Conservative as well as aggressive methods to deal with down cycles in your business.
By Marty McGhie
The point of this strategy is to rein in the business, get conservative, and try to ride out the storm. History has proven that many businesses have survived by implementing just this type of philosophy.
Going on the offensive
While the conservative strategy makes sound fiscal sense, perhaps a different, more aggressive approach will better suit your business. What if, instead of taking a defensive approach, you went on the offensive?
Let’s assume, for instance, that you are currently running two shifts and your sales have slowed down to the point that you find yourself with some excess capacity on your second shift. Instead of laying personnel off on that shift, you change your approach to figure out how to get more work in to fill up that second shift. This may involve a very aggressive approach to your marketing. For instance: Try cutting prices on some of the products where you currently have capacity, or run specials for a specified period of time on your products to fill capacity. Keeping in mind my prior warning about price reductions, make it clear to your sales reps and your customers that this is a special deal for a limited period of time. (If you don’t know how to pull that off, go visit your nearest mattress store-they’ll teach you.) If you roll out a plan for 60 to 90 days and it works to generate some additional sales and cash, try another product for the next quarter.
A short review on the accounting theory of "break-even analysis" can help validate this type of strategy. Let’s examine a simple example: Assume that the fixed costs to operate your business for one month total $200,000. These costs include building rent, health insurance, worker’s-compensation insurance, salaried employees, lease or finance payments on loans, etc.; these are costs that have to be paid, regardless of how many sales you have. Let’s assume that your gross profit margins run at 50%. Hence, if you sell something for $1000, after the labor and materials and other variable costs related to the manufacturing of that product are paid, you have $500 left to pay toward your fixed costs.
So, the math in our break-even analysis example tells us that if you sell $400,000 at a 50% margin, you will generate $200,000 to cover all of your fixed expenses and thus break even. Keeping this in mind, let’s go back to our example.
Now let’s assume that you fight like crazy to just get to your break-even point of $400,000. Because you have now covered your fixed costs, you have the luxury of discounting the very next sale and dropping all of the dollars generated after labor and materials to the bottom line. Who cares if it doesn’t equal a 50% margin? If it generates a 30% margin, those dollars go directly to the bottom line. This strategy allows you some flexibility when strategically pricing jobs.
Of course, the trick is to get to the point where you have met your revenue goals to break even. During tough times, this is challenging. A similar pricing strategy would be to discount some of your sales right from the start. The price decrease would, of course, lower your gross margins and drive your break-even point of sales higher than normal. However, if you dig back into your economic lessons on the theory of elasticity, you can assume that by lowering your prices, demand for your product will go up, and the additional sales will generate profits-even at lower margins-and ultimately help you to survive a dip in your business cycle.
Keep in mind that even the most aggressive shop strategies should include some of the same measures as the conservative plans. For instance, in tough times you should always carefully review expenditures to evaluate where you can cut excess costs, and you need to continually examine ways to build sales. Going through this exercise is sound business practice no matter where you are in a business cycle.
The perfect plan for your business may very well be a mix of these different methods. Regardless, if you find yourself in the midst of some tough times, choose your strategy wisely, commit to it, then go to work. Soon, you’ll be heading in the right direction.
Marty McGhie (email@example.com) is VP finance/operations of Ferrari Color, a digital-imaging center with Salt Lake City, San Francisco, and Sacramento locations.