The previous briefing explained that accumulating resources are important.
So now we need to understand how to work out the result when it happens…
The following figure shows how to picture this idea. The box icon in the middle is the ‘tank’ containing the cash in your bank account, and the oval icons are the pumps, pumping cash in and out at some rate. If the inflow and outflow rates differ, as they do here, you know exactly how fast the resource is changing, so if these numbers continue through time, you will have $1050 at the end of next month, $1100 at the end of the month after, and so on. It is also easy to work out what will happen if, say, your rent goes up from $200 to $300/month.This math is known as “integration” but don’t worry if this sounds scary – if this illustration makes sense to you, it seems you already know how to “integrate” resources over time, even if you didn’t realize it.This figure only looks at the relationship between a resource and its flow rates for a single period, but we made a big deal in previous briefings about the need to understand how performance varies continuously over time … so we also need to understand what happens to resource levels over time … so we need to understand the relationship between resources and their flow rates from period to period.
To clarify this point, the next figure shows sales for some product, driven by customers who buy at a steady rate of seven units per month. The business starts with 100 customers, and wins five new customers per month, ending the year with 160 customers. Sales start the year at the rate of 700 units per month, and end the year at 1120 units per month (160 customers * 7 units per customer per month).
What happens when a customer flow rate is not constant but itself is changing over time. In the final figure, the business is winning 20 customers per month, and initially losing only 12/month. But as each month passes, this loss rate increases, rising in successive months to 14, 16, 18, and so on, until by the end of month 12, customers are leaving at the rate of 36 per month.
We have a straight-line trend on customer losses, and a constant win rate, but the stock of customers follows a curving path through time, peaking at 120 during month five (when 20 customers are won and another 20 are lost), then decreasing ever more rapidly until the year ends with only 64 customers in place.
Although this may seem an unfamiliar way of looking at business performance, it simply re-presents what could equally be shown in a spreadsheet. The table at the foot of this briefing shows the causal logic and calculation sequence:
- the resources available at the start of each month (customers) determine the performance rate (total sales)
- resources added and lost during the month (new customers and customers lost) determine the resource that at the start of next month
The spreadsheet adds an extra line for average sales last month, to get a more accurate explanation for the performance over each period.
Note that the resource flow rates here—new customers and customers lost per month – tell us the trajectory on which the business is heading at the start of each period. The customer base starts heading upwards by a net +8 per month. By month 4, customer losses match the win rate, so there is no net change in customers. By month 12, customer losses are way faster than the win rate, so into the next month (month 13), the net change will be –16/month.
This structure has a critical implication:
It is vital to know, separately, resource inflows and outflows.
Winning 20 customers and losing 12 is not the same as winning 100 and losing 92!
Where in your business would understanding the inflows and outflows of a key reource make a difference to management?
Until next time…
If you would like to receive the series from the beginning in your email inbox, please register on on our website and subscribe to Briefings in “My Account”
More than a ‘theory’!
The simple mechanism captured in these figures portray a deeply fundamental principle – the amount of any resource right now is the sum of everything ever added, minus everything ever lost. This is not a matter of opinion, a result of surveys, research or statistical analysis. It is more even than a “theory”—it just IS the way the world works, and is mathematically unavoidable. There is no other explanation for the amount of cash in your account besides the historical sum of what was paid in and out.
Well – “this is all pretty obvious”, you might say – and indeed it is, but it is only obvious, and helpful, if you bother to ask about it! … and serious folk in serious organizations fail to do so amazingly often. Take the case of a branded pain-relief product in the US market. Market growth was minimal, and sales were changing only at a very slow rate indeed. However, far from the stability that these low rates implied, buyers of pain-relief products were actually churning quite quickly, with nearly 13% switching their preferred product each year. Consequently, although net change in consumer numbers and sales was very small, there was great scope for improving the situation. Rather than trying still harder to capture new customer, attention shifted to retaining specific consumers who were leaving most rapidly. (Customers leaving buy more than new customers, so sales were actually falling in spite of increasing customer numbers).
Further work showed that customer churn could readily be reduced by two percentage points a year, comparable to the best performing competitor, an improvement worth over $1 million per year in extra sales, and a significant increase in market share. Better still, this could be achieved with a lower marketing spend than previously, since there was less competitive marketing activity directed at the consumer group who were leaving.
Sure, this was obvious – but the fact is that no-one had asked this question about customer win- and loss-rates before.
This briefing summarises discussion from chapter 3 of Strategic Management Dynamics, pages 128-133
Read more about the book on our websiteShare