Council Post: Financial Decision-Making Frameworks For Growth And Efficiency

Abhinav Swarup is Vice President of Finance at Zeus Living and has worked as a finance leader at Patreon, PayPal, Netflix, Amazon and PwC.

Need For Decision-Making Frameworks

In a world with limited human and capital resources but several paths for business growth and product development, it becomes important for a CFO to evaluate business initiatives and their impact from the correct perspective. As finance professionals, we often learn and hear about frameworks such as net present value (NPV), return on investment (ROI) and the customer lifetime value to customer acquisition cost ratio (LTV to CAC). In this article, I wanted to introduce a couple of other less-used frameworks that I have found very helpful in my career to inform decisions from a growth and efficiency perspective.

Differences In Frameworks For Growth Versus Efficiency

Business decisions are often driven keeping in mind the circumstances a company faces. In times of growth, companies pursue revenue more than profit. In times of austerity, the focus is on efficiency and maximizing margins. Although one can argue that maximizing profitability should always be a goal, the timing to pursue profitability may not always align with growth imperatives.

In this context, I have found it helpful to use downstream impact and unit economics frameworks to evaluate business initiatives for pure revenue growth and for driving efficiency, respectively.

Downstream Impact

One key goal for a company is to drive customer engagement with its products and/or services as much as possible. For companies that have multiple products, one way to drive engagement is to have customers keep on trying new products in order to deepen the relationship of the company with the customer. Using one company to buy multiple products often makes it more cost-effective for the customers and easier in terms of handling logistics. More engagement also drives stickiness in customer behavior and makes it harder for the competitors to make the customers switch over to their offerings.

This brings us to downstream impact analysis. When a company is thinking of launching a new product or a service, one way to evaluate the plan is to try to quantify how the launch will help customers engage more with the company and try out products or services they have not previously tried.

If a product launch helps drive customer conversion to other parts of the business, the net incremental impact of the launch will be much higher than just the revenue earned by that single product since it will include revenue from sales that otherwise would not happen. Quantifying this impact can be tricky. It requires some assumptions on adoption rates potentially based on data from prior launches of similar products and comparing the performance of customer cohorts who tried the new product versus those who did not.

This type of analysis can help identify initiatives that—on a stand-alone basis—may not look very attractive, but coupled with incremental revenue streams from other parts of the business, might make for a good business case.

Unit Economics

I have found unit economics to be the most effective framework to drive efficiency in a complex business. Companies differ in operational complexities, but usually, businesses having field employees, warehouses, fulfillment networks, etc. tend to be better suited for a unit economics framework.

In order to build the unit economics framework, it is helpful if one can segment the business into different business activities such as the actual selling of a good to a customer, providing repairs and maintenance to customers, delivering items to the customer’s house, managing inbound and outbound flows of goods from warehouses, etc. Once the appropriate segmentation has been done, one can calculate the expense for each of these business activities for every unit of product sold. In addition, if the company is charging to provide a particular service, then the corresponding revenue per unit should also be recorded.

This side-by-side comparison of revenue and cost gives a very good idea of the profit-driven or the loss incurred per unit of product sold for every business activity. Once you get an understanding of cash in and cash out for each activity, you can focus on areas where you can drive incremental revenue or cut costs. It is also a good idea to appoint one person as the responsible individual for each activity so that individuals can own driving revenue and cost improvement for the teams they manage.

Ideally, the unit economics analysis should be updated every month to track the impact of ongoing initiatives and to identify any early trends that otherwise may not be captured. Unit economics framework can also be used to drive company planning and building goals for each business unit around revenue per unit or cost per unit their activities should drive.

Conclusion

In the end, there is no hard rule for picking one framework over the other. A CFO should evaluate the circumstances holistically and pick one over the other. Finally, irrespective of the framework picked, we should always remember that in the end, it is the people who drive business initiatives. So, it becomes crucial to pick the correct person for these initiatives and then give them the resources to be successful.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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