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.
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 is calculated 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.
- 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.
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—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 or Victoria's Secret. 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.