Nominal versus Real
In recent time inflation in Australia and most parts of the western developed economies has been low. However it has been the case particularly here in Australia that some years ago we had high levels of inflation. Inflation has a role to play in marketing of our products and services.
Many marketers say that if you have a product that is for sale at $50, don’t sell it for $50, sell it for $75 discounted to $50. As time goes by inflation could eat into your profit and you’ll have to raise the price, but if you have it advertised as a reduced figure you can reduce the discount. So the price would still be $75, discounted now instead of $50 to say $55 or $60.
This technique is often done by a lot of the retailers and as consumers we look at the top line price, even though the reality is that top line price was never probably a real price. The issue of understanding the power of inflation in pricing is important to consider.
Photo by:- Alan Cleaver
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The Decisions We Make About Price
The decisions we make about price have some important lessons for us in selling our products and services, so lets consider a survey question that was asked by two researchers in determining how people make decisions about price.
“Imagine that you were about to purchase a jacket for $125 and a calculator for $15. The calculator salesman informs you that the calculator you wish to buy is on sale for $10 at the other branch of the store located 20 minutes away. Would you make the trip to the other store?”
This question was asked in 1981 when $125 and $10 was appropriate, so accordingly we could rephrase the question to maybe say a jacket worth $300 and a calculator or some computer device worth $150. Now the calculator/computer salesman informs you that the item that you wish to buy is on sale for $120 at another store, would you make the trip?
When this question was asked the majority of people said they would. The question was slightly varied and another group of people was asked. In the different version the jacket was only $15 and the calculator $125 and now the calculator was on sale for $120 at the other store and the question was, “Was that worth the trip?” and most said no.
In both versions of the question the buyer is planning to spend $140 total and the drive saves exactly $5 so why are we more willing to drive across town to save money on a small purchase than a large one? It is this understanding of the behaviour that is driving these pricing decisions that is important for us to understand in pricing the products and services of our business.
Photo by:- Andres Rueda
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Models Are Useful Until They Are Not
Matt Church of Thought Leaders Global recently stated “Models are useful until they are not.” This comment has provoked some thoughts for me.
This statement is probably best illustrated by the financial services industry which has lead to the global financial crisis of 2008 and 2009 relied on some investment models, but unfortunately could not see when they were of no use.
In business (be it small or large) we can get trapped into relying on a model of business, a model of how they service their customers, a model of how what services and products they provide and don’t realise when they are no longer useful.
Within a business people can get trapped with respect to their understanding of various aspects of their business eg. customers. They may have three years ago had an exact picture of what their customers looked like, where they shopped, how they shopped, how they behaved, what the decisions were that they were making, but is that model of their customer still the case today? Or have the customer’s behaviours changed and altered in some way that the business needs to adjust for?
Models are useful until they are not.
When do we recognise when the model that we are operating under is no longer useful? The business needs to have a culture of constantly looking for new information that would enhance their way of operating or mean that they need to change what they are doing. The management of the business needs to have the attitude of being able to be willing to explore all possibilities, to watch the information, but they need to be willing to measure and review the necessary information. If the information that you are looking at is the profit and loss statement and balance sheet, then that’s useless; it gives you no understanding of whether the model under which you are operating needs to change. You need to have a complete and detailed understanding of your customer and exactly know what they are doing to determine whether the model you are operating under is useful.
So models are useful until they are not. Is the model that you are operating under still useful?
By the way I am a Mentor at Thought Leaders Global. If you want to know more individual or organisational thought leadership then please contact me.
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How to use metrics to stay focused within a vision.
The secret to stay focused within a vision is to find metrics that make your achievements seem small.
This may seem a little crazy. Often we want to celebrate our and our teams achievements. We don’t want people to lose heart in the goal. So there is a balance to be achieved here.
We can have the various goals that reward and motivate performance along the path but also never lose sight of the vision.
To this end I heard a senior executive of Pandora Radio www.pandora.com stating that despite their magnificent growth figures they still only had about 2% of the total radio hours in the USA. So the metrics of growth, number of new subscribers were motivating metrics along the path but the overall metric of share of radio hours keeps them focused on their long term vision. If there was not the metric of radio hour share then they could be distracted by their achievements. It could lead to complacency.
It is still necessary to celebrate the progress but also staying focused on the vision is important.
What metric do you have to make your achievements seem small and keeps you focused within a vision?
Photo by:- Krisph
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Cash Flow Measurements – Some Useful Metrics
As you know from reading my blog, I’m a firm believer that there is one main metric in a business of which we need to focus on. This does not mean that there aren’t other support metrics which can be useful to the management of the business. The one main metric provides an insight to the future whereas the other support metrics usually are financial and provide analysis of what has happened.
Today in this blog post I’m going to cover a couple of cash flow metrics, which give an insight into the management of cash flow in a business.
The first one is cash flow to sales ratio. This is calculated as: -
(Net Income + Non-Cash Expenses - Non-Cash Sales) ÷ Total Sales
This shows cash as a percentage of sales and its variation from the net profit margin is where we need to analyze. If there is a significant positive or negative variance, then we need to look at what is throwing off cash, or soaking up cash.
This metric can be also done on a product or service basis, so that we’re looking at the cash flow generated by each product, to determine whether there are products that are soaking up cash more than they should. Even though whilst profitable we may need to look at how these product lines are dealt with.
The second metric is the fixed charge coverage ratio. This is calculated as:-
fixed costs ÷ by the cash flow as defined above.
In respect to fixed costs these are all the commitments that the business has to meet no matter what happens. So it could be loan commitments, lease commitments, rent commitments on an office space or factory premises etc.
All of the fixed costs that are necessary to the management of the business.
This fixed charge coverage shows how much cash flow is being generated above the fixed cost coverage. It is assumed that if we aren’t meeting our fixed costs then we would not be able to keep our business doors open.
These two metrics are useful in the measurement and management of cashflow.
Photo: Ivan Walsh
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The Hospital Debate - Measuring Effectiveness or Efficiency
Health care and management of the hospital system is vexed issue here in Australia as well as the very significant bill in the USA. Recently there was an excellent article in Harvard Business Review titled “Turning Doctors into Leaders” . In this article Dr Thomas Lee states that one of the significant problem of the US Health system is that results are not being measured and people being held accountable to this.
The more I have thought about this the more I agree. In the Australian context there has been a lot of discussion recently regarding the efficiency or lack of efficiency of the State based hospitals. The conversation has focused on dollars spent, waiting lists, number of admin staff to medical staff etc.
What there has not been any meaningful data on is the effectiveness or otherwise of the hospital system. There is no measures on the health outcomes not just the inputs. As Dr Lee states the rising cost of health is a symptom not the cause.
A very important step would be for governments (and other administrators) to start collecting and measuring health outcomes. With this data and the measures then people need to be held accountable. Why is this so hard for our governments to do? Why is their focus only on the inputs?
This measuring of health outcomes is possible. The Cleveland Clinic in the US not only measures health outcomes, it publishes the results on its website for all to see. It compiles and publishes Quality and Patient Experience Measures. The model is here. Accountability is very public. It can be done and we must do it.
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Australian Wellbeing Index - A good measure of performance
French President Nicolas Sarkozy is reported to have said at the Group 20 Summit in Pittsburgh in late 2009 that the world could have predicted the economic crisis had it looked at happiness, wellbeing and sustainability.
Governments and intergovernmental organisations have been looking for additional measures to the traditional quantitative measures like GDP (gross domestic product) and GNP (gross national product).
Well here in Australia there is the answer. The Australia Unity Welling Index is a simple but effective index of wellbeing. This index is compiled scientifically and is meaningful. There is the Personal Wellbeing Index and the National Wellbeing Index.
Presently the index has risen to 76.3 on a 100 point scale which show Australians are more satisfied with their future security and standard of living.
There are many interesting stats within the data from the index however the point is that qualitative data collected in a correct manner can add more value to the quantitative data. It completes the picture of the nation or the business.
You can access the index measurement tool on australianunity.com.au/wellbeingindex/
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Cash Flow Management – A Useful Metric
There are many financial metrics that can be utilised to look at the working capital and cash flow issues of a business. For the purposes of this post I want to focus on one number that can be a useful tool for a business.
This is a financial metric called days of working capital. To calculate this metric it is:
Working Capital ÷ Sales By Day
Working capital is defined as Accounts Receivable + Inventory – Accounts Payable.
This metric shows how much working capital we have on hand, and we need to cover sales. If the answer comes up as 22, then we have 22 days of working capital on hand to cover sales generation. Whilst this is a historical indicator, it is still a useful number to know to consider sustainable growth ie growth that we can fund from existing working capital.
Too many businesses fall into the trap of growing quickly and not being able to keep up with cash. This number shows a business how many days of working capital they have on hand and thus shows what sales growth is sustainable.
To be able to grow faster it will be necessary to add to working capital. This could be added by taking out a long-term liability, which will add to the current cash position of a business, to ensure that the sustainable sales targets are able to be met. This metric gives an insight into managing the sales and working capital needs of a business.
Photo: Alan Cleaver
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Quantitative and Qualitative Measures
Quantitative data never tells the whole story. Quantitative data is easier to collect and analyse and thus we tend to give it a far greater importance in our business. The accounting industry makes it easy for us to get a raft of quantitative data on the performance of the business.
Qualitative data though completes the story. But collecting and analysing qualitative data is a much harder process, and thus often is neglected in the management of the business.
For example to make a good product decision we need to know what is being sold, to whom, at what margin, this is the quantitative data. But we also need to know why some products are selling more than others. This question of answering the why takes a qualitative analysis of our customer’s decision, and often this involves judgment calls. But it is this qualitative data that will complete the story about the reason why a product or service is selling more than another.
The quantitative information may imply, a pricing or a market need, but the qualitative data, ie. actually asking the customer, may indicate that there’s something altogether different that is going on.
We need to have both qualitative and quantitative measures in a business. We need to have the judgment calls as much as we need to have the cold hard factual financial analysis. The blend of qualitative and quantitative data will give us the tools to lead and manage a business.
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A Metric to manage inventory & sales growth
Inventory management, or stock management in a business is critical to both the cash flow and sales growth. Too little stock has the issue of effecting sales, and too much stock has the issue of negatively effecting cash flow. It is a fine balance of the stock levels that meet the twin criteria of cash flow and sales growth.
Larger businesses invest in sophisticated systems to manage this balance. They have invested in sophisticated ordering processes and reporting. In all businesses though it is useful to keep an eye on a measure that can give an insight to this balance. This measure is inventory compared with sales.
We measure this by: -
Sales ÷ Average Inventory
We can look at this on a monthly, quarterly or annual basis. This shows how much inventory we have as a percentage of sales.
The important issue with this metric is to measure it on a trend-line. A one off snapshot does not give a lot of an insight into the management of inventory. The trend of this metric though can give an insight as to whether our inventory policies are better managing or are negatively managing our stock levels.
It is not the metric that’s going to provide all insights into the business, but it is a useful measure, particularly looking at it from the trend-line.
Closely related to this is the average inventory turnover. This is having a look at how many times the inventory turns over in a year. The greater the turnover the better, because it is the velocity of the inventory through a business that determines both the sales and cash flow growth.
These measures can provide a useful insight into the management of an important area of the business, being inventory.
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