Business operators often concentrate on growth, but it’s not just about increasing output and expanding your business.
It’s also about making your business more profitable and obtaining increased profit.
In fact, there’s an interesting phenomenon that sometimes occurs when a business goes through a growth stage where the profit might actually drop off due to increased expenses.
Known as the law of diminishing returns, it’s an important problem to recognise and address, and it comes down to implementing one of three key strategies.
What is the law of diminishing returns?
The law of diminishing returns is an economic principle that notes if one input in the production of a product or commodity is increased while all other inputs remain the same, there is a point where producing that product becomes less profitable and efficient.
And it is a principle that holds true in business as well.
For example, if you hire additional staff to produce the same volume of products in a factory, the cost of producing each product increases and the profitability of the operation decreases.
It’s an important principle to consider when businesses look to create growth. It’s not about growth for growth’s sake, but has to involve a focus on the bottom line and growth in profit.
So how do you ensure that’s the case?
Know the destination
If you’re considering a growth phase in your business, you need to get crystal clear on the profit margins you are hoping to achieve.
For each staff member, piece of technology or expense you add, you need to know the direct costs and return on investment expected.
Say for example, you run a painting business, and you’re looking to increase your staff base to complete extra jobs.
Before you hire additional team members, you need to know exactly how many extra jobs you are aiming to do in order to:
- Account for time spent training
- Pay that person’s wage, entitlements and superannuation
- Cover their insurance
- Account for time spent in administration for that employee (payroll, instruction, super etc)
This provides the baseline of the business expenses involved in expanding your team, and then you can set KPIs (number of additional jobs they will need to complete) in order to create actual profit from that investment.
Ensure it aligns with your goals and plans
No business should look to grow just for the sake of it. There has to be a clear goal, plan, and strategy for that growth.
When growth becomes a knee-jerk reaction, there is a higher risk of reducing the actual profitability and efficiency of your business.
In other words, map out exactly how you intend your growth to look, what will be required, and how you can ensure that growth adds efficiency and profitability.
This involves achievable goal setting, planning and action – all of which should be documented in your business plan, along with the expenses, cash flow, sales targets and risks involved.
Ensure there is the market for it
As you consider your growth strategy, there is one critical question to consider. Is there actually a market for this growth?
In other words, are there enough new customers out there in need of extra services or products? Or are there enough existing customers who want to use more services or customers?
Too often business owners aim to grow without looking at whether the market will sustain their growth intentions.
Talk Strategy with Clive
With more than 30 years’ experience in mentoring small to medium-sized businesses around Australia. Clive works with company owners and their teams to grow their business and achieve goals through startegic coaching.