YOU MAY BE familiar with the term “the butterfly effect.” Created by mathematician and meteorologist Edward Lorenz in the 1970s, the butterfly effect illustrated how a small change (the flapping of a butterfly’s wings) can create a larger outcome (the starting of a tornado).
The butterfly effect has been cited in many non-weather examples over the years, with countless examples represented in the business world. There are few better illustrations of its impact than how small tweaks in margin can lead to large-scale increases in the bottom line.
Let’s look at your fast-selling product in diamonds. Given the 80/20 rule applying twice — firstly to the low number of overall store items sold that are diamonds compared to your total items sold, and secondly due to the fact that a large amount of your diamond dollar sales for one year may be produced by just a handful of diamond items — it starts to become easy to see how a slight increase in margin can drive a more significant increase in sales.
Our example store achieves $400,000 of their $1 million in annual sales from diamond product. This is achieved from selling just 400 items at an average of $1,000 from total store unit sales of 5,000 items that made up the $1 million in sales. Already we are seeing the first 80/20 rule applying (8% of sales units (400/5000) have contributed 40% of sales ($400K/$1M).
Of these 400 items, just 8 items (2%) were responsible for half the diamond sales ($200K) at an average sale of $25,000 ($200K/8). Our second 80/20 rule has kicked in.
So, 8 items (just 0.16% of total items sold) are responsible for 20% of the total year’s sales ($200K/$1M). Suddenly, it becomes crucial what margin was made on this product. The store owner achieved 35% margin on these eight items. What if the store owner had achieved 40% margin on these same items? The $70,000 gross profit achieved at 35% suddenly becomes $80,000 at 40% margin and $90,000 at 45% margin. Given other costs are fixed, these eight items will suddenly contribute an additional $10,000 or $20,000 to the bottom-line profit, depending on the margin used.
Eight sales … $20,000 extra profit. Yes, it may be easier said than done, but is there a quicker way of adding to your bottom line than to review the price you set on your biggest dollar sales achieved? You don’t need to flap the wings too many times to create a hurricane on your bottom-line profit.
