Reginald Tomas Lee is a Professor of Business Analytics at Xavier University in Cincinnati, Ohio. He has a PhD in Mechanical Engineering, and he’s been involved in supply chain since ’96. Reginald’s most recent book is called Project Profitability. And one fun thing, he can’t go on vacation, because he has two killer dogs.
In this episode, Reginald shares wisdom with regards to the modeling he’s been making as he talks about the power of helping people understand more clearly how what it is that they do impacts cash.
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Why you have to check out today’s podcast:
- Understand why you should start seeing things from a cash perspective in relation to knowing what it is that it enables you to save
- Learn about the difference of cash cost and non-cash cost through situational examples from real life experiences
- Find out how your actions and decisions impact how you generate cash in a business
“Don’t focus on accounting margins.”
– Reginald Tomas Lee
Topics Covered:
01:17 – How Reginald shifted from being a mechanical engineer to thinking about supply chains and costing
03:44 – What Reginald does: Helping people understand how their decisions impact cash
07:18 – Talking about contribution margins: Accounting for things from a cash perspective
11:09 – How to figure out the optimal price without using some measure of contribution margin
14:34 – Hope as a strategy: Mark’s opportunity cost vs. Reginald’s opportunity revenue
17:15 – Two types of costs: The cash cost and the non-cash cost
21:41 – Reginald’s sales pitch: Very specifically identifying what the savings are
24:02 – Discussion about Mark’s value table and Reginald’s improvement projects
27:59 – Projecting revenue and the uncertainty that comes with it
30:24 – Reginald’s piece of pricing advice for today’s listeners
Key Takeaways:
“We should shift away from looking at accounting data and look specifically at operations and cash.” – Reginald Tomas Lee
“From a cash perspective, materials and labor don’t vary. When we look at contribution margins for products that we make, and we assume that those costs vary and they affect the contribution margin, my argument is they don’t vary. And so therefore, it’s not a reflection of cash.” – Reginald Tomas Lee
“As we know, hope’s not a strategy. We’re hoping that the demand would be there, but I’ve seen situations, actually, where people have bought more just to get a lower price so that they can report a higher gross margin. It’s not a good business decision at all. And that’s why I shift over to cash, because cash will tell you don’t do that, but accounting may, because I can put it in inventory.” – Reginald Tomas Lee
“If you want to save money, what you have to do is basically buy fewer people. Buy four people instead of buying 10 people. Buy less capacity, then I’m spending less money.” – Reginald Tomas Lee
“I focus specifically on what changes the software will enable, and then point out that if you want the cash savings, you need to make managerial decisions. You have to make a decision to get rid of the four people because the software is not going to fire them. That’s what you have to do. The software is not making the cost savings happen. It’s my management decision and action that was at that.” – Reginald Tomas Lee
“I define efficiency as engineers do – output over input. So, if my input is my organization, what I’m spending on the organization, and the output is what it is that they can do, then what this will do is that we’ll generally allow them to either create more output with the same group, or consume less of that group to create the existing amount of output. But the size of the organization itself doesn’t change until I, as a manager, change it.” – Reginald Tomas Lee
“Based on how we choose to calculate this cost, that may have an impact on whether we take the business or not. So instead of focusing on accounting margins, if you can take a look at the cash impact of the decision that you make, then I think you’ll be in a much better position to be able to negotiate price and feel good about taking prices that in some cases you may not have taken just because someone calculated a number that happen to be lower than someone else’s calculation.” – Reginald Tomas Lee
People / Resources Mentioned:
- Project Profitability: https://www.amazon.com/Project-Profitability-Ensuring-Improvement-Projects/dp/1637421699
- The Goal: https://www.amazon.com/Goal-Process-Ongoing-Improvement/dp/0884271951
Connect with Reginald Tomas Lee:
- Email: [email protected]
- LinkedIn: https://www.linkedin.com/in/reginaldtomas/
Connect with Mark Stiving:
- LinkedIn: https://www.linkedin.com/in/stiving/
- Email: [email protected]
Full Interview Transcript
(Note: This transcript was created with an AI transcription service. Please forgive any transcription or grammatical errors. We probably sounded better in real life.)
Reginald Tomas Lee
Don’t focus on accounting margins.
[Intro]
Mark Stiving
Welcome to Impact Pricing, the podcast where we discuss pricing, value, and the co-impactful relationship between them.
My name is Mark Stiving. Our guest today is Dr. Reginald Tomas Lee. Here are three things you’d want to learn about Reginald before we start.
He is the Professor of Business Analytics at Xavier University in Cincinnati, Ohio. He has a PhD in Mechanical Engineering; has to be the first Mechanical Engineering PhD we’ve ever interviewed here. He’s been involved in supply chain since ‘96, almost as long as I’ve been in pricing. His most recent book is Project Profitability. And one fun thing, he can’t go on vacation, because he has two killer dogs.
Welcome, Reginald.
Reginald Tomas Lee
Thank you, Mark. It’s great to be here.
Mark Stiving
Okay, to be fair, you did say the dogs are really nice.
Reginald Tomas Lee
They’re very nice. They just have that reputation thing going against them, you know?
Mark Stiving
Yeah, exactly.
So, I usually ask the question “how do you get into pricing?” but I wouldn’t say you’re in pricing. In fact, I’m going to call you a costing person, given what I’ve heard, etc. But how did you get in here? You went from mechanical engineering to thinking about supply chains and cost.
Reginald Tomas Lee
Sure. So, I think the supply chain path is a little bit more logical. I started off as an Engineer, I worked for General Motors, I worked for IBM, and then I started teaching Industrial Engineering. So that was early on in the supply chain, before they really started referring to that space of supply chain. But I was basically working in the supply chain space from the time I got my undergraduate degree.
The costing is a little less direct, though. And what happened there was I’d gone through this really interesting Manufacturing Leadership program up at Harvard and learned a little bit about activity-based costing, and I thought, hey, this could be really fun. And so, I started talking to some of the professors. And I really wanted to go there to do my Doctorate work. And my wife, we just had a little baby, and she said, “No way. I’ve got a support system here. I don’t know anyone in Cambridge. This isn’t going to happen.”
So, I went back to the University of Dayton where I had my undergrad and Master’s in Engineering, and I said, “Hey, is there any way that I can do my PhD in Engineering, but I want to understand the business elements of it,” because they didn’t have a PhD in business. And so, they said, “Yeah, it sounds like it’s a lot of fun.” And so, during that process, what I wanted to do, Mark, was I wanted to be able to document both the operational and financial benefits of some of the improvements that we make as engineers. And when I looked at the math to begin quantifying the impact, I thought, well, this is crazy. How can I get away with this and be out of jail?
So, I started looking at it, and I just started looking more deeply at the math, and understanding, okay, so what is the math really telling me when I started thinking about improvements? And one of the things that influenced me was I read the book “The Goal”. Have you read The Goal?
Mark Stiving
Yup! Absolutely.
Reginald Tomas Lee
Yeah. So, in reading The Goal and focusing on cash, my thought was, well, if the improvements, that I should be able to model the improvements and demonstrate the impact that they have from a cash perspective, and I started realizing that accounting couldn’t do that. And so, as a result, I started building my own models to reflect the cash elements of the improvements. And from there, I just expanded.
Now, I’ve got business-wide models that I use to help me understand what’s going on within organizations, and now I’m sharing that through the books and through teaching and consulting and executive education.
Mark Stiving
So now, to be fair, most of my listeners – including me – are not accountants. We don’t understand accounting all that well, but we kind of make it up as we go. We pretend like we understand it to some extent. So, you’ve got to keep it really simple for us.
Reginald Tomas Lee
Sure. Okay.
Mark Stiving
First off, the simple thing is, isn’t what you’re describing just cash-based accounting instead of accrual-based accounting?
Reginald Tomas Lee
Well, it depends on how you’re defining this, because I don’t think that I do any accounting at all, because to me, accounting involves accounting for something. And so, what I do is I look at, I basically break the organization down into two sides – operations and cash – and I call that the operations and cash domain, and then I’ve got the accounting domain.
So, when you talk about accounting, what I’m trying to do is explain what happened from a business perspective in accounting terms, for reporting purposes, right? So, how much did I sell? What was the cost of what I sold? What did I pay? When did I pay it? So that’s the accounting side of it. I don’t deal with that. What I deal with is, when we’re managing organizations, we buy things, and most of what we buy is capacity. So, we buy space, labor, materials, equipment, technology. And I define capacity as what we buy in anticipation of use. And so, when I buy capacity, I spend money, so that affects the cash that goes out of the organization. When I sell things or when I get investors to infuse money into my organization, I receive cash.
And so, what I do is I model the cash related to business decisions and managing organizations and help people understand more clearly how what it is that they do impacts cash.
I’ll give you an example. I had a client and the lead sales guy, the VP of sales, would regularly take orders with very short turnaround times. And he would think, “Oh, well, I’m going to just mark up the cost a little bit from an accounting perspective, still get a nice margin, and so therefore, it’s a profitable project for us.” The operations guy would always get angry at him, because to get that order out on time, he had to run overtime. So, they would get $75,000–$100,000 cash hit with the next payroll cycle. And so, when you look at it from a cash perspective, you see those things. When you look at it from an accounting perspective, you don’t necessarily see those things.
So, I leave accounting to accountants, and what I try to do is convince people to stop focusing on the accounting data and focus on the true raw data, which is the money I’m spending on my organization, how efficient, effective, productive my resources are, what I’m doing to generate cash, which ties into pricing. So, I do get into a little bit of pricing with my work, but I don’t look at things such as contribution margin which people look at, I don’t consider the accounting margins. I don’t consider all that stuff.
So, cash-based accounting, I’m accounting for things. To me, I just, you know, cash-based accounting would just take what I do, flip it over into the accounting domain, and say, “Here, there’s a good relationship there.” But when you look at things like, for instance, cash flow statements, I know that I spent money, so I’ve got these different categories or accounts and I’ve got account for, let’s say, office space, I have account for people that I have. What I don’t have is the context. How much office space did I buy? How effectively did I use it? When I look at labor on a cash flow statement, I don’t know how many people I had. I don’t know if I use them effectively. I don’t know what output they’re creating. I know nothing about them. And so, to me, that does nothing from a management perspective, so I think we should shift away from looking at accounting data and look specifically at operations and cash.
Mark Stiving
Okay. So, there are two really important places where I think what you do and how you think applies directly to my world and what I think, and I want to explore these with you if I can.
Reginald Tomas Lee
Sure.
Mark Stiving
The first one you said was, you don’t think about contribution margin. Now, I’m going to tell you, I love contribution margin. And I’ll say it in a way that’s really simple, and then you can tell me the complex way where this just makes no sense.
Reginald Tomas Lee
Okay.
Mark Stiving
So, if I’m going to go sell shirts, I buy a shirt and then I turn around and resell the shirt. It’s really obvious what it costs me to buy the shirt, and so my contribution margin is that incremental cost – I’m sorry, it’s the price minus that incremental cost, and now I want to know what that contribution margin is if you believe in demand curves, if I raise prices or lower prices, I sell more, I sell less, and there’s a profit-maximizing price in there, because I’ve got a, I like to call it a take-it-or-leave-it market. I only get to set one price and everybody chooses the bottom. In that case, contribution margin feels really important to me.
Now, if I missed something in that…
Reginald Tomas Lee
Nope. No. In that context, actually, when I price my own work, I look at it fairly similarly, because what you have there is you’ve got, in some way, a cash transaction that’s involved with the shirt. Now, in your example, if you bought one shirt, and you said, “Okay, I bought the shirt for $5. I’m going to sell it for $15,” then that ends up being a $10 contribution, which makes sense. However, what if you bought 10 shirts for $50? From a cash perspective, you’ve spent $50. If you sell one for $15, you’re still in the hole for $35.
And so, what happens is, a lot of times, people may make decisions based on what they think is a positive contribution margin, but they don’t necessarily consider the entirety of the transaction. I’ve got to sell enough of those shirts to be able to pay off the $50 for the shirts, I mean, for the price I purchased it for, or otherwise, I’m still in the hole from a cash perspective.
So, in your example, what I would like for people to understand is that when I buy things, 10 for $50, the cash transaction was for all the shirts. I didn’t get it for $5/shirt. I bought 10 shirts for $50. I can’t really separate those. If I buy one shirt for $5, yes. That makes sense?
Mark Stiving
That makes all the sense in the world. And so essentially, what you just said is I may have nine shirts sitting in inventory, I have a sunk cost of $50, I’ve sold the first shirt at $15 so we made profit on one shirt if you do the accounting that way, but I have nine shirts worth of inventory that I already paid for that is only worth what I can get my market to pay me for it.
Reginald Tomas Lee
Exactly.
Mark Stiving
Okay.
Reginald Tomas Lee
Now, it gets a little bit more complicated when we start dealing with products where, for instance, I’m producing them. Because now, when I look at contribution margins I’ve got, I’m considering my variable costs from an accounting perspective, and the variable costs, typically, are labor and are materials. But what I argue there is that those are not true variable costs from a cash perspective. This is where we start diverging from accounting versus my modeling.
When I pay for someone to be in my factory, I pay them $25 for an hour, and at $25, I have to pay them whether they make no products or they make an infinite number of products. Likewise, with materials, if I buy 100 pounds of steel, then the price I paid for the steel is the cash transaction, and I’d pay that whether I make no items with the steel or I use it all up, right? So, from a cash perspective, materials and labor don’t vary.
So, when we look at contribution margins for products that we make, and we assume that those costs vary and they affect the contribution margin, my argument is they don’t vary. And so therefore, it’s not a reflection of cash.
Mark Stiving
Okay. Before I ask this next, what I think is going to be a really hard question, let me make sure you and I are on the same page.
Reginald Tomas Lee
Sure.
Mark Stiving
And that is I described what I call a take-it-or-leave-it market, which is a shirt, a retailer, I walk in and say I’m going to buy it or I’m not going to buy it; I don’t walk up and negotiate the price. In a lot of B2B sales, we have negotiated prices, in which case, I don’t think contribution margin matters at all. The only thing that matters is what’s the best price the salesperson can negotiate, and do we want to take that deal or not.
And so, I want to go back and make sure we’re talking about retail for just a second, we’re talking about a take-it-or-leave-it type marketplace.
Reginald Tomas Lee
Okay. Purely take-it-or-leave-it? Yes?
Mark Stiving
Purely take-it-or-leave-it marketplace.
So now, I now manufacture shirts instead of buy and resell shirts. I have labor. I have material. How do I figure out the optimal price if I’m not using some measure of contribution margin?
Reginald Tomas Lee
Well, can you define optimal price for me? What does that mean to you?
Mark Stiving
Profit-maximizing price.
Reginald Tomas Lee
So, from a cash perspective, what I look at is what I call the marginal cash associated with the transaction. Okay? I’ll give you an example, and then maybe, we can tie it back to take-it-or-leave-it.
I was doing work with a company that had online storage, cloud-based storage, and they would calculate a cost to be able to provide you, let’s say, with a terabyte of storage. Okay? So now, with that cost, they want to price it to offset that cost and get as much profit as they possibly can, okay? Now, for them to be able to bring you on as a customer, probably from a cash perspective, doesn’t cost anything. Nothing’s really going to change with their operations. So, anything that I can get that’s tied to the value that you perceive of having a terabyte of data on the cloud would be your profit maximization, because I’m looking at just generating the sales with really no change and spin. Okay?
Now, what’s different is, what if you came to me and said, “Hey, I’d like to buy a terabyte of data, and I realized I only have a half a terabyte of data space available. I’ve got to buy another server.” Now, I’ve got to spend money to buy a server to be able to sell you that terabyte of data.
So, with the same price in both cases, one, it could be a very positive transaction, because there’s really no marginal cost from a cash perspective, the other could be very negative, because I just spent $3,000 on a server, and I’m going to charge you $9 a month for the next year, right?
So, when I look at situations like that, what I look at is, are there changes in spend associated with getting the business? And so, if I, for instance, I’m doing a consulting job and it’s just me doing the work, I don’t have to really spend any money doing it. However, if I’ve got to hire someone with a specific skill set, then I’ve got to consider, “Alright, so I’ve got to pay them if I take this work. So how much price can I generate to offset what I have to pay them?” And so, at that point, we shift over into pricing being value. Whatever they will perceive for my services or whatever I can convince them is the value for my service, then that ends up being the maximum price or the maximum profit.
Mark Stiving
So first off, to be clear, I always think that price has to do with value. It has to do with the value for the service. So, we’re certainly in agreement there. It seems to me, though, I’m trying to find the right words to make this make sense.
Reginald Tomas Lee
Sure.
Mark Stiving
I’ve got- we’re doing the terabytes. I happen to have three terabytes left. I could take your business for $1 a month, but that’s an opportunity cost that I’m giving up, because there’s another customer somewhere down the line that’s about to pay me 10 bucks a month if I just wait a little bit. Now-
Reginald Tomas Lee
Though- okay, I’m sorry.
Mark Stiving
I’ll just let you go.
Reginald Tomas Lee
Sure. So first of all, I get worried when I think about opportunity costs, and the reason is, to me, it’s really opportunity revenue, because it’s money coming in. That’s not really a cost in my mind. But when I think about that, notionally, I get a little bit nervous. I get nervous primarily because there’s a customer somewhere that’s going to come in and pay $10. We hope, right? It’s kind of a hope, and as we know, hope’s not a strategy, right?
Mark Stiving
But that’s the same reason we bought 10 shirts instead of one shirt. We hope.
Reginald Tomas Lee
Maybe. Well, we’re hoping that the demand would be there, but I’ve seen situations, actually, where people have bought more just to get a lower price so that they can report a lower gross margin. I mean, a higher gross margin.
Mark Stiving
Yeah. I would say that’s tricky accounting, not good business decisions.
Reginald Tomas Lee
It’s not a good business decision at all. And that’s why I shift over to cash, because cash will tell you don’t do that, but accounting may, because I can put it in inventory. But when I sell that one shirt and it goes on to my income statement, it looks like a pretty decent profit.
Mark Stiving
Oh, that’s interesting.
Mark Stiving
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Please purchase and read Win Keep Grow wherever fine books are sold.
Mark Stiving
Okay. Can I completely flip this upside down now?
Reginald Tomas Lee
Sure.
Mark Stiving
By the way, this is great conversation. I love this, Reginald. I’m learning something. But I’m going to flip it upside down now.
Reginald Tomas Lee
Sure.
Mark Stiving
And instead of me trying to set a price on something I want to sell and make sure I understand how the costs matter, now, I often teach salespeople how to convince buyers they’re getting value from our products.
Reginald Tomas Lee
Okay.
Mark Stiving
And one of the ways to do that is by saying, “Oh, look. When you do this, your costs go down.”
Now, you have no idea how nervous I was as soon as I said those words, with what’s about to come out of your mouth, but let’s go.
Reginald Tomas Lee
So, my last book, Project Profitability, addresses that head on. When I think about costs going down. First of all, in my work, I break costs down into two types. One is a cash cost; that’s where I spend money. So, for instance, if I buy a book for $25, that book costs me $25. I pay the $25 in cash, right? The other is a non-cash cost. And so, anytime I calculate a cost, if I’ve got to figure it out, then that’s a non-cash cost.
I’ll give you an example. Let’s say, you remember when we used to have landlines, right? And so, you pay $25 a month and you can make unlimited local calls, but they charge you 10 cents a minute for long distance, right? So, we know that 10-minute long distance call will cost us $1, right? But what will a 10-minute local call cost us? And therein lies the problem.
So, with cash costs, that’s the long distance. The more I buy, the more I spent. But with most of the cost that you calculate, that’s not really a situation where I’m dealing with cash. For example, when people talk about a product costing $5 to make, does that mean we’re spending $5 every time we make one? No. Does that mean that we’re saving $5 if we don’t make one? No. What that represents is the values and opinion of the value of the labor and the materials that are going into that product. And I say it’s an opinion because I can choose what’s in scope in terms of calculating the cost, I can choose the method that I want to calculate the cost. I’m choosing these things, so there’s subjectivity there. So as a result, the cost itself doesn’t reflect money. It’s not a cash transaction, so I call those non-cash costs.
So oftentimes, when you hear people saying your costs will go down, what cost are you talking about? Because if you’re talking about cash costs going down, then you have to be able to demonstrate, as a salesperson, how your customer is going to spend that much less money as a result of buying your product or service.
Now, an example of that. I had a customer who- I talked about this in the Project Profitability book. A salesman came and said, “Hey, I want you to buy our warehouse software. You’re going to save $4 million.” And he said, oh. Better information, faster information, he said, to get that, oh. Better quality information, your people will be more effective. And finally, he said, “you’re telling me that if I buy your software, I’m going to spend 4 million fewer dollars. I need you to tell me how that’s going to happen. Tell me how your software will make $4 million just poof, go away.” And he said, “I can’t.” And then Gary said, “Alright. In that case, I’ll buy your software. I’m buying it because it’s a value to my company, but I’m not saving any money.”
So, when I talk about cost going down, what’s happening is this, in many cases. You’ve got someone who makes $100,000 a year. Your software makes them 20% more efficient, so they say, “Well, that means we’ve saved $20,000.” Well, no, you haven’t, because you’re still paying them $100,000 to work there. What you’ve saved is time, which you’re valuing at $20,000.
And so, that’s where we get the difference between what’s happening from an accounting perspective, which I can identify that as a cost savings, and from a cash savings would say, “No, you’re still spending the same amount of cash. You just now made that person more efficient. Now you have more of their time available to them.”
Mark Stiving
Okay. I love the last example, because it’s the one that that many, many companies deal with very often, right? “I’m going to make this person 20% more efficient.”
So now, put yourself in the shoes of the salesperson. What’s your sales pitch? Because it isn’t, “Oh, I’m going to save you $20,000.” What is it?
Reginald Tomas Lee
What I do, and I spent a lot of time modeling this in the book, what I do is I identify, very specifically, what the savings are, the explicit business outcome as a result.
So, for instance, if I want to sell them software, I will let them know that this is what the software can do. So, the software can provide, you know, going back to Gary’s situation, for the people who were doing picking and packing and shipping in the warehouse, they should be able to do that X percent faster. As a result of that, operationally, then, you’ll be able to pick more orders, you can pick orders at a faster rate, for example, or what I may be able to do is I can reduce the amount of time spent on doing inventory counts, primarily because they are more accurate in terms of putting the items away. So, I’ve been focused on operations. We’ll say, “this is the operational improvement that will be enabled by my software.”
Now, if you want to save money, what you have to do is basically buy fewer people, you know. So, if, as a result of my software, you can operate with six people instead of 10 in your warehouse, the only way you’re going to get a cost reduction in that context is to buy fewer people. Buy four people instead of buying 10 people. Buy less capacity, then I’m spending less money.
If there are issues associated with, you know, I’m not going to lose sales, for example, as a result of this software, then I may want to point that out, that what we found in our analysis is that you’re losing sales primarily because items are not in the right place, and so therefore, they can’t find them and we can’t sell it. So, from our software, we should be able to put find where items are, and then go and pick that item and make it available to the customer.
So, I focus specifically on what changes the software will enable, and then point out that if you want the cash savings, you need to make managerial decisions. You have to make a decision to get rid of the four people because the software is not going to fire them. That’s what you have to do. And I can buy the software and get rid of the four people or I can buy the software and keep them, right? I have those choices. So, the software is not making the cost savings happen. It’s my management decision and action that was at that.
Mark Stiving
Nice. Okay. So, while you were talking, I think I made sense of all this.
Reginald Tomas Lee
Okay.
Mark Stiving
So, I often teach my clients what I call a value table – how do we get the value, and value table tends to have four columns. The four columns are the solution, the problem, the result, and the value. The solution is a product or a feature of the product, and the problem is a problem that a customer has, this is what we’re trying to solve, this is why we built the feature, why we built the product. If a customer has this problem, they buy our solution, they get some results. That result is some quantifiable, measurable something. And I think, so far, you and I are 100% on the same page until we get to the value column.
Reginald Tomas Lee
Okay.
Mark Stiving
And once we get to the value column, I always teach salespeople, well, you can use business acumen to help the client calculate the value of this result, and of course, I will calculate it as $20,000 savings because you’ve made them 20% more efficient, and you would repeat it differently or you would say it differently.
Reginald Tomas Lee
Yup.
Mark Stiving
It isn’t that it’s completely wrong. Instead, it may be slightly misleading the way I do it.
Reginald Tomas Lee
Yeah. I think that, for me, I would want to explain what the $20,000 means, right? If I’m still paying that person $100,000 to be there, that’s the value I’m putting on their time. Because what I wouldn’t want to do is have them spend $10,000 on my solution, thinking they’re going to save $20,000. They don’t, and in fact, they end up paying $10,000 in the hole as a result, then that’s egg on my face, and so that’s what I try to avoid.
And I talk about this a lot in the book, because we used to do that when I was consulting for larger companies. We wanted to sell a big Oracle implementation. So, what would we do? We’d find all these people, find how much we’d saved them, save in terms of their time, and we come up with these huge $50 million value propositions. And then the company says, “Well, hey, if you can save me 50 million, it makes sense for me to spend 25 million on this Oracle implementation or SAP implementation.” So, what happens? They buy the consulting, they spend two years implementing the software, and the organization stays the same. And to me, that’s not good business. It’s just my personal opinion. What I’d rather do is have them understand, specifically, what that’s going to do for them.
Now, if they’re cash savings, let’s point out the path to get there. Like I said, usually, I call these improvement projects. Usually, improvement projects will improve efficiency within organizations. So, I define efficiency as engineers do – output over input. So, if my input is my organization, what I’m spending on the organization, and the output is what it is that they can do, then what this will do is that we’ll generally allow them to either create more output with the same group, or consume less of that group to create the existing amount of output. But the size of the organization itself doesn’t change until I, as a manager, change it.
And so, what I show is that when we model, when we’re selling something, what we should do is be very clear, going back to your term business acumen, and understanding how will my solution improve your efficiency. Based on that improvement in efficiency, what will that enable, right? For instance, as an enabler, what it might enable is, as I grow, I can hire people at a slower rate. That’s a good thing, right? If I’m reducing, if my market is going down, I can reduce people at a faster rate. That’s a good thing. The improvement itself won’t fire people, but it enables me to do that. And so, with my business acumen, what I’ll say is, “Hey, so with these improvements, here are some decisions that you can make that will lead to true cash savings.”
Mark Stiving
Okay. So, I think the efficiency one, I understand, especially in the sense that I don’t want to sound misleading people, but I think I’m not telling the full story the way you see the full story.
Tell me about revenue. So, when I walk in and I say, “Hey, this is going to help you sell 20% more units. That’s a million dollars a year. You happen to have a 10% margin in general for your company. So, what is that? $100,000 in your pocket.” Did I just lie to them?
Reginald Tomas Lee
Well, yes, potentially.
Mark Stiving
I knew that was coming.
Reginald Tomas Lee
Yeah, potentially. Here’s why.
The 10% margin is over in the accounting domain. So, my margin is a function of my revenue minus the cost of goods sold, right? Now, I can choose what my margin is, right? For instance, take this stylus, right? Let’s say that it cost the remarkable company $50 to make it. We calculate the cost of being $50, right? That’s my version of what this thing costs. You can use your techniques and say, “No, I came up with a cost of $40.” And somebody else can cost and say, “I think the cost is $60.” So, what is the margin? It really depends on which cost we choose, which has nothing to do with the money that was spent, right? So, there’s that element of it.
And then I think, the other side is, when it comes to projecting revenue, one of the things that, I picked up this when I was a strategist, there’s uncertainty associated with that projection. And so, to say $2 million, well, it may be 2 million, it may not, right?
I’ll give you an example of how these projections work.
On the board of this group, and we were talking about an acquisition, and a woman who was the Executive Director of the company said, “I use a weighted average cost of capital of 10%.” And so, a guy said, “Why do you use 10%?” “Well, because we’re told 10 is best.” “I don’t know that 10 is best.” And so now I’m arguing whether that’s 10% or not, right?
And so, we learn as we bound it. We think it’s going to be between eight and 10, or eight and 12, and these are the assumptions that bound it. And now, you’re in a better situation to be more correct about what the software will be able to do. I can’t tell you because I have way too much uncertainty to tell you for certain, it’s going to be $2 million, but I can tell you with a high degree of certainty, that’s going to be between 1.5 and 2.5, and here’s why the assumptions lead to that number.
Now, you’re not arguing over 2 million or not. You’re arguing where in that continuum you may fall.
Mark Stiving
Right. Reginald, I got to tell you, this has just been absolutely fascinating. Time has flown by, so I’m going to have to wrap it up. Let me ask you the final question.
Reginald Tomas Lee
Sure.
Mark Stiving
What’s the one piece of pricing advice you would give our listeners that you think could have a big impact on their business?
Reginald Tomas Lee
That’s a really good question. And I’m trying to figure out how best to say this.
Don’t focus on accounting margins. And I’ll go back to that last example to explain why.
The pen. I calculated it at $50. So, if someone offers me $45, I say no, right? You calculated it at $40. Someone offers you $45. You might take it. So now, based on how we choose to calculate this cost, that may have an impact on whether we take the business or not.
So instead of focusing on accounting margins, if you can take a look at the cash impact of the decision that you make, then I think you’ll be in a much better position to be able to negotiate price and feel good about taking prices that in some cases you may not have taken just because someone calculated a number that happen to be lower than someone else’s calculation.
Mark Stiving
Nice. As always, you have my brain just thinking really hard.
Reginald, thank you so much for your time today. If anybody wants to contact you, how can they do that?
Reginald Tomas Lee
Email is probably the best way. My email address is reginald.lee@b (as in boy) d (as in david) rco.org. Again, [email protected]
Mark Stiving
Alright. Thank you.
Episode 167 is all done. Thank you for listening. If you enjoyed this, would you please leave us a rating and a review?
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