Ever heard the term “margin compression”? Put simply, margin compression occurs when the costs to make a product or deliver a service rise faster than the sales price of the product or service. Hence, putting pressure on profit margins.
Causes of Margin Compression
There may be many causes of margin compression…
- Increased competition
- Internal production problems
- Macroeconomic factors
- Rising SG&A costs without a proportional increase in price
Increased Competition
When I started The Strategic CFO over 16 years ago, I remember how hard it was to sell the idea of a part-time CFO. Nobody was doing it, so it was tough to convince people that there was a need.
These days, there are so many new companies providing interim CFO services that trade show sponsors struggle to separate our booths in the exhibit hall.
As you might expect, the influx of new firms offering the same services as SCFO put pressure on our margins. One of the ways that we have responded is by developing alternative income streams. As a result, we now offer additional services complementary to consulting that aren’t yet so competitive.
Internal Production Problems
Sometimes, a business can put pressure on itself. Internal problems such as not using resources wisely can cause a business to incur more costs than necessary.
Resource waste may take the form of labor or material cost overruns due to poor planning, out-of-date processes or equipment, poor systems design, etc. Regardless of the source, it’s important for businesses to monitor and improve key drivers in order to ensure that all resources are as productive as possible.
Macroeconomic Factors
Unless you’ve been living under a rock, you’re probably aware that low oil prices are wreaking havoc on much of the energy industry, as well as many tertiary industries. While it may seem like there’s little a business can do to deal with such macroeconomic factors, there’s still hope.
Even though it’s tempting to be reactionary in the face of crisis, focusing on the long-term goals of the company rather than the short-term obstacles is critical. Yes, you should closely examine costs and cut those that aren’t mission-critical. It’s important to realize, however, that the crisis will end and you must still have the necessary resources to take advantage of the recovery. The best antidote for these “black swans” is to plan for the crisis before it’s upon you.
SG&A Costs Out of Whack With Pricing
How do you price your products or services? Some companies apply a markup to their direct costs. Others set their prices to achieve a desired margin. Very few, however, take their pricing down to the net income level.
While it may seem heavy-handed, examining all costs that go into making a product or delivering a service is necessary. Otherwise, it’s easy to ignore creeping SG&A costs and their impact on profitability. To guarantee that you’re pricing for profit, make sure that your pricing model takes into account SG&A costs.
Think you might have a pricing problem? Download our free Pricing for Profit Inspection Guide here.
Regardless of what is causing your margin compression, there is a solution. Diversification, improving productivity, planning for lean times and pricing for profit are just a few ways to deal with the problem.
How have you dealt with margin pressure? Leave us a comment below with you thoughts.
