When customers invest their money to acquire your products or services, they obtain an asset. Their goal is to turn it over as quickly as possible so that it will revert to cash. Then they can reinvest in another asset with you and start the process over again. If they make good investments with you, they will end each investment cycle with more money than they started with. Asset turnover is the secret to making money. The more assets turned and the faster they turn over, the more money is made.
Accounts receivable and inventory are a customer's two major current assets. Current assets, by being turned over, are more quickly convertible to cash than are fixed assets. Anything you can do to speed up a customer's asset turnover in these two areas makes money for both of you. If you and a customer allow these assets to build up—if a customer's sales decline and inventories grow or if your customer's customers delay paying their bills—both of you are incurring the costs of lost opportunities.
Ideally, customers would like to have zero investments in accounts receivable and inventory. Every day that you can help them condense their collection period is money in the bank. Every additional turn of inventory also improves profits. An item that turns over 1.7 times a year sits in inventory approximately seven months before being sold. If you can help move it in six months, using the power of one, you can accelerate its contribution to earnings by one-seventh.
Asset turnover is especially important in selling to a customer's profit center managers. One of their key performance indicators is ROI, which is calculated by dividing their earnings by the investment in their asset base. The higher their ROI, the greater the investment that top management continues to make in their profit centers, and the higher the reward each center's manager receives.
The ROI of your customers is a good index of how good a comanaging partner you are. If you have the ability to affect inventory, but you let them stock out on their highest margin products, you are a poor comanager of your customers' assets. If you have the ability to affect collections, but you let their money languish in accounts receivable, you are more of a mismanager than a comanager. Increasing inventory turns and decreasing collection cycles make you better.
Whenever you make proposals to customers, you are challenging them to assess a risk. If you ask them to invest with you to expand their capacity to produce their existing products, you are offering them a median risk. All other types of investment have a higher or lower risk. Investments for replacement or repair are the safest. Past experience can accurately help foretell their probable cash flows. Cost reduction investments are somewhat riskier. No one can calculate the exact magnitude of their potential savings. The riskiest type of investment concerns new products or new market development, where neither the costs nor the revenues can be predicted with certainty.
As soon as customers invest with you, they incur an opportunity cost equal to the return they could have earned from an alternative investment of the same funds. The opportunity cost is in addition to the direct cost they pay you and the indirect costs they incur in implementation. The further away you take them from their median risk, where they know the return they can expect, the more risk-averse they will be and the more proof they will demand and the closer partnership with you they will expect.
Whenever risk increases, customers balance it against its return. In high-risk situations, they are more interested in whether the return is sufficient to justify the risk than the rate of return itself, however high it may be.
The risk-return trade-off is the basis of management. The only fully known sum of money in any transaction is its investment. Future benefits are always uncertain. As risk increases, the anticipated return must increase with it. If managers are confronted with two equal investments that promise a similar return, they will probably choose the investment with the lower risk—that is, the one with the higher net present value per dollar invested.
Where risk is equal or minimal, it is not a factor. Under these conditions, it is better to make an investment rather than let money sit idle—and thereby incur opportunity cost—as long as a positive net present value can be returned. This means that it must equal or exceed the customer's cost of capital. As long as it does either one or the other, the investment is acceptable. This is simply another way of calculating the worth of an investment based on its net present value. According to NPV, investing $50 million today for a stream of future cash flows with a value today of $59.755 million is an acceptable investment. In effect, the customer is paying $50 million for an asset worth $59.755 million, gaining $9.755 million of new value. Since the NPV is well over zero, this is a good investment. If it were only zero, the customer's wealth would be unchanged and time would be wasted, consumed by opportunity cost.
Risk, no matter how minimal, increases over time. That is one reason why a dollar today is always worth more than a dollar in the future. Two other reasons why money has a time value are inflation and the opportunity cost that is incurred when money is not productively invested.
Because money has a time value, every dollar returned by an investment is worth less as time goes on. In the way that customer managers think about investments, they say that if I have 91 cents on hand today, I can invest it at 10 percent interest and it will grow into one dollar within one year. Is this the best deal available to me at this time? Can I get a better rate of interest anywhere else? Can I get a quicker payback? Can I get a larger return?
The fear of opportunity loss can be a powerful motivator to commit. Consultative sellers always calculate the value of a lost opportunity to invest with them, reminding their customers of how much it is costing them for each day, week, month, and quarter of deliberation and delay in comanaging a PIP. This puts a penalty on "missing out on a good thing" and, conversely, awards brownie points for biting the bullet.
In traditional vendor selling, time is always on the customers' side. The longer that a purchasing cycle is allowed to run on, the lower the eventual price. For this reason, delay is a more profitable strategy for customers than closing quickly. While prolonging price negotiation is in the customers' self-interests, the opposite is true for their suppliers.
Whenever vendors negotiate price, they lose twice. Loss of time is loss of money. As time is lost, vendors lose even more by discounting their price. Until they reach the price point where the customer calculates it will no longer be worthwhile to trade more time for an even greater discount, no close will take place.
Vendor prices are always initially unacceptable to customers because time will bring them down. Quick discounts rarely move customers to close. They know that the discounts will become successively deeper. Closure takes place when they perceive that each additional unit of waiting time earns them a diminishing return of discounted price.
When the value of time has such a different meaning for a customer and a supplier, there is no way that their relationship can be anything but adversarial. Talk of partnership by vendors is gibberish.
Consultative Selling makes partnership possible by endowing time with a mutual value. With a PIP proposal process, immediate closing benefits customers and suppliers alike. If customers stall closing a PIP, they incur a calculable opportunity cost from postponing today's profits until tomorrow. The dollars themselves can usually be made up; year five cash flow may have to wait to be recoverable until year six. But because money has a time value in addition to a dollar value, the worth of each dollar tomorrow will always be less than the worth of the same dollar today.
For the supplier, delay is also expensive. Any value proposed today begins to depreciate as soon as it is PIPped. PIPs are enabled by the application of technology, which is perishable. From commercialization forward, all technology is obsolescent. As its value depreciates, its once-exclusive ability to make a contribution to customer profits may become equalized or superseded by a competitive technology. As a result, a PIP's value proposition must be revised downward at the same time that its customer's opportunity cost is rising: It is lose-lose.
The unwillingness on both sides to absorb opportunity cost drives quick PIP closure. Each party is motivated by self-interest in wanting its money now. The customer wants to maximize the net present value of time. The supplier wants to maximize the net present value of technology. A waiting game is a losing game for both of them.