get back to that formula: Say you’ve done your research and figured out that you have 4 000 active leads coming into your business per year, and that your conversion rate is 25% (ie. you have 1 000 paying customers out of the 4 000 prospects).
They each buy from you twice a year and they spend around R1 000 each time they do. That gives you a yearly revenue of R2 million. If your average profit margin is 25%, your business is making R500 000 in profit per annum.
Laid out, it looks like this:
4 000 (leads) x 25% (conversion rate) = 1 000 (customers)
1 000 (customers) x 2 (number of transactions) x 1 000 (average rand sale) = 2 000 000 (revenue)
2 000 000 (revenue) x 25% (profit margin) = R500 000 (profit)
What would happen if you boosted each of the five elements by just 10%? Let’s see:
4 400 (leads) x 27,5% (conversion rate) = 1 210 (customers)
1 210 (customers) x 2,2 (number of transactions) x 1 110 (average rand sale)
= 2 954 820 (revenue)
2 954 820 (revenue) x 27,5% (profit margin) = R812 575,50 (profit)
By increasing each individual element by just 10%, you’d gain a whopping R312 575,50 extra profit – an increase of more than 60%.
The best place to start implementing ‘5 Ways’ is at the last step – profit. Generally, customers won’t quibble over a 10% increase in price, especially if your service is excellent and you deliver a great customer experience.
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Choose your best-selling product or service and start with that one. Then work your way backwards, finishing with lead generation – which is the hardest figure to improve, and yet where most businesses choose to start.
Once you start plugging your own business figures into the ‘5 Ways’ equation, you’ll quickly see its potential, and it should motivate you to start boosting each element by 10%, then 20%, and so on.