Entrepreneurs start companies for all sorts of reasons. Maybe they have a passion, like being in control, want more flexibility--or even hate their current jobs.
But no matter the inspiration, one thing’s for sure: They’d better make money. A rising revenue line might make for good cocktail conversation, but if you don’t turn a profit--and keep turning one--you won’t be an entrepreneur very long.
With the help of Sageworks, a Raleigh, N.C.-based private-company data provider, Forbes.com has assembled a list of the 10 most and least profitable businesses--on a pretax basis--that aspiring entrepreneurs might hope to launch. Average pretax profits ranged from a juicy 25% to a knee-wobbling negative 7%.
The data were drawn from recent financial statements for nearly 100,000 privately held companies in the U.S.--most with annual revenues under $10 million--and bucketed by Internal Revenue Service classifications. We included only industries for which Sageworks had data from at least 50 companies--750 in all--and eliminated categories too broad to be meaningful.
While based on U.S. companies, the numbers also shed light on global profit trends. ”The dynamics of each specific industry are slightly different in each country,” says Sageworks founder Brian Hamilton. ”[But] the relative profitability of these industries--on a pretax basis--holds, generally, throughout the globe.”
Of the winners, little surprise that professional services--accounting, law, design and medical-related firms--accounted for eight of the top 10. Two big perks here: constant demand (no matter what the economy is doing, people will still get sick and still sue each other) and relatively low overhead. Bean counters trumped all, with a 25% average pretax margin. Next came the legal-service firms, at 21.6%, followed by dental offices (20.9%) and specialty design shops (17.6%).
Specialization helps in health services, too. Chiropractors, optometrists, podiatrists, and physical, speech and mental health therapists--the fifth most profitable group as a whole, with a 17.5% margin--often have more pricing power (and require less expensive training) than general physicians. A big reason: Many of these niche providers are able to circumvent the large health insurers and health maintenance organizations skilled at taking their pounds of flesh.
Another nice thing about professional services is all the repeat customers. ”If someone’s been doing my taxes for 20 years, why would I switch?” says John Czepiel, professor of marketing at New York University’s Stern School of Business. ”There’s a perceived cost of switching that keeps customers coming back.”
As for those bleeding red ink, the reasons are myriad. Low barriers to entry, huge fixed and variable costs, lack of product differentiation, and little or no pricing power with buyers and suppliers are but a few.
Take community care facilities, the worst of the bunch with a -7.2% average pretax margin. This sector includes residential care facilities that also offer nursing assistance or other health services. Not only is the overhead overbearing, there’s a shortage of nurses worldwide, pushing up wages. Pricing power is limited, too: In the United States, these facilities get paid by Medicare and Medicaid, a relatively stingy twosome.
A hodgepodge of support services is next on the loser list. These struggling outfits do everything from organizing trade shows and conferences to labeling and wrapping gifts--not exactly quantum physics. These functions have low barriers to entry and plenty of competition. Coordinator-types also have to pay out subcontractors, gobbling what little profit they hope to make. Average margin: -2.6%.
The next three groups also traffic in commodity products: beverage makers (-2.2%), real estate services (-2.1%), and bakeries and tortilla makers (-0.9%). Small food manufacturers really get squeezed in the value chain--trapped between suppliers, with whom they have little leverage relative to larger players, and massive retail chains with lots of buying power. ”The only people making money in the food chain are big corporations, because scale is the only driver of profits in that industry,” says James Nolen, finance professor at the McCombs School of Business at the University of Texas at Austin.
To be fair, these numbers are something of a snapshot, as the profitability of any industry ebbs and flows, at least somewhat, with the overall economy. ”In [the early 1980s], the U.S. moved from a retail economy to a service-based economy,” says Nolen. ”In the late 1990s, [it] moved largely to a knowledge-based economy. You can sell [those skills] at a higher rate.”
But there are other factors at play. Temporary jolts, such as high fuel costs, a weak U.S. dollar, collapsing real estate prices and a credit crunch, can turn winners into losers, and visa versa. Take small banks and credit unions, the tenth most profitable businesses on our list (margin: 13.6%). Small lenders have been more insulated from the credit crisis than the big guys, like Citigroup (nyse: C - news - people ) and Bank of America (nyse: BAC - news - people ), though who knows for how long.
On the other hand, U.S. liquor retailers haven’t fared particularly well--not only because they don’t have much pricing power with distributors, but because the weak dollar means they have to pay a lot more for imported alcohol these days.
Size matters too--even within the small-company universe. Tiny shops may not require a lot of overhead, but at some point--say, around $3 million in revenues--the relative level of overhead spikes, crimping margins. Generally speaking, economies of scale don’t kick in until a business hits the $10 million in revenue range, says Nolen.
Business models and industry dynamics matter, but they aren’t everything, says Sara Sarasvathy, associate professor of business administration at the Darden Business School at the University of Virginia. She conducted a study of 45 ”expert entrepreneurs”--individuals who have built, and taken public, at least one company. Her hopeful conclusion: Entrepreneurs who profit in a given industry can see new opportunities where others can’t, and are willing to bet on them.
”Philosophically, [expert] entrepreneurs don’t think of the world as a given,” says Sarasvathy. ”They see everything as transformable.”
Maybe--but then, data often speak louder than dreams.
■ No. 10: Community Care Facilities
Average Pretax Margin: -7.2%
This sector includes residential care facilities that also offer nursing assistance or other health services. Not only is the overhead overbearing, there’s a shortage of nurses worldwide, pushing up wages. Pricing power is limited too: In the United States, these facilities get paid by Medicare and Medicaid, a relatively stingy twosome.
■ No. 9: ”Other Support” Services
Average Pretax Margin: -2.6%
These struggling outfits do everything from organizing trade shows and conferences to labeling and wrapping gifts--not exactly quantum physics. These functions have low barriers to entry and plenty of competition. Coordinator-types also have to pay out subcontractors, squeezing what little profit they make.
■ No. 8: Beverage Manufacturing
Average Pretax Margin: -2.2%
This bucket includes wineries, brewing companies, bottlers, distilleries, soft-drink makers, ice makers and water purifiers. Plenty of competitors can crank out these commodities, and small fry don’t have enough scale to compete.
■ No. 7: Real Estate Related Services
Average Pretax Profit: -2.1%
Included here are appraisers and property managers. Appraising is a relationship business, with low barriers to entry; volume is the name of the game. Building services, like collecting rents and fixing pipes, aren’t particularly hard to come by--but decent margins are.
■ No. 6: Bakeries And Tortilla Manufacturing
Average Pretax Profit: -0.9%
It’s tough to make dough making dough. It takes people and equipment--though not an inordinate amount of skill--to combine water and flour into consumable carbohydrates. Scale and pricing power are elusive in this commodity business.
■ No. 5: Amusement and Recreation Services
Average Pretax Profit:% -0.9
Think golf clubs, ski resorts, marinas, fitness centers and bowling alleys. Greens fees and lift tickets may seem pricey enough, but staffing and maintenance costs chew up those revenues pretty fast. Worse, many markets are already saturated with recreational options--compelling owners to invest yet more capital on newer, fancier attractions to keep patrons coming back. Finally, these businesses are tightly linked to the overall economy--too bad the fixed costs remain, even though customers may not.
■ No. 4: Motor Vehicle Parts Manufacturing
Average Pretax Profit:% -0.7
Not even the big guys can make a decent buck making car parts--just look at Delphi. The main reason: buyer power. Automakers--themselves under siege--have historically demanded price cuts from their parts suppliers. In that nasty pricing environment, efficiency only will get you so far.
■ No. 3: Specialty Retailers
Average Pretax Profit: -0.5%
With Wal-Mart and other big-box retailers dotting the landscape, it’s hard even for niche retailers--of sporting goods, musical instruments or hobby supplies--to make money. The big guys can live on slim margins because they have sophisticated inventory-management systems that keep the merchandise moving; they also have pricing power with their suppliers. Small fry have neither, so they have to compete on customer service, and that can get expensive. Selling online shaves costs, but everyone can do it, so those savings get priced away.
■ No. 2: Beer, Wine And Liquor Retailers
Average Pretax Profit: -0.18%
These shops have a particularly hard time in the U.S. due to strict regulations on distribution dating back to the Prohibition era. Today, distributors have a near monopoly in a given area, and that translates into serious pricing power. Some state laws also dictate how quickly distributors must be paid by retailers, making it hard to manage their cash flow. Best bet: Find a niche (say, organic wines) and pray you cultivate loyal customers.
■ No. 1: Travelers’ Accommodations
Average Pretax Profit: 0.26%
Hoteliers ebb and flow with the economy, but their high fixed costs greet them every day. That’s why they have to keep the rooms filled, even if it means lowering prices--and sacrificing profit margins--to do it. If you want pricing power, you’d better have a prime location--in which case, of course, your rent is huge. Significant, too, are the annual capital expenditures. Two words: money pit.
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