An understanding of the profit multiplier is essential for any business.
By focusing on the profit multiplier in your marketing, operations and sales it will make the operation of your business easier and much more profitable.
The best thing about the profit multiplier is that you don’t have to make massive changes to boost your profits. The key is continuing making a number of small changes that when multiplied together massively increase your profits.
Let us use the simple example below to illustrate the concept:
A small business has 1,000 customers and on average they buy 3 times per annum and each time they spend $100. The gross profit rate is 40% (makes $40 gross profit on each sale). The total profit therefore $120,000
Let’s see what happens when we increase each of the factors by a small margin say 5%.
So you target your marketing at getting 50 new customers this year. You could ask for referrals from your existing customers, advertise, use direct mail, letterbox drops, run seminars etc.
You want to increase the number of times each customer on average comes back by 0.15 times per annum (1 in 8 customers make an extra purchase each year). You concentrate on developing relationships with your existing customers, send them newsletters with special offers, new products, information. You could send an offer to all “dead” customers (once were customers buy have not bought for say 1 year) to see if they come back. By the way, special offers should be product bundles, value adding rather than a discount.
“Would you like fries with that?” is probably the most famous line for increasing the average dollar sale. In the example, we are increasing the average dollar sale by $5 from $100 to $105. The focus is on upselling with products that are related to the original sale – shoes + socks, dessert/coffee at the end of a meal, suit + shirt + tie, checklists for a camping store or home handyman, package deals etc.
Increasing gross profit from 40% to 42%. There are a number of ways to achieve this – costs and sale price. You can find more efficient methods of production, source cheaper products. You can also increase your prices but we don’t have to increase it by 5%, you only have to increase prices by 2% (5% x 40%). Remember the customer you want buy on value not on price. Develop the value proposition of your products and services.
So let us look at the result of increasing each of those 4 items by 5%.
| Customers | 1,000 | 1,050 |
| Frequency of Buying per Annum | 3.00 | 3.15 |
| Number of Selling Opprortunities | 3,000 | 3,308 |
| Average sale | $ 100 | $ 105 |
| Total Sales | $ 300,000 | $ 347,288 |
| Gross Profit Rate | 40% | 42% |
| Gross Profit | 120,000 | 145,861 |
| Increase in Gross Profit | 22% |
Profits have increased by 22% from $120,000 to $145,861, just from making small adjustments. The important point to remember is that you can keep on making those small adjustments and make your profits soar.
Understanding the profit multiplier gives your business focus.