When you write up a list of business expenses, you probably include utilities, maintenance, landscaping, payroll, benefits, the cost of new equipment, and marketing.
If your list looks something like that, I would like to suggest that you are making a mistake in the way you are thinking about your costs of doing business, because marketing is an investment that pays you back, not an expense. Unlike the money you spend to keep your lights on and get your floors waxed, it delivers a very big return. In fact, it pays a much bigger return than you probably realize.
The Value of Contribution Margin
Why can marketing have the potential to pay you an oversize ROI? Contribution margin is one reason. Contribution margin is the margin your company makes after paying variable costs. It’s a really important concept to understand. Let me explain.
Let’s say, for example, that your business is generating $1 million a year. Let’s also say that because you have a contribution margin of 50%, you have contribution dollars (dollars that do not go to cover variable expenses) of $500,000. Let’s also assume that you are covering all your fixed expenses from that $500,000. If that is the case, each additional new dollar you bring in contributes $0.50 in profitability, because your contribution margin is 50%.
That helps explain why the dollars you spend on advertising pay you an oversize ROI. Once you’ve reached the magical spot where your contribution dollars from your contribution margin have covered all your fixed costs, your contribution margin becomes your profitability margin on all future business.
A Case Study
A $1 million-a-year restaurant (but it could be any business) spent an extra $50,000 on marketing, which produced $250,000 in incremental sales. So, the cost of the extra marketing that yielded those sales was 20%, which was much higher than the 5% increase the restaurant received on its first $1 million in business. But that’s okay, because all the fixed costs of the restaurant were covered in the initial million dollars of business.
Because the restaurant’s fixed costs were already covered, the incremental profitability of the restaurant improved by $75,000. (The contribution margin produces an additional $125,000 in profit, less the additional 50,000 you spent in marketing; that equals $75,000 in additional profit.)
Although this example is a restaurant, its lessons apply to virtually every business. I invite you to look at your financial statements and model the impact of increasing your advertising spend in the table above. I believe you will see the opportunity for a substantial increase in profitability, because once you have covered your fixed costs, you can justify spending more in incremental marketing spend, because the contribution dollars will cover that expense.
It’s very important to understand contribution margin, which is your margin after covering all variable expenses and your breakeven point, which is the point where your sales and expenses match. Increasing your marketing dollars after that point even, at a much lower return of marketing dollars to revenue, can significantly improve your bottom line.
Furthermore, when you market effectively and increase your sales, you also are bringing more customers through your doors – in effect, exposing your business to more people. As a result, you are going to increase your repeat and referral business, and your entire enterprise will grow. That is another reason why marketing is not a cost, but an investment that pays you a return. It is a catalyst for growing your enterprise.
Evan Hackel is 35-year franchising veteran as both a franchisor and franchisee. He is CEO of Tortal Training, a leading training development company in Charlotte, North Carolina, and Principal and Founder of Ingage Consulting in Woburn, Massachusetts. Evan is the host of Training Unleashed and author of Ingaging Leadership. To hire Evan as a speaker, visit evanspeaksfranchising.com. Follow @ehackel.