Don’t Ignore Profit Margins

It can be hard to talk about business in an abstract context. That’s why we’ve created a fictional company in one of the country’s fastest-growing industries to illustrate how profit margins apply to growth.

Castaway Brewing began as a small nano brewery with wholesale distribution as their only means of generating revenue. They operated for a couple of years with very limited overhead after receiving gift funds to start their business, and they paid no rental fees for their workspace. Their brand was steadily growing, and their profits followed suit. The owners weren’t sure how to expand their operation and still sustain growth. They decided to take a close look at two specific profit margins to see the potential feasibility of long-term growth.

Margin for Business
A company's operating margin is a measure of how efficient the business is as a whole. Operating margins are calculated by dividing a company's operating income (total profit after expenses) by net sales.

Margins for Products
Gross profit margin is an indicator of the profitability of a specific product. It’s calculated by comparing the revenue of the product to the cost of goods sold. Castaway only had three flagship beers, but the gross profit margins were substantial on every one of them. Wilson Pale Ale operated at a 60 percent margin, Bamboo Brown Ale at a 55 percent margin, and Sandcrab IPA at a 50 percent margin. With few employees, limited overhead, and three products that produced high individual revenue, the overall operating profit margin of the company was in great shape. With this foundation, the brewery was ready to expand and take on the giants in the industry. But first, they had to figure out their strategy.

How to Find Your Margins
To compete with other companies in the local market, it was clear that Castaway was going to need new beers, a new location, and a shift in production. This meant operating costs were going to change, and all of their margins right along with it.

Beer: They needed to find projected margins for the new beers. They decided to keep the three flagship brews year-round and expand by adding two seasonal releases and one specialty release. After calculating the costs of the raw materials, employee time, and miscellaneous debts, they calculated 30 percent gross profit margin for their three new products.

Location: By opening a retail site, there was considerable potential for the overall operating profit margin to shift drastically. It’s much more lucrative to sell your product at retail than wholesale. When you sell at wholesale, you don’t get the luxury of marking up the product — the customer you sell to does. At retail, you can produce and mark up the product on your own, thus putting more revenue back in your business’s pocket. The only caveat for Castaway was that a new location meant a lease for a workspace, which was an added expense.

Production: The new production elements could also affect Castaway’s operating profit margin. More product means more production, more storage, more employees, and ultimately, more red to add to the bottom line.

Margins for New and Old Companies
Margins for new companies and margins for established companies are much different. When you see a rapidly growing company, odds are that they are growing in total revenue but their overall profit margins are actually decreasing. In the instance of Castaway, they had limited overhead in the beginning, but as they expanded, liabilities increased. More employees, benefit programs, storage needs, and production caused their operating margins to take a substantial hit.

How Margins Factor Into Decision-Making
Let’s take Castaway’s decision to add the three new beers as an example. New products generate excitement, especially when they are only available for a short amount of time. But for any one of those new beers to be as successful as their flagships, they would have to produce and sell nearly double the product. This increases production necessity, which increases man-hours and decreases net revenue.

Balancing Margins With Passion
Perhaps the most challenging part of any growing company is balancing what’s best for the company with what its leaders are passionate about. The vision and the long-term sustainability of every business is dependent on both of these concepts. Often, passion leads to decisions that cause weak profit margins, but focusing too much on margins can dilute your brand. A healthy harmony and balance between the two is key to success.