18/01/31

# Consider the Profit Potential of International Expansion

By Raymond Hopkins

Each year, many entrepreneurial, growing, and developing companies contemplate international expansion as a marketing and growth strategy. When developing a strategic blueprint to launch international business expansion, developing companies and their consultants must always consider the potential profit of that undertaking and weigh this against the potential risks before embarking on the effort. Calculating the profit potential clarifies the big picture, especially when dealing with an expansion whose profitability can wildly vary under different scenarios. A product’s profit potential is the potential to generate revenue, which, after expenses, leads to net income, a projection, not a guarantee. For example, the simple profit potential1 is then:

100 units in inventory x (sale price of \$5 per unit - expenses of \$3 per unit) = \$200 profit potential

Put another way:  I x (P-E) = PP, where: I = inventory or potential demand, in units, P = sale price per unit, E = expenses per unit and PP = profit potential. Note potential demand multiplied by sale price per unit equates to expected, not guaranteed revenue. Expected revenue less expenses, therefore, equals profit potential.

Let's dig a bit deeper into the concept using an example with the fictitious aerospace company, ABC Industries (ABC). ABC is the maker of commercial and military aircraft and helicopters. Unfortunately for the government consumer, ABC Industries only produces a standard version of each product. ABC Industries accounts for the expenses of each product separately. Let's take this step by step.

### Step 1: Estimate Future Revenue

Start by calculating the profits—or revenue—you anticipate in the new market. Begin by determining the size of the market. In particular, research figures of equivalent products, if any, and estimate the number of prospective customers deciding on the portion of the market niche you seek to net. You may be lucky enough to claim the entire market share, but don’t overestimate your initial success. ABC Industries will want to multiply its estimate by a price the market can tolerate, taking into consideration the prospect of domestic and international competitors, landed cost, respectable profit and converting this price into its own currency.

ABC Industries anticipates the following pricing and demand for its products (see Figure 1):

• Fighter Aircraft: Sale price of \$350,000 per plane; projected demand of 100 units this year
• Commercial Aircraft: Sale price of \$200,000 per box car; projected demand of 50 units this year.
• Helicopters: Sale price of \$15,000 per car; projected demand of 1,000 units this year.

### Step 2: Estimate Your Variable Costs

Variable Costs are those monthly costs to you of the goods or services you'll sell as part of achieving your sales estimate. They're called variable, or sometimes incremental, because they go up or down depending on the volume of products or services you produce or sell (see Figure 2). They commonly include:

• Direct materials – charges to expense when the associated products are sold.
• Sales Commissions – charges an international representative earns when sales transactions are completed.
• Billable labor - charges to expense when the associated sales transactions are completed.
• Labor – costs incurred for employee labor based on the number of units produced.
• Tariffs – costs charged by a foreign government applied to imported goods
• Packing - costs incurred to ensure delivery arrives in tact for customer use.
• Shipping – depending on the Incoterms of sale you negotiate with your customer for costs incurred by freight forwarders and actual transportation expense incurred in delivering the product.

### Step 3: Estimate Your Fixed Costs

Fixed costs are business expenses which do not depend on the level of goods and services you offer. Initial operating costs distinguish international versus domestic markets. Researching the market will consume staff time, if you don’t outsource market research. Research costs include those costs you will incur in uncovering regulatory/legal issues, cultural behavior, translation, and finding the in-country assistance you might require such as representation. If you elect to produce product in-country, you’ll need to also estimate and include the cost of assets and their operation associated with that effort (see Figure 3).

These you will subtract from your price as well (see Figure 4).

### Step 4: Calculate Your Gross Profit Margin

It's also useful to know your gross profit margin. Gross profit margin measures the difference between the costs of producing a product or providing a service and what you're selling it for. In short, it lets you know how profitable your products and services are.

To get your profit margin, divide your estimated average monthly gross profit by your estimated monthly sales. Generating this calculation is beyond the scope of this illustration. What's a good profit margin? The answer varies across industries and your own requirements. Without looking at the costs of a company's overhead, such as marketing and administration, profit margins don't give the whole picture of a company's profitability. So it is worth examining this aspect of profitability as well.

Of course, the above figures are fictitious, but they do depict the type of analysis you and your firm need to thoroughly conduct before launching into foreign markets. Given the above, one might question whether or not your firm should expand to international markets. Realize expanding into international markets can mean positive growth for your company and a hedge against economic downturns in your home marketplace, providing your market research warrants the effort and expense involved in taking that step.

1 Cozad, M. A. Profit Potential: Definition & Overview. Retrieved and adapted from http://study.com/academy/lesson/profit-potential-definition-lesson-quiz.html. Used with permission.