Your Clients – Page 6 – Ric Payne's Blog: The Consulting Accountant

What We Can Learn From A Carwash Cafe

I have just been asked what I’ve been up to — I have been very quite on the blogging front lately … here’s why. I’ve been totally re-writing the Boot Camp content to make it more focused on a program that will help you and your team get real results for your clients and your firm. Keep your eye on this spot for more details.

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. Continue reading “What We Can Learn From A Carwash Cafe”

Price to Grow Profit not Revenue

In a recent post I referred to memo a business manager sent to his direct reports concerning the need to maintain margin even in tough times. I received a comment from a reader who wanted to know my views about pricing when you have surplus capacity in a industry with many competitors and low entry barriers. His view was that discounting makes sense in such a case especially if you have a lower cost structure. On the surface I would have to agree with that suggestion but I thought it would be useful to throw a few more thoughts around.

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.

There are other strategies you might consider. For example:

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

A businessman’s view of margin management

I recently had the pleasure of meeting socially with the manager of a large business unit of a listed public company. As any self-respecting accountant would do immediately after meeting someone new, I invited him to look over my shoulder while I did some work on the Fundable Growth Rate model in GamePlan. His eyes lit up and he immediately recognized how valuable this type of analytical tool must be for our members’ business clients. He was so impressed with the FGR application, especially in the current economic climate that I decided to record the conversation we were having so you can get a sense of how business people relate to analytical tools such as this.

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.

Podcast: Play in new window | Download

Lessons from Tiger Woods

Few people would question the proposition that Tiger Woods is by far the best golfer in the world and in time he will probably go down in history as the best ever.

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.

The Madonna Effect

Last year I read a book by Oren Harari called Break From The Pack: How To Compete in a Copycat Economy. It is a book worth reading and certainly challenges the idea that the best way to build a great business is to copy what everyone else is doing.

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?

Do what you believe you were put here to do what you do

I was talking with a member a couple of weeks ago and he remarked that he’s quite happy with the way his life has gone he can’t help feeling that he’s not doing what he set out to do and what he knows he’s capable of doing.

I asked him what he meant and he said that when he went to college and did a business degree he found accounting both interesting and something he thoroughly enjoyed studying. He particularly liked the idea that it would offer him lots of business opportunities and he saw a future in management or as an advisor to management.

After graduating from college he accepted a position with a second tier firm and together with a bunch of other new employees found himself involved in a wide variety of engagements that gave him excellent experience and he progressed through to manager level quite rapidly.

Soon enough he was offered a senior position with a quality regional firm and the promise of partnership which eventually came and before he knew it he was caught up in the day-to-day rabble we call public practice.

Financially he’s doing well and from that point of view he has no regrets but when he looks back on his professional life to date he said he can’t help feeling that he’s allowed himself to be hijacked by a system that drives you down the same path everyone is on simply because it’s there and relatively easy. But he’s not helping people build a better business, he’s merely a service provider that businesses need. Perhaps more importantly, he’s not really getting much challenge or satisfaction from what he’s doing.

He concedes that most of the things he learned at college have been long forgotten and what he felt he had a real talent for and the potential to do, seems to be slipping further and further from his reach.

It’s so easy in these circumstances to rationalize the situation rather than take personal responsibility and control. I believe a serious challenge we face after we become owners of a professional firm is the belief that we have arrived! We find ourselves making quite a nice income so there’s no need to push ourselves to learn new skills and perfect our performance—this is pay-back time. The hard work, we think, is behind us! We reach a level of acceptable performance (perhaps mediocre is the word I should use) at which point we more or less plateau and so does our firm.

But I think there comes a time when we reflect back on what we’ve accomplished and ask ourselves the question: what could I have done if I’d exploited my full potantial? If you ask yourself that question and you feel a twinge of guilt, there is no better time than now to do something about it.

There are many people who never stop seeking to achieve what they believe they’re born to do. I find people with this inner drive very inspirational. One such person is Paul Potts, a mobile phone salesman. Take a look at this video to see what I mean then go out and do what you are capable of.

httpv://www.youtube.com/watch?v=1k08yxu57NA