Wednesday 25 June 2008

Local Revenue, Global Cost

I have been observing this phenomena in Malaysia that we are increasing paying cost that reflects the global cost while still earning, generally, local revenue. The recent increase in the fuel price is an obvious example. Other example includes the increase in food prices, be it rice or vegetables. The recent lifting of ceiling prices of steel and cement is also an indicator that we could no longer shield ourselves from paying what others from other parts of the globe are paying.

The issue about brain drain to be is principally driven by the fact that we are not paying the global cost for local talents. The easy way out for them, especially Generation-Y, is to go elsewhere and get paid better for the same amount of contribution that they provide to their employers. What more if they get better deal in work-life balance and better amenities and facilities in foreign land.

Unless your business earns foreign revenue through export, or selling locally to foreigners at the prices they are paying in their own country (like what some of our cabbies normally do), you are going to face tough challenges in balancing between revenue and cost.

How could our businesses be re-structured to manage this risk?

First, we should look at maximising return from the production of goods and services that are generated from our businesses. Could we export if we are not exporting yet? Or, could be increase our export if we are an existing exporter. The whole idea is to get more from the same amount of output since out cost to generate the output is increasing as well. we could also have another serious look at the market segment that we are selling at. Could we move up the chain and re-package our products and offer new value proposition to get better demand and pricing? Increasing revenue is about selling more to existing market and selling to new market that was not served before. What about the way you distribute your products and services?

Second is about productivity improvements. Could we generate more with the same resources? This may require product re-designing, process review, increase training and motivation among the employees and perhaps investing in new technology which would allow you to run your business differently. Its all about identifying opportunities for improvement and having the attitude of not accepting everything as given and untouchable.

Improvements in your supply chain is the third avenue which may enable your businesses to be more efficient. Under the present cirsumstances, the concern is not just about buying at the right price, but security of supply and product quality are also critical. When was the last time you review your supply chain?

I am sure you could also figure out other options that you could consider in making you businesses more resilient and sustainable. The key issue is to understand the shift in the business landscape and review your strategies before the environment turns against your business.

Under the present circumstances, I do not believe that entrepreneurs are not forewarned enough about how much more challenging the future would be. Ignorance is not an excuse, and you'll be paying dearly when your businesses lose their viability.

Sunday 15 June 2008

Pricing Strategy in an Inflationary Environment

While the recent hike in fuel price would certainly increase the cost to run your business, another factor that would create challenge to entrepreneurs would be how to price their products and services. In as much as we would like to pass the increase in cost to customers, this may not be feasible in all circumstances.
How do you develop your pricing strategy in an inflationary environment?

Consider the following three factors.
First is to establish whether your target market is price sensitive or not. If the market is mature, that is when you have a lot of players selling more or less similar products or services, then there is a high chance that pricing would be the determinant when customers make their purchasing decision. Pre-paid handphone card is an example. We can find outlets selling pre-paid cards almost everywhere now days. That's why the margin for the re-seller is very thin. Under such circumstances, increase in pricing would results in customers moving to the next cheaper competitors. Higher price would also exclude certain customers who may not afford to spend on your products anymore.

Second is to consider the impact to your cost structure and the cost of your competitors' products and services. Are they having the same problems? Any of them coming up with new sales strategy which will eat into your market share? Can you use this as an opportunity to differentiate your business and gain more market share by maintaining your present price level by controlling cost?

Finally, look at opportunities to re-package your products or services in such a way where your customers would have similar or better deal and you are not worse off.

Once you understand how the increase in fuel price impacts your customers, your competitors and your own business, you are in a better position to decide the way forward. The idea is to at least maintain the gross profit margin of your products.
Let's look as the following example for us to work out the pricing strategy.
Say presently your product is selling at RM 100 and your cost of sales is RM 80, your profit margin is RM 20 or 20%. If your cost goes up by 10%, that is RM 8, your margin is now RM 12 or 12%. For you to maintain similar gross profit, you have to sell your product at RM 167 to get back RM 20. How do your get the additional 67% in sales?
Your options are:
  1. Sell the product at RM 167. However, can your customer absorb the increase in price or would they go to other competitors who are selling at lower price? One way to commit your customer for an automatic increment in prices is to have a "price escalation clause" in the agreement with your customer.

  2. Increase your price by lower amount and you absorb the different. Here, is your business able to withstand lower profit margin?

  3. Sell more of the same product to get back the margin. For example, you need to sell 2 units at RM 100 each to get back margin of RM 24. You could, for example, offer volume discount to encourage customers to go for higher volume. The challenge here is whether the market can absorb higher sales volume and whether there is capacity to purchase on the side of the customers.
From the above, the better risk mitigation measure is to prevent a huge increase in production cost in the first place. If cost can be contained through better purchasing strategy, using alternative materials which would not result in decrease in quality, higher productivity or re-engineering of your production process, the pressure to recover margin through price increases would be reduced.

Do you really know the cost of your product or services? Well, if you do not have this information, your decision making may not be reasonable and as demonstrated above, the risks to your business would be higher.

Under the present circumstances, all businesses are calculating the impact of the increase in the fuel prices and working out their responses. If you are still not sure at this stage of what to do next, that is the sign of close and present danger!

Wednesday 4 June 2008

Waking Up to the Reality of Life!

It is now confirmed that we have to pay more whenever we fill up the tanks of our cars. Some of us thought that we, Malaysians, are insulated from the effect of global oil price increase due to the subsidy from the government and the fact that Malaysia is a net exporter of petroleum. The raise in the pump prices of petroleum products is a real wake up call for everybody.
I'm sure by tomorrow, you are going to pay more for your teh tarik and roti canai and more price increases will follow suit. Looks like cost to do business will go up as well and early indicators in the media suggests that we may be looking at an inflation rate of 5%, and that may seems low for some of us who has to pay significantly more for most of things that we buy.

What are the options that you have when it comes to managing the impact of fuel price on your businesses?
First is to look at the impact on your cash flow and make sure there is no adverse impact to your operational cash flow. You have to understand the expenditure that would be affected by the new fuel prices such as transportation and material cost. Next is to look for the effect on the collection pattern from your customers. Is there any customer which may be adversely affected. Transportation companies could be among the likely candidates for this category. Having understood the possible implications, you could more or less figure out how far you operating cash flow would be reduced.

Second, is to consider options in ensuring the higher expenditure could be mitigated. First option that would come to the mind of most entrepreneurs would be to cut expenditure. However, this has to be done after careful analysis as the last thing that you want is to make your business to be less attractive to you customers due to deterioration is product or service quality. This is where you should be able to differentiate critical expenditure and discretionary expenditure. A discretionary expenditure is those that you could do without while still maintaining you core business offerings. Getting your team to travel economy class instead of business class would not affect your service to your customers. Off course this may reduce the morale of your team members! You could for example list down the discretionary expenditures of your business and perhaps, by going through with your team members, you would be able to identify those that could be reduced or deferred.
The third step is to look for opportunities which come along with the price increase. Could you, for example, offer products which help others to reduce their business cost. Offering teleconference facilities for companies which have high number of face to face meetings could be a growth area. This would help to reduce travelling cost while at the same time enables people to have more time to do other productive things rather than travelling. Similarly, helping companies to communicate to their customers or team members using electronic means instead of paper based communication would also reduce cost while at the same time increasing the effectiveness of the process.
In short, we have to accept the reality of the regime where cost to run business will increase. Doing the same thing over and over again will not lead us towards different results. We have to do things differently and quickly as well.