Maximizing profitability: Mind your Ps and Qs
By Barbara Bix and Melissa Josephson Edwards
Accountants' top directives to companies may very well be: aim to maximize profit. Yet, in the frenzy of everyday work, it is not uncommon for "urgent" issues to supplant "important" ones. How, then, can companies stay on target and maximize profitability? Marketers at your client companies need to consciously choose a strategy for optimizing sales and marketing resources—and then stick to it.
Selecting the Right Target Market
Picking the right target market by selecting the most profitable group of customers is the critical first step in developing an effective marketing strategy. Doing so enables marketers to concentrate their firepower and limited resources on those prospects that will yield the greatest profit.
When identifying the most profitable market segments, advise marketers to look for the group of accounts that...
- Will derive the greatest value from your products and services and will therefore pay top dollar for them,
- Is large enough to generate the desired revenue,
- Is the least expensive to serve.
A good example of targeting profitable customers is James, a British-born certified public accountant with his own consulting business in the United States. Through conversations with his business network, James found a much more lucrative market niche: established companies who were seeking new business ventures overseas.
Executives at these companies were willing to pay top dollar for James's services because James was skilled in accounting practices in both the U.S. and European markets, and his experiences proved invaluable to the success of their businesses.
These companies also turned out to be more profitable to serve. Because the companies' needs were very similar, James was able to create a standard — and effective — offering that he easily adapted for each new client.
The irony was that once James identified this more profitable market, it also became much easier to generate new business. The business executives at these companies had natural and tightly knit networks through their expatriate communities and often referred James to their friends and colleagues. Word of James's services spread quickly, generating more business from high paying clients — and, therefore, higher profits for James.
Dissecting the Profitability Equation
As demonstrated by James's example, the best market segments are those that that optimize the Profitability Equation: Profits = (Price x Quantity) – Expenses. Marketers must examine and weigh the best combination of these three variables. It helps to start by analyzing the makeup of each variable and how the variables affect one another:
- Price: As illustrated in James's example, different customers derive different value from the same product and will pay different prices for it. Therefore, maximizing price requires knowing who derives the greatest value from your products or services. To determine the most desirable market segments, ask: What alternatives do prospective clients have? What is the availability and quality of substitute products? What are the prices of these competing products and services? How do your products and services better meet the needs of your customers? If you can articulate a stronger value proposition, you can charge higher prices.
- Quantity: There is a direct relationship between price and quantity. If you can charge higher prices, you don't need to sell as much volume to achieve the same profit. James was able to charge higher prices to a much more concentrated group of clients.
- Expense: One way to look at expenses is in terms of actual dollars spent to acquire and serve customers. Another important factor is the actual amount of time spent on each customer. Customers require different levels of attention, and some are much more expensive to serve than others. If you can determine which market segments are easiest to acquire and serve, you have the flexibility to discount prices or sell less and still achieve your profitability goals. When determining which market segments to target, don't neglect to ask: Do certain customers require ancillary services for which the company may not be able to charge? What are your selling expenses? Are certain market segments harder to reach? Do particular customers require custom product development?
Applying the Profitability Equation to Select Your Target Market
Much of the information you need to evaluate these three variables lies within your current customer database. By starting with the current customer base as a guide, marketers can look at a whole market to...
- Find groupings and identify segments. Some natural groupings will automatically pop up, such as customers by geography, industry, specific purchases, etc. Ultimately, look for customers in a segment that share similar characteristics.
- Assess the relative benefits of serving each segment. How large is each market segment? What are their alternatives? What will they pay? What will it cost to reach them? How long will they take to make a buying decision? How much effort will it take to turn them into satisfied reference accounts?
- Identify potential threats, such as competing solutions, that might cut into volume or require additional expenses to thwart.
- Apply the "profit maximizing" formula and do the math. Review price points, calculate the volume of customers at each price point, and incorporate associated expense information into each segment.
When your clients are armed with this information, creating an effective marketing strategy is much easier. Once they apply the profit maximizing formula, it's easy to select the right target market, focus their marketing dollars, and make the most of their resources.
About the authors
Barbara Bix is Principal of BB Marketing Plus, a strategic marketing consultant that works with professional service organizations, and a member of the AccountingWEB Bloggers Crew. Melissa Josephson Edwards is a strategic marketing consultant and an expert in creating marketing communications programs. She can be reached at email@example.com.