To increase profitability, businesses must either reduce expenses or increase revenue. Variable costs, such as labor, can be cut, but layoffs can harm productivity. Increasing revenue by adding new products or services, charging premiums, or raising prices is desirable but risky. Finding a balance between customer willingness to pay and profitability is key.
There are many suggestions that can be made when it comes to ways to increase profitability. However, despite all the formulas and suggestions, ways to increase profitability boil down to two things. Business managers must find a way to reduce expenses or increase revenue, or find a combination that meets both.
For most companies, whenever they find themselves in tough economic times, the first tendency is to cut expenses as a way to increase profitability. This is a natural trend as it naturally seems like there are some expenses that can always be cut. However, there are others that cannot be. In economics, these are known as fixed costs and variable costs. Variable costs are the ones that can be cut most easily.
There are several ways to reduce variable costs. However, it should be pointed out that the biggest of all variable costs for the vast majority of businesses is labor. Therefore, even in moderately severe situations, a certain amount of layoffs, or at least reduced man hours, will likely be required to make a significant impact on reducing expenses.
While layoffs and reduced hours may be a popular way to cut costs and, as a natural result, increase profitability, there is a certain risk to this strategy. First, others will have to find ways to make up for this lack of help. While this adjustment takes place, it can be nearly impossible to increase profitability because productivity will suffer.
The most desirable, but also the most difficult, option for increasing profitability is to increase revenue by keeping expenses rising at a slower rate than revenue growth. There are several ways to do this, depending on the type of business you have. Companies that produce a product can add new product lines or raise prices. The service company might add services, charge premiums for some things, or raise prices.
As an example, the airline industry is a master at finding ways to increase profitability or, at least in some cases, at least decrease the amount of loss. From charging for luggage, charging for onboard beverages, the industry has found ways to increase revenue by looking at potential streams that had never been explored before. However, complicit in such actions are certain risks.
Customers often balk at higher prices and may decide to take their business elsewhere. The key for many companies is finding a balance between prices that customers are willing to pay and a price that allows the company to increase profitability. Of course, the law of supply and demand will normally ensure that the market finds equilibrium. However, a substantial amount of financial hardship could occur before this balance is achieved.
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