There are many reasons people start a business, but the bottom line is that you must clear a profit or the business will not survive. (Even a non-profit business must have a profitable bottom line to survive!)
Small businesses tend to place a lot of emphasis on the quality of product or service that they deliver, and on the profit they make. Costs influence profit.
Your business success depends on how well you manage your expenses. Companies compete predominantly on two things, price and differentiation. When you are competing on price, cost management is even more critical. So as a small-business owner this means that you must know what costs you are incurring at what stage and for which product/service.
There are two kinds of costs, fixed costs, and variable costs; they either change with unit volume produced or they do not. Ask yourself, if I did not create a single product nor render any service, what would be my costs? Answering this question gives you your fixed costs. Examples of fixed costs are rent, lease, utilities, and salary for full-time staff members.
Your variable costs are the costs that increase as you produce more or fewer products or render more or less service. Variable costs might also change with unit volume, times of year, discounts or opportunity sales. Examples of variable costs are seasonal labor costs, supplier costs, and sales commissions.
To tie both fixed costs and variable costs together let’s look at Brian’s landscaping. Brian takes out a loan to acquire equipment for his business; he also rents space to house his equipment and to conduct business. Brian’s employees are three full-time members, and during busy periods he employs additional staff. Brian’s three full-time employees consist of an administrative role, a sales and marketing role, and a landscaper. Brian’s fixed costs will then be his rent, the loan payments for the equipment, utilities, and salary for his full-time staff members. His variable cost would be the sales commission for his sales & marketing employee, supplier costs such as mulch, topsoil, flowers, etc., and the salary for his seasonal staff members.
Variable costs and fixed costs are both a part of your product cost. As a business owner knowing your product cost gives you more confidence in setting your prices. After all, you can only charge what the market is willing to pay. For example at Brian’s landscaping, if he incurred costs due to the usage of expensive equipment, he may not recover that cost in his pricing unless his clients are paying him enough to recover his costs.
So how can you as an entrepreneur manage your product costs? By monitoring the cost of each element in each product. Even as a small business owner this task is overwhelming. For example, if your supplier needs to increase the price of raw material, you need to know what duration and start exploring other supplier options. Another question you need to ask is, how important is this raw material to the overall quality of my product? If the raw material is not important to the overall quality of your product, then you have more options available. You could find a cheaper equivalent or substitute.
What this means for you: Know Your Business
Take the time to understand how your business works and understand how your business is incurring costs. Ensure that you are indeed focusing your time and money on what drives value for your company. Meaning, you may not have to carry out all the processes in your organization to deliver your value proposition. For example, should Brian outsource the landscaping maintenance aspect of his business, especially in remote locations? Depending on the tasks involved, and the cost that he might incur, outsourcing might make sense. He might find that subcontracting other landscaping companies that are close-by each property would save time in travel and increase client satisfaction. Both the travel time and the disgruntled customer could cost Brian significantly. To help Brian answer this question, he should start by looking at his resources, the demand from his customers and figure out the cost to meet that demand with in-house resources versus the price of outsourcing.
Remember that success in business is a journey and not a sprint. It takes conscious and deliberate effort at each stage, no exception.
In depth reading on this topic:
Blocher, Edward, Cokins, Gary, Juras, Paul, and David Stout. Cost management: A Strategic Emphasis. 7th ed. New York, NY: McGraw-Hill Education, 2016.