Why and How to Lower Your Break-Even Point
The break-even point is that magic sold product volume where the contributions (revenue minus variable costs) of sold products cover initial investment and fixed costs. The contribution of every product sold beyond the break-even point makes your business ever more profitable. The break-even point can be calculated for a specific project, investment or a new venture as a whole. As a consequence, any given new project or venture should strive to have the lowest possible break-even point. Here's why:
- A lower break-even point leads to more profit, more cash and more room to maneuver in terms of product development, new investments and R&D -- all activities that are the lifeblood of companies determined to stay competitive.
- Even for mass producers, a high break-even point means you have to appeal to a wider customer base. Unfortunately this requirement often forces businesses to try out unexciting, bland and possibly unsuccessful products with the hopes of pleasing everybody.
- The situation where the break-even point is met with ever lower contribution margins can easily lead to financial stagnation. With no action taken, it can well end up in inactivity.
- A low break-even point and healthy profit margins open up the potential of niche markets, attractive designs, high brand recognition and better protection from competitors.
So how do you arrive at this sweet spot? Here are three proven ways to lower the break-even point:
1. Raise prices. Contrary to what most managers believe, raising product prices is not such a toxic option. It takes of course good market knowledge and reliable information on competitor prices. If manufacturing orders are bursting at the seams, it's a good time to question whether demand exceeds supply, and act accordingly.
2. Outsource activities to reduce fixed costs. Outsourced activities only incur costs by volume, which is a huge boost for profitability. Suppliers have every interest to sell more products and essentially become close business partners. Have you ever wondered why electronics and automotive OEMs outsource so many product modules or even the complete product manufacture?
3. Build an attractive brand, up-sell, cross-sell. Luxury car manufacturers and now online companies are masters in this technique, as they almost always offer a basic service that offers just enough to keep the product useful, but holds back just enough to get customers interested in signing up for a more exclusive membership. Netflix is a great example of this. It offers standard definition content at low prices, and HD or 4K streaming at higher ones.
Look at Apple vs. Samsung if you want a good example of all of this. Samsung is consistently beating Apple in sales volumes, and even acts as a strategic supplier of Apple smartphones. But despite its world-class brand name, its product range is so wide that it has diluted the company's profitability. As a result, Samsung's smartphone division is dealing with one profitability crisis after another, and has to continuously attend to frail finance.
Apple, on the other hand, has managed to create what's arguably the world's highest regarded brand and design image to carve out its niche at the highest, most profitable end of the market. It not only manages to get away with two basic smartphone models but also manages a sophisticated outsourced production model with the lowest possible fixed costs.
Every company would love to be in a position similar to Apple's. That may be a hard goal to reach (never say never) but it's worth using their example plus the other tips mentioned above if you really want to strike gold with a low break-even point.