Stretch your margins to gain some wriggle room

Having higher margins and the depth to get through more difficult times will not only give your business more than a fair go at survival, but when the upturn comes will allow you to ratchet-up your competitive advantage. By TOM McKASKILL

By Tom McKaskill

This story first appeared 14 November 2008

Having higher margins and the depth to get through more difficult times will not only give your business more than a fair go at survival, but when the upturn comes will allow you to ratchet-up your competitive advantage.

If you have a choice, go for a premium position in your marketplace. I am not referring to your ego, but to a basic business philosophy that says that it is easier to survive, grow and be profitable if you have higher margins.

Higher margins give you room to react, attack and innovate. Not only can you compete more aggressively when you have to, but the extra margin allows you to invest to more aggressively build competitive advantage.

Nice idea, but how do you engineer yourself into such a position?

When we examine the nature of competitive advantage, we can see that the firms with the highest margins typically have built strong intellectual capital or intellectual property around complex problems in tightly defined niche markets.

Leaving aside the competitive advantage that comes from a leadership position in a large market built on economies of scale, most SMEs have to dig deep into a well-defined niche market to create a defensible position.

Almost without exception, the business that achieves high margins without the protection of intellectual property will have to build a deep expertise around solving a complex problem. This then gives us a pointer to where we need to grow our business.

Simply put, it takes a long time to build expert knowledge and to create a business capable of delivering products and services around it. This creates a significant barrier to entry.

So a business that proactively concentrates its efforts over time to gain expertise in a specific area, especially one that has nasty complex problems, that directs its marketing to attract business in that area, and which builds a reputation as being the best in its class, will be able to leverage up its prices – and thus its margins.

Large companies get trapped by their need to standardise their offerings over large markets and to de-skill their service delivery, thus they need to stay away from smaller niche markets that require expert knowledge. This gives the smaller firm an opening to build a defensible high margin position.

Higher margins have other benefits than just generating profits. Better margins allow you room to make mistakes and be able to afford to correct them to protect your reputation. You can use your margins to fend off competition.

High margins in expert situations are often due to much higher productivity in solving customer problems. With lower costs, the high margin business can still be making a profit at prices where their competitors are losing money. If you then use your extra profit to invest in innovation, the competitive advantage can be increased. Being the best will allow you to attract the best staff, reinforcing your leadership position.

You can often grow revenue simply be decreasing prices and cutting margins, but it is a path littered with business failures. Small problems become major stumbling blocks as there is no depth in the business to survive and recover.

If you can, move your business into higher margin business, even at smaller revenue numbers. The end result will be a business that is much better positioned to take advantage of growth opportunities.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.