The Miracle of Compounding in Retail
The miracle of compounding in investments is a powerful phenomenon that happens when an investment sits over time in an instrument that yields interest. It grows as each year the interest earned is added to the principal.
For example, If you invest $100,000 at 5% over 5 years it is worth $127,628 after 5 years. The account has grown by 27.6%. This is sometimes thought of as a snowball effect. Initially it is small, but as it rolls downhill it gathers more snow and grows larger and faster. Time and achieving a specific interest rate over time are the two keys.
Compounding is not limited to just investments. It relates to knowledge, skills, and relationships. How often it is said, I only wish I knew then, what I know now.
For indie retailers the results can be the same, and frankly, quite astonishing…
For example, a million dollar business growing at 5% per year, after five years would be generating $1,276,281 in annual volume. The increase of $276,281 in sales is a 28% increase over the initial $1,000,000. This is an example where time matters.
The chart below illustrates what a year over year increase would yield at 5 ,6, and 7% going out five years.
Incremental change compounded in time yields significant results. It is easier to think about small increases, as it is more manageable, feels realistic, and the pressure to create larger increases reduces the stress. Additionally you are creating the cash necessary for incremental infrastructure expenses required to support a growing business. You are investing in yourself, unlike financial investments where your control is limited to the classifications you want to place.
In your business you are managing the risk daily, and have power over all the decisions. For me personally, I was more comfortable investing profits back into the business. I did, and still have a managed portfolio, but when I owned my business the majority of the profits stayed reinvested to cover growth.
Let's look at profit.
For example, if your break-even volume is $1,000,000 and your contribution margin is 32%, then the $276,281 increase in revenue will yield $88,400 in cash profit. The compounding effect would also apply here as in each year the cash profit will be 32% of the increase. That is assuming your contribution margin also remains consistent over time.
Looking at compounding as a strategy is a way to focus your energies and build a path for the long run. What do I need to achieve this year to achieve the desired increase, and to build the foundation for future increases?
Often the changes needed to achieve the desired increase need only be 1 or 2 focused strategies, and those can be carried forward into future years. Remember the compounding effect also relates to skills and relationships. Two key areas of retaining and building clients.
There are always many changes that can be made to improve revenue. You might want to start with a SWOT, Strengths, Weaknesses, Opportunities, and Threats, and filter those down to specific measurable Objectives. Focusing on people and products is a great place to start.
The merchandise plan is also a key to uncovering hidden opportunities. What classifications are growing, have a high efficiency and a strong cash margin? A deep dive with your retail expert could provide significant insights.
In your personal investments and in your business, which is part of your personal portfolio, the concept of compounding will deliver astonishing results.
Onwards and Upwards,
Marc
