How to Use Salary Caps to Sustainably Scale Your Small Business
When small businesses are making the transition to medium-sized businesses, it’s possible to fall into a dangerous feedback loop of borrowing and spending. As you scale your business, your costs grow, and it’s tempting to see breaking even—your previous measure of success—as sufficiently safe growth.
However, medium-sized businesses have vastly larger costs, and can’t afford the breakneck growth speed that smaller, more agile operations can attain. As your costs grow, it’s important to retain control over those which you have the power to influence—and the biggest of these is labor costs.
Avoiding a labor cost feedback loop
One of the best ways to rein in ballooning labor costs is by introducing a salary cap that protects 10% profits. A simple calculation can help you determine the total labor costs allowable with your current revenues.
So if you have 1 million in revenues, then your aim is for at least 100,000 in profits (.1×1,000,000). Now simply subtract all of your non-labour costs from 900,000, and you’re left with your firm’s total salary cap.
Creating room for growth
Once you have your salary cap based on 10% profits and are reliably achieving those numbers, you can sustainably grow by aiming to enhance profits to 15%. Simply recalculate your salary cap to accommodate 15% of your total revenue in profits, and look for ways you can balance the equation by increasing productivity in your non-labor costs.
Once at 15%, you have a comfortable 5% profits to spend on increasing labor costs (through raises or hires), all while preserving that vital 10% profit margin. This is the best method of safely growing your business while always remaining profitable.
Making smart personnel investments to save on salaries
How can this work in practice? Take the NFL, where all teams operate under strict total salary caps. The New England Patriots, under Bill Belichick, won the Superbowl a disproportionate number of times between 2001 and 2009. How did they do it? Many prominent commentators put this down to Bill’s ability to get more for each dollar spent: by onboarding younger talent and investing in their future, for example. If Bill can do it, so can you!
Many small businesses stumble when forced to scale quickly. By forcing yourself to retain a 10% profit margin, you insulate yourself from costs and events beyond your control by always keeping a comfortable gap between yourself and a deficit.
Greg Crabtree and Beverly Blair Harzog provide a lot more insights about growing businesses in their book, Simple numbers, straight talk, big profits!. You can also read the book’s key insights on Blinkist – it’ll only take 15 minutes! You’ll also learn:
- why every business leader should pay themselves what they deserve;
- why you should never, ever go into debt; and
- why you should pay your staff like a winning NFL coach would.