A:

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.

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 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 of sales a company actually keeps in earnings.

Reducing costs or increasing revenue can add to a company's bottom line – the net profit figure – but it may not improve the company's net profit margin.

Impact of Increasing Revenue

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 margin by almost 20 percent.

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 price 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.

A more 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.

RELATED FAQS
  1. How can a company improve its net margin?

    Learn about what businesses can do to increase their net margin, including ways to increase sales revenue and decrease operational ... Read Answer >>
  2. What is the difference between profitability and profit?

    Calculating company profit and profitability are not one and the same, and investors should understand the difference between ... Read Answer >>
  3. Profit margin versus operating margin: What's the difference?

    There are some distinctions between profit margin and operating margin. Both measure efficiency of a firm, but one takes ... Read Answer >>
  4. How do economic profit and accounting profit differ?

    Accounting profit is the profit after costs and expenses are subtracted from total revenue while economic profit factors ... Read Answer >>
  5. How do gross profit and gross margin differ?

    Both gross profit and gross margin measure how profitable a company is during a given period, but each shows profitability ... Read Answer >>
  6. What costs are not counted in gross profit margin?

    Gross profit margin is the percentage of revenue that exceeds the cost of goods sold for a company. However, not all expenses ... Read Answer >>
Related Articles
  1. Investing

    3 Profit Metrics Every Investors Should Understand

    In this article, you will understand how the three metrics gross profit, operating profit, and net profit helps investors see how a company is performing.
  2. Investing

    4 Tips to Evaluate Growth Companies (KO, AAPL)

    Discover the best metrics for stock investors to utilize when selecting and evaluating the best opportunities in growth investing.
  3. Investing

    Is Net Income The Same As Profit?

    Net income and profit both deal with positive cash flow, but there are important differences between the two concepts.
  4. Investing

    Profitability Indicator Ratios

    Learn about profit margin analysis, effective tax rate, return on assets, return on equity and return on capital employed.
  5. Investing

    Interpreting a Strategy Performance Report

    A strategy performance report can provide key metrics to decide if your strategy is a winner.
  6. Financial Advisor

    Key Metrics to Measure Your Advisory Practice

    These key metrics can help financial advisors measure their success.
  7. Financial Advisor

    Corporate Profits Fall, But They're Still Too High

    Corporate profits are falling--but is it because profits were too high in the first place?
  8. Insights

    Do Declining Corporate Margins Point To Recession in 2016?

    Learn how declining profit margins have foretold nearly every recession of the past 50 years, and analyze whether they may signal economic contraction in 2016.
RELATED TERMS
  1. Marginal Profit

    Marginal profit is the profit earned by a firm or individual ...
  2. Profitability Ratios

    Profitability ratios are a class of financial metrics that are ...
  3. After-Tax Profit Margin

    After-tax profit margin is a financial performance ratio calculated ...
  4. Gross Profit Margin

    A gross profit margin is a financial metric used to assess financial ...
  5. Gross Margin

    A company's total sales revenue minus its cost of goods sold, ...
  6. Corporate Profit

    Corporate profit is the money left over after a corporation pays ...
Trading Center