This can lead to real Business Model Problems
I am rarely on Facebook but on one of those rare occasions, I happen to come across a post by a gentleman, who claims to be an expert in our business. I did not agree with the key contents of the post (not because it is open to interpretation) but mathematically it was injurious to the business models of most distributors and advisors.
Before coming to the point, I must make a few disclosures: First, I did not comment on his post as he had mentioned “If you agree to this approach, do comment below – Will Measure MVT” as this indicated to me, he was not expecting some feedback there. Second, he reads my blog regularly, so this was the best way to put across the feedback not only to him but to others as well. Third, I mean no disrespect here, just honest, and candid feedback as the concept of Cost per hour that was put forth along with some indicative numbers can cause serious problems in your business or practice model. Fourth. Just like him, I have the best interests of all of you at heart.
The post mentioned “In training, we do for financial advisors around Business Numbers, when I ask people to share their rough hourly costs, people generally don’t have it. Cost per hour can simply be calculated dividing your personal take home per annum by number of working hours per annum.”
I agree that most people do not have their rough hourly costs. However, the definition in bold is simply wrong. Do you think that your net take home is the only cost in the business? Let us say if your take home is Rs. 20 Lakh and you divide it by 2000 annual average working hours. Then this comes to Rs.1000 per hour. What about taxes? What about your office rent, team salaries, technology, operations, compliance, accounting, audit, and every other expense? By the way even toilet paper costs money. Once you factor in all the costs, you will realize that your cost per hour is simply not your net take home divided by the number of hours.
To calculate your cost per hour, make sure you put in all your expenses and then divide it by 2000 (typical annual hours). Also, it is important to understand that your cost per hour or someone who is acquiring clients (her cost per hour) is different than someone who has no client facing role. You can do this exercise for each of your team members and then make it as complex as possible. Do not yet waste your time on this exercise (just do it for the client acquisition team members with all expenses of the firm factored and apportioned accordingly). For example, if you have 2 members who are acquiring clients, and your annual expenses are 2 Crore, and 1 team member is responsible for generating 1.2 Crore of Revenue and another 0.8 Crore. Then, team member 1 Cost per Hour = 1.2 Crore / 2000 Hours = Rs. 6000.
Another key concept that you must understand is the difference between cost, price and value. Most people who do not understand the nuances of this business or know the science of pricing fail to differentiate among Cost, Price and Value. They are 3 different things.
If you just think Cost per Hour and price accordingly means that your business or practice is generating no profit. This also means there is no business model or practice model. There is only an income model (a job where you are the boss and everything else). This also means that there is no business value (equity value) that you have created. Thus, Price per Hour needs to be different than Cost Per Hour and needs to reflect your business profit that allows you to invest further in your business and grow. Not thinking about this will COST you dearly.
Now that you see the difference between Price and Cost (which I am sure most of you knew), the next key aspect is about Pricing. Many after figuring costs think of a Cost-Plus Pricing Model – a pricing model where you figure the costs first and then add firm profits to the Cost to arrive at the Price Per Hour (Accountants are very well trained to think of such models). However, a Cost-Plus Pricing Model is not the model for world class professional firms, and this is where Value based Pricing comes in. Pricing truly is a very deep subject, and the rest of the post will not be sufficient to cover such a critical topic. One of things you must understand is that the business models of distributors and advisors (in their current avatar) are quite different. Most make a mistake of thinking it is just about commissions and fees. I will address this point in another post but for now will move on to VALUE (The Variable after Price). The Value that you deliver should far exceed your price. Imagine this, do you ever argue (or have seen someone arguing) with a surgeon “You just put one needle, some stitches and you took 15 minutes. Why are you charging Rs.4 Lakh?” I do not think any of us do because we know the VALUE she is delivering.
So, what is the VALUE you are delivering and for whom are you delivering it? You are impacting financial lives just like a surgeon impacts life. You should then always start with VALUE and never ever have to justify your Price (the way a world class surgeon behaves). Not justifying price is a different topic and we will have a Nano post on this in the New Year.
For now, Remember this Equation
Your Value >>>>>>Your Price Per Hour >>>>>>Your Overall Cost Per Hour