By Randy Sadler, CIC Services
For CEOs, the importance of profit simply cannot be overstated. And simply making a profit is rarely enough. Profit growth over time is often the mark of success. This is because bank covenants are tied to profit, and investors usually base their allocation of capital on profit. Also, retained earnings also provide a safety net during difficult times, so maximising profit is important when the business has a tail wind. Nevertheless, even if a CEO can lead revenue growth, delivering profit and profit growth is increasingly difficult, as numerous cost multiplying forces are arrayed against businesses in the current environment.
However, many businesses struggle with profitability. According to small business statistics, only 40% operating within the U.S. are profitable and 20% fail within the first year. It’s not only small businesses and startups that struggle with profitability. There are huge brands that have struggled turn a profit like Uber, Blue Apron and DropBox, to name a few. While profitability has always been a concern for businesses, 2022 poses its own unique challenges. In these recent times, CEOs should be aware of these potential culprits that can eat into their company’s bottom line:
When a business fails to generate revenue, there’s usually a bigger problem behind it. Perhaps the pricing strategy is wrong, the company’s product or service isn’t resonating with its target audience or they need to adjust their strategic communications plan to connect better with customers. In fact, according to Hubspot research, over 40% of businesses don’t listen to their customers. Neglecting customer needs equates to losing customers, and without a growing customer or client base, it’s impossible to remain profitable.
The U.S. has experienced the largest inflation increase in 40 years, peaking at 7.9%. Although it has decreased since February, it still remains high. When inflation is high, consumers buy fewer goods and services. For businesses, this often translates to decreased sales—but businesses may be impacted differently due to price elasticity of demand and whether the goods or services are essential or nonessential. But like consumers, businesses are also impacted by rising prices. For example, the construction industry has felt the burden of the rising prices of lumber which are three times what they were pre-pandemic. Businesses may also experience increased borrowing costs as interest rates are increased to counter the inflation rate. All of these scenarios lead to decreased profitability.
Labor shortages, turnover and rising payroll costs
A broad range of industries have experienced labor shortages and high turnover rates during the “Great Resignation.” While the labor shortages have heavily impacted the restaurant and hospitality industries, it’s also been felt by retailers. A February 2022 survey by Alignable found that 60% of businesses reported struggling from labor shortages. When companies can’t fill their recruitment needs it harms productivity. In some cases, businesses both large and small have had to cut their hours at times, or scale back their operations, like McDonalds and Starbucks. A loss in productivity and decreased operations means less revenue and a hit to profit.
A 2021 survey by Digits found that most small businesses lack the financial visibility they need to be successful and are uncertain how their money is being spent. Even those that have an accounting and finance team report that their decisions are made with incomplete information. It’s easy for spending to quickly get out of control. Unused subscription service fees add up, errors in billing may not be checked and travel, perks and discretionary spending can accumulate into large sums. When a company faces a profitability problem, reining expenses is a good place to start.
Hardening of insurance market and rising health care costs
One major expense for businesses is insurance. Commercial property insurance is experiencing ongoing price increases. Auto liability rates are seeing a double-digit uptick. General liability and health care costs are rising as well. The change is a result of a “hardening” of the insurance market after more than a decade of flat or even decreasing premiums. According to underwriters and brokers, this hardening has the potential to last for months or even years. For a CEO, there aren’t many things worse than turning in a no-loss year on insurance policies, only to be met by significant rate hikes.
Given these five trending culprits when it comes to a profitability problem, what is the solution? While there’s no one-size-fits-all approach, one innovative and emerging solution that addresses multiple facets is captive insurance—or owning your own insurance company. As a licensed insurance company, a captive can re-insure or pool its risk with other unrelated captives to spread the risk of loss.
With the hardening of the insurance market, insurance is a costly expense and owning a captive insurance company enables businesses to turn their insurance premiums from sunk costs into profit. In this sense, a captive insurance company enables a business to vertically integrate and create a second profit center. It also ensures that a company is protected against losses that third party insurers will not insure or risks where the cost to insure with a third party is prohibitive. In essence, it protects profitability and reduces the potential for losses that would otherwise have a business face partial or total closure.
While a CEO’s job is particularly challenging, a key to maintaining profitability and profit growth is crafting a strategy to stay ahead of rising costs. A good place to start is to focus on all cost centers and understand which are impacting the company’s bottom line. Then, exploring alternatives (EG new vendors or new approaches) can help curb identified rising costs. The next step is to anticipate cost centers that may increase in the future and begin work today to head off potential increases. Finding approaches to hold on to a little more profit today can add to a much needed war chest for the economic challenges that inevitably lie ahead.
About the Author
Randy Sadler started his career in risk management as an officer in the U.S. Army, where he was responsible for the training and safety of hundreds of soldiers and over 150 wheeled and tracked vehicles. He graduated from the U.S. Military Academy at West Point with a Bachelor of Science degree in International and Strategic History with a focus on U.S. – Chinese Relations in the 20th century. He has been a Principal with CIC Services, LLC for 7 years and consults directly with business owners, CEOs and CFOs in the formation of captive insurance programs for their respective businesses. CIC Services, LLC manages over 100 captives.
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