For the commercial manager, whether of a large of small business, January is a month of contemplation on the past twelve months on what went right and what went wrong, and how the results compared to the business plan and forecast. Regardless of when a financial year begins or ends, there is always pressure on the commercial manager to at least maintain and preferably improve results.
Commercial managers are responsible for producing sustainable profitable income for the long term future of their business. To do this effectively, requires both new ideas, experience of the market and an understanding of the organisation’s previous business getting and retaining activities. Making profitable income results from a combination of price, volume of sales, and the control of costs. Getting the balance of this combination right is fundamental to the commercial manager’s success.
One priority must be to always seek new customers, as they provide a source for additional sales. However, there needs to be a continuous flow of new customers in order to replace the natural wastage from the customer base owing to the effects of customers’ changing requirements and erosion by other competitors. Ultimately, commercial managers are measured by the amount of profitable income that they produce and how efficiently they use their resources in its production.
Ideal pricing identifies those product market combinations that allow a company to achieve its targeted rate of return on all the capital employed. However, achieving an ideal pricing that produces a targeted rate of return is far from easy, especially as emphasising a rate of return in price setting, often ignores market and customer requirements to the detriment of the business.
Price is that value which the purchaser is prepared to pay for a service or commodity, and is not related to cost. Cost is the sum of materials, labour and overheads in the production of the commodity or service. If the cost of a product or service exceeds the price that the market is prepared to pay, then the product or service will fail. It follows that accurate costing is essential only to establish the level of profit that can be obtained from the price of the product or service. In practice, when margins are low, small movements in price, volume and cost tend to have a magnified effect, but when margins are large, they have diminishing effects on profitability.
Improving profitability by 10 or 20% can be a tall order, especially in businesses where profit margins are small. In such cases, the answer is often given to cut costs and to increase sales, both of which are easier said than done, especially if the demand is for say a 10% cut in costs, or a target of a 10% increase in sales. In fact an increase in sales may well incur an increase in costs, so the answer is never simple.
Small incremental changes to operations are much easier to effect than large ones. It is much easier to cut costs by 1% than it is by 10%. Similarly it is much easier to make a price increase of one per cent than ten percent, as a one per cent change is hardly noticeable by the consumer and therefore easily acceptable. Likewise, increasing sales by 1% is much easier to attain than trying to attain a 10% increase. It is important to realize that the accumulated effect of small changes can result in a much bigger result.
From the example below it is easy to see the cumulative effect of a 1% increase in volume and price, with a 1% cut in variable costs results in almost 25% increase in profits.
But it follows that care must be taken when prices are cut because there has to be a disproportionate increase in volume to offset the negative effect on profitability.
For the commercial manager, achieving a number of small changes that produce the required result from their cumulative effect, can be much easier than trying to achieve a similar result with a single large change.