Most organisations only focus on one type of cost. If you ignore the other two, you do so at your peril.
It was the final lecture of our Strategic Marketing class and our professor looked at myself and the other final year commerce students, paused, took a deep breath, and with great emphasis told us there is really only one thing we needed to remember for success in our business careers.
With baited breath a hall of expectant students waited for the greatest insight we might receive throughout our university careers.
He simply turned to the whiteboard and wrote P = R – C (Profit = Revenue less Cost)
Turning to his students our professor smiled and said that whilst any business gets complicated, it always breaks down to this simple equation.
Whilst revenue is always more important than cost (See 3 Simple Rules from HBR), cost shouldn’t be ignored.
Unfortunately, what most organisations do is only focus on one type of cost at the peril of ignoring two other very important costs.
There are three broad types of costs that lead to three very different types of losses that every leader in any organisation needs to consider:
1. Financial Cost
Financial cost can lead to profit loss.
There is no deep explanation required here. It costs organisations ‘something’ to produce ‘something’. Understanding financial costs is business management 101. This is what my university professor was pointing out. Keep the main thing the main thing, know how to make a surplus/profit. The only way you know how to make profit is if you truly understand the two inputs.
What happens if you don’t manage your financial costs? An unmanaged financial cost can lead to a profit loss. Manage your costs well and you’re halfway to managing your profit well.
2. Opportunity Cost
Opportunity cost can lead to revenue loss.
Any good economist will always point out that doing ‘one thing’ is at the expense of a potential ‘something else’ – opportunity cost.
When we choose to take on this client or produce this type of product, for example, we do so at the expense of another client or another product. An opportunity that may have been is an opportunity cost.
What happens if you don’t assess opportunities well? Opportunity cost. Whilst opportunity cost doesn’t always lead to a profit loss (although it can), opportunity cost leads to a revenue loss.
Part of maximising revenue is managing opportunity cost.
3. Emotional Cost
Emotional cost can lead to culture loss.
There is always an emotional cost present in projects. A good project tends to return that cost positively with team engagement, higher morale, increased skill and experience, and an overall improvement in culture. A bad project can often turn that emotional cost into a culture loss represented in lost confidence, dysfunctional teams, bitterness, poor customer relationships or frustrated teams.
Not every bad project has to result in a culture loss. This is perhaps the only loss that can be turned around within the organisation without customer or client involvement. How leaders respond, review, reaffirm and regroup post poor projects is a pivotal factor in building emotional value within your organisation.
Emotional cost can lead to culture loss – but it doesn’t have to. It can, if managed well, lead to a culture gain.
As leaders, managing our ‘costs’ is not just about managing our dollars. As I get a little older and wiser and realise building profits is really not as simple as ‘2 less 1’, I’ve begun to realise understanding true costs was what my university professor was actually trying to tell us.
Are you managing your ‘costs’? Are you looking to turn costs into gain?
If you would like assistance in translating growth across your brand, business model and culture, talk to myself our our team. Contact me here.