You did $750,000 in revenue last year. You should have taken home $150,000 to $200,000. Instead, you took home $75,000. Where did the other half go?
Most service business owners can’t accurately state their profit margin. They know revenue because that’s easy to track. The number at the top of the P&L statement gets celebrated. But margins stay fuzzy. The pattern repeats constantly. Revenue grows 20 percent year over year, but profit only grows 5 percent. Something is eating the difference, and most owners can’t identify what.
There’s a phenomenon called cost creep where expenses slowly increase as revenue grows. It’s like dinner plates getting bigger as the food budget increases. A business hits $500,000 in revenue with $75,000 in annual fixed costs. Three years later at $750,000 in revenue, fixed costs are somehow $140,000. Nobody approved a massive expense increase. It just happened gradually, one subscription renewal at a time, one vendor price increase at a time, one decision at a time.
Calculate Your Profit Margin Right Now
Here’s the math most business owners never do. Take your annual revenue. Subtract all costs. That means payroll, rent, materials, subscriptions, insurance, everything. Divide what’s left by your revenue. Multiply by 100. That percentage is your actual profit margin.
For service businesses doing $250,000 to $3 million annually, that number should be 15 to 25 percent. If yours is under 10 percent, you have a profit problem. If it’s under 5 percent, you have a crisis disguised as a business.
You’re not losing money to market conditions or competition or economic factors you can’t control. You’re losing it to expenses you forgot you had, vendors who raised prices without you noticing, and costs that made sense two years ago but don’t serve you today. The profit is there. You’re just spending it before it reaches your pocket.
The Hidden Profit Solution
What if you could improve your profit margins by 10 to 20 percentage points without generating a single additional lead, closing one more sale, or working longer hours? That’s not theoretical. It’s the predictable result of systematically eliminating costs that don’t serve your business growth.
Profit margin is the percentage of revenue that becomes profit after all costs. A business doing $500,000 in revenue with a 20 percent profit margin makes $100,000 in profit. That same business with a 10 percent profit margin makes $50,000. Same revenue, half the profit. The difference isn’t in how much you sell. It’s in how much you keep.
Why This Matters More Than Revenue
A pattern emerges across service businesses. They chase revenue growth believing more sales solve profit problems. Revenue climbs from $500,000 to $750,000. Profit barely moves because costs grew at the same rate as revenue. The business is busier, the team is larger, the owner works more hours, but profit remains stagnant. More revenue doesn’t fix a margin problem. Better margins fix a margin problem.
What’s a Good Profit Margin?
Industry benchmarks for service businesses show typical profit margins range from 10 to 20 percent. Margins above 25 percent indicate excellent cost management and pricing strategy. Margins below 10 percent signal serious problems requiring immediate attention.
The specific industry matters significantly. Professional services like consulting and accounting typically run 20 to 30 percent margins because overhead is relatively low compared to revenue. Trade services like HVAC, plumbing, and electrical typically run 10 to 20 percent margins because materials and direct labor costs are higher. Healthcare services like dental and chiropractic practices typically run 15 to 25 percent margins depending on staffing models. Construction services typically run 5 to 15 percent margins because material costs and subcontractor expenses are substantial.
If you’re under 10 percent in any of these industries, profit improvement should be your only focus until that changes. Nothing else matters if you’re not keeping enough of what you earn.
Calculate Your Current Profit Margin
Use this simple three-step process. First, take your total revenue for the last 12 months. Second, subtract all expenses for those same 12 months including payroll, rent, materials, insurance, software, everything. Third, divide the result by your total revenue and multiply by 100.
Example: $600,000 revenue minus $510,000 total expenses equals $90,000 profit. Divide $90,000 by $600,000 equals 0.15. Multiply by 100 equals 15 percent profit margin.
If your margin is under 10 percent, you need to cut $30,000 to $60,000 in annual expenses or raise prices strategically. If your margin is 10 to 15 percent, you’re in the typical range but leaving significant profit on the table. If your margin is 15 to 20 percent, you’re doing well but could still improve. If your margin is above 20 percent, you’re managing costs effectively.
The Three Levers of Profit Margin Improvement
Improving profit margins comes down to three levers you can pull. The first lever is cost reduction, which means eliminating expenses that don’t drive customer acquisition, retention, or lifetime value. The second lever is pricing optimization, which means charging appropriately for the value you deliver. The third lever is revenue efficiency, which means focusing on high-margin services and clients while reducing or eliminating low-margin work.
Most business owners only think about the third lever, pursuing more revenue. They completely ignore the first two levers even though cost reduction and pricing optimization often produce faster profit improvement than revenue growth.
An HVAC company doing $850,000 annually had 8 percent profit margins. They implemented a systematic cost review using the approach outlined here. Six months later, margins improved to 18 percent without losing a single employee, cutting service quality, or raising prices. The difference came from eliminating $7,000 per month in expenses that weren’t helping them obtain customers, retain customers, or increase customer value. That $84,000 annually dropped straight to profit.
The 5 Factors That Affect Your Profit Margin
Before diving into the cost elimination process, understand what actually determines your profit margin. Five factors account for virtually all margin variation across service businesses.
Factor 1: Pricing Strategy How you price services relative to costs and market positioning. Underpricing is the fastest way to destroy margins. Many service businesses price based on what competitors charge rather than what their actual costs require plus desired profit. This guarantees mediocre margins at best.
Factor 2: Fixed Cost Management Your recurring monthly expenses regardless of sales volume. Rent, salaries, insurance, software subscriptions, utilities. These should stay relatively stable as revenue grows. When fixed costs grow faster than revenue, margins compress rapidly.
Factor 3: Variable Cost Efficiency Costs that change based on volume. Materials, subcontractors, direct labor for specific projects, commissions. How efficiently you manage these per-unit costs directly impacts margins. A 10 percent reduction in variable costs often translates to several percentage points of margin improvement.
Factor 4: Revenue Mix Not all services are equally profitable. Some have 40 percent margins, others have 5 percent margins. Your overall margin reflects the mix. Businesses that shift toward higher-margin services see dramatic margin improvement without changing pricing or cutting costs.
Factor 5: Operational Efficiency How much time and resources you consume delivering services. Inefficient processes, rework, project delays, and poor resource allocation all eat profit. Businesses with documented systems and trained teams consistently achieve better margins than those operating reactively.
Understanding these five factors helps you identify where your specific margin problems originate. Most businesses have opportunities in all five areas, but one or two factors typically account for most of the margin gap.
The 3-Question Cost Filter for Profit Margin Improvement
Improving profit margins requires a systematic approach to evaluating every expense in your business. The Three-Question Cost Filter provides that system. It’s not about deprivation or cutting corners. It’s about strategic resource allocation. Every dollar you spend should serve one of three purposes. If an expense doesn’t pass this filter, it gets eliminated or renegotiated.
The 3-Question Cost Filter
Before paying any recurring expense, ask three questions about that cost.
Question 1: Does this expense help me obtain customers? If the cost directly contributes to lead generation, brand awareness, or client acquisition, it passes the first test. Marketing spend, website hosting, CRM software, networking memberships fall here. But be honest. That premium analytics tool you look at twice a year doesn’t help you obtain customers. The industry magazine subscription you don’t read doesn’t help you obtain customers.
Question 2: Does this expense help me retain customers? If the cost improves customer experience, service delivery quality, or client relationship management, it serves retention. Project management software that keeps clients informed passes. The fancy office furniture clients never see doesn’t. Customer service training for your team passes. The executive coaching program you haven’t attended in six months doesn’t.
Question 3: Does this expense increase customer lifetime value? If the cost enables upsells, cross-sells, or repeat purchases, it impacts lifetime value. Tools that help you deliver premium services pass. Equipment that expands service offerings passes. The software upgrade with features nobody uses doesn’t.
The Critical Rule: If an expense doesn’t clearly answer yes to at least one question, it gets cut immediately or renegotiated to a lower cost. No exceptions. No justifications about how it might be useful someday. If it doesn’t serve customer acquisition, retention, or lifetime value, it doesn’t serve profit.
Step 1: Identify Your Fixed Cost Creep
Fixed costs are regular, expected monthly expenses regardless of sales volume. Rent, payroll, insurance, software subscriptions, utilities, equipment leases. These costs should stay relatively stable as revenue grows, but they rarely do.
Fixed costs tend to unnecessarily increase as revenue increases. A business hits $500,000 in annual revenue with $6,000 monthly overhead. Revenue grows to $750,000 over three years. Monthly overhead somehow climbed to $11,500. Nobody approved a 90 percent cost increase. It happened through small incremental decisions. A subscription upgrade here. A new software tool there. A vendor price increase accepted without negotiation.
Pull your bank statements, credit card statements, and P&L reports for the last 6 to 12 months. List every recurring monthly expense. Calculate total fixed costs per month. Now compare that total to what it was 12 months ago, then 24 months ago. The difference is your cost creep. For most service businesses, that number is shocking.
What to look for specifically: software subscriptions you forgot you had, tools purchased for a specific project but never cancelled, price increases you accepted automatically, services that made sense at lower revenue but aren’t necessary now, equipment leases you could renegotiate, insurance policies you haven’t shopped in three years.
Step 2: Apply the 3-Question Filter to Every Fixed Expense
Take your complete list of fixed costs. Go through each one and honestly answer the three questions. Does this help me obtain customers? Does this help me retain customers? Does this increase customer lifetime value?
Common failures include the premium office space in an expensive building when clients never visit your office. Fails all three questions. The industry association membership you joined three years ago and attend one event annually. Fails all three questions. The upgraded software features nobody on your team actually uses. Fails all three questions. The subscription services that duplicate functionality you already have elsewhere. Fails all three questions.
What passes the filter: CRM software that tracks leads and automates follow-up passes Question 1 for obtaining customers. Project management tools that keep clients informed and prevent service failures pass Question 2 for retaining customers. Training programs that enable your team to deliver premium services pass Question 3 for increasing lifetime value.
Some expenses feel important but don’t pass the filter. That expensive industry conference you enjoy but generates zero leads or client relationships. The premium business insurance coverage levels beyond what your contracts actually require. The consultants you hired months ago whose recommendations you never implemented. These feel like investments, but they’re not serving customer acquisition, retention, or lifetime value. They’re serving comfort or habit or status.
Everything that fails the three-question test gets one of three actions. Cancel it immediately if it’s pure waste. Renegotiate it to a lower price if it has some value but you’re overpaying. Replace it with a cheaper alternative if the function is needed but the current cost is unjustified.
Step 3: Optimize Your Variable Costs
Variable costs change based on your production or service delivery volume. Materials for projects, subcontractor labor, direct employee labor on specific jobs, sales commissions, shipping and delivery. These costs scale with revenue, but that doesn’t mean they’re optimized.
Materials and Supplies: Can you negotiate bulk purchasing discounts with suppliers? Many vendors offer 10 to 20 percent discounts for larger orders or annual commitments. The question becomes whether the carrying costs of inventory offset the savings. For high-use materials with stable shelf life, bulk purchasing usually improves margins. For specialized materials used infrequently, it doesn’t.
Are there alternative material sources with better pricing? Business owners often stick with the same suppliers for years without checking competitive pricing. Periodically shopping your materials costs can reveal significant savings opportunities. Even a 5 percent reduction in material costs can improve overall margins by 2 to 3 percentage points for businesses with high material expenses.
Subcontractor and Labor Costs: Are you paying competitive rates for subcontract labor? If using subcontractors extensively, regularly verify you’re getting market rates. Subcontractors who haven’t adjusted pricing in years might be undercharging, but those who raised prices annually might be overcharging compared to alternatives.
Should you use employees instead of subcontractors or vice versa? This decision impacts both costs and flexibility. Employees create fixed costs through salaries and benefits but typically cost less per hour than subcontractors. Subcontractors are variable costs you only pay when needed but charge premium hourly rates. The right choice depends on demand consistency and volume.
Are you paying overtime when adding workers would cost less? A pattern emerges where businesses rely on existing staff working 50 to 60 hour weeks rather than hiring additional team members. If overtime is consistent rather than occasional, the math often favors hiring. Overtime at time-and-a-half costs more than straight-time for new hires, plus exhausted employees make more mistakes which impacts quality and rework costs.
Commission and Performance Costs: Are commission structures still aligned with profit goals? Commission plans created years ago might incentivize wrong behaviors. If commissions are paid on revenue rather than profit, salespeople might chase low-margin work. Restructuring commissions to reward profitable sales rather than just volume can shift margins significantly.
Variable cost optimization requires different thinking than fixed cost elimination. You can’t eliminate variable costs without reducing revenue. But you can make each dollar of variable cost more efficient, which directly improves profit margins even as revenue grows.
Step 4: Understand Margin vs. Markup (And Why It Matters)
One reason business owners struggle with profit margins is confusing margin with markup. They’re not the same thing, and mixing them up costs money.
Profit margin is the percentage of the selling price that’s profit. If you sell a service for $100 and your costs are $70, your profit is $30. Your margin is 30 percent, calculated by dividing $30 profit by $100 price.
Markup is the percentage added to your costs. Using the same example, your costs are $70 and your profit is $30. Your markup is 43 percent, calculated by dividing $30 profit by $70 cost.
A 50 percent margin is not a 50 percent markup. A 50 percent margin means half the price is profit, half is cost. To achieve a 50 percent margin, you need a 100 percent markup, which means doubling your costs. Business owners who think they mark everything up 30 percent often have margins far below 30 percent because they’re confusing the two calculations.
If you want a 40 percent profit margin, you need approximately a 67 percent markup. If you want a 30 percent margin, you need approximately a 43 percent markup. If you want a 25 percent margin, you need approximately a 33 percent markup. The confusion leads to underpricing which directly impacts profit margins.
A contractor who wants a 25 percent margin but only adds 25 percent markup to their costs actually achieves a 20 percent margin. That 5 percentage point difference on $500,000 in revenue is $25,000 in lost profit annually. Multiply that over several years and the confusion becomes extremely expensive.
Calculate Your Hidden Profit Opportunity
You can’t grow your way out of a margin problem. Revenue growth with stagnant margins means working harder for the same profit. The math doesn’t work. A business doing $750,000 at 10 percent margins makes $75,000 profit. Growing to $1 million at the same 10 percent margins makes $100,000 profit. That’s 33 percent more revenue for 33 percent more profit, which requires significantly more work, team size, and complexity.
But improving margins from 10 percent to 20 percent at current revenue makes $150,000 profit. That’s double the profit without a single new customer, without expanding the team, without working longer hours. The entire profit improvement comes from keeping more of what you already earn.
Cost creep happens to every growing business. Expenses increase gradually without justification. Software subscriptions accumulate. Vendor prices increase without pushback. Services purchased for specific projects become permanent fixed costs. The difference between a 12 percent margin and a 22 percent margin for a $500,000 business is $50,000 annually. That’s not small money. That’s the difference between financial stress and financial breathing room.
February is when businesses review fourth quarter financials and prepare taxes. This is your window to fix margin problems before they compound for another year. You’ll see exactly what you made, what you spent, and what’s left. Use that clarity to make different decisions.
Find Your Hidden Profit
I’m currently interviewing service business owners for the second edition of Profit Foundation, my book on profit strategies for small businesses. During these 45-minute conversations, I walk through the Three-Question Cost Filter with your actual expenses and identify exactly where profit is hiding in your business.
It’s a research conversation, not a sales pitch. I’m gathering insights for the book while sharing what I’m learning about profit margin improvement across different industries. Most business owners walk away with two to three specific cost categories to eliminate or renegotiate in the next 30 days that typically save $15,000 to $30,000 annually.
If you’d like to participate and receive a free copy of the book when it’s published in 2026, you can schedule here: https://mediaaceadvisors.com/contact/
There’s no cost and no sales pitch. These are real research conversations. I’ll analyze your cost structure using the Three-Question Filter, you’ll see where profit is leaking, and I’ll get insights for the book. The February slots are filling up as business owners prepare tax returns and see their actual margins for 2024, so if this interests you, schedule before the end of the month.
Stop chasing more revenue. Start keeping more profit from the revenue you already have.
About the Author: I’m Ryan Herrst with Media Ace Advisors. I help service business owners with annual revenue between $250,000 and $3 million identify hidden profit opportunities and create clear pathways to growth. My approach focuses on systematic improvements across all seven profit levers, with special emphasis on cost management strategies that improve profit margins by 10 to 20 percentage points without increasing marketing spend or working longer hours.