Relating High Margins to High Values

The ability of Consultative Selling to command high-margin price points for products, services, and systems is documented by cost-benefit analysis. The objective of analysis is to derive a customer's economic benefits; the benefits can then drive the costs, which compose the investment required to generate them. In the cost-benefit process, the customer's investment is a function of the supplier's benefits. Benefits are the cause of the customer's paying out an expense, not the result.

Figures 9-3 and 9-4 show how iterative what-iffing can bring an investment into commensurate alignment with its return. This ensures the supplier's margin while the customer still gets a good deal.

Cost Benefit Analysis
(000)	Year 0	Year 1		Year 2		Year 3		Year 4		Year 5		Total
			Month		Month		Month		Month		Month		Leased
Investment (Capitalized/Amortized)
Amortized Expenditures
Software 1	($250)	($25)	0	($25)	0	($25)	0	($25)	0	($25)	0	($375)	N
Subtotal	($250)	($25)		($25)		($25)		($25)		($25)		($375)
Total Cap./Amort	($250)	($25)		($25)		($25)		($25)		($25)		($375)
Investment (Expenses)
Expenses
Consulting	($250)	($100)		($100)		($100)		($100)		($100)		($750)	N
Subtotal	($250)	($100)		($100)		($100)		($100)		($100)		($750)
Leasing Costs		$0		$0		$0		$0		$0		$0
Depreciation:		$0		$0		$0		$0		$0		$0
Amortization:		($55)		($60)		($65)		($70)		($75)		($325)
Total Expenses:	($250)	($155)		($160)		($165)		($170)		($175)		($1,075)
Benefits (Net Cash In)
Revenue Increases
Revenue Increases		$4,000		$11,200		$20,560		$26,644		$33,641		$96,045
Subtotal		$4,000		$11,200		$20,560		$26,644		$33,641		$96,045
Cost Savings
Cost Savings 1		$480		$624		$811		$933		$1,073		$3,921
Subtotal		$480		$624		$811		$933		$1,073		$3,921
Total Benefits:		$4,480		$11,824		$21,371		$27,577		$34,714		$99,966
Profit Improvement (PI)
Gross PI:	($250)	$4,325		$11,664		$21,206		$27,407		$34,539		$98,891
Less Taxes	$100	($1,730)		($4,666)		($8,482)		($10,963)		($13,816)		($39,556)
Net PI:	($150)	$2,595		$6,998		$12,724		$16,444		$20,723		$59,335
Add Back Deprn:	($250)	$30		$35		$40		$45		$50		($50 )
Cash Flow	($400)	$2,625		$7,033		$12,764		$16,489		$20,773		$59,285
Cum. Cash Flow	($400)	$2,225		$9,258		$22,022		$38,511		$59,285
NPV	($400)	$2,386		$5,813		$9,589		$11,262		$12,899		$41,550
IRR:	798.1%
Payback (Months): 2
Tax Rate	40.0 %
Hurdle:	10.0 %
Amortization Method.		Straight Line

Figure 9-3: What-iffing a $250,000 price point.

Cost Benefit Analysis
(000)	Year 0	Year 1		Year 2		Year 3		Year 4		Year 5		Total
			Month		Month		Month		Month		Month		Leased
Investment (Capitalized/Amortized)
Amortized Expenditures
Software 1	($1,000)											($1,000)	N
Subtotal	($1,000)											($1,000)
Total Cap ./Amort	($1,000)	$0		$0		$0		$0		$0		($1,000)
Investment (Expenses)
Expenses
Consulting	($250)	($100)		($100)		($100)		($100)		($100)		($750)	N
Software Main		($100)		($100)		($100)		($100)		($100)		($500)	N
Subtotal	($250)	($200)		($200)		($200)		($200)		($200)		($1,250)
Leasing Costs		$0		$0		$0		$0		$0		$0
Depreciation:		$0		$0		$0		$0		$0		$0
Amortization:		($200)		($200)		($200)		($200)		($200)		($1,000)
Total Expenses:	($250)	($400)		($400)		($400)		($400)		($400)		($2,250)
Benefits (Net Cash In)
Revenue Increases
Revenue Increases		$2,000		$7,000		$13,940		$17,362		$21,430		$61,732
Subtotal		$2,000		$7,000		$13,940		$17,362		$21,430		$61,732
Cost Savings
Cost Savings 1		$480		$624		$811		$933		$1,073		$3,921
Subtotal		$480		$624		$811		$933		$1,073		$3,921
Total Benefits:		$2,480		$7,624		$14,751		$18,295		$22,503		$65,653
Profit Improvement (PI)
Gross PI:	($250 )	$2,080		$7,224		$14,351		$17,895		$22,103		$63,403
Less Taxes	$100	($832 )		($2,890)		($5,740)		($7,158 )		($8,841 )		($25,361)
Net PI:	($150 )	$1,248		$4,334		$8,611		$10,737		$13,262		$38,042
Add Back Deprn:	($1,000)	$200		$200		$200		$200		$200		$0
Cash Flow	($1,150)	$1,448		$4,534		$8,811		$10,937		$13,462		$38,042
Cum. Cash Flow	($1,150)	$298		$4,832		$13,643		$24,580		$38,042
NPV	($1,150)	$1,316		$3,747		$6,620		$7,470		$8,359		$26,362
IRR:	240.5 %
Payback (Months): 10
Tax Rate	40.0 %
Hurdle:	10.0 %
Amortization Method.		Straight Line

Figure 9-4: What-iffing a $1 million price point.

The two figures represent consecutive iterations of what-if price strategizing. In each case, the supplier is the same provider of a collaborative software system that allows geographically separated product developers to use their corporate intranet to cooperatively build "more better new products faster and cheaper." The eventual cost-benefit analysis will be the engine of a Profit Improvement Proposal to be presented to a manufacturer's new product development manager.

The benefits to be quantified are primarily the increased revenues from getting the manager's forthcoming new product to market faster than competition. In this way, greater volume at higher margins can be creamed from early adopters. As a result of collaboration, the product should also come closer to best-of-breed performance and thereby enable a greater contribution to customer profits. Cost savings are expected from a reduced innovation cycle, and lower selling costs should be achievable with a more advantageously designed and engineered product.

Both iterations of the analysis assume a 20 percent increase in year-one revenues over the customer's original projection of $20 million, followed by a 30 percent increase in years two and three. The rate of increase drops to 15 percent in years four and five as competitive replication and obsolescence start to erode net present value.

Margins are also projected to increase by 10 percent over plan in year one. Their rate of increase declines to 5 percent in years two and three and to 3 percent thereafter.

Figure 9-3 bases its analysis on a price point of $250,000 per system plus annual maintenance, upgrading, and consultation. This yields total benefits over five years of almost $100 million. The customer's IRR is 798 percent.

In the belief that an IRR of 798 percent is a philanthropic donation and not a business deliverable, a second iteration shown in Figure 9-4 costs out the system at a price point of $1 million: four times the amount of the customer investment in Figure 9-3. Total benefits over five years are reduced to $66 million at an internal rate of return of 240 percent.

While total expenses have doubled and payback takes eight months longer, Figure 9-4 shows that the supplier's PIP can be a good deal even at $1 million. This gives the supplier three options to locate a floating price point:

1. The supplier can accept the comparatively low margin that is realizable from an investment of $250,000. The resulting 798 percent IRR proves that it is unnecessary in order to compel the sale by being 788 percent in excess of the customer's hurdle rate.

2. The supplier can ask for the $1 million price and still exceed the customer's hurdle rate by 230 percent.

3. The supplier can ask a price anywhere in between $250,000 and $1 million and attach an incremental gainsharing schedule to it as an added margin equivalent.

The floating point that Consultative Selling makes of price gives the supplier, and all suppliers, considerable flexibility in making margin. Fairness is maintained as long as an IRR in the low three figures proves that the customer is receiving an otherwise unobtainable return on each dollar invested.