One invaluable piece of wisdom I read somewhere a long time ago, stated something to the effect that being first in a category allows you to maximize your profit margin compared to entering an area where competition exists.
Unfortunately, I hadn’t heard about this stratagem when I started my first company. I’m not sure I would have understood its impact at the time, because I felt, naively, that I knew what it took to run a business. However through the power of hindsight, I now realize that I had wasted this first mover advantage.
At the time, I reasoned that I couldn’t or shouldn’t charge a premium for the service because what we were proposing had never been done and I didn’t want to scare the prospective clients away. I also thought that if I kept my pricing low, clients would line up for the service. I was wrong on both counts.
What I didn’t realize was, regardless of the pricing, convincing companies to use this new service was difficult. So for all the pioneering work and effort we put in to help create an industry, we hadn’t maximized our return. Of course it wasn’t long before the industry took off and competitors came out of the woodwork that resulted in the predictable margin squeeze.
By not maximizing the margin potential when I had a chance, I forfeited the opportunity to generate enough profit to reinvest in some necessary technologies that were later introduced by some of our deep pocketed competitors. Secondly, by starting with lower prices, it became very evident that it would be almost impossible to increase them once the competition showed up. And for the record, clients never lined up.
So, after eight years of building the company to 150 people strong, with seven figure revenues and minimal profit, I finally sold it for far less than the effort to create it would have suggested, and moved on to my next venture. This time I vowed not to repeat past mistakes.
I once again chose to provide a new service to the same industry but this time maximizing the margin while I had first mover advantage. I decided that I didn’t want every possible client out there, only those that could afford our service. This higher level positioning did slow the client acquisition process, but those clients that we did get, provided a healthy margin. This allowed the company to be profitable from the start. Aside from taking a regular paycheque, something I hadn’t experienced with my first enterprise, these profits allowed for continual investment in training and technology. Not only did this investment serve to improve our performance, but grew our margins even higher. I finally sold this company after 17 years for what I thought was a fair value. The funny thing is, serious competition never really materialized.
So what lessons did I learn?
1. Don’t Waste Your Time
Don’t waste your time or effort starting a business in an industry that is already being served by a number of competitors, you’re just cutting the pie into smaller pieces. Second, when you have first mover advantage capitalize on it by ensuring you get the highest possible price for as long as you can. Reinvesting some of these early profits in productivity enhancement activities, may actually serve to minimize competition by creating such high standards or image that they may think it too expensive or difficult to try to steal your customers.
2. You Don’t Want Every Customer
You don’t want every customer, just those that can afford to pay a premium for your service. Having a bunch of low margin customers requires a lot of resources to manage them. By focusing on a fewer, higher paying customers, allow you to spend more time on improving the customer experience with fewer but higher trained staff.
3. Find a Niche
If you’re stuck in what you consider to be a low margin business, evaluate your existing products and services to find the higher margin products you’re now selling. Then determine if by spending a little more time and effort on these products, you can generate enough revenue to begin moving your business away from the highly competitive low margin categories.
4. Target a New Industry
Consider taking your services to an industry that traditionally has never used your services before. You could create a first mover advantage in a new industry. At the end of the day, you need to break away from the mainstream and find a niche that allows for more pricing power.
Moving away from low margin activities may reduce your revenue but if executed properly, should increase your profitability. Because Revenue Without Profit is Pointless. And isn’t that why we’re in business?
Copyright © Greg Weatherdon 2012
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