(0:00) When you understand value in the value formula, you will drive better financial and operational performance, and you'll enjoy, guess what, higher profits and cash flow. Welcome to Business Strategy, where we are documenting the best strategies and valuable lessons learned to build more profitable and iconic companies. Please share and enjoy.

(0:21) Let me guess, if you're a business owner, you want to drive more value in your organization. Here's the problem, most people can't even define what value is. If you can't define it, how are you going to drive it higher? I'm going to walk you through what exactly value is, and the drivers you can pursue in order to get more of it in your organization.

(0:39) My name is Steve Coughran, I'm the founder of Coltivar. I've spent the last 15 years of my life turning around and growing organizations by focusing on strategy and finance and connecting them together to increase firm value. That's what we're going to be talking about today, so if you're interested, buckle up and let's jump in to point number one.

(0:58) When it comes to value, the most simple definition comes from Warren Buffett, where he says, value can be defined as the present value of all the future cash flows a company is expected to generate over its useful life. So it's the present value, it's the value in today's dollars, which requires some discounting. So if you're a nerd, you could discount it, just like me, I'm a nerd.

(1:20) You build financial models and you could bring it back to the present value. But without all that, without complicating it, you just want to think about it in this terms. It's all the cash this machine, called a business or an asset, is going to generate over its remaining useful life.

(1:36) All right, so the key term here is cash flow. It's not about profit, it's not about revenue, because look, some companies can generate profits, but then those profits may have to be reinvested back into the property, plant, and equipment required to run the business, or that profit is trapped in working capital. The difference between current assets and current liabilities.

(1:59) And therefore, profit doesn't mean much. In fact, 70% of companies that go bankrupt are profitable when they close their doors. So it's all about cash, baby. That's the key. It's all about cash flow. Now, there's three ways to get more cash flow in a business.

(2:15) That's it, just three ways. Very simple, and I'm going to start from a high level. Number one is to get price premiums. You may think, that's easy. So Steve, I just need to raise my price. That's not true, because remember, when price exceeds value, if this is price and here's value, customers aren't going to buy, because the price outstrips the value.

(2:36) When value exceeds price, customers buy. So how do you increase the value of your offering? Number one, you can enhance the customer experience. Number two, you can increase the perceived quality. Number three, you could create customer lock-in. And there are other micro strategies that you can pursue to make your product or service more valuable to your customers.

(3:00) All right, but the key is to drive greater value. Now, here's the problem that I see with organizations. Driving greater value is much more difficult than lowering the price. So a lot of organizations, their price is up here, their value's down here, they're not selling their products or services, so they discount, right? They just lower their price and then they start selling again.

(3:20) That's a terrible strategy, especially for the long term. So I don't recommend that. But that's approach number one, is to get price premiums. And in fact, that's the number one driver. That's the best driver to pull, typically, in organizations.

(3:35) All right, number two, the second way to drive value in an organization is to improve cost and capital efficiencies. So this comes through economies of scale, by innovating the operating model, by adopting technology, by eliminating waste through lean practices, et cetera. There are a variety of strategies you could pursue, once again, to improve your cost and capital efficiencies.

(4:01) Now, I will say, on an income statement, there's revenue, there's cost of goods sold. Those are typically made up of your variable cost, like materials, labor, contractors, equipment, maintenance, et cetera. All the costs associated with fulfilling your revenue are in cost of goods sold, the second section. And then you have operating expenses.

(4:20) I'll tell you, the best levers you could pull are in cost of goods sold, typically. Reducing overhead, the operating expenses, will have some impact on the bottom line. But if you can improve your variable cost, it'll make all the difference in the world.

(4:35) When I'm working with organizations, one of the most important metrics I look at is the lifetime gross profit of a customer compared to their customer acquisition cost. The cost that is incurred to pick up a new client. And this ratio is really important to optimize because if your lifetime gross profit of a customer is $2, but it costs you $1 to get them, that's a really terrible model.

(5:00) It's a very expensive model to acquire customers. But if you could change that from your lifetime gross profit from $2, you can increase it to $10, or you can lower your customer acquisition cost to like 10 cents, then that ratio becomes bigger. And once you figure that out, you can pour the gasoline on your business, which leads into point number three, which is growth.

(5:21) Now, growth is really good for a company if it's strategic, right? It's really easy to grow actually, but you can grow yourself out of business. You can grow so fast that your working capital just traps all your money and you run out of cash, or you grow, grow and grow and your system fall apart and your margin slip and cashflow ultimately falls behind as well.

(5:40) So you have to be very strategic with your growth. And that's why I introduced that LTGP to CAC ratio as a precursor to this point. That's probably the number one metric you can measure in your business when it comes to sales efficiency and your ability to scale the organization.

(6:00) So those are the three drivers to focus on, price premiums, improved costs and capital efficiencies, or grow strategically. Now, when it comes to your strategy, because I'm a big strategy person, and I'm gonna connect this back to strategy, finance and strategy, I'm gonna put it together. Here it comes. When you're looking at your initiatives, all right, the initiatives in your business, and those initiatives should help you to do one of four things or all four things, okay? But at least one of these four.

(6:25) Number one, your initiatives should help you to overcome your strategic problem. Number two, they should help you to enhance the customer experience. Number three, they should help you to foster innovation. And number four, they should help you to build competitive advantages. But at the end of the day, if your initiatives aren't driving higher firm value, maybe your initiatives are off track.

(6:47) So your initiatives should result in one of these three things that we talked about today with value creation. The initiative should do those four things, which should then give you an output of either price premiums, cost and capital efficiencies, or strategic growth. If not, if they're not resulting in one of those three things, or if you can't clearly tie an initiative back to those three things, then maybe it's the wrong initiative. The same thing is true with your action steps.

(7:16) So we use a framework at Coltivar called IARs, Initiatives, Actions, Results. And if those actions, those are your hypotheses of how you're gonna push your initiative forward. If your actions don't impact one of those value drivers, then maybe those actions aren't worth pursuing as well.

(7:32) So when you understand a value and the value formula, then you can get super focused on what really matters in your organization. And when you do this over and over again, you will drive better financial and operational performance, and you'll enjoy, guess what? Higher profits and cashflow. All right, that's all I have for you.

(7:49) If you need help with any of this, you can always connect with us at Coltivar.com. All right, if you found value in this, please be sure to share. And until next time, take care of yourself. Cheers.