How to Maximize Profits for Your Small Business

By identifying and exploiting high-margin products, you can maximize profits

Maximizing your profits is not always as easy as maximizing sales. Considerations must be made for variable costs and opportunity costs. By using the simple concept of marginal analysis, small business owners can determine how to hone in and exploit high-margin products.

Things You'll Need

• Annual or quarterly sales report Annual or quarterly expense report

Instructions

Using Marginal Analysis

1. Determine variable costs, the costs that change when sales change. For an arts and crafts store, variable costs would be labor and inventory. Variable costs would not include utilities and rent, which would be paid regardless of how many products are sold.

2. Determine opportunity costs, the costs that can be defined as sacrificed revenue. For example, a hairdresser may have to turn down a request to style someone’s hair for her wedding because he had already scheduled a haircut for someone else at the same time. The forgone income of the wedding hairstyle would be recorded as an opportunity cost for doing the haircut.

3. Determine marginal costs, which are the total variable and opportunity costs of selling one item. For example, a restaurant owner would determine variable costs as follows for a patron who orders a cheeseburger, fries and a soda: costs of ingredients total $2 and labor totals $10. Let’s assume this patron lingered over his meal for two hours. During that time, the restaurant could have seated two other parties at that table, for an average total ticket of $20 each. Therefore, the opportunity cost for serving the cheeseburger and fries patron is $40. Total marginal costs for this patron total $52.

4. Determine marginal revenue, simply the price of one product, excluding sales tax and other add-ons not pocketed. For our cheeseburger patron above, the total price of his meal was $25. This price, not including tax and tip (which go into others’ pockets) is the marginal revenue.

5. Determine marginal profit, or more commonly, the margin, is the difference between the marginal revenue and marginal costs. To continue with the restaurant example above, our cheeseburger patron has a negative margin of $27 due mostly to the opportunity cost. Many fail to include opportunity costs in this analysis.

6. Determine products with the highest margin and exploit those products. For our cheeseburger patron, marginal costs are high for two reasons: the patron stayed so long that two other meals could have been sold, and he ordered inexpensive menu items. Most restaurant owners know that mixed drinks and appetizers carry the widest margin. How can our restaurant owner reduce the time a customer enjoys a meal without inconveniencing him? How can he encourage higher margin foods and drinks for patrons? The restaurant owner might consider not offering free refills for soda to discourage patrons from lingering. He might advertise cocktail hour specials to bring in customers apt to order drinks and appetizers.

Tips & Warnings

• Even if they are difficult to quantify, be sure to consider long-term sacrifices as opportunity costs. When one customer may not seem a high-margin customer per visit, he may become a loyal customer that accumulates worth over time.

• When focusing on exploiting high-margin products, be sure not to rid your business of intangible value. For example, a restaurant that specializes in romantic dinners would not be advised to rush customers in order to serve the next patron.