Despite what you hear on the news, small business owners are thriving in very real ways. This article details three client case studies on how these small business owners have successfully delivered more Net Profit to their pocket.
Most small business owners have never read a Jim Collins book. That is a real shame, because a fundamental business principle is to face the facts (both good and bad) head-on. We saw this in the energy bust in 2015. Several companies that had planned very conservatively from the 2007 drop had built up large cash reserves. The only guarantee when you have a boom is that you will have a bust. The question for business owners should not be, what will happen to your business, but rather, what are you planning to do to prepare for it? So, for those that were prepared, they swept in and bought up a number of assets that were on a fire sale, from those other companies that were highly leveraged, had failed to plan, and were simply trying to ride the wave to fortune and riches.
This article details three privately owned, small businesses that operate in larger metro areas. Company Alpha is a commercial service company; Company Bravo is a design/manufacturing company; and Company Charlie is a professional services firm. Each has their own unique value proposition, and as you will read, has figured out a way to either raise their prices and/or raise their net profit.
Alpha has been around for about 15 years. The owner is a technician and started the company by himself. He shortly found himself with an abundance of service calls, and so he started to hire more technicians and the necessary support staff to support his early stage company. The demand for his service is so great, a typical service call goes like this:
Client: I have a broken piece of equipment, how soon can you get here to fix it?
Alpha: Mr. Client, we are happy to help you but it looks like all our techs are scheduled thru the next five days.
Client: 5 days is unacceptable. Isn’t there any way you can get here quicker?
Alpha: We do have our after-hours program, but you pay a premium since we are paying our staff overtime.
Client: That’s fine, when can they get here?
Alpha: Did I mention that there is an after-hours service charge in addition to the wage premium?
Client: That’s fine, when can they get here?
Alpha: There is also a 15% markup on their mileage for these after hour calls.
Client: That’s fine, when can they get here?
You get the point. Alpha’s work is in such high demand that time is much more important than price. Alpha has worked hard to cross-train its field technicians to be able to repair any piece of equipment in the field, giving them ultimate flexibility with their logistics and being able to maximize their gross profit on a daily basis. Alpha keeps adding additional “service fees” or bumping up its hourly rate until customers not only complain about it, but when they start to see a decrease in the number of service calls by that particular client. Then they go back and negotiate a “standard rate” for that client, which is still a 25% increase over the base rate, because they will provide priority scheduling for that client. This is an excellent example of the business principle, “the price you are willing to pay for something is directly proportional to your need of it.”
Bravo is a really neat design/manufacturing firm. They make custom engineering applications for various companies. Whenever you see the word “custom” your mind should immediately register “higher net profit.” Whenever the economy tightens up and clients look for ways to increase efficiencies/output, they call on Bravo. Bravo’s best years since 2001 were 2007-2010 and also 2015-2017. Since he has now successfully expanded his client base during two past downturns, he now has more recurring maintenance revenue than ever before, which provides great cash flow, and also increases their project work, because now they are the first call for a larger number of clients. Bravo’s clients are able to get quotes from other vendors, but the other vendors have much more overhead than Bravo does, and so even with the very healthy gross profit margins that Bravo uses in its estimates, it is still generally the lowest bidder. They had been working with one large Fortune 500 client for about three years, and they finally figured out the purchasing game. The Operations Department would contract with them to provide a custom application. The Operations Department Manager would then beat them up a little bit, trying to play the bids against each other, and generally was able to get a 2-4% bid price reduction. The Engineering Department Manager would then beat them up a little more on price and try to get another 1-2% reduction in the bid. Then the Purchasing Department would beat them up a little more and try to get another 5-10% reduction. Bravo figured this out after a while and simply added another 25% to the initial bid estimate, so that even if they “agree” to a 16% price reduction, they are still 9% higher than they were before. The old line of “be careful what you wish for because you might just get it” comes to mind for their client here. This is on top of Bravo’s standard practice of adding 25%-50% contingency (internal) into their initial estimate, since many times they have no idea how many design hours will be needed or how difficult it will be to manufacture a particular piece. They also have a clause in their contract that states, if there is more than a 15% variance in our bid estimate to actual, then client will pay for all additional fees and expenses at market rate. If you customize something for someone, then you should absolutely get paid for it.
Charlie is a professional service company that now operates like a well-oiled machine. They provide a service that is required by law. As with many of these types of services, the client is not concerned with value because he is forced to contract this service. What the client is interested in is price and speed. Charlie decided to build a company that is the lowest cost provider, will be able to take a significant portion of market share, and then he will reverse engineer how to drive a significant net profit from the low price. He invested heavily in technology, and so where his competitors use two field technicians, he can use one. His competitors still enjoy driving around very large trucks, and he has put his people into fuel-efficient cars and smaller SUV’s. He has streamlined the back-office processing to where they can produce the necessary client documents to the cloud or email within 1 business day of the site inspection. Charlie started the company in 2003 and waited for the economy to take a dive. In 2006 he had about 30% of the market share. By 2010 he has over 60% of the market share. By leveraging technology and investing in training, he has been able to drive his gross profit to above 70% and his net profit to about 32%. I don’t know any company that would sneeze at 32% net profit margins! He aligns all his employees with the company direction by providing real-time data on their performance to them, as well as paying large bonuses for gains in their productivity. The faster and more efficiently they work, the more money they make. Charlie’s theory is that he can “perfect” this business model in Houston and then replicate it in all the large metropolitan areas that have the economic indicators that show it would be a great location for his particular service.
These three companies provide a small snapshot into the world of small business. According to the US Census Bureau, there are 27.9 million small businesses in the US. If we assume Pareto’s law of 80/20, that means that about 5 million of these businesses are the rock-stars, like the companies we have read about above. Until you go and listen to their stories, dig a little into their business models, and understand how they are functioning, you would have no idea just how profitable these little businesses are. If you are an employee for one of these companies, you are extremely happy because they are providing great work environments, as much work as you want to do, good benefits, a family environment, and an opportunity to develop and take on as much responsibility as you want.
The trick is that on average, only 1 in 6 of the companies you interview at will be in this category. Choose wisely…
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:
