South African startups must acquire more new customers to sustain themselves given the stagnant growth of the economy, but doing so comes with its own dangers.
This is according to Jeremy Lang, regional general manager at risk finance firm Business Partners, who says the current economic environment in South Africa makes it difficult for small and medium enterprise (SME) to sustain themselves, let alone increase profit margins.
The June 2016 Quarterly Financial Statistics (QFS) released by Statistics SA last week show though there was an increase in turnover and net profit increased in all eight industries covered compared to the previous quarter, all are down year-on-year, especially for small businesses.
Lang said small businesses tend to be more vulnerable to sustained periods of low economic growth and increasing costs, meaning as long as the South African economy remains stagnant small businesses will struggle to maintain sufficient profit margins.
With the pie not getting any bigger, SMEs have to acquire new customers from existing markets or industries, away from other players and competitors in the market, to sustain themselves.
“The quick and easy solution to attract new customers within an existing industry is to reduce prices,” Lang said.
However, this comes with its own risks.
“Given the increased competition to retain and attract customers, this can lead to a risk of ‘price wars’ within a certain industry, resulting in profit margins coming under further pressure,” he said.
Understanding costing structures, and income and expenditure, is crucial to managing and driving profit margins.
“Profit margin is made up of variable and fixed costs. Variable costs are incurred when producing or selling a product, while fixed costs, such as rent and wages, are payable regardless of whether the business sells anything or not,” Lang said.
“It is important for business decision-makers to consider these costs when pricing products or services, in order not to compromise on their projected profit margin.”
For example, Lang said though reducing prices may bring more customers, overheads remain the same, meaning dropping prices could also put pressure on margins.
“Similarly, raising prices could improve profit margins, but this may put the business at risk of being priced above the market and potentially losing customers in the process,” he said.
“It is key to understand how customers perceive value and to what extent a business can raise prices to the point that customers will still be willing to pay for the product or service offered. This can be done by finding a unique selling point, such as superior service or quality, that will help the business stand out from competitors.”
Increasing prices may not be viable due to the reality that many business owners are finding themselves operating within the confines of limited economic growth, Lang said. He advises, in such an instance, to effectively manage variable costs such as utilities, input costs and labour.
“For example, business owners should negotiate discounts with current suppliers or explore the use of alternative suppliers that can provide the same products or service at a lower cost without compromising on quality,” he said.
“To save on utilities such as electricity or water, a business can make a more conscious effort to utilise these resources more effectively. In terms of labour, businesses can incentivise staff to become more productive and deliver greater output during the same hours. Another aspect is ensuring the business has sufficient security and adequate stock controls in order to minimise theft.”
He did, however, advise that whichever option a company chooses to maximise its profit margins, it must continue to refer back to the business plan regularly, as this will secure long-term business success, especially during trying economic conditions.