Stop Thinking of Capacity as a Ceiling and Turn It into Your Foundation for Growth
Are you surprised by your capacity? Do you even know what it is? And if you did know it, how would you use that knowledge?
If this business attained that $100K every month it would add $300K in revenue every year. That’s a 33% increase in revenues. What business wouldn’t like a 33% revenue increase in one year?
I think there are two important ways to look at capacity:
- What is your business’s maximum capacity? Why is that the maximum?
- What can you do to grow revenues when you’ve reached your capacity? How can you think of capacity as a floor rather than a ceiling?
Knowing your maximum capacity
The factors that constitute capacity include:
Physical space: retail or consumer businesses such as restaurants, automotive services, bricks and mortar stores; schools; manufacturing (heavy industry and also light industries such as food production, garden shops, bicycle shops)
Time: 1) when your business is based on selling units of time, your capacity is the combined amount of time people work; 2) operating hours
Personnel: your capacity is determined by the quality of personnel and the amount of work any level of staffing can produce.
In many businesses capacity is a combination of these factors. The capacity of the case study business mentioned at the start is bounded by its physical space, its operating hours and the quantity and quality of work of the staff.
To grow your revenue you must know your current capacity. Before you start thinking about revenue growth you need to know what the business as it is now constituted has the capacity to reach. There’s no sense setting a revenue goal that is impossible given the current maximum. Or to set a goal so low that it doesn’t make use of the capacity you already have.
Once you know your maximum capacity, what next? That creates two growth paths. They are not exclusive and they are not parallel. They work in concert with each other.
Path #1 is to reach full capacity. This means more sales to maximize use of the capacity
Path #2 is to determine how to grow revenue within the parameters of your capacity. You use capacity as a floor, not as a ceiling.
In our case study business, the owner and I looked closely at what sales and work took place during that $100K month. He saw that there were several projects that were larger than usual. The difficulty of the projects and the use of high-cost parts led to higher sales. Also, there were more customers than usual, keeping everyone busy more of the time, which increased revenue.
When we looked at these details we concluded that 1) there is clearly unused capacity and 2) that higher revenues did not translate into proportionally higher profits because the high costs of parts and the labor intensity offset the revenue.
Getting a clear picture of the capacity will help this business take steps to keep capacity utilized (path #1) and help them create new revenue streams with higher profit margins (path #2).
Capacity limited by time
The revenue of too many businesses is generated based on units of time. There are professional firms that do this (lawyers, consultants, CPAs, financial, medical practices, freelancers) and there are hundreds of government contractors who are required to submit bids based on hourly labor costs. Many services businesses also price their services based on labor costs (e.g., salons, automotive, child care).
In every case, the business creates an artificial maximum capacity because there are only so many hours in a business day and week and there’s a limit to how much you can charge buyers for an hour of work. Time has no intrinsic value unless it is used precisely, such as on a manufacturing line.
Our case study business use hourly labor rates as part of its revenue. When we began to talk about increasing high-profit margin revenue, we agreed that increasing labor rates was not a smart move because customers can’t differentiate and ascribe value to the work in that way. However, the business could better manage use of their labor combined with smarter use of their physical space to increase revenue. They could increase high-profit margin revenue by creating offerings that aren’t dependent on time.
Capacity limited by personnel
One of the most egregious mistakes companies make is reducing the number and quality of their personnel to simply add dollars to their bottom line. Personnel costs are deducted from revenue so reducing the amount you’re spending on personnel gives you a quick boost to your bottom line. This is a terrible, false economy that hurts your business competitively. The more qualified your personnel are, the more they can produce and the better the quality of their output. Highly qualified personnel can be the biggest contributor to high-profit-margin revenue.
Our case study business depends heavily on their front line staff. Yet the thinking has always been that the front line position should be filled by a low-wage, minimal-skills person. When you have a minimal-skills person, you get a minimal-skills person’s contribution. Part of this business’ plan to generate higher profit-margin business required a more highly skilled front line person. In just weeks, that expenditure has returned substantial value: better use of the physical capacity, more organization and less confusion, and better customer service to customers who already gave their customer service high marks. There’s been an uptick in repeat business and referrals. In a fairly short period of time, more of their capacity is being used.
Capacity limited by physical space
Space is a significant component of a business’s fixed costs. It is also much harder to adjust than either time or personnel. Therefore it is especially important to know how your space affects your current capacity and what you can do to increase revenues and profit margins once your capacity is filled.
The importance of physical space is obvious in retail or consumer businesses, as well as for any tangible item that is produced. If you don’t have enough room to show your products or for your people to produce or provide your services, you will limit your revenue unless you can generate revenue unrelated to the use of space.
Physical space as a parameter is less obvious in businesses whose products and services are primarily knowledge work. People need enough space to think, meet, and communicate with customers. Enough space is also how you generate high-profit-margin revenue. How effectively can your people provide intellectual property that is in demand and generates high profit margins when they are cramped together in shared spaces or cube farms, or have no office space at all? Your best clients will not be impressed by someone who regularly talks to them from coffee shops or on trains, cars and planes.
Our case study business is constrained by physical space. Once we analyzed the business in relationship to their space (how many customers could be served at any given time in the space) we were able to create a plan to maximize the use of the space. This is in two forms: the kind of work done in the space and the length of time it takes to do the work.
In order to meet the revenue goal and increase profit margins, this company has to offer some services that aren’t dependent on their space. They created several high-level packages that utilize other vendors as partners, with this business being responsible for deploying those vendors on behalf of their customers.
Capacity as a Floor from Which you Grow
With respect to all three components of capacity—time, personnel, physical space—you can set these as floors and turn to creative, innovative and imaginative offerings that aren’t limited by them. Most importantly, focus on your best customers and clients, not your average ones. The best customers are where the opportunities for high-profit-margin revenue lie.
Look at each component individually and make a short list (5 items) of how your business uses them. Next to each item, write down something more, beyond, innovative, unconstrained by the component. What can you offer that has high value to the buyer and doesn’t take much time or space? What can you offer that has high value and can be delivered by a highly qualified person? Think about the value you will provide to your best customers. Some examples of high value to top level customers are speed, convenience and uniqueness or rarity. Do not underestimate the contribution to these buyer’s prestige, ego and reputation.
You can increase your profit margins by using your capacity as a floor from which to grow your business if you are willing to shelve past habits and thinking, recognize that growth requires change, and enjoy taking prudent risks for high returns. Isn’t it time to decide the sky is the only limit?