Running a small or mid-sized company comes with its fair share of challenges, especially when cash flow is tight and profits are low. Without a clear and effective profit strategy, CEOs can feel trapped in a cycle of constant struggle.
In fact, many companies face the difficult reality of improved gross margins yet still experience losses. Research shows that nearly 35% of companies experience losses even when gross margins improve.
So, what’s the key to turning things around?
The answer lies in two areas: improving your gross margins and optimizing operational efficiency. These are the foundation of profitability and long-term business success—especially when preparing for a sale or an exit.
By the end of this article, you’ll gain actionable insights to boost your company’s performance. Whether you’re gearing up for a sale or an exit or simply aiming to enhance operations, these tips will guide you toward success.
Understanding Gross Margins and Operational Efficiency
Before getting into strategies, let’s first define the two essential components: gross profit margins and operational efficiency. These metrics are important to understanding where your company stands financially and where you can improve.
What Are Gross Profit Margins?
Gross profit margins are a key part of your profit strategy. They refer to the difference between revenue and the cost of goods sold (COGS), expressed as a percentage of revenues. This number is important because it tells you how efficiently your business is producing its products or delivering services.
For example, in a service-based business, such as a consulting firm, your direct costs include salaries for client-facing employees. In retail, it would likely encompass the cost of goods sold.
Several factors can erode gross margins, including:
- Rising input costs (materials, labor, or technology).
- Pricing pressures that do not reflect the value you deliver.
- Inefficiencies in the delivery of products or services.
For businesses, understanding your gross margins—and the factors affecting them—is crucial for improvement. This key metric offers valuable insights into your pricing strategies and overall financial health.
However, gross margins alone don’t give the full picture. To gain a complete understanding, it’s essential to evaluate operational efficiency as well.
What Is Operational Efficiency?
Operational efficiency refers to how well your business uses its resources—time, money, and labor—to produce its outputs. The goal is to deliver high-quality results with the least amount of waste.
For any business owner, inefficiency can be a silent profit killer. Missed deadlines, excessive overhead, redundant processes, underutilized technology and poor resource allocation, can erode profitability, frustrate customers, and make scaling harder.
Improving operational efficiency is not just about addressing daily challenges; it’s about aligning your operations with long-term goals. Streamlined processes and optimal resource use not only enhance profitability and customer satisfaction but also create a business that’s more attractive to potential buyers.
By showcasing well-managed operations, you demonstrate stability and scalability, which can lead to fewer surprises during due diligence and a stronger valuation. This alignment between efficiency and strategic objectives bridges the gap between running a business effectively and preparing it for growth or exit opportunities.
If you’re looking to make the due diligence process even smoother, we have a free resource that lists all the key documents most buyers request. You can download it by clicking the button below!
We’ve defined gross margins and operational efficiency. Now, let’s see why improving both has a powerful ripple effect.
The Connection Between the Two
Gross margins and operational efficiency go hand in hand. Improving efficiency often reduces direct costs, which in turn improves margins. For example:
- Minimizing waste in workflows reduces expenses associated with inefficiencies.
- Optimizing processes can cut labor costs and/or increase output without requiring additional resources.
The relationship is straightforward: improving efficiency often drives better margins. This synergy not only boosts profitability but also positions your business for success—whether you’re focused on growth or preparing for a sale.
With this understanding established, let’s explore actionable strategies to increase gross profit margins.
5 Ways to Improve Gross Profit Margins
Improving gross margins isn’t about making drastic cuts or increasing prices indiscriminately. Instead, it’s about thoughtful adjustments that reflect the value you deliver while keeping costs under control.
1. Optimizing Pricing Strategies
A strong profit strategy starts by revisiting your pricing model.
Are you charging based on the value your product or service delivers—or simply adding a markup to costs?
For example, a tech firm might find that clients are willing to pay a premium for customized solutions rather than off-the-shelf packages.
How to do it:
- Conduct market and competitor analysis to identify pricing opportunities.
- Shift to value-based pricing to reflect the unique benefits your business offers.
This makes sure your pricing aligns with customer expectations while maximizing your profit potential.
2. Reducing Direct Costs
Lowering the costs tied directly to your product or service is another effective way to boost margins.
Ideas for action:
- Negotiate with suppliers for better pricing and payment terms.
- Review recurring expenses tied to production or service delivery.
- Evaluate whether technology upgrades can replace costly manual tasks.
Even service businesses can benefit by automating routine tasks, like scheduling or invoicing, to save both time and money.
3. Improving Production or Workflow Processes
Efficiency isn’t limited to manufacturing; any business can gain from examining its workflows to identify and eliminate bottlenecks.
A proven method is lean operations consulting, which emphasizes pinpointing and reducing waste. This approach not only cuts operational costs but also enhances productivity and overall output.
Ideas for action:
- Map out your existing processes, identify delays or redundancies, and consider technology enhancements.
- Implement lean principles like reducing waste or standardizing workflows.
For example, a marketing agency could simplify its campaign approval process. This would reduce back-and-forth emails and save hours on each project.
4. Enhancing Product or Service Mix
A strategic way to boost gross profit margins is by optimizing your product or service mix and discontinuing low- or non-profitable offerings.
For instance, a restaurant might find that appetizers have higher profit margins than desserts. By promoting and upselling appetizers, the restaurant can increase profitability while allocating resources more effectively.
How to do it:
- Review historical sales and margin reports to identify your most profitable products or services.
- Tailor your offerings to align with customer demand, focusing on the items they value most.
- Test strategies like bundling or premium pricing for high-margin offerings to maximize revenue.
- Stay ahead of market changes to refine your mix and capitalize on emerging opportunities.
By focusing on high-margin items, you can boost profitability and set your business up for long-term growth.
5. Analyze Profitability by Customer
Not all customers contribute equally to your gross profit margins—some may even be costing you money. Conducting regular customer profitability to identify opportunities to revise your pricing for some of your customers. This analysis ensures you’re focusing on clients who drive value rather than drain resources.
For example, NYFG worked with a manufacturer generating $80 million in sales. We found that 10% of these sales had negative gross margins. These losses stemmed from offering excessive discounts to long-standing clients. By shifting focus to higher-value customers, the company significantly improved its profitability.
How to do it:
- Analyze revenue and cost data by customer to identify unprofitable clients.
- Group clients based on profitability tiers and focus efforts on high-value segments.
- Consider adjusting pricing or service agreements with low-margin clients.
- Allocate resources and incentives to nurture your most valuable customers.
An annual profitability analysis helps you create a stronger client base. It also enables you to use resources where they work best.
How to Improve Operational Efficiency
Improving operational efficiency isn’t just about cutting costs. It’s about making smarter decisions and improving processes to boost long-term profitability.
Additionally, process improvements lay the groundwork for ongoing enhancements and can help meet regulatory requirements and reduce the risk of non-compliance. Focusing on technology, workforce productivity, and resource management can help you get there.
Here’s how to improve operational efficiency for your business:
1. Invest in Technology
Technology can greatly improve efficiency. Using ERP software and automating repetitive tasks should reduce errors and speed up processes.
How to do it:
- Implement ERP systems for better data management.
- Automate routine tasks like invoicing or reporting.
- Explore IoT solutions if you’re in manufacturing to improve tracking and operations.
These steps will streamline your operations, save time, and increase your profit margins.
2. Streamline Supply Chain Management
Efficient supply chain management is key. It helps you avoid unnecessary costs and keeps things running smoothly.
How to do it:
- Improve inventory management to prevent overstocking or stock outs.
- Build strong relationships with reliable suppliers.
- Negotiate better pricing and payment terms with suppliers for cost savings.
This reduces costs and guarantees that products reach customers on time.
3. Improve Workforce Productivity
A well-trained team is essential for operational efficiency. Providing training boosts skills and reduces errors.
How to do it:
- Offer regular training to improve staff skills.
- Recognize top performers to boost morale and motivation.
- Set clear goals to keep the team focused on key tasks.
A productive workforce will help your business run more smoothly and profitably
4. Emphasize Energy Efficiency
Energy efficiency can cut your operating costs over time. Small steps can lead to big savings.
How to do it:
- Conduct an energy audit to identify areas of waste.
- Upgrade to energy-efficient equipment where possible.
- Turn off unused equipment or lights to save energy.
These changes can lower your utility bills and make your operations more sustainable.
By focusing on potential improvements related to your business, you can improve operational efficiency and increase profitability in the long run.
Linking Efficiency and Margins to Exit Planning
When preparing to sell your business, strong margins and efficient operations play a big role. A company that runs efficiently with strong margins is more attractive to buyers and commands a higher valuation. Here’s how these elements intersect with exit planning.
1. How Margins and Efficiency Impact Company Valuation
When preparing to sell your business, buyers will closely examine your financial health. Strong gross profit margins and operational efficiency signal that your company is performing well and has the potential for sustained profitability.
- Higher Margins: Consistent gross margins are a key indicator of a profitable and well-managed business, making it more appealing to buyers.
- Operational Efficiency: Streamlined operations demonstrate that your company can sustain profitability, even post-sale.
By improving margins and efficiency ahead of a sale, you enhance your business’s attractiveness and potential valuation.
2. Streamlined Operations = Streamlined Due Diligence
Due diligence is often a stressful process for both buyers and sellers. When your operations are efficient and your margins are healthy, buyers will feel more confident in their decision.
- Transparent Financial Health: Strong margins demonstrate effective management and profitability, alleviating concerns about future expenses.
- Streamlined Operations: Efficient workflows make a business more appealing to buyers and minimize potential complications during due diligence.
Efficient operations and strong margins streamline due diligence, increasing buyer confidence and speeding up the sale process.
If you’re looking to make the due diligence process even smoother, we have a free resource that lists all the key documents most buyers request. You can download it by clicking the button below!
Now, let’s explore how strategic partnerships and advisors can improve margins and efficiency.
The Role of Strategic Partnerships and Advisors
Improving gross profit margins and operational efficiency is easier with the right advisors. Business consultants and finance and operations experts can help you find areas that need improvement. They can also help you put the right strategies in place.
1. Financial Diagnostics: The First Step in Improvement
Before making any changes, it’s important to understand where your business stands. This is where finance and operations advisors like NYFG, LLC come in. We conduct a thorough financial and operational health check to identify weaknesses in your gross margins and operational shortages.
What we evaluate:
- Key metrics and ratios like gross profit margin, operating margin, and inventory turnover help pinpoint areas that need improvement.
- Benchmarking your business against industry standards to highlight potential areas for growth.
- Mapping your current processes and providing suggestions for improvements.
This diagnostic process sets the stage for creating a custom action plan tailored to your unique business needs.
2. Operational Audits: Pinpointing Inefficiencies
First, we assess the financials. We then conduct an operational review to find inefficiencies in every area of the business, from production to sales and delivery. This review helps uncover waste, redundancies, or processes that aren’t functioning at optimal capacity.
Common inefficiencies we help clients address include:
- Supply chain delays which can lead to higher costs and customer displeasure.
- Excessive overhead costs, such as untapped staff or outdated equipment.
By addressing these inefficiencies, we can help businesses run more smoothly, saving time and money while improving overall profitability.
3. Specific Support from NYFG
At NYFG, LLC, we provide hands-on support to help you improve your margins and operational efficiency. Here’s how we can specifically help:
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- Due Diligence in Operational AssessmentsWe closely examine your business operations to identify areas that can be improved. We aim to help you spot shortcomings that might be holding you back from reaching your full potential.
- Custom Action PlansBased on our findings, we create tailored action plans. These plans boost cash flow, improve margins, and run your operations more efficiently.
When to engage with an advisor?
There are several key indicators that it may be time to engage an advisor:
- Consistent margin erosion: If your margins are shrinking, we can help. We will find the causes and suggest solutions.
- Preparing for an exit: When planning to sell or merge, we help optimize your company. This guarantees a smooth transition and a higher valuation.
Engaging with an advisor can help you make strategic improvements. These changes will position your business for a successful exit.
Improving gross profit margins and operational efficiency isn’t just about boosting current profitability. These efforts also increase your business’s long-term value. This makes it more appealing to potential buyers when you’re ready to exit.
By focusing on these areas and getting expert support, you can improve your company’s performance. This will help increase its valuation and ensure a successful exit strategy.
Ready to take the next step? Contact NYFG today for a financial health check or an operational audit to start improving your margins and efficiency. Together, we’ll set your business up for success—now and in the future.
