Strategic Planning Analogy #553 Part 2: Revenue Statement

BACKGROUND
In my last blog, I discussed why the traditional financial statements (income statement, balance sheet, cash flow) are inappropriate for planning. In this blog, we will look at one of the documents to use in their place—the Revenue Statement.

THE REVENUE STATEMENT
The purpose of the Revenue Statement is to provide a strategic framework for predicting sales. Yes, the income statement also has a line for sales. However, the income statement doesn’t tell you why that number was chosen and what the strategies are to reach that number. In addition, as mentioned in the last blog, the sales line in an income statement is disconnected from the other lines which directly influence it, like marketing. To remedy these weaknesses, I designed the Revenue Statement.

Since there are so many different types of business models out there, the Revenue Statement would need to be tweaked a bit to fit each type of industry. But a rough example can be seen in the figure below.

1) The Baseline

The first part of the Revenue Statement is used to determine the baseline. This is what sales would be if nothing changed and there were no new strategic initiatives.

To calculate the baseline, one needs to make two calculations. First you need to project a baseline for the overall industry. This number would be based on anticipated demand and competitive response to that demand. This number would come from insights from your industry research.

Second, you need to project what portion of that demand (market share) you will get if you stick with your current status quo approach.  In other words, if you do nothing new, what portion of the business should you expect to achieve. In the example, we see that the baseline sales is expected to decline over time. This is not unusual, since if you do nothing to the business there is a greater risk of becoming less relevant and losing share to astute competition.

That is one of the reasons why strategic planning is so important. It helps a company find initiatives that will increase sales beyond the baseline.

2) Pricing Decisions

One area where strategy can improve sales is with pricing decisions. How should you charge for your offering and how much should the charge be? Should you use a Freemium model, where most pay nothing and only the premium customers are charged (like Linkedin)? Should you have tiered pricing like the airlines? Should pricing be raised? lowered? Should pricing be bundled like fast food combo meals (or unbundled)? Who do you charge for services (in health care it can be patients, insurers, government, etc.)? Is my strategic position anchored on low prices or something else?

Remember, sales is based on how much money you get for what you offer. Pricing decisions have a huge impact on how much money comes in. This can be very strategic.

It is a good idea to review your pricing strategy when planning and this is the place to do that. So in the second section of the Revenue Statement, you would state any changes to your pricing strategy. Then you would calculate the impact on your sales.

The impact could be threefold. First, your pricing decisions could impact overall demand for the product. For example, back in the 1980s, it could cost close to $100 to buy a prerecorded video of a movie. As a result, most people rented movies rather than buy them. But in the 1990s, Warner Brothers decided to slash the price its videos to $20 or less. Suddenly, the demand for purchasing videos went up astronomically.

The second impact is what a pricing change could do to your market share. If your change makes you more or less competitive in the marketplace, it should impact your market share (although keep in mind that competition may retaliate on their own pricing and mitigate some of your impact).

Finally, your sales will change at a different rate from your units if you change prices. For example, if you used to sell something for $1 and now you sell it for $2, your sales per unit double.

All of this gets calculated in the second section.

3) Marketing Decisions

Your baseline sales assume a baseline marketing expense. Any changes to that level of marketing should have an impact on sales. After all, you probably wouldn’t increase marketing spending if you didn’t think it was going to improve sales.

So in this third section, you put in the baseline marketing expense and the anticipated change in marketing expense. Then you calculate how you expect the change in marketing expense to change sales.

4) Sales Force Decisions

Similar to marketing, changes in salesforce expenditures should have an impact on sales. Therefore, similar to section 3, this section looks at baseline sales force expenditures, changes to the baseline, and how the changes to sales force expenditures impact sales.

5) New Strategic Decisions

Almost every new strategic decision is made in order to improve the company’s long-term position. And most of the time, that improvement includes an impact on sales. So in this fifth section, one calculates the anticipated impact on sales from each strategic initiative (each covered separately in this section).

In a sense, while sections 2 and 3 looks at the changes in the QUANTITY spent to improve sales, section 4 looks at the changes in the QUALITY of what you do to improve sales.

In a simple example, if a strategic initiative is to add a new product line, the impact to sales is rather straightforward. You add in the sales of the new product and subtract out the cannibalization of the old product.

If the initiative is to improve the quality of a baseline product, then one must estimate how improved quality will impact sales.

Since strategic decisions are often made for long-term benefit, there may be a short-term decline to sales during the transition. That is why, in my example, I show a negative impact in year one from the strategic initiative (but larger improvements later).

6) Net Results

The sixth and final section looks at the net impact of the first four sections, both in terms of impact on sales and impact on sales-related expenses. Basically, you take the baseline and add to it changes from pricing, marketing, salesforce and other strategies. The end result is your estimated sales and the estimated sales-related costs to get there. When you subtract those costs from sales, you get your “Sales Contribution”: the money you have left to pay for everything else.

BENEFITS
The benefits from using a Revenue Statement are as follows:

• It proactively links all of your activities to their impact on sales. It makes sure that when you change your approach, the appropriate change to sales is also made.
• It separates all of the components of sales, so that you can critique each one for reasonableness.
• It provides the ability to look at the more indirect influencers of sales, like changes in product quality, product features, service levels, repositionings, etc.
• It makes sure that the benefits and costs of each strategic initiative are incorporated into the plan (at least the sales portion).
• It forces one to reconsider issues like pricing and the expenditures for marketing and sales forces.

SUMMARY
To more comprehensively understand the sales portion of a strategic plan, it is recommended that some form of a Revenue Statement be used. A Revenue Statement has six sections:

1. Calculation of Baseline Sales
2. Impact of Pricing Decisions
3. Impact of Marketing/Advertising Decisions
4. Impact of Sales Force Decisions
5. Impact of Other Strategic Decisions
6. Net Results

FINAL THOUGHTS
Sales is too important an element of strategy to be left as a single line on an income statement.