Why a Service Business Under 80% Gross Margin Gets Stuck — Transcript

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1. 0:00Um, my name's Adam. I have a music
2. 0:02lessons and recording studio in Atlanta,
3. 0:04Georgia.
4. 0:05Um,
5. 0:07and your your content, you and Leila,
6. 0:09what you what you've done is profoundly
7. 0:12changed my life because you've uh put me
8. 0:15out of my comfort zone
9. 0:16in how I think.
10. 0:18And so,
11. 0:20I sell music lessons to neurodivergent
12. 0:23kids between 8 and 18. We have a half
13. 0:25million dollars of revenue.
14. 0:26>> Awesome.
15. 0:26>> I think we could be at two million
16. 0:28dollars of revenue.
17. 0:29>> Yeah.
18. 0:29>> And what's stopping me is I've realized
19. 0:31that the model is completely broken. I'm
20. 0:34underpriced,
21. 0:35I'm overcompensating the staff, we're
22. 0:37underutilizing capacity in terms of
23. 0:41>> Square footage.
24. 0:42>> time and and physical space and time.
25. 0:46And so,
26. 0:47my question is
27. 0:49how would you apply first principles
28. 0:51thinking
29. 0:52>> Yeah.
30. 0:52>> to what I should do now, next, and later
31. 0:56>> Sure.
32. 0:57>> to run the business that I've got as we
33. 1:00make the transition to one that becomes
34. 1:02an asset.
35. 1:03>> Yeah. So, um,
36. 1:05basically the core So, there there's
37. 1:07there's two a chunk down version and a
38. 1:09chunked up version of the core economic
39. 1:11engine that makes a business successful.
40. 1:13So, LTV to CAC is the the most the
41. 1:15smallest version of that engine. You put
42. 1:17some money in, you get more money out.
43. 1:18That's the the the gross profit you run
44. 1:20the entire business off of. At a higher
45. 1:22level, it's return on invested capital.
46. 1:24Right? So, it's like, okay, that's what
47. 1:26the core machine is, but then there's
48. 1:27also equipment, there's leases, there's
49. 1:29build-outs, there's all that stuff that
50. 1:30goes into it that's not typically
51. 1:31included in LTV to CAC. And then, how
52. 1:33much does it cost us to build this
53. 1:34machine again and again? So, that's kind
54. 1:36of how I think about it. Like, micro
55. 1:37level, it's LTV to CAC. Return on
56. 1:39invested capital is what it is at the
57. 1:40macro level. When you're like opening
58. 1:42more and more locations and saying, it
59. 1:43cost me $500,000 to open a location,
60. 1:46location makes me $500,000 in the first
61. 1:476 months. Okay, cool. I've got a two to
62. 1:49one, you know, return on on capital
63. 1:51within a year, which is awesome, right?
64. 1:53So, let's tackle for you. So, the nice
65. 1:56thing about the music business is that
66. 1:58it's actually identical to the gym
67. 1:59business, so I know a lot about it.
68. 2:00>> [laughter]
69. 2:01>> Um and so, the the the models that I
70. 2:03have seen works unbelievably well have
71. 2:06been um semi-private models,
72. 2:08um number one.
73. 2:09Uh or
74. 2:12uh the 30-minute multiple times a week,
75. 2:14much higher ticket,
76. 2:16um
77. 2:17people you know, people stay 3 4 5 years
78. 2:19with music lessons with their their
79. 2:20their person. Um I prefer semi-private
80. 2:24because I think you get more loyalty to
81. 2:25the brand and it's less about the music
82. 2:28teacher who can then leave and then take
83. 2:29all of those, you know, students who go
84. 2:31private. Um and so, I like semi-private
85. 2:34in general. Also, I'm sure you could
86. 2:35sell around the idea that they get a
87. 2:37little bit more socialized and it's
88. 2:38probably good for them and all that
89. 2:40jazz. Um
90. 2:42and in terms of pricing, I want my gross
91. 2:44margins to be at least 80%. Ideally 90.
92. 2:48And so, um
93. 2:50now you can do that when you're one on
94. 2:52six. Harder one on one.
95. 2:56And so, if let's say you have
96. 2:58uh six kids, right, in a class or four.
97. 3:01I mean, you can you can you can you
98. 3:02know, level into it. But let's say it's
99. 3:04one on four, keep it math simple.
100. 3:06Um and you charge $200
101. 3:10um
102. 3:11sorry, $50 per session times four kids
103. 3:13is 200 you make $200 per session. Right?
104. 3:16Well, for you to pay for an hour of
105. 3:18music teacher's time, what does that
106. 3:20cost?
107. 3:21>> Right now, that would be 40 to $50 a
108. 3:25class.
109. 3:25>> Okay, so that's 80% right there.
110. 3:28So, 240, so 80% gross margins right
111. 3:31there. Now, if you charge 60 bucks a
112. 3:32session, you'd be at 240, so then you'd
113. 3:34be at like 84, whatever, in terms of
114. 3:36gross margin, so you're above that. But
115. 3:37that's my line that's my rule of thumb
116. 3:40for uh brick-and-mortar service
117. 3:42businesses is I want it to be over 80.
118. 3:44Ideally over 90, but I will not do a
119. 3:46business if it has lower than 80% gross
120. 3:48margin. Some people will I just don't
121. 3:50like to.
122. 3:52Cuz you don't have enough cash to do
123. 3:53anything.
124. 3:55>> Right.
125. 3:55>> And so then the question is, okay, how
126. 3:56do we how [clears throat] do we create
127. 3:57the sales process and the positioning so
128. 3:59that Now, you already are working with a
129. 4:01special class of customers. And so I
130. 4:05would imagine that you would be able to
131. 4:06probably even more easily than a
132. 4:07traditional music academy
133. 4:10sell at a premium price.
134. 4:12Because if I'm a parent who had a
135. 4:14neurodivergent kid,
136. 4:16I would be willing to pay for a
137. 4:17specialist.
138. 4:19And so specialist prices are at premium.
139. 4:22So I think that
140. 4:24would work.
141. 4:27And in terms of the model, um
142. 4:29you can I mean, it's just head count
143. 4:31divided by
144. 4:33uh teachers, basically.
145. 4:35But you have to get the the core gross
146. 4:37profit right in the business, and then
147. 4:39everything else kind of flows from
148. 4:40there.
149. 4:40>> I'm kind of in the same position that
150. 4:42this guy over here was, and I don't have
151. 4:43an operator, and so I'm just kind of in
152. 4:45that swamp, too, and
153. 4:47um
154. 4:48trying to navigate
155. 4:49>> have to get more margin.
156. 4:51You have to get more cash flow.
157. 4:52Cash flow allows everybody to breathe
158. 4:54better.
159. 4:55>> So, okay, I guess that makes sense. We
160. 4:57raise prices and
161. 5:00get that a different sort of client
162. 5:02um
163. 5:03funding.
164. 5:04>> Sell one on four and say and and just
165. 5:06sell around the fact that it's a better
166. 5:09experience for them.
167. 5:12Because you don't want them to be
168. 5:13married to a teacher. You want them to
169. 5:14married to Like, this is how I would
170. 5:16sell it.
171. 5:17>> [laughter]
172. 5:17>> I would say, "Listen, Mrs. whatever.
173. 5:20Like, if your child becomes really
174. 5:22attached to a single teacher, then if
175. 5:25that teacher leaves, then all of a
176. 5:26sudden this skill that they spent all
177. 5:27this time on they'll associate with the
178. 5:29teacher, and then all of a sudden they
179. 5:30stop playing violin after 5 years. You
180. 5:32don't want that, I don't want that. What
181. 5:33we want is to create a a positive
182. 5:35relationship with the skill, so they
183. 5:37just continue for life, right? Right.
184. 5:39And so we facilitate that by having
185. 5:41other people in the sessions, and so
186. 5:43that the teacher sometimes you change so
187. 5:45that no one really gets too attached to
188. 5:47anybody, but they really grow attached
189. 5:49to the craft.
190. 5:51That's how I would sell it.
191. 5:52Whether that's true or not, no idea. But
192. 5:54that's
193. 5:55I don't
194. 5:55>> Yeah.
195. 5:56>> But like that's how I would sell it.
196. 5:57>> Right.
197. 5:57>> Uh does that make sense?
198. 5:58>> It does.
199. 5:59>> Yeah. So that would be my positioning.
200. 6:00And I think if you if you just switch
201. 6:01the ratio uh to to one on four. And so
202. 6:05okay. Everybody. So if you are capacity
203. 6:07constrained, so some of you guys are in
204. 6:09that position. Like you you're you can't
205. 6:11you can barely handle the customers that
206. 6:12you have right now.
207. 6:14Um you have three solutions. The easiest
208. 6:16solution is you just raise prices.
209. 6:18Because if you have supply constraint,
210. 6:20then that means that you have more
211. 6:21demand than you have supply, prices go
212. 6:23up. Right? And most people just don't do
213. 6:25that and just suffer. So just raise the
214. 6:26prices, make more money. That's solution
215. 6:28number one.
216. 6:29The second solution is change client
217. 6:31delivery ratio, which we just covered.
218. 6:33So instead of going one on one, you go
219. 6:34one on four. So you get more out of what
220. 6:35you already have. This gives you
221. 6:36leverage. And it gives you cash flow.
222. 6:39And it brings your gross margins. The
223. 6:40third way is to bring other people in
224. 6:42who can do what you do,
225. 6:44uh which is then delegating, you know,
226. 6:46the responsibility, right? To somebody
227. 6:47else. So that's the ultimate leverage.
228. 6:48So you don't have to do any of it.
229. 6:50Does that make sense? So those are kind
230. 6:51of like the three steps that I think
231. 6:52about when I have somebody who's um
232. 6:54supply constrained and they don't have
233. 6:56any time. They can't grow the business
234. 6:58and they can't sell more customers, but
235. 6:59they need to sell more customers to grow
236. 7:00the business. And so they're they're a
237. 7:01rock and a hard place. And the nice
238. 7:03thing is we start with price cuz it's
239. 7:04the fastest and easiest one to do.
240. 7:07You don't have to do anything. You don't
241. 7:07have to change anything. You just say a
242. 7:08different word and then
243. 7:10you make more money.
244. 7:11>> So our our primary thing when we opened
245. 7:13was it was 100% private lessons.
246. 7:15>> Yeah.
247. 7:16>> Uh and so that's what that's basically
248. 7:17the only difference in the the
249. 7:19hypothetical gym in gym launch, which I
250. 7:23read the whole thing on the plane over
251. 7:24here. You know, how I didn't know that
252. 7:25book didn't exist until we
253. 7:27>> It's a good book.
254. 7:27>> It's awesome.
255. 7:28>> Yeah.
256. 7:29>> But like so what would the what would
257. 7:30the um
258. 7:31>> You can still have one on one. You can
259. 7:33still have one on one. Just I would
260. 7:35predominantly sell semi-private. And if
261. 7:37someone's like, "Well, I want the
262. 7:38special snowflake treatment." Then
263. 7:39you're like, "Awesome. I'll give you the
264. 7:40special snowflake price."
265. 7:41>> Right. What How would you design the
266. 7:44that uh uh
267. 7:45the the initial offer
268. 7:48for that type of model?
269. 7:50The 6-week beginner challenge.
270. 7:53>> So, I would have So, you would know this
271. 7:55You would know the outcome better than I
272. 7:56do.
273. 7:57But, it would be something Whatever
274. 7:59Whatever the fast outcome that you can
275. 8:00deliver to a kid who's neurodivergent
276. 8:02who picks up a violin or whatever the
277. 8:04instruments that you teach are.
278. 8:06Right? It's like they'll be able to play
279. 8:07this like a song in this period of time.
280. 8:10Right? Now, it might not be good, but
281. 8:12like they'll be able to You'll You'll
282. 8:13recognize it kind of, right?
283. 8:15Uh but like I would want some sort of
284. 8:17discrete outcome.
285. 8:18Um and that would be like an outcome.
286. 8:20You could also do some sort of uh
287. 8:22subjective thing, which is that like
288. 8:23they rate X or they Like you could have
289. 8:26a survey at the beginning, survey at the
290. 8:27end. That would be kind of more of an
291. 8:28internal thing.
292. 8:30>> Got it.
293. 8:31>> But yeah, typically you'll serve you'll
294. 8:32you'll sell some sort of package up
295. 8:34front. I I'm going to guess that the
296. 8:36price point for what you're looking at
297. 8:38is going between 600 and 2,000.
298. 8:40Um is what the upfront package would be,
299. 8:42and then you'd upsell or at least let
300. 8:44people go into continuity on the back
301. 8:46end. And it'd probably be somewhere in
302. 8:47the neighborhood of like 6 weeks to 6
303. 8:48months. You'd know that range better in
304. 8:50terms of how long this software is.
305. 8:52>> Wow.
306. 8:52Okay. Yeah, and the best thing that
307. 8:55We're drowning in content. We're a
308. 8:56recording studio. So, these kids are
309. 8:57making songs all the time.
310. 8:59And they should be feeding the
311. 9:00marketing, but it's just so much Then
312. 9:03there's that whole problem, but
313. 9:04>> Yeah. You just need time, man.
314. 9:06Like I think what's interesting is that
315. 9:07like the more stressed you are, the
316. 9:08lower This is not me. This is not a
317. 9:10slight, just to be clear. I'm saying in
318. 9:12general. The more stressed anyone is,
319. 9:14the lower your IQ is. And so, I'm saying
320. 9:16this to say that Again, this [snorts]
321. 9:19isn't a use case. I'm saying that the
322. 9:21problems that you struggle with when you
323. 9:24are stressed, when you have a good
324. 9:25night's sleep and a little bit of time,
325. 9:27you solve it in like 5 minutes.
326. 9:29And so,
327. 9:30>> [clears throat]
328. 9:30>> if you want to increase your capacity,
329. 9:32it's like let's solve for capacity. And
330. 9:34then a lot of these things that that
331. 9:35keeping you up at night, you're like,
332. 9:36"Oh,
333. 9:37we'll just run a six-week thing, run a
334. 9:3812-week thing, we'll solve for this. I
335. 9:40can see how the margins work out. And
336. 9:41like, we already have more demand than
337. 9:42we can handle, so it's okay if people
338. 9:44say no at our higher prices, cuz we'll
339. 9:46make it up in profit anyways. If you
340. 9:47like this video and you're business
341. 9:48owner who wants to break through your
342. 9:49current revenue ceiling, I distilled
343. 9:51every lesson from scaling 10 businesses
344. 9:52past 10 million and three businesses
345. 9:54past 100 million into a completely free
346. 9:56scaling road map that I've used to go
347. 9:58from zero to one, zero to 10, and zero
348. 10:00to 100 plus. And so, you can click here
349. 10:02and you can check it out. Again,
350. 10:03absolutely free. And since you're
351. 10:04business owner, appreciate you and
352. 10:06enjoy.