The answer, even if it may seem trivial in theory, is not at all when it comes to practice. In theory, you can follow some well-defined paths (increase prices, increase sales, reduce costs...) but in practice many of them are not viable because the room for maneuver is limited, or they risk bringing an increase in profit that is too small.
There are many constraints: internal and market. In which direction should we move, then? Are the chances of success greater if the company invests in new stores or if it promotes an internal reorganization aimed at reducing costs?
To identify the strategy to follow, one of the tools at our disposal is the Net Profit Tree (or Profit Tree, in English). By putting down on paper the different possible paths and the margins related to each of them, we will in fact have an effective support for a more rational choice.
The Net Profit Tree
Below is a general representation of the Net Income Tree. It is a standard version that will work for almost any business, but each industry and business may need a slightly customized structure.
For example, revenues could be derived from models other than the simple “quantity sold x price” formula: think for example of companies that sell both single services and subscriptions, and which would probably see a split in the REVENUE item at that point in the tree (with, for example, SUBSCRIPTION REVENUE and SALES REVENUE separated into two different branches).
At an operational level, therefore, the first thing you should do is carefully study what is the best representation for your revenue tree, including for example a distinction between divisions or other peculiar and relevant aspects of your business.
These are, in short, the items to consider and the way in which the structure is defined. Each terminal part of the tree, each “leaf”, corresponds to a lever that can be acted upon to obtain an increase in the company's net profit.
The revenue section
Revenue comes from PRICE and QUANTITY sold.
The price can be changed directly; if you want to act on the quantities instead, you need to leverage either the acquisition of new customers or increased sales to current customers.
In turn, a new customer could be stolen from the competition or could be someone who previously did not purchase that type of product.
The cost section
Costs, seen from a marketing point of view, can be grouped into three large families:
Cost of Goods Sold (COGS): all costs related to production, i.e. raw materials, labor, logistics, outsourced processes.
Marketing costs: communication, sales or seller incentives, distribution costs.
Other Costs, or the costs of all business functions that are not related to production or marketing. These include, for example, administrative or R&D costs.
Here is the final representation of a standard manufacturing company; as mentioned, you will customize it to your company's unique characteristics to arrive at your own personal Net Profit Tree.
Look for room for improvement
Now that we have a clear idea of the general structure, let's start evaluating the different possibilities for action.
We can evaluate revenue growth (or top-line growth) : to achieve this goal we could increase prices, increase sales to existing customers, or find new customers.
Or, we can focus on bottom-line growth, which translates into cost savings : working to reduce the cost of goods sold (COGS), marketing costs, or other costs that companies face.
The important thing is to evaluate, for each path, what could be a realistic estimate of the obtainable result and insert the value in the corresponding box of our tree diagram.
There are obviously some factors that need to be carefully considered: for example, cost reduction can usually be calculated more precisely than increasing market share, because these are variables over which the company has full control (which cannot be said of the market).
We will see in the next paragraph what aspects to take into consideration for each of the
