Which Matters More to B2B Buyers, ROI or NPV?

We recently wrote about the correct usage of the term ROI in a B2B sales event. A great follow-up question we received was, “How do I know what to show my customer, ROI or NPV (net present value)?” Let’s take a look.

We’ve already looked closer at ROI, so let’s spend a moment on NPV. Net present value is important because it measures the incoming cash flow from an investment over time, and converts that cash flow to today’s dollars. To quote Investopedia:

NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.

Your prospects are concerned with the potential profitability of their investments, so if you want them to spend money with you, NPV is something you should be prepared to discuss. (As a side note, we’ve previously discussed why preparing a business case is critical to sales success. We also wrote about how to inspire confidence in your proposal. Those are two initial considerations before you even get to NPV.)

Now, let’s imagine your prospect is comparing your offering (Investment A) to an unrelated investment opportunity (Investment B). The NPV for Investment A is $3,760 and for Investment B it’s $2,949. Remember, NPV measures the cash flow over time from an investment and converts that cash flow to today’s dollars. (For those of you scoring at home, we used an eight percent discount rate in this example.) So, you’re feeling pretty good because your investment opportunity provides a higher NPV.

But what if I told you that the ROI for Investment A is 21 percent and the ROI for Investment B is 1,025 percent? ROI is a simple metric that suggests the rate of expected return for every dollar invested in a project. Now you are thinking, uh-oh, my offering’s ROI is much lower.

Let’s introduce a third metric, payback period. Payback period tells us how long before the cash flow from a project turns positive. In our example, Investment A has a five-month payback period and Investment B has an eight-month payback period.

Which Matters More, ROI or NPV?Present your business case and let it stand on its own merit. The evaluation of the financial indicators is going to vary from prospect to prospect. One prospect might focus on the payback period because they want to know how soon they are going to get back their investment. In this case, the prospect would favor Investment A. Another prospect may be risk-averse and focus on finding the highest ROI with lowest project costs because they are thinking how much capital they’ll lose if the investment doesn’t deliver the benefits. This favors Investment B.

The only guarantee is that if you don’t quantify the value of your solution for prospects, none of the above will matter because your deal will never merit serious consideration.

Do you always give prospects a business case? Are you comfortable with concepts such as ROI and NPV? Share your thoughts in the comments section.

Fit your Business Case to Sell to Small Companies

During one of my recent client presentations, I got an interesting question: do you still need a business case when selling to smaller companies?

I’ll always be a big proponent of a business case. However, you need to adjust your approach if you’re selling to smaller companies (which I’d define as any company with less than $100 million in annual sales, that lacks a formal hierarchical management structure, and/or is owned by one person or just a few individuals).

We’ve written before about how it’s important for sales professionals to understand some key financial metrics so that they can talk about them intelligently, know how their offering improves their customer’s income statement, and make sure they present the right financial metrics to the CFO. However, a smaller company probably has a less formal and less hierarchical organizational structure. A detailed business case is still a critical component of the selling process, but be aware that the final decision maker may be the company’s founder or a group of family members rather than a CFO.

You also have to be careful about the implications your offering might represent to a small business versus a large business. For example, your solution might enable your prospect to reduce labor costs. However, if the business owner employs his brother-in-law, he may or may not be so interested in investing in a solution that would allow him to lay off a family member.

You still want to talk about how much it’s worth for the prospect to solve his or her business challenge. But you want to be sure you find out about the kind of trade-offs this person is prepared to make. In some cases, the small-business owner might want to allocate funds to buy his kid a new car rather than buying a system that might help his business. In this case, the decision is personal, so you’ll want to talk about the financial benefit in a way that takes those trade-offs into account. For example, you can talk about the payback period and show the owner the amount of time he would have to defer the car purchase if he invested in your solution now and how much he will be better off after the purchase. Another example is that the owner may be looking to make a sizable investment now to reduce his tax liability now in exchange for a longer-term benefit. You’ll have to conduct some discovery to find these trade-offs, but it will be well worth your effort.

This is what we mean when we say that value is specific to each individual customer. And, as we’ve said before, the way you talk about value fluctuates depending on where you are in the sales cycle. When a company lacks a structured management team, think about how you can narrow the scope of your conversation around value. When composing your business case, simplicity is probably better. For example, maybe you will get a better result if you focus less on a complex financial metric such Internal Rate of Return (IRR) and more on payback period, which is a concept that many people already understand.

The bottom line is that you need to realize that the conversation that tends to get traction with a larger customer might not be the same for a smaller business. Know your prospect’s needs, and tailor your business case accordingly.

Do you adjust your sales conversations based on the size of the company you’re selling to? What are the differences you notice? Share your thoughts in the comments section. 

Understanding Your Impact on a Customer’s Income Statement

We’ve said this many times: before you can deliver value, you must first demonstrate to the customer that you understand their business challenges.

Knowing the fundamentals of an income statement can really help you in this regard. Unless you understand its components (maybe not fully, but at least to some extent), your conversations with customers are probably still centered on marketing-speak and you haven’t yet gotten to the level of talking about a true value proposition.

An income statement is simply a financial statement showing how much money the company made during a certain period of time (usually a month, quarter, or year) and what the company’s revenue and costs were. Here is the basic flow of an income statement (sometimes called the P&L):

Sales Revenue

Subtract Cost of Goods Sold (CoGS), which would include things like:

 

  •             Materials
  •             Labor
  •             Other Direct Costs

 

Cost of Goods Sold subtracted from sales revenue tells you your Gross Margin.

Now subtract all of the following expenses (collectively known as SG&A)

 

  • Sales
  • Marketing
  • Research, Development & Engineering (RD&E)
  • General expenses
  • Administrative expenses

 

Once these items are subtracted, you’ll end up with net profit.

If the company is public, an income statement will be published in its quarterly and annual reports (this is by law). The top line of the income statement is how much the company made in sales (revenue). The bottom line is the company’s earnings (profit). For simplicity, we are going to ignore the corporate level concerns like income tax, interest, and other corporate expenses.

Let’s take a closer look at some of these terms.

Cost of goods sold (CoGS). This is simply the direct costs incurred by the company to produce and/or deliver whatever they’ve sold. This amount typically includes the cost of materials and direct labor costs. If your product can lower your customer’s raw material costs or production labor costs, you can impact the CoGS.

Gross margin. Gross margin, also sometimes called gross profit, is simply the company’s sales revenue minus its cost of goods sold. Often the gross margin is expressed as a percentage and calculated as: (sales revenue – CoGS) / sales revenue * 100.

If your offering helps your customers increase sales revenue, the increase in gross margin is how you would quantify the bottom-line impact of increased sales (since your customers gross margin dollars would increase as sales increased). The calculation you should use is simple: increase in sales revenue * (1 – CoGS %) = gross margin dollars.

SG&A. This stands for Sales, General, and Administrative. These are costs the company incurs as part of doing business and is otherwise known as “overhead.” Things like telecommunications charges, IT, office rent, and consulting services (for example, legal representation) would go into SG&A. These costs are independent of any goods you’ve sold, because you pay overhead no matter how many units you sell (or don’t sell). If your solution lowers data center cooling costs, then you are impacting your customers’ SG&A costs.

Net income.

If a company’s leaders want to improve profitability, they have three basic options.

Increase Revenue

1)    Increase the volume of what they sell.

2)    Increase the price of what they sell.

3)    Create a new product to sell.

Decrease CoGS

1)    Reduce the cost to produce the product.

2)    Reduce the cost to deliver the product.

Decrease SG&A

1)    Reduce marketing cost.

2)    Reduce selling cost.

3)    Reduce R&D (or engineering cost).

4)    Reduce administrative cost.

5)    Reduce other overhead cost (including IT).

So, how does it help you to know what’s in a company’s income statement? For one thing, it helps to show the prospect that you understand where their company is financially. For another, it sets you up to talk about your offering in the context of whatever their financials look like. If your offering cannot impact the prospect’s income statement in a positive way (aka, by helping them do one of the three things listed above), then you haven’t yet figured out how you can deliver value to this customer. If that’s the case, you need to figure out how you can impact their financials or move on to another prospect.

How do you leverage financial statements when talking with customers? Share your thoughts in the comments section. 

The ROI of Winning an Oscar

OscarOne of the coolest things (in our opinion) about ROI is that you can calculate it on almost anything.

In the B2B world we obviously use ROI calculations to show our prospects and customers what they’ll gain by investing in our solution or offering. Recently – and just in time for the Oscars – we came across an interesting post from Forbes showcasing a list of actors that deliver the best return on investment for movie studios. Although it’s common to see lists made of actors that command the highest salaries, it’s slightly more unusual to see someone thinking from the perspective of ROI. Here’s the methodology they used:

Taking a star’s pay on a film, and the movie’s estimated budget, box-office receipts and DVD sales, we calculated a return on investment number, and then averaged the numbers for their last three films to get an overall return.

By this reckoning, Forbes placed Jennifer Lawrence third on the list, noting that she yields a return of $68.60 for every $1 she was paid. They also note that actors that accept smaller paychecks actually increase their ROI. (This is why Emma Stone ranked #1 on the list.)

You might assume that an Oscar winner would command a higher salary, but this separate Forbes post indicates that the equation isn’t so straightforward. In fact, winning an Oscar is not a good indication of higher salary earnings.

This is another good example of how there’s more to value than just price tags and budgets. Value is always in the eye of the beholder. To some, going home with a gold statue holds infinitely more value than a multimillion-dollar paycheck. As Forbes notes, actors who put a premium on winning an Oscar sometimes agree to lower paychecks for the chance to work on films that offer lower budgets but higher artistic credibility. To them, the trade-off in salary is more than worth it.

The same principles apply in the business world. Just because a solution is more expensive than anything else on the market does not guarantee that the customer will see a higher ROI. In fact, a higher price makes it more difficult to show a higher ROI. Conversely, the cheapest solution is not necessarily the best value. As we pointed out in a recent post about differentiating from your competition, value is relative not to what you paid for the solution but to what the next-best alternative is. Value encompasses price, plus the cost to deploy and maintain your offering, costs in other areas, and the impact on the customer’s revenue. All of those elements need to be taken into consideration when calculating ROI.

We’ve not yet been asked to assemble a value calculator for a Hollywood studio, but I’m sure it would be fun to try.

What do your customers value? What are some of the trade-offs they make in the name of value? Share your thoughts in the comments section. 

The Value Lifecycle: Justifying the Cost of Your Offering

This is Part V of a five-part series about the lifecycle of value in B2B selling and marketing.

You’ve set your price, shown the customer the cost of his problem, and proven you’re a better option than your competitors. Congratulations, you’ve now made it to Phase 4 of the Value Lifecycle.

This is the point at which you perform a rock solid analysis that convinces your prospect to invest in your offering. If done right, Phase 4 the Value Lifecycle is a lot of fun, because success at this stage means you’ve closed the deal.

The decision maker at Phase 4 is usually someone from the financial team (often the Chief Financial Officer) who will want to see a business case before they free up company funds and allocate them to your project. The challenge here is to create a comparison of results between what your offering can do and what the prospect’s current business state is (aka, what they’re currently doing to solve their problem, which may be nothing).

This is where an ROI tool can be an invaluable asset to you. One of our best examples to illustrate this is a story about a special kind of packaging material developed by one of our clients. The initial trouble with the new packaging material was price — it was 5-10 times more expensive than the existing material customers were using (and customers were already pretty happy with the results they were getting with the existing material). Without a business case to show how the new material was a wise investment, the client’s sales reps were left to sell on price alone. Understandably, they were getting laughed out of the offices of purchasing managers around the world.

We worked with the client and walked them through the four phases of the Value Lifecycle. We also performed a full ROI analysis to compare total costs of the new material versus the existing material and made some very interesting discoveries. For one thing, we discovered that the new packaging material would allow the client’s customer to fit two to three times more of its product into each package. For another, we found that it would use far less energy, produce less waste, and be less labor intensive. In fact, in almost every aspect of the comparison, the new packaging material almost always yielded a lower total cost of packaging than the current material.

We built an ROI tool to clearly illustrate that value and turned it over to our client to use on their sales calls. In the end, our client went from getting laughed out of meetings to becoming the standard provider of packaging material for eight of the top 10 companies in their industry in just a few years. The ROI tool was the game changer that helped them convince their customers that there was greater value to be had from the new packaging material, even with a significantly higher purchase price than that of the existing packaging material.

Again, a cost-justified business case is key to convince a financially minded approver that an investment in your solution is in their economic best interest. That’s why it’s so important to understand how CFOs think. According to IDC research, an IT investment of one million dollars is typically associated with a decision cycle that lasts for 18 months. When a customer is able to measure the business impact of the investment, however, research shows that 65% of such purchases occur in 6 months or less.

So if a CFO has a million dollars to invest, you want to make sure you’re able to make a convincing case for why it’s worthwhile to spend the money with you as opposed to funding other areas of the business or simply putting off a decision indefinitely. If you can show them the money, your sales team should have very little problem closing the deal.

Interested in learning more about ROI tools? See an example here

The Value Lifecycle: Differentiating from Your Competition

This is Part IV of a five-part series about the life-cycle of value in B2B selling and marketing. This post explores Phase 3: Differentiating from your competition.

So far we’ve learned two important points about the value life-cycle.

1) In Phase 1, the maximum price you can charge for your product/solution is the value you create minus the value of the next best alternative, plus the price of the next best alternative.

2) In Phase 2, your job is to show not only how much the customer’s problems are costing them (both in terms of actual cost but also lost revenue), but also how much your solution can help them overcome that cost.

After you’ve established your price and gotten the prospect concerned about their business challenges, it’s time to turn your attention to Phase 3: differentiating against your competition. Obviously, this issue tends to be a popular topic with sellers and marketers. Everyone wants to win. However, the reality is that not every product or solution has the right level of value to be a worthwhile investment for prospects. (The good news is that a thorough analysis can uncover those gaps and you can then work on a way to create more value.)

In this phase of the Value Lifecycle, you are showing that the total value your solution creates is higher than the total value created by the next-best alternative (aka, a competitor). This is often referred to as TCO, or Total Cost of Ownership. A formal TCO analysis is a very effective and airtight way to show your value versus the competition’s value, and it takes into account the features and benefits of your solution. Unfortunately, features, functions, and benefits are where the conversation starts and ends for a lot of sales and marketing professionals.

Features and benefits are all well and good, but they don’t tell the whole story (and sometimes they actually tell a false story, as you’ll see below). When you’re in a competitive situation, you’re not just talking about the things you do well, or that you’re priced 10 percent lower than the competition, or that you have bells and whistles that your competitor lacks. You want to engage the customer in a discussion about the relative value you create compared to a competitive offering. Your net value needs to be higher than that of the competition, and it needs to include more than your price and/or the cost required to deploy and maintain your solution. It must reflect an analysis of the total value you create, which would include price, cost to deploy and maintain, reduced costs in other areas, and even increases in revenue..

This chart illustrates the point.

Alternatives

 

 

 

 

 

 

 

Let’s say you create $20,000 of net value and your competitor (Alternative 1) is creating $25,000. That probably doesn’t make you very happy. But as we pointed out in Phase 1, value is always specific to each customer. In other words, if your offering comes up short, you can try to adjust to suit this particular prospect. If you lower your price so that you create $30,000 in net value, for example, then you create more value and can convince the prospect to buy from you versus Alternative 1. If you didn’t want to lower your price, you could add to the Total Benefit category instead — going from $80,000 to $100,000 would help you create $40,000 in net value. Another option would be to lower deployment and maintenance so that costs fall below $20,000.

No matter what you do, remember that a good TCO analysis always takes into account all possible factors: price, benefits, and cost. As you can see from this example, if you stopped evaluating purchasing options at benefits, then Alternative 2 would look like the clear winner (when, in fact, it provides the least value to the prospect).

There are only two things you can’t do. One is to remain ignorant of the total value you create. If you’re in sales or marketing, it’s simply part of your job to know your total value, and also to know how that value compares to a competitor’s value. The second thing you can’t do is tweak your messaging to try to get around the fact that your competitor creates more value than you. If that’s the case, you’re essentially lying to customers and adding to the perception that marketers and sellers are just trying to make a sale at any cost. Your job is never to convince customers to buy independent of the truth.

Next week we’ll dive into the final phase of the Value Lifecycle: justifying the cost of your investment.

The Value Lifecycle: Generating Demand for Your Solution

This is Part III of a five-part series about the life cycle of value in B2B selling and marketing. This post examines Phase 2 of the Value Lifecycle: Demand Generation.

Last week we talked about value as it relates to pricing. In Phase 2 of the Value Lifecycle, our understanding of value shifts slightly.

Value phase II

Your aim in Phase 2 is to establish the total cost of the prospect’s current business problem (or problems). That cost could be represented by money the customer is currently spending needlessly, and/or revenue the customer is currently missing out on. As we often explain to our clients, shining a flashlight on the size of a prospect’s problem sets you up to illustrate to the prospect how much value your solution can create for them.

Let’s look at a simple example. Say your prospective customer has a process in place for posting new job openings. This process is paper-based and requires three people to manage it. The labor cost to employ those three people is the size of the problem. Now let’s say your company has a solution that’s electronically based and only requires one person to manage the process. Not only would the customer save the labor cost of two employees, they’d also save on spending money to buy ink and paper. That’s the value created by your solution.

These kinds of cost savings scenarios can exist almost anywhere for customers. Your solution might reduce rent, labor costs, IT support costs, etc. Or your solution might, for example, impact revenue by increasing the number of sales leads or improving an online store’s uptime. No matter the specifics, the general question is, “How much is not implementing our offering/solution costing you?” and/or, “How much revenue are you losing because you lack our offering/solution?”

A key metric in Phase 2 is cost-to-delay per month. That’s the total value of the problem over the period of time (and, again, could be represented by potential revenue lost, unnecessary costs, or both). A month is usually a nice time frame, but you could also quantify the problem in weeks or years. Essentially, this calculation allows you to tell the customer, “Every month you don’t solve this problem, it’s costing you X amount.” Again, this is a way to create a sense of urgency around solving the problem.

Note that Phase 2 analysis doesn’t take into account what your competitors are offering and how you compare to their solution. In the demand generation phase, you’re mostly concerned with what the customer is currently doing today. Why? The way you measure value changes based on where you are in the Value Lifecycle. In Phase 2, you’re not concerned with proving how you’re unique and different – that comes at a later stage. Your primary concern at this stage is to get the prospect excited about solving their current problem.

In Phase 3 you can start to explore the question, “Why should the customer buy from us,” (instead of either doing nothing or buying from your competitor). We’ll explore that concept in next week’s post.

What’s your biggest challenge in quantifying your prospect’s problems? Share your thoughts in the comments section.