The Margin Manifesto: 11 Tenets for Reaching (or Doubling) Profitability in 3 Months

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Profitability often requires better rules and speed, not more time. (Photo: Jetta Girl)

I wrote this “margin manifesto” several months ago and somehow neglected to post it. Your requests for more content on start-up economics and processes reminded me.

These are the principles I review whenever facing operational overwhelm or declining/stagnating profits. Hope you find them useful.

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The financial goal of a start-up should be simple: profit in the least time with the least effort. Not more customers, not more revenue, not more offices or more employees: more profit.

Based on my interviews with high-performing (using profit-per-employee metrics) CEOs in more than a dozen countries, here are the 11 basic tenets of the “Margin Manifesto”… a return-to-basics call that gives permission to do the uncommon to achieve the uncommon: consistent profitability (or doubling of it) in 3 months or less.

1. Niche is the New Big — The Lavish Dwarf Entertainment Rule:

Several years ago, an investment banker was jailed for trade violations. He was caught partly due to his lavish parties on yachts, often featuring hired dwarves. The owner of the dwarf rental company, Danny Black, was quoted in the Wall Street Journal as saying: “Some people are just into lavish dwarf entertainment.” Niche in the new big. But here’s the secret: it’s possible to niche market and mass sell. iPod commercials don’t feature dancing 50-year olds, they feature hip and fit 20-30-somethings, but everyone and his grandmother wants to feel youthful and hip, so they strap on Nanos and call themselves Apple converts. Who you portray in your marketing isn’t necessarily the only demographic who buys your product — it’s often the demographic that most people want to identify with or belong to. The target isn’t the market. No one aspires to be the bland average, so don’t water down messaging to appeal to everyone–it will end up appealing to no one.

2. Revisit Drucker — What Gets Measured Gets Managed:
Measure compulsively, for as Peter Drucker stated: what gets measured gets managed. Useful metrics to track, besides the usual operational stats, include CPO (“Cost-Per-Order,” which includes advertising, fulfillment and expected returns, chargebacks, and bad debt), ad allowable (the maximum you can spend on an advertisement and expect breakeven), MER (media efficiency ratio), and projected lifetime value (LV) given return rates and reorder %. Consider applying direct response advertising metrics to your business.

3. Pricing before Product – Plan Distribution First:
Is your pricing scalable? Many companies will sell direct-to-consumer by necessity in early stages, only to realize that their margins can’t accommodate resellers and distributors when they come knocking. If you have a 40% profit margin and a distributor needs a 70% discount to sell into wholesale accounts, you’re forever limited to direct-to-consumer… unless you increase your pricing and margins. It’s best to do this beforehand if possible – otherwise, you’ll need to launch new or “premium” products — so plan distribution before setting pricing. Test assumptions and find hidden costs by interviewing those who have done it: will you need to pay for co-op advertising, offer rebates for bulk purchases, or pay for shelfspace or featured placement? I know one former CEO of a national brand who had to sell his company to one of the world’s largest soft drink manufacturers before he could access front-of-store shelving in top retailers. Test your assumptions and do your homework before setting pricing.

4. Less is More – Limiting Distribution to Increase Profit:

Is more distribution automatically better? No. Uncontrolled distribution leads to all manner of head-ache and profit-bleeding, most often related to rogue discounters. Reseller A lowers pricing to compete with online discounter B, and the price cutting continues until neither is making sufficient profit on the product and both stop reordering. This requires you to launch a new product, as price erosion is almost always irreversible. Avoid this scenario and consider partnering with one or two key distributors instead, using that exclusivity to negotiate better terms: less discounting, prepayment, preferred placement and marketing support, etc. From iPods to Rolex and Estee Lauder, sustainable high-profit brands usually begin with controlled distribution. Remember, more customers isn’t the goal; more profit is.

5. Net-0 — Create Demand vs. Offering Terms:
Focus on creating end-user demand so you can dictate terms. Often one trade publication advertisment, bought at discount remnant rates, will be enough to provide this leverage. Outside of science and law, most “rules” are just common practice. Just because everyone in your industry offers terms doesn’t mean you have to, and offering terms is the most consistent ingredient in start-up failure. Cite start-up economics and the ever-so-useful “company policy” as reasons for prepayment and apologize, but don’t make exceptions. Net-30 becomes net-60, which become net-120. Time is the most expensive asset a start-up has, and chasing delinquent accounts will prevent you from generating more sales. If customers are asking for your product, resellers and distributors will need to buy. It’s that simple. Put funds and time into strategic marketing and PR to tip the scales in your favor.

6. Repetition is Usually Redundant — Good Advertising Works the First Time:

Use direct response advertising (call-to-action to a phone number or website) that is uniquely trackable – fully accountable advertising — instead of image advertising, unless others are prepurchasing to offset the cost (e.g. “If you prepurchase 288 units, we’ll feature your store/URL/phone exclusively in a full-page ad in….”). Don’t listen to advertising salespeople who tell you that 3, 7, or 27 exposures are needed before someone will act on an advertisement. Well-designed and well-targeted advertising works the first time. If something works partially well (e.g., high response with low percentage conversion to sales, low response with high conversion, etc.), indicating that a strong ROI might be possible with small changes, tweak one controlled variable and micro-test once more. Cancel anything that cannot be justified with a trackable ROI.

7. Limit Downside to Ensure Upside — Sacrifice Margin for Safety:
Don’t manufacture product in large quantities to increase margin unless your product and marketing are tested and ready for roll-out without changes. If a limited number of prototypes cost $10 per piece to manufacture and sell for $11 each, that’s fine for the initial testing period, and essential for limiting downside. Sacrifice margin temporarily for the testing phase, if need be, and avoid potentially fatal upfront overcommitments.

8. Negotiate Late — Make Others Negotiate Against Themselves:
Never make a first offer when purchasing. Flinch after the first offer (“$3,000!” followed by pure silence, which uncomfortable salespeople fill by dropping the price once), let people negotiate against themselves (“Is that really the best you can offer?” elicits at least one additional drop in price), then “bracket”. If they end up at $2,000 and you want to pay $1,500, offer $1,250. They’ll counter with approximately $1,750, to which you respond: “I’ll tell you what — let’s just split the difference. I’ll overnight FedEx you a check, and we can call it a day.” The end result? Exactly what you wanted: $1,500.

9. Hyperactivity vs. Productivity — 80/20 and Pareto’s Law:
Being busy is not the same as being productive. Forget about the start-up overwork ethic that people wear as a badge of honor–get analytical. The 80/20 principle, also known as Pareto’s Law, dictates that 80% of your desired outcomes are the result of 20% of your activities or inputs. Once per week, stop putting out fires for an afternoon and run the numbers to ensure you’re placing effort in high-yield areas: What 20% of customers/products/regions are producing 80% of the profit? What are the factors that could account for this? Invest in duplicating your few strong areas instead of fixing all of your weaknesses.

10. The Customer is Not Always Right — “Fire” High-Maintenance Customers:
Not all customers are created equal. Apply the 80/20 principle to time consumption: What 20% of people are consuming 80% of your time? Put high-maintenance, low-profit customers on auto-pilot–process orders but don’t pursue them or check up on them–and “fire” high-maintenance, high-profit customers by sending a memo detailing how a change in business model requires a few new policies: how often and how to communicate, standardized pricing and order process, etc. Indicate that, for those clients whose needs are incompatible with these new policies, you are happy to introduce other providers. “But what if my largest customer consumes all of my time?” Recognize that 1) without time, you cannot scale your company (and, oftentimes, life) beyond that customer, and 2) people, even good people, will unknowingly abuse your time to the extent that you let them. Set good rules for all involved to minimize back-and-forth and meaningless communication.

11. Deadlines over Details – Test Reliability Before Capability:
Skills are overrated. Perfect products delivered past deadline kill companies faster than decent products delivered on-time. Test someone’s ability to deliver on a specific and tight deadline before hiring them based on a dazzling portfolio. Products can be fixed as long as you have cash-flow, and bugs are forgiven, but missing deadlines is often fatal. Calvin Coolidge once said that nothing is more common than unsuccessful men with talent; I would add that the second most common is smart people who think their IQ or resume justifies delivering late.

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Posted on: June 24, 2008.

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128 comments on “The Margin Manifesto: 11 Tenets for Reaching (or Doubling) Profitability in 3 Months

  1. Now that was amazing. I was just wrapping up a company meeting where we were discussing applying the 80/20 rule to a product that is consuming too much of our time to fulfill. After we discussed our options on how to make some adjustments, my RSS reader went “ding!” as if your post wanted to participate in our meeting. Great timing. :-)

    Jeff

    Like

  2. Outstanding Post. How would you perceive companies that are not based on products directly? I mean companies like Myspace, Facebook, Twitter, companies that rely on hits being the metric by which they become successful. How can one measure whether a community will be built around a single idea?

    Thanks

    Jose Castro-Frenzel

    Like

  3. Great advice, amazing how a profitable business can be had by following a few simple steps. Glitz and snazzy PR work, at the end of the day, doesn’t have staying power. I mean, at some point we’ll be tired of talking about Paris Hilton, right? right?

    Like

  4. Tim-Love the post. I especially like the part about firing high maintenance customers and focusing on a tight niche.

    I also liked your points about Pareto’s law. I have more trouble with this, but I’m making progress. I’ve been able to cut my work hours to around 20/week which allows me time to work on a side business and still have time for a personal life.

    Keep up the good work!

    Like

  5. This is (mostly) common sense to me. The key to all of this is the product. What product are all of your followers becoming newly rich on? Seems like all I see are spin-off lifestyle blogs promoting mediocre ebooks. The product is key and a product that works the way you describe is *very hard* to find. There are only so many people that can make money selling brain-enhancing supplements. Sorry, this post is based in frustration in trying to find a great product following your tenets.. Arrg.. I’ve been brainstorming sinceI read your book right after it came out! :)

    I do love the blog. Thanks for sharing.

    Victor

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    Hi Victor,

    Not to worry. Nothing worth doing is easy. Simple, often, but easy — not often.

    Examples of successful products range from photograph enhancement and software design, to magazine publication and restaurants. It’s not at all limited to “brain supplements” or anything of the type, and I — on the record in many cases — actively dissuade people from pursuing ingestibles.

    I think spin-offs are common because they require less thought than an original product. Some will no doubt generate temporary income, and there is nothing wrong with derivatives, but I question the shelf-life.

    Hope that helps,

    Tim

    Like

  6. Tim,

    I’m glad you are taking the time to flesh out some of the start-up principles you outlined in the book. For me, this has been the area I’ve struggled with the most since trying to achieve my own 4 hour work week. (Planning for mini-retirement– no problem!) I’ve started my first company based on your model and have been learning on the run… in particular, I’ve struggled with pricing. As you wrote, many companies don’t build enough margin in during the ‘direct sell’ phase and I’ve caught myself in a bind where I feel like I would be sacrificing sales now in order to preserve distribution channels which don’t always have clear terms, and may or may not pan out.

    Can you (or someone on the board) point to some resources further actionable insights on these topics? In addition to the pricing and distribution issues, I am interested in examples of how to create demand with ‘good advertising’ that can be measured.

    Thanks for your help,
    Dan

    Like

  7. So what you are saying is if you retail your product out for a specific price then later you want to sell it to distributors you must have that specific profit margin in mind to begin with. Wouldn’t that be setting yourself up to losing customers on the retail end in the beginning? Maybe I misunderstood. I have a couple of websites, one retail. Blogging is causing it take off. My next step is to hire a copywriter, but until that is in the budget I will have to settle for buying Headliner Pro or Glyphius. Have you heard of either?

    Like

  8. In your negotiation example, when it comes to services I get a little apprehensive to negotiate too much. Often the service is inferior and the trouble to fix it is a large headache.

    My friend does bids for his services and the company requires in the bid to show his profit margin. Counter to my thinking they actually want him to make a reasonable profit. They know he will be around where the others may not eventually.

    Like

  9. Thanks for the $1,500 correx, all. Fixed.

    @All

    Setting pricing to allow for distributors/retail shouldn’t lose you customers in the beginning.

    If you choose a product and then just mark it up X times to allow for retail, yes, you could lose them, but that’s not what I’m suggesting.

    I’m suggesting that — keeping necessary margins in mind — you choose a product that will allow for those margins while still offering a reasonable end price to consumers.

    In other words: abandon a product that doesn’t offer sufficient margin at a reasonable price to both retailers and the end user. Do not choose a product, then multiply cost to reach necessary margin.

    @Victor,

    Not to worry. Nothing worth doing is easy. Simple, often, but easy — not often.

    Examples of successful products range from photograph enhancement and software design, to magazine publication and restaurants. I — on the record in many cases — actively dissuade people from pursuing ingestibles. Too much liability for the inexperienced and undercapitalized.

    I think spin-offs are common because they require less thought than an original product. Some will no doubt generate temporary income, and there is nothing wrong with derivatives, but I question the shelf-life.

    Hope that helps.

    @Jose

    I think non-product companies like Twitter, Digg, etc. are perfectly viable IF the entrepreneurs’ objectives are in sync with potential exits (IPOs, acquisition, etc.) and they can live w/ a worst-case scenario contingency plan if that doesn’t happen.

    Pura vida,

    Tim

    Like

  10. Awesome post Tim, thanks. I am launching a new blog soon and I have been thinking about many of the principles that you noted, you just slammed dunked the whole process. You rule
    Brad

    Like