SPEAKER_00 0:16

Okay, last week we spoke about underlying demand and having a business that has very weak underlying demand, and that can be obviously a weakness in the business model, the industry, or the product. Today we want to talk about margins and your reach channel. So, you know, whether you're able to attract enough customers. Because I reckon there's a lot of businesses out there that are really struggling and they tend to struggle from both things low margins and also not enough customers. And they're the sorts of businesses where sort of people are just making ends meet. They might be paying themselves kind of a living salary, but not much more than that. And quite often it's how the business model is designed, not how much effort the person's putting in. I mean, it could be effort, of course, but typically it's not because people that go into business and start a business obviously put a lot of effort into it. They sort of see the business as an alter ego, as a representation of themselves. And that typically means that they do as much hard work as necessary to make the business successful. But if you've got a low margin business that really doesn't have enough customers and that's the result of a weakness in the business model, it doesn't matter how many hours a week you work, you're still not going to make very much money. Similarly, if you've got a low margin business and you go and scale it, normally by scaling a business, it's going to require an investment in people, machinery, or stock, maybe all three or at least one of those things. But either way, it's taking on a much larger financial commitment. And if you've got very thin margins, that's a risky thing to do. You know, if I go out and hire 50 people, of course I'm on the hook for that wage bill every fortnight. And if I've got a low margin business, only a couple things need to go wrong, and all of a sudden I'm not making any money. So low margins and not enough customers, probably the most common weakness in most small businesses. But we can't take this personally because sometimes, you know, when we don't achieve the results that we're desiring or aiming to achieve, we do take it personally. We think we haven't worked hard enough, we don't have the right skill, we don't know business. But again, you put the best business person in the world in a business that has a very weak business model. There's nothing they can do about it. So we believe the starting point is to interrogate the business model. And that's what we want to talk about today. We want to talk about margins, pricing power, and how you can navigate those challenges and then also reach. So how do you get more customers finding you and how do you find more customers? So let's start there, Mina. Let's talk about margin and how we or if we can control our margin. Thanks, Stuart.

SPEAKER_01 2:54

And I think margin probably starts with pricing and understanding what pricing actually looks like for your business. So I'll break it down into really two factors, whether you're a price maker or a price taker. And a price maker is one that can really raise prices without losing customers. So a good example of this and one that we often sort of reference is Apple. Now they've generated the brand, they've generated a lot of recognition in their brand, whether they're with their ecosystem, their product, and so forth. And regardless of what they set the tone of in price, most customers will actually still pay it. So whatever the their next iPhone comes out in September or whenever it is, there'll still be a big cohort of people that would still pay it, regardless of their income status. Whereas if you're a price taker, you generally can't. It's you're basically competing in the ecosystem that you're subjected to and you're and you can't raise prices without losing customers. So a good example of this is probably supermarkets. Now, supermarkets, they all just compete on price. They rely on volume, they can't raise prices without actually losing a customer to probably a competitive brand. Similarly, if we apply it to a service-based business, such as a mortgage brokering business, for example, it's the bank commissions that really set the tone of what your pricing is. No broker can really charge more than the other broker. It's whatever the aggregator really provides in terms of their net commissions for that loan product. So no matter what you do, you can't change the price on that. Whereas Apple, for example, their gross margins on iPhones are 40 to 60%, well and truly above their competitors like Samsung or Google because they've engineered genuine pricing power. They've got their brand recognition, they've got their ecosystem. So they are the ones that are regarded as price makers. Now there's really three layers that shape margin. So I'll I'll break these down so we can sort of go through these individually and understand what really makes your pricing power. And the first one is your industry, your industry economics. What sets the baseline in your industry? So think about things like competitive intensity. How many customers do you actually have wanting your product or your service? If there's a switch involved in it, so think of, for example, telcos. What are those switching costs? What are the downtimes for them? What's the regulations around switching or providing your product or service? So back to the mortgage brokering example here, it's really the again the banks that really set the tone here. No matter what you do, you're not going to really change your price. Now the second layer is the business model. So this is what determines how value really becomes cash. So again, coming back to the Apple example, they've got a certain product design, a certain ecosystem, a certain model that allows you that you're once you're invested in that ecosystem, you just want to invest more and more. Whether you've got the iPhone or the MacBook or the iPad, all speaks to each other and it's all easy to resonate, and people really identify with the product. And they've got a great business model that basically sells itself. It's really just a status symbol as well. So they've done this really well, and this is what sort of leads into the third layer, which is operational excellence. Now, operational excellence really refers to your cycle time, how productive you are, how long it takes you to deliver that certain product or service and what the rework looks like. Now, this is regardless whether you're a price maker or price taker. So if I use the mortgage brokering example again, whether you're got great value or not, or whether your engine is right is really comes down to how well you're delivering that service. So for example, if I'm writing a loan and it only takes me two hours to write, then I'm creating great value. I'm creating great margins and I'm delivering a great service. Whereas if that loan is taking me 20 or 40 hours a week, then I don't really have any operational excellence. It's costing me a lot of money, it's there's probably a lot of rework. My cost per hour is actually quite high. So it's really important to understand the underlying engine of your business so that you can really drive margin. Similarly, if you're a price maker again to Apple example, now their investor relationship team is actually only two people for a $4 trillion business. Now that's huge. That's great economies of scale there. Any other business at that kind of level will have an abundant amount of people thrown at a business like that. So they've obviously achieved a whole lot of operational excellence in that regard. Now, healthy margins are all well and good, but if you don't have the appropriate reach or customers going to your business, then that's a problem.

SPEAKER_00 7:06

That's exactly right, Mina. And, you know, quite often people think marketing is a bit of an afterthought. So I designed my business model and you know, once I've done that, I'll then think about okay, well, where am I going to find customers? But actually, that is not the right approach. Really, marketing or your reach strategy is part of every part of your business strategy and your business model. So, really, your reach strategy is defined as your ability to reliably connect with your right target customers that are willing and motivated to buy your product or service at the price that you want to sell them with as little friction as possible. So that's the definition we're working with. That's how we sort of define reach strategy. It can be inbound reach, which means customers find you and seek you out, or it can be outbound reach, which means that you go and find people that look like your target customer and interrupt their day and educate them that you exist. So the definition though deliberately includes things like product design, hiring operations, not just promotion, not just taking out an ad in a newspaper or running some Facebook ads online. It's really inbuilt to everything. So even if you think about a product like social media, the reach strategy is inbuilt into the product because if you're on a social media platform, Instagram, Facebook, whatever, it's no good if you're the only person on there that you know. But if all your friends are on there, it increases the enjoyment of being online. I don't know. I'm not really on social media, but certainly that's how that product works. So it's got shareability built into the product design. And so that's what we really want to understand is how do you build shareability and the desire to talk about your business, your product, your service into your business model. The other thing to think about with a reach strategy is the no like trust path. So that is that you need to, the the target customer needs to know you exist. They then need to like you as a business, so like your product, like your brand, like what you're doing, like how you present to the market, and then trust you in order to actually do business with you. And if you sort of split the REACH strategy up into kind of no like trust and think it about it that way, it certainly helps you kind of understand and put a coherent REACH strategy together. And in terms of trust, trust is a really interesting one, right? So trust isn't important to every single business, but where the trust is important typically depends on the price. So the more expensive your product or service is, the higher trust element is required. Perceived risk and then frequency of purchase. So if you think about, say, you know, Cartier Jewelry, for example, very high price, perceived risk. Well, if you buy the wrong thing for your partner, you know, it's not it's not going to work out very well for you. And frequency, it's not something you buy every day. So trust is a big element. And a brand like Cartier and those sort of luxury brands have invested a lot of money into building trust with their community or their target customer. A coffee shop, however, is on the other side of the coin. So price is relatively low, take away coffee. Perceived risk. Well, if I buy a shit coffee, I can bin it, I don't have to drink it. And frequency is something I do all the time. So with a coffee shop, it can use a different REACH strategy than, say, a financial services business. So if I'm selling financial advice, for example, price is high, perceived risk is very high because if I choose the wrong advice or wrong planner, it's not going to work out for me. And frequency, hopefully, I make one choice in my lifetime, find the best financial advisor for me and stick with them for the long run. So in that situation, the no like trust path for a financial advisory business compared to a coffee shop, extremely different. So therefore, we need to relate that to our reach strategy. So for example, if I'm a financial advisory business and I'm running Facebook ads, and those Facebook ads and that Facebook ad strategy doesn't build into the path to like the business and then to spend a lot of time to build trust, it's not going to work, right? Because it's going to generate leads perhaps, but though those leads will just waste a lot of time. The conversion rate will be low. And as a result, the customer acquisition cost will end up being high because I've got to kiss a lot of frogs before I can find, you know, a perfect target customer for me. But a Facebook ad campaign for a coffee shop, probably more likely to work because of the no like trust path. So that's kind of only one element or one example of how a REACH strategy is inbuilt into the business model. And as you can kind of see, as I said at the start, sometimes when we have low margins and not enough customers, we think we need to work harder, but actually it's a business model issue. But understanding the economics around a REACH strategy is really important. So, Mina, maybe you can talk a little bit about customer acquisition costs relative to lifetime customer value.

SPEAKER_01 12:04

So I think it's important to probably sort of explain what an expensive reach is or what an expensive customer acquisition cost is. And this is really where the lifetime value of your customer is really high and where the growth really consumes more than what you're producing. So, for example, if you think about back to Stuart's examples around the coffee shop, now you might actually spend a lot of money on your social media ads and so forth. But truth be told, at the end of the day, coffee shop is a coffee shop, it's quite transactional, and you could lose a customer very quickly for just a bad cup of coffee. So you really have no lifetime value from that customer in that regard. Whereas in a professional services business, such as a financial planning industry, monthly recurring revenue, so you can afford to have a high customer acquisition cost. And it's typical of the industry, right? Because at the end of the day, you need to establish that trust. And sometimes it requires, I know I speak firsthand in our business, we put a lot of information out there. We might have a few meetings as well before that customer is actually converted. So there's a lifetime cycle of about could be about 12 to 24 months before that customer is actually won over. So there's a high customer acquisition cost, but there's also a high, very high retention rate. So that lifetime value is actually quite high. So how you measure this is understanding what customer acquisition cost is. And this really is your direct marketing expense plus any other direct cost to convert that client or that product. So that could be anything such as the staff time spent to actually convert that customer over or any other sort of regulatory costs. So think about the example around the financial planning industry. If we use the Facebook ads as an example, we might have 20 meetings before we find one client that's suitable for the business. It's a high customer acquisition cost as a result. But how we measure the lifetime value of that customer is the net present value of that future profit of that of that customer or that client. Now, as I said before, it's a high acquisition cost, but we've got a lot of recurring revenue as a result. So once that customer is converted, that lifetime value is quite high. So that's really how you measure customer acquisition cost and lifetime value. But from our perspective, I believe that the best reach strategies are actually owned, not borrowed. Isn't that right, Stuart?

SPEAKER_00 14:13

Yeah, that's exactly right, Mina. And you know, a borrowed reach strategy means that you're borrowing from the audience or the trust that someone has with an audience. So for example, if I'm paying for Facebook ads, that's a borrowed reach channel because I've actually, it costs me, I've got to pay Facebook to be able to obviously serve ads. If I'm advertising in, say, a newspaper, probably not really a good modern example, but if I'm adding advertising a newspaper that has credibility with it, you know, that similar really large, well-known trusted business also advertise in, then I'm paying for that reach strategy and paying for that associated trust, if you like. So really the owned reach strategies are really the ones that are least fragile because they're lower cost. Once you own them, of course, you need to invest in them, but once you own them, you don't need to keep paying for advertising and things like sponsorship and these sorts of things with a borrowed reach strategy. So an inbound owned strategy are things like website, blog, podcast. Remember, inbound is your target customer finding you. So they'll find you by going to your website, blog, podcast. It could be a membership thing. And to a lesser extent, because these aren't perfectly owned, but it could be YouTube, writing articles for the media, media appearances. Again, you don't own that channel, but if you build credibility and, you know, a good source of commentary, for example, the media will keep coming back to you. Speaking engagement. So they're all sort of inbound reach strategy, outbound reach strategies like email newsletters, direct marketing, whether that's by email, SMS, post, whatever it might be, your sales team making outbound contact to known sort of prospects or existing clients. So they're examples of owned reach strategies. But what we what I really want to talk about is the weakness of borrowed reach strategies. And this can, you know, result in quite a fragile strategy because what I want is I don't want a large proportion of my customers coming from one borrowed reach strategy. So you can see sometimes online you see these businesses advertising or espousing the benefits of I keep talking about Facebook marketing, but it's such a perfect example because it's so measurable and a lot of businesses use it. But if I'm getting most of my customers, 80% of my customers from doing Facebook ads, that's a very fragile reach strategy. Because firstly, I want most of my customers coming from owned reach channels. And then if I am going to use borrowed reach channels, which is fine and certainly something that new businesses tend to need to do, you don't want to be uh relying on just one of those borrowed reach channels. Because as you can imagine, if your advertising cost goes up 50%, bang, all of a sudden you're not making any margin. Well, I mean, it depends what your margin is, but it's almost certainly going to wipe your margin out and because it increases the customer acquisition costs. But if the lifetime value of a customer doesn't change, then you're at a loss. And obviously, what you want to do is you want the greatest gap between customer acquisition costs and lifetime value so that you can keep most of the profit that is resulting from serving that customer. So if we're faced with a business that isn't isn't attracting enough customers, isn't finding enough new prospective customers, it's not about finding a new reach channel. It's really about the design of the business model is to make sure that you're building in reach into the design of the business model. It's about making sure that you're investing most of your time and energy in owned inbound and outbound reach channels. And then if you are going to use borrowed reach channels, it's about making sure you understand the numbers around customer acquisition cost and lifetime customer value so that you're growing profitably. And ultimately over the long run, hopefully what it means is that more and more and more of your customers are coming via owned reach channels because the owned reach channels compound. So if we talk about, for example, a podcast, if I start a podcast and it starts to become a little bit more successful, because I've got a back catalog of previous episodes, people listen to that back catalog. It just means that I get more and more listens every week and every month, and that makes the podcast even more popular. And it tip then, if it's attracting the right audience, makes the inbound reach strategy more and more popular. So by owning your reach channels, they typically get better and better and more valuable and more valuable the longer that you invest in them. Whereas with borrowed reach channels, you're always gonna have to pay for them, right? You never own Facebook, you're always gonna have to pay and probably pay more and more. So you're always gonna deal with that margin pressure. So, really, the central point today is that margins and an empty pipeline of customers typically isn't a personal failing. It's not because you haven't put enough effort in. It's almost more often a design problem. It's a business model design problem. So when your results disappoint you, the first question to ask yourself is this a structural choice or is it an industry setting? Is it the pricing model? Is it the reach channel mix before you start interrogating effort or willpower or how well you've executed on those strategies? If you're feeling like you're dealing with really thin margins, you're gonna need to interrogate whether you're a price maker, price taker. If you're a price maker, whether you're invested enough in creating more value and creating some pricing power. If you're a price taker, then it's gonna depend, as Mina said, it's about your execution, your business engine, and delivering your product with a consistent quality at a low cost so that you get to keep more of the revenue that you're generating. If it's a pipeline issue, you don't have enough customers, then you need to really interrogate the business model to make sure that your reach strategy is inherently reflected in all parts of your business. And then it's about really understanding the reach channels that you're using, making sure that you're investing in owned reach channels, and if you're using borrowed reach channels, that the numbers make sense, that you're doing it in a profitable and sustainable way. And this is what we're trying to do progressively in this podcast is give you a framework for navigating these challenges that most businesses have to deal with. And whether you're dealing with them today or whether you'll deal with them in the future, you know, industries and customer preferences and products and all these sorts, the landscape is constantly changing. So it's something that we have to keep asking ourselves and interrogating on. Next week, we're going to introduce the Vert flywheel methodology, which really talks about the components, the four pillars of the Vert flywheel, which is obviously value engine, reach and team. And as you can see, what we're going to do over the coming weeks and months is we're going to give you some practical ways to implement and improve, you know, your overall business model so that it compounds and the positive impacts that you make in your reach strategy, for example, and reach channels positively impact your value, your engine, and the team members that run behind the business. We just wanted to spend these last few weeks as kind of setting up to sort of then introduce the vert flywheel. So until next week, bye for now.