Is “How cheap can we make it?” always the right question?

A couple of years ago I helped judge a Dragon’s Den-type competition in a local school (you might know this as Shark Tank if you’re outside the UK).

Groups of students each had to create a gift which they could “sell” to students who wanted to say “thank you” to their teachers for being so helpful and supportive that school year (which I’ve always thought was a great use of the power of hypnotic suggestion on the teachers’ behalf…but that’s not entirely the point of this article).

On the appointed day, each group presented their suggestions to the panel of “Dragons”, of which I was one.

There were some super ideas in there, but the one I remember most was the group which proposed, in essence, using a free web design service to produce a quick design, which could be printed off on a piece of flimsy card, thin enough to fit through a home inkjet printer, and handed to the teacher at the end of the school year at a cost of just a pound or so each..

All the students took turns to present different elements of the idea to the panel, but I still remember the boy who led the pricing section of his group’s pitch beginning his remarks with “Obviously, we wanted to make this as cheap as possible…”

Whilst I didn’t interrupt the presentation or try to derail their ideas…I might be a Finance Director and CFO, but I’m not an ogre…I did seek out this group afterwards to give them some feedback.

“Why, ” I asked, “would you want to go out of your way to make something as cheap as possible when it’s intended as a heartfelt thank you to someone who has been extra-nice to you? When your parents give you their heartfelt congratulations on your exam results or passing your driving test, do they think “how can we make this as cheap as possible?” or do they try to get you the very best of whatever they can afford to show their appreciation for your hard work?”

Bear in mind, this was a school which caters to a pretty well-off group of parents. I lived close enough to know kids who went there were often treated to exotic holidays for doing well in their exams and new cars when they passed their driving tests.

I don’t begrudge them any of that…after all, who among us wouldn’t do the very best for our own children?…but it was an interesting perspective.

The boy who’d done the pricing section spoke up. “Well, we’re in business, so we have to make everything as cheap as possible.”

I agreed that no business would last for long if it over-paid for the products it buys. But I asked him what car his dad drove…and wasn’t too surprised to hear it was a swanky BMW towards the top end of their model range as that seemed to be about the running average when I saw parents dropping their children off at this school each morning.

Why is that, I asked…I’m sure your dad knows there are plenty of cars cheaper than his BMW. Any one of them would get him to work pretty reliably. Or he could catch a bus.

And BMW are a business, yet they sell products which both they and their customers know for sure aren’t the cheapest way of getting to work.

So how cheap they can make their transportation doesn’t seem to be the most significant factor for people who buy BMWs, at least. We know that for sure because, if lowest-cost transportation was their overriding consideration, they wouldn’t buy a BMW in the first place.

I ended up having a nice conversation with this group about how things like branding can make a big difference to what people are prepared to pay, and how, in the eyes of the receiver, an expensive gift might be viewed very differently from a cheap one.

I don’t know if I helped this group of students see the world in a different light. I’d like to think so but, as I recall from being that age myself, 16 and 17 year-olds have plenty of other things going on inside their minds, so I’m not banking on it.

Now, don’t think I’m being too hard on a group of well-meaning 16 and 17 year-olds. We were all young and foolish once…yes, even future Finance Directors and CFOs.

But I find it a lot harder when this conversation comes up in a business context. While, of course, having an eye on costs and margins matters, too often middle and senior managers in sizeable organisations spend their time focused on how cheap they can make something when that’s just about the worst question anybody in business can ask.

The question they should ask instead is how they could build in significant amounts of extra perceived value for customers, provided the business can deliver it for an additional cost which is less than their customers’ perception of what those extra features and services are worth.

This is Economics 101.

If a business makes a 10% margin on its £100 product, that’s a tenner in its bank account.

If someone finds a way to increase the price to £200 by packing in more value…in the eyes of their customers…but it only costs an extra £50 to build in those features, the business goes from making £10 per unit to making £60 per unit.

The margin has gone from 10% on a £100 product to 30% on a £200 product.

What’s more, your customers are happy to pay double compared to what they paid before.

I fully accept if you’re in the commodity business…mining for coal, perhaps, manufacturing paper or smelting aluminium…market forces mean you’ll only get the same price per tonne as everyone else who can deliver to the same technical standards.

But a lot more businesses behave as if they were commodity producers, competing purely on price, than actually are commodity producers. More often than not, that’s just down to the business’s lack of imagination.

Sometimes the £100 product is very little different to the £200 version, but at the higher price point it comes bundled with a range of extra services which justifies the higher price point in the eyes of customers.

There really is no excuse for businesses not to try to improve the value they offer to customers.

That doesn’t mean overpaying. You have to make sure the commercial terms work in your favour. But, strange as this may sound, it means businesses should be actively seeking to increase their costs, because…unless they’re staggeringly inefficient now…that’s how they’ll deliver greater value to customers.

To illustrate, let’s flip that around…very few businesses have customers who are likely to allow it to make more profit by providing a worse service or poorer-quality products.

If a business focuses on cutting costs, its £100 product with a 10% margin might…if it’s diligent with the cost-cutting and lucky enough that its customers don’t notice or don’t care too much about the corners it’s cut along the way…become a £90 product with its original 10% margin maintained.

Except now you’re making £9 per unit instead of the £60 you could have made. And making £60 per unit isn’t going to be six times harder than making £9.

If you’re doing it right, it’s likely to be no harder…perhaps even easier as you’ll have the budget for a slick, well-managed operation rather than running the business on a shoe-string which needs regular urgent intervention to keep its under-resourced people and services on track.

Perversely, it’s often a lot harder to run a business when you fire the expensive, long-serving staff who know all about your products and your customers and replace them with casual workers hired only when you’ve got something for them to do. Often businesses end up using a lot more labour as a “blunt force” solution to a problem when a much smaller number of highly-paid people might have crafted a more elegant and effective solution at a lower overall net cost.

Or when you replace the top-quality German computer-controlled machines which some pale imitation from goodness knows where at half the upfront cost…but which extract a much higher price in maintenance, repairs and additional downtime across the lifetime of the machine itself.

Not only is it a lot harder to run a business supposedly “on the cheap”…it’s usually more expensive in the end too.

That’s not what the business case for making the changes will say, of course, but it’s what people will gradually realise six or nine months down the line when holes start appearing in its product or service delivery and the business moves firmly into “recovery mode”.

That’s when the customer complaints department has to take on more staff. The quality inspections have to go up. The refunds to customers when the products don’t last out their guarantee period goes up. And the business will spend a lot more on marketing to attract a constant stream of new customers prepared to give a poor quality service a try than it would have to spend if the brand and reputation did more of the heavy lifting on the sales front.

If you doubt this, just think to yourself…when did you last see an advertisement for a Rolls Royce?

I’m not sure I’ve ever seen one. Yet everyone knows that “the Rolls Royce of the XYZ industry” is the byword for a product of unimpeachable style and reassuringly good quality.

Which is why I’ve always been mystified that supposedly intelligent people, often with fancy MBAs, spend so much time reducing costs…often to the detriment of their staff, their customers and ultimately their business…when they should instead be actively seeking ways to make their products more expensive by offering additional value to their customers and standing out from the crowd rather than becoming just another bland price-based operation.

Don’t blame your customers for choosing the cheapest deal if price is the only thing you’re competing on. Some customers will always choose the cheapest option because that’s just the way they’re wired.

But more customers…maybe even most customers…are only deciding on price grounds because you haven’t given them any reason to make a different choice.

Were businesses to work on improving their branding, their reputation, their customer service, the marketing, their customer loyalty, their staff motivation, their product development, their design and any one of the dozens of other aspects that define the customer’s perception of the product or service they’re buying…then they might be surprised how many customers will happily pay for the extra value they receive.

That’s why, whether you’re a 16 year-old student or a 45 year-old middle manager with an MBA, “how cheap can we make it?” is rarely a good question to ask.

A better question would be “how much additional value can we build into our products and services such that customers will happily pay more than any extra costs we incur?”

Perhaps we shouldn’t ask “how cheap can we make it?”.

Maybe we should ask “how expensive can we make it?”.

(Photo by Manuel Cosentino on Unsplash)

The difference between a good accountant and a great Finance Director / CFO

In his play ‘Lady Windermere’s Fan’, Oscar Wilde described a cynic as someone who knows the price of everything, but the value of nothing.

That’s pretty much the difference between a good accountant and a great Finance Director or CFO….a good accountant can tell you what you’ve spent, a great Finance Director or CFO should be building value for your business.

Let me give you an example.

Some years ago I worked for a business which gave all its employees, after a qualifying period of, I think, a year or two, one day’s paid time every month to volunteer for a local community project of their choice.

Out of approximately 20 working days in a month, you might say this initiative “cost” the business around 5% of the salary bill for eligible employees.

The volunteering initiative was in place before I arrived at the business, so I can’t take any credit for it, but in reality it didn’t cost the business a penny. It made much more money than it cost…alongside doing a lot of sterling service for our local community. Here’s just a few of the more obvious benefits…

  • People who volunteer for community projects tend to be naturally enthusiastic, high-energy people who are dedicated to making the world a better place. Their presence lifted our whole business and their continued enthusiasm in the face of adversity brought incalculable benefits when our backs were against the wall.
  • They did their jobs, on average, much better than the rest of the workforce – typically by 10-20%. Nearly all of our high performers were also community volunteers, so they covered the cost of the scheme just through their own natural positive energy and their desire to do a great job for a company that let them volunteer on company time to support their passions.
  • You might be wondering whether those naturally enthusiastic people would have done a better-than-average job anyway, even without the volunteering scheme, and at some level they probably would. But even then, there’s a difference between doing a pretty good job and striving to do the best job humanly possible. The difference between those two levels of contribution is easily worth 5-10% on productivity, output and quality in my experience. By offering a volunteering scheme, we unlocked the “striving” level of commitment.
  • Not only that, but when skills were scarce our very best employees tended to stay with us, even when there was more money on offer from another local business, because they couldn’t get their volunteering time paid anywhere else. Were people occasionally tempted by a few grand a year extra in their pay packet…sometimes yes, but they tended not to last in their new job and often came back because they missed the opportunity to volunteer in their local community.
  • The cost of recruiting and training a new member of staff is somewhere between £20-30,000 a time, according to ACAS statistics. So every person who stayed with us saved the business that amount of money. This easily covered the cost of the volunteering scheme on its own in a high-turnover industry. It also mitigated against the risk that when we recruited a replacement for a top performer, we didn’t get an average (or worse) performer in their place which would have diluted the quality of our workforce as a whole.
  • Without us having to put on an expensive training and development programme, many of our volunteers ended up in management roles with the business a few years down the line. They were, without exception, great managers. The skills they learned while volunteering – how to deal with people, managing tight-to-non-existent budgets, developing their creative thinking and many skills they picked up along the way – made them first-rate managers who we “recruited” without an executive search fee and without the risk that someone who was “good on paper”, or a seasoned interview performer, but not that good in practice, would manage to sneak through our hiring processes and cause more problems than they solved.

I could go on, but you get the idea. The community volunteering scheme wasn’t a cost at all. It generated significant value for the business which more than covered any costs it incurred.

A good accountant could tell you this scheme cost approximately 5% of the salary for eligible employees.

A great Finance Director or CFO could tell you that the community volunteering scheme generated so much value for the business, in both obvious and less-obvious ways, that spending whatever it cost with a smile on our faces was by far the most sensible, and economically valuable, option.

At the very least, any costs were covered by the greater productivity our community volunteers tended to display in their “day jobs”. More likely there was a significant upside to the business as a result of having unwittingly developed one of the smartest staff retention, productivity enhancement and management training schemes we could ever have hoped for.

We learned the value of the volunteering scheme, and didn’t obsess about its cost. Oscar Wilde would have been proud.