That is why when a company reports a drop in revenue, its share price sometimes tank despite also reporting profitability growth. So, when are revenues actually more important than profits and what are the implications?
A loss making business can sometimes be looked at as one with intrinsic value provided revenue is growing. This is because a growth in revenue indicates the losses it is experiencing may be temporary due to high operating cost or interest expenses or taxes or a combination of all. In this instance, investors view the company as one that requires major restructuring of operations rather than one that needs to shut down.
As mentioned above, sometimes a business can rack up losses because it has failed to reign in on cost. However reining in on cost typically takes time and does not immediately translate to reversing losses. So whilst cost cutting is the right step in the right direction, it must also show that this move has not impacting negatively on revenue.
Revenue must also be seen to be growing or at least stable in the near term. Some products take time to break-even and during this tutelage period can run up losses. The company may be spending so much on research and development; marketing and promotional cost all in a bid to ensure its product is noticeable and garnering market share. In such cases, what you focus on is revenues and not necessarily profits. An increase in revenue shows that consumers like the products resulting in higher demand which sooner rather than later turns to profit.
Some industries are synonymous with very few competitors. Businesses like that can create a pseudo monopoly precipitating market dominance. However, for this to be a competitive advantage investors look at revenue growth as a key driver rather than profits which might seem good in the short term. Once you can show that revenues are growing exponentially then investors know your business really has that ability to sustain profitability growth. Just as barrier to entry due to technological advantage is great so does a company with an inherent comparative advantage.
According to Warren Buffet, the word moat refers to companies such as Coca-Cola who sold products that everyone hardly did without regardless of the alternatives around.
A company with an economic moat typically report increase in revenues in spite of the competition around it and even in economic downturns. If it consistently grows revenues despite competition then investors believe even when it suffers losses it is temporary and profitability will resume once the problems are identified and resolved. Some companies face huge losses due to misfortune or circumstances beyond heir control. Castle managers were quite surprised at the width of the price band for their Power-Lite model, but on reflection, concluded that it was due to differences in account sizes.
The company had a clear strategy of rewarding account volume with lower price, rationalizing that cost to serve would decrease with account volume. But when management examined the Power-Lite pocket prices against total account sizes for a sample of 50 accounts, it found no correlation—it was a virtual shotgun blast. A number of relatively small accounts were buying at very low pocket prices while some very large accounts were buying at very high pocket price levels.
Castle managers, perplexed by the scatter of pocket prices by account size, launched an immediate investigation. In most cases, they found no legitimate reason why certain low-volume accounts were paying such discounted prices.
Often, they discovered that these accounts were unusually experienced and clever accounts—customers who had been dealing with Castle for 20 years or more and who knew just whom to call at Castle headquarters to get that extra exception discount, that percentage point of additional co-op advertising, that extra 30 or 60 days to pay. These favorite old accounts were granted extra discounts based on familiarity and relationships rather than on economic justification.
Castle senior management realized that its transaction pricing process was out of control, that decision making up and down the waterfall lacked discipline, and that no one was focusing on the comprehensive total of those decisions.
To correct its transaction pricing situation, Castle mounted a three-part program. Management identified the problem accounts and explained the situation and its impact on overall company profits to the sales force.
Then the company gave the sales force nine months to fix or drop those outliers. Second, Castle launched a program to stimulate volume in larger accounts that had higher than average pocket prices compared with accounts of similar size.
Sales and marketing personnel investigated them carefully to determine the nonprice benefits to which each was most sensitive. The company increased volume in these accounts not by lowering price but by delivering the specific benefits that were most important to each: higher service levels for some, shortened order lead times for others, more frequent sales calls for still others. Finally, Castle embarked on a crash program to get the transaction pricing process back under control.
This program included, among other components, setting clear decision rules for each discretionary item in the waterfall. Management also set up new information systems to guide and monitor transaction pricing decisions. And Castle established pocket price as the universal measure of price performance in all of these systems. It began to track and assign, transaction-by-transaction, all of the significant off-invoice waterfall elements that were previously collected and reported only on a companywide basis.
Further, pocket price realization became a major component of the incentive compensation of salespeople, sales managers, and product managers. Castle reaped rich and sustained rewards from these three transaction pricing initiatives. The company realized additional pocket price gains in each of the two subsequent years.
Castle also received some unexpected strategic benefits from its newfound transaction pricing capability. Account-specific pocket price reporting revealed a small but growing distribution channel where Castle pocket prices were consistently higher than average. The fresh and more detailed business perspective that Castle senior managers gained from their transaction pricing involvement became the catalyst for an ongoing stream of similar strategic insights.
The Tech-Craft Company Case. Consider another case—one that takes an even finer cut than the Castle example. Here, top management used both the pocket price waterfall and the pocket price band as broader tools.
The company not only assimilated valuable information about its pricing policies but also used that knowledge to manipulate its pricing system and influence its retailers. The Tech-Craft Company took the waterfall and band and extended the concept, successfully applying the lessons of a financial tool to benefit its marketing strategy. Tech-Craft is a manufacturer of home appliances, with microwave ovens as its primary line.
Tech-Craft sells its microwave ovens directly to appliance retailers and a variety of mass merchandisers and department stores. With dozens of major and minor brands available, the microwave market is highly competitive and most retail outlets carry multiple brands. Very complex price structures had evolved over the years in this competitive market. Exhibit 6 shows the average pocket price waterfall on a percentage of dealer list price basis for a Tech-Craft transaction to an appliance retailer.
The company gave a total pocket discount of Exhibit 6. Tech-Craft Gave a Pocket Discount of For example, they varied by cash discount terms, co-op advertising rates, volume bonus discounts, volume break points, and freight payment policies. The variety and complexity of price structures made it somewhat difficult for appliance retailers to compare microwave prices among competitors. Further research showed that most retailers used just invoice price minus cash discount as their yardstick for comparing prices, taking for granted most of the off-invoice items.
With this knowledge, Tech-Craft managers made a simple price structure change to one product line. They took their largest off-invoice discount—the annual volume bonus—and shifted it to on-invoice. The result so intrigued Tech-Craft managers that they researched their pocket price waterfall even further, discovering evidence that retailers were not equally sensitive to price changes across all elements of the waterfall.
First, when they wanted to lower price to stimulate volume, Tech-Craft managers adjusted the waterfall elements to which their retailers were most sensitive—thus engendering the maximum volume growth. Conversely, when they wanted to raise price to increase margins, they adjusted the elements to which their retailers were least sensitive—thus minimizing loss of volume. By doing so, Tech-Craft made sure it was getting the most retailer buying preference for its discount dollars. Not unlike Castle, Tech-Craft reaped rich rewards from its new-found skills and initiatives in transaction pricing.
While the specific moves required to capture untapped transaction pricing opportunity can vary widely from company to company, the most useful improvement actions fall into three general areas. Manage the pocket price band. An understanding of pocket price and its variability across customers and transactions provides the bedrock of successful transaction price management.
The entire pricing process should be managed toward pocket price realization rather than invoice price or list price. Pocket price should be the sole yardstick for determining the pricing attractiveness of products, customers, and individual deals.
All price measurement and performance gauges should be recast with pocket price used as the base for calculating revenues. Creating information systems that correctly measure and report pocket price is problematic for many companies. Elements of the waterfall often reside on different systems or do not exist in data systems at all.
These difficulties notwithstanding, companies should make the investment to produce a correct and comprehensive pocket price calculation. Managers must resist the temptation to leave elements out of the waterfall because they are difficult to calculate or inconvenient to include from an information systems standpoint.
Effective transaction price management often requires tough customer initiatives, but incorrect or incomplete pocket price reporting gives managers an excuse not to initiate necessary pricing policies. Marketing and sales should target customers with transactions at the high end of the price band for increased volume. These departments should also identify clients at the low price end, marking them for actions that will either result in improved price levels or their termination as customers.
Management should not exclude any low-price customers, regardless of their history or relationship with the company, from such corrective actions. The hard pocket price numbers must determine which customers require remedial price action. Revenue also has critical psychological implications both internally and externally for your business. Employees want to feel confident in their employer and have a sense of security and stability in their jobs. Strong revenue production offers employees this feeling of comfort.
Revenue affords similar comfort to business partners, suppliers, community members and other stakeholders impacted by your business. More confidence from stakeholders makes them more likely to take risks and make decisions to support your company.
Neil Kokemuller has been an active business, finance and education writer and content media website developer since He has been a college marketing professor since Kokemuller has additional professional experience in marketing, retail and small business. Business Factors Indicating Liquidity Problems.
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