Study Notes

Methods of Improving Profit

Level:: A-Level, GCSE

Board:: AQA, Edexcel, IB, OCR

Last updated 22 Mar 2021

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There are several ways in which a business can seek to improve its profitability.

A business should always be looking to improve the returns that it makes. This can both in:

Absolute terms (i.e. increase the total profit), and
Relative terms (i.e. the profit margin or return on capital)

Let’s look at each option in a little more detail to see what the challenges are:

(1) Increase the quantity sold (higher sales volume)

Why?	Higher sales volumes = higher sales, assuming that the selling price is not lowered Makes better use of production capacity (i.e. fixed costs should not rise) May result in higher market share
Will it work?	Depends on elasticity of demand Sales value may actually fall if price has to be reduced to achieve higher sales volumes Does business have capacity to sell more?
Why it might not work	Competitors are likely to respond Marketing efforts may fail – e.g. promotional campaign does not generate results Fixed costs might actually rise – e.g. higher marketing

(2) Increase the selling price (higher price per unit sold)

Why?	Higher selling price = higher sales (assuming quantity sold does not fall in response) Maximises value extracted from customers Customers may perceive product as higher quality No need for extra production capacity
Will it work?	Depends on price elasticity of demand Sales value may actually fall price rise is matched by an even bigger fall in quantity sold It will work if customers remain loyal and still perceive product to be good value
Why it might not work	Competitors are likely to respond (e.g. prices lower) Customers may decide to switch to competitors

(3) Reduce variable costs per unit

Why?	Increase the value added per unit sold Higher profit margin on each item produced and sold Customers do not notice a change in price
Will it work?	Yes, if suppliers can be persuaded to offer better prices Yes, if quality can be improved through lower wastage Yes, if operations can be organised more efficiently
Why it might not work	Lower input costs might mean lower quality inputs – which can lead to greater wastage Customers may notice a decrease in product quality

(4) Increase output

Why?	Provides greater quantity of product to be sold Enables business to maximise share of market demand Spreads fixed costs over a greater number of units
Will it work?	Yes, if the extra output can be sold (e.g. finding a new market, offering a lower price for a more basic product) Yes, if the business has spare capacity
Why it might not work	A dangerous option – what if the demand is not there? Fixed costs might actually rise (e.g. stepped fixed costs) Production quality might be compromised (lowered) in the rush to produce more

(5) Reduce fixed costs

Why?	A drop in fixed costs translates directly into higher profits Reduces the break-even output Often substantial savings to be made by cutting unnecessary overheads
Will it work?	Yes, provided costs cut don’t affect quality, customer service or output A business can nearly always find savings in overheads
Why it might not work	Might reduce ability of business to increase sales Intangible costs – e.g. lower morale after making redundancies

As you can see, each of the above approaches has its advantages and disadvantages. A business will often try more than one of the above approaches at the same time in order to increase profit.

There are some other more complex approaches that can be taken. You don’t need to know these in detail, but here is a summary:

Reduce product range