Driving value by smart resource allocation

Profile picture for user denis_pombriant By Denis Pombriant January 2, 2017
Summary:
As businesses consider how their preferred business model can respond to changes in customer perception, we look at how alternative approaches drive value. The subscription model comes under the microscope.

resource-shift
 Driving value is always top of mind in the C-suite but how does this work in a world where the economic norms are shifting and where new business models are surprising incumbent businesses?

There was a flurry of good articles on the Harvard Business Review site (HBR.org) that cover the value topic. One in particular that caught my eye, “Why Leaders Are Still So Hesitant to Invest in New Business Models” by Barry Libert, Megan Beck and Steven Cracknell offers food for thought in the coming year.

The gist of the piece is that over the working careers of some of the more senior managers among us, what is valued as a business asset by financial market makers has undergone a complete shift though we often fail to grasp the reality and demonstrate this understanding in our resource allocation processes:

According to Ocean Tomo, a consulting firm focused on intellectual capital, physical assets (plant, property, and equipment) made up more than 80% of the market value of the S&P 500 in 1975. In other words, the companies listed on the S&P owned a lot of physical stuff, such as land, warehouses, and machines, and were considered valuable as a result.

However today, that ratio has completely reversed with the same 80 percent going to intangible assets the

networks, platforms, intellectual property, customer relationships, big data

that are so important to business success today. (See image to the right at the top of this story).

The article doesn’t delve into the large number of models that could allocate resources differently but instead classifies four types of leaders by their allocation tendencies including reactors, transformers, aligners, and disrupters. You can take your own assessment from this link.

While this is useful, I think time would be better spent identifying at least one new business model that gets to the heart of the problem stated in the piece.

To be clear, this is not a criticism of the piece but a way to take the discussion further. The best example I can come up with is the subscription. In the last 20 years subscriptions have gone from a way to sell magazines, to a method of selling anything.

Subscriptions offer a way to deliver value at a fraction of the inherent cost of selling or licensing traditional products. There are multiple examples of subscriptions available from car leases to software as a service to monthly delivery of different products. This last category runs a gamut from wine, to shaving sundries, to underwear.

What subscription vendors have figured out that all of us need to internalize, are ways to look at the customer and the relationship that keep a focus on how to best deliver value to customers and thus properly allocate precious resources. Taken to this level, resource allocation becomes less of a black art and much more of a strategic approach to revenue generation.

This is important to all vendors, even those who have no intention of offering their wares as a service for one simple reason: Customers have already been trained to be subscribers. They understand their needs come first in ways that were not prevalent in 1975. So they think like subscribers even when dealing with a vendor in a more traditional business model and the most telling subscriber behavior, to be avoided if at all possible, is attrition.

Customers, our relationships with them and their propensity to like us and to tell others about us are the primary soft asset any company has. As a result, subscription vendors have enshrined these ideas in the metrics that support their business models, metrics that are often not used in traditional business.

For example, customer lifetime value (CLV) may be used in a variety of businesses but it takes on additional importance in subscriptions where transactions are usually small but accrue over time, (assuming no attrition).

Some traditional vendors might see small transactions as unnecessarily labor intensive but the flip side is customer commitment that makes future budgeting—and resource allocation—far easier. A subscription vendor with a customer base of committed and contracted customers knows at the start of the year, what that base will contribute to revenues so that making goal is all about keeping the base satisfied and chasing incremental growth. In contrast the traditional vendor typically has to reinvent the wheel and then some in every annual plan.

Other metrics like recurring revenue (either annual or monthly) provide an accurate incentive to allocate resources appropriately or to at least understand the pitfalls if that’s not done.

Lastly, there are plenty of metrics around the idea of growth efficiency or the cost of acquiring new revenue. With this toolkit, managers can clearly compare the cost of resource allocation to two of the most important areas of a business—sales and service.

At the risk of shameless self promotion, in Solve for the Customer, I discuss the four things that go into creating a good metric. Briefly, they are,

  1. A metric has to come from credible data, i.e. a trusted source with minimal effort such as customer use data, customer demographics, and revenue.
  2. Simple calculation and transparency—most are simple ratios.
  3. Easy and unambiguous interpretation. For instance churn means something different from attrition though both have a common root. When churn is up it means paying attention to short term sales and marketing and also service levels and the onboarding process. When attrition is up it signals that a company’s offerings including services and policies may need review.
  4. You can easily figure out what to do when presented with a given value for a metric, especially if you have data from several reporting periods to compare—is it going up or down and is that good or bad?

So that’s one important new business model and hopefully this demystifies how to allocate resources within it.

My take

Resource allocation is always tricky and never more so than during a disruption such as today’s era of the drive to all things digital. Doing it right shouldn’t be hard; it’s more a question of engineering, not hard science.

In science you perform experiments and gather original data to derive a logical conclusion. All that’s been done by the time you get to engineering, which is largely the effort to move from theory to practice.

Arriving at an appropriate resource allocation mix is a matter of taking stock of and possibly changing your business model to best reflect what customers expect in the context of the business you do today. Things like Generally Accepted Accounting Principles (GAAP) often ignore intangible assets because of uncertainty that is abhorrent to the GAAP model. The history of the subscription movement has been partly a story of educating GAAP people about the subscription reality.

That done, it’s much easier today to opt for a different and likely better business model than it was a few years ago.

For further reading, check out the selected stories we've added at the end of this story.