6 Reasons to Sacrifice Profit Margin in the Name of Growth

May 28, 2018 Business Strategy, Customers, Marketing, Technology, The Manager's Resource Handbook

6 Reasons to Sign a Contract Even if You Won’t Make Money

With all the talk about powerhouse brands like Amazon, UBER and Apple, we often hear about companies experiencing rapid growth and making record profits. But these firms are clearly exceptions to the norms that countless small businesses experience. Without a doubt, every business owner wants to be profitable and hopes to generate enough cash to fuel expansion. However, achieving strong profit and fast growth is a pinnacle achievement in business – getting both at the same time is not easy. When growing your business, you sometimes need to put strategic interests ahead of making profit. Let’s take a look at some of the key business and strategic reasons to sign a contract with lower profit margins.

What Is a Good Profit Margin?

The answer to this simple question is that there is no “good” profit margin. Profit margins are highly dependent on industry, negotiating power, competitor moves and strategic interests. While a 20% margin may be good for one company in one industry, 4% may be considered exemplary for another company in a different industry. The number is not important because a “good” profit margin is unique to each individual company. Rather, the goal of every business leader should be to maximize profit; that is, to earn the highest amount possible while still signing the deal.

Questions to Ask Yourself Before Signing a Given Deal:
Is there a better opportunity out there that can yield higher profits?
Does the reward (profit) match the risk you will take?
Are you willing to lose the deal entirely if you hold firm on your price?
Is the profit worth the time and effort of the resources the project will consume?
If you simply broke even, would the work you perform position your business for future success?

Make no mistake about it: generating profit is very important. Businesses that do not create cash are only short-lived. It is why any business exists – to provide products and services at a profit. But back to our question, what is a good profit margin? Consider this: if your target profit margin is 20%, for example, would you walk away from the table with a major new client if the final negotiated contract value would only yield 18%? Would 18% be considered bad business?

Now, here are 6 reasons to sacrifice profit in order to grow your business.

1. Market Penetration

Entering a new market has the potential to trigger growth, but crossing the barrier may require short-term sacrifices as the newcomer. In order to establish your footing in a new region or industry, you may need to agree to unusual financial terms – lower margins, just breaking even, or even losing money. Ultimately, the reason any company enters a new market is to achieve long-term growth. When seeking market penetration, remember that the fate of your long-term growth should not be at the mercy of your near-term gains (or losses).

2. To Gain New Customers

There are two primary ways to grow a business. First, you can offer a greater quantity of products and services to your existing client base. Alternatively, you can grow your business by selling your current products to a greater number of customers. Perhaps the most common example of reaching new customers is a marketing promotion that incentivizes new customers to try your product. Bakery owners, for example, may offer a free coffee with a purchase of a pastry to help reach new customers. While money is lost by giving away the coffee, the promotion may help generate future sales should new customers return.

3. To Increase Volume

From a business perspective, increasing the volume of your operation can have several benefits. First, it can improve cash flow as more product leaves your production line. Second, increasing production volume can help dilute overhead expenses across a great number of units. Third, increased volume also helps improve operating efficiency by reducing the starts and stops of batch processes. How does this relate to profit margin? Typically, when prices of a given product are decreased, more customers will purchase the item (which drives up volume). Thus, accepting new business at lower margins can still be beneficial as it can help improve your operating efficiency for the future.

4. Customer Relationship or Goodwill

In a world of increasing business competition and rapidly changing technology, customer loyalty is a tremendous asset to any company. Perhaps the biggest threat to repeat business is upsetting your customers and driving them to your competitors. Thus, great customer service and going above and beyond for the customer has the potential to earn tremendous brand loyalty and yield future business. Small investments to ensure your customers come back – like replacing some defective parts free of charge or providing more valued service than the price paid – makes for great business.

5. To Outlast The Competition

In some industries with limited participants, companies may sacrifice profit margin in order to displace or prevent the competition from winning a contract. Not that you should elect to break even just to keep your competitor at bay, but you should carefully consider profit margins in strategic or important markets such that you prevent your competitor from encroaching on your turf.

6. To Introduce New Technology

While new technology is often welcomed in terms the possibilities it represents, it is sometimes treated with caution due to uncertainty. The aerospace industry is one such example. Customers welcome new technology, but stiff regulatory controls over safety present a steep barrier to entry for unproven or new technologies. Reducing profit margin (and therefore price) is one such way to entice customers to take on the risk of the unknown. Such an investment on your part can provide valuable product pedigree that will enable your new technology to become more acceptable for future customers.

The Takeaway

Here’s the bottom line: while as business owners we want to profit and to grow, long-term strategic moves may often need to take priority over short-term profitability. Thus, not every deal you sign should just be about the cash reward. We should always seek to make as much money as possible, but we also need to be willing to accept less profitable business arrangements when they help support our future strength.