Profit squeeze definition
/What is a Profit Squeeze?
A profit squeeze is a decline in earnings over a period of time. A profit squeeze can damage a firm severely, so management needs to anticipate its underlying causes and shift the business into a different market segment or geographic area, or adopt some other innovation that allows the firm to continue earning its accustomed profit. Otherwise, the organization will eventually fail or be acquired by some other party.
Causes of a Profit Squeeze
There are many reasons for a profit squeeze. Here are several possibilities for why it might be occurring:
Increased costs. A business could suffer from increased operating costs, increased financing costs, or increased taxes.
Increased competition. A business might be suffering from increased competition, leading to a decline in the prices at which it sells goods and services to customers.
Altered regulation. A business might be suffering from more burdensome regulatory oversight that requires more staff time.
Changes in consumer preferences. Customers may find that the company’s products are no longer appealing, and so begin to make purchases elsewhere, causing a decline in sales.
Profit Squeeze Examples
Here are several examples of how a profit squeeze can impact different types of businesses:
Rising input costs. A manufacturer of consumer electronics faces rising costs for raw materials like semiconductors and rare earth metals. If competitive pressures or customer sensitivity prevent the company from raising its product prices, profit margins shrink.
Labor cost increases. A retail chain experiences an increase in wages due to government-mandated minimum wage hikes. If the company cannot pass these costs on to customers through higher prices, its profitability suffers.
Supply chain disruptions. A furniture company relies on overseas suppliers for components. A sudden increase in shipping costs, combined with delays, forces the company to pay more for expedited logistics. It absorbs these costs to avoid losing customers but suffers a profit squeeze.
Price competition. A grocery store chain is in a competitive market where rival stores continuously lower their prices. To maintain market share, the chain reduces its prices but sacrifices profitability.
Declining demand. A luxury fashion brand sees a drop in consumer spending during a recession. Customers opt for less expensive alternatives, leaving the company with excess inventory and lower revenue without proportional cost reductions.
Regulatory costs. A pharmaceutical company faces increased regulatory compliance costs due to new government health and safety requirements. These additional costs reduce its net income unless it can find ways to offset them.
Currency fluctuations. An exporter sells products overseas and faces a strengthening domestic currency, making its goods more expensive for international buyers. To remain competitive, the company lowers prices in foreign markets, reducing its profit margins.
Energy price spikes. A chemical manufacturing company depends heavily on energy. A sudden increase in oil or natural gas prices raises production costs, squeezing profits unless the company can raise prices on its products.
Technology investments. A logistics firm invests heavily in new technology to improve efficiency but faces unexpectedly high implementation and training costs. While long-term savings are expected, short-term profitability is squeezed.
Changing consumer preferences. A fast-food chain with a menu dominated by high-calorie options experiences a shift in consumer preferences toward healthier food. It invests in new menu items, marketing, and training, all of which squeeze profits until the new offerings gain traction.
Increasing interest rates. A real estate company with significant debt faces rising interest rates, increasing the cost of servicing its loans. Without corresponding increases in rental income, its profit margins shrink.