Suntec City Convention Centre, Ballroom 3
Friday, 28 March 2008
The current business environment is one of:-
- $107 per barrel of oil,
- strengthening SGD,
- tightening labour market, (In Mar 2008’s edition of CFO Asia, cost and availability of labour are top 2 concerns of CFOs in Asia.)
- escalating rental rate,
- increasing prices of raw materials …
Against this background, the focus of my presentation today is to ask ourselves as to how we can use these cost pressures to positively “excite” the way a business operates and ultimately its bottomline.
Some businesses do have the uncanny ability to transfer the increase in costs to their customers. These are companies who can price their product at a base selling price plus a fuel surcharge while demand for their products remains unchanged.
Utilities companies too are able to review their selling prices on a quarterly basis to its customers in the form of thousands of households.
At the other end of the spectrum, there are businesses who are holding on their prices for their dear life while absorbing the blows of increasing costs.
By some good fortune, there maybe some businesses out there who may say they currently not experiencing any such cost pressures. While life is good and dandy for these businesses, they should not rest on their laurels.
Can we “excite” the business from its comfort zone by injecting some sort of cost pressures into the system without costing it an arm and a leg?
Well the answer may lie in reviewing your business’s depreciation policies.
Here we look at how to achieve this awareness when analyzing depreciation, which can represent a big portion of the expenses found on a company’s income statement.
While there are rules governing how depreciation is expensed, there is still plenty of room for management to make creative accounting decisions that can create the necessary pressures to stimulate the business. It pays to examine depreciation closely.
What Is Depreciation?
Depreciation is the process by which a company allocates an asset’s cost over the duration of its useful life.
Each time a company prepares its financial statements, it records a depreciation expense to allocate a portion of the cost of the buildings, machines or equipment it has purchased to the current fiscal year.
For intangible assets – such as brands and intellectual property – this process of allocating costs over time is called amortization.
Assumptions Critical assumptions about expensing depreciation are left to the company’s management.
Management makes the call on the following things:-
- Method and rate of depreciation
- Useful life of the asset
- Scrap value of the asset
Traditional Application of Depreciation
In the traditional mode of thinking, we take the sales turnover figure as given.
By adjusting the various components of the depreciation methods, our bottomline would be affected immediately ie. depreciation, being an expense would reduce our profit.
So to show higher profit, we can apply a longer useful life or switch from reducing balance method to straight line method of depreciation.
Now consider this…
What if we tighten the depreciation policy instead ie…
By reducing the useful life of certain key non-current assets or by changing the depreciation method from a straight line to reducing balance method, we immediately put pressure on the bottomline by increasing the depreciation expense in the early years.
The higher non-cash expense and consequently total costs would translate to a higher breakeven level.
The higher breakeven level is not meant to be kept top secret. We should instead translate these cost information into headline KPIs for all to see. Staff from all levels of a business must be aware of the KPIs.
Harness that awareness!!
Create a suitable environment to harness that awareness heightened by the injection of the additional cost pressures. Can the heightened awareness encourage ideas to freeflow?
Management must rally its troops to use the cost pressures positively to think of ways of improving the topline. Topline is a function of price and quantity sold.
Think of how we can sharpen our business model to sell more units? Or how to get our customers to pay more for our products?
If a business had priced its exports in SGD while the SGD continues to strengthen, it has to give its customers continuous good reasons to do business with us.
The process of creating these “continuous good reasons” for customers to keep coming back and buy from us is to innovate to differentiate.
The “good reasons” must be dug up from:-
- production processes,
- product design,
- customer service,
- staff training and retention,
- management of call centres,
- accounts dept,
- support services, etc etc etc.
- No stone should be left unturned.
Some examples of innovation that I observed recently.
Eg. 1 – moving to higher yield products by removing economy class seats and replacing them with business class seats. Revenue per flight would consequently increase. Brilliant!
Eg. 2 – In a product I drink quite often, the manufacturer raise the price after adding some vitamins. The “non-vitamised” product was removed from retail. Customers are again left with no choice but to buy the higher price product.
Eg. 3 – In the banking business, a simple switch from a 365-day year to a 360-day year in interest computation would translate to millions more to the bottomline.
Were these ideas the fruits of the cost pressures?
For it to be sustainable for a long time, the cost pressures must induce a PARADIGM shift all together to adapt to the extreme environment.
If the business is currently experiencing cost pressures, use it to create, to innovate.
If the business is currently immune from current cost upheavals, perhaps you may “adopt” some cost increase by reviewing your depreciation policy.
Translate the higher breakeven into KPIs for all to see.
KPIs heightened awareness.
Harness the awareness.
We then await the fruits of our effort.
I shall conclude my paper today by quoting Mr John Kao, the Chinese-American innovation evangelist, who was in Singapore recently.
He said, “innovation enables people to adapt to the waves of disruptive change”.
Whether the business is facing the disruptive waves now or otherwise, innovation to differentiate can and must be institutionalised within an organisation, compelled or otherwise.
On that note, I wish you all a good day. I thank you.