It's impossible to determine whether lowering costs or increasing revenue is more important across the board for all companies. There are too many factors that can influence the answer for a given company, in a given market, or in a given economy. A specific marketing focus may be the key to financial stability and steadily increasing profits.
Key Takeaways
- Whether it is better to cut costs or increase revenue often depends on the company and the industry in which it operates.
- Profit margins, which are computed as net income divided by revenue, do not always improve when sales are increased or costs are reduced.
- Increasing revenue can result in higher costs and lower profit margins.
- Cutting costs can result in diminished sales and also lower profit margins if market share is lost over time.
- Focusing on branding and quality can help sustain higher prices on sales and ensure higher profit margins over the long term.
Understanding Profitability
It's important to understand the basic metrics of profitability, such as the difference between profit and profit margin. Profit is the money a business makes after accounting for all expenses.Profit margin iscalculated as net income divided by revenue.Profit margins are expressed as a percentage and, in effect, measure how much—out of every dollar in sales—a company actually keeps in earnings.
Impact of Increasing Revenue
Reducing costs or increasing revenue can add to a company's net profit figure (bottom line), but it may not improve the company's net profit margin. Consider a hypothetical company that increases annual revenue from $1 million to $2.2 million by increasing its sales staff from five to 15 people with an average salary of $100,000 each. The additional $1.2 million in revenue only results in $200,000 additional net profit and actually reduces profit margins by almost 20%.
The company has to address the question of whether the lower profit margin is acceptable in return for the absolute dollar increase in profits, as the lower margin may not offer a sufficient financial cushion to ensure the company's continued viability. The company may have additional dollars in the bank, but it may be in a less healthy or less secure financial condition.
Impact of Reducing Costs
Reducing costs increases profitability, but only if sales prices and number of sales remain constant. If cost reductions result in a lowering of the quality of the company's products, then the company may be forced to reduce prices to maintain the same level of sales. This can wipe out any potential gains and result in a net loss.
An even greater negative impact may result over time from a gradual loss of market share as the reduction in quality makes it impossible to maintain sales figures. However, if a company can efficiently cut costs without affecting quality, sales price, or sales figures, then that provides a path to higher profitability.
Strategies for Increasing Profitability
Another factor to consider is whether increasing revenues or significantly reducing costs is a viable option. A company may already be operating near maximum efficiency in terms of reducing costs, having negotiated the best possible prices for materials, personnel, and facilities. In regard to increasing revenue, a company may be in a market that is so competitive or an economy that is so depressed that increasing sales numbers or raising prices are not realistic goals.
One strategy for increasing profitability through increased revenue is commanding higher prices through successful branding. Examples of such success are classic firms such as Coca-Cola or Sony, or high-end retailers such as Abercrombie & Fitch. These companies have established identities that enable them to command significantly higher prices than competitors while simultaneously increasing market share and maintaining that premium market status even in economic downturns.
Focusing on quality and branding as the means to increasing revenues and solidifying a customer base may be a company's surest path to long-term prosperity.
How Do Businesses Lower Costs Without Hurting Their Revenue?
In order to lower costs without adversely impacting revenue, businesses need to increase sales, price their products higher or brand them more effectively, and be more cost efficient in sourcing and spending on their highest cost items and services.
How Does Cost-Cutting Translate to Greater Profitability?
Cutting costs can make more funding available to the business, which can result in increased profits and better dividend payouts for shareholders. Cost reduction can also free up more money for the company to reinvest so as to develop or expand the business.
Is Cost Cutting a More Effective Way of Boosting Profits Than Raising Revenue?
Cost cutting is often a faster, easier, and more streamlined way of boosting profits than growing revenue, which can be a slow, arduous process. A higher dollar amount of revenue istypically needed to generate the same profits that would be generated by cutting costs.
