Revenue drives business. An initial response is to say—more is better. But on reflection, you know that isn’t true. Revenue must be profitable to be desirable. And profitability means more than gross margin. Understanding profitability takes a coordinated organizational effort involving marketing, sales, finance, operations, and logistics. Coordination requires revenue and cost information that is causal, reflects operations and economic reality, and is agreed upon across the organization. It also requires an understanding of the basic principles of revenue management which is a topic that surprisingly is missing from both accounting and marketing educational curriculum. A recent Statement on Management Accounting (SMA) by the Institute of Management Accountants titled Revenue Management Fundamentals outlines the core principles.
A few key concepts include: understanding your customer segments, knowing what characteristics customer groups value about your products, and designing your products to efficiently and profitably respond to those demands. Consider the accompanying graphic to this article—it illustrates the benefits of responding to customer segments with variations in products or associated services.
4 Levers of Revenue
Revenue management has four levers that help you understand and manage the operational response to customer variability.
Lever 1—Pricing Basis: This lever is obvious. You need to determine how much customers will pay for the differentiation desired so that you can decide if it is profitable for you to produce or offer it. Alternatively, can you remove some capabilities or services, reduce price, and gain more less demanding customers profitably? It is important to remember pricing is set by the market and customer value; your cost determines if you should be in the that line of business.
Lever 2—Inventory Allocation: This refers to both physical inventory available and the inventory of productive capability. Are you collecting the demand information about your customers and customer segments to adapt your inventory of products, associated services, and productive capability to the most advantageous and profitable components of demand? Rush orders, late orders, the size of orders, the seasonality of orders, and many other characteristics are attributes of the product or the associated services that can be managed with a price response and/or a customer desirability determination. Do you have enough information about customer profitability and control over your selling and production to ensure your inventory and productive capacity is going to your most profitable customers? Can you use slow periods to bring in less profitable customers?
Lever 3—Product Configuration: This lever involves both physical product configuration and non-physical elements such as terms and conditions or customer education/consulting. Have you identified the key physical and non-physical attributes that your customer segments value? What is your ability to profitably adapt a product, its features, and its associated services to customer demands? Are you meeting the demands of the customers that have the potential to improve profitability because they are willing to pay for more profitable features and service?
Lever 4—Duration Control: This lever involves collecting the information and using operating and process changes to predict or shape customer behavior to enable improvements in profitability. Normally, the goal is to make customers more predictable and optimize your time and effort to meet their demands. Duration control can involve internal process changes or changes that involve customer communication or interaction. Examples may include incentives to order more regularly, when to focus sales force efforts, improvements in order picking/packing/shipping, improvements in customer order acceptance procedures, etc.
Too often organizations focus on increasing sales revenue or reducing product cost. This concentration of effort leaves a great deal of the customer experience unexplored. Revenue management focuses on the profitability of existing and new sales by understanding what segments customers value, are willing to pay for, and how the organization can adapt itself and customer behavior to meet those needs profitably.