Picture this: You open up a bistro and enjoy some early success. Everyone wants to try the new hotspot. A few months later, two similar restaurants open nearby, and they take a deep bite out of your profits. It’s not unusual for new businesses to struggle with turning a profit — especially those in intensely competitive industries, such as restaurants. If you’re thinking of starting a business, understanding what affects the profitability of your industry is one key to managing risk.
Financial information and software firm Sageworks recently identified the most profitable industries — as well as the least profitable — by analyzing the average net profit margins (the percentage of revenue turned into profit) of privately held companies. Although the research covers only a one-year period, it can suggest factors that help and hurt profitability. Here are reasons why some industries are more profitable than others.
Skilled and knowledgeable workers
When entering an industry requires you to be an expert or have specialized education, there’s lower likelihood of new competitors. Less competition means you’ll spend less money retaining customers and you’ll keep more profits. With net profit margins of 18.4%, accounting, tax preparation, bookkeeping and payroll took the top spot on Sageworks’ most profitable industries list. There’s a low threat of new competition because of the education required to start such a business, says Libby Bierman, vice president of marketing for Sageworks. This can include getting a degree in accounting and passing the CPA exam. Offices of real estate agents and brokers — another industry whose profitability relies on the skills and qualifications of its professionals — ranked seventh on the list with a net profit margin of 14.3%.
Customers do less comparison shopping
In some industries, cost may not be customers’ top consideration. For example, in the death care services industry (10.8% profit margin), which includes businesses such as funeral homes and crematories, price wars are less intense because customers make decisions more quickly based on emotions and are less likely to shop around, says Dan Olszewski, director at the Weinert Center for Entrepreneurship at the Wisconsin School of Business. On the flip side are industries in which intense rivalry among competitors drives down prices and lowers profits. This is the case with grocery stores (2.2% profit margin), beer, wine and liquor stores (2.4%), automobile dealers (2.4%) and restaurants (6%).
Few alternative products or services
If a new company enters your industry and offers consumers an alternative to your product or service, it can threaten your profitability. Take automobile dealers (2.4% margins). Ride-sharing options such as Uber and Lyft threaten them because they provide alternatives to buying a vehicle, Olszewski says. With net profit margins of 17.9% and the second spot on the Sageworks list, lessors of real estate — houses, apartment buildings and townhomes, as well as mini-warehouses and self-storage — fared much better. For those looking to rent out a home or store personal items, there are few alternatives to property management companies and self-storage facilities. Likewise, there’s no substitute for expertise and experience for those seeking legal help. Legal firms took the third spot on Sageworks’ list with net profit margins of 17.4%. Other top profitable industries on the list include medical and diagnostic laboratories (12.1% margins), automotive equipment rental and leasing (12%), warehousing and storage (11%), management, scientific and technical consulting services (10.3%) and specialized design services (10.2%).
Other factors that affect profitability
Your strengths. If the industry you’re considering is highly competitive and less profitable, it doesn’t mean that you won’t succeed. It’s more about skills and approach than it is the industry landscape, Olszewski says.
The long game. Sageworks’ data provides only a one-year snapshot, so look into industry trends over a longer period. And be realistic as you approach your new business. A startup likely won’t have the same profit margins as industry averages. Have a strong business plan, and be prepared for industry downturns or recessions.
Standing out. By providing excellent customer service, differentiating your product or service, advertising and marketing your business effectively and focusing on competitive pricing, you’ll better position your business for success, regardless of the industry you decide to enter.
Steve Nicastro is a writer at NerdWallet. Email: [email protected]. Twitter: @StevenNicastro.
The article Profit and Loss: Why Some Industries Fare Better Than Others originally appeared on NerdWallet.