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.

Strategic Planning Analogy #354: Strength in Diversity

THE STORY
Last week I was on vacation. One of the places I visited was the Niobrara Buffalo and Elk Wildlife Refuge near Valentine, Nebraska. The wildlife refuge was located at the intersection of four distinctly different ecosystems. From the west came the Rocky Mountain pine forest, from the south were the sparse sandhills of the Great Plains, from the north came the harsh environment of the Dakota Blackhills, and from the east were the lush deciduous forests. All four ecosystems comingled within the nature preserve. It was beautiful.

The wildlife refuge claimed that being on the edge of multiple ecosystems creates an ideal environment for animals. First of all, the variety of ecosystems brings a variety of eating options. There is more diversity both in terms of plants and other animals to eat. This makes it easier to find nourishment all year long, regardless of the changing climate conditions.

Second, this ecological diversity creates a variety of habitats for the animals. Depending on the time of day, time of year, and type of activity, different habitats are more desirable than others. By being in an area with multiple habitats, the animals can be in the optimal place at the right time.

Unfortunately, at the time of year I was at the refuge, the Elk and Buffalo were hiding in a portion of the property which was off-limits to humans. But I did get to enjoy the beauty of the ecosystems and see a waterfall up close. And although I did not get to see a buffalo, I did get to eat a buffalo burger (from commercially grown buffalos, not the nature refuge).

THE ANALOGY
Strategic planning tries to find places where businesses can be strong and prosper. According to this nature refuge, animals get stronger and more prosperous when they live in an area of diversity. In many ways, I think this fact also applies to businesses.

Just as there is strength in diversity for wildlife, there is strength in diversity for businesses. Is your planning taking advantage of the richness to be found in diversity?

THE PRINCIPLE
In many of my prior blogs, I have spoken of the power of focus. In fact, it is almost impossible to succeed in business if you are not focused. Strategies are critical in that they point to where a firm should focus its efforts.

However, being focused should not be confused with being narrow-minded. Almost a century ago, Henry Ford had great initial success by mass producing the simple Model-T automobile, which only came in the color black. By narrow-mindedly sticking to this single product for far too long, the Ford Motor Company almost went bankrupt, because the market had shifted to nicer cars in more colors. Ford had to diversify its offering in order to survive. Kodak narrowly focused far too long on analog photography and missed virtually all the growth in digital imaging. Its fortunes faded along with the fading of its narrow focus.

As we can see from nature, there is power in diversity. The challenge for strategic planning is to apply the benefits of diversity without losing the benefit of focus.

The wildlife refuge saw two benefits from diversity: habitats and nourishment. We will now apply those two areas to strategic planning to show how to blend diversity with focus.

1. Diversity of Habitat = Diversity of Backgrounds (Process)
Just as animals live in many different places, people live in many different places. There is a great diversity in people depending upon the backgrounds of where they come from. Each background provides a unique perspective on the world, a perspective which is colored by the experiences that background provides.

One of the goals of the strategic planning process is to provide an understanding of the marketplace in which a company competes. This understanding is richer when developed with a diverse group of people.

To paraphrase Colin Powell, former US Secretary of State and Chairman of the Joint Chiefs of Staff, if your team is made up of people who think just like you, then most of you are redundant. How much redundancy is there in the people involved in your strategic planning process? Do they all tend to be about the same age, same gender, same race, from the same country, having similar incomes, with the same educational background? Does your group include any people who live more on the edges of society?

If you want a rich understanding of the world, it helps to have a rich variety of backgrounds in the people who are building that understanding. Multiple perspectives and points of view will help you to avoid blind spots in your analysis. As the market shifts, you will be better able to both detect the shift and adapt to it, because you will already understand that perspective. If your team can only see the world “as it used to be”, you will fall into the obsolescence traps we saw earlier with Henry Ford and Kodak.

Consider carefully the mix of people you place into the planning process, to ensure diversity of perspective. It should not just be a few senior executives. In addition to broadening the diversity of employees in the process, one could also consider including suppliers and customers in the process.

During the process, don’t hide in the corporate office. Get out into the various habitats where your product is used. See what’s going on at the point of sale. See what’s going on in places where you are both successful and not successful. Enrich your perspective.

The diversity of animal habitats allow the animals to be in the right place at the right time. The diversity of thought and perspective allow your business to be in the right place at the right time.

Diversity of thought does not mean randomness of action. Focus is not thrown away. A company still needs to focus. But that focus will be more effective if you have a broader understanding of the environmental context surrounding that focus. It allows you to truly optimize your focused efforts, because you truly see the world as it really is—in all of its diversity.

2. Diversity of Nourishment = Diversity of Revenue Sources (Outcome)
Animals are nourished by food. Businesses are nourished by sales income, or revenue. Animals die without food. Businesses die without income.

Diversity of food sources benefit animals. A diversity of revenue sources benefit businesses. As the old saying goes, if all of your eggs are in one basket, you lose everything if you drop that basket. It is better to diversify that revenue source into multiple baskets.

There are two ways to diversify one’s revenues. First, you can diversify your customer base. For example, if you only sold to new construction businesses, you were in severe trouble when the recent great recession virtually wiped out new construction. Had you also sold to other customers who were less severely hit by the recession (like refurbishers of old construction), you would have had a stronger base of revenue.

Second, you can diversify your product offering. By focusing too much on analog imaging products, Kodak missed the benefits which they could have gotten by diversifying faster and more aggressively into digital imaging products.

This diversity does not mean you should try to sell anything to anybody. You still need focus.

Here are two examples of how to diversify your revenue sources while still maintaining a focus.

Bausch and Lomb is focused on helping people have superior eyesight. Yet, within that focus they have diversified their product offering to include corrective lenses, eye surgery devices, eye nutrition products, eye care products, and so on. No matter which way the market moves in terms of superior eyesight, Bausch and Lomb is ready. They won’t become obsolete when a particular approach to eye care becomes obsolete, because Bausch and Lomb has a diverse enough offering to be able to shift with the times. By focusing on the solution (superior eyesight) rather than a single product to get there, they have strengthened their ability to survive and be nourished with sales for a long time.

3M focuses on particular technologies. In particular, they tend to focus on technologies in a handful of areas, like adhesives, abrasives, and substrates. However, once they master a technology, they try to sell it to as many customer bases as possible. For example, 3M is the master of the technology behind adhesive tape. This technology is applied to as many markets as possible, such as the consumer market (Scotch Tape), the home improvement market (masking tape), the medical market (tape for bandages), the security market (reflective tape), and so on. There is still a focus (on technology), but a richness in revenue by applying that technology to as many diverse customer bases as makes sense.

SUMMARY
Although focus is still essential for strategic success, that focus is made more powerful when properly blended with diversity. The first type of diversity is the diversity of thought used in the strategic planning process. The more perspectives you bring to examining your area of focus, the less likely you will miss opportunities within that focus. The second type of diversity is diversity of revenue sources. By sticking to your area of focus, you can still improve revenues by applying that focus to a broader base of products or customers.

FINAL THOUGHTS
In the Buffalo and Elk Wildlife Refuge, the Buffalo did not try to become elk and the elk did not try to become buffalo. They stuck to the essential focus of who they were as animals. Yet at the same time, they prospered by exploiting the diversity of the multiple ecosystems around them. You should do the same.