Low vs. High Margin Businesses: Which Is Right for You?

Small entrepreneurial businesses can be broken into two categories: Low-margin businesses and high-margin businesses.

You can analyze your best and most efficient path to attain your goals and choose your next business with greater understanding. Often, the primary difference is in the DNA of the business model itself and is readily apparent to any business analyst, but many entrepreneurs ignore any analysis and go for their passion or convenience.

People go into low margin businesses because they love the type of work, or because they unexpectedly fell into it or because they followed in the footsteps of someone they admired, usually without consideration of the financial consequences.

Example Low Margin Businesses

• All types of home building contractors and sub-contractors, including all small plumbers, electricians, painters, flooring installers, framers, concrete finishers, tile installers, landscapers, blacktop companies too small for government jobs, etc.
• Small one-location eateries of all types – less than 150 seating
• Small private schools: Under 500 students enrolled on all levels of education, unless government funded
• Small doctor’s offices, in small towns with a low volume of patients
• Small (one-of-a-kind) retail stores that charge reasonable prices, but not enough to pay the rent
• Small used car lots, in fact, used-anything lots
• Small hardware stores, and small retail stores

Yet, exemptions to this rule abound! Times change, market size changes, the needs and desires of people change, and administrative and “tax” costs – in the broadest sense -- continue to rise without an accurate way to gauge them.

One thing is for sure: If you choose to engage in a low margin business your path to financial success (and longevity) will be more challenging than if you choose a high margin business. To put it another way, it’s just easier to succeed if you select a high margin business to pursue.

Example High Margin Businesses

• The easiest way to make a gazillion dollars is to come up with an app for your smart phone that you seriously NEED. It’s not simple, but it’s easier than laying tile or mowing lawns.
• Some individual high volume franchises: McDonald’s, Starbucks, etc. are real gold mines. If anyone you know owns one, go to work for them and, when they get old, offer to buy them out.
• Get a law degree and take the bar: Big city lawyers work long hours at high rates, like $600 per hour PLUS a percentage of your winnings. PLUS you get the first pick at a lot of opportunities as you watch other people go under, or start up something with real potential.
• Hedge funds: You’d be surprised at how easy it is to start a hedge fund. If you have investors ready to go, and you’re up for the ultimate challenge, you can make it happen, with the right law firms.
• Real estate developments that own the land your home sits on. If you control the maintenance fees, you’re set for life with just one property.
• Condo management companies who can charge cost-plus and adjust their prices annually without resistance.
• Jewelers – even small time / small town jewelers. Their mark-up is so sweet it’s hard to fail at this, even with one small shop in a small town, if you can develop a clientele. Parlay this into three large stores in a major metropolitan area and you’re set for life, and so are your grandchildren.
• Realtors, even small ones who still get a percentage of the deal as commission and still get first opportunity to buy up the good stuff cheap, before anyone else even sees it. This is a GREAT career for someone who loves interaction with people, driving them around and making conversation. They usually end up rich, one way or another.

Most of today’s new entrepreneurs ignore the difference between high margin (HM) and low margin (LM) businesses when they start their first business.

Today’s entrepreneurs are attracted to the freedom to pursue their passion as a primary reason to start their own business. Second is their desire for the freedom to control their own schedule. Taking third place is the desire to make more money than working for someone else. And, lastly, in fourth place is the desire for an extraordinarily high monetary reward. From what we have seen since 1981 at HBS, most people starting a business want to do what they want, on their own time, that allows them to live well, as compared to working for someone else, IF they can make more money doing it.

Does that describe you? If so, there is a strong chance you’ll be going entrepreneurial some time in your future on your path to your ultimate success.

I can’t prove it, but I’m betting there is an “entrepreneurial gene” that is a part of the makeup of a good percentage of the people of all cultures and countries. Individuals who desire to start a business will start a business because the gene is there. The decision as to what kind of business to start, and especially the analysis of the potential margin of the endeavor may determine how successful a person becomes, but is too seldom considered beforehand.

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