What’s eating away at SME profit margins?

5 October 2017 Category:
What’s eating away at SME profit margins?

SME profit margins are under pressure.

If you’re running a small or medium-sized company and seeing your profit margins eroded all round, you’re not alone. 

Dubai is often seen as a hotbed for SMEs in our region – even globally – yet comparing it with other centres yields a surprising result. Productivity in Dubai’s SME sector is actually lower than other trading and service-oriented economies, including Singapore and South Korea. The UAE Banking Federation reported last year that an initiative to support struggling SMEs had resulted in the restructuring of AED 7bn of debts held by 1,700 companies.

His Excellency Abdul Baset Al Janahi, the CEO of Dubai SME (the Dubai government body which promotes small businesses) recognises there’s an issue. In comments reported last year he acknowledged that while there’s often a lot of money and ideas in the boardrooms of our SMEs, there was also often a mismatch between the two. This was caused by various factors which included lack of trust and methods of doing business which were too conventional. He felt it was time SMEs in Dubai started matching talent with capital more effectively, which would encourage the government to make more co-funding available to the sector.

So where do we go from here?

To start, let’s examine four areas that are contributing to the SME situation in our region, and some solutions to help entrepreneurs develop better innovative reflexes, drive change and generate healthier profits. 

1. Is the price right? Pricing is something that many young businesses overlook. So you’ve done your research, made your decisions on pricing your products or services and gone to market. It doesn’t stop there. Even if your initial pricing at launch was based on sound assumptions and rationales, they might not hold true for long. Not until you’re in the white heat of actual business can you start to really test your assumptions.

Pricing is something that many young businesses overlook.

Studies have shown that there’s more to good pricing than finding equilibrium. For instance, in over-saturated markets, consumers can easily get overwhelmed and fail to choose the best price available. This allows space for experimentation around pricing, which may even have the effect of revealing the price which optimises your margin.

But the fact is that good pricing is hard to do. It isn’t something you just pluck out of the air. Nor does it lend itself to extensive trial and error: changing your pricing too much will put customers off or confuse them.

One approach is to establish a comprehensive database of intelligence, by whatever means you can. Use resources available to find information on your competitors’ pricing. Learn what everyone else is doing and build up a comprehensive picture of the real marketplace in which you operate at this moment in time – it may be quite different to the one you researched before you started.

Also, invest strategically in genuine market research. It will take time and resources but it will be worth it, to help you really understand how pricing works in your sector and what you need to do to price optimally for your own business.

2. Are you overspending? In an SME there’s no room to overspend. As your business grows, you may feel it’s too time-consuming to stay on top of every item spent by every department, every day of the week. But to protect your margins you have to stay on top of this. For a start, budget in a detailed and disciplined fashion that you know you can monitor. Be realistic about what you can and can’t monitor, but ideally make your budgeting process as granular as possible so you can have visibility over the key trends.

Invest in a decent cost control system that’s appropriate to the scale of your business. Hiring a financial controller with the right skillset and experience to monitor and control your spend is an option. Having solid information about where you’re spending (and why) is the first step towards keeping it under control and from there trimming back where necessary.

Again, take advice about the systems that are available to help your business. There are lots of them around, and with the advent of intelligent technology they are much more affordable than they were a few years ago.

If there’s one thing you can do to protect your margins that is within your control, it’s this. Cost control may be unglamorous and difficult but it’s the one essential day-to-day process which could make the difference to your survival as an SME.

3. Are you finding economies of scale? Economies of scale don’t just happen of their own accord as your business grows. And getting the information on where and how to invest in order to achieve such savings is tricky. It takes hard work, market intelligence and analysis about your company, your competitors and your customers.

Often you won’t be able to achieve economies of scale without significant up-front investment, especially if you’re in the manufacturing sector, where you may need to invest in plants or machinery to achieve the lower unit costs that come with scale production.

So, plan carefully. Assess the different market scenarios that may arise for your business, and plan in detail for the risks. Look at the things you can control as well as the things you can’t. Analyse the market: can it absorb your increase in production at a price that will maintain your margins? What about timescales? Are you prepared to run at a small loss for a period while you build up market share from your increased production? Do you have reserves and funding to help you invest in this kind of business building, reducing short term profits or even running at a loss in order to benefit from a stronger revenue flow later?

Do you have reserves and funding to help you invest in this kind of business building, reducing short term profits or even running at loss in order to benefit from a stronger revenue flow later?

Assess the risks. Be disciplined in your thinking regarding this problem. Take advice from experts about what the market can absorb. Then, if the time is right, bite the bullet and invest as much as you can to reduce your eventual marginal costs. It might be the best thing you ever do for your business.

4. Is outsourcing to agencies actually costing more?

When starting a company, many entrepreneurs are understandably cautious about taking on too many employees. This may lead an SME to outsource to agencies. It makes sense. As noted in the paper Culture, community and networks: The hidden cost of outsourcing the rationale for outsourcing is ‘simple and compelling’ and that if ‘contracting something out is cheaper than doing it yourself, outsource.’

This is tempered, however, with the conclusion reached in the paper which is that outsourcing does mean control of your company culture is taken out of your hands somewhat – so outsourcing ‘should be assessed in terms of its impact on a range of organisational characteristics.’

So does company culture really impact profits? Look at some of the biggest companies in the world – particularly those in Silicon Valley – and the premium they place on company culture. This applies whether you’re a multinational or an SME, in the US or the UAE. In fact, research by PwC on companies operating in the Gulf Cooperation Council (GCC) shows that 67% of staff at every level of organisation believe company culture to be a cornerstone of a busines’s chance of success. 

Research by PwC on companies operating in the Gulf Cooperation Council (GCC) shows that 67% of staff at every level of organisation believe company culture to be a cornerstone of a busines’s chance of success.

Watching the margins

For any SME owner, feeling your profit margin is under stress is a very uncomfortable place to be. And while there is no magic bullet solution, the four points mentioned above do go some way to changing our thinking about what factors may be influencing shrinking profit margins and what steps we may take to rectify that situation.

Setting up your own business has never been easier. Virtuzone takes care of it all so you can focus on what matters – building your business. For more information about company formation in the UAE mainland or free zones, please call us on +971 4 457 8200, send an email to info@vz.ae, or click here.

About the author: Neil Petch, Chairman at Virtugroup
About the author: Neil Petch, Chairman at Virtugroup

With a history of business successes, Neil Petch is well known in the UAE and beyond as a visionary entrepreneur with a passion for helping others establish and grow their own businesses. Neil founded Virtuzone in 2009 and quickly established it as the region’s leading company formation expert, before launching Virtugroup, a holding company that has a wider mandate of supporting startups from establishment; to successful market entry; and all the way through to exit.