The Margin You Never Worked Out
What one sale leaves behind once it has paid for itself
Take one thing you sell. One product, one project, one month of a retainer. Write down what the customer pays for it. Now write down everything it costs you to deliver that one thing: the materials or the software, the contractor or the team member's hours, the share of the tools you pay for anyway, and your own hours at the rate it would cost to replace you. Subtract the second number from the first. What is left is the margin on a single sale, and in my experience most owners have never done this sum.
They have not done it because the business works in aggregate. Money comes in, money goes out, and at the end of the year the accountant says whether there was more of the first than the second. That aggregate hides everything. It hides the product that makes nothing once the owner's time is counted. It hides the client that is profitable on paper and a loss once the revisions, the calls and the chasing are added up. It hides the fact that the business is in effect two businesses, one that earns the margin and one that spends it, and the owner is spending her week on the second.
When I was an analyst the first thing I did with any company was to take the business apart by product and ask what each piece earned. Companies hated this, because the aggregate was always more flattering than the parts. A growing top line could hide a core product that had stopped making money years ago, propped up by one good line that nobody was paying attention to. The same is true of a business with six people in it. The margin by product is where the truth lives, and the aggregate is where it hides.
The number that comes out of this sum is often a shock. Services priced by instinct, years ago, at a level that felt fair, turn out to pay the owner less per hour than the person she hired to help deliver them. Products that are popular turn out to be popular because they are cheap, and cheap because nobody ever worked out what they cost. The owner is not foolish for having missed this. She was running the business from the roof, and from the roof every sale looks the same.
The response is to do the sum for everything you sell, and then to act on what it tells you, which is the harder part.
Lay the products out in a table. Price, cost to deliver including your time, margin, and how many you sold last year. Multiply the margin by the volume and you have what each line actually contributed. Sort by that column. The result is nearly always the same shape: two or three lines carry the business and the rest are passengers, some of them expensive ones. This is not a reason to cut everything below the top three. It is a reason to know, and to stop pretending the passengers are pulling.
Then look at the time column. The product that earns a fine margin but eats forty hours of your month is not a fine product; it is a job you have given yourself. The product that earns a modest margin and takes almost none of your time may be the best thing in the business. Margin per hour of owner time is the figure that tells you what to do more of, and nobody calculates it, because nobody counts the owner's hours.
Finally, hold the prices up against the margins. If a line is leaving nothing behind once it has paid for itself, there are three choices: raise the price, cut the cost of delivering it, or stop selling it. There is no fourth choice that involves keeping it as it is and hoping volume will fix it, because a product that loses money on each sale loses more money the more of it you sell. The owner who knows her margins makes this decision in an afternoon. The owner who does not makes it in a crisis. Tomorrow, the second question from the business model: who actually pays, and the gap between them and the people you built the business for.
Continue reading: Who Pays, and Who You Wish Paid →
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