Last year my friend called me about 1 o’clock in the afternoon asking me if I wanted to go for a ride. I thought a short lunchtime ride would be just what I needed. When we got out on the road I found myself woefully unprepared for the distances and the climbing we were going to be doing. 4 hours later were almost home and had a few steep hills to climb before we could call it quits. It was at the bottom of the first hill I hit the wall. I had to call my wife to come and pick me up.
We have all been there. We have all bonked. We head out unprepared for the ride ahead and because we have not nourished ourselves enough we end up falling short on our energy stores.
In business, our fuel is profit. More precisely it is our Return on our Investment, Assets, or Equity. So if we do not want our businesses to “Bonk”, we need to know how to maximize our return. There is a simple formula you can use to calculate the return in your business. Return = Margin x Velocity. If we know the desired return we have two variables we can work with, margin and velocity. If we increase the either or both, margin or velocity, we could get a larger return. Margin and velocity are interdependent in nature. The challenge is in achieving the right balance between the two.
Let me take you back to the bike to demonstrate. Let’s say you want to keep an average speed of 20 MPH (Return) on a flat road. Once you have warmed up a little you will probably settle into a certain gear (Margin) and cadence (Velocity). You look over at one of your riding companions and you see their cadence is significantly slower than yours, yet you are both traveling at the same speed. It is obvious without even looking that your friend is pushing a much larger gear. As you look at this example, you may be asking yourself, “What is the right combination of Margin and Velocity”? The answer is, that depends.
Just like in cycling you may find in some situations a higher velocity and lower margins are optimal. In other cases you may find yourself wanting to stick with higher margins and lower velocity. The correct answer is more varied than the gear and cadence combinations on your bike. So think about this. You are climbing up a hill and you are going for a personal best. You have a chance to push a larger gear with a cadence of 40 rpm or a smaller gear at 60 rpm. Which is the most effective way to climb the hill?
The lower the cadence and the larger the gear the further you travel with each pedal stroke. It is also more likely you will expend more energy and get tired near the top. The faster the cadence and lower the gear, the less distance you will travel per stroke, but the more strokes you will take climbing the hill and the less energy it will take to get there. The person who makes it to the top first, is the person who judges their strengths and limitations best, and chooses the right combination.
As you think about your business, ask yourself the following questions:
What is our velocity? (How fast are we turning our products, closing sales, collecting debt, etc?)
What are our margins? ((Total Sales – Cost of Goods Sold) / Total Sales)
What could we do to increase velocity without decreasing margins?
What would the velocity be if we slightly decrease margin?
What is the optimal ratio of velocity to margin to give us the highest return?
I hope next time you are out on a ride you maximize your return both on the bike and in your business.