The quality of business outcomes (which we could define in terms of return on capital employed, return on shareholders’ funds, team turnover, growth in market share, earnings per share …. whatever you care to use as your objective function) will depend on the quality of decisions.  The quality of decisions, in turn, depends on the quality of information on which they are based.  When I refer to the quality of information I’m talking about its relevance to the critical success factors of the business, timing, accuracy and accessibility.

It also seems to me that a business that has better quality information to guide decisions taken by people who understand what they are looking at will have a clear competitive advantage over businesses that are run “by the seat of their managers’ pants.”  The purpose of a KPI, in my view, is to get people to think about what’s going on. Albert Camus, a French Philosopher and Nobel Prize winner, said “life is the sum of all your choices”, I say, and so it is for business too. An understanding of how to use relevant KPIs will lead to better choices.

Net Profit is an example of a common KPI.  Subject to the measurement rules embodied in GAAP this KPI reveals the financial consequence of past management decisions and operational activities given the economic environment that prevailed.  In its simplest configuration, Net Profit is a residual being the difference between revenue, cost of sales and expenses.  On its own it doesn’t tell us much other than the fact that revenues exceeded (or perhaps fell short of) total expenses. However, if it differs from expectation then management should want to know why.

If a loss has been incurred the questions management should ask are: Is this likely to continue? Why did the business lose money and what can we do to address the situation? For example, was it gross margin decline due to poor pricing and/or poor control over variable costs? Was it a physical sales volume issue? Are customers moving to competitors? Are customers’ buying patterns changing? Was it due to poor expense control? Was it due to a one-off extraordinary expense charge?  The point I’m making here is that the measure of Net profit serves as a useful KPI but only if it is followed up by exploratory questions which require more information.

Net Profit becomes an even more useful KPI when looked at over time or in relation to other denominators or in relation to a target.  For example, the trend in net profit is a useful indicator of what the future might hold if nothing changes.  In this respect it serves as a high order key predictive indicator but potentially a dangerous one because it’s highly unlikely that “nothing” changes.

What’s far more revealing is an analysis of the factors that drive profitability.  I’m talking about the impact of revenue (sales volume x price or average transaction value), gross profit margin, and expenses.

The Annual Business Performance Review generated by GamePlan provides an analysis of the impact that each of the net profit drivers have.  This gives management some useful insights into the reasons for the change in profit from one year to the next.

Consider the analysis summarized in the above graph.  The first point I’d make is this graph is a much more effective way to communicate what’s happening in a business that a table of numbers.  But back to the discussion, there was a decrease in net profit before tax of $5,600.  This was the net result from an increase in revenue of some $260,000 that was accompanied by a decline in GP% to yield a net increase in Gross Profit of $197,000 – the sterling sales effort was diluted by a reduction in margin margin.  The decline in GP% (which means average selling prices did not keep pace with COGS) was accompanied, in this but not all cases, by a decline the average transaction value meaning that the number of transactions increased.  This probably explains why Overheads have increased dramatically, so much so that the additional GP was more than consumed by additional overhead.

The profit drivers graph graph tells the story of what’s happened in the past year and like all good stories there should be something learned from it.  It appears that the company drove sales hard due in part to aggressive pricing (reflected by a fall in GP%) and probably increased advertising expenses, perhaps higher sales commissions, more sales people etc. (there’s a need for further analysis of overheads). The net effect was virtually no change in net profit – a lot of effort for little result.

But there’s more, on yet even deeper analysis we discover that the GP% was just 1.16 percentage points below what it had been the previous year and 2.67 percentage points below the highest it had been in the past 5 years.  Now these may appear to be small numbers but on revenues of $5,195,000 this decline in GP “cost” the business $60,000 and $139,000 respectively which represented more than 25% of its final net profit.

What’s also very important is the fact that if management had been aware of the “small” decline in GP% it may have been able to manage pricing more effectively.  In fact a modest price increase of about 2% across the board would have preserved last year’s margin and added at least $60,000 to the bottom line.  To achieve the highest GP% the price increase would have needed to be about 5%.

For the vast majority of small businesses the Income Statement is not being monitored regularly and rarely, if at all, are the sort of calculations I’ve talked about above been done.  People in business for the most part do not understand either the logic or the algebra but what they do understand is:

Because you didn’t arrest the fall in your GP%, you have left $138,000 on the table.  To avoid that outcome going forward all you needed to do is raise your prices by 5%

A popular cliché is the phrase “what you can measure you can manage.”  Cliché though it is, in my experience it is a very useful idea.  Time and time again, business people respond positively when you have a conversation about such things as: (1) there are just 4 ways to grow a business, (2) great results come from small changes, (3) when you monitor your business monthly you have 11 opportunities every year to get to where you want to be, (4) it’s the set of the sail that gets you to your destination not the intensity or direction of the wind, (5) expenses are the cost of resources used to generate your revenue, what return are you getting from them? (6) the most important non-financial KPI you need to be monitoring is the number of transactions (or some other activity metric)—from this an unbelievably rich source of information and probing questions will emerge.

Now one final point, most people would probably say that the mere act of measurement does not in itself change the object of measurement.  I disagree.  I have found that when a goal is put in place and it’s subject to a monitoring process the goal is achieved or exceeded more often than not.  The key to this is not the goal, it is the regular monitoring and it comes back to the point I made earlier, if you intelligently review outcomes at least monthly then you’ll have multiple opportunities to “get it right.”  If you give the goal attention, the activities you need to achieve the goal will be given attention.  Simply having a target and casually comparing actuals with the target (if done at all) without giving attention to the causes and consequences is a waste of time.

His goal was to understand what experience the “average” fan had when attending the game so that he could identify what needed to be improved to enhance the value they got for their ticket price. Cuban’s business philosophy is simply to create the best possible experience for his customers in all of his businesses.

I read about this in the November 2011 (page 40) edition of Success Magazine which I devour every month.  It’s by far my favorite source of business building ideas.  I even rank it ahead of Accounting Today for inspiration and content.  This is how the magazine article described how Cuban created an additional $153 million in value:

… rather than hanging out in the owners box, he tried to catch games in a variety of locations within the arena. He sat in the nosebleed seats to get a feel for what the view was like, if there were any obstructions, if the scoreboard was visible. He sat courtside to see if the seats were comfortable, the leg room sufficient, the noise level good. And he sat just about everywhere in between, counting how many times vendors passed by and and how convenient the various amenities were. He also stood in line for concessions, timing each wait and evaluating the quality of each product when he received it. He used the public restrooms to make sure they were kept clean and were sufficient to meet demand.

He then acted on what he found. For example, new scoreboards were installed so that the view was blocked from any seats in the stadium and new practices were put in place to improved the efficiency of concessions.  Getting into the detail and seeing the world through the eyes of customers is his mantra.  He makes the point that “… if you aren’t a customer of your own business, you are fooling yourself if you think you fully understand the customer’s needs.”

This article reminds me of the critical importance of regularly doing Customer Advisory Boards for your firm and your clients.  This, together with “blind shopping” is a a fantastic way to gather invaluable information and ideas that can dramatically change the fortunes of a business.  Customers generally don’t complain about little sources of annoyance, they just don’t feel much loyalty.  Loyalty is reflected by an improvement in the frequency with which customers deal with you, in the customer defection rate and in your customers acquisition rate.  A single metric that will keep you appraised of how your business is performing on the loyalty front is Fred Reichheld’s Net Promoter Score.

If you want to quickly and easily help your clients run a better business.  Help them see it through the eyes of their customers (do likewise for your own firm), conduct a CAB for them, read Reichheld’s book and then introduce the idea of implementing a NPS monitoring process in their business as part of a Management Control Process that you introduce them to.

I am writing to tell you about the worst experience I have had since Boot Camp. I feel lots of emotional pain about it. What a “dope” I have been! I don’t plan on repeating it!  The salt in the wound was reading your Results Revisited manual.

Not long after attending Boot Camp I sold our first Planning Session to a client we have had for almost 20 years. Not only did we sell a Planning Session, involving all of their team members, but we also sold Towards Awesome Service and Phone Right all for about $10,000. The client is a wholesaler located in a small community with revenue of about $67 million.

We were feeling great! But the client was not ready to commit to additional service other than the monthly financial statements we were already producing for them. They wanted to wait and see what they would be able to do on their own after the Planning Session and the other two ‘products’. I outlined additional services, from monthly team meetings to identifying and monitoring KPIs as part of a Management Control Plan. But “no sale”.

Last week the client called and asked that I attend a meeting today involving the owners of the company, their executive management group and their consultants. Unknown to me, the “consultants” had analyzed the company and were presenting a review meeting to everyone, including the company’s banker.

At the meeting I found:

• The consultants had reviewed all the processes of the company
• The consultants had developed a management plan for the company.
• The consultants had developed performance standards for each of the key positions of the company.
• The consultants had developed KPIs (they call them Critical Performance Metrics or something like that).
• The consultants had developed draft budgets, cash flow projections, etc.
• Two people were there for three weeks and were paid $45,000.

I felt terrible that we didn’t get it because I know we could have done all of this work.

So what did we do wrong?

1. First, we sold products instead of a process. For example, we told them we could do a TAS team training program which we did and they loved it! BUT we did not position it as a marketing initiative linked back to a client advisory board and tied it to an ongoing KPI monitoring metrics such as referral rates, customer satisfaction, average transaction values, frequency of transactions. Our Phone Right training program was also a huge success but we did not integrate it into the company’s sales productivity monitoring system e.g. a KPI that monitored sales conversion rates.

2. We did not keep “taking the message to them”. We just continued as accountants without showing them the continuing process of business development. I gave up after the client didn’t show continuing interest.

3. I failed to see a buying signal the client gave us earlier this year when they asked us to “recharge” them again.

I recently picked up and read your Results Revisited Manual and it hit me between the eyeballs. Your ideas are right on target. Our initial work with clients after the Boot Camp was geared at selling them products (Towards Awesome Service, etc.) instead of looking at these as tools to supplement our work on the systems of the business.

Thanks for all you guys do for us. Boot Campers like me will eventually get the process “right”! Actually I hope this same experience has happened many times to other Boot Campers that way I won’t feel so stupid!

We all worked in the Wool Marketing Section of the Bureau of Agricultural Economics in Canberra (the Capital of Australia for the information of my friends abroad.) Through this employment connection we had close contact with the sheep industry and in particular wool marketing.  One of my partners was a Kiwi (aka a New Zealander) and over a glass of beer he mentioned that sheepskin shops were popping up all over NZ to cater to the exploding Japanese tourism market — they loved sheepskin floor mats as gifts to take home. He suggested that we open a shop in Canberra. We thought that was a great idea (everything sounds great after a few beers – have you noticed that?) and with no real plan in mind we each contributed $300 to start the venture. By the way, we were economists not business graduates so we really had no idea about business at all.  I had taken one class in Accounting and that was the sum total of our collective business wisdom and that qualified me to ne the General Manager.

Now $900 was quite a lot of money in 1970 but we quickly discovered it’s not really enough to start a business.  By far our biggest challenge was the cost of  carrying inventory. Most of our initial funding was invested in setting up the shop – which we did on a shoestring by the way. But we sweet-talked one of Australia’s best sheepskin tanneries to supply us on a cash-for-product basis. That is, we gave him $200 up front and he delivered us about 50 skins overnight. We took out an advertisement in a cheap tourism brochure that simply said “The Perfect Gift: Authentic Australian Sheepskins from an Australian Shearing Shed”. We stretched the truth a small bit in that it was not an authentic Australian shearing shed but The Shearing Shed was the name of the business. That ad got some attention and we sold all our stock in the first week.

We parlayed $200 into $300, a GP of $100, in our first week which annualizes to revenue of about $21,000.  That was scarcely enough to make us rich but what the heck, we had another job and it was fun and at least we were in a position to buy some more stock with our next order which we did. The next week we also sold most of our stock again. This continued for several weeks and we kept buying more stock but then a chance meeting, again over a few beers, with a guy changed everything.  With beer in hand he said to me what do you do? I told him I was research officer with the BAE but my real passion was our business. I then asked him what he did and he said he was an accountant.  I said “really! we need a ‘good’ accountant [how many times have you heard that inane statement!], do you work with new businesses? Our sheepskin business is going great (truth stretching again).”  He said “of course we do!”  His name was Tim by the way.

Then Tim said, “tell me about the business.” So I did and he listened as he asked a few more probing questions that told me he was genuinely interested! Then he said “so you’re saying that you turn your stock every 5 days.” Correct I replied. He said “that’s a stock turn of 70 times a year–amazing!” I had no idea what stock turn meant let alone considered it to be amazing – would any of your clients be in the same boat?  All I knew was that every dollar we made went straight out the door to pay for inventory, wages, rent etc. But I digress.  He went on, “you’re telling me that when Japanese tourists come into your shop they never leave without buying something?”  “Correct.” I replied again. Then he said, “let’s sit down and take a look at this” as he led me to a vacant table and flipped over a drink coaster and took a pen out of his pocket.

On the coaster (it turned out to be several of them actually) he showed me that our GP was just $33 out of every $100 of revenue and that was all we had available to cover all of our expenses and finance additional stock. Then he pointed out that if we were able to sell virtually everything in the store each week we are not charging enough for our product. He then suggested that I do, or at least try by testing for a month, two things.  First he said to apply a 100% mark-up on cost to get our GP% up to 50% – this did happen and as we all now know it’s the first way to grow a business i.e. average transaction value (price effect) and secondly, he suggested we quadruple our order size and negotiate 7 day payment terms, or better if we can, with our sheepskin supplier on the strength of our past track record (even though it was short). He continued, “not only will this give you a gross margin of 50% but I suspect with the obvious demand for your product you will sell more because you have greater availability [which did happen] and you can increase that even more by adding other related product lines that fit with the sheepskin-Australian-shearing shed theme.  This as we all know is the second variation of the first way to grow a business – i.e. average transaction value (volume effect). And he continued, “your additional revenue will be generated with very little additional cost other than the cost of product so your net margin will increase as you utilize your facilites more productively” this, as we all know is the fourth way to grow a business i.e. resource expense productivity and it did happen.

That conversation lasted less than 1 hour because we had a serious amount of beer to consume.  But the impact on our business was amazing. In our first full year, the business did a few pennies under $1 million and threw off a gross margin of about 52%. We ended up manufacturing powder puffs for Elizabeth Arden, and in addition to selling thousands of skins we made sheepskin carpets, ugg boots, coats, mittens, underblankets for hospitals and the elderly, car seat and steering wheel covers.  All of this came from a conversation and a single but simple question: “tell me about your business.” 

Tim became our accountant and he continued to give us really valuable business advice, he visited us frequently and took obvious delight in our success.  On one of his visits we were talking about the fact that one tourist bus operator had been bringing visitors to the store on their way back from a local tour of Parliament House and Tim said “it would be interesting to contact all the tour operators and see if they would do likewise.” This as we all know is the second way to grow a business i.e. attract more customers of the type you want. Isn’t this a BFO – why didn’t we think of this?  Most of the people we approached were not interested but a couple were and what happened is simply amazing: after a couple of months at least one bus (sometimes 3-4) would park at the back of the shop 5 days a week. Between 20-30 people would get off each bus and by mid afternoon we were frequently close to being out of stock. 

Because of the high margin and tight cash control we were able to grow the business really quickly, we secured 30 day credit terms, rented a warehouse to carry our inventory and serve as a manufacturing facility and the rest as they say is history. This would not have happend had I not had a chance meeting and conversation with an accountant who was willing to listen and smart enough to ask a couple of dead simple questions.

Interestingly after Tim moved back to Adelaide we were passed on to another guy (I have forgotten his name – that’s how impactful he was) who took no interest in us or the business other than to tell us when we had to get our books to him for our taxes.  Needless to say, we left that firm in the fullness of time and he probably didn’t even notice and will never know what fees he walked away from as a result of his indifference.  But there’s more to this story. As a result of this experience I decided that I wanted to learn more about business and in particular the role that accountants can play and the profound impact they can have on their clients. I left my “secure” government job and enrolled in graduate school and took as many accounting classes as I could to qualify and do the sort of things Tim did for us. The business also made it financially possible for me to do that.  That one conversation that lasted less than 1 hour changed the direction of my life completely.

As I look back on this event in my life and the subsequent path it took me on I think about it quite differently than I did at the time. Here are the lessons I have learned that you might like to reflect on during the Christmas Holiday.

1. Everything good and bad starts with a conversation.
2. Listen and not only might you learn something but you will develop trust with the other person. Once you have that you can become an agent of change.
3. A pen and the back of a drink coaster or envelop is all the technology you really need to change people’s lives which is why we created concept models to help you engage in concept model grass-roots conversation.
4. Accountants have the ability and positioning to make a huge difference to the lives of people.
5. Visiting with your clients is what really shows how interested you are in them and their business.
6. People outside a business (i.e. you) are far more likely to come up with ideas on how to improve it than the people in the business especially the owners. And I would add to that, I found I came up with a lot more ideas when I was at a client’s business than I ever did at my desk.  The reason for this is what I call environmental immersion which is akin to experience we have had with our Mastermind Alliance – the collective wisdom of a group of people talking, thinking about and focusing on an issue is far more powerful than a person thinking alone.
7. Perhaps the biggest lesson of all …. this is not rocket science, conversing about the 4 ways to grow a business large, or small, is a no-brainer framework for a robust conversation.  So with that in mind go back to bullet point 1.

During the Holidays you might like to think about the conversations you’ve had with clients this past year.  How many of those conversations may have, or will, change lives?  How many conversations could you have had that might have change lives? How many conversations will you have this coming year that could change lives? And if someone asks you what you’d like for Christmas suggest they give you a pack of envelopes then spend some time practicing your conversation on the back of them.  Never leave home or your office without an envelop and a pen in your pocket. Finally, never forget that there are just 4 ways to grow a business, any business, and when you master a conversation around those 4 ways you’ll grow you own business.

I’m in Australia at the moment and I just returned from a visit to the Ballina’s Big W store owned by Woolworths (for the benefit of our readers abroad, one of Australia’s “leading” retailers.)  The experience I had was less than great.

Let me explain.

Yesterday I purchased a food steamer.  When I got it home and opened the box it was obvious that it had already been opened because the secondary wrapping was lying on the bottom of the box .  I noticed hat a critical part of the product was missing so I took it back to the store today and requested a refund.  This was a Moment of Truth. I was quite OK with the fact that the product was incomplete.  I was even OK with the fact that I had been inconvenienced by having to return it.  I wanted a refund rather than a replacement because I was not satisfied with the quality of the product after seeing it and sensing that the box had already been opened.

At that instant, things started to go downhill.  The store assistant who’s name was Ashleigh BTW, looked at the diagram on the box with her associate  and advised me that all of the components were in fact there.  I knew differently because I have several of these appliances and I knew how they work.  I told her that it was not complete and that I would like a refund at which point she advised me that it was “company policy not to give refunds when the box had been opened!”  In other words, even though I was not happy with the product that was now my problem because I had opened the box.  Unfortunately, I did not know I would be unhappy with the product UNTIL I had opened the box. Her associate went off and looked at the product display and discovered to her surprise (but not mine) that there was in fact a part missing. Ashleigh then told me they’d give me the missing part but could not give me a refund because of company policy.

I advised Ashleigh that I would like to speak to the store manager about it.  After a surly expression and some raising of eyebrows she advised her associate to get the store manager.  The store manager was not willing to come and meet with me (another MOT) which confirmed that s/he wasn’t really interested in talking with a customer but s/he must have told the store associate to go ahead and give me a refund together with a lecture on what the refund policy is and to advise me that “they will refund it on this occasion but next time they will not do so!”  So we have yet another MOT – this time a really bad one.

I said to Ashleigh that with the greatest respect I was not interested in being lectured on their store policy, all I wanted a refund so that I could get on my way and the Woolworths folk could get on with their work.  At that point she threw the box that the the appliance came in down on to the counter and proceed to process the refund.  All in all it was a very unpleasant experience.  I asked her not to be rude to which she responed with: “you are being rude to me!”  Wow!  What great customer service training they have in that store — argue with customers if you believe you are right!  Interestingly, it is the Coles-Myer Group (Woolworths direct competitor) that has been using Principa’s Towards Awesome Service training program with 20,000 of its team members.

Now let’s think about this for a moment.  In the US, where I live most of the year, if I’m unhappy with a store purchase for any reason from practically any store, and certainly from all of the major retailers, I simply take it back and a refund is processed immediately, without any questions or any unpleasantness.  If I don’t have the receipt they will give me a store credit.  The result of this “policy” is that I have no hesitation going back to that store over and over again to buy merchandise in the full knowledge that if I’m not happy for any reason the store will refund me.  In other words, the store understands the concept of risk reversal, the concept of the lifetime value of a customer (which in my case is several thousand dollars with Woolworths) and the power of a guarantee for building customer loyalty.  As a relevant aside, I also own several thousand shares in the company which I’m now considering selling because this returns policy does not auger well for long term growth in shareholder value.

Woolworths clearly do not understand these concepts.

The experience I had today is NOT Ashleigh’s fault.  She is simply following company policy.  The fact that the store manager could not be bothered to visit with me is appalling and probably reflects the culture that Woolworths has developed.  This is turn reflects top managements’ real view how to treat customers–a necessary evil.  After all, a fish stinks from the head down so responsibility for what a customer experiences at store level comes to rest at the foot of the CEO.

May I suggest that you talk to your clients about their customer service policies and perhaps pull out TAS as a catalyst to help then re-define the concept of customer centricity in their business.  People notice these things but they don’t necessarily make much of a noise about them.  They just don’t come back to the business  and an opportunity is lost.  The cost of lost opportunities (read lost customers and/or lost transactions) is one of the biggest expenses incurred by businesses and they don’t even realize it because there is nothing that shows up on heir P&L.

In the meantime, my colleague Mark James sent me a summary of an experience watching the 4 ways to grow your business be executed by a business in Sydney recently.  I thought it would make an excellent “guest blog” entry so here it is, it is something you could share with your clients to let them know that even in these tough times opportunities to run a better business are everywhere.

A recent storm blew 20,000 tonnes of red dust from Western NSW to the East Coast of Australia and on to New Zealand leaving my, and every other Sydneysider’s, car covered with a layer of orange dust. An unwelcome event, but one that led me to a local car wash cafe where I was able to observe the clever implementation of the 4 Ways to Grow a Business principles with, no doubt, a very tidy profit being made along the way.

My morning went something like this:

At the car wash I was greeted by a concierge who kindly asked what type of service I wanted. I replied that I would like my car washed and cleaned inside and out for the advertised $42. Rather than just taking my keys and moving onto the next in a long queue of customers, the concierge walked me around my car and showed me the various imperfections on the vehicle that a wax and polish would remove. He explained that this, along with the wash and vacuum, would cost $95. I told him that I appreciated the time he spent bringing this to my attention but I only had time for a wash and vacuum.

My response did not deter this guy from the sales process in which he was clearly well trained. He was determined to ensure I was making an educated decision and, in a pleasant and non-confronting way, spent an extra couple of minutes talking up the benefits of choosing the wax and polish as a value added service. In the end we agreed that to-day I would settle for the basic service.

I heard the same offer pitched to the next customer but in this case the concierge was successful. From this point my curiosity was aroused and my interest in business and its profitability got the better of me. I now wanted to know how much extra time it would take for the car behind me to get a wax and polish and thereby the additional profits the business would make in up-selling its customers.

Let’s look at the revenue side of the process. A wash, wax and polish costs $95, but part of the sales person’s sales pitch to me (in the latter stage of the negotiations) was to offer a discount of $10, so let’s assume this was also offered to the car behind me. By encouraging this customer to upgrade the business effectively increased the transaction size by 100%, in comparison to the base level wash that I purchased for $42.

Of course it’s essential to know the additional time investment required to deliver this extra value in order to quantify the additional profits that resulted. As both of our cars were in at roughly the same time, I all of a sudden had a nice little business experiment going on in front of my eyes.

2 cups of coffee later I had witnessed a brilliant example of a business practicing the 4 Ways to Grow to great effect.

My car took 50 minutes to get through the end to end process and I was delivered a clean car that I was satisfied with (although the marks the concierge pointed out were still there, as agreed). I had therefore received good value for the outcome and customer experience I had paid for.

Now what about the car behind me?
In order to see the result of my experiment, I needed to wait around to see how long it took for the car behind me to get the wax and polish. So, when my car was ready I parked it across the road and went back to the café in the car wash and bought another coffee.

What was the result?

The car behind me took an extra 20 minutes to get through the full service. I watched the handover of the keys to the owner of the car behind me and the quality and value of the service clearly met his expectations.

Therefore, the Car Wash had created 2 happy customers who got a successful outcome and felt the fee charged adequately reflected this value, even though one of us had paid 100% more than the other.

Let’s Do The Numbers

Through having a planned and efficient sales process, the business received a 100% increase in price for every customer they sold up to the wax and polish. To deliver this additional service the business utilized an additional 20 minutes of capacity plus some materials (let’s assume a full cost of say $10) which then yielded incremental revenue of $43 assuming the car owner got the $10 discount.  The result is an incremental profit margin of $33 on each up-graded customer—nearly double the profit on my transaction.  Pretty impressive stuff given that all it took was a 3-5 minute sales consultation.

By the way, while I was there as many cars were receiving a wax and polish as were receiving a standard wash and vacuum, so the conversion rate of the sales people was running at 50%.   I wonder if they measure that?  I bet they do because I suspect the owner of this business understands that what you can measure you can manage.

What this business has done that so impressed me

Through a planned and methodical process the business is focused on increasing its profitability by engaging in simple but effective business practices, resulting in an increase in the average transaction size of 51% (assumes a 50% conversion rate of customers that include a wax and polish as part of the service) and in the process greatly improving the profitability of the business.

On The 4 Ways To Grow A Business

So far I’ve only discussed 1 of the 4 Ways to Grow your Business (increase your average transaction value). Let me finish the story.

After I left my car with the attendant, I went to the café to have my complimentary coffee and decided to buy a muffin (an increase in the average transaction size).

I sat in a cafe that was well presented, clean and had some relaxing background music playing, plenty of reading material, a TV area and a mix of lounges, chairs and tables (something for everyone). The experience was pleasant and I would happily go back (increasing the frequency with which you deal with them).

The business is located on a main road in a busy area of the community in which I live, it is well signposted, and always looks clean and tidy from the road, hence a potential customer would be enticed to try their service (increasing the number of customers you have).

Once inside, your perception of this business does not disappoint. The team members are all well presented, clean and tidy, the supervisors and managers are well identified by a different uniform, every team member is courteous and welcoming and there are clear systems and processes in place at each stage of the product cycle that ensure efficiency and productivity (improving the productivity of the business resources).

To conclude my story, before I drove away I was given a voucher for a $5 discount to use on my next visit that has an expiry date to ensure I am encouraged to come back within a time frame (again, increase the frequency with which you deal with them).

What are the take aways?

Let’s first recap on the 4 ways to grow a business:

1. Increase the number of customers you have.
2. Increase the frequency with which you deal with them.
3. Increase the average transaction size.
4. Increase the productivity of your business resources.

Do you think this is a profitable, growing business? And do you think it’s happened by luck or because they have a strong view of who they are and what they offer their targeted customers.  I have a feeling they have a sound strategic plan that underpins all their systems and processes.

What inspired me to write this note is not to let you know of a good customer experience I had, BUT to challenge and inspire you to think of ways to improve the growth and profitability of not only your firm but those SME customers who choose to work with you.

It may be easy to applaud this business but still argue that their success would not translate to another industry. But why not? Their strategies could easily apply to any commodity-style of business. Their success highlights a point I made in an earlier article “Long Term Business Success through Tough Times” that if you find it hard to create a point of difference for your product or service then you need to focus on the process by which the product or service is delivered. Both what and how you deliver can create a compelling value proposition for your customers.

The owners of this car wash have built a strategy on a strong sales protocol and a customer experience. As a result they are not attempting to compete on price.

In the last few weeks, now that the dust has settled, I have made a point of driving past the car wash and the place is always humming.  In my view this is the result of good management not good luck.

On the issue of price, some people may say “why would I want to pay $42 to get my car washed. I can get mine done for $25.”  Fortunately for the people who own the business not everyone in Sydney wants to go there!  They’re happy with the subset that are willing to put $95 on the table.

Mark James

Managing Director, Principa Coaching Pty Ltd.

Pricing is both and art and a science but it’s the “science” bit that I’m going to refer to now.  It is arguable that the pricing decision is the most important decision that any organization makes given its critical impact on revenue.

Other things being equal if you raise price the quantity of your products or services that customers are willing to buy will fall and vice versa when you drop your price.  It’s important to note, however, that a decline in the physical volume of sales as a result of a price increase does not necessarily result is a decline in revenue.  It might (and in fact often does!) result in an increase in revenue for the simple reason that people do not consider price to be the most important factor in their decision to purchase or, to put that another way, “all things” are NOT equal.  Economists refer to this situation as inelastic demand and the more effectively you can “brand” your products or services and/or differentiate your business in other ways, the more pricing power you will have.

The big point is that you should always focus on pricing for profit not for revenue.  If you have a lower cost structure than your competitors then you can drive home this competitive advantage by pursuing a low price strategy.  If there are enough customers who consider price to be an important factor in their purchasing decision this would be a successful strategy–but note, the essential strategic focus is profit not revenue.  Even though you have a cost leadership advantage you may also be able to differentiate in other ways that are valued by customers in which case you may choose to “bank” your cost advantage and let those other points of difference drive your volume.

But what if you do not have a cost leadership position? There may be times when you must consider lowering your prices.  For example, suppose there is a downturn in the economy and a key customer demands a price drop; you probably don’t have a lot of choices unless you have significant supplier power to match your customer’s buying power.  As long as the agreed price is greater than the variable costs associated with supplying the product or service you will achieve a positive contribution margin.  This would be a rational pricing decision in the circumstances.

The above situation should be viewed as a special case because simply generating a positive contribution margin will not necessarily yield a net profit at the end of the day; this will only occur when your total contribution margin exceeds the total of your fixed costs.  Any rational pricing decision needs to be cognizant of costs as well as pricing realities because although in the short term a loss may be tolerated as long as there is still a positive contribution margin, in the long term it will be necessary to raise prices or find some other way to reduce costs in order to return to profitability.

Remember, however, you may not have to drop your prices across the board (this should be an absolute last resort strategy) nor do you have to drop your prices for all of your customers.  When you consider just how much additional physical sales volume you need to compensate for a price drop it’s easy to see why such a strategy will inevitably lead to lower profit.  The table below shows that 50% more volume would be required to maintain your profitability if you were operating on a 30% Gross Profit and you were considering a price drop of just 10% – even if customers were that responsive to a 10% price cut it’s highly unlikely you would be able to accommodate a 50% volume increase with your existing capacity constraints.  You can download this spreadsheet by clicking here.

Margin Table

There are other strategies you might consider.  For example:

1. Offer a range of product or service offerings with different price points ranging from high to low.
2. Articulate very clearly what your value proposition is and price accordingly.
3. Don’t voluntarily discount prices.
4. Unbundle components of your offering.
5. Bundle additional components into your offering (this might be done jointly with another business that deals with the same type of customers as you).
6. Turn products into services.
7. Turn services into products.

By far and away the most important strategy to implement in tough times is an unrelenting focus on your customer service protocols.  For the most part, customers are not moved one way or the other by discounts.  If you are attentive to your customers’ needs you should not have to discount to retain their loyalty.  What’s most important is that you don’t fall into the trap of believing that in tough times revenue is king.  Cash is king and cash flows from profit together with sound working capital management.

Listen to a conversation I had with the manager. It’s a 10 minute chat – 10 minutes well invested as you’ll hear some good advice from someone who thinks just like YOUR clients.

One of the matters that came up in discussion was how the FGR model could be used to graphically show the lunacy of focusing on volume rather than margin in tough times so I gave him a working copy of a small Margin Table application for him to take away and play around with.  A couple of days later he sent me a copy of a memorandum he’d just sent to his management team.

I have reproduced his memo below after removing all confidential data but otherwise what you see is what he wrote — this is precisely the sort of analysis every single one of your business clients need to be having with you today.

Hi Team

Please see an attached spreadsheet called Margin Table that graphically shows the negative effects of discounting our pricing to win work and the profit impact  of gaining 1 or 2 or 3 percentage points of margin operationally or as a pricing strategy.

As a team we have had many discussion over the last few months on the impact of discounting work just to win a job and what that means from a revenue perspective to ensure we achieve our profit target.

By making the decision to invest our capacity (a finite resource) in lower margin work, as you can see from the table, the pressure that puts on us to bring in more revenue is great.  Take our budgeted Gross Profit Margin (GPM) of 25% (currently our YTD is actually GPM 23.5%).  If 2009 pans out as expected and economic times become harder and we find ourselves cutting margins to get work or we continually find ourselves chasing jobs on price and cutting margins as a result of competitive pressure we’re going to be for a really tough time.

For example, say we cut our price by 4 percentage points (to a GPM of 21%), to compensate for this deployment of capacity (overhead) at this lower margin we will need to find an additional 19% of revenue to maintain budgeted profitability (or $X.Xm of additional work over and above our budget revenue).  With work already being hard to get, that’s going to be hard to achieve.

Exactly the same thing will apply from an operational perspective.  For example, if we are loosing 4% on the job due to poor supervision, cost management, poor estimates, etc. the same impact applies.  You can also see that if this goes to 10% as a result of both poor management and soft pricing (say a GPM of 15%), we will need to find an additional 67% of revenue ($XX.Xm) over budget to compensate for this and remain at the same profit level.

As you are all aware, any business has an overhead commitment that can deliver a certain capacity.  In our business our capacity is not determined by machine output BUT people output (administration, supervision, estimating, sales, management, etc) and as such any overhead investment can only deliver a finite capacity before additional costs need to be brought into the business.  As you can see at a 10% erosion of margin any business with our GPM will run out of capacity to deliver the additional 67% of revenue required, assuming it can find the new work, no matter how efficient.  As such this business strategy is an irrational and fruitless exercise.

As with all things, the inverse applies (and remember in business it is far easier to loose money than make it).  If we can gain an extra 2% at the pricing stage or drive it operationally on the job, that means 7% less revenue we will be needed that year (assuming a 25% GPM).  With our revenue target of $XX million an extra 2% means we do not need to find $XXXk worth of work to achieve the same level of profitability.  We all know how hard it is to find $XXXk worth of work, it’s usually easier to get an extra 2% operational improvement or increase in price by selling harder the non price benefits of using our services.

This is even more valuable information for the smaller branches as you will run out of capacity far quicker than the larger business units.

I hope this is useful information and please remember it the next time we are having discussions over margins, pricing your next job and why we cannot let them fall.  I understand that all jobs must be priced on a case by case basis BUT the overall end result must achieve the budget GPM (in our group for this year it is 25% – that is a 33% mark up on cost) and every fraction of a % drop from this makes life very difficult, to the point of becoming impossible.  It will also be a false dawn as everyone will be working hard and feel they and the business are very busy but the end results will not be there financially and this can break morale.

This memo reflects the type of conversation every business advisor should now be having with his or her business clients.  In tough times it is margin rather than volume that’s important.

Too many of your clients are knee-jerking into the wrong actions in a desperate bid to maintain market share and you need to be able to show them the way.

Now you’d think that if someone is that good there wouldn’t be much pressure on him to work on getting better. From 1999 to 2002 Tiger absolutey dominated the field but towards the end of 2002 he was having a problem with stress on his left knee and realized that something had to change for him to stay at the top. From 2003 through 2004 he worked on developing a new swing adjustment to take pressure off his left knee and in this period his winning streak all but disappeared.

But the 2005 season saw a new Tiger. His swing was now working for him and he won the 2005 US Masters and the 2005 British Open as well as several other PGA events. But 2006 was not a great year, his father died in May and he took some time out to be with his family but by the time the 2006 Open came around at Royal Liverpool Golf Club he was again at the top of his game and won by 4 strokes.

There are several lessons for us mortals in this.

First, no matter how good you are, there’s always room for improvement

Second, what’s worked well for you in the past in not guaranteed to keep you at the top of your game

Third, even the best performers in their class will occassionally deal with adversity and they need to perservere to get back to their top form

Fourth, no matter how good you are there will be times when you lose your touch and that’s when you must take a close look at what you’re doing and have the guts to make changes if you want to return to your best.

One of the concepts Harari introduced that I particularly liked is what he calls the Madonna Effect. Madonna, he notes, is a phenomenally successful pop star having sold more than 140 million albums over 25 years but in addition to that her concerts are sell-outs, she’s done movies, written books and created videos. Robbie Williams, himself a gigantic star, says “she’s an absolute legend and makes us all look like amateurs.”

Madonna obviously has staying power in a very fickle industry. Harari notes that her success comes from her “extraordinary ability to reinvent herself in anticipation of many fashions.” Every couple of years she comes up with a new way of presenting herself and her work. She takes note of what other groups are experimenting with, then in her own creative way she gets in front of the pack and leads her audience there—far enough away from conventional wisdom to be considered somewhat of an edgy rebel but not so far to be labeled bizarre. This is not unlike the famous statement made by Wayne Gretzky when asked why he scored so many goals in his career he said, “I skate to where the puck is going to be, not where it has been.”

The ability to re-invent yourself is a characteristic of great business leadership. Our environment is in a continuous state of change and in such circumstances businesses need to cintinuously re-think their business model. You need only look at IBM under both Lou Gerstner and then Sam Palminsano and to all of the “Good to Great” companies documented by Jim Collins to realize that the difference between ordinary and great is a willingness to apply the Madonna Effect. The leaders of all of these companies took a critical look at where they were and made a conscious decision to go to a better place.

If you accept the proposition that winners stay ahead of the pack you should be behaving as a Madonna. Here’s a self test that I have put together based on Harari’s thoughts that you might like to use to determine how well you are doing at it. On a scale of 1 to 5 where 1 is a resounding NO and 5 is a resounding YES how does your firm stack up?

No matter how good you are now you know in your heart that change is inevitable and that good today does not mean good forever. You’re therefore constantly looking for better ways of doing things and for different market opportunities.

You closely monitor trends in your environment and visualize how your firm will be taking advantage of a different set of circumstances.

You are not afraid to walk away from current products, services or customers or if you believe there is a greater opportunity to deploy your resources for greater long term returns elsewhere.

You constantly experiment with new ideas and you invite your customers to experiment with you and help you find better ways to create value for them.

You are deliberately provocative. Your ideas may range from the sublime to the ridiculous but you could never be accused of being indifferent.

You passionately believe in a different future for your business and your ability to prevail but you are still firmly connected to reality. Jim Collins refers to this as the Stockdale Paradox and notes that it is a fundamental characteristic of all the great companies he studied.

You are always upbeat, optimistic and excited about the future and what opportunities it offers your firm to break from the pack.

How did you score yourself?