The bank notified Michelle that she had insufficient funds for her last check that she had used to pay her credit card bill. She decided to pay the minimum payment once again so that she would have some money in her checking account.
Michelle knew that she could always get money from her husband to get her account balance up; but she didn't want to do that again. She didn't want to face her husband's criticism about her business one more time. But she also didn't want to keep losing money.
Michelle started a business from her hobby of creating custom masks. Michelle made custom masks that were used as wall hangings. At first, she just liked creating these artistic masks. Then she started giving them as gifts. Her friends and family kept referring their friends to Michelle, and so she started charging for her masks.
She charged double what it cost her to make them, and she was still losing money. It didn't make sense. If she increased her prices, sales would plummet; and there seemed to be no way to cut costs. How on earth could she make money in her newfound business?
Michelle knew she needed help, but how could she pay a consultant when she couldn't even pay off her credit card bill?
Michelle decided to talk to her husband to get one last bit of money to hire a business coach. She saw that Coach Russ was offering an introductory coaching package that included four 1-hour sessions for $500. He claimed that he could double profits by the end of the four sessions.
If Michelle could double her profits, she would be able to pay off her credit cards and possibly invest in growing her mask business. Michelle's husband willingly gave her the $500 she needed. Although, he said that if this didn't work, she’d need to think about going back to hobby mask making instead of draining their savings.
The first session was over the phone.
Coach Russ asked Michelle some basic questions about revenues, profits and how she was currently marketing her business. Michelle was getting $500 per month of revenue as she could only sell 20 of her $25 masks each month. She indicated that it only cost her $13 for materials, but that shipping charges and a lot of expenses made her company a loser.
After they discussed the basic vital signs of the business, Russ explained how he could help Michelle with her business, "I've created a simple formula to help startup businesses gain enough clients and improve their prices to become profitable relatively quickly. I call it my 5-Steps to Business Success.
Step 1 is getting more leads.
Step 2 is increasing the conversion rate of those leads.
Step 3 is increasing the number of transactions per each conversion;
Step 4 is increasing the price of each transaction; and
Step 5 is increasing your overall business profitability.”
Michelle was intrigued, but also disappointed, "I’m interested to learn more, but I think I’m doing as good as I can at all of these things. What if people just don't want to buy my masks?"
"That would be a problem. However, I think you’ve already demonstrated that at least 20 people a month do like your masks and are making purchases. Let me show you how the math works on my formula. You’re currently getting about 30-leads per month. Of those 30 leads, you are converting 20 into paying customers. Since you’re selling your masks for $25 for each mask, you are getting $500 of revenue. Your gross profit on this $500 is $250 or 50%. Unfortunately, this gross profit is insufficient to pay for some of your small expenses."
"I know. That's just information I told you."
"Right you are. Now, what if I can show you how to increase each one of the five aspects that I described in my steps with your business by only 10%?"
"I suppose I’ll get $550 per month in revenue as my income will increase by 10%."
"That's a common perception. Your revenue will increase quite a bit more. Let’s think about it. If you increase your leads by 10% from 30 leads to 33 leads; then increase your conversion rate from 2/3rds of your leads to 3/4ths of those leads, you’ll have 25 customers, right?"
Michelle seemed bewildered by the math, and said, "I guess so."
"Then, if you can increase the numbers of transactions by10%, you’ll have roughly 28 transactions instead of only 25 transactions for 25 customers. If you then increase your price by 10% to $27.50 instead of $25, you’ll have $688 per month in revenue, right?"
Michelle was overwhelmed, “Look, Russ! You are throwing a lot of numbers at me. I can’t do all of this math in my head.”
Russ could see that he was getting too detailed and so he wrote down the math on a piece of notebook paper and Michelle agreed that the math made sense.
Russ continued expanding his math even further on the notebook, “Since you currently have a 50% gross margin, you would normally make only $344 on that $688 in revenue. If we can improve that profit margin by10% as well, you’ll make $378 on that revenue, right?"
Michelle could more easily follow Russ now that he was writing everything down. She exclaimed, "You're right. I think I see what’s happening. I can increase my monthly profits by over 50% if I can improve each of the five elements of my business by10%. Right?"
“You’re catching on. But the math works differently. When you increase one area by 10% and then multiply it by another 10% increase, you get a higher increase than 20%.”
“So, if I increase one area by 10% then another area by 10%, and multiple them, I get a total increase of 21%.”
“That’s right! Because each increase is cumulative.”
Michelle started writing on the notepad, “Wow! When I do this five times, I get a total increase of 61%, instead of 50%.”
"You got it, Michelle. Our session for today has come to an end. I want you to think about how you can improve each area of your business and be ready to talk about your findings in our session next week."
Michelle expressed her disappointment, "Coach Russ, I thought you would teach me how to increase my profits. Why is a rookie like me coming up with these ideas?"
"First, you're no rookie. Second, I want you to put your mind to work to develop confidence in your own abilities to improve your business. If you come up empty, I'll help you along next week."
Michelle decided she would try to do as Coach Russ said. Over the next week, she did the homework that she was assigned by Russ.
First, Michelle thought about her lead generation. She currently relied on referrals, word of mouth and Facebook™ to generate leads. She thought that she could improve leads using Instagram™ to show pictures of her masks.
As far as improving the conversion rate. Michelle already had a high conversion rate. She wasn’t sure how she could improve from 67% to 74%.
She then considered how she could increase the number of transactions. What if she offered two masks for a discounted price of $45 instead of $50?
Then she got stuck at prices. If she increased prices, she’d lose the customers she just gained. She didn't want to do anything with her prices.
Then it came to profits. If she ordered more mask blanks, she would be able to save 5% on her product costs. But this would mean that her credit card balance would go up. Michelle didn't see how she could effectively cut her costs without driving her credit card balance up.
Maybe Coach Russ could help her with some of these challenges.
It was time for session number two. Coach Russ asked Michelle about her homework. She shared her list with him.
Coach Russ congratulated Michelle on her efforts and said that she had done quite well with her homework. Michelle would start an Instagram™ account this coming week and create a following. Michelle would also offer discounts for bigger orders.
Coach Russ and Michelle agreed that she would make much more money by offering bulk discounts as her overhead on larger orders was much smaller. Therefore, Michelle would create a sliding scale for orders all the way up to 100 masks.
Coach Russ asked, "Why did you not do anything to increase your conversion rate?"
Michelle responded, "Are you kidding? I have a conversion rate of 67%. How can I do better than that?"
"How often do you contact people who didn't buy from you?"
"Why would I contact people who don't want my stuff?"
"Usually, when a prospective client says no, the timing may not be right for them; or they felt the price was a little higher than they wanted; or something else. But in most cases these people who said no are still interested. What would happen if you sent them an email to ask them if they have reconsidered?"
"I don't know. Isn't that just annoying?"
"It's your business and your call. If you’re annoying them, they will tell you. However, some may be grateful you reminded them and may make a purchase. What do you say?"
"I guess it couldn't hurt."
"Awesome. I think you’ve your hands full for this next week. I want you to make the changes we talked about, and we’ll start working on the other areas next week."
Michelle was amazed at how many leads she picked up after she started her Instagram™ account.
She found out that many of her Facebook™ friends started following her right away; and started sharing her posts on Instagram even when they didn't share these same posts on Facebook™.
Within a week she got three new leads. She was also amazed that two customers responded to her follow up email telling her they had changed their mind and were interested in giving her masks a second look. There were no takers on her new, improved large volume pricing. The five additional leads were progress.
Michelle was excited to share her success stories with Coach Russ on their third session.
Russ was excited for Michelle, “I knew you could do it, Michelle! I’m so proud of you!”
Michelle was beaming, then added, “One thing that hasn’t yet worked is our bulk pricing. No one responded with large orders to take advantage of these larger discounts.”
“About that. I think that may be a blessing in disguise.”
Russ seemed deep in thought, “I think your prices are too low.”
Michelle shared her fear, "I don't think I can raise prices. Even some of the people who wouldn't buy from me in the past said that $25 was way too expensive for a mask."
Russ said, "Pricing is a tricky thing. As you increase prices, some prospects won’t buy, but others may be more attracted to your product at a higher price because they feel your masks are higher quality."
"What? What about supply and demand in economics? I thought that demand will always go down as you increase price?"
"On a macro-economic basis, supply and demand are certainly at work. However, business pricing on a micro-economic basis is quite different. You won't know your prices are too high until you increase your price and you lose customers."
"But I told you I had customers who wouldn't buy at $25 per mask. That must mean my prices are as high as they can go. Maybe my prices are too high."
"Not necessarily. Just because one or two customers won't buy at your current price, you may pick up more customers at a higher price."
"Really? I don't believe it. What if I ask my current customers what they think of my price?"
"When given an option, all customers don’t want to pay more than they’ve already paid for a given product. I recommend you try a little experiment. Try to increase the price of your single mask to $30. Then decrease the price if your customers buy more than one mask. You can even drop your price to $20 per mask if they purchase 100-masks."
Michelle paused for a while, "Okay. I'll try this new price for a month. But, if I lose customers, I'm dropping my prices right away."
"That's all I can ask. Our session is up for today. I’d like to wait a month before we have our fourth session to give these changes a chance to work. Is that okay with you?"
"Sure. Talk to you in a month."
It was an interesting month.
Michelle picked up even more leads through Instagram. Her bulk pricing also paid off. Michelle received an order of 50 masks from their local college who wanted logo masks for their championship football team. They thought it would be a classy and unique gift for players, cheerleaders, and coaches. With their bulk order of 50-masks they paid $23 per mask.
Michelle was mostly surprised about her price increase. She was convinced that she would harm sales by increasing her price from $25 to $30 per mask. A few people told her that they wouldn’t buy at the higher price. But there were many more additional customers who did pay the extra $5. Her conversion rate went from 67% to 75%, so price was obviously not a deterrent.
Michelle decided to do some math before her fourth session with Coach Russ. With the bulk order and the increased leads and conversions, Michelle's mask business had $2,000 in revenue. Within a month, she had quadrupled her revenue from $500 per month to $2,000 per month.
Michelle started the fourth session with gratitude, “I can't believe how much you've helped my business, Russ. I’m so grateful for all you’ve done in just three coaching sessions."
Russ reacted, "Michelle, you've done all of the work. You need to congratulate yourself. I’ve merely helped you question some beliefs that had been holding you back. You decided to try out Instagram™, you came up with the bulk-pricing idea; and you followed up with previous prospects who said no; and you ultimately decided to increase your prices."
Michelle smiled, "Then why am I paying you?"
"Because without me, you wouldn't have seen these things that were holding you back. We all have limitations; and we never see them until someone with experience points them out. Do you think I have earned my pay for the last month?"
"Of course! Now that I have made such progress, can you help me improve my business even more?"
Russ laughed, "Hopefully, you can pay down your credit card bills. I'm guessing you have higher aspirations for your mask business than making $2,000 per month. Right?"
"I do, but how can I increase my monthly revenue any further? Haven't we really done all we can with your 5-Steps to Business Success?"
"We’ve only just begun. You want to make sure that you invest time on the items we've started; and then continue to work on improving each of these five variables. If you focus on only these five things in your business, you’ll continue to grow as large as you want."
"I'd like to continue my growth. Would you be willing to help me?"
"I'd be glad to help. The normal cost of my services is $300 per month for one monthly session. What do you say?"
"There's no way I could have hired you at my $500 per month mask business. I now see the magic you can perform. I have a good feeling my mask business won't be small for long. I'm in!"
Let’s break down the lessons in today’s story.
I know that there was a lot of math. But welcome to business.
Most people will start a business and then get quickly discouraged. They get discouraged because the don’t fully understand the “mechanics” of business. Our story today was intended to illustrate the mechanical components of the business in mathematical terms.
The five components that were highlighted were: 1) lead generation; 2) conversion of those leads; 3) number of transactions; 4) pricing; and 5) profitability.
Most new business owners know on an intuitive level they need customers. They think that if they can just get these customers, their business will be successful. For sure, getting customers is important. However, the rest of the business machine is just as important.
Let’s take these components one at a time.
Getting More Leads
Let’s talk about getting more leads. A lead is a person who is interested in your product or service. The common word for this part of any business is MARKETNG. In our story, Michelle decided to start using Instagram™ to increase the number of leads she got for her mask business. While Instagram™ worked well for Michelle, it could be a complete dud for you. We literally have a thousand ways we can market our products and services. The best way to increase your leads is to understand where your customers reside and how that specific method of marketing will work for your business.
If you have a visually appealing product that you want to market to anyone under 50-years old, Instagram™ will may be a good resource.
Facebook™ may be a good resource for residential services, or general product sales.
Angie’s List™ or Home Advisor™ may be a good way to market a home improvement company.
If you’re offering services to business professionals, maybe LinkedIn™ would be a good platform.
I encourage most of my clients to pick three marketing tactics and then stick with those tactics for six months. If they’re duds, drop them. If they work, stick with them. In either case, be aware that marketing will cost you money in most cases. I expect to pay between 10% to 20% of my revenue in marketing costs to get leads.
Converting Leads into Paying Customers
The next item to consider is converting the leads you get into paying customers. This conversion process is called SALES or SELLING. Now that you have a person who is interested in your product, they may or may not be a good candidate to buy from you. If you have good marketing, you will often only attract qualified buyers. If you have deceptive marketing, you will get leads who will never buy.
The conversion process is a process of education.
I’ve been in sales for a long time. When I was offered my first sales job after being an engineer, I was reluctant. I was convinced that salespeople were liars, cheaters, and thieves. The only way they could get someone to buy their stuff was to deceive them with fancy words and manipulation.
I learned quite the opposite. If you want to succeed in selling, you must honestly educate your prospective customer on your product or service. They will make the buying decision that is right for them. No manipulation or lying required.
Increasing Number of Transactions
This next element of “increasing the number of transactions” is tricky. In our story, Michelle did this by offering bulk pricing discounts. There are many tactics to increasing the number of transactions. The key is to understand how your company makes money. Let’s say that you sell a $100 product that costs you $50 in direct costs to make. You estimate based on your sales volume that there is an additional $25 per product in general expenses, leaving you a net profit of $25 per product. The only cost that increases as you sell more products is your “direct costs”. Your margin of $50 is a fixed cost. To offer bulk-pricing or volume discounts, you must understand your break-even point in your business.
Let’s take our $100 product. Let’s say that my pricing is based on selling 10 products a month. That means that my monthly expenses are $250, and my direct costs are $500 for a total of $750 resulting in a net profit of $250. If I can increase my monthly volume to 50 products per month, my direct costs increase to $2,500 and my monthly expenses stay at $250. If I want to triple the profit with this increase volume, my profit will be $750. If I add $750 to $250 to $2,500, the total sales volume will be $3,500. If I divide this $3,500 by my 50 products, this is $70 per product. This means I can give up to a 30% discount on my product for bulk purchases.
This may have seemed like a lot of math, but good businesspeople do this math in their head during most pricing negotiations. If this felt overwhelming for you, I encourage you to practice looking at your pricing at different volume levels. This will help you set better bundling and bulk-rate pricing to increase the number of transactions you make for each sale.
Increasing Your Price
Increasing your price is challenging. The right price is a combination of: 1) your costs; 2) your competitor’s price; and 3) your customers value perception.
Your cost is a relatively easy thing to know. However, even your cost can be reduced if you consider bulk buying as our character Michelle did with her mask blanks. A standard gross profit margin on your costs is 50% for most products and services. That means that if your cost is $50, your price should be $100.
Your Competitor's Price
Your competitor’s price is also relatively straight forward. With the advent of the internet, you can do any Google™ search you want and find the price of almost anything. I encourage you to do that from time to time with your own product or service. If you find that your competitor’s price is ridiculously low, question your cost structure and think about how you may be paying too much for labor or materials. If you find your competitor’s price ridiculously high, think about how you can improve the quality of the products or services you offer. Remember, that your competitor is battling with setting their price just like you are and so they may have the wrong price altogether. That’s why you need to check out multiple competitors to see how your price compares.
Your Customer's 'Perception' of Value
The final variable, your customer’s perception of value is one of the hardest items to quantify when you’re setting your price. This perception is done in three ways: 1) Return on investment; 2) Comparative Price; and 3) Fit.
Value Perception - Return on Investment
Let’s quickly talk about return on investment. In the coaching business, I hear a lot of business coaches make claims that they can increase your revenue by $1,000,000 so paying $50,000 per year for coaching is a bargain. If you can follow through on such a claim, then most buyers will feel justified in paying a high fee like this. Just remember that the higher price you want to charge, the more benefit you must be able to provide.
Value Perception - Comparison
The next perception variable is comparison. If there is a $25,000 business coach that can also provide $1,000,000 in benefit, most buyers will buy from the lower cost provider to get more value for their dollar. If the result is truly the same, they would be making a wise decision in doing so. The best way to think of comparative value is in buying and selling stocks. If you could by Microsoft stock for $45 would that be a good price? Most sophisticated stock analysts’ answer would be it depends on earnings today and earnings potential in the next several years. The amateur stock buyer will look at the price the stock is trading. If they see that the stock market says the price of Microsoft stock is $100, then a $45 price is a steal. If the price of Microsoft stock is $20, then they’ll feel you’re cheating them by charging $45.
Most buyers of your products are services are amateurs. They will look at what they think they can buy your product or service for from your competition. If you feel your product or service is better than your competitors, you should be prepared to convert your amateur buyer into an educated buyer through your sales process so that they understand your price.
Value Perception - Fit
The final variable is “fit”. Price is the easiest thing for any buyer to see to better understand value of the product or service they are buying. If a luxury car buyer is shopping for a car, they will not give a $20,000 car a second look. It doesn’t matter if this $20,000 car is magically better than the $100,000 car they decide to buy. If you’re unsure of how valuable your product or service is and you set a low price hoping to attract more buyers, you may be repelling the buyers you truly want. Likewise, if you’ve artificially inflated the price of your product or service, you’ll repel all buyers because you don’t offer as much value as your competition.
The last item that Michelle was to focus on in our story was profitability. Profit is the amount of money you have after you’ve paid all your expenses. If you’re a micro-business owner like Michelle, you may be doing a lot of the work and not paying yourself a paycheck. In Michelle’s case, she was not accounting for her time in her costs, but you need to include your time in all the costs of your products. The amount left after paying yourself is your profit.
Profit is the cushion that all businesses must use to invest in and grow their company. Without it, your business will die quickly. The best way to affect your profitability is to print out periodic financial reports on your business. Each month, you should review your profit & loss statement. A reasonable net profit margin is 10%. If your profit margin is low, think about adjusting your price or costs to get it back to where it needs to be. If your profit margin is high, consider growth investments.
There you have it. If you focus on these five elements of lead generation, conversion rate of leads, number of transactions per sale, pricing and profitability, your business will create wealth for you and benefit for your customers and employees. I have made an eBook entitled “5-Part Formula for Business Success”. It describes these 5-principles in more detail if you’d like to learn more.
That’s it for our story and lesson today. I hope you’ve learned a few things from Michelle’s story and our brief discussion. If you’d like to learn more about me or my business coaching practice, I invite you to check us out at www.mmbizcoach.com.
I write a blog post and record a podcast weekly. I write/talk on business advice, small business turn around stories, political interaction with business, business mindset and spiritual intersection with business matters. If you want to get email reminders when I post something new, please sign up.