Crisis tip: Think of increasing cash revenues, not of reducing costs

The income statement has always been the focus of business. It measures profitability. The classic equation is revenue less costs equals profit.

Revenue is a reflection of quality or customer satisfaction. The greater the satisfaction of customers and/or the greater the number of satisfied customers, the greater the revenues will be. Costs are the expenses the entrepreneur incurs in the delivery of quality to the customers. Profit is a measure of productivity because it measures the efficient use of costs to deliver the revenue. The less cost per unit of revenue, the higher the profitability.

In times of crisis, the tendency of most entrepreneurs is to reduce costs. This is dangerous. The entrepreneur may reduce the wrong costs and, in the process, also reduce revenue. If the cost item reduced is critical to the quality the customer is looking for, then one will end up not with higher profits but with many low-cost items in inventory.

This brings to the fore the new jargon to the standard accounting glossary of terms such as LIFO and FIFO: FISH and OSSH. LIFO means last in first out and FIFO means first in first out. Now comes FISH or first in still here! And OSSH or oh shucks still here!

The presence of non-moving inventory is a signal that the product is unwanted by customers. Reducing costs may result in money out than money in.

In times of crisis, it is better to bring money in. This means increasing cash revenues. This means increased quality management. This means better customer satisfaction. And if the incremental cost of delivery quality is less than the incremental increase in cash revenues, then there will be more cash in than cash out.

Q. Are there firms that use this increase-revenue approach rather than the reduce-cost approach?

A. Yes, many have used this approach of increasing revenues by increasing the number of customers. I will not mention names but will instead use examples.

In times of crisis, the budget of a family will tend to buy less goods. Entrepreneurial firms have used the concept by not finding ways to reduce the quality of the products sold but instead by keeping the quality and repackaging the products into smaller packs.

If the food packages are not re-packed into smaller volumes, the customer will have to make a choice between one product over another. But if the packages are made smaller, then the customer can have a mix of products instead of a choice between products.

This approach has been used with tooth paste, shampoo and even mayonnaise. There was no reduction of quality nor money out. There might have been an increased cost but this was offset by the corresponding increase in revenue because the customers got what they wanted.

Truth to tell, if one were to compute the cost to the customer, it might have been cheaper for the customer to buy the bigger pack. However, under the circumstances, the customer did not have enough cash to buy it without trading off other purchases.

Clearly, it is not a cost issue but a cash-flow issue. This is also being done with automotive products. Instead of stripping the cars of amenities, the terms of payment are adjusted for longer periods and lesser amounts.

Q. Is the approach only applicable during crisis times?

A. No. Even during good times, the approach of increasing revenues by increasing the number of customers can be used. If the entrepreneur wants to increase revenues by entering a market that has cash-flow constraints, the approach is very applicable. It allows the cash-constrained customer to "afford" the product. Of course, this assumes that the product can be re-packaged.

One student of mine in the Master in Entrepreneurship (ME) program told me that she wanted to reposition her product for a cash-flow constrained market. Her product was a book. I told her to think about how the book could be repackaged. Could it be sold in chapters? If it were a cookbook, could it be sold by recipe? Could it be sold by episode? How could it be broken down into a product that the customer would still buy?

The rule is: do not bundle in order to have better value. Do not downgrade the product by reducing its quality. Un-bundle or finely slice the product so that the customer can afford it. But do not reduce the quality of the product. Reduce the volume instead. This is also known in the vernacular as the tingi approach.

Over at AIM, it is not uncommon to find student-entrepreneurs who are engaged in cross-businesses. An ME student in the restaurant business was setting up a new branch and was in discussion with another ME student in the air-conditioning business. The business transaction, which initially involved the purchase of air-conditioning units, ended up as a purchase of "cold air".

The restaurant owner wanted terms for the purchase of the air-conditioning units. The cash was to be used for the other requirements of the investment. The counter-offer of the other student went thus: "I understand your predicament. So, can I just sell you cold air? Pay me a monthly lease or your units and I will assure you that when you turn it on, cold air will be provided."

As it turned out, the deal was a fixed monthly lease for a fixed period of time to cover the cost of the unit, installation, maintenance and servicing – plus cost of money. This scheme delighted the restaurant owner since the business would pay for the air-con from its earnings and not by way of a front-end investment.

The air-con entrepreneur locked in the customer for service and maintenance over and above the unit and financing margins.

The other approach is to break down the cash-flow requirements. Some have called this the "lay-away plan" while others used the installment plan. This has always worked for cash-constrained markets. The idea is to increase revenues by making payments lighter for the customer. Remember, the true customer must pay for costs and profits. Otherwise, you do not have a customer. You have a "cost-to-me".

(Alejandrino Ferreria is the associate dean of the Asian Center for Entrepreneurship of the Asian Institute of Management. For further information/comments, you may mail him at: [email protected]).