Tag Archives: profitability

competing with lower prices is stupid

The other week I said “Cutting costs and only competing on price is a death spiral. Always has been, always will be.”  I then got asked why a couple of times, so I thought I might expand on this point a bit.

I don’t want to give a lecture, but I thought it might be time to delve into a bit of business 101 first.

Business FailureCosts generally come in two flavours; the first type type is variable costs which can also be known as direct costs, cost of goods sold, cost of materials etc.  Variable costs are the $10 that you spend to acquire a light fitting that you sell for say $25.   The second type of costs are the fixed costs; also known as indirect costs or overheads.  These are costs like the annual rental for the shop you sell the light fittings in.  Of course some costs are hybrids, having a fixed and variable component.

The key to sustainable profitability is understanding exactly what yours costs are and how much of your variable and fixed costs to get allocated to each dollar of sale.  Unfortunately, this is where things get tricky.

  • The timing of variable costs may be out of sync with the sale. Take for example General Aviation.    Every time you run the engine on a light aircraft, you not only use fuel, but  create an engine maintenance liability.  The engine may need to be serviced every 1,000 hours and overhauled every 10,000 hours.  This is horrendously costly and must be factored in to the cost of running your business.
  • The true costs may be hidden from you. Take the example of employing a computer service person.  He may cost you $75,000 plus superannuation at $6,750.  This makes a total of $81,750 , a figure you thought you could be confident about.  However that employee is only going to work 48 weeks of the year as you have also offered them leave.  This means you will need to buy in a another resource to cover them, whilst they are away.  Turns out that resource is going to cost you $10,000 for the four weeks.  So your labour costs are actually $91,750 – or 22% higher than the salary offered, and we haven’t even discussed other on costs such as payroll tax yet.
  • It may be difficult to “apportion” fixed costs to every sale due to uncertainty about expected revenue. You can argue “but I don’t know if I will sell $400,000 or $500,000 of light fitting this year, so how can I apportion the  shop rental when working out my costs?”  The answer is of course to make an estimate or budget, and review it regularly.  Its probably better to estimate on the conservative side so that any variance is likely to be in your favour.

These three examples, and I’m sure there are more, highlight the key to sustainable profitability – “knowing your costs”.  But they are not the key to being competitive and having a successful business.  This is because you will  always have competitors that don’t have this insight into their products and services.  They will unwittingly sell below cost, and when the costs that they haven’t factored in eventually appear, their business will go under.  Sometimes they will naively sell below cost deliberately to buy market share in the hope they can ramp up prices later.  Unfortunately they you don’t get to win then, because there will always be another fool ready to step into their shoes and compete below cost.

Over the last 20 or so year, I have worked in oil, electrical equipment, engineering, computing and marketing.  In every industry I have seen multiple examples of firms competing with prices that are too low to sustain business over the longer term.  In every case when these businesses fail, they were immediately replaced with someone with the same strategy.  There will always be people prepared  to run unprofitable business, mostly because they don’t know they are doing it.

So its quite obvious to me that competing with “lower prices” is generally a stupid idea.  The nice thing though is that there is a virtually unlimited number of other areas you can compete on, and you are only limited by your imagination.  The first step is to find out what your customer’s actually value, because its always going to be more than lower prices.

A modern parable for tough times

Most forecasters seem to agree that despite the fact we have sidestepped the worst of the global financial crisis, we still have tough times ahead. And in tough times, one of the things you need to do is be innovative and work your assets harder.   Note,  Competitors that don’t innovate – die. Which I like to think of as nature’s bonus for innovating.

Anyway, there is a parable I know which helps get the juices flowing when thinking about how to work your assets harder. I call it “How many times can you sell a piece of land”.   It goes like this:

Once there was a man who bought a piece of land
1. He sold the metal under the ground to a mining company who it dug out and left a pile of dirt.
2. He sold the pile of dirt to a landscaping company, which left a hole in the ground.
3. He sold the hole in the ground to a waste company, who filled it up with rubbish and refurbished the land.
4. He sold a lease on the refurbished land to a sporting club, because nothing could be built there yet.
5. He sold the land to a long term investor.

Selling one piece of land five times? Gets my juices flowing.

How I learnt to love bad customers

I think that my journey to love bad customers started with Warren. He was making a reasonable living out of multi-level marketing and wanted to embrace the internet.

Highly enthusiastic, Warren would never plan because planning and paperwork were beneath him. Instead, everything occurred at the last minute and had to be the latest technology because he was dynamic go-getter. Over a 12 month period, Warren taught me a variety of things about writing proposals, service delivery and collecting cash.

Warren taught me that my ideas are just as valuable as my work. He would endlessly ask for advice and insist it was part of the sales process and not chargeable. He taught me to write proposals for the consulting and initial design, not just provide it free.

He taught me to avoid showing costs for individual line items in my proposals if I could avoid it. If a costed item wasn’t the core deliverable, but part of a quality approach, he would ask for it to be removed to lower the cost.

Warren also helped me understand that the customer wants best quality for the lowest price. Offering him choices via more than one proposal, allowed me to negotiate in the quality/price/timing tradeoff.

Warren never bothered to keep any paperwork. He was a wheeler-dealer. To get paid, he would write “approved” on invoices and get us to claim them on his Diners Club.

At the end of our relationship, he rang Diners Club and advised them that he hadn’t approved a number of things we had claimed and that we were bad guys. I spent a lovely afternoon with Diners Club working through his file and proving we weren’t. I am glad he taught me to keep good records.

Finally, Warren taught me that no one respects lawyers’ warning letters. Go hard and sue as fast as you can. It appears that a lot more people respect a summons. Thank you, Warren.

Then there was Joe. Joe taught me to specify deliverables carefully because Joe would always fight to include as much as possible into a fixed price.

Dealing with Joe was difficult. He would also introduce additional items, “just add a little here, it’s nothing”. Downstream, of course, he would argue that we had not delivered in the timeframe we had promised, even though it was all his little changes that had created the differences.

While I was dealing with Joe, I was renovating my house. I found that I was signing variations on my house, and that even when there was no cost impact, there was always a time impact. “You want us to not fit out your kitchen? That will reduce your costs by $12,500 but your contract time is increased by 20 days.”

With Joe I started generating variation agreements: one-page documents that would get signed, or not signed at our weekly meetings. I found that there was never a complaint when this discipline was introduced from the beginning.

The there was Linda. She taught that me that I need to specify exactly how my warranty worked, because unless I told her upfront, I would always end up wasting time and pissing her off when she found out my work wasn’t guaranteed forever, even after her cousin had made some minor changes.

Finally there was Mark. Mark taught me that everyone is an expert. Mark used to look at my quotations for multimedia work and insist that it wouldn’t take as long as I forecast.

His position was that he shouldn’t have to pay for my time checking my work as I should be getting it right in the first place. Mark taught me to quote on deliverables, rather than provide hour estimates.

Thank you, guys.

How I learnt to love bad suppliers

I got a quote the other day from a computer guy, who emailed: “I will charge you $350 to upgrade your Drupal installation to the latest version.” This was probably the worst quotation I have ever received. (Drupal is an open source content management system that I use in one of my businesses.)

So I thought I might write about bad suppliers, whom I learnt to love even before I learned to love bad customers.

My first bad supplier experience (that I really thought about) was about a decade ago. I was the financial controller at a multinational engineering group at the time, and I received a bill from an IT company on which was simply stated: “Server tweaking – $750.”

At this point in time I realised that customers enjoy having verbose invoices, and I was instantly grumpy because server tweaking just didn’t sound like value for money.

In later life I actually created a series of paragraphs for use on invoices. When my techo said, “I tweaked the server” on the service sheet, I would paste into the invoice a large standard paragraph about applying patches, checking logs, changing settings, checking virus controls, etc. Everyone was happy.

Then there was the consulting group, who taught me that the time that it will take to complete the work is completely disconnected from when the work will actually be scheduled.

And a special thankyou to my heating guy, who taught me that you need to specify exactly what is excluded from a quote if you want to avoid a customer absolutely hating you and wishing acid rain pouring down at your place.

In fact, I have learnt so many lessons, that I created an open letter to anyone who wants me to buy from them, that includes the following points.

  • Only quotations in writing will be considered.
  • Let me know whether the cost includes GST.
  • Let me know which costs are once off, and which are recurring.
  • Let me know what isn’t included in your quote that might be expected to be.
  • Are there other third-party costs to be incurred?
  • Is invoicing linked to milestones, and if so what are they?
  • When will the work be scheduled?
  • When will the work be completed?
  • What do I need to supply, and by when?
  • What are the risks involved?
  • What are your payment terms?
  • What milestones will I be billed against?
  • What is your warranty?
  • Whom exactly am I buying from?
  • How will you communicate with me over the course of the job?
  • Who will be working on my job?
  • Where will the work occur?
  • Don’t charge me for learning on the job, unless I am getting a discount for it.
  • And finally, if you don’t invoice me within 30 days of doing the work, expect me to pay in the same timeframe.

So of course the computer guy didn’t get the work. In fact, he didn’t even get a response. But if he ever follows me up, we will have plenty to talk about.