As a casual observer of the world of professional sports and as an amateur coach, the ideas of analytics has always intrigued me as a method of creating performance. I hope to draw some similarities and use the much more entertaining world of sports to hopefully draw some useful insights for the small to medium-sized business owner.
In every game there is a final score. One side or the other is declared the winner. In business there are also winners (those who make money) and losers (those who do not). Since I am from Cleveland, and most fans feel this way at one time or another, there are also teams with great fan loyalty, and potential for next season, but who seem to be perennial losers. Their business counterpart might be venture funded startups, long on dreams, short on profits, and always looking to next year for a break through.
Business in many ways is simple. Buy low, sell high and repeat that enough times in a row so that you make enough to cover your overhead and take home a profit.
Take a simple business that sells roses on a street corner. The owner and sole employee determines if they can buy 1000 roses at $.50 and sell them for $1.00, he can make $500 a day a tidy income of $100,000 if he works 200 days. Our happy owner has a business with a unit contribution margin of $.50, no fixed costs and his business decision making is pretty easy.
Every business has a cost of goods/services1 sold. Every business has a price for its product/service. The difference between the two (usually called gross margin) is a fundamental determinant of making money; your margin % is the most critical analytical measure in your business.
Margins determine the underlying economic model for the business. How many do you have to sell at a given price in order to make money. These price/volume relationships drive the size and scope of all business activities. The cost side of the equation is critical in these calculations.
Costs determine the ability of the business to withstand competition from competitors. Most every business faces pricing pressure of one sort or another. This may come in the form of lower prices or in the form of extra included services or features for the same price.
Many businesses price on the basis of cost plus a markup to determine their prices.
Margins define limits on the amount you can afford to spend on selling your product, and thus indirectly methods you can employ to get your product sold. Channel decisions (direct, indirect to customers) require allocating part of your margin along the chain of parties that sell your product to the customer. Margins will determine the types of “salespeople” you employ and the options for how you pay them.
As businesses get more complex, calculating margins gets harder than our street corner flower vendor. Costs begin to have relationships to volume that are non-linear, non-variable, and in the case of capital assets, disconnected in time from a sale. Margin metrics proliferate just as do sports performance metrics; for a baseball/softball pitcher it is ERA, walks per inning, average speed, pitch speed diversion, strikes to balls ratios, performance vs right or left-handed batters, and on and on.
The math may get complex but running a business without margin metrics is as foolhardy as drafting players based on the score of the games in which they played.
Would you like to delve further into the idea of product and service costing? Check out our 5-part series on costing to learn more