New customers are signing on, revenue is up, and your team is busier than ever. But for some reason, your bottom line doesn’t look as good as the growth says it should.
If that sounds like you, this article is for you.
The framework we’ll share is meant for established businesses in the $3 to $30 million revenue range. And if you’re not there yet, that’s OK. You will be, and the earlier you learn this, the less you’ll have to fix later.
We’ll cover how growth erodes margin, share a three-pillar approach that will prevent deterioration, and an actionable check you can run, today, to find where your margins are leaking.
The material covered in this article originally appeared in our Pricing Strategies Through a CFO Lens webinar. If you prefer learning in a presentation-style environment, you can watch the full replay below.
Where Did Our Margin Go?
The short version is growth adds complexity, and what works at $1M can break at $10M+.
And this is more than just a scary story. During the webinar, 100% of attendees admitted to a habit (discounting) that plays a starring role in what follows.
Imagine you run a $12 million distribution company. Last year, revenue grew by 20%. Fantastic work! That’s the kind of growth everyone’s chasing.
But then you crunch the year-end numbers, and despite roughly $2 million in new revenue, gross profit was flat. More sales; same take-home.
What happened?
It’s tough to say exactly, but we can make some educated guesses. And once we break down our customer base one by one? The leak starts to get clear.
The sales team had the go-ahead for some attractive discounts this year, and they made it rain. That seemed like a good thing at the time. It brought in new business, right? But then, overhead went up too. More customers meant more work for the fulfillment and support teams, so headcount had to grow.
But after the discounts, and the new hires you needed to handle the new volume, margin on the new business came down to about 10% — a third of your normal rate. Plus, some customers paid on 90-day terms, and tied up your working capital along the way.
The pattern here is common (complexity + discounts + overhead growth). But how do we catch it early, and what can we do about it?
The Three Pillar Pricing Framework
Great pricing stands on three legs. Miss one? Your base might be unstable.
“Your cost structure sets the floor, and what the market is willing to pay sets the ceiling. Good pricing lives in the space between.” -Karen Rinehart, indinero CFO lead
Look Forward: Oftentimes, businesses price through last year’s costs, using last year’s margins. But by the time those numbers tell you something’s wrong, you’re already months down the road, with locked-in customer contracts, and the damage is already done.
Find the Leak: Look beyond the blended P&L, segment by customer, product line, cost contribution, and find out which parts of your business are thriving and which are holding you back.
Know the Floor: Instead of a flat increase based on last year’s numbers, calculate your break-even point (on a customer-by-customer and product-by-product basis) before you raise a price, offer a discount, or decide to hold things steady.
Pillar 1: Look Forward
When you drive a car, do you spend more time looking in the rearview mirror? Or through the windshield?
Rearview pricing is an important starting point, but if you rely too much on it (perhaps with a flat increase tacked on), margin erosion is quick to show up.
On the other hand, forward-looking pricing builds in what’s already changing, like a committed wage increase or scheduled vendor price hike, and considers those costs before they reach your margin.
Pillar 2: Uncover the Leak
Blended P&L obscures the story behind the numbers. Which customers are carrying the average? Which are dragging you down? Averages can’t tell you that.
There’s a good chance you already know that. After all, most of our webinar attendees (60%) shared they already look beyond the top-level margin to see what’s going on under the surface.
However, if you fall into the second camp, here’s how to pinpoint the leak:
- Allocate shared costs by customer/product segment. Not revenue. Through this lens, every customer/unit sold counts equally, regardless of order volume.
- Sort those segments by margin, highest to lowest. Find the tail.
- Then, compare your revenue-weighted margin (blended P&L) with the count-weighted margin you just calculated. If they diverge, you’ve found where to start.
What story are your numbers telling you? Does anything surprise you? Do the below-average counts have something in common? Are discounts clustering, perhaps around a single service or salesperson? Is there an outlier account?
Armed with those answers, you can get to the bottom of where your margin is going.
Same Revenue, “Same” Gross Margin, Very Different Customers
Here’s an example of what a count-weighted margin can reveal.
Let’s say you have two customers. Each brings in $100,000 at a 22.5% “gross” margin. On paper, they’re identical twins (but only if you allocate costs evenly). However, their costs are anything but identical:
- Customer A: 6 orders and 3 support tickets per year.
- Customer B: 90 orders and 50 support tickets per year.
That’s roughly 15 times the load! Same revenue, “same” gross margin, but one customer is considerably more profitable than the other.
A CFO might refer to this by several names: segment margin, customer profitability analysis, customer-level P&L, fully loaded margin. However, the underlying principle is the same (look at costs, not just revenue). And while we’ve used customers here, you can segment by anything that might matter to your business.
This is also how you’ll reveal a big fish. Blended P&L could make them look like great customers, but the segmented view may tell a completely different story.
Pillar 3: Know Your Floor (Before You Make a Move)
Picture a trapeze artist mid-swing, reaching for the next bar. She’s a trained professional. What looks risky from the outside is actually a calculated decision; she can fully commit to the next move because of the net beneath her.
For a business, break-even sets the floor; the absolute bare minimum you can charge without going backward.
So, let’s pretend we’re thinking of changing our prices (up or down) and look at an example. And please bear with us a moment. The math is simpler than it looks, and it’s important for illustrating the concept.
- All things equal, raising the price means we (might) lose customers, while lowering the price means we (might) gain.
- We’re comparing a 5% price increase with a 10% discount on a service operating at 40% gross margin.
- What’s our break-even point on each bet? How many customers do we have to gain to justify the discount? And how many can we afford to lose before the price increase hurts us?
In this scenario, a ten-point discount demands a third more business. Would it actually deliver? Conversely, a 5-point increase can afford an 11% loss in customers before it negatively impacts profit.
What’s more likely?
You’re intimately familiar with your business, and your market, so you’re much better equipped to answer that question than this article. But nearly all of our webinar attendees shared they have a habit of discounting to win business, and it’s likely that decision may be costing at least some of them.
Guardrails: Turning Pillars Into Policy
Salespeople win deals one at a time. They should be focused on today. But protecting margin at scale is a long game, and you win that with policy.
Three guardrails we often recommend with clients:
- Set the Floor: Break-even math sets a minimum margin and discount threshold, plus a cushion if you want margins to grow. Put it in writing, and as long as reps stay within those lines, no approval or added administrative layers required.
- Make the Trade a Rule: Every concession should earn something back. Discounts are still valuable tools, but use them only as bargaining chips: longer contract terms, more volume, faster payment terms. If trades happen by policy, rather than last-ditch efforts to close a deal, the impact will trickle through.
- Manage the Exceptions: The exception you approve today eventually becomes the price everyone expects, so deep discounts need a good justification.
Your Homework: Compare Two Margins
Start by running your revenue-weighted margin. It’s the blended gross margin on your P&L, where bigger customers carry more weight. Then, calculate your count-weighted margin. Every customer’s revenue counts the same through this lens.
Finally, compare. If they line up, that’s fantastic news. Your growth is real and profitable, which is exactly what you want to know before you chase more. But if they’re different, you’ve got some challenges to consider.
Questions From the Webinar
“How do you develop a methodology for assigning expenses to specific customers?”
Let’s assume we’re talking about shared expenses, shared costs, shared overhead. Take your help desk, for example. Hopefully you have a department for your help desk, so you capture all of those costs in one place.
Now you have your cost pool, and you know what the total is. The help desk serves customers, generally by responding to tickets. So you divide your cost pool by the number of tickets; if your cost pool is $10,000 and you have 1,000 tickets, that’s $10 per ticket.
Then you look at your customers, because those tickets are coming from somewhere, right? Which customer does each ticket apply to? If a customer had five tickets during the month, they get a $50 allocation.
If you have a specific follow-up, feel free to book a meeting with me, and I’d be happy to help.
“Is the margin floor tied to the cash liquidity floor?”
No, the margin floor is really tied to your gross margin. When you’re talking about liquidity, you’re talking about payment terms and getting cash in the door quickly. That certainly does cost money, and terms are important for separate reasons. But the margin is the gross margin we’re trying to protect.
If we’re already making a 40% margin, the question is: Do we want to keep making 40%? Are there things happening in the market that will prevent us from keeping that 40%? Maybe we do get squeezed down to 36%, and that’s okay. That’s what the floor is about: What’s the minimum we’re willing to make? If we’re going to go below that, we need a darn good reason.
Your Next Step
Book a free 30-minute consultation with our head of CFO services, Karen Rinehart. Bring your homework, and we’ll work through any gaps and questions you may have.
Not ready to chat 1:1? No problem. Check our list of upcoming webinars and attend in person, or watch any of our past webinars (for free) on your own time.
We’ll take care of the numbers. You focus on growth.
