high margin vs low margin


1

What are some key factors for a startup to consider when determining to build a low margin/high volume business or a high margin/low volume business?

The only factor I can think of is the sales cycle. If the sales cycle is long and complex a high margin/low volume business model seems to make more sense.

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asked Nov 21 '11 at 10:59
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Mike Nereson
411 points
  • What type of business? – Joel Friedlaender 9 years ago
  • Hi Joel. Fast food. Antique dealership. Laundry mat. Does the business matter? If so, what about the business maters? Abstract that again and you've probably started identifying the factors that are interesting. – Mike Nereson 9 years ago
  • One factor that comes to mind is support. If you are a software service that requires ongoing support for your users then the number of users vs. price matters in that regard. If you are just selling products and they don't come back, then there are other factors in play. I think the nature of the business will affect which factors you should consider. – Joel Friedlaender 9 years ago
  • Another thought I had is the engine of growth. If you're relying on viral or social triggers for growth, in general you'd want high volume over low volume. – Mike Nereson 9 years ago
  • re: High price and long sales cycle - I think you're confusing cause and effect. I would think that high price leads to long sales cycle, not the other way around. – Ryan 9 years ago

2 Answers


2

Delivery cycle is just as important as sales. If it takes 1/2 year to develop a piece of software then your sales people had better not line up 200 sales per year, because your going to choke.

There are high volume, high margin businesses like Apples iXXX range. This is pretty much the ultimate for high margin business ... match that to successful chocolate bar manufacturers and they do well with high volume $2 sales ... these are the two ends of the spectrum which a lot of pundants suggest you should fit one or the other model to be successful ... anything else in the middle will be killed by the extreme ends. Over the long term (80 years+) this seems to play out if you study history like cars and finance ... be one or the other, sit on the fence and your dead.

From my expreience.. the key issues you face with high margin :

  • You have to be unique. As soon as there are serious competitors being cheaper (not just alternative like cars) then your in a downward spiral.
  • You have to pay for a lot of good people. Quality is your key differenciator and typically you get what you pay for, so if you don't aren't paying to create the quality then you aren't actually balancing the equation.

This is the market I play in for the most part ... The key problems I have:

  • People take a long time to make up their mind. So cashflow is a major issue in the high volume market ... typically you always need more on the boil than you are capable of dealing with if you were to land them all at once ... most of the time this is ok, every now and then it bites you on the bum.
  • You can't hope to service a large volume of people, so you have to let some go and you have to be selective about the ones you hold onto. This can be very difficult because the better long term prospect is not always the best short term "keep the wages coming in" prospect ... and its up to you to choose.
  • You have a feast and famine issue which means you are always saving a considerable amount for a "rainy day" when you are between jobs and need to keep it all rolling.
  • The expectations of quality and service are far higher. You spend a lot of non-chargable time ensuring you maintain the flow of chargable time ... this costs and no-one factors for it properly ... its just called "risk"
  • You need to invest far more in your staff. You need a combination of skillset, motivation, personal contact and drive that is very hard to find so you spend a lot of time finding and nurturing it.
  • Any one client is worth far more to you so you have to consider how you deal with them and what the "fall out" of your decision will be far more than if you have 1,000,000 clients and one doesn't work out.
  • Your ultimately always the one infront of the client when things haven't gone well and its always a very LARGE problem you have to make a call on. This can be a lot more stressful at a point when it happens.
  • Any one client represents a major percentage of your business ... each problem is costly, each loss is substatial and its very hard for you to maintain the feedback loop with a small base to adjust on ... maintaining good relationships is the only way to ensure you can balance this.
  • Sales cycles can take for ever, and are more annoyingly unpredicable ... but when they come through can be millions of dollars better off in a single sale.
The flip side is the market my father played in, the high volume, low margin business :

  • There is no direct corrolation between production cost and realisation of value. You can pay everyone 4-6 months before you make you money from the investment ... this is hard when your starting, but once you have the pattern is good. (Established businesses are worth buying)
  • Staff costs are lower, which helps but you struggle to hold onto anyone who is good because its so standardised they get bored.
  • You don't have many barriers to entry besides brand name and price so you are always worried about being knocked off by your competitors or some "overseas" competitor who can do it cheaper OR by a better funded company who can market better than you can.
  • You are more open to the fluctations is prices of your component prices. Because your margin is so small if a raw material cost doubles your entire profitablity model has to be re-examined ... and your competitors may not have the same issue.
  • Scaling for physical world stuff can be harder, there is a real limit to production volume per day/month in a factory, so you need more factories and these costs have their "management issues" to go along with them.
  • Staff are typically not interested and not motivated by the same goals as the company. They get minimum wage and their priorities are typically different. High value companies have people whos motivations (somewhat money driven but not completely) are more inline with the companies needs.
  • You can use feedback metrics to understand your business and you can make adjustments before the a critical 10% margine has been affected ... downside is you may not have the staff or means to do what needs to be done.
  • Sales cycles must be small and short, you can monitor the changes in these cycles "on average" rather than one by one ... this is great if your refining a single product, but if your product is out of favour it is very hard and risky to "bring it back on track" ... the run away product just keeps going down and you have only a limited amount of time to guess what is actually wrong and recover it.
So in conclusion.

Both models can work, both models have different but serious challengaes they face. The question comes down to you, and your personality, what works better, what do you understand. What are you prepared to risk.

  • High volume will scale larger, with a more "modelable" business but is eaiser to compete against for the same reason.
  • Low volume is harder to compete but has many more restrictions against scaling and has expectations from clients that are more costly to meet and maintain.

Which one suits you, suits your business, suits your staff and your customer base?

Pick one, go hard and good luck.

answered Nov 22 '11 at 20:11
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Robin Vessey
8,394 points
  • Robin, great conclusion. Thanks. Wouldn you also say that a high margin business is ripe for commoditization? – Mike Nereson 9 years ago
  • If you can swing it sure, but then everyone else will be tempted to try like the iPad recently. This longer term will drive down the price or lose dominance in the market. – Robin Vessey 9 years ago

0

Not exactly an answer but this is a great set of posts covering the "High cost, low volume" approach. Very refreshing as for some reason most attention goes on "Low cost, high volume" (app store being near the this spectrum)

http://nukemanbill.blogspot.com/ You will also find him on Joels Business of Software board under the username CC I believe.

http://discuss.joelonsoftware.com/default.asp?biz

answered Nov 22 '11 at 19:21
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Ryan
1,365 points

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