Businesses Need to Innovate to Reign Cost and Upend Profit Margins

Every business has to guard its cost frontiers and navigate its path from market headwinds. The primary objective of every enterprise is to be profitable, and in this, profit margin management is a business quintessential. This is not a measure taken only when profit starts nosediving but a prudent measure requiring a 360-degree review of all cost and revenue drivers impacting profits. It must not be triggered as a result of a wake-up call post reviewing monthly or quarterly results but as a part of the company’s checks and balances process.?

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A company's net profitability is primarily determined by its revenue, less the cost of sales and overheads. Therefore, net profit margin matters as sometimes high overheads, and SGAs may eclipse this.?Especially in the context of management role, net margin is an important indicator of their performance and a key management KPI. In context of listed companies, retaining a minimum % of net margins and strong operating cashflows reigns over the market perception of company performance. Even in private companies, this applies, where the boards and shareholders demand healthy bottom lines, robust cash positions and most of their valuation permutation combinations revolve around these magic numbers.?

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In the list of many dos concerning net profit margin management, scrutiny of all operating costs is an essential tool in tweaking desired bottom-line outcomes. It is a continuous struggle for every CEO to reign costs and innovate ways to seek reprieve to manage any problems negative impact, leveraging everything within their available chest to retain or increase profit margins. It is the only way out when coping with market pressures. Inflationary fears and economic downturns often prompt austerity to cut costs. However, there are other situations where margins come under pressure due to stiff competition, not due to any market downturn; therefore, austerity may not necessarily be the way forward in such situations. The best way to mitigate competition risk, amongst other proactive measures, is to funnel innovation and creativity in the business offering, as often cost-cutting may impact the quality of the offering, upending competition risk. Therefore, pushing sales through innovation is the only way to retain or boost margins. For instance, in the current situation, despite significant industry growth; cost, clients, and competition are the factors pounding industry margins. Therefore, in order to improve margins, businesses must devise strategies and measures from cost consolidation to address cost inflation, inculcate creativity in offering to counter stiff competition and build collaboration with existing clients to bolster business growth through variations and retention.

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In any business lifecycle, there are specific market trends, from growth to recession to one event like a pandemic, etc., and such cycles need particular business treatment levers impacting margins. Margin management requires perpetual tightening of the belts, even if the warning signs are not displayed. While it is essential to lower business operating costs and exploring all strategies to limit the impact, there are a few suggestions to help navigate this daunting situation.

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1. Foremost is to review expenses: Conduct a thorough analysis of business expenses, both overheads to cost of sales, to identify areas where one can reduce costs without compromising the quality of business offering and look for any cost-saving opportunities from renegotiating contracts with suppliers, optimising supply chain, or finding more affordable alternatives on resource deployment including outsourcing.

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2. Increase operational efficiency: Seeking ways to improve business processes and streamline operations, including automating specific tasks, adopting lean management principles, or investing in productivity technology. By becoming more efficient, one can reduce wastage in the context of material and workforce. Especially in most services businesses, the people productivity and logistics cost matters. Recently, supply chain and logistics have significantly impacted the margins. This is where outside-the-box thinking matters, as efficiency can extract hidden costs.

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3. Focus on customer retention is pivotal in optimising revenue generation. Instead of squandering businesses at low margins, prioritise retaining and expanding the scope of services with existing clients. In EFS, more than 25% of incremental profits usually come from variations, mostly from existing customers. The key to this is service excellence driven by solid customer retention.

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4. Another way to address the lower margin issue is by creating a unique value proposition to rise above the competition to retain a higher margin. Indeed, the method is to differentiate your business offering to stand out from your competitors by offering unique value propositions or finding a niche market to target. In the case of EFS, with 97% contract retention, we realised the power of that differential. By providing something distinctive, one can potentially charge a premium to retain, if not increase, the margins. Use quality market studies and benchmarks to tweak gaps in the offering.

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5. Explore new revenue streams by looking for other revenue-generating avenues strictly within the backward or forward integration. In 2022 - 2023, we increased 15% of the bottom line by introducing new service lines that we were primarily outsourcing or not included in our scope. Diversifying product or service offerings, expanding into new markets, and exploring strategic partnerships or collaborations are unique ways to boost profits. Expanding into new revenue streams becomes necessary when conventional revenue lines come under pressure. One can offset such downturns from traditional to new to maintain healthier profit margins.

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7. Conversion of net profit to cashflow: While net profit is an essential indicator of a company's profitability, it doesn't necessarily represent the actual cash a company has on hand. The conversion of net profit to cash flow is vital in understanding a company's liquidity and its ability to cover its immediate obligations. Several non-cash items, like depreciation and amortization, can impact net profit but do not affect cash flow. Conversely, operations-related changes in working capital, like variations in accounts receivable and payable, can significantly influence cash flow while not directly impacting net profit. Hence, while a company may report robust net profits, its actual cash flow could be far different, underlining the importance of scrutinizing both metrics to get a comprehensive view of the company's financial health.

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6. Above all, continuously monitor and analyse budget compliance and P&L trends with market and customer feedback. Stay updated on industry changes and adapt your strategies accordingly. Proactively monitoring your business' performance can identify potential issues and make timely adjustments to sustain net profit margins.

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Remember, though these are generic but relevant suggestions, the best approach may vary depending on your specific industry, market conditions, and business model. It's always advisable to seek prudent financial measures and sound business insights. One must not instill fear in business to invoke cost-cutting but use credible data to build apt insights to guide the margin restitution process.