Travails of returns - Part 16

Continuing the series on starting business in India. So far, (covered) a range of topics (one a week for the 16th week now) that I thought defined our early journey.

Now onto a topic that I discovered in my early B-school days, which I have seen translate at work. It’s the concept of matching and building value. The concept of matching described that each cost element on the P&L corresponds to a revenue one. And the concept of building value is that higher the proportion of revenue built out from the corresponding cost element, more the value. And the indicator of these are return ratios. 6 return ratios that are important, not exactly mutually exclusive, but a good thought starter.

1. Gross Margin (i.e., return on COGS) – Building a higher gross margin is great but tough. Higher gross margin means you are adding a lot of value to the product or adding some value that nobody can. Every business has a gross margin character, which is tough to change drastically over the years. In our experience, we have seen that a higher gross margin in the early years has a lot of costs below it.
2. Return on Sales and Marketing – Ones that a lot of us rely on, especially early. It gets built over time when brand (or “pull”) takes over pure “push” strategies (like discounting, availability). It’s also tough to measure. And is inevitably low at the beginning. Not one that you can rely on to build early on.
3. Yield – This is true for financing companies, take debt at a borrowing rate and lend it at a higher lending rate. Given that money is a commodity, higher yield means one is fundamentally taking more risk. Thus, seldom are big businesses built on high yields; they are built with less risk and more frugality. (This could also be for general companies, wherein they are giving out sales on credit but not being paid enough for both the capital deployed and the risk involved – bane of many new age companies).
4. Return on the tech $ – At the very minimum, tech gives you access and convenience, which most of the world pays for. Indian customers will too, one day. But the day is not there yet. Thus, the tech $s are a necessary and great investment for the future, not the metric for measuring business today. Tech $s spent in building systems for business controls are a great investment, though, but tough to discern on a P&L.
5. Return on overheads – True for many professional firms: accounting, legal, investment banking. In those cases, the more you travel, the more you meet and get visibility. Similar to Return on Sales and Marketing in characteristics.
6. Return on Human Capital – Building with human values and culture. Everyone can take an industry expert and a “Been there, Done that” and build a business but its far more valuable when you can build a business out of the lesser knowing i.e., young talent or not-so-skilled talent. At @OfBusiness and @Oxyzo, our focus has always been on this return metric. We found it the easiest to tilt in our early years.

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