Cost Analysis versus ROI (Return on Investment)

A return on investment study is more important to a business than a cost analysis.  On the first day of class pursuing my MBA, the instructor spoke to the primary goal of all businesses:  maximizing profit and revenues.  In may have been the second day, as the first day they hand out the syllabus and do class introductions. 😉

Product Life Cycle Profit Curves

I am writing this post for sales professionals, but certainly some of the lessons shouldn’t be lost on some business owners.  I come in front of both and sales representatives use cost analysis to demonstrate current versus proposed costs that provide a savings.  Business owners speak to me about how happy they are with their current business and that there is no need to grow or change.  In each instance, they neglect the primary goal although savings could be interpreted as profit while ignoring the declining revenues, which affect profit.  I call both of these “A Going OUT of Business” strategy.

The featured image was something shared in a marketing course and/or a product development course.  It demonstrates the product life cycle and where profit resides.  In the instance of the happy owner that doesn’t need to grow or change, this should be alarming as they should recognize that over time when products mature they are either supplanted by something new or they are commoditized causing the profits to decrease.  In my industry, copier industry, this couldn’t be truer.

A cost analysis speaks to a current state while a ROI speaks to both the current state and to possibilities.  An ROI should allow you to speak to GROWTH, new applications, costs, new revenues, and profits.

The word, INVESTMENT, is so under-utilized.  Sales professionals, you have a responsibility to use this word more often and when pushed on costs you should challenge your customer as to what their business goals are!  You don’t buy a stock or real estate (investments), to hope that you get back what you paid for it.  The same can be said for equipment.  A cost analysis demonstrates savings that usually has a large payback period while an ROI can have very short payback periods depending on the scenario.

Why do Proctor and Gamble and Johnson & Johnson own so many products?  Why is Elon Musk going into Solar Panels or Google developing a driverless vehicle?  If you ever apply for a business loan, a common question that you will encounter is “Who is your biggest customer?” and “What percentage of your business do they represent?”  This is also important when it comes to business valuation.  If you lose that customer, it some instances, it could put you OUT of business.  Diversification is not only important in stock portfolios but it is also important in business.  I suggest to business owners that they should segment areas of their business or products that their business produces and evaluate them in silos for revenues and profits.  I also share that they should think about how a new product can affect their business growth.  This can provide excellent business intelligence when making business decisions.  A cost analysis speaks to one scenario while an ROI allows you to walk through several different scenarios.

How do you maximize revenues and profits?  You can either enter a new market with your current product that leads to more customers thus increasing revenues and profits.  You can improve people, process or technology thus lowering costs of production to increase profits and hopefully new technology provides the ability for new products that can increase both revenues and profits.  You can introduce new products to existing customers to increase wallet share and loyalty thus increasing revenues and profits.  Be careful of the last one, as customers may feel more empowered to request price breaks given the size of the business they are giving you which lowers revenues and profits.  A cost analysis can demonstrate process improvement in one scenario, however I only see this 20% of the time if that.  An ROI will allow you to show all of the above scenarios.

I owned a business and I have spoken to a lot of business owners through out my travels.  A business owner should understand that revenues and profits only increase with new customers.  I would tell my team that if we maintained a 100% of our existing customers without gaining any new customers that our revenues and profits would decrease year over year.  A customer will usually ask for a lower price that lowers revenues and profits.  Best-case scenario, we were able to lower our costs of production thus flat lining the revenues and profits.  This is not the way to conduct business and is highly stressful.  Your employees will feel energized and engaged about your business if they see INVESTMENT because they recognize the new opportunity that comes with new products and GROWTH.  A cost analysis speaks to an existing base of customers.  An ROI speaks to the potential of new customers.

Why do second and third generation businesses have such a high failure rate?  I cringe when I hear a business owner talk to how they will be handing their business over to their son or daughter.  The reason is that in that same conversation we may be talking about how a new product or technology can impact their business and they will say that they are going to retire and that there in no need.  I will visit that same person year after year as they continue to work and as their business revenues and profits continue to decline.  This sets the son or daughter up for failure.  A business requires INVESTMENT.  It also requires VISION.

If you do what you did, then you get what you got.  In the instance of business, you get a little less every year of what you got because maintaining 100% retention and the same cost model over time is unrealistic.  If you are interested in how I can help your business with GROWTH, then please don’t hesitate to contact me.  If I missed any lessons that you know, then please share them with me by commenting.

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