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So it is the end of the year and you have this big pile of cash sitting in your account. You fear that if you do not spend it you will have to pay huge taxes on this cash.
This problem is typical of most successful small businesses. The only way most business owners feel they can advert this tax is by making a huge purchase which by the way is not really necessary. So now this business owner has spent $20,000 to avoid an additional $5,000 in taxes. I call this penny wise and pound foolish for while he/ she has adverted $5,000 in taxes he is out of an extra $15,000. It is never a wise purchase to buy things you do not need to “save money”. So what happens next year, there is not enough money to cover inventory and now the business has to go into debt to cover expenses and this vicious cycle goes on year after year.
Be sure to hire a professional if you do not understand how to evaluate how your business is really doing.
You have often heard it said that one should have a budget . A budget is a plan that guides our spending habit. However, for the freelance and small biz owner where income is not consistent, where do you start. You might budget $400 for food, but $400 ends up being more than one fifth of your budget that month. So what do you do when your wages cannot be predicted on a weekly or monthly basis?
- Project: For people with non consistent income a budget is even more helpful because it helps you level your high earning days with your low earning days. , it is best to start by honestly estimating what your annual income will be based on projected or past demand. If the amount you project is not enough to meet your living needs then a part time job might be needed till your business or freelance job is able to fully support you.
- Be thrifty: In the first few years when your business is still striving to break even, it will be best to be thrifty about what you spend. Being thrifty frees you up to spend time promoting yourself while spending less.
- Income smoothing: save the extra in months when you make more than needed
- Using all the above techniques, income and expenses can be moderated throughout the year.
There are many complex forces that could affect a market but the one I will like to focus on in this blog is the market structure and how it affects you as a producer.
In economics, a market structure describes the varying level of competition i.e. how much power each firm in an industry has. There are many forms a market structure can take but the most common are:
- Too much competition aka perfect competition: This market structure barely exists in real life. In perfect competition everybody in the market sells exactly the same type of product. In other words in a market for pens, everybody sells a blue pen with exactly the same design. So as a producer in a perfect competition, you possess no power and are at the mercy of the market. If you try and set your price above what everyone else is selling, no one will buy from you. And if you set your price below what everyone is selling you will make a loss and eventually go out of business.
- No competition aka as monopoly: This market structure is not very common but does exist. In this market structure you are the only one who produces your product in your market. No one else produces a close substitute. Normally this structure exists because someone has a very advanced technology which only they can use because of a patent or because it is more efficient for one company to produce that product because of the high cost of having more than one company doing it. An example of where it is efficient for only one company to produce a product will be electricity. CWLP has a monopoly on producing electricity for Springfield residence. If someone else should come in and try to compete it will be too expensive and not worth their time. Another example of a monopoly was Microsoft. For a long time Microsoft had virtually a monopoly in the software applications market. They were able to charge ridiculous prices because customers did not have much choice. They were effective in keeping other software makers from effectively competing with them. Microsoft had a lot of power in the market. So they were able to set prices at levels that were very profitable for them.
- Little competition aka oligopoly: In an oligopoly there are very few sellers selling the same product. Each seller has enough power to affect the price of the product. A very good example of this is the airline industry. Because of the expense one would have to incur in setting up an airline, not too many people start airline business. Each company or producer in the market has a lot of power which can lead to price war. A price war means that if I am American Airline charges $250 from Springfield to DC then United will immediately match the price of $250 and divert some of American’s customers to them. Because of price wars producers in an oligopoly hate to compete on price. So they focus on differentiating their products. American airlines say we will give u more leg room. Southwest says we will get you there on time cheaply.
- Too much competition but variation in products aka monopolistic competition: The last market structure I will like to talk about is monopolistic competition. This market structure is the most common in real life. In a monopolistic competition, your power to affect the price of the product in your market depends on how well you can differentiate your product. Which is very different from monopoly where you have to focus on telling people they need your product? In a monopolistic competition, everybody in the market sells similar product but they are differentiated. For example, I can sell red pens and someone else sells blue pens. Or I sell snowman cookies and someone else sells sunshine cookies. Each difference appeals to different customer taste. If I am in a market where people prefer the sunshine, then probability is I can charge them more for my sunshine cookies. This concept is known as perceived value. Perceived value is when I charge consumers a certain price for a product because of the value or sentiments they have attached to it. Perceived value is very different from actual value because where actual value focuses on how much it costs me to produce a certain product, perceived value focuses on how much will my consumers be willing to pay. In monopolistic competition, producers try to increase perceived value by adding sentiments, extra services or condiments to their product. For example Straw cereal, is a different concept. Use your straw to drink your milk and then eat your straw. You always have to think differently to succeed in this market. There are 2 ways you can compete in a market with many sellers:
- Cost Leadership: That is you choose to compete based on price. Example Wal-Mart.
- Differentiation: You think of very creative ways to make your product different.
So now that we know about market structures, how should that affect you?
- Well for one it can affect the product you choose to sell.
- You may choose to innovate a product people are willing to pay for but no one else produces. Here you have the most power because if it is a product people really want, they will pay what you are asking for it.
- Or you may choose a product that only few other people produce but highly differentiate yours to drive consumers to you (oligopoly).
- Or if you choose to compete with everyone else, be sure to develop a strategy to differentiate yourself or become the cost leader.
So now let us talk about how to set prices:
How do you know how to set the price of your product?
Well, price setting has a lot to do with your market structure
- Know your cost: Try not to set the price below your cost because u will eventually go out of business
- Know the perceived value of your product: This information is based on how much power you have in the market as we discussed earlier.
- Price your product based on perceived value but not below cost.
Ways you can increase value:
- Branding: Make a catchy name that everybody will catch on to
- Packaging: Using more attractive packaging for your product
- Deals: Do a buy one get one free. Even though buyers will theoretically be paying the same for the product, no one wants to pass up a free deal
- Offer coupons for next purchase: that way people are willing to come back to your store.
As a seller with a lot of competition you always have to think of creative way of increasing your market share.
Here are a couple of questions I will like to leave you with:
What kind of competitor are you in the market?
So what should you do differently to increase your power in the marketplace?
Ever tried to launch a new period and was faced with the decision to price it. It sounds insane to buy a product for $10 and sell for $11 but yet a lot of businesses engage in this practice because they have no idea how much it truly costs to bring the product to market. This is why cost management is important. Most often the indirect costs of launching a product are often ignored and not apportioned to the total cost. This is why sometimes it seems like you should be making a lot of money but yet the bottom line never shows it. A budget could help you think through all the possible scenarios you will need to successfully launch your product. A budget does not have to be long and tedious as long as it is relevant to the tasks at hand. While developing your budget do not be afraid to ask the difficult questions like what will happen if my most optimistic sales do not occur. In circumstance where fixed costs are high, honestly answering this question is very important as you will need a minimum amount of sales to break even.
When starting out and testing the market try to keep as much of your expenses variable and do not forget to contact an expert to see how different scenarios could affect the taxes you will owe. Taxes are one of the biggest expenses that erode profit and with proper planning you could maximize profits and minimize taxes.
As business owners we are often bugged down with the everyday tasks to keep our business afloat. Rarely do we stop to do a big picture review of where we want to go. A business that never stops to think is a business that will be go where ever the wind blows. A budget is one of the tools a business owner can use to tell its business where he/ she will like their business to go. A budget gives direction, purpose and the means in which goals can be achieved. Long term planning and budgeting will allow a business to rise ahead its current circumstance and succeed even when similar business are failing.
The information derived from all the previous steps is used in creating a budgeted income statement.