A question I am often asked is "How much profit should a entrepreneur / business owner-manager make from their business?"
There are no hard fast answers but there are a few guidelines which I use to help people base their expectations for profit.
Why Are Profit Expectations Important?
The simple answer is feedback.
Having a clear expectation of how much profit you expect to make from a business gives you as the owner-manager the opportunity to answer the following question:
"How am I doing? Am I performing up to standard?
There are two vital reasons why every business owner should ask themselves this question:
- By being brutally honest with yourself it forces you to address your strengths and weaknesses.
Can you make better use of your strengths and make them even stronger?
Can you find a way around your weaknesses (delegation or outsourcing) or can you correct a fundamental weakness?
It can even make you question whether a "strength" is really a competitive strength. You may believe you are a good sales person and rate selling skills as a key strength but are you better than your competitors?
You may be good but if they are better, good is not good enough. It is only through reflection that you recognise that a personal strength is a competitive weakness.
- The question breaks the lower profit expectations trap.
You are told to set goals by guru after guru and while some emphasise that they should be achievable, the general view is that they should stretch you rather than be easy to achieve.
This sets you up to accept goal failure as the normal way of life.
It does make sense although it may sound crazy.
Let us assume that you are about to launch a new product on the Internet. You are pretty certain that you can sell 100 in the first year. You calculate that if you can get 500 leads and convert 20%, then that would give you your 100 sales.
So you could set 100 as your goal and just do what you are planning to do.
Or you could set 120 as a little more demanding goal. It puts you under a bit more pressure but you believe that with a fair wind it is achievable.
It would only take 600 leads instead of 500 or a conversion rate of 24% rather than 20%.
So at the end of year 1 if you sell 114 you can look back and think "That's not bad at all. I didn't make my goal but I sold more than I thought I would. It's time for a celebration."
I can't criticise this performance. You deserve to celebrate but you haven't "maxed out" and perhaps you should be critical of yourself.
Now suppose you set a goal of 250 sales in the first year.
You look at it and you know that there is no way you can possibly achieve 250 sales with the plans that you have.
So you start thinking about other ways that you can generate extra leads. Perhaps you start a pay per click campaign on the Internet. Perhaps you create an affiliate program to reward other people for selling your service.
But then you also start thinking that if you are improving your lead generation, you could also improve your lead conversion.
So you buy a book on copywriting and you learn how important the headline is, how you need to talk to one person at a time about their issues and solutions and how you need make a compelling offer and reduce the risk of the purchase.
After reading the book, you know much more about good copywriting and you now have the confidence to hire a copywriter and make it clear what you expect.
With these improvements in place, you are sure that the 500 leads originally expected is much lower than it could be so you set your target at 1,000. Since your sales letter is much more compelling you raise your lead conversion forecast to 25%.
Now you set the goal of selling 250 and believe this is achievable.
At the end of the year, you find that you have sold 235 copies. Still below your new goal of 250 but a whopping 135% above your original goal because you have stretched your expectations and opened your mind to other ways of working.
Unfortunately many small business owners don't thing like this.
They don't identify the drivers of their performance (in this case leads and conversion rates). Many owners of small businesses focus more on problems than opportunities and possibilities but this creates lower profit expectations.
I hear things like "It's been tough this year and next year will be even worse. [insert reason for lower expectations]. Hopefully we can make the same profit."
The reasons for the lower expectations can vary.
Now the easy excuse is "It's the economy. I think we're heading for a recession." but it could just as easily be "XYZ competitor has brought out a new product" or "Andy our best salesperson has left and it's going to take the new guy Steve some months to get up to speed."
At the end of the year, it's no surprise but the "goal" of matching the current performance hasn't been met. It may have only been missed by 10% but these 10% compound over the years.
In Year 0 profit = 100%
In Year 1 profit = 90%
In year 2 profit = 81%
In year 3 profit = 72%...
It is these lower expectations (the profit expectations trap) which condemn many small business owners to working at near to subsistence levels. Because they don't aim higher, they don't open up their minds to new ways of working.
So What Can Be Done About Changing Expectations?
I will be looking at this in tomorrow's article Entrepreneurs How Much Should You Earn.