In two previous blogs, I reviewed the basic model and concept of the new business world presented by veteran speaker, Sam Bowers. Here are his views on added value, cost structure and accounting in its context.
Bowers claims “The concept of “added value” is one of the worst concepts introduced in the 90’s. Capitalism relies on price. Yet, the ‘best’ business books of that time tried to convince that you could fool capitalism and out-think the market on price. How many companies in those books are still in business?”
The buyer always controls price. You don’t. The only thing that you can control is cost. But, when customers ask you to lower your price, you may walk away from the business too quickly. The old accounting and pricing structures don’t allow you to calculate what your true “Kenny Rogers Line” is. To thrive in the new economy, you have to shift from measuring gross margin to net profit. You need to allocate all costs using activity-based accounting.
A typical manufacturing company’s P & L looks like this:
|COGS||(50,000)||Transaction or variable costs|
|SG&A||35,000||Fixed and allocate to customers based upon % of revenue.|
|Net Operating Profit||15,000|
Standard accounting measures transaction costs down to the gross margin line. After that, most other most costs are spread out below the line as a percentage of revenue. Spreading your G&A costs as a flat percentage of revenue is not valid because most of those costs are incurred to generate new business as illustrated by the example below.
Assume that new customers represent 30% of your annual revenue and repeat customers represent 70%. Under the old methodology, the new customers cover 30% of your costs, while they actually consume 80-90% of them. Repeat customers cover 70% of your costs, while they use only 10-20% of them.
Allocating SG&A costs by revenue makes your repeat customers look more costly than they actually are and vice versa for your new customers. How can you determine an accurate “Kenny Rogers Line” using this system?
Every business has “strings” of services that they use to keep margins high. When clients try to move you to the left, the old model says to add more strings (value added) so that the client will continue to see you as unique and allow you to keep your margins. After a while, you add so many strings that they become part of your basic product or service. In the new model, you have to unbundle your strings and charge for them rather than giving them away.
The odds that your clients want every single string are minimal. Unbundle them and identify how much each one costs. If clients want a string, charge them for it. If they don’t want the string, reduce your costs by the appropriate amount. Every string has to stop being a cost center and become a profit center. If you can’t make a profit with a string, drop it.
Eliminate the idea that you have fixed costs. In the new economy, there is no such thing as a fixed cost. Office space, desks, postage, etc. —in today’s world none of those is a given. Even things like full-time employment and benefits for your employees are not a given. Depending on your market and your product/service, your customers may not be willing to pay for those things. Identify all costs that your clients aren’t willing to pay for and get rid of them. In most cases, your biggest cost comes from still thinking that you are selling.
Stop using traditional cost accounting methods and move toward activity-based accounting. You’ll have a more accurate picture of what your costs are for each customer, and that gives you a more accurate idea of how to generate profit.
In the new economy, your new cost structure looks like this, where almost all costs are variable and revenue and costs are assigned to each service by customer.
In my next blog, I will review Bowers’ views on pricing.