Taking steps to improve profitability can actually help you to increase customer value and build brand equity.
Every business has a break-even volume on their product line. For example, GM’s break-even point in 2011 is estimated to be 2 million vehicles (20 percent share of a 10 million U.S. vehicle market). Their profits on the first 2 million vehicles went to pay back their investment in the model; they did not make their first dollar of return for the shareholders until that point. By contrast, BMW appears to have been profitable in North America with only 300,000 units.
These very different break-even points lead to very different customer value propositions and business models. By lowering your break-even volume, you can increase your return on investment (ROI) and potentially pursue new, more profitable business models.
Break-even Point: Why Do You Care?
Your break-even point is a key determinant of your business model:
With a higher break-even point you are forced to deliver products that appeal to a broader customer base
This may drive your design and feature decisions toward the bland, as your design focus moves away from “creating delight” toward “avoiding dislike”
Over the long term, blandness reduces brand equity, which lowers your price points and margins
Lower prices and margins increase your breakeven point, leading to a vicious cycle of increasingly bland products selling in larger volumes at lower margins
By contrast, lowering your break-even point can work wonders on your business model:
You can target smaller, more attractive niches rather than the broader market
You can tailor your products and services to those niche needs, providing more value to the customer
Providing more value will build greater brand equity, with positive effects on price, margin and/or share
With higher margins you may be able to further reduce your break-even point
For example, BMW can produce much more distinctive and stylish products, appealing to a narrow niche of consumers, in part because they have such a low break-even volume. As a result, they have built enormous brand equity.
3 Ways to Lower Your Break-even Point
Break-even volume is calculated as follows:
Break-even volume = Fixed Costs / (Contribution Per Unit)
Contribution per Unit = (Revenue less all variable costs) / (Number of Units)
Every business has opportunities to lower their break-even volume point. Here are three ways you might do so:
1. Raise your price
As a simple mathematical identity, raising prices increases contribution per unit, which lowers the number of units required to break even.
For many businesses, raising prices seems like the impossible dream, especially in the current economic environment. Managers may rightly fear that lost volume would more than offset higher per-unit costs.
However, a few executives with whom we have worked have been pleasantly surprised at their ability to push through price increases. One executive of a specialty plastics firm checked with his biggest customers after he raised prices 15 percent. Many of them told him, “We were wondering what took you so long to raise price; our other suppliers had pushed through similar price increases a year ago.” The moral of the story: You may have more pricing power than you think.
2. Remove fixed costs from your system
Many businesses find they can outsource some of their fixed costs and transform them into variable or per-unit costs. Look at your individual costs line-by-line and ask yourself: “Am I creating a competitive advantage from insourcing this cost? If not, can I pay someone else to hold these fixed costs and charge me a per-unit price?” Many non-essential costs can be outsourced.
Even if you end up paying a higher per-unit price by outsourcing a fixed cost, you may still be better off. With variable costs you only pay for what you use, so you have profitability protection if your sales lag. In effect, you are now sharing the risk of underperformance with your outsourcing vendor.
Outsourcing non-essential costs also allows you to focus your investment on the “good costs” in your business; namely, the things that help you create a competitive advantage. Never underestimate the value of focus!
3. Up-sell and Cross-sell
By creating attractive product and service bundles, you may be able to convince your customers to purchase a higher-end offer or sell them additional products and services. This will raise the average profitability of a customer and lower the number of customers you need to break even. One of our clients increased their average selling price by almost 30 percent by selling complementary products in an attractively priced bundle, which lowered their break-even volume dramatically.
These steps can help you manage your break-even point and improve ROI. If you choose to ignore the opportunities to lower your business’s break-even point, you may find yourself paddling ever harder just to stay in place.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark