Do You Know the Key to Small Business Profitability?

This article is an excerpt from the Shortform book guide to "The $100 Startup" by Chris Guillebeau. Shortform has the world's best summaries and analyses of books you should be reading.

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What is the key to small business profitability? What are some things you could do to amp up the profits of your venture?

In order for your small business to survive, you must be able to make a profit. Ensuring the profitability of a small business can be boiled down to two principles: 1) be mindful of what you spend your money on and 2) keep thinking of ways to generate more income.

Read about the two basic principles of small business profitability.

2 Basic Principles of Small Business Profitability

All businesses, big or small, are bound by one simple rule: it takes money to get money. Especially in the early stages of development, keep in mind the two basic principles of small business profitability: 1) spend money wisely and 2) generate more income.

1) Spend Money Wisely 

It’s often tempting to spend significant amounts of money on large ad campaigns, complex websites, or custom merchandise. However, if a purchase won’t build your brand or generate sales, it hinders—not helps—the long-term profitability of your small business.

The key to long-term small business profitability is keeping costs low and spending money only on items that have a direct impact on sales. For example, if you buy a branded hoodie for $20 and sell it on for $40, that’s an investment that has a direct impact on sales. However, if you spend $750 on a custom website that ultimately doesn’t generate significant traffic or sales, then you generate no return on your investment.

Avoid Taking Out Loans

In the internet age, there are many ways to start a company on limited funds. Online storefronts and digital consulting remove the need for a physical space, thus reducing costs. As a result, the need for business loans has decreased. 

Of course, there are still costs associated with starting a small business. If possible, avoid borrowing money as it can hinder the long-term profitability of your business. Instead, consider starting a crowdfunding campaign online. This allows you to raise money while building an audience in the process. You can offer gifts for different levels of donation but be sure to keep your promises realistic. 

2) Generate More Income

While this seems obvious, many companies struggle to bring in enough cash to stay afloat. To generate more income, consider the following strategies: 

Strategy 1: Price Your Product Based on its Benefits

When pricing your product, charge your customers based on the benefits they’re receiving, not the cost of producing the product. For example, if a single physical book cost you $1 to produce, you wouldn’t charge $2 for the product. Instead, you’d determine the value of the content of the book and charge $20-25.

When you set your prices, be prepared to defend your product. People will complain that the price is too high, or that they can find it for a lower price. If someone is unwilling to pay for your product at its price point, don’t crumble to their demands. You may lose one or two sales in the process, but appeasing people who don’t see the value of your product is not worth it.

Strategy 2: Offer Tiered Packages

Once you know the value of your product, create tiers that offer more pricing options for your customers. If you can, price up from your base model, not down, and keep the range limited. For example, if you charge $75 for your service, you could offer a $100 advanced service and a $150 complete service. 

If people are going to spend their money on a product or service, they want to feel like they’re getting the complete experience without breaking the bank. Because of this, typically, a few people will go for the basic item, and a few people will go for the premium item, but most will go for the central item, allowing you to make more money in the process.

The following shows a potential income difference from 20 sales using a single pricing model versus a tiered pricing model:

Single Pricing Model (Sales/Income)Tiered Pricing Model (Sales/Income)
Basic Website Package ($100)20/$2,0005/$500
Comprehensive Website Package ($150)Not Offered10/$1,500
Premium Website Package ($200)Not Offered5/$1,000
Total 20/$2,00020/$3,000

Strategy 2: Create a Recurring Payment Model

Instead of selling a single product per customer, find ways that your business can offer a subscription or membership service that includes a recurring payment. Recurring payments create a more reliable source of income and keep your customers coming back. 

For example, if you make olive oils, you could start a box subscription service where you send the “oils of the month” to your customers. If you get 100 subscribers at $20 per month, you’ll make $2,000 per month. Without that subscription model, you’d have to rely on individual purchases, which can vary wildly from month-to-month.

Do You Know the Key to Small Business Profitability?

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Darya Sinusoid

Darya’s love for reading started with fantasy novels (The LOTR trilogy is still her all-time-favorite). Growing up, however, she found herself transitioning to non-fiction, psychological, and self-help books. She has a degree in Psychology and a deep passion for the subject. She likes reading research-informed books that distill the workings of the human brain/mind/consciousness and thinking of ways to apply the insights to her own life. Some of her favorites include Thinking, Fast and Slow, How We Decide, and The Wisdom of the Enneagram.

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