Strategies for healthy growth.
What is Profitable Growth?
More often than not, we hear people talking about business growth in terms of an increase in revenue. And while revenue is critical, profit is the key to sustainable growth. Profitable growth is all about growing the business responsibly. Ultimately, the measure of a successful business is in making decisions that maximize revenue while minimizing costs, ensuring true long-term growth.
What Does Profitable Growth Look Like?
Profitable growth is made possible by keeping an eye on profit margins even as you focus on growing your business. Naturally, it isn’t always linear. Profitability may take a hit when you pursue aggressive growth strategies that require significant investments. It can also move the other direction, often due to sacrificing future growth prospects by cutting investments. While profitability will fluctuate over time, one thing is true: businesses must grow profitably to stay healthy and competitive over the long run.
Why is managing Profitable Growth important?
While revenue is simple to measure as orders come rolling in, profitability isn’t so easily computed—at least, not as quickly. There are too many cost factors spread across the entire organization to understand the immediate impact. Marketing and advertising costs are incurred to bring customers to your website. Promotions and discounts cut into your margin as you work to encourage sales. Outbound shipping and delivery costs further reduce profitability. Unsold items must be sold at a loss before they become obsolete. These are all unavoidable costs—and not all of them are easy to predict or measure.
The path to profitability is difficult. Profitable growth requires a clear line of sight to all factors that impact revenue growth, along with the costs required to make that revenue possible. It also requires a willingness to make difficult business decisions based on those insights.
Customer Centricity and Profitable Growth
Customer-centric businesses are those that make business decisions with the customers’ perspective in mind. These organizations have developed an intimate understanding of each of their customers, and are better able to address their needs, wants, and preferences as a result—even when those aren’t directly communicated. Customer-centricity isn’t just a mindset, either. According to a 2019 McKinsey study, “A fundamental change of mindset focusing on the customer, along with operational and IT improvements, can generate a 20 to 30 percent uplift in customer satisfaction, a 10 to 20 percent improvement in employee satisfaction, and economic gains ranging from 20 to 50 percent of the cost base addressed in the various journeys.”
When a business is centered on customers, company policies, processes, capabilities ensure the customer remains the ultimate beneficiary. Customer-centric businesses also ensure there is a direct link between the investments they make and the impact on the end customer.
All of these results in customer-centric businesses acquiring highly profitable customers with high spend potential AND retaining them for a long period of time into the future, making profitable growth a definite outcome.
Drivers for Profitable Growth
Drivers for revenue growth are separate from those that drive the profit margins. That said, there is often a tradeoff between those drivers. For instance, in order to avoid backorders (which increase revenue), businesses must maintain a high level of inventory on hand (which increases both cost and the risk of obsolescence). If and when these risks materialize, they increase costs and reduce profitability.
Generally, a focused pursuit of sales and growth is seen as an aggressive strategy, while a focus on profitability is the cornerstone of a defensive strategy. Both are important priorities for a successful business, but where a company’s focus lies depends on their industry and their business model.
Drivers for Revenue Growth
Today, businesses are working hard to reach customers wherever they are. The COVID-19 pandemic has caused a dramatic shift in consumer behaviors and, by some estimates, generated nearly five years’ worth of growth in just one year. This whirlwind of change is blurring the line between various business models and opening up new avenues for growth.
Consumer packaged goods (CPG) companies that traditionally sold through retailers are selling directly to consumers through their own websites. The trend has been especially strong over the past five years, with nearly 60% of CPG investments going to direct-to-consumer brands. The pandemic has only extended, if not accelerated, this trend.
Physical retailers have increased their online presence and are offering delivery services. Kroger grew their online sales by 79%, breaking into the list of top 10 e-commerce businesses in the US. Five of the top 10 e-commerce businesses in the US also have a dominant physical presence, including Target, Costco, HomeDepot, Apple, and Walmart.
Digital native brands that formerly sold only through their websites are now selling through other distribution channels, similar to their more traditional CPG counterparts. Casper mattresses are available through Target. Warby Parker has opened retail stores. Harry’s is also available through retail channels, in addition to a strong e-commerce presence.
As the market and opportunity continue to shift and grow, keep these key drivers for revenue growth in mind:
Customer acquisition strategies
Conversion rate optimization strategies
Customer retention and maximizing the lifetime value of every customer
Depending on how your business has evolved, as well as the lifecycle stage of your business, some of these drivers are more important than others. In early-stage companies, customer acquisition strategy and proper channel selection are extremely important. Compare that to an already growing business, where a focus on customer retention and adding additional channels is vital.
Profitable Growth Strategy 1: Customer acquisition: sell to more people
New customers drive growth. E-commerce businesses need new customers who keep coming back, ideally with a high degree of spend potential.
While digital advertising will continue its dominance over the next 5 years as the most impactful channel, other media including TV, Radio, Direct Mail, and out-of-home advertising could be a better fit for your business, depending on the product categories you’re marketing and your business model. Identifying the right audience to market to, investing in the right marketing channels, and making the required investments to drive them to a sales channel are key drivers for revenue growth.
Profitable Growth Strategy 2: Sales channels: sell at more places
E-commerce businesses have the potential to sell across a wide variety of channels. And more channels mean more opportunities to sell—whether that’s on your website or through marketplaces like Amazon, Walmart, Etsy, eBay, Rakuten, etc., each of which rank among the top marketplaces. Of course, that’s just a start. Something like Instagram could serve as a very effective channel for fashion, apparel, and other visual-friendly categories. Some e-commerce businesses have even ventured into selling through physical stores. But each of these channels requires a significant amount of time, resources, and investment to be successful. Selecting and investing in the right mix of sales channels is a key driver for revenue growth over the long run.
Profitable Growth Strategy 3: Conversion Rate Optimization (CRO): sell better
Once prospective customers land on the website, e-commerce companies must make every effort to maximize the chance of a sale. The most important elements of this strategy include:
Chatbots that intervene thoughtfully to answer prospect questions and perform guided selling. According to MarTech Advisor, chatbots increased sales by an average of 67%, with 26% of all sales starting through a chatbot interaction.
Popups that detect the intent to exit and offer additional incentives to encourage a sale can increase sales between 5% to 10%.
Minimizing canceled orders and backorders by ensuring inventory is available for listed products.
Following up on abandoned carts and making efforts to convert them into a sale. AnnexCloud reports 10.7% conversions from abandoned carts prompted by timely emails.
Profitable Growth Strategy 4: Customer Retention and Customer Lifetime Value: sell more and better to your existing customers
Once the challenge of acquiring a customer is met, the next area of focus should be maximizing their value. Existing customers provide invaluable signals of their intent and needs. Organizations that invest in understanding their customers at an individual level will be the most successful in increasing customer lifetime value. Several studies show a near-universal impact of personalization on revenue growth. However, the relevance and depth of personalization determine the size of the impact on sales. The key elements of personalization include:
Precise targeting for customer retention: Identifying the customers who are most likely to purchase—then marketing only to them—increases the likelihood of sales. Indiscriminate marketing will annoy customers and result in customers leaving your brand.
Cross-sell: Product recommendations based on individual customer preferences will increase the basket value.
Upsell: Value-added selling by bundling services, warranties, accessories will increase the basket value.
Profitable Growth Strategy 6: Merchandising: organize better for more sales.
Effective merchandising is all about making the purchasing decision easy for the customer, while greatly increasing the basket value. The key elements of an effective merchandising strategy include:
Personalized homepages for known customers
Home page iterations based on segmentation for anonymous customers.
Products on the home page that reflect the customers’ current needs.
A virtual try-on and a “see in the room” experience for categories such as home decor, furniture, eyeglasses, apparel, cosmetics. These technologies improve the shopping experience and increase conversions by as much as 40%.
An assortment of products that customers are likely to buy together. This will increase the basket value and increase the Average Order Value over time.
Product and category level promotions that provide the biggest revenue lift.
Drivers for Profitability
COVID-19 has caused significant changes in how customers are shopping and significantly increased the costs of service. While the pandemic-induced surge in demand will probably trend back to normal over time, new expectations have been set for customers, and will only increase with time. Some of the dominant trends that we expect to strengthen include:
Buy online, pickup in-store
Refunds with no returns required
Delivery by Instacart and other third-party delivery providers
Free shipping and free returns
Each of these features reduces profit margin. Businesses that understand the true cost of service can take steps to protect their profit margins by optimizing in other areas.
The key factors that drive profitability include:
- Acquisition planning
- Promotion spend
- Other selling costs
Profitable Growth Strategy 7: Acquisition planning
How many customers do you need to acquire? A lot of businesses plan for revenue, but far fewer break down their revenue goals based on the number of new customers they need to acquire. Determining how many new customers to acquire forces you to understand how much revenue potential remains among existing customers. Acquiring more customers than required not only increases marketing costs, but also takes away the focus on customer retention and impedes your efforts to maximize the revenue from existing customers. Key strategies for effective acquisition planning include:
Acquiring new customers based on revenue goals and optimizing your spend on marketing.
Maximizing the lifetime value of every customer and monitoring the Lifetime Value (LTV) to Customer Acquisition Cost (CAC) ratio. According to Klipfolio, healthy companies have a ratio of approximately 3:1.
Controlling avoidable customer churn where a customer prematurely stops buying. According to Statista research, the Retail industry experiences a 24% churn.
Developing and implementing programs to win back lost customers.
Profitable Growth Strategy 8: Pricing that optimizes demand and margins.
Pricing is rarely performed in isolation. Not only is it dependent on the competitive environment, but it varies based on your business model.
For retailers: If your e-commerce business does not have private label products, then the price you can charge is already governed by your agreements with the manufacturer brand and the price that the other retailers are charging. Analytics plays a major role in determining optimal pricing. The key factors impacting margins include:
Estimating—with a high degree of accuracy—the relationship between price and demand for your products.
Quantifying the impact of a loss-leader strategy. This involves pricing some items very low to attract customers, with the expectation that a low margin on those items will be earned back when customers purchase additional products at a higher margin.
Pricing for new products to maximize profitability in the initial weeks of launch.
For Brands: The risk for brands comes in the form of wholesale customers bundling additional discounts, even while technically in compliance with Minimum Advertised Price (MAP) policies. On marketplaces like Amazon, unauthorized sellers often undercut by reselling at a discount.
McKinsey’s pricing strategy for retailers is a great primer to help you get up to speed on additional pricing considerations.
Profitable Growth Strategy 9: Optimizing Promotion spend
Product category level and product level promotions are expensive, and ineffective promotions will quickly reduce the overall profitability of your entire operation. Key factors to a successful promotion strategy include:
Promoting the products that provide the highest return per dollar spent.
Promoting categories that will lift revenues for adjacent categories as well.
Avoiding promotions that incur additional administration and logistics costs—shipping of toys, merchandise, etc.
Most promotions work initially but lose their effectiveness over time, as customers begin to understand the promotion patterns and wait for promotions. Bain outlines this effectively in their essay, The Pricing Is Right: Lessons from Top-Performing Consumer Companies. The findings show a significant opportunity for the retailer who gets their promotion strategy and capabilities in place. However, only 17% of companies are making promotion decisions that are consistent with their positioning, only 14% know how to leverage deep consumer insights, and only 9% have the data, tools, or processes to deliver dynamic pricing.
Profitable Growth Strategy 10: Minimize other costs of sales
There are a wide variety of other costs that can quickly add up and further erode your profit margins. Some of these require a more long-term adjustment, like shipping costs. Retailers need to be selective about free shipping. It’s true that increased customer expectations have made free shipping a given, but there are steps that can be taken to reduce the overall impact on profitability. For example, offering free shipping based on product type or order value are common approaches to help keep costs down. Other helpful options include:
Reducing shipping costs: Offer customers an incentive to receive products in regular mail instead of priority shipping, even if the customer otherwise qualifies for priority shipping.
Bundling into fewer shipments
Using the most appropriate box size—carriers charge based on the size of the box rather than the weight of the box.
Another option to minimize the costs of sales is to take a strategic approach to discounts. Indiscriminate discounts condition customers to expect fire sales, and can limit the purchase of full-price items. But for e-commerce retailers that carry a large amount of unsold inventory, deep discount sales are often unavoidable. The root causes of this problem are inaccurate demand forecasting and pricing that is not aligned with what customers are willing to pay.
One final, important factor not to forget: third party costs. Third-Party Fulfillment (3PL) providers carry inventory in their warehouses and fulfill orders on behalf of the organization. Outsourcing a part of your warehousing and logistics can free up internal resources, but present a considerable drag on profit margins. Consider these strategies to optimize third party costs:
Factor in Third-Party delivery services
Instacart, DoorDash, Uber, and other last-mile carriers have become mainstream. Customers expect that E-commerce retailers will support them. However, an analysis of the transactions by DoorDash shows these services can erode profit margins by as much as 20%. E-commerce businesses need to understand the implications of adding these services and work to adjust pricing and protect the profit margins.
Reduce returns related expenses
Virtual Try-On, measurement tools, “Visualize Your Space”, installation guides, and attentive customer support aid in reducing buyer remorse and lower the potential for returns. Consider offering refunds on returns without actually requiring customers to return the product. This will save you the expense of shipping and handling costs on returns.
Bringing It All Together
Profitable growth is, first and foremost, a mindset. It requires not only a thorough understanding of the factors that drive growth and profitability, but also an embrace of data and analytics to help you appreciate opportunities and threats within your market. Together, this knowledge will help you set the stage for continued growth with a structured, strategic plan.
Of course, your plan is just that—a plan. It should be flexible enough to shift with your business and the market and continue to be refined over time. As new customers come through your (virtual) doors, you will begin to understand them better, which will in turn allow you to offer the products and value-added services that matter most to them. There will be twists and turns as you proceed, but with the right approach, you can ensure every critical decision is an informed decision. Organizations with a culture of analytics and a bias towards action will thrive in this changing market.
About the author
Suresh Chaganti is the co-founder and COO at VectorScient. Suresh is a retail industry expert and a regular contributor at RetailWire, a leading retail industry publication. He is also a member of RetailWire BrainTrust, a panel of retail industry thought leaders. His perspectives feature regularly in Forbes and Business Insider. Before co-founding VectorScient, Suresh spent a couple of decades in business and analytics leadership roles in e-commerce, manufacturing, and distribution businesses.
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