The gain of changing production factors will reach a point where the marginal per unit output will start to decrease.

Here’s how my economics professor explained it: If you’re thirsty, drinking an ice-cold glass of water is very satisfying. Each additional glass of water thereafter is less satisfying and 10 glasses might even cause you to vomit. Sales volume works this way. In the beginning it can be a huge profit boost but eventually that return diminishes. 

Here are some things to keep in mind.

Don’t randomly grow.

Try to find your sweet spot. Most overhead items are fixed and it takes a certain volume to be competitive. However, uncontrolled growth can cause an increase in overhead and at some point, the competitive gains per unit stops. For example, suppose your rent is $1,500 a month equaling $18,000 a year. A rule of thumb is that every employee generates approximately 2,000 hours a year (40 hours per week by 50 weeks). Your rental cost per field hour looks something like this:

  • 5 employees =10,000 hours and $1.80 an hour for rent ($18,000 ÷ 10,000 hours)
  • 10 employees = 20,000 hours and $.90 an hour for rent ($18,000 ÷ 20,000 hours)
  • 20 employees = 40,000 hours and $.45 an hour for rent ($18,000 ÷ 40,000 hours)

From five to 20 employees the rental cost per hour dropped 75 percent. Note from five to 10 employees rental overhead decreased by 90 cents an hour but only 45 cents from 10 to 20 employees. The cost per hour decreases slower as billable hours increase. At some point, such growth will require fundamental overhead addition such as needing a bigger office or another project manager. When it comes to overhead you want to do as much volume as you can without increasing overhead or outgrowing your production capacity.

Production and the rubber band effect.

The more you stretch a rubber band, the more power you get. Stretch it too far and it breaks. Stretching your organization will maximize profits, but stretch it too far and it also breaks. Things begin to fall through the cracks and contracting is not very forgiving. A couple of bad jobs and you have a catastrophe. A couple of key managers leave and you have a crisis. You can only stretch your organization so far.

Everyone you add is a little worse than the one you had before.

Take a sheet of paper and list by name the people you would lay off first, second, etc. Now divide the list in half and I bet the list of people you’d keep is quite a bit more productive than the folks you’d get rid of. Rarely do you add new people who are as good as the better people you already have. This has a way of fixing itself over time as you weed the bad folks out, but can be painful and costly as you go through this process. 

Hurrying leads to mistakes.

My father-in-law was a construction superintendent and he kept this note above his desk. The “hurrier I go, the confusier I get.” More volume means more tasks. As people become busier the odds increase that they’ll make a mistake. A bad estimate or two can prove to be both financially and emotionally devastating. You already have more work than you can easily perform. Suddenly, you are tied up on work that’s losing money. When you hurry, it’s also easy to miss the tell-tale signs of a crazy customer or a complicated, dangerous job. I know a contractor who had a nice profitable business, was busy, but took a $600,000 job that never should have been taken. The customer was difficult, the conditions poor and the job complicated. It cost $1.2 million out-of-pocket to complete and they’re now struggling to survive. 

Sloppy expenses and buying habits can become a factor.

When you’re broke and have no work, you squeeze every dime. However, when you’re overloaded with work there’s a tendency to not control costs as well. Suddenly, no one is checking employee gas cards, you simply buy stuff and don’t try to get a better price, you pay overtime when it may not be effective or needed. Run a quarterly profit and loss. Make sure it’s accrual, not cash and select an option that shows each line item’s percentage of sales. If your raw labor cost was 25 percent of sales last year and 30 percent this year, that doesn’t seem like a lot but it’s a huge number. It’s now costing you 5 percent more to get the work done, which is a 20 percent increase in labor cost, not just 5 percent (5 percent increase divided by 25 percent equals 20 percent). Don’t quit looking at the numbers because you think everything is OK.

Finally, don’t let increases lull you into complacency. Business is unforgiving. Pay attention to the details and maximize your profits.